Week 14, Day 1 - Quiz 3 Solutions

Week 14, Day 1 - Quiz 3 Solutions - QUIZ #3 SOLUTIONS 1. e...

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QUIZ #3 SOLUTIONS 1. e The budget balance is a poor indicator of whether the government is implementing discretionary policy or not. A larger budget deficit can be the result of discretionary expansionary policy or the operation of the automatic stabilizer that leads to higher transfers and lower taxes. The cyclically adjusted budget balance is a better indicator of discretionary fiscal policy. 2. c Since the cyclically adjusted budget balance decreased, the government must be deliberately undertaking a discretionary expansionary fiscal policy (higher government purchases, higher transfers or lower taxes). If the budget surplus has increased, then at the same time, real GDP must be increasing. Therefore, the government is automatically collecting more in tax revenues and paying less in transfers. 3. c During a recession, the government's budget balance decreases (ie moves to a larger deficit) because tax revenues automatically decrease and transfers automatically increase. If the government is required to keep its budget balance in balance, then it must offset the effects of the automatic stabilizers on the budget balance. Specifically, it must implement discretionary contractionary policies that involve lower government purchases, lower transfers, and higher taxes. Balanced budget legislation requires that government implement discretionary policies that worsen the effects of a recession. 4. c The cyclically adjusted budget balance (CABB) is the budget balance that would exist if the economy was at its potential level of output. If the actual budget balance is less than the CABB, then the economy must be in a recessionary gap because the government is spending more on transfers and collecting less in revenues than it would if the economy was at its potential. If the actual budget balance is greater than the CABB, then the economy must be in an inflationary gap because the government is spending less on transfers and collecting more in revenues than it would if the economy was at its potential. 5. d If the government implemented discretionary expansionary fiscal policy (ie increased government purchases or transfers or decreased taxes), the cyclically adjusted budget balance (CABB) should have decreased. However, since the CABB did not change, something else must have happened. The CABB is not corrected for changes in the interest rate which affects the amount that the government spends on interest on its debt. Specifically, the government must have paid less interest on its debt and as a result, the effect of the discretionary expansionary fiscal policy is offset by lower government spending on interest on its debt. 6. c Money is a unit of account. Without money, an economy must use barter and the prices of products would need to be expressed in terms of other products. 7.
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Week 14, Day 1 - Quiz 3 Solutions - QUIZ #3 SOLUTIONS 1. e...

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