# economics chapter 11

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### Assume the MPC is 0.80. The change in total spending for the economy due to a \$200 billion government spending increase is: A. \$160 billion. B. \$200 billion. C. \$800 billion. D. \$1,000 billion.

D
The value of the multiplier is equal to 1 divided by 1 minus the marginal propensity to consume. If the MPC is .8, the multiplier is 5. The amount that AD increases from fiscal stimulus is equal to the multiplier times the new spending injection or fiscal stimulus. So if the government increases spending by \$200 billion, the total change in spending will by \$1000 billion (5 × 200).

### To eliminate an AD shortfall of \$120 billion when the economy has an MPC of 0.75, the government should decrease taxes by: A. \$400 billion. B. \$120 billion. C. \$30 billion. D. \$40 billion.

D
The desired fiscal stimulus is equal to the AD shortfall divided by the multiplier. (\$120/4 = \$30) The general formula for computing the desired tax cut is the desired fiscal stimulus divided by the MPC. (\$30/.75 = \$40) Therefore the government should decrease taxes by \$40 billion.

### Assume the MPC is 0.75. To eliminate an AD shortfall of \$200 billion, the government should: A. Decrease spending by \$50 billion. B. Increase spending by \$50 billion. C. Increase taxes by \$66.7 billion. D. Increase spending by \$800 billion.

B.
The general formula for computing the desired stimulus (increase in government spending) is the AD shortfall divided by the multiplier, therefore \$200 billion divided by 4 (1/(1 - .75)) is equal to \$50 billion. A decrease in spending or an increase in taxes would cause the shortfall to increase.

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### Assume the MPC is 0.75, taxes increase by \$100 billion, and government spending increases by \$100 billion. Aggregate demand will: A. Increase by \$400 billion. B. Increase by \$100 billion. C. Decrease by \$400 billion. D. Not change.

B
The balanced budget multiplier is equal to 1. In this case, a \$100 billion increase in government expenditures combined with an equivalent increase in taxes increases aggregate demand by \$100 billion.

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### Assume the MPC is 0.75. To eliminate an AD shortfall of \$200 billion, the government should: A. Decrease spending by \$50 billion. B. Increase spending by \$50 billion. C. Increase taxes by \$66.7 billion. D. Increase spending by \$800 billion.

B.
The general formula for computing the desired stimulus (increase in government spending) is the AD shortfall divided by the multiplier, therefore \$200 billion divided by 4 (1/(1 - .75)) is equal to \$50 billion. A decrease in spending or an increase in taxes would cause the shortfall to increase.

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