Fiscal Policy, Economic Growth, and Productivity: Review Questions for AP Economics

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By — McGraw-Hill Professional
Updated on Mar 4, 2011

The study guides for these review questions can be found at:


  1. Which of the following would NOT be an example of contractionary fiscal policy?
    1. Decreasing money spent on social programs.
    2. Increasing income taxes.
    3. Canceling the annual cost of living adjustments to the salaries of government employees.
    4. Increasing money spent to pay for government projects.
    5. Doing nothing with a temporary budget surplus.
  2. In a long period of economic expansion the tax revenue collected ___ and the amount spent on welfare programs ___ , creating a budget ___.
    1. increases, decreases, surplus
    2. increases, decreases, deficit
    3. decreases, decreases, surplus
    4. decreases, increases, deficit
    5. increases, increases, surplus
  3. The "crowding out" effect from government borrowing is best described as
    1. the rightward shift in AD in response to the decreasing interest rates from contractionary fiscal policy.
    2. the leftward shift in AD in response to the rising interest rates from expansionary fiscal policy.
    3. the effect of the President increasing the money supply, which decreases real interest rates, and increases AD.
    4. the effect on the economy of hearing the chairperson of the central bank say that he/she believes that the economy is in a recession.
    5. the lower exports due to an appreciating dollar versus other currencies.
  4. Which of the following fiscal policies is likely to be most effective when the economy is experiencing an inflationary gap?
    1. The government decreases taxes and keeps spending unchanged.
    2. The government increases spending and keeps taxes unchanged.
    3. The government increases spending matched with an increase in taxes.
    4. The government decreases spending and keeps taxes unchanged.
    5. The government increases taxes and decreases spending.
  5. Which of the following would likely slow a nation's economic growth?
    1. Guaranteed low-interest loans for college students.
    2. Removal of a tax on income earned on saving.
    3. Removal of the investment tax credit.
    4. More research grants given to medical schools.
    5. Conservation policies to manage the renewable harvest of timber.
  6. The U.S. economy currently suffers a recessionary gap. Which of the following choices best describes the appropriate fiscal policy, the impact on the market for loanable funds, the interest rate, and the market for the U.S. dollar?

Answers and Explanations

  1. D—This is expansionary policy and the others either contract the economy or do nothing.
  2. A—In an expansion, households should earn more income, which increases the taxes paid to the government. At the same time, people who needed welfare, or other government assistance, do not need it now because the unemployment level is low and wages are high. In this time of prosperity, the government should run a budget surplus.
  3. B—If the government borrows to expand the economy, interest rates rise, thus crowding out private investors. This shifts AD leftward, weakening the fiscal policy impact.
  4. E—Real GDP is at a level above full employment so AD must be shifted leftward. Choice D shifts AD to the left and lessens the inflationary gap, but choice E couples higher taxes with lower spending and therefore is the most effective remedy. All other choices increase AD and worsen the inflationary gap.
  5. C—An investment tax credit rewards firms that invest in physical assets. Removal of this tax credit slows investment, productivity and growth. All other policies would increase the productivity of resources or increase technological innovation.
  6. C—When facing a recessionary gap, the appropriate fiscal policy is to cut taxes and run a budget deficit. The borrowing necessary to pay for a budget deficit decreases the supply of loanable funds and increases the interest rate. Rising interest rates create a stronger demand for the U.S. dollar because U.S. Treasury bondholders are receiving more interest income. Knowing that the economy is in a recession allows you to quickly eliminate all tax increases.
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