MEcon Master of Economics Public Finance and Fiscal Policy 1 — Questions and Answers
Question 1: Automatic stabilizers in fiscal policy are government programs that:
- Require new legislation to activate
- Automatically increase spending or cut taxes during recessions without new legislation (Correct answer)
- Stabilize the money supply
- Prevent the budget deficit from changing over the cycle
Correct answer: Automatically increase spending or cut taxes during recessions without new legislation
Automatic stabilizers like unemployment insurance and progressive taxes automatically inject demand in downturns and withdraw it in booms without requiring discretionary action.
Question 2: The Ricardian Equivalence proposition suggests that deficit financing of government spending:
- Always stimulates aggregate demand
- Has no effect on aggregate demand because households save the tax cut to pay future taxes (Correct answer)
- Leads to higher interest rates always
- Reduces national savings permanently
Correct answer: Has no effect on aggregate demand because households save the tax cut to pay future taxes
Ricardo-Barro equivalence holds that rational households, anticipating future taxes to repay debt, save an equal amount when taxes are cut today, leaving aggregate demand unchanged.
Question 3: A progressive income tax system is one in which the marginal tax rate:
- Is the same for all income levels
- Rises as income rises (Correct answer)
- Falls as income rises
- Equals the average tax rate at all levels
Correct answer: Rises as income rises
Under a progressive system, additional income is taxed at successively higher marginal rates, causing the average tax rate to rise with income.
Question 4: The concept of 'fiscal multiplier' refers to the ratio of:
- Tax revenue change to spending change
- Change in GDP to the initial change in government expenditure (Correct answer)
- Change in interest rates to change in taxes
- Budget deficit to GDP
Correct answer: Change in GDP to the initial change in government expenditure
The fiscal multiplier measures how much total output changes relative to a given change in fiscal policy; a multiplier greater than one means stimulus has an amplified effect.
Question 5: A Pigouvian tax is designed to correct for:
- Income inequality
- Negative externalities by making the polluter internalize social costs (Correct answer)
- Budget deficits by raising revenue
- Monopoly power in regulated industries
Correct answer: Negative externalities by making the polluter internalize social costs
A Pigouvian tax equal to the marginal social damage of an externality shifts the private cost curve up to equal the social cost curve, restoring the efficient output level.
Question 6: Public goods are characterized by:
- Rivalry and excludability
- Non-rivalry and non-excludability (Correct answer)
- High marginal production costs
- Private provision through markets
Correct answer: Non-rivalry and non-excludability
A pure public good is non-rival (one person's consumption doesn't reduce availability) and non-excludable (you can't prevent anyone from benefiting), leading to market underprovision.
MEcon Master of Economics Public Finance and Fiscal Policy 1
Automatic stabilizers in fiscal policy are government programs that: