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Test Bank Of Economics Principles Applications And Tools 8th Edition By Aruth OSullivan
SAMPLE QUESTIONS

Macroeconomics: Prin., Apps, & Tools, 8e (O’Sullivan) TB2

Chapter 3   Exchange and Markets

 

3.1   Comparative Advantage and Exchange

 

1) The ability of one person or nation to produce a good at a lower opportunity cost than another is called a(n):

  1. A) market advantage.
  2. B) comparative advantage.
  3. C) absolute advantage.
  4. D) specialization advantage.

Answer:  B

Diff: 2

Topic:  Specialization and the Gains from Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

2) The ability of one person or nation to produce a good at a lower resource cost than another is called a(n):

  1. A) market advantage.
  2. B) comparative advantage.
  3. C) absolute advantage.
  4. D) specialization advantage.

Answer:  C

Diff: 2

Topic:  Specialization and the Gains from Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

3) Suppose Bob can produce more jeans than Joe in a day. Bob has ________ advantage over Joe in sewing jeans.

  1. A) an absolute
  2. B) an absolute and a comparative
  3. C) a comparative
  4. D) neither an absolute nor a comparative

Answer:  A

Diff: 1

Topic:  Specialization and the Gains from Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

4) Suppose that in the time it takes for him to bake a cake, Bob can sew 5 pairs of jeans. In the time it takes for Joe to bake a cake, he can sew 8 pairs of jeans day. In this example, Bob has ________ advantage over Joe in cake baking.

  1. A) an absolute
  2. B) an absolute and a comparative
  3. C) a comparative
  4. D) neither an absolute nor a comparative

Answer:  C

Diff: 1

Topic:  Specialization and the Gains from Trade

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

5) Suppose that in the time it takes for him to bake a cake, Bob can sew 5 pairs of jeans. In the time it takes for Joe to bake a cake, he can sew 8 pairs of jeans day. In this example, who has the comparative advantage in baking a cake?

  1. A) Joe
  2. B) both Bob and Joe
  3. C) Bob
  4. D) neither Bob nor Joe

Answer:  C

Diff: 1

Topic:  Specialization and the Gains from Trade

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

6) Suppose that in the time it takes for him to bake a cake, Bob can produce sew 5 pairs of jeans. In the time it takes for Joe to bake a cake, he can produce sew 8 pairs of jeans day. In this example, who has the absolute advantage in baking a cake?

  1. A) Joe
  2. B) both Bob and Joe
  3. C) Bob
  4. D) There is insufficient information to answer this question.

Answer:  D

Diff: 1

Topic:  Specialization and the Gains from Trade

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

Table 3.1

 

7) Table 3.1 illustrates Willy and Blythe’s hourly production for apples and carrots. Based on the table, Blythe’s opportunity cost of 1 carrot is:

  1. A) 3 apples.
  2. B) 4 apples.
  3. C) 6 apples.
  4. D) 1.5 apples.

Answer:  A

Diff: 2

Topic:  Specialization and the Gains from Trade

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

8) Table 3.1 illustrates Willy and Blythe’s hourly production for apples and carrots. Based on the table, Blythe’s opportunity cost of 1 apple is:

  1. A) 1 carrot.
  2. B) 4 carrots.
  3. C) 6 carrots.
  4. D) 1/3 carrot.

Answer:  D

Diff: 2

Topic:  Specialization and the Gains from Trade

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

9) Table 3.1 illustrates Willy and Blythe’s hourly production for apples and carrots. Based on the table, Willy’s opportunity cost of 1 carrot is:

  1. A) 3 apples.
  2. B) 4 apples.
  3. C) 6 apples.
  4. D) 1.5 apples.

Answer:  D

Diff: 2

Topic:  Specialization and the Gains from Trade

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

10) Table 3.1 illustrates Willy and Blythe’s hourly production for apples and carrots. Based on the table, Willy’s opportunity cost of 1 apple is:

  1. A) 1 carrot.
  2. B) 2/3 carrot.
  3. C) 4 carrots.
  4. D) 6 carrots.

Answer:  B

Diff: 2

Topic:  Specialization and the Gains from Trade

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

11) Table 3.1 illustrates Willy and Blythe’s hourly production for apples and carrots. From the table, we can conclude that:

  1. A) Willy should specialize in carrots and trade for apples.
  2. B) Willy should specialize in apples and trade for carrots.
  3. C) Blithe should specialize in both goods.
  4. D) Willy should specialize in both goods.

Answer:  A

Diff: 2

Topic:  Specialization and the Gains from Trade

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

12) Table 3.1 illustrates Willy and Blythe’s hourly production for apples and carrots. From the table, we can conclude that:

  1. A) Blythe should specialize in carrots and trade for apples.
  2. B) Blythe should specialize in apples and trade for carrots.
  3. C) Blythe should specialize in both goods.
  4. D) Willy should specialize in both goods.

Answer:  B

Diff: 2

Topic:  Specialization and the Gains from Trade

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

13) Table 3.1 illustrates Willy and Blythe’s hourly production for apples and carrots. From the table, we can conclude that:if Willy and Blythe choose to specialize and trade, then:

  1. A) Willy will specialize in apples and trade apples for carrots.
  2. B) Willy will specialize in carrots and trade carrots for apples.
  3. C) Blythe will specialize in carrots and trade carrots for apples.
  4. D) None of the above; specialization and trade are not beneficial for Willy and Blythe.

Answer:  B

Diff: 2

Topic:  Specialization and the Gains from Trade

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

14) Table 3.1 illustrates Willy and Blythe’s hourly production for apples and carrots. From the table, we can conclude that:

  1. A) Willy has an absolute advantage in producing apples but not carrots.
  2. B) Willy has an absolute advantage in producing carrots but not apples.
  3. C) Willy has an absolute advantage in producing both goods.
  4. D) Willy does not have an absolute advantage in producing either good.

Answer:  C

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

15) Table 3.1 illustrates Willy and Blythe’s hourly production for apples and carrots. From the table, we can conclude that:

  1. A) Willy has a comparative advantage in producing apples but not carrots.
  2. B) Willy has a comparative advantage in producing carrots but not apples.
  3. C) Willy has a comparative advantage in producing both goods.
  4. D) Willy does not have a comparative advantage in producing either good.

Answer:  B

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

16) Table 3.1 illustrates Willy and Blythe’s hourly production for apples and carrots. From the table, we can conclude that:

  1. A) Willy has both an absolute and comparative advantage in apple production.
  2. B) Willy has both an absolute and comparative advantage in carrot production.
  3. C) Willy has neither an absolute nor comparative advantage in apple production.
  4. D) Willy has neither an absolute nor a comparative advantage in carrot production.

Answer:  B

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

17) Table 3.1 illustrates Willy and Blythe’s hourly production for apples and carrots. From the table, we can conclude that:

  1. A) Blythe has an absolute advantage in producing apples but not carrots.
  2. B) Blythe has an absolute advantage in producing carrots but not apples.
  3. C) Blythe has an absolute advantage in producing both goods.
  4. D) Blythe has an absolute advantage in producing neither good.

Answer:  D

Diff: 1

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

Table 3.2

 

18) Consider two individuals, Rose and Sharon, who produce fish and coconuts. Rose and Sharon’s hourly productivity are shown in Table 3.2. Rose’s opportunity cost of producing 1 coconut is:

  1. A) 1/3 fish.
  2. B) 1 1/2 fish.
  3. C) 3 fish.
  4. D) 6 fish.

Answer:  A

Diff: 1

Topic:  Comparative Advantage and Exchange

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

19) Consider two individuals, Rose and Sharon, who produce fish and coconuts. Rose and Sharon’s hourly productivity are shown in Table 3.2. Sharon’s opportunity cost of producing 1 coconut is:

  1. A) 3/4 fish.
  2. B) 1 1/3 fish.
  3. C) 3 fish.
  4. D) 4 fish.

Answer:  B

Diff: 1

Topic:  Comparative Advantage and Exchange

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

20) Consider two individuals, Rose and Sharon, who produce fish and coconuts. Rose and Sharon’s hourly productivity are shown in Table 3.2. Rose’s opportunity cost of producing 1 fish is:

  1. A) 1/3 coconut.
  2. B) 1 1/2 coconuts.
  3. C) 3 coconuts.
  4. D) 6 coconuts.

Answer:  C

Diff: 1

Topic:  Comparative Advantage and Exchange

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

21) Consider two individuals, Rose and Sharon, who produce fish and coconuts. Rose and Sharon’s hourly productivity are shown in Table 3.2. Which of the following is true?

  1. A) Rose has a comparative advantage in producing coconuts but not fish.
  2. B) Rose has a comparative advantage in producing fish but not coconuts.
  3. C) Rose has a comparative advantage in producing both goods.
  4. D) Rose does not have a comparative advantage in producing either good.

Answer:  A

Diff: 1

Topic:  Comparative Advantage and Exchange

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

22) Consider two individuals, Rose and Sharon, who produce fish and coconuts. Rose and Sharon’s hourly productivity are shown in Table 3.2. Sharon’s opportunity cost of producing 1 fish is:

  1. A) 3/4 coconut.
  2. B) 1 1/3 coconuts.
  3. C) 3 coconuts.
  4. D) 4 coconuts.

Answer:  A

Diff: 1

Topic:  Comparative Advantage and Exchange

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

23) Consider two individuals, Rose and Sharon, who produce fish and coconuts. Rose and Sharon’s hourly productivity are shown in Table 3.2. Which of the following is true?

  1. A) Rose has an absolute advantage in producing coconuts but not fish.
  2. B) Rose has an absolute advantage in producing fish but not coconuts.
  3. C) Rose has an absolute advantage in producing both goods.
  4. D) Rose does not have an absolute advantage in producing either good.

Answer:  A

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

24) Consider two individuals, Rose and Sharon, who produce fish and coconuts. Rose and Sharon’s hourly productivity are shown in Table 3.2. Which of the following is true?

  1. A) Rose has both an absolute and comparative advantage in coconut production.
  2. B) Rose has both an absolute and comparative advantage in fish production.
  3. C) Rose has neither an absolute nor comparative advantage in coconut production.
  4. D) Rose has neither an absolute nor a comparative advantage in fish production.

Answer:  A

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

25) Consider two individuals, Rose and Sharon, who produce fish and coconuts. Rose and Sharon’s hourly productivity are shown in Table 3.2. Which of the following is true?

  1. A) Sharon has an absolute advantage in producing coconuts but not fish.
  2. B) Sharon has an absolute advantage in producing fish but not coconuts.
  3. C) Sharon has an absolute advantage in producing both goods.
  4. D) Sharon does not have an absolute advantage in producing either good.

Answer:  B

Diff: 1

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

26) Producer A has a comparative advantage over Producer B if, in producing a good:

  1. A) A can produce more of the good than B can in a given time period.
  2. B) A has a lower opportunity cost of producing the good than does B.
  3. C) A has to trade off more than B does to produce the good.
  4. D) A has a higher opportunity cost of producing the good than does B.

Answer:  B

Diff: 2

Topic:  Comparative Advantage and Exchange

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

Table 3.3

 

27) Consider two individuals, Bob and Jerry, who produce guitars and banjos. Bob and Jerry’s weekly productivity are shown in Table 3.3. Which of the following is true?

  1. A) Bob has a comparative advantage in producing guitars but not banjos.
  2. B) Bob has a comparative advantage in producing banjos but not guitars.
  3. C) Bob has a comparative advantage in producing both goods.
  4. D) Bob does not have a comparative advantage in producing either good.

Answer:  D

Diff: 3

Topic:  Comparative Advantage and Exchange

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

28) Consider two individuals, Bob and Jerry, who produce guitars and banjos. Bob and Jerry’s weekly productivity are shown in Table 3.3. Which of the following is true?

  1. A) Bob has an absolute advantage in producing both goods, and a comparative advantage in producing guitars.
  2. B) Bob has an absolute advantage in producing both goods, and a comparative advantage in producing banjos.
  3. C) Bob has an absolute and a comparative advantage in producing both goods.
  4. D) Bob has an absolute advantage in producing both goods, but no one has a comparative advantage in producing either good.

Answer:  D

Diff: 3

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

29) The ability of one person or nation to produce a good at a lower absolute cost than another is called a(n):

  1. A) market advantage.
  2. B) comparative advantage.
  3. C) absolute advantage.
  4. D) specialization advantage.

Answer:  C

Diff: 1

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

30) An individual or country that has a comparative advantage in the production of one good:

  1. A) must have an absolute advantage in the good’s production.
  2. B) must not have an absolute advantage in the good’s production.
  3. C) may or may not have an absolute advantage in the good’s production.
  4. D) must not have an absolute advantage in the production of the other good.

Answer:  C

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

31) A rich nation will trade with a poor nation because the:

  1. A) rich nation has the absolute advantage in all products.
  2. B) poor nation has the absolute advantage in all products.
  3. C) poor nation has the comparative advantage in a product.
  4. D) rich nation has the comparative advantage in all products.

Answer:  C

Diff: 2

Topic:  Comparative Advantage and International Trade

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

32) For country A, an export is a good produced in:

  1. A) country B and purchased by residents of country B.
  2. B) country B and purchased by residents of country A.
  3. C) country A and purchased by residents of country B.
  4. D) country A and purchased by residents of country A.

Answer:  C

Diff: 1

Topic:  Comparative Advantage and International Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

33) For country A, an import is a good produced in:

  1. A) country B and purchased by residents of country B.
  2. B) country B and purchased by residents of country A.
  3. C) country A and purchased by residents of country B.
  4. D) country A and purchased by residents of country A.

Answer:  B

Diff: 1

Topic:  Comparative Advantage and International Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

34) A product produced in a foreign country and purchased by residents of the home country is:

  1. A) an export.
  2. B) an import.
  3. C) savings.
  4. D) investment.

Answer:  B

Diff: 1

Topic:  Comparative Advantage and International Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

35) A product produced in the home country and sold in another country is:

  1. A) an export.
  2. B) an import.
  3. C) savings.
  4. D) investment.

Answer:  A

Diff: 1

Topic:  Comparative Advantage and International Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

36) Suppose a car is completely produced and assembled in Germany and is sold to the United States. In this example, the country that imports the car is ________ while the country that exports the car is ________.

  1. A) the United States; Germany
  2. B) Germany; the United States
  3. C) Germany; Germany
  4. D) the United States; the United States

Answer:  A

Diff: 1

Topic:  Outsourcing

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

37) Suppose a car is completely produced and assembled in Germany and is sold to the United States. In this example, if the United States restricts the purchase of the car from Germany, then the country whose overall welfare would be reduced by this policy would be:

  1. A) the United States.
  2. B) Germany.
  3. C) neither Germany nor the United States.
  4. D) both Germany and the United States.

Answer:  D

Diff: 1

Topic:  Outsourcing

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

38) ________ occurs when a firm is shifting part of its production to another country.

  1. A) Outsourcing
  2. B) Importing
  3. C) Exporting
  4. D) All of the above are correct.

Answer:  A

Diff: 1

Topic:  Outsourcing

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

39) ________ is another term for “offshoring.”

  1. A) Outsourcing
  2. B) Importing
  3. C) Exporting
  4. D) Insourcing

Answer:  A

Diff: 1

Topic:  Outsourcing

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

40) The more times a worker performs a particular task, the more proficient the worker becomes at that task. This is called:

  1. A) continuity.
  2. B) innovation.
  3. C) specialization.
  4. D) repetition.

Answer:  D

Diff: 1

Topic:  The Division of Labor and Exchange

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

41) A specialized worker does not spend time switching from one task to another. This is called:

  1. A) continuity.
  2. B) innovation.
  3. C) functionality.
  4. D) repetition.

Answer:  A

Diff: 1

Topic:  The Division of Labor and Exchange

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

42) When a specialized worker gains insights into a particular task that leads to better production methods it is called:

  1. A) continuity.
  2. B) innovation.
  3. C) specialization.
  4. D) repetition.

Answer:  B

Diff: 1

Topic:  The Division of Labor and Exchange

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

Recall Application 1, “Absolute Advantage and Comparative Disadvantage in Latvia,” to answer the following questions:

 

43) According to the Application, which good does Latvia have absolute advantage on?

  1. A) timber
  2. B) grain
  3. C) milk
  4. D) none of the above

Answer:  D

Diff: 1

Topic:  Application 1, Absolute Disadvantage and Comparative Advantage in Latvia

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

44) According to the Application, which good does Latvia have comparative advantage on?

  1. A) timber
  2. B) grain
  3. C) milk
  4. D) livestock

Answer:  A

Diff: 1

Topic:  Application 1, Absolute Disadvantage and Comparative Advantage in Latvia

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

45) According to the Application, if Latvia has no absolute advantage relative to its neighboring European y countries, should it still trade with its neighbors?

  1. A) Yes, it should specialize in timber because it has comparative advantage in it.
  2. B) Yes, it should specialize in livestock because it has comparative advantage in it.
  3. C) Yes, it should specialize in grain because it has comparative advantage in it.
  4. D) No, it should not specialize in anything, and it should just trade with countries outside its neighboring European countries.

Answer:  A

Diff: 2

Topic:  Application 1, Absolute Disadvantage and Comparative Advantage in Latvia

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

46) According to the Application, Latvia would be better off if it does not trade with any of its neighboring European countries.

Answer:  FALSE

Diff: 1

Topic:  Application 1, Absolute Disadvantage and Comparative Advantage in Latvia

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

47) The principles of comparative advantage and specialization apply to trade between countries.

Answer:  TRUE

Diff: 1

Topic:  Comparative Advantage and International Trade

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

48) Specialization in production will increase total output.

Answer:  TRUE

Diff: 1

Topic:  Specialization and the Gains from Trade

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

49) Absolute advantage is when one producer has greater productivity compared to another producing the same product.

Answer:  TRUE

Diff: 1

Topic:  Specialization and the Gains from Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

50) A product produced in a foreign country and purchase by residents of the home country is an import.

Answer:  TRUE

Diff: 1

Topic:  Specialization and the Gains from Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

51) A product produced overseas and sold in another country is an export.

Answer:  FALSE

Diff: 1

Topic:  Specialization and the Gains from Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

52) A product produced in the home country and sold in another country is an export.

Answer:  TRUE

Diff: 1

Topic:  Specialization and the Gains from Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

53) If a person has an absolute advantage in some activity, she must have a comparative advantage in that activity as well.

Answer:  FALSE

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

54) If a person has a comparative advantage in some activity, she must have an absolute advantage in that activity as well.

Answer:  FALSE

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

55) A comparative advantage is the ability of one person or nation to produce a good at an opportunity cost that is lower than that of another person or nation.

Answer:  TRUE

Diff: 1

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

56) If Tom can produce 20 multiple choice questions or 30 true/false questions in an hour, and Mary can produce 15 multiple choice questions or 15 true/false questions in an hour, then Tom has a comparative advantage in writing true/false questions.

Answer:  TRUE

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

57) If Tom can produce 20 multiple choice questions or 30 true/false questions in an hour, and Mary can produce 15 multiple choice questions or 15 true/false questions in an hour, then Tom has a comparative advantage in writing multiple choice questions.

Answer:  FALSE

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

58) If Tom can produce 20 multiple choice questions or 30 true/false questions in an hour, and Mary can produce 15 multiple choice questions or 15 true/false questions in an hour, then Mary has a comparative advantage in writing true/false questions.

Answer:  FALSE

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

59) If Tom can produce 20 multiple choice questions or 30 true/false questions in an hour, and Mary can produce 15 multiple choice questions or 15 true/false questions in an hour, then Mary has a comparative advantage in writing multiple choice questions.

Answer:  TRUE

Diff: 2

Topic:  Specialization and the Gains from Trade

Skill:  Analytical

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

60) Consider two individuals, Willy and Blythe, who produce carrots and apples. Willy and Blythe’s hourly productivity are as follows:

 

 

Who has the absolute advantage or comparative advantage in the production of apples or carrots?

Answer:  Willy has the absolute advantage in producing both goods. But Willy only has comparative advantage in the production of carrots, not apples. Willy’s opportunity cost of an apple is 2/3 of a carrot; Blythe’s opportunity cost of an apple is only 1/3 of a carrot. Their opportunity costs of carrots are obviously just the reciprocals.

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

61) Consider two individuals, Phil and Oprah, who produce toy trucks and flowers. Phil and Oprah’s hourly productivity are as follows:

 

 

Who has the absolute advantage or comparative advantage in the production of flowers or trucks?

Answer:  Oprah has the absolute advantage in flowers and Phil has the absolute advantage in trucks. Oprah also has the comparative advantage in flowers while Phil has it in trucks.

Diff: 1

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

62) Imagine two countries, Bruceland and Davidia. Bruceland is producing everything at a lower absolute cost than Davidia. If the two countries trade what is the reason?

Answer:  Just because Bruceland has an absolute advantage in the production of all goods does not mean that it is not beneficial for the two countries to trade. Suppose there are only two goods. Bruceland may have a comparative advantage in only one of the two goods, while Davidia may have a comparative advantage in the other. So Bruceland could be made better off by specializing in the good in which it has the comparative advantage and trading with Davidia for the other good.

Diff: 1

Topic:  Comparative Advantage and International Trade

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

63) When a person producing a particular product has a lower opportunity cost than another person, that person is considered to have a ________ over the other.

Answer:  comparative advantage

Diff: 1

Topic:  Specialization and the Gains from Trade

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

64) What are the three reasons Adam Smith said led to increase productivity with specialization and division of labor?

Answer:  repetition, continuity and innovation

Diff: 2

Topic:  The Division of Labor and Exchange

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

65) What is the difference between comparative and absolute advantage.

Answer:  Comparative advantage is the ability to produce at a lower opportunity cost while absolute advantage is the ability to produce at a lower resource cost.

Diff: 2

Topic:  Comparative Advantage Versus Absolute Advantage

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

66) If two people both produce goods and each has a comparative advantage, and they exchange goods with each other for mutual benefit, it is called a ________.

Answer:  voluntary exchange

Diff: 1

Topic:  Specialization and the Gains from Trade

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

67) Can an individual with no absolute advantage find himself with a comparative in producing a good or a service?

Answer:  Yes. An individual with no absolute advantage can have a comparative advantage. In the example provided in the book, Kate had the comparative advantage in gathering coconuts even though Fred had the absolute advantage over Kate in both gathering coconuts and catching fish.

Diff: 2

Topic:  Specialization and the Gains from Trade

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

68) What is an import?

Answer:  a product produced in a foreign country and purchased by residents of the home country

Diff: 1

Topic:  Comparative Advantage and Exchange

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

69) What is an export?

Answer:  a product produced in the home country and sold in another country

Diff: 1

Topic:  Comparative Advantage and Exchange

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

3.2   Markets

 

1) In modern economies, individuals in markets make most of the decisions about:

  1. A) what to produce.
  2. B) how to produce.
  3. C) for whom to produce.
  4. D) all of the above.

Answer:  D

Diff: 1

Topic:  Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

2) Markets exist:

  1. A) as an arrangement that allows buyers and sellers to exchange things.
  2. B) because people are not self-sufficient.
  3. C) because people specialize in the production of one or two products.
  4. D) all of the above.

Answer:  D

Diff: 1

Topic:  Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

3) A centrally planned economy has a planning authority that decides:

  1. A) what products to produce.
  2. B) how the products are produced.
  3. C) who receives the products.
  4. D) all of the above.

Answer:  D

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

4) One of the most obvious clues to the relative scarcity of a product in a market economy is:

  1. A) the variations in available sizes.
  2. B) its current market price.
  3. C) the limited selection of colors.
  4. D) none of the above.

Answer:  B

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

5) The decrease in the scarcity of a product usually results in:

  1. A) an increased number of sizes.
  2. B) more colors being available.
  3. C) lower prices.
  4. D) more stores selling the product.

Answer:  C

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

6) A contract:

  1. A) specifies the term of exchange facilitating exchange between strangers.
  2. B) increases the profitability of inventions encouraging firms to develop new products.
  3. C) provides the public with reliable information about the performance of a firm.
  4. D) increases the risk faced by entrepreneurs.

Answer:  A

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

7) Patents:

  1. A) specifies the term of exchange facilitating exchange between strangers.
  2. B) increases the profitability of inventions encouraging firms to develop new products.
  3. C) provides the public with reliable information about the performance of a firm.
  4. D) increases the risk faced by entrepreneurs.

Answer:  B

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

8) Accounting rules:

  1. A) specifies the term of exchange facilitating exchange between strangers.
  2. B) increases the profitability of inventions encouraging firms to develop new products.
  3. C) provides the public with reliable information about the performance of a firm.
  4. D) increases the risk faced by entrepreneurs.

Answer:  C

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

9) Insurance:

  1. A) specifies the term of exchange facilitating exchange between strangers.
  2. B) reduces the risk of entrepreneurs.
  3. C) provides the public with reliable information about the performance of a firm.
  4. D) increases the risk faced by entrepreneurs.

Answer:  B

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

10) In a market system, prices:

  1. A) signal the relative scarcity of a product.
  2. B) are unfair.
  3. C) are too high.
  4. D) all of the above.

Answer:  A

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

11) In a market system profits:

  1. A) are unfair.
  2. B) are too high.
  3. C) signal to entrepreneur what to produce.
  4. D) all of the above.

Answer:  C

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

12) Adam Smith used the metaphor “invisible hand” to explain that:

  1. A) people acting in their own self interest may actually promote the interest of the society as a whole.
  2. B) people need a push from the government to do what the government thinks is right.
  3. C) people always act with the interest of society in the back of their minds.
  4. D) governments always act in the best interest of its citizenry.

Answer:  A

Diff: 1

Topic:  Virtues of Markets

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

13) Suppose a new use for aluminum has been discovered, making aluminum more expensive. In a market system:

  1. A) the aluminum roof producers may choose to look for other substitutes for aluminum.
  2. B) aluminum producers will choose to increase production of aluminum.
  3. C) auto manufacturers will find it in their best interest to use more aluminum.
  4. D) A and B are correct.

Answer:  D

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

14) Suppose a product suddenly becomes very popular and the firms producing the product begin to realize large profits. In response, entrepreneurs would:

  1. A) enter the market and increase production.
  2. B) enter the market and decrease production.
  3. C) exit the market and decrease production.
  4. D) exit the market and increase production.

Answer:  A

Diff: 1

Topic:  The Role of Entrepreneurs

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

15) Suppose a product suddenly loses popularity and the firms producing the product begin to realize large losses. In response, entrepreneurs would:

  1. A) enter the market and increase production.
  2. B) enter the market and decrease production.
  3. C) exit the market and decrease production.
  4. D) exit the market and increase production.

Answer:  C

Diff: 1

Topic:  The Role of Entrepreneurs

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

16) Suppose a product suddenly loses popularity and the firms producing the product begin to realize large losses. As firms exit the market, the equilibrium price in the market will:

  1. A) increase and make the remaining firms stay in business.
  2. B) decrease and make the remaining firms stay in business.
  3. C) decrease further and push more firms out of business.
  4. D) decrease further while making the remaining firms realize profits again.

Answer:  A

Diff: 1

Topic:  The Role of Entrepreneurs

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

17) During World War II before there was trade among camps, items not consumed by the majority of the camp (such as coffee in British camps and beef in Sikh camps) were:

  1. A) more expensive than in other camps.
  2. B) scarcer than in other camps.
  3. C) cheaper than in other camps.
  4. D) not provided to the prisoners.

Answer:  C

Diff: 2

Topic:  Example of the Emergence of Markets: POW Camps

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

Recall Application 2, “The Market for Meteorites,” to answer the following questions:

 

18) According to the Application, a chunk of space debris that enters our atmosphere is called a:

  1. A) meteor.
  2. B) meteorite.
  3. C) meteoroid.
  4. D) All of the above are correct.

Answer:  A

Diff: 2

Topic:  Application 2, The Market for Meteorites

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Explain how supply and demand function in competitive markets.

 

 

19) According to the Application, a chunk of space debris that enters our atmosphere and survives an impact into the earth is called a:

  1. A) meteor.
  2. B) meteorite.
  3. C) meteoroid.
  4. D) All of the above are correct.

Answer:  B

Diff: 2

Topic:  Application 2, The Market for Meteorites

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Explain how supply and demand function in competitive markets.

20) According to the Application, what determines the price of a meteorite?

  1. A) age
  2. B) rarity
  3. C) color
  4. D) similarity to earth rocks

Answer:  B

Diff: 2

Topic:  Application 2, The Market for Meteorites

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Explain how supply and demand function in competitive markets.

 

21) During World War II, trade among camps caused the price of beef in camps with mainly Sikh prisoners who did not eat beef to:

  1. A) fall dramatically compared to the price other camps.
  2. B) become roughly equal to the price in other camps.
  3. C) rise above the price in other camps.
  4. D) remain unchanged.

Answer:  B

Diff: 1

Topic:  Example of the Emergence of Markets: POW Camps

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

22) Under a market system, the people with information about buyers’ desires, production technology, and resources make the decisions.

Answer:  TRUE

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

23) Markets exist to facilitate exchange between people.

Answer:  TRUE

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

24) The market system works by getting each person, motivated by his or her own self-interest, to produce products for other people.

Answer:  TRUE

Diff: 1

Topic:  Virtues of Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

Recall Application 2, “The Market for Meteorites,” to answer the following questions:

 

25) According to the Application, all meteorites are rare and expensive.

Answer:  FALSE

Diff: 1

Topic:  Application 2, The Market for Meteorites

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

26) When people exchange things, trading what they have for what they want, it is called a ________ economy.

Answer:  market

Diff: 1

Topic:  Markets

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

 

27) Identify markets in which there is an exchange.

Answer:  financial capital, lending money for interest income, borrowing money and paying interest

Diff: 1

Topic:  Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

28) To specify terms of exchange and facilitate exchange between strangers, a ________ is often used.

Answer:  contract

Diff: 1

Topic:  Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

29) To make new commercial ventures more attractive for entrepreneurs, ________ can be used to reduce risk.

Answer:  insurance

Diff: 1

Topic:  Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

30) People who develop new products and production processes increase their profitability by taking out ________ on their inventions.

Answer:  patents

Diff: 1

Topic:  Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

31) In order to have reliable information about commercial enterprises and to encourage other people to invest their time and money ________ have been established to ensure universal understanding.

Answer:  accounting rules

Diff: 1

Topic:  Markets

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss different types of market systems and the gains that can be made from trade.

 

3.3   Market Failure and the Role of Government

 

1) When the market does not produce the most efficient outcomes, it is known as:

  1. A) market failure.
  2. B) corruption.
  3. C) fraud.
  4. D) capitalism.

Answer:  A

Diff: 1

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

2) A market failure could be caused by:

  1. A) competition.
  2. B) imperfect information.
  3. C) profit.
  4. D) capitalism.

Answer:  B

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

 

3) If the banking industry is unable to review a borrower’s credit history, then the market will experience a bank failure caused by:

  1. A) imperfect information.
  2. B) public goods.
  3. C) perfect information.
  4. D) imperfect competition.

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

4) A market failure could be caused by:

  1. A) firms not bearing the full costs of production.
  2. B) firms competing against each other for customers.
  3. C) profit.
  4. D) capitalism.

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

5) A market failure could be caused by:

  1. A) imperfect production.
  2. B) many firms competing against each other for customers.
  3. C) profit.
  4. D) imperfect competition.

Answer:  D

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

 

6) An example of a market failure due to a firm not fully bearing the costs of its production decision is:

  1. A) a levee.
  2. B) pollution.
  3. C) profit.
  4. D) imperfect information.

Answer:  B

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

7) When it comes to pollution, economists believe that the government must:

  1. A) allow firms to pollute as long as they bear the full cost of their pollution.
  2. B) never allow pollution to exist.
  3. C) allow firms to pollute as long as the benefits of pollution is positive.
  4. D) allow pollution to exist unabated.

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

8) The reason why the government taxes the gasoline used by pollution-causing automobiles is because it is trying to:

  1. A) make the drivers face the full cost of their driving decisions.
  2. B) make the government face the full cost of the driver’s driving decisions.
  3. C) make the oil companies face the full cost of the driver’s driving decisions.
  4. D) make the people who suffer from asthma face the full cost of the driver’s driving decisions.

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

 

9) Suppose that a vehicle is invented such that it emits no pollutants into the atmosphere. To achieve an efficient market outcome, the government must:

  1. A) allow other vehicles that emit pollutants into the atmosphere, as long as vehicle owners pay all the costs associated with their pollution.
  2. B) outlaw SUV and other vehicles that pollute the environment.
  3. C) be the sole producer of that vehicle.
  4. D) require all auto makers to produce the vehicles that produces zero emissions.

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

10) Which of the following best defines a public good?

  1. A) A public good is available for anyone to utilize, regardless on who pays and who doesn’t.
  2. B) A public good is a good that uses public funds to finance its production.
  3. C) A public good is a good that is sold to other people in the market.
  4. D) A public good is a good that requires government approval before it can be produced.

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

11) In a market economy, what is the role of the government with regards to public goods?

  1. A) The government has to facilitate the collective decision making in the production of public goods.
  2. B) The government must force the firms to produce all the public goods.
  3. C) The government must take over the production of all goods in the market, public or private.
  4. D) The government must hold a referendum before any public good is produced.

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

 

12) An example of a public good is:

  1. A) a levee.
  2. B) a monopoly.
  3. C) profit.
  4. D) imperfect information.

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

13) An example of a public good is:

  1. A) a levee.
  2. B) national defense.
  3. C) space exploration.
  4. D) All of the above are examples of public goods.

Answer:  D

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

14) An example of a public good is:

  1. A) national defense.
  2. B) Pay-Per-View broadcasts.
  3. C) an apple.
  4. D) a seat in a bus.

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

15) Which of the following is not a public good?

  1. A) national defense
  2. B) space exploration
  3. C) a hamburger
  4. D) levees

Answer:  C

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

16) Which of the following is an example of a market failure caused by the existence of a public good?

  1. A) A levee is not built because no one wants to pay for it, even though everyone agrees that it is important.
  2. B) We send a chimpanzee to space. You think it would be better if we send a lemur.
  3. C) We spend $300 billion for national defense. You think it is too much.
  4. D) McDonalds is your favorite restaurant. Other people think the food they serve is unappealing.

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

17) When there is imperfect competition, the role of the government is to:

  1. A) take over production.
  2. B) tell the firms how much to produce.
  3. C) foster competition.
  4. D) all of the above.

Answer:  C

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Ethical Reasoning

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

18) When the government filed a lawsuit against Microsoft in 1998 alleging that Microsoft illegally bundled Internet Explorer in its operating software, the government’s objective was to:

  1. A) foster competition.
  2. B) reduce uncertainty.
  3. C) combat pollution.
  4. D) reduce imperfect information.

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

19) Among the roles of the government in a market economy is to:

  1. A) enforce property rights.
  2. B) own the means of production.
  3. C) determine what is produced.
  4. D) all of the above

Answer:  A

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

20) The main reason why the government enforces contracts and maintains a legal system that punishes those who violate contracts is:

  1. A) to facilitate exchange.
  2. B) to decrease imperfect competition.
  3. C) to decrease imperfect information.
  4. D) to increase uncertainty.

Answer:  A

Diff: 2

Topic:  The Government Enforces the Rules of Exchange

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

21) Why does the government’s role of enforcing contracts facilitate exchange?

  1. A) Enforcing contracts allows people to trade with confidence that the contracts they enter will be met.
  2. B) Enforcing contracts guarantees consumers that the government will bail them out in case the seller does not fulfill his end of the contract.
  3. C) Enforcing contracts guarantees sellers that the government will bail them out in case the buyer does not fulfill his end of the contract.
  4. D) Enforcing the contract effectively makes the government the seller’s partner in the business.

Answer:  A

Diff: 2

Topic:  The Government Enforces the Rules of Exchange

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

22) When the government provides its citizens an unemployment insurance program, it is providing its citizens:

  1. A) a social safety net.
  2. B) a public good.
  3. C) a new job.
  4. D) uncertainty.

Answer:  A

Diff: 1

Topic:  Government Can Reduce Economic Uncertainty

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

23) When the government provides its citizens an unemployment insurance program, it is:

  1. A) trying to reduce economic uncertainty.
  2. B) trying to create new jobs for the unemployed.
  3. C) trying to increase economic uncertainty.
  4. D) encouraging workers to look for jobs in the government sector.

Answer:  A

Diff: 1

Topic:  Government Can Reduce Economic Uncertainty

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

24) Which of the following tend to reduce economic uncertainty?

  1. A) unemployment insurance
  2. B) health insurance
  3. C) social security
  4. D) all of the above are correct.

Answer:  D

Diff: 1

Topic:  Government Can Reduce Economic Uncertainty

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

Recall Application 3, “Civil Liberties and the Efficiency of Government,” to answer the following questions:

 

25) According to the application, improved civil liberties has been shown to be positively correlated with:

  1. A) return to government investment projects.
  2. B) the number of failed government projects.
  3. C) the size of the government.
  4. D) the number of successful private investment projects.

Answer:  A

Diff: 2

Topic:  Application 3, Civil Liberties and the Efficiency of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

26) According to the application, country’s civil liberty includes which of the following?

  1. A) freedom of expression
  2. B) right to own property
  3. C) freedom of religion
  4. D) All of the above are part of a country’s civil liberty.

Answer:  D

Diff: 2

Topic:  Application 3, Civil Liberties and the Efficiency of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

27) According to the application, why is a government’s efficiency improved with stronger civil liberties?

  1. A) Stronger civil liberties encourage corruption.
  2. B) Stronger civil liberties force the government to hand out more subsidies.
  3. C) Stronger civil liberties encourage citizen participation and government accountability.
  4. D) All of the above are correct.

Answer:  C

Diff: 2

Topic:  Application 3, Civil Liberties and the Efficiency of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

28) If the findings in the application are true, then if the World Bank wants to improve the return of its infrastructure projects in countries with inefficient governments like Zimbabwe, then it must first:

  1. A) improve the people’s right to own property.
  2. B) discourage freedom of expression.
  3. C) encourage the government to nationalize all industries.
  4. D) bribe the country’s politicians.

Answer:  A

Diff: 2

Topic:  Application 3, Civil Liberties and the Efficiency of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

29) A role of government is to ensure firms bear the full costs of their production.

Answer:  TRUE

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Ethical Reasoning

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

30) When there is imperfect competition, the role of government is to take control of production.

Answer:  FALSE

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

31) A market failure occurs when companies defraud the public.

Answer:  FALSE

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

32) A public good is any good that is produced by the government.

Answer:  FALSE

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

33) When there is imperfect information, a role of government is to disseminate information and promote informed choice.

Answer:  TRUE

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Ethical Reasoning

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

Recall Application 3, “Civil Liberties and the Efficiency of Government,” to answer the following questions:

 

34) The returns to public sector investment is highest in poor countries like North Korea and Afghanistan, where measures of civil liberties are lower.

Answer:  FALSE

Diff: 1

Topic:  Application 3, Civil Liberties and the Efficiency of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

 

35) What are some of the sources of market failure?

Answer:  people not bearing the full costs of their decisions, public goods, imperfect information, imperfect competition.

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

36) What are some of the roles of government in a market economy?

Answer:  seeing to it that decision makers realize the full costs of their decisions, enforcing property rights, reducing economic uncertainty, fostering competition, facilitating collective decision making about public goods and disseminating information and promoting informed choice

Diff: 2

Topic:  Market Failure and the Role of Government

Skill:  Conceptual

AACSB:  Ethical Reasoning

Learning Outcome:  List ways in which governments intervene in markets and explain the consequences of such intervention

 

Macroeconomics: Prin., Apps, & Tools, 8e (O’Sullivan) TB2

Chapter 17   Macroeconomic Policy Debates

 

17.1   Should We Balance the Federal Budget?

 

1) If what a government spends exceeds what it collects in taxes in a year, then the government is experiencing a:

  1. A) government net revenue.
  2. B) government net expenditure.
  3. C) government budget deficit.
  4. D) government budget surplus.

Answer:  C

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

2) In 2012, the city of Canfield collected $500,000 in taxes and spent $450,000. In 2012, the city of Canfield had a:

  1. A) budget surplus of $450,000.
  2. B) budget surplus of $50,000.
  3. C) budget deficit of $$50,000.
  4. D) budget surplus of $5,000.

Answer:  B

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

3) In 2012, the city of Canfield collected $500,000 in taxes and spent $550,000. In 2012, the city of Canfield had a:

  1. A) budget surplus of $450,000.
  2. B) budget surplus of $50,000.
  3. C) budget deficit of $$50,000.
  4. D) budget surplus of $5,000.

Answer:  C

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

4) The sum of all past deficits is called:

  1. A) the government debt.
  2. B) the government deficit.
  3. C) the government surplus.
  4. D) the government expenditures.

Answer:  A

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

5) A decrease in government spending and an increase in taxes will cause the:

  1. A) budget deficit to decrease.
  2. B) budget deficit to increase.
  3. C) budget deficit to remain unchanged.
  4. D) government debt to increase.

Answer:  A

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

6) An increase in government spending and a decrease in taxes will cause the:

  1. A) budget deficit to decrease.
  2. B) budget deficit to remain unchanged.
  3. C) budget deficit to increase.
  4. D) budget deficit to increase slightly.

Answer:  C

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

7) If a government currently has a budget deficit:

  1. A) it does not necessarily have a debt.
  2. B) its debt is increasing.
  3. C) government expenditures exceed revenues.
  4. D) all of the above

Answer:  D

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

8) If the government were to experience a budget surplus in the next three years, the government’s total debt would:

  1. A) decrease over the next three years.
  2. B) stay the same over the next three years.
  3. C) increase over the next three years.
  4. D) would decrease only on the third year.

Answer:  A

Diff: 2

Topic:  Should We Balance the Federal Budget?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

9) If the government were to experience a budget deficit in the next three years, the government’s total debt would:

  1. A) decrease over the next three years.
  2. B) stay the same over the next three years.
  3. C) increase over the next three years.
  4. D) would increase only on the third year.

Answer:  C

Diff: 2

Topic:  Should We Balance the Federal Budget?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

10) Suppose that the government debt is $100 million at the beginning of the year. If the government collects $45 million in taxes and incurs $50 million in expenditures this year, then the government is experiencing a ________ and the debt will be ________ at the end of the year.

  1. A) deficit, $105 million
  2. B) surplus, $95 million
  3. C) deficit, $95 million
  4. D) surplus, $105 million

Answer:  A

Diff: 2

Topic:  Should We Balance the Federal Budget?

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

11) Suppose that the government debt is $100 million at the beginning of the year. If government collects $55 million in taxes and incurs $50 million in expenditures this year, then the government is experiencing a ________ and the debt will be ________ at the end of the year.

  1. A) deficit, $105 million
  2. B) surplus, $95 million
  3. C) deficit, $95 million
  4. D) surplus, $105 million

Answer:  B

Diff: 2

Topic:  Should We Balance the Federal Budget?

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

12) The U.S. federal government had a budget ________ over the entire 1970 to 1997 period; by historical standards, it was particularly ________ in the 1980s.

  1. A) deficit; small
  2. B) surplus; large
  3. C) surplus; small
  4. D) deficit; large

Answer:  D

Diff: 1

Topic:  The Budget in Recent Decades

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

13) Federal government debt as a percentage of GDP:

  1. A) did not change significantly between 1982 and 1992.
  2. B) fell significantly between 1982 and 1992.
  3. C) rose rapidly between 1970 and 1982.
  4. D) rose rapidly between 1982 and 1992.

Answer:  D

Diff: 2

Topic:  The Budget in Recent Decades

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

14) From the end of 1997 through 2000, federal government debt as a percentage of GDP:

  1. A) increased.
  2. B) decreased.
  3. C) became negative.
  4. D) remained constant.

Answer:  B

Diff: 2

Topic:  The Budget in Recent Decades

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

15) From the end of 1997 through 2000, the U.S. budget:

  1. A) was in deficit.
  2. B) was in surplus.
  3. C) was balanced.
  4. D) deficit was decreasing as a percentage of GDP.

Answer:  B

Diff: 2

Topic:  The Budget in Recent Decades

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

16) In 2001, the federal budget turned ________ and, as a result of this, it is expected that the ratio of government debt to GDP is expected to ________.

  1. A) from a deficit into a surplus; increase
  2. B) from a surplus into a deficit; increase
  3. C) from a deficit into a surplus; decrease
  4. D) from a surplus into a deficit; decrease

Answer:  B

Diff: 2

Topic:  The Budget in Recent Decades

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

17) In the United States in recent years, the national debt has been approximately ________ percent of GDP.

  1. A) 25
  2. B) 50
  3. C) 100
  4. D) 150

Answer:  B

Diff: 1

Topic:  The Budget in Recent Decades

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

18) In the late 1990s, the United States had:

  1. A) a budget deficit and a national debt.
  2. B) a budget deficit, but no national debt.
  3. C) a budget surplus and a national debt.
  4. D) a budget surplus, but no national debt.

Answer:  C

Diff: 1

Topic:  The Budget in Recent Decades

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

19) Which of the following ways does the federal government finance its expenditures?

  1. A) tax revenues
  2. B) issuing bonds
  3. C) creating money
  4. D) all of the above

Answer:  D

Diff: 1

Topic:  The Budget in Recent Decades

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

20) Which is not a way in which the federal government can finance its expenditure?

  1. A) issuing bonds
  2. B) creating money
  3. C) buying federal government securities
  4. D) tax revenues

Answer:  C

Diff: 1

Topic:  The Budget in Recent Decades

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

21) Which of the following contributed to the $455 billion budget deficit in 2008?

  1. A) the recession that started in December 2007
  2. B) the tax cuts in January 2008 that were geared to stimulate the economy
  3. C) the continuing wars in Iraq and Afghanistan
  4. D) All of the above are correct.

Answer:  D

Diff: 1

Topic:  The Budget in Recent Decades

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

22) Which of the following events is expected to worsen the budget deficit in the years following 2008?

  1. A) the increased government spending to deal with the financial crisis in 2008
  2. B) the expected improvement in the economy once the financial crisis is in order
  3. C) the expiration of some of George Bush’s tax cuts in 2010
  4. D) All of the above are correct.

Answer:  A

Diff: 1

Topic:  The Budget in Recent Decades

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

23) How large was the federal government deficit during the fiscal year 2011?

  1. A) $1.3 trillion
  2. B) $700 billion
  3. C) $160 billion
  4. D) $3.7 trillion

Answer:  A

Diff: 1

Topic:  The Budget in Recent Decades

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

24) The debt to GDP ratio in 2011 was:

  1. A) 67.7 percent.
  2. B) 95.2 percent.
  3. C) 111.4 percent.
  4. D) 45.8 percent.

Answer:  A

Diff: 1

Topic:  The Budget in Recent Decades

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

25) Budget deficits can lead to inflation if:

  1. A) crowding out occurs.
  2. B) the government monetizes the deficit.
  3. C) the debt to GDP rises.
  4. D) government borrowing pushes up interest rates.

Answer:  B

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

26) Monetizing the deficit occurs when:

  1. A) the central bank purchases newly issued government bonds.
  2. B) the central bank prints more money because the private sector’s money demand has increased.
  3. C) banks lend more dollars to the central bank.
  4. D) banks buy more treasury bills from the US Treasury.

Answer:  A

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

27) Printing money to finance budget deficits ultimately leads to:

  1. A) inflation.
  2. B) higher interest rates.
  3. C) lower levels of investment.
  4. D) a drop in the price level.

Answer:  A

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

28) Between 1996 and 1997, the budget deficit in Egypt fell dramatically. Other things being constant, this decline should have made interest rates ________ and investment ________.

  1. A) fall; rise
  2. B) rise; rise
  3. C) fall; fall
  4. D) rise; fall

Answer:  A

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

29) The decrease in investment caused by an increase in government borrowing is called:

  1. A) the reshuffle effect.
  2. B) Ricardian equivalence.
  3. C) monetizing the debt.
  4. D) crowding out.

Answer:  D

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

30) Part of the argument against budget deficits is that they ________ interest rates and ________ investment.

  1. A) increase; increase
  2. B) decrease; decrease
  3. C) increase; decrease
  4. D) decrease; increase

Answer:  C

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

31) Some argue that deficits can cause a smaller government because:

  1. A) deficits make it harder for politician to increase spending.
  2. B) deficits make it easier for politicians to increase spending.
  3. C) deficits make it easier for politicians to print money.
  4. D) deficits make it harder for politicians to print money.

Answer:  A

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

32) Which of the following would lower the burden of increased government spending on future generations?

  1. A) increased spending to subsidize the losses of government owned enterprises
  2. B) increased spending to subsidize consumption
  3. C) increased spending to subsidize education
  4. D) increased spending to subsidize imported consumption goods

Answer:  C

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

33) Which of the following is a correct sequence of events during a recession?

  1. A) Unemployment falls, income falls, tax revenue falls, unemployment benefits rise, and the budget deficit rises.
  2. B) Unemployment rises, income falls, tax revenue falls, unemployment benefits rise, and the budget deficit rises.
  3. C) Unemployment rises, income falls, tax revenue rises, unemployment benefits fall, and the budget deficit falls.
  4. D) Unemployment rises, income rises, tax revenue rises, unemployment benefits rise, and the budget deficit rises.

Answer:  B

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

34) Which of the following is a correct sequence of events during an expansion?

  1. A) Unemployment falls, income falls, tax revenue falls, unemployment benefits rise, and the budget deficit falls.
  2. B) Unemployment falls, income rises, tax revenue falls, unemployment benefits rise, and the budget deficit rises.
  3. C) Unemployment falls, income rises, tax revenue rises, unemployment benefits rise, and the budget deficit falls.
  4. D) Unemployment falls, income rises, tax revenue rises, unemployment benefits fall, and the budget deficit falls.

Answer:  D

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

35) The presence of automatic stabilizers means that the federal budget deficit is ________ than it otherwise would be in a recession and ________ than it otherwise would be in an expansion.

  1. A) larger; smaller
  2. B) smaller; larger
  3. C) smaller; smaller
  4. D) larger; larger

Answer:  A

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

36) During a recession, automatic stabilizers cause the federal budget deficit to:

  1. A) decrease.
  2. B) either increase or decrease.
  3. C) remain unchanged.
  4. D) increase.

Answer:  D

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

37) An example of an automatic stabilizer is:

  1. A) the food stamp program.
  2. B) changing the tax laws to increase the marginal tax rates.
  3. C) the indexation of social security benefits to the consumer price index.
  4. D) the interest the government pays on loans.

Answer:  A

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

38) The reason why the budget deficit increases during recessions is:

  1. A) higher welfare payments.
  2. B) higher tax revenues.
  3. C) lower tax rates.
  4. D) Both A and C are correct.

Answer:  A

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

39) The reason why the budget deficit decreases during economic expansions is:

  1. A) higher welfare payments.
  2. B) higher tax revenues.
  3. C) lower tax revenues.
  4. D) Both A and B are correct.

Answer:  B

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

40) The existence of automatic stabilizers causes:

  1. A) the size of any budget deficit to increase as the economy enters a recession.
  2. B) the size of any budget deficit to decrease as the economy enters a recession.
  3. C) the effects of a given change in autonomous expenditures on output to be larger than they would be if there were no automatic stabilizers.
  4. D) no change in the size of the budget deficit as the economy enters a recession.

Answer:  A

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

41) The proposition that states that whether government finances its deficit by borrowing or by increasing taxes is irrelevant is called:

  1. A) the Ricardian Equivalence.
  2. B) the quantity theory of money.
  3. C) the law of demand.
  4. D) monetizing the deficit.

Answer:  A

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

42) The proposition that states that whether government finances its deficit by borrowing or by increasing taxes is irrelevant was named after:

  1. A) David Ricardo.
  2. B) Adam Smith.
  3. C) John Maynard Keynes.
  4. D) Paul Samuelson.

Answer:  A

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

43) If the Ricardian Equivalence were true, the effect of an increase in government expenditure:

  1. A) is the same regardless on whether it is financed by borrowing or by taxation.
  2. B) is the better it is financed by borrowing instead of taxation.
  3. C) is the better it is financed by taxation instead of borrowing.
  4. D) is effective only if done both by borrowing and by taxation.

Answer:  A

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

44) If the Ricardian Equivalence were true, the effect of an increase in government expenditure:

  1. A) will have no effect on investment.
  2. B) will increase investment by the amount of the increased government spending.
  3. C) will decrease investment by the amount of the government spending.
  4. D) will increase investment by more than the increase in government spending.

Answer:  A

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

45) One way to prove the Ricardian equivalence is true is to show that when the government deficit increases, (the) ________ also increase(s).

  1. A) private sector saving
  2. B) country’s imports
  3. C) consumption expenditures
  4. D) money supply

Answer:  A

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

46) Critics of a balanced-budget amendment believe that a balanced budget would not allow the government enough flexibility to:

  1. A) get the economy out of recessions.
  2. B) raise wages for civil servants.
  3. C) fight inflation.
  4. D) spend budget surpluses.

Answer:  A

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

47) If the government is required to balance the budget and the economy is in a recession and experiencing an expanding budget deficit, the government must:

  1. A) raise taxes.
  2. B) decrease spending.
  3. C) A and B are correct.
  4. D) neither A nor B

Answer:  C

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

Recall Application 1, “Creating the U.S. Federal Fiscal System Through Debt Policy,” to answer the following questions:

 

48) According to the Application, what was the reason why the states, after the new Constitution was enacted in 1789, gave up their rights to raise revenues by taxing imported goods?

  1. A) The federal government assumed their debts.
  2. B) The federal government shared the revenue with them.
  3. C) The federal government forced them to do so.
  4. D) The federal government gave the states guns and ammunition in return.

Answer:  A

Diff: 2

Topic:  Application 1, Creating the Federal Fiscal System Through Debt Policy

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

49) According to the Application, what was the reason why the federal government did not bail the states that had fiscal difficulties in the 1840s?

  1. A) The federal government did not want to enhance its control over the states.
  2. B) The federal government wanted to force the states to have fiscal discipline.
  3. C) A and B are correct.
  4. D) A and B are both incorrect.

Answer:  C

Diff: 2

Topic:  Application 1, Creating the Federal Fiscal System Through Debt Policy

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

50) According to the Application, what was the reason why the states started to have fiscal difficulties in the 1840s?

  1. A) The states were at war.
  2. B) The states experienced a recession.
  3. C) The states undertook overly ambitious infrastructure projects.
  4. D) The federal government stopped sending states their share of tax revenues.

Answer:  C

Diff: 2

Topic:  Application 1, Creating the Federal Fiscal System Through Debt Policy

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

51) A budget deficit causes the national debt to fall.

Answer:  FALSE

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

52) Typically, in the United States, the ratio of debt to GDP has risen during times of war.

Answer:  TRUE

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

53) The nation’s total federal debt represents the total of all accumulated deficits minus surpluses over time.

Answer:  TRUE

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

54) A government’s budget deficit or surplus is the difference between what it spends and what it collects in taxes in a year.

Answer:  TRUE

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

55) If the government experiences a budget deficit that it finances through borrowing, then the country’s Debt/GDP ratio will always increase, even if the economy experiences economic growth.

Answer:  FALSE

Diff: 1

Topic:  The Budget in Recent Decades

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

56) In most cases, a government generates inflation when it creates money to finance its expenditures.

Answer:  TRUE

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

57) An increase in the federal budget deficit will lower the level of crowding out in the economy.

Answer:  FALSE

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

58) In a closed economy, when the government runs a budget deficit, national saving is reduced, interest rates rise, and investment falls, holding all else constant.

Answer:  TRUE

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Analytical

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

59) Since a budget deficit places a burden on future generations, it can never be justified.

Answer:  FALSE

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

60) When the federal government runs a budget deficit, it is possible for current taxpayers to pass the tax burden to future generations.

Answer:  TRUE

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

61) During recessions, automatic stabilizers work to reduce government expenditures and increase government revenues.

Answer:  FALSE

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

62) The budget deficit increases during economic booms and decreases during recessions.

Answer:  FALSE

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

63) The government debt tends to rise when GDP rises, and tends to fall when GDP falls.

Answer:  FALSE

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

64) What is the difference between a government budget deficit and government debt?

Answer:  The deficit is the difference between government revenues and expenditures in any given year. The debt is the accumulated deficits less accumulated surpluses that are used to pay down the debt.

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

65) Explain the reasons why the US had a budget surplus in the late 1990s.

Answer:  The budget surpluses in the late 1990s were brought about by two things: a growing economy and federal rules that limited government spending. When an economy is growing rapidly, the tax revenues received from income taxes and sales taxes increase. This coupled with the decrease in government spending brought about by the government’s desire at that time to balance the budget resulted in budget surpluses.

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

66) Can the government experience a deficit yet experience a declining debt to GDP ratio? Explain.

Answer:  Yes, it can. Though a deficit will increase the total amount of debt that the government experiences, if the GDP growth rate outpaces the growth rate of the government debt, then the debt/GDP ratio will decrease.

Diff: 1

Topic:  The Budget in Recent Decades

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

67) List the four options the federal government faces in regard to its budget surpluses.

Answer:  (1)    Let the current surpluses reduce the government debt.

(2)        Increase the surplus by raising taxes or reducing government spending.

(3)        Use the surpluses to increase government spending.

(4)        Use the surpluses to decrease taxes.

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

68) Explain how a budget deficit can lead to inflation.

Answer:  The government can create inflation by monetizing the debt. This occurs when the Federal Reserve purchases newly issued government bonds and increases the money supply.

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

69) Can a large budget deficit not lead to inflation?

Answer:  Yes. A budget deficit leads to inflation only when the central bank monetizes the debt. Most large and stable countries such as the US and Japan do not monetize their deficits/ debts because they can borrow from the public. These countries experience large budget deficits without experiencing high inflation rates.

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

70) What is meant by monetizing the debt?

Answer:  Monetizing the debt occurs when the Federal Reserve (or a country’s central bank) purchases newly issued government bonds.

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

71) List the two ways in which the national debt can place a burden on future generations.

Answer:  (1)    The debt can lead to a reduction in investment. This lowers the level of capital in the economy and thereby reduces future real incomes.

(2)        A large national debt means that future generations will have to pay higher taxes to pay for the interest on the debt.

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

72) What happens to investment and interest rates if the government runs a budget deficit in a closed economy? Assume that the Ricardian Equivalence does not hold. Explain.

Answer:  A budget deficit reduces national saving. Thus, the interest rate will rise and investment will fall.

Diff: 1

Topic:  Should We Balance the Federal Budget?

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

73) What happens to investment and interest rates if the government runs a budget deficit in a closed economy? Assume that the Ricardian Equivalence holds. Explain.

Answer:  A budget deficit does not reduce national saving, as households forsee that they will be taxed in the future to pay back the increased spending made by the government today. Thus, the interest rate and investment will not change.

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

74) What is Ricardian equivalence?

Answer:  Ricardian equivalence, the proposition that it does not matter whether government spending is financed by taxes or debt.

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

75) Explain the logic behind Ricardian equivalence.

Answer:  If the government reduces taxes and finances the tax cut by issuing new debt, individuals will realize that the increase in debt will mean higher taxes in the future and will therefore increase their saving. As individuals increase their saving, they will be able to finance the future investment they planned before the tax cut. This means that investment in the future is unaffected by a tax cut.

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

76) Suppose the government cuts taxes to stimulate growth in an economy deep in a recession. How will this tax cut affect investment spending today, if the Ricardian Equivalence holds?

Answer:  The tax cut increases disposable income in the short run, but will not increase consumption spending as households will choose to save all of the additional disposable income in anticipation of higher taxes in the future. As a result, the tax increase will not increase aggregate demand or GDP.

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

77) Explain how unemployment compensation operates as an automatic stabilizer within the economy during a recession.

Answer:  During a recession, workers become unemployed and receive unemployment compensation. Workers’ income is supported and so consumption does not fall as much as would have been the case otherwise. Therefore, economic activity is partially stabilized and the recession is somehow milder.

Diff: 2

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

78) Explain automatic stabilizers and their impact on the economy.

Answer:  Automatic stabilizers represent automatic and nondiscretionary changes in government spending and tax revenue receipts that are countercyclical. Thus, they result in higher government spending and lower taxes during a recession, and lower government spending and higher taxes during an expansion.

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

79) Illustrate examples of the countercyclical effects of the automatic stabilizers.

Answer:  Government spending for needed public assistance for unemployment compensation are examples of automatic spending changes. Government spending for unemployment compensation increases during a recession as unemployment rises, and decreases during an expansionary period when unemployment declines. Also, the progressive income tax increases tax obligations of consumers as incomes rise during economic expansion, and decreases tax obligations as incomes decline during recessionary periods. Automatic stabilizers tend to moderate the recessionary decline in spending and the excessive spending of rapid expansion.

Diff: 2

Topic:  Should We Balance the Federal Budget?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

80) If the economy goes into a recession, the automatic stabilizers are likely to increase the budget deficit. Why might such a deficit be beneficial?

Answer:  By increasing aggregate demand, the deficit may help to prevent the recession from becoming too severe.

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

 

81) List two arguments for the passage of a balanced budget amendment.

Answer:  (1) Stimulate private capital formation (reducing crowding-out)

(2) Prevent the shifting of tax burdens onto future generations.

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

82) List two arguments against the passage of a balanced budget amendment.

Answer:  (1)    There may not be enough flexibility to deal with recessions.

(2)        Congress could devise special budgets and take some spending programs “off budget.”

Diff: 1

Topic:  Five Debates About Deficits

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss fundamental approaches to fiscal policy.

 

17.2   Should the Fed Target Inflation or Pursue Other Objectives?

 

1) In the Employment Act of 1946, the federal government was broadly charged to:

  1. A) pursue maximum employment, production and purchasing power.
  2. B) achieve zero unemployment.
  3. C) encourage all citizens to get a job.
  4. D) maximize income and government revenue.

Answer:  A

Diff: 2

Topic:  Should the Fed Target Inflation or Pursue Other Objectives?

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

2) In the Humphrey Hawkins Act of 1978, the federal government was broadly charged to pursue:

  1. A) full employment.
  2. B) balanced trade.
  3. C) price stability.
  4. D) All of the above are correct.

Answer:  D

Diff: 2

Topic:  Should the Fed Target Inflation or Pursue Other Objectives?

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

 

3) If the Fed were to focus only on inflation:

  1. A) the private sector would become less responsive to the Fed’s policies.
  2. B) its capacity to fight recessions would be diminished.
  3. C) its independence from political pressures would decrease.
  4. D) its credibility would be reduced.

Answer:  B

Diff: 2

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

4) Which of the following statements is false concerning policies to reduce inflation?

  1. A) They are likely to have a lower cost if people think that the central bank is credible.
  2. B) The costs are likely to exceed the benefits.
  3. C) They have permanent benefits.
  4. D) They are likely to be more credible if the government also makes an attempt to reduce the budget deficit.

Answer:  B

Diff: 2

Topic:  Should the Fed Target Inflation or Pursue Other Objectives?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

5) The rule of thumb used to measure the cost of reducing inflation suggests that if the actual unemployment rate exceeds the natural rate of unemployment by 1 percentage point for one year, the inflation rate:

  1. A) falls by 1 percentage point per year.
  2. B) rises by 1 percentage point per year.
  3. C) falls by 0.5 percentage point per year.
  4. D) falls by 1.5 percentage points per year.

Answer:  C

Diff: 1

Topic:  Should the Fed Target Inflation or Pursue Other Objectives?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

6) Suppose that the natural rate of unemployment is 4% and the current inflation rate is 2% per year. To bring the inflation rate down to zero, the actual unemployment rate in the economy would have to be:

  1. A) 6%.
  2. B) 4%.
  3. C) 8%.
  4. D) 2%.

Answer:  C

Diff: 2

Topic:  Should the Fed Target Inflation or Pursue Other Objectives?

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

7) Suppose that the natural rate of unemployment is 5% and the current inflation rate is 1% per year. To bring the inflation rate down to zero, the actual unemployment rate in the economy would have to be:

  1. A) 6%.
  2. B) 4%.
  3. C) 8%.
  4. D) 7%.

Answer:  D

Diff: 2

Topic:  Should the Fed Target Inflation or Pursue Other Objectives?

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

8) If the Fed follows a policy of targeting the inflation rate:

  1. A) its credibility will be lowered.
  2. B) the natural rate of unemployment will rise.
  3. C) it will likely face fewer political pressures.
  4. D) the automatic stabilizers will not work.

Answer:  C

Diff: 2

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

 

9) If the Fed follows a policy of targeting the inflation rate:

  1. A) its credibility will be enhanced.
  2. B) the natural rate of unemployment will rise.
  3. C) it will likely face more political pressures.
  4. D) the financial market will be more confused.

Answer:  A

Diff: 2

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

10) Allowing the Fed to set its own inflation targets:

  1. A) would make the Fed even more independent from Congress.
  2. B) would require a constitutional amendment.
  3. C) would diminish the Fed’s authority and control over the economy.
  4. D) would eliminate the need for the Treasury Department.

Answer:  A

Diff: 2

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

11) If the Fed enhances its credibility when it sets its own inflation targets:

  1. A) long term interest rates will be more responsive to changes in the short term interest rates.
  2. B) long term interest rates will be less responsive to changes in the short term interest rates.
  3. C) short term interest rates will be more responsive to changes in the long term interest rates.
  4. D) short term interest rates will be less responsive to changes in the long term interest rates.

Answer:  A

Diff: 2

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

12) Critics of inflation targeting worry that if the Fed focuses only in fighting inflation:

  1. A) Congress would have no tools to fight a recession.
  2. B) Congress would have nothing left to fight.
  3. C) Congress would have no tools to fight a boom.
  4. D) Congress would have no tools left to fight a deficit.

Answer:  A

Diff: 2

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

13) Targeting a range of inflation rates, instead of a single inflation level, would:

  1. A) prevent the central bank from meeting employment targets.
  2. B) give the central bank some “wiggle room” to meet employment targets.
  3. C) give Congress some “wiggle room” to meet employment targets.
  4. D) prevent Congress from meeting employment targets.

Answer:  B

Diff: 2

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

14) Which of the following countries have central banks that explicitly target inflation?

  1. A) the United Kingdom
  2. B) Canada
  3. C) Australia
  4. D) the United States

Answer:  A

Diff: 2

Topic:  Two Debates About Inflation Targeting

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

Recall Application 2, “Would a Policy Rule Have Prevented the Housing Boom?” to answer the following questions:

 

15) According to the application, which of the following did John Taylor identify as the cause of the housing boom from 2001-2004?

  1. A) the Fed’s “easy money” policy
  2. B) the Fed’s “tight money” policy
  3. C) the Treasury’s bailout of banks
  4. D) Congress’ tax cuts

Answer:  A

Diff: 2

Topic:  Application 2, Would a Policy Rule Have Prevented the Housing Boom?

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

 

16) According to the application, which of the following European countries deviated the most from the “Taylor rule” and suffered the worst boom and bust in housing?

  1. A) Spain
  2. B) France
  3. C) Germany
  4. D) the United Kingdom

Answer:  A

Diff: 2

Topic:  Application 2, Would a Policy Rule Have Prevented the Housing Boom?

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

17) Is it possible for the Fed to reduce the inflation rate with little increase in the unemployment rate? Explain.

Answer:  Yes, it is possible for the Fed to lower inflation without a significant increase in the unemployment rate if the Fed was credible in its commitment to reducing inflation. If workers adjust their inflationary expectations, it would be possible for the Fed to reduce inflation with a smaller increase in unemployment.

Diff: 2

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

18) Are there any reasons why reducing the inflation rate to zero would be a bad policy for the Fed to pursue? Explain.

Answer:  Yes. For example, it is not clear that the costs of inflation are high. Some economists also argue that the economy will be less able to deal with aggregate demand shocks, because workers will not want to see a decline in their nominal wages. It is also difficult to quantify what stable prices mean; the measurement of the inflation rate is in itself a source of controversy.

Diff: 2

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

19) Explain the arguments for monetary policy targeting only the inflation rate.

Answer:  Concentrating on the inflation rate will relieve some of the political pressures that the Fed faces. In addition, it will enhance the Fed’s credibility. This will lower the need for active monetary policies.

Diff: 1

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

 

20) Explain the arguments against monetary policy targeting only the inflation rate.

Answer:  Concentrating on the inflation rate only will give the government one less policy tool to fight a recession. This could potentially be dangerous for an economy since fiscal policy tends to have a long inside lag.

Diff: 1

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

21) What is the difference between inflation targeting and the alternative developed by John Taylor of Stanford University?

Answer:  With Taylor’s method, the Fed has a long-run inflation target and will increase or decrease interest if the GDP is above or below potential. The main difference with this approach as opposed to inflation targeting is that the Fed follows an explicit rule on what the interest rate should be set at. With inflation targeting, the Fed makes ad hoc decisions on the interest rates.

Diff: 2

Topic:  Two Debates About Inflation Targeting

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

17.3   Should We Tax Consumption Rather than Income?

 

1) A tax system that discourages savings hurts long-run growth prospects because:

  1. A) the trade balance deteriorates.
  2. B) investment spending decreases.
  3. C) consumption spending remains constant.
  4. D) the federal budget turns into surplus.

Answer:  B

Diff: 2

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

2) The U.S. tax system discourages savings because:

  1. A) taxpayers pay taxes only on their wages.
  2. B) taxpayers pay a federal tax on their consumption spending.
  3. C) taxpayers pay taxes on both their wages and on the earnings from their savings.
  4. D) taxpayers pay a value-added tax on their savings.

Answer:  C

Diff: 3

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

3) An example of a consumption tax in the US is the:

  1. A) sales tax.
  2. B) state income tax.
  3. C) social security tax.
  4. D) property tax.

Answer:  A

Diff: 1

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

4) An income tax system can be converted to a consumption tax by:

  1. A) not taxing earnings from saving.
  2. B) not taxing income from a second job.
  3. C) by not taxing corporate income.
  4. D) by not taxing food expenditures.

Answer:  A

Diff: 1

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

5) A key feature of consumption taxation is that you should:

  1. A) not pay more taxes if you choose to save more of your income.
  2. B) pay more taxes if you choose to save more of your income.
  3. C) pay more taxes if you are richer.
  4. D) pay more taxes if you are poorer.

Answer:  A

Diff: 1

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

6) When an individual in the US invests in a 401K, that person is taxed:

  1. A) only after cashing-in the investment.
  2. B) immediately after making the investment.
  3. C) only after the person dies.
  4. D) one year after making the investment.

Answer:  A

Diff: 1

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

7) A consumption tax is likely to increase savings as long as individuals:

  1. A) choose to consume more, even though the lower tax on savings makes them less wealthy.
  2. B) choose to retire later, so that their pension funds are taxed less severely.
  3. C) choose to consume less, even though the lower tax on savings makes them wealthier.
  4. D) choose to transfer balances from saving accounts with no tax advantages into tax-favored investments.

Answer:  C

Diff: 3

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

8) Double taxation of corporate profits, first through the corporate tax on profits and later through the personal income tax on dividends, is likely to lead to:

  1. A) additional issues of stock shares, instead of additional issues of bonds.
  2. B) larger capital gains, if the corporations pay dividends.
  3. C) less efficient investments, but more lightly taxed ones.
  4. D) smaller capital inflows into real estate investment.

Answer:  C

Diff: 3

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

9) A higher rate of return to saving has:

  1. A) income and substitution effects that both decrease saving.
  2. B) an income effect that discourages saving and a substitution effect that encourages saving.
  3. C) income and substitution effects that both increase saving.
  4. D) an income effect that encourages saving and a substitution effect that discourages saving.

Answer:  B

Diff: 3

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

 

10) IRA, 401(k), 403(b), and Keogh plans:

  1. A) impose added taxes on those who save.
  2. B) place no limits on the amount that individuals can deposit in these accounts.
  3. C) encourage saving while limiting tax liabilities.
  4. D) are never taxed.

Answer:  C

Diff: 1

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

11) Which of the following are ways to save money and still limit your taxes?

  1. A) individual retirement accounts (IRAs)
  2. B) buying tax exempt bonds
  3. C) Keogh plans
  4. D) All of the above are correct.

Answer:  D

Diff: 1

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

12) Replacing the personal income tax with a consumption tax would:

  1. A) favor wealthy and high income individuals.
  2. B) favor poor and low income individuals.
  3. C) increase overall federal revenues from taxation.
  4. D) favor all taxpayers equally, regardless of their personal wealth.

Answer:  A

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

13) Replacing the personal income tax with a consumption tax would:

  1. A) be more favorable to corporations than to households.
  2. B) be the same as imposing a “flat tax.”
  3. C) require higher tax rates in order to keep government revenues unchanged.
  4. D) allow for lower tax rates for everyone.

Answer:  A

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

14) If the flat tax is 27 percent, a person who makes $3000 a month will pay ________ a month in income taxes.

  1. A) $810
  2. B) $270
  3. C) $8100
  4. D) $2190

Answer:  A

Diff: 2

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

15) If the flat tax is 27 percent, a person who makes $3000 a month will have an income net of taxes equal to ________ a month.

  1. A) $2190
  2. B) $2730
  3. C) $270
  4. D) $810

Answer:  A

Diff: 2

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

16) Suppose that the flat tax is 20 percent. A worker who earns $1000 before taxes and puts all of the income net of taxes into a bond that earns 10 percent per annum will earn an additional ________ in one year.

  1. A) $80
  2. B) $8
  3. C) $800
  4. D) $880

Answer:  A

Diff: 2

Topic:  Two Debates About Consumption Taxation

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

17) Suppose that the flat tax is 20 percent. A worker who earns $1000 before taxes and puts all of the income net of taxes into a bond that earns 10 percent per annum will pay an additional ________ in taxes from interest income next year.

  1. A) $80
  2. B) $8
  3. C) $800
  4. D) $880

Answer:  B

Diff: 2

Topic:  Two Debates About Consumption Taxation

Skill:  Analytical

AACSB:  Analytic Skills

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

18) Capital gains are profits of investors when they:

  1. A) sell stocks and other assets.
  2. B) sell their labor.
  3. C) sell used cars.
  4. D) sell their services.

Answer:  A

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

19) Capital gains are heavily concentrated on:

  1. A) the middle class.
  2. B) the very wealthy.
  3. C) the poor.
  4. D) the homeless.

Answer:  B

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

 

20) One effect of removing capital gains tax is that:

  1. A) it promotes social inequality.
  2. B) it makes the income tax system more progressive.
  3. C) it promotes social equality.
  4. D) it promotes a flat tax system.

Answer:  A

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

21) The “flat tax” designed by Robert Hall and Alvin Rabushka feature:

  1. A) a flat tax for corporations that is lower than the flat tax for individuals.
  2. B) a flat tax for corporations that is higher than the flat tax for individuals.
  3. C) a single flat tax for corporations and for individuals.
  4. D) a single flat tax levied only on those individuals who earn more than $500,000 a year.

Answer:  A

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

Recall Application 3, “Is a VAT in our Future?” to answer the following questions.

 

22) According to the application, what does VAT stand for?

  1. A) value-added tax
  2. B) vigorously administered tax
  3. C) very annoying tax
  4. D) veto any tax

Answer:  A

Diff: 1

Topic:  Application 3, Is a VAT in Our Future?

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

 

23) According to the application, which industrialized country does not have a value-added tax (VAT)?

  1. A) the U.S.
  2. B) the U.K.
  3. C) Canada
  4. D) all of the above are correct.

Answer:  A

Diff: 1

Topic:  Application 3, Is a VAT in Our Future?

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

24) According to the application, what is the difference between a VAT and a sales tax?

  1. A) The VAT is already embedded in the price of the good, while sales taxes are paid upon purchase.
  2. B) The sales tax is regressive while the VAT is not.
  3. C) The sales tax is easy to collect while the VAT is not.
  4. D) The sales tax is a consumption tax while the VAT is not.

Answer:  A

Diff: 1

Topic:  Application 3, Is a VAT in Our Future?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

25) According to the application, what is the difficulty in imposing VAT in the U.S.?

  1. A) The US already imposes retail level taxes collected by state governments.
  2. B) The VAT is a lot more difficult to collect than sales taxes.
  3. C) Some conservatives oppose the tax because the VAT is regressive.
  4. D) Some liberals oppose the tax because the VAT is too efficient.

Answer:  A

Diff: 1

Topic:  Application 3, Is a VAT in Our Future?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

26) Based on what you learned from the application, the VAT is a form of a flat tax.

Answer:  FALSE

Diff: 1

Topic:  Application 3, Is a VAT in Our Future?

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

 

27) Tax changes that favor people who save will also tend to favor those with relatively higher incomes.

Answer:  TRUE

Diff: 2

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

28) Increases in the rate of return on saving will increase the level of saving in the economy.

Answer:  TRUE

Diff: 2

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

29) In the United States, corporate profits are taxed twice.

Answer:  TRUE

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Fact

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

30) A sales tax is a form of consumption tax.

Answer:  TRUE

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

31) What is a consumption tax? Give two examples.

Answer:  A consumption tax is a tax that is based on the consumption, not the income, of the individual. Sales taxes in the United States and value-added taxes abroad are examples of consumption taxes.

Diff: 1

Topic:  Should We Tax Consumption Rather Than Income?

Skill:  Definition

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

 

32) Why do many economists advocate a consumption tax rather than an income tax?

Answer:  The current income tax means that income is taxed at the same rate whether it is used for current consumption or if it is saved. A consumption tax would encourage saving because individuals would be taxed only when they spend. Income saved would be exempt from tax until it is ultimately used for consumption.

Diff: 2

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

33) Why are policies that give tax breaks to saving likely to be harder on the poor rather than the rich?

Answer:  The poor are generally able to save a smaller proportion of their incomes. Poor families generally have to spend most of their incomes on rent, food, clothing, and other basic necessities and have little left over for saving.

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

34) What are some of the features of Robert Hall and Alvin Rabushka’s flat tax?

Answer:  Hall and Rabushka’s flat tax features a unified tax system for both individual income and corporate income. Under the flat tax, a single low rate applies to both personal and corporate incomes. To avoid double taxation and to give incentives to job growth, businesses can deduct wage payments and investment expenditures before their incomes are taxed.

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

35) From the point of view of firms, what makes Hall and Rabushka’s flat tax a consumption tax?

Answer:  Hall and Rabushka’s flat tax is like a consumption tax because firms are allowed to deduct all spending related to investment spending. Allowing a deduction for investment is the same as allowing a deduction for saving.

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.

 

36) How does Hall and Rabushka’s flat tax make sure that the very wealthy pay taxes?

Answer:  Hall and Rabushka’s flat tax requires that dividends and capital gains be taxed. Further if a firm earns extraordinary returns (e.g., Chevron makes large profits when the price of oil rose to $147 per barrel in mid 2008), then the extraordinary profits are fully taxable.

Diff: 1

Topic:  Two Debates About Consumption Taxation

Skill:  Conceptual

AACSB:  Reflective Thinking

Learning Outcome:  Discuss the fundamentals of key macroeconomic theories.