Fiscal and Monetary Policy — High School Economics practice questions

Public goods are:

1. Excludable and rivalrous
2. Just food
3. Only physical objects
4. Always cheap
5. Non-excludable and non-rivalrous (e.g., national defense, lighthouses) — market underprovides because of free-rider problem; government typically provides

Answer: E — Non-excludable and non-rivalrous (e.g., national defense, lighthouses) — market underprovides because of free-rider problem; government typically provides

Public goods: non-excludable (can't prevent use), non-rivalrous (one's use doesn't reduce another's). Examples: defense, fireworks, clean air, knowledge. Free-rider problem. Pure private goods: excludable AND rivalrous. Common-pool goods: rivalrous, non-excludable.

If Congress passes a $200 billion increase in government spending and the marginal propensity to consume (MPC) is 0.75, the simple spending multiplier predicts the maximum increase in real GDP is:

1. $200 billion
2. $400 billion
3. About $800 billion — using 1/(1−MPC) = 1/0.25 = 4 → 4 × $200B
4. $1.5 trillion

Answer: C — About $800 billion — using 1/(1−MPC) = 1/0.25 = 4 → 4 × $200B

C) Spending multiplier = 1/(1−MPC) = 4; ΔY = 4 × $200B = $800B. A) Ignores the multiplier. B/D) Use wrong multipliers.

Inflation is best described as:

1. An increase in the unemployment rate
2. A drop in interest rates
3. A specific government program
4. A sustained increase in the general price level over time

Answer: D — A sustained increase in the general price level over time

D) Aggregate price level rising. A/B/C) Each is a different macro concept.

Monetary policy in US is conducted by:

1. President alone
2. Federal Reserve System (Fed) — controls money supply via interest rates, open-market operations, bank reserve requirements, to achieve stable prices and full employment
3. Congress only
4. Supreme Court
5. Treasury alone

Answer: B — Federal Reserve System (Fed) — controls money supply via interest rates, open-market operations, bank reserve requirements, to achieve stable prices and full employment

Federal Reserve: US central bank (created 1913). 12 regional banks + Board of Governors. Federal Open Market Committee (FOMC) sets policy. Dual mandate: max employment + price stability. Independent of political branches by design.

EXPANSIONARY fiscal policy typically involves:

1. Selling Treasury securities
2. Cutting government spending and raising taxes
3. Raising the federal funds rate
4. Increasing government spending and/or CUTTING taxes to boost aggregate demand

Answer: D — Increasing government spending and/or CUTTING taxes to boost aggregate demand

D) Fiscal = tax and spending policy. Expansionary = boosts AD via more spending or lower taxes. B) Contractionary fiscal. A/C) Monetary policy tools (classic mix-up trap).

In the AS-AD model, an EXPANSIONARY monetary policy shift most directly:

1. Has no effect on output
2. Shifts aggregate supply left
3. Shifts aggregate demand left
4. Shifts aggregate demand RIGHT — lower interest rates boost investment and consumption, raising output and price level in the short run

Answer: D — Shifts aggregate demand RIGHT — lower interest rates boost investment and consumption, raising output and price level in the short run

D) Lower rates → more spending → AD shifts right → higher Y and P short-run. B) That would be a supply shock. C) Reverses direction. A) In the short run, monetary policy affects real output.

Which is an example of contractionary monetary policy by the Fed?

1. Buying Treasury securities
2. Lowering the federal funds target rate
3. Selling Treasury securities in open-market operations, raising the discount rate, and increasing reserve requirements
4. Cutting payroll taxes

Answer: C — Selling Treasury securities in open-market operations, raising the discount rate, and increasing reserve requirements

C) Each action shrinks reserves/money supply or raises interest rates, cooling the economy. A/B) Expansionary monetary. D) Fiscal policy, not monetary.

The FEDERAL FUNDS RATE is:

1. The interest rate the Treasury pays on new bonds
2. The rate banks charge each other for overnight loans of reserves — the Fed's primary policy target
3. The average mortgage rate
4. The credit-card interest rate ceiling

Answer: B — The rate banks charge each other for overnight loans of reserves — the Fed's primary policy target

B) Textbook definition and the Fed's key policy lever. A) Treasury yields differ. C) Retail rate. D) No federal ceiling exists.

When the Federal Open Market Committee (FOMC) buys Treasury securities from banks, this most directly:

1. Reduces commercial-bank reserves
2. Increases bank reserves and tends to lower short-term interest rates, supporting an expansionary stance
3. Raises reserve requirements
4. Lowers the federal debt

Answer: B — Increases bank reserves and tends to lower short-term interest rates, supporting an expansionary stance

B) Open-market purchases add reserves to the banking system; banks then expand lending, and the federal funds rate tends to fall. A) Reverses the direction. C) Different tool. D) Doesn't pay down the debt held by the public on net.

What is crowding out?

When government borrowing raises interest rates and reduces private investment.

What is monetary policy?

Central bank actions to manage money supply and interest rates. Conducted by the Federal Reserve in the U.S.

What is the multiplier effect?

A change in spending leads to a larger overall change in GDP because each round of spending generates further spending.

What does it mean when the Fed 'lowers interest rates'?

Lowering the federal funds target rate to encourage borrowing, investment, and consumer spending — expansionary monetary policy.