Question

1) Take the scenario where an economist is analyzing data for an economy in which Ricardian equivalence holds true. If there is an increase by $25 in the budget deficit, then:

a) investment expenditure will decrease by $25

b) investment expenditure will increase by $25

c) consumption expenditure will decrease by $25

2) Select the reason below that leads to effective policy making.

a) Macroeconomic forecasting is very accurate.

b) Permanent tax cuts induce changes in the behavior of businesses and households.

c) Policy actions work with lags.

3) After the 1970s, what did economists learn?

a) In the long-run, an economy can be affected by changes in aggregate supply.

b) Changes in the economy in the short-run are best understood by looking at both aggregate demand and aggregate supply.

c) In the long-run, an economy can be affected by changes in aggregate demand.

4) From a neoclassical point of view effective government policies to promote long term economic growth might include:

a) creating a stable economic environment through the government taking a hands-off approach.

b) government spending on national defense.

c) government unemployment benefits.

Answer 1

1. The correct option is C.

According to Ricardian equivalence, people internalise the government's spending pattern into their consumption decisions. So, if government makes a deficit of 25 dollars to increase spending, people would know that they will be taxed later and they will save 25 dollars rather than spending it. Thus, consumption will fall by 25 dollars.

2. The correct option is B.

Due to the changes in businesses and consumption behaviour induced by permanent tax cuts, the policy becomes effective.

Lags create problems in effective policy making. And macroeconomic forecasting is not very accurate and often creates difficulties.