Fiscal policy and Monetary policy: Practice Questions

Which of the following is an example of an expansionary fiscal policy?

Suppose the government increases expenditure on public infrastructure and finances this by reducing the corporate profits tax rate. According to the AD-AS model, what are the most likely effects on the general price level and real output in the short run?

An economy is experiencing an inflationary gap. The central bank implements a contractionary monetary policy by raising the reserve requirement ratio. Simultaneously, the government, aiming to support household income, decides to decrease income tax rates. What is the most likely short-run effect on the equilibrium price level and real output, assuming the monetary policy has a stronger impact on aggregate demand than the fiscal policy?

Under a proportional tax system, the tax rate __________ as the taxpayer's level of income increases.

In an economy currently facing a budget deficit, the government decides to decrease the corporate profits tax rate while keeping its public expenditure unchanged. Which of the following is the most likely result of this policy?

Explain how an increase in the legal reserve ratio by the central bank affects the interest rate and aggregate demand (\(AD\)) of an economy.

Suppose the central bank implements a contractionary monetary policy. Explain the effects of this policy on the market price of existing bonds and the general price level in the short run.

In an economy facing a deep recession with the central bank's policy rate already at its effective lower bound, explain why expansionary fiscal policy might become a more effective tool for stimulating aggregate demand.

The government of an economy announces its annual budget for the next financial year. The estimated total revenue is 500 billion dollars, while the estimated total expenditure is 580 billion dollars. Additionally, the government plans to introduce a new progressive tax on personal income.

(a) Define a direct tax and explain why personal income tax is classified as a direct tax. (2 points)

(b) Define the meaning of a progressive tax. (1 point)

(c) Based on the figures provided, identify the type of budget (surplus, deficit, or balanced) the government is planning. (1 point)

An economy is currently facing a recession with its equilibrium output level falling below the full-employment output level. To stimulate the economy, the government proposes a reduction in the corporate profits tax rate.

(a) Distinguish between a direct tax and an indirect tax. (2 points)

(b) With the aid of an Aggregate Demand-Aggregate Supply (AD-AS) diagram, explain how a reduction in the corporate profits tax rate affects the equilibrium price level and real output in the short run. (3 points)