AP Macroeconomics : Effect of Deficit Spending on Output
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Example Questions
Example Question #1 : Deficit Spending
According to Keynesian Economics, which of the following would weaken the multiplier effect?
Selling government bonds
An increase in interest rates
An increase in government spending
High velocity of money
An increase in interest rates
The correct answer is that an increase in interest rates would weaken the multiplier effect. The reason is that an increase in interest rates would make it more attractive for consumers to save money, so as a result, there would be less of a propensity to consume.
Example Question #2 : Deficit Spending
Which of these is a negative aspect of a law mandating a balanced budget?
It creates excess funds for public projects.
It leads to fluctuating tax rates.
It is pro-cyclical (makes the business cycle more severe)
It leads to increasingly high taxes.
It is pro-cyclical (makes the business cycle more severe)
A balanced budget law is pro-cyclical because when the economy enters a recession (GDP decreases), the amount of production the government is able to tax decreases, leading to a decrease in government revenue. The government is unable to spend at a deficit, so the government must decrease expenditures. Government expenditures make up a substantial portion of GDP, so GDP decreases even more.
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