Government Aims and Fiscal Policy: practice questions

Question 1

In Halvern, the unemployment rate fell to a record low of 3% over the course of one year. Over the same year, firms competed hard to hire from an increasingly scarce pool of workers, wages rose quickly, and the rate of inflation increased from 2% to 6%.

Which pair of the government's macroeconomic aims does this situation best illustrate as being in conflict?

Accepted Answer

B

Question 2

The government of Sarvenna raises revenue from residents in two ways. - It charges an annual tax on the assessed value of any land a resident owns. Landowners pay this tax directly to the government's tax office each year. - It charges a general sales tax of 8% on the price of m…

Accepted Answer

((a)) The land tax is a direct tax. The sales tax is an indirect tax.  ((b)) A direct tax, such as the land tax, is charged on what someone owns (or earns) and is paid straight to the government by that same person, so its burden falls on them directly and cannot easily be passed on to anyone else. An indirect tax, such as the sales tax, is charged on sp…  ((c)) Because the sales tax applies to every individual purchase, it is far more efficient for the seller, who is already handling the transaction, to add the tax to the price and forward the revenue on, rather than the tax office trying to collect small amounts directly from every bu…

Question 3

In one financial year, the government of Kestria collected $46 billion in tax revenue. Its total government spending for the same year was $52 billion. (a) Define what is meant by a government budget deficit. [2] (b) Using the figures above, calculate the size of Kestria's budge…

Accepted Answer

((a)) A government budget deficit occurs when, over a given period such as a year, government spending is greater than the tax revenue (and other income) the government collects, so the shortfall has to be financed by borrowing.  ((b)) Kestria's budget deficit = $52 billion - $46 billion = $6 billion.  ((c)) To finance the $6 billion shortfall, Kestria's government is likely to borrow, and the extra spending this allows adds to total demand in the economy without necessarily adding to what the economy can produce. If the economy is already close to full capacity, this extra demand c…

Question 4

The government of Norvale taxes annual income according to the following bands. - The first $8,000 of income is tax-free. - Income between $8,000 and $30,000 is taxed at 10%. - Any income above $30,000 is taxed at 25%. Person A earns $20,000 per year. Person B earns $60,000 per…

Accepted Answer

((a)) Person A pays $1,200 in tax ($0 on the first $8,000, then 10% of the remaining $12,000).  ((b)) Person B pays $9,700 in tax ($0 on the first $8,000, 10% of the next $22,000 = $2,200, plus 25% of the remaining $30,000 = $7,500).  ((c)) Person A's average tax rate is 6% ($1,200 out of $20,000). Person B's average tax rate is about 16.2% ($9,700 out of $60,000). Because the average rate of tax rises as income rises, Norvale's income tax system is progressive.

Question 5

A government is experiencing demand-pull inflation and decides to use fiscal policy, rather than monetary policy, to bring the inflation rate down. Which action is most likely to achieve this aim?

Accepted Answer

C

Question 6

In Bellmoor, real GDP grew by 8% a year for three consecutive years, driven mainly by rapid expansion of heavy manufacturing and construction. Over the same period, factory emissions rose sharply, several forests near the industrial belt were cleared to make way for new factory sites, and air quality in nearby towns worsened noticeably.

Which pair of the government's macroeconomic aims does this situation best illustrate as being in conflict?

Accepted Answer

B

Question 7

The government of Kelmoor charges every working adult a flat annual "national health contribution" of $600, regardless of how much they earn. Person C earns $15,000 per year. Person D earns $90,000 per year. (a) Calculate the average rate of tax (the fee paid as a percentage of…

Accepted Answer

((a)) Person C's average rate of tax is 600/15000×100=4% and Person D's average rate of tax is 600/90000×100≈0.67%  ((b)) The tax is regressive, because the average rate of tax falls as income rises (4% for Person C compared with about 0.67% for Person D), rather than staying the same or rising.  ((c)) A flat fee takes the same dollar amount from everyone, so it represents a much larger share of a low earner's income than a high earner's income. This breaches the principle that people with a greater ability to pay, meaning higher income, should contribute a larger share of tha…

Question 8

The government of Farrow's budget for one year allocates: - $3.5 billion to building two new hospitals and upgrading regional rail lines. - $10.5 billion to paying the salaries of public sector doctors, nurses and teachers already in post. (a) Calculate Farrow's total spending o…

Accepted Answer

((a)) Total spending on the two items is $3.5 billion + $10.5 billion = $14 billion, and the hospital-and-rail item is 3.5/14×100=25% of this total.  ((b)) The $3.5 billion for hospitals and rail lines is capital spending, and the $10.5 billion for salaries is current spending. Capital spending creates long-lasting physical assets that continue providing a service for years, while current spending pays for the day-to-day running co…  ((c)) Healthcare and education are merit goods that benefit society more widely than just the individual who consumes them, for example a healthier and better-educated workforce raises productivity across the whole economy, so if they were left entirely to the private market, people o…

Question 9

In one financial year, the government of Astwick collected the following tax revenue: $18 billion in income tax, $9 billion in sales tax, and $5 billion in corporation tax. Over the same year, it spent $11 billion on healthcare, $9 billion on education, $4 billion on infrastruct…

Accepted Answer

((a)) Total revenue = $18bn + $9bn + $5bn = $32 billion. Total spending = $11bn + $9bn + $4bn + $3bn = $27 billion. Since revenue exceeds spending, this is a budget surplus of $32 billion - $27 billion = $5 billion.  ((b)) The government could use the $5 billion surplus to pay down part of its existing national debt, reducing the amount of interest it has to pay in future years.  ((c)) Because Astwick's government is withdrawing more from the economy in tax revenue than it is injecting back through spending, a budget surplus reduces total demand compared with a balanced budget or a deficit. If firms respond to this weaker demand by producing less and investing…

Question 10

The government of Rennick has run a budget deficit every year for the past five years, and each year's deficit has added to the total amount the government owes.

Which statement correctly distinguishes Rennick's annual budget deficit from its national debt?

Accepted Answer

B

Government Aims and Fiscal Policy: Economics 0455 (Cambridge O Level / IGCSE)

Syllabus coverage

Question 1

Question 2

Question 3

Question 4

Question 5

Question 6

Question 7

Question 8

Question 9

Question 10