Question

Cassiopeia is a country facing an acute financial crisis. Coupled with a negative growth? rate, the rate of inflation in the economy has increased to almost 12 percent. The government of Cassiopeia has recently appointed a panel of experts to suggest suitable fiscal measures. Ronald? Boyle, a member of the National Trade Union in? Cassiopeia, feels that the best policy on the part of the government would be to announce an income tax rebate in the current year.? However, Danny? Cox, an? economist, feels that income tax rebates will only reduce government revenue. According to? him, a substantial increase in aggregate demand can only result from government investment in real assets.

Which of the following is most supported by the information given in the? question?

A. The level of private sector spending on real assets in Cassiopeia has traditionally been low.
B. Both Ronald and Danny believe that an expansionary fiscal policy is always more effective than an expansionary monetary policy.
C. The government of Cassiopeia is currently running a budget surplus.
D. The marginal propensity to consume in Cassiopeia is high.
E. Irrespective of what policy measure the government implements to combat the? crisis, inflation in Cassiopeia is likely to increase further.

Answer 1

These two statements are correct:

A. The level of private sector spending on real assets in Cassiopeia has traditionally been low.

If the economist Danny Cox is recommending increases in government investment in real assets, it must be because the private sector is not investing enough.

An economy with low levels of private investment is an economy that in the long-run will not grow because investing is what produces capital accumulation, and what faciliates technological change, and those two factors are the most important variables for economic growth.

E. Irrespective of what policy measure the government implements to combat the crisis, inflation in Cassiopeia is likely to increase further.

This statement is correct if it is referring to the two policies recommended by economist Cox and unionist Boyle. Niether an income tax refund, or an increase in government spending are measures that tackle inflation, and in fact, both could increase inflation.

A income tax refund would put more cash in the hands of the public, and if demand for money is low, this would increase the velocity of circulation, and the more rapidly money circulates, the higher the inflation rate according to the quantity theory of money.

And more government spending is a form of expansionary fiscal policy that could increase inflation if the government finances the expenses by printing money.