2.6.2 Demand-side policies Quiz: Pearson Edexcel Economics A, Unit 2

The 20 questions

1. The distinction between monetary policy and fiscal policy is that:

   • monetary policy uses government spending, while fiscal policy uses interest rates, with the Treasury and central bank swapped
   • monetary policy is set by the Treasury, while fiscal policy is set by the central bank, since the Treasury controls the money supply
   • monetary policy works through interest rates and money supply, while fiscal policy uses government spending and taxation
   • both policies use only the exchange rate as their main instrument, so the difference lies only in which institution sets the rate

2. Which is a monetary policy instrument used by the Bank of England?

   • the rate of income tax set in the annual budget, which the Bank of England adjusts each year to control inflation and spending
   • the Bank Rate, which influences market interest rates across the economy
   • the level of tariffs on imported goods, which the central bank sets to control the price of imports and the exchange rate
   • government spending on infrastructure projects, which the central bank funds directly through its own budget to boost demand

3. Quantitative easing (QE) involves:

   • the government raising income tax to reduce household spending, which lowers demand and so reduces inflationary pressure
   • the central bank selling assets to reduce the money supply, which raises interest rates and reduces borrowing by households and firms
   • the central bank buying financial assets, such as government bonds, to increase the money supply
   • the government cutting welfare spending to balance its budget, which removes money from the economy and reduces the deficit

4. Fiscal policy instruments include:

   • asset purchases by the central bank
   • the exchange rate and foreign currency reserves
   • interest rates and open market operations
   • government spending and taxation

5. A budget deficit occurs when:

   • the central bank sells government bonds to the public
   • the trade balance is in surplus for the year
   • government spending exceeds government revenue in a given year
   • government revenue exceeds government spending in a given year

6. A budget surplus occurs when:

   • government revenue exceeds government spending in a given year
   • the central bank buys government bonds in the market
   • government spending exceeds government revenue in a given year
   • the current account of the balance of payments is in deficit

7. Which of the following is an example of a direct tax?

   • income tax paid directly by workers on their earnings
   • excise duty on petrol and tobacco products
   • a tariff levied on imported goods at the border
   • value added tax paid on goods bought in shops

8. Which of the following is an example of an indirect tax?

   • corporation tax paid on company profits
   • national insurance contributions paid by employees on wages
   • income tax deducted from wages by employers
   • value added tax (VAT) charged on goods and services at the point of sale

9. Using an AD/AS diagram, expansionary monetary policy is most likely to:

   • shift AD to the left through higher interest rates that discourage borrowing
   • shift LRAS to the right by raising the money supply
   • shift AD to the right through lower interest rates that encourage borrowing and spending
   • shift SRAS to the left by reducing the money supply

10. Using an AD/AS diagram, contractionary fiscal policy is most likely to:

    • shift AD to the right through higher government spending
    • shift LRAS to the left through higher investment
    • shift SRAS to the right through lower taxes
    • shift AD to the left through higher taxes or lower government spending

11. The Monetary Policy Committee (MPC) of the Bank of England is responsible for:

    • setting the Bank Rate to meet the government's inflation target
    • deciding the level of government spending on public services
    • setting the rate of income tax to balance the budget
    • setting the UK's tariffs on imported goods

12. A government runs a budget deficit during a recession. Which demand-side policy does this illustrate?

    • expansionary fiscal policy, using higher spending or lower taxes to support demand
    • contractionary monetary policy, using higher interest rates, because a deficit in a recession is best cut by raising the cost of borrowing
    • supply-side policy, using deregulation to raise productivity, because a deficit shows that the economy's productive capacity is too low
    • contractionary fiscal policy, using higher taxes to reduce demand, because a deficit shows the government needs more revenue

13. Which of these is a weakness of using interest rates as a monetary policy tool?

    • interest rates can only affect exports, not domestic spending, because rate changes operate only through the exchange rate and trade
    • the effect on spending is always instant and certain in all cases
    • the effect on spending can be slow and uncertain, and the impact may vary across households and firms
    • interest rates have no effect on borrowing or investment, because borrowers ignore the cost of credit when deciding how much to spend

14. Which is a strength of demand-side policy?

    • it works only in economies with a fixed exchange rate
    • it can be used quickly to support aggregate demand during a downturn
    • it always increases potential output permanently
    • it removes all inflationary pressure without side effects

15. Which is a weakness of expansionary fiscal policy?

    • it has no effect on aggregate demand in any circumstance
    • it always reduces the budget deficit because spending rises, since extra output raises tax receipts by more than the cost of the spending
    • it may increase government borrowing and debt, and may crowd out private spending in some circumstances
    • it removes all inflationary pressure from the economy, because higher spending always increases the supply of goods by the same amount

16. Which statement about the Great Depression and demand-side policy is most accurate?

    • Economists disagree over whether the Great Depression was worsened by insufficient demand or by monetary contraction and bank failures
    • There is universal agreement that the Great Depression was caused by excessive government spending, which crowded out private investment
    • The Great Depression showed that demand-side policy has no role in recovery
    • The Great Depression was caused by a rise in interest rates in every country

17. Which response to the Global Financial Crisis of 2008 is consistent with demand-side policy?

    • lowering interest rates and using asset purchases (QE) to support spending and lending
    • increasing tariffs on imports to protect domestic industry
    • raising interest rates sharply to reduce household debt, which was seen as the main route to restoring stability in banking after 2008
    • cutting government spending to balance budgets immediately, which was the main policy response adopted by most governments in 2008 and 2009

18. Which statement best evaluates demand-side policy in response to a recession?

    • It can support demand quickly, but its effectiveness depends on confidence, credit conditions and the size of any fiscal deficit
    • It only affects prices and never output in any period, because demand policy changes the price level without any effect on real activity
    • It is always effective because demand is fixed in every economy
    • It is never effective because the economy always returns to full employment automatically

19. Which of these best describes a monetary policy transmission mechanism?

    • changes in the Bank Rate directly set the level of government spending
    • changes in the Bank Rate affect only the exchange rate and not spending, because the rate operates solely through currency markets
    • changes in the Bank Rate directly change tax rates on incomes, so the central bank adjusts how much households pay to the government
    • changes in the Bank Rate affect market interest rates, borrowing, spending and so aggregate demand

20. Which statement about the Monetary Policy Committee's independence is most accurate?

    • It has no link to the inflation target at all, because the committee sets rates to meet its own internal objectives rather than any target
    • It sets interest rates independently of the government, but works within the government's inflation target
    • It sets government spending and tax rates independently of the Treasury, so the committee decides how much the government spends each year
    • It sets the government's inflation target independently each year, so the committee chooses the target that the Chancellor must then meet

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