Fiscal Policy Practice Questions

8 representative multiple-choice questions on fiscal policy for AP Macroeconomics, drawn from our 39-question bank for this module. Work through each one, then open “Show answer” for the correct choice and an explanation. For scored, timed practice across the full bank, take a full practice test.

Prefer to read? The same questions, with answers

1. 1. Which of the following describes expansionary fiscal policy?

   • A. The Federal Reserve lowers interest rates by buying bonds
   • B. Congress increases government spending or cuts taxes to boost aggregate demand
   • C. The Treasury pays down the national debt
   • D. Congress raises taxes to reduce the budget deficit
   Show answer

   Correct answer: B. Congress increases government spending or cuts taxes to boost aggregate demand

   Expansionary fiscal policy is Congress using spending increases or tax cuts to shift AD right, boost real GDP, and lift the price level. The 2009 Recovery Act ($831B) and the 2020 CARES Act ($2.2T) are the textbook examples. Option A describes monetary policy, which is handled by the Fed, not Congress. Option C is a debt management decision, not policy aimed at AD. Option D is contractionary fiscal policy and does the opposite of what the question asks.

2. 2. In the AD/AS model, contractionary fiscal policy would:

   • A. Shift AD to the left, decreasing the price level and real GDP
   • B. Shift AD to the right, increasing the price level and real GDP
   • C. Shift SRAS to the right, decreasing the price level
   • D. Shift LRAS to the left, decreasing potential output
   Show answer

   Correct answer: A. Shift AD to the left, decreasing the price level and real GDP

   Contractionary fiscal policy cuts spending or raises taxes, which pulls AD left. Output falls along SRAS, and the price level drops. The policy is aimed at inflationary gaps, but it's politically difficult because nobody wants to vote for tax hikes or spending cuts. Option B describes expansionary policy, which is the opposite. Options C and D incorrectly locate fiscal policy on the supply side of the AD/AS model.

3. 3. An increase in the progressive income tax rate structure primarily functions as:

   • A. A discretionary fiscal policy tool
   • B. An automatic stabilizer that reduces disposable income during expansions
   • C. A monetary policy tool used by the Federal Reserve
   • D. A way to increase the money supply
   Show answer

   Correct answer: B. An automatic stabilizer that reduces disposable income during expansions

   A progressive tax structure is automatic because it doesn't require new laws once set up. During expansions, rising incomes push households into higher brackets, which pulls purchasing power out of the economy without any legislative action. During contractions, falling incomes move people into lower brackets automatically, which softens the blow. This happens quietly in the background across millions of taxpayers. Option A confuses the initial rate-setting decision (discretionary) with the automatic ongoing stabilization (structural).

4. 4. A supply-side economist would argue that tax cuts targeted at investment and business activity:

   • A. Only affect aggregate demand through the multiplier effect
   • B. Shift both AD (via increased disposable income) and LRAS (via increased incentives to work, save, and invest) rightward
   • C. Only benefit high-income households and have no macroeconomic impact
   • D. Reduce government revenue but have no effect on output
   Show answer

   Correct answer: B. Shift both AD (via increased disposable income) and LRAS (via increased incentives to work, save, and invest) rightward

   Supply-side economics argues that well-designed tax cuts boost both demand and supply. The demand channel works through higher disposable income and the standard multiplier. The supply channel works through sharper incentives to work, save, and invest, which expands productive capacity and shifts LRAS right. The 1981 Reagan tax cuts and the 2017 Tax Cuts and Jobs Act are contentious but classic real-world applications of this framework. Option A captures only the demand-side piece. The AP exam does test the distinction between demand-side and supply-side fiscal policy effects, so understanding both channels matters.

5. 5. Same $500 billion gap, same MPC of 0.8, but the government wants to use a tax cut instead. How large must the cut be?

   • A. $125 billion
   • B. $500 billion
   • C. $625 billion
   • D. $100 billion
   Show answer

   Correct answer: A. $125 billion

   The tax multiplier has magnitude 4, so 500 / 4 = $125 billion. A tax cut always has to be LARGER than the equivalent spending increase, because households save part of it, and only the spent part enters the multiplier chain. Answering $100 billion applies the spending multiplier to a tax change, which is the most common error in this topic.

6. 6. Why does a progressive income tax act as an automatic stabilizer during a boom?

   • A. Tax rates are cut when incomes rise
   • B. As incomes rise, a larger share is taken in tax, damping the increase in disposable income
   • C. The government spends more during booms
   • D. It shifts long-run aggregate supply left
   Show answer

   Correct answer: B. As incomes rise, a larger share is taken in tax, damping the increase in disposable income

   As incomes rise, taxpayers move into higher brackets and the average tax rate rises, so disposable income grows more slowly than pre-tax income. That restrains consumption and cools the boom without any policy decision. It works symmetrically in a recession, when falling income pushes people into lower brackets.

7. 7. The economy is in a recessionary gap. Which combination of policies is expansionary on both fronts?

   • A. Raise taxes and buy bonds
   • B. Cut taxes and sell bonds
   • C. Raise government spending and buy bonds
   • D. Cut government spending and raise the discount rate
   Show answer

   Correct answer: C. Raise government spending and buy bonds

   Raising government spending is expansionary fiscal policy and buying bonds is expansionary monetary policy, so both shift AD right. The pairs that raise taxes while buying bonds, or cut taxes while selling bonds, each mix one expansionary action with one contractionary one, and cutting spending alongside a higher discount rate is contractionary on both. Questions like this test whether you can classify each lever independently before combining them.

8. 8. A government cuts taxes by $125 billion when MPC = 0.8. What is the resulting change in real GDP, ignoring crowding out?

   • A. An increase of $625 billion
   • B. A decrease of $500 billion
   • C. An increase of $100 billion
   • D. An increase of $500 billion
   Show answer

   Correct answer: D. An increase of $500 billion

   Multiply the tax change by the tax multiplier: a cut of $125 billion is a change of -125, and -125 x -4 = +$500 billion. The two negatives are where most errors happen. $625 billion applies the spending multiplier of 5, which overstates the effect because part of a tax cut is saved.