These are original Marlbridge practice questions, not past exam questions. All questions use Valdoria, a fictional country whose currency is the valda (VD); all data are fictional. The rubrics are a suggested Marlbridge rubric to help you check your work; they are not an official scoring guideline. Assumptions: tax rates and benefit rules stay the same unless a question says otherwise; national income is treated as equal to real GDP; calculations look at the first round of spending only.
Question 1 (multiple choice · foundation)
Which of the following is an automatic stabilizer?
- (A) A law, passed during a recession, that cuts income tax rates for one year
- (B) Unemployment benefit payments that increase as more workers lose their jobs
- (C) A government decision to build new railway lines when unemployment is high
- (D) The central bank lowering interest rates when real GDP falls
Answer and explanation
Answer: (B). The benefit rules already exist. When more workers lose their jobs, more people qualify, so transfer payments rise with no new decision. This supports disposable income and consumption in a recession.
- (A) is discretionary fiscal policy. The tax cut needs a new law, with the decision and implementation lags that come with it.
- (C) is a deliberate change in government purchases, so it is also discretionary fiscal policy.
- (D) is monetary policy, not fiscal policy. Automatic stabilizers are part of the government’s tax and transfer system.
Question 2 (multiple choice · foundation)
Valdoria enters a recession. Its tax rates do not change. Which of the following best describes what happens?
- (A) Tax revenue falls, so households’ disposable income falls by less than their income.
- (B) Tax revenue rises, because the government needs more money to pay for unemployment benefits.
- (C) Tax revenue falls, so households’ disposable income falls by more than their income.
- (D) Tax revenue does not change, because the tax rates do not change.
Answer and explanation
Answer: (A). With lower incomes, spending and profits, households and firms pay less tax at the same rates. Part of the loss of income is a loss of tax, not of disposable income, so disposable income and consumption fall by less.
- (B) gets the direction wrong. Revenue depends on incomes and spending, which fall in a recession. Nothing in the tax rules raises revenue to match benefit spending.
- (C) reverses the cushioning effect. Paying less tax makes the fall in disposable income smaller.
- (D) confuses tax rates with tax revenue. Revenue = rate × the amount being taxed, and the amount being taxed has fallen.
Question 3 (multiple choice · core)
In a Valdorian recession, national income falls by VD 40 billion in the first round. Tax revenue falls by 30% of the fall in income, and transfer payments rise by VD 3 billion. The MPC is 0.75. By how much does consumption fall in the first round?
- (A) VD 18.75 billion
- (B) VD 21.00 billion
- (C) VD 25.00 billion
- (D) VD 30.00 billion
Answer and explanation
Answer: (A). Tax revenue falls by 0.30 × 40 = VD 12 billion. Change in disposable income = −40 + 12 + 3 = −VD 25 billion. Consumption falls by 0.75 × 25 = VD 18.75 billion.
- (B) ignores the rise in transfers: 0.75 × (40 − 12) = 21.
- (C) is the fall in disposable income, not in consumption. You still need to multiply by the MPC.
- (D) ignores both stabilizers: 0.75 × 40 = 30. This is what would happen if neither taxes nor transfers responded to income.
Question 4 (multiple choice · core)
Which of the following is the main advantage of automatic stabilizers over discretionary fiscal policy?
- (A) They remove recessionary and inflationary gaps completely.
- (B) They begin to act as soon as incomes change, without waiting for a decision to be made and put into practice.
- (C) They keep the government budget balanced every year.
- (D) They increase the economy’s full-employment output, shifting LRAS to the right.
Answer and explanation
Answer: (B). Discretionary policy has lags: the time to agree on a policy and the time to put it into action. Stabilizers are already built into the tax and benefit rules, so they respond straight away.
- (A) overstates their effect. They make AD shift by less, so gaps are smaller, but the gaps do not disappear.
- (C) is the opposite of what happens. Lower revenue and higher transfers in a recession make the budget balance worse automatically.
- (D) confuses short-run demand management with long-run growth. Stabilizers affect AD, not LRAS.
Question 5 (calculation · core)
In this question, Valdoria’s income tax takes 20% of each valda of income and the MPC is 0.9. During an expansion, national income rises by VD 50 billion in the first round, and fewer people qualify for benefits, so transfer payments fall by VD 2 billion.
(a) Calculate the change in tax revenue. (b) Calculate the change in disposable income. (c) Calculate the change in consumption, and compare it with the change if taxes and transfers did not respond to income. (d) By how much does the government’s budget balance change? Did the government change policy?
Worked solution
(a) 0.20 × 50 = +VD 10 billion.
(b) 50 − 10 + (−2) = +VD 38 billion.
(c) 0.9 × 38 = +VD 34.20 billion. Without stabilizers: 0.9 × 50 = VD 45 billion. Consumption rises by VD 10.80 billion less, so spending grows more slowly and the economy is less likely to overheat.
(d) Revenue is up by VD 10 billion and transfers are down by VD 2 billion, so the budget balance improves by VD 12 billion. The government changed no policy: the tax rate and benefit rules are the same.
Suggested mark points (4): 1 for the change in tax revenue; 1 for disposable income, subtracting the tax and the fall in transfers; 1 for VD 34.20 billion with the comparison to VD 45 billion; 1 for VD 12 billion with the statement that no policy changed. Carry forward an error from (a) or (b).
Question 6 (constructed response · core)
Valdoria is in long-run equilibrium when a recession in its main trading partners sharply reduces demand for Valdorian exports.
(a) Draw a correctly labelled AD–AS graph showing Valdoria’s long-run equilibrium. Label full-employment output Yf and the price level PL₁. (b) On your graph, show the effect of the fall in exports on aggregate demand. Label the new short-run equilibrium output Y₂ and price level PL₂. (c) Valdoria’s income tax takes 25% of each valda of income. National income falls by VD 40 billion in the first round. Calculate the automatic change in income tax revenue. (d) In the same period, 100,000 more workers become unemployed, and each receives a benefit of VD 20,000 a year. With an MPC of 0.8, calculate the first-round change in consumption. (e) Explain how the changes in (c) and (d) affect the size of the change in real GDP, compared with an economy whose taxes and transfers do not respond to income.
Worked solution and suggested Marlbridge rubric
(a) Axes labelled “Price level” (vertical) and “Real GDP” (horizontal). A downward-sloping AD₁, an upward-sloping SRAS and a vertical LRAS all cross at one point, with Yf on the horizontal axis and PL₁ on the vertical axis.
(b) AD shifts left to AD₂. The new equilibrium is where AD₂ crosses SRAS, with Y₂ to the left of Yf and PL₂ below PL₁.
(c) 0.25 × (−40) = −VD 10 billion. Revenue falls by VD 10 billion, though the tax rate is unchanged.
(d) Transfers rise by 100,000 × VD 20,000 = VD 2 billion. Change in disposable income = −40 + 10 + 2 = −VD 28 billion. Change in consumption = 0.8 × (−28) = −VD 22.40 billion.
(e) Without stabilizers, consumption would fall by 0.8 × 40 = VD 32 billion. Lower tax payments and higher transfers protect part of households’ disposable income, so consumption falls by VD 9.60 billion less in the first round, and the later rounds are smaller too. AD shifts left by less than it would otherwise, so real GDP (and the price level) fall by less: the recessionary gap is smaller. It is not removed: Y₂ is still below Yf.
| Point | What earns it |
|---|---|
| 1 | Correctly labelled long-run equilibrium with AD, SRAS and LRAS crossing at Yf and PL₁ |
| 1 | AD shifted left, with Y₂ below Yf and PL₂ below PL₁ |
| 1 | Tax revenue falls by VD 10 billion |
| 1 | Consumption falls by VD 22.40 billion (disposable income −28 seen or implied) |
| 1 | Explains that smaller falls in disposable income and consumption make AD fall by less, so real GDP falls by less than without stabilizers |
Accept values carried forward from an earlier error. In (e), “stabilizers help the economy” with no link to disposable income or consumption does not earn the point. An answer saying stabilizers return output to Yf does not earn it either.
Question 7 (constructed response · stretch)
Valdoria’s full-employment output is VD 840 billion. It currently raises income tax with a proportional tax of 20% of income. A minister proposes replacing it with a fixed tax of the same amount on every one of Valdoria’s 4.2 million households, set so that it raises the same revenue when output is at full employment.
(a) Calculate the revenue from the current tax at full employment, and the fixed tax each household would pay. (b) A recession cuts national income from VD 840 billion to VD 810 billion. Calculate the tax revenue under each system. (c) With an MPC of 0.8 and no change in transfers, calculate the first-round fall in consumption under each system. (d) Explain which system is the stronger automatic stabilizer, and why the minister’s plan could make Valdoria’s business cycle more severe in both directions.
Model answer and suggested Marlbridge rubric
(a) 0.20 × 840 = VD 168 billion. Fixed tax = VD 168,000,000,000 ÷ 4,200,000 = VD 40,000 per household.
(b) Proportional: 0.20 × 810 = VD 162 billion (a fall of VD 6 billion). Fixed: still VD 168 billion, because every household pays VD 40,000 whatever its income.
(c) Proportional: disposable income falls by 30 − 6 = VD 24 billion, so consumption falls by 0.8 × 24 = VD 19.20 billion. Fixed: disposable income falls by the full VD 30 billion, so consumption falls by 0.8 × 30 = VD 24 billion.
(d) The proportional tax is the stronger stabilizer. Its revenue falls when incomes fall, so it cushions disposable income and consumption in a recession. In an expansion its revenue rises, which slows consumption and helps prevent overheating. The fixed tax collects the same amount whatever happens to income, so it gives no cushion in a recession and no brake in a boom. Swings in consumption and AD would be larger, so recessions would be deeper and booms more inflationary.
| Point | What earns it |
|---|---|
| 1 | VD 168 billion and VD 40,000 per household |
| 1 | VD 162 billion (proportional) and VD 168 billion (fixed) |
| 1 | Consumption falls of VD 19.20 billion and VD 24 billion |
| 1 | Identifies the proportional tax as the stronger stabilizer because its revenue moves with income |
| 1 | Explains both directions: no cushion for consumption in a recession and no restraint in an expansion, so swings in AD are larger |
Accept the fixed-tax fall in consumption written as “the same as with no stabilizer”. The last point needs both the recession and the expansion side.
How did you do?
- Q1 or Q4 wrong: re-read “The idea: a fiscal policy that runs itself” and Worked example 3 in the study guide.
- Q2 or Q7 wrong: revisit “Taxes as automatic stabilizers”.
- Q3, Q5 or Q6(c)–(d) wrong: work through Worked examples 1 and 2; check the signs in income − taxes + transfers.
- Q6(a)–(b) or (e) wrong: revisit “Showing the effect in the AD–AS model” and Figure 1.
Then tick off the topic checklist.