2.2.4 Government Expenditure — Practice Questions

Six original multiple-choice questions on government expenditure, written to the style and difficulty of Edexcel Paper 2 Section A.

6 questions Edexcel A-Level Multiple choice Model answers included

Not read the notes yet? Start with the 2.2.4 Government Expenditure revision notes.

1. 1. In a recession, welfare spending rises and tax receipts fall without any minister deciding anything. The government then also announces a new road-building programme. The second of these is

   Definition in context

   Select one answer

   A An automatic stabiliser.

   B Contractionary fiscal policy.

   C Discretionary fiscal policy.

   D A supply-side policy only.
   Show model answer

   Answer: C (Discretionary fiscal policy.). The stem deliberately puts the two side by side. The first half is an automatic stabiliser: spending and receipts move with the cycle on their own, with nobody choosing it.
   The road programme is the opposite. Someone decided to do it, so it is discretionary fiscal policy — a deliberate change in spending made to pursue a policy aim.
   The practical difference is timing. Stabilisers act immediately; discretionary measures need a decision, legislation and time to build, by which point the recession may be over.

   Why the other options are wrong

   • A — Automatic stabilisers require no decision. The road programme was announced, which is what makes it discretionary.
   • B — The programme raises spending, so it is expansionary. Contractionary policy would cut spending or raise taxes.
   • D — Roads do raise productive potential, so there is a supply-side element. But the spending raises aggregate demand immediately too, so calling it supply-side only misses half of what it does.

2. 2. An economy enters a strong boom. With no change in policy at all, the government's budget position will tend to

   Applied reasoning

   Select one answer

   A Improve, as receipts rise and welfare spending falls.

   B Improve, as ministers cut spending deliberately.

   C Worsen, as receipts fall and welfare spending rises.

   D Worsen, as the government must raise its borrowing.
   Show model answer

   Answer: A (Improve, as receipts rise and welfare spending falls.). In a boom more people are working and earning, so income tax and National Insurance receipts rise, and VAT receipts rise with spending. At the same time fewer people claim unemployment-related benefits, so welfare spending falls.
   Both movements improve the budget, and neither needed a decision. That is the automatic fiscal contraction side of the stabilisers: by taking money out of a fast-growing economy, they cool it without anyone having to act.

   Why the other options are wrong

   • B — The improvement here is automatic. The stem specifies that policy has not changed.
   • C — This describes a recession, when receipts fall and welfare claims rise. A boom does the reverse.
   • D — Borrowing falls in a boom, because the gap between spending and receipts narrows.

3. 3. A government increases spending on new hospitals by £8bn in an economy with substantial spare capacity. The most likely effect is

   Applied reasoning

   Select one answer

   A No change in either real GDP or the price level.

   B No change in real GDP and a higher price level.

   C Higher real GDP and a sharply higher price level.

   D Higher real GDP with little price level effect.
   Show model answer

   Answer: D (Higher real GDP with little price level effect.). Government spending is a direct component of aggregate demand, so £8bn of hospital building shifts AD to the right.
   What happens next depends entirely on spare capacity. With unemployed workers and idle equipment available, firms meet the extra demand by producing more rather than by raising prices. Real GDP rises and the price level barely moves.
   The same £8bn in an economy at full capacity would do the opposite, which is why the state of the economy matters as much as the size of the injection.

   Why the other options are wrong

   • A — Aggregate demand has risen, so something must change. AD is a component of the model, not a bystander.
   • B — Prices rise instead of output only when there is no spare capacity to draw on. The stem says there is substantial spare capacity.
   • C — A sharply higher price level is the full-capacity outcome. With slack in the economy the pressure on prices is mild.

4. 4. Government spending on transport infrastructure raises aggregate demand in the short run. Its distinctive long-run effect is that it

   Applied reasoning

   Select one answer

   A Increases welfare payments automatically.

   B Raises the economy's productive potential.

   C Reduces the government's budget deficit.

   D Reduces the marginal propensity to consume.
   Show model answer

   Answer: B (Raises the economy's productive potential.). Roads, railways and ports are capital. Once built, they lower transport costs and raise productivity across every industry that uses them.
   That shifts long-run aggregate supply to the right — the economy can produce more than before. Combined with the short-run boost to AD, it is why infrastructure spending is treated as both a demand-side and a supply-side measure, and why it is the form of government spending most often defended on growth grounds.

   Why the other options are wrong

   • A — Welfare payments move with the economic cycle as automatic stabilisers. They have nothing to do with building a railway.
   • C — The spending adds to the deficit in the short run. Any improvement comes much later, and only if the growth it generates raises tax receipts by more than the cost.
   • D — Nothing here changes how households divide extra income between spending and saving.

5. 5. Table 1 lists four pressures on a government's spending plans.
   Using Table 1, the pressure that raises spending automatically rather than by decision is

   Data interpretation

   Table 1: Four pressures on spending plans

   	Pressure
   Pressure 1	The share of the population aged over 70 is rising
   Pressure 2	A manifesto promised more police officers
   Pressure 3	Unemployment rises as the economy slows
   Pressure 4	Ministers decide to expand apprenticeship funding

   Select one answer

   A Pressure 1.

   B Pressure 2.

   C Pressure 3.

   D Pressure 4.
   Show model answer

   Answer: C (Pressure 3.). The test is whether anyone has to decide anything. Rising unemployment raises welfare spending through the existing benefit system: more people qualify, so more is paid out, with no new policy at all.
   That is an automatic stabiliser in operation, and it supports aggregate demand at exactly the moment the economy is weakening. The other three all require a choice, whatever pressure lies behind them.

   Why the other options are wrong

   • A — An ageing population does raise pension and healthcare spending, but the level of pensions and the shape of the health service are still set by decisions.
   • B — A manifesto promise is a political choice about priorities, however firmly it has been made.
   • D — Expanding apprenticeship funding is a deliberate decision, and a discretionary supply-side one at that.

6. 6. A government raises its spending sharply while the economy is already operating at full capacity. The most likely result is

   Applied reasoning

   Select one answer

   A Higher prices with little extra real output.

   B Higher real output with a stable price level.

   C Lower prices alongside higher real output.

   D No effect on either prices or real output.
   Show model answer

   Answer: A (Higher prices with little extra real output.). Aggregate demand shifts right, but at full capacity there is nothing left to draw on — no idle workers, no spare machinery. Firms cannot produce more, so the extra demand competes for output that already exists.
   The result is inflationary pressure rather than growth. This is the mirror image of the spare-capacity case, and it is the standard argument against fiscal expansion late in a boom: the same policy that raises output in a slump raises only prices at the peak.

   Why the other options are wrong

   • B — Higher output with stable prices is what happens when there is spare capacity. At full capacity the output cannot be produced.
   • C — Rising aggregate demand pushes the price level up, not down, and the output constraint is binding either way.
   • D — Government spending is a component of AD, so raising it must have an effect. At full capacity that effect lands almost entirely on prices.