B — $200bn and $100bn.

G enters autonomous spending one-for-one: ΔPAE = 100, multiplier 1/(1 − 0.5) = 2, so ΔY = 200. The tax cut enters as −cT: ΔPAE = 0.5 × 100 = 50, so ΔY = 50 × 2 = 100. Dollar for dollar, spending is twice as powerful here, because households save part of a tax cut.

C is the trap: it stops at ΔPAE and never applies the multiplier. (The counterargument for tax cuts is speed — they reach people faster than new programs can be stood up.)

C — decreases the surplus, raises PAE.

The surplus is T − G. Expansion means spending more or taxing less, both of which shrink T − G while pushing planned spending up.

B is the trap — it is the definition of contractionary policy. These two get inverted more than any other pair in the chapter, so read the word before you answer.

B — $200bn.

The multiplier is 1/(1 − 0.75) = 4, so an $800bn output gap was produced by a PAE shift of 800/4 = 200. Reversing a 200 shift reverses the whole 800 gap, because the same multiplier applies in both directions.

A is the trap: sizing the policy to ΔY rather than ΔPAE, which over-stimulates by a factor of the multiplier.

C — debt does not have to be repaid.

The course is explicit that debt can be serviced rather than repaid. That is precisely why the intergenerational worry is framed as higher servicing costs (option D), not as a looming repayment.

D is the trap for anyone skimming: it sounds like the same claim as C, but it is the correct version of it.

(a) Multiplier = 1/(1 − 0.75) = 4. ΔY = 4 × (−400) = −$1,600bn.

(b) G enters autonomous spending one-for-one, so raise G by $400bn — match the shift in PAE, not the $1,600bn output gap.

(c) A tax cut enters as −cΔT, so it must be larger: ΔPAE = 0.75 × cut = 400 ⟹ cut taxes by $533.3bn. Households save the other quarter.

(d) Spending is stronger per dollar, so it is the cheaper way to close the gap; tax cuts are defensible because they reach households faster than new programs can be stood up. The real difficulty is timing and magnitude: you cannot directly observe how far PAE has shifted, and you need a forecast of how long it stays depressed — if more than a year, the stimulus must last more than a year. The 2009 Recovery Act counteracted some, but by no means all, of the 2008–09 fall.

On the diagram: PAE₁ shifts down in parallel by 400 to PAE₂, output slides from Y₁ to Y₂ (a fall of 1,600); the policy shifts the line back up by 400 to PAE₃, restoring Y₁.

Investment. Housing is a form of capital, and the bust slashed its expected future MRP_K, which by Unit 14 lowers the present value of new housing capital and therefore investment in it. The financial crisis then damaged animal spirits and made credit hard for firms to obtain. Both cut I^P.

Consumption. Collapsing house and stock prices destroyed wealth, and wealth is a determinant of C. The crisis also hurt consumer confidence and restricted household access to credit. The bubble had already pushed C and I^P above normal and left households heavily indebted, which made the reversal sharper.

Both shift PAE down, and the multiplier turns that into a larger fall in Y.

Constraints. Savers must be willing to buy the debt; state and local governments face balanced budget requirements that force service and school cuts in exactly the wrong part of the cycle; and the federal government faces debt ceilings and budget fights — the 2025 shutdown was the longest on record, ended by a continuing resolution on 12 November 2025. Federal debt held by the public is already historically high, and the CBO projects the July 2025 reconciliation bill adds about 9.5 percentage points by 2034.