Reference no: EM131025925

Practice Questions 5-

I. True/False and explain:

1. If Diana makes a ten dollar cash withdrawal from her checking account, M1 has risen by $10, ceteris paribus.

2. If the required reserve ratio is increased, the money multiplier will decrease.

3. The required reserve ratio is the Fed's most frequently used tool of monetary policy.

4. An advantage of barter over money is that, in a barter system, there is no need for a double coincidence of wants.

5. Demand deposits are assets of the commercial banks.

6. The mismatch between the timing of money inflow and the timing of money outflow is called the synchronization of income and spending.

7. When market interest rates rise, bond values fall.

8. An increase in the price level causes the demand for money curve to shift to the right.

9. In a recession, where many people are unemployed and have low incomes, the demand for money is very high.

10. An easy money policy will reduce the equilibrium rate of interest.

II. Multiple Choice Questions:

1. The store of value function of money refers to the ability of money to:

a. generate valuable interest earnings over time.

b. purchase valuable durable commodities.

c. retain its purchasing power over time.

d. buy surplus output for future consumption.

2. Which of the following assets is included in M2 but not in M1?

a. Federal Reserve Notes.

b. Money market accounts.

c. Travelers' checks.

d. Demand deposits.

3. First National Bank is a commercial bank. Which of the following items are among First National Bank's assets?

a. Deposits of First National Bank's customer, Mr. Smith.

b. Loan by First National Bank to Mr. Smith.

c. Currency held by the public.

d. First National Bank's net worth.

4. The required reserve ratio is 20%. Given the following T account for First National Bank (a commercial bank) which is fully loaned up, determine the level of reserves::

Assest                            Liabilities

Reserves                        Deposits      800 
Loans                            Net Worth    200 
Total                              Total         1000

a. 0.

b. 40.

c. 160.

d. 200.

5.  First National Bank is currently loaned up. Which of the following will occur if the required reserve ratio for the banking system is increased?

a. First National Bank will have additional reserves available.

b. First National Bank will have to reduce the volume of its new loans.

c. First National Bank will increase its deposits until the ratio is reduced to 10% once more.

d. First National Bank will be able to increase the volume of its loans because it is no longer fully loaned up.

6. The banking system is closed and fully loaned up. The required reserve ratio is 10%. Now Mr. Smith deposits a $100 bill into his account at First National Bank. Loans in the banking system can increase by _______ and the money supply can increase by _______.

a. $900, $900.

b. $900, $1000.

c. $1000, $900.

d. $1000, $1000.

7. The required reserve ratio is 25%. Commercial banks are fully loaned up and have total deposits of $1200 million. Now the required reserve ratio is reduced to 20%. The money supply will increase by:

a. $240 million.

b. $300 million. Banking system reserves can support $1200 million when the reserve ratio is 25%. Reserves must be $300 million. When the money multiplier increases to 5, the money supply can increase to $1500 million.

c.  $1500 million.

d.  $6000 million.

8.  Which of the following pairs of actions by the Fed will have the greatest likelihood of increasing the money supply?

a. A decrease in the required reserve ratio and an increase in the discount rate.

b. An open market sale of government securities and an increase in the discount rate.

c. An open market sale of government securities and a decrease in the required reserve ratio.

d. An open market purchase of government securities and a decrease in the required reserve ratio.

9.  Which of the following factors will not reduce the size of the money multiplier?

a. Banks become more willing to hold excess reserves.

b. More of the individuals who have received bank loans prefer to hold the currency rather than to redeposit the funds in the banking system.

c. The required reserve ratio is increased.

d. The Fed reduces the discount rate.

10.  Which of the Fed's policy tools for controlling the money supply is the most significant?

a. The required reserve ratio, because it directly controls the money multiplier.

b. The discount rate, because the ultimate goal of the Fed is to control lending and interest rates.

c. Moral suasion.

d. Open market operations, because buying and selling of government securities can be done quickly and with precision.

11. If I loan the U. S. government $940 today and the U. S. government repays me the amount of $1,000 exactly one year from today, the interest rate I would earn would be

a. 6.4%.

b. 6.0%.

c. $60.

d. 106.4%

12. Jim's optimal money balance would be larger the __________ the rate of interest and the ___________ his money management costs.

a. higher; lower

b. higher; higher

c. lower; higher

d. lower; lower

13. According to the speculative motive, when the interest rate is below normal, people expect bond prices to __________ in the future. As a result, the demand for money tends to be __________ today.

a. rise; larger

b. fall; larger

c. rise; smaller

d. fall; smaller

14.  The __________ the price level, the lower is the demand for money and the lower the aggregate output (income), the __________ is the demand for money.

a. lower; lower

b. lower; higher

c. higher; lower

d. higher; higher

15.  To macroeconomists, the demand for money refers to

a. the desire to borrow money for consumption and investment purposes.

b. the desire to earn income.

c. the desire to be wealthy.

d. how much of their financial assets people wish to hold in the form of money.

16.  A change in the level of aggregate output (income) will cause __________ the demand for money curve and a change in the interest rate will cause __________ the demand for money curve.

a. a movement along; a movement along

b. a movement along; a shift in

c. a shift in; a movement along

d. a shift in; a shift in

17. The demand for money curve has a __________ slope and the supply of money curve has a __________ slope.

a. negative; vertical

b. negative; positive

c. vertical; negative

d. positive; negative

18. When the interest rate is above the equilibrium level

a. there is an excess supply of money and both bond prices and the rate of interest will fall.

b. there is an excess supply of money, bond prices rise, and the interest rate falls.

c. there is a shortage of money, bond prices fall, and the interest rate rises.

d. there is an excess supply of money, bond prices fall, and the rate of interest rises.

19.  A tight monetary policy occurs when

a. the U. S. government reduces its purchases of goods and services thus keeping money out of the economy.

b. the U. S. government reduces personal taxes forcing itself to cut its own spending.

c. a recession has occurred, people have lost jobs and income, and consumption spending fall.

d. the Federal Reserve reduces the money supply.

20. An easy money policy would

a. shift the demand for money curve down.

b. shift the money supply curve upward.

c. shift the supply of money curve to the right.

d. shift the demand for money curve to the left and the supply of money curve to the right.

21. Which of the following statements regarding money is incorrect?

a. Money is a medium of exchange.

b. Money reduces transaction costs.

c. Money increases the gains from trade.

d. Money reduces the need to specialize.

22. The value (purchasing power) of fiat money is determined by

a. the quantity of gold which backs it.

b. the price level.

c. its intrinsic value.

d. the government which issues it.

23. The money supply measure known as M1 does not include

a. paper currency and coins.

b. demand deposits and other checkable deposits.

c. traveler's checks.

d. savings deposits.

24. M2 is equal to M1

a. minus currency plus savings deposits.

b. plus savings deposits.

c. plus savings deposits, small-denomination time deposits, and money market mutual funds.

d. plus savings deposits, small-denomination time deposits, and treasury bonds.

25. Which of the following would appear on the asset side of a commercial bank balance sheet?

a. Vault cash and reserves at the Fed.

b. Loans outstanding.

c. U.S. government securities.

d. All of the above.

26. Banks are required by law to keep a fraction of their checking deposits in the form of an asset known as

a. excess reserves.

b. required reserves.

c. borrowed reserves.

d. U.S. government reserves.

27. The early goldsmiths' actions contributed to the expansion of the money supply by

a. extending loans to customers.

b. keeping only a fraction of the gold deposited with them as a reserve.

c. issuing certificates for deposited gold which were later used as money.

d. all of the above.

28. If First Whistler's Bank confronts a 20 percent reserve requirement and has excess reserves of $1,000,000, what is the maximum amount of additional loans that this bank can extend?

a. $200,000.

b. $800,000.

c. $1,000,000.

d. $5,00,000.

29. The potential deposit expansion multiplier is equal to

a. 1/required reserve ratio.

b. 1/excess reserves.

c. excess reserve ratio/required reserve ratio.

d. deposits/reserves.

30. If the banking system has $3 billion in excess reserves and the required reserve ratio is 25.0 percent, the banking system as a whole could increase the money supply by a maximum of

a. $3 billion.

b. $12 billion.

c. $15 billion.

d. $75 billion.

31. Which of the following will cause the actual deposit expansion multiplier to fall?

a. People decide to take part of their loans in the form of currency rather than checking deposit.

b. Banks decide that they will no longer keep excess reserves.

c. The Fed reduces banks' actual reserves.

d. All of the above.

32. The decision-making center of the Fed is

a. the Board of Governors.

b. the Federal Open Market Committee.

c. the U.S. Congress.

d. the President's Council of Economic Advisors.

33. Which of the following would cause an increase in the money supply?

a. An increase in the required reserve ratio.

b. A decrease in the discount rate.

c. A sale of government securities by the Federal Reserve.

d. None of the above.

34. Which one of the following would cause households and businesses to want to hold greater money balances?

a. A higher price level in the economy.

b. Lower nominal interest rates.

c. An expansion in real GDP.

d. All of the above.

35. The view that erratic monetary policy is the chief cause of fluctuations in real GDP and inflation is held by the group of economists known as

a. monetarists.

b. Keynesians.

c. classical economists.

d. all of the above.

36. If the interest rate is below the equilibrium level of interest people will want to

a. decrease their holdings of money balances.

b. increase their holdings of money balances.

c. hold their money balances constant at current levels.

d. keep the quantity of bonds they hold constant at current levels.

37. Given the money supply and money demand curve, people may be expected to want to increase their purchases of bonds if the interest rate is

a. i1.

b. i2.

c. i3.

d. None of these interest rates will impact the bond market.

38. Omit:  will not be covered this semester

39.  Omit: will not be covered this semester

40. The initial effect of an unanticipated shift to expansionary monetary policy will be

a. increased prices, interest rates, output, and employment.

b. increased prices, lower interest rates, and increased output and employment.

c. decreased prices, interest rates, output, and employment.

d. decreased prices and interest rates, and increased output and employment.

41. The economic relationships defined by the equation of exchange include:

a. MV = PY.

b. Velocity is equal to money supply divided by nominal GDP.

c. Rate of inflation + Growth rate of real output = Growth rate of money supply + Growth rate of velocity.

d. All of the above.

42. If the money supply is $125 billion and the nominal GDP is $500 billion, then the velocity of money is

a. 2.

b. 4.

c. 8.

d. 0.25.

43. Modern economic analysis suggests that in the long run a sustained increase in money supply growth relative to the growth rate of potential real GDP will

a. have no effect on the nominal interest rate.

b. cause a higher inflation rate.

c. cause the real output level to rise.

d. all of the above.

44. The initial effects of a more expansionary monetary policy may be

a. strengthened by the effect of lower nominal interest rates on the velocity of money.

b. weakened by the effect of higher nominal interest rates on the velocity of money.

c. strengthened by the effect of higher nominal interest rates on the velocity of money.

d. weakened by the effect of lower nominal interest rates on the velocity of money.

45. Historically in the United States, recessions

a. have usually been preceded by an increase in the growth rate of the money supply.

b. have usually been preceded by a decline in the growth rate of the money supply.

c. have followed on the heels of an increase in the budget deficit.

d. have followed on the heels of a decrease in the budget deficit.

III. Short Answer Question:

Zebra is a country that produces a single type of good called a widget.  Widgets cost 2 dollars a piece and 3 million widgets are currently being produced in Zebra. The country of Zerbia is suffering an economic downturn.  One economist suggests a solution to the President of Zerbia: drop additional currency into the country using a helicopter.  Prior to the dropping of currency by the helicopter there are $900,000 dollars in circulation in Zerbia.

Use the Classical Quantity Theory of Money to answer the following questions.

a. Assume Zebra is in monetary equilibrium (i.e., money demand equals money supply) prior to the helicopter drop.  What is the ratio of desired money holdings to income?

b. If the helicopter drops $45,000 on the country, what will the new price of a widget be?

c. What is the impact of the helicopter drop on Zebra's level of real output?  Explain your answer.

d. Another economist disagrees with the helicopter idea.  She recommends that the President should increase government spending on national defense and pay for the increase by enlarging the nation's deficit.  She claims this will increase the real GDP of the country and therefore the average standard of living will be higher next year.  According to the Classical Model will this policy result in any change in real output?  If there's a change, what kind of change in real output will there be?  Give a reason for your answer.