Reference no: EM131025387
Practice Questions 8-
Part A:
1. The distinction between M1 and M2 is based on
a. portability-the ease with which an asset can be moved.
b. divisibility-the ease with which an asset can be used to make smaller payments.
c. liquidity-the ease with which an asset can be converted into cash.
d. storability-how long an asset will retain its value.
2. When a banker accepts a deposit of $1,000 in cash and puts $200 aside as required reserves and then makes a loan of $800 to a new borrower, this set of transactions
a. decreases the money supply by $1,000.
b. decreases the money supply by $200.
c. increases the money supply by $200.
d. increases the money supply by $800.
3. If the Federal Open Market Committee decides to expand the money supply, then it will
a. raise the discount rate to member banks.
b. issue directions to purchase government securities, thus putting more reserves in member banks.
c. issue directions to sell government securities, thus taking reserves from member banks.
d. order new Federal Reserve notes delivered to member banks.
4. The Fed conducts an open market purchase of Treasury bills of $10 million. If the required reserve ratio is .10, what change in the money supply can be expected using the demand deposit multiplier?
a. $100 million
b. $10 million
c. -$10 million
d. -$100 million
5. How are Treasury bond prices affected when the interest rate falls?
a. The purchaser of the bond needs to spend less money to obtain a given number of dollars of interest per year, so the price of the bond must decrease.
b. The purchaser of the bond needs to spend more money to obtain a given number of dollars of interest per year, so the price of the bond must increase.
c. The purchaser of the bond needs to spend more money to obtain a given number of dollars of interest per year, so the price of the bond must decrease.
d. The purchaser of the bond needs to spend less money to obtain a given number of dollars of interest per year, so the price of the bond must increase.
6. Assume the required reserve ratio is 10 percent and the FOMC orders an open market sale of $50 million in government securities from member banks. If the demand deposit multiplier is assumed, then the money supply will
a. increase by $500 million.
b. increase by $100 million.
c. decrease by $100 million.
d. decrease by $500 million.
7. If the Fed wants to reduce banks' reserves, it can
a. buy securities in the open market.
b. lower the reserve ratio.
c. lower the federal funds rate.
d. raise the discount rate.
8. If the Fed raises the discount rate, what will be the effect on the money supply?
a. It will decrease the money supply.
b. It will increase the money supply.
c. No change in the money supply.
d. Not enough data to give an answer.
9. Assume that the banking system has $200 billion in reserves. There are no excess reserves in the system. If the reserve requirement is decreased from 10 percent to 8 percent, what will happen to the level of excess reserves in the system?
a. There will be a deficiency of $40 billion in reserves.
b. There will be a deficiency of $20 billion in reserves.
c. There will be $20 billion in excess reserves.
d. There will be $40 billion in excess reserves.
10. The Federal Reserve System has purchased $10 million in government securities from banks, paying for them with increases in banks' reserves. Describe the changes in the balance sheets of the commercial banks and the Federal Reserve System, respectively.
11. Assume that the required reserve ratio is 10 percent. After the transaction in question 10 is completed, what happens to actual reserves, required reserves, and excess reserves? Assume that the transaction in question 10 is the only transaction/adjustment that has occurred.
12. In question 11, compute the total change in the money supply using the demand deposit multiplier.
13. Suppose the demand for money is given by
Md = 750 - 50r
where Md is the quantity of money demanded (in billions of dollars) and r is the interest rate in percentage points. The supply of money is set at $400 billion.
a. At an interest rate 12%, is the quantity of money demanded greater than the quantity of money supplied? Compute the excess demand/supply in the money market, if any. Also, compute the excess demand/supply in the bond market, if any. What will happen to the bond price and the interest rate?
b. Compute the equilibrium interest rate.
14. The demand for money is
Md = 650 - 50r
where Md is the quantity of money demanded (in billions of dollars) and r is the interest rate in percentage points. The supply of money is set at $250 billion. Suppose that all demand deposits are held in commercial banks, and that all commercial banks are subject to fractional reserve requirements where the required reserve ratio (RRR) is 50%.
a. Compute the equilibrium interest rate.
b. Suppose the Fed wants the interest rate to be 4% and so it tries to change the money supply by intervening in the open market. What amount of bonds should the Fed sell or buy?
15. Suppose the demand for money is given by
Md = 750 - 50r
where Md is the quantity of money demanded (in billions of dollars) and r is the interest rate in percentage points. The supply of money is set at $350 billion. The aggregate expenditure (AE) in billions of dollars is given by
AE = .5Y + 2,250
a. Compute the equilibrium interest rate in the money market and the equilibrium real GDP.
b. The Fed has decided to increase the money supply by $100 billion. For the time being, we suppose the spending in the economy is never sensitive to the change in the interest rate. Compute the equilibrium interest rate and the real GDP in this case.
c. Now, let us suppose that every 1 percent point decrease in the real interest rate stimulates the spending in the economy by 500 billion dollars. However, the quantity of money demanded is never affected by the change in the real GDP. Compute the equilibrium real GDP given the change in part (b). [Hint: think carefully about how you need to modify the equation(s) you need.]
d. Finally, we suppose that every 1,000 billion dollars increase in the real GDP creates an additional money demand by 25 billion dollars. Find the equilibrium interest rate given the level of real GDP you found in part (c).
16. Now let us go back to the original example in question 15. That is, we are now given the equilibrium interest rate and the equilibrium real GDP computed in the question 15. a.
a. Suppose the government has decided to increase its expenditure by 1,000 billion dollars. For the time being, the money demand is never affected by the change in the real GDP and hence the interest rate is not affected by the change in the real GDP. Compute the new equilibrium real GDP in this case.
b. Now, let us suppose that every 1,000 dollars increase in the real GDP creates an additional money demand by 25 billion dollars. However, the interest rate change never affects the spending in the economy. Find the equilibrium interest rate in this case.
c. Finally, we suppose that every 1 percent point increase in the interest rate reduces the spending by 500 billion dollars. Compute the equilibrium real GDP in this case. Did the original increase in the government expenditure crowd out the private spending? Explain.
Part B:
1. The aggregate demand curve
a. represents the relationship between prices and quantities of all goods produced in an economy.
b. is derived from equilibrium conditions in the labor and money markets.
c. gives the equilibrium level of real GDP corresponding to a given price level.
d. plots the interest rate as a function of output.
2. An increase in the price level will lead to which of the following sequences
a. The money demand curve shifts leftward, the interest rate drops, the aggregate expenditure line shifts upward, and there is movement downward along the aggregate demand curve.
b. The money demand curve shifts rightward, the interest rate increases, the aggregate expenditure line shifts downward, and there is movement upward along the aggregate demand curve.
c. The money demand curve shifts rightward, the interest rate increases, the aggregate expenditure line shifts upward, and there is movement downward along the aggregate demand curve.
d. The money demand curve shifts leftward, the interest rate drops, the aggregate expenditure line shifts upward, and there is movement upward along the aggregate demand curve.
3. Which of the following would lead to a downward movement along the aggregate demand curve?
a. a decrease in government purchases.
b. an increase in the money supply.
c. a decrease in the price level.
d. a decrease in taxes.
4. Which of the following would not cause the AD curve to shift?
a. a change in the money supply.
b. the publics' expectations of a fall in the interest rate.
c. a change in aggregate expenditure caused by a change in the price level.
d. a change in autonomous consumption spending.
5. Which of the following would shift the aggregate demand curve to the right?
a. increase in government purchases, investment spending, autonomous consumption, taxes, or the money supply.
b. increase in government purchases, investment spending, autonomous consumption, or the money supply.
c. increase in government purchases, investment spending, autonomous consumption or taxes.
d. decrease in government purchases or investment spending, and increases in autonomous consumption, taxes, or the money supply.
6. Nominal wages react slowly to changes in output for all of the following reasons except:
a. the nominal wage may be fixed and independent of output because of labor contracts that last up to three years.
b. the real wage remains constant despite changes in output.
c. changing the nominal wage can be costly to firms.
d. the nominal wage may be set by slow-moving corporate bureaucracies.
7. The aggregate supply curve:
a. indicates the markup at which firms are willing to supply a given level of output.
b. is derived from equilibrium conditions in the money market.
c. has a positive slope because an increase in real GDP causes an increase in the cost of resources.
d. illustrates how a change in the price level affects total output.
8. If output increases, which of the following occurs?
a. Prices of non-labor inputs, input requirement per unit of output, and unit costs would all increase, and the economy would move downward along the aggregate supply curve.
b. Prices of non-labor inputs, input requirement per unit of output, and unit costs would all decrease, and the economy would move downward along the aggregate supply curve.
c. Prices of non-labor inputs, input requirement per unit of output, and unit costs would all decrease, and the economy would move upward along the aggregate supply curve.
d. Prices of non-labor inputs, input requirement per unit of output, and unit costs would all increase, and the economy would move upward along the aggregate supply curve.
9. The aggregate supply curve would shift downward if
a. unit costs increase due to an increase in output.
b. the wage rate increases.
c. good weather increases crop yields.
d. an increase in real GDP causes the price level to decrease.
10. If the economy is on the aggregate supply curve but to the right of the aggregate demand curve, which of the following will be the first market force to lead the economy toward an equilibrium?
a. At the current price level, output will be too low, inventories will diminish, and firms will increase their production.
b. At the current price level, prices will be too high and firms will lower their prices.
c. At the current price level, output will be too high and so prices will drop so that output will drop.
d. At the current price level, output will be too high, inventories will pile up and firms will cut back on their production.
11. In the short run, an increase in the money supply will
a. decrease the interest rate, increase real GDP, and decrease the price level.
b. increase the interest rate, decrease real GDP, and decrease the price level.
c. result in decreases in the interest rate and real GDP, which are then followed by increases in the interest rate which offset some of the increase in real GDP.
d. result in decreases in the interest rate and increases in real GDP, which are then followed by increases in the interest rate which offset some of the increase in real GDP.
12. If a demand shock causes an economy to operate at a point above potential GDP, then
a. the aggregate supply curve will shift to return the economy to the original point of equilibrium.
b. the economy will correct itself through rising wages and prices.
c. this short run equilibrium point will become the new long run equilibrium GDP.
d. the economy will correct itself through falling wage rates and prices.
13. In the long run AS-AD model,
a. the position of the AD curve determines output.
b. the self-correcting mechanism of the economy is irrelevant.
c. the AS curve shifts leftward whenever the economy is growing.
d. the position of the AD curve determines the price level.
14. If the price level is increasing and output is falling, which of the following could be the reason?
a. A positive supply shock.
b. A positive supply shock combined with a positive demand shock.
c. A negative supply shock.
d. A positive demand shock.
15. The price level in the economy is 100 and the money supply is $550 billion. Money demand is given by the equation
Md = 1,050 - 50r
where r is the interest rate in percentage points and Md is billion of dollars demanded.
a. Compute the equilibrium interest rate in the money market.
b. At the interest rate from part (a), aggregate expenditure is given by the equation
AE = 3,000 + .5Y
where AE is the aggregate expenditure in billions of dollars and Y is the level of real GDP. Find the equilibrium real GDP in this case.
c. Now, suppose the price level has increased to 130. What will happen to the money market? Which curve will shift and in which direction?
d. Suppose the shift described in part (c) is in the amount of $100 billion at every level of the interest rate. Compute the new equilibrium interest rate in the money market. Is it higher or lower than the interest rate in (a)? Which direction will the AE shift as a result of this change in the interest rate?
e. Suppose the shift in AE described in part (d) is in the amount of $1,000 billion at every level of real GDP. Using the multiplier process, find the new equilibrium real GDP in this case.
f. Is the Aggregate Demand curve (AD) downward sloping?
16. The economy has an output of $7,000 billion and a price level of 100.
a. Suppose that the economy's real GDP increases from $7,000 billion to $8,500 billion. In this case, explain what will happen to the price of non-labor inputs, unit costs, and the price level in the economy.
b. Suppose the increase in real GDP describe in part (b) changes the price level by 40. Can you plot the Aggregate Supply curve (AS)? Is it upward sloping?
17. The full employment output for some economy is $6 billion. Aggregate demand and aggregate supply are given by
Aggregate demand: AD = 16 - P/10
Aggregate supply: AS = P/10 - 4
where P is the price level.
a. Calculate the equilibrium price level and real GDP. Is the economy in the long run equilibrium?
b. Suppose the Fed decreases the money supply through open market sales of bonds. Explain the effect of this open market operation on the interest rate, interest-sensitive consumption and investment spending, real GDP, and AD.
c. Suppose the shift of AD described in part (b) is in the amount of $4 billion at every price level. What is the new AD curve?
d. Find the price level and real GDP in the new short run equilibrium. Is the change in the real GDP greater or smaller than the change in AD given in part (c)?
e. In this short run equilibrium, real GDP is below its full employment level. The unusually high unemployment rate drives the wage rate down. As a result, the AS curve will shift downward until a new long run equilibrium is achieved. Find the price level and real GDP in the new long run equilibrium.
f. What is the shape of long run AS curve?
Part C:
1. If the demand for money decreases, an active monetary policy requires the Fed to
a. consult with leaders in the financial markets to see whether it should introduce credit controls.
b. watch to see whether the investment spending decreases.
c. decrease the supply of money.
d. decrease the interest rate.
2. If there is a leftward shift of the money demand curve, which of the following the following should the Fed do if it wants to keep the price level stable?
a. Lower its interest rate.
b. Sell bonds in the open market.
c. Raise its interest rate target.
d. Buy bonds in the open market.
3. If the Fed is maintaining an interest rate target and notices a drop in the interest rate, which of the following would be its likely interpretation and response?
a. Money demand has increased; sell government bonds.
b. Money supply has decreased; buy government bonds.
c. Money demand has decreased; sell government bonds.
d. Money demand has increased; buy government bonds.
4. Suppose that money demand increases. If the Fed wants to offset the shock, it will use
a. active monetary policy, decreasing the money supply and increasing the interest rate.
b. active monetary policy, increasing the money supply and decreasing the interest rate.
c. passive monetary policy, decreasing the money supply and increasing the interest rate.
d. passive monetary policy, leaving the money supply and interest rate constant.
5. If there is a sudden increase in government spending, which of the following should the Fed do if it wants to keep output unchanged?
a. Sell bonds in the open market.
b. Wait, since output usually does not change when government spending increases.
c. Decrease the required reserve ratio.
d. Buy bonds in the open market.
6. If autonomous consumption decreases, which of the following would be most likely to happen under an active monetary policy?
a. The money supply would increase, real GDP would decrease, and the interest rate would increase.
b. The money supply would decrease, real GDP would not change, and the interest rate would increase.
c. The money supply would increase, real GDP would not change, and the interest rate would decrease.
d. The money supply would increase, real GDP would increase, and the interest rate would decrease.
7. If there is an increase in the price of oil and the Fed wished to maintain price stability, what should it do?
a. Do nothing, because the self-correcting mechanism will adjust the economy.
b. Sell bonds in the open market.
c. Wait, because the price level seldom changes when there is an increase in the price of oil.
d. Buy bonds in the open market.
8. Suppose a supply shock shifts the aggregate supply curve leftward and decreases output below full employment. If the Fed then decreases the money supply, it will
a. stabilize the price level, but cause a further decline in output.
b. return output to its full employment level, but at the expense of an increase in the price level.
c. stabilize the price level and return output to its full employment level.
d. decrease the price level and shift the aggregate demand curve to the right until output returns to its full employment level.
9. The economy is at full employment. Now, suppose a demand shock shifts both the aggregate demand curve and the money demand curve rightward. If the Fed wants to maintain full employment in the short run, it should
a. increase the money supply to keep the interest rate stable.
b. use a passive monetary policy and allow the economy to self-correct.
c. decrease the money supply, which will further increase the interest rate and shift the aggregate supply curve upward.
d. decrease the money supply, which will further increase the interest rate and shift the aggregate demand curve leftward.
10. Ongoing inflation has its own momentum because
a. prices rise whenever firms see other price rising.
b. the public learns to expect inflation and adjusts its decision in response.
c. more and more people now have jobs.
d. public officials are unwilling to stop prosperity.
11. If people come to expect ongoing inflation, what will happen over time independent of the Fed's response?
a. The long run aggregate supply curve will shift to the right.
b. The aggregate supply curve will continue to shift upward.
c. The aggregate demand curve will continue to shift to the right.
d. The aggregate supply curve will continue to shift downward.
12. How can the Fed reduce a continuing inflation?
a. By increasing the money supply.
b. By slowing the continuing leftward shift of the aggregate demand curve.
c. By decreasing the required reserve ratio.
d. By slowing the continuing rightward shift of the aggregate demand curve.
Part D:
1. Government outlays consist of
a. All governmental purchases resulting from contracts with the private sector and foreign organizations.
b. Government purchases, transfer payments, and interest on the national debt.
c. Any purchase by an organization that does not to earn a profit.
d. Government purchases and transfer payments minus the interest rate on the national debt.
2. Which of the following is not true?
a. A progressive tax taxes those with more income at higher rates.
b. A regressive tax is a tax whose rate increases as income increases.
c. The average rate of taxation is the fraction of total income paid as tax.
d. The marginal rate of taxation is the tax rate on an additional dollar of income.
3. When the U.S. government runs a deficit, it usually does the following:
a. It buys government bonds from the public.
b. It sells new government bonds to the public.
c. It borrows money directly form the Federal Reserve.
d. It asks the Treasury Department to print money to pay for the deficit.
4. The government's structural deficit
a. is not affected by a recession.
b. acts as an automatic stabilizer.
c. smoothes what would otherwise be a pattern of cyclical instability in GDP.
d. reduces the size of the multiplier.
5. Which of the following best describes what happens during a recession?
a. The cyclical deficit increases and so does the structural deficit.
b. The cyclical deficit increases and the structural deficit is unchanged.
c. The cyclical deficit is unchanged and the structural deficit increases.
d. The cyclical deficit is unchanged and so is the structural deficit.
6. Which of the following is not considered as an automatic stabilizer?
a. Food stamps program for people with low incomes.
b. Welfare program for families with dependent children.
c. Medicaid, a health program for the poor.
d. Financial assistance for disabled people.
7. Countercyclical fiscal policy refers to
a. The use of taxes and government spending to keep the economy close to potential GDP in the short run.
b. Any fiscal policy that is employed during a business cycle.
c. The use of open market purchases of bonds to keep the economy close to potential GDP in the short run.
d. The use of changes in tax rates to keep the economy at potential output in the long run.
8. In the long run,
a. large government budget deficits cause the money supply to increase, thereby leading to inflation.
b. Large government budget deficits drive down the interest rate and reduce investment spending.
c. Large government budget surpluses mean reductions in the money supply.
d. Large government budget deficits drive up interest rates and reduce investment spending.
9. Under what condition can the U.S. government continue to pay interest rate on a rising debt without eventually needing to increase the average tax rate?
a. If the national debt grows at the same rate as nominal GDP.
b. If the nominal interest on the national debt grows faster than nominal GDP.
c. If the national debt grows faster than nominal GDP.