ECON 2105 Study Guide for Exam #3 (Chapters 6-8)_with key at end

Exam Date: Wednesday, 04/15/2015

Format: 20-25 Multiple-Choice Questions/Problems
Resources Allowed During Exam: calculator (no cell phones allowed); 4 pages of notes (2
sheets of paper, front and back only). Any use of notes in excess of page allotment will
result in confiscation of examination and a grade of 0 awarded.
Extra Credit Paper Opportunity: Worth 7 points towards exam #3 grade only. Extra credit
paper for exam#3 is and will be the format and requirements as the extra credit paper for
exam#1 and exam#2. Extra credit paper will not be accepted late or by email under any
circumstances.
Name: __________________________ Date: _____________
Use the following to answer question 1:

1. (Table: Individual and Aggregate Consumption Functions) Which of the following

represents Fred's individual consumption function?
A) C = 100 + 0.7YD.
B)

C = 100 + 0.5YD.

C)

C = 150 + 0.8YD.

D) C = 0.80YD.

2. The most important factor affecting a household's consumer spending is:

A) its expected future disposable income.
B)

its current disposable income.

C)

its wealth.

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D) the current interest rate.

3. In an economy without government purchases, government transfers, or taxes, aggregate

autonomous consumer spending is $750 billion, planned investment spending is $300
billion, and the marginal propensity to consume is 0.75. What is the expression for
planned aggregate spending?
A) AEPlanned = $1,050 + 0.75 YD.
B)

AEPlanned = $300 + 0.25 YD.

C)

AEPlanned = $750 + 0.75 YD.

D) AEPlanned = $500 + 0.25 YD.

4. If the marginal propensity to save is 0.3, the size of the multiplier is:
A) 3.3.
B)

2.3.

C)

1.3.

D) 0.7.

5. The multiplier is:

A) 1 / (1 MPC).
B)

MPS / MPC.

C)

1 / (MPC).

D) 1(1 + MPC).

6. Whenever GDP exceeds planned aggregate spending:

A) firms reduce production, thereby reducing GDP.
B)

households increase consumption, thereby increasing disposable income.

C)

firms increase production, thereby increasing GDP.

D) households decrease consumption, thereby decreasing disposable income.

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7. Which of the following is true regarding the tradeoff a firm makes when it spends
money on an investment project?
A) Borrowing money will always be more expensive than using retained earnings.
B)

The cost of retained earnings is unrelated to the cost of borrowing money.

C)

The tradeoff a firm faces when using retained earnings or borrowed funds is the
same.
D) Using retained earnings has a higher opportunity cost than does using borrowed
money because retained earnings come from past profits.
8. The most important determinant of consumer spending is:
A) the government budget deficit or surplus.
B)

the price of gasoline.

C)

the trade deficit.

D) disposable income.

Use the following to answer question 9:

Scenario: IncomeExpenditure Equilibrium
GDP is $8,000, autonomous consumption is $500, and planned investment spending is $200. The
marginal propensity to consume is 0.8.
9. (Scenario: IncomeExpenditure Equilibrium) What is the consumption function?
A) C = 8,000 + 0.8 YD
B)

C = 8,700 + 0.2 YD

C)

C = 500 + 0.8 YD

D) C = 1,700 + 0.2 YD

10. If the slope of the aggregate expenditures curve = 0.9, the multiplier is equal to:
A) 1.
B)

4.

C)

5.

D) 10.

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11. According to the table, the MPC and autonomous consumption are ________ and
________, respectively, for Bob.

A) 0.6; $10,000
B)

0.4; $13,000

C)

0.6; $9,000

D) 0.4; $9,000

Use the following to answer question 12:

Figure: Aggregate Expenditures Curve II

12. (Figure: Aggregate Expenditures Curve II) The equilibrium level of real GDP in the
aggregate expenditures model shown in this figure is:
A) $800.
B)

$1,000.

C)

$2,000.

D) $4,000.

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Use the following to answer question 13:

Figure: Consumption and Real GDP

13. (Figure: Consumption and Real GDP) If real GDP is $8 trillion, consumption is
_______ trillion and saving is _______ trillion.
A) $4; $4
B)

$5; $3

C)

$6; $2

D) $7; $1

14. Planned investment spending is:

A) actual investment in a period.
B)

investment spending minus depreciation in a period.

C)

investment spending that businesses plan to undertake during a period.

D) always equal to savings.

15. The MPC plus the MPS must:

A) equal each other.
B)

equal 1.

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C)

be less than 1.

D) be greater than 1.

16. Actual investment spending is equal to:

A) the difference between unplanned investment spending and planned investment
spending.
B) the difference between planned investment spending and unplanned investment
spending.
C) the sum of planned investment spending and unplanned investment spending.
D) the ratio of planned investment spending to unplanned investment spending.

17. The marginal propensity to consume (MPC) is equal to the change in:
A) consumer spending divided by the change in disposable income.
B)

consumer spending divided by the change in investment spending.

C)

consumer spending divided by the change in gross domestic product.

D) disposable income divided by the change in consumer spending.

18. If the aggregate consumption equals $100 million + 0.75 YD, then autonomous
consumption is:
A) 0.75.
B)

0.25.

C)

$75 million.

D) $100 million.

19. According to the National Bureau of Economic Research, the U.S. economy is going
through a severe recession. Most households are trying to save more of their income
than before. This increase in private spending will lead to:
A) an increase in aggregate income, as more saving means more funds for business
investment.
B) a fall in aggregate income, as more saving means people will spend less.
C)

no change in aggregate income, because there is no saving multiplier.

D) an increase in aggregate income, as an increase in saving will make people

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wealthier.
Use the following to answer question 20:

20. (Table: Aggregate Spending) Suppose the economy has no government spending and no
foreign trade. With no taxes and transfers, real GDP is equal to disposable income (YD).
The data in the table show consumption spending (C) and planned investment (Iplanned).
At what level of real GDP will the economy find its IncomeExpenditure Equilibrium?
A) $2,000
B)

$2,500

C)

$3,500

D) $4,500

21. Whenever GDP exceeds planned aggregate expenditure, unplanned investment is

_______; whenever GDP falls short of planned aggregate expenditure, unplanned
investment is _________.
A) positive; negative
B)

negative; positive

C)

zero; positive

D) zero; negative

22. A fall in the market interest rate makes any investment project:
A) less profitable if the funds were borrowed and more profitable if it came from
retained earnings.

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B)

less profitable whether the funds were borrowed or came from retained earnings.

C)

more profitable whether the funds were borrowed or came from retained earnings.

D) more profitable only if the funds were borrowed.

23. A firm has enough retained earnings to finance an investment project. For this firm, the
market interest rate:
A) is not relevant to the investment decision.
B)

represents the opportunity cost of using retained earnings.

C)

will help to calculate the rate of return for the project.

D) has no impact on the profitability of the investment project.

24. Planned investment spending is:

A) what investment firms plan to make during a given period.
B)

inventory investment changes.

C)

not considered part of GDP.

D) dependent only on interest rates.

25. If other things are equal, expectations of lower disposable income in the future would
________ and shift the consumption function _________.
A) increase autonomous consumption; up
B)

decrease the marginal propensity to consume; down

C)

decrease autonomous consumption; down

D) increase the marginal propensity to consume; up

Use the following to answer question 26:

Scenario: IncomeExpenditure Equilibrium
GDP is $8,000, autonomous consumption is $500, and planned investment spending is $200. The
marginal propensity to consume is 0.8.

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26. (Scenario: IncomeExpenditure Equilibrium) If GDP is $3,000, planned aggregate

spending is:
A) $2,400.
B)

$2,900.

C)

$3,100.

D) $3,000.

Use the following to answer question 27:

Figure: Consumption and Real GDP

27. (Figure: Consumption and Real GDP) If real GDP is $12 trillion, consumption is
_______ trillion.
A) $5
B)

$7

C)

$9

D) $11

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Use the following to answer question 28:

Figure: Consumption Functions

28. (Figure: Consumption Functions) An economy's consumption function would shift from
curve C to curve C when there is a(n):
A) decrease in wealth.
B)

increase in the price level.

C)

increase in expected future disposable income.

D) increase in wealth.

29. Suppose investment spending increases by $50 billion and as a result the equilibrium
income increases by $200 billion. The investment multiplier is:
A) 8.
B)

10.

C)

4.

D) 0.25.

30. An increase in aggregate wealth:

A) increases the consumption of each individual.
B)

increases the aggregate consumption function.

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C)

decreases the consumption of each individual.

D) decreases the aggregate consumption function.

31. Planned investment spending depends on:

A) the market interest rate.
B)

wealth.

C)

expected future disposable income.

D) the life-cycle hypothesis.

32. The accelerator principle states that:

A) investment spending by firms is positively related to the expected future growth of
real GDP.
B) investment spending by firms is negatively related to the expected future growth of
real GDP.
C) investment spending by firms is negatively related to the current level of real GDP.
D) investment spending by firms is positively related to the current level of real GDP.

Use the following to answer question 33:

Scenario: A Country's Consumption Function
A country is closed. It has no government sector, and its aggregate price levels and interest rate
levels are fixed. Furthermore, the marginal propensity to consume is constant and the country's
consumption function is as follows: C = 200 + 0.75YD, where YD is disposable income and C is
consumption. Assume that planned investment equals 75.
33. (Scenario: A Country's Consumption Function) When real GDP equals $900:
A) planned investment equals $900.
B)

unplanned inventory investment is negative.

C)

autonomous consumption equals $900.

D) the economy is in incomeexpenditure equilibrium.

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34. A sudden decrease in the growth rate of GDP will cause a change in:
A) planned investment spending.
B)

unplanned investment spending.

C)

both planned and unplanned investment spending

D) neither planned nor unplanned investment spending.

Use the following to answer question 35:

Scenario: Aggregate Consumption Equation
Suppose that the aggregate consumption function is given by the equation: C = 200 + 0.8YD,
where C represents consumption and YD represents disposable income.
35. (Scenario: Aggregate Consumption Equation) If disposable income is $500, autonomous
consumption is:
A) $0.
B)

$200.

C)

$400.

D) $600.

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Use the following to answer question 36:

Figure: The Multiplier

36. (Figure: The Multiplier) If this economy is currently at Y1 and investment spending
increases, then:
A) AD1 will shift to the left, reflecting a multiplied decrease in the real GDP at every
price level.
B) AD1 will shift to the right, reflecting a multiplied increase in the real GDP at every
price level.
C) an upward movement along the AD1 will take place, reflecting an increase in the
price level.
D) a downward movement along the AD1 will take place, reflecting a decrease in the
price level.

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37. Suppose that political instability in the Middle East temporarily interrupts the supply of
oil to the United States. Which of the following is most likely to occur?
A) The short-run aggregate supply curve shifts right, output increases, and prices
decrease.
B) The short-run aggregate supply curve shifts left, output decreases, and prices
increase.
C) The aggregate demand curve shifts left, output decreases, and prices decrease.
D) The aggregate demand curve shifts right, output increases, and prices increase.

38. Government purchases of goods and services differ from changes in taxes and transfer
payments because government purchases of goods and services:
A) is a type of fiscal policy while changes in taxes and transfer payments is a type of
monetary policy.
B) is a type of monetary policy while changes in taxes and transfer payments is a type
of fiscal policy.
C) influences aggregate demand directly while changes in taxes and transfer payments
influence aggregate demand indirectly.
D) influences aggregate demand indirectly while changes in taxes and transfer
payments influence aggregate demand directly.
39. In the short run, a positive demand shock:
A) reduces aggregate output and increases the aggregate price level.
B)

increases aggregate output and reduces the aggregate price level.

C)

reduces aggregate output and the aggregate price level.

D) increases aggregate output and the aggregate price level.

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Use the following to answer question 40:

Figure: Shift of the Aggregate Demand Curve

40. (Figure: Shift of the Aggregate Demand Curve) A movement from point B on AD1 to
point E on AD2 could have been the result of:
A) an increase in consumer optimism.
B)

an increase in consumer pessimism.

C)

an increase in personal income taxes.

D) the central bank reducing the quantity of money.

Use the following to answer question 41:

Figure: ADAS Model I

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41. (Figure: ADAS Model I) If the economy is at point X, there is:

A) an inflationary gap with low unemployment.
B)

an inflationary gap with high unemployment.

C)

a recessionary gap with low unemployment.

D) a recessionary gap with high unemployment.

42. Which of the following represent the three consequences of the decline in demand
during the Great Depression?
A) falling prices, declining output, and a surge in unemployment
B)

falling prices, increasing output, and a surge in unemployment

C)

rising prices, increasing output, and a surge in unemployment

D) rising prices, declining output, and a surge in unemployment

43. Changes in aggregate demand can be caused by changes in:

A) the stock of physical capital.
B)

business costs.

C)

raw materials costs.

D) the expenses of complying with government regulations.

44. An inflationary gap is automatically closed by _______ wages that shift the _______ .
A) falling; SRAS curve rightward
B)

falling; SRAS curve leftward

C)

rising; SRAS curve rightward

D) rising; SRAS curve leftward

45. Which of the following factors cannot shift the aggregate demand curve?
A) changes in expectations
B)

changes in wealth

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C)

changes in stock market indices

D) changes in the price level

46. Potential output:

A) is the level of output that the economy would produce if all prices, including
nominal wages, were fully flexible.
B) varies with the price level.
C)

is dependent on the level of consumer confidence.

D) is greater in periods of expansion than in recessions.

47. Stagflation may result from:

A) an increase in the supply of money.
B)

a decrease in the supply of money.

C)

an increase in the price of imported oil.

D) a decrease in the price of imported oil.

48. If membership falls in labor unions and unions become less popular, then:
A) production costs will increase, SRAS will shift to the left, decreasing equilibrium
GDP and increasing the aggregate price level.
B) production costs will fall, there will be a downward movement along SRAS,
equilibrium GDP will increase and aggregate price level will fall.
C) production costs will not change, AD will shift to the right, increasing equilibrium
GDP and aggregate price level.
D) production costs will fall, SRAS will shift to the right, increasing equilibrium GDP
and lowering the aggregate price level.
49. If the Fed increases the quantity of money in circulation:
A) interest rates decrease, investment increases, and the aggregate demand curve shifts
to the right.
B) interest rates increase, investment increases, and the aggregate demand curve shifts
to the right.
C) interest rates decrease, investment increases, and the aggregate demand curve shifts
to the left.
D) interest rates increase, investment decreases, and the aggregate demand curve shifts
to the left.

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Use the following to answer question 50:

Figure: The Multiplier

50. (Figure: The Multiplier) If this economy is currently at Y1 and the price level decreases,
then:
A) AD1 will shift to the left, reflecting a multiplied decrease in the real GDP at every
price level.
B) AD1 will shift to the right, reflecting a multiplied increase in the real GDP at every
price level.
C) an upward movement along the AD1 will take place, reflecting an increase in the
price level.
D) a downward movement along the AD1 will take place, reflecting a decrease in the
price level.

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51. The short run in macroeconomic analysis is a period:

A) in which many production costs can be taken as fixed.
B)

in which wages become fully flexible.

C)

of 2 months, and the long run is a period greater than 12 months.

D) in which interest rates are fixed.

52. The SRAS curve is upward sloping because:

A) a higher aggregate price level leads to lower output as costs of production increase.
B)

a higher aggregate price level leads to higher output since most production costs
are fixed in the short run.
C) a lower aggregate price level leads to higher output since production costs tend to
fall in the short run.
D) a lower aggregate price level leads to higher profit and higher productivity.

Use the following to answer question 53:

Figure: Inflationary and Recessionary Gaps

53. (Figure: Inflationary and Recessionary Gaps) The level of income associated with Y1 in
panel (b):
A) is equal to potential output.
B)

reveals an inflationary gap compared with Yp.

C)

is a long-run equilibrium.

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D) is caused by flexible wages and prices.

Use the following to answer question 54:

Figure: ADAS

54. (Figure: ADAS) Suppose the economy is in an inflationary gap where SRAS1 intersects
AD2. The size of the gap is equal to
A) Y1-YP.
B)

Y1.

C)

Y1-Y2.

D) YP-Y2.

55. As a recessionary gap is eliminated through self-correcting adjustment, the equilibrium

price level _______ and the equilibrium real output _______.
A) rises; decreases
B)

rises; increases

C)

falls; decreases

D) falls; increases

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56. Suppose that an economy is in an inflationary gap in the short run. In the long run:
A) the economy's self-correcting mechanism will restore GDP to its potential level.
B)
C)

there will be spiraling inflation unless the government takes dramatic fiscal
measures.
sustained inflation will make money lose its value.

D) a combination of fiscal and monetary policies may lower prices but output will
remain higher than potential level.
57. The aggregate demand curve is negatively sloped in part because of the impact of:
A) the wealth effect on consumption.
B)

a changing exchange rate on potential output.

C)

the stickiness of nominal wages and salaries.

D) the flexibility of nominal wages and salaries.

Use the following to answer question 58:

Figure: An Increase in Aggregate Demand

58. (Figure: An Increase in Aggregate Demand) Assume that the economy is initially in
long-run equilibrium at YP and P1. Now suppose that there is an increase in the level of
government purchases at each price level. This will:
A) shift the aggregate demand curve from AD2 to AD1.
B)

shift the aggregate demand curve from AD1 to AD2.

C)

lead to increased output and a decrease in the price level.

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D) lead to decreased output and price level.

59. According to the aggregate demand curve, when the aggregate price level _________,
the quantity of _________.
A) rises; aggregate output supplied falls
B)

falls; aggregate output demanded falls

C)

rises; aggregate output demanded falls

D) rises; aggregate output demanded does not change

60. In the late 1970s, the U.S. economy slid to the:

A) left along the aggregate supply curve.
B)

right along the aggregate supply curve.

C)

left along the aggregate demand curve.

D) right along the aggregate demand curve.

61. Aggregate demand will increase if:

A) the public becomes more optimistic about future income.
B)

the aggregate price level falls.

C)

government spending is reduced.

D) household wealth decreases.

62. Aggregate demand will decrease if:

A) the aggregate price level falls.
B)

the government raises the tax rate.

C)

productivity declines.

D) the money supply increases.

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Use the following to answer question 63:

Figure: Aggregate Demand

63. (Figure: Aggregate Demand) Using the accompanying figure, the quantity of output
demanded if the price level is 120 is:
A) $9 trillion.
B)

$10 trillion.

C)

$11 trillion.

D) $12 trillion.

64. Suppose that the economy is in long-run macroeconomic equilibrium and aggregate
demand increases. As the economy moves to short-run macroeconomic equilibrium,
there is:
A) a recessionary gap with high inflation.
B)

a recessionary gap with low inflation.

C)

an inflationary gap with high unemployment.

D) an inflationary gap with low unemployment.

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65. In the short run, the equilibrium price level and the equilibrium level of total output are
determined by the intersection of:
A) LRAS and SRAS.
B)

LRAS and aggregate demand.

C)

SRAS and aggregate demand.

D) potential output and LRAS.

66. If legislation were introduced to require the budget to be balanced at all times:
A) fiscal policy could not operate as an automatic stabilizer of the business cycle.
B)

the effectiveness of monetary policy as an automatic stabilizer of the business cycle

would decrease.
C) the effectiveness of fiscal policy as an automatic stabilizer of the business cycle
would increase.
D) monetary policy could not operate as an automatic stabilizer of the business cycle.

67. Congress increases personal income tax rates in order to balance the budget. Which of
the following is likely to result?
A) Automatic stabilizers will increase the contractionary impact of the decrease in
aggregate demand.
B) Automatic stabilizers will decrease the contractionary impact of the decrease in
aggregate demand.
C) Automatic stabilizers will increase the expansionary impact of the increase in
aggregate demand.
D) Automatic stabilizers will decrease the expansionary impact of the increase in
aggregate demand.
68. If the current level of real GDP lies below potential GDP, then an appropriate fiscal
policy would be to _____, which will shift the _____ curve to the _____.
A) increase government purchases; AD; left.
B)

increase transfer payments; AS; right.

C)

increase tax rates; AD; right.

D) increase government purchases; AD; right.

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69. If the government spends an extra $5 billion on goods and services:

A) GDP will go up by $5 billion.
B)

GDP will remain unchanged.

C)

GDP will increase by less than $5 billion.

D) GDP will increase by more than $5 billion.

Use the following to answer question 70:

Figure: Fiscal Policy I

70. (Figure: Fiscal Policy I) Suppose that this economy is in equilibrium at E2. If there is an
increase in taxes, then:
A) AD2 will shift to the left, causing an increase in the price level and a decrease in
real GDP.
B) AD2 will shift to the left, causing a decrease in the price level and a decrease in the
real GDP.
C) AD1 will shift to the right, causing an increase in the price level and an increase in
real GDP.
D) AD1 will shift to the right, causing a decrease in the price level and an increase in
real GDP.
71. Time lags associated with policy decision making and implementation suggest that:
A) increases in spending to fight a recessionary gap can be timed correctly.

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B)

increases in spending to fight a recessionary gap may occur too early.

C)

increases in spending to fight a recessionary gap may occur too late.

D) most information is old before the public is aware of it.

72. Assume that the marginal propensity to consume is 0.8 and potential output is $800
billion. The government spending multiplier is:
A) 0.8.
B)

1.25.

C)

5.

D) 4.

73. When the unemployment rate increases, the budget:

A) is unaffected.
B)

tends to move into deficit.

C)

tends to move into a surplus.

D) remains neutral.

74. Contractionary fiscal policy includes:

A) decreasing taxes.
B)

decreasing the money supply.

C)

decreasing government expenditures.

D) increasing government expenditures.

75. Spending promises made by governments that are effectively a debt, despite the fact that
they are not included in the usual debt statistics, are known as:
A) implicit liabilities.
B)

explicit liabilities.

C)

implicit assets.

D) explicit assets.

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76. If the marginal propensity to consume is 0.75 and the federal government increases
spending by $100 billion, the income expenditure model would predict that real GDP
will increase by:
A) $100 billion.
B)

$750 billion.

C)

$400 billion.

D) $300 billion.

77. If the MPC is 0.8 and the government spending decreases by $50 million, then
equilibrium GDP will decrease by:
A) $40 million.
B)

$50 million.

C)

$200 million.

D) $250 million.

78. The public debtGDP ratio for the United States in 2011 was:
A) more or less the same as that of other wealthy countries.
B)

the largest ratio in the world.

C)

less than 5%.

D) over 200%.

79. The theory of Ricardian equivalence argues that expansionary fiscal policy:
A) will have no effect on the economy because consumers, anticipating higher future
taxes to pay for government spending, will decrease spending today to save for the
future higher taxes.
B) is not effective because it causes higher interest rates and crowds out investment
spending.
C) is effective, but contractionary fiscal policy is not.
D) is more effective than expansionary monetary policy.

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80. Implicit liabilities of a government are:

A) bonds held by foreigners.
B)
C)

spending promises, like Social Security benefits, that are effectively debt although
no bond is associated with the promise.
debt of a country adjusted for the price ratio.

D) the ratio of a country's debt to its GDP.

81. To close a recessionary gap by employing fiscal policy, the government could:
A) increase national savings so that the interest rate falls.
B)

lower the annual income exempt from paying the personal income tax.

C)

lower the corporate income tax rate.

D) lower the amount of unemployment insurance benefits.

82. Medicaid, Medicare, and Social Security are examples of:

A) unilateral payments.
B)

transfer payments.

C)

monetary policy.

D) taxes.

83. Because of the role of automatic stabilizers and discretionary fiscal policy, the historical
record of the United States since 1970 shows that:
A) the budget tends to move into a deficit during expansions.
B)

the budget tends to move into a surplus during recessions.

C)

the budget tends to move into a deficit during recessions.

D) the budget tends to remain balanced throughout expansions and recessions.

84. An inflationary gap can be closed with:

A) expansionary monetary policy.
B)

a decrease in taxes.

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C)

a decrease in government purchases.

D) expansionary fiscal policy.

85. The national debt _______ in years in which the federal government incurs a _______.
A) falls; deficit
B)

rises; surplus

C)

stays the same; surplus

D) rises; deficit

Use the following to answer question 86:

Figure: ADAS

86. (Figure: ADAS) Suppose the economy is producing the output level Yp and a negative
demand shock shifts the AD1 curve to AD3. The economy now has:
A) an inflationary gap, which can be closed by expansionary fiscal policy.
B)

a recessionary gap, which can be closed by contractionary fiscal policy.

C)

a recessionary gap, which can be closed by expansionary fiscal policy.

D) an inflationary gap, which can be closed by contractionary fiscal policy.

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87. A reduction in government transfers ________, therefore shifting the aggregate demand
curve to the ________.
A) increases labor costs to companies, increasing investment; left
B)
C)

decreases government purchases of goods and services, decreasing consumption;

right
increases the marginal propensity to save, decreasing consumption; right

D) decreases disposable income and consumption; left

88. Each of the following is an expansionary fiscal policy EXCEPT:

A) an increase in government transfers.
B)

an increase in government purchases.

C)

an increase in tax rates.

D) lowering marginal tax rates.

89. Assume that the marginal propensity to consume is 0.8 and potential output is $800
billion. If current real GDP is $700 billion:
A) there is an inflationary gap.
B)

there is a recessionary gap.

C)

the economy is in long-run equilibrium.

D) government transfers should be decreased.

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Use the following to answer question 90:

Figure: Fiscal Policy Choices

90. (Figure: Fiscal Policy) Contractionary fiscal policy would most likely be used to shift
aggregate demand in _______ from _______.
A) panel (b); AD1 to AD2
B)

panel (a); AD2 to AD1

C)

panel (a); AD1 to AD2

D) panel (b); AD2 to AD1

91. If a government's debt is increasing but its GDP is increasing faster, one will find the
government's:
A) total debt falling.
B)

debtGDP ratio falling.

C)

deficit falling.

D) ability to pay falling.

92. Decreasing funding to explore space:

A) will shift the aggregate supply curve to the left.
B)

will shift the aggregate supply curve to the right.

C)

will shift the aggregate demand curve to the left.

D) will shift the aggregate demand curve to the right.

Page 31

93. The cyclically adjusted budget balance is:

A) an estimate of the contractionary fiscal policy needed to close an inflationary gap.
B)
C)

an estimate of the tax increase needed to compensate for larger government

transfers so that the budget remains balanced.
an estimate of the expansionary fiscal policy needed to close a recessionary gap.

D) an estimate of what the budget balance would be if real GDP were exactly equal to
potential output.
94. When the economy is in a recession:
A) tax receipts decrease but unemployment insurance payments increase.
B)

both tax receipts and unemployment insurance payments increase.

C)

tax receipts increase but unemployment insurance payments decrease.

D) both tax receipts and unemployment insurance payments decrease.

95. Discretionary fiscal policy may fail to stabilize the economy or may even make the
economy less stable because of:
A) its ineffectiveness.
B)

government waste.

C)

lags in deciding on and implementing a policy change.

D) the business cycle.

96. The European Central Bank was created:

A) during the French Revolution at the end of the eighteenth century.
B)

in 1913, at the same time as the U.S. Federal Reserve System.

C)

as part of the treaty ending World War II.

D) in 1999, when the euro was adopted.

Page 32

Use the following to answer question 97:

Scenario: Money Supply Changes
The reserve requirement is 10% and Jack withdraws $5,000 from his checkable bank deposit to
pay for a trip to New York City. Assume that banks do not hold any excess reserves and that the
public holds no currency, only checkable bank deposits.
97. (Scenario: Money Supply Changes) As a result of the withdrawal, excess reserves
_______ by ________.
A) increase; $5,000
B)

increase; $500

C)

decrease; $4,500

D) decrease; $500

98. Banks are illiquid because:

A) their deposits are less liquid than their loans.
B)

their loans are less liquid than their deposits.

C)

their assets are greater than their liabilities.

D) their liabilities are greater than their assets.

99. Paper money in the United States, which has no intrinsic value but can be converted into
a valuable good on demand and is used as a medium of exchange, is an example of:
A) fiat money.
B)

commodity-backed money.

C)

a stock.

D) a bond.

100. The U.S. dollar in your pocket today is best described as:
A) commodity money.
B)

near-money.

C)

fiat money.

Page 33

D) commodity-backed money.

101. The government has almost eliminated the possibility of bank runs by instituting
protective measures. All of the following are such measures EXCEPT:
A) the capital requirements.
B)

the reserve requirements.

C)

the loan guarantee.

D) the deposit insurance.

102. Which of the following would be the initial effect if an individual made a $10,000 cash
deposit in a bank?
A) The money supply would rise by $10,000.
B)

The money supply would fall by $10,000.

C)

The money supply would not be affected by the deposit.

D) The money supply would fall but by less than the $10,000 deposit.

103. The money multiplier is equal to:

A) 1 divided by the reserve ratio.
B)

1 divided by excess reserves.

C)

1 minus the reserve ratio.

D) the reserve ratio plus excess reserves divided by the reserve ratio.

104. Suppose a group of people decided to create their own economic system with cartons of
milk serving as money. If we decided to use this liquid asset as our medium of
exchange and all prices were measured in cartons of milk, milk would still not be a good
form of money because it would not be a good:
A) medium of exchange.
B)

unit of account.

C)

store of value.

D) near-money.

Page 34

Use the following to answer question 105:

105. (Scenario: Assets and Liabilities of the Banking System) Suppose that the reserve ratio
is 10% when the Federal Reserve sells $11,000 worth of U.S. Treasury bills to the
banking system. If the banking system does NOT want to hold any excess reserves,
_______ will be _______ the money supply.
A) $110,000; added to
B)

$110,000; subtracted from

C)

$250,000; subtracted from

D) $250,000; added to

Use the following to answer question 106:

Scenario: Money Supply Changes II
Charlotte withdraws $8,000 from her checkable bank deposit to pay tuition this semester.
Assume that the reserve requirement is 20% and that banks do not hold excess reserves.
106. (Scenario: Money Supply Changes II) As a result of the withdrawal, excess reserves
______ by ________.
A) increase; $8,000
B)

decrease; $8,000

C)

decrease; $6,400

D) decrease; $1,600

107. An economy that lacks a medium of exchange must use a(n):

A) anarchist system.
B)

barter system.

Page 35

C)

communist system.

D) expanding system.

108. When we use money to buy groceries, money is playing the role of a:
A) medium of exchange.
B)

reserve of wealth.

C)

unit of account.

D) store of value.

109. Which of the following is TRUE concerning the monetary base in the United States?
A) Currency in circulation is not part of the monetary base.
B)

Bank reserves are part of the monetary base.

C)

Most of the monetary base consists of checkable deposits.

D) The money multiplier is the ratio of the monetary base to the money multiplier.

110. Suppose the banking system does NOT hold excess reserves and the reserve ratio is
20%. If Sam deposits $500 cash into his checking account, the banking system can
increase the money supply by:
A) $5,000.
B)

$2,000.

C)

$2,500.

D) $400.

111. Open-market operations occur when the Federal Reserve:

A) buys U.S. Treasury bills from the federal government.
B)

buys or sells foreign currency.

C)

buys or sells existing U.S. Treasury bills.

D) sells U.S. Treasury bills to the federal government.

Page 36

112. The three main monetary policy tools are:

A) interest rates, taxes, and government purchases.
B)

currency, near-moneys, and reserve ratio.

C)

deposit insurance, discount rate, and money multiplier.

D) reserve requirements, the discount rate, and open-market purchases.

113. Suppose the reserve ratio is 25%; the money multiplier is:
A) 5.
B)

0.25.

C)

4.

D) 0.04.

114. The Federal Reserve's main liabilities are:

A) currency and bank reserves.
B)

the facilities of the twelve district banks.

C)

corporate stocks and bonds.

D) U.S. Treasury bills.

115. When, in The Wealth of Nations, Adam Smith wrote of a sort of waggon-way through
the air, he was referring to:
A) the invisible hand.
B)

the forces of competition.

C)

mass transit systems of the future.

D) paper money.

116. The reserve ratio is:

A) the fraction of its deposits that a bank holds as reserves.
B)

the fraction of its loans that a bank is required to hold.

Page 37

C)

the fraction of its loans that a bank holds as reserves.

D) the fraction of its assets that a bank is required to hold.

Use the following to answer question 117:

Scenario: Money Creation
The reserve requirement is 20%, and Leroy deposits the $1,000 check he received as a
graduation gift in his checking account. The bank does NOT want to hold excess reserves.
117. (Scenario: Money Creation) What is the maximum expansion in the money supply
possible?
A) $1,000
B)

$1,800

C)

$4,000

D) $5,000

118. Which of the following assets is the MOST liquid?

A) a $50 bill
B)

a $50 Amazon.com gift certificate

C)

100 shares of Microsoft stock

D) an economics textbook

119. Which of the following is true concerning the monetary aggregates?

A) M2 includes the gold stock but not M1.
B)

M2 includes M1.

C)

The gold stock backs M2 but not M1.

D) M1 includes M2 but not the gold stock.

120. Holding everything else constant, if the required reserve ratio falls, then:
A) the money multiplier increases.

Page 38

B)
C)

a $1 loan can lead to a smaller change in the money supply than before the change
in the required reserve ratio.
the amount of excess reserves falls also.

D) the money multiplier decreases.

121. If it looks like a bank won't meet the Federal Reserve Bank's reserve requirement,
normally it will first turn to the:
A) other member banks and borrow money at the federal funds rate.
B)

Federal Reserve and borrow money at the discount rate.

C)

open market and borrow money there.

D) Congress to borrow funds.

122. An example of a double coincidence of wants is:

A) a car mechanic who wants a TV finding an owner of an electronics store who wants
a car repaired.
B) a car dealer who wants a TV finding an electronics store owner who wants money.
C)

an electronics store owner who wants car repairs finding a car mechanic who wants
money.
D) a car dealer who wants a new employee finding a car mechanic who wants money.

123. The tools of conducting monetary policy include:

A) changes in the required reserve requirement.
B)

changes in the prime rate.

C)

open market purchases of corporate stock.

D) changing tax rates.

124. Which of the following combination of assets is considered to be money?

A) currency in circulation, checkable bank deposits, and credit cards
B)

currency in circulation, checkable bank deposits, and travelers' checks

C)

currency in circulation and in bank vaults, checkable bank deposits, and travelers'
checks
D) currency in circulation and in bank vaults, checkable bank deposits, and credit

Page 39

cards
Use the following to answer question 125:
Scenario: Money Supply Changes
The reserve requirement is 10% and Jack withdraws $5,000 from his checkable bank deposit to
pay for a trip to New York City. Assume that banks do not hold any excess reserves and that the
public holds no currency, only checkable bank deposits.
125. (Scenario: Money Supply Changes) Which of the following is an accurate description of
the bank's balance sheet after the withdrawal?
A) Reserves decrease by $5,000, and checkable deposits decrease by $5,000.
B)

Reserves decrease by $5,000, and checkable deposits increase by $5,000.

C)

Reserves increase by $5,000, and checkable deposits decrease by $5,000.

D) Reserves increase by $500, and checkable deposits increase by $5,000.

126. Currency, checkable deposits, and traveler's checks are about _______ of M1.
A) 10%
B)

55%

C)

75%

D) 100%

127. A decrease in bank deposits that is matched by an increase in currency in circulation:

A) decreases the monetary base.
B)

does not affect the monetary base.

C)

increases the monetary base.

D) increases the money supply.

128. To change the money supply, the Federal Reserve most frequently uses:
A) changes in the required reserve ratios.
B)

changes in the discount rate.

Page 40

C)

open-market operations.

D) changes in the inflation rate.

Use the following to answer question 129:

Scenario: Holding Cash
Suppose that the public holds 50% of the money supply in currency and the reserve requirement
is 20 percent. Banks hold no excess reserves. A customer deposits $6,000 in her checkable
deposit.
129. (Scenario: Holding Cash) As a result of the deposit, the bank's loans will increase by:
A) $6,000
B)

$1,200

C)

$3,000

D) $4,800

130. Suppose the reserve ratio is 20%. If Holly deposits $1,000 of cash into her checking
account and her bank lends $600 to Freda, the money supply:
A) remains the same.
B)

decreases by $1,000.

C)

decreases by $600.

D) increases by $600.

131. The demand for money is higher in Japan than in the United States because:
A) telecommunications and information technology is more advanced in the United
States than in Japan.
B) Japanese consumers use credit cards more than people in the United States.
C)

Japanese interest rates are very high in comparison to interest rates in the United
States.
D) Japanese interest rates are very low in comparison to interest rates in the United
States.

Page 41

Use the following to answer question 132:

Figure: Economic Adjustments

132. (Figure: Economic Adjustments) Refer to the information in the figure Economic
Adjustments. Assume that the economy is at point b. A decrease in the money supply is
represented by a:
A) shift of the SRAS1 curve to SRAS2.
B)

shift of the SRAS2 curve to SRAS1.

C)

shift of the AD1 curve to AD2.

D) shift of the AD2 curve to AD1.

133. If the aggregate price level doubles:

A) the money supply will also double.
B)

neither the money demand nor money supply will rise.

C)

both the money demand and the money supply will rise proportionally.

D) the money demand at any given interest rate will also double.

134. If the Federal Reserve wants to lower interest rates, it can:

A) decrease the money supply by selling Treasury bills.
B)

decrease the money supply by buying Treasury bills.

C)

increase the money supply by selling Treasury bills.

D) increase the money supply by buying Treasury bills.

Page 42

Use the following to answer question 135:

Figure: Output Gap

135. (Figure: Output Gap) Refer to the information in the figure Output Gap. If the economy
is at Y1 as a result of expansionary monetary policy and no further policy is
implemented, in the long run:
A) nominal wages will increase and shift the short-run aggregate supply curve to the
left, decreasing real output.
B) nominal wages will increase and shift the short-run aggregate supply curve to the
right, increasing real output.
C) nominal wages will decrease and shift the short-run aggregate supply curve to the
left, decreasing real output.
D) nominal wages will decrease and shift the short-run aggregate supply curve to the
right, increasing real output.
136. Assume the money market is in equilibrium. The Federal Reserve Bank has decided to
purchase Treasury bills in an open market operation. The result of this action will be a
_____ in the interest rate as the money _____ shifts _____.
A) fall; supply curve; outward
B)

fall; supply curve; inward

C)

fall; demand curve; inward

D) rise; demand curve; outward

Page 43

137. The short-term interest rate is the interest rate on financial assets that mature within:
A) less than a year.
B)

a year or more.

C)

2 years.

D) 5 years.

138. If a checking account has an interest rate of 1% and a Treasury bill has an interest rate of
3%, the opportunity cost of holding cash in a checking account is:
A) zero.
B)

0.02%.

C)

1%.

D) 2%.

Use the following to answer question 139:

Figure: Short-Run Determination of the Interest Rate

139. (Figure: Short-Run Determination of the Interest Rate) If the money supply is at MS2
and the Fed conducts contractionary monetary policy, in the short run the interest rate
increases to r1. In the long run:
A) prices will decrease and decrease the demand for money.
B)

prices will decrease and increase the demand for money.

Page 44

C)

prices will increase and decrease the demand for money.

D) prices will increase and increase the demand for money.

Use the following to answer question 140:

Figure: Monetary Policy I

140. (Figure: Monetary Policy I) Refer to the information in the figure Monetary Policy I. If
the money market is initially at E2 and the central bank chooses to sell bonds:
A) AD2 will shift to the right, creating an inflationary gap.
B)

AD2 may shift to AD1, creating a recessionary gap.

C)

SRAS1 will shift immediately to the left, closing an existing inflationary gap.

D) SRAS2 will shift immediately to the right, increasing an existing inflationary gap.

141. To close an inflationary gap using monetary policy, the Federal Reserve should
________ the money supply to ________ investment and consumer spending and shift
the aggregate demand curve to the ________.
A) increase; increase; left
B)

decrease; decrease; left

C)

increase; increase; right

D) decrease; decrease; right

Page 45

142. A sale of bonds by the Federal Reserve:

A) raises interest rates and increases the money supply.
B)

raises interest rates and reduces the money supply.

C)

lowers interest rates and reduces the money supply.

D) lowers interest rates and increases the money supply.

Use the following to answer question 143:

Figure: A Money Market

143. (Figure: A Money Market) The accompanying graph shows the money market. In this
market, if the interest rate is r3, we would expect to see the interest rate _____ because
there is a ______ of money in the market.
A) fall; surplus
B)

fall; shortage

C)

rise; surplus

D) rise; shortage

144. If the economy is in a recessionary gap, the Federal Reserve should conduct _______
monetary policy by _________ the money supply.
A) expansionary; decreasing
B)

expansionary; increasing

Page 46

C)

contractionary; decreasing

D) contractionary; increasing

Use the following to answer question 145:

Figure: Short-Run and Long-Run Effects of Monetary Policy

145. (Figure: Short-Run and Long-Run Effects of Monetary Policy) Refer to the information
in the figure Short-Run and Long-Run Effects of Monetary Policy. If the economy is
initially at E2 and the central bank makes no change in its monetary policy:
A) AD2 will shift to the right, increasing the existing inflationary gap.
B)

AD2 will shift to the left, closing the inflationary gap.

C)

SRAS1 will eventually shift to the left, closing the existing inflationary gap but
raising the aggregate price level.
D) SRAS2 will immediately shift to the right, increasing the existing inflationary gap.

Page 47

Use the following to answer question 146:

Figure: Monetary Policy and the ADSRAS Model

146. (Figure: Monetary Policy and the ADSRAS Model) Refer to the information in the
figure Monetary Policy and the ADSRAS Model. If the economy is in a recessionary
gap at point f, it could move to point g as a result of:
A) a decrease in government spending.
B)

raising the discount rate.

C)

a decrease in the money supply.

D) buying government securities in the open market.

Use the following to answer question 147:

Figure: Equilibrium in the Money Market

Page 48

147. (Figure: Equilibrium in the Money Market) Refer to the information in the figure
Equilibrium in the Money Market. Equilibrium in this money market will occur at
interest rate _______ and quantity of money _______.
A) r2; Q0
B)

r0; Q2

C)

r1; Q1

D) r1; Q2

148. The federal funds rate is the interest rate on ______, and it is controlled by the
_________.
A) loans from the Federal Reserve to banks; Federal Open Market Committee
B)

reserves that banks lend to each other; Federal Open Market Committee

C)

loans from the Federal Reserve to banks; president and Congress

D) reserves that banks lend to each other; president and Congress

149. In the long run, changes in the money supply:

A) don't affect the interest rate.
B)

lower the interest rate.

C)

raise the interest rate.

D) have a small but indeterminate impact on the interest rate.

150. When the short-term interest rate _____, the opportunity cost of holding money _____,
and the quantity of money individuals want to hold _____.
A) falls; falls; falls
B)

falls; falls; rises

C)

rises; falls; falls

D) rises; falls; rises

Page 49

151. To fight inflation, the Federal Reserve should conduct _____ monetary policy to ______
interest rates, which will shift the aggregate demand curve to the _____.
A) contractionary; raise; left
B)

contractionary; raise; right

C)

expansionary; lower; right

D) expansionary; raise; left

152. When the Federal Reserve buys Treasury bills, this leads to:
A) a decrease in the money supply.
B)

an increase in the money supply.

C)

an increase in short-term interest rates.

D) an increase in the Federal Reserve funds rate.

153. When Federal Reserve officials say they are targeting federal funds rate, how are they
doing this?
A) via open market operations
B)

via changes in the discount rate

C)

via changes in deposit insurance maximums

D) via government spending

Page 50

Use the following to answer question 154:

Figure: The Money Supply and Aggregate Demand

154. (Figure: The Money Supply and Aggregate Demand) Refer to the figure The Money
Supply and Aggregate Demand. Panel (b) illustrates what happens when the Federal
Reserve decides to _______ the money supply and _______ interest rates.
A) decrease; lower
B)

increase; raise

C)

increase; lower

D) decrease; raise

155. If the interest rate is below the equilibrium rate, the:

A) supply of nonmonetary financial assets is greater than the demand for them.
B)

demand for nonmonetary financial assets is greater than the supply.

C)

demand and supply of money can still be in balance.

D) supply of money is greater than the demand.

156. Short-term interest rates:

A) fluctuate widely depending on their terms.
B)

tend to move together.

C)

move in the same direction as long-term interest rates.

Page 51

D) are always less than long-term interest rates.

157. When an individual decides to hold money instead of other assets:

A) that individual is giving up the interest that could have been earned by holding
other types of assets.
B) that individual becomes more likely to suffer from money illusion.
C)

that individual is not affected by unanticipated inflation.

D) that individual is able to maintain a higher standard of living.

158. The loanable funds model focuses on the:

A) demand for money.
B)

supply of funds from lenders.

C)

supply of funds from borrowers and the demand by lenders.

D) supply of funds from lenders and the demand from borrowers.

159. To close a recessionary gap using monetary policy, the Federal Reserve should
________ the money supply to ________ investment and consumer spending and shift
the aggregate demand curve to the ________.
A) increase; increase; left
B)

decrease; decrease; left

C)

increase; increase; right

D) decrease; decrease; right

160. A decrease in the demand for money would result from:

A) an increase in income.
B)

an increase in real GDP.

C)

a decrease in the price level.

D) an increase in nominal GDP.

Page 52

Answer Key
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
31.
32.
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
43.
44.

A
B
A
A
A
A
C
D
C
D
D
C
B
C
B
C
A
D
B
C
A
C
B
A
C
C
B
A
C
B
A
A
B
A
B
B
B
C
D
A
D
A
A
D

Page 53

45.
46.
47.
48.
49.
50.
51.
52.
53.
54.
55.
56.
57.
58.
59.
60.
61.
62.
63.
64.
65.
66.
67.
68.
69.
70.
71.
72.
73.
74.
75.
76.
77.
78.
79.
80.
81.
82.
83.
84.
85.
86.
87.
88.
89.
90.

D
A
C
D
A
D
A
B
B
A
D
A
A
B
C
C
A
B
B
D
C
A
B
D
D
B
C
C
B
C
A
C
D
A
A
B
C
B
C
C
D
C
D
C
B
A

Page 54

91.
92.
93.
94.
95.
96.
97.
98.
99.
100.
101.
102.
103.
104.
105.
106.
107.
108.
109.
110.
111.
112.
113.
114.
115.
116.
117.
118.
119.
120.
121.
122.
123.
124.
125.
126.
127.
128.
129.
130.
131.
132.
133.
134.
135.
136.

B
C
D
A
C
D
C
B
A
C
C
C
A
C
B
C
B
A
B
B
C
D
C
A
D
A
C
A
B
A
A
A
A
B
A
D
C
C
D
D
D
D
D
D
A
A

Page 55

137.
138.
139.
140.
141.
142.
143.
144.
145.
146.
147.
148.
149.
150.
151.
152.
153.
154.
155.
156.
157.
158.
159.
160.

A
D
A
B
B
B
A
B
C
D
C
B
A
B
A
B
A
D
A
B
A
D
C
C

Page 56