Macroeconomics - Exam #2

U.S. interest on its national debt, measured as a percentage of GDP, fell during ____ and rose during the _____.

1990s; 1980s

Which of the following is TRUE regarding the possible effects of a tax change?

Higher marginal tax rates tend to depress economic activity.

Which of the following statements does NOT describe a problem of balancing the budget over the business cycle?

Increasing taxes at the top of the cycle exacerbates inflation.

Which of the following regarding supply-side fiscal policy is INCORRECT?

It is geared toward short-term increases in employment.

What is the likely chain of events if asset prices rise?

People feel wealthier, so their spending rises and their saving falls, causing interest rates to rise.

(Figure: Determining SRAS Shifts) If there is a decrease in input prices, the short-run aggregate supply curve will shift from SRAS0 to _____ and the price level will become _____.

SHIFT RIGHT - SRAS1; P1

When households decide to increase saving, real interest rates fall and investment rises. T or F

T

Which of the following statements regarding the short-run aggregate supply curve is TRUE?

The short-run aggregate supply curve shifts to the right with a reduction in burdensome regulations.

Which of the following assets is included in M1?

checkable deposits

This economy is at point a. This figure depicts an economy:

in both short-run and long-run equilibrium

Assume that the Federal Reserve sets the reserve requirement at 10%. If a bank has $100 million in deposits, then its required reserves must equal:

$10 million

New deposits of $1 billion are placed in a bank. The reserve requirement is 20%. How much does the money supply increase, assuming no leakages?

$5 billion

SCENARIO: Assume that the Empathy State Bank begins with the balance sheet below and is fully loaned up. Empathy State Bank Assets Liabilities Vault Cash $2,500 Deposits $100,000 Deposits at the Federal Reserve 7,500 Loans 90,000 If this bank is subject to a reserve requirement of 5%, how much more can it loan out if it wants to be fully loaned up?

$5,000

About 10% of U.S. dollars are held outside the United States. T or F

F

Banks:

create money by making loans using the deposits of their customers.

Which of the following factors is NOT a component of aggregate demand?

income

Fiscal policy that focuses on shifting the long-run aggregate supply curve to the right is:

supply-side fiscal policy.

Mandatory spending comprises nearly ________ of the federal budget.

two-thirds

In open market operations, the Federal Reserve buys and sells gold on the open market to preserve the value of the dollar. T or F

F

Many U.S. retirement accounts have regained much of their lost value since the 2007-2009 stock market crash because investors switched their portfolio mix from stocks to bonds. T or F

F

The 2007 housing crisis led banks to increase lending in an effort to offset foreclosures. T or F

F

Which of the following will NOT shift the aggregate supply curve to the left?

a decrease in corporate taxes

If a person borrows $2,000 at 5% interest and never makes any payments, how much will the loan balance be after five years?

$2,552.56

Perry deposits $10,000 in his bank account. If the reserve requirement is 15%, how much of this amount can his bank make in new loans?

$8,500

Kim recently purchased a perpetual bond for $1,000. The bond pays $50 in interest per year. Suppose market interest rates rise to 7% after the purchase. The price of the bond:

falls to $714.

What is the interest rate for money borrowed to satisfy daily reserve requirements?

federal funds rate

The demand curve for loanable funds represents _____ and is _____.

investors; downward sloping

A stronger dollar will shift the U.S. aggregate demand curve to the _____ and _____ output demanded.

left; decrease

If an economy is producing at a level beyond full employment, using contractionary fiscal policy to reduce aggregate demand means a tradeoff between ________ price levels and ________ output.

lower; lower

The short-run aggregate supply curve is positively sloped because:

many input prices are slow to change in the short run.

All of the following are determinants of aggregate supply EXCEPT:

net exports

Which of the following is NOT a policy tool of the Federal Reserve?

fiscal policy

Because of the wealth effect, a rising aggregate price level ____ the purchasing power of wealth and therefore _____ output demanded.

reduces; reduces

To say that interest rates represent the opportunity cost of holding money means that as interest rates rise:

there is a movement upward along the demand curve for money.

Which of the following is a goal of the agencies that regulate financial institutions?

to increase transparency and the flow of information to investors

Suppose policymakers wish to use fiscal policy to fight inflation. Which statement is MOST accurate?

Essentially, the way to lower the inflation rate is to decrease aggregate demand and cause a recession.

A deferment on a college loan means that it need not be paid off at all. T or F

F

An investment tax credit for pharmaceutical research is a demand-side fiscal policy. T or F

F

Bond prices and interest rates are positively related. T or F

F

Checking accounts are not money T or F

F

If a $1,000 bond is issued with a coupon rate of 12%, the bondholder will receive $12 per year for the life of the bond. T or F

F

Savings deposits are included in M1. T or F

F

When an economy moves to a point below full employment, economists say that an inflationary spiral has set in. T or F

F

Which of the following statements about fiscal policy and aggregate supply is CORRECT?

Fiscal policies that influence aggregate supply don't always require tradeoffs between price levels and output.

When money is deposited in a bank, why is the deposit both an asset and a liability?

Money deposited in a bank is a liability because the bank is holding something that belongs to the depositor. In effect, the bank borrows the funds. It can, however, use the fund for making loans. Since it is a resource for generating profits, it is an asset to the bank.

If the federal government were required to balance its budget annually:

a recession would lead to higher taxes or reduced spending.

What would cause inflation to rise and employment to increase?

a shift of the AD curve to the right

When the economy booms, tax revenues rise faster than income. T or F

T

The long-run aggregate supply curve represents the full-employment capacity of the economy. T or F.

TRUE

Show graphically the difference between a movement along an aggregate demand curve and a shift to a new aggregate demand curve. Explain what causes each.

The aggregate demand curve is negatively sloped. Everything else held constant, a change in the aggregate price level will change the quantity of real GDP demanded. This change would cause a movement along the aggregate demand curve. Hence, if aggregate demand is represented by AD0 in the following figure and the aggregate price level changes, then the quantity of real GDP demanded will change, as represented as a movement along curve AD0. The determinants of aggregate demand are factors that shift the entire aggregate demand curve when they change. They are the "everything else held constant." If one of these components of aggregate spending changes, the aggregate demand curve will shift. At first, aggregate demand is AD0, so a shift to AD1 represents an increase in aggregate demand; more real output is demanded at the same price level, P0. If, for example, businesses decide to invest more in new technology, more real output is demanded at the current price level, P0. For similar reasons, a decline in aggregate demand to AD2 means that less real output is being demanded. If consumers for some reason fear the onset of a recession and decide to reduce spending to increase their saving reserves, less output, Q2, will be demanded.

Describe the crowding-out effect.

When the government runs a deficit, it must sell bonds to either the public or the Federal Reserve. If it sells bonds to the Federal Reserve when the economy is near full employment, inflation will result. At full employment, expansionary monetary policy results in an increase in aggregate demand, increasing output temporarily above full employment, with a corresponding increase in aggregate price level. Eventually the economy moves back to full employment at a higher price when the government runs a deficit. The government must sell bonds to finance the deficit, causing a movement up the now higher aggregate demand curve, with the resulting higher prices and inflation. Alternatively, when the federal government spends more than tax revenues permit, it can sell bonds to the public. As the supply of bonds sold on the market rises, prices drop and interest rates rise. As interest rates rise, consumption and private investment drops. The consequence of decreased investment is that future generations will be bequeathed a smaller and potentially less productive economy, resulting in a lower standard of living. This is the crowding-out effect of deficit spending.

A practical implication of the crowding-out effect is that it:

Makes expansionary fiscal policy less effective.

An increase in subsidies will lead to an increase in aggregate supply T or F

T

Each regional Federal Reserve branch helps to compile information about the economic conditions in its home region. T or F

T

For a fiscal policy to be sustainable, the present value of all projected future revenues must equal the present value of projected future spending. T or F

T

If a bank makes a loan of $5,000, which is then withdrawn in cash and spent in another country, the money supply will not grow. T or F

T

Missing a minimum payment on your credit card can make it less likely that certain employers will hire you. T or F

T

One argument against using taxation to pay off the public debt is that it will redistribute wealth from people who do not hold bonds to bondholders. T or F

T

Open market operations consist of buying and selling government securities on the open market. T or F

T

When the Federal Reserve buys bonds, it effectively lowers the nominal interest rate in the market. T or F

T

Show graphically the difference between a movement along a short-run aggregate supply curve and a shift to a new curve. Explain what causes each.

The aggregate supply curve is positively sloped in the short run. Everything else held constant, a change in the aggregate price level will change the quantity of aggregate output supplied in the short run, causing a movement along the short-run aggregate supply curve. Hence, if the short-run aggregate supply is represented in the figure provided by SRAS0 and the aggregate price level changes, the quantity of aggregate output supplied will change as represented as a movement along curve SRAS0. The determinants of aggregate supply—the "other things held constant"—include changes in input prices, productivity, taxes, regulation, the market power of firms, and business and inflationary expectations. When any of these determinants changes, the entire short-run aggregate supply curve shifts. An increase in aggregate supply is indicated by a shift from SRAS0 to SRAS1; a decrease in aggregate supply is indicated by a shift from SRAS0 to SRAS2.

Suppose a perpetuity bond pays an interest of $40. The financial investor can earn a 5% return elsewhere. What is the maximum amount buyers would be willing to pay for this bond?

The formula to calculate the price of a perpetuity is Price = Interest Payment / Yield. If there are other options available to the investor that yield a 5% return, then the buyer must receive 5% in order to make it worthwhile to purchase the bond. The interest payment of $40 is fixed by the terms of the bond. Hence, the price of the bond must be $800 (or $40 / 5%).

In the economists' toolkit, both demand-side and supply-side fiscal expansionary policies include tax cuts. What accounts for the different effects of the two tax cuts on the economy?

The main difference is where the tax cut is applied. If the purpose is to provide funds for households to spend on buying final goods and services, then the policy is targeted to increase the aggregate demand curve. An income tax cut is an example of such a policy. If the tax cut is designed to encourage investment, such as by building new factories or encouraging education, then the policy is designed to increase aggregate supply. A tax cut tied to investment spending is a supply-side policy. And a tax cut that is designed to encourage more work, like a reduction in marginal tax rates, is a supply-side strategy.

What are the three functions of money? Which function addresses the double coincidence of wants problem?

The medium of exchange function means that the asset is generally accepted for making purchases, thus solving the double coincidence of wants problem caused by the barter system. The problem is that if one wishes to trade away item A in return for item B, one must find someone willing to trade away B for A. The unit of account function allows people in an economy to compare the value of different goods and services. The store of value function allows saving for future transactions.

Explain how the wealth, export, and interest rate effects cause a negative relationship between the price level and GDP.

The three effects show how price level changes (inflation or deflation) change the real value of goods, services, and financial assets. The wealth effect states that as prices rise, the real value of financial assets falls, causing households to spend less. According to the export effect, inflation causes the prices of exports to rise in the world markets, so purchases of these goods drop. The interest rate effect says that when prices rise, interest rates rise and investment spending drops.

In 2008 the Fed began paying banks interest on the reserves they held at the Fed. How did this change the incentives banks had for making loans?

This policy changed the incentives banks faced by reducing the opportunity cost of choosing not to lend. In tough economic times, for instance, banks may choose to forgo making loans in favor of earning interest on their excess reserves deposited at the Fed.

In September 2013, the Bank of India raised the rate at which it lends to commercial banks. a. The Fed lends to commercial banks, just as India does. What is the name for the rate that the Fed charges commercial banks and other eligible institutions for loans? b. Was the Bank of India attempting to increase or decrease the money supply by increasing the rate at which it lends to commercial banks? c. The Bank of India has tools very similar to those of the Federal Reserve in the United States. How could the Bank of India have used its other tools to achieve the same result as raising the rate at which it lends to commercial banks?

a. The Fed lends to commercial banks at the discount rate. b. The Bank of India was attempting to decrease the money supply. c. The Bank of India could have raised its reserve requirements or sold bonds in the open market to decrease the money supply.

The use of money as a medium of exchange helps reduce the inefficiencies inherent in:

barter

At Christmas, people tend to draw money out of their checking accounts to pay for Christmas presents. As a result, the money multiplier will:

decrease

In February 2010, the Central Bank of Brazil raised reserve requirements. By raising reserve requirements, Brazil was attempting to:

decrease its money supply.

A(n) __________ in government spending, a __________ domestic currency, and ________ interest rates will shift a country's aggregate demand to the left.

decrease; stronger; higher

When the price of a given product declines, the consumer's spendable income rises because it takes less income to purchase the same quantity. This is called the:

income effect

Reducing tax rates can _____ aggregate demand and __________ aggregate supply.

increase;increase

Automatic stabilizers include all of the following EXCEPT

increased research and development.

Monetary policy involves all of the following EXCEPT:

increases in personal taxes.

Decreased interest rates will shift the aggregate demand curve to the _____ and _____ output demanded.

right; increase

Ceteris paribus, suppose an economy institutes reforms that reduce government regulations. In this case the demand for loanable funds shifts ______ and the equilibrium interest rate _______.

right; rises

Other things equal, when the U.S. aggregate price level falls, U.S. exports _______ and U.S. imports ________.

rise; fall

Money is employed as a _____ because it enables people to save the money they earn today and use it to buy goods and services later.

store of value

______ are components of consumer spending that affect aggregate demand.

taxes