Ch 18 Macro Practice Questions

IS curve moves left

a. Suppose that consumers and businesses become convinced that the economy will soon enter a recession. Adjust the diagram to show the effect of this belief.

IS curve shifts to the left (point doesn't move)

a. Worried about potential softening in the economy, the Fed decides to lower interest rates. The real interest rate was 4% prior to the Fed's action. - decide what movement occurs at the point on the IS curve to illustrate the likely effect of the interest rate decrease on the output gap or shift the curve

The equation for aggregate expenditure in an open economy is:

C + I + G + (X − M)

Which of these changes could lead to a more positive output gap? (i) The GDP of an important trading partner falls. (decreaseing exports (more negative output gap)) (ii) Defense spending increases. (more positive output gap) (iii) Consumer wealth increases. (higher consumer spending more positive output gap) (iv) The risk premium decreases (shifts MP curve down: more positive output gap)

ii, iii, and iv

What is the multiplier?

measure of how much GDP changes as a result of both the direct and indirect effects flowing from each dollar of spending ΔGDP = ΔSpending × Multiplier (or total GDP/ God spending)

Consider the aggregate expenditure model. Suppose there is an increase in real GDP in the economy. Which economic variables decrease when real GDP increases? - consumption - government spending - exports - aggregate spending - natural rate of output - investment - net exports - imports - marginal propensity to consume

net exports

The U.S. imposed a tariff on solar panels produced in China. How did this affect China's IS curve?

net exports decreased, leading to a left shift of the IS curve

How do you caculate the risk free rate?

nominal intrest rate - inflation rate - risk premium

What happens if actual GDP is less than potential GDP?

unemployment will rise

If the nominal rate of interest is 4.8%, the rate of inflation is 2%, and the risk premium is 0.75%, theMPcurve is at:

2.8%

If potential GDP is $26.5 trillion, and actual GDP is $27.49 trillion, the output gap is:

3.74%

The risk-free interest rate is currently 3.5% and the risk premium is 1.5%. The real-interest rate is:

5.0%

MP curve shifts down

In 2008, the Federal Reserve committed funds to stabilize the banking system and lower the risk premium in the economy. Which of these shows the correct effect on theIS-MPframework?

a movement from point A to point B

In October 2019, the Federal Reserve lowered real interest rates in the economy. Which of these shows the correct effect on theIScurve?

MP curve shifts up

Shift the MP curve to reflect the economic event described. a. The Federal Reserve lowers the federal funds rate.

MP curve shifts down

Shift the MP curve to reflect the economic event described. b. A vague statement by the Federal Reserve Chair about the Fed's future plans creates uncertainty about the future path of interest rates.

MP curve shifts up

Shift the MP curve to reflect the economic event described. c. Double-digit inflation suddenly appears. The Fed responds accordingly.

MP curve shifts upwards

What happens to the IS-MP framework when there is an increase in the risk premium in an economy?

a movement form point C to D

What movement will happen on theIScurve if there is a decrease in personal income tax rates?

IS curve shifts to right

What will change on the IS-MP framework if there is a rise in home values and wealth in an economy?

MP curve shifts upwards

What will change on the IS-MP framework if there is a sharp increase in loan default rates in an economy?

a movement from point C to point B

Which of these shows the correct effect on theIScurve of an increase in the real interest rate?

In macroeconomic equilibrium in an open economy:

Y = C + I + G + (X − M)

Higher intrest rates cause the U.S. dollar to:

appreciate

no movement occurs

b. An international dispute threatens to disrupt trade between a country and its neighbor. - decide what movement occurs on the IS curve to illustrate how increased pessimism about the country's economy would influence the IS curve

Which of these cause(s) theMPcurve to shift? - business optimism - spending shocks - changes in monetary policy - consumer pessimism

changes in monetary policy

Which things cause the MP curve to shift?

changes in monetary policy (ex risk free rates or risk premium) or inflation

You spend $400 on new books for your courses this semester. Which component of aggregate expenditure includes this expenditure?

consumption

You spend $45 on a haircut, $30 on a couple of T-shirts, and $17 on lunch at a restaurant. Which component of aggregate expenditure includes these expenditures?

consumption

What is planned investment?

expenditure on capital goods by buisnesses

Consider the aggregate expenditure model. Suppose there is an increase in real GDP in the economy. Which economic variables stay the same when real GDP increases? - consumption - government spending - exports - aggregate spending - natural rate of output - investment - net exports - imports - marginal propensity to consume

government spending, natural rate of output, marginal propensity to consume, exports, investment

What is the relationship between higher interest rates and aggregate expenditure?

higher intrest rates cause aggregate expenditure to fall

Which of these changes could lead to a more negative output gap? (i) The United States places additional tariffs on imports. (ii) Foreign countries place tariffs on U.S. exports. (iii) There is a reduction in availability of money or credit from banks and lenders. (iv) Consumer pessimism increases.

i, ii, iii, iv

Which of these changes could create a more positive output gap in an economy? (i) Government spending increases. (ii) There is a reduction in taxes. (iii) The risk premium increases. (iv) The default rates on loans falls.

i, ii, iv

A good proxy for the risk-free interest rate is the interest rate on a:

loan to the U.S. government

What is the relationship between lower interest rates and aggregate expenditure?

lower intrest rates boost aggregate expenditure

You're a staff analyst at the Federal Reserve. Economic forecasters are predicting a slowdown in U.S. economic growth due to contractionary fiscal policies implemented by European governments, causing U.S. net exports to fall. The Fed is considering whether to use expansionary monetary policy to counteract these contractionary effects. You're asked to schematize the series of events that will occur in this scenario, starting with the slowdown in U.S. economic growth. Using theIS-MPmodel, your schematization is:

rightward shift of theIScurve, downward shift of theMPcurve, lower real interest rate., an more negative output gap

If government expenditure rises by $27.5 billion, and the multiplier is 2.5, then real GDP:

rises by $68.75 billion (just multiply), and the IS curve shifts to the right

Many economists believe that World War II—the massive increase in defense-related production and employment in defense-related industries—ended the Great Depression of the 1930s. In theIS-MPmodel, this would appear as a _____ shock, shifting the _____, and causing the output gap to become more _____.

spending; IS curve rightwards; positive

When the perceived financial risk in an economy falls:

the TED spread decreases

Who sets the risk-free intrest rate?

the federal reserve

What does the MP curve represnt?

the real intrest rate

If actual GDP is less than potential GDP:

unemployment will rise

If the nominal rate of interest is 4.5%, the rate of inflation is 2%, and the risk premium is 1.5%, the risk-free rate is:

1%

If government spending rises by $62 billion, and GDP rises by $110 billion, then the multiplier in the economy is approximately:

1.77 (110/62)

MP curve shifts down

Shift the MP curve to reflect the economic event described. d. Billionaire investor Lawrence Riskalot's new book—which advocates borrowing to cover stock purchases—tops the best-seller list for three months. An ethic of risk-taking takes hold among investors. The stock market soars.

MP curve shifts to 0, IS curve shifts to the right

Suppose the economy is experiencing a recession, and the government chooses to use expansionary monetary policy to try to eliminate the output gap. a. Adjust the accompanying diagram to show monetary policy used to its maximum efffect in seeking to close the output gap. (Assume there is no inflation and that the risk premium is zero.) b. The government is not fully satisfied with the result of its efforts and decides to supplement its expansionary monetary policy with an expansionary fiscal policy. Adjust the diagram to show how the government could successfully close the output gap by adding in fiscal policy.

In a closed economy, the equation for aggregate expenditure is:

C + I + G

What is aggregate expenditure and what is it made of?

total spending in the economy: the sum of consumption, planned investment, government purchases, and net exports

downward shift of MP curve and borrowing costs fall

1) How would policymakers address a recessionary equilibrium strictly through monetary policy in this graph? 2) Under the strict monetary policy approach, output rises because:

If the risk-free rate is 1.5% and the risk premium is 2%, theMPcurve is at:

3.5%

Suppose that the Federal Reserve has recently raised interest rates, and there is a credible forecast that the Fed will again raise interest rates in the future. A manager who isIS-MP-savvy will expect that: (mp curve shifted up)

GDP will fall and sales will decrease

a movement from point C to point A

After the inflationary period of 1979, Paul Volcker, chair of the Federal Reserve, raised real interest rates sharply. Which of these shows the correct effect on theIScurve?

a: is curve shifts left, b: point moves down

For each scenario, graphically illustrate how the IS curve is affected, either by shifting the curve or moving the point along the curve. (Do not both shift the curve and move the point along the curve.) a. Poor numbers from several leading economic indicators cause businesses to become pessimistic about the future of the economy. b. The real interest rate falls, which causes consumption spending to rise.

Consider the aggregate expenditure model. Suppose there is an increase in real GDP in the economy. Which economic variables increase when real GDP increases? - consumption - government spending - exports - aggregate spending - natural rate of output - investment - net exports - imports - marginal propensity to consume

aggregate expenditures, consumption and imports

A fall in the real interest rate causes a:

movement down and to the right of the IS curve.

A rise in the real interest rate causes a:

movement up and to the left along the IS curve

What is the relationship between real interest rates and net exports in the economy?

negative relationship

The risk premium is the:

extra intrest charged by lenders to account for risk

a: upward shift of MP curve, b: downward shift of MP curve

Given the macroeconomic shock described in each scenario, determine whether the IS or MP curve would shift and which direction. a. Increased political uncertainty leads many executives to put their investment plans on hold. b. In an effort to boost the economy, the Federal Reserve lowers the federal funds rate.

What do lower intrest rates lead to?

a rise in every component of aggregate expenditure, boosting consumption, planned investment, government purchases (maybe), and net exports

The belief that there will soon be a recession results in

a recession

TheIS curve is constructed by:

adding up the level of aggregate expenditure at each intrest rate

What does the IS-MP curve illustrate?

how the output gap depends on the real intrest rate and what the real intrest rate will be

Consumption is $151 billion, government expenditure is $70.2 billion, investment is $65.8 billion, and net exports amount to −$21 billion. What is aggregate expenditure in this economy?

$266 billion

Consumption is $1.2 trillion, government expenditure is $0.75 trillion, investment is $0.8 trillion, and net exports amount to $0.4 trillion. What is aggregate expenditure in this economy?

$3.15 trillion

rightward shift of IS curve, of an initial bout of spending that gives rise to subsequent additional rounds of spending

1) How would policymakers address a recessionary equilibrium strictly through fiscal policy in this graph? 2) Under the fiscial policy approach, output rises because:

TheIS curve shows the relationship between:

lower intrest rates and higher real GDP and thus a more positive output gap

Revenue is down at your pastry shop, forcing you to lay off one of your workers. Your reduced costs restore profitability for a time, but then your revenues decline again, forcing you to lay off another worker. Fellow shop-owners say they are experiencing the same thing: as they cut labor costs to restore profitability, their revenues continue to decline. After a while, economic activity seems to reach a stasis but with fewer workers employed than initially. What, MOST likely, is happening to the economy?

output equals aggregate expenditure at a negative output gap

In view of the risk premiums involved in the following types of loans, which loan would have the highest interest rate?

a personal loan from a bank

leftward shift of IS curve (both)

Housing prices in the United States decline dramatically and remain depressed for several months. a. Using the IS-MP graph, show what happens to the macroeconomic equilibrium in the United States. b. Using the IS-MP graph, show how the housing market crash impacts the Canadian economy, one of the United States' largest trading partners.

4% to 3%

Suppose the economy is in recession, with an output gap of −2%. To eliminate the output gap, the Federal Reserve might act to move the real interest rate from:

Which of these will shift theMPcurve downward? - a stock market boom - an increase in the federal funds rate - a central bank commitment to act as a "lender of last resort" (i.e., provider of liquidity to troubled financial institutions) during a financial panic - a period of slow economic growth

a central bank commitment to act as a "lender of last resort" (i.e., provider of liquidity to troubled financial institutions) during a financial panic

A slowdown in global economic might affect the output gap in the United States by the following route: Global demand for U.S. exports _____, _____ U.S. net exports, and shifting theIScurve to the _____. As a result, the U.S. output gap becomes more _____.

falls; decerasing; left; negative

How do interest rates affect consumption in the economy?

lowered consumption after higher intrest rates discourage conusmers from making financial purchases