chapter 16: sample

The tax cut will have a larger impact on aggregate demand in the economy with the

permanent tax cut .

With the economy in a recession because of inadequate aggregate demand, the government increases its purchases by $1,200. Suppose the central bank adjusts the money supply to hold the interest rate constant, investment spending is fixed, and the marginal propensity to consume is . How large is the increase in aggregate demand?

3,600

Suppose the government increases its purchases by $1,200 while holding the money supply constant. The change in aggregate demand resulting from an increase in government purchases if the government allows interest rates to adjust (as compared to the change if it were to hold them constant) will be

smaller but still positive.

The following graph shows the money market in a hypothetical economy. The central bank in this economy is called the Fed. Assume that the Fed fixes the quantity of money supplied. Suppose the price level increases from 150 to 175. Shift the appropriate curve on the graph to show the impact of an increase in the overall price level on the market for money.

After the increase in the price level, the quantity of money demanded at the initial interest rate of 6% will begreater than the quantity of money supplied by the Fed at this interest rate. People will try toincrease their money holdings. In order to do so, people willsell bonds and other interest-bearing assets, and bond issuers will find that theyhave to offer higher interest rates until the money market reaches its new equilibrium at an interest rate of8%.

increase, decrease

If the central bank wants to expand aggregate demand, it can ________ the money supply, which would ________ the interest rate

decrease, increase

If the government wants to contract aggregate demand, it can ________ government purchases or ________ taxes.

The following graph shows the money market in a hypothetical economy. The central bank in this economy is called the Fed. Assume that the Fed fixes the quantity of money supplied. Suppose the price level increases from 150 to 175

The change in the interest rate that you found previously will cause residential and business investment spending tofall , leading toa decrease in the quantity of output demanded in the economy

What does the previous analysis suggest about the market for money?

The demand for money arises largely from its usefulness in making daily transactions. Since the opportunity cost of holding money rises as the interest rate rises, people will hold a smaller fraction of their assets as money when the interest rate is high—in other words, they demand less money at higher interest rates.

Which of the following is an example of an automatic stabilizer? When the economy goes into a recession

more people become eligible for unemployment insurance benefits.

The Federal Reserve's target rate for the federal funds rate

commits the Fed to set a particular money supply so that it hits the announced target