Chapter 21

The interest-rate effect stems from the idea that a higher price level decreases the real value of households' money holdings. True False

false

The multiplier effect states that there are additional shifts in aggregate supply from fiscal policy because it increases income and thereby increases consumer spending. True False

false

The theory of liquidity preference only attempts to explain the nominal interest rate. True False

false

When the interest rate increases, the opportunity cost of holding money decreases, so the quantity of money demanded decreases. True False

false

According to liquidity preference theory, the money-supply curve would shift if the Fed engaged in open-market operations. True False

true

If the marginal propensity to consume is 0.80, and there is no investment accelerator or crowding out, a $10 billion increase in government expenditures would shift the aggregate demand curve to the right by $50 billion $40 billion $8 billion $10 billion

$50 billion

changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action

Automatic stabilizers

the additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending

multiplier effect

A reduction in personal income taxes increases aggregate demand through an increase in private savings. True False

false

A tax increase has a multiplier effect but not a crowding-out effect. True False

false

According to liquidity preference theory, the opportunity cost of holding money is the inflation rate. True False

false

During periods of expansion, automatic stabilizers cause government expenditures to rise and taxes to fall. True False

false

If the Fed conducts open-market purchases, the money supply decreases and aggregate demand shifts right. True False

false

The Federal Funds Rate is the interest rate the Fed charges depository institutions for short-term loans. True False

false

Keynes's theory that the interest rate adjusts to bring money supply and money demand into balance

theory of liquidity preference

If the Fed decreases the money supply, the interest rate increases. True False

true

If the interest rate is below the Fed's target, the Fed should sell bonds to decrease the money supply. True False

true

Keynes would agree with the statement that irrational waves of pessimism cause aggregate demand to be unstable. True False

true

The multiplier effect amplifies the effects of an increase in government expenditures, while the crowding-out effect diminishes the effect. True False

true

The tax system is the most important automatic stabilizer. True False

true

the setting of the level of government spending and taxation by government policymakers

Fiscal policy

Which of the following Fed actions would increase the money supply? a. Buying bonds b. Increasing the discount rate c. Raising the reserve requirement d. Selling bonds

a. Buying bonds

Which of the following is true about the interest-rate effect? a. It is the most important reason, in the case of the United States, for the downward slope of the aggregate-demand curve. b. It states that the interest rate is unrelated to the quantity of goods and services demanded. c. It does not explain the slope of the aggregate-demand curve. d. It depends on the idea that increases in interest rates increase the quantity of goods and services demanded.

a. It is the most important reason, in the case of the United States, for the downward slope of the aggregate-demand curve.

Which of the following statements about the multiplier effect is NOT true? a. Tax reductions are said to have a multiplier effect on aggregate supply. b. The multiplier effect states that there are additional shifts in aggregate demand from fiscal policy because it increases income and thereby increase consumer spending. c. The logic of the multiplier effect applies to any change in spending on any component of GDP. d. Government purchases are said to have a multiplier effect on aggregate demand.

a. Tax reductions are said to have a multiplier effect on aggregate supply.

Which of the following policy actions does NOT shift the aggregate-demand curve? a. a change in the price level b. an increase in government spending c. a decrease in taxes d. open-market operations by the Fed

a. a change in the price level

Which of the following does fiscal policy not primarily affect in the long run? a. aggregate demand b. growth c. investment d. saving

a. aggregate demand

If the stock market booms, then a. aggregate demand increases, which the Fed could offset by selling government bonds. b. aggregate supply decreases, which the Fed could offset by buying government bonds. c. aggregate supply increases, which the Fed could offset by decreasing the money supply. d. aggregate demand increases, which the Fed could offset by increasing the money supply.

a. aggregate demand increases, which the Fed could offset by selling government bonds.

Which of the following events would cause the Fed to stabilize output through increasing the money supply? a. an increase in taxes b. an increase in net exports c. an increase in government spending d. a decrease in interest rates

a. an increase in taxes

If the Federal Reserve decided to lower interest rates, it could a. buy bonds to raise the money supply. b. sell bonds to lower the money supply. c. sell bonds to raise the money supply. d. buy bonds to lower the money supply.

a. buy bonds to raise the money supply

If expected inflation is constant and the nominal interest increases by 3 percentage points, then the real interest rate a. increases by 3 percentage points. b. decreases but by less than 3 percentage points. c. decreases by 3 percentage points. d. increases but by less than 3 percentage points.

a. increases by 3 percentage points.

Which of the following is true about liquidity preference theory? a. it is most relevant to the short run of interest rates. b. It is most helpful in understanding the wealth effect. c. It does not refer directly to Keynes' theory concerning the effects of changes in money demand and supply on interest rates. d. It supposes that the price level adjusts to bring money supply and money demand into balance.

a. it is most relevant to the short run of interest rates.

An increase in the marginal propensity to consume (MPC) a. raises the value of the multiplier. b. has no impact on the value of the multiplier. c. lowers the value of the multiplier. d. rarely occurs because the MPC is set by congressional legislation.

a. raises the value of the multiplier.

If money demand shifted to the left and the Federal Reserve desired to return the interest rate to its original value, it could a. sell bonds to decrease the money supply. b. buy bonds to decrease the money supply. c. buy bonds to increase the money supply. d. sell bonds to increase the money supply.

a. sell bonds to decrease the money supply.

To stabilize interest rates, the Federal Reserve will respond to a decrease in money demand by a. selling government bonds, which decreases the supply of money. b. buying government bonds, which increases the supply of money. c. buying government bonds, which decreases the supply of money. d. selling government bonds, which increases the supply of money.

a. selling government bonds, which decreases the supply of money.

In the market for real output, the initial effect of an increase in the money supply is to a. shift aggregate demand to the right. b. shift aggregate supply to the left. c. shift aggregate supply to the right. d. shift aggregate demand to the left.

a. shift aggregate demand to the right.

When the supply and demand for money are expressed in a graph with the interest rate on the vertical axis and the quantity of money on the horizontal axis, an increase in the price level a. shifts money demand to the right and increases the interest rate. b. shifts money demand to the left and increases the interest rate. c. shifts money demand to the right and decreases the interest rate.

a. shifts money demand to the right and increases the interest rate.

According to liquidity preference theory, an increase in money demand for some reason other than a change in the price level causes a. the interest rate to rise, so aggregate demand shifts left. b. the interest rate to fall, so aggregate demand shifts right. c. the interest rate to fall, so aggregate demand shifts left. d. the interest rate to rise, so aggregate demand shifts right.

a. the interest rate to rise, so aggregate demand shifts left.

When an increase in government purchases increases the income of some people, and those people spend some of that increase in income on additional consumer goods, we have seen a demonstration of a. the multiplier effect. b. the investment accelerator. c. the crowding-out effect. d. supply-side economics.

a. the multiplier effect.

If the marginal propensity to consume (MPC) is 0.75, the value of the multiplier is a. 0.75. b. 4. c. 5. d. 7.5.

b. 4.

Which of the following shifts aggregate demand to the left? a. The price level rises. b. A decrease in the money supply. c. The Fed purchases government bonds on the open market. d. The price level falls.

b. A decrease in the money supply.

Which of the following is NOT correct? a. A lower price level shifts money demand leftward. b. As the interest rate falls, the quantity of money demanded falls. c. A lower interest rate increases the quantity of goods and services demanded. d. When money demand shifts leftward, the interest rate falls.

b. As the interest rate falls, the quantity of money demanded falls.

Suppose Jason believes that the government should follow an active stabilization policy when the economy is experiencing severe unemployment. Which of the following policies would he recommend in this case? a. Sell bonds to the public. b. Decrease taxes. c. Decrease government expenditures. d. Repeal an investment tax credit.

b. Decrease taxes.

Which of the following is NOT true according to classical macroeconomics theory? a. Output is determined by the supplies of capital and labor and the available production technology. b. For any given level of output, the interest rate adjusts to balance the supply of, and demand for, money. c. Given output and the interest rate, the price level adjusts to balance the supply of, and demand for, money. d. For any given level of output, the interest rate adjusts to balance the supply of, and demand for, loanable funds.

b. For any given level of output, the interest rate adjusts to balance the supply of, and demand for, money.

In the short run, which of the following statements is true about the effects of an increase in the money supply? a. It will cause interest rates to increase. b. It will lower the cost of borrowing. c. It will decrease investment. d. It will cause aggregate demand to shift left.

b. It will lower the cost of borrowing.

Which of the following statements is true about the Kennedy administration in the early 1960s? a. The Kennedy tax cut of 1964 was not successful in stimulating the economy. b. The Kennedy administration made considerable use of fiscal policy to stimulate the economy. c. The Kennedy administration made considerable use of monetary policy to stimulate the economy. d. The Kennedy tax cut of 1964 was designed to shift the aggregate supply curve to the left.

b. The Kennedy administration made considerable use of fiscal policy to stimulate the economy.

According to the theory of liquidity preference, which of the following is NOT true? a. If the interest rate is below the equilibrium level, then the quantity of money people want to hold is greater than the quantity of money the Fed has created. b. The supply of money depends on the interest rate. c. The demand for money is represented by a downward-sloping line on a supply-and-demand graph. d. If the interest rate is above the equilibrium level, then the quantity of money people want to hold is less than the quantity of money the Fed has created.

b. The supply of money depends on the interest rate.

The initial impact of an increase in government spending is to shift a. aggregate supply to the right. b. aggregate demand to the right. c. aggregate supply to the left. d. aggregate demand to the left.

b. aggregate demand to the right.

Which of the following events would cause the Fed to stabilize output through decreasing the money supply? a. an increase in taxes b. an increase in net exports c. a decrease in government spending d. an increase in interest rates

b. an increase in net exports

Changes in taxes or government spending that increase aggregate demand without requiring policy makers to act when the economy goes into a recession are called a. the crowding-out effect. b. automatic stabilizers. c. time lags. d. stabilization policies.

b. automatic stabilizers.

Suppose a wave of investor and consumer optimism has increased spending so that the current level of output exceeds the long-run natural rate. If policymakers choose to engage in activist stabilization policy, they should a. decrease taxes, which shifts aggregate demand to the right. b. decrease government spending, which shifts aggregate demand to the left. c. decrease taxes, which shifts aggregate demand to the left. d. decrease government spending, which shifts aggregate demand to the right.

b. decrease government spending, which shifts aggregate demand to the left.

Which of the following policies would Keynes's followers support when a decrease in business optimism shifts the aggregate-demand curve away from long-run equilibrium? a. sell bonds to the public b. decrease taxes c. decrease government expenditures d. decrease the money supply

b. decrease taxes

The initial effect of an increase in the money supply is to a. increase the price level. b. decrease the interest rate. c. increase the interest rate.

b. decrease the interest rate.

Mark is having a policy debate with his cousin Gina. Gina points out that the political process is mostly responsible for the lag in implementing a. both fiscal policy and monetary policy. b. fiscal policy c. monetary policy d. neither fiscal policy nor monetary policy.

b. fiscal policy

The long-run effect of an increase in the money supply is to a. decrease the price level. b. increase the price level. c. increase the interest rate. d. decrease the interest rate.

b. increase the price level.

Steve is having a policy debate with his brother Brian. He points the fact that business firms make investment plans far in advance. This is a lag problem associated with a. both monetary policy and fiscal policy. b. monetary policy. c. fiscal policy. d. neither monetary policy nor fiscal policy.

b. monetary policy.

An increase in U.S. net exports would shift U.S. aggregate demand a. leftward. In an attempt to stabilize the economy, the government could decrease expenditures. b. rightward. In an attempt to stabilize the economy, the government could decrease expenditures. c. rightward. In an attempt to stabilize the economy, the government could increase expenditures. d. leftward. In an attempt to stabilize the economy, the government could increase expenditures

b. rightward. In an attempt to stabilize the economy, the government could decrease expenditures.

Suppose the government increases its purchases by $16 billion. If the multiplier effect exceeds the crowding-out effect, then a. the aggregate-supply curve shifts to the right by more than $16 billion. b. the aggregate-demand curve shifts to the right by more than $16 billion. c. the aggregate-demand curve shifts to the left by more than $16 billion. d. the aggregate-supply curve shifts to the left by more than $16 billion.

b. the aggregate-demand curve shifts to the right by more than $16 billion.

When an increase in government purchases raises incomes, shifts money demand to the right, raises the interest rate, and lowers investment, we have seen a demonstration of a. the investment accelerator. b. the crowding-out effect. c. the multiplier effect. d. the liquidity trap. e. supply-side economics.

b. the crowding-out effect.

When an increase in government purchases causes firms to purchase additional plant and equipment, we have seen a demonstration of a. the multiplier effect. b. the investment accelerator. c. the crowding-out effect.

b. the investment accelerator.

According to liquidity preference theory, which of the following is NOT true? a. A decrease in the interest rate increases the quantity of money demanded. b. A decrease in the interest rate does not affect the money-supply curve. c. A decrease in the price level shifts money demand to the right. d. A decrease in the interest rate is shown as a movement along the money-demand curve.

c. A decrease in the price level shifts money demand to the right.

Which of the following illustrates how the investment accelerator works? a. An increase in government expenditures increases the interest rate so that the demand for stocks and bonds issued by Starshine Inc. rises. b. An increase in government expenditures decreases the interest rate so that Starshine Inc. finds it profitable to update its car-wash equipment. c. An increase in government expenditures increases aggregate spending so that Starshine Inc. finds it profitable to update its car-wash equipment. d. An increase in government expenditures increases the interest rate so that the Starshine Inc. decides to open up new car-wash in additional locations.

c. An increase in government expenditures increases aggregate spending so that Starshine Inc. finds it profitable to update its car-wash equipment.

Which of the following Fed actions would decrease the money supply? a. Buying bonds b. Decreasing the discount rate c. Raising the reserve requirement d. Lowering the reserve requirement

c. Raising the reserve requirement

Which of the following best describes how an increase in the money supply shifts aggregate demand? a. The money supply shifts right, prices fall, spending increases, and aggregate demand shifts right. b. The money supply shifts right, prices rise, spending falls, and aggregate demand shifts left. c. The money supply shifts right, the interest rate falls, investment increases, and aggregate demand shifts right. d. The money supply shifts right, the interest rate rises, investment decreases, and aggregate demand shifts left.

c. The money supply shifts right, the interest rate falls, investment increases, and aggregate demand shifts right.

Which of the following is NOT an automatic stabilizer? a. the welfare system b. unemployment benefits c. an increase in money supply d. the U.S. tax system

c. an increase in money supply

When money demand is expressed in a graph with the interest rate on the vertical axis and the quantity of money on the horizontal axis, an increase in the interest rate a. increases the quantity demanded of money. b. increases the demand for money. c. decreases the quantity demanded of money. d. decreases the demand for money.

c. decreases the quantity demanded of money.

Which among the following assets is the most liquid? a. fine art b. stocks and bonds c. deposits that can be withdrawn using ATMs d. real estate

c. deposits that can be withdrawn using ATMs

Suppose a wave of investor and consumer pessimism causes a reduction in spending. If the Federal Reserve chooses to engage in activist stabilization policy, it should a. decrease government spending and increase taxes. b. increase government spending and decrease taxes. c. increase the money supply and decrease interest rates. d. decrease the money supply and increase interest rates.

c. increase the money supply and decrease interest rates.

Keynes's liquidity preference theory of the interest rate suggests that the interest rate is determined by a. aggregate supply and aggregate demand. b. the supply and demand for loanable funds. c. the supply and demand for money. d. the supply and demand for labor.

c. the supply and demand for money.

Which of the following is an example of an automatic stabilizer? a. an increase in money demand b. the minimum wage c. the unemployment compensation system d. an increase in tax rates in response to an expansion

c. the unemployment compensation system

Which of the following is an automatic stabilizer? a. military spending b. spending on public schools c. unemployment benefits d. spending on the space station

c. unemployment benefits

If the multiplier is 5, then the MPC is a.10 b.2 c.0.8 d.0.2

c.0.8

the offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending

crowding-out effect

The multiplier for changes in government spending is calculated as a. 1/(1 + MPC). b. MPC/(1 - MPC). c. 1 - MPC. d. 1/(1 - MPC).

d. 1/(1 - MPC).

which of the following is an example of crowding out? a. A decrease in the money supply increases interest rates, causing investment to fall. b. A decrease in government spending increases interest rates, causing investment to fall. c. A decrease in consumption increases interest rates, causing investment to fall. d. A decrease in taxes increases interest rates, causing investment to fall.

d. A decrease in taxes increases interest rates, causing investment to fall.

Which of the following statements regarding taxes is correct? a. A decrease in taxes shifts the aggregate-supply curve to the left. b. An increase in taxes shifts the aggregate-demand curve to the right. c. Most economists believe that, in the short run, the greatest impact of a change in taxes is on aggregate supply, not aggregate demand. d. A permanent change in taxes has a greater effect on aggregate demand than a temporary change in taxes.

d. A permanent change in taxes has a greater effect on aggregate demand than a temporary change in taxes.

Sometimes during times of heightened national security, government expenditures are larger than normal. What could the Fed do to reduce the effects this spending creates on interest rates? a. Decrease the money supply by selling bonds. b. Decrease the money supply by buying bonds. c. Increase the money supply by selling bonds. d. Increase the money supply by buying bonds.

d. Increase the money supply by buying bonds.

Which of the following is NOT true about the Employment Act of 1946? a. It reflected the ideas promoted in Keynes's influential book, The General Theory of Employment, Interest, and Money. b. It implies that the government should avoid being a cause of economic fluctuations. c. It implies that the government should respond to changes in the private economy to stabilize aggregate demand. d. It states that the government should not promote full employment and production.

d. It states that the government should not promote full employment and production.

Which of the following statements about stabilization policy is true? a. In the short run, a decision by the Fed to increase the targeted money supply is essentially the same as a decision to increase the targeted interest rate. b. Congress has veto power over the monetary policy decisions of the Fed. c. Long lags enhance the ability of policymakers to "fine-tune" the economy. d. Many economists prefer automatic stabilizers because they affect the economy with a shorter lag than activist stabilization policy.

d. Many economists prefer automatic stabilizers because they affect the economy with a shorter lag than activist stabilization policy.

Jason is a critic of stabilization policy. Which of the following statements would he NOT agree with? a. Stabilization policy can be a source of, instead of a cure for, economic fluctuations. b. There is a lag between the time a policy is passed and the time a policy has an impact on the economy. c. There is a lag between the time a policy is needed and the time it takes to be implemented. d. The Fed should try to fine-tune the economy during times of economic fluctuations.

d. The Fed should try to fine-tune the economy during times of economic fluctuations.

Which of the following is an example of an increase in government purchases? a. The government decreases Social Security payments. b. The government increases corporate taxes. c. The Federal Reserve sells government bonds. d. The government builds new bridges.

d. The government builds new bridges.

Temporary tax cuts shift the aggregate-demand curve a. farther to the left than do permanent tax cuts. b. not as far to the left as do permanent tax cuts. c. farther to the right than do permanent tax cuts. d. not as far to the right as do permanent tax cuts.

d. not as far to the right as do permanent tax cuts.

Assume the MPC is 0.6. Assume there is a multiplier effect and that the crowding-out effect is $10 billion. An increase in government purchases of $20 billion will shift aggregate demand to the a. left by $10 billion b. left by $30 billion c. right by $50 billion d. right by $40 billion

d. right by $40 billion

For the United States, the most important source of the downward slope of the aggregate-demand curve is a. the exchange-rate effect. b. the wealth effect. c. the fiscal effect. d. the interest-rate effect

d. the interest-rate effect

The fraction of extra income that a household consumes rather than saves is called a. the savings rate. b. fiscal policy. c. the multiplier. d. the marginal propensity to consume.

d. the marginal propensity to consume.

In a certain economy, when income is $200, consumer spending is $160. The value of the multiplier for this economy is 4. It follows that, when income is $300, consumer spending is a.$560 b.$260 c.$240 d.$235

d.$235

If the marginal propensity to consume is 2/3, then the government purchases multiplier is a.1.67 b.2 c.0.33 d.3

d.3