ECO285 Final Exam Practice Questions

Ch. 13 If the Federal Reserve wishes to increase the money supply by $30,000 and the reserve requirement ratio is 0.4, how big a purchase of government bonds will the Fed need to make? A. $75,000 B. $12,000 C. $1,000 D. $30,000 E. $3,000

B. $12,000 Increase in money supply = reserve injection × (1/RRR) $30,000 = reserve injection × (1/0.4) reserve injection = $30,000 × 0.4 (or, $30,000 = reserve injection × 2.5) reserve injection = $12,000

Ch. 13 Assuming that households do not change their cash holdings and banks loan out all of their excess reserves, if the required reserve ratio (RRR) is 20 percent and the Fed purchases $2,000 worth of government bonds from a bond dealer, how much money will be eventually created? A. $1,800 B. $2,000 C. $10,000 D. $18,000 E. $20,000

C. $10,000 ∆DD (increase in money supply; money created) = reserve injection × (1/RRR) ∆DD = $2,000 × (1/0.2) ∆DD = $2,000 × 5 ∆DD = $10,000

Ch. 15 If the price level is increasing and output is falling, which of the following could be the reason? A. A negative demand shock B. A positive supply shock C. A positive supply shock combined with a positive demand shock D. A negative supply shock E. A positive demand shock.

D. A negative supply shock If the price level is increasing and output is falling, this situation is called stagflation. It is a decrease in aggregate supply (AS shifts leftward or upward) caused by a negative supply shock. "Negative" means this shock decreases output.

Ch. 13 Given the following information, calculate M1. Small time deposits: $800 billion Checking deposits: $400 billion Savings-type accounts: $900 billion Money market mutual funds: $700 billion Traveler's checks: $50 billion Large time deposits: $750 billion Cash on hand: $150 billion A. $600 billion B. $2,100 billion C. $2,800 billion D. $1,900 billion

A. $600 billion M1 = Cash in the hands of the public + Checking account deposits + Traveler's checks = 150 + 400 + 50 = 600

Ch. 15 If the government announces a big tax cut, which of the following would occur? A. A rightward shift of the aggregate demand curve B. A leftward shift of the aggregate demand curve C. A rightward shift of the aggregate supply curve D. A leftward shift of the aggregate supply curve

A. A rightward shift of the aggregate demand curve The setting of the level of government spending (G) and taxation (T) by government policymakers is called fiscal policy. If the government announces a big tax cut, consumption spending will increase. This will shift AD curve to the right.

Ch. 15 In the aggregate demand-aggregate supply model, an increase in the price level will A. increase money demand, raise the interest rate, reduce aggregate expenditure, and decrease equilibrium real GDP B. decrease money demand, lower the interest rate, increase aggregate expenditure, and increase real GDP C. increase the money supply, lower the interest rate, increase aggregate expenditure, and increase real GDP D. decrease the money supply, raise the interest rate, reduce aggregate expenditure, and decrease real GDP E. not change money supply, money demand or the interest rate, but will shift the aggregate demand curve to the right

A. increase money demand, raise the interest rate, reduce aggregate expenditure, and decrease equilibrium real GDP This is how we derive the AD curve. An increase in price level causes the money demand curve to shift rightward; this shift of Md causes r to increase; and this increase in r causes GDP to decrease. By the way, a decrease or increase in the price level will cause a movement along the aggregate demand curve.

Ch. 15 The vertical aggregate supply curve in the long run is consistent with A. the classical model B. the short run macro model C. a typical firm's supply curve D. a positive demand shock E. a negative demand shock

A. the classical model The long-run AS curve is vertical. See slides 30-32 of Ch15 notes. Only FYI. We did not cover this topic in class.

Ch. 15 If a war interrupted oil production, which of the following would most likely happen in the short run? A. Unit costs would decrease and there would be an upward movement along the aggregate supply curve. B. Unit costs would increase and the aggregate supply curve would shift upward. C. Unit costs would increase and the aggregate supply curve would shift downward. D. Unit costs would decrease and the aggregate supply curve would shift upward. E. Unit costs would increase and there would be movement along the aggregate supply curve.

B. Unit costs would increase and the aggregate supply curve would shift upward. If a war interrupted oil production, then the world oil prices would increase. Oil is a key input to major industry. Unit costs would increase, and prices or the price level would rise. Anything other than a change in real GDP causes price level to change, then AS curve shifts. So, it would be an upward shift of the AS curve.

Ch. 15 The decline in output at the onset of the Great Depression was caused primarily by A. a positive demand shock B. a negative demand shock C. a positive supply shock D. a negative supply shock E. simultaneous shocks to supply and demand

B. a negative demand shock Read our textbook: pages 443-444. "In the fall of 1929, the bubble of optimism burst. The stock market crashed, and investment and consumption spending plummeted." These "contributed to a leftward shift of the AD curve, causing both output and the price level to fall." An event that causes the AD curve to shift is called a demand shock.

Ch. 13 Fiat money is A. money with intrinsic value like gold coins. B. anything that serves as a means of payment by government declaration. C. any currency made of paper. D. a tangible asset like a house. E. money that is backed by gold.

B. anything that serves as a means of payment by government declaration. Fiat means "let there be."

Ch. 14 Open market purchases of government bonds by the Federal Reserve A. reduce the pressures on bond markets B. increase real GDP C. lead to open market sales of bonds D. increase the interest rate E. encourage tax increases

B. increase real GDP An open market purchase of government bonds by the Fed will shift the money supply curve to the right, decrease interest rate, stimulate spending, and then increase GDP.

Ch. 14 If there is an excess demand for money, there is an excess A. supply of bonds and interest rate will decrease. B. supply of bonds and interest rate will increase. C. demand for bonds and interest rate will decrease. D. demand for bonds and interest rate will increase. E. supply of bonds and interest rate will not change.

B. supply of bonds and interest rate will increase. An excess demand for money exists if the interest rate is below the equilibrium rate. An excess demand for money means an excess supply of bonds. The competition among bond sellers will drive the interest rate up since some bond sellers will increase interest rate to attract people to buy more bonds.

Ch. 13 Assume a bank currently holds $75 million in demand deposits, $10 million in vault cash and $25 million deposited at the Federal Reserve. If the required reserve ratio is 15 percent, how much must the bank hold in required reserves? A. $15.0 million B. $3.75 million C. $11.25 million D. $16.5 million E. $12.75 million.

C. $11.25 million 75 * 15% = 11.25 Reserves are deposits that banks have received but have not loaned out. Reserves are vault cash plus balances held at the Fed. But we don't need the information on vault cash and deposits at the Fed to answer this question. Required reserves are minimum amount of reserves a bank must hold; it equals demand deposits × required reserve ratio.

Ch. 13 Which of the following is not a tool for controlling the money supply? A. Buying government bonds B. Selling government bonds C. Changing tax rates D. Changing the required reserve ratio E. Changing the discount rate

C. Changing tax rates This question is FYI. See Ch13 notes: slides 32 and 40. The Fed can take the following actions to change the money supply: Open market operations—purchases or sales of government bonds; Changes in the required reserve ratio; Changes in the discount rate; Changes in the interest rate on reserves.

Ch. 14 Which of the following is the opportunity cost of money? A. The use of money as a means of payment B. The trouble of having to get money out of the bank C. The interest forgone by holding money D. The ability to purchase things at a moment's notice E. Commissions paid to brokers

C. The interest forgone by holding money Individuals choose how to divide wealth between two assets: money and bonds. When you hold money, you bear an opportunity cost—the interest you could have earned by holding bonds.

Ch. 15 If the Fed conducts an open market sale of bonds, which of the following will happen? A. The interest rate will decrease, the aggregate expenditure line will shift upward and the aggregate demand curve will shift rightward B. The interest rate will decrease, the aggregate expenditure line will shift downward and the aggregate demand curve will shift rightward C. The interest rate will increase, the aggregate expenditure line will shift downward and the aggregate demand curve will shift leftward D. The interest rate will decrease, the aggregate expenditure line will shift upward and the aggregate demand curve will shift leftward E. The interest rate will increase, the aggregate expenditure line will shift downward and the aggregate demand curve will shift rightward.

C. The interest rate will increase, the aggregate expenditure line will shift downward and the aggregate demand curve will shift leftward An open market sale of bonds shifts money supply curve to the left (money supply decreases), interest rate increases, spending decreases, the AE line shifts downward, and GDP decreases at any given price level. So, AD curve shifts leftward. Anything other than price level causes equilibrium GDP to change: AD curve shifts. The shifter or demand shock here is a decrease in money supply. We did not cover this in class. So, this topic is FYI.

Ch. 13 The Federal Reserve A. issues new government bonds to finance budget deficits B. issues bonds for the U.S. Treasury C. buys and sells already-existing bonds D. increases the money supply by selling bonds E. raises and lowers tax rates and disburses money for government purchases and transfer payments

C. buys and sells already-existing bonds When the Fed increases or decreases the money supply, the most common way is to purchase or sell second-hand government bonds. These actions are called open market operations.

Ch. 15 The aggregate supply curve A. indicates the markup at which firms are willing to supply a given level of output B. is derived from equilibrium conditions in the money market C. has a positive slope because an increase in real GDP causes an increase in the cost of resources D. is found by summing up the supply curves of all the firms in an economy E. illustrates how a change in the price level affects total output

C. has a positive slope because an increase in real GDP causes an increase in the cost of resources This is how we derive the AS curve. As total output or GDP increases, firms begin using inputs that are less well suited to their industry. Greater amounts of inputs are needed to produce each unit of output. Unit cost (cost of inputs when producing one unit of output) rises. (Then a firm sets the price of its products as a markup (i.e., profit) over unit cost. An increase in a firm's unit cost will result in a higher price. When there is an economy-wide increase in unit costs, the price level goes up.)

Ch. 14 The U.S. economy boomed during President Bill Clinton's eight years in office. Real GDP/income rose, business spending increased, the stock market soared, and the economy grew at unprecedented rates. How did this affect money demand? A. the quantity of money demanded increased (moving the economy rightward along the curve) B. the quantity of money demanded decreased (moving the economy leftward along the curve) C. money demand increased (shifting the curve to the right) D. money demand decreased (shifting the curve to the left)

C. money demand increased (shifting the curve to the right) An increase in real GDP/income shifts the Md curve rightward: higher income, more spending, more money you want to hold at each interest rate.

Ch. 13 What interest rate does the Fed charge when it makes loans to banks? A. the prime rate B. the U.S. Treasury Bond rate C. the discount rate D. the federal funds rate E. the U.S. Treasury Bill rate

C. the discount rate This question is FYI. Discount rate is the interest rate on the loans that the Fed makes to banks. Lower discount rate encourages banks to borrow more reserves from the Fed, increases the quantity of reserves in the banking system, which in turn increases the money supply.

Ch. 14 Equilibrium in the money market means that the quantity of money people are holding equals A. their entire wealth B. their entire income C. the quantity of money that they want to hold D. the money supply E. the value of bonds in their financial portfolios

C. the quantity of money that they want to hold Quantity of money people are actually holding is quantity supplied; and quantity of money people want to hold is quantity demanded. When money market is at equilibrium, quantity supplied equals quantity demanded.

Ch. 13 Which of the following is the relationship among excess reserves, required reserves, and total reserves? A. total reserves = required reserves - excess reserves B. excess reserves = total reserves/required reserves C. total reserves = excess reserves + required reserves D. total reserves = excess reserves - required reserves E. excess reserves = required reserves - total reserves

C. total reserves = excess reserves + required reserves This question is FYI. Excess reserves are reserves in excess of required reserves, or reserves beyond the minimum requirement.

Ch. 14 Which of the following would lead to a rightward shift of the money demand curve? A. A decrease in the price level B. A decrease in output C. An open market sale of bonds by the Fed D. An increase in the price level E. An open market purchase of bonds by the Fed.

D. An increase in the price level An increase in the price level also shifts the Md curve rightward: a rise in the price level raises the dollar cost of your purchases and increases the amount of money you want to hold at each interest rate.

Ch. 14 In the short-run macro model, open market sales of government bonds by the Federal Reserve reduce the money supply and A. move the economy to the right along the aggregate expenditure line B. move the economy to the left along the aggregate expenditure line C. shift the aggregate expenditure line upward D. shift the aggregate expenditure line downward E. not affect the aggregate expenditure line

D. shift the aggregate expenditure line downward Open market sales of government bonds reduce the money supply (i.e., money supply curve shifts to the left) and increase interest rate. Spending decreases. Aggregate expenditure (AE) line shifts downward.

Ch. 13 The organization responsible for creating and regulating the U.S. money supply is A. the Department of Commerce B. the Council of Economic Advisers C. the U.S. Mint D. the Federal Reserve System E. the Department of the Treasury

D. the Federal Reserve System The Federal Reserve System is the central bank and national monetary authority. It creates and regulates money supply. At the Fed, it is the Federal Open Market Committee (FOMC) that controls money supply by buying and selling government bonds in open bond market.

Ch. 14 The money supply curve is vertical because A. real income does not influence the quantity of money supplied B. the price level does not influence the level of spending C. only the interest rate influences the quantity of money supplied D. the Federal Reserve sets the money supply E. nominal income does not influence the quantity of money supplied

D. the Federal Reserve sets the money supply Money supply is set by the Fed and therefore independent of the interest rate. Once the Fed sets the money supply, it remains constant until the Fed changes it.

Ch. 15 Which of the following is an accurate description of the aggregate demand curve? A. It is the sum of all individual demand curves for all products B. It shows all price levels at which firms' unit costs equal their percent markups. C. It is the curve decided upon by the voters. D. It shows the relationship between firms' unit costs and their percentage markups. E. It shows the equilibrium level of GDP associated with price level.

E. It shows the equilibrium level of GDP associated with price level. The AD curve tells us equilibrium GDP at any price level. A better name would be "equilibrium output at each price level" curve. This question is not very important.

Ch. 15 If a new insect invasion devastates crops all across the United States, which of the following would most likely occur in the short run? A. Unit costs would decrease and the economy would move upward along the aggregate supply curve. B. Unit costs would increase and the aggregate supply curve would shift downward. C. Unit costs would increase and there would be movement along the aggregate supply curve. D. Unit costs would decrease and the aggregate supply curve would shift upward. E. Unit costs would increase and the aggregate supply curve would shift upward.

E. Unit costs would increase and the aggregate supply curve would shift upward. If a new insect invasion devastates crops, farmers' yields would decrease. For given inputs, unit costs would increase. The price of agricultural goods would rise. As agricultural products are important inputs to many other firms, unit costs and prices in other firms would increase. Finally, the price level for the entire economy would go up. Anything other than a change in real GDP causes price level to change, then AS curve shifts. So, it would be an upward shift of the AS curve.

Ch. 13 Which of the following is counted as money? A. bonds B. credit card payments C. savings accounts D. corporate stock E. currency

E. currency By definition, only cash (including coins and paper currency), checking account deposits, and traveler's checks are counted as money.