ECON FINAL

38. A developing country can be expected to rely more on: A. tariffs than quotas since tariffs are an easy way to raise tax revenue. B. tariffs than quotas because tariffs are more effective means of reducing imports. C. quotas than tariffs since quotas provide better protection for infant industries. D. quotas than tariffs since quotas are easier to enforce and give rise to less corruption among officials.

A. tariffs than quotas since tariffs are an easy way to raise tax revenue Tariffs are a potentially lucrative source of tax revenues.

39. Transshipments, which are commonly used in international trade, tend to: A. undermine the effectiveness of an embargo. B. strengthen the national security argument for trade restrictions. C. increase the effectiveness of trade restrictions. D. reduce the volume of world trade.

A. undermine the effectiveness of an embargo Transshipment occurs when goods are exported from one country to another and then again to a third country. It is one way in which an embargo can be circumvented.

40. What problem do economists see with free trade areas such as NAFTA and the European Union? A. They tend to lead to free trade rather than fair trade. B. They can lead to regional trading blocs that restrict trade with outsiders. C. They lead to globalization. D. They encourage countries to rely on others rather than being self-sufficient.

B. They can lead to regional trading blocs that restrict trade with outsiders. Economists prefer free trade, and fear that trading blocs will limit it.

37. All of the following are arguments in support of protectionist legislation except: A. supporting infant industries. B. preserving domestic employment. C. increasing global trade. D. promoting national security.

C. increasing global trade. Protectionist legislation reduces imports and thereby reduces global trade.

36. Regulatory trade restrictions: A. are always justified. B. are never justified. C. may be justified depending on the nature of the restriction. D. are irrelevant since they are seldom used.

C. may be justified depending on the nature of the restriction Regulatory trade restrictions may be justified if they involve legitimate health and safety concerns.

12. The curve most economists use to follow the relationship between the interest rates and bonds' time to maturity is the: A. effective supply of money curve. B. aggregate demand curve. C. yield curve. D. demand of money curve.

C. yield curve. The curve that shows the relationship between the interest rates and the bonds' time to maturity is the yield curve.

16. Engineering models: A. are deductive in their approach to understanding the economy and their policy recommendations. B. have no formal foundations because they are based on observed relationships in the data only. C. have carefully specified formal foundations; their purpose is to understand the economy for the sake of understanding. D. have loose formal foundations; their purpose is to guide thinking about policy.

D. have loose formal foundations; their purpose is to guide thinking about policy. See definition of engineering models in the textbook.

30. If the reserves in U.S. banks totaled $8,000 and total deposits were $100,000, the banking system's reserve ratio would be: A. .08. B. .10. C. .80 D. .92

A. .08. The reserve ratio is the ratio of reserves to total deposits (8,000/100,000 = .08).

28. The text mentions ten sources of U.S. comparative advantage. Which of the following is NOT one of them? A. A large military B. Skills of the labor force C. A stable government D. An extensive physical and technological infrastructure

A. A large military The U.S. military is not mentioned. Some economists argue that it is an economic burden for the U.S., and that countries that skimp on military spending, trusting the U.S. to maintain world peace, are free-riding on a world public good that the U.S. provides.

21. Which of the following is a disadvantage of the standard macro model? A. It assumes that people are not forward looking. B. It makes highly-restrictive assumptions for the sake of mathematical tractability. C. It is based on the fallacy of composition. D. It assumes that people are infinitely lived.

A. It assumes that people are not forward looking. The relationships in the standard models assumed that people based their actions on current variables. This led to their models as viewed as being flawed.

28. Suppose consumers shift money out of checking accounts and pay their credit cards. This shift will affect: A. M1. B. M2. C. M3. D. L.

A. M1. Only M1 will be affected because only M1 includes checking accounts and credit cards are not money.

34. Which of the following groups would be most likely to benefit from a tariff on Japanese-manufactured light trucks (e.g., pickup trucks)? A. U.S. domestic pickup truck manufacturers B. Japanese auto workers C. U.S. consumers of pickup trucks D. U.S. firms that export products to Japan

A. U.S. domestic pickup truck manufacturers U.S. domestic pickup truck manufacturers would benefit from the higher price of their foreign competition, while pickup truck buyers would not. Japanese auto workers' jobs would be at risk, while U.S. firms that export products would find that their Japanese customers having greater difficulty acquiring the dollars they nedded to buy U.S.-made goods and services.

26. If the relative opportunity costs of producing goods are identical across countries, then there are: A. no gains from trade. B. gains from trade if trade is based on absolute advantage. C. gains from trade if trade is based on comparative advantage. D. gains from trade that depend on the degree of competition between international traders.

A. no gains from trade. If relative opportunity costs are identical, then gains from trade cannot exist because no nation will possess a comparative advantage in the production of any good.

14. Property taxes are: A. not an automatic stabilizer because they do not vary with income. B. not an automatic stabilizer because they vary with income. C. an automatic stabilizer because they do not vary with income. D. an automatic stabilizer because they vary with income.

A. not an automatic stabilizer because they do not vary with income. Property taxes are based on the value of a piece of property and do not vary with income, so they cannot be an automatic stabilizer.

4. Expansionary fiscal policy that raises the budget deficit may: A. reduce business investment by increasing interest rates. B. reduce business investment by reducing interest rates. C. increase business investment by increasing interest rates. D. increase business investment by reducing interest rates.

A. reduce business investment by increasing interest rates Expansionary fiscal policy raises interest rates if it is financed by increased government bond sales. Higher interest rates reduce business investment by increasing the cost of borrowing.

15. The provisions in state constitutions requiring them to balance their budgets means that A. state governments often behave procyclically because lower revenues during recessions mean lower state spending. B. state government spending acts as an automatic stabilizer for the national economy. C. state governments can follow a functional finance approach with greater consistency than the federal government, which has no such requirement. D. state governments can only use monetary policy to affect their economies.

A. state governments often behave procyclically because lower revenues during recessions mean lower state spending. See the discussion under "State Government Finance and Procyclical Fiscal Policy."

7. Suppose one economist believes that the target rate of unemployment is 5 percent while another believes that it is 6 percent. If GDP is $10 trillion and the unemployment rate is 6 percent, then Okun's rule of thumb implies that the target output levels for these two economists will differ by: A. $100 billion. B. $200 billion. C. $500 billion. D. $600 billion.

B. $200 billion. Okun's rule of thumb states that every one percentage point drop in unemployment increases output by two percentage points. This means that reducing unemployment from 6 percent to 5 percent will increase output by 2 percent, or $200 billion in this case.

31. The formula for the simple money multiplier is: A. 1/e where e is the excess reserve ratio. B. 1/r where r is the reserve ratio. C. 1/r where r is the required reserve ratio. D. 1/c where c is the ratio of cash people hold to deposits.

B. 1/r where r is the reserve ratio. See the formula for the simple money multiplier in the text. Students might mistakenly choose 1/r where r is the required reserve ratio, but r includes all reserves (even excess reserves).

7. If the Fed funds rate is below the Fed's target range the Fed should: A. follow expansionary policy. B. follow contractionary policy. C. print money. D. do nothing.

B. follow contractionary policy. The Fed funds rate being below the Fed's target would mean that money supply is loose and the Fed should follow a contractionary monetary policy.

13. Fiscal policies are policies that directly affect: A. interest rates. B. government spending and taxes. C. the money supply. D. the price level.

B. government spending and taxes. See the definition of fiscal policy in the textbook.

23. The social and cultural issues raised by international trade are: A. largely ignored by economics because they are not important. B. largely ignored by economics because economics is better suited to examine other issues. C. stressed by economics because they are important. D. stressed by economics because the economic way of thinking was designed to study them.

B. largely ignored by economics because economics is better suited to examine other issues. See the Added Dimension box "International Issues in Perspective".

14. When people expect higher inflation, usually nominal interest rates will: A. fall. B. rise. C. remain unchanged. D. move erratically.

B. rise. If lenders expect higher inflation, they will raise nominal interest rates so as to preserve purchasing power.

26. When the stock market crashed in 1929, most economists thought that: A. an extremely deep depression was just about to begin. B. stocks were going to bounce back immediately to previous highs. C. a major fiscal expansion was needed immediately. D. a mild recession would ensue.

B. stocks were going to bounce back immediately to previous highs. Even if the stock market bubble had been significant, individuals believed that the economy would eventually move in a positive direction, because it had before. However it took a financial meltdown in the banking sector to push the economy into a depression.

2. The reason why the AS/AD model does not depend upon the concepts of substitution and opportunity cost is that: A. in groups, people do not make the same choices as when they are alone. B. the AS/AD model considers total output. There are no goods to substitute. C. the AS/AD model considers the effects of other countries' decisions. D. other things remain constant in the AS/AD model.

B. the AS/AD model considers total output. There are no goods to substitute. Since the AS/AD model is describing the economy in aggregate, the principle of substitution and opportunity cost are not applicable.

38. An unfunded pension system is viable as long as: A. the population's age structure changes considerably. B. the population's age structure does not change considerably. C. the annual death rate changes considerably. D. the workforce level varies greatly over long periods of time.

B. the population's age structure does not change considerably.

27. The analysis of international trade suggests that trading companies earn higher than normal profits in: A. the long-run, but not in the short-run. B. the short-run, but not in the long-run. C. both the short-run and the long-run. D. neither the short-run nor the long-run.

B. the short-run, but not in the long-run In the long-run, entry by other traders will drive down the profits of trading companies.

33. Given a required reserve ratio of 20 percent for all banks and assuming individuals hold no cash, total bank reserves of $300 billion could support maximum deposits of: A. $60 billion. B. $1,200 billion. C. $1,500 billion. D. $2,000 billion.

C. $1,500 billion. Since the required reserve ratio is 20% and people hold no cash, the money multiplier is 5. Thus total back reserves of $300 billion will support deposits of $300 * 5 = $1500 billion.

29. The text mentions ten sources of U.S. comparative advantage. Which of the following is NOT one of them? A. Wealth from past production B. English is the international language of business C. A high ratio of lawyers to the population D. Extensive natural resources

C. A high ratio of lawyers to the population Legal services are hard to export because every country has a different legal code. To the extent that lawyers engage in rent-seeking (an activity those seeking tort reform say is commonplace), they may make business climate in the U.S. less favorable and would reduce the United States' comparative advantage in certain goods.

35. Which of the following is not a regulatory trade restriction? A. Vegetables prohibited because of excess pesticide usage. B. Inspections designed to impede trade processes. C. A limit on the number of imported cars. D. Leather products banned because of tanning by urine.

C. A limit on the number of imported cars. Quantitative import limits represent quotas, not regulatory trade restrictions.

14. Suppose the target rate of unemployment is 5 percent but the actual rate of unemployment is 4 percent. Given this information, which of the following policies is most appropriate according to the AS/AD model? A. A tax cut. B. An increase in government spending. C. A tax increase. D. No change in taxes or government spending.

C. A tax increase. Because the unemployment rate is beneath the target rate, output is most likely above potential, so a contractionary policy is most appropriate.

37. Which of the following would make the impending Social Security problem worse? A. Raising social security taxes. B. Raising the age at which one is eligible to receive payments. C. An increase in the average age at which people die. D. Taxing social security payments received.

C. An increase in the average age at which people die. Longer life expectancy means higher Social Security payments.

24. Which of the following does not explain why financial institutions felt comfortable with riskier mortgage securities leading up to the financial crisis? A. Credit rating agencies gave these securitized mortgages a "seal of approval." B. House prices were expected to keep rising. C. Consumers were becoming over-leveraged. D. As long as the mortgages were bundled together, the diversification reduced the risk.

C. Consumers were becoming over-leveraged. The fact that consumer debt burden was rising would not be a reason to be comfortable with taking on more mortgages. It would be a source of concern.

16. As income increases during the recovery from a recession, automatic stabilizers will: A. increase taxes and increase government spending, increasing the overall size of the government. B. reduce taxes and increase government spending, accelerating the recovery. C. increase taxes and decrease government spending, slowing the recovery. D. reduce taxes on high-income individuals and raise taxes on the poor, increasing economic inequality.

C. increase taxes and decrease government spending, slowing the recovery. See the discussion under "The Negative Side of Automatic Stabilizers" in the textbook.

5. The Federal funds rate: A. is always slightly higher than the discount rate. B. can never be close to zero. C. may sometimes have to be targeted at zero. D. is an intermediate target.

C. may sometimes have to be targeted at zero. The Federal Funds rate has become the Fed's operating target, and in response to the 2008 financial crisis, the Fed lowered the rate to almost zero to jumpstart the economy.

25. Multi-level pattern finding models are: A. theoretical at this point; no models have been developed. B. solved mathematically from which conclusions are drawn. C. modeled with computers from which patterns emerge. D. contrary to modern macroeconomic theory.

C. modeled with computers from which patterns emerge. See definition of ACE models in the textbook.

18. According to the Classical advocates of sound finance, if an economy is in a recession, the government should run: A. a budget deficit and increase spending, which will increase output. B. a budget surplus and decrease spending, which will increase output. C. neither a surplus nor a deficit since changes in deficit spending do not affect output. D. neither a surplus nor a deficit since changes in spending affect output.

C. neither a surplus nor a deficit since changes in deficit spending do not affect output. An economist with a Classical, sound-finance point of view would recommend running neither a surplus nor a deficit since such changes do not affect output.

25. Buying on "margin" occurs when: A. banks borrow from the Federal Reserve. B. people put down payments on purchases of automobiles and houses. C. people borrow money from stockbrokers to buy shares they could not afford on their own. D. people borrow money from banks using their stock as collateral.

C. people borrow money from stockbrokers to buy shares they could not afford on their own. See definition of margin buying in the text.

22. Immediately following World War II, the U.S. ran trade: A. deficits and was an international lender. B. deficits and was an international borrower. C. surpluses and was an international lender. D. surpluses and was an international borrower.

C. surpluses and was an international lender. During this period the U.S. acquired large amounts of foreign assets, but the large trade deficits the U.S. has run since the 1980s have caused it to become a debtor nation.

35. Politicians who support a "lockbox" for Social Security argue that: A. taxes need to be increased in order to solidify the Social Security system. B. the Social Security surplus should never be used to reduce the government debt. C. the Social Security surplus should be used to purchase government bonds and reduce government debt. D. the existing Social Security program is viable and should not be changed.

C. the Social Security surplus should be used to purchase government bonds and reduce government debt. Supporters of a lockbox want to use the existing surplus in Social Security to reduce government debt and in this way reduce the burden of the debt when Social Security begins to incur deficits.

18. Keynesian economics was based on a concept known as: A. the post-hoc fallacy. B. the fallacy of causation. C. the fallacy of composition. D. perfect foresight.

C. the fallacy of composition. Keynesian economics believed that some of the features of the economy as a whole can't be understood just by understanding the behavior of individuals and firms.

15. Monetary regimes: A. do not set policy on the basis of a predetermined framework. B. rely on the discretion of monetary policy officials. C. use predetermined rules to set monetary policy. D. produce greater variation in expected inflation than individual monetary policies.

C. use predetermined rules to set monetary policy. A monetary regime is a predetermined statement of the policy that will be followed in a given situation.

6. Suppose one economist believes that the target rate of unemployment is 4 percent while another believes that it is 6 percent. If GDP is $10 trillion and the unemployment rate is 6 percent, then Okun's rule of thumb implies that the target output levels for these two economists will differ by: A. $100 billion. B. $200 billion. C. $300 billion. D. $400 billion.

D. $400 billion. Okun's rule of thumb states that every one percentage point drop in unemployment increases output by two percentage points. This means that reducing unemployment from 6 percent to 4 percent will increase output by 4 percent, or $400 billion in this case.

19. What event in the 1930s challenged the Classical precepts and led to the development of the Keynesian model? A. Oil price shocks. B. The adoption of trade tariffs. C. The boom in the global monetary system. D. A dramatic decline in output and rise in unemployment.

D. A dramatic decline in output and rise in unemployment. The Great Depression (decline in output and rise in unemployment) led economists to re-evaluate the models they use to describe the economy, because the classical economists could not provide any insight into how to fix the decline.

1. Which is not a function of the Fed? A. Conducting monetary policy. B. Serving as a lender of last resort. C. Providing financial services such as check clearing to commercial banks. D. Financing U.S. budget deficits.

D. Financing U.S. budget deficits. Financing U.S. budget deficits is the job of the Treasury Department.

3. Even as the U.S. government ran large budget deficits in the early 2000s, the interest rate did not rise substantially. Which of the following is among the reasons that crowding out did not raise interest rates at that time? A. Americans increased their willingness to save at the same time that the budget deficits appeared. B. The government spent the borrowed money in such a way that productivity and therefore the availability of savings dramatically increased. C. The Federal Reserve decreased the money supply. D. Foreigners were willing to finance the U.S. deficit with their abundant supply of savings.

D. Foreigners were willing to finance the U.S. deficit with their abundant supply of savings. See the discussion under "Functional Finance in Practice" in the textbook.

16. Why are financial-sector crises scarier than collapses in other sectors of the economy? A. The financial sector is the biggest sector. B. Financial-sector crises happen more often than collapses in other sectors. C. Most people work in the financial sector. D. If the financial sector fails, it can bring the whole economy down with it.

D. If the financial sector fails, it can bring the whole economy down with it. All other sectors in the economy depend on a financial sector that functions to its full extent in terms of getting access to credit. The financial sector was in serious danger of collapsing in 2007/2008, which is why policymakers took immediate action to fix the financial sector, and prevent another Great Depression.

5. An increase in the budget deficit will have a: A. more negative effect on income when crowding out is weak. B. more positive effect on income when crowding out is strong. C. less negative effect on income when crowding out is weak. D. less positive effect on income when crowding out is strong.

D. less positive effect on income when crowding out is strong. If crowding out is significant, then increasing the budget deficit will raise interest rates and reduce business investment to an extent that will significantly offset the increase in income associated with a fiscal expansion.

1. Economists who believe in sound finance would say that in a recession, the government should: A. run a budget deficit because the Ricardian equivalence theorem is true both in theory and in practice. B. run a budget deficit despite the truth of the Ricardian equivalence theorem. C. maintain a balanced budget because the Ricardian equivalence theorem is true in practice. D. maintain a balanced budget for political and moral reasons.

D. maintain a balanced budget for political and moral reasons. Economists who subscribed to sound finance supported this position on moral grounds, not because of their views on the Ricardian equivalence theorem.

27. As a result of the financial meltdown in the 1930s, the government created deposit insurance. This would be considered to be part of the: A. treatment stage. B. triage stage. C. intervention stage. D. rehabilitation stage.

D. rehabilitation stage. The government as a result of the Great Depression set up various structures to prevent financial markets from freezing up in the future. Deposit Insurance was one of these systems.

36. The imbalance between aggregate supply and aggregate demand caused by the retirement of the baby boomers could be reduced by all of the following except: A. increased saving. B. increased productivity. C. higher inflation. D. shorter work weeks.

D. shorter work weeks. Shorter work weeks will reduce aggregate supply, creating an even greater gap between aggregate demand and aggregate supply

23. A policy maker sees a tradeoff between inflation and unemployment. She tries to base policy on this and discovers that the tradeoff no longer works. This observation can be best described by: A. the time inconsistency problem. B. the credibility problem. C. the Ricardian equivalence problem. D. the Lucas critique problem.

D. the Lucas critique problem. The policy maker has not taken into account that individuals may be rational. If individuals are rational, they will expect higher inflation, and the trade-off will not occur. This is the Lucas critique.

7. During the Vietnam War, Congress increased government expenditures while raising taxes. As a result: A. the AD curve likely shifted to the left. B. the AD curve likely shifted to the right. C. the AD curve likely remained unchanged. D. what happened to the AD curve is unclear.

D. what happened to the AD curve is unclear. An increase in government expenditures shifts the AD curve to the right while an increase in taxes shifts it to the left. Depending on the relative shifts, the AD curve could shift to the left, to the right, or not at all.

30. The text calls the type of comparative advantage that is not easily changed, such as climate, A. stable comparative advantage. B. inherent comparative advantage. C. equilibrium comparative advantage. D. permanent comparative advantage.

B. inherent comparative advantage. Refer to the definition of inherent comparative advantage in the text.

2. A key difference between functional finance and sound finance is that in the functional finance approach the government has the potential for: A. a more active role in spending and taxing decisions. B. a less active role in spending and taxing decisions. C. no role since functional finance holds that on moral principle the budget should be balanced. D. more active role in spending and taxing but only during depressions.

A. a more active role in spending and taxing decisions. The functional finance principle states that the government should have a more active role in spending and taxing decisions in order to affect the level of output in the economy. This role is effective during major or minor recessions. In contrast, the sound finance promotes a less active role of the government based on moralistic and political principles.

5. A fall in a foreign country's income will most likely cause: A. a reduction in U.S. exports, so the U.S. aggregate demand curve shifts left. B. a reduction in U.S. exports, so the U.S. aggregate demand curve shifts right. C. an increase in U.S. exports, so the U.S. aggregate demand curve shifts left. D. an increase in U.S. exports, so the U.S. aggregate demand curve shifts right.

A. a reduction in U.S. exports, so the U.S. aggregate demand curve shifts left. A fall in foreign income reduces U.S. aggregate demand, shifting its AD curve left.

31. A budget deficit is defined as: A. a shortfall of revenues compared to expenditures. B. a shortfall of expenditures compared to revenue. C. accumulated deficits minus accumulated surpluses. D. accumulated surpluses minus accumulated deficits.

A. a shortfall of revenues compared to expenditures. See the definition of a deficit in the text.

11. The income tax is: A. an automatic stabilizer because income tax revenues rise as income increases, slowing an economic expansion. B. an automatic stabilizer because income tax revenues rise as income increases, accelerating an economic expansion. C. an automatic stabilizer because income tax revenues fall as income increases, accelerating an economic expansion. D. not an automatic stabilizer.

A. an automatic stabilizer because income tax revenues rise as income Higher income generates higher income tax revenues, which cause aggregate demand to increase less rapidly than it otherwise would.increases, slowing an economic expansion.

10. The introduction of "rainy-day funds" by states would: A. decrease the pro-cyclical nature of current state budgeting procedures. B. increase the pro-cyclical nature of current state budgeting procedures. C. decrease the counter-cyclical nature of current state budgeting procedures. D. increase the counter-cyclical nature of current state budgeting procedures.

A. decrease the pro-cyclical nature of current state budgeting procedures Rainy-day funds would set aside budget surpluses in good years to offset budget deficits in bad years. States currently must balance their budgets.

17. Standard macro models are largely: A. engineering models. B. deductive scientific models. C. outdated and no longer used. D. those designed by current top macro theorists.

A. engineering models. Standard macro models are designed to provide advice to policymakers, and therefore focus less on deduction and more on statistical regularities. They are engineering models.

9. As the economy contracts, tax revenues: A. fall and transfer payments rise, causing the economy to contract by less than it would in the absence of automatic stabilizers. B. rise and transfer payments rise, causing the economy to contract by more than it would in the absence of automatic stabilizers. C. fall and transfer payments fall, causing the economy to contract by more than it would in the absence of automatic stabilizers. D. rise and transfer payments fall, causing the economy to contract by less than it would in the absence of automatic stabilizers.

A. fall and transfer payments rise, causing the economy to contract by less than it would in the absence of automatic stabilizers. Lower income and higher unemployment reduce tax revenues and increase transfer payments, helping to maintain consumption and reduce the size of the recession.

26. Every financial asset has a corresponding: A. financial liability. B. real liability. C. real asset. D. financial asset.

A. financial liability. The value of a financial asset depends on the issues meeting certain obligations, which are liabilities for the issuer.

12. Refer to the graph above. In the graph, if the price level is P1 and the aggregate demand curve is AD0 then the economy is: A. in a recessionary gap. B. in an inflationary gap. C. in a long-run equilibrium. D. fully employed.

A. in a recessionary gap. Since aggregate demand is less than potential output at this combination, the economy is in a recessionary gap.

4. When aggregate demand is declining and the price level needs to fall to bring about equilibrium, pressure for the price level to fall brings expectations of falling aggregate demand, lower asset prices, and financial panics triggered by the decline in the value of financial assets. If these forces are strong enough, these dynamic effects can create a: A. leftward shift in the aggregate demand curve. B. leftward shift in the short-run aggregate supply curve. C. rightward shift in the aggregate demand curve. D. a rightward shift in the long-run aggregate supply curve.

A. leftward shift in the aggregate demand curve. Each of these forces counteracts the standard effects that cause AD to increase when the price level falls, and may be strong enough to cause AD to shift to the left.

34. A month ago, you bought a one-year bond with a value of $100 that pays a fixed interest rate of 5 percent per year. The interest rate of the economy was also 5 percent. Today you read in the newspaper that the interest rate in the economy decreased to 3 percent. You are holding a bond that is: A. more desirable to other investors. B. less desirable to other investors. C. not desirable at all. D. desirable to you.

A. more desirable to other investors. When the interest rate in the economy decreases, the price of the bond increases and it is more desirable to other investors.

32. Suppose that the economy has a structural deficit of $100 billion and a budget deficit of $100 billion. It follows that output: A. must equal potential output. B. must be above potential output. C. must be below its potential output. D. could be at, above, or below potential output.

A. must equal potential output. Since the structural deficit equals the budget deficit, the passive budget must be zero, implying that output must equal potential output.

22. Underlying the Lucas critique problem is that: A. the standard macro models are based on patterns in historical data and not on what causes those patterns. B. the process of undertaking government policy is too long to be effective in addressing current problems. C. policymakers are too subject to efforts by lobbyists to take an objective view of policy. D. models of the economy are necessarily complex and cannot take into account historical patterns in the data.

A. the standard macro models are based on patterns in historical data and not on what causes those patterns. The Lucas critique arose because Keynesian models did not have a sufficient explanation for patterns in the data. As a result, these models could not predict the changes in the patterns when those models were used to make policy advice.

8. In the early 2000s the European Central Bank warned that higher oil prices were a threat to economic growth. The Bank President called the higher prices "a sizeable adverse shock" to the economy. In terms of the AS-AD framework, this shock would be represented as a shift: A. up (to the left) of the AS curve. B. down (to the right) of the AS curve. C. left of the AD curve. D. right of the AD curve.

A. up (to the left) of the AS curve. Higher oil prices increase production costs. A rise in input prices shifts the AS curve up (to the left).

6. A change in the distribution of income affects the AD curve because: A. workers are more likely than stockholders to spend the income they receive. B. stockholders are more likely than workers to spend the income they receive. C. workers and stockholders are equally likely to spend the income they receive. D. the distribution of income is always shifting in favor of stockholders.

A. workers are more likely than stockholders to spend the income they receive. People tend to spend more out of wage income than out of other income, so a change in the distribution of income that alters the wage share of income shifts the AD curve.

1. Which of the following statements best depicts laypeople's explanation of the Depression at that time? A. Government policies kept prices too high. B. An oversupply of goods had glutted the market. C. Unions were keeping the good jobs for themselves. D. An oversupply of goods is impossible.

B. An oversupply of goods had glutted the market. Laypeople believed that an oversupply of goods had glutted the market. The other statements depict arguments by Classical economists.

24. Assume that in Canada the opportunity cost of producing 1 television set is 2 bushels of wheat. Assume that in the U.S. the opportunity cost of producing 1 bushel of wheat is 2 television sets. If these two countries specialize according to comparative advantage and then trade with one another, then: A. Canada will export both televisions and wheat. B. Canada will export wheat and import televisions. C. the U.S. will export wheat and import televisions. D. the U.S. will export both televisions and wheat.

B. Canada will export wheat and import televisions. Since the opportunity cost of producing wheat in Canada (1/2 a television) is less than the opportunity cost of producing wheat in the U.S. (2 televisions), Canada has a comparative advantage in wheat production.

10. Which of the following is a Fed tool? A. Interest rate spreads. B. Discount rate. C. Stock prices. D. Fed funds rate.

B. Discount rate. The Fed tools are the open market operations, discount rate, and reserve requirements.

25. Myopia and Utopia are two countries with equivalent resources. The country of Myopia can produce up to 100 tons of yak butter or up to 5,000 prayer wheels, if it devotes all its resources to yak butter or all its resources to prayer wheels. Similarly, the country of Utopia can produce up to 500 tons of yak butter or up to 3,000 prayer wheels. We know that the production possibility curves for both Myopia and Utopia are straight lines. If international trade exists between Utopia and Myopia, we would expect to find: A. Utopia exporting prayer wheels and Myopia exporting yak butter. B. Myopia exporting prayer wheels and Utopia exporting yak butter. C. Utopia exporting both goods to Myopia. D. Myopia exporting both goods to Utopia.

B. Myopia exporting prayer wheels and Utopia exporting yak butter. This pattern of trade is consistent with the comparative advantage of each country.

13. Which of the following gives the correct relationship between nominal and real interest rates? A. Real interest rate = nominal interest rate + expected inflation rate. B. Nominal interest rate = real interest rate + expected inflation rate. C. Nominal interest rate + real interest rate = expected inflation rate. D. Nominal interest rate = real interest rate - expected inflation.

B. Nominal interest rate = real interest rate + expected inflation rate. The real interest rate equals the nominal interest rate adjusted for expected inflation.

21. As a country develops economically, what changes usually take place in the goods it exports? A. There is little change because comparative advantage does not change. B. Raw materials and agricultural products decline in importance and are replaced by services and manufactured goods. C. Services and manufactured goods decline in importance and are replaced by raw materials and agricultural products. D. Exports go from being diversified to being specialized in whatever the country finds to be its comparative advantage.

B. Raw materials and agricultural products decline in importance and are replaced by services and manufactured goods. See the discussion in the text. As a country develops, its higher level of capital and its better-educated work force allow it to specialize in those goods which well-capitalized, well-educated nations have a comparative advantage in: services and manufactured goods.

32. As the reserve ratio goes up, the simple money multiplier goes: A. up, and more money will be created. B. down, and less money will be created. C. up, and less money will be created. D. down, and more money will be created.

B. down, and less money will be created. The simple money multiplier is 1/r. The simple money multiplier is inversely related to the reserve ratio. Since the money multiplier will go down, less money will be created.

29. Which of the following does NOT explain why the Glass-Steagall regulations lost their effectiveness? A. Over time, non bank financial firms were able to borrow directly from the public, rather than having to borrow from commercial banks. B. The Federal Reserve created regulations that ran counter to what the government was trying to do. C. With the advent of new financial instruments, regulated banks lost business to unregulated institutions, and credit began to flow through unregulated systems. D. As regulations became too successful, people wanted to eliminate these regulations in order to pursue the magic of the free market.

B. The Federal Reserve created regulations that ran counter to what the government was trying to do. The Glass-Steagall act though successful when implemented in the 1930s, became irrelevant over time, as financial markets became deregulated and non bank lenders found ways to avoid these regulations.

9. Which of the following is an operating target for the Fed? A. Sustainable growth. B. The Federal funds rate. C. Stable prices. D. Stock prices.

B. The Federal funds rate. The Federal funds rate is the only real operating target for the Fed.

21. Refer to the graph above. Suppose we incorporate extrapolative expectations into our supply and demand model and demanders expect the price to continue to rise. Which of the following would be the correct outcome when the demand curve shifts from D0 to D1? A. The quantity on the market will end up at Q1, and there is equilibrium. B. The market will continue to move away from equilibrium as a result of the small price adjustment to P1. C. The price of the good will rise to P1, and there is equilibrium. D. The price of the good will initially rise to P3.

B. The market will continue to move away from equilibrium as a result of the small price adjustment to P1. The increase in prices to P1 leads people to expect further price increases. This will shift the demand curve to D2 and the resulting higher price will lead people to expect further price increases, and will shift the demand curve out again, which leads to higher prices and the expectation of higher price increases.

17. Which of the following is not a stage of a financial crisis? A. The forming of an asset bubble. B. The public announcement by the government of a financial crisis occurring. C. The bursting of an asset bubble. D. The collapse of the financial sector.

B. The public announcement by the government of a financial crisis occurring. In order to understand the 1930s crisis, the 2008 crisis, and any future financial crisis, it is useful to break them down into stages. We can understand that they all have something in common, with slight variations. The main part of a crisis is the bubble, creation and bursting, and this will lead to a crash in the financial sector.

23. Prior to the beginning of the 21st century, what was Freddie Mac and Fannie Mae's role in the economy? A. They oversaw the Federal Deposit Insurance Program. B. They were the dominant player in the secondary mortgage market. C. They regulated lending practices for commercial banks. D. They acted as a lender of last resort for commercial banks.

B. They were the dominant player in the secondary mortgage market. These companies bought safe mortgages and pooled these mortgages together and sold slices of income from these mortgages as a security.

34. A constant debt to GDP ratio in a growing economy is consistent with: A. a continual surplus. B. a continual deficit. C. a balanced budget. D. a falling level of total debt.

B. a continual deficit. If GDP is rising, the debt can rise (i.e. the budget can be in continual deficit) by the same percent as the rise in GDP and still maintain a constant debt to GDP ratio.

11. Suppose that investment is not very responsive to interest rates, so that a sizable increase in interest rates has only a minor effect on investment. In this case, monetary policy would have: A. no effect on output. B. a modest effect on output at best. C. a substantial effect on output. D. a massive effect on output.

B. a modest effect on output at best. If investment is insensitive to interest rates, aggregate demand will also be insensitive, reducing the effectiveness of monetary policy.

17. In contrast to the functional finance view, Classical sound-finance macroeconomics assumes that individuals: A. do not adjust their spending to account for future tax payments. B. adjust their spending to account for future tax payments. C. do not adjust their spending to account for future incomes. D. adjust their spending to account for future incomes.

B. adjust their spending to account for future tax payments. The Classical, sound-finance macroeconomics states that individuals will adjust their spending to account for future tax payments and therefore, it is irrelevant whether the government runs a deficit or not or how it finances the deficits.

8. Because reducing both unemployment and inflation simultaneously are conflicting goals: A. there is a policy that will allow policymakers to achieve either objective. B. aggregate demand policy will allow policymakers to achieve one of these objectives, but not both. C. aggregate demand policy will allow policymakers to achieve both objectives, but only if it is expansionary. D. aggregate demand policy will allow policymakers to achieve both objectives, but only if it is contractionary.

B. aggregate demand policy will allow policymakers to achieve one of these objectives, but not both. The AS/AD model demonstrates that expansionary aggregate demand policies reduce unemployment but increase inflation and that contractionary fiscal policies do the reverse.

12. Unemployment compensation is: A. an automatic stabilizer because it rises as income increases, slowing an economic expansion. B. an automatic stabilizer because it falls as income increases, slowing an economic expansion. C. an automatic stabilizer because it falls as income decreases, slowing an economic contraction. D. not an automatic stabilizer.

B. an automatic stabilizer because it falls as income increases, slowing an economic expansion. Higher income generates higher employment and thus lower unemployment compensation, so aggregate demand does not increase as rapidly as it otherwise would.

19. When there is unsustainable rapidly rising prices of some type of financial asset, such as stock, we refer to this a(n): A. liquidity trap. B. bubble. C. bad-precedent problem. D. moral-hazard problem.

B. bubble. See definition of bubble in the text.

3. To increase the nation's money supply, the Fed can: A. increase the required reserve ratio. B. decrease the discount rate. C. increase the discount rate. D. sell bonds.

B. decrease the discount rate. A cut in the discount rate reduces the cost that banks pay when they borrow from the Fed and is usually a signal that the Fed wants banks to engage in additional lending.

28. The use of quantitative easing to alleviate the 2008 crisis could fall under which of the following stages? A. Treatment. B. Rehabilitation. C. Triage. D. Intoxication.

C. Triage. The financial markets were in danger of collapsing and the Federal Reserve took steps to stabilize the banking system, and this involved expanding monetary policy as much as they could.

30. When the government bails out one sector, other sectors go to Congress and ask for bailout money. This is referred as: A. the law of diminishing control. B. a moral hazard problem. C. a bad precedent problem. D. quantitative easing.

C. a bad precedent problem. See definition of bad precedent problem in the text.

31. After one cow in Alberta was found with mad cow disease, the U.S. banned all imports of Canadian cattle and beef. This action is an example of: A. a tariff. B. a quota. C. a regulatory trade restriction. D. an embargo.

C. a regulatory trade restriction The justification was to protect American beef from infection. It also had the effect of protecting American beef producers from Canadian competition.

20. Suppose I am a rational consumer and base my current consumption on lifetime income. I receive a one-time $3,000 tax rebate as part of the stimulus package. This would lead me to consume: A. more than $3,000 worth of goods and services immediately. B. a substantial fraction of the rebate immediately. C. a relatively small fraction of the rebate immediately. D. exactly $3,000 worth of goods and services immediately.

C. a relatively small fraction of the rebate immediately. Rational consumers base their consumption on lifetime income, and they would not increase their consumption much at all in response to an increase in current income.

13. If taxes and government expenses did not vary with income, then income would: A. be more stable. B. not be more or less stable. C. be less stable. D. be closer to potential income.

C. be less stable. The presence of automatic stabilizers like the income tax, welfare payments, and unemployment insurance help to stabilize output because these variables behave countercyclically.

9. A shift in the long run aggregate supply curve will change: A. output but not the price level. B. the price level but not output. C. both output and the price level. D. neither output nor the price level.

C. both output and the price level. A shift in the long run aggregate supply curve will affect both output and price level.

27. M1 consists primarily of cash in the hands of the public and: A. savings account balances. B. commercial paper. C. checking account deposits. D. certificates of deposit.

C. checking account deposits. M1 includes currency, checking accounts, and traveler's checks.

15. A fiscal policy in which the government attempts to offset any change in aggregate expenditures that would create a business cycle is called a: A. supply side policy. B. regulatory policy. C. countercyclical fiscal policy. D. laissez-faire policy.

C. countercyclical fiscal policy. See the definition of countercyclical fiscal policy in the textbook.

4. If the Fed simultaneously reduces the discount rate and the required reserve ratio, the money supply will: A. contract. B. remain unchanged. C. expand. D. take on a value that cannot be determined from the information given.

C. expand. Both policies increase bank reserves and thereby expand the money supply.

24. When people copy other successful behavior even though the successful behavior might have been luck, we call this: A. predictable irrationality. B. a nudge. C. herding. D. a push.

C. herding. See definition of herding in the textbook.

35. Suppose an asset pays no interest. The expected change in price of an asset could be called the: A. explicit interest rate. B. prime rate. C. implicit interest rate. D. benchmark interest rate.

C. implicit interest rate. See the definition of implicit interest rate in the text.

18. Suppose the people in my town hear a rumor that their local bank is in trouble and all rush to withdraw money from the bank. This is referred to as: A. leverage. B. a moral hazard problem. C. a bad precedent problem. D. a bank run.

D. a bank run. See definition of bank run in the text.

8. Suppose the Federal funds rate is 5 percent. If the Fed decides to decrease the target for the Federal funds rate from 5 percent to 4 percent, it should take: A. a defensive action and raise reserve requirements. B. a defensive action and reduce reserve requirements. C. an offensive action and raise reserve requirements. D. an offensive action and reduce reserve requirements.

D. an offensive action and reduce reserve requirements. Because the Fed is changing the existing monetary policy when it changes the target range for the Federal funds rate, it must take an offensive action. Because it must decrease the Federal funds rate to meet the new target, it should adopt an expansionary monetary policy.

3. If the price level falls but people don't feel richer because of that fall, then the AD curve would likely: A. shift in. B. shift out. C. be flatter than it otherwise would be. D. be steeper than it otherwise would be.

D. be steeper than it otherwise would be. Since the money wealth effect would become inoperative, the AD curve would become steeper.

10. An economy's resources: A. can never be over-utilized. B. can always be over-utilized. C. are always fully employed. D. can be over-utilized, but only temporarily.

D. can be over-utilized, but only temporarily. Resources can be over-utilized temporarily by adding shifts and running equipment longer, but eventually workers tire and machines break down, so over-utilization cannot be sustained.

2. The monetary base includes: A. currency and coin in circulation plus checkable deposits. B. currency and coin in circulation only. C. vault cash plus checkable deposits. D. currency and cash plus commercial bank deposits at the Fed.

D. currency and cash plus commercial bank deposits at the Fed. The monetary base represents the liabilities or IOUs of the Fed, which include vault cash plus commercial bank deposits at the Fed.

29. Checking account balances are: A. not money. B. not included in M1. C. included in M2 but not M1. D. included in M1 and serve as a medium of exchange.

D. included in M1 and serve as a medium of exchange. Checking account balances are included in M1. They are liabilities for banks since they are an obligation to pay. They are a medium of exchange since you can write checks in exchange for goods.

6. A reduction in the Federal funds rate could be caused by an: A. open market sale of government securities. B. increase in the reserve requirement. C. increase in the discount rate. D. increase in the excess reserves of the banking system.

D. increase in the excess reserves of the banking system. An increase in the reserves of the banking system increases the availability of credit in the Federal funds market and reduces the Federal funds rate.