FINA 6204 Chapter 34 & Quiz

With the economy in a recession due to inadequate aggregate demand, the government increases its purchases by $1,200. Suppose the central bank adjusts the money supply to hold the interest rate constant, investment spending remains unchanged, and the marginal propensity to consume is ⅔. How large is the increase in aggregate demand?

$3,600

If the marginal propensity to consume (MPC) is 0.75, the value of the multiplier is

4

Which of the following statements regarding taxes is correct?

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

Which of the following best describes how an increase in the money supply shifts aggregate demand?

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

Monetary policy affects the economy with a lag mainly because it takes a long time

for a change in interest rates to affect investment spending.

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

increase the money supply and decrease interest rates.

The long-run effect of an increase in the money supply is to

increase the price level.

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

increase; decrease

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

more people become eligible for unemployment insurance benefits.

investment accelerator.

positive feedback from demand to investment is sometimes

An increase in the marginal propensity to consume (MPC)

raises the value of the multiplier.

Fiscal Policy

refers to the government's choices regarding the overall levels of government purchases and taxes.

In the market for real output, the initial effect of an increase in the money supply is to

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

shifts money demand to the right and increases the interest rate

Suppose a wave of negative "animal spirits" overruns the economy, and people become pessimistic about the future. To stabilize aggregate demand, the Fed could ________ its target for the federal funds rate or Congress could ________ taxes.

decrease; decrease

If the central bank wants to contract aggregate demand, it can ________ the money supply and thereby ________ the interest rate.

decrease; increase

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

decreases the quantity demanded of money.

If the central bank in the preceding question had instead held the money supply constant and allowed the interest rate to adjust, the change in aggregate demand resulting from the increase in government purchases would have been

smaller but still positive

What is the most important automatic stabilizer?

tax system

multiplier effect

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

Suppose the government increases its purchases by $16 billion. If the multiplier effect exceeds the crowding-out effect, then

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

the crowding-out effect.

For the United States, the most important source of the downward slope of the aggregate-demand curve is

the interest-rate effect.

When an increase in government purchases causes firms to purchase additional plant and equipment, we have seen a demonstration of

the investment accelerator.

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

the multiplier effect.

crowding out effect

the reduction in aggregate demand that results when a fiscal expansion raises the interest rate

Keynes's liquidity preference theory of the interest rate suggests that the interest rate is determined by

the supply and demand for money.

According to the theory of liquidity preference, an economy's interest rate adjusts

to balance the supply and demand for money

Which of the following is an automatic stabilizer?

unemployment benefits

Which of the following statements about stabilization policy is true?

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

The initial impact of an increase in government spending is to shift

aggregate demand to the right.

The initial effect of an increase in the money supply is to

decrease the interest rate.

automatic stabilizers

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

The Fed's target for the federal funds rate

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

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

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