Chapter 5

Which of the following best describes a limitation of monetary policy? A Crowding out of private borrowers B Long time lags until implementation C Unexpected responses from consumers

C is correct. Monetary policies are intended to change the behaviour of busi- nesses and consumers to stimulate or slow the economy. One of the drawbacks is that consumers and businesses may not respond as expected, leading to ineffective policies. A and B are incorrect because both are limitations of fiscal policy. Increased government borrowing and spending may crowd out private borrowers. Unlike fiscal policy, monetary policy can be implemented quickly.

Holding all other factors constant, an increase in imports would most likely cause total GDP to: A decrease. B remain the same. C increase.

A is correct. Imports involve domestic residents spending money on foreign goods. Higher imports would cause GDP to decrease as defined by the follow- ing equation: GDP = C + I + G + (X - M), where C is consumer spending, I is gross investment, G is government spending, X is exports, and M is imports.

An economy experiencing deflation is most likely characterized by A delayed consumption. B increased production. C reduced unemployment.

A is correct. In a deflationary environment, consumers may expect prices to continue falling and delay purchases (consumption). B and C are incorrect because companies, as a result of reduced consumer spending, are likely to reduce production, which leads to increased unemployment.

Integrated global financial markets have most likely caused business cycles between countries to be: A less aligned. B unrelated. C more aligned.

C is correct. Integrated global financial markets have caused business cycles of various countries to become more closely aligned.

More closely aligned movements in the business cycles between countries is best explained by: A reduced international trade. B decreased mobility of labour. C increasingly connected financial markets.

C is correct. Movements in the business cycles of countries have become more closely aligned as a result of increasingly connected financial markets. A and B are incorrect because increased mobility of labour and growth in international trade result in economies becoming more closely aligned.

Which of the following phases of the business cycle most likely follows the peak phase? A Trough B Recovery C Contraction

C is correct. The business cycle can vary, but it typically follows a patternof expansion, peak, contraction, trough, recovery, and back to expansion. Therefore, an economic peak is most likely followed by a contraction phase. A and B are incorrect because the trough and recovery phases typically occur following the contraction cycle.

Fiscal policy that is intended to stimulate the economy includes decreases in: A tax rates. B interest rates. C public spending.

A is correct. A decrease in tax rates is a fiscal policy intended to stimulate an economy by increasing spending and aggregate demand. B is incorrect because a decrease in interest rates is an example of monetary policy intended to stim- ulate the economy. C is incorrect because a decrease in public spending is an example of a fiscal policy intended to slow an economy.

If all other factors remain the same, which of the following changes would most likely cause an increase in the growth rate of a country's GDP? A An increase in productivity B An increase in unemployment C A decrease in the availability of capital

A is correct. An increase in productivity will lead to an increase in GDP, all other factors remaining the same. B is incorrect because an increase in unem- ployment (a decrease in the employed labour force) will lead to a decrease in GDP, all other factors being unchanged. C is incorrect because a decrease in the availability of capital will lead to a decrease in GDP, all other factors being unchanged.

Gross domestic product (GDP) is best defined as the total: A output of a country. B output of a country per person. C changes in real output of a country.

A is correct. GDP is the total output of a country. It is the total value of final goods and services produced within a country over a period of time. B is incor- rect because the total output of a country per person measures GDP per capita. C is incorrect because total changes in real output of a country is a measure of economic growth.

Tools of fiscal policy include: A government spending. B open market operations. C changes in the central bank lending rate.

A is correct. Government spending and tax policies are tools of fiscal policy. B and C are incorrect because open market operations and changes in the central bank lending rate are tools of monetary policy.

In a given year, if a country's GDP per capita decreases while total GDP is unchanged, then the population of the country has: A decreased. B remained the same. C increased.

C is correct. GDP per capita is calculated as total GDP divided by the popu- lation. A lower GDP per capita with an unchanged total GDP implies that the population has increased.

Which stage of the business cycle is most often characterised by rising interest rates and higher wages? A Recession B Expansion C Contraction

B is correct. During an economic expansion, production, inflation, interest rates, employment, and investment spending all tend to rise. Employees have more bargaining power in demanding higher wages. A and C are incorrect because inflation and interest rates tend to decline and unemployment tends to increase during a contraction. A recession is a significant economic contraction.

Which of the following best measures the relative wealth of citizens of different countries? A Real GDP B GDP per capita C Nominal GDP

B is correct. GDP per capita is defined as a country's total GDP divided by pop- ulation and describes the average wealth of each citizen of a country. A and C are incorrect because GDP—real and nominal—is a measure of total wealth of a country, which can be highly dependent on total population.

Which of the following indicators is most appropriate to use in forcasting future economic activity? A Lagging economic indicators B Leading economic indicators C Coincident economic indicators

B is correct. Leading indicators usually signal changes in the economy in the future and, therefore, are considered useful for economic prediction and policy formulation. A is incorrect because lagging indicators signal a change in eco- nomic activity after it has already changed. C is incorrect because coincident indicators reveal current economic conditions but do not have predictive value.

Which of the following is a monetary policy tool? A Changes in tax rates B Open market operations C Decreases in government spending

B is correct. Monetary policies are typically carried out by central banks and include such tools as open market operations, changes in central bank lending rates, and changes in reserve requirements for commercial banks. A and C are incorrect because both are examples of fiscal policy tools.

Monetary policy is similar to fiscal policy in that: A legislation is required to implement policy decisions. B a time lag may occur before it affects economic growth. C commercial banks tend to react immediately by changing their lending terms.

B is correct. There can be a time lag before the effects of monetary and fiscal policies are realised. A is incorrect because fiscal policy is set by lawmakers whereas monetary policy is usually set by a central bank, which is often inde- pendent from other government branches and may not require legislative action. C is incorrect because commercial banks tend to respond quickly to monetary policy but not to fiscal policy.

Which of the following will most likely decrease when an economy is in the expansion phase of the business cycle? A Production B Unemployment rate C Consumer spending

B is correct. Unemployment tends to fall when an economy is in the expansion phase of the business cycle. A and C are incorrect because production and consumer spending tend to increase during the expansion phase of the business cycle.

If consumers anticipate an inflationary environment, it may lead to consumer spending: A decreasing. B remaining unchanged. C increasing.

C is correct. Consumers may change the timing of their purchases in response to expected price changes. If they expect prices to increase (inflation), they may buy now rather than save (a lower savings rate).

Financial panics are most likely: A limited to specific countries. B limited to specific securities markets. C easily spread throughout the global economy.

C is correct. As financial markets are increasingly global, financial panics are easily spread throughout the global economy. A and B are incorrect because financial panics generally do not remain contained to specific markets or coun- tries, but spread globally as experienced from 2007 to 2009.

Time lags until policies affect the economy are most likely associated with: A only fiscal policy. B only monetary policy. C both fiscal policy and monetary policy.

C is correct. Both monetary policies and fiscal policies can have a significant time lag between a change in policy and when actions based on policy changes affect the economy.

Current economic conditions are best shown by: A lagging economic indicators. B leading economic indicators. C coincident economic indicators.

C is correct. Coincident indicators reveal current economic conditions but do not have predictive value. A is incorrect because lagging indicators signal a change in economic activity after it has already changed. B is incorrect because leading indicators usually signal changes in the economy in the future.

The largest component of total GDP is most likely to be: A gross investment. B government spending. C consumer or household spending.

C is correct. Consumer or household spending is the largest component of total spending, and may be as high as 70% of total GDP.