ECON 202 CH. 16-21 HW MULTIPLE CHOICE QUESTIONS

The Federal Open Market Committee is comprised of: a. 7 board of governors and the chairman of the Fed b. 7 board of governors, some CEOs of the regional Fed Banks and the chairman of the Fed c. CEOs of the Regional Fed Banks and the chairman of the Fed d. CEOs of the Regional Fed Banks

b. 7 board of governors, some CEOs of the regional Fed Banks and the chairman of the Fed

IF the Fed buys US government bonds, then: a. The price of bonds increases and thus the return from bonds (the nominal interest rate)increases. b. The price of bonds decreases and thus the return from bonds (the nominal interest rate)decreases. c. The price of bonds decreases and thus the return from bonds (the nominal interest rate)increases. d. The price of bonds increases and thus the return from bonds (the nominal interest) decreases

d. The price of bonds increases and thus the return from bonds (the nominal interest) decreases Reasoning: - When the Federal Reserve buys US government bonds through open market operations, it increases the demand for bonds, which drives up their price. The increase in bonds leads to a decrease in the return on investment, which is the opposite of the nominal interest rate. Therefore, the price of bonds increases and thus the return from bonds decreases.

If MPC is 0.9, then which of the following is the value of multiplier? (a) 10 (b) 5 (c) 3 (d) 20

a. 10 Reasoning: If MPC (marginal propensity to consume) is 0.9, then the value of the multiplier can be calculated using the formula: Multiplier = 1 / (1 - MPC) Substituting MPC = 0.9 in the formula, we get: Multiplier = 1 / (1 - 0.9) = 1 / 0.1 = 10 Therefore, the value of the multiplier is 10 (option A).

A boom in the stock market makes households rich and causes: a. AD curve shift to the right b. AD curve shift to the left c. Nothing to the AD curve

a. AD curve shift to the right Reasoning: - A boom in the stock market makes households rich, which tends to increase consumption demand. As a result, the AD curve shifts to the right. Therefore, option (a) is the correct answer.

Suppose Prices increase but income and interest rate are unchanged. Then what happens to money demand? (a) Increases (b) Decreases (c) Remains unchanged

a. Increases Reasoning: - If prices increase but income and interest rate remain unchanged, then money demand will increase. This is because with higher prices, people need more money to purchase the same quantity of goods and services as before. In other words, the purchasing power of money decreases when prices increase. Therefore, people need more money to maintain the same level of purchasing power. As a result, the demand for money increases.

According to Quantity Equation of Money, if both velocity of money and the real GDP growth rate are constant, then: (a) Inflation Rate=Money Growth Rate (b) Inflation Rate>Money Growth Rate (c) Inflation Rate<Money Growth Rate

a. Inflation Rate=Money Growth Rate Reasoning: - According to the Quantity Equation of Money, MV = PY, where M represents the money supply, V represents the velocity of money, P represents the price level, and Y represents real GDP. Assuming that the velocity of money and the real GDP growth rate are constant, then any change in the money supply (M) will lead to an equal change in the nominal GDP (PY). - The inflation rate is the percentage change in the price level, which can be expressed as (P2 - P1)/P1, where P1 is the initial price level and P2 is the final price level. Therefore, if both the velocity of money and real GDP growth rate are constant, and the money supply increases by a certain percentage, then the price level must increase by the same percentage to maintain the equation. Hence, the inflation rate will be equal to the money growth rate. Therefore, the answer is (a) Inflation Rate = Money Growth Rate.

If the citizens of the country become optimistic about the future of the economy, then a. Investment demand will increase and hence AD will shift to the right b. Investment demand will decrease and hence AD will shift to the right c. Investment demand will increase and hence AD will shift to the left d. Investment demand will decrease and hence AD will shift to the left

a. Investment demand will increase and hence AD will shift to the right Reasoning: - If the citizens of a country become optimistic about the future of the economy, they will expect higher future incomes and profits, which leads to an increase in investment demand. When investment demand increases, businesses will invest more in capital goods and hiring, which leads to an increase in production, employment, and incomes. This increase in investment demand will shift the Aggregate Demand (AD) curve to the right, resulting in an increase in both real GDP and the price level.

If a ten-year old investment tax credit expires, then: a. Investment falls and then AD curve shifts to the left b. Investment rises and then AD curve shifts to the left c. Consumption rises and then AD shifts the right d. Investment demand falls and then AD shifts to the right

a. Investment falls and then AD curve shifts to the left Reasoning: - If a ten-year-old investment tax credit expires, it means that the tax incentive that was previously offered to investors to encourage them to invest in certain projects or activities is no longer available. As a result, investors will likely reduce their investment in those activities because they will no longer receive the tax credit. This reduction in investment will lead to a decrease in the aggregate demand (AD) for goods and services because fewer goods and services will be produced. Therefore, option A is correct, investment falls and then AD curve shifts to the left.

Which of the following is the Quantity Equation of Money? (a) MV=PY (b) Y=C+I+G+NX

a. MV=PY Reasoning: - The Quantity Equation of Money (also known as the equation of exchange) is MV=PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is real output. The equation states that the money supply times the velocity of money equals the price level times real output. This equation is a useful tool for understanding the relationship between money supply, price level, and real output in an economy. It suggests that changes in the money supply can affect the price level and real output, and vice versa.

Which of the following is an example of Nominal variable? (a) Nominal GDP (b) Relative price (c) Real interest rate (d) Real GDP

a. Nominal GDP Reasoning: - Nominal variables are measurements that are NOT adjusted for inflation, while real variables are adjusted for changes in inflation. (a) Nominal GDP is an example of a nominal variable because it measures the value of goods and services produced in an economy using current market prices. It does not take into account inflation or changes in the purchasing power of money over time. (b) Relative price is not an example of a nominal variable because it compares the price of one good or service to another, without necessarily relying on current market prices. (c) Real interest rate is not an example of a nominal variable because it adjusts the nominal interest rate to give an accurate measure of the true cost of borrowing or lending money. (d) Real GDP is not an example of a nominal variable because it measures the values of goods and services produced in an economy using constant prices from a base year, which takes into account changes in inflation over time.

Using the Open Market Operations if the Fed wants to increase money supply in the US economy, then: a. The Fed needs to buy US government bonds b. The Fed needs to sell US government bonds c. The Fed needs to both buy and sell US government bonds d. None of the above

a. The Fed needs to buy US government bonds Reasoning: - Open market operations refers to the buying and selling of government securities, such as Treasury bills, notes, and bonds by the Federal Reserve in the open market with the aim of influencing money supply in the economy. If the Fed wants to increase the money supply, it can purchase government securities from banks and other financial institutions. When the Fed buys these securities, it pays for them with newly created electronic reserves. As a result, banks and financial institutions have more reserves, which they can use to make loans, thus increasing the money supply in the economy. - Therefore, to increase the money supply in the US economy, the Fed needs to by US government bonds through open market operations.

With everything else being equal, what happens if money supply decreases? (a) The interest rate increases (b) The interest rate decreases (c) The interest rate remains unchanged

a. The interest rate increases Reasoning: - If money supply decreases with everything else being equal, the interest rate would increase. This is because a decrease in money supply would lead to a decrease in the amount of money available for borrowing, which in turn would increase the cost of borrowing money, i.e., interest rates. The increase in interest rates would also reduce the demand for credit and slow down economic activity. Conversely, an increase in money supply would reduce interest rates and increase the demand for credit, thereby boosting economic activity.

A Bank with high leverage ratio indicates high risk a. True b. False

a. True Reasoning: - A bank's leverage ratio is the ratio of its total assets to its equity capital. The ratio indicated the amount of debt that the bank has in relation to its equity. A higher leverage ratio means that the bank has taken on more debt to finance its operations and investments. - A high leverage ratio may indicate that the bank has a higher risk of default because it has less equity to absorb potential losses. This means that if the bank experiences unexpected losses or shocks, it may not be able to pay off its debts which could lead to financial distress and even bankruptcy. - Therefore, a high leverage ratio is generally considered to be a sign of higher risk for the bank and its stakeholders.

An expansionary fiscal policy increases the interest rate causing the private investment to down. This in turn causes the aggregate demand to decreases. This called Crowding Out Effect. (a) True (b) False

a. True Reasoning: - Expansionary fiscal policy refers to government policies that increase government spending, decrease taxes, or both, in order to stimulate economic growth and increase aggregate demand. - When the government spends more money or cuts taxes, it may have to borrow money by issuing bonds. This increases the demand for loans in the financial market, causing the interest rate to rise. - Higher interest rates discourage private investment, as borrowing becomes more expensive for businesses and individuals. This means that the increased government spending may be offset by decreased private investment, leading to a smaller increase in aggregate demand than expected. - This phenomenon is known as the crowding out effect, which suggests that government borrowing may "crowd out" private investment and limit the effectiveness of fiscal policy.

Liquidity Trap is a situation when the interest rate becomes zero and the central bank's policy becomes ineffective to help the economy. (a) True (b) False

a. True Reasoning: - The statement is generally true. A liquidity trap occurs when the interest rate is so low that people and businesses prefer to hold onto their money in cash instead of investing or spending it, despite the low returns. In this situation, monetary policy becomes ineffective as the central bank cannot further lower interest rates to stimulate economic activity. This can lead to a prolonged period of economic stagnation, as businesses invest less and consumers spend less, resulting in lower aggregate demand and slower economic growth.

If a country experiences immigration flow causing labor supply to increase or develops better technology to produce goods and services, then long-run AS curve shifts to the right. a. True b. False

a. True Reasoning: - The statement is true. An increase in labor supply due to immigration or better technology that improves productivity can shift the long-run aggregate supply (LRAS) curve to the right. This is because an increase in labor supply or productivity can increase the potential output of the economy, which is the maximum amount of goods and services an economy can produce with its resources and technology. When the LRAS curve shifts to the right, the economy can produce more goods and services at the same price level, resulting in an increase in real GDP and a decrease in the price level.

If the central bank doubles the money supply, then all nominal variables will double but the real variables will remain unchanged. (a) True (b) False

a. True Reasoning: - When the central bank doubles the money supply, all nominal variables, such as prices and nominal GDP, will double, but real variables, such as real GDP and real interest rates, will remain unchanged. This is because the increase in the money supply will lead to a proportional increase in prices, leaving real variables unaffected.

If the Congress cuts government spending in order to balance the budget, then, with everything else being equal, (a) Aggregate Demand will increase (b) Aggregate Demand will decrease (c) Aggregate Demand will remain unchanged

b. Aggregate demand will decrease Reasoning: - If Congress cuts government spending in order to balance the budget, then, with everything else being equal, the Aggregate Demand will decrease. This is because government spending is a component of Aggregate Demand, and a decrease in government spending means less spending in the economy, which reduces the overall level of Aggregate Demand. As a result, this reduction in Aggregate Demand may lead to lower economic growth, lower employment levels, and possibly lower inflation.

M1 includes a. Currency and savings deposits .b. Currency and demand deposits. c. None of the above d. money market funds

b. Currency and demand deposits Reasoning: - M1 is a measure of the money supply that includes most liquid forms of money, meaning those that can be easily and quickly converted into goods and services. - Currency, which refers to physical money such as banknotes and coins, is included in M1 because it is readily accepted as a medium of exchange. - Demand deposits, which are checking account balances held at banks and other depository institutions, are also included in M1. These deposits can be withdrawn at any time, without advance notice, and are used to make payments or to transfer funds. - Savings deposits are not included in M1. Although they are part of the broader money supply, they are less liquid than demand deposits because they may require advance notice or penalty fees for withdrawal. - Money market funds, which are investments in short-term debt securities, such as Treasury bills, commercial paper, and certificates of deposit, are also not included in M1 because they are not considered to be a form of money.

Suppose interest rate rises, but income and prices are unchanged. What happens to money demand? (a) Increases (b) Decreases (c) Remains unchanged

b. Decreases Reasoning: - When interest rates rise, the opportunity cost of holding money increases because holding money doesn't earn any interest. Therefore, people would prefer to save their money in interest-earning accounts or invest in other assets that yield a higher return. This leads to a decrease in money demand, as people hold less money and shift their funds to other assets. Thus, the answer is (b) Decreases.

If the Fed decreases the Discount Rate (the interest rate at which the Fed lends money other banks and financial institutions), then market interest rate increase. a. True b. False

b. False Reasoning: - If the Fed decreases the Discount Rate, it becomes cheaper for banks to borrow money from the Fed. This can lead to an increase in the overall supply of money in the economy as banks are able to lend more to consumers and businesses at a lower cost. - However, the change in the discount rate does not necessarily lead to an increase in market interest rates. Market interest rates are determined by a variety of factors, including the supply and demand for credit and the perceived risk associated with lending. Therefore, a decrease in the Discount Rate does not lead to an increase in market interest rates. - In fact, a decrease in the Discount rate can sometimes lead to a decrease in market interest rates, as it signals that the Fed is easing its monetary policy and may be willing to keep interest rate low for longer periods.

If the Fed sells US government bonds, then: a. Money supply in the US economy increases b. Money supply in the US economy decreases c. Money Supply in the US economy remains unchanged

b. Money supply in the US economy decreases Reasoning: - When the Federal Reserve sells US government bonds through open market operations, it takes electronic money out of the economy and gives bonds to banks and financial institutions. As a result, banks and financial institutions have fewer reserves, which limits their ability to make new loans, thus decreasing money supply in the economy. - Moreover, the increased supply of bonds leads to a decrease in their price, which in turn leads to an increase in the return on investment. This increase can lead to higher interest rates, which can also decrease borrowing and spending and further decrease the money supply.

The federal funds rate is the interest rate that a. The Fed charges when it gives loan to commercial banks b. One commercial bank charges when it gives loan to another commercial bank c. Commercial banks usually charges when they give loan to consumers d. None

b. One commercial bank charges when it gives loan to another commercial bank Reasoning: - The federal funds rate is the interest rate at which one commercial bank lends money to another commercial bank for a very short period, usually overnight. This helps banks meet their reserve requirements set by the Federal Reserve. The Federal Reserve directly influences this rate by buying or selling Treasury securities. The federal funds rate is important because it affects other interest rates, such as those on loans and mortgages. By changing the federal funds rate, the Federal Reserve can affect the overall level of economic activity in the U.S

Velocity of money is: (a) The amount of money in the economy at a point of time (b) The rate at which money changes hands. (c) The amount of money in checking accounts (d) The amount of money in savings account

b. The rate at which money changes hands. Reasoning: - Velocity of money is the rate at which money is exchanged in the economy. It represents the number of times a unit of currency is spent over a period of time. For example, if the velocity of money is 2, it means that each dollar is spent twice in a given period of time (e.g. a year). It is calculated by dividing nominal GDP by the money supply.

If the reserve ratio increases, then: a. The supply of money increases b. The supply of money decreases c. None of the above

b. The supply of money decreases. Reasoning: - The reserve ratio is the percentage of deposits that banks are required to hold in reserve, meaning they cannot lend out or invest that portion of the deposit. When the reserve ratio increases, banks must hold a larger percentage of their deposits in reserve and can lend out less money. This decreases the amount of money in circulation in the economy, thereby reducing the overall supply of money. For example: if the reserve ratio is 10%, and a bank receives a deposit of $1000, it can lend out $900 (90% of the deposit and must hold $100 (10% of the deposit) in reserve. However, if the reserve ratio is increased to 20%, the bank can only lend out $800 (80% of the deposit) and must hold $200 (20% of the deposit) in reserve. This means there is less money available to be loaned out to individuals and businesses, resulting in a decrease in money supply.

Which of the following statement is true about Money Neutrality? (a) An increase in money supply affects real variables both in the short run and long run (b) An increases in money supply affects real variables in the long run (c) An increase in money supply affects nominal variable both in short run and long run

c. An increase in money supply affects nominal variable both in short run and long run Reasoning: - An increase in the money supply affects nominal variables both in the short run and the long run. In the short run, real variables such as output and employment may also be affected due to various factors such as sticky prices and wages, but in the long run, the increase in the money supply only affects nominal variables such as prices and inflation, while real variables return to their long-run equilibrium levels.

Which of the following statements is true? (a) Recessions are periods of falling incomes and rising unemployment (b) Severe Recessions are called Depressions (c) Both of the above (d) None of the above

c. Both of the above Reasoning: (a) Recessions are periods of falling incomes and rising unemployment: This statement is true. In a recession, economic activity slows down, businesses may cut production, and people may lose jobs. As a result, incomes fall and unemployment rises. (b) Severe recessions are called depressions: This statement is also true. A depression is an extreme and prolonged recession that lasts several years and is characterized by a severe decline in economic activity, high unemployment rates, and a significant drop in the stock market. - Therefore, both statements (a) and (b) are true, making option (c) "Both of the above" the correct answer.

Which of the following is an example of Expansionary Fiscal policy? (a) Lowering tax rate (b) Increasing government spending (c) Both of the above (d) None of the above

c. Both of the above Reasoning: - Both (a) lowering tax rate and (b) increasing government spending are examples of expansionary fiscal policy. - When tax rates are lowered, households have more disposable income, which they can either save or spend on goods and services. This leads to an increase in consumption demand and hence a rise in aggregate demand (AD). Similarly, when the government increases spending, it creates jobs and increases the overall demand for goods and services, which also leads to a rise in AD. - Expansionary fiscal policy is typically used during economic recessions or when there is a slowdown in economic growth, as it helps to stimulate economic activity and reduce unemployment.

Which of the following is an example of Contractionary Fiscal policy? (a) Lowering tax rate (b) Increasing government spending (c) Increasing taxes (d) None of the above

c. Increasing taxes Reasoning: - Contractionary fiscal policy refers to the measures taken by the government to decrease aggregate demand and slow down economic growth. Increasing taxes is one of the ways to implement contractionary fiscal policy. When taxes are increased, households and firms have less disposable income and less money to spend or invest, which leads to a decrease in consumption and investment spending. As a result, aggregate demand decreases, causing the economy to slow down.

In the 1980s, a few South American countries, with constant velocity of money, experienced an inflation rate that was higher than the money growth rate. Which of the following was true for those countries? (a) Real GDP growth rate was zero for those countries (b) Real GDP growth rate was positive for those countries (c) Real GDP growth was negative for those countries

c. Real GDP growth was negative for those countries Reasoning: - The Quantity Equation of Money is MV = PY, where M is the money supply, V is the velocity of money, P is the price level, and Y is the real GDP. - If we assume that the velocity of money and the real GDP growth rate are constant, then any change in the money supply (M) will directly impact the price level (P). So, if the money supply (M) increases faster than the increase in the real GDP, then the price level (P) will also increase at a faster rate. This means that inflation will be higher than the growth rate of the money supply. - In the case of the South American countries mentioned in the previous question, they experienced a situation where the inflation rate was higher than the growth rate of the money supply. This implies that the money supply was growing, but not as fast as the increase in prices. Therefore, the real GDP must have been growing at a positive rate, as negative real GDP growth would result in a decrease in prices.

Which of the following variables money demand depends on? (a) Income (b) Interest rate (c) Price level (d) All of the above

d. All of the above Reasoning: - Money demand refers to the desire of individuals and firms to hold money in the form of cash or in bank accounts. The variables that influence money demand are the factors that determine how much money people want to hold. These factors include: - Income: As people's incomes rise, they tend to want to hold more money to finance their spending and saving activities. - Interest rate: When interest rates are higher, people have an incentive to hold more of their wealth in interest-bearing assets such as savings accounts, bonds, or stocks. This reduces the demand for money. - Price level: When prices are higher, people need more money to purchase the same goods and services. Therefore, the demand for money increases with the price level. So, the correct option is (d) all of the above.

Which of the following statement(s) is (are) true? (a) If the price level increases, then the value of money decrease. (b) If money supply increases, then the price level increases and the value of money decreases. (c) If money supply decrease, then the price level decreases and the value of money increase. (d) All of the above

d. All of the above Reasoning: (a) When prices of goods and services increase, the value of money decreases because more money is needed to buy the same amount of goods and services. (b) If there is more money available in the economy, people have more money to spend, which can drive up prices of goods and services, reducing the value of money. (c) If there is less money available in the economy, people have less money to spend, which can drive down prices of goods and services, increasing the value of money.

Aggregate Demand (AD) curve is downward sloping because: a. When the price level increases, consumption demand decreases b. When the price level increases, investment demand decreases c. When the price level increases, net export decreases d. All of the above

d. All of the above Reasoning: (a) When the price level increases, consumption demand decreases: When the price level increases, the purchasing power of money decreases, so people can buy fewer goods and services with the same amount of money. Therefore, consumption demand decreases, and this causes the AD curve to slope downward. (b) When the price level increases, investment demand decreases: When the price level increases, the cost of borrowing money also increases. Higher interest rates make borrowing money for investment purposes more expensive, reducing investment demand. Therefore, investment demand decreases, and this causes the AD curve to slope downward. (c) When the price level increases, net export decreases: When the price level increases, the domestic currency appreciates relative to other currencies, making exports more expensive for other countries and imports cheaper for domestic consumers. As a result, net exports decrease, and this causes the AD curve to slope downward.

Which of the following is true? a. AD curve is downward sloping b. Short-run AS curve is upward sloping c. Long-run AS is vertical d. All of the above

d. All of the above Reasoning: - The AD curve is downward sloping because an increase in price level decreases the purchasing power of money, leading to a decrease in consumption, investment, and net exports, causing a decrease in the quantity of goods and services demanded. - The short-run AS curve is upward sloping because some input prices are sticky in the short run, meaning they do not adjust immediately to changes in the price level. As a result, an increase in price level increases output prices, leading firms to increase production and employment, causing an increase in the quantity of goods and services supplied. - The long-run AS curve is vertical because in the long run, all input prices are flexible and adjust to changes in the price level. Therefore, an increase in the price level does not affect the quantity of goods and services supplied, as the economy will adjust to the new price level over time.

Which of the following is an example of Real variable? (a) Relative price (b) Real interest rate (c) Real GDP (d) All of the above

d. All of the above Reasoning: - A real variable is a measure that has been adjusted for changes in the price level, so that it gives a more accurate picture of the underlying economic reality. For example, real GDP is a measure of the value of all goods and services produced in an economy, but it has been adjusted for inflation so that it is measured in terms of constant prices from a base year. This allows us to compare the level of production over time, without being influenced by changes in prices. - Therefore, (c) Real GDP is an example of a real variable, because it has been adjusted for inflation, while (a) Relative price is not a real variable, because it does not involve adjusting for changes in the price level. (b) Real interest rate is also an example of a real variable, because it has been adjusted for inflation, to give an accurate measure of the true cost of borrowing or lending money.

Which of the following statements is NOT true? a. Commodity money has intrinsic value b. Money is used as a unit of account c. Money is used as a store of value d. Money is used as medium of exchange e. None of the above

e. None of the above Reasoning: -(A) Commodity money is a type of money that has intrinsic value because it is made from a valuable commodity such as gold or silver. The commodity itself has value, which gives money value. - (B) Money is used as a unit of account, meaning it is used to measure the value of goods and services. - (C) Money is used as a store value, meaning it can be saved and used in the future. - (D) Money is used as a medium of exchange, meaning it is accepted in exchange for goods and services.