Econ Unit 6 and 7

Suppose the Reserve Ratio is 10% and a bank with no excess reserves had $100,000 deposited into a checking account. What would the potential increase in the money supply be? HINT: The bank has no excess reserves. So it must keep 10% of the $100,000 deposit in reserve. The other $90,000 may be lent out and if the full $90,000 was redeposited (and so on) by the time the redeposits were all lent out, the final impact of the money would be $90,000 (excess reserves times 1/RR). Extra Hint: Excess reserves is the cash in the bank that is not a part of the required reserve but also is not being lent out.

$900,000 because excess reserves impact will be 10 to 1 impact.

Which of the following would most likely cause the United States economy to fall into a recession? HINT: Consumption is one of the four major components of GDP. An increase in welfare payments would increase disposable income. An increase in exports would increase GDP. A decrease in savings by consumers would correspond with an increase in consumption. A decrease in the required reserve ratio would increase the money supply and, if this increases lending, would increase spending & GDP. A decrease in consumer spending would decrease AD & GDP.

a decrease in consumer spending

Which of the following would most likely cause the United States economy to fall into a recession?

a decrease in consumer spending

If the MPC is two- thirds, then an increase in personal income taxes of $100 will initially result in

a decrease in consumption of $67 & a decrease in savings of $33.

In the secondary bond market where already issued bonds are exchanged, an increase in the interest rate will lead to:

a decrease in the price of these already issued bonds.

According to the short run Phillips Curve (SRPC), an increase in inflation will be accompanied by

a decrease in unemployment

What are the three primary goals for every economy?

price stability, full employment, economic growth

When people with higher incomes pay a higher tax rate and those with lower incomes pay a lower tax rate, we say that the income tax is:

progressive

Given a marginal propensity to save MPS of 0.25, a government tax increase of $500 million would be expected to provide a HINT: Because this question involves a change in taxes, we need to calculate the tax multiplier in order to answer the question The tax multiplier is defined as the multiple by which GDP changes in response to a change in taxes. The equation for the tax multiplier is MPC/MPS. The marginal propensity to consume and save are defined as the percentage of disposable Income that is gained (or lost) that an average person spends and saves. The MPS is 0.25. Since the MPS plus the MPC equals one, that means that the MPC is question is 0.75. 0.75 divided by 0.25 equals 3. Therefore the value of the tax multiplier in this question is 3. Once we know the value of the tax multiplier, all we need to do is multiply the multiplier times the amount of the change in taxes. Since this is a tax increase, money is being taken from consumers.

$1.5 billion contractionary effect.

Output in Econoland falls $100 billion short of full employment output. What is the minimum increase in government expenditures necessary to bring output up to the full-employment level if the marginal propensity to save is 0.20?

$20 billion

Output in Econoland falls $100 billion short of full-employment output. What is the minimum decrease in personal income taxes necessary to bring output up to the full-employment level if the marginal propensity to save is 0.20?

$25 billion

Assume an economy is in a long-run equilibrium with an actual unemployment rate of 5%, an expected inflation rate of 2%, a nominal interest rate of 4%. What is the NRU & the actual inflation rate in this economy? HINT: In the long run, expected inflation & actual inflation are the same. Because of the match between people's expectations of inflation & inflation, the actual rate of unemployment will be equal to the NRU.

5%, 2%

Which of the following occur when a short-run Phillips curve shifts to the right? HINT: A short-run Phillips curve shifts to the right when at every unemployment rate the inflation rate increases. This reflects a higher inflation rate at every unemployment rate and a higher unemployment rate at every inflation rate.

At each unemployment rate, the inflation rate is higher and at each inflation rate, the unemployment rate is higher.

Which of the following is most likely when the Federal Reserve increases the reserve requirement? HINT: When the reserve requirement is increased, banks must hold a larger percentage of their deposits on reserve.

Bank lending is reduced.

If market interest rates fall, what will likely occur?

Bond prices will rise.

Assume an economy is operating at the NRU. Which of the following is true of consensus expected inflation?

Consensus expected inflation is the same as actual inflation.

If the Demand Curve for money shifts to the right, which of the following has most likely occurred?

Households or individuals reduced their holdings of money.

If a one year, a $1000 bond pays 5% APR then which of the following is true? The bond will pay $50 at maturity. ll. Maturity occurs after one year. lll. Deficit spending has occurred. HINT: Bonds earn interest over time. To calculate the return on a one-year $1000 bond, simply convert the APR to a decimal equivalent (0.05) and multiply it by the face value ($1000). $50 interest will be owed at maturity. Since it is a one-year bond maturity occurs at one year. One cannot say with absolute certainty that deficit spending has occurred because businesses may also sell bonds.

I and II

In a closed economy with no taxes in which the marginal propensity to consume (MPC) is 0.75, which of the following is true?

If income is $100, then saving is $25.

Which of the following does the Fed have the least amount of control over? HINT: The Fed has the least amount of control over long-term interest rates because those rates tend to be controlled by expectations of inflation. The Fed does have tools to influence short-term interest rates. The federal funds rate and T-Bill rates are both short-term rates. The amount of reserves banks must keep is also controllable by the Fed.

Long-Term Interest Rates

Which of the following is the strictest, and thereby most liquid, monetary aggregate (that is, definition of the money supply)?

M1

Which of the following is most likely the result of the Fed implementing a contractionary monetary policy? HINT: Contractionary monetary policies shrink the money supply.

Nominal interest rates would rise.

According to the long-run Phillips curve, which of the following is true? HINT: The long-run Phillips curve represents the NRU at every level of inflation. At each rate of inflation consistent with the NRU, the expected rate of inflation equals the rate of inflation. Monetary & fiscal policy that affect AD at the short run have no effect on the long run Phillips Curve.

The NRU is independent of monetary & fiscal policy changes that affect aggregate demand.

If real GDP increased in the last quarter, how could this data not indicate economic growth occurred? HINT: An increase in GDP could be the result of a short run economic fluctuation, such as the economy coming out of a recession & increasing its production back up to the economy's potential - a good thing, but not growth. Economic growth is an increase in the potential of the economy to produce goods & services.

The economy was in recession, & the increase in GDP was the result of a recovery.

When interest rates increase, how is the price of existing bonds affected?

The price decreases.

According to the quantity theory of money, what happens if the money supply increases by 10% assuming the current rate of unemployment is equal to the natural rate of unemployment? HINT: If the economy is at full employment then according to the quantity theory of money, changes in the MS do not affect real variables, such as real output. In such a situation the only effect of increasing the MS is an increase in the price level i.e. inflation.

The price level increases by 10%

How do we correctly describe the relationship between bond prices and interest rates?

The price of a bond varies inversely with market interest rates.

Which of the following statements correctly describes the relationship between bond prices and interest rates?

The price of a bond varies inversely with market interest rates.

How would the rate of economic growth be affected by an increase in deficit spending to finance investments in public infrastructure? HINT: An increase in deficit spending would cause the real interest rate to increase in the market for loanable funds so private investment spending would be decrease. However, government spending on new capital can add to a country's capital stock. The rate of economic growth will increase if the government's actions increase the country's capital stock. The decrease in private investment spending & the increase in public infrastructure investment have offsetting effects on the capital stock, so whether the capital stock increases, decreases or remains unchanged depends on which change is greater. The first option does not recognize that some forms of government spending can add more physical or human capital to the country's capital stock. The second option confuses increases in real GDP in the short run with long run economic growth. The third option identified the impact on private investment but did not account for additional public infrastructure's impact on the capital stock. The fourth option identified the increase in capital stock from the added public infrastructure but did not account for the reduction in private investment spending because of the higher interest rates resulting from the government's deficit financing.

The rate of economic growth would increase only if the public infrastructure investment more than offset the decrease in private investment due to higher interest rates.

According to the quantity theory of money, which of the following best describes what determines the rate of inflation in the long run? HINT: The quantity theory of money states that the velocity of money in the equation of exchange is constant. In the long run real output (Y) is also constant. If both V and Y are constant in the equation below, any change in the money supply (M) will cause an equivalent change in the price level (P). Therefore, in the long run, changes in inflation (which are changes in the price level) are only the result of changes in the money supply.

The rate of growth of the money supply

Which of the following is true regarding the Phillips Curve? HINT: Watching this 3:00 minute video will help: https://www.youtube.com/watch?v=zatnIhwmu1c

The short run Phillips curve shifts right when Aggregate Supply shifts right

Which of the following curves illustrates that there is a trade-off between inflation and the unemployment rate? HINT: High rates of unemployment are associated with low rates of inflation, and low rates of unemployment are associated with high rates of inflation.

The short-run Phillips curve (SRPC)

In which of the following scenarios is the Fed most likely to buy bonds?

The unemployment rate is higher than the natural rate.

In which of the following scenarios is the Federal Reserve most likely to sell bonds? HINT: When the Fed sells bonds in this situation, AD would shift left, raising the unemployment rate towards the natural rate.

The unemployment rate is lower than the natural rate.

Which of the following is true if the economy is producing at the full employment level of output?

There is still frictional unemployment.

An economy is experiencing stagflation. Which of the following could have caused the stagflation? HINT: Stagflation refers to the simultaneous occurrence of decreasing Real GDP& rising unemployment (stagnation) & an increasing general price level (inflation). If aggregate supply decreases, the leftward shift in the aggregate supply curve leads to a new short-run macroeconomic equilibrium at a lower level of Real GDP & higher price level. A general increase in nominal wages would cause a decrease in aggregate supply.

There was a general increase in nominal wages.

Assume the velocity of money is 3 and the LRAS curve is vertical at $100 million. What impact will a 10% increase in the money supply have on real output? HINT: The LRAS curve is vertical whenever prices are able to completely adjust and output does not change. According to the quantity theory of money (MV=PY) if V (velocity) is constant and Y (output) is constant, then an increase in the money supply will only impact price level.

There will be no impact on real output

Which of the following fiscal policy actions would have the largest impact on AD & RGDP?

a $100 million increase in government purchases of goods & services when the economy is in short-run equilibrium with output below full-employment output.

An unanticipated decrease in AD when the economy is in equilibrium will result in: HINT: When the economy is starting at equilibrium, this means that the intersection of AD & short-run aggregate supply cross at the vertical LRAS, & thus the unemployment rate is at the natural rate. An unanticipated decrease in AD is not offset by any corresponding drop in wages. Thus, the economy goes into recession, with a decrease in real gross domestic product. A decrease in voluntary unemployment & a decrease in unplanned inventories may be a sign of an economy heating up, not one going into recession. A change in AD is not going to impact the LRAS nor the NRU, which would remain unchanged.

a decrease in real gross domestic product.

Which of the following changes would cause an economy's aggregate demand curve to shift to the right?

an increase in autonomous consumption spending

Which of the following would increase the NRU? HINT: The NRU is the rate at which there is only frictional & structural unemployment. So for the NRU to change there must be a change in frictional or structural unemployment. Cyclical unemployment is independent of the natural rate.

an increase in frictional unemployment

In the short run, when the Fed decreases the quantity of money:

bond prices fall and the interest rate rises.

In the short run, when the Fed increases the quantity of money:

bond prices rise and the interest rate falls.

What must increase in order for any type of government policy to have a positive impact on economic growth?

capital stock

Econoland is experiencing high inflation rates. What fiscal policy would be appropriate to address the inflationary gap? HINT: Fiscal policy involves government spending and taxing, not interest rates or the money supply. In order to address the expansionary gap with high inflation, we would conduct actions to decrease aggregate demand by decreasing government purchases and increasing taxes to decrease incomes and spending.

decrease government purchases and increase taxes

Assume an economy is at full employment when a negative supply shock occurs. Which of the following will NOT occur? HINT: This question begs for you to draw the AD/AS model. Four of these choices must happen. One does not.

decrease in AD

If the economy was in a severe recession, the best expansionary fiscal policy would be to: HINT: Decreasing personal income taxes would increase incomes, consumption, & aggregate demand. Increasing government spending would have a complementary effect. Both decreasing taxes & increasing government spending would shift AD right, decreasing the recessionary gap.

decrease personal income taxes & increase government spending by equal amounts.

Which of the following explains why higher interest rates from a U.S. government budget deficit can decrease exports? HINT: Higher interest rates from a budget deficit attract capital flow into the U.S. These funds go to financial assets like bonds or savings with the higher rate of return. In order to purchase these financial assets, dollars must be purchased. The higher demand for the dollar will appreciate the dollar relative to other currencies. A stronger dollar makes exports less affordable as holders of other currencies must exchange more of their currency to buy dollars.

dollar-denominated financial assets become more attractive, increasing demand for the dollar, & the stronger dollar makes exports relatively less affordable

When banks make loans to each other, they charge the:

federal funds rate.

Which of the following is not included in M2?

gold

"Crowding out" occurs when:

government borrowing leads to higher interest rates which discourages private investment.

Crowding out occurs when: HINT: Government borrowing causes interest rates to rise & the higher interest rates cause a decrease in private investment. Therefore, government borrowing crowds out private borrowing.

government borrowing to finance its spending decreases private sector investment.

Under which of the following circumstances would expansionary fiscal policy be most effective? HINT: Expansionary policy is used to increase AD & to pursue the goal of full employment. It is most effective if unemployment is high & inflation is low.

high unemployment & low inflation

Under which of the following circumstances would expansionary fiscal policy be most effective? HINT: Expansionary policy is used to increase aggregate demand and to pursue the goal of full employment. It is most effective if unemployment is high and inflation is low.

high unemployment and low inflation

Suppose workers receive training or education that helps them develop skills that make them more productive than they were before. An economist would say there was an increase in what resource? HINT: Physical capital refers to factories, machines, tools & equipment that is used to produce goods. Natural resources refer to the raw materials coming from nature, such as water, minerals or trees. Infrastructure includes things like roads, ports, electrical grids & sewer systems - all of which are physical capital that are used by many in society rather than just by one firm.

human capital

As the price level decreases, the value of money:

increases, so people want to hold less of it.

According to the short-run Phillips Curve, there is a trade-off between

inflation and unemployment

Nominal interest rates are determined in the money market, and real interest rates in the:

loanable funds market.

When the quantity of money demanded is greater than the quantity of money supplied, people will most likely ________ bonds while the interest rate will ________.

sell; rise

Assume the economy is operating at full employment. If the economy enters a sudden economic expansion, the quantity of money available in the economy will:

stay the same.

The opportunity cost of holding money is equal to:

the interest rate.

Government Spending generally falls into two categories, spending on goods and services and:

transfer payments.

If Joe's disposable income increases from $600 to $650 & his level of personal- consumption increases from $480 to $520, you may conclude his MPC is

0.8

According to the "Rule of 70," if a country's real GDP per capita grows at a rate of 2% per year, it will take how many years for real GDP per capita to double?

35

If a country's real GDP per capita doubles in 10 years, what was its average annual rate of growth of real GDP per capita?

7%

If businesses are experiencing an unplanned increase in inventories, which of the following is most likely to be true?

AD is less than output, & the level of spending will decrease.

If businesses are experiencing an unplanned increase in inventories, which of the following is most likely to be true? HINT: When unplanned inventories increase, more goods are being produced but not consumed. This is a sign that consumption is falling & thus AD is less than current output for the price level. A new equilibrium will eventually be reached & the drop in spending will reduce real GDP.

AD is less than output, & the level of spending will decrease.

If a data point on the Short Run Phillips Curve moved from the lower right of the Phillips Curve to the upper left then: HINT: Movements along the Short Run Phillips Curve are always caused by shifting Aggregate Demand. The SRPC mirrors SRAS so as AD shifts right and the equilibrium point moves up to the right, then the data point on SRPC moves up to the left. We would see higher inflation and lower unemployment due to the increased Aggregate Demand.

Aggregate Demand Increased.

Which of the following would cause the long-run Phillips curve to shift to the right? HINT: The natural rate of unemployment is equal to structural and frictional unemployment. So, if one of the components of the natural rate of unemployment increases, the LRPC shifts to the right.

An increase in structural unemployment

What is true of the relationship between inflation & unemployment in the long run? HINT: In the long run there is no relationship or trade-off between inflation & unemployment. In the long run consensus inflation expectations will match actual inflation. & therefore, any inflation rate is consistent with the NRU.

Any level of inflation is consistent with the NRU.

What is the relationship between real interest rates and investment?

As real interest rates fall, investment spending rises.

In a mild recession, which of the following is the mostly likely monetary policy solution? HINT: Monetary policy always deals with changes in the money supply by the Fed. Taxing and government spending are disqualified because they are examples of fiscal policy. Each of the remaining choices is a tool of the Fed and each is actually correct. However, a well-informed student will know that the Fed rarefy charges the reserve requirement (it has been over 10 years since the last change). The discount rate does change but only infrequently. The FED usually responds first with Open Market Operations. By purchasing secondhand securities, they increase the supply of money in circulation making money easier to get driving down interest rates and stimulating consumption and investment.

Federal Reserve Purchase of secondary Securities.

Which of the following is NOT a drawback of fiscal policy? HINT: One of the best ways to use fiscal policy is to use it to enhance monetary policy. All of the other answer options are drawbacks of fiscal policy.

Fiscal policy can be used to enhance the effects of monetary policy.

Which of the following fiscal actions will have the best impact on correcting an economy in mild recession? HINT: When the government increases its spending, the full amount of the stimulus reaches the economy, whereas only part of a tax break might be spent because people may save the additional disposable income rather than save it. Increasing minimum wage would create more demand, but employers might decide to reduce workforce because of the increased cost of doing business which is not an effective approach to ending a recession. Reducing subsidies would not be beneficial to Aggregate Demand or Aggregate Supply and would reduce one or both.

Increase Government purchases of goods and services.

Which of the following fiscal policy actions would have the greatest positive potential impact on a recession? HINT: Providing a tax cut merely increases disposable income. It does not guarantee additional spending. The money could be saved.

Increase government expenditure with no additional tax revenues being raised.

If aggregate demand increases (thus decreasing unemployment) what happens to inflation in the short run, and how would this be illustrated on a short-run Phillips curve graph? HINT: Inflation and unemployment are inversely related in the short run because inflation expectations and input prices are unchanging. The short-run Phillips curve reflects this short-run phenomenon, when unemployment decreases inflation increases and is shown by moving up along an existing short-run Phillips curve.

Inflation increases, moving up along an existing short-run Phillips curve

If an economy is operating at an output level above full employment, what will eventually happen to inflation expectations and the short-run Phillips curve? HINT: When an economy is operating at an output level above full employment, actual inflation is higher than consensus inflationary expectations. People begin to expect higher inflation and build this expectation into their economic decisions. Workers ask for higher wages. These higher inflationary expectations are illustrated by shifting the short-run Phillips curve to the right.

Inflationary expectations will increase shifting the short-run Phillips curve to the right.

If government spending causes government budget deficits to add to the public debt & push up interest rates, how would an increase in government spending of $100 million affect output if the marginal propensity to consume equals 0.5? HINT: With no crowding out, AD would increase by $200 million. The multiplier is 2 or 1/MPS. Multiplied by the increase of government spending of $100 million, the increase in AD would be $200 million. If the higher interest rates from budget deficits decrease private investment spending, then the ultimate change in AD would be less than $200 million.

Investment may be crowded out, while AD & output would increase by less than $200 million.

If government spending causes government budget deficits to add to the public debt & push up interest rates, how would an increase in G of $100 million affect net exports?

Net Exports would fall because the higher interest rates make U.S. dollar assets more attractive to foreign savers & the value of the U.S. Dollar would rise.

Assume that wages and prices are fully flexible and all inflation is correctly anticipated. According to the quantity theory of money, what would be the impact of expansionary monetary policy on real output and the price level? HINT: According to the quantity theory of money, an increase in the money supply will have no impact on real variables in the long run when wages and prices are fully flexible, but will increase the price level. The quantity theory of money states that MV=PY and that the velocity of money (V) is constant. If prices are fully flexible and there is no unanticipated inflation, then real output (Y) is also constant, so any change in the money supply (M) will only have an impact on the price level (P).

No impact on real output, price level increases

If the government spends $1 billion on infrastructure improvements & the marginal propensity to consume is 0.75, which of the following is true?

Output may increase by as much as $4 billion.

A surplus of money in the money market will be eliminated how?

People buy bonds to reduce cash holdings, bidding up their price and pushing interest rates down.

In 2008 the Fed took the extraordinary step of buying distressed stock from troubled banks. This activity is most effectively termed: HINT: The Fed used quantitative easing to increase cash reserves of troubled (and non-troubled) banks to try to thaw the liquidity trap that created frozen credit. Banks did not want to lend to each other because they were unsure of the assets potential borrowing banks held. To erase that fear the Federal Reserve bought those troubled assets.

Quantitative Easing.

Assume the government implements a tax incentive to encourage individuals to increase savings for retirement. How would the real interest rate change and how would that affect the capital stock and aggregate supply in the long run? HINT: The increase in savings would shift the supply of loanable funds to the right and cause the real interest rate to fall, so the last two options should be eliminated. The real interest rate is the cost of borrowing, so when it decreases then investment spending increases and the capital stock subsequently increases. The impact of the lower real interest rates on the capital stock would eliminate the third and fourth options. An increase in capital stock would increase the productive capacity of an economy and shift LRAS to the right. The correct connection between capital stock and economic growth would rule out the first, third and last options.

Real interest rates would decrease, the capital stock would increase and the LRAS would shift to the right.

In order to finance an increase in government spending on national defense, the government borrows funds from the public. As a result of the increased government borrowing, what would happen to the real interest rate, private investment spending, and the rate of economic growth? HINT: Explanation: The increase in government borrowing would result in a higher real interest rate in the market for loanable funds, so the last two options should be eliminated. The real interest rate is the cost of borrowing, so when it increases then investment spending decreases. The inverse relationship between real interest rates and investment spending would eliminate the second option. A decrease in investment spending would lead to a less of an increase (or potentially a decrease) in capital stock that would decrease the rate of economic growth. The correct connection between investment spending, capital stock and economic growth would rule out the first option.

Real interest rates would increase, investment spending would decrease, and the rate of economic growth would decrease.

What is the opportunity cost of investing resources into new capital goods? HINT: There is an opportunity cost for using resources to produce new capital goods because those resources cannot be used to produce other things. New capital will increase the capital stock & increase the country's ability to produce goods & services in the future, but opportunity cost is what you give up to get something.

The goods that could have been produced with those resources & consumed today.

What is the primary cause of deflation according to monetarist theory? HINT: Monetarists theory concludes that the most important source of macroeconomic instability is inappropriate monetary policy. If real output decreases, the money supply should also decrease. However, decreasing the money supply more rapidly than real output decreases leads to deflation.

The money supply decreases faster than real output decreases.

According to monetarists, what is the primary cause of inflation? HINT: Monetarists claim that the most important source of macroeconomic instability is inappropriate monetary policy. If the money supply is increases more rapidly rate than output increases, inflation results because there is more money "chasing" fewer goods.

The money supply increases faster than real output is increases

According to the long-run Phillips curve, which of the following is true?

The natural rate of unemployment is independent of monetary and fiscal policy changes that affect aggregate demand.

Which of the following policies might the Fed adopt to counter a recession?

The purchase of bonds

Which of the following would be contractionary monetary policy?

The sale of bonds

Assume that the NRU in an economy is 5% & the current unemployment rate is 7% & the current inflation rate is 3%. If no policy actions are taken, what will happen to unemployment & inflation in the long run? HINT: In the long run the actual unemployment rate will equal the NRU. If the economy is in recession as this economy is at a 7% unemployment rate, with no policy actions taken, nominal wages & inflation expectations will decrease as workers accept lower wages in order to go back to work. This will move the economy to the NRU (5% for this economy) & a lower inflation rate with consistent with lower inflation expectation.

Unemployment will decrease to 5% & inflation will decrease.

In the short run, following a decrease in aggregate demand there will be: Hint: As aggregate demand decreases along a given short-run aggregate supply curve, both price level and output decrease. As output decreases unemployment increases. This change is shown along a short run Phillips curve by moving downward along the curve. This reflects a decrease in the rate of inflation and an increase in the rate of unemployment.

a movement downward along an existing Phillips curve.

An increase in short-run aggregate supply caused by declining key input prices would be consistent with which of the following? HINT: When short-run aggregate supply increases, the price level declines and employment increases, decreasing unemployment. A decrease in both inflation and unemployment would be shown on a Phillips curve graph by shifting the short-run Phillips curve to the left.

a shift of the short-run Phillips curve to the left

To counter the crowding-out effect on interest rates caused by the government's deficit spending, the Federal Reserve can

buy bonds through open market operations.

Suppose-a new fear of imminent bank failure pervaded the American economy due to a looming recession and negative economic data Also. suppose this caused large numbers of private citizens to withdraw funds from barks. The most likely Fed action would be to: HINT: The Fed would be concerned with getting the economy back on track. If people were withdrawing funds in large numbers, that would impact the interest rate in the loanable funds market. As the loanable funds supply shifted left, the interest rate would begin rising. Rising interest rates would not be good for the economic health of an economy heading toward recession so buying bonds would drive down short-term rates by increasing the Money Supply. Limiting foreign investment would merely make the supply of loanable funds issue worse and in a banking crisis the Fed would not want to increase fear by doing away with the FDIC

buy bonds.

Narnia is experiencing high inflation rates. What fiscal policy would be appropriate to address the inflationary gap? HINT: Fiscal policy involves government spending & taxing, not interest rates or the money supply. In order to address the expansionary gap with high inflation, we would conduct actions to decrease AD by decreasing government purchases & increasing taxes to decrease incomes & spending.

decrease government purchases & increase taxes

If the economy was in a severe recession, the most expansionary fiscal policy would be to: HINT: Decreasing personal income taxes would increase incomes, consumption, and aggregate demand. Increasing government spending would have a complementary effect. Both decreasing taxes and increasing government spending would shift aggregate demand right, decreasing the recessionary gap.

decrease personal income taxes and increase government spending by equal amounts.

When government budget deficits lead to higher public debt, interest rates may rise. A rise in interest rates may lead to which of the following? HINT: Private investment is inversely related to interest rates. If government borrowing leads to higher interest rates, fewer private investment projects will be financially viable & reduced private investment projects will occur.

decreased private investment, known as "crowding out"

Narnia is in short-run equilibrium with output below full employment. Which of the following would be an appropriate fiscal policy to increase output & decrease unemployment? HINT: Fiscal policy involves government spending & taxing, not interest rates or the money supply. In order to address the recessionary gap with high unemployment, we would conduct actions to increase AD by increasing government spending & increasing incomes by decreasing taxes.

increase government purchases & decrease taxes

Econoland is in short-run equilibrium with output below full employment. Which of the following would be an appropriate fiscal policy to increase output and decrease unemployment? HINT: Fiscal policy involves government spending and taxing, not interest rates or the money supply. In order to address the recessionary gap with high unemployment, we would conduct actions to increase aggregate demand by increasing government spending and increasing incomes by decreasing taxes.

increase government purchases and decrease taxes

The purchase of securities on the open market by the FED will:

increase the supply of money.

If a worker's nominal wage rate increases from $10 to $12 per hour & at the same time the general price level increases by 10 percent, the worker's real wage has approximately:

increased by 10%

If nominal wages increase from $10 to $12 per hour and at the same time the general price level increases by 10%, the worker's real wage has:

increased by 10%.

When the Federal Reserve buys bonds, which of the following happens to interest rates and bond prices? HINT: When the Fed buys bonds, this increases demand for existing bonds in the bond market. It is easy to see that by increasing demand for bonds, the price of bonds is pushed up. What harder to see is that with a higher price of bonds the interest yield as a portion of the price of the bonds is now lower. Remember bond prices and the interest rate are inversely related.

interest rates decrease; bond prices increase

If the demand for money increases in the money market, what will happen to the nominal interest rate, the quantity of money and the price of bonds?

nominal interest rate increases, quantity of money remains the same and the price of bonds decreases

Suppose the economy had the following statistics. The most likely monetary response to this situation would be to: -3% unemployment -Real GDP growth of 4.5% -5% inflation HINT: If the economy is overheated as it is with 5% inflation they would want to gradually slow the economy because the FED goal for inflation is 2%. The FED has various tools it can use to slow the economy and the tool of choice the FED uses most often is Open Market Operations. Whenever the FED uses Open Market Operations it can manipulate the money supply by selling previously purchased bonds (government securities) it holds. When the FED sells those bonds to individuals, businesses, or institutional investors it is paid with cash. The cash then is removed from circulation as it goes into the vaults at the conclusion of the sale. Fewer dollars in circulation means a decrease in the Money Supply and this drives up interest rates. Higher interest rates decrease the desire to borrow by Consumers and businesses (Investment) and this will slow down the Aggregate Demand and reduce pressure on scarce resources causing lower prices which address the inflation issue.

sell bonds on the open market

The money supply curve is vertical no matter what the interest rate is because:

the Federal Reserve controls the supply of money.

One drawback of using fiscal policy to close a recessionary gap is that

the equilibrium price level will rise.

The interaction between institutions through which money is supplied to individuals, firms, and other institutions is referred to by economists as:

the money market.

In an economy at full employment, a presidential candidate proposes cutting the government debt in half in four years by increasing income tax rates and reducing government expenditures. According to Keynesian theory, implementation of these policies is most likely to increase: HINT: Both increasing tax rates and reducing government expenditures are restrictive fiscal policy actions. Both would shift aggregate demand left, decreasing output and increasing unemployment.

unemployment

If aggregate demand decreases (thus decreasing inflation in the short run) what happens to unemployment, and how would this be illustrated on a short-run Phillips curve graph? HINT: Inflation and unemployment are inversely related in the short run because inflation expectations and input prices are unchanging. The short-run Phillips curve reflects this short-run phenomenon when inflation decreases unemployment increases and is shown by moving down along an existing short-run Phillips curve.

unemployment increases, moving down along an existing short-run Phillips curve

In an economy at full employment, a presidential candidate proposes cutting the government debt in half in four years by increasing income tax rates & reducing government expenditures. According to Keynesian theory, implementation of these policies is most likely to increase: HINT: Both increasing tax rates & reducing government expenditures are restrictive fiscal policy actions. Both would shift AD left, decreasing output & increasing unemployment.

unemployment.