Macro Ch 21
In a Recession: -output declines, incomes fall, people pay less taxes, government tax revenue decreases -unemployment increases, welfare expenditures increase In a Boom: -output increases, incomes rise, people pay more taxes, government tax revenue increases -unemployment decreases, welfare expenditure decreases
Automatic Fiscal Policy
Changes in fiscal policy that do not require deliberate action on the part of policymakers
Automatic stabilizers
Keynes's theory that the interest rate is determined from supply and demand for money in the short run
Theory of liquidity preference
True or False: Because of the multiplier effect, an increase in government spending of $40 billion will shift the aggregate-demand curve to the right by more than $40 billion (assuming there is no crowding out).
True
True or False: Crowding out occurs when an increase in government spending increase incomes, shifts money demand to the right, raises the interest rate, and reduces private investment
True
True or False: In the short run, a decision by the Fed to increase the money supply is essentially the same as a decision to decrease the interest rate target
True
True or False: Keynes's theory of liquidity preference suggests that the interest rate is determined by the supply and demand for money
True
True or False: Many economists prefer automatic stabilizers because they affect the economy with a shorter lag than activist stabilization policies.
True
True or False: The interest-rate effect suggests that aggregate demand slopes downward because an increase in the price level shifts money demand to the right, increases the interest rate, and reduces investment
True
True or False: Unemployment benefits are an example of an automatic stabilizer because when incomes fall, unemployment benefits rise
True
True or False: When money demand is drawn on 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
True
The long-run effect of an increase in the money supply is to a) increase the price level b) decrease the price level c) increase the interest rate d) decrease the interest rate
a) increase the price level
An increase in the marginal propensity to consume (MPC) a) raises the value of the multiplier b) lowers the value of the multiplier c) has no impact on the value of the multiplier d) rarely occurs because the MPC is set by congressional legislation
a) raises the value of the multiplier
In the market for real output, the initial effect of an increase in the money supply is to a) shift aggregate demand to the right b) shift aggregate demand to the left c) shift aggregate supply to the right d) shift aggregate supply to the left
a) shift aggregate demand to the right
When the supply and demand for money and 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 a) shifts money demand to the right and increases the interest rate b) shifts money demand to the left and increases the interest rate c) shifts money demand to the right and decreases the interest rate d) shifts money demand to the left and decreases the interest rate e) does none of the above
a) shifts money demand to the right and increases the interest rate
When an increase in government purchases increases the income of some people, and those people people spend some of that increase in income on additional consumer goods, we have seen a demonstration of a) the multiplier effect b) the investment accelerator c) the crowding-out effect d) supply-side economics e) none of the above
a) the multiplier effect
The dampening of shift in aggregate demand from expansionary fiscal policy, which raises the interest rate and reduces investment spending
Crowding-out effect
•Effect on Investment and Net Exports: -yields higher interest rates, discouraged investment, and reduces Net Exports •Effect on National Debt: -causes budget deficit to grow, national debt grows, creates burden on future generations •Effect on Inflation: -no effect •During Recession: -⬆️ government spending, ⬇️ taxes
Expansionary Fiscal Policy
-does not cause budget deficit to grow & has no effect on national debt -causes inflation (long run) if unchecked During Recession: -sets a new lower target for federal funds rate -money supply increases
Expansionary Monetary Policy
True or False: An increase in the interest rate increases the quantity demanded of money because it increases the rate of return of money
False; an increase in the interest rate decreases the quantity demanded of money because it raises the opportunity cost of holding money
True or False: In the short run, the interest rate is determined by the loanable-funds market, while in the long run, the interest rate is determined by money demand and money supply
False; in the short run, the interest rate is determined by money demand and money supply, while in the long run, it is determined by the loanable funds market
True or False: An increase in the money supply shifts the money supply curve to the right, increases the interest rate, decreases investment, and shifts the aggregate-demand curve to the left
False; increase in the money supply decreases the interest rate, increases investment, and shifts aggregate demand to the right
True or False: Suppose investors and consumers become pessimistic about the future and cut back on expenditures. If fiscal policymakers engage in activist stabilization policy, the policy response should be to decrease government spending and increase taxes.
False; policymakers should increase government spending and decreases taxes
True or False: Suppose investors and consumers become pessimistic about the future and cut back on expenditures. If the Fed engages in activist stabilization policy, the policy response should be to decrease the money supply.
False; the Fed should increase the money supply
True or False: Suppose the government increases its expenditure by $10 billion. If the crowding-out effect exceeds the multiplier effect, then the aggregate-demand curve shifts to the right by more than $10 billion.
False; the aggregate-demand curve shifts to the right by less than $10 billion
True or False: If the MPC (marginal prosperity to consume) is 0.80, then the value of the multiplied is 8.
False; the value of the multiplier is 5 Formula: 1 / (1 - MPC) 1/(1-0.8) = 5
The interest rate banks charge one another for short-term loans
Federal funds rate
•Must be legislated by Congress and signed by the President •Takes time •Effectiveness: -enhanced by the expenditure multiplier effect -dampened by many crowding out effect
Fiscal Policy
The setting of the level of government spending and taxation by government policymakers
Fiscal policy
The amplification of the shift in aggregate demand from expansionary fiscal policy, which raises investment expenditures
Investment accelerator
The ease with which an asset is converted into a medium of exchange
Liquidity
The fraction of extra income that a household spends on consumption
Marginal propensity to consume, or MPC
•Decided and implemented by Open Market Committee •can be done quickly and easily •Effectiveness: -enhanced by the money multiplier effect & expenditure multiplier effect -not dampened by any sort of crowding out effect •Effect on Investment and Net Exports: Yields lower interest rates, promotes investment & increases net exports -Preferred policy
Monetary Policy
The amplification of the shift in aggregate demand from expansionary fiscal policy, which raises incomes and further increases consumption expenditures Formula: EM = 1/(1-MPC)
Multiplier effect
The use of fiscal and monetary policies to reduce fluctuations in the economy
Stabilization policy
If the marginal propensity to consume (MPC) is 0.75, the value of the multiplier is a) 0.75 b) 4 c) 5 d) 7.5 e) none of the above
b) 4 Formula: 1/(1-MPC) 1/(1-0.75) = 4
Which of the following statements regarding regarding taxes is correct? a) Most economics believe that, in the short run, the greatest impact of a change in taxes is on aggregate supply, not aggregate demand b) A permanent change in taxes has a greater effect on aggregate demand than a temporary changes in taxes c) An increases in taxes shifts the aggregate-demand curve to the right d) A decrease in taxes shifts the aggregate-supply curve to the left
b) A permanent change in taxes has a greater effect on aggregate demand than a temporary changes in taxes
Which of the following best describes how an increase in the money supply shifts aggregate demand? a) The money supply shifts right, the interest rate rises, investment decrease, and aggregate demand shifts left b) The money supply shifts right, the interest rate falls, investment increases, and aggregate demand shifts right c) The money supply shifts right, prices rise, spending falls, and aggregate demand shifts left d) The money supply shifts right, prices fall, spending increases, and aggregate demand shifts right
b) The money supply shifts right, the interest rate falls, investment increases, and aggregate demand shifts right
When an increase in government purchases causes firms to purchase additional plant and equipment, we have seen a demonstration of a) the multiplier effect b) the investment accelerator c) the crowding-out effect d) supply-side economics e) none of the above
b) the investment accelerator
Keynes's liquidity preferences theory of the interest rate suggests that the interest rate is determined by a) the supply and demand for loanable funds b) the supply and demand for money c) the supply and demand for labor d) aggregate supply and aggregate demand
b) the supply and demand for money
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 a) increases the quantity demanded of money b) increases the demand for money c) decreases the quantity demanded of money d) decreases the demand for money e) does none of the above
c) decreases the quantity demanded of money
The initial impact of an increase in government spending is to shift a) aggregate supply to the right b) aggregate supply to the left c) aggregate demand to the right d) aggregate demand to the left
c) aggregate demand to the right
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 a) increase government spending and decrease taxes b) decrease government spending and increase taxes c) increase the money supply and decrease interest rates d) decrease the money supply and increase interest rates
c) increase the money supply and decrease interest rates
Suppose the government increases its purchases $16 billion. If the multiplier effect exceeds the crowing-out effect, then a) the aggregate-supply curve shifts to the right by more than $16 billion b) the aggregate-supply shifts to the left by more than $16 billion c) the aggregate-demand curve shifts to the right right by more than $16 billion d) the aggregate-demand curve shifts to the left by more than $16 billion
c) the aggregate-demand curve shifts to the right right by more than $16 billion
When an increase in government purchases raises incomes, shift money demand to the right, raises the interest rate, and lowers investment, we have seen a a) the multiplier effect b) the investment accelerate c) the crowding-out effect d)supply-side economics e) the liquidity trap
c) the crowding-out effect
Which of the following is an automatic stabilizer? a) military spending b) spending on public schools c) unemployment benefits d) spending on the space shuttle e) All of the above are automatic stabilizers
c) unemployment benefits
Which of the following statements about stabilization policy is true? a) In the short run, a decision by the Fed to increase the targeted money supply is essentially the same as a decision to increase the targeted interest rate b) Congress has veto power over the monetary policy decisions of the Fed c) Long lags enhance the ability of policymakers to "fine-tune" the economy d) Many economists prefer automatic stabilizers because they affect the economy with a shorter lag than activist stabilization policy e) All of the Above are true
d) Many economists prefer automatic stabilizers because they affect the economy with a shorter lag than activist stabilization policy
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 chooses to engage in activist stabilization policy, they should a) decrease taxes, which shifts aggregate demand to the right b) decrease taxes, which shifts aggregate demand to the left c) decrease government spending, which shifts aggregate demand to the right d) decrease government spending, which shifts aggregate demand to the left
d) decrease government spending, which shifts aggregate demand to the left
The initial effect of an increase in the money supply is to a) increase the price level b) decrease the price level c) increase the interest rate d) decrease the interest rate
d) decrease the interest rate
For the United States, most important sources of the downward slope of the aggregate-demand curve is a) the exchange-rate effect b) the wealth effect c) the fiscal effect d) the interest-rate effect e) none of the above
d) the interest-rate effect
