Macro Exam 3 review

1. A bank has checkable deposits of $1,000,000, loans of $600,000, and government securities of $400,000. If the required reserve ratio is 5 percent, the amount of required reserves is $20,000. $30,000. $30,000. $50,000. $1,00,000.

$50,000. Required reserves = 5 percent of checkable deposits = (5/100) x 1,000,000 = $50,000

13. The Fed buys $50,000 of government securities. The required reserve ratio is 10 percent. What will be the change in the quantity of money, assuming banks are fully lent up and that there are no cash leaks? $50,000 $0 $500,000 $5,000,000 $5,000

$500,000 Change in the money supply = + value of bonds bought by the Fed OR - value of bonds sold by the Fed x The money multiplier The money multiplier (when banks are fully lent up and there are no cash leaks) = 1 / RRR, the RRR expressed in decimals, so that 10% = 0.01. Therefore, the change in the money supply in this case = +$50,000 x 1/0.1= +$50,000 x 10 = +$500,000. In other words, the resulting change in the money supply is +$500,000, i.e., the money supply increases by $500,000 (a positive change is an increase).

3. An economy has no imports or income taxes. The MPC is 0.75 and real GDP is $120 billion. Businesses increase investment by $4 billion. The expenditure multiplier is ________ and the change in AD from the increase in investment is ________ billion.Answer 4; $16 4; $25 5; $16 5; $25 0.75; $3

4; $16 The expenditure multiplier = investment spending multiplier = 1/(1-MPC) = 1/(1-0.75) = 1/0.25 = 4 Change in AD = change in investment spending x investment spending multiplier= +S4 billion x [1/(1MPC)] = +$4 billion x [1/(1-0.75)] = +$4 billion x 1/0.25 = +$4 billion x 4 = +$16 billion

9. In December 2009, currency was $400 billion, traveler's checks were $5 billion; checkable deposits owned by individuals and businesses were $600 billion, saving deposits were $2,00 billion, time deposits were $1,500 billion; and money market funds were $1,200 billion. What was the M1 in December 2009? M1 = $3,005 billion M1 = $405 billion M1 = $3500 billion M1 = $3505 billion M1 = $1,005 billion

M1 = $1,005 billion M1 = currency with the public + checkable deposits + traveler's checks with the public = $(400 + 600 + 5) billion = $1,005 billion.

18. The magnitude of the tax multiplier is smaller than the magnitude of the government expenditure multiplier because an increase in taxes decreases expenditures. a change in taxes creates additional induced taxes. a change in taxes does not change expenditures by as much as the same size change in government. a change in taxes does not change expenditures.a decrease in government expenditure decreases tax revenue.

a change in taxes does not change expenditures by as much as the same size change in government The value of the govt. spending multiplier is 1/(1-MPC) whereas the absolute value of the tax multiplier is MPC/(1-MPC). Since MPC < 1, the absolute value of the tax multiplier is smaller than the value of the govt. spending multiplier (both multipliers have the same denominator but one has the smaller numerator, making it the smaller multiplier).

8. If the economy is in equilibrium with real GDP less than potential GDP, there is ________ gap and a fiscal policy that ________ is appropriate. a recessionary; increases potential GDP an inflationary; increases aggregate demand an inflationary; decreases aggregate demand a recessionary; decreases aggregate demand a recessionary; increases aggregate demand

a recessionary; increases aggregate demand If equilibrium real GDP (determined by the intersection of the AD and AS curves) is less than potential GDP (full employment real GDP), there is a 'recessionary gap'. In order to narrow this gap, the govt. would follow expansionary fiscal policy (raise spending and cut taxes) in order to shift the AD curve rightwards.

21. The short-run Phillips curve shows the expected inflation rate. potential GDP. the natural unemployment rate. a tradeoff between real GDP and unemployment. a tradeoff between the unemployment rate and the inflation rate.

a tradeoff between the unemployment rate and the inflation rate. Along a short-run Phillips curve, a lowering of the unemployment rate (a movement leftward along the horizontal axis) results in a rise in the rate of inflation (movement upward along the vertical axis). A lowering of the unemployment rate is accomplished by means of a rightward shift of the AD curve. Such a shift causes the equilibrium price level to increase, i.e., causes inflation.

6. By using open market operations, the Federal Reserve adjusts the supply and demand of reserves to keep the federal funds interest rate equal to its target. adjusts the supply of reserves to keep the federal funds interest rate equal to its target. adjusts the demand of reserves to keep bank rates in line with the federal funds rate target. controls banks' demand for reserves, thereby keeping the federal funds rate equal to its target. None of the above answers is correct.

adjusts the supply of reserves to keep the federal funds interest rate equal to its target When the Fed buys securities (e.g., bonds) from banks, banks' reserves increase. With more reserves to lend, banks increase their supply of funds in the federal funds market (the market for inter-bank loans). This causes the interest rate in this market, called the 'federal funds rate', to decrease. More to the point, more bank lending causes the real interest to decrease, which stimulates C, I, and X-M.

16. The expenditure multiplier is larger than one because an increase in autonomous expenditure brings about a reduction in the real interest rate. an increase in autonomous expenditure induces further decreases in aggregate expenditure. additional expenditure induces lower incomes. the price level rises, thereby reinforcing the initial effect. an increase in autonomous expenditure, such as govt. spending, induces further increases in aggregate

an increase in autonomous expenditure, such as govt. spending, induces further increases in aggregate As discussed in Q. 5 above, a dollar increase in govt. spending on highway construction will, first, end up in the pockets of the construction workers, who will then spend part of this increase in their income on bread from the baker. The baker, in turn, will spend part of the consequent increase in his income on meat from the butcher, the butcher, in turn, will spend part of the consequent increase in his income on something else, etc. In sum, a dollar increase in autonomous expenditure 'induces' a change in consumption spending.

2. All of the following shift the aggregate demand curve to the right EXCEPT Answer an increase in foreign income. an increase in expected future profit. an increase in government expenditure. an expansion of the global economy. an increase in taxes.

an increase in taxes. An increase in taxes will leave consumers with less disposable income to spend. So, consumer spending shall decrease, causing a decrease in AD (leftward shift of the AD curve).

23. The supply-side effects of a change in taxes on labor income means that ________ in taxes on labor income shift the ________. an increase; labor supply curve leftward an increase; labor supply curve leftward and the labor demand curve rightward an increase; labor supply curve rightward a decrease; labor demand curve leftward a decrease; labor demand curve rightward

an increase; labor supply curve leftward According to the 'supply-side economics' favored by the Republicans, a rise in taxes shall reduce workers' incentives to supply their labor (why work long hours if the govt. is going to take away a larger proportion of one's hourly earnings?). A decrease in the supply of labor shall cause a decrease in aggregate supply (leftward shift of the AS curve).

17. The crowding out effect refers to the ________ from ________ in the government's budget deficit. decrease in employment; an increase increase in investment; an increase decrease in consumption; an increase decrease in investment; an increase increase in consumption; an increase

decrease in investment; an increase When the govt. increases its spending without increasing taxes, its budget deficit increases and it must borrow. Govt. borrowing in the market for loanable funds causes the real interest to rise. This rise in interest causes investment spending (consumption spending and net exports as well) to decrease.

12. Suppose the economy is in an equilibrium in which real GDP is less than potential GDP. To increase real GDP, the government can use a fiscal stimulus of decreasing government expenditure and simultaneously increasing taxes. decreasing government expenditure only. increasing the quantity of money.increasing taxes only. decreasing taxes and/or increasing government expenditure.

decreasing taxes and/or increasing government expenditure. See Q. 8 above.

19. The monetary policy instrument the Federal Reserve choose to use is the monetary base federal funds rate. exchange rate. required reserves rate. quantity of money.

federal funds rate. The Federal Reserve Bank aims for a certain federal funds rate (the rate of interest in the inter-bank market for loans). If the economy is in recession, the Fed will aim to lower the federal funds rate by engaging in an open market purchase of bonds from banks. Such an open market operation will cause banks' reserves to swell and, so, encourage bank lending, with the result that the real interest rate shall fall, causing C, I, and X - M to increase.

24. When the government's expenditures exceed its tax revenue, the budget has a deficit and the national debt is decreasing. has a surplus and the national debt is increasing. is balanced and the national debt is increasing. has a deficit and the national debt is increasing. None of the above because by law the government's expenditures cannot exceed its tax revenue.

has a deficit and the national debt is increasing. When the govt. spends more than it collects in taxes, it runs a budget deficit and must borrow, thereby increasing the national or public debt.

25. Which of the following is a tool the Federal Reserve System can use to regulate the quantity of money? i and ii i only ii only ii and iii i, ii, and iii

i, ii, and iii The Fed's tools of monetary policy include open market operations (the buying and selling of bonds), changing the RRR, and changing the discount rate. If it wishes to increase the money supply (called for in a recession), the Fed will purchase bonds from banks and the public, lower the RRR, and lower the discount rate.

7. Changes in which of the following shifts the aggregate supply curve?i. the price level.ii. the money wage rate.iii. potential GDP. i onlyi , ii, and iii iii only ii and iii ii only

ii and iii If the money wage (or nominal wage) rose, for any given price level the real wage would rise (the real wage = nominal wage / price level). As rise in the real wage would cause firms to hire fewer workers. Consequently, the supply of real GDP would decrease (a leftward shift of the AS curve). Similarly, a change in the level of potential GDP (full employment real GDP) too would cause the AS curve to shift. Recall that potential GDP 'anchors' the AS curve.

4. Banks create money by minting coins. printing paper money. buying government securities. making loans. None of the above because banks cannot create money, only the Federal Reserve can create money.

making loans Banks create money by making loans. When a bank makes a loan, the lent money is spent by the borrower and, so, ends up in someone else's (e.g., a store's) bank account, thereby causing the sum total of the nation's checkable deposits to grow. Since checkable deposits are a part of the money supply (M1), the money supply, as a result, increases.

10. In order to reduce inflationary pressure on the economy, what fiscal policy can the government use? cut taxes increase the quantity of money increase government expenditure on goods and services cut interest rates raise taxes

raise taxes In order to reduce inflationary pressures, the govt. would attempt to shift the AD curve leftwards (or at least slow down the rapid rightward shift of this curve). Hence, it would follow contractionary fiscal policy (cut spending and raise taxes). The raising of taxes would serve to curb consumer spending.

11. Moving along the AS curve, when the price level increases the nominal wage rate falls and there is an increase in the quantity of real GDP supplied. real wage rate falls and there is an increase in the quantity of real GDP supplied. real wage rate rises and there is a decrease in the quantity of real GDP supplied. nominal wage rate rises and there is a decrease in the quantity of real GDP supplied. real wage rate rises and there is an increase in the quantity of real GDP supplied.

real wage rate falls and there is an increase in the quantity of real GDP supplied In the short-run, nominal wages are fixed because of wage contracts between firms and workers. With nominal wages fixed, a rise in the price level would cause real wages to fall (real wage = nominal wage/price level). A fall in real wages would cause firms to higher more workers (since workers are cheaper in real terms). The hiring of more workers would cause firms' quantity supplied of real GDP to increase.

5. Because of the existence of the aggregate demand multiplier, a $10 billion change in expenditure changes the slope of the aggregate demand curve so it is less steep. shifts the aggregate demand curve by $10 billion. shifts the aggregate demand curve by more than $10 billion. changes the slope of the aggregate demand curve so it is steeper. shifts the aggregate demand curve by less than $10 billion.

shifts the aggregate demand curve by more than $10 billion. A $10 billion change in expenditure causes AD to change by more than $10 billion because of the expenditure multiplier. For example, a dollar increase in govt. spending on highway construction will, first, end up in the pockets of the construction workers, who will then spend part of this increase in their income on bread from the baker. The baker, in turn, will spend part of the consequent increase in his income on meat from the butcher, the butcher, in turn, will spend part of the consequent increase in his income on something else, etc. The end result is a multiplied increase in aggregate demand.

22. The steps in the transmission of monetary policy are Congress increases the money supply, which lowers the interest rate, and leads to an increase in aggregate demand. Congress increases government expenditures on goods and services, leading to an increase in aggregate demand. the Federal Reserve increases government expenditures on goods and services, leading to an increase in aggregate demand. Congress increases the budget deficit, which increases the money supply, which increases aggregate supply. the Federal Reserve lowers the federal funds rate, which lowers the real interest rate, and leads to an

the Federal Reserve lowers the federal funds rate, which lowers the real interest rate, and leads to an As discussed in Q. 19 above, if the economy is in recession, the Fed will aim to lower the federal funds rate by engaging in an open market purchase of bonds from banks. Such an open market operation will cause banks' reserves to swell and, so, encourage bank lending, with the result that the real interest rate shall fall, causing C, I, and X - M to increase.

20. The national debt is government outlays minus tax revenue. the amount lent by the government of past budget surpluses. the amount borrowed by the government to finance past budget deficits. tax revenue minus government outlays. the excess of this year's budget surplus minus this year's budget deficit

the amount borrowed by the government to finance past budget deficits. The national or public debt is the total sum owed by the govt. In other words, it is the sum of all of the govt.'s past borrowing, and the govt. borrows only when it runs a budget deficit.

14. The aggregate demand curve illustrates the relationship between the price level and the quantity of goods demanded by households, firms, government, and foreigners. the price level and the potential demand for real GDP. the real wage rate and the hours of labor demanded by firms. the price level and the potential quantity demanded of real GDP. the price level and the quantity of goods supplied by firms.

the price level and the quantity of goods demanded by households, firms, government, and foreigners. The AD curve describes the negative relationship between the price level and the quantity demanded of real GDP. The parties who demand real GDP are: households, the govt., firms, and the rest of the world.

15. The aggregate supply curve shows the relationship between potential GDP and the price level. potential GDP and real GDP. potential GDP and the aggregate demand curve. the quantity of real GDP supplied and the price level. the quantity of real GDP supplied and the interest rate.

the quantity of real GDP supplied and the price level. The AS curve describes the positive relationship between the price level and the quantity supplied of real GDP by firms.