Economics Section III Pt. 2

C The short-run aggregate supply curve, which slopes upward, can shift for several reasons, including changes in price level and supply shocks. In the long run, potential output can also increase because of technological developments.

29. Over time, a country's output will likely a. increase due to political improvements b. increase due to increased human capital c. increase due to technological developments d. decrease due to aggregate supply shocks e. decrease due to fluctuating price levels

A Actual output exceeding potential output results in inflationary pressures. In response, a government could reduce the money supply, which would raise interest rates and thus discourage investment and consumer spending.

3. If actual output exceeds potential output, a government could a. reduce the money supply to raise interest rates b. reduce the money supply to maintain interest rates c. increase the money supply to lower interest rates d. reduce the money supply to lower interest rates e. increase the money supply to raise interest rates

B In the AD-AS model, the short-run aggregate supply curve slopes upward while the long-run supply curve is vertical.

31. In the AD-AS model, the short-run aggregate supply curve a. is vertical b. slopes upward c. is horizontal d. slopes downward e. is kinked

A A number of factors affect long-run potential output, including the rate of technological advancements. However, in the short run, the output gap—the difference between potential and actual output—causes short-run fluctuations.

34. Which of the following factors causes MOST short run fluctuations in an economy? a. the output gap b. the inflation rate c. aggregate supply d. aggregate demand e. real GDP

C The interaction between the supply of and demand for money determines money's value in the long run. The transactions consumers participate in primarily controls this demand for money.

44. What is the primary factor influencing demand for money? a. the financial investments businesses want to make b. the interest rate charged by banks on loans c. the transactions consumers in which participate d. the economy's overall inflation rate e. the proportion of income households decide to save

E Arthur Okun, who introduced Okun's law, was a leading economist in President Kennedy's administration. Okun's law describes the relationship between an economy's unemployment and its output gap

10. Arthur Okun was an economic advisor for a. President Nixon b. President Eisenhower c. President Johnson d. President Ford e. President Kennedy

D Nominal quantities are measured in monetary units, while real quantities are measured in physical units. An example is the difference between nominal GDP and real GDP.

11. Nominal quantities differ from real quantities in that one a. factors in social benefit while the other does not b. accounts for inflation while the other does not c. is more useful in macroeconomics than the other d. measures using monetary units instead of physical units e. factors in opportunity costs while the other does not

D The discount rate and federal funds rate are closely related; the difference is that banks charge the federal funds rate when they lend to other banks, while the Federal Reserve charges the discount rate when it loans to banks. A higher discount rate or federal funds rate decreases the money supply.

1. What is the PRIMARY difference between the discount rate and the federal funds rate? a. The discount rate applies to loans with maturities of under one year, while the federal funds rate applies to loans with maturities of a year or longer. b. The federal funds rate applies to loans with maturities of under one year, while the discount rate applies to loans with maturities of a year or longer. c. The federal funds rate is the rate the Federal Reserve charges banks, while the discount rate is the rate banks charge when they lend to other banks. d. The discount rate is the rate the Federal Reserve charges banks, while the federal funds rate is the rate banks charge when they lend to other banks. e. The federal funds rate is the rate the Federal Reserve charges on M1, while the discount rate is the rate the Federal Reserve charges on M2.

A While the free market will drift back toward its long-run potential if a recession occurs, the government might use fiscal or monetary policy to quicken that process. The time it takes the free market to correct itself is valuable.

12. Why might a government use fiscal or monetary policy during a recession? a. The market's natural adjustment back to equilibrium may take a long time. b. The free market will never return to the previous long-run output. c. The free market's natural response could lower the price level and increase unemployment. d. Hyperinflation may occur in the absence of government intervention. e. It wants to minimize frictional and structural unemployment.

B The reserve ratio, a number set by the Federal Reserve that indicates the percentage of excess reserves banks must hold as cash, is the reciprocal of the money multiplier, the amount of money the banking sector can create from $1 in reserves. With a reserve ratio of 20%, the money multiplier is therefore 5, and so the banking sector can create $25,000 from $5,000 in reserves.

13. How much money can the banking sector create from $5,000 in reserves, given a reserve ratio of 20%? a. $100,000 b. $25,000 c. $1,000 d. $250 e. $1,000,000

B The long-run neutrality of money means that changes in price level do not affect real quantities. However, inflation is still costly because it taxes those who hold money, increases firms' costs, and distorts prices and the future value of goods and services.

14. Which of the following statements does NOT correctly identify a major economic cost of inflation? a. Inflation distorts prices, making them less valuable in coordinating economic decisions. b. Inflation makes it more difficult for consumers to spend. c. Inflation increases costs for firms, who have to frequently adjust their prices. d. Inflation makes gauging the future value of goods and services more uncertain. e. Inflation effectively taxes those who hold money.

C Because Canada's unemployment is equal to its natural rate, resources are fully employed and there is no output gap. As a result, short-run aggregate supply is equal to its long-run potential output.

15. The unemployment rate in Canada is equal to its natural rate. Therefore, short-run aggregate supply is equal to a. aggregate demand b. its minimum c. long-run potential output d. its output gap e. its maximum

D A lower price level increases the supply of savings, thereby lowering the interest rate. A lower interest rate encourages consumption and investment by making loaning money less expensive.

16. According to the interest rate effects, increasing the supply of savings can also increase a. government spending and consumption b. consumption and net exports c. net exports and government spending d. consumption and investment e. investment and net exports

C While the Federal Reserve can control the money supply through monetary policy—including by changing the reserve ratio and by engaging in open market operations—supply and demand control the value of money in the long run

17. What controls the value of money in the long run? a. the financial sector b. the Department of the Treasury c. supply and demand d. the Federal Reserve e. real GDP growth

E The Federal Reserve lowering the discount rate will increase the money supply. However, the long-run neutrality of money means that this expanded money supply will not affect real quantities in the economy.

18. According to the long-run neutrality of money, the Federal Reserve's lowering of the discount rate will a. decrease the money supply b. increase real quantities in the economy c. decrease real quantities in the economy d. increase the long-run value of money e. not affect real quantities in the economy

C Economists split money into two primary categories: fiat money and commodity money. Fiat money is different from commodity money in that it has no intrinsic value; an example of fiat money is a U.S. dollar bill, as the paper itself is not worth anything.

19. Fiat money is different from commodity money in that it a. is primarily digital b. has a higher liquidity c. has no intrinsic value d. is a unit of account e. is issued by the government

A In economics, money is an asset that serves as a unit of account, medium of exchange, and store of value—meaning that one can use money to transfer purchasing power to the future. In this case, because Jorge stores the purchasing power he receives for his birthday through money, money acts as a store of value

2. Jorge receives money for his birthday but plans to save it for his trip to Europe in three years. This scenario BEST exemplifies money's function as a a. store of value b. transaction facilitator c. unit of account d. economic asset e. medium of exchange

A The Federal Open Market Committee, which controls the United States economy's money supply, includes twelve members, one of whom is always the president of the New York Federal Reserve.

20. Which of the following people is always part of the Federal Open Market Committee? a. the president of the New York Federal Reserve b. the president of the Chicago Federal Reserve c. the president of the Atlanta Federal Reserve d. the president of the Washington D.C. Federal Reserve e. the president of the St. Louis Federal Reserve

A To combat a recession using a combination of fiscal and monetary policy, a government could cut taxes to increase consumers' disposable income and reduce the reserve requirement to encourage banks to make more loans.

21. What combination of fiscal and monetary policy might a government take to combat a recession? a. cutting taxes and reducing the reserve requirement b. raising the discount rate and lowering taxes c. reducing the reserve requirement and buying bonds d. increasing government spending and lowering taxes e. reducing the reserve requirement and raising taxes

D Because of fractional reserve banking, banks only hold a portion of their assets as currency. So, when many people decide to convert their assets into currency, banks do not have the necessary cash to meet their depositors' demand; this situation is called a bank run. However, bank runs do not occur frequently in the current era.

22. Which of the following statements about bank runs is FALSE? a. They occur when many people want to hold their assets in currency. b. They can happen to solvent banks. c. The Federal Reserve is largely responsible for fixing them. d. They occur somewhat frequently today. e. They occur in part due to fractional reserve banking.

C When an economy has an output gap of zero, it is producing at its potential output, and so the unemployment rate is equal to its natural rate. The natural rate of unemployment occurs when there is no cyclical unemployment, and so only frictional and structural unemployment exist.

23. Which of the following types of unemployment exist in an economy with an output gap of 0? a. cyclical and structural b. frictional and seasonal c. frictional and structural d. cyclical and structural e. structural and seasonal

C Economists classify parts of the money supply based on their liquidity: the most liquid assets like cash and demand deposits make up M1, while M2 consists of M1 plus various other assets including savings deposits and retail money funds. However, neither M1 nor M2 includes credit cards, because people use credit cards to delay payments—not actually make them

24. All of the following assets are part of M2 EXCEPT a. retail money funds b. currency c. credit cards d. demand deposits e. savings deposits

A In the aggregate demand and aggregate supply model, there are three main curves: aggregate demand, short-run aggregate supply, and long run aggregate supply. According to Keynesian theory, the interaction between aggregate demand and short-run aggregate supply cause short-run economic variations.

25. Keynesian theory holds that short-run economic variations arise from a. aggregate demand and short-run aggregate supply b. short-run productivity and changes in GDP growth rates c. an economy's budget and trade deficits or surpluses d. fluctuating price levels and their impact on equilibrium quantity e. aggregate demand and long-run aggregate supply

B Economists classify parts of the money supply based on their liquidity: the most liquid assets like cash and demand deposits make up M1, while M2 consists of M1 plus various other assets including savings deposits. Because M2 includes all of M1, if $500 billion are added to M1, M2 will increase by $500 billion

26. If $500 billion of assets are added to the M1 money supply, M2 will a. remain the same b. increase by $500 billion c. increase by $1 trillion d. decrease by $1 trillion e. decrease by $500 billion

B Between the years 1960 and 2008, CPI—one of economists' measures of inflation—increased by a factor of around 7, signaling a rise in the overall price level in the United States economy.

27. From 1960 to 2008, CPI increased by a factor of around a. 3 b. 7 c. 11 d. 8 e. 6

C In economics, the term "short run" refers to the time period during which output differs from its long-term potential. In practice, the "short run" is usually one to three years.

28. In economics, the "short run" typically lasts from a. six months to one year b. five to ten years c. one to three years d. six months to two years e. three to five years

A In economics, money is an asset that serves as a store of value, unit of account, and medium of exchange—meaning that consumers can use money to purchase goods and services. Because Lisa uses the $10 to buy vegetables—a good—she exemplifies money's role as a medium of exchange. [

30. Lisa goes to the local grocery store and buys $10 worth of vegetables. Lisa's purchase exemplifies money's role as a(n) a. medium of exchange b. economic asset c. transaction facilitator d. unit of account e. store of value

E Along with interest rate effects and wealth effects, foreign exchange effects help explain the downward-sloping demand curve. A lower price level means that domestically produced goods are cheaper—both for domestic citizens and for foreigners—and so net exports will increase.

32. Which of the following statements BEST summarizes foreign exchange effects? a. The higher a country's price level, the more expensive domestically produced goods are, leading to an increase in net exports b. The higher a country's price level, the cheaper domestically produced goods are, leading to an increase in net exports c. The higher a country's price level, the cheaper domestically produced goods are, leading to a decrease in net exports d. The higher a country's price level, the more expensive domestically produced goods are, leading to a decrease in net exports e. The lower a country's price level, the cheaper domestically produced goods are, leading to an increase in net exports.

B If the federal government buys bonds—an example of open market operations—the money supply will increase, thereby lowering the value of money

33. If the federal government buys bonds, the value of money will a. increase, and the supply of money will increase b. decrease, and the supply of money will increase c. increase, and the supply of money will decrease d. remain the same, and the supply of money will increase e. decrease, and the supply of money will decrease

D If the aggregate demand curve shifts left and reduces output to below its potential level, the short-run aggregate supply curve will shift down as wages and other input costs become less expensive, thereby increasing supply. The short run aggregate supply curve will continue to shift until it intersects aggregate demand where output equals potential.

35. Consumer spending drastically falls, shifting the aggregate demand curve to the left and reducing output to below its potential level. Absent government intervention, why will the economy return to its potential output? a. The aggregate demand curve will shift down until it intersects aggregate demand where output equals potential. b. The long-run aggregate supply curve will shift down until it intersects aggregate demand where output equals potential. c. The aggregate demand curve will shift up until it intersects aggregate demand where output equals potential. d. The short-run aggregate supply curve will shift down until it intersects aggregate demand where output equals potential. e. The short-run aggregate supply curve will shift up until it intersects aggregate demand where output equals potential

E Unemployment typically rises during a recession, so this country's rising unemployment suggests that it was in a recession. And the rate of inflation typically slows down during a recession, which most likely occurred in this scenario.

36. In the span of two years, a country's unemployment rate rises from 3% to 10%. During those two years, the country's a. inflation rate likely sped up b. investment likely remained the same c. real GDP likely increased d. net exports likely increased e. inflation rate likely slowed down

B When an economy uses its resources at normal rates, it is producing at its potential output. At this point, unemployment is equal to its natural rate, and there is no cyclical unemployment.

37. Which of the following terms describes an economy's production when it uses its resources at normal rates? a. potential production b. potential output c. maximum efficiency d. potential efficiency e. maximum production

D Established in 1913, the Federal Reserve System includes the Federal Reserve Board and 12 regional banks. One of the Federal Reserve's primary responsibilities is to act as a lender of last resort to struggling banks.

38. How many regional banks are in the Federal Reserve system? a. 10 b. 7 c. 14 d. 12 e. 5

C If the Federal Reserve buys bonds, the money supply will increase, thus raising the expected price level. As a result, the short-run aggregate supply curve will shift upward, resulting a lower short-run aggregate supply.

39. Which of the following results could arise if the Federal Reserve buys bonds? a. Short-run aggregate supply remains the same. b. Short-run aggregate supply increases. c. Short-run aggregate supply decreases. d. Long-run aggregate supply decreases. e. Long-run aggregate supply increases.

E Made up of the seven governors of the Federal Reserve in addition to five regional bank presidents, the Federal Open Market Committee (FOMC) is responsible for controlling the money supply in the United States. One tool the FOMC uses to influence the money supply is open market operations.

4. Which group is responsible for controlling the money supply in the United States? a. the Department of the Treasury b. the Federal Reserve c. the Internal Revenue Service d. the Bureau of Labor Statistics e. the Federal Open Market Committee

E An increase in net exports will increase aggregate demand, thus shifting the aggregate demand curve to the right. The new equilibrium point will be higher, reflecting the higher price level that accompanies this increase in aggregate demand.

40. According to the AD-AS model, an increase in net exports will shift the a. short-run aggregate demand curve left and increase the price level b. short-run aggregate demand curve right and decrease the price level c. aggregate demand curve left and increase the price level d. long-run aggregate demand curve right and decrease the price level e. aggregate demand curve right and increase the price level

C In response to the failure of traditional microeconomic thought during the Great Depression wrote The General Theory of Employment, Interest, and Money. In this book, Keynes introduced the idea that government intervention could help eliminate output gaps

41. Which economist introduced the idea that government intervention could help eliminate output gaps? a. Arthur Okun b. Joseph Schumpeter c. John Maynard Keynes d. Abram Bergson e. Milton Friedman

D Though fiscal and monetary policy could theoretically help an economy return to its long run potential more quickly, it may take too long before an economy feels the policy's intended results. Moreover, collecting the data necessary to make informed economic policy often takes a long time.

42. Which of the following reasons helps explain why economists may hesitate to support fiscal or monetary policy? a. The free market's response is always more time efficient. b. Short-run market fluctuations are natural and signal a healthy national economy. c. Control over fiscal and monetary policy is not explicitly included in the Constitution. d. It may take too long before an economy feels the policy's intended results. e. Politicians do not have the economic expertise that economists do.

E If the Federal Reserve reduces the reserve requirement, banks can lend out a larger portion of their excess reserves, thereby increasing the money supply. An increased money supply in turn lowers interest rates, encouraging consumer and investment spending

43. Which of the following events is a possible consequence of the Federal Reserve's reducing the reserve requirement? a. decreased real GDP and increased interest rates b. decreased consumer spending and increased inflation c. decreased inflation and net exports d. decreased government spending and investment e. increased consumer and investment spending

C Okun's Law holds that for every 1 percent that an economy's unemployment rate differs from its natural rate, the output gap increases by 2 percent. Therefore, if unemployment differs from the natural rate by 6 percent, the output gap will be 12 percent.

45. Korea's natural rate of unemployment is 4%. According to Okun's law, if unemployment is at 10%, Korea will have an output gap of a. 6% b. 8% c. 12% d. 10% e. 20%

C The Federal Reserve buying bonds would increase the money supply. And according to the equation for the velocity of money, an increase in the money supply could lead to an increase in the price level or real GDP or a decrease in the velocity of money

46. According to the equation for the velocity of money, a possible consequence of the Federal Reserve buying bonds is a(n) a. increase in the velocity of money b. decrease in real GDP c. increase in the price level d. decrease in nominal GDP e. decrease in the price level

C The Federal Reserve can influence the money supply using open market operations—the buying and selling of government bonds. By selling bonds, the Federal Reserve reduces the money supply. It is important to note that while raising the reserve requirement, for example, would reduce the money supply, open market operations refers only to the buying and selling of government bonds.

47. If the Federal Reserve wants to reduce the money supply in the United States economy using open market operations, it could a. increase the federal funds rate b. buy bonds c. sell bonds d. raise the reserve requirement e. lower the reserve requirement

D Monetary base, also known as high-powered money, is equal to the amount of currency plus reserves in an economy.

48. Which of the following statements correctly defines monetary base? a. Monetary base is equal to M1. b. Monetary base is equal to M2. c. Monetary base is the difference between M1 and M2. d. Monetary base is equal to the amount of currency plus reserves. e. Monetary base is equal to the money supply.

D Government spending and taxes can influence aggregate demand. The government cutting income tax rates means that households have more disposable income to use for consumption, increasing aggregate demand and thus shifting the aggregate demand curve to the right.

49. The federal government implements a 10% income tax cut. In the short run, economists would expect the a. short-run aggregate supply curve to shift left b. short-run aggregate demand curve to shift right c. aggregate demand curve to shift left d. aggregate demand curve to shift right e. long-run aggregate demand curve to shift right

B The Federal Reserve can expand the money supply through monetary policy, including by lowering the discount rate. Lowering taxes would also expand the money supply, but that is a part of fiscal policy—carried out by Congress, not the Federal Reserve.

5. Which of the following actions could the Federal Reserve take to expand the money supply? a. raising the reserve ratio b. lowering the discount rate c. selling government bonds d. lowering taxes e. raising the federal funds rate

C When a supply shock like the OPEC oil embargo of 1973 occurs, short-run aggregate supply shifts right until output equals potential. A government could also use fiscal and monetary policy in an attempt to quicken the recovery time.

50. What happens when a supply shock causes a recession? a. Long-run aggregate supply shifts right until output equals potential b. Short-run aggregate supply shifts left until output equals potential c. Short-run aggregate supply shifts right until output equals potential. d. Long-run aggregate supply shifts right until output equals potential e. Aggregate demand shifts left until output equals potential

A The liquidity of an asset describes how easily one can convert said asset into a medium of exchange. In this scenario, cash is the most liquid asset, as it is ready for use as a medium of exchange, while an antique art collection is the least liquid, as it would require the most effort to convert the art collection into something used to buy goods and services.

6. Which of the following assets is LEAST liquid? a. an antique art collection b. shares of Walmart stock c. funds in a checking account d. cash e. funds in a mutual fund

C A recession occurs when an economy's real GDP falls for two consecutive quarters. Because Country X's real GDP has been declining for more than six months, it is in a depression.

7. Country X's real GDP declined in January and continued to do so until the current month of October. Therefore, Country X is in a(n) a. recession b. budget surplus c. depression d. expansion e. budget deficit

E The National Bureau of Economic Research (NBER) is a group of economists that focuses on short-run economic fluctuations. One of NBER's responsibilities is to determine the start and end dates of expansions and recessions in the United States.

8. Which organization determines when expansions and recessions in the United States begin and end? a. the Federal Open Market Committee b. the American Economic Development Council c. the National Economic Advisory Association d. the Department of the Treasury e. the National Bureau of Economic Research

A In addition to interest rate effects and foreign exchange effects, wealth effects contribute to the downward sloping nature of the aggregate demand curve. A lower price level increases people's effective wealth and thus spending

9. Which of the following concepts is an explanation for the downward-sloping aggregate demand curve? a. wealth effects b. GDP deflation c. quality differences d. frictional demand e. substitution bias