Practice Test 1
Automatic stabilizers reduce the severity of business cycle fluctuations because they produce changes in the government's budget that A. result in long-run balanced budgets B. result in constant growth of GDP C. help offset changes in employment D. produce a cyclically adjusted budget E. produce a full employment budget
C. help offset changes in employment (C) Automatic stabilizers increase or decrease with expansion and contraction of the economy. Examples of automatic stabilizers are unemployment insurance and Temporary Assistance to Needy Families (TANF). Tax revenues also change automatically, in a direct relationship with the business cycle. If GDP rises, tax revenues increase and transfer payments decline. Conversely, as GDP declines, tax revenues decrease and transfer payments increase. Therefore, the stabilizers help to minimize the effects of the business cycle, offsetting some of the natural fluctuations in employment that result from inflationary and recessionary gaps.
Leakages from the income-expenditure stream are A. consumption, saving, and transfers B. investment, spending, and transfer payments C. saving, taxes, and transfers D. saving, taxes, and imports E. imports, taxes, and transfers
D. saving, taxes, and imports (D) The injection-leakage analysis of AE/GDP considers, by definition, leakages to consist of savings, taxes, and imports. All three items represent no spending in the domestic economy.
From an economist's perspective, which of the following is NOT considered to be investment (Ig)? A. Purchasing new computers for the accounting office B. Building a new plant facility C. Buying back outstanding shares of company stock D. Building an office complex E. Increases in the warehouse inventories of finished product
(C) In the formula to determine GDP, C + Ig + G + Xn, Ig represents the gross investment in capital goods by a firm. Therefore, any expenditure that adds to the future productivity of the firm is classified as an investment. Repurchasing stock in the firm does not alter productivity, so it is not an expenditure on investment.
In the aggregate expenditures model, the primary determinant of the level of consumption and saving in the economy is the A. inflation rate B. level of investment C. level of income D. level of prices E. interest rate
(C) Income has a direct relationship to aggregate expenditure. If disposable income increases, then expenditure also increases in relation to the MPC.
Select the statement most associated with Classical economists that Keynes disagreed with A. A market economy eventually results in monopolies that damage the standard of living. B. Market economies function best when government makes supply decisions. C. Market economies are generally free from price and output cycles. D. A market economy is self-correcting and thus will eventually recover from recession without intervention. E. The factor market underpays workers without minimum wage laws.
(D) Keynes challenged the long-held assumption of Classical economists that long-run AS is perfectly inelastic. They reasoned that price levels, output, and employment were self-regulating. Keynes argued that an economy can become fixed in a cycle of long-run recession, from which it will recover only if stimulated. Keynes argued that by increasing spending and cutting taxes (budget deficit) to the household, the C element of aggregate expenditure will stimulate expansion in the economy.
If the U.S. balance of payments had a current account surplus, which of the following would also exist? A. An equal deficit in the capital account B. An equal deficit in the federal budget C. An equal surplus in the capital account D. A depreciation of the U.S. dollar in the foreign exchange market E. A balance in net exports
A. An equal deficit in the capital account (A) Because a balance of payments must equal an accounting zero, any surplus in the current account either must be reflected as a decrease in the excess reserve of foreign money or, if used to buy foreign assets, must appear as a deficit in the capital account.
Assume that demand-pull inflationary pressure is a growing problem for the economy. In response to this threat, the Federal Reserve decides to pursue a policy to reduce the inflationary pressure. At the same time, Congress decides to eliminate a budget surplus. Which set of policy changes by the Fed and Congress would result, thereby offsetting each other? A. Monetary Policy selling government securities, Fiscal Policy lowering taxes B. Monetary Policy buying government securities, Fiscal Policy increasing spending C. Monetary Policy selling government bonds, Fiscal Policy raising taxes . Monetary Policy buying government bonds, Fiscal Policy increasing subsidies E. Monetary Policy selling government bonds, Fiscal Policy increasing spending
A. Monetary Policy selling government securities, Fiscal Policy lowering taxes (A) The monetary policy of selling government securities would reduce the money supply, increase interest rates, and reduce the Ig component of AE/AD. This would be contractionary in nature. This reduction of expenditure would be offset by a fiscal policy of lowering taxes, which would increase income, increase AE/AD, and be expansionary in nature.
If exchange rates are allowed to fluctuate freely and the U.S. demand for Mexican pesos decreased, which of the following will most likely occur? A. The dollar price of Mexican goods will decrease. B. The peso price of U.S. goods will decrease. C. The dollar price of the peso will increase. D. The dollar price of Mexican goods will increase. E. Importing of Mexican goods will decrease.
A. The dollar price of Mexican goods will decrease. (A) When the domestic demand for a foreign currency decreases, its price in the foreign currency falls. This depreciation of value means that the price of the foreign currency requires fewer domestic dollars, making it cheaper.
As Americans increase their purchase of foreign goods and services, the aggregate expenditure relationship to the aggregate demand and supply model would indicate that a A. fall in our aggregate expenditure will cause domestic price level to decrease, aggregate demand to fall, and GDP to decline B. fall in our domestic price level will decrease our imports and increase our exports, thereby reducing the net exports component of aggregate demand C. fall in our domestic price levels will decrease our imports and reduce unemployment D. rise in our domestic price level will increase our imports and reduce our exports, thereby reducing the net exports component of aggregate demand E. rise in our domestic price level will decrease our imports and increase our exports, thereby reducing the net exports component of aggregate demand
A. fall in our aggregate expenditure will cause domestic price level to decrease, aggregate demand to fall, and GDP to decline (A) Purchase of imports is a leakage from domestic aggregate expenditure, so it would cause Xn to decrease. If AE falls from AE1 to AE2, then so does AD, from AD1 to AD2. As AD decreases so do price levels (depending on relationship to AS stage), employment, and GDP. This can be seen in the following graphic depiction:
If a government raises its expenditure by $25 billion and at the same time levies a lump-sum tax of $25 billion, the net effect on the economy will be to A. increase GDP by $25 billion B. increase GDP by less than $100 billion, because the multiplier is 4 C. increase GDP by more than $50 billion D. increase GDP by $50 billion E. make no change in GDP
A. increase GDP by $25 billion (A) [This question follows up the concept discussed in question 25.] The reaction of consumers to a tax increase, which is then subject to the multiplier, explains what is known as the balanced budget multiplier. This gap is always equal to a factor of 1. In other words, any equal combination of spending increase and tax increase ($100 million spending and $100 million tax increase adds $100 million to the GDP), will always result in that amount added to the economy. This is because government spending is subject to the full multiplier, whereas taxes are first reduced by the MPS and then subject to the multiplier. Thus, a recessionary or inflationary gap always results from equal amounts of spending and tax quantities.
In the short run, an expansionary fiscal policy will cause aggregate demand, employment, and price level to react in which of the following combinations? A. Aggregate Demand decrease, Employment decrease, Price Level decrease B. Aggregate Demand increase, Employment increase, Price Level increase C. Aggregate Demand no change, Employment no change, Price Level decrease D. Aggregate Demand increase, Employment decrease, Price Level increase E. Aggregate Demand decrease, Employment increase, Price Level no change
B. Aggregate Demand increase, Employment increase, Price Level increase (B) In the short run, supply is fixed. If government increases spending while at the same time cutting taxes, the AE will increase, causing the AD to increase (move to the right). This change in AD causes an increase in employment and an increase in price levels
If domestic real interest rates remain constant at 5.5% and a foreign nation's real interest rates rise to 8.5%, which of the following is the correct domestic reaction? A. Domestic Bonds Prices rise, Foreign Bonds Sell, Foreign Currency Value Depreciate B. Domestic Bonds Prices fall, Foreign Bonds Buy, Foreign Currency Value Appreciate C. Domestic Bonds Buy, Foreign Bonds Buy, Foreign Currency Value Unaffected D. Domestic Bonds Unaffected, Foreign Bonds Unaffected, Foreign Currency Value Unaffected E. Domestic Bonds Sell, Foreign Bonds Buy, Foreign Currency Value Depreciate
B. Domestic Bonds Prices fall, Foreign Bonds Buy, Foreign Currency Value Appreciate (B) Investors are attracted to profit and repelled by loss. Therefore, domestic bondholders would sell their bonds (causing prices to fall) and buy the foreign bonds as they receive a higher yield. Because foreign bonds must be purchased with foreign currency, the demand for foreign currency would increase and the price of the foreign currency would rise (appreciation).
The inflation measurement that would react to a rise in the price of apples, by accounting for the consumer's substitution of oranges, and compare orange prices over the last year would be the A. CPI B. PCE index C. GNP D. GDP E. real inflation rate
B. PCE index (B) The PCE index measures actual consumption. This allows for consumer substitutions if the price of a good rises. The PCE then links that good to its prior year's price, giving a better short-run inflation indicator.
The U.S. FTC finds Japan guilty of "dumping" steel in the U.S. market. Select the description of a protective tariff response. A. The United States places an excise tax on products that are not produced domestically in order to raise revenues for the steel industry B. The United States places an excise tax on Japanese steel producers, putting them at a competitive disadvantage in selling steel in U.S. domestic markets C. The United States sets a specific maximum amount of steel that may be imported, in a given period of time, to protect U.S. producers of steel D. U.S. steel firms would no longer be allowed to export steel products to Japan E. The United States restricts the issuance of licenses for imported products and sets unreasonable standards for quality or safety in order to restrict imports of steel and protect domestic markets
B. The United States places an excise tax on Japanese steel producers, putting them at a competitive disadvantage in selling steel in U.S. domestic markets B) "Dumping" is when a nation (or firm) sells a good below cost as a means of harming its competition. Under the rules established by the WTO, countries found guilty of dumping goods in another nation's market may be penalized by the WTO, which may allow the offended nation to place a tariff on the foreign producer's good as a remedy. This tax punishes the offending nation and returns the field to a competitive market.
Which of the following is the most accurate description of events when monetary authorities increase the size of commercial banks' excess reserves?
B. The money supply is increased, which decreases the interest rate and causes investment spending, output, and employment to increase
If aggregate demand increases and, as a result, the price level increases, while real domestic output and employment are unaffected, we can assume that A. aggregate demand intersects aggregate supply in the intermediate range of the aggregate supply curve B. aggregate demand intersects aggregate supply in the vertical range of the aggregate supply curve C. aggregate demand intersects aggregate supply in the horizontal range of the aggregate supply curve D. aggregate supply increases to accommodate the change in aggregate demand E. aggregate supply has shifted inward due to foreign supply shock
B. aggregate demand intersects aggregate supply in the vertical range of the aggregate supply curve (B) If AD increases and as a result price levels rise, while GDP and employment are unaffected, the AD must be in stage 3 of the AS. This results in hyperinflation. Notice the extreme rise in prices that results from these events.
Other things being equal, if U.S. steel exports fell, the economy would see a(n) A. increase in domestic aggregate expenditures and the equilibrium level of GDP B. decrease in domestic aggregate expenditures and the equilibrium level of GDP C. decrease in government spending and a decrease in GDP D. zero effect on domestic GDP, because imports will offset the change in exports E. decrease in the marginal propensity to balance trade
B. decrease in domestic aggregate expenditures and the equilibrium level of GDP (B) Exports, as a component of AE, are an injection into the economy. If exports fell and all else remained equal, the AE would decrease and the equilibrium level of GDP would decrease.
In a closed private economy, if the interest rate falls, businesses expect expansion of the economy, and as a result the investment demand also rises, then the A. expenditure equilibrium will shift downward and GDP will decline B. investment schedule and aggregate expenditures schedule will shift upward C. investment and aggregate expenditures schedules will shift downward with greater unemployment D. investment schedule will shift upward and the aggregate expenditures schedule will shift downward, and output will decrease E. investment schedule will shift downward and the aggregate expenditures schedule will shift upward
B. investment schedule and aggregate expenditures schedule will shift upward (B) When interest rates fall (8% to 2%) and business expectations change, a shift in investment demand (Id to Id1) will stimulate an increase in the Ig component of AE (AE to AE1).
In a closed economy with no government, an increase in autonomous investment of $25 billion increases domestic output from $600 billion to $700 billion. The marginal propensity to consume is A. 0.25 and the multiplier is 4 B. 0.50 and the multiplier is 2 C. 0.75 and the multiplier is 4 D. 0.80 and the multiplier is 5 E. the MPS is 0.75 with a multiplier of 4
C. 0.75 and the multiplier is 4 (C) A change in AE of $25 billion results in an increase in output of $100 billion. [Give the necessary data to determine the MPC/MPS and the multiplier]. Since an AE change of 25 yields a 100 change in output, the multiplier is 4 (25 × 4 = 100). To have a multiplier of 4, the MPS must be 0.25 and the MPC 0.75. This is so because 1/MPS (1/0.25 = 4) = the multiplier and 1 - MPS (1 - 0.25 = 0.75) = MPC.
Which of the following would a Keynesian recommend to combat high inflation? A. No change in taxation and increased subsidy B. Increased taxation and increased government spending C. Increased taxation and decreased government spending D. Decreased taxation and no change in government spending E. No change in taxation and increased government spending
C. Increased taxation and decreased government spending (C) Keynes advocated government intervention in the business cycle to manage the economy in an attempt to moderate the extremes of the business cycle. Through fiscal policy, the government can counter the cycle, stimulating during recession and contracting during expansion. So, if inflation were occurring because of an AD that is too high, the government could cause a contraction in the consumption segment of AD by increasing taxes and reducing government spending.
If the national savings rate increased, which of the following shows how real interest rates and investment spending would react? A. Real Interest Rate Increase, Investment Spending Decrease B. Real Interest Rate No change, Investment Spending Increase C. Real Interest Rate Decrease, Investment Spending Increase D. Real Interest Rate Increase, Investment Spending Increase E. Real Interest Rate Decrease, Investment Spending Decrease
C. Real Interest Rate Decrease, Investment Spending Increase (C) When the savings rate increases, the money supply available for banks to lend increases. An increase in the supply of money to lend lowers the price of money (real interest rates), and as the price falls, the quantity demanded by investors increases.
According to the short-run Phillips curve, which of the following occurs when the Federal Reserve reduces the money supply? A. The unemployment rate and the inflation rate both decrease. B. The unemployment rate and the inflation rate both increase. C. The inflation rate decreases and the unemployment rate increases. D. The inflation rate decreases and the unemployment rate is unchanged. E. The inflation rate increases and the unemployment rate decreases.
C. The inflation rate decreases and the unemployment rate increases. (C) In the short-run Phillips curve, an inverse relationship exists between inflation and unemployment. A reduction of the money supply (the Federal Reserve sells bonds) causes a rise in nominal interest rates (money is withdrawn from banks because higher returns are available in the bond market). As real interest rates rise (the bank's money supply decreases) in reaction to the Fed's actions, the quantity demanded by investors decreases. As aggregate demand decreases, price levels fall (disinflation or even deflation). As aggregate demand falls, the quantity supplied falls. Thus, layoffs occur.
If a nation was running a current account surplus with country X, it could prevent its currency from appreciating by A. lowering the price of its goods and services to country X B. encouraging more foreign tourism of country X's residents C. purchasing country X's assets D. selling its foreign assets E. increasing its interest rates
C. purchasing country X's assets (C) The balance of payments is the current account plus the financial account. If a current account deficit was offset by an equal financial account surplus (foreign purchase of domestic assets), currency values would not change because the supply and demand of currencies would be constant.
Consumers purchase bonds, rather than continuing to hold currency, because they believe that interest rates will decline in the future. Such purchases point to which of the following scenarios? A. There has been an upward shift in consumers' marginal propensity to consume B. Consumers expect little need for cash C. Consumers expect the value of currency to appreciate in the short term D. Consumers speculate that currency will depreciate in the future E. Bonds will drop in value relative to currency
D. Consumers speculate that currency will depreciate in the future D) Bonds are an investment alternative to holding cash. Remember that inflation erodes the value of currency over time. Bonds (corporate and government) are promissory notes whereby the buyer loans money to the seller in exchange for repayment of the loaned amount (principal) plus a set interest rate of return at a set date of maturity. The risk in this investment is that the buyer foregoes the current purchasing power of the currency, in the belief that the interest payment will more than cover any inflation that might occur over the length of the bond maturity—hence, the speculatory nature of the investment.
According to the theory of rational expectations, a fully anticipated expansionary fiscal policy causes the price level and real output to react in which of the following combinations? A. Price Level Increase, Real Output Increase B. Price Level Increase, Real Output Decrease C. Price Level No change, Real Output No change D. Price Level Increase, Real Output No change E. Price Level No change, Real Output Increase
D. Price Level Increase, Real Output No change (D) Rational expectations is a key element of neoclassical economic theory (see definition in the Glossary). For example, when the federal government deficit spends, producers realize that this is an inflationary action and respond by raising prices to offset the reduced dollar value. Producers do not change output because higher prices would forestall any increase in aggregate demand.
A demand deposit at a commercial bank is A. an asset to a bank and a liability to the Fed B. a liability to the depositor and an asset to the bank C. a liability to both the depositor and the bank D. an asset to the depositor and a liability to the bank E. an asset to both the depositor and the bank
D. an asset to the depositor and a liability to the bank (D) By definition, a deposit at a bank is placed on the bank's books as a liability, as this is money that is owed by the bank to the depositor. The deposit is an asset to the depositor, as it represents value owned by the depositor.
If a lump-sum tax of $40 billion is levied and the MPS is 0.25, then the saving schedule will shift A. upward by $10 billion B. downward by $160 billion C. upward by $25 billion D. downward by $10 billion E. downward by $25 billion
D. downward by $10 billion (D) [This question tests knowledge of the unique relationship of tax, consumer behavior, and change in AE.] Consumers will react to taxes by adjusting their savings in an amount determined by their MPS. Tax increases will be offset by a reduction in savings. In this case, a $40 billion dollar tax levy would be compensated for, by consumers, through a reduction in savings of $10 billion (40 × 0.25 = 10).
The crowding-out effect suggests that A. an increase in household consumption is always at the expense of saving B. any increase in MPC effects a reduction in MPS C. government budget-spending increases close a recessionary gap D. government deficit spending may raise the interest rate and thereby reduce investment E. government borrowing increases the money supply and encourages business investment, thereby reducing household borrowing
D. government deficit spending may raise the interest rate and thereby reduce investment (D) Crowding out is another damaging side effect of fiscal policy that monetary policy avoids. This happens when government pursues an expansionary fiscal policy. To finance government deficit spending, the government must borrow money through the sale of Treasury bonds. As the demand for money increases, interest rates rise and the supply of money available to business is lessened. Also, Ig will demand a lower quantity at higher interest-rate prices. This is obviously counterproductive from an injection-leakage analysis, as the decrease in Ig would partially offset the increase in G. So, as the following diagram shows, interest rates would rise from 4% to 8%, reducing the Ig component of AE. The AD/AS model demonstrates the intended results of fiscal policy, moving AD1 to AD2 with the actual lessened impact AD1 to AD2a, due to crowding out. Most economists contend, however, that this crowding-out effect would be rendered irrelevant during recession if the Federal Reserve cooperated with an easing of money policy.
A recessionary gap exists when the short-run equilibrium level of real GDP A. results in price level rises for two business quarters B. equals the NRU C. is above the full employment level of real GDP D. is below the full employment level of real GDP E. is beyond the LRAS
D. is below the full employment level of real GDP (D) A recessionary gap occurs when the aggregate demand intersects the SRAS below the full employment level. This indicates that unemployed resource inputs exist and the economy is operating below potential.
A senator calls for legislation reducing corporate taxes, to increase investment and promote economic growth. This senator would most likely be advocating a A. contractionary fiscal policy B. reduction in automatic stabilizers C. nondiscretionary fiscal policy D. supply-side fiscal policy E. growth in aggregate demand through fiscal policy
D. supply-side fiscal policy (D) Supply-side economists contend that tax reductions aimed at the Ig will promote increases in productivity and thus output, along with job creation and higher income. This is attained without inflation because the increase in income is equal to the increase in output. This is a revisit of Say's Law. Many economists are critical of the degree to which tax cuts affect investment and thus AS expansion. Some contend that the lower tax rates only serve to enhance the wealth of business owners and further distort income distribution. This area continues to be investigated by economists for evidence of some impact of tax policy on AS expansion.
According to a supply-side economist, which of the following statements is true? A. A cut in tax rates increases the federal deficit and thus increases aggregate supply. B. An increase in the government's supply of transfer payments helps distribute income equitably. C. Government should work to balance trade. D. An increase in tax rates helps to increase the aggregate demand for goods and stimulate increased aggregate supply E. A cut in tax rates provides increased incentive to invest and produce, thereby shifting the aggregate supply curve to the right.
E. A cut in tax rates provides increased incentive to invest and produce, thereby shifting the aggregate supply curve to the right. (E) Supply-side economic theory stems in part from Say's Law (supply creates its own demand) and the Laffer curve (tax cuts increase tax revenues; as the economy grows, a greater national income is taxable). When taxes are cut, investors keep a larger share of the profits. This stimulates investment in capital goods, which creates jobs (real output equals real income), increased output (the AS curve shifts to the right), and increased demand.
Which of the following would cause the production possibilities curve shown above to shift outward? A. Reopening a cereal plant that had been closed B. Rehiring laid-off cereal workers C. Using machinery for missile production instead of cereal production D. Using machinery for cereal production instead of missile production E. Developing a more efficient cereal-making process
E. Developing a more efficient cereal-making process
Based upon the preceding data, the terms of trade will be A. Nigeria wanting at least 2 units of cocoa for 1 unit of banana B. no trade; neither country has a comparative advantage C. more than 4 units of cocoa for 1 unit of banana D. Nigeria wanting more than 5 units of banana for 1 unit of cocoa and Colombia wanting more than 3 units of banana for 1 unit of cocoa E. Nigeria wanting more than 3 units of cocoa for 1 unit of banana and Colombia wanting more than 1 unit of banana for every 5 units of cocoa
E. Nigeria wanting more than 3 units of cocoa for 1 unit of banana and Colombia wanting more than 1 unit of banana for every 5 units of cocoa (E) [This answer is based on comparative advantage analysis, as shown in the answer to question 45, and adding the terms of trade principle.] After specialization, countries will want more goods than they had prior to it. They must receive a ratio of return greater than they had from their domestic production. In this case, Nigeria (3 cocoa for 1 banana) produces bananas and Colombia (5 cocoa for 1 banana) produces cocoa. Nigeria will want to get more than its domestic return of 3 cocoa for 1 banana (say, 4 cocoa for 1 banana +1), which increases its standard of living. Colombia will want to get a greater return than its domestic production of 1 banana for 5 cocoa (say, 1.25 banana for 5 cocoa).
If the economy is operating in stage 2, the intermediate range, of aggregate supply, and business investment decreases, then price level, income, and employment would most likely change in which of the following ways? A. Price Level increase, Income increase, Employment increase B. Price Level increase, Income increase, Employment decrease C. Price Level increase, Income decrease, Employment increase D. Price Level decrease, Income increase, Employment decrease E. Price Level decrease, Income decrease, Employment decrease
E. Price Level decrease, Income decrease, Employment decrease (E) Business investment is a component of AE and thus has a direct influence on AD. If the other three elements of AE remained constant and Ig decreased, then AE would move downward and the AD would move inward. This is depicted in the two models above. Notice that price levels, GDP, and employment all decrease.
An economy is experiencing hyperinflation. The government wants to reduce household consumption by $48 billion to reduce inflationary pressure. The MPC is 0.75. Which of the following government actions would achieve its objective? A. Increasing spending by $48 billion B. Raising taxes by $6 billion C. Increasing spending by $9 billion and raising taxes by $48 billion D. Raising taxes by $12 billion E. Raising taxes by $16 billion
E. Raising taxes by $16 billion (E) [The basis for this answer involves a knowledge of both the multiplier and the realization that a change in tax is partially absorbed by the marginal propensity to save (prior to the effect of the multiplier).] With an MPC of 0.75, the MPS is 0.25; therefore, the initial tax change must be reduced by 0.25. A tax raise of $16 billion would first be offset by a $4 billion reduction in household savings. The remainder of $12 billion (16 - 4 = 12) is then subject to the multiplier, which is 4 because it equals 1/MPS (1/0.25 = 4). A $12 billion net tax would reduce the household consumption component of GDP by $48 billion (12 × 4 = 48).
A surplus in the U.S. current account can be described as an A. excess of foreign purchase of U.S. financial assets B. event that would deplete U.S. gold reserves C. excess of U.S. purchases of foreign financial assets D. excess of U.S. purchases of foreign goods and services E. excess of foreign purchases of U.S. goods and services
E. excess of foreign purchases of U.S. goods and services (E) The current account measures net exports of goods and services. A surplus in the current account indicates that foreign nations are buying more U.S. goods and services than the United States is buying of theirs.
Other things being equal, the international value of foreign currencies will decrease against the U.S. dollar ($) if A. U.S. citizens increase spending on foreign goods B. U.S. businesses reduce exports C. the U.S. Federal Reserve lowers real interest rates D. the number of foreign tourists to Walt Disney World decreases E. foreigners increase deposits into U.S. money markets
E. foreigners increase deposits into U.S. money markets (E) If foreign demand for dollars to deposit into U.S. money markets increases (D1 to D2), then the value of the dollar will appreciate, because the foreign currencies would depreciate (5 to 7.5 foreign currency units per dollar).
The United States is experiencing inflation, so Congress adopts a contractionary fiscal policy to reduce inflation. The net export effect suggests that net exports would A. decrease due to the resulting decrease in interest rates, thus decreasing aggregate demand and partially reinforcing the fiscal policy B. increase, as the decline in the value of the dollar would increase exports C. decrease, thus increasing aggregate demand and partially offsetting the fiscal policy D. increase, thus decreasing aggregate demand and partially reinforcing the fiscal policy E. increase as imports decreased, thus increasing aggregate demand and partially offsetting the fiscal policy
E. increase as imports decreased, thus increasing aggregate demand and partially offsetting the fiscal policy (E) When Congress pursues a contractionary fiscal policy, it reduces spending and increases taxes. The result of this behavior is to decrease the money supply. This causes interest rates to rise, discouraging households from purchasing g/s (both domestic and foreign). Initially, the weak dollar (due to inflation) coupled with stronger foreign currencies results in exports rising while imports fall. Thus, the Xn component of AE/AD increases and partially offsets the decrease in the C, Ig, and G components. In the long run, the higher interest rates attract foreign investors and the increased demand for the dollar causes it to appreciate, reversing the trade balance trend (long-run trade equilibrium concept).
Assume that the required reserve ratio for commercial banks is 20 percent. If the Federal Reserve Banks buy $5 billion in government securities from commercial banks, the lending ability of the banking system will A. decrease by $9 billion B. increase by $9 billion C. increase by $15 billion D. increase by $20 billion E. increase by $25 billion
E. increase by $25 billion (E) If the reserve is 20 percent, the multiplier is 5 (1/0.20 = 5). If $5 billion is added to commercial bank reserves, 5 times that amount would eventually enter the economy ($5 billion × 5 = 25).
The short-run Phillips curve indicates that A. there is a direct relationship between inflation and unemployment. B. there is no trade-off between unemployment and inflation C. as prices rise the quantity demanded decreases D. the natural rate of unemployment is unchanging E. there is an indirect relationship between unemployment and inflation
E. there is an indirect relationship between unemployment and inflation (E) The short-run Phillips curve can operate inside or outside the natural rate of unemployment. If inside the NRU (LRAS), the increased unemployment drives wages and prices down. In the long run, however, the indirect relationship between unemployment and inflation will lower prices and stimulate an increase in AD returning to the NRU (LRAS) level. Beyond the NRU, the opposite would occur.
Refer to the preceding diagram. A decrease in total spending in Stage 2 will
decrease employment, output, and the price level (C) The second stage of the AS curve, as one moves rightward, represents diminishing marginal productivity and increasing opportunity costs that lead to rising price levels. If we reduce the aggregate demand, the AD curve moves inward, resulting in lower output, employment, and disposable income. These changes would result in overall lower price levels. Also, as fewer resource inputs are required by producers, marginal productivity would actually increase, cost per unit would decline, and a lower price would be charged.
If the Fed buys government bonds from commercial banks in the open market,
commercial banks give the bonds to the Fed, which then pays for them by increasing the reserves of the commercial banks, thereby encouraging lower interest rates (D) When the FOMC orders bonds to be purchased from commercial banks, the bond is given to the Fed in exchange for a credit to the reserves of the commercial bank. This credit enables the bank to increase its loans and thus the money supply. This increase in the money supply relative to the demand for money generally lowers interest rates, thereby encouraging expansion in the economy.
The primary mission of monetary policy is to assist the economy in achieving
price stability, economic growth, and full employment level of total output
The Open Market Committee of the Federal Reserve System (the Fed) is the committee that
sets policy on the sale and purchase of government bonds by the Fed
If the Fed sells government bonds to the public in the open market,
the Fed gives the bonds to the public; the public pays for them by writing checks that (when cleared) will decrease commercial bank reserves at the Fed, raising interest rates (B) This action has the opposite impact of the action taken in question 55. When the Fed sells bonds, it removes money from circulation and replaces it with a bond. As money is removed from the market, available interest rates rise. Also, as the supply of bonds in the bond market increases, their price decreases. As mentioned earlier, this increases their interest rate yield.
Refer to the preceding diagram. An increase in total spending in Stage 3 will increase
the price level, but not output or employment (D) The vertical stage three of AS represents an economy that has reached maximum productivity. All resource inputs are being used. Therefore, any increase in aggregate demand cannot be met with increased production. Because demand has increased while supply has remained fixed, a higher price level results. This is sometimes referred to as "hyperinflation," as the rise in prices in this environment can be very large.