ECN 204 Lecture Notes - Lecture 8: Potential Output, Deflation, Real Interest Rate
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1.Ceteris paribus, if the U.S. federal government reduces its budget deficit which of the following will be observed?
Answer
| a. | The aggregate demand curve will shift to the right. | |
| b. | The economy will always approach potential GDP. | |
| c. | The marginal propensity to consume will increase. | |
| d. | The average price level will increase. | |
| e. | The aggregate demand curve will shift to the left. |
2. If the government wants to close a GDP gap, it can:
Answer
| a. | lower government spending on social security. | |
| b. | adopt contractionary fiscal policies to control inflation. | |
| c. | increase its budget deficit. | |
| d. | repay its borrowings. | |
| e. | raise both direct and indirect tax rates. |
3. Suppose the short-run equilibrium level of income exceeds the full employment level of income and there is high inflation. Hence, the government decides to implement a fiscal policy that will act to reduce national output and price level. This can be accomplished by:
Answer
| a. | lowering average tax rates such that aggregate supply is increased. | |
| b. | increasing government spending such that aggregate expenditures are increased. | |
| c. | increasing transfer payments such that aggregate expenditures decline. | |
| d. | raising taxes and government spending by the same amount such that aggregate supply is decreased and aggregate demand is increased. | |
| e. | decreasing government spending such that aggregate demand is reduced. |
4. A drop in investment spending caused by increased government budget deficits is referred to as:
Answer
| a. | the multiplier effect. | |
| b. | crowding out. | |
| c. | an expansionary gap. | |
| d. | the paradox of thrift. | |
| e. | the Ricardian equivalence. |
5. Discretionary fiscal policy is best defined as:
Answer
| a. | the deliberate manipulation of the money supply to expand the economy. | |
| b. | the deliberate change in tax laws and government spending to change equilibrium income. | |
| c. | the policy action taken by the Congress to reduce the federal budget deficit. | |
| d. | the arbitrary fluctuation in tax laws and budget requirements. | |
| e. | the automatic change in certain fiscal instruments when real GDP changes. |
6. Which of the following can be considered as an automatic stabilizer in the economy?
Answer
| a. | Money supply | |
| b. | Disposable income | |
| c. | Real exchange rate | |
| d. | Real interest rate | |
| e. | Unemployment insurance |
7. Which of the following is true about automatic stabilizers?
Answer
| a. | When income rises, automatic stabilizers increase/boost spending. | |
| b. | Automatic stabilizers are a part of discretionary fiscal policy. | |
| c. | An automatic stabilizer is any program that responds to fluctuations in the business cycle in a way that moderates the effects of those fluctuations. | |
| d. | Any kind of trade policy adopted by the government will be considered as an automatic stabilizer. | |
| e. | The interest rate is an example of an automatic stabilizer. |
8. Increased budget deficits
Answer
| a. | can cause interest rates to increase and hence decrease net exports | |
| b. | have no effect on net exports | |
| c. | can cause interest rates to decrease and hence increase net exports | |
| d. | never impose additional interest costs on the government |
9. The Ricadian Equivalence implies that when financing additional government expenditures
Answer
| a. | there is no difference between increasing current taxes or borrowing now and increasing taxes in the future because consumption will decrease either way. | |
| b. | there is no difference between increasing current taxes or borrowing now and increasing taxes in the future because consumption will increase either way. | |
| c. | increasing borrowing is the best option | |
| d. | increasing current taxes is the best option |
10. Assuming no effects on aggregate supply, if the government increases government spending and decreases taxes in an attempt to prevent a possible recession, aggregate demand will shift to the ____, the price level will either remain constant or ____, and the level of real GDP will ____.
Answer
| a. | right; decrease; increase | |
| b. | right; decrease; decrease | |
| c. | left; decrease; decrease | |
| d. | left; increase; increase | |
| e. | right; increase; increase |
11. For a hypothetical economy, the MPS is 0.08 and the MPI is 0.17. If government spending increases by $35 and taxes increase by $35, what will be the net effect on equilibrium income?
Answer
| a. | A decrease of $35 | |
| b. | An increase of $105 | |
| c. | An increase of $35 | |
| d. | A decrease of $105 | |
| e. | A decrease of $15 |
1.
12.12. The term fiscal policy refers to
Answer
| a. | the adjustment of the GDP for inflation. | |
| b. | the purchase and sale of U.S. government securities to regulate the money supply. | |
| c. | the use of government spending and taxation to influence the level of economic growth and inflation. | |
| d. | the use of fines to penalize unfair business practices. | |
| e. | a policy action by Congress to overrule unpopular budget cuts by the president. |
13. If aggregate demand intersects aggregate supply in the vertical range of the aggregate supply curve, then, other things equal, an increase in government spending will
Answer
| a. | raise the price level and leave real GDP unchanged. | |
| b. | raise real GDP by the amount indicated by the government spending multiplier and leave the price level unchanged. | |
| c. | raise both real GDP and the price level by a multiple of the initial spending increase. | |
| d. | have no effect on real GDP or on the price level, because all private investment will be crowded out. | |
| e. | lower real GDP by an amount equal to the spending increase and reduce inflation. |
14. Which of the following is not a means to finance government spending?
Answer
| a. | Government subsidies | |
| b. | Government debt | |
| c. | Capital gains taxes | |
| d. | Personal income taxes | |
| e. | Money creation |
15. An automatic stabilizer is
Answer
| a. | a change in government spending aimed at achieving a policy goal. | |
| b. | an element of fiscal policy that automatically changes in value as real GDP changes. | |
| c. | an element of monetary policy that automatically changes in value as real GDP changes. | |
| d. | a decrease in tax rates as the economy moves into a recession. | |
| e. | a deliberate change in taxation aimed at increasing real GDP. |
16. Budget deficits tend to grow during recessions because
Answer
| a. | real GDP growth is zero, which causes neither tax receipts nor government expenditures to grow. | |
| b. | real GDP growth is positive, which reduces both tax receipts and transfer payments. | |
| c. | real GDP growth is negative, which reduces transfer payments in relation to tax receipts. | |
| d. | real GDP growth is negative, which reduces tax receipts in relation to government expenditures. | |
| e. | real GDP growth is positive, which increases tax receipts in relation to government expenditures. |
TRUE / FALSE
1. True False In the aggregate expenditures model presented in the textbook,
investment is assumed to rise with increases in real GDP and fall with decreases in real GDP.
2. True False When C + Ig = GDP in a private closed economy, S = Ig and there are no unplanned changes in inventories.
3. True False The risk-free interest rate is the rate on long-term U.S. government bonds.
4. True False Bond prices and interest rates are directly or positively related.
5. True False The public debt is the accumulation of all deficits and surpluses that have occurred through time.
6. True False The M2 money supply may be larger or smaller than the M1 money supply depending on the size of small-denominated time deposit balances and Money Market Mutual Fund balances held by individuals.
7. True False Excess reserves are the amount by which required reserves exceed actual reserves.
8. True False The public debt is held as Treasury bills, Treasury notes, Treasury bonds, and U.S. savings bonds.
9. True False The equilibrium price level and equilibrium level of real GDP occur at the intersection of the aggregate demand curve and the aggregate supply curve.
10. True False Investment is highly stable; it increases over time at a very steady rate.
MULTIPLE CHOICE
11. A recessionary expenditure gap is:
A. the amount by which the full-employment GDP exceeds the level of aggregate expenditures.
B. the amount by which equilibrium GDP falls short of the full-employment GDP.
C. the amount by which investment exceeds saving at the full-employment GDP.
D. the amount by which aggregate expenditures exceed the full-employment level of GDP.
12. The multiplier effect indicates that:
A. a decline in the interest rate will cause a proportionately larger increase in investment.
B. a change in spending will change aggregate income by a larger amount.
C. a change in spending will increase aggregate income by the same amount.
D. an increase in total income will generate a larger change in aggregate expenditures.
13. Which one of the following is true about the U.S. Federal Reserve System?
- There are 12 regional Federal Reserve Banks.
B. The head of the U.S. Treasury also chairs the Federal Reserve Board.
C. There are 14 members of the Federal Reserve Board.
D. The Open Market Committee is smaller in size than the Federal Reserve Board.
14. If the nominal interest rate is 18 percent and the real interest rate is 6 percent, the inflation rate is:
A. 18 percent.
B. 24 percent.
C. 12 percent.
D. 6 percent.
15.
Refer to the above diagram for a private closed economy. The equilibrium level of GDP is:
A. $400.
B. $300.
C. $200.
D. $100.
16. Which of the following represents the most expansionary fiscal policy?
A. a $10 billion tax cut
B. a $10 billion increase in government spending
C. a $10 billion tax increase
D. a $10 billion decrease in government spending
17.
Refer to the above table. The economy shown is a:
A. private economy.
B. private open economy.
C. mixed closed economy.
D. mixed open economy.
18. Currency held in the vault of First National Bank is:
A. counted as part of M1.
B. counted as part of M2, but not M1.
C. only counted as part of M1 if it was deposited into a checking account.
D. not counted as part of the money supply.
19. If the dollar appreciates relative to foreign currencies, we would expect:
A. the multiplier to decrease.
B. the country's exports and imports to both fall.
C. the country's net exports to rise.
D. the country's net exports to fall.
20. The most important determinant of consumption and saving is the:
A. level of bank credit.
B. level of income.
C. interest rate.
D. price level.
21. The multiple by which the commercial banking system can increase the supply of money on the basis of each dollar of excess reserves is equal to:
A. the reciprocal of the required reserve ratio.
B. 1 minus the required reserve ratio.
C. the reciprocal of the income velocity of money.
D. 1/MPS.
22. Which one of the following would not shift the aggregate demand curve?
A. a change in the price level
B. depreciation of the international value of the dollar
C. a decline in the interest rate at each possible price level
D. an increase in personal income tax rate
23. The cyclically-adjusted budget tells us:
A. that in a full-employment economy the Federal budget should be in balance.
B. that tax revenues should vary inversely with GDP.
C. what the size of the Federal budget deficit or surplus would be if the economy was at full
employment.
D. the actual budget deficit or surplus realized in any given year.
24. The aggregate supply curve:
A. is explained by the interest rate, real-balances, and foreign purchases effects.
B. gets steeper as the economy moves from the top of the curve to the bottom of the curve.
C. shows the various amounts of real output that businesses will produce at each price level.
D. is downsloping because real purchasing power increases as the price level falls.
25.
Refer to the above diagram. If the equilibrium price level is P1, then:
A. aggregate demand is AD2.
B. the equilibrium output level is Q3.
C. the equilibrium output level is Q2.
D. producers will supply output level Q1
26. Discretionary fiscal policy refers to:
A. any change in government spending or taxes that destabilizes the economy.
B. the authority that the President has to change personal income tax rates.
C. intentional changes in taxes and government expenditures made by Congress to stabilize the economy.
D. the changes in taxes and transfers that occur as GDP changes.
27.
Refer to the above diagram. Which tax system has the most built-in stability?
A. T4
B. T3
C. T2
D. T1
28.
| Refer to the given graph. A shift of the consumption schedule from C1 to C2 might be caused by a(n):
|
29. When a bank loan is repaid the supply of money:
A. is constant, but its composition will have changed.
B. is decreased.
C. is increased.
D. may either increase or decrease.
30. The Federal budget deficit is found by:
A. subtracting government tax revenues plus government borrowing from government spending in a particular year.
B. subtracting government tax revenues from government spending in a particular year.
C. cumulating the differences between government spending and tax revenues over all years since the nation's founding.
D. subtracting government revenues from the noninvestment-type government spending in a particular year.
31.
Refer to the above information. Money supply M1 for this economy is:
A. $ 60.
B. $ 70.
C. $ 130.
D. $ 140.
32. Which of the following statements is true as a result of Federal Reserve efforts to rescue the financial industry from the financial crisis of 2007 and 2008?
- From February 2008, to May 2009, the Fed oversaw the consolidation of 20 major financial institutions into fewer than a dozen.
B. From March 2008, to February 2009, the Fed experienced a 50 percent decline in the value of assets held.
C. From February 2008, to March 2009, Fed assets more than doubled to nearly $2 trillion.
D. From February 2008, to March 2009, Fed lending caused the U.S. public debt to rise by over $1 trillion.
33. Which of the following is the basic economic policy function of the Federal Reserve Banks?
- holding the deposits or reserves of commercial banks
B. acting as fiscal agents for the Federal government
C. controlling the supply of money
D. the collection or clearing of checks among commercial banks
34. In a fractional reserve banking system:
A. bank panics cannot occur.
B. the monetary system must be backed by gold.
C. banks can create money through the lending process.
D. the Federal Reserve has no control over the amount of money in circulation.
| 35. |
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36. Assume the Continental National Bank's balance statement is as follows:
Assuming a legal reserve ratio of 20 percent, how much in excess reserves would this bank have after a check for $10,000 was drawn and cleared against it?
A. $ 3,000
B. $ 24,000
C. $ 6,000
D. $ 16,000
37. Answer the question on the basis of the following table for a commercial bank or thrift:
Refer to the above table. When the legal reserve ratio is 25 percent, the excess reserves of this single bank are:
A. $0.
B. $1,000.
C. $5,000.
D. $30,000.
38. Which of the following is a tool of monetary policy?
A. open market operations
B. changes in banking laws
C. changes in tax rates
D. changes in government spending
39. An increase in nominal GDP increases the demand for money because:
A. interest rates will rise.
B. more money is needed to finance a larger volume of transactions.
C. bond prices will fall.
D. the opportunity cost of holding money will decline.
40. Answer the next question on the basis of the following table:
At equilibrium in the above market for money, the total amount of money demanded is:
A. $500.
B. $480.
C. $460.
D. $440.
41. For most financial assets investors must be compensated for:
A. non-diversifiable and diversifiable risk.
B. diversifiable risk and time preference.
C. non-diversifiable risk and time preference.
D. non-diversifiable and diversifiable risk, and time preference.
42. Reserves must be deposited in the Federal Reserve Banks by:
A. only commercial banks which are members of the Federal Reserve System.
B. all depository institutions, that is, all commercial banks and thrift institutions.
C. state chartered commercial banks only.
D. federally chartered commercial banks only.
43.
|
Refer to the diagrams. Assuming a constant price level, an increase in aggregate expenditures from AE1to AE2 would:
|
44. The discount rate is the interest:
A. rate at which the central banks lend to the U.S. Treasury.
B. rate at which the Federal Reserve Banks lend to commercial banks.
C. yield on long-term government bonds.
D. rate at which commercial banks lend to the public.
45. What concept describes how quickly an investment increases in value when interest is paid not only on the original amount invested, but also on the accumulated interest payments?
A. present value
B. future value
C. compound interest
D. real rate of interest
46. The aggregate demand curve:
A. is upsloping because a higher price level is necessary to make production profitable as production costs rise.
B. is downsloping because production costs decline as real output increases.
C. shows the amount of expenditures required to induce the production of each possible level of real output.
D. shows the amount of real output that will be purchased at each possible price level.
47. The Security Market Line depicts the relationship between the:
A. average expected rate of return on stocks and the average expected rate of return on bonds.
B. average expected rate of return of a financial asset and the discount rate.
C. risk level of a financial asset and the prime interest rate.
D. average expected rate of return and risk level of a financial asset.
48. Arbitrage causes all financial assets:
A. of the same risk level to have the same price.
B. to have the same expected rate of return.
C. to have the same beta.
D. of the same risk level to have the same average expected rate of return.
| 49. |
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50. Given the expected rate of return on all possible investment opportunities in the economy:
A. an increase in the real rate of interest will reduce the level of investment.
B. a decrease in the real rate of interest will reduce the level of investment.
C. a change in the real interest rate will have no impact on the level of investment.
D. an increase in the real interest rate will increase the level of investment.
END OF THE EXAM