bade fomac7a v2 crc

Test Bank to Accompany

Foundations of Macroeconomics

Volume 2 Seventh Edition

by

Bade/Parkin

Pearson Education

c.2015 6/9/14

Contents Chapter 8 Potential GDP and the Natural Unemployment Rate ................................................ 723

Chapter 9 Economic Growth ............................................................................................................ 799

Chapter 10 Finance, Saving, and Investment ................................................................................... 877

Chapter 11 The Monetary System ..................................................................................................... 973

Chapter 12 Money, Interest, and Inflation ..................................................................................... 1085

Chapter 13 Aggregate Supply and Aggregate Demand ............................................................... 1172

Chapter 8 Potential GDP and theNatural Unemployment Rate

8.1 Potential GDP

1) The Classical macroeconomic model proposes that

A) government intervention is required to help the economy reach its potential.

B) real GDP equals potential GDP as long as inflation equals zero.

C) changes in the quantity of money are critical in driving economic growth.

D) markets work efficiently to produce the best macroeconomic outcomes.

E) socialism produces the most efficient economic outcomes for a society.

Answer: DTopic: Macroeconomic modelsSkill: Level 4: Applying modelsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

2) The Keynesian macroeconomic model states that

A) the economy is inherently unstable and government intervention is required to maintain

continued economic growth.

B) markets work efficiently to produce the best macroeconomic outcomes.

C) fluctuations in the quantity of money are responsible for most economic recessions.

D) changes in technology generate business cycles.

E) the economy is fairly stable.

Answer: ATopic: Macroeconomic modelsSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

3) According the Keynesian macroeconomic model, which of the following was responsible for

starting the Great Depression?

A) too little private spending

B) too little government spending

C) high taxes

D) decreases in the quantity of money

E) decreases in technology


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Copyright © 2015 Pearson Education, Inc.

4) Which of the following ideas reflect the Monetarist macroeconomic model?

i) The Monetarist model supports the Classical model, in general.

ii) Decreases in the growth rate of the quantity of money trigger recessions.

iii) Government intervention is an appropriate tool to steady the economy.

A) i and ii

B) i only

C) i, ii and iii

D) ii and iii

E) i and iii


5) The Monetarist model expands the Keynesian model by proposing that

A) decreases in the quantity of money lead to higher interest rates.

B) the government should lower taxes promote economic growth.

C) decreases in tax rates generate higher consumption.

D) decreases in the growth rate of the quantity of money trigger expansions by controlling

inflation.

E) markets should be left alone to determine the optimal outcome.


6) The Lucas Wedge shows

A) the negative impact a slowdown in real GDP growth has on potential GDP.

B) the increased impact of government spending on real GDP.

C) the negative impact inflation has on consumer spending.

D) the positive impact lower taxes have on real GDP.

E) whether a country needs to slow its real GDP growth rate.

Answer: ATopic: Eye on the U.S. economySkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Written and oral communication

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7) The Lucas Wedge is estimated to

A) total over $406,000 per person as a result of the slowdown in the growth rate of real GDP.

B) have reached about $13,000 per person in the last year.

C) be about 2 percent of real GDP per year.

D) be negative due to the severe recession in 2008-2009.

E) be positive in some years and negative in others.

Answer: ATopic: Eye on the U.S. economySkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: RevisedAACSB: Written and oral communication

8) Which of the following would have the biggest payoff?

A) restoring real GDP growth to its 1960s growth rate

B) eliminating the Okun Gap

C) increasing the Okun Gap

D) making the Okun Gap equal the Lucas Wedge

E) increasing the Lucas Wedge

Answer: ATopic: Eye on the U.S. economySkill: Level 4: Applying modelsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

9) The level of real GDP the economy produces at full employment is called

A) sustainable GDP.

B) nominal GDP.

C) potential GDP.

D) maximum GDP.

E) Lucas GDP.

Answer: CTopic: Potential GDPSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: RevisedAACSB: Reflective thinking

10) The level of real GDP the economy produces at full employment is

A) nominal GDP.

B) potential GDP.

C) never reached in reality.

D) called the Lucas level.

E) real GDP.

Answer: BTopic: Potential GDPSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: RevisedAACSB: Reflective thinking

Page 725


11) Suppose that Australia has fully employed all of its resources. This situation means that

Australia

A) is operating at its potential GDP.

B) is growing at a faster rate than the United States.

C) has a negative Okun Gap.

D) has a positive Lucas Wedge.

E) is experiencing zero unemployment.

Answer: ATopic: Potential GDPSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

12) If the economy is fully employed, which of the following is true?

A) The price level equals 100.

B) Real and nominal GDP are equal.

C) Real and potential GDP are equal.

D) The unemployment rate is zero.

E) Real GDP cannot increase.

Answer: CTopic: Potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

13) Potential GDP is the level of

A) real GDP that the economy would produce if it was at full employment.

B) nominal GDP that the economy would produce if it was at full employment.

C) real GDP that the economy would produce if there was no inflation.

D) nominal GDP that the economy would produce if there was no inflation.

E) real GDP that the economy would produce if there was no unemployment.

Answer: ATopic: Potential GDPSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

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14) Potential GDP is

A) equal to the maximum amount of goods and services that can be produced at any given

time.

B) another name for real GDP.

C) the level of output produced when the economy is fully employed.

D) a measure of the short term fluctuations in real GDP.

E) another name for nominal GDP.

Answer: CTopic: Potential GDPSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

15) Potential GDP

A) is the same as real GDP.

B) is the same as nominal GDP.

C) is another name for the Lucas Wedge.

D) is the level of output produced when the economy is fully employed.

E) shows that the Okun Gap vastly exceeds the Lucas Wedge.

Answer: DTopic: Potential GDPSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

16) If New Zealand is operating at potential GDP, which of the following is true?

i) New Zealand only has frictional and structural unemployment.

ii) There is no inflation in New Zealand.

iii) New Zealand has positive net exports.

A) i, ii and iii

B) i only

C) i and ii

D) i and iii

E) ii only

Answer: BTopic: Potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

27


17) The idea that potential GDP is the sustainable upper limit of production means that

A) real GDP may be temporarily larger than potential GDP, but not permanently.

B) the economy is operating environmentally efficiently.

C) real GDP may be temporarily less than potential GDP.

D) inflation must always occur in a growing economy.

E) unemployment can only temporarily be zero in a healthy economy.

Answer: ATopic: Potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

18) Suppose an economist stated that Brazil had achieved its potential GDP 2013. This would

imply that at this level of real GDP, Brazil experienced

A) peak in its business cycle in 2013.

B) unemployment equal to zero.

C) inflation equal to zero.

D) full employment.

E) a negative Okun Gap.


19) Suppose Germanyʹs economy is experiencing full employment. This means that, in Germany,

A) the unemployment rate is equal to zero.

B) real GDP is equal to potential GDP.

C) real GDP is greater than potential GDP.

D) potential GDP is greater than real GDP.

E) real GDP equals nominal GDP.


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20) At full employment, actual ________ equals ________.

A) nominal GDP; potential GDP

B) real GDP; potential GDP

C) real GDP; nominal GDP

D) potential GDP; nominal GDP

E) unemployment; zero


21) Which of the following is true?

A) Real GDP fluctuates around potential GDP.

B) Potential GDP fluctuates around nominal GDP.

C) Nominal GDP fluctuates around real GDP.

D) Real GDP never equals potential GDP.

E) The Okun Gaps are much larger than the Lucas Wedge.


22) Over the business cycle, real GDP fluctuates around

A) the business cycle trough.

B) the business cycle peak.

C) nominal GDP.

D) potential GDP.

E) the Lucas Wedge.


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23) Which of the following statement or statements are correct about potential GDP?

i. Actual real GDP equals potential GDP when the economy is at full employment.

ii. Real GDP can be less than potential GDP.

iii. When real GDP equals potential GDP, it also equals nominal GDP.

A) i only

B) ii only

C) ii and iii

D) i and ii

E) i, ii, and iii


24) Choose which statement is most correct.

A) Real GDP can never exceed potential GDP.

B) Real GDP must always equal potential GDP.

C) At times, real GDP can exceed potential GDP.

D) Nominal GDP can never exceed potential GDP.

E) Nominal GDP must always equal potential GDP.

Answer: CTopic: Above full-employment equilibrium

Skill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

25) The amount of real GDP produced at any one time depends on

i) a fixed amount of capital.

ii) a fixed level of technology.

iii) decisions people make about leisure versus working.

A) ii only

B) ii and iii

C) i and ii

D) i only

E) i, ii and iii

Answer: ETopic: Production functionSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

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26) The sustainable upper limit of real GDP is a level of GDP that is

A) greater than potential GDP, but by how much greater is unknown and controversial.

B) less than potential GDP, but by how much less is unknown and controversial.

C) potential GDP.

D) determined only by what is the full employment equilibrium in the labor market.

E) None of the above answers is correct because there is no sustainable upper limit to real

GDP because real GDP can always be increased.


27) As an economic expansion approaches its peak, it is very likely that real GDP will

A) exceed nominal GDP.

B) exceed potential GDP.

C) equal nominal GDP but not potential GDP.

D) be less than potential GDP.

E) equal nominal GDP and equal potential GDP.


28) During a business cycle recession, it is very likely that real GDP will

A) exceed nominal GDP.

B) be less than potential GDP.

C) equal nominal GDP but not equal potential GDP.

D) equal nominal GDP and equal potential GDP.

E) be greater than potential GDP.


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29) A country reports that its actual real GDP is greater than its potential GDP. It must be that

A) an error was made when calculating actual real GDP.

B) the price level is increasing.

C) more workers decided to quit work in order to enjoy leisure time.

D) the excess by which real GDP exceeds potential GDP is only temporary, and eventually

real GDP will decrease to be equal to potential GDP.

E) None of the above answers is correct because it is impossible for a countryʹs real GDP to

exceed its potential GDP.

Answer: DTopic: Potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

30) A countryʹs potential GDP is determined, in part, by

A) the equilibrium price level.

B) demand and supply in the labor market.

C) the Lucas Wedge.

D) actual real GDP.

E) the Okun Gap.

Answer: BTopic: Production function and labor market basicsSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

31) To determine GDP from the production function, we need to know

A) the quantity of labor employed.

B) the quantity of labor available for work.

C) the unemployment rate.

D) the quantity of labor supplied by firms.

E) the real wage rate.

Answer: ATopic: Production function and labor market basicsSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

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32) At any given time, which factor of production is NOT fixed?

A) labor

B) technology

C) entrepreneurship

D) land

E) money

Answer: ATopic: Production functionSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

33) The production function is a relationship between the amount of labor employed and

A) the maximum quantity of real GDP that can be produced.

B) the maximum quantity of nominal GDP that can be produced.

C) the wage rate paid to the workers.

D) all other resources at different levels of employment.

E) the amount of labor workers supply.


34) The production function describes the relationship between

A) the real wage and the quantity of labor supplied.

B) real GDP and the quantity of labor employed.

C) real and potential GDP.

D) real and nominal GDP.

E) potential GDP and the real wage rate.

Answer: BTopic: Production functionSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

35) The ________ describes the relationship between the amount of labor employed and real GDP.

A) production function

B) production possibilities frontier

C) Lucas Wedge

D) inflation rate

E) Okun Gap


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36) The production function shows that potential GDP increases when the

A) price level rises.

B) price level falls.

C) inflation rate falls.

D) quantity of labor employed increases.

E) the wage rate falls.

Answer: DTopic: Production functionSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

37) The production function displays

A) increasing returns.

B) real returns.

C) diminishing returns.

D) average returns.

E) normal returns.

Answer: CTopic: Diminishing returnsSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

38) Diminishing returns means that

A) each additional unit of labor produces successively less real GDP.

B) hiring more labor results in less real GDP.

C) each extra unit of real GDP produced requires less labor.

D) each additional unit of labor produces successively more real GDP.

E) hiring more labor must lower the real wage rate.

Answer: ATopic: Diminishing returnsSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

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39) The idea of ʺdiminishing returnsʺ means that real GDP ________ as the quantity of labor

increases.

A) increases at a slower rate

B) decreases at a slower rate

C) increases at a faster rate

D) decreases at a faster rate

E) does not change


40) According to the production function, as the quantity of labor employed increases, real GDP

increases

A) at an increasing rate.

B) at a decreasing rate.

C) at a constant rate.

D) and then eventually decreases.

E) until it reaches potential GDP, and then it no longer changes.

Answer: BTopic: Diminishing returnsSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

41) As additional units of labor hours are employed, holding all other factors constant, along the

production function,

A) real GDP increases at an increasing rate.

B) nominal GDP decreases at an increasing rate.

C) real GDP increases at a decreasing rate.

D) real GDP increase at a constant rate.

E) real GDP initially decreases and then starts to increase.

Answer: CTopic: Diminishing returnsSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

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42) The idea that the production function exhibits _______implies that ________.

A) diminishing returns; the Lucas Wedge increases at output increases

B) diminishing returns; each additional unit of labor employed generates an

ever-decreasing amount of real GDP

C) increasing returns; potential GDP is always increasing

D) increasing returns; output should increase steadily as technology grows

E) constant returns; each additional unit of labor employed generates an increasing amount

of real GDP

Answer: BTopic: Diminishing returnsSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

43) As the quantity of labor employed increases, the production functions exhibits a

A) positive, linear relationship.

B) positive relationship, with each additional unit of labor producing less additional real

GDP.

C) positive relationship, with each additional unit of labor producing more additional real

GDP.

D) negative, linear relationship.

E) U-shaped curve.

Answer: BTopic: Diminishing returnsSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

44) Diminishing returns along a production function means that each additional hour of labor

employed

A) produces a successively smaller additional amount of real GDP.

B) produces a successively larger additional amount of real GDP.

C) produces a constant additional amount of real GDP.

D) does not produce any additional real GDP.

E) forces the real wage rate to rise.


Page 736


45) The production function shows that as employment increases, real GDP

A) increases at an increasing rate.

B) increases at a decreasing rate.

C) increases at a constant rate.

D) decreases at a decreasing rate.

E) increases until it reaches potential GDP and then it starts to decrease.

Answer: BTopic: Diminishing returnsSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

46) Diminishing returns, so that each additional hour of labor employed produces successively

smaller additional amounts of real GDP, exist because

A) labor is not very productive.

B) extra labor produces more output.

C) all other factors are held fixed.

D) the price level rises as more workers are employed.

E) additional workers are paid higher wage rates.


47) As more labor is hired, moving along the production function, diminishing returns occur

because

A) workers are overworked and so their productivity decreases.

B) the wage rate paid is too low and so workers decrease their work effort.

C) there are fixed quantities of other resources.

D) the real wage rate must increase in order to hire additional workers.

E) real GDP increases more rapidly the more workers are hired.

Answer: CTopic: Diminishing returnsSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Page 737


48) A reason a nation faces diminishing returns along a production function is because

A) unemployment always exists.

B) potential GDP is fixed.

C) the quantity of physical capital is fixed.

D) full employment is not possible.

E) the wage rate is fixed while moving along the production function.


49) ________ in the United States ________ in most European countries.

A) GDP per hour; is greater than GDP per hour

B) Average weekly hours; are greater than average weekly hours

C) The Okun Gap; is equal to the Okun Gap

D) The Lucas Wedge; is greater than the Lucas Wedge

E) Both A and B are true.

Answer: ETopic: Eye on the global economy, why do Americans earn moreSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Written and oral communication

50) The gap in GDP between the United States and Europe can be explained by the fact that

A) U.S. labor is more productive than European labor.

B) prices are higher in the United States.

C) the Okun Gap is larger in the United States.

D) income taxes are higher in the United States.

E) equilibrium employment is higher in Europe.

Answer: ATopic: Eye on the global economy, why do Americans earn moreSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Written and oral communication

Page 738


51) Employing an additional 1 billion hours of labor increases real GDP by $12 billion. Employing

another 1 billion hours beyond the first 1 billion increases real GDP by $11 billion. Hence we

can conclude from this information that as employment increases, real GDP

A) increases at an increasing rate.

B) decreases at an increasing rate.

C) decreases at a decreasing rate.

D) increases at a decreasing rate.

E) falls from $12 billion to $11 billion as more workers are hired.

Answer: DTopic: Diminishing returnsSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

52) If adding an initial 100 billion labor hours per year increases real GDP by $3 trillion,

diminishing returns informs us that an additional 100 billion labor hours per year will increase

real GDP by

A) exactly $3 trillion.

B) less than $3 trillion.

C) more than $3 trillion.

D) either exactly $3 trillion or by less than $3 trillion, depending on whether the real wage

rate remains constant or rises.

E) some amount but there is not enough information to tell by how much.

Answer: BTopic: Diminishing returnsSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

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Labor

(billions of hours

per year)

Real GDP

(trillions of

2009 dollars

70

90

110

130

150

4.0

4.7

5.2

5.4

5.5

53) The table above gives a nationʹs production function. Which of the following is NOT an

attainable combination of real GDP and labor?

A) real GDP of $4.0 trillion and labor of 90 billion hours per year

B) real GDP of $4.7 trillion and labor of 110 billion hours per year

C) real GDP of $4.0 trillion and labor of 70 billion hours per year

D) real GDP of $5.2 trillion and labor of 90 billion hours per year

E) real GDP of $5.5 trillion and labor of 150 billion hours per year

Answer: DTopic: Production functionSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

54) In 2011, real GDP in the United States was $60 per hour worked. In major European

economies, real GDP averaged on $48 per hour worked. This difference is explained by the

points that ________ and ________.

A) Americans work more hours than Europeans; Americans produce more per hour than

Europeans

B) Americans are equally as productive as Europeans; Americans work more hours on

average

C) Americans work the same number of hours per week as Europeans on average;

Americans are less productive due to technology differences

D) Americans take more vacations than Europeans; Americans take more sick days than

Europeans

E) Americans work less hours than Europeans; Americans take less sick days than

Europeans

Answer: ATopic: Real GDPSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: NewAACSB: Application of knowledge

Page 740


55) The above figure shows a nationʹs production function. Point A is

A) attainable if the economy is inefficient.

B) unattainable given the state of the economy.

C) attainable if the nation uses resources efficiently.

D) the maximum amount of real GDP the nation can produce.

E) the labor market equilibrium quantity of employment and real GDP.

Answer: BTopic: Production functionSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

56) The above figure shows a nationʹs production function. Point B is

A) unattainable.

B) attainable if the nation uses resources inefficiently.

C) attainable if the nation uses resources efficiently.

D) the maximum amount of real GDP the nation can ever produce.

E) Both answers C and D are correct.

Answer: CTopic: Production functionSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

Page 741


57) The above figure shows a nationʹs production function. Point C is

A) unattainable given the nationʹs resource level.

B) attainable if the nation uses resources efficiently.

C) attainable if the nation uses resources inefficiently.

D) the maximum amount of real GDP the nation can produce.

E) the labor market equilibrium point.

Answer: CTopic: Production functionSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

58) The above figure shows a nationʹs production function. Point B is ________ and ________

because ________.

A) attainable; efficient; the nation is using resources efficiently

B) attainable; inefficient; the nation is using resources inefficiently

C) unattainable; inefficient; the nation is using resources inefficiently

D) unattainable; inefficient; the nation is using resources efficiently but they could be more

efficient

E) unattainable; efficient; the nation would be using resources efficiently if they could attain

this level of production

Answer: ATopic: Production functionSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: NewAACSB: Analytical thinking

59) The above figure shows a nationʹs production function. Point C is ________ and ________

because ________.

A) attainable; inefficient; the nation is using resources inefficiently

B) attainable; efficient; the nation is using resources efficiently

C) unattainable; inefficient; the nation is using resources inefficiently

D) unattainable; inefficient; the nation is using resources efficiently but they could be more

efficient

E) unattainable; efficient; the nation would be using resources efficiently if they could attain

this level of production

Answer: ATopic: Production functionSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: NewAACSB: Analytical thinking

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60) The above figure that most accurately shows a production function is

A) Figure A.

B) Figure B.

C) Figure C.

D) Figure D.

E) Both Figure A and Figure B; Figure A for an economy with an excess of labor and Figure

B for an economy with a shortage of labor.


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61) Based on the production function in the above figure, which of the following is an attainable

combination of labor and real GDP?

i. 300 billion hours of labor and real GDP of $20 trillion

ii. 300 billion hours of labor and real GDP of $8 trillion

iii. 100 billion hours of labor and real GDP of $12 trillion

A) i only B) ii only C) iii only D) ii and iii E) i and ii


62) Suppose that the Australian economy initially uses 50 billion hours of labor to produce $5

trillion of real GDP. If 50 billion more hours are employed and Australiaʹs real GDP increases

by $4 trillion more,

A) Australiaʹs production function exhibits diminishing returns.

B) Australiaʹs production function exhibits increasing returns.

C) Australia has an Okun Wedge of $1 trillion.

D) Australia has positive Lucas Wedge.

E) Australiaʹs production possibility frontier has a positive slope.

Answer: ATopic: Production functionSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

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63) The real wage rate is the ________ divided by the ________.

A) quantity of labor demanded; quantity of labor supplied

B) nominal wage rate; price level

C) quantity of labor supplied; quantity of labor demanded

D) nominal wage rate; inflation rate

E) equilibrium quantity of employment; potential GDP

Answer: BTopic: Real wage rateSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

64) Suppose the price of a product is $4 and the nominal wage that the firm must pay is $20. Then

the firmʹs real wage is

A) $20. B) $80. C) $5. D) $0.20. E) $4.

Answer: CTopic: Real wage rateSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

65) The benefit to the firm of hiring another worker is

A) the nominal wage.

B) the price level.

C) the real wage.

D) the extra output produced by the worker.

E) measured as the height of the production function.

Answer: DTopic: Demand for laborSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

66) The quantity of labor demanded is the labor hours all

A) firms plan to hire at a given real wage rate.

B) firms plan to hire at a given nominal wage rate.

C) employees plan to work at a given real wage rate.

D) employees plan to work at a given nominal wage rate.

E) Both answers A and C are correct.

Answer: ATopic: Demand for laborSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

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67) The total labor hours that all the firms in the economy plan to hire during a given time period

at one particular real wage rate is the

A) demand for labor.

B) quantity of labor demanded.

C) supply of labor.

D) quantity of labor supplied.

E) quantity of jobs supplied.

Answer: BTopic: Demand for laborSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

68) If the real wage rate decreases from $14.00 per hour to $13.00 per hour, the

A) quantity demanded of labor increases.

B) demand for labor increases.

C) quantity supplied of labor increases.

D) supply of labor increases.

E) equilibrium quantity of employment must decrease.

Answer: ATopic: Demand for laborSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

69) When all other influences on firmsʹ hiring plans remain the same, the

A) lower the real wage rate, the greater is the quantity of labor supplied

B) higher the real wage rate, the greater is the quantity of labor demanded.

C) lower the real wage rate, the smaller is the quantity of labor demanded.

D) lower the real wage rate, the greater is the quantity of labor demanded.

E) None of the above answers is correct because firmsʹ hiring decisions depend on how

profitable hiring a worker is, which depends on how much added profit the worker can

create.

Answer: DTopic: Demand for laborSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

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70) The lower the real wage rate, the

A) fewer workers firms can profitably hire.

B) more workers firms can profitably hire.

C) more workers will supply labor.

D) higher the nominal wage rate.

E) larger the quantity of labor supplied.

Answer: BTopic: Demand for laborSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

71) The demand for labor reflects the point that the

A) lower the real wage rate, the greater the quantity of labor demanded.

B) higher the real wage rate, the greater the quantity of labor demanded.

C) real wage rate does not affect the quantity demanded of labor.

D) nominal wage rate and not the real wage rate determines the quantity of labor

demanded.

E) demand for labor depends on the supply of labor.


72) An increase in the real wage rate ________ the quantity of labor demanded and ________ the

quantity of labor supplied.

A) increases; increases

B) increases; decreases

C) decreases; increases

D) decreases; decreases

E) does not change; does not change

Answer: CTopic: Demand for labor, supply of laborSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Page 747


73) The demand for labor curve is

A) a vertical line because firms have to hire labor.

B) upward sloping, showing that as the real wage rate increases, more workers are hired.

C) a horizontal line because we assume that the real wage rate is fixed.

D) downward sloping, showing that the quantity of labor demanded increases when the

real wage falls.

E) U-shaped.

Answer: DTopic: Demand for laborSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

74) A firmʹs demand for labor depends on the

A) nominal wage rate because it pays workers in dollars.

B) real wage rate, which equals the nominal wage divided by the price level.

C) real wage rate, which equals the nominal wage divided by the hours worked.

D) nominal wage rate, which equals the real wage divided by the price level.

E) supply of labor.

Answer: BTopic: Demand for laborSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

75) The quantity of labor demanded by a firm depends upon

A) the nominal wage rate not the real wage rate.

B) the real wage rate not the nominal wage rate.

C) both the real wage rate and the nominal wage rate.

D) neither the real wage rate nor the nominal wage rate.

E) either the real wage rate or the nominal wage rate, depending whether the price level is

increasing or decreasing.


Page 748


76) A firm hires labor up to the point where the

A) real wage rate equals the nominal wage rate.

B) additional hour of labor produces extra output that equals the real wage rate.

C) additional hour of labor produces extra output that equals the nominal wage rate.

D) firm can sell the extra output.

E) real wage rate exceeds the nominal wage rate.


77) Firms hire more labor as long as

A) the real wage rate is less than the additional output the labor produces.

B) the real wage rate is greater than the additional output the labor produces.

C) extra labor will produce more output.

D) the nominal wage rate exceeds the real wage rate.

E) the nominal wage rate is less than the real wage rate.


78) As long as an additional worker hired by a firm produces

A) more output than the real wage rate, the firm will hire that worker.

B) more output than the real wage rate, the firm will not hire that worker.

C) less output than the real wage rate, the firm will hire that worker.

D) some output, the firm will hire that worker.

E) more output than the nominal wage rate, the firm will hire that worker.

Answer: ATopic: Demand for laborSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

79) Hershey Chocolate Factory pays a money wage rate equal to $30 per hour and sells its candy

bars for $1.50 each. Hershey Chocolate Factory should hire labor until an additional unit of

labor produces ________ candy bars an hour.

A) 45 B) 1.5 C) 20 D) 30 E) 10

Answer: CTopic: Demand for laborSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

Page 749


80) The Bubby Gum factory produces bubble gum. Joanne is one of the employees, and she

produces 10 packs of bubble gum per hour. Joanneʹs money wage rate is $12 per hour. Based

on this information, the Bubby Gum company should

A) keep Joanne because she creates a profit for the firm.

B) fire Joanne because she creates a loss for the firm.

C) decrease Joanneʹs wage rate because she is paid too much.

D) increase its demand for labor.

E) None of the above answers is correct because more information about Joanneʹs real wage

is needed to decide what to do.

Answer: ETopic: Demand for laborSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking


produces 10 packs of bubble gum per hour. Joanneʹs money wage rate is $12 per hour. If a

packet of bubble gum sells for $1.00, then

A) Joanne is creating a $2.00 per hour loss for the firm.

B) Joanne is creating a $2.00 per hour profit for the firm.

C) the Bubby Gum company should decrease the price of the bubble gum so it sells more

and makes a larger profit.

D) the Bubby Gum company should pay Joanne more.

E) None of the above answers is correct because more information about Joanneʹs real wage

is needed to decide what to do.

Answer: ATopic: Demand for laborSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking


produces 10 packs of bubble gum per hour. Joanneʹs money wage rate is $12 per hour. If a

packet of bubble gum sells for $1.00, then Joanne ________ because ________.

A) is creating a $2.00 per hour loss for the firm; her real wage rate is more than her output

per hour

B) is creating a $2.00 per hour profit for the firm; her real wage rate is more than her output

per hour

C) should recommend that the Bubby Gum company should decrease the price of the

bubble gum ; it would sell more and bring a larger profit

D) should ask for a raise in pay; then her real wage would be less than her output per hour

E) is the last person the Bubby Gump company will employ; an additional hire would

produce equal the amount of additional labor to real wage per hour

Answer: ATopic: Demand for laborSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: NewAACSB: Reflective thinking

Page 750


83) To maximize profits, firms hire labor as long as

A) each additional hour hired produces more additional output than the real wage rate.

B) the total hours hired produces more additional output than the real wage rate.

C) each additional hour hired produces more additional output than the nominal wage rate.

D) the quantity of labor supplied increases as the real wage rate increases.

E) workers continue to supply labor to the firm.


84) For a household, the opportunity cost of not working is the

A) nominal wage rate.

B) real wage rate.

C) cost of living.

D) price level.

E) demand for labor.

Answer: BTopic: Supply of laborSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

85) Which of the following statements is (are) true?

i. As the real wage rate increases, the householdʹs income decreases, which influences

people to work more hours.

ii. As the real wage rate increases, the quantity of labor demanded increases.

iii. As the real wage rate increases, the opportunity cost of not working increases.

A) i only

B) ii only

C) iii only

D) i and iii

E) i, ii, and iii

Answer: CTopic: Supply of laborSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Page 751


86) As demonstrated by the labor supply schedule, the quantity of labor supplied depends on

A) the nominal wage.

B) the amount of labor that firms want to hire.

C) the real wage.

D) the value of the dollar.

E) workersʹ productivity.


87) The supply of labor is defined as the relationship between the real wage rate and the

A) quantity of labor supplied by firms.

B) amount of jobs supplied by firms.

C) quantity of labor supplied by households.

D) amount of jobs supplied by households.

E) equilibrium quantity of employment.


88) Which of the following statements is true?

A) According to the labor supply curve, as the real wage rises, employers are willing to

provide more jobs.

B) According to the labor supply curve, as the real wage rises, workers are willing to

provide more hours of labor.

C) According to the labor supply curve, as the real wage rises, employers are willing to

provide fewer jobs.

D) According to the labor supply curve, as the real wage rises, workers are willing to

provide fewer hours of labor.

E) According to the labor supply curve, as the real wage rises, more workers leave the labor

force.

Answer: BTopic: Supply of laborSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Page 752


89) Households increase the quantity of labor supplied when the

A) real wage rate rises because the opportunity cost of not working falls.

B) nominal wage rate rises because the real wage rate must also rise.

C) real wage rate rises because the opportunity cost of not working rises.

D) nominal wage rate falls because the opportunity cost of not working rises.

E) income tax rises because an increase in the income tax increases the demand for labor.

Answer: CTopic: Supply of laborSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

90) Households increase the quantity of labor supplied when

A) the real wage rate increases.

B) the real wage rate decreases.

C) job opportunities increase.

D) the nominal wage decreases and the price level rises.

E) income taxes increase.

Answer: ATopic: Supply of laborSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

91) Holding all other influences constant, the quantity of labor supplied in a given time period

depends

A) inversely on the real wage rate so that a higher real wage decreases the quantity of labor

supplied.

B) directly on the real wage rate so that a higher real wage increases the quantity of labor

supplied.

C) inversely on the quantity of labor demanded.

D) on the money wage rate not the real wage rate.

E) directly on the quantity of labor demanded.

Answer: BTopic: Supply of laborSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Page 753


92) When all other influences on work plans remain the same, the

A) lower the real wage rate, the smaller the quantity of labor supplied.

B) higher the real wage rate, the greater the quantity of labor demanded.

C) lower the real wage rate, the greater the quantity of labor supplied.

D) lower the real wage rate, the smaller the quantity of labor demanded.

E) lower the real wage rate, the larger the labor force participation.

Answer: ATopic: Supply of laborSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

93) The quantity of labor supplied increases as the real wage rises because

A) higher real wages mean that nominal wages have increased.

B) the opportunity cost of working increases.

C) the quantity of labor demanded increases.

D) the opportunity cost of leisure rises.

E) labor force participation decreases so that only serious workers are left in the labor force.

Answer: DTopic: Supply of laborSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

94) As the real wage rate rises, the opportunity cost of

A) working rises.

B) saving rises.

C) leisure rises.

D) leisure falls.

E) buying goods and services rises.


95) The labor force participation rate

A) increases as the real wage increases.

B) decreases as the real wage increases.

C) has nothing to do with the real wage rate.

D) increases as the opportunity cost of working increases.

E) is one of the major reasons that firms pay efficiency wages.

Answer: ATopic: Labor force participationSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Page 754


96) The labor market is in equilibrium whenever

A) the nominal wage rate is decreasing.

B) the nominal wage rate is increasing.

C) the nominal wage rate is not changing.

D) the real wage rate is increasing.

E) the quantity of labor demanded equals the quantity of labor supplied.

Answer: ETopic: Labor market equilibriumSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

97) A surplus of labor is eliminated by ________ in the real wage rate and a shortage of labor is

eliminated by ________ in the real wage rate.

A) an increase; an increase

B) an increase; a decrease

C) a decrease; an increase

D) a decrease; a decrease

E) None of the above answers is correct because shortages and surpluses are eliminated by

changes in the demand for labor and the supply of labor, not the wage rate.

Answer: CTopic: Labor market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

98) A surplus in the labor market indicates that the

A) real wage rate is above the equilibrium wage rate but it is too low to eliminate the

surplus of labor.

B) quantity of labor demanded is less than the quantity of labor supplied.

C) real wage rate has to rise before the labor market will reach equilibrium.

D) workers are not looking for work because they enjoy their leisure time.

E) real wage rate is less than the equilibrium wage rate.

Answer: BTopic: Labor market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Page 755


99) When the labor market is in equilibrium so that the quantity of labor supplied equals the

quantity demanded,

A) there is no unemployment.

B) the economy is at full employment.

C) nominal GDP equals real GDP.

D) there is no inflation.

E) real GDP might be more than, less than, or equal to potential GDP.

Answer: BTopic: Labor market equilibriumSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

100) When the labor market is in equilibrium,

i. the quantity demanded of labor equals the quantity supplied.

ii. there is full employment.

iii. potential GDP is produced.

A) i only

B) ii only

C) iii only

D) i and iii

E) i, ii, and iii

Answer: ETopic: Labor market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

101) When the labor market is in equilibrium,

A) there is excess labor supplied, which keeps real GDP less than potential GDP.

B) there is full employment, which means that real GDP equals potential GDP.

C) the real wage rate falls to equal the nominal wage rate because real GDP is greater than

potential GDP.

D) the real wage rate rises to allow real GDP to equal potential GDP.

E) there is full employment but real GDP might be greater than, less than, or equal to

potential GDP.

Answer: BTopic: Labor market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Page 756


102) In a labor market without an efficiency wage, minimum wage, or union wage, when the real

wage rate exceeds the equilibrium real wage rate, there is a ________ of labor and the real

wage rate will ________.

A) surplus; fall

B) shortage; fall

C) shortage; rise

D) surplus; rise

E) surplus; not change because only efficiency wages or union wages can change.

Answer: ATopic: Labor market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Real wage rate

(2009 dollars

per hour)

Quantity of labor

demanded

(billions of hours

per year)

Quantity of labor

supplied

(billions of hours

per year)

40

35

30

25

20

15

200

220

240

260

280

300

320

310

300

290

280

270

103) The table above shows the labor demand and labor supply schedules for a nation. The

equilibrium real wage rate is ________ and the equilibrium quantity of labor is ________

billions of hours per year.

A) $25; 260 B) $20; 280 C) $20; 260 D) $15; 260 E) $40; 320

Answer: BTopic: Labor market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

Page 757


Real wage rate

(2009 dollars)

Quantity of labor

demanded

(billions of hours

per year)

Quantity of labor

supplied

(billions of hours

per year)

50

40

30

20

10

80

90

100

110

120

100

90

80

70

60

Employment

(billions

of hours

per year)

Real GDP

(billions of

2009 dollars)

60

70

80

90

110

2.0

3.0

3.7

4.2

4.5

104) The tables above show a nationʹs labor demand and labor supply schedules and its production

function. The equilibrium real wage rate is ________ and the equilibrium quantity of labor is

________ billion hours per year.

A) $50; 100 B) $40; 90 C) $30; 80 D) $40; 80 E) $20; 110

Answer: BTopic: Full employment and potential GDPSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

105) The tables above show a nationʹs labor demand and labor supply schedules and its production

function. Given the equilibrium in the labor market, potential GDP is

A) $3.0 trillion.

B) $3.7 trillion.

C) $4.2 trillion.

D) $4.5 trillion.

E) $2.0 trillion.

Answer: CTopic: Full employment and potential GDPSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

106) In the United States between the 1970s and the 2000s, the productivity of labor increased. This

increase led to

A) an increase in the demand for labor.

B) an increase in the supply of labor.

C) a downward shift of the production function.

D) a decrease in the supply of labor.

E) no change in either the demand for or the supply of labor.

Answer: ATopic: Demand for laborSkill: Level 4: Applying modelsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Page 758


107) ________ adopts the view that aggregate fluctuations are a natural consequence of an

expanding economy.

A) Classical macroeconomics

B) Keynesian economics

C) The new macroeconomics

D) The Lucas Wedge

E) The Okun Gap

Answer: CTopic: New macroeconomicsSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

108) Potential GDP

A) is the quantity of GDP produced when the economy is at full employment of all

resources.

B) can never be exceeded.

C) can never be attained.

D) is another name for real GDP.

E) is another name for nominal GDP.


109) With fixed quantities of capital, land, and entrepreneurship and fixed technology, the amount

of real GDP produced increases when ________ increases.

i. the quantity of labor employed

ii. the inflation rate

iii. the price level

A) i only

B) ii only

C) iii only

D) ii and iii

E) i, ii, and iii


Page 759


110) The production function graphs the relationship between

A) nominal GDP and real GDP.

B) real GDP and the quantity of labor employed.

C) real GDP and capital.

D) nominal GDP and the quantity of labor employed.

E) real GDP and the supply of labor.

Answer: BTopic: Production functionSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

111) The quantity of labor demanded definitely increases if the

A) real wage rate rises.

B) real wage rate falls.

C) nominal wage rate rises.

D) nominal wage rate falls.

E) supply of labor decreases.


112) The supply of labor curve has a ________ slope because as the real wage rate rises, ________.

A) negative; firms hire fewer workers

B) positive; the opportunity cost of leisure rises

C) positive; the opportunity cost of leisure falls

D) negative; households work more hours

E) positive; firms offer more jobs

Answer: BTopic: Supply of laborSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Page 760


113) The real wage rate is $35 an hour. At this wage rate there are 100 billion labor hours supplied

and 200 billion labor hours demanded. There is a

A) shortage of 300 billion hours of labor.

B) shortage of 100 billion hours of labor.

C) surplus of 100 billion hours of labor.

D) surplus of 300 billion hours of labor.

E) shortage of 200 billion hours of labor.

Answer: BTopic: Labor market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

114) When the labor market is in equilibrium, real GDP ________ potential GDP.

A) is greater than

B) is equal to

C) is less than

D) might be greater than, less than, or equal to

E) is not comparable to

Answer: BTopic: Labor market equilibriumSkill: Level 1: DefinitionSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

115) Compared to the U.S. production function, the European production function is

A) higher.

B) lower.

C) the same.

D) lower than the U.S. production function at low levels of employment and higher than the

U.S. production function at high levels of employment.

E) higher than the U.S. production function at low levels of employment and lower than the

U.S. production function at high levels of employment.

Answer: BTopic: Eye on the global economy, why do Americans earn moreSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Reflective thinking

Page 761


8.2 The Natural Unemployment Rate

1) The unemployment rate at full employment is

A) zero.

B) the natural unemployment rate.

C) equal to the rationed rate of unemployment.

D) undefined because the economy is never at full employment.

E) equal the amount of unemployment caused by job search.

Answer: BTopic: Natural unemployment rateSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

2) Which of the following explain the natural rate of unemployment?

i. job search

ii. the Okun Gap

iii. the production function

A) i and iii B) i only C) iii only D) ii and iii E) i and ii

Answer: BTopic: Natural unemployment rateSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

3) The natural unemployment rate is the result of

A) bad government policies.

B) insufficient demand for labor.

C) job search and job rationing.

D) the Lucas Wedge.

E) the Okun Gap.

Answer: CTopic: Natural unemployment rateSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

4) Suppose job search has decreased over the last several years. This decrease could be a result of

i. a change in unemployment benefits.

ii. a positive structural change.

iii. a higher inflation rate.

A) ii only B) i only C) i and ii D) ii and iii E) i and iii

Answer: CTopic: Job searchSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 762


5) The increase in the average unemployment rate in the 1970s was the result of

A) the reduction of overly generous unemployment benefits in the 1970s.

B) an increase in the birth rate in the early 1970s.

C) an increase in the birth rate in the late 1940s and early 1950s.

D) higher real wage rates.

E) repeated increases in the minimum wage.

Answer: CTopic: Demographic changeSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

6) A newspaper headline reads ʺA New Wave of Workers Enters the Job Market!ʺ This wave of

young, new entrants to the labor market is likely to lead to

A) an increase in the natural unemployment rate.

B) a decrease in the unemployment rate.

C) no effect on the unemployment rate.

D) a decrease in the countryʹs potential GDP.

E) a decrease in the natural unemployment rate but an increase in the actual unemployment

rate.

Answer: ATopic: Demographic changeSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Written and oral communication

7) Which of the following increases frictional and/or structural unemployment?

i. more young workers entering the labor force

ii. more generous unemployment benefits

iii. a structural slump with some industries dying

A) i only

B) ii only

C) iii only

D) i and ii

E) i, ii. and iii

Answer: ETopic: Demographic change, unemployment benefitsSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 763


8) The length of time an unemployed person searches for a job is likely to increase as

A) the working age population gets older.

B) the birth rate declines.

C) new technologies make workers more productive.

D) unemployment benefits become more generous.

E) job rationing decreases.

Answer: DTopic: Demographic change, unemployment benefitsSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

9) If the amount paid as unemployment benefits decreases, the opportunity cost of job search

A) rises and people would stay unemployed longer.

B) is not affected because unemployment benefits do not change job availability.

C) rises and people stay unemployed for a shorter time.

D) falls and people stay unemployed for a shorter time.

E) falls and people stay unemployed for a longer time.

Answer: CTopic: Unemployment benefitsSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

10) More generous unemployment benefits ________ the opportunity cost of looking for a new job

and therefore ________ the job search process

A) lower; extend

B) lower; shorten

C) raise; extend

D) raise; shorten

E) lower; does not change

Answer: ATopic: Unemployment benefitsSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 764


11) The natural unemployment rate is higher if

A) unemployment benefits become more generous.

B) there is a decrease in the working-age population.

C) there are fewer two-income households.

D) many of the new jobs created require skills possessed by the available labor.

E) efficiency wages are lower.

Answer: ATopic: Unemployment benefitsSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

12) The lower the amount of unemployment benefits citizens receive, the

A) higher the opportunity cost of job search.

B) lower the opportunity cost of job search.

C) the higher the natural unemployment rate.

D) the longer people search for jobs.

E) higher the wage people must be offered before they accept a job.

Answer: ATopic: Unemployment benefitsSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

13) The length of time people spend in search of a job increases if

A) the population ages.

B) unemployment benefits increase.

C) the criteria necessary to qualify for unemployment benefits increases.

D) there is a sudden change in technology.

E) the minimum wage is decreased.

Answer: BTopic: Unemployment benefitsSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 765


14) France is considering implementing policies that will reduce the duration of job search. A

possible option is for France to

A) increase the minimum wage.

B) help negotiate higher union benefits for employed workers.

C) reduce unemployment benefits.

D) require all residents between the ages of 19 and 26 to obtain a part-time or full-time job.

E) Both answers A and B are correct.

Answer: CTopic: Unemployment benefitsSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

15) If we compare the Canadian natural unemployment rate to the U.S. natural unemployment

rate, we find that for most years since 1980

A) they are essentially the same because we have a lot in common.

B) the Canadian rate is higher, possibly the result of higher unemployment benefits in

Canada for most of those years.

C) the U.S. rate is higher, possibly the result of greater job search within a larger country.

D) the Canadian rate is higher, possibly the result of higher unemployment benefits in the

United States for most of those years.

E) The U.S. rate is higher, possibly the result of more structural change occurring in the

United States.

Answer: BTopic: Eye on the global economy, unemployment benefitsSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: RevisedAACSB: Reflective thinking

16) Structural change influences the unemployment rate and such structural change is created by

changes in

A) real GDP.

B) the seasons.

C) technology.

D) population.

E) the minimum wage.

Answer: CTopic: Structural changeSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 766


17) Job rationing occurs when the real wage rate is

A) below the equilibrium wage rate so there is an excess supply of labor.

B) above the equilibrium wage rate so there is a shortage of labor.

C) equal to the equilibrium wage rate so there is no excess supply of labor.

D) above the equilibrium wage rate so there is an excess supply of labor.

E) Both answers A and D are correct because whenever the real wage rate is above or below

the equilibrium wage rate, there is an excess supply of labor.

Answer: DTopic: Job rationingSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

18) Which of the following creates job rationing?

A) The real wage rate is below the equilibrium level.

B) The real wage rate is above the equilibrium level.

C) The real wage rate is equal to the equilibrium level.

D) Job search decreases.

E) An increase in unemployment benefits.

Answer: BTopic: Job rationingSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

19) Job rationing occurs when the real wage is ________ the equilibrium level and there is a

________ of labor.

A) above; shortage

B) above; surplus

C) below; shortage

D) below; surplus

E) equal to; shortage

Answer: BTopic: Job rationingSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 767


20) Which of the following can result in job rationing?

i. minimum wage

ii. union wage

iii. diminishing returns

A) i only

B) ii only

C) iii only

D) i and ii

E) i, ii, and iii

Answer: DTopic: Job rationingSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

21) Suppose the full-employment equilibrium real wage rate is $11 per hour while the actual real

wage rate is $12 per hour. If the actual real wage rate does not change, then

A) job rationing will occur.

B) job search will decline.

C) a positive Okun Gap will occur.

D) the production function will shift downward.

E) job rationing will decrease.

Answer: ATopic: Job rationingSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

22) Efficiency wages, above equilibrium minimum wage rates, and higher union wages are likely

to

A) increase the natural unemployment rate.

B) increase cyclical unemployment.

C) reduce the equilibrium real wage rate.

D) increase the equilibrium real wage rate.

E) decrease the natural unemployment rate.

Answer: ATopic: Job rationingSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 768


23) The presence of efficiency, minimum and union wages

A) can explain job rationing because they lower the natural unemployment rate.

B) can explain job rationing because they raise the real wage rate above equilibrium.

C) can explain job rationing because they lower the real wage rate below equilibrium.

D) does not affect job rationing because they affect only the amount of job search.

E) cannot explain job rationing because they are a natural part of the economy.

Answer: BTopic: Job rationingSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

24) Efficiency wages are

A) mandated by law.

B) set below the equilibrium level of the real wage.

C) offered by firms who want to reduce turnover in the labor force.

D) special wages offered to teenagers.

E) the result of demographic change.

Answer: CTopic: Efficiency wageSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

25) An efficiency wage

A) is set above the equilibrium real wage rate to induce greater work effort.

B) is set below the equilibrium real wage rate to reduce labor costs.

C) increases the supply of labor and therefore increases potential GDP.

D) increases the demand for labor and therefore increases potential GDP.

E) reduces frictional unemployment.

Answer: ATopic: Efficiency wageSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

26) An efficiency wage is designed to

A) induce more work effort.

B) keep the minimum wage from rising.

C) keep the minimum wage from falling.

D) to induce more employment.

E) decrease the need for workers to search for jobs.

Answer: ATopic: Efficiency wageSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 769


27) An efficiency wage is designed to ________ work effort and to ________ labor turnover.

A) decrease; lower

B) decrease; raise

C) increase; raise

D) increase; lower

E) not change; decrease

Answer: DTopic: Efficiency wageSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

28) An efficiency wage is ________ because the result is ________.

A) set above the equilibrium real wage; reduced turnover and less work effort

B) set above the equilibrium real wage; increased turnover and more work effort

C) set below the equilibrium real wage; reduced turnover and more work effort

D) set above the equilibrium real wage; reduced turnover and more work effort

E) not often used; not much different from minimum wage use

Answer: DTopic: Efficiency wageSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: NewAACSB: Reflective thinking

29) An efficiency wage ________ because ________.

A) decreases job rationing; the real wage rate is lowered below the equilibrium

B) increases job rationing; the real wage rate is lowered below the equilibrium

C) decreases job rationing; the real wage rate is raised above the equilibrium

D) increases job rationing; the real wage rate is raised above the equilibrium

E) is used often; it is inexpensive and effective

Answer: DTopic: Efficiency wageSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: NewAACSB: Reflective thinking

Page 770


30) Efficiency wages are

A) the legal minimum wage a firm can pay a worker.

B) a possible cause of job rationing because they drive wages below their equilibrium level.

C) a possible cause of job rationing because they drive wages above their equilibrium level.

D) a possible cause of job rationing because they force wages to equal their equilibrium

level.

E) another name for the equilibrium wage.

Answer: CTopic: Efficiency wageSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

31) The figure above shows the market for fast food restaurant employees in a college town in a

small nation to the East. The local Taco Bell pays its workers $12 an hour. This wage rate is

A) an efficiency wage aimed at reducing employee turnover.

B) designed reduce the unemployment rate.

C) an effort to increase the demand for labor.

D) the actual equilibrium wage rate.

E) illegal because the equilibrium wage rate is $6 an hour.

Answer: ATopic: Efficiency wageSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Analytical thinking

Page 771


32) The figure above shows the labor market in a small town. If the government imposes a wage

of $10 that firms must at least pay,

A) the government has imposed a minimum wage and market forces are not allowed to

work.

B) the government has imposed an efficiency wage.

C) job search will decrease.

D) job rationing will decrease.

E) inflation will occur as wages rise.

Answer: ATopic: Minimum wage, searchSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Analytical thinking

33) The figure above shows the labor market in a small town. If the government imposes ________

that firms must at least pay, the effect will be ________ because ________.

A) a minimum wage of $10; an increase in unemployment; a surplus of labor is created

B) a minimum wage of $10; a decrease in unemployment; a shortage of labor is created

C) an efficiency wage of $10; a decrease in unemployment; a surplus of labor is created

D) an efficiency wage of $10; an increase in unemployment; a shortage of labor is created

E) a minimum wage of $10; no change in unemployment; it will not affect how firms

demand labor

Answer: ATopic: Minimum wage, searchSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: NewAACSB: Analytical thinking

34) To increase workersʹ incomes, the City of New Yorkʹs government set a wage below which it is

illegal for employers to pay employees. This wage is referred to as the

A) minimum wage.

B) efficiency wage.

C) government wage.

D) union wage.

E) city wage.

Answer: ATopic: Minimum wageSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 772


35) A minimum wage rate that is set ________ the equilibrium real wage rate creates a ________ of

labor.

A) above; surplus

B) above; shortage

C) below; surplus

D) below; shortage

E) equal to; shortage


36) If the minimum wage rate is set above the equilibrium wage rate, then

A) unemployment definitely increases.

B) unemployment definitely decreases.

C) unemployment definitely does not change.

D) unemployment either decreases or does not change.

E) None of the above answers is correct because the minimum wage decreases search but its

effect on unemployment is ambiguous.


37) The minimum wage is a

A) possible cause of job search because it lowers wages below their equilibrium.

B) possible cause of job rationing because it lowers wages below their equilibrium.

C) government established highest wage that is legal to pay.

D) possible cause of job rationing because it raises wages above their equilibrium.

E) factor that decreases unemployment because fewer people search for work if the

minimum wage is increased.

Answer: DTopic: Minimum wageSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 773


38) A minimum wage set above the equilibrium wage rate

A) increases the natural unemployment rate.

B) increases the demand for labor.

C) increases the number of workers employed.

D) decreases job rationing.

E) decreases the natural unemployment rate because fewer workers will become

unemployed.

Answer: ATopic: Minimum wageSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

39) Which of the following will increase the natural unemployment rate?

i. a minimum wage set above the equilibrium wage rate

ii. efficiency wages

iii. union-negotiated wages

A) i only

B) i and ii

C) i and iii only

D) ii and iii only

E) i, ii and iii

Answer: ETopic: Natural unemployment rateSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

40) If the minimum wage is set

A) below the equilibrium wage rate, it will create unemployment.

B) above the equilibrium wage rate, it will create unemployment.

C) equal to the equilibrium wage rate, it will create a shortage of labor.

D) below the equilibrium wage rate, it will create a shortage of labor.

E) equal to the equilibrium wage rate, it will create a surplus of labor.

Answer: BTopic: Minimum wageSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 774


Real wage rate

(2009 dollars

per hour)

Quantity of labor demanded

(millions of hours

per month)

Quantity of labor supplied

(millions of hours

per month)

5 360 260

10 325 275

15 300 300

20 280 330

25 250 350

41) According to the above table, if the minimum wage is set at $20 per hour, then

A) there is an excess demand for labor.

B) the quantity of labor supplied exceeds the quantity of labor demanded by 50 million

hours per month.

C) the quantity of labor demanded will increase until it is equal to the quantity of labor

supplied.

D) the labor demand curve will shift until $20 is the new equilibrium real wage rate.

E) the labor supply curve will shift until $20 is the new equilibrium real wage rate.

Answer: BTopic: Minimum wageSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Analytical thinking

Real wage rate

(2009 dollars

per hour)

Quantity of labor demanded

(millions of hours

per month)

Quantity of labor supplied

(millions of hours

per month)

7.15 90 25

7.65 70 32

8.00 60 60

8.50 45 70

9.00 20 85

42) The table above gives the labor market for a small foreign economy. Equilibrium in the labor

market occurs at a real wage rate of

A) $7.15 per hour.

B) $7.65 per hour.

C) $8.00 per hour.

D) $8.50 per hour.

E) $9.00 per hour.

Answer: CTopic: The labor marketSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Analytical thinking

Page 775


43) The table above gives the labor market for a small foreign economy. A minimum wage law

that sets the minimum wage at $8.50 per hour produces

A) equilibrium in the labor market.

B) a labor surplus of 25 million hours.

C) a labor shortage of 25 million hours.

D) a labor surplus of $0.50 per hour.

E) a labor surplus of 65 million hours.

Answer: BTopic: Minimum wageSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Analytical thinking

44) The table above gives the labor market for a small foreign economy. A(n) ________ would

create ________.

A) minimum wage of $5.00; an increase in job rationing.

B) union-negotiated wage of $7.50; unemployment and job rationing.

C) efficiency wage of $8.00; unemployment and job rationing.

D) efficiency wage of $9.00; an increase in job rationing.

E) minimum wage of $9.00; a decrease in job search.

Answer: DTopic: Job rationingSkill: Level 4: Applying modelsSection: Checkpoint 8.2Status: OldAACSB: Analytical thinking

Page 776


45) In the above figure, a minimum wage will not change the unemployment rate if it is set at

A) $6.00.

B) $9.00.

C) $12.00.

D) Both B and C are correct because any wage rate that exceeds $9 per hour has no effect on

the unemployment rate.

E) None of the above because the minimum wage always affects the unemployment rate.

Answer: ATopic: Minimum wageSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Analytical thinking

46) In the above figure, a(n) ________ would be set ________.

A) efficiency wage; above $9.00 and would increase the natural rate of unemployment

B) effective minimum wage; above $6.00.

C) union wage; above $9.00 but would not affect the natural rate of unemployment.

D) efficiency wage; above $6.00.

E) efficiency wage; below $9.00

Answer: ATopic: Unemployment rateSkill: Level 4: Applying modelsSection: Checkpoint 8.2Status: OldAACSB: Analytical thinking

Page 777


47) It is estimated that, on the average and without taking account of skill differentials, union

wages are

A) less than nonunion wages.

B) equal to nonunion wages.

C) 30 percent higher than nonunion wages.

D) 100 percent higher than nonunion wages.

E) 66 percent higher than nonunion wages.

Answer: CTopic: Union wageSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: RevisedAACSB: Reflective thinking

48) It is estimated that, on the average and taking account of skill differentials, union wages are

A) less than nonunion wages.

B) equal to nonunion wages.

C) 10-25 percent higher than nonunion wages.

D) 100 percent higher than nonunion wages.

E) 66 percent higher than nonunion wages.

Answer: CTopic: Union wageSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: NewAACSB: Reflective thinking

49) It is estimated that, on the average and ________, union wages are ________ because ________.

A) without taking account of skill differentials; 15-20 percent higher than nonunion wages;

employers are biased against nonunion workers

B) taking account of skill differentials; 30 percent higher than nonunion wages; in some

industries union workers perform jobs that require greater skill than nonunion workers

and employers show bias against nonunion workers

C) without taking account of skill differentials; 30 percent higher than nonunion wages; in

some industries union workers perform jobs that require greater skill than nonunion

workers

D) taking account of skill differentials; 30 percent higher than nonunion wages; union

workers are better qualified than nonunion workers

E) without taking account of skill differentials; equal to nonunion wages; differentiating

based on union membership is discrimination and illegal

Answer: CTopic: Union wageSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: NewAACSB: Reflective thinking

Page 778


50) The presence of union wages leads to

A) a fall in the real wage rate as fewer people are hired.

B) a fall in the real wage rate as more people are hired.

C) less job search as more workers are hired.

D) job rationing because the real wage exceeds the equilibrium real wage.

E) lower unemployment because workers do not want to lose the high union wage they are

being paid.

Answer: DTopic: Union wageSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

51) The Fair Labor Standards Act originally set the minimum wage at

A) $1.25 in 1983.

B) $1.25 in 1938.

C) $0.25 in 1938.

D) $0.25 in 1983.

E) $3.00 in 1960.

Answer: CTopic: Eye on the U.S. economy, the federal minimum wageSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

52) The real minimum wage rate

A) has generally increased since 1967.

B) has generally decreased during the 1970s and 1980s and has fluctuated around a $6.50

per hour average since the mid-1980s.

C) was at its highest level in 1995.

D) fell after 1967 until it reached a minimum around 1985 and has generally risen since then.

E) has stayed in the range between $6 and $5 (measured in 2009 dollars per hour) since

1967.

Answer: BTopic: Eye on the U.S. economy, the federal minimum wageSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: RevisedAACSB: Reflective thinking

Page 779


53) The two fundamental causes of unemployment at full employment are

A) seasonal jobs and technological change.

B) foreign competition and financial bankruptcies.

C) job search and job rationing.

D) decreases in labor productivity and more generous retirement benefits.

E) demographic change and decreases in the demand for labor.

Answer: CTopic: Natural unemployment rateSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

54) In the United States since 1960, the average unemployment rate was highest during the decade

of the

A) 1960s. B) 1970s. C) 1980s. D) 1990s. E) 2000s.

Answer: CTopic: Eye on the past, average unemployment ratesSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

55) Job search is defined as

A) the activity of looking for an acceptable, vacant job.

B) saying you are looking for a job when you are actually not looking.

C) attending school to increase your employability.

D) equivalent to job rationing.

E) being paid an efficiency wage.

Answer: ATopic: Job searchSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

56) The more generous the amount of unemployment benefits, the

A) higher the opportunity cost of job search.

B) lower the opportunity cost of job search.

C) shorter the time spent searching until accepting a suitable job.

D) shorter the time spent searching for a suitable job and the higher the opportunity cost of

being unemployed.

E) lower the natural unemployment rate.

Answer: BTopic: Unemployment benefitsSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 780


57) The existence of union wages, efficiency wages, and the minimum wage

A) raises the real wage rate above the equilibrium wage rate and creates a shortage of labor.

B) lowers the real wage rate below the equilibrium wage rate and creates a shortage of

labor.

C) raises the real wage rate above the equilibrium wage rate and raises the natural

unemployment rate.

D) does not have an impact on the equilibrium wage rate or on the amount of

unemployment.

E) raises the real wage rate above the equilibrium wage rate and lowers the natural

unemployment rate.

Answer: CTopic: Job rationingSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

58) Job rationing occurs if

A) the minimum wage is set below the equilibrium wage rate.

B) an efficiency wage is set below the equilibrium wage rate.

C) a union wage is set below the equilibrium wage rate.

D) the real wage rate is pushed above the equilibrium wage rate.

E) the Lucas wedge is positive.

Answer: DTopic: Job rationingSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

59) Intel wants to attract the most productive and knowledgeable workers. To achieve this goal it

could pay ________ wage.

A) an efficiency

B) a minimum

C) a nominal

D) an equilibrium

E) a Lucas wedge

Answer: ATopic: Efficiency wageSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 781


60) Collective bargaining by unions can result in a union wage rate that is ________ the

equilibrium real wage rate and creates a ________ of labor.

A) above; surplus

B) above; shortage

C) below; surplus

D) below; shortage

E) equal to; surplus

Answer: ATopic: Union wageSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

Page 782


8.3 Chapter Figures

1) The figure above shows the U.S. production function. How would an increase in capital be

shown in the figure?

A) an upward shift or rotation of the production function

B) a downward shift or rotation of the production function

C) a movement from point A to point B

D) a movement from point C to point B

E) None of the above because the effects of an increase in capital cannot be shown in the

figure.


Page 783


2) The figure above shows the U.S. production function. How would an increase in

unemployment benefits be shown in the figure?

A) a movement from point C to point B

B) a movement from point A to point B

C) an upward shift or rotation of the production function

D) a downward shift or rotation of the production function

E) None of the above because the effects of an increase in unemployment benefits cannot be

shown in the figure.

Answer: ATopic: Production functionSkill: Level 4: Applying modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

3) The figure above shows the U.S. production function. How would an increase in income taxes

be shown in the figure?

A) a movement from point C to point B

B) a movement from point A to point B

C) an upward shift or rotation of the production function

D) a downward shift or rotation of the production function

E) None of the above because the effects of an increase in taxes cannot be shown in the

figure.


Page 784


4) The figure above shows the U.S. demand for labor curve. If there is a simultaneous increase in

the nominal wage rate of 10 percent and a 10 percent increase in the price level, there will be a

A) rightward shift of the demand for labor curve.

B) leftward shift of the demand for labor curve.

C) movement downward along the demand for labor curve from a point such as A to a

point such as B.

D) movement upward along the demand for labor curve from a point such as C to a point

such as B.

E) None of the above answers is correct because there is no change in the demand for labor

curve.

Answer: ETopic: Demand for labor curveSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

Page 785


5) The figure above shows the U.S. supply of labor curve. If there is a simultaneous increase in

the nominal wage rate of 10 percent and a 10 percent increase in the price level, there will be a

A) rightward shift of the supply of labor curve.

B) leftward shift of the supply of labor curve.

C) movement downward along the supply of labor curve from a point such as A to a point

such as B.

D) movement upward along the supply of labor curve from a point such as C to a point

such as B.

E) None of the above answers is correct because there is no change in the supply of labor

curve.

Answer: ETopic: Supply of labor curveSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

Page 786


6) The figure above shows the U.S. supply of labor curve. An increase in the income tax rate

leads to a

A) rightward shift of the supply of labor curve.

B) movement upward along the supply of labor curve from a point such as C to a point

such as B.

C) movement downward along the supply of labor curve from a point such as A to a point

such as B.

D) leftward shift of the supply of labor curve.

E) None of the above answers is correct because there is no change in the supply of labor

curve.

Answer: DTopic: Supply of labor curveSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

7) The figure above shows the U.S. supply of labor curve. What was the effect of the decline in

birth rates during the 1960s and 1970s on the supply of labor curve in the 1980s?

A) a rightward shift of the supply of labor curve

B) The supply of labor curve became steeper.

C) a movement downward along the supply of labor curve from a point such as A to a point

such as B

D) a leftward shift of the supply of labor curve

E) None of the above answers is correct because there was no change in the supply of labor

curve.

Answer: DTopic: Supply of labor curveSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

8.4 Integrative Questions

1) If the government increases unemployment benefits, then the labor

A) demand curve shifts rightward.

B) demand curve shifts leftward.

C) supply curve shifts rightward.

D) supply curve shifts leftward.

E) Both answers B and D are correct.

Answer: DTopic: IntegrativeSkill: Level 4: Applying modelsSection: IntegrativeStatus: OldAACSB: Analytical thinking

Page 787


2) If the government increases unemployment benefits, then the equilibrium amount of

employment ________ and potential GDP ________.







3) If the government raises income taxes, then the labor

A) demand curve shifts rightward.

B) demand curve shifts leftward.

C) supply curve shifts rightward.

D) supply curve shifts leftward.

E) Both answers B and D are correct.


4) If the government raises income taxes, then the equilibrium amount of employment ________

and potential GDP ________.







Page 788


5) An increase in the time spent on job search

A) decreases potential GDP.

B) decreases the unemployment rate.

C) decreases the labor force participation rate.

D) decreases the demand for labor.

E) decreases the real wage rate.

Answer: ATopic: IntegrativeSkill: Level 3: Using modelsSection: IntegrativeStatus: OldAACSB: Reflective thinking

6) The smaller the extent of job rationing, the

A) lower potential GDP.

B) lower the unemployment rate.

C) lower the labor force participation rate.

D) higher the labor supply.

E) higher the real wage rate.

Answer: BTopic: IntegrativeSkill: Level 3: Using modelsSection: IntegrativeStatus: OldAACSB: Reflective thinking

8.5 Essay: Potential GDP

1) Define potential GDP. Under what circumstances does actual real GDP fall short of potential

GDP, equal potential GDP, and exceed potential GDP?

Answer: Potential GDP is the level of real GDP that the economy produces when it is at full

employment. Potential GDP can be contrasted with actual real GDP, the amount of real

GDP the country actually produces. Actual real GDP can be less than potential GDP

when the economy is producing at less than full employment, that is, when there is less

than full employment in the labor market. Actual real GDP equals potential GDP when

the economy is producing at full employment. Actual real GDP can exceed potential

GDP temporarily as the economy approaches and then recedes from a business cycle

peak.Topic: Potential GDPSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Written and oral communication

Page 789


2) Briefly define real and potential GDP, and explain the relationship between real GDP and

potential GDP. How can we measure potential GDP?

Answer: Real GDP is the actual level of GDP, adjusted for inflation. Potential GDP is what the

GDP would be if the economy was fully employed. Because of the business cycle, real

GDP fluctuates around potential GDP. Thus real GDP is sometimes greater than

potential GDP, sometimes smaller than potential GDP, and sometimes equal to

potential GDP. Over time, the larger-than-normal and smaller-than-normal values

cancel out and we can estimate potential GDP by using the average of real GDP.Topic: Potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Written and oral communication

3) Discuss the production function. How does the production function relate to the labor market

and potential GDP?

Answer: The production function shows the maximum amounts of real GDP that can be

produced as the quantity of labor changes, holding constant all other influences on

production. As the quantity of labor increases, real GDP increases but at a decreasing

rate, that is, the production function shows diminishing returns. The production

function ʺstands betweenʺ the labor market and potential GDP. In particular, the

quantity of employment is determined in the labor market. The production function

then shows the amount of real GDP that is produced by this quantity of employment.

When the quantity of employment determined in the labor market is the equilibrium

quantity, then the amount of real GDP produced is potential GDP.Topic: Production functionSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Written and oral communication

4) Define the production function. Discuss why the production function exhibits diminishing

returns.

Answer: The production function is the relationship that shows the maximum quantity of real

GDP that can be produced as the quantity of labor employed changes and all other

influences on production remain the same. The production function exhibits

diminishing returns because the quantity of capital (and other resources) is fixed. As

more labor is hired, the extra output produced decreases because the extra workers

have less capital with which to work. As a result, the additional workers cannot

produce as much additional output as did the previously hired workers.Topic: Production functionSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Written and oral communication

Page 790


5) Explain how the real wage and the extra output produced by each worker determine the

quantity of labor demanded by a firm.

Answer: The firm compares the cost of hiring an extra worker (the real wage) to the benefit (the

extra output produced by an extra worker). Because the firm wants to make a profit, it

hires the worker as long as the extra output is greater than the real wage. Thus the firm

will demand (hire) the quantity of workers such that the extra output produced by the

worker is greater than or equal to the real wage rate. Because labor has diminishing

returns, there is some point at which the last worker hired produces just enough output

to justify the wage rate and so additional workers will not be hired.Topic: Demand for laborSkill: Level 2: Using definitionsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

6) Explain how the labor market and the production function determine potential GDP.

Answer: The labor market determines the equilibrium quantity of labor. In other words, the

amount of employment is determined by supply and demand in the labor market. The

production function shows the amount of output, real GDP, that is produced for all

different amounts of employment. In other words, the production function ʺconvertsʺ

the amount of employment from the labor market into real GDP. If the labor market is

in equilibrium, so that the level of employment is equal to full employment, then the

amount of real GDP produced, determined from the production function is potential

GDP.Topic: Full employment and potential GDPSkill: Level 3: Using modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

Page 791


Labor demand

(billions of

hours per year)

Real wage rate

(2009 dollars)

Labor supply

(billions of

hours per year)

0 30 6

1 25 5

2 20 4

3 15 3

4 10 2

Employment

(billions of

hours per year)

Real GDP

(billions of 2005

dollars)

6 95

5 90

4 80

3 60

2 30

7) The first table above gives the labor demand and labor supply schedules for a nation. The

second table gives its production function.

a. What are the equilibrium real wage rate and the level of employment?

b. What is potential GDP?

Answer: a. The equilibrium real wage rate is $15 an hour because this is the real wage rate for

which the quantity of labor demanded equals the quantity supplied. The equilibrium

level of employment is 3 billion hours a year.

b. With employment equal to 3 billion hours per year, potential GDP is equal to $60

billion.Topic: Full employment and potential GDPSkill: Level 4: Applying modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

Real wage rate

(2009 dollars)

Labor demand

(billions of

hours per year)

Labor supply

(billions of

hours per year)

30 100 700

25 200 600

20 300 500

15 400 400

10 500 300

Employment

(billions of

hours per year)

Real GDP

(trillions of 2009

dollars)

200 3.0

300 4.0

400 4.8

500 5.4

600 5.8




b. What is potential GDP?




b. With employment equal to 400 billion hours per year, potential GDP is equal to $4.8

trillion.Topic: Full employment and potential GDPSkill: Level 4: Applying modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

Page 792


Real wage rate

(2009 dollars)

Labor demand

(billions of

hours per year)

Labor supply

(billions of

hours per year)

5 360 260

10 325 275

15 300 300

20 280 330

Employment

(billions of

hours per year)

Real GDP

(trillions of 2009

dollars)

100 2.0

200 3.0

300 3.8

400 4.4




b. What is potential GDP? If you cannot determine a precise amount, give the range in which

potential GDP must lie.




b. With employment equal to 300 billion hours per year, potential GDP is equal to $3.8

trillion.Topic: Full employment and potential GDPSkill: Level 4: Applying modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

Page 793


10) Over the last decade, a country experiences a significant increase in labor productivity.

a. Draw and label a labor market supply and demand diagram. Show how the equilibrium

real wage rate and the equilibrium quantity of labor change as productivity increases.

b. Draw and label a production function. Show how potential GDP changes as labor

productivity increases.

Answer:

a. The figure above shows the effect of an increase in productivity in the labor market.

The increase in productivity shifts the labor demand curve rightward and, as

illustrated, raises the real wage rate and increases the quantity of employment.

b. The production function shifts upward as shown in the figure. Potential GDP

increases for two reasons: there is a greater quantity of labor, and the new production

function is higher than the old one.

Page 794


Topic: Full employment and potential GDPSkill: Level 4: Applying modelsSection: Checkpoint 8.1Status: OldAACSB: Analytical thinking

8.6 Essay: The Natural Unemployment Rate

1) Looking over the last six decades since 1950, how did the average U.S. unemployment rate

during the 2000s compare to the other five decades?

Answer: The average unemployment rate during the 2000s was essentially tied for the second

highest decade-average unemployment rate for the five decades since 1950. The

decade-average unemployment rate during the 2000s was higher than the average

unemployment rates during the 1950s, 1960s, and 1990s. It was basically tied with the

decade average unemployment rate during the 1970s and was lower the highest decade

average unemployment rate during the 1980s.Topic: Eye on the past, unemployment ratesSkill: Level 1: DefinitionSection: Checkpoint 8.2Status: OldAACSB: Written and oral communication

2) What is the effect of an increase in unemployment benefits on the unemployment rate?

Answer: An increase in unemployment benefits decreases the overall costs of being unemployed.

As a result it increases the length of time unemployed workers search for a new job and

hence increases the unemployment rate.Topic: Unemployment benefitsSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Written and oral communication

3) For most years since 1980, the natural unemployment rate was higher in Canada than in the

United States. What possible explanation for some of this difference has been suggested?

Answer: Quite likely unemployment benefits are at least part of the reason why the natural

unemployment rate has been higher in Canada than in the United States. Canada has

more generous and more widely available unemployment benefits than the does the

United States. This difference gives workers in Canada the incentive to search longer for

jobs, which raises the natural unemployment rate in Canada.Topic: Eye on the global economy, unemployment benefitsSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Written and oral communication

Page 795


4) What is job search and what is the relationship between job search and unemployment? What

factors can affect the amount of job search? Briefly discuss the effect of each factor.

Answer: Job search is the activity of looking for a suitable job. Unemployed workers are

searching for a job, and so the longer these workers search, the greater the amount of

unemployment. Three major factors affect the amount of job search: demographic

change, unemployment benefits, and structural change. Demographic change refers to

the fact that at times there are more young people looking for their first jobs and at

other times there are fewer young people searching for a job. When more young people

are searching, the unemployment rate rises and when fewer young people are

searching, the unemployment rate falls. Unemployment benefits affect the amount of

job search. An increase in unemployment benefits lowers the cost of remaining

unemployed and so workers search for longer periods of time. As a result, the

unemployment rate rises. Finally, structural change affects the amount of job search.

Structural change is the result of technological change. At times, this change creates a

slump during which workers from failing industries are not good matches for the jobs

created in booming sectors. In this case, the amount of job search and unemployment

rises. At other times, the workers released by the slowing sectors have skills that are

good matches for the expanding sectors and so the amount of job search and

unemployment falls.Topic: Job searchSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Written and oral communication

5) Explain how some structural changes can increase the natural unemployment rate while other

structural changes can decrease the natural unemployment rate.

Answer: Any structural change creates some jobs and destroys others. The effect of structural

change on the natural unemployment rate depends on how well the skills required for

the new jobs align with the skills possessed by workers looking for jobs and how well

the locations of the jobs align with the workers looking for jobs. If the skills and

locations are similar, so that the jobs are good matches for people looking for work, then

the structural change brings a structural boom and the natural unemployment rate

decreases. However, if the skills and locations are different, so that the workers looking

for work are not good matches for the newly created jobs, structural change creates a

structural slump and the natural unemployment rate rises.Topic: Structural changeSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Written and oral communication

Page 796


6) What factors can lead the real wage rate to be above its full-employment equilibrium level?

Answer: There are at least three reasons why the real wage rate might be above its equilibrium

level. First, firms might pay an efficiency wage, which is a wage rate set above the

full-employment equilibrium wage rate in order to induce greater work effort from

workers. Second, a minimum wage law might set a minimum wage that is above the

full-employment equilibrium wage rate. Finally, a union might negotiate a wage rate

that is above the full-employment equilibrium level.Topic: Real wage rateSkill: Level 4: Applying modelsSection: Checkpoint 8.2Status: OldAACSB: Written and oral communication

7) ʺJob rationing occurs when the quantity of labor demanded exceeds the quantity supplied.ʺ Is

the previous statement true or false? Explain your answer.

Answer: The statement is false. Job rationing occurs when the quantity of labor supplied exceeds

the quantity demanded. In this circumstance, jobs must be apportionedrationed

among the people willing to work.Topic: Job rationingSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Reflective thinking

8) What is job rationing and how does it relate to unemployment? What factors can lead to job

rationing? Briefly explain these factors.

Answer: Job rationing occurs when the real wage is above its equilibrium level and there is a

surplus of labor. In this case, not all the workers who are looking for work can find jobs

and therefore the jobs must somehow be dividedrationedamong them. Three factors

can account for job rationing: efficiency wage, the minimum wage, and union wage. An

efficiency wage is a wage rate set by a firm above the equilibrium wage rate. An

efficiency wage motivates the firmʹs workers to work hard in order to keep their jobs

because the workers know that if they are fired, the wage rate they will get at a new job

probably will be less than the efficiency wage. The minimum wage is a government

regulation that sets the lowest legal wage. If the minimum wage is set above the

equilibrium wage rate, the equilibrium wage rate becomes illegal and, because the

minimum wage exceeds the equilibrium wage, a surplus of labor results. Finally, a

union wage is a wage rate that results from bargaining between a firm and a labor

union. Typically the labor union can negotiate a wage rate that exceeds the equilibrium

level in a competitive market and so, once again, there is a surplus of labor.Topic: Job rationingSkill: Level 2: Using definitionsSection: Checkpoint 8.2Status: OldAACSB: Written and oral communication

Page 797


9) What factors can push the real wage rate above its equilibrium level? Briefly explain each

factor.

Answer: The three factors that can push the real wage rate above the equilibrium wage rate are

efficiency wages, the minimum wage, and union wages. An efficiency wage is a wage

rate that is set by a firm above the equilibrium wage rate. The idea is that the firmʹs

workers will work hard in order to keep their jobs because they know that if they are

fired the (equilibrium) wage they are likely to get at a new job will be less than the

efficiency wage. The minimum wage is a government regulation that sets the lowest

legal wage. If the minimum wage is set above the equilibrium wage rate, the

equilibrium wage rate becomes illegal. Finally, a union wage is a wage rate that results

from bargaining between a firm and a labor union. Typically the labor union can

negotiate a wage rate that exceeds the equilibrium level in a competitive market.Topic: Job rationingSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Written and oral communication

10) What is an efficiency wage and what effect does it have in the labor market?

Answer: An efficiency wage rate is a wage that is set by a firm above the equilibrium wage rate

in order to motivate the firmʹs workers to work hard. The idea is that workers will work

hard in order to keep their jobs because they know that if they are fired the

(equilibrium) wage rate they are likely to get at a new job will be less than the efficiency

wage. An efficiency wage is one of the factors that push the wage rate above its

equilibrium and thereby create unemployment.Topic: Efficiency wageSkill: Level 3: Using modelsSection: Checkpoint 8.2Status: OldAACSB: Written and oral communication

Page 798


Chapter 9 Economic Growth

9.1 The Basics of Economic Growth

1) Economic growth is defined as

A) a decrease in the rate of inflation.

B) an increase in employment.

C) a sustained expansion of production possibilities.

D) an increase in the wage rate.

E) an increase in the nationʹs population.

Answer: CTopic: Economic growthSkill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

2) Economic growth is a sustained expansion of production possibilities, as measured by the

increase in ________ over time.

A) real GDP

B) population

C) inflation

D) the price level

E) employment

Answer: ATopic: Economic growthSkill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

3) A country will likely experience an increase in poverty if

A) its population decreases over time.

B) its real GDP growth rate decreases or slows over time.

C) its inflation rate decreases or slows over time.

D) its real GDP per person growth rate increases over time.

E) it does not receive foreign aid.

Answer: BTopic: Economic growthSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

9


4) Economic growth is defined as equal to the increase in

A) employment.

B) population.

C) real GDP.

D) the price level.

E) the inflation rate.

Answer: CTopic: Economic growthSkill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

5) Which of the following variables is used to determine a countryʹs economic growth?

i. real GDP

ii. wages

iii. inflation

A) i and ii only

B) i, ii and iii

C) ii and iii

D) i only

E) i and iii

Answer: DTopic: Economic growthSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

6) The growth rate of real GDP equals

A) [(employment in the current year - employment in previous year)/employment in

previous year] × 100.

B) [(real GDP in current year - real GDP in previous year) ÷ real GDP in previous year] ×

100.

C) [(real GDP in previous year - real GDP in current year) ÷ real GDP in previous year] ×

100.

D) [(real GDP in current year - real GDP in previous year) ÷ real GDP in current year] × 100.

E) (real GDP in current year - real GDP in previous year) × 100.

Answer: BTopic: Economic growthSkill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

0


7) If real GDP was $13.1 trillion in 2013 and $13.3 in 2014, what is the growth rate?

A) 15.0 percent

B) -1.5 percent

C) 1.5 percent

D) $0.2 trillion

E) 2.1 percent

Answer: CTopic: Calculating growth ratesSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

8) Suppose Franceʹs real GDP grew from $750 billion in 2010 to $821 billion in 2011. What was

the growth rate of Franceʹs real GDP?

A) 10 percent

B) 9.5 percent

C) 9.1 percent

D) 8.6 percent

E) $71 billion

Answer: BTopic: Growth rateSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

9) U.S. real GDP in 2007 was $13.25 trillion and U.S. real GDP in 2008 was $13.31 trillion. What

was the economic growth rate of the United States during this period?

A) 18 percent

B) -1.36 percent

C) 0.45 percent

D) 6.9 percent

E) $1.8 trillion

Answer: CTopic: Calculating growth ratesSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: RevisedAACSB: Analytical thinking

Page 801


10) If real GDP in year 1 is $72 million and real GDP in year 2 is $87 million, then the growth rate

of real GDP is

A) 15 percent.

B) $15 million.

C) 20.8 percent.

D) 17 percent.

E) 83 percent.

Answer: CTopic: Calculating growth ratesSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

11) In 2008, real GDP in the United States was $13,312 billion. In 2009, real GDP in the United

States was $13,112 billion. What was the U.S. economic growth rate from 2008 to 2009?

A) -1.5 percent

B) 1.5 percent

C) 0.98 percent

D) 0.12 percent

E) $200 million

Answer: ATopic: Growth rateSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Year

Real GDP

(trillions of 2009 dollars)

Population

(millions of people)

2009

2010

2011

7.00

7.50

8.25

100.0

105.0

110.0

12) Using the data in the table above, the growth rate of real GDP for 2010 is equal to

A) 9.09 percent.

B) 7.00 percent.

C) 5.00 percent.

D) 4.76 percent.

E) 10.0 percent.

Answer: BTopic: Calculating growth ratesSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 802


13) Using the data in the table above, real GDP per person in 2009 is

A) $70,000.

B) $71,429.

C) $75,000.

D) $70 trillion.

E) 7 percent.

Answer: ATopic: Calculating growth ratesSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

14) Using the data in the table above, the growth rate of real GDP has

A) increased from year to year.

B) increased more rapidly from year to year.

C) remained constant from year to year.

D) slowed from year to year.

E) probably changed, but more information is needed about the price level to determine by

how much it has changed.

Answer: ATopic: Calculating growth ratesSkill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

15) Suppose India wants to measure how much the standard of living has changed over the last

decade. Which piece of data should India use?

A) population

B) real GDP per person

C) real GDP

D) wages

E) inflation

Answer: BTopic: Standard of livingSkill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

Page 803


16) To measure the change in the standard of living, it is best to use the growth rate

A) from the Rule of 70.

B) of real GDP.

C) of the population.

D) of real GDP per person.

E) of the price level.

Answer: DTopic: Standard of livingSkill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

17) In growth theory, the change in a countryʹs standard of living is measured by the change in

A) real GDP per person.

B) real GDP.

C) the nationʹs capital stock.

D) wages per person.

E) employment.

Answer: ATopic: Standard of livingSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

18) A measure of growth in the standard of living is the growth in

A) real GDP.

B) population.

C) real GDP minus the growth in population.

D) population minus the growth in real GDP.

E) employment.

Answer: CTopic: Standard of livingSkill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

19) Growth in the standard of living is measured by the increase in

A) real GDP.

B) the Rule of 70.

C) employment.

D) real GDP per person.

E) consumption.


Page 804


20) The growth rate of real GDP per person equals the

A) population growth rate plus the growth rate of real GDP.

B) change in the economic growth rate divided by the change in the population growth rate.

C) the economic growth rate per person divided by the change in the population growth

rate.

D) growth rate of real GDP minus the growth rate of the population.

E) population growth rate plus the growth rate of real GDP then divided by the initial level

of real GDP.

Answer: DTopic: Growth rate, real GDP per personSkill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

21) If real GDP grows at a faster rate than does population, then the standard of living, as

measured by real GDP per person,

A) improves.

B) worsens.

C) remains the same.

D) cannot be measured.

E) either improves, worsens, or stays the same, depending on the size of the population and

the actual level of real GDP.

Answer: ATopic: Growth rate, real GDP per personSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

22) The population in the current year is 31.5 million and the real GDP is $814 million. The

previous yearʹs statistics were a population of 31 million and a real GDP of $800 million. The

change in the standard of living, measured by growth in real GDP per person, is

A) 1.6 percent.

B) 7.75 percent.

C) 0.13 percent.

D) 6 percent.

E) 0 percent.

Answer: CTopic: Growth rate, real GDP per personSkill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 805


23) Assume the population growth rate is 2 percent and the real GDP growth rate is 5 percent. The

change in standard of living, as measured by the growth rate in real GDP per person, is

A) 7 percent.

B) 2.5 percent.

C) 5 percent.

D) 3 percent.

E) -3 percent.

Answer: DTopic: Growth rate, real GDP per personSkill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

24) Real GDP in the country of Oz is growing at 5 percent and its population is growing at 2

percent. In the country of Lilliput, real GDP is growing at 4 percent and its population is

growing at 0.5 percent. Thus,

A) real GDP per person in Oz is growing at a faster rate than in Lilliput.

B) real GDP per person in Lilliput is growing at a faster rate than in Oz.

C) real GDP per person in Lilliput is growing at the same rate as in Oz.

D) real GDP per person in Lilliput is growing at a rate that is not comparable to that in Oz.

E) We need more information to determine if real GDP per person in Lilliput is growing

faster or slower than real GDP per person in Oz.

Answer: BTopic: Growth rate, real GDP per personSkill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

25) If the U.S. population grew at a 0.9 percent and real GDP grew at a 4.4 percent during the

same period, what was the growth rate of real GDP per person?

A) 3.5 percent

B) 5.3 percent

C) 4.0 percent

D) -3.5 percent

E) 4.4 percent

Answer: ATopic: Growth rate, real GDP per personSkill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 806


26) If real GDP grows at a rate of 6 percent and population grows at a rate of 2 percent, then real

GDP per person grows at a rate of

A) 4 percent.

B) 2 percent.

C) 0.5 percent.

D) -3 percent.

E) 8 percent.


27) Icelandʹs real GDP grows at a rate of 2.6 percent and population grows at a rate of 0.8 percent.

Icelandʹs real GDP per person grows at a rate of

A) 1.8 percent.

B) 2.6 percent.

C) 3.4 percent.

D) 3.0 percent.

E) 3.2 percent.


28) If an economyʹs growth rate of real GDP is 3 percent per year and the growth rate of the

population is 2.5 percent per year, the growth rate of real GDP per person is

A) 3 + 2.5 = 5.5 percent per year.

B) [(3 - 2.5) ÷ 2.5] × 100 = 20 percent per year.

C) [(2.5 - 3) ÷ 3] × 100 = 16.6 percent per year.

D) 3 - 2.5 = 0.5 percent per year.

E) 2.5 - 3 = -0.5 percent per year.

Answer: DTopic: Growth rate, real GDP per personSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 807


29) In 2009, U.S. real GDP decreased by 3 percent and the population grew by 1 percent. Thus, real

GDP per person

A) increased 2 percent.

B) decreased 2 percent.

C) increased 4 percent.

D) decreased 4 percent.

E) decreased 3 percent.


30) If a country experiences a real GDP growth rate of 1 percent and population growth of 2

percent, then the growth rate of real GDP per person is

A) 3 percent.

B) 2 percent.

C) 1 percent.

D) -1 percent.

E) 0 percent.


31) During 2008, Swaziland had a real GDP growth rate of 1.8 percent and a real GDP growth rate

per person of -1.3 percent. These rates indicate that in Swaziland

A) there was an error when calculating the growth rates because the growth rate of real

GDP per person cannot be negative.

B) the population growth rate was negative.

C) the population grew at a faster rate than real GDP.

D) poverty levels are declining.

E) real GDP grew more rapidly than did the population.

Answer: CTopic: Growth rate, real GDP per personSkill: Level 5: Critical thinkingSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 808


32) In India last year, the growth rate of real GDP was 3.5 percent and the population grew from

1,000 million people to 1,100 million. Real GDP per person

A) increased by 13.5 percent.

B) decreased by 6.5 percent.

C) increased by 6.5 percent.

D) decreased by 13.5 percent.

E) increased by 3.5 percent.


33) Belgiumʹs real GDP per person is $33,000 and Austriaʹs is $34,700. The population growth rate

in Belgium is 0.13 percent and the growth rate of real GDP is 3.0 percent. The population

growth rate in Austria is 0.08 percent and the growth rate of real GDP is 3.3 percent. If these

growth rates continue, how many years will it take for Belgiumʹs real GDP per person to equal

Austriaʹs real GDP per person?

A) Belgiumʹs standard of living will never equal Austriaʹs.

B) just over 23 years

C) just over 24 years

D) just over 21 years

E) over 230 years


34) If Country Aʹs real GDP is growing at 6 percent per year and Country Bʹs real GDP is growing

at 6 percent per year, then the standard of living is

A) growing more rapidly in Country A.

B) higher in Country B.

C) changing at the same rate in Country A and Country B.

D) growing more slowly in Country A.

E) changing at the same rate in Country A and Country B only if the rate of population

growth is the same in both countries.

Answer: ETopic: Growth rate, real GDP per personSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

Page 809


35) If Country Aʹs real GDP per person is growing at 6 percent and Country Bʹs real GDP per

person is growing at 3 percent, then

A) the standard of living is higher in Country A.

B) the standard of living is higher in Country B.

C) the standard of living is growing more rapidly in Country A.

D) We cannot say whose standard of living is growing more rapidly without knowing the

population growth rate.

E) We cannot say whose standard of living is growing more rapidly without knowing the

growth rate of real GDP.

Answer: CTopic: Growth rate, real GDP per personSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

Year

Real GDP

(millions of 2009 dollars)

Population


Year 1 500 10

Year 2 550 11

36) According to the data in the table above,

A) the standard of living improved between year 1 and year 2.

B) the standard of living worsened between year 1 and year 2.

C) as measured by real GDP per person, the standard of living remained the same between

year 1 and year 2.

D) real GDP grew more rapidly than population between year 1 and year 2.

E) real GDP grew more slowly than population between year 1 and year 2.

Answer: CTopic: Standard of livingSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

37) According to the data in the table above, real GDP grew at a rate of ________ between year 1

and year 2.

A) 10 percent

B) 1 percent

C) 50 percent

D) 5 percent

E) 55 percent

Answer: ATopic: Calculating growth ratesSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 810


38) According to the data in the table above, real GDP per person grew at a rate of ________

between year 1 and year 2.

A) 10 percent

B) 0 percent

C) 1 percent

D) 5 percent

E) 50 percent


39) The Rule of ________ can be used to calculate the number of years that it takes for the level of a

variable to ________.

A) 20; double

B) 70; triple

C) 70; double

D) 20; triple

E) thumb; double

Answer: CTopic: Rule of 70Skill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

40) The Rule of 70 states that the level of a variable will double in

A) 70 years.

B) the number of years equal to the variableʹs annual rate of growth divided by 70.

C) the number of years equal to 70 divided by the variableʹs annual growth rate.

D) the number of years equal to the variableʹs annual growth rate minus 70.

E) the number of years equal to 70 multiplied by the variableʹs annual growth rate

expressed as a decimal.

Answer: CTopic: Rule of 70Skill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

Page 811


41) The Rule of 70, as applied to real GDP growth, can be used to find the

A) real GDP growth rate necessary to double growth.

B) number of years it takes for the level of real GDP to double.

C) growth rate of real GDP.

D) number of years it takes for the growth rate of real GDP to double.

E) population growth rate necessary to double the GDP growth rate.

Answer: BTopic: Rule of 70Skill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

42) The Rule of 70 can be used to calculate the

A) economic growth rate per month.

B) population growth rate per year.

C) number of years it would take for the level of any variable to double.

D) 70 percent level of the economic growth rate.

E) economic growth rate per year.

Answer: CTopic: Rule of 70Skill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

43) Approximately how long will it take Ethiopia to double its real GDP per person of $100 if its

growth rate of real GDP per person is 0.9 percent?

A) 63 years

B) 77.7 years

C) 70 years

D) 109 years

E) 100 years

Answer: BTopic: Rule of 70Skill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

44) If Country Aʹs real GDP grows at a rate of 14 percent per year, about how many years will it

take for Country Aʹs real GDP to double?

A) 10 B) 7 C) 5 D) 30 E) 14

Answer: CTopic: Rule of 70Skill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 812


45) According to the Rule of 70, if a country grows at 2.0 percent per year instead of 1.5 percent

per year, how many fewer years will it take to double its level of real GDP?

A) It will take 11.6 years fewer.

B) It will take 35 years fewer.

C) It will take 58.3 years fewer.

D) It will take 20 years fewer.

E) It will take 17.9 years fewer.

Answer: ATopic: Rule of 70Skill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

46) The annual growth rate of an economy is 10 percent. The economyʹs GDP will double in about

________ years.

A) 7 B) 10 C) 12 D) 14 E) 20


47) Using the rule of 70, a sustained 3 percent per year real GDP growth rate will

A) last for 70 years.

B) double the current level of real GDP in about 23 years.

C) double the current level of real GDP in about 210 years.

D) double the current level of real GDP in about 70 years.

E) double the current level of real GDP in about 40 years.

Answer: BTopic: Rule of 70Skill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

48) A nationʹs annual growth rate of real GDP per person is 2 percent. Its standard of living will

A) double in 35 years.

B) not change because its population is growing.

C) fall because of its population growth.

D) double in 10 years.

E) double in 50 years.


Page 813


49) If a country experiences a real GDP growth rate of 6 percent, real GDP will double in

A) 10 years.

B) 11.67 years.

C) 14 years.

D) 17.5 years.

E) 16.67 years.

Answer: BTopic: Rule of 70Skill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

50) This year, real GDP per person in Country A is eight times real GDP per person in Country B.

If Country Bʹs real GDP per person grows at a rate of 5 percent, about how many years will it

take for Country B to reach the level of real GDP per person in Country A in this year?

A) 14 years

B) 28 years

C) 56 years

D) 42 years

E) It will never reach Country Aʹs level of GDP per person.

Answer: DTopic: Rule of 70Skill: Level 4: Applying modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

51) This year Iceland has a real GDP per person that is approximately 8 times greater than that of

Cape Verde. Cape Verdeʹs growth rate of real GDP per person was 5.2 percent. If Cape Verde

maintains this current growth rate, approximately how many years will it take for Cape

Verdeʹs real GDP per person to reach the same level that Iceland has this year?

A) 13.5 years

B) 20 years

C) 27 years

D) 40 years

E) 54 years

Answer: DTopic: Rule of 70Skill: Level 4: Applying modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 814


52) If it took 20 years for real GDP to double, what was the growth rate of real GDP?

A) 4.5 percent

B) 3.0 percent

C) 3.5 percent

D) 4 percent

E) 5 percent

Answer: CTopic: Rule of 70Skill: Level 4: Applying modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

53) In this year, Country A has a real GDP per person that is 4 times greater than that of Country

B. Country Bʹs growth rate of real GDP per person is 3.5 percent per year. How many years

will it take for Country Bʹs real GDP per person to reach the same level that Country A had in

this year?

A) 10 years B) 20 years C) 40 years D) 60 years E) 56 years

Answer: CTopic: Rule of 70Skill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

54) Suppose Mexicoʹs real GDP per person in 2008 is $6,000 and the U.S. real GDP per person is

$24,000. Mexico has annual growth in real GDP per person of 5 percent. Approximately how

many years will it take Mexico to equal $24,000 of real GDP per person?

A) 14 years B) 18 years C) 28 years D) 36 years E) 40 years

Answer: CTopic: Rule of 70Skill: Level 4: Applying modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

55) Over the past 110 years, real GDP per person in the United States has grown at an average rate

of about ________ per year.

A) 1 percent

B) 2 percent

C) 5 percent

D) 10 percent

E) 7.5 percent

Answer: BTopic: Eye on the past, how fast has real GDP per person grown?Skill: Level 1: DefinitionSection: Checkpoint 9.1Status: RevisedAACSB: Reflective thinking

Page 815


56) For the world, what period of time experienced the fastest growth rate of real GDP per person?

A) around 500 B.C.

B) around 400 A.D.

C) between 1000 A.D. and 1500 A.D.

D) after about 1850 A.D.

E) between 1500 A.D. and 1850 A.D.

Answer: DTopic: Eye on the past, how fast has real GDP per person grown?Skill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

57) Real GDP per person averaged $150 a year (in 2009 dollars) from 1,000,000 BC until 1620.

During this time there was a period when it rose to ________ around ________ because

________.

A) $210; 1620; the Pilgrim Fathers began to arrive in the Americas

B) $210; 1492; Columbus sailed to the Americas

C) $140; 400 BC; the Roman Empire collapsed

D) $190; 500 BC; of the gains from human capital while Aristotle and Plato were teaching in

Athens

E) a 1-million year high; the 1340s; the Black Death gripped Europe

Answer: DTopic: Eye on the past, how fast has real GDP per person grown?Skill: Level 1: DefinitionSection: Checkpoint 9.1Status: NewAACSB: Reflective thinking

58) Real GDP per person averaged $150 a year (in 2009 dollars) from 1,000,000 BC until 1620. Then

in ________ real GDP began to increase without limit and by 1850 had risen to twice its 1650

level because ________.

A) 1650; the Pilgrims arrived in the Americas

B) 1750; Columbus arrived in the Americas

C) 1650; of the Industrial Revolution

D) 1750; of the Industrial Revolution

E) 1776; United States was founded


Page 816


59) Since the beginning of the 20th century the decade with the slowest real GDP per person

growth rate other than the 1930s is ________ because of the ________.

A) 2000-2010; the war on terror

B) 1990-2000; fear of Y2K

C) 1930-1940; Great Depression

D) 2000-2010; 2008/2009 deep recession

E) 2010-2020; Keynesian economic policies being used more frequently than in the 1930s


60) The economic growth rate is measured as the

A) annual percentage change of real GDP.

B) annual percentage change of employment.

C) amount of real GDP.

D) annual percentage change of the population.

E) amount of population.


61) Economic growth is a sustained expansion of production possibilities measured as the increase

in ________ over a given period.

A) real GDP

B) real GDP per person

C) the standard of living

D) capital per person

E) population


Page 817


62) The economic growth rate is expressed as the

A) annual percentage change of real GDP per person.

B) growth rate of real GDP minus the growth rate of population.

C) standard of living.

D) annual percentage change of real GDP.

E) growth rate of the population.

Answer: DTopic: Economic growthSkill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

63) Real GDP is $9 trillion in the current year and $8.6 trillion in the previous year. The economic

growth rate between these years has been

A) 10.31 percent.

B) 4.65 percent.

C) 5.67 percent.

D) 7.67 percent.

E) $0.4 trillion.


Year

Real GDP

(trillions of 2009 yen)

1997 484

1996 480

64) The table gives information about the economy of Japan. The economic growth rate in 1997 is

________ percent.

A) 8.0 B) 0.8 C) 0.08 D) 0.008 E) 4


Page 818


65) The standard of living is measured by

A) real GDP.

B) employment.

C) employment per person.

D) real GDP per person.

E) the population.


66) If the growth rate of population is greater than a nationʹs growth rate of real GDP, then its real

GDP per person

A) falls.

B) rises.

C) does not change.

D) might rise, fall, or not change.

E) cannot be measured.

Answer: ATopic: Standard of livingSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

Year

Employment


Real GDP

(billions of 2009 francs)

1998 58.85 8,243.9

1997 58.61 7,992.2

67) The table above gives information about the economy of France. The growth rate of real GDP

per person in 1998 is ________ percent.

A) 3.1 B) 0.4 C) 3.6 D) 4.0 E) 1.9

Answer: CTopic: Growth rate, real GDP per personSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: RevisedAACSB: Analytical thinking

68) If real GDP increases by 6 percent and at the same time the population increases by 2 percent,

then real GDP per person grows by

A) 6 percent. B) 4 percent. C) 2 percent. D) 8 percent. E) 3 percent.

Answer: BTopic: Growth rate, real GDP per personSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 819


69) If real GDP grew 5 percent last year and the population grew 2 percent, then real GDP per

person grew by ________ percent.

A) 10 B) 5 C) 3 D) 2 E) 7

Answer: CTopic: Growth rate, real GDP per personSkill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

70) If a country experiences a real GDP growth rate of 4 percent, real GDP will double in

A) 14 years.

B) 17.5 years.

C) 23.3 years.

D) 35 years.

E) 25 years.


71) Suppose that in the future, real GDP per person grows 2 percent a year in the United States

and 4 percent a year in China. It will take real GDP per person approximately ________ years

to double in the United States and approximately ________ years to double in China.

A) 70; 35 B) 35; 17.5 C) 35; 8.75 D) 50; 25 E) 20; 10


Year

Real GDP

(billions of 2009 pesetas)

1998 45,901

1997 44,224

72) The table above gives information about the economy of Spain. If the growth rate in 1998 is

maintained, real GDP will double in ________ years.

A) 4 B) 19 C) 10 D) 18 E) 25

Answer: DTopic: Rule of 70Skill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 820


9.2 Labor Productivity Growth

1) Labor productivity is defined as

A) total real GDP.

B) real GDP per person.

C) total output multiplied by total hours of labor.

D) real GDP per hour of labor.

E) hours of work per person.

Answer: DTopic: Sources of growth, labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

2) Labor productivity equals

A) real GDP.

B) real GDP per hour of labor.

C) the total production of labor.

D) the quantity of labor hours divided by real GDP.

E) real GDP divided by the amount of human capital.

Answer: BTopic: Labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

3) Labor productivity is equal to the quantity of

A) real GDP produced by one hour of labor.

B) workers employed during one hour.

C) real GDP consumed by the total population in one hour.

D) real GDP.

E) workers who are gainfully employed.

Answer: ATopic: Labor productivitySkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

Page 821


4) The quantity of real GDP produced by one hour of labor is defined as

A) real GDP per person.

B) the advance in technology.

C) the growth rate of technology.

D) labor productivity.

E) economic growth.

Answer: DTopic: Labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

5) Labor productivity is calculated as

A) (real GDP ÷ aggregate hours).

B) (real GDP ÷ aggregate hours × number of workers).

C) (real GDP ÷ number of workers × ratio of capital per worker).

D) (real GDP ÷ technology level).

E) (real GDP ÷ aggregate hours × number of workers) × 100.

Answer: ATopic: Labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

6) Sustained increases in the standard of living depend on

A) increases in the quantity of labor.

B) increases in the population.

C) increases in aggregate hours.

D) increases in labor productivity.

E) decreases in labor productivity.

Answer: DTopic: Sources of growth, labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

Page 822


7) An increase in labor productivity

A) increases the standard of living.

B) decreases the standard of living.

C) might be the result of an increase in the quantity of labor.

D) generally occurs when physical capital decreases because firms must then hire more

workers.

E) cannot occur without a corresponding increase in employment.

Answer: ATopic: Labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

8) Last year, in a nation far to the South, real GDP was $90 million and 900,000 workers were

employed. This year real GDP is $100 million, 950,000 workers are employed, and the number

of hours each worker works per year did not change. Hence, labor productivity

A) has increased.

B) has decreased.

C) has remained constant.

D) cannot be compared between the two years because both real GDP and the number of

workers increased.

E) might have changed, but more information is needed to determine if it changed.

Answer: ATopic: Labor productivitySkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

9) If real GDP is $6,460 billion, the population is 184.6 million people, and aggregate hours is 170

billion hours, labor productivity is

A) $2.63 an hour.

B) $2.86 an hour.

C) $35,000.

D) $38.00 an hour.

E) 920 hours.

Answer: DTopic: Labor productivitySkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

Page 823


10) Real GDP is $700 billion, average hours worked per week is 42 and aggregate hours is 150

billion hours. What is the economyʹs labor productivity?

A) $1.80 per hour

B) $3.75 per hour

C) $16.67 per hour

D) $4.67 per hour

E) $4.50 per hour

Answer: DTopic: Labor productivitySkill: Level 3: Using modelsSection: Checkpoint 9.2Status: RevisedAACSB: Analytical thinking

11) Labor productivity growth depends on

i. saving and investment.

ii. increases in human capital.

iii. technological growth.

A) i only

B) ii only

C) iii only

D) Both ii and iii

E) i, ii, and iii

Answer: ETopic: Increase in labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

12) Labor force productivity has increased from $30 per hour to $32 per hour over the past year.

This could result from

A) only an increase in real GDP.

B) an increase in real GDP with no change in the aggregate hours or a decrease in aggregate

hours with no change in real GDP.

C) only a decrease in aggregate hours.

D) an increase in the labor force participation rate.

E) an increase in population.

Answer: BTopic: Increase in labor productivitySkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

Page 824


13) In recent years, Taiwan has experienced increases in savings and investment. As a result of the

higher investment and saving, we expect

i. increases in physical capital.

ii. increases in the inflation rate.

iii. advances in technology.

A) i and iii

B) i and ii

C) ii only

D) ii and iii

E) i, ii and iii

Answer: ATopic: Increase in labor productivity, physical capitalSkill: Level 3: Using modelsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

14) If the stock of physical capital (that is machinery, equipment, etc.) and human capital remains

the same and the population increases, then

A) labor productivity will increase.

B) labor productivity will decrease.

C) the standard of living will increase.

D) the new labor will be more productive.

E) real GDP decreases.

Answer: BTopic: Increase in labor productivity, physical capitalSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

15) The widespread adoption of computers in the workplace has likely led to

A) no change in the quantity of labor hours.

B) an increase in labor productivity because computers are a capital good.

C) a decrease in labor productivity because computers are a capital good.

D) a decrease in human capital because computers are physical capital.

E) an increase in the supply of labor because people are needed to operate the computers.

Answer: BTopic: Increase in labor productivity, physical capitalSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

Page 825


16) An increase in capital brings a large increase in output at a ________ quantity of capital and a

small increase in output at a ________ quantity of capital because of ________.

A) small; large; increasing returns along the productivity curve

B) small; large; diminishing returns along the productivity curve

C) large; small; diminishing returns along the productivity curve

D) large; small; increasing returns along the productivity curve

E) large; small; the greater the quantity of capital the greater the output

Answer: BTopic: Increase in labor productivity, physical capitalSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: NewAACSB: Reflective thinking

17) Which of the following are required for economic growth?

i. more goods and services produced per hour of work

ii. an increase in the average hours of labor per person

iii. an increase in prices

A) i and iii B) i and ii C) ii and iii D) i only E) ii only

Answer: BTopic: Increase in labor productivitySkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

18) A reason for an increase in labor productivity growth is

A) an increase in peopleʹs human capital.

B) a decrease in the capital stock so that firms must hire more workers.

C) growth in the supply of labor.

D) an increase in the population so that firms hire more workers.

E) an increase in the quantity of labor.

Answer: ATopic: Increase in labor productivity, human capitalSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

19) Human capital refers to the

A) accumulated skill and knowledge of human beings.

B) accumulated equipment used by human beings.

C) accumulation of money by human beings.

D) accumulation of money and equipment used by human beings.

E) accumulated financial capital people have acquired.

Answer: ATopic: Increase in labor productivity, human capitalSkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

Page 826


20) Human capital is defined as the

A) amount of machinery human beings have.

B) number of factories built for human beings.

C) accumulated skill and knowledge of human beings.

D) accumulated amount of machinery and factories human beings own.

E) skills that people are born with.

Answer: CTopic: Increase in labor productivity, human capitalSkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

21) Increases in human capital can come

A) only from formal schooling.

B) from employing more machinery.

C) only from on-the-job experience.

D) from formal education and on-the-job learning.

E) from nowhere because whatever human capital an individual possesses is what he or she

was born with.

Answer: DTopic: Increase in labor productivity, human capitalSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

22) Expansion of a nationʹs human capital can be achieved through

A) education and training.

B) education and saving.

C) education and technology improvements.

D) education only.

E) nothing because human capital is determined by the skills people are born with.

Answer: ATopic: Increase in labor productivity, human capitalSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

Page 827


23) Human capital is acquired

A) only in school.

B) only through on-the-job training.

C) only through job experience.

D) through schooling, job training, and experience.

E) only at birth, that is, itʹs peopleʹs inborn talents.

Answer: DTopic: Increase in labor productivity, human capitalSkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

24) Advances in technology and growth in human capital ________ because ________.

A) shift the productivity curve downward; labor and capital become less productive

B) shift the productivity curve downward; labor and capital become more productive

C) shift the productivity curve upward; labor and capital become less productive

D) shift the productivity curve upward; labor and capital become more productive

E) do not shift the productivity curve; there is a movement along the productivity curve

Answer: DTopic: Increase in labor productivity, human capitalSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: NewAACSB: Reflective thinking

25) The expansion of human capital and the discovery of new technologies ________ because

________.

A) are subject to diminishing returns; they shift the productivity curve downward

B) are subject to diminishing returns; they shift the productivity curve upward

C) are not subject to diminishing returns; they shift the productivity curve downward

D) are not subject to diminishing returns; they shift the productivity curve upward

E) are not subject to diminishing returns; they result in a movement along the productivity

curve

Answer: DTopic: Increase in labor productivity, human capitalSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: NewAACSB: Reflective thinking

Page 828


26) Labor productivity increases if

i. human capital decreases.

ii. technology advances.

iii. quality of education decreases.

A) i only

B) ii only

C) iii only

D) Both i and ii

E) Both ii and iii

Answer: BTopic: Increase in labor productivity, technologySkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

27) ________ increases with education, training, and job experience.

i. Physical capital

ii. Human capital

iii. Financial capital

A) i only

B) ii only

C) iii only

D) both ii and iii

E) i, ii, and iii

Answer: BTopic: Increase in labor productivity, human capitalSkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

28) U.S. labor productivity slowed during the 1970s because of

i. increasing government taxes and regulations on production.

ii. the necessity to cope with energy price increases.

iii. inflation, which shortened the horizon over which businesses made their borrowing plans.

A) i only

B) ii only

C) iii only

D) Both i and ii

E) i, ii, and iii

Answer: ETopic: Eye on the U.S. economy, U.S. labor productivity growthSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

Page 829


29) Over the last 50 years, U.S. labor productivity grew the fastest during the ________ because of

________.

A) 1900s; the war on terror and return to the basics of education

B) 1990s; advancements in healthcare due to the unlocking of the human genome

C) 1980s; the invention of the computer and the oil embargo

D) 1970s; an increase in government taxes and expanded regulations

E) 1960s; fast paced technological change and large increases in human capital

accumulation

Answer: ETopic: Eye on the U.S. economy, U.S. labor productivity growthSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: NewAACSB: Reflective thinking

30) The law of diminishing marginal returns states that

A) output increases at a constant rate as more capital is added.

B) output decreases at a constant rate as more capital is added.

C) as both labor and capital are increased, output does not change.

D) as both labor and capital are increased, output increases at a decreasing rate.

E) output increases at a decreasing rate as more capital is added.

Answer: ETopic: Law of diminishing marginal returnsSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

31) According to the law of diminishing returns, an additional unit of

A) capital produces more output than an additional unit of labor.

B) labor decreases output.

C) capital produces the same amount of output as an additional unit of labor.

D) capital produces more output than the previous unit.

E) capital produces less output than the previous unit.

Answer: ETopic: Law of diminishing marginal returnsSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

Page 830


32) The shape of the productivity curve reflects the

A) effects of capital accumulation.

B) effects of technological progress.

C) change in labor productivity as human capital increases.

D) law of diminishing marginal returns.

E) effects of population growth.

Answer: DTopic: Law of diminishing marginal returnsSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

33) The productivity curve is a relationship between

A) real GDP per hour of labor and capital per hour of labor, with technology held constant.

B) nominal GDP per hour of labor and capital per hour of labor, with technology held

constant.

C) real GDP per hour of labor and capital per hour of labor whenever technological growth

occurs.

D) real GDP per unit of capital and capital per hour of labor, with technology held constant.

E) capital per hour of labor and technological growth.

Answer: ATopic: Productivity curveSkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

34) The productivity curve is a relationship between ________ and ________.

A) real GDP; hours of labor

B) real GDP; capital

C) real GDP per hour of labor; capital

D) capital per hour of labor; labor per hour of capital

E) real GDP per hour of labor; capital per hour of labor

Answer: ETopic: Productivity curveSkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

Page 831


35) A diagram of a productivity curve has

A) real GDP per hour of labor on the y-axis and capital per hour of labor on the x-axis.

B) real GDP per hour of labor on the y-axis and hours of labor on the x-axis.

C) capital per hour of labor on the y-axis and real GDP per hour of labor on the x-axis.

D) real wages per hour on the y-axis and real GDP per hour of labor on the x-axis.

E) real GDP per hour of labor on the y-axis and real wages per hour on the x-axis.


36) The productivity curve

A) has a positive slope.

B) has a negative slope.

C) is vertical.

D) is horizontal.

E) is U-shaped.


37) Suppose that an Intel worker rearranges existing machines and labor and increases the

quantity of chips Intel can produce. Using the productivity curve graphed, this innovation

would be described as

A) a movement upward along the curve.

B) a movement downward along the curve.

C) a shift of the curve upward.

D) a shift of the curve downward.

E) no change to the productivity curve.

Answer: CTopic: Productivity curveSkill: Level 3: Using modelsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

Page 832


38) If capital per hour of labor increases, GDP per hour of labor

A) decreases for a given level of technology.

B) increases because the level of technology advances.

C) increases for a given level of technology.

D) decreases because the level of technology decreases.

E) changes only if technology also advances.

Answer: CTopic: Productivity curveSkill: Level 3: Using modelsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

39) If capital per hour of labor decreases, real GDP per hour of labor

A) decreases because the level of technology decreases.

B) increases because the level of technology increases.

C) increases for a given level of technology.

D) decreases for a given level of technology.

E) changes only if technology also advances.

Answer: DTopic: Productivity curveSkill: Level 3: Using modelsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

40) If the level of technology rises, GDP per hour of labor

A) increases for any level of capital per hour of labor.

B) increases because the level of capital per hour of labor increases.

C) decreases for a given level of capital per hour of labor.

D) decreases because the level of capital per hour of labor decreases.

E) does not change because GDP increases only when capital or labor increases.

Answer: ATopic: Productivity curve, technological advanceSkill: Level 3: Using modelsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

41) A technological change ________ and a change in the capital stock ________.

A) shifts the productivity curve; shifts the productivity curve

B) shifts the productivity curve; creates a movement along the productivity curve

C) creates a movement along the productivity curve; shifts the productivity curve

D) does not change the productivity curve; creates a movement along the productivity curve

E) does not change the productivity curve; shifts the productivity curve

Answer: BTopic: Productivity curveSkill: Level 4: Applying modelsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

Page 833


42) The expansion of human capital and the discovery of new technologies ________ because

________.

A) decrease real GDP; they shift the productivity curve downward

B) decrease real GDP; they shift the productivity curve upward

C) increase real GDP; they shift the productivity curve downward

D) increase real GDP; they shift the productivity curve upward

E) increase real GDP; they result in a movement upward along the productivity curve

Answer: DTopic: Labor productivitySkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: NewAACSB: Reflective thinking

43) Increases in capital per worker ________ because ________.

A) increase real GDP; they shift the productivity curve downward

B) increase real GDP; they shift the productivity curve upward

C) increase real GDP; they create a movement downward along the productivity curve

D) increase real GDP; they create a movement upward along the productivity curve

E) may increase or decrease real GDP; the result is a movement along the productivity

curve but the direction depends on other factors not given

Answer: DTopic: Labor productivitySkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: NewAACSB: Reflective thinking

44) Labor productivity equals ________.

A) real GDP × aggregate hours

B) real GDP ÷ aggregate hours

C) aggregate hours ÷ real GDP

D) aggregate hours × labor productivity

E) aggregate hours ÷ labor productivity

Answer: BTopic: Labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

Page 834


45) Labor productivity equals

A) real GDP divided by the capital stock.

B) real GDP divided by the population.

C) total wages divided by real GDP.

D) real GDP divided by aggregate hours.

E) aggregate hours divided by employment.

Answer: DTopic: Labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

46) If real GDP is $1,200 billion, the population is 60 million, and aggregate hours are 80 billion,

labor productivity is

A) $5.00 an hour.

B) $6.67 an hour.

C) $15.00 an hour.

D) $20,000.

E) $150 an hour.

Answer: CTopic: Labor productivitySkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

47) If aggregate hours are 100 billion hours and labor productivity is $40 an hour, than real GDP

equals

A) $100 billion.

B) $40 billion.

C) $100 trillion.

D) $2.5 trillion.

E) $4 trillion.

Answer: ETopic: Labor productivitySkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

Page 835


48) Which of the following lists gives factors that increase labor productivity?

A) saving and investment in physical capital, and wage increases

B) expansion of human capital, labor force increases, and discovery of new technologies

C) expansion of human capital, population growth, and discovery of new technologies

D) saving and investment in physical capital, expansion of human capital, and discovery of

new technologies

E) labor force increases and wage increases

Answer: DTopic: Increase in labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

49) Growth in physical capital depends most directly upon the

A) amount of saving and investment.

B) number of firms in the nation.

C) speed of population growth.

D) amount of government expenditures.

E) level of human capital.

Answer: ATopic: Sources of economic growthSkill: Level 2: Using definitionsSection: Checkpoint 9.2Status: OldAACSB: Reflective thinking

50) The productivity curve shifts upward when

A) physical capital increases.

B) human capital decreases.

C) hours of labor increase.

D) hours of labor decrease.

E) technology advances.

Answer: ETopic: Productivity curveSkill: Level 3: Using modelsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

Page 836


9.3 Economic Growth Theories: Old and New

1) Thomas Malthus was an economist who contributed to the ________ theory of growth.

A) classical

B) neoclassical

C) new growth

D) socialist

E) Keynesian

Answer: ATopic: Classical growth theorySkill: Level 1: DefinitionSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

2) The Malthusian theory

A) is also called the classical growth theory and predicts that we will run out of resources.

B) is also called the neoclassical growth theory.

C) predicts that the real GDP per person will continue to increase as long as technology

increases.

D) claims that the subsistence wage will increase over time.

E) shows that the production function will shift upward continuously.


3) A key element of the classical growth theory is that

A) economic growth can be sustained as long as government intervention does not occur.

B) increases in technology drive economic growth.

C) an increase in population leads to increase in labor supply and a decline in real GDP per

person.

D) low taxes promote economic growth.

E) market forces drive economic growth.

Answer: CTopic: Classical growth theorySkill: Level 2: Using definitionsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

Page 837


4) The classical theory was developed in the late 18th and early 19th centuries

A) and therefore is not accepted today.

B) during a time of population decline.

C) and has proponents today who fear population growth and overpopulation.

D) and cannot be explained using the modern tool of the productivity function.

E) and still applies to the most developed nations today, though not to the less developed

nations.

Answer: CTopic: Classical growth theorySkill: Level 1: DefinitionSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

5) Classical growth theory predicts that in the long run there will be

A) zero economic growth.

B) positive economic growth.

C) negative economic growth.

D) sustained increases in the productivity growth rate.

E) sustained increases in economic growth.

Answer: ATopic: Classical growth theorySkill: Level 2: Using definitionsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

6) According to classical growth theory, people earn only a subsistence real income because of

growth in

A) technology.

B) capital.

C) population.

D) employment.

E) labor productivity.

Answer: CTopic: Classical growth theorySkill: Level 2: Using definitionsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

Page 838


7) Which of the following are predicted by the classical growth theory?

i. Population growth will end economic growth.

ii. Real GDP per person will return to subsistence level.

iii. Technology drives persistent economic growth.

A) i and ii

B) i, ii and iii

C) i only

D) ii only

E) i and iii


8) If real GDP per person rises above the subsistence level then, according to classical growth

theory,

A) population growth will slow down.

B) a population explosion will occur.

C) labor productivity growth permanently increases.

D) real GDP per person will remain above the subsistence level.

E) real GDP per person will fall below the subsistence level.

Answer: BTopic: Classical growth theorySkill: Level 2: Using definitionsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

9) According to classical growth theory, if labor productivity increases,

A) the population grows and eventually real GDP returns to the subsistence level.

B) the population grows but more slowly than real GDP so that peopleʹs incomes are

permanently higher.

C) the pursuit of profit causes further increases in capital per hour and technology and

economic growth continues indefinitely.

D) the growth rate of real GDP per person permanently increases.

E) people save more, which increases the capital per hour even more, and so economic

growth continues indefinitely.


Page 839


10) Classical growth theory predicts that increases in real GDP per person will

A) not last because higher income leads to a population explosion.

B) last because higher growth leads to new technology.

C) last because people make choices in the pursuit of higher profits.

D) not last because higher income encourages smaller families and a lower population

growth rate.

E) last only if the government directs firms to make more investments in capital and new

technology.

Answer: ATopic: Classical growth theorySkill: Level 3: Using modelsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

11) Classical growth theory predicts that economic growth

A) will continue at the classical rate of 3 percent forever.

B) will eventually stop because of population growth.

C) occurs because of hard-working citizens.

D) is merely an illusion.

E) decreases the supply of labor.

Answer: BTopic: Classical growth theorySkill: Level 3: Using modelsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

12) The classical growth theory asserts that

A) economic growth will continue indefinitely.

B) economic growth and population growth complement each other.

C) population growth increases a nationʹs economic growth.

D) population growth will lead to people earning only a subsistence level of income.

E) population growth leads to more growth in technology.

Answer: DTopic: Classical growth theorySkill: Level 1: DefinitionSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

Page 840


13) In classical growth theory, if real GDP per person is above the subsistence level,

A) the economy will keep growing without limit.

B) population grows and lowers real GDP per person to its subsistence level.

C) technological growth occurs and keeps real GDP per person above its subsistence level.

D) the pursuit of profit will cause economic growth to accelerate.

E) None of the above is correct because the classical growth theory asserts that real GDP per

person can never exceed the subsistence level.

Answer: BTopic: Classical growth theorySkill: Level 3: Using modelsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

14) Classical growth theory predicts

A) a slowdown in population growth over time.

B) real GDP per person will remain at the subsistence level over time.

C) sustained increases in economic growth in the long run.

D) the population growth rate slows as real GDP per person rises.

E) sustained increases in the standard of living in the long run.


15) The new growth theory was developed by ________ and proposes that ________.

A) Paul Romer; the desire for profits drives increases in real GDP per person

B) Robert Solow; increases in technology growth are responsible for economic growth

C) Thomas Malthus; increases in population drive wages to their subsistence level

D) Adam Smith; markets will determine the appropriate economic growth rate

E) Ben Bernanke; changes in the money supply drive economic growth

Answer: ATopic: New growth theorySkill: Level 2: Using definitionsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

Page 841


16) In explaining economic growth, new growth theory stresses the role played by

A) human choices.

B) population moderation.

C) women in the workforce.

D) the participation rate of elderly workers.

E) the government in directing the nationʹs investments.

Answer: ATopic: New growth theorySkill: Level 2: Using definitionsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

17) According to the new growth theory, which of the following promote economic growth?

i. discoveries that bring profit

ii. choices that expand human capital

iii. random events that create technology change

A) i and iii

B) i and ii

C) i, ii and iii

D) ii only

E) i only

Answer: BTopic: New growth theorySkill: Level 2: Using definitionsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

18) In new growth theory, growth in real GDP per person occurs because

i. human capital grows indefinitely.

ii. technology advances as a result of choices individuals make.

iii. profit incentives encourage technological change.

A) i only

B) ii only

C) iii only

D) both i and iii

E) i, ii, and iii

Answer: ETopic: New growth theorySkill: Level 2: Using definitionsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

Page 842


19) New growth theory asserts that

i. human capital grows because of choices.

ii. discoveries result from choices.

iii. competition brings profits.

A) i only

B) ii only

C) iii only

D) both i and iii

E) both i and ii

Answer: ETopic: New growth theorySkill: Level 2: Using definitionsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

20) According to the new growth theory, real GDP per person grows because

A) the population increases.

B) the labor force participation rate increases.

C) people make choices in pursuit of profits.

D) the retirement age increases.

E) the government subsidizes firmsʹ research and development.

Answer: CTopic: New growth theorySkill: Level 1: DefinitionSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

21) The new growth theory asserts that profits are

A) permanent, because they are derived from discoveries.

B) temporary, because the discoveries that lead to profits are eventually used by all.

C) an illusion, since costs are never fully covered.

D) permanent, because physical activities can be replicated.

E) not an essential component determining whether the economy grows or not.


Page 843


22) The new growth theory asserts that

A) the population growth rate will increase when real GDP per person increases.

B) a discovery can be used by only one person, the discoverer.

C) technology improves slowly while population grows rapidly.

D) production processes can be replicated at many different firms in the economy.

E) eventually people earn only a subsistence living.

Answer: DTopic: New growth theorySkill: Level 1: DefinitionSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

23) A central theme of the new growth theory is that

A) firms donʹt really experience profit.

B) humans can work harder than previously thought.

C) the economy doesnʹt experience diminishing returns.

D) firms donʹt experience diminishing returns.

E) the government is more efficient than private markets.

Answer: CTopic: New growth theorySkill: Level 3: Using modelsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

24) The new growth theory

A) corrects for poor estimates of population growth.

B) eliminates technological advances from the growth picture.

C) applies to only very poor, less-developed nations.

D) explains the source of technological advances.

E) asserts that economic growth can be rapid but can only persist for a limited period of

time.

Answer: DTopic: New growth theorySkill: Level 3: Using modelsSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

Page 844


25) New growth theory asserts that ________ will lead us to greater productivity and economic

growth.

A) new machinery

B) government regulation

C) unlimited wants

D) leisure time

E) nothing

Answer: CTopic: New growth theorySkill: Level 1: DefinitionSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

26) Which of the following statements is likely to be made by someone who believes in the new

growth theory?

A) Population growth will limit long-run gains in real GDP per person.

B) Competition will encourage discoveries of new ideas leading to greater economic

growth.

C) Although technological changes increase real GDP, these changes are random and

unexplainable.

D) Choices made by human capital are likely to be inefficient.

E) Economic growth will eventually slow.


27) The new growth theoryʹs comparison of the economy to a perpetual motion machine implies

that

A) permanent growth is not possible.

B) the economy will forever create and destroy jobs.

C) overpopulation will eventually overtake the resources of the planet.

D) technology changes just happen.

E) labor productivity has no influence on the economy.


Page 845


28) Which of the following theories predicts that there can be no sustained rise in real GDP per

person above the subsistence level?

i. Classical growth theory

ii. New growth theory

A) i only

B) ii only

C) Neither i nor ii

D) Both i and ii

E) None of the above because whether the rise in real GDP per person is sustained or not

depends on what created the rise.


29) Classical growth theory predicts that increases in

A) real GDP per person are permanent and sustainable.

B) real GDP per person are temporary and not sustainable.

C) resources permanently increase labor productivity.

D) resources permanently increase real GDP per person.

E) competition increase economic growth.

Answer: BTopic: Classical growth theorySkill: Level 1: DefinitionSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

30) If real GDP per person is above the subsistence level then, according to classical growth

theory,

A) the population will increase.

B) the population will decrease.

C) the standard of living will continue to improve.

D) labor productivity will increase.

E) more technological advances occur.


Page 846


31) According to classical growth theory, when real GDP per person ________, the population

grows.

A) is less than the subsistence real income

B) exceeds the subsistence real income

C) exceeds capital per hour of labor

D) is less than capital per hour of labor

E) is constant


32) New growth theory predicts that

A) economic growth is only temporary.

B) economic growth can last indefinitely.

C) economic growth is eroded by changes in taxes.

D) government policies can do nothing to foster increased growth.

E) ultimately people earn a subsistence wage.

Answer: BTopic: New growth theorySkill: Level 1: DefinitionSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

33) The new growth theory states that

A) technological advances are the result of random chance.

B) technological advances are the result of discoveries and choices.

C) technological advances are the responsibility of the government.

D) the subsistence level income leads to technological advances.

E) it is impossible to replicate production activities.

Answer: BTopic: New growth theorySkill: Level 1: DefinitionSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

Page 847


34) According to new growth theory, growth

A) occurs when real GDP greater than the subsistence level.

B) is unending.

C) ends when competition disappears.

D) depends on the population growth rate.

E) cannot be sustained without government help.


35) The theory that suggests that our unlimited wants will lead to perpetual economic growth is

the

A) classical growth theory.

B) sustained growth theory.

C) old growth theory.

D) new growth theory.

E) Malthusian growth theory.

Answer: DTopic: New growth theorySkill: Level 1: DefinitionSection: Checkpoint 9.3Status: OldAACSB: Reflective thinking

36) According to the new growth theory, ________ is the factor that motivates technological

change.

A) random chance

B) profit

C) diminishing returns

D) the replication of activities

E) decisions about how much human capital to acquire


Page 848


9.4 Achieving Faster Growth

1) At its most basic level, economic growth depends on

A) creating the right incentives.

B) saving by the government.

C) government leadership.

D) governmentʹs fixing prices to encourage stability.

E) political freedom.

Answer: ATopic: Preconditions for growthSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

2) If a country lacks ________, economic growth ________.

A) a democratic form of government; cannot occur

B) a proper incentive system; cannot occur

C) pure capitalism; will be slower compared to other countries

D) a proper incentive system; will occur at a pace suggested by the new growth theory

E) economic freedom; will increase at a faster pace

Answer: BTopic: Preconditions for growthSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

3) The presence of an incentive system that encourages growth

A) guarantees that growth will occur.

B) creates the right conditions for growth to occur.

C) cannot exist in poor countries.

D) existed even in hunter-gatherer societies.

E) means that the government must be a democracy.

Answer: BTopic: Preconditions for growthSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 849


4) All of the following are preconditions for economic growth EXCEPT

i. property rights.

ii. democracy.

iii. free markets.

A) i only

B) ii only

C) iii only

D) Both i and ii

E) i, ii, and iii


5) A key reason why some nations show little or no growth is

A) overpopulation that overuses limited resources.

B) lack of incentives to undertake actions toward growth.

C) too much private property not directed by the government.

D) patents in rich nations that keep technology only for the rich.

E) too much international trade so that all economic growth spills over to foreigners.


6) An important condition required for economic growth is

A) a democratic government.

B) a totalitarian government.

C) a libertarian government.

D) economic freedom.

E) the incentive to limit international trade so that all economic growth remains within the

country.

Answer: DTopic: Preconditions for growth, economic freedomSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 850


7) A basic precondition necessary to achieve economic growth is

A) well-functioning factories.

B) well-being of society.

C) a well-functioning legal system.

D) a well-organized work force.

E) a strong central government that directs the nationʹs research and development activities.

Answer: CTopic: Preconditions for growth, economic freedomSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

8) Economic freedom

A) is not important for nations to grow.

B) must come from a democratic government.

C) is founded, in part, on the rule of law.

D) is created when the nation imposes many regulations on businesses.

E) is harmed by having too many property rights.

Answer: CTopic: Preconditions for growth, economic freedomSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

9) Economic freedom requires

A) that there are no regulations and restrictions set on businesses and households by the

government.

B) the rule of law and the ability to enforce the laws.

C) strong labor unions.

D) freedom to bribe government officials.

E) that the government be a democracy.

Answer: BTopic: Preconditions for growth, economic freedomSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 851


10) Economic freedom provides the

A) political system that encourages democracy.

B) social system that supports families.

C) production system that discourages property rights.

D) incentive system that encourages growth-producing activities.

E) necessary alternative to free markets.

Answer: DTopic: Preconditions for growth, economic freedomSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

11) Countries that enjoy economic growth

A) have property rights and markets which provide incentives for discovering new

technologies.

B) have economies that allow the government to make decisions in everyoneʹs best interests.

C) restrict international trade so that domestic industries can grow.

D) place high taxes on saving and investment.

E) place controls on property rights so that firms are protected from competition.

Answer: ATopic: Preconditions for growth, economic freedomSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

12) For economic freedom to exist,

A) copyright laws must be abolished and markets supervised by the government.

B) democracy must exist.

C) property rights must be protected and markets must be free.

D) human capital must be given away free.

E) money must be free.


Page 852


13) Hong Kong is an example of an economy that

A) does not experience economic growth because it is not a democracy.

B) experiences economic growth in spite of the fact that is lacks democratic freedom.

C) grows more slowly than other Asian countries because property rights are not valued.

D) needs to promote investment so that economic growth can occur.

E) lacks economic freedom and therefore experiences the slowest economic growth of all

developed economies.

Answer: BTopic: Preconditions for growth, economic freedomSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

14) A condition necessary for a country to achieve economic growth is

A) high tax rates so the government can purchase a lot of capital equipment.

B) strict environmental regulations.

C) economic freedom.

D) government control of the banking system.

E) democracy.

Answer: CTopic: Preconditions to economic growth, economic freedomSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

15) Economic freedom is a precondition for economic growth. Which of the following is a

characteristic of economic freedom?

i. A democratic form of government

ii. Property rights must be protected.

iii. The government must support and pay for inventions and innovations.

A) i only

B) ii only

C) Both i and ii

D) Both ii and iii

E) Both i and iii


Page 853


16) Economic freedom is present, at least in part, when

A) there are no property rights to limit peopleʹs freedom.

B) there is no private property.

C) people are able to make personal choices.

D) there is no government.

E) money is free.


17) Economic growth is slow or absent in some economies because those lack

A) political freedom.

B) economic freedom.

C) democracy.

D) cultural freedom.

E) a strong government.


18) A key reason why some countries are growing very slowly is

A) they lack a democratic government.

B) they lack economic freedom.

C) their inflation rate is too high.

D) they are too poor, so there is no saving.

E) there is too much competition within their economies.


Page 854


19) A reason why many of the third world countries are not achieving an increase in their

standard of living is that they

A) donʹt have enough natural resources.

B) donʹt have strong military power to force people to work harder.

C) donʹt have social institutions with a strong rule of law and economic freedom.

D) strongly encouraged international trade.

E) donʹt have a strong central government.

Answer: CTopic: Preconditions for growth, economic freedomSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

20) Property rights

A) donʹt include intellectual property.

B) donʹt include financial property.

C) donʹt include physical property.

D) include physical, financial, and intellectual property.

E) slow the economic growth by placing limits on who can use what.

Answer: DTopic: Preconditions for growth, property rightsSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

21) Property rights assure people that

A) the government will not confiscate their income or savings.

B) the government will provide a minimum standard of living.

C) the factors of production and goods are owned jointly by the government and the

people.

D) economic growth will enhance government involvement in the economy.

E) international trade will be limited.

Answer: ATopic: Preconditions to economic growth, property rightsSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 855


22) Jose and Julia were discussing the necessary components to achieve economic growth. Jose

stated that the economy must include free markets, specialization and trade, and an ethical

judicial system. Julia reminded Jose that another key component is

A) freedom of speech.

B) freedom of religion.

C) a guaranteed high rate of return on savings.

D) property rights.

E) democracy.

Answer: DTopic: Preconditions for growth, property rightsSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

23) One possible way of achieving faster economic growth is to

A) regulate the amount of international trade and limit it so that not too much occurs.

B) limit research and development because research and development does not contribute

anything to todayʹs production.

C) assign the government ownership of all capital.

D) protect property rights and free markets.

E) tax saving so that people spend more and firmsʹ profits are higher.


24) Which of the following are important for countries to promote with property rights and

incentives if economic growth is to occur?

i. specialization

ii. saving and investment

iii. increases in human capital

iv. discovery of new technology

A) i, ii, iii and iv.

B) ii and iii.

C) iii and iv.

D) ii and iv.

E) i, ii and iv only.

Answer: ATopic: Preconditions for growth, property rightsSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 856


25) One way to achieve faster growth in GDP per person is to increase the

A) number of women working in the home rather than in the workforce.

B) growth rate of the quantity of money.

C) growth rate of human capital.

D) growth rate of the population.

E) limits on international trade in order to keep more of total spending on domestically

produced goods.

Answer: CTopic: Preconditions for growth, human capitalSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

26) The following government policies will help achieve faster economic growth EXCEPT

A) discouraging saving and encouraging spending.

B) encouraging research and development.

C) establishing and protecting property rights.

D) improving the quality of education.

E) increasing saving.

Answer: ATopic: Policies for faster growth, savingSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

27) If Turkey wants to promote faster economic growth, it will need to

A) promote incentive systems to encourage saving, research and development, increased

trade and improved education.

B) restrict economic freedom so the government has better control of markets.

C) restrict international trade to protects its own workers.

D) promote government intervention to help markets determine incentives.

E) restrict property rights so that individuals can better share inventions.

Answer: ATopic: Policies for faster growthSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 857


28) Retirement savings accounts, such as IRAs, help increase economic growth because

A) people have an incentive to work harder and longer hours to save for the future.

B) they keep the interest rates high.

C) savings finances investment.

D) government invests them.

E) they encourage international trade.

Answer: CTopic: Policies for faster growth, savingSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking


A) encourage saving.

B) protect the economy from international trade.

C) limit investment because investment adds nothing to production today.

D) eliminate property rights because they prevent people from using other peopleʹs ideas.

E) tax saving so that people spend more and businesses make more profit.


30) East Asian economies have grown

A) rapidly because of high saving rates.

B) rapidly despite a lack of property rights.

C) slowly because of a lack of property rights.

D) slowly because of low saving rates.

E) rapidly because they virtually eliminated international trade.


31) One of the possible roles governments can play in sponsoring growth is to

A) provide tax incentives to encourage saving.

B) own more of the nationʹs resources in order to put them to use.

C) close the nation to trade in order to protect its domestic producers.

D) make decisions for its citizens as to the most suitable job.

E) limit the use of property rights in order to decrease the harm they create.

Answer: ATopic: Policies for faster growth, savingSkill: Level 3: Using modelsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 858


32) Many economists argue that an incentive to save is

A) high income tax rates.

B) a tax on consumption rather than on income.

C) a tax on income rather than a tax on consumption.

D) greater government regulation of the banking and securities industries.

E) strengthening the property rights that savers have to the physical capital they purchase.

Answer: BTopic: Policies for faster growth, savingSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking


A) abolish the system of patents and copyrights so that everyone can use peopleʹs ideas.

B) limit international trade to only a few countries so that the nation is not hurt by too much

trade.

C) encourage research and development.

D) limit schooling in order to have more people in the labor force, producing goods and

services.

E) promote tax saving so that people spend more and businessesʹ profits are larger.

Answer: CTopic: Preconditions for growth, R&DSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking


A) limit international trade.

B) encourage international trade.

C) limit research and development and concentrate on production of goods and services.

D) abolish the system of patents and copyrights so that everyone can use peopleʹs ideas.

E) let the government decide what research and development should be undertaken.

Answer: BTopic: Policies for faster growth, international tradeSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 859


35) Encouraging international trade will

A) slow economic growth when a country is forced to specialize and trade with other

countries.

B) slow economic growth as many workers lose their jobs to foreign workers.

C) speed economic growth as workers diversify their knowledge and limit trade.

D) speed economic growth as workers specialize and trade with others.

E) speed economic growth because international trade limits the harm done by property

rights.

Answer: DTopic: Policies for faster growth, international tradeSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

36) The fastest growing nations today

A) are not saving but instead are investing.

B) have erected many trade barriers to protect domestic firms.

C) have the fastest growing exports and imports.

D) have non-democratic political systems.

E) have the government directing all their research and development.

Answer: CTopic: Policies for faster growth, international tradeSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

37) Chinaʹs growth rate has ________ that of most other countries, ________.

A) topped; but its real GDP per person is still lower than other industrialized countries

B) lagged behind; and its real GDP is close to other Asian economies

C) lagged behind; but its real GDP per person is higher than other Asian economies

D) topped: but its real GDP per person declined in 2008-09

E) equalled; and its real GDP per person declined in 2008-09

Answer: ATopic: Eye on convergence and gapsSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 860


38) Governments should promote education because education contributes to the nationʹs

A) employment.

B) free markets.

C) economic growth potential.

D) international trade.

E) protection of property rights.

Answer: CTopic: Policies for faster growth, educationSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

39) Brian is running for state senator and if elected, pledges to improve economic growth. His

plan for economic growth includes increasing spending on public education and providing tax

incentives to encourage improved private education. His plan is likely to

A) slow economic growth because it includes a provision for private education.

B) have no effect on economic growth because property rights are not changed.

C) speed economic growth as the quality of resources improve.

D) fail because the provision for private education limits government involvement in

education.

E) have no effect on economic growth because government spending cannot affect the

economic growth rate.

Answer: CTopic: Policies for faster growth, educationSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

40) If Kenya institutes policies that support economic freedom and growth, it is likely that Kenya

will

A) immediately reap the benefits of double digit increase in economic growth.

B) immediately reap the benefits of a 4 percent to 6 percent increase in economic growth.

C) slowly reap the benefits of economic growth as the economy grows over time.

D) lose control of the economy and plunge into a long recession.

E) suffer from too much competition within its economy.

Answer: CTopic: Faster growth, the difference policy makesSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 861


41) Which of the following is NOT a necessary precondition for economic growth?

A) economic freedom

B) democracy

C) property rights

D) free markets

E) ALL of the above are necessary preconditions.

Answer: BTopic: Preconditions for growthSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

42) Which of the following characteristics is a precondition for economic growth?

i. economic freedom

ii. free markets

iii. active government policy to discourage saving

A) i only

B) ii only

C) iii only

D) Both i and ii

E) Both ii and iii

Answer: DTopic: Preconditions for growthSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

43) Economic freedom means that

A) firms are regulated by the government.

B) some goods and services are free.

C) people are able to make personal choices and their property is protected.

D) the rule of law does not apply.

E) the nationʹs government is a democracy.


Page 862


44) Property rights protect

A) only the rights to physical property.

B) only the rights to financial property.

C) all rights except rights to intellectual property.

D) rights to physical property, financial property, and intellectual property.

E) the governmentʹs right to impose taxes.


45) Activities that encourage faster growth are

A) high levels of saving and investment in human capital.

B) high levels of consumption and low levels of savings.

C) taxes on saving that serve to encourage more spending and less saving.

D) imposing trade barriers to limit international trade and thereby protect national

industries.

E) limiting property rights so that everyone can use any invention.

Answer: ATopic: Policies for faster growthSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

46) Which of the following statements is FALSE?

A) Saving helps create economic growth.

B) Improvements in quality of education are important for economic growth.

C) Free international trade helps create economic growth.

D) Faster population growth is the key to growth in real GDP per person.

E) Economic freedom requires property rights.

Answer: DTopic: Policies for faster growthSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 863


47) In order to increase economic growth, a government can

A) discourage research and development.

B) decrease funding on education.

C) discourage specialization and trade.

D) establish property rights and a legal system.

E) tax saving in order to encourage more spending.

Answer: DTopic: Policies for faster growthSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

48) Saving

A) slows growth because it decreases consumption.

B) finances investment which brings capital accumulation.

C) has no impact on economic growth.

D) is very low in most East Asian nations.

E) is important for a country to gain the benefits of international trade.

Answer: BTopic: Policies for faster growth, savingSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

49) A government policy that taxes saving in order to discourage saving and encourage spending

will

A) slow economic growth.

B) speed economic growth.

C) create a greater incentive for people to specialize.

D) strengthen peopleʹs property rights.

E) increase the growth rate of capital.

Answer: ATopic: Policies for faster growth, savingSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

Page 864


50) The fastest growing nations today are those with

A) barriers that significantly limit international trade.

B) the fastest growing exports and imports.

C) government intervention in markets to ensure high prices.

D) few funds spent on research and development.

E) the least saving.

Answer: BTopic: Policies for faster growth, international tradeSkill: Level 2: Using definitionsSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking

51) Economic growth is enhanced by

A) free international trade.

B) limiting international trade so that the domestic economy can prosper.

C) discouraging saving, because increased saving means less spending.

D) ignoring incentive systems.

E) increasing welfare payments to the poor so they can afford to buy goods.

Answer: ATopic: Policies for faster growth, international tradeSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Reflective thinking


1) Economic growth in Cuba has been slow. What can best explain the slow growth?

A) lack of economic resources

B) lack of incentive mechanisms and economic freedom

C) labor productivity is low.

D) a non-democratic form of government

E) too much competition within the economy

Answer: BTopic: IntegrativeSkill: Level 4: Applying modelsSection: IntegrativeStatus: OldAACSB: Reflective thinking

Page 865


2) The idea of continuous economic growth as a ʺperpetual motion machineʺ best reflects the

prediction of which growth theory?

A) the classical growth theory

B) the traditional growth theory

C) the Keynesian growth theory

D) the new growth theory

E) no growth theory

Answer: DTopic: IntegrativeSkill: Level 3: Using modelsSection: IntegrativeStatus: OldAACSB: Reflective thinking

3) Workers in the United States are ________ workers in China because ________.

A) more productive than; workers in the United States have more capital per worker.

B) more productive than; there are more college-educated workers in the United States.

C) less productive than; there are fewer workers in the United States.

D) less productive than; the labor force participation rate is lower in the United States.

E) equally as productive as; Chinaʹs real GDP per person equals the U.S. real GDP per

person.

Answer: ATopic: IntegrativeSkill: Level 3: Using modelsSection: IntegrativeStatus: OldAACSB: Reflective thinking

4) The presence of government corruption in some countries

A) slows their economic growth.

B) speeds their economic growth.

C) invalidates the new growth theoryʹs predictions.

D) supports the classical growth theoryʹs predictions.

E) invalidates the neoclassical growth theoryʹs predictions.

Answer: ATopic: IntegrativeSkill: Level 2: Using definitionsSection: IntegrativeStatus: OldAACSB: Reflective thinking

Page 866


5) Which of the following policies encourages economic growth?

A) increased taxes on income and business profits

B) reduction of government support of higher education

C) high tariffs and strict import quotas on foreign-made products

D) creation of tax free savings accounts

E) limiting the years people spend in education so that they can start productive work

Answer: DTopic: IntegrativeSkill: Level 4: Applying modelsSection: IntegrativeStatus: OldAACSB: Reflective thinking

9.6 Essay: The Basics of Economic Growth

1) Why is growth in GDP different from growth in a nationʹs standard of living? Is it possible for

a nationʹs GDP to grow while its standard of living falls?

Answer: The standard of living is measured by real GDP per person, so growth in the standard

of living equals growth in real GDP per person. The growth rate of real GDP per person

equals the growth rate of real GDP minus the growth rate of the population. Hence it is

indeed possible for a nationʹs GDP to grow, while its standard of living decreases. This

outcome occurs whenever the population grows more rapidly than real GDP.Topic: Standard of livingSkill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Written and oral communication

2) How do we calculate growth in a nationʹs standard of living?

Answer: The standard of living is measured by real GDP per person. Thus growth in the

standard of living is calculated using the growth rate of real GDP per person.Topic: Standard of livingSkill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

3) What is the Rule of 70?

Answer: The Rule of 70 is that the number of years it takes for the level of any variable to double

is approximately 70 divided the annual percentage growth rate of the variable.Topic: Rule of 70Skill: Level 1: DefinitionSection: Checkpoint 9.1Status: OldAACSB: Reflective thinking

Page 867


4) A nationʹs population was 250 million last year and is 255 million this year. If its real GDP was

$8.5 trillion last year and is $8.8 trillion this year, what is its growth rate of real GDP per

person?

Answer: Last year real GDP per person equaled ($8.5 trillion)/(250 million) = $34,000 per person.

This year, real GDP per person is $34,510 per person. Thus the growth in real GDP per

person equals $34,510 - $34,000

$34,000 × 100 = 1.5 percent.

Topic: Growth rate, real GDP per personSkill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Year

Real GDP

(billions of 2009 dollars)

Population


1961 2,432 184

1962 2,578 186

5) U.S. real GDP per person grew rapidly in the early 1960s. The table above has U.S. real GDP

and population for 1961 and 1962.

a. What was U.S. real GDP per person in 1961?

b. What was U.S. real GDP per person in 1962?

c. Between 1961 and 1962, how rapidly did U.S. real GDP per person grow?

Answer: a. U.S. real GDP per person in 1961 = ($2,432 billion)/(184 million) = $13,217.

b. U.S. real GDP per person in 1962 = ($2,578 billion)/(186 million) = $13,860.

c. The growth rate of real GDP per person equals $13,860 - $13,217

$13,217 × 100 = 4.9

percent.Topic: Growth rate, real GDP per personSkill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

6) If a nationʹs population grows at 2 percent and its real GDP grows at 4 percent, what is the

growth rate of real GDP per person?

Answer: The growth rate of real GDP per person equals the growth rate of real GDP minus the

population growth rate. Hence, in the question at hand, the real GDP per person growth

rate equals 4 percent minus 2 percent, or 2 percent.Topic: Growth rate, real GDP per personSkill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 868


7) Suppose that real GDP grows at 3 percent per year. What is the growth rate of real GDP per

person if the population grows at:

a. 2 percent? What happens to the standard of living?

b. 3 percent? What happens to the standard of living?

c. 4 percent? What happens to the standard of living?

Answer: a. The growth rate of real GDP per person equals the growth rate of real GDP minus

the population growth rate. Hence the growth rate of real GDP per person equals 3

percent minus 2 percent or 1 percent. The standard of living increases because real GDP

per person increases.

b. The growth rate of real GDP per person equals 3 percent minus 3 percent or 0

percent. The standard of living does not change because real GDP per person does not

change.

c. The growth rate of real GDP per person equals 3 percent minus 4 percent or -1

percent. The standard of living decreases because real GDP per person decreases.Topic: Growth rate, real GDP per personSkill: Level 3: Using modelsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

8) During 2005, real GDP in Ireland grew 9.8 percent. If Ireland maintains this level of growth in

the future, real GDP will double in approximately how many years?

Answer: With an annual growth rate of 9.8 percent, the Rule of 70 shows that Irelandʹs real GDP

will double in approximately 70 ÷ 9.8 = 7.1 years.Topic: Rule of 70Skill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

9) Suppose real GDP grows at 7 percent per year and the population grows at 2 percent per year.

How many years will it take for real GDP and real GDP per person to double?

Answer: Use the Rule of 70 for both answers. The growth rate of real GDP is given in the

question, and so the Rule of 70 directly indicates that real GDP doubles in 70 ÷ 7 = 10

years. To determine the number of years it takes for real GDP per person to double, it is

necessary to calculate the growth rate of real GDP per person. The growth rate of real

GDP per person equals 7 percent minus 2 percent or 5 percent per year. Hence the Rule

of 70 shows that real GDP per person doubles in 70 ÷ 5 = 14 years.Topic: Rule of 70Skill: Level 2: Using definitionsSection: Checkpoint 9.1Status: OldAACSB: Analytical thinking

Page 869


9.7 Essay: Labor Productivity Growth

1) Real GDP can increase either because the quantity of labor increases or because labor

productivity increases. What is the effect on the standard of living if real GDP increases

because

a. the quantity of labor increases?

b. labor productivity increases?

Answer: a. An increase in real GDP because the quantity of labor increases has no effect on the

standard of living.

b. An increase in real GDP because labor productivity increases boosts the nationʹs

standard of living.Topic: Labor productivitySkill: Level 5: Critical thinkingSection: Checkpoint 9.2Status: OldAACSB: Written and oral communication

2) What is the effect on real GDP per person if labor productivity increases? What is the effect on

the nationʹs standard of living?

Answer: Real GDP equals (aggregate hours) × (labor productivity). Hence an increase in labor

productivity increases real GDP. Real GDP per person equals (real GDP) ÷ (population).

Therefore an increase in real GDP with no change in the population increases real GDP

per person. The nationʹs standard of living is measured by real GDP per person. So, an

increase in labor productivity boosts real GDP per person and therefore boosts the

nationʹs standard of living.Topic: Labor productivitySkill: Level 5: Critical thinkingSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

3) Real GDP equals $12 trillion and aggregate hours equals 300 billion hours. What does labor

productivity equal?

Answer: Labor productivity is defined as (real GDP ÷ aggregate hours), so labor productivity

equals ($12 trillion ÷ 300 billion hours) = $40 per hour.Topic: Labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

4) Labor productivity is $30 per hour and aggregate hours are 165 billion hours. What does real

GDP equal?

Answer: Real GDP equals (labor productivity × aggregate hours)

= ($30 per hour × 165 billion hours) = $4,950 billion.Topic: Labor productivitySkill: Level 3: Using modelsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

Page 870


5) Labor productivity is $20 per hour and aggregate hours are 400 billion hours.

a. What does real GDP equal?

b. Because of technological advances, labor productivity doubles to $40 per hour.

Furthermore, assume that aggregate hours decrease to 300 billion hours. What does real GDP

equal?

Answer: a. Real GDP equals (labor productivity × aggregate hours)

= ($20 per hour × 400 billion hours) = $8 trillion.

b. Real GDP now equals $12 trillion.Topic: Labor productivitySkill: Level 3: Using modelsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

6) Define labor productivity. Discuss the relationship between labor productivity, human capital

growth, and technology change.

Answer: Labor productivity is real GDP per hour of labor, so it equals (real GDP) ÷ (aggregate

hours). The expansion of human capital and the discovery of new technology are two

factors that increase labor productivity. Increasing human capital increases labor

productivity because workersʹ skills and knowledge increase, which allows them to

produce more goods and services without boosting aggregate hours. Similarly, the

discovery and use of new technologies allows workers to produce more goods and

services without increasing aggregate hours.Topic: Increase in labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

7) List and explain the three factors that can increase labor productivity.

Answer: The three factors that can increase labor productivity are saving and investment in

physical capital, expansion of human capital, and discovery of new technology. Saving

and investing in physical capital increases the amount of capital per worker and thereby

increases workersʹ productivity. Increasing the amount of human capital means that

workersʹ skills, knowledge, and talents increase, which thereby increases their

productivity. And, the discovery and use of new technologies allows workers to

produce more goods and services than before, which increases their productivity.Topic: Increase in labor productivitySkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Written and oral communication

Page 871


8) What are the sources of human capital?

Answer: Human capital, the accumulated skills and knowledge people possess, comes from both

formal education and training, and from on-the-job experience. On-the-job experience

creates ʺlearning by doing,ʺ in which workers become more knowledgeable about the

best way to accomplish a task as they do the task.Topic: Labor productivity, human capitalSkill: Level 1: DefinitionSection: Checkpoint 9.2Status: OldAACSB: Written and oral communication

9) Explain the productivity curve and how the components interact.

Answer: The productivity curve is a relationship that shows how real GDP per hour of labor

varies as the amount of capital per hour of labor changes with no change in technology.

An increase in the amount of capital per hour of labor leads to a movement along a

productivity curve. An increase in technology shifts the productivity curve upward.Topic: Productivity curveSkill: Level 3: Using modelsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

10) What does a productivity curve reflect? What leads to movements along a productivity curve

and what leads to shifts in a productivity curve?

Answer: The productivity curve shows the relationship between the amount of capital per hour

of labor and real GDP per hour of labor, that is, between capital per hour labor and

labor productivity. The curve is upward sloping, but, due to diminishing returns, the

slope becomes less steep as capital per hour of labor increases. If the amount of capital

per hour of labor changes, there is a movement along the productivity curve. If the

amount of human capital increases and/or technology advance occurs, the productivity

curve shifts upward.Topic: Productivity curveSkill: Level 3: Using modelsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

Page 872


11) What is the law of diminishing returns? Give an example of what the law of diminishing

returns implies.

Answer: The law of diminishing returns is the observation that as the quantity of one input

increases with the quantities of all other inputs remaining the same, output increases

but by ever smaller increments. Hence, as more workers (or capital) are used by a firm,

each additional worker (or unit of capital) increases output, but by less than previous

worker (or unit of capital). For instance, a law firm might have one paralegal typing

briefs on one personal computer. Hiring an additional paralegal will increase the

number of briefs, but with only one personal computer, the additional paralegal will not

double the number of briefs. Similarly, buying another computer, while employing only

one paralegal, might increase the number of briefs typed, but will not double the

number.Topic: Productivity curveSkill: Level 4: Applying modelsSection: Checkpoint 9.2Status: OldAACSB: Analytical thinking

9.8 Essay: Economic Growth Theories: Old and New

1) In the classical theory of growth, what is the final outcome of an increase in growth and labor

productivity?

Answer: In the classical growth theory, a rise in labor productivity and the resulting economic

growth result in a population explosion that drives real GDP per person back to the

subsistence level. In the classical viewpoint, resources are limited and technological

change occurs infrequently, so that technological advances are not sufficient to

compensate for the lack of resources. Hence, in the long run people earn only a

subsistence level of real income.Topic: Classical growth theorySkill: Level 1: DefinitionSection: Checkpoint 9.3Status: OldAACSB: Written and oral communication

Page 873


2) Of the two economic growth theories, which is the most optimistic about the chances of real

GDP per person growing indefinitely? Which is the most pessimistic? What accounts for the

differences?

Answer: The most optimistic is the new growth theory, which concludes that real GDP per

person can continue to grow indefinitely. The most pessimistic is the classical theory,

which concludes that growth in real GDP per person will stop and that people will

produce only the subsistence level of real GDP per person. The difference in the two

conclusions can be traced to differences in assumptions in three key areas. First, the new

growth theory concludes that technology will advance forever because people, seeking

profit, make decisions to develop new technology. Classical growth theory assumes that

technological advances are rare and infrequent. Second, the new growth theory assumes

that the economy is not subject to diminishing returns. Hence, as the economy

accumulates more capital, the returns to capital do not diminish and so the incentive to

add yet more capital continues undiminished. The classical growth theory assumes that

capital (and labor) is subject to diminishing returns. Thus as more capital is

accumulated, the returns diminish, and so the incentive to continue adding more capital

disappears. Thus the capital stock eventually stops growing. Finally, the new growth

theory assumes that the population does not grow more rapidly as real GDP per person

increases. The classical theory assumes that whenever real GDP per person exceeds the

subsistence level, rapid population growth occurs and, because of diminishing returns

to labor, the increased population drives the level of real GDP back to the subsistence

amount.Topic: New growth theorySkill: Level 2: Using definitionsSection: Checkpoint 9.3Status: OldAACSB: Written and oral communication

3) What do the classical growth theory and the new growth theory predict for global growth

amongst different nations? Comment on the accuracy of the predictions.

Answer: The classical growth theory predicts that nations will produce only the subsistence level

of real GDP per person. This prediction is incorrect. According to the theory, each

country is driven to the subsistence level by increased population growth whenever real

GDP per person exceeds the subsistence amount. Hence the classical theory predicts

that the nations with the highest levels of real GDP per person will be the nations in

which real GDP per person is falling the most rapidly. This prediction also is wildly at

variance with the facts.

The new growth theory predicts that nations will grow indefinitely and that the

growth rate depends on the incentives within each nation to save, invest, accumulate

human capital, and develop new technology. Hence the new growth theory predicts

that real GDP per person will converge among some nations (those with similar

incentives) while the gaps in real GDP per person among other nations will persist. This

prediction is accurate.Topic: Growth in the global economySkill: Level 4: Applying modelsSection: Checkpoint 9.3Status: OldAACSB: Written and oral communication

Page 874


9.9 Essay: Achieving Faster Growth

1) What is economic freedom and why is it important for economic growth?

Answer: Economic freedom is a condition when people are able to make their own choices, their

private property is protected, and they are free to trade in markets. Economic freedom is

a necessary precondition for economic growth because all three aspects of economic

freedom are highly growth enhancing. People are the best judges of their own interests

and abilities, so allowing them to make their own decisions creates the best decisions

about what activities will be undertaken. Protecting private property is necessary in

order to give people the incentives to specialize and trade as well as to save and invest,

all actions that will increase economic growth. Letting people trade in free markets

again respects peopleʹs abilities to make the best decisions for themselves, and also

increases peopleʹs incentives to specialize and trade.Topic: Economic freedomSkill: Level 1: DefinitionSection: Checkpoint 9.4Status: OldAACSB: Written and oral communication

2) Why is economic growth so slow or non-existent in many third world countries? What

policies would you propose to improve the situation?

Answer: Slow-growing third world countries generally lack the necessary preconditions for

economic growth: economic freedom, secure property rights, and freely functioning

markets. In many of these nations, a corrupt legal system and government means that

the rule of law and property rights are absent. In order to increase economic growth in

these nations, policies that create economic freedom, secure property rights, and free

markets must be adopted. It does not matter if these policies are adopted by a

democratic government or by an authoritarian government, the key point is that they

are necessary for the nation to grow. Thus, specific policies include creating an efficient

legal system that respects the rule of law and enforces property rights and contracts;

eliminating government corruption that undermines the rule of law; and, in order to

establish free markets, decreasing government bureaucracy and limits to trade, such as

high taxes, regulations, and import bans.Topic: Preconditions for growth, economic freedomSkill: Level 4: Applying modelsSection: Checkpoint 9.4Status: OldAACSB: Written and oral communication

Page 875


3) What policies can a government undertake to achieve faster economic growth?

Answer: There are several policies a government can undertake. First the government must

insure that the preconditions for growth are present. The government must insure that

economic freedom exists, that property rights are enforced, and that markets are free.

After these crucial preconditions are in place, the government can create incentive

mechanisms to save, invest, and innovate; can encourage saving; can encourage

research and development; can encourage international trade; and can improve the

quality of education.Topic: Policies for faster growthSkill: Level 4: Applying modelsSection: Checkpoint 9.4Status: OldAACSB: Written and oral communication

4) A countryʹs leadership believes that the neoclassical growth theory is correct. The country

already has the necessary preconditions for growth, so suggest policy changes the government

might enact to help speed economic growth.

Answer: The policy changes should encourage technological innovation and capital formation

because these are the key engines of growth within the neoclassical growth theory.

Hence, the government should encourage research and development, possibly by

directly funding research and development. In addition, the government should

support policies that increase saving, because an increase in saving will lead to

increased investment and hence new capital, some of which will have the new

technologies embodied in it.Topic: Policies for faster growth, research and developmentSkill: Level 5: Critical thinkingSection: Checkpoint 9.4Status: OldAACSB: Written and oral communication

5) Why are the governments of developed countries concerned about the quality of education in

their countries? What effect does education play in determining the countryʹs economic

growth rate and its standard of living? Why does it have this effect?

Answer: Improving the quality of education is an important policy that the government can

undertake to increase the nationʹs economic growth rate. A higher quality education

increases the nationʹs human capital. Increases in human capital boost labor

productivity and, in turn, the increase in labor productivity raises the nationʹs economic

growth rate as well as its standard of living.Topic: Policies for faster growth, educationSkill: Level 5: Critical thinkingSection: Checkpoint 9.4Status: OldAACSB: Written and oral communication

Page 876


Chapter 10 Finance, Saving, and Investment

10.1 Financial Institutions and Markets

1) Economists use the word ʺcapitalʺ to mean

A) the tools, instruments, and other produced goods used to produce goods and services.

B) the funds that firms use to buy and operate their businesses.

C) purchases in the market for stocks and bonds.

D) the workers that firms employ to produce goods and services.

E) peopleʹs skills and talents.

Answer: ATopic: Physical capitalSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

2) Federal Expressʹs purchase of trucks and planes

A) is financial capital.

B) includes depreciation.

C) is an example of physical capital.

D) creates wealth.

E) reflects capital gains.

Answer: CTopic: Physical capitalSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

3) The distinction between physical and financial capital is that

A) physical capital is equal to financial capital plus depreciation.

B) financial capital is used to purchase and operate physical capital.

C) the value of financial capital depends on the amount of available physical capital.

D) physical capital is equal to financial capital minus depreciation.

E) financial capital depreciates and physical capital does not.

Answer: BTopic: Physical capital and financial capitalSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 877


4) Financial capital

A) is accumulated investment.

B) is another name for the machines and tools that businesses buy.

C) is independent of physical capital.

D) depends on saving and borrowing decisions.

E) depreciates each year.

Answer: DTopic: Financial capitalSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

5) Financial capital is used to help finance

A) consumption expenditure by households.

B) the purchase of physical capital by firms.

C) gross investment but not net investment.

D) net investment but not gross investment.

E) peopleʹs savings.

Answer: BTopic: Financial capitalSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

6) The funds firms use to buy and operate physical capital are referred to as

A) physical capital.

B) financial capital.

C) government capital.

D) human capital.

E) business capital.

Answer: BTopic: Financial capitalSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

7) An example of financial capital is

A) machines.

B) buildings.

C) computers.

D) bonds.

E) the talents of a highly paid movie star.

Answer: DTopic: Financial capitalSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 878


8) ________ increases the quantity of capital, and ________ decreases the quantity of capital.

A) Net investment; gross investment

B) Investment; depreciation

C) Depreciation; net investment

D) Investment; saving

E) Gross investment; net investment

Answer: BTopic: Depreciation, investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

9) ________ decreases a firmʹs capital stock, and ________ increases its capital stock.

A) Saving; depreciation

B) Saving; investment

C) Depreciation; investment

D) Time; depreciation

E) Investment; saving

Answer: CTopic: Depreciation, investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

10) The total amount spent on new capital goods is called

A) net investment.

B) gross investment.

C) depreciation.

D) financial capital.

E) wealth.

Answer: BTopic: Gross investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 879


11) Which of the following is correct?

A) Gross investment equals net investment minus depreciation.

B) Net investment is the same as capital consumption.

C) Gross investment is the total spent on capital.

D) Net investment is the total spent on capital.

E) The change in the nationʹs capital stock over a year equals the amount of gross

investment.

Answer: CTopic: Gross investment, net investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

12) The total amount spent to buy new physical capital and replace old capital is referred to as

A) depreciation.

B) net investment.

C) savings.

D) gross investment.

E) wealth.

Answer: DTopic: Gross investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

13) Billʹs Lawn service starts the year with 20 lawn mowers. During the year, 3 mowers break and

are not worth fixing. Bill also expands his business and buys 10 more mowers. Billʹs gross

investment is ________ mowers.

A) 10 B) 13 C) 7 D) 27 E) 30

Answer: ATopic: Gross investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

Page 880


14) During the year, suppose a countryʹs total purchases of newly produced capital goods is

$2,000 billion, issues $1,600 billion of stock certificates, and has $500 billion in depreciation.

Gross investment in this country equals

A) $2,000 billion.

B) $2,500 billion.

C) $3,600 billion.

D) $4,100 billion.

E) $2,100 billion.

Answer: ATopic: Gross investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

15) On January 1, Rickʹs Photo owned $50,000 of equipment. During the year, the value of the

equipment fell by $10,000, plus Rick bought $25,000 in new equipment. Rickʹs company

experienced

A) $10,000 of depreciation.

B) $40,000 of depreciation.

C) an increase of new capital by $10,000.

D) an increase of net investment of $35,000.

E) a change in total financial capital of $15,000.

Answer: ATopic: DepreciationSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

16) Gross investment equals

A) net investment plus depreciation.

B) net investment minus depreciation.

C) gross financial capital minus depreciation.

D) gross financial capital plus depreciation.

E) net investment financial investment.

Answer: ATopic: Gross investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

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17) Net investment equals

A) new capital plus old capital.

B) capital plus depreciation.

C) gross investment minus depreciation.

D) gross investment plus depreciation.

E) the amount of national wealth.

Answer: CTopic: Net investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

18) Net investment equals

A) gross financial capital minus stock dividends.

B) depreciation plus gross investment.

C) gross investment minus interest payments.

D) gross investment minus depreciation.

E) depreciation minus gross investment.

Answer: DTopic: Net investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

19) Net investment is

A) the same as gross investment.

B) the same as depreciation.

C) gross investment minus depreciation.

D) gross investment plus depreciation.

E) the same as wealth.

Answer: CTopic: Net investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

20) Which of the following statements is correct?

A) Gross investment minus financial capital equals net investment.

B) Net investment plus depreciation equals gross investment.

C) Net investment plus corporate profits equals gross investment.

D) Net investment is greater than gross investment.

E) Net investment minus depreciation equals gross investment.

Answer: BTopic: Net investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

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21) If an economyʹs depreciation is greater than its gross investment, then

A) net investment is positive and saving is negative.

B) the economyʹs capital stock decreases.

C) net investment is positive and saving is positive.

D) net investment is negative and saving is negative.

E) net investment must equal saving.

Answer: BTopic: Net investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

22) The Zonamo company produces waste disposal machines and sells them to militaries all over

the world. The company started last year with $10 million of capital on hand and invested $15

million in new capital throughout the year. At the end of the year, the companyʹs capital stock

was $17 million. Hence, for the year, depreciation equaled ________ and net investment

equaled ________.

A) $8 million; $7 million

B) $7 million; $8 million

C) $25 million; $5 million

D) $5 million; $5 million

E) $8 million; $15 million

Answer: ATopic: Net investmentSkill: Level 3: Using modelsSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

23) The local Allied Moving Company begins this year with capital equal to $250,000. During the

year the firm depreciates $150,000 worth of its capital and ends the year with capital equal to

$250,000. Which statement correctly summarizes Allied Moving Companyʹs investment?

A) Allied Moving Company made no capital investment during the year.

B) Allied Moving Company made no gross investment during the year.

C) Allied Moving Company made no net investment during the year.

D) Allied Moving Company made net investment of $150,000 during the year.

E) Allied Moving Company made gross investment of $250,000 during the year.

Answer: CTopic: Net investmentSkill: Level 3: Using modelsSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

Page 883



are not worth fixing. Bill also expands his business and buys 10 more mowers. Billʹs net

investment is ________ mowers.

A) 10 B) 13 C) 7 D) 27 E) 20

Answer: CTopic: Net investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking


are not worth fixing. Bill also expands his business and buys 10 more mowers. Billʹs capital at

the end of the year is ________ mowers.

A) 20 B) 30 C) 27 D) 33 E) 10

Answer: CTopic: CapitalSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: RevisedAACSB: Analytical thinking

26) At the beginning of the year, AAA-1 Towing owns trucks and buildings for a total value of $1

million. During the year, it invests $250,000 to replace towing trucks worth $230,000 destroyed

in a flood and to cover $50,000 worth of depreciation. AAA-1 Towingʹs net investment was

A) $200,000. B) $20,000. C) $280,000. D) -$30,000. E) $250,000.

Answer: DTopic: Net investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

27) At the beginning of the year, AAA-1 Towing owns trucks and buildings for a total value of $1

million. During the year, it invests $250,000 to replace towing trucks worth $230,000 destroyed

in a flood and to cover $50,000 worth of depreciation. AAA-1 Towingʹs capital stock at the end

of the year was

A) $970,000.

B) $1,250,000.

C) $950,000.

D) $1,280,000.

E) $1,020,000.

Answer: ATopic: Net investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

Page 884




experienced

A) net investment of $15,000.

B) an increase in financial capital of $65,000.

C) a decrease in financial capital of $15,000.

D) depreciation of $15,000.

E) gross investment of $50,000.

Answer: ATopic: Net investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: RevisedAACSB: Analytical thinking



experienced ________ because ________.

A) net investment of $15,000; net investment equals gross investment minus depreciation

B) gross investment of $15,000; gross investment equals net investment minus depreciation

C) gross investment of $40,000; gross investment equals net investment plus depreciation

D) net investment of $15,000; net investment equals beginning year financial capital minus

depreciations and investment

E) depreciation of $15,000; depreciation equals investment in new products minus loss in

values

Answer: ATopic: Net investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: NewAACSB: Analytical thinking

30) On January 1, Derek had CD recording devices valued at $30,000. During the year, the value of

Derekʹs devices depreciated by $20,000. He spent $30,000 on new devices. Derekʹs net

investment was ________ and at the end of the year Derek had capital valued at ________.

A) $10,000; $40,000

B) $30,000; $40,000

C) $20,000; $60,000

D) $40,000; $70,000

E) $10,000; $60,000


Page 885


31) During 2013, a countryʹs total purchases of newly produced capital goods are $1,000 billion,

the country issues $750 billion of stock certificates, and there is $200 billion of depreciation.

Net investment in this country equals

A) $800 billion.

B) $1,550 billion.

C) $1,000 billion.

D) $1,750 billion.

E) $550 billion.


32) The change in the quantity of capital from one period to the next is equal to

A) net investment.

B) gross investment.

C) depreciation.

D) financial investment.

E) wealth.

Answer: ATopic: Net investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

33) Which of the following equals the change in an economyʹs capital stock from one period to the

next?

A) depreciation

B) gross investment

C) net investment

D) wealth

E) stock

Answer: CTopic: Net investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

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34) The difference between the amount of capital at the beginning of a year and the amount of

capital at the end of the year is equal to

A) net investment.

B) capital consumption.

C) gross investment.

D) financial consumption.

E) depreciation.

Answer: ATopic: Net investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

35) U.S. capital at the end of 2012 equals U.S. capital at the beginning of 2012 plus

A) nothing, because capital canʹt change in just one year.

B) gross investment during 2012.

C) gross investment during 2012 minus net investment in 2012.

D) net investment during 2012.

E) depreciation during 2012 minus gross investment during 2012.

Answer: DTopic: Net investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

36) Wealth is to ________ as capital stock is to ________.

A) saving; investment

B) income; earnings

C) investment; saving

D) income; net investment

E) saving; depreciation

Answer: ATopic: Wealth and savingSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 887


37) Economists use the term wealth to mean

A) the same thing as income.

B) what a person earns.

C) what a person owns.

D) the amount of income that is spent and not saved.

E) a personʹs investment.

Answer: CTopic: WealthSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

38) Wealth is

A) defined as the money in your savings account.

B) another name for income.

C) the value of all the things that a person owns.

D) equivalent to saving.

E) the same as investment in financial capital.

Answer: CTopic: WealthSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

39) A household increases its wealth by

A) spending more on consumption goods.

B) saving.

C) increasing its capital consumption.

D) decreasing its depreciation.

E) making sure that its net investment exceeds its gross investment.

Answer: BTopic: Wealth and savingSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 888


40) If capital gains equal zero, then the Ng familyʹs wealth at the end of the year equals their

wealth at the beginning of the year

A) minus personal income taxes.

B) plus saving.

C) minus consumption.

D) plus income.

E) plus consumption minus income.

Answer: BTopic: WealthSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

41) During this year, Barbara earned $60,000 as a financial analyst, paid taxes of $5,000 and

consumed $53,000. If Barbaraʹs wealth was $4,000 at the beginning of the year, at the end of the

year Barbaraʹs wealth was

A) $2,000. B) $4,000. C) $5,000. D) $6,000. E) $60,000.

Answer: DTopic: WealthSkill: Level 3: Using modelsSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

42) Assuming there are no capital gains, a nationʹs wealth at the start of a year is equal to the

wealth at the start of the previous year plus

A) nothing because wealth does not change from one year to the next.

B) income.

C) saving during the year.

D) income minus saving during the year.

E) saving minus depreciation during the year.

Answer: CTopic: National wealthSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 889


43) During the year a countryʹs income was $6.0 trillion and its consumption was $5.5 trillion. At

the start of the year its wealth was $30.0 trillion. The countryʹs wealth at the end of the year

was

A) $30.0 trillion.

B) $30.5 trillion.

C) $35.5 trillion.

D) $36.0 trillion.

E) $6.0 trillion.

Answer: BTopic: National wealthSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

44) To acquire financial capital, a firm can

i. obtain a loan from a bank.

ii. issue stock.

iii. issue bonds.

A) i only

B) ii only

C) iii only

D) i and iii

E) i, ii, and iii

Answer: ETopic: Financial marketsSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

45) A document that promises to pay specified sums of money on specified dates and is a debt to

the issuer is called

A) a stock.

B) a bond.

C) net investment.

D) depreciation.

E) gross investment.

Answer: BTopic: BondSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 890


46) When Bank of America finances your purchase of a new car, you are

A) lending in the capital market.

B) borrowing in the bond market.

C) lending in the bond market.

D) borrowing in the loan market.

E) borrowing in the stock market.

Answer: DTopic: Loan marketSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

47) Which of the following are typically financed in the loan market?

i. a mortgage for a house

iii. credit card balances

iii. the purchase of a share of stock in a corporation.

A) i and iii

B) i only

C) i, ii and iii

D) i and ii

E) ii and iii

Answer: DTopic: Loan marketSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

48) Which of the following are typically financed in a ʺbond marketʺ?

i. a mortgage for a house

ii. state government borrowing for a new road project

iii. your purchase of 4000 shares of stock in Google

A) ii only B) i and ii C) ii and iii D) i only E) i and iii

Answer: ATopic: Bond marketSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 891


49) Lulu purchased a security that promises to pay $50 twice a year from January 15, 2012 to

January 15, 2016 and then pay $1,000 on January 15, 2016. The security is a debt to the

company that issued it. The security is a

A) depreciating asset.

B) bond.

C) share of stock.

D) physical capital.

E) net investment to the company that issued it.

Answer: BTopic: BondSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

50) A share of stock is a

A) promise to pay specified sums of money on specified dates.

B) certificate of ownership and claim to the profits made by a firm.

C) collection of funds that travels the world looking for the highest return.

D) set of demanders and suppliers for the savings of households.

E) form of investment in physical capital.

Answer: BTopic: StockSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

51) A certificate of ownership and claim to part of a firmʹs profits is called

A) a stock.

B) a bond.

C) a certificate of deposit.

D) depreciation.

E) physical capital.

Answer: ATopic: StockSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 892


52) Which of the following are typically financed in a ʺstock marketʺ?

i. shares sold by a firm to finance its international growth plans

ii. new mortgages for home buyers

iii. credit card balances

A) i only

B) i, ii and iii

C) ii and iii

D) ii only

E) i and iii

Answer: ATopic: Stock marketSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

53) Which of the following represents ownership of a firm?

A) stocks

B) bonds

C) short-term securities

D) loans

E) commodities

Answer: ATopic: StockSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

54) A distinction between stocks and bonds is that

A) bonds can be traded many times in the bond market, while stocks are non-transferable.

B) although the return on a bond is determined by the forces of supply and demand, the

return on a stock is set by the stock exchange.

C) bonds cannot be sold to anyone other than the company that issued it while stocks can be

resold to anyone.

D) stocks represent ownership claims to the company and bonds do not.

E) bonds must be held for a fixed number of years whereas stocks can be bought and sold at

any time.

Answer: DTopic: Bonds versus stocksSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 893


55) A stockholder ________ an owner of the firm, and a bondholder ________ an owner of the

firm.

A) is; is

B) is; is not

C) is not; is

D) is not; is not

E) might be; is not

Answer: BTopic: Bonds versus stocksSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

56) Investment banks differ from commercial banks in the fact that

A) investment banks help other financial institutions and governments engage in financial

markets while commercial banks work with individuals.

B) investment banks work only with wealthy customers while commercial banks work only

with private firms.

C) commercial banks service the needs of local governments while investment banks work

with the federal government.

D) commercial banks issue stocks and bonds while investment banks do not.

E) commercial banks sell stocks on behalf of their customers while investment banks just

finance loans.

Answer: ATopic: Investment banksSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

57) What do Fannie Mae and Freddie Mac have in common?

A) They are both government-sponsored mortgage lenders.

B) They are both investment banks.

C) They are both pension funds.

D) Both firms went out of business in the 2008 financial crisis.

E) Both firms issue bonds on behalf of the government.

Answer: ATopic: Fannie and FreddieSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 894


58) Which of the following is NOT an example of physical capital?

A) a building

B) a bond

C) a dump truck

D) a lawn mower

E) a computer

Answer: BTopic: Physical capitalSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

59) The decrease in the value of the capital that results from its use and obsolescence is

A) appreciation.

B) deconstruction.

C) depreciation.

D) gross investment.

E) net investment.

Answer: CTopic: DepreciationSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

60) Which of the following formulas is correct?

A) Net investment = gross investment + depreciation

B) Net investment = gross investment + capital

C) Net investment = gross investment - depreciation

D) Net investment = gross investment - saving

E) Net investment = gross investment - wealth

Answer: CTopic: Net investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

61) Intelʹs capital at the end of the year equals Intelʹs capital at the beginning of the year

A) minus its stock dividends.

B) plus net investment.

C) minus depreciation.

D) plus gross investment.

E) plus depreciation.

Answer: BTopic: Net investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 895


62) Economists use the term ʺfinancial marketsʺ to mean the markets in which

A) firms purchase their physical capital.

B) firms supply their goods and services.

C) households supply their labor services.

D) firms get the funds that they use to buy physical capital.

E) the government borrows to fund any budget surplus.

Answer: DTopic: Financial marketsSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

63) When a student uses a credit card to buy an iPod, the student is

A) borrowing in the bond market.

B) lending in the bond market.

C) lending in the loan market.

D) borrowing in the loan market.

E) lending in the stock market.

Answer: DTopic: Financial marketsSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

64) Which of the following is NOT a financial institution?

A) an insurance company

B) a pension fund

C) Freddie Mac

D) a commercial bank

E) None of the above is correct because they are all financial institutions.

Answer: ETopic: Financial marketsSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 896


65) If the market value of what it has lent is less than the market value of what it has borrowed, a

financial institutionʹs net worth is ________ and it is ________.

A) negative; illiquid but not necessarily insolvent

B) negative; insolvent but not necessarily illiquid

C) positive; illiquid and insolvent

D) negative; illiquid and insolvent

E) positive; insolvent but not necessarily illiquid

Answer: BTopic: Financial marketsSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: RevisedAACSB: Reflective thinking

66) A bondʹs price is $80 and the bond pays $8 in interest every year. The bondʹs interest rate is

________.

A) 8 percent

B) 10 percent

C) 4 percent

D) 80 percent

E) None of the above are correct.

Answer: BTopic: Interest ratesSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

10.2 The Loanable Funds Market

1) One type of demander in the loanable funds market

A) wants funds to purchase financial capital.

B) wants funds to purchase physical capital.

C) lends funds to purchase financial capital.

D) lends funds to purchase physical capital.

E) wants physical capital in order to purchase financial capital.

Answer: BTopic: Loanable funds marketSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 897


2) The demand for loanable funds includes demand for

i. loans.

ii. stocks.

iii. bonds.

A) i, ii and iii

B) i only

C) i and ii

D) iii only

E) ii and iii

Answer: ATopic: Demand for loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

3) In the loanable funds market, demanders of funds are ________ and suppliers of funds are

________.

A) firms and the government if it has a budget surplus; households and the government if it

has a budget deficit

B) firms and the government if it has a budget deficit; households and the government if it

has a budget surplus

C) households and the government if it has a budget surplus; firms and the government if it

has a budget deficit

D) households and the government if it has a budget deficit; firms and the government if it

has a budget surplus

E) households and firms; the government if it has a budget deficit

Answer: BTopic: Loanable funds marketSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

4) In the loanable funds market, which of the following is an example of investment demand?

A) Mary buying stocks for her retirement portfolio

B) George purchasing United States savings bonds for his sonʹs college fund

C) Scott purchasing a rookie-year baseball card for last yearʹs World Series MVP

D) Brian, owner of Bryan Games, purchasing computers to enhance the production of

games

E) Mark buying rare gold coins

Answer: DTopic: Investment demandSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 898


5) The opportunity cost of the financial resources used to finance the purchase of capital is

A) the real interest rate.

B) the supply of investment.

C) capital investment.

D) the quantity of investment demanded.

E) the price of the capital goods purchased.

Answer: ATopic: Investment demandSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

6) ________ reflects a use of loanable funds, while ________ reflects a supply of loanable funds.

A) Business investment; the government budget deficit.

B) International investment; business investment.

C) The government budget deficit; private saving.

D) A government budget surplus; a government budget deficit.

E) International borrowing; a government budget deficit.

Answer: CTopic: Loanable funds marketSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

7) If a firm wants to borrow $10 million and the real interest rate increases from 5 percent to 6

percent, then the cost of the investment has increased by

A) $1 million per year.

B) $100,000 per year.

C) $6 million per year.

D) $600,000 per year.

E) nothing because the real interest rate is the return the firm will earn on its investment.

Answer: BTopic: Investment demandSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 899


8) Other things remaining the same, as the real interest rate increases,

A) firms will borrow more funds.

B) firms will borrow less funds.

C) firmsʹ demand for funds will not change.

D) firms will purchase new capital with its own funds instead of taking a loan.

E) the demand for loanable funds curve shifts leftward.

Answer: BTopic: Quantity of loanable funds demandedSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

9) Other things remaining the same, the ________ the real interest rate, the ________.

A) lower; greater the quantity of loanable funds demanded

B) lower; greater the demand for loanable funds

C) higher; greater the quantity of loanable funds demanded

D) higher; greater the demand for loanable funds

E) lower; greater the quantity of loanable funds supplied

Answer: ATopic: Quantity of loanable funds demandedSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

10) Suppose the real interest rate increases from 4 percent to 6 percent. As a result,

A) governments decrease the quantity supplied of loanable funds.

B) firms increase their demand for loanable funds.

C) governments decrease their demand for loanable funds.

D) firms decrease the quantity demanded of loanable funds.

E) governments increase the supply of loanable funds.

Answer: DTopic: Quantity of loanable funds demandedSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

11) If the real interest rate rises,

A) the quantity of loanable funds demanded increases.

B) the quantity of loanable funds demanded decreases.

C) there is is movement down along the demand for loanable funds curve.

D) the demand for loanable funds curve shifts leftward.

E) the demand for loanable funds curve shifts rightward.

Answer: BTopic: Quantity of loanable funds demandedSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 900


12) An increase in the quantity of loanable funds demanded occurs when

A) the real interest rate falls.

B) the real interest rate rises.

C) the supply of loanable funds decreases.

D) the expected profit rises.

E) wealth decreases.

Answer: ATopic: Quantity of loanable funds demandedSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

13) The quantity of loanable funds demanded increases if the real interest rate falls, all other

things remaining the same, because the real interest rate

A) determines the cost of living.

B) is the opportunity cost of investment.

C) affects the quantity of saving supplied.

D) is not related to the price of bonds and stocks.

E) affects the supply of saving which, in turn, determines the quantity of investment.

Answer: BTopic: Quantity of loanable funds demandedSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

14) As the economy enters a strong expansion, then firmsʹ demand for loanable funds

A) increases because expected profit increases.

B) decreases because expected profit decreases.

C) increases because the nominal interest rate rises.

D) decreases because the nominal interest rate falls.

E) increases because the real interest rate rises.

Answer: ATopic: Demand for loanable fundsSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 901


15) Ford Motor Corporation is considering purchasing new technology that will increase

productivity by twenty percent. If Ford Motor Corporation decides to make this investment at

the going real interest rate, then

A) the quantity of loanable funds demanded increases.

B) the supply of loanable funds increases.

C) the demand for loanable funds increases.

D) Fordʹs profits will decline.

E) saving increases.

Answer: CTopic: Changes in the demand for loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

16) The demand for loanable funds

A) increases in an expansion and decreases in a recession.

B) decreases in an expansion and increases in a recession.

C) increases if population growth declines.

D) increases if the expected rate of profit decreases.

E) increases if wealth increases.

Answer: ATopic: Changes in the demand for loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

17) Which of the following decreases the demand for loanable funds and shifts the demand for

loanable funds curve leftward?

A) The real interest rate rises.

B) The economy experiences a recession.

C) Technology that increases productivity is introduced.

D) An economy experiences a rapid increase in population.

E) Wealth decreases.

Answer: BTopic: Changes in the demand for loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 902


18) Technological change can increase the demand for loanable funds because it

A) lowers the interest rate.

B) can increase the expected profit.

C) has little effect on production cost.

D) decreases the need for additional equipment.

E) increases peopleʹs expected future disposable income.

Answer: BTopic: Changes in the demand for loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

19) The demand for loanable funds curve shifts in response to changes in


B) the amount of household savings.

C) expected profits.

D) the expected future disposable income.

E) wealth.


20) The demand for loanable funds increases if

A) technological growth slows.

B) population growth slows.

C) expected profit increases.

D) firms fear a recession.

E) wealth increases.

Answer: CTopic: Changes in the demand for loanable fundsSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 903


21) The demand for loanable funds curve shows the relationship between the quantity of loanable

funds demanded and


B) the price level.

C) the capital stock.

D) depreciation.

E) the expected rate of profit.

Answer: ATopic: Demand for loanable funds curveSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

22) The demand for loanable funds curve shows the

A) negative relationship between the interest rate and the quantity of loanable funds

demanded.

B) positive relationship between the interest rate and the quantity of loanable funds

demanded.

C) negative relationship between the demand for loanable funds curve and the supply of

loanable funds curve.

D) positive relationship between the demand for loanable funds curve and the supply of


E) U-shaped relationship between the interest rate and the quantity of loanable funds

demanded.


23) The demand for loanable funds curve illustrates

A) the quantity of loanable funds demanded at any given level of disposable income.

B) the quantity of loanable funds demanded at any given level of the real interest rate.

C) the quantity of loanable funds supplied to the loanable funds market at any given level

of disposable income.

D) how the quantity of loanable funds demanded changes when the peopleʹs expectations

about their future income changes.

E) how the quantity of loanable funds demanded changes when wealth changes.

Answer: BTopic: Demand for loanable funds curveSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 904


24) The demand for loanable funds curve shows that the higher the real interest rate, the

A) smaller the quantity of loanable funds demanded.

B) smaller the demand for loanable funds.

C) larger the quantity of loanable funds demanded.

D) larger the demand for loanable funds.

E) more the loanable funds demand curve shifts leftward.


25) The demand for loanable funds curve slopes downward because the

A) higher the real interest rate, the lower the cost of investment.

B) expected rate of profit is related positively to the real interest rate.

C) price of bonds and stocks is not related to the real interest rate.

D) real interest rate is the opportunity cost of investment.

E) expected rate of profit is factor that ʺrewardsʺ firms for their investment.

Answer: DTopic: Demand for loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

26) If the real interest rate falls, there is

A) an upward movement along the demand for loanable funds curve.

B) a downward movement along the demand for loanable funds curve.

C) a rightward shift of the demand for loanable funds curve.

D) a leftward shift of the demand for loanable funds curve.

E) a leftward shift of the supply of loanable funds curve.

Answer: BTopic: Demand for loanable funds curveSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 905


27) Which of the following occurs if the real interest rate falls?

A) The demand for loanable funds increases and the demand for loanable funds curve shifts

rightward.

B) The demand for loanable funds decreases and the demand for loanable funds curve

shifts leftward.

C) The quantity of loanable funds demanded increases and there is a movement down

along the demand for loanable funds curve.

D) The quantity of loanable funds demanded decreases increases and there is a movement

up along the demand for loanable funds curve.

E) The quantity of loanable funds demanded increases and the demand for loanable funds

curve shifts rightward.

Answer: CTopic: Demand for loanable funds curveSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

28) A fall in the real interest rate brings a

A) movement down along the demand for loanable funds curve but no shift in the curve.

B) rightward shift of the demand for loanable funds curve but no movement along the

curve.

C) movement up along the demand for loanable funds curve.

D) leftward shift of the demand for loanable funds curve.

E) movement down along the demand for loanable funds curve and a rightward shift of the

demand for loanable funds curve.


29) In a business cycle recession, which of the following occurs?

A) Investment demand increases and the demand for loanable funds curve shifts rightward.

B) Investment demand decreases and the demand for loanable funds curve shifts leftward.

C) The quantity of investment demanded increases and there is a movement down along

the demand for loanable funds curve but no shift in the curve.

D) The quantity of investment demanded decreases increases and there is a movement up

along the demand for loanable funds curve but no shift in the curve.

E) The quantity of investment demanded decreases and there is a rightward shift of the


Answer: BTopic: Demand for loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 906


30) During a recession, firmsʹ expected profit from investment ________ so the demand for

loanable funds curve ________.

A) falls; shifts rightward

B) falls; shifts leftward

C) rises; shifts rightward

D) rises; shifts leftward

E) falls; does not shift

Answer: BTopic: Demand for loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

31) What happens to the demand for loanable funds curve when the economy enters a recession?

A) The demand for loanable funds curve shifts rightward because the real interest rate falls.

B) The demand for loanable funds curve shifts leftward because the real interest rate falls.

C) The demand for loanable funds curve shifts rightward because expected profit falls.

D) The demand for loanable funds curve shifts leftward because expected profit falls.

E) The demand for loanable funds curve shifts leftward because wealth decreases.

Answer: DTopic: Demand for loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

32) The demand for loanable funds curve shifts rightward when

A) the real interest rate rises.

B) the real interest rate falls.

C) expected profit increases.

D) expected profit decreases.

E) wealth rises.

Answer: CTopic: Demand for loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 907


33) When the expected profit ________, investment demand ________ and the demand for

loanable funds curve shifts ________.

A) falls; decreases; leftward

B) rises; increases; leftward

C) falls; decreases; rightward

D) rises; decreases; rightward

E) falls; increases; rightward

Answer: ATopic: Demand for loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

34) An increase in the expected profit from new capital brings about a

A) movement up along the demand for loanable funds curve.

B) movement down along the demand for loanable funds curve.

C) rightward shift of the demand for loanable funds curve.

D) leftward shift of the demand for loanable funds curve.

E) rightward shift of the supply of loanable funds curve.

Answer: CTopic: Demand for loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

35) Which of the following occurs if the expected profit increases?

A) Investment demand increases and the demand for loanable funds curve shifts rightward.

B) Investment demand decreases and the demand for loanable funds curve shifts leftward.

C) The quantity of investment demanded increases and there is a movement down along

the demand for loanable funds curve.

D) The quantity of investment demanded decreases and there is a movement up along the


E) The savings increases and the supply of loanable funds curve shifts rightward.

Answer: ATopic: Demand for loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 908


36) If firms became more optimistic about the future of the economy, which of the following

occurs?

A) Investment demand increases, and the demand for loanable funds curve shifts

rightward.

B) Investment demand decreases, and the demand for loanable funds curve shifts leftward.

C) The quantity of investment demanded increases, and there is a movement down along

the demand for loanable funds curve.

D) The quantity of investment demanded decreases, and there is a movement up along the


E) The saving decreases, and the supply of loanable funds curve shifts leftward.

Answer: ATopic: Demand for loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

37) In the figure above, the rightward shift from the demand for loanable funds curve DLF1 to the

demand for loanable funds curve DLF2, could be the result of

A) a rise in the interest rate.

B) an increase in wealth.

C) an increase in expected profit.

D) a decrease in expected profit.

E) a fall in the interest rate.

Answer: CTopic: Demand for loanable funds curveSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 909


38) In the figure above, the shift from DLF1 to DLF2 could result from

A) the economy entering a strong expansion.

B) an increase in the nominal interest rate.

C) a decrease in the real interest rate.

D) an increase in a government budget surplus.

E) the economy entering a recession.

Answer: ATopic: Demand for loanable funds curveSkill: Level 4: Applying modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

39) In the figure above, the leftward shift from the demand for loanable funds curve DLF1 to the


A) a decrease in interest rates during an economic recession.

B) an increase in interest rates during an economic expansion.

C) the economy entering a recession.

D) a government budget surplus.

E) the economy entering an expansion.

Answer: CTopic: Demand for loanable funds curveSkill: Level 4: Applying modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

40) In the figure above, the leftward shift from the demand for loanable funds curve DLF1 to the


A) a fall in the interest rate.

B) a decrease in expected profit.

C) an advancement in technology.

D) an increase in the population.

E) a rise in the interest rate.

Answer: BTopic: Demand for loanable funds curveSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 910


41) The supply of loanable funds is from

A) households and the government if it has a budget surplus.

B) households and the government if it has a budget deficit.

C) firms and the government if it has a budget surplus.

D) firms and the government if it has a budget deficit.

E) households and firms.

Answer: ATopic: Supply of loanable fundsSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

42) The quantity of loanable funds supplied increases if the real interest rate rises, all other things

remaining the same, because the

A) real interest rate is the opportunity cost of saving.

B) real interest rate is the opportunity cost of consumption.

C) cost of living is determined by the real interest rate.

D) real interest rate is inversely related to the cost of buying on credit.

E) demand for investment increases when the real interest rate rises.

Answer: BTopic: Supply of loanable fundsSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

43) The quantity of loanable funds supplied increases if the ________, all other things remaining

the same, because the ________.

A) real interest rate rises; real interest rate is the opportunity cost of saving

B) real interest rate rises; real interest rate is the opportunity cost of consumption

C) real interest rate rises; cost of living is determined by the real interest rate

D) real interest rate falls; real interest rate is the opportunity cost of consumption

E) real interest rate falls; real interest rate is the opportunity cost of saving

Answer: BTopic: Supply of loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: NewAACSB: Reflective thinking

Page 911


44) The real interest rate is ________ related to the supply of loanable funds because ________.

A) positively; the opportunity cost of consumption expenditure increases as the real interest

rate rises

B) negatively; the opportunity cost of consumption expenditure increases as the real interest

rate rises

C) positively; people are motivated to increase their consumption expenditure as the real

interest rate rises

D) negatively; people are motivated to save more as the real interest rate rises

E) None of the above answers is correct.

Answer: ATopic: Supply of loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

45) If the real interest rate falls, people decide to ________ because the opportunity cost of

________.

A) increase their consumption expenditure; saving has decreased

B) increase their consumption expenditure; consumption has decreased

C) decrease their consumption expenditure; consumption has decreased

D) save more; saving has decreased


Answer: BTopic: Supply of loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

46) If the interest rate on student loans ________, students will ________.

A) rises from 6 percent to 12 percent; increase their saving in order to pay back the loan

sooner

B) rises from 6 percent to 12 percent; increase their consumption before it becomes too

expensive

C) falls from 6 percent to 1 percent; increase their saving in order to pay back the loan

sooner

D) falls from 6 percent to 1 percent; not change their saving but will change their investment


Answer: ATopic: Supply of loanable fundsSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 912


47) Increasing savings and ________ go hand in hand because they both ________.

A) decreasing expenditures; are the result of an increase in real interest rates on the loanable

funds market

B) decreasing expenditures; are the result of an increase in nominal interest rates on the

loanable funds market

C) increasing expenditures; are the result of an increase in real interest rates on the loanable

funds market

D) increasing expenditures; are the result of an increase in nominal interest rates on the

loanable funds market


Answer: ATopic: Supply of loanable fundsSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: NewAACSB: Reflective thinking

48) The supply of loanable funds schedule shows that the

A) higher the real interest rate, the greater the quantity of loanable funds supplied.

B) higher the real interest rate, the greater the opportunity cost of supplying loanable funds.

C) higher the real interest rate, the lower the profit from making new investment.

D) lower the real interest rate, the greater the quantity of loanable funds supplied.

E) higher the real interest rate, the more the supply of loanable funds curve shifts

rightward.

Answer: ATopic: Supply of loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: RevisedAACSB: Reflective thinking

49) An increase in the real interest rate

A) has no effect on the loanable funds.

B) increases the quantity of loanable funds supplied.

C) increases current consumption.

D) decreases the quantity of loanable funds supplied.

E) shifts the supply of loanable funds curve rightward.

Answer: BTopic: Supply of loanable fundsSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 913


50) As the real interest rate rises, the quantity of loanable funds supplied ________ and the

quantity of loanable funds demanded ________.






Answer: BTopic: Supply of loanable funds, demand for loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

51) A decrease in peopleʹs disposable income

A) increases saving.

B) increases consumption.

C) decreases saving.

D) increases saving and decrease consumption.

E) increases investment demand.

Answer: CTopic: Changes in saving supplySkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

52) As the economy enters an expansion so that peopleʹs expected future incomes rise, there will

be

A) an increase in the supply of loanable funds.

B) a leftward shift in the supply of loanable funds curve.

C) a decrease in the nominal interest rate.

D) a leftward shift in the demand for loanable funds curve.


Answer: ATopic: Changes in saving supplySkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 914


53) When disposable income increases, saving will

A) decrease, and there is a movement downward along the supply of loanable funds curve.

B) increase, and there is a movement upward along the supply of loanable funds curve.

C) not change.

D) increase, and the supply of loanable funds curve shifts rightward.

E) decrease, and the supply of loanable funds curve shifts leftward.

Answer: DTopic: Changes in the supply of loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

54) If the disposable income decreases, then

A) the supply of loanable funds increases.

B) the supply of loanable funds decreases.

C) the quantity of loanable funds demanded increases.

D) the quantity of loanable funds supplied decreases.

E) the demand for loanable funds increases.

Answer: BTopic: Changes in the supply of loanable fundsSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

55) If expectations about future income change, there is

A) no change in saving until income actually changes.

B) a decrease in saving if people expect income to increase in the future.

C) an increase in saving if people expect income to increase in the future.

D) a decrease saving if people expect income to decrease in the future.

E) a change in the quantity of loanable funds supplied and a movement along the supply of


Answer: BTopic: Changes in the supply of loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 915


56) If expected future income increases, then

A) the supply of loanable funds increases.

B) the supply of loanable funds decreases.

C) the quantity of loanable funds demanded increases.

D) the quantity of loanable funds supplied decreases.

E) the demand for loanable funds decreases.

Answer: BTopic: Changes in the supply of loanable fundsSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

57) In 2008 the fall in the value of the stock market decreased peopleʹs wealth. As a result of this

change alone, the supply of loanable funds

A) increased.

B) did not change, and there was no movement along the supply of loanable funds curve.

C) decreased.

D) did not change, and there was an upward movement along the supply of loanable funds

curve.

E) did not change, and there was a downward movement along the supply of loanable

funds curve.

Answer: ATopic: Changes in the supply of loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

58) When ________ changes, the supply of loanable funds curve shifts.

A) the expected rate of profit

B) peopleʹs expected future income

C) the price level

D) ʺanimal spiritsʺ

E) investment

Answer: BTopic: Shifts of the supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 916


59) Which of the following factors changes saving supply and hence shifts the supply of loanable

funds curve?

i. disposable income

ii. wealth

iii. expected profit

A) i only

B) ii only

C) iii only

D) i and ii

E) i, ii, and iii

Answer: DTopic: Supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

60) Which of the following shifts the supply of loanable funds curve?

A) change in the real interest rate

B) change in investment demand

C) change in disposable income

D) change in expected profit

E) change in ʺanimal spiritsʺ

Answer: CTopic: Supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

61) A fall in the real interest rate brings a

A) movement up along the supply of loanable funds curve.

B) rightward shift of the supply of loanable funds curve.

C) movement down along the supply of loanable funds curve.

D) leftward shift of the supply of loanable funds curve.

E) rightward shift of the demand for loanable funds curve.

Answer: CTopic: Supply of loanable funds curveSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 917


62) If the real interest rate rises, then the

A) supply of saving increases and the supply of loanable funds curve shifts rightward.

B) supply of saving decreases and the supply of loanable funds curve shifts leftward.

C) quantity of saving increases and there is a movement up along the supply of loanable

funds curve.

D) quantity of saving decreases and there is a movement down along the supply of loanable

funds curve.

E) demand for investment decreases and the demand for loanable funds curve shifts

leftward.

Answer: CTopic: Supply of loanable funds curveSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

63) If the real interest rate

A) rises, the supply of loanable funds curve shifts rightward.

B) rises, the supply of loanable funds curve shifts leftward.

C) falls, there is a movement along the supply of loanable funds curve to a higher quantity

of saving.

D) falls, there is a movement along the supply curve of loanable funds to a lower quantity of

loanable funds .

E) falls, the supply of loanable funds curve shifts leftward.

Answer: DTopic: Supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

64) The supply of loanable funds curve has a positive slope because the

A) higher the real interest rate, the lower the return to saving.

B) average return in the stock market is directly related to the real interest rate.

C) lower the real interest rate, the higher the return to saving.

D) lower the real interest rate, the lower the return to saving.

E) quantity of investment increases when the real interest rate increases.

Answer: DTopic: Supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 918


65) If wealth ________, then saving increases, which is shown by a ________.

A) increases; movement upward along the supply of loanable funds curve

B) decreases; movement downward along the supply of loanable funds curve

C) increases; rightward shift of the supply of loanable funds curve

D) decreases; rightward shift of the supply of loanable funds curve

E) increases; leftward shift of the supply of loanable funds curve

Answer: DTopic: Supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

66) Which of the following factors does NOT shift the supply of loanable funds curve?

i. change in disposable income

ii. change in wealth

iii. change in expected profit

A) i only B) ii only C) iii only D) i and ii E) ii and iii

Answer: CTopic: Supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

67) The supply of loanable funds curve has a ________ slope and the demand for loanable funds

curve has a ________ slope.

A) positive; positive

B) positive; negative

C) negative; positive

D) negative; negative

E) vertical; horizontal

Answer: BTopic: Supply of loanable funds curve, demand for loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 919


68) In which of the following cases would the supply of loanable funds curve shift rightward?

A) Joe is worried about cutbacks at his firm, so his expected future income falls.

B) In June, Sally learns that at yearʹs end she will receive a bonus that will double her

current salary.

C) The stock market booms, so peopleʹs wealth increases.

D) The economy moves into a recession.

E) Investment demand increases.

Answer: ATopic: Shifts of the supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

69) A decrease in householdsʹ disposable income ________ saving supply, and the supply of

loanable funds curve ________.

A) decreases; shifts rightward

B) decreases; shifts leftward

C) increases; shifts rightward

D) increases; shifts leftward

E) does not change; does not shift

Answer: BTopic: Shifts of the supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

70) An increase in disposable income leads to a

A) leftward shift of the demand for loanable funds curve.

B) downward movement along the supply of loanable funds curve.

C) rightward shift of the supply of loanable funds curve.



Answer: CTopic: Shifts of the supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 920


71) A decrease in wealth leads to a

A) leftward shift of the demand for loanable funds curve.






72) An increase in wealth ________ saving supply, and the supply of loanable funds curve

________.







73) When wealth ________, saving supply ________, and the supply of loanable funds curve shifts

________.

A) decreases; decreases; leftward

B) increases; increases; leftward

C) decreases; decreases; rightward

D) increases; decreases; leftward

E) increases; increases; rightward

Answer: DTopic: Shifts of the supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 921


74) An increase in peopleʹs expected future disposable income ________ saving supply, and the

supply of loanable funds curve ________.







75) A decrease in expected future income leads to a

A) rightward shift of the demand for loanable funds curve.




E) leftward shift of the demand for loanable funds curve.


Page 922


76) Suppose that the initial supply of loanable funds curve is SLF1. In the figure above, an increase

in the real interest rate leads to

i. a shift in the supply of loanable funds curve from SLF1 to SLF2.

ii. a shift in the supply of loanable funds curve from SLF1 to SLF3.

iii. a movement along the supply of loanable funds curve SLF1.

iv. no change whatever.

A) i only B) ii only C) iii only D) i and iii E) iv only

Answer: CTopic: Supply of loanable funds curveSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

77) In the figure above, the shift in the supply of loanable funds curve from SLF1 to SLF2 could be

the result of

A) an increase in the real interest rate.

B) a decrease in disposable income.

C) an increase in expected rate of profit.

D) a decrease in wealth

E) an increase in expected future disposable income.

Answer: DTopic: Supply of loanable funds curveSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 923


78) In the loanable funds market, a shortage of loanable funds occurs when the

A) demand for loanable funds exceeds supply of loanable funds.

B) supply of loanable funds exceeds demand for loanable funds.

C) quantity of loanable funds supplied exceeds the quantity of loanable funds demanded.

D) quantity of loanable funds demanded exceeds the quantity of loanable funds supplied.

E) supply of loanable funds curve shifts rightward.

Answer: DTopic: Loanable funds market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

79) If the real interest rate is less than the equilibrium real interest rate, there is a ________ of

loanable funds, and ________.

A) surplus; some borrowers cannot find the funds they want

B) shortage; some borrowers cannot find the funds they want

C) surplus; borrowers have an easy time finding the funds they want

D) shortage; borrowers have an easy time finding the funds they want

E) shortage; savers increase their saving supply to restore the equilibrium

Answer: BTopic: Loanable funds market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

80) When the real interest rate ________ the equilibrium real interest rate, there is a ________ of

loanable funds and the real interest rate ________.

A) exceeds; surplus; rises

B) is less than; surplus; rises

C) exceeds; shortage; rises

D) is less than; shortage; rises

E) is less than; shortage; falls


Page 924


81) If a surplus of loanable funds exists in the loanable funds market, the real interest rate

________ and the quantity of saving ________.

A) rises; increases

B) rises; decreases

C) falls; increases

D) falls; decreases

E) falls; does not change


82) The equilibrium real interest rate is 5 percent. If the real interest rate is

A) 3 percent, then the supply of loanable funds curve will shift leftward as new savers enter

the market.

B) 6 percent, the demand for loanable funds curve will shift rightward as firms enter the

market to borrow at the lower rate.

C) 8 percent, there is a surplus of loanable funds.

D) 2 percent, there is a shortage of loanable funds.

E) anything other than 5 percent, the supply of loanable funds curve and/or the demand for

loanable funds curve will shift to move the real interest rate to 5 percent.

Answer: CTopic: Loanable funds market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

83) In the loanable funds market, if the real interest rate is higher than the equilibrium real interest

rate,

A) there is a shortage of loanable funds.

B) there is a surplus of loanable funds.

C) there is a surplus of investment.

D) the demand for loanable funds curve shifts rightward to restore the equilibrium.

E) the demand for loanable funds curve shifts leftward to restore the equilibrium.


Page 925


84) At the current interest rate, the quantity of loanable funds supplied is greater than the quantity

of loanable funds demanded. Therefore

A) the real interest rate is below the equilibrium level.

B) the real interest rate is above the equilibrium level.

C) equilibrium will not be achieved until something shifts the supply of loanable funds

curve leftward.

D) equilibrium will not be achieved until something shifts the demand for loanable funds

curve rightward.

E) equilibrium will not be achieved until something shifts the supply of loanable funds

curve rightward.


85) When the real interest rate ________ the equilibrium real interest rate, there is a ________ of

loanable funds and the real interest rate ________.

A) exceeds; surplus ; falls

B) is less than; surplus; rises

C) exceeds; shortage; rises

D) is less than; shortage; falls

E) exceeds; surplus; rises

Answer: ATopic: Loanable funds market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 926


86) The figure above shows the loanable funds market. The equilibrium real interest rate is

________, and the equilibrium quantity of loanable funds is ________.

A) 6 percent; $2.0 trillion

B) 4 percent; $2.5 trillion

C) 8 percent; $1.5 trillion

D) 0 percent; $3.5 trillion

E) 4 percent; $1.5 trillion

Answer: ATopic: Loanable funds market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

87) The figure above shows the loanable funds market. If the real interest rate is 2 percent, then

A) there will be government intervention in the market to make sure there is no credit crisis.

B) there will be a leftward shift in the demand for loanable funds curve.

C) there is a surplus in the loanable funds market.

D) there is a shortage in the loanable funds market

E) the demand for loanable funds curve will shift rightward.

Answer: DTopic: Capital market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 927


88) The figure above shows the loanable funds market. If the real interest rate is 10 percent, then

A) there is a shortage in the loanable funds market.

B) there is a surplus in the loanable funds market.

C) the interest rate must increase.

D) the government must intervene in order to prevent a credit crisis.

E) savers will exit the market because of the high opportunity cost of saving.

Answer: BTopic: Loanable funds marketSkill: Level 4: Applying modelsSection: Checkpoint 10.2Status: RevisedAACSB: Analytical thinking

89) The figure above shows the loanable funds market. The equilibrium real interest rate is

________ percent, and the equilibrium quantity of loanable funds is ________.

A) 4; $1.8 trillion

B) 6; $1.6 trillion

C) 8; $1.4 trillion

D) 4; $1.4 trillion

E) 8; $1.8 trillion

Answer: BTopic: Loanable funds market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 928


90) The figure above shows the loanable funds market. At an interest rate of

A) 8 percent, there is a surplus of loanable funds.

B) 8 percent, the quantity demanded of loanable funds exceeds the quantity supplied.

C) 4 percent, the quantity supplied of loanable funds equals $18 trillion.

D) 6 percent, the quantity demanded of loanable funds equals $14 trillion.

E) 4 percent, there is a surplus of loanable funds.

Answer: ATopic: Loanable funds market equilibriumSkill: Level 4: Applying modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

91) The figure above shows the loanable funds market. At an interest rate of

A) 4 percent, there is a surplus of loanable funds.

B) 4 percent, there is a shortage of loanable funds.

C) 8 percent, the quantity of loanable funds supplied is $14 trillion.

D) 8 percent, the quantity demanded of loanable funds is $18 trillion.

E) 6 percent, savers will exit the market because the reward to saving is too low.

Answer: BTopic: Loanable funds market equilibriumSkill: Level 4: Applying modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

92) Suppose that there is an increase in disposable income and simultaneously an increase in the

expected profitability of investment. As a result, the equilibrium real interest rate ________

and the equilibrium quantity of loanable funds ________.

A) rises; increases

B) falls; increases

C) remains unchanged; increases

D) might rise, fall, or remain unchanged; increases

E) might rise, fall, or remain unchanged; decreases

Answer: DTopic: Loanable funds market equilibriumSkill: Level 4: Applying modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 929


93) Suppose that there is an increase in expected future disposable income and simultaneously an

increase in the expected profitability of investment. As a result, the equilibrium real interest

rate ________ and the equilibrium quantity of loanable funds ________.

A) rises; might increase, decrease, or not change

B) rises; increases

C) rises; decreases

D) falls; might increase, decrease, or not change

E) falls; increases

Answer: ATopic: Loanable funds market equilibriumSkill: Level 4: Applying modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

94) Suppose firms become more optimistic about the economyʹs ability to avoid a recession and

hence the expected profit increases. As a result, the demand for loanable funds curve shifts

________ and the real interest rate ________.

A) rightward; rises

B) rightward; falls

C) leftward; rises

D) leftward; falls

E) rightward; does not change


95) A decrease in expected profit

A) lowers the equilibrium real interest rate.

B) raises the equilibrium real interest rate.

C) increases the demand for loanable funds.

D) decreases the supply of loanable funds.

E) increases the supply of loanable funds.


Page 930


96) If the real interest rate falls, other things being the same, the quantity of loanable funds

demanded ________ and the quantity of loanable funds supplied ________.

A) increases; decreases

B) increases; increases

C) decreases; does not change

D) does not change; decreases

E) decreases; decreases

Answer: ATopic: Supply of loanable funds, demand for loanable fundsSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

97) The demand for loanable funds

A) increases in a recession.

B) decreases in an expansion.

C) increases when firms are optimistic about the profit from investing in capital.

D) increases when wealth increases.

E) decreases when wealth increases.


98) Other things remaining the same, a ________ in the real interest rate ________ the quantity of

saving supplied and ________ the quantity of loanable funds supplied.

A) fall; increases; increases

B) rise; increases; increases

C) fall; increases; decreases

D) fall; decreases; increases

E) rise; increases; decreases

Answer: BTopic: Saving supplySkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 931


99) An increase in wealth leads to ________ loanable funds.

A) an increase in the supply of

B) an increase in the demand for

C) a decrease in the supply of

D) a decrease in the demand for

E) no change in either the supply of loanable funds or the demand for

Answer: CTopic: Changes in the supply of loanable fundsSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

100) If the real interest rate falls, there is

A) an upward movement along the supply of loanable funds curve.

B) a downward movement along the supply of loanable funds curve.

C) a rightward shift of the supply curve of loanable funds and no shift in the demand for


D) a leftward shift of the supply of loanable funds curve and no shift in the demand for


E) a leftward shift of the supply of loanable funds curve and a rightward shift in the


Answer: BTopic: Supply of loanable funds curveSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

101) If, at the current interest rate, the quantity of loanable funds supplied is less than the quantity

of loanable funds demanded, then

A) the supply of loanable funds curve shifts rightward and the real interest rate rises.

B) the supply of loanable funds curve shifts leftward and the real interest rate falls.

C) the real interest rate falls.

D) the real interest rate rises.

E) the supply of loanable funds curve shifts leftward and the real interest rate rises.


Page 932


102) If expected profit falls, the demand for loanable funds curve shifts ________, and the real

interest rate ________.

A) rightward; rises

B) rightward; falls

C) leftward; rises

D) leftward; falls

E) leftward; does not change

Answer: DTopic: Loanable funds market equilibriumSkill: Level 4: Applying modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

10.3 Government in Loanable Funds Market

1) For a government to add to the supply of loanable funds, it must

A) borrow.

B) have a budget surplus.

C) have a budget deficit.

D) raise the real interest rate.

E) increase its investment demand.

Answer: BTopic: Government savingSkill: Level 1: DefinitionSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

2) If a government has a budget deficit, it must

A) borrow in the loanable funds market.

B) increase taxes.

C) lower the real interest rate.

D) decrease its expenditures.

E) decrease taxes.

Answer: ATopic: Government savingSkill: Level 1: DefinitionSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

Page 933


3) Government saving is equal to

A) the quantity of investment demanded.

B) net taxes minus government expenditures.

C) net taxes plus government expenditures.

D) private savings minus government expenditures.

E) net taxes.

Answer: BTopic: Government savingSkill: Level 1: DefinitionSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

4) If there is no Ricardo-Barro effect, the government

A) plays no direct role in the loanable funds market because it doesnʹt affect either the

demand for loanable funds or the supply of loanable funds.

B) always has negative saving and therefore lowers the real interest rate.

C) only affects the demand for loanable funds curve in the loanable funds market.

D) increases the supply of loanable funds if it has a budget surplus and shifts the supply of


E) has no effect because private saving changes to offset the effect that the governmentʹs

budget deficit or surplus might otherwise have.

Answer: DTopic: Government savingSkill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

5) If there is no Ricardo-Barro effect, an increase in the government budget surplus

A) decreases private saving.

B) increases private saving.

C) decreases the supply of loanable funds.

D) increases the supply of loanable funds.

E) has no effect on the demand for loanable funds, the supply of loanable funds, or the real

interest rate.

Answer: DTopic: Government savingSkill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

Page 934


6) If there is no Ricardo-Barro effect, a government budget surplus

A) increases the supply of loanable funds.

B) decreases the supply of loanable funds.

C) increases the demand for loanable funds.

D) decreases the demand loanable funds.

E) has no effect on the demand for loanable funds, the supply of loanable funds, or the real

interest rate.

Answer: ATopic: Government savingSkill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

7) If there is no Ricardo-Barro effect, an increase in the government budget surplus will

A) decrease the supply of loanable funds.

B) raise the real interest rate.

C) lower the real interest rate.

D) decrease the demand for loanable funds.

E) not change the demand for loanable funds, the supply of loanable funds, or the real

interest rate.

Answer: CTopic: Effect of a government budget surplusSkill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

8) If there is no Ricardo-Barro effect, an increase in the government budget deficit

A) raises the equilibrium real interest rate.

B) lowers the equilibrium real interest rate.

C) decreases the demand for loanable funds.

D) decreases the supply of loanable funds.


Answer: ATopic: Effect of a government budget deficitSkill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

Page 935


9) If there is no Ricardo-Barro effect, a government budget surplus ________ the total supply of

loanable funds and ________ the real interest rate.

A) increases; raises

B) increases; lowers

C) decreases; raises

D) decreases; lowers


Answer: BTopic: Effect of a government budget surplusSkill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

10) With no Ricardo-Barro effect, a government budget surplus

A) decreases the supply of loanable funds and lowers the real interest rate.

B) decreases the demand for loanable funds and increases the real interest rate.

C) increases the demand for loanable funds and lowers the real interest rate.

D) increases the supply of loanable funds and lowers the real interest rate.

E) increases the demand for loanable funds and raises the real interest rate.

Answer: DTopic: Effect of a government budget surplusSkill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

11) Suppose the government has a budget surplus of $2 billion. If there is no Ricardo-Barro effect,

what occurs?

A) The supply of loanable funds curve shifts rightward, lowering the interest rate, and

increasing investment.

B) The demand for loanable funds curve shifts rightward, raising the interest rate, and


C) The supply of loanable funds curve shifts leftward, raising the interest rate, and

decreasing investment.

D) The demand for loanable funds curve shifts leftward, lowering the interest rate, and

decreasing investment.

E) The supply of loanable funds curve shifts leftward, lowering the interest rate, and


Answer: ATopic: Effect of a government budget surplusSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

Page 936


12) Chinaʹs government runs a budget surplus. As a result,

A) if there is no Ricardo-Barro effect, the supply of loanable funds curve lies to the right of

the private supply of loanable funds curve.

B) interest rates should increase.

C) the Ricardo-Barro effect predicts that the real interest rate will increase.

D) the quantity of loanable funds decreases.

E) saving will exceed investment.

Answer: ATopic: Government savingSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

13) Indiaʹs government runs a government budget surplus. If there is no Ricardo-Barro effect, the

surplus means that the

A) private supply of loanable funds curve lies to the left of the supply of loanable funds

curve.

B) private demand for loanable funds curve lies to the left of the demand for loanable funds

curve.

C) private supply of loanable funds curve lies to the right of the supply of loanable funds

curve.

D) private supply of loanable funds curve is the same as the supply of loanable funds curve.


Answer: ATopic: Government savingSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

14) If there is no Ricardo-Barro effect, when the government runs a budget surplus, it

A) competes with businesses for private saving.

B) shifts the supply of loanable funds curve leftward.

C) shifts the demand for loanable funds curve leftward.

D) contributes to financing investment.

E) shifts the demand for loanable funds curve rightward.

Answer: DTopic: Effect of a government budget surplusSkill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

Page 937


15) If there is no Ricardo-Barro effect, a government budget surplus ________ the supply of

loanable funds and ________ equilibrium investment.






Answer: ATopic: Effect of a government budget surplusSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

Real interest rate

(percent per year)

Investment

(billions of

2009 dollars)

Private saving

(billions of

2009 dollars)

Net taxes

(billions of

2009 dollars)

Government expenditures

(billions of

2009 dollars)

3 60 20 40 20

4 50 30 40 20

5 40 40 40 20

6 30 50 40 20

7 20 60 40 20

16) The table above gives a nationʹs investment demand and saving supply schedules. It also has

the governmentʹs net taxes and expenditures. The government has a budget

A) surplus of $60 billion.

B) surplus of $20 billion.

C) deficit of $20 billion.

D) deficit of $60 billion.

E) surplus of $40 billion.

Answer: BTopic: Government savingSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking


the governmentʹs net taxes and expenditures. When the real interest rate is 4 percent, the

supply of loanable funds is equal to

A) $80 billion.

B) $30 billion.

C) $50 billion.

D) $90 billion.

E) $10 billion.

Answer: CTopic: Government savingSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking

Page 938



the governmentʹs net taxes and expenditures. The loanable funds market is in equilibrium

when the real interest rate is

A) 4 percent. B) 5 percent. C) 6 percent. D) 7 percent E) 3 percent


19) In the figure above, the SLF curve is the supply of loanable funds curve and the PSLF curve is

the private supply of loanable funds curve. Given these curves, there is a government budget

________ and therefore the real interest rate is ________ than it would be otherwise.

A) surplus; higher

B) surplus; lower

C) deficit; higher

D) deficit; lower

E) deficit; not different

Answer: BTopic: Government savingSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking

Page 939



the private supply of loanable funds curve. The equilibrium interest rate is ________ percent

and the equilibrium quantity of loanable funds is ________.

A) 6; $1.6 trillion

B) 6; $2.0 trillion

C) 4; $1.4 trillion

D) 4; $1.8 trillion

E) 4; $2.0 trillion

Answer: DTopic: Loanable funds market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking


the private supply of loanable funds curve. If there is no Ricardo-Barro effect and the

government now runs a balanced budget,

A) the interest rate will increase from 4 percent to 6 percent.

B) the equilibrium interest rate is 6 percent and investment is $1.6 trillion.

C) the equilibrium interest rate is 4 percent and investment is $1.8 trillion.

D) there is a surplus of investment funds and the interest rate falls to 4 percent.

E) there is shortage of investment funds of $0.4 trillion.

Answer: BTopic: Loanable funds marketSkill: Level 4: Applying modelsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking


the private supply of loanable funds curve. If there is no Ricardo-Barro effect, the figure

shows a situation in which the government has a budget

A) surplus of $0.2 trillion.

B) deficit of $0.2 trillion.

C) surplus of $1.4 trillion.

D) deficit of $1.6 trillion.

E) surplus of $1.8 trillion.

Answer: ATopic: Government savingSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking

Page 940


23) In the figure above, if there is no Ricardo-Barro effect, the government has a ________ because

________.

A) budget surplus; the SLF curve lies to the right of the PSLF curve.

B) budget deficit; the SLF curve lies to the right of the PSLF curve.

C) balanced budget; there is no Ricardo-Barro effect.

D) budget surplus; there is no Ricardo-Barro effect.

E) budget deficit; there is no Ricardo-Barro effect.

Answer: ATopic: Government savingSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: NewAACSB: Analytical thinking

24) In the figure above, if there is no Ricardo-Barro effect, the government has a budget ________

because the ________.

A) surplus of 0.2 trillion; SLF curve lies to the right of the PSLF curve.

B) surplus of 0.4 trillion; SLF curve shows a larger quantity of LF than the PSLF curve.

C) deficit of 0.2 trillion; SLF curve lies to the right of the PSLF curve.

D) deficit of 0.4 trillion; SLF curve shows a smaller quantity of LF than the PSLF curve.

E) surplus of -0.2 trillion; SLF curve lies to the right of the PSLF curve.

Answer: ATopic: Government savingSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: NewAACSB: Analytical thinking

Page 941



the private supply of loanable funds curve. The equilibrium interest rate is ________ percent

and the equilibrium quantity of loanable funds is ________.

A) 6; $12 trillion

B) 6; $14 trillion

C) 4; $13 trillion

D) 4; $11 trillion

E) 4; $14 trillion

Answer: CTopic: Loanable funds market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking

Page 942


26) In the figure above, the DLF curve is the demand for loanable funds curve and the PDLF curve

is the private demand for loanable funds curve. If there is no Ricardo-Barro effect, the figure

shows a situation in which the government has a budget

A) deficit of $1 trillion.

B) surplus of $1 trillion.

C) deficit of $0.5 trillion.

D) deficit of $1.5 trillion.

E) surplus of $0.5 trillion.

Answer: ATopic: Loanable funds marketSkill: Level 4: Applying modelsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking

27) In the figure above, the DLF curve is the demand for loanable funds curve and the PDLF curve

is the private demand for loanable funds curve. If there is no Ricardo-Barro effect, the figure

shows the situation in which the government has a ________ so that the equilibrium real

interest rate is ________ and the equilibrium quantity of investment is ________.

A) budget surplus; 4 percent; $1 trillion

B) budget deficit; 4 percent; $1 trillion

C) budget deficit; 6 percent; $1.5 trillion

D) budget surplus; 6 percent; $1.5 trillion

E) balanced budget; 6 percent; $1.5 trillion

Answer: CTopic: Loanable funds marketSkill: Level 4: Applying modelsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking

Page 943


28) If there is no Ricardo-Barro effect, a government budget deficit increases

A) private savings and raises the real interest rate.

B) the supply of loanable funds and raises the real interest rate.

C) the demand for loanable funds and raises the real interest rate.

D) investment demand and lowers the real interest rate.

E) private savings and lowers the real interest rate.

Answer: CTopic: Crowding-out effect

Skill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking

29) The crowding-out effect is the tendency for

A) lower private saving to decrease investment.

B) higher government budget deficits to increase total savings.

C) higher government budget deficits to decrease investment.

D) higher private savings to decrease government budget surpluses.

E) lower private saving to increase the budget deficit.



30) The tendency for higher government budget deficits to decrease investment is called the

A) deficit effect.

B) Ricardo-Barro effect.

C) wealth effect.

D) crowding-out effect.

E) inflation effect.

Answer: DTopic: Crowding-out effect


Page 944


31) The crowding-out effect implies that a government budget deficit ________ the demand for

loanable funds and ________ equilibrium investment.






Answer: BTopic: Crowding-out effect


32) If there is no Ricardo-Barro effect, an increase in the budget deficit

A) decreases the amount of investment.

B) lowers the equilibrium real interest rate.

C) increases the amount of investment.

D) decreases the demand for loanable funds.


Answer: ATopic: Crowding-out effect

Skill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

33) The crowding-out effect describes how a government budget ________ ________ the real

interest rate and thereby ________ equilibrium investment.

A) deficit; raises; decreases

B) deficit; lowers; increases

C) surplus; raises; decreases

D) surplus; lowers; decreases

E) deficit; lowers; decreases



Page 945


34) Suppose the governmentʹs budget deficit increases by $500 billion. If there is no Ricardo-Barro

effect, what occurs?

A) The demand for loanable funds curve shifts rightward, the real interest rate rises, and the

quantity of loanable funds increases.

B) The supply of loanable funds curve shifts leftward, the real interest rate rises, and the

quantity of loanable funds decreases.

C) The demand for loanable funds curve shifts leftward, the real interest rate falls, and the

quantity of loanable funds decreases.

D) The supply of loanable funds curve shifts rightward, the real interest rate falls, and the


E) The supply of loanable funds curve shifts leftward, the real interest rate rises, and the




35) A country initially has an equilibrium real interest rate of 4 percent and an equilibrium

quantity of investment of $2 trillion. The governmentʹs budget deficit then increases.

According to the crowding-out effect, the

A) demand for loanable funds curve shifts leftward, the real interest rate falls, and

investment increases.

B) supply of loanable funds curve shifts rightward, the real interest rate rises, and


C) demand for loanable funds curve shifts rightward, the real interest rate falls, and


D) demand for loanable funds curve shifts rightward, the real interest rate rises, and

investment decreases.

E) supply of loanable funds curve shifts leftward, the real interest rate falls, and investment

decreases.



Page 946


36) Suppose the government has a budget deficit of $2 billion. If there is no Ricardo-Barro effect,

how much crowding out of investment occurs?

A) more than $2 billion

B) some crowding out occurs, but less than $2 billion

C) exactly equal to $2 billion dollars

D) No crowding out occurs and investment does not change.

E) No crowding out occurs because investment increases.



37) According to the Ricardo-Barro effect, a government budget

A) surplus increases private saving supply.

B) deficit increases private saving supply.

C) deficit decreases private saving supply.

D) surplus decreases private investment demand.

E) deficit decreases private investment demand.

Answer: BTopic: Ricardo-Barro effect

Skill: Level 1: DefinitionSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

38) According to the Ricardo-Barro effect, an increase in the government budget deficit

A) does not change the real interest rate.

B) lowers the real interest rate.

C) shifts the supply of loanable funds curve leftward.

D) has no effect on the nominal interest rate but does change the real interest rate.

E) shifts the demand for loanable funds curve leftward.

Answer: ATopic: Ricardo-Barro effect


Page 947


39) The Ricardo-Barro effect refers to how ________ in response to a government budget

________.

A) investment demand changes; surplus

B) investment demand changes; deficit

C) saving supply changes; deficit

D) government budget changes; surplus or deficit

E) investment demand and saving supply change; surplus

Answer: CTopic: Ricardo-Barro effect


40) A prediction of the Ricardo-Barro effect is

A) a larger increase in the real interest rate when the government runs a budget deficit.

B) a larger decrease in the real interest rate when the government runs a budget surplus.

C) no effect on the real interest rate when the government runs a budget deficit.

D) a larger decrease in investment when the government runs a budget deficit.

E) a larger decrease in investment when the government runs a budget surplus.



41) The Ricardo-Barro effect argues that the crowding-out effect

A) is the result of a government budget surplus and higher interest rates.

B) will not occur, because the private saving supply will change to offset any change in the

government budget deficit.

C) is the result of the government budget deficit and higher interest rates.

D) will occur, because the private saving supply will change to offset any change in the

government budget deficit.

E) is stronger when the government runs a budget surplus than when it runs a budget

deficit.



Page 948


42) The Ricardo-Barro effect is based on the idea that ________ when the government has a

budget deficit.

A) people decrease their private saving

B) people increase their private saving

C) investment demand increases because expected future profits increase

D) investment demand decreases because of the higher real interest rate

E) people immediately increase their tax payments



43) Evidence to support the Ricardo-Barro effect would show that

A) higher government budget deficits decrease investment.

B) higher government budget surpluses decrease investment.

C) government budget deficits increase household consumption.

D) government budget deficits have no effect on the real interest rate or investment.

E) higher government budget deficits raise the real interest rate.

Answer: DTopic: Ricardo-Barro effect


44) Suppose the government has a budget deficit of $2 billion. If the Ricardo-Barro effect is

correct, then how much crowding out of investment occurs?

A) more than $2 billion

B) some crowding out occurs, but less than $2 billion

C) exactly equal to $2 billion dollars

D) No crowding out occurs and investment does not change.

E) No crowding out occurs because investment increases by $2 billion.

Answer: DTopic: Ricardo-Barro effect

Skill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking

Page 949


Real interest rate

(percent per year)

Demand for loanable funds

(billions of

2009 dollars)

Supply of loanable funds

(billions of

2009 dollars)

3

4

5

6

7

8

9

750

700

650

600

550

500

450

450

500

550

600

650

700

750

45) The above table has the private demand for loanable funds and the private supply of loanable

funds schedules. If the government budget surplus is $200 billion, and there is no

Ricardo-Barro effect, the equilibrium real interest rate is ________ and the equilibrium

quantity of loanable funds is ________.

A) 6 percent; $600 billion

B) 4 percent; $700 billion

C) 8 percent, $500 billion

D) 8 percent; $700 billion

E) 4 percent; $500 billion




funds schedules. If the government budget deficit is $200 billion, and there is no

Ricardo-Barro effect, the equilibrium real interest rate is ________ and the equilibrium

quantity of investment is ________.








Page 950



funds schedules. If the government budget surplus is $200 billion, and there is a Ricardo -Barro

effect, the equilibrium real interest rate is ________ and the equilibrium quantity of loanable

funds is ________.









funds schedules. If the government budget deficit is $200 billion, and there is a Ricardo-Barro

effect, the equilibrium real interest rate is ________ and the equilibrium quantity of investment

is ________.







Skill: Level 3: Using modelsSection: Checkpoint 10.3Status: RevisedAACSB: Analytical thinking

49) During financial crisis of 2008-09, the government rescued financial firms and the auto

industry. As a result,

A) the governmentʹs budget deficit increased, the governmentʹs demand for loanable funds

increased and private investment was crowded out.

B) real interest rates decreased.

C) the supply of loanable funds decreased in response to the governmentʹs budget deficit.

D) the private demand for loanable funds increased.

E) the governmentʹs rescue plan created a surplus of loanable funds.

Answer: ATopic: Did the rescue plan crowd out investment?Skill: Level 1: DefinitionSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

Page 951


50) As a result of the governmentʹs rescue of financial firms and the auto industry in 2008, which

of the following occurred?

i) The governmentʹs demand for loanable funds increased the real interest rate.

ii) Investment expenditures were crowded out.

iii) The supply of loanable funds curve shifted leftward.

A) i and ii

B) i, ii and iii

C) i only

D) ii only

E) ii and iii

Answer: ATopic: Did the rescue plan crowd out investment?Skill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

51) With no Ricardo-Barro effect, a government budget surplus

A) increases the supply of loanable funds.

B) increases the demand for loanable funds.

C) decreases the supply of loanable funds.

D) decreases the demand for loanable funds.

E) has no effect on either the supply or the demand for loanable funds.

Answer: ATopic: Government savingSkill: Level 1: DefinitionSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

52) Suppose the government has a budget surplus. Then

A) private saving is equal to investment.

B) private saving is greater than investment and government saving is positive.

C) private saving is less than investment and government saving is positive.

D) private investment is greater than the sum of government saving and private saving.

E) private saving is greater than investment and government saving is negative.

Answer: CTopic: Government savingSkill: Level 1: DefinitionSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

Page 952


53) When there is no Ricardo-Barro effect, a government budget surplus ________ the real interest

rate because the ________ loanable funds increases.

A) raises; demand for

B) lowers; demand for

C) raises; supply of

D) lowers; supply of

E) None of the above answers is correct because the real interest rate does not change.

Answer: DTopic: Effect of a government budget surplusSkill: Level 2: Using definitionsSection: Checkpoint 10.3Status: RevisedAACSB: Reflective thinking

54) The ʺcrowding-out effectʺ refers to how a government budget deficit

A) shifts only the supply of loanable funds curve leftward.

B) shifts only the demand for loanable funds curve leftward.

C) shifts both the demand for and the supply of loanable funds curves leftward.

D) decreases the equilibrium quantity of investment.

E) increases the equilibrium quantity of investment.



55) If there is no Ricardo-Barro effect, a government budget deficit will ________ the equilibrium

real interest rate and ________ the equilibrium quantity of investment.

A) raise; increase

B) raise; decrease

C) lower; increase

D) lower; decrease

E) not change; not change



Page 953


56) The Ricardo-Barro effect says that a government budget deficit leads to

A) a higher real interest rate.

B) a lower real interest rate.

C) no change in the real interest rate.

D) an increase in demand for loanable funds.

E) an increase in the quantity of investment.



57) When the U.S. government launched a massive rescue plan in response to the 2008-2009

financial crisis, one of the main actions taken was to ________ because the desire was to lessen

the severity of the recession by ________.

A) increase the supply of loanable funds; encouraging decrease in investment

B) decrease the supply of loanable funds; encouraging decrease in investment

C) increase the supply of loanable funds; limiting the decrease in investment

D) decrease the supply of loanable funds; limiting the decrease in investment

E) increase the demand of loanable funds; encouraging decrease in investment

Answer: CTopic: Supply of loanable fundsSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: NewAACSB: Reflective thinking

58) When the U.S. government launched a massive rescue plan in response to the 2008-2009

financial crisis, the overall demand for loanable funds ________ because the ________.

A) increased; demand by households, businesses, and financial institutions increased as did

the federal government demand

B) decreased; demand by households, businesses, and financial institutions changed by the

same amount as the federal government demand

C) decreased; demand by households, businesses, and financial institutions decreased by

more than the federal government demand increased

D) increased; demand by households, businesses, and financial institutions increased by

more than the federal government demand increased

E) did not change; demand by households, businesses, and financial institutions changed

by the same amount as the federal government demand

Answer: CTopic: Supply of loanable fundsSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: NewAACSB: Reflective thinking

Page 954


59) In 2007 the real interest rate in the United States was 2 percent. By 2013, the equilibrium real

interest in the United States was ________ because the ________.

A) 3.5 percent; United States began to recover from the deep recession and financial crisis of

2008-2009

B) 0.5 percent; United States began to recover from the deep recession and financial crisis of

2008-2009

C) 0.5 percent; United States experienced a deep recession as a result of a financial crisis in

2008-2009

D) 3.5 percent; United States experienced a deep recession as a result of a financial crisis in

2008-2009

E) not yet calculated; effects of the financial crisis of 2008-2009 have not yet been tallied

Answer: CTopic: Real interest rateSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: NewAACSB: Reflective thinking

Page 955


10.4 Chapter Figures

The figure above shows the demand for loanable funds curve.

1) In the figure above, a movement from point A to point C can be the result of

A) an increase in expected profit.


C) a rise in the real interest rate.

D) a fall in the real interest rate.

E) an increase in the government budget deficit.

Answer: DTopic: Demand for loanable funds curveSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 956


2) If the demand for loanable funds curve shifts rightward from the curve shown in the figure

above, the shift could be the result of

A) an increase in expected profit.




E) a decrease in real GDP.

Answer: ATopic: Demand for loanable funds curveSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

The figure above shows the supply of loanable funds curve.

3) In the figure above, a movement from point A to point C can be the result of

A) a fall in expected future income.

B) an increase in disposable income.



E) an increase in wealth.

Answer: CTopic: Supply of loanable funds curveSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 957


4) If the supply of loanable funds curve shifts rightward from the curve shown in the figure


A) a fall in expected future income.


C) a decrease in the demand for loanable funds.

D) a decrease in the supply of loanable funds.


Answer: ATopic: Supply of loanable funds curveSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking



A) a rise in expected future income.

B) an increase in disposable income.




Answer: BTopic: Supply of loanable funds curveSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking



A) a rise in expected future income.




E) a decrease in wealth.

Answer: ETopic: Supply of loanable funds curveSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 958



1) If investment demand increases, the equilibrium real interest rate ________ and the

equilibrium quantity of investment ________.

A) rises; increases

B) rises; decreases

C) falls; increases

D) falls; decreases


Answer: ATopic: IntegrativeSkill: Level 3: Using modelsSection: IntegrativeStatus: OldAACSB: Analytical thinking

2) If saving supply decreases, the equilibrium real interest rate ________ and the equilibrium

quantity of investment ________.

A) rises; increases

B) rises; decreases

C) falls; increases

D) falls; decreases


Answer: BTopic: IntegrativeSkill: Level 3: Using modelsSection: IntegrativeStatus: OldAACSB: Analytical thinking

3) In the late 1990s, the U.S. federal government had a budget surplus. If there is no

Ricardo-Barro effect, these surpluses ________ the supply of loanable funds and ________ the

real interest rate.

A) increased; raised

B) increased; lowered

C) decreased; raised

D) decreased; lowered

E) did not change; did not change

Answer: BTopic: IntegrativeSkill: Level 4: Applying modelsSection: IntegrativeStatus: OldAACSB: Analytical thinking

Page 959


4) In 2012, the U.S. federal government budget had a budget deficit. If there is no Ricardo -Barro

effect, this deficit ________ the demand for loanable funds and ________ the real interest rate.

A) increased; raised

B) increased; lowered

C) decreased; raised

D) decreased; lowered


Answer: ATopic: IntegrativeSkill: Level 4: Applying modelsSection: IntegrativeStatus: OldAACSB: Analytical thinking

5) In the late 1990s, the U.S. federal government had a budget surplus. If there is no

Ricardo-Barro effect, the budget surplus ________ the real interest rate and ________ the

equilibrium quantity of investment.

A) raised; increased

B) raised; decreased

C) lowered; increased

D) lowered; decreased


Answer: CTopic: IntegrativeSkill: Level 4: Applying modelsSection: IntegrativeStatus: OldAACSB: Analytical thinking

6) In 2012, the U.S. federal government had a budget deficit. If there is no Ricardo -Barro effect,

the budget deficit ________ the real interest rate and ________ the equilibrium quantity of

investment.

A) raised; increased

B) raised; decreased

C) lowered; increased

D) lowered; decreased



Page 960


7) Crowding out can occur when a government budget ________ raises the real interest rate and

the equilibrium quantity of investment ________.

A) surplus; increases

B) surplus; decreases

C) deficit; increases

D) deficit; decreases

E) surplus; does not change


8) What does the Ricardo-Barro Effect predict?

A) The level of saving in a developed economy will be very low.

B) There is no way to explain animal spirits or irrational exuberance.

C) Private saving will offset the impact of government borrowing.

D) Government budget deficits crowd out private investment.

E) Net investment and gross investment will be equal.

Answer: CTopic: IntegrativeSkill: Level 3: Using modelsSection: IntegrativeStatus: OldAACSB: Analytical thinking

9) If the government runs a budget deficit to fight a war and there is no Ricardo-Barro effect,

what is an impact of the deficit?

A) The quantity of private saving decreases.

B) Firms purchase more capital equipment.

C) Animal spirits or irrational exuberance is created.

D) The real interest rate rises.

E) The quantity of investment increases.


Page 961


10.6 Essay: Financial Institutions and Markets

1) What is the difference, if any, between physical capital and financial capital?

Answer: Physical capital refers to the actual tools, machinery, instruments, and buildings that

have been produced in the past and are now being used to produce additional goods

and services. Financial capital refers to the funds used to purchase the physical capital.

Financial capital includes stocks and bonds.Topic: Physical capital and financial capitalSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

2) Define gross investment and net investment. Discuss the relationship between gross

investment and net investment.

Answer: Gross investment is the total amount spent on new capital goods to increase the

quantity of capital and replace the depreciated capital. Net investment is the amount

spent on new capital that exceeds the value of the depreciated capital or, in other words,

net investment equals gross investment minus depreciation. Net investment is equal to

the change in the capital stock.Topic: Gross investment, net investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

3) What is the distinction between gross investment and net investment?

Answer: Gross investment is the total spending on capital goods. Net investment equals gross

investment minus depreciation. From one year to the next, the capital stock increases by

the amount of net investment.Topic: Gross investment, net investmentSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

4) ʺWhen a companyʹs depreciation is larger than its gross investment, net investment becomes

negative and the firmʹs capital stock decreases.ʺ Is the previous statement correct or incorrect?

Explain your answer.

Answer: The statement is correct. Net investment equals gross investment minus depreciation. If

depreciation is larger than gross investment, net investment will be negative. Net

investment is the change in the capital stock, and so the companyʹs capital stock

decreases. Essentially, because depreciation is larger than the companyʹs gross

investment, the company is not buying enough capital to replace the capital that

depreciated. As a result, the total amount of the companyʹs capital decreases.Topic: Net investmentSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Written and oral communication

Page 962


5) Is wealth the same thing as income?

Answer: No, wealth is different from income. Wealth is the value of what people own. Income,

however, is an amount that is received during a given time period.Topic: WealthSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

6) Define wealth. What is the relationship between wealth and saving?

Answer: Wealth is the value of all the things that are owned. The amount of saving is added to

wealth.Topic: WealthSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

7) If a firm wants to buy a piece of capital equipment, is this firm a demander or supplier in the

financial market?

Answer: A financial market is where firms get the funds to buy capital. So, if the firm wants to

buy a piece of capital equipment, the firm will be looking for funds to borrow. Hence

the firm is a demander in the financial market.Topic: Financial marketsSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

8) In the nationʹs financial markets, what are the various ways a firm can obtain financial capital?

Answer: A firm can obtain financial capital by issuing shares of stock, selling bonds, issuing a

commercial bill, or borrowing funds from banks and other financial institutions.Topic: Financial marketsSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

Page 963


9) List three different types of financial markets and discuss the type of financial instruments

traded in the markets.

Answer: Financial markets are the stock market, the bond market, and the loan market. The stock

market is a market in which shares in the stocks of companies are traded. These shares

give the stockholder partial ownership in the company and a claim on the companyʹs

profit. The bond market is a market in which bonds issued by companies and

governments are traded. A bond is a promise to pay a specified sum of money on

specified dates and is a debt for the issuer of the bond. The loan market is the market for

loans from banks. Firms can borrow funds from banks. These loans are generally not

traded.Topic: Financial marketsSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Written and oral communication

10) Describe two main differences between bonds and stocks.

Answer: Stocks represent ownership of the issuing company, whereas bonds are a debt of the

issuing company. Because stocks represent ownership of a company, a stockholder has

a claim on (part) of the companyʹs profit. Bondholders, however, have no claim on the

companyʹs profit. Instead, they have a promise by the company to pay them specified

amounts of money at specified dates in the future.Topic: Stocks and bondsSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Written and oral communication

11) Does a stock certificate or a bond represent ownership of a company and a claim on its profits?

Answer: A stock certificate represents ownership of a company. A bond is a debt of the issuing

company, not an ownership claim on the company.Topic: Stocks and bondsSkill: Level 1: DefinitionSection: Checkpoint 10.1Status: OldAACSB: Reflective thinking

12) At the beginning of the year, Beckyʹs wealth was $30,000. During the year, she earned $50,000

of income, paid $6,000 in taxes and consumed $43,000 of goods and services. What is Beckyʹs

wealth at the end of the year?

Answer: Beckyʹs wealth is $31,000, the sum of her initial wealth ($30,000) plus her new saving of

$1,000.Topic: Wealth and savingSkill: Level 2: Using definitionsSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

Page 964


13) At the beginning of the year, United Delivery had trucks valued at $1.3 million. During the

year, United Delivery purchased new trucks valued at $500,000. If the value of the trucks at the

end of the year was $1.5 million, what is the amount of its net investment and its depreciation

during the year?

Answer: Net investment is the change in the capital stock from one period to the next. Hence for

United Delivery, net investment equals $1.5 million - $1.3 million = $200,000. Net

investment also equals gross investment minus depreciation. Thus depreciation equals

gross investment minus net investment. Gross investment, the total amount spent on

new capital equipment, was $500,000. Net investment was calculated to be $200,000.

Therefore depreciation equals $500,000 - $200,000 = $300,000.Topic: Capital and investmentSkill: Level 3: Using modelsSection: Checkpoint 10.1Status: OldAACSB: Analytical thinking

10.7 Essay: The Loanable Funds Market

1) ʺAn increase in the real interest rate increases the quantity of investment.ʺ Is the previous

statement correct or incorrect?

Answer: The statement is false. The interest rate is the opportunity cost of the funds used to

make an investment. Hence an increase in the interest rate decreases the quantity of

investment demanded.Topic: Investment demandSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

2) Explain the relationship between the real interest rate and investment demand. Compare that

relationship to the relationship between expected profit and investment demand.

Answer: The real interest rate determines the quantity of investment demanded. There is an

inverse relationship between the real interest rate and the quantity of investment

demanded. Expected profit affects investment. An increase in the expected profit from

investing increases investment. Hence there is a positive relationship between

investment and expected profit.Topic: Investment demand, expected profitSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Written and oral communication

3) How does an increase in expected profit affect investment demand and the demand for

loanable funds curve?

Answer: An increase in expected profit increases investment and shifts the demand for loanable

funds curve rightward.Topic: Investment demand, expected profitSkill: Level 2: Using definitionsSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

Page 965


4) Does a change in the real interest rate shift the supply of loanable funds curve? Explain your

answer.

Answer: A change in the real interest rate does not shift the supply of loanable funds curve.

Instead, the change in the real interest rate results in a change in the quantity of

loanable funds supplied and a movement along the supply of loanable funds curve. The

supply of loanable funds curve shifts if some factor that influences the supply of

loanable funds other than the real interest rate changes.Topic: Supply of loanable fundsSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Written and oral communication

5) What are the factors that change saving and shift the supply of loanable funds curve?

Answer: There are three main factors that change saving and shift the supply of loanable funds

curve: disposable income, wealth, and the expected future income. The higher the

disposable income, the more people save, so an increase in disposable income shifts the

supply of loanable funds curve rightward. The higher wealth, the less people save

because households feel richer and do not see the need to save. Thus an increase in

wealth shifts the supply of loanable funds curve leftward. Finally, the higher the

expected future income, the less people save today. Thus an increase in the expected

future income shifts the supply of loanable funds curve leftward.Topic: Supply of loanable fundsSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Written and oral communication

6) Explain how each of the following events would affect the supply of loanable funds curve:

a. The economy is in a recession so peopleʹs disposable income is lower.

b. The stock market is booming so peopleʹs wealth is higher.

c. The future looks a bit more grim, so expected future income is lower.

d. The real interest rate increases.

Answer: a. Disposable income is lower, so saving is decreased. The supply of loanable funds

curve shifts leftward.

b. People are wealthier, so they save less. The supply curve of loanable funds shifts

leftward.

c. Expected future income is lower, so people save more. The supply of loanable funds

curve shifts rightward.

d. The quantity of saving increases. There is an upward movement along the supply of

loanable funds curve but no shift in the curve.Topic: Supply of loanable funds curveSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Written and oral communication

Page 966


7) ʺA shortage in the loanable funds market occurs when the quantity of loanable funds supplied

exceeds the quantity of loanable funds demanded.ʺ Explain why this statement is correct or

incorrect.

Answer: The statement is incorrect because a shortage occurs when the quantity of loanable

funds demanded exceeds the quantity of loanable funds supplied.Topic: Loanable funds market equilibriumSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

8) ʺIn the loanable funds market, when there is a shortage of funds, the real interest rate will

increase.ʺ Explain whether the previous statement is correct or not.

Answer: The statement is correct. The shortage of loanable funds means that there are firms

attempting to obtain loans who cannot do so. As a result, the real interest rate will rise

until equilibrium is attained.Topic: Loanable funds market equilibriumSkill: Level 1: DefinitionSection: Checkpoint 10.2Status: OldAACSB: Reflective thinking

9) In the loanable funds market, what will change to eliminate a shortage of loanable funds and

how is the shortage eliminated?

Answer: The real interest rate changes to eliminate the shortage of funds. A shortage of funds

means that businesses want to borrow more than households are willing to loan.

(Alternatively, the quantity of loanable funds demanded exceeds the quantity of

loanable funds supplied.) The shortage of funds means that some businesses are willing

to pay a higher interest rate in order to secure a loan. The real interest rate rises, and as

it does so, the quantity of loanable funds demanded decreases (that is, the quantity of

investment demanded decreases) and the quantity of loanable funds supplied increases

(that is, the quantity of savings increases). Both changes help eliminate the shortage of

loanable funds, and so the real interest rate rises until it reaches its equilibrium value.Topic: Loanable funds market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Written and oral communication

Page 967


10) How does each of the following shift the supply of loanable funds and the demand for

loanable funds curves? What is the effect of each on the equilibrium real interest rate and

equilibrium quantity of loanable funds?

a. Householdsʹ disposable incomes increase

b. An increase in expected profit

Answer: a. Saving increases and the supply of loanable funds curve shifts rightward. The real

interest rate falls and the quantity of loanable funds increases.

b. Investment demand increases and the demand for loanable funds curve shifts

rightward. The real interest rate rises and the quantity of loanable funds increases.Topic: Loanable funds market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

11) Suppose a government tax cut increases disposable income. If there is no change in the

government deficit or surplus, what effect would this tax cut have on the supply of loanable

funds and the demand for loanable funds? What will happen to the real interest rate?

Answer: By increasing disposable income, the tax cut will increase saving. The supply curve of

loanable funds will shift rightward. The real interest rate will decrease, the quantity of

loanable funds will increase, and there will be no change in the demand for loanable

funds curve.Topic: Loanable funds market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Real interest rate

(percent per year)





10 7 15

8 9 13

6 11 11

4 14 9

2 17 7

12) The table above shows the supply of loanable funds and the demand for loanable funds

schedules.

a. What is the equilibrium real interest rate and the equilibrium quantity of loanable funds?

b. If the real interest rate is 4 percent, is there a shortage or surplus? What will happen in the

market?

Answer: a. The equilibrium real interest rate is 6 percent and the equilibrium quantity of

loanable funds is $11 billion.

b. If the real interest rate is 4 percent, there is a shortage of loanable funds. The

shortage means that the quantity of funds demanded for investment exceeds the

quantity supplied, so the real interest rate will rise to its equilibrium of 6 percent.Topic: Loanable funds market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 968


13) Using the figure above, show the effect on the real interest rate and the quantity of loanable

funds of an increase in expected profit.

Answer:

The increase in expected profit increases investment and shifts the demand for loanable

funds curve rightward. As the figure shows, the result is that the real interest rate rises

(to 8 percent in the figure) and the equilibrium quantity of loanable funds increases (to

$4 trillion in the figure).Topic: Loanable funds market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 10.2Status: OldAACSB: Analytical thinking

Page 969


10.8 Essay: Government in Loanable Funds Market

1) Ignoring the Ricardo-Barro effect, what impact does the government have in the loanable

funds market?

Answer: The government has two effects in the market for loanable funds. First, if the

government has a budget surplus, it adds to private saving and increases the supply of

loanable funds. Second, if a government has a budget deficit, it increases the demand

for loanable funds.Topic: Government savingSkill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Reflective thinking

2) Explain how a government budget deficit might crowd out private investment.

Answer: If there is no Ricardo-Barro effect, a government budget deficit increases the demand

for loanable funds. As a result, the equilibrium real interest rate rises and the

equilibrium quantity of loanable funds increases. But the rise in the real interest rate

decreases investment. The governmentʹs budget deficit has thus ʺcrowded out

investment.ʺTopic: Crowding-out effect

Skill: Level 2: Using definitionsSection: Checkpoint 10.3Status: OldAACSB: Written and oral communication

3) ʺThe crowding-out effect occurs when a government budget surplus reduces private savings.ʺ

Is the previous statement true or false? Explain your answer.

Answer: The statement is false. The crowding-out effect occurs when a government budget

deficit reduces investment, not saving. Indeed, the crowding-out effect predicts that a

government budget deficit results in a higher real interest rate, which increases the

quantity of private savings.Topic: Crowding-out effect


4) ʺA government surplus can decrease investment through the crowding-out effect because the

surplus decreases the supply of loanable funds.ʺ Is the previous assertion right or wrong?

Why?

Answer: The assertion is wrong on two counts. First, the crowding-out effect asserts that a

government budget deficitnot a surplusdecreases investment. Second, a government

surplus increasesnot decreasesthe supply of loanable funds.Topic: Crowding-out effect


Page 970


5) According to the crowding-out effect, if the government runs a budget deficit of $100 billion,

what is the change in the equilibrium quantity of investment?

Answer: Investment decreases. The government budget deficit increases the demand for loanable

funds and, as a result, the real interest rate rises. The increase in the real interest rate

decreases the quantity of investment. However, the decrease in investment is less than

$100 billion because the higher real interest rate also increases the quantity of private

saving.Topic: Crowding-out effect


6) What is the crowding-out effect and how does it operate? What is its relationship to the

Ricardo-Barro effect?

Answer: The crowding-out effect is the tendency for a government budget deficit to decrease

investment. A government budget deficit increases the demand for loanable funds. If

private savers do not change their saving, so that the private supply of saving does not

change, a government budget deficit raises the equilibrium real interest rate and

decreases the equilibrium quantity of investment. The Ricardo-Barro effect asserts that

people change their private saving in response to a government budget deficit. In

particular, when the government has a budget deficit, people increase their saving by

the amount of the deficit. As a result, both the demand for loanable funds and the

supply of loanable funds increase by the same amount so there is no impact on the

equilibrium real interest rate or on the equilibrium quantity of investment.Topic: Crowding-out effect, Ricardo-Barro effect


7) Discuss why a budget deficit results in a different real interest rate under the Ricardo-Barro

effect than under the crowding-out effect.

Answer: The Ricardo-Barro effect holds that a budget deficit has no effect on real interest rates.

A government budget deficit increases the demand for loanable funds. The

Ricardo-Barro effect argues that rational taxpayers know that a budget deficit today

means higher taxes tomorrow. As a result, taxpayers increase their savings today. The

higher private saving increases the supply of loanable funds. Because both the demand

for loanable funds and the supply of loanable funds increase by the same amount, there

is no change in the real interest rate.

The crowding-out effect holds that a budget deficit increases real interest rates.

The crowding-out effect argues that a budget deficit has no effect on the supply of

loanable funds. Hence only the demand for loanable funds increases so that the real

interest rate rises.Topic: Crowding-out effect, Ricardo-Barro effect

Skill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Written and oral communication

Page 971


8) According to the Ricardo-Barro effect, if the government runs a budget deficit of $100 billion,

by how much does the amount of equilibrium investment increase or decrease?

Answer: Equilibrium investment does not increase or decrease. There is no change in the amount

of investment because private saving changes to precisely offset the government budget

deficit. In other words, the $100 billion deficit leads to an increase in private saving of

$100 billion which exactly matches the increase in the demand for loanable funds. As a

result, neither the equilibrium real interest rate nor the equilibrium amount of loanable

funds changes.Topic: Ricardo-Barro effect


9) According to the Ricardo-Barro effect, what is the effect on the real interest rate of a

government budget surplus?

Answer: The government budget surplus, by itself, increases the supply of loanable funds.

However the Ricardo-Barro effect asserts that people decrease their private saving by the

exactly same amount. This change precisely offsets the effect the government budget

surplus has on the supply of loanable funds. Thus a government surplus has no effect

on the equilibrium real interest rate.Topic: Ricardo-Barro effect

Skill: Level 5: Critical thinkingSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking

Real interest rate

(percent per year)





12 8.0 13.0

10 9.5 12.0

8 11.0 11.0

6 12.5 10.0

4 14.0 9.0

2 15.5 8.0

10) The table above gives the demand for loanable funds and private supply of loanable funds

schedules.

a. What is the equilibrium real interest rate and quantity of loanable funds?

b. Suppose that the government has a budget surplus of $2.5 billion. If there is no

Ricardo-Barro effect, what is the equilibrium real interest rate and quantity of loanable funds?

Answer: a. The equilibrium real interest rate is 8 percent and the quantity of loanable funds is

$11.0 billion.

b. Add $2.5 billion to each quantity of the supply of loanable funds schedule. The

equilibrium real interest rate becomes 6 percent and the equilibrium quantity of

loanable funds increases to $12.5 billion.Topic: Government savingSkill: Level 3: Using modelsSection: Checkpoint 10.3Status: OldAACSB: Analytical thinking

Page 972


Chapter 11 The Monetary System

11.1 What Is Money?

1) Which statement about money is most correct?

A) Money is a new invention and only includes dollar bills and coins.

B) Money is a new invention and can include anything that is accepted as a means of

payment.

C) Money has been around for a long time and can include anything that is accepted as a

means of payment.

D) Money has been around for a long time and only includes dollar bills and coins.

E) Money has been around for a long time and only includes checking and savings

accounts.

Answer: CTopic: MoneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

2) For a commodity or token to be money it must

A) be accepted in exchange for all other goods and services.

B) have a double coincidence of wants.

C) be backed by government precious metals, like gold.

D) be paper.

E) be issued by the government or a government agency.

Answer: ATopic: MoneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

3) Money is any commodity or token that is

A) backed by gold.

B) generally accepted as a means of measurement.

C) generally accepted as a means of payment.

D) issued by the government.

E) a store of value.


Page 973


4) Money is any commodity or token that

A) is generally accepted as a means of payment.

B) is backed up and controlled by the government.

C) is naturally accepted by households to accumulate wealth.

D) does not change in value over time.

E) is backed by gold.

Answer: ATopic: MoneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

5) In order for any given commodity to be considered money, it has to

A) have some intrinsic value.

B) be generally acceptable as a means of payment.

C) be issued and controlled by some governmental institution.

D) be convertible into gold or silver.

E) be used in barter transactions.

Answer: BTopic: MoneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

6) For anything to be considered money it must be

A) a valuable commodity, such as gold.

B) a token, such as a green piece of paper.

C) either a commodity or a token, as long as it is generally accepted as a means of payment.

D) a mystical token, such as whale teeth.

E) used in barter transactions.


7) A common trait of money through history and across cultures is that money

A) always had mystical properties.

B) was always issued by the local government.

C) was always based on gold or some other precious commodity.

D) was always generally accepted as a means of payment.

E) was always fiat money.

Answer: DTopic: MoneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 974


8) Money is best defined as

A) anything that has value.

B) anything accepted as a means of payment.

C) anything that can be sold to pay for something.

D) currency.

E) anything that is backed by gold.


9) Money must be ________ which includes the fact that is should ________.

A) in physical form; not be transferable using electronic means

B) accepted as a means of payment across countriesʹ borders; not be fiat money

C) generally accepted as a means of payment; be recognizable and divisible into small parts

D) whatever is used in a barter system; transferable across countriesʹ borders

E) backed by gold; not decrease in value over time

Answer: CTopic: What is money?Skill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

10) For an asset to be a ʺmeans of payment,ʺ the asset

A) is valuable and backed by gold.

B) is valuable and backed by the government.

C) can be used to settle a debt.

D) requires a double coincidence of wants.

E) must be used when bartering.

Answer: CTopic: What is money?Skill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 975


11) The functions of money are

A) medium of exchange, unit of account, and store of value.

B) medium of exchange, the ability to buy goods and services, and the ability to pay off

debts.

C) medium of exchange, the ability to buy goods and services, and checking accounts.

D) credit cards, checking accounts, currency, and coins.

E) store of value, use as a barter mechanism, and unit of account.

Answer: ATopic: Functions of moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

12) Money serves as a

A) means of payment, legal obligation, and public tax.

B) medium of exchange, unit of account, and store of value.

C) means of settling debts, transaction lubricant, and private commodity.

D) means of worker exploitation and capitalist enrichment.

E) means to conduct barter transactions.

Answer: BTopic: Functions of moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

13) Which of the following is NOT among the primary functions of money?

A) unit of account

B) store of value

C) indicator of supply

D) medium of exchange

E) an object that is generally accepted in return for goods and services

Answer: CTopic: Functions of moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

14) Money performs all of the following functions EXCEPT serving as a

i. medium of exchange.

ii. unit of account.

iii. barter mechanism.

A) i only B) ii only C) iii only D) i and ii E) ii and iii


Page 976


15) When you join the local organic food market and then buy produce each month, money is

used as

A) only a store of value.

B) only a unit of account.

C) a medium of exchange and a store of value.

D) a medium of exchange and a unit of account.

E) a store of value and a unit of account.

Answer: DTopic: Functions of moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

16) Barter requires the

A) use of commodity money as a medium of payment.

B) use of fiat money as a medium of exchange.

C) the triple non-coincidence of wants.

D) exchange of goods and services directly for other goods and services.

E) use of money as a unit of account.

Answer: DTopic: Functions of money, medium of exchangeSkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

17) The medium of exchange is defined as

A) barter.

B) the exchange of goods and services directly for goods and services.

C) an object that is accepted in return for goods and services.

D) credit cards.

E) an item that can be stored and hold its value over time.

Answer: CTopic: Functions of money, medium of exchangeSkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 977


18) A barter system of payment is

A) similar to a money system of payment because both require a double coincidence of

wants.

B) similar to a money system of payment because both use one asset as a unit of account.

C) different from a money system of payment because the barter system is a better unit of

account.

D) different from a money system of payment because money does not require a double

coincidence of wants.

E) similar to a money system of payment because both are used as stores of value and units

of account.

Answer: DTopic: BarterSkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

19) In performing which of its primary functions does money solve the problem of the double

coincidence of wants?

A) medium of exchange

B) unit of account

C) store of value

D) barter system

E) money supply

Answer: ATopic: BarterSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

20) The ʺdouble coincidence of wantsʺ is

A) what is needed to use money.

B) eliminated with the use of money.

C) eliminated when we barter instead of using money.

D) how value is stored when we transact with money.

E) moneyʹs role as a unit of account.

Answer: BTopic: BarterSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 978


21) When we use money to purchase goods and services, we are using money as a

A) unit of account.

B) reserve of wealth.

C) medium of exchange.

D) store of value.

E) bartering tool.

Answer: CTopic: Functions of money, medium of exchangeSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

22) When you use currency to buy lunch, money is performing which function?


B) unit of purchase

C) store of value

D) barter token

E) unit of currency

Answer: ATopic: Functions of money, medium of exchangeSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

23) What is a problem with barter that makes it so difficult to use?

A) Individuals have to produce something to trade with.

B) Barter requires a double coincidence of wants.

C) Barter is very efficient but illegal because it avoids taxation.

D) Barter requires use of only fiat money.

E) Barter omits the store of value role for money.

Answer: BTopic: Functions of money, medium of exchangeSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

24) Which of the following best describes a double coincidence of wants?

A) Two buyers want the same good.

B) Neither buyer wants a good.

C) You have what another wants and you want what they have.

D) A buyer and a seller rather than two buyers or two sellers must meet.


Answer: CTopic: Functions of money, medium of exchangeSkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 979


25) The unit of account is defined as

A) the exchange of goods and services directly for other goods and services.

B) barter.

C) an object that is accepted in return for goods and services.

D) an agreed upon measure for stating prices of goods and services.

E) the medium of exchange.

Answer: DTopic: Functions of money, unit of accountSkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

26) If you shop for a car online and compare car prices across dealerships, money is functioning as

a

A) medium of exchange.

B) unit of account.

C) means of payment.

D) store of value.

E) barter mechanism.

Answer: BTopic: Functions of money, unit of accountSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

27) The function of money that helps assess the opportunity cost of an activity is moneyʹs use as a


B) store of value.

C) unit of account.

D) store of debt.

E) barter tool.

Answer: CTopic: Functions of money, unit of accountSkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 980


28) When we put a price tag on goods and services, we are using money as a

A) store of value.

B) medium of exchange.

C) barter token.

D) unit of account.

E) means of payment.

Answer: DTopic: Functions of money, unit of accountSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

29) When you see a mansion and think to yourself that it must be worth a million dollars, you are

using money to perform which function?


B) unit of account

C) store of value

D) means of payment

E) method of avoiding barter


30) Money is used as a ________ when you visit the local farmersʹ market and compare prices

across different vendors.

A) means of payment

B) unit of account

C) store of value

D) medium of exchange

E) measure of barter


Page 981


31) When money is used to compare the relative price of a burrito and a taco, money is being used

as a


B) store of value.

C) measurement of inflation.

D) unit of account.

E) token of bartering.

Answer: DTopic: Functions of money, unit of accountSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

32) The store of value function is defined as the

A) pricing of goods and services in one measure.

B) exchange of goods and services directly for other goods and services.

C) holding of money from one transaction to be used later in another transaction.

D) double coincidence of wants that is used in the debate over barter versus money.

E) use of money as a medium of exchange.

Answer: CTopic: Functions of money, store of valueSkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

33) When we keep part of our wealth in a bank checking account, we are using money as a

A) store of value.

B) medium of exchange.

C) barter token.

D) unit of account.

E) unit of currency.

Answer: ATopic: Functions of money, store of valueSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 982


34) When we keep part of our wealth in a bank checking account, we are using money as a

________ because ________.

A) store of value; we are holding the money to exchange for goods at a later time

B) medium of exchange; we are holding the money to gain interest earned

C) barter token; we are holding the money to exchange for goods at a later time

D) unit of account; we are holding the money to exchange for goods at a later time

E) unit of currency; we have agreed upon the value of the money with bank

Answer: ATopic: Functions of money, store of valueSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: NewAACSB: Reflective thinking

35) Keeping $20 in currency to be able to buy gasoline, money is performing which function?


B) unit of account

C) store of value

D) barter mechanism

E) symbol of fiat

Answer: CTopic: Functions of money, store of valueSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

36) The word ʺfiatʺ is

A) used to describe todayʹs money because it is money set by law.

B) used to describe money from when Kings ruled by decree or fiat.

C) the term used to define the concept of barter.

D) another word to mean the ʺdouble coincidence of wants.ʺ

E) Latin for ʺbacked by gold.ʺ

Answer: ATopic: Fiat moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 983


37) Money today

A) is the demand for loanable funds.

B) is the supply of loanable funds.

C) is only currency inside banks.

D) is fiat money.

E) in the United States, is only dollar bills and coins .

Answer: DTopic: Fiat moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

38) The U.S. dollar is called

A) fiat money because the law decrees it is money.

B) faith money.

C) commodity money, because it is convertible into gold.

D) frail money because wear and tear ruins paper bills.

E) convertible money because the government stands ready to convert it into gold or silver.

Answer: ATopic: Fiat moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

39) Fiat money means

A) Italian currency.

B) moneyʹs value does not change.

C) the government has decreed that something is money.

D) the money can be converted into gold.

E) only currency counts as money.

Answer: CTopic: Fiat moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

40) The objects that we use as money today are

A) checks and credit cards.

B) currency and checks.

C) currency and deposits.

D) deposits and checks.

E) currency, deposits, and gold.

Answer: CTopic: What is included in moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 984


41) Which statement most accurately captures the state of money today?

A) Money today includes currency, bank deposits and checks.

B) Money today includes currency and checks but not bank deposits.

C) Money today includes bank deposits and currency but not checks.

D) Money today includes bank deposits and checks but not currency.

E) Money today includes checks and credit cards.

Answer: CTopic: What is included in moneySkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

42) Which of the following is an example of money?

A) currency in your wallet

B) currency inside the banks

C) checks written as payment for a good or service

D) credit card used as a payment for a good or service

E) a debit card

Answer: ATopic: What is included in moneySkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

43) The objects we use as money today include

A) currency inside banks and bank deposits.

B) currency outside the banks and bank deposits.

C) only currency outside the banks.

D) only deposits inside the banks.

E) credit cards and debit cards.

Answer: BTopic: What is included in moneySkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 985


44) Checkable deposits are money because

A) they are protected by the Federal Reserve.

B) they are guaranteed by banks.

C) checks bounce when there are not enough funds to cash them.

D) they can be converted into currency on demand and are used directly as a means of

payment.

E) only banks and other financial institutions can offer them.

Answer: DTopic: What is included in moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

45) Which of the following is the best example of money?

A) phone card

B) checkable deposit

C) credit card

D) gold

E) share of Intel stock


46) Which of the following is money?

A) credit card

B) debit card

C) e-checks

D) checkable deposit

E) checks

Answer: DTopic: What is included in moneySkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 986



A) a credit card with no credit left

B) the check you write to pay tuition

C) a credit card that still has credit available on it

D) a checkable deposit in your bank

E) the current credit available on a credit card



A) debit cards

B) e-checks

C) credit cards

D) checkable deposits

E) checks


49) Checks are not money because they

A) are just instruments to transfer money between banks.

B) are not guaranteed by banks.

C) can bounce when there are not enough funds to cash them.

D) are not issued by the government.

E) are not always accepted when trying to purchase goods or services.

Answer: ATopic: What is included in moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

50) If you use a check to pay your monthly rent,

A) the check is considered money because you received something in return.

B) the check is not money because it is just an instruction to your bank to make a payment.

C) you have used money because the landlord accepted it as a means of payment.

D) the check becomes money when it arrives at the landlordʹs bank.

E) the check is not money because it is not part of M1.

Answer: BTopic: What is included in moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 987


51) A credit card is

A) money.

B) barter money.

C) not money.

D) fiat money.

E) not money, but the cardʹs credit line is money.


52) Credit cards are

A) a form of money used to make purchases.

B) a special ID card that is not money.

C) a special ID card that is the same as money.

D) a form of money that is not generally accepted.

E) included in the M1 measure of money.


53) When you use a credit card to pay your tuition,

A) youʹve used the credit card as money because it is a means of payment.

B) the credit card is not money but is an ID card for an instant loan.

C) the credit card is not money because it involves an electronic transaction.

D) the credit card is not money because it is not officially issued by the government.

E) youʹve used the credit card as money because you received something in return.


54) Credit cards are

i. a generally accepted form of payment and therefore part of M1.

ii. included in M1 because you write a check to pay your monthly bill.

iii. a means of borrowing money.

A) i only B) ii only C) iii only D) i and ii E) i and iii

Answer: CTopic: What is included in moneySkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 988


55) When Dale buys a new computer for $1,000 using a credit card,

A) he is taking out a loan for $1,000.

B) his bank account decreases by $1,000.

C) the credit card is acting as money.

D) the money supply decreases by $1,000.

E) the credit card is performing the function of an unit of account.

Answer: ATopic: What is included in moneySkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

56) Debit cards and e-checks are not money because

A) they can be forged easily.

B) they can fail their purpose of being mediums of exchange as a result of technical

difficulties.

C) they are just instruments to transfer money between people.

D) not all banks offer them and not all businesses accept them.

E) they are not regulated by the government.


57) A debit card is

A) money because it is a means of payment.

B) not money but is used to transfer bank deposits which are money.

C) money because it is generally accepted as a means of payment.

D) not money because it is not officially issued by the government.

E) part of the M2 money supply but not part of the M1 money supply.


Page 989


58) Which of the following are considered money?

i. electronic checks

ii. paper checks

iii. the deposit transferred using an e-check

A) i, ii and iii

B) i and iii

C) i and ii

D) iii only

E) ii and iii


59) An official measure of money in the United States is M1, which includes the sum of

A) checkable deposits plus small time deposits.

B) currency plus checkable deposits.

C) currency plus credit card transactions.

D) currency plus travelerʹs checks plus time deposits.

E) currency plus travelerʹs checks plus checkable deposits plus small time deposits plus

money market funds and other deposits.

Answer: BTopic: M1Skill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

60) M1 is composed of

A) currency held by individuals and businesses, travelerʹs checks, and checkable deposits

owned by individuals and businesses.

B) checkable deposits owned by individuals and businesses, saving deposits, and

certificates of deposit.

C) currency inside of banks, travelerʹs checks, and government-issued checks.

D) travelerʹs checks, credit cards, and e-cash.

E) currency held by individuals and businesses, travelerʹs checks, and the credit line on

credit cards.

Answer: ATopic: M1Skill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 990


61) Which of the following are included in the M1 definition of money?

A) currency and checkable deposits

B) currency and savings deposits

C) travelerʹs checks and money market mutual funds

D) currency and small time deposits

E) travelerʹs checks and savings deposits


62) M1 is defined as a measure of money including, in part,

A) checkable deposits and currency.

B) time deposits and currency.

C) currency and savings deposits.

D) time deposits and money market fund deposits.

E) the lines of credit on credit cards and currency.


63) Which of the following items is included in the M1 money supply?

A) $10 bills in the Bank of America

B) a $5,000 student loan granted to a U.S. citizen

C) coins in a Pepsi vending machine, waiting to be used as change

D) a $5,000 line of credit on a newly graduated studentʹs credit card

E) $1,500 in a studentʹs saving account

Answer: CTopic: M1Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

64) Which of the following is NOT a component of M1?

A) demand deposits

B) travelerʹs checks

C) savings deposits

D) currency

E) Both answers C and D are correct.

Answer: CTopic: Official measures of moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 991


65) If Rob deposits $300 in currency into his savings account at Bank of America,

A) M1 decreases.

B) M1 does not change.

C) M2 increases.

D) M2 decreases.

E) M1 and M2 both increase.

Answer: ATopic: M1Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

66) Suppose you use your debit card to buy soda from a soda machine. Which of the following is

true regarding the transaction?

A) The debit card is not money; itʹs only an instruction to make a loan.

B) The debit card is money; your use reflects the exchange of a good.

C) The debit card is not money; its use is only a tool to cause money to move from your

account.

D) Your use makes the debit card money, as funds are transferred between your account

and the machine owner.

E) Using the debit card is like using a check and is, therefore, money.

Answer: CTopic: MoneySkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

67) When Maria deposits $100 in currency in her checkable deposit at Bank of America, the

immediate effect is that the quantity of M1

A) decreases.

B) does not change.

C) increases.

D) changes, but the direction of the change depends on whether the deposit was accepted

by a thrift institution or a commercial bank.

E) changes only if Bank of America does not have excess reserves.

Answer: BTopic: M1Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 992


68) When Maria deposits $100 in currency in her checkable deposit at Bank of America, the

immediate effect is that the quantity of M1 ________ because ________.

A) decreases; checkable deposits are included in M2 but are not included in M1

B) does not change; both currency and checkable deposits are included in M1

C) increases; both currency and checkable deposits are included in M1

D) changes, but the direction of the change cannot be determined; the direction of the

change depends on what Bank of America does with the deposit

E) changes only if Bank of America has excess reserves; if the bank does not have excess

reserves, the overall effect to M1 is too small to notice

Answer: BTopic: M1Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: NewAACSB: Reflective thinking

69) When people make deposits of currency into a bank, the quantity of M1

A) immediately decreases by the amount of the deposit.

B) immediately increases by the amount of the deposit.

C) does not immediately change.

D) immediately changes but whether it increases or decreases depends on whether the bank

had excess reserves or did not have excess reserves.

E) changes only if the deposit is an open market operation.

Answer: CTopic: M1Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

70) If you deposit $1,000 in cash in your checkable deposit at your bank, the quantity of M1

immediately

A) increases by $1,000.

B) decreases by $1,000.

C) increases by $2,000.

D) does not change in size.

E) changes, but more information about the required reserve ratio is necessary to determine

the amount of the change.

Answer: DTopic: M1Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 993


71) In December 2009, currency was $400 billion, travelerʹs 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?

A) M1 = $405 billion

B) M1 = $1,005 billion

C) M1 = $3,005 billion

D) M1 = $3500 billion

E) M1 = $3505 billion

Answer: BTopic: M1Skill: Level 3: Using modelsSection: Checkpoint 11.1Status: OldAACSB: Analytical thinking

72) If Joe withdraws a $100 bill from his checking account and Jack deposits another $100 bill in

his savings account, by how will M1 and M2 change?

A) M1 will decrease, but M2 will remain the same.

B) M1 will increase, and M2 will increase.

C) M2 will decrease by $100.

D) Both M1 and M2 will remain the same.

E) M1 will remain the same, and M2 will increase.

Answer: ATopic: M1, M2Skill: Level 3: Using modelsSection: Checkpoint 11.1Status: OldAACSB: Analytical thinking

73) Susan just sold her text books for $200 cash and deposited the cash she received in her

checking account. This transaction has

A) increased the quantity of M1.

B) decreased the quantity of M1.

C) increased the quantity of M2.

D) decreased the quantity of M2.

E) not changed either M1 or M2.

Answer: ETopic: M1, M2Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 994


74) M2 consists of

A) M1 plus travelerʹs checks.

B) M1 plus saving deposits, small time deposits, and money market funds.

C) M1 plus checkable deposits.

D) M1 plus currency at the banks.

E) M1 plus Federal Reserve notes.


75) Which of the following are included in the M2 definition of money?

A) currency outside of banks and checkable deposits

B) currency outside of banks and credit lines on credit cards

C) time deposits and the value of prime grade bonds

D) currency both inside and outside of banks

E) currency inside of banks and banksʹ reserves


76) If we look at the components of M2, we find that

A) money market funds are the largest component.

B) savings deposits are the largest component.

C) currency is the largest component.

D) banksʹ reserves are the largest component.

E) loans are the largest component.

Answer: BTopic: M2Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 995


77) In December 2009, currency outside of banks was $400 billion, travelerʹs checks were $5 billion;

checkable deposits owned by individuals and businesses were $600 billion, saving deposits

were $2,000 billion, time deposits were $1,500 billion; and money market funds were $1,200

billion. What was the M2 in December 2009?

A) M2 = $5,705 billion

B) M2 = $3705 billion

C) M2 = $1,005 billion

D) M2 = $2,505 billion

E) M2 = $5,700 billion

Answer: ATopic: M2Skill: Level 3: Using modelsSection: Checkpoint 11.1Status: OldAACSB: Analytical thinking

78) If currency outside of banks is $800 billion; travelerʹs checks are $10 billion; checkable deposits

owned by individuals and businesses are $700 billion; savings deposits are $4,000 billion;

small time deposits are $1,000 billion; and money market funds and other deposits are $800

billion, then M2 equals ________ billion.

A) $7,310 B) $5,800 C) $2,510 D) $1,510 E) $710

Answer: ATopic: M2Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Amount

(dollars)

Checkable deposits 350

Savings deposits 900

Money market funds 500

Small time deposits 600

Travelerʹs checks 10

Currency outside of banks 250

79) The above table has information about the hypothetical economy of Robotica. Based on the

data, the size of M1 is

A) $610 billion.

B) $1,510 billion.

C) $600 billion.

D) $1,110 billion.

E) $2,600 billion.

Answer: ATopic: M1Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Analytical thinking

Page 996


80) The above table has information about the hypothetical economy of Robotica. Based on the

data, the size of M2 is

A) $2,600 billion.

B) $2,610 billion.

C) $610 billion.

D) $600 billion.

E) $1,710 billion.

Answer: BTopic: M2Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Analytical thinking

81) Physical currency is ________ popular than e-cash, ________.

A) less; and both are portable and recognizable

B) more; and both are portable and recognizable

C) more; but only physical currency is portable and recognizable

D) more; and both are portable, untraceable and anonymous

E) less; but both are portable, untraceable and anonymous


82) ________ like a check and ________ considered money.

A) Debit cards work; are not

B) Debit cards work; are

C) E-checks work; are

D) E-cash works; is not

E) E-cash works; is

Answer: ATopic: MoneySkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 997


83) Which of the following best defines what money is now and what it has been in the past?

A) currency

B) currency plus checking deposits

C) currency plus credit cards

D) anything accepted as a means of payment

E) anything used as a store of value


84) Which of the following is NOT a function of money?

i. unit of account

ii. store of value

iii. unit of debt

A) i only

B) ii only

C) iii only

D) both ii and iii

E) both i and ii


85) Barter is

A) the exchange of goods and services for money.

B) the pricing of goods and services with one agreed upon standard.

C) the exchange of goods and services directly for other goods and services.

D) a generally accepted means of payment.

E) storing money for use at a later date.

Answer: CTopic: BarterSkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 998


86) If someone buries money in a tin can beneath a tree, the money is functioning as a


B) unit of account.

C) means of payment.

D) store of value.

E) bartering tool.

Answer: DTopic: Functions of money, store of valueSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

87) Credit cards, debit cards, and e-checks are

A) always counted as money.

B) not money.

C) sometimes counted as money, depending on how they are used.

D) sometimes counted as money, depending on what is purchased.

E) sometimes counted as money, depending on what measure of money is being used.


88) Which of the following counts as part of M1?

A) $5,000 worth of gold

B) $5,000 worth of government bonds

C) $5,000 in a checking account

D) $5,000 credit line on a credit card

E) $5,000 of real estate

Answer: CTopic: M1Skill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 999


89) M2 equals

A) M1 and is just another name for currency outside of banks.

B) M1 plus savings deposits, small time deposits, and money market fund deposits.

C) M1 minus travelerʹs checks because they are not really money.

D) currency plus savings deposits, all time deposits, and money market funds and other

deposits.

E) M1 plus savings deposits and small time deposits minus money market fund deposits.


90) If currency outside of banks is $800 billion; travelerʹs checks are $10 billion; checkable deposits

owned by individuals and businesses are $700 billion; savings deposits are $4,000 billion;

small time deposits are $1,000 billion; and money market funds and other deposits are $800

billion, then M1 equals ________ billion.

A) $7,310 B) $5,800 C) $2,510 D) $1,510 E) $710

Answer: DTopic: M1Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

11.2 The Banking System

1) A commercial bank is defined as

A) any institution that accepts deposits.

B) a firm that is chartered to accept deposits and make loans.

C) the institution that sets regulations for commercial activities.

D) a firm that obtains funds by selling shares and then buys U.S. Treasury bills.

E) any institution that makes loans.

Answer: BTopic: Commercial banksSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

Page 1000


2) Which statement is most correct about the types of deposits a commercial bank can accept?

A) A commercial bank accepts checking, savings and time deposits.

B) A commercial bank can only accept checking deposits from commercial enterprises.

C) A commercial bank accepts savings and time deposits, but not checking deposits.

D) A commercial bank does not accept deposits but sells shares.

E) A commercial bank can accept loan deposits, reserve deposits, and checkable deposits.

Answer: ATopic: Commercial banksSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

3) The goal of a commercial bank is to

A) establish good regulations for commercial activities.

B) make only safe, no-risk loans.

C) maximize its stockholdersʹ wealth.

D) minimize its taxes paid to state governments.

E) accept only deposits made in money.

Answer: CTopic: Banksʹ profitSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

4) Banks earn a profit by

A) keeping as many reserves on hand as possible.

B) making loans at a lower interest rate than the rate that they offer on their deposits.

C) charging an interest rate on their depositorsʹ accounts.

D) making loans at a higher interest rate than the rates that they offer on their deposits.

E) not paying interest on their reserves.

Answer: DTopic: Banksʹ profitSkill: Level 3: Using modelsSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

Page 1001


5) Which of the following are assets of commercial banks?

i. reserves

ii. loans

iii. deposits

A) i only

B) ii only

C) i and ii

D) ii and iii

E) i, ii, and iii

Answer: CTopic: Banksʹ assetsSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

6) Banks generally earn the highest interest rate

A) on service charges on individualsʹ checking accounts.

B) by making loans to business firms.

C) by making mortgage loans to individuals.

D) by making credit card loans.

E) by buying government securities.

Answer: DTopic: Banksʹ assetsSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

7) The largest category of commercial banksʹ assets is

A) loans.

B) reserves.

C) currency.

D) securities.

E) checkable deposits.

Answer: ATopic: Banksʹ assetsSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

Page 1002


8) Which of the following is NOT held as an asset by banks?

A) reserves

B) loans

C) securities

D) currency in the banksʹ vaults

E) checkable deposits

Answer: ETopic: Banksʹ assetsSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

9) Which of the following describes the ʺinventionʺ of banking?

A) The British Empire created a banking system to fund its exploration of the New World.

B) Members of the New York Stock Exchange founded the Bank of America in the 1700s.

C) Goldsmiths in the sixteenth century issued gold receipts which entitled its owners to

reclaim their gold on demand.

D) Clergy in the Renaissance created the banking system to help further the growth of the

church.

E) The United States government founded the Federal Reserve in 1913.

Answer: CTopic: Eye on the Past: The ʺInventionʺ of BankingSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

10) When goldsmiths issued receipts to gold owners, and those gold receipts circulated while gold

stayed in the goldsmithsʹ safes,

A) the gold receipts were considered money because they were used as a means of payment.

B) an infant banking system developed in sixteenth century Europe.

C) fiat money was created.

D) money was invented.

E) Both A and B are correct.

Answer: ETopic: Eye on the Past: The ʺInventionʺ of BankingSkill: Level 5: Critical thinkingSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

Page 1003


11) A commercial bankʹs reserves are equal to the amount of

A) the bankʹs deposits.

B) the bankʹs government securities.

C) the bankʹs loans.

D) currency in the bankʹs vault plus the balance on its reserve account at a Federal Reserve

Bank.

E) only the currency in its vault.

Answer: DTopic: Banksʹ reservesSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

12) In 2013 banks kept reserves equal to about ________ of their assets.

A) 75 percent

B) 25 percent

C) 18 percent

D) 50 percent

E) 37 percent

Answer: CTopic: Banksʹ reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: RevisedAACSB: Reflective thinking

13) Commercial bank reserves are typically less than 1 percent of total assets, however in 2013

bank reserves ________ because of ________.

A) rose to around 88 percent; the financial crisis of 2008-2009

B) dropped drastically to near zero; the financial crisis of 2008-2009

C) rose to around 18 percent; the financial crisis of 2008-2009

D) dropped drastically to near zero; the wave of natural disasters experienced in the nation

and around the world

E) rose drastically to around 18 percent; the wave of natural disasters experienced in the

nation and around the world

Answer: CTopic: Banksʹ reservesSkill: Level 3: Using modelsSection: Checkpoint 11.2Status: NewAACSB: Reflective thinking

Page 1004


14) When a commercial bank receives a deposit, it must keep part of the deposit as cash reserves

to satisfy its

A) securities and loans.

B) required reserves.

C) excess reserves.

D) interbank loans.

E) loan requirements.

Answer: BTopic: Banksʹ reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

15) 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

A) $100,000. B) $30,000. C) $50,000. D) $80,000. E) $20,000.

Answer: CTopic: Required reserve ratioSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Analytical thinking

16) A bank has $250 in checking deposits, $1,000 in savings deposits, $1,200 in time deposits,

$1,000 in loans to businesses, $400 in outstanding credit card balances, $800 in government

securities, $25 in currency in its vault, and $25 in deposits at the Fed. Of these, ________ are

part of M2.

A) $3,450 B) $2,450 C) $2,850 D) $2,200 E) $2,600

Answer: BTopic: Banksʹ depositsSkill: Level 3: Using modelsSection: Checkpoint 11.2Status: OldAACSB: Analytical thinking

17) A bank has $250 in checking deposits, $1,000 in savings deposits, $1,200 in time deposits,

$1,000 in loans to businesses, $400 in outstanding credit card balances, $800 in government

securities, $25 in currency in its vault, and $25 in deposits at the Fed. The bankʹs reserves are

equal to

A) $25. B) $275. C) $2,225 D) $50. E) $350.

Answer: DTopic: Banksʹ reservesSkill: Level 3: Using modelsSection: Checkpoint 11.2Status: OldAACSB: Analytical thinking

Page 1005


Amount

(dollars)

Checking deposits 600

Savings deposits 1000

Time deposits 1,500

Loans 1,200

Government securities 2,000

Outstanding credit card balances 400

Currency in vault 10

Deposits in reserve account at the Fed 20

18) The above table gives assets and deposits for a (small) bank. The bankʹs deposits that are part

of M1 are equal to

A) $1,600. B) $600. C) $3,100. D) $3,130. E) $30.

Answer: BTopic: Banksʹ depositsSkill: Level 3: Using modelsSection: Checkpoint 11.2Status: OldAACSB: Analytical thinking

19) The above table gives assets and deposits for a (small) bank. The bankʹs deposits that are part

of M2 are equal to

A) $600. B) $1600. C) $3,100. D) $30. E) $5,100.

Answer: CTopic: Banksʹ depositsSkill: Level 3: Using modelsSection: Checkpoint 11.2Status: OldAACSB: Analytical thinking

20) The above table gives assets and deposits for a (small) bank. The bankʹs reserves are equal to

A) $20. B) $30. C) $600. D) $630. E) $620.

Answer: BTopic: Banksʹ reservesSkill: Level 3: Using modelsSection: Checkpoint 11.2Status: OldAACSB: Analytical thinking

Page 1006


21) Cisco is considering opening a financial institution that accepts savings deposits from only its

employees and makes loans to only its employees. The best description of this financial

institution is that it is a

A) credit union.

B) commercial bank.

C) savings and loan association.

D) savings bank.

E) federal government chartered credit bank.

Answer: ATopic: Credit unionSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

22) Which of the following is a thrift institution?

i. a credit union

ii. the Fed

iii. a savings bank

A) i only

B) ii only

C) iii only

D) Both i and iii

E) i, ii, and iii

Answer: DTopic: Thrift institutionsSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

23) A commercial bankʹs main goal is to

A) provide loans to its customers.

B) maximize the wealth of its stockholders.

C) help the government when it needs money.

D) lend money to the Federal Reserve Banks.

E) open checking accounts.

Answer: BTopic: Banksʹ profitSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

Page 1007


24) Which of the following lists includes only banksʹ assets?

A) liquid assets, loans, securities, and reserves

B) reserves, savings deposits, securities, and loans

C) reserves, securities, liquid assets, and savings deposits

D) securities, reserves, checkable deposits, and liquid assets

E) reserves, checkable deposits, securities, and loans

Answer: ATopic: Banksʹ assetsSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

25) A commercial bankʹs reserves are

A) bonds issued by the U.S. government that are very safe.

B) the provision of funds to businesses and individuals.

C) currency in its vault plus the balance on its reserve account at a Federal Reserve Bank.

D) savings and time deposits.

E) its loans.

Answer: CTopic: Banksʹ reservesSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

26) A bank has $400 in checkable deposits, $800 in savings deposits, $700 in time deposits, $900 in

loans to businesses, $300 in outstanding credit card balances, $500 in government securities,

$10 in currency in its vault, and $20 in deposits at the Fed. The bankʹs deposits that are part of

M1 are equal to

A) $1,900. B) $400. C) $1,210. D) $530. E) $410.

Answer: BTopic: Banksʹ depositsSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Analytical thinking

Page 1008


27) Which of the following accept deposits from or sell shares to the general public?

i. money market funds

ii. thrift institutions

iii. commercial banks

A) i only

B) ii only

C) iii only

D) Both ii and iii

E) i, ii, and iii

Answer: ETopic: Depository institutionsSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

28) Which of the following is a thrift institution?

A) a savings and loan association

B) a money market fund

C) a commercial bank

D) a loan institution

E) the Federal Reserve

Answer: ATopic: Thrift institutionsSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

11.3 The Federal Reserve System

1) A public authority that provides banking services to commercial banks and regulates financial

institutions and markets is called a

A) commercial bank.

B) thrift institution.

C) central bank.

D) money market fund.

E) mint.

Answer: CTopic: Central banksSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1009


2) All of the following are financial institutions that accept deposits and make loans to people

and businesses EXCEPT

A) commercial banks.

B) savings and loans.

C) credit unions.

D) central banks.

E) savings banks.

Answer: DTopic: Central banksSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

3) As the central bank, the Federal Reserve System provides banking services to

A) individuals and controls the quantity of money.

B) the government and the stock market.

C) foreign corporations and determines the exchange rate.

D) banks and regulates financial institutions and markets.

E) banks and determines how much the U.S. government will borrow.

Answer: DTopic: Central banksSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

4) Because the Federal Reserve System is a central bank, it provides banking services to

A) businesses only.

B) consumers and business.

C) commercial banks.

D) no one.

E) the government only.

Answer: CTopic: Central banksSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1010


5) The Federal Reserve System provides banking services to ________ because ________.

A) consumers and businesses; it is a central bank with responsibilities to the entire U.S.

population

B) banks and businesses; it is a central bank with the primary purpose of regulating

financial institutions and markets

C) commercial banks; it is a central bank with the primary purpose of regulating financial

institutions and markets

D) no one; it is a central bank with the primary purpose of regulating financial markets

E) FDIC insured banks; they are the ones that have paid their membership fees and the only

ones the U.S. central bank guarantees

Answer: CTopic: Central banksSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: NewAACSB: Reflective thinking

6) The Fed is a central bank and as such

A) does business only with the federal government.

B) provides banking services to banks but not individuals.

C) provides banking services to individuals and firms.

D) does business with international organizations such as the United Nations.

E) is where the Federal Government turns when it needs to borrow.

Answer: BTopic: Central banksSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

7) What is the central bank of the United States?

A) There is no central bank in the United States.

B) The Department of Treasury

C) The Federal Reserve System

D) Each state has its own central bank, which, when all taken together, constitute the central

bank of the United States.

E) The U.S. Mint

Answer: CTopic: Federal Reserve SystemSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1011


8) ________ the quantity of money in the United States.

A) The State Department regulates

B) The Department of Treasury regulates

C) The Federal Reserve System regulates

D) Commercial banks regulate

E) The President of the United States regulates


9) The Federal Reserve System is organized into

A) one large district covering the entire United States.

B) three districts, one for each of the countries in North America.

C) 12 districts, dividing up the United States.

D) 12 districts, dividing up the countries in North America.

E) 50 districts, one per state.


10) Conducting the nationʹs monetary policy is the duty of the

A) Department of Commerce.

B) U.S. Treasury department.

C) Federal Reserve System.

D) Federation of Banks.

E) Federal Bank Supervisor.

Answer: CTopic: Federal Reserve SystemSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

11) Who regulates the quantity of money circulating in the economy?

A) the Federal Reserve

B) the banking system

C) the U.S. Congress

D) the President of the United States

E) The U.S. Congress and the President share the control.

Answer: ATopic: Federal ReserveSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1012


12) The Federal Reserve System is organized into ________ Federal Reserve districts.

A) 6 B) 10 C) 12 D) 15 E) 50


13) All of the following are elements in the structure of the Fed EXCEPT the

A) Federal Open Market Committee.

B) Executive Council to the Governor.

C) 12 Federal Reserve Banks.

D) Board of Governors.

E) presidents of the 12 Federal Reserve Banks.

Answer: BTopic: Federal Reserve SystemSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

14) The Board of Governors of the Federal Reserve is

A) the collection of the 12 presidents of the Federal Reserve Banks.

B) a seven-member board, each one serving a 14-year term.

C) a 14-member board, each one serving a seven-year term.

D) the main policy-making body of the Fed.

E) a seven-member board, each one serving a one-year term.

Answer: BTopic: Federal Reserve System, Board of GovernorsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

15) The Board of Governors of the Federal Reserve System has

A) seven members serving for 12-year terms.

B) 12 members serving for seven-year terms.

C) seven members serving for seven-year terms.

D) seven members serving for 14-year terms.

E) seven members serving life terms.

Answer: DTopic: Federal Reserve System, Board of GovernorsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1013


16) The Board of Governors has

A) seven members appointed to 14-year terms.

B) 14 members appointed to 10-year terms.

C) four members appointed to seven-year terms.

D) 14 members appointed to four-year terms.

E) seven members appointed for life.

Answer: ATopic: Federal Reserve System, Board of GovernorsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

17) The Federal Open Market Committee is

A) the main policy making body of the Fed.

B) a seven-member board, each serving a 14-year term.

C) comprised of the presidents of the 12 Federal Reserve Banks.

D) another name for the Board of Governors.

E) the government committee charged with determining income tax rates.

Answer: ATopic: FOMCSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

18) The main policy making body of the Federal Reserve System is the

A) Board of Governors of the Federal Reserve System.

B) Board of Presidents of the Federal Reserve Banks.

C) Federal Open Market Committee.

D) Board of Advisors.

E) Federal Monetary Conditions Board.

Answer: CTopic: FOMCSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

19) Which of the following Federal Reserve Banks carries out the decisions of the FOMC?

A) the Kansas City Federal Reserve Bank

B) the New York Federal Reserve Bank

C) the Dallas Federal Reserve Bank

D) the San Francisco Federal Reserve Bank

E) the Atlanta Federal Reserve Bank

Answer: BTopic: FOMCSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1014


20) The voting members of the Federal Open Market Committee consists of the

A) seven Board of Governor members and the 12 Federal Reserve Bank presidents.

B) seven Board of Governor members and five Federal Reserve Bank presidents.

C) 12 Board of Governor members and the seven Federal Reserve Bank presidents.

D) 12 Board of Governor members and the five Federal Reserve Bank presidents.

E) six Board of Governor members and six Federal Reserve Bank presidents.

Answer: BTopic: FOMCSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

21) The Federal Open Market Committee consists of

A) 12 members, all of whom are the presidents of Federal Reserve Banks.

B) 12 members, seven of whom are the members of the Board of Governors, four of whom

are presidents of Federal Reserve Banks, and the president of the United States.

C) 12 members, seven of whom are the members of the Board of Governors and five of

whom are presidents of Federal Reserve Banks.

D) 12 committees, all serving on the Board of Governors.

E) 12 members, split evenly so that six of whom are members of the Board of Governors

and six of whom are presidents of Federal Reserve Banks.

Answer: CTopic: FOMCSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

22) In order to influence the interest rate, the Federal Reserve System can immediately adjust the

A) reserves of the banking system.

B) inflation level.

C) unemployment rate.

D) taxes that citizens must pay.

E) amount the government borrows.

Answer: ATopic: Monetary policySkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1015


23) The four main policy tools the Federal Reserve System uses to influence the interest rate are

setting

A) the prime rate, open market operations, extraordinary crisis management and setting the

excess reserve ratio.

B) quantitative easing, market interest rate and the discount rate, as well as open market

operations.

C) the discount rate, open market operations, extraordinary crisis measures and setting the

required reserve ratio.

D) credit easing, the discount rate, setting tax rates, and setting the required reserve ratio.

E) quantitative easing, open market operations, setting tax rates, and setting the required

reserve ratio.

Answer: CTopic: Fed policy toolsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

24) Which of the following is NOT one of the Fedʹs monetary policy tools?

A) changing the discount rate

B) conducting open market purchases of government securities

C) changing the coupon rate

D) changing the required reserve ratio

E) conducting open market sales of government securities

Answer: CTopic: Fed policy toolsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

25) Which of the following is a tool the Federal Reserve System can use to regulate the quantity of

money?

i. changing the discount rate

ii. conducting open market operations

iii. changing the required reserve ratio

A) i only

B) ii only

C) ii and iii

D) i and ii

E) i, ii, and iii

Answer: ETopic: Fed policy toolsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1016


26) Which of the following is a policy tool of the Fed?

i. setting the required reserve ratios

ii. conducting open market operations

iii. quantitative easing

A) i only

B) ii only

C) iii only

D) Both i and ii

E) i, ii, and iii


27) The Fed influences the interest rate by using which of the following tools?

i. open market operations

ii. taxes on bank accounts

iii. changes in required reserve ratios

A) i only

B) ii only

C) iii only

D) Both i and iii

E) i, ii and iii

Answer: DTopic: Fed policy toolsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

28) Which of the following are policy tools used by the Federal Reserve?

i. the federal personal income tax

ii. open market operations

iii. changing the required reserve ratio

A) i only

B) ii only

C) iii only

D) ii and iii

E) i, ii, and iii

Answer: DTopic: Fed policy toolsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1017


29) Which of the following is a tool the Fed uses to adjust the quantity of money?

i. The Fed can change the interest rate banks charge for loans to their prime customers.

ii. The Fed can change the discount rate on loans to banks.

iii. The Fed can buy or sell government securities.

A) i only B) ii only C) iii only D) i and iii E) ii and iii


30) Required reserve ratios are the minimum amount of

A) deposits any one bank is allowed to accept as percentage of its capital.

B) reserves any one bank must hold as a percentage of its loans.

C) reserves any one bank must hold as a percentage of its deposits.

D) deposits any one bank must hold as a percentage of its reserves.

E) reserves any one bank must hold as a percentage of its total assets.

Answer: CTopic: Fed policy tools, required reserve ratioSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

31) The required reserve ratio is 10 percent and Charlie deposits $3,000 in her checking account.

The bank must

A) increase reserves by $3,000.

B) increase reserves by $300.

C) decrease reserves by $3,000.

D) decrease reserves by $300.

E) not change its reserves until Charlie decides to withdraw her funds.

Answer: BTopic: Fed policy tools, required reserve ratioSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Analytical thinking

Page 1018


32) The required reserve ratio is the minimum percentage of ________ that banks are required to

hold by regulation.

A) reserves as total assets

B) deposits as total assets

C) reserves as deposits

D) deposits as reserves

E) reserves as total liabilities

Answer: DTopic: Fed policy tools, required reserve ratioSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

33) The required reserve ratio is the

A) amount of excess reserves the bank holds just in case.

B) total amount of reserves the bank holds in its vaults.

C) total amount of reserves the bank holds at the Fed.

D) amount of reserves banks are required by the Fed to be held as a percentage of the bankʹs

deposits.

E) amount of reserves banks are required by the Fed to be held as a percentage of the bankʹs

loans.

Answer: DTopic: Fed policy tools, required reserve ratioSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking


A) required reserves = (total deposits) × (excess reserve ratio)

B) required reserves = (total reserves) × (excess reserve ratio)

C) required reserves = (total deposits) × (required reserve ratio)

D) required reserves = (total deposits) ÷ (required reserve ratio)

E) required reserves = (total deposits) × (required reserve ratio) - excess reserves

Answer: CTopic: Fed policy tools, required reserve ratioSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Analytical thinking

Page 1019


35) The interest rate the Federal Reserve charges a bank when it borrows reserves from the Fed is

called the

A) market interest rate.

B) federal funds rate.

C) discount rate.

D) prime rate.

E) borrowing rate.

Answer: CTopic: Fed policy tools, discount rateSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

36) The discount rate is the

A) banksʹ real interest rate.

B) interest rate at which the Fed will loan reserves to commercial banks.

C) interest rate banks charge the Fed when the Fed borrows from the banks.

D) name of the interest rate banks charge their most credit-worthy borrowers.

E) interest rate paid on U.S. government securities.

Answer: BTopic: Fed policy tools, discount rateSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

37) The discount rate is

A) the interest rate paid when a bank borrows reserves from another bank.

B) the interest rate paid when a commercial bank borrows reserves from the Fed.

C) the reduction in the interest rate given to the bankʹs best customers.

D) another name for the long-term interest rate.

E) the interest rate the Fed pays banks for the reserves the banks keep at the Fed.

Answer: BTopic: Fed policy tools, discount rateSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1020


38) The discount rate is

A) the interest rate that commercial banks have to pay for any reserves that they borrow

from the non-bank public.

B) the interest rate that commercial banks have to pay to the owners of bank deposits.

C) equal to the nominal interest rate minus the inflation rate.

D) the interest rate that commercial banks pay for reserves that they borrow from the Fed.

E) the interest rate that commercial banks receive for the reserves that they have on reserve

at the Fed.

Answer: DTopic: Fed policy tools, discount rateSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

39) If the Fed increases the discount rate,

A) commercial banks pay a higher interest rate if they borrow from the Fed.

B) commercial banks pay a lower interest rate if they borrow from the Fed.

C) commercial banksʹ assets increase.

D) commercial banks find it more profitable to increase their loans to businesses.

E) commercial banks increase their lending to the Fed.

Answer: ATopic: Fed policy tools, discount rateSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

40) If the Fed increases the discount rate, commercial banks pay a ________ interest rate if they

borrow money from the Fed and will therefore ________.

A) higher; borrow less money from the Fed and make fewer loans to consumers

B) higher; borrow more money from the Fed and make more loans to consumers

C) lower; borrow more money from the Fed and make more loans to consumers

D) lower; borrow less money from the Fed and make fewer loans to consumers

E) higher; deposit more money into their reserves at the Fed

Answer: ATopic: Fed policy tools, discount rateSkill: Level 3: Using modelsSection: Checkpoint 11.3Status: NewAACSB: Reflective thinking

Page 1021


41) Open market operations are the

A) purchase or sale of government securities by the Fed.

B) lending of reserves to the banking system by the Fed.

C) borrowing of reserves by the Fed from the banking system.

D) minimum percentage of loans that banks must retain as reserves in the open market.

E) purchase or sale of gold by the Fed.

Answer: ATopic: Fed policy tools, open market operationsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

42) Open market operations are when the Fed buys or sells

A) government securities from the government.

B) corporate securities from banks or some other business.

C) government securities from banks or some other business.

D) corporate securities from the government.

E) gold.

Answer: CTopic: Fed policy tools, open market operationsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

43) When the Fed engages in open market operations, it is buying or selling

A) capital equipment.

B) U.S. government securities newly issued by the U.S. Treasury.

C) U.S. government securities.

D) loans made to banks to meet the legal reserve requirement ratio.

E) gold.

Answer: CTopic: Fed policy tools, open market operationsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

44) In response to the financial crisis in 2008, the Fed created which of the following policy tools?

A) quantitative easing

B) the required reserve ratio

C) the discount rate

D) the federal funds rate

E) open market operations

Answer: ATopic: Fed policy tools, crisis measuresSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1022


45) Which of the following policy tools did the Fed create in 2008 to address the financial crisis?

i) quantitative easing

ii) credit easing

iii) open market operations

A) i and ii B) i only C) ii only D) i and iii E) ii and iii

Answer: ATopic: Fed policy tools, crisis measuresSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

46) Quantitative easing by the Fed refers to

A) the creation of bank reserves by engaging in large-scale open market operation at very

low interest rates.

B) selling private securities issued by the Fed.

C) decreasing the money supply during a recession to prevent inflation.

D) lowering the federal funds rate while increasing the discount rate.

E) lowering the required reserve ratio to zero percent.

Answer: ATopic: Quantitative easingSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

47) If the Fed engages in quantitative easing, it has likely

A) decreased the federal funds rate to almost zero by buying large sums of securities.

B) increased the discount rate to prevent inflation.

C) decreased the discount rate by selling its own securities.

D) increased the federal funds rate by selling private securities.

E) started paying interest on required reserves.

Answer: ATopic: Quantitative easingSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1023


48) In 2008, the Fed created a new policy tool called

A) quantitative easing, which allowed the Fed to buy private securities as well as

government securities.

B) quantitative easing, which required the Fed to pay interest on required reserves.

C) open market operations, which required the Fed to buy securities from only the federal

government.

D) federal funds zero-rate, which required the Fed to lower the rate to near zero percent.

E) interest rate reductions, which allowed the Fed to lower interest rates paid to banks.

Answer: ATopic: Quantitative easingSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

49) ________ by the Fed means that the Fed ________.

A) Credit easing; bought private securities from financial institutions

B) Credit easing; made loans directly to home buyers

C) Credit easing; tried to lower long-term interest rates

D) Quantitative easing; required private banks to increase their lending to home buyers

E) Quantitative easing; decreased in the required reserve ratio

Answer: ATopic: Credit easingSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

50) The policy tool of ʺcredit easingʺ refers to the ________.

A) Fedʹs purchase of private securities to stimulate banksʹ lending

B) Fedʹs requirement that the federal government must lend to directly to home buyers

C) federal governmentʹs requirement that the Fed must lend directly to home buyers

D) Fedʹs lowering of the federal funds rate to zero

E) Treasuryʹs issuance of federal debt to finance home buying

Answer: ATopic: Credit easingSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1024


51) The monetary base is the sum of

A) Federal Reserve notes and banksʹ reserves at the Fed.

B) coins, Federal Reserve notes, and individualsʹ deposits at the Fed.

C) Federal Reserve notes, Treasury deposits at the Fed, banksʹ reserves at the Fed, and coins.

D) coins, Federal Reserve notes, and banksʹ reserves at the Fed.

E) coins, Federal Reserve notes, and gold at the Fed.

Answer: DTopic: Monetary baseSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

52) The monetary base is equal to

A) banksʹ assets plus liabilities.

B) Federal Reserve notes plus coins plus banksʹ reserves at the Fed.

C) checkable deposits plus coins plus travelerʹs checks.

D) checkable deposits plus coins plus banksʹ assets.

E) M2 minus M1.

Answer: BTopic: Monetary baseSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

53) The monetary base is equal to

A) M1.

B) M2.

C) currency and coins in circulation plus checkable deposits.

D) the sum of coins, Federal Reserve notes, and banksʹ reserves at the Fed.

E) the sum of coins, Federal Reserve notes, and gold at the Fed.

Answer: DTopic: Monetary baseSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

54) The monetary base is equal to the sum of coins,

A) currency and banksʹ reserves at the Federal Reserve.

B) currency and checkable deposits at banks.

C) currency, banksʹ reserves at the Federal Reserve and checkable deposits at banks.

D) and checkable deposits at banks.

E) U.S. government securities owned by the Federal Reserve and Federal Reserve notes.

Answer: ATopic: Monetary baseSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1025


55) The monetary base does NOT include which of the following items?

i. Federal Reserve notes

ii. banksʹ reserves at the Federal Reserve

iii. U.S. government securities owned by the Federal Reserve

A) i only

B) ii only

C) iii only

D) both i and ii

E) both ii and iii

Answer: CTopic: Monetary baseSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

56) Regulating the amount of money in the United States is one of the most important

responsibilities of the

A) State Department.

B) state governments.

C) Treasury Department.

D) Federal Reserve.

E) U.S. Mint.

Answer: DTopic: Federal Reserve SystemSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

57) The Board of Governors of the Federal Reserve System has

A) 12 members appointed by the president of the United States.

B) 12 members elected by the public.

C) seven members appointed by the president of the United States.

D) seven members elected by the public.

E) seven members appointed to life terms.

Answer: CTopic: Federal Reserve System, Board of GovernorsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1026


58) The Board of Governors of the Federal Reserve System has seven members appointed by the

________ that serve a term of ________ in order to ________.

A) U.S. congress; 4 years; fulfill a mandate within the U.S. constitution

B) U.S. senate; 14 years; provide continuity in the governing of the U.S. economy

C) U.S. president and confirmed by the U.S. senate; 14 years; provide continuity in the

governing of the U.S. economy

D) U.S. president and confirmed by the U.S. congress; 14 years; provide continuity in the

governing of the U.S. economy

E) U.S. president and confirmed by the U.S. senate; 4 years; fulfill a mandate within the U.S.

constitution

Answer: CTopic: Federal Reserve System, Board of GovernorsSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: NewAACSB: Reflective thinking

59) The Fedʹs policy is determined by the

A) Federal Open Market Committee.

B) Executive Council to the Governor.

C) Regional Federal Reserve Banks.

D) Board of Governors.

E) Federal Monetary Policy Committee.

Answer: ATopic: FOMCSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

60) The Fedʹs policy tools include

A) required reserve ratios, the discount rate, open market operations, and extraordinary

crisis measures.

B) holding deposits for the U.S. government, reserve requirements, and the discount rate.

C) setting regulations for lending standards and extraordinary crisis measures.

D) supervision of the banking system and buying and selling commercial banks.

E) required reserve ratios, income tax rates, and open market operations.

Answer: ATopic: Fed policy toolsSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1027


61) The minimum percent of deposits that banks must hold and cannot loan is determined by the

A) interest rate.

B) discount rate.

C) required reserve ratio.

D) federal funds rate.

E) ratio of M2 to M1.

Answer: CTopic: Fed policy tools, required reserve ratioSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

62) The discount rate is the interest rate that

A) commercial banks charge their customers.

B) commercial banks charge each other for the loan of reserves.

C) the Fed charges the government for loans.

D) the Fed charges commercial banks when it loans reserves to the banks.

E) the Fed pays commercial banks on their reserves held at the Fed.

Answer: DTopic: Fed policy tools, discount rateSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

63) The monetary base is the

A) minimum reserve banks must hold to cover any losses from unpaid loans.

B) sum of coins, Federal Reserve notes, and banksʹ reserves at the Fed.

C) sum of gold and foreign exchange held by the Fed.

D) sum of government securities and loans to banks held by the Fed.

E) sum of coins, required reserves, and banksʹ loans.

Answer: BTopic: Monetary baseSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1028


64) If Federal Reserve notes and coins are $765 billion, and banksʹ reserves at the Fed are $8

billion, the gold stock is $11 billion, and the Fed owns $725 billion of government securities,

what does the monetary base equal?

A) $765 billion

B) $773 billion

C) $776 billion

D) $744 billion

E) $1,509 billion

Answer: BTopic: Monetary baseSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

65) If the Federal Reserve ________ the required reserve ratio, the interest rate ________.

A) lowers; rises

B) lowers; falls

C) raises; does not change

D) raises; falls

E) Not enough information is given because the effect depends also on the size of the

monetary base.

Answer: BTopic: Required reserve ratioSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

66) If the Federal Reserve lowers the required reserve ratio, people will end up taking out

________ because the interest rates ________.

A) fewer loans; will rise

B) more loans; will fall

C) the same number of loans; will not change

D) more loans; will rise

E) fewer loans; are controlled by the economic conditions alone

Answer: BTopic: Required reserve ratioSkill: Level 3: Using modelsSection: Checkpoint 11.3Status: NewAACSB: Reflective thinking

Page 1029


11.4 Regulating the Quantity of Money

1) New money is created in the U.S. economy by

A) increased federal government expenditures.

B) banks that create checkable deposits.

C) the U.S. Treasury.

D) U.S. Department of Mint.

E) the U.S. Congress.

Answer: BTopic: How banks create moneySkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

2) Banks create money by

A) printing dollar bills without limit.

B) creating deposits without limit.

C) printing money up to their required reserve limit.

D) making loans and creating deposits, a process that is limited by the size of banksʹ excess

reserves.

E) buying U.S. government securities with cash.

Answer: DTopic: How banks create moneySkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking


A) printing paper money.

B) minting coins.

C) making loans.

D) buying government securities.

E) None of the above because banks cannot create money; only the Federal Reserve can

create money.

Answer: CTopic: How banks create moneySkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1030


4) When a bank receives deposits,

A) it must hold the entire amount as reserves in case of withdrawal.

B) the Fed requires it to hold only a small percentage as reserves.

C) it and it alone decides how much it will hold as reserves.

D) its liabilities increase in amount but its assets do not change.

E) its assets increase in amount but its liabilities do not change.

Answer: BTopic: How banks create moneySkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking


A) printing currency.

B) asking the Fed to print more currency.

C) lending to the Fed.

D) making loans.

E) buying government securities.

Answer: DTopic: How banks create moneySkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

6) The amount of loans that a bank can create is limited by

A) a law enacted by Congress.

B) the bankʹs excess reserves.

C) a directive from the Federal Reserve System, which takes into account the bankʹs

financial stability.

D) the real interest rate.

E) the bankʹs government securities.


Page 1031


7) The process of money creation by the banking system is limited, in part, by the

A) number of banks.

B) desired reserve ratio.

C) number of depositors.

D) Comptroller of the Currency.

E) laws passed each year by the U.S. Congress.


8) Assume the First Bank of Townsville makes a loan of $2,500. This loan will

A) increase the quantity of money initially by $2,500.

B) decrease the quantity of money initially by $2,500.

C) have no change on the quantity of money, just its composition.

D) increase the First Bank of Townvilleʹs liabilities at the Fed.

E) increase the First Bank of Townvilleʹs reserves.

Answer: ATopic: How banks create moneySkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

9) When the First Bank of Townsville makes a loan, it

A) prints money.

B) borrows the money from the Fed.

C) creates a checkable deposit.

D) decreases the quantity of money.

E) increases its reserves.

Answer: CTopic: How banks create moneySkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1032


10) If the desired reserve ratio is 15 percent, then for every dollar that is deposited in the bank, the

bank will

A) keep 15 cents as reserves.

B) keep 85 cents as reserves.

C) keep 85 cents as reserves and loan 85 cents.

D) loan 15 cents.

E) keep 15 cents as reserves and loan 15 cents.

Answer: ATopic: Desired reserve ratioSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

11) Riley deposits $4,000 cash in her checkable deposit at Fershur Bank. If the desired reserve ratio

is 5 percent, Fershur Bankʹs

A) desired reserves increase by $4,000.

B) assets and its liabilities change in opposite directions.

C) desired reserves increase by $200 and its excess reserves increase by $3,800.

D) excess reserves increase by $4,000.

E) liabilities do not change but its assets increase.

Answer: CTopic: Desired reserve ratioSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

12) Suppose the desired reserve ratio is 10 percent. If Urban Bank has total deposits of $1000 and

total assets of $10,000, the amount of desired reserves is

A) $100. B) $900. C) $1,000. D) $9,000. E) $1,100.

Answer: ATopic: Desired reserve ratioSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

13) A bank has $200 of reserves and $4,000 of deposits. It is just meeting its desired reserves and

has no excess reserves. Thus the desired reserve ratio is

A) 10 percent.

B) 20 percent.

C) 25 percent.

D) 5 percent.

E) $200.

Answer: DTopic: Desired reserve ratioSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1033


14) If the desired reserve ratio is 7 percent and a bank has $10,000 of deposits, then its desired

reserves are

A) $7. B) $700. C) $9,300. D) $930. E) $7,000.

Answer: BTopic: Desired reserve ratioSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

15) When Zane deposits $20,000 cash in his checkable deposit at the Citicorp and the Citicorpʹs

desired reserves increase by $5,000, the desired reserve ratio is

A) 5 percent.

B) 75 percent.

C) 25 percent.

D) 20 percent.

E) $5,000.


16) A bank reports reserves of $500,000, physical capital of $200,000, loans of $1,000,000, deposits

of $1,000,000, and ownersʹ equity of $500,000. If the desired reserve ratio is 5 percent, the

bankʹs desired reserves are

A) $10,000.

B) $25,000.

C) $50,000.

D) $1,000,000.

E) $500,000.


Page 1034


17) The Banks of the Mississippi has excess reserves of $20,000, desired reserves of $80,000 and the

desired reserve ratio is 5 percent. What is the total amount of deposits in this bank?

A) $5,000

B) $1,000,000

C) $1,600,000

D) $100,000

E) $180,000


18) The part of a commercial bankʹs reserves that are larger than desired are called

A) additional reserves.

B) required reserves.

C) excess reserves.

D) nonrequired reserves.

E) unnecessary reserves.

Answer: CTopic: Excess reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

19) Banks can make loans as long as they have

A) deposits.

B) reserves.

C) required reserves.

D) excess reserves.

E) excess government securities.

Answer: DTopic: Excess reservesSkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1035


20) Actual reserves are equal to

A) minimum balances plus desired reserves.

B) required reserves plus fractional deposits.

C) excess reserves plus liabilities.

D) desired reserves plus excess reserves.

E) government securities plus cash in the bankʹs vault.

Answer: DTopic: Excess reservesSkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

21) When Grayce deposits $4,000 cash in her checkable deposit at the Beach Bank and the Beach

Bankʹs excess reserves increase by $3,600, the desired reserve ratio is

A) 5 percent.

B) 10 percent.

C) 15 percent.

D) 90 percent.

E) $400.

Answer: BTopic: Excess reservesSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

22) If Bulge Bank has a desired reserve ratio of 10 percent, loans of $25,000, deposits of $100,000,

vault cash of $10,000, and reserves at the Fed of $65,000, then the bank

A) has no remaining capacity to make loans.

B) does not have enough reserves to meet its requirement.

C) has excess reserves of $65,000.

D) has excess reserves of $55,000.

E) has excess reserves of $75,000.

Answer: CTopic: Excess reservesSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1036


23) The Commerce Bank of Beverly Hills has total deposits of $1,000,000 and total reserves of

$220,000. The desired reserve ratio is 10 percent. The bankʹs excess reserves are

A) $22,000.

B) $120,000.

C) $100,000.

D) $80,000.

E) $1,000,000.

Answer: BTopic: Excess reservesSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

24) A bank has deposits of $400, reserves of $50, and the desired reserve ratio is 7 percent. The

bankʹs excess reserves are

A) $0. B) $22. C) $28. D) $3.50 E) $50.

Answer: BTopic: Excess reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

25) Suppose the desired reserve ratio is 10 percent. If the Commerce Bank has total deposits of

$20,000, total assets of $10,000, and actual reserves of $8000, the amount of excess reserves is

A) $2,000. B) $6,000. C) $800. D) $100. E) $0.

Answer: BTopic: Excess reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

26) A bank has deposits of $100,000, reserves of $20,000, and loans of $80,000. If the desired

reserve ratio is 10 percent, then its excess reserves are

A) 0. B) $8,000. C) $10,000. D) $2,000. E) $12,000.

Answer: CTopic: Excess reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1037


27) The required reserve ratio is 20 percent and banks have no excess reserves. Katie deposits $300

in her bank. What are the bankʹs excess reserves immediately after Katie makes her deposit?

A) $30 B) $90 C) $240 D) $60 E) $300

Answer: CTopic: Excess reservesSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

28) If Jose deposits $2,000 in his bank and the desired reserve ratio is 10 percent, what is the

amount of new loans that the bank can make?

A) $2,000 B) $200 C) $1,800 D) $1,900 E) $2,200

Answer: CTopic: Excess reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

29) Suppose a bank has $1,000 in deposits and $100 in reserves. If the desired reserve ratio is 5

percent, how much can this bank increase its loans?

A) $0 B) $400 C) $80 D) $50 E) $100

Answer: DTopic: Excess reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

30) The desired reserve ratio is 10 percent and banks have no excess reserves. Juliet deposits $300

in her bank. What is the maximum that Julietʹs bank can now loan?

A) $3,000 B) $270 C) $30 D) $330 E) $300

Answer: BTopic: Money creation processSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

31) The desired reserve ratio is 3 percent. Robert deposits $3,000 in Bank America. Bank America

keeps its minimum desired reserves and lends the excess to Fredrica. How much does Bank

America lend to Fredrica?

A) $3,000 B) $2,910 C) $300 D) $2700 E) $900

Answer: BTopic: Money creation processSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1038


32) The desired reserve ratio is 10 percent. Joe deposits $1,000 in Bank A. Bank A keeps its

minimum desired reserves and lends the excess to Fred. Fred spends his loan at J.C. Penney.

J.C. Penney deposits the check it receives from Fred in Bank B. Bank B keeps its minimum

desired reserves and lends the excess to Mary. How much can Bank B lend to Mary?

A) $900 B) $90 C) $810 D) $100 E) $1,000

Answer: CTopic: Money creation processSkill: Level 4: Applying modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

33) Whenever somebody deposits a check from bank A into a checkable deposit at bank B, bank

Aʹs reserves ________ and bank Bʹs reserves ________.

A) increase; decrease

B) increase; increase

C) decrease; decrease

D) decrease; increase

E) do not change; do not change

Answer: DTopic: Clearing checksSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

34) When the Fed buys or sells securities, it is conducting ________ operation.

A) a government debt

B) an open market

C) a money multiplier

D) a deposit

E) a currency

Answer: BTopic: Open market operationSkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

35) Open market operations are defined as

A) a bank borrowing from the Fed.

B) the buying and selling of securities by the Fed.

C) the buying and selling of securities between banks.

D) the amount banks can lend on each deposit.

E) a bank making a loan to the Fed.


Page 1039


36) If the Fed makes an open market purchase of $1 million of government securities, the

monetary base

A) is decreased by $1 million.

B) is unchanged in size, though its composition changes.

C) is increased by $1 million.

D) will decrease by a multiple of $1 million over time.

E) will increase by a multiple of $1 million over time.

Answer: CTopic: Open market operation and the monetary baseSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

37) Assume the desired reserve ratio is 10 percent, banks loan all excess reserves and the currency

drain is zero. If the Fed sells $100 million of U.S. government securities to Boise Bank, the

monetary base increases by

A) $1 million.

B) $10 million.

C) $100 million.

D) $1,000 million.

E) $90 million.

Answer: CTopic: Open market operation and the monetary baseSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

38) When the Fed buys securities from the public, banksʹ reserves ________ and the quantity of

money ________.

A) increase; increases

B) increase; decreases

C) decrease; increases

D) decrease; decreases

E) do not change; increases

Answer: ATopic: Open market operationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1040


39) When the Fed ________, the quantity of banksʹ reserves decreases.

A) hikes taxes

B) buys government securities

C) sells government securities

D) lowers the required reserve ratio

E) raises the required reserve ratio

Answer: CTopic: Open market operationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

40) When the Fed buys government securities, the immediate effect of the purchase is that banksʹ

A) reserves increase.

B) deposits increase.

C) assets increase.

D) reserves decrease.

E) loans decrease.


41) When the Fed buys $100 million of securities from a commercial bank the

A) monetary base increases.

B) money supply decreases.

C) bankʹs reserves decrease.

D) required reserve ratio decreases.

E) bank is risking its depositorsʹ money.

Answer: ATopic: Open market operation and the monetary baseSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

42) If the reserve requirement is 20 percent and the Fed buys $10,000 worth of Treasury bonds,

what is the change in the banksʹ total reserves?

A) $2,000 B) $10,000 C) $20,000 D) $8,000 E) $100,000

Answer: BTopic: Open market operation and the monetary baseSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: RevisedAACSB: Analytical thinking

Page 1041


43) When the Fed sells $100 million of securities to a commercial bank, the

A) monetary base increases.

B) money supply increases.

C) bankʹs reserves decrease.

D) required reserve ratio decreases.

E) bankʹs reserves do not change.


44) When the Fed purchases government securities,

A) excess reserves in the banking system increase, leading to more loans being made.

B) required reserves in the banking system increase, leading to more loans being made.

C) excess reserves in the banking system decrease, leading to fewer loans being made.

D) required reserves in the banking system decrease, leading to fewer loans being made.

E) the monetary base does not change.


45) When the Fed purchases government securities ________ loans end up being made because

________.

A) more; excess reserves in the banking system increase

B) more; excess reserves in the banking system decrease

C) fewer; excess reserves in the banking system increase

D) fewer; excess reserves in the banking system decrease

E) fewer; required reserves in the banking system increase but desired reserves decrease

Answer: ATopic: Open market operationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: NewAACSB: Reflective thinking

Page 1042


46) To increase the quantity of money in the economy, the Federal Reserve can

A) print more money and give it to the banks.

B) increase the required reserve ratio.

C) buy government bonds in an open market operation.

D) sell government bonds in an open market operation.

E) cut taxes.


47) When the Fed ________ securities in an open market operation, banksʹ reserves ________, and

therefore lending ________.

A) sells; increase; increases

B) buys; increase; increases

C) sells; decrease; increases

D) buys; decrease; decreases

E) buys; do not change; does not change

Answer: BTopic: Open market operationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

48) The Fed buys $100 million U.S. government securities from Bank of America. Bank of

Americaʹs balance sheet shows this transaction as ________ in total assets and ________ in

reserves.

A) no change; a $100 million decrease

B) no change; a $100 million increase

C) a $100 million increase; no change

D) a $100 million increase; a $100 million increase

E) a $100 million decrease; a $100 million decrease


Page 1043


49) If the Fed purchases securities in the amount of $100,000 from First Union Bank, then the

A) assets of First Union Bank decrease by $100,000.

B) assets of the Fed decrease by $100,000.

C) assets of First Union Bank change in composition but not in amount.

D) liabilities of the Fed change in composition but not in amount.

E) liabilities of First Union decrease by $100,000.


50) The Fed purchases $100 million of U.S. government securities from First National Bank. The

balance sheet for First National Bank shows ________ in its total assets and ________ in its total

liabilities.

A) a $100 million increase; a $100 million increase

B) a $100 million decrease; a $100 million increase

C) a $100 million increase; a $100 million decrease

D) no change; no change

E) a $100 million increase; no change

Answer: DTopic: Open market operationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

51) Suppose the Fed buys $1 million of government securities from Bank One, a large commercial

bank. Bank Oneʹs reserves ________ and its deposits ________.

A) increase by $1 million; do not change

B) increase by $1 million; increase by $1 million

C) do not change; increase by $1 million

D) do not change; do not change

E) decrease by $1 million; do not change


Page 1044


52) The Fed sells $300 million U.S. government securities to commercial banks. This action leads to

________ in Fed assets and ________ in Fed liabilities.

A) a $300 million increase; a $300 million increase

B) a $300 million increase; a $300 million decrease

C) no change; no change

D) a $300 million decrease; a $300 million decrease in

E) a $300 million decrease; a $300 million increase


53) When the Fed sells government securities to banks, the sale

A) increases banksʹ reserves.

B) increases the quantity of money.

C) creates more excess reserves.

D) decreases banksʹ reserves.

E) increases the monetary base.


54) An open market purchase of securities by the Fed leads to all of the following EXCEPT

A) an initial increase in excess reserves.

B) an increase in bank lending.

C) a decrease in the quantity of money.

D) an increase in banksʹ reserves.

E) an increase in the monetary base.


Page 1045


55) If the Fed sells government securities to a member of the nonbank public, then the resulting

effect on the quantity of money is

A) much larger than if the securities were sold to a bank.

B) much smaller than if the securities were sold to a bank.

C) the same as if the securities were sold to a bank.

D) that there is no change in the quantity of money.



56) Comparing the effect on the monetary base between an open market purchase of government

securities from a bank and the same open market operation conducted with the general public,

the monetary base

A) increases by a larger amount if the general public sells the securities than if a bank sells

the securities.

B) increases by a larger amount if a bank sells the securities than if the general public sells

the securities.

C) does not change if it is the general public that sells the securities.

D) increases by the same amount if the general public sells the securities or if a bank sells

the securities.

E) decreases by the same amount if the general public sells the securities or if a bank sells

the securities.

Answer: DTopic: Open market operationSkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

57) If the Fed buys government securities from the non-bank public, then

A) reserves at banks decrease.

B) loans at banks decrease.

C) deposits at banks increase and banksʹ reserves decrease.

D) deposits at banks increase and banksʹ reserves increase.

E) deposits at banks decrease and banksʹ reserves increase.


Page 1046


58) The Fed purchases $1 million of U.S. government securities from First Bank. The desired

reserve ratio is 10 percent, the currency drain ratio is zero, and banks loan all excess reserves.

The Fedʹs purchase increases First Bankʹs excess reserves by how much?

A) $900,000

B) $1,000,000

C) $1,100,000

D) $10,000,000

E) $100,000


59) When the desired reserve ratio is 10 percent, suppose the Fed buys $1,000,000 of government

securities from banks. As a result, the banksʹ excess reserves

A) increase by $900,000.

B) increase by $1,000,000.

C) increase by $10,000.

D) decrease by $10,000.

E) decrease by $1,000,000.

Answer: BTopic: Open market operationSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

60) The FUN Bank has no excess reserves when a new deposit of $20,000 is made. The desired

reserve ratio is 5 percent. After the deposit, but before making any loans, how much does The

FUN Bank have in excess reserves?

A) $1,000 B) $20,000 C) $9,000 D) $19,000 E) $21,000

Answer: DTopic: Money creation processSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1047


61) When a bank receives $100,000 in new deposits, the amount of loans the bank can make is

limited by

A) federal law.

B) the annual federal budget.

C) the Treasury Department.

D) its desired reserve ratio.

E) state law, with banks in different states being able to make different amounts of loans.

Answer: DTopic: Money creation processSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

62) At any point in time, a single bank can loan an amount equal to

A) its excess reserves.

B) its required reserves.

C) its government securities.

D) the amount of loans the bank made in the past.

E) its total reserves.

Answer: ATopic: Money creation processSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

63) Assume First Central Bank has a desired reserve ratio of 15 percent; $80,000 in total deposits,

loans equal to $60,000, and has $20,000 in actual reserves. First Central can make additional

loans totaling

A) $8,000. B) $12,000. C) $20,000. D) $60,000. E) $80,000.

Answer: ATopic: Money creation processSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

64) Bank One has reserves of $100,000, government securities of $200,000, loans of $700,000, and

checkable deposits of $800,000. If the desired reserve ratio is 10 percent, Bank One can make

additional loans totaling

A) $0.00. B) $10,000. C) $20,000. D) $80,000. E) $100,000.

Answer: CTopic: Money creation processSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1048


65) A new bank has reserves of $600,000, checkable deposits of $500,000, and government

securities of $100,000. If the desired reserve ratio is 10 percent, the amount of loans this bank

can make is

A) $50,000. B) $60,000. C) $540,000. D) $550,000. E) $600,000.

Answer: DTopic: Money creation processSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

66) If a single bank has $25,000 in excess reserves and the desired reserve ratio is 20 percent, what

is the maximum this bank can loan?

A) $5,000 B) $20,000 C) $25,000 D) $125,000 E) $30,000


67) A-1 bank initially has no excess reserves. If the desired reserve ratio is 10 percent and a new

deposit of $10,000 is made in A-1, then A-1

A) is required to hold the deposit in its reserves.

B) can immediately loan a multiple of the $10,000.

C) can immediately loan $9,000.

D) can immediately loan $100,000.

E) can immediately loan $10,000.


68) A currency drain is

A) an increase in currency held outside banks.

B) when the Fed buys securities, but it is not when the Fed sells securities.

C) when the Fed sells securities, but it is not when the Fed buys securities.

D) when the Fed either buys or sells securities.

E) when the Fed raises the required reserve ratio.

Answer: ATopic: Currency drainSkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1049


69) A currency drain occurs when the

A) Fed increases the required reserve ratio.

B) Fed sells U.S. government securities.

C) non-bank public increases its holdings of currency outside the banking system.

D) banks reduce the number of loans they create with their excess reserves.

E) Fed buys U.S. government securities.

Answer: CTopic: Currency drainSkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

70) The currency drain reduces the amount of

A) reserves available to banks to make loans.

B) currency the Fed has outstanding in the economy.

C) currency available for banks to borrow from the Fed.

D) the monetary base.

E) open market operations the Fed can make.

Answer: ATopic: Currency drainSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

71) A currency drain ________ the amount of bank reserves available to banks to make loans

because ________.

A) reduces; people are holding more money outside of the banks

B) increases; people are holding less money outside of the banks

C) reduces; people are holding less money outside of the banks

D) reduces the monetary base; people are holding more money outside of the banks

E) reduces; people are holding onto the money the banks could have borrowed from the

Fed

Answer: ATopic: Currency drainSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: NewAACSB: Reflective thinking

Page 1050


72) Suppose the Federal Reserve buys $50 million worth of securities from a commercial bank. As

a result, the monetary base ________, and the quantity of money will ________ $50 million due

to the ________.

A) increases; increase by more than; money multiplier

B) decreases; decrease by more than; money multiplier

C) increases; increase by more than; expenditure multiplier

D) decreases; decrease by less than; expenditure multiplier

E) increases; decrease by; currency drain

Answer: ATopic: Money multiplierSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

73) The money multiplier is the

A) fraction of the monetary base that is kept in currency.

B) factor by which a change in the monetary base is multiplied to give the change in the

quantity of money.

C) factor by which a change in the deposits base is multiplied to give the change in the

monetary base.

D) proportion by which a change in the quantity of money changes the monetary base.

E) number of times that the Fed conducts open market operations in a month.

Answer: BTopic: Money multiplierSkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

74) The number by which a change in the monetary base is multiplied to find the resulting change

in the quantity of money is called the

A) desired reserve ratio.

B) money multiplier.

C) currency multiplier.

D) currency drain.

E) open market operation.


Page 1051


75) If the money multiplier is 3.0, a $1,000 increase in the monetary base

A) increases quantity of money by $3,000.

B) decreases quantity of money by $3,000.

C) increases the monetary base by $300.

D) increases the money multiplier by 3 percent.

E) decreases the quantity of money by 3 percent.

Answer: ATopic: Money multiplierSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

76) C/D is the currency drain ratio and R/D is the desired reserve ratio. The money multiplier

equals

A) 1 + C/D

R/D + C/D.

B) 1 + R/D

R/D + C/D.

C) 1 + R/D

1 + C/D.

D)R/D - C/D

1 + R/D.

E) R/D + C/D

1 + C/D.

Answer: ATopic: Money multiplierSkill: Level 4: Applying modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

77) The Fed purchases $1 million of U.S. government securities from First Bank. The desired

reserve ratio is 10 percent, the currency drain ratio is zero, and banks loan all excess reserves.

The money multiplier is equal to

A) 0.10.

B) 1.0.

C) 10.0.

D) 100.0.

E) $1 million.

Answer: CTopic: Money multiplierSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1052


78) Suppose the currency drain ratio is 33.33 percent and the desired reserve ratio is 10 percent.

The money multiplier equals

A) 4.27. B) 3.00. C) 3.08. D) 2.50. E) 6.67.

Answer: CTopic: Money multiplierSkill: Level 5: Critical thinkingSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

79) If the currency drain ratio is 0.2 and the desired reserve ratio is 0.03, the money multiplier is

A) 0.76. B) 6.67. C) 3.23. D) 4.46. E) 5.22.

Answer: ETopic: Money multiplierSkill: Level 5: Critical thinkingSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

80) Suppose the currency drain ratio is 25 percent and the desired reserve ratio is 20 percent. The

money multiplier equals

A) 4.00. B) 3.00. C) 2.78. D) 2.00. E) 5.42.


81) If the currency drain ratio is 30 percent and the desired reserve ratio is 10 percent, the money

multiplier is

A) 0.80. B) 1.25. C) 3.25. D) 5.00. E) 10.0.


82) The monetary multiplier is 3 and the change in the monetary base is $100,000. How much will

the quantity of money increase?

A) $300,000 B) $200,000 C) $100,000 D) $70,000 E) $33,333

Answer: ATopic: Money multiplierSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1053


83) If the currency drain ratio is zero, which of the following situations leads to the greatest total

increase in the quantity of money?

A) an increase in the monetary base of $100,000 when the desired reserve ratio is 5 percent

B) an increase in the monetary base of $120,000 when the desired reserve ratio is 10 percent

C) an increase in the monetary base of $200,000 when the desired reserve ratio is 20 percent

D) an increase in the monetary base of $250,000 when the desired reserve ratio is 15 percent

E) an increase in the monetary base of $100,000 when the desired reserve ratio is 50 percent


84) The Fed buys $50,000 of government securities. The desired reserve ratio is 10 percent and the

currency drain ratio is zero. What will be the change in the quantity of money?

A) $5,000

B) $50,000

C) $500,000

D) $5,000,000

E) $0




A) $5,000 B) $20,000 C) $25,000 D) $125,000 E) $50,000

Answer: DTopic: Money multiplierSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

86) If the desired reserve ratio is 10 percent and there is no currency drain, then a $100 increase in

the monetary base leads the banking system to increase the quantity of money by

A) $1,000. B) $400. C) $900. D) $110. E) $1,100.


Page 1054


87) Suppose the desired reserve ratio is 20 percent and there is no currency drain. Then a $1

increase in the monetary base leads to the banking system to increase the quantity of money

by

A) $0.02. B) $4. C) $5. D) $20. E) $2.


88) Suppose the desired reserve ratio is 10 percent and there is no currency drain. Then a $200

increase in the monetary base results in the banking system increasing the quantity of money

by

A) $200. B) $2,000. C) $20. D) $10. E) $2,190.

Answer: BTopic: Money multiplierSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

89) If the required reserve ratio is 15 percent, there is no currency drain, and banks loan all of their

excess reserves, an increase in the monetary base of $20,000 leads to a total increase in the

quantity of money of

A) $3,000. B) $20,000. C) $133,333. D) $200,000. E) $300,000.

Answer: CTopic: Money multiplierSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

90) The Fed conducts an open market purchase of securities of $5,000. If the currency drain ratio is

0 percent and the desired reserve ratio is 10 percent, then the total increase in the quantity of

money is

A) $5,000. B) $20,000. C) $50,000. D) $10,000. E) $4,000.


Page 1055


91) Suppose the Fed sells $100 of government securities. If the desired reserve ratio is 20 percent

and there is no currency drain, then the quantity of money

A) decreases by $100.

B) decreases by $500.

C) decreases by $400.

D) increases by $100.

E) decreases by $80.




A) $20,000 B) $400,000 C) $399,980 D) $19,000 E) $5,000


93) If the Fed buys $10 million of government securities when the desired reserve ratio is 20

percent and the currency drain ratio is 5 percent, the quantity of money

A) increases by $42 million.

B) increases by $50 million.

C) decreases by $42 million.

D) decreases by $50 million.

E) increases by $7.5 million.

Answer: ATopic: Money multiplierSkill: Level 5: Critical thinkingSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

94) Which of the following reduces the money multiplier?

A) Banks loan all their excess reserves.

B) Bank customers hold some of the loan proceeds as currency outside the banking system.

C) The Fed reduces the required reserve ratio.

D) Banks impose a currency drain on bank customers.

E) The Fed sells U.S. government securities.

Answer: BTopic: Size of money multiplierSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1056


95) The quantity of money decreases if

A) the currency drain ratio increases.

B) the desired reserve ratio decreases.

C) banks loan all excess reserves.

D) the Treasury Department issues fewer government securities.

E) the Fed buys U.S. government securities.

Answer: ATopic: Size of money multiplierSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

96) ________ in the currency drain ratio and ________ in the desired reserve ratio ________ the

money multiplier.

A) An increase; an increase; increase

B) An increase; a decrease; decrease

C) A decrease; an increase; decrease

D) A decrease; a decrease; increase

E) An increase; a decrease; increase

Answer: DTopic: Size of money multiplierSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

97) An increase in the currency drain ratio ________.

A) increases the size of the money multiplier

B) decreases the size of the money multiplier

C) increases the deposits in all banks

D) decreases the size of the monetary base

E) increases the size of the monetary base

Answer: BTopic: Size of money multiplierSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1057


98) An increase in the currency drain ratio

A) decreases the size of the money multiplier.

B) increases the size of the money multiplier.

C) increases the money supply.

D) decreases the required reserve ratio.

E) increases the desired reserve ratio.


99) If there is an increase in the amount of currency held outside banks, then the

A) monetary base will decrease.

B) quantity of money will increase.

C) quantity of money and the monetary base will decrease.

D) quantity of money will decrease.

E) quantity of money will not change.

Answer: DTopic: Size of money multiplierSkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking


A) decreases the monetary base.


C) increases bank reserves.

D) does not change the amount of the monetary base.

E) does not change the quantity of money.

Answer: DTopic: Size of money multiplierSkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking


A) decreases the quantity of money.

B) decreases the monetary base.

C) increases banksʹ reserves.

D) increases banksʹ deposits.

E) has no effect on the amount of the monetary base or the quantity of money.


Page 1058


102) ________ increases the size of the money multiplier.

A) An increase in the currency drain ratio

B) An open market purchase of government securities by the Fed

C) A reduction in the desired reserve ratio

D) An open market sale of government securities by the Fed

E) An increase in the size of open market operations

Answer: CTopic: Size of money multiplierSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

103) If the monetary base does not change and the desired reserve ratio increases, the money

multiplier ________ and the quantity of money ________.





E) decreases; does not change

Answer: DTopic: Size of money multiplierSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

104) The ________ the desired reserve ratio, the ________ the ________ in the quantity of money

created from an initial increase of $100,000 in the monetary base.

A) larger; larger; decrease

B) larger; larger; increase

C) larger; smaller; decrease

D) smaller; larger; decrease

E) smaller; larger; increase

Answer: ETopic: Size of money multiplierSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1059


105) When part of a bank loan does not return to the banking system but rather remains outside the

banking system as currency, then the money multiplier ________ in size and the amount of

money created by an open market operation ________.

A) increases; decreases

B) does not change; increases

C) decreases; decreases

D) increases; increases



106) Decisions of ________ determine the magnitude of the monetary multiplier.

A) only the Fed

B) only the public

C) both the Fed and the public

D) neither the Fed nor the public

E) the Fed and the U.S. Congress


107) As a result of the Fedʹs actions during the 2008 financial crisis and banksʹ lending policies,

A) the M2 money multiplier has fallen from about 9 to about 4.

B) the M2 money multiplier more than doubled.

C) the monetary base decreased by 50 percent.

D) the ratio of currency to M2 deposits more than doubled.

E) the reserve requirement ratio increased.

Answer: ATopic: Eye on creating moneySkill: Level 4: Applying modelsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1060


108) As a result of the Fedʹs actions during the 2008 financial crisis and banksʹ lending policies, the

money multiplier ________ as a direct result of the ________.

A) fell from about 9 to about 4; surge in banksʹ desired reserve ratios as they took on less

risk

B) rose from about 4 to about 9; surge in banksʹ desired reserve ratios as they took on less

risk

C) fell from about 9 to about 4; low risk experienced by banks because of the FDIC

increasing their default coverage amounts

D) rose drastically; consistent decrease in banksʹ desired reserve ratios as they took on less

risk

E) decreased drastically; consistent decrease in banksʹ desired reserve ratios as they took on

less risk

Answer: ATopic: Eye on creating moneySkill: Level 4: Applying modelsSection: Checkpoint 11.4Status: NewAACSB: Reflective thinking

109) As of 2013, the U.S. monetary base has ________ its 2007 level, the level held before the 2008

financial crisis, as a direct result of ________.

A) quadrupled; the Fedʹs actions with quantitative easing

B) doubled; the Fedʹs actions with quantitative easing

C) tripled; the Fedʹs actions with quantitative easing

D) quadrupled; the Fedʹs actions and the resulting reduction of the money multiplier

E) tripled; the Fedʹs actions and the resulting reduction of the currency drain

Answer: ATopic: Eye on creating moneySkill: Level 4: Applying modelsSection: Checkpoint 11.4Status: NewAACSB: Reflective thinking

110) The M2 multiplier in the United States is currently about

A) 1. B) 4. C) 16. D) 50. E) 23.

Answer: BTopic: Eye on creating moneySkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1061


111) During the 2008 financial crisis, banks restricted ________, and the M2 money multiplier

________.

A) lending; decreased

B) lending; increased

C) deposits; increased

D) buying securities; increased

E) deposits; decreased

Answer: ATopic: Eye on creating moneySkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

112) Excess reserves are the

A) same as the required reserves.

B) amount of reserves the Fed requires banks to hold.

C) amount of reserves held over what is desired.

D) amount of reserves a bank holds at the Fed.

E) amount of reserves banks keep in their vaults.

Answer: CTopic: Excess reservesSkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

113) Banks can make loans up to an amount equal to their

A) total deposits.

B) total reserves.

C) required reserves.

D) excess reserves.

E) total government securities.

Answer: DTopic: Excess reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1062


114) If the Fed buys government securities, then

A) the quantity of money is not changed, just its composition.

B) new bank reserves are created.

C) the quantity of money decreases.

D) bank reserves are destroyed.

E) banksʹ excess reserves decrease.


115) The Citizens First Bank sells $100,000 of government securities to the Fed. This sale

immediately


B) decreases the bankʹs checkable deposits.

C) increases the bankʹs reserves.

D) decreases the bankʹs assets.

E) increases the bankʹs required reserves.


116) When the Fed conducts an open market purchase, the first round changes in the money

creation process are that excess reserves ________, bank deposits ________, and the quantity of

money ________.

A) decrease; decrease; decreases

B) increase; do not change; increases

C) decrease; increase; does not change

D) do not change; increase; increases

E) increase; increase; increases

Answer: ETopic: Open market operationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1063


117) A currency drain is cash ________ and has ________ effect on the money multiplier.

A) draining into the banks; no

B) draining into the banks; an

C) held outside the banks; an

D) held at the Fed; an

E) held as reserves; no

Answer: CTopic: Currency drainSkill: Level 1: DefinitionSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

118) The money multiplier is used to determine how much the

A) monetary base increases when the Fed purchases government securities.

B) quantity of money increases when the monetary base increases.

C) monetary base increases when the quantity of money increases.

D) quantity of money increases when the required reserve ratio increases.

E) monetary base increases when the Fed sells government securities.


119) The Fed makes an open market operation purchase of $200,000. The currency drain ratio is

33.33 percent and the desired reserve ratio is 10 percent. By how much does the quantity of

money increase?

A) $800,000

B) $333,333

C) $2,000,000

D) $615,416

E) $465,116

Answer: DTopic: Money multiplierSkill: Level 5: Critical thinkingSection: Checkpoint 11.4Status: RevisedAACSB: Analytical thinking

Page 1064



1) Money market mutual funds

A) are included in M2 but not M1.

B) are included in M1 but not M2.

C) are included in M1 and M2.

D) are the largest part of the monetary base.

E) None of the above is correct.

Answer: ATopic: IntegrativeSkill: Level 1: DefinitionSection: IntegrativeStatus: OldAACSB: Reflective thinking

2) Which of the following financial institutions does NOT have to meet minimum reserve ratios?

i. the Fed

ii. commercial banks

iii. credit unions

A) i only

B) ii only

C) iii only

D) ii and iii

E) i, ii, and iii

Answer: ATopic: IntegrativeSkill: Level 2: Using definitionsSection: IntegrativeStatus: OldAACSB: Reflective thinking

3) If the desired reserve ratio increases, then

A) banksʹ desired reserves increase and their excess reserves decrease.

B) bank customers become more willing to make deposits in banks.

C) banks are able to make more loans.

D) banks can buy more government securities.

E) the Fed has supplied banks with more reserves.

Answer: ATopic: IntegrativeSkill: Level 4: Applying modelsSection: IntegrativeStatus: OldAACSB: Reflective thinking

Page 1065


4) If the desired reserve ratio decreases, then

A) banksʹ desired reserves increase and their excess reserves decrease.

B) bank customers become more willing to make deposits in banks.

C) banks are able to make more loans.

D) banks are forced to buy fewer government securities.

E) banksʹ desired reserves decrease and their excess reserves do not change.

Answer: CTopic: IntegrativeSkill: Level 4: Applying modelsSection: IntegrativeStatus: OldAACSB: Reflective thinking

5) If the Fed buys a $100,000 government security from a bank when the desired reserve ratio is

20 percent and the currency drain ratio is 5 percent, the bank can loan a maximum of

A) $75,000. B) $80,000. C) $100,000. D) $95,000. E) $85,000.

Answer: BTopic: IntegrativeSkill: Level 1: DefinitionSection: IntegrativeStatus: OldAACSB: Analytical thinking

6) If the Fed buys a $100,000 government security from a bank when the desired reserve ratio is

10 percent and the currency drain ratio is 50 percent, the bank can loan a maximum of

A) $50,000. B) $40,000. C) $100,000. D) $90,000. E) $60,000.

Answer: DTopic: IntegrativeSkill: Level 1: DefinitionSection: IntegrativeStatus: OldAACSB: Analytical thinking

11.6 Essay: What Is Money?

1) Define money and list its functions.

Answer: Money is any commodity or token that is generally accepted as a means of payment. It

has three main functions. It serves as a medium of exchange, a unit of account, and a

store of value.Topic: MoneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 1066


2) List and define the three functions of money.

Answer: The three functions of money are a medium of exchange, a unit of account, and a store

of value. A medium of exchange is an object that is generally accepted in exchange for

goods and services. A unit of account is an agreed upon measure for stating the prices

of goods and services. A store of value is anything that can be held and later exchanged

for goods and services. Money serves all three of these functions.Topic: Functions of moneySkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Written and oral communication

3) What is barter? What is a double coincidence of wants? How does the existence of money

affect barter?

Answer: Barter is the direct exchange of one good or service for another. Barter is inefficient

because it requires a ʺdouble coincidence of wants,ʺ that is, the good one person offers

for exchange must be the good the trading partner wants and the trading partnerʹs good

must be what the first person wants. The existence of money means that we do not need

to engage in barter. Instead, we can sell a good or service for money and then use the

money to purchase another good or service we desire. There is no necessity for the

ʺdouble coincidence of wantsʺ because the seller is willing to accept money from any

buyer.Topic: BarterSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Written and oral communication

4) Explain which of the following count as money.

a. a check in Annʹs checkbook

b. currency in Annʹs bank

c. currency in Annʹs purse

d. Annʹs checking deposit

Answer: Only parts (c), currency in Annʹs purse, and (d), Annʹs checking deposit, are money.

Annʹs check, given in part (a), is a method of transferring money from Ann to someone

else. Thus the check (itself) is not money. Part (b), the currency in Annʹs bank, is not

money until someone withdraws it because currency inside a bank does not count as

money.Topic: MoneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Written and oral communication

Page 1067


5) What is fiat money?

Answer: Fiat money is objects that are money because the law declares them to be money.

Todayʹs money is fiat money. In past times, money used to be items, such as salt or

gold, that had an intrinsic value, that is, a value of their own outside of their role as

money.Topic: Fiat moneySkill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Written and oral communication

6) ʺEven though we can convert them into money, deposits at banks are not money.ʺ Is the

previous statement correct or not?

Answer: The statement is incorrect. Some deposits at banks, such as checkable deposits, are a

means of payment and fulfill all the functions of money. These deposits are therefore

money.Topic: DepositsSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

7) Are checks money?

Answer: Checks are instructions to transfer funds from one personʹs checking account to another

personʹs checking account. Checks are not money, but the checking account deposits

that the check transfers are money.Topic: ChecksSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

8) ʺCredit cards are considered money because they serve to purchase goods and services.ʺ Is the

previous statement true or false?

Answer: The statement is false. Credit cards are an ID card that, when presented, allow the

owner to get an immediate loan. A loan is not money because a loan needs to be repaid

with money. Thus a credit card is not money.Topic: Credit cardSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

Page 1068


9) Are credit cards or debit cards money? Explain your answer.

Answer: Neither credit cards nor debit cards are money. Credit cards are a type of ID card that,

when presented, allow the owner to get an immediate loan. The loan is not money;

indeed, it must be repaid using money. A debit card allows the customer to pay

immediately for his or her purchase by transferring money from the customerʹs

checking account to the sellerʹs account. Debit cards are similar to checks insofar as they

are essentially instructions to move money from one person to another. The funds

transferred are money, the debit card is not money.Topic: Credit card, debit cardSkill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Written and oral communication

10) What makes up M1? Is M1 larger or smaller than real GDP?

Answer: M1 is the sum of currency held by individuals and businesses plus checkable deposits

owned by individuals and businesses plus travelerʹs checks. All the assets in M1 are

accepted as means of payment and so all the assets are money. M1 is much smaller than

real GDP. Real GDP is about 7 times larger than M1.Topic: M1Skill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Written and oral communication

11) What assets are included in M1? In M2? Is all of M1 and M2 money? If some assets of M1 or

M2 are not money, why are they included in M1 or M2?

Answer: M1 is the sum of currency held by individuals and businesses plus checkable deposits

owned by individuals and businesses plus travelerʹs checks. All the assets in M1 are

accepted as means of payment and so all the assets are money. M2 includes all of M1

plus savings deposits, small time deposits, and money market funds. Some components

of M2, such as time deposits, are not money because they are not a means of payment.

But they are easily convertible into money, which is why they are included in M2.Topic: M1, M2Skill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Written and oral communication

12) Explain what is included in M1 and M2. Is all of M1 money? Is all of M2 money?

Answer: M1 is equal to the sum of currency held by individuals and businesses plus travelerʹs

checks plus checking deposits owned by individuals and businesses. These assets are all

money because they are all a means of payment. M2 is equal to M1 plus saving deposits

plus small time deposits plus money market funds. Not all of M2 is money because not

all of M2 are a means of payment. In other words, some parts of M2, such as time

deposits, cannot be used directly to make a purchase.Topic: M1, M2Skill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Written and oral communication

Page 1069


13) What is larger: M1 or M2? Why?

Answer: M2 is larger than M1. M2 includes M1 plus additional assets, so M2 must be larger than

M1. In June, 2011, M1 was approximately $1,950 billion and M2 was about 5 times

larger at approximately $9,100 billion.Topic: M1, M2Skill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Analytical thinking

14) ʺBy definition, all parts of M2 are money.ʺ Is the previous statement correct or not? Explain

your answer.

Answer: The statement is incorrect. Many of the assets in M2 are money. But not all the assets are

money. Some of the savings deposits, time deposits, and money market funds are not

means of payment and hence are not money. But they are included in M2 because they

are easily converted into money.Topic: M2Skill: Level 1: DefinitionSection: Checkpoint 11.1Status: OldAACSB: Reflective thinking

15) If you have assets that include $50 in cash, a checking account with $135, a savings account

with $500, and a jar of coins for laundry of $15.75, how much M1 do you have?

Answer: You have $200.75 of M1, comprised of the $50 in cash, plus the $135 in the checking

account, plus the $15.75 jar of coins.Topic: M1Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Analytical thinking

16) If you hold $25 in cash, have $150 in a checking account, and have $250 in a savings account,

how much of M2 do you have?

Answer: All of the assets mentioned are included in M2, so you have $25 + $150 + $250 = $425 of

M2.Topic: M2Skill: Level 2: Using definitionsSection: Checkpoint 11.1Status: OldAACSB: Analytical thinking

Page 1070


11.7 Essay: The Banking System

1) What are the institutions that make up the nationʹs banking system?

Answer: Part of the nationʹs banking system is the Federal Reserve System. The other part

consists of the banks and other institutions that accept deposits and that provide the

services that enable people and businesses to make and receive payments. There are

three general types of financial institutions: commercial banks, thrift institutions, and

money market funds.Topic: Monetary institutionsSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

2) What are the three types of financial institutions that accept deposits that are part of the U.S.

money supply? Briefly describe each of the three types of financial institutions.

Answer: The three institutions are commercial banks, thrift institutions, and money market

funds. Commercial banks are financial firms that accept deposits and make loans. There

are about 8,600 commercial banks in the United States. Thrift institutions include

savings and loan associations, savings banks, and credit unions. These firms also accept

deposits and make loans. The last type of financial institution is money market funds.

Money market funds obtain funds by selling shares and using the proceeds to buy

assets such as U.S. Treasury bills.Topic: Monetary institutionsSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Written and oral communication

3) Explain what is meant by the phrase a bankʹs ʺbalancing act.ʺ

Answer: Banks accept deposits and make loans with the funds they receive from the deposits.

Banks profit if the interest rate they charge on their loans exceeds the interest rate they

pay on their deposits. Loans are made for a specified length of time and cannot be called

in before they are due. However, deposits can be withdrawn at any time by the

depositors. Therefore a bank must perform a balancing act: It is risky to lend too much

of the deposits and run the risk of mass withdrawals that would create a crisis for the

bank. However, it is by making loans that the bank earns a profit.Topic: Bank profitSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Written and oral communication

Page 1071


4) ʺBanks make a profit by paying depositors a high rate to attract funds and making loans at a

low rate to encourage borrowing.ʺ Is the previous statement correct or not?

Answer: The statement is incorrect. Banks make a profit if the interest rate they collect on the

loans they make exceeds the interest rate they must pay on the deposits they attract.Topic: Bank profitSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

5) ʺBanks hold about 50 percent of their assets as reserves.ʺ Is the previous statement correct or

not?

Answer: The statement is incorrect. In 2011 banks kept an average of 13 percent of their assets as

reserves.Topic: Banksʹ reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

6) ʺTo count as required reserves, the reserves must be on deposit at the bankʹs district Federal

Reserve Bank.ʺ Is the previous statement correct or incorrect?

Answer: The statement is incorrect. Currency held in the bankʹs vault also counts as reserves.Topic: Banksʹ reservesSkill: Level 1: DefinitionSection: Checkpoint 11.2Status: OldAACSB: Reflective thinking

7) The First National Bank of Townville has $125,000 in U.S. government securities, $200,000 in

savings accounts, $300,000 in checking accounts, $50,000 in its reserve account at the Fed,

$10,000 of currency in its vault, and loans of $250,000. What is the amount of its reserves?

Answer: Reserves include the bankʹs deposit in its reserve account at the Fed and the currency in

its vault. Therefore, the First National Bank of Townville has $50,000 + $10,000 = $60,000

in reserves.Topic: Banksʹ reservesSkill: Level 3: Using modelsSection: Checkpoint 11.2Status: OldAACSB: Analytical thinking

8) The Second National Bank of Townville has $400,000 in checking deposits, $125,000 in savings

deposits, $500,000 in loans, $20,000 in its reserve account at the Fed, and $5,000 of currency in

its vault. What is the amount of its reserves?

Answer: Reserves include the bankʹs deposit in its reserve account at the Fed and the currency in

its vault. Therefore the Second National Bank of Townville has $20,000 + $5,000 =

$25,000 in reserves.Topic: Banksʹ reservesSkill: Level 3: Using modelsSection: Checkpoint 11.2Status: OldAACSB: Analytical thinking

Page 1072


9) The Second National Bank of Townville has $400,000 in checking deposits, $125,000 in savings

deposits, $500,000 in loans, $20,000 in its reserve account at the Fed, and $5,000 of currency in

its vault. What is the amount of these assets and liabilities that is in M1?

Answer: The only deposit that is in M1 is the checking deposits, so the amount that is in M1 is

checking deposits of $400,000.Topic: Bankʹs balance sheetSkill: Level 3: Using modelsSection: Checkpoint 11.2Status: OldAACSB: Analytical thinking

10) A bank has checking deposits of $400, saving deposits of $900, time deposits of $900, loans of

$950, government securities of $900, outstanding credit card balances of $400, currency in its

vault of $40, and deposits in its reserve account at the Fed of $40.

a. What is the amount of this bankʹs deposits that are in M1?

b. What is the amount of this bankʹs deposits that are in M2?

c. What is the amount of this bankʹs reserves?

Answer: a. The only deposit that is in M1 is the checking deposits, so the amount of this bankʹs

deposits that are in M1 is $400.

b. Deposits in M2 include checking deposits, saving deposits, and time deposits.

Therefore the amount of this bankʹs deposits that are in M2 equals $400 + $900 + $900 =

$2,200.

c. Reserves are the sum of the currency in the bankʹs vault plus its deposits in its

reserve account at the Fed. Therefore the bankʹs reserves are $40 + $40 = $80.Topic: Bankʹs balance sheetSkill: Level 3: Using modelsSection: Checkpoint 11.2Status: OldAACSB: Analytical thinking

11.8 Essay: The Federal Reserve System

1) The Federal Reserve is the nationʹs central bank. Therefore, does it provide banking services to

individual citizens?

Answer: No, because it is the nationʹs central bank, the Federal Reserve provides banking

services to the nationʹs banks but not to individual citizens.Topic: Central banksSkill: Level 1: DefinitionSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

2) Does the Federal Reserve conduct both the nationʹs monetary policy and its fiscal policy?

Answer: The Federal Reserve does not conduct both fiscal and monetary policy. The Federal

Reserve is responsible for only the nationʹs monetary policy but it does not conduct the

nationʹs fiscal policy.Topic: Structure of the Federal ReserveSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

Page 1073


3) Are the members of the Board of Governors of the Federal Reserve System elected officials?

Answer: No, the members are not elected. They are appointed by the president of the United

States (for 14-year terms) and confirmed by the U.S. Senate.Topic: Structure of the Federal ReserveSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

4) The president of which Federal Reserve Bank is always a voting member of the FOMC? Why?

Answer: The president of the New York Federal Reserve Bank is always a voting member of the

FOMC. The presidents of the other Federal Reserve Banks rotate on and off as voting

members. The president of the New York Federal Reserve Bank is always a voting

member because the New York Federal Reserve Bank implements the Fedʹs policy

decisions.Topic: FOMCSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

5) What is the FOMC? Who are the members of the FOMC? What policy does the FOMC decide?

Answer: The FOMC is the Federal Open Market Committee. All seven members of the Board of

Governors and the 12 Federal Reserve Bank presidents attend and discuss the economy

at the FOMC meeting. The voting members of the FOMC, however, are only the seven

members of the Board of Governors, the president of the Federal Reserve Bank of New

York, and four presidents of the remaining Federal Reserve Banks who serve on an

annual rotating basis. The FOMC meets approximately every six weeks to review the

state of the economy and decide the monetary policy actions to be carried out by the

Federal Reserve Bank of New York.Topic: FOMCSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Written and oral communication

6) ʺBecause monetary policy must be approved by the president of the United States, the

president is chair of the Federal Open Market Committee.ʺ Analyze the previous statementis

it correct or incorrect?

Answer: The statement is incorrect on several dimensions. First, monetary policy does not need

to be approved by the President of the United States. Second, the president of the

United States is not chair of the Federal Open Market Committee, FOMC. Third, the

president of the United States is not even a member of the FOMC! The chair of the FOMC

is the chair of the Federal Reserveʹs Board of Governors.Topic: FOMCSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Written and oral communication

Page 1074


7) What is the interaction between the Federal Reserve districts and the Board of Governors of

the Federal Reserve System?

Answer: The Federal Reserve System divides the nation into 12 regions, each with a Federal

Reserve Bank. Each Federal Reserve Bank has a nine-member board of directors. Of the

nine members, six are elected by the commercial banks within the Federal Reserve

district and three are appointed by the Board of Governors. The directors of each

Federal Reserve Bank appoint the president of the bank, subject to approval from the

Board of Governors.Topic: Structure of the Federal ReserveSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Written and oral communication

8) What is the structure of the Federal Reserve Bank System?

Answer: The key elements in the structure of the Fed are:

a. The Board of Governors. The Board of Governors has seven members who are

appointed by the President of the United States and confirmed by the Senate, each for a

14-year term.

b. The Regional Federal Reserve Banks. There are 12 regional banks, one for each of

the 12 Federal Reserve districts. Each of these 12 banks has nine directors who appoint

the bankʹs president, which is subject to approval by the Board of Governors.

c. The Federal Open Market committee or FOMC. The FOMC is the Fedʹs main

policy-making committee. It has 12 voting members. Seven of the members are on the

Board of Governors. One of the members is the president of the Federal Reserve Bank in

New York. The other four members are presidents of other Federal Reserve Banks.

Which four presidents are members changes on an annual rotating basis.Topic: Structure of the Federal ReserveSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Written and oral communication

9) Briefly describe the Federal Reserve System, how it is governed, and its roles in the economy.

Answer: The Federal Reserve, or Fed, is the U.S. central bank. The Fed consists of twelve regional

Federal Reserve Banks scattered across the United States. These banks are overseen by

the Board of Governors, a seven member board located in Washington D.C., whose

members are appointed by the President of the United States and confirmed by the

Senate. The Federal Open Market Committee, or FOMC, is the group within the Fed

that sets the nationʹs monetary policy. The voting members of the FOMC consist of the

chair and other six members of the Board of Governors, the president of the Federal

Reserve Bank of New York, and four presidents of the other regional Federal Reserve

Banks, on a yearly rotating basis. The Fedʹs primarily role in the economy is to set and

conduct the nationʹs monetary policy. The Fed also provides banking services to banks

and helps regulate the nationʹs financial institutions and markets.Topic: Federal Reserve SystemSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Written and oral communication

Page 1075


10) List the Fedʹs main policy tools and briefly explain each one.

Answer: The Fedʹs main policy tools are: required reserve ratios, the discount rate, open market

operations, and extraordinary crisis measures. Banks and thrifts are required to hold a

minimum percentage of deposits as reserves. This minimum percentage is determined

by the Fed and is known as a required reserve ratio. The discount rate is the rate that the

Fed charges commercial banks that borrow reserves from it. An open market operation

is the buying and selling of government bonds by the Fed in the open market.

Extraordinary crisis measures have been undertaken since the financial crisis of 2008.

They consist of quantitative easing, when the Fed creates a massive amount of reserves

at a very low--possibly zero--federal funds rate, credit easing, when the Fed buys

private securities or makes loans to financial institutions to stimulate their lending, and

operation twist, when the Fed buys long-term securities and sells short-term securities

to lower long-term interest rates.Topic: Fed policy toolsSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Written and oral communication

11) What is the discount rate?

Answer: The discount rate is the interest rate that the Fed charges banks when the banks borrow

reserves from the Fed.Topic: Fed policy tools, discount rateSkill: Level 2: Using definitionsSection: Checkpoint 11.3Status: OldAACSB: Reflective thinking

12) The Federal Reserve reports that it has coins valued at $10 billion, bank reserves at the Fed of

$15 billion, gold valued at $10 billion, Federal Reservesnotes of $400 billion, and U.S.

government securities of $300 billion. What is the size of the monetary base?

Answer: The monetary base is the sum of coins, Federal Reserve notes, and banksʹ reserves at the

Federal Reserve. Therefore the monetary base equals

$10 billion + $400 billion + $15 billion = $425 billion.Topic: Monetary baseSkill: Level 3: Using modelsSection: Checkpoint 11.3Status: OldAACSB: Analytical thinking

Page 1076


11.9 Essay: Regulating the Quantity of Money

1) Describe how actual reserves are calculated. Explain the difference between required reserves

and excess reserves. How do reserves affect the amount of loans a bank can make?

Answer: Actual reserves are equal to the bankʹs reserves it keeps on deposit at the Federal

Reserve plus the currency in the bankʹs vault. Required reserves are equal to the

required reserve ratio multiplied by the bankʹs deposits. Banks might want to keep

reserves over and above their required reserves. The amount of reserves banks want to

keep is their desired reserves. Excess reserves equal actual reserves minus desired

reserves. A bank can make loans equal to the amount of its excess reserves.Topic: Required reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Written and oral communication

2) ʺA bank can only use its excess reserves to make loans, while required reserves can only be

used to buy U.S. government securities.ʺ Explain whether the previous statement is correct or

incorrect.

Answer: The statement is incorrect on two dimensions. First, a bank can use excess reserves to

buy government securities as well as make loans. Second, a bank is not allowed to use

its required reserve to buy U.S. government securities. Required reserves must be kept

in the form of reserves, which are either reserve deposits the bank has made at the

Federal Reserve or cash in the bankʹs vault.Topic: Required reservesSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Written and oral communication

3) A bank reports reserves of $100,000, government securities of $250,000, loans of $750,000,

checkable deposits of $900,000, and ownersʹ equity of $200,000. The desired reserve ratio is 10

percent and the bank wants to hold as reserves only the amount it is required to hold. What is

the amount of excess reserves for this bank? Show your work.

Answer: Excess reserves equal the actual reserves minus the desired reserves. The actual reserves

are $100,000. The bank desires to keep 10 percent of its checkable deposits as reserves,

so the desired reserves are ($900,000) × 0.10 = $90,000. Thus excess reserves equal

$100,000 - $90,000 = $10,000.Topic: Required reservesSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1077


4) The desired reserve ratio is 10 percent. Fly By Night Bank has deposits of $250,000 and

reserves of $25,000. What is the amount of its excess reserves?

Answer: The bank has no excess reserves. It desires to have ($250,000) × (0.10) = $25,000 as

desired reserves. Its actual reserves equal $25,000. Therefore its excess reserves equal

$25,000 - $25,000, or $0.Topic: Excess reservesSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

5) A bank has reserves of $50, deposits of $100, loans of $20, and government securities of $30.

Assume the desired reserve ratio is 20 percent.

a. What are the bankʹs assets and what are its liabilities?

b. How much does the bank have in excess reserves?

c. What can the bank do with its excess reserves that will affect the quantity of money?

Answer: a. Assets are reserves, loans, and securities. Liabilities are deposits.

b. The excess reserves are $30, equal to the actual reserves of $50 minus the desired

reserves of $20 (= 20 percent of $100 of deposits).

c. The bank can use its excess reserves to make loans. When it makes the loan, it will

increase the quantity of money.Topic: Money creationSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

6) Explain the process by which the banking system creates money.

Answer: When a bank gains excess reserves, it uses the excess reserves to make a loan. The

person or a business receiving the loan receives a depositmoney! The borrower then

generally spends the loan and it ends up as a depositmoneyin another companyʹs

account. That companyʹs bank then gains some excess reserves, which it loans, and so

more money is created. Thus the banking system creates money by making loans.Topic: Money creationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Written and oral communication

7) Does an open market operation in which the Fed buys securities from the general public

decrease or increase the banking systemʹs reserves?

Answer: An open market purchase of government securities by the Fed increases the banking

systemʹs reserves.Topic: Open market operationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

Page 1078


8) The Fed conducts an open market operation and buys $50,000 of government securities from

Commerce Bank. The desired reserve ratio is 25 percent. What is the change in Commerce

Bankʹs total reserves and its excess reserves?

Answer: When the Fed buys $50,000 of government securities from Commerce Bank, Commerce

Bankʹs total reserves increase by $50,000. None of these reserves are desired reserves, so

Commerce Bankʹs excess reserves also increase by $50,000.Topic: Open market operationSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

9) If the Fed sells $100 million of U.S. government securities, what happens to the quantity of

money?

Answer: If the Fed sells $100 million of U.S. government securities, the monetary base decreases

and, along with it, the quantity of money decreases. The money multiplier shows that

the quantity of money decreases by more than $100 million.Topic: Open market operationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Written and oral communication

10) When the Fed buys a government security, what happens to the monetary base and the

quantity of money? Which changes by more or do both change by the same amount?

Answer: When the Fed buys a government security, both the monetary base and the quantity of

money increase. As reflected by the money multiplier, the increase in the quantity of

money exceeds the increase in the monetary base.Topic: Open market operationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Written and oral communication

11) ʺWhen the Fed makes an open market purchase of government securities, the quantity of

money will eventually decrease by a fraction of the initial change in the monetary base.ʺ Is the

previous statement correct or incorrect? Explain your answer.

Answer: The statement is wrong on two counts. First, if the Fed makes an open market purchase

of government securities, the quantity of money will increase rather than decrease.

Second, the money multiplier points out that the change in the quantity of money will

be greater than, not less than, the initial change in the monetary base.Topic: Open market operationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Written and oral communication

Page 1079


12) If a bank receives an additional deposit of $50,000 and the desired reserve ratio is 20 percent,

what is the amount of new loans the bank can make?

Answer: The bank can make loans equal to its excess reserves. With the $50,000 deposit, the

bankʹs desired reserves are ($50,000 × 0.20) = $10,000, so the bank has excess reserves of

$40,000. Therefore the bank can make $40,000 of loans.Topic: The rounds of money creationSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

13) How can a new deposit of $10,000 at one bank create other new deposits at other banks?

Suppose the desired reserve ratio is 10 percent and people keep no currency outside of the

banks. What will be the new amount of deposits in the second and third rounds?

Answer: When the bank receives a new deposit of $10,000, it will loan some of the deposit. The

proceeds of the loan will be deposited in another bank, which will then loan some of its

new deposits. Hence an initial deposit at one bank leads to deposits at other banks.

With the desired reserve ratio of 10 percent, the first bank keeps $1,000 as reserves

(10 percent of $10,000) and it can loan the remainder, $9,000. Thus the deposit at the

second round bank will be $9,000. The second round bank keeps $900 as reserves (10

percent of $9,000) and can loan the remainder, $8,100. The deposit in the third round

bank will be $8,100.Topic: The rounds of money creationSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

14) The Fed conducts an open market operation and increases a bankʹs excess reserves by $2,000.

Explain the first five rounds of the money creation process if the desired reserve ratio is 25

percent and if people keep no currency outside of the banking system.

Answer: In round one, the bank gains $2,000 of reserves which it lends. The next bank receives as

a deposit the amount of the loan. The bank keeps $500 as desired reserves and lends

$1,500. In round three, the third bank receives the $1,500 in a deposit. It keeps 25

percent, or $375, as desired reserves and lends the rest, $1,125. In round four, the fourth

bank receives the $1,125 in a deposit. It keeps 25 percent, $281.25, as desired reserves

and lends the remainder, $843.75. Finally in round five, the next bank receives the

$843.75 in a deposit. It keeps $210.94 as desired reserves and lends the rest, $632.81.Topic: The rounds of money creationSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1080


15) ʺIf the currency drain ratio increases, the monetary base decreases.ʺ Explain whether the

previous statement is correct or incorrect.

Answer: The statement is false. If the currency drain ratio increases, the money multiplier (and

the quantity of money) decreases but the monetary base itself is unaffected.Topic: Currency drainSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Reflective thinking

16) What is a ʺcurrency drainʺ? How and why does it affect the money multiplier?

Answer: An increase in currency held outside the banks is a currency drain. A currency drain

decreases the size of the money multiplier. The money multiplier exists because when

banks loan their excess reserves, the funds wind up in other banks as excess reserves,

where they are loaned once again. As a result, an initial increase in reserves and the

monetary base wind up increasing the quantity of money by a magnified amount. A

currency drain means that when banks make loans, some of the funds are taken out as

cash and not deposited back in another bank. Thus the other banksʹ excess reserves do

not increase as much, so the amount that they can loan is decreased. The decrease in

loans means that the ultimate increase in the quantity of money is less, so that the

money multiplier is smaller.Topic: Currency drainSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Written and oral communication

17) How does a currency drain affect the money multiplier?

Answer: If the currency drain is zero so that all money created is deposited in bank accounts, the

money multiplier is equal to one divided by the desired reserve ratio. If the currency

drain is positive, then some newly created money is held in cash and is not deposited in

bank accounts. In this case, the money multiplier is smaller so that a change in the

monetary base leads to a smaller change in the quantity of money.Topic: Currency drainSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Written and oral communication

Page 1081


18) Explain how the currency drain ratio affects the size of the money multiplier. In your

explanation, suppose that in one round of the money creation process a bank gains $1 million

in new deposits and reserves. Further suppose that the desired reserve ratio is 10 percent and

the currency drain ratio is 50 percent.

Answer: The currency drain ratio decreases the size of the money multiplier. The money

multiplier reflects the fact that the banking system has a magnified effect on any change

in reserves because the reserves are loaned by many banks. A currency drain decreases

the amount of reserves that stay within the banking system.

For example, take the bank that gains $1 million in new deposits and reserves. With

the desired reserve ratio equal to 10 percent, start by assuming there is no currency

drain. In this case, the desired reserve ratio of 10 percent means that the bank keeps

$100,000 as reserves and so it will loan $900,000. The entire $900,000 will be deposited in

a second bank. The entire $900,000 deposit adds to the initial $1 million deposit to create

$1.9 million of new money. That bank will then keep $90,000 as reserves and loan

$810,000. In this stage, the entire $810,000 will be deposited in a third bank and so the

total new money (so far) created will become $2.71 million. Now, suppose that there is a

currency drain, say the currency drain ratio is 50 percent. In this case, of the $900,000

first loan, only $600,000 is deposited in the second bank because $300,000 (50 percent of

the $600,000 of deposits) is kept outside the banks as currency. Hence the second bank,

which keeps $60,000 as reserves, can loan only $540,000. And of this loan and ensuing

deposit, 50 percent or $180,000 is kept as currency and only $360,000 is left deposited in

the third bank. Therefore the amount that each bank can loan is reduced and so the

ultimate effect on the quantity of money is decreased.Topic: Currency drainSkill: Level 2: Using definitionsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

19) If the currency drain ratio increases, how can the Fed adjust the monetary base to offset the

effect on the quantity of money?

Answer: If the currency drain ratio increases, the size of the money multiplier decreases, which

decreases the quantity of money. To maintain the quantity of money at its initial

amount by changing the monetary base, the Fed must increase the monetary base.Topic: Currency drainSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Written and oral communication

Page 1082


20) Suppose the Fed conducts an open market operation in which it buys government securities

from a commercial bank. Why is there a multiplier effect on the quantity of money?

Answer: When the Fed buys government securities from a bank, the payment to the bank is in

the form of reserves. Hence the bank gains excess reserves. The bank can loan these

excess reserves. When the loan is spent, the recipients deposit some or all of the funds in

their banks. These banks gain deposits (which increase the quantity of money) as well as

excess reserves. The ʺsecond roundʺ banks then loan their excess reserves. And when

these loans are spent, once again the recipients deposit some or all of the funds in their

banks. These third-round banks thereby gain deposits (which further increases the

quantity of money) as well as excess reserves. These reserves are loaned, spent, and then

deposited in a fourth round of banks, which still further increases the quantity of

money. Hence the process of loaning and depositing the proceeds increases the quantity

of money by a multiple of the initial amount of the open market operation.Topic: Money multiplierSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Written and oral communication

21) If the currency drain ratio is 40 percent and the desired reserve ratio is 15 percent, what does

the money multiplier equal?

Answer: The money multiplier is 2.55. The money multiplier equals 1 + C/D

R/D + C/D with C/D = 0.40

and R/D = 0.15. Therefore, the money multiplier equals 1 + 0.40

0.15 + 0.40 =

1.40

0.55 = 2.55.

Topic: Money multiplierSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

22) Suppose the currency drain is 20 ratio percent and the desired reserve ratio is 10 percent.

a. What does the money multiplier equal?

b. If the Fed purchases $10 million of U.S. government securities, by how much will the

quantity of money increase or decrease?

Answer: a. The money multiplier is 4.00. The money multiplier equals 1 + C/D

R/D + C/D with C/D =

0.20 and R/D = 0.10. Therefore, the money multiplier equals 1 + 0.20

0.10 + 0.20 =

1.20

0.30 = 4.00.

b. If the Fed purchases $10 million of U.S. government securities, the quantity of

money increases by ($10 million × 4.00) = $40.0 million.Topic: Money multiplierSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1083


23) The Fed purchases $100,000 of U.S. government securities from One Bank. Assuming the

desired reserve ratio is 10 percent, banks loan all excess reserves, and the currency drain is 20

percent, how much does the quantity of money increase?

Answer: The quantity of money increases by (money multiplier × $100,000). The money

multiplier equals 1 + C/D

R/D + C/D with C/D = 0.20 and R/D = 0.10. Therefore, the money

multiplier equals 1 + 0.20

0.10 + 0.20 =

1.20

0.30 = 4.00. So the quantity of money increases by

(4.00) × ($100,000) = $400,000.Topic: Money multiplierSkill: Level 3: Using modelsSection: Checkpoint 11.4Status: OldAACSB: Analytical thinking

Page 1084


Chapter 12 Money, Interest, and Inflation

12.1 Money and the Interest Rate

1) The quantity of money demanded is the

A) average daily volume of bank account withdrawals.

B) amount that people and businesses choose to hold.

C) fraction of cash holdings in an average investment portfolio.

D) income and volume of profits that people and businesses would like to receive.

E) sum of checkable and savings deposits at banks.


2) The quantity of money demanded

A) is the total currency in circulation.

B) is the same as the money supply.

C) is equal to real GDP.

D) is the money that people choose to hold.

E) changes only when real GDP changes.


3) When you accumulate more money,

A) the marginal benefit of holding money decreases.

B) the opportunity cost of holding money decreases.

C) your marginal tax rate falls.

D) you earn a lower rate of interest on your checkable deposit.

E) the interest rate you are paid on your currency increases.

Answer: ATopic: Benefit of holding moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1085


4) When the opportunity cost of holding money increases, then

A) people want to hold more money.


C) the nominal interest rate falls.

D) people want to hold less money.

E) the quantity of money supplied increases.

Answer: DTopic: Opportunity cost of holding moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

5) As opportunity cost of holding money increases, people can

A) do nothing.

B) try to maximize marginal benefit.

C) find a better job.

D) seek substitutes for money.

E) increase the demand for money but not the quantity of money they hold.

Answer: DTopic: Opportunity cost of holding moneySkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

6) The opportunity cost of holding money is that you

A) run a greater risk of being robbed.

B) pay a higher tax rate.

C) forego interest on an alternative asset.

D) have trouble balancing your check book.

E) must make more trips to the bank to manage the money.

Answer: CTopic: Opportunity cost of holding moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

7) The opportunity cost of holding money instead of an interest earning asset is the

A) real interest rate.

B) nominal interest rate.

C) inflation rate minus the nominal interest rate.

D) inflation rate.

E) inflation rate minus the real interest rate.

Answer: BTopic: Opportunity cost of holding moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1086


8) The opportunity cost of holding money is the

A) nominal interest rate.

B) real interest rate.

C) inflation rate.

D) time it takes to go to the ATM or bank.

E) growth rate of real GDP.

Answer: ATopic: Opportunity cost of holding moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: RevisedAACSB: Reflective thinking

9) When the nominal interest rate falls, the opportunity cost of holding money

A) decreases and the demand for money curve shifts leftward.

B) decreases and there is a movement downward along the demand for money curve.

C) increases and there is a movement upward along the demand for money curve.

D) decreases and the demand for money curve shifts rightward.

E) increases and the demand for money curve shifts rightward.


10) The quantity of money demanded will decrease if the

A) inflation rate decreases.

B) nominal interest rate decreases.

C) real interest rate decreases.

D) nominal interest rate increases.

E) price level rises.

Answer: DTopic: Opportunity cost of holding moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

11) The lower the nominal interest rate, the

A) greater the demand for money.

B) greater the quantity of money demanded.

C) greater the quantity of money supplied.

D) smaller the demand for goods and services.

E) smaller the quantity of money demanded.


Page 1087


12) The ________ the nominal interest rate, the ________ is the quantity of money demanded.

A) lower; greater

B) lower; smaller

C) higher; greater

D) more variable; smaller

E) None of the above because the nominal interest rate does not influence the quantity of

money demanded.

Answer: ATopic: Opportunity cost of holding moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

13) Mary has $1,000 and is considering purchasing a $1,000 bond that pays 7 percent interest per

year. Mary decides not to buy the bond and holds the $1,000 as cash. If the inflation rate is 4

percent, the opportunity cost of holding the $1,000 as money is

A) $30.00. B) $40.00. C) $70.00. D) $110.00. E) $100.00.

Answer: CTopic: Opportunity cost of holding moneySkill: Level 4: Applying modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

14) Suppose you can earn 5 percent on your savings account if you deposit $500 in it. The inflation

rate is 3 percent. The opportunity cost of holding the $500 as money is

A) $25. B) $100. C) $80. D) $525. E) $30.

Answer: ATopic: Opportunity cost of holding moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

15) The relationship between the nominal interest rate, the real interest rate, and the inflation rate

is that the

A) real interest rate is equal to the nominal interest rate plus the inflation rate.

B) nominal interest rate is equal to the real interest rate plus the inflation rate.

C) real interest rate is equal to the nominal interest rate multiplied by the inflation rate.

D) nominal interest rate is equal to the real interest rate divided by the inflation rate.

E) nominal interest rate is equal to the real interest rate minus the inflation rate.

Answer: BTopic: Interest ratesSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1088


16) The real interest rate equals the

A) nominal interest rate - inflation rate.

B) (nominal interest rate ÷ inflation rate) × 100.

C) inflation rate - nominal interest rate.

D) (nominal interest rate × inflation rate)/100.

E) nominal interest rate ÷ inflation rate.

Answer: ATopic: Interest ratesSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

17) The difference between the nominal interest rate and the real interest rate is the

A) inflation rate.

B) unemployment rate.

C) GDP growth rate.

D) money growth rate minus the growth rate of real GDP.

E) price level.

Answer: ATopic: Interest ratesSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

18) In the long run, the nominal interest rate is

A) negatively related to the price level.

B) positively related to the price level.

C) negatively related to the inflation rate.

D) positively related to the inflation rate.

E) not related to the price level or the inflation rate.

Answer: DTopic: Interest ratesSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

19) You have a $500 saving bond. The nominal interest rate is 10 percent, and the inflation rate is 4

percent. After a year, in real terms you have earned

A) $70. B) $40. C) $50. D) $30. E) $510.

Answer: DTopic: Interest ratesSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1089


20) You have a $500 saving bond. If the nominal interest rate is 10 percent, then the inflation rate

must be

A) zero, otherwise you would sell the bond.

B) 10 percent if in real terms you earned $200.

C) 4 percent if in real terms you earned $70.

D) 4 percent if in real terms you earned $30.

E) 10 percent if in real terms you earned $100.

Answer: DTopic: Interest ratesSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: NewAACSB: Analytical thinking

21) Suppose the nominal interest rate on a savings bond is 7 percent a year and the inflation rate is

4.5 percent a year. How much is the real interest rate?

A) 1.56 percent

B) 11.5 percent

C) 2.5 percent

D) 7 percent

E) 4.5 percent

Answer: CTopic: Interest ratesSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

22) If the inflation rate is 2.5 percent and the nominal interest rate is 10 percent, then the real

interest rate is

A) 2.5 percent.

B) 7.5 percent.

C) -7.5 percent.

D) -2.5 percent.

E) 12.5 percent.

Answer: BTopic: Interest ratesSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1090


23) If the inflation rate is 5 percent and the real interest rate is 2.5 percent, then the nominal

interest rate is

A) -2.5 percent.

B) 2 percent.

C) 7.5 percent.

D) 2.5 percent.

E) 10 percent.


24) If the real interest rate is 8 percent and the inflation rate is 2.5 percent, then the nominal

interest rate is

A) 10.5 percent.

B) 2.5 percent.

C) 5.5 percent.

D) 8 percent.

E) 3.2 percent.

Answer: ATopic: Interest ratesSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

25) Barbara is willing to loan $10,000 if she can earn a real interest rate of 6 percent. Everything

else the same, if the inflation rate is 2 percent, she would agree to loan the $10,000 if the

nominal interest rate is

A) 4 percent.

B) 10 percent.

C) 3 percent.

D) 8 percent.

E) 12 percent.

Answer: DTopic: Interest ratesSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1091


26) Barbara is willing to loan $10,000 if she can earn a real interest rate of 6 percent. Everything

else the same, if the inflation rate is 2 percent, she would agree to loan the $10,000 if the

nominal interest rate is ________ because ________.

A) 8 percent; she would earn more than her desired amount of 6 percent

B) 4 percent or higher; she would not earn her desired amount of 6 percent if the nominal

interest rate was any lower

C) 4 percent or lower; she would not earn her desired amount of 6 percent if the nominal

interest rate was any higher

D) 8 percent or higher; she would not earn her desired amount of 6 percent if the nominal

interest rate was any lower

E) 8 percent or lower; she would not earn her desired amount of 6 percent if the nominal

interest rate was any higher

Answer: DTopic: Interest ratesSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: NewAACSB: Analytical thinking

27) Assume you have a credit card balance of $2,000 at 15 percent and the inflation rate is 3

percent. What are the nominal and real interest rates?

A) 15 percent nominal and 3 percent real

B) 3 percent nominal and 12 percent real

C) 15 percent nominal and 12 percent real

D) 15 percent nominal and 18 percent real

E) 12 percent nominal and 15 percent real


28) The nominal interest rate is 12 percent and the inflation rate is 4 percent. The opportunity cost

of holding a dollar for a year is

A) 12 cents. B) 16 cents. C) 88 cents. D) 8 cents. E) 48 cents.

Answer: ATopic: Opportunity cost of holding moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1092


29) The opportunity cost of holding money

A) increases as the nominal interest rate increases.

B) decreases as the nominal interest rate increases.

C) does not change with the changes in the nominal interest rate.

D) is fixed at all interest rates.

E) is the price level.

Answer: ATopic: Demand for moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

30) The demand for money curve shows the relationship between the quantity of money

demanded and

A) the nominal interest rate.

B) the real interest rate.

C) the inflation rate.

D) the price level.

E) real GDP.


31) Which of the following increases the quantity of money demanded?

A) a rise in the nominal interest rate

B) a rise in the inflation rate

C) a rise in the real interest rate

D) a fall in the nominal interest rate

E) an increase in real GDP

Answer: DTopic: Demand for moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1093


32) When the nominal interest rate falls, there is

A) an upward movement along the demand for money curve.

B) a downward movement along the demand for money curve.

C) a rightward shift of the demand for money curve.

D) a leftward shift of the demand for money curve.

E) no movement along the demand for money curve and the curve does not shift.

Answer: BTopic: Demand for moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

33) An increase in the nominal interest rate leads to

A) a rightward shift in the demand for money curve.

B) a movement upward along the demand for money curve.

C) a leftward shift in the demand for money curve.

D) a movement downward along the demand for money curve.

E) neither a shift in nor a movement along the demand for money curve.


34) The demand for money curve slopes downward because a rise in the nominal interest rate

________ the opportunity cost of holding money and therefore ________ the quantity of money

demanded.





E) increases; does not change


Page 1094


35) The demand for money schedule shows the ________ relationship between money demand

and the nominal interest rate which means that as the ________.

A) negative; nominal interest rate increases, the opportunity cost of holding money

increases

B) negative; nominal interest rate increases, the opportunity cost of holding money

decreases

C) positive; nominal interest rate increases, the opportunity cost of holding money increases

D) positive; nominal interest rate increases, the opportunity cost of holding money

decreases

E) negative; opportunity cost of holding money increases, the nominal interest rate

increases

Answer: ATopic: Demand for moneySkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

36) When the nominal interest rate increases, the

A) quantity of money demanded increases and there is a movement upward along the

demand for money curve.

B) quantity of money demanded decreases and there is a movement upward along the


C) demand for money increases and the demand for money curve shifts rightward.

D) demand for money decreases and the demand for money curve shifts leftward.

E) supply of money curve shifts rightward.


37) As the nominal interest rate increases, the opportunity cost of holding money ________ and

the quantity of money demanded ________.





E) increases; does not change because people need money


Page 1095


38) If the interest rate rises from 1 percent to 3 percent, the ________ decreases and the

opportunity cost of holding money ________.

A) quantity of money demanded; rises

B) quantity of money demanded; falls

C) quantity of money supplied; rises

D) quantity of money supplied; falls

E) demand for money; rises


39) In 2009, the interest rate fell below 1 percent in the United States. As a result, there was a

A) leftward shift in the supply of money curve.

B) rightward shift in the demand for money curve.

C) movement downward along the demand for money curve.

D) movement upward along the demand for money curve.

E) movement upward along the money supply curve.

Answer: CTopic: Demand for moneySkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

40) As the economy enters a strong expansion in which real GDP increases, which of the following

occurs?

A) The demand for money curve shifts rightward.

B) The demand for money curve shifts leftward.

C) The demand for money decreases and there is a movement upward along the demand

for money curve.

D) The demand for money increases and there is a movement downward along the demand

for money

curve.

E) The nominal interest rate falls as the demand for money curve shifts leftward.


Page 1096


41) The quantity of money demanded is proportional to

A) the inflation rate.

B) real GDP.

C) the price level.

D) the real interest rate.

E) the nominal interest rate.

Answer: CTopic: Demand for money, price levelSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

42) The demand for money is

A) positively related to the price level.

B) positively related to the nominal interest rate.

C) negatively related to the price level.

D) negatively related to real GDP.

E) positively related to the real interest rate.

Answer: ATopic: Demand for money, price levelSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

43) If the price level increases, the

A) demand for money increases.

B) demand for money decreases.

C) quantity of money demanded increases.

D) quantity of money demanded decreases.

E) demand for money does not change and the quantity of money demanded does not

change.


Page 1097


44) Suppose that the price level does not change while real GDP decreases. As a result,

A) the demand for money increases and the demand for money curve shifts rightward.

B) the supply of money curve shifts leftward.

C) the supply of money curve shifts rightward.

D) the quantity of money demanded decreases and there is a movement downward along

the demand for money curve.

E) the demand for money decreases so that households and firms hold smaller amounts of

money.

Answer: ETopic: Demand for moneySkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

45) When the price level increases, people demand ________ money and the demand for money

curve ________.

A) more; shifts rightward

B) more; shifts leftward

C) less; shifts rightward

D) less; shifts leftward

E) the same amount of; does not shift


46) The demand for money increases and the demand for money curve shifts rightward if

A) the real interest rate increase.

B) the nominal interest rate increases.

C) the price level increases.

D) the inflation rate increases.

E) real GDP decreases.


Page 1098


47) If the price level rises, there is

A) an upward movement along the demand for money curve and the curve does not shift.

B) a downward movement along the demand for money curve and the curve does not shift.



E) no movement along the demand curve for money and the curve does not shift.


48) If the price level falls, the




D) quantity of money demanded decreases.

E) demand for money does not change and the quantity of money demanded does not

change.

Answer: BTopic: Demand for money, price levelSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

49) The ________ the price level, the ________.

A) higher; greater the demand for money

B) higher; smaller the demand for money

C) lower; greater the demand for money

D) higher; greater the supply of money

E) higher; smaller the supply of money


Page 1099


50) An increase in the price level leads to a

A) rightward shift in the demand for money curve.

B) movement upward along the demand for money curve and no shift of the curve.

C) leftward shift in the demand for money curve.

D) movement downward along the demand for money curve and no shift of the curve.

E) rightward shift of the supply of money curve.


51) An increase in the price level leads to ________ in the demand for money, and an increase in

real GDP leads to ________ in the demand for money.





E) no change; an increase

Answer: ATopic: Demand for money, price level and real GDPSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

52) If real GDP decreases, the




D) supply of money decreases.

E) supply of money increases.

Answer: BTopic: Demand for money, real GDPSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1100


53) An increase in real GDP affects the demand for money because

A) when real GDP increases, more money is needed to make expenditures.

B) at the higher price level, it takes more dollars to make expenditures.

C) tax payments rise because more income is earned.

D) there is an inverse relationship between the quantity money demanded and nominal

GDP.

E) the larger real GDP, the higher the real interest rate.

Answer: ATopic: Demand for money, real GDPSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

54) The ________ real GDP, the ________.

A) larger; larger the demand for money

B) larger; smaller the demand for money

C) smaller; larger the demand for money

D) larger; larger the supply of money

E) larger; smaller the supply of money


55) All else the same, when real GDP increases, the

A) demand for money decreases.

B) demand for money increases.

C) supply of money decreases.

D) supply of money increases.

E) supply of money does not change, and the demand for money does not change.

Answer: BTopic: Demand for money, real GDPSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1101


56) The demand for money increases and the demand curve for money shifts rightward as a result

of

A) an increase in real GDP.

B) a decrease in the real interest rate.

C) an increase in the use of credit cards.

D) a decrease in the price level.

E) a decrease in the nominal interest rate.


57) If real GDP decreases, there is

A) an upward movement along the demand for money curve and no shift of the curve.

B) a downward movement along the demand for money curve and no shift of the curve.



E) no movement along the demand for money curve and the curve does not shift.

Answer: DTopic: Demand for money, real GDPSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

58) When real GDP increases, the demand for money ________ and the demand for money curve

________.

A) increases; shifts rightward

B) increases; shifts leftward

C) decreases; shifts rightward

D) decreases; shifts leftward



Page 1102


59) The demand for money increases and the demand for money curve shifts rightward if

A) the real interest rate increases.

B) the nominal interest rate increases.

C) real GDP increases.

D) the inflation rate increases.

E) the price level falls.

Answer: CTopic: Demand for money, real GDPSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

60) An increase in real GDP leads to


B) a movement upward along the demand for money curve but no shift of the curve.


D) a movement downward along the demand for money curve but no shift of the curve.

E) neither a shift in the demand for money curve nor a movement along the curve.


61) During an economic expansion when real GDP increases, the



C) supply of money decreases.

D) nominal interest rate is constant.

E) real interest rate is constant.


62) During an economic expansion, the demand for money ________ because ________.

A) increases; real GDP increases

B) increases; nominal GDP does not change

C) decreases; real GDP increases

D) decreases; nominal GDP increases

E) does not change; people make more purchases with credit cards

Answer: ATopic: Demand for money, real GDPSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: NewAACSB: Reflective thinking

Page 1103


63) During a(n) ________ the demand for money decreases because ________.

A) recession; real GDP decreases

B) expansion; real GDP decreases

C) recession; nominal GDP increases

D) recession; the price level rises

E) equilibrium; real GDP decreases

Answer: ATopic: Demand for money, real GDPSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: NewAACSB: Reflective thinking

64) Which of the following shifts the demand for money curve?

i. change in the nominal interest rate

ii. change in real GDP

iii. change in the price level

A) i only

B) ii only

C) iii only

D) ii and iii

E) i, ii, and iii

Answer: DTopic: Demand for moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

65) Which statement most accurately describes the effect financial technology has had on the

demand for money in the United States?

A) Advances in financial technology have all decreased the demand for money.

B) Advances in financial technology have all increased the demand for money.

C) Some advances in financial technology have increased the demand for money while

others have decreased it.

D) Advances in financial technology have had no effect on the demand for money.

E) It is not possible to tell what would be the effect because financial technology has not

changed over the past three decades.

Answer: CTopic: Demand for moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1104


66) Advances in financial technology

A) must increase the demand for money.

B) must decrease the demand for money.

C) have no effect on the demand for money or on the supply of money.

D) might increase or decrease the demand for money.

E) affect only the supply of money.

Answer: DTopic: Demand for moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

67) The increased use of credit cards leads to


B) a movement upward along the demand for money curve.


D) a movement downward along the demand for money curve.

E) no movement along the demand curve for money nor a shift in the demand curve.

Answer: CTopic: Demand for money, credit cardsSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

68) As more and more businesses accept credit cards, the




D) supply of money decreases.

E) quantity of money demanded decreases.

Answer: BTopic: Demand for money, credit cardsSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

69) If credit card usage exhibits a sharp increase, there is

A) an upward movement along the demand for money curve.

B) a downward movement along the demand for money curve.



E) a leftward shift of the supply of money curve.

Answer: DTopic: Demand for money, credit cardsSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1105


70) All of the following shift the demand for money curve EXCEPT

A) an improvement in financial technology.

B) an increase in real GDP.

C) a rise in the nominal interest rate.

D) a decrease in real GDP.

E) an increase in the price level.

Answer: CTopic: Demand for moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

71) In the above figure, a movement from point A to point B represents

A) an increase in the demand for money that might be the result of an increase in real GDP.

B) a decrease in the demand for money that might be the result of a fall in the price level.

C) a decrease in the quantity of money demanded.

D) an increase in the quantity of money demanded.

E) an increase in the demand for money that might be the result of a fall in the price level.

Answer: DTopic: Demand for moneySkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1106


72) In the above figure, a movement from point B to point C represents

A) an increase in the demand for money that might be the result of an increase in real GDP.

B) a decrease in the demand for money that might be the result of an increase in real GDP.

C) a decrease in the quantity of money demanded.

D) an increase in the quantity of money demanded.

E) an increase in the demand for money that might be the result of a fall in the price level.

Answer: ATopic: Demand for moneySkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

73) From 1970 to 2010, as a fraction of GDP, the quantity of money that people and businesses

have held has been

A) decreasing.

B) increasing.

C) fluctuating erratically.

D) independent of peopleʹs use of credit cards.

E) changing only as the interest rate changed.

Answer: ATopic: Eye on the U.S. economy, money and credit cardsSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Written and oral communication

74) Since 1970, as a percent of GDP, M1 held has steadily decreased. Which of the following can

account for this fact?

A) Real GDP has increased since 1970.

B) The price level has risen since 1970.

C) Credit cards have become more widely available since 1970.

D) The nominal interest rate has steadily risen since 1970.

E) The nominal interest rate has steadily fallen since 1970.

Answer: CTopic: Eye on the U.S. economy, money and credit cardsSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Written and oral communication

Page 1107


75) In the United States since 1970, the quantity of M1 money people hold as a percentage of GDP

has

A) increased.

B) decreased.

C) remained constant.

D) increased at first and the decreased.

E) decreased at first and then increased.

Answer: BTopic: Eye on the U.S. economy, money and credit cardsSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Written and oral communication

76) As a result of increased use of credit cards,

A) the demand for money has decreased and the demand for money curve has shifted

leftward.

B) the demand for money has decreased and there has been a movement up along the


C) the demand for money has decreased and there has been a movement down along the


D) the equilibrium nominal interest rate has increased and bond prices have decreased.

E) the equilibrium nominal interest rate has decreased and bond prices have fallen.

Answer: ATopic: Eye on the U.S. economy, money and credit cardsSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

77) From 1970 to 2007 the quantity of M1 fell from 20 percent of GDP to less than 10 percent. This

change is because the ownership of credit cards ________ during this time period since

________.

A) expanded from 18 percent to 76 percent; credit cards became more widely available and

utilized

B) fell from 76 percent to 18 percent; credit cards became less widely available and utilized

C) remained unchanged; credit cards do not affect the quantity of money

D) fell from 76 percent to 18 percent; there were several recessions during that period

E) expanded from 18 percent to 76 percent; there were several recessions during that period

Answer: ATopic: Eye on the U.S. economy, money and credit cardsSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: NewAACSB: Analytical thinking

Page 1108


78) From 1970 to 2007 households held ________ because ________.

A) less money relative to income; people began using credit cards more often

B) less money relative to income; people began using credit cards less often

C) less money relative to income; the price level began to rise

D) more money relative to income; people began using credit cards more often

E) more money relative to income; people began using credit cards less often

Answer: ATopic: Eye on the U.S. economy, money and credit cardsSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: NewAACSB: Analytical thinking

79) The supply of money curve is

A) upward sloping, showing the influence of the interest rate.

B) horizontal because interest rates are fixed at any one moment.

C) vertical because the quantity of money is fixed at any one moment.

D) downward sloping, showing the negative influence of the interest rate.

E) horizontal because the Fed controls the quantity of money supplied.

Answer: CTopic: Supply of moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

80) In the demand and supply model of the money market, the

i. supply of money curve is a vertical straight line.

ii. supply of money is the quantity that must be held by households and firms.

iii. quantity of money is determined by Fed actions.

A) i only

B) ii only

C) iii only

D) ii and iii

E) i, ii, and iii

Answer: ETopic: Supply of moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1109


81) On any given day, ________ changes to achieve equilibrium in the money market.

A) real GDP

B) the price level

C) the inflation rate

D) the nominal interest rate

E) the real interest rate

Answer: DTopic: Money market equilibriumSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

82) Every day, ________ changes to make the quantity of money demanded equal the quantity of

money supplied.

A) real GDP

B) the money supply

C) the price level

D) the nominal interest rate

E) the inflation rate

Answer: DTopic: Money market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

83) In the money market, if the nominal interest rate is below the equilibrium level,

A) the quantity of money demanded exceeds the quantity of money supplied.

B) the quantity of money supplied exceeds the quantity of money demanded.

C) asset prices will rise.

D) the demand for money curve will shift leftward.

E) the supply of money curve will shift leftward.

Answer: ATopic: Money market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1110


84) Suppose that the equilibrium nominal interest rate is 4 percent and the equilibrium quantity of

money is $1 trillion. At any interest rate above 4 percent,

A) less than $1 trillion will be demanded and bond prices will increase.

B) less than $1 trillion will be demanded and bond prices will fall.

C) more than $1 trillion will be supplied and bond prices will fall.

D) more than $1 trillion will be supplied and the interest rate will rise.

E) there is a shortage of money and the interest rate will rise.

Answer: ATopic: Money market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

85) Suppose that the equilibrium nominal interest rate is 5 percent and the equilibrium quantity of

money is $1 trillion. At any interest rate below 5 percent,

A) the interest rate will rise and bond prices will fall.

B) the interest rate will fall and bond prices will fall.

C) there will be a surplus of money and bond prices will fall.

D) there will be a surplus of money and bond prices will increase.

E) the supply of money will decrease.


86) If the quantity of money demanded is greater than the quantity supplied, then in the short run

the

A) demand for financial assets increases.

B) nominal interest rate falls.

C) nominal interest rate rises.

D) price of financial assets rises.


Answer: CTopic: Money market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1111


87) If the nominal interest rate is less than the equilibrium nominal interest rate determined in the

money market, then households and firms

A) are holding more money than they prefer.

B) are holding less money than they prefer.

C) expect the nominal interest rate to decrease.

D) expect the price level to increase.

E) expect real GDP to increase.

Answer: BTopic: Money market equilibriumSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

88) If the nominal interest rate is less than the equilibrium nominal interest rate determined in the

money market, then in the short run households and firms

A) sell financial assets.

B) buy financial assets.

C) raise the price level.

D) lower the price level.

E) increase real GDP.

Answer: ATopic: Money market equilibriumSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

89) When households and firms sell financial assets, such as government securities, the

A) nominal interest rate falls.

B) market price of the securities increases.

C) nominal interest rate rises.

D) demand for money curve shifts leftward.

E) supply of money curve shifts leftward.

Answer: CTopic: Money market equilibriumSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1112


90) When the nominal interest rate is ________ the equilibrium interest rate, the quantity of money

demanded is less than the quantity of money supplied; when the nominal interest rate is

________ the equilibrium interest rate, the quantity of money demanded exceeds the quantity

of money supplied.

A) less than; greater than

B) equal to; less than

C) greater than; equal to

D) greater than; less than

E) equal to; greater than

Answer: DTopic: Money market equilibriumSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

91) In the money market, if the quantity of money supplied exceeds the quantity of money

demanded, the nominal interest rate will ________ and the prices of assets will ________.

A) rise; increase

B) rise; decrease

C) fall; increase

D) fall; decrease

E) fall; not change

Answer: CTopic: Money market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

92) If the quantity of money supplied is greater than the quantity of money demanded, then the

A) nominal interest rate rises.


C) price of financial assets falls.

D) money supply decreases.

E) price level falls.

Answer: BTopic: Money market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1113


93) When the Fed changes the quantity of money, there is an immediate effect on

A) the nominal interest rate.

B) real GDP.

C) the price level but not the inflation rate.

D) the inflation rate but not the price level.

E) the price level and the inflation rate.

Answer: ATopic: Money market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

94) If the Fed wants to raise the interest rate, in the short run in the money market the Fed



C) shifts the demand for money curve leftward.

D) shifts the demand for money curve rightward.

E) directly raises the interest rate and does nothing to either the supply of money or the

demand for money.


95) If the Fed is worried about inflation and wants to raise the interest rate, in the short run it can

A) increase the demand for money.

B) increase the quantity of money.

C) decrease the demand for money.

D) decrease the quantity of money.

E) directly raise the interest rate without affecting either the demand for money or the

supply of money.

Answer: DTopic: Money market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1114


96) In the money market, in the short run if the quantity of money exceeds the quantity of money

demanded, then to achieve equilibrium the

A) supply of money increases.


C) inflation rate increases.

D) demand for money increases.


Answer: BTopic: Money market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

97) In the money market, in the short run in order to decrease the nominal interest rate, the Fed

must

A) increase the quantity of money.

B) increase the discount rate.

C) decrease the demand for money.

D) decrease the quantity of money.

E) directly lower the interest rate and not change either the demand for money or the

supply of money.

Answer: ATopic: Money market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

98) In the short run, when the Fed increases the quantity of money, the


B) price level decreases.

C) nominal interest rate falls.

D) quantity demanded of money decreases.

E) demand for money decreases.

Answer: CTopic: Money market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1115


99) Other things the same, if the Fed increases the quantity of money, the supply of money curve

shifts

A) rightward and the nominal interest rate decreases.

B) leftward and the nominal interest rate increases.

C) rightward and the real interest rate increases.

D) leftward and the real interest rate increases.

E) leftward and the nominal interest rate decreases.


100) Other things the same, if the Fed increases the quantity of money, the ________ because

________.

A) nominal interest rate decreases; the supply of money curve shifts rightward

B) nominal interest rate decreases; the supply of money curve shifts leftward

C) nominal interest rate does not change; only the real interest rate is effected

D) nominal interest rate increases; the supply of money curve shifts rightward

E) nominal interest rate increases; the supply of money curve shifts leftward

Answer: ATopic: Money market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: NewAACSB: Analytical thinking

101) In the money market, if real GDP increases, then the demand for money ________ and the

equilibrium nominal interest rate ________.

A) increases; rises

B) increases; falls

C) decreases; rises

D) decreases; falls



Page 1116


102) In the money market, if the price level rises, then the demand for money ________ and the

equilibrium nominal interest rate ________.

A) increases; rises

B) increases; falls

C) decreases; rises

D) decreases; falls



103) A change in financial technology that reduces the need to hold cash balances ________ the

demand for money and ________ the equilibrium nominal interest rate.

A) increases; raises

B) increases; lowers

C) decreases; raises

D) decreases; lowers


Answer: DTopic: Money market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1117


104) In the above figure, if the interest rate is 8 percent per year, the quantity of money demanded

is

A) less than the quantity of money supplied, and the interest rate will change.

B) greater than the quantity of money supplied, and the interest rate will change.

C) less than the quantity of money supplied, and the demand curve for money will shift.

D) greater than the quantity of money supplied, and the demand curve for money will shift.

E) greater than the quantity of money supplied, and the supply curve of money will shift.


105) In the above figure, the equilibrium interest rate is ________ and the equilibrium quantity of

money is ________ trillion.

A) 8 percent; $1.2

B) 4 percent; $0.6

C) 4 percent; $1.2

D) 8 percent; $0.6

E) 0 percent; $1.2

Answer: BTopic: Money market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1118



is



C) less than the quantity of money supplied, and the demand for money curve will shift.

D) greater than the quantity of money supplied, and the demand for money curve will shift.

E) greater than the quantity of money supplied, and the supply of money curve will shift.



is



C) less than the quantity of money supplied, and the demand for money curve will shift.

D) greater than the quantity of money supplied, and the demand for money curve will shift.

E) greater than the quantity of money supplied, and the supply of money curve will shift.


108) In the above figure, if the interest rate is 2 percent per year, the ________ because ________.

A) interest rate will change; the quantity of money demanded is less than the quantity of

money supplied

B) interest rate will change; the quantity of money demanded is greater than the quantity of

money supplied

C) demand for money curve will shift; the quantity of money demanded is less than the

quantity of money supplied

D) demand for money curve will shift; the quantity of money demanded is greater than the


E) supply of money curve will shift; the quantity of money demanded is greater than the


Answer: BTopic: Money market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: NewAACSB: Analytical thinking

Page 1119


Nominal interest rate

(percent per year)

Quantity of

money demanded

(trillions of dollars)

Quantity of

money supplied


5 2.9 2.5

6 2.8 2.5

7 2.7 2.5

8 2.6 2.5

9 2.5 2.5

10 2.4 2.5

109) The above table has the demand and supply schedules for money. What is the equilibrium

nominal interest rate?

A) 5 percent B) 9 percent C) 8 percent D) 7 percent E) 6 percent


110) The above table has the demand and supply schedules for money. If the Fed increases the

quantity of money by $0.1 trillion, the new equilibrium nominal interest rate is

A) 8 percent. B) 9 percent. C) 7 percent. D) 5 percent. E) 6 percent.


111) The above table has the demand and supply schedules for money. Real GDP increases and, as

a result, the demand for money increases by $0.1 trillion at each level of the nominal interest

rate. The new equilibrium interest rate is

A) 3 percent.

B) 7 percent.

C) 10 percent.

D) 5 percent.

E) 2 percent.

Answer: CTopic: Money market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: RevisedAACSB: Analytical thinking

Page 1120


112) The quantity of money demanded

A) is infinite.

B) has no opportunity cost.

C) is the quantity that balances the benefit of holding an additional dollar of money against

the opportunity cost of doing so.

D) is directly controlled by the Fed.

E) changes very infrequently.

Answer: CTopic: Real moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking


A) Nominal interest rate = Real interest rate - Inflation rate

B) Nominal interest rate = Real interest rate + Inflation rate

C) Nominal interest rate = Inflation rate - Real interest rate

D) Nominal interest rate = Inflation rate + Price index

E) Nominal interest rate = Inflation rate ÷ Real interest rate

Answer: BTopic: Real moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

114) The demand for money ________ when the ________.

A) increases; price level increases

B) decreases; price level increases

C) remains constant; price level increases

D) increases; nominal interest rate increases

E) increases; supply of money decreases


Page 1121


115) If the nominal interest rate is above its equilibrium value, then

A) people sell financial assets and the interest rate falls.

B) people buy financial assets and the interest rate falls.

C) the demand curve for money shifts rightward and the interest rate rises.

D) the supply curve of money shifts leftward and the interest rate rises.

E) the demand curve for money shifts leftward and the interest rate falls.

Answer: BTopic: Money market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

116) When the Fed increases the quantity of money, the

A) equilibrium nominal interest rate falls.

B) equilibrium nominal interest rate rises.

C) demand for money curve shifts rightward.

D) supply of money curve shifts leftward.

E) demand for money curve shifts leftward.


12.2 Money, the Price Level, and Inflation

1) In the long-run, money market equilibrium determines

A) the value of money.

B) the nominal interest rate

C) the real interest rate.

D) real GDP.

E) velocity.

Answer: ATopic: Money market in the long runSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

Page 1122


2) The ʺvalue of moneyʺ

A) is the quantity of goods and services that a unit of money can buy.

B) is determined by Fed regulations.

C) increases during inflationary periods.

D) increases during economic expansions.

E) is directly related to the price level.

Answer: ATopic: Value of moneySkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

3) Which of the following applies to the ʺvalue of moneyʺ?

i. It is the inverse of the price level.

ii. The value of money falls during economic expansions.

iii. It is the quantity of goods and services that a unit of money will buy.

A) i and iii

B) i, ii and iii

C) iii only

D) ii and iii

E) i and ii

Answer: ATopic: Value of moneySkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

4) In the long run, what determines the value of money?

A) the government budget balance

B) international trade

C) money market equilibrium

D) equilibrium in the loanable funds market

E) real GDP

Answer: CTopic: Value of moneySkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

Page 1123


5) If the quantity of money supplied ________ the quantity demanded, in the long run the value

of money ________.

A) exceeds; falls as people spend their surplus money

B) exceeds; rises as people buy bonds

C) is less than; falls as people spend their surplus money

D) is less than; does not change unless the Fed increases the money supply

E) equals; equals zero

Answer: ATopic: Value of moneySkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

6) The long-run money demand curve shows

A) that the value of money influences the quantity of money that households and firms plan

to hold.

B) that the value of money is directly related to the quantity of money demanded.

C) the relationship between real GDP and money demand.

D) the relationship between potential GDP and money demand.

E) how the Fed determines the appropriate interest rate.

Answer: ATopic: Long-run money demand


7) If the Fed increases the quantity of money, in the short run the ________ and in the long run

the ________.

A) price level rises; the nominal interest rate falls

B) nominal interest rate falls; the price level falls

C) nominal interest rate rises; the price level falls

D) nominal interest rate falls; the price level rises

E) nominal interest rate rises; the price level rises

Answer: DTopic: Long-run money demand


Page 1124


8) In the figure above, in the long run what happens if the Fed increases the quantity of money

by 5 percent?

A) The value of money falls by 5 percent and there will be a movement down along the

LRMD curve.

B) The real interest rate falls and the LRMD curve shifts rightward.

C) The nominal interest rate rises by 5 percent.

D) The price level rises by 5 percent and the LRMD shifts leftward.

E) The value of money rises by 5 percent.

Answer: ATopic: Long-run money demand


9) In the figure above, what happens if the Fed increases the quantity of money by 8 percent?

A) The LRMD curve shifts rightward to restore equilibrium.

B) The value of money falls to 0.92 and there is a movement downward along the LRMD.

C) The price level falls to 1.08.

D) The interest rate rises to 1.08.

E) The value of money rises to 1.08.

Answer: BTopic: Long-run money demand


Page 1125


10) In the long run, an increase in the quantity of money ________ the value of money and

________ the price level.

A) raises; raises

B) raises; does not change

C) lowers; lowers

D) lowers; does not change

E) lowers; raises

Answer: ETopic: Money market in the long runSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

11) In the long run, when the Fed increases the quantity of money, the

A) price level rises.


C) demand for money decreases.

D) price level falls.

E) real interest rate rises.

Answer: ATopic: Money and the price levelSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

12) In the long run, an increase in the quantity of money leads to

A) an equal percentage increase in the real interest rate.

B) a smaller percentage increase in the real interest rate.

C) an equal percentage increase in the price level.

D) a smaller percentage increase in the price level.

E) no effect on the price level or on real GDP.

Answer: CTopic: Money and the price levelSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

Page 1126


13) In the long run, an increase in the quantity of money, other things remaining the same,

A) increases the price level.

B) decreases the price level.

C) increases real GDP.

D) decreases real GDP.

E) has no effect on the price level or real GDP.

Answer: ATopic: Money and the price levelSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

14) Other things remaining the same, in the long run ________ in the quantity of money brings an

equal percentage ________.

A) an increase; decrease in the price level

B) a decrease; decrease in the price level

C) a decrease; increase in the price level

D) a decrease; increase in the nominal interest rate

E) an increase; increase in the real interest rate

Answer: BTopic: Money and the price levelSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

15) The proposition that in the long run when real GDP equals potential GDP, an increase in the

quantity of money leads to an equal percentage increase in the price level is the called the

quantity theory of

A) constant velocity.

B) inflation.

C) money.

D) equal change.

E) the long run.

Answer: CTopic: Quantity theory of moneySkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

Page 1127


16) When real GDP equals potential GDP, the quantity theory of money says that an increase in

the quantity of money brings an equal percentage

A) increase in the price level.

B) increase in real GDP.

C) decrease in the price level.

D) decrease in velocity.

E) decrease in real GDP.

Answer: ATopic: Quantity theory of moneySkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

17) Using the quantity theory of money, in the long run a 3 percent increase in the quantity of

money leads to a 3 percent

A) increase in the price level.

B) increase in the real interest rate.

C) decrease in the price level.

D) decrease in the real interest rate.

E) increase in real GDP.

Answer: ATopic: Quantity theory of moneySkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

18) The average number of times in a year each dollar is used to buy goods and service is called

A) velocity of circulation.

B) inflation.

C) circulation rate.

D) nominal GDP.

E) rate of circulation speed.

Answer: ATopic: Equation of exchangeSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

Page 1128


19) The ʺvelocity of circulationʺ refers to the

A) ratio between the quantity of money and the price level.

B) average number of times in a year each dollar is used to buy goods and services.

C) average number of times a dollar is deposited and withdrawn from a bank account.

D) average speed with which the Fed increases or decreases the quantity of money.

E) average speed with which the nominal interest rate changes when the inflation rate

changes.

Answer: BTopic: Equation of exchangeSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

20) The velocity of circulation is defined as the

A) average number of times in a year that each dollar is used to buy goods and services.

B) quantity of money supplied by the Fed.

C) quantity of money demanded at equilibrium.

D) price level obtained when the money market is at its equilibrium.

E) speed with which changes in the interest rate spread throughout the economy.

Answer: ATopic: Equation of exchangeSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

21) The velocity of circulation is equal to

A) the price level divided by real GDP.

B) the price level multiplied by the quantity of money.

C) nominal GDP divided by the quantity of money.

D) the quantity of money divided by the price level and then multiplied by real GDP.

E) the quantity of money divided by nominal GDP.

Answer: CTopic: Equation of exchangeSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

Page 1129


22) According to the equation of exchange, the

A) quantity of money multiplied by the inflation rate equals nominal GDP.

B) velocity of circulation is always smaller than the inflation rate.

C) quantity of money divided by the inflation rate equals real GDP.

D) quantity of money multiplied by the velocity of circulation equals nominal GDP.

E) quantity of money minus the velocity of circulation equals real GDP minus the price

level.

Answer: DTopic: Equation of exchangeSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

23) The equation of exchange shows that

A) P = (M ÷ V) × Y.

B) P = (M × Y) ÷ V.

C) P = (V × M) × Y.

D) P = (M × V) ÷ Y.

E) P - Y = M + V.

Answer: DTopic: Equation of exchangeSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

24) Velocity is V, the quantity of money is M, the price level is P, and real GDP is Y. Which of the

following formulas is correct?

A) V = (P × Y) ÷ M

B) V = (P + Y) × M

C) Y = V × M

D) Y = (P × M) ÷ V

E) Y = (P + M) - V

Answer: ATopic: Equation of exchangeSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

25) If the quantity of money is $6 billion and nominal GDP is $9 billion, the velocity of circulation

is

A) 0.67. B) 3. C) 1.5. D) 36. E) 54.

Answer: CTopic: Equation of exchangeSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

Page 1130


26) If nominal GDP is $6.0 trillion and the quantity of money is $1.5 trillion, then the

A) price level is 110.

B) price level is 120.

C) velocity of circulation is 4.

D) velocity of circulation is 10.

E) price level is 4.00.


27) If real GDP is $200, the price level is 2.5, and velocity is 5, then the quantity of money is

A) $200. B) $100. C) $750. D) $1,000. E) $500.

Answer: BTopic: Equation of exchangeSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

28) Suppose the quantity of money and real GDP do not change. If velocity increases, then the

A) price level will rise.

B) price level will fall.

C) real interest rate will rise.

D) real interest rate will fall.

E) inflation rate will fall.

Answer: ATopic: Equation of exchangeSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

29) According to the equation of exchange, if velocity and real GDP do not change, a 3 percent

increase in the quantity of money

A) raises the price level by 3 percent.

B) raises the price level by 3 ÷ (velocity).

C) lowers the price level by 3 ÷ (real GDP).

D) lowers the price level by 3 percent.

E) raises the price level by less than 3 percent.


Page 1131


30) According to the equation of exchange, if the quantity of money is $20 billion, velocity 3, and

real GDP is $6 billion, then the price level is

A) 10. B) 40. C) 1.6. D) 1.1. E) 2.


31) Suppose the quantity of money is $1,000, the velocity of circulation is 6, and real GDP is

$4,000. Then the price level is

A) 2.5. B) 2.0. C) 1.5. D) 1.1. E) 6.0.


32) Suppose nominal GDP is $2,000 a year and the quantity of money is $400. Then the velocity of

circulation equals

A) 5. B) 1/5. C) 10. D) 2. E) 8.


33) If the price level is 2, real GDP is $50 billion, and the quantity of money is $4 billion, then

velocity is

A) 4. B) 10. C) 25. D) 12.5. E) 8.


Page 1132


34) According to the equation of exchange, if the quantity of money is $4 billion and the velocity

of circulation is 3, nominal GDP is

A) $12 billion.

B) $7 billion.

C) $1.3 billion.

D) $0.75 billion.

E) $8 billion.

Answer: ATopic: Equation of exchangeSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

35) If velocity is equal to 6, and the quantity of money is $50 billion, according to the equation of

exchange, nominal GDP is equal to

A) $18 billion.

B) $8.3 billion.

C) $300 billion.

D) $56 billion.

E) $150 billion.


36) Nominal GDP is $9.6 million dollars, real GDP is $9 million, and velocity is 1.2. The quantity of

money is ________ million.

A) $8 B) $11.52 C) $7.5 D) $10.8 E) $12


37) If velocity does not change and the quantity of money grows at the same rate as does real

GDP, then in the long run

A) the inflation rate equals the growth rate of the quantity of money.

B) the nominal interest rate is less than the real interest rate.

C) the real interest rate is less than the nominal interest rate.

D) the inflation rate equals zero.

E) the nominal interest rate equals zero.

Answer: DTopic: Money growth and inflationSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

Page 1133


38) If velocity does not change and if real GDP and the quantity of money grow at the same rate,

then the price level

A) rises and the inflation rate is negative.

B) falls and the inflation rate is negative.

C) does not change and the inflation rate is zero.

D) rises and the inflation rate is positive.

E) falls and the inflation rate is positive.

Answer: CTopic: Money growth and inflationSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

39) If real GDP and the velocity of circulation do not change and the quantity of money grows by

3 percent, then in the long the inflation rate is

A) 3 percent.

B) 0 percent.

C) -3 percent.

D) larger than 3 percent.

E) More information is needed to answer the question.

Answer: ATopic: Money growth and inflationSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

40) If real GDP grows by 3 percent, the velocity of circulation does not change, and the quantity of

money grows by 3 percent, then in the long run the inflation rate is

A) 3 percent.

B) 0 percent.

C) -3 percent.

D) -6 percent.

E) 6 percent.

Answer: BTopic: Money growth and inflationSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

Page 1134


41) The velocity of circulation grows at 1 percent and real GDP grows at 3 percent. If the quantity

of money grows at 2 percent, the inflation rate is

A) 2 percent.

B) 4 percent.

C) 8 percent.

D) zero.

E) 10 percent.

Answer: DTopic: Money growth and inflationSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

42) The velocity of circulation grows at 1 percent and real GDP grows at 3 percent. If the quantity

of money grows at 4 percent, the inflation rate is

A) 2 percent.

B) 4 percent.

C) 8 percent.

D) zero.

E) 10 percent.


43) If real GDP grows by 3 percent, the velocity of circulation grows by 4 percent, and the quantity

of money grows by 3 percent, then in the long run the inflation rate is

A) 4 percent.

B) 0 percent.

C) -4 percent.

D) 10 percent.

E) 7 percent.


Page 1135


44) If real GDP grows by 3 percent, the velocity of circulation grows by -4 percent, and the

quantity of money grows by 3 percent, then in the long run the inflation rate is

A) 4 percent.

B) -4 percent.

C) -1 percent.

D) 10 percent.

E) 1 percent.

Answer: BTopic: Money growth and inflationSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: RevisedAACSB: Analytical thinking

45) If real GDP grows by 3 percent, the velocity of circulation does not change, and the quantity of

money grows by 5 percent, then in the long run the inflation rate is

A) 3 percent.

B) -5 percent.

C) -2 percent.

D) 8 percent.

E) 2 percent.

Answer: ETopic: Money growth and inflationSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

46) If real GDP grows at 4 percent, the quantity of money grows at 6 percent, and velocity does

not change, then in the long run the inflation rate is

A) 4 percent.

B) 6 percent.

C) 10 percent.

D) 2 percent.

E) 1.5 percent.


Page 1136


47) Suppose that real GDP grows by 3 percent a year, the quantity of money grows 6 percent a

year, and velocity grows by 1 percent. In the long run, the inflation rate equals

A) 9 percent.

B) 4 percent.

C) 5 percent.

D) 12 percent.

E) 10 percent.


48) Suppose that real GDP grows by 3 percent a year, the quantity of money grows 5 percent a

year, and velocity does not change. In the long run, the inflation rate equals

A) 8 percent.

B) 3 percent.

C) 5 percent.

D) 2 percent.

E) 10 percent.


49) If real GDP grows at 3 percent a year, the quantity of money grows at 5 percent a year, and the

velocity of circulation is constant, then the price level must be

A) increasing at 8 percent a year.

B) decreasing at 8 percent a year.

C) increasing at 2 percent a year.

D) decreasing at 2 percent a year.

E) increasing at 15 percent a year.


Page 1137


50) If the quantity of money starts to grow more rapidly than real GDP and velocity does not

change, the result is

A) more rapid growth in potential GDP.

B) the inflation rate rises.

C) an increase in investment.

D) an eventual slowing in the growth rate of the quantity of money.

E) slower growth in the price level.


51) If the inflation rate increases,

A) the velocity of circulation increases.

B) potential GDP increases.

C) real GDP growth increases.

D) the nominal interest rate falls.

E) the real interest rate rises.

Answer: ATopic: Money growth and inflationSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

52) Hyperinflation is defined as periods of

A) negative price changes.

B) low inflation.

C) inflation over 50 percent per month.

D) inflation under 10 percent per year.

E) inflation over 25 percent per year

Answer: CTopic: HyperinflationSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

Page 1138


53) Inflation at a rate that exceeds 50 percent per month is called

A) extreme inflation.

B) super inflation.

C) hyperinflation.

D) megainflation.

E) skyflation.

Answer: CTopic: HyperinflationSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

54) Hyperinflation

A) occurs in the United States during each business cycle.

B) occurs only in theory, never in reality.

C) has never occurred in the United States.

D) happens in all countries at some time during their business cycle.

E) is a period of time when inflation exceeds 20 percent per year.

Answer: CTopic: HyperinflationSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

55) In the early 1920s, Germany experienced hyperinflation because Germanyʹs

A) economy was growing very rapidly.

B) population was growing very rapidly.

C) quantity of money was growing very rapidly.

D) real GDP was growing faster than nominal GDP.

E) demand for money skyrocketed.

Answer: CTopic: Eye on the past, hyperinflation in Germany in the 1920sSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

56) During the early 1920s, Germany experienced

A) negative inflation as a result of high money creation.

B) hyperinflation as a result of low money creation.

C) moderate price changes as a result of a recession.

D) hyperinflation as a result of high money creation.

E) hyperinflation as a result of rapidly increasing demand for money.

Answer: DTopic: Eye on the past, hyperinflation in Germany in the 1920sSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

Page 1139


57) In 2008 and 2009, the quantity theory of money did a ________ job of predicting year -to-year

changes in the inflation rate because ________.

A) poor; velocity of circulation plunged

B) poor; the Fed changed the growth rate of the quantity of money too quickly

C) good; real GDP remained stable

D) good; interest rates behaved predictably

E) poor; the price level and the velocity of circulation did not change

Answer: ATopic: Eye on the cause of inflationSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

58) With a large and growing deficit, the Fed may face pressure from the government to

A) decrease the inflation tax.

B) keep interest rates low, but the Fed risks inflation by doing so.

C) decrease the quantity of money to keep the value of money high.

D) increase the velocity of circulation.

E) increase the quantity of money to prevent inflation.

Answer: BTopic: Eye on the cause of inflationSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

59) In the long run, the price level adjusts

A) so that the real interest rate equals the nominal interest rate.

B) so that the inflation rate equals zero.

C) to achieve money market equilibrium.

D) so that the inflation rate equals the growth rate of real GDP.

E) so that the inflation rate is moderate.

Answer: CTopic: Money and the price levelSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

Page 1140


60) In the long run, an increase in the quantity of money ________ the value of money and

________ the price level.

A) raises; raises

B) does not change; raises

C) raises; lowers

D) lowers; raises

E) lowers; lowers

Answer: DTopic: Money and the price levelSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

61) Other things remaining the same, if the quantity of money increases by a given percentage,

then in the long run the ________ by the same percentage.

A) price level rises

B) price level falls

C) real interest rate rises

D) real interest rate falls

E) nominal interest rate falls

Answer: ATopic: Money and the price levelSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

62) The quantity theory of money is a proposition about

A) the Fedʹs methods used to change the quantity of money.

B) nominal and real interest rates.

C) the relationship between a change in the quantity of money and the price level.

D) the relationship between financial assets and currency demanded.

E) the nominal interest rate and the quantity of money demanded.

Answer: CTopic: Quantity theory of moneySkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

63) Suppose that P × Y is $5,000 million a year and the quantity of money is $500 million. Then the

velocity of circulation is

A) 50. B) 500. C) 10. D) 20. E) 2,500,000.


Page 1141


64) If the quantity of money grows at 3 percent per year, velocity does not grow, and real GDP

grows at 2 percent per year, then the inflation rate equals

A) 6 percent.

B) 5 percent.

C) 1 percent.

D) -1 percent.

E) 12 percent.


65) If the quantity of money grows at 4 percent a year, velocity grows at 2 percent, and real GDP

grows at 2 percent a year, then the inflation rate equals

A) 6 percent.

B) 2 percent.

C) 0 percent.

D) 8 percent.

E) 4 percent.

Answer: ETopic: Money growth and inflationSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

66) Hyperinflation is

A) inflation caused by negative growth in the quantity of money.

B) inflation at a rate that exceeds 50 percent a month.

C) inflation caused by excessive growth in the demand for money.

D) inflation at a rate that exceeds 5 percent a month.

E) only theoretical and has never occurred in the real world.

Answer: BTopic: HyperinflationSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

Page 1142


12.3 The Cost of Inflation

1) High inflation

A) leads to a more correct allocation of resources.

B) lowers the price level.

C) decreases uncertainty.

D) makes it easier to use money as a standard of account.

E) makes money function less well as a store of value.

Answer: ETopic: Costs of inflationSkill: Level 2: Using definitionsSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

2) High inflation makes money ________ because ________.

A) function less well as a store of value; it decreases the price level and increases the buying

power of money

B) function better as a store of value; it leads to a more accurate allocation of resources

C) function better as a unit of account; money never loses value but it does gain purchasing

power in some regions

D) function better as a store of value; the money gains value and therefore has greater

purchasing power

E) function less well as a store of value; the money loses value and therefore has less

purchasing power

Answer: ETopic: Costs of inflationSkill: Level 3: Using modelsSection: Checkpoint 12.3Status: NewAACSB: Reflective thinking

3) During an inflationary period, a household with savings of $100,000

A) gains because inflation increases the value of their savings.

B) loses because the inflation increases the after-tax real interest rate.

C) gains because the inflation gives savers more money and so more purchasing power.

D) loses because inflation increases the real tax on the interest paid.

E) neither gains nor loses because inflation does not affect savers.

Answer: DTopic: Costs of inflationSkill: Level 2: Using definitionsSection: Checkpoint 12.3Status: RevisedAACSB: Reflective thinking

Page 1143


4) One effect of inflation is that it is a tax that redistributes goods and services from

A) government to households.

B) investors to savers.

C) government to businesses.

D) households and businesses to the government.

E) businesses to households.

Answer: DTopic: Inflation as a taxSkill: Level 2: Using definitionsSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

5) Inflation is known as a ________ because it ________.

A) revenue; is the only source of business income for the government

B) bad thing; allows people to obtain the wrong kind of wealth

C) good thing; keeps the value of goods and services increasing

D) tax; redistributes goods and services from households and businesses to the government

E) tax; redistributes goods and services from the government to households and businesses

Answer: DTopic: Inflation as a taxSkill: Level 2: Using definitionsSection: Checkpoint 12.3Status: NewAACSB: Reflective thinking

6) Inflation ________ the cost of holding money and ________ the after -tax real interest rate.






Answer: BTopic: Costs of inflation, taxes and interestSkill: Level 2: Using definitionsSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

7) Assume an economy begins with zero inflation, a 25 percent income tax rate, and a real

interest rate of 4 percent. If inflation rises to 4 percent, the nominal interest rate becomes

________ percent and the after-tax real interest becomes ________ percent.

A) 0; 1 B) 8; 2 C) 8; 4 D) 6; 2 E) 8; 6

Answer: BTopic: Costs of inflation, taxes and interestSkill: Level 3: Using modelsSection: Checkpoint 12.3Status: OldAACSB: Analytical thinking

Page 1144


8) The ʺshoe-leather costsʺ of inflation are the costs from

A) higher prices for all goods, including necessities such as shoes.

B) the government taking a higher percentage of interest income.

C) confusion as people lose track of real costs and benefits.

D) time spent trying to spend money quickly.

E) higher taxes due to higher inflation.

Answer: DTopic: Cost of inflation, shoe-leather costs


9) The ________ cost of inflation is the result of a(n) ________ in velocity and is so-named

because of ________.

A) tax; decrease; the government collecting more tax revenue on all goods and services

including basic items like shoes

B) shoe leather; increase; the higher prices for all goods and services including basic items

like shoes

C) confusion; increase; the shoe leather that is wasted by people running around trying to

spend money quickly

D) shoe leather; increase; the shoe leather that is wasted by people running around trying to

spend money quickly

E) shoe leather; decrease; the shoe leather that is wasted in people running around trying to

spend money quickly

Answer: DTopic: Cost of inflation, shoe-leather costs

Skill: Level 1: DefinitionSection: Checkpoint 12.3Status: NewAACSB: Reflective thinking

10) Shoe-leather costs of inflation arise from the

A) increasing costs of apparel (clothes and shoes) as inflation rises.

B) increase of velocity as inflation rises.

C) decline in the use of money as a unit of account.

D) increasing costs of agricultural products as inflation rises.

E) confusion that results from higher inflation.

Answer: BTopic: Cost of inflation, shoe-leather costs


Page 1145


11) Because the inflation rate is so high Wanda refuses to carry cash. Even though it is a bother,

she now goes to the ATM twice as often to get the cash she needs. Wandaʹs actions are an

example of the

A) shoe-leather costs of inflation.

B) tax costs of inflation.

C) confusion costs of inflation.

D) uncertainty costs of inflation.

E) tax distorting costs of inflation.

Answer: ATopic: Cost of inflation, shoe-leather costs


12) If inflation is making it difficult for people to estimate the true marginal benefits and true

marginal costs of activities, inflation is leading to

A) tax costs.

B) shoe-leather costs.

C) confusion costs.

D) uncertainty costs.

E) increased economic growth.

Answer: CTopic: Costs of inflation, confusionSkill: Level 2: Using definitionsSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

13) Uncertainty costs arise from inflation because inflation makes long-term planning ________ so

people respond by ________ investment.

A) more difficult; increasing

B) more difficult; decreasing

C) less difficult; not changing

D) more difficult; not changing

E) less difficult; increasing

Answer: BTopic: Costs of inflation, uncertaintySkill: Level 1: DefinitionSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

Page 1146


14) Inflation is a tax because as the government ________ the quantity of money, the price level

________, and the purchasing power of householdsʹ money ________.

A) increases; rises; increases

B) decreases; falls; decreases

C) increases; rises; decreases

D) decreases; rises; decreases

E) does not change; rises; increases

Answer: CTopic: Inflation as a taxSkill: Level 1: DefinitionSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

15) Which of the following is NOT a cost of inflation?

A) tax cost

B) confusion cost

C) uncertainty cost

D) unemployment cost

E) shoe-leather cost

Answer: DTopic: Costs of inflationSkill: Level 1: DefinitionSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

16) Which of the following is NOT a cost of inflation?

A) tax costs

B) confusion costs

C) uncertainty costs

D) government spending costs

E) shoe-leather costs

Answer: DTopic: Costs of inflationSkill: Level 1: DefinitionSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

17) Becky holds $30,000 as money. After a year during which inflation was 5 percent a year, the

inflation tax over that year was

A) $500. B) $1,000. C) $1,500. D) $3,000. E) $5.

Answer: CTopic: Inflation as a taxSkill: Level 2: Using definitionsSection: Checkpoint 12.3Status: OldAACSB: Analytical thinking

Page 1147


18) Suppose a country has a real interest rate of 4 percent and an inflation rate of 3 percent. If the

income tax rate is 20 percent, then the after-tax real interest rate is

A) 2.6 percent.

B) 4.0 percent.

C) 5.6 percent.

D) 7.0 percent.

E) 1.4 percent.

Answer: ATopic: Costs of inflation, taxes and interestSkill: Level 3: Using modelsSection: Checkpoint 12.3Status: OldAACSB: Analytical thinking

19) Shoe-leather costs arise from inflation because the velocity of circulation of money ________ as

the inflation rate ________.

A) increases; falls

B) decreases; rises

C) increases; rises

D) does not change; rises

E) does not change; falls

Answer: CTopic: Cost of inflation, shoe-leather costs


20) A consequence of hyperinflation is that people

A) who make fixed-payment loans to others receive higher payments as inflation increases.

B) spend time trying to keep their money holdings near zero.

C) receive higher real wage hikes, which increases their purchasing power for goods and

services.

D) want to lend funds because interest rates are so high.

E) increase the quantity of money demanded.

Answer: BTopic: Cost of inflation, shoe-leather costs


Page 1148


21) The uncertainty costs of inflation cause people to

A) increase their demand for money.

B) increase investment causing economic growth to decrease.

C) focus on the short run, which decreases investment and slows growth.

D) focus on the long run, which increases investment and speeds growth.

E) incur more shoe leather costs.

Answer: CTopic: Costs of inflation, uncertaintySkill: Level 2: Using definitionsSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

22) The uncertainty costs of inflation cause ________ because ________.

A) a decrease in investment and slower growth; people increase their demand for money

B) an increase in investment and faster growth; people decrease their demand for money

C) a decrease in investment and slower growth; people focus on the short run and not the

long run

D) a decrease in investment and slower growth; people focus on the long run and not the

short run

E) an increase in investment and faster growth; people focus on the short run and not the

long run

Answer: CTopic: Costs of inflation, uncertaintySkill: Level 3: Using modelsSection: Checkpoint 12.3Status: NewAACSB: Reflective thinking

23) The costs of inflation ________ when inflation is more rapid and ________ when inflation is

more unpredictable.

A) increase; increase

B) increase; decrease

C) decrease; increase

D) increase; do not change

E) do not change; increase

Answer: ATopic: Cost of inflation, predictabilitySkill: Level 2: Using definitionsSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

Page 1149


24) It is estimated that if the inflation rate is lowered from 3 percent a year to 0 percent a year, the

growth rate of real GDP will rise by ________ percentage points a year.

A) 0.06 to 0.09

B) 1 to 3

C) 2.3

D) 3.2

E) 0

Answer: ATopic: Costs of inflation, amountSkill: Level 1: DefinitionSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

Page 1150



1) The demand for money curve is shown in the figure above. A movement from point B to point

C could be the result of

A) a fall in the nominal interest rate.

B) a decrease in the total benefit from holding money.

C) an increase in the quantity of money held by banks.

D) a rise in the real interest rate.

E) a rise in the real interest rate matched by an equal fall in the nominal interest rate.

Answer: ATopic: Demand for moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1151


2) The demand for money curve is shown in the figure above. What could shift the demand for

money curve rightward from the curve illustrated in the figure above?

A) a decrease in the supply of money

B) a decrease in real GDP

C) a fall in the real interest rate

D) a fall in the nominal interest rate.

E) an increase in the price level

Answer: ETopic: Demand for money, price levelSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

3) The demand for money curve is shown in the figure above. What could shift the demand for

money curve rightward from the curve illustrated in the figure above?

A) a decrease in the supply of money

B) an increase in the supply of money

C) a fall in the inflation rate

D) a fall in the nominal interest rate

E) an increase in real GDP

Answer: ETopic: Demand for money, real GDPSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1152


4) The figure above shows the money market. At which interest rate are people selling bonds and

thereby changing the interest rate?

A) 6 percent

B) 5 percent

C) 4 percent

D) 6 percent and 4 percent

E) 6 percent, 5 percent, and 4 percent

Answer: CTopic: Money market equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking


1) The dominant factor why the nominal interest rate differs among nations is that ________

differs among nations.

A) potential GDP

B) the unemployment rate

C) inflation rate

D) the price level

E) the quantity of money

Answer: CTopic: IntegrativeSkill: Level 5: Critical thinkingSection: IntegrativeStatus: OldAACSB: Analytical thinking

Page 1153


2) If the inflation rate is zero, the nominal interest rate is

A) greater than the real interest rate.

B) less than the real interest rate.

C) equal to the real interest rate.

D) equal to the inflation rate.

E) positive and the real interest rate is negative.

Answer: CTopic: IntegrativeSkill: Level 1: DefinitionSection: IntegrativeStatus: OldAACSB: Analytical thinking

3) The long-run effect of a decrease in the growth rate of the quantity of money is a

A) lower real interest rate.

B) higher real interest rate.

C) lower nominal interest rate.

D) higher nominal interest rate.

E) higher inflation rate.


4) The long-run effect of an increase in the growth rate of the quantity of money is a

A) lower real interest rate.

B) higher real interest rate.

C) lower nominal interest rate.

D) higher nominal interest rate.

E) lower inflation rate.

Answer: DTopic: IntegrativeSkill: Level 2: Using definitionsSection: IntegrativeStatus: OldAACSB: Reflective thinking

Page 1154


5) If the Fed wants to lower the nominal interest rate in the short run, the Fed ________ the

growth rate of the quantity of money.

A) raises

B) lowers

C) does not change

D) first lowers and then raises

E) None of the above answers is correct because the premise of the question is wrong since

the Fed cannot affect the nominal interest rate, only the real interest rate.


6) If the Fed wants to lower the nominal interest rate in the long run, the Fed ________ the

growth rate of the quantity of money.

A) raises

B) lowers

C) does not change

D) first lowers and then raises

E) None of the above answers is correct because the premise of the question is wrong since

the Fed cannot affect the nominal interest rate, only the real interest rate.


7) In the long run, the real interest rate is 3 percent, real GDP grows at 4 percent, velocity is

constant, and the quantity of money grows at 8 percent. The nominal interest rate is

A) 6 percent.

B) 7 percent.

C) 8 percent.

D) 10 percent.

E) 12 percent.

Answer: BTopic: IntegrativeSkill: Level 5: Critical thinkingSection: IntegrativeStatus: OldAACSB: Analytical thinking

Page 1155


8) In the long run, the real interest rate is 3 percent, real GDP grows at 4 percent, velocity is

constant, and the quantity of money grows at 6 percent. The nominal interest rate is

A) 3 percent.

B) 4 percent.

C) 5 percent.

D) 10 percent.

E) 6 percent.


9) In the short run, an increase in the growth rate of the quantity of money ________ the nominal

interest rate and in the long run it ________ the nominal interest rate.

A) raises; raises

B) raises; lowers

C) lowers; raises

D) lowers; lowers

E) does not change; raises


10) In the long run, an increase in the growth rate of the quantity of money ________ the inflation

rate and ________ the nominal interest rate.

A) raises; raises

B) raises; lowers

C) lowers; raises

D) lowers; lowers

E) raises; does not change


Page 1156


11) In the long run, when an economy experiences inflation, the price level ________ and the

nominal interest rate ________.

A) rises; remains constant

B) remains constant; rises

C) rises; rises

D) falls; rises

E) rises; falls


12) During the 1990s, Canada had an average inflation rate of 1.5 percent while Columbia had an

average inflation rate of 21.5 percent. You would expect that nominal interest rates in Canada

are

A) less than nominal interest rates in Columbia.

B) equal to nominal interest rates in Columbia.

C) greater than nominal interest rates in Columbia.

D) unpredictably different from nominal interest rates in Columbia.

E) not comparable to nominal interest rates in Columbia.

Answer: ATopic: IntegrativeSkill: Level 5: Critical thinkingSection: IntegrativeStatus: OldAACSB: Analytical thinking

13) Inflation decreases the growth of capital because

i. when the after-tax real interest rate falls, savings decreases.

ii. velocity increases when inflation increases.

iii. the higher the inflation rate, the higher is the true income tax rate on income from capital.

A) i only

B) ii only

C) iii only

D) i and iii

E) i, ii, and iii


Page 1157


14) In a period of hyperinflation, the velocity of circulation increases because

A) households and firms spend money as soon as they receive payment.

B) the nominal interest rate decreases.

C) potential GDP increases.

D) the real interest rate rises.

E) money is valuable everyone wants it.


15) During a period of hyperinflation, as households and firms avoid holding money,

A) potential GDP increases.

B) long term savings accounts become more popular.

C) barter becomes more common.

D) capital investment increases.

E) the costs of inflation decrease.


12.6 Essay: Money and the Interest Rate

1) What is the opportunity cost of holding money?

Answer: The opportunity cost of holding money is the nominal interest rate.Topic: Demand for moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

2) Why is the nominal interest rate the opportunity cost of holding money?

Answer: The nominal interest rate is the opportunity cost of holding money because the nominal

interest is the income forgone by holding money. For instance, an individual with

$1,000 can hold the funds either as money or as a financial asset with an interest rate of,

say, 7 percent. If the funds are held as money, the interest paid is $0; if they are held as a

financial asset, the interest paid is $70. Choosing to hold the funds as money therefore

has an opportunity cost of the interest income forgone, which is $70 or 7 percent per

dollar. So, the opportunity cost of each dollar held as money is 7 percent.Topic: Demand for moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Written and oral communication

Page 1158


3) What effect does an increase in the nominal interest rate have on the opportunity cost of

holding money and on the demand for money curve?

Answer: An increase in the nominal interest rate increases the opportunity cost of holding

money. There is a movement upward along the demand for money curve.Topic: Demand for moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

4) If the inflation rate is 3 percent and the real interest rate is 3 percent, then what is the nominal

interest rate?

Answer: The nominal interest rate equals the real interest rate plus the inflation rate, or

(3 percent) + (3 percent) = 6 percent.Topic: Interest ratesSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

5) If the real interest rate is 3 percent and the inflation rate is 2 percent, what is the nominal

interest rate?

Answer: The nominal interest rate equals the real interest rate plus the inflation rate, or

(3 percent) + (2 percent) = 5 percent.Topic: Interest ratesSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

6) What factors lead to changes in the quantity demanded of money and what factors lead to

changes in the demand for money?

Answer: Changes in the nominal rate of interest change the quantity of money demanded.

Changes in the price level, real GDP, and financial technology change the demand for

money.Topic: Demand for moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

7) What effect does an increase in the price level have on the demand for money and the demand

for money curve?

Answer: An increase in the price level increases the demand for money and shifts the demand

for money curve rightward.Topic: Demand for money, price levelSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1159


8) What effect does an increase in real GDP have on the demand for money?

Answer: An increase in real GDP increases the demand for money and shifts the demand for

money curve rightward.Topic: Demand for money, real GDPSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

9) How would a widespread adoption of credit cards affect the demand for money and the

demand for money curve?

Answer: The widespread adoption of credit cards decreases the demand for money and shifts the

demand for money curve leftward.Topic: Demand for moneySkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

10) In the United States since 1970, how has the use of credit cards affected the demand for M1 as

a percentage of GDP?

Answer: Since 1970, credit cards have become more widespread. As a result, the demand for M1

as a percentage of real GDP has decreased.Topic: Eye on the U.S. economy, money and credit cardsSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

11) ʺBecause the nominal interest rate is the opportunity cost of holding money, the supply curve

of money slopes downward.ʺ Is the previous statement correct or incorrect?

Answer: The statement is incorrect. Because the nominal interest rate is the opportunity cost of

holding money, the demand for money curve slopes downward but the supply curve of

money does not slope downward.Topic: Supply of moneySkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Written and oral communication

12) How is the price of a financial asset, such as government bonds, related to the interest rate?

Answer: The price of financial assets, such as government bonds, is negatively related to the

interest rate. If the interest rate rises, the price of government bonds falls and if the

interest rate falls, the price of government bonds rises.Topic: Interest rate and asset priceSkill: Level 1: DefinitionSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1160


13) Jeremy purchases a bond that pays $600 in interest. If Jeremy paid $9,000 for the bond, what is

the interest rate? If Jeremy paid $10,000 for the bond, what is the interest rate? How did a rise

in the price of the bond affect the interest rate?

Answer: When Jeremy paid $9,000 for the bond, the interest rate is ($600 ÷ $9,000) × 100 = 6.67

percent. When Jeremy paid $10,000 for the bond, the interest rate is ($600 ÷ $10,000) ×

100 = 6.00 percent. The rise in the price of the bond brought about a fall in its interest

rate.Topic: Interest rate and asset priceSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

14) If a bond pays $50 a year to its holder and you buy it for $200, what is your interest rate?

Answer: The interest rate is ($50 ÷ $200) × 100 = 25.0 percent.Topic: Interest rate and asset priceSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

15) Suppose the quantity of money is greater than the quantity of money demanded. In the short

run, what occurs to set the quantity of money equal to the quantity of money demanded?

Answer: In the money market, the interaction between the supply of money and the demand for

money determines the equilibrium nominal interest rate. The quantity of money

available is greater than the quantity of the money demanded when the nominal

interest rate is above the equilibrium interest rate. When this occurs, in an effort to

decrease the amount of money to the quantity people want to hold, people buy bonds

with the excess. As a result, the demand for bonds increases. The price of bonds rises

and the interest rate falls. When the nominal interest rate reaches its equilibrium, there

is no longer an excess supply of money because at the equilibrium nominal interest rate,

the quantity of money supplied equals the quantity demanded.Topic: Equilibrium interest rateSkill: Level 2: Using definitionsSection: Checkpoint 12.1Status: OldAACSB: Written and oral communication

16) In the short run, how does the Fed change the nominal interest rate?

Answer: The Fed changes the nominal interest rate by changing the quantity of money. If the Fed

increases the quantity of money, the supply of money curve shifts rightward and the

equilibrium nominal interest rate falls. If the Fed decreases the quantity of money, the

supply of money curve shifts leftward and the equilibrium nominal interest rate rises.Topic: Equilibrium interest rateSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Reflective thinking

Page 1161


17) Suppose in the money market the equilibrium nominal interest rate is 5 percent. If the Fed

increases the quantity of money, what is the effect on the nominal interest rate?

Answer: If the Fed increases the quantity of money, the supply of money curve shifts rightward

and the nominal interest rate falls.Topic: Equilibrium interest rateSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

18) In the short run, how is the nominal interest rate determined? If the nominal interest rate is

less than the equilibrium nominal interest rate, what occurs?

Answer: The nominal interest rate is determined in the money market by the interaction of the

demand for money and the supply of money. If the nominal interest rate is less than the

equilibrium, there is an excess demand for money. In order to increase the quantity of

money they hold, people sell bonds and other financial assets. As a result, the price of

financial assets falls and the interest rate rises. People continue to sell assets and the

interest rate continues to rise until it reaches its equilibrium.Topic: Equilibrium interest rateSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Written and oral communication

19) Assume the Fed wants to lower the interest rate. How does the Fed lower the interest rate in

the short run?

Answer: In order to lower the interest rate, the Fed increases the quantity of money. In the short

run, when the quantity of money increases, the interest rate falls.Topic: Equilibrium interest rateSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1162


20) In the figure below, label the axes and then draw a demand for money curve. Illustrate an

increase in the demand for money.

Answer:

A completed figure is above. An increase in the demand for money is reflected in a

rightward shift of the demand for money curve, as in the figure with the shift from MD1

to MD2.

Topic: Demand for moneySkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1163



(percent per year)

Quantity of

money demanded


8 0.7

6 0.9

4 1.1

2 1.3

21) The above table has the demand for money schedule.

a. If the Fed supplies $1.1 trillion dollars, what is the equilibrium nominal interest rate?

b. Discuss how equilibrium is restored if the interest rate is greater than the equilibrium rate

found in part (a).

Answer: a. The equilibrium nominal interest rate is 4 percent.

b. If the interest rate is greater than 4 percent, there is an excess supply of money. In

this case, to be rid of their ʺextraʺ money, people buy bonds. The price of bonds rises

and so the interest rate falls until it reaches its equilibrium value, 4 percent. At this

interest rate, there is no longer an excess supply of money because the quantity

demanded equals the quantity supplied.Topic: Money market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking


(percent per year)

Quantity of

money demanded


3 2.0

4 1.5

5 1.0

6 0.5

22) The above table has the demand for money schedule.

a. If the Fed sets the quantity of money equal to $1.0 trillion, what is the equilibrium nominal

interest rate?

b. If the Fed wants the interest rate to be 4 percent, what must it do?

Answer: a. If the Fed sets the quantity of money equal to $1.0 trillion, the equilibrium nominal

interest rate is 5 percent.

b. If the Fed wants the interest rate to be 4 percent, it must set the quantity of money

equal to $1.5 trillion.Topic: Money market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1164


23) The above diagram has a demand for money curve. Suppose the Fed initially sets the quantity

of money equal to $0.6 trillion. Draw the supply of money curve in the figure. What is the

equilibrium interest rate? Now suppose the Fed increases the quantity of money to

$0.9 trillion. Draw the new supply curve. What is the new equilibrium interest rate?

Answer:

The initial supply of money curve is MS1 and the equilibrium interest rate is 6 percent.

When the Fed increases the quantity of money, the supply of money curve shifts to MS2

and the equilibrium interest rate falls to 4 percent.Topic: Money market equilibriumSkill: Level 3: Using modelsSection: Checkpoint 12.1Status: OldAACSB: Analytical thinking

Page 1165


12.7 Essay: Money, the Price Level, and Inflation

1) A government policymaker suggests ʺDouble the money supply and U.S. citizensʹ real

incomes will double.ʺ In the long run, is this policy advice correct?

Answer: This statement is incorrect because in the long run an increase in the quantity of money

increases only the price level. Indeed, it increases the price level by the same percentage.

So if the Fed followed the advice and increased the quantity of money by 100 percent

(which doubles it), then in the long run the only effect is to increase the price level by

100 percent.Topic: Money and the price levelSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

2) In the money market, how is the adjustment to equilibrium brought about in the short run and

in the long run?

Answer: In the short run, the nominal interest rate adjusts to restore equilibrium in the money

market. In the long run, however, the nominal interest rate equals the real interest plus

the inflation rate, so it cannot freely adjust to restore equilibrium in the money market.

In the long run when the economy is at full employment, the price level changes to

restore equilibrium in the money market.Topic: Money market equilibrium in the short run and the long runSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

3) What is the short-run and long-run effect on the nominal interest rate from an increase in the

growth rate of the quantity of money?

Answer: In the short run, the increase in the growth rate of the quantity of money lowers the

nominal interest rate. However in the long run the increase in the growth rate of the

quantity of money creates higher inflation and the higher inflation leads to a rise in the

nominal interest rate.Topic: Money growth and the nominal interest rateSkill: Level 4: Applying modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

4) If the Fed makes the quantity of money grow at the same rate as the growth rate of real GDP

and velocity does not change, in the long run what happens to the price level and the inflation

rate?

Answer: If the quantity of money is growing at the same rate as real GDP and velocity does not

change, then the price level does not change. In this case, the inflation rate equals 0

percent.Topic: Money growth and inflationSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

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5) Suppose velocity does not change. Then, in the long run, a growth rate of the quantity of

money that exceeds growth in real GDP has what effect?

Answer: In the long run, growth in the quantity of money that exceeds growth in real GDP

brings inflation. With velocity constant, the inflation rate equals the growth rate of the

money supply minus the growth rate of real GDP.Topic: Money growth and inflationSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

6) ʺIf the inflation rate is positive, then the real interest rate is greater than the nominal interest

rate.ʺ Is the previous statement correct or incorrect? Explain your answer.

Answer: The statement is incorrect. The nominal interest rate equals the real interest rate plus the

inflation rate. Therefore, if the inflation rate is positive, the nominal interest rate is

greater than the real interest rate.Topic: Nominal interest rate and inflation rateSkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

7) According to the quantity theory of money, what is the effect of an increase in the quantity of

money?

Answer: According to the quantity theory, in the long run an increase in the quantity of money

brings an equal percentage increase in the price level.Topic: Quantity theory of moneySkill: Level 1: DefinitionSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

8) Define the quantity theory of money and show how it is related to the equation of exchange.

Answer: The quantity theory of money is the proposition that in the long run, an increase in the

quantity of money brings an equal percentage increase in the price level (other things

remaining the same). The equation of exchange states that the quantity of money

multiplied by velocity of circulation equals the price level times real GDP, or

M × V = P × Y. Divide both sides of this formula by V to obtain P = (M × V) ÷ Y. This

formula shows that when M increases, as long as V and Y do not change, P increases by

the same percentage, which is the conclusion of the quantity theory of money.Topic: Equation of exchangeSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Written and oral communication

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9) What is the equation of exchange? Suppose that real GDP and velocity are constant. In this

case, what effect will an increase in the quantity of money have?

Answer: The equation of exchange is that M × V = P × Y, where M is the quantity of money, V is

the velocity of circulation, P is the price level, and Y is real GDP. If real GDP and

velocity are constant, then an increase in the quantity of money will increase the price

level.Topic: Equation of exchangeSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

10) ʺThe velocity of circulation is the average speed with which money is loaned to businesses and

households.ʺ Is the previous statement correct or incorrect?

Answer: The statement is incorrect. The velocity of circulation is the average number of times in

a year that each dollar of money is used to purchase final goods and services.Topic: Equation of exchangeSkill: Level 2: Using definitionsSection: Checkpoint 12.2Status: OldAACSB: Reflective thinking

11) If the growth rate of the quantity of money is 4 percent per year, potential GDP and real GDP

grow at 3 percent per year, and velocity does not change, in the long run what is the inflation

rate?

Answer: With velocity constant, in the long run, the inflation rate equals the growth in the

quantity of money minus the growth in potential GDP, or

(4 percent) - (3 percent) = 1 percent.Topic: Money growth and inflationSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

12) If the growth of the quantity of money is 5 percent per year, potential and real GDP grow at 3

percent per year, and velocity does not change, in the long run what is the inflation rate?

Answer: With velocity constant, in the long run, the inflation rate equals the growth in the

quantity of money minus the growth in potential GDP, or

(5 percent) - (3 percent) = 2 percent.Topic: Money growth and inflationSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

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13) The quantity of money is $1 billion, the price level is 1.10, and real GDP is $10 billion. What is

the velocity of money?

Answer: The velocity of money equals 11.Topic: Equation of exchangeSkill: Level 3: Using modelsSection: Checkpoint 12.2Status: OldAACSB: Analytical thinking

12.8 Essay: The Cost of Inflation

1) ʺInflation acts as a tax because the government gains purchasing power.ʺ Is the previous

statement correct or incorrect?

Answer: The statement is correct. Inflation decreases the purchasing power of peopleʹs money

and the government essentially gains the purchasing power.Topic: Inflation as a taxSkill: Level 1: DefinitionSection: Checkpoint 12.3Status: OldAACSB: Reflective thinking

2) Explain how the government gains revenue during inflation.

Answer: The government issues securities and buys goods and services with the funds it raises.

When the securities are bought by the Fed, money is created and the result is inflation.

The government owns the Fed, so when the government pays interest to the Fed, the

Fed returns the interest to the government and there is no overall cost to the

government from issuing the securities. As a result, the government gets the revenue

from selling the securities.

Furthermore, as the incomes of households and firms increase during inflation, they

move into a higher marginal tax brackets and consequently pay higher taxes. The higher

taxes are another source of government revenue from inflation.Topic: Inflation as a taxSkill: Level 3: Using modelsSection: Checkpoint 12.3Status: OldAACSB: Written and oral communication

Page 1169


3) What are the costs of inflation? Briefly explain each.

Answer: The costs of inflation are the tax costs, the shoe-leather costs, the confusion costs, and

the uncertainty costs. The tax costs refer to the point that the higher the inflation rate,

the lower the after-tax real interest rate. As a result, people decrease their saving and so

investment decreases. Shoe-leather costs reflect the costs incurred by people to spend

money as rapidly as possible when inflation is high because high inflation means that

the value of money is decreasing rapidly. Confusion costs are the result of inflation

making it more difficult to use money to compare the costs and benefits of actions, such

as saving or investing. Finally, uncertainty costs occur because people are uncertain

about the long-term inflation rate. When making an investment or saving decision,

people must try to factor in what the inflation rate will be throughout the life of the

investment or saving, which is a difficult endeavor.Topic: Costs of inflationSkill: Level 2: Using definitionsSection: Checkpoint 12.3Status: OldAACSB: Written and oral communication

4) Explain the ʺshoe-leatherʺ costs of inflation.

Answer: When prices rise rapidly during anticipated inflation, people with money spend time

finding goods to purchase to get rid of money. Households and firms also spend time

finding others to barter goods for goods and spend time watching foreign exchange

rates to be able to trade falling value domestic currency for constant value foreign

currencies. These activities are costly, in part because they force people to spend time

dealing with the rapidly falling value of money. The costs that people incur from

running around to get rid of money are the shoe-leather costs.Topic: Cost of inflation, shoe-leather costs


5) ʺInflation reduces the velocity of money because people reduce their money holdings.ʺ Is the

previous statement correct or incorrect? Explain your answer.

Answer: The statement is incorrect. As the inflation rate rises, people reduce their money

holdings by spending money more rapidly. As a result, the velocity rises rather than

falls.Topic: Cost of inflation, shoe-leather costs


Page 1170


6) George purchased a $10,000 bond that pays a nominal interest rate of 8 percent per year.

Georgeʹs marginal income tax rate is 28 percent. Over the last year, inflation was 3 percent.

Find Georgeʹs before-tax real interest rate and his after-tax real interest rate.

Answer: The before-tax interest rate equals the nominal interest rate minus the inflation rate, or

8 percent - 3 percent = 5 percent. For the after-tax real interest rate, note that George

must pay tax on the entire 8 percent (nominal) interest. Hence George pays

(8 percent interest rate × 28 percent tax rate) = 2.24 percent as taxes. Therefore his

after-tax real interest rate equals his before-tax real interest rate, 5 percent, minus what

he pays in taxes, or 5 percent - 2.24 percent = 2.76 percent as his after-tax real interest

rate.Topic: Cost of inflation, saving and investmentSkill: Level 4: Applying modelsSection: Checkpoint 12.3Status: OldAACSB: Analytical thinking

Page 1171


Chapter 13 Aggregate Supply and Aggregate Demand

13.1 Aggregate Supply

1) Over the business cycle, factors such as the quantity of capital, human capital and technology

A) grow but do not fluctuate as much as the quantity of labor employed.

B) change drastically, fluctuating more than the quantity of labor employed.

C) fluctuate about the same amount as the quantity of labor employed.

D) do not grow and are therefore not the source of economic growth.

E) change randomly, sometimes growing, sometimes falling.

Answer: ATopic: Aggregate supply basicsSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

2) Over a business cycle, the quantities of capital, human capital, and entrepreneurial talent

A) change gradually and do not fluctuate much.

B) cycle alongside real GDP.

C) are completely unpredictable and cannot be forecast.

D) cycle more than real GDP.

E) are constant and do not change.

Answer: ATopic: Aggregate supply basicsSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

3) Which of the following does NOT affect potential GDP?

A) the quantity of money

B) the quantity of labor employed

C) the quantity of capital and human capital

D) the amount of entrepreneurial talent available

E) the quantity of land and natural resources


Page 1172


4) Potential GDP

A) increases as the price level increases because firms supply more goods and services.

B) decreases as the price level increases because people demand fewer goods and services.

C) might either increase or decrease as the price level increases, depending on whether

aggregate demand increases or decreases.

D) is independent of the price level.

E) never changes.


5) The line showing potential GDP is a vertical straight line because

A) there is only one level of full employment at any point in time.

B) economists are unsure about how to determine potential GDP.

C) it represents the minimum level of real GDP in a recession.

D) when nothing else changes, a higher price level has no effect on real GDP.

E) the aggregate supply curve is upward sloping.


6) A rise in the price level produces ________ the potential GDP line.

A) a rightward shift of

B) a movement downward along

C) a leftward shift of

D) a movement upward along

E) neither a shift of the potential GDP line nor a movement along

Answer: DTopic: Potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1173


7) Which of the following is true?

A) Aggregate supply is another name for potential GDP.

B) Potential GDP increases as the price level increases.

C) At full employment, aggregate supply is equal to potential GDP.

D) Potential GDP decreases as the price level increases.

E) The potential GDP line has a negative slope.


8) Moving along the potential GDP line, when the price level changes, the

i. real wage rate stays at the full-employment equilibrium level.

ii. money wage rate changes by the same percentage.

iii. money prices of non-labor resources change by the same percentage.

A) i only

B) ii only

C) iii only

D) i and ii

E) i, ii, and iii

Answer: ETopic: Potential GDPSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

9) The real wage rate definitely falls if the money wage rate ________ and the price level ________.

A) remains constant; rises

B) remains constant; falls

C) rises; falls

D) rises; rises

E) falls; falls

Answer: ATopic: Real wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

Page 1174


10) A fall in the real wage rate ________ firmsʹ profits and leads to ________ in the quantity

supplied.

A) raises; an increase

B) raises; a decrease

C) lowers; an increase

D) lowers; a decrease

E) does not change; no change

Answer: ATopic: Real wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

11) The aggregate supply curve shows the relationship between

A) potential GDP and the price level.

B) potential GDP and real GDP.

C) the quantity of real GDP supplied and the price level.

D) the quantity of real GDP supplied and the interest rate.

E) potential GDP and the aggregate demand curve.

Answer: CTopic: Aggregate supply, price levelSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

12) The slope of the aggregate supply curve shows that, all else the same, the

A) quantity of real GDP supplied increases as the price level increases.

B) quantity of real GDP supplied decreases as the price level increases.

C) quantity of real GDP supplied remains constant as the price level increases.

D) price level remains constant as real GDP increases.

E) price level remains constant as potential GDP increases.

Answer: ATopic: Aggregate supply, price levelSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1175


13) Other things remaining the same, an increase in the price level

A) increases aggregate supply.

B) decreases aggregate supply.

C) increases the quantity of real GDP supplied.

D) decreases the quantity of real GDP supplied.

E) neither changes aggregate supply nor changes the quantity of real GDP supplied.

Answer: CTopic: Aggregate supply, price levelSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

14) Moving along the AS curve, when the price level increases, the

A) real wage rate falls, and there is an increase in the quantity of real GDP supplied.

B) real wage rate rises, and there is an increase in the quantity of real GDP supplied.

C) nominal wage rate falls, and there is an increase in the quantity of real GDP supplied.

D) nominal wage rate rises, and there is a decrease in the quantity of real GDP supplied.

E) real wage rate rises, and there is a decrease in the quantity of real GDP supplied.


15) Moving along the aggregate supply curve, when the price level rises,

A) the quantity supplied does not change because the aggregate supply curve is a vertical

line.

B) the quantity supplied increases.

C) the quantity supplied decreases.

D) the aggregate demand curve shifts rightward.

E) the aggregate demand curve shifts leftward.

Answer: BTopic: Aggregate supply, price levelSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1176


16) An increase in the price level leads to

A) an upward movement along the aggregate supply curve.

B) a downward movement along the aggregate supply curve.

C) a leftward shift of the aggregate supply curve.

D) a rightward shift of the aggregate supply curve.

E) neither a movement along the aggregate supply curve nor a shift of the aggregate supply

curve.


17) The ________, the ________ is the quantity of real GDP supplied.

A) lower the price level; greater

B) higher the price level; greater

C) greater the demand for labor; smaller

D) lower the supply of labor; greater

E) lower aggregate demand; greater


18) The slope of the aggregate supply curve shows that the ________ the price level, the ________.

A) higher; greater is the quantity of real GDP supplied

B) higher; smaller is the quantity of real GDP supplied

C) lower; greater is the quantity of real GDP supplied

D) higher; is the quantity of potential GDP supplied

E) lower; is the quantity of potential GDP supplied


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19) ________ increases the quantity of real GDP supplied and is shown as a movement along the

AS curve.

A) A decrease in the quantity of money

B) A decrease in consumption expenditure

C) A fall in the expected rate of profit

D) A rise in the price level

E) An increase in potential GDP

Answer: DTopic: Aggregate supply curveSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

20) The aggregate supply curve illustrates that the

A) higher the price level, the greater the quantity of real GDP supplied.

B) higher the price level, the smaller the quantity of real GDP supplied.

C) aggregate demand curve is not needed to determine the aggregate price level.

D) price level does not affect the quantity of real GDP supplied.

E) amount of potential GDP increases when the price level rises.

Answer: ATopic: Aggregate supply, price levelSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

21) Because there is a ________ relationship between the price level and the quantity of real GDP

supplied, the aggregate supply curve is ________ curve.

A) negative; an upward-sloping

B) positive; a downward-sloping

C) positive; an upward-sloping

D) negative; a downward-sloping

E) positive; a vertical

Answer: CTopic: Aggregate supply curveSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1178


22) The aggregate supply curve is a(n) ________ curve because it represents the relationship

between price level and the quantity of real GDP supplied, two items that are ________

correlated.

A) upward-sloping; negatively

B) downward-sloping; positively

C) upward-sloping; positively

D) downward-sloping; negatively

E) vertical; not

Answer: CTopic: Aggregate supply curveSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: NewAACSB: Reflective thinking

23) If there is a rise in the price level, there is ________ in the quantity of real GDP supplied and a

movement ________ along the AS curve.

A) a decrease; downward

B) an increase; upward

C) an increase; downward

D) a decrease; upward

E) no change; upward


24) If there is a rise in the price level, there is a(n) ________ movement along the AS curve because

there is ________ in the quantity of real GDP supplied.

A) downward; a decrease

B) upward; an increase

C) downward; an increase

D) upward; a decrease

E) upward; no change

Answer: BTopic: Aggregate supply, price levelSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: NewAACSB: Reflective thinking

Page 1179


25) If the price level increases from 110.0 to 115.0, the quantity of

A) real GDP supplied will increase.

B) real GDP supplied will decrease.

C) potential GDP will decrease.

D) real GDP demanded will increase.

E) potential GDP will increase.


26) A change in the price level

A) shifts the aggregate supply curve rightward.

B) shifts the potential GDP line.

C) shifts the aggregate supply curve leftward.

D) changes the quantity of real GDP supplied.

E) shifts the aggregate demand curve leftward.

Answer: DTopic: Aggregate supply, price levelSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

27) The quantity of real GDP supplied increases when the price level increases because

A) investment increases.

B) the quantity of money increases.

C) the real wage rate falls.

D) the real wage rate rises.

E) aggregate demand increases.

Answer: CTopic: Aggregate supply, price levelSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

28) The quantity of real GDP supplied ________ when the price level increases because ________.

A) decreases; investment increases

B) increases; the quantity of money increases

C) increases; the real wage rate falls

D) decreases; the real wage rate rises

E) increases; aggregate demand increases

Answer: CTopic: Aggregate supply, price levelSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: NewAACSB: Reflective thinking

Page 1180


29) During 2010, a country reports that its price level fell and the money wage rate did not change.

These changes led to

A) a higher real wage rate, lower profits, and a decrease in the quantity of real GDP

supplied.

B) a higher real wage rate, higher profits, and an increase in the quantity of real GDP

supplied.

C) a lower real wage rate, lower profits, and a decrease in the quantity of real GDP

supplied.

D) a lower real wage rate, higher profits, and an increase in the quantity of real GDP

supplied.

E) no change in the real wage rate and an increase in aggregate demand.


30) During 2012, a country reports that its price level fell and the money wage rate did not change.

These changes led to a(n) ________ because their country experienced a(n) ________.

A) decrease in the quantity of real GDP supplied; higher real wage rate and lower profits for

firms

B) increase in the quantity of real GDP supplied; higher real wage rate and lower profits for

firms

C) decrease in the quantity of real GDP supplied; lower real wage rate and lower profits for

firms

D) increase in the quantity of real GDP supplied; lower real wage rate and higher profits for

firms

E) decrease in aggregate demand; economic expansion

Answer: ATopic: Aggregate supply, price levelSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: NewAACSB: Reflective thinking

31) The quantity of real GDP supplied decreases if the price level ________ because it ________

profits.

A) rises; increases

B) rises; decreases

C) falls; increases

D) falls; decreases

E) None of the above answers is correct because the AS curve is vertical so that the quantity

of real GDP supplied does not change when the price level changes.

Answer: DTopic: Aggregate supply, price levelSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1181


32) If profits are high because the price level rose,

A) it is likely the result of an increase in the real wage rate.

B) new businesses open and the quantity of real GDP supplied increases.

C) business failures rise and the quantity of real GDP supplied increases.

D) potential GDP must be decreasing.

E) the AS curve shifts leftward.

Answer: BTopic: Aggregate supply, price levelSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

33) When the price level rises, the quantity of real GDP supplied ________ because ________.

A) decreases; new businesses open

B) increases; new businesses open

C) decreases; businesses fail and have to shut their doors

D) increases; AS curve shifts rightward

E) increases; businesses fail and have to shut their doors

Answer: BTopic: Aggregate supply, price levelSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: NewAACSB: Reflective thinking

34) If the price level rises but the money wage rate does not, then firms will hire ________ labor

and the quantity of real GDP supplied will ________.

A) more; increase

B) the same amount of; not change

C) less; decrease

D) more; not change

E) less; increase


Page 1182


35) It is profitable to hire more labor if the price level ________ and the money wage rate ________.

A) rises; falls

B) falls; rises

C) falls; does not change

D) does not change; rises

E) rises; rises by the same percentage


36) If the price level falls and the money wage rate does not change, some firms ________ and

there is ________.

A) shut down; a leftward shift of the aggregate supply curve

B) start up; a rightward shift of the aggregate supply curve

C) shut down; a decrease in the quantity of real GDP supplied

D) shut down; a decrease in potential GDP

E) start up; an increase in potential GDP

Answer: CTopic: Aggregate supply, price levelSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

37) When the price level rises and the money wage rate does not change,

A) the quantity of real GDP supplied increases as more businesses start up and potential

GDP does not change.

B) the quantity of real GDP supplied decreases as more businesses fail and potential GDP

does not change.

C) profits fall and more businesses fail.

D) existing businesses do not change their level of output.

E) the quantity of potential GDP increases because the quantity of real GDP supplied

increases.


Page 1183


38) Moving along the aggregate supply curve,

A) the quantity of capital used increases.

B) only the price level changes.

C) technology advances.

D) the stock of human capital increases.

E) the real wage rate is constant.

Answer: BTopic: Aggregate supply, price levelSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

39) A rise in the price level produces a ________ the aggregate supply curve.

A) rightward shift of

B) movement downward along

C) leftward shift of

D) movement upward along

E) rightward shift of the aggregate supply curve and a movement downward along

Answer: DTopic: Aggregate supply, price levelSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

40) A fall in the price level produces a ________ the aggregate supply curve.





E) rightward shift of the aggregate supply curve and a movement downward along


Page 1184


41) If the money wage rate does not change, a decrease in the price level will ________ the real

wage rate and ________ firmsʹ profit.

A) raise; decrease

B) raise; increase

C) lower; decrease

D) lower; increase

E) lower; not change

Answer: ATopic: Aggregate supply, real wage rateSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

42) The money wage rate is constant when moving along

A) only the aggregate supply curve.

B) only the aggregate supply curve and the potential GDP line.

C) only the potential GDP line.

D) neither the aggregate supply curve nor the potential GDP line.

E) the aggregate supply curve, the potential GDP line, and the aggregate demand curve.

Answer: ATopic: Aggregate supply, real wage rateSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

43) The aggregate supply curve slopes ________ because a ________ in the price level brings a

________ in the real wage rate.

A) upward; rise; rise

B) downward; fall; rise

C) upward; rise; fall

D) upward; fall; fall

E) downward; rise; rise

Answer: CTopic: Aggregate supply, real wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1185


44) Along the aggregate supply curve, the quantity of real GDP supplied increases when the price

level rises because

A) profits decrease.

B) the real wage rate falls.

C) the real wage rate rises.

D) the real wage rate and profits both fall.

E) the demand for the goods and services increases.

Answer: BTopic: Aggregate supply, real wage rateSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

45) A fall in the price level brings a ________ in the real wage rate that ________ profits and can

lead to ________.

A) rise; reduces; firms going out of business

B) rise; reduces; new firms entering business

C) fall; increases; firms going out of business

D) rise; increases; new firms entering business

E) fall; decreases; new firms entering business

Answer: ATopic: Aggregate supply, real wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

46) A rise in the price level brings a ________ in the real wage rate that ________ profits which

leads to ________ production.

A) rise; reduces; decreasing

B) rise; reduces; increasing

C) fall; increases; increasing

D) rise; increases; decreasing

E) fall; decreases; decreasing

Answer: CTopic: Aggregate supply, real wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1186


47) A fall in the price level brings a ________ in the real wage rate that ________ profits which

leads to ________.

A) rise; reduces; firms restarting production

B) rise; reduces; firms temporarily shutting down

C) fall; increases; firms temporarily shutting down

D) rise; increases; firms restarting production

E) rise; increases; firms temporarily shutting down

Answer: BTopic: Aggregate supply, real wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

48) Which of the following changes aggregate supply and shifts the aggregate supply curve?

i. change in the price level

ii. change in potential GDP

iii. change in the money wage rate

A) i only

B) ii only

C) iii only

D) ii and iii

E) i, ii, and iii

Answer: DTopic: Changes in aggregate supplySkill: Level 3: Using modelsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

49) Changes in which of the following shifts the aggregate supply curve?

i. the price level

ii. the money wage rate

iii. potential GDP

A) i only

B) ii only

C) iii only

D) ii and iii

E) i, ii, and iii

Answer: DTopic: Changes in aggregate supplySkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1187


50) An increase in the money wage rate ________ and an increase in the money prices of raw

materials ________.

A) shifts the AS curve rightward; shifts the AS curve rightward

B) shifts the AS curve leftward; shifts the AS curve leftward

C) shifts the AS curve rightward; shifts the AS curve leftward

D) shifts the AS curve leftward; shifts the AS curve rightward

E) shifts the AS curve leftward; does not shift the AS curve

Answer: BTopic: Changes in aggregate supplySkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

51) Changes in which of the following do NOT shift the AS curve?

i. the price level

ii. potential GDP

iii. the money wage rate

A) i only

B) ii only

C) iii only

D) i and ii

E) i, ii, and iii

Answer: ATopic: Changes in aggregate supplySkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

52) A change in the price level brings a ________ the aggregate supply curve, NOT a ________ the

aggregate supply curve.

A) shift in; movement along

B) vertical displacement of; change in the slope of

C) movement along; shift in

D) change in the slope of; horizontal displacement of

E) shift in; change in the slope of

Answer: CTopic: Changes in aggregate supplySkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1188


53) Which of the following changes aggregate supply and shifts the AS curve?

i. a change in the price of a major resource

ii. increases in the amount of capital

iii. a change in the money income of consumers

A) i only

B) ii only

C) iii only

D) i and ii

E) i, ii, and iii

Answer: DTopic: Changes in aggregate supplySkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

54) If the costs of production decrease, there is

A) an increase in aggregate supply and the AS curve shifts rightward.

B) a decrease in aggregate supply and the AS curve shifts leftward.

C) an increase in the quantity of real GDP supplied and a movement up along the AS curve.

D) a decrease in the quantity of real GDP supplied and a movement down along the AS

curve.

E) an increase in aggregate supply and the AS curve shifts leftward.

Answer: ATopic: Shifts in the aggregate supply curveSkill: Level 3: Using modelsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

55) If the costs of production increase, there is

A) an increase in aggregate supply and the AS curve shifts rightward.

B) a decrease in aggregate supply and the AS curve shifts leftward.

C) an increase in the quantity of real GDP supplied and a movement up along the AS curve.

D) a decrease in the quantity of real GDP supplied and a movement down along the AS

curve.

E) a decrease in aggregate supply and the AS curve shifts rightward.

Answer: BTopic: Shifts in the aggregate supply curveSkill: Level 3: Using modelsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1189


56) Which of the following shifts the aggregate supply curve rightward?

i. The money wage rate rises.

ii. Potential GDP increases.

iii. Government expenditure on goods and services increases.

A) i only

B) ii only

C) iii only

D) ii and iii

E) i, ii, and iii

Answer: BTopic: Shifts in the aggregate supply curveSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

57) Which of the following best describes the effect on the aggregate supply curve if political

negotiations result in a substantial decrease in the price of oil?

A) The AS curve shifts rightward.

B) There is no change to the AS curve.

C) The AS curve does not shift but there is an upward movement along it.

D) The AS curve does not shift but there is a downward movement along it.

E) The AS curve shifts leftward.

Answer: ATopic: Changes in aggregate supply, money prices of resourcesSkill: Level 3: Using modelsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

58) The aggregate supply curve shifts rightward when

A) potential GDP decreases.

B) the money wage rate falls.

C) income taxes increase.

D) government purchases increase.

E) the money wage rate rises.

Answer: BTopic: Changes in aggregate supply, money wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1190


59) The aggregate supply curve shifts

A) rightward if potential GDP decreases.

B) rightward if the money wage rate falls.

C) rightward if the money wage rate rises.

D) leftward if potential GDP increases.

E) leftward if the aggregate demand curve shifts leftward.


60) A fall in the money wage rate ________ aggregate supply and ________.

A) decreases; shifts the AS curve rightward

B) increases; shifts the AS curve leftward

C) increases; shifts the AS curve rightward

D) decreases; shifts the AS curve leftward

E) does not change; does not shift the AS curve

Answer: CTopic: Changes in aggregate supply, money wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

61) An increase in the money wage rate leads to

A) an upward movement along the aggregate supply curve.

B) a downward movement along the aggregate supply curve.

C) a leftward shift of the aggregate supply curve.

D) a rightward shift of the aggregate supply curve.

E) a leftward shift of the aggregate demand curve.

Answer: CTopic: Changes in aggregate supply, money wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

62) A rise in the money wage rate shifts the

A) AD curve rightward.

B) AD curve leftward.

C) AS curve rightward.

D) AS curve leftward.

E) potential GDP curve rightward.

Answer: DTopic: Changes in aggregate supply, money wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1191


63) If the money wage rate increases, then the

A) aggregate supply curve shifts rightward.


C) potential GDP decreases.

D) aggregate supply curve shifts leftward.

E) aggregate demand curve shifts leftward.

Answer: DTopic: Changes in aggregate supply, money wage rateSkill: Level 3: Using modelsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

64) ________ decreases aggregate supply.

A) An increase in potential GDP

B) An increase the quantity of capital

C) A rise in the price level

D) A rise in the money wage rate

E) A fall in the money wage rate

Answer: DTopic: Changes in aggregate supply, money wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

65) Which of the following shifts the aggregate supply curve leftward?

A) increase in potential GDP

B) increase in the money wage rate

C) increase in real GDP

D) decrease in the money price of oil

E) a fall in the price level


Page 1192


66) Which of the following statements is true?

A) An increase in potential GDP increases aggregate supply and shifts the AS curve

leftward.

B) A decrease in potential GDP decreases aggregate supply and shifts the AS curve

leftward.

C) An increase in the money wage rate shifts the AS curve rightward.

D) A fall in the price level shifts the AS curve leftward.

E) An increase in the money wage rate increases potential GDP.

Answer: BTopic: Changes in aggregate supply, potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

67) Which of the following shifts the aggregate supply curve leftward?

A) a decrease in potential GDP

B) a fall in the money wage rate

C) a decrease in the price level

D) a fall in the real wage rate

E) an increase in potential GDP

Answer: ATopic: Changes in aggregate supply, potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

68) An increase in potential GDP ________ aggregate supply and ________.

A) decreases; shifts the AS curve rightward

B) increases; shifts the AS curve leftward

C) increases; shifts the AS curve rightward

D) decreases; shifts the AS curve leftward

E) has no effect on; does not shift the AS curve

Answer: CTopic: Changes in aggregate supply, potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

Page 1193


69) If potential GDP increases, then the

A) aggregate supply curve shifts leftward.

B) aggregate supply curve shifts rightward.

C) real wage rate increases.

D) real wage rate falls.

E) aggregate demand curve shifts rightward.

Answer: BTopic: Changes in aggregate supply, potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

70) Which of the following shifts the aggregate supply curve rightward?

A) increase in potential GDP

B) increase in the money wage rate

C) increase in real GDP

D) increase in the money price of oil

E) increase in consumersʹ incomes


71) If potential GDP increases,

A) aggregate supply does not change.

B) the quantity of aggregate supply decreases.

C) aggregate supply increases.

D) the price level rises.

E) the money wage rate must have fallen.

Answer: CTopic: Changes in aggregate supply, potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1194


72) When potential GDP increases, the potential GDP line ________, and the aggregate supply

curve ________.

A) shifts rightward; shifts rightward

B) shifts rightward; shifts leftward

C) shifts leftward; shifts rightward

D) shifts leftward; shifts leftward

E) shifts rightward; does not shift

Answer: ATopic: Changes in aggregate supply, technologySkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

73) An increase in ________ increases potential GDP and ________ aggregate supply.

A) technology; increases

B) technology; decreases

C) the money wage rate; increases

D) the money price of oil; decreases

E) the money wage rate; decreases


74) An increase in technology ________ potential GDP and ________ aggregate supply.







Page 1195


75) A technological advance ________ potential GDP, ________ aggregate supply, and shifts the

aggregate supply curve ________.

A) increases; increases; leftward

B) decreases; decreases; leftward

C) increases; increases; rightward

D) decreases; increases; rightward

E) increases; decreases; leftward

Answer: CTopic: Changes in aggregate supply, potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

76) The change in potential real GDP and aggregate supply shown in the graph above can be a

result of

A) an increase in the real wage rate.

B) an increase in the quantity of capital.

C) a decrease in the money wage rate.

D) a decrease in the money price of oil.

E) a fall in the price level.

Answer: BTopic: Changes in aggregate supply, potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

Page 1196


77) As the money wage rate increases,


B) potential GDP decreases.

C) aggregate supply increases.

D) aggregate supply decreases.

E) aggregate supply and potential GDP do not change.

Answer: DTopic: Changes in aggregate supply, money wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

78) The change reflected in the above figure might be a result of

A) a decrease in the money wage rate.

B) a decrease in the real wage rate.

C) an increase in the money wage rate.

D) an increase in the real wage rate.

E) a rise in the price level.

Answer: ATopic: Changes in aggregate supply, money wage rateSkill: Level 3: Using modelsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

Page 1197


79) The change reflected in the above figure might be a result of

A) a decrease in the quantity of capital.

B) an increase in the quantity of labor.

C) a rise in the money wage rate.

D) a decrease in the money prices of resources other than labor.

E) a fall in the price level.

Answer: CTopic: Changes in aggregate supply, money wage rateSkill: Level 3: Using modelsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

80) Moving along the potential GDP line, the money wage rate changes by the same percentage as

the change in the price level so that the real wage rate

A) increases.

B) decreases.

C) stays at the full-employment equilibrium level.

D) might either increase or decrease.

E) stays the same, though not necessarily at the full-employment equilibrium level.

Answer: CTopic: Potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1198


81) The aggregate supply curve is

A) upward sloping.

B) downward sloping.

C) a vertical line.

D) a horizontal line.

E) U-shaped.

Answer: ATopic: Aggregate supply curveSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

82) When the price level falls,

A) the AS curve shifts rightward but the potential GDP line does not shift.

B) there is a movement upward along the AS curve.

C) the AS curve shifts leftward but the potential GDP line does not shift.

D) there is a movement downward along the AS curve.

E) both the potential GDP line and the AS curve shift leftward.

Answer: DTopic: Aggregate supply, price levelSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

83) As the price level rises relative to costs and the real wage rate falls, profits ________ and the

number of firms in business ________.

A) increase; increases

B) increase; decreases

C) decrease; increases

D) decrease; decreases

E) do not change; do not change


Page 1199


84) When potential GDP increases,

A) the AS curve shifts rightward.

B) there is a movement up along the AS curve.

C) the AS curve shifts leftward.

D) there is a movement down along the AS curve.

E) there is neither a movement along nor a shift in the AS curve.

Answer: ATopic: Changes in aggregate supply, potential GDPSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

85) If the money wage rate rises,

A) the AS curve shifts rightward.

B) there is a movement up along the AS curve.

C) the AS curve shifts leftward.

D) there is a movement down along the AS curve.

E) there is neither a movement along or a shift in the AS curve.

Answer: CTopic: Changes in aggregate supply, money wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

13.2 Aggregate Demand

1) A rise in the price level

A) decreases aggregate demand.

B) increases aggregate demand.

C) decreases the quantity of real GDP demanded.

D) increases the quantity of real GDP demanded.

E) has no effect on aggregate demand or on the quantity of real GDP demanded.

Answer: CTopic: Aggregate demandSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1200



A) The price level does not affect the level of real GDP demanded.

B) The lower the price level, the greater the quantity of real GDP demanded.

C) The lower the price level, the more the aggregate demand curve shifts rightward.

D) The lower the price level, the more the aggregate demand curve shifts leftward.

E) The higher the price level, the more the aggregate demand curve shifts rightward.

Answer: BTopic: Aggregate demandSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

3) The AD curve is a graph depicting the

A) relationship between the price level and the quantity of real GDP supplied.

B) business cycle during expansions and recessions.

C) relationship between the price level and the quantity of real GDP demanded.

D) relationship between the price level and potential GDP.

E) relationship between the aggregate quantity of real GDP demanded and the aggregate

quantity of real GDP supplied.

Answer: CTopic: Aggregate demand curveSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

4) The aggregate demand curve illustrates the relationship between

A) the price level and the quantity of goods demanded by households, firms, government,

and foreigners.

B) the real wage rate and the hours of labor demanded by firms.

C) the price level and the potential quantity demanded of real GDP.

D) the price level and the quantity of goods supplied by firms.

E) the price level and the potential demand for real GDP.

Answer: ATopic: Aggregate demand curveSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1201


5) Which of the following produces a movement along the aggregate demand curve and does not

shift the aggregate demand curve?

A) a change in foreign incomes

B) a change in the price level

C) a change in monetary policy

D) a change in expectations about the future

E) a change in government expenditures on goods and services

Answer: BTopic: Aggregate demand curveSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

6) A change in the price level produces a ________ the aggregate demand curve.

i. shift in

ii. change in the slope of

iii. movement along

A) i only B) ii only C) iii only D) i and iii E) i and ii


7) A fall in the price level produces a ________ the aggregate demand curve.





E) change in the slope of

Answer: BTopic: Aggregate demand curveSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

8) An increase in the price level leads to

A) a rightward shift of the aggregate demand curve.

B) a leftward shift of the aggregate demand curve.

C) a movement upward along the aggregate demand curve.

D) a movement downward along the aggregate demand curve.

E) neither a shift in the aggregate demand curve nor a movement along it.


Page 1202


9) If the price level increases, there is ________ the AD curve and the quantity of real GDP

demanded ________.

A) a movement upward along; increases

B) a movement downward along; increases

C) a movement upward along; decreases

D) a leftward shift in; decreases

E) no change in; does not change


10) A rise in the price level ________ the buying power of money and ________ the quantity of real

GDP demanded.

A) does not affect; increases

B) lowers; increases

C) raises; decreases

D) lowers; decreases

E) does not affect; does not change

Answer: DTopic: Buying power of moneySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

11) A rise in the price level brings a ________ in the buying power of money that ________

consumption expenditures and causes the quantity of real GDP demanded to ________.

A) rise; decreases; decrease

B) fall; decreases; decrease

C) fall; increases; increase

D) rise; increases; increase

E) fall; decreases; increase

Answer: BTopic: Buying power of moneySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1203


12) When the price level increases there is ________ movement along the aggregate demand curve

because the buying power of money ________.

A) an upward; decreases

B) a downward; decreases

C) an upward; increases

D) a downward; increases

E) no; does not change

Answer: ATopic: Buying power of moneySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

13) Last year the price level increased from 118 to 122. The increase in the price level leads to a

decrease in

A) the buying power of money.

B) the real interest rate.

C) the money wage rate.

D) the price of domestic goods and services relative to foreign goods and services.

E) potential GDP.


14) At a price level of 100, John has savings equal to $20,000. If the price level increases to 130, the

buying power of Johnʹs savings is approximately

A) $12,780. B) $15,400. C) $20,000. D) $26,000. E) $30,000.

Answer: BTopic: Buying power of moneySkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

15) A year over year ________ in the buying power of money means that definitely ________ from

one year to the next.

A) decrease; the price level increased

B) increase; the price level increased

C) decrease; inflation increased

D) increase; inflation increased

E) Both answers A and C are correct.

Answer: ATopic: Buying power of moneySkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

Page 1204


16) If the price level doubles, it will

A) increase the quantity of money.

B) have no effect on the buying power of money.

C) decrease the buying power of money.

D) increase potential GDP.

E) decrease potential GDP.

Answer: CTopic: Buying power of moneySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

17) When the price level rises and increases the demand for money, the nominal interest rate

________ and the real interest rate ________.

A) rises; rises

B) rises; falls

C) falls; rises

D) falls; falls


Answer: ATopic: Buying power of moneySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: RevisedAACSB: Reflective thinking

18) In the short run, a rise in the price level brings a ________ in the real interest rate that ________

investment, bringing ________ in the quantity of real GDP demanded.

A) rise; decreases; a decrease

B) fall; decreases ; a decrease

C) fall; increases ; an increase

D) rise; increases ; an increase

E) rise; decreases; an increase


Page 1205


19) A reason why an increase in the price level decreases the quantity of real GDP demanded is

that

A) the buying power of money increases.


C) the price of domestic goods and services increases relative to foreign goods and services.

D) the inflation rate decreases.

E) potential GDP decreases.

Answer: CTopic: Relative price of domestic and foreign goodsSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

20) A rise in the U.S. price level brings a ________ in the price of U.S. exports relative to imports

that ________ exports of U.S. goods, bringing ________ in the quantity of U.S. real GDP

demanded.

A) rise; decreases; a decrease

B) fall; decreases; a decrease

C) fall; increases; an increase

D) rise; increases; an increase

E) rise; increases; a decrease

Answer: ATopic: Relative price of domestic and foreign goodsSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

21) When the U.S. price level rises relative to other nationsʹ price levels, then

A) U.S. firmsʹ profits increase and the aggregate demand curve shifts rightward.

B) U.S. exports increase and the aggregate demand curve shifts rightward.

C) U.S. exports decrease, U.S. imports increase, and the aggregate demand curve shifts

leftward.

D) U.S. exports decrease, U.S. imports increase, and there is a movement upward along the

aggregate demand curve.

E) U.S. exports decrease, U.S. imports increase, and the aggregate demand curve shifts

rightward.

Answer: DTopic: Relative price of domestic and foreign goodsSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1206


22) Sherri lives in Canada and is considering buying a new sofa. If the price level in Canada falls

and the price level in the United States does not change, Canadian manufactured sofas are

relatively

A) more expensive, so Sherri will likely purchase a U.S. manufactured sofa.

B) more expensive, so Sherri will likely purchase a Canadian manufactured sofa.

C) less expensive, so Sherri will likely purchase a U.S. manufactured sofa.

D) less expensive, so Sherri will likely purchase a Canadian manufactured sofa.

E) Both answers B and D could be correct depending on whether U.S. manufactured sofas

were initially more expensive or less expensive than Canadian sofas.

Answer: DTopic: Relative price of domestic and foreign goodsSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

23) When the domestic price level increases, exports decrease and imports increase. Other things

the same, this change is illustrated by a

A) movement upward along the aggregate demand curve.

B) movement downward along the aggregate demand curve.

C) rightward shift of the aggregate demand curve.

D) leftward shift of the aggregate demand curve.

E) rightward shift of the aggregate supply curve.

Answer: ATopic: Relative price of domestic and foreign goodsSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

24) The aggregate demand curve shifts when any of the following factors change EXCEPT

A) foreign income.

B) the price level.

C) monetary policy.

D) expectations about the future.

E) fiscal policy.

Answer: BTopic: Changes in aggregate demandSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1207


25) Which of the following does NOT shift the aggregate demand curve?

A) a change in the money wage

B) a change in expectations about the future

C) a change in monetary policy

D) a change in fiscal policy

E) a change in foreign income

Answer: ATopic: Changes in aggregate demandSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

26) All of the following shift the aggregate demand curve to the right EXCEPT

A) an increase in taxes.

B) an expansion of the global economy.

C) an increase in foreign income.

D) an increase in government expenditure.

E) an increase in expected future profit.

Answer: ATopic: Changes in aggregate demandSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

27) All of the following actions shift the aggregate demand curve to the right EXCEPT

A) the Fed raises the interest rate.

B) an increase in government transfer payments.

C) inflation is expected to rise next year.

D) an increase in expected future profit.

E) a decrease in taxes.

Answer: ATopic: Changes in aggregate demandSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

28) If there is an increase in expected future income, then

A) the aggregate demand curve shifts rightward.

B) the aggregate demand curve shifts leftward.

C) there is an upward movement along the aggregate demand curve.

D) there is a downward movement along the aggregate demand curve.

E) the aggregate demand curve becomes steeper.

Answer: ATopic: Changes in aggregate demand, expectationsSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1208


29) Aggregate demand

A) decreases if expected future income rises.

B) increases if the exchange rate rises.

C) increases if government expenditures decrease.

D) increases if the expected inflation rate increases.

E) increases if aggregate supply increases.

Answer: DTopic: Changes in aggregate demand, expectationsSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

30) Aggregate demand ________ if the expected inflation rate increases because ________.

A) increases; people expect to receive cost of living raises as the inflation begins

B) decreases; people wait for the exchange rates to change before making purchases

C) does not change; inflation does not affect the aggregate demand curve

D) increases; people want to make purchases now before the price of goods and services

begin to increase

E) decreases; people want to wait for the price of goods and services begin to decrease

Answer: DTopic: Changes in aggregate demand, expectationsSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: NewAACSB: Reflective thinking

31) If peopleʹs expectations about future income improve so they think their future income will be

higher than previously believed, then the AD curve

A) will not change until income actually rises.

B) will shift leftward because people will spend less now.

C) will shift rightward because people will increase spending now.

D) and the AS curve will both shift leftward because people will increase their saving.

E) will not shift, but potential GDP will increase.

Answer: CTopic: Changes in aggregate demand, expectationsSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1209


32) If firmsʹ expectations about the future become pessimistic so that they think future profits will

be lower, then

A) aggregate demand decreases and the AD curve shifts leftward.

B) aggregate demand increases and the AD curve shifts rightward.

C) the quantity of real GDP demanded decreases, and there is a movement up along the AD

curve.

D) the quantity of real GDP demanded increases, and there is a movement down along the

AD curve.

E) the aggregate demand curve does not shift, but potential GDP decreases.

Answer: ATopic: Changes in aggregate demand, expectationsSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

33) Which of the following decreases aggregate demand and shifts the AD curve leftward?

A) a tax cut

B) a decrease in price level

C) a decrease in government expenditures

D) a decrease in the price of exported goods and services

E) a decrease in potential GDP

Answer: CTopic: Changes in aggregate demand, fiscal policySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

34) An increase in government expenditure on goods and services leads to the

A) aggregate supply curve shifting rightward.

B) aggregate supply curve shifting leftward.

C) aggregate demand curve shifting rightward.

D) aggregate demand curve shifting leftward.

E) potential GDP increasing.

Answer: CTopic: Changes in aggregate demand, fiscal policySkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1210


35) Aggregate demand ________ and shifts the AD curve ________ when ________.

A) increases; rightward; government expenditure increases

B) increases; rightward; taxes increase

C) increases; rightward; future expected profit decreases

D) decreases; leftward; foreign income increases

E) increases; leftward; government expenditure increases

Answer: ATopic: Changes in aggregate demand, fiscal policySkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

36) A tax increase

A) decreases aggregate demand and the AD curve shifts leftward.

B) increases aggregate demand and the AD curve shifts rightward.

C) decreases the quantity of real GDP demanded and there is a movement up along the AD

curve.

D) increases the quantity of real GDP demanded and there is a movement down along the

AD curve.

E) does not shift or lead to a movement along the aggregate demand curve.

Answer: ATopic: Changes in aggregate demand, fiscal policySkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

37) Which of the following shifts the aggregate demand curve rightward?

A) a decrease in expected future income

B) a decrease in the price level

C) a tax cut

D) a decrease in the quantity of money

E) a decrease in government expenditures on goods and services

Answer: CTopic: Changes in aggregate demand, fiscal policySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1211


38) A tax cut ________ aggregate demand and ________.

A) decreases; shifts the AD curve rightward

B) increases; shifts the AD curve leftward

C) increases; shifts the AD curve rightward

D) decreases; shifts the AD curve leftward

E) does not change; does not shift the AD curve

Answer: CTopic: Changes in aggregate demand, fiscal policySkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking


A) An increase in peopleʹs expected future income shifts the aggregate demand curve

leftward.

B) A tax increase shifts the aggregate demand curve leftward.

C) An increase in potential GDP shifts the aggregate demand curve rightward.

D) An increase in exports shifts the aggregate demand curve leftward.

E) The higher the price level, the larger is the quantity of real GDP demanded.

Answer: BTopic: Changes in aggregate demand, fiscal policySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

40) If taxes are cut, there is

A) an increase in aggregate demand and the AD curve shifts rightward.

B) a decrease in aggregate demand and the AD curve shifts leftward.

C) an increase in the quantity of real GDP demanded and a movement up along the AD

curve.

D) a decrease in the quantity of real GDP demanded and a movement down along the AD

curve.

E) no change in aggregate demand, only a change in potential GDP.

Answer: ATopic: Changes in aggregate demand, fiscal policySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1212


41) Which of the following decreases aggregate demand and shifts the AD curve leftward?

A) a tax cut

B) an interest rate hike

C) an increase in quantity of money

D) an increase in government expenditures on goods and services

E) a decrease in potential GDP

Answer: BTopic: Changes in aggregate demand, monetary policySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

42) If a country is trying to recover from a recent recession, it is unlikely their government officials

will decide to ________ because it would ________.

A) lower interest rates; decrease aggregate demand

B) raise interest rates; decrease aggregate demand

C) raise interest rates; increase aggregate demand

D) institute a tax cut; increase aggregate demand

E) increase taxes; increase aggregate demand

Answer: BTopic: Changes in aggregate demand, monetary policySkill: Level 3: Using modelsSection: Checkpoint 13.2Status: NewAACSB: Reflective thinking

43) If the Fed increases the quantity of money, then

A) aggregate demand decreases and the AD curve shifts leftward.

B) aggregate demand increases and the AD curve shifts rightward.

C) the quantity of real GDP demanded decreases and there is a movement up along the AD

curve.

D) the quantity of real GDP demanded increases and there is a movement down along the

AD curve.

E) both the aggregate demand curve and the aggregate supply curve shift leftward.

Answer: BTopic: Changes in aggregate demand, monetary policySkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1213


44) An increase in the quantity of money ________ aggregate demand and ________.

A) increases; shifts the aggregate demand curve rightward

B) increases; shifts the aggregate demand curve leftward

C) decreases; shifts the aggregate demand curve rightward

D) decreases; shifts the aggregate demand curve leftward

E) increases; rotates the aggregate demand curve so it is steeper

Answer: ATopic: Changes in aggregate demand, monetary policySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking


A) An increase in the price level shifts the aggregate demand curve rightward.

B) An increase in the price level shifts the aggregate demand curve leftward.

C) An increase in the quantity of the money shifts the aggregate demand curve rightward.

D) An increase in the real interest rate shifts the aggregate demand curve rightward.

E) An increase in the money wage rate shifts the aggregate demand curve leftward.

Answer: CTopic: Aggregate demand curveSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking


A) decreases; leftward; government expenditure increases

B) increases; rightward; taxes increase

C) decreases; leftward; foreign incomes decrease

D) decreases; rightward; government expenditure increases

E) increases; leftward; taxes decrease

Answer: CTopic: Changes in aggregate demand, foreign incomeSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking


A) decreases; leftward; the price level rises

B) increases; leftward; taxes increase

C) increases; rightward; foreign incomes increase

D) decreases; rightward; government expenditure increases

E) increases; rightward; taxes increase

Answer: CTopic: Changes in aggregate demand, foreign incomeSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

Page 1214


48) One of the influences that the world economy has on U.S. aggregate demand comes from

changes in

A) world opinion.

B) foreign income.

C) foreign governments.

D) world pollution.

E) foreign aid.

Answer: BTopic: Changes in aggregate demand, foreign incomeSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

49) If European economies enter a recession,

A) U.S. aggregate demand decreases and the U.S. AD curve shifts leftward.

B) U.S. aggregate demand increases and the U.S. AD curve shifts rightward.

C) the quantity of real GDP demanded in the United States decreases and there is a

movement down along the U.S. AD curve.

D) the quantity of real GDP demanded in the United States increases and there is a

movement up along the U.S. AD curve.

E) U.S. aggregate demand decreases and the U.S. AD curve shifts rightward.

Answer: ATopic: Changes in aggregate demand, foreign incomeSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

50) A decrease in foreign income ________ exports of U.S.-made goods, so aggregate demand

________ and the aggregate demand curve shifts ________.

A) increases; increases; rightward

B) decreases; decreases; leftward

C) decreases; increases; rightward

D) increases; increases; leftward

E) decreases; decreases; rightward

Answer: BTopic: Changes in aggregate demand, foreign incomeSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

Page 1215


51) Suppose the exchange rate in the year 2010 was 4 yuan per dollar and in 2011 the exchange

rate fell to 3 yuan per dollar. If the price of a Chinese sweater was 120 yuan in both years, the

new dollar price in 2011 would be ________ and imports of Chinese sweaters would ________.

A) $40; increase

B) $30; decrease

C) $40; decrease

D) $30; increase

E) $40; stay the same because the price stayed the same at 120 yuan

Answer: CTopic: Changes in aggregate demand, foreign exchange rateSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

52) In the figure above, as the price level increases, the aggregate demand curve will

A) shift from AD1 to AD3.

B) shift from AD1 to AD2.

C) not shift, but the aggregate demand curve will change so that it is positively sloped.

D) not shift.

E) shift from AD1 to AD3 and then back to AD1.

Answer: DTopic: Aggregate demand curveSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

Page 1216


53) In the figure above, the shift in the aggregate demand curve from AD1 to AD2 could be result

of

A) a fall in the price level.

B) a decrease in the quantity of money.

C) an increase in government expenditures on goods and services.

D) an increase in taxes.


Answer: CTopic: Changes in aggregate demand, fiscal policySkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

54) In the figure above, the shift in the aggregate demand curve from AD1 to AD3 could be the

result of

A) a decrease in the real interest rate.

B) a decrease in the buying power of money.

C) an increased expectation of a recession that lowers the expected rate of profit from

investment.

D) a decrease in the foreign exchange rate.

E) an increase in the price level.

Answer: CTopic: Changes in aggregate demand, expectationsSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking


result of

A) a fall in the price level.

B) a tax cut.

C) an increased expectation of a recession that lowers peopleʹs expected future incomes.

D) a decrease in the foreign exchange rate.


Answer: CTopic: Changes in aggregate demand, expectationsSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

Page 1217



result of an increase in

A) expected future income.

B) the foreign exchange rate.

C) foreign incomes.

D) the price level.

E) aggregate supply.

Answer: BTopic: Changes in aggregate demand, foreign exchange rateSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

57) A change in any component of aggregate demand creates a larger change in overall aggregate

demand. This is the ________ effect, and it means, for example, that a(n) ________ in

consumption will cause an even larger ________ in AD.

A) multiplier; increase; increase

B) liquidity; decrease; decrease

C) growth; increase; decrease

D) multiplier; decrease; decrease

E) liquidity; increase; increase

Answer: DTopic: Aggregate demand multiplierSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

58) The aggregate demand multiplier effect says that an initial increase in expenditure plans leads

to an induced

A) increase in consumption expenditure.

B) increase in production expenditure.

C) increase in government expenditures on goods and services.

D) decrease in the price level.

E) increase in exports.

Answer: ATopic: Aggregate demand multiplierSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1218


59) Because of the existence of the aggregate demand multiplier, a $10 billion change in

expenditure

A) shifts the aggregate demand curve by more than $10 billion.

B) shifts the aggregate demand curve by $10 billion.

C) shifts the aggregate demand curve by less than $10 billion.

D) changes the slope of the aggregate demand curve so it is less steep.

E) changes the slope of the aggregate demand curve so it is steeper.

Answer: ATopic: Aggregate demand multiplierSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

60) If investment spending increases by $1 million, then the aggregate demand curve shifts

A) rightward by $1 million.

B) rightward by more than $1 million.

C) rightward by less than $1 million.

D) leftward by more than $1 million.

E) leftward by less than $1 million.

Answer: BTopic: Aggregate demand multiplierSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

61) When the price level rises there is a ________ the aggregate demand curve.


B) movement down along


D) movement up along

E) rotation of

Answer: DTopic: Changes in the price levelSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

Page 1219


62) A rise in the price level

A) raises the buying power of money.

B) decreases the prices of exports.

C) lowers the buying power of money.

D) increases aggregate demand.

E) makes the aggregate demand curve steeper.

Answer: CTopic: Buying power of moneySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

63) When the price level rises, the real interest rate ________ and the quantity of real GDP

demanded ________.

A) rises; increases

B) rises; decreases

C) falls; increases

D) falls; decreases


Answer: BTopic: Real interest rateSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

64) A change in any of the following factors EXCEPT ________ shifts the aggregate demand curve.

A) expectations about the future

B) the money wage rate

C) monetary and fiscal policy

D) foreign income

E) the foreign exchange rate

Answer: BTopic: Changes in aggregate demandSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

Page 1220


65) Which of the following shifts the aggregate demand curve leftward?

A) a decrease in government expenditure on goods and services

B) an increase in the price level

C) a tax cut

D) an increase in foreign income

E) a decrease in the price level

Answer: ATopic: Changes in aggregate demand, expectationsSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

66) When investment increases, the ________ in aggregate demand is ________ the change in

investment.

A) increase; greater than

B) increase; smaller than

C) increase; the same as

D) decrease; the same as

E) decrease; greater than

Answer: ATopic: Aggregate demand multiplierSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

13.3 Explaining Economic Trends and Fluctuations

1) Macroeconomic equilibrium occurs when

A) there is no inflation.

B) real GDP is equal to potential GDP.

C) the aggregate quantity demanded is equal to the aggregate quantity supplied.

D) the economy is fully employed.

E) the price level equals the potential price level.

Answer: CTopic: Macroeconomic equilibriumSkill: Level 1: DefinitionSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1221


2) A macroeconomic equilibrium occurs when the

A) quantity of real GDP demanded is greater than the quantity of real GDP supplied.

B) quantity of real GDP demanded is less than the quantity of real GDP supplied.

C) quantity of real GDP demanded equals the quantity of real GDP supplied even if they

are not equal to potential GDP.

D) quantity of real GDP demanded equals the quantity of real GDP supplied and both equal

potential GDP.


Answer: CTopic: Macroeconomic equilibriumSkill: Level 1: DefinitionSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

3) If the economy is at macroeconomic equilibrium, then real GDP

A) must equal potential GDP.

B) must be less than potential GDP.

C) must be great than potential GDP.

D) might be equal to, greater than, or less than potential GDP

E) cannot be compared to potential GDP.

Answer: DTopic: Macroeconomic equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

4) According to the AS-AD model,

A) the aggregate quantity supplied is typically greater than the aggregate quantity

demanded, thereby leading to unemployment.

B) the equilibrium is where the AS curve crosses the AD curve, but the amount of real GDP

at this point is not always equal to potential GDP.

C) the aggregate quantity demanded is typically greater than the aggregate quantity

supplied, thereby leading to inflation.

D) the AS curve is always equal to potential GDP.

E) changes in the amount of potential GDP is the only factor that shifts both the aggregate

supply curve and the aggregate demand curve.

Answer: BTopic: Macroeconomic equilibriumSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1222


5) In its macroeconomic equilibrium, the economy can be producing at

i. below full employment.

ii. full employment.

iii. above full employment.

A) i only B) ii only C) iii only D) i or ii E) i, ii, or iii

Answer: ETopic: Macroeconomic equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

6) When the quantity of real GDP demanded exceeds the quantity of real GDP supplied, firms

A) increase production and prices.

B) decrease production and prices.

C) increase production and lower prices.

D) decrease production and increase prices.

E) do not change production because aggregate demand and potential GDP will adjust.

Answer: ATopic: Macroeconomic equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

7) If the quantity of real GDP demanded is less than the quantity of real GDP supplied, then

A) the economy must be producing at potential GDP.

B) the price level falls and firms decrease production.

C) the price level falls and firms increase production.

D) the price level rises to restore the macroeconomic equilibrium.

E) aggregate demand changes to restore the equilibrium.

Answer: BTopic: Macroeconomic equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

8) If the quantity of real GDP demanded is greater than the quantity of real GDP supplied, then

A) the economy must be producing at potential GDP.

B) the price level falls and firms decrease production.

C) the price level rises and firms increase production.

D) the price level falls to restore the macroeconomic equilibrium.

E) aggregate demand changes to restore equilibrium.

Answer: CTopic: Macroeconomic equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1223


9) If real GDP is greater than potential GDP, then to restore equilibrium, ________ and the price

level ________.

A) the aggregate demand curve shifts leftward; rises

B) the aggregate demand curve shifts rightward; falls

C) the aggregate supply curve shifts leftward; rises

D) the aggregate supply curve shifts rightward; falls

E) potential GDP increases; falls

Answer: CTopic: Inflationary gapSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

10) If the aggregate demand curve and the aggregate supply curve intersect at a level of real GDP

more than potential GDP, there is

A) a recessionary gap.

B) an inflationary gap.

C) a falling price level.

D) a rising real GDP.

E) a below-full employment equilibrium.

Answer: BTopic: Inflationary gapSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

11) During an inflationary gap,

A) real GDP is less than potential GDP.

B) the aggregate demand curve and the aggregate supply curve intersect at potential GDP.

C) the aggregate demand curve and the aggregate supply curve intersect at a level of real

GDP that exceeds potential GDP.

D) the aggregate demand curve and the aggregate supply curve do not intersect.

E) the price level will fall to restore the long-run equilibrium.

Answer: CTopic: Inflationary gapSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1224


12) Starting from a situation of full employment, an increase in aggregate demand creates

________ and ________ the price level.

A) an inflationary gap; raises

B) a recessionary gap; lowers

C) a recessionary gap; raises

D) an inflationary gap; lowers

E) a recessionary gap; does not change

Answer: ATopic: Inflationary gapSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

13) If real GDP is less than potential GDP, then the money wage rate ________, and aggregate

supply ________ so that the price level ________.

A) rises; decreases; rises

B) falls; increases; falls

C) rises; increases; falls

D) falls; decreases; rises

E) does not change; increases; falls

Answer: BTopic: Recessionary gapSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

14) If real GDP is less than potential GDP, then the ________ and the price level ________.

A) aggregate demand curve shifts leftward; rises

B) aggregate demand curve shifts rightward; falls

C) aggregate supply curve shifts leftward; rises

D) aggregate supply curve shifts rightward; falls

E) amount of potential GDP increases; falls

Answer: DTopic: Recessionary gapSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1225


15) A recessionary gap occurs when ________ so that real GDP is ________ potential GDP.

A) aggregate supply increases; less than

B) aggregate supply decreases; less than

C) aggregate demand increases; greater than

D) aggregate demand decreases; less than

E) potential GDP decreases; greater than

Answer: DTopic: Recessionary gapSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

16) If the aggregate demand curve and the aggregate supply curve intersect at a level of real GDP

less than potential GDP, there is



C) a rising price level.

D) a falling real GDP.

E) an above full-employment equilibrium.

Answer: ATopic: Recessionary gapSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

17) If the equilibrium price level is 135 but the actual price level is 150, then

A) firms increase their production because they are able to sell their output at a higher than

expected price.

B) the quantity of real GDP demanded is less than the quantity of real GDP supplied.

C) the quantity of real GDP demanded is greater than the quantity of real GDP supplied.

D) aggregate demand will increase to restore equilibrium.

E) aggregate demand will decrease to restore equilibrium.

Answer: BTopic: Macroeconomic equilibriumSkill: Level 4: Applying modelsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1226


18) If the equilibrium price level is 135 but the actual price level is 120, then

A) firms decrease their production because they cannot sell the output they produce.

B) the quantity of real GDP demanded is less than the quantity of real GDP supplied.

C) the quantity of real GDP demanded is greater than the quantity of real GDP supplied.

D) aggregate demand will increase to restore equilibrium.

E) aggregate demand will decrease to restore equilibrium.

Answer: CTopic: Macroeconomic equilibriumSkill: Level 4: Applying modelsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

19) At a peak in the business cycle, the macroeconomic equilibrium is ________ the level of

potential real GDP.

A) greater than

B) equal to

C) less than

D) falling below

E) None of the above answers is always correct because the relationship depends on

whether the previous phase of the business cycle had been a recession or an expansion.

Answer: ATopic: Macroeconomic equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

20) At a trough in the business cycle, the macroeconomic equilibrium is ________ the level of

potential real GDP.

A) greater than

B) rising above

C) equal to

D) less than

E) None of the above answers is always correct because the relationship depends on

whether the previous phase of the business cycle had been a recession or an expansion.

Answer: DTopic: Macroeconomic equilibriumSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1227


Price level

(GDP deflator)

Real GDP demanded

(trillions of 2009

dollars)

Real GDP supplied

(trillions of 2009

dollars)

80

90

100

110

120

130

10

9

8

7

6

4

2

4

6

7

8

9

The table gives the aggregate demand and aggregate supply schedules for a nation.

21) Based on the table above, equilibrium real GDP is

A) $10 trillion.

B) $9 trillion.

C) $8 trillion.

D) $7 trillion.

E) $6 trillion.

Answer: DTopic: Equilibrium AD and ASSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

22) Based on the table above, the equilibrium price level is

A) 130. B) 120. C) 110. D) 100. E) 90.

Answer: CTopic: Equilibrium AD and ASSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

23) Refer to the table above. If the price level is 120, then the aggregate quantity demanded is

________ than the aggregate quantity supplied and the price level ________.

A) greater; rises

B) greater; falls

C) less; rises

D) less; falls

E) less; might fall, rise or not change depending on whether real GDP is more than, less

than, or equal to potential GDP.

Answer: DTopic: Equilibrium AD and ASSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

Page 1228


24) If the price level is 90, then the price level will ________ because ________.

A) either fall or rise; markets are unstable and macroeconomic equilibrium is difficult to

predict

B) fall; the aggregate quantity demanded is less than the aggregate quantity supplied

C) rise; the aggregate quantity demanded is less than the aggregate quantity supplied

D) rise; the aggregate quantity demanded is greater than the aggregate quantity supplied

E) fall; the aggregate quantity demanded is greater than the aggregate quantity supplied

Answer: DTopic: Equilibrium AD and ASSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: NewAACSB: Analytical thinking

Price level

(GDP deflator)

Potential GDP


Real GDP supplied


Real GDP demanded


150 25 34 16

140 25 31 19

130 25 28 22

120 25 25 25

110 25 23 28

25) The table above gives data for the nation of Pearl, a small island in the South Pacific. The

economy is at full employment when real GDP is

A) $25 billion.

B) $28 billion.

C) $22 billion.

D) $31 billion.

E) $34 billion.

Answer: ATopic: Equilibrium AD and ASSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

26) The table above gives data for the nation of Pearl, a small island in the South Pacific. When the

economy is at full employment the price level is

A) 130. B) 120. C) 110. D) 140. E) 150.

Answer: BTopic: Equilibrium AD and ASSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

Page 1229


27) The table above gives data for the nation of Pearl, a small island in the South Pacific. If a

supply shock decreases the quantity of real GDP supplied by $6 billion at each price level, the

new equilibrium real GDP is

A) $16 billion.

B) $19 billion.

C) $22 billion.

D) $23 billion.

E) $17 billion.


28) The table above gives data for the nation of Pearl, a small island in the South Pacific. If

aggregate demand increases so that the quantity of real GDP demanded is $6 billion more at

each price level, the new equilibrium real GDP is

A) $34 billion.

B) $31 billion.

C) $28 billion.

D) $25 billion.

E) $23 billion.


29) The table above gives data for the nation of Pearl, a small island in the South Pacific. If

aggregate demand increases so that the quantity of real GDP demanded is $6 billion more at

each price level, the new equilibrium real GDP is ________, and the nation is now experiencing

a(n) ________.

A) $22 billion; inflationary gap

B) $22 billion; recessionary gap

C) $28 billion; inflationary gap

D) $28 billion; recessionary gap

E) $25 billion; equilibrium

Answer: CTopic: Equilibrium AD and ASSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: NewAACSB: Analytical thinking

Page 1230


30) According to the figure above, which point or points correspond to full employment?

A) only point a

B) only point b

C) only point c

D) points a and b

E) points a, b, and c

Answer: DTopic: Adjustment to full employmentSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

Page 1231


31) In the figure above, the economy is at an equilibrium with real GDP of $16 trillion and a price

level of 110. At this point there is

A) an inflationary gap.

B) a recessionary gap.

C) price stability.

D) a full-employment equilibrium.

E) an above full-employment equilibrium.

Answer: BTopic: Recessionary gapSkill: Level 1: DefinitionSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking


level of 110. As the economy moves toward its ultimate equilibrium, the ________ curve shifts

________.

A) aggregate supply; leftward

B) aggregate supply; rightward

C) aggregate demand; rightward

D) aggregate demand; leftward

E) potential GDP; leftward

Answer: BTopic: Adjustment to full employmentSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

Page 1232



level of 110. As the economy moves toward its ultimate equilibrium, the ________ curve shifts

________ because ________.

A) aggregate supply; leftward; the money wage rate rises

B) aggregate supply; rightward; the money wage rate falls

C) aggregate demand; rightward; the money wage rate falls

D) aggregate demand; leftward; the money wage rate rises

E) potential GDP; leftward; the money wage rate falls

Answer: BTopic: Adjustment to full employmentSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: NewAACSB: Analytical thinking

34) An economy experiences a recessionary gap. As the economy adjusts to full employment, the

money wage rate

A) falls, shifting the aggregate supply curve rightward.

B) rises, shifting the aggregate supply curve leftward.

C) rises, shifting the aggregate demand curve rightward.

D) falls, shifting the aggregate demand curve leftward.

E) falls, increasing potential GDP.

Answer: ATopic: Adjustment to full employmentSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

35) If the economy is above full employment, there is ________ gap, and as the economy adjusts

toward full employment, the price level ________.

A) an inflationary; rises

B) an inflationary; falls

C) a recessionary; rises

D) a recessionary; falls

E) an inflationary; does not change

Answer: ATopic: Adjustment to full employmentSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1233


36) Which of the following can start an inflation?

A) an increase in aggregate demand

B) an increase in aggregate supply

C) a decrease in aggregate supply

D) Both answers A and C are correct.

E) Answers A, B, and C are correct.

Answer: DTopic: InflationSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

37) Inflation can be started by

A) a decrease in aggregate supply or a decrease in aggregate demand.

B) a decrease in aggregate supply or an increase in aggregate demand.

C) an increase in aggregate supply or an increase in aggregate demand.

D) an increase in aggregate supply or a decrease in aggregate demand.

E) an increase in aggregate demand or an increase in potential GDP.

Answer: BTopic: InflationSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

38) Demand-pull inflation starts with

A) an increase in aggregate demand.

B) a decrease in aggregate demand.

C) an increase in potential GDP.

D) an increase in aggregate supply.

E) a decrease in aggregate supply.

Answer: ATopic: Demand-pull inflation, start


39) Demand-pull inflation starts with a shift of the

A) AS curve rightward.

B) AD curve rightward.

C) AS curve leftward.

D) AD curve leftward.

E) potential GDP line leftward.

Answer: BTopic: Demand-pull inflation, start


Page 1234


40) Demand pull inflation can be started by

A) a decrease in the quantity of money.

B) an increase in government expenditure.

C) a decrease in net exports.

D) an increase in the price of oil.

E) a decrease in the money price of resources.

Answer: BTopic: Demand-pull inflation, start


41) Which of the following factors could start a demand-pull inflation?

A) an increase in tax rates

B) a decrease in government expenditure

C) a decrease in the money wage rate

D) an increase in the money wage rate

E) an increase in the quantity of money

Answer: ETopic: Demand-pull inflation, start


42) Increases in the quantity of money can start a ________ inflation and an increase in

government expenditure can start a ________ inflation.

A) demand-pull; demand-pull

B) demand-pull; cost-push

C) cost-push; cost-push

D) cost-push; demand-pull

E) None of the above is correct because increases in the quantity of money are necessary to

continue an inflation but cannot start an inflation.

Answer: ATopic: Demand-pull inflation, start


Page 1235


43) Initially, demand-pull inflation will

A) increase the price level and not change real GDP.

B) increase both the price level and increase real GDP.

C) increase the price level and decrease real GDP.

D) shift the aggregate supply curve rightward.

E) decrease potential GDP.

Answer: BTopic: Demand-pull inflation


44) A demand-pull inflation initially is characterized by

A) increasing real output and a labor shortage.

B) increasing real output and a labor surplus.

C) decreasing real output and a labor shortage.

D) decreasing real output and a labor surplus.

E) no change in real output and a labor shortage.

Answer: ATopic: Demand-pull inflation


45) If demand pull inflation occurs when the economy is already at potential GDP, then following

the initial increase in aggregate demand, the

A) AS curve shifts rightward.

B) potential GDP line shifts rightward.

C) AS curve shifts leftward.

D) potential GDP line shifts leftward.

E) None of the above is correct because demand-pull inflation shifts only the aggregate

demand curve.

Answer: CTopic: Demand-pull inflation


Page 1236


46) Compared to the initial equilibrium, an initial increase in aggregate demand that is NOT

followed by an increase in the quantity of money results in new long-run equilibrium with

A) a higher price level but the same real GDP.

B) a higher price level and an increased level of real GDP.

C) the same price level and a lower level of real GDP.

D) the same price level and the same real GDP.



Skill: Level 4: Applying modelsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

47) A demand-pull inflation consists of ________ shifts in the AD curve and ________ shifts in the

AS curve.

A) rightward; rightward

B) rightward; leftward

C) right; no

D) leftward; rightward

E) leftward; leftward



48) In a persisting demand-pull inflation

A) aggregate supply decreases and aggregate demand increases.

B) aggregate demand decreases and aggregate supply decreases.

C) aggregate demand increases and potential GDP decreases.

D) aggregate supply increases and aggregate demand increases.




Page 1237


49) Demand-pull inflation results from continually increasing the quantity of money, which leads

to continually

A) decreasing potential GDP.

B) increasing potential GDP.

C) increasing aggregate supply.

D) decreasing aggregate demand.

E) increasing aggregate demand.

Answer: ETopic: Demand-pull inflation


50) Demand-pull inflation persists because of

A) continuing increases in government expenditures.

B) continuing increases in the quantity of money.

C) continuing increases in the real wage rate.

D) continuing decreases in the money wage rate.

E) continuing increases in aggregate supply.



51) For a demand-pull inflation to persist requires persistent increases in

A) tax rates.

B) the real wage rate.

C) real GDP.

D) the quantity of money.

E) government expenditures.

Answer: DTopic: Demand-pull inflation


Page 1238


52) During a demand-pull inflation, if the Fed tries to maintain a level of real GDP above potential

GDP, the AD curve will ________ and the AS curve will ________.

A) shift rightward once; shift rightward continuously

B) shift rightward continuously; shift rightward continuously

C) shift rightward continuously; not shift

D) not shift; shift rightward continuously

E) shift rightward continuously; shift leftward continuously

Answer: ETopic: Demand-pull inflation


53) In a demand-pull inflation, money wage rates rise because

A) a decrease in aggregate demand creates a labor shortage.

B) an increase in aggregate demand creates a labor surplus.

C) an increase in aggregate demand creates a labor shortage.

D) a decrease in aggregate demand creates a labor surplus.

E) an increase in aggregate supply creates a labor shortage.



54) To prevent demand-pull inflation,

A) firms must refuse to increase the money wage rate.

B) firms must refuse to increase the real wage rate.

C) the Fed must not let the quantity of money persistently rise.

D) the natural unemployment rate must increase.

E) real GDP must increase.


Skill: Level 4: Applying modelsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1239


55) In a demand-pull inflation, if the Fed stops expanding the quantity of money,

A) a cost-push inflation will occur.

B) government expenditure will cause the demand-pull inflation to continue.

C) a deflation will occur.

D) the demand-pull inflation ends.


Answer: DTopic: Demand-pull inflation


56) The main sources of cost-push inflation are increases in

A) the money wage rate and the price of raw materials.

B) the real wage rate and the price of raw materials.

C) the money wage rate and aggregate demand.

D) the quantity of money and the real wage rate.

E) government expenditure and the quantity of money.

Answer: ATopic: Cost-push inflation


57) Cost-push inflation can be started by

A) a decrease in the money wage rate.

B) an increase in the money prices of raw materials.

C) an increase in the quantity of money.

D) an increase in government expenditure on goods and services.

E) a decrease in government expenditure on goods and services.

Answer: BTopic: Cost-push inflation


58) Cost-push inflation can start with

A) a decrease in investment.

B) an increase in oil prices.

C) an increase in government expenditure.

D) a decrease in government expenditure.

E) a decrease in the quantity of money.



Page 1240


59) Cost-push inflation might initially result from

A) an increase in the quantity of money.

B) a decrease in the quantity of money.

C) the use of new technology.

D) an increase in government expenditure.

E) an increase in the cost of resources.

Answer: ETopic: Cost-push inflation


60) Cost-push inflation starts with

A) an increase in aggregate demand.

B) a decrease in aggregate demand.

C) an increase in aggregate supply.

D) a decrease in aggregate supply.

E) an increase in potential GDP.

Answer: DTopic: Cost-push inflation


61) When cost-push inflation starts, real GDP ________ and the unemployment rate ________.

A) decreases; falls

B) does not change; falls

C) decreases; rises

D) does not change; does not change

E) increases; falls

Answer: CTopic: Cost-push inflation


62) When cost-push inflation starts, real GDP ________ and the price level ________.

A) decreases; falls

B) does not change; falls

C) decreases; rises

D) does not change; does not change

E) increases; falls



Page 1241


63) At the start of a cost-push inflation,

A) the price level remains constant and real GDP decreases.

B) the price level and real GDP both increase.

C) the price level remains constant and real GDP increases.

D) the price level rises and real GDP decreases.

E) the price level rises and real GDP does not change.



64) Suppose that the money prices of raw materials increase so that short-run aggregate supply

decreases. If the Federal Reserve does not respond, the higher money price of raw materials

will

i. repeatedly shift the aggregate demand curve rightward and raise the price level.

ii. shift the aggregate demand curve rightward and the aggregate supply curve leftward,

raising prices.

iii. result initially in lower employment and a higher price level.

A) i only

B) both i and ii

C) both ii and iii

D) i and iii

E) iii only

Answer: ETopic: Cost-push inflation


65) By itself, an increase in the price of oil shifts the

A) aggregate supply curve leftward and does not shift the aggregate demand curve.

B) aggregate supply curve rightward and does not shift the aggregate demand curve.

C) aggregate demand curve leftward and does not shift the aggregate supply curve.

D) aggregate demand curve rightward and does not shift the aggregate supply curve.

E) aggregate demand curve rightward and shifts the potential GDP line rightward.

Answer: ATopic: Cost-push inflation


Page 1242


66) The AS curve shifts leftward if

A) good weather increases agricultural harvests.

B) OPEC reduces world oil prices.

C) tax cuts stimulate labor supply.

D) the money wage rate increases.

E) government expenditure increases.



67) If oil prices increase, then in the short run, real GDP will ________ and the price level will

________.

A) increase; rise

B) increase; fall

C) decrease; rise

D) decrease; fall

E) not change; rise



68) In the short-run, an increase in the price of raw materials will ________ the price level and

________ real GDP.

A) raise; increase

B) raise; decrease

C) raise; not change

D) lower; increase

E) lower; decrease



Page 1243


69) By itself, a supply shock, such as a hike in the price of oil, can

A) cause real GDP to permanently decrease year after year.

B) not result in persisting inflation.

C) be inflationary as long as there is no policy response.

D) result in persisting inflation if aggregate supply persistently increases.

E) result in a persisting wage-price spiral.



70) A combination of recession and inflation is called

A) an expansion.

B) stagflation.

C) a business cycle.

D) depression.

E) a recession.

Answer: BTopic: StagflationSkill: Level 1: DefinitionSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

71) Stagflation is defined as a period when real GDP ________ and the price level ________.





E) is constant; rises rapidly

Answer: CTopic: StagflationSkill: Level 1: DefinitionSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

72) A combination of declining real GDP and rising price level is referred to as

A) an expansion.

B) a trough.

C) stagflation.

D) deflation.

E) a depression.


Page 1244


73) Reasons that the recession of 2008-2009 did not become a depression include:

i. The Fed bailed out troubled financial institutions.

ii. The government aggressively balanced its budget.

iii. The government increased its expenditures, which increased aggregate demand.

A) i only B) ii only C) iii only D) i and iii E) i and ii

Answer: DTopic: 2008-2009 recession


74) As a result of OPEC ________ oil prices in 1973 and 1980, real GDP in United States ________.

A) increasing; increased

B) increasing; decreased

C) decreasing; increased

D) decreasing; decreased

E) increasing; did not change

Answer: BTopic: Eye on the past, oil price cycles in U.S. & global economiesSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

75) Oil price hikes

A) increase aggregate supply.

B) decrease aggregate supply.

C) increase aggregate demand.

D) decrease aggregate demand.

E) increase potential GDP.

Answer: BTopic: Eye on the past, oil price cycles in U.S. & global economiesSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

76) When OPEC nearly tripled the price of oil in late 1973,

A) U.S. real GDP increased as profits by oil producers increased.

B) U.S. real GDP did not change although the price level rose.

C) the U.S. price level fell because production became too expensive.

D) the U.S. price level rose and real GDP decreased.

E) both U.S. real GDP and the price level increased.

Answer: DTopic: Eye on the past, oil price cycles in U.S. & global economiesSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1245


77) At the beginning of 2015, a country is at full-employment. During 2015, oil-producing

countries decrease oil production leading to much higher oil prices. The higher oil prices can

A) increase aggregate demand and lead to an expansion.

B) increase aggregate supply and lead to an expansion.

C) decrease aggregate demand and lead to a stagflation.

D) decrease aggregate supply and lead to a stagflation.

E) decrease aggregate demand and lead to a higher price level.

Answer: DTopic: Eye on the past, oil price cycles in U.S. & global economiesSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

78) Potential GDP increased from 4.7 trillion to 16.6 trillion between 1970 and 2013 resulting in

economic growth. Also, during this time ________ occurred because ________.

A) inflation; aggregate demand decreased by more than potential GDP

B) stagflation; aggregate demand increased by more than potential GDP

C) deflation; aggregate demand increased by more than potential GDP

D) inflation; aggregate demand increased by more than potential GDP

E) inflation; aggregate demand increased by less than potential GDP

Answer: DTopic: Eye on the U.S. economySkill: Level 3: Using modelsSection: Checkpoint 13.3Status: NewAACSB: Analytical thinking

79) In reality, AD rarely ________; however, the economy performs as though it does when it

________.

A) decreases; fluctuates with potential GDP

B) increases; decreases at a pace much slower than potential GDP

C) stagnates; increases at a pace much faster than potential GDP

D) decreases; increases at a pace much slower than potential GDP

E) decreases; increases at a pace much faster than potential GDP


Page 1246


80) The 2008-2009 recession must have been a result of ________ because otherwise the

combination of the ________ cannot be explained.

A) a decrease in AD and an increase in AS; fall in the price level and the decrease in real

GDP

B) a decrease in AD and an increase in AS; rise in the price level and the decrease in real

GDP

C) an increase in AD and AS; rise in the price level and the decrease in real GDP

D) a decrease in AD and AS; rise in the price level and the decrease in real GDP

E) a decrease in AD and AS; decrease in the price level and the decrease in real GDP


81) If the quantity of real GDP supplied equals the quantity of real GDP demanded, then

A) nominal GDP must equal real GDP.

B) real GDP must equal potential GDP.

C) real GDP must be greater than potential GDP.

D) real GDP might be greater than, equal to, or less than potential GDP.

E) real GDP must be less than potential GDP.

Answer: DTopic: Macroeconomic equilibriumSkill: Level 1: DefinitionSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

82) An increase in investment ________ aggregate demand, the aggregate demand curve shifts

________ and the economy is in the ________ phase of the business cycle.

A) decreases; rightward; expansion

B) increases; rightward; expansion

C) decreases; leftward; recession

D) increases; rightward; recession

E) increases; leftward; recession

Answer: BTopic: Aggregate demand fluctuationsSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

Page 1247


83) If the price of oil rises, the

A) AD curve shifts rightward, real GDP increases, and the price level rises.

B) AS curve shifts leftward, the price level rises, and real GDP decreases.

C) AD curve and the AS curve shift leftward, real GDP decreases, and the price level rises.

D) AD curve and the AS curve shift rightward, the price level rises, and real GDP decreases.

E) AS curve shifts leftward, the price level rises, and real GDP increases.

Answer: BTopic: Aggregate supply fluctuationsSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

84) Stagflation is a combination of ________ real GDP and a ________ price level.

A) increasing; rising

B) increasing; falling

C) decreasing; rising

D) decreasing; falling

E) no change in; rising


85) An inflationary gap is created when

A) real GDP is greater than potential GDP.

B) real GDP equal to potential GDP.

C) the inflation rate is less than potential inflation.

D) the price level exceeds the equilibrium price level.

E) potential GDP is greater than real GDP.

Answer: ATopic: Inflationary gapSkill: Level 1: DefinitionSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1248


86) The economy is at full employment. If aggregate demand increases,

A) an inflationary gap is created and the AS curve shifts leftward as the money wage rate

rises.

B) an inflationary gap is created and the AD curve shifts leftward.

C) an inflationary gap is created and potential GDP increases to close the gap.

D) a recessionary gap is created and the AS curve shifts leftward as the money wage rate

falls.

E) a recessionary gap is created and the AS curve shifts leftward as the money wage rate

rises.

Answer: ATopic: Adjustment to full employmentSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

Page 1249



The figure above shows the aggregate supply curve and potential GDP.

1) Based on the figure above, the aggregate supply curve shifts rightward and the potential GDP

line does not change when

A) the money wage rate rises.

B) the price level rises.

C) the money wage rate falls.

D) the price level falls.

E) both the price level and money wage rate rise by the same proportion.

Answer: CTopic: Shifts in the aggregate supply curveSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

Page 1250


2) If potential GDP increases, then in the figure above the potential GDP line ________, and the

aggregate supply curve ________.

A) shifts rightward; does not shift

B) does not shift; shifts rightward

C) shifts rightward; shifts rightward

D) shifts rightward; shifts leftward

E) does not shift; does not shift

Answer: CTopic: Shifts in the aggregate supply curveSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

3) If the money wage rate and the price level both rise by the same proportion, then in the figure

above the potential GDP line ________, and the aggregate supply curve ________.

A) shifts rightward; does not shift

B) does not shift; shifts rightward

C) shifts rightward; shifts rightward

D) shifts rightward; shifts leftward

E) does not shift; shifts leftward

Answer: ETopic: Shifts in the aggregate supply curveSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

Page 1251


The figure above shows the aggregate demand curve.

4) The aggregate demand curve in the figure above shifts rightward if



C) taxes are hiked.

D) government expenditure decreases.

E) the expected future profit increases so that investment increases.

Answer: ETopic: Shifts in the aggregate demand curveSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking




C) taxes are cut.


E) the Federal Reserve raises the interest rate.

Answer: CTopic: Shifts in the aggregate demand curveSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

Page 1252





C) taxes are raised.

D) government expenditure increases.


Answer: DTopic: Shifts in the aggregate demand curveSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking




C) taxes are raised.


E) the Federal Reserve lowers the interest rate.


Page 1253


The figure above shows aggregate demand curves.

8) Based on the figure above, the aggregate demand curve will shift from AD0 to AD1 when


B) the price level falls.

C) the price level rises.










Answer: DTopic: Shifts in the aggregate demand curveSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

Page 1254





C) taxes are lowered.

D) government expenditure increases.








E) taxes are lowered.



1) An increase in the price level ________ the aggregate quantity supplied and ________ the

aggregate quantity demanded.





E) does not change; decreases


Page 1255


2) The ________, the ________ is the quantity of real GDP supplied and the ________ is the

quantity of real GDP demanded.

A) lower the price level; greater; smaller

B) higher the price level; greater; smaller

C) greater the demand for labor; smaller; greater

D) lower the supply of labor; greater; smaller

E) lower aggregate demand; greater; smaller


3) The aggregate supply curve shifts

A) rightward if potential GDP decreases.

B) rightward if the money wage rate falls.

C) rightward if the money wage rate rises.

D) leftward if potential GDP increases.

E) leftward if the aggregate demand curve shifts leftward.

Answer: BTopic: IntegrativeSkill: Level 2: Using definitionsSection: IntegrativeStatus: OldAACSB: Reflective thinking

4) During the late 1960s, U.S. defense spending increased as the United States fought in Vietnam.

This increase in government expenditure on goods and services most likely created



C) a decrease in aggregate supply.

D) a decrease in aggregate demand because consumersʹ expenditures decreased.

E) an increase in potential GDP.


Page 1256


5) A recession in the rest of the world means U.S.

A) aggregate supply decreases.

B) aggregate demand decreases.

C) potential GDP decreases.

D) exports increase.

E) potential GDP increases.


6) ________ increases potential GDP.

A) A decrease in the money wage rate

B) A recessionary gap

C) A recession

D) An increase in the amount of human capital

E) An increase in aggregate demand


7) Unemployment increases when

A) an inflationary gap is created.


C) the government decreases its expenditure on goods and services.

D) aggregate demand increases.

E) aggregate supply increases.

Answer: CTopic: IntegrativeSkill: Level 5: Critical thinkingSection: IntegrativeStatus: OldAACSB: Reflective thinking

Page 1257


8) In the late 1920s, the U.S. economy experienced a decrease in investment, which perhaps

triggered the Great Depression. The decrease in investment

A) increased aggregate supply.

B) decreased aggregate supply.

C) increased aggregate demand.

D) decreased aggregate demand.

E) increased potential GDP.

Answer: DTopic: IntegrativeSkill: Level 5: Critical thinkingSection: IntegrativeStatus: OldAACSB: Analytical thinking

9) When the macroeconomic equilibrium is such that real GDP exceeds potential real GDP, the

economy is suffering from ________, and the government policy to eliminate this gap will

________ real GDP and ________ the price level.

A) an inflationary gap; increase; increase

B) a recessionary gap; decrease; decrease

C) an inflationary gap; increase; decrease

D) a recessionary gap; increase; decrease

E) an inflationary gap; decrease; decrease

Answer: ETopic: IntegrativeSkill: Level 5: Critical thinkingSection: IntegrativeStatus: OldAACSB: Analytical thinking

10) When the macroeconomic equilibrium is such that real GDP is less than potential real GDP,

the economy is suffering from ________, and the government policy to eliminate this gap will

________ real GDP and ________ the price level.

A) a recessionary gap; decrease; decrease

B) an inflationary gap; increase; decrease

C) a recessionary gap; increase; increase

D) an inflationary gap; decrease; increase

E) a recessionary gap; decrease; increase


Page 1258


11) A decrease in investment leads to ________ in aggregate demand and ________ in real GDP.





E) no change; a decrease


12) A deep recession hits the world economy, and real GDP in the rest of the world decreases. In

the United States,

A) aggregate supply and aggregate demand both increase, and the price level rises.

B) aggregate supply decreases while aggregate demand does not change, and the price level

rises.

C) aggregate demand decreases while aggregate supply does not change, and the price level

falls.

D) aggregate supply increases and aggregate demand decreases, so the effect on the price

level is uncertain.

E) aggregate supply and aggregate demand both decrease, and the price level rises.


13) If the AD curve shifts rightward, then

A) both the price level and real GDP will increase.

B) the price level will increase, but no change will occur in real GDP.

C) the price level will not change, but real GDP will increase.

D) both the price level and real GDP will decrease.

E) potential GDP increases.


Page 1259


14) An economy is at a full-employment equilibrium, and then the aggregate demand curve shifts

leftward. As a result, the price level ________ and real GDP ________.

A) rises; increases

B) rises; decreases

C) falls; increases

D) falls; decreases

E) falls; does not change


15) An increase in government expenditure on goods and services ________ aggregate demand,

shifting the aggregate demand curve ________ and potentially bringing the ________ phase of

the business cycle.


B) increases; rightward; recession

C) decreases; leftward; recession

D) increases; rightward; expansion

E) increases; leftward; recession


16) The the government increases the level of government expenditure. If there is no change in the

aggregate supply curve, then aggregate demand will ________, real GDP will ________, and

the price level will ________.

A) increase; remain the same; increase

B) remain the same; increase; increase

C) increase; increase; increase

D) decrease; increase; increase

E) decrease; remain the same; decrease


Page 1260


17) If the AD curve shifts rightward while the AS curve and potential GDP donʹt change, then

A) the economy will move from a peak into recession.

B) the expansion phase of the business cycle occurs.

C) there will be no change in real GDP, so the economy is at the peak of the cycle.

D) there will be no change in real GDP, so the economy is at the trough of the cycle.

E) real GDP does not change.


18) The global economy enters a recession, thereby decreasing the level of U.S. exports. If the

aggregate supply curve does not shift, then aggregate demand will ________, real GDP will

________, and the price level will ________.


B) remain the same; increase; increase

C) increase; increase; remain the same

D) decrease; increase; increase

E) decrease; decrease; decrease

Answer: ETopic: IntegrativeSkill: Level 4: Applying modelsSection: IntegrativeStatus: OldAACSB: Analytical thinking

19) The government passes a law which doubles the wages of all workers. Aggregate supply will

________, and real GDP will ________, and the price level will ________.

A) increase; remain the same; increase.

B) remain the same; increase; increase.

C) increase; increase; remain the same.

D) decrease; increase; increase.

E) decrease; decrease; increase.

Answer: ETopic: IntegrativeSkill: Level 4: Applying modelsSection: IntegrativeStatus: OldAACSB: Analytical thinking

Page 1261


20) A technological advance ________ aggregate supply, shifting the aggregate supply curve

________ and potentially bringing the ________ phase of the business cycle.


B) decreases; leftward recession

C) increases; rightward; expansion

D) increases; rightward; recession

E) increases; leftward; expansion


21) An increase in the price of oil ________ aggregate supply, shifting the aggregate supply curve

________ and potentially bringing the ________ phase of the business cycle.


B) increases; rightward; recession

C) increases; rightward; expansion

D) decreases; leftward; recession

E) decreases; rightward; recession


22) A crisis in the Middle East drastically raises the price of petroleum. If the aggregate demand

curve does not shift, then aggregate supply will ________, real GDP will ________, and the

price level will ________.


B) decrease; decrease; increase

C) increase; increase; increase

D) remain the same; increase; increase

E) decrease; remain the same; decrease


Page 1262


23) Which of the following could result in a recession?

A) a rise in the price of oil

B) an increase in investment

C) a tax cut

D) an increase in the quantity of money

E) an increase in government expenditures on goods and services


24) ________ could result in a recession because it would ________.

A) A rise in the price of oil; shift the AS curve to the left.

B) An increase in investment; shift the AD curve to the right.

C) A tax cut; shift the AS curve to the left.

D) An increase in the quantity of money; shift the AS curve to the right.

E) An increase in government expenditures on goods and services; shift the AD curve to the

right.

Answer: ATopic: IntegrativeSkill: Level 4: Applying modelsSection: IntegrativeStatus: NewAACSB: Reflective thinking

25) Real GDP definitely increases if

A) both the AD curve and the AS curve shift rightward.

B) both the AD curve and AS curve shift leftward.

C) the AD curve shifts leftward and the AS curve shifts rightward.

D) the AS curve shifts leftward and the AD curve does not shift.

E) potential GDP decreases so that real GDP exceeds potential GDP.


Page 1263


13.6 Essay: Aggregate Supply

1) Name the four factors of production that determine the quantity of real GDP supplied. Which

one fluctuates the most over the course of the business cycle?

Answer: The factors are the quantity of labor employed, the quantities of capital and human

capital and the technologies they employ, the quantities of land and natural resources,

and the amount of entrepreneurial talent available. Over the course of a business cycle,

the quantity of labor employed fluctuates the most.Topic: Aggregate supplySkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Written and oral communication

2) What factor changes the quantity of real GDP supplied and results in a movement along the

AS curve?

Answer: Changes in the price level change the quantity of real GDP supplied and result in a

movement along the AS curve.Topic: Aggregate supply, price levelSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

3) Does a rise in the price level bring a movement along the aggregate supply curve or does it

shift the aggregate supply curve?

Answer: A rise in the price level results in an upward movement along the aggregate supply

curve. It does not shift the aggregate supply curve.Topic: Aggregate supply, price levelSkill: Level 1: DefinitionSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

4) If the money wage rate is constant and the price level increases, what happens to the real wage

rate, firmsʹ profits, and the aggregate quantity supplied?

Answer: The real wage rate falls. Because the price level has increased and money wage rates are

constant while real wage rates are lower, firmsʹ profits increase. As a result, the

aggregate quantity of goods and services supplied increases.Topic: Aggregate supply, price levelSkill: Level 3: Using modelsSection: Checkpoint 13.1Status: OldAACSB: Written and oral communication

Page 1264


5) List three changes that lead to a shift of the aggregate supply curve. Discuss why each change

shifts the aggregate supply curve and in which direction the curve shifts.

Answer: A change in potential GDP, a change in the money wage rate, and a change in the

money prices of other resources shift the aggregate supply curve. If potential GDP

increases (decreases) or the money wage rate decreases (increases) or the money prices

of other resources decrease (increase), aggregate supply increases (decreases) and the

AS curve shifts rightward (leftward).Topic: Changes in aggregate supplySkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Written and oral communication

6) How does a fall in the money wage rate affect the aggregate supply curve?

Answer: A fall in the money wage rate lowers firmsʹ costs and shifts the aggregate supply curve

rightward.Topic: Changes in aggregate supply, money wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

7) Give examples of factors that decrease aggregate supply. Which way does the AS curve shift?

Answer: Aggregate supply decreases if potential GDP decreases. A rise in the money wage rate

or the money price of other resources such as the price of oil raises firmsʹ costs and

decreases aggregate supply. The AS curve shifts leftward.Topic: Aggregate supply curveSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Written and oral communication

8) What is the effect on aggregate supply and potential GDP of an increase in the money wage

rate?

Answer: An increase in the money wage rate decreases aggregate supply and shifts the

aggregate supply curve leftward. It has no effect on potential GDP.Topic: Changes in aggregate supply, money wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Reflective thinking

Page 1265


9) ʺMoving along the AS curve, the real wage rate is constant while moving along the potential

GDP line, the real wage rate changes.ʺ Explain whether the previous statement is correct or

incorrect.

Answer: The statement is incorrect. It reverses the situation. Moving along the AS curve, the

money wage rate is constant and so the real wage rate changes. Moving along the

potential GDP line, money wage rates have adjusted to the change in the price level and

so the real wage rate is constant.Topic: Changes in aggregate supply, money wage rateSkill: Level 2: Using definitionsSection: Checkpoint 13.1Status: OldAACSB: Written and oral communication

10) What can lead to the shift illustrated in the figure above?

Answer: A decrease in the money wage rate or in the money prices of other resources, such as

the price of oil, increase aggregate supply and shift the AS curve rightward while not

changing potential GDP.Topic: Changes in aggregate supply, money wage rateSkill: Level 3: Using modelsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

Page 1266


11) In the above figure, illustrate the effect on the AS curve from an increase in the money price of

a key resource such as oil.

Answer:

An increase in the money price of a key resource such as oil squeezes firmsʹ profits and

decreases aggregate supply. As illustrated in the figure above, the AS curve shifts

leftward, in the figure from AS1 to AS2.

Topic: Changes in aggregate supply, money prices of resourcesSkill: Level 3: Using modelsSection: Checkpoint 13.1Status: OldAACSB: Analytical thinking

Page 1267


13.7 Essay: Aggregate Demand

1) What is the effect on the aggregate demand curve from an increase in the price level? In

particular, does the aggregate demand curve shift leftward or rightward?

Answer: When the price level increases, there is a movement along the aggregate demand curve.

The quantity of real GDP demanded decreases in response to an increase in the price

level. However, the aggregate demand curve does not shift.Topic: Aggregate demand curveSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Written and oral communication

2) How does an increase in the price level affect the aggregate quantity of goods and services

demanded?

Answer: An increase in the price level decreases the aggregate quantity of goods and services

demanded for three reasons. First, it decreases the buying power of money. As a result,

people decrease their demand for goods and services. Second, it raises the real interest

rate. The real interest rate rises because an increase in the price level increases the

demand for money, which raises the nominal interest rate, which, in the short run,

raises the real interest rate. When the real interest rate rises, people and businesses

delay plans for investment and purchases of big-ticket items. Finally, an increase in the

price level makes domestically produced goods and services more expensive relative to

foreign-produced goods and services. As a result, people and firms buy more foreign

produced and fewer domestically produced goods and services, which decreases the

quantity demanded of domestically produced goods and services.Topic: Aggregate demand curveSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Written and oral communication

3) Explain the difference between a movement along the aggregate demand curve and a shift of

the aggregate demand curve.

Answer: There is a movement along the aggregate demand curve if there is a change in the price

level. If some factor that affects aggregate demand other than the price level changes,

such as monetary or fiscal policy, income in the rest of the world, or expectations, there

is a shift in the aggregate demand curve.Topic: Aggregate demand curveSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Written and oral communication

Page 1268


4) How does the aggregate demand curve reflect an increase in aggregate demand?

Answer: An increase in aggregate demand means that the aggregate demand curve shifts

rightward.Topic: Aggregate demand curveSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

5) State how each of the following affect the aggregate demand curve.

a. The price level increases.

b. Consumers expect higher inflation in the future.

c. The exchange rate rises.

d. Foreign income decreases.

Answer: a. There is a movement upward along the aggregate demand curve. The aggregate

demand curve does not shift.

b. The aggregate demand curve shifts rightward.

c. The aggregate demand curve shifts leftward.

d. The aggregate demand curve shifts leftward.Topic: Changes in aggregate demandSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Analytical thinking

6) Give examples of factors that decrease aggregate demand. Which way does the aggregate

demand curve shift?

Answer: Anything that decreases spending decreases aggregate demand. A rise in the interest

rate, a decrease in the quantity of money, a decrease in government expenditures or a

tax hike, and a decrease in real GDP in the rest of the world all decrease spending and

decrease aggregate demand. The aggregate demand curve shifts leftward.Topic: Changes in aggregate demandSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Written and oral communication

Page 1269


7) How does a rise in the foreign exchange rate affect aggregate demand in the United States?

Explain your answer.

Answer: An increase in the foreign exchange rate decreases U.S. aggregate demand. The foreign

exchange rate is the amount of a foreign currency that a dollar can buy. If the exchange

rate rises, a dollar buys more foreign currency. As a result, foreign goods and services

become cheaper to U.S. citizens because U.S. citizens need to spend fewer dollars to buy

foreign-produced goods and services. Simultaneously, U.S.-produced goods and

services become more expensive to foreigners because they must spend more of their

currency in order to buy the dollars necessary to buy the U.S.-produced goods and

services. As a result, U.S. imports increase and U.S. exports decrease, both of which

decrease U.S. aggregate demand.Topic: Changes in aggregate demand, foreign exchange rateSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Written and oral communication

8) How does a recession in Asia affect U.S. aggregate demand and the U.S. aggregate demand

curve?

Answer: A recession in Asia means that Asians purchase fewer U.S.-made goods and services.

As a result, U.S. exports decrease so that U.S. aggregate demand decreases and the U.S.

aggregate demand curve shifts leftward.Topic: Changes in aggregate demand, world incomeSkill: Level 3: Using modelsSection: Checkpoint 13.2Status: OldAACSB: Written and oral communication

9) ʺAn increase in Mexican income decreases aggregate demand in the United States.ʺ Is the

preceding statement correct or incorrect? Briefly explain your answer.

Answer: The statement is incorrect. An increase in Mexican income means that Mexican citizens

buy more goods and services exported from the United States. The increase in U.S.

exports increases U.S. aggregate demand.Topic: Changes in aggregate demand, world incomeSkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Written and oral communication

Page 1270


10) What are the two channels through which the world economy can affect U.S. aggregate

demand? State what changes in the world economy can increase U.S. aggregate demand.

Answer: The world economy can affect aggregate demand through the foreign exchange rate and

foreign income. If the foreign exchange rate falls, then U.S. aggregate demand increases

because U.S. exports become cheaper to foreign residents while U.S. imports become

more expensive to U.S. citizens. If foreign income increases, then U.S. aggregate

demand increases because foreign citizens will spend some of their increased income on

U.S.-produced goods and services.Topic: Changes in aggregate demand, world economySkill: Level 2: Using definitionsSection: Checkpoint 13.2Status: OldAACSB: Written and oral communication

11) ʺThe aggregate demand multiplier results in the aggregate demand curve shifting by more

than any given initial change in expenditure.ʺ Is the previous statement correct or incorrect?

Answer: The statement is correct. The implication is that a, say $10 billion increase in investment

shifts the aggregate demand curve rightward by more than $10 billion.Topic: Aggregate demand multiplierSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Reflective thinking

12) What is the aggregate demand multiplier and why does it occur?

Answer: The aggregate demand multiplier is an effect that magnifies changes in expenditure

plans. So, for example, if some component of expenditure such as investment increases,

aggregate demand increases by more than the increase in investment. The aggregate

demand multiplier exists because when aggregate demand increases, householdsʹ

incomes increase. Then the increase in income results in an increase in consumption

expenditure, which adds to the initial increase in aggregate demand.Topic: Aggregate demand multiplierSkill: Level 1: DefinitionSection: Checkpoint 13.2Status: OldAACSB: Written and oral communication

Page 1271


13.8 Essay: Explaining Economic Trends and Fluctuations

1) What two variables are determined in an aggregate supply-aggregate demand figure? Is the

slope of the aggregate supply curve positive or negative? Is the slope of the aggregate demand

curve positive or negative?

Answer: The aggregate supply-aggregate demand framework determines the equilibrium price

level and equilibrium real GDP. The aggregate supply curve is positively sloped,

indicating that an increase in the price level increases the aggregate quantity of goods

and services supplied. The aggregate demand curve is negatively sloped, indicating that

an increase in the price level decreases the aggregate quantity of goods and services

demanded.Topic: Aggregate supply and aggregate demand modelSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Written and oral communication

2) Can actual real GDP exceed potential GDP?

Answer: Yes, actual real GDP temporarily can exceed potential GDP as the economy nears a

business cycle peak.Topic: Business cycleSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

3) Define potential GDP. Under what circumstances does actual real GDP fall short of potential

GDP, equal potential GDP, and exceed potential GDP?

Answer: Potential GDP is the level of real GDP that the economy produces when it is at full

employment. Potential GDP can be contrasted with actual real GDP, the amount of real

GDP the country actually produces. Actual real GDP can be less than potential GDP

when the economy is producing at less than full employment, that is, when there is less

than full employment in the labor market. Actual real GDP equals potential GDP when

the economy is producing at full employment. Actual real GDP can exceed potential

GDP temporarily as the economy approaches and then recedes from a business cycle

peak.Topic: Business cycleSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1272


Price level

(GDP deflator,

2009 = 100)

Quantity of real

GDP demanded

(trillions of

2009 dollars)

Quantity of real

GDP supplied

(trillions of

2009 dollars)

115 6.8 12.0

110 9.4 11.0

105 10.0 10.0

100 10.6 9.0

95 11.2 8.0

90 11.8 7.0

4) Based on the table above,

a. What is the equilibrium price level and real GDP?

b. If potential GDP is $11.0 trillion, what does that imply about the economyʹs level of

employment?

c. If potential GDP is $9.0 trillion, what does that imply about the economyʹs level of

employment?

Answer: a. The equilibrium price level is 105; the equilibrium real GDP is $10.0 trillion.

b. If potential GDP is $11.0 trillion, then the economy is at an equilibrium that is a

below full-employment equilibrium with a recessionary gap.

c. If potential GDP is $9.0 trillion, then the economy is at an equilibrium that is an

above full-employment equilibrium with an inflationary gap.Topic: Inflationary gap and recessionary gapSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

5) Suppose that during 2005, the actual real GDP of Chile was 3.5 billion pesos at the same time

the potential GDP was 3.4 billion pesos. What sort of equilibrium existed in Chile?

Answer: Chileʹs actual real GDP exceeded its potential GDP, so Chile was in an above

full-employment equilibrium with an inflationary gap.Topic: Inflationary gapSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

6) When the aggregate supply curve intersects the aggregate demand curve at a level of real GDP

that exceeds potential GDP, is there an inflationary gap or a deflationary gap? What

adjustments will take place?

Answer: There is an inflationary gap because real GDP exceeds potential GDP. In this situation,

the money wage rate will rise, shifting the aggregate supply curve leftward and raising

the price level. Eventually the economy will return to potential GDP. At this time, real

GDP is lower than when the inflationary gap existed but the price level is higher.Topic: Inflationary gapSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Written and oral communication

Page 1273


7) The economy is at full employment and then aggregate demand increases. Describe what

happens as an immediate result of the increase in aggregate demand. Describe how the

economy adjusts back to full employment.

Answer: The immediate effect of an increase in aggregate demand is to increase both the price

level and real GDP. The money wage rate does not change, so with the higher price

level the real wage rate falls. Eventually, however, workers demand a higher (money)

wage rate to compensate for the higher price level. As firms pay the higher money wage

rate, aggregate supply decreases. The decrease in aggregate supply means that the price

level rises and real GDP decreases. Workers continue to demand a higher money wage

rate and aggregate supply continues to decrease until finally the economy returns to full

employment. At that point, the money wage rate has increased enough so that the real

wage rate is back to its initial level. Real GDP once again equals potential GDP, so the

changes in real GDP were only temporary. The price level, though, is higher than its

initial level, so the increase in the price level is permanent.Topic: Inflationary gapSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Written and oral communication

Page 1274


8) What is the current equilibrium price level and real GDP for the economy illustrated in the

figure above? Does this economy have an inflationary gap, a recessionary gap, or neither? As it

adjusts toward full employment, which curve shifts? What is the equilibrium real GDP and

price level that the economy will ultimately reach?

Answer: The equilibrium is where the aggregate demand and aggregate supply curves intersect.

Thus the equilibrium price level is 110 and equilibrium real GDP is $16.5 trillion. Real

GDP exceeds potential GDP, so the economy has an inflationary gap. The aggregate

supply curve will shift leftward as the economy adjusts to full employment. Ultimately

the aggregate supply curve will shift so that it intersects the aggregate demand curve

where the aggregate demand curve crosses the potential GDP line. Thus ultimately

equilibrium real GDP equals potential GDP, $16.0 trillion, and the price level is 120.Topic: Inflationary gapSkill: Level 4: Applying modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

9) Explain how changes in foreign income can impact real GDP in a country.

Answer: Changes in the income of any nation impact the level of exports and imports of all other

nations trading with it. For example, in the United States aggregate demand increases if

the income of our trading partners, such as Mexico and Canada, increases because some

of the increase in Mexican and Canadian income translates into buying goods and

services imported from the United States. As a result, U.S. aggregate demand increases,

which means that U.S. real GDP increases. Thus increases in foreign income increase

domestic real GDP while decreases in foreign income decrease domestic real GDP.Topic: Aggregate demand fluctuationsSkill: Level 5: Critical thinkingSection: Checkpoint 13.3Status: OldAACSB: Written and oral communication

Page 1275


10) How does a cut in interest rates that increases investment affect the quantity of real GDP

demanded, the aggregate demand curve, real GDP, and the price level?

Answer: The increase in investment increases the aggregate quantity demanded and shifts the

AD curve rightward. As a result, the equilibrium price level rises and the equilibrium

real GDP increases.Topic: Aggregate demand fluctuationsSkill: Level 5: Critical thinkingSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

11) State how shifts in the aggregate demand curve can explain the movement of real GDP around

potential GDP.

Answer: When the aggregate demand curve and the aggregate supply curve intersect at the level

of potential GDP, then real GDP is equal to potential GDP. When something shifts the

aggregate demand curve rightward, then the aggregate demand curve and the

aggregate supply curve will intersect at a level of real GDP that is above potential GDP.

The economy will be in an expansion. When something shifts the aggregate demand

curve leftward, then the aggregate demand curve and the aggregate supply curve will

intersect at a level of real GDP that is below potential GDP. The economy will be in a

recession.Topic: Aggregate demand fluctuationsSkill: Level 3: Using modelsSection: Checkpoint 13.3Status: OldAACSB: Analytical thinking

12) What is demand-pull inflation?

Answer: An inflation that starts from an initial increase in aggregate demand is a demand-pull

inflation.Topic: Demand-pull inflation


Page 1276


13) What are sources that can start a demand-pull inflation?

Answer: Demand-pull inflation starts with an increase in aggregate demand. This increase can

arise by increases in the quantity of money, increases in government expenditure, or

increases in net exports because any of these three shift increase aggregate demand and

shift the AD curve rightward. The increase in aggregate demand leads to a higher price

level and, temporarily, a higher level of real GDP. If the economy began at full

employment, then temporarily the level of real GDP will be above potential. In the long

run, however, the money wage rate rises to offset the increase in the price level, so

aggregate supply decreases and the AS curve shifts leftward. The decrease in aggregate

supply also raises the price level. So the only way the inflation can continue is if

aggregate demand continues to increase.Topic: Demand-pull inflation


14) Describe how a demand-pull inflation can occur.

Answer: Demand-pull inflation starts from an initial increase in aggregate demand. But if this

increase is a one-time only event, the result is a higher price level but not inflation. For

inflation to occur, aggregate demand needs to continue to increase. Continuing

increases in the quantity of money result in continuing increases in aggregate demand,

so monetary growth is necessary for a demand-pull inflation.Topic: Demand-pull inflation


15) What is a cost-push inflation?

Answer: A cost-push inflation is an inflation that starts as a result of an increase in costs. Money

wage rates and the cost of raw materials are the main sources of cost-push inflation.Topic: Cost-push inflation


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16) What factors can start a cost-push inflation? What must the Fedʹs response be for the inflation

to continue?

Answer: Cost push inflation starts with a decrease in aggregate supply, that is, a leftward shift of

the AS curve. The decrease in aggregate supply can be the result of an increase in the

money wage rate or an increase in the money price of other raw materials. In either

instance firmsʹ costs have risen and they respond by decreasing production, which

decreases aggregate supply. The dilemma for the Fed is that the decreases in aggregate

supply means that real GDP falls below potential GDP and the price level rises. If the

Fed responds by increasing the quantity of money in order to increase aggregate

demand and move real GDP back to potential GDP, the price level will rise still higher.

And if the initial agent that raised costs responds to the higher price level by again

raising its costs, then a cost-push inflation might well occur.Topic: Cost-push inflation


17) Define ʺstagflationʺ and explain how it can be created.

Answer: Stagflation is a combination of two words: stagnation and inflation. Stagnation means

real GDP is below the full employment level and falling, that is, the economy is in

recession while at the same time the price level is rising, that is, the economy is

experiencing inflation. An increase in the price of a major resource that decreases

aggregate supply can trigger stagflation.Topic: StagflationSkill: Level 2: Using definitionsSection: Checkpoint 13.3Status: OldAACSB: Reflective thinking

Page 1278


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