monetary and fiscal policy skyveiw school quiz

Chapter 21The Influence of Monetary and Fiscal Policy on Aggregate Demand

MULTIPLE CHOICE

1. Fiscal policy affects the economya. only in the short run.b. only in the long run.c. in both the short and long run.d. in neither the short nor long run.

ANSWER: c. in both the short and long run.TYPE: M DIFFICULTY: 1 SECTION: 21.0

2. Which of the following is not a reason the aggregate demand curve slopes downward? As the price level increasesa. real wages decline.b. real wealth declines.c. the interest rate increases.d. the exchange rate increases.

ANSWER: a. real wages decline.TYPE: M DIFFICULTY: 1 SECTION: 21.1

3. For the U.S. economy, which of the following is the most important reason for the downward slope of the aggregate-demand curve?a. the wealth effectb. the interest-rate effectc. the exchange-rate effectd. the real-wage effect

ANSWER: b. the interest-rate effectTYPE: M DIFFICULTY: 1 SECTION: 21.1

4. Which of the following reasons for the downward slope of the aggregate demand curve would likely be more important for a small economy than for the United States?a. the wealth effectb. the interest-rate effectc. the exchange-rate effectd. the real-wage effect

ANSWER: c. the exchange-rate effectTYPE: M DIFFICULTY: 1 SECTION: 21.1

5. Which of the following is not a response that would result from a decrease in the price level and so help to explain the slope of the aggregate demand curve?a. When interest rates fall, Sleepwell Hotels decides to build some new hotels.b. The exchange rate falls, so French restaurants in Paris buy more Iowa pork.c. Janet feels wealthier because of the price drop and so she decides to remodel her bathroom.d. With prices down and wages fixed by contract, Gatekeeper Computers decides to lay off workers.

ANSWER: d. With prices down and wages fixed by contract, Gatekeeper Computers decides to lay off workers.

TYPE: M DIFFICULTY: 1 SECTION: 21.1

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566 Chapter 21/The Influence of Monetary and Fiscal Policy on Aggregate Demand

6. The wealth effect helps explain the downward slope of the aggregate demand curve. This effect isa. relatively important in the United States because expenditures on consumer durables is very

responsive to changes in wealth.b. relatively important in the United States because consumption spending is a large part of GDP.c. relatively unimportant in the United States because money holdings are a small part of consumer

wealth.d. relatively unimportant because it takes a large change in wealth to make a significant change in

interest rates.ANSWER: c. relatively unimportant in the United States because money holdings are a small part of

consumer wealth.TYPE: M DIFFICULTY: 1 SECTION: 21.1

7. Which of the following claims concerning the importance of effects that explain the slope of the aggregate demand curve is correct?a. The exchange-rate effect is relatively small because exports and imports are a small part of real

GDP.b. The interest-rate effect is relatively small because investment spending is not very responsive to

interest rate changes.c. The wealth effect is relatively large because money holdings are a significant portion of most

households’ wealth.d. None of the above is correct.

ANSWER: a. The exchange-rate effect is relatively small because exports and imports are a small part of real GDP.


8. Liquidity preference refers directly to Keynes’ theory concerninga. the effects of changes in money demand and supply on interest rates.b. the effects of changes in money demand and supply on exchange rates.c. the effects of wealth on expenditures.d. the difference between temporary and permanent changes in income.

ANSWER: a. the effects of changes in money demand and supply on interest rates.TYPE: M DIFFICULTY: 1 SECTION: 21.1

9. According to liquidity preference theory, equilibrium in the money market is achieved by adjustments ina. the price level.b. the interest ratec. the exchange rated. real wealth.

ANSWER: b. the interest rateTYPE: M DIFFICULTY: 1 SECTION: 21.1

10. Liquidity preference theory is most relevant to thea. short run and supposes that the price level adjusts to bring money supply and money demand into

balance.b. short run and supposes that the interest rate adjusts to bring money supply and money demand

into balance.c. long run and supposes that the price level adjusts to bring money supply and money demand into

balance.d. long run and supposes that the interest rate adjusts to bring money supply and money demand

into balance.ANSWER: b. short run and supposes that the interest rate adjusts to bring money supply and money

demand into balance.TYPE: M DIFFICULTY: 2 SECTION: 21.1

11. If expected inflation is constant, then when the nominal interest rate increases, the real interest ratea. increases by more than the change in the nominal interest rate.b. increases by the change in the nominal interest rate.c. decreases by the change in the nominal interest rate.d. decreases by more than the change in the nominal interest rate.

ANSWER: b. increases by the change in the nominal interest rate.TYPE: M DIFFICULTY: 1 SECTION: 21.1

Chapter 21/The Influence of Monetary and Fiscal Policy on Aggregate Demand 567

12. If expected inflation is constant and the nominal interest rate increased 3 percentage points, the real interest rate woulda. increase 3 percentage points.b. increase, but by less than 3 percentage points.c. decrease, but by less than 3 percentage points.d. decrease by 3 percentage points.

ANSWER: a. increase 3 percentage points.TYPE: M DIFFICULTY: 1 SECTION: 21.1

13. The theory of liquidity preference assumes that the nominal supply of money is determined by thea. level of real GDP.b. rate of inflation.c. interest rate.d. the Federal Reserve.

ANSWER: d. the Federal Reserve.TYPE: M DIFFICULTY: 1 SECTION: 21.1

14. According to the theory of liquidity preference, the money supply isa. positively related to the interest rate.b. negatively related to the interest rate.c. independent of the interest rate.d. negatively related to both the interest rate and the price level.

ANSWER: c. independent of the interest rate.TYPE: M DIFFICULTY: 1 SECTION: 21.1

15. According to liquidity preference theory, the money supply curve isa. upward sloping.b. downward sloping.c. vertical.d. horizontal.

ANSWER: c. vertical.TYPE: M DIFFICULTY: 1 SECTION: 21.1

16. According to liquidity preference theory, the money supply curve would shift righta. if the money demand curve shifted right.b. only if the Federal Reserve chose to increase it.c. if the interest rate increased.d. if the price level fell or the interest rate decreased.

ANSWER: b. only if the Federal Reserve chose to increase it.TYPE: M DIFFICULTY: 1 SECTION: 21.1

17. According to liquidity preference theory, the money supply curve would shift if the Feda. engaged in open-market transactions.b. changed the discount rate.c. changed the reserve requirement.d. did any of the above.

ANSWER: d. did any of the above.TYPE: M DIFFICULTY: 1 SECTION: 21.1

18. When the Fed buys government bonds, the reserves of the banking systema. increase, so the money supply increases.b. increase, so the money supply decreases.c. decrease, so the money supply increases.d. decrease, so the money supply decreases.

ANSWER: a. increase, so the money supply increases.TYPE: M DIFFICULTY: 1 SECTION: 21.1

19. Liquidity refers toa. the relation between the price and interest rate of an asset.b. the risk of an asset relative to its selling price.c. the ease with which an asset is converted into a medium of exchange.d. the sensitivity of investment spending to changes in the interest rate.

ANSWER: c. the ease with which an asset is converted into a medium of exchange.TYPE: M DIFFICULTY: 1 SECTION: 21.1


20. Which of the following is the most liquid asset?a. capital goodsb. stocks and bonds with a low riskc. stocks and bonds with a high riskd. funds in a checking account

ANSWER: d. funds in a checking accountTYPE: M DIFFICULTY: 1 SECTION: 21.1

21. People own or hold money primarily because ita. has a guaranteed nominal return.b. serves as a store of value.c. can directly be used to buy goods and services.d. functions as a unit of account.

ANSWER: c. can directly be used to buy goods and services.TYPE: M DIFFICULTY: 1 SECTION: 21.1

22. When the interest rate increases, the opportunity cost of holding moneya. increases, so the quantity of money demanded increases.b. increases, so the quantity of money demanded decreases.c. decreases, so the quantity of money demanded increases.d. decreases, so the quantity of money demanded decreases.

ANSWER: b. increases, so the quantity of money demanded decreases.TYPE: M DIFFICULTY: 1 SECTION: 21.1

23. When the interest rate decreases, the opportunity cost of holding moneya. increases, so the quantity of money demanded increases.b. increases, so the quantity of money demanded decreases.c. decreases, so the quantity of money demanded increases.d. decreases, so the quantity of money demanded decreases.

ANSWER: d. decreases, so the quantity of money demanded decreases.TYPE: M DIFFICULTY: 1 SECTION: 21.1

24. The opportunity cost of holding moneya. decreases when the interest rate increases, so people desire to hold more of it.b. decreases when the interest rate increases, so people desire to hold less of it.c. increases when the interest rate increases, so people desire to hold more of it.d. increases when the interest rate increases, so people desire to hold less of it.

ANSWER: d. increases when the interest rate increases, so people desire to hold less of it.TYPE: M DIFFICULTY: 1 SECTION: 21.1

25. According to liquidity preference theory, the opportunity cost of holding money isa. the interest rate on bonds.b. the inflation rate.c. the cost of converting bonds to a medium of exchange.d. the difference between the inflation rate and the interest rate on bonds.

ANSWER: a. the interest rate on bonds.TYPE: M DIFFICULTY: 1 SECTION: 21.1

26. According to liquidity preference theory, the money demand curve is downward sloping becausea. interest rates rise as the Fed reduces the quantity of money demanded.b. interest rates fall as the Fed reduces the supply of money.c. people will want to hold less money as the cost of doing so falls.d. people will want to hold more money as the cost of doing so falls.

ANSWER: d. people will want to hold more money as the cost of doing so falls.TYPE: M DIFFICULTY: 1 SECTION: 21.1

27. According to the theory of liquidity preference, which variable adjusts to balance the supply and demand for money?a. interest rateb. money supplyc. quantity of outputd. price level

ANSWER: a. interest rateTYPE: M DIFFICULTY: 1 SECTION: 21.1


For the following four questions consult the diagram below:

28. If the current interest rate is 2 percent,a. there is excess money supply.b. people will sell more bonds, which drives interest rates up.c. as the money market moves to equilibrium, people will buy more goods.d. All of the above are correct.

ANSWER: b. people will sell more bonds, which drives interest rates up.TYPE: M DIFFICULTY: 2 SECTION: 21.1

29. There is excess money demand at an interest rate ofa. 2 percent.b. 3 percent.c. 4 percent.d. None of the above are correct.

ANSWER: a. 2 percent.TYPE: M DIFFICULTY 1 SECTION 34.1

30. At an interest rate of 4 percent there is excessa. money demand equal to the distance between a and b.b. money demand equal to the distance between b and c.c. money supply equal to the distance between b and a.d. money supply equal to the distance between c and b.

ANSWER: c. money supply equal to the distance between b and a.TYPE: M DIFFICULTY: 2 SECTION: 21.1

31. Which of the following is correct?a. If the interest rate is 4 percent, there is excess money demand, and the interest rate will fall.b. If the interest rate is 3 percent, there is excess money supply, and the interest rate will rise.c. If the interest rate is 4 percent, the demand for goods will rise when the money market is in its

new equilibrium.d. None of the above is correct.

ANSWER: c. If the interest rate is 4 percent, the demand for goods will rise when the money market is in its new equilibrium.


32. According to liquidity preference theory, if the quantity of money demanded is greater than the quantity supplied, the interest rate willa. increase and the quantity of money demanded will decrease.b. increase and the quantity of money demanded will increase.c. decrease and the quantity of money demanded will decrease.d. decrease and the quantity of money demanded will increase.

ANSWER: a. increase and the quantity of money demanded will decrease.TYPE: M DIFFICULTY: 2 SECTION: 21.1


33. According to liquidity preference theory, if the quantity of money supplied is greater than the quantity demanded the interest rate willa. increase and the quantity of money demanded will decrease.b. increase and the quantity of money demanded will increase.c. decrease and the quantity of money demanded will decrease.d. decrease and the quantity of money demanded will increase.

ANSWER: d. decrease and the quantity of money demanded will increase.TYPE: M DIFFICULTY: 2 SECTION: 21.1

34. If at some interest rate the quantity of money demanded is greater than the quantity of money supplied, people will desire toa. sell interest-bearing assets causing the interest rate to decrease.b. sell interest-bearing assets causing the interest rate to increase.c. buy interest-bearing assets causing the interest rate to decrease.d. buy interest-bearing assets causing the interest rate to increase.

ANSWER: b. sell interest-bearing assets causing the interest rate to increase.TYPE: M DIFFICULTY: 2 SECTION: 21.1

35. If at some interest rate the quantity of money supplied is greater than the quantity of money demanded, people will desire toa. sell interest-bearing assets causing the interest rate to decrease.b. sell interest-bearing assets causing the interest rate to increase.c. buy interest-bearing assets causing the interest rate to decrease.d. buy interest-bearing assets causing the interest rate to increase.

ANSWER: c. buy interest-bearing assets causing the interest rate to decrease.TYPE: M DIFFICULTY: 2 SECTION: 21.1

36. If there is excess money demand, people willa. deposit more into interest-bearing accounts, and the interest rate will fall.b. deposit more into interest-bearing accounts, and the interest rate will rise.c. withdraw money from interest-bearing accounts, and the interest rate will fall.d. withdraw money from interest-bearing accounts, and the interest rate will rise.

ANSWER: d. withdraw money from interest-bearing accounts, and the interest rate will rise.TYPE: M DIFFICULTY: 2 SECTION: 21.1

37. If there is excess money supply, people willa. deposit more into interest-bearing accounts, and the interest rate will fall.b. deposit more into interest-bearing accounts, and the interest rate will rise.c. withdraw money from interest-bearing accounts, and the interest rate will fall.d. withdraw money from interest-bearing accounts, and the interest rate will rise.

ANSWER: a. deposit more into interest-bearing accounts, and the interest rate will fall.TYPE: M DIFFICULTY: 2 SECTION: 21.1

38. People will want to hold more money if the price levela. or the interest rate increases.b. or the interest rate decreases.c. increases or the interest rate decreases.d. decreases or the interest rate increases.

ANSWER: c. increases or the interest rate decreases.TYPE: M DIFFICULTY: 2 SECTION: 21.1

39. People will want to hold less money if the price levela. or the interest rate increases.b. or the interest rate decreases.c. increases or the interest rate decreases.d. decreases or the interest rate increases.

ANSWER: d. decreases or the interest rate increases.TYPE: M DIFFICULTY: 2 SECTION: 21.1


40. Which of the following is correct?a. Both liquidity preference and classical theory assume the interest rate adjusts to bring the money

market into equilibrium.b. Both liquidity preference and classical theory assume the price level adjusts to bring the money

market into equilibriumc. Liquidity preference theory assumes the interest rate adjusts to bring the money market into

equilibrium. Classical theory assumes the price level adjusts to bring the money market into equilibrium.

d. Liquidity preference theory assumes the price level adjusts to bring the money market into equilibrium. Classical theory assumes the interest rate adjusts to bring the money market into equilibrium.

ANSWER: c. Liquidity preference theory assumes the interest rate adjusts to bring the money market into equilibrium. Classical theory assumes the price level adjusts to bring the money market into equilibrium.


41. Changes in the interest rate bring the money market into equilibrium according toa. both liquidity preference theory and classical theory.b. neither liquidity preference theory nor classical theory.c. liquidity preference theory, but not classical theory.d. classical theory, but not liquidity preference theory.

ANSWER: c. liquidity preference theory, but not classical theory.TYPE: M DIFFICULTY: 2 SECTION: 21.1

42. Which of the following statements is true?a. In the long run, output is determined by the amount of capital, labor, and technology; the interest

rate adjusts to balance the supply and demand for money; and the price level adjusts to balance the supply and demand for loanable funds.

b. In the long run, output is determined by the amount of capital, labor, and technology; the interest rate adjusts to balance the supply and demand for loanable funds; and the price level adjusts to balance the supply and demand for money.

c. In the long run, output is determined by the amount of capital, labor, and technology; the interest rate adjusts to balance the supply and demand for loanable funds; and the price level is stuck.

d. In the long run, output responds to the aggregate demand for goods and services; the interest rate adjusts to balance the supply and demand for loanable funds; and the price level adjusts to balance the supply and demand for money.

ANSWER: b. In the long run, output is determined by the amount of capital, labor, and technology; the interest rate adjusts to balance the supply and demand for loanable funds; and the price level adjusts to balance the supply and demand for money.

TYPE: M SECTION 34.1 DIFFICULTY 2

43. Which of the following statements is true?a. In the short run, output is determined by the amount of capital, labor, and technology; the

interest rate adjusts to balance the supply and demand for money; and the price level adjusts to balance the supply and demand for loanable funds.

b. In the short run, output is determined by the amount of capital, labor, and technology; the interest rate adjusts to balance the supply and demand for loanable funds; and the price level adjusts to balance the supply and demand for money.

c. In the short run, output responds to the aggregate demand for goods and services; the interest rate adjusts to balance the supply and demand for money; and the price level is stuck.

d. In the short run, output responds to the aggregate demand for goods and services; the interest rate adjusts to balance the supply and demand for loanable funds; and the price level adjusts to balance the supply and demand for money.

ANSWER: c. In the short run, output responds to the aggregate demand for goods and services; the interest rate adjusts to balance the supply and demand for money; and the price level is stuck.

TYPE: M SECTION 34.1 DIFFICULTY 2


44. The effects of the interest rate in the short run are usually best shown usinga. either liquidity preference theory or classical theory.b. neither liquidity preference theory or classical theory.c. only liquidity preference theory.d. only classical theory.

ANSWER: c. only liquidity preference theory.TYPE: M DIFFICULTY: 2 SECTION: 21.1

45. Which of the following shifts money demand to the right?a. an increase in the price levelb. a decrease in the price levelc. an increase in the interest rated. a decrease in the interest rate

ANSWER: a. an increase in the price levelTYPE: M DIFFICULTY: 2 SECTION: 21.1

46. Which of the following shifts money demand to the left?a. an increase in the price levelb. a decrease in the price levelc. an increase in the interest rated. a decrease in the interest rate

ANSWER: b. a decrease in the price levelTYPE: M DIFFICULTY: 2 SECTION: 21.1

47. Which of the following shifts money demand to the right?a. an increase in either the price level or the interest rateb. an increase in the price level or a decrease in the interest ratec. a decrease in the interest rate but not a change in the price leveld. an increase in the price level but not a change in the interest rate

ANSWER: d. an increase in the price level but not a change in the interest rateTYPE: M DIFFICULTY: 2 SECTION: 21.1

48. Assume the money market is initially in equilibrium. If the price level increases, according to liquidity preference theory there is an excessa. supply of money until the interest rate increases.b. supply of money until the interest rate decreases.c. demand for money until the interest rate increases.d. demand for money until the interest rate decreases.

ANSWER: c. demand for money until the interest rate increases.TYPE: M DIFFICULTY: 2 SECTION: 21.1

49. Assume the money market is initially in equilibrium. If the price level decreases, according to liquidity preference theory there is an excessa. supply of money until the interest rate increases.b. supply of money until the interest rate decreases.c. demand for money until the interest rate increases.d. demand for money until the interest rate decreases.

ANSWER: b. supply of money until the interest rate decreases.TYPE: M DIFFICULTY: 2 SECTION: 21.1

50. According to liquidity preference theory if the price level increases, the equilibrium interest ratea. rises so that the aggregate quantity of goods demand rises.b. rises so that the aggregate quantity of goods demanded falls.c. falls so that the aggregate quantity of goods demanded rises.d. falls so that the aggregate quantity of goods demanded falls.

ANSWER: b. rises so that the aggregate quantity of goods demanded falls.TYPE: M DIFFICULTY: 2 SECTION: 21.1


51. According to liquidity preference theory, an increase in the price level shifts thea. money demand curve right so the interest rate increases.b. money demand curve right so the interest rate decreases.c. money demand curve left so the interest rate decreases.d. money demand curve left so the interest rate increases.

ANSWER: a. money demand curve right so the interest rate increases.TYPE: M DIFFICULTY: 1 SECTION: 21.1

52. An increase in the U.S. interest ratea. induces firms to invest more.b. induces households to increase consumption.c. shifts money demand to the right.d. leads to the appreciation of the U.S. exchange rate.

ANSWER: d. leads to the appreciation of the U.S. exchange rate.TYPE: M DIFFICULTY: 2 SECTION: 21.1

53. Which of the following responses would we expect to result from an increase in interest rates?a. Your aunt puts more money in her savings account.b. Foreign citizens decide to buy fewer U.S. bonds.c. You decide to purchase a new oven for your cookie factory.d. All of the above are correct.

ANSWER: a. Your aunt puts more money in her savings account.TYPE: M DIFFICULTY: 1 SECTION: 21.1

54. According to liquidity preference theory, the price level and interest rate area. positively related as are the interest rate and aggregate demand.b. inversely related as are the interest rate and aggregate demand.c. positively related while the interest rate and aggregate demand are inversely related.d. inversely related while the interest rate and aggregate demand are positively related.

ANSWER: c. positively related while the interest rate and aggregate demand are inversely related.TYPE: M DIFFICULTY: 2 SECTION: 21.1

55. According to liquidity preference theory, other things equal, in the short run a higher price level leads households toa. increase consumption and firms to buy more capital goods.b. increase consumption and firms to buy fewer capital goods.c. decrease consumption and firms to buy more capital goods.d. decrease consumption and firms to buy fewer capital goods.

ANSWER: d. decrease consumption and firms to buy fewer capital goods.TYPE: M DIFFICULTY: 2 SECTION: 21.1

56. According to liquidity preference theory, an increase in the price level causes the interest rate toa. increase, which makes output demanded increase.b. increase, which makes output demanded decrease.c. decrease, which makes output demanded increase.d. decrease, which makes output demanded decrease.

ANSWER: b. increase, which makes output demanded decrease.TYPE: M DIFFICULTY: 2 SECTION: 21.1

57. According to liquidity preference theory, a decrease in the price level causes the interest rate toa. increase, which makes output demanded increase.b. increase, which makes output demanded decrease.c. decrease, which makes output demanded increase.d. decrease, which makes output demanded decrease.

ANSWER: c. decrease, which makes output demanded increase.TYPE: M DIFFICULTY: 2 SECTION: 21.1

58. According to the theory of liquidity preference, an increase in the price level causes thea. interest rate and investment to rise.b. interest rate and investment to fall.c. interest rate to rise and investment to fall.d. interest rate to fall and investment to rise.

ANSWER: c. interest rate to rise and investment to fall.TYPE: M DIFFICULTY: 2 SECTION: 21.1


59. According to theory of liquidity preference, a decrease in the price level causes thea. interest rate and investment to rise.b. interest rate and investment to fall.c. interest rate to rise and investment to fall.d. interest rate to fall and investment to rise.

ANSWER: d. interest rate to fall and investment to rise.TYPE: M DIFFICULTY: 2 SECTION: 21.1

60. According to liquidity preference theory, people will demand fewer goods and services if the price levela. or interest rate increase.b. or interest rate decrease.c. increases or the interest rate decreases.d. decreases or the interest rate increases.

ANSWER: a. or interest rate increase.TYPE: M DIFFICULTY: 2 SECTION: 21.1

61. The main reason the aggregate demand curve slopes downward is because as the price levela. increases, interest rates increase, and investment decreases.b. increases, interest rates decrease, and investment increases.c. decreases, interest rates increase, and investment increases.d. decreases, interest rates decrease, and investment decreases.

ANSWER: a. price level increases, interest rates increase, and investment decreases.TYPE: M DIFFICULTY: 2 SECTION: 21.1

62. Which of the following properly describes the interest rate effect?a. As the money supply increases, the interest rate falls, so spending rises.b. As the money supply increases, the interest rate rises, so spending falls.c. As the price level increases, the interest rate falls, so spending rises.d. As the price level increases, the interest rate rises, so spending falls.

ANSWER: d. As the price level increases, the interest rate rises, so spending falls.TYPE: M DIFFICULTY: 2 SECTION: 21.1

63. Which of the following properly describes the interest rate effect?a. A higher price level leads to higher money demand, higher money demand leads to higher

interest rates, a higher interest rate increases the quantity of goods and services demanded.b. A higher price level leads to higher money demand, higher money demand leads to lower interest

rates, a higher interest rate reduces the quantity of goods and services demanded.c. A lower price level leads to lower money demand, lower money demand leads to lower interest

rates, a lower interest rate reduces the quantity of goods and services demanded.d. A lower price level leads to lower money demand, lower money demand leads to lower interest

rates, a lower interest rate increases the quantity of goods and services demanded.ANSWER: d. A lower price level leads to lower money demand, lower money demand leads to lower

interest rates, a lower interest rate increases the quantity of goods and services demanded.


64. In the short run, an increase in the money supply causes interest rates toa. increase, and aggregate demand to shift right.b. increase, and aggregate demand to shift left.c. decrease, and aggregate demand to shift right.d. decrease, and aggregate demand to shift left.

ANSWER: c. decrease, and aggregate demand to shift right.TYPE: M DIFFICULTY: 2 SECTION: 21.1

65. In the short run, a decrease in the money supply causes interest rates toa. increase, and aggregate demand to shift right.b. increase, and aggregate demand to shift left.c. decrease, and aggregate demand to shift right.d. decrease, and aggregate demand to shift left.

ANSWER: b. increase, and aggregate demand to shift left.TYPE: M DIFFICULTY: 2 SECTION: 21.1


66. Which of the following shifts aggregate demand to the right?a. an increase in the price levelb. an increase in the money supplyc. a decrease in the price leveld. a decrease in the money supply

ANSWER: b. an increase in the money supplyTYPE: M DIFFICULTY: 1 SECTION: 21.1

67. Which of the following shifts aggregate demand to the left?a. an increase in the price levelb. an increase in the money supplyc. a decrease in the price leveld. a decrease in the money supply

ANSWER: d. a decrease in the money supplyTYPE: M DIFFICULTY: 2 SECTION: 21.1

68. Which of the following shifts aggregate demand right?a. The price level rises.b. The price level falls.c. The money supply falls.d. None of the above is correct.

ANSWER: d. None of the above is correct.TYPE: M DIFFICULTY: 1 SECTION: 21.1

69. If the Fed conducts open-market sales, the money supplya. increases and aggregate demand shifts right.b. increases and aggregate demand shifts left.c. decreases and aggregate demand shifts right.d. decreases and aggregate demand shifts left.

ANSWER: d. decreases and aggregate demand shifts left.TYPE: M DIFFICULTY: 2 SECTION: 21.1

70. If the Fed conducts open-market purchases, the money supplya. increases and aggregate demand shifts right.b. increases and aggregate demand shifts left.c. decreases and aggregate demand shifts right.d. decreases and aggregate demand shifts left.

ANSWER: a. increases and aggregate demand shifts right.TYPE: M DIFFICULTY: 2 SECTION: 21.1

71. A monetary injection by the Feda. increases interest rates and increases aggregate demand.b. increases interest rates and decreases aggregate demand.c. decreases interest rates and decreases aggregate demand.d. decreases interest rates and increases aggregate demand.

ANSWER: d. decreases interest rates and increases aggregate demand.TYPE: M DIFFICULTY: 2 SECTION: 21.1

72. Open-market purchasesa. increase the price level and real GDP.b. decrease the price level and real GDP.c. increases the price level and decreases real GDP.d. decreases the price level and increases real GDP.

ANSWER: a. increase the price level and real GDP.TYPE: M DIFFICULTY: 2 SECTION: 21.1

73. Open-market salesa. increase the price level and real GDP.b. decrease the price level and real GDP.c. increases the price level and decreases real GDP.d. decreases the price level and increases real GDP.

ANSWER: b. decrease the price level and real GDP.TYPE: M DIFFICULTY: 2 SECTION: 21.1


74. The economy is in long-run equilibrium. Suppose that automatic teller machines become cheaper and more convenient to use, and as a result the demand for money falls. Other things equal, we would expect that in the short run,a. the price level and real GDP would rise, but in the long run they would both be unaffected.b. the price level and real GDP would rise, but in the long run the price level would rise and real

GDP would be unaffected.c. the price level and real GDP would fall, but in the long run they would both be unaffected.d. the price level and real GDP would fall, but in the long run the price level would fall and real GDP

would be unaffected.ANSWER: b. the price level and real GDP would rise, but in the long run the price level would rise and

real GDP would be unaffected.TYPE: M SECTION 34.1 DIFFICULTY 3

75. When the price level falls, the interest ratea. rises. When the money supply falls, the interest rate rises.b. rises. When the money supply falls, the interest rate falls.c. falls. When the money supply falls, the interest rate rises.d. falls. When the money supply falls, the interest rate falls.

ANSWER: c. falls. When the money supply falls, the interest rate rises.TYPE: M DIFFICULTY: 2 SECTION: 21.1

76. In recent years, the Federal Reserve has conducted policy by setting a target fora. bank reserves.b. the monetary growth rate.c. the exchange rate.d. the federal funds rate.

ANSWER: d. the federal funds rate.TYPE: M DIFFICULTY: 1 SECTION: 21.1

77. In recent years, the Fed has chosen to target interest rates rather than the money supply becausea. they were ordered to do so by Congress.b. they were ordered to do so by the president.c. the money supply is hard to measure with sufficient precision.d. changes in the interest rate change aggregate demand, but changes in the money supply do not.

ANSWER: c. the money supply is hard to measure with sufficient precision.TYPE: M DIFFICULTY: 1 SECTION: 21.1

78. The theory of liquidity preference illustrates the principle thata. monetary policy can be described either in terms of the money supply or in terms of the interest

rate.b. monetary policy can be described either in terms of the exchange rate or the interest rate.c. monetary policy must be described in terms of the money supply.d. monetary policy must be described in terms of the interest rate.

ANSWER: a. monetary policy can be described either in terms of the money supply or in terms of the interest rate.


79. When the Fed sets a target for the interest rate, it commits itself toa. revealing its target to the public.b. adjusting the demand for money in order to make the equilibrium in the money market hit that

target.c. adjusting the money supply in order to meet the interest rate target.d. having to make open-market sales.

ANSWER: c. adjusting the money supply in order to meet the interest rate target.TYPE: M DIFFICULTY: 1 SECTION: 21.1

80. If the Fed targets the interest rate,a. it can then set the money supply at whatever value it wants.b. it must increase the money supply if the interest rate is above its target.c. it must decrease the money supply if the interest rate is above its target.d. None of the above is correct.

ANSWER: b. it must increase the money supply if the interest rate is above its target.TYPE: M DIFFICULTY: 1 SECTION: 21.1


81. If the interest rate is above the Fed’s target, the Fed shoulda. buy bonds to increase the money supply.b. buy bonds to decrease the money supply.c. sell bonds to increase the money supply.d. sell bonds to decrease the money supply.

ANSWER: a. buy bonds to increase the money supply.TYPE: M DIFFICULTY: 2 SECTION: 21.1

82. If the interest rate is below the Fed’s target, the Fed woulda. buy bonds to increase the money supply.b. buy bonds to decrease the money supply.c. sell bonds to increase the money supply.d. sell bonds to decrease the money supply.

ANSWER: d. sell bonds to decrease the money supply.TYPE: M DIFFICULTY: 2 SECTION: 21.1

83. The Fed is concerned about stock market booms because the boomsa. increase consumption spending.b. increase investment spending.c. Both of the above are correct.d. None of the above is correct.

ANSWER: c. Both of the above are correct.TYPE: M DIFFICULTY: 2 SECTION: 21.1

84. Which of the following actions might we logically expect to result from rising stock prices?a. Jim increases his consumption spending.b. Firms sell fewer shares of new stock.c. Firms spend less on investment.d. None of the above is correct.

ANSWER: a. Jim increases his consumption spending.TYPE: M DIFFICULTY: 2 SECTION: 21.1

85. If the stock market booms,a. aggregate demand increases, which the Fed could offset by increasing the money supply.b. aggregate supply increases, which the Fed could offset by increasing the money supply.c. aggregate demand increases, which the Fed could offset by decreasing the money supply.d. aggregate supply increases, which the Fed could offset by decreasing the money supply.

ANSWER: c. aggregate demand increases, which the Fed could offset by decreasing the money supply.TYPE: M DIFFICULTY: 2 SECTION: 21.1

86. If the stock market boomsa. household spending increases. To offset the effects of this on the price level and real GDP, the

Fed would increase the money supply.b. household spending increases. To offset the effects of this on the price level and real GDP, the

Fed would decrease the money supply.c. household spending decreases. To offset the effects of this on the price level and real GDP, the

Fed would increase the money supply.d. household spending decreases. To offset the effects of this on the price level and real GDP, the

Fed would decrease the money supply.ANSWER: b. household spending increases. To offset the effects of this on the price level and real GDP,

the Fed would decrease the money supply.TYPE: M DIFFICULTY: 2 SECTION: 21.1

87. If the stock market crashes,a. aggregate demand increases, which the Fed could offset by increasing the money supply.b. aggregate demand increases, which the Fed could offset by decreasing the money supply.c. aggregate demand decreases, which the Fed could offset by increasing the money supply.d. aggregate demand decreases, which the Fed could offset by decreasing the money supply.

ANSWER: c. aggregate demand decreases, which the Fed could offset by increasing the money supply.TYPE: M DIFFICULTY: 2 SECTION: 21.1


88. When the Fed decreases the money supply we expecta. interest rates and stock prices to rise.b. interest rates and stock prices to fall.c. interest rates to rise and stock prices to fall.d. interest rates to fall and stock prices to rise.

ANSWER: c. interest rates to rise and stock prices to fall.TYPE: M DIFFICULTY: 2 SECTION: 21.1

89. In the long run, fiscal policy primarily affectsa. aggregate demand. In the short run, it affects primarily aggregate supply.b. aggregate supply. In the short run, it affects primarily saving, investment, and growthc. saving, investment, and growth. In the short run, it affects primarily aggregate demand.d. saving, investment, and growth. In the short run, it affects primarily aggregate supply.

ANSWER: c. saving, investment, and growth. In the short run, it affects primarily aggregate demand.TYPE: M DIFFICULTY: 1 SECTION: 21.2

90. Fiscal policy refers to the idea that aggregate demand is changed by changes ina. the money supply.b. government spending and taxes.c. trade policy.d. All of the above are correct.

ANSWER: b. government spending and taxes.TYPE: M DIFFICULTY: 1 SECTION: 21.2

91. An increase in government spending initially and primarily shiftsa. aggregate demand right.b. aggregate demand left.c. aggregate supply right.d. neither aggregate demand nor aggregate supply.

ANSWER: a. aggregate demand right.TYPE: M DIFFICULTY: 1 SECTION: 21.2

92. A decrease in government spending initially and primarily shiftsa. aggregate demand right.b. aggregate demand left.c. aggregate supply right.d. neither aggregate demand nor aggregate supply.

ANSWER: b. aggregate demand left.TYPE: M DIFFICULTY: 1 SECTION: 21.2

93. Which of the following shifts aggregate demand right?a. an increase in government expenditures or a decrease in the price levelb. a decrease in government expenditures or an increase in the price levelc. an increase in government expenditures, but not a change in the price leveld. a decrease in the price level, but not an increase in government expenditures

ANSWER: c. an increase in government expenditures, but not a change in the price levelTYPE: M DIFFICULTY: 1 SECTION: 21.2

94. Which of the following tends to make aggregate demand shift right farther than the amount government expenditures increase?a. the crowding-out effectb. the multiplier effectc. the wealth effectd. the interest-rate effect

ANSWER: b. the multiplier effectTYPE: M DIFFICULTY: 1 SECTION: 21.2

95. The multiplier effect is the multiplied impact ona. the money supply of a given increase in government purchases.b. tax revenues of a given increase in government purchases.c. investment of a given increase in interest rates.d. aggregate demand of a given increase in government purchases.

ANSWER: d. aggregate demand of a given increase in government purchases.TYPE: M DIFFICULTY: 1 SECTION: 21.2


96. The government buys a bridge. The owner of the company that builds the bridge pays her workers. The workers increase their spending. Firms that the workers buy goods from increase their output. This type of effect on spending illustratesa. the multiplier effect.b. the crowding-out effect.c. the marginal propensity to consume effect.d. None of the above is correct.

ANSWER: a. the multiplier effect.TYPE: M DIFFICULTY: 1 SECTION: 21.2

97. Which of the following illustrates how the investment accelerator works?a. An increase in government expenditures increases the interest rate so that the Sleepwell Hotel

chain decides to build fewer new hotels.b. An increase in government expenditures increases aggregate spending so that the Sleepwell

Hotel chain finds it profitable to build more new hotels.c. An increase in government expenditures increases the interest rate so that the demand for stocks

and bonds issued by the Sleepwell Hotel chain rises.d. An increase in government expenditures decreases the interest rate so that the Sleepwell Hotel

chain decides to build more new hotels.ANSWER: b. An increase in government expenditures increases aggregate spending so that the

Sleepwell Hotel chain finds it profitable to build more new hotels.TYPE: M DIFFICULTY: 2 SECTION: 21.2

98. The positive feedback from aggregate demand to investment is calleda. the investment multiplier.b. the stock-market effect.c. the investment accelerator.d. the crowding-in multiplier.

ANSWER: c. the investment accelerator.TYPE: M DIFFICULTY: 2 SECTION: 21.2

99. The marginal propensity to consume (MPC) is defined as the fraction ofa. extra income that a household consumes rather than saves.b. extra income that a household either consumes or saves.c. total income that a household consumes rather than saves.d. total income that a household either consumes or saves.

ANSWER: a. extra income that a household consumes rather than saves.TYPE: M DIFFICULTY: 2 SECTION: 21.2

100. The government purchases multiplier is defined asa. MPC.b. 1 – MPC.c. 1/MPC.d. 1/(1 – MPC).

ANSWER: d. 1/(1 – MPC).TYPE: M DIFFICULTY: 2 SECTION: 21.2

101. The government purchases multiplier is defined asa. 1/MPC.b. 1/(1 – MPC).c. MPC/(1 – MPC).d. (1 – MPC)/MPC

ANSWER: b. 1/(1 – MPC).TYPE: M DIFFICULTY: 2 SECTION: 21.2

102. If the MPC = 3/5, then the government purchases multiplier isa. 5/3.b. 5/2.c. 5.d. 15.

ANSWER: b. 5/2.TYPE: M DIFFICULTY: 2 SECTION: 21.2


103. If the MPC = .85, then the government purchases multiplier is abouta. 1.18.b. 3.33.c. 6.67.d. 8.5.

ANSWER: c. 6.67.TYPE: M DIFFICULTY: 2 SECTION: 21.2

104. If the multiplier is 2.5, the MPC isa. 0.2.b. 0.6.c. 0.75.d. 1.00.

ANSWER: b. 0.6.TYPE: M DIFFICULTY: 2 SECTION: 21.2

105. If the multiplier is 5, the MPC isa. 0.05.b. 0.5.c. 0.6.d. 0.8.

ANSWER: d. 0.8.TYPE: M DIFFICULTY: 2 SECTION: 21.2

106. The reduction in demand that results when a fiscal expansion raises the interest rate is called thea. multiplier effect.b. crowding-out effect.c. accelerator effect.d. Riccardian equivalence effect.

ANSWER: b. crowding-out effect.TYPE: M DIFFICULTY: 2 SECTION: 21.2

107. If there is crowding out, which of the following might decrease as government expenditures increased?a. the overall change in real GDPb. the demand for money curvec. interest ratesd. demand for capital goods

ANSWER: d. demand for capital goodsTYPE: M DIFFICULTY: 2 SECTION: 21.2

108. Which of the following correctly explains the crowding-out effect?a. An increase in government expenditures decreases the interest rate and so increases investment

spending.b. An increase in government expenditures increases the interest rate and so reduces investment

spending.c. A decrease in government expenditures increases the interest rate and so increases investment

spending.d. A decrease in government expenditures decreases the interest rate and so reduces investment

spending.ANSWER: b. An increase in government expenditures increases the interest rate and so reduces

investment spending.TYPE: M DIFFICULTY: 2 SECTION: 21.2

109. Assuming no crowding-out, investment-accelerator, or multiplier effects, a $100 billion increase in government expenditures shifts aggregate demanda. right by more than $100 billion.b. right by $100 billion.c. left by more than $100 billion.d. left by $100 billion.

ANSWER: b. right by $100 billion.TYPE: M DIFFICULTY: 2 SECTION: 21.2


110. Assuming multiplier but no crowding-out or investment-accelerator effects, a $100 billion increase in government expenditures shifts aggregatea. demand right by more than $100 billion.b. demand right by less than $100 billion.c. supply left by more than $100 billion.d. supply left by less than $100 billion.

ANSWER: a. demand right by more than $100 billion.TYPE: M DIFFICULTY: 2 SECTION: 21.2

111. Assuming crowding-out but no multiplier or investment-accelerator effects, a $100 billion increase in government expenditures shifts aggregatea. demand right by more than $100 billion.b. demand right by less than $100 billion.c. supply left by more than $100 billion.d. supply left by less than $100 billion.

ANSWER: b. demand right by less than $100 billion.TYPE: M DIFFICULTY: 3 SECTION: 21.2

112. If the MPC is 0.80 and there are no crowding-out or accelerator effects, an initial increase in AD of $100 billion will eventually shift the AD curve to the right bya. $80 billion.b. $125 billion.c. $500 billion.d. $800 billion.

ANSWER: c. $500 billion.TYPE: M DIFFICULTY: 2 SECTION: 21.2

113. Suppose that the MPC is .60 and there is no investment accelerator or crowding- out effects. If government expenditures increase $10 billion, aggregate demanda. shifts right $40 billion.b. shifts right $25 billion.c. shifts right $16 billion.d. None of the above is correct.

ANSWER: b. shifts right $25 billion.TYPE: M DIFFICULTY: 2 SECTION: 21.2

114. Assume that the MPC is 0.75. The multiplier isa. .75.b. 4/3.c. 4.d. 7.5

ANSWER: c. 4.TYPE: M DIFFICULTY: 2 SECTION: 21.2

115. Assume that the MPC is 0.75. Assuming only the multiplier effect matters, an increase in government purchases of $200 billion will shift the aggregate demand curvea. left by $150 billion.b. left by $200 billion.c. right by $800 billion.d. None of the above are correct.

ANSWER: c. right by $800 billion.TYPE: M DIFFICULTY: 2 SECTION: 21.2

116. Assume that the MPC is 0.75. Assuming that only the multiplier effect matters, a decrease in government purchases of $10 billion will shift the aggregate demand curvea. left by $13.5 billion.b. left by $40 billion.c. right by $75 billion.d. None of the above are correct.

ANSWER: b. left by $40 billion.TYPE: M DIFFICULTY: 2 SECTION: 21.2


117. Assume that the MPC is 0.75. Assume that there is a multiplier effect and that the total crowding-out effect is $6 billion. An increase in government purchases of $10 billion will shift aggregate demanda. left by $24 billion.b. left by $36 billion.c. right by $34 billion.d. right by $36 billion.

ANSWER: c. right by $34 billion.TYPE: M DIFFICULTY: 2 SECTION: 21.2

118. Assume that the MPC is 0.75. Assume that the total crowding-out effect is $20 billion. An increase in government purchases of $10 billion when the multiplier is 5 will shift the AD curvea. right $150 billion.b. right $70 billion.c. right $30 billion.d. None of the above is correct.

ANSWER: c. right $30 billion.TYPE: M DIFFICULTY: 2 SECTION: 21.2

119. If the MPC is 0, the multiplier isa. 0.b. 1.c. infinite.d. None of the above is correct.

ANSWER: b. 1.TYPE: M DIFFICULTY: 2 SECTION: 21.2

120. As the MPC gets close to 1, the value of the multiplier approachesa. 0.b. 1.c. infinity.d. None of the above is correct.

ANSWER: c. infinity.TYPE: M DIFFICULTY: 2 SECTION: 21.2

121. An increase in the MPCa. increases the multiplier, so that changes in government expenditures have a larger effect on

aggregate demand.b. increases the multiplier, so that changes in government expenditures have a smaller effect on

aggregate demand.c. decreases the multiplier, so that changes in government expenditures have a larger effect on

aggregate demand.d. decreases the multiplier, so that changes in government expenditures have a smaller effect on

aggregate demand.ANSWER: a. increases the multiplier, so that changes in government expenditures have a larger effect

on aggregate demand.TYPE: M DIFFICULTY: 1 SECTION: 21.2

122. According to the crowding-out effect, an increase in government spendinga. increases the interest rate and so increases investment spending.b. increases the interest rate and so decreases investment spending.c. decreases the interest rate and so increases investment spending.d. decreases the interest rate and so decreases investment spending.

ANSWER: b. increases the interest rate and so decreases investment spending.TYPE: M DIFFICULTY: 2 SECTION: 21.2

123. According to the crowding-out effect, a decrease in government spendinga. increases the interest rate and so increases investment spending.b. increases the interest rate and so decreases investment spending.c. decreases the interest rate and so increases investment spending.d. decreases the interest rate and so decreases investment spending.

ANSWER: c. decreases the interest rate and so increases investment spending.TYPE: M DIFFICULTY: 2 SECTION: 21.2


124. An increase in government purchases is likely toa. decrease interest rates.b. result in a net decrease in aggregate demand.c. crowd out investment spending by business.d. decrease money demand.

ANSWER: c. crowd out investment spending by business.TYPE: M DIFFICULTY: 2 SECTION: 21.2

125. The multiplier effecta. and the crowding-out effect both amplify the effects of an increase in government expenditures.b. and the crowding-out effect both diminish the effects of an increase in government expenditures.c. diminishes the effects of an increase in government expenditures, while the crowding-out effect

amplifies the effects.d. amplifies the effects of an increase in government expenditures, while the crowding-out effect

diminishes the effects.ANSWER: d. amplifies the effects of an increase in government expenditures, while the crowding-out

effect diminishes the effects.TYPE: M DIFFICULTY: 1 SECTION: 21.2

126. Tax cutsa. and increases in government expenditures shift aggregate demand right.b. and increases in government expenditures shift aggregate demand left.c. shift aggregate demand right while increases in government expenditures shift aggregate

demand left.d. shift aggregate demand left while increases in government expenditures shift aggregate demand

right.ANSWER: a. and increases in government expenditures shift aggregate demand right.TYPE: M DIFFICULTY: 1 SECTION: 21.2

127. If taxesa. increase, consumption increases, aggregate demand shifts right.b. increase, consumption decreases, aggregate demand shifts left.c. decrease, consumption increases, aggregate demand shifts left.d. decrease, consumption decreases, aggregate demand shifts right.

ANSWER: b. increase, consumption decreases, aggregate demand shifts left.TYPE: M DIFFICULTY: 1 SECTION: 21.2

128. When the government reduces taxes, which of the following decreases?a. consumptionb. take-home payc. household savingd. None of the above is correct.


129. Which of the following tends to make the size of a shift in aggregate demand resulting from a tax change smaller than otherwise?a. the multiplier effectb. the crowding-out effectc. the accelerator effectd. None of the above is correct.

ANSWER: b. the crowding-out effectTYPE: M DIFFICULTY: 1 SECTION: 21.2

130. The economy is in long-run equilibrium. Technological change shifts the long-run aggregate supply curve $60 billion to the right. At the same time, government purchases increase by $30 billion. If the MPC equals 0.8 and the crowding-out effect is $60 billion, we would expect that in the long-run,a. both real GDP and the price level would be higher.b. both real GDP and the price level would be lower.c. real GDP would be higher but the price level would be lower.d. real GDP would be higher but the price level would be the same.

ANSWER: a. both real GDP and the price level would be higher.TYPE: M DIFFICULTY: 3 SECTION: 21.2


131. The economy is in long-run equilibrium. Congress passes regulations that make it more costly to conduct business, so the long-run aggregate supply curve shifts $60 billion to the left. At the same time, government purchases increase by $60 billion. If the MPC equals 0.8 and the crowding-out effect is $60 billion, we would expect that in the long run,a. both real GDP and the price level would be higher.b. both real GDP and the price level would be lower.c. real GDP would be lower but the price level would be higher.d. real GDP would be lower but the price level would be the same.

ANSWER: c. real GDP would be lower but the price level would be higher.TYPE: M DIFFICULTY: 3 SECTION: 21.2

132. The economy is in long-run equilibrium. Immigration of skilled workers shifts the long-run aggregate supply curve $60 billion to the right. At the same time, government purchases increase by $30 billion. If the MPC equals 0.8 and the crowding-out effect is $150 billion, we would expect that in the long-run,a. both real GDP and the price level would be higher.b. both real GDP and the price level would be lower.c. real GDP would be higher but the price level would be lower.d. real GDP would be higher but the price level would be the same.

ANSWER: c. real GDP would be higher but the price level would be lower.TYPE: M DIFFICULTY: 3 SECTION: 21.2

133. The economy is in long-run equilibrium. Immigration of skilled workers shifts the long-run aggregate supply curve $60 billion to the right. At the same time, government purchases increase by $30 billion. If the MPC equals 0.8 and the crowding-out effect is $90 billion, we would expect that in the long-run,a. both real GDP and the price level would be higher.b. both real GDP and the price level would be lower.c. real GDP would be higher but the price level would be lower.d. real GDP would be higher but the price level would be the same.

ANSWER: d. real GDP would be higher but the price level would be the same.TYPE: M DIFFICULTY: 3 SECTION: 21.2

134. The economy is in long-run equilibrium. Pessimism on the part of investors then shifts the aggregate demand curve $50 billion to the left. The government wants to increase spending in order to avoid a recession. If the crowding-out effect is always half as strong as the multiplier effect, and if the MPC equals 0.9, by how much does government purchases have to rise?a. $10 billionb. $50 billionc. $90 billiond. $100 billion

ANSWER: a. $10 billionTYPE: M DIFFICULTY: 3 SECTION: 21.2

135. The economy is in long-run equilibrium. Advances in technology shift the long-run aggregate supply curve $50 billion to the right. Optimistic investors have shifted the aggregate demand curve $100 billion to the right. In order to stabilize the price level at its original value, the government wants to reduce its spending. If the crowding-out effect is always half of the multiplier effect, and if the MPC equals 0.75, then the government must cut its spending bya. $4 billion.b. $25 billion.c. $50 billion.d. $100 billion.

ANSWER: b. $25 billion.TYPE: M DIFFICULTY: 3 SECTION: 21.2

136. If households view a tax cut as being temporary, the tax cuta. has no affect on aggregate demand.b. has more of an affect on aggregate demand than if households view it as permanent.c. has the same affect as when households view the cut as permanent.d. has less of an affect on aggregate demand than if households view it as permanent.

ANSWER: d. has less of an affect on aggregate demand than if households view it as permanent.TYPE: M DIFFICULTY: 2 SECTION: 21.2


137. The most extreme example of a temporary tax cut was the one announced in 1992 by President Bush. The effect of that tax cut on consumer spending and aggregate demand wasa. larger than the size of the tax cut.b. about the size of the tax cut.c. positive, but smaller than the size of the tax cut.d. about zero.

ANSWER: c. positive, but smaller than the size of the tax cut.TYPE: M DIFFICULTY: 1 SECTION: 21.2

138. Permanent tax cuts shift the AD curvea. farther to the right than temporary tax cuts.b. less to the right than temporary tax cuts.c. farther to the left than temporary tax cuts.d. less to the left than temporary tax cuts.

ANSWER: a. farther to the right than temporary tax cuts.TYPE: M DIFFICULTY: 1 SECTION: 21.2

139. Most economists believe that fiscal policy affectsa. only aggregate demand and not aggregate supply.b. mostly aggregate demand.c. mostly aggregate supply.d. only aggregate supply and not aggregate demand.

ANSWER: b. mostly aggregate demand.TYPE: M DIFFICULTY: 1 SECTION: 21.2

140. Supply-side economists focus more than other economists ona. how fiscal policy affects consumption.b. the multiplier affect of fiscal policy.c. how fiscal policy affects aggregate supply.d. the accelerator and exchange-rate effects.

ANSWER: c. how fiscal policy affects aggregate supply.TYPE: M DIFFICULTY: 1 SECTION: 21.2

141. If the government cuts the tax rate, workers get to keepa. less of each additional dollar they earn, so work effort increases, and aggregate supply shifts

right.b. less of each additional dollar they earn, so work effort decreases, and aggregate supply shifts left.c. more of each additional dollar they earn, so work effort increases, and aggregate supply shifts

right.d. more of each additional dollar they earn, so work effort decreases, and aggregate supply shifts

left.ANSWER: c. more of each additional dollar they earn, so work effort increases, and aggregate supply

shifts right.TYPE: M DIFFICULTY: 2 SECTION: 21.2

142. Supply-side economists believe that a reduction in the tax ratea. always decrease government tax revenue.b. shifts the aggregate supply curve to the right.c. provides no incentive for people to work more.d. would decrease consumption.

ANSWER: b. shifts the aggregate supply curve to the right.TYPE: M DIFFICULTY: 2 SECTION: 21.2

143. Most economists believe that a cut in tax ratesa. would increase government tax revenue.b. decreases significantly the hours people work.c. has a relatively small effect on the aggregate supply curve.d. All of the above are correct.

ANSWER: c. has a relatively small effect on the aggregate supply curve.TYPE: M DIFFICULTY: 1 SECTION: 21.2


144. Supply-side economists believe that changes in government purchases affecta. only aggregate demand.b. only aggregate supply.c. both aggregate demand and aggregate supply.d. neither aggregate demand nor aggregate supply.

ANSWER: c. both aggregate demand and aggregate supply.TYPE: M DIFFICULTY: 1 SECTION: 21.2

145. An increase in government spending on goods to build or repair infrastructurea. shifts the aggregate demand curve to the right.b. has a multiplier effect.c. shifts the aggregate supply curve to the right in the long run.d. All of the above are correct.

ANSWER: d. All of the above are correct.TYPE: M DIFFICULTY: 1 SECTION: 21.2

146. The economy is in long-run equilibrium when the government decides to significantly increase spending on transportation infrastructure, which will lower shipping costs for many businesses. We might expect that in the short run,a. real GDP will increase and the price level will fall, but in the long run , there will be no effect.b. real GDP will increase and the price level will fall, but in the long run, real GDP will increase and

the price level might rise, fall or stay the samec. real GDP will increase and the price level might rise, fall or stay the same, and in the long run,

real GDP will increase and the price level might rise, fall or stay the same.d. real GDP will increase and the price level might rise, fall or stay the same, but in the price level

will increase and real GDP might rise, fall or stay the same.ANSWER: c. real GDP will increase and the price level might rise, fall or stay the same, and in the long

run, real GDP will increase and the price level might rise, fall or stay the same.TYPE: M DIFFICULTY: 3 SECTION: 21.2

147. If Congress cuts spending to balance the federal budget, the Fed can act to prevent unemployment and recession while maintaining the balanced budget bya. increasing the money supply.b. decreasing the money supply.c. raising taxes.d. cutting expenditures.

ANSWER: a. increasing the money supply.TYPE: M DIFFICULTY: 2 SECTION: 21.2

148. The Employment Act of 1946 states thata. the Fed should use monetary policy only to control the rate of inflation.b. the government should promote full employment and production.c. the government should periodically increase the minimum wage and unemployment insurance

benefits.d. All of the above are correct.

ANSWER: b. the government should promote full employment and production.TYPE: M DIFFICULTY: 1 SECTION: 21.2

149. Which of the following actions is inconsistent with the Employment Act of 1946?a. When there is a recession, the Fed increases the money supply.b. The government maintains a balanced budge regardless of current economic conditions.c. When there is an expansion, the government raises taxes.d. All of the above are inconsistent.

ANSWER: b. The government maintains a balanced budge regardless of current economic conditions.TYPE: M DIFFICULTY: 1 SECTION: 21.2


150. Keynes argued that aggregate demand isa. stable, because the economy returns to long-run equilibrium.b. stable, because changes in consumption are mostly offset by changes in investment and vice

versa.c. unstable, because waves of pessimism and optimism create fluctuations in aggregate demand.d. unstable, because seasonal variations create fluctuations in aggregate demand.

ANSWER: c. unstable, because waves of pessimism and optimism create fluctuations in aggregate demand.


151. Keynes argued thata. irrational waves of pessimism would cause a decrease in aggregate demand and increase

unemployment.b. irrational waves of optimism would cause a reduction in aggregate demand and decrease

unemployment.c. changes in business and consumer expectations generally stabilize the economy.d. All of the above are correct.

ANSWER: a. irrational waves of pessimism would cause a decrease in aggregate demand and increase unemployment.


152. Keynes used the term "animal spirits" to refer toa. debates by politicians concerning fiscal policy.b. arbitrary changes in attitudes of household and firms.c. mean spirited economists who believed in the classical dichotomy.d. firms’ relentless efforts to maximize profits.

ANSWER: b. arbitrary changes in attitudes of household and firms.TYPE: M DIFFICULTY: 1 SECTION: 21.2

153. Which of the following policy alternatives would be an appropriate response to an increase in investment demand by a government that wants to stabilize output?a. increase taxesb. increase the money supplyc. increase government expendituresd. All of the above are correct.

ANSWER: a. increase taxesTYPE: M DIFFICULTY: 1 SECTION: 21.2

154. Which of the following policies would someone who wants the government to follow an active stabilization policy recommend when the economy is experiencing unemployment above the natural rate?a. decrease the money supplyb. increase government expendituresc. increase taxesd. All of the above are correct.

ANSWER: b. increase government expendituresTYPE: M DIFFICULTY: 1 SECTION: 21.2

155. Which of the following policies would Keynes’ followers support when an increase in business optimism shifts the aggregate demand curve to the right away from long-run equilibrium?a. decrease taxesb. increase government expendituresc. increase the money supplyd. None of the above is correct.



156. Which of the following policies would stabilization policy activists support when the economy is experiencing unemployment above the natural rate?a. a decrease in the money supplyb. a reduction in tax ratesc. a decrease in government purchasesd. None of the above is correct.

ANSWER: b. a reduction in tax ratesTYPE: M DIFFICULTY: 2 SECTION: 21.2

For the following four questions, use the diagram below:

157. Which of the following would cause the aggregate demand curve to shift from AD1 to AD2?a. an increase in government purchasesb. a decrease in stock pricesc. consumers and firms become more optimistic about the future.d. an increase in the price level

ANSWER: b. a decrease in stock pricesTYPE: M DIFFICULTY: 2 SECTION: 21.2

158. If the economy is at point b, a policy to restore full employment would bea. an increase in the money supply.b. a decrease in government purchasesc. an increase in taxesd. All of the above are correct.

ANSWER: a. an increase in the money supply.TYPE: M DIFFICULTY: 2 SECTION: 21.2

159. Which of the following is true?a. A wave of optimism could move the economy from a to b.b. If aggregate demand moves from AD1 to AD2 the economy will stay at b in both the short and

long run.c. It is possible that either fiscal or monetary policy might have caused the shift from AD1 to AD2.d. All of the above are correct.

ANSWER: c. It is possible that either fiscal or monetary policy might have caused the shift from AD1 to AD2.


160. Which of the following is true?a. Unemployment rises as the economy moves from a to b.b. Either fiscal or monetary policy could be used to move the economy from b to a.c. If the economy is left alone, then as the economy moves from b to long-run equilibrium, the price

level will fall farther.d. All of the above are correct.



161. In the early 1960s, the Kennedy administration made considerable use ofa. fiscal policy to stimulate the economy.b. fiscal policy to slow down the economy.c. monetary policy to stimulate the economy.d. monetary policy to slow down the economy.

ANSWER: a. fiscal policy to stimulate the economy.TYPE: M DIFFICULTY: 2 SECTION: 21.2

162. The Kennedy tax cut of 1964 wasa. successful in stimulating the economy.b. designed to shift the aggregate demand curve to the right.c. designed to shift the aggregate supply curve to the right.d. All of the above are correct.


163. The Kennedy tax cut of 1964 included an investment tax credit designed toa. increase aggregate demand in the short run and aggregate supply in the long run.b. increase aggregate supply in the short run and aggregate demand in the long run.c. only increase aggregate supply in the long run.d. only increase aggregate demand in the long run.

ANSWER: a. increase aggregate demand in the short run and aggregate supply in the long run.TYPE: M DIFFICULTY: 2 SECTION: 21.2

164. Some economists argue thata. monetary policy should actively be used to stabilize the economy.b. fiscal policy should actively be used to stabilize the economy.c. fiscal policy can be used to shift the AD curve.d. All of the above are correct.


165. Economists agree on all of the following except thata. increases in the money supply shift aggregate demand to the right.b. in the long run, increases in the money supply increase prices, but not output.c. recessions are associated with decreases in consumption, investment, and employment.d. government should use fiscal policy to try and stabilize the economy.

ANSWER: d. government should use fiscal policy to try and stabilize the economy.TYPE: M DIFFICULTY: 1 SECTION: 21.3

166. Critics of stabilization policy argue thata. there is a lag between the time policy is passed and policy has an impact on the economy.b. the impact of policy may last longer than the problem it was designed to offset.c. policy can be a source of, instead of a cure for, economic fluctuations.d. All of the above are correct.


167. The lag problem associated with monetary policy is due mostly toa. the fact that business firms make investment plans far in advance.b. the political system of checks and balances that slows down the process of determining monetary

policy.c. the time it takes for changes in government spending to affect the interest rate.d. All of the above are correct.

ANSWER: a. the fact that business firms make investment plans far in advance.TYPE: M DIFFICULTY: 1 SECTION: 21.3

168. Opponents of active stabilization policya. advocate a monetary policy designed to offset changes in the unemployment rate.b. argue that fiscal policy is unable to change aggregate demand or aggregate supply.c. believe that the political process creates lags in the implementation of fiscal policy.d. None of the above are correct.

ANSWER: c. believe that the political process creates lags in the implementation of fiscal policy.TYPE: M DIFFICULTY: 1 SECTION: 21.3


169. Opponents of active stabilization policya. generally don’t believe that fiscal policy can stabilize the economy even in theory.b. generally agree that fiscal policy has no impact in the long run.c. believe the effects of monetary policy may be long-lived.d. think the Fed should simply try to fine tune the economy.

ANSWER: c. believe the effects of monetary policy may be long lived.TYPE: M DIFFICULTY: 2 SECTION: 21.2

170. Automatic stabilizersa. increase the problems that lags cause in using fiscal policy as a stabilization tool.b. are changes in taxes or government spending that increase aggregate demand without requiring

policy makers to act when the economy goes into recession.c. are changes in taxes or government spending that policy makers quickly agree to when the

economy goes into recession.d. All of the above are correct.

ANSWER: b. are changes in taxes or government spending that increase aggregate demand without requiring policy makers to act when the economy goes into recession.


171. Which of the following is not an automatic stabilizer?a. the minimum wageb. the unemployment compensation systemc. the federal income taxd. the welfare system

ANSWER: a. the minimum wageTYPE: M DIFFICULTY: 1 SECTION: 21.2

172. Taxes tend toa. rise and so shift aggregate demand right during recessions.b. rise and so shift aggregate demand right during expansions.c. fall and so shift aggregate demand right during recessions.d. fall and so shift aggregate demand right during expansions.

ANSWER: c. fall and so shift aggregate demand right during recessions.TYPE: M DIFFICULTY: 2 SECTION: 21.2

173. If there are automatic stabilizers but no deliberate action by policymakers, government expendituresa. rise as output rises.b. remain unchanged as output rises.c. rise as output falls.d. None of the above is correct.

ANSWER: c. rise as output falls.TYPE: M DIFFICULTY: 2 SECTION: 21.2

174. During expansions, automatic stabilizers make government expendituresa. and taxes fall.b. and taxes rise.c. rise, and taxes fall.d. fall and taxes rise.

ANSWER: d. fall and taxes rise.TYPE: M DIFFICULTY: 1 SECTION: 21.2

175. During recessions, automatic stabilizers tend to make the government’s budgeta. move toward deficit.b. move toward surplus.c. move toward balance.d. not necessarily move the budget in any particular direction.

ANSWER: a. move toward deficit.TYPE: M DIFFICULTY: 2 SECTION: 21.2


176. The most important automatic stabilizer isa. open-market transactions.b. the tax system.c. unemployment compensation.d. welfare benefits.

ANSWER: b. the tax system.TYPE: M DIFFICULTY: 1 SECTION: 21.2

177. A constitutional amendment requiring the federal government always to run a balanced budgeta. would result in a more stable economy.b. is supported by a majority of economists.c. would eliminate the effects of automatic stabilizers.d. would increase the level of government spending.

ANSWER: c. would eliminate the effects of automatic stabilizers.TYPE: M DIFFICULTY: 1 SECTION: 21.2

178. In the short run,a. the price level alone adjusts to balance the supply and demand for money.b. output responds to changes in the aggregate demand for goods and services.c. changes in the money supply cause a proportional change in the price level.d. changes in the money supply shift the aggregate supply curve causing output to rise.

ANSWER: b. output responds to changes in the aggregate demand for goods and services.TYPE: M DIFFICULTY: 2 SECTION: 21.2

179. In the long run, the level of outputa. depends on the money supply.b. depends on the price level.c. is determined by supply-side factors.d. All of the above are correct.

ANSWER: c. is determined by supply-side factors.TYPE: M DIFFICULTY: 2 SECTION: 21.2

180. In the long run, changes in the money supply affecta. prices.b. output.c. unemployment rates.d. All of the above.

ANSWER: a. prices.TYPE: M DIFFICULTY: 1 SECTION: 21.2

181. When the Fed lowers the growth rate of the money supply, it must take into accounta. only the short-run effect on production.b. only the short-run effects on inflation and production.c. only the long-run effect on inflation.d. the long-run effect on inflation as well as the short-run effect on production.

ANSWER: d. the long-run effect on inflation as well as the short-run effect on production.TYPE: M DIFFICULTY: 1 SECTION: 21.2

182. When Congress reduces spending in order to balance the budget, it needs to considera. both the short-run effects on aggregate demand and aggregate supply, and the long-run effects

on saving and growth.b. only the short-run effects on aggregate demand and aggregate supply.c. only the long-run effects on saving and growth.d. the long-run effects on aggregate demand and aggregate supply.

ANSWER: a. both the short-run effects on aggregate demand and aggregate supply, and the long-run effects on saving and growth.


TRUE/FALSE

1. For the most part, fiscal policy affects the economy in the short run while monetary policy primarily matters in the long run.

ANSWER: F TYPE: TF DIFFICULTY: 1 SECTION: 21.0


2. For the United States, the most important reason for the downward slope of the aggregate demand curve is the interest-rate effect.

ANSWER: T TYPE: TF DIFFICULTY: 1 SECTION: 21.0

3. If inflation is zero, then the nominal and real interest rate are the same.ANSWER: T TYPE: TF DIFFICULTY: 1 SECTION: 21.1

4. In liquidity preference theory, an increase in the interest rate decreases the quantity of money demanded, but does not shift the money demand curve.


5. An increase in the price level shifts the money demand curve to the left making interest rates rise.ANSWER: F TYPE: TF DIFFICULTY: 1 SECTION: 21.1

6. An increase in the money supply shifts the aggregate supply curve right.ANSWER: F TYPE: TF DIFFICULTY: 1 SECTION: 21.1

7. When the Fed increases the money supply, the interest rate decreases. This decrease in the interest rate increases consumption and investment demand so the aggregate demand curve shifts to the right.


8. Stock prices often rise when the Fed raises interest rates.ANSWER: F TYPE: TF DIFFICULTY: 1 SECTION: 21.1

9. Both the multiplier and the investment accelerator tend to make the aggregate demand curve shift farther than the increase in government expenditures.


10. The multiplier is found as MPC/(1 – MPC).ANSWER: F TYPE: TF DIFFICULTY: 1 SECTION: 21.2

11. Permanent tax cuts have a larger impact on consumption spending than temporary ones.ANSWER: T TYPE: TF DIFFICULTY: 1 SECTION: 21.2

12. In principle the government could increase the money supply or government expenditures to try to offset the effects of a wave of pessimism about the future of the economy.


13. The main criticism of those who doubt the ability of the government to respond in a useful way to the business cycle is that the theory by which money and government expenditures change output is flawed.


14. The most important lag for monetary policy is the time it takes to formulate policy, while the most important lag for fiscal policy it the time it takes for the economy to respond to changes in government spending.


15. Unemployment insurance and welfare programs work as automatic stabilizers.ANSWER: T TYPE: TF DIFFICULTY: 1 SECTION: 21.3

16. During recessions, the government tends to run a budget deficit.ANSWER: T TYPE: TF DIFFICULTY: 1 SECTION: 21.3

SHORT ANSWER

1. What is the difference between monetary policy and fiscal policy?ANSWER: The Federal Reserve Bank conducts monetary policy. It consists of policies to affect the

financial side of the economy—most notably the supply of money in the economy. Fiscal policy is conducted by the executive and Congressional branches of government, and entails decisions about taxes and government spending.

TYPE: S DIFFICULTY: 2 SECTION: 21.0


2. Why do economists think that the wealth effect and exchange-rate effect are not very important factors in explaining why aggregate demand slopes downward, at least in the United States?

ANSWER: The wealth effect is not very important because it operates through changes in the real value of money, and money is only a small fraction of household wealth. So it is unlikely that changes in the price level will lead to large changes in consumption spending through this channel. The exchange-rate effect is not very important in the United States because trade with other countries represents a relatively small fraction of U.S. GDP.


3. Explain why the interest rate is the opportunity cost of holding currency. What is the benefit of holding currency?

ANSWER: The nominal interest rate on currency is zero. The next best alternative is to buy a bond and earn the interest. Currency is used as a medium of exchange. Bonds are illiquid and so are costly to convert to a medium of exchange.


4. Describe the process in the money market by which the interest rate reaches its equilibrium value if it starts above equilibrium.

ANSWER: If the interest rate is above equilibrium, there is an excess supply of money. People with more money than they want to hold given the current interest rate deposit the money in banks and buy bonds. The increase in funds to lend out causes the interest rate to fall. As the interest rate falls, the quantity of money demanded increases, which tends to diminish the excess supply of money.


5. Use the money market to explain why the aggregate demand curve slopes downward.ANSWER: When the price level falls, people need less money for their transactions. The decreased

demand for money leads to a decrease in interest rates. Lower interest rates encourage consumption and investment spending. Thus, an increase in the price level lowers the quantity of goods and services demanded.


6. Explain the logic according to liquidity preference theory by which an increase in the money supply changes the aggregate demand curve.

ANSWER: When the money supply increases, the interest rate falls. As the interest rate falls people will want to spend more and firms will want to build more factories and buy more capital goods. This increase in aggregate demand happens for any given price level, so aggregate demand shifts right.


7. How does a reduction in the money supply by the Fed make owning stocks less attractive?ANSWER: The reduction in the money supply raises the interest rate. So the return on bonds increases

relative to the return on stocks. The increase in the interest rate also causes spending to fall so that revenues and profits fall making shares of ownership in corporations less valuable.


8. Suppose that the government spends more on a missile defense program. What does this do to aggregate demand? How is you answer affected by the presence of the multiplier, crowding-out, and investment-accelerator effects?

ANSWER: The increase in expenditures means that government spending rises. The aggregate demand curve shifts to the right. Aggregate demand shifts farther if there is a multiplier effect or an investment accelerator and shifts less if there is crowding out.


9. Supposing that there are no crowding-out effects and the MPC is .9. By how much must the government increase expenditures to shift the aggregate demand curve right by $10 billion?

ANSWER: An MPC of .9 means the multiplier = 1/(1 – .9) = 10. The increase in aggregate demand equals the multiplier times the change in government expenditures. So to increase aggregate demand by $10 billion, the government would have to increase expenditures by $1 billion.



10. Suppose that consumers become pessimistic about the future health of the economy, and so cut back on their consumption spending. What will happen to aggregate demand and to output? What might the president and Congress have to do to keep output stable?

ANSWER: As consumers become pessimistic about the future of the economy, they cut their expenditures so that aggregate demand shifts left and output falls. The president and Congress could adjust fiscal policy to increase aggregate demand. They could either increase government spending, or cut taxes, or both.


11. Explain how unemployment insurance acts as an automatic stabilizer.ANSWER: As income falls, unemployment rises. More people will apply for unemployment compensation

from the government and so government spending rises. An increase in government spending tends to increase aggregate demand, output, and income.


12. Why and in what way are fiscal policy lags different from monetary policy lags?ANSWER: The fiscal policy lags are mostly a matter of waiting to implement the policy. By the time the

president and Congress can agree to and pass legislation changing expenditures or taxes, the recession may have ended. The Federal Reserve can act to change the money supply quickly, but it may take some time before the effects of an increase in the money supply work their way through the economy.


monetary and fiscal policy skyveiw school quiz

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