Chapter 10

Measuring a Nation’s Income

1. In the circular flow model, the source of the factors of production used to create
goods and services is
a. the product market.
b. the resource market.
c. firms.
d. households.

2. In the circular flow model, firms use the money they earn from selling their goods
and services to pay for the
a. goods and services they buy on the product market.
b. resources they buy on the product market.
c. goods and services they buy from government.
d. resources they buy in the factor market.

3. In the circular flow model, for every flow of goods, services, and resources there is
a counter-flow of
a. more goods, services, and resources.
b. people from firms to households.
c. people from households to firms.
d. money.

4. In producing a sweater, a man who shears sheep pays a farmer $4 for a sheep. The
shearing shop sells the wool to a knitting mill for $7. The knitting mill buys he wool
and makes it into a fine fabric and sells it to a sweater-making firm for $13. The
sweater-making firm sells the sweater to a clothing store for $20, and the clothing
store sells the sweater, gift wrapped, for $50. What is the contribution to GDP of the
previous sales transactions?
a. $4.
b. $44.
c. $50.
d. $94.
5. Susie grows corn in her backyard garden to feed her family. The corn she grows is
not counted in GDP because
a. it was not produced for the marketplace.
b. it is an intermediate good which Susie will process further.
c. the corn has no value.
d. it reduces the amount of corn she will buy at the store.

6. Which of the following would be counted in U.S. GDP?

a. the purchase of an historical house
b. the purchase of a haircut
c. the purchase of a $1000 government savings bond
d. the value generated when you wash your car in your driveway

7. Personal consumption spending now comprises approximately what fraction of

GDP?
a. one-third
b. one-sixth
c. three-quarters
d. one half

8. If private investment increased by $50 billion while GDP remained the same, which
of the following could have occurred, all else being the same?
a. Consumption spending decreased by $50 billion.
b. Exports increased by $50 billion.
c. Imports decreased by $50 billion.
d. Net exports increased by $50 billion.

9. Assume net exports are –$220, consumption is $5,000, tax revenues are $1,000,
government purchases are $1,500, and 1997 GDP, calculated by the expenditures
approach, is $8,000. We can conclude that
a. private investment was $1,940.
b. public investment was $310.
c. private investment was $320.
d. private investment was $1,720.
10. The four categories of expenditures that make up GDP are consumption,
investment,
a. exports, and government purchases.
b. imports, and government purchases.
c. net exports, and government [query: purchases].
d. net exports, and government transfer payments.

11. Which of the following would be counted as an investment expenditure in the

national income accounts?
a. The Navy builds a new battleship.
b. Microsoft expands plant capacity to produce new software.
c. A public high school builds a new football stadium.
d. All of the above would be counted as an investment expenditure.

12. Real GDP is nominal GDP

a. plus depreciation.
b. adjusted for changes in the price level.
c. minus depreciation.
d. minus taxes.

13. Nominal GDP in 1998 is

a. $402.
b. $12,000.
c. $200,200
d. $410,000

14. Nominal GDP in 1999 is

a. $18,000.
b. $180,000.
c. $612,000.
d. $1,250,000.

15. Real GDP in 1998 is

a. $6,000.
b. $240,000.
c. $410,000.
d. $612,000.

16. Real GDP in 1999 is

a. $6,000.
b. $410,000.
c. $612,000.
d. $808,000.

17. The GDP deflator in 1999 is about

a. .76.
b. .67.
c. .51.
d. 1.32.

18. The growth rate of nominal GDP in 1999 was about

a. 10 percent.
b. 49 percent.
c. 78 percent.
d. 100 percent.

19. The growth rate of real GDP in 1999 was about

a. 24 percent.
b. 50 percent.
c. 97 percent.
d. 125 percent.

20. The rate of inflation in 1999 was about

a. –48 percent.
b. –24 percent.
c. 33 percent.
d. 67 percent.
21. Suppose a person marries his or her gardener and therefore no longer pays him or
her for gardening services. GDP
a. stays the same as long as the services are still provided.
b. increases since the services are now provided for free.
c. decreases since there is no longer a market exchange.
d. stays the same, since services are not included in GDP.

22. Which of the following would most likely cause GDP to overstate the actual output
produced in a year?
a. increased production in the underground economy
b. a decline in the quality of goods and services produced
c. increased production for home use (non-market production)
d. a decline in population

23. Suppose that population grows by 2 percent. For the standard of living to rise,
which of the following must occur?
a. Nominal GDP must grow by more than 2 percent.
b. Real GDP must grow by more than 2 percent.
c. Real GDP per capita must grow by more than 2 percent.
d. consumption spending must grow by more than 2 percent.

24. During recessions, GDP falls and unemployment increases. Why might the actual
output produced
not fall as much as officially measured GDP during a recession?
a. There is an increase in involuntary part-time employment, the output from which is
not accounted for in GDP.
b. Workers who became unemployed during the recession may produce goods in the
underground economy.
c. Unemployment benefits to laid-off workers will allow them to purchase nearly as
much output as before.
d. Laid off workers may start their own businesses, but profit income from self-
employment is not accounted for in GDP.

25. Which of the following is a problem with the measurement of GDP?

a. Transfer payments are not included.
b. Production in the underground economy is not counted.
c. Non-market production is not counted.
d. Both b and c are correct.
Chapter 11
Measuring the Cost of Living

1. Which price index measures the average price of things purchased by the typical
family in an urban area?
a. GDP deflator
b. producer price index
c. consumer price index
d. minimum wage

2. Which item would receive the most weight in the consumer price index?
a. salt
b. toothpicks
c. pencils
d. food

3. Which item would receive the least weight in the consumer price index?
a. brooms
b. automobiles
c. color televisions
d. automobile tires

4. The good that receives the most weight in the CPI is the good that
a. consumers buy most frequently.
b. has experienced the greatest price increase.
c. has the highest price.
d. consumers spend the largest fraction of their income on.

5. Which of the following is a reason why the Consumer Price Index (CPI) is not
calculated as a simple average of all prices?
a. Some goods experience large price changes and the CPI would be too variable if
computed by a simple average.
b. Goods differ in their importance in the average consumer’s budget.
c. Some goods never experience price changes and the CPI would not be variable
enough if computed as a simple average.
d. It would be difficult to compute a price index using a simple average of all prices.
6. If the price of the market basket of goods in the base year of 1994 was $20,000 and
the price of the same basket had risen to $22,000 by 1998, the CPI for 1998
a. cannot be calculated.
b. is $12,000.
c. is 200.
d. is 110.
7. Suppose you spend 30 percent of your budget on food, 20 percent on medical care,
40 percent on rent, 5 percent on entertainment, and 5 percent on miscellaneous items.
If the price of all parts of your budget rises equally in percentage terms, which would
have the most weight on your cost of living increase? (Assume you calculate your
index the same way the CPI is calculated.)
a. food
b. medical care
c. rent
d. entertainment

8. Substitution bias
a. is one factor that causes the CPI to underestimate the inflation rate.
b. is caused by the poor quality of many imported products.
c. is one of the primary causes of inflation.
d. involves consumer behavior that helps explain why the CPI overestimates the
inflation rate.
9. Improvements in the quality of consumer goods and services over time
a. cause the CPI to overstate actual inflation.
b. cause the CPI to understate actual inflation.
c. are accounted for in the CPI.
d. are insignificant and thus would not affect the CPI even if accounted for.

10. Factors that cause the CPI to exaggerate the inflation rate do not include
a. the tendency of consumers to substitute relatively cheaper goods for those that have
become relatively more expensive.
b. political pressure from unions and retirees on the Bureau of Labor Statistics to
overstate the inflation rate.
c. the introduction of new technologies that make it easier to obtain the same standard
of living.
d. improvements over time on the quality of products.
11. Which of the following answers would accurately describe the bias in the CPI
resulting from the fact that oil prices suddenly increase?
a. underestimate the cost of living
b. overestimate the cost of living
c. have no bias effect on the CPI
d. could overestimate or underestimate the cost of living, depending upon the quantity
of oil purchased in that year

12. The CPI differs from the GDP deflator in that the CPI includes
a. raw material prices whereas the GDP deflator does not.
b. only goods whereas the GDP deflator includes both goods and services.
c. only services whereas the GDP deflator includes both goods and services.
d. only items the typical household buys, whereas the GDP deflator includes all goods
and services produced in the economy.

13. The CPI differs from the GDP deflator in that the CPI
a. uses base-year quantities of goods to weight prices.
b. uses current-year quantities of goods to weight prices.
c. is not a weighted price index.
d. always indicates a higher rate of inflation than the GDP deflator.
14. The GDP deflator differs from the CPI because the GDP deflator includes goods
we __________, while the CPI includes goods we __________.
a. import; export
b. export; import
c. buy; sell
d. consume; produce

15. If the consumer price index has a value of 150 today and the base year is 1987,
then consumer prices have
a. increased by 50 percent since 1987.
b. doubled since 1987.
c. more than doubled since 1987.
d. declined 50 percent since 1987.
16. If the consumer price index has a value of 150 today and the base year is 1987,
then it costs
a. $100 today to buy what cost $150 in the base year.
b. $1 today to buy what cost $150 in the base year.
c. $150 today to buy what cost $100 in the base year.
d. $2 today to buy what cost $1 in the base year.
17. Use this table to find the real wage in 2002.

a. $8.06
b. $8.13
c. $13.00
d. $20.80
18. If the CPI increases from 100 to 200 and the nominal wage increases from $100 to
$400, what is the change in the real wage in terms of the beginning year’s dollars?
a. $200
b. $400
c. $100
d. –$200
19. The real interest rate on a loan
a. is the amount that the consumer agrees to pay.
b. is always the same as the nominal rate.
c. is the percentage increase in the lender’s purchasing power that results from making
the loan.
d. decreases as the inflation rate increases.

20. If a lender wants a real return of 6 percent and she expects inflation to be 4 percent,
which of the following is the nominal interest rate to charge?
a. 4 percent
b. 6 percent
c. 2 percent
d. 10 percent
21. Suppose that a labor union leader is trying to bargain for an increase in union
workers’ real wages of 5 percent. If she expected the price level to rise at a rate of 3
percent this year, how much would nominal wages need to increase for her to
accomplish her objective?
a. 2 percent
b. 3 percent
c. 5 percent
d. 8 percent

22. When borrowing money to purchase an automobile, Wei has the choice between a
fixed nominal interest rate or adjustable nominal interest rate loan. Typically the
adjustable rate loans start with a lower rate than the fixed rate loans. Given that, Wei
would most likely want to borrow money at the higher fixed rate when she expects the
a. inflation rate to rise.
b. inflation rate to fall.
c. inflation rate to remain unchanged.
d. government to take action to lower the inflation rate in the near future.

23. If you borrow money at a nominal interest rate of 5 percent and the inflation rate is
10 percent, what real interest rate will you pay?
a. –5 percent
b. .5 percent
c. 2 percent
d. 10 percent

24. When the inflation rate ends up being lower than expected,
a. everyone benefits because money is cheaper.
b. everyone benefits because prices do not increase.
c. lenders of fixed-rate mortgages generally benefit because they will make higher
profits than they had calculated.
d. borrowers with fixed-rate loans will benefit because their purchasing power will not
decline as much.
25. In general, a higher-than-anticipated inflation rate
a. helps everyone.
b. hurts everyone.
c. helps creditors and harms debtors.
d. helps debtors and harms creditors.
Chapter 13
Saving, Investment, and the Financial System

1. Bond markets allow firms to pursue

a. equity financing.
b. debt financing.
c. limited-growth policies.
d. government loans and subsidy programs.

2. Junk bonds are issues by firms with

a. high degrees of financial security.
b. business ties to the trash-hauling industry.
c. high degrees of financial insecurity.
d. the ability to offer lower interest rates to lenders.

3. The stock market is an institution that promotes

a. buying and selling of debt financing.
b. the purchase and sale of firm equities.
c. the purchase and sale of mutual funds.
d. bank borrowing and lending.

4. The major advantage of mutual funds is that

a. they allow people with limited funds to diversify.
b. they encourage households to spend their money on current consumption.
c. fund managers are replaced by household administrators.
d. they always use index funds to limit investor risk.

5. If an asset functions as a medium of exchange it

a. holds its value over a long period of time.
b. can be used by people to cover transactions.
c. can be used by firms for debt financing.
d. can be used by firms for equity financing.

6. The four categories of expenditures that make up GDP are consumption,

a. investment, net exports, and government expenditures.
b. investment, government purchases, and depreciation.
c. interest, government purchases, and net exports.
d. investment, exports, and rental expenditures.

7. Economists say that investment occurs when

a. someone buys stock on the New York Stock Exchange.
b. someone buys a U.S. government bond.
c. a firm increases its capital stock.
d. a government buys goods from another country.

8. Which of the following would be counted as a private investment expenditure in the

national income accounts?
a. The Navy builds a new battleship.
b. Microsoft expands plant capacity to produce new software.
c. A public high school builds a new football stadium.
d. All of the above are correct.

9. If a series of major technological breakthroughs occur in the economy at the same

time, then the most likely outcome would be that the economy’s
a. investment demand curve will shift downward.
b. investment demand curve will shift upward.
c. consumption curve will shift downward.
d. position along the existing investment curve will move upward.

10. Households make their savings available to borrowers through

a. resource markets.
b. the loanable funds market.
c. the labor market.
d. taxes.

11. What is the price of funds in the loanable funds market?

a. the real wage rate
b. the consumer price index
c. the nominal interest rate
d. the average firm profit rate
12. Assuming the economy is in equilibrium, use the following information to
determine the amount of funds supplied to the loanable funds market.
Consumption Spending $3.5 trillion
Net Taxes $2.7 trillion
Household Saving $2.5 trillion
Investment Spending $2.2 trillion
Government Purchases $3.0 trillion.
a. $2.2 trillion
b. $2.5 trillion
c. $2.7 trillion
d. $3.0 trillion

13. The quantity of loanable funds supplied is

a. positively related to the level of income.
b. negatively related to the price level.
c. positively related to the price level.
d. positively related to the interest rate.

14. The supply of loanable funds curve is upward sloping because a rise in the interest
rate
a. decreases the opportunity cost of firms’ investment spending.
b. increases the opportunity cost of firms’ investment spending.
c. decreases the opportunity cost to households of consuming.
d. increases the opportunity cost to households of consuming.

15. The investment demand curve

a. is upward sloping.
b. is downward sloping.
c. is horizontal.
d. begins sloping upward, then becomes horizontal.

16. When interest rates rise, the quantity of loanable funds demanded by
a. firms decreases.
b. government decreases.
c. firms increases.
d. government increases.
17. Market clearing in the loanable funds market
a. guarantees that total spending will be just sufficient to purchase whatever output is
produced.
b. means that the interest rate never changes.
c. guarantees that total spending will equal the quantity of loanable funds demanded.
d. requires that the government run a budget deficit.

18. If taxes are reduced with no change in government spending, and people spend all
the money from the tax cut on consumption
a. the demand for loanable funds will increase and the interest rate will increase.
b. the demand for loanable funds will increase and the interest rate will decrease.
c. the supply of loanable funds will decrease and the interest rate will increase.
d. neither the demand nor the supply of loanable funds will change.

19. If taxes are reduced with no change in government spending, and people save all
the money from the tax cut,
a. the demand for loanable funds will increase and the interest rate will increase.
b. the demand for loanable funds will increase and the interest rate will remain
constant.
c. the supply of loanable funds will increase and the interest rate will decrease.
d. neither the demand nor the supply of loanable funds will change.

20. A(n) __________ allows a firm to decrease its tax liability by a fraction of the
investment it initiates during a particular period.
a. tax on corporate profits
b. tax on retained earnings
c. investment tax credit
d. personal income tax

21. If the U.S. government wants to increase the level of employment and real output,
it could
a. increase corporate income taxes.
b. provide an investment tax credit.
c. decrease expenditures on roads and dams.
d. increase the personal income tax.
22. Assuming the economy was in equilibrium, use the following information to
determine the government’s budget deficit or surplus.
Consumption Spending $3.5 trillion
Net Taxes $2.7 trillion
Household Saving $2.5 trillion
Investment Spending $2.2 trillion
The government’s deficit (surplus) was
a. $.3 trillion surplus.
b. $.2 trillion surplus.
c. $.3 trillion deficit.
d. $.5. trillion deficit.

23. The government budget deficit is

a. the difference between government purchases and government revenues from bonds
and taxes.
b. caused by a lack of business sector investment.
c. created when the government expenditures exceed net taxes.
d. caused by leakages in the economy.

24. If the government budget deficit increases, the

a. supply of loans increases and the equilibrium interest rate increases.
b. supply of loans increases and the equilibrium interest rate decreases.
c. demand for loans increases and the equilibrium interest rate decreases.
d. demand for loans increases and the equilibrium interest rate increases.

25. If technical progress raises productivity permanently, then

a. the equilibrium interest rate will increase.
b. equilibrium saving will increase.
c. real GDP will increase.
d. All of the above are correct.
Chapter  15
Unemployment and Its Natural Rate   
1. The amount of __________increases when the economy goes into a
recession and decreases when the economy goes into an expansion.  
 a. structural unemployment  
 b. seasonal unemployment  
 c. cyclical unemployment  
 d. frictional unemployment  

2. It is difficult for cyclically unemployed persons to find jobs because  

 a. they typically do not meet the qualifications required for the
available jobs.  
b. the economy is in a recession.  
c. they voluntarily quit their last jobs and employers may view
them as unreliable.  
d. they typically have not looked long enough to find a job.  

3. The natural rate of unemployment is the economist’s notion of  

 a. full employment.  
 b. cyclical employment.  
 c. structural unemployment.  
 d. frictional unemployment.  

4. Yuan recently completed his college degree and is entering the labor market
for the first time. He has been submitting applications and has been
interviewed twice in the last two weeks, but so far has not found a job. Yuan
could be classified as  
 a. frictionally unemployed.  
 b. seasonally unemployed.  
 c. structurally unemployed.  
 d. cyclically unemployed.  

5. Providing training for unemployed individuals will help to alleviate  

 a. frictional unemployment.  
 b. seasonal unemployment.  
 c. structural unemployment.  
 d. cyclical unemployment.  

6. According to the data from the Bureau of Labor Statistics found here,
the labor force totals  
Number of workers employed 8,400  
 Frictional unemployment 250  
 Structural unemployment 350  
 Cyclical unemployment 600  
 Discouraged workers 400  
 Adult population 12,000  
 a. 7,550.  
 b. 8,000.  
 c. 8,400.  
 d. 9,600  

7. According to the data from the Bureau of Labor Statistics found here, the
unemployment rate is 
 a. 12.5 percent.  
 b. 15 percent.  
 c. 16 percent.  
 d. 24 percent.  

8. According to the data from the Bureau of Labor Statistics found here, the
labor force participation rate is  
 a. 12.5 percent.  
 b. 25 percent.  
 c. 60 percent.  
 d. 80 percent.  

9. Brian Vargo, an auto repair mechanic who remains unemployed because he

refuses to work for less than $1,000 per hour, is  
 a. counted as part of the labor force and is unemployed.  
 b. considered frictionally unemployed.  
 c. an underemployed worker.  
 d. not counted as part of the labor force.  

10. The existence of many discouraged workers in an economy may cause us to  

a. overstate the employment rate.  
b. understate the employment rate.  
c. overstate the unemployment rate.  
d. understate the unemployment rate.  

11. Changes in the composition of demand among industries or

regions are called  
a. frictional shifts.  
 b. sectoral shifts.  
 c. structural shifts.  
 d. temporary shifts.  

12. Unemployment insurance  

 a. tends to increase unemployment by decreasing the cost of being
unemployed.  
b. tends to decrease unemployment by providing limited resources to
the unemployed.  
c. increases the hardships associated with unemployment.  
d. increases the amount of job security demanded by employees.  

13. Fred is a low-skilled worker who washes dishes in a local restaurant. He is

worried about a  proposed increase in the minimum wage because price  
 a. floors tend to create shortages.  
 b. ceilings tend to create shortages.  
 c. floors tend to reduce quantity demanded.  
 d. ceilings tend to reduce quantity demanded.  

14. If the market for day care workers is in

equilibrium at $5.00 per hour as shown in this
diagram, a  minimum wage of $8.00 per hour will
increase unemployment by 

 a. 300 workers.  

 b. 500 workers.  
 c. 600 workers.  
 d. no workers.  

15. Consider two labor markets in which jobs are equally attractive in all
respects other than the wage rate. All workers are equally able to do either job.
Initially, both labor markets are perfectly competitive. If a union organizes
workers in one of the markets, then the wage rates will tend to  
a. rise in both markets.  
 b. fall in both markets  
 c. rise for the union jobs, but remain unchanged for the nonunion jobs.  
 d. rise for the union jobs and fall for the nonunion jobs.  

16. Unions attempt to raise wage rates for their members by  
 a. reducing the supply of the product their members produce.  
 b. lowering barriers to entry so their members have greater
opportunities.  
c. reducing the demand for labor so there are fewer nonunion
competitors.  
d. negotiating a higher-than-competitive wage rate.  

17. The process of negotiation between union and management to arrive at a

labor contract is called  
a. arbitration.  
b. mediation.  
c. collective bargaining.  
d. reconciliation.  

18. The legislation that granted unions the legal right to organize workers and
bargain collectively with  employers was the  
 a. Norris-LaGuardia Act.  
 b. Wagner Act.  
 c. Taft-Hartley Act.  
 d. Sherman Act.  

19. To negotiate a higher wage rate, a union cannot  

 a. start with a strike and then work to reach a contract to end the strike. 
 b. negotiate in good faith and expect to hold its bargaining power.  
 c. expect to maintain the same level of employment.  
 d. offer a supply curve of labor that is horizontal.  

20. Efficiency wages are  

a. lower than market wages paid by employers to increase profitability.  
b. higher than market wages paid by employers to increase productivity.  
c. government-determined minimum wages set to protect workers from
unfair employers.  
d. negotiated by unions when officials are interested in trimming work
forces.  

21. The idea of paying workers an efficiency wage is that  

a. doing so is more efficient than paying them the market wage.  
b. paying them less gives them the incentive to work harder.  
c. workers and management gain at the expense of the stockholders
of the company.  
d. workers have the incentive to do high-quality work.  

22. Henry Ford found that by paying an efficiency wage  

 a. he was able to bust the autoworkers union.  
 b. workers worked longer hours.  
 c. absentee and quit rates fell.  
 d. he could spend less on workers and more on capital equipment.  

23. A potential problem with efficiency wages is that if all firms try to do it  
 a. no one will have a job.  
 b. unemployment will occur.  
 c. workers will have higher salaries than managers.  
 d. unions will go on strike against them.  
24. When an agent lacks an incentive to promote the best interests of the
principal, and the principal  cannot observe the actions of the agent, there is
said to be  
 a. an optimal contract.  
 b. monitoring.  
 c. a separating equilibrium.  
 d. moral hazard.  

25. Carlos, who knew nothing about construction, paid Joe to remodel a room
in his house. Two years  later, the wall of the new room crumbled because Joe
used poor-quality materials. This is an  example of  
 a. moral hazard.  
 b. an optimal contract.  
 c. monitoring.  
 d. adverse selection.  

26. The fact that someone with a high risk of medical problems is more
likely to buy a lot of health  insurance is an example of  
 a. adverse selection.  
 b. monitoring.  
 c. moral hazard.  
 d. an optimal contract.  

27. Guarantees may not completely eliminate adverse selection

problems because  
a. no one guarantees a product 100%. 
 b. getting the firm to honor guarantees is too much work.  
 c. a firm that makes low-quality products may issue guarantees and then
go out of business.  
d. a firm offering guarantees subjects itself to lawsuits concerning their
obligations.  

28. Adverse selection is less of a problem  

 a. the less often buyers and sellers deal with each other.  
 b. the more often buyers and sellers deal with each other.  
 c. if guarantees are not enforceable.  
 d. if there is also a lot of moral hazard. 
Chapter  16
The Monetary System  
1. Barter exchange tends to be inefficient because  
 a. gold is difficult to transport.  
 b. it limits the time and effort required for trade.  
 c. it can be a very time-consuming process to find a double coincidence of
wants.  
d. a standardized unit of value can be difficult to find in a primitive economy.  

2. In order for something to function well as a medium of exchange, it must be  

a. issued by a central government.  
 b. readily and widely accepted in trade.  
 c. backed by a valuable commodity.  
 d. All of the above are correct.  

3. If a society chooses fiat money as its money form, it  

 a. must guarantee its convertibility into gold.  
 b. must worry about its liquidity.  
 c. cannot make use of a banking system.  
 d. must worry about controlling its quantity.  

4. Which of the following is the most liquid category of assets?  

 a. large time deposits  
 b. money market mutual fund balances  
 c. small time deposits  
 d. demand deposits  

5. Fred Jones won a lottery prize of $1 million. He put the money in the
bank to save it for his  daughter’s college education. For him, money
was functioning primarily as a  
a. unit of account.  
 b. store of value.  
 c. means of payment.  
 d. type of short-term loan.  

6. Which of the following is not included in the M1 money stock?  

 a. small time deposits.  
 b. demand deposits.  
 c. travelers’ checks.  
 d. cash in the hands of the public.  

7. Given the following information, what would be the

values of M1 and M2?   Small time deposits $650 billion  
  Checking deposits $300 billion  
 Savings-type deposits $750 billion  
 Money market mutual funds $600 billion  
 Travelers’ checks $ 25 billion  
 Large time deposits $600 billion  
 Cash in hand $100 billion  
 a. M1 = $400 billion, M2 = $2,450 billion. 
b. M1 = $100 billion, M2 = $1,075 billion.  
 c. M1 = $425 billion, M2 = $2, 425 billion.  
 d. M1 = $425 billion, M2 = $1,850 billion.  

8. Credit cards are  

 a. included in M2 but not in M1.  
 b. not considered money.  
 c. included in M3 but not in M2 or M1.  
 d. considered money only when they are in the hands of the public.  

9. The Federal Reserve is  

 a. part of the executive branch of the government.  
 b. not part of any branch of the government.  
 c. part of the judicial branch of the government.  
 d. included in all three branches of government.  

10. Which of the following would not be used by the Fed to

influence interest rates?   a. selling securities  
 b. buying stocks  
 c. setting reserve requirements  
 d. changing the discount rate  

11. The interest rate that the Fed charges banks that borrow
reserves from it is the   a. federal funds rate.  
 b. discount rate.  
 c. reserve requirement.  
 d. prime rate.  

12. Which of the following can banks count as reserves?  

 a. coins in the bank vaults  
 b. paper currency in bank vaults  
 c. deposits at the Federal Reserve banks  
 d. All of the above are correct.  

13. The most effective and frequently used tool the Fed has at its disposal to
change the economy’s  money supply is  
 a. open market operations.  
 b. the discount rate.  
  c. the reserve requirement.  
 d. the federal funds rate.  

14. The Federal Open Market Committee is composed of  

a. 12 Federal Reserve bank presidents and presidents of the seven largest
commercial banks in the  U.S.  
 b. the Board of Governors and the 12 Federal Reserve bank presidents.  
 c. the Board of Governors, the Secretary of the Treasury, and the
President of the FDIC.  
d. the Board of Governors and presidents of five Federal Reserve Banks.  

15. An open market purchase occurs when  

 a. the Fed buys government securities from a bank.  
 b. a bank buys government securities from the Fed.  
 c. a securities dealer buys shards of stock from the Fed. 
 d. the Treasury buys government securities from the Fed.  

16. The legal reserve requirement is  

 a. the minimum amount of reserves the Fed requires a bank to hold.  
 b. the interest rate that the Fed charges banks who borrow from it.  
 c. the interest rate on loans made by banks to other banks.  
 d. an appeal by the Fed to banks, asking for voluntary compliance with the Fed’s
100% reserves  policy.  

17. Given an initial deposit of $5,000 and a legal reserve requirement of 25%,
the amount of money  potentially created by the banking system is  
 a. $15,000.  
 b. $20,000.  
 c. $25,000.  
 d. $10,000.  

18. When the potential money multiplier is 7, a $3,000 increase in demand

deposits could support the  creation of __________ additional new demand
deposits.  
 a. $3,000  
 b. $9,000  
 c. $15,000  
 d. $18,000  

19. If a bank receives a new demand deposit of $10,000, and the legal reserve
requirement is 20 percent,  then the bank can lend out  
 a. $2,000.  
 b. $10,000.  
 c. $40,000.  
 d. $8,000.  
 20. If the legal reserve requirement decreases, the  
 a. money multiplier increases.  
 b. money multiplier decreases.  
 c. amount of excess reserves the bank has decreases.  
 d. money multiplier is unaffected.  

21. Given the information in the table, if the legal reserve requirement is 20
percent, this bank has  excess reserves of  
 a. $80,000.  
 b. $60,000.  
 c. $40,000.  
 d. $20,000.  
 Assets Liabilities  
 Reserves $80,000 Demand deposits $100,000   Loans
$20,000  

22. Given the information in the table, if the legal reserve requirement is 20
percent, this bank can  expand its loans by as much as  
 a. $80,000.  
 b. $60,000.  
 c. $40,000.  
 d. $20,000. 
Chapter The Monetary System  

23. If a bank keeps some of its excess reserves, the actual money multiplier  
 a. increases.  
 b. stays the same.  
 c. goes to zero.  
 d. decreases.  

24. If the Fed reduces the money supply, banks will often initially have  
 a. more reserves than they are required to hold.  
 b. excess reserves.  
 c. increases demand deposits.  
 d. deficient reserves.  

25. If the Fed decides to sell $10 million in securities and the Paris National
Bank writes out a $10  million check to purchase these securities, then
the  
 a. Paris National Bank now has $10 million more of excess
reserves at the Fed.  
b. Paris National Bank now has $10 million fewer reserves at
the Fed.  
 c. Fed has increased its asset position by $20 million.  
 d. money supply has increased.  

26. When the Fed decreases the discount rates, it makes it easier for
banks to  
a. decrease their reserves by borrowing from the Fed, causing the money
supply to shrink.  
b. increase their reserves by borrowing from the Fed, causing the money
supply to grow.  
c. protect against the inevitable accompanying increase in the legal
reserve requirement.  
d. convert its loans into deposits.  

27. The Fed loses some control over the interest rate once it targets the
money supply,  
a. but the interest rate does not move in an inappropriate direction with
respect to the Fed’s  monetary policy.  
 b. and the interest rate often moves in the opposite direction of
the Fed’s target.  
c. but it can still dictate what the interest rate will be.  
 d. and also loses some control over open market operations, which are linked to
the interest rate.  

28. If there is a recession, the Fed would most likely  

 a. encourage banks to provide loans by lowering the discount rate.  
 b. encourage banks to provide loans by raising the discount rate.  
 c. restrict bank lending by lowering the discount rate.  
 d. restrict bank lending by raising the discount rate. 
 Chapter  17
Money Growth and Inflation   
1. The price level that equates the quantity of money demanded with the quantity
of  money supplied is called the  
 a. equilibrium price level.  
 b. natural price level.  
 c. relative price level.  
 d. commodity price level.  

2. Real economic variables measure  

 a. value in the prices of some certain base year.  
 b. value in the prices of the current year.  
 c. nominal values adjusted for the current interest rate.  
 d. nominal values adjusted for the current money supply.  

3. According to the equation of exchange, money times velocity

equals  
a. nominal GDP.  
 b. real GDP.  
 c. inflation-adjusted total output in the economy.  
 d. the number of times each unit of money is spent on goods and services.  

4. If real output in an economy is 1000 goods per year, the money supply is
$300, and  each dollar is spent 3 times per year, then the average price of goods
is  
a. $0.90.  
 b. $1.11.  
 c. $1.50.  
 d. $1.33.  

5. Within the context of the equation of exchange, the higher the equilibrium
price  level is  
 a. the higher is the nominal money supply.  
 b. the lower is the nominal interest rate.  
 c. the higher is real GDP.  
 d. the lower is velocity.  

6. If real GDP falls and the nominal interest rate rises, then the equilibrium price
level   a. must fall.  
 b. must rise.  
 c. will fall if the effect of the decline in real GDP dominates.  
 d. will fall if the effect of the increase in the nominal interest rate dominates. 
 7. If the supply of money is greater than the amount of money people want to
hold,  then  
 a. spending will increase and the price level will fall.  
 b. spending will increase and the price level will rise.  
 c. spending will increase and the rate of interest will rise.  
 d. None of the above are correct. The amount of money supplied is never greater 
than the amount people want to hold.  

8. According to classical economists  

 a. prices are rigid.  
 b. both velocity and real output are variable.  
 c. changes in the money supply cause changes in velocity.  
 d. the velocity of money is constant.  

9. Since classical economists believe that both velocity and real output are
constants,  the equation of exchange becomes a theory in which  
 a. the quantity of money explains prices.  
 b. the quantity of money explains real GDP.  
 c. changes in the money supply cause changes in velocity.  
 d. prices are fixed.  

10. According to the classical view, to prevent price level changes when real output
is  growing by 3 percent per year, the money supply must  
 a. decrease by 3 percent per year.  
 b. increase by 3 percent per year.  
 c. increase by more than 3 percent per year.  
 d. remain constant.  

11. The irrelevance of monetary changes for real variables is

called   a. the classical dichotomy.  
 b. the equation of exchange.  
 c. monetary neutrality.  
 d. hyperinflation.  

12. Which of the following is a major source of inflation in the United

States?  
a. faster growth of the money supply than growth in GDP  
 b. monopoly power  
 c. low productivity  
 d. government regulation  

13. If a government supplies more money than the quantity people want to
hold  
a. spending will decrease and the price level will fall.  
 b. spending will increase and the price level will rise.  
  c. spending will remain constant but the price level will rise. 
 d. there will be no change in the level of economic activity or prices; money is 
neutral.  

14. Hyperinflation occurs because governments want to __________ spending but

they  ignore the fact that increasing the money supply will __________ .  
 a. decrease, require greater government spending  
 b. increase, also increase the price level  
 c. increase, put upward pressure on interest rates  
 d. decrease, put downward pressure on interest rates  

15. The inflation tax is  

 a. a tax on windfall profits.  
 b. a special tax imposed on owners of shares of stock.  
 c. a special tax imposed on profits when inflation is over 10% per year.  
d. the loss incurred when inflation reduces the purchasing power of assets.  

16. The beneficiaries of the inflation tax are  

 a. those who borrow money.  
 b. all corporations.  
 c. all multinational corporations that can shift assets into alternative
currencies.   d. exporters of goods and services.  

17. If the nominal interest rate is 10%, the expected rate of inflation is 7%,
and the  growth rate of the money supply is 6%, then the real interest rate is
a. –4%.  
 b. –3%.  
 c. 3%.  
 d. 4%.  

18. Studies of money demand indicate that the nominal demand for
money   a. does not depend on interest rates.  
 b. does not depend on the price level.  
 c. is proportional to the price level.  
 d. is proportional to the nominal interest rate.  

19. In 1985, the U.S. government indexed the federal personal income tax system.
With  indexing, households are pushed into a higher tax bracket only if their
nominal  income  
 a. rises as fast as the rate of inflation.  
 b. rises slower than the rate of inflation.  
 c. rises faster than the rate of inflation.  
 d. decreases by the amount of inflation.  
20. Investors criticize the federal income tax system because they must pay
taxes 
a. on gains that merely reflect the effects of inflation.  
 b. only on gains that exceed the effects of inflation.  
 c. on losses as well as gains.  
 d. on losses but not on gains.  

21. Unanticipated inflation helps  

 a. investors at the expense of savers.  
 b. proprietorships at the expense of partnerships.  
 c. borrowers at the expense of lenders.  
 d. taxpayers at the expense of government.  

22. Some economists feel inflation is bad  

 a. because it reduces real GDP so much.  
 b. only if it is steady.  
 c. because it redistributes income arbitrarily.  
 d. only if it is anticipated.  

23. Betty spends the entire week before Christmas shopping. However,
inflation is so  high in her community that she must make three trips to the
bank each day so as  not to lose too much purchasing power. These costs of
inflation are called  
a. menu costs.  
 b. shoeleather costs.  
 c. the inflation fallacy.  
 d. redistribution costs.  

24. When news reporters blame inflation on monopoly sellers, or on

greed, they  
a. are correctly distinguishing between relative prices and the level of
prices.  
b. are confusing the level of prices with the rate of change of prices.  
c. are identifying the major cause of inflation in the United States.  
d. None of the above are correct.  

25. Monopoly sellers  

 a. charge higher prices than more competitive firms and therefore cause
inflation.  
b. can achieve economies of scale not available to competitive firms and
therefore  charge lower prices, which causes deflation.  
 c. charge higher prices than more competitive firms, but do not cause inflation.  
d. are much greedier than sellers in more competitive markets. 
Chapter 18:
Open-Economy Macroeconomics:
Basic Concepts
1. A country’s balance of international trade is positive when
a. exports exceed imports.
b. exports plus investment exceed imports plus domestic saving.
c. imports exceed exports.
d. imports plus domestic saving exceed exports plus investment.

2. Which of the following would be recorded as an U.S. merchandise export?

a. An American tourist spends 10,000 francs on vacation in the south of France.
b. A machine shop in Ohio purchases a grinder made in Italy.
c. An American receives a $50 dividend check on stock she owns in a business in
Germany.
d. France purchases a new jet fighter aircraft from the Boeing Company in the
United States.

3. Which of the following is equivalent to the trade deficit?

a. imports/exports
b. net capital inflow
c. exports + imports
d. net exports – imports

4. If U.S. imports total $100 billion and U.S. exports total $150 billion, which of the
following would be true?
a. U.S. net exports equal –$50 billion
b. The U.S. has a trade surplus of $50 billion.
c. The U.S. has a trade deficit of $100 billion.
d. The U.S. has a trade deficit of $50 billion.

5. What does a positive U.S. capital inflow signify?

a. Nothing.
b. That the government is running a budget deficit.
c. That more funds were invested in the United States by foreigners than the
United States invested abroad.
d. That the United States is running a trade surplus.

6. International trade in financial assets

a. increases risk because little is known about firms in foreign lands.
b. increases risk because default risk is greater in foreign countries.
c. increases risk because of currency fluctuations.
d. reduces risk by allowing for increased diversification.

7. It must always be true that net capital outflow

a. is greater than net exports.
b. is less than net exports.
c. is equal to net exports.
d. equals 0.

8. If savings in Germany is $300 billion and investment in Germany is $550 billion,

then
a. there must be net capital outflow of –$550 billion.
b. there must be net capital outflow of –$250 billion.
c. the German government must be running a $250 billion surplus.
d. the German financial market must be experiencing a net capital outflow.

9. If interest rates in Canada rise above those in the rest of the world, then
a. the demand for Canadian dollars decreases.
b. exports from Canada to other countries increases.
c. imports into Canada from other countries decreases.
d. it raises Canada’s exchange rate and this may result in a deficit on Canada’s
current account.

10. Foreign direct investment differs from foreign portfolio investment in that
a. direct investments involve stocks and bonds.
b. direct investments can only be made by the International Monetary Fund.
c. direct investments involve physical capital; portfolio investments involve
financial capital
d. a government must be involved in direct investment, but portfolio investment
can involve private firms.
11. Which of the following would be classified as a direct foreign investment?
a. a purchase of 100 shares of British Petroleum stock
b. a loan of $1 million to a Brazilian utilities firm
c. A loan of $1 million from the World Bank to Surinam
d. building a new Pizza Hut in St. Petersburg, Russia

12. Net capital outflow measures

a. the flow of goods and services between countries.
b. the flow of assets between countries.
c. government budget surpluses and deficits relative to those experienced in other
countries.
d. the amount of physical capital built in foreign countries.

13. U.S. trade deficits are a sign of

a. reduced national savings.
b. reduced production of manufactured goods.
c. an over reliance on the service economy.
d. high rates of unemployment in the U.S. economy.

14. The exchange rate is the

a. value of money.
b. quantity of dollars, yen, etc., that are traded on currency markets.
c. amount of foreign currency that is used to buy goods made in your country.
d. number of units of a foreign currency that can be bought with one unit of your
own currency.

15. If you were told that the exchange rate was 1.5 U.S. dollars per 1 Canadian dollar
(CDN), that would mean that Canadians would have to spend __________ to by a
$12 watch in New York City.
a. $18 CDN
b. $15 CDN
c. $1.5 CDN
d. $12 CDN

16. Currencies depreciate and appreciate all the time. Who gains and who loses when
the Mexican peso depreciates?
a. Americans holding Mexican pesos gain, U.S. tourists to Mexico lose.
b. U.S. exporters to Mexico gain, Americans holding pesos lose.
c. Mexican exporters gain, Mexican importers lose.
d. Mexican importers gain, Mexican exporters lose.

17. When Italy devalues its currency

a. the dollars per Italian lira will increase.
b. the drain of U.S. reserves on Italian lira will fall.
c. U.S. exports to Italy will increase.
d. the price of imported Italian olive oil in the United States will fall.

18. When fewer U.S. dollars are needed to buy a unit of Japanese yen, the dollar
a. is devalued.
b. is inflated.
c. appreciates.
d. depreciates.

19. If one country has a lower inflation rate than other countries, its
a. currency tends to appreciate.
b. currency tends to depreciate.
c. real interest rate will be higher than in other countries.
d. nominal interest rate will be higher than in other countries.

20. In the long run, exchange rates

a. are determined by business cycle fluctuations.
b. are determined by movements of Eurodollars.
c. will adjust until the price of a bundle of goods is the same in both countries.
d. will reflect economic fluctuations in both countries.

21. Which of the following is a statement of the purchasing power parity theory of
exchange rate determination? The exchange rate will adjust in the
a. long run until the interest rate is roughly the same in both countries.
b. long run until real GDP is roughly the same in both countries.
c. long run until the average price of goods is roughly the same in both countries.
d. short run until the average price of goods is roughly the same in both countries.
22. Suppose the same basket of goods costs $100 in the U.S. and 50 pounds in Britain.
According to PPP, if the prices do not change, what will be the exchange rate?
a. 2 dollars/pound
b. 4 dollars/pound
c. 5 dollars/pound
d. .5 dollars/pound

23. Which of the following is a reason why exchange rates may deviate from their
purchasing power parity values for many years?
a. Some goods are not tradable.
b. In some cases, a foreign-produced good is not a perfect substitute for a
domestically-produced version of the same thing.
c. In some markets, import quotas limit the ability of firms to agree on exchange
prices.
d. Both a and b are correct.

24. If the U.S. price level is increasing by 3 percent annually and the Swiss price level
is increasing by 5 percent annually, by what percent would the dollar price of francs
need to change according to purchasing power parity?
a. depreciate by 5 percent
b. appreciate by 3 percent
c. appreciate by 5 percent
d. depreciate by 2 percent

25. Arbitrage refers to

a. simultaneously buying and selling a currency in order to profit from a difference
in exchange rates.
b. simultaneously buying and selling a currency in order to change the exchange
rate.
c. buying a currency when its price is high and selling it when its price is low.
d. exchanging the domestic currency for a foreign currency.
Chapter 20
Aggregate Demand and Aggregate Supply

1. A severe and prolonged recessionary phase of a business cycle is sometimes

described as
a. an inverted peak.
b. a trough.
c. a recession.
d. a depression.

2. If you and your friends are still looking for a job eighteen months after graduation,
even after lowering your wage expectations, you are probably in the business cycle
phase of a
a. recession.
b. peak.
c. boom.
d. recovery

3. Ethel maintains that she can predict when the economy is going to move up or
down a business cycle. In fact
a. most economists can predict the business cycle.
b. the business cycle is quite regular, with a new phase beginning every 24 months.
c. business cycles are irregular and unpredictable in the short run.
d. only the Federal Reserve can predict moves in the business cycle.

4. Recessions do not last forever because

a. workers get tired of being unemployed.
b. firms eventually have incentives to increase employment and produce more
output.
c. government steps in and boosts spending back to long-run levels.
d. the Federal Reserve has perfect control over the money supply.

5. In the long run, the aggregate demand curve is

a. horizontal.
b. upward sloping.
c. downward sloping.
d. vertical.

6. When studying the short run, the assumption of money neutrality is

a. not relevant.
b. increasingly important.
c. still relevant but the classical dichotomy no longer holds.
d. Both b and c are correct.

7. If we are most interested in short-run changes in economic activity,

a. the classical model is an unreliable guide.
b. total spending can be ignored.
c. labor markets are irrelevant.
d. we should assume that neither expansions nor recessions can occur.

8. Anyone seeking to understand the causes of recessions must examine

a. the saving behaviors of different age groups.
b. investment patterns in the housing market.
c. disequilibrium in the manufacturing sector.
d. changes in the level of spending.

9. The wealth effect, interest rate effect, and foreign trade effect all explain why the
aggregate
a. supply curve is horizontal.
b. supply curve is vertical.
c. supply curve is upward sloping.
d. demand curve is downward sloping.

10. According to the __________ effect, a lower price level decreases interest rates,
which results in additional spending on investment goods and so increases the
aggregate quantity of goods and services demanded.
a. money supply
b. interest rate
c. consumption
d. investment

11. Due to expectations of a future recession, companies do not think that they can sell
all of their output and therefore purchase less equipment and machinery. As an
immediate result, the aggregate
a. supply curve becomes vertical.
b. supply curve shifts right.
c. demand curve shifts right.
d. demand curve shifts left.

12. Movements along the aggregate supply curve are caused by changes in
a. technology.
b. government regulations.
c. wages and salaries.
d. the price level.

13. Which of the following will cause the aggregate supply curve to shift to the right?
a. increases in wages and salaries paid to employees
b. increases in the prices of oil and natural gas
c. increases in taxes for business
d. new work rules that increase the productivity of labor

14. Rising oil prices in the U.S. during the 1970s caused the economy’s aggregate
a. supply curve to shift to the right.
b. supply curve to shift to the left.
c. demand curve to become vertical.
d. demand curve to become horizontal.

15. To say that nominal prices are sticky means

a. the average price level seldom changes.
b. relative prices seldom change.
c. it takes at least one year for prices to change to a new equilibrium level.
d. it takes time for prices to adjust to equilibrium.

16. Which of the following is not a determinant of long-run aggregate supply?

a. the level of skills in the workforce
b. the price level
c. technology
d. the quantity of capital
17. The long-run effect of an increase in government spending is to raise
a. both real output and the price level.
b. real output and lower the price level.
c. real output and leave the price level unchanged.
d. the price level and leave real output unchanged.

18. If prices in an economy are sticky, then a decrease in the money supply
a. will cause a recession.
b. cannot be responsible for causing a recession.
c. will not have adverse effects on the economy.
d. will not affect prices.

19. Many economists believe that the severity of the Great Depression was due to
a. a flood of imported goods brought about by tariff reductions.
b. the failure of the Federal Reserve to prevent a large drop in the money supply.
c. the huge budget deficits of the federal government.
d. hyperinflation that occurred following World War I.

20. Which of the following will reduce the price level and raise real output?
a. an adjustment of prices to equilibrium
b. an increase in wage rates
c. the short-run aggregate supply curve becoming steeper
d. technical progress

21. Which of the following will reduce the price level and reduce real output in the
short run?
a. an increase in the money supply
b. an increase in oil prices
c. a decrease in the money supply
d. technical progress

22. Which of the following will cause stagflation?

a. an increase in the money supply
b. an increase in oil prices
c. a decrease in the money supply
d. technical progress

23. Recessions in South Korea and Indonesia will cause

a. an upward movement along the U.S. AD curve.
b. a downward movement along the U.S. AD curve.
c. the U.S. AS curve to shift to the right.
d. the U.S. AD curve to shift to the left.

24. If there is speculation that a recession is around the corner, which means that our
future incomes will most likely fall, then the effect of all this on the economy now
will be that the
a. AS curve will shift to the left.
b. AD curve will shift to the right.
c. price level will rise and real output will rise.
d. price level will fall and real output will fall.

25. Any factor that increases resource availability causes a(n)

a. increase in AD.
b. decrease in AD.
c. increase in AS.
d. decrease in AS.
Chapter
The Influence of Monetary and Fiscal
Policy on Aggregate Demand
1. The opportunity cost of holding money is the
a. dollar cost necessary to change other assets into money.
b. time cost of accessing funds.
c. value of the goods and services a person is able to obtain with the money.
d. interest a person could have earned by holding other forms of wealth instead.
2. Which of the following is the opportunity cost of money?
a. money being a means of payment
b. the trouble of having to get money out of the bank
c. the interest forgone by holding money
d. the ability to purchase things at a moment’s notice
3. When the interest rate falls,
a. the opportunity cost of holding money rises.
b. people shift out of holding interest-yielding assets and into holding more liquid
forms of
money.
c. the quantity of money people will hold decreases.
d. investment spending decreases.
4. The equilibrium interest rate occurs in the money market where the
a. quantity of money available is zero.
b. the maximum quantity of funds has been borrowed and loaned.
c. the money supply is equal to the money demand.
d. the quantity of money demanded is zero.
5. As the price level increases, the money demand curve will
a. shift to the left.
b. become steeper.
c. stay in the same position.
d. shift to the right.
6. The money supply curve is vertical because
a. real income does not influence the quantity of money supplied.
b. the price level does not influence the level of spending.
c. only the interest rate influences the quantity of money supplied.
d. the Federal Reserve sets the money supply.
7. The federal funds rate is the
a. federally mandated upper limit on credit card interest rates.
b. interest rate that banks charge to their most preferred clients.

c. interest rate that the Fed charges member banks for loans of reserves.
d. interest rate that banks charge for lending their excess reserves to other banks.
8. When the Fed increases the money supply, the interest rate
a. rises and spending increases.
b. rises and spending decreases.
c. falls and spending increases
d. falls and spending decreases.
9. In the short-run macro model, an open-market purchase of bonds by the Fed will
a. raise the interest rate, reduce spending, and increase output.
b. raise the interest rate, reduce spending, and decrease output.
c. lower the interest rate, reduce spending, and decrease output.
d. lower the interest rate, increase spending, and increase output.
10. Open market sales of bonds by the Federal Reserve reduce the money supply and
a. reduce aggregate expenditures.
b. increase real aggregate expenditures.
c. are helpful in monetizing the federal debt.
d. stimulate purchases of consumer durables.
11. Which of these diagrams describes an open market sale by the Fed?

a. a
b. b
c. c
d. d
12. __________ is the use of government expenditures and taxes to promote full
employment,
stable prices, and economic growth.
a. Monetary policy
b. Incomes policy
c. Stabilization policy
d. Fiscal policy

13. The marginal propensity to consume (MPC) is

a. the change in consumption divided by the change in disposable income.
b. total consumption divided by total disposable income.
c. the change in disposable income divided by the change in consumption.
d. total disposable income divided by total consumption.
14. Use this table to determine the MPC.
Disposable Consumption
Income Spending
($ billions) ($ billions)
0 $ 100
$200 280
$400 460
$600 640
a. 0
b. .8
c. .9
d. 1.0
15. The multiplier effect
a. tells us that a change in government spending changes equilibrium GDP by more
than
the change in government spending.
b. works only for increases in investment.
c. is relevant only in situations where the MPC cannot be determined.
d. tells us whether a change in government policy has been effective.
16. If the marginal propensity to consume is .5, what is the value of the multiplier?
a. 1.0 b. 1.5 c. 2.0 d. 5
17. If government spending decreases by $500 billion and if MPC = .6,
a. equilibrium GDP will rise by $1,250 billion.
b. equilibrium GDP will fall by $500 billion.
c. equilibrium GDP will fall by $1,250 billion.
d. nothing will happen in the short run, but real output will rise by $500 billion in the
long
run.
18. The crowding-out effect occurs when increased government expenditures and the
subsequent budget deficits cause
a. the money supply to increase, which curtails loans to consumers.
b. interest rates to increase, which reduces investment spending.
c. inflation, which erodes the purchasing power of the dollar.
d. the imports of goods and services to rise, and exports to decline.
19. Which of the following is not true for the crowding-out effect?
a. Federal budget deficits increase interest rates, which reduces investment spending.
b. Crowding out reduces the ability of fiscal policy to combat a recession.

c. If the government spends more on education, ceteris paribus, households may be

forced
to spend less on new homes.
d. Crowding out occurs especially when the economy is in a deep recession and people
are
not spending all the available money.
20. When George W. Bush was elected, he promised sweeping decreases in income
tax rates
for households. His idea with this plan was that the
a. tax cuts would lead to increased savings.
b. tax cuts would stimulate household spending, even though they might cause
minimal
increases in interest rates.
c. tax cuts would stimulate household spending and at the same time lower interest
rates.
d. long-run aggregate supply curve would remain fixed while the aggregate demand
curve
and interest rates increased.
21. The Employment Act of 1946 provided that
a. the Federal Reserve should use monetary policy to stabilize the economy.
b. the Federal Deposit Insurance Corporation should insure bank deposits.
c. the federal government should use its spending and taxation powers to stabilize the
economy.
d. state and local governments should regulate wages and employment in the electric
and
natural gas industries.
22. If the federal government announces a tax cut, which of the following is most
likely in the
short run?
a. a decrease in output, an increase in money demand, and an increase in the interest
rate
b. an increase in output, a decrease in money demand, and a decrease in the interest
rate
c. a decrease in output, a decrease in money demand, and a decrease in the interest rate
d. an increase in output, an increase in money demand, and an increase in the interest
rate
23. Government spending on infrastructure
a. increases aggregate demand but not aggregate supply.
b. increases productivity of private business firms and hence aggregate supply.
c. cannot affect aggregate demand because the money does not go to households.
d. shifts the long-run aggregate supply curve to the left.
24. The automatic fiscal stabilizers include all of the following except
a. corporate income taxes.
b. unemployment insurance benefits.
c. the prime interest rate.
d. food stamps.
25. Unlike discretionary fiscal policy, automatic stabilizers consist of
a. deliberate changes in government spending to counteract recession and inflation.
b. deliberate changes in household taxes to counteract recession and inflation.
c. deliberate changes in corporation income taxes to counteract recession and inflation.
d. changes in government spending and tax revenues that occur automatically as the
economy fluctuates.