Chapter 13

Saving, Investment, and the Financial System

MULTIPLE CHOICE

1. When opening a restaurant you may need to by ovens, freezers, tables, and cash registers. Economists call these
expenditures
a. capital investment.
b. investment in human capital.
c. business consumption expenditures.
d. None of the above are correct.

2. When a country saves a larger portion of its GDP, it will have

a. less investment, and so have more capital and higher productivity.
b. less investment, and so have less capital and higher productivity.
c. more investment, and so have more capital and higher productivity.
d. more investment, and so have less capital and higher productivity.

3. Institutions in the economy that help to match one person's saving with another person's investment are collectively
called the
a. Federal Reserve system.
b. banking system.
c. monetary system.
d. financial system.

4. Alfred’s income exceeds his expenditures. Alfred is a

a. saver who demands money from the financial system.
b. saver who supplies money to the financial system.
c. borrower who demands money from the financial system.
d. borrower who demands money from the financial system.

5. Lucy wants to start her own psychiatric practice, but her expenditures exceed her income. Lucy is a
a. saver who demands money from the financial system.
b. saver who supplies money to the financial system.
c. borrower who demands money from the financial system.
d. borrower who supplies money to the financial system.

6. A bond is a
a. financial intermediary.
b. certificate of indebtedness.
c. certificate of partial ownership in an enterprise.
d. None of the above are correct.

7. A certificate of indebtedness that specifies the obligations of the borrower to the holder is called a
a. bond.
b. stock.
c. mutual fund.
d. All of the above are correct.

8. If the government’s expenditures exceeded its receipts, it would likely

a. lend money to a bank or other financial intermediary.
b. borrow money from a bank or other financial intermediary.
c. directly buy bonds from the public.

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 d. directly sell bonds to the public.

9. If Microsoft sells a bond they are

a. borrowing directly from the public.
b. borrowing indirectly from the public.
c. lending directly to the public.
d. lending indirectly to the public.

10. Which of the following is correct?

a. The maturity of a bond refers to the amount to be paid back.
b. The principal of the bond refers to the person selling the bond.
c. A bond buyer cannot sell a bond before it matures.
d. None of the above are correct.

11. Which of the following is NOT a nonsensical headline?

a. British perpetuities about to mature.
b. Disney issues new bonds with term of $1,000 each.
c. Government bonds currently pay less interest than corporate bonds.
d. Standard and Poor’s judges new junk bond to have very low credit risk.

12. The length of time until a bond matures is called the

a. duration.
b. term.
c. maturity.
d. intermediation.

13. A perpetuity is distinguished from other bonds in that it

a. pays continuously compounded interest.
b. pays interest only when it matures.
c. never matures.
d. will be used to purchase another bond when it matures unless the owner specifies otherwise.

14. Which of the following is correct?

a. Some bonds have terms as short as a few months.
b. Because they are so risky, junk bonds pay a low rate of interest.
c. Corporations buy bonds to raise funds.
d. All of the above are correct.

15. Which of the following is correct?

a. Lenders sell bonds and borrowers buy them.
b. Long-term bonds usually pay a lower interest rate than do short-term bonds because long-term bonds are riskier.
c. Junk bonds refer to bonds that have been resold many times.
d. None of the above are correct.

27. The sale of stocks

a. and bonds to raise money is called debt finance.
b. and bonds to raise money is called equity finance.
c. to raise money is called debt finance, while the sale of bonds to raise funds is called equity finance.
d. to raise money is called equity finance, while the sale of bonds to raise funds is called debt finance.

29. Stock represents

a. a claim to the profits of a firm.
b. ownership in a firm.
c. equity finance.
d. All of the above are correct

32. People who buy stock in a corporation such as General Electric become
 a. creditors of General Electric, so the benefits of holding the stock depend on General Electric’s profits.
b. creditors of General Electric, but the benefits of holding the stock do not depend on General Electric’s profits.
c. part owners of General Electric, so the benefits of holding the stock depend on General Electric’s profits.
d. part owners of General Electric, but the benefits of holding the stock do not depend on General Electric’s profits.

34. Compared to bonds, stocks offer the holder

a. lower risk.
b. partial ownership.
c. the likelihood of a lower return.
d. All of the above are correct.

37. All else equal, when people become more optimistic about a company's future, the
a. supply of the stock and the price will both rise.
b. supply of the stock and the price will both fall.
c. demand for the stock and the price will both rise.
d. demand for the stock and the price will both fall.

38. Suppose that the government finds a major defect in one of a company’s products and demands that they take it off
the market. We would expect that the
a. supply of the stock and the price will both rise.
b. supply of the stock and the price will both fall.
c. demand for the stock and the price will both rise.
d. demand for the stock and the price will both fall.

39. World Wide Delivery Service Corporation develops a way to speed up their deliveries and reduce their costs. We
would expect that this would
a. raise the demand for existing shares of the stock, causing its price to rise.
b. decrease the demand for existing shares of the stock, causing its price to fall.
c. raise the supply of the existing shares of stock, causing its price to rise.
d. raise the supply of the existing shares of stock, causing its price to fall.

40. Other things being constant, when a business issues more stock, the
a. supply of the stock is greater and thus the price will fall.
b. supply of the stock is less and thus the price will rise.
c. demand for the stock is greater and thus the price will rise.
d. demand for the stock is less and thus the price will fall.

41. Which of the following statements is most likely to be correct?

a. A general, persistent decline in stock prices is a signal that the economy is about to enter a boom period
because people will be able to buy stock for less money.
b. A general, persistent decline in stock prices is a signal that the economy is about to enter a recession because
low stock prices may mean that people are expecting low corporate profits.
c. A general, persistent decline in stock prices does not tell us anything about the business cycle because stock
prices can fall for many reasons.
d. A general, persistent decline in stock prices is a signal that the economy is about to enter a recession because
low stock prices mean that corporations have had low profits in the past.

42. Stock indexes are

a. the average of a group of stock prices.
b. the average of a group of stock yields.
c. reports in the newspaper that report on the price of the stock and earnings of the corporation.
d. measures of the risk relative to the profitability of corporations.

45. The single most important piece of information about a stock is the
a. price-earnings ratio.
b. dividend.
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 c. volume
d. price.

46. Volume, as reported in stock tables refers to the

a. number of shares traded.
b. percentage of shares outstanding traded.
c. number of shares traded times the price they sold at.
d. number of shares of a company traded divided by the shares of all companies traded.

47. Profits paid out to stockholders are

a. retained earnings.
b. dividends.
c. the denominator in the price-earnings ratio.
d. All of the above are correct.

48. Profits not paid out to stockholders are

a. retained earnings.
b. known as dividends.
c. the denominator in the price-earnings ratio.
d. All of the above are correct.

76. The identity that shows that GDP is both total income and total expenditure is represented by
a. GDP = Y.
b. Y = PI + DI + NX.
c. GDP = GNP – NX.
d. Y = C + I + G + NX.

77. Y = C + I + G + NX is an identity because

a. each symbol identifies a variable.
b. the right-hand and left-hand sides are equal.
c. the equality holds due to the way the variables are defined.
d. None of the above are correct.

78. A closed economy does not

a. trade with other economies.
b. have free markets.
c. allow immigration.
d. All of the above are correct.

79. Which of the following equations will always represent GDP in an open economy?
a. S = I – G
b. I = Y – C + G
c. Y = C + I + G
d. Y = C + I + G + NX

80. Which of the following equations most simply represents GDP in a closed economy?
a. Y = C + I + G + NX
b. S = I – G
c. I = Y – C + G
d. Y = C + I + G

81. Which of the following equations represents national saving in a closed economy?
a. Y – I – G – NX
b. Y – C – G
c. Y – I – C
d. G + C – Y
82. In a closed economy, national saving equals
a. investment.
b. income minus the sum of consumption and government expenditures.
c. private saving plus public saving.
d. All of the above are correct.

83. In a closed economy, national saving is

a. usually greater than investment.
b. equal to investment.
c. usually less than investment because of the leakage of taxes.
d. always less than investment.

84. In a closed economy, what remains after paying for consumption and government purchases is
a. national disposable income.
b. national saving.
c. public saving.
d. private saving.

85. In a closed economy, what does (T – G) represent?

a. national saving
b. investment
c. private saving
d. public saving

86. In a closed economy, what does (Y – T – C) represent?

a. national saving
b. government tax revenue
c. public saving
d. private saving

87. Suppose that in a closed economy GDP is equal to 10,000, Taxes are equal to 1,500, Consumption equals 6,500,
and Government expenditures equal 2,000. What is national saving?
a. –500
b. 0
c. 1500
d. None of the above are correct.

88. Suppose that in a closed economy GDP is equal to 10,000, Taxes are equal to 2,000, Consumption equals 6,500,
and Government expenditures equal 2,500. What are private saving and public saving?
a. 1500 and –500
b. 1500 and 500
c. 1000 and –500
d. 1000 and 500

89. Suppose that in a closed economy GDP is equal to 10,000, taxes are equal to 2,500 Consumption equals 6,500 and
Government expenditures equal 2,000. What are private saving, public saving, and national saving?
a. 1500, 1000, 500
b. 1000, 500, 1500
c. 500, 1500, 1000
d. None of the above are correct.

90. Suppose that in a closed economy GDP is 10,000, consumption is 6,500, and taxes are 2,000. What value of
Government expenditures would make national savings equal to 1000 and at that value would the government have
a deficit or surplus?
a. 2,500 deficit
b. 2,500 surplus
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 c. 1,000 deficit
d. 1,000 surplus

97. Which of the following is not always correct in a closed economy?

a. National saving equals private saving plus public saving.
b. Net exports equal zero.
c. Real GDP measures both income and expenditures.
d. Private saving equals investment.

98. If the tax revenue of the federal government exceeds spending, then the government
a. runs a budget deficit.
b. runs a budget surplus.
c. runs a national debt.
d. will increase taxes.

99. A budget surplus is created if

a. the government sells more bonds than it buys back.
b. the government spends more than it receives in tax revenue.
c. private savings are greater than zero.
d. None of the above are correct.

100. In the language of macroeconomics, investment refers to

a. saving.
b. the purchase of new capital.
c. the purchase of stocks, bonds, or mutual funds.
d. All of the above are correct.

101. Which of the following would a macroeconomist consider as investment?

a. Ernest purchases a bond issued by Star-Kist.
b. Jerry purchases stock issued by IBM.
c. Alice builds a new restaurant.
d. All of the above are correct.

102. Henry buys a bond issued by Ralston Purina, which uses the funds to buy new machinery for one of its factories.
a. Henry and Ralston Purina are both investing.
b. Henry and Ralston Purina are both saving.
c. Henry is investing; Ralston Purina is saving.
d. Henry is saving; Ralston Purina is investing.

103. The source of the supply of loanable funds

a. is saving and the source of demand for loanable funds is investment.
b. is investment and the source of demand for loanable funds is saving.
c. and the demand for loanable funds is saving.
d. and the demand for loanable funds is investment.

104. The slope of the demand for loanable funds curve represents the
a. positive relation between the real interest rate and investment.
b. negative relation between the real interest rate and investment.
c. positive relation between the real interest rate and saving.
d. negative relation between the real interest rate and saving.

105. Fred is considering expanding his dress shop. If interest rates rise he is
a. less likely to expand. This illustrates why the supply of loanable funds slopes downward.
b. more likely to expand. This illustrates why the supply of loanable funds slopes upward.
c. less likely to expand. This illustrates why the demand for loanable funds slopes downward.
d. more likely to expand. This illustrates why the demand for loanable funds slopes upward.
107. The slope of the supply of loanable funds curve represents the
a. positive relation between the real interest rate and investment.
b. positive relation between the real interest rate and saving.
c. negative relation between the real interest rate and investment.
d. negative relation between the real interest rate and saving.

108. A higher interest rate induces people to

a. save more, so the supply of loanable funds slopes upward.
b. save less, so the supply of loanable funds slopes downward.
c. invest more, so the supply of loanable funds slopes upward.
d. invest less, so the supply of loanable funds slopes downward.

109. The supply of loanable funds slopes

a. upward because an increase in the interest rate induces people to save more.
b. downward because an increase in the interest rate induces people to save less.
c. downward because an increase in the interest rate induces people to invest less.
d. upward because an increase in the interest rate induces people to invest more.

110. If the current market interest rate for loanable funds is below the equilibrium level, then the quantity of loanable funds
a. demanded will exceed the quantity of loanable funds supplied and the interest rate will rise.
b. supplied will exceed the quantity of loanable funds demanded and the interest rate will rise.
c. demanded will exceed the quantity of loanable funds supplied and the interest rate will fall.
d. supplied will exceed the quantity of loanable funds demanded and the interest rate will fall.

111. If the current market interest rate for loanable funds is above the equilibrium level, then
a. the quantity of loanable funds demanded will exceed the quantity of loanable funds supplied and the interest rate
will rise.
b. the quantity of loanable funds supplied will exceed the quantity of loanable funds demanded and the interest rate
will rise.
c. the quantity of loanable funds demanded will exceed the quantity of loanable funds supplied and the interest rate
will fall.
d. the quantity of loanable funds supplied will exceed the quantity of loanable funds demanded and the interest rate
will fall.

112. If the current market interest rate for loanable funds is below the equilibrium level, then there is a
a. surplus of loanable funds and the interest rate will rise.
b. shortage of loanable funds and the interest rate will rise.
c. shortage of loanable funds and the interest rate will fall.
d. surplus of loanable funds and the interest rate will fall.

113. If the current market interest rate for loanable funds is above the equilibrium level, then there is a
a. surplus of loanable funds and the interest rate will rise.
b. shortage of loanable funds and the interest rate will rise.
c. shortage of loanable funds and the interest rate will fall.
d. surplus of loanable funds and the interest rate will fall.

114. If there is shortage of loanable funds, then

a. the supply for loanable funds shifts right and the demand shifts left.
b. the supply for loanable funds shifts left and the demand shifts right.
c. neither curve shifts, but the quantity of loanable funds supplied increases and the quantity demanded decreases
as the interest rate rises to equilibrium.
d. neither curve shifts, but the quantity of loanable funds supplied decreases and the quantity demanded increases
as the interest rate falls to equilibrium.

116. The nominal interest rate is the

a. interest rate corrected for inflation.
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 b. interest rate as usually reported by banks.
c. real rate of return to the lender.
d. real cost of borrowing to the borrower.

117. If the nominal interest rate is 5 percent and the rate of inflation is 2 percent, then the real interest rate is
a. 7 percent.
b. 3 percent.
c. 2.5 percent.
d. 2/5 percent.

118. If the inflation rate is 2 percent and the real interest rate is 3 percent, then the nominal interest rate is
a. 5 percent.
b. 1 percent.
c. 1.5 percent
d. 2/3 percent.

119. If the nominal interest rate is 10 percent and the inflation rate is 4 percent, then the real interest rate is
a. 14 percent.
b. 6 percent.
c. 2.5 percent.
d. 4/10 percent.

120. The nominal interest rate is 6 percent and the real interest rate is 2 percent, what is the inflation rate?
a. 8 percent
b. 4 percent
c. 3 percent
d. None of the above are correct.

121. Generally when economists and the text talk of the "interest rate," they are talking about the
a. real interest rate.
b. current nominal interest rate.
c. real interest rate minus the inflation rate.
d. equilibrium nominal interest rate.

122. What would happen in the market for loanable funds if the government were to increase the tax on interest income?
a. The supply of loanable funds would shift right.
b. The demand for loanable funds would shift right.
c. The supply of loanable funds would shift left.
d. The demand for loanable funds would shift left.

123. What would happen in the market for loanable funds if the government were to decrease the tax rate on interest
income?
a. The supply of and demand for loanable funds would shift right.
b. The supply of and demand for loanable funds would shift left.
c. The supply of loanable funds would shift right and the demand for loanable funds would shift left.
d. None of the above are correct.

124. Suppose that the government were to replace the income tax with a consumption tax. This would make the interest
rate
a. and investment increase.
b. and investment decrease.
c. increase and investment decrease.
d. decrease and investment increase.

125. Which of the following would not be a result of replacing the income tax with a consumption tax?
a. The interest rate would decrease.
b. Investment would decrease.
 c. The standard of living would eventually rise.
d. The supply of loanable funds would shift right.

126. In 1995 Congressperson Bill Archer proposed that the income tax be replaced with a consumption tax. If his program
had been passed, then today it is likely that the equilibrium interest rate
a. and quantity of loanable funds would be lower.
b. and quantity of loanable funds would be higher.
c. would be higher and the equilibrium quantity of loanable funds would be lower.
d. would be lower and the equilibrium quantity of loanable funds would be higher.

127. What would happen in the market for loanable funds if the government were to increase the tax on interest income?
a. Interest rates would rise.
b. Interest rates would be unaffected.
c. Interest rates would fall.
d. The change in the interest rate would be ambiguous.

128. What would happen in the market for loanable funds if the government were to decrease the tax on interest income?
a. There would be an increase in the amount of loanable funds borrowed.
b. There would be a reduction in the amount of loanable funds borrowed.
c. There would be no change in the amount of loanable funds borrowed.
d. The change in loanable funds borrowed would be ambiguous.

129. If Congress reduced the tax rate on interest income, investment

a. would increase and saving would decrease.
b. would decrease and saving would increase.
c. and saving would increase.
d. and saving would decrease.

140. If the government currently has a budget deficit,

a. it does not necessarily have a debt.
b. the debt is increasing.
c. government expenditures are greater than taxes.
d. All of the above are correct.

141. An increase in the budget deficit

a. changes the supply of loanable funds.
b. changes the demand for loanable funds.
c. changes both the supply of and demand for loanable funds.
d. does not influence the supply of or the demand for loanable funds.

142. Other things the same, a government budget deficit

a. increases both private saving and national saving.
b. increases public saving but reduces national saving.
c. reduces both public and national saving.
d. reduces private saving, but increases national saving.

143. In the last few years the U.S. government has gone from a surplus to a deficit. Other things the same, this means
that
a. supply of loanable funds shifted right.
b. supply of loanable funds shifted left.
c. demand for loanable funds shifted right.
d. demand for loanable funds shifted left.