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SDSU - ECON 101 - Study Guide - Midterm

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SDSU - ECON 101 - Study Guide - Midterm

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background image Chapter 12
Fiscal Policy: Incentives and Secondary  Effects
Problem 1 The following graph shows the market for loanable funds in Abierto, a large open economy. The government of Abierto has just instituted  a tax cut, increasing the deficit.
On the graph, shift either the demand curve or the supply curve to illustrate the change
in fiscal policy. The increase in deficit causes the interest rate in Abierto to increase. As an open economy, this change in interest rate causes the net capital inflow to Abierto to
increase. This change in net capital inflow causes Abierto's currency to appreciate,
which in turn causes Abierto's net exports to decrease.
The change in net exports caused by the tax cut decreases the impact on aggregate
demand of the expansionary fiscal policy. Problem 2 Deborah lives in the fictional country of Lindelof, which raises government revenue by taxing everyone the same amount. The government of Lindelof has just implemented a
tax cut that reduces annual taxes by $1,000 per person. However, government spending
has not changed, nor is it likely change in the future.
The tax cut has raised Deborah's income by $1,000. If Deborah acts according to the
prediction of new classical economics (and doesn't plan to leave Lindelof), her
consumption  is likely to increase by $0.
Suppose  that instead of cutting taxes while keeping its spending the same, the
government did the opposite: it increased its spending by $1,000 per person while
keeping taxes the same. If everyone in Lindelof acted like Deborah, the likely increase in
aggregate demand would be $0 per person. Problem 3 Suppose  the government of a hypothetical economy decides to pursue a restrictive fiscal policy by permanently increasing taxes .
The following graph shows the market for loanable funds in this hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by shifting the appropriate curve or curves on the following graph of the loanable funds
market. If you decide that the policy produced no effect, leave the graph unchanged.
The following graph shows the goods and services market for the same hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by
shifting the appropriate curve or curves (aggregate demand, AD; aggregate supply, AS)
on the following graph of the goods and services market. If you decide that the policy
produced no effect, leave the graph unchanged. Fill in the first column of the table to summarize the short-run effects of a restrictive fiscal policy according to the new classical view. Then fill in the second column to
summarize the short-run effects of a restrictive fiscal policy according to the Keynesian
view. (Note: Assume that there are no crowding-out or crowding-in effects.) Problem 4 While there are intense debates among macroeconomists regarding the effectiveness of expansionary fiscal policy during a severe recession, both the Keynesian and non-
Keynesian economists agree that fiscal policy is subject to some limitations as a
stabilization tool. Which of the following issues do most macroeconomists widely agree upon? Check all that apply. Discretionary fiscal policy can be counterproductive because of policy lags. A. The use of the federal budget as an automatic stabilizer can help smooth business cycle fluctuations. B. Discretionary fiscal policy is less effective than is implied by the early Keynesian view. C. Problem 5 Consider a fictional economy that is operating at its long-run equilibrium. The following graph shows  the aggregate demand curve (AD) and short-run aggregate supply curve
(SRAS) for the economy. The long-run aggregate supply curve (LRAS) is represented by a
vertical line at $6 trillion. The economy is initially producing at potential output.
Suppose  that fiscal authorities decide to decrease marginal tax rates. Assume that this
change in marginal tax rates is perceived as a long-term change.
Shift the appropriate curves to illustrate the supply-side view of the fiscal policy effect on
output and the price level. True or False: Supply-side economics is a long-run, growth-oriented strategy. True A. False B. Problem 6 How does the new classical theory of fiscal policy differ from the crowding-out model? Anticipation of higher future interest rates will reduce private spending when government expenditures are financed by debt , whereas the crowding-out effect
posits that this result occurs through higher interest rates.
A. Anticipation of higher future taxes will reduce private spending when government expenditures are financed by debt, whereas the crowding-out
effect posits that this result occurs through higher interest rates.
B. Anticipation of lower future taxes will reduce private spending when government expenditures are financed by debt whereas the crowding-out effect posits that
this result occurs through higher interest rates.
C. Anticipation of higher future taxes increases private spending when government expenditures are financed by debt, whereas the crowding-out effect posits that
this result occurs through higher interest rates.
D. Problem 7 Suppose  that the government provides each taxpayer with a $1,000 tax rebate financed by issuing additional Treasury bonds.
Evaluate the following statement.
True or False: Keynesian economists believe that increases in government spending financed by borrowing will increase aggregate demand and help promote recovery.
Non-Keynesian economists argue that such policies will lead to higher future interest
rates and taxes, inefficient use of resources, and wasteful rent-seeking that will both
retard recovery and slow future economic growth.
True A. False B. Problem 8 If the government becomes more heavily involved in subsidizing some businesses  and sectors of the economy while levying higher taxes on others, the quantity of rent
seeking will increase due to which of the following?
Resources will be channeled toward wasteful rent-seeking and away from productive activities. A. Such policies lead to lower future interest rates and taxes and discourage wasteful rent-seeking, thereby facilitating future economic growth. B. Problem 9 Evaluate the following statement. True or False: Increases in government spending increase both disposable income and incentives to earn, producing an immediate positive impact on the financial position of
households.  In contrast, tax cuts often involve a lengthy process spread over several
years. True A. False B. Problem 10 The American Wind Energy Association argues for additional government support because wind-generated electricity creates more employment per kilowatt-hour than
the alternatives: 27% more jobs than coal and 66% more than natural gas.
Evaluate the following statement.
If the jobs created pay similar wages, the statement implies that the cost of generating energy with wind power is higher relative to the cost of coal and natural gas. True A. False B. Chapter 13
Money and the Banking System
Problem 1 True or False: The rate that is charged when banks, seeking additional reserves, borrow short-term funds from banks with excess reserves is known  as the federal funds rate. True A. False B. If the Fed wants to use open market operations to lower the federal funds rate, it should purchase U.S. securities and other financial assets on the open market. Problem 2 Indicate how each event in the following table would affect M1 and M2. Problem 3 Suppose  that the reserve requirement is 10% and the following table shows  the balance sheet of the People’s National Bank. The required reserves of People’s National Bank are $30,000 while the excess reserves are $45,000. Thus, if this bank wanted to extend a loan, the maximum amount for this
additional loan would be $45,000. Assuming the bank extends this loan, the total
amount of loans in the bank’s balance sheet would be $245,000. Suppose  the reserve
requirement increases to 20%.
The bank would only be in a position  to extend additional loans amounting to $15,000.
Problem 4 Consider the relative liquidity of the following assets: Select the assets in order of their liquidity, from most liquid to least liquid. Problem 5 The Federal Reserve sets the reserve requirement, which banks must meet through deposits at the Fed and cash held at the bank. What do these requirements
achieve? Check all that apply.
They help to facilitate transfers of funds between banks when a customer from one bank writes a check to a customer of another. A. They help to prevent bank runs by reassuring the public that banks will not make too many loans and run out of cash. B. They help to control the money supply. C. They mean that banks must have one dollar of deposits  for every dollar it loans. D. Problem 6 Assume that the following table portrays the balance sheet of First Southern bank. First Southern's bank reserves are equal to $250,000. If the Federal Reserve sets the required reserve ratio to 0.05, First Southern's  required reserves would be $47,5000.
Therefore, it would have $202,500 in excess reserves.
If First Southern  loaned all of its excess reserves, the maximum amount by which the
money supply could subsequently  increase is $4,050,000.
If the Fed were instead to set the required reserve ratio to 0.10, required reserves
would be $95,000, excess reserves would be $155,000, and the maximum increase in
the money supply would be $1,550,000.
The maximum potential increase in the money supply will be larger if the Fed chooses a
required reserve ratio of 0.05. Problem 7 Fill in the blanks in the following table to indicate differences between the U.S. Treasury and the Federal Reserve. Problem 8 If the central bank pursues an expansionary monetary policy, the growth rate of the money supply is likely to increase.
Which of the following changes would likely lead to a decrease in the M1 money supply
in the United States? Check all that apply. The use of credit cards for payments made both in person and in online purchases becomes widespread. A. A financial crisis reduces many people’s faith in money market mutual funds, causing them to switch to demand deposits. B. Many people decide to shift their money from savings accounts to interest- earning checking accounts. C. The U.S. dollar becomes more popular among developing countries, where it is increasingly used in daily transactions. D. Chapter 14
Modern Macroeconomics  and Monetary  Policy
Problem 1 The following diagram represents the money market in the United States, which is currently in equilibrium. Shift either the money supply curve or the money demand curve, or both, to illustrate on the graph the effects of this policy.
Suppose  the Federal Reserve announces  that it is lowering its target interest rate by 75
basis points, or 0.75%. It would achieve this by increasing the money supply.
The sequence of events that results in a new equilibrium interest rate, after the Fed
makes the change you selected, may be described as follows: Because there is more
money in the financial system, the quantity of interest-bearing financial assets such as
bonds demanded increases, which means that bond issuers can issue bonds at lower
interest rates and still
sell the bonds.  This process continues until the new equilibrium
interest rate is achieved. Problem 2 The following graph shows the short-run aggregate supply (SRAS) and aggregate demand (AD) curves for a fictional economy that is producing at point A (grey star
symbol), which corresponds  to the intersection of the AD1 and SRAS1 curves.
According to the graph, actual output  of this economy is $1 trillion higher than potential output, which means that the economy experiences an expansion.
Along SRAS1, wages would have been negotiated based on an expected price level
of 40. Since the actual price level at point A is 50, this means that real wages are lower
than
had been negotiated, which will decrease unemployment.
If the Fed does not intervene, these labor market conditions would cause nominal
wages to increase, shifting the SRAS1 curve to the left. Eventually, the economy would
reach a new long-run equilibrium.
On the previous graph, place the purple point (diamond symbol) at the new long-run equilibrium output and price level if the Fed intervenes. (Hint: Assume there are no
feedback effects on the curve that does not shift.)
Now, suppose the Fed chooses to intervene in an effort to move the economy more quickly back to its potential output.  To do so, the Fed will decrease the money supply,
which will increase the interest rate, thereby giving firms an incentive to decrease
investment, shifting the AD curve leftward. On the previous graph, place the green point (triangle symbol) at the new long-run equilibrium output and price level if the Fed does not intervene and successfully brings
the economy back to long-run equilibrium. (Hint: Assume there are no feedback effects
on the curve that does not shift.) Compare your answers to the previous few questions. If the Fed does not intervene, the economy will likely have relatively high inflation. On the other hand, if the Fed does
intervene, it risks causing relatively low inflation, especially if it changes the money
supply too much. Problem 3 Consider a hypothetical economy that produces at its long-run macroeconomic equilibrium at a price level of 100.
Suppose  that the central bank in this economy is expanding the money supply by 4%
each year. In order for the price level to be maintained at 100, real GDP must grow at
an annual rate of 4% if the velocity of money remains constant.
Suppose  the central bank enacts an unanticipated expansionary monetary policy. As a
result, the supply of loanable funds increases, leading to a fall in short-term interest
rates.
The following graph shows the goods and services market of this economy at full employment. Assume that potential output  remains constant. Adjust the graph to show the long-run effect of an unanticipated expansionary monetary policy on the goods and services market by
dragging the aggregate demand (AD) curve, the short-run  aggregate supply (AS) curve,
or both. An expansionary monetary policy when the economy is at full employment leads to a temporary increase in real GDP and a permanent increase in the price level. True or False: Money growth is closely related to inflation. True A. False B. Problem 4 Suppose  the economy is currently in long-run, full-employment equilibrium. Assume that expected inflation is 0% in the short run.
An unanticipated increase in the money supply in the United States will increase real
output  in the short run.
A sustained increase in the money supply in the United States will not affect real output
in the long run. Problem 5 Suppose  the Fed shifts to a more expansionary monetary policy. As part of this policy, the Fed will generally purchase bonds  in the open market. In the following table, indicate how this action will influence each factor in the economy in the short run. Chapter 15
Macroeconomic  Policy, Economic Stability,  and the Federal Debt
Problem 1 Compared with instability prior to World War II, economic instability during the past sixty years decreased due to a more stabile monetary policy. Problem 2 The index of leading economic indicators is an index composed of economic variables that tend to turn down prior to the beginning of a recession and turn up prior to the
beginning of a business expansion.
Problem 3 Consider the following economic situation: The current inflation rate is 3%, and this rate was widely anticipated more than a year ago.
The actual rate of unemployment is equal to the natural rate of unemployment.
Problem 4
What are some of the practical problems that limit the effective use of discretionary
monetary and fiscal policy as stabilization tools? Check all that apply. The recognition lag A. The adaptive lag B. The impact lag C. The administrative lag D. Problem 5 Can expansionary monetary policy stimulate a higher growth rate of real output in the long run? No, people adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will lead to inflation without permanently
increasing output and employment.
A. Yes, people never fully adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will increase inflation and increase output
and employment.
B. Problem 6 Economists disagree about how quickly the economy adjusts to an aggregate demand shock. In the view of some economists, people form expectations based on present
realities and change expectations gradually as their experience unfolds.  Such
expectations are said to be adaptive.
The following graph shows the aggregate demand curve (AD), the short-run aggregate
supply (SRAS), and the long-run aggregate supply curve (LRAS) for a hypothetical
economy that is initially in equilibrium,
operating at potential output  at point N.
Suppose  an unanticipated increase in investment spending causes the aggregate demand curve to shift to the right (from AD1 to AD2). According to adherents of the
adaptive-expectations theory, the unanticipated change in aggregate demand will cause
the economy to move in which direction? A. Directly from point N to point Z B. From point N to point K, before returning to point N C. From point N to point D, before returning to point N D. From point N to point D and, eventually, from point D to point Z Now suppose that the increase in investment spending was entirely anticipated by firms and workers. This means the public fully anticipates the rightward shift of the aggregate
demand curve (from AD1 to AD2). According to rational-expectations adherents, the
anticipated change in aggregate demand will cause the economy to move in which
direction?
A. From point N to point K, before returning to point N B. From point N to point D, before returning to point N C. Directly from point N to point Z D. From point N to point D and, eventually, from point D to point Z Problem 7 The following graph shows the short-run Phillips curve within the expectations framework.
On the graph, place the grey star point to illustrate the situation when people accurately
anticipate the inflation rate. When people accurately anticipate the inflation rate, the natural rate of unemployment is 5%. On the previous graph, place the black cross point to illustrate the situation when people overestimate inflation by 3%. When people underestimate inflation, the resulting unemployment  rate is below the natural rate.
True or False: The modern view of the Phillips curve indicates that to keep the
unemployment rate low, policymakers should rapidly increase inflation rates. A. True
B. False
Problem 8 Despite ongoing debates about the appropriateness of macroeconomic policies, many macroeconomists have reached a modern consensus  on several important issues. Which of the following statements regarding monetary policy are true according to the macroeconomic consensus  in the United States? Check all that apply. A. Monetary policy should focus on price stability. B. Congress, not the Federal Reserve, should be in charge of monetary policy. C. Expansionary monetary policies should  be used to keep unemployment  below its natural rate. Test 3 Study Guide Tuesday,  November  28, 2017 2:07 PM
background image Chapter 12
Fiscal Policy: Incentives and Secondary  Effects
Problem 1 The following graph shows the market for loanable funds in Abierto, a large open economy. The government of Abierto has just instituted  a tax cut, increasing the deficit.
On the graph, shift either the demand curve or the supply curve to illustrate the change
in fiscal policy. The increase in deficit causes the interest rate in Abierto to increase. As an open economy, this change in interest rate causes the net capital inflow to Abierto to
increase. This change in net capital inflow causes Abierto's currency to appreciate,
which in turn causes Abierto's net exports to decrease.
The change in net exports caused by the tax cut decreases the impact on aggregate
demand of the expansionary fiscal policy. Problem 2 Deborah lives in the fictional country of Lindelof, which raises government revenue by taxing everyone the same amount. The government of Lindelof has just implemented a
tax cut that reduces annual taxes by $1,000 per person. However, government spending
has not changed, nor is it likely change in the future.
The tax cut has raised Deborah's income by $1,000. If Deborah acts according to the
prediction of new classical economics (and doesn't plan to leave Lindelof), her
consumption  is likely to increase by $0.
Suppose  that instead of cutting taxes while keeping its spending the same, the
government did the opposite: it increased its spending by $1,000 per person while
keeping taxes the same. If everyone in Lindelof acted like Deborah, the likely increase in
aggregate demand would be $0 per person. Problem 3 Suppose  the government of a hypothetical economy decides to pursue a restrictive fiscal policy by permanently increasing taxes .
The following graph shows the market for loanable funds in this hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by shifting the appropriate curve or curves on the following graph of the loanable funds
market. If you decide that the policy produced no effect, leave the graph unchanged.
The following graph shows the goods and services market for the same hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by
shifting the appropriate curve or curves (aggregate demand, AD; aggregate supply, AS)
on the following graph of the goods and services market. If you decide that the policy
produced no effect, leave the graph unchanged. Fill in the first column of the table to summarize the short-run effects of a restrictive fiscal policy according to the new classical view. Then fill in the second column to
summarize the short-run effects of a restrictive fiscal policy according to the Keynesian
view. (Note: Assume that there are no crowding-out or crowding-in effects.) Problem 4 While there are intense debates among macroeconomists regarding the effectiveness of expansionary fiscal policy during a severe recession, both the Keynesian and non-
Keynesian economists agree that fiscal policy is subject to some limitations as a
stabilization tool. Which of the following issues do most macroeconomists widely agree upon? Check all that apply. Discretionary fiscal policy can be counterproductive because of policy lags. A. The use of the federal budget as an automatic stabilizer can help smooth business cycle fluctuations. B. Discretionary fiscal policy is less effective than is implied by the early Keynesian view. C. Problem 5 Consider a fictional economy that is operating at its long-run equilibrium. The following graph shows  the aggregate demand curve (AD) and short-run aggregate supply curve
(SRAS) for the economy. The long-run aggregate supply curve (LRAS) is represented by a
vertical line at $6 trillion. The economy is initially producing at potential output.
Suppose  that fiscal authorities decide to decrease marginal tax rates. Assume that this
change in marginal tax rates is perceived as a long-term change.
Shift the appropriate curves to illustrate the supply-side view of the fiscal policy effect on
output and the price level. True or False: Supply-side economics is a long-run, growth-oriented strategy. True A. False B. Problem 6 How does the new classical theory of fiscal policy differ from the crowding-out model? Anticipation of higher future interest rates will reduce private spending when government expenditures are financed by debt , whereas the crowding-out effect
posits that this result occurs through higher interest rates.
A. Anticipation of higher future taxes will reduce private spending when government expenditures are financed by debt, whereas the crowding-out
effect posits that this result occurs through higher interest rates.
B. Anticipation of lower future taxes will reduce private spending when government expenditures are financed by debt whereas the crowding-out effect posits that
this result occurs through higher interest rates.
C. Anticipation of higher future taxes increases private spending when government expenditures are financed by debt, whereas the crowding-out effect posits that
this result occurs through higher interest rates.
D. Problem 7 Suppose  that the government provides each taxpayer with a $1,000 tax rebate financed by issuing additional Treasury bonds.
Evaluate the following statement.
True or False: Keynesian economists believe that increases in government spending financed by borrowing will increase aggregate demand and help promote recovery.
Non-Keynesian economists argue that such policies will lead to higher future interest
rates and taxes, inefficient use of resources, and wasteful rent-seeking that will both
retard recovery and slow future economic growth.
True A. False B. Problem 8 If the government becomes more heavily involved in subsidizing some businesses  and sectors of the economy while levying higher taxes on others, the quantity of rent
seeking will increase due to which of the following?
Resources will be channeled toward wasteful rent-seeking and away from productive activities. A. Such policies lead to lower future interest rates and taxes and discourage wasteful rent-seeking, thereby facilitating future economic growth. B. Problem 9 Evaluate the following statement. True or False: Increases in government spending increase both disposable income and incentives to earn, producing an immediate positive impact on the financial position of
households.  In contrast, tax cuts often involve a lengthy process spread over several
years. True A. False B. Problem 10 The American Wind Energy Association argues for additional government support because wind-generated electricity creates more employment per kilowatt-hour than
the alternatives: 27% more jobs than coal and 66% more than natural gas.
Evaluate the following statement.
If the jobs created pay similar wages, the statement implies that the cost of generating energy with wind power is higher relative to the cost of coal and natural gas. True A. False B. Chapter 13
Money and the Banking System
Problem 1 True or False: The rate that is charged when banks, seeking additional reserves, borrow short-term funds from banks with excess reserves is known  as the federal funds rate. True A. False B. If the Fed wants to use open market operations to lower the federal funds rate, it should purchase U.S. securities and other financial assets on the open market. Problem 2 Indicate how each event in the following table would affect M1 and M2. Problem 3 Suppose  that the reserve requirement is 10% and the following table shows  the balance sheet of the People’s National Bank. The required reserves of People’s National Bank are $30,000 while the excess reserves are $45,000. Thus, if this bank wanted to extend a loan, the maximum amount for this
additional loan would be $45,000. Assuming the bank extends this loan, the total
amount of loans in the bank’s balance sheet would be $245,000. Suppose  the reserve
requirement increases to 20%.
The bank would only be in a position  to extend additional loans amounting to $15,000.
Problem 4 Consider the relative liquidity of the following assets: Select the assets in order of their liquidity, from most liquid to least liquid. Problem 5 The Federal Reserve sets the reserve requirement, which banks must meet through deposits at the Fed and cash held at the bank. What do these requirements
achieve? Check all that apply.
They help to facilitate transfers of funds between banks when a customer from one bank writes a check to a customer of another. A. They help to prevent bank runs by reassuring the public that banks will not make too many loans and run out of cash. B. They help to control the money supply. C. They mean that banks must have one dollar of deposits  for every dollar it loans. D. Problem 6 Assume that the following table portrays the balance sheet of First Southern bank. First Southern's bank reserves are equal to $250,000. If the Federal Reserve sets the required reserve ratio to 0.05, First Southern's  required reserves would be $47,5000.
Therefore, it would have $202,500 in excess reserves.
If First Southern  loaned all of its excess reserves, the maximum amount by which the
money supply could subsequently  increase is $4,050,000.
If the Fed were instead to set the required reserve ratio to 0.10, required reserves
would be $95,000, excess reserves would be $155,000, and the maximum increase in
the money supply would be $1,550,000.
The maximum potential increase in the money supply will be larger if the Fed chooses a
required reserve ratio of 0.05. Problem 7 Fill in the blanks in the following table to indicate differences between the U.S. Treasury and the Federal Reserve. Problem 8 If the central bank pursues an expansionary monetary policy, the growth rate of the money supply is likely to increase.
Which of the following changes would likely lead to a decrease in the M1 money supply
in the United States? Check all that apply. The use of credit cards for payments made both in person and in online purchases becomes widespread. A. A financial crisis reduces many people’s faith in money market mutual funds, causing them to switch to demand deposits. B. Many people decide to shift their money from savings accounts to interest- earning checking accounts. C. The U.S. dollar becomes more popular among developing countries, where it is increasingly used in daily transactions. D. Chapter 14
Modern Macroeconomics  and Monetary  Policy
Problem 1 The following diagram represents the money market in the United States, which is currently in equilibrium. Shift either the money supply curve or the money demand curve, or both, to illustrate on the graph the effects of this policy.
Suppose  the Federal Reserve announces  that it is lowering its target interest rate by 75
basis points, or 0.75%. It would achieve this by increasing the money supply.
The sequence of events that results in a new equilibrium interest rate, after the Fed
makes the change you selected, may be described as follows: Because there is more
money in the financial system, the quantity of interest-bearing financial assets such as
bonds demanded increases, which means that bond issuers can issue bonds at lower
interest rates and still
sell the bonds.  This process continues until the new equilibrium
interest rate is achieved. Problem 2 The following graph shows the short-run aggregate supply (SRAS) and aggregate demand (AD) curves for a fictional economy that is producing at point A (grey star
symbol), which corresponds  to the intersection of the AD1 and SRAS1 curves.
According to the graph, actual output  of this economy is $1 trillion higher than potential output, which means that the economy experiences an expansion.
Along SRAS1, wages would have been negotiated based on an expected price level
of 40. Since the actual price level at point A is 50, this means that real wages are lower
than
had been negotiated, which will decrease unemployment.
If the Fed does not intervene, these labor market conditions would cause nominal
wages to increase, shifting the SRAS1 curve to the left. Eventually, the economy would
reach a new long-run equilibrium.
On the previous graph, place the purple point (diamond symbol) at the new long-run equilibrium output and price level if the Fed intervenes. (Hint: Assume there are no
feedback effects on the curve that does not shift.)
Now, suppose the Fed chooses to intervene in an effort to move the economy more quickly back to its potential output.  To do so, the Fed will decrease the money supply,
which will increase the interest rate, thereby giving firms an incentive to decrease
investment, shifting the AD curve leftward. On the previous graph, place the green point (triangle symbol) at the new long-run equilibrium output and price level if the Fed does not intervene and successfully brings
the economy back to long-run equilibrium. (Hint: Assume there are no feedback effects
on the curve that does not shift.) Compare your answers to the previous few questions. If the Fed does not intervene, the economy will likely have relatively high inflation. On the other hand, if the Fed does
intervene, it risks causing relatively low inflation, especially if it changes the money
supply too much. Problem 3 Consider a hypothetical economy that produces at its long-run macroeconomic equilibrium at a price level of 100.
Suppose  that the central bank in this economy is expanding the money supply by 4%
each year. In order for the price level to be maintained at 100, real GDP must grow at
an annual rate of 4% if the velocity of money remains constant.
Suppose  the central bank enacts an unanticipated expansionary monetary policy. As a
result, the supply of loanable funds increases, leading to a fall in short-term interest
rates.
The following graph shows the goods and services market of this economy at full employment. Assume that potential output  remains constant. Adjust the graph to show the long-run effect of an unanticipated expansionary monetary policy on the goods and services market by
dragging the aggregate demand (AD) curve, the short-run  aggregate supply (AS) curve,
or both. An expansionary monetary policy when the economy is at full employment leads to a temporary increase in real GDP and a permanent increase in the price level. True or False: Money growth is closely related to inflation. True A. False B. Problem 4 Suppose  the economy is currently in long-run, full-employment equilibrium. Assume that expected inflation is 0% in the short run.
An unanticipated increase in the money supply in the United States will increase real
output  in the short run.
A sustained increase in the money supply in the United States will not affect real output
in the long run. Problem 5 Suppose  the Fed shifts to a more expansionary monetary policy. As part of this policy, the Fed will generally purchase bonds  in the open market. In the following table, indicate how this action will influence each factor in the economy in the short run. Chapter 15
Macroeconomic  Policy, Economic Stability,  and the Federal Debt
Problem 1 Compared with instability prior to World War II, economic instability during the past sixty years decreased due to a more stabile monetary policy. Problem 2 The index of leading economic indicators is an index composed of economic variables that tend to turn down prior to the beginning of a recession and turn up prior to the
beginning of a business expansion.
Problem 3 Consider the following economic situation: The current inflation rate is 3%, and this rate was widely anticipated more than a year ago.
The actual rate of unemployment is equal to the natural rate of unemployment.
Problem 4
What are some of the practical problems that limit the effective use of discretionary
monetary and fiscal policy as stabilization tools? Check all that apply. The recognition lag A. The adaptive lag B. The impact lag C. The administrative lag D. Problem 5 Can expansionary monetary policy stimulate a higher growth rate of real output in the long run? No, people adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will lead to inflation without permanently
increasing output and employment.
A. Yes, people never fully adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will increase inflation and increase output
and employment.
B. Problem 6 Economists disagree about how quickly the economy adjusts to an aggregate demand shock. In the view of some economists, people form expectations based on present
realities and change expectations gradually as their experience unfolds.  Such
expectations are said to be adaptive.
The following graph shows the aggregate demand curve (AD), the short-run aggregate
supply (SRAS), and the long-run aggregate supply curve (LRAS) for a hypothetical
economy that is initially in equilibrium,
operating at potential output  at point N.
Suppose  an unanticipated increase in investment spending causes the aggregate demand curve to shift to the right (from AD1 to AD2). According to adherents of the
adaptive-expectations theory, the unanticipated change in aggregate demand will cause
the economy to move in which direction? A. Directly from point N to point Z B. From point N to point K, before returning to point N C. From point N to point D, before returning to point N D. From point N to point D and, eventually, from point D to point Z Now suppose that the increase in investment spending was entirely anticipated by firms and workers. This means the public fully anticipates the rightward shift of the aggregate
demand curve (from AD1 to AD2). According to rational-expectations adherents, the
anticipated change in aggregate demand will cause the economy to move in which
direction?
A. From point N to point K, before returning to point N B. From point N to point D, before returning to point N C. Directly from point N to point Z D. From point N to point D and, eventually, from point D to point Z Problem 7 The following graph shows the short-run Phillips curve within the expectations framework.
On the graph, place the grey star point to illustrate the situation when people accurately
anticipate the inflation rate. When people accurately anticipate the inflation rate, the natural rate of unemployment is 5%. On the previous graph, place the black cross point to illustrate the situation when people overestimate inflation by 3%. When people underestimate inflation, the resulting unemployment  rate is below the natural rate.
True or False: The modern view of the Phillips curve indicates that to keep the
unemployment rate low, policymakers should rapidly increase inflation rates. A. True
B. False
Problem 8 Despite ongoing debates about the appropriateness of macroeconomic policies, many macroeconomists have reached a modern consensus  on several important issues. Which of the following statements regarding monetary policy are true according to the macroeconomic consensus  in the United States? Check all that apply. A. Monetary policy should focus on price stability. B. Congress, not the Federal Reserve, should be in charge of monetary policy. C. Expansionary monetary policies should  be used to keep unemployment  below its natural rate. Test 3 Study Guide Tuesday,  November  28, 2017 2:07 PM
background image Chapter 12
Fiscal Policy: Incentives and Secondary  Effects
Problem 1 The following graph shows the market for loanable funds in Abierto, a large open economy. The government of Abierto has just instituted  a tax cut, increasing the deficit.
On the graph, shift either the demand curve or the supply curve to illustrate the change
in fiscal policy. The increase in deficit causes the interest rate in Abierto to increase. As an open economy, this change in interest rate causes the net capital inflow to Abierto to
increase. This change in net capital inflow causes Abierto's currency to appreciate,
which in turn causes Abierto's net exports to decrease.
The change in net exports caused by the tax cut decreases the impact on aggregate
demand of the expansionary fiscal policy. Problem 2 Deborah lives in the fictional country of Lindelof, which raises government revenue by taxing everyone the same amount. The government of Lindelof has just implemented a
tax cut that reduces annual taxes by $1,000 per person. However, government spending
has not changed, nor is it likely change in the future.
The tax cut has raised Deborah's income by $1,000. If Deborah acts according to the
prediction of new classical economics (and doesn't plan to leave Lindelof), her
consumption  is likely to increase by $0.
Suppose  that instead of cutting taxes while keeping its spending the same, the
government did the opposite: it increased its spending by $1,000 per person while
keeping taxes the same. If everyone in Lindelof acted like Deborah, the likely increase in
aggregate demand would be $0 per person. Problem 3 Suppose  the government of a hypothetical economy decides to pursue a restrictive fiscal policy by permanently increasing taxes .
The following graph shows the market for loanable funds in this hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by shifting the appropriate curve or curves on the following graph of the loanable funds
market. If you decide that the policy produced no effect, leave the graph unchanged.
The following graph shows the goods and services market for the same hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by
shifting the appropriate curve or curves (aggregate demand, AD; aggregate supply, AS)
on the following graph of the goods and services market. If you decide that the policy
produced no effect, leave the graph unchanged. Fill in the first column of the table to summarize the short-run effects of a restrictive fiscal policy according to the new classical view. Then fill in the second column to
summarize the short-run effects of a restrictive fiscal policy according to the Keynesian
view. (Note: Assume that there are no crowding-out or crowding-in effects.) Problem 4 While there are intense debates among macroeconomists regarding the effectiveness of expansionary fiscal policy during a severe recession, both the Keynesian and non-
Keynesian economists agree that fiscal policy is subject to some limitations as a
stabilization tool. Which of the following issues do most macroeconomists widely agree upon? Check all that apply. Discretionary fiscal policy can be counterproductive because of policy lags. A. The use of the federal budget as an automatic stabilizer can help smooth business cycle fluctuations. B. Discretionary fiscal policy is less effective than is implied by the early Keynesian view. C. Problem 5 Consider a fictional economy that is operating at its long-run equilibrium. The following graph shows  the aggregate demand curve (AD) and short-run aggregate supply curve
(SRAS) for the economy. The long-run aggregate supply curve (LRAS) is represented by a
vertical line at $6 trillion. The economy is initially producing at potential output.
Suppose  that fiscal authorities decide to decrease marginal tax rates. Assume that this
change in marginal tax rates is perceived as a long-term change.
Shift the appropriate curves to illustrate the supply-side view of the fiscal policy effect on
output and the price level. True or False: Supply-side economics is a long-run, growth-oriented strategy. True A. False B. Problem 6 How does the new classical theory of fiscal policy differ from the crowding-out model? Anticipation of higher future interest rates will reduce private spending when government expenditures are financed by debt , whereas the crowding-out effect
posits that this result occurs through higher interest rates.
A. Anticipation of higher future taxes will reduce private spending when government expenditures are financed by debt, whereas the crowding-out
effect posits that this result occurs through higher interest rates.
B. Anticipation of lower future taxes will reduce private spending when government expenditures are financed by debt whereas the crowding-out effect posits that
this result occurs through higher interest rates.
C. Anticipation of higher future taxes increases private spending when government expenditures are financed by debt, whereas the crowding-out effect posits that
this result occurs through higher interest rates.
D. Problem 7 Suppose  that the government provides each taxpayer with a $1,000 tax rebate financed by issuing additional Treasury bonds.
Evaluate the following statement.
True or False: Keynesian economists believe that increases in government spending financed by borrowing will increase aggregate demand and help promote recovery.
Non-Keynesian economists argue that such policies will lead to higher future interest
rates and taxes, inefficient use of resources, and wasteful rent-seeking that will both
retard recovery and slow future economic growth.
True A. False B. Problem 8 If the government becomes more heavily involved in subsidizing some businesses  and sectors of the economy while levying higher taxes on others, the quantity of rent
seeking will increase due to which of the following?
Resources will be channeled toward wasteful rent-seeking and away from productive activities. A. Such policies lead to lower future interest rates and taxes and discourage wasteful rent-seeking, thereby facilitating future economic growth. B. Problem 9 Evaluate the following statement. True or False: Increases in government spending increase both disposable income and incentives to earn, producing an immediate positive impact on the financial position of
households.  In contrast, tax cuts often involve a lengthy process spread over several
years. True A. False B. Problem 10 The American Wind Energy Association argues for additional government support because wind-generated electricity creates more employment per kilowatt-hour than
the alternatives: 27% more jobs than coal and 66% more than natural gas.
Evaluate the following statement.
If the jobs created pay similar wages, the statement implies that the cost of generating energy with wind power is higher relative to the cost of coal and natural gas. True A. False B. Chapter 13
Money and the Banking System
Problem 1 True or False: The rate that is charged when banks, seeking additional reserves, borrow short-term funds from banks with excess reserves is known  as the federal funds rate. True A. False B. If the Fed wants to use open market operations to lower the federal funds rate, it should purchase U.S. securities and other financial assets on the open market. Problem 2 Indicate how each event in the following table would affect M1 and M2. Problem 3 Suppose  that the reserve requirement is 10% and the following table shows  the balance sheet of the People’s National Bank. The required reserves of People’s National Bank are $30,000 while the excess reserves are $45,000. Thus, if this bank wanted to extend a loan, the maximum amount for this
additional loan would be $45,000. Assuming the bank extends this loan, the total
amount of loans in the bank’s balance sheet would be $245,000. Suppose  the reserve
requirement increases to 20%.
The bank would only be in a position  to extend additional loans amounting to $15,000.
Problem 4 Consider the relative liquidity of the following assets: Select the assets in order of their liquidity, from most liquid to least liquid. Problem 5 The Federal Reserve sets the reserve requirement, which banks must meet through deposits at the Fed and cash held at the bank. What do these requirements
achieve? Check all that apply.
They help to facilitate transfers of funds between banks when a customer from one bank writes a check to a customer of another. A. They help to prevent bank runs by reassuring the public that banks will not make too many loans and run out of cash. B. They help to control the money supply. C. They mean that banks must have one dollar of deposits  for every dollar it loans. D. Problem 6 Assume that the following table portrays the balance sheet of First Southern bank. First Southern's bank reserves are equal to $250,000. If the Federal Reserve sets the required reserve ratio to 0.05, First Southern's  required reserves would be $47,5000.
Therefore, it would have $202,500 in excess reserves.
If First Southern  loaned all of its excess reserves, the maximum amount by which the
money supply could subsequently  increase is $4,050,000.
If the Fed were instead to set the required reserve ratio to 0.10, required reserves
would be $95,000, excess reserves would be $155,000, and the maximum increase in
the money supply would be $1,550,000.
The maximum potential increase in the money supply will be larger if the Fed chooses a
required reserve ratio of 0.05. Problem 7 Fill in the blanks in the following table to indicate differences between the U.S. Treasury and the Federal Reserve. Problem 8 If the central bank pursues an expansionary monetary policy, the growth rate of the money supply is likely to increase.
Which of the following changes would likely lead to a decrease in the M1 money supply
in the United States? Check all that apply. The use of credit cards for payments made both in person and in online purchases becomes widespread. A. A financial crisis reduces many people’s faith in money market mutual funds, causing them to switch to demand deposits. B. Many people decide to shift their money from savings accounts to interest- earning checking accounts. C. The U.S. dollar becomes more popular among developing countries, where it is increasingly used in daily transactions. D. Chapter 14
Modern Macroeconomics  and Monetary  Policy
Problem 1 The following diagram represents the money market in the United States, which is currently in equilibrium. Shift either the money supply curve or the money demand curve, or both, to illustrate on the graph the effects of this policy.
Suppose  the Federal Reserve announces  that it is lowering its target interest rate by 75
basis points, or 0.75%. It would achieve this by increasing the money supply.
The sequence of events that results in a new equilibrium interest rate, after the Fed
makes the change you selected, may be described as follows: Because there is more
money in the financial system, the quantity of interest-bearing financial assets such as
bonds demanded increases, which means that bond issuers can issue bonds at lower
interest rates and still
sell the bonds.  This process continues until the new equilibrium
interest rate is achieved. Problem 2 The following graph shows the short-run aggregate supply (SRAS) and aggregate demand (AD) curves for a fictional economy that is producing at point A (grey star
symbol), which corresponds  to the intersection of the AD1 and SRAS1 curves.
According to the graph, actual output  of this economy is $1 trillion higher than potential output, which means that the economy experiences an expansion.
Along SRAS1, wages would have been negotiated based on an expected price level
of 40. Since the actual price level at point A is 50, this means that real wages are lower
than
had been negotiated, which will decrease unemployment.
If the Fed does not intervene, these labor market conditions would cause nominal
wages to increase, shifting the SRAS1 curve to the left. Eventually, the economy would
reach a new long-run equilibrium.
On the previous graph, place the purple point (diamond symbol) at the new long-run equilibrium output and price level if the Fed intervenes. (Hint: Assume there are no
feedback effects on the curve that does not shift.)
Now, suppose the Fed chooses to intervene in an effort to move the economy more quickly back to its potential output.  To do so, the Fed will decrease the money supply,
which will increase the interest rate, thereby giving firms an incentive to decrease
investment, shifting the AD curve leftward. On the previous graph, place the green point (triangle symbol) at the new long-run equilibrium output and price level if the Fed does not intervene and successfully brings
the economy back to long-run equilibrium. (Hint: Assume there are no feedback effects
on the curve that does not shift.) Compare your answers to the previous few questions. If the Fed does not intervene, the economy will likely have relatively high inflation. On the other hand, if the Fed does
intervene, it risks causing relatively low inflation, especially if it changes the money
supply too much. Problem 3 Consider a hypothetical economy that produces at its long-run macroeconomic equilibrium at a price level of 100.
Suppose  that the central bank in this economy is expanding the money supply by 4%
each year. In order for the price level to be maintained at 100, real GDP must grow at
an annual rate of 4% if the velocity of money remains constant.
Suppose  the central bank enacts an unanticipated expansionary monetary policy. As a
result, the supply of loanable funds increases, leading to a fall in short-term interest
rates.
The following graph shows the goods and services market of this economy at full employment. Assume that potential output  remains constant. Adjust the graph to show the long-run effect of an unanticipated expansionary monetary policy on the goods and services market by
dragging the aggregate demand (AD) curve, the short-run  aggregate supply (AS) curve,
or both. An expansionary monetary policy when the economy is at full employment leads to a temporary increase in real GDP and a permanent increase in the price level. True or False: Money growth is closely related to inflation. True A. False B. Problem 4 Suppose  the economy is currently in long-run, full-employment equilibrium. Assume that expected inflation is 0% in the short run.
An unanticipated increase in the money supply in the United States will increase real
output  in the short run.
A sustained increase in the money supply in the United States will not affect real output
in the long run. Problem 5 Suppose  the Fed shifts to a more expansionary monetary policy. As part of this policy, the Fed will generally purchase bonds  in the open market. In the following table, indicate how this action will influence each factor in the economy in the short run. Chapter 15
Macroeconomic  Policy, Economic Stability,  and the Federal Debt
Problem 1 Compared with instability prior to World War II, economic instability during the past sixty years decreased due to a more stabile monetary policy. Problem 2 The index of leading economic indicators is an index composed of economic variables that tend to turn down prior to the beginning of a recession and turn up prior to the
beginning of a business expansion.
Problem 3 Consider the following economic situation: The current inflation rate is 3%, and this rate was widely anticipated more than a year ago.
The actual rate of unemployment is equal to the natural rate of unemployment.
Problem 4 What are some of the practical problems that limit the effective use of discretionary monetary and fiscal policy as stabilization tools? Check all that apply. The recognition lag A. The adaptive lag B. The impact lag C. The administrative lag D. Problem 5 Can expansionary monetary policy stimulate a higher growth rate of real output in the long run? No, people adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will lead to inflation without permanently
increasing output and employment.
A. Yes, people never fully adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will increase inflation and increase output
and employment.
B. Problem 6 Economists disagree about how quickly the economy adjusts to an aggregate demand shock. In the view of some economists, people form expectations based on present
realities and change expectations gradually as their experience unfolds.  Such
expectations are said to be adaptive.
The following graph shows the aggregate demand curve (AD), the short-run aggregate
supply (SRAS), and the long-run aggregate supply curve (LRAS) for a hypothetical
economy that is initially in equilibrium,
operating at potential output  at point N.
Suppose  an unanticipated increase in investment spending causes the aggregate demand curve to shift to the right (from AD1 to AD2). According to adherents of the
adaptive-expectations theory, the unanticipated change in aggregate demand will cause
the economy to move in which direction? A. Directly from point N to point Z B. From point N to point K, before returning to point N C. From point N to point D, before returning to point N D. From point N to point D and, eventually, from point D to point Z Now suppose that the increase in investment spending was entirely anticipated by firms and workers. This means the public fully anticipates the rightward shift of the aggregate
demand curve (from AD1 to AD2). According to rational-expectations adherents, the
anticipated change in aggregate demand will cause the economy to move in which
direction?
A. From point N to point K, before returning to point N B. From point N to point D, before returning to point N C. Directly from point N to point Z D. From point N to point D and, eventually, from point D to point Z Problem 7 The following graph shows the short-run Phillips curve within the expectations framework.
On the graph, place the grey star point to illustrate the situation when people accurately
anticipate the inflation rate. When people accurately anticipate the inflation rate, the natural rate of unemployment is 5%. On the previous graph, place the black cross point to illustrate the situation when people overestimate inflation by 3%. When people underestimate inflation, the resulting unemployment  rate is below the natural rate.
True or False: The modern view of the Phillips curve indicates that to keep the
unemployment rate low, policymakers should rapidly increase inflation rates. A. True
B. False
Problem 8 Despite ongoing debates about the appropriateness of macroeconomic policies, many macroeconomists have reached a modern consensus  on several important issues. Which of the following statements regarding monetary policy are true according to the macroeconomic consensus  in the United States? Check all that apply. A. Monetary policy should focus on price stability. B. Congress, not the Federal Reserve, should be in charge of monetary policy. C. Expansionary monetary policies should  be used to keep unemployment  below its natural rate. Test 3 Study Guide Tuesday,  November  28, 2017 2:07 PM
background image Chapter 12
Fiscal Policy: Incentives and Secondary  Effects
Problem 1 The following graph shows the market for loanable funds in Abierto, a large open economy. The government of Abierto has just instituted  a tax cut, increasing the deficit.
On the graph, shift either the demand curve or the supply curve to illustrate the change
in fiscal policy. The increase in deficit causes the interest rate in Abierto to increase. As an open economy, this change in interest rate causes the net capital inflow to Abierto to
increase. This change in net capital inflow causes Abierto's currency to appreciate,
which in turn causes Abierto's net exports to decrease.
The change in net exports caused by the tax cut decreases the impact on aggregate
demand of the expansionary fiscal policy. Problem 2 Deborah lives in the fictional country of Lindelof, which raises government revenue by taxing everyone the same amount. The government of Lindelof has just implemented a
tax cut that reduces annual taxes by $1,000 per person. However, government spending
has not changed, nor is it likely change in the future.
The tax cut has raised Deborah's income by $1,000. If Deborah acts according to the
prediction of new classical economics (and doesn't plan to leave Lindelof), her
consumption  is likely to increase by $0.
Suppose  that instead of cutting taxes while keeping its spending the same, the
government did the opposite: it increased its spending by $1,000 per person while
keeping taxes the same. If everyone in Lindelof acted like Deborah, the likely increase in
aggregate demand would be $0 per person. Problem 3 Suppose  the government of a hypothetical economy decides to pursue a restrictive fiscal policy by permanently increasing taxes .
The following graph shows the market for loanable funds in this hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by shifting the appropriate curve or curves on the following graph of the loanable funds
market. If you decide that the policy produced no effect, leave the graph unchanged.
The following graph shows the goods and services market for the same hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by
shifting the appropriate curve or curves (aggregate demand, AD; aggregate supply, AS)
on the following graph of the goods and services market. If you decide that the policy
produced no effect, leave the graph unchanged. Fill in the first column of the table to summarize the short-run effects of a restrictive fiscal policy according to the new classical view. Then fill in the second column to
summarize the short-run effects of a restrictive fiscal policy according to the Keynesian
view. (Note: Assume that there are no crowding-out or crowding-in effects.) Problem 4 While there are intense debates among macroeconomists regarding the effectiveness of expansionary fiscal policy during a severe recession, both the Keynesian and non-
Keynesian economists agree that fiscal policy is subject to some limitations as a
stabilization tool. Which of the following issues do most macroeconomists widely agree upon? Check all that apply. Discretionary fiscal policy can be counterproductive because of policy lags. A. The use of the federal budget as an automatic stabilizer can help smooth business cycle fluctuations. B. Discretionary fiscal policy is less effective than is implied by the early Keynesian view. C. Problem 5 Consider a fictional economy that is operating at its long-run equilibrium. The following graph shows  the aggregate demand curve (AD) and short-run aggregate supply curve
(SRAS) for the economy. The long-run aggregate supply curve (LRAS) is represented by a
vertical line at $6 trillion. The economy is initially producing at potential output.
Suppose  that fiscal authorities decide to decrease marginal tax rates. Assume that this
change in marginal tax rates is perceived as a long-term change.
Shift the appropriate curves to illustrate the supply-side view of the fiscal policy effect on
output and the price level. True or False: Supply-side economics is a long-run, growth-oriented strategy. True A. False B. Problem 6 How does the new classical theory of fiscal policy differ from the crowding-out model? Anticipation of higher future interest rates will reduce private spending when government expenditures are financed by debt , whereas the crowding-out effect
posits that this result occurs through higher interest rates.
A. Anticipation of higher future taxes will reduce private spending when government expenditures are financed by debt, whereas the crowding-out
effect posits that this result occurs through higher interest rates.
B. Anticipation of lower future taxes will reduce private spending when government expenditures are financed by debt whereas the crowding-out effect posits that
this result occurs through higher interest rates.
C. Anticipation of higher future taxes increases private spending when government expenditures are financed by debt, whereas the crowding-out effect posits that
this result occurs through higher interest rates.
D. Problem 7 Suppose  that the government provides each taxpayer with a $1,000 tax rebate financed by issuing additional Treasury bonds.
Evaluate the following statement.
True or False: Keynesian economists believe that increases in government spending financed by borrowing will increase aggregate demand and help promote recovery.
Non-Keynesian economists argue that such policies will lead to higher future interest
rates and taxes, inefficient use of resources, and wasteful rent-seeking that will both
retard recovery and slow future economic growth.
True A. False B. Problem 8 If the government becomes more heavily involved in subsidizing some businesses  and sectors of the economy while levying higher taxes on others, the quantity of rent
seeking will increase due to which of the following?
Resources will be channeled toward wasteful rent-seeking and away from productive activities. A. Such policies lead to lower future interest rates and taxes and discourage wasteful rent-seeking, thereby facilitating future economic growth. B. Problem 9 Evaluate the following statement. True or False: Increases in government spending increase both disposable income and incentives to earn, producing an immediate positive impact on the financial position of
households.  In contrast, tax cuts often involve a lengthy process spread over several
years. True A. False B. Problem 10 The American Wind Energy Association argues for additional government support because wind-generated electricity creates more employment per kilowatt-hour than
the alternatives: 27% more jobs than coal and 66% more than natural gas.
Evaluate the following statement.
If the jobs created pay similar wages, the statement implies that the cost of generating energy with wind power is higher relative to the cost of coal and natural gas. True A. False B. Chapter 13
Money and the Banking System
Problem 1 True or False: The rate that is charged when banks, seeking additional reserves, borrow short-term funds from banks with excess reserves is known  as the federal funds rate. True A. False B. If the Fed wants to use open market operations to lower the federal funds rate, it should purchase U.S. securities and other financial assets on the open market. Problem 2 Indicate how each event in the following table would affect M1 and M2. Problem 3 Suppose  that the reserve requirement is 10% and the following table shows  the balance sheet of the People’s National Bank. The required reserves of People’s National Bank are $30,000 while the excess reserves are $45,000. Thus, if this bank wanted to extend a loan, the maximum amount for this
additional loan would be $45,000. Assuming the bank extends this loan, the total
amount of loans in the bank’s balance sheet would be $245,000. Suppose  the reserve
requirement increases to 20%.
The bank would only be in a position  to extend additional loans amounting to $15,000.
Problem 4 Consider the relative liquidity of the following assets: Select the assets in order of their liquidity, from most liquid to least liquid. Problem 5 The Federal Reserve sets the reserve requirement, which banks must meet through deposits at the Fed and cash held at the bank. What do these requirements
achieve? Check all that apply.
They help to facilitate transfers of funds between banks when a customer from one bank writes a check to a customer of another. A. They help to prevent bank runs by reassuring the public that banks will not make too many loans and run out of cash. B. They help to control the money supply. C. They mean that banks must have one dollar of deposits  for every dollar it loans. D. Problem 6 Assume that the following table portrays the balance sheet of First Southern bank. First Southern's bank reserves are equal to $250,000. If the Federal Reserve sets the required reserve ratio to 0.05, First Southern's  required reserves would be $47,5000.
Therefore, it would have $202,500 in excess reserves.
If First Southern  loaned all of its excess reserves, the maximum amount by which the
money supply could subsequently  increase is $4,050,000.
If the Fed were instead to set the required reserve ratio to 0.10, required reserves
would be $95,000, excess reserves would be $155,000, and the maximum increase in
the money supply would be $1,550,000.
The maximum potential increase in the money supply will be larger if the Fed chooses a
required reserve ratio of 0.05. Problem 7 Fill in the blanks in the following table to indicate differences between the U.S. Treasury and the Federal Reserve. Problem 8 If the central bank pursues an expansionary monetary policy, the growth rate of the money supply is likely to increase.
Which of the following changes would likely lead to a decrease in the M1 money supply
in the United States? Check all that apply. The use of credit cards for payments made both in person and in online purchases becomes widespread. A. A financial crisis reduces many people’s faith in money market mutual funds, causing them to switch to demand deposits. B. Many people decide to shift their money from savings accounts to interest- earning checking accounts. C. The U.S. dollar becomes more popular among developing countries, where it is increasingly used in daily transactions. D. Chapter 14
Modern Macroeconomics  and Monetary  Policy
Problem 1 The following diagram represents the money market in the United States, which is currently in equilibrium. Shift either the money supply curve or the money demand curve, or both, to illustrate on the graph the effects of this policy.
Suppose  the Federal Reserve announces  that it is lowering its target interest rate by 75
basis points, or 0.75%. It would achieve this by increasing the money supply.
The sequence of events that results in a new equilibrium interest rate, after the Fed
makes the change you selected, may be described as follows: Because there is more
money in the financial system, the quantity of interest-bearing financial assets such as
bonds demanded increases, which means that bond issuers can issue bonds at lower
interest rates and still
sell the bonds.  This process continues until the new equilibrium
interest rate is achieved. Problem 2 The following graph shows the short-run aggregate supply (SRAS) and aggregate demand (AD) curves for a fictional economy that is producing at point A (grey star
symbol), which corresponds  to the intersection of the AD1 and SRAS1 curves.
According to the graph, actual output  of this economy is $1 trillion higher than potential output, which means that the economy experiences an expansion.
Along SRAS1, wages would have been negotiated based on an expected price level
of 40. Since the actual price level at point A is 50, this means that real wages are lower
than
had been negotiated, which will decrease unemployment.
If the Fed does not intervene, these labor market conditions would cause nominal
wages to increase, shifting the SRAS1 curve to the left. Eventually, the economy would
reach a new long-run equilibrium.
On the previous graph, place the purple point (diamond symbol) at the new long-run equilibrium output and price level if the Fed intervenes. (Hint: Assume there are no
feedback effects on the curve that does not shift.)
Now, suppose the Fed chooses to intervene in an effort to move the economy more quickly back to its potential output.  To do so, the Fed will decrease the money supply,
which will increase the interest rate, thereby giving firms an incentive to decrease
investment, shifting the AD curve leftward. On the previous graph, place the green point (triangle symbol) at the new long-run equilibrium output and price level if the Fed does not intervene and successfully brings
the economy back to long-run equilibrium. (Hint: Assume there are no feedback effects
on the curve that does not shift.) Compare your answers to the previous few questions. If the Fed does not intervene, the economy will likely have relatively high inflation. On the other hand, if the Fed does
intervene, it risks causing relatively low inflation, especially if it changes the money
supply too much. Problem 3 Consider a hypothetical economy that produces at its long-run macroeconomic equilibrium at a price level of 100.
Suppose  that the central bank in this economy is expanding the money supply by 4%
each year. In order for the price level to be maintained at 100, real GDP must grow at
an annual rate of 4% if the velocity of money remains constant.
Suppose  the central bank enacts an unanticipated expansionary monetary policy. As a
result, the supply of loanable funds increases, leading to a fall in short-term interest
rates.
The following graph shows the goods and services market of this economy at full employment. Assume that potential output  remains constant. Adjust the graph to show the long-run effect of an unanticipated expansionary monetary policy on the goods and services market by
dragging the aggregate demand (AD) curve, the short-run  aggregate supply (AS) curve,
or both. An expansionary monetary policy when the economy is at full employment leads to a temporary increase in real GDP and a permanent increase in the price level. True or False: Money growth is closely related to inflation. True A. False B. Problem 4 Suppose  the economy is currently in long-run, full-employment equilibrium. Assume that expected inflation is 0% in the short run.
An unanticipated increase in the money supply in the United States will increase real
output  in the short run.
A sustained increase in the money supply in the United States will not affect real output
in the long run. Problem 5 Suppose  the Fed shifts to a more expansionary monetary policy. As part of this policy, the Fed will generally purchase bonds  in the open market. In the following table, indicate how this action will influence each factor in the economy in the short run. Chapter 15
Macroeconomic  Policy, Economic Stability,  and the Federal Debt
Problem 1 Compared with instability prior to World War II, economic instability during the past sixty years decreased due to a more stabile monetary policy. Problem 2 The index of leading economic indicators is an index composed of economic variables that tend to turn down prior to the beginning of a recession and turn up prior to the
beginning of a business expansion.
Problem 3 Consider the following economic situation: The current inflation rate is 3%, and this rate was widely anticipated more than a year ago.
The actual rate of unemployment is equal to the natural rate of unemployment.
Problem 4 What are some of the practical problems that limit the effective use of discretionary monetary and fiscal policy as stabilization tools? Check all that apply. The recognition lag A. The adaptive lag B. The impact lag C. The administrative lag D. Problem 5 Can expansionary monetary policy stimulate a higher growth rate of real output in the long run? No, people adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will lead to inflation without permanently
increasing output and employment.
A. Yes, people never fully adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will increase inflation and increase output
and employment.
B. Problem 6 Economists disagree about how quickly the economy adjusts to an aggregate demand shock. In the view of some economists, people form expectations based on present
realities and change expectations gradually as their experience unfolds.  Such
expectations are said to be adaptive.
The following graph shows the aggregate demand curve (AD), the short-run aggregate
supply (SRAS), and the long-run aggregate supply curve (LRAS) for a hypothetical
economy that is initially in equilibrium,
operating at potential output  at point N.
Suppose  an unanticipated increase in investment spending causes the aggregate demand curve to shift to the right (from AD1 to AD2). According to adherents of the
adaptive-expectations theory, the unanticipated change in aggregate demand will cause
the economy to move in which direction? A. Directly from point N to point Z B. From point N to point K, before returning to point N C. From point N to point D, before returning to point N D. From point N to point D and, eventually, from point D to point Z Now suppose that the increase in investment spending was entirely anticipated by firms and workers. This means the public fully anticipates the rightward shift of the aggregate
demand curve (from AD1 to AD2). According to rational-expectations adherents, the
anticipated change in aggregate demand will cause the economy to move in which
direction?
A. From point N to point K, before returning to point N B. From point N to point D, before returning to point N C. Directly from point N to point Z D. From point N to point D and, eventually, from point D to point Z Problem 7 The following graph shows the short-run Phillips curve within the expectations framework.
On the graph, place the grey star point to illustrate the situation when people accurately
anticipate the inflation rate. When people accurately anticipate the inflation rate, the natural rate of unemployment is 5%. On the previous graph, place the black cross point to illustrate the situation when people overestimate inflation by 3%. When people underestimate inflation, the resulting unemployment  rate is below the natural rate.
True or False: The modern view of the Phillips curve indicates that to keep the
unemployment rate low, policymakers should rapidly increase inflation rates. A. True
B. False
Problem 8 Despite ongoing debates about the appropriateness of macroeconomic policies, many macroeconomists have reached a modern consensus  on several important issues. Which of the following statements regarding monetary policy are true according to the macroeconomic consensus  in the United States? Check all that apply. A. Monetary policy should focus on price stability. B. Congress, not the Federal Reserve, should be in charge of monetary policy. C. Expansionary monetary policies should  be used to keep unemployment  below its natural rate. Test 3 Study Guide Tuesday,  November  28, 2017 2:07 PM
background image Chapter 12
Fiscal Policy: Incentives and Secondary  Effects
Problem 1 The following graph shows the market for loanable funds in Abierto, a large open economy. The government of Abierto has just instituted  a tax cut, increasing the deficit.
On the graph, shift either the demand curve or the supply curve to illustrate the change
in fiscal policy. The increase in deficit causes the interest rate in Abierto to increase. As an open economy, this change in interest rate causes the net capital inflow to Abierto to
increase. This change in net capital inflow causes Abierto's currency to appreciate,
which in turn causes Abierto's net exports to decrease.
The change in net exports caused by the tax cut decreases the impact on aggregate
demand of the expansionary fiscal policy. Problem 2 Deborah lives in the fictional country of Lindelof, which raises government revenue by taxing everyone the same amount. The government of Lindelof has just implemented a
tax cut that reduces annual taxes by $1,000 per person. However, government spending
has not changed, nor is it likely change in the future.
The tax cut has raised Deborah's income by $1,000. If Deborah acts according to the
prediction of new classical economics (and doesn't plan to leave Lindelof), her
consumption  is likely to increase by $0.
Suppose  that instead of cutting taxes while keeping its spending the same, the
government did the opposite: it increased its spending by $1,000 per person while
keeping taxes the same. If everyone in Lindelof acted like Deborah, the likely increase in
aggregate demand would be $0 per person. Problem 3 Suppose  the government of a hypothetical economy decides to pursue a restrictive fiscal policy by permanently increasing taxes .
The following graph shows the market for loanable funds in this hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by shifting the appropriate curve or curves on the following graph of the loanable funds
market. If you decide that the policy produced no effect, leave the graph unchanged.
The following graph shows the goods and services market for the same hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by
shifting the appropriate curve or curves (aggregate demand, AD; aggregate supply, AS)
on the following graph of the goods and services market. If you decide that the policy
produced no effect, leave the graph unchanged. Fill in the first column of the table to summarize the short-run effects of a restrictive fiscal policy according to the new classical view. Then fill in the second column to
summarize the short-run effects of a restrictive fiscal policy according to the Keynesian
view. (Note: Assume that there are no crowding-out or crowding-in effects.) Problem 4 While there are intense debates among macroeconomists regarding the effectiveness of expansionary fiscal policy during a severe recession, both the Keynesian and non-
Keynesian economists agree that fiscal policy is subject to some limitations as a
stabilization tool. Which of the following issues do most macroeconomists widely agree upon? Check all that apply. Discretionary fiscal policy can be counterproductive because of policy lags. A. The use of the federal budget as an automatic stabilizer can help smooth business cycle fluctuations. B. Discretionary fiscal policy is less effective than is implied by the early Keynesian view. C. Problem 5 Consider a fictional economy that is operating at its long-run equilibrium. The following graph shows  the aggregate demand curve (AD) and short-run aggregate supply curve
(SRAS) for the economy. The long-run aggregate supply curve (LRAS) is represented by a
vertical line at $6 trillion. The economy is initially producing at potential output.
Suppose  that fiscal authorities decide to decrease marginal tax rates. Assume that this
change in marginal tax rates is perceived as a long-term change.
Shift the appropriate curves to illustrate the supply-side view of the fiscal policy effect on
output and the price level. True or False: Supply-side economics is a long-run, growth-oriented strategy. True A. False B. Problem 6 How does the new classical theory of fiscal policy differ from the crowding-out model? Anticipation of higher future interest rates will reduce private spending when government expenditures are financed by debt , whereas the crowding-out effect
posits that this result occurs through higher interest rates.
A. Anticipation of higher future taxes will reduce private spending when government expenditures are financed by debt, whereas the crowding-out
effect posits that this result occurs through higher interest rates.
B. Anticipation of lower future taxes will reduce private spending when government expenditures are financed by debt whereas the crowding-out effect posits that
this result occurs through higher interest rates.
C. Anticipation of higher future taxes increases private spending when government expenditures are financed by debt, whereas the crowding-out effect posits that
this result occurs through higher interest rates.
D. Problem 7 Suppose  that the government provides each taxpayer with a $1,000 tax rebate financed by issuing additional Treasury bonds.
Evaluate the following statement.
True or False: Keynesian economists believe that increases in government spending financed by borrowing will increase aggregate demand and help promote recovery.
Non-Keynesian economists argue that such policies will lead to higher future interest
rates and taxes, inefficient use of resources, and wasteful rent-seeking that will both
retard recovery and slow future economic growth.
True A. False B. Problem 8 If the government becomes more heavily involved in subsidizing some businesses  and sectors of the economy while levying higher taxes on others, the quantity of rent
seeking will increase due to which of the following?
Resources will be channeled toward wasteful rent-seeking and away from productive activities. A. Such policies lead to lower future interest rates and taxes and discourage wasteful rent-seeking, thereby facilitating future economic growth. B. Problem 9 Evaluate the following statement. True or False: Increases in government spending increase both disposable income and incentives to earn, producing an immediate positive impact on the financial position of
households.  In contrast, tax cuts often involve a lengthy process spread over several
years. True A. False B. Problem 10 The American Wind Energy Association argues for additional government support because wind-generated electricity creates more employment per kilowatt-hour than
the alternatives: 27% more jobs than coal and 66% more than natural gas.
Evaluate the following statement.
If the jobs created pay similar wages, the statement implies that the cost of generating energy with wind power is higher relative to the cost of coal and natural gas. True A. False B. Chapter 13
Money and the Banking System
Problem 1 True or False: The rate that is charged when banks, seeking additional reserves, borrow short-term funds from banks with excess reserves is known  as the federal funds rate. True A. False B. If the Fed wants to use open market operations to lower the federal funds rate, it should purchase U.S. securities and other financial assets on the open market. Problem 2 Indicate how each event in the following table would affect M1 and M2. Problem 3 Suppose  that the reserve requirement is 10% and the following table shows  the balance sheet of the People’s National Bank. The required reserves of People’s National Bank are $30,000 while the excess reserves are $45,000. Thus, if this bank wanted to extend a loan, the maximum amount for this
additional loan would be $45,000. Assuming the bank extends this loan, the total
amount of loans in the bank’s balance sheet would be $245,000. Suppose  the reserve
requirement increases to 20%.
The bank would only be in a position  to extend additional loans amounting to $15,000.
Problem 4 Consider the relative liquidity of the following assets: Select the assets in order of their liquidity, from most liquid to least liquid. Problem 5 The Federal Reserve sets the reserve requirement, which banks must meet through deposits at the Fed and cash held at the bank. What do these requirements
achieve? Check all that apply.
They help to facilitate transfers of funds between banks when a customer from one bank writes a check to a customer of another. A. They help to prevent bank runs by reassuring the public that banks will not make too many loans and run out of cash. B. They help to control the money supply. C. They mean that banks must have one dollar of deposits  for every dollar it loans. D. Problem 6 Assume that the following table portrays the balance sheet of First Southern bank. First Southern's bank reserves are equal to $250,000. If the Federal Reserve sets the required reserve ratio to 0.05, First Southern's  required reserves would be $47,5000.
Therefore, it would have $202,500 in excess reserves.
If First Southern  loaned all of its excess reserves, the maximum amount by which the
money supply could subsequently  increase is $4,050,000.
If the Fed were instead to set the required reserve ratio to 0.10, required reserves
would be $95,000, excess reserves would be $155,000, and the maximum increase in
the money supply would be $1,550,000.
The maximum potential increase in the money supply will be larger if the Fed chooses a
required reserve ratio of 0.05. Problem 7 Fill in the blanks in the following table to indicate differences between the U.S. Treasury and the Federal Reserve. Problem 8 If the central bank pursues an expansionary monetary policy, the growth rate of the money supply is likely to increase.
Which of the following changes would likely lead to a decrease in the M1 money supply
in the United States? Check all that apply. The use of credit cards for payments made both in person and in online purchases becomes widespread. A. A financial crisis reduces many people’s faith in money market mutual funds, causing them to switch to demand deposits. B. Many people decide to shift their money from savings accounts to interest- earning checking accounts. C. The U.S. dollar becomes more popular among developing countries, where it is increasingly used in daily transactions. D. Chapter 14
Modern Macroeconomics  and Monetary  Policy
Problem 1 The following diagram represents the money market in the United States, which is currently in equilibrium. Shift either the money supply curve or the money demand curve, or both, to illustrate on the graph the effects of this policy.
Suppose  the Federal Reserve announces  that it is lowering its target interest rate by 75
basis points, or 0.75%. It would achieve this by increasing the money supply.
The sequence of events that results in a new equilibrium interest rate, after the Fed
makes the change you selected, may be described as follows: Because there is more
money in the financial system, the quantity of interest-bearing financial assets such as
bonds demanded increases, which means that bond issuers can issue bonds at lower
interest rates and still
sell the bonds.  This process continues until the new equilibrium
interest rate is achieved. Problem 2 The following graph shows the short-run aggregate supply (SRAS) and aggregate demand (AD) curves for a fictional economy that is producing at point A (grey star
symbol), which corresponds  to the intersection of the AD1 and SRAS1 curves.
According to the graph, actual output  of this economy is $1 trillion higher than potential output, which means that the economy experiences an expansion.
Along SRAS1, wages would have been negotiated based on an expected price level
of 40. Since the actual price level at point A is 50, this means that real wages are lower
than
had been negotiated, which will decrease unemployment.
If the Fed does not intervene, these labor market conditions would cause nominal
wages to increase, shifting the SRAS1 curve to the left. Eventually, the economy would
reach a new long-run equilibrium.
On the previous graph, place the purple point (diamond symbol) at the new long-run equilibrium output and price level if the Fed intervenes. (Hint: Assume there are no
feedback effects on the curve that does not shift.)
Now, suppose the Fed chooses to intervene in an effort to move the economy more quickly back to its potential output.  To do so, the Fed will decrease the money supply,
which will increase the interest rate, thereby giving firms an incentive to decrease
investment, shifting the AD curve leftward. On the previous graph, place the green point (triangle symbol) at the new long-run equilibrium output and price level if the Fed does not intervene and successfully brings
the economy back to long-run equilibrium. (Hint: Assume there are no feedback effects
on the curve that does not shift.) Compare your answers to the previous few questions. If the Fed does not intervene, the economy will likely have relatively high inflation. On the other hand, if the Fed does
intervene, it risks causing relatively low inflation, especially if it changes the money
supply too much. Problem 3 Consider a hypothetical economy that produces at its long-run macroeconomic equilibrium at a price level of 100.
Suppose  that the central bank in this economy is expanding the money supply by 4%
each year. In order for the price level to be maintained at 100, real GDP must grow at
an annual rate of 4% if the velocity of money remains constant.
Suppose  the central bank enacts an unanticipated expansionary monetary policy. As a
result, the supply of loanable funds increases, leading to a fall in short-term interest
rates.
The following graph shows the goods and services market of this economy at full employment. Assume that potential output  remains constant. Adjust the graph to show the long-run effect of an unanticipated expansionary monetary policy on the goods and services market by
dragging the aggregate demand (AD) curve, the short-run  aggregate supply (AS) curve,
or both. An expansionary monetary policy when the economy is at full employment leads to a temporary increase in real GDP and a permanent increase in the price level. True or False: Money growth is closely related to inflation. True A. False B. Problem 4 Suppose  the economy is currently in long-run, full-employment equilibrium. Assume that expected inflation is 0% in the short run.
An unanticipated increase in the money supply in the United States will increase real
output  in the short run.
A sustained increase in the money supply in the United States will not affect real output
in the long run. Problem 5 Suppose  the Fed shifts to a more expansionary monetary policy. As part of this policy, the Fed will generally purchase bonds  in the open market. In the following table, indicate how this action will influence each factor in the economy in the short run. Chapter 15
Macroeconomic  Policy, Economic Stability,  and the Federal Debt
Problem 1 Compared with instability prior to World War II, economic instability during the past sixty years decreased due to a more stabile monetary policy. Problem 2 The index of leading economic indicators is an index composed of economic variables that tend to turn down prior to the beginning of a recession and turn up prior to the
beginning of a business expansion.
Problem 3 Consider the following economic situation: The current inflation rate is 3%, and this rate was widely anticipated more than a year ago.
The actual rate of unemployment is equal to the natural rate of unemployment.
Problem 4 What are some of the practical problems that limit the effective use of discretionary monetary and fiscal policy as stabilization tools? Check all that apply. The recognition lag A. The adaptive lag B. The impact lag C. The administrative lag D. Problem 5 Can expansionary monetary policy stimulate a higher growth rate of real output in the long run? No, people adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will lead to inflation without permanently
increasing output and employment.
A. Yes, people never fully adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will increase inflation and increase output
and employment.
B. Problem 6 Economists disagree about how quickly the economy adjusts to an aggregate demand shock. In the view of some economists, people form expectations based on present
realities and change expectations gradually as their experience unfolds.  Such
expectations are said to be adaptive.
The following graph shows the aggregate demand curve (AD), the short-run aggregate
supply (SRAS), and the long-run aggregate supply curve (LRAS) for a hypothetical
economy that is initially in equilibrium,
operating at potential output  at point N.
Suppose  an unanticipated increase in investment spending causes the aggregate demand curve to shift to the right (from AD1 to AD2). According to adherents of the
adaptive-expectations theory, the unanticipated change in aggregate demand will cause
the economy to move in which direction? A. Directly from point N to point Z B. From point N to point K, before returning to point N C. From point N to point D, before returning to point N D. From point N to point D and, eventually, from point D to point Z Now suppose that the increase in investment spending was entirely anticipated by firms and workers. This means the public fully anticipates the rightward shift of the aggregate
demand curve (from AD1 to AD2). According to rational-expectations adherents, the
anticipated change in aggregate demand will cause the economy to move in which
direction?
A. From point N to point K, before returning to point N B. From point N to point D, before returning to point N C. Directly from point N to point Z D. From point N to point D and, eventually, from point D to point Z Problem 7 The following graph shows the short-run Phillips curve within the expectations framework.
On the graph, place the grey star point to illustrate the situation when people accurately
anticipate the inflation rate. When people accurately anticipate the inflation rate, the natural rate of unemployment is 5%. On the previous graph, place the black cross point to illustrate the situation when people overestimate inflation by 3%. When people underestimate inflation, the resulting unemployment  rate is below the natural rate.
True or False: The modern view of the Phillips curve indicates that to keep the
unemployment rate low, policymakers should rapidly increase inflation rates. A. True
B. False
Problem 8 Despite ongoing debates about the appropriateness of macroeconomic policies, many macroeconomists have reached a modern consensus  on several important issues. Which of the following statements regarding monetary policy are true according to the macroeconomic consensus  in the United States? Check all that apply. A. Monetary policy should focus on price stability. B. Congress, not the Federal Reserve, should be in charge of monetary policy. C. Expansionary monetary policies should  be used to keep unemployment  below its natural rate. Test 3 Study Guide Tuesday,  November  28, 2017 2:07 PM
background image Chapter 12
Fiscal Policy: Incentives and Secondary  Effects
Problem 1 The following graph shows the market for loanable funds in Abierto, a large open economy. The government of Abierto has just instituted  a tax cut, increasing the deficit.
On the graph, shift either the demand curve or the supply curve to illustrate the change
in fiscal policy. The increase in deficit causes the interest rate in Abierto to increase. As an open economy, this change in interest rate causes the net capital inflow to Abierto to
increase. This change in net capital inflow causes Abierto's currency to appreciate,
which in turn causes Abierto's net exports to decrease.
The change in net exports caused by the tax cut decreases the impact on aggregate
demand of the expansionary fiscal policy. Problem 2 Deborah lives in the fictional country of Lindelof, which raises government revenue by taxing everyone the same amount. The government of Lindelof has just implemented a
tax cut that reduces annual taxes by $1,000 per person. However, government spending
has not changed, nor is it likely change in the future.
The tax cut has raised Deborah's income by $1,000. If Deborah acts according to the
prediction of new classical economics (and doesn't plan to leave Lindelof), her
consumption  is likely to increase by $0.
Suppose  that instead of cutting taxes while keeping its spending the same, the
government did the opposite: it increased its spending by $1,000 per person while
keeping taxes the same. If everyone in Lindelof acted like Deborah, the likely increase in
aggregate demand would be $0 per person. Problem 3 Suppose  the government of a hypothetical economy decides to pursue a restrictive fiscal policy by permanently increasing taxes .
The following graph shows the market for loanable funds in this hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by shifting the appropriate curve or curves on the following graph of the loanable funds
market. If you decide that the policy produced no effect, leave the graph unchanged.
The following graph shows the goods and services market for the same hypothetical economy.
Show the effect of the restrictive fiscal policy according to the new classical view by
shifting the appropriate curve or curves (aggregate demand, AD; aggregate supply, AS)
on the following graph of the goods and services market. If you decide that the policy
produced no effect, leave the graph unchanged. Fill in the first column of the table to summarize the short-run effects of a restrictive fiscal policy according to the new classical view. Then fill in the second column to
summarize the short-run effects of a restrictive fiscal policy according to the Keynesian
view. (Note: Assume that there are no crowding-out or crowding-in effects.) Problem 4 While there are intense debates among macroeconomists regarding the effectiveness of expansionary fiscal policy during a severe recession, both the Keynesian and non-
Keynesian economists agree that fiscal policy is subject to some limitations as a
stabilization tool. Which of the following issues do most macroeconomists widely agree upon? Check all that apply. Discretionary fiscal policy can be counterproductive because of policy lags. A. The use of the federal budget as an automatic stabilizer can help smooth business cycle fluctuations. B. Discretionary fiscal policy is less effective than is implied by the early Keynesian view. C. Problem 5 Consider a fictional economy that is operating at its long-run equilibrium. The following graph shows  the aggregate demand curve (AD) and short-run aggregate supply curve
(SRAS) for the economy. The long-run aggregate supply curve (LRAS) is represented by a
vertical line at $6 trillion. The economy is initially producing at potential output.
Suppose  that fiscal authorities decide to decrease marginal tax rates. Assume that this
change in marginal tax rates is perceived as a long-term change.
Shift the appropriate curves to illustrate the supply-side view of the fiscal policy effect on
output and the price level. True or False: Supply-side economics is a long-run, growth-oriented strategy. True A. False B. Problem 6 How does the new classical theory of fiscal policy differ from the crowding-out model? Anticipation of higher future interest rates will reduce private spending when government expenditures are financed by debt , whereas the crowding-out effect
posits that this result occurs through higher interest rates.
A. Anticipation of higher future taxes will reduce private spending when government expenditures are financed by debt, whereas the crowding-out
effect posits that this result occurs through higher interest rates.
B. Anticipation of lower future taxes will reduce private spending when government expenditures are financed by debt whereas the crowding-out effect posits that
this result occurs through higher interest rates.
C. Anticipation of higher future taxes increases private spending when government expenditures are financed by debt, whereas the crowding-out effect posits that
this result occurs through higher interest rates.
D. Problem 7 Suppose  that the government provides each taxpayer with a $1,000 tax rebate financed by issuing additional Treasury bonds.
Evaluate the following statement.
True or False: Keynesian economists believe that increases in government spending financed by borrowing will increase aggregate demand and help promote recovery.
Non-Keynesian economists argue that such policies will lead to higher future interest
rates and taxes, inefficient use of resources, and wasteful rent-seeking that will both
retard recovery and slow future economic growth.
True A. False B. Problem 8 If the government becomes more heavily involved in subsidizing some businesses  and sectors of the economy while levying higher taxes on others, the quantity of rent
seeking will increase due to which of the following?
Resources will be channeled toward wasteful rent-seeking and away from productive activities. A. Such policies lead to lower future interest rates and taxes and discourage wasteful rent-seeking, thereby facilitating future economic growth. B. Problem 9 Evaluate the following statement. True or False: Increases in government spending increase both disposable income and incentives to earn, producing an immediate positive impact on the financial position of
households.  In contrast, tax cuts often involve a lengthy process spread over several
years. True A. False B. Problem 10 The American Wind Energy Association argues for additional government support because wind-generated electricity creates more employment per kilowatt-hour than
the alternatives: 27% more jobs than coal and 66% more than natural gas.
Evaluate the following statement.
If the jobs created pay similar wages, the statement implies that the cost of generating energy with wind power is higher relative to the cost of coal and natural gas. True A. False B. Chapter 13
Money and the Banking System
Problem 1 True or False: The rate that is charged when banks, seeking additional reserves, borrow short-term funds from banks with excess reserves is known  as the federal funds rate. True A. False B. If the Fed wants to use open market operations to lower the federal funds rate, it should purchase U.S. securities and other financial assets on the open market. Problem 2 Indicate how each event in the following table would affect M1 and M2. Problem 3 Suppose  that the reserve requirement is 10% and the following table shows  the balance sheet of the People’s National Bank. The required reserves of People’s National Bank are $30,000 while the excess reserves are $45,000. Thus, if this bank wanted to extend a loan, the maximum amount for this
additional loan would be $45,000. Assuming the bank extends this loan, the total
amount of loans in the bank’s balance sheet would be $245,000. Suppose  the reserve
requirement increases to 20%.
The bank would only be in a position  to extend additional loans amounting to $15,000.
Problem 4 Consider the relative liquidity of the following assets: Select the assets in order of their liquidity, from most liquid to least liquid. Problem 5 The Federal Reserve sets the reserve requirement, which banks must meet through deposits at the Fed and cash held at the bank. What do these requirements
achieve? Check all that apply.
They help to facilitate transfers of funds between banks when a customer from one bank writes a check to a customer of another. A. They help to prevent bank runs by reassuring the public that banks will not make too many loans and run out of cash. B. They help to control the money supply. C. They mean that banks must have one dollar of deposits  for every dollar it loans. D. Problem 6 Assume that the following table portrays the balance sheet of First Southern bank. First Southern's bank reserves are equal to $250,000. If the Federal Reserve sets the required reserve ratio to 0.05, First Southern's  required reserves would be $47,5000.
Therefore, it would have $202,500 in excess reserves.
If First Southern  loaned all of its excess reserves, the maximum amount by which the
money supply could subsequently  increase is $4,050,000.
If the Fed were instead to set the required reserve ratio to 0.10, required reserves
would be $95,000, excess reserves would be $155,000, and the maximum increase in
the money supply would be $1,550,000.
The maximum potential increase in the money supply will be larger if the Fed chooses a
required reserve ratio of 0.05. Problem 7 Fill in the blanks in the following table to indicate differences between the U.S. Treasury and the Federal Reserve. Problem 8 If the central bank pursues an expansionary monetary policy, the growth rate of the money supply is likely to increase.
Which of the following changes would likely lead to a decrease in the M1 money supply
in the United States? Check all that apply. The use of credit cards for payments made both in person and in online purchases becomes widespread. A. A financial crisis reduces many people’s faith in money market mutual funds, causing them to switch to demand deposits. B. Many people decide to shift their money from savings accounts to interest- earning checking accounts. C. The U.S. dollar becomes more popular among developing countries, where it is increasingly used in daily transactions. D. Chapter 14
Modern Macroeconomics  and Monetary  Policy
Problem 1 The following diagram represents the money market in the United States, which is currently in equilibrium. Shift either the money supply curve or the money demand curve, or both, to illustrate on the graph the effects of this policy.
Suppose  the Federal Reserve announces  that it is lowering its target interest rate by 75
basis points, or 0.75%. It would achieve this by increasing the money supply.
The sequence of events that results in a new equilibrium interest rate, after the Fed
makes the change you selected, may be described as follows: Because there is more
money in the financial system, the quantity of interest-bearing financial assets such as
bonds demanded increases, which means that bond issuers can issue bonds at lower
interest rates and still
sell the bonds.  This process continues until the new equilibrium
interest rate is achieved. Problem 2 The following graph shows the short-run aggregate supply (SRAS) and aggregate demand (AD) curves for a fictional economy that is producing at point A (grey star
symbol), which corresponds  to the intersection of the AD1 and SRAS1 curves.
According to the graph, actual output  of this economy is $1 trillion higher than potential output, which means that the economy experiences an expansion.
Along SRAS1, wages would have been negotiated based on an expected price level
of 40. Since the actual price level at point A is 50, this means that real wages are lower
than
had been negotiated, which will decrease unemployment.
If the Fed does not intervene, these labor market conditions would cause nominal
wages to increase, shifting the SRAS1 curve to the left. Eventually, the economy would
reach a new long-run equilibrium.
On the previous graph, place the purple point (diamond symbol) at the new long-run equilibrium output and price level if the Fed intervenes. (Hint: Assume there are no
feedback effects on the curve that does not shift.)
Now, suppose the Fed chooses to intervene in an effort to move the economy more quickly back to its potential output.  To do so, the Fed will decrease the money supply,
which will increase the interest rate, thereby giving firms an incentive to decrease
investment, shifting the AD curve leftward. On the previous graph, place the green point (triangle symbol) at the new long-run equilibrium output and price level if the Fed does not intervene and successfully brings
the economy back to long-run equilibrium. (Hint: Assume there are no feedback effects
on the curve that does not shift.) Compare your answers to the previous few questions. If the Fed does not intervene, the economy will likely have relatively high inflation. On the other hand, if the Fed does
intervene, it risks causing relatively low inflation, especially if it changes the money
supply too much. Problem 3 Consider a hypothetical economy that produces at its long-run macroeconomic equilibrium at a price level of 100.
Suppose  that the central bank in this economy is expanding the money supply by 4%
each year. In order for the price level to be maintained at 100, real GDP must grow at
an annual rate of 4% if the velocity of money remains constant.
Suppose  the central bank enacts an unanticipated expansionary monetary policy. As a
result, the supply of loanable funds increases, leading to a fall in short-term interest
rates.
The following graph shows the goods and services market of this economy at full employment. Assume that potential output  remains constant. Adjust the graph to show the long-run effect of an unanticipated expansionary monetary policy on the goods and services market by
dragging the aggregate demand (AD) curve, the short-run  aggregate supply (AS) curve,
or both. An expansionary monetary policy when the economy is at full employment leads to a temporary increase in real GDP and a permanent increase in the price level. True or False: Money growth is closely related to inflation. True A. False B. Problem 4 Suppose  the economy is currently in long-run, full-employment equilibrium. Assume that expected inflation is 0% in the short run.
An unanticipated increase in the money supply in the United States will increase real
output  in the short run.
A sustained increase in the money supply in the United States will not affect real output
in the long run. Problem 5 Suppose  the Fed shifts to a more expansionary monetary policy. As part of this policy, the Fed will generally purchase bonds  in the open market. In the following table, indicate how this action will influence each factor in the economy in the short run. Chapter 15
Macroeconomic  Policy, Economic Stability,  and the Federal Debt
Problem 1 Compared with instability prior to World War II, economic instability during the past sixty years decreased due to a more stabile monetary policy. Problem 2 The index of leading economic indicators is an index composed of economic variables that tend to turn down prior to the beginning of a recession and turn up prior to the
beginning of a business expansion.
Problem 3 Consider the following economic situation: The current inflation rate is 3%, and this rate was widely anticipated more than a year ago.
The actual rate of unemployment is equal to the natural rate of unemployment.
Problem 4 What are some of the practical problems that limit the effective use of discretionary monetary and fiscal policy as stabilization tools? Check all that apply. The recognition lag A. The adaptive lag B. The impact lag C. The administrative lag D. Problem 5 Can expansionary monetary policy stimulate a higher growth rate of real output in the long run? No, people adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will lead to inflation without permanently
increasing output and employment.
A. Yes, people never fully adjust their inflationary expectations to actual inflation, so that sustained expansionary policies will increase inflation and increase output
and employment.
B. Problem 6 Economists disagree about how quickly the economy adjusts to an aggregate demand shock. In the view of some economists, people form expectations based on present
realities and change expectations gradually as their experience unfolds.  Such
expectations are said to be adaptive.
The following graph shows the aggregate demand curve (AD), the short-run aggregate
supply (SRAS), and the long-run aggregate supply curve (LRAS) for a hypothetical
economy that is initially in equilibrium,
operating at potential output  at point N.
Suppose  an unanticipated increase in investment spending causes the aggregate demand curve to shift to the right (from AD1 to AD2). According to adherents of the
adaptive-expectations theory, the unanticipated change in aggregate demand will cause
the economy to move in which direction? A. Directly from point N to point Z B. From point N to point K, before returning to point N C. From point N to point D, before returning to point N D. From point N to point D and, eventually, from point D to point Z Now suppose that the increase in investment spending was entirely anticipated by firms and workers. This means the public fully anticipates the rightward shift of the aggregate
demand curve (from AD1 to AD2). According to rational-expectations adherents, the
anticipated change in aggregate demand will cause the economy to move in which
direction?
A. From point N to point K, before returning to point N B. From point N to point D, before returning to point N C. Directly from point N to point Z D. From point N to point D and, eventually, from point D to point Z Problem 7 The following graph shows the short-run Phillips curve within the expectations framework.
On the graph, place the grey star point to illustrate the situation when people accurately
anticipate the inflation rate. When people accurately anticipate the inflation rate, the natural rate of unemployment is 5%. On the previous graph, place the black cross point to illustrate the situation when people overestimate inflation by 3%. When people underestimate inflation, the resulting unemployment  rate is below the natural rate.
True or False: The modern view of the Phillips curve indicates that to keep the
unemployment rate low, policymakers should rapidly increase inflation rates. A. True
B. False
Problem 8 Despite ongoing debates about the appropriateness of macroeconomic policies, many macroeconomists have reached a modern consensus  on several important issues. Which of the following statements regarding monetary policy are true according to the macroeconomic consensus  in the United States? Check all that apply. A. Monetary policy should focus on price stability. B. Congress, not the Federal Reserve, should be in charge of monetary policy. C. Expansionary monetary policies should  be used to keep unemployment  below its natural rate. Test 3 Study Guide Tuesday,  November  28, 2017 2:07 PM

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School: San Diego State University
Department: Engineering
Course: Principles of Economics
Professor: R.frantz
Term: Fall 2015
Tags: Macroeconomics
Name: Econ Test 3 Study Guide
Description: Study guide for Test 3 of Econ that covers Chapters 12 through 15.
Uploaded: 11/28/2017
42 Pages 841 Views 672 Unlocks
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