EC 110 Study Guide - Fiscal Policy, Aggregate Demand, Demand For Money

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30 Oct 2014

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Ch 21: the influence of monetary and fiscal policy on aggregate demand. Monetary and fiscal policy can both affect ad. Spending by households can shift ad, monetary and fiscal policymakers often want to offset these shifts. Most important: the exchange-rate effect: lower price level reduces int rate, investors move money overseas for higher returns. More dollars in foreign markets lower their relative value. Exports & imports are only small part of u. s. gdp, exchange rate not that important. Theory of liquidity preference: keynes"s theory that the interest rate adjusts to bring money supply and money demand into balance. We are explaining the theory with both nominal & real. Assumption: fed directly controls the supply of money, does not depend on other economic variables like interest rate (vertical line) People choose to hold money instead of other assets that offer higher rates of return because money can be used to buy goods and services.

Related Questions

If a country's central bank adopts an expansionary monetary policy, which of the following is most likely to be the effect of such as policy, all other factors remaining unchanged? (Please give a brief explanation for your choice.)

A. An increase in the price level that reduces the real value of households' money holdings and stimulates consumer spending

B. A decrease in the price level that reduces the interest rate and lowers the real value of the domestic currency foreign-exchange market

C. An increase in the price level that stimulates spending on net exports and increases the demand for money

D. A decrease in the price level that reduces the amount of money that people want to hold and decreases the interest rate

1.Ceteris paribus, if the U.S. federal government reduces its budget deficit which of the following will be observed?

Answer

	a.	The aggregate demand curve will shift to the right.
	b.	The economy will always approach potential GDP.
	c.	The marginal propensity to consume will increase.
	d.	The average price level will increase.
	e.	The aggregate demand curve will shift to the left.

2. If the government wants to close a GDP gap, it can:

Answer

	a.	lower government spending on social security.
	b.	adopt contractionary fiscal policies to control inflation.
	c.	increase its budget deficit.
	d.	repay its borrowings.
	e.	raise both direct and indirect tax rates.

3. Suppose the short-run equilibrium level of income exceeds the full employment level of income and there is high inflation. Hence, the government decides to implement a fiscal policy that will act to reduce national output and price level. This can be accomplished by:

Answer

	a.	lowering average tax rates such that aggregate supply is increased.
	b.	increasing government spending such that aggregate expenditures are increased.
	c.	increasing transfer payments such that aggregate expenditures decline.
	d.	raising taxes and government spending by the same amount such that aggregate supply is decreased and aggregate demand is increased.
	e.	decreasing government spending such that aggregate demand is reduced.

4. A drop in investment spending caused by increased government budget deficits is referred to as:

Answer

	a.	the multiplier effect.
	b.	crowding out.
	c.	an expansionary gap.
	d.	the paradox of thrift.
	e.	the Ricardian equivalence.

5. Discretionary fiscal policy is best defined as:

Answer

	a.	the deliberate manipulation of the money supply to expand the economy.
	b.	the deliberate change in tax laws and government spending to change equilibrium income.
	c.	the policy action taken by the Congress to reduce the federal budget deficit.
	d.	the arbitrary fluctuation in tax laws and budget requirements.
	e.	the automatic change in certain fiscal instruments when real GDP changes.

6. Which of the following can be considered as an automatic stabilizer in the economy?

Answer

	a.	Money supply
	b.	Disposable income
	c.	Real exchange rate
	d.	Real interest rate
	e.	Unemployment insurance

7. Which of the following is true about automatic stabilizers?

Answer

	a.	When income rises, automatic stabilizers increase/boost spending.
	b.	Automatic stabilizers are a part of discretionary fiscal policy.
	c.	An automatic stabilizer is any program that responds to fluctuations in the business cycle in a way that moderates the effects of those fluctuations.
	d.	Any kind of trade policy adopted by the government will be considered as an automatic stabilizer.
	e.	The interest rate is an example of an automatic stabilizer.

8. Increased budget deficits

Answer

	a.	can cause interest rates to increase and hence decrease net exports
	b.	have no effect on net exports
	c.	can cause interest rates to decrease and hence increase net exports
	d.	never impose additional interest costs on the government

9. The Ricadian Equivalence implies that when financing additional government expenditures

Answer

	a.	there is no difference between increasing current taxes or borrowing now and increasing taxes in the future because consumption will decrease either way.
	b.	there is no difference between increasing current taxes or borrowing now and increasing taxes in the future because consumption will increase either way.
	c.	increasing borrowing is the best option
	d.	increasing current taxes is the best option

10. Assuming no effects on aggregate supply, if the government increases government spending and decreases taxes in an attempt to prevent a possible recession, aggregate demand will shift to the ____, the price level will either remain constant or ____, and the level of real GDP will ____.

Answer

	a.	right; decrease; increase
	b.	right; decrease; decrease
	c.	left; decrease; decrease
	d.	left; increase; increase
	e.	right; increase; increase

11. For a hypothetical economy, the MPS is 0.08 and the MPI is 0.17. If government spending increases by $35 and taxes increase by $35, what will be the net effect on equilibrium income?

Answer

	a.	A decrease of $35
	b.	An increase of $105
	c.	An increase of $35
	d.	A decrease of $105
	e.	A decrease of $15

12.12. The term fiscal policy refers to

Answer

	a.	the adjustment of the GDP for inflation.
	b.	the purchase and sale of U.S. government securities to regulate the money supply.
	c.	the use of government spending and taxation to influence the level of economic growth and inflation.
	d.	the use of fines to penalize unfair business practices.
	e.	a policy action by Congress to overrule unpopular budget cuts by the president.

13. If aggregate demand intersects aggregate supply in the vertical range of the aggregate supply curve, then, other things equal, an increase in government spending will

Answer

	a.	raise the price level and leave real GDP unchanged.
	b.	raise real GDP by the amount indicated by the government spending multiplier and leave the price level unchanged.
	c.	raise both real GDP and the price level by a multiple of the initial spending increase.
	d.	have no effect on real GDP or on the price level, because all private investment will be crowded out.
	e.	lower real GDP by an amount equal to the spending increase and reduce inflation.

14. Which of the following is not a means to finance government spending?

Answer

	a.	Government subsidies
	b.	Government debt
	c.	Capital gains taxes
	d.	Personal income taxes
	e.	Money creation

15. An automatic stabilizer is

Answer

	a.	a change in government spending aimed at achieving a policy goal.
	b.	an element of fiscal policy that automatically changes in value as real GDP changes.
	c.	an element of monetary policy that automatically changes in value as real GDP changes.
	d.	a decrease in tax rates as the economy moves into a recession.
	e.	a deliberate change in taxation aimed at increasing real GDP.

16. Budget deficits tend to grow during recessions because

Answer

	a.	real GDP growth is zero, which causes neither tax receipts nor government expenditures to grow.
	b.	real GDP growth is positive, which reduces both tax receipts and transfer payments.
	c.	real GDP growth is negative, which reduces transfer payments in relation to tax receipts.
	d.	real GDP growth is negative, which reduces tax receipts in relation to government expenditures.
	e.	real GDP growth is positive, which increases tax receipts in relation to government expenditures.

1) If the economy was experiencing a severe recession, which of the following combinations of monetary and fiscal policy actions would be most appropriate?

a. a decrease in the reserve requirement coupled with an increase in taxes

b. the sale of government securities by the Fed coupled with an increase in the level of government spending.

c. the purchase of government securities by the Fed coupled with a decrease in the level of government spending.

d. the purchase of government securities by the Fed coupled with a tax reduction

e. an increase in the reserve requirement coupled with a tax reduction

f. the purchase of government securities by the Fed coupled with a tax increase

2) Many years ago, the traditional mortgage loan structure specified
A. a down payment of 20%.
B. an initial loan-to-value ratio of 100%.
C. a variable interest rate.
D. all of the above.

3) Unlike the traditional mortgage amortization schedule, "negative-amortization" mortgages permit the
A. mortgage payments to exceed the accrued interest during the early years of the mortgage.
B. principal payments to grow at a constant rate during the early years of the mortgage.
C. value of the house to depreciate during the early years of the mortgage.
D. outstanding balance to increase over a part of the life of the mortgage.

4) The traditional mortgage amortization schedule specifies a monthly payment that is
A. increasing over the life of the mortgage.
B. decreasing over the life of the mortgage.
C. constant over the life of the mortgage.
D. first increasing, then decreasing, over the life of the mortgage.

5) The "interest-only" mortgage typically converts later to a
A. traditional mortgage with a higher payment.
B. traditional mortgage with a lower payment.
C. "negative-amortization" mortgage with a lower payment.
D. "exotic" mortgage with a lower payment.

6) "Exotic" mortgages became popular in part because they allow someone of
A. means to get into a home they would easily have been able to afford.
B. modest means to get into a home they might otherwise not have been able to afford.
C. modest means to build more equity in their home than a traditional mortgage would allow.
D. modest means to build their credit score by proving they could make challenging payments.

7) Other things equal, increasing home prices tend to
A. force homeowners to spend less than they earn.
B. allow homeowners to spend more than they earn.
C. leave homeowners' ability to spend unaffected.
D. increase the likelihood that homeowners will default on their mortgages.

8) If homeowners purchased a $250,000 home with a zero-down, interest-only mortgage, and the value of the home subsequently fell to $200,000, in order to sell the house and move to another city, the homeowners would be required at closing to pay (in addition to the proceeds from the home sale)
A. nothing.
B. $50,000.
C. any transaction costs and real estate fees.
D. $50,000 plus any transaction costs and real estate fees.

9) Home price escalation in the U.S. during 2005 fueled booms in
A. Iraq and Afghanistan
B. stocks of dot com startups in Silicon Valley and U.S. government bonds
C. home building and home equity lines of credit
D. mortgage foreclosures and home demolition

10) The stimulus package proposed by the Bush Administration in early 2008 relied upon

A. a permanent increase in personal income tax rates
B. a temporary surtax added to existing personal income tax rates
C. making permanent the 2003 income tax rate cuts, as well as tax rebates to taxpayers
D. a requirement that any children claimed as dependents have social security numbers

11) The stimulus plan adopted in 2009 by newly-elected President Obama consisted of
A. only tax cuts
B. only spending increases on newly-created federal programs
C. only attempts to shore up Medicaid, welfare and unemployment programs
D. roughly equal tax cuts and spending increases, with additional spending to shore up existing federal programs

12) The main effect on the economy of the financial sector crisis in late 2008 was
A. reduced aggregate demand
B. increased aggregate demand
C. reduced aggregate supply
D. increased aggregate supply

13) If not corrected, the financial sector crisis of late 2008 would have tended to
A. increase both Real GDP and the general price level
B. increase Real GDP and lower the general price level
C. lower Real GDP and increase the general price level
D. lower both Real GDP and the general price level

14) Monetary policy designed to counteract a reduction in aggregate demand might include
A. a reduction in the money stock
B. a reduction in short-term interest rates
C. increased government infrastructure spending
D. an increase in individual income tax rates

EC 110 Study Guide - Fiscal Policy, Aggregate Demand, Demand For Money

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