1. C
Ø If more money is demanded than supplied, this means we are to the right of the intersection of the supply and demand curves of money. Since people demand more money, they will sell bonds and such to obtain money. This causes us to move up along the demand curve until equilibrium is restored.
2. C
Ø A nation’s current domestic product includes final goods and services produced during that year. It does not include financial transactions like the purchase of stock simply because that is just a transfer of ownership (nothing has been produced). Second hand sales also aren’t included since the product was originally counted when it was first produced (nothing has been added to our economy). If a retailer increases her stock of imported shoes (she is buying goods not produced in the U.S. and, therefore, they aren’t counted in GDP). If the government increases its purchases, GDP will increase since production has obviously increased.
3. B
Ø An increase in energy costs, increase the costs of production. This means the aggregate supply curve will shift to the left thereby causing prices to rise and real GDP to fall.
4. A
Ø Classical economists are all about self-correction. They believe there is virtually no need for government involvement. In addition, they feel that prices and wages are flexible.
5. D
Ø Households demand products produced by firms, yet at the same time, they supply their resources (labor) to firms.
6. B
Ø If we run on a budget deficit, that means our expenditures are greater than our revenues. If this happens the size of the national debt will increase (since it is the total accumulation of all deficits and surpluses).
7. D
Ø Remember, you can do two things with your income: spend or save it. Y = C + S. Thus, if income increases by a given amount, savings will increase, but not by the entire amount since you will consume some of that additional income.
8. C
Ø If a $300 deposit increased excess reserves by $225, then $75 must be the required reserves from that deposit ($300 - $225). So, the reserve ratio (the % of reserves that can’t be loaned out) is simply $75 / $300 = 25%.
9. C
Ø The Fed can increase the money supply by buying government bonds on the open market, decreasing the discount rate, or decreasing the reserve ratio.
10. C
Ø If people hold money because they think interest rates are going to rise in the future, they are speculating that rates will increase so that they will benefit from holding the money. Thus, the purpose of money is that of speculation.
11. B
Ø An increase in the money supply shifts the money supply curve to the right. This causes real interest rates to fall. As real interest rates fall, the level of investment demand increases (since the interest rate represents the cost of investing). And, since investment (I) is one of the components of aggregate demand (AD), it will cause AD to increase (shift to the right) thereby increasing real output.
12. A
Ø Expansionary monetary policy increases the money supply. This causes interest rates to fall and, thus, investment to increase.
13. B
Ø An inflationary gap means that there is too much spending. An increase in the money supply would result in lower interest rates and more investment. This would not eliminate, but rather worsen our inflationary problem.
14. E
Ø A contractionary supply shock is something that decreases aggregate supply. The result of this would be an increase in the general price level and a decrease in employment.
15. D
Ø If Japan is demanding more U.S. goods, they will also be demanding more dollars so that they can buy our goods. This increased demand for dollars would cause the value of the dollar to appreciate (increase in value) since the demand curve for dollars is shifting to the right.
16. E
Ø Opportunity cost is a measure of what must be forgone in order to have more of something else. When moving from point P to R we must give up units of Y (10 units) to have more X, and when moving from point R to P we must give up units of X (8 units) to have more Y. The opportunity cost of moving from Q to R is nothing simply because at Q some of our resources were underemployed. This means that we won’t have to give up anything to produce more of X or Y.
17. B
Ø Real = Nominal – Inflation. Thus, if real GDP is increasing at 3% and nominal GDP is increasing at 7%, inflation must be 7% - 3% = 4%. Therefore, price levels are increasing. Remember, inflation is a general increase in the price level.
18. D
Ø First off, the full employment rate of unemployment equals the natural rate of unemployment. Second, the official unemployment rate underestimates the actual level of unemployment since it does not include discouraged workers as part of the labor force. Discouraged workers are those who have simply given up looking for work.
19. B
Ø Since our income is currently $1000 while the full employment level is $2000, we are experiencing a recession.
20. A
Ø Since we want to stimulate the economy so that we reach full employment, the appropriate monetary policy would be to increase the money supply. The ways the Fed can increase the money supply include buying bonds, lowering the discount rate, or lowering the reserve requirement.
21. C
Ø To determine the minimum increase in government spending necessary to reach full employment, we must first calculate the spending multiplier. The spending multiplier (m) = [1 / (1 – MPC)], where MPC is the marginal propensity to consume. MPC (b) is simply the slope of the expenditures function. The slope of the line above is (1000 – 500) / (1000 – 0) = 500/1000 = 1/2. Thus, the spending multiplier (m) = [1 / (1 – ½)] = [1 / (1/2)] = 2. Now that we know the multiplier and know that we want to increase income by 1000 (2000 –1000), we can simply solve for the change in government spending. 1000 = 2 x (Change in government spending). Therefore, the change in government spending to eliminate this recessionary gap must be 1000 / 2 = $500
22. B
Ø If aggregate demand increases, the AD curve shifts to the right. Since we know that we are on the upward sloping portion of the AS curve (intermediate range), we know that prices and output will increase while unemployment will decrease (because we are producing more).
23. E
Ø The spending multiplier (m) = [1 / (1 – MPC)], where MPC = marginal propensity to consume. In addition, since 1 – MPC = MPS (marginal propensity to save), the spending multiplier can be re-written as m = 1 / MPS. So, if MPS ↑, the value of the spending multiplier must decrease.
24. B
Ø The $100 increase in government spending will increase AD and, thus, incomes will increase. As incomes rise, consumers will spend more on consumption thereby causing equilibrium income to rise by more than the initial $100 increase in government spending. This process is known as the consumer re-spending effect.
25. C
Ø The money-creating ability of the banking system is based on the money multiplier and the fact that banks will lend out all of their excess reserves and that people will deposit all of their money into a bank. If people hold a portion of their money in the form of currency, the banks’ lending potential has been reduced (they don’t have as much excess reserves to loan out) and, therefore, the money creating ability of the banking system will be less than the maximum amount indicated by the money multiplier.
26. B
Ø M1 consists of currency (coins and paper money) and checkable (demand) deposits. Out of these two components, checkable (demand) deposits constitute the largest component of the United States money supply.
27. A
Ø A restrictive monetary policy is used to slow down an economy that is growing too fast. Thus, it would be most appropriate if we were experiencing high inflation.
28. D
Ø Automatic stabilizers don’t require any action in order to take effect. They are automatically built into the economy and, thus, work without the passage of new legislation.
29. A
Ø A discovery of vast new oil deposits, a decrease in the infant mortality rate, or a decrease in wages would result in an increase in AS (and, therefore, an increase in GDP). If net investment is negative, then our supply of capital stock is decreasing thereby explaining a decline in potential GDP (our ability to produce more in the future).
30. E
Ø If investors increase their purchases of United States government bonds, they are going to be demanding more dollars. As the demand for dollars increases (demand curves shifts to the right), the international value of the dollar also increases.
31. D
Ø Trade results in specialization and, thus, an improved allocation of domestic resources and an increased standard of living (since more can be produced as a result of trade). Trade means that you are depending on someone else for a good or service. Therefore, trade does not result in self-sufficiency.
32. D
Ø GDP underestimates a country’s production of goods and services when there is an increase in household production since these goods and services produced within a house are excluded from GDP (because they don’t involve a market transaction).
33. D
Ø As businesses produce too much, inventories begin to pile up. When these increases are unexpected, we can predict that there will soon be a decrease in production since there will no longer be the need to produce as much.
34. A
Ø An increase in the cost of productive resources would likely shift the SRAS curve to the left. An increase in productivity would shift the SRAS curve to the right. An increase in the money supply would result in the AD curve shifting to the right. Also, if we are running on a budget deficit, chances are that AD is shifting to the right (increasing). In addition, if the number of imports increases, AD would shift to the left, as Net Exports would be declining (Exports – Imports).
35. B
Ø Investment spending is one of the components of aggregate demand. Thus, a change in investment will result in a change in the level of output and employment since the AD curve will be shifting.
36. C
Ø If APC = 0.75, APS = 1 – 0.75 = 0.25. Remember, APC = Consumption / Income. And, APS = Savings / Income. By trial and error, you’ll find that the correct choice is “c.” If income is $200 and APS = 0.25, simply solve for the amount of savings. 0.25 = Savings / $200. Savings = 0.25 x $200 = $50.
37. A
Ø A restrictive fiscal policy entails decreasing government spending and/or increasing taxes. The result of these policies is a decrease in aggregate demand. As AD shifts to the left (decreases), output and price level both decrease.
38. E
Ø The tools of the Fed consist of buying/selling government securities on the open market, lowering/raising the discount rate (the interest rate the Fed charges banks for loans), or lowering/raising the reserve requirement (the % of reserves that banks can’t loan out).
39. B
Ø The bank may increase its loans by the amount of its excess reserves. Since the reserve requirement is 20%, this bank must keep 20% x $10,000 = $2000 on hand as required reserves. Thus, it can loan out $10,000 - $2,000 = $8,000.
40. A
Ø MV = PQ. Since PQ does not change and M ↓, V must ↑ in order for the equation to remain balanced.
41. –
42. E
Ø High inflation and high unemployment is known as stagflation. An economy could experience stagflation if aggregate supply (AS) decreased. Negative supply shocks that cause factor prices to increase would result in AS decreasing.
43. C
Ø Government borrowing causes the demand for loanable funds to increase. It is this increase in demand that causes interest rates to rise. Higher interest rates, in turn, decrease private sector investment. This decrease in private investment is known as crowding out.
44. E
Ø If we are in a recession, we are going to want to implement expansionary policies. Thus, we would want to buy bonds and do nothing with regards to fiscal policy. The effects of expansionary fiscal policy are partially negated due to the crowding-out effect. In addition, since fiscal policy results in higher interest rates, our long-run growth would actually be slowed since investment would decrease.
45. D
Ø High tariffs on imported goods would result in increased domestic production. An indirect effect of this tariff is simply the fact that inefficient industries are expanding while efficient industries abroad are being forced to contract. Thus, the United States economy would become less efficient. The number of job in the U.S. may increase, but only temporarily since our trading partners will be weakened (since their exports will be down) and, thus, they will be unable to buy our products causing our exports to decrease. This would result in less production and employment in the long run.
46. A
Ø If Mary Jane were to build the cabinets herself, she would save $60/hr on carpenter fees, but she would give up her lawyer salary of $150/hr during that time. Thus, it would actually cost her $150 - $60 = $90/hr to build the cabinets herself. Since it only costs her $20/hr to hire a carpenter, she should specialize in law and hire a carpenter (despite the fact that she has an absolute advantage in both).
47. C
Ø In other words, what are the axes on the AD/AS model? On the vertical axis, we have price level. And, on the horizontal axis, we have real national output (real GDP).
48. A
Ø It would not change because investment and consumption are both components of aggregate demand. Thus, in the end, it wouldn’t matter how you classify them.
49. E
Ø An open market sale by the Fed would decrease the money supply and cause interest rates to increase. As interest rates rise, investment decreases thereby decreasing aggregate demand. And, if aggregate demand decreases, chances are the economy will fall into a recession. All of the other choices would result in aggregate demand increasing. If aggregate demand increases, we may experience an inflationary period.
50. C
Ø Since wages represent a cost of production, if wage are reduced then aggregate supply will increase (shift to the right). Increased taxes or mandates would result in a decrease in aggregate supply (shift to the left). Likewise, if plants shutdown the aggregate supply curve would decrease (shift to the left).
51. E
Ø Remember, you can either save or consume your income. Y = C + S. Thus, $1,000 = $700 + S. So, S = $1,000 - $700 = $300. If the MPC = 0.6 and income increases by $100, you would consume .60 x $100 = $60 of the $100 increase. Since you are consuming $60, you must be saving the other $40. Therefore, consumption now equals $700 + $60 = $760 and savings now equals $300 + $40 = $340.
52. A
Ø If the government does not want to increase inflation, it must increase taxes so that the policies are completely offset. Remember, changes in government spending have a direct effect, whereas changes in taxes have an indirect effect. Changes in taxes affect aggregate demand by changing incomes and, thus, consumer spending. However, people don’t spend all of their income (they do save some portion of it). Thus, the actual change in consumption is equal to the marginal propensity to consumer (MPC) times the change in taxes. So, in order for no inflation to occur, the government is going to have to raise taxes by more than the $100 billion (which is the amount that they increased government spending by).
53. B
Ø With a 15% reserve requirement and a deposit of $200, a bank’s required reserves will increase by 15% x $200 = $30. And, the bank’s liabilities have increased by $200 since that is the amount of the new demand deposit.
54. C
Ø Open market operations are the buying and selling of government securities (bonds) by the Fed.
55. B
Ø Expansionary fiscal policies result in the government running on a budget deficit since G > T. As the government borrows money to finance their budget, the demand for loanable funds increases (shift to the right). This increased demand causes interest rates to rise (thereby crowding out some private investors). So, while expansionary monetary policy results in lower interest rates due to an increase in the money supply, expansionary fiscal policy results in higher interest rates (thereby negating some of the intended effect of the policy).
56. A
Ø Monetarists dislike expansionary fiscal policy because of crowding out. In addition, they dislike fiscal policy in general because it is too slow!
57. B
Ø If unemployment is high, a Keynesian is going to want to stimulate the economy with some form of expansionary fiscal policy. Thus, they would decrease taxes and/or increase government spending. They would run on a budget deficit during this time.
58. A
Ø Keynesians believe that prices and wages are not flexible downwards due to minimum wage laws, unions, and the nature of our businesses in general. In addition, since prices are rigid downward, the economy will not be capable of self-correction.
59. D
Ø Stagflation occurs when there are simultaneous increases in price level and unemployment. This occurs when there is a decrease (shift left) in aggregate supply.
60. D
Ø An open market sale of bonds by the Fed will decrease the money supply. As the money supply decreases (shifts left), interest rates will increase. Higher interest rates in the U.S. entice foreigners to invest in our markets. In order to invest, foreigners will need to have dollars. Thus, there will be an increase in the demand for dollars. It is this increased demand for dollars that results in the value of the dollar increasing.