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Chapter 9: Income and Spending

Difficulty: Easy

1. A consumption function of the form C = Co+ cYD has a positive vertical intercept Co, whichindicates thatA some consumption is unaffected !y chan"es in disposa!le income# the mpc will increase as disposa!le income increasesC the apc will always increase as disposa!le income increasesD the apc will always !e less than the mpcE all of the a!oveAns: A

Difficulty: Easy$. %he mar"inal propensity to consume &mpcA shows the fraction of total national income that is used for consumption# added to the mar"inal propensity to save &mps always e'uals (eroC is the relationship !etween a chan"e in consumer purchases and the chan"e in disposa!le

income that allows consumption to chan"eD declines as disposa!le income declines, eventually !ecomin" (ero as disposa!le income

reaches (eroE decreases as autonomous savin" increasesAns: C

Difficulty: Easy). *n a eynesian model of income determination, when intended spendin" is "reater than

actual output, the adustment to a new macro-economic e'uili!rium is !ased on chan"es inA autonomous consumption# unplanned inventoriesC "overnment spendin"D net eportsE all of the a!oveAns: #

Difficulty: Easy/. %otal autonomous spendin"A is dependent on the level of output

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# is only determined !y the e'uation for the consumption functionC is not part of a""re"ate demandD is independent of the level of incomeE increases when disposa!le income increasesAns: D

Difficulty: Easy0. %he ependiture multiplier is used to calculate the chan"e inA spendin" caused !y a chan"e in income# e'uili!rium income caused !y a chan"e in autonomous spendin"C intended spendin" caused !y a chan"e in consumptionD disposa!le income caused !y a chan"e in savin"E "overnment ependitures caused !y a chan"e in incomeAns: #

Difficulty: Easy. *n a simple model with no "overnment or forei"n sector, the chan"e in unplanned inventory

at e'uili!rium isA dependent upon the amount of consumption# e'ual to output minus consumptionC (eroD always positiveE usually ne"ativeAns: C

Difficulty: Easy2. *f there is no "overnment or forei"n sector and planned investment e'uals planned savin",

thenA actual output is e'ual to planned spendin" on consumption and investment# consumption plus investment e'uals incomeC the 'uantity of output produced is e'ual to a""re"ate demandD there are no unplanned inventory chan"esE all of the a!oveAns: E

Difficulty: 3edium

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4. Assume a model with no "overnment or forei"n sector. *f actual output is 51).1 trillion whilea""re"ate demand is 51).$ trillion, we 6now that

A the ma"nitude of unintended inventory adustments is - 5177 !illion# the ma"nitude of unintended inventory adustments is + 5177 !illionC the ma"nitude of unintended inventory adustments is + 517 !illion

D the actual income level is a!ove its e'uili!riumE there currently is an ecess supply of "oods and servicesAns: A

Difficulty: Difficult8. Assume a simple model without any "overnment. *f an increase in autonomous investment of

/7 leads to an increase in consumption of 17, then the mar"inal propensity to save isA 7.17# 7.$7

C 7.$0D 7./7E 7.47Ans: #

Difficulty: 3edium17. *n a model with no "overnment or forei"n sector, if savin" is defined as 9 = - $77 + &7.1Y

and investment is *o= $77, what is the e'uili!rium level of consumptionA ),477# ),77C 1,477D $,777E 1,777Ans: A

Difficulty: 3edium11. *n a model with no "overnment or forei"n sector, if autonomous consumption is Co= 47,

investment is *o= 27, and the mar"inal propensity to save is s = 7.$0, e'uili!rium income isA 107# $77C $$0D 77E 207Ans: D

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Difficulty: 3edium1$. %he ependiture multiplier measures

A the num!er of steps it ta6es to move from one e'uili!rium to another# the rise in savin" resultin" from a rise in incomeC the chan"e in investment resultin" from a chan"e in incomeD the chan"e in induced consumption caused !y a chan"e in incomeE none of the a!oveAns: E

Difficulty: 3edium1). ;hen calculatin" the multiplier for "overnment purchases &

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Difficulty: 3edium1. *n a simple model with no "overnment or forei"n sector, a decline in investment of 517

!illion will lead to a 507 !illion decline in the e'uili!rium level of income ifA the mps is 7.$# the mpc is 7.0C the ratio of total consumption to total income is 7.4D chan"es in consumption divided !y chan"es in income e'ual 7.$E chan"es in savin" divided !y chan"es in income e'ual 7.4Ans: A

Difficulty: Easy

12. Assume a model with no "overnment or forei"n sector. *f national income is Y = 477,autonomous consumption is Co= 177, and the mar"inal propensity to consume is c = 7.2,then total consumption is

A 177# 07C 7D 277E 477Ans: C

Difficulty: Difficult14. Assume a simple model of the ependiture sector with no income taes. *f a lump sum ta

decrease of $77 leads to an increase in income of 477, what is the si(e of the mpsA 7.17# 7.$7C 7.$0D 7./7E 7.47Ans: #

Difficulty: 3edium18. *f autonomous investment increases !y 177 and "overnment purchases decrease !y 177,

which of the followin" is trueA income will increase !y 177

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# income will increase !y $77C income will increase !y the multiplier times 177D income will decrease !y the multiplier times 177E income will not chan"eAns: E

Difficulty: Easy$7. Assume a model with no "overnment, where consumption is the only component of

a""re"ate demand. *f the consumption function is of the form C = /77 + &7.8Y, what is thee'uili!rium level of consumption

A /77# 1.777C 1,77D ),77

E /,777Ans: E

Difficulty: Difficult$1. Assume a model of the ependiture sector with no "overnment or forei"n sector. *f the

savin"s function is defined as 9 = - )77 + &7.1Y and autonomous investment increases !y$77, !y how much will consumption increase

A 147# $77C 1,477D $,777E $,177Ans: C

Difficulty: 3edium$$. %he reason that an increase in autonomous spendin" leads to an even "reater increase in

e'uili!rium level of output is thatA as firms increase output to meet demand, income increases, and this induces more

consumption spendin"# the multiplier increases with an increase in autonomous spendin"C prices rise with increased output and this raises nominal

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Ans: A

Difficulty: 3edium

$). Assume a simple model with no "overnment or forei"n sector. *f an increase in autonomousinvestment of 177 leads to an increase in consumption of )77, the si(e of the ependituremultiplier is

A 7.20# 1.))C ).77D /.77E 0.77Ans: D

Difficulty: Easy$/.

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# a decrease in "overnment spendin"C a decrease in "overnment transfer paymentsD an increase in the ependiture multiplierE all of the a!oveAns: D

Difficulty: 3edium$2. Assume a model with no forei"n sector, no income taation, and a consumption function

defined as C = /77 + &7.20YD. *f "overnment transfer payments decrease !y $77, thenA income will decrease !y 77# income will decrease !y 477C income will increase !y 477D income will increase !y $77E income will increase !y 107

Ans: A

Difficulty: 3edium$4. ;hich of the followin" will >?% happen if the income ta rate &t is increasedA the ependiture multiplier and consumption will !oth decrease# disposa!le income, savin", and consumption will all decreaseC consumption and income !oth will decrease, !ut savin" will increaseD the full-employment !ud"et surplus will increaseE autonomous spendin" will stay the same !ut national income will decreaseAns: C

Difficulty: 3edium$8. An increase in "overnment spendin" willA not affect a""re"ate demand unless it is de!t-financed# not affect a""re"ate demand if it is financed !y a ta increase of e'ual ma"nitudeC decrease a""re"ate demand if it is financed !y a ta increase of e'ual ma"nitudeD stimulate a""re"ate demand !y less than a ta decrease of e'ual ma"nitudeE none of the a!oveAns: E

Difficulty: 3edium)7. *f total autonomous spendin" is Ao= 477, the mar"inal propensity to save is mps = 7.$, and

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the mar"inal ta rate is t = 7.$0, what is the level of e'uili!rium incomeA 477# 1,777C $,777D ),$77

E /,777Ans: C

Difficulty: Difficult)1. *f the consumption function is defined as C = 477 + &7.20YD, the mar"inal income ta rate

is t = 7.0, and autonomous investment decreases !y 07, then the !ud"et surplus willA remain unaffected# decrease !y 177C decrease !y 47

D decrease !y /7E decrease !y 17Ans: D

Difficulty: Difficult)$. *f the savin"s function is 9 = - /77 + &7.$0YD, the mar"inal income ta rate is t = 7.$, and

the e'uili!rium level of income increases !y 1,777, !y how much will consumption chan"eA $07# /77C 77D 207E 477Ans: C

Difficulty: Difficult)). Assume the consumption function is of the form C = $77 + &7.20YD and the income ta rate

is t = 7.$. ;hat would !e the effect of an increase in "overnment transfers of $77 A an increase in income of 477# an increase in income of 077C an increase in income of )20D an increase in income of )77E an increase in income of 1$0Ans: C

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Difficulty: 3edium)/. *n a model with income taes, an increase in autonomous imports willA increase the !ud"et deficit

# increase a""re"ate demandC not affect savin"D increase consumptionE decrease the trade deficitAns: A

Difficulty: Difficult)0. Assume an economy with no forei"n sector, a mar"inal propensity to save of mps = 7.1, and

a mar"inal income ta rate of t = 1@). ;hat chan"e in "overnment purchases would lead to an

increase in national income of 077A 07# 177C $77D )77E 077Ans: C

Difficulty: Difficult). Assume an economy with no forei"n sector, a mar"inal propensity to save of mps = 7.1, and

a mar"inal income ta rate of t = 1@). *f autonomous savin" decreases !y )77, which of thefollowin" is true

A total consumption will increase !y )77# national income will increase !y 077C disposa!le income will increase !y 207D the !ud"et surplus will increase !y $07E the !ud"et surplus will !e unaffectedAns: D

Difficulty: Difficult)2. Assume an economy with no forei"n sector, a mar"inal propensity to save of mps = 7.1, and

a mar"inal income ta rate of t = 1@). *f "overnment transfer payments decrease !y $77,which of the followin" is true

A national income will decrease !y /07

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# income ta revenues will decrease !y 107C the !ud"et surplus will increase !y 07D all of the a!oveE only A and #Ans: D

Difficulty: 3edium)4. Assume that the savin"s function is of the form 9 = - 177 + &7.$YD and the mar"inal income

ta rate is t = 7.$0. ;hat would !e the effect on the e'uili!rium level of output if

autonomous consumption chan"es !y Co= - 07A a decrease in output of /77# a decrease in output of $07C a decrease in output of $77D a decrease in output of 1$0

E a decrease in output of 177Ans: D

Difficulty: 3edium)8. *f the savin"s function is of the form 9 = - $77 + &7.1YD and the mar"inal income ta rate is

t = 7.$, an increase in income of $77 will increase consumption !yA 147# 1//C 47

D 2$E $7Ans: #

Difficulty: 3edium/7. Assume a model with an income ta rate of t = 7.$0 and a mar"inal propensity to consume of

c = 7.4. ;hat could cause the level of e'uili!rium income to decrease !y 1,777A a decrease in autonomous net eports of /77# a decrease in autonomous savin" of $77

C a decrease in "overnment purchases of $07D a decrease in "overnment transfer payments of 077E an increase in autonomous investment of 077Ans: A

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Difficulty: 3edium/1. A decrease in the income ta rate &t willA increase the full-employment !ud"et surplus# increase the si(e of the ependiture multiplier

C increase disposa!le income and autonomous spendin"D increase consumption !ut decrease savin"E none of the a!oveAns: #

Difficulty: Difficult/$. Assume a model where mar"inal propensity to save is 7.$, the mar"inal propensity to import

is 7.1 and the mar"inal income ta rate is 7.$0. ;hat is the si(e of the ependiture multiplierA 17

# 0C /D $.0E $Ans: E

Difficulty: Difficult/). Assume a model with income taes in which imports increase proportionally to national

income. ;hich of the followin" is AB9EA the ependiture multiplier will increase with an increase in the mar"inal propensity to import# the ependiture multiplier will increase with a decrease in the mar"inal propensity to saveC the ependiture multiplier will decrease with an increase in the mar"inal propensity to saveD the ependiture multiplier will decrease with an increase in the mar"inal income ta rateE the ependiture multiplier will decrease with an increase in the mar"inal propensity to importAns: A

Difficulty: 3edium//. *n $778, the .9. federal !ud"et deficit wasA a!out 50/7 !illion or rou"hly ) percent of

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Difficulty: Easy/0. %he full-employment !ud"et surplus increases if

A "overnment transfer payments decrease# welfare spendin" increasesC defense spendin" increasesD the economy "oes into a recessionE the economy "oes into a !oomAns: A

Difficulty: 3edium/. Assume the savin"s function is defined as 9 = - $77 + &7.$0YD and the mar"inal income ta

rate is t = 7.0. *f autonomous investment increased !y 07, then the full-employment !ud"etsurplus wouldA not !e affected# increase !y 17C increase !y /7D increase !y 47E increase !y 177Ans: A

Difficulty: Easy/2. A decrease in the full-employment !ud"et surplus willA increase national income# increase savin"C increase consumptionD all of the a!oveE none of the a!oveAns: D

Difficulty: 3edium/4. *n a model with income taes, if net eports decrease, which of the followin" is AB9EA the !ud"et deficit will not !e affected# the !ud"et deficit will increaseC disposa!le income will decreaseD savin" will decrease

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E income will decrease !y more than net eportsAns: A

Difficulty: 3edium/8. *n a model with income taes, assume that autonomous investment decreases. ;hich of thefollowin" will !e %E

A the full-employment !ud"et surplus will decrease# the actual !ud"et surplus will decreaseC the cyclical component of the !ud"et surplus will decreaseD the actual !ud"et surplus will not !e affectedE !oth # and CAns: E

Difficulty: 3edium07. *f the full-employment !ud"et surplus is positive !ut the actual !ud"et surplus is ne"ative,

what can we concludeA nothin"# that savin" eceeds investmentC that the economy is in a !oomD that fiscal policy is too restrictiveE that fiscal policy is too epansionaryAns: D

Technical Problems

1.a. AD = C + * = 177 + &7.4Y + 07 = 107 + &7.4Y

%he e'uili!rium condition is Y = AD ==

Y = 107 + &7.4Y == &7.$Y = 107 == Y = 0F107 = 750.

1.b. 9ince %A = % = 7, it follows that 9 = YD - C = Y - C. %herefore

9 = Y - G177 + &7.4YH = - 177 + &7.$Y == 9 = - 177 + &7.$207 = - 177 + 107 = 50.

As we can see 9 = *, which means that the e'uili!rium condition is fulfilled.

1.c. *f the level of output is Y = 477, then AD = 107 + &7.4477 = 107 + /7 = 790.

%herefore the amount of involuntary inventory accumulation is

* = Y - AD = 477 - 287 = 10.

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1.d. ADI = C + *I = 177 + &7.4Y + 177 = $77 + &7.4Y

rom Y = ADI == Y = $77 + &7.4Y == &7.$Y = $77 == Y = 0F$77 = 1,000

Note:%his result can also !e achieved !y usin" the multiplier formula:

Y = &multiplier&9p = &multiplier&* == Y = 0F07 = 50,

that is, output increases from Yo= 207 to Y1= 1,777.

1.e. rom 1.a.and 1.d.we can see that the multiplier is ! " 5.1.#.

AD Y = ADAD1= $77 = &7.4Y

ADo= 107 + &7.4Y

$77

107 7

207 1,777 Y

.a. 9ince the mpc has increased from 7.4 to 7.8, the si(e of the multiplier is now lar"er.%herefore we should epect a hi"her e'uili!rium income level than in 1.a.

AD = C + * = 177 + &7.8Y + 07 = 107 + &7.8Y ==

Y = AD == Y = 107 + &7.8Y == &7.1Y = 107 == Y = 17F107 = 1,500.

.b. rom Y = &multiplier&* = 17F07 = 077 == Y1= Yo+ Y = 1,077 + 077 = ,000.

.c. 9ince the si(e of the multiplier has dou!led from J = 0 to J1= 17, the chan"e in output &Ythat results from a chan"e in investment &* now has also dou!led from $07 to 500.

.d. Y = AD ADAD1= $77 = &7.8Y

ADo= 107 + &7.8Y

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$77

107 7

1,077 $,777 Y

$.a. AD = C + * + < + >K = 07 + &7.4YD + 27 + $77 + 7 =)$7 + &7.4GY - %A + %H

= )$7 + &7.4GY - &7.$Y + 177H = /77 + &7.4&7.4Y = /77 + &7./Y

rom Y = AD == Y = /77 + &7./Y == &7.)Y = /77

== Y = &1@7.)/77 = &$.24/77 = 1,111.11

%he si(e of the multiplier is J = 1@7.) = .7%.

$.b. #9 = tY - % - < = &7.$&1,111.11 - 177 - $77 = $$$.$$ - )77 = & 77.7%

$.c. ADI = )$7 + &7.4GY - &7.$0Y + 177H = /77 + &7.4&7.20Y = /77 + &7.Y

rom Y = ADI == Y = /77 + &7.Y == &7./Y = /77 == Y = &$.0/77 = 1,000

%he si(e of the multiplier is now reduced to J1= &1@7./ = .5.

$.d. %he si(e of the multiplier and e'uili!rium output will !oth increase with an increase in themar"inal propensity to consume. %hus income ta revenue will also "o up and the !ud"etsurplus should increase. %his can !e seen as follows:

#9I = &7.$0&1,777 - 177 - $77 = - 07 == #9I - #9 = - 07 - &-22.24 = ' 7.7%

$.e. *f the income ta rate is t = 1, then all income is taed. %here is no induced spendin" ande'uili!rium income always increases !y eactly the chan"e in autonomous spendin". *n otherwords, the si(e of the ependiture multiplier is 1. ;e can see this from

Y = C + * + < == Y = Co+ c&Y - %A + % + *o+

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Chapter 10: (one), Interest, and Income

Difficulty: Easy1. ?ver the last three decades, in which years have interest rates on .9. %reasury !ills !een at

their hi"hest levelA 182# 1841C 184D 188E $77$

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Ans: #

Difficulty: Easy

$. Boo6in" at the !ehavior of interest rates over time, we reali(e thatA they tend to fall !efore a recession# they tend to !e hi"h !efore a recession and fall durin" a recessionC they tend to rise in a recovery and fall in a recessionD they tend to !e hi"h in a recessionE !oth # and CAns: E

Difficulty: Easy

). %he level of investment spendin" is affected !y chan"es in the interest rate, since hi"herinterest ratesA will increase the cost of !orrowin" and thus lower the incentive to purchase capital

e'uipment# will ma6e it more profita!le to invest in the stoc6 mar6etC will increase the return on savin"D will lower the value of "overnment !onds so !an6s will lend more to firms and less to the

"overnmentE all of the a!oveAns: A

Difficulty: 3edium/. *nterest rate chan"es have an important side effect on the economy since even a small chan"e

in interest rates can si"nificantly chan"eA the composition of output demanded# the level of private savin"C the level of consumptionD the level of "overnment spendin"E none of the a!oveAns: A

Difficulty: Easy0. %he two maor determinants of the level of private investment spendin" areA the interest rate and !usiness epectations

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C the levels of national income and savin"# the levels of consumption and savin"D corporate income taes and the level of savin"E interest rates and the level of private savin"Ans: A

Difficulty: Easy. *n the *9-B3 model, the interest rate serves as a lin6 !etweenA household savin" and !usiness investment# "overnment spendin" and consumer spendin"C actions of the central !an6 and chan"es in consumer spendin"D the "oods mar6et and the assets mar6etE domestic mar6ets and forei"n mar6etsAns: D

Difficulty: Easy2. *f the level of "overnment transfer payments increases while everythin" else stays the same,

thenA the *9-curve will shift to the left# the *9-curve will shift to the ri"htC the *9-curve will !ecome flatter and shift to the ri"htD the B3-curve will shift to the ri"htE the B3-curve will !ecome flatter and shift to the ri"htAns: #

Difficulty: 3edium4. *f investment !ecomes more responsive to chan"es in the interest rate, thenA the si(e of the "overnment spendin" multiplier will increase# a "iven increase in the interest rate will lead to a lar"er increase in incomeC the *9-curve will !ecome flatterD the *9-curve will !ecome steeperE !oth A and CAns: C

Difficulty: Easy8. rom which of the followin" e'uations can the e'uation for the *9-curve !e derived

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A * + < + >K = 9 + %A - %# Y = C + * + < + >KC 3@ = 6Y - hiD 3O = YE !oth A and #

Ans: E

Difficulty: 3edium17. ;e can epect the *9-curve to "et steeper, asA money demand !ecomes less sensitive to chan"es in the interest rate# the mar"inal propensity to save increasesC investment !ecomes more sensitive to chan"es in the interest rateD the income ta rate decreasesE the ependiture multiplier increases

Ans: #

Difficulty: 3edium11. ;hich of the followin" is %E as we move alon" the *9-curveA a lower interest rate is compati!le with a hi"her e'uili!rium output level# a hi"her e'uili!rium output level is compati!le with a hi"her interest rateC a lower e'uili!rium income level is compati!le with a hi"her level of transactions demand

for moneyD a hi"her interest rate is compati!le with a hi"her level of e'uili!rium income and therefore a

hi"her level of consumptionE a hi"her interest rate is compati!le with hi"her asset prices and therefore a hi"her level of

savin"Ans: A

Difficulty: 3edium1$. ;e can epect the *9-curve to !ecome flatter asA the supply of money decreases# the mar"inal propensity to consume decreasesC the income ta rate increasesD investment !ecomes more sensitive to interest rate chan"esE money demand !ecomes more sensitive to interest rate chan"esAns: D

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Difficulty: Easy1). ;hich of the followin" "overnment policy actions will result in a parallel shift of the *9-

curve to the leftA a decrease in "overnment purchases

# an increase in "overnment purchasesC an increase in transfer paymentsD a decrease in the income ta rateE an increase in the income ta rateAns: A

Difficulty: 3edium1/. ;hich of the followin" will >?% cause a shift of the *9-curveA a chan"e in transfer payments

# a chan"e in taesC a chan"e in money demandD a chan"e in !usiness and consumer confidenceE a chan"e in autonomous savin"Ans: C

Difficulty: 3edium10. *f there is an increase in the income ta rate, then the *9-curve willA !ecome flatter and shift to the ri"ht# !ecome steeper and shift to the leftC !ecome steeper and shift to the ri"htD shift parallel to the leftE shift parallel to the ri"htAns: #

Difficulty: 3edium1. %he *9-curve will !ecome flatter ifA money demand increases# investment !ecomes less sensitive to chan"es in the interest rateC the mar"inal propensity to save increasesD the income ta rate is reducedE either # or C occursAns: D

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Difficulty: 3edium12. A decrease in autonomous investmentA results in a shift of the *9-curve to the left

# results in a shift of the *9-curve to the ri"htC occurs as we move alon" the *9-curve from ri"ht to leftD occurs as we move alon" the *9-curve from left to ri"htE is caused !y an increase in "overnment ependituresAns: A

Difficulty: 3edium14. ;hich of the followin" is the e'uation for the *9-curve

A i = &1@!Ao + &!@Y

# i = &1@!AoP &!@YC i = &6@hY + &1@h&3@D i = &6@hY P &1@h&3@E B = 6Y P hiAns: #

Difficulty: 3edium18. *n an *9-B3 model, any point that is to the left and !elow the *9-curve indicates a situation

where

A there is ecess demand for "oods and services in the ependiture sector# there is ecess supply of "oods and services in the ependiture sectorC the ependiture sector is in e'uili!rium !ut the money sector is notD there is ecess demand for money in the money sectorE there is ecess supply of money in the money sectorAns: A

Difficulty: Easy

$7. *f the 'uantity of money demanded eceeds the 'uantity supplied at the current interest rate,thenA !ond prices and the interest rate will !oth rise# !ond prices and the interest rate will !oth fallC !ond prices will rise and the interest rate will fallD !ond prices will fall and the interest rate will rise

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E the value of !oth stoc6s and !onds will increaseAns: D

Difficulty: 3edium$1. eople will hold more money if they epectA !ond prices to rise# yields on !onds to fallC yields on !onds to riseD the "overnment !ud"et surplus to increaseE to "et paid more fre'uentlyAns: C

Difficulty: Easy$$. *f the central !an6 increases money supply, then real money !alances will rise andA so will the interest rate# the interest rate will fallC the B3Pcurve will shift to the leftD the *9-curve will shift to the ri"htE asset prices will fallAns: #

Difficulty: Easy$). *n the money sector, other thin"s !ein" the same, an increase in the supply of money will

causeA a decrease in the demand for !onds# a decrease in interest ratesC a decrease in !ond pricesD a decrease in stoc6 valuesE !oth C and DAns: #

Difficulty: 3edium$/. %he B3-curveA shows the relationship !etween the interest rate and the level of investment spendin"# is ne"atively sloped !ecause increases in the income level can only !e achieved if the interest

rate is lowered

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C is ne"atively sloped since increases in money supply always lower interest ratesD is upward slopin" !ecause a hi"her income level is always associated with a hi"her nominal

money supplyE shows com!inations of the interest rate and the income level such that money supply and

money demand are e'ual

Ans: E

Difficulty: 3edium$0. %he B3-curve !ecomes steeper ifA money demand !ecomes less sensitive to chan"es in the interest rate# money demand !ecomes more sensitive to chan"es in the interest rateC investment !ecomes more sensitive to chan"es in the interest rateD investment !ecomes less sensitive to chan"es in the interest rateE money demand !ecomes less sensitive to chan"es in income

Ans: A

Difficulty: 3edium$. *f we chan"e the assumption that money supply is fied !ut instead assume that the amount

of money supplied increases as the interest rate increases, thenA the B3-curve will !ecome flatter# the B3-curve will !ecome steeperC the B3-curve will shift to the leftD monetary policy will !e more effectiveE !oth A and DAns: A

Difficulty: Difficult$2. *f money demand !ecomes more income elastic, then the B3-curve willA shift parallel to the ri"ht# shift parallel to the leftC !ecome steeperD !ecome flatterE !ecome flatter and shift to the ri"htAns: C

Difficulty: Easy

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$4. ;hich of the followin" will result in a parallel shift of the B3-curve to the ri"htA an increase in interest rates# an increase in autonomous savin"C an increase in money supplyD an increase in money demand

E an increase in investmentAns: C

Difficulty: 3edium$8. *n an *9-B3 model, an increase in the money supply willA lower interest rates and therefore decrease the level of savin" and investment# lower interest rates, stimulate investment spendin", and increase national incomeC lower interest rates and !ond prices and decrease money demandD stimulate investment spendin", shiftin" !oth the B3- and *9-curves to the ri"ht

E increase "overnment spendin" since more funds !ecome availa!leAns: #

Difficulty: 3edium)7. ;hich of the followin" is the e'uation for the B3-curveA B= 6Y + hi# B = 6Y P hiC i = &6@hY + &1@h&3@D i = &1@hG6Y P &3@H

E i = &1@!Ao - &!@YAns: D

Difficulty: 3edium)1. *f there is a decrease in "overnment transfer paymentsA the *9-curve will !ecome flatter and shift to the ri"ht# the *9-curve will !ecome steeper and shift to the leftC the *9-curve will shift to the leftD the B3-curve will shift to the left

E the B3-curve will !ecome steeper and shift to the leftAns: C

Difficulty: 3edium

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)$. *n an *9-B3 model, a decrease in the level of "overnment purchases will result inA a decrease in the level of consumption# an increase in the level of investmentC an increase in real money !alancesD a decrease in money supply

E !oth A and #Ans: E

Difficulty: 3edium)). *n an *9-B3 model, a decrease in autonomous savin" willA decrease income !ut increase the interest rate# shift the B3-curve to the leftC shift the *9-curve to the leftD increase !oth income and the interest rate

E decrease !oth income and the interest rateAns: D

Difficulty: 3edium)/. *n an *9-B3 model, an increase in money supply willA increase income, the interest rate and investment# increase income !ut decrease the interest rate and investmentC increase income and investment !ut decrease the interest rateD increase income and consumption !ut leave the interest rate unchan"edE increase the interest rate and investment !ut leave consumption unchan"edAns: C

Difficulty: 3edium)0. *n an *9-B3 model, an increase in the personal income ta rate willA lower consumption and the interest rate !ut increase investment# lower consumption and investment !ut increase the interest rateC increase a""re"ate money demand and therefore cause interest rates to increaseD increase the ependiture multiplierE decrease real money !alancesAns: A

Difficulty: 3edium

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). *n an *9-B3 model, an increase in autonomous spendin"A is caused !y a fall in the interest rate# will cause a fall in the interest rateC will lead to an increase in income and the interest rateD will shift the B3-curve to the ri"ht

E is caused !y a movement alon" the *9-curve from left to ri"htAns: C

Difficulty: Difficult)2. *n an *9-B3 model, if the "overnment decides to cut welfare spendin",A the interest rate will decrease while personal savin" will increase# the interest rate and the level of consumption will !oth decreaseC the interest rate will decrease while income ta revenue will increaseD the federal !ud"et deficit will decrease and the level of output will increase

E none of the a!oveAns: #

Difficulty: 3edium)4. *n an *9-B3 framewor6, a decrease in money supply will lead toA an increase in a""re"ate money demand# an increase in !oth income and the interest rateC an increase in the interest rate and a decrease in incomeD a decrease in the si(e of the monetary policy multiplierE !oth A and CAns: C

Difficulty: 3edium)8. 3onetary policy !ecomes more effective asA the interest sensitivity of investment increases# money demand !ecomes less sensitive to chan"es in the interest rateC the mar"inal propensity to save decreasesD the income ta rate decreasesE all of the a!oveAns: E

Difficulty: 3edium

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/7. %he monetary policy multiplier is lar"e ifA the B3-curve is steep and the *9-curve is flat# the B3-curve is flat and the *9-curve is steepC money demand is very interest sensitiveD investment is very interest insensitive

E !oth money supply and money demand are very interest sensitiveAns: A

Difficulty: Difficult/1. *f the mar"inal propensity to save suddenly increases, thenA the si(e of the fiscal policy multiplier will !ecome lar"er# the si(e of the monetary policy multiplier will increaseC the *9-curve will !ecome steeperD the *9-curve will shift to the ri"ht and income will increase

E income will increase !ut the interest rate will decreaseAns: C

Difficulty: 3edium/$. An increase in the fiscal policy multiplier can !e caused !yA an increase in the interest sensitivity of investment# an increase in the interest sensitivity of money demandC a decrease in the interest sensitivity of money demandD an increase in the income ta rateE a decrease in autonomous savin"Ans: #

Difficulty: 3edium/). An increase in the interest sensitivity of money demand willA increase the si(e of the monetary policy multiplier# decrease the si(e of the monetary policy multiplierC ma6e fiscal policy less effectiveD ma6e the B3-curve steeperE !oth A and DAns: #

Difficulty: 3edium

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//. *f investment !ecomes more sensitive to chan"es in the interest rate, thenA the si(e of the fiscal policy multiplier will decrease# the si(e of the fiscal policy multiplier will increaseC the si(e of the monetary policy multiplier will decreaseD the si(e of the monetary policy multiplier will increase

E !oth A and DAns: E

Difficulty: Difficult/0. *f money demand !ecomes more sensitive to chan"es in income, thenA the B3-curve will !ecome flatter# the B3-curve will !ecome steeperC the AD-curve will !ecome flatterD fiscal policy will !e more effective

E !oth # and CAns: E

Difficulty: 3edium/. A decrease in the income ta rate willA decrease the fiscal policy multiplier# increase the slope of the *9-curveC decrease the monetary policy multiplierD decrease the slope of the AD-curveE !oth A and #Ans: D

Difficulty: Difficult/2. %he movement alon" the AD-curve from left to ri"ht is e'uivalent to a shift ofA the B3-curve to the ri"ht due to an increase in real money !alances# the *9-curve to the ri"ht due to a decrease in interest ratesC the B3-curve to the ri"ht due to an increase in nominal money supplyD the *9-curve to the ri"ht due to a lower price levelE !oth the *9- and B3-curves to the ri"ht due to more spendin" and hi"her money !alancesAns: A

Difficulty: Difficult

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/4. %he slope of the AD-curve will !ecome flatter ifA money demand !ecomes more income inelastic# money demand !ecomes more interest elasticC investment !ecomes more interest elasticD the mar"inal propensity to save increases

E !oth A and CAns: E

/8. %he slope of the AD-curve will !ecome steeper ifA money demand !ecomes more income inelastic# money demand !ecomes more interest elasticC investment !ecomes more interest elastic

D the income ta rate is decreasedE none of the a!oveAns: #

Difficulty: 3edium07. ;hich of the followin" is the e'uation for the AD-curve

A Y = &AoP !i# Y = &h@6i + &1@6&3o@o

C Y = A - &!@h&3o@o

D Y = A + &!@h&3o@E = &6@hY P &1@hiAns: D

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Technical Problems

1.a. Each point on the *9-curve represents an e'uili!rium in the ependiture sector. &>ote that this is a closedeconomy, that is, >K = 7. %he *9-curve can !e derived !y settin" actual income e'ual to intended spendin", or

Y = C + * + < = &7.4G1 - &7.$0HY + 877 - 07i + 477 = 1,277 + &7.Y - 07i ==

&7./Y = 1,277 - 07i == Y = &$.0&1,277 - 07i == * " +,50 & 15i. IS&cr-e

1.b. %he *9-curve shows all com!inations of the interest rate and the output level such that the ependiture sector&the "oods mar6et is in e'uili!rium, that is, actual output e'uals intended spendin". A decrease in the interestrate stimulates investment spendin", ma6in" intended spendin" "reater than actual output. %he resultin"unintended inventory decrease leads firms to increase their production until actual output is a"ain e'ual tointended spendin". %his means that the *9-curve is downward slopin".

1.c. Each point on the B3-curve represents an e'uili!rium in the money sector. %herefore the B3-curve can !ederived !y settin" real money supply e'ual to real money demand, that is,

3@ = B == 077 = &7.$0Y - $.0i == Y = /&077 + $.0i

== * " ,000 ' 50i. (&cr-e

1.d. %he B3-curve shows all com!inations of the interest rate and level of output such that the money sector is ine'uili!rium, that is, the demand for real money !alances is e'ual to the supply of real money !alances. Anincrease in income will increase the demand for real money !alances.

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rom *9 = B3 == /,$07 - 1$0i = $,777 + $07i == $,$07 = )20i == i " /

== Y = /,$07 - 1$0F = /,$07 - 207 == * " $,500

Chec:Y = $,777 + $07F = $,777 + 1,077 = ),077

i

1$0 *9

B3

7 $,777 ),077 /,$07 Y

.a. As we have seen in 1.a., the value of the ependiture multiplier is = $.0. %his multiplier is derived in the sameway as in Chapter 8. #ut now intended spendin" also depends on the interest rate, so we no lon"er have Y =

Ao, !ut rather

Y = &Ao- !i = &1@G1 - c + ctH&Ao- !i == Y = &$.0&1,277 - 07i = /,$07 - 1$0i.

.b. *n the *9-B3 model, an increase in "overnment purchases &

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.d. %he simple multiplier = $.0 in .a.shows the ma"nitude of the hori(ontal shift in the *9-curve, "iven a chan"ein autonomous spendin" !y one unit. #ut an increase in income increases money demand and this leads to anincrease in the interest rate. %he hi"her interest rate crowds out some investment spendin" and this has adampenin" effect on the level of output. %he multiplier effect in .b.is therefore smaller than the multiplier

effect in .a., and has !een reduced to 1= 1,2.

$.a. An increase in the income ta rate &t will reduce the si(e of the ependiture multiplier & . #ut as theependiture multiplier !ecomes smaller, the *9-curve !ecomes steeper. As we can see from the e'uation for the*9-curve, a chan"e in the income ta rate &t will cause a rotation around its vertical intercept, as is shown!elow:

Y = &Ao- !i = G1@&1 - c + ctH&Ao- !i

== i = &1@!Ao- &@!Y = &1@!AoP G&1 - c + ct@!HY.

*n other words, as the income ta rate &t "ets lar"er, the slope of the *9-curve "ets steeper, while the verticalintercept remains unaffected.

$.b. *f the *9-curve shifts to the left and !ecomes steeper, the e'uili!rium income level will decrease.A hi"her ta rate will reduce private spendin" and this will lead to a lower level of nationalincome.

$.c. *91 i *9$ B3

i1

i$

7 Y$ Y1 Y

As we can see from the dia"ram a!ove, the e'uili!rium level of income and the interest rate !oth decrease whenthe income ta rate is increased. %he adustment to the new e'uili!rium can !e epressed as follows:

t R == C S == Y S == mdS == i S == * R == Y R. 2##ect: * and i

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5.%he price adustment, that is, movement alon" the AD-curve, can !e eplained in the followin"way: ;ith nominal money supply &3 fied, real money !alances &3@ decrease as the pricelevel & increases. %his causes an ecess demand for money and interest rates rise, leadin" to alower level of investment spendin". %hus, the level of output demanded decreases. *n otherwords, as the price level increases and we move from ri"ht to left alon" the AD-curve, realmoney !alances decrease and the B3-curve shifts to the left, reachin" a new simultaneous

e'uili!rium in the ependiture and money sectors at a hi"her price level, a hi"her interest rate,and a lower level of output.

/. %he classical A9-curve is vertical at the full-employment level of output. *n this case, anyincrease in a""re"ate demand due to epansionary monetary policy will lead to an increase inthe price level !ut no increase in the level of output. An increase in money supply will firstshift the B3-curve to the ri"ht. %his implies a shift of the AD-curve to the ri"ht, causin" anecess demand for "oods and services. As the price level !e"ins to rise, real money !alances!e"in to fall a"ain, eventually returnin" to their ori"inal level. %his implies that the shift ofthe B3-curve to the ri"ht due to the epansionary monetary policy &and the resultin" shift ofthe AD-curve will !e eactly offset !y the price adustment, which causes the B3-curve toshift !ac6 to the left &resultin" in a movement alon" the AD-curve to the new lon"-rune'uili!rium. At the new lon"-run e'uili!rium, the level of output and interest rates will nothave chan"ed while the price level will have chan"ed proportionally to the nominal moneysupply, leavin" real money !alances unchan"ed. *n other words, money is neutral in the lon"run &the classical case.

7.a. A decrease in the demand for money will lower the interest rate and increase the level ofoutput demanded, that is, it will shift the B3-curve to the ri"ht. As a result, the AD-curve willalso shift to the ri"ht. *n the eynesian case, the price level is assumed to !e fied, that is, theA9-curve is hori(ontal. *n this case, the increase in the output level in the AD-A9 dia"ram ise'uivalent to the increase in the output level in the *9-B3 dia"ram, since there is no price

adustment. *n other words, the real !alance effect does not come into play since the price leveldoes not chan"e.

7.b. A decrease in the demand for money will lower the interest rate and increase the level ofoutput demanded, that is, it will shift the B3-curve to the ri"ht. As a result, the AD-curve

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will also shift to the ri"ht. *n the classical case, the level of output will not chan"e, since theA9-curve is vertical. *n this case, the shift in the AD-curve will simply !e reflected in a priceincrease, !ut the level of output will remain unchan"ed. %he real !alance effect causes theB3-curve to shift !ac6 to its ori"inal level, since the price increase causes a decrease in realmoney !alances.

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Chapter 11: (onetar) and 3iscal Polic)

Difficulty: Easy

1. A chan"e in which of the followin" will >?% shift the *9-curveA autonomous investment# autonomous money demandC autonomous consumptionD autonomous net eportsE autonomous savin"Ans: #

Difficulty: 3edium

$. *f money supply is held constant, a cut in "overnment transfer payments will eventuallycause interest rates toA decline, enhancin" the epansionary impact of the policy# decline, decreasin" the restrictive impact of the policyC increase, decreasin" the epansionary impact of the policyD increase, decreasin" the restrictive impact of the policyE increase, enhancin" the restrictive impact of the policyAns: #

Difficulty: 3edium). *n an *9-B3 model, if the "overnment enacts restrictive fiscal policy throu"h a ta increase

or a cut in "overnment purchases,A the interest rate will decline, lowerin" the incentive to save and thus also the level of

investment spendin"# the level of income will decrease !ut the interest rate will increaseC !oth income and the interest rate will decreaseD the B3-curve will shift to the leftE the *9-curve will shift to the left, followed !y a shift of the B3-curve to the left since this

policy will chan"e interest rates and therefore money demandAns: C

Difficulty: Easy/. ;hen the "overnment employs a Mti"ht fiscal policy,N we should epect thatA the level of output will only !e affected !y a small amount

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# interest rates will increaseC monetary policy will !e TeasyT at the same timeD inflation will !e lowered more than unemploymentE the !ud"et deficit will decreaseAns: E

Difficulty: 3edium0. ?ne side effect of epansionary fiscal policy is thatA hi"her interest rates cause a chan"e in the composition of

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4. 3onetary policy !ecomes less effective asA the mar"inal propensity to consume increases# the interest sensitivity of money demand decreasesC the interest sensitivity of investment decreasesD the B3-curve !ecomes steeper

E the *9-curve !ecomes flatterAns: C

Difficulty: Easy8. %he li'uidity trap eists whenA the *9-curve is vertical# the B3-curve is verticalC the B3-curve is hori(ontalD an increase in "overnment spendin" is always fully crowded out

E money demand is completely insensitive to chan"es in the interest rateAns: C

Difficulty: 3edium17. *f we have a normal *9-curve !ut a hori(ontal B3-curve,A fiscal policy is the most effective way to reduce unemployment# fiscal policy is at its wea6est in reducin" unemploymentC monetary policy can aid fiscal policy in reducin" unemploymentD monetary policy is the most effective way to reduce unemploymentE neither fiscal nor monetary policy is effective in reducin" unemploymentAns: A

Difficulty: 3edium11. *n an *9-B3 model, if we assume that money demand is completely insensitive to chan"es in

the interest rate,A fiscal policy cannot chan"e the level of output !ut will chan"e the composition of

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Difficulty: Easy1$. %he view that Tonly money mattersT is accurate whenA investment is completely interest insensitive# money demand is completely interest inelasticC money demand is completely interest elastic

D we are in the li'uidity trapE !oth C and DAns: #

Difficulty: 3edium1). ;hen the B3-curve is vertical,A the monetary policy multiplier is (ero# monetary policy is at its wea6est !ut fiscal policy has a maimum effect on incomeC monetary policy has a maimum effect, !ut fiscal policy has no effect on income

D fiscal policyIs impact on interest rates will not affect investmentE monetary policy affects interest rates !ut no chan"e in investment spendin" resultsAns: C

Difficulty: 3edium1/. %he B3-curve is vertical whenA the interest elasticity of investment is (ero# the central !an6 6eeps nominal money supply constantC we are in the classical caseD we are in the li'uidity trapE none of the a!oveAns: C

Difficulty: Difficult10. ;hich of the followin" descri!es a part of the transmission mechanismA a chan"e in real money !alances causes a portfolio dise'uili!rium and asset holdersI

reactions influence interest rates# an income ta rate cut stimulates private spendin" !ut the resultin" interest rate increase

dampens the income epansionC the central !an6 underta6es open mar6et purchases and the resultin" interest rate increase

encoura"es people to save moreD an increase in "overnment spendin" is partially offset !y the crowdin" out of private

investmentE !oth # and D

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Ans: A

Difficulty: 3edium

1. *n the classical case,A the fiscal policy multiplier is (ero# crowdin" out cannot occurC investment does not respond to interest rate chan"esD an increase in the income ta rate cannot lower the !ud"et deficitE monetary policy is totally ineffectiveAns: A

Difficulty: 3edium

12. %he transmission mechanismA is the process !y which fiscal policy affects a""re"ate demand# wor6s !est if money demand is completely interest elasticC fails if none of the components of a""re"ate demand responds to chan"es in interest ratesD relates to the effects of ta rate chan"es on the fiscal multiplierE all of the a!oveAns: C

Difficulty: 3edium14. %he transmission mechanism !etween an open mar6et purchase !y the central !an6 and an

increase in a""re"ate demand can !rea6 down ifA !an6s are unwillin" to lend to private firms# money demand is totally interest inelasticC investment is very interest sensitiveD !ond prices increase too muchE none of the a!oveAns: A

Difficulty: 3edium18. *f the ed underta6es open mar6et sales, thenA the B3-curve will shift to the ri"ht# the B3-curve will shift to the leftC interest rates will decrease and income will increaseD !ond prices will increase

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E !oth A and CAns: #

Difficulty: 3edium$7. *f investment is not very sensitive to interest rate chan"es,A fiscal policy will !e lar"ely ineffective in chan"in" output# monetary policy will !e very effective in chan"in" outputC the economy is in the classical caseD monetary policy cannot !e used to lower interest ratesE the si(e of the crowdin" out effect followin" epansionary fiscal policy will !e smallAns: E

Difficulty: 3edium$1. iscal policy is wea6est and monetary policy is stron"est whenA we are in the li'uidity trap# money demand is very interest elasticC investment is very interest inelasticD we are in the classical caseE the *9-curve is very steep and the B3-curve is very flatAns: D

Difficulty: 3edium$$. iscal policy !ecomes more powerful in chan"in" the level of output asA investment !ecomes more interest elastic# money demand !ecomes more interest inelasticC money demand !ecomes more income elasticD the mar"inal propensity to save "ets smallerE the mar"inal propensity to consume "ets smallerAns: D

Difficulty: Difficult$). Assume we com!ine restrictive monetary policy with epansionary fiscal policy. ;hich is

most li6ely to occurA unemployment and interest rates will !oth "o down# unemployment will "o down !ut interest rates will stay the sameC investment and consumption will !oth increase

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D interest rates and the !ud"et deficit will !oth decreaseE investment will decrease and the !ud"et deficit will increaseAns: E

Difficulty: 3edium$/. Assume the "overnment cuts the level of "overnment purchases and the ed responds !y

increasin" money supply. ;hich of the followin" is the most li6ely resultA lower interest rates and a hi"her !ud"et surplus# a lar"e decrease in the interest rate and outputC a decrease in investment and the !ud"et deficitD an increase in consumption and lower ta revenuesE a decrease in consumption and investmentAns: A

Difficulty: 3edium$0. 3onetary policy is said to !e accommodatin" whenA the central !an6 underta6es open mar6et sales to fi"ht inflation# the central !an6 responds to a ta increase !y increasin" money supplyC the central !an6 responds to fiscal epansion !y underta6in" open mar6et salesD in the course of fiscal epansion, the central !an6 increases money supply to prevent interest

rates from risin"E the central !an6 does not interfere in any way when the "overnment underta6es fiscal policyAns: D

Difficulty: 3edium$. A policy mi desi"ned to promote economic "rowth throu"h an increase in investment mi"ht

involveA open mar6et sales com!ined with income ta cuts# a "overnment spendin" increase financed !y a ta increaseC cuts in "overnment purchases com!ined with hi"her investment ta creditsD an increase in "overnment purchases com!ined with monetary restrictionE removal of investment su!sidiesAns: C

Difficulty: 3edium$2. Assume that policy mi A com!ines restrictive monetary policy with epansionary fiscal

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policy, while policy mi # com!ines epansionary monetary policy with restrictive fiscalpolicy. Compared to policy mi #, policy mi A will cause

A a lower level of investment# a hi"her level of investmentC a lower level of consumption

D a hi"her level of savin"E !oth C and DAns: A

Difficulty: 3edium$4. Epansionary fiscal policy can !e successful without a ne"ative impact on the level of

investment ifA the "overnment spendin" increase is financed !y a ta increase# the ed underta6es open mar6et sales at the same time

C it is implemented via an investment su!sidy rather than a cut in personal income taesD money demand is completely interest inelasticE it is implemented throu"h a cut in personal income taes rather than an increase in

"overnment purchasesAns: C

Difficulty: Easy$8. Crowdin" out occurs whenA an increase in defense spendin" causes a decrease in consumption# epansionary monetary policy fails to stimulate economic "rowthC epansionary fiscal policy causes interest rates to rise, there!y reducin" private spendin"D ta increases result in a drop in consumptionE a policy desi"ned to increase the !ud"et surplus causes the economy to enter a recessionAns: C

Difficulty: 3edium)7. *n a normal *9-B3 framewor6, crowdin" out may !e avoided ifA !an6s ration credit# the "overnment matches a ta increase with an increase in "overnment purchasesC the central !an6 increases the money supply to accommodate fiscal epansionD the central !an6 sells "overnment !onds on a lar"e scaleE !oth C and DAns: C

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Difficulty: 3edium)1. *n an *9-B3 framewor6, fiscal epansion "enerally leads to income epansionA only if it is com!ined with monetary epansion

# ecept if we are in the li'uidity trapC !ut interest rates will increase, leadin" to a lower level of savin"D !ut the composition of output will chan"eE !ut most consumption spendin" will !e crowded outAns: D

Difficulty: 3edium)$. %he crowdin" out effect is (ero ifA the B3-curve is hori(ontal

# the B3-curve is verticalC the central !an6 conducts open mar6et sales followin" fiscal epansionD income is stimulated via a ta cut rather than an increase in "overnment spendin"E none of the a!oveAns: A

Difficulty: 3edium)). Crowdin" outA does not occur in the li'uidity trap# is caused !y a rise in interest rates resultin" from epansionary fiscal policiesC cannot happen if the B3-curve is hori(ontalD cannot happen if the *9-curve is verticalE all of the a!oveAns: E

Difficulty: Easy)/. Assume the "overnment wants to increase the level of consumption and investment. ;hich

of the followin" policies should !e implementedA hi"her investment ta credits# removal of investment su!sidies com!ined with monetary restrictionC an income ta cut com!ined with monetary restrictionD an increase in "overnment transfer payments to low income households financed !y a ta

increase on hi"h income householdsE none of these

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Ans: A

Difficulty: 3edium

)0.

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D 1847sE 1887sAns: E

Difficulty: Easy)8. ;hen conductin" monetary policy, a central !an6 shouldA never moneti(e the !ud"et deficit since this will lower the level of investment# !e less concerned with current conditions than with future conditionsC always try to 6eep interest rates lowD always respond to epansionary fiscal policy !y epandin" money supplyE none of the a!oveAns: #

Difficulty: 3edium/7. *n an *9-B3 model, which is most li6ely to occurA epansionary fiscal policy will not !e crowded out if the ed underta6es open mar6et sales at

the same time# epansionary monetary policy will increase the level of spendin" on investment and

consumptionC increased "overnment spendin" will not affect the level or the composition of K = >Ko,

!ut instead is assumed to decrease as the level of income increases &that is, >K = >KoP mY,with m 7, then

A the *9-curve will !ecome steeper and shift to the left# the *9-curve will !ecome flatter and shift to the ri"htC the B3-curve will !ecome steeper and shift to the leftD the B3-curve will !ecome flatter and shift to the ri"htE the fiscal policy multiplier will !ecome lar"erAns: A

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Difficulty: Difficult/$. Assume the "overnment wants to 6eep national income sta!le !ut chan"e the composition of

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C interest rates !y one percentD interest rates !y one-tenth of a percentE interest rates !y one-hundredth of a percentAns: E

Difficulty: Easy/. Durin" the recession of $772-78, the .9. edA lowered the federal funds rate to almost (ero percent# !ou"ht lar"e num!ers of securities that were !ac6ed !y private mort"a"esC too6 actions that increased the monetary !ase to more than dou!le its ori"inal si(eD made loans to tar"eted sectors of the financial mar6etE all of the a!oveAns: E

Difficulty: Easy/2. Durin" the recession of $772-78 in the nited 9tates,A the monetary !ase more than dou!led !ut 3-$ did not, as !an6s were reluctant to fund loans# short-term interest rates fell close to (ero percent, so the ed felt compelled to !uy lar"e

'uantities of financial assets to reduce lon"-term interest ratesC a stron" fiscal stimulus pac6a"e intended to stimulate a""re"ate demand was implementedD all of the a!oveE only A and CAns: D

Difficulty: 3edium/4. An interestin" aspect of the recession of 1887@81 was thatA !ecause of risin" oil prices, the inflation rate did not fall# unemployment and inflation !oth increased sharply all throu"h 1881C fiscal policy was hi"hly restrictive and the ed was very inactiveD fiscal policy was immo!ili(ed due to a lar"e !ud"et deficit, while monetary policy did not

wor6 well due to credit rationin" !y !an6sE while the war a"ainst *ra' stimulated the economy, the ed restricted money supplyAns: D

Difficulty: 3edium/8. ;hich of the followin" is %E

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A the

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Combined e##ect: * sta)s abot the same 4hile i goes do4n.

i B31 *91

*9$ B3$i1 1

i$ $

i) )

7 Y$ Y1 Y

. A cut in the income ta rate will flatten the *9-curve and shift it to the ri"ht. #oth the level ofincome and the interest rate will increase. *f the ed increases money supply to 6eep theinterest rate constant, the B3-curve will also shift to the ri"ht, maimi(in" the multipliereffect, since no crowdin" out will ta6e place. Qowever, if money supply is held constant, theB3-curve will not shift and the overall effect on income will !e wea6ened, since the increasein the interest rate will crowd out investment.

i *9$

*91 B31 B3$

$ i$

1 ) i1

7 Y1 Y$ Y) Y

%he adustment process is as follows:

1--$: t == C == Y == md == i == * == Y E##ect: * and i .

$--): &3@ == i == * == Y == md == i 2##ect: * and i .Combined e##ect: * goes p 4hile i sta)s abot the same.

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$. Either a removal of an investment su!sidy or an increase in the income ta rate will shift the*9-curve to the left. %his will lead to a decrease in income and the interest rate. Qowever, theeffects on the composition of

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interest rate will increase investment spendin" a"ain and we will move alon" the newinvestment schedule from left to ri"ht. %hus the effect of the shift will !e partially offset !ythe decrease in the interest rate. ?verall, we will have a decrease in the levels of income,consumption, and investment.

%his time, the adustment process can !e descri!ed as follows:

1--$: *o== Y == md== i == * == Y . 2##ect: * and i .

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+. Epansionary monetary policy will lower interest rates, which will stimulate investment andthus output. %he B3-curve will shift to the ri"ht, and a new e'uili!rium will !e reached atpoint E$in i"ure 11-4.

iscal epansion will increase output and interest rates. %he *9-curve will shift to theri"ht and a new e'uili!rium can !e reached at point E1in i"ure 11-4. 3onetary epansion will increase spendin" on investment &due to lower interest rates

and consumption &due to an increase in income. eople or firms who would !enefit from areduction in interest rates or who advocate pro-"rowth policies clearly would favor thispolicy chan"e over fiscal epansion.iscal epansion throu"h an increase in "overnment purchases will allow pu!lic spendin" asa share of

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Chapter 1: International inages

Difficulty: Easy1. %he record of international trade in "oods and services and international transfer payments iscalled

A the !alance of payments# the capital accountC the current accountD the forei"n accountE the echan"e rate accountAns: C

Difficulty: Easy$. *f a rench citi(en !uys 177 shares of *#3 stoc6 on the >ew Yor6 9toc6 Echan"e, the

transaction will !e recorded asA a surplus item in the capital account# a deficit item in the capital accountC a surplus item in the current accountD a deficit item in the current accountE a decrease in ranceIs

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A a

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# forei"n incomeC the real echan"e rateD the differential !etween domestic and forei"n interest ratesE all of the a!oveAns: E

Difficulty: 3edium8. *f the price level of .9. "oods is $77, the price level of forei"n "oods is 1$0, and the dollar

price of forei"n currency is 1.$7, what is the real echan"e rateA 1.8$# 1.7C 1.7/D 7.20E 7.)

Ans: D

Difficulty: 3edium17. *f the real echan"e rate is 1.47, the .9. price level is 1$7, and the forei"n price level is $/7,

what is the dollar price of forei"n echan"eA ).# $.7C 7.8D 7.4E 7.0Ans: C

Difficulty: 3edium11. *f the real echan"e rate is 1.7, the price level of .9. "oods is 1$7, and the dollar price of

forei"n echan"e is 7.4, what is the price level of forei"n "oodsA 20# 47C 177D 1$7E 107Ans: E

Difficulty: Easy1$. *f the .9. real echan"e rate is "reater than 1, we can epect that

8-0

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A "oods in the .9., on avera"e, are more epensive than "oods a!road# "oods a!road, on avera"e, are more epensive than "oods in the .9.C forei"ners are less li6ely to !uy more .9. "oodsD the echan"e rate should increaseE domestic prices should decrease

Ans: #

Difficulty: Easy1). *f the real echan"e rate is e'ual to 1,A currencies are at purchasin" power parity# the relative demand for domestically produced "oods will riseC the relative demand for domestically produced "oods will fallD forei"n investors will try to !uy more domestic assetsE net eports is e'ual to (ero

Ans: A

Difficulty: 3edium1/. ;hich of the followin" is the e'uation for the real echan"e rateA = f@# = @fC = e&f@D = e@&@fE = e @&fP Ans: C

Difficulty: 3edium10. %he reason for the slow adustment of the real echan"e rate toward purchasin" power parity

is thatA there are always transportation costs involved in the movement of "oods across !orders# "overnments may have imposed tariffs on forei"n "oodsC certain "oods cannot !e tradedD people in different countries do not necessarily consume the same mar6et !as6et of "oodsE all of the a!oveAns: E

Difficulty: 3edium1. %he ease with which international investors can shift their assets around the world affectsA real echan"e rates

8-02

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# the a!ility of central !an6s to control interest ratesC national incomesD the a!ility of central !an6s to conduct monetary policyE all of the a!oveAns: E

Difficulty: 3edium12. ?ur countryVs net eports will increase ifA there is an increase in domestic income# there is a decrease in the real echan"e rateC there is an increase in domestic inflationD many of our trade partners eperience inflationE domestic interest rates rise due to epansionary fiscal policyAns: D

Difficulty: Easy14. %he !alance of payments measuresA the amount of forei"n echan"e intervention needed from the central !an6s# eports minus importsC the record of echan"e in "oods and servicesD the value of a representative !as6et of forei"n currencies in terms of the dollarE none of the a!oveAns: A

Difficulty: 3edium18. %he increase in the real echan"e rate showsA the increase in the ratio of domestic to forei"n prices# the increase in forei"n prices epressed in .9. dollars relative to prices of "oods produced in

the .9.C the decrease in forei"n prices epressed in .9. dollars relative to prices of "oods produced

in the .9.D the decrease in competitiveness of .9. "oodsE the decrease in the dollar price of forei"n echan"eAns: #

Difficulty: Easy$7. *f the dollar price of forei"n "oods increases, we can epect thatA .9. imports and .9. eports will !oth increase# .9. imports will decrease and .9. eports will increase

8-04

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C .9. imports will increase and .9. eports will decreaseD .9. imports will increase and .9. eports will stay the sameE .9. net eports will decreaseAns: #

Difficulty: Easy$1. Assume the Wapanese yen has appreciated relative to the .9. dollar. ;hich of the followin"

is trueA each dollar can now !uy more yen# each yen can now !uy more dollarsC each dollar can now !uy more Wapanese "oodsD the Wapanese central !an6 is forced to sell dollarsE !oth A and CAns: #

Difficulty: Easy$$. A real depreciation of the domestic currency willA improve the trade !alance and increase a""re"ate demand# improve the trade !alance and lower a""re"ate demandC improve the trade !alance !ut not affect a""re"ate demandD lower the trade !alance and a""re"ate demandE lower the trade !alance and increase a""re"ate demandAns: A

Difficulty: 3edium$). *f an increase in national income has a ne"ative effect on the trade !alance, we should epect

thatA domestic interest rates will rise, attractin" forei"n funds# domestic interest rates will fall, causin" an outflow of fundsC domestic assets will !ecome more epensiveD the central !an6 will epand money supplyE the central !an6 will !uy forei"n currency thus increasin" its reservesAns: A

Difficulty: 3edium$/. An increase in "overnment spendin" in Wapan shouldA affect the .9.

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C increase the .9.

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C increases .9. net eportsD !oth A and #E !oth A and CAns: D

Difficulty: 3edium$8. ;hen echan"e rates are fied and capital is perfectly mo!ile, monetary policyA is very effective in chan"in" the level of output# is completely ineffective in chan"in" the level of outputC is effective in chan"in" the level of output !ut not domestic interest ratesD can !e conducted independently of echan"e rate considerationsE will shift the B3-curve, !ut the *9-curve will have to shift su!se'uently since interest rates

canVt chan"eAns: #

Difficulty: 3edium)7. nder flei!le echan"e rates and perfect capital mo!ilityA monetary policy is ineffective while fiscal policy is very effective in chan"in" the level of

output# monetary and fiscal policy are !oth very effective in chan"in" the level of outputC monetary policy is effective while fiscal policy is ineffective in chan"in" the level of outputD monetary and fiscal policy are !oth fairly ineffective in chan"in" the level of outputE monetary and fiscal policy have to !e carefully coordinated if the level of output needs to !e

chan"edAns: C

Difficulty: Easy)1. *f echan"e rates are determined in the forei"n echan"e mar6et, they are neverA fied# flei!leC mana"edD floatin"E influenced !y actions of the central !an6Ans: A

Difficulty: 3edium)$. A fied echan"e rate system is in effectA a free mar6et system

8-1

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# an open mar6et systemC a price support systemD an international transactions systemE an international transfer systemAns: C

Difficulty: 3edium)). nder fied echan"e rates, when a forei"n central !an6 devalues its currency itA lowers the dollar price of its currency# raises the dollar price of its currencyC purchases dollars in the forei"n echan"e mar6etD sells dollars in the forei"n echan"e mar6etE adds a variety of other forei"n currencies to its reservesAns: A

Difficulty: Easy)/. *f capital is perfectly mo!ile internationally, thenA si"nificant differences in interest rates across countries can persist over a lon" time# one countryIs interest rates can !e su!stantially hi"her than the world interest rate over the

lon" runC countries with interest rates much lower than in the rest of the world will eperience an

outflow of capitalD an increase in .9. interest rates will worsen the .9. !alance of payments since .9. !an6s

are more willin" to lend internationallyE all of the a!oveAns: C

Difficulty: 3edium)0. *n a model with perfect capital mo!ility and flei!le echan"e rates, an increase in

"overnment purchases willA increase net eports !ut decrease private domestic investment# !e totally crowded !y a decrease in private domestic investment of the same ma"nitudeC crowd out net eports due to an echan"e rate appreciationD increase net eports due to a depreciation of the echan"e rateE increase consumption and net eports !ut decrease private domestic savin"Ans: C

Difficulty: Difficult

8-$

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). *n an *9-B3 model with flei!le echan"e rates and perfect capital mo!ility, a restriction inmoney supply will

A decrease the level of output permanently !ut increase the interest rate only temporarily# decrease !oth the level of output and the interest rate !ut only temporarilyC temporarily decrease the level of output and temporarily increase the interest rate

D shift the B3-curve first to the left and then !ac6 to the ri"ht as the central !an6 is forced to!uy forei"n currency reservesE !oth C and DAns: A

Difficulty: 3edium)2. *n a flei!le echan"e rate system with perfect capital mo!ility, if restrictive fiscal policy is

implemented, we will seeA a shift of the *9-curve to the left followed !y a depreciation of the currency and a su!se'uent

shift of the *9-curve !ac6 to its ori"inal position# a shift of the *9-curve to the left followed !y a depreciation of the currency and a su!se'uentshift of the B3-curve to the left, leavin" the domestic interest rate unchan"ed

C a shift of the *9-curve to the left followed !y an appreciation of the currencyD a shift of the B3-curve to the left followed !y an appreciation of the currency and a

su!se'uent shift of the B3-curve !ac6 to its ori"inal positionE a temporary decrease in the interest rate !ut a lon"-term decrease in the level of outputAns: A

Difficulty: Difficult)4. *n an *9-B3 model with fied echan"e rates and perfect capital mo!ility, a cut in

"overnment spendin" shifts the *9-curve to the leftA without affectin" the B3-curve# !ut then !ac6 to the ri"ht a"ain !ecause of the resultin" increase in net eportsC !ut then the central !an6 is forced to restrict the money supply, so the B3-curve also shifts to

the leftD !ut then the central !an6 is forced to epand money supply, so the B3-curve shifts to the

ri"htE !ut then a capital inflow from a!road results, forcin" the "overnment to reverse its policyAns: C

Difficulty: 3edium)8. *n a model with perfect capital mo!ility and flei!le echan"e rates, which of the followin"

is AB9EA an increase in eports has no lastin" effect on the e'uili!rium output level# an increase in eports is eactly offset !y an decrease in investment

8-)

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C an increase in eports leads to a currency appreciation and an increase in importsD an increase in eports increases domestic interest rates !ut only temporarilyE an increase in eports leads to an inflow of funds from a!roadAns: #

Difficulty: 3edium/7. *n an *9-B3 model with flei!le echan"e rates and perfect capital mo!ility, restrictive fiscal

policy willA cause an appreciation of the domestic currency# shift first the B3-curve and then the *9-curve to the leftC not chan"e the overall level of output, !ut will chan"e its compositionD cause a decrease in net eportsE lower the level of output !ut leave the interest rate unchan"edAns: C

Difficulty: Easy/1. *n a model with flei!le echan"e rates and capital mo!ility, epansionary fiscal policy is

li6ely to causeA a currency depreciation# an increase in the current account surplusC a reduction in net eportsD a decrease in importsE an outflow of fundsAns: C

Difficulty: Easy/$. *n an *9-B3 model with flei!le echan"e rates and perfect capital mo!ility, a decrease in

the income ta rate willA initially stimulate the economy !ut in the end not chan"e the e'uili!rium level of output# increase the domestic interest rate !ut only temporarilyC cause a chan"e in the composition of outputD cause an inflow of funds that will lead to an appreciation of the domestic currencyE all of the a!oveAns: E

Difficulty: 3edium/). *n a flei!le echan"e rate system with perfect capital mo!ilityA epansionary monetary policy will appreciate the domestic currency

8-/

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# fiscal epansion is very effective in stimulatin" a""re"ate demandC fiscal epansion causes a depreciation of the domestic currencyD the domestic interest rate canVt su!stantially deviate from the world interest rate for very lon"E all of the a!oveAns: D

Difficulty: Easy//. A country followin" a !e""ar-thy-nei"h!or policy isA inducin" an echan"e rate depreciation to increase domestic output# inducin" an echan"e rate appreciation to create unemployment in other countriesC imposin" a ta on "oods that are eportedD imposin" tariffs on importsE as6in" other nations for forei"n aidAns: A

Difficulty: Difficult/0. *n an open economy *9-B3 model with perfect capital mo!ility and flei!le echan"e rates,

restrictive monetary policy causes the B3-curve to shiftA to the left with a su!se'uent shift of the *9-curve to the left due to a currency appreciation# to the ri"ht with a su!se'uent shift of the *9-curve to the ri"ht due to a currency appreciationC to the left with a su!se'uent shift of the *9-curve to the ri"ht due to a currency appreciationD first to the left and then !ac6 to the ri"ht due to a currency appreciationE to the left while the *9-curve remains the sameAns: A

Difficulty: Easy/. A !e""ar-thy-nei"h!or policy is a policy thatA creates domestic employment at the epense of other countries# uses fiscal epansion to depreciate a countryIs echan"e rate in an effort to increase net

eports, output and employmentC uses fiscal policy restriction to depreciate a countryIs currency and stimulate demand for

domestic "oodsD com!ines eport su!sidies with cuts in corporate income taesE uses monetary restriction to raise interest rates in an effort to attract forei"n capitalAns: A

Difficulty: Easy/2. After the re-unification of

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epansion to help the economy of the five new states &former East

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D Buem!our"E 9painAns: #

1. An increase in "overnment purchases &et eports &>K will !e crowded out to the point where the demand fordomestic "oods is reduced to the ori"inal level. %he current account will now show a deficit.*n the end, the level of output and the interest rate will remain unchan"ed. *n an *9-B3model, an increase in "overnment purchases &K will shift the *9-curve !ac6 to the left, until the level of output is !ac6 to itsori"inal level and interest rates are !ac6 to the world level &if.

i *91 = *9) *9$ B3

i$

if

7 Y1 Y$ Y

8-2

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+. i *9$ B31 *91

B3$ i$

if

7 Y1 Y$ Y) Y

Epansionary fiscal policy &assume an increase in "overnment purchases will shift the *9-curveto the ri"ht, and this will lead to an increase in the level of output. ;ith this increase ineconomic activity &and increased "overnment !orrowin", the domestic interest rate will risea!ove the world level &if. ;ith perfect capital mo!ility there will !e an inflow of capital thatwill result in a currency appreciation. nder a fied echan"e rate system, the central !an6will have to respond !y increasin" the domestic money supply to avoid the currencyappreciation. %his will shift the B3-curve to the ri"ht until the domestic interest rate is a"ainin line with the world interest rate &i f. *n this case there is no crowdin" out and the fiscalpolicy will have the full multiplier effect. %he assumption of a fied price level is only validover the very short run, and the *9-B3 framewor6 represents a short-run model in which theprices are assumed to !e fied. Qowever, prices can chan"e in the lon"er run, and then theanalysis is somewhat more complicated.

5. Epansionary fiscal policy will have its maimum effect under a fied echan"e rate systemwith perfect capital mo!ility. %his is !ecause fiscal epansion must always !e com!ined with

monetary epansion to !rin" domestic interest rates !ac6 in line with forei"n interest rates.Epansionary fiscal policy will shift the *9-curve to the ri"ht and increase the level of outputdemanded and the interest rate. #ut with perfect capital mo!ility, hi"her domestic interestrates will attract funds from a!road, which will put upward pressure on the value of thedomestic currency. %o avoid an appreciation of the currency, the central !an6 will have toincrease money supply to !rin" interest rates !ac6 in line with world levels. %his implies thatthe B3-curve will have to shift to the ri"ht to match the shift of the *9-curve. *n the end, nocrowdin" out of either investment or net eports will ta6e place and the level of output willincrease !y the full multiplier effect.