Question 1

The Fed can influence the money supply by changing the interest rate it pays banks on the reserves they are holding.

Accepted Answer

The Federal Reserve can influence the money supply by adjusting the interest rate it pays on reserves held by banks, as this can affect the amount of money banks choose to lend out. Higher interest rates on reserves can encourage banks to hold more reserves, reducing the money supply, while lower rates can encourage lending, increasing the money supply.

Question 2

If the spending multiplier is 8, then the marginal propensity to consume must be 7/8.

Accepted Answer

The spending multiplier is calculated as 1/(1-MPC), so if the multiplier is 8, then 1/(1-MPC) = 8, solving for MPC gives MPC = 7/8.

Question 3

Both the multiplier effect and the investment accelerator tend to make the aggregate-demand curve shift further than it does due to an initial increase in government expenditures.

Accepted Answer

The multiplier effect amplifies the impact of government spending on aggregate demand through increased consumption as people earn more, while the investment accelerator further increases investment in response to rising demand, both contributing to a larger shift in the aggregate-demand curve than the initial government expenditure alone would cause.

Question 4

A significant lag for monetary policy is the time it takes to for a change in the money supply to change the economy. A significant lag for fiscal policy is the time it takes to pass legislation authorizing it.

Accepted Answer

Monetary policy actions, such as changes in interest rates or the money supply, often take time to influence the economy due to factors like the decision-making process of businesses and consumers. Fiscal policy, involving government spending and taxation decisions, faces delays primarily due to the legislative process required to enact these changes.

Question 5

If the marginal propensity to consume is 6/7, then the multiplier is 7.

Accepted Answer

The multiplier is calculated as 1/(1 - marginal propensity to consume), so if the marginal propensity to consume is 6/7, the multiplier is 1/(1 - 6/7) = 7.

Question 6

An essential piece of the liquidity preference theory is the demand for money.

Accepted Answer

The liquidity preference theory, proposed by John Maynard Keynes, suggests that the demand for money is a key component in determining interest rates, emphasizing that individuals prefer to hold their wealth in liquid form for transactions, precautionary, and speculative motives.

Question 7

The theory of liquidity preference is largely at odds with the basic ideas of supply and demand.

Accepted Answer

The theory of liquidity preference, proposed by John Maynard Keynes, actually incorporates the principles of supply and demand within the context of the money market, where the demand for money (liquidity preference) and the supply of money determine the interest rate.

Question 8

The interest-rate effect is partially explained by the fact that a higher price level reduces money demand.

Accepted Answer

The interest-rate effect is partially explained by the fact that a higher price level increases money demand, which in turn increases interest rates and reduces investment spending.

Question 9

The main criticism of those who doubt the ability of the government to respond in a useful way to the business cycle is that the theory by which money and government expenditures change output is flawed.

Accepted Answer

The answer of The main criticism of those who doubt...

Question 10

If the marginal propensity to consume is 4/5, then a decrease in government spending of $1 billion decreases the demand for goods and services by $5 billion.

Accepted Answer

The marginal propensity to consume (MPC) is the proportion of an additional dollar of household income that is used for consumption. If the MPC is 4/5, it means that for every dollar decrease in income, consumption decreases by 80 cents. The multiplier effect, calculated as 1/(1-MPC), in this case, is 1/(1-4/5) = 5. Therefore, a $1 billion decrease in government spending would decrease the demand for goods and services by 5 times that amount, or $5 billion, due to the multiplier effect.

Question 11

During recessions, unemployment insurance payments tend to rise.

Accepted Answer

During recessions, more people are likely to lose their jobs due to economic downturns, leading to an increase in unemployment insurance claims and payments.

Question 12

If the MPC is 4/5, the multiplier is 5/4.

Accepted Answer

The multiplier is calculated as 1/(1-MPC), so if the MPC is 4/5, the multiplier would be 1/(1-4/5) = 5.

Question 13

Government expenditures on capital goods such as roads could increase aggregate supply. Such effects on aggregate supply are likely to matter more in the short run than in the long run.

Accepted Answer

Government expenditures on capital goods like roads can increase aggregate supply by improving infrastructure, which enhances productivity. These effects are more significant in the long run as the benefits of improved infrastructure accumulate over time, rather than having an immediate impact in the short run.

Question 14

In principle, the government could increase the money supply or increase government expenditures to try to offset the effects of a wave of pessimism about the future of the economy.

Accepted Answer

Increasing the money supply or government expenditures are fiscal and monetary policy tools, respectively, that governments can use to stimulate economic activity and counteract pessimism about the economy's future.

Question 15

The multiplier is computed as MPC / (1 - MPC).

Accepted Answer

The correct formula for the multiplier is 1 / (1 - MPC), where MPC is the marginal propensity to consume.

Question 16

Other things the same, an increase in taxes shifts aggregate demand to the left. In the short run this makes output fall which makes the interest rate rise.

Accepted Answer

An increase in taxes shifts aggregate demand to the left, which in the short run can lead to a decrease in output and a decrease in the demand for money, potentially leading to a lower interest rate, not a rise.

Question 17

Depending on the size of the multiplier and crowding-out effects, the rightward shift in aggregate demand from a tax cut could be larger or smaller than the tax cut.

Accepted Answer

The size of the multiplier effect, which amplifies the initial increase in aggregate demand from a tax cut, and the extent of crowding-out effects, which can dampen this increase by raising interest rates and reducing investment, together determine whether the overall shift in aggregate demand is larger or smaller than the initial tax cut.

Question 18

Permanent tax cuts have a larger impact on consumption spending than temporary ones.

Accepted Answer

Permanent tax cuts are perceived by consumers as an increase in their long-term disposable income, leading to a greater willingness to spend more consistently over time, whereas temporary tax cuts are often seen as short-term windfalls, leading to more cautious spending or saving.

Question 19

Some economists, called supply-siders, argue that changes in the money supply exert a strong influence on aggregate supply.

Accepted Answer

Supply-siders primarily argue that lower taxes and decreased regulation can increase aggregate supply by incentivizing production, not that changes in the money supply exert a strong influence on aggregate supply.

Question 20

Unemployment insurance and welfare programs work as automatic stabilizers.

Accepted Answer

Unemployment insurance and welfare programs automatically increase government spending during economic downturns, when unemployment rises, providing a stabilizing effect on the economy by supporting income and consumption.

Quiz 34: The Influence of Monetary and Fiscal Policy on Aggregate Demand