Question 1

Assume that the MPC is 0.8. Assume that the total crowding-out effect is $25 billion. How will an increase in government purchases of $9 billion shift the AD curve?
A)It will shift the AD curve right by $25 billion.
B)It will shift the AD curve left by $25 billion.
C)It will shift the AD curve right by $20 billion.
D)It will shift the AD curve left by $20 billion

Accepted Answer

The formula for the total impact of a change in government purchases is:
ΔY = ΔG × (1/(1-MPC)) 
where ΔY is the change in real GDP and ΔG is the change in government purchases. 
Using the given values, we get:
ΔY = $9 billion × (1/(1-0.8)) = $45 billion 
However, we know that there will be a crowding-out effect of $25 billion. This means that the net increase in aggregate demand is only $20 billion ($45 billion - $25 billion). Therefore, the AD curve will shift right by $20 billion.

Question 2

In a small open economy with perfect capital mobility, if exchange rates are fixed, how could aggregate demand be increased?
A)by increasing government expenditures
B)by increasing tax rates
C)by increasing the money supply
D)by decreasing the money supply

Accepted Answer

In a small open economy with perfect capital mobility and fixed exchange rates, the monetary policy is determined by the exchange rate regime, usually a currency board or a fixed exchange rate system. Therefore, the government can only use fiscal policy to increase aggregate demand by increasing government expenditures. Increasing tax rates would reduce disposable income and decrease consumption, while increasing the money supply or decreasing it would not have any effect on the economy as the exchange rates are fixed.

Question 3

In a small open economy with a flexible exchange rate, an expansionary fiscal policy will cause which of the following to happen?
A)It will cause the dollar to depreciate.
B)It will cause the dollar to appreciate.
C)It will cause net exports to increase.
D)It will cause a lasting effect on aggregate demand.

Accepted Answer

An expansionary fiscal policy increases government spending or decreases taxes, leading to higher interest rates. This attracts foreign capital, causing the domestic currency to appreciate.

Question 4

For the following questions, consult the diagram below.
Figure 15-2 
-Refer to Figure 15-2. If the closed economy is at point b, which of the following is the best policy to restore full employment?
A)increasing the money supply
B)decreasing government purchases
C)increasing taxes
D)selling Canadian dollars

Accepted Answer

If the economy is at point b, it is below the full employment level of output (Yfe). To restore full employment, the aggregate demand needs to be increased. The best policy to increase aggregate demand is to increase the money supply, which will lead to a decrease in interest rates, an increase in investment and consumption spending, and an increase in aggregate demand. Decreasing government purchases or increasing taxes would decrease aggregate demand, and selling Canadian dollars would not have a direct impact on aggregate demand.

Question 5

If the Bank of Canada maintains a fixed exchange rate, which of the following effects will an expansionary fiscal policy have?
A)It will cause a large and permanent rightward shift in the AD curve.
B)It will cause a large and permanent leftward shift in the AD curve.
C)It will have no permanent effect on the position of the AD curve, but it will cause interest rates to rise.
D)It will have no permanent effect on either the position of the AD curve or the interest rate.

Accepted Answer

The answer of If the Bank of Canada maintains a...

Question 6

For the following questions, consult the diagram below.
Figure 15-2 
-Refer to Figure 15-2. Which of the following can happen in a closed economy?
A) an increase in government purchases
B) a decrease in stock prices
C) consumers and firms becoming more optimistic about the future
D) an increase in the price level

Accepted Answer

The answer of For the following questions, consult the diagram...

Question 7

If the Bank of Canada allows the exchange rate to vary freely, which of the following effects will an expansionary fiscal policy have?
A)It will cause a large and permanent rightward shift of the AD curve.
B)It will cause a large and permanent leftward shift of the AD curve.
C)It will have no permanent effect on the position of the AD curve, but it will cause interest rates to permanently increase.
D)It will have no permanent effect on either the position of the AD curve or the interest rate.

Accepted Answer

When the Bank of Canada allows the exchange rate to vary freely, an expansionary fiscal policy will lead to a temporary increase in AD due to higher government spending and lower taxes. However, the increase in demand will eventually lead to a higher price level and higher interest rates, which will reduce demand for Canadian goods and services and shift the AD curve back to its original position. Therefore, the expansionary fiscal policy will have no permanent effect on the position of the AD curve or the interest rate.

Question 8

For the following questions, consult the diagram below.
Figure 15-2 
-Refer to Figure 15-2. In a closed economy, which of the following could have caused the economy to move from a to b?
A)a wave of optimism
B)a decrease in price
C)either fiscal or monetary contraction
D)an increase in the price of oil

Accepted Answer

The movement from a to b could be caused by either fiscal or monetary contraction, as this leads to a decrease in aggregate demand and therefore a decrease in output and a decrease in the price level. A wave of optimism or an increase in oil prices would both lead to an increase in aggregate demand, causing a movement to the right, from a to c. A decrease in price would cause a movement down along the same aggregate demand curve, from a to d.

Question 9

For the following questions, consult the diagram below.
Figure 15-2 
-Refer to Figure 15-2. In a closed economy, which of the following would cause the aggregate demand curve to shift from AD to AD*?
A)an increase in government purchases
B)a decrease in stock prices
C)consumers and firms becoming more optimistic about the future
D)an increase in the price level

Accepted Answer

The answer of For the following questions, consult the diagram...

Question 10

Suppose that the MPC is 0.50 and there is no investment accelerator or crowding-out effects. If government expenditures increase by $20 billion, what happens to aggregate demand?
A)It shifts right by $20 billion.
B)It shifts right by $25 billion.
C)It shifts right by $40 billion.
D)It shifts left by $40 billion.

Accepted Answer

Given the MPC = 0.50, we use the formula to calculate the change in aggregate demand:

ΔAD = ΔG × (1/1-MPC) = $20 billion × (1/1-0.50) = $40 billion

Therefore, the aggregate demand curve shifts right by $40 billion.

Question 11

In a small open economy with perfect capital mobility, if the exchange rate is flexible, which of the following would be the effect of an expansionary monetary policy?
A)It would cause the domestic interest rate to remain above the world interest rate.
B)It would cause the domestic interest rate to remain below the world interest rate.
C)It would leave the domestic interest rate equal to the world interest rate.
D)It would cause the domestic currency to appreciate.

Accepted Answer

In a small open economy with perfect capital mobility and a flexible exchange rate, the domestic interest rate is determined by the world interest rate. Expansionary monetary policy would lead to a depreciation of the domestic currency, but the domestic interest rate would remain equal to the world interest rate due to capital mobility.

Question 12

In a small open economy with a flexible exchange rate, which of the following effects will a contractionary fiscal policy have?
A)It will cause the Canadian interest rate to fall below the world interest rate for a short period of time, which in turn will cause the dollar to depreciate and net exports to increase.
B)It will cause the Canadian interest rate to rise above the world interest rate for a short period of time, which in turn will cause the dollar to appreciate and net exports to decrease.
C)It will cause the Canadian interest rate to fall below the world interest rate for a short period of time, which in turn will cause the dollar to appreciate and net exports to decrease.
D)It will cause the Canadian interest rate to rise above the world interest rate for a short period of time, which in turn will cause the dollar to depreciate and net exports to increase.

Accepted Answer

Contractionary fiscal policy reduces domestic demand, leading to lower interest rates. This makes domestic assets less attractive, causing the currency to depreciate and net exports to increase.

Question 13

In a small open economy with perfect capital mobility, if the Bank of Canada chooses to fix the value of the Canadian dollar, what will a contractionary monetary policy do?
A)It will have no effect.
B)It will shift the AD curve to the left.
C)It will shift the AD curve to the right.
D)It will shift both the AD curve and the short-run AS curve to the left.

Accepted Answer

In a small open economy with perfect capital mobility, if the central bank fixes the value of the currency, a contractionary monetary policy will have no effect on the aggregate demand (AD) curve. This is because the central bank must buy or sell domestic currency to keep the exchange rate fixed, which offsets the effects of the contractionary monetary policy on domestic interest rates and thus on aggregate demand.

Question 14

Assume that the MPC is 0.75. Assuming only the multiplier effect matters, how will an increase in government purchases of $400 billion shift the aggregate demand curve?
A)It will shift the aggregate demand curve left by $150 billion.
B)It will shift the aggregate demand curve left by $250 billion.
C)It will shift the aggregate demand curve right by $750 billion.
D)It will shift the aggregate demand curve right by $1600 billion.

Accepted Answer

The multiplier is calculated as 1/(1-MPC), which is 1/(1-0.75) = 4. Therefore, an increase in government purchases of $400 billion will shift the aggregate demand curve right by 4 * $400 billion = $1600 billion.

Question 15

Assume that the MPC is 0.8. Assuming that only the multiplier effect matters, how will a decrease in government purchases of $15 billion shift the aggregate demand curve?
A)It will shift the aggregate demand curve left by $12 billion.
B)It will shift the aggregate demand curve left by $15 billion.
C)It will shift the aggregate demand curve right by $15 billion.
D)It will shift the aggregate demand curve left by $75 billion.

Accepted Answer

The multiplier is calculated as 1/(1-MPC), which is 1/(1-0.8) = 5. A decrease in government purchases of $15 billion will shift the aggregate demand curve left by $15 billion * 5 = $75 billion.

Question 16

If the Bank of Canada chooses to prevent any change in the exchange rate when government spending increases, which of the following is most likely to happen?
A)crowding out effects
B)no crowding out effects
C)no increase in the demand for goods and services
D)a decrease in aggregate demand

Accepted Answer

If the Bank of Canada prevents any change in the exchange rate, it can offset the crowding out effects by adjusting monetary policy to accommodate the increase in government spending, maintaining aggregate demand.

Question 17

In a small open economy with a flexible exchange rate, an expansionary fiscal policy will cause which of the following to happen?
A)It will cause the dollar to depreciate.
B)It will cause net exports to rise.
C)It will cause an additional investment accelerator effect.
D)It will cause a reduction in the demand for Canadian-produced goods.

Accepted Answer

The answer of In a small open economy with a...

Question 18

Assume that the MPC is 0.8. Assume that there is a multiplier effect and that the total crowding-out effect is $7 billion. How will an increase in government purchases of $8 billion shift aggregate demand?
A)It will shift aggregate demand left by $1 billion.
B)It will shift aggregate demand left by $33 billion.
C)It will shift aggregate demand right by $1 billion.
D)It will shift aggregate demand right by $33 billion.

Accepted Answer

The multiplier effect amplifies the initial increase in government purchases, so the total increase in aggregate demand will be greater than the initial $8 billion. To calculate the total increase in aggregate demand, we use the formula:

Multiplier = 1 / (1 - MPC)
Multiplier = 1 / (1 - 0.8)
Multiplier = 5

Total increase in aggregate demand = Initial increase x Multiplier
Total increase in aggregate demand = $8 billion x 5
Total increase in aggregate demand = $40 billion

However, the total crowding-out effect of $7 billion reduces the net increase in aggregate demand to:

Net increase in aggregate demand = Total increase - Crowding-out effect
Net increase in aggregate demand = $40 billion - $7 billion
Net increase in aggregate demand = $33 billion

Since the government purchases are increasing, the direction of aggregate demand shift will be to right. Therefore, the correct answer is D.

Question 19

How do tax cuts and government expenditure affect aggregate demand?
A)Both shift aggregate demand right.
B)Both shift aggregate demand left.
C)Tax cuts shift aggregate demand right; government expenditure shifts aggregate demand left.
D)Tax cuts shift aggregate demand left; government expenditure shifts aggregate demand right.

Accepted Answer

Tax cuts and government expenditure both lead to an increase in aggregate demand as they put more money in the hands of consumers and businesses. Tax cuts increase disposable income, and government expenditure injects money directly into the economy. As a result, both policies shift aggregate demand to the right.

Question 20

Hoe do the multiplier effect and the crowding-out effect change the consequences of an increase in government spending?
A)They both amplify the consequences.
B)They both diminish the consequences.
C)The multiplier effect diminishes the consequences, while the crowding-out effect amplifies the consequences.
D)The multiplier effect amplifies the consequences, while the crowding-out effect diminishes the consequences.

Accepted Answer

The multiplier effect amplifies the consequences of an increase in government spending because it leads to further economic activity and growth, while the crowding-out effect diminishes the consequences by offsetting the positive impact of government spending with a decrease in private sector spending. Therefore, both effects have opposite impacts on the consequences of an increase in government spending, with the multiplier effect amplifying and the crowding-out effect diminishing the impact.

Quiz 15: The Influence of Monetary and Fiscal Policy on Aggregate Demand

Assume that the MPC is 0.8. Assume that the total crowding-out effect is $25 billion. How will an increase in government purchases of $9 billion shift the AD curve?

In a small open economy with perfect capital mobility, if exchange rates are fixed, how could aggregate demand be increased?

In a small open economy with a flexible exchange rate, an expansionary fiscal policy will cause which of the following to happen?

For the following questions, consult the diagram below. Figure 15-2 -Refer to Figure 15-2. If the closed economy is at point b, which of the following is the best policy to restore full employment?

If the Bank of Canada maintains a fixed exchange rate, which of the following effects will an expansionary fiscal policy have?

For the following questions, consult the diagram below. Figure 15-2 -Refer to Figure 15-2. Which of the following can happen in a closed economy?

If the Bank of Canada allows the exchange rate to vary freely, which of the following effects will an expansionary fiscal policy have?

For the following questions, consult the diagram below. Figure 15-2 -Refer to Figure 15-2. In a closed economy, which of the following could have caused the economy to move from a to b?

For the following questions, consult the diagram below. Figure 15-2 -Refer to Figure 15-2. In a closed economy, which of the following would cause the aggregate demand curve to shift from AD to AD*?

Suppose that the MPC is 0.50 and there is no investment accelerator or crowding-out effects. If government expenditures increase by $20 billion, what happens to aggregate demand?

In a small open economy with perfect capital mobility, if the exchange rate is flexible, which of the following would be the effect of an expansionary monetary policy?

In a small open economy with a flexible exchange rate, which of the following effects will a contractionary fiscal policy have?

In a small open economy with perfect capital mobility, if the Bank of Canada chooses to fix the value of the Canadian dollar, what will a contractionary monetary policy do?

Assume that the MPC is 0.75. Assuming only the multiplier effect matters, how will an increase in government purchases of $400 billion shift the aggregate demand curve?

Assume that the MPC is 0.8. Assuming that only the multiplier effect matters, how will a decrease in government purchases of $15 billion shift the aggregate demand curve?

If the Bank of Canada chooses to prevent any change in the exchange rate when government spending increases, which of the following is most likely to happen?

In a small open economy with a flexible exchange rate, an expansionary fiscal policy will cause which of the following to happen?

Assume that the MPC is 0.8. Assume that there is a multiplier effect and that the total crowding-out effect is $7 billion. How will an increase in government purchases of $8 billion shift aggregate demand?

How do tax cuts and government expenditure affect aggregate demand?

Hoe do the multiplier effect and the crowding-out effect change the consequences of an increase in government spending?