Question 1

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 and investment accelerator both amplify the initial increase in government expenditure, resulting in a greater shift of the aggregate-demand curve.

Question 2

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 3

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 4

An increase in the money supply decreases the interest rate in the short run.

Accepted Answer

When the money supply increases, there is a surplus of money, and this excess supply will lower the cost of borrowing or the interest rate. This occurs because borrowers have additional money that they can lend, which drives down the price or interest rate borrowers demand to lend that money. This relationship between money supply and interest rate is known as the liquidity preference theory. So, an increase in the money supply leads to lower interest rates in the short run, and a decrease in the money supply leads to higher interest rates in the short run.

Question 5

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 6

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

An increase in the money supply or government expenditures can stimulate economic activity and help offset the effects of pessimism, as it provides more funds for investment and consumption. However, the effectiveness of these measures depends on various factors such as the state of the economy and the level of inflation.

Question 7

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

This statement accurately describes the significant lags for monetary and fiscal policy.

Question 8

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

Accepted Answer

The multiplier is actually the reciprocal of the MPC, which would be 5/4 if the MPC is 4/5.

Question 9

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

If MPC is 4/5, then the multiplier is 1/(1-MPC) = 5. Therefore, a decrease in government spending of $1 billion results in a decrease in demand for goods and services by $5 billion ($1 billion x 5).

Question 10

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 11

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 12

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

Accepted Answer

The liquidity preference theory states that individuals and firms have a preference for holding their assets in liquid form, and the demand for money represents this preference. Therefore, the demand for money is an essential piece of the theory.

Question 13

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

Accepted Answer

Supply-side economics focuses on policy interventions that increase the productive capacity of the economy, such as tax cuts and deregulation. Changes in the money supply, which affect aggregate demand, are more relevant to demand-side economics.

Question 14

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

Accepted Answer

This statement is true. By changing the interest rate paid on reserves, the Fed can encourage or discourage banks from lending and thus affect the amount of money in circulation in the economy.

Question 15

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

Accepted Answer

Permanent tax cuts provide households with a greater level of certainty about their future income, which can encourage them to spend more. Temporary tax cuts, on the other hand, may not provide enough incentive for households to increase their spending because they know that the tax cut will expire in the near future. Therefore, permanent tax cuts tend to have a more significant impact on consumption spending.

Question 16

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

Accepted Answer

The multiplier is the reciprocal of the marginal propensity to save, which is 1 - 6/7 = 1/7. Thus, the multiplier is 1/(1/7) = 7.

Question 17

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 18

Other things equal, the higher the price level, the higher is the real wealth of households.

Accepted Answer

The statement is false. A higher price level reduces the purchasing power of households' wealth, and hence their real wealth decreases.

Question 19

When the Fed announces a target for the federal funds rate, it essentially accommodates the day-to-day fluctuations in money demand by adjusting the money supply accordingly.

Accepted Answer

When the Fed announces a target for the federal funds rate, it buys or sells government securities to adjust the money supply and keep the federal funds rate close to its target. This helps to accommodate the day-to-day fluctuations in money demand.

Question 20

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

Accepted Answer

The multiplier is computed as 1 / (1 - MPC), where MPC is the marginal propensity to consume.

Quiz 16: The Influence of Monetary and Fiscal Policy on Aggregate Demand