Question 1

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

Accepted Answer

Supply-siders argue that changes in the money supply primarily affect aggregate demand, not aggregate supply.

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

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 4

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

Accepted Answer

Permanent tax cuts provide more certainty and predictability for consumers, leading to greater confidence in their ability to spend. Temporary tax cuts may not create the same level of consumer confidence, as individuals may view the extra money as a one-time windfall that they may choose to save or use to pay down debt.

Question 5

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

Accepted Answer

The multiplier is simply the inverse of the marginal propensity to save. Therefore, if the marginal propensity to consume is 6/7, the marginal propensity to save is 1/7, and the multiplier is 1/ (1/7) = 7.

Question 6

When the Fed increases the money supply, the interest rate decreases. This decrease in the interest rate increases consumption and investment demand, so the aggregate-demand curve shifts to the right.

Accepted Answer

When the Fed increases the money supply, interest rates tend to decrease due to the increased supply of money available for lending. This decrease in interest rates makes borrowing cheaper and more attractive, which can lead to increased consumption and investment spending by households and businesses. This increase in spending leads to a shift in the aggregate-demand curve to the right.

Question 7

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

Accepted Answer

When the Fed changes the interest rate paid on reserves, it affects the incentive for banks to hold excess reserves, which can impact the money supply.

Question 8

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

Accepted Answer

The demand for money is a central concept in the liquidity preference theory developed by John Maynard Keynes. According to this theory, people hold money not only to make transactions but also as a precautionary measure against unexpected expenses and as a speculative asset that provides liquidity in uncertain times. The demand for money depends on various factors such as income, interest rates, and expectations about the future, and it affects the overall level of interest rates in the economy.

Question 9

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

Both the multiplier effect and the investment accelerator amplify the initial impact of government expenditures, leading to a larger shift of the aggregate-demand curve.

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 formula for calculating the change in demand resulting from a change in government spending is:

Change in demand = (1 - MPC)/MPC x Change in government spending

Substituting the given MPC of 4/5, and a decrease in government spending of $1 billion, we get:

Change in demand = (1 - 4/5)/(4/5) x (-$1 billion)
Change in demand = (-1/5) / (4/5) x (-$1 billion)
Change in demand = (-1/5) x (-5) x ($1 billion)
Change in demand = $1 billion

Therefore, a decrease in government spending of $1 billion will decrease the demand for goods and services by $1 billion, not $5 billion.

Question 11

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 12

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 13

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

This is true. The Fed uses open market operations to adjust the money supply in order to keep the federal funds rate within its target range, which helps to stabilize short-term interest rates and keep inflation under control.

Question 14

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

Accepted Answer

The answer of The multiplier is computed as MPC /...

Question 15

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

Accepted Answer

The statement is incorrect. Other things equal, a higher price level means that the purchasing power of households' wealth is reduced, leading to a lower real wealth.

Question 16

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

Accepted Answer

When the money supply increases, there is more money available to borrow and lend, which puts downward pressure on interest rates. This relationship is known as the liquidity effect and is a short-run phenomenon. However, in the long run, the increase in the money supply can lead to inflation, which can in turn drive interest rates back up.

Question 17

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 two tools that the government can use to stimulate the economy and offset the effects of a wave of pessimism. When the government increases the money supply, it lowers interest rates and encourages borrowing and investment. When the government increases government expenditures, it injects more money into the economy, which can lead to increased demand and economic growth. However, it is important to note that these tools have potential drawbacks, such as inflation and a larger government deficit.

Question 18

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 19

Stock prices often rise when the Fed raises interest rates.

Accepted Answer

Stock prices tend to decrease when the Fed raises interest rates, as higher interest rates make it more expensive for companies to borrow money and can lead to slower economic growth.

Question 20

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

Accepted Answer

The MPC (Marginal Propensity to Consume) + MPS (Marginal Propensity to Save) always equals 1. Therefore, if MPC is 4/5, then MPS is 1/5. The multiplier is calculated as 1/MPS, which in this case would be 1 ÷ (1/5) = 5. So the correct statement would be "If the MPC is 4/5, the multiplier is 5."

Quiz 24: The Influence of Monetary and Fiscal Policy on Aggregate Demand