Question 1

Suppose an increase in interest rates causes rising unemployment and falling output. To counter this, the Federal Reserve would
A)increase government spending.
B)increase the money supply.
C)decrease government spending.
D)decrease the money supply.

Accepted Answer

To counter rising unemployment and falling output caused by an increase in interest rates, the Federal Reserve would increase the money supply. This action can lower interest rates, stimulate borrowing and spending, and ultimately support economic growth and employment.

Question 2

If the marginal propensity to consume is 0.75, and there is no investment accelerator or crowding out, a $115 billion increase in government expenditures would shift the aggregate demand curve right by
A)$460 billion, but the effect would be larger if there were an investment accelerator.
B)$460 billion, but the effect would be smaller if there were an investment accelerator.
C)$345 billion, but the effect would be larger if there were an investment accelerator.
D)$345 billion, but the effect would be smaller if there were an investment accelerator.

Accepted Answer

The multiplier effect is calculated as 1/(1-MPC), where MPC is the marginal propensity to consume. With an MPC of 0.75, the multiplier is 1/(1-0.75) = 4. Therefore, a $115 billion increase in government expenditures would result in a total increase in aggregate demand of 4 * $115 billion = $460 billion. The presence of an investment accelerator would amplify this effect further.

Question 3

If households view a tax cut as temporary, then the tax cut
A)has no effect on aggregate demand.
B)has more of an effect on aggregate demand than if households view it as permanent.
C)has the same effect as when households view the cut as permanent.
D)has less of an effect on aggregate demand than if households view it as permanent.

Accepted Answer

When households perceive a tax cut as temporary, they are less likely to significantly increase their spending because they anticipate that their long-term income will not change substantially. As a result, the immediate boost to aggregate demand is smaller compared to when they believe the tax cut is permanent and adjust their spending habits more substantially.

Question 4

Scenario 34-2. The following facts apply to a small economy.
• Consumption spending is $6,720 when income is $8,000.
• Consumption spending is $7,040 when income is $8,500.
-Refer to Scenario 34-2. In response to which of the following events could aggregate demand increase by $1,500?
A)A stock-market boom stimulates consumer spending by $300, and there is an operative crowding-out effect.
B)A stock-market boom stimulates consumer spending by $550, and there is a small operative crowding-out effect.
C)An economic boom overseas increases the demand for U.S.net exports by $550, and there is no crowding-out effect.
D)An economic boom overseas increases the demand for U.S.net exports by $300, and there is no crowding-out effect.

Accepted Answer

The marginal propensity to consume (MPC) can be calculated as the change in consumption divided by the change in income, which is ($7,040 - $6,720) / ($8,500 - $8,000) = 0.64. To increase aggregate demand by $1,500, the initial increase in spending must be larger due to the multiplier effect. With an MPC of 0.64, the multiplier is 1/(1-0.64) = 2.78. Therefore, an initial increase in spending of $550 would result in an increase in aggregate demand of $550 * 2.78 = $1,529, which is close to $1,500, considering a small crowding-out effect.

Question 5

Initially, the economy is in long-run equilibrium. Aggregate demand then shifts leftward by $50 billion. The government wants to increase its spending in order to avoid a recession. If the crowding-out effect is always one-third as strong as the multiplier effect, and if the MPC equals 0.6, then by how much do government purchases have to increase in order to offset the $50 billion leftward shift?
A)By $90 billion
B)By $60 billion
C)By $20 billion
D)By $30 billion

Accepted Answer

The multiplier effect is calculated as 1/(1-MPC), which equals 1/(1-0.6) = 2.5. If the crowding-out effect is one-third as strong, it reduces the multiplier effect to 2/3 of its original value, making the effective multiplier 2.5 * (2/3) = 5/3. To offset a $50 billion shift, we solve for X in the equation (5/3)X = $50 billion, giving X = $30 billion.

Question 6

If the MPC is 3/5 then the multiplier is
A)4, so a $100 increase in government spending increases aggregate demand by $400.
B)1.5, so a $100 increase in government spending increases output by $150.
C)2.5, so a $100 increase in government spending increases aggregate demand by $250.
D)1.67, so a $100 increase in government spending increases output by $166.67.

Accepted Answer

The multiplier is calculated as 1/(1-MPC). With an MPC of 3/5, the multiplier is 1/(1-3/5) = 1/(2/5) = 2.5. Therefore, a $100 increase in government spending increases aggregate demand by $250.

Question 7

Which of the following policies would be advocated by someone who wants the government to follow an active stabilization policy when the economy is experiencing severe unemployment?
A)Decrease the money supply
B)Increase government expenditures
C)Increase taxes
D)Increase interest rates

Accepted Answer

An active stabilization policy to combat severe unemployment typically involves measures to stimulate economic activity and increase demand for labor. Increasing government expenditures can directly inject money into the economy, boosting demand for goods and services, and in turn, increasing employment.

Question 8

Suppose there is a tax decrease. To stabilize output, the Federal Reserve could
A)decrease government spending.
B)decrease the money supply.
C)increase government spending.
D)increase the money supply.

Accepted Answer

To counteract the inflationary effect of a tax decrease and stabilize output, the Federal Reserve could decrease the money supply. This action would help to control any potential increase in inflation that might result from the tax cut by making borrowing more expensive and slowing down the economy.

Question 9

Suppose there was a large increase in net exports. If the Fed wanted to stabilize output, it could
A)increase the money supply, which will reduce interest rates.
B)decrease the money supply, which will reduce interest rates.
C)increase the money supply, which will increase interest rates.
D)decrease the money supply, which will increase interest rates.

Accepted Answer

To stabilize output in the face of increased net exports, the Fed might aim to counteract the inflationary pressure by decreasing the money supply, which would lead to higher interest rates, thereby cooling down the economy.

Question 10

A significant example of a temporary tax cut was the one announced in 1992 by President George H. W. Bush. The effect of that tax cut on consumer spending and aggregate demand was
A)zero.
B)likely smaller than if the cut had been permanent.
C)likely about the same as if the cut had been permanent.
D)likely larger than if the cut had been permanent.

Accepted Answer

Temporary tax cuts are generally believed to have a smaller impact on consumer spending and aggregate demand than permanent ones because consumers may save rather than spend the additional income, anticipating the tax cut's temporary nature.

Question 11

Assume the MPC is 0.80. Assume there is a multiplier effect and that the total crowding-out effect is $7 billion. An increase in government purchases of $40 billion will shift aggregate demand to the
A)left by $165 billion.
B)left by $193 billion.
C)right by $193 billion.
D)right by $165 billion.

Accepted Answer

The multiplier effect is 1/(1-MPC) = 1/(1-0.80) = 5. So the increase in government purchases of $40 billion will increase aggregate demand by $40 billion x 5 = $200 billion. However, the crowding-out effect is $7 billion, so the net increase in aggregate demand is $200 billion - $7 billion = $193 billion.

Question 12

If taxes
A)decrease, then consumption decreases, and aggregate demand shifts rightward.
B)decrease, then consumption increases, and aggregate demand shifts leftward.
C)increase, then consumption decreases, and aggregate demand shifts leftward.
D)increase, then consumption increases, and aggregate demand shifts rightward.

Accepted Answer

When taxes increase, disposable income decreases, leading to a decrease in consumption. This reduction in consumption contributes to a leftward shift in aggregate demand, as there is less overall spending in the economy.

Question 13

If the MPC is 0.50 and there are no crowding-out or accelerator effects, then an initial increase in aggregate demand of $205 billion will eventually shift the aggregate demand curve to the right by
A)$216 billion.
B)$150 billion.
C)$410 billion.
D)$480 billion.

Accepted Answer

The multiplier effect is calculated as 1/(1-MPC), which in this case is 1/(1-0.50) = 2. Therefore, an initial increase in aggregate demand of $205 billion will eventually lead to a total shift in the aggregate demand curve of 205 billion * 2 = $410 billion.

Question 14

The Employment Act of 1946 states that
A)the Fed should use monetary policy only to control the rate of inflation.
B)the government should promote full employment and production.
C)the government should periodically increase the minimum wage and unemployment insurance benefits.
D)the government should aim for a 0% unemployment rate.

Accepted Answer

The Employment Act of 1946 primarily established that it is the policy and responsibility of the federal government to promote maximum employment, production, and purchasing power. It did not specifically mandate the use of monetary policy solely for controlling inflation, nor did it set a goal of 0% unemployment or stipulate periodic increases in minimum wage and unemployment benefits.

Question 15

If a $1,000 increase in income leads to an $800 increase in consumption expenditures, then the marginal propensity to consume is
A)0.2 and the multiplier is 1.25.
B)0.8 and the multiplier is 5.
C)0.2 and the multiplier is 5.
D)0.8 and the multiplier is 8.

Accepted Answer

The marginal propensity to consume (MPC) is calculated as the change in consumption divided by the change in income, which is $800/$1000 = 0.8. The multiplier is calculated as 1/(1-MPC), which is 1/(1-0.8) = 5.

Question 16

A tax cut shifts the aggregate demand curve the farthest if
A)the MPC is large and if the tax cut is permanent.
B)the MPC is large and if the tax cut is temporary.
C)the MPC is small and if the tax cut is permanent.
D)the MPC is small and if the tax cut is temporary.

Accepted Answer

A tax cut shifts the aggregate demand curve the farthest if the marginal propensity to consume (MPC) is large and the tax cut is perceived as permanent. A large MPC means consumers are likely to spend a significant portion of any extra income they receive, and a permanent tax cut is more likely to encourage spending rather than saving, as people expect their higher disposable income to last.

Question 17

When taxes increase, interest rates
A)decrease, making the change in aggregate demand larger.
B)decrease, making the change in aggregate demand smaller.
C)increase, making the change in aggregate demand larger.
D)increase, making the change in aggregate demand smaller.

Accepted Answer

When taxes increase, disposable income decreases, leading to a decrease in aggregate demand. To offset this decrease, the central bank may lower interest rates to stimulate spending and investment, making the change in aggregate demand smaller.

Question 18

Which of the following policies would Keynes's followers support when an increase in business optimism shifts the aggregate demand curve away from long-run equilibrium?
A)Increase taxes
B)Increase government expenditures
C)Increase the money supply
D)Lower interest rates

Accepted Answer

The answer of Which of the following policies would Keynes's...

Question 19

If net exports fall $40 billion, the MPC is 9/11, and there is a multiplier effect but no crowding out and no investment accelerator, then
A)aggregate demand falls by 2 × $40 billion.
B)aggregate demand falls by 11/2 × $40 billion.
C)aggregate demand falls by 11/9 × $40 billion.
D)aggregate demand falls by 9/11 × $40 billion.

Accepted Answer

The multiplier effect is calculated as 1/(1-MPC), which in this case is 1/(1-9/11) = 11/2. Therefore, the fall in aggregate demand is 11/2 times the initial decrease in net exports, which is 11/2 × $40 billion.

Question 20

Assume there is a multiplier effect, some crowding out, and no accelerator effect. An increase in government expenditures changes aggregate demand more,
A)the smaller the MPC and the stronger the influence of income on money demand.
B)the smaller the MPC and the weaker the influence of income on money demand.
C)the larger the MPC and the stronger the influence of income on money demand.
D)the larger the MPC and the weaker the influence of income on money demand.

Accepted Answer

A larger MPC increases the multiplier effect, and a weaker influence of income on money demand reduces crowding out, leading to a greater change in aggregate demand.

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

Suppose an increase in interest rates causes rising unemployment and falling output. To counter this, the Federal Reserve would

If the marginal propensity to consume is 0.75, and there is no investment accelerator or crowding out, a $115 billion increase in government expenditures would shift the aggregate demand curve right by

If households view a tax cut as temporary, then the tax cut

Scenario 34-2. The following facts apply to a small economy. • Consumption spending is $6,720 when income is $8,000. • Consumption spending is $7,040 when income is $8,500. -Refer to Scenario 34-2. In response to which of the following events could aggregate demand increase by $1,500?

If the MPC is 3/5 then the multiplier is

Which of the following policies would be advocated by someone who wants the government to follow an active stabilization policy when the economy is experiencing severe unemployment?

Suppose there is a tax decrease. To stabilize output, the Federal Reserve could

Suppose there was a large increase in net exports. If the Fed wanted to stabilize output, it could

A significant example of a temporary tax cut was the one announced in 1992 by President George H. W. Bush. The effect of that tax cut on consumer spending and aggregate demand was

Assume the MPC is 0.80. Assume there is a multiplier effect and that the total crowding-out effect is $7 billion. An increase in government purchases of $40 billion will shift aggregate demand to the

If taxes

If the MPC is 0.50 and there are no crowding-out or accelerator effects, then an initial increase in aggregate demand of $205 billion will eventually shift the aggregate demand curve to the right by

The Employment Act of 1946 states that

If a $1,000 increase in income leads to an $800 increase in consumption expenditures, then the marginal propensity to consume is

A tax cut shifts the aggregate demand curve the farthest if

When taxes increase, interest rates

Which of the following policies would Keynes's followers support when an increase in business optimism shifts the aggregate demand curve away from long-run equilibrium?

If net exports fall $40 billion, the MPC is 9/11, and there is a multiplier effect but no crowding out and no investment accelerator, then

Assume there is a multiplier effect, some crowding out, and no accelerator effect. An increase in government expenditures changes aggregate demand more,