Question 1

Keynes's theory that the interest rate adjusts to bring money supply and money demand into balance is called: 
A) the theory of sticky wages
B) the theory of sticky prices
C) the classical dichotomy theory
D) the theory of liquidity preference

Accepted Answer

The theory that the interest rate adjusts to bring money supply and money demand into balance is called the theory of liquidity preference, which was developed by John Maynard Keynes. Choice A refers to a different theory that focuses on the stickiness of wages, while choice B refers to a theory that focuses on the stickiness of prices. Choice C refers to a classical theory that emphasizes the separation between real variables (like output and employment) and monetary variables (like the price level and inflation rate), which is distinct from Keynes's theory of liquidity preference.

Question 2

If the interest rate is below equilibrium, the excess demand for money puts downward pressure on the interest rate.

Accepted Answer

If the interest rate is below equilibrium, the excess demand for money puts upward pressure on the interest rate as borrowers compete for the limited supply of funds.

Question 3

When the government increases its purchases, the increase in aggregate demand could be more than or less than the increase in government purchases, depending on whether the multiplier effect or the crowding-out effect is larger.

Accepted Answer

The multiplier effect refers to the increase in aggregate demand that results from an initial increase in spending. The crowding-out effect refers to the decrease in private investment and consumption that can result from government borrowing to finance its increased purchases. If the multiplier effect is larger than the crowding-out effect, the increase in aggregate demand will be greater than the increase in government purchases. If the crowding-out effect is larger than the multiplier effect, the increase in aggregate demand will be less than the increase in government purchases.

Question 4

The multipler > 1 represents a less than proportionate change on economic activity as a result of government spending.

Accepted Answer

The statement is incorrect. A multiplier greater than 1 represents a greater than proportionate change on economic activity as a result of government spending.

Question 5

The theory of Ricardian equivalence suggests that an increase in public saving will be balanced by an increase in private saving.

Accepted Answer

The theory of Ricardian equivalence suggests that government borrowing does not affect the overall level of savings in an economy because individuals anticipate future taxes to pay off the debt and increase their savings accordingly, not that an increase in public saving will be balanced by an increase in private saving.

Question 6

Changes in government spending affect saving and growth in the long run, and aggregate demand and employment in the short run.

Accepted Answer

Government spending can impact the overall level of economic activity and affect savings and growth in the long run. In the short run, changes in government spending can impact aggregate demand and employment levels.

Question 7

The liquidity of money explains the demand for money. People own or hold money because money: 
A) offers a high nominal return
B) can directly be used to buy goods and services
C) protects the owner against unforeseen inflation
D) all of the above

Accepted Answer

The demand for money arises mainly from its ability to be used for transactions, in other words, as a medium of exchange to buy goods and services. The other options, such as nominal returns and protection against inflation, may also be factors that influence the demand for money, but they are not as direct or universal as its use in transactions.

Question 8

The quantity of money demanded is _____ the interest rate. 
A) the opportunity cost of
B) independent of
C) positively related to
D) inversely related to

Accepted Answer

The quantity of money demanded is inversely related to the interest rate. As the interest rate increases, the opportunity cost of holding money increases, causing people to demand less money. Conversely, as the interest rate decreases, the opportunity cost of holding money decreases, causing people to demand more money.

Question 9

The multiplier effect suggests that the increase in aggregate demand could be smaller than the increase in government purchases, while the crowding-out effect suggests that the increase in aggregate demand could be larger than the increase in government purchases.

Accepted Answer

The multiplier effect suggests that the increase in aggregate demand will be larger than the increase in government purchases, while the crowding-out effect suggests that the increase in aggregate demand could be smaller than the increase in government purchases.

Question 10

In the long run, the interest rate adjusts to balance the supply and demand for money, whereas in the short run, the interest rate adjusts to balance national saving and desired investment.

Accepted Answer

In the long run, the interest rate adjusts to balance national saving and desired investment, whereas in the short run, it can be influenced by monetary policy and the supply and demand for money.

Question 11

The global financial crisis has shown that the Australian government can influence the behaviour of the economy only with fiscal policy.

Accepted Answer

Both monetary and fiscal policies have been used by the Australian government to influence the behaviour of the economy in response to the global financial crisis. Monetary policy measures, such as adjusting interest rates and injecting liquidity into the financial system, have also been employed by the Reserve Bank of Australia in collaboration with the government's fiscal policy interventions.

Question 12

Personal income tax and government outlays act as automatic stabilisers.

Accepted Answer

Personal income tax and government outlays (such as unemployment benefits) are designed to increase during economic downturns and decrease during economic upswing. This helps to stabilize the economy by providing income support during recessions and reducing spending during booms, thus mitigating the fluctuations in economic activity.

Question 13

Changes in monetary policy can only be viewed in terms of a changing target for the interest rate.

Accepted Answer

Changes in monetary policy can also involve changes in the money supply, inflation targeting, and other tools such as open market operations and reserve requirements. Therefore, the statement that changes in monetary policy can only be viewed in terms of a changing target for the interest rate is false.

Question 14

According to the RBA's policy guidelines, if the RBA sees rising inflation, it would then increase interest rates.

Accepted Answer

The RBA's policy guidelines state that if there is rising inflation, the RBA would increase interest rates as a way to curb inflation.

Question 15

At a higher price level, the demand for money increases, the interest rate increases, and the demand for business and residential investment falls. Hence the aggregate-demand curve slopes downward.

Accepted Answer

As the price level increases, people need more money for transactions, which increases the demand for money. This leads to higher interest rates, making borrowing more expensive and thus reducing investment in business and residential projects. Consequently, overall demand decreases, illustrating why the aggregate-demand curve slopes downward.

Question 16

The theory of liquidity preference states that the interest rate adjusts to bring money supply and money demand into balance.

Accepted Answer

The theory of liquidity preference, proposed by John Maynard Keynes, argues that the interest rate adjusts to balance the supply and demand for money. This occurs through the willingness of individuals to hold cash, which is determined by the rate of interest. If the interest rate is too high, people will choose to hold less cash and invest more, decreasing the demand for money and lowering the interest rate. Conversely, if the interest rate is too low, people will choose to hold onto more cash, increasing the demand for money and raising the interest rate. Therefore, the interest rate acts as a mechanism to bring money supply and demand into equilibrium, according to Keynes' theory of liquidity preference.

Question 17

John Maynard Keynes proposed the model of the money market called the liquidity preference theory.

Accepted Answer

This statement is true. John Maynard Keynes proposed the liquidity preference theory in his 1936 book "The General Theory of Employment, Interest, and Money."

Question 18

In the long run, the interest rate and inflation rate adjust to accommodate a fixed level of output. In the short run, the interest rate and output adjust to accommodate a predetermined level of prices.

Accepted Answer

The answer of In the long run, the interest rate...

Question 19

Any change in government spending has a multiplier effect on the level of economic activity.

Accepted Answer

When the government increases or decreases its spending, it results in a multiplier effect on the economy. This is because government spending creates more employment opportunities, which in turn increases the incomes of people. As a result, people tend to spend more, which increases demand for goods and services, leading to more economic activity. On the contrary, when the government reduces its spending, it leads to a decrease in employment opportunities, income, and demand, leading to a decline in economic activity.

Question 20

A lower inflation rate leads to a higher interest rate through Reserve Bank policy and the higher interest rate stimulates investment spending.

Accepted Answer

A lower inflation rate typically leads to lower interest rates, as central banks may reduce rates to encourage borrowing and investment, not increase them.

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

Keynes's theory that the interest rate adjusts to bring money supply and money demand into balance is called: