1. Fiscal policy refers to the:
a. manipulation of government spending and taxes to stabilize domestic output, employment, and the price level.
b. manipulation of government spending and taxes to achieve greater equality in the distribution of income.
c. altering of the interest rate to change aggregate demand.
d. fact that equal increases in government spending and taxation will be contractionary.
2. Expansionary fiscal policy is so named because it:
a. involves an expansion of the nation's money supply.
b. necessarily expands the size of government.
c. is aimed at achieving greater price stability.
d. is designed to expand real GDP.
3. Suppose that the economy is in the midst of a recession. Which of the following policies would be consistent with active fiscal policy?
a. a Congressional proposal to incur a Federal surplus to be used for the retirement of public debt
b. a reduction in agricultural subsidies and veterans' benefits
c. a postponement of a highway construction program
d. a reduction in Federal tax rates on personal and corporate income
4. An appropriate fiscal policy for a severe recession is:
a. a decrease in government spending.
b. a decrease in tax rates.
c. appreciation of the dollar.
d. an increase in interest rates.
5. An appropriate fiscal policy for severe demand-pull inflation is:
a. an increase in government spending.
b. depreciation of the dollar.
c. a reduction in interest rates.
d. a tax rate increase.
6. In an aggregate demand-aggregate supply diagram, equal decreases in government spending and taxes will:
a. shift the AD curve to the right.
b. increase the equilibrium GDP.
c. not affect the AD curve.
d. shift the AD curve to the left.
7. An expansionary fiscal policy is shown as a:
a. rightward shift in the economy's aggregate demand curve.
b. movement along an existing aggregate demand curve.
c. leftward shift in the economy's aggregate supply curve.
d. leftward shift in the economy's aggregate demand curve.
8. Which of the following is not an item in the list of leading economic indicators?
a. changes in mutual fund balances b. the length of the average work week c. the money supply
d. the value of the index of consumer expectations 9. In the United States, the money supply (M1) is comprised of:
a. coins, paper currency, and checkable deposits.
b. currency, checkable deposits, and Series E bonds.
c. coins, paper currency, checkable deposits, and credit balances with brokers.
d. paper currency, coins, gold certificates, and time deposits.
10. The value of money varies:
a. inversely with the price level.
b. directly with the volume of employment.
c. directly with the price level.
d. directly with the interest rate.
11. The difference between M1 and M2 is that:
a. the former includes time deposits.
b. the latter includes small time deposits, non-checkable savings accounts, money market deposit accounts, and money market mutual fund balances.
c. the latter includes negotiable government bonds.
d. the latter includes cash held by commercial banks and the U. S. Treasury.
12. The purchase of government securities from the public by the Fed will cause:
a. commercial bank reserves to decrease.
b. the money supply to increase.
c. demand deposits to decrease d. the interest rate to increase.
13. Which of the following will increase commercial bank reserves?
a. the purchase of government bonds in the open market by the Federal Reserve Banks
b. a decrease in the reserve ratio c. an increase in the discount rate
d. the sale of government bonds in the open market by the Federal Reserve Banks
14. If the Federal Reserve System buys government securities from commercial banks and the public:
a. commercial bank reserves will decline.
b. commercial bank reserves will be unaffected.
c. it will be easier to obtain loans at commercial banks.
d. the money supply will contract.
15. Which of the following best describes the cause-effect chain of an easy money policy?
a. A decrease in the money supply will lower the interest rate, increase investment spending, and increase aggregate demand and GDP.
b. A decrease in the money supply will raise the interest rate, decrease investment spending, and decrease aggregate demand and GDP.
c. An increase in the money supply will raise the interest rate, decrease investment spending, and decrease aggregate demand and GDP.
d. An increase in the money supply will lower the interest rate, increase investment spending, and increase aggregate demand.
16. If the economy were encountering a severe recession, proper monetary and fiscal policies would call for:
a. selling government securities, raising the reserve ratio, lowering the discount rate, and a budgetary surplus.
b. buying government securities, reducing the reserve ratio, reducing the discount rate, and a budgetary deficit.
c. buying government securities, raising the reserve ratio, raising the discount rate, and a budgetary surplus.
d. buying government securities, reducing the reserve ratio, raising the discount rate, and a budgetary deficit.
17. Suppose the total market value of all final goods and services produced in a particular country in 2001 is $500 billion and the total market value of final goods and services sold is $450 billion. We can conclude that:
a. GDP in 2001 is $450 billion.
b. NDP in 2001 is $450 billion.
c. GDP in 2001 is $500 billion.
d. inventories in 2001 fell by $50 billion.
18. In national income accounting, consumption expenditures include:
a. purchases of both new and used consumer goods.
b. consumer durable goods and consumer nondurable goods, but not services.
c. consumer durable goods, consumer nondurable goods, and services.
d. changes in business inventories.
19. Suppose that GDP was $200 billion in year 1 and that all other components of expenditures remained the same in year 2 except that business inventories increased by $10 billion. GDP in year 2 is:
a. $180 billion.
b. $190 billion.
c. $200 billion.
d. $210 billion.
20. GDP differs from NDP in that:
a. GDP is based on gross exports, while NDP is based on net exports.
b. GDP includes, but NDP excludes, indirect business taxes.
c. net investment is used in calculating GDP and gross investment is used in calculating NDP.
d. gross investment is used in calculating GDP and net investment is used in calculating NDP.
21. NDP is:
a. NI plus net foreign factor income earned in the U.S. plus indirect business taxes.
b. NI plus corporate income taxes.
c. GDP deflated for increases in the price level.
d. GDP minus indirect business taxes.
5Q-2
22. If personal income exceeds national income in a particular year, we can conclude that:
a. transfer payments exceeded the sum of social security contributions, corporate income taxes, and indirect business taxes.
b. the sum of social security contributions, corporate income taxes, and undistributed corporate profits exceeded transfer payments.
c. consumption of fixed capital and indirect business taxes exceeded personal taxes.
d. transfer payments exceeded the sum of social security contributions, corporate income taxes, and undistributed corporate profits.
23. The amount of after-tax income received by households is measured by:
a. discretionary income.
b. national income.
c. disposable income.
d. personal income.
24. Real GDP measures:
a. current output at current prices.
b. current output at base year prices.
c. base year output at current prices.
d. base year output at current exchange rates.
25. The fact that nominal GDP has risen faster than real GDP:
a. suggests that the base year of the GDP price index has been shifted.
b. tells us nothing about what has happened to the price level.
c. suggests that the general price level has fallen.
d. suggests that the general price level has risen.
26. The aggregate demand curve:
a. is up-sloping because a higher price level is necessary to make production profitable as production costs rise.
b. is down-sloping because production costs decline as real output increases.
c. shows the amount of expenditures required to induce the production of each possible level of real output.
d. shows the amount of real output that will be purchased at each possible price level.
27. Which one of the following would not shift the aggregate demand curve?
a. a change in the price level
b. depreciation of the international value of the dollar
c. a decline in the interest rate at each possible price level
d. an increase in personal income tax rates
28. An increase in investment spending caused by higher expected rates of return will:
a. shift the aggregate supply curve to the left.
b. move the economy up along an existing aggregate demand curve.
c. shift the aggregate demand curve to the left.
d. shift the aggregate demand curve to the right.
29. The U.S. Gross Domestic Product (GDP) is defined as which of the following?
a. The value of all goods and services produced.
b. The value of all goods and services produced by Americans.
c. The value of all goods and services produced in America.
d. The value of all final goods and services produced in America.
30. All the following are “leading” indicators of the level of economic activity in the U.S. EXCEPT:
a. New private housing construction starts b. Common stock prices
c. Average weekly new claims for unemployment compensation
d. Size of the money supply
31. Assume the following data for the U.S. economy in a recent year:
Personal consumption expenditures $5,015 billion
Exports $106 billion
Government purchases of goods/services $1,040 billion
M1 $247 billion
Imports $183 billion
Gross private domestic investment $975 billion Open market purchases by Federal Reserve $4 billion Which of the following is the U.S. GDP based on the above information?
a. $4,087 billion b. $5,123 billion c. $6,953 billion d. $7,208 billion
32. A tightening of monetary policy would normally be expected to result in:
a. Higher bond and common stock prices.
b. Lower interest rates and stock prices.
c. Higher interest rates and lower stock prices.
d. Higher interest rates and higher stock prices.
33. If the Consumer Price Index rises during the year from 176.0 to 179.5, the rate of inflation during the year is:
a. 1.1%
b. 1.9%
c. 2.0%
d. Answer cannot be determined from the information provided.
34. Which of the following is (are) among the elements of fiscal policy?
(1) Government actions to raise or lower taxes
(2) Government actions to raise or lower the size of the money supply
(3) Government actions to raise or lower the amount it spends
a. (1) only b. (1) and (3) only c. (2) and (3) only d. (1), (2), and (3)
35. When the Federal Reserve engages in open market operations by buying government securities, which of the following is (are) likely to result?
(1) Lower interest rates
(2) Lower size of the money supply a. (1) only
b. (2) only c. Both (1) and (2) d. Neither (1) nor (2)
36. When the Federal Reserve wants to tighten the availability of credit, it should so which of the following?
(1) Sell government securities (2) Raise the discount rate a. (1) only
b. (2) only c. Both (1) and (2) d. Neither (1) nor (2)
37. The discount rate is the rate at which:
a. The Federal Reserve will sell government securities.
b. Banks will lend to their best customers.
c. The Treasury auctions off Treasury bills.
d. The Federal Reserve will lend to member banks.
38. A raising of the reserve requirement by the Federal Reserve is likely to have all the following effects EXCEPT:
a. Tighten the money supply b. Lead to higher stock prices c. Raise interest rates
d. Slow down the growth of GDP
39. The federal government measures inflation with which of the following indicators?
a. Dow Jones Index.
b. Consumer Price Index.
c. Consumer Confidence Index.
d. Corporate profits.
40. Which of the following concepts compares the price of goods in a given year to a base year?
a. Consumer Price Index.
b. Consumer Confidence Index.
c. Gross National Product.
d. Net National Product.
5Q-4
Chapter Five
Answers to Multiple Choice Questions
1. Answer (a) is the correct answer. Fiscal policy makes use of government spending and taxation to regulate the economy for stability. Answer (b) is not correct because government spending and taxation do not have the purpose of achieving greater equality in the distribution of income. Answer (c) is not correct because it is monetary policy, not fiscal policy, that is used to alter the interest rate to change aggregate demand. Answer (d) is not correct because fiscal policy deals with government spending and taxation; but not with the fact that government spending and taxation will be contradictory. In fact the increase in government spending along with a reduction in taxation would be expansionary.
2. Answer (d) is the correct answer. The word expansionary explains it all. Answer (a) is not correct because fiscal supply is not designed to change the money supply. Answer (b) is not the correct answer because fiscal policy may or may not expand the size of government. Answer (c) is not the correct answer because monetary policy, not fiscal policy, is focused on price stability.
3. Answer (d) is the correct answer. A reduction in federal tax rates is an appropriate fiscal policy to bring the economy out of a recession. Answer (a) is not correct because such an action would use higher taxes to buy back federal debt instruments. Answer (b) is not correct because such actions would negatively impact aggregate demand.
Answer (c) is not correct because such an action would involve a reduction in government spending.
4. Answer (b) is the correct answer. A decrease in taxes will increase aggregate demand. Answer (a) is not correct because a decrease in government spending will tend to decrease aggregate demand. Answer (c) is not correct because an appreciation of the dollar will tend to make exports more expensive in the world market, thus negatively impacting aggregate demand. Answer (d) is not correct because an increase in interest rates will tend to shift the aggregate demand curve to the left.
5. Answer (d) is the correct answer. A tax rate increase is a fiscal policy and it is appropriate in that it will reduce customer spending and shift the aggregate demand curve inward. Answer (a) is not correct because an increase in government spending will move the aggregate demand curve outward. Answer (b) is not correct because depreciation of the dollar will cause exports to increase. Answer (c) is not correct because a reduction in interest rates will cause an outward shift in the aggregate demand curve and that will tend to increase the price level even more.
6. Answer (d) is the correct answer. Each of those two actions will tend to shift the aggregate demand curve inward and to the left because the decrease in government spending will have a greater impact than the impact of lower taxes. This is true because some of the lower taxes will be saved by consumers. Answer (a) is not correct because the government spending impact will be greater than the tax impact. Answer (b) is not correct because the aggregate supply will not change and the aggregate demand will shift to cause a lower price level. Answer (c) is not correct because the government spending impact on aggregate demand will be greater than the tax impact on aggregate demand.
7. Answer (a) is the correct answer. An expansionary fiscal policy will result in a rightward, or outward shift in the aggregate demand curve. Answer (b) is not correct because fiscal policy involves government spending and taxation and both are intended to shift the aggregate demand curve. Answer (c) is not correct because fiscal policy does not impact the aggregate supply curve. Answer (d) is not correct because the impact on the aggregate demand curve will be just the opposite.
8. Answer (a) is the correct answer. Changes in mutual fund balances are not part of the list of leading economic indicators. Answer (b) is not correct because the length of the average work week is in the list of leading economic indicators. Answer (c) is not correct because the money supply is in the list of leading economic indicators. Answer (d) is not correct because the value of the index of consumer expectations is in the list of leading economic indicators.
9. Answer (a) is the correct answer. M1 is the most liquid of the money supply classifications. Answer (b) is not correct because Series E bonds are not a part of the money supply. Answer (c) is not correct because credit balances with brokers is not a part of the money supply. Answer (d) is not correct because gold certificates are not a part of
10. Answer (a) is the correct answer. As the price level increases, the value of money declines. Answer (b) is not correct because as the volume of employment increases, the price level is likely to increase and a price level increase will cause a decrease in the value of money. Answer (c) is not correct because the value of money declines as the price level increases. Answer (d) is not correct because inflation will tend to cause interest rates to increase and inflation causes the value of money to decline.
11. Answer (b) is the correct answer. The list provided in the question includes items that are included in M2, but not in M1. Answer (a) is not correct because M1 does not include time deposits. Answer (c) is not correct because the money supply does not include negotiable government bonds. Answer (d) is not correct because cash held in the U. S. Treasury is not included in the money supply.
12. Answer (b) is the correct answer. The purchase of government securities by the government puts money in the hands of consumers. Answer (a) is not correct because the purchase of government securities by the government will tend to cause commercial bank reserves to increase because it will put money in the hands of the people. Answer (c) is not correct because the purchase of government securities by the government will cause demand deposits to increase as people put the money in their bank accounts. Answer (d) is not correct because such an action will increase the money supply and the increase in the money supply will tend to cause interest rates to decrease.
13. Answer (a) is the correct answer. The purchase of government bonds by the Fed will put money in the hands of people and those people will put the money in commercial banks. Answer (b) is not correct because only a specific policy decision by the Fed can change the reserve ratio. Answer (c) is not correct because only a specific policy decision by the Fed can change the discount rate. Answer (d) is not correct because the sale of government bonds will take money out of the hands of the people and the people will pay for the bonds by withdrawing money from the commercial banks.
14. Answer (c) is the correct answer. The Fed’s buying of government securities puts money in the hands of people and the people will deposit the money in commercial banks causing the bank to have more loanable reserves.
Answer (a) is not correct because money will flow into the banks, not out of the banks. Answer (b) is not correct because money will flow into the banks and cause reserves to increase. Answer (d) is not correct because money will flow into the hand of the people.
15. Answer (d) is the correct answer. An increase in the money supply will lower the interest rate, increase investment spending, and increase aggregate demand. Answer (a) is not correct because a decrease in the money supply will not cause a lower interest rate. Answer (b) is not correct because a decrease in the money supply may not result in a decline in GDP if the aggregate demand curve crosses the aggregate supply curve in the vertical range of the aggregate supply curve. Answer (c) is not correct because an increase in the money supply will reduce the interest rate.
16. Answer (b) is the correct answer. The specified combination of Fed monetary policies and Federal Fiscal policies would be appropriate for a severe recession. Answer (a) is not correct because raising the reserve ratio and a budgetary surplus would be contrary actions in the face of a severe recession. Answer (c) is not correct because raising the reserve ratio, raising the discount rate, and a budgetary surplus are inconsistent with an attempt to overcome a severe recession. Answer (d) is not correct because raising the discount rate has the effect of reducing the money supply at a time when the money supply needs to increase to address the severe recession.
17. Answer (c) is the correct answer. GDP measures the value of all final goods and services produced, not sold.
Answer (a) is not correct because GDP measures the value of all final goods and services produced, not sold.
Answer (b) is not correct because NDP is the value of all final goods and services produced within a nation’s borders less depreciation. Answer (d) is not correct because the logic of changes in inventory would suggest that inventories increased rather than decreased.
18. Answer (c) is the correct answer. Consumption expenditures include consumer durable goods, non-durable goods, and services. Answer (a) is not correct because consumption expenditures do not include second-hand goods because there is no production of those goods in the current year. Answer (b) is not correct because consumption expenditures do include the expenditures for services. Answer (d) is not correct because business inventories represent goods that have been produced but not yet purchased.
5S-2
19. Answer (d) is the correct answer. GDP measures the value of all final goods and services produced and the $10 billion increase in business inventories represents the only change from the prior year. Answer (a) is not correct because there is not information that would lead to that answer. Answer (b) is not correct because the change in business inventories was an increase, not a decrease. Answer (c) is not the correct answer because the change in business inventories suggests that more goods were produced in year 2 than in year 1.
20. Answer (d) is the correct answer. NDP is GDP less depreciation. Answer (a) is not correct because exports do not explain the difference between NDP and GDP. Answer (b) is not correct because indirect business taxes do not explain the difference between NDP and GDP. Answer (c) is not correct because gross investment is used in calculating GDP.
21. Answer (a) is the correct answer. Net foreign factor income and indirect business taxes explain the difference between NI and NDP. Answer (b) is not correct because corporate taxes are part of the difference between national income (NI) and personal income (PI). Answer (c) is not correct because GDP deflated for price level changes is called “Real GDP.” Answer (d) is not correct because indirect business taxes is only one of the elements that explains the difference between NDP and NI.
22. Answer (d) is the correct answer. Personal income is equal to national income less social security contributions, less undistributed corporate profits, less corporate income taxes, plus transfer payments. Answer (a) is not correct because indirect business taxes are not an element in the difference between personal income and national income.
Answer (b) is not correct because in such a situation, personal income would be less than national income. Answer (c) is not correct because indirect business taxes, consumption of fixed capital (depreciation), and personal taxes are not elements that explain the difference between national income and personal income.
23. Answer (c) is the correct answer. Disposable income is personal income less personal taxes. Answer (a) is not correct because discretionary income is the income available after making all payments on contractual obligations.
Answer (b) is not correct because national income has not yet had taxes deducted. Answer (d) is not correct because personal income has not yet had personal taxes deducted.
24. Answer (b) is the correct answer. Real GDP measures current output at base year prices. Answer (a) is not correct because the word “Real” suggests that the measure is based on other than current prices. Answer (c) is not correct because Real GDP refers to the current year production. Answer (d) is not correct because exchange rates are not used to convert nominal GDP to real GDP.
25. Answer (d) is the correct answer. If nominal GDP rises faster than real GDP, it means that the general price level has risen. Answer (a) is not correct because the shifting of the base year is never done. Answer (b) is not correct because the relationship between nominal GDP and real GDP does reveal meaningful information about the price level. Answer (c) is not correct because if the price level had fallen, the real GDP would be lower than the previous year.
26. Answer (d) is the correct answer. The aggregate demand curve shows the relationship between the price level and real GDP. Answer (a) is not correct because the answer better describes the aggregate supply curve. Answer (b) is not correct because production costs are used to describe the slopes of the aggregate supply curve. Answer (c) is not correct because the aggregate demand curve shows the relationship between real GDP and some other variable other than “expenditures required.”
27. Answer (a) is the correct answer. A change in the price level would result in an increase in real GDP without shifting the aggregate demand curve. Answer (b) is not correct because depreciation of the international value of the dollar will impact demand for exports and that will cause a shift in the aggregate demand curve. Answer (c) is not correct because the aggregate demand curve shows the relationship between the price level and real GDP. Answer (d) is not correct because an increase in personal income tax rates will cause a shift in the aggregate demand curve.
28. Answer (d) is the correct answer. An increase in investment spending will cause the aggregate demand curve to shift to the right. Answer (a) is not correct because an increase in investment impacts the aggregate supply curve.
Answer (b) is not correct because an increase in investment spending will not have an impact on the price level, one of the axis of the aggregate demand curve. Answer (c) is not correct because an increase in investment spending will have a positive impact on real GDP.
29. Answer (d) is the correct answer. Answer (a) is incorrect because it includes all intermediate goods, such as automobile transmissions along with the auto itself. Answer (b) is not correct because it includes intermediate goods and also because production in America by non-Americans is also included in GDP. Answer (c) is not correct because it includes all intermediate goods, such as automobile transmissions along with the auto itself.
30. Answer (a) is the correct answer. Building permits, not construction starts, is an item among the leading indicators of economic activity. Answer (b) is not correct because common stock prices is an item among the leading economic indicators. Answer (c) is not correct because average weekly new claims for unemployment compensation is an item among the leading economic indicators. Answer (d) is not correct because the size of the money supply is an item among the leading economic indicators.
31. Answer (c) is correct. Consumption ($5,015) + Investment ($975) + Government ($1,040) – Net Imports ($183 -
$106) = $6,953. Answer (a) is not correct because Consumption + Investment + Government – Net Imports = GDP.
Answer (b) is not correct because Consumption + Investment + Government – Net Imports = GDP. Answer (d) is not correct because Consumption + Investment + Government – Net Imports = GDP.
32. Answer (c) is the correct answer. Tighter monetary policy means that actions are being taken by the Federal Reserve that will cause interest rates to rise, and rising interest rates will cause stock prices to be lower. Answer (a) is incorrect because tighter monetary policy suggests higher interest rates and higher interest rates will result in lower bond values and likely lower common stock prices. Answer (b) is incorrect because a tighter monetary policy will likely result in higher interest rates. Answer (d) is incorrect because a tighter monetary policy will likely result in higher interest rates which will cause lower stock prices.
33. Answer (c) is the correct answer because (179.5 – 176.0) /176.0 = 2.0%. Answer (a) is not correct because (X – Y) / Y is the formula. Answer (b) is not correct because (X –Y) / Y is the formula. Answer (d) is not correct because (X –Y) / Y is the formula.
34. Answer (b) is the correct answer. Fiscal policy is implemented through the raising and lowering of taxes and through the raising and lowering of government spending. Answer (a) is not correct because there is another aspect to fiscal policy other than just taxation. Answer (c) is not correct because government actions to raise or lower the size of the money supply is an aspect of monetary policy, not fiscal policy. Answer (d) is not correct because government actions to raise or lower the size of the money supply is an aspect of monetary policy, not fiscal policy.
35. Answer (a) is the correct answer. The Fed’s buying of government securities will increase the money supply and lower interest rates. Answer (b) is not correct because the Fed’s buying of government securities will increase the money supply. Answer (c) is not correct because the Fed’s buying of government securities will increase the money supply. Answer (d) is not correct because the Fed’s buying of government securities will lower interest rates.
36. Answer (c) is the correct answer. Both the selling of government securities and the raising of the discount rate will tend to tighten the availability of credit. Answer (a) is not correct because raising the discount rate will also tighten the availability of credit. Answer (b) is not correct because selling government securities will also tighten the availability of credit. Answer (d) is not correct because both the selling of government securities and the raising of the discount rate will tend to tighten the availability of credit.
37. Answer (d) is the correct answer. The discount rate is the rate at which the Fed will lend to member banks.
Answer (a) is not correct because the rate at which the Fed will sell government securities is determined by the market. Answer (b) is not correct because the rate at which the banks will lend to their customers is determined by competition among banks. Answer (c) is not correct because the rate at which the Treasury auctions off Treasury bills is determined by the market.
38. Answer (b) is the correct answer. The raising of the reserve requirements will tend to raise interest rates and that will tend to cause lower stock prices. Answer (a) is not correct because a raising of the reserve requirements will tend to tighten the money supply. Answer (c) is not correct because the raising of the reserve requirement will tend to raise interest rates. Answer (d) is not correct because the raising of the reserve requirement will tend to raise interest rates and that will tend to slow down the growth of GDP.
5S-4
39. Answer (b) is the correct answer. The Consumer Price Index measures inflation in the U.S. by comparing the price of a market basket in the current year to the price of the same market basket in the base year. Answer (a) is wrong because the Dow Jones Index is an average of a basket of blue-chip stocks. Answer (b) is incorrect because the Consumer Confidence Index is considered a variable in causing changes in business cycles.
40. Answer (a) is the correct answer. The Consumer Price Index measures inflation in the U.S. by comparing the price of a market basket in the current year to the price of the same market basket in the base year.