Question

A. According to John Maynard Keynes,

1. the demand for money in a country is determined entirely by that nation’s central bank.

2. the supply of money in a country is determined by the overall wealth of the citizens of that country.

3. the interest rate adjusts to balance the supply of, and demand for, money.

4. the interest rate adjusts to balance the supply of, and demand for, goods and services.

B. While a television news reporter might state that “Today the Fed raised the federal funds rate from 1 percent to 1.25 percent,” a more precise account of the Fed’s action would be as follows:

1. “Today the Fed told its bond traders to conduct open­market operations in such a way that the equilibrium federal funds rate would increase to 1.25 percent.”

2. “Today the Fed raised the discount rate by a quarter of a percentage point, and this action will force the federal funds rate to rise by the same amount.”

3. “Today the Fed took steps to increase the money supply by an amount that is sufficient to increase the federal funds rate to 1.25 percent.”

4. “Today the Fed took a step toward expanding aggregate demand, and this was done by raising the federal funds rate to 1.25 percent.”

C. Refer to the graph above, if the current interest rate is 2 percent,

1. there is an excess supply of money.

2. people will sell more bonds, which drives interest rates up.

3. as the money market moves to equilibrium, people will buy more goods.

4. All of the above are correct.

D. Suppose that the Federal reserve is concerned about the effects of falling stock prices on the economy. What could it do?

1. buy bonds to raise the interest rate

2. buy bonds to lower the interest rate

3. sell bonds to raise the interest rate

4. sell bonds to lower the interest rate

E. The economy is in recession. Shifting the AD curve rightward by $200 billion would end the recession. Which of the following statements is correct?

1. If MPC = 0.8 and there is no crowding out, the Congress needs to increase G by $160 billion to end the recession.

2. If MPC = 0.8 and there is no crowding out, the Congress needs to increase G by $40 billion to end the recession.

3.. If MPC = 0.8 and there is crowding out, the Congress needs to increase G by a smaller amount than when there is no crowding out.

4. If MPC = 0.8 and there is crowding out, the Congress needs to increase G by the same amount than when there is no crowding out.

F. In 1986, OPEC countries increased their production of oil. This caused

1. the price level to rise.

2. aggregate supply to shift right.

3. unemployment to rise.

4. None of the above is correct.

G. Suppose the economy is in long-run equilibrium. If there is a sharp decline in government purchases combined with a significant increase in immigration of skilled workers, then in the short run,

1. real GDP will rise and the price level might rise, fall, or stay the same. In the long-run, real GDP will rise and the price level might rise, fall, or stay the same.

2. the price level will fall, and real GDP might rise, fall, or stay the same. In the long-run, real GDP and the price level will be unaffected.

3. the price level will rise, and real GDP might rise, fall, or stay the same. In the long run, real GDP will rise and the price level will fall.

4. the price level will fall, and real GDP might rise, fall, or stay the same. In the long run, real GDP will rise and the price level will fall.

H. Suppose the economy is in long-run equilibrium. In a short span of time, there is a sharp increase in the supply of labor, a major new discovery of oil, and new environmental regulations that raise the cost of electricity production. In the short run

1. the price level will rise and real GDP will fall.

2. the price level will fall and real GDP will rise.

3. the price level and real GDP will both stay the same.

4. All of the above are possible.

I. If the Fed conducts open-market sales, which of the following quantities increase(s)?

1. interest rates, prices, and investment spending

2. interest rates and prices, but not investment spending

3. interest rates and investment, but not prices

4. interest rates, but not investment or prices

J. A tax cut shifts aggregate demand (Note here we are asking for the theoretical case)

1. by more than the amount of the tax cut.

2. by the same amount as the tax cut.

3. by less than the tax cut.

4. None of the above is necessarily correct.

 

Answer 1

A. Among all four options, only option 3 is correct. Demand and supply of money is balanced by interest rates.

B. Among all four options, only option 1 is correct. Here, the Federal Reserve can conduct open market operations (by selling bonds and securities) to decrease the money supply. As a result, federal funds can be increased.

C. At equilibrium interest rate, there is a balance between demand and supply of money. As people sell bonds, money supply will increase which decreases interest rates. With increase in money supply, people will buy more goods. Here, only option 3 is correct whereas, options 1 and 2 are incorrect. Hence, option 3 is the correct answer.

D. Fed can buy bonds and increase money supply which will cause interest rates to fall. Falling interest rates leads to increase in investment and higher stock prices. Here, option 2 is the correct answer and all other options are inappropriate here.

E. When MPC = 0.8, value of the multiplier = 1/(1-0.8) = 5.

Thus, increasing government spending by $40 billion will increase GDP by $40*5 = $200 billion(where 5 is the multiplier value).Here, option 2 is the correct answer as other options are not enough to close the output gap.

F. Increase in production of oil shifts the aggregate supply curve to the right. Here, only option 2 is correct. All other options are not valid.

G. With decline in government purchases, short-run aggregate demand curve shifts to the left. As a result, price level fall whereas, real GDP may rise, fall or remain same. Now, with increase of immigrant workers, long run real GDP will rise. Here, option 4 is the best possible answer.

H. In this case, short-run aggregate supply curve shifts to the right. As a result, price level rises whereas, the real GDP may rise, fall or remain the same. Here, option 4 is the correct answer.

I. With the Fed conducting open market sales, money supply decreases. As a result, interest rates rises. This leads to fall in investment and aggregate demand. With leftward shift in aggregate demand, price level falls. Here, option 4 is the correct alternative.

J. Here option 1 is correct, as the shift in aggregate demand is more than the reduction in tax cut.