Question

30. non intervention (self correction) works to bring the economy out of a recessionary gap by

a. shifting aggregate demand by reducing taxes

b. raising wages and shifting the short run aggregate supply

c. lowering wages and shifting the short run aggregate supply

d. shifting aggregate demand by increasing taxes

34. If the reserve requirement is 10% and initial new deposits (reserves) created by the Federal Reserve are $20 million, what is the maximum total deposits (M2) that can be created?

a. $200 million

b. $100 million

c. $40 million

d.$2 billion

35.If the reserve requirement is 10% and initial new deposits (reserves) created by the Federal Reserve are $20 million, what is the maximum total Loans that banks can make?

a. $20 million

b. $180 million

c. $80 million

d. $420 million

38.If the economy were in an inflationary gap situation, what is an appropriate monetary policy?

a. Federal Reserve increasing taxes

b. Open market purchases

c. Discount window loans

d. Open market sales

Answer 1

30. A self correcting mechanism is one where economy adjusts itself in the long run when prices and wages become flexible.

A recessionary gap is one caused when actual output is below the potential long run output. This generally occurs due to fall in aggregate demand which decreases price level and output. Now let's observe each option-

a. Shifting aggregate demand by reducing taxes - Incorrect. This is not a self correcting mechanism. Tax reduction is a expansionary fiscal policy that the government uses to increase aggregate demand and close recessionary gap.

b.raising wages and shifting short run Aggregate Supply is incorrect. Due to recession, price level are at a lower level than the long run level. In the long run when wages are no longer rigid and prices are fully flexible then this price fall due to recession will decrease real wages and not increase them. If for the sake of argument we consider a rise in wage then it causes a left shift of SRAS. This would just increase the gap further and raise prices.

c. Lowering wages and shifting short run Aggregate Supply is correct. During recession prices fall below long run level. When economy self adjusts in long run, wages no longer remain rigid and hence wages fall due to this fall in prices. A decrease in wages mean that the input cost of suppliers have decreased. This increases short run Aggregate Supply. This causes output to increase to the long run level - closing the recessionary gap. This also deceases prices further down. I have drawn a graph to illustrate the self correcting mechanism. It is self explanatory based on all the explanation given.

d. shifting aggregate demand by increasing taxes is incorrect. This is not self correcting mechanism. It's a governement controlled fiscal policy and a contractionary one.

Option c is correct.