1. If the MPS = 0.1, then the value of the multiplier equals: a. 5. b. 10. c. 9. d. 1.

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1 1. If the MPS = 0.1, then the value of the multiplier equals: a. 5. b. 10. c. 9. d The marginal propensity to consume (MPC) is equal to the change in: a. consumer spending divided by the change in gross domestic product. b. consumer spending divided by the change in disposable income. c. consumer spending divided by the change in investment spending. d. disposable income divided by the change in consumer spending. 15/35

2 3. Figure: Consumption and Real GDP Reference: Ref 11 1 (Figure: Consumption and Real GDP) The slope of the consumption function is called the: a. average propensity to consume. b. marginal propensity to save. c. marginal propensity to consume. d. marginal consumption increment. 16/35

3 4. Figure: Consumption and Real GDP Reference: Ref 11 1 (Figure: Consumption and Real GDP) The marginal propensity to consume in this example is: a b. 0. c d /35

4 5. Figure: Consumption and Real GDP Reference: Ref 11 1 (Figure: Consumption and Real GDP) If real GDP is \$8 trillion, consumption is trillion and saving is trillion. a. \$4; \$2 b. \$5; \$3 c. \$5; \$2 d. \$4; \$3 6. Suppose the marginal propensity to consume changes from 0.75 to 0.9. How will this affect the consumption function? a. Autonomous consumption will increase. b. The function will shift upward. c. The slope will get steeper and autonomous consumption will increase. d. The slope will get steeper. 18/35

5 7. Reference: Ref 11 2 (Table: Individual and Aggregate Consumption Functions) Which of the following represents Mark's individual consumption function? a. C = YD. b. C = 0.8YD. c. C = YD. d. C = YD. 8. Scenario: Consumption Spending Suppose that the consumption function is: C = \$ YD, where YD is disposable income. Reference: Ref 11 5 (Scenario: Consumption Spending) Autonomous consumption is: a. 0. b. 0.8 of disposable income. c. \$1,300 if disposable income is \$1,000. d. \$ /35

6 9. Scenario: Consumption Spending Suppose that the consumption function is: C = \$ YD, where YD is disposable income. Reference: Ref 11 5 (Scenario: Consumption Spending) The marginal propensity to save is: a b. \$500. c d Figure: Consumption Functions Reference: Ref 11 7 (Figure: Consumption Functions) An economy's consumption function would shift from curve C to curve Cʹʹ when there is a(n): a. increase in wealth. b. increase in expected future disposable income. c. decrease in wealth. d. increase in the price level. 20/35

7 11. Planned investment spending depends on all of the following EXCEPT: a. the rate of interest. b. the expected future level of real GDP. c. the current level of real GDP. d. the current productive capacity in the economy. 12. Most recessions originate from: a. a decrease in aggregate supply. b. an increase in investment spending. c. a decrease in investment spending. d. an increase in aggregate supply. 13. The supply of loanable funds increases when people decide to be thriftier. Which of the following is most likely to occur? a. Interest rates decrease, and investment spending increases. b. Interest rates increase, and investment spending increases. c. Interest rates increase, and investment spending decreases. d. Interest rates decrease, and investment spending decreases. 14. Planned investment spending is to the interest rate because. a. positively related; a fall in the market interest rate decreases the supply of loanable funds b. positively related; a fall in the market interest rate decreases the opportunity cost of investing c. negatively related; a rise in the market interest rate causes consumption to crowd out investment d. negatively related; a rise in the market interest rate makes any given investment project less profitable 21/35

8 15. Inventory investment is: a. a part of the consumption spending, as these are unsold goods. b. a part of planned investment spending and is always positive. c. not a part of investment spending by firms, as it can't be properly planned ahead of time. d. a part of unplanned investment spending and may either be positive or negative. 16. If a CD store has 10,000 CDs at the start of the period and 15,000 CDs at the end of the period, then its inventory investment during the period was: a. 5,000. b c d. 5, Negative inventory investment occurs when companies: a. reduce their inventories by decreasing production. b. reduce their inventories because sales increase. c. add to their inventories by increasing production. d. add to their inventories because sales fall. 22/35

9 18. In an economy without government purchases, government transfers, or taxes, aggregate autonomous consumer spending is \$750 billion, planned investment spending is \$300 billion, and the marginal propensity to consume is What is the expression for planned aggregate spending? a. AE Planned = \$ YD. b. AE Planned = \$ YD. c. AE Planned = \$ YD. d. AE Planned = \$1, YD. 19. Figure: Aggregate Expenditures and Real GDP Reference: Ref 11 9 (Figure: Aggregate Expenditures and Real GDP) If the level of real GDP equals \$9,000 billion and there are no changes in the consumption function or in planned investment, then real GDP will in the next period. a. remain unchanged b. fall, but only if there is an offsetting change in autonomous consumption c. fall d. rise 23/35

10 20. Scenario: Income Expenditure Equilibrium GDP is \$8,000, autonomous consumption is \$500, and planned investment spending is \$200. The marginal propensity to consume is 0.8. Reference: Ref (Scenario: Income Expenditure Equilibrium) How much is planned aggregate spending? a. \$8,000 b. \$7,100 c. \$6,400 d. \$ Scenario: Income Expenditure Equilibrium GDP is \$8,000, autonomous consumption is \$500, and planned investment spending is \$200. The marginal propensity to consume is 0.8. Reference: Ref (Scenario: Income Expenditure Equilibrium) How much is unplanned inventory investment? a. \$1,100 b. 0 c. \$900 d. \$ Which of the following factors cannot shift the aggregate demand curve? a. changes in wealth b. changes in the price level c. changes in expectations d. changes in stock market indices 24/35

11 23. If prices are constant, but there is an increase in the value of financial assets: a. aggregate demand shifts to the left b. aggregate supply shifts to the right. c. aggregate supply shifts to the left. d. aggregate demand shifts to the right. 24. Which of the following would cause a shift in the short run aggregate supply curve? a. changes in aggregate demand b. a change in commodity prices c. the quantity of real output supplied d. the price level 25. The long run aggregate supply curve is vertical because in the long run: a. technological progress outpaces raises in nominal wages. b. all factors of production increase. c. the price of labor is flexible, while the price of physical capital is fixed. d. all prices are flexible. 25/35

12 26. Producing an aggregate output level that is higher than potential output is possible only if nominal wages: a. remain fixed. b. adjust fully in an upward direction. c. haven't yet fully adjusted downward. d. haven't yet fully adjusted upward. 27. An increase in aggregate demand will generate in real GDP and in the price level in the short run. a. no change; an increase b. an increase; an increase c. a decrease; no change d. an increase; no change 28. When the economy is producing output above the potential, it has a(n): a. falling wages. b. Keynesian gap c. recessionary gap. d. inflationary gap. 26/35

13 29. An economy is currently operating at an output level below its potential real GDP. If the government wishes use fiscal policy to bring the economy back to its potential real GDP, it will: a. increase taxation. b. increase government spending. c. decrease the money supply. d. increase the money supply. 30. A government might want to increase aggregate demand to: a. lower prices in the economy. b. close an inflationary gap. c. lower employment in the economy. d. close a recessionary gap. 31. Expansionary fiscal policy includes: a. decreasing government expenditures. b. increasing government expenditures. c. increasing taxes. d. increasing the money supply. 27/35

14 32. Contractionary fiscal policy causes the aggregate demand curve to shift to the and is used to close a(n) gap. a. left; recessionary b. right; recessionary c. left; inflationary d. right; inflationary 33. Figure: Fiscal Policy Options Reference: Ref 13 8 (Figure: Fiscal Policy Options) If the aggregate demand curve is AD : a. a contractionary fiscal policy may be warranted. b. an expansionary fiscal policy may be warranted. c. the economy is experiencing a recessionary gap. d. the economy is in long run equilibrium. 28/35

15 34. If the economy is at full employment, expansionary fiscal policy is most likely to lead to: a. higher inflation rates. b. lower inflation rates. c. increases in unemployment. d. decreases in interest rates. 35. Decreasing funding to explore space: a. will shift the aggregate supply curve to the right. b. will shift the aggregate demand curve to the left. c. will shift the aggregate demand curve to the right. d. will shift the aggregate supply curve to the left. 36. If the marginal propensity to consume is 0.75 and the federal government increases spending by \$100 billion, the income expenditure model would predict that real GDP will increase by: a. \$100 billion. b. \$400 billion. c. \$750 billion. d. \$300 billion. 29/35

16 37. A cut in taxes will have a greater impact on aggregate demand if it is given to: a. those who hold a large amount of wealth. b. people with a high MPC. c. people with a low MPC. d. everyone in the economy. 38. Which of the following is an automatic stabilizer? a. Medicare payments to the elderly b. military spending on the war in Iraq c. unemployment compensation payments to unemployed autoworkers d. disability payments to war veterans 39. Which one of the following represents the government budget surplus most accurately? a. T G TR b. T + TR G c. T + G TR d. T + G + TR 40. Expansionary fiscal policies: a. make the budget deficit smaller. b. affect only taxes. c. affect only government spending. d. make the budget surplus smaller. 30/35

17 41. Most economists believe that a balanced budget requirement would: a. undermine the role of taxes and transfers as automatic stabilizers. b. strengthen the ability of policy makers to conduct discretionary fiscal policy. c. not have any impact on the role of taxes and transfers as automatic stabilizers. d. enhance the effect of automatic stabilizers in the economy. 42. If the current level of real GDP lies below potential GDP, then an appropriate fiscal policy would be to, which will shift the curve to the. a. increase government purchases; AD; right. b. increase government purchases; AD; left. c. increase tax rates; AD; right. d. increase transfer payments; AS; right. 43. The national debt in years in which the federal government incurs a. a. stays the same; surplus b. rises; deficit c. falls; deficit d. rises; surplus 31/35

18 44. How does a nation's saving rate, as measured by the marginal propensity to save, affect the size of the spending multiplier? Explain with both intuition and the formula for the multiplier. Perhaps include a diagram of the circular flow of the economy. Answer: The multiplier process relies upon spending at every step. If disposable income rises, consumers increase spending at every stage of the process, by an amount equal to the marginal propensity to consume multiplied by the increase in disposable income. If the MPC is large, the MPS is small, and more total spending is multiplied throughout the economy. However, if consumers decide to increase savings at each stage of the process, the MPS increases, and disposable income leaks out of the spending multiplier. The multiplier M = 1 / (1 MPC). If the MPS increases, the MPC decreases, so (1 MPC) increases. If (1 MPC) increases, 1 / (1 MPC) decreases and the multiplier, M, falls. 32/35

19 45. Reference: Ref (Table: Real GDP) Suppose the economy has no government spending and no foreign trade. With no taxes and transfers, real GDP is equal to disposable income (YD). The data in the accompanying table show consumption spending (C) and planned investment (I planned ). a. What is the MPC in this economy? b. At what level of real GDP will the economy find its income expenditure equilibrium? Answer: a. As YD increases by \$1,000, C increases by \$900, so the MPC = 900 / 1,000 = b. If you create a new column for AE planned = C + I planned, you will see that real GDP = AE planned at \$7, /35

20 46. Suppose the economy is in short run equilibrium. Use the AD AS model to predict short run changes to real GDP and the aggregate price level if commodity prices suddenly increase. Explain your reasoning. Answer: Producers use commodities to produce final goods and services. If commodity prices are rising, it becomes more expensive to produce those goods and services, and therefore shifts the SRAS to the left. This leftward shift in SRAS will decrease real GDP and increase the aggregate price level. 47. Suppose the economy is initially in long run equilibrium and there is a negative demand shock to the economy. Describe the short run effects of this demand shock and how the economy will adjust in the long run. Use a diagram. Answer: If the economy is initially at potential real GDP and the AD curve shifts to the left, it will decrease real GDP and the price level along the SRAS curve. This is a recessionary gap. Because of the high level of unemployment, nominal wages eventually fall, which gradually shifts the SRAS to the right. As the SRAS increases, real GDP increases and the price level decreases along the new AD curve. The adjustment process concludes when real GDP again reaches the level of potential real GDP, but at a lower price level. 34/35

21 48. Many economists caution against extremely active stabilization policy because of time lags in its use. Explain this rationale. Answer: It takes several months for enough economic data to be gathered and analyzed, so there is a lag in the recognition of a recessionary or inflationary gap. There is also a time lag in crafting appropriate legislative action to remedy the economy. Once the law has been passed, there is a time lag in implementing the policy. Because of these time lags, the policy makers may be far behind the actual business cycle, thereby engaging in policy that is no longer necessary or perhaps even counterproductive. 49. Explain the difference between automatic stabilizers and discretionary fiscal policy measures. Provide examples to clarify the distinctions. Answer: Automatic stabilizers are spending and taxation rules that automatically help to slow down recessions and also help to slow down economic expansions, without requiring deliberate action by lawmakers. For example, more people qualify for unemployment benefits during a recession. This puts transfer payments in the hands of more people, thus helping to expand the economy. Discretionary fiscal policy is fiscal policy that is the direct result of deliberate actions by lawmakers. For example, the president and Congress might pass an economic stimulus package during a recession to give tax breaks to most households. This deliberate reduction in taxes acts as expansionary fiscal policy. 35/35

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