Tutorial 6
Chapter 8: Private sector demand: consumption and investment
Multiple choice questions
Question 1
Which ONE of the following is an important difference between aggregate consumption and aggregate private investment?
a. The investment decision of firms is characterized by rationality, whereas consumption decisions of households are much less rational.
b. Investment decisions are forward-looking and consumption decisions are backward-looking.
c. Consumption is relatively less variable than investment.
d. Households are subject to a budget constraint, whereas firms are able to borrow.
Question 2
Point M is the endowment of Crusoe, who faces a real interest rate of r. Which ONE of the following statements is NOT consistent with the figure above?
a. Crusoe’s wealth is equal to OB.
b. Crusoe would borrow in order to consume at point R.
c. Crusoe is unable to consume his entire second-period income.
d. The marginal rate of inter-temporal substitution is higher at M than at R.
Question 3
If a household anticipates a permanent fall in income, which ONE of the following will occur?
a. Saving will increase in the current period.
b. Consumption-smoothing will be random.
c. There will be a permanent fall in consumption that is of similar size to the anticipated fall in income.
d. The real interest rate will increase.
Question 4
If the real interest rate were to decrease, why would the optimal capital stock for a firm increase?
a. Because of the accelerator principle of investment.
b. Because a lower real interest rate provides an incentive to invest, since the marginal productivity of the existing capital stock would be higher than the marginal cost of capital.
c. Because the ‘animal spirits’ of entrepreneurs will become less volatile.
d. Because the lower interest rate would stimulate consumption.
Question 5
Suppose that, for current and expected future incomes, a household is observed to borrow at the current real rate of interest. If the real rate of interest were to increase, what would we expect this household to do?
a. To decrease its saving this period.
b. To decrease both its saving and its consumption this period.
c. To decrease its consumption this period.
d. Neither to decrease or increase its consumption in this period.
Question 6
Assuming that v is a constant value and greater than 1, then the relationship between current investment I1 and expected growth in output (Y2 – Y1): I1 = v (Y2 – Y1) is an explanation for which ONE of the following?
a. Lifetime consumption being relatively smooth compared to fluctuations in aggregate output.
b. The multiplier effect.
c. The volatility of aggregate saving.
d. The accelerator effect.
Open question: Exercise 2 from the book (only first part, not national level).
Extra questions: Exercises 1, 3, 5 and 11 from the book.
Chapter 9: Money and monetary policy
Multiple choice questions
Question 1
In the two figures below, we see the same demand for nominal money, but two different supplies of nominal money, corresponding to different monetary policies. Which ONE of the following can we conclude?
a. The interest rate is endogenous on the left and the money supply is endogenous on the right, holding the price level constant in both diagrams.
b. The money supply is endogenous on the left and the interest rate is endogenous on the right, holding the price level constant in both diagrams.
c. The price level is endogenous on the left and the interest rate is endogenous on the right, holding the quantity of money constant in both diagrams.
d. The price level is endogenous on the left and the money supply is endogenous on the right, holding the real rate of interest constant in both diagrams.
Question 2
The reserve multiplier is no greater than 1/rr, where rr = the required reserve ratio, for which ONE of the following reasons?
a. Banks charge higher interest on loans than they pay to depositors, and banks hold prudential reserves.
b. Banks sometimes reject loan applications as too risky and must keep their reserves at the central bank.
c. Banks are only required to keep a minimum fraction of their deposits as reserves by regulation and may choose to hold a higher fraction when additional security is judged prudential.
d. By borrowing, households can spend more than their income in a period, but never more than their creditworthiness.
Question 3
Open market operations usually take the form of a [(A)______] from the central bank to commercial banks, but can also involve purchases and sales of [(B)______].
a. (A) money order; (B) reserves
b. (A) government deficit; (B) short-term loans
c. (A) transfer payment; (B) commodities
d. (A) short-term loan; (B) assets
Question 4
Suppose that the Taylor rule for a central bank is as shown below.
If the GDP gap were equal to minus 0.06 and the actual inflation rate were [(A)______], the central bank’s target inflation rate, the central bank would [(B)______] the interest rate from the central bank’s neutral interest rate.
a. (A) 0.02 below; (B) not change
b. (A) 0.02 below; (B) increase
c. (A) 0.02 above; (B) not change
d. (A) 0.02 above; (B) increase
Question 5
Which ONE of the following is the purpose of requiring banks to maintain a minimum net worth in relation to their volume of deposits?
a. To increase the likelihood that a bank will survive, even if a sudden, unanticipated, and severe loss in value of some its assets were to occurs.
b. To prevent a speculative acquisition of the bank by another bank.
c. To provide funds that pay for deposit insurance.
d. To provide a private buffer of funds that is available for assisting other banks to survive a bank run.
Open question: Exercise 1 and 9 from the book. When answering the second question of Exercise 1 (about the growth rate of the reserves) assume that there is no cash in the economy, i.e., C = 0.
Extra questions: Exercises 5, 8, 11 and 12 from the book.