Practice Test 4
Useful Formulas
(1) MPC = ∆ C / ∆ Disposable Income or ∆ C / ∆ YD
(2) MPC + MPS = 1
(3) Exp. Multiplier = 1/(1-MPC)
(4) ∆GDP = Exp Mult. * ∆AE
(5) Δ AE = Δ Income * MPC
(6) Money Multiplier = 1/rrr
(7) ∆Money Supply = Money Mult. * ∆Reserves
1
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1
1)
1
Moving along the aggregate supply curve when the price level rises, the
1
1)
1
______
1
A)
1
the quantity supplied decreases.
1
B)
1
the quantity supplied increases.
1
C)
1
the aggregate demand curve shifts rightward.
1
D)
1
the aggregate demand curve shifts leftward.
1
E)
1
quantity supplied does not change because the aggregate supply curve is a vertical line.
1
1
2)
1
If people's expectations about future income improve so they think their future income will be higher than previously believed, then the AD curve
1
2)
1
______
1
A)
1
will not change until income actually rises.
1
B)
1
will not shift but potential GDP will increase.
1
C)
1
and the AS curve will both shift leftward because people will increase their saving.
1
D)
1
will shift leftward because people will spend less now.
1
E)
1
will shift rightward because people will increase spending now.
1
1
3)
1
When the domestic price level increases, exports decrease and imports increase. Other things the same, this change is illustrated by a
1
3)
1
______
1
A)
1
movement upward along the aggregate demand curve.
1
B)
1
movement downward along the aggregate demand curve.
1
C)
1
leftward shift of the aggregate demand curve.
1
D)
1
rightward shift of the aggregate supply curve.
1
E)
1
rightward shift of the aggregate demand curve.
1
1
1
4)
1
The change in potential real GDP and aggregate supply shown in the graph above can be a result of
1
4)
1
______
1
A)
1
an increase in the quantity of capital.
1
B)
1
a decrease in the money wage rate.
1
C)
1
a decrease in the money price of oil.
1
D)
1
a fall in the price level.
1
E)
1
an increase in the real wage rate.
1
1
5)
1
The business cycle has two phases,
1
5)
1
______
1
A)
1
expansion and peak.
1
B)
1
expansion and trough.
1
C)
1
recession and expansion.
1
D)
1
recession and trough.
1
E)
1
peak and trough.
1
1
1
6)
1
In the figure above, the shift in the aggregate demand curve from AD1 to AD3 could be the result of an increase in
1
6)
1
______
1
A)
1
aggregate supply.
1
B)
1
the foreign exchange rate.
1
C)
1
the price level.
1
D)
1
expected future income.
1
E)
1
foreign incomes.
1
1
1
7)
1
In the figure above, the economy is at an equilibrium with real GDP of $10 trillion and a price level of 110. At this point there is
1
7)
1
______
1
A)
1
a full-employment equilibrium.
1
B)
1
an inflationary gap.
1
C)
1
an above full-employment equilibrium.
1
D)
1
a recessionary gap.
1
E)
1
price stability.
1
1
8)
1
If the aggregate demand curve and the aggregate supply curve intersect at a level of real GDP more than potential GDP, there is
1
8)
1
______
1
A)
1
a falling price level.
1
B)
1
a recessionary gap.
1
C)
1
a below-full employment equilibrium.
1
D)
1
an inflationary gap.
1
E)
1
a rising real GDP.
1
1
9)
1
As a result of an initial increase in investment of $200 billion, real GDP increased by $800 billion. Given this information, the expenditure multiplier equals
1
9)
1
______
1
A)
1
1/4.
1
B)
1
6.
1
C)
1
$800 billion.
1
D)
1
2.
1
E)
1
4.
1
1
10)
1
That portion of a firm's production that is not sold and is stored is called
1
10)
1
______
1
A)
1
planned expenditures.
1
B)
1
multiplied production.
1
C)
1
postponed expenditure.
1
D)
1
inventory.
1
E)
1
unplanned expenditures.
1
1
11)
1
In Germany, expected future income increased during 2007. This increase lead to
1
11)
1
______
1
A)
1
a movement upward along the consumption function.
1
B)
1
a movement downward along the consumption function.
1
C)
1
a downward shift of the consumption function.
1
D)
1
no movement along the consumption function and no shift of the consumption function.
1
E)
1
an upward shift of the consumption function.
1
1
12)
1
Taxes that change with the level of real GDP and income are called
1
12)
1
______
1
A)
1
GDP taxes.
1
B)
1
voluntary taxes.
1
C)
1
induced taxes.
1
D)
1
forced taxes.
1
E)
1
flexible taxes.
1
1
13)
1
The Fed increases the quantity of money to counteract
1
13)
1
______
1
A)
1
a federal budget surplus.
1
B)
1
a recessionary gap.
1
C)
1
inflation.
1
D)
1
an inflationary gap.
1
E)
1
negative net exports.
1
1
14)
1
The national debt is the amount
1
14)
1
______
1
A)
1
by which government tax receipts exceed expenditure in a given year.
1
B)
1
by which government expenditure exceeds tax receipts in a given year.
1
C)
1
of debt outstanding that arises from past budget deficits.
1
D)
1
of all future entitlement spending.
1
E)
1
of government expenditures summed over time.
1
1
15)
1
An increase in government expenditure can ______potential GDP and an increase in taxes can ______potential GDP.
1
15)
1
______
1
A)
1
increase; increase
1
B)
1
never change; never change
1
C)
1
increase; never change
1
D)
1
increase; decrease
1
E)
1
decrease; decrease
1
1
16)
1
The balanced budget multiplier applies when a $50 billion increase in government expenditure is financed by a $50 billion ______in tax revenue and the balanced budget multiplier shows that in this case there is ______effect on aggregate demand.
1
16)
1
______
1
A)
1
increase; no
1
B)
1
increase; a positive
1
C)
1
increase; a negative
1
D)
1
decrease; no
1
E)
1
decrease; a positive
1
1
17)
1
If the Fed increases interest rates, other things remaining the same, foreigners demand ______dollars thereby ______the price of the dollar on the foreign exchange market.
1
17)
1
______
1
A)
1
the same number of; not affecting
1
B)
1
more; increasing
1
C)
1
fewer; increasing
1
D)
1
fewer; decreasing
1
E)
1
more; decreasing
1
1
18)
1
When the Federal Reserve increases the Federal funds rate, the quantity of reserves ______, the quantity of money ______, and the quantity of loans ______.
1
18)
1
______
1
A)
1
decreases; decreases; does not change
1
B)
1
decreases; decreases; decreases
1
C)
1
decreases; does not change; does not change
1
D)
1
increases; increases; decreases
1
E)
1
increases; increases; increases
1
1
19)
1
In the United States,
1
19)
1
______
1
A)
1
the President initializes changes in monetary policy and the Fed approves the changes.
1
B)
1
Congress initializes changes in monetary policy and the Fed approves the changes.
1
C)
1
the Federal Reserve sets monetary policy.
1
D)
1
the Federal Reserve sets monetary and fiscal policies.
1
E)
1
Congress must approve monetary policy changes.
1
1
20)
1
If the Fed fears a recession, it
1
20)
1
______
1
A)
1
decreases aggregate supply.
1
B)
1
sells government securities.
1
C)
1
decreases aggregate demand.
1
D)
1
buys government securities.
1
E)
1
decreases the quantity of money.
1
1
1
21)
1
In the figure above, the shift in the aggregate demand curve from AD1 to AD3 could be the result of
1
21)
1
______
1
A)
1
a decrease in the foreign exchange rate.
1
B)
1
a decrease in the real interest rate.
1
C)
1
a decrease in the buying power of money.
1
D)
1
an increased expectation of a recession that lowers the expected rate of profit from investment.
1
E)
1
an increase in the price level.
1
1
22)
1
Resources are most underused during which phase of the business cycle?
1
22)
1
______
1
A)
1
under-phase
1
B)
1
recession
1
C)
1
expansion
1
D)
1
peak
1
E)
1
trend-bottom phase
1
1
23)
1
During 2010, exports increase from $1.0 trillion to $1.5 trillion. If the slope of the aggregate planned expenditure (AE) curve is 0.75, real GDP increases by
1
23)
1
______
1
A)
1
$8.0 trillion.
1
B)
1
$1.0 trillion.
1
C)
1
$6.0 trillion.
1
D)
1
$2.0 trillion.
1
E)
1
$4.0 trillion.
1
1
24)
1
Jack Nelson, a supervisor in the hardware department at Sears, received a $3,000 increase in his annual disposable income. Suppose his marginal propensity to consume is 0.80. How much of the $3,000 increase will Jack spend on consumption?
1
24)
1
______
1
A)
1
$3,000.
1
B)
1
$2,750
1
C)
1
$2,400
1
D)
1
$2,500
1
E)
1
$2,200
1
1
25)
1
In 2001, Congress passed tax laws to reduce income tax rates for all taxpayers. This action is called
1
25)
1
______
1
A)
1
an automatic fiscal policy.
1
B)
1
a discretionary fiscal policy.
1
C)
1
an annual tax policy.
1
D)
1
induced tax policy.
1
E)
1
a discretionary revenue policy
1
26)
1
A hike in the federal funds rate results in ______in the real interest rate which leads to a ______in investment.
1
26)
1
______
1
A)
1
a decrease; no change
1
B)
1
a decrease; a decrease
1
C)
1
an increase; a decrease
1
D)
1
a decrease; an increase
1
E)
1
an increase; an increase
1
1
1
27)
1
If an economy is at the short-run equilibrium illustrated by the figure above, a discretionary fiscal policy to adjust the economy to full employment is to
1
27)
1
______
1
A)
1
decrease the quantity of money.
1
B)
1
increase the quantity of money.
1
C)
1
increase government spending.
1
D)
1
increase taxes and decrease government spending simultaneously.
1
E)
1
decrease taxes.
1
1
28)
1
Monetary policy decisions in the United States are made by the
1
28)
1
______
1
A)
1
Federal Reserve in consultation with the U.S. Treasury.
1
B)
1
Federal Reserve in consultation with Congress.
1
C)
1
U.S. Mint.
1
D)
1
Federal Reserve.
1
E)
1
Congress and the President.
1
1
29)
1
If the price level increases from 110.0 to 115.0, the quantity of
1
29)
1
______
1
A)
1
potential GDP will decrease.
1
B)
1
real GDP supplied will increase.
1
C)
1
potential GDP will increase.
1
D)
1
real GDP demanded will increase.
1
E)
1
real GDP supplied will decrease.
1
Short Answer: Answer all the following questions. Use graphs and equations when they are asked for.
Question 1:
a. Explain and illustrate the shape of the AD curve and what each point on the curve entails?
b. What does the AS curve show you? Explain and illustrate. Why is it upward sloping?
c. Using both graphs illustrate equilibrium and explain what it means when the AS and AD curve meet.
Question 2
a. Given that there is a recessionary GAP of 500 Billion dollars and we have an MPC=.8, calculate the amount of spending that would be necessary to achieve FE-GDP?
b. Using the calculations above show the results on the AE and AD/AS graphs. Make sure to use your calculations when labeling the graphs.
c. How would your answer change if instead of a spending change the gov’t wanted to implement a tax cut to achieve the same result?
d. What could the FED do in order to alleviate this? Explain and illustrate your answer in the money market.
Question 3
a. Label and explain the Consumption-Function. Make sure to illustrate the MPC and autonomous consumption and explain each of these concepts using the graph to accompany your discussion.
b. What would happen to the line if autonomous cons. ↓? Illustrate and explain with the CF. Show this in a new graph. What does this change mean?
c. Using the consumption function illustrate and explain both savings and dissavings in the graph.
Question 4
a. Using the AE Line illustrate SR equilibrium. Make sure to label the graph fully and provide an explanation for why it is an equilibrium.
b. Why is GDP1 not equilibrium? Make sure to compare AE and GDP and discuss what is happening with inventories at that level of GDP.
c. If you are given that MPC is equal to 0.85, how much would you expect GDP to change if there is an initial increase in spending of ΔAE = +100 Million? Show your calculations for full credit and illustrate graphically your results using the graph below.
1