Deck 34: The Influence of Monetary and Fiscal Policy on Aggregate Demand

Question 1

Keynes's theory that the interest rate adjusts to bring money supply and money demand into balance is called:

A) the theory of sticky wages
B) the theory of sticky prices
C) the classical dichotomy theory
D) the theory of liquidity preference

Answer 1

the theory of liquidity preference

Question 2

If the interest rate is below equilibrium, the excess demand for money puts downward pressure on the interest rate.

Answer 2

False

Question 3

When the government increases its purchases, the increase in aggregate demand could be more than or less than the increase in government purchases, depending on whether the multiplier effect or the crowding-out effect is larger.

Answer 3

True

Question 4

The multipler > 1 represents a less than proportionate change on economic activity as a result of government spending.

Question 5

The theory of Ricardian equivalence suggests that an increase in public saving will be balanced by an increase in private saving.

Question 6

Changes in government spending affect saving and growth in the long run, and aggregate demand and employment in the short run.

Question 7

The liquidity of money explains the demand for money. People own or hold money because money:

A) offers a high nominal return
B) can directly be used to buy goods and services
C) protects the owner against unforeseen inflation
D) all of the above

Question 8

The quantity of money demanded is _____ the interest rate.

A) the opportunity cost of
B) independent of
C) positively related to
D) inversely related to

Question 9

The multiplier effect suggests that the increase in aggregate demand could be smaller than the increase in government purchases, while the crowding-out effect suggests that the increase in aggregate demand could be larger than the increase in government purchases.

Question 10

In the long run, the interest rate adjusts to balance the supply and demand for money, whereas in the short run, the interest rate adjusts to balance national saving and desired investment.

Question 11

The global financial crisis has shown that the Australian government can influence the behaviour of the economy only with fiscal policy.

Question 12

Personal income tax and government outlays act as automatic stabilisers.

Question 13

Changes in monetary policy can only be viewed in terms of a changing target for the interest rate.

Question 14

According to the RBA's policy guidelines, if the RBA sees rising inflation, it would then increase interest rates.

Question 15

At a higher price level, the demand for money increases, the interest rate increases, and the demand for business and residential investment falls. Hence the aggregate-demand curve slopes downward.

Question 16

The theory of liquidity preference states that the interest rate adjusts to bring money supply and money demand into balance.

Question 17

John Maynard Keynes proposed the model of the money market called the liquidity preference theory.

Question 18

In the long run, the interest rate and inflation rate adjust to accommodate a fixed level of output. In the short run, the interest rate and output adjust to accommodate a predetermined level of prices.

Question 19

Any change in government spending has a multiplier effect on the level of economic activity.

Question 20

A lower inflation rate leads to a higher interest rate through Reserve Bank policy and the higher interest rate stimulates investment spending.

Question 21

The two macroeconomic effects that make the size of the shift in aggregate demand differ from the change in government purchases are:

A) the multiplier effect and the crowding-out effect
B) the multiplier effect and the Doppler effect
C) the Keynes effect and the crowding-out effect
D) the accelerator effect and the multiplier effect

Question 22

Supply-side economists focus on:

A) how fiscal policy affects aggregate demand
B) how tax-policy affects the incentives to work
C) how fiscal policy affects aggregate supply
D) both A and B
E) both B and C

Question 23

The positive feedback from demand to investment is called:

A) the investment multiplier
B) the investment accelerator
C) the multiplier accelerator
D) the demand accelerator

Question 24

An increase in the price level would:

A) shift the money demand to the left
B) shift the money demand to the right
C) shift the money supply to the right
D) shift the money supply to the left

Question 25

The government-purchases multiplier is defined as:

A) 1 - (1/MPC)
B) 1/(MPC - 1)
C) 1 - (MPC - 1)
D) 1/(1 - MPC)

Question 26

The government-purchases multiplier is defined as:

A) 1 - (1/MPC)
B) 1/(MPC - 1)
C) 1 - (MPC - 1)
D) 1/(1 - MPC)

Question 27

An increase in government purchases of $100 billion will shift the aggregate-demand curve to the:

A) left by more than $100 billion
B) left by more or less than $100 billion
C) right by more than $100 billion
D) right by more or less than $100 billion

Question 28

Economists agree that:

A) fiscal policy can be used to shift the aggregate-demand curve
B) monetary policy should actively be used to stabilise the economy
C) fiscal policy should actively be used to stabilise the economy
D) all of the above

Question 29

Assume that the money market is initially in equilibrium. A decrease in the price level would result in _____ of money at the initial interest rate.

A) equilibrium
B) an excess demand
C) an excess supply
D) none of the above

Question 30

For a given fixed price level, an increase in the money supply will lead to:

A) an increase in the interest rate, which in turn decreases the quantity of goods and services demanded
B) an increase in the interest rate, which in turn increases the quantity of goods and services demanded
C) a fall in the interest rate, which in turn increases the quantity of goods and services demanded
D) a fall in the interest rate, which in turn decreases the quantity of goods and services demanded

Question 31

Assume that the MPC is 0.5. A $100-billion cut in taxes will shift the aggregate-demand curve to the:

A) right by $500 billion
B) right by $250 billion
C) left by $250 billion
D) none of the above

Question 32

The notion that when the government increases its purchases of aeroplanes, the owners and employees of the aeroplane manufacturing companies will also purchase more as their incomes rise, and hence total purchases will increase by more than the initial change in government purchases, is known as the:

A) crowding-out effect
B) Keynesian effect
C) multiplier effect
D) acceleration effect

Question 33

The money-demand curve is downward-sloping because:

A) people will want to hold less money as the interest rate falls
B) people will want to hold more money as the interest rate falls
C) interest rates rise as the Reserve Bank reduces the quantity of money demanded
D) interest rates fall as the Reserve Bank reduces the supply of money

Question 34

When the government reduces taxes, households' take-home pay:

A) increases, households' saving increases and households' consumption increases
B) decreases, households' saving decreases and households' consumption decreases
C) increases, households' saving is unaffected and households' consumption increases
D) increases, households' saving increases and households' consumption is unaffected

Question 35

Most economists believe that a cut in tax rates:

A) will give people the incentive to work less hours
B) will increase government tax revenue
C) will have only a small effect on the aggregate-supply curve
D) all of the above

Question 36

A change in monetary policy that aims to expand aggregate demand can be described either as:

A) increasing the money supply or as raising the interest rate
B) decreasing the money supply or as raising the interest rate
C) decreasing the money supply or as lowering the interest rate
D) increasing the money supply or as lowering the interest rate

Question 37

Which of the following policies would Keynes have supported when the economy is experiencing unemployment?

A) An open-market purchase
B) A reduction in tax rates
C) An increase in government purchases
D) All of the above

Question 38

Suppose government purchases increase by $200 billion, that there is no crowding-out effect, and that the marginal propensity to consume is 0.75. What is the total effect of this increase in government purchases?

A) $150 billion
B) $267 billion
C) $800 billion
D) $600 billion

Question 39

Fiscal policy refers to the idea that changes in:

A) the Reserve Bank of Australia with its money supply mechanisms can affect aggregate demand
B) government purchases and taxing policy can affect aggregate demand
C) the price level affects the equilibrium interest rate
D) the exchange rate affects net exports

Question 40

Assuming that the crowding-out effect is $100 billion and the multiplier effect of an increase in government purchases is $120 billion, then the total effect on aggregate demand will be:

A) an $80 billion increase
B) an $80 billion decrease
C) a $20 billion increase
D) a $20 billion decrease

Question 41

Suppose government purchases increase by $100 billion, that there is no crowding-out effect, and that the marginal propensity to consume is 0.8. What is the total effect of this increase in government purchases?

A) $500 billion
B) $400 billion
C) $125 billion
D) $80 billion

Question 42

Automatic stabilisers:

A) reduce the problems that lags cause in using fiscal policy as a stabilisation tool
B) are changes in fiscal policy that stimulate aggregate demand automatically when the economy goes into a recession
C) are changes in fiscal policy that restrain aggregate demand automatically when the economy is growing too fast
D) none of the above
E) all of the above

Question 43

The marginal propensity to save

A) plus the marginal propensity to consume equals one
B) plus the marginal propensity to consume equals zero
C) plus the average propensity to consume equals one
D) plus the average propensity to consume equals zero

Question 44

If there is a major increase in economic activity, an appropriate policy for government would be to:

A) encourage individuals to save more
B) increase the budget surplus
C) tighten up monetary policy
D) all of these

Question 45

Suppose we observe that an increase in government spending of $10 billion raises the total aggregate demand by $40 billion. If there is no crowding-out effect, what would be the marginal propensity?

A) 0.25
B) 0.4
C) 0.75
D) 4

Question 46

A reduction in direct taxes will result in:

A) an increase in output and a little inflation if the economy is near full employment
B) a decrease in inflation and a small increase in output if the economy is near full employment
C) a leftward shift in the AD curve
D) no shift in the AD curve of these

Question 47

In the long run, the level of output is:

A) determined by the quantity of goods and services demanded
B) determined by the quantity and productivity of resources
C) determined by the level of interest rates
D) none of the above

Question 48

In the short run:

A) price level is fixed at some level, the level of output adjusts to balance the supply and demand for money, and the interest rate responds to changes in aggregate demand and aggregate supply
B) level of output is fixed at some level, the price level adjusts to balance the supply and demand for money, and the interest rate responds to changes in aggregate demand and aggregate supply
C) interest rate is fixed at some level, the price level adjusts to balance the supply and demand for money, and the level of output responds to changes in aggregate demand and aggregate supply
D) price level is fixed at some level, the interest rate adjusts to balance the supply and demand for money, and the level of output responds to changes in aggregate demand and aggregate supply

Question 49

If MPC = 0.6, then the government purchases multiplier is:

A) 0.4
B) 4
C) 2.5
D) 25

Question 50

According to the Ricardian equivalence theory, what would happen if the government were to cut taxes without changing its spending?

A) Public and national saving would fall
B) Public and national saving would rise
C) Public and national saving would not change
D) Private saving would rise, public saving would fall, and national saving would be unaffected

Question 51

According to classical macroeconomic theory:

A) output is determined by the level of aggregate demand
B) the price level is, in the long run, relatively unresponsive to changes in aggregate demand
C) the interest rate adjusts to balance the supply and demand for loanable funds
D) none of the above
E) all of the above

Question 52

An increase in Australia's marginal propensity to import will:

A) have no effect on GDP, because GDP only includes spending in Australia
B) cause an increase in GDP, because Australians have risen their spending
C) cause a decrease in GDP, because some existing spending will demand production overseas instead of in Australia
D) always be bad for the economy

Question 53

If the interest rate increases through monetary policy, the:

A) aggregate demand curve shifts to the right
B) aggregate demand curve shifts to the left
C) aggregate supply curve shifts to the right
D) aggregate supply curve shifts to the left

Question 54

If the economy is producing a real output that is less than capacity output, a(n):

A) expansionary monetary policy could be used to decrease aggregate demand and decrease the general price level
B) contractionary monetary policy could be used to increase aggregate demand and increase the general price level
C) contractionary monetary policy could be used to decrease aggregate demand and decrease the general price level
D) expansionary monetary policy could be used to increase aggregate demand and increase the general price level

Question 55

Assume there is no crowding-out effect. If an increase in government spending of $10 billion raises the total aggregate demand by $50 billion, then the marginal propensity is:

A) 0.2
B) 0.5
C) 5
D) 0.8

Question 56

The lag problem associated with monetary policy is due to:

A) the fact that firms make investment plans far in advance
B) the political process
C) the time it takes for monetary policy to affect the interest rate
D) none of the above

Question 57

Suppose the government reduces taxes by $200 million, that there is no crowding-out effect, and that the marginal propensity to consume is 0.75. What is the total effect on aggregate demand?

A) $150 million
B) $600 million
C) $267 million
D) $800 million

Question 58

Suppose government purchases increase by $100 billion, that there is no crowding-out effect, and that the marginal propensity to consume is 0.9. What is the total effect of this increase in government purchases?

A) $90 billion
B) $111 billion
C) $900 billion
D) $1000 billion

Question 59

If the economy is in a recession, an appropriate combination of monetary and fiscal policies might be to:

A) increase taxes, lower government spending, expand the money supply
B) increase taxes, raise government spending, expand the money supply
C) decrease taxes, raise government spending, expand the money supply
D) decrease taxes, lower government spending, contract the money supply

Question 60

The government reduces taxes by $20 million. Suppose that there is no crowding-out effect, and that the marginal propensity to consume is 0.9. What is the total effect on aggregate demand?

A) $18 million
B) $22 million
C) $180 million
D) $200 million

Question 61

Suppose that equilibrium in the money market is described by the equation M = aP/r, where M is the money supply, P is the price level, r is the interest rate and a is a constant. Suppose that investment is described by the equation I = b - kr, where b and k are constants. Using the equation Y = C + I + G (where Y is GDP, C is consumption and G is government spending), show that a higher price level leads to lower GDP.

Question 62

Suppose an increase in oil prices puts the economy in recession. Either fiscal policy or monetary policy could be used to eliminate the recession. In terms of the short-run impact on output and prices, is there any difference between the two?

Question 63

Money pays no interest - if you keep a hundred-dollar bill for a year, then next year you will have a hundred dollars. Other assets earn interest - if you place $100 in a savings account or in government bonds, you will have more than $100 next year. Why, then, are people ever willing to hold money?

Question 64

When the economy goes into a recession, the amount of taxes collected by the government falls automatically. Why?

Question 65

Is the effect of an election cycle (every three years) putting at risk long-term structural changes to the economy?

Question 66

Define expansionary and contractionary fiscal policy, giving examples of each.
ANS:
expansionary = a planned decrease in the budget surplus (T-G); e.g. a tax cut
contractionary (or tight) = a planned increase in the budget surplus (T-G); e.g. reduced government spending without any reduction in taxes

Question 67

If an economy goes into an expansion, then the government's:

A) outlays (e.g. transfer payments) will automatically fall and receipts (e.g. tax revenue) will automatically rise
B) outlays will automatically rise and receipts will automatically fall
C) outlays and receipts will automatically rise
D) outlays and receipts will automatically fall

Question 68

If an increase in interest rates reduces investment spending by $25m:

A) real GDP will decrease by $25 million
B) GDP will decrease by $25 million
C) GDP will decrease by more than $25 million
D) GDP will decrease by less than $25 million

Question 69

To eliminate a deflationary gap when the MPC is 0.75 and the deflationary gap is $500 million, investment will need to increase by how much?

Question 70

All else held constant, net taxes (i.e. taxes - transfers):

A) remain constant as GDP rises
B) increase as GDP falls
C) decrease as GDP falls
D) decrease as GDP rises

Question 71

What are the key determinants of the interest rate in the short run? What are the key determinants of the interest rate in the long run?

Question 72

Why could there be a great deal of frustration for policy makers when the long-term effects of their decisions do not seem to flow through, as they wanted?

Question 73

Suppose the government reduces taxes by $20 million, that there is no crowding-out effect, and that the marginal propensity to consume is 0.9. What is the total effect on aggregate demand? What would be the total effect on aggregate demand if the government increased purchases by $20 million?
ANS:
a. The initial effect of the tax reduction of $20 billion is to increase aggregate demand by $20 ? 0.9 = $18 billion. With an MPC of 0.9, the multiplier is 1/(1 - 0.9) = 10. So the total effect of a tax cut is 10 ? $18 billion = $180 billion.
b. The total effect of an increase in government purchases is 10 ? $20 billion = $200 billion.