Deck 15: The Influence of Monetary and Fiscal Policy on Aggregate Demand

Question 1

According to the theory of liquidity preference, how is the money supply affected by the interest rate?

A)positively
B)negatively
C)not affected
D)directly

Answer 1

C

Question 2

According to the liquidity preference theory, equilibrium in the money market is achieved by adjustments in which of the following?

A)the price level
B)the interest rate
C)the exchange rate
D)real wealth

Answer 2

B

Question 3

Which of the following is the most liquid asset?

A)capital goods
B)stocks and bonds with a low risk
C)stocks and bonds with a high risk
D)funds in a chequing account

Answer 3

D

Question 4

For the Canadian economy, which of the following is the LEAST important reason for the downward slope of the aggregate-demand curve?

A)the wealth effect
B)the interest-rate effect
C)the exchange-rate effect
D)the real-wage effect

Question 5

According to liquidity preference theory, what action taken by the Bank of Canada would shift the money supply curve?

A)if the Bank of Canada engaged in arbitrage
B)if the Bank of Canada changed the inflation rate
C)if the Bank of Canada changed the exchange rate
D)if the Bank of Canada engaged in open-market transactions

Question 6

Which of the following is NOT a reason the aggregate demand curve slopes downward?

A)As the price level increases, real wages decline.
B)As the price level increases, real wealth declines.
C)As the price level increases, the interest rate increases.
D)As the price level increases, the exchange rate increases.

Question 7

Which of Keynes's theories does liquidity preference refer to?

A)the effects of changes in money demand and supply on interest rates
B)the effects of changes in money demand and supply on exchange rates
C)the effects of wealth on expenditures
D)the difference between temporary and permanent changes in income

Question 8

Over what period of time is the liquidity preference theory most relevant, and what does it suppose?

A)short run; it supposes that the price level adjusts to bring money supply and money demand into balance
B)short run; it supposes that the interest rate adjusts to bring money supply and money demand into balance
C)long run; it supposes that the price level adjusts to bring money supply and money demand into balance
D)long run; it supposes that the interest rate adjusts to bring money supply and money demand into balance

Question 9

Which of the following is characteristic of aggregate demand in Canada?

A)The exchange-rate effect is relatively small because exports and imports are a small part of real GDP.
B)The interest-rate effect is relatively small because investment spending is not very responsive to interest rate changes.
C)The wealth effect is relatively large because money holdings are a significant portion of most households' wealth.
D)The interest rate effect is relatively large.

Question 10

If expected inflation is constant and the nominal interest rate increases, how does the real interest rate change?

A)It increases by more than the change in the nominal interest rate.
B)It increases by the change in the nominal interest rate.
C)It decreases by the change in the nominal interest rate.
D)It decreases by more than the change in the nominal interest rate.

Question 11

The wealth effect helps explain the downward slope of the aggregate demand curve. How important is this effect and why?

A)relatively important in Canada because expenditures on consumer durables is very responsive to changes in wealth
B)relatively important in Canada because consumption spending is a large part of GDP
C)relatively unimportant in Canada because money holdings are a small part of consumer wealth
D)relatively unimportant in Canada because it takes a large change in wealth to make a significant change in interest rates

Question 12

When the Bank of Canada buys government bonds, how do the reserves of the banking system change and what happens to the money supply?

A)The reserves increase, so the money supply increases.
B)The reserves increase, so the money supply decreases.
C)The reserves decrease, so the money supply increases.
D)The reserves decrease, so the money supply decreases.

Question 13

According to liquidity preference theory, when would the money supply curve shift right?

A)if the money demand curve shifted right
B)only if the Bank of Canada chose to increase the money supply
C)if the interest rate increased
D)if the price level fell or the interest rate decreased

Question 14

What does liquidity refer to?

A)the relation between the price and interest rate of an asset
B)the risk of an asset relative to its selling price
C)the ease with which an asset is converted into a medium of exchange
D)the sensitivity of investment spending to changes in the interest rate

Question 15

The theory of liquidity preference assumes that the nominal supply of money is determined by which of the following?

A)the level of real GDP
B)the rate of inflation
C)the interest rate
D)the central bank

Question 16

How long does fiscal policy affect the economy?

A)only in the short run
B)only in the long run
C)in both the short and long run
D)in neither the short nor long run

Question 17

Which of the following is NOT a response that would result from a decrease in the price level and so help to explain the slope of the aggregate demand curve?

A)When interest rates fall, Sleepwell Hotels decides to build some new hotels.
B)The exchange rate falls, so French restaurants in Paris buy more Canadian beef.
C)Janet feels wealthier because of the price drop, and so she decides to remodel her bathroom.
D)With prices down and wages fixed by contract, Gatekeeper Computers decides to lay off workers.

Question 18

If expected inflation is constant and the nominal interest rate increased 5 percentage points, what would happen to the real interest rate?

A)It would increase 5 percentage points.
B)It would increase, but by less than 5 percentage points.
C)It would decrease, but by less than 5 percentage points.
D)It would decrease by 5 percentage points.

Question 19

Which of the following reasons for the downward slope of the aggregate demand curve would likely be more important for a small closed economy?

A)the wealth effect
B)the interest-rate effect
C)the exchange-rate effect
D)the real-wage effect

Question 20

According to liquidity preference theory, what shape is the money supply curve?

A)upward sloping
B)downward sloping
C)vertical
D)horizontal

Question 21

For the following questions, consult the diagram below.
Figure 15-1
Refer to Figure 15-1. At which of the following interest rates is there an excess money demand?

A)2 percent
B)3 percent
C)4 percent
D)5 percent

Question 22

For the following questions, consult the diagram below.
Figure 15-1
Refer to Figure 15-1. At an interest rate of 4 percent, how much is the excess money demand or supply?

A) There is an excess money demand equal to the distance between a and b.
B) There is an excess money demand equal to the distance between b and c.
C) There is an excess money supply equal to the distance between b and a.
D) There is an excess money supply equal to the distance between c and b.

Question 23

If there is excess money demand, what will people do and what happens to the interest rate?

A)People will deposit more into interest-bearing accounts, and the interest rate will fall.
B)People will deposit more into interest-bearing accounts, and the interest rate will rise.
C)People will withdraw money from interest-bearing accounts, and the interest rate will fall.
D)People will withdraw money from interest-bearing accounts, and the interest rate will rise.

Question 24

For the following questions, consult the diagram below.
Figure 15-1
Refer to Figure 15-1. At the interest rate specified, which of the following is most likely to happen?

A)If the interest rate is 4 percent, there is excess money demand, and the interest rate will fall.
B)If the interest rate is 3 percent, there is excess money supply, and the interest rate will rise.
C)If the interest rate is 4 percent, the demand for goods will rise when the money market is in its new equilibrium.
D)If the interest rate is 2 percent, there is an excess supply of money and the interest rates will rise.

Question 25

In recent years, the Bank of Canada has conducted policy by setting a target for which of the following?

A)bank reserves
B)the monetary growth rate
C)the exchange rate
D)the bank rate

Question 26

If at some interest rate the quantity of money supplied is greater than the quantity of money demanded, what will people desire to do and what happens to the interest rate?

A)People will sell interest-bearing assets, causing the interest rate to decrease.
B)People will sell interest-bearing assets, causing the interest rate to increase.
C)People will buy interest-bearing assets, causing the interest rate to decrease.
D)People will buy interest-bearing assets, causing the interest rate to increase.

Question 27

If there is excess money supply, what will people do and what happens to the interest rate?

A)People will deposit more into interest-bearing accounts, and the interest rate will fall.
B)People will deposit more into interest-bearing accounts, and the interest rate will rise.
C)People will withdraw money from interest-bearing accounts, and the interest rate will fall.
D)People will withdraw money from interest-bearing accounts, and the interest rate will rise.

Question 28

For the following questions, consult the diagram below.
Figure 15-1
Refer to Figure 15-1. Which of the following will happen if the current interest rate is 2 percent?

A)There will be excess money supply.
B)People will sell more bonds, which drives interest rates up.
C)As the money market moves to equilibrium, people will buy more goods.
D)People will sell more bonds, which drives the interest rates down.

Question 29

In which of the following situations do people want to hold more money?

A)when the price level or the interest rate increases
B)when the price level or the interest rate decreases
C)when the price level increases or the interest rate decreases
D)when the price level decreases or the interest rate increases

Question 30

According to liquidity preference theory, if the quantity of money supplied is greater than the quantity demanded, what will happen to the interest rate and the quantity of money demanded?

A)The interest rate will increase, and the quantity of money demanded will decrease.
B)The interest rate will increase, and the quantity of money demanded will increase.
C)The interest rate will decrease, and the quantity of money demanded will decrease.
D)The interest rate will decrease, and the quantity of money demanded will increase.

Question 31

According to liquidity preference theory, if the quantity of money demanded is greater than the quantity supplied, what will happen to the interest rate and the quantity of money demanded?

A)The interest rate will increase, and the quantity of money demanded will decrease.
B)The interest rate will increase, and the quantity of money demanded will increase.
C)The interest rate will decrease, and the quantity of money demanded will decrease.
D)The interest rate will decrease, and the quantity of money demanded will increase.

Question 32

According to liquidity preference theory, why is the money demand curve downward sloping?

A)because interest rates rise as the Bank of Canada reduces the quantity of money demanded
B)because interest rates fall as the Bank of Canada reduces the supply of money
C)because people will want to hold less money as the cost of doing so falls
D)because people will want to hold more money as the cost of doing so falls

Question 33

In which of the following situations do people want to hold less money?

A)when the price level or the interest rate increases
B)when the price level or the interest rate decreases
C)when the price level increases or the interest rate decreases
D)when the price level decreases or the interest rate increases

Question 34

If at some interest rate the quantity of money demanded is greater than the quantity of money supplied, what will people desire to do and what will happen to the interest rate?

A)People will sell interest-bearing assets, causing the interest rate to decrease.
B)People will sell interest-bearing assets, causing the interest rate to increase.
C)People will buy interest-bearing assets, causing the interest rate to decrease.
D)People will buy interest-bearing assets, causing the interest rate to increase.

Question 35

When does the opportunity cost of holding money decrease or increase, and how does people's desire to hold money change?

A)The opportunity cost of holding money decreases when the interest rate increases, so people desire to hold more money.
B)The opportunity cost of holding money decreases when the interest rate increases, so people desire to hold less money.
C)The opportunity cost of holding money increases when the interest rate increases, so people desire to hold more money.
D)The opportunity cost of holding money increases when the interest rate increases, so people desire to hold less money.

Question 36

Why do people primarily own or hold money?

A)because it has a guaranteed nominal return
B)because it has a guaranteed real return
C)because it can directly be used to buy goods and services
D)because it functions as a unit of account

Question 37

When the interest rate increases, how do the opportunity cost of holding money and the quantity of money demanded change?

A)The opportunity cost of holding money increases, so the quantity of money demanded increases.
B)The opportunity cost of holding money increases, so the quantity of money demanded decreases.
C)The opportunity cost of holding money decreases, so the quantity of money demanded increases.
D)The opportunity cost of holding money decreases, so the quantity of money demanded decreases.

Question 38

When the interest rate decreases, what happens to the opportunity cost of holding money and the quantity of money demanded?

A)The opportunity cost of holding money increases, so the quantity of money demanded increases.
B)The opportunity cost of holding money increases, so the quantity of money demanded decreases.
C)The opportunity cost of holding money decreases, so the quantity of money demanded increases.
D)The opportunity cost of holding money decreases, so the quantity of money demanded decreases.

Question 39

According to liquidity preference theory, what is the opportunity cost of holding money?

A)the interest rate on bonds
B)the inflation rate
C)the cost of converting bonds to a medium of exchange
D)the difference between the inflation rate and the interest rate on bonds

Question 40

According to the theory of liquidity preference, which of the following variables adjusts to balance the supply and demand for money?

A)interest rate
B)money supply
C)quantity of output
D)price level

Question 41

According to liquidity preference theory, if the price level increases, in which direction does the demand curve shift, and how does the interest rate change?

A)The demand curve shifts right, so the interest rate increases.
B)The demand curve shifts right, so the interest rate decreases.
C)The demand curve shifts left, so the interest rate decreases.
D)The demand curve shifts left, so the interest rate increases.

Question 42

According to which theory do changes in the interest rate bring the money market into equilibrium?

A)both liquidity preference theory and classical theory
B)neither liquidity preference theory nor classical theory
C)liquidity preference theory, but not classical theory
D)classical theory, but not liquidity preference theory

Question 43

According to liquidity preference theory, other things equal, a higher price level leads households to do which of the following in the short run?

A)increase consumption
B)decrease the amount of cash they want to hold
C)buy bonds
D)decrease consumption

Question 44

The effects of the interest rate in the short run are usually best shown using which theory?

A)either liquidity preference theory or classical theory
B)neither liquidity preference theory or classical theory
C)only liquidity preference theory
D)only classical theory

Question 45

Which of the following lists of events is consistent with the long-run and short-run economic theories studied?

A)In the long run, output is determined by the amount of capital, labour, and technology; the interest rate adjusts to balance the supply and demand for money; and the price level adjusts to balance the supply and demand for loanable funds.
B)In the long run, output is determined by the amount of capital, labour, and technology; the interest rate adjusts to balance the supply and demand for loanable funds; and the price level adjusts to balance the supply and demand for money.
C)In the long run, output is determined by the amount of capital, labour, and technology; the interest rate adjusts to balance the supply and demand for loanable funds; and the price level is stuck.
D)In the long run, output responds to the aggregate demand for goods and services; the interest rate adjusts to balance the supply and demand for loanable funds; and the price level adjusts to balance the supply and demand for money.

Question 46

According to liquidity preference theory, if the price level increases, how do the equilibrium interest rate and the aggregate quantity of goods change?

A)The interest rate and the quantity demanded rise.
B)The interest rate rises and the quantity demanded falls.
C)The interest rate falls and the quantity demanded rises.
D)The interest rate and the quantity demanded fall.

Question 47

According to the theory of liquidity preference, what does a decrease in the price level cause the interest rate and investment to do?

A)It causes both the interest rate and investment to rise.
B)It causes both the interest rate and investment to fall.
C)It causes the interest rate to rise and investment to fall.
D)It causes the interest rate to fall and investment to rise.

Question 48

According to liquidity preference theory, how are the price level and the interest rate related?

A)positively
B)inversely
C)negatively
D)unrelated

Question 49

Which of the following shifts money demand to the right?

A)an increase in the price level
B)a decrease in the price level
C)an increase in the interest rate
D)a decrease in the interest rate

Question 50

What is the variable that balances the money demand and supply in the liquidity preference and the classical theories?

A)the interest rate in both theories
B)the price level in both theories
C)the interest rate in the liquidity preference theory and the price level in the classical theory
D)the price level in the liquidity preference theory and the interest rate in the classical theory

Question 51

Assume the money market is initially in equilibrium. If the price level increases, according to liquidity preference theory, what is in excess and for how long?

A)The supply of money is in excess until the interest rate increases.
B)The supply of money is in excess until the interest rate decreases.
C)The demand for money is in excess until the interest rate increases.
D)The demand for money is in excess until the interest rate decreases.

Question 52

Which of the following shifts money demand to the left?

A)an increase in the price level
B)a decrease in the price level
C)an increase in the interest rate
D)a decrease in the interest rate

Question 53

Which of the following shifts money demand to the right?

A)an increase in either the price level or the interest rate
B)an increase in the price level or a decrease in the interest rate
C)a decrease in the interest rate but not a change in the price level
D)an increase in the price level but not a change in the interest rate

Question 54

Assume the money market is initially in equilibrium. If the price level decreases, according to liquidity preference theory, what is in excess and for how long?

A)The supply of money is in excess until the interest rate increases.
B)The supply of money is in excess until the interest rate decreases.
C)The demand for money is in excess until the interest rate increases.
D)The demand for money is in excess until the interest rate decreases.

Question 55

According to the theory of liquidity preference, what does an increase in the price level cause the interest rate and investment to do?

A)It causes both the interest rate and investment to rise.
B)It causes both the interest rate and investment to fall.
C)It causes the interest rate to rise and investment to fall.
D)It causes the interest rate to fall and investment to rise.

Question 56

Which of the following lists of events is consistent with the long-run and short-run economic theories studied?

A)In the short run, output is determined by the amount of capital, labour, and technology; the interest rate adjusts to balance the supply and demand for money; and the price level adjusts to balance the supply and demand for loanable funds.
B)In the short run, output is determined by the amount of capital, labour, and technology; the interest rate adjusts to balance the supply and demand for loanable funds; and the price level adjusts to balance the supply and demand for money.
C)In the short run, output responds to the aggregate demand for goods and services; the interest rate adjusts to balance the supply and demand for money; and the price level is stuck.
D)In the short run, output responds to the aggregate demand for goods and services; the interest rate adjusts to balance the supply and demand for loanable funds; and the price level adjusts to balance the supply and demand for money.

Question 57

According to liquidity preference theory, how does a decrease in the price level affect the interest rate and output demanded, respectively?

A)The interest rate increases, and output demanded increases.
B)The interest rate increases, and output demanded decreases.
C)The interest rate decreases, and output demanded increases.
D)The interest rate decreases, and output demanded decreases.

Question 58

Which of the following is an effect of an increase in the interest rate?

A)It induces firms to invest more.
B)It induces households to increase consumption.
C)It shifts money demand to the right.
D)It leads to the appreciation of the exchange rate.

Question 59

Which of the following is an effect of an increase in the interest rate?

A)People put more money in their savings accounts.
B)Foreign citizens decide to buy fewer Canadian bonds.
C)Firms decide to purchase new machinery.
D)People decide to consume more.

Question 60

According to liquidity preference theory, how does an increase in the price level affect the interest rate and output demanded, respectively?

A)The interest rate increases, and output demanded increases.
B)The interest rate increases, and output demanded decreases.
C)The interest rate decreases, and output demanded increases.
D)The interest rate decreases, and output demanded decreases.

Question 61

In the short run, a decrease in the money supply causes interest rates and aggregate demand to do what?

A)It causes interest rates to increase and aggregate demand to shift right.
B)It causes interest rates to increase and aggregate demand to shift left.
C)It causes interest rates to decrease and aggregate demand to shift right.
D)It causes interest rates to decrease and aggregate demand to shift left.

Question 62

What do open-market purchases do to the price level and real GDP?

A)They increase the price level and real GDP.
B)They decrease the price level and real GDP.
C)They increase the price level and decrease real GDP.
D)They decrease the price level and increase real GDP.

Question 63

Which of the following properly describes the interest rate effect?

A)A higher price level leads to higher money demand, higher money demand leads to higher interest rates, and a higher interest rate increases the quantity of goods and services demanded.
B)A higher price level leads to higher money demand, higher money demand leads to lower interest rates, and a higher interest rate reduces the quantity of goods and services demanded.
C)A lower price level leads to lower money demand, lower money demand leads to lower interest rates, and a lower interest rate reduces the quantity of goods and services demanded.
D)A lower price level leads to lower money demand, lower money demand leads to lower interest rates, and a lower interest rate increases the quantity of goods and services demanded.

Question 64

Which of the following shifts aggregate demand to the right?

A)an increase in the price level
B)an increase in the money supply
C)a decrease in the price level
D)a decrease in the money supply

Question 65

The economy is in long-run equilibrium. Suppose that automatic teller machines become cheaper and more convenient to use, and as a result the demand for money falls. Other things equal, what would we expect will happen to the price level and real GDP in the short and long run?

A)In the short run, the price level and real GDP would rise, but in the long run they would both be unaffected.
B)In the short run, the price level and real GDP would rise, but in the long run the price level would rise and real GDP would be unaffected.
C)In the short run, the price level and real GDP would fall, but in the long run they would both be unaffected.
D)In the short run, the price level and real GDP would fall, but in the long run the price level would fall and real GDP would be unaffected.

Question 66

In the short run, an increase in the money supply causes interest rates and aggregate demand to do what?

A)It causes interest rates to increase and aggregate demand to shift right.
B)It causes interest rates to increase and aggregate demand to shift left.
C)It causes interest rates to decrease and aggregate demand to shift right.
D)It causes interest rates to decrease and aggregate demand to shift left.

Question 67

If the Bank of Canada conducts open-market purchases, how do the money supply and the aggregate demand change?

A)The money supply increases, and aggregate demand shifts right.
B)The money supply increases, and aggregate demand shifts left.
C)The money supply decreases, and aggregate demand shifts right.
D)The money supply decreases, and aggregate demand shifts left.

Question 68

How does the interest rate change when the price level falls and when the money supply falls?

A)The interest rate rises both when the price level falls and when the money supply falls.
B)The interest rate rises when the price level falls and falls when the money supply falls.
C)The interest rate falls when the price level falls and rises when the money supply falls.
D)The interest rate falls both when the price level falls and when the money supply falls.

Question 69

According to liquidity preference theory, when do people demand fewer goods and services?

A)when the price level or interest rate increase
B)when the price level or interest rate decrease
C)when the price level increases or the interest rate decreases
D)when the price level decreases or the interest rate increases

Question 70

If the interest rate is above a central bank's target, what should the central bank do?

A)buy bonds to increase the money supply
B)buy bonds to decrease the money supply
C)sell bonds to increase the money supply
D)sell bonds to decrease the money supply

Question 71

What is the main reason the aggregate demand curve slopes downward?

A)As the price level increases, interest rates increase, and investment decreases.
B)As the price level increases, interest rates decrease, and investment increases.
C)As the price level decreases, interest rates increase, and investment increases.
D)As the price level decreases, interest rates decrease, and investment decreases.

Question 72

What does a monetary injection by the Bank of Canada do to interest rates and aggregate demand?

A)It increases interest rates and increases aggregate demand.
B)It increases interest rates and decreases aggregate demand.
C)It decreases interest rates and decreases aggregate demand.
D)It decreases interest rates and increases aggregate demand.

Question 73

Which of the following shifts aggregate demand to the left?

A)an increase in the price level
B)an increase in the money supply
C)a decrease in the price level
D)a decrease in the money supply

Question 74

What do open-market sales do to the price level and real GDP?

A)They increase the price level and real GDP.
B)They decrease the price level and real GDP.
C)They increase the price level and decrease real GDP.
D)They decrease the price level and increase real GDP.

Question 75

If the Bank of Canada conducts open-market sales, how do the money supply and the aggregate demand change?

A)The money supply increases, and aggregate demand shifts right.
B)The money supply increases, and aggregate demand shifts left.
C)The money supply decreases, and aggregate demand shifts right.
D)The money supply decreases, and aggregate demand shifts left.

Question 76

When a central bank sets a target for the interest rate, it commits itself to which of the following?

A)revealing its target to the public
B)adjusting the demand for money in order to make the equilibrium in the money market hit that target
C)adjusting the money supply in order to meet the interest rate target
D)having to make open-market sales

Question 77

Which of the following shifts aggregate demand right?

A)an increase in interest rates
B)a decrease in the price level
C)a decrease in the money supply
D)a decrease in the bank rate

Question 78

Which of the following properly describes the interest rate effect?

A)As the money supply increases, the interest rate falls, so spending rises.
B)As the money supply increases, the interest rate rises, so spending falls.
C)As the price level increases, the interest rate falls, so spending rises.
D)As the price level increases, the interest rate rises, so spending falls.

Question 79

Which of the following principles does the theory of liquidity preference illustrate?

A)Monetary policy can be described either in terms of the money supply or in terms of the interest rate.
B)Monetary policy can be described either in terms of the exchange rate or the interest rate.
C)Monetary policy must be described in terms of the money supply.
D)Monetary policy must be described in terms of the interest rate.

Question 80

If a central bank targets the interest rate, what does this imply?

A)The central bank can then set the money supply at whatever value it wants.
B)The central bank must increase the money supply if the interest rate is above its target.
C)The central bank must decrease the money supply if the interest rate is above its target.
D)The central bank must not change the money supply.