Q: Suppose the government increases its spending by $100 billion. If the marginal propensity to consume (MPC) is 0.8, what is the total change in real GDP according to the government purchases multiplier formula?

$$\frac{1}{1-0.8} = 5$$, so $$100 \times 5 = 500$$ billion increase in real GDP.

Question 1

Suppose the government increases its spending by $100 billion. If the marginal propensity to consume (MPC) is 0.8, what is the total change in real GDP according to the government purchases multiplier formula?

Accepted Answer

$$\frac{1}{1-0.8} = 5$$, so $$100 	imes 5 = 500$$ billion increase in real GDP.

Question 2

Which of the following would cause the short-run aggregate supply (SRAS) curve to shift to the left?

Accepted Answer

An increase in the price of oil, a key input for many industries.

Question 3

If the Federal Reserve wants to decrease the money supply, which of the following actions should it take?

Accepted Answer

Sell government securities in the open market.

Question 4

According to the quantity theory of money, if the velocity of money ($$V) $$and real output ($$Y) $$are constant, what happens to the price level ($$P) if $$the money supply ($$M) $$doubles?

Accepted Answer

The price level ($$P) $$will double.

Question 5

Which of the following best describes the difference between M1 and M2 in the U.S. money supply?

Accepted Answer

M2 includes all of M1 plus savings deposits, small time deposits, and money market mutual funds.

Question 6

Suppose the economy is initially at long-run equilibrium. If aggregate demand increases, what is the short-run effect on real GDP and the price level?

Accepted Answer

Both real GDP and the price level increase in the short run.

Question 7

If the Federal Reserve lowers the federal funds rate, what is the most likely short-run effect on aggregate demand?

Accepted Answer

Aggregate demand will increase due to lower borrowing costs.

Question 8

Which of the following is NOT a function of money?

Accepted Answer

A means of production.

Question 9

During the 2007-2009 recession, the Federal Reserve implemented quantitative easing. What was the primary goal of this policy?

Accepted Answer

To increase the money supply and lower long-term interest rates.

Question 10

If the government increases taxes by $50 billion and the marginal propensity to consume (MPC) is 0.75, what is the expected change in real GDP using the tax multiplier?

Accepted Answer

The tax multiplier is $$-\frac{MPC}{1-MPC} = -\frac{0.75}{0.25} = -3$$, so $$-3 	imes 50 = -150$$ billion.

Question 11

Which of the following would shift the long-run aggregate supply (LRAS) curve to the right?

Accepted Answer

An increase in the capital stock due to higher investment.

Question 12

If the economy is experiencing a recessionary gap, which fiscal policy action is most appropriate to restore full employment?

Accepted Answer

Increase government spending or decrease taxes.

Question 13

Suppose the velocity of money ($$V) is 4$$, the money supply ($$M) is$$ $$2$$ trillion, and real GDP ($$Y) is$$ $$8$$ trillion. What is the price level ($$P) $$according to the quantity equation $$MV = PY$$?

Accepted Answer

$$P = \frac{MV}{Y} = \frac{4 	imes 2}{8} = 1$$

Question 14

Which of the following best explains why the short-run aggregate supply curve is upward sloping?

Accepted Answer

Wages and some input prices are sticky in the short run, so higher prices increase profits and output.

Question 15

If the government runs a budget deficit, which of the following is a likely consequence in the long run?

Accepted Answer

An increase in the national debt.

Question 16

Which of the following is an example of an automatic stabilizer?

Accepted Answer

Unemployment insurance payments that increase during a recession.

Question 17

Suppose the economy is at potential GDP. If the government increases transfer payments, what is the likely short-run effect?

Accepted Answer

Aggregate demand increases, potentially causing inflation.

Question 18

Which of the following best describes the role of banks in the money creation process?

Accepted Answer

Banks create money by making loans, which increases the money supply.

Question 19

If the marginal propensity to consume (MPC) is 0.6, what is the value of the government spending multiplier?

Accepted Answer

$$\frac{1}{1-0.6} = 2.5$$

Question 20

Which of the following is a limitation of using fiscal policy to stabilize the economy?

Accepted Answer

There are time lags in recognizing problems, enacting policy, and seeing results.

Aggregate Demand, Aggregate Supply, Monetary Policy, and Fiscal Policy: Study Notes

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