question
Suppose the government provides a tax cut today that is matched by a tax increase in the future that's equal in present value to the tax cut. This causes a consumer's saving to
answer
Answer: increase
question
Which of the factors listed below might cause the Ricardian equivalence proposition to be violated?
answer
Answer: Consumers may not understand that an increase in government borrowing today is likely to lead to higher future taxes
question
Last year, Linus earned a salary of $25,000 and he spent $24,000, thus saving $1000. At the end of the year, he received a bonus of $1000 and he spent $500 of it, saving the other $500. What was his marginal propensity to consume?
answer
Answer: .50
question
Desired national saving would decrease unambiguously if there were
answer
Answer: a decrease in current output and a decrease in taxes
question
The stock market just crashed; the Dow Jones Industrial Average fell by 750 points. You would expect the effect on aggregate consumption to be the largest if which of the following facts was true?
answer
Answer: Many individuals had invested in the stock market immediately prior to the crash
question
When a person gets an increase in current income, what is likely to happen to consumption and saving?
answer
Answer: Consumption increases and saving increases
question
The substitution effect of a decrease in real interest rates is to cause a consumer to
answer
Answer: decrease future consumption and increase current consumption
question
Desired national saving would increase unambiguously if there were
answer
Answer: a fall in both government purchases and expected future output
question
If Claudette gets a permanent increase in her income of $1000 per year, she saves an extra $200 this year and consumes an extra $800 this year. If the increase in income had been temporary instead of permanent, she would have saved ________ of the extra income.
answer
Answer: more than $200
question
The desire to have a relatively even pattern of consumption over time is known as
answer
Answer: the consumption-smoothing motive
question
For a borrower, an increase in the real interest rate will lead to
answer
Answer: lower current consumption and less borrowing
question
If an investor has a tax rate on interest income of 25% and the inflation rate is 4%, which bond has the lowest expected after-tax real interest rate?
answer
Answer: A Treasury bond paying 7%
question
The fraction of additional current income that a person consumes in the current period is known as the
answer
Answer: marginal propensity to consume
question
An increase in expected future output while holding today's output constant would
answer
Answer: increase today's desired consumption and decrease desired national saving
question
If the substitution effect of the real interest rate on saving is larger than the income effect of the real interest rate on saving, then a rise in the real interest rate leads to a ________ in consumption and a ________ in saving, for someone who's a lender.
answer
Answer: fall; rise
question
When a person receives an increase in wealth, what is likely to happen to consumption and saving?
answer
Answer: Consumption increases and saving decreases
question
Desired national saving equals
answer
Answer: Y - Cd - G
question
Aunt Agatha has just left her nephew $5000. The most likely response is for her nephew to
answer
Answer: increase both current consumption and future consumption
question
With no inflation and a nominal interest rate (i) of .03, a person can trade off one unit of current consumption for ________ units of future consumption.
answer
Answer: 1.03
question
With a nominal interest rate of 4%, an expected inflation rate of 1%, and interest income taxed at a rate of 25%, what is the expected after-tax real interest rate?
answer
Answer: 2%
question
If the government cuts taxes today, issuing debt today and repaying the debt plus interest next year, a rational taxpayer will
answer
Answer: increase saving today, leaving consumption unchanged
question
A curve that connects all the consumption combinations that yield the same level of utility is known as
answer
Answer: an indifference curve
question
Three factors that cause interest rates among different financial instruments to vary are
answer
Answer: default risk, maturity, and taxability
question
The nominal interest rate is 10%, the expected inflation rate is 5%, and the combined state-federal tax rate is 35%. The expected after-tax real interest rate is
answer
Answer: 1.50%
question
David consumes 200 in the current period and 330 in the future period. The real interest rate is 10% per period. David's present value of lifetime consumption is
answer
Answer: 500
question
Rachel earns nothing during her learning period, 1100 during her working period, and nothing during her retirement period. She has initial assets of 300. The real interest rate is zero. Rachel is not allowed to borrow by the banks. Whenever possible, Rachel wants to smooth consumption between periods. How much will she save during her working period?
answer
Answer: 550
question
The yield curve generally slopes upward because
answer
Answer: longer maturity bonds typically pay higher interest rates than shorter maturity bonds
question
If the substitution effect of the real interest rate on saving is smaller than the income effect of the real interest rate on saving, then a rise in the real interest rate leads to a ________ in consumption and a ________ in saving, for someone who's a lender.
answer
Answer: rise; fall
question
The yield curve shows
answer
Answer: the interest rates on bonds of different maturities
question
Cummins, Hubbard, and Hassett found that investment responded to a tax change that affected the user cost of capital, with an elasticity of
answer
Answer: -0.66
question
At the start of the year, your firm's capital stock equaled $100 million, and at the end of the year it equaled $105 million. The average depreciation rate on your capital stock is 20%. Gross investment during the year equaled
answer
Answer: $25 million
question
The relationship between stock prices and firms' investments in physical capital is captured by what theory?
answer
Answer: q theory
question
Which of the following machines has the lowest user cost? Machine A costs $15,000 and depreciates at a 25% rate, machine B costs $10,000 and depreciates at a rate of 20%, machine C costs $20,000 and depreciates at a rate of 10%, and machine D costs $17,000 and depreciates at a rate of 11%. The expected real interest rate is 5%.
answer
Answer: Machine B
question
The user cost of capital is given by the following formula, where pk is the real price of capital goods, d is the depreciation rate, and r is the expected real interest rate.
answer
Answer: uc = (r + d)pk
question
Calculate the user cost of capital of a machine that costs $100,000 and depreciates at a rate of 25%, when the nominal interest rate is 4% and the expected inflation rate is 1%.
answer
Answer: $28,000
question
Cummins, Hubbard, and Hassett studied the effects of taxes on investment by
answer
Answer: examining what happened to investment when major tax reforms took place
question
Your firm has capital stock of $10 million and a depreciation rate of 15%. Gross investment is $3 million. How much is net investment?
answer
Answer: $1.5 million
question
What is the difference between gross investment and net investment?
answer
Answer: Net investment = gross investment minus depreciation
question
You have just purchased a home that cost $250,000. The nominal mortgage interest rate is 8% per annum, mortgage interest payments are tax deductible, and you are in a 30% tax bracket. The expected inflation rate is 4%. Maintenance and other expenses are 8% of the initial value of the house. What is the real user cost of your house?
answer
Answer: $24,000
question
Which of the following machines has the lowest user cost? Machine A costs $15,000 and depreciates at a rate of 25%, machine B costs $10,000 and depreciates at a rate of 20%, machine C costs $20,000 and depreciates at a rate of 10%, and machine D costs $17,000 and depreciates at a rate of 11%. The expected real interest rate is 0%.
answer
Answer: Machine D
question
A technological improvement will
answer
Answer: increase the desired capital stock
question
At the start of the year, your firm's capital stock equaled $10 million, and at the end of the year it equaled $15 million. The average depreciation rate on your capital stock is 20%. Net investment during the year equaled
answer
Answer: $5 million
question
Suppose your company is in equilibrium, with its capital stock at its desired level. A permanent increase in the depreciation rate now has what effect on your desired capital stock?
answer
Answer: Lowers it, because the user cost of capital is now higher
question
If consumers believe that next year a recession will occur, then the real interest rate ________ and investment ________.
answer
Answer: falls; increases
question
If the government reduces the effective tax rate on capital, then the real interest rate ________ and saving ________.
answer
Answer: rises; increases
question
An increase in the expected real interest rate tends to
answer
Answer: raise desired saving, but lower desired investment
question
An invention that raises the future marginal product of capital would cause an increase in desired investment, which would cause the investment curve to shift to the ________ and would cause the real interest rate to ________.
answer
Answer: right; increase
question
If the stock market booms and people feel wealthier, then the real interest rate ________ and investment ________.
answer
Answer: rises; declines
question
When desired national saving equals desired national investment, what market is in equilibrium?
answer
Answer: The goods market
question
If the rate of depreciation increases, then user cost ________ and the desired capital stock ________.
answer
Answer: rises; falls
question
Suppose your company is in equilibrium, with its capital stock at its desired level. A permanent decline in the expected real interest rate now has what effect on your desired capital stock?
answer
Answer: Raises it, because the user cost of capital is now lower
question
Tobin's q is equal to
answer
Answer: the ratio of capital's market value to its replacement cost
question
You are trying to figure out how much capacity to add to your factory. You will increase capacity as long as
answer
Answer: the expected marginal product of capital is greater than or equal to the user cost of capital
question
Calculate the user cost of capital of a machine that costs $5000 and depreciates at a rate of 25%, when the nominal interest rate is 10% and the expected inflation rate is 5%
answer
Answer: $1500
question
Calculate the tax-adjusted user cost of capital of a machine that costs $10,000 and depreciates at a rate of 10%, when the real interest rate is 3% and the tax rate on revenue is 5%.
answer
Answer: $1368
question
If consumers foresee future taxes completely, a reduction in taxes this year that is accompanied by an offsetting increase in future taxes would cause
answer
Answer: a shift in neither the saving nor the investment curve.
question
A temporary decrease in government purchases would cause
answer
Answer: a rightward shift in the saving curve, but no shift in the investment curve.
question
If the stock market value of a firm is $10 million and the firm owns $15 million of capital, then Tobin's q equals
answer
Answer: 2/3
question
The saving-investment diagram shows that a higher real interest rate due to a leftward shift of the saving curve
answer
Answer: the ratio of capital's market value to its replacement cost
question
Onerous regulations on businesses that take effect next year reduce businesses' expected future marginal product of capital. As a result, the real interest rate ________ and saving ________.
answer
Answer: falls; declines
question
A temporary supply shock, such as a drought, would
answer
Answer: have no effect on the desired investment curve
question
Money's primary role in the economy comes from the benefits of lowering transactions costs and allowing specialization. This function of money is called
answer
Answer: medium of exchange
question
When a government prints money to finance its expenditures, it is likely to cause
answer
Answer: inflation
question
M2 does not include
answer
Answer: Treasury bonds
question
When the real quantity of money supplied equals the real quantity of money demanded, there is said to be
answer
Answer: asset market equilibrium
question
If the quantity of money demanded exceeds the quantity of money supplied, then
answer
Answer: the quantity of nonmonetary assets supplied exceeds the quantity demanded
question
Velocity is defined as
answer
Answer: nominal GDP/nominal money stock
question
M1 does not include
answer
Answer: MMMFs
question
If real money demand doubles while the nominal money supply is unchanged, what happens to the price level?
answer
Answer: The price level falls by one-half
question
We shouldn't be concerned about U.S. currency held abroad because
answer
Answer: it represents an interest-free loan to the United States
question
Suppose the real interest rate is 4% and the expected inflation rate is 3%. If the money supply increases by 10% and output, the real interest rate, and the expected inflation rate are unchanged, then the price level increases by
answer
Answer: 10%
question
Large differences in inflation rates among countries are almost always the result of large differences in
answer
Answer: the growth rates of nominal money supplies
question
What's the most common way for a central bank to reduce the money supply?
answer
Answer: Sell bonds to the public
question
If the income elasticity of money demand is 3/4 and income increases 8%, by about how much does the price level change?
answer
Answer: Falls by 6%
question
Suppose a new law imposes a tax on all trades of bonds and stock. What is the likely effect on money demand?
answer
Answer: Money demand rises
question
The number of units of one good that trade for one unit of alternative goods can be determined most easily when
answer
Answer: there is one unit of account
question
If nominal money supply grows 3% and real money demand grows 8%, the inflation rate is
answer
Answer: -5%
question
If the nominal money supply doubles while real money demand is unchanged, what happens to the price level?
answer
Answer: The price level doubles
question
If the interest elasticity of money demand is -0.1, by what percent does money demand change if the nominal interest rate rises from 2% to 3%?
answer
Answer: -5%
question
Suppose the real money demand function is
Md/P = 2400 + 0.2 Y - 10,000 (r + πe).
Assume M = 4000, P = 2.0, πe = .03, and Y = 5000. The real interest rate that clears the asset market is
Md/P = 2400 + 0.2 Y - 10,000 (r + πe).
Assume M = 4000, P = 2.0, πe = .03, and Y = 5000. The real interest rate that clears the asset market is
answer
Answer: 11%
question
A disadvantage of the barter system is that
answer
Answer: the opportunity to specialize is greatly reduced
question
If the nominal money supply grows 10%, the inflation rate is 6%, and the income elasticity of money demand is 1.0, then real income growth equals
answer
Answer: 4%
question
Suppose your bank raises its minimum-balance requirement for free checking on checking accounts by $500. You take $500 out of your passbook savings account and put it in your checking account. What is the overall effect on M1 and M2?
answer
Answer: M1 rises by $500, M2 is unchanged
question
The opportunity cost of holding currency decreases when
answer
Answer: the interest rate on bonds decreases
question
Which of the following is not part of M1?
answer
Answer: Time deposits
question
If there is a financial panic and increased uncertainty about the returns in the stock market and bond market, what is the likely effect on money demand?
answer
Answer: Money demand rises
question
The set of assets that a holder of wealth chooses to own is called
answer
Answer: a portfolio
question
In economics, money refers to
answer
Answer: assets used and accepted as payment
question
The uncertainty about the return an asset will earn is
answer
Answer: Risk
question
A developing country does not have enough taxes to cover its expenditures and is unable to borrow. This government would be most likely to cover its deficit by
answer
Answer: selling newly issued government bonds directly to the central bank
question
Which of the following statements about M1 and M2 is true?
answer
Answer: Savings deposits are part of M2
question
If real income rises 4%, prices rise 1%, and nominal money demand rises 4%, what is the income elasticity of real money demand?
answer
Answer: 3/4
question
An increase in the real interest rate would cause an increase in the real demand for money
answer
Answer: if expected inflation fell by more than the rise in the real interest rate
question
The ease and quickness with which an asset can be exchanged for goods, services, or other assets is its
answer
Answer: liquidity
question
Suppose real money demand is L = 0.8 Y - 100,000 (r + πe).
If the nominal money supply is 12,000, real output is 15,000, the real interest rate is .02, and the expected inflation rate is .01, then the price level is
If the nominal money supply is 12,000, real output is 15,000, the real interest rate is .02, and the expected inflation rate is .01, then the price level is
answer
Answer: 4/3
question
Money demand is given by
Md/P = 1000 + .2Y - 1000i.
Given that P = 200, Y = 2000, and i = .10, velocity is equal to
Md/P = 1000 + .2Y - 1000i.
Given that P = 200, Y = 2000, and i = .10, velocity is equal to
answer
Answer: 1.54
question
If the income elasticity of money demand is 3/4 and the interest elasticity of money demand is -1/4, by what percent does money demand rise if income rises 10% and the nominal interest rate rises from 4% to 5%?
answer
Answer: 1.25%
question
If real GDP is $4 billion, the price level is 1.25, and the nominal money stock is $500 million, then velocity is
answer
Answer: 10
question
If the nominal money supply grows 5%, real income falls 2%, and the income elasticity of money demand is 0.8, then the inflation rate is
answer
Answer: 6.6%
question
People in other countries want to hold U.S. dollars as a
answer
Answer: store of value
question
Suppose the real money demand function is
Md/P = 2400 + 0.2 Y - 10,000 (r + πe).
Assume M = 5000, πe = .03, and Y = 5000. If the price level were to decrease from 2.5 to 2.0, then the real interest rate would decrease by how many percentage points (assuming Md, πe, and Y are unchanged)?
Md/P = 2400 + 0.2 Y - 10,000 (r + πe).
Assume M = 5000, πe = .03, and Y = 5000. If the price level were to decrease from 2.5 to 2.0, then the real interest rate would decrease by how many percentage points (assuming Md, πe, and Y are unchanged)?
answer
Answer: 5
question
Under a situation of asset market equilibrium,
answer
Answer: the quantity of money supplied equals the quantity of money demanded
question
Which of the following is the most likely explanation for the causes behind the "case of the missing money"?
answer
Answer: Financial innovations, such as money market mutual funds, changed the demand for narrow definitions of money such as M1
question
An increase in expected inflation is likely to cause
answer
Answer: a decline in the demand for real balances
question
The use of money is more efficient than barter because the introduction of money
answer
Answer: reduces transaction costs
question
If the nominal money supply grows 6%, real income rises 2%, and the inflation rate is 5%, then the income elasticity of money demand is
answer
Answer: 0.5
question
People's best guesses about returns on assets are called
answer
Answer: expected returns
question
The most likely explanation for the high inflation rates that countries like Russia and the Ukraine have suffered is that
answer
Answer: borrowing from the central bank is the most expedient method of funding the government's expenditures
question
Why do people keep currency in their pockets when bank deposits pay interest?
answer
Answer: Because currency is more liquid
question
Money demand is given by
Md/P = 1000 + .2Y - 1000i.
Given that P = 200, Y = 2000, and i = .10, real money demand is equal to
Md/P = 1000 + .2Y - 1000i.
Given that P = 200, Y = 2000, and i = .10, real money demand is equal to
answer
Answer: 1,300
question
Suppose velocity is constant at 4, real output is 10, and the price level is 2. From this initial situation, the government increases the nominal money supply to 6. If velocity and output remain unchanged, by how much will the price level increase?
answer
Answer: 20%
question
One of money's primary roles in the economy comes from the use of money to transfer purchasing power to the future. This role of money is called
answer
Answer: store of value
question
If real money demand increases 5% and real money supply increases 10%, by about how much does the price level change?
answer
Answer: Rises by 5%
question
Which of the following is most likely to lead to an increase of 1% in the nominal demand for money?
answer
Answer: An increase of 1% in the price level
question
A 10% decrease in real income usually leads to ________ in money demand
answer
Answer: a decrease of less than 10%
question
AAA Company stock has a higher expected rate of return than ZZZ Company stock. All else being equal, you would expect that relative to ZZZ, AAA company stock provides
answer
Answer: more risk and less liquidity
question
Over half of U.S. currency is
answer
Answer: held abroad
question
A good that is used as a medium of exchange as well as being a consumption good is called
answer
Answer: a commodity money
question
Which of the following measures is the best measure of money as a medium of exchange?
answer
Answer: M1
question
In some countries, prices in stores are listed in terms of U.S. dollars, rather than in units of the local currency. That's most likely because
answer
Answer: the country has experienced high rates of inflation
question
M2 includes
answer
Answer: M1
question
Suppose the real money demand function is
Md/P = 2400 + 0.2 Y - 10,000 (r + πe).
Assume M = 5000, P = 2.0, and πe = .03. If Y were to increase from 4000 to 5000, then the real interest rate would increase by how many percentage points?
Md/P = 2400 + 0.2 Y - 10,000 (r + πe).
Assume M = 5000, P = 2.0, and πe = .03. If Y were to increase from 4000 to 5000, then the real interest rate would increase by how many percentage points?
answer
Answer: 2
question
Time to maturity refers to the amount of time until
answer
Answer: an asset repays the principal to an investor
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