Question 1

Depending on the size of the multiplier and crowding-out effects, the rightward shift in aggregate demand from a tax cut could be larger or smaller than the tax cut.

Accepted Answer

The size of the multiplier and crowding-out effects will determine the ultimate impact of a tax cut on aggregate demand, which may be larger or smaller than the initial tax cut.

Question 2

The theory of liquidity preference is largely at odds with the basic ideas of supply and demand.

Accepted Answer

The theory of liquidity preference, proposed by John Maynard Keynes, actually incorporates the principles of supply and demand within the context of the money market, where the demand for money (liquidity preference) and the supply of money determine the interest rate.

Question 3

If the MPC is 4/5, the multiplier is 5/4.

Accepted Answer

The multiplier is the reciprocal of the MPC, so if the MPC is 4/5, the multiplier is 5/4.

Question 4

If the marginal propensity to consume is 6/7, then the multiplier is 7.

Accepted Answer

The multiplier is the reciprocal of the marginal propensity to save, which is 1 - MPC. Therefore, if MPC is 6/7, then MPS is 1/7, and the multiplier is 1/(1/7), which simplifies to 7.

Question 5

Unemployment insurance and welfare programs work as automatic stabilizers.

Accepted Answer

Unemployment insurance and welfare programs help to stabilize the economy during times of economic downturns by providing income to those who have lost their jobs or are struggling financially. This helps to boost consumer spending and can help prevent the economy from slipping into a deeper recession. Therefore, they are considered automatic stabilizers.

Question 6

The Fed can influence the money supply by changing the interest rate it pays banks on the reserves they are holding.

Accepted Answer

When the Fed raises the interest rate it pays on reserve balances, banks are more likely to hold onto their reserves, reducing the amount of money circulating in the economy. Conversely, when the Fed lowers the interest rate on reserves, banks are incentivized to lend out more money, increasing the money supply.

Question 7

If the spending multiplier is 8, then the marginal propensity to consume must be 7/8.

Accepted Answer

The spending multiplier is calculated as 1/(1-MPC), so if the multiplier is 8, then 1/(1-MPC) = 8, solving for MPC gives MPC = 7/8.

Question 8

Other things the same, an increase in taxes shifts aggregate demand to the left. In the short run this makes output fall which makes the interest rate rise.

Accepted Answer

An increase in taxes shifts aggregate demand to the left, which in the short run can lead to a decrease in output and a decrease in the demand for money, potentially leading to a lower interest rate, not a rise.

Question 9

Permanent tax cuts have a larger impact on consumption spending than temporary ones.

Accepted Answer

Permanent tax cuts provide individuals and businesses with a more stable and predictable tax environment, leading to greater confidence in future income and financial stability. This confidence can lead to increased consumption spending, as individuals feel more secure in their financial situation and are more willing to spend money over the long term. Temporary tax cuts, on the other hand, may provide a short-term boost to consumption spending, but the uncertainty about whether and when the tax cuts will expire can limit their impact on consumer behavior.

Question 10

An essential piece of the liquidity preference theory is the demand for money.

Accepted Answer

The liquidity preference theory proposes that the demand for money is crucial in determining the interest rate, and therefore the level of investment and overall economic activity.

Question 11

The multiplier is computed as MPC / (1 - MPC).

Accepted Answer

The answer of The multiplier is computed as MPC /...

Question 12

Some economists, called supply-siders, argue that changes in the money supply exert a strong influence on aggregate supply.

Accepted Answer

Supply-siders focus on the supply side of the economy, emphasizing incentives for production, not changes in the money supply. Monetarists, on the other hand, emphasize the importance of the money supply in affecting aggregate demand.

Question 13

During recessions, unemployment insurance payments tend to rise.

Accepted Answer

During recessions, companies often lay off workers, leading to higher unemployment rates. As a result, more people are eligible for unemployment insurance payments, causing the payments to rise.

Question 14

Government expenditures on capital goods such as roads could increase aggregate supply. Such effects on aggregate supply are likely to matter more in the short run than in the long run.

Accepted Answer

Government expenditures on capital goods like roads can increase aggregate supply by improving infrastructure, which enhances productivity. These effects are more significant in the long run as the benefits of improved infrastructure accumulate over time, rather than having an immediate impact in the short run.

Question 15

A significant lag for monetary policy is the time it takes to for a change in the money supply to change the economy. A significant lag for fiscal policy is the time it takes to pass legislation authorizing it.

Accepted Answer

This is correct. The time it takes for monetary policy to impact the economy is often referred to as the "time lag." Similarly, it can take a considerable amount of time for fiscal policy initiatives to be passed into law, which can create a lag in implementing changes.

Question 16

In principle, the government could increase the money supply or increase government expenditures to try to offset the effects of a wave of pessimism about the future of the economy.

Accepted Answer

Increasing the money supply or government expenditures can boost economic activity and confidence, potentially offsetting the effects of pessimism. However, it is important to consider the potential long-term consequences and trade-offs of such actions.

Question 17

The interest-rate effect is partially explained by the fact that a higher price level reduces money demand.

Accepted Answer

The interest-rate effect is partially explained by the fact that a higher price level increases money demand, which in turn increases interest rates and reduces investment spending.

Question 18

The main criticism of those who doubt the ability of the government to respond in a useful way to the business cycle is that the theory by which money and government expenditures change output is flawed.

Accepted Answer

The answer of The main criticism of those who doubt...

Question 19

Both the multiplier effect and the investment accelerator tend to make the aggregate-demand curve shift further than it does due to an initial increase in government expenditures.

Accepted Answer

Both the multiplier effect and the investment accelerator amplify the initial impact of government expenditures on aggregate demand, resulting in a larger shift in the demand curve.

Question 20

If the marginal propensity to consume is 4/5, then a decrease in government spending of $1 billion decreases the demand for goods and services by $5 billion.

Accepted Answer

The marginal propensity to consume (MPC) is the fraction of a change in income that is spent on consumption. In this case, an MPC of 4/5 means that for every additional dollar of income, 80 cents will be spent on consumption. Therefore, a decrease in government spending of $1 billion will reduce income by $1 billion and reduce consumption by $0.8 billion (= $1 billion x 4/5). Using the formula for the expenditure multiplier (1/MPC), we can see that a $1 billion change in government spending causes a $5 billion change in aggregate demand: 1/(4/5) = 1.25; $1 billion x 1.25 = $5 billion. So the statement is true.

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