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Economics 2 Unit Test 3
Class Day and Time:
Name:
Part A. Answer the following 4 questions in the space provided. Each question is worth 4 points.
1. Using a table similar to the one used in class, show the effect of a $225 increase in government spending
in the Keynesian system. Show the effect on government, consumption, and GDP for each of three rounds
and what the total effect will be on each after all potential rounds are completed. Assume the marginal
propensity to consume (MPC) is 2/3 or 0.67 Also assume there is no crowding out. Illustrate the effect of
the first 2 rounds and the total effect after all the rounds are completed on an AD/AS diagram with a flat
SRAS curve. Be sure to write the amount of the change for each line shift on your diagram and the
amount of the total change.
2. Redo question 1 directly above, but this time assume there is complete crowding out and add a column for
change in investment. Illustrate the effect of the first 2 rounds and the total effect after all the rounds are
completed on an AD/AS diagram with a flat SRAS curve. Be sure to write the amount of the change for
each line shift on your diagram and the amount of the total change.
3. Use the aggregate demand and short-run aggregate supply curves to show the effect of
a perfectly expected increase in the money supply on output and prices. Label the
beginning quantity Q1 and the quantity we move to Q2. If you think we will move to
more than one new quantity over time, label the successive quantities Q2, Q3 and so
on. Do the same for the price level, using P1, P2 and so on.
4. Use the aggregate demand and short-run aggregate supply curves to show the effect of
an unexpected increase in the money supply on output and prices. Label the beginning
quantity Q1 and the quantity we move to Q2. If you think we will move to more than one
new quantity over time, label the successive quantities Q2, Q3 and so on. Do the same for
the price level, using P1, P2 and so on.
Part B. State whether the following 3 statements are true, false, or uncertain, and explain your answer.
Each question is worth 4 points.
1. When the interest rate on bonds falls, then people will keep more cash in their cookie jar.
2. It is more difficult for the federal reserve to increase the money supply when interest rates on safe
loans are close to zero than if interest rates are significantly above zero.
3. If people expect inflation to be higher next year, this should cause velocity to rise this year.
Part C. Answer the following 32 multiple choice questions by marking the letter of the best answer on
your scantron. Each question is worth 1 point.
1. The money supply is $100, quantity is 50, velocity is 2. What are prices?
a. $ 1
b. $ 2
c. $ 4
d. $ 8
2. What is the meaning of “velocity” in the previous question?
a. The number of times a dollar is spent in a year on final goods and services.
b. The number of times a dollar is spent in a year on anything, including intermediate goods and stocks.
c. How quickly we are making the goods we produce.
d. How quickly we reach the long-run equilibrium.
3. What two variables does the “simple quantity theory of money” assume are fixed?
a. Quantity and velocity.
b. Money supply and velocity.
c. Prices and velocity.
d. Quantity and prices.
4. According to the simple quantity theory of money, when the money supply is doubled, then prices go up:
a. more than double.
b. less than double.
c. exactly double.
d. the quantity theory makes no prediction about what happens to prices.
5. If the money supply doubles and velocity increases, then aggregate demand goes up by:
a. more than double.
b. less than double.
c. exactly double.
d. there is not enough information to tell.
6. If the fed creates a small amount of money which does not cause people to expect inflation, then
interest rates:
a. fall.
b. rise.
c. stay the same.
7. If the fed creates a large amount of money which does cause people to expect inflation, then
interest rates:
a. fall.
b. rise.
c. stay the same.
8. If the interest rate falls, then velocity:
a. rises.
b. falls.
c. stays the same.
9. The demand for money and the velocity of money always:
a. go in opposite ways, so if one rises, the other falls.
b. move the same way, so if one rises, the other also rises.
c. have no stable relationship, so sometimes answer a is correct, and sometimes b is correct.
10. What is the real rate of interest?
a. the inflation rate minus the nominal interest rate.
b. the nominal interest rate minus the inflation rate.
c. the nominal interest rate plus the inflation rate.
d. the nominal interest rate times the inflation rate.
11. Keynesians would propose contractionary fiscal policy:
a. if the economy is in a recessionary gap.
b. if the economy is in an inflationary gap.
c. as a stabilizing measure if the economy is in long-run equlibrium.
12. Which of the following combinations constitutes contractionary fiscal policy?
a. Increasing government spending and cutting taxes.
b. Cutting government spending and cutting taxes.
c. Increasing government spending and increasing taxes.
d. Cutting government spending and increasing taxes.
13. Which of the following would cause an increase in government expenditures financed by
borrowing to increase aggregate demand?
a. The government borrows money which had been in people’s cookie jars which they had not been
planning on spending.
b. The government borrows money from people they had been planning on spending on cars, which they
now do not buy.
c. The government borrows the money from banks, which now raise their interest rate, and in response
businesses cut back on their investment/expansion plans buy an equal amount.
d. Both b and c.
14. An expansionary fiscal policy will have a greater effect on Real GDP when there is:
a. incomplete crowding out.
b. complete crowding out.
c. zero crowding out.
15. If the MPC is 0.9, then a $100 increase in government spending financed by borrowing (with no
crowding out), causes GDP to rise by how much?
a. $0
b. $90
c. $100
d. $900
e. $1,000
16. When would the fed do expansionary monetary policy?
a. When the main problem facing the economy is a recession.
b. When the main problem facing the economy is inflation.
c. When the main problem facing the economy is we are producing at the natural real GDP.
17. What is expansionary monetary policy?
a. The fed taking steps to increase the money supply.
b. The fed taking steps to decrease the money supply.
c. The fed trying to maintain a steady money supply.
18. When there is unexpected inflation, which of the following is a winner?
a. People holding money.
b. Lenders
c. Borrowers
d. Both a and b.
19. Which behavior fits best with the rational expectations model?
a. People expect inflation next year to be what it was last year.
b. People read newspaper articles featuring economists’ predictions about inflation next year
based on current Federal Reserve policy.
c. When inflation becomes a problem, people switch to signing longer term fixed wage contracts.
d. Both a and c.
20. What is the effect of a tax increase in the Keynesian system?
a. GDP goes up.
b. GDP goes down.
c. GDP stays the same.
21.. Which of the of following is a reason the government may not be able to use Keynesian fiscal
policy to fix the economy?
a. There could be lags gathering the necessary data, then further lags for Congress to pass the
program and then to move down the rounds of the Keynesian table.
b. Political fighting between the parties may keep Congress doing what Keynesians think is
correct.
c. Crowding out may keep the Keynesians policy from having the desired effect on aggregate
demand.
d. All of the above.
22. Which school of economists thinks that the government running deficits will increase V?
a. Keynesian.
b. Monetarist.
c. Rational Expectationist.
d. Marxist.
23. Which school of economists things that the fed creating new money will usually not increase real
GDP because people see what it is doing and take actions that keep it from affecting output?
a. Keynesian.
b. Monetarist.
c. Rational Expectationist.
d. Marxist.
24. Which school of economists is known for believing that because of crowding out, the only way for
the government to increase AD is to create new money?
a. Keynesian.
b. Monetarist.
c. Rational Expectationist.
d. Marxist.
25. Which of the following is a financial intermediary?
a. Home.
b. Store.
C. School.
d. Bank.
26. When people grow very confident they are not going to lose their job, their demand for money:
a. increases.
b. decreases.
c. stays the same.
27. Lags are a problem for:
a. monetary policy.
b. fiscal policy.
c. both of the above.
d. none of the above.
28. If the government did not collect taxes but simply paid for its purchases by printing up money, this
would cause:
a. very high inflation.
b. very high unemployment.
c. both of the above.
d. none of the above.
29. In the last five years in the U.S. financial system, which of the of the following have increased by
more than 100%?
a. The money supply.
b. The velocity of money.
c. Excess reserves of banks.
d. Prices.
30. For the last 5 years, which is true?
a. The money supply and velocity both increased.
b. The money supply and velocity both decreased.
c. The money supply increased and velocity decreased.
d. The money supply decreased and velocity increased.
31. For the Great Depression in the early 1930’s, which is true?
a. The money supply and velocity both increased.
b. The money supply and velocity both decreased.
c. The money supply increased and velocity decreased.
d. The money supply decreased and velocity increased.
32. The market monetarists are known for believing that if the fed commits to causing inflation in the future,
that will cause the current aggregate demand to:
a. stay the same, after all if they do something in the future, that should affect the future, not the now .
b. increase.
c. decrease.
d. do any of the above.