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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 $900 decrease 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 0.667 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 predicted 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. The past five years, the federal reserve board has done the equivalent of increasing the amount of
currency that exists by over 500% (that is, it has increased the monetary base by 500%), so the
money supply must have also increased by close to 500%.
2. The monetarist critics of President Obama’s Keynesian stimulus package believe it did not work
because it had the effect of increasing the velocity of money.
3. When the federal reserve board increases the money supply, this has the effect of lowering interest
rates.
Part C. Answer the following 34 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 $400, quantity is 200, velocity is 3. What are prices?
a. $ 2
b. $ 3
c. $ 6
d. $ 8
2. According to the simple quantity theory of money, doubling the money supply:
a. causes quantity to double and prices to stay the same.
b. causes prices to double and quantity to stay the same.
c. causes both quantity and prices to double.
d. causes prices to double and quantity to increase by less than double.
3. If velocity rises, the fed can attempt to minimize the effect on overall aggregate demand by doing what
to the money supply?
a. Increase the money supply.
b. Decrease the money supply.
c. Keep the money supply constant.
4. When interest rates falls, what happens to the amount of money that people wish to have?
a. It increases.
b. It decreases.
c. It stays the same.
5. Which of the following counts as spending for purposes of finding velocity?
a. Buying a hamburger at Bob’s Big Boy.
b. Ford Auto Co. buying steel from U.S. Steel.
c. Walmart paying its employees their salaries.
d. All of the above.
6. Rational expectationist economists believe that people:
a. predict the future perfectly.
b. do not make systematic mistakes in predicting the future.
c. expect the future to be what the past was.
d. both a and b.
7. Which central bank has created more money over the last 5 years?
a. The federal reserve board of the United States.
b. The European central bank of many European countries, run primarily by Germany.
c. They’ve both created about the same amount of money.
8. A tax cut in the Keynesian system works by:
a. increasing velocity.
b. decreasing velocity.
c. making sure velocity stays the same.
9. Market monetarists think the fed can increase velocity now by:
a. promising to create inflation later.
b. promising to lower inflation later.
c. promising to keep inflation the same later.
10. What is the real rate of interest?
a. the inflation rate minus the nominal interest rate.
b. the nominal interest rate plus the inflation rate.
c. the nominal interest rate minus 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 0.6, then a $100 increase in government spending financed by borrowing (with no
crowding out), causes GDP to rise by how much?
a. $0
b. $60
c. $100
d. $250
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. Workers and bosses sign wage contracts with immediate raises tied to the government’s
announced CPI inflation statistics each month.
d. Both b and c.
20. If the SRAS curve is a line straight up and down, then increasing AD causes:
a. prices to rise, but not output.
b. output to rise, but not prices.
c. both output and prices to rise.
d. neither output nor prices to rise.
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 believes the government can increase AD without increasing the
money supply?
a. Keynesian.
b. Monetarist.
c. Rational Expectationist.
d. Marxist.
23. Which school of economists is known for thinking that when the government increases AD, the
SRAS curve shifts at the same time?
a. Keynesian.
b. Monetarist.
c. Rational Expectationist.
d. Marxist.
24. If people expect inflation to decrease, then what happens to velocity?
a. rises.
b. falls.
c. stays the same.
25. Which of the following is a financial intermediary?
a. Home.
b. Store.
c. Bank.
26. When people grow fearful they’re going to lose their jobs:
a. their demand for money increases.
b. their demand for money decreases.
c. their demand for money stays the same.
27. Congress and the president are directly in charge of:
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. If we are at natural real GDP, then the simple quantity theory prediction that creating more money
will not increase Q is more true:
a. in the short-run.
b. in the long-run.
c. equally true for both the short-run and the long-run.
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. Keynes believed that in the Great Depression, the government should:
a. have a balanced budget.
b. have a deficit.
c. Have a surplus.
33. The rational expectationists Phillip’s curve looks like:
a. The Keynesian slanted “C” Phillip’s curve of the 1960’s.
b. The Friedman long-run vertical Phillip’s curve at UN.
c. Both of the above (it has two curves, a short-run and a long-run curve).
d. A line slanting up at about a 45 degree angle.