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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 $1,200 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 3/4 or 0.75 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. a. List 3 things that will reduce the amount of money people want to hold, assuming they are
making the same income. Each question is worth 1 point.
(1)
(2)
(3)
b. If people want to hold less money, what happens to the velocity of money? Circle the correct
answer below. This question is worth 1 point.
Velocity increases
Velocity decreases
Velocity stays the same
5. Draw a Keynesian short-run Phillips curve for part a and draw a rational expectationists Philips
curve for part b. Each part is worth 2 points. Don’t forget to label both axis for each curve. You
do not have to have numbers on your diagram, but will be graded on the shape of your line.
a.
b.
Part B. State whether the following 2 statements are true, false, or uncertain, and explain your answer.
Each question is worth 4 points.
1. Increasing the money supply increases the quantity of goods a country produces.
2. President Obama’s Keynesian economic advisors believed the economic stimulus program passed
by Congress in 2009 would increase the velocity of money.
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 600, 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 decreases, 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. If the fed announces that they will act to make next year’s inflation higher than this year’s, what will
happen to velocity.?
a. It increases.
b. It decreases.
c. It stays the same.
5. If the fed creates money, but a small enough amount of money so that no inflation is expected, what
happens to interest rates?
a. Rise.
b. Fall.
c. Stay the same.
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 less 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 will (assuming there is no crowding out):
a. move AD left.
b. move AD right.
c. not move AD.
9. What does the phrase “zero bound problem” refer to?
a. How greatly increasing the money supply does not increase AD when people’s preferences to buy
goods has gone to zero.
b. How the federal government can not increase its own spending when there is zero money left in the
treasury from tax revenue.
c. How the fed can not increase the money supply further when interest rates have hit zero percent.
10. What is the real rate of interest?
a. the nominal interest rate plus the inflation rate.
b. the nominal interest rate minus the inflation rate.
c. the nominal interest rate times the inflation rate.
d. the inflation rate minus the nominal interest rate.
11. Keynesians would propose expansionary 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 equilibrium.
12. Which of the following combinations constitutes expansionary 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 not 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 $200 increase in government spending financed by borrowing (with no
crowding out), causes GDP to rise by how much?
a. $0
b. $60
c. $120
d. $500
e. $1,200
16. When would the fed do contractionary 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 contractionary 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 loser?
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 horizontal line straight flat across, 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 is known for thinking the time period of the short-run is zero.?
a. Keynesian.
b. Monetarist.
c. Rational Expectationist.
d. Marxist.
23. Which school of economists is known for thinking that changes in the money supply are the
primary force changing aggregate demand?
a. Keynesian.
b. Monetarist.
c. Rational Expectationist.
d. Marxist.
24. When the sales price of bond worth $100 at maturity rises, that means the interest rate has:
a. risen.
b. fallen.
c. stayed the same.
25. The SRAS curve is most likely to be flat when the economy has:
a. no unused resources of production.
b. some unused resources of production.
c. a great many unused resources of production.
26. The SRAS curve is most likely to be a vertical line straight up and down:
a. in the inflationary gap.
b. in the recessionary gap.
c. at natural real GDP (QN)
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. The simple quantity theory of money predicts that if the money supply increases, then:
a. velocity increases.
b. prices increase.
c. quantity produced increases.
30. For the last 6 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 is famous as an English economist writing at the time of:
a. The American Revolution.
b. The Industrial Revolution.
c. The American Great Depression.
d. Now.
33. Milton Friedman explained that when the people of the 1960’s began to expect a higher rate of inflation
in the early 1970’s,
a. the short-run Phillips curve shifted up and to the right (away from the origin), which made the
economy worse.
b. the short-run Phillips curve shifted up and to the right (away from the origin), which made the
economy better.
c. the short-run Phillips curve shifted down and to the left (towards the origin), which made the
economy better.
d. the short-run Phillips curve shifted down and to the left (towards the origin), which made the
economy worse.