The only way for a firm to obtain resources to invest in capital is via borrowing in financial markets

Financial Markets, Saving, and Investment

True or False

1.  The only way for a firm to obtain resources to invest in capital is via borrowing in financial markets.

2.  There is no difference in meaning between the terms saving and savings.

3.  The amount of saving and investment are the foundation of economic growth.

4.  New capital and new technology are completely separate factors of production.

5.  In terms of economic growth, increases in the capital stock come at the expense of workers.

6.  Owners of preferred stock are the residual claimants of the resources of a corporation.

7.  Both bondholders and stockholders receive increased payments as a company prospers.

8.  Preferred stockholders have a higher priority than bondholders and common stockholders when debts of the firm are settled.

9.  Corporations can acquire additional financial resources by issuing new shares of stock or reinvesting profits.

10. Firms are more likely to issue new shares of stock and increase expenditures on new capital equipment in periods of optimism. 

11. The values of securities change with the expectations of benefits and costs. 

12.  For a firm to raise additional capital through selling new shares of stock is more common when stock prices are high than when they are low.

13.  If you and a large group of others have all received a “hot” stock tip, it is unlikely to be a source of unusually high profits.

14.  Historically, the U.S. stock market has outperformed other financial assets.

15.  A firm’s price-earnings ratio is its stock price divided by its annual dividend.

16. The demand for loanable funds varies inversely with the real interest rate, other things equal. 

17. If businesses expect higher rates of return on their investments, it would shift the loanable funds demand curve to the right. 

18. An increase in business taxes would shift the loanble funds demand curve to the left.  

19. The supply of national savings is the sum of all private savings. 

20. Increases in current disposable income from a tax deduction will increase the loanable funds supply curve. 

21. If the real interest rate is below equilibrium, the quantity of loanable funds demanded would be less than the quantity of loanable funds supplied.  

  • At a real interest rate above equilibrium, a surplus of loanable funds would occur.  
  • If the government spends more money than it collects in taxes, national saving is negative.  
  • If the government goes from a balanced budget to a deficit, public saving would become negative and national saving would decrease, other things equal.  
  • A move toward a government budget surplus would increase national saving, reduce real interest rates, and increase investment, other things equal.  
  • A move toward a government budget deficit would tend to reduce private investment and reduce economic growth, other things equal.  
  • A move toward a government budget surplus would tend to decrease the real interest rate, other things equal.  
  • When foreigners supply fewer funds than they demand, a capital outflow from the United States occurs.  
  • When the domestic real interest rate is high, capital will tend to flow out to foreign countries.  
  • An increase in disposable income would shift the supply of loanable funds curve to the right.  
  • Lower real interest rates will shift the loanable funds demand curve right.  
  • Higher real interest rates will increase the quantity of loanable funds supplied, but not change the loanable funds supply curve.  
  • If the loanable funds demand curve shifted right, we would expect higher real interest rates and an increased quantity of loanable funds demanded to result.  

34. If the loanable funds supply curve shifted left, we would expect higher real interest rates and an increased quantity of loanable funds demanded to result.  

  • If the loanable funds supply curve shifted right, it would cause a temporary surplus of loanable funds, which would result in a lower real interest rate.  
  • There were only one or two major contributing factors to the financial crisis of 2008.
  • The housing market decline after 2006 was roughly similar throughout the United States.
  • Worldwide interest rates were low early in the twenty-first century in part because of a large amount of savings in emerging markets. 
  • Maintaining very low real interest rates for a substantial period of time contributed to the housing price run-up.  

40. Fannie Mae and Freddy Mac encouraged the lowering of standards for low income families in an effort to increase homeownership. 

  • Allowing mortgage borrowers to borrow with little or no money down increased the number of high-risk borrowers.
  • In 2006, a substantial minority of subprime loans were hybrid loans.

43.  Excessive lending to subprime borrowers did not appreciably affect other homeowners.

44.  The rapid increase in housing prices during the housing bubble made both borrowers and lenders expect that the risks of subprime lending was minimal. 

45. The traditional safety of home loans in the U.S. helped make investors eager to buy mortgage backed securities.

46.  There was no one in the world who knew exactly where all the mortgage backed securities were being held when it began to experience trouble.

47.  After the Fed began pushing short term interest rates up in 2005, the higher interest rates and falling housing prices pushed many homeowners into default and foreclosure.

48.  When house prices began falling and many went into default and foreclosure, the housing industry continued to produce new housing at a rapid rate.

49.  The fact that Fannie Mae and Freddy Mac were buying large amounts of risky mortgages meant that other buyers perceived the risks of such investments as lower than they really were.

50.  The federal government had to take over both Fannie Mae and Freddy Mac as a result of the financial crisis.

Multiple Choice – AD and AS model

1. The largest component of aggregate demand is

a. government purchases.

b. net exports.

c. consumption.

d. investment.

2. A reduction in personal income taxes, other things being equal, will

a. leave consumers with less disposable income.

b. decrease aggregate demand.

c. leave consumers with more disposable income.

d. increase aggregate demand.

e. do both c and d.

3. Aggregate demand is the sum of ____________.

a. C + I + G

b. C + I + G + X

c. C + I + G + (X – M)

d. C + I + G + (X + M)

4. Empirical evidence suggests that consumption ______________ with any ___________________.

a. decreases, increase in income

b. decreases, tax cut

c. increases, decrease in consumer confidence

d. increases, increase in income

e. Both a and b are true.

5. Investment (I) includes

a. the amount spent on new factories and machinery.

b. the amount spent on stocks and bonds.

c. the amount spent on consumer goods that last more than one year.

d. the amount spent on purchases of art.

e. all of the above.

6. If private consumption in the United States were 67 percent of GDP, investment were 16 percent, government purchases were 13 percent, exports were 12 percent, and imports were 8 percent, net exports would be equal to ____________ percent of GDP.

a. 4

b. -4

c. 20

d. -20

e. none of the above

7. If our exports of final goods and services increase more than our imports, other things being equal, aggregate demand will

a. increase.

b. be negative.

c. decrease by the change in net exports.

d. stay the same.

e. do none of the above.

8. The aggregate demand curve

a. is negatively sloped.

b. demonstrates an inverse relationship between the price level and real gross domestic product demanded.

c. shows how real gross domestic product demanded changes with the changes in the price level.

d. All of the above are correct.

9. As the price level increases, other things being equal,

a. aggregate demand decreases.

b. the quantity of real gross domestic product demanded increases.

c. the quantity of real gross domestic product demanded decreases.

d. aggregate demand increases.

e. both a and c occur.

10. According to the real wealth effect, if you are living in a period of falling price levels on a fixed income (that is not indexed), the cost of the goods and services you buy ____________ and your real income ____________.

a. decreases; decreases

b. increases; increases

c. decreases; remains the same

d. decreases; increases

11. As the price level decreases, real wealth ____________, purchasing power ____________, and the quantity of RGDP

demanded ____________.

a. increases; decreases; increases

b. increases; increases; increases

c. decreases; decreases; decreases

d. decreases; decreases; increases

e. increases; decreases; decreases

12. As the price level increases, interest rates ____________, investments ____________, and the quantity of RGDP demanded ____________.

a. decrease; increase; decreases

b. increase; increase; decreases

c. decrease; decrease; increases

d. decrease; increase; increases

e. increase; decrease; decreases

13. What is the open economy effect?

a. If prices of the goods and services in the domestic market rise relative to those in global markets as a result of a higher domestic price level, consumers and businesses will buy less from foreign producers and more from domestic producers.

b. People are allowed to trade with anyone, anywhere, anytime.

c. It is the ability of firms to enter or leave the marketplace—easy entry and exit with low entry barriers.

d. If prices of the goods and services in the domestic market rise relative to those in global markets as a result of a higher domestic price level, consumers and businesses will buy more from foreign producers and less from domestic producers, other things being equal.

14. Which of the following helps explain the downward slope of the aggregate demand curve?

a. the real wealth effect

b. the interest effect

c. the open economy effect

d. all of the above

e. none of the above

15. Which of the following will result as part of the interest rate effect when the price level rises?

a. Money demand will increase.

b. Interest rates will increase.

c. The dollar amount of investment will decrease.

d. A lower quantity of real GDP will be demanded.

e. All of the above will result.

16. Which of the following will not decrease when the price level falls?

a. money demand

b. the real interest rate

c. the real level of investment

d. a and b

e. b and c

17. A decrease in the U.S. price level will

a. increase U.S. exports.

b. increase U.S. imports.

c. increase RGDP demanded in the United States.

d. do both a and c.

e. do both b and c.

18. An economic bust or severe downturn in the Japanese economy will likely result in a(n)

a. decrease in U.S. exports and U.S. aggregate demand.

b. increase in U.S. exports and U.S. aggregate demand.

c. decrease in U.S. imports and U.S. aggregate demand.

d. increase in U.S. imports and U.S. aggregate demand.

19. Which of the following will cause consumption and, as a result, aggregate demand to decrease?

a. a tax increase

b. a fall in consumer confidence

c. reduced stock market wealth

d. rising levels of consumer debt

e. all of the above

20. A massive increase in interstate highway construction will affect aggregate demand through which sector? Will this change increase or decrease aggregate demand?

a. investment, increase

b. government purchases, increase

c. government purchases, decrease

d. consumption, decrease

21. An increase in government purchases, combined with a decrease in investment, would have what effect on aggregate demand?

a. AD would increase.

b. AD would decrease.

c. AD would stay the same.

d. AD could either increase or decrease, depending on which change was of greater magnitude.

22. An increase in consumption, combined with an increase in exports, would have what effect on aggregate demand?

a. AD would increase.

b. AD would decrease.

c. AD would stay the same.

d. AD could either increase or decrease, depending on which change was of greater magnitude.

23. What would happen to aggregate demand if the federal government increased military purchases and state and local governments decreased their road-building budgets at the same time?

a. AD would increase because only federal government purchases affect AD.

b. AD would decrease because only state and local government purchases affect AD.

c. AD would increase if the change in federal purchases were greater than the change in state and local purchases.

d. AD would decrease if the change in federal purchases were greater than the change in state and local purchases.

24. If exports and imports both decrease, but exports decrease more than imports,

a. AD would decrease.

b. AD would increase.

c. AD would be unaffected.

d. AD could either increase or decrease.

25. If exports increased and imports decreased,

a. AD would decrease.

b. AD would increase.

c. AD would be unaffected.

d. AD could either increase or decrease.

26. The short-run aggregate supply curve slopes

a. downward because firms can sell more, and hence, will produce more when prices are lower.

b. downward because firms find it costs less to purchase labor and other inputs when prices are lower, and hence they produce more.

c. upward because when the price level rises, output prices rise relative to input prices (costs), raising profit margins and increasing production and sales.

d. upward because firms find that it costs more to purchase labor and other inputs when prices are higher, and hence they must produce and sell more in order to make a profit.

27. If the price level rises, what will happen to the quantity of RGDP produced along the long-run aggregate supply curve?

a. It will increase.

b. It will usually increase, but not always.

c. Nothing will happen to it.

d. It will decrease.

e. It will usually decrease, but not always.

28. If the price level rises, what happens to the level of real GDP supplied?

a. It will increase in both the short run and long run.

b. It will increase in the short run but not in the long run.

c. It will decrease in both the short run and long run.

d. It will decrease in the short run but not in the long run.

e. It will usually decrease, but not always.

29. What is the typical response of firms to an increase in the price of what they sell, for given input prices?

a. an increase in output

b. an increase in hiring factors of production

c. an increase in the profit level of firms

d. an increase in employment in the industry

e. all of the above

30. The short run is

a. a time period in which the prices of output cannot change but in which the prices of inputs have time to adjust.

b. a time period in which output prices can change in response to supply and demand but in which all input prices have not yet been able to completely adjust.

c. a time period in which neither the prices of output nor the prices of inputs are able to change.

d. any time period of less than a year.

31. The profit effect is explained in the text as follows:

a. When the price level decreases, output prices rise relative to input prices (costs), raising producers’ short-run profit margins.

b. At equilibrium prices, when costs rise, profit margins are able to float with them and be passed along.

c. The profit effect is only a long-run phenomenon.

d. When the price level rises, output prices rise relative to input prices (costs), raising producers’ short-run profit margins.

32. The text’s explanation of the misperception effect for an upward-sloping short-run aggregate supply curve is based on

a. falling profit margins as the price level rises.

b. rising costs of production as the price level rises.

c. fixed-wage labor contracts.

d. the fact that producers may be fooled into thinking that the relative price of the item they are producing is rising and as a result increase production.

33. In the short run, a decrease in the price level

a. increases output prices relative to input prices.

b. increases the profit margins of many producers.

c. decreases RGDP supplied.

d. decreases unemployment rates.

e. does none of the above.

34. Which of the following would shift the long-run aggregate supply curve if it changed?

a. the level of capital in the economy

b. the amount of land in the economy

c. the amount of labor in the economy

d. the technology in the economy

e. any of the above

35. The short-run aggregate supply curve will shift to the left, other things being equal, if

a. energy prices fall.

b. technology and productivity increase in the nation.

c. a short-term increase in input prices occurs.

d. the capital stock of the nation increases.

36. An increase in input prices causes

a. the short-run aggregate supply curve to shift outward, which means the quantity supplied at any price level declines.

b. the short-run aggregate supply curve to shift inward, which means the quantity supplied at any price level declines.

c. the short-run aggregate supply curve to shift inward, which means the quantity supplied at any price level increases.

d. the short-run aggregate supply curve to shift outward, which means the quantity supplied at any price level increases.

37. How will an increase in money wages affect the short-run aggregate supply curve?

a. It will shift left (a decrease in short-run aggregate supply).

b. It will shift left (an increase in short-run aggregate supply).

c. It will shift right (a decrease in short-run aggregate supply).

d. It will shift right (an increase in short-run aggregate supply).

38. An unusual series of rainstorms washes out the grain crop in the upper plains states, severely curtailing the supply of corn and wheat, as well as soybeans. What effect would this situation have on aggregate supply?

a. It would shift the SRAS left, but not the LRAS.

b. It would shift both the SRAS and the LRAS left.

c. It would shift the SRAS right, but not the LRAS.

d. It would shift both the SRAS and the LRAS right.

39. Any permanent increase in the quantity of any of the factors of production—capital, land, labor, or technology—available, will cause

a. the SRAS to shift to the left and LRAS to remain constant.

b. the SRAS to shift to the right and LRAS to remain constant.

c. both SRAS and LRAS to shift to the right.

d. both SRAS and LRAS to shift to the left.

40. Which of the following could be expected to shift the short-run aggregate supply curve upward?

a. a rise in the price of oil

b. a natural disaster

c. wage increases without increases in labor productivity

d. all of the above

41. A temporary positive supply shock will shift _______________; a permanent positive supply shock will shift _______________.

a. SRAS and LRAS right; SRAS and LRAS right

b. SRAS but not LRAS right; SRAS and LRAS right

c. SRAS and LRAS right; SRAS but not LRAS right

d. SRAS but not LRAS right; SRAS but not LRAS right

42. A year of unusually good weather for agriculture would

a. increase SRAS but not LRAS.

b. increase SRAS and LRAS.

c. decrease SRAS but not LRAS.

d. decrease SRAS and LRAS.

43. When the price of oil experiences a temporary sharp increase, which curve(s) will shift left?

a. SRAS

b. LRAS

c. neither SRAS nor LRAS

d. both SRAS and LRAS

44. Inflation that occurs as a result of a decrease in aggregate supply is called

a. cost-push.

b. demand-pull.

c. inflationary push.

d. none of the above.

45. Assuming a constant level of aggregate demand, the short-run effects of an adverse supply shock include

a. an increase in the price level and a decrease in real output.

b. an increase in the price level and an increase in real output.

c. a decrease in the price level and an increase in real output.

d. a decrease in the price level and a decrease in real output.

46. Cost-push inflation occurs when

a. the aggregate demand curve shifts right at a faster rate than short-run aggregate supply.

b. the short-run aggregate supply curve shifts left, while aggregate demand is fixed.

c. the aggregate demand curve shifts left and aggregate supply is fixed.

d. the short-run aggregate supply curve shifts right.

47. A recession could result from

a. a decrease in aggregate demand.

b. an increase in long-run aggregate supply.

c. an increase in aggregate demand.

d. an increase in short-run aggregate supply.

e. none of the above.

48. When SRAS and AD intersect at the natural level of real output, it is

a. a short-run equilibrium and a long-run equilibrium.

b. a short-run equilibrium but not necessarily a long-run equilibrium.

c. just a short-run equilibrium.

d. not necessarily either a short-run equilibrium or a long-run equilibrium.

49. Where SRAS and AD currently intersect at a real output level greater than the natural level of real output,

a. it is a short-run equilibrium, and real output will tend to fall from its current level as it adjusts to long-run equilibrium.

b. it is a short-run equilibrium, and real output will tend to rise from its current level as it adjusts to

long-run equilibrium.

c. it is a short-run disequilibrium, and real output will tend to fall from its current level as it adjusts to long-run equilibrium.

d. it is a short-run disequilibrium, and real output will tend to rise from its current level as it adjusts to long-run equilibrium.

50. Starting from long-run equilibrium, an increase in aggregate demand will cause

a. an inflationary gap in the short run.

b. a recessionary gap in the short run.

c. an inflationary gap in the short run and long run.

d. a recessionary gap in the short run and long run.

e. neither an inflationary nor a recessionary gap in the short run or the long run.

51. When a recessionary gap occurs,

a. real output exceeds the natural level of output, and unemployment exceeds its natural rate.

b. real output exceeds the natural level of output, and unemployment is less than its natural rate.

c. real output is less than the natural level of output, and unemployment exceeds its natural rate.

d. real output is less than the natural level of output, and unemployment is less than its natural rate.

52. Which of the following could begin an episode of demand-pull inflation?

a. an increase in consumer optimism

b. a faster rate of economic growth for a major trading partner country

c. expectations of higher rates of return in investment

d. any of the above

e. none of the above

53. If real output is currently less than the natural level of real output, a decrease in aggregate demand will

a. make the current inflationary gap larger.

b. make the current inflationary gap smaller.

c. make the current recessionary gap larger.

d. make the current recessionary gap smaller.

54. In the short run, demand-pull inflation

a. increases both unemployment and the price level.

b. increases unemployment but not the price level.

c. increases the price level but not unemployment.

d. decreases unemployment and increases the price level.

55. In a stagflation situation,

a. unemployment increases and the price level increases.

b. unemployment increases and the price level decreases.

c. unemployment decreases and the price level increases.

d. unemployment decreases and the price level decreases.

56. A sharp fall in oil prices will cause a(n) ____________________; a sudden increase in the wages demanded by workers will cause a(n) ____________________.

a. recessionary gap; inflationary gap

b. recessionary gap; recessionary gap

c. inflationary gap; inflationary gap

d. inflationary gap; recessionary gap

57. Starting from long-run equilibrium, an increase in aggregate demand

a. causes an inflationary gap.

b. results in a lower price level.

c. increases unemployment.

d. does all of the above.

e. does b and c, but not a.

58. During the self-correction process after a fall in aggregate demand,

a. the price level increases and real output increases.

b. the price level increases and real output decreases.

c. the price level decreases and real output increases.

d. the price level decreases and real output decreases.

59. Which of the following can contribute to slowing the adjustment to a recessionary gap?

a. efficiency wages

b. the minimum wage

c. menu costs

d. all of the above

e. b and c, but not a

60. An unexpected increase in aggregate demand will

a. increase real wages in the short run but not the long run.

b. increase real wages in the short run and long run.

c. decrease real wages in the short run but not the long run.

d. decrease real wages in the short run and long run.

61. If the economy was operating on a completely flat segment of the short-run aggregate supply curve, an increase in aggregate demand would

a. increase real output and increase the price level.

b. increase real output and decrease the price level.

c. decrease real output and increase the price level.

d. decrease real output and decrease the price level.

e. do none of the above.

62. “In the long run, both wages and prices should adjust freely to changes in demand and supply, and the economy will be at its full-employment level of real output.”

a. Classical economists, but not Keynesian economists, would accept this statement.

b. Keynesian economists, but not classical economists, would accept this statement.

c. Both classical economists and Keynesian economists would accept this statement.

d. Neither classical economists nor Keynesian economists would accept this statement.

63. Which of the following statements is true?

a. The classical short-run aggregate supply curve gets steeper as real output increases.

b. The Keynesian short-run aggregate supply curve gets steeper as real output increases.

c. The classical long-run aggregate supply curve gets steeper as real output increases.

d. The Keynesian long-run aggregate supply curve gets steeper as real output increases.

Problems – Fiscal Policy

1. Why are federal government actions that increase deficits considered expansionary fiscal policy and those that decrease deficits considered contractionary fiscal policy?

2. Are increases in both government purchases and net taxes at the same time expansionary or contractionary?  Would both changes together increase or decrease the federal government deficit?

3. Answer the following questions:

a. If the current budget shows a surplus, what would an increase in government purchases do to it?

b.What would that increase in government purchases do to aggregate demand?  

c.When would an increase in government purchases be an appropriate countercyclical fiscal policy?

4. Answer the following questions:

a. If the current budget shows a deficit, what would an increase in taxes do to it?

b. What would that increase in taxes do to aggregate demand?

c. When would an increase in taxes be an appropriate contractionary fiscal policy?

5. Use the accompanying diagram (from page 789) to answer questions a–f.

Problem%203

a. At what short-run equilibrium point might expansionary fiscal policy make sense to help stabilize the economy?

b. What would be the result of appropriate fiscal policy in that case?

c. What would be the long-run result if no fiscal policy action were taken in that case?

d. At what short-run equilibrium point might contractionary fiscal policy make sense to help stabilize the economy?

e. What would be the result of appropriate fiscal policy in that case?

f. What would be the long-run result if no fiscal policy action were taken in that case?

6. What is a recessionary gap?  What would be the appropriate fiscal policy to combat or offset one?  What is an inflationary gap?  What would be the appropriate fiscal policy to combat or offset one?

7. What would the multiplier be if the marginal propensity to consume was

a. 1/3?             

b. 1/2? 

c. 3/4?             

9. Could the multiplier be written as 1 divided by the marginal propensity to save (MPS)?

10. Why does it take a larger reduction in taxes to create the same increase in AD as a given increase in government purchases?

11. Explain why an equal dollar increase in both government purchases and net taxes would increase aggregate demand.

12. Use the accompanying diagram to answer questions a and b.

Problem%207
  1. Starting from the initial equilibrium in the diagram, illustrate the case of a supply-side fiscal policy that left the price level unchanged in both the short run and long run.
Problem%207a
  • Compared to your answer in a, when would a supply-side fiscal policy result in an increase in the price level?
Problem%207b

13. Why can a decrease in tax rates increase AS as well as AD, whereas an increase in government purchases will increase AD but not AS?

14. How do automatic stabilizers affect budget deficits and surpluses?  How would automatic stabilizers be affected by an annually balanced budget rule?

15. Why do automatic stabilizers minimize the lag problems with fiscal policy?

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