Macro Economics Midterm 2

marginal propensity to consume (MPC)

the change in consumption divided by the change in income

marginal propensity to save (MPS)

the change in saving divided by the change in income

Fiscal policy

the spending and tax policies used by the government to influence the economy

Suppose the consumption function is represented as follows: C = 200 + .50Y. If Y increases by $1, then consumption will increase by

0.5

government purchases multiplier

the ratio of the change in the equilibrium level of output to a change in government purchases

A decrease in lump-sum taxes will

shift the consumption function upward

If MPC is greater than zero but less than one, then we can be sure that when income rises by $1, consumption will

will rise by less than $1

tax multiplier

the ratio of the change in the equilibrium level of output to the change in taxes

When David has no income, he spends $500. If his income (Y) increases to $2,000, he spends $1,900. Which of the following represents his consumption function?

C = $500 + 0.7 × Y

What is part of a fiscal policy

• tax rates set by the government

• government transfers to individuals

• government purchases of goods and services

A tax cut will have a greater impact on the consumption expenditure of

People with a high MPC

After the government is added to the income-expenditure model, the formula for the aggregate consumption function is

C = a + b (Y + T )

In the absence of government, planned aggregate expenditure is a/an ____ shift of consumption function by the amount of planned investment

upward

Planned investment spending

is negatively related to the interest rate

If the consumption function is of the form [C = 80 + 0.4 Y] , the MPS equals

0.6

When you pay $8 for a salad you ordered for lunch, you are using money as a(n)

medium of exchange

Which of the following will most likely cause a decrease in the quantity of money demanded?

an increase in the interest rate

The demand for money and the interest rate are

negatively related

When the interest rate rises, bond values

fall

When the manager of a department store attaches price tags to his/her products, he/she is using money as a

unit of account

Which of the following instruments is not used by the Federal Reserve to change the money supply?

the federal tax code

The Fed uses open market operations to

buy or sell government securities

The discount rate is

the interest rate the Fed charges commercial banks for borrowing funds.

Assume that all commercial banks are loaned up. Total deposits in the banking system are $200 million. The required reserve ratio is increased.
The money supply will

decrease

Which of the following alternatives is TRUE

Higher interest rate causes lower planned investments, lower planned aggregate expenditures, and equilibrium income or output

Which of the following represents an action by the Federal Reserve that is designed to increase the money supply?

a decrease in the required reserve ratio

If the Fed sells government securities (bonds), then there is

a decrease in the supply of money

As investment becomes more responsive to the changes in the interest rate

a given increase in the money supply will cause a larger change in equilibrium income or output

An open-market sale of securities by the Fed results in ________ in reserves and ________ in the supply of money

a decrease; a decrease

A commercial bank lists

deposits as liabilities

A reduction in the money supply will cause

a leftward shift of the aggregate demand curve

An increase in the money supply can cause both the interest rate and the price level to go up

false

Which of the following sequence of events follows an open market purchase by the Fed?

r↓ ⇒ I↑ ⇒ PAE↑ ⇒ Y↑

Which of the following sequences of events follows a rise in the discount rate?

r↑ ⇒ I↓ ⇒ PAE↓ ⇒ Y↓

Which of the following could cause the quantity of money demanded to increase?

a decrease in the interest rate

consumption function

mathematical relationship between planned consumption expenditure and income

consumption function formula

C = a + bY

what does the consumption function tell us

how income generated in an economy determines the demand for goods and services by the Household Sector

autonomous part of consumption

level of consumer spending that occurs independently of income

marginal propensity to consume (MPC) measures

how much of each additional dollar of income is spent on consumption rather than saved

MPC forumla

change in consumption over change in income

high MPC

people spent most of extra income

low MPC

people save more of extra income

marginal propensity of saving (MPS) measures

how much of each additional dollar of income is saved rather than spent on consumption

MPS formula

change in savings over change in income

high MPS

people are saving more

low MPS

people are spending more

how are MPC and MPS related

MPC + MPS = 1

expression for planned aggregate expenditure for a simple economy WITHOUT government

PAE = C_p + I_p = C_p + I

expression for planned aggregate expenditure for a simple economy WITHOUT government, incorporating consumption and investment function

PAE = a + I₀ + bY

why does an economy gravitate toward the equilibrium level of output or income?

Firms adjust production in response to unplanned changes in inventories. increasing output when spending exceeds production and reducing output when production exceeds spending.

investment multiplier

measures how much total income or output in the economy changes when theres a change in investment spending

government spending multiplier

1/1-MPC

tax multiplier

-MPC/1-MPC

what is disposable income (Yd)

the amount of money households have left to spend or save after paying taxes

disposable income (Yd) formula

Yd=Y-T

what is the consumption function when income is replaced by disposable income

C=a+b(Y-T)

government expenditure multiplier formula

change in equilibrium level of output/change in government spending

what is government expenditure multiplier

tells us how many units equilibrium income/output will change in an economy if government expenditure changes by one unit

tax multiplier formula

change in the equilibrium level of output/change in taxes

what is tax multiplier

value tells us by how many units equilibrium income/output will change in an economy if taxes changes by one unit

balance budget multiplier

shows how equal increases in government spending (G) and taxes (T) affect the equilibrium level of income (Y)

balance budget multiplier formula

change in Y = change in G

what role does money play in modern society

• medium of exchange

• unit of account

• store of value

• standard of deferred payment

what 3 properties must a commodity satisfy to qualify as money

• must be able to store value

• can be used as a unit if accounts

• universally accepted as a medium of transaction

M1

money that can be directly used for transactions. a stock measure, it is measured at a point in time

M1 formula

M1 = currency held outside banks + demand deposits + travelers checks + other checkable deposits

M2 formula

M2 = M1 + savings accounts + money market accounts + other near monies

what does Fed do to increase the supply of money

allows banks to make additional loans

what does Fed do to decrease the supply of money

restricts banks to make loans

reasons for changing money supply

• to control inflation

• to control interest rates

• to change equilibrium levels of income/output

What tools can Fed use to control money supply

• changing the required reserves ratio

• engaging in open market operations

• changing the discount rate

required reserves ratio

the percentage of its total deposits that a bank must keep as reserves at the Federal Reserve

money multiplier formula

1/rrr

excess reserve

difference between a bank’s actual reserves and its required reserves

how does the bank create demand deposit and money

if banks are able to lend more, more demand deposits will be created and money supply will increase

what is the money multiplier

multiple by which demand deposits can increase for every dollar increase in reserves

how does money supply change when Fed increases discount rate

lowers lending, lower demand deposit is created, money supply decreases

how does money supply change when Fed increases required reserves ratio

lowers lending, lower demand deposit is created, money supply decreases

how does money supply change when Fed sells bonds

lowers lending, lower demand deposit is created, money supply decreases

how does money supply change when Fed purchases bonds

lend more, demand deposit creation increases, money supply increases

there is a ______ relationship between interest rate and demand for money

negative

when output (income) rises how does the money demand curve shift

the total number of transactions rises, and demand for money shifts curve to the right

when price level rises how does the money demand curve shift

average dollar amount of each transaction rises, thus quantity of money needed rises, demand for money shifts the curve to the right. 

how is the equilibrium interest rate determined

the point at which the quantity of money demanded equals the quantity of money supplied

how does Fed change equilibrium interest rate when money is higher than economy wants to hold

offer lower interest rates

how does Fed change equilibrium interest rate when money is lower than economy wants to hold

offer higher interest rates

when the interest rate falls

planned investment rises

when interest rate rises

planned investment falls