Economics 102
Practice Questions 5
Spring 2001
I. Concepts:
Liquidity
Cash in the hands of public
Demand Deposits
M1
M2
Financial Intermediary
Balance Sheet
Bond
Loan
Reserves
Required Reserves
Required Reserve Ratio
Net Worth
Central Bank
Federal Open Market Committee
Discount Rate
Open Market Operations
Excess Reserves
Demand Deposit Multiplier
Run on the bank
Banking Panic
Wealth Constraint
Money Demand Curve
Money Supply Curve
Excess Supply of Money
Excess Demand for Bonds
Federal Funds Rate
II. True/False and explain
1. If Diana makes a ten dollar cash withdrawal from her checking account, M1
has risen by $10, ceteris paribus.
2. If the required reserve ratio is increased, the money multiplier will decrease.
3. The required reserve ratio is the Fed's most frequently used tool of
monetary
policy.
4. An advantage of barter over money is that, in a barter system, there is
no
need for a double coincidence of wants.
5. Demand deposits are assets of the commercial banks.
6. The mismatch between the timing of money inflow and the timing of money
outflow is called the synchronization of income and spending.
7. When market interest rates rise, bond values fall.
8. An increase in the price level causes the demand for money curve to shift
to
the right.
9. In a recession, where many people are unemployed and have low incomes,
the demand for money is very high.
10. An easy money policy will reduce the equilibrium rate of interest.
III. Multiple Choice Questions
1. The store of value function of money refers to the ability of money to:
a. generate
valuable interest earnings over time.
b. purchase
valuable durable commodities.
c. retain its
purchasing power over time.
d. buy surplus
output for future consumption.
2. Which of the following assets is included in M2 but not in M1?
a.
Federal Reserve Notes.
b. Money
market accounts.
c.
Travelers' checks.
d.
Demand deposits.
3. First National Bank is a commercial bank. Which of the following
items are
among First National Bank's assets?
a.
Deposits of First National Bank's customer, Mr. Smith.
b. Loan by First
National Bank to Mr. Smith.
c. Currency
held by the public.
d. First
National Bank's net worth.
4. The required reserve ratio is 20%. Given the following T account
for
First National Bank (a commercial bank) which is fully
loaned up, determine the level of reserves::
Assest Liabilities
Reserves
Deposits 800
Loans Net Worth
200
Total
Total 1000
a. 0.
b. 40.
c. 160.
d. 200.
5. First National Bank is currently loaned up. Which of the
following will occur if the
required reserve ratio for the banking
system is increased?
a. First
National Bank will have additional reserves available.
b. First
National Bank will have to reduce the volume of its new loans.
c. First
National Bank will increase its deposits until the ratio is reduced to 10%
once more.
d. First
National Bank will be able to increase the volume of its loans because it
is no longer fully loaned up.
6. The banking system is closed and fully loaned up. The required
reserve
ratio is 10%. Now Mr. Smith deposits a
$100 bill into his account at
First National Bank. Loans in the banking system
can increase by _______ and
the money supply can increase by _______.
a. $900,
$900.
b. $900,
$1000.
c. $1000,
$900.
d. $1000,
$1000.
7. The required reserve ratio is 25%. Commercial banks are fully
loaned up
and have total deposits of $1200 million. Now
the required reserve ratio is
reduced to 20%. The money supply will increase
by:
a. $240
million.
b. $300
million. Banking system reserves can support $1200 million when
the reserve ratio is 25%. Reserves must be $300 million. When the money
multiplier increases to 5, the money supply can increase to $1500 million.
c.
$1500 million.
d.
$6000 million.
8. Which of the following pairs of actions by the Fed will have
the greatest
likelihood of increasing the money supply?
a. A
decrease in the required reserve ratio and an increase in the discount
rate.
b. An open
market sale of government securities and an increase in the
discount rate.
c. An open
market sale of government securities and a decrease in the
required reserve ratio.
d. An open
market purchase of government securities and a decrease in
the required reserve ratio.
9. Which of the following factors will not reduce the size of
the money
multiplier?
a. Banks
become more willing to hold excess reserves.
b. More of
the individuals who have received bank loans prefer to hold the
currency rather than to redeposit the funds in the banking system.
c. The
required reserve ratio is increased.
d. The Fed
reduces the discount rate.
10. Which of the Fed's policy tools for controlling the money
supply is the most
significant?
a. The
required reserve ratio, because it directly controls the money
multiplier.
b. The
discount rate, because the ultimate goal of the Fed is to control
lending and interest rates.
c. Moral
suasion.
d. Open
market operations, because buying and selling of government
securities can be done quickly and with precision.
11. If I loan the U. S. government $940 today and the U. S. government
repays
me the amount of $1,000 exactly one year from today, the
interest rate I
would earn would be
a. 6.4%.
b. 6.0%.
c. $60.
d. 106.4%
12. Jim's optimal money balance would be larger the __________ the
rate of
interest and the ___________ his money
management costs.
a.
higher; lower
b. higher;
higher
c. lower;
higher
d. lower;
lower
13. According to the speculative motive, when the interest rate is
below normal,
people expect bond prices to __________ in the
future. As a result, the
demand for money tends to be __________ today.
a. rise;
larger
b. fall;
larger
c. rise;
smaller
d. fall;
smaller
14. The __________ the price level, the lower is the demand for
money and the
lower the aggregate output
(income), the __________ is the demand for
money.
a. lower;
lower
b. lower;
higher
c. higher;
lower
d. higher;
higher
15. To macroeconomists, the demand for money refers to
a. the
desire to borrow money for consumption and investment purposes.
b. the
desire to earn income.
c. the
desire to be wealthy.
d. how much
of their financial assets people wish to hold in the form of
money.
16. A change in the level of aggregate output (income) will
cause __________
the demand for money curve and a change in
the interest rate will cause
__________ the demand for money curve.
a. a
movement along; a movement along
b. a
movement along; a shift in
c. a shift
in; a movement along
d. a shift
in; a shift in
17. The demand for money curve has a __________ slope and the supply
of
money curve has a __________ slope.
a.
negative; vertical
b. negative;
positive
c. vertical;
negative
d. positive;
negative
18. When the interest rate is above the equilibrium level
a. there
is an excess supply of money and both bond prices and the rate of
interest will fall.
b. there is
an excess supply of money, bond prices rise, and the interest
rate falls.
c. there is
a shortage of money, bond prices fall, and the interest rate rises.
d. there is
an excess supply of money, bond prices fall, and the rate of
interest rises.
19. A tight monetary policy occurs when
a. the U.
S. government reduces its purchases of goods and services thus
keeping money out of the economy.
b. the U. S.
government reduces personal taxes forcing itself to cut its own
spending.
c. a
recession has occurred, people have lost jobs and income, and
consumption spending fall.
d. the
Federal Reserve reduces the money supply.
20. An easy money policy would
a. shift
the demand for money curve down.
b. shift the
money supply curve upward.
c. shift the
supply of money curve to the right.
d. shift the
demand for money curve to the left and the supply of money
curve to the right.
21. Which of the following statements regarding money is incorrect?
a. Money is a medium of exchange.
b. Money reduces transaction costs.
c. Money increases the gains from trade.
d. Money reduces the need to specialize.
22. The value (purchasing power) of fiat money is determined by
a. the quantity of gold which backs it.
b. the price level.
c. its intrinsic value.
d. the government which issues it.
23. The money supply measure known as M1 does not include
a. paper currency and coins.
b. demand deposits and other checkable deposits.
c. traveler's checks.
d. savings deposits.
24. M2 is equal to M1
a. minus currency plus savings deposits.
b. plus savings deposits.
c. plus savings deposits, small-denomination time deposits, and
money market mutual funds.
d. plus savings deposits, small-denomination time deposits, and
treasury bonds.
25. Which of the following would appear on the asset side of a commercial bank balance sheet?
a. Vault cash and reserves at the Fed.
b. Loans outstanding.
c. U.S. government securities.
d. All of the above.
26. Banks are required by law to keep a fraction of their checking
deposits in the form of an asset
known as
a. excess reserves.
b. required reserves.
c. borrowed reserves.
d. U.S. government reserves.
27. The early goldsmiths' actions contributed to the expansion of the money supply by
a. extending loans to customers.
b. keeping only a fraction of the gold deposited with them as a
reserve.
c. issuing certificates for deposited gold which were later used
as money.
d. all of the above.
28. If First Whistler's Bank confronts a 20 percent reserve
requirement and has excess reserves of
$1,000,000, what is the maximum amount of
additional loans that this bank can extend?
a. $200,000.
b. $800,000.
c. $1,000,000.
d. $5,00,000.
29. The potential deposit expansion multiplier is equal to
a. 1/required reserve ratio.
b. 1/excess reserves.
c. excess reserve ratio/required reserve ratio.
d. deposits/reserves.
30. If the banking system has $3 billion in excess reserves and the
required reserve ratio is 25.0
percent, the banking system as a whole
could increase the money supply by a maximum of
a. $3 billion.
b. $12 billion.
c. $15 billion.
d. $75 billion.
31. Which of the following will cause the actual deposit expansion multiplier to fall?
a. People decide to take part of their loans in the form of
currency rather than checking deposit.
b. Banks decide that they will no longer keep excess reserves.
c. The Fed reduces banks' actual reserves.
d. All of the above.
32. The decision-making center of the Fed is
a. the Board of Governors.
b. the Federal Open Market Committee.
c. the U.S. Congress.
d. the President's Council of Economic Advisors.
33. Which of the following would cause an increase in the money supply?
a. An increase in the required reserve ratio.
b. A decrease in the discount rate.
c. A sale of government securities by the Federal Reserve.
d. None of the above.
34. Which one of the following would cause households and businesses
to want to hold greater
money balances?
a. A higher price level in the economy.
b. Lower nominal interest rates.
c. An expansion in real GDP.
d. All of the above.
35. The view that erratic monetary policy is the chief cause of fluctuations
in real GDP and inflation
is held by the group of economists known
as
a. monetarists.
b. Keynesians.
c. classical economists.
d. all of the above.
36. If the interest rate is below the equilibrium level of interest people will want to
a. decrease their holdings of money balances.
b. increase their holdings of money balances.
c. hold their money balances constant at current levels.
d. keep the quantity of bonds they hold constant at current
levels.
37. Given the money supply and money demand curve, people may be
expected to want to increase
their purchases of bonds if the interest rate is
a. i1.
b. i2.
c. i3.
d. None of these interest rates will impact the bond market.
38. Omit: will not be covered this semester
39. Omit: will not be covered this semester
40. The initial effect of an unanticipated shift to expansionary monetary policy will be
a. increased prices, interest rates, output, and employment.
b. increased prices, lower interest rates, and increased output
and employment.
c. decreased prices, interest rates, output, and employment.
d. decreased prices and interest rates, and increased output and
employment.
41. The economic relationships defined by the equation of exchange include:
a. MV = PY.
b. Velocity is equal to money supply divided by nominal GDP.
c. Rate of inflation + Growth rate of real output = Growth rate of
money supply + Growth rate of velocity.
d. All of the above.
42. If the money supply is $125 billion and the nominal GDP is $500
billion, then the velocity of
money is
a. 2.
b. 4.
c. 8.
d. 0.25.
43. Modern economic analysis suggests that in the long run a sustained
increase in money supply
growth relative to the growth rate of potential
real GDP will
a. have no effect on the nominal interest rate.
b. cause a higher inflation rate.
c. cause the real output level to rise.
d. all of the above.
44. The initial effects of a more expansionary monetary policy may be
a. strengthened by the effect of lower nominal interest rates
on the velocity of money.
b. weakened by the effect of higher nominal interest rates on the
velocity of money.
c. strengthened by the effect of higher nominal interest rates on
the velocity of money.
d. weakened by the effect of lower nominal interest rates on the
velocity of money.
45. Historically in the United States, recessions
a. have usually been preceded by an increase in the growth rate
of the money supply.
b. have usually been preceded by a decline in the growth rate of
the money supply.
c. have followed on the heels of an increase in the budget
deficit.
d. have followed on the heels of a decrease in the budget deficit.
IV. Short Answer Question:
Zebra is a country that produces a single type of good called a
widget. Widgets cost 2 dollars a piece and 3 million widgets are currently
being produced in Zebra. The country of Zerbia is suffering an economic
downturn. One economist suggests a solution to the President of Zerbia:
drop additional currency into the country using a helicopter. Prior to
the dropping of currency by the helicopter there are $900,000 dollars in
circulation in Zerbia.
Use the Classical Quantity Theory of Money to answer the following questions.
a. Assume Zebra is in monetary equilibrium (i.e., money demand equals money supply) prior to the helicopter drop. What is the ratio of desired money holdings to income?
b. If the helicopter drops $45,000 on the country, what will the new price of a widget be?
c. What is the impact of the helicopter drop on Zebra's level of real output? Explain your answer.
d. Another economist disagrees with the helicopter idea. She
recommends that the President should increase government spending on national
defense and pay for the increase by enlarging the nation's deficit. She
claims this will increase the real GDP of the country and therefore the average
standard of living will be higher next year. According to the Classical
Model will this policy result in any change in real output? If there's a
change, what kind of change in real output will there be? Give a reason
for your answer.