29 terms

Chapters 12-14

1. Discretionary fiscal policy refers to:
changes in taxes and government expenditures made by Congress to stabilize the economy.
2. Contractionary fiscal policy is so named because it:
is aimed at reducing aggregate demand and thus achieving price stability.
3. Suppose that the economy is in the midst of recession. Which of the following policies would most likely end the recession and stimulate output growth?
a reduction in Federal tax rates on personal and corporate income
4. A contractionary fiscal policy is shown as a:
leftward shift in the economy's aggregate demand curve
5. Refer to the diagram on the right → in which Qf is the full-employment output. If aggregate demand curve AD1describes the current situation
appropriate fiscal policy would be to: ,reduce taxes and increase government spending to shift the aggregate demand curve from AD1to AD2.
6. Which of the following best describes the built-in stabilizers as they function in the United States?
Personal and corporate income tax collections automatically rise and transfers and subsidies automatically decline as GDP rises.
7. Economists refer to a budget deficit that exists when the economy is achieving full employment as a:
full-employment deficit..
8. To say money is socially defined means that::
whatever performs the functions of money extremely well is considered to be money.
9. A $70 price tag on a sweater in a department store window is an example of money functioning as a:
unit of account.
10. In defining money as M1-economists exclude time deposits because:
they are not directly or immediately a medium of exchange.
11. Suppose that the Federal government suddenly declared that wheat was to be used as money. What is a possible outcome of that decision?
a-Value of the wheat dollar would be unstable depending on crop yields from year to year-b-farmers would replace corn and soy crops with wheat.-c-wheat would function as money so long as people accept it in exchange for goods and services.-d.All of these are possible outcomes.
12. Refer to the information on the right Money supply M1 for this economy is:
13. Refer to the above information. Money supply M2 for this economy is:
14. Refer to the above information. The value of the "near-monies" that are part of M2
15. The purchasing power of the dollar:
is the reciprocal of the price level.
16. During periods of rapid inflation-money may cease to work as a medium of exchange:
because people and businesses will not want to accept it in transactions.
17. Stabilizing a nation's price level and the purchasing power of its money can be achieved:
with both fiscal and monetary policy.
18. Which of these pairs of financial institutions are most alike in terms of their main lines of business?
commercial banks and thrifts.
19. In a fractional reserve banking system:
banks can create money through the lending process.
20. The reserves of a commercial bank consist of:
deposits at the Federal Reserve Bank and vault cash.
21. The primary purpose of the legal reserve requirement is to:
provide a means by which the monetary authorities can influence the lending ability of commercial banks.
22. Banks create money when they:
exchange checkable deposits for the IOU's of businesses and individuals.
23. Explain how built-in (or automatic) stabilizers work.
In a phrase ―net tax revenues vary directly with GDP.‖ When GDP is rising so are tax collections- both income taxes and sales taxes. At the same time- government payouts—transfer payments such as unemployment compensation- and welfare—are decreasing. Since net taxes are taxes less transfer payments- net taxes definitely rise with GDP- which dampens the rise in GDP. On the other hand- when GDP drops in a recession tax collections slow down or actually diminish while transfer payments rise quickly. Thus- net taxes decrease along with GDP which softens the decline in GDP.
24. What are the differences between proportional- progressive- and regressive tax systems as they relate to an economy's built-in stability?
A progressive tax system would have the most stabilizing effect of the three tax systems and the regressive tax would have the least built-in stability.This follows from the previous paragraph. A progressive tax increases at an increasing rate as incomes rise- thus having more of a dampening effect on rising incomes and expenditures than would either a proportional or regressive tax. The latter rate would rise more slowly than the rate of increase in GDP with the least effect of the three types. Conversely- in an economic slowdown-a progressive tax falls faster because not only does it decline with income- it becomes proportionately less as incomes fall.This acts as a cushion on declining incomes—the tax bite is less- which leaves more of the lower income for spending. The reverse would be true of a regressive tax that falls- but more slowly than the progressive tax- as incomes decline.
25. What determines the value (domestic purchasing power) of money?
There is no concrete backing to the money supply in the United States. Paper money- which has no intrinsic value- has value only because people are willing to accept it in exchange for goods and services- including their labor services as employees. And people are willing to accept paper as money because they know that everyone else is also willing to do so. If the monetary authorities were issuing new banknotes at a rate far in excess of available output- the acceptability of paper money would diminish. People would start to worry about whether the banknotes would be worth much after they received them. Checks are part of the money supply and are not legal tender- but people accept them willingly from people believed trustworthy.
26. How does the purchasing power of money relate to the price level?
The purchasing power of money is inversely related to the price level
27. Who is the U.S. is responsible for maintaining money's purchasing power?
The Board of Governors of the Federal Reserve System (the Fed) is responsible for managing the United States money supply so that money retains its purchasing power.
28. Explain why a single commercial bank can safely lend only an amount equal to its excess reserves but the commercial banking system can lend by a multiple of its excess
When a bank grants a loan- it can expect that the borrower will not leave the proceeds of the loan sitting idle in his or her account. Most people borrow to spend. Therefore the lending bank can expect that checks will be written against the loan and that the bank will shortly lose reserves to other banks- as the checks are presented for payment- to the full extent of the loan. In short- when a bank grants loans to the full extent of its excess reserves- it can shortly expect to lose these excess reserves to other banks. From this it can be seen why a bank cannot safely lend more than its excess reserves. If it did- it would soon find that its cash reserves were below its legal reserve requirement. From the above it can be seen why the commercial banking system can safely lend a multiple of its excess reserves. Whereas one bank loses reserves to other banks- the system does not. With a legal cash reserve requirement of- say- 20 percent- Bank ―B‖ on receiving as a new deposit the $100 loaned by Bank ―A‖ (the excess reserves of Bank ―A‖)- may safely lend $80 (80 percent of $100). Bank ―C‖-on receiving as a new deposit the $80 loan of Bank ―B‖- loans 80 percent of that- namely $64. Note that the $100 initial excess reserves of the banking system have already resulted in the money supply increasing by $244 (= $100 + $80 + $64). The money supply will continue to increase- at a diminishing rate (Bank ―D‖ will increase the money supply by $51.20 in loaning this amount), until the total increase in the money supply is $500. From the above it can be seen why the commercial banking system can safely lend a multiple of its excess reserves.
29. What is the monetary multiplier and how does it relate to the reserve ratio?
The algebra underlying the monetary multiplier is that of an infinite geometric progression. Designating the fixed fraction of the previous number as b (0.8 in our case) and k as the sum of the progression- we have: k = 1 + b + b2 + b3 + ..... + bn Solving this for a very large n- we get- k = 1 / (1 - b) In our example- the multiplier k is 1/(1 - 0.8) = 1/.2 = 5. And 5 is the reciprocal of the reserve ratio of 20 percent of 0.2. The multiplier is inversely related to the reserve ratio.