Question

1) If the stock market crashes, then

aggregate demand increases, which the Fed could offset by increasing the money supply.

aggregate demand increases, which the Fed could offset by decreasing the money supply.

aggregate demand decreases, which the Fed could offset by increasing the money supply.

aggregate demand decreases, which the Fed could offset by decreasing the money supply.

2) In order to avoid entering a recession, the government of Batavia spent $300 billion improving infrastructure around the country. Assuming that the marginal propensity to consume is ½ and without considering any crowding out effects, how much would aggregate demand increase?

$150 billion

$250 billion

$600 billion

$900 billion

3) The government builds a new water-treatment plant. The owner of the company that builds the plant pays her workers. The workers increase their spending. Firms from which the workers buy goods increase their output. This type of effect on spending illustrates Question 13 options:

the multiplier effect. the crowding-out effect.

the Fisher effect.

the wealth effect.

4) If businesses become pessimistic about the economy, the Federal Reserve can attempt to reduce the impact on the price level and real GDP by

increasing the money supply, which raises interest rates.

increasing the money supply, which lowers interest rates.

decreasing the money supply, which raises interest rates.

decreasing the money supply, which lowers interest rates.

5) Opponents of using policy to stabilize the economy generally believe that

neither fiscal nor monetary policy have much impact on aggregate demand

. attempts to stabilize the economy decrease the magnitude of economic fluctuations

. unemployment and inflation are not cause for much concern.

economic conditions can easily change between the start of policy action and when it takes effect.

Answer 1

1) aggregate demand decreases, which the Fed could offset by increasing the money supply. A stock market crash would drive demand down due to pessimism. The fed can increase mone supply to drive output and demand up.

2) $600 billion

MPC = 0.5

Multiplier = 1/(1-MPC) = 2

Therefore, increase in AD = 2 * (increase in G) = $600 billion

3) Wealth effect: The wealth effect is a behavioral economic theory suggesting that people spend more as the value of their assets rise.

4) increasing the money supply, which lowers interest rates. Raising money supply would spur output and demand. Lowering interest rates would increase investments and overall real GDP will rise.

5) economic conditions can easily change between the start of policy action and when it takes effect. A lot of times there is a lag before the policy outcomes are observed.