Question

1. The Federal Reserve sets _____ policy, while the president and Congress set _____ policy. These two policies influence aggregate _____.  

2. The wealth-effect notes that a _____ price level increases the real value of households’ wealth. The larger real wealth _____ the quantity of goods and services demanded.  

3. Last year, total income increased $1,000 and consumption increased $800. An increase in government spending equal to $10 would cause output to increase by $_____ because the multiplier is ______.  

4. Permanent tax changes have a _____ effect on aggregate demand compared to temporary tax changes

5. To stabilize output, the Federal Reserve will _____ the money supply when aggregate demand falls.

6. To offset increased pessimism by households, the government may _____ government spending and/or _____ taxes

Answer 1

(1) Federal Reserve sets monetary policy and Congress sets fiscal policy. Together, these two policies influence aggregate demand.

(2) Wealth effect notes that a decrease in rice level increases real value of wealth. The larger wealth increases the quantity of goods and services demanded.

(3) MPC = Increase in consumption / Increase in income = $800/$1000 = 0.8

Multiplier = 1 / (1 - MPC) = 1 / (1 - 0.8) = 1 / 0.2 = 5

An increase in government spending equal to $10 would cause output to increase by $50 (= $10 x 5) because the multiplier is 5.

(4) Permanent tax changes have a lower effect on aggregate demand.

(5) Federal Reserve will increase money supply when aggregate demand falls.

(6) To offset increased pessimism, government may increase government spending and/or decrease taxes.