exam review 3

The Fed has decreased the money supply through open market operations. Which of the following has occurred?

• a. Open market sales and bank reserves increase.

• b. Open market purchases and bank reserves decrease.

• c. Open market sales and bank reserves decrease.

• d. Open market purchases and bank reserves increase.

Answer explanation

Correct. In order to decrease the money supply, the Fed will have to conduct open market sales of government bonds. When individuals purchase bonds from the Fed, they will use currency, most often withdrawn from their bank accounts. Since this money ends up in the hands of the Fed, the money is no longer circulating in the general public. This means the money supply has decreased, and since some of that money came from bank accounts, reserves and lending will decrease as well.

A bank's reserve ratio is 20 percent and the bank has $1,000 in deposits. Its reserves amount to _______.

• a. $20

• b. $50

• c. $200

• d. $2,000

Answer explanation

Correct. The reserve ratio of a bank is the fraction of deposits that banks hold as reserves. This means that if bank has $1,000 in deposits, and a 20 percent reserve ratio, its reserves must be $1,000 X 20 percent = $200.

The sticky-wage theory of the short-run aggregate-supply curve says that when the price level is higher than expected, _______.

• a. relative to prices wages are lower and employment rises

• b. relative to prices wages are higher and employment rises

• c. relative to prices wages are lower and employment falls

• d. relative to prices wages are higher and employment falls

Answer explanation

Correct. If the price level is higher than expected, wages are lower relative to prices. In response, firms hire more workers.

Which of the following describes the relationship between the value of money and the price level?

• a. As the price level falls, the value of money falls.

• b. As the price level rises, the value of money rises.

• c. As the price level falls, the value of money does not change.

• d. As the price level falls, the value of money rises.

Answer explanation

Correct. As the price level falls, the value of money rises because less money is needed to buy a representative basket of goods.

Which of the following, other things the same, would make the price level increase and real GDP decrease?

• a. Aggregate-demand curve shifts to the left

• b. Long-run aggregate-supply curve shifts to the left

• c. Aggregate-demand curve shifts to the right

• d. Long-run aggregate-supply curve shifts to the right

Answer explanation

Correct. If the long-run aggregate-supply curve shifts left while the aggregate-demand curve does not change, the new equilibrium will have an increased price level and a decreased real GDP.

The members of the Federal Reserve's Board of Governors _______.

• a. are required to have been economics professors at elite universities

• b. have 10 members in total

• c. serve 16-year terms to get insulated from political pressures

• d. are appointed by the president of the U.S. and confirmed by the U.S. Senate

Answer explanation

Correct. The board of governors of the Fed is made up of the seven members that must be appointed by the president and confirmed by the U.S. Senate. The governors serve terms of 14-years in order to get insulated from the current political climate and to make more objective decisions.

The Federal Funds Rate is the interest rate the Fed charges depository institutions for short-term loans.

• True

• False

Answer explanation

False. The Federal Funds rate is the interest rate banks charge each other for short-term loans. The discount rate is the interest rate on the loans that the Fed makes to banks.

If the money multiplier is 5 and the Fed wants to increase the money supply by $100,000, it could _______.

• a. buy $20,000 worth of bonds

• b. sell $100,000 worth of bonds

• c. sell $20,000 worth of bonds

• d. buy $100,000 worth of bonds

Answer explanation

Correct. When the Fed purchases government bonds, the money supply increases. To determine how much the money supply increases, you must use the money multiplier. If the Fed buys $20,000 worth of government bonds, eventually the money supply will increase by $20,000 X 5 =$100,000 because of the fractional reserve banking system in the U.S. Therefore, if the Fed wishes to increase the money supply by $100,000 and the money multiplier is 5, the Fed should purchase $20,000 worth of bonds.

Refer to the figures. Unemployment is represented by _______.

• a. line A only

• b. line X only

• c. neither line A nor line X

• d. both line A and line X

Answer explanation

Correct. Since 1965, unemployment has fluctuated, moving upward in recessions and downward in expansions

If the stock market booms, then _______.

• a. aggregate demand increases, which the Fed could offset by selling government bonds

• b. aggregate supply decreases, which the Fed could offset by buying government bonds

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

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

Answer explanation

Correct. If the stock market booms, then aggregate demand increases. If the Fed wants to offset this, it needs to conduct open-market operations that decrease aggregate demand. This can be achieved through selling government bonds which decreases the money supply, raises the interest rate, and lowers aggregate demand.