Subjective Short Answer
1. The Federal Reserve sets _____ policy, while the president and Congress set _____ policy. These two policies
influence aggregate _____.
2. Policymakers use _____ policy and _____ policy to stabilize _____ and _____ in the short run.
3. Changes in aggregate demand can cause fluctuations in _____ and _____ in the short run, and only ____ in the long
run.
4. 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.
5. The _____ effect states that a lower price level reduces the amount of money people wish to hold. When they lend out
their excess savings, the _____ falls causing investment spending to rise and increases the quantity of goods and services
demanded.
6. A decrease in the domestic _____ causes domestic goods to become less expensive relative to foreign goods and
increases net exports. The increase in net exports causes a(n) _____ in the quantity of domestic aggregate goods and
services demanded and is known as the _____ effect.
7. An increase in households’ desired money holding causes a(n) _____ in interest rates. This causes a(n) _____ in
investment spending and aggregate demand.
8. According to the Theory of Liquidity Preference, a fall in the _____ reduces the amount of money that people wish to
hold. As a result, falling interest rates stimulates investment spending and aggregate _____.
9. The theory of _____ states that the _____ adjusts to bring money supply and money demand into balance.
10. When there is an excess demand for money, households will _____ interest-bearing bonds, causing interest rates to
_____.
Figure 34–14
11. Refer to Figure 34-14. Initial equilibrium exists at point A. A decline in prices will cause households to _____ their
desired money holdings, moving the interest rate to _____.
12. Refer to Figure 34-14. Households’ desired money holdings are given by MD1. If the current rate of interest is r3,
then there is excess _____. Households will _____ interest-earning assets, which causes the interest rate to _____.
13. The ease with which an asset can be converted into the medium of exchange is known as _____.
14. When the money supply increases, there is an excess _____ of money. As a result, interest rates _____ and aggregate
demand _____.
15. An open-market purchase by the Federal Reserve creates an excess _____ of money. This causes interest rates to
_____ and investment to _____. The change in investment causes aggregate demand to shift to the _____.
16. Open-market purchases cause a(n) _____ in interest rates and a(n) _____ in real GDP in the short run.
decrease, increase
17. Suppose the Federal Reserve lowers the target on the interest rate in the Federal Funds market. The Federal Reserve
will _____ the money supply and aggregate demand will _____.
18. When the interest rate is above equilibrium, there is excess _____ of money. Households will _____ interest-earning
assets, which _____ the interest rate.
supply, purchase, decreases
19. When the Federal Funds rate is above the Federal Reserve’s target, it will ____ bonds to _____ the money supply.
20. If the Federal Reserve’s goal is to stabilize aggregate demand, then it will _____ the money supply in response to a
stock market boom. This causes interest rates to _____.
21. When the Federal Reserve conducts an open-market purchase, the money supply _____ and aggregate demand _____.
22. If the Federal Reserve’s goal is to stabilize aggregate demand, then in response to an increase in money demand, the
Federal Reserve will _____ the money supply.
23. To stabilize output, the Federal Reserve will _____ the money supply when aggregate demand falls.
24. The government’s choices regarding the overall level of government purchases and taxes is known as _____.
25. To reduce aggregate demand, the government may reduce _____ or increase _____.
26. The additional shifts in aggregate demand that result when there is an increase in government spending is known as
the _____.
27. What is the value of the multiplier if the marginal propensity to consume is 0.5?
28. A European recession that reduces U.S. net exports by $50 billion may ultimately lead to a $_____ billion reduction in
aggregate demand if the MPC is 0.75.
29. 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 ______.
Figure 34–10
30. Refer to Figure 34-10. Suppose the multiplier is 4 and the economy is currently at point A. An increase in
government purchases of $10 will increase aggregate demand to $_____ if there is no crowding-out. If crowding-out
exists, then aggregate demand will likely to increase to $_____.
31. Refer to Figure 34-10. Suppose the multiplier is 2 and there is no crowding-out, but there is an accelerator effect. If
the economy is currently at point A, then an increase in government purchases of $10 will likely increase aggregate
demand to point _____ where output is $_____.
32. The potential positive feedback that government spending may have on investment is known as the _____. The
potential negative effect that government spending may have on investment is known as the _____ effect.
33. An increase in taxes shifts the aggregate _____ curve to the _____.
34. The crowding-out effect occurs because an increase in government spending _____ interest rates, causing _____ to
fall.
35. A decrease in taxes ____ aggregate demand through larger _____ by households.
36. A decrease in taxes will shift aggregate demand to the _____, cause consumption to _____, and cause output to _____.
Due to the crowding-out effect, investment will _____.
37. Permanent tax changes have a _____ effect on aggregate demand compared to temporary tax changes.
38. The idea that aggregate demand fluctuates due to irrational waves of pessimism by households and firms is known as
_____.
39. To offset increased pessimism by households, the government may _____ government spending and/or _____ taxes.
40. The goal of stabilization policy is to stabilize aggregate _____. As a result, stabilization policy will also stabilize
_____ and _____.
41. To increase output, policymakers can _____ the money supply, _____ taxes, and/or _____ government purchases.
42. Suppose households attempt to increase money holdings. To stabilize output and employment, the Federal Reserve
will _____.
43. Suppose a wave of optimism causes firms to increase investment. To stabilize output and employment, the Federal
Reserve will _____.
Figure 34–11
44. Refer to Figure 34-11. The economy is currently at point A. To stabilize output, the president and Congress can
reduce _____ and/or increase _____.
Figure 34–12
45. Refer to Figure 34-12. Suppose the multiplier is 5 and the economy is currently at point A. To stabilize output at
$1000, the government should _____ purchases by $_____.
Figure 34–13
46. Refer to Figure 34-13. The economy is currently at point A. Given the current situation, the Federal Reserve will
_____ bonds, which causes interest rates to _____.
47. Critics of stabilization policy argue that monetary and fiscal policies affect the economy with _____.
48. _____ are changes in fiscal policy that stimulate aggregate demand when the economy goes into recession without
policymakers having to take any deliberate action.
49. The _____ is the most important automatic stabilizer.
50. Unemployment insurance benefits are an example of _____.
51. What is the difference between monetary policy and fiscal policy?
52. There are three factors that help explain the slope of the aggregate demand curve. Which two are less important? Why
are they less important?
53. Explain why the interest rate is the opportunity cost of holding currency. What is the benefit of holding currency?
54. Describe the process in the money market by which the interest rate reaches its equilibrium value if it starts above
equilibrium.
55. Use the money market to explain the interest-rate effect and its relation to the slope of the aggregate demand curve.
56. Explain the logic according to liquidity preference theory by which an increase in the money supply changes the
aggregate demand curve.
57. How does a reduction in the money supply by the Fed make owning stocks less attractive?
58. Suppose that the government spends more on a missile defense program. What does this do to aggregate demand?
How is your answer affected by the presence of the multiplier, crowding-out, taxes, and investment-accelerator effects?
59. Suppose that there are no crowding–out effects and the MPC is .9. By how much must the government increase
expenditures to shift the aggregate demand curve right by $10 billion?
60. Suppose that the government increases expenditures by $150 billion while increasing taxes by $150 billion. Suppose
that the MPC is .80 and that there are no crowding out or accelerator effects. What is the combined effects of these
changes? Why is the combined change not equal to zero?
61. Suppose that consumers become pessimistic about the future health of the economy. What will happen to aggregate
demand and to output? What might the president and Congress have to do to keep output stable?
62. Explain how unemployment insurance acts as an automatic stabilizer.