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SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
1. According to the theory of liquidity preference, the interest rate adjusts to
balance the supply and demand for money. Therefore, a decrease in the money
2. If the government reduces spending on highway construction by $10 billion, the
3. If people become pessimistic about the future, they will spend less, causing the
aggregate-demand curve to shift to the left. If the Fed wants to stabilize aggregate
Chapter Quick Quiz
1. b
Questions for Review
1. The theory of liquidity preference is Keynes's theory of how the interest rate is
determined. According to the theory, the aggregate-demand curve slopes
2. A decrease in the money supply shifts the money-supply curve to the left. The
3. If the government spends $3 billion to buy police cars, aggregate demand might
569
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 34/The In)uence of Monetary and Fiscal Policy on Aggregate Demand ❖ 570
4. If pessimism sweeps the country, households reduce consumption spending and
rms reduce investment, so aggregate demand falls. If the Fed wants to stabilize
5. Government policies that act as automatic stabilizers include the tax system and
government spending through the unemployment-benet system. The tax system
Problems and Applications
1. a. When the Fed’s bond traders buy bonds in open-market operations, the
money-supply curve shifts to the right from MS 1 to MS 2, as shown in Figure 1.
The result is a decline in the interest rate.
Figure 1 Figure 2
b. When an increase in credit card availability reduces the cash people hold, the
c. When the Federal Reserve reduces reserve requirements, the money supply
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 34/The In)uence of Monetary and Fiscal Policy on Aggregate Demand ❖ 571
d. When households decide to hold more money to use for holiday shopping, the
Figure 3
e. When a wave of optimism boosts business investment and expands aggregate
Figure 4
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 34/The In)uence of Monetary and Fiscal Policy on Aggregate Demand ❖ 572
2. a. The increase in the money supply will cause the equilibrium interest rate to
5.
Figure 5
b. As shown in Figure 5, the increase in aggregate demand will cause an increase
c. When the economy makes the transition from its short-run equilibrium to its
d. The increase in the price level will cause an increase in the demand for
e. Yes. While output initially rises because of the increase in aggregate demand,
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 34/The In)uence of Monetary and Fiscal Policy on Aggregate Demand ❖ 573
Figure 6
3. a. When fewer ATMs are available, money demand is increased and the
b. If the Fed wants to stabilize aggregate demand, it should increase the money
c. To increase the money supply using open market operations, the Fed should
buy government bonds.
4. A tax cut that is permanent will have a bigger e$ect on consumer spending and
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 34/The In)uence of Monetary and Fiscal Policy on Aggregate Demand ❖ 574
5. a. The current situation is shown in Figure 7.
Figure 7
b. The Fed will want to stimulate aggregate demand. Thus, it will need to lower
Figure 8
c. As shown in Figure 8, the Fed's purchase of government bonds shifts the
d. The Fed's purchase of government bonds will increase aggregate demand as
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 34/The In)uence of Monetary and Fiscal Policy on Aggregate Demand ❖ 575
Figure 9
6. a. Legislation allowing banks to pay interest on checking deposits increases the
b. If the money supply remained constant (at MS1), the increase in the demand
c. To maintain a constant market interest rate, the Fed would need to increase
Figure 10
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 34/The In)uence of Monetary and Fiscal Policy on Aggregate Demand ❖ 576
7. a. If there is no crowding out, then the multiplier equals 1/(1 – MPC ). Because
b. If there is crowding out, then the MPC would be larger than 2/3. An MPC that is
8. If the marginal propensity to consume is 4/5, the spending multiplier will be 1/(1 –
9. If government spending increases, aggregate demand rises, so money demand
10. a. Expansionary scal policy is more likely to lead to a short-run increase in
investment if the investment accelerator is large. A large investment
b. Expansionary scal policy is more likely to lead to a short-run increase in
11. a. Y=C+I+G is the equilibrium condition for GDP in a closed economy (output
b. The marginal propensity to consume is 0.75.
c. When the interest rate, r, is 4 percent,
d. Assuming no change in monetary policy, an increase in government purchases
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
Chapter 34/The In)uence of Monetary and Fiscal Policy on Aggregate Demand ❖ 577
e. Assuming no change in scal policy, a decrease of 1 percent (from 4 percent
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website,
in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise
on a password-protected website or school-approved learning management system for classroom use.
