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									                                      Macro Economics
                                   Answers to Practice Test # 4

The following answers are very helpful, but not enough to prepare you for the final. Study
everything thoroughly, and make sure you understand the why, how, when, what, and who?

1. Keynes advises that the government should incur a budget deficit during a recessionary gap

2. Student Pell Grants are an example of supply-side fiscal policy. False. If not, then give an
example: A change in business taxes, in business subsidies, or in a form of bill forgiveness
would qualify, not Pell Grants—geared toward the household sector, which means AD, not AS.

3. What do we call transfer payments and progressive taxes? Remember they are incorporated
into the system.
        Automatic stabilizers.

4. Who mints the coins?
      The Treasury does. And coins comprise 1% of the entire money supply.

5. What does an increase in the price level do to net-exports?
       Price level (inflation) and net-exports are inversely related; net-exports would decrease if
the general price level were to increase. Depreciation of the US dollar has the same impact.

6. When the taxes levied increase with income we call those progressive taxes.

7. Expansionary discretionary F. P. does this: (circle all that apply)
    a. Increase AD      b. Increase the RGDP c. Increase inflation       d. decrease inflation

8. How independent is the Federal Reserves really?

 9. Income inequality gets exacerbated rather than remedied when the federal debt increases,
since the more the government borrows, the more it transfers in interest paid to securities
holders, who are usually of the wealthier. True

10. During a recession taxes are usually reduced in order to increase disposable income,
aggregate demand (AD), aggregate supply (AS) and RGDP. True

11. Transfer payments are part of automatic fiscal policy because they adjust government
spending automatically whenever there is a change in the unemployment rate. True

12. An open market sale decreases the money supply.

13. The value of money is measured by how much it buys in goods and services. True

    14. How is the Federal Reserves different from the Treasury?
    The Treasury and the Fed work together, yet still maintain separate duties. In Managing
    Government Funds…
    The Department of the Treasury and Federal Reserve work together in an effort to maintain a
    stable economy. The Federal Reserve serves as the government's banker, processing transactions,
    such as accepting electronic payments for Social Security taxes, issuing payroll checks to
    government employees and clearing checks for tax payments and other government receivables.

    The Federal Reserve and the Department of the Treasury also work together to borrow money
    when the government needs to raise cash. The Federal Reserve issues U.S. Treasury securities
    and conducts Treasury securities auctions, selling these securities on behalf of the Department of
    the Treasury. Examples of Treasury securities include:
          Treasury bonds
          Treasury bills
          Treasury notes
          Treasury inflation-protected securities (TIPS)

    Additional differences include the following:
    The Department of the Treasury, established in 1789, is the older institution. While the
    Department of the Treasury is perhaps best known for its role in collecting taxes and managing
    government revenue, its official mission is to "serve the American people and strengthen national
    security by managing the U.S. government's finances effectively, promoting economic growth
    and stability and ensuring the safety, soundness and security of the U.S. and international
    financial systems."

    To accomplish its mission, the Department provides economic advice to the president and works
    with other federal institutions to "encourage global economic growth, raise standards of living
    and to the extent possible, predict and prevent economic crises."

    On the other hand…The Federal Reserve System was established in 1913. It serves as the
    central bank of the U.S., with a mandate to "keep our money valuable and our financial system
    healthy." Its primary method of accomplishing this task is through its influence on monetary

    This effort involves ensuring that lenders and borrowers have access to money and credit. It also
    involves balancing the access to money through adjustments to the discount rate and federal
    funds rate in order to keep inflation in check.

    15. How do we reduce the budget deficit?
           There are only 2 ways to do so. Either government spending has to drop, or taxes have to
    increase. Think of how President Clinton was able to diminish the federal deficit. Never consider

selling securities as an option here. That only adds to the debt.

16. What happens to disposable income and government spending when enacting contractionary
discretionary Fiscal Policy?
        Both disposable income and government spending decrease. Why? In order to reduce

17. Why does the government collect taxes?
      There are 3 purposes to collecting taxes:
              a. In order for the government to collect revenues. Governments need to manage
                  fiscal affairs, which requires money for all the 4 resources, especially labor
                  and capital.
              b. In order to minimize income equality. This is accomplished by increasing
                  income security and by increasing the incentive to work.
              c. The government reallocates resources between states, also between
                  industries. By using taxes to subsidize states and various industries, the
                  government is able to calibrate the economy to a certain extent.

18. Ability-to-pay principle is a tax that is only applicable to public goods, like tolls, public
meters, public ports (airports and seaports) taxes, and much more. Look up additional examples.

19. The real balance effect is about the changes that occur in the RDGP based on the inverse
relationship of the price level on real consumption. True.

20. Banks create money via checkable deposits. How? Be sure to review the notes carefully.
Money creation is done via checkable deposits. You need to explain in detail. For example.
       If required reserves are 20% and the government increases the money supply (MS) by
$100, then the MS will increase by another $400 to a total of $500. Each time a new checking
account is opened with the lent-out excess reserves increase the MS.
               1. First the Fed. deposits $100 in a regular checking account. Then the bank
                   withholds $20 in required reserves (20% of $100), but lends out $80 in excess
               2. The borrower of the $80 deposits it into his checking account. So $16 is
                   withheld, and $64 is lent out.
               3. The borrowing continues with the $64. Now $12.8 is withheld, and $51.2 is
                   lent out
               4. 10.24…, and 40.96
               5. 8.192…, and 32.768
               6. etc… until required reserves equal zero, by the time banks have exhausted all
                   excess reserves they would have added $400 to the original $100 added by the
                   Fed, bringing the total increase in the MS to $500.

21. Credit cards are money. False


22. What is stagflation?
        When rapid inflation is accompanied by high unemployment. Know the percentages, and
the history.

23. The treasury is responsible for the government’s accounting, while the Fed’s sole purpose is
to ensure proper rates of exchange and enough quantity of money in circulation. True
Use the links I have for on my Web site to understand more.

24. If required reserves were 5% and we needed to shrink the money supply by $50 billion
(50,000,000,000) then the Fed. would have to remove this much from circulation: What is 5% of
$50 billion? $ 2.5 billion.

25. Benefits-received principle is a tax that is only applicable to private goods, like property tax,
gasoline taxes, luxury taxes.

26. The public choice theory claims that the government is less efficient than the private sector
       There are 5 reasons. They are all in your notes.

27. What are the 4 ways that the Fed. increases M3? (The opposite is true when reducing it.)
       The Federal Reserves increase the MS by using expansionary monetary policy. Check the
4 ways listed in your booklet.

28. Make sure that you know all the functions of the Fred. There are 8. Know at least 5.

29. What other forms of currencies have there been throughout history?
      Salt…Roman soldiers…
      Dead rats on Easter Island
      Opium in Indo-China
      Frankincense and myrrh in the Middle East
      The quetzal bird feathers in Peru


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