Multiple-Choice Answers and Explanations
- E.The circular flow model illustrates firms as the suppliers in a product market. In a product market, the
physical flow of goods and services goes from firms to households and, in return, households send a monetary
flow for the goods and services. This is called a product market. - D. According to classicalists, the market is self-correcting when it enters disequilibrium. Classicalists believe
that if abnormal circumstances (such as war, domestic crisis, and supply shocks) take place, the economy will be
able to automatically adjust and return to full-employment output. - B.An increase in corporate taxes will affect aggregate supply because firms will be forced to cut back on
production. Higher taxes cause production costs to rise for firms. As production costs rise, firms decrease
production, thereby decreasing aggregate supply. - C.Remember that GDP does not include stock market transactions, such as the purchasing of stock, so that rules
out A. GDP does not include nonmarket transactions, such as the selling of water skis to a family member. GDP
is affected when the government spends money on goods and services because the government is acting as a
consumer. The money being spent goes directly to firms for goods and services and may be used in the current
year’s calculation. - B.If the economy is experiencing excessive demand, then interest rates increase because of the demand for
money. As people demand more money, interest rates rise for two reasons: First, an inverse relationship exists
between interest rates and the demand for money, and second, the economy might be approaching dangerous
inflation and so higher interest rates will help curb demand. - D. An increase in personal income taxes takes away purchasing power from the consumer. Since inflation is
caused by excessive demand, an increase in purchasing power curbs the excessive demand and either slows down
the rate of inflation or halts it. - A.Keynesians believe that lower interest rates promote more investing. As interest rates fall, investment rises.
Remember that investment is not the buying of stock; rather, it is the purchase of capital. When interest rates
decline, more firms increase their purchases of capital. - E.When the Fed wants to increase the money supply, it has a variety of tools it can use. The most common tool
the Fed uses is the buying and selling of open-market securities. When the Fed wants to increase the money
supply, it buys government bonds. Conversely, when the Fed wants to decrease the money supply, it sells
securities. - A.If there is an initial deposit of $400 and the bank’s excess reserves expand by $350, then the reserve
requirement is 13 percent. The difference between $400 and $350 is $50. You can divide the $50 by the $400 to
get 13 percent. The bank, in this example, must keep 13 percent of the deposit in its reserves while 87 percent of
the deposit can go to its excess reserve (where that money can be lent out). - A.When there is an increase in income, there is an increase in spending by consumers. The propensity to
consume is always higher than the propensity to save. Whenever there is an increase in income, savings rise but
not at the rate of the increase in income because most of the increase in income is going to consumption. - D. Individuals choose to hold money instead of investing in bonds because they are anticipating a rise in interest
rates. If interest rates are low, there is no incentive for individuals to hold money in a bank. Therefore, individuals
keep money on hand to deposit into interest-bearing accounts when interest rates rise. They are anticipating the
rise of interest rates. - D. If the federal government is experiencing a budget deficit, the deficit will soon turn into debt because the
government will need to spend money. When the government realizes a deficit, it covers that deficit by borrowing
money. When it borrows money, the government creates debt. - C.When foreign countries demand increases for U.S. goods, the value of the dollar increases because of that
demand. Italy will cause the demand for the dollar and U.S. goods to rise, thereby strengthening the dollar. An
eventual impact of this scenario might be that the U.S dollar gains too much strength, thus causing exports to
decrease.
Part IV: AP Macroeconomics & Microeconomics Tests