Mankew Review Book With Answers

Chapter 1—Ten Principles of Economics
MULTIPLE CHOICE
1. Choices must be made in the use of resources

a. because they are in finite supply.
b. because they are in finite demand.
c. only if the resources are nonrenewable.
d. because they are in infinite supply.
ANS: A
because they are in finite supply.
REF: SECTION: 1 OBJ: TYPE: 1
2. The cost to an airline of letting its employees fly at no charge

a. is zero.
b. will depend on the value employees place upon travel.
c. is greater during the Christmas holidays than at most other times.
d. depends on the alternatives open to the employees.
ANS: C
is greater during the Christmas holidays than at most other times.
3. Social security programs are aimed at making the distribution of resources in an economy more
a. efficient.
b. inefficient.
c. equitable.
d. inequitable.
ANS: C
equitable.
4. The opportunity cost of building an additional parking lot at your school is

a. the cost of concrete, labor, etc. used to build the lot.
b. the value of the property and resources used at their next-best alternative use.
c. the value of the property and resources used at all of their alternative uses.
d. infinite; we cannot estimate it.
ANS: B
the value of the property and resources used at their next-best alternative use.
5. Suppose you are considering going to the movies, and you place a $12 value on your anticipated
enjoyment of the movie. The ticket price is $6 and you would be giving up two hours of work, where
you earn $5 per hour. You would go to
a. work; the opportunity cost of the movies exceeds the expected benefit.
b. the movies; your incentive is the $6 excess expected benefit.
c. the movies; your enjoyment will exceed the lost wages by $2.
d. the movies; the benefit of $18 exceeds the lost wages.
ANS: A
work; the opportunity cost of the movies exceeds the expected benefit.
6. Metro North Railway is trying to decide whether or not to run an additional train into New York City
from New Haven, Connecticut at 8:15 a.m. The total cost of running trains between 8:00 a.m. and 9:00
a.m. is $45,000 and the expected revenues on any given day are $100,000 during this time period. The
cost of running the additional train is $4,000 and it is expected that revenues will rise to $103,500.
Metro North should
a. run the train because the total revenues are greater than the total costs.
b. run the train because the firm's revenues will rise.
c. not run the train because the total costs are already too high.
d. not run the train because the marginal cost of $4000 is greater than the marginal revenue
of $3,500.
ANS: D
not run the train because the marginal cost of $4000 is greater than the marginal revenue of $3,500.
7. A proposed regulation to require infants traveling in airplanes to sit in approved safety seats has never
been adopted. If we think about how people respond to incentives, the most likely reason is that
a. people would switch from flying to driving, so the death rate would rise.
b. the airline industry is a powerful lobby in Washington.
c. it would require every seat in airplanes to be made wider so the infant seats would fit.
d. the airlines threatened to bring a lawsuit against the government.
ANS: A
people would switch from flying to driving, so the death rate would rise.
8. A nation's standard of living can be increased by

a. improvements in technology and international trade.
b. improvements in technology but not international trade.
c. international trade but not improvements in technology.
d. neither international trade nor improvements in technology.
ANS: A
improvements in technology and international trade.
9. In a market economy, the economic well being of society is the responsibility of

a. central planners.
b. central bankers.
c. government policymakers.
d. no one; self-interested individuals bring about the well-being of society.
ANS: D
no one; self-interested individuals bring about the well-being of society.
10. An important element of the market process is that

a. although people trade voluntarily, one party "wins" and the other party "loses."
b. the government determines the extent of market activity in order for all parties to benefit.
c. people are better off if they are self-sufficient than if they trade with others in the market.
d. people trade voluntarily and all parties expect to benefit.
ANS: D
people trade voluntarily and all parties expect to benefit.
11. Adam Smith argues in the Wealth of Nations that an economy will produce more goods and services if
a. people act in the public interest than if they act selfishly.
b. people act selfishly, than if the government directs economic activity.
c. the government controls the use of the nation's scarce resources.
d. people ignore their own interests and contribute to national wealth as a whole.
ANS: B
people act selfishly, than if the government directs economic activity.
12. If there is a way to change a situation so that at least some people gain while no one in the economy
loses, the situation is
a. economically inefficient.
b. economically efficient.
c. providing an inequitable distribution of resources to the community.
d. neither equitable nor efficient.
ANS: A
is economically inefficient.
13. Assume that there are spillover benefits associated with keeping cars in good mechanical conditions.
Without government intervention (i.e., with a free market), we would expect people to
a. give their cars too much maintenance.
b. stop driving and start walking.
c. subsidize each other's car maintenance bills.
d. not maintain their cars as much as they should.
ANS: D
not maintain their cars as much as they should.
14. Suppose that Rebecca throws her soda bottle out the car window and it smashes on the road. Jim drives
over the broken glass and gets a flat tire. Rebecca's soda consumption has resulted in
a. the production of a public good.
b. an externality.
c. monopoly power for Rebecca.
d. greater efficiency in consumption.
ANS: B
an externality.
15. The market power that your school's bookstore has is now limited by
a. new federal antitrust laws.
b. public goods provided by the government.
c. university policies against monopoly power.
d. increased access to other booksellers provided by the internet.
ANS: D
increased access to other booksellers provided by the internet.
16. The Department of Justice recently brought a suit against Microsoft for
a. generating external costs.
b. generating external benefits.
c. creating excess market power for itself.
d. providing public goods to the marketplace.
ANS: C
creating excess market power for itself.
17. The poor in the United States are disproportionately people who
a. have less than a high school education.
b. have incomes that are essentially nonwage incomes.
c. have families with over five children.
d. live in cities.
ANS: A
have less than a high school education.
18. According to economists who emphasize the connection between productive contribution and
economic reward, a more equal income distribution
a. is fundamental to economic growth.
b. always helps the poor in the long run.
c. creates inefficiency.
d. generates greater productivity.
ANS: D
generates greater productivity.
19. Inflation reduces

a. the price level.
b. employment.
c. the money supply.
d. the purchasing power of money.
ANS: D
the purchasing power of money.
20. The inflation rate is the

a. price level.
b. average price of goods and services in an economy.
c. growth rate of the price level.
d. purchasing power of money.
ANS: C
growth rate of the price level.
21. What caused the collapse of the German economy after World War I?
a. hyperinflation due to large amounts of currency printed
b. too many returning soldiers taking jobs away from other people
c. low interest rates causing too much investment
d. high business profits and racketeering
ANS: A
Hyperinflation due to large amounts of currency printed
22. The long-run relationship between inflation and the growth rate of the money supply
a. is unique to the United States.
b. is a recent phenomenon.
c. is quite different for industrialized countries than for LDCs.
d. exists in a wide variety of countries throughout the world.
ANS: D
exists in a wide variety of countries throughout the world.
23. Which of the following diagrams represents a Phillips Curve:
A B C D
a. Graphic A
b. Graphic B
c. Graphic C
d. Graphic D
ANS: D REF: SECTION: 3 OBJ: TYPE: 8
24. When we say that prices are "sticky" in the short run, we mean that
a. prices will not change without government intervention.
b. prices change slowly in response to changes in the economy.
c. prices will never change unless resource costs fall.
d. labor unions will not make concessions in the short run.
ANS: B
prices change slowly in response to changes in the economy.
25. Policymakers can make effective short-term policy actions because

a. prices will immediately respond to changes in the macroeconomy.
b. central banks always accommodate changes in the economy by increasing or decreasing
the money supply.
c. prices are sticky so that changes in the economy occur relatively slowly.
d. the Phillips curve is downward sloping.
ANS: C
prices are sticky so that changes in the economy occur relatively slowly.

Chapter 2—Thinking Like an Economist
MULTIPLE CHOICE
1. A simplifying assumption
a. affects the important conclusions of an economic model.
b. increases the level of detail in an economic model.
c. limits the validity of an economic model's conclusion.
d. eliminates unnecessary details from an economic model.
ANS: D
eliminates unnecessary details from an economic model.
2. The ultimate purpose of an economic model is to

a. explain reality as completely as possible.
b. establish assumptions that closely resemble reality.
c. help us to understand economic behavior.
d. guide government policy decisions.
ANS: C
help us to understand economic behavior.
3. An economic model
a. uses equations to understand normative economic phenomena.
b. often omits crucial elements.
c. simplifies reality in order to focus on crucial elements.
d. cannot be proven wrong.
ANS: C
simplifies reality in order to focus on crucial elements.
4. Which of the following activities would occur in a market for goods and services?
a. Harry mows his grass.
b. General Motors hires additional workers to run a third shift at a factory.
c. Jane bakes pies for Thanksgiving dinner.
d. Dolly buys a ticket to a ball game.
ANS: D
Dolly buys a ticket to a ball game.
5. The three sources of income for the household are

a. taxes, subsidies from the government, and rent.
b. wages, rent, and profit.
c. wages, rent, and subsidies from the government.
d. wages, rebates, and rent.
ANS: B
wages, rent, and profit.
6. Households play what role(s) in the circular flow diagram?

a. purchasers of factors of production and sellers of services
b. purchasers of factors of production and sellers of goods
c. purchasers of goods and services only
d. purchasers of goods and services and sellers of factors of production
ANS: D
purchasers of goods and services and sellers of factors of production
7. Which of the following is not an assumption that underlies an economy's production possibilities
frontier?
a. fixed income
b. fixed resources
c. unchanged technology
d. fully employed resources
ANS: A
fixed income.

8. Which of the following would not result in an outward shift of a nation's production possibilities
frontier?
a. a reduction in the unemployment rate
b. a rise in labor productivity
c. advances in technology
d. an expanding resource base
ANS: A
a reduction in the unemployment rate
9. The production possibilities frontier demonstrates the basic economic principle that:
a. economies are always efficient.
b. assuming full employment, supply will always determine demand.
c. assuming full employment, an economy is efficient only when the production of capital
goods in a particular year is greater than the production of consumption goods in that year.
d. assuming full employment, to produce more of any one thing, the economy must produce
less of at least one other good.
ANS: D
assuming full employment, to produce more of any one thing, the economy must produce less of at
least one other good.
Figure 2-1
10. Refer to Figure 2-1. Suppose an economy has the production possibilities frontier shown in the
diagram and is operating at position A. Which of the statements below is false?
a. This economy could produce more of both capital and consumption goods.
b. This economy is experiencing full employment.
c. This economy could produce more capital goods without decreasing the quantity of
consumption goods produced.
d. This economy could produce more consumption goods without decreasing the quantity of
capital goods produced.
ANS: B
This economy is experiencing full employment.

11. Refer to Figure 2-1. If the economy shown in the diagram moves from position A to position B, we
would know that
a. the rate of unemployment increased.
b. consumption goods production increased, but capital goods production decreased.
c. its unemployment decreased, but at the expense of either capital or consumption good
production.
d. it has achieved full employment of its resources.
ANS: D
it has achieved full employment of its resources.
12. Opportunity costs most often increase as you move down a production possibilities frontier because
a. resources are not completely adaptable to alternative uses.
b. factors of production are limited and human wants are unlimited.
c. efficiencies are generated by large-scale production.
d. economic efficiency is only possible in the short run.
ANS: A
resources are not completely adaptable to alternative uses.
13. All points on a production possibilities frontier show the

a. maximum satisfaction that households receive from their purchases of goods.
b. minimum quantities of resources that must be used to produce a given quantity of output.
c. maximum output that society can produce with given resources and technology.
d. minimum output that society can produce with given resources and technology.
ANS: C
maximum output that society can produce with given resources and technology.
14. The branch of economics that is concerned with the overall performance of the economy is called
a. resource economics.
b. contemporary economics.
c. macroeconomics.
d. microeconomics.
ANS: C
macroeconomics.
15. Which of the following questions would not be of particular interest to a microeconomist?
a. Why do national economies grow?
b. What percentage of consumer income is spent on entertainment?
c. Why do workers prefer the 4-day workweek?
d. What happens to worker productivity when a business shifts to a 4-day workweek?
ANS: A
Why do national economies grow?
16. The television network newscaster reports that the national inflation rate in the past year equaled 4
percent. This report is most likely prepared from work done by a(n)
a. microeconomist.
b. normative economist.
c. macroeconomist.
d. social scientist rather than an economist.
ANS: C
macroeconomist
17. The Secretary of Labor states that wage rates in the country have risen by 2 percent this past year. The
head of a local labor union states that wage gains should have been higher. The Secretary's statement is
a __________ economic statement, and the labor head's statement is a __________economic
statement.
a. normative; normative
b. normative; positive
c. positive; normative
d. positive; positive
ANS: C
positive; normative
18. "An increase in interest rates will lower economic growth." This statement is
a. a positive economic statement.
b. a normative economic statement.
c. untrue in every case.
d. controversial, and so not a valid economic issue.
ANS: A
a positive economic statement.
19. The distinction between positive and normative economics

a. is that positive economics applies only to microeconomic problems.
b. is that normative economics applies only to microeconomic problems.
c. explains why economics is not a social science but a natural science.
d. helps us to understand why economists sometimes disagree with one another.
ANS: D
helps us to understand why economists sometimes disagree with one another.
20. Which of the following is most closely associated with positive economics?
a. Determining the impact of government spending on the actual level of total employment.
b. Determining the best level of immigration into a country.
c. Determining whether too many luxury goods are being produced.
d. Determining whether or not the government should reduce poverty.
ANS: A
Determining the impact of government spending on the actual level of total employment.
Figure 2-2
21. Refer to Figure 2-2. In the diagram, the slope of the curve is
a. increasing at a constant rate.
b. increasing at a decreasing rate.
c. decreasing at a constant rate.
d. decreasing at an increasing rate.
ANS: D
decreasing at an increasing rate.
REF: SECTION: APP
22. Refer to Figure 2-2. In the diagram, the slope of the curve between points A and B is
a. -5.
b. -1.
c. -1/5.
d. None of the above are correct.
ANS: A
-5.
REF: SECTION: APP
23. Refer to Figure 2-2. In the diagram, the slope of the curve is
a. constant.
b. increasing.
c. decreasing.
d. increasing at some points and decreasing at others.
ANS: A
constant.
REF: SECTION: APP

24. In the diagram, the slope of the curve between points C and D is
a. 5
b. 10
c. -10
d. 50
ANS: D
50
REF: SECTION: APP
25. If two variables tend to increase and decrease together, they are
a. positively correlated.
b. negatively correlated.
c. uncorrelated.
d. quasi-correlated
ANS: A
positively correlated.
REF: SECTION: APP
26. The number of rainy days in the year and annual sales of suntan lotion are probably
c. uncorrelated.
d. quasi-correlated.
ANS: B
negatively correlated.
REF: SECTION: APP
27. A student's course grade and amount of time spent studying for the course are generally
c. uncorrelated.
d. quasi-correlated.
ANS: A
positively correlated.
REF: SECTION: APP
28. Which of the following activities would occur in a market for factors of production?
a. Reesa buys a new computer to help balance her personal checkbook.
b. Randy pays a speeding ticket.
c. Ian mows his grass.
d. General Motors hires additional workers to run a third-shift at a factory.
ANS: D
General Motors hires additional workers to run a third shift at a factory.

Chapter 3—Interdependence and the Gains from Trade
MULTIPLE CHOICE
1. The slope of the production possibilities frontier is determined by

a. the opportunity cost of producing one more unit of the good on the horizontal axis.
b. the market prices of the goods that the economy can produce.
c. the distribution of incomes in the economy.
d. whether production is performed using efficient or inefficient methods.
ANS: A
the opportunity cost of producing one more unit of the good on the horizontal axis.
2. The production possibilities frontier is a downward-sloping straight line when the

a. opportunity cost of producing each good depends on the amount produced.
b. technology of production is constant.
c. opportunity cost of producing each good is independent of the amount of the good
produced.
d. economy is industrialized.
ANS: C
opportunity cost of producing each good is independent of the amount of the good produced.
3. In voluntary exchange between two countries, if one country gains then

a. the other must lose, unless the exchange generates external costs.
b. the other country must lose under any circumstances.
c. the other country must lose an equal amount.
d. there is no reason to expect that the other country must lose.
ANS: D
there is no reason to expect that the other country must lose.
4. International trade tends to occur whenever

a. labor is cheaper in one country than in another.
b. one of the trading nations is self sufficient and producing surplus goods.
c. one nation can profit from trade at the expense of the other.
d. both nations can benefit from trade.
ANS: D
both nations can benefit from trade.
5. If Japan can produce each unit of steel using fewer resources than Canada does,
a. Canada has an absolute advantage in steel production.
b. Japan has an absolute advantage in steel production.
c. Japan has a comparative advantage in steel production.
d. Canada has a comparative advantage in steel production.
ANS: B
Japan has an absolute advantage in steel production.
6. Which of the following statements is true?

a. Exports tend to decrease economic efficiency.
b. A nation should specialize in producing a good in which it has an absolute advantage.
c. A nation should specialize in producing a good only when it has both an absolute and a
comparative advantage.
d. A nation should specialize in producing a good in which it has a comparative advantage.
ANS: D
A nation should specialize in producing a good in which it has a comparative advantage.
7. Suppose Russia has an absolute advantage in the production of all goods. In this instance, Russia
a. will have no incentive to engage in international trade.
b. should specialize in producing the goods for which it has a lower opportunity cost than
other countries.
c. also has a comparative advantage in the production of those goods.
d. is producing at a point on its production possibilities frontier.
ANS: B
should specialize in producing the goods for which it has a lower opportunity cost than other countries.
8. What can be said regarding absolute advantage in production for the two countries shown in this
figure?
Number of workers needed to produce one unit of each of the following goods:
Korea Colombia
1 Radio 3 4
1 Calculator 6 2
a. Colombia has an absolute advantage in producing both calculators and radios.

b. Korea only has an absolute advantage in producing calculators.
c. Korea has an absolute advantage in producing both radios and calculators.
d. Colombia only has an absolute advantage in producing calculators.
ANS: D
Colombia only has an absolute advantage in producing calculators.
9. Which of the following will change a nation's comparative advantage?

a. a technological advance in producing manufactured goods
b. a doubling of all wages
c. quotas on imports
d. a change in consumers' preferences for imported goods
ANS: A
a technological advance in producing manufactured goods
10. If a nation does not have an absolute advantage in producing anything, it

a. has no comparative advantage either.
b. could have a comparative advantage in something.
c. will try to get along without trade.
d. will export raw materials and import finished products.
ANS: B
could have a comparative advantage in something.
11. In the marketplace, John voluntarily sells his last two loaves of bread to Mary for $2. We can infer that
this will benefit
a. both John and Mary.
b. Mary, but not John, since these are John's last two loaves of bread.
c. Mary, while imposing a cost on John equal to the benefit Mary receives.
d. neither John nor Mary.
ANS: A
both John and Mary.
12. Trade based on each country's comparative advantage is

a. economically efficient because both countries are better off than they were before they
traded.
b. economically inefficient because the country with the absolute advantage is made worse
off.
c. ineffective in improving efficiency, since one country's gain will be offset by the other
country's loss.
d. economically efficient only if each country also has the absolute advantage in producing
their good.
ANS: A
economically efficient because both countries are better off than they were before they traded.

13. If Armenia can produce two rugs or 100 spy novels in an hour, and Turkey can produce one rug or 50
spy novels in an hour
a. Turkey should produce both rugs and spy novels.
b. Turkey should produce only rugs.
c. Armenia should produce only rugs.
d. there are no gains from trade between these two countries with these two goods.
ANS: D
there are no gains from trade between these two countries with these two goods.
14. Suppose these diagrams depict the production possibilities frontiers of wheat and corn for two
countries, the United States and Canada. What is the most wheat the U.S. would be willing to trade for
one unit of Canada's corn?
a. 1/3
b. 1/4
c. 3
d. 4
ANS: D
4
15. Suppose these diagrams depict the production possibilities frontiers of wheat and corn for two
countries, the United States and Canada. What is the most corn the Canada would be willing to trade
for one unit of U.S. wheat?
a. 1/3
b. 1/4
c. 3
d. 4
ANS: D
4
16. A good produced in Japan and sold to Korea

a. is a Korean export and Japanese import.
b. is a Korean import and Japanese export.
c. implies that Japan has an absolute advantage in the production of the good.
d. implies that Korea has a comparative advantage in the production of the good.
ANS: B
is a Korean import and Japanese export.
17. A nation should only import those goods for which it has
a. lower opportunity costs than its trading partner.
b. higher opportunity costs than its trading partner.
c. zero transactions costs.
d. lower costs of production than its trading partner.
ANS: B
higher opportunity costs than its trading partner.
Scenario 3-1
Jill can sew a child's dress in 3 hours and can knit a baby's blanket in 2 hours. Sarah can sew a child's
dress in 6 hours and can knit a baby's blanket in 3 hours. Use this information to answer the following
questions.
18. Refer to Scenario 3-1. We can infer that Jill has the comparative advantage in
a. sewing.
b. knitting.
c. both activities.
d. neither activities.
ANS: A
sewing.
19. Refer to Scenario 3-1. We know that Sarah has the comparative advantage in
a. sewing.
b. knitting.
c. both activities.
ANS: B
knitting.
20. Refer to Scenario 3-1. Jill should specialize in

a. sewing.
b. knitting.
c. both activities.
ANS: A
sewing.
21. Refer to Scenario 3-1. Sarah should specialize in

a. sewing.
b. knitting.
c. both activities.
ANS: B
knitting.

22. Refer to Scenario 3-1. Which of the following describes the production possibilities frontier for Jill and
Sarah together if each works for 12 hours? The intercept on the dress axis is __________ units and the
intercept on the blanket axis is __________ units.
a. 10; 6
b. 9;5
c. 4;4
d. 6;10
ANS: D
6;10
23. Refer to Scenario 3-1. Given the above information, Jill would trade her dresses for Sarah's blankets if
the price of a dress in terms of blankets was
a. less than 2/3 blankets for 1 dress.
b. more than 2 blankets for 1 dress.
c. at least 3/2 blankets for 1 dress.
d. Jill would never trade with Sarah.
ANS: C
at least 3/2 blankets for 1 dress.
24. Refer to Scenario 3-1. Given the above information, Sarah would trade her blankets for Jill's dresses if
the price of a blanket in terms of dresses was
a. more than 1/2 dress for one blanket.
b. less than 1/2 dress for one blanket.
c. more than 2/3 dress for 1 blanket.
d. Sarah would never trade with Jill.
ANS: A
more than 1/2 dress for one blanket.
25. Refer to Scenario 3-1. Which of the following would be a mutually agreeable rate of exchange
between Jill and Sarah for dresses and blankets?
a. less than 1/2 dress for 1 blanket.
b. more than 2/3 dress for 1 blanket.
c. between 1/2 and 2/3 dress for 1 blanket.
d. between 2/3 and 2 dresses for 1 blanket.
ANS: C
between 1/2 and 2/3 dress for 1 blanket.

Chapter 4—The Market Forces of Supply and Demand
MULTIPLE CHOICE
1. The commercial jetliner industry, consisting of Boeing and Airbus, represents

a. perfect competition.
b. oligopoly.
c. monopoly.
ANS: B
oligopoly.
2. In a perfectly competitive market,

a. advertising is widely used to influence demand and price.
b. firms are price takers rather than price makers.
c. firms produce a small number of differentiated products.
d. a small number of firms produce an identical product.
ANS: B
firms are price takers rather than price makers.
3. Suppose that a large dairy farmer is able to raise the market price of milk by withholding milk supply
from the market. In this instance,
a. the milk market is perfectly competitive.
b. buyers will decrease their demand for milk.
c. buyers will increase their demand for milk.
d. the milk market is imperfectly competitive.
ANS: D
the milk market is imperfectly competitive.
4. A group of buyers and sellers with the potential to trade is known as a(n)
a. cartel.
b. market.
c. industry.
d. sector.
ANS: B
market
5. The amount of a good or service that buyers would be willing and able to purchase at a specific price
is known as
a. quantity demanded.
b. demand.
c. supply.
d. quantity supplied.
ANS: A
quantity demanded.

6. The demand curve for Beanie Baby dolls shows the quantity of dolls demanded
a. by suppliers of those dolls.
b. at the equilibrium price for Beanie Baby dolls.
c. at each level of income.
d. at each possible price of Beanie Baby dolls.
ANS: D
at each possible price of Beanie Baby dolls.
Figure 4-1
7. Refer to Figure 4-1. This diagram shows the market for in-line roller skates. Which of the following
would cause a move from point A to point B?
a. an increase in the price of bicycles
b. a decrease in the price of bicycles
c. a decrease in consumer incomes
d. a popular new movie that convinces teens that skateboards are really cool
ANS: A
an increase in the price of bicycles
8. Refer to Figure 4-1. This diagram shows the market for in-line roller skates. Which of the following
would cause a move from point A to point C?
a. an increase in the price of bicycles
b. a decrease in the price of bicycles
c. a decrease in the price of in-line roller skates
d. a decrease in consumer incomes
ANS: C
a decrease in the price of in-line roller skates
9. Which of the following are the best examples of substitute goods?

a. personal computers and computer software programs
b. milk and cookies
c. IBM and Gateway personal computers
d. hot dogs and mustard
ANS: C
IBM and Gateway personal computers
10. Which of the following sets of goods are most likely to be complementary goods?
a. shoes and pizza
b. automobiles and computers
c. baseballs and baseball gloves
d. football tickets and baseball tickets
ANS: C
baseballs and baseball gloves
11. The diagram below shows the supply of oranges per week provided by Farmer Jones. When the price
increases from $1.00 per pound to $2.00 per pound, the quantity supplied increases to
a. 50.
b. 100.
c. 150.
d. 500.
ANS: B
100.
12. If the same dairy can produce either whole milk or skim milk, an increase in the profitability of whole
milk results in a(n)
a. decrease in the quantity supplied of whole milk.
b. increase in the supply of whole milk.
c. decrease in the supply of skim milk.
d. increase in the supply of skim milk.
ANS: C
decrease in the supply of skim milk.
13. An increase in the number of tomato producers will

a. increase market supply because the price of tomatoes will rise.
b. increase market supply because market demand will increase as more tomatoes are
produced.
c. increase market supply because market supply is the sum of all the individual tomato
producers' supply curves.
d. increase market demand but leave market supply unchanged.
ANS: C
increase market supply because market supply is the sum of all the individual tomato producers'
supply curves.
14. Consider a market in equilibrium. Firms who advertise in this market are attempting to shift the
a. supply curve to the right.
b. supply curve to the left.
c. demand curve to the left.
d. demand curve to the right.
ANS: D
demand curve to the right.
15. Suppose that the demand for apples increased more than the supply of apples increased. The net effect
of these two changes would be a(n)
a. increase in the equilibrium price and a decrease in the equilibrium quantity.
b. increase in the equilibrium price and an increase in the equilibrium quantity.
c. decrease in the equilibrium price and an increase in the equilibrium quantity.
d. decrease in the equilibrium price and a decrease in the equilibrium quantity.
ANS: B
increase in the equilibrium price and an increase in the equilibrium quantity.
Table 4-1
QUANTITY QUANTITY
DEMANDED SUPPLIED
PRICE (units per week) (units per week)
$100 1,000 100
$150 900 300
$200 800 500
$250 600 600
$300 300 650
16. Refer to Table 4-1. Given this data, the equilibrium price and quantity of CD players are
a. $150 and 300 players.
b. $200 and 800 players.
c. $250 and 600 players.
d. $300 and 650 players.
ANS: C
$250 and 600 players.
17. Refer to Table 4-1. Given this data, if the price of CD players is $200,
a. there will be a surplus.
b. there will be a shortage.
c. the market is in equilibrium.
d. the supply will increase.
ANS: B
there will be a shortage.
18. Temporary shortages in a market are eliminated by

a. decreases in the price, which cause quantity supplied to fall and quantity demanded to rise.
b. decreases in the price, which cause quantity supplied to rise and quantity demanded to fall.
c. increases in the price, which cause quantity supplied to fall and quantity demanded to rise.
d. increases in the price, which cause quantity supplied to rise and quantity demanded to fall.
ANS: D
increases in the price, which cause quantity supplied to rise and quantity demanded to fall.
19. When a market is in equilibrium,

a. quantity demanded will equal quantity supplied.
b. a shortage will be present.
c. a surplus will be present.
d. sellers will continue to expand production to increase revenues.
ANS: A
quantity demanded will equal quantity supplied.
20. If a drought destroyed half of the U.S. garlic crop at a time when the health benefits of garlic were
being well publicized, economists would expect that in the market for garlic
a. quantity exchanged would rise but the change in price is uncertain without further
information.
b. price would rise but the change in quantity exchanged is uncertain without further
information.
c. both price and quantity exchanged would rise.
d. price would rise and quantity exchanged would fall.
ANS: B
price would rise but the change in quantity exchanged is uncertain without further information.
21. The discovery of new gold in South America will __________ the price of gold and __________ the
quantity of gold traded.
a. raise; raise
b. lower; raise
c. raise; lower
d. lower; lower
ANS: B
lower; raise
22. Higher wages in the U.S. auto industry would __________ the prices of autos and __________ the
quantity exchanged.
a. lower; lower
b. lower; raise
c. raise; lower
d. raise; raise
ANS: C
raise; lower
Figure 4-2
23. Refer to Figure 4-2. In this diagram of the market for beachfront property in Connecticut, the
equilibrium price is
a. $100,000 per acre.
b. $200,000 per acre.
c. $300,000 per acre.
d. $400,000 per acre.
ANS: D
$400,000 per acre.
24. Refer to Figure 4-2. If the local government decides to establish a price of $200,000 per acre there will
be
a. a shortage of land.
b. a surplus of land.
c. an equilibrium quantity of land exchanged.
d. no land exchanged in the market.
ANS: A
a shortage of land.
25. Refer to Figure 4-2. Consider this diagram of the market for beachfront property in Connecticut. At a
price of zero,
a. 500 acres will be demanded.
b. 1000 acres will be demanded.
c. 10,000 acres will be demanded.
d. an infinite number of acres will be demanded.
ANS: C
10,000 acres will be demanded.

Chapter 6—Supply, Demand, and Government Policies
MULTIPLE CHOICE
1. When the government issues ration coupons, it is an indication that the government has prohibited the
use of which rationing mechanism?
a. merit
b. need
c. price
d. age
ANS: C
price
2. If the equilibrium price of bread is $2 and the government imposes a $1.50 price ceiling on the price of
bread,
a. more bread will be produced to meet the increased demand.
b. there will be a shortage of bread.
c. the demand for bread will decrease because suppliers will reduce their supply.
d. a surplus of bread will emerge.
ANS: B
there will be a shortage of bread.
3. Rent controls typically end up

a. increasing rents received by landlords.
b. raising property values.
c. encouraging landlords to overspend for maintenance.
d. discouraging new housing construction.
ANS: D
discouraging new housing construction.

4. A price ceiling might be an appropriate government response to a
a. period of falling farm prices due to unusually good harvests.
b. substantial increase in farm productivity due to applications of new technology in
agriculture.
c. national security crisis leading to major shortages of essential goods.
d. period of extraordinary large surpluses of farm goods.
ANS: C
national security crisis leading to major shortages of essential goods.
5. Suppose that the government places a price ceiling in the fish market, and that the ration coupons it
issues are bought and sold on a ration coupon market before they are used to purchase fish. The
a. excess supply of fish will be eliminated.
b. purpose of that price ceiling would be defeated.
c. price ceiling must have been too low.
d. price of fish set by the price ceiling would rise.
ANS: B
purpose of that price ceiling would be defeated.
6. Assume that the government sets a ceiling on the interest rate that banks charge on loans. If the ceiling
is set below the market equilibrium interest rate, the result will be
a. a surplus of credit.
b. a shortage of credit.
c. greater profits for banks issuing credit.
d. a perfectly inelastic supply of credit in the market place.
ANS: B
a shortage of credit.
7. In a market where the government imposes a price control, the excess demand or excess supply created
will be determined by the
a. imposed price and the slope of the demand curve.
b. imposed price and the slope of the supply curve.
c. difference between quantity demanded and quantity supplied at the imposed price.
d. difference between the imposed price and the equilibrium price.
ANS: C
difference between quantity demanded and quantity supplied at the imposed price.
REF: SECTION: 1 OBJ: TYPE: 1 & 2
8. Government-created price floors are typically imposed to

a. help consumers.
b. help producers.
c. raise tax revenue.
d. shift the supply curve to the right.
ANS: B
help producers.
9. Suppose the government imposed a minimum price in a market and a reporter for a local newspaper
wrote a story on it. The headline on the story would read:
a. "Government Action Calls for Ration Coupons"
b. "Rationing Price Replaces Market Price"
c. "Price Ceiling Replaces Equilibrium Price"
d. "Price Floor Protects Sellers from Low Incomes"
ANS: D
"Price Floor Protects Sellers from Low Incomes"
10. In the supply and demand schedules for socks shown here, if a price floor of $10 is imposed by the
government, the quantity of socks actually purchased will be
a. 6 units.
b. 10 units.
c. 2 units.
d. 8 units.
ANS: C
2 units.
11. In the supply and demand schedules for socks shown here, if a price floor of $10 is imposed by the
government, there will be a
Price Quantity Quantity

Per Pair Demanded Supplied
$ 2.00 18 3
$ 4.00 14 4
$ 6.00 10 5
$ 8.00 6 6
$10.00 2 8
a. surplus of socks equal to 8 pairs.

b. shortage of socks equal to 16 pairs.
c. surplus of socks equal to 6 pairs.
d. market clearing quantity of 6 pairs of socks exchanged.
ANS: C
surplus of socks equal to 6 pairs.
12. When the minimum wage is set above the equilibrium market wage,
a. there will be an excess demand for labor at the minimum wage.
b. it will have no effect on the quantity of labor employed.
c. the unemployment rate will rise.
d. the quality of the labor force will rise.
ANS: C
the unemployment rate will rise.
13. If the government imposes a binding price floor on sugar, it may also have to
a. establish programs to expand supply in the private sector.
b. establish programs to reduce demand in the private sector.
c. produce some sugar itself.
d. purchase the surplus sugar.
ANS: D
purchase the surplus sugar.
14. Consider this diagram, which shows the market for wheat. A price floor of $2.00 per bushel is
a. binding and will generate a surplus of 100 bushels.

b. not binding and will generate a shortage of 100 bushels.
c. binding and will generate an equilibrium in this market.
d. not binding.
ANS: D
not binding.
15. A tax on sales of a good, when compared to the market equilibrium without the tax, will result in a
__________ price paid by buyers and a __________ quantity traded.
a. higher; lower
b. lower; lower
c. higher; higher
d. lower; higher
ANS: A
higher; lower
16. Taxes levied directly on consumers

a. always hurt consumers rather than producers.
b. always hurt producers rather than consumers.
c. generate more revenue than taxes levied on producers.
d. have the same effect as taxes directly levied on producers.
ANS: D
have the same effect as taxes directly levied on producers.
17. The per-unit tax on a good is the

a. difference between the list price and the actual price paid by the buyer.
b. licensing fees and other business taxes paid by sellers, averaged over the total quantity of
goods sold.
c. difference between the total price paid by the buyer and the price received by the seller.
d. difference between wholesale and retail prices.
ANS: C
difference between the total price paid by the buyer and the price received by the seller.
18. Given the market described in this diagram, the burden of the tax will fall on
a. buyers and sellers equally.

b. only the buyers.
c. only the sellers.
d. both buyers and sellers, with sellers paying the larger share.
ANS: C
only the sellers.
19. A 5 percent tax is levied on products A and B, both of which have the same demand elasticity. Unit
sales of A are nearly the same after the tax, while unit sales of B fall dramatically. Which of the
following can we conclude?
a. Producers of A bear a greater share (relative to consumers) of their market's tax burden
than the producers of B.
b. Product B has a smaller elasticity of supply than product A.
c. Tax revenue is greater from product A.
d. Tax revenue is greater from product B.
ANS: A
Producers of A bear a greater share (relative to consumers) of their market's tax burden than the
producers of B.
Figure 6-3
20. Refer to Figure 6-3. Consider the impact of a tax on sellers, shown in this diagram of the market for
whiskey. In this case, the total tax revenue collected by the government is
a. $3.00.
b. $1500.00.
c. $13,500.00.
d. $40,500.00.
ANS: C
$13,500.00
21. Refer to Figure 6-3. Consider the impact of a tax on sellers, shown in this diagram of the market for
whiskey. In this case, the buyers' share is __________ and the sellers' share is __________.
a. $500; $500
b. $6750; $6750
c. $9000; $4500
ANS: C
$9000; $4500
22. Suppose the government wants to raise additional tax revenues with the least disruption to prevailing
demand patterns. For which product should an excise tax be levied?
a. Coca Cola
b. liquor
c. Cheerios
d. hot tubs
ANS: B
liquor
23. The government is thinking about increasing the gasoline tax to raise additional revenue rather than to
promote conservation. The tax will result in the greatest amount of tax revenue if the price elasticity of
demand for gasoline equals
a. 1.8.
b. 1.4.
c. 1.0.
d. .5.
ANS: D
.5.
24. The government is thinking about increasing the gasoline tax to promote conservation. The tax will
discourage the consumption of gasoline by the greatest extent when the price elasticity of demand
equals
a. 0.1.
b. 0.7.
c. 1.3.
d. 2.0.
ANS: D
2.0.
25. If a new excise tax is imposed on steak,

a. government's tax revenue will decrease.
b. government's tax revenue will increase.
c. amount of steak produced and sold will increase.
d. market price of steak will decrease.
ANS: B
government's tax revenue will increase.
26. A tax on fur coats will most likely

a. raise large amounts of tax revenue for the government.
b. cause a large decline in the sales of fur coats because demand is elastic.
c. be an effective way to tax the rich.
d. fall mostly on the fur coat buyers rather than the producers.
ANS: B
cause a large decline in the sales of fur coats because demand is elastic.

Chapter 9—Application: International Trade
MULTIPLE CHOICE
1. Nations would gain from trade if a(n) __________ exists.
a. absolute advantage
b. specialization
c. comparative advantage
d. infant industry
ANS: C
comparative advantage
2. If Canada has a comparative advantage over Denmark in the production of wood, this implies that
a. it requires fewer resources in Canada than in Denmark to produce wood.
b. the opportunity cost of producing wood in Canada is lower than in Denmark.
c. Denmark does not benefit by trading with Canada.
d. Canada should buy wood from Denmark.
ANS: B
the opportunity cost of producing wood in Canada is lower than in Denmark.
3. If two countries specialize

a. the other countries trading with them cannot specialize.
b. everyone in both countries benefits.
c. the total of goods produced increases.
d. all goods will be produced in both countries.
ANS: C
the total of goods produced increases.
4. As a result of free trade in a commodity, the

a. price of the commodity must be the same in all countries.
b. total quantity imported will exceed the total quantity exported.
c. price of the commodity will be higher in the producing country.
d. price of the commodity will be lower in the producing country.
ANS: A
price of the commodity must be the same in all countries.
5. If at the world equilibrium price the U.S. quantity demanded is greater than the U.S. quantity supplied,
then the
a. United States will import the good.
b. United States will export the good.
c. world price will fall.
d. world price will rise.
ANS: A
United States will import the good.

Figure 9-1
6. Refer to Figure 9-1. Consider this diagram of the market for pocket calculators in Venezuela. In the
absence of trade, the price and quantity of calculators sold are
a. $3.00 and 10 calculators.
b. $3.00 and 60 calculators.
c. $8.00 and 60 calculators.
d. $8.00 and 80 calculators.
ANS: C
$8.00 and 60 calculators.
7. Refer to Figure 9-1. Consider this diagram of the market for pocket calculators in Venezuela. With free
trade, Venezuela produces __________, consumes __________, and imports __________.
a. 10 calculators; 80 calculators; 70 calculators.
b. 10 calculators; 110 calculators; 100 calculators.
c. 40 calculators; 40 calculators; 20 calculators.
d. 80 calculators; 110 calculators; 30 calculators.
ANS: B
10 calculators; 110 calculators; 100 calculators.
8. Refer to Figure 9-1. Consider this diagram of the market for pocket calculators in Venezuela. With free
trade, consumer surplus
a. increases by 300.
b. increases by 425.
c. decreases by 125.
ANS: B
increases by 425.
9. Refer to Figure 9-1. Consider this diagram of the market for pocket calculators in Venezuela. A tariff
would completely eliminate imports of calculators if it equaled
a. $2.00.
b. $3.00.
c. $4.00.
d. $5.00.
ANS: D
$5.00
10. Refer to Figure 9-1. Consider this diagram of the market for pocket calculators in Venezuela. With a
per-unit tariff of $3.00, the Venezuelan government collects tariff revenues of
a. $80.00.
b. $100.00.
c. $120.00.
d. $140.00.
ANS: C
$120.00.
11. If the opportunity cost of a television set equals 20 cameras in China, but 10 cameras in Japan, then we
know
a. China has a comparative advantage in producing cameras.
b. Japan has a comparative advantage in producing TV sets.
c. market exchange of 1 TV set for 15 cameras would produce not only mutually beneficial
trade, but would also split the gains from trade equally between the two countries.
d. All of the above are correct.
ANS: D
All of the above are correct.
12. When customers are free to buy at the lowest prices, they will
a. purchase goods from the country that has a comparative advantage in producing it.
b. purchase only goods produced in their own country.
c. purchase only goods produced in their own local area.
d. prefer to purchase only well-made, foreign-produced goods.
ANS: A
purchase goods from the country that has a comparative advantage in producing it.
13. With international trade

a. producers and consumers in both countries must gain; otherwise, there would be no trade.
b. producers in both countries must gain.
c. consumers in both countries must gain.
d. consumer surplus in the country that imports the good rises.
ANS: D
consumer surplus in the country that imports the good rises.

14. The United States is the world's leading grain producing nation. Exporting U.S. grain causes the
a. domestic consumption of grain to rise because of the added foreign demand.
b. price of grain in the domestic market to fall because foreigners are now taking some of the
domestic demand.
c. price of grain to domestic consumers to rise because of the added foreign demand.
d. U.S. standard of living to improve but reduces the standard of living of foreigners.
ANS: C
price of grain to domestic consumers to rise because of the added foreign demand.
15. If the United States imports shoes in a free-trade situation, we can infer that
a. the domestic production of shoes in a no-trade situation is lower than if there is free trade.
b. domestic consumption of shoes is higher in a no-trade situation than if there is free trade.
c. the domestic price of shoes in a no-trade situation is higher than the free-trade world price.
d. the domestic price of shoes in a no-trade situation is lower than the free-trade world price.
ANS: C
the domestic price of shoes in a no-trade situation is higher than the free-trade world price.
16. Domestic producers gain from the opportunity to export goods to foreign countries because
a. the free-trade price of the good is higher than the domestic price in the absence of trade.
b. producers are able to reach a wider market.
c. although the free-trade price is lower than in the absence of trade, producers are able to
sell a greater quantity.
d. production rises, although there is no change in the price of the good compared to the no-
trade situation.
ANS: A
the free-trade price of the good is higher than the domestic price in the absence of trade.
Figure 9-2
17. Refer to Figure 9-2. Consider this diagram of the market for tea in China. If the world price is $20,
consumer surplus is
a. $60.
b. $600.
c. $900.
d. $1800.
ANS: C
$900.
18. Refer to Figure 9-2. Consider this diagram of the market for tea in China. If the government imposes a
quota of 10 units of tea per day, the consumer surplus will
a. $50.
b. $625.
c. $900.
d. $1250.
ANS: B
$625.
quota of 10 units of tea per day, the import license holders receive
a. $50.
b. $100.
c. $625.
d. $225.
ANS: B
$100.
quota of 10 units of tea per day, the deadweight loss will be
a. $50.
b. $100.
c. $225.
d. $275.
ANS: A
$50.
21. One big difference between tariffs and quotas is that tariffs
a. raise the price of a good while quotas lower it.
b. generate tax revenues while quotas do not.
c. stimulate international trade while quotas inhibit it.
d. hurt domestic producers while quotas help them.
ANS: B
generate tax revenues while quotas do not.
22. Suppose the United States decides to impose a $1,000 tax on every Japanese minivan sold in the
United States. This is an example of
a. a tariff.
b. a subsidy.
c. comparative disadvantage.
d. a quota.
ANS: A
a tariff.
23. The U.S. military aircraft industry sought protection from foreign competition by using the
__________ argument to persuade Congress to impose trade restrictions.
a. infant industries
b. national security
c. unfair competition
d. protection-as-bargaining-chip
ANS: B
national security
24. A less-developed country would probably use __________ to argue for trade restrictions.
a. national security
b. infant industry
c. increased efficiency
d. unfair competition
ANS: B
infant industry
25. Many U.S. producers complain about limited access to the Japanese market. They say that they cannot
export to Japan because Japanese import restrictions are so severe. Who gains? Who loses?
a. Everyone loses.
b. Japanese producers gain, U.S. producers and Japanese consumers lose.
c. Japanese producers and consumers gain, U.S. producers and consumers lose.
d. Japanese consumers and U.S. consumers gain, Japanese producers lose.
ANS: B
Japanese producers gain, U.S. producers and Japanese consumers lose.
26. Textile workers in the U.S. complain that they cannot compete with low-cost, foreign textile producers.
While some U.S. textile workers may lose their jobs, an advantage is
a. the United States gets cheaper textiles.
b. U.S. imports will become more expensive so U.S. domestic producers gain.
c. workers in other countries will buy more U.S. clothing.
d. the United States can retaliate with punishing trade policies.
ANS: A
the United States gets cheaper textiles.

Chapter 10—Externalities
MULTIPLE CHOICE
1. Market failure in the form of externalities arises when

a. production costs are included in the prices of goods.
b. not all costs and benefits are included in the prices of goods.
c. the benefits exceed the costs of consuming goods.
d. the market fails to achieve equilibrium.
ANS: B
not all costs and benefits are included in the prices of goods.
REF: SECTION: INTRO OBJ: TYPE: 1
2. Which of the following is an example of a positive externality?

a. air pollution
b. a person littering in a public park
c. a nice garden in front of your neighbor's house
d. the pollution of a stream
ANS: C
a nice garden in front of your neighbor's house
3. The social cost of a good is

a. its benefit to the people who buy and consume it.
b. its total benefit to everyone in society.
c. its cost to everyone in the society that occurs in addition to the private costs.
d. the cost paid by the firm that produces and sells it.
ANS: C
its cost to everyone in the society that occurs in addition to the private costs.
4. The private benefit of consuming a good is

a. its benefit to the people who buy and consume it.
b. its total benefit to everyone in the society.
c. its cost to everyone in the society.
d. the cost paid by the firm that produces and sells it.
ANS: A
its benefit to the people who buy and consume it.

5. When a person drives a car that pollutes the air the
a. private cost of consuming the car's services exceeds the social cost.
b. private benefit of consuming the car's services exceeds the social benefit.
c. social cost of consuming the car's services exceeds the private cost.
d. social benefit of consuming the car's services exceeds the private benefits.
ANS: C
social cost of consuming the car's services exceeds the private cost.
6. If a perfectly competitive industry is not forced to take account of a negative externality it creates, it
will produce where
a. the marginal cost of production equals the marginal private benefit.
b. the marginal cost of production equals the marginal social benefit.
c. the marginal social cost of production equals the marginal social benefit.
d. price equals marginal social benefit.
ANS: A
the marginal cost of production equals the marginal private benefit.
7. Flu shots are associated with a positive externality. (Those who come in contact with people who are
inoculated are helped as well.) Given perfect competition with no government intervention in the
vaccination market, which of the following holds?
a. At the current output level, the marginal social benefit exceeds the marginal private
benefit.
b. The current output level is inefficiently low.
c. A per-shot subsidy could turn an inefficient situation into an efficient one.
ANS: D
8. Because there are positive externalities from higher education,

a. private markets would provide too little of it.
b. private markets would provide too much of it.
c. the government should impose a tax on college students.
d. the government should impose a tax on students' families.
ANS: A
private markets would provide too little of it.
Figure 10-1
9. Refer to Figure 10-1. This diagram represents the tobacco industry. Which of the following would be
included in the supply (private cost) curve?
a. the cost of labor
b. the cost to the government of the hospital expenses of smokers with cancer
c. the increased risk of cancer to the nonsmoking passengers in the smoker's car pool
d. the price of a pack of cigarettes
ANS: A
the cost of labor
10. Refer to Figure 10-1. This diagram represents the tobacco industry. It is clear that the industry creates
a. positive externalities.
b. negative externalities.
c. no externalities.
d. no equilibrium in the market.
ANS: B
negative externalities.
11. Refer to Figure 10-1. This diagram represents the tobacco industry. The market creates an equilibrium
price and quantity exchanged of
a. $1.90 and 42 units.
b. $1.80 and 35 units.
c. $1.60 and 42 units.
d. $1.35 and 59 units.
ANS: C
$1.60 and 42 units.
12. Refer to Figure 10-1. This diagram represents the tobacco industry. The socially optimal price and
quantity exchanged are
a. $1.90 and 42 units.
b. $1.80 and 35 units.
c. $1.60 and 42 units.
d. $1.35 and 59 units.
ANS: B
$1.80 and 35 units.
13. Refer to Figure 10-1. This diagram represents the tobacco industry. If the government uses a pollution
tax, how much of a tax must be imposed on each unit of production?
a. $1.30
b. $0.50
c. $1.80
d. $0.30
ANS: D
$0.30
14. Refer to Figure 10-1. This diagram represents the tobacco industry. If the government uses a pollution
tax, how much tax revenue will the government receive?
a. $12.60
b. $10.50
c. $66.50
d. $63.00
ANS: B
$10.50.
15. Internalizing an externality means

a. the good becomes a public good.
b. government regulations or taxes are sufficient to eliminate the externality completely.
c. government imposes regulations that eliminate the externality completely.
d. incentives are altered so that people take account of the external effects of their actions.
ANS: D
incentives are altered so that people take account of the external effects of their actions.
16. A dentist shared an office building with a radio station. The electrical current from the dentist's drill
causes static in the radio broadcast, causing the radio station to lose $10,000 in discounted future
profits. The radio station could put up a shield at a cost of $30,000; the dentist could buy a new drill
that causes less interference for $6,000. Either would restore the radio station's lost profits. What is the
economically efficient outcome?
a. The radio station puts up a shield, which it pays for.
b. The radio station puts up a shield, which the dentist pays for.
c. The radio station does not put up a shield and the dentist does not buy a new drill.
d. The dentist gets a new drill and it does not matter who pays for it.
ANS: D
The dentist gets a new drill and it does not matter who pays for it.
17. Why can't private individuals always internalize an externality without the help of government?
a. Legal restrictions prevent side payments between individuals.
b. Transactions costs may be too high.
c. Side payments between individuals are inefficient.
d. Side payments between individuals violate equity standards.
ANS: B
Transactions costs may be too high.
18. What economic argument suggests that if transactions costs are sufficiently low, the equilibrium is
economically efficient regardless of how property rights are distributed?
a. The Coase Theorem
b. Say's Law
c. The Law of Comparative Advantage
d. The Law of Supply
ANS: A
The Coase Theorem
19. Assume the production of the product in the figure imposes a cost on society of $7.00 per unit. If the
free market equilibrium output is 50 units, the government should
a. impose a tax of $2.50 per unit.

b. reduce the output of the firm by approximately 39 units.
c. impose a lump-sum tax of $350 per period.
d. impose a tax of $7.00 per unit.
ANS: D
impose a tax of $7.00 per unit.
20. A benefit of taxes over regulation to internalize externalities is

a. it is easier to choose the optimal amount of taxes than the optimal amount of regulation.
b. regulations are more difficult to impose than taxes.
c. taxes equate the social costs with the social benefits.
d. taxes provide incentives to adopt new methods to reduce the externality.
ANS: D
taxes provide incentives to adopt new methods to reduce the externality.
21. If the government wants to tax a polluter, the economically efficient outcome occurs when the
a. marginal tax equals the marginal cost to other people from the pollution.
b. average tax equals the average cost to other people from the pollution.
c. total tax equals the total cost to other people from the pollution.
d. tax is high enough to stop pollution completely.
ANS: A
marginal tax equals the marginal cost to other people from the pollution.
22. Which of the following is NOT a method that could effectively deal with negative externalities?
a. relying on voluntary compliance
b. taxing the output of industries that pollute
c. creating legal environmental standards
d. increasing public spending on cleanup and reduction of pollution
ANS: A
relying on voluntary compliance.
23. A common complaint about environmental regulation and enforcement is that it

a. applies only to firms that produce goods, not services.
b. is politically motivated and so is always misdirected.
c. can be too burdensome to producers who can pay the fines more easily than they can
reduce pollution.
d. results in more pollution than without the regulations.
ANS: C
can be too burdensome to producers who can pay the fines more easily than they can reduce pollution.
24. The benefit to a pollution tax over other forms of internalizing a pollution externality is that it
a. eliminates pollution completely.
b. forces cleanup to occur.
c. is imposed only on the market with the externality.
d. creates positive externalities to compensate for negative externalities.
ANS: C
is imposed only on the market with the externality.
25. Pollution permits

a. impose regulations on firms that they must achieve.
b. set a quantity of pollution that will exist.
c. cannot be traded between firms in order to make sure that the worst offenders must clean
up their production processes.
d. are efficient because they eliminate all pollution.
ANS: B
set a quantity of pollution that will exist.
26. This diagram shows the market for pollution when permits are issued to firms and traded in the
marketplace. The equilibrium price of pollution here is
a. $500.
b. $1000.
c. $1500.
d. $2000.
ANS: B
$1000.

Chapter 11—Public Goods and Common Resources
MULTIPLE CHOICE
1. Which of the following is NOT a characteristic of a public good?

a. It requires resources to produce.
b. It is not diminished or depreciated as additional people consume the good.
c. Its benefits cannot be withheld from anyone.
d. It is a free good with zero opportunity cost.
ANS: D
It is a free good with zero opportunity cost.

2. Which of the following would be the best example of a public good?
a. a candy bar
b. a painting by Monet
c. a beautiful sunset
d. a crowded beach
ANS: C
a beautiful sunset
3. To achieve the optimal provision of public goods the

a. market should be allowed to find its equilibrium without government intervention.
b. government must limit the provision of the goods.
c. government must tax producers of these goods.
d. government must either provide the goods or subsidize their production.
ANS: D
government must either provide the goods or subsidize their production.
4. Imagine a 2,000-acre park with picnic benches, trees, and a pond. Suppose it is publicly owned, and
people are invited to enjoy its beauty. Of course, when the weather is nice it is difficult to find parking,
and the trash cans overflow with food wrappers on summer afternoons. Otherwise, it is a great place.
The park is a common good because
a. when trash cans overflow, a negative externality becomes a positive externality.
b. it is not fenced to control access.
c. if too many people use it, one person's use can prevent others from using it.
d. you have to drive to get there and the automobile is a private good.
ANS: C
if too many people us it, one person's use can prevent others from using it.
5. Public goods are

a. rival and excludable.
b. rival but excludable.
c. nonrival but excludable.
d. nonrival and nonexcludable.
ANS: D
nonrival and nonexcludable.
6. Private goods are

a. rival and excludable.
b. rival but excludable.
c. nonrival but excludable.
d. nonrival and nonexcludable.
ANS: A
rival and excludable.
7. Who among the following is a free rider?

a. Barry steals candy from the store where he works.
b. Betty regularly uses the local public library in the town in which she lives.
c. Joe drives 20,000 miles a year on public streets, but he pays no more in taxes than Sam,
who only drives 1,000 miles.
d. Fred watches many public television programs, but he has never sent in a contribution to
the station.
ANS: D
Fred watches many public television programs, but he has never sent in a contribution to the station.
8. People have little incentive to produce a public good because

a. the social benefit is less than the private benefit.
b. the social benefit is less than the social cost.
c. there is a free-rider problem.
d. there is a tragedy of the commons.
ANS: C
there is a free-rider problem.
9. The free-rider problem

a. forces supply of a public good to exceed demand.
b. allows more people to pay for the public good than if it were a private good.
c. encourages overuse of a good that is freely available.
d. holds the equilibrium quantity of a public good below the economically efficient level.
ANS: D
holds the equilibrium quantity of a public good below the economically efficient level.
Table 11-1
This table describes the defense demands for three groups of people in Happyville. Each curve shows
the maximum amount the group is willing to pay for a given quantity of Happyville defense.
Price Group #1 Group #2 Group #3

$14 0 0 0
$12 0 0 3
$10 0 3 6
$ 8 3 6 13
$ 6 6 13 22
$ 4 13 22 33
$ 2 22 33 44
$ 0 33 44 58
10. Refer to Table 11-1. What is the value of the 33rd unit of national defense in Happyville?
a. $0
b. $2
c. $4
d. $6
ANS: D
$6
11. Refer to Table 11-1. If the marginal cost of national defense is constant at $12 per unit, what is the
efficient level of national defense to provide?
a. 6 units
b. 13 units
c. 22 units
d. 33 units
ANS: C
22 units
12. A drawback of government provision of a public good is that

a. the government lacks information about what people are willing to pay for the good.
b. taxes have to be raised to pay for the good.
c. the government does not provide enough of any public good.
d. it would be cheaper for the private sector to provide the good.
ANS: A
the government lacks information about what people are willing to pay for the good.
13. A drawback of government provision of a public good is that

a. government programs may reflect political considerations rather than economic efficiency.
b. taxes have to be raised to pay for the good.
c. the government does not provide enough of any public good.
d. it would be cheaper for the private sector to provide the good.
ANS: A
government programs may reflect political considerations rather than economic efficiency.
14. The "open source" movement in the technology industry supports the idea that programming code
should be made freely available. This group believes that
a. there is a negative externality generated by technological advancement when private
property rights are enforced.
b. the costs of maintaining private property rights are greater than the benefit to society of
making advances freely available.
c. the costs of maintaining private property rights are less than the benefits to society of
making advances freely available.
d. the costs and benefits of making advances freely available exactly offset one another.
ANS: C
the costs of maintaining private property rights are less than the benefits to society of making advances
freely available.
15. If antipoverty and public assistance programs are public goods, then
a. the private benefits to society of providing such programs are undervalued.
b. the private marketplace can provide a socially optimal quantity of these programs with no
government interference.
c. the private benefits to society of providing such programs are overvalued.
d. Both a and b are correct.
ANS: A
the private benefits to society of providing such programs are undervalued.
16. The best way of determining the value of a human life is to

a. evaluate the value of their expected earnings in the labor market.
b. evaluate the risks people are willing to take and what they would have to be paid to take
them.
c. determine how much money a person had at the time of death.
d. do nothing; human life is priceless.
ANS: B
evaluate the risks people are willing to take and what they would have to be paid to take them.
17. A television signal is an example of

a. a private good.
b. a nonrival good.
c. a social good.
d. a normal good.
ANS: B
a nonrival good.
18. Music is an example of

a. a private good.
b. a social good.
c. a nonrival good.
d. a common good.
ANS: C
a nonrival good.
19. The commercial value of ivory is a threat to the elephant, but the commercial value of beef is a
guardian of the cow. This is because
a. the cow is raised in developed economies while the elephant lives primarily in less-
developed nations.
b. cows are private goods while elephants tend to roam without owners.
c. cows and elephants are public goods, but ivory is nonrival.
d. ivory is nonrival and nonexclusive but beef is rival and exclusive.
ANS: B
cows are private goods while elephants tend to roam without owners.
20. What causes the tragedy of the commons?

a. Social and private incentives differ.
b. Common goods are nonrival and nonexclusive.
c. Common goods are nonexclusive, but rival.
d. Both A and C are correct.
ANS: D
Both A and C are correct.
21. The overuse of a common resource relative to its economically efficient use is called
a. monopolistic competition.
b. tragedy of the commons.
c. common resource abuse.
d. communism.
ANS: B
tragedy of the commons.
22. The tragedy of the commons is the

a. fact that government regulation is required to combat externalities.
b. overuse of a common resource relative to its economically efficient use.
c. idea that monopoly elements in society lead to inefficient production.
d. false hope that government can solve our social problems.
ANS: B
overuse of a common resource relative to its economically efficient use.
23. When species of life are endangered because they are overhunted, the problem is said to be
a. economically unsound.
b. environmentally inefficient.
c. a positive externality.
d. a tragedy of the commons.
ANS: D
a tragedy of the commons.
24. An overcrowded beach is an example of

a. a positive externality.
b. a tragedy of the commons.
c. environmentally inefficient allocation.
d. economically unsound allocation.
ANS: B
a tragedy of the commons.
25. One economically efficient way to eliminate the tragedy of the commons is to
a. tax the owners of the resource.
b. prevent anyone from using the resource.
c. reduce the marginal social benefit of the resource.
d. establish private ownership of the resource.
ANS: D
establish private ownership of the resource.
REF: SECTION: 3 OBJ: TYPE:

Chapter 12—The Design of the Tax System
MULTIPLE CHOICE
1. During what war did government spending rise dramatically in the United States, and then never again
fall to its peacetime levels?
a. Civil War
b. World War I
c. World War II
d. Vietnam War
ANS: C
World War II
2. Which type of tax is used to finance the Social Security program in the United States?
a. consumption tax
b. income tax
c. payroll tax
d. property tax
ANS: C
payroll tax
3. All of the following are transfer payments except

a. Medicaid.
b. unemployment compensation.
c. personal income taxes.
d. food stamps.
ANS: C
personal income taxes.
4. If Nebraska imposed a tax on milk of 10 cents per gallon,

a. this is an excise tax.
b. this is an income tax.
c. tax revenue will fall.
d. the supply of milk will rise.
ANS: A
this is an excise tax.
5. If either supply or demand is perfectly inelastic, then the deadweight social loss from a tax is
a. infinite.
b. large.
c. small.
d. zero.
ANS: D
zero.
6. The deadweight loss from a tax increases as supply becomes more __________ or as demand becomes
more __________.
a. inelastic; inelastic
b. inelastic; elastic
c. elastic; elastic
d. elastic; inelastic
ANS: C
elastic; elastic
7. Minimizing the total deadweight loss from taxes that raise a certain amount of revenue for the
government is known as
a. an external benefit.
b. optimal taxation.
c. a lump-sum tax scheme.
d. horizontal equity.
ANS: B
optimal taxation
8. In the short run, the imposition of a payroll tax of $1 per labor hour will have which of the following
effects?
a. The quantity of labor exchanged will fall.
b. The after-tax wage received by workers will fall.
c. The quantity of labor traded will become inefficient.
ANS: D
All of the above correct.
9. A person's tax obligation divided by her income is called her

a. marginal social tax rate.
b. marginal private tax rate.
c. marginal tax rate.
d. average tax rate.
ANS: D
average tax rate.
10. A person's average tax rate equals her

a. tax obligation divided by her marginal tax rate.
b. increase in taxes if her income were to rise by $1.
c. tax obligation divided by her income.
d. increase in taxes if her marginal tax rate were to rise 1%.
ANS: C
tax obligation divided by her income.
11. A person's marginal tax rate equals

a. her tax obligation divided by her average tax rate.
b. the increase in taxes she would pay as a percentage of the rise in her income.
c. her tax obligation divided by her income.
d. the increase in taxes if her average tax rate were to rise 1%.
ANS: B
the increase in taxes she would pay as a percentage of the rise in her income.
12. Pat figures that for every extra dollar she earns, she owes the government 33 cents. Her total income
now is $35,000, on which she pays taxes of $7,000. Her average tax rate is __________ and her
marginal tax rate is __________.
a. 33%; 20%
b. 20%; 33%
c. 20%; 20%
d. 33%; 33%
ANS: B
20%; 33%
13. Horizontal equity in taxation refers to the idea that people

a. in unequal conditions should be treated differently.
b. in equal conditions should pay equal taxes.
c. should be taxed according to their ability to pay.
d. should receive government benefits according to how much they have been taxed.
ANS: B
in equal conditions should pay equal taxes.
14. The idea that people in equal conditions should pay equal taxes is referred to as
a. horizontal equity.
b. vertical equity.
c. diagonal equity.
d. linear equity.
ANS: A
horizontal equity
15. Vertical equity in taxation refers to the idea that people

a. in unequal conditions should be treated differently.
b. in equal conditions should pay equal taxes.
c. should be taxed according to their age and experience.
d. should receive government benefits according to how much they have been taxed.
ANS: A
in unequal conditions should be treated differently.
16. A tax that is higher for men than for women violates the criterion of
a. diagonal equity.
b. linear equity.
c. vertical equity.
d. horizontal equity.
ANS: D
horizontal equity.
17. The benefits principle of taxation is LEAST characteristic in

a. Social Security taxes.
b. gasoline taxes.
c. taxes on airline tickets.
d. tolls used to finance the construction of a bridge.
ANS: A
Social Security taxes.
18. A tax is __________ if it takes a constant fraction of income as income rises.

a. regressive
b. proportional
c. progressive
d. aggressive
ANS: B
proportional
19. A tax is __________ if it takes a smaller fraction of income as income rises.

a. regressive
b. proportional
c. progressive
d. aggressive
ANS: A
regressive
20. Most economists argue that when federal, state, and local taxes are combined, the overall effect is
a. proportional.
b. progressive.
c. regressive.
d. unfair.
ANS: A
proportional.
21. In its purest form, a __________ system would eliminate the existing array of different tax rates on
personal income and replace them with a single tax.
a. value-added tax
b. consumption tax
c. sales tax
d. flat-rate income tax
ANS: D
flat-rate income tax
22. The main arguments in favor of a modified flat-rate tax system (such as a proposal to place a 19% tax
on all income over $20,000 with no deductions) are it would
a. raise more revenue than the current tax system, and it would be simpler.
b. raise more revenue than the current tax system, and it would lower marginal tax rates.
c. be simpler and it would lower average tax rates.
d. be simpler and it would lower marginal tax rates.
ANS: D
be simpler and it would lower marginal tax rates.
23. If the government imposed a $1,000 tax on every individual,

a. this would be an equitable tax.
b. allocative efficiency would have to be sacrificed.
c. this would be an efficient tax.
d. this would be an income tax.
ANS: C
this would be an efficient tax.
24. In choosing the form of a tax, there is a trade-off between

a. allocative and productive efficiency.
b. profits and revenues.
c. efficiency and fairness.
d. fairness and profits.
ANS: C
efficiency and fairness.
25. If society is interested in devising a tax that is fair to its citizens,

a. the tax will raise efficiency.
b. none can be devised.
c. the tax will create inefficiencies.
d. it should choose a lump-sum tax.
ANS: C
the tax will create inefficiencies.
Chapter 36—Five Debates over Macroeconomic Policy
MULTIPLE CHOICE
1. Stabilization policy is useful because

a. there is no reason for society to suffer through the booms and busts of the business cycle.
b. the economy would stabilize itself too quickly without government intervention.
c. there are significant lags due to the nature of the political process.
ANS: A
there is no reason for society to suffer through the booms and busts of the business cycle.
2. The Federal Reserve will tend to tighten monetary policy when

a. interest rates are rising too rapidly.
b. it thinks the unemployment rate is too high.
c. the growth rate of real GDP is quite sluggish.
d. it thinks inflation is too high today, or will become too high in the future.
ANS: D
it thinks inflation is too high today, or will become too high in the future.
3. If the Federal Reserve loosened monetary policy today because it believed a recession was going to hit
the economy in about one year, this is an indication that the Fed
a. is undertaking an inappropriate monetary policy.
b. recognizes the problem of lags.
c. recognizes the fact that money is neutral.
d. is conducting a procyclical monetary policy.
ANS: B
recognizes the problem of lags.
4. When economists say that there is a time lag in the effect of monetary policy, they mean that
a. it takes time to observe the effects of fiscal policy on the economy.
b. the Fed takes awhile to figure out what it wants to do.
c. the Congress takes awhile to figure out what it wants to do.
d. it takes time to observe the effects of monetary policy on the economy.
ANS: D
it takes time to observe the effects of monetary policy on the economy.
5. The outcome of monetary policy can never be certain because

a. unemployment is always changing.
b. the concept of a natural rate of unemployment is still not accepted by all policy actions.
c. the slope of the AS curve is never clear.
d. time lags disrupt policy planning.
ANS: D
time lags disrupt policy planning.
6. Time inconsistency occurs when what currently seems best for today and tomorrow
a. is not best for tomorrow.
b. is not best for today.
c. does not appear to be best when tomorrow comes.
d. cannot be determined.
ANS: C
does not appear to be best when tomorrow comes.
7. In general, economists who believe the Federal Reserve should stabilize aggregate demand favor
a. policy rules that specify how the Fed should respond to economic fluctuations.
b. a laissez-faire view of monetary policy.
c. discretionary monetary policy.
d. placing limits on the Federal Reserve's open-market operations.
ANS: C
discretionary monetary policy.
8. One reason some economists argue for a credible monetary policy rule is a belief that such a rule could
be used to
a. reduce inflationary expectations, and lower actual inflation without raising the
unemployment rate.
b. reduce inflationary expectations, and lower actual inflation without raising the
unemployment rate very much.
c. reduce inflationary expectations, and lower actual inflation while the unemployment rate
rises for only a short time period.
d. change the growth rate of real GDP without affecting the unemployment rate.
ANS: A
reduce inflationary expectations and lower actual inflation without raising the unemployment rate.
9. If the Federal Reserve followed a credible monetary policy rule, it would be better for the economy
than discretionary monetary policy because the Fed could use a rule that creates low inflation; people
would expect
a. low inflation, and the unemployment rate would be at its natural level.
b. low inflation, and the unemployment rate could be kept below the natural level.
c. even lower inflation, and the unemployment rate would be kept below the natural level.
d. higher inflation, and the unemployment rate would be kept below its natural level.
ANS: A
low inflation, and the unemployment rate would be at its natural level.
10. Proponents of credible policy rules for monetary policy argue that credible rules are better than
discretionary policy because
a. only unanticipated policy actions affect real economic variables.
b. over a period of time discretionary actions of the Fed will become known, and then the
Fed's actions will no longer affect real economic variables.
c. credible rules reduce uncertainty in the economy.
ANS: C
credible rules reduce uncertainty in the economy.
11. The federal government has run budget deficits every year since 1969. In recent years Congress has
voted on a constitutional amendment that would require a balanced budget. If such an amendment
were enacted it would
a. indicate that policy makers were taking a "business as usual" attitude.
b. probably not change expectations.
c. increase the credibility of a deficit-reduction plan.
d. probably raise interest rates in the economy.
ANS: C
increase the credibility of a deficit-reduction plan.
12. If the Federal Reserve follows a policy of targeting the federal funds interest rate, then the money
supply will increase when
a. the unemployment rate falls.
b. when the rate of interest falls.
c. inflation decreases.
d. the demand for bank reserves increases.
ANS: D
the demand for bank reserves increases.
13. One reason the Fed tolerates ongoing inflation is because it

a. believes that the CPI understates the actual inflation rate.
b. believes that the CPI overstates the actual inflation rate.
c. accepts the idea that a zero inflation rate would make labor markets work more smoothly.
d. wants to focus more on price stability than on full employment.
ANS: B
believes that the CPI overstates the actual inflation rate.
14. Why doesn't the Fed eliminate inflation from the economy entirely?
a. It believes that the measured inflation rate understates the true rate of inflation.
b. It recognizes that continuing inflation helps labor markets adjust more easily.
c. If it did so, no one would get a raise in salary.
ANS: B
It recognizes that continuing inflation helps labor markets adjust more easily.
15. What is the major cost of slowing down ongoing inflation?

a. Output must rise above potential.
b. The Fed must sell bonds to the public at lower prices than those at which the bonds were
purchased.
c. Output must fall below potential.
d. The Fed must spend money on purchasing bonds from the public.
ANS: C
Output must fall below potential.
16. Ongoing inflation means the Fed must respond to

a. an upward-shifting AS curve.
b. a downward-shifting AS curve.
c. changing interest rate targets.
d. a lower real interest rate.
ANS: A
an upward-shifting AS curve.
17. The national debt

a. can be paid off without major economic effects.
b. need never be paid off.
c. is no more serious a problem than is a corporation's debt.
d. should not exist during a period of economic prosperity.
ANS: B
need never be paid off.
18. The national debt

a. exists because of past government budget deficits.
b. is the difference between the government's spending and revenue in a given year.
c. is the amount households owe on credit cards, mortgages and other loans.
d. is the same as the government's budget deficit.
ANS: A
exists because of past government budget deficits.
19. Government debt and interest payments on that debt

a. are problems if they grow faster than GDP.
b. are unrelated in the short run.
c. are unrelated in the long run, but not in the short run.
d. generally grow faster than government spending.
ANS: A
are problems if they grow faster than GDP.
20. In the long run, large and continuing budget surpluses

a. mean higher taxes and a lower standard of living.
b. mean a larger money supply and higher interest rates.
c. are a problem because they crowd out private spending.
d. permit the government to lower taxes, thereby encouraging work, investment and saving.
ANS: D
permit the government to lower taxes, thereby encouraging work, investment and saving.
21. The substitution effect of higher interest rates says that

a. smaller amounts of savings will generate the same amount of interest income.
b. higher rates of return increase the value of savings.
c. higher taxes will increase savings.
d. higher taxes will decrease savings.
ANS: B
higher rates of return increase the value of savings.
22. The income effect of higher interest rates says that

a. smaller amounts of savings will generate the same amount of interest income.
b. higher rates of return increase the value of savings.
c. higher taxes will increase savings.
d. higher taxes will decrease savings.
ANS: A
smaller amounts of savings will generate the same amount of interest income.
23. U.S. government policy discourages savings by

a. taxing the income from capital.
b. reducing benefits for those who have accumulated wealth.
c. limiting interest payments that banks can make on savings accounts.
ANS: D
Both a and b are correct.
24. As compared to discretionary tax policy, a credible commitment to low taxes on capital would tend to
a. cause people to expect higher taxes in the future, reduce incentives to invest, and reduce
tax revenues collected on capital.
b. allay people's expectations of future tax increases, increase incentives to invest, and reduce
tax revenues collected on capital.
c. allay people's expectations of future tax increases, increase incentives to invest, and
increase tax revenues collected on capital.
d. allay people's expectations of future tax increases, increase incentives to invest, and could
either increase or decrease tax revenues collected on capital.
ANS: C
allay people's expectations of future tax increases, increase incentives to invest, and increase tax
revenues collected on capital.
25. According to supply-side economists, lowering corporate income taxes

a. results in higher wages without creating higher levels of labor productivity.
b. creates greater income equality.
c. checks the expansion of GDP and employment.
d. stimulates investment and spurs on economic growth.
ANS: D
stimulates investment and spurs on economic growth.

Chapter 35—The Short-Run Tradeoff between Inflation and Unemployment
MULTIPLE CHOICE
1. Most macroeconomists agree that the fundamental issues facing an economy are
a. unemployment and inflation, and what should be done about them.
b. the economy's long-run equilibrium position and how to get there.
c. the quantity of money and its velocity.
d. the long-run Phillips curve and the Laffer curve and whether they generate conflicting
outcomes.
ANS: A
unemployment and inflation, and what should be done about them.
2. One explanation that economists offer to explain why a decline in the unemployment rate can raise the
rate of inflation is that
a. firms will be put in a position of competing more intensely for scarce resources.
b. people will pay higher prices because competition among the suppliers-the firms-
intensifies.
c. workers will focus more directly on protecting their jobs.
d. firms will refuse to shift higher labor costs along to consumers for fear of losing their
markets.
ANS: A
firms will be put in a position of competing more intensely for scarce resources.
3. The short-run Phillips Curve is drawn on the assumption that

a. technology does not affect output in the short run.
b. the skill level of the workforce does not affect output in the short run.
c. prices and wages are sticky in the short run.
ANS: C
prices and wages are sticky in the short run.
4. The Phillips curve traces a set of combinations of rates of

a. interest and unemployment.
b. real GDP and inflation.
c. real GDP and interest.
d. unemployment and inflation.
ANS: D
unemployment and inflation.
Figure 35-1
5. Refer to Figure 35-1. Suppose that the government in the economy of this diagram regards 9 percent
unemployment as unacceptable. If the government insists on reducing the unemployment rate from 9
percent to 7 percent, regardless of the consequences, then
a. pressure will build in the economy to continuously reduce the rate of inflation.
b. the long-run Phillips curve becomes horizontal, freezing the rates of inflation and
unemployment.
c. the inflation rate will increase but the unemployment rate will stay at 7 percent.
d. in the long run the rate of unemployment remains unchanged, but inflation will likely
accelerate.
ANS: D
in the long run the rate of unemployment remains unchanged, but inflation will likely accelerate.
6. Refer to Figure 35-1. Suppose the federal government decreases tax rates dramatically in order to
decrease the level of employment. We would expect to see aggregate demand shift to the
a. left and a move up the Phillips curve.
b. left and a move down the Phillips curve.
c. right and a move up the Phillips curve.
d. right and a move down the Phillips curve.
ANS: C
right and a move up the Phillips curve.
7. If the economy were left on its own without the interference of government or the Fed, it would move
toward an equilibrium rate of growth that would produce, with only minor interruptions, the natural
rate of unemployment without changes in the inflation rate. What economists would support this view?
a. Friedman and Phelps.
b. Phillips.
c. Samuelson and Solow.
d. Greenspan.
ANS: A
Friedman and Phelps.
8. The tradeoffs between rates of employment and inflation during the 1970s and 1980s forced
economists to reassess their earlier beliefs about the Phillips curve to conclude that
a. the Phillips curve was upward sloping, not downward sloping as first thought.
b. rather than there being one Phillips curve, there is a set of such curves.
c. the expected trade-offs did not occur, meaning that policy to lower unemployment rates
would not cause inflation.
d. the aggregate supply curve actually sloped downward because price levels fell when real
GDP rose.
ANS: B
rather than there being one Phillips curve, there is a set of such curves.
9. When an economy is at full employment, this means

a. the unemployment rate is zero.
b. unemployment is at its natural rate.
c. frictional unemployment is zero.
d. job creation equals job destruction.
ANS: B
unemployment is at its natural rate.
10. The long-run Phillips curve is vertical at

a. zero unemployment.
b. zero frictional unemployment.
c. the natural rate of unemployment.
d. the natural rate of inflation.
ANS: C
the natural rate of unemployment.
11. We would be most likely to experience a shift from one Phillips curve to another if the government
attempts to
a. reduce the unemployment rate, and workers, fearing inflation, react by bargaining for
higher wages.
b. reduce the unemployment rate, and consumers, fearing higher taxes, cut their spending.
c. reduce the unemployment rate and firms hire more employees without having to raise
wage rates.
d. reduce the unemployment rate and the inflation rate simultaneously.
ANS: A
reduce the unemployment rate, and workers, fearing inflation, react by bargaining for higher wages.
12. As prices adjust to a change in economic conditions, the

a. aggregate demand curve becomes horizontal.
b. aggregate demand curve becomes vertical.
c. Phillips curve and the aggregate supply curves become vertical.
d. Phillips curve and the aggregate supply curves become horizontal.
ANS: C
Phillips curve and the aggregate supply curves become vertical.
13. According to Friedman and Phelps, the unemployment rate is equal to

a. (the natural rate) + (the expected inflation rate).
b. (the natural rate) - (the expected inflation rate).
c. (the expected inflation rate) + (the actual inflation rate).
d. (the natural rate) - (the actual inflation rate - the expected inflation rate).
ANS: D
(the natural rate) - (the actual inflation rate - the expected inflation rate).
14. An increase in expected inflation will shift

a. both the short-run and the long-run Phillips curves to the right.
b. only the short-run Phillips curve to the right.
c. only the long-run Phillips curve to the right.
d. the short-run Phillips curve to the right and increase the slope of the long-run Phillips
curve.
ANS: B
only the short-run Phillips curve to the right.
15. If people expect less inflation in the future, then the

a. long-run Phillips curve will become steeper.
b. long-run Phillips curve will become flatter.
c. short-run Phillips curve will become steeper.
d. short-run Phillips curve will shift down and to the left.
ANS: D
short-run Phillips curve will shift down and to the left.
16. A movement along a short-run Phillips curve holds which of the following constants?
a. the level of GDP
b. actual inflation
c. expected inflation
d. employment
ANS: C
expected inflation
17. An increase in worker productivity brought about by the introduction of new technology into the
workplace will
a. shift the long-run Phillips curve to the left.
b. shift the long-run Phillips curve to the right.
c. decrease aggregate demand, since workers will lose their jobs.
d. cause the aggregate demand curve to become horizontal.
ANS: B
shift the long-run Phillips curve to the right.
18. Which of the following will reduce the price level and increase real output in the long run?
a. an increase in the money supply
b. an increase in wage rates
c. a decrease in the money supply
d. technical progress
ANS: D
technical progress
19. The natural rate hypothesis argues that

a. inflation eventually returns to its natural rate, regardless of the rate of unemployment.
b. the inflation rate and the unemployment rate always return to their natural levels.
c. inflation will increase at a natural rate, regardless of monetary policy.
d. unemployment eventually returns to its natural rate, regardless of the rate of inflation.
ANS: D
unemployment eventually returns to its natural rate, regardless of the rate of inflation.
REF: SECTION: 3
20. Suppose that an economy is currently experiencing 10 percent unemployment and 15 percent inflation.
If in the process of bringing inflation down by 2 percent real GDP falls by 4 percent, the sacrifice ratio
is
a. 5 percent.
b. 2 percent.
c. 12 percent.
ANS: B
2 percent.
21. To bring inflation down, an economy must sacrifice

a. real GDP.
b. exports.
c. employment for some people.
d. Both a and c are correct.
ANS: D
Both a and c are correct.
22. Which of the following would tend to shorten recessions associated with anti inflation policies of the
Federal Reserve?
a. People adjust their expectations of inflation slowly.
b. People believe policy announcements made by Fed officials.
c. The short-run Phillips curve does not shift immediately.
ANS: B
People believe policy announcements made by Fed officials.
23. The largest recession in the United States since the Great Depression occurred
a. after the Vietnam War ended in 1975.
b. after President Carter imposed credit controls on the economy in 1980.
c. after Paul Volcker reduced the growth rate of the money supply in 1981.
d. when consumer confidence fell in 1990.
ANS: C
after Paul Volcker reduced the growth rate of the money supply in 1981.
24. According to the theory of rational expectations,

a. workers' experience tells them that government action to lower unemployment will not
affect inflation.
b. consumers and investors generally behave so that rationally formed government attempts
to stimulate aggregate demand have their desired effects.
c. policy goals can be achieved more easily in the short run than in the long run.
d. workers' wage demands include anticipated inflation.
ANS: D
workers' wage demands include anticipated inflation.
25. According to the theory of rational expectations,

a. the Phillips curve is upward sloping in the short run and downward sloping in the long
run.
b. both for the short and long runs, the Phillips curve is horizontal.
c. both for the short and long runs, the Phillips curve is vertical.
d. there is no Phillips curve.
ANS: C
both for the short and long runs, the Phillips curve is vertical.

Chapter 34—The Influence of Monetary and Fiscal Policy on Aggregate Demand
MULTIPLE CHOICE
1. The opportunity cost of holding money is the

a. dollar cost necessary to change other assets into money.
b. time cost of accessing funds.
c. value of the goods and services a person is able to obtain with the money.
d. interest a person could have earned by holding other forms of wealth instead.
ANS: C
value of the goods and services a person is able to obtain with the money.
2. Which of the following is the opportunity cost of money?

a. money being a means of payment
b. the trouble of having to get money out of the bank
c. the interest forgone by holding money
d. the ability to purchase things at a moment's notice
ANS: C
the interest forgone by holding money
3. When the interest rate falls,

a. the opportunity cost of holding money rises.
b. people shift out of holding interest-yielding assets and into holding more liquid forms of
money.
c. the quantity of money people will hold decreases.
d. investment spending decreases.
ANS: B
people shift out of holding interest-yielding assets and into holding more liquid forms of money.
4. The equilibrium interest rate occurs in the money market where the
a. quantity of money available is zero.
b. the maximum quantity of funds has been borrowed and loaned.
c. the money supply is equal to the money demand.
d. the quantity of money demanded is zero.
ANS: C
the money supply is equal to the money demand.
5. As the price level increases, the money demand curve will

a. shift to the left.
b. become steeper.
c. stay in the same position.
d. shift to the right.
ANS: D
shift to the right.
6. The money supply curve is vertical because

a. real income does not influence the quantity of money supplied.
b. the price level does not influence the level of spending.
c. only the interest rate influences the quantity of money supplied.
d. the Federal Reserve sets the money supply.
ANS: D
the Federal Reserve sets the money supply.
7. The federal funds rate is the

a. federally mandated upper limit on credit card interest rates.
b. interest rate that banks charge to their most preferred clients.
c. interest rate that the Fed charges member banks for loans of reserves.
d. interest rate that banks charge for lending their excess reserves to other banks.
ANS: D
interest rate that banks charge for lending their excess reserves to other banks.
8. When the Fed increases the money supply, the interest rate
a. rises and spending increases.
b. rises and spending decreases.
c. falls and spending increases
d. falls and spending decreases.
ANS: C
falls and spending increases.
9. In the short-run macro model, an open-market purchase of bonds by the Fed will
a. raise the interest rate, reduce spending, and increase output.
b. raise the interest rate, reduce spending, and decrease output.
c. lower the interest rate, reduce spending, and decrease output.
d. lower the interest rate, increase spending, and increase output.
ANS: D
lower the interest rate, increase spending, and increase output.
10. Open market sales of bonds by the Federal Reserve reduce the money supply and
a. reduce aggregate expenditures.
b. increase real aggregate expenditures.
c. are helpful in monetizing the federal debt.
d. stimulate purchases of consumer durables.
ANS: A
reduce aggregate expenditures.
11. Which of these diagrams describes an open market sale by the Fed?
a. a
b. b
c. c
d. d
ANS: A
Graphic A
12. __________ is the use of government expenditures and taxes to promote full employment, stable
prices, and economic growth.
a. Monetary policy
b. Incomes policy
c. Stabilization policy
d. Fiscal policy
ANS: D
Fiscal policy
13. The marginal propensity to consume (MPC) is

a. the change in consumption divided by the change in disposable income.
b. total consumption divided by total disposable income.
c. the change in disposable income divided by the change in consumption.
d. total disposable income divided by total consumption.
ANS: A
the change in consumption divided by the change in disposable income.
14. Use this table to determine the MPC.
Disposable Consumption
Income Spending
($ billions) ($ billions)
0 $100
$200 280
$400 460
$600 640
a. 0
b. .8
c. .9
d. 1.0
ANS: C
.9
15. The multiplier effect

a. tells us that a change in government spending changes equilibrium GDP by more than the
change in government spending.
b. works only for increases in investment.
c. is relevant only in situations where the MPC cannot be determined.
d. tells us whether a change in government policy has been effective.
ANS: A
tells us that a change in government spending changes equilibrium GDP by more than the change in
government spending.
16. If the marginal propensity to consume is .5, what is the value of the multiplier?
a. 1.0
b. 1.5
c. 2.0
d. .5
ANS: C
2.0
17. If government spending decreases by $500 billion and if MPC = .6,

a. equilibrium GDP will rise by $1,250 billion.
b. equilibrium GDP will fall by $500 billion.
c. equilibrium GDP will fall by $1,250 billion.
d. nothing will happen in the short run, but real output will rise by $500 billion in the long
run.
ANS: C
equilibrium GDP will fall by $1,250 billion.
18. The crowding-out effect occurs when increased government expenditures and the subsequent budget
deficits cause
a. the money supply to increase, which curtails loans to consumers.
b. interest rates to increase, which reduces investment spending.
c. inflation, which erodes the purchasing power of the dollar.
d. the imports of goods and services to rise, and exports to decline.
ANS: B
interest rates to increase, which reduces investment spending.

19. Which of the following is not true for the crowding-out effect?
a. Federal budget deficits increase interest rates, which reduces investment spending.
b. Crowding out reduces the ability of fiscal policy to combat a recession.
c. If the government spends more on education, ceteris paribus, households may be forced to
spend less on new homes.
d. Crowding out occurs especially when the economy is in a deep recession and people are
not spending all the available money.
ANS: D
Crowding out occurs especially when the economy is in a deep recession and people are not spending
all the available money.
20. When George W. Bush was elected, he promised sweeping decreases in income tax rates for
households. His idea with this plan was that the
a. tax cuts would lead to increased savings.
b. tax cuts would stimulate household spending, even though they might cause minimal
increases in interest rates.
c. tax cuts would stimulate household spending and at the same time lower interest rates.
d. long-run aggregate supply curve would remain fixed while the aggregate demand curve
and interest rates increased.
ANS: B
the tax cuts would stimulate household spending, even though they might cause minimal increases in
interest rates.
21. The Employment Act of 1946 provided that

a. the Federal Reserve should use monetary policy to stabilize the economy.
b. the Federal Deposit Insurance Corporation should insure bank deposits.
c. the federal government should use its spending and taxation powers to stabilize the
economy.
d. state and local governments should regulate wages and employment in the electric and
natural gas industries.
ANS: C
the federal government should use its spending and taxation powers to stabilize the economy.
22. If the federal government announces a tax cut, which of the following is most likely in the short run?
a. a decrease in output, an increase in money demand, and an increase in the interest rate
b. an increase in output, a decrease in money demand, and a decrease in the interest rate
c. a decrease in output, a decrease in money demand, and a decrease in the interest rate
d. an increase in output, an increase in money demand, and an increase in the interest rate
ANS: D
an increase in output, an increase in money demand, and an increase in the interest rate
23. Government spending on infrastructure

a. increases aggregate demand but not aggregate supply.
b. increases productivity of private business firms and hence aggregate supply.
c. cannot affect aggregate demand because the money does not go to households.
d. shifts the long-run aggregate supply curve to the left.
ANS: B
increases productivity of private business firms and hence aggregate supply.
24. The automatic fiscal stabilizers include all of the following except
a. corporate income taxes.
b. unemployment insurance benefits.
c. the prime interest rate.
d. food stamps.
ANS: C
the prime interest rate.
25. Unlike discretionary fiscal policy, automatic stabilizers consist of

a. deliberate changes in government spending to counteract recession and inflation.
b. deliberate changes in household taxes to counteract recession and inflation.
c. deliberate changes in corporation income taxes to counteract recession and inflation.
d. changes in government spending and tax revenues that occur automatically as the
economy fluctuates.
ANS: D
changes in government spending and tax revenues that occur automatically as the economy fluctuates.

Chapter 33—Aggregate Demand and Aggregate Supply
MULTIPLE CHOICE
1. A severe and prolonged recessionary phase of a business cycle is sometimes described as

a. an inverted peak.
b. a trough.
c. a recession.
d. a depression.
ANS: D
a depression.
2. If you and your friends are still looking for a job eighteen months after graduation, even after lowering
your wage expectations, you are probably in the business cycle phase of a
a. recession.
b. peak.
c. boom.
d. recovery
ANS: A
recession.
3. Ethel maintains that she can predict when the economy is going to move up or down a business cycle.
In fact
a. most economists can predict the business cycle.
b. the business cycle is quite regular, with a new phase beginning every 24 months.
c. business cycles are irregular and unpredictable in the short run.
d. only the Federal Reserve can predict moves in the business cycle.
ANS: C
business cycles are irregular and unpredictable in the short run.
4. Recessions do not last forever because

a. workers get tired of being unemployed.
b. firms eventually have incentives to increase employment and produce more output.
c. government steps in and boosts spending back to long-run levels.
d. the Federal Reserve has perfect control over the money supply.
ANS: B
firms eventually have incentives to increase employment and produce more output.
5. In the long run, the aggregate demand curve is

a. horizontal.
b. upward sloping.
c. downward sloping.
d. vertical.
ANS: D
vertical.
6. When studying the short run, the assumption of money neutrality is

a. not relevant.
b. increasingly important.
c. still relevant but the classical dichotomy no longer holds.
d. Both b and c are correct.
ANS: A
not relevant.
7. If we are most interested in short-run changes in economic activity,

a. the classical model is an unreliable guide.
b. total spending can be ignored.
c. labor markets are irrelevant.
d. we should assume that neither expansions nor recessions can occur.
ANS: A
the classical model is an unreliable guide.
8. Anyone seeking to understand the causes of recessions must examine

a. the saving behaviors of different age groups.
b. investment patterns in the housing market.
c. disequilibrium in the manufacturing sector.
d. changes in the level of spending.
ANS: D
changes in the level of spending.
9. The wealth effect, interest rate effect, and foreign trade effect all explain why the aggregate
a. supply curve is horizontal.
b. supply curve is vertical.
c. supply curve is upward sloping.
d. demand curve is downward sloping.
ANS: D
demand curve is downward sloping.
10. According to the __________ effect, a lower price level decreases interest rates, which results in
additional spending on investment goods and so increases the aggregate quantity of goods and services
demanded.
a. money supply
b. interest rate
c. consumption
d. investment
ANS: B
interest rate
11. Due to expectations of a future recession, companies do not think that they can sell all of their output
and therefore purchase less equipment and machinery. As an immediate result, the aggregate
a. supply curve becomes vertical.
b. supply curve shifts right.
c. demand curve shifts right.
d. demand curve shifts left.
ANS: D
demand curve shifts left.
12. Movements along the aggregate supply curve are caused by changes in
a. technology.
b. government regulations.
c. wages and salaries.
d. the price level.
ANS: D
the price level.
13. Which of the following will cause the aggregate supply curve to shift to the right?
a. increases in wages and salaries paid to employees
b. increases in the prices of oil and natural gas
c. increases in taxes for business
d. new work rules that increase the productivity of labor
ANS: D
new work rules that increase the productivity of labor
14. Rising oil prices in the U.S. during the 1970s caused the economy's aggregate
a. supply curve to shift to the right.
b. supply curve to shift to the left.
c. demand curve to become vertical.
d. demand curve to become horizontal.
ANS: B
supply curve to shift to the left.
15. To say that nominal prices are sticky means

a. the average price level seldom changes.
b. relative prices seldom change.
c. it takes at least one year for prices to change to a new equilibrium level.
d. it takes time for prices to adjust to equilibrium.
ANS: D
it takes time for prices to adjust to equilibrium.
16. Which of the following is not a determinant of long-run aggregate supply?

a. the level of skills in the workforce
b. the price level
c. technology
d. the quantity of capital
ANS: B
the price level
17. The long-run effect of an increase in government spending is to raise

a. both real output and the price level.
b. real output and lower the price level.
c. real output and leave the price level unchanged.
d. the price level and leave real output unchanged.
ANS: D
the price level and leave real output unchanged.
18. If prices in an economy are sticky, then a decrease in the money supply
a. will cause a recession.
b. cannot be responsible for causing a recession.
c. will not have adverse effects on the economy.
d. will not affect prices.
ANS: A
will cause a recession.
19. Many economists believe that the severity of the Great Depression was due to
a. a flood of imported goods brought about by tariff reductions.
b. the failure of the Federal Reserve to prevent a large drop in the money supply.
c. the huge budget deficits of the federal government.
d. hyperinflation that occurred following World War I.
ANS: B
the failure of the Federal Reserve to prevent a large drop in the money supply.
20. Which of the following will reduce the price level and raise real output?
a. an adjustment of prices to equilibrium
b. an increase in wage rates
c. the short-run aggregate supply curve becoming steeper
ANS: D
technical progress
21. Which of the following will reduce the price level and reduce real output in the short run?
b. an increase in oil prices
ANS: C
a decrease in the money supply
22. Which of the following will cause stagflation?

b. an increase in oil prices
ANS: B
an increase in oil prices
23. Recessions in South Korea and Indonesia will cause

a. an upward movement along the U.S. AD curve.
b. a downward movement along the U.S. AD curve.
c. the U.S. AS curve to shift to the right.
d. the U.S. AD curve to shift to the right.
ANS: D
the U.S. AD curve to shift to the right.
24. If there is speculation that a recession is around the corner, which means that our future incomes will
most likely fall, then the effect of all this on the economy now will be that the
a. AS curve will shift to the left.
b. AD curve will shift to the right.
c. price level will rise and real output will rise.
d. price level will fall and real output will fall.
ANS: D
price level will fall and real output will fall.
25. Any factor that increases resource availability causes a(n)

a. increase in AD.
b. decrease in AD.
c. increase in AS.
d. decrease in AS.
ANS: C
increase in AS.

Chapter 32—A Macroeconomic Theory of the Open Economy
MULTIPLE CHOICE
1. Households make their savings available to borrowers through

a. resource markets.
b. the loanable funds market.
c. the labor market.
d. taxes.
ANS: B
the loanable funds market.
2. The supply of funds curve is upward sloping because a rise in the interest rate
a. decreases the opportunity cost of firms' investment spending.
b. increases the opportunity cost of firms' investment spending.
c. decreases the opportunity cost to households of consuming.
d. increases the opportunity cost to households of consuming.
ANS: D
increases the opportunity cost to households of consuming.
3. Market clearing in the loanable funds market

a. guarantees that total spending will be just sufficient to purchase whatever output is
produced.
b. means that the interest rate will never change.
c. guarantees that total spending will equal the quantity of loanable funds demanded.
d. requires that the government run a budget deficit.
ANS: A
guarantees that total spending will be just sufficient to purchase whatever output is produced.
4. Which of the following changes would cause a movement along the U.S. demand curve for a foreign
currency?
a. an increase in U.S. real GDP
b. a decrease in U.S. real GDP
c. an increase in the U.S. interest rate
d. a change in the real exchange rate
ANS: D
a change in the real exchange rate
5. As the U.S. interest rate falls relative to the British interest rate,
a. the U.S. demand curve for pounds will not change.
b. the U.S. demand curve for pounds will shift to the left.
c. the U.S. demand curve for pounds will shift to the right.
d. there will be a move down the existing U.S. demand curve for pounds.
ANS: C
the U.S. demand curve for pounds will shift to the right.
6. The supply of foreign exchange is

a. determined by the real exchange rate.
b. independent of the real exchange rate.
c. determined by central bankers.
d. determined by the President.
ANS: B
independent of the real exchange rate.
7. Which of the following could increase the supply of dollars in the foreign exchange market?
a. lower inflation in foreign countries than in the United States
b. lower interest rates in foreign countries than in the United States
c. higher prices in the United States
d. a depreciation of other currencies
ANS: B
lower interest rates in foreign countries than in the United States
8. Which of the following could decrease the supply of dollars in the foreign exchange market?
a. a higher inflation rate in foreign countries
b. lower interest rates in foreign countries
c. lower prices in the United States
d. an appreciation of other currencies
ANS: C
lower prices in the United States
9. Equilibrium in an open economy is characterized by

a. net exports = net capital outflow.
b. net exports + net capital outflow = savings.
c. domestic investment + net capital outflow = savings.
ANS: D
10. The link between the loanable funds market and the foreign exchange market is
a. the governments of the countries involved.
b. the International Monetary Fund.
c. net capital outflow.
d. purchasing power parity.
ANS: C
net foreign investment.
11. After reunification, Germany experienced a tremendous increase in the demand for loanable funds as
many rebuilding projects were initiated. As a result, interest rates
a. rose, there was a decrease in net capital outflow, there was a decrease in the supply of
marks, and the real exchange rate fell.
b. rose, there was a decrease in net capital outflow, there was a decrease in the supply of
marks, and the real exchange rate rose.
c. fell, there was an increase in net capital outflow, there was a decrease in the supply of
d. fell, there was an increase in net capital outflow, there was an increase in the supply of
ANS: B
rose, there was a decrease in net capital outflow, there was a decrease in the supply of marks, and the
real exchange rate rose.
12. Japan has historically had a high savings rate relative to other countries. This means that the
a. supply of loanable funds is larger, interest rates are lower, and net capital outflow is
higher.
b. supply of loanable funds is smaller, interest rates are lower, and net capital outflow is
higher.
c. demand for loanable funds is larger, interest rates are lower, and net capital outflow is
higher.
d. government must subsidize production in order to encourage international trade.
ANS: A
supply of loanable funds is larger, interest rates are lower, and net capital outflow is higher.
13. Foreign investment in the U.S. causes the

a. balance on current account to become positive.
b. sum of the capital and current accounts to be positive.
c. balance of trade to become negative.
d. value of the dollar to increase.
ANS: D
value of the dollar to increase.
14. The "twin deficits" refer to

a. the U.S. and Canadian trade deficits.
b. the U.S. trade deficit and the U.S. federal government budget deficit.
c. the current account and capital account deficits.
d. trade deficits that match one another when two countries trade.
ANS: B
the U.S. trade deficit and the U.S. federal government budget deficit.
15. If the United States government wants to eliminate a trade deficit, it could
a. reduce tariffs.
b. encourage imports.
c. reduce quotas on imports.
d. depreciate the dollar.
ANS: D
depreciate the dollar.
16. Which of the following would not be an appropriate response to a trade deficit for the United States?
a. increase tariffs
b. appreciate the dollar
c. subsidize exports
d. impose import quotas
ANS: B
appreciate the dollar
17. Currently, the U.S. government is running a budget deficit. This means that the
a. supply of loanable funds has increased.
b. supply of loanable funds has decreased.
c. real interest rate has fallen.
d. real exchange rate has fallen.
ANS: B
supply of loanable funds has decreased.
18. Crowding out caused by government budget deficits will lead to

a. an increase in the real exchange rate.
b. a decrease in the real exchange rate.
c. no change in the real exchange rate.
d. a devaluation in a nation's currency.
ANS: A
an increase in the real exchange rate.
19. Surprisingly, government trade policies

a. can eliminate a trade imbalance.
b. often increase a trade deficit.
c. have no real affect on the trade balance.
d. can lower a deficit on current account but not on the capital account.
ANS: C
have no real affect on the trade balance.
20. A tariff is a
a. tax on goods produced domestically.
b. tax on exported goods.
c. tax on imported goods.
d. limit placed on the quantity of goods that a country can import.
ANS: C
tax on imported goods.
21. A import quota is a

ANS: D
limit placed on the quantity of goods that a country can import.
22. Consider this diagram of the market for foreign exchange. If the U.S. government decides to increase
import tariffs on imported steel, we could expect the
a. demand for dollars to shift from D1 to D2.

b. demand for dollars to shift from D2 to D1.
c. supply of dollars to increase.
d. supply of dollars to decrease.
ANS: A
demand for dollars to shift from D1 to D2.
23. In response to an import quota

a. exports increase by more than imports.
b. imports increase by more than exports.
c. imports and exports are unaffected, but the government collects revenues.
d. imports and exports are both reduced but net exports are unchanged.
ANS: D
imports and exports are both reduced but net exports are unchanged.
24. A large and sudden movement of capital out of a country is called

a. a capital inflow.
b. capital flight.
c. a trade deficit.
d. a trade surplus.
ANS: B
capital flight.
25. The first step to analyzing capital flight is to expect a(n)

a. increase in net capital outflow for the country experiencing the flight.
b. decrease in net capital outflow for the country experiencing the flight.
c. decrease in the supply of domestic currency for the country experiencing the flight.
d. decrease in the demand for loanable funds for the country experiencing the flight.
ANS: A
increase in net foreign investment for the country experiencing the flight.
26. Capital flight is often caused by

a. political stability.
b. shifts away from the industrial sector and towards the service sector.
c. political instability.
d. policies of the International Monetary Fund.
ANS: C
political instability.

Chapter 32—A Macroeconomic Theory of the Open Economy
MULTIPLE CHOICE

d. taxes.
ANS: B
2. The supply of funds curve is upward sloping because a rise in the interest rate
ANS: D

produced.
b. means that the interest rate will never change.
ANS: A
4. Which of the following changes would cause a movement along the U.S. demand curve for a foreign
currency?
a. an increase in U.S. real GDP
b. a decrease in U.S. real GDP
c. an increase in the U.S. interest rate
d. a change in the real exchange rate
ANS: D
a change in the real exchange rate
5. As the U.S. interest rate falls relative to the British interest rate,
a. the U.S. demand curve for pounds will not change.
b. the U.S. demand curve for pounds will shift to the left.
c. the U.S. demand curve for pounds will shift to the right.
d. there will be a move down the existing U.S. demand curve for pounds.
ANS: C
the U.S. demand curve for pounds will shift to the right.
6. The supply of foreign exchange is

a. determined by the real exchange rate.
b. independent of the real exchange rate.
c. determined by central bankers.
d. determined by the President.
ANS: B
independent of the real exchange rate.
7. Which of the following could increase the supply of dollars in the foreign exchange market?
a. lower inflation in foreign countries than in the United States
b. lower interest rates in foreign countries than in the United States
c. higher prices in the United States
d. a depreciation of other currencies
ANS: B
lower interest rates in foreign countries than in the United States

8. Which of the following could decrease the supply of dollars in the foreign exchange market?
a. a higher inflation rate in foreign countries
b. lower interest rates in foreign countries
c. lower prices in the United States
d. an appreciation of other currencies
ANS: C
lower prices in the United States
9. Equilibrium in an open economy is characterized by

a. net exports = net capital outflow.
b. net exports + net capital outflow = savings.
c. domestic investment + net capital outflow = savings.
ANS: D
10. The link between the loanable funds market and the foreign exchange market is
a. the governments of the countries involved.
b. the International Monetary Fund.
c. net capital outflow.
d. purchasing power parity.
ANS: C
net foreign investment.
11. After reunification, Germany experienced a tremendous increase in the demand for loanable funds as
many rebuilding projects were initiated. As a result, interest rates
a. rose, there was a decrease in net capital outflow, there was a decrease in the supply of
b. rose, there was a decrease in net capital outflow, there was a decrease in the supply of
c. fell, there was an increase in net capital outflow, there was a decrease in the supply of
d. fell, there was an increase in net capital outflow, there was an increase in the supply of
ANS: B
rose, there was a decrease in net capital outflow, there was a decrease in the supply of marks, and the
real exchange rate rose.
12. Japan has historically had a high savings rate relative to other countries. This means that the
a. supply of loanable funds is larger, interest rates are lower, and net capital outflow is
higher.
b. supply of loanable funds is smaller, interest rates are lower, and net capital outflow is
higher.
c. demand for loanable funds is larger, interest rates are lower, and net capital outflow is
higher.
d. government must subsidize production in order to encourage international trade.
ANS: A
supply of loanable funds is larger, interest rates are lower, and net capital outflow is higher.
13. Foreign investment in the U.S. causes the

a. balance on current account to become positive.
b. sum of the capital and current accounts to be positive.
c. balance of trade to become negative.
d. value of the dollar to increase.
ANS: D
value of the dollar to increase.
14. The "twin deficits" refer to

a. the U.S. and Canadian trade deficits.
b. the U.S. trade deficit and the U.S. federal government budget deficit.
c. the current account and capital account deficits.
d. trade deficits that match one another when two countries trade.
ANS: B
the U.S. trade deficit and the U.S. federal government budget deficit.
15. If the United States government wants to eliminate a trade deficit, it could
a. reduce tariffs.
b. encourage imports.
c. reduce quotas on imports.
d. depreciate the dollar.
ANS: D
depreciate the dollar.
16. Which of the following would not be an appropriate response to a trade deficit for the United States?
a. increase tariffs
b. appreciate the dollar
c. subsidize exports
d. impose import quotas
ANS: B
appreciate the dollar
17. Currently, the U.S. government is running a budget deficit. This means that the
a. supply of loanable funds has increased.
b. supply of loanable funds has decreased.
c. real interest rate has fallen.
d. real exchange rate has fallen.
ANS: B
supply of loanable funds has decreased.
18. Crowding out caused by government budget deficits will lead to

a. an increase in the real exchange rate.
b. a decrease in the real exchange rate.
c. no change in the real exchange rate.
d. a devaluation in a nation's currency.
ANS: A
an increase in the real exchange rate.
19. Surprisingly, government trade policies

a. can eliminate a trade imbalance.
b. often increase a trade deficit.
c. have no real affect on the trade balance.
d. can lower a deficit on current account but not on the capital account.
ANS: C
have no real affect on the trade balance.
20. A tariff is a
ANS: C
tax on imported goods.
21. A import quota is a

ANS: D
limit placed on the quantity of goods that a country can import.

22. Consider this diagram of the market for foreign exchange. If the U.S. government decides to increase
import tariffs on imported steel, we could expect the
a. demand for dollars to shift from D1 to D2.

b. demand for dollars to shift from D2 to D1.
c. supply of dollars to increase.
d. supply of dollars to decrease.
ANS: A
demand for dollars to shift from D1 to D2.
23. In response to an import quota

a. exports increase by more than imports.
b. imports increase by more than exports.
c. imports and exports are unaffected, but the government collects revenues.
d. imports and exports are both reduced but net exports are unchanged.
ANS: D
imports and exports are both reduced but net exports are unchanged.
24. A large and sudden movement of capital out of a country is called

a. a capital inflow.
b. capital flight.
c. a trade deficit.
d. a trade surplus.
ANS: B
capital flight.
25. The first step to analyzing capital flight is to expect a(n)

a. increase in net capital outflow for the country experiencing the flight.
b. decrease in net capital outflow for the country experiencing the flight.
c. decrease in the supply of domestic currency for the country experiencing the flight.
d. decrease in the demand for loanable funds for the country experiencing the flight.
ANS: A
increase in net foreign investment for the country experiencing the flight.
26. Capital flight is often caused by

a. political stability.
b. shifts away from the industrial sector and towards the service sector.
c. political instability.
d. policies of the International Monetary Fund.
ANS: C
political instability.

Chapter 31—Open-Economy Macroeconomics: Basic Concepts
MULTIPLE CHOICE
1. A country's balance of international trade is positive when

a. exports exceed imports.
b. exports plus investment exceed imports plus domestic saving.
c. imports exceed exports.
d. imports plus domestic saving exceed exports plus investment.
ANS: A
exports exceed imports.
2. Which of the following would be recorded as an U.S. merchandise export?

a. An American tourist spends 10,000 francs on vacation in the south of France.
b. A machine shop in Ohio purchases a grinder made in Italy.
c. An American receives a $50 dividend check on stock she owns in a business in Germany.
d. France purchases a new jet fighter aircraft from the Boeing Company in the United States.
ANS: D
France purchases a new jet fighter aircraft from the Boeing Company in the United States.
3. Which of the following is equivalent to the trade deficit?

a. imports/exports
b. net capital inflow
c. exports + imports
d. net exports - imports
ANS: B
net capital inflow
4. If U.S. imports total $100 billion and U.S. exports total $150 billion, which of the following would be
true?
a. U.S. net exports equal -$50 billion
b. The U.S. has a trade surplus of $50 billion.
c. The U.S. has a trade deficit of $100 billion.
d. The U.S. has a trade deficit of $50 billion.
ANS: B
The U.S. has a trade surplus of $50 billion.
5. What does a positive U.S. capital inflow signify?

a. Nothing.
b. That the government is running a budget deficit.
c. That more funds were invested in the United States by foreigners than the United States
invested abroad.
d. That the United States is running a trade surplus.
ANS: C
That more funds were invested in the United States by foreigners than the United States invested
abroad.
6. International trade in financial assets

a. increases risk because little is known about firms in foreign lands.
b. increases risk because default risk is greater in foreign countries.
c. increases risk because of currency fluctuations.
d. reduces risk by allowing for increased diversification.
ANS: D
reduces risk by allowing for increased diversification.
7. It must always be true that net capital outflow

a. is greater than net exports.
b. is less than net exports.
c. is equal to net exports.
d. equals 0.
ANS: C
is equal to net exports.
8. If savings in Germany is $300 billion and investment in Germany is $550 billion, then
a. there must be net capital outflow of -$550 billion.
b. there must be net capital outflow of -$250 billion.
c. the German government must be running a $250 billion surplus.
d. the German financial market must be experiencing a net capital outflow.
ANS: B
there must be net capital outflow of -$250 billion.

9. If interest rates in Canada rise above those in the rest of the world, then
a. the demand for Canadian dollars decreases.
b. exports from Canada to other countries increases.
c. imports into Canada from other countries decreases.
d. it raises Canada's exchange rate and this may result in a deficit on Canada's current
account.
ANS: D
it raises Canada's exchange rate and this may result in a deficit on Canada's current account.
10. Foreign direct investment differs from foreign portfolio investment in that
a. direct investments involve stocks and bonds.
b. direct investments can only be made by the International Monetary Fund.
c. direct investments involve physical capital; portfolio investments involve financial capital
d. a government must be involved in direct investment, but portfolio investment can involve
private firms.
ANS: C
direct investments involve real capital; portfolio investments involve financial capital.
11. Which of the following would be classified as a direct foreign investment?

a. a purchase of 100 shares of British Petroleum stock
b. a loan of $1 million to a Brazilian utilities firm
c. A loan of $1 million from the World Bank to Surinam
d. building a new Pizza Hut in St. Petersburg, Russia
ANS: D
building a new Pizza Hut in St. Petersburg, Russia
12. Net capital outflow measures

a. the flow of goods and services between countries.
b. the flow of assets between countries.
c. government budget surpluses and deficits relative to those experienced in other countries.
d. the amount of physical capital built in foreign countries.
ANS: B
the flow of assets between countries.
13. U.S. trade deficits are a sign of

a. reduced national savings.
b. reduced production of manufactured goods.
c. an over reliance on the service economy.
d. high rates of unemployment in the U.S. economy.
ANS: A
reduced national savings.
14. The exchange rate is the

a. value of money.
b. quantity of dollars, yen, etc., that are traded on currency markets.
c. amount of foreign currency that is used to buy goods made in your country.
d. number of units of a foreign currency that can be bought with one unit of your own
currency.
ANS: D
number of units of a foreign currency that can be bought with one unit of your own currency.
15. If you were told that the exchange rate was 1.5 U.S. dollars per 1 Canadian dollar (CDN), that would
mean that Canadians would have to spend __________ to by a $12 watch in New York City.
a. $18 CDN
b. $15 CDN
c. $1.5 CDN
d. $12 CDN
ANS: A
$18 CDN
16. Currencies depreciate and appreciate all the time. Who gains and who loses when the Mexican peso
depreciates?
a. Americans holding Mexican pesos gain, U.S. tourists to Mexico lose.
b. U.S. exporters to Mexico gain, Americans holding pesos lose.
c. Mexican exporters gain, Mexican importers lose.
d. Mexican importers gain, Mexican exporters lose.
ANS: C
Mexican exporters gain, Mexican importers lose.
17. When Italy devalues its currency

a. the dollars per Italian lira will increase.
b. the drain of U.S. reserves on Italian lira will fall.
c. U.S. exports to Italy will increase.
d. the price of imported Italian olive oil in the United States will fall.
ANS: D
the price of imported Italian olive oil in the United States will fall.
18. When fewer U.S. dollars are needed to buy a unit of Japanese yen, the dollar
a. is devalued.
b. is inflated.
c. appreciates.
d. depreciates.
ANS: C
appreciates.
19. If one country has a lower inflation rate than other countries, its
a. currency tends to appreciate.
b. currency tends to depreciate.
c. real interest rate will be higher than in other countries.
d. nominal interest rate will be higher than in other countries.
ANS: A
currency tends to appreciate.
20. In the long run, exchange rates

a. are determined by business cycle fluctuations.
b. are determined by movements of Eurodollars.
c. will adjust until the price of a bundle of goods is the same in both countries.
d. will reflect economic fluctuations in both countries.
ANS: C
will adjust until the price of a bundle of goods is the same in both countries.
21. Which of the following is a statement of the purchasing power parity theory of exchange rate
determination? The exchange rate will adjust in the
a. long run until the interest rate is roughly the same in both countries.
b. long run until real GDP is roughly the same in both countries.
c. long run until the average price of goods is roughly the same in both countries.
d. short run until the average price of goods is roughly the same in both countries.
ANS: C
long run until the average price of goods is roughly the same in both countries.
22. Suppose the same basket of goods costs $100 in the U.S. and 50 pounds in Britain. According to PPP,
if the prices do not change, what will be the exchange rate?
a. 2 dollars/pound
b. 4 dollars/pound
c. 5 dollars/pound
d. .5 dollars/pound
ANS: A
2 dollars/pound
23. Which of the following is a reason why exchange rates may deviate from their purchasing power
parity values for many years?
a. Some goods are not tradable.
b. In some cases, a foreign-produced good is not a perfect substitute for a domestically-
produced version of the same thing.
c. In some markets, import quotas limit the ability of firms to agree on exchange prices.
ANS: D
Both a and b are correct.
24. If the U.S. price level is increasing by 3 percent annually and the Swiss price level is increasing by 5
percent annually, by what percent would the dollar price of francs need to change according to
purchasing power parity?
a. depreciate by 5 percent
b. appreciate by 3 percent
c. appreciate by 5 percent
d. depreciate by 2 percent
ANS: D
depreciate by 2 percent
25. Arbitrage refers to

a. simultaneously buying and selling a currency in order to profit from a difference in
exchange rates.
b. simultaneously buying and selling a currency in order to change the exchange rate.
c. buying a currency when its price is high and selling it when its price is low.
d. exchanging the domestic currency for a foreign currency.
ANS: A
simultaneously buying and selling a currency in order to profit from a difference in exchange rates.

Chapter 30—Money Growth and Inflation
MULTIPLE CHOICE
1. The price level that equates the quantity of money demanded with the quantity of money supplied is
called the
a. equilibrium price level.
b. natural price level.
c. relative price level.
d. commodity price level.
ANS: A
equilibrium price level.
REF: SECTION: OBJ: TYPE: 1
2. Real economic variables measure

a. value in the prices of some certain base year.
b. value in the prices of the current year.
c. nominal values adjusted for the current interest rate.
d. nominal values adjusted for the current money supply.
ANS: A
value in the prices of some certain base year.
3. According to the equation of exchange, money times velocity equals

a. nominal GDP.
b. real GDP.
c. inflation-adjusted total output in the economy.
d. the number of times each unit of money is spent on goods and services.
ANS: A
nominal GDP.
4. If real output in an economy is 1000 goods per year, the money supply is $300, and each dollar is spent
3 times per year, then the average price of goods is
a. $0.90.
b. $1.11.
c. $1.50.
d. $1.33.
ANS: A
$0.90.
5. Within the context of the equation of exchange, the higher the equilibrium price level is
a. the higher is the nominal money supply.
b. the lower is the nominal interest rate.
c. the higher is real GDP.
d. the lower is velocity.
ANS: A
the higher is the nominal money supply.
6. If real GDP falls and the nominal interest rate rises, then the equilibrium price level
a. must fall.
b. must rise.
c. will fall if the effect of the decline in real GDP dominates.
d. will fall if the effect of the increase in the nominal interest rate dominates.
ANS: B
must rise.
7. If the supply of money is greater than the amount of money people want to hold, then
a. spending will increase and the price level will fall.
b. spending will increase and the price level will rise.
c. spending will increase and the rate of interest will rise.
d. None of the above are correct. The amount of money supplied is never greater than the
amount people want to hold.
ANS: B
spending will increase and the price level will rise.
8. According to classical economists

a. prices are rigid.
b. both velocity and real output are variable.
c. changes in the money supply cause changes in velocity.
d. the velocity of money is constant.
ANS: D
the velocity of money is constant.
9. Since classical economists believe that both velocity and real output are constants, the equation of
exchange becomes a theory in which
a. the quantity of money explains prices.
b. the quantity of money explains real GDP.
c. changes in the money supply cause changes in velocity.
d. prices are fixed.
ANS: A
the quantity of money explains prices.
10. According to the classical view, to prevent price level changes when real output is growing by 3
percent per year, the money supply must
a. decrease by 3 percent per year.
b. increase by 3 percent per year.
c. increase by more than 3 percent per year.
d. remain constant.
ANS: B
increase by 3 percent per year.
11. The irrelevance of monetary changes for real variables is called

a. the classical dichotomy.
b. the equation of exchange.
c. monetary neutrality.
d. hyperinflation.
ANS: C
monetary neutrality.
12. Which of the following is a major source of inflation in the United States?
a. faster growth of the money supply than growth in GDP
b. monopoly power
c. low productivity
d. government regulation
ANS: A
faster growth of the money supply than growth in GDP
13. If a government supplies more money than the quantity people want to hold
a. spending will decrease and the price level will fall.
b. spending will increase and the price level will rise.
c. spending will remain constant but the price level will rise.
d. there will be no change in the level of economic activity or prices; money is neutral.
ANS: B
spending will increase and the price level will rise.
14. Hyperinflation occurs because governments want to __________ spending but they ignore the fact that
increasing the money supply will __________.
a. decrease, require greater government spending
b. increase, also increase the price level
c. increase, put upward pressure on interest rates
d. decrease, put downward pressure on interest rates
ANS: B
increase, also increase the price level
15. The inflation tax is

a. a tax on windfall profits.
b. a special tax imposed on owners of shares of stock.
c. a special tax imposed on profits when inflation is over 10% per year.
d. the loss incurred when inflation reduces the purchasing power of assets.
ANS: D
the loss incurred when inflation reduces the purchasing power of assets.
16. The beneficiaries of the inflation tax are

a. those who borrow money.
b. all corporations.
c. all multinational corporations that can shift assets into alternative currencies.
d. exporters of goods and services.
ANS: A
those who borrow money.

17. If the nominal interest rate is 10%, the expected rate of inflation is 7%, and the growth rate of the
money supply is 6%, then the real interest rate is
a. -4%.
b. -3%.
c. 3%.
d. 4%.
ANS: C
3%.
18. Studies of money demand indicate that the nominal demand for money
a. does not depend on interest rates.
b. does not depend on the price level.
c. is proportional to the price level.
d. is proportional to the nominal interest rate.
ANS: C
is proportional to the price level.
19. In 1985, the U.S. government indexed the federal personal income tax system. With indexing,
households are pushed into a higher tax bracket only if their nominal income
a. rises as fast as the rate of inflation.
b. rises slower than the rate of inflation.
c. rises faster than the rate of inflation.
d. decreases by the amount of inflation.
ANS: C
rises faster than the rate of inflation.
20. Investors criticize the federal income tax system because they must pay taxes
a. on gains that merely reflect the effects of inflation.
b. only on gains that exceed the effects of inflation.
c. on losses as well as gains.
d. on losses but not on gains.
ANS: A
on gains that merely reflect the effects of inflation.
21. Unanticipated inflation helps

a. investors at the expense of savers.
b. proprietorships at the expense of partnerships.
c. borrowers at the expense of lenders.
d. taxpayers at the expense of government.
ANS: C
borrowers at the expense of lenders.
22. Some economists feel inflation is bad

a. because it reduces real GDP so much.
b. only if it is steady.
c. because it redistributes income arbitrarily.
d. only if it is anticipated.
ANS: C
because it redistributes income arbitrarily.
23. Betty spends the entire week before Christmas shopping. However, inflation is so high in her
community that she must make three trips to the bank each day so as not to lose too much purchasing
power. These costs of inflation are called
a. menu costs.
b. shoeleather costs.
c. the inflation fallacy.
d. redistribution costs.
ANS: B
shoeleather costs.
24. When news reporters blame inflation on monopoly sellers, or on greed, they
a. are correctly distinguishing between relative prices and the level of prices.
b. are confusing the level of prices with the rate of change of prices.
c. are identifying the major cause of inflation in the United States.
ANS: B
are confusing the level of prices with the rate of change of prices.
25. Monopoly sellers

a. charge higher prices than more competitive firms and therefore cause inflation.
b. can achieve economies of scale not available to competitive firms and therefore charge
lower prices, which causes deflation.
c. charge higher prices than more competitive firms, but do not cause inflation.
d. are much greedier than sellers in more competitive markets.
ANS: C
charge higher prices than more competitive firms, but do not cause inflation.

Chapter 29—The Monetary System
MULTIPLE CHOICE
1. Barter exchange tends to be inefficient because

a. gold is difficult to transport.
b. it limits the time and effort required for trade.
c. it can be a very time-consuming process to find a double coincidence of wants.
d. a standardized unit of value can be difficult to find in a primitive economy.
ANS: C
it can be a very time-consuming process to find a double coincidence of wants.
2. In order for something to function well as a medium of exchange, it must be

a. issued by a central government.
b. readily and widely accepted in trade.
c. backed by a valuable commodity.
ANS: B
readily and widely accepted in trade.
3. If a society chooses fiat money as its money form, it

a. must guarantee its convertibility into gold.
b. must worry about its liquidity.
c. cannot make use of a banking system.
d. must worry about controlling its quantity.
ANS: D
must worry about controlling its quantity.
4. Which of the following is the most liquid category of assets?

a. large time deposits
b. money market mutual fund balances
c. small time deposits
d. demand deposits
ANS: D
demand deposits
5. Fred Jones won a lottery prize of $1 million. He put the money in the bank to save it for his daughter's
college education. For him, money was functioning primarily as a
a. unit of account.
b. store of value.
c. means of payment.
d. type of short-term loan.
ANS: B
store of value.
6. Which of the following is not included in the M1 money stock?

a. small time deposits.
b. demand deposits.
c. travelers' checks.
d. cash in the hands of the public.
ANS: A
small time deposits.
7. Given the following information, what would be the values of M1 and M2?
Small time deposits $650 billion

Checking deposits $300 billion
Savings-type deposits $750 billion
Money market mutual funds $600 billion
Travelers' checks $25 billion
Large time deposits $600 billion
Cash in hand $100 billion
a. M1 = $400 billion, M2 = $2,450 billion.

b. M1 = $100 billion, M2 = $1,075 billion.
c. M1 = $425 billion, M2 = $2, 425 billion.
d. M1 = $425 billion, M2 = $1,850 billion.
ANS: C
M1 = $425 billion, M2 = $2,425 billion.
8. Credit cards are

a. included in M2 but not in M1.
b. not considered money.
c. included in M3 but not in M2 or M1.
d. considered money only when they are in the hands of the public.
ANS: B
not considered money.
9. The Federal Reserve is

a. part of the executive branch of the government.
b. not part of any branch of the government.
c. part of the judicial branch of the government.
d. included in all three branches of government.
ANS: B
not part of any branch of the government.
10. Which of the following would not be used by the Fed to influence interest rates?
a. selling securities
b. buying stocks
c. setting reserve requirements
d. changing the discount rate
ANS: B
buying stocks
11. The interest rate that the Fed charges banks that borrow reserves from it is the
a. federal funds rate.
b. discount rate.
c. reserve requirement.
d. prime rate.
ANS: B
discount rate.
12. Which of the following can banks count as reserves?

a. coins in the bank vaults
b. paper currency in bank vaults
c. deposits at the Federal Reserve banks
ANS: D
13. The most effective and frequently used tool the Fed has at its disposal to change the economy's money
supply is
a. open market operations.
b. the discount rate.
c. the reserve requirement.
d. the federal funds rate.
ANS: A
open market operations.
14. The Federal Open Market Committee is composed of

a. 12 Federal Reserve bank presidents and presidents of the seven largest commercial banks
in the U.S.
b. the Board of Governors and the 12 Federal Reserve bank presidents.
c. the Board of Governors, the Secretary of the Treasury, and the President of the FDIC.
d. the Board of Governors and presidents of five Federal Reserve Banks.
ANS: D
the Board of Governors and presidents of five Federal Reserve Banks.
15. An open market purchase occurs when

a. the Fed buys government securities from a bank.
b. a bank buys government securities from the Fed.
c. a securities dealer buys shards of stock from the Fed.
d. the Treasury buys government securities from the Fed.
ANS: A
the Fed buys government securities from a bank.
16. The legal reserve requirement is

a. the minimum amount of reserves the Fed requires a bank to hold.
b. the interest rate that the Fed charges banks who borrow from it.
c. the interest rate on loans made by banks to other banks.
d. an appeal by the Fed to banks, asking for voluntary compliance with the Fed's 100%
reserves policy.
ANS: A
the minimum amount of reserves the Fed requires a bank to hold.
17. Given an initial deposit of $5,000 and a legal reserve requirement of 25%, the amount of money
potentially created by the banking system is
a. $15,000.
b. $20,000.
c. $25,000.
d. $10,000.
ANS: A
$15,000.
18. When the potential money multiplier is 7, a $3,000 increase in demand deposits could support the
creation of __________ additional new demand deposits.
a. $3,000
b. $9,000
c. $15,000
d. $18,000
ANS: D
$18,000
19. If a bank receives a new demand deposit of $10,000, and the legal reserve requirement is 20 percent,
then the bank can lend out
a. $2,000.
b. $10,000.
c. $40,000.
d. $8,000.
ANS: D
$8,000.
20. If the legal reserve requirement decreases, the

a. money multiplier increases.
b. money multiplier decreases.
c. amount of excess reserves the bank has decreases.
d. money multiplier is unaffected.
ANS: A
money multiplier increases.
Table 29-1
Assets Liabilities
Reserves $80,000 Demand deposits $100,000
Loans $20,000
21. Refer to Table 29-1. Given the information in the table, if the legal reserve requirement is 20 percent,
this bank has excess reserves of
a. $80,000.
b. $60,000.
c. $40,000.
d. $20,000.
ANS: B
$60,000.
22. Refer to Table 29-1. Given the information in the table, if the legal reserve requirement is 20 percent,
this bank can expand its loans by as much as
a. $80,000.
b. $60,000.
c. $40,000.
d. $20,000.
ANS: B
$60,000.
23. If a bank keeps some of its excess reserves, the actual money multiplier
a. increases.
b. stays the same.
c. goes to zero.
d. decreases.
ANS: D
decreases.

24. If the Fed reduces the money supply, banks will often initially have
a. more reserves than they are required to hold.
b. excess reserves.
c. increases demand deposits.
d. deficient reserves.
ANS: D
deficient reserves.
25. If the Fed decides to sell $10 million in securities and the Paris National Bank writes out a $10 million
check to purchase these securities, then the
a. Paris National Bank now has $10 million more of excess reserves at the Fed.
b. Paris National Bank now has $10 million fewer reserves at the Fed.
c. Fed has increased its asset position by $20 million.
d. money supply has increased.
ANS: B
Paris National Bank now has $10 million fewer reserves at the Fed.
26. When the Fed decreases the discount rates, it makes it easier for banks to
a. decrease their reserves by borrowing from the Fed, causing the money supply to shrink.
b. increase their reserves by borrowing from the Fed, causing the money supply to grow.
c. protect against the inevitable accompanying increase in the legal reserve requirement.
d. convert its loans into deposits.
ANS: B
increase their reserves by borrowing from the Fed, causing the money supply to grow.
27. The Fed loses some control over the interest rate once it targets the money supply,
a. but the interest rate does not move in an inappropriate direction with respect to the Fed's
monetary policy.
b. and the interest rate often moves in the opposite direction of the Fed's target.
c. but it can still dictate what the interest rate will be.
d. and also loses some control over open market operations, which are linked to the interest
rate.
ANS: A
but the interest rate does not move in an inappropriate direction with respect to the Fed's monetary
policy.
28. If there is a recession, the Fed would most likely

a. encourage banks to provide loans by lowering the discount rate.
b. encourage banks to provide loans by raising the discount rate.
c. restrict bank lending by lowering the discount rate.
d. restrict bank lending by raising the discount rate.
ANS: A
encourage banks to provide loans by lowering the discount rate.

Chapter 28—Unemployment and Its Natural Rate
MULTIPLE CHOICE
1. The amount of __________increases when the economy goes into a recession and decreases when the
economy goes into an expansion.
a. structural unemployment
b. seasonal unemployment
c. cyclical unemployment
d. frictional unemployment
ANS: C
cyclical unemployment
2. It is difficult for cyclically unemployed persons to find jobs because

a. they typically do not meet the qualifications required for the available jobs.
b. the economy is in a recession.
c. they voluntarily quit their last jobs and employers may view them as unreliable.
d. they typically have not looked long enough to find a job.
ANS: B
the economy is in a recession.
3. The natural rate of unemployment is the economist's notion of

a. full employment.
b. cyclical employment.
c. structural unemployment.
d. frictional unemployment.
ANS: A
full employment.
4. Yuan recently completed his college degree and is entering the labor market for the first time. He has
been submitting applications and has been interviewed twice in the last two weeks, but so far has not
found a job. Yuan could be classified as
a. frictionally unemployed.
b. seasonally unemployed.
c. structurally unemployed.
d. cyclically unemployed.
ANS: A
frictionally unemployed.

5. Providing training for unemployed individuals will help to alleviate
a. frictional unemployment.
b. seasonal unemployment.
c. structural unemployment.
d. cyclical unemployment.
ANS: C
structural unemployment.
6. According to the data from the Bureau of Labor Statistics found here, the labor force totals
Number of workers employed 8,400

Frictional unemployment 250
Structural unemployment 350
Cyclical unemployment 600
Discouraged workers 400
Adult population 12,000
a. 7,550.
b. 8,000.
c. 8,400.
d. 9,600
ANS: D
9,600.
7. According to the data from the Bureau of Labor Statistics found here, the unemployment rate is
a. 12.5 percent.
b. 15 percent.
c. 16 percent.
d. 24 percent.
ANS: A
12.5 percent.
8. According to the data from the Bureau of Labor Statistics found here, the labor force participation rate
is
a. 12.5 percent.
b. 25 percent.
c. 60 percent.
d. 80 percent.
ANS: D
80 percent.
9. Brian Vargo, an auto repair mechanic who remains unemployed because he refuses to work for less
than $1,000 per hour, is
a. counted as part of the labor force and is unemployed.
b. considered frictionally unemployed.
c. an underemployed worker.
d. not counted as part of the labor force.
ANS: D
not counted as part of the labor force.
10. The existence of many discouraged workers in an economy may cause us to

a. overstate the employment rate.
b. understate the employment rate.
c. overstate the unemployment rate.
d. understate the unemployment rate.
ANS: D
understate the unemployment rate.
11. Changes in the composition of demand among industries or regions are called
a. frictional shifts.
b. sectoral shifts.
c. structural shifts.
d. temporary shifts.
ANS: B
sectoral shifts.
12. Unemployment insurance

a. tends to increase unemployment by decreasing the cost of being unemployed.
b. tends to decrease unemployment by providing limited resources to the unemployed.
c. increases the hardships associated with unemployment.
d. increases the amount of job security demanded by employees.
ANS: A
tends to increase unemployment by decreasing the cost of being unemployed.
13. Fred is a low-skilled worker who washes dishes in a local restaurant. He is worried about a proposed
increase in the minimum wage because price
a. floors tend to create shortages.
b. ceilings tend to create shortages.
c. floors tend to reduce quantity demanded.
d. ceilings tend to reduce quantity demanded.
ANS: C
floors tend to reduce quantity demanded.

14. If the market for day care workers is in equilibrium at $5.00 per hour as shown in this diagram, a
minimum wage of $8.00 per hour will increase unemployment by
a. 300 workers.
b. 500 workers.
c. 600 workers.
d. no workers.
ANS: C
600 workers.
15. Consider two labor markets in which jobs are equally attractive in all respects other than the wage rate.
All workers are equally able to do either job. Initially, both labor markets are perfectly competitive. If
a union organizes workers in one of the markets, then the wage rates will tend to
a. rise in both markets.
b. fall in both markets
c. rise for the union jobs, but remain unchanged for the nonunion jobs.
d. rise for the union jobs and fall for the nonunion jobs.
ANS: D
rise for the union jobs and fall for the nonunion jobs.
16. Unions attempt to raise wage rates for their members by

a. reducing the supply of the product their members produce.
b. lowering barriers to entry so their members have greater opportunities.
c. reducing the demand for labor so there are fewer nonunion competitors.
d. negotiating a higher-than-competitive wage rate.
ANS: D
negotiating a higher-than-competitive wage rate.
17. The process of negotiation between union and management to arrive at a labor contract is called
a. arbitration.
b. mediation.
c. collective bargaining.
d. reconciliation.
ANS: C
collective bargaining.
18. The legislation that granted unions the legal right to organize workers and bargain collectively with
employers was the
a. Norris-LaGuardia Act.
b. Wagner Act.
c. Taft-Hartley Act.
d. Sherman Act.
ANS: B
Wagner Act.
19. To negotiate a higher wage rate, a union cannot

a. start with a strike and then work to reach a contract to end the strike.
b. negotiate in good faith and expect to hold its bargaining power.
c. expect to maintain the same level of employment.
d. offer a supply curve of labor that is horizontal.
ANS: C
expect to maintain the same level of employment.
20. Efficiency wages are

a. lower than market wages paid by employers to increase profitability.
b. higher than market wages paid by employers to increase productivity.
c. government-determined minimum wages set to protect workers from unfair employers.
d. negotiated by unions when officials are interested in trimming work forces.
ANS: B
higher than market wages paid by employers to increase productivity.
21. The idea of paying workers an efficiency wage is that

a. doing so is more efficient than paying them the market wage.
b. paying them less gives them the incentive to work harder.
c. workers and management gain at the expense of the stockholders of the company.
d. workers have the incentive to do high-quality work.
ANS: D
workers have the incentive to do high-quality work.

22. Henry Ford found that by paying an efficiency wage
a. he was able to bust the autoworkers union.
b. workers worked longer hours.
c. absentee and quit rates fell.
d. he could spend less on workers and more on capital equipment.
ANS: C
absentee and quit rates fell.
23. A potential problem with efficiency wages is that if all firms try to do it
a. no one will have a job.
b. unemployment will occur.
c. workers will have higher salaries than managers.
d. unions will go on strike against them.
ANS: B
unemployment will occur.
24. When an agent lacks an incentive to promote the best interests of the principal, and the principal
cannot observe the actions of the agent, there is said to be
a. an optimal contract.
b. monitoring.
c. a separating equilibrium.
d. moral hazard.
ANS: D
moral hazard.
25. Carlos, who knew nothing about construction, paid Joe to remodel a room in his house. Two years
later, the wall of the new room crumbled because Joe used poor-quality materials. This is an example
of
a. moral hazard.
b. an optimal contract.
c. monitoring.
d. adverse selection.
ANS: A
moral hazard.
26. The fact that someone with a high risk of medical problems is more likely to buy a lot of health
insurance is an example of
a. adverse selection.
b. monitoring.
c. moral hazard.
d. an optimal contract.
ANS: A
adverse selection.
27. Guarantees may not completely eliminate adverse selection problems because
a. no one guarantees a product 100%.
b. getting the firm to honor guarantees is too much work.
c. a firm that makes low-quality products may issue guarantees and then go out of business.
d. a firm offering guarantees subjects itself to lawsuits concerning their obligations.
ANS: C
a firm that makes low-quality products may issue guarantees and then go out of business.
28. Adverse selection is less of a problem

a. the less often buyers and sellers deal with each other.
b. the more often buyers and sellers deal with each other.
c. if guarantees are not enforceable.
d. if there is also a lot of moral hazard.
ANS: B
the more often buyers and sellers deal with each other.

Chapter 27—The Basic Tools of Finance
MULTIPLE CHOICE
1. The amount of money that someone would pay today for the right to receive a future payment is called
the
a. present value of the future payment.
b. determinate value of the future payment.
c. market interest rate.
d. principal.
ANS: A
present value of the future payment.
2. Which of the following changes would increase the present value of a future payment?
a. a decrease in the size of the payment
b. a decrease in the certainty of the payment actually being received
c. an increase in the amount of time that elapses before receiving the payment
d. a decrease in the interest rate
ANS: D
a decrease in the interest rate
3. You have a bond that you can redeem for $10,000 one year from now. The interest rate is 10 percent
per year. How much is the bond worth today?
a. $9,091.01
b. $10,000.00
c. $8,264.46
d. 9,523.81
ANS: A
$9,091.01
4. A snowplow will generate a net income of $2,000 per year for its owner. After 8 years, the plow will
break down and have zero value. The maximum amount of money anyone would pay for the plow is
a. less than $2,000.
b. $2000.
c. between $2,000 and $16,000.
d. $16,000.
ANS: C
between $2,000 and $16,000.
5. You have a choice among three options. Option 1: receive $900 immediately. Option 2: receive $1,200
one year from now. Option 3: receive $2,000 five years from now. The interest rate is 15% per year.
Rank these three options from highest present value to lowest present value.
a. Option 1; Option 2; Option 3
b. Option 3; Option 2; Option 1
c. Option 2; Option 3; Option 1
d. Option 3; Option 1; Option 2
ANS: C
Option 2; Option 3; Option 1
6. Someone who cares only about expected return and doesn't worry about risk is someone who is
a. risk averse.
b. risk neutral.
c. risk seeking.
d. irrational.
ANS: B
risk neutral.
7. Diversification has the advantage of

a. reducing expected return.
b. reducing actual return.
c. reducing risk.
d. reducing the profits of insurance companies.
ANS: C
reducing risk.
8. To diversify, a homeowner with a variable-rate mortgage should choose investments that

a. pay higher returns when interest rates rise and lower returns when interest rates fall.
b. pay lower returns when interest rates rise and higher returns when interest rates fall.
c. provide a higher return than the market average.
d. provide a lower return than the market average.
ANS: A
pay higher returns when interest rates rise and lower returns when interest rates fall.
9. Rex is a mortgage broker, who is paid by commission. When interest rates decline, he does a lot of
business and earns a lot of money, as more people buy houses or refinance their mortgages. But when
interest rates rise, business falls substantially. To diversify, Rex should choose investments that
a. provide a higher return than the market average.
b. provide a lower return than the market average.
c. pay higher returns when interest rates rise and lower returns when interest rates fall.
d. pay lower returns when interest rates rise and higher returns when interest rates fall.
ANS: C
pay higher returns when interest rates rise and lower returns when interest rates fall.
10. A person is risk averse if he or she

a. prefers a riskier income, holding fixed its expected value.
b. doesn't care about the riskiness of income.
c. prefers a less-risky income, holding fixed its expected value.
d. refuses to diversify risk.
ANS: C
prefers a less-risky income, holding fixed its expected value.
11. When an agent lacks an incentive to promote the best interests of the principal, and the principal
cannot observe the actions of the agent, there is said to be
b. diversification.
c. moral hazard.
d. idiosyncratic risk.
ANS: C
moral hazard.
12. Steve bought fire insurance for his house for an amount that was greater than his house was worth,
then became careless about leaving burning cigarettes around. This is an example of
b. diversification.
c. moral hazard.
d. aggregate risk.
ANS: C
moral hazard.
13. Adverse selection occurs when

a. sellers have relevant information about some aspect of the product's quality that buyers
lack (or vice versa).
b. an agent lacks the incentive to act in the best interests of the principal and the principal
cannot observe the actions of the agent.
c. a principal and an agent reach an agreement that maximizes the principal's profit while
providing an incentive for the agent to participate.
d. a principal obtains information about an agent's actions.
ANS: A
sellers have relevant information about some aspect of the product's quality that buyers lack (or vice
versa).
14. The fact that someone with a high risk of medical problems is more likely to buy a lot of health
insurance is an example of
a. adverse selection.
b. monitoring.
c. moral hazard.
d. an optimal contract.
ANS: A
adverse selection.
15. Diversification can eliminate

a. all types of risk.
b. idiosyncratic risk but not aggregate risk.
c. aggregate risk but not idiosyncratic risk.
d. all types of risk but only if insurance is purchased.
ANS: B
idiosyncratic risk but not aggregate risk.
16. Bonds are preferred to stocks by individual investors who

a. need to have immediate access to their money.
b. don't think the business is profitable.
c. prefer a guaranteed lower return to a risky higher return.
d. prefer a risky higher return to a guaranteed lower return.
ANS: C
prefer a guaranteed lower return to a risky higher return.
17. Corporate profits that are not reinvested in the corporation are distributed to
a. consumers in the form of lower prices.
b. management and bondholders.
c. management and the board of directors.
d. shareholders in the form of dividends.
ANS: D
shareholders in the form of dividends.
18. Which of the following factors would be considered by a fundamental analyst when predicting a firm's
stock price?
a. recent changes in the stock's price
b. the knowledge and skills of the firm's current management
c. the marketing strategies of the firm's competitors
ANS: D
Both b and c are correct.
19. Which of the following factors would not be considered by a fundamental analyst when predicting
stock prices?
a. the future demand for a firm's products
b. the patents held by a firm
c. the likelihood of new firms competing with an existing firm
d. recent jumps in a firm's stock prices
ANS: D
recent jumps in a firm's stock prices
20. If the price of stock is greater than what you believe to be the true value of the business then the stock
is
a. undervalued.
b. overvalued.
c. fairly valued.
d. no longer going to be traded.
ANS: B
overvalued.
21. According to the efficient markets hypothesis,

a. fundamental analysis is a way to profit from predicting stock prices.
b. fundamental and technical analysis are largely useless.
c. technical analysis is the best approach to profit from predicting stock prices.
d. fundamental and technical analysis must be synthesized in order to profit from predicting
stock prices.
ANS: B
fundamental and technical analysis are largely useless.
22. The efficient markets view of the stock market says that new information
a. is quickly and completely incorporated into stock prices.
b. is incorporated into stock prices only when discovered by fundamental analysis.
c. causes stock prices to increase.
d. has little impact on stock prices.
ANS: A
is quickly and completely incorporated into stock prices.
23. If the efficient markets theory is correct, stock prices

a. do not respond to unpredictable events.
b. are unpredictable.
c. rise at the beginning of a month and fall at the end of a month.
d. follow a predictable pattern over time.
ANS: B
are unpredictable.
24. If stock prices follow a random walk, it means

a. long periods of declining prices are followed by long periods of rising prices.
b. the greater the number of consecutive days of price declines, the greater the probability
prices will increase the following day.
c. stock prices are unrelated to random events that shock the economy.
d. stock prices are just as likely to rise as to fall at any given time.
ANS: D
stock prices are just as likely to rise as to fall at any given time.
25. If stock prices follow a random walk then stock investors can make large profits by
a. using computer programs that perform technical analysis using past stock trends.
b. performing fundamental analysis of stocks using data contained in annual reports.
c. quickly responding to rumors of mergers between companies.
d. using inside information.
ANS: D
using inside information.
Chapter 26—Saving, Investment, and the Financial System
MULTIPLE CHOICE
1. Bond markets allow firms to pursue
a. equity financing.
b. debt financing.
c. limited-growth policies.
d. government loans and subsidy programs.
ANS: B
debt financing.
2. Junk bonds are issues by firms with

a. high degrees of financial security.
b. business ties to the trash-hauling industry.
c. high degrees of financial insecurity.
d. the ability to offer lower interest rates to lenders.
ANS: C
high degrees of financial insecurity.
3. The stock market is an institution that promotes

a. buying and selling of debt financing.
b. the purchase and sale of firm equities.
c. the purchase and sale of mutual funds.
d. bank borrowing and lending.
ANS: B
the purchase and sale of firm equities.
4. The major advantage of mutual funds is that

a. they allow people with limited funds to diversify.
b. they encourage households to spend their money on current consumption.
c. fund managers are replaced by household administrators.
d. they always use index funds to limit investor risk.
ANS: A
they allow people with limited funds to diversify.
5. If an asset functions as a medium of exchange it

a. holds its value over a long period of time.
b. can be used by people to cover transactions.
c. can be used by firms for debt financing.
d. can be used by firms for equity financing.
ANS: B
can be used by people to cover transactions.

6. The four categories of expenditures that make up GDP are consumption,
a. investment, net exports, and government expenditures.
b. investment, government purchases, and depreciation.
c. interest, government purchases, and net exports.
d. investment, exports, and rental expenditures.
ANS: A
investment, net exports, and government expenditures.
7. Economists say that investment occurs when

a. someone buys stock on the New York Stock Exchange.
b. someone buys a U.S. government bond.
c. a firm increases its capital stock.
d. a government buys goods from another country.
ANS: C
a firm increases its capital stock.
8. Which of the following would be counted as a private investment expenditure in the national income
accounts?
a. The Navy builds a new battleship.
b. Microsoft expands plant capacity to produce new software.
c. A public high school builds a new football stadium.
ANS: B
Microsoft expands plant capacity to produce new software.
9. If a series of major technological breakthroughs occur in the economy at the same time, then the most
likely outcome would be that the economy's
a. investment demand curve will shift downward.
b. investment demand curve will shift upward.
c. consumption curve will shift downward.
d. position along the existing investment curve will move upward.
ANS: B
investment demand curve will shift upward.

d. taxes.
ANS: B
11. What is the price of funds in the loanable funds market?

a. the real wage rate
b. the consumer price index
c. the nominal interest rate
d. the average firm profit rate
ANS: C
the nominal interest rate
12. Assuming the economy is in equilibrium, use the following information to determine the amount of
funds supplied to the loanable funds market.
Consumption Spending $3.5 trillion

Net Taxes $2.7 trillion
Household Saving $2.5 trillion
Investment Spending $2.2 trillion
Government Purchases $3.0 trillion
a. $2.2 trillion
b. $2.5 trillion
c. $2.7 trillion
d. $3.0 trillion
ANS: B
$2.5 trillion
13. The quantity of loanable funds supplied is

a. positively related to the level of income.
b. negatively related to the price level.
c. positively related to the price level.
d. positively related to the interest rate.
ANS: D
positively related to the interest rate.
14. The supply of loanable funds curve is upward sloping because a rise in the interest rate
ANS: D

15. The investment demand curve
a. is upward sloping.
b. is downward sloping.
c. is horizontal.
d. begins sloping upward, then becomes horizontal.
ANS: A
is upward sloping.
16. When interest rates rise, the quantity of loanable funds demanded by
a. firms decreases.
b. government decreases.
c. firms increases.
d. government increases.
ANS: A
firms decreases.

produced.
b. means that the interest rate never changes.
ANS: A
18. If taxes are reduced with no change in government spending, and people spend all the money from the
tax cut on consumption
a. the demand for loanable funds will increase and the interest rate will increase.
b. the demand for loanable funds will increase and the interest rate will decrease.
c. the supply of loanable funds will decrease and the interest rate will increase.
d. neither the demand nor the supply of loanable funds will change.
ANS: A
the demand for loanable funds will increase and the interest rate will increase.
19. If taxes are reduced with no change in government spending, and people save all the money from the
tax cut,
a. the demand for loanable funds will increase and the interest rate will increase.
b. the demand for loanable funds will increase and the interest rate will remain constant.
c. the supply of loanable funds will increase and the interest rate will decrease.
d. neither the demand nor the supply of loanable funds will change.
ANS: C
the supply of loanable funds will increase and the interest rate will decrease.
20. A(n) __________ allows a firm to decrease its tax liability by a fraction of the investment it initiates
during a particular period.
a. tax on corporate profits
b. tax on retained earnings
c. investment tax credit
d. personal income tax
ANS: C
investment tax credit
21. If the U.S. government wants to increase the level of employment and real output, it could
a. increase corporate income taxes.
b. provide an investment tax credit.
c. decrease expenditures on roads and dams.
d. increase the personal income tax.
ANS: B
provide an investment tax credit.
22. Assuming the economy was in equilibrium, use the following information to determine the
government's budget deficit or surplus.
Consumption Spending $3.5 trillion

Net Taxes $2.7 trillion
Household Saving $2.5 trillion
Investment Spending $2.2 trillion
The government's deficit (surplus) was

a. $.3 trillion surplus.
b. $.2 trillion surplus.
c. $.3 trillion deficit.
d. $.5. trillion deficit.
ANS: C
.3 trillion deficit.
23. The government budget deficit is

a. the difference between government purchases and government revenues from bonds and
taxes.
b. caused by a lack of business sector investment.
c. created when the government expenditures exceed net taxes.
d. caused by leakages in the economy.
ANS: C
created when the government expenditures exceed net taxes.
24. If the government budget deficit increases, the

a. supply of loans increases and the equilibrium interest rate increases.
b. supply of loans increases and the equilibrium interest rate decreases.
c. demand for loans increases and the equilibrium interest rate decreases.
d. demand for loans increases and the equilibrium interest rate increases.
ANS: D
demand for loans increases and the equilibrium interest rate increases.
25. If technical progress raises productivity permanently, then

a. the equilibrium interest rate will increase.
b. equilibrium saving will increase.
c. real GDP will increase.
ANS: D

Chapter 25—Production and Growth
MULTIPLE CHOICE
1. If one wants to know how the material well-being of the average person has changed over time the
appropriate measure to look at is the growth
a. rate of real GDP.
b. rate of nominal GDP.
c. rate of per capita real GDP.
d. in the percentage of the labor force that is employed.
ANS: C
rate of per capita real GDP.
2. Per capita real GDP differs from per capita nominal GDP in that real GDP
a. measures the opportunity cost of growth.
b. has been adjusted for the time value of money.
c. has been adjusted for inflation.
d. has been discounted to the present.
ANS: C
has been adjusted for inflation.
3. Poor countries are poor for all of the following reasons except
a. their technology is less than modern.
b. their labor productivity is low.
c. foreign investment funds are difficult to attract.
d. their labor force is too small.
ANS: D
their labor force is too small.
4. Of the following, which country experienced the fastest growth rate for the period 1900-1998?
a. United States
b. Japan
c. Canada
d. Brazil
ANS: B
Japan
5. Which of the following represents a productivity-enhancing investment in human capital?

a. a new labor-saving technology
b. a new health clinic
c. a new factory that will employ 1,000 workers
d. an increase in fringe benefits, such as paid vacations and overtime pay
ANS: B
a new health clinic
6. If the capital stock increases faster than employment, then we would expect
a. both output and labor productivity to rise.
b. output to rise but labor productivity to fall.
c. both output and labor productivity to fall.
d. output to fall but labor productivity to rise.
ANS: A
both output and labor productivity to rise.
7. As its capital stock increases, a nation will

a. move to the right along a fixed production function.
b. move to the left along a fixed production function.
c. find its production function shifting up.
d. find its production function shifting down.
ANS: C
find its production function shifting up.
8. An increase in the capital stock causes labor productivity to

a. decrease and the standard of living to increase.
b. increase and the standard of living to increase.
c. decrease and the standard of living to decrease.
d. increase while the standard of living remains constant.
ANS: B
increase and the standard of living to increase.
9. If 100 lumberjacks generate $5,000 in real GDP, the output per laborer would be
a. .02
b. .05
c. 50
d. 100
ANS: C
50
10. Labor productivity, measuring the output per worker,

a. increases with increases in technology.
b. decreases with increases in technology.
c. increases with increases in capital stock.
d. is impossible to measure since so many workers are involved in the service sector.
ANS: A
increases with increases in technology.
11. Investments in human capital are often opposed because

a. investments in plant and machinery are more important.
b. the increase in productivity comes with opportunity costs to workers and firms.
c. investments in plant and machinery will have greater monetary payoffs.
d. they rarely lead to long-term economic growth.
ANS: B
the increase in productivity comes with opportunity costs to workers and firms.
12. One reason the prices of some exhaustible natural resources have fallen is
a. their supply has decreased rapidly.
b. the demand for them has increased quite rapidly.
c. technical progress has increased their supply.
d. they are not subject to diminishing returns.
ANS: C
technical progress has increased their supply.
13. Historical evidence indicates that scarcity of natural resources has

a. caused slower world economic growth.
b. nearly stopped economic growth in most countries throughout the world.
c. not limited economic growth.
d. limited economic growth, but only in high-growth countries.
ANS: C
not limited economic growth.
14. The data on U.S. growth rates during the last half of the 20 th century suggest that when the savings rate
increases the rate of
a. growth can increase or decrease depending on the phase of the business cycle the economy
is in.
b. economic growth increases.
c. economic growth decreases.
d. economic growth is unaffected.
ANS: B
economic growth increases.
15. The most direct opportunity cost of having large families in a poor country such as Egypt is the
a. loss of its customs and traditions.
b. benefit of having more hands to help in agricultural production.
c. larger tax revenues government will collect from families.
d. sacrifice of per capita material goods and services needed in the development process.
ANS: D
sacrifice of per capita material goods and services needed in the development process.
16. Poor countries often have a difficult time attracting foreign investment funds because
a. wages are low in poor countries.
b. investment risks are quite low in poor countries so rates of return are low.
c. property rights are not protected so investors fear their property may be confiscated.
ANS: C
property rights are not protected so investors fear their property may be confiscated.
17. Which of the following would decrease the likelihood that foreign business firms will invest in a
country?
a. a low corporate profit tax rate
b. political stability
c. a well-established legal system
d. political instability
ANS: D
political instability

18. Which of the following countries achieved economic growth, in part, by mandating a reduction in
population growth?
a. the former Soviet Union
b. Great Britain
c. China
d. Hong Kong
ANS: C
China
19. Most countries that are developing with slow growth rates are characterized by
a. inadequate labor forces.
b. a high proportion of the population under the age of 15.
c. unfertile and uncultivable soil.
d. low total productivity but high per capita productivity.
ANS: B
a high proportion of the population under the age of 15.
20. A high proportion of the population under the age of 15 undermines economic growth because
a. the young require more infrastructure than older people.
b. the young require more capital goods than older people.
c. they present such a huge increase in human capital.
d. the young consume but they do not produce.
ANS: D
the young consume but they do not produce.
21. Countries like South Korea and Singapore have shown tremendous growth rates in recent years
because
a. of diminishing returns.
b. of the catch-up effect.
c. of lower levels of domestic investment in recent years.
d. they have limited international trade.
ANS: B
of the catch-up effect.
22. Inward-oriented policies stall economic growth because

a. international trade leads to lower domestic employment.
b. they encourage the brain-drain.
c. infant industries are unable to compete with the rest of the world.
d. they do not allow a country to take advantage of the gains from trade.
ANS: D
they do not allow a country to take advantage of the gains from trade.
23. Suppose everyone working the land in Exland knows the usefulness of investing in land irrigation
systems but those who work the land may choose not to invest in these profitable irrigations systems as
long as
a. the investment is too expensive.
b. the natural climate, such as abundant rain, makes the irrigation projects unnecessary.
c. their property rights, with respect to the land, are subject to change.
d. the government dictates the choice of investment.
ANS: C
their property rights, with respect to the land, are subject to change.
24. A singular important link between politics and economics in countries that are attempting to increase
their economic growth rates is that
a. democracies are more productive than non democracies.
b. democracies must constantly make difficult budgetary choices.
c. political instability is incompatible with long-term private investment.
d. conservative governments tend to focus development on military industries.
ANS: C
political instability is incompatible with long-term private investment.
25. The main reason that some countries have serious reservations about increasing foreign direct
investment in their countries is because they
a. think this will cause political instability.
b. believe that tax revenues will fall.
c. anticipate many of their most productive workers will leave the country.
d. fear a return to colonialism.
ANS: D
fear a return to colonialism.

Chapter 24—Measuring the Cost of Living
MULTIPLE CHOICE
1. Which price index measures the average price of things purchased by the typical family in an urban
area?
a. GDP deflator
b. producer price index
c. consumer price index
d. minimum wage
ANS: C
consumer price index

2. Which item would receive the most weight in the consumer price index?
a. salt
b. toothpicks
c. pencils
d. food
ANS: D
food
3. Which item would receive the least weight in the consumer price index?
a. brooms
b. automobiles
c. color televisions
d. automobile tires
ANS: A
brooms
4. The good that receives the most weight in the CPI is the good that
a. consumers buy most frequently.
b. has experienced the greatest price increase.
c. has the highest price.
d. consumers spend the largest fraction of their income on.
ANS: D
consumers spend the largest fraction of their income on.
5. Which of the following is a reason why the Consumer Price Index (CPI) is not calculated as a simple
average of all prices?
a. Some goods experience large price changes and the CPI would be too variable if
computed by a simple average.
b. Goods differ in their importance in the average consumer's budget.
c. Some goods never experience price changes and the CPI would not be variable enough if
computed as a simple average.
d. It would be difficult to compute a price index using a simple average of all prices.
ANS: B
Goods differ in their importance in the average consumer's budget.
6. If the price of the market basket of goods in the base year of 1994 was $20,000 and the price of the
same basket had risen to $22,000 by 1998, the CPI for 1998
a. cannot be calculated.
b. is $12,000.
c. is 200.
d. is 110.
ANS: D
is 110.
7. Suppose you spend 30 percent of your budget on food, 20 percent on medical care, 40 percent on rent,
5 percent on entertainment, and 5 percent on miscellaneous items. If the price of all parts of your
budget rises equally in percentage terms, which would have the most weight on your cost of living
increase? (Assume you calculate your index the same way the CPI is calculated.)
a. food
b. medical care
c. rent
d. entertainment
ANS: C
rent
8. Substitution bias
a. is one factor that causes the CPI to underestimate the inflation rate.
b. is caused by the poor quality of many imported products.
c. is one of the primary causes of inflation.
d. involves consumer behavior that helps explain why the CPI overestimates the inflation
rate.
ANS: D
involves consumer behavior that helps explain why the CPI overestimates the inflation rate.
9. Improvements in the quality of consumer goods and services over time

a. cause the CPI to overstate actual inflation.
b. cause the CPI to understate actual inflation.
c. are accounted for in the CPI.
d. are insignificant and thus would not affect the CPI even if accounted for.
ANS: A
cause the CPI to overstate actual inflation.
10. Factors that cause the CPI to exaggerate the inflation rate do not include
a. the tendency of consumers to substitute relatively cheaper goods for those that have
become relatively more expensive.
b. political pressure from unions and retirees on the Bureau of Labor Statistics to overstate
the inflation rate.
c. the introduction of new technologies that make it easier to obtain the same standard of
living.
d. improvements over time on the quality of products.
ANS: B
political pressure from unions and retirees on the Bureau of Labor Statistics to overstate the inflation
rate.

11. Which of the following answers would accurately describe the bias in the CPI resulting from the fact
that oil prices suddenly increase?
a. underestimate the cost of living
b. overestimate the cost of living
c. have no bias effect on the CPI
d. could overestimate or underestimate the cost of living, depending upon the quantity of oil
purchased in that year
ANS: B
overestimate the cost of living
12. The CPI differs from the GDP deflator in that the CPI includes
a. raw material prices whereas the GDP deflator does not.
b. only goods whereas the GDP deflator includes both goods and services.
c. only services whereas the GDP deflator includes both goods and services.
d. only items the typical household buys, whereas the GDP deflator includes all goods and
services produced in the economy.
ANS: D
only items the typical household buys, whereas the GDP deflator includes all goods and services
produced in the economy.
13. The CPI differs from the GDP deflator in that the CPI
a. uses base-year quantities of goods to weight prices.
b. uses current-year quantities of goods to weight prices.
c. is not a weighted price index.
d. always indicates a higher rate of inflation than the GDP deflator.
ANS: A
uses base-year quantities of goods to weight prices.
14. The GDP deflator differs from the CPI because the GDP deflator includes goods we __________,
while the CPI includes goods we __________.
a. import; export
b. export; import
c. buy; sell
d. consume; produce
ANS: B
export; import
15. If the consumer price index has a value of 150 today and the base year is 1987, then consumer prices
have
a. increased by 50 percent since 1987.
b. doubled since 1987.
c. more than doubled since 1987.
d. declined 50 percent since 1987.
ANS: A
increased by 50 percent since 1987.
16. If the consumer price index has a value of 150 today and the base year is 1987, then it costs
a. $100 today to buy what cost $150 in the base year.
b. $1 today to buy what cost $150 in the base year.
c. $150 today to buy what cost $100 in the base year.
d. $2 today to buy what cost $1 in the base year.
ANS: C
$150 today to buy what cost $100 in the base year.
17. Use this table to find the real wage in 2002.
Year Nominal Wage ($/Hour) CPI

2001 $12.50 155.0
2002 $13.00 160.0
a. $8.06
b. $8.13
c. $13.00
d. $20.80
ANS: B
$8.13
18. If the CPI increases from 100 to 200 and the nominal wage increases from $100 to $400, what is the
change in the real wage in terms of the beginning year's dollars?
a. $200
b. $400
c. $100
d. -$200
ANS: C
$100
19. The real interest rate on a loan

a. is the amount that the consumer agrees to pay.
b. is always the same as the nominal rate.
c. is the percentage increase in the lender's purchasing power that results from making the
loan.
d. decreases as the inflation rate increases.
ANS: C
is the percentage increase in the lender's purchasing power that results from making the loan.
20. If a lender wants a real return of 6 percent and she expects inflation to be 4 percent, which of the
following is the nominal interest rate to charge?
a. 4 percent
b. 6 percent
c. 2 percent
d. 10 percent
ANS: D
10 percent
21. Suppose that a labor union leader is trying to bargain for an increase in union workers' real wages of 5
percent. If she expected the price level to rise at a rate of 3 percent this year, how much would nominal
wages need to increase for her to accomplish her objective?
a. 2 percent
b. 3 percent
c. 5 percent
d. 8 percent
ANS: D
8 percent
22. When borrowing money to purchase an automobile, Wei has the choice between a fixed nominal
interest rate or adjustable nominal interest rate loan. Typically the adjustable rate loans start with a
lower rate than the fixed rate loans. Given that, Wei would most likely want to borrow money at the
higher fixed rate when she expects the
a. inflation rate to rise.
b. inflation rate to fall.
c. inflation rate to remain unchanged.
d. government to take action to lower the inflation rate in the near future.
ANS: A
inflation rate to rise.
23. If you borrow money at a nominal interest rate of 5 percent and the inflation rate is 10 percent, what
real interest rate will you pay?
a. -5 percent
b. .5 percent
c. 2 percent
d. 10 percent
ANS: A
-5 percent
24. When the inflation rate ends up being lower than expected,
a. everyone benefits because money is cheaper.
b. everyone benefits because prices do not increase.
c. lenders of fixed-rate mortgages generally benefit because they will make higher profits
than they had calculated.
d. borrowers with fixed-rate loans will benefit because their purchasing power will not
decline as much.
ANS: D
borrowers with fixed-rate loans will benefit because their purchasing power will not decline as much.
25. In general, a higher-than-anticipated inflation rate

a. helps everyone.
b. hurts everyone.
c. helps creditors and harms debtors.
d. helps debtors and harms creditors.
ANS: D
helps debtors and harms creditors.

Chapter 23—Measuring a Nation's Income
MULTIPLE CHOICE
1. In the circular flow model, the source of the factors of production used to create goods and services is
a. the product market.
b. the resource market.
c. firms.
d. households.
ANS: D
households.
2. In the circular flow model, firms use the money they earn from selling their goods and services to pay
for the
a. goods and services they buy on the product market.
b. resources they buy on the product market.
c. goods and services they buy from government.
d. resources they buy in the factor market.
ANS: D
resources they buy in the factor market.
3. In the circular flow model, for every flow of goods, services, and resources there is a counter-flow of
a. more goods, services, and resources.
b. people from firms to households.
c. people from households to firms.
d. money.
ANS: D
money.
4. In producing a sweater, a man who shears sheep pays a farmer $4 for a sheep. The shearing shop sells
the wool to a knitting mill for $7. The knitting mill buys he wool and makes it into a fine fabric and
sells it to a sweater-making firm for $13. The sweater-making firm sells the sweater to a clothing store
for $20, and the clothing store sells the sweater, gift wrapped, for $50. What is the contribution to GDP
of the previous sales transactions?
a. $4.
b. $44.
c. $50.
d. $94.
ANS: C
$50.
5. Susie grows corn in her backyard garden to feed her family. The corn she grows is not counted in GDP
because
a. it was not produced for the marketplace.
b. it is an intermediate good which Susie will process further.
c. the corn has no value.
d. it reduces the amount of corn she will buy at the store.
ANS: A
it is not produced for the marketplace.
6. Which of the following would be counted in U.S. GDP?

a. the purchase of an historical house
b. the purchase of a haircut
c. the purchase of a $1000 government savings bond
d. the value generated when you wash your car in your driveway
ANS: B
the purchase of a haircut
7. Personal consumption spending now comprises approximately what fraction of GDP?

a. one-third
b. one-sixth
c. three-quarters
d. one half
ANS: C
three-quarters

8. If private investment increased by $50 billion while GDP remained the same, which of the following
could have occurred, all else being the same?
a. Consumption spending decreased by $50 billion.
b. Exports increased by $50 billion.
c. Imports decreased by $50 billion.
d. Net exports increased by $50 billion.
ANS: A
Consumption spending decreased by $50 billion.
9. Assume net exports are -$220, consumption is $5,000, tax revenues are $1,000, government purchases
are $1,500, and 1997 GDP, calculated by the expenditures approach, is $8,000. We can conclude that
a. private investment was $1,940.
b. public investment was $310.
c. private investment was $320.
d. private investment was $1,720.
ANS: D
private investment was $1,720.
10. The four categories of expenditures that make up GDP are consumption, investment,
a. exports, and government purchases.
b. imports, and government purchases.
c. net exports, and government [query: purchases].
d. net exports, and government transfer payments.
ANS: C
net exports, and government[query: purchases].
11. Which of the following would be counted as an investment expenditure in the national income
accounts?
a. The Navy builds a new battleship.
b. Microsoft expands plant capacity to produce new software.
c. A public high school builds a new football stadium.
d. All of the above would be counted as an investment expenditure.
ANS: B
Microsoft expands plant capacity to produce new software.
12. Real GDP is nominal GDP

a. plus depreciation.
b. adjusted for changes in the price level.
c. minus depreciation.
d. minus taxes.
ANS: B
adjusted for changes in the price level.
Table 23-1
An economy produces only two goods, oranges and VCRs. The quantities and prices for the years
1998 and 1999 are shown in the table. The base year is 1998.
1998 1999
Price Quantity Price Quantity
Oranges $2 5,000 $3 4,000
VCRs $400 1,000 $300 2,000
13. Refer to Table 23-1. Nominal GDP in 1998 is

a. $402.
b. $12,000.
c. $200,200
d. $410,000
ANS: D
$410,000
14. Refer to Table 23-1. Nominal GDP in 1999 is

a. $18,000.
b. $180,000.
c. $612,000.
d. $1,250,000.
ANS: C
$612,000.
15. Refer to Table 23-1. Real GDP in 1998 is

a. $6,000.
b. $240,000.
c. $410,000.
d. $612,000.
ANS: C
$410,000.
16. Refer to Table 23-1. Real GDP in 1999 is

a. $6,000.
b. $410,000.
c. $612,000.
d. $808,000.
ANS: D
$808,000

17. Refer to Table 23-1. The GDP deflator in 1999 is about
a. .76.
b. .67.
c. .51.
d. 1.32.
ANS: A
.76
18. Refer to Table 23-1. The growth rate of nominal GDP in 1999 was about
a. 10 percent.
b. 49 percent.
c. 78 percent.
d. 100 percent.
ANS: B
49 percent.
19. Refer to Table 23-1. The growth rate of real GDP in 1999 was about
a. 24 percent.
b. 50 percent.
c. 97 percent.
d. 125 percent.
ANS: C
97 percent.
20. Refer to Table 23-1. The rate of inflation in 1999 was about
a. -48 percent.
b. -24 percent.
c. 33 percent.
d. 67 percent.
ANS: B
-24 percent.
21. Suppose a person marries his or her gardener and therefore no longer pays him or her for gardening
services. GDP
a. stays the same as long as the services are still provided.
b. increases since the services are now provided for free.
c. decreases since there is no longer a market exchange.
d. stays the same, since services are not included in GDP.
ANS: C
decreases since there is no longer a market exchange.
22. Which of the following would most likely cause GDP to overstate the actual output produced in a
year?
a. increased production in the underground economy
b. a decline in the quality of goods and services produced
c. increased production for home use (non-market production)
d. a decline in population
ANS: B
a decline in the quality of goods and services produced
23. Suppose that population grows by 2 percent. For the standard of living to rise, which of the following
must occur?
a. Nominal GDP must grow by more than 2 percent.
b. Real GDP must grow by more than 2 percent.
c. Real GDP per capita must grow by more than 2 percent.
d. consumption spending must grow by more than 2 percent.
ANS: B
Real GDP must grow by more than 2 percent.
24. During recessions, GDP falls and unemployment increases. Why might the actual output produced not
fall as much as officially measured GDP during a recession?
a. There is an increase in involuntary part-time employment, the output from which is not
accounted for in GDP.
b. Workers who became unemployed during the recession may produce goods in the
underground economy.
c. Unemployment benefits to laid-off workers will allow them to purchase nearly as much
output as before.
d. Laid off workers may start their own businesses, but profit income from self-employment
is not accounted for in GDP.
ANS: B
Workers who became unemployed during the recession may produce goods in the underground
economy.
25. Which of the following is a problem with the measurement of GDP?

a. Transfer payments are not included.
b. Production in the underground economy is not counted.
c. Non-market production is not counted.
ANS: D
Both b and c are correct.

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Chapter 1—Ten Principles of Economics

1. Choices must be made in the use of resources

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2. The cost to an airline of letting its employees fly at no charge

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4. The opportunity cost of building an additional parking lot at your school is

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8. A nation's standard of living can be increased by

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9. In a market economy, the economic well being of society is the responsibility of

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10. An important element of the market process is that

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19. Inflation reduces

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20. The inflation rate is the

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23. Which of the following diagrams represents a Phillips Curve:

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25. Policymakers can make effective short-term policy actions because

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2. The ultimate purpose of an economic model is to

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5. The three sources of income for the household are

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6. Households play what role(s) in the circular flow diagram?

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13. All points on a production possibilities frontier show the

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19. The distinction between positive and normative economics

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