Macroeconomics 4th Australian Edition Glenn Hubbard – Test Bank

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Chapter 5

Economic growth, the financial system and business cycles

 

Choose the one alternative that best completes the statement or answers the question.

1) The only way the standard of living of the average person in a country can increase is by increasing ________ faster than ________.

  1. A) production; population
  2. B) income; population
  3. C) population; production
  4. D) population; income

Answer: A

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

2) Which of the following describes the growth in real GDP per person in Australia from 1901 to 2016?

  1. A) It has decreased more times than it has increased.
  2. B) It has increased by more than five times.
  3. C) It has doubled.
  4. D) Nominal GDP has increased but real GDP has slowly decreased.

Answer: B

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

3) When production in an economy grows more quickly than the population in that economy, which of the following must be occurring?

  1. A) Real GDP is falling.
  2. B) Incomes are growing at a slower rate than the population.
  3. C) Real GDP per capita is rising.
  4. D) Living standards are falling.

Answer: C

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

4) Which of the following is the best measure of the standard of living?

  1. A) Nominal GDP for the whole economy.
  2. B) Real GDP for the whole economy.
  3. C) Nominal GDP per capita.
  4. D) Real GDP per capita.

Answer: D

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

5) Over the past 100 years, economic growth has ________ health, and health has ________ economic growth.

  1. A) improved; worsened
  2. B) improved; improved
  3. C) worsened; improved
  4. D) worsened; worsened

Answer: B

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

6) Which of the following has not been a long-term trend in the Australian economy since 1901?

  1. A) increasing nominal GDP
  2. B) increasing real GDP
  3. C) increasing unemployment rates
  4. D) increasing real GDP per capita

Answer: C

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

7) ‘Long-term economic growth’ is a term used to describe the:

  1. A) falling unemployment rates over time.
  2. B) rising price level over time.
  3. C) more rapid growth in population than of real output.
  4. D) increasing trend in real GDP per capita.

Answer: D

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

8) Suppose that real GDP for 2017 was $10 000 billion and real GDP for 2018 was $11 000 billion. What is the rate of growth of real GDP?

  1. A) 11%
  2. B) 10%
  3. C) 5%
  4. D) 2%

Answer: B

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to translate knowledge of business and management into practice

 

9) Suppose that real GDP for 2017 was $10 000 billion and real GDP for 2018 was $9 500 billion. What is the rate of growth of real GDP?

  1. A) -10%
  2. B) 1%
  3. C) 5%
  4. D) -5%

Answer: D

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to translate knowledge of business and management into practice

 

10) If, between 2007 and 2017, the economy’s real GDP grew from $20 billion to $40 billion, the average growth rate in the economy was

  1. A) 3%.
  2. B) 7%.
  3. C) 20%.
  4. D) 100%.

Answer: B

Difficulty: Complex

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to translate knowledge of business and management into practice

 

11) If GDP grew 3% in 2015, 2.8% in 2016 and 2.4% in 2017, then what is the average annual growth rate over this period?

  1. A) 5%
  2. B) 2.7%
  3. C) 4%
  4. D) -2.2%

Answer: B

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to translate knowledge of business and management into practice

 

12) If GDP grows at a rate of 2.8% per year, approximately how long will it take for GDP to double in size?

  1. A) 12 years
  2. B) 21 years
  3. C) 23 years
  4. D) 25 years

Answer: D

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to translate knowledge of business and management into practice

 

13) If an economy is growing at a rate of 2.3% per year, how long will it take the economy to double in size?

  1. A) 60 years
  2. B) 43 years
  3. C) 36 years
  4. D) 30 years

Answer: D

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to translate knowledge of business and management into practice

 

14) The ‘rule of 70’ states that:

  1. A) it takes an economy 70 years to double in size.
  2. B) the number of years it takes an economy to double is 70 divided by the growth rate.
  3. C) the number of years it takes an economy to double is the growth rate multiplied by 70.
  4. D) the number of years it takes an economy to double is the growth rate divided by 70.

Answer: B

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

15) If GDP is currently $13 trillion and is growing at a rate of 2.6% per year, how long will it take GDP to reach $26 trillion?

  1. A) about 15 years
  2. B) about 17 years
  3. C) about 27 years
  4. D) about 30 years

Answer: C

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to translate knowledge of business and management into practice

 

16) ‘Labour productivity’ is the quantity of:

  1. A) output that can be produced in one hour by several workers.
  2. B) labour produced in one hour in an economy.
  3. C) output produced in one hour by one worker.
  4. D) output produced in one hour by one machine.

Answer: C

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

17) ‘Labour productivity’ will increase if the ________ increases and ________.

  1. A) quantity of capital per hour worked; technological change occurs
  2. B) quantity of labour per unit of capital; technological change occurs
  3. C) quantity of capital per hour worked; immigration increases while capital is fixed
  4. D) quantity of labour per unit of capital; immigration increases while capital is fixed

Answer: A

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

18) What is ‘human capital’?

  1. A) A term used to describe the underground labour market.
  2. B) Manufactured goods that are used to produce other goods.
  3. C) Accumulated knowledge and skills acquired by a worker.
  4. D) The manager or owner of a business.

Answer: C

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

19) When the capital stock per hour worked:

  1. A) increases, labour productivity in increases.
  2. B) increases, labour productivity falls, as workers are being replaced with capital and machinery.
  3. C) decreases, labour productivity increases.
  4. D) increases, capital productivity increases.

Answer: A

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

20) Workers in ________ countries have ________ to work with than do workers in low income countries.

  1. A) high income; less physical capital
  2. B) high income; more physical capital
  3. C) high income; more labour
  4. D) low income; less labour

Answer: B

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

21) Which of the following will result in an increase in labour productivity?

  1. A) A decrease in the number of people attending institutions of higher education.
  2. B) A decline in the amount of human capital per worker.
  3. C) An increase in technology.
  4. D) A decline in the capital stock per hour worked.

Answer: C

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

22) Which of the following is most likely to be able to sustain economic growth in an economy?

  1. A) sustained increases in the labour force participation rate
  2. B) technological change
  3. C) increases in capital per hour worked
  4. D) the accumulation of economic resources

Answer: B

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

23) Long-run economic growth:

  1. A) is due to increases in capital productivity rather than labour productivity.
  2. B) does not usually occur due to the economic recessions that occur as part of the business cycle.
  3. C) depends more on increases in capital per hour worked than on technological change.
  4. D) depends more on technological change than on increases in capital per hour worked.

Answer: D

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

24) If, as economist Alwyn Young has suggested, high economic growth rates in Singapore are not a result of technological progress, how are growth rates in Singapore expected to change over time?

  1. A) Without technological progress, the high growth rates cannot be sustained.
  2. B) As long as the labour force participation rate is rising, growth can still continue, despite a lack of technological progress.
  3. C) As long as the amount of capital per hour worked continues to expand, the growth rate in Singapore will continue to rise at an increasing rate.
  4. D) Agricultural workers will continue to expand their productivity, thereby allowing Singapore to achieve growth rates above those of higher-income countries.

Answer: A

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

25) ‘Potential GDP’ is defined as the:

  1. A) maximum level of GDP that the economy can produce.
  2. B) amount of GDP produced if there is a zero rate of unemployment.
  3. C) level of GDP attained when all firms are producing at capacity.
  4. D) amount of GDP produced when the economy is in equilibrium.

Answer: C

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

26) Potential GDP in Australia:

  1. A) does not change much over time.
  2. B) grows as the economy grows.
  3. C) changes over the business cycle.
  4. D) declines over time.

Answer: B

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

27) Which of the following would not increase potential GDP?

  1. A) an increase in the size of the labour force
  2. B) technological change
  3. C) a fall in the rate of unemployment
  4. D) new factories being built

Answer: C

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

Write ‘True’ if the statement is correct and ‘False’ is the statement is incorrect.

28) Long-run economic growth is measured by changes in real GDP per person over time.

Answer: True

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

29) The ‘rule of 70’ states that it takes approximately 70 years for a developing economy to become a developed economy once economic growth begins.

Answer: False

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

30) ‘Labour productivity’ increases when capital stock per person falls, as there is a trade-off between capital and labour.

Answer: False

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

31) Economic growth depends more on technological change than on increases in capital per hour worked.

Answer: True

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

32) Potential GDP is always greater than real GDP in an economy.

Answer: False

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to analyse and frame problems

 

Write your answer in the space provided or on a separate sheet of paper.

33) Outline the trend in real GDP per capita in Australia from 1901 to 2016.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

It has trended upwards, increasing by about five times during this time, while experiencing short-term falls during times of depression, recession or economic contraction.

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to communicate effectively orally and in writing

 

34) Explain why the increase in GDP per capita understates the whole effect of economic growth on the standard of living.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

Economic growth has led not just to an increase in the quantity of goods and services per person, but new goods and services becoming available, improved medical technology and improved education.

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to communicate effectively orally and in writing

 

35) Use the ‘rule of 70’ to illustrate how small differences in growth rates can have a large impact on how rapidly the standard of living in a country increases.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

The rule of 70 is a calculation that tells the number of years it will take for real GDP to double in an economy for a particular growth rate. The formula is as follows:

 

Number of years to double =

 

If the growth rate is 1%, it will take 70 years for GDP to double. If the growth rate is 2%, GDP will double in 70/2 years = 35 years. A small increase in the growth rate (from 1% to 2%) halves the number of years it takes for the economy to double. If the growth rate is 5%, GDP will double in 14 years. So when the rate of growth jumps 3 more percentage points, GDP doubles in less than half the time as when growth was 2%.

Difficulty: Complex

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to communicate effectively orally and in writing

 

36) What factors determine labour productivity?

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

The quantity of capital per hour worked, the level of technology, and the health and education levels of workers.

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to communicate effectively orally and in writing

 

37) Outline the various actions the government sector could take to promote growth.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

The government should secure private property rights. Private property rights are crucial for a smoothly functioning market system. The government should create a court system that will enforce contracts. It should also assist in the development of the country’s financial system. Additional endeavours also include strengthening the education, communication and transportation systems.

Difficulty: Moderate

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to communicate effectively orally and in writing

 

38) What is ‘potential GDP’?

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

Potential GDP is the level of GDP attained when all firms are producing at capacity. A firm’s capacity is measured by its production when operating on normal hours using its normal workforce.

Difficulty: Basic

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to communicate effectively orally and in writing

 

39) Suppose you are a highly regarded international economic advisor. You have been asked to assess the possibilities of growth in an African country. It is a country abundant in labour and some natural resources. The capital to labour ratio is low. It has a free market economy. You have found that this country does not have a very strong and healthy banking system; however, the political system is stable and the government does a good job protecting property rights. Assess this country’s prospects for growth. Recommend two things that would enhance the country’s growth.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

The prospects for this country’s growth are fairly good. It has a lot of labour and some natural resources. Having abundant factors of production can contribute to strong growth. The free market system is also another characteristic that should help enhance economic growth. Entrepreneurs can respond quickly and adopt technological innovations. We know that technological change can increase labour productivity. Also, the fact that the government enforces property rights can help the free market to flourish. The political stability of the government is also a good sign. Investors are less likely to be afraid to risk investing in the country. To increase the capital to labour ratio, the country could try to attract foreign investment, or perhaps give tax incentives to firms that increase the amount they invest.

Difficulty: Complex

Learning Objective: 5.1 Discuss the importance of long-run economic growth and its impact on living standards.

Topic: Long-run economic growth is the key to rising living standards

AACSB: Able to communicate effectively orally and in writing

 

Choose the one alternative that best completes the statement or answers the question.

40) What are financial securities that represent partial ownership of a firm?

  1. A) bonds
  2. B) shares
  3. C) treasury bills
  4. D) certificates of deposit

Answer: B

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

41) What are financial securities that represent promises to repay a fixed amount of funds?

  1. A) bonds
  2. B) shares
  3. C) savings accounts
  4. D) certificates of deposit

Answer: A

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

42) Which one of the following is not considered a financial intermediary?

  1. A) a building society
  2. B) a managed fund
  3. C) an insurance company
  4. D) a financial advisor

Answer: D

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

43) What is the ease with which a financial security can be exchanged for money?

  1. A) liquidity
  2. B) the face value
  3. C) risk
  4. D) the rate of return

Answer: A

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

44) Which of the following is not one of the key services provided by the financial system?

  1. A) decreasing taxes
  2. B) risk sharing
  3. C) liquidity
  4. D) information

Answer: A

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

45) A financial intermediary’s main function is to match ________ with excess funds to ________ who want to borrow funds.

  1. A) households; firms
  2. B) firms; firms
  3. C) households; households
  4. D) firms; households

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

46) What is the term for a country with no trade and no borrowing and lending with other countries?

  1. A) planned economy
  2. B) closed economy
  3. C) open economy
  4. D) market economy

Answer: B

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

47) Let I = investment; Y = total income; C = consumption; G = government purchases.

In a closed economy:

  1. A) I = Y – C – G.
  2. B) I = Y + C – G.
  3. C) I = Y – C + G.
  4. D) I = Y + C + G.

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

48) If real GDP in a closed economy is $50 billion, consumption is $30 billion, and government purchases are $15 billion, what is investment?

  1. A) $15 billion
  2. B) $30 billion
  3. C) $40 billion
  4. D) $70 billion

Answer: A

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to translate knowledge of business and management into practice

 

49) Let Y = total income; C = consumption; G = government purchases; T = taxes; TR = transfer payments. Private saving is defined as:

  1. A) Y + TR – C – T.
  2. B) T + G + TR.
  3. C) T – G + TR.
  4. D) Y + TR + C – T.

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

50) Let Y = total income; C = consumption; G = government purchases; T = taxes; TR = transfer payments. Public saving is defined as:

  1. A) Y + TR – C – T.
  2. B) T + G + TR.
  3. C) T – G – TR.
  4. D) Y + TR + C – T.

Answer: C

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

51) How can public savings in the economy be increased?

  1. A) raising taxes
  2. B) raising government spending
  3. C) lowering taxes
  4. D) raising transfer payments

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

52) Let Y = total income; C = consumption; G = government purchases; T = taxes; TR = transfer payments. Total saving in the economy can be expressed as:

  1. A) Y + TR – C – T.
  2. B) Y – T.
  3. C) T – G – TR.
  4. D) Y – C – G.

Answer: D

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

53) If, in a closed economy, real GDP is $25 billion, consumption is $15 billion, and government purchases are $7 billion, what is the total saving in the economy?

  1. A) $7 billion
  2. B) $15 billion
  3. C) $25 billion
  4. D) $55 billion

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to translate knowledge of business and management into practice

 

54) In a closed economy, the relationship between saving and investment is that:

  1. A) saving is greater than investment.
  2. B) investment is equal to saving.
  3. C) investment is greater than saving.
  4. D) investment may be greater or smaller than saving.

Answer: C

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

55) If taxes are more than transfer payments plus government spending, then there:

  1. A) are positive savings.
  2. B) is a balanced budget.
  3. C) is a budget surplus.
  4. D) is dissaving.

Answer: C

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

56) Let G = government purchases; T = taxes; TR = transfer payments. There is public dissaving if:

  1. A) G + TR > T.
  2. B) G + TR < T.
  3. C) TR > G + T.
  4. D) TR < G + T.

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

57) Let G = government purchases; T = taxes; TR = transfer payments. The budget deficit is defined as:

  1. A) T – (G + TR) < 0.
  2. B) T – (G + TR) > 0.
  3. C) T + (G – TR) < 0.
  4. D) T + (G+ TR) < 0.

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

58) Let G = government purchases; T = taxes; TR = transfer payments. The budget surplus is defined as:

  1. A) T – (G + TR) > 0.
  2. B) T – (G + TR) < 0.
  3. C) T + (G – TR) > 0.
  4. D) T + (G + TR) > 0.

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

59) Which of the following statements about the Australian federal budget is true?

  1. A) In 2010, the federal budget was in deficit by $54 billion.
  2. B) In 1996, the federal budget was in deficit by $5 billion.
  3. C) In 2007, the federal budget was in surplus by $17 billion.
  4. D) All of these options are correct.

Answer: D

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

60) A federal budget surplus could be reduced by:

  1. A) raising taxes.
  2. B) lowering government spending.
  3. C) increasing transfer payments.
  4. D) lowering interest rates.

Answer: C

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

61) When is there a federal budget deficit?

  1. A) the government spends more than it collects in taxes
  2. B) the government spends less than it collects in taxes
  3. C) the government spends the same amount it collects in taxes
  4. D) taxes are too high

Answer: A

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

62) When is there a federal budget surplus?

  1. A) the government spends more than it collects in taxes
  2. B) the government spends less than it collects in taxes
  3. C) the government spends the same amount it collects in taxes
  4. D) taxes are too high

Answer: B

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

63) The demand for loanable funds has a ________ slope because the lower the interest rate, the ________ number of investment projects are profitable, and the ________ the quantity of loanable funds demanded.

  1. A) negative; greater; greater
  2. B) negative; greater; lesser
  3. C) negative; lesser; greater
  4. D) positive; lesser; lesser

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

64) A decrease in the real interest rate does which of the following?

  1. A) increases the demand for loanable funds
  2. B) decreases saving
  3. C) increases consumption spending
  4. D) decreases the demand for loanable funds

Answer: C

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

65) The demand for loanable funds is determined by the willingness of ________ to borrow money to engage in new investment projects.

  1. A) government
  2. B) households
  3. C) banks
  4. D) firms

Answer: D

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

66) Using the market for loanable funds, which of the following has the potential to raise the real interest rate?

  1. A) an increase in the demand for loanable funds
  2. B) an increase in the quantity demanded of loanable funds
  3. C) an increase in the supply of loanable funds
  4. D) an increase in the quantity supplied of loanable funds

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

67) An increase in the real interest rate results in which of the following?

  1. A) an increase in the demand for loanable funds
  2. B) a decrease in the demand for loanable funds
  3. C) an increase in the quantity of loanable funds supplied
  4. D) Both B and C will occur as a result of an increase in the real interest rate.

Answer: C

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

68) An increase in the real interest rate will:

  1. A) decrease consumption and reduce investment.
  2. B) decrease saving and investment.
  3. C) increase investment and government spending.
  4. D) decrease consumption and investment.

Answer: D

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

69) The supply of loanable funds has a ________ slope because the greater the interest rate, the ________ the reward to savings, and the ________ the quantity of loanable funds supplied.

  1. A) positive; lesser; lesser
  2. B) positive; greater; lesser
  3. C) negative; lesser; greater
  4. D) positive; greater; greater

Answer: D

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

70) Equilibrium in the loanable funds market determines the:

  1. A) nominal interest rate.
  2. B) current interest rate.
  3. C) real interest rate.
  4. D) expected interest rate.

Answer: C

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

71) If firms are anticipating that the profitability of new investments will be lower in the future, then the ________ curve for loanable funds will shift to the ________.

  1. A) supply; right
  2. B) supply; left
  3. C) demand; right
  4. D) demand; left

Answer: D

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

72) If technological change increases the profitability of new investment for firms, then the ________ curve for loanable funds will shift to the ________ and the equilibrium real interest rate will ________.

  1. A) supply; right; fall
  2. B) supply; left; rise
  3. C) demand; right; rise
  4. D) demand; left; fall

Answer: C

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

73) In the model of the market for loanable funds, which of the following will not shift the demand curve for loanable funds?

  1. A) expectations of high returns to investments
  2. B) the effect of technological change on profitability
  3. C) lower interest rates
  4. D) the expectation of a recession by businesses

Answer: C

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

74) In the model of the market for loanable funds, which of the following will not shift the supply curve for loanable funds?

  1. A) expectations of high returns to investments
  2. B) a decrease in taxation on interest earned on savings accounts
  3. C) a government budget surplus
  4. D) a government budget deficit

Answer: A

Difficulty: Complex

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

75) A government budget deficit will shift the ________ curve for loanable funds to the ________ and the equilibrium real interest rate will ________.

  1. A) supply; right; fall
  2. B) supply; left; rise
  3. C) demand; right; rise
  4. D) demand; left; fall

Answer: B

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

76) A government budget surplus will shift the ________ curve for loanable funds to the ________ and the equilibrium real interest rate will ________.

  1. A) supply; right; fall
  2. B) supply; left; rise
  3. C) demand; right; rise
  4. D) demand; left; fall

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

Refer to Figure 5.1 for the following questions.

 

Figure 5.1

 

 

77) Refer to Figure 5.1. An increase in the supply of loanable funds could result in which of the following combinations of the real interest rate and quantity of loanable funds at a new equilibrium?

  1. A) The real interest rate is 5%, and the quantity of loanable funds is $150 million.
  2. B) The real interest rate is 5%, and the quantity of loanable funds is $90 million.
  3. C) The real interest rate is 3%, and the quantity of loanable funds is $150 million.
  4. D) The real interest rate is 3%, and the quantity of loanable funds is $90 million.

Answer: C

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to translate knowledge of business and management into practice

 

78) Refer to Figure 5.1. As a result of an increase in the government budget deficit, the ________ for loanable funds will ________, thereby ________ the equilibrium real interest rate and ________ the equilibrium quantity of loanable funds.

  1. A) demand; rise; increasing; decreasing
  2. B) supply; rise; decreasing; increasing
  3. C) demand; fall; decreasing; decreasing
  4. D) supply; fall; increasing; decreasing

Answer: D

Difficulty: Complex

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to translate knowledge of business and management into practice

 

79) Refer to Figure 5.1. If the current real interest rate is 5%, which of the following is true?

  1. A) The loanable funds market is in equilibrium.
  2. B) There is a surplus of loanable funds in the market.
  3. C) There is a shortage of loanable funds in the market.
  4. D) The quantity of loanable funds being demanded in the market is less than $90 million.

Answer: B

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to translate knowledge of business and management into practice

 

80) Refer to Figure 5.1. Beginning at equilibrium, if the government budget deficit rises, which of the following would you expect to see?

  1. A) The quantity of loanable funds demanded by firms will rise above $120 million.
  2. B) The quantity of loanable funds demanded by firms will fall below $120 million.
  3. C) The budget deficit will have no impact on the quantity of loanable funds demanded by firms.
  4. D) The interest rate will fall below 4%.

Answer: B

Difficulty: Complex

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to translate knowledge of business and management into practice

 

81) If you spend more of your income on consumption goods, which of the following will occur?

  1. A) The production of investment goods will fall.
  2. B) Economic growth will be stimulated.
  3. C) Investments in education will rise.
  4. D) For every dollar you spend on consumption, real GDP will fall by a dollar.

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

82) A decrease in public saving has what impact on the market for loanable funds?

  1. A) The supply of loanable funds increases.
  2. B) The demand for loanable funds increases.
  3. C) The supply of loanable funds decreases.
  4. D) The demand for loanable funds decreases.

Answer: C

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

83) Economist Steve Landsburg has pointed out that Ebenezer Scrooge’s change in behaviour from miser to spender might actually be detrimental to the economy because:

  1. A) Scrooge’s miserly saving helped contribute to the production of investment goods rather than consumption goods.
  2. B) Scrooge was happiest when he was saving money, and happiness is the key to economic growth.
  3. C) Saving has to be greater than consumption for the economy to grow.
  4. D) Scrooge’s consumption habits were more detrimental to the environment than were his earlier saving habits.

Answer: A

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

Write ‘True’ if the statement is correct and ‘False’ is the statement is incorrect.

84) Retained earnings are usually sufficient to finance a firm’s rapid expansion in a high growth economy.

Answer: False

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

85) Financial markets and financial intermediaries comprise the financial system in Australia.

Answer: True

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

86) In an open economy, the relationship between total income (Y) and expenditures is:

Y = C + I + G.

Answer: False

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

87) Public saving is equal to taxation receipts, minus government purchases, minus transfer payments.

Answer: True

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

88) Government budget surpluses and deficits affect the supply of loanable funds, and therefore affect interest rates.

Answer: True

Difficulty: Moderate

Learning Objective: 5. Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

89) Empirical evidence shows that the impact of government budget deficits and surpluses on the equilibrium interest rate is quite large.

Answer: False

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to analyse and frame problems

 

Write your answer in the space provided or on a separate sheet of paper.

90) How does the existence of financial intermediaries affect liquidity in the financial market?

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

Liquidity is the ease with which a financial asset can be converted into money. A financial intermediary provides individuals with a market in which they can buy and sell their securities and convert them into cash. Those that hold shares and bonds can easily trade them in the share market or bond market. Without these organised markets, savers would have to contact potential buyers on their own, which would extend the amount of time it would take to convert the share or bond to cash. Financial intermediaries increase liquidity in the financial market.

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to communicate effectively orally and in writing

 

91) How do financial intermediaries affect risk in the financial market?

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

The existence of financial intermediaries decreases the amount of risk a saver might encounter when buying a financial asset. Risk is the chance that the value of the financial asset will change relative to what one might expect. A financial intermediary can help a saver spread the amount of risk on savings by allowing the saver to invest in many different financial assets. For example, instead of buying one type of share or bond, a saver can buy into a managed fund. This fund is a combination of many different financial assets, with different levels of risk. The saver then incurs the average level of risk in the fund. This has the effect of lowering the amount of risk that the individual would face in the absence of the financial intermediary.

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to communicate effectively orally and in writing

 

92) Carefully define the two categories of ‘saving’ in the economy.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

There are two categories of saving in the economy are: private saving by households and public saving by the government. Private saving is what is left of income after subtracting consumers’ purchases of goods and services and subtracting consumers’ tax payments. Public saving is the amount of tax revenue that the government retains after subtracting government expenditures and transfer payments.

Difficulty: Basic

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to communicate effectively orally and in writing

 

93) Using equations, show that saving must be equal to investment in the closed economy. Begin with the expression of total saving in the economy.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

Start with the expression of total saving in the economy. This is the sum of private saving and public saving:

S = Sprivate + Spublic. (1)

Private saving is:

Sprivate = Y + TR – C – T. (2)

This states that private saving is what is left over after consumption expenditures (C) and taxes (T) are subtracted from household income (Y) plus transfers (TR).

 

Public saving is:

Spublic = T – G – TR. (3)

Public saving is what is left over after government spending (G) and transfer payments (TR) are subtracted from taxes (T).

 

Combining (2) and (3) into (1) we get

S = Y + TR – C – T + T – G – TR. Note that taxes and transfers cancel each other out leaving:

S = Y – C – G (4)

 

Now we know that income (Y) is exactly equal to production or Y = C + I + G in a closed economy. Substituting the right-hand side of this expression in (4), we get S = C + I + G – C – G. The consumption values cancel, as does the level of government spending, leaving S = I.

Difficulty: Complex

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to translate knowledge of business and management into practice

 

94) Explain why increasing the government budget deficit can decrease investment spending.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

Saving must equal investment in the economy or S = I. Saving in the economy is equal to the sum of private saving plus public saving or

S = Sprivate + Spublic and since saving must equal investment we get:

I = Sprivate + Spublic.

Interpreting this expression, the larger saving is in the economy, the larger too is investment. One way to increase saving is to increase public saving. Public saving is Spublic = T – G – TR. The budget deficit is defined as the difference between taxes (T) and government spending plus transfer payments. When the expression for public saving is negative, the government is running a deficit. When this occurs, the total amount of saving in the economy falls. Since the total amount of saving in the economy equals investment, investment falls.

Difficulty: Complex

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to communicate effectively orally and in writing

 

95) Explain why the demand for loanable funds curve has a negative slope.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

The demand for loanable funds reflects the willingness of firms to borrow the money that they need to launch new investment projects, such as building a new factory, or overhauling the equipment that they use for production. Most firms do not have the funds internally in retained earnings to finance these projects, so they must borrow them. Firms undertake these ventures in order to earn profit. Each of these projects has a rate of return. It is profitable for a firm to undertake a project as long as the rate of return of the project exceeds the interest rate. That is, if a firm expects to earn 10% return on opening a new factory, the project will be profitable if the firm can borrow the funds at a rate less than 10%. As the interest rate falls, more investment projects become viable for the firm. So as the interest rate falls, the quantity demanded of loanable funds would rise as the firm would need to borrow more funds to invest in these newly profitable projects.

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to communicate effectively orally and in writing

 

96) Explain and show graphically how a decrease in household saving affects the equilibrium interest rate and the equilibrium quantity of loanable funds.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

A decrease in household saving decreases the supply of loanable funds, shifting the supply curve for loanable funds to the left, as shown in the following graph. The decrease in the supply of loanable funds results in an increase in the equilibrium interest rate and a decrease in the equilibrium quantity of loanable funds.

 

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to translate knowledge of business and management into practice

 

97) Explain and show graphically how a decrease in government spending, ceteris paribus, affects the equilibrium interest rate and equilibrium quantity of loanable funds in the market for loanable funds.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

When government spending decreases, government saving (T G TR) rises. This increase in government saving shifts the supply curve for loanable funds to the right, decreasing the equilibrium interest rate and increasing the equilibrium quantity of loanable funds, as shown in the following graph.

 

Difficulty: Moderate

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to translate knowledge of business and management into practice

 

98) Assume that the government reduces taxation on earnings from dividends on shares. Use the model of the loanable funds market to describe what will happen to the savings, investment, economic growth, the real interest rate and the quantity of loanable funds exchanged.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

Dividends are the share of company profits paid to shareholders. Dividends are subject to income tax. If taxes on dividends are decreased, this raises the after-tax rate of return on shares that offer dividends. Since the return to savings would increase, savings will increase and the supply of loanable funds will increase. The shift to the right by the supply curve for loanable funds should lower the real interest rate and increase the quantity of loanable funds exchanged. This will raise investment spending in the economy. As investment spending grows, the capital stock and capital per hour worked should grow, and the rate of economic growth should increase.

Difficulty: Complex

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to communicate effectively orally and in writing

 

99) Explain how a decrease in the tax rate on interest earned on savings would affect saving, investment, the interest rate and economic growth.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

One determinant of the amount of household saving is the interest rate or the after-tax rate of return that households earn on the amount that they save. The higher the rate of return, the more the households will save. Individuals care about the rate of return that they earn from savings after taxes. Decreasing the tax rate on income earned from savings will increase the after-tax return from savings.

 

Since the after-tax rate of return rises for every dollar invested, the supply of loanable funds will increase, shifting the supply of loanable funds to the right. If the supply of loanable funds shifts to the right, this will lower the interest rate. As the interest rate declines, more investment projects become profitable. Firms will respond by increasing the amount of investment. This will raise the amount of capital available per worker. As the capital to labour ratio increases, so does labour productivity and growth in the economy.

Difficulty: Complex

Learning Objective: 5.2 Discuss the role of the financial system in facilitating long-run economic growth.

Topic: Saving, investment and the financial system

AACSB: Able to communicate effectively orally and in writing

 

Choose the one alternative that best completes the statement or answers the question.

100) During the expansion phase of the business cycle:

  1. A) production increases.
  2. B) employment decreases.
  3. C) income decreases.
  4. D) unemployment increases.

Answer: A

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

101) A period of expansion in the business cycle ends when:

  1. A) real GDP is equal to potential GDP.
  2. B) the business cycle reaches its peak.
  3. C) the business cycle reaches its trough.
  4. D) real GDP is less than potential GDP.

Answer: B

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

102) What happens during the contraction phase of the business cycle?

  1. A) production increases
  2. B) unemployment increases
  3. C) income increases
  4. D) employment increases

Answer: B

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

103) A ‘technical recession’ is defined as:

  1. A) one year of negative economic growth.
  2. B) six months of negative economic growth.
  3. C) a contraction in the economic growth rate from 5% to 3%.
  4. D) a period of rising prices.

Answer: B

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

104) A(n) ________ comes to an end with a business cycle ________.

  1. A) recession; peak
  2. B) recession; trough
  3. C) expansion; trough
  4. D) expansion; phase

Answer: B

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

105) A ‘recession’ is often defined as:

  1. A) two consecutive quarters experiencing a decline in the economic growth rate.
  2. B) two consecutive quarters of declining nominal GDP.
  3. C) a significant decline in activity visible in industrial production, employment, real income, and wholesale/retail trade lasting more than a few months.
  4. D) a significant decline in inflation and unemployment lasting more than a few months.

Answer: C

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

106) The beginning of an economic contraction coincides with a/an ________ while during an economic expansion ________

  1. A) decrease in government spending; investment increases.
  2. B) decrease in investment; investment increases.
  3. C) decrease in government spending; government spending increases.
  4. D) increase in government spending; investment decreases.

Answer: B

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

107) Which of the following is not a phase in the business cycle?

  1. A) shutdown
  2. B) trough
  3. C) peak
  4. D) expansion

Answer: A

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

108) As the economy nears the end of an expansion, interest rates usually ________ and wages rise more ________ than prices.

  1. A) rise; rapidly
  2. B) rise; slowly
  3. C) fall; rapidly
  4. D) fall; slowly

Answer: A

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

109) An ‘economic contraction’ begins with a/an ________ in spending by firms on capital goods and a/an ________ in spending on durable goods by households.

  1. A) increase; decrease
  2. B) increase; increase
  3. C) decrease; increase
  4. D) decrease; decrease

Answer: D

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

110) During an expansion, how do inflation and unemployment typically change?

  1. A) inflation and unemployment both rise
  2. B) inflation and unemployment both fall
  3. C) inflation falls and unemployment rises
  4. D) inflation rises and unemployment falls

Answer: D

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

111) Which of the following goods would usually see the largest decline in demand during a recession?

  1. A) cars
  2. B) food
  3. C) clothing
  4. D) hair cuts

Answer: A

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to translate knowledge of business and management into practice

 

112) Because a company such as Boeing produces expensive durable goods (aircraft), the demand for their goods:

  1. A) is likely to increase during recession.
  2. B) declines when incomes in the economy are rising.
  3. C) is consistently high, regardless of the state of the economy.
  4. D) tends to follow the business cycle.

Answer: D

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to translate knowledge of business and management into practice

 

113) What happens when a recession ends?

  1. A) Firms increase the amount of borrowing.
  2. B) Households decrease spending on durable goods.
  3. C) The household sector decreases spending substantially.
  4. D) Interest rates decrease.

Answer: A

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

114) Total motor vehicle sales in Australia:

  1. A) have slowly decreased over time.
  2. B) decline by a greater percentage than does GDP during an economic contraction.
  3. C) decline by a smaller percentage than does GDP during an economic contraction.
  4. D) remain constant during business cycles.

Answer: B

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

115) The experience of recessions in Australia has shown that:

  1. A) cyclical unemployment has been non-existent.
  2. B) unemployment continues to rise after a recession ends.
  3. C) unemployment falls about 12 months after a recession begins.
  4. D) unemployment rises on average about 5 percentage points 12 months after a recession begins.

Answer: B

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

116) The experience of recessions in Australia has shown that the unemployment rate:

  1. A) rises for about six months after the recession has finished.
  2. B) rises for at least one year after the recession has finished.
  3. C) falls within one year of a recession finishing.
  4. D) falls within six months of a recession finishing.

Answer: B

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

117) Which of the following explains why the rate of unemployment continues to rise once a recession is over?

  1. A) Discouraged workers leave the labour force.
  2. B) Wages rise faster than productivity increases so firms are reluctant to hire workers.
  3. C) Firms are operating below capacity for some time after the recession is finished.
  4. D) The unemployment rate does not continue to rise after a recession is over.

Answer: C

Difficulty: Complex

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

118) An ‘economic contraction’ can cause the unemployment rate to ________ and the inflation rate to ________.

  1. A) fall or rise; rise
  2. B) rise; fall or rise
  3. C) fall; rise
  4. D) fall; fall

Answer: B

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

119) How is the ‘inflation rate’ defined?

  1. A) As the percentage decrease in the price level between time periods.
  2. B) As the percentage change in the price level between time periods.
  3. C) As the dollar increase in prices between time periods.
  4. D) As the percentage change in real GDP during a year.

Answer: B

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

120) The ‘long boom’ in Australia referred to the general period of strong economic growth that occurred between:

  1. A) 1928 and 1931.
  2. B) the late 1950s to the late 1980s.
  3. C) the late 1940s to the early 1970s.
  4. D) 1991 and 2007.

Answer: C

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

121) Which of the following experiences in the Australian economy led to an increase in the unemployment rate and the inflation rate?

  1. A) The world oil shock of 1974.
  2. B) The policy of high interest rates in the late 1980s.
  3. C) The introduction of the Goods and Services Tax (GST) in 2000.
  4. D) The introduction of unemployment benefit payments in 1944.

Answer: A

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

122) Which of the following is a true statement about the length of recessions and expansions in the Australian economy?

  1. A) After 1950, the length of expansions equalled the length of recessions.
  2. B) After 1950, the length of expansions were much less than the length of recessions.
  3. C) After 1950, the length of expansions were much longer than the length of recessions.
  4. D) After 1950, the length of expansions were brief and almost non-existent.

Answer: C

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

123) Which of the following is not a reason why the Australian economy has generally been more stable since 1950 than before that time?

  1. A) Goods have become a larger fraction of GDP and services have become a smaller fraction of GDP.
  2. B) The government has actively pursued economic policy to combat recessions and prolong expansions.
  3. C) Unemployment benefits and other government programs curtail the decline in spending that occurs during a recession.
  4. D) Services have become a larger fraction of GDP and goods have become a smaller fraction of GDP.

Answer: A

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

Write ‘True’ if the statement is correct and ‘False’ is the statement is incorrect.

124) A period of economic expansion ends with a business cycle trough.

Answer: False

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

125) The lengths of the recession and expansion phases and which sectors of the economy are most affected will rarely be the same in any two business cycles.

Answer: True

Difficulty: Basic

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

126) The rate of inflation does not necessarily increase during the expansion phase of the business cycle.

Answer: True

Difficulty: Complex

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

127) As a proportion of GDP, the Australian economy produced fewer services in the 2000s than it did in the 1950s, which has contributed to an increase in economic stability over time.

Answer: False

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to analyse and frame problems

 

Write your answer in the space provided or on a separate sheet of paper.

128) What type of consumer good is most affected by the business cycle – durable goods or non-durable goods? Why?

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

Some workers lose income during an economic contraction or recession and cut back on their spending. Other workers fear losing their jobs or may suffer wage cuts. These workers also reduce their spending. When they cut back on their spending, workers are more likely to cut back on consumer durable goods. Consumer durable goods such as cars, appliances and furniture are goods that are expected to last for three or more years. Therefore, the consumer can continue to use these goods for some time. The consumer will put off trying to replace these expensive goods, until his/her income position is stronger and job security is more assured.

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to communicate effectively orally and in writing

 

129) Outline the phases of the business cycle, and explain why business cycles have generally become less severe in Australia since the 1950s.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

The phases are: the expansion phase, the business cycle peak, the contraction phase, possibly a recession, and the business cycle trough. Generally, business cycles have become less severe due to government stabilisation policy, transfer payments and the increasing importance of services as a proportion of GDP. However, severe recessions can still occur, as evidenced in many countries following the global financial cycle of 2007-2009.

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to communicate effectively orally and in writing

 

130) Suppose you are an advisor to the federal government. You are asked to look at macroeconomic data to evaluate whether the economy has entered an economic contraction this year. Which data do you look at? How does the economy behave at the onset of an economic contraction?

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

Since an economic contraction occurs when there is a significant decline in economic activity, we would look at data that would indicate this decline. The data that illustrate economic activity include real GDP growth rates, real income and unemployment rates. We might also look for declines in spending by households and firms paying attention to durable goods sales, capital goods sales and wholesale and retail sales.

A contraction usually begins with a decline in spending on the part of households and/or firms. Firms start to buy less capital goods, equipment, machinery, tools and buildings. Purchases of durable goods such as appliances and cars by households also begin to decline. Purchases of houses begin to slow. This slowness in spending causes firms that produce capital goods, consumer durables and houses to cut back on producing these items. They begin to lay off workers. Income declines as profits fall and workers who are laid off are no longer being paid. This drop in income leads to further declines in spending and other firms start to cut back on production and lay workers off. The economy may then move into recession.

Difficulty: Complex

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to communicate effectively orally and in writing

 

131) Explain what happens to inflation and unemployment during the business cycle.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

The changes in the inflation rate depend on the causes of the phases in the business cycles. An economic contraction or recession caused by a fall in investment or a fall in business or consumer confidence will lead to a decrease in the rate of inflation. An economic contraction or recession caused by a supply shock or a decline in productivity will initially lead to an increase in the rate of inflation. The inflation rate may subsequently fall as spending declines. During an economic expansion that leads to spending increasing at a faster rate than the growth in productivity and potential GDP, the rate of inflation will rise. The business cycle has this effect on inflation because spending is usually strong during an expansion and firms will find it easier to raise prices. However, if there is an expansion that is caused by productivity increases and an expansion in capacity, the rate of inflation may not rise.

 

Unemployment will fall during an expansion and rise during a contraction. When the economy begins slowing down during a contraction, firms cut back on production and workers get laid off and the economy may end up in a recession. But it doesn’t stop there. The unemployment rate typically rises even after the end of a recession. This happens for a couple of different reasons. First, it reflects the behaviour of discouraged workers. When the economy goes into recession, the number of discouraged workers rises. When a discouraged worker drops out of the labour force, this actually lowers the unemployment rate. During the recession, the unemployment rate does not rise as much as it would if we counted discouraged workers as unemployed. When the recovery begins, these former discouraged workers re-enter the labour force and start searching for work again. This influx of people without jobs into the labour force raises the unemployment rate. Secondly, firms are reluctant to start hiring workers when the recovery begins to take hold. They are cautious and want to be sure that the recession is over. They work their workers overtime rather than hire new workers. Both these effects, discouraged workers re-entering the labour market and firm’s reluctance to hire in the early part of a recovery, contribute to keeping the unemployment rate high. Finally, firms often have excess capacity during a recession and may be able to increase output after the recession is over without hiring more workers for a time.

Difficulty: Complex

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to communicate effectively orally and in writing

 

132) Explain why the Australian economy has generally been more stable since the 1950s than before that time.

_____________________________________________________________________________________________

_____________________________________________________________________________________________

Answer:

First, the economy has changed over time in terms of the types of goods produced. Manufacturing production as a proportion of GDP has fallen over time. Manufacturing production fluctuates more over the business cycle. Durable goods manufacturing is extremely volatile. Services as a proportion of GDP has risen over time, from 59% in 1960 to around 70% by 2010. GDP is relatively more stable because service production is more stable over the business cycle.

Secondly, government programs such as unemployment benefits, pensions and other social security measures have increased over time. The extent of the downturn tends to be less severe as the people who take advantage of these programs do not have to curtail their spending as much as they would if the programs did not exist. The additional spending may have the effect of shortening contractions or recessions.

Thirdly, the government has actively implemented policies to smooth out the business cycle, with the intention to shorten contractions and prolong expansions. Many economists believe that these policies have stabilised the economy. However, it is not a settled issue, as other economists disagree, believing that government policy prolongs or worsens business cycle fluctuations and can hinder the market restructuring required for long-term economic growth.

Difficulty: Moderate

Learning Objective: 5.3 Understand what happens during the business cycle.

Topic: The business cycle

AACSB: Able to communicate effectively orally and in writing

 

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