AP Macro Unit 4 Review with ample reserves

Front

If the expected inflation rate increases, what will happen to Sam's payments on a five-year fixed interest rate auto loan?

Back

Sam will pay a lower real interest rate.

Answer explanation

As inflation increases, the purchasing power of money decreases. Since Sam's loan has a fixed interest rate, the real interest rate (nominal rate minus inflation) will effectively decrease, meaning he pays a lower real interest rate.

Front

Which of the following changes in the loanable funds market will decrease the equilibrium real interest rate: An increase in foreign financial capital inflows, An increase in government spending on highways financed by borrowing, An investment tax credit for plant and equipment, A decrease in private savings?

Back

An increase in foreign financial capital inflows

Answer explanation

An increase in foreign financial capital inflows increases the supply of loanable funds, leading to a decrease in the equilibrium real interest rate. This contrasts with the other options, which either increase demand or decrease supply.

Front

Which of the following will happen when interest rates increase in an economy? The opportunity cost of holding money will increase. Investment spending will increase. The spending multiplier will decrease. The cost of borrowing will decrease.

Back

The opportunity cost of holding money will increase.

Answer explanation

When interest rates increase, the opportunity cost of holding money rises because individuals forgo higher returns from interest-bearing assets. This discourages holding cash, making the first choice correct.

Front

If the interest rate on loans before adjusting for inflation is 9%, and the expected inflation rate is 4%, then which of the following must be true? The expected real interest rate is 13%, The expected real interest rate is 9%. The nominal interest rate is 9%. Lenders are expected to receive an additional 4% on their loaned funds.

Back

The nominal interest rate is 9%.

Answer explanation

The nominal interest rate is the stated rate before inflation adjustment. Since the question states the interest rate on loans is 9%, this confirms that the nominal interest rate is indeed 9%.

Front

Which of the following is a monetary policy action a central bank with limited reserves would implement to control inflation?
Lower the required reserve ratio,
Lower the discount rate,
Target a lower overnight interbank lending rate,
Sell government bonds to the public

Back

Sell government bonds to the public

Answer explanation

Selling government bonds reduces the money supply, which helps control inflation. The other options either increase liquidity or do not effectively address inflation in a scenario with limited reserves.

Front

Which of the following will happen if the central bank of a nation purchases government bonds on the open market? Options: The monetary base will increase and the money supply will not change. The monetary base will increase and the money supply will increase. The monetary base will decrease and the money supply will increase. The monetary base will decrease and the money supply will not change.

Back

The monetary base will increase and the money supply will increase.

Answer explanation

When a central bank purchases government bonds, it injects money into the economy, increasing the monetary base and the money supply. Thus, the correct choice is that both the monetary base and the money supply will increase.

Front

Which of the following is considered the most liquid asset? Currency, Real estate, Bonds, Stocks

Back

Currency

Answer explanation

Currency is considered the most liquid asset because it can be easily and quickly exchanged for goods and services without any loss of value, unlike real estate, bonds, or stocks which may take time to sell.

Front

The use of favolis to express the price of goods is ...

Back

Unit of account

Answer explanation

The price of goods in favolis serves as a unit of account, providing a standard measure to express and compare the value of different goods. This distinguishes it from a medium of exchange or means of payment.

Front

ABC Bank is a commercial bank in Country X. Assume the required reserve ratio is 25%. If ABC Bank sells $20 million worth of government bonds to Country X’s central bank, what will happen to the money supply?

Back

The money supply will decrease by a maximum of $80 million.

Answer explanation

When ABC Bank sells $20 million in bonds, it loses reserves. With a 25% reserve ratio, it can lend out $15 million. The total potential decrease in money supply is $20 million (initial sale) + $60 million (subsequent lending) = $80 million.

Front

Which of the following will most likely result in a lower real interest rate in a nation?
- The nation provides an investment tax credit to new businesses.
- The nation’s central bank sells government bonds in the open market.
- The nation is experiencing political instability and economic risk.
- The citizens of the nation increase their savings for retirement.

Back

The citizens of the nation increase their savings for retirement.