AP Macro 5.3/5.4/5.5

According to the quantity theory of money, an increase in the money supply will most likely lead to:

• A decrease in nominal GDP

• An increase in the velocity of money

• An increase in the price level if real output is constant

• A decrease in the unemployment rate without affecting inflation

• A decrease in aggregate demand

Answer explanation

According to the quantity theory of money, if the money supply increases while real output remains constant, it leads to higher price levels, as more money chases the same amount of goods.

If the money supply grows at a faster rate than real GDP, what is the likely effect?

• Deflation

• Lower nominal interest rates

• Higher real interest rates

• Inflation

• A decrease in the velocity of money

Answer explanation

When the money supply increases faster than real GDP, it typically leads to inflation. This is because more money in circulation can increase demand for goods and services, driving prices up.

Which of the following statements best describes the long-run effect of a rapid increase in the money supply?

• An increase in real GDP

• A decrease in aggregate demand

• An increase in nominal wages but not real wages

• A decrease in nominal GDP

• A lower natural rate of unemployment

Answer explanation

A rapid increase in the money supply leads to higher nominal wages due to inflation, but real wages remain unchanged as purchasing power declines. Thus, the correct choice is an increase in nominal wages but not real wages.

The classical dichotomy suggests that in the long run, an increase in the money supply affects:

• Only real variables

• Only nominal variables

• Both real and nominal variables

• The unemployment rate permanently

• The production possibilities curve

Answer explanation

The classical dichotomy states that in the long run, changes in the money supply only influence nominal variables, such as prices and wages, while real variables, like output and employment, remain unaffected.

If the Federal Reserve doubles the money supply in an economy with flexible prices, the most likely result will be:

• A proportional increase in nominal GDP

• An increase in real GDP only

• A decrease in the price level

• A decrease in real interest rates but no change in inflation

• A decrease in velocity

Answer explanation

Doubling the money supply in an economy with flexible prices typically leads to a proportional increase in nominal GDP, as prices adjust to the increased money supply, reflecting higher nominal output.

In the short run, an unexpected increase in the money supply is most likely to:

• Decrease nominal wages

• Increase real GDP

• Increase unemployment

• Decrease aggregate demand

• Increase the velocity of money

Answer explanation

In the short run, an unexpected increase in the money supply boosts spending, leading to higher demand for goods and services. This increase in demand typically results in an increase in real GDP.

The Fisher effect suggests that an increase in expected inflation will lead to:

• A decrease in nominal interest rates

• An increase in real interest rates

• No change in nominal interest rates

• An increase in nominal interest rates

• A decrease in money demand

Answer explanation

The Fisher effect states that when expected inflation rises, nominal interest rates increase to maintain real interest rates. Thus, an increase in expected inflation leads to an increase in nominal interest rates.

If the velocity of money is constant and real GDP is growing at 3% per year, then according to the quantity theory of money, a 6% increase in the money supply will result in:

• 6% inflation

• 3% inflation

• 9% inflation

• 0% inflation

• 6% real GDP growth

Answer explanation

According to the quantity theory of money, if the money supply increases by 6% and real GDP grows by 3%, the remaining 3% will manifest as inflation, leading to 3% inflation.

A budget deficit occurs when:

• Government spending exceeds tax revenue

• The national debt decreases

• Tax revenue exceeds government spending

• The economy is in a recession

• The money supply decreases

Answer explanation

A budget deficit occurs when government spending exceeds tax revenue, meaning the government is spending more money than it collects from taxes.

If the government finances a deficit by borrowing from the public, what is the immediate impact?

• An increase in private investment

• An increase in the national debt

• A decrease in the money supply

• A decrease in nominal interest rates

• A decrease in aggregate demand

Answer explanation

When the government borrows to finance a deficit, it increases the national debt as it accumulates more obligations to repay. This is the immediate impact, while other options do not directly result from this action.