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FIN201 - chapter7

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Chapter 7The Asset Market, Money, and PricesT Multiple Choice Questions1. A disadvantage of the barter system is that (a) no trade occurs. (b) people must produce all their own food, clothing, and shelter. (c) the opportunity to specialize is greatly reduced. (d) gold is the only unit of account. Answer: C Level of difficulty: 1 Section: 7.1 The use of money is more efficient than barter because the introduction of money (a) reduces the need for economic specialization. (b) reduces the need to exchange goods. (c) reduces the need for other stores of value. (d) reduces transaction costs. Answer: D Level of difficulty: 1 Section: 7.1 In economics, money refers to (a) income. (b) wealth. (c) assets used and accepted as payment. (d) currency. Answer: C Level of difficulty: 1 Section: 7.1 Moneys primary role in the economy comes from the benefits of lowering transactions costs and allowing specialization. This function of money is called (a) store of value. (b) medium of exchange. (c) standard of deferred payment. (d) unit of account. Answer: B Level of difficulty: 1 Section: 7.1

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In some countries, prices in stores are listed in terms of U.S. dollars, rather than in units of the local currency. Thats most likely because (a) the countrys political system is unstable. (b) interest rates are higher using U.S. dollars than using the local currency. (c) there is no other store of value. (d) the country has experienced high rates of inflation. Answer: D Level of difficulty: 1 Section: 7.1 A good that is used as a medium of exchange as well as being a consumption good is called (a) a barter money. (b) a commodity money. (c) a legal tender. (d) a debased money. Answer: B Level of difficulty: 1 Section: 7.1 Why do people keep currency in their pockets when bank deposits pay interest? (a) Because banks might steal your money. (b) Because currency is more liquid. (c) Because bank deposits lose value due to inflation. (d) Because bank deposits lose value due to changes in interest rates. Answer: B Level of difficulty: 1 Section: 7.1 One of moneys primary roles in the economy comes from the use of money to transfer purchasing power to the future. This role of money is called (a) store of value. (b) unit of account. (c) medium of exchange. (d) standard of deferred payment. Answer: A Level of difficulty: 1 Section: 7.1 Which of the following measures is the best measure of money as a medium of exchange? (a) M1 (b) M2 (c) M3 (d) None of the above Answer: A Level of difficulty: 1 Section: 7.1

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Suppose your bank raises its minimum-balance requirement for free checking on checking accounts by $500. You take $500 out of your passbook savings account and put it in your checking account. What is the overall effect on M1 and M2? (a) M1 rises by $500, M2 falls by $500. (b) M1 is unchanged, M2 is unchanged. (c) M1 rises by $500, M2 is unchanged. (d) M1 is unchanged, M2 falls by $500. Answer: C Level of difficulty: 3 Section: 7.1 M1 does not include (a) MMMFs. (b) travelers checks. (c) currency. (d) demand deposits. Answer: A Level of difficulty: 1 Section: 7.1 Which of the following statements about M1 and M2 is true? (a) Demand deposits are not part of M1. (b) M2 is more liquid than M1. (c) M1 is larger than M2. (d) Savings deposits are part of M2. Answer: D Level of difficulty: 1 Section: 7.1 M2 includes (a) large-denomination time deposits. (b) institutional MMMFs. (c) commercial paper. (d) M1. Answer: D Level of difficulty: 1 Section: 7.1 M2 does not include (a) Treasury bonds. (b) passbook savings accounts. (c) small-denomination time deposits. (d) M1. Answer: A Level of difficulty: 1 Section: 7.1

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NOW accounts are different from demand deposits because (a) stores prefer checks from demand deposits rather than NOW accounts. (b) NOW accounts are not insured by the FDIC. (c) NOW accounts pay interest. (d) money in NOW accounts may not be withdrawn from the bank without 30 days prior notice. Answer: C Level of difficulty: 1 Section: 7.1 Weighted monetary aggregates (a) ignore the fact that some assets are more moneylike than others. (b) are constructed by simply adding up the outstanding amounts of various types of assets. (c) give greater weight to currency than to savings deposits. (d) value coins more than currency. Answer: C Level of difficulty: 1 Section: 7.1 Over half of U.S. currency is (a) held abroad. (b) used in the underground economy. (c) held by banks as reserves. (d) held by businesses, especially retailers, for making transactions. Answer: A Level of difficulty: 1 Section: 7.1 People in other countries want to hold U.S. dollars as a (a) medium of exchange. (b) store of value. (c) unit of account. (d) standard of deferred payment. Answer: B Level of difficulty: 1 Section: 7.1 We shouldnt be concerned about U.S. currency held abroad because (a) the currency will never return to the United States. (b) foreigners use it to buy U.S. bonds. (c) it represents an interest-free loan to the United States. (d) foreigners cant spend it in their own countries. Answer: C Level of difficulty: 1 Section: 7.1

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Whats the most common way for a central bank to reduce the money supply? (a) Collect higher taxes (b) Sell bonds to the public (c) Buy bonds from the government (d) Buy bonds from the public Answer: B Level of difficulty: 1 Section: 7.1 A developing country does not have enough taxes to cover its expenditures and is unable to borrow. This government would be most likely to cover its deficit by (a) purchasing government bonds from the public. (b) selling government bonds to the public. (c) selling newly issued government bonds directly to the central bank. (d) buying newly issued government bonds directly from the central bank. Answer: C Level of difficulty: 2 Section: 7.1 Peoples best guesses about returns on assets are called (a) expected returns. (b) liquidity. (c) risk. (d) the term structure of returns. Answer: A Level of difficulty: 1 Section: 7.2 AAA Company stock has a higher expected rate of return than ZZZ Company stock. All else being equal, you would expect that relative to ZZZ, AAA company stock provides (a) less risk and less liquidity. (b) less risk and more liquidity. (c) more risk and less liquidity. (d) more risk and more liquidity. Answer: C Level of difficulty: 1 Section: 7.2 A 10% decrease in real income usually leads to _____ in money demand. (a) an increase (b) no change (c) a decrease of less than 10% (d) a decrease of 10% Answer: C Level of difficulty: 1 Section: 7.3

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Which of the following is most likely to lead to a decrease of 10% in the nominal demand for money? (a) An increase in real inome of 5% (b) A decrease in real income of 5% (c) A decline of 10% in the price level (d) An increase of 10% in the price level Answer: C Level of difficulty: 2 Section: 7.3 The opportunity cost of holding currency decreases when (a) income decreases. (b) the interest rate on bonds decreases. (c) the interest rate on money decreases. (d) wealth decreases. Answer: B Level of difficulty: 1 Section: 7.3 An increase in the real interest rate would cause an increase in the real demand for money (a) no matter what the change in expected inflation. (b) if expected inflation fell by less than the rise in the real interest rate. (c) if expected inflation fell by the same amount as the rise in the real interest rate. (d) if expected inflation fell by more than the rise in the real interest rate. Answer: D Level of difficulty: 2 Section: 7.3 An increase in expected inflation is likely to cause (a) a decline in the demand for real balances. (b) an increase in the demand for real balances. (c) no change in the demand for real balances. (d) no change in the demand for real balances only if the income elasticity of real money demand is zero. Answer: A Level of difficulty: 1 Section: 7.3 Money demand is given by M /P = 1000 + .2Y 1000i.d

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Given that P = 200, Y = 2000, and i = .10, real money demand is equal to (a) 1300. (b) 1500. (c) 260,000. (d) 300,000. Answer: A Level of difficulty: 2 Section: 7.3

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Over time, the wealth of society increases and payments technologies get more efficient. What is the effect on money demand of these two changes? (a) Money demand rises proportionately to the rise in wealth. (b) Money demand rises, but less than proportionately to the rise in wealth. (c) The overall effect is ambiguous. (d) Money demand declines. Answer: C Level of difficulty: 2 Section: 7.3 If there is a financial panic and increased uncertainty about the returns in the stock market and bond market, what is the likely effect on money demand? (a) Money demand declines first, then rises when inflation increases. (b) Money demand rises. (c) The overall effect is ambiguous. (d) Money demand declines. Answer: B Level of difficulty: 2 Section: 7.3 Suppose a new law imposes a tax on all trades of bonds and stock. What is the likely effect on money demand? (a) Money demand declines first, then rises when inflation increases. (b) Money demand rises. (c) The overall effect is ambiguous. (d) Money demand declines. Answer: B Level of difficulty: 2 Section: 7.3 If real income rises 4%, prices rise 1%, and nominal money demand rises 4%, what is the income el