AP Macroeconomics

Unit 4 Practice Quiz #1 - KEY

Loanable Funds Questions
1) Which of the following is true about the loanable funds market?
A. The supply of loanable funds shows an inverse relationship between real interest rates and the quantity supplied of loanable funds.
B. Investment is financed by national savings in a closed economy.
C. Investment is financed by government borrowing in an open economy.
D. Public savings is the sum of national savings and private savings.

2) Which of the following changes will necessarily occur as a result of an increase in the nominal interest rate?
A. The money demand curve will shift to the left. B. The money demand curve will shift to the right.
C. The quantity of money supplied will decrease. D. The quantity of money demanded will decrease.

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

4) The loanable funds market is currently in equilibrium at a real interest rate of r1. An increase in household savings will
affect the loanable funds market in which of the following ways?
A. There will be a shortage of funds and the real interest rate will decrease.
B. The demand for loanable funds will increase and the real interest rate will increase.
C. The supply of loanable funds will increase and the real interest rate will increase.
D. The supply of loanable funds will increase and the real interest rate will decrease.

5) Country X’s economy is enjoying political stability and attracting foreign financial capital. At the same time Country X’s
government is borrowing to finance spending. How will these changes affect the loanable funds market in Country X?
A. There will be a decrease in the supply of loanable funds.
B. There will be a decrease in the demand for loanable funds.
C. There will be an increase in the equilibrium nominal interest rate.
D. There will be an indeterminate effect on the equilibrium real interest rate.

Money & Interest Rate Questions

6) Cash, a house, bonds, and a savings account are all financial assets. Which of the following rankings lists these assets from
the least liquid to the most liquid?
A. Cash, bonds, house, savings account B. Bonds, house, savings account, cash
C. Savings account, cash, bonds, house D. House, bonds, savings account, cash

7) Which of the following is adjusted by the actual inflation rate?

A. Automatic stabilizers B. Unemployment rate
C. Price of previously issued bonds D. Real interest rates
8) Spencer took a 9 percent one-year fixed-rate loan to buy a new car. He expected to pay a real interest rate of 5 percent. If at
the end of the year Spencer only paid a 3 percent real interest rate, which of the following is true?
A. . The actual inflation rate was 6% B. The nominal interest rate was 5%
C. The actual inflation rate was 4% D. The nominal interest rate was 3%

9) If the interest rate on a one-year loan is 5% and the expected inflation rate is −2% for the same period, what is the expected
real interest rate on the loan?
A. 7% B. −2% C. 2% D. 3%

10) Mia transferred $1,000 from her checking account to her savings account. How will M1 and M2 measures of the money
supply change?
A. M1 will increase and M2 will decrease. B. M1 will increase and M2 will increase.
C. M1 will decrease and M2 will increase. D. M1 will decrease and M2 will not change.

Monetary Policy Questions

11) Which of the following is true at the nominal interest rate (i3) illustrated in the graph above ?
A. The money market is at equilibrium because the quantity demanded is equal to the quantity supplied.
B. There is a surplus in the money market because the quantity demanded is less than the quantity supplied.
C. There is a surplus in the money market because the quantity demanded is greater than the quantity supplied.
D. There is a shortage in the money market because the quantity demanded is greater than the quantity supplied.

12) Suppose that the economy has entered a recession. Which of the following is a monetary policy action a central bank can
take to restore full-employment output?
A. Selling government bonds B. Decreasing government spending
C. Decreasing the discount rate D. Increasing the federal funds rate

13) A country’s central bank purchased government bonds from the public in the open market. How would this action affect
the nominal interest rate and the price level in the short run?
A. There would be a decrease in the nominal interest rate and a decrease in the price level.
B. There would be a decrease in the nominal interest rate and an increase in the price level.
C. There would be an increase in the nominal interest rate and a decrease in the price level.
D. There would be an increase in the nominal interest rate and a decrease in the price level.

14) Which of the following is a monetary policy action a central bank would implement to control inflation?
A. Target a lower overnight interbank lending rate B. Sell government bonds to the public
C. Lower the discount rate D. Lower the required reserve ratio

15) Which of the following will shift the aggregate demand curve in the
direction shown in the diagram above?
A. A decrease in the money supply
B. A decrease in the monetary base
C. A decrease in the discount rate
D. An increase in the required reserve ratio
Practice FRQs KEY
1) A national newspaper’s headline reads “Business Confidence Reaches Highest Level in 5 Years.”

(a) Draw a correctly labeled graph of the loanable funds market, and show the effect of high business confidence on the equilibrium
real interest rate.

(b) Assume the government increases its spending on capital projects and infrastructure. Would financing the increased government
spending by borrowing result in a higher, a lower, or the same equilibrium real interest rate? Explain.
The equilibrium real interest rate will be higher and explains that this is because increased government spending financed by
borrowing will increase the demand for loanable funds.

(c) If the expected inflation rate decreases to zero, will the nominal interest rate be greater than, less than, or equal to the real interest
rate? Explain.
The nominal interest rate will be equal to the real interest rate and because the real interest rate is the nominal interest rate adjusted for
inflation; therefore, when the expected inflation rate is zero, the nominal interest rate is equal to the real interest rate.
2. Assume a country’s economy is currently in recession.

(a) Draw a correctly labeled graph of the long-run aggregate supply, short-run aggregate supply, and aggregate demand curves, and
show each of the following: Current equilibrium, labeled Y1, and current price level, labeled PL1 & Full employment, labeled Yf

(b) Identify one action of monetary policy the central bank can take to help the economy recover from the recession.
Buy bonds, or lower reserve ratio or lower the discount rate

(c) On your graph for part (a), show the effect of the central bank’s action identified in part (b) on real output and the price level.
See above AD to AD’ causes real output to increase (Y1 to Yf) & Price Level to grow (PL1 to PL2)

(d) Draw a correctly labeled graph of the money market (Money Supply), and show the impact of the central bank’s (Fed) actions
identified in part (b) on the nominal interest rate.

MS graph shifts right and interest rates fall (i1 to i2)