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Chapter 26

Saving, Investment, and the Financial System


TRUE/FALSE
1. The financial system coordinates investment and saving, which are important determinants of long-run real
GDP.
ANS: T DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment | Saving MSC: Definitional
2. When economists refer to investment, they mean the purchasing of stocks and bonds and other types of saving.
ANS: F DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment | Saving MSC: Definitional
3. Banks and mutual funds are examples of financial markets.
ANS: F DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial intermediaries | Financial markets MSC: Definitional
4. When a firm wants to borrow directly from the public to finance the purchase of new equipment, it does so by
selling shares of stock.
ANS: F DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Stock MSC: Definitional
5. Most entrepreneurs finance their purchases of real capital using their past saving.
ANS: F DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Definitional
6. Other things the same, the higher the rate of saving and investment in a country, the higher will be the
standard of living.
ANS: T DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Saving | Investment MSC: Interpretive
7. Lenders sell bonds and borrowers buy them.
ANS: F DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Definitional
8. When a firm wants to borrow directly from the public to finance the purchase of new equipment, it does so by
selling bonds.
ANS: T DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Stock MSC: Definitional
9. Other things the same, corporate bonds generally feature higher interest rates than U.S. government bonds.
ANS: T DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Definitional
10. The sale of either stocks or bonds to raise money is known as equity finance.
ANS: F DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Stock MSC: Definitional

206
207 ❖ Chapter 26/Saving, Investment, and the Financial System
11. When a corporation experiences financial problems, bondholders are paid before stockholders.
ANS: T DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Stock MSC: Definitional
12. Corporations receive no proceeds from the resale of their stock.
ANS: T DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Definitional
13. Generally, if people begin to expect a company to have higher future profits, the price of the company’s stock
will begin to decrease.
ANS: F DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
14. If a share of stock in Skylight Chili sells for $75, the retained earnings per share are $5, and the divided per
share is $2, then the price-earnings ratio is 15.
ANS: F DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
15. If people become less optimistic about the future earnings of Hyde Park Jazz Studio, then the price of the
company’s stock will fall.
ANS: T DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock. MSC: Interpretive
16. Mutual funds are a type of financial intermediary.
ANS: T DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Mutual funds | Financial intermediaries MSC: Definitional
17. Index funds are usually outperformed by mutual funds that are actively managed by professional money
managers.
ANS: F DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Mutual funds MSC: Definitional
18. To state that national saving is equal to investment, for a closed economy, is to state an accounting identity.
ANS: T DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Identities MSC: Interpretive
19. National saving is equal to Y - T - C.
ANS: F DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving MSC: Interpretive
20. Public saving is T - G, while private saving is Y - T - C.
ANS: T DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Private saving | Public saving MSC: Interpretive
21. Public saving is equal to national saving minus private saving.
ANS: T DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving MSC: Definitional
Chapter 26/Saving, Investment, and the Financial System ❖ 208
22. To state that public saving is equal to investment, for a closed economy, is to state an accounting identity.
ANS: F DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Identities MSC: Interpretive
23. In a closed economy, investment must be equal to private saving.
ANS: F DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Private saving | Investment MSC: Definitional
24. If, for an imaginary closed economy, investment amounts to $10,000 and the government is running a $2,500
deficit, then private saving must amount to $12,500.
ANS: T DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Identities | Private saving | Investment MSC: Applicative
25. If, for an imaginary closed economy, investment amounts to $12,000 and the government is running a $2,000
deficit, then private saving must amount to $10,000.
ANS: F DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Identities | Private saving | Investment MSC: Applicative
26. Suppose a small closed economy has GDP of $5 billion, consumption of $3 billion, and government
expenditures of $1 billion. Then investment and national saving are both $1 billion.
ANS: T DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving | Investment MSC: Applicative
27. Joan uses some of her income to buy mutual fund shares. A macroeconomist refers to Joan's purchase as
investment.
ANS: F DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Saving | Investment MSC: Interpretive
28. Alberta buys a paint sprayer and a lift for her car customizing shop. A macroeconomist would refer to these
purchases as investment.
ANS: T DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Interpretive
29. The demand for loanable funds comes from saving and the supply of loanable funds comes from investment.
ANS: F DIF: 1 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Market for loanable funds MSC: Definitional
30. A decrease in taxes on interest income would increase the interest rate.
ANS: F DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Saving | Market for loanable funds MSC: Applicative
31. If Congress instituted an investment tax credit, the demand for loanable funds would shift rightward.
ANS: T DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Applicative
32. When the government budget deficit rises, national saving is reduced, interest rates rise, and investment falls.
ANS: T DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Budget deficits MSC: Applicative
209 ❖ Chapter 26/Saving, Investment, and the Financial System
33. The term crowding out refers to decreases in the interest rate caused by government budget surpluses.
ANS: F DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Crowding out MSC: Definitional
34. When the U.S. government is in debt during a given year, it follows that its budget is in deficit for that year.
ANS: F DIF: 1 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Government debt | Budget deficits MSC: Interpretive
35. The ratio of government debt to GDP was higher during the Reagan presidency than at any previous time in
U.S. history.
ANS: F DIF: 1 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Government debt MSC: Definitional
36. An increase in the demand for loanable funds increases the equilibrium interest rate and increases the
equilibrium level of saving.
ANS: T DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and applying economic models
TOP: Market for loanable funds MSC: Applicative
37. An increase in the demand for loanable funds increases the equilibrium interest rate and decreases the
equilibrium level of saving.
ANS: F DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and applying economic models
TOP: Market for loanable funds MSC: Applicative
38. The term loanable funds refers to all income that is not used for consumption.
ANS: F DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Market for loanable funds MSC: Definitional
39. The term loanable funds refers to all income that is not used for consumption or government expenditures.
ANS: T DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Market for loanable funds MSC: Definitional
40. We interpret the term loanable funds to mean the flow of resources available to fund private investment.
ANS: T DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Market for loanable funds MSC: Interpretive
41. An increase in the budget deficit shifts the demand for loanable funds to the right.
ANS: F DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Budget deficits MSC: Applicative
42. A government may use deficit financing to smooth tax rates over time.
ANS: T DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Budget deficits MSC: Analytic
Chapter 26/Saving, Investment, and the Financial System ❖ 210
SHORT ANSWER
1. What are the basic differences between bonds and stocks?
ANS:
A bond is a certificate of indebtedness that specifies the obligations of the borrower to the holder of the bond, while
stock represents a share of ownership in a firm and is, therefore, a claim on the profits that the firm makes. The sale
of bonds to raise money is called debt finance, while the sale of stock is called equity finance. Whereas the owner of
shares of stock in a company share in the profits of a company, the owner of bonds receives a fixed interest rate.
Compared to bonds, stocks offer the holder both higher risk and a potentially higher return.
DIF: 2 REF: 26-1 NAT: Analytic
LOC: The Study of economics, and definitions of economics TOP: Stock | Bonds
MSC: Interpretive
2. Which of the two bonds in each example would you expect to generally pay the higher interest rate? Explain
why.
a. a U.S. government bond or a Brazilian government bond
b. a U.S. government bond or a municipal bond with the same term and issued by a creditworthy
municipality.
c. a 6-month Treasury bill or a 20-year Treasury bond
d. a Microsoft bond or a bond issued by a new recording company
ANS:
a. The Brazilian government bond would likely pay a higher interest rate because the market perceives a
higher level of risk for the Brazilian bond relative to the U.S. bond.
b. Because of the tax advantages of municipal bonds, the U.S. government bond would likely pay the
higher interest rate.
c. The 20-year bond would likely pay a higher interest rate than would the 6-month bill. The future is
uncertain and therefore more risky for a 20-year bond than for a 6-month bill.
d. Since Microsoft is less likely to default than a new and unknown company, the interest on the bond of
the new company is likely to be higher.
DIF: 2 REF: 26-1 NAT: Analytic
LOC: The Study of economics, and definitions of economics TOP: Bonds
MSC: Applicative
3. Suppose that you are a broker and people tell you the following about themselves. What sort of bond would
you recommend to each? Defend your choices.
a. "I am in a high federal income tax bracket and I don't want to take very much risk."
b. "I want a high return and I am willing to take a lot of risk to get it."
c. "I want a decent return and I have enough deductions that I don't value tax breaks highly."
ANS:
a. A municipal bond. Municipal bonds generally have low credit risk and are not subject to federal income
tax.
b. A junk bond. Junks bonds have a high return because they have high risk.
c. A corporate bond that isn't a junk bond. Corporate bonds have more risk than government bonds but
have no special tax treatment, so they pay moderate rates of return.
DIF: 2 REF: 26-1 NAT: Analytic
LOC: The Study of economics, and definitions of economics TOP: Bonds
MSC: Analytical
211 ❖ Chapter 26/Saving, Investment, and the Financial System
4. Your brother-in-law wants to buy either stock or bonds in Cedar Valley Furniture, which manufactures
wooden furniture. He wants your advice on whether to buy stock or bonds. Explain how each of his quotes
below should affect his choice between the stock and the bond.
a. "I have reason to believe that people are soon going to find rocking chairs have health benefits."
b. "I would like to tell people I am part owner of Cedar Valley Furniture."
c. "I do not want to take on much risk."
ANS:
a. Presumably, when this happens, unless everyone else has anticipated it, dividends, the price of the stock,
or both will increase. The interest rate on bonds will not change as profits increase, so this quote
suggests buying stock would better suit your brother-in law's purposes.
b. Bondholders are simply creditors, while stockholders are part owners. So this quote indicates your
brother-in-law would prefer to buy stock.
c. In case of financial difficulties stockholders get paid after bondholders, so the stock is somewhat more
risky. So, your brother-in-law may prefer the bond.
DIF: 2 REF: 26-1 NAT: Analytic
LOC: The Study of economics, and definitions of economics TOP: Stock | Bonds
MSC: Interpretive
5. Suppose the Move It! exercise chain has revenues of $45 million, accounting costs of $15 million, and
currently has issued 10 million shares of stocks selling at $90 each. Compute the price-earning ratio. Show
your work. Is this ratio relatively high or low? What might an increase in the price-earnings ratio indicate?
ANS:
The earnings per share is ($45 million - $15 million)/10 million = $3. So, the price-earnings ratio is $90/$3 = 30.
This is a high P/E ratio, as the historical average for the market is about 15. An increase in the PE ratio may indicate
the people expect the firm to have higher earnings in the future or that the stock has become overvalued.
DIF: 2 REF: 26-1 NAT: Analytic
LOC: The Study of economics, and definitions of economics TOP: Stock
MSC: Analytical
6. In the national income accounting identity showing the equality between national saving and investment, what
are the algebraic expressions for private saving and public saving?
ANS:
Private saving is Y - C - T, Public Saving is T - G
DIF: 2 REF: 26-2 NAT: Analytic
LOC: The Study of economics, and definitions of economics
TOP: Private saving | Public saving MSC: Interpretive
7. Identify each of the following acts as representing either saving or investment.
a. Fred uses some of his income to buy government bonds.
b. Julie takes some of her income and buys mutual funds.
c. Alex purchases a new truck for his delivery business using borrowed funds.
d. Elaine uses some of her income to buy stock in a major corporation.
e. Henrietta hires a builder to construct a new building for her bicycle shop.
ANS:
a. Fred is saving.
b. Julie is saving.
c. Alex is investing.
d. Elaine is saving.
e. Henrietta is investing.
DIF: 1 REF: 26-2 NAT: Analytic
LOC: The Study of economics, and definitions of economics TOP: Saving | Investment
MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 212
8. Draw and label a graph showing equilibrium in the market for loanable funds.
ANS:
Market for Loanable Funds

DIF: 1 REF: 26-3 NAT: Analytic


LOC: Understanding and Applying Economic Models TOP: Market for loanable funds
MSC: Interpretive
9. Explain why the demand for loanable funds slopes downward and why the supply of loanable funds slopes
upward.
ANS:
When the interest rate rises investment spending becomes more expensive, so people invest less. As the interest rate
rises saving becomes more rewarding, so people want to save more. The inverse relation between interest and
borrowing is reflected in the downward slope of the demand for loanable funds curve. The positive relation between
interest and saving is reflected in the upward slope of the supply of loanable funds curve.
DIF: 2 REF: 26-3 NAT: Analytic
LOC: Understanding and Applying Economic Models TOP: Market for loanable funds
MSC: Interpretive
10. The model of the market for loanable funds shows that an investment tax credit will cause interest rates to rise
and investment to rise. Yet we also suppose that higher interest rates lead to lower investment. How can these
two conclusions be reconciled?
ANS:
The claim that an increase in the interest rate decreases investment supposes that only the interest rate changes and
everything else is constant. The investment tax credit causes investment to rise at each interest rate. As firms want to
borrow more the interest rate will rise. The rise in interest rates does make investment less than it would otherwise
be, but unless the supply of loanable funds is vertical, the increase in investment demand from the tax credit is larger
than the decrease in investment demand from the rising interest rate.
DIF: 3 REF: 26-3 NAT: Analytic
LOC: Understanding and Applying Economic Models TOP: Investment
MSC: Analytical
213 ❖ Chapter 26/Saving, Investment, and the Financial System
11. Using a graph representing the market for loanable funds, show and explain what happens to interest rates and
investment if the government budget goes from a deficit to a surplus.
ANS:
As shown in the graph below, the economy starts in equilibrium at point E0 with interest rate r0 and equilibrium
quantity of saving and investment at q0. If the government succeeds in obtaining a surplus, there will be more public
saving in the economy and so more national saving at each interest rate, and the supply of loanable funds curve will
shift from S0 to S1. The new equilibrium will be at E1, with a lower interest rate, r1 and a higher quantity of saving
and investment, q1. Hence, if the federal government succeeds in having a surplus, interest rates will fall and
investment will increase.
Market for Loanable Funds

DIF: 2 REF: 26-3 NAT: Analytic


LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Budget surpluses MSC: Applicative

Sec00 - Saving, Investment, and the Financial System


MULTIPLE CHOICE
1. When opening a print shop you need to buy printers, computers, furniture, and similar items. Economists call
these expenditures
a. capital investment.
b. investment in human capital.
c. business consumption expenditures.
d. personal saving.
ANS: A DIF: 1 REF: 26-0
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Definitional
2. If you were to start a business delivering documents, you might need to purchase cell phones, bicycles, desks,
and chairs.
a. These purchases are called capital investment. If you raise the funds from others to purchase them
you are a saver.
b. These purchases are called capital investment. If you raise the funds from others to purchase them
you are a borrower.
c. These purchases are called consumption. If you raise the funds from others to purchase them you
are a saver.
d. These purchases are called consumption. If you raise the funds from others to purchase them you
are a borrower.
ANS: B DIF: 2 REF: 26-0
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Investment MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 214
3. When a country saves a larger portion of its GDP than it did before, it will have
a. more capital and higher productivity.
b. more capital and lower productivity.
c. less capital and higher productivity.
d. less capital and lower productivity.
ANS: A DIF: 1 REF: 26-0
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Saving | Investment MSC: Interpretive
4. Institutions that help to match one person's saving with another person's investment are collectively called the
a. Federal Reserve system.
b. banking system.
c. monetary system.
d. financial system.
ANS: D DIF: 1 REF: 26-0
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial system MSC: Definitional
5. The primary economic function of the financial system is to
a. keep interest rates low.
b. provide expert advice to savers and investors.
c. match one person’s consumption expenditures with another person’s capital expenditures.
d. match one person’s saving with another person’s investment.
ANS: D DIF: 2 REF: 26-0
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial system MSC: Interpretive
6. Given that Lekeisha's income exceeds her expenditures, Lekeisha is best described as a
a. saver or as a supplier of funds.
b. saver or as a demander of funds.
c. borrower or as a supplier of funds.
d. borrower or as a demander of funds.
ANS: A DIF: 1 REF: 26-0
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Saving MSC: Interpretive
7. Alyssa is opening a bicycle shop, and her monthly expenditures to get the shop up and running exceed her
monthly income. Alyssa is best described as a
a. saver or as a supplier of funds.
b. saver or as a demander of funds.
c. borrower or as a supplier of funds.
d. borrower or as a demander of funds.
ANS: D DIF: 1 REF: 26-0
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Interpretive
8. Most entrepreneurs do not have enough money of their own to start their businesses. When they acquire the
necessary funds from someone else,
a. their consumption expenditures are being financed by someone else’s saving.
b. their consumption expenditures are being financed by someone else’s investment.
c. their investments are being financed by someone else’s saving.
d. their saving is being financed by someone else’s investment.
ANS: C DIF: 2 REF: 26-0
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment | Saving MSC: Interpretive
215 ❖ Chapter 26/Saving, Investment, and the Financial System
Sec01 - Saving, Investment, and the Financial System - Financial Institutions in the
U.S. Economy
MULTIPLE CHOICE
1. At the broadest level, the financial system moves the economy’s scarce resources from
a. the rich to the poor.
b. financial institutions to business firms and government.
c. households to financial institutions.
d. savers to borrowers.
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial system MSC: Interpretive
2. The fact that borrowers sometimes default on their loans by declaring bankruptcy is directly related to the
characteristic of a bond called
a. credit risk.
b. interest risk.
c. term risk.
d. private risk.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Definitional
3. When a large, well-known corporation wishes to borrow directly from the public, it can
a. sell bonds.
b. sell shares of stock.
c. go to a bank for a loan.
d. All of the above are correct.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Interpretive
4. Which of the following statements about the term of a bond is correct?
a. Term refers to the various characteristics of a bond, including its interest rate and tax treatment.
b. The term of a bond is determined entirely by its credit risk.
c. The term of a bond is determined entirely by how much sales charge the buyer of the bond pays
when he or she purchases the bond.
d. Interest rates on long-term bonds are usually higher than interest rates on short-term bonds.
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Interpretive
5. We would expect the interest rate on Bond A to be higher than the interest rate on Bond B if the two bonds
have identical characteristics except that
a. the credit risk associated with Bond A is lower than the credit risk associated with Bond B.
b. Bond A was issued by the state of New York and Bond B was issued by the Exxon Mobil
Corporation.
c. Bond A has a term of 20 years and Bond B has a term of 2 years.
d. All of the above are correct.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Applicative
Chapter 26/Saving, Investment, and the Financial System ❖ 216
6. We would expect the interest rate on Bond A to be higher than the interest rate on Bond B if the two bonds
have identical characteristics except that
a. Bond A was issued by a financially weak corporation and Bond B was issued by a financially
strong corporation.
b. Bond A was issued by the General Electric Corporation and Bond B was issued by the state of
California.
c. Bond A has a term of 20 years and Bond B has a term of 1 year.
d. All of the above are correct.
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Applicative
7. As an alternative to selling shares of stock as a means of raising funds, a large company could, instead,
a. invest in physical capital.
b. use equity finance.
c. sell bonds.
d. purchase bonds.
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock | Bonds MSC: Interpretive
8. Which of the following statements is correct?
a. The expected future profitability of a corporation influences the demand for that corporation’s
stock.
b. When a corporation sells stock as a means of raising funds it is engaging in debt finance.
c. The owners of bonds sold by the Microsoft Corporation are part owners of that corporation.
d. All bonds are, by definition, perpetuities.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock | Bonds MSC: Interpretive
9. Which of the following statements is correct?
a. A corporation receives a monetary payment every time its shares of stock are traded by
stockholders on organized stock exchanges.
b. When a corporation sells bonds as a means of raising funds it is engaging in debt finance.
c. A share of stock is an IOU.
d. The two most important financial markets in the economy are the stock market and financial
intermediaries.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock | Bonds MSC: Interpretive
10. The economy’s two most important financial markets are
a. the investment market and the saving market.
b. the bond market and the stock market.
c. banks and the stock market.
d. financial markets and financial institutions.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial markets MSC: Interpretive
11. Two of the economy’s most important financial intermediaries are
a. suppliers of funds and demanders of funds.
b. banks and the bond market.
c. the stock market and the bond market.
d. banks and mutual funds.
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial intermediaries MSC: Interpretive
217 ❖ Chapter 26/Saving, Investment, and the Financial System
12. We associate the term debt finance with
a. the bond market, and we associate the term equity finance with the stock market.
b. the stock market, and we associate the term equity finance with the bond market.
c. financial intermediaries, and we associate the term equity finance with financial markets.
d. financial markets, and we associate the term equity finance with financial intermediaries.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial markets | Financial intermediaries MSC: Interpretive
13. A bond is a
a. financial intermediary.
b. certificate of indebtedness.
c. certificate of partial ownership in an enterprise.
d. None of the above is correct.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Definitional
14. Which of the following is a financial-market transaction?
a. A saver buys shares in a mutual fund.
b. A saver deposits money into a credit union.
c. A saver buys a bond a corporation has just issued so it can purchase capital.
d. None of the above is correct.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial markets | Bonds MSC: Interpretive
15. A certificate of indebtedness that specifies the obligations of the borrower to the holder is called a
a. bond.
b. stock.
c. mutual fund.
d. All of the above are correct.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Definitional
16. Long-term bonds are
a. riskier than short-term bonds, and so interest rates on long-term bonds are usually lower than
interest rates on short-term bonds.
b. riskier than short-term bonds, and so interest rates on long-term bonds are usually higher than
interest rates on short-term bonds.
c. less risky than short-term bonds, and so interest rates on long-term bonds are usually lower than
interest rates on short-term bonds.
d. less risky than short-term bonds, and so interest rates on long-term bonds are usually higher than
interest rates on short-term bonds.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Interpretive
17. If the government's expenditures exceeded its receipts, it would likely
a. lend money to a bank or other financial intermediary.
b. borrow money from a bank or other financial intermediary.
c. buy bonds directly from the public.
d. sell bonds directly to the public.
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Financial system MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 218
18. A national chain of grocery stores wants to finance the construction of several new stores. The firm has
limited internal funds, so it likely will
a. demand the required funds by buying bonds.
b. demand the required funds by selling bonds.
c. supply the required funds by buying bonds.
d. supply the required funds by selling bonds.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment | Bonds MSC: Interpretive
19. Skyline Chili wants to finance the purchase of new equipment for its restaurants. The firm has limited internal
funds, so Skyline likely will
a. demand funds from the financial system by buying bonds.
b. demand funds from the financial system by selling bonds.
c. supply funds to the financial system by buying bonds.
d. supply funds to the financial system by selling bonds.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment | Bonds MSC: Interpretive
20. If Proctor and Gamble sells a bond it is
a. borrowing directly from the public.
b. borrowing indirectly from the public.
c. lending directly to the public.
d. lending indirectly to the public.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Financial markets MSC: Interpretive
21. Which of the following is correct?
a. The maturity of a bond refers to the amount to be paid back.
b. The principal of the bond refers to the person selling the bond.
c. A bond buyer cannot sell a bond before it matures.
d. None of the above is correct.
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Definitional
22. Which of the following is not correct?
a. By saving a larger portion of its GDP, a country can raise its output per worker.
b. Savers supply their money to the financial system with the expectation that they will get it back
with interest at a later date.
c. Financial intermediaries are the only type of financial institution.
d. The financial system helps match people’s saving with other people’s borrowing.
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Financial system MSC: Interpretive
23. Which of the following is not a nonsensical headline?
a. British perpetuities about to mature.
b. Disney issues new bonds with term of $1,000 each.
c. Government bonds currently pay less interest than corporate bonds.
d. Standard and Poor's judges new junk bond to have very low credit risk.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Interpretive
219 ❖ Chapter 26/Saving, Investment, and the Financial System
24. The length of time until a bond matures is called the
a. perpetuity.
b. term.
c. maturity.
d. intermediation.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Definitional
25. A perpetuity is distinguished from other bonds in that it
a. pays continuously compounded interest.
b. pays interest only when it matures.
c. never matures.
d. will be used to purchase another bond when it matures unless the owner specifies otherwise.
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Perpetuities MSC: Definitional
26. Which of the following is correct?
a. Some bonds have terms as short as a few months.
b. Because they are so risky, junk bonds pay a low rate of interest.
c. Corporations buy bonds to raise funds.
d. All of the above are correct.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Interpretive
27. Which of the following is not correct?
a. If you buy a bond from a corporation, you can sell the bond to someone else before it matures.
b. Term refers to the scheduling of periodic interest rate payments on a bond.
c. A bond is an IOU.
d. There are millions of different bonds in the U.S. economy.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Definitional
28. A bond that never matures is known as a
a. perpetuity.
b. an intermediary bond.
c. an indexed bond.
d. a junk bond.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Perpetuities MSC: Definitional
29. A bond buyer is a
a. saver. Bond buyers must hold their bonds until maturity.
b. saver. Bond buyers may sell their bonds prior to maturity.
c. borrower. Bond buyers must hold their bonds until maturity.
d. borrower. Bond buyers may sell their bonds prior to maturity.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Bonds MSC: Definitional
Chapter 26/Saving, Investment, and the Financial System ❖ 220
30. Which of the following is correct?
a. Lenders sell bonds and borrowers buy them.
b. Long-term bonds usually pay a lower interest rate than do short-term bonds because long-term
bonds are riskier.
c. The term junk bonds refers to bonds that have been resold many times.
d. None of the above is correct.
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Interpretive
31. Short-term bonds are generally
a. less risky than long-term bonds and so they feature higher interest rates.
b. less risky than long-term bonds and so they feature lower interest rates.
c. more risky than long-term bonds and so they feature higher interest rates.
d. more risky than long-term bonds and so they feature lower interest rates.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Risk MSC: Interpretive
32. Compared to short-term bonds, other things the same, long-term bonds generally have
a. more risk and so they pay higher interest rates.
b. less risk and so they pay lower interest rates.
c. less risk and so they pay higher interest rates.
d. about the same risk and so they pay about the same interest rate.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Risk MSC: Interpretive
33. Two bonds have the same term to maturity. The first was issued by a state government and the probability of
default is believed to be low. The other was issued by a corporation and the probability of default is believed
to be high. Which of the following is correct?
a. Because they have the same term to maturity the interest rates should be the same.
b. Because of the differences in tax treatment and credit risk, the state bond should have the higher
interest rate.
c. Because of the differences in tax treatment and credit risk, the corporate bond should have the
higher interest rate.
d. It is not possible to say if one bond has a higher interest rate than the other.
ANS: C DIF: 3 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Bonds | Interest rates MSC: Applicative
34. On which of these bonds is the prospect of default most likely?
a. a junk bond
b. a municipal bond
c. a U.S. government bond
d. a corporate bond issued by General Electric Corporation
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Risk MSC: Interpretive
35. On which of these bonds is the prospect of default least likely?
a. a junk bond
b. a bond issued by the state of Texas
c. a bond issued by the federal government
d. a bond issued by Exxon Mobil Corporation
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Risk MSC: Interpretive
221 ❖ Chapter 26/Saving, Investment, and the Financial System
36. Assume the bonds below have the same term and principal and that the state or local government that issues
the municipal bond has a good credit rating. Which list has bonds correctly ordered from the one that pays the
highest interest rate to the one that pays the lowest interest rate?
a. corporate bond, municipal bond, U.S. government bond
b. corporate bond, U.S. government bond, municipal bond
c. municipal bond, U.S. government bond, corporate bond
d. U.S. government bond, municipal bond, corporate bond
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Risk MSC: Interpretive
37. Other things the same, as the maturity of a bond becomes longer, the bond will pay
a. a lower interest rate because it has less risk.
b. a lower interest rate because it has more risk.
c. a higher interest rate because it has more risk.
d. the same interest rate, because there is no relationship between term and risk.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Risk MSC: Interpretive
38. Suppose the issuer of a bond fails to pay some of the interest or principal that was promised to the
bondholders. This failure is referred to as a
a. breach.
b. default.
c. risk.
d. term failure.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Definitional
39. Suppose the city of Springfield has a high credit rating, and so when Springfield borrows funds by selling
bonds,
a. the city’s high credit rating and the tax status of municipal bonds both contribute to a lower interest
rate than would otherwise apply.
b. the city’s high credit rating and the tax status of municipal bonds both contribute to a higher interest
rate than would otherwise apply.
c. the city’s high credit rating contributes to a lower interest rate than would otherwise apply, while
the tax status of municipal bonds contributes to a higher interest rate than would otherwise apply.
d. the city’s high credit rating contributes to a higher interest rate than would otherwise apply, while
the tax status of municipal bonds contributes to a lower interest rate than would otherwise apply.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Interest rates MSC: Applicative
40. Municipal bonds pay a relatively
a. low rate of interest because of their high default risk and because the interest they pay is subject to
federal income tax.
b. low rate of interest because of their low default risk and because the interest they pay is not subject
to federal income tax.
c. high rate of interest because of their high default risk and because federal taxes must be paid on the
interest they pay.
d. high rate of interest because of their low default risk and because the interest they pay is not subject
to federal income tax.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Interest rates MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 222
41. Which of the following bond buyers did not buy the bond that best met his or her objective?
a. Mia wanted a bond with a high interest rate and was willing to take a lot of risk. She purchased a
junk bond.
b. Anna wanted a bond that would let her best avoid federal income taxes. She purchased a municipal
bond.
c. Bill wanted to purchase a bond whose seller was unlikely to default. He purchased a bond that
Standards and Poor's rated a low credit risk.
d. Toby held long-term bonds rather than short-term ones to avoid risk.
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Applicative
42. You hold bonds issued by the state of Ohio. The interest you earn each year on these bonds
a. is not subject to federal income tax and so these bonds pay a higher interest rate than otherwise
comparable bonds issued by the U.S. government.
b. is not subject to federal income tax and so these bonds pay a lower interest rate than otherwise
comparable bonds issued by the U.S. government.
c. is subject to federal income tax and so these bonds pay a higher interest rate than otherwise
comparable bonds issued by the U.S. government.
d. is subject to federal income tax and so these bonds pay a lower interest rate than otherwise
comparable bonds issued by the U.S. government.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Interest rates MSC: Interpretive
43. Other things the same, bonds are likely to have higher interest rates if they have
a. tax exemptions and short terms.
b. tax exemptions and long terms.
c. no tax exemptions and short terms.
d. no tax exemptions and long terms.
ANS: D DIF: 1 REF: 26-1
TOP: Interest on bonds MSC: Definitional
44. Other things the same, which bond would you expect to pay the highest interest rate?
a. a bond issued by the U.S. government
b. a bond issued by IBM
c. a bond issued by New York State
d. a bond issued by a new restaurant chain
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Interest rates MSC: Applicative
45. Other things the same, which bond would you expect to pay the lowest interest rate?
a. a bond issued by a state with a very good credit rating
b. a bond issued by the U.S. government
c. a bond issued by a fairly new company doing genetic research
d. a bond issued by Nabisco
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Interest rates MSC: Applicative
223 ❖ Chapter 26/Saving, Investment, and the Financial System
46. You are thinking of buying a bond from Knight Corporation. You know that this bond is long term and you
know that Knight’s business ventures are risky and uncertain. You then consider another bond with a shorter
term to maturity issued by a company with good prospects and an established reputation. Which of the
following is correct?
a. The longer term would tend to make the interest rate on the bond issued by Knight higher, while the
higher risk would tend to make the interest rate lower.
b. The longer term would tend to make the interest rate on the bond issued by Knight lower, while the
higher risk would tend to make the interest rate higher.
c. Both the longer term and the higher risk would tend to make the interest rate lower on the bond
issued by Knight.
d. Both the longer term and the higher risk would tend to make the interest rate higher on the bond
issued by Knight.
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Interest rates | Risk MSC: Applicative
47. Jerry has the choice of two bonds, one that pays 3 percent interest and one that pays 6 percent interest. Which
of the following is most likely?
a. The 6 percent bond is less risky than the 3 percent bond.
b. The 6 percent bond is a U.S. government bond, and the 3 percent bond is a junk bond.
c. The 6 percent bond has a longer term than the 3 percent bond.
d. The 6 percent bond is a municipal bond, and the 3 percent bond is a U.S. government bond.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Risk MSC: Applicative
48. Lacey, a financial advisor, has told her clients the following things. Which of her statements is not correct?
a. "U.S. government bonds generally have a higher rate of interest than municipal bonds."
b. "The interest received on corporate bonds is taxable."
c. "U.S. government bonds have the lowest default risk."
d. "If you purchase a bond, you must hold it until it matures."
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Applicative
49. The sale of stocks
a. and bonds to raise money is called debt finance.
b. and bonds to raise money is called equity finance.
c. to raise money is called debt finance, while the sale of bonds to raise funds is called equity finance.
d. to raise money is called equity finance, while the sale of bonds to raise funds is called debt finance.
ANS: D DIF: 1 REF: 26-1
TOP: Bonds | Stock MSC: Definitional
50. ABC Co. sells newly issued bonds. JLG Co. sells newly issued stocks. Which company is raising funds in
financial markets?
a. only ABC
b. only JLG
c. both ABC and JLG
d. neither ABC nor JLG
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Stock MSC: Definitional
Chapter 26/Saving, Investment, and the Financial System ❖ 224
51. Papa Mario's Pizza Company sells common stock. The company is using
a. equity financing and the return shareholders earn is fixed.
b. equity financing and the return shareholders earn depends on how profitable the company is.
c. debt financing and the return shareholders earn is fixed.
d. debt financing and the return shareholders earn depends on how profitable the company is.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
52. Stock represents
a. a claim to a share of the profits of a firm.
b. ownership in a firm.
c. equity finance.
d. All of the above are correct
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Definitional
53. The bond market
a. is a financial market, whereas the stock market is a financial intermediary.
b. is a financial intermediary, whereas the stock market is a financial market.
c. is a financial market, as is the stock market.
d. is a financial intermediary, as is the stock market.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bond market, stock market MSC: Definitional
54. Which of the following would likely make the interest rate on a bond higher than otherwise?
a. both high credit risk and a long term
b. high credit risk but not a long term
c. a long term but not a high credit risk
d. neither high credit risk nor a long term
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Bonds | Interest rates MSC: Definitional
55. People who buy newly issued stock in a corporation such as Crate and Barrel provide
a. debt finance and so become part owners of Crate and Barrel.
b. debt finance and so become creditors of Crate and Barrel.
c. equity finance and so become part owners of Crate and Barrel.
d. equity finance and so become creditors of Crate and Barrel.
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Definitional
56. People who buy stock in a corporation such as General Electric become
a. creditors of General Electric, so the benefits of holding the stock depend on General Electric's
profits.
b. creditors of General Electric, but the benefits of holding the stock do not depend on General
Electric's profits.
c. part owners of General Electric, so the benefits of holding the stock depend on General Electric's
profits.
d. part owners of General Electric, but the benefits of holding the stock do not depend on General
Electric's profits.
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
225 ❖ Chapter 26/Saving, Investment, and the Financial System
57. If Huedepool Beer runs into financial difficulty, the stockholders as
a. part owners of Huedepool are paid before bondholders get paid anything at all.
b. part owners of Huedepool are paid after bondholders get paid.
c. creditors of Huedepool are paid before bondholders get paid anything at all.
d. creditors of Huedepool are paid after bondholders get paid.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
58. As chief financial officer you sell newly issued bonds on behalf of your firm. Your firm is
a. borrowing directly.
b. borrowing indirectly.
c. lending directly.
d. lending indirectly.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Definitional
59. Which of the following people purchased the correct asset to meet his or her objective?
a. Michelle wanted to be a part owner of Mamma Rosa's Pizza, so she purchased a bond issued by
Mamma Rosa's Pizza.
b. Tim wanted a high return, even if it meant taking some risk, so he purchased stock issued by
Specific Electric instead of bonds issued by Specific Electric.
c. Jennifer wanted to buy equity in Honda, so she purchased bonds sold by Honda.
d. All of the above are correct.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds | Stock MSC: Interpretive
60. If a firm sells a total of 100 shares of stock, then
a. each share represents 1 percent of the firm’s indebtedness.
b. each share represents ownership of 1 percent of the firm.
c. the firm is engaging in debt finance.
d. the firm is engaging in term finance.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
61. The prices of stock traded on exchanges are determined by
a. the Corporate Stock Administration.
b. the administrators of NASDAQ.
c. the supply of, and demand for, the stock.
d. All of the above are correct.
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
62. Which of the following is not an important stock exchange in the United States?
a. New York Stock Exchange
b. American Stock Exchange
c. Chicago Mercantile Exchange
d. NASDAQ
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock market MSC: Definitional
Chapter 26/Saving, Investment, and the Financial System ❖ 226
63. All else equal, when people become more optimistic about a company's future, the
a. supply of the stock and the price will both rise.
b. supply of the stock and the price will both fall.
c. demand for the stock and the price will both rise.
d. demand for the stock and the price will both fall.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
64. Suppose the government finds a major defect in one of a company's products and demands that the product be
taken off the market. We would expect that the
a. supply of existing shares of the stock and the price will both rise.
b. supply of existing shares of the stock and the price will both fall.
c. demand for existing shares of the stock and the price will both rise.
d. demand for existing shares of the stock and the price will both fall.
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
65. World Wide Delivery Service Corporation develops a way to speed up its deliveries and reduce its costs. We
would expect that this would
a. raise the demand for existing shares of the stock, causing the price to rise.
b. decrease the demand for existing shares of the stock, causing the price to fall.
c. raise the supply of the existing shares of stock, causing the price to rise.
d. raise the supply of the existing shares of stock, causing the price to fall.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
66. In the late summer of 2005 some regions of the country were suffering from drought. What effect would we
expect this to have on the stock of companies such as John Deere that manufacture farm equipment?
a. raise the demand for existing shares of the stock, causing the price to rise
b. decrease the demand for existing shares of the stock, causing the price to fall
c. raise the supply of the existing shares of stock, causing the price to rise
d. raise the supply of the existing shares of stock, causing the price to fall
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
67. In the Coen Brothers’ movie The Hudsucker Proxy the board of directors picks someone to run the company
who they believe will make poor decisions. If things turn out as they plan,
a. the price of a share of stock in the Hudsucker corporation should decline as the demand for shares
falls.
b. the price of a share of stock in the Hudsucker corporation should rise as the demand for shares
rises.
c. the price of a share of stock in the Hudsucker corporation should decline as the supply of existing
shares falls.
d. the price of a share of stock in the Hudsucker corporation should rise as the supply of existing
shares rises.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
227 ❖ Chapter 26/Saving, Investment, and the Financial System
68. Suppose that the tires of a certain tire manufacturer are discovered to be defective. Other things the same, this
news would cause
a. the demand for this company’s stock to decrease, so the price would rise.
b. the demand for this company’s stock to decrease, so the price would fall.
c. the supply of this company’s stock to decrease, so the price would fall.
d. the supply of this company’s stock to decrease, so the price would rise.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
69. Nastech Pharmaceuticals announced it has developed a nasal spray that would reduce hunger cravings. Other
things the same we would expect
a. the demand for existing shares of stock in this company to decrease, so the price would fall.
b. the demand for existing shares of stock in this company to increase, so the price would rise.
c. the supply of existing shares of stock in this company to decrease, so the price would fall.
d. the supply of existing shares of stock in this company to increase, so the price would rise.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
70. Other things being constant, when a firm sells new shares of stock, the
a. supply of the stock increases and the price decreases as a result.
b. supply of the stock decreases and the price increases as a result.
c. demand for the stock increases and the price increases as a result.
d. demand for the stock decreases and the price decreases as a result.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
71. Which of the following is a certificate of indebtedness?
a. stocks and bonds
b. stocks but not bonds
c. bonds but not stocks
d. neither stocks nor bonds
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Bonds | Stocks MSC: Definitional
72. Compared to stocks, bonds offer the holder
a. lower risk and lower potential return.
b. lower risk and higher potential return.
c. higher risk and lower potential return.
d. higher risk and higher potential return.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds, Stock MSC: Interpretive
73. Which of the following statements is correct?
a. A general, persistent decline in stock prices may signal that the economy is about to enter a boom
period because people will be able to buy stock for less money.
b. A general, persistent decline in stock prices may signal that the economy is about to enter a
recession because low stock prices may mean that people are expecting low corporate profits.
c. A general, persistent decline in stock prices may signal that the economy is about to enter a
recession because low stock prices mean that corporations have had low profits in the past.
d. Expectations about the business cycle have no impact on stock prices.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
Chapter 26/Saving, Investment, and the Financial System ❖ 228
74. A stock index is
a. an average of a group of stock prices.
b. an average of a group of stock yields.
c. a measure of the risk relative to the profitability of corporations.
d. a report in a newspaper or other media outlet on the price of the stock and earnings of the
corporation that issued the stock.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock indexes MSC: Definitional
75. The Dow Jones Industrial Average has been computed regularly since
a. 1976.
b. 1948.
c. 1913.
d. 1896.
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock indexes MSC: Definitional
76. The Dow Jones Industrial Average is now based on the prices of the stocks of
a. 30 major U.S. corporations.
b. 100 major U.S. corporations.
c. 500 representative U.S. corporations.
d. 1,000 representative U.S. corporations.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock indexes MSC: Definitional
77. The single most important piece of information about a stock is its
a. term.
b. dividend.
c. daily volume.
d. price.
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
78. Potential buyers of ABC Corporation bonds are not concerned about ABC Corporation declaring bankruptcy.
Potential buyers of XYZ Corporation bonds are concerned that XYZ Corporation may declare bankruptcy.
Which of the following statements is correct?
a. Other things equal, the interest rate on XYZ Corporation bonds will be high relative to the interest
rate on ABC Corporation bonds.
b. An ABC Corporation bond is a perpetuity, whereas an XYZ Corporation bond is not a perpetuity.
c. XYZ Corporation bonds carry more interest-rate risk than do ABC Corporation bonds.
d. All of the above are correct.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Bonds MSC: Interpretive
79. Compared to bondholders, stockholders
a. face higher risk and have the potential for higher returns.
b. face higher risk but receive a fixed payment.
c. face lower risk and have the potential for higher returns.
d. face lower risk but receive a fixed payment.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Bonds | Stock MSC: Interpretive
229 ❖ Chapter 26/Saving, Investment, and the Financial System
80. After a corporation issues stock, the stock
a. can not be resold.
b. can be resold only if the corporation wants to buy it back.
c. can be resold on exchanges; the resale will raise additional funds for the corporation.
d. None of the above are correct.
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Stock MSC: Definitional
81. A high demand for a company’s stock is an indication that
a. the company is in need of funds.
b. the company has recently sold a large quantity of bonds.
c. people are optimistic about the company’s future.
d. people are pessimistic about the company’s future.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
82. The price of a stock will rise if
a. the managers of a stock exchange decide the price should be higher.
b. the demand for the stock rises.
c. the supply of the stock rises.
d. None of the above are correct.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
83. Volume, as reported in stock tables, refers to the
a. number of shares traded.
b. percentage of shares outstanding traded.
c. number of shares traded times the price they sold at.
d. number of shares of a company traded divided by the shares of all companies traded.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Definitional
84. A corporation’s earnings are the amount of revenue it receives for the sale of its products
a. minus its cost of production as measured by its accountants. Earnings must be paid out as
dividends.
b. minus its cost of production as measured by its accountants. Earnings may be paid out as dividends
or retained by the corporation.
c. minus its direct and indirect costs as measured by its economists. Earnings must be paid out as
dividends.
d. minus its direct and indirect cost as measure by its economists. Earnings may be paid out as
dividends or retained by the corporation.
ANS: B DIF: 2 REF: 26-2
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Dividends | Stock MSC: Definitional
85. All or part of a firm’s profits may be paid out to the firm’s stockholders in the form of
a. retained earnings.
b. dividends.
c. interest payments.
d. capital accounts.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Dividends MSC: Definitional
Chapter 26/Saving, Investment, and the Financial System ❖ 230
86. Profits not paid out to stockholders are
a. retained earnings.
b. known as dividends.
c. the denominator in the price-earnings ratio.
d. All of the above are correct.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Definitional
87. A stock’s dividend yield is the
a. dividend as a percentage of the price per share.
b. stock price as a percentage of the dividend.
c. dividend as a percentage of the retained earnings per share.
d. retained earnings per share as the percentage of the dividend.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Dividends MSC: Definitional
88. A particular stock pays an annual dividend of $2 per share and the annual dividend yield is 4 percent. The
price of a share of this stock is
a. $2.08.
b. $5.00.
c. $8.00
d. $50.00.
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Dividends MSC: Interpretive
89. In 2008, XYZ Corporation had total earnings of $200 million and 50 million shares of the corporation’s stock
were outstanding. If the price-earnings ratio for XYZ is 20, then what is the price of a share of its stock?
a. $5
b. $10
c. $80
d. $500
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
90. In 2008, CDZ Corporation had total earnings of $500 million and CDZ retained 30 percent of its earnings for
future investments. If the price of a share of CDZ stock is $70 and if 80 million shares of its stock were
outstanding, then what is the price-earnings ratio?
a. 0.14
b. 11.2
c. 16.0
d. 37.3
ANS: B DIF: 3 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
91. The number of shares of Biggie Corporation stock outstanding in 2007 was 100 million. In 2007, Biggie stock
paid a dividend of $2.40 per share and its dividend yield was 4 percent. If the price-earnings ratio is 16, then
Biggie’s total earnings in 2007 amounted to
a. $1.92 million.
b. $87.50 million.
c. $375.00 million.
d. $960.00 million.
ANS: C DIF: 3 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
231 ❖ Chapter 26/Saving, Investment, and the Financial System
92. Camp Company had total earnings of $600 million in 2008, out of which it retained $150 million for future
investments. In 2008, its stock featured a dividend yield of 3 percent and 200 million shares were outstanding.
The price-earnings ratio for Camp Company stock was
a. 8.33.
b. 12.00.
c. 16.67.
d. 25.00.
ANS: D DIF: 3 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
93. Fortunade Corporation stock has a price of $100 per share, a dividend of $1.60 per share, and retained
earnings of $2.00 per share. The dividend yield on this stock is
a. 2.8 percent.
b. 2.0 percent.
c. 1.6 percent.
d. 0.4 percent.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Dividends MSC: Applicative
94. Queen City Sausage stock is selling at $40 per share, it has retained earnings of $2.00 per share and dividends
of $.50 per share. What is the price-earnings ratio and what is the dividend yield?
a. 20, 1.25 percent
b. 20, 6.25 percent
c. 16, 1.25 percent
d. None of the above is correct.
ANS: C DIF: 3 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
95. Stock in Creole Cuisine Restaurants is selling at $25 per share. Creole Cuisine had earnings of $5 a share and
a dividend yield of 5 percent. The dividend is
a. $0.25 and the price-earnings ratio is 5.
b. $.25 and the price-earnings ratio is 6.7.
c. $1.25 and the price-earnings ratio is 5.
d. $1.25 and the price-earnings ratio is 6.7.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
96. Stock in Tasty Greens Restaurants is selling at $80 per share with 1 million shares outstanding. Last year,
Tasty Greens earned $5 million, of which it retained $1 million for future investments. The dividend yield on
the stock is
a. 1 percent.
b. 2 percent.
c. 4 percent.
d. 5 percent.
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock | Dividends MSC: Applicative
Chapter 26/Saving, Investment, and the Financial System ❖ 232
97. Buskin’s Corporation has issued 2 million shares of stock. Its earnings were $10 million, of which it retained
$6 million. What was the dividend per share?
a. $2.
b. $3.
c. $5
d. None of the above is correct.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Dividends MSC: Analytical
98. Over-the-Rhine Cheese Corporation had a P/E ratio of 20, retained earnings of $1.50 per share and a dividend
of $.50. What was its dividend yield?
a. 1.25%
b. 1.67%
c. 3.33%
d. 7.50%
ANS: A DIF: 3 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Dividends MSC: Analytical
99. Dependable Appliances had a P/E ratio of 25, earnings per share of $4, and retained earnings per share of $3.
What was its dividend yield?
a. 4%
b. 3%
c. 1%
d. None of the above is correct.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Dividends MSC: Analytical
100. XDF Corp. had a price-earnings ratio of 15, paid a dividend of $1, and retained earnings of $2 a share. What
was the price of a share of XDF stock?
a. $15
b. $30
c. $45
d. None of the above is correct.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
101. Thomas Publishing has a share price of $28, retained earnings of $0.60 per share, and a dividend yield of 5
percent. What is its price-earnings ratio?
a. 24
b. 16
c. 14
d. 12
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
233 ❖ Chapter 26/Saving, Investment, and the Financial System
102. A corporation's earnings are
a. the amount of revenue it receives for the sale of its products minus its costs of production as
measured by its accountants minus the dividends paid out.
b. the amount of revenue it receives for the sale of its products minus its direct and indirect costs of
production as measured by its economists minus the dividends paid out.
c. the amount of revenue it receives for the sale of its products minus its costs of production as
measured by its accountants.
d. the amount of revenue it receives for the sale of its products minus its direct and indirect costs of
production as measured by its economists.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Profits MSC: Definitional
103. Retained earnings are
a. earnings of a company that are not paid out to stockholders.
b. the amount of revenue a corporation receives for the sale of its products minus its costs of
production as measured by its accountants.
c. the single most important piece of information about a stock.
d. computed by multiplying the dividend yield by the price of the stock.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Profits MSC: Interpretive
104. The amount of revenue a firm receives for the sale of its products minus its costs of production as measured by
its accountants is the firm's
a. earnings.
b. retained earnings.
c. economic, or real, profit.
d. dividend.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Profits MSC: Definitional
105. Historically, the typical price-earnings ratio for stocks is about
a. 3
b. 8
c. 15
d. 26
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Definitional
106. A high price-earnings ratio for a stock indicates that either the stock is
a. undervalued or people are relatively optimistic about the corporation's prospects.
b. overvalued or people are relatively optimistic about the corporation's prospects.
c. overvalued or people are relatively pessimistic about the corporation's prospects.
d. undervalued or people are relatively pessimistic about the corporation's prospects.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
107. A low price-earnings ratio indicates that either the stock is
a. undervalued or people are relatively optimistic about the corporation's prospects.
b. overvalued or people are relatively optimistic about the corporation's prospects.
c. overvalued or people are relatively pessimistic about the corporation's prospects.
d. undervalued or people are relatively pessimistic about the corporation's prospects.
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 234
108. PacknCamp Corporation has a stock price of $50, has issued 2,000,000 shares of stock, has retained earnings
of $4 million dollars, and a dividend yield of 4 percent. The price-earnings ratio of PacknCamp is
a. 25, which is high compared to historical standards of the market.
b. 25, which is low compared to historical standards of the market.
c. 12.5, which is low compared to historical standards of the market.
d. 12.5, which is high compared to historical standards of the market.
ANS: C DIF: 3 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
109. Metals, Inc. has a price of $20 a share, outstanding shares of 2.5 million, retained earnings of $1 million
dollars, and a dividend yield of 2 percent. It has a price-earnings ratio of
a. 50, which is high by historical standards.
b. 50, which is low by historical standards.
c. 25, which is high by historical standards.
d. 25, which is low by historical standards.
ANS: C DIF: 3 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
110. Zeta Corporation has a price of $20 a share, outstanding shares of 2.5 million, retained earnings of $1 million
dollars, and a dividend yield of 1 percent. It has a price-earnings ratio which is
a. high, perhaps indicating that people expect future earnings to rise.
b. high, perhaps indicating that people expect future earnings to fall.
c. low, perhaps indicating that people expect future earnings to rise.
d. low, perhaps indicating that people expect future earnings to fall.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Analytical
111. A low P/E for a stock indicates that
a. people may expect earnings to fall in the future, perhaps because the firm will be faced with
increased competition.
b. its dividends have been low so that no one is willing to pay very much for it.
c. the corporation is possibly overvalued.
d. All of the above are correct.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
112. Suppose Sarah Lee Corporation stock has a P/E ratio of 8. This P/E ratio is relatively
a. low, indicating that buyers may expect earnings to rise.
b. low, indicating that buyers may expect earnings to fall.
c. high, indicating that buyers may expect earnings to rise.
d. high, indicating that buyers may expect earnings to fall.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Interpretive
113. Which of the following is correct?
a. Joan takes some of her income and buys mutual fund shares. Joan’s purchase will be included in the
investment category of GDP.
b. If a share of stock in Virtual Pizza Corporation sells for $77, the earnings per share are $5, and the
dividend per share is $2, then the P/E ratio is 11.
c. In order to use equity finance, a firm must sell about equal values of stocks and bonds.
d. None of the above is correct.
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
235 ❖ Chapter 26/Saving, Investment, and the Financial System
Use the following table to answer the following questions.
Table 26-1
Stock Sym Yld % P/E Vol 100s Hi Lo Close Net Chg.
GenMills GIS 2.5 35 13758 44.3 43.5 43.97 –0.63
Gillette G 2.2 31 30428 31.1 29.7 30 0.17
Graco GGG 1.2 16 705 24.2 23.1 23.95 –0.53
Hershey HSY 2.1 38 5418 63.4 61.7 62.45 0.72
114. Refer to Table 26-1. In dollar terms, which company paid the highest dividend per share?
a. GenMills
b. Gillette
c. Graco
d. Hershey
ANS: D DIF: 3 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Dividends MSC: Applicative
115. Refer to Table 26-1. What was Hershey's earnings per share?
a. $38
b. $1.64
c. $1.31
d. $0.61
ANS: B DIF: 3 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
116. Refer to Table 26-1. Assume that the closing price was also the average price at which each stock transaction
took place. What was the total dollar volume of Gillette stock traded that day?
a. $912,840,000
b. $91,284,000
c. $9,128,400
d. $912,840
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
117. Refer to Table 26-1. Which firm had the P/E ratio that was closest to the historically typical P/E ratio?
a. GenMills
b. Gillette
c. Graco
d. Hershey
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Definitional
Chapter 26/Saving, Investment, and the Financial System ❖ 236
Use the following table to answer the following questions.
Table 26-2
Stock Sym Yld % P/E Vol 100s Hi Lo Close Net
Chg.
Boeing Co. BA 1.55 30.48 4,531,600 64.78 63.70 64.62 +.93
Eli Lily and Co. LLY 2.60 29.71 3,765,700 58.98 58.21 58.52 +.16
H. J. Heniz and Co. HNZ 3.30 15.33 1,350,200 36.55 36.26 36.33 +.21
Kellog Co. K 2.22 20.50 1,990,600 45.72 45.20 45.50 +.24
118. Refer to Table 26-2. Which company had the highest dollar dividend?
a. Boeing Co.
b. Eli Lilly and Co.
c. H. J. Heinz and Co.
d. Kellog Co.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
119. Refer to Table 26-2. Which company had the lowest dollar dividend?
a. Boeing Co.
b. Eli Lilly and Co.
c. H. J. Heinz and Co.
d. Kellog Co.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
120. Refer to Table 26-2. Which company had the highest earnings per share?
a. Boeing Co.
b. Eli Lilly and Co.
c. H. J. Heinz and Co.
d. Kellog Co.
ANS: C DIF: 3 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
121. Refer to Table 26-2. Which company had the lowest earnings per share?
a. Boeing Co.
b. Eli Lilly and Co.
c. H. J. Heinz and Co.
d. Kellog Co.
ANS: B DIF: 3 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
122. Refer to Table 26-2. For which company’s stock is the P/E ratio closest to what is historically typical?
a. Boeing Co.
b. Eli Lilly and Co.
c. H. J. Heinz and Co.
d. Kellog Co.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock MSC: Applicative
237 ❖ Chapter 26/Saving, Investment, and the Financial System
123. Financial intermediaries are
a. the same as financial markets.
b. individuals who make profits by buying a stock low and selling it high.
c. a more general name for financial assets such as stocks, bonds, and checking accounts.
d. financial institutions through which savers can indirectly provide funds to borrowers.
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial intermediaries MSC: Definitional
124. Which of the following is both a financial institution and a financial intermediary?
a. banks
b. stock exchanges
c. the bond market
d. All of the above are correct.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Financial intermediaries | Financial institutions MSC: Definitional
125. Which of the following statements is correct?
a. Stocks, bonds, and deposits are all similar in that each provides a common medium of exchange.
b. Most buyers of stocks and bonds prefer those issued by large and familiar companies.
c. Banks charge borrowers a slightly lower interest rate than they pay to depositors.
d. None of the above is correct.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Stock | Bonds | Banks MSC: Interpretive
126. Which of the following is a financial intermediary?
a. a mutual fund
b. the stock market
c. a U.S. government bond
d. a wealthy individual who regularly buys and holds large quantities of government bonds
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial intermediaries MSC: Definitional
127. Which of the following are financial intermediaries?
a. both banks and mutual funds
b. banks but not mutual funds
c. mutual funds but not banks
d. neither banks or mutual funds
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial intermediaries MSC: Definitional
128. Which of the following is an example of financial intermediation?
a. Susan buys shares of stock issued by a fast food company.
b. A foreign government buys bonds issued by the U.S. Treasury.
c. John makes a deposit at a bank and the bank uses this money to make an auto loan to Luke.
d. None of the above is correct.
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Financial intermediaries MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 238
129. Which of the following statements is correct?
a. A large, well-known corporation such as Proctor and Gamble would generally use financial
intermediation to finance expansion of its factories.
b. On average, indexed funds outperform managed funds.
c. Unlike corporate bonds and stocks, checking accounts are a store of value.
d. Financial intermediaries are institutions through which savers can directly provide funds to
borrowers.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Financial intermediaries MSC: Interpretive
130. Which of the following statements is correct?
a. A large, well-known corporation such as Intel generally would use financial intermediation to
finance expansion of its facilities.
b. On average, managed funds outperform indexed funds.
c. Unlike corporate bonds and stocks, checking accounts are a medium of exchange.
d. A mutual fund is a financial market.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Medium of exchange MSC: Interpretive
131. Which of the following is both a store of value and a common medium of exchange?
a. corporate bonds
b. mutual funds
c. checking account balances
d. All of the above are correct.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Store of value | Medium of exchange MSC: Interpretive
132. A checking deposit functions as
a. a medium of exchange and as a store of value.
b. a medium of exchange, but not as a store of value.
c. a store of value, but not as a medium of exchange.
d. neither a medium of exchange nor as a store of value.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Store of value | Medium of exchange MSC: Interpretive
133. In addition to
a. performing financial intermediation, banks are important in that they help create a medium of
exchange.
b. serving as financial markets, mutual funds are important in that they help create a store of value.
c. serving as stores of value, stocks and bonds also serve as media of exchange.
d. All of the above are correct.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Medium of exchange MSC: Interpretive
239 ❖ Chapter 26/Saving, Investment, and the Financial System
134. Stocks and bonds
a. and checking accounts are all stores of value and commonly function as mediums of exchange.
b. and checking accounts are all stores of value, but only stocks and bonds commonly function as
mediums of exchange.
c. and checking accounts are all stores of value, but only checking accounts commonly function as
mediums of exchange.
d. and checking accounts all commonly function as mediums of exchange, but only stocks and bonds
are a store of value.
ANS: C DIF: 2 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Bonds | Medium of exchange | Stocks | Store of value MSC: Interpretive
135. A U.S. Treasury bond is a
a. store of value and common medium of exchange.
b. store of value, but not a common medium of exchange.
c. a common medium of exchange, but not a store of value.
d. neither a store of value nor a common medium of exchange.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Store of value | Medium of exchange MSC: Interpretive
136. A mutual fund
a. is a financial market where small firms mutually agree to sell stocks and bonds to raise funds.
b. is funds set aside by local governments to lend to small firms who want to invest in projects that are
mutually beneficial to the firm and community.
c. sells stocks and bonds on behalf of small and less known firms who would otherwise have to pay
high interest to obtain credit.
d. is an institution that sells shares to the public and uses the proceeds to buy a selection of various
types of stocks, bonds, or both stocks and bonds.
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Mutual funds MSC: Definitional
137. It is claimed that mutual funds have two advantages. The first is that mutual funds allow people with small
amounts of money to diversify. The second is that mutual funds provide the skills of professional money
managers who buy stocks they believe will be the most profitable and thereby increase the return that mutual
fund depositors earn on their savings.
a. Economists strongly agree with both claims.
b. Economists are skeptical of both claims.
c. Economists are skeptical of the first claim, but strongly agree with the second.
d. Economists strongly agree with the first claim, but are skeptical of the second.
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Mutual funds MSC: Interpretive
138. The primary advantage of mutual funds is that they
a. always make a return that "beats the market."
b. allow people with small amounts of money to diversify.
c. provide customers with a medium of exchange.
d. All of the above are correct.
ANS: B DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Mutual funds | Diversification MSC: Definitional
Chapter 26/Saving, Investment, and the Financial System ❖ 240
139. The old adage, “Don’t put all your eggs in one basket,” is very similar to a modern bit of advice concerning
financial matters:
a. “Buy low-risk bonds.”
b. “Use a medium of exchange.”
c. “Diversify.”
d. “Intermediate.”
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Diversification MSC: Interpretive
140. As a money management fee, mutual funds usually charge their customers
a. between 0.5 and 2.0 percent of assets each year.
b. between 1.5 and 3.0 percent of assets each year.
c. nothing, because they receive commissions from the firms whose stock they buy.
d. a flat fee of about $50.
ANS: A DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Mutual funds MSC: Definitional
141. It is claimed that a secondary advantage of mutual funds is that
a. an investor can avoid investment charges and fees.
b. they give ordinary people access to loanable funds for investing.
c. they usually outperform stock market indexes.
d. they give ordinary people access to the skills of professional money managers.
ANS: D DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Mutual funds MSC: Interpretive
142. Index funds
a. typically have a higher rate of return and higher costs than managed mutual funds.
b. typically have a higher rate of return and lower costs than managed mutual funds.
c. typically have a lower rate of return and higher costs than managed mutual funds.
d. typically have a lower rate of return and lower costs than managed mutual funds.
ANS: B DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Mutual funds | Index funds MSC: Interpretive
143. Index funds
a. buy all the stocks in a given stock index.
b. promise to beat the market by a certain percentage known as an index.
c. provide a return that is adjusted for changes in the consumer price index.
d. buy industries within a particular category of the North American Industry Classification System.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Index funds MSC: Definitional
144. Managed funds
a. typically have a higher rate of return and higher costs than index funds.
b. typically have a higher rate of return and lower costs than index funds.
c. typically have a lower rate of return and higher costs than index funds.
d. typically have a lower rate of return and lower costs than index funds.
ANS: C DIF: 1 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Mutual funds | Index funds MSC: Interpretive
241 ❖ Chapter 26/Saving, Investment, and the Financial System
145. Which of the following statements about mutual funds is correct?
a. A mutual fund is a financial intermediary.
b. A mutual fund acquires its funds primarily by selling shares to the public.
c. People who buy shares from a mutual fund accept all of the risk and return associated with the
mutual fund’s portfolio.
d. All of the above are correct.
ANS: D DIF: 2 REF: 26-1
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Mutual funds MSC: Interpretive
146. Which advantage(s) do mutual funds claim to provide?
a. diversification and access to the skills of professional money managers
b. diversification but not access to the skills of professional money managers
c. access to the skills of professional money managers but not diversification
d. neither diversification nor access to the skills of professional money managers.
ANS: A DIF: 1 REF: 26-1
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Mutual funds MSC: Interpretive

Sec02 - Saving, Investment, and the Financial System - Saving and Investment in the
National Income Accounts
MULTIPLE CHOICE
1. Which of the following is not correct?
a. Gross domestic product is both total income in an economy and total expenditures on the
economy’s output of goods and services.
b. In a closed economy net exports are zero.
c. National saving is the sum of private saving and public saving.
d. Purchases of capital goods are excluded from GDP.
ANS: D DIF: 1 REF: 26-2
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Investment | Gross domestic product MSC: Definitional
2. You observe a closed economy that has a government deficit and positive investment. Which of the following
is correct?
a. Private and public saving are both positive.
b. Private saving is positive; public saving is negative.
c. Private saving is negative; public saving is positive.
d. Both private saving and public saving are negative.
ANS: B DIF: 2 REF: 26-2
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Private saving | Public saving MSC: Analytic
3. If national saving in a closed economy is greater than zero, which of the following must be true?
a. Either public saving or private saving must be greater than zero.
b. Investment is positive.
c. Y - C - G > 0
d. All of the above are correct.
ANS: D DIF: 2 REF: 26-2
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: National saving MSC: Analytic
Chapter 26/Saving, Investment, and the Financial System ❖ 242
4. Which of the following is correct?
a. In the national income accounts, investment and private saving refer to the same thing.
b. In a closed economy if national saving is greater than zero, then everyone must be saving.
c. The financial system channels funds from savers to borrowers.
d. People whose consumption exceeds their income are savers.
ANS: C DIF: 1 REF: 26-2
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Financial system | Saving MSC: Definitional
5. A closed economy does not
a. trade with other economies.
b. have free markets.
c. allow financial intermediation.
d. All of the above are correct.
ANS: A DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Closed economies MSC: Definitional
6. The assumption of a closed economy
a. applies to the world economy.
b. applies to most national economies.
c. requires us to assume that the government’s budget is always balanced.
d. All of the above are correct.
ANS: A DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Closed economies MSC: Interpretive
7. In a closed economy, what does (T - G) represent?
a. national saving
b. investment
c. private saving
d. public saving
ANS: D DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Public saving MSC: Definitional
8. In a closed economy, what remains after paying for consumption and government purchases is
a. national disposable income.
b. national saving.
c. public saving.
d. private saving.
ANS: B DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving MSC: Interpretive
9. In a closed economy, what does (Y - T - C) represent?
a. national saving
b. government tax revenue
c. public saving
d. private saving
ANS: D DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Private saving MSC: Definitional
243 ❖ Chapter 26/Saving, Investment, and the Financial System
10. In which of the following cases would it necessarily be true that national saving and private saving are equal
for a closed economy?
a. Private saving is equal to government expenditures.
b. Public saving is equal to investment.
c. After paying their taxes and paying for their consumption, households have nothing left.
d. The government’s tax revenue is equal to its expenditures.
ANS: D DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving | Private saving MSC: Applicative
11. Which of the following statements is correct?
a. The total income in the economy that remains after paying for consumption and government
purchases is called private saving.
b. The sum of private saving and national saving is called public saving.
c. For a closed economy, the sum of private saving and public saving must equal investment.
d. For a closed economy, the sum of consumption, national saving, and taxes must equal GDP.
ANS: C DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Identities MSC: Interpretive
12. Net exports must equal zero for any economy
a. that is closed.
b. for which Y = C + I + G.
c. for which S = Y - C - G.
d. All of the above are correct.
ANS: D DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Closed economies MSC: Applicative
13. In national income accounting, we use which of the following pairs of terms interchangeably?
a. “investment” and “private saving”
b. “investment” and “purchases of stocks and bonds”
c. “saving” and “national saving”
d. “public saving” and “government tax revenue minus government spending”
ANS: D DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving MSC: Definitional
14. The purchase of a new house is the one form of
a. investment that is financed by private saving rather than public saving.
b. household spending that is not counted as part of investment in the national income accounts.
c. household spending that is investment rather than consumption.
d. household spending that does not contribute to GDP.
ANS: C DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Definitional
15. The identity that shows that total income and total expenditure are equal is
a. GDP = Y.
b. Y = DI + T + NX.
c. GDP = GNP - NX.
d. Y = C + I + G + NX.
ANS: D DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Gross domestic product MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 244
16. Which of the following lists correctly identifies the four expenditure categories of GDP?
a. consumption, government purchases, investment, net-exports
b. consumption, investment, depreciation, net-exports
c. consumption, saving, investment, depreciation,
d. consumption, government purchases, investment, savings
ANS: A DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Gross domestic product MSC: Definitional
17. Y = C + I + G + NX is an identity because
a. each symbol identifies a macroeconomic variable.
b. the right-hand and left-hand sides are equal when an equilibrium is reached.
c. the equality holds due to the way the variables are defined.
d. None of the above is correct.
ANS: C DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Identities | Gross domestic product MSC: Interpretive
18. Which of the following equations will always represent GDP in an open economy?
a. S = I - G
b. I = Y - C + G
c. Y = C + I + G
d. Y = C + I + G + NX
ANS: D DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Gross domestic product MSC: Interpretive
19. Which of the following equations represents GDP for a closed economy?
a. Y = C + I + G + T
b. S = I - G
c. I = Y - C + G
d. Y = C + I + G
ANS: D DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Gross domestic product | Closed economies MSC: Interpretive
20. Which of the following equations represents GDP for an open economy?
a. Y = C + I + G + NX
b. NX = I - G
c. I = Y - C + G + NX
d. Y = C + I + G
ANS: A DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Gross domestic product | Open economies MSC: Interpretive
21. Which of the following expressions must be equal to national saving for a closed economy?
a. Y - I - G - NX
b. Y - C - G
c. Y - I - C
d. G + C - Y
ANS: B DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving MSC: Interpretive
245 ❖ Chapter 26/Saving, Investment, and the Financial System
22. In a closed economy, national saving equals
a. investment.
b. income minus the sum of consumption and government purchases.
c. private saving plus public saving.
d. All of the above are correct.
ANS: D DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving MSC: Interpretive
23. In a closed economy, national saving is
a. usually greater than investment.
b. equal to investment.
c. usually less than investment because of the leakage of taxes.
d. always less than investment.
ANS: B DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving MSC: Definitional
24. In a small closed economy investment is $20 billion and private saving is $22 billion. What are public saving
and national saving?
a. $24 billion and $2 billion
b. $20 billion and -$2 billion
c. $2 billion and $24 billion
d. -$2 billion and $20 billion
ANS: D DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving | Public saving MSC: Applicative
25. Suppose a closed economy had public saving of $3 trillion and private saving of $2 trillion. What are national
saving and investment for this country?
a. $5 trillion, $5 trillion
b. $5 trillion, $2 trillion
c. $1 trillion, $5 trillion
d. $1 trillion, $2 trillion
ANS: A DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving | Investment MSC: Applicative
26. Consider the expressions T - G and Y - T - C. Which of the following statements is correct?
a. Each one of these is equal to national saving.
b. Each one of these is equal to public saving.
c. The first of these is private saving; the second one is public saving.
d. The first of these is public saving; the second one is private saving.
ANS: D DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Public saving | Private saving MSC: Definitional
27. According to the definitions of private and public saving, if Y, C, and G remained the same, an increase in
taxes would
a. raise both private and public saving.
b. raise private saving and lower public saving.
c. lower private saving and raise public saving.
d. lower private and public saving.
ANS: C DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Private saving | Public saving MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 246
28. According to the definitions of national saving and private saving, if Y, C, and G remained the same, an
increase in taxes would
a. raise both national saving and private saving.
b. raise national saving and reduce private saving.
c. leave national saving and private saving unchanged.
d. leave national saving unchanged and reduce private saving.
ANS: D DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving | Private saving MSC: Interpretive
29. According to the definitions of national saving and public saving, if Y, C, and G remained the same, an
increase in taxes would
a. raise national saving and public saving.
b. raise national saving and raise public saving.
c. leave national saving and public saving unchanged.
d. leave national saving unchanged and raise public saving.
ANS: D DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving | Public saving MSC: Interpretive
30. Suppose that in a closed economy GDP is equal to 11,000, taxes are equal to 1,500, consumption equals 7,500,
and government purchases equal 2,000. What is national saving?
a. -500
b. 0
c. 1,500
d. None of the above is correct.
ANS: C DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving MSC: Applicative
31. Suppose that in a closed economy GDP is equal to 11,000, taxes are equal to 2,500, consumption equals 7,000,
and government purchases equal 3,000. What are private saving and public saving?
a. 1,500 and -500, respectively
b. 1,500 and 500, respectively
c. 1,000 and -500, respectively
d. 1,000 and 500, respectively
ANS: A DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Public saving | Private saving MSC: Applicative
32. Suppose that in a closed economy GDP is equal to 11,000, taxes are equal to 2,500 consumption equals 7,500
and government purchases equal 2,000. What are private saving, public saving, and national saving?
a. 1,500, 1,000, and 500, respectively
b. 1,000, 500, and 1,500, respectively
c. 500, 1,500, and 1,000, respectively
d. None of the above is correct.
ANS: B DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Private saving | Public saving | National saving MSC: Applicative
247 ❖ Chapter 26/Saving, Investment, and the Financial System
33. Suppose that in a closed economy GDP is 11,000, consumption is 7,500, and taxes are 2,000. What value of
government purchases would make national savings equal to 1,000 and at that value would the government
have a deficit or surplus?
a. 2,500, deficit
b. 2,500, surplus
c. 1,000, deficit
d. 1,000, surplus
ANS: A DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving | Budget deficits MSC: Applicative
34. Suppose the economy is closed with national saving of $2 trillion, consumption of $7 trillion, and government
purchases of $1 trillion. What is GDP?
a. $8 trillion
b. $9 trillion
c. $10 trillion
d. $11 trillion
ANS: C DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Gross domestic product MSC: Applicative
35. Suppose the economy is closed and consumption is 6,500, taxes are 1,500, and government purchases are
2,000. If national saving amounts to 1,000, then what is GDP?
a. 9,500
b. 10,000
c. 10,500
d. None of the above is correct.
ANS: A DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Gross domestic product MSC: Applicative
36. For a closed economy, GDP is $11 trillion, consumption is $7 trillion, taxes are $2 trillion and the government
runs a deficit of $1 trillion. What are private saving and national saving?
a. $4 trillion and $1 trillion, respectively
b. $4 trillion and $-1 trillion, respectively
c. $2 trillion and $1 trillion, respectively
d. $2 trillion and $-1 trillion, respectively
ANS: C DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Private saving | National saving MSC: Applicative
37. For a closed economy, GDP is $11 trillion, consumption is $7 trillion, taxes are $3 trillion and the government
runs a surplus of $1 trillion. What are private saving and national saving?
a. $4 trillion and $1 trillion, respectively
b. $4 trillion and $5 trillion, respectively
c. $1 trillion and $2 trillion, respectively
d. $1 trillion and $1 trillion, respectively
ANS: C DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Private saving | National saving MSC: Applicative
Chapter 26/Saving, Investment, and the Financial System ❖ 248
38. If in a closed economy Y = $11 trillion, which of the following combinations would be consistent with national
saving of $2.5 trillion?
a. C = $8 trillion, G = $.5 trillion
b. C = $6.5 trillion, G = $3 trillion
c. C = $8.5 trillion, G = $2 trillion
d. C = $9 trillion, G = $.5 trillion
ANS: A DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: National saving MSC: Interpretive
39. For an imaginary closed economy, T = $5,000; S = $11,000; C = $50,000; and the government is running a
budget deficit of $1,000. Then
a. private saving = $10,000 and GDP = $54,000.
b. private saving = $10,000 and GDP = $58,000.
c. private saving = $12,000 and GDP = $67,000.
d. private saving = $12,000 and GDP = $72,000.
ANS: C DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Private saving | Gross domestic product MSC: Applicative
Scenario 26-1. Assume the following information for an imaginary, closed economy.
GDP = $110,000; consumption = $70,000; private saving = $8,000; national
saving = $12,000.
40. Refer to Scenario 26-1. For this economy, investment amounts to
a. $4,000.
b. $8,000.
c. $12,000.
d. $16,000.
ANS: C DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Applicative
41. Refer to Scenario 26-1. This economy’s government is running a
a. budget surplus of $4,000.
b. budget surplus of $8,000.
c. budget deficit of $4,000.
d. budget deficit of $8,000.
ANS: A DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Government purchases MSC: Applicative
42. Refer to Scenario 26-1. For this economy, government purchases amount to
a. $12,000.
b. $18,000.
c. $28,000.
d. $40,000.
ANS: C DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Government purchases MSC: Applicative
43. Refer to Scenario 26-1. For this economy, taxes amount to
a. $16,000.
b. $24,000.
c. $28,000.
d. $32,000.
ANS: D DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Taxes MSC: Applicative
249 ❖ Chapter 26/Saving, Investment, and the Financial System
44. In the small closed economy of San Lucretia, the currency is the denar. Statistics for last year show that
private saving was 60 billion denars, taxes were 70 billion denars, government purchases of goods and
services were 80 billion denars, there were no transfer payments by the government, and GDP was 400 billion
denars. What were consumption and investment in San Lucretia?
a. 270 billion denars, 50 billion denars
b. 260 billion denars, 60 billion denars
c. 250 billion denars, 70 billion denars
d. None of the above is correct.
ANS: A DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Consumption | Investment MSC: Analytical
45. The country of Meditor uses the merit as its currency. Recent national income statistics showed that it had
GDP of $700 million merits, no government transfer payments, taxes of $210 million merits, a budget surplus
of $60 billion merits, and investment of $100 billion merits. What were its consumption and government
expenditures on goods and services?
a. 450 million merits and $150 million merits
b. 410 million merits and $150 million merits
c. 330 million merits and $270 million merits
d. 290 million merits and $270 million merits
ANS: A DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Consumption | Government purchases MSC: Analytical
46. Consider three different closed economies with the following national income statistics. Country A has taxes
of $40 billion, transfers of $20 billion, and government expenditures on goods and services of $30 billion.
County B has private savings of $60 billion, and investment expenditures of $50 billion. Country C has GDP
of $300 billion, investment of $70, consumption of $180 billion, taxes of $60 billion and transfers of $20
billion. From this information we know that there is a $10 billion government budget deficit for
a. only country A.
b. only country B.
c. only country C.
d. all three countries.
ANS: D DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Budget deficits MSC: Analytical
47. In examining the national income accounts of the closed economy of Nepotocracy you see that this year it had
taxes of $100 billion, transfers of $40 billion, and government purchases of goods and services of $80 billion.
You also notice that last year it had private saving of $50 billion and investment of $70 billion. In which year
did Nepotocracy have a budget deficit of $20 billion?
a. this year and last year
b. this year but not last year
c. last year but not this year
d. neither this year nor last year
ANS: B DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Budget deficits MSC: Applicative
Chapter 26/Saving, Investment, and the Financial System ❖ 250
48. You have some estimates of national accounts numbers for a closed economy for the coming year. Under one
set of expectations, government purchases will be $30 billion, transfer payments will be $10 billion, and taxes
will be $45 billion. Under another set of expectations, GDP will be $200 billion, taxes will be $50 billion,
transfer payments will be $20 billion, consumption will be $120 million, and investment will be $40 billion.
Based on these numbers in the first case there should be a
a. $15 billion surplus, and in the second case a $10 billion surplus.
b. $15 billion surplus, and in the second case a $10 billion deficit.
c. $5 billion surplus, and in the second case a $10 billion surplus.
d. $5 billion surplus, and in the second case a $10 billion deficit.
ANS: D DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Budget deficits | Budget surpluses MSC: Analytical
49. The country of Cedarland does not trade with any other country. Its GDP is $20 billion. Its government
purchases $3 billion worth of goods and services each year, collects $6 billion in taxes, and provides $2 billion
in transfer payments to households. Private saving in Cedarland is $4 billion. What is investment in
Cedarland?
a. $5 billion
b. $4 billion
c. $3 billion
d. $2 billion
ANS: A DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Applicative
50. The country of Growpaw does not trade with any other country. Its GDP is $17 billion. Its government
purchases $4 billion worth of goods and services each year, collects $6 billion in taxes, and provides $1 billion
in transfer payments to households. Private saving in Growpaw is $4 billion. For Growpaw,
a. investment is $6 billion and consumption is $9 billion.
b. investment is $6 billion and consumption is $8 billion.
c. investment is $5 billion and consumption is $8 billion.
d. investment is $5 billion and consumption is $7 billion.
ANS: C DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment | Consumption MSC: Applicative
51. The country of Hykenia does not trade with any other country. Its GDP is $20 billion. Its government collects
$4 billion in taxes and pays out $3 billion to households in the form of transfer payments. Consumption equals
$15 billion and investment equals $2 billion. What is public saving in Hykenia, and what is the value of the
goods and services purchased by the government of Hykenia?
a. -$2 billion and $3 billion
b. $1 billion and $3 billion
c. -$1 billion and $4 billion
d. There is not enough information to answer the question.
ANS: A DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Public saving | Government purchases MSC: Analytical
52. The country of Yokovia does not trade with any other country. Its GDP is $30 billion. Its government
purchases $5 billion worth of goods and services each year, collects $7 billion in taxes, and provides $3 billion
in transfer payments to households. Private saving in Yokovia amounts to $5 billion. What are consumption
and investment in Yokovia?
a. $18 billion and $5 billion, respectively
b. $21 billion and $4 billion, respectively
c. $13 billion and $7 billion, respectively
d. There is not enough information to answer the question.
ANS: B DIF: 3 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Consumption | Investment MSC: Analytical
251 ❖ Chapter 26/Saving, Investment, and the Financial System
53. In a closed economy, private saving is
a. the amount of income that households have left after paying for their taxes and consumption.
b. the amount of income that businesses have left after paying for the factors of production.
c. the amount of tax revenue that the government has left after paying for its spending.
d. always equal to investment.
ANS: A DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Private saving MSC: Definitional
54. In a closed economy, public saving is the
a. amount of income that households have left after paying for taxes and consumption.
b. amount of income that businesses have left after paying for the factors of production.
c. amount of tax revenue that the government has left after paying for its spending.
d. sum of A, B, and C.
ANS: C DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Public saving MSC: Definitional
55. Which of the following is not always correct for a closed economy?
a. National saving equals private saving plus public saving.
b. Net exports equal zero.
c. Real GDP measures both income and expenditures.
d. Private saving equals investment.
ANS: D DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Closed economies MSC: Interpretive
56. If the tax revenue of the federal government exceeds spending, then the government necessarily
a. runs a budget deficit.
b. runs a budget surplus.
c. runs a national debt.
d. will increase taxes.
ANS: B DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Budget deficits MSC: Interpretive
57. A budget surplus is created if
a. the government sells more bonds than it buys back.
b. the government spends more than it receives in tax revenue.
c. private saving is greater than zero.
d. None of the above is correct.
ANS: D DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Budget surpluses MSC: Definitional
58. In the language of macroeconomics, investment refers to
a. saving.
b. the purchase of new capital.
c. the purchase of stocks, bonds, or mutual funds.
d. All of the above are correct.
ANS: B DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Definitional
Chapter 26/Saving, Investment, and the Financial System ❖ 252
59. Larry buys stock in A to Z Express Company. Curly Corporation builds a new factory. Whose transaction
would be an act of investment in the language of macroeconomics?
a. only Larry’s
b. only Curly Corporation’s
c. Larry’s and Curly Corporation’s
d. neither Larry’s nor Curly Corporation’s
ANS: B DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Interpretive
60. Which of the following would be included as investment in the GDP accounts?
a. the government buys goods from another country
b. someone buys stock in an American company
c. a firm increases its capital stock
d. All of the above are correct.
ANS: C DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Interpretive
61. Which of the following would a macroeconomist consider as investment?
a. Charlie purchases a bond issued by Proctor and Gamble Corp.
b. Karlee purchases stock issued by Texas Instruments, Inc.
c. Mariah builds a new coffee shop.
d. All of the above are correct.
ANS: C DIF: 1 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Interpretive
62. Fran buys 1,000 shares of stock issued by Miller Brewing. In turn, Miller uses the funds to buy new
machinery for one of its breweries.
a. Fran and Miller are both investing.
b. Fran and Miller are both saving.
c. Fran is investing; Miller is saving.
d. Fran is saving; Miller is investing.
ANS: D DIF: 2 REF: 26-2
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Investment MSC: Interpretive

Sec03 - Saving, Investment, and the Financial System - The Market for Loanable
Funds
MULTIPLE CHOICE
1. The source of the supply of loanable funds
a. is saving and the source of demand for loanable funds is investment.
b. is investment and the source of demand for loanable funds is saving.
c. and the demand for loanable funds is saving.
d. and the demand for loanable funds is investment.
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Definitional
253 ❖ Chapter 26/Saving, Investment, and the Financial System
2. Assuming the market for loanable funds is in equilibrium, use the following numbers to determine the quantity
of loanable funds supplied.

GDP $8.7 trillion


Consumption Spending $3.5 trillion
Taxes Net of Transfers $2.7 trillion
Government Purchases $3.0 trillion

a. $2.2 trillion
b. $2.5 trillion
c. $3.9 trillion
d. $5.2 trillion
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Applicative
3. Suppose the market for loanable funds is in equilibrium. Given the numbers below, determine the quantity of
loanable funds demanded.

GDP $100 billion


Consumption $65 billion
Taxes Net of Transfers $15 billion
Government Spending $20 billion

a. $25 billion
b. $20 billion
c. $15 billion
d. $10 billion
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Applicative
4. The slope of the demand for loanable funds curve represents the
a. positive relation between the real interest rate and investment.
b. negative relation between the real interest rate and investment.
c. positive relation between the real interest rate and saving.
d. negative relation between the real interest rate and saving.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
5. The Eye of Horus incense company has $10 million in cash which it has accumulated from retained earnings.
It was planning to use the money to build a new factory. Recently, the rate of interest has increased. The
increase in the rate of interest should
a. not influence the decision to build the factory because The Eye of Horus doesn't have to borrow any
money.
b. not influence the decision to build the factory because its stockholders are expecting a new factory.
c. make it more likely that The Eye of Horus will build the factory because a higher interest rate will
make the factory more valuable.
d. make it less likely that The Eye of Horus will build the factory because the opportunity cost of the
$10 million is now higher.
ANS: D DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment | Market for loanable funds MSC: Applicative
Chapter 26/Saving, Investment, and the Financial System ❖ 254
6. Other things the same, when the interest rate rises,
a. people would want to lend more, making the supply of loanable funds increase.
b. people would want to lend less, making the supply of loanable funds decrease.
c. people would want to lend more, making the quantity of loanable funds supplied increase.
d. people would want to lend less, making the quantity of loanable funds supplied decrease.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
7. Fred is considering expanding his dress shop. If interest rates rise he is
a. less likely to expand. This illustrates why the supply of loanable funds slopes downward.
b. more likely to expand. This illustrates why the supply of loanable funds slopes upward.
c. less likely to expand. This illustrates why the demand for loanable funds slopes downward.
d. more likely to expand. This illustrates why the demand for loanable funds slopes upward.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment | Market for loanable funds MSC: Interpretive
8. The slope of the supply of loanable funds curve represents the
a. positive relation between the real interest rate and investment.
b. positive relation between the real interest rate and saving.
c. negative relation between the real interest rate and investment.
d. negative relation between the real interest rate and saving.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
9. Other things the same, a higher interest rate induces people to
a. save more, so the supply of loanable funds slopes upward.
b. save less, so the supply of loanable funds slopes downward.
c. invest more, so the supply of loanable funds slopes upward.
d. invest less, so the supply of loanable funds slopes downward.
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
10. The supply of loanable funds slopes
a. upward because an increase in the interest rate induces people to save more.
b. downward because an increase in the interest rate induces people to save less.
c. downward because an increase in the interest rate induces people to invest less.
d. upward because an increase in the interest rate induces people to invest more.
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
11. Other things the same, an increase in the interest rate
a. would shift the demand for loanable funds to the right.
b. would shift the demand for loanable funds to the left.
c. would increase the quantity of loanable funds demanded.
d. would decrease the quantity of loanable funds demanded.
ANS: D DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
255 ❖ Chapter 26/Saving, Investment, and the Financial System
12. If the quantity of loanable funds demanded exceeds the quantity of loanable funds supplied,
a. there is a surplus and the interest rate is above the equilibrium level.
b. there is a surplus and the interest rate is below the equilibrium level.
c. there is a shortage and the interest rate is above the equilibrium level.
d. there is a shortage and the interest rate is below the equilibrium level.
ANS: D DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
13. If the quantity of loanable funds supplied exceeds the quantity of loanable funds demanded,
a. there is a surplus and the interest rate is above the equilibrium level.
b. there is a surplus and the interest rate is below the equilibrium level.
c. there is a shortage and the interest rate is above the equilibrium level.
d. there is a shortage and the interest rate is below the equilibrium level.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
14. If there is a surplus of loanable funds, then
a. the quantity of loanable funds demanded is greater than the quantity of loanable funds supplied and
the interest rate is above equilibrium.
b. the quantity of loanable funds demanded is greater than the quantity of loanable funds supplied and
the interest rate is below equilibrium.
c. the quantity of loanable funds supplied is greater than the quantity of loanable funds demanded and
the interest rate is above equilibrium.
d. the quantity of loanable funds supplied is greater than the quantity of loanable funds demanded and
the interest rate is below equilibrium.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
15. If there is a shortage of loanable funds, then
a. the quantity of loanable funds demanded is greater than the quantity of loanable funds supplied and
the interest rate is above equilibrium.
b. the quantity of loanable funds demanded is greater than the quantity of loanable funds supplied and
the interest rate is below equilibrium.
c. the quantity of loanable funds supplied is greater than the quantity of loanable funds demanded and
the interest rate is above equilibrium.
d. the quantity of loanable funds supplied is greater than the quantity of loanable funds demanded and
the interest rate is below equilibrium.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
16. If there is a surplus of loanable funds, then
a. the quantity demanded is greater than the quantity supplied and the interest rate will rise.
b. the quantity demanded is greater than the quantity supplied and the interest rate will fall.
c. the quantity supplied is greater than the quantity demanded and the interest rate will rise.
d. the quantity supplied is greater than the quantity demanded and the interest rate will fall.
ANS: D DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 256
17. If there is a shortage of loanable funds, then
a. the quantity demanded is greater than the quantity supplied and the interest rate will rise.
b. the quantity demanded is greater than the quantity supplied and the interest rate will fall.
c. the quantity supplied is greater than the quantity demanded and the interest rate will rise.
d. the quantity supplied is greater than the quantity demanded and the interest rate will fall.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
18. If there is shortage of loanable funds, then
a. the supply for loanable funds shifts right and the demand shifts left.
b. the supply for loanable funds shifts left and the demand shifts right.
c. neither curve shifts, but the quantity of loanable funds supplied increases and the quantity
demanded decreases as the interest rate rises to equilibrium.
d. neither curve shifts, but the quantity of loanable funds supplied decreases and the quantity
demanded increases as the interest rate falls to equilibrium.
ANS: C DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
19. If there is surplus of loanable funds, then
a. the supply for loanable funds shifts right and the demand shifts left.
b. the supply for loanable funds shifts left and the demand shifts right.
c. neither curve shifts, but the quantity of loanable funds supplied increases and the quantity
demanded decreases as the interest rate rises to equilibrium.
d. neither curve shifts, but the quantity of loanable funds supplied decreases and the quantity
demanded increases as the interest rate falls to equilibrium.
ANS: D DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
20. If the demand for loanable funds shifts to the right, then the equilibrium interest rate
a. and quantity of loanable funds rise.
b. and quantity of loanable funds fall.
c. rises and the quantity of loanable funds falls.
d. falls and the quantity of loanable funds rises.
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
21. If the demand for loanable funds shifts to the left, then the equilibrium interest rate
a. and quantity of loanable funds rise.
b. and quantity of loanable funds fall.
c. rises and the quantity of loanable funds falls.
d. falls and the quantity of loanable funds rises.
ANS: B DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
22. If the supply for loanable funds shifts to the left, then the equilibrium interest rate
a. and quantity of loanable funds rise.
b. and quantity of loanable funds fall.
c. rises and the quantity of loanable funds falls.
d. falls and the quantity of loanable funds rises.
ANS: C DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
257 ❖ Chapter 26/Saving, Investment, and the Financial System
23. If the supply of loanable funds shifts to the right, then the equilibrium interest rate
a. and quantity of loanable funds rise.
b. and quantity of loanable funds fall.
c. rises and the quantity of loanable funds falls.
d. falls and the quantity of loanable funds rises.
ANS: D DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
24. Which of the following could explain an increase in the interest rate and the equilibrium quantity of loanable
funds?
a. The demand for loanable funds shifted rightward.
b. The demand for loanable funds shifted leftward.
c. The supply of loanable funds shifted rightward.
d. The supply of loanable funds shifted leftward.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
25. Which of the following would necessarily create a surplus at the original equilibrium interest rate in the
loanable funds market?
a. an increase in the supply of or a decrease in the demand for loanable funds
b. an increase in the supply of or an increase in the demand for loanable funds
c. a decrease in the supply of or a decrease in the demand for loanable funds
d. a decrease in the supply of or an increase in the demand for loanable funds
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
26. Which of the following could explain a decrease in the equilibrium interest rate and in the equilibrium quantity
of loanable funds?
a. The demand for loanable funds shifted rightward.
b. The demand for loanable funds shifted leftward.
c. The supply of loanable funds shifted rightward.
d. The supply of loanable funds shifted leftward.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
27. Which of the following could explain a decrease in the equilibrium interest rate and an increase in the
equilibrium quantity of loanable funds?
a. The demand for loanable funds shifted rightward.
b. The demand for loanable funds shifted leftward.
c. The supply of loanable funds shifted rightward.
d. The supply of loanable funds shifted leftward.
ANS: C DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
28. Which of the following could explain an increase in the equilibrium interest rate and a decrease in the
equilibrium quantity of loanable funds?
a. The demand for loanable funds shifted right.
b. The demand for loanable funds shifted left.
c. The supply of loanable funds shifted right.
d. The supply of loanable funds shifted left.
ANS: D DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 258
29. Which of the following would necessarily increase the equilibrium interest rate?
a. The demand for and the supply of loanable funds shift right.
b. The demand for and the supply of loanable funds shift left.
c. The demand for loanable funds shifts right and the supply of loanable funds shifts left.
d. The demand for loanable funds shifts left and the supply of loanable funds shifts right.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
30. In 2002 mortgage rates fell and mortgage lending increased. Which of the following could explain both of
these changes?
a. The demand for loanable funds shifted right.
b. The demand for loanable funds shifted left.
c. The supply of loanable funds shifted right.
d. The supply of loanable funds shifted left.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Applicative
31. The nominal interest rate is the
a. interest rate corrected for inflation.
b. interest rate as usually reported by banks.
c. real rate of return to the lender.
d. real cost of borrowing to the borrower.
ANS: B DIF: 1 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Nominal interest rate MSC: Definitional
32. If the nominal interest rate is 5 percent and the rate of inflation is 2 percent, then the real interest rate is
a. 7 percent.
b. 3 percent.
c. 2.5 percent.
d. .4 percent.
ANS: B DIF: 1 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Nominal interest rate | Real interest rate MSC: Definitional
33. If the inflation rate is 2 percent and the real interest rate is 3 percent, then the nominal interest rate is
a. 5 percent.
b. 1 percent.
c. 1.5 percent
d. 0.67 percent.
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Nominal interest rate | Real interest rate MSC: Definitional
34. If the nominal interest rate is 10 percent and the inflation rate is 4 percent, then the real interest rate is
a. 14 percent.
b. 6 percent.
c. 2.5 percent.
d. .4 percent.
ANS: B DIF: 1 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Nominal interest rate | Real interest rate MSC: Definitional
259 ❖ Chapter 26/Saving, Investment, and the Financial System
35. If the nominal interest rate is 6 percent and the real interest rate is 2 percent, then what is the inflation rate?
a. 8 percent
b. 4 percent
c. 3 percent
d. None of the above is correct.
ANS: B DIF: 1 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Nominal interest rate | Real interest rate MSC: Definitional
36. Which of the following statements is correct?
a. As a group, economists see no purpose in distinguishing between the nominal interest rate and the
real interest rate.
b. The interest rate that is usually reported is the nominal interest rate.
c. If the nominal interest rate increases and the inflation rate remains unchanged, then the real interest
rate decreases.
d. All of the above are correct.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Nominal interest rate | Real interest rate MSC: Interpretive
37. Which of the following statements is correct?
a. The interest rate that is usually reported is the interest rate that has been corrected for inflation.
b. The supply of, and demand for, loanable funds depend on the real (rather than nominal) interest
rate.
c. If the nominal interest rate has decreased and the real interest rate has also decreased, then the
inflation rate must have decreased as well.
d. All of the above are correct.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Nominal interest rate | Real interest rate MSC: Interpretive
38. Suppose the market for loanable funds is in equilibrium. What would happen in the market for loanable funds,
other things the same, if the Congress and President increased the maximum contribution limits to 401(k) and
403(b) tax-deferred retirement accounts?
a. the interest rate and quantity of loanable funds would increase
b. the interest rate and quantity of loanable funds would decrease.
c. the interest rate would increase and the quantity of loanable funds would decrease.
d. the interest rate would decrease and the quantity of loanable funds would increase.
ANS: D DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Saving MSC: Analytical
39. What would happen in the market for loanable funds if the government were to increase the tax on interest
income?
a. Interest rates would rise.
b. Interest rates would be unaffected.
c. Interest rates would fall.
d. The effect on the interest rate is uncertain.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Saving | Market for loanable funds MSC: Applicative
Chapter 26/Saving, Investment, and the Financial System ❖ 260
40. What would happen in the market for loanable funds if the government were to decrease the tax rate on
interest income?
a. There would be an increase in the amount of loanable funds borrowed.
b. There would be a reduction in the amount of loanable funds borrowed.
c. There would be no change in the amount of loanable funds borrowed.
d. The change in loanable funds is uncertain.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Saving | Market for loanable funds MSC: Applicative
41. If Congress reduced the tax rate on interest income, investment
a. would increase and saving would decrease.
b. would decrease and saving would increase.
c. and saving would increase.
d. and saving would decrease.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Saving | Investment | Market for loanable funds MSC: Analytical
42. If the government institutes policies that increase incentives to save, then in the loanable funds market
a. the demand for loanable funds shifts right.
b. the demand for loanable funds shifts left.
c. the supply of loanable funds shifts right.
d. the supply of loanable funds shifts left.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Saving | Market for loanable funds MSC: Analytical
43. If a reform of the tax laws encourages greater saving, the result would be
a. higher interest rates and greater investment.
b. higher interest rates and less investment.
c. lower interest rates and greater investment.
d. lower interest rate and less investment.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Saving | Investment | Interest rates MSC: Analytical
44. What would happen in the market for loanable funds if the government were to increase the tax on interest
income?
a. The supply of loanable funds would shift right.
b. The demand for loanable funds would shift right.
c. The supply of loanable funds would shift left.
d. The demand for loanable funds would shift left.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Applicative
45. What would happen in the market for loanable funds if the government were to decrease the tax rate on
interest income?
a. The supply of and demand for loanable funds would shift right.
b. The supply of and demand for loanable funds would shift left.
c. The supply of loanable funds would shift right and the demand for loanable funds would shift left.
d. None of the above is correct.
ANS: D DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Taxes | Market for loanable funds MSC: Applicative
261 ❖ Chapter 26/Saving, Investment, and the Financial System
46. What would happen in the market for loanable funds if the government were to decrease the tax rate on
interest income?
a. The supply of loanable funds would shift rightward and investment would increase.
b. The supply of loanable funds would shift leftward and investment would decrease.
c. The demand for loanable funds would shift rightward and investment would increase.
d. The demand for loanable funds would shift leftward and investment would decrease.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Taxes | Market for loanable funds MSC: Analytical
47. Suppose the government were to replace the income tax with a consumption tax so that interest on savings was
not taxed. The result would be that the interest rate
a. and investment both would increase.
b. and investment both would decrease.
c. would increase and investment would decrease.
d. would decrease and investment would increase.
ANS: D DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Taxes | Interest rates | Investment MSC: Analytical
48. Which of the following would not be a result of replacing the income tax with a consumption tax so that
interest income was no longer taxed?
a. The interest rate would decrease.
b. Investment would decrease.
c. The standard of living would eventually rise.
d. The supply of loanable funds would shift right.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Taxes | Interest rates | Investment MSC: Analytical
49. If in the past Congress had taken additional actions to make saving more rewarding, then today it is likely that
the equilibrium interest rate
a. and the equilibrium quantity of loanable funds both would be lower.
b. and the equilibrium quantity of loanable funds both would be higher.
c. would be higher and the equilibrium quantity of loanable funds would be lower.
d. would be lower and the equilibrium quantity of loanable funds would be higher.
ANS: D DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Saving | Market for loanable funds MSC: Applicative
50. Suppose a country has a consumption tax that is similar to a state sales tax. If its government were to eliminate
the consumption tax and replace it with an income tax that includes an income tax on interest from savings,
what would happen?
a. There would be no change in the interest rate or saving.
b. The interest rate would decrease and saving would increase.
c. The interest rate would increase and saving would decrease.
d. None of the above is correct.
ANS: C DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Saving | Interest rates MSC: Analytical
Chapter 26/Saving, Investment, and the Financial System ❖ 262
51. Suppose a country has only a sales tax. Now suppose it replaces the sales tax with an income tax that includes
a tax on interest income. This would make equilibrium
a. interest rates and the equilibrium quantity of loanable funds rise.
b. interest rates rise and the equilibrium quantity of loanable funds fall.
c. interest rates fall and the equilibrium quantity of loanable funds rise.
d. interest rates and the equilibrium quantity of loanable funds fall.
ANS: B DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Taxes | Market for loanable funds MSC: Analytical
52. Suppose a government that taxed all interest income changed its tax law so that the first $5,000 of a taxpayer’s
interest income was tax free. This would shift the
a. supply of loanable funds to the right, causing interest rates to fall.
b. supply of loanable funds to the left, causing interest rates to rise.
c. demand for loanable funds to the right, causing interest rates to rise.
d. demand for loanable funds to the left, causing interest rates to fall.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Taxes | Interest rates | Market for loanable funds MSC: Applicative
53. Which of the following is not correct?
a. American families save a larger fraction of their incomes than their counterparts in many other
countries such as Germany and Japan.
b. Saving is an important long-run determinant of a nation's standard of living.
c. A change in tax laws that encouraged greater saving would lower interest rates.
d. Taxes on interest income can substantially decrease the future value of current saving.
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Saving MSC: Interpretive
54. If Congress instituted an investment tax credit, the interest rate would
a. rise and saving would rise.
b. fall and saving would fall.
c. rise and saving would fall.
d. fall and saving would rise.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment tax credit | Interest rates | Saving MSC: Analytical
55. If Congress instituted an investment tax credit, the equilibrium quantity of loanable funds would
a. rise.
b. fall.
c. be unchanged.
d. move in an uncertain direction.
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment tax credit | Market for loanable fundsMSC: Applicative
263 ❖ Chapter 26/Saving, Investment, and the Financial System
56. Suppose the U.S. offered a tax credit for firms that built new factories in the U.S.. Then
a. the demand for loanable funds would shift rightward, initially creating a surplus of loanable funds
at the original interest rate.
b. the demand for loanable funds would shift rightward, initially creating a shortage of loanable funds
at the original interest rate.
c. the supply of loanable funds would shift rightward, initially creating a surplus of loanable funds at
the original interest rate.
d. the supply of loanable funds would shift rightward, initially creating a shortage of loanable funds at
the original interest rate.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment tax credit | Market for loanable fundsMSC: Applicative
57. Suppose that Congress were to institute an investment tax credit. What would happen in the market for
loanable funds?
a. The demand for loanable funds would shift left.
b. The supply of loanable funds would shift left.
c. The demand for loanable funds would shift right.
d. The supply of loanable funds would shift right.
ANS: C DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment tax credit | Market for loanable fundsMSC: Applicative
58. Suppose that Congress were to repeal an investment tax credit. What would happen in the market for loanable
funds?
a. The demand and supply of loanable funds would shift right.
b. The demand and supply of loanable funds would shift left.
c. The supply of loanable funds would shift right.
d. The demand for loanable funds would shift left.
ANS: D DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment tax credit | Market for loanable fundsMSC: Applicative
59. Suppose a country repealed its investment tax credit. The effects of this are represented by shifting the
a. demand for and the supply of loanable funds to the right.
b. demand for and the supply of loanable funds to the left.
c. supply of loanable funds to the right and the demand for loanable funds to the left.
d. None of the above is correct.
ANS: D DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment tax credit | Market for loanable fundsMSC: Applicative
60. Suppose Congress institutes an investment tax credit. What would happen in the market for loanable funds?
a. The interest rate and investment would fall.
b. The interest rate and investment would rise.
c. The interest rate would rise and investment would fall.
d. None of the above is necessarily correct.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment tax credit | Market for loanable fundsMSC: Applicative
Chapter 26/Saving, Investment, and the Financial System ❖ 264
61. In the loanable funds model, an increase in an investment tax credit would create a
a. shortage at the former equilibrium interest rate. This shortage would lead to a rise in the interest
rate.
b. shortage at the former equilibrium interest rate. This shortage would lead to a fall in the interest
rate.
c. surplus at the former equilibrium interest rate. This surplus would lead to a rise in the interest rate.
d. surplus at the former equilibrium interest rate. This surplus would lead to a fall in the interest rate.
ANS: A DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment tax credit | Market for loanable fundsMSC: Analytical
62. If the government currently has a budget deficit, then
a. it does not necessarily have a debt.
b. its debt is increasing.
c. government expenditures are greater than taxes.
d. All of the above are correct.
ANS: D DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Budget deficits MSC: Interpretive
63. A budget deficit
a. changes the supply of loanable funds.
b. changes the demand for loanable funds.
c. changes both the supply of and demand for loanable funds.
d. does not influence the supply of or the demand for loanable funds.
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits MSC: Interpretive
64. Other things the same, a government budget deficit
a. reduces public saving, but not national saving..
b. reduces national saving, but not public saving.
c. reduces both public and national saving.
d. reduces neither public saving nor national saving.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Public saving | National saving MSC: Interpretive
65. A larger budget surplus
a. raises the interest rate and investment.
b. reduces the interest rate and investment.
c. raises the interest rate and reduces investment.
d. reduces the interest rate and raises investment.
ANS: D DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget surpluses MSC: Definitional
66. A larger budget deficit
a. raises the interest rate and investment.
b. reduces the interest rate and investment.
c. raises the interest rate and reduces investment.
d. reduces the interest rate and raises investment.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget surpluses MSC: Interpretive
265 ❖ Chapter 26/Saving, Investment, and the Financial System
67. In the first part of this decade the U.S. government went from a surplus to a deficit. Other things the same, this
means the
a. supply of loanable funds shifted to the right.
b. supply of loanable funds shifted to the left.
c. demand for loanable funds shifted to the right.
d. demand for loanable funds shifted to the left.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Market for loanable funds MSC: Interpretive
68. If Canada increases its budget deficit, it will reduce
a. private saving and so shift the supply of loanable funds left.
b. investment and so shift the demand for loanable funds left.
c. public saving and so shift the supply of loanable funds left.
d. None of the above is correct.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Market for loanable funds MSC: Applicative
69. An increase in the budget deficit would cause a
a. shortage of loanable funds at the original interest rate, which would lead to falling interest rates.
b. surplus of loanable funds at the original interest rate, which would lead to rising interest rates.
c. shortage of loanable funds at the original interest rate, which would lead to rising interest rates.
d. surplus of loanable funds at the original interest rate, which would lead to falling interest rates.
ANS: C DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Interest rates MSC: Analytical
70. An increase in the budget deficit
a. makes investment spending fall.
b. makes investment spending rise.
c. does not affect investment spending.
d. may increase, decrease, or not affect investment spending.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Crowding out MSC: Interpretive
71. Suppose the government deficit increases, but the interest rate remains the same. Which of the following
things might have happened simultaneously to keep interest rates the same?
a. The government reduces the amount that people may put into savings accounts on which the
interest is tax exempt.
b. Because they are optimistic about the future of the economy, firms desire to borrow more to
purchase physical capital.
c. Consumers decide to decrease consumption and work more.
d. All of the above could explain why the interest rate would be unchanged.
ANS: C DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits MSC: Analytical
72. Other things the same, if the government increases transfer payments to households, then the effect of this on
the government’s budget
a. will make investment rise.
b. will make the rate of interest rise.
c. will make public saving rise.
d. All of the above are correct.
ANS: B DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Interest rates MSC: Analytical
Chapter 26/Saving, Investment, and the Financial System ❖ 266
73. Suppose government expenditures on goods and services increase, transfers are unchanged, and taxes rise by
less than the increase in expenditures. These changes in the government’s budget cause
a. both the equilibrium interest rate and the equilibrium quantity of loanable funds to fall.
b. both the equilibrium interest rate and the equilibrium quantity of loanable funds to rise.
c. the equilibrium interest rate to rise and the equilibrium quantity of loanable funds to fall.
d. the equilibrium interest rate to fall and the equilibrium quantity of loanable funds to rise.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Market for loanable funds MSC: Analytical
74. Suppose government expenditures on goods and services and net taxes both decrease, and expenditures fall by
more than net taxes. The effects of these changes on the budget deficit cause
a. both the equilibrium interest rate and the equilibrium quantity of loanable funds to fall.
b. both the equilibrium interest rate and the equilibrium quantity of loanable funds to rise.
c. the equilibrium interest rate to rise and the equilibrium quantity of loanable funds to fall.
d. the equilibrium interest rate to fall and the equilibrium quantity of loanable funds to rise.
ANS: D DIF: 2 REF: 26-3
NAT: Analytic TOP: Budget deficits | Market for loanable funds
MSC: Analytical
75. Bolivia had a smaller budget deficit in 2003 than in 2002. Other things the same, we would expect this
reduction in the budget deficit to have
a. increased both interest rates and investment.
b. increased interest rates and decreased investment.
c. decreased interest rates and increased investment.
d. decreased both interest rates and investment.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic TOP: Budget deficits | Market for loanable funds
MSC: Applicative
76. Suppose a country had a smaller increase in debt in 2008 than it had in 2007. Then other things the same, we
would expect
a. lower interest rates and investment in 2008 than in 2007.
b. lower interest rates and greater investment in 2008 than in 2007.
c. higher interest rates and greater investment in 2008 than in 2007.
d. higher interest rates and lower investment in 2008 than in 2007.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Market for loanable funds MSC: Analytical
77. Suppose the government ran a budget surplus in 2008 and a larger surplus in 2009. The loanable funds model
would predict that, as a result of the increase in the surplus,
a. both the government debt and interest rates increased between 2008 and 2009.
b. both the government debt and interest rates decreased between 2008 and 2009.
c. the government debt increased and interest rates decreased between 2008 and 2009.
d. the government debt decreased and interest rates increased between 2008 and 2009.
ANS: B DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget surpluses | Market for loanable funds MSC: Interpretive
78. Crowding out occurs when investment declines because
a. a budget deficit makes interest rates rise.
b. a budget deficit makes interest rates fall.
c. a budget surplus makes interest rates rise.
d. a budget surplus makes interest rates fall.
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Crowding out MSC: Definitional
267 ❖ Chapter 26/Saving, Investment, and the Financial System
79. When the government runs a budget deficit,
a. interest rates are lower than they would be if the budget were balanced.
b. national saving is higher than it would be if the budget were balanced.
c. investment is lower than it would be if the budget were balanced.
d. All of the above are correct.
ANS: C DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Crowding out MSC: Interpretive
80. Suppose the Congress and president decreased the maximum annual contributions limits to retirement
accounts and at the same time reduced the budget deficit. What would happen to the interest rate?
a. It would decrease.
b. It would increase.
c. It would stay the same.
d. It might do any of the above.
ANS: D DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Saving | Interest rates MSC: Analytical
81. Which of the following events could explain a decrease in interest rates together with an increase in
investment?
a. The government went from surplus to deficit.
b. The government instituted an investment tax credit.
c. The government reduced the tax rate on savings.
d. None of the above is correct.
ANS: C DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Taxes | Saving MSC: Analytical
82. Which of the following events could explain an increase in interest rates together with a decrease in
investment?
a. The government budget went from surplus to deficit.
b. The government instituted an investment tax credit.
c. The government reduced the tax rate on savings.
d. None of the above is correct.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget surpluses | Budget deficits MSC: Analytical
83. Which of the following events could explain an increase in interest rates together with an increase in
investment?
a. The government runs a larger deficit.
b. The government institutes an investment tax credit.
c. The government replaces the income tax with a consumption tax.
d. None of the above is correct.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment MSC: Analytical
84. Interest rates fall and investment falls. Which of the following could explain these changes?
a. The government goes from a surplus to a deficit.
b. The government repeals an investment tax credit.
c. The government replaces a consumption tax with an income tax.
d. None of the above is correct.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Investment tax credit MSC: Analytical
Chapter 26/Saving, Investment, and the Financial System ❖ 268
85. The supply of loanable funds would shift to the right if either
a. tax reforms encouraged greater saving or the budget deficit became smaller.
b. tax reforms encouraged greater saving or investment tax credits were increased.
c. the budget deficit became larger or investment tax credits were increased.
d. the budget deficit became larger or tax reforms discouraged saving.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Taxes | Budget deficits MSC: Analytical
86. A change in the tax laws that increases the supply of loanable funds will have a bigger effect on investment
when
a. the demand for loanable funds is more elastic and the supply of loanable funds is more inelastic.
b. the demand for loanable funds is more inelastic and the supply of loanable funds is more elastic.
c. both the demand for and supply of loanable funds are more elastic.
d. both the demand for and supply of loanable funds are more inelastic.
ANS: A DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Taxes | Market for loanable funds MSC: Analytical
87. A government budget deficit affects the supply of loanable funds, rather than the demand for loanable funds,
because
a. in our model of the loanable funds market, we define “loanable funds” as the flow of resources
available to fund private investment.
b. in our model of the loanable funds market, we define “loanable funds” as the flow of resources
available from private saving.
c. markets for government debt are fundamentally different from markets for private debt.
d. of our assumption that the economy is closed.
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Budget deficits | Market for loanable funds MSC: Interpretive
88. If we were to change the interpretation of the term “loanable funds” in such a way that government budget
deficits would affect the demand for loanable funds, rather than the supply of loanable funds, then
a. crowding out would not be a consequence of an increase in the budget deficit.
b. higher interest rates would not be a consequence of an increase in the budget deficit.
c. an increase in the budget deficit would cause the demand for loanable funds to decrease.
d. we would be making only a semantic change in how we analyze the effects of government budget
deficits.
ANS: D DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Budget deficits | Market for loanable funds MSC: Interpretive
89. Which of the following statements is not correct?
a. If GDP is rising faster than debt, the government is, in some sense, living within its means.
b. The ratio of debt to GDP in the United States has always been less than one.
c. Debts during wars may distribute the burden of fighting the war more evenly across generations.
d. During times of peace the ratio of debt to GDP sometimes rose.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Government debt MSC: Interpretive
90. In recent years the U.S. national debt has been about
a. 10-20 percent of GDP.
b. 30-40 percent of GDP.
c. 50-60 percent of GDP.
d. 70-80 percent of GDP.
ANS: B DIF: 1 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Government debt MSC: Definitional
269 ❖ Chapter 26/Saving, Investment, and the Financial System
91. The ratio of debt to GDP in the United States tended to fall
a. during wars.
b. during the late 1990s.
c. during the first half of this decade
d. None of the above is correct.
ANS: B DIF: 1 REF: 26-3
NAT: Analytic LOC: The Study of economics, and definitions of economics
TOP: Government debt MSC: Definitional
92. The source of the supply of loanable funds is
a. saving, and the source of the demand for loanable funds is investment.
b. consumption, and the source of the demand for loanable funds is investment.
c. investment, and the source of the demand for loanable funds is saving.
d. the interest rate, and the source of the demand for loanable funds is saving.
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and applying economic models
TOP: Market for loanable funds MSC: Interpretive
93. In the market for loanable funds, the interaction of the demand for, and supply of, loanable funds determines
the equilibrium level of
a. the inflation rate.
b. gross domestic product.
c. the real interest rate.
d. the nominal interest rate.
ANS: C DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and applying economic models
TOP: Market for loanable funds MSC: Interpretive
94. Suppose the government changed the tax laws, with the result that people were encouraged to consume more
and save less. Using the loanable funds model, a consequence would be
a. lower interest rates and lower investment.
b. lower interest rates and greater investment.
c. higher interest rates and lower investment.
d. higher interest rates and higher investment.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and applying economic models
TOP: Market for loanable funds MSC: Interpretive
95. According to the loanable funds model, which of the following events would result in higher interest rates and
greater saving?
a. Firms become pessimistic about the future and, as a result, they cut back on their plans to buy new
equipment and build new factories.
b. The government goes from running a budget deficit to running a budget surplus.
c. Congress passes a reform of the tax laws that encourages greater saving.
d. Congress passes a reform of the tax laws that encourages greater investment.
ANS: D DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and applying economic models
TOP: Market for loanable funds MSC: Interpretive
96. Which of the following counts as part of the supply of loanable funds?
a. bank deposits and purchases of bonds
b. bank deposits but not purchases of bonds
c. purchases of bonds but not bank deposits
d. neither purchases of bonds nor bank deposits
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Market for loanable funds MSC: Definitional
Chapter 26/Saving, Investment, and the Financial System ❖ 270
97. Which of the following is included in the demand for loanable funds?
a. investment and government borrowing
b. investment but not government borrowing
c. government borrowing but not investment
d. neither government borrowing nor investment
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Market for loanable funds MSC: Definitional
98. Which of the following is correct?
a. In a closed economy equilibrium in the market for loanable funds occurs where saving =
investment.
b. Investment is the source for the supply of loanable funds.
c. If there is a surplus in the market for loanable funds, the interest rate rises.
d. All of the above are correct
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Equilibrium | Market for loanable funds MSC: Analytic
99. A policy that induces people to save more shifts
a. the supply of loanable funds and raises interest rates.
b. the supply of loanable funds and reduces interest rates.
c. the demand for loanable funds and raises interest rates.
d. the demand for loanable funds and reduces interest rates.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Saving MSC: Interpretive
100. If the government instituted an investment tax credit, then which of the following would be higher in
equilibrium?
a. saving and the interest rate
b. saving but not the interest rate
c. the interest rate but not saving
d. neither saving nor the interest rate
ANS: A DIF: 2 REF: 26-3
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Investment tax credit MSC: Analytic
101. If the budget deficit increases then
a. saving and the interest rate rise
b. saving rises and the interest rate falls
c. saving falls and the interest rate rises
d. saving and the interest rate falls
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Budget deficits MSC: Analytic
102. Which of the following are effects of an increased budget deficit?
a. the supply of loanable funds does not change; a higher interest rate reduces private saving
b. the supply of loanable funds does not change; a higher interest rate raises private saving
c. at any interest rate the supply of loanable funds is less; a higher interest rate reduces private saving
d. at any interest rate the supply of loanable funds is less; a higher interest rate raises private saving
ANS: D DIF: 3 REF: 26-3
NAT: Analytic LOC: The study of economics, and definitions of economics
TOP: Budget deficits MSC: Analytic
271 ❖ Chapter 26/Saving, Investment, and the Financial System
Figure 26-1. The figure depicts a demand-for-loanable-funds curve and two
supply-of-loanable-funds curves.

S1 S2

Demand

103. Refer to Figure 26-1. What is measured along the vertical axis of the graph?
a. the nominal interest rate
b. the real interest rate
c. the quantity of investment
d. the quantity of saving
ANS: B DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and applying economic models
TOP: Market for loanable funds MSC: Interpretive
104. Refer to Figure 26-1. Which of the following events would shift the supply curve from S1 to S2?
a. In response to tax reform, firms are encouraged to invest more than they previously invested.
b. In response to tax reform, households are encouraged to save more than they previously saved.
c. Government goes from running a balanced budget to running a budget deficit.
d. Any of the above events would shift the supply curve from S1 to S2.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and applying economic models
TOP: Market for loanable funds MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 272
Figure 26-2. The figure depicts a supply-of-loanable-funds curve and two
demand-for-loanable-funds curves.

Supply

D2
D1

105. Refer to Figure 26-2. What is measured along the horizontal axis of the graph?
a. the quantity of loanable funds
b. the size of the government budget deficit or surplus
c. the real interest rate
d. the nominal interest rate
ANS: A DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and applying economic models
TOP: Market for loanable funds MSC: Interpretive
106. Refer to Figure 26-2. Which of the following events would shift the demand curve from D1 to D2?
a. The government goes from running a budget deficit to running a budget surplus.
b. Firms become optimistic about the future and, as a result, they plan to increase their purchases of
new equipment and construction of new factories.
c. A change in the tax laws encourages people to consume less and save more.
d. A change in the tax laws encourages people to consume more and save less.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and applying economic models
TOP: Market for loanable funds MSC: Interpretive
273 ❖ Chapter 26/Saving, Investment, and the Financial System
Figure 26-3. The figure shows two demand-for-loanable-funds curves and two supply-of-loanable-funds curves.

S2

C
S1

B
F

D2
A

D1

107. Refer to Figure 26-3. What, specifically, does the label on the vertical axis, i, represent?
a. the nominal interest rate
b. the real interest rate
c. the inflation rate
d. the dividend yield
ANS: B DIF: 1 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
108. Refer to Figure 26-3. A shift of the supply curve from S1 to S2 is called
a. an increase in the supply of loanable funds.
b. an increase in the quantity of loanable funds supplied.
c. a decrease in the supply of loanable funds.
d. a decrease in the quantity of loanable funds supplied.
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
109. Refer to Figure 26-3. A shift of the demand curve from D1 to D2 is called
a. an increase in the demand for loanable funds, and that increase would originate from people who
had some extra income they wanted to lend.
b. an increase in the demand for loanable funds, and that increase would originate from households
and firms who wish to borrow to make investments.
c. a decrease in the demand for loanable funds, and that decrease would originate from people who
had some extra income they wanted to lend.
d. a decrease in the demand for loanable funds, and that decrease would originate from households
and firms who wish to borrow to make investments.
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Market for loanable funds MSC: Interpretive
Chapter 26/Saving, Investment, and the Financial System ❖ 274
110. Refer to Figure 26-3. Which of the following movements shows the effects of the government going from a
budget deficit to a budget surplus?
a. a movement from Point A to Point B
b. a movement from Point B to Point A
c. a movement from Point A to Point F
d. a movement from Point C to Point B
ANS: B DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Budget surpluses MSC: Applicative
111. Refer to Figure 26-3. Which of the following movements shows the effects of a new law that makes more
people than before eligible for Individual Retirement Accounts?
a. a movement from Point A to Point B
b. a movement from Point B to Point F
c. a movement from Point C to Point F
d. a movement from Point C to Point B
ANS: C DIF: 2 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Budget surpluses MSC: Applicative
112. Refer to Figure 26-3. Which of the following movements would be consistent with the government budget
going from deficit to surplus and the simultaneous enactment of an investment tax credit?
a. a movement from Point A to Point C
b. a movement from Point B to Point A
c. a movement from Point B to Point F
d. a movement from Point C to Point B
ANS: C DIF: 3 REF: 26-3
NAT: Analytic LOC: Understanding and Applying Economic Models
TOP: Budget deficits | Budget surpluses | Investment tax credit MSC: Analytical