TUTORIAL 4 ECO113/SEM22015

Tutorial 4: Chapters 25-26

Part I - Chapter 25

1. With the help of a diagram, explain the Laffer curve

2. Igor has been elected to lead Transylvania. Igor’s first action is to hire a crack team of economists
and to ask them what fiscal policy he should propose.
a. If Transylvania has an inflationary gap, what fiscal policies should Igor’s economists propose?
b. If Transylvania has a deflationary gap, what fiscal policies should Igor’s economists propose?
c. Because the legislature decides to meet only at night, it takes a year to get a fiscal policy in
place in Transylvania. Suppose that Igor’s economists predict that next year, without any
government policy, Transylvania will have a deflationary gap. The government passes a fiscal
policy that is designed to correct a deflationary gap. However, the prediction is incorrect and
without any government policy Transylvania actually will have full employment. What happens
when the fiscal policy takes effect?

3. In the figure below, show the effect of an increase in taxes. Assume there is no effect on
potential GDP.

4. What is the difference between a cyclical budget deficit and a structural budget deficit?

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Multiple Choice Questions: Chapter 25

1. 2.

3. 4.

5. 6.

7. 8.

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9. 10.

Part II - Chapter 26

1. The desired reserve ratio is 0.05 and banks have no excess reserves. Katie deposits $500 in currency in
her bank. Calculate:
a. The change in the bank’s reserves as soon as Katie makes the deposit.
b. The bank’s excess reserves as soon as Katie makes the deposit.
c. The maximum amount that Katie’s bank can loan.

2. If the desired reserve ratio is 10 percent and the currency drain ratio is 30 percent of deposits, what is
the size of the money multiplier? By how much will a $10 billion increase in the monetary base change
the quantity of money?

3. If the desired reserve ratio is 20 percent and the currency drain ratio is 30 percent of deposits, what is
the size of the money multiplier? By how much will a $10 billion increase in the monetary base change
the quantity of money?

4. Using problems 2 and 3, what is the effect on the money multiplier when the desired reserve ratio
rises?

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Multiple Choice Questions: Chapter 26

1. Which of the following best defines what money is now and what it has been in the past?
a. currency plus checking deposits, b. currency plus credit cards
c. anything accepted as a means of payment, d. anything used as a store of value

2. Credit cards, debit cards, and e-checks are

a. always counted as money.
b. not money.
c. sometimes counted as money, depending on how they are used.
d. sometimes counted as money, depending on what is purchased.

3. A commercial bank’s reserves are

a. bonds issued by the U.S. government that are very safe.
b. the provision of funds to businesses and individuals.
c. currency in its vault plus the balance on its reserve account at a Federal Reserve Bank.
d. savings and time deposits.

4. The minimum percent of deposits that banks must hold and cannot loan is determined by the
a. interest rate. .b. discount rate. ,c. required reserve ratio. ,d. federal funds rate.

5. The discount rate is the interest rate that

a. commercial banks charge their customers.
b. commercial banks charge each other for the loan of reserves.
c. the Fed charges the government for loans.
d. the Fed charges commercial banks when it loans reserves to the banks.

6. The monetary base is the

a. minimum reserves banks must hold to cover any losses from unpaid loans.
b. sum of coins, Federal Reserve notes, and banks’ reserves at the Fed.
c. sum of gold and foreign exchange held by the Fed.
d. sum of coins, required reserves, and bank loans.

7. If Federal Reserve notes and coins are $765 billion, and banks’ reserves at the Fed are $8 billion,
the gold stock is $11 billion, and the Fed owns $725 billion of government securities, what does the
monetary base equal?
a. $765 billion, b. $773 billion, c. $776 billion, d. $744 billion
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