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Chapter 26 Saving, Investment, and the Financial System

1. Bond markets allow firms to pursue a. equity financing. b. debt financing. c. limited-growth policies. d. government loans and subsidy programs. ANSWER: b debt financing. SECTION: 1 OBJECTIVE: 1 2. Junk bonds are issues by firms with a. high degrees of financial security. b. business ties to the trash-hauling industry. c. high degrees of financial insecurity. d. the ability to offer lower interest rates to lenders. ANSWER: c high degrees of financial insecurity. SECTION: 1 OBJECTIVE: 1 3. The stock market is an institution that promotes a. buying and selling of debt financing. b. the purchase and sale of firm equities. c. the purchase and sale of mutual funds. d. bank borrowing and lending. ANSWER: b the purchase and sale of firm equities. SECTION: 1 OBJECTIVE: 1 4. The major advantage of mutual funds is that a. they allow people with limited funds to diversify. b. they encourage households to spend their money on current consumption. c. fund managers are replaced by household administrators. d. they always use index funds to limit investor risk. ANSWER: a they allow people with limited funds to diversify. SECTION: 1 OBJECTIVE: 1 5. If an asset functions as a medium of exchange it a. holds its value over a long period of time. b. can be used by people to cover transactions. c. can be used by firms for debt financing. d. can be used by firms for equity financing. ANSWER: b can be used by people to cover transactions. SECTION: 1 OBJECTIVE: 1

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154 Chapter 26/Saving, Investment, and the Financial System 6. The four categories of expenditures that make up GDP are consumption, a. investment, net exports, and government expenditures. b. investment, government purchases, and depreciation. c. interest, government purchases, and net exports. d. investment, exports, and rental expenditures. ANSWER: a investment, net exports, and government expenditures. SECTION: 2 OBJECTIVE: 2 7. Economists say that investment occurs when a. someone buys stock on the New York Stock Exchange. b. someone buys a U.S. government bond. c. a firm increases its capital stock. d. a government buys goods from another country. ANSWER: c a firm increases its capital stock. SECTION: 2 OBJECTIVE: 2 8. Which of the following would be counted as a private investment expenditure in the national income accounts? a. The Navy builds a new battleship. b. Microsoft expands plant capacity to produce new software. c. A public high school builds a new football stadium. d. All of the above are correct. ANSWER: b Microsoft expands plant capacity to produce new software. SECTION: 2 OBJECTIVE: 2 9. If a series of major technological breakthroughs occur in the economy at the same time, then the most likely outcome would be that the economys a. investment demand curve will shift downward. b. investment demand curve will shift upward. c. consumption curve will shift downward. d. position along the existing investment curve will move upward. ANSWER: b investment demand curve will shift upward. SECTION: 2 OBJECTIVE: 2 10. Households make their savings available to borrowers through a. resource markets. b. the loanable funds market. c. the labor market. d. taxes. ANSWER: b the loanable funds market. SECTION: 3 OBJECTIVE: 4 11. What is the price of funds in the loanable funds market? a. the real wage rate b. the consumer price index c. the nominal interest rate d. the average firm profit rate ANSWER: c the nominal interest rate SECTION: 3 OBJECTIVE: 4

Chapter 26/Saving, Investment, and the Financial System 155 12. Assuming the economy is in equilibrium, use the following information to determine the amount of funds supplied to the loanable funds market. Consumption Spending $3.5 trillion Net Taxes $2.7 trillion Household Saving $2.5 trillion Investment Spending $2.2 trillion Government Purchases $3.0 trillion. a. $2.2 trillion b. $2.5 trillion c. $2.7 trillion d. $3.0 trillion ANSWER: b $2.5 trillion SECTION: 3 OBJECTIVE: 4 13. The quantity of loanable funds supplied is a. positively related to the level of income. b. negatively related to the price level. c. positively related to the price level. d. positively related to the interest rate. ANSWER: d positively related to the interest rate. SECTION: 3 OBJECTIVE: 4 14. The supply of loanable funds curve is upward sloping because a rise in the interest rate a. decreases the opportunity cost of firms investment spending. b. increases the opportunity cost of firms investment spending. c. decreases the opportunity cost to households of consuming. d. increases the opportunity cost to households of consuming. ANSWER: d increases the opportunity cost to households of consuming. SECTION: 3 OBJECTIVE: 4 15. The investment demand curve a. is upward sloping. b. is downward sloping. c. is horizontal. d. begins sloping upward, then becomes horizontal. ANSWER: a is upward sloping. SECTION: 3 OBJECTIVE: 4 16. When interest rates rise, the quantity of loanable funds demanded by a. firms decreases. b. government decreases. c. firms increases. d. government increases. ANSWER: a firms decreases. SECTION: 3 OBJECTIVE: 4

156 Chapter 26/Saving, Investment, and the Financial System 17. Market clearing in the loanable funds market a. guarantees that total spending will be just sufficient to purchase whatever output is produced. b. means that the interest rate never changes. c. guarantees that total spending will equal the quantity of loanable funds demanded. d. requires that the government run a budget deficit. ANSWER: a guarantees that total spending will be just sufficient to purchase whatever output is produced. SECTION: 3 OBJECTIVE: 4 18. If taxes are reduced with no change in government spending, and people spend all the money from the tax cut on consumption a. the demand for loanable funds will increase and the interest rate will increase. b. the demand for loanable funds will increase and the interest rate will decrease. c. the supply of loanable funds will decrease and the interest rate will increase. d. neither the demand nor the supply of loanable funds will change. ANSWER: a the demand for loanable funds will increase and the interest rate will increase. SECTION: 3 OBJECTIVE: 4 19. If taxes are reduced with no change in government spending, and people save all the money from the tax cut, a. the demand for loanable funds will increase and the interest rate will increase. b. the demand for loanable funds will increase and the interest rate will remain constant. c. the supply of loanable funds will increase and the interest rate will decrease. d. neither the demand nor the supply of loanable funds will change. ANSWER: c the supply of loanable funds will increase and the interest rate will decrease. SECTION: 3 OBJECTIVE: 4 20. A(n) __________ allows a firm to decrease its tax liability by a fraction of the investment it initiates during a particular period. a. tax on corporate profits b. tax on retained earnings c. investment tax credit d. personal income tax ANSWER: c investment tax credit SECTION: 3 OBJECTIVE: 4 21. If the U.S. government wants to increase the level of employment and real output, it could a. increase corporate income taxes. b. provide an investment tax credit. c. decrease expenditures on roads and dams. d. increase the personal income tax. ANSWER: b provide an investment tax credit. SECTION: 3 OBJECTIVE: 4

Chapter 26/Saving, Investment, and the Financial System 157 22. Assuming the economy was in equilibrium, use the following information to determine the governments budget deficit or surplus. Consumption Spending $3.5 trillion Net Taxes $2.7 trillion Household Saving $2.5 trillion Investment Spending $2.2 trillion The governments deficit (surplus) was a. $.3 trillion surplus. b. $.2 trillion surplus. c. $.3 trillion deficit. d. $.5. trillion deficit. ANSWER: c .3 trillion deficit. SECTION: 3 OBJECTIVE: 5 23. The government budget deficit is a. the difference between government purchases and government revenues from bonds and taxes. b. caused by a lack of business sector investment. c. created when the government expenditures exceed net taxes. d. caused by leakages in the economy. ANSWER: c created when the government expenditures exceed net taxes. SECTION: 3 OBJECTIVE: 5 24. If the government budget deficit increases, the a. supply of loans increases and the equilibrium interest rate increases. b. supply of loans increases and the equilibrium interest rate decreases. c. demand for loans increases and the equilibrium interest rate decreases. d. demand for loans increases and the equilibrium interest rate increases. ANSWER: d demand for loans increases and the equilibrium interest rate increases. SECTION: 3 OBJECTIVE: 5 25. If technical progress raises productivity permanently, then a. the equilibrium interest rate will increase. b. equilibrium saving will increase. c. real GDP will increase. d. All of the above are correct. ANSWER: d All of the above are correct. SECTION: 3 OBJECTIVE: 5