26

Saving, Investment, and the Financial
System
.
When opening a construction company, you might need to buy trucks, tools, and a storage
shed. Economists call these expenditures
a. business consumption expenditures.
b. investment in human capital.
c. capital investment.
d. None of the above are correct.
When a country saves a larger portion of its GDP, it will have

a. more investment, and so have more capital and higher productivity.
b. more investment, and so have less capital and higher productivity.
c. less investment, and so have more capital and higher productivity.
d. less investment, and so have less capital and higher productivity.
Institutions in the economy that help to match one person's saving with another person's
investment are collectively called
a. the financial system.
b. the Federal Reserve system.
c. the banking system.
d. the monetary system.
Savers
a. and borrowers demand money from the financial system.
b. and borrowers supply money to the financial system.
c. demand money from the financial system; borrowers supply money to the financial
system.
Harcourt, Inc. items and derived items copyright 2001 by Harcourt, Inc.
d.
supply money to the financial system; borrowers demand money from the financial
system.
What are the two basic categories of financial institutions?

a. the foreign exchange markets and the stock markets
b. the market for loanable funds and the market for capital
c. the financial markets and financial intermediaries
d. the lending market and the checkable deposit market
The bond market, the stock market, banks, and mutual funds are all part of the U.S.
a. Federal Reserve.
b. financial system.
c. banking system.
d. investment system.
Financial markets are

a. the financial institutions through which savers can indirectly provide funds to
borrowers.
b. the financial institutions through which savers can directly provide funds to
borrowers.
c. the financial institutions that sell shares to the public and use the proceeds to buy a
selection of various types of stocks and/or bonds.
The two most important financial markets in our economy are the
a. foreign exchange market and the mutual fund market.
b. bond market and stock market.
c. stock market and the mutual fund market.
d. bond market and the market for loanable funds.
A bond is a
a. a financial intermediary.
b. a certificate of indebtedness.
c. a certificate of partial ownership in an enterprise.
A certificate of indebtedness that specifies the obligations of the borrower to the holder is
called a
a. mutual fund.
b. bond.
c. stock.
d. All of the above are correct.
When large corporations, the federal government, or state and local governments need to
borrow to finance their purchases, they usually borrow
a. directly from the public by selling bonds.
b. directly from the public by buying bonds.
c. indirectly from the public by buying bonds.
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 can sell the bond before it matures.
Alonzo pays $10,000 to buy a bond from IBM that promises repayment ten years from
today. Which of the following is correct?
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a.
b.
c.
d.
Alonzo is the principal of this bond.

The bond matures in 10 years.
The term of the bond is $10,000.
All of the above are correct.
The length of time until a bond matures is called the

a. duration.
b. term.
c. maturity.
d. intermediation.
The term of a bond is the

a. interest rate of the bond.
b. credit risk rating of the bond.
c. principal amount of the bond.
d. length of time until the bond matures.
A perpetuity is distinguished from other bonds in that it

a. never matures.
b. pays continuously compounded interest.
c. is issued only by the U.S. government.
d. will be used to purchase another bond when it matures unless the owner specifies
otherwise.

a. Some bonds have terms as short as a few months.
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b.
c.
d.
Because they are so risky, junk bonds pay a low rate of interest.
Corporations buy bonds to raise funds.
In the United States, there are

a. hundreds of different bonds.
b. thousands of different bonds.
c. hundreds of thousands of different bonds.
d. millions of different bonds.
Long-term bonds are generally

a. more risky than short-term bonds and so pay higher interest.
b. more risky than short-term bonds and so pay lower interest.
c. less risky than short-term bonds and so pay higher interest.
d. less risky than short-term bonds and so pay lower interest.
Which of the following is not a nonsensical headline?

a. British perpetuities about to mature.
b. Standard and Poors judges new junk bond to have very low credit risk.
c. Disney issues new bonds with term of $1,000 each.
d. Government bonds currently pay less interest than corporate bonds.
On which bond is default most likely?

a. a U.S. government bond
b. a municipal bond
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c.
d.
a junk bond
a corporate bond issued by McDonalds
Assuming that the term and principal are the same, which list has bonds ordered from the
one that pays the least to the one that pays the most interest?
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
Other things the same, as the maturity of a bond becomes longer, the bond will
a. have greater risk and so tend to pay greater interest.
b. have greater risk and so tend to pay less interest.
c. have less risk and so tend to pay greater interest.
Which of the following bond buyers did not buy the bond that best met their objective?
a. Mia wanted a bond with a high interest rate, regardless of the risk. She purchased a
junk bond.
b. Ann wanted a bond that would let her best avoid taxes. She purchased a U.S.
government bond.
c. Ralph wanted to purchase a bond that never matures. He purchased a British
perpetuity.
d. Bill wanted to purchase a bond that was unlikely to have default. He purchased a
bond that Standards and Poors rated a low credit risk.
Municipal bonds pay a

a. high rate of interest because of their high default risk and because federal taxes must
be paid on the interest they pay.
b. high rate of interest because of their low default risk and because the interest they pay
is not subject to federal income tax.
c. low rate of interest because of their high default risk and because the interest they pay
is subject to federal income tax.
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d.
low rate of interest because of their low default risk and because the interest they pay
is not subject to federal income tax.
Which bond would you expect to pay the highest interest rate?
a. a bond of the U.S. government
b. a bond issued by a new restaurant chain
c. a bond issued by General Motors
d. a bond issued by New York state
Irving is fiscally conservative (risk averse). Which of the following bonds would Irving be
most likely to purchase?
a. a bond issued by Microsoft
b. a U.S. government bond
c. a municipal bond from Orange County, California
d. a Russian government saving bond
Rudolph has the choice of two bonds, one that pays 5 percent interest and the other that
pays 10 percent interest. Which of the following is most likely?
a. the 10 percent bond is more risky than the 5 percent bond
b. the 10 percent bond has a shorter term than the 5 percent bond
c. the 10 percent bond is a U.S. government bond, and the 5 percent bond is a junk bond
d. the 10 percent bond is a municipal bond, and the 5 percent bond is a corporate bond
Sam, a financial advisor has told his clients the following things. Which of his statements
is incorrect?
a. The interest received on most bonds is taxable.
b. U.S. government bonds have the lowest default risk.
c. Bond sales are called debt financing.
d. If you purchase a bond, you must hold it until it matures.
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.
Stock represents
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a.
b.
c.
d.
a claim to the profits of a firm.

ownership in a firm.
equity finance.
People who buy stock in a corporation such as Starbucks provide

a. debt finance and so become part owners of Starbucks.
b. debt finance and so become creditors of Starbucks.
c. equity finance and so become part owners of Starbucks.
d. equity finance and so become creditors of Starbucks.
If Quaker Oats runs into financial difficulty, the stockholders

a. as part owners of Quaker Oats are paid before bondholders get paid anything at all.
b. as part owners of Quaker Oats are paid after bondholders get paid.
c. as creditors of Quaker Oats are paid before bondholders get paid anything at all.
d. as creditors of Quaker Oats are paid after bondholders get paid.
People who buy stock in a corporation such as Coca Cola become
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a.
b.
c.
d.
part owners of Coca Cola, so the benefits of holding the stock depend on Coca Colas
profits.
part owners of Coca Cola, but the benefits of holding the stock do not depend on
Coca Colas profits.
creditors of Coca Cola, so the benefits of holding the stock depend on Coca Colas
profits.
creditors of Coca Cola, but the benefits of holding the stock do not depend on Coca
Colas profits.
Which of the following people purchased the correct asset to meet their objective?
a. Michelle wanted to be a part owner of Burger King, so she purchased a bond issued
by Burger King.
b. Tim wanted a high return, even if it meant taking some risk, so he purchased stock
issued by RCA instead of bonds issued by RCA.
c. Jennifer wanted to buy equity in Honda, so she purchased bonds sold by Honda.
Compared to bonds, stocks offer the holder

a. higher risk.
b. potentially higher return.
c. ownership in a firm.
The prices at which shares of stock trade on stock exchanges are determined by
a. the Corporate Stock Administration.
b. the supply and demand for the stock.
c. NASDAQ.
Which of the following is not an important stock exchange in the United States?
a. New York Stock Exchange
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b.
c.
d.
American Stock Exchange

Chicago Mercantile Exchange
NASDAQ
All else equal, when people become more optimistic about a company's future,
a. the supply of the stock (and thus the price) rises.
b. the supply of the stock (and thus the price) falls.
c. the demand for the stock (and thus the price) rises.
d. the demand for the stock (and thus the price) falls.
Suppose that the government finds a major defect in one of a companys product and
demands them to take it off the market. We would expect that
a. the supply of the stock (and thus the price) rises.
b. the supply of the stock (and thus the price) falls.
Other things being constant, when a business issues more stock,

a. the supply of the stock is greater and thus the price would fall.
b. the supply of the stock is less and thus the price would rise.
c. the demand for the stock is greater and thus the price would rise.
d. the demand for the stock is less and thus the price would fall.
Stock indexes are

a. reports in the newspapers that report on the price of the stock and earnings of the
corporation.
b. measures of the risk relative to the profitability of corporations.
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c.
d.
the average of a group of stock prices.

the average of a group of stock yields.
The most famous stock index is

a. the S&P 500.
b. the Dow Jones Industrial Average.
c. the NASDAQ.
The Dow-Jones Industrial Average has been computed regularly since

a. 1996.
b. 1948.
c. 1913.
d. 1896.
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. 300 representative U.S. corporations.
d. 1000 representative U.S. corporations.
The single most important piece of information about a stock is the

a. priceearnings ratio.
b. dividend.
c. volume
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d.
price.
The number of stock shares sold during the past day of trading is called the
a. transaction history.
b. velocity.
c. volume.
d. flow rate.
Profits paid out to stockholders are

a. retained earnings.
b. dividends.
c. the denominator in the priceearnings ratio.
Profits not paid out to stockholders are

b. known as dividends.
c. the denominator in the priceearnings ratio.
A dividend yield is the

a. dividend as a percentage of the stock price.
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.
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A corporation has a price of $50, a dividend of $.60, and retained earnings of $1.00 per
share. The dividend yield on this stock is
a. 3.2 percent.
b. 2 percent.
c. 1.2 percent.
d. .8 percent.
A corporation's earnings is
a. the amount of revenue it receives for the sale of its products minus its costs of
production as measured by its accountants.
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.
c. 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.
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 minus the dividends paid
out.
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 firms
a. earnings.
b. retained earnings.
c. economic, or real, profit.
d. dividend.
Historically, the typical priceearnings ratio is about

a. 20.
b. 15.
c. 8.
d. 3.
A high priceearnings ratio indicates that
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a.
b.
c.
d.
either the stock is overvalued or people have become more optimistic about the
corporations prospects.
either the stock is overvalued or people have become less optimistic about the
either the stock is undervalued or people have become more optimistic about the
either the stock is undervalued or people have become less optimistic about the
A low P/E for a stock indicates that

a. people may expect earnings to rise in the future perhaps because the firm has found
a way to reduce its production costs.
b. people feel the stock is overvalued.
c. the corporation's stock is cheap relative to its recent earnings.
Financial intermediaries are

a. the same as financial markets.
b. individuals who make a profit 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.
Which of the following is a financial intermediary?

a. the stock market
c. a mutual fund

a. A large, well-known corporation like Caterpillar typically uses financial
intermediation to finance expansion of its factories.
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b.
c.
d.
Banks borrow money at a low rate and then lend it out at a higher rate.
Unlike corporate bonds and stocks, checking accounts are a store of value.
Financial intermediaries are institutions through which savers can directly provide
funds to borrowers.
Which of the following is both a store of value and a common medium of exchange?
a. corporate bonds
b. stocks
c. checking account balances
A mutual fund
a. sells stocks and bonds on behalf of small and not-very-well-known firms who would
otherwise have to pay high interest to obtain credit.
b. 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.
c. is a financial market where small firms sell stocks and bonds to raise funds.
d. is money 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.
The primary advantage of mutual funds is that they

a. eliminate brokerage fees.
b. provide customers with a medium of exchange.
c. always make a return that beats the market.
d. allow people with small amounts of money to diversify.
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 5.0 percent of assets each year.
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c.
d.
nothing, because they receive commissions from the firms whose stock they buy.
a flat fee of $35.
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 give ordinary people access to the skills of professional money managers.
Index funds
a. typically have higher rates of return than more actively managed funds.
b. typically have about the same rate of return as more actively managed funds.
c. typically have lower rates of return than more actively managed funds.
d. contain the stocks and bonds of a single corporation.
Some people believe that as of early 2000 the stock market is overvalued. According to the
article by Glassman and Hassett in the text,
a. this belief is justified because bonds pay a higher return than stocks.
b. this belief is justified because of the current high levels of priceearning ratios.
c. this belief is unjustified because the equity premium on stocks should be high.
d. this belief is unjustified because the recent rise in stock prices reflects a change in the
understanding of stock market risk.
The identity that shows that GDP is both total income and total expenditure is represented
by
a. Y = PI + DI + NX.
b. Y = C + I + G + NX.
c. GDP = GNP - NX.
d. GDP = Y.
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Y = C + I + G + NX is an identity because
a. the right-hand and left-hand sides are equal.
b. the equality holds due to the way the variables are defined.
c. each symbol identifies a variable.
ANSWER: b. the equality holds due to the way the variables are defined.
TYPE: M KEY1: E SECTION: 2 OBJECTIVE: 2 RANDOM: Y
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A closed economy does not

a. allow for increases in the capital stock.
b. trade with other economies.
c. have free markets.
d. allow immigration.
An open economy
a. trades with other countries.
b. has unregulated banking.
c. has unrestricted immigration.
Which of the following equations will always represent GDP in an open economy?
a. Y = C + I + G + NX
b. S = I - G
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c.
d.
I=Y-C+G
Y=C+I+G
Which of the following equations most simply represents the GDP in a closed economy?
a. Y = C + I + G + NX
b. S = I - G
c. I = Y - C + G
d. Y = C + I + G
Which of the following equations represents national saving in a closed economy?

a. Y - I G - NX
b. Y - I C
c. Y - C - G
d. G + C - Y
In a closed economy, national saving equals

a. investment.
b. income minus the sum of consumption and government expenditures.
c. private saving plus public saving.
In a closed economy, national saving

a. is usually greater than investment.
b. is usually less than investment because of the leakage of taxes.
c. is always less than investment.
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d.
must equal investment.
In a closed economy, the total income that remains after paying for consumption and
government purchases is
a. public saving.
b. private saving.
c. national saving.
d. national disposable income.
In a closed economy, what does (T - G) represent?

a. private saving
b. public saving
c. national saving
d. investment
In a closed economy, what does (Y - T - C) represent?

a. national saving
b. government tax revenue
c. public saving
d. private saving
Suppose that in a closed economy GDP is equal to 8,000, Taxes are equal to 2,000,
Consumption equals 5,000, and Government expenditures equal 1,000. What is national
saving?
a. 0
b. 2000
c. 3000
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Suppose that in a closed economy GDP is equal to 8,000, Taxes are equal to 2,000,
Consumption equals 5,000, and Government expenditures equal 1,000. What are private
saving and public saving?
a. 2000 and -2000
b. 2000 and 1000
c. 1000 and -1000
d. 1000 and 2000
In a closed economy, private saving is

a. the amount of income that households have left after paying their taxes and paying
for their 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.
In a closed economy, public saving is

a. the amount of income that businesses have left after paying for the factors of
production.
b. the amount of tax revenue that the government has left after paying for its spending.
c. the amount of income that households have left after paying their taxes and paying
for their consumption.
d. always equal to investment.
Which of the following is not always correct in 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.
If the tax revenue of the federal government exceeds spending, then the government
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a.
b.
c.
d.
runs a national debt.

will increase taxes.
runs a budget deficit.
runs a budget surplus.
A budget deficit is created when the government

a. buys back more bonds than it issues.
b. spends more than it receives in tax revenue.
c. receives more tax revenue than it spends.
In the language of macroeconomics, investment refers to

a. the purchase of stocks, bonds, or mutual funds.
b. the purchase of new capital.
c. saving.
Which of the following would a macroeconomist consider as investment?

a. Alan purchases a bond issued by Kelloggs.
b. Paul purchases stock issued by IBM.
c. Arthur buys a new sewing machine for his tailoring business.
Henry buys a bond issued by Speedo Corporation, which uses the funds to buy new
machinery for one of its factories.
a. Henry and Speedo are both investing.
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b.
c.
d.
Henry and Speedo are both saving.

Henry is investing; Speedo is saving.
Henry is saving; Speedo is investing.
The source of the supply of loanable funds

a. and the demand for loanable funds is saving.
b. and the demand for loanable funds is investment.
c. is saving and the source of demand for loanable funds is investment.
d. is investment and the source of demand for loanable funds is saving.
The slope of the demand for 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.
The slope of the supply of loanable funds curve represents the

a. positive relation between the real interest rate and investment.
d. negative relation between the real interest rate and saving.
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.
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c.
d.
invest more so the supply of loanable funds slopes upward.

invest less so the supply of loanable funds slopes downward.
The supply of loanable funds

a. slopes upward because an increase in the interest rate induces people to save more.
b. slopes upward because an increase in the interest rate induces people to invest more.
c. slopes downward because an increase in the interest rate induces people to save less.
d. slopes downward because an increase in the interest rate induces people to invest less.
A higher interest rate induces people to

a. save more, so the demand for loanable funds slopes upward.
b. save less, so the demand for loanable funds slopes downward.
c. invest more so the demand for loanable funds slopes upward.
d. invest less so the demand for loanable funds slopes downward.
The demand of loanable funds

b. slopes upward because an increase in the interest rate induces people to invest more.
c. slopes downward because an increase in the interest rate induces people to save less.
If the current market interest rate for loanable funds is below the equilibrium level, then
a. the quantity of loanable funds demanded will exceed the quantity of loanable funds
supplied and the interest rate will rise.
b. the quantity of loanable funds supplied will exceed the quantity of loanable funds
demanded and the interest rate will rise.
c. the quantity of loanable funds demanded will exceed the quantity of loanable funds
supplied and the interest rate will fall.
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d.
the quantity of loanable funds supplied will exceed the quantity of loanable funds
demanded and the interest rate will fall.
If the current market interest rate for loanable funds is above the equilibrium level, then
a. the quantity of loanable funds demanded will exceed the quantity of loanable funds
supplied and the interest rate will rise.
b. the quantity of loanable funds supplied will exceed the quantity of loanable funds
demanded and the interest rate will rise.
c. the quantity of loanable funds demanded will exceed the quantity of loanable funds
supplied and the interest rate will fall.
d. the quantity of loanable funds supplied will exceed the quantity of loanable funds
demanded and the interest rate will fall.
If the current market interest rate for loanable funds is below the equilibrium level, then
a. there is a surplus of loanable funds and the interest rate will rise.
b. there is a surplus of loanable funds and the interest rate will fall.
c. there is a shortage of loanable funds and the interest rate will rise.
d. there is a shortage of loanable funds and the interest rate will fall.
If the current market interest rate for loanable funds is above the equilibrium level, then
a. there is a surplus of loanable funds and the interest rate will rise.
d. there is a shortage of loanable funds and the interest rate will fall.
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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.
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.
The nominal interest rate is

a. the interest rate corrected for inflation.
b. the interest rate as usually reported.
c. the real rate of return to the lender.
d. the real cost of borrowing to the borrower.
The real interest rate is

a. the nominal interest rate corrected for inflation.
c. the nominal interest rate minus the inflation rate.
d. Both a and c are correct.
If the nominal interest rate is 6 percent and the rate of inflation is 2 percent, then the real
interest rate is
a. 12 percent.
b. 8 percent.
c. 4 percent.
d. 3 percent.
If the inflation rate is 2 percent and the real interest rate is 3 percent, then the nominal
interest rate is
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a.
b.
c.
d.
6 percent.
5 percent.
1 percent.
2/3 percent.
Generally when economists and the text talk of the "interest rate," they are talking about
a. the real interest rate.
b. the current nominal interest rate.
c. the real interest rate minus the inflation rate.
d. the equilibrium nominal interest rate.
Promises of future payments have the smallest present value when

a. interest rates are high and the time until the future payment is received is long.
b. interest rates are high and the time until the future payment is received is short.
c. interest rates are low and the time until the future payment is received is long.
d. interest rates are low and the time until the future payment is received is short.
Your eccentric Uncle has promised to give you $50,000 when you graduate. You think that
you will graduate in three years and could get about 7 percent on any money you saved.
What is the present value of the $50,000?
a. $50,000
b. $50,000(1.07)3
c. $50,000/(1.07)3
Your company has a project that will provide $1,000 of revenue today and $2,000 of
revenue one year from today. The present value of this project is
a. $3,000.
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b.
c.
d.
$1,000 + $2,000/(1 + r).

$1,000/(1 + r) + $2,000/(1 + r)2.
None of the above are correct.
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 supply of loanable funds would shift left
c. the demand for loanable funds would shift right
d. the demand for loanable funds would shift left
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.
What would happen in the market for loanable funds if the government were to increase
a. interest rates would rise
b. interest rates would be unaffected
c. interest rates would fall
d. the change in the interest rate would be ambiguous
What would happen in the market for loanable funds if the government were to decrease
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.
110
111
112
113
c.
d.
There would be no change in the amount of loanable funds borrowed.

The change in loanable funds borrowed would be ambiguous.
If Congress reduced the tax on interest income,

a. investment and saving would increase.
b. investment and saving would decrease.
c. investment would increase and saving would decrease.
d. investment would decrease and saving would increase.
If the government increased the tax on interest income, investment

a. would rise.
b. would be unaffected.
c. would fall.
d. could rise, fall, or remain unchanged.
The effects of a reduction in tax on interest income suggest that, other things the same,
countries that tax saving less will have
a. higher interest rates and higher investment than other countries.
b. higher interest rates and lower investment than other countries.
c. lower interest rates and higher investment than other countries.
d. lower interest rates and lower investment than other countries.
Which of the following is incorrect?

a. American families save a smaller 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 nations standard of living.
c. A change in the tax law that encouraged greater saving would reduce interest rates.
114
115
116
117
d.
Taxes on interest income do not substantially decrease future payments from current
saving.
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 right
b. the supply of loanable funds would shift right
c. the demand for loanable funds would shift left
d. the supply of loanable funds would shift left
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.
Suppose Congress decides to do away with an existing investment tax credit. What would
happen?
a. Interest rates would rise.
b. Interest rates would be unaffected.
c. Interest rates would fall.
d. The change in the interest rate would be ambiguous.
If Congress instituted an investment tax credit, the quantity of saving would

a. rise.
b. be unaffected.
c. fall.
d. change in an uncertain direction.
118
119
120
121
Suppose Congress institutes an investment tax credit. What would happen in the market
for loanable funds?
a. The interest rate and the quantity of saving would rise.
b. The interest rate and the quantity of saving would fall.
c. The interest rate would rise and the quantity of saving would fall.
d. None of the above is necessarily correct.
Suppose Congress institutes an investment tax credit. What would happen in the market
for loanable funds?
a. The interest rate and investment would rise.
b. The interest rate and investment would fall.
c. The interest rate would rise and investment would fall.
d. None of the above is necessarily correct.
If a change in the tax laws encouraged a greater demand for loanable funds for
investment, there would be
a. higher interest rates.
b. greater saving.
c. greater growth.
If the government currently has a budget deficit,

a. it does not necessarily have a debt.
b. the debt is increasing.
c. government expenditures are greater than taxes.
An increase in the budget deficit
122
123
124
125
126
a.
b.
c.
d.
changes the supply of loanable funds.

changes the demand for loanable funds.
changes both the supply of and demand for loanable funds.
does not influence the supply of or the demand for loanable funds.
A government budget deficit

a. increases private savings and national saving.
b. increases public savings but reduces national saving.
c. reduces private saving, but increases national saving.
d. reduces both public and national saving.

a. shifts the supply of loanable funds left.
b. shifts the supply of loanable funds right.
c. shifts the demand for loanable funds left.
d. shifts the demand for loanable funds right.

a. reduces public saving and so shifts the supply of loanable funds left.
b. reduces private saving and so shifts the supply of loanable funds left.
c. reduces investment and so shifts the demand for loanable funds left.

a. drives the price of loanable funds higher.
127
128
129
130
b.
c.
d.
drives the price of loanable funds lower.

does not affect the price of loanable funds.
has an ambiguous effect on the price of loanable funds.
An increase in the budget deficit would

a. cause a shortage of loanable funds at the original interest rate, which would lead to
rising interest rates.
b. cause a shortage of loanable funds at the original interest rate, which would lead to
falling interest rates.
c. cause a surplus of loanable funds at the original interest rate, which would lead to
rising interest rates.
d. cause a surplus of loanable funds at the original interest rate, which would lead to
falling interest rates.

a. drives investment spending down.
b. drives investment spending up.
c. does not affect investment spending.
d. may increase, decrease, or not affect investment spending.
If a government went from a deficit to a surplus, government

a. debt would rise, the supply of loanable funds would shift right, and interest rates
would rise.
b. debt would rise, the supply of loanable funds would shift right, and interest rates
would fall.
c. debt would fall, the supply of loanable funds would shift left, and interest rates would
rise.
d. debt would fall, the supply of loanable funds would shift right, and interest rates
would fall.
Between 1996 and 1997 the government deficit in Egypt fell by almost two-thirds. This
decrease should have made
a. interest rates and investment rise.
b. interest rates and investment fall.
131
132
133
134
c.
d.
interest rates rise and investment fall.

interest rates fall and investment rise.
The fall in investment due to government borrowing is called

a. the reverse equity premium.
b. crowding out.
c. the reshuffle effect.
d. the Ricardian Principle.
When the government runs a budget deficit,

a. interest rates are higher than otherwise.
b. national saving is lower than otherwise.
c. investment is lower than otherwise.
Which of the following beliefs would make someone less likely to oppose government
deficits?
a. The demand for loanable funds curve is very steep.
b. The return on private investment is higher than the return on public investment.
c. Taxes considerably distort private decision making.
d. All of the above would make someone less likely to oppose government deficits.
Which of the following is incorrect?

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 U.S. has always been less than one.
c. Debts during wars may distribute the burden of fighting the war more evenly across
generations.
135
136
137
138
d.
Some increases in debt to GDP took place during peacetime.
In recent years the national debt has been about

a. 25 percent of GDP.
b. 50 percent of GDP.
c. 100 percent of GDP.
d. 200 percent of GDP.
The ratio of debt to GDP tended to fall

a. during wars.
b. during the late 1990s.
c. during most of the Reagan administration.
The price of loanable funds

a. is governed by the forces of supply and demand.
b. is the interest rate.
c. rations the available loanable funds to those who value them the most.
139
140
141
ANSWERS
1
~ANSWER:
c. capital investment
TYPE: M KEY1: D OBJECTIVE: 1 RANDOM: Y
2
~ANSWER:
a. more investment, and so have more capital and higher productivity.
3
~ANSWER:
a. the financial system.
4
~ANSWER:
d. supply money to the financial system; borrowers demand money from the financial system.
TYPE: M KEY1: D OBJECTIVE: 1 SECTION: 1 RANDOM: Y
5
~ANSWER:
c. the financial markets and financial intermediaries
TYPE: M KEY1: D SECTION: 1 OBJECTIVE: 1 RANDOM: Y
6
~ANSWER:
b. financial system.
7
~ANSWER:
b. the financial institutions through which savers can directly provide funds to borrowers.
8
~ANSWER:
b. bond market and stock market.
9
~ANSWER:
b. a certificate of indebtedness.
10
~ANSWER:
b. bond.
11
~ANSWER:
a. borrow directly from the public by selling bonds.
12
~ANSWER:
c. A bond buyer can sell the bond before it matures.
13
~ANSWER:
b. The bond matures in 10 years.
14
~ANSWER:
b. term.
15
~ANSWER:
d. the length of time until the bond matures.
16
~ANSWER:
a. never matures.
17
~ANSWER:
a. Some bonds have terms as short as a few months.
18
~ANSWER:
d. millions of different bonds.
19
~ANSWER:
a. more risky than short-term bonds and so pay higher interest.
20
~ANSWER:
d. Government bonds currently pay less interest than corporate bonds..
21
~ANSWER:
c. a junk bond
22
~ANSWER:
c. municipal bond, US government bond, corporate bond

23
~ANSWER:
a. have greater risk and so tend to pay greater interest.
24
~ANSWER:
b. Ann wanted a bond that would let her best avoid taxes. She purchased a U.S. government bond.
TYPE: M KEY1: G SECTION: 1 OBJECTIVE: 1 RANDOM: Y
25
~ANSWER:
d. low rate of interest because of their low default risk and because the interest they pay is not subject to
federal income tax.
26
~ANSWER:
b. a bond issued by a new restaurant chain
27
~ANSWER:
TYPE: M KEY1: C SECTION: 1 OBJECTIVE: 1 RANDOM: Y
28
~ANSWER:
a. the 10 percent bond is more risky than the 5 percent bond
29
~ANSWER:
d. If you purchase a bond, you must hold it until it matures.
30
~ANSWER:
d. to raise money is called equity financing, while the sale of bonds to raise funds is called debt financing.
31
~ANSWER:
32
~ANSWER:
c. equity finance and so become part owners of Starbucks.
33
~ANSWER:
b. as part owners of Quaker Oats are paid after bondholders get paid.
34
~ANSWER:
a. part owners of Coca Cola, so the benefits of holding the stock depend on Coca Colas profits.
35
~ANSWER:
b. Tim wanted a high return, even if it meant taking some risk, so he purchased stock issued by RCA instead of
the bonds they were selling.
36
~ANSWER:
37
~ANSWER:
b. the supply and demand for the stock.
38
~ANSWER:
c. Chicago Mercantile Exchange
39
~ANSWER:
40
~ANSWER:
41
~ANSWER:
a. the supply of the stock is greater and thus the price would fall.
42
~ANSWER:
c. the average of a group of stock prices.
43
~ANSWER:
c. the Dow Jones Industrial Average.

44
~ANSWER:
d. 1896.
45
~ANSWER:
a. 30 major US corporations.
46
~ANSWER:
d. price.
47
~ANSWER:
c. volume.
48
~ANSWER:
b. paid as dividends.
49
~ANSWER:
50
~ANSWER:
a. the dividend as a percentage of the stock price.
51
~ANSWER:
c. 1.2 percent.
52
~ANSWER:
a. the amount of revenue it receives for the sale of its products minus its costs of production as measured by
its accountants.
53
~ANSWER:
a. earnings.
54
~ANSWER:
b.
15.
55
~ANSWER:
a. either the stock is overvalued or people have become more optimistic about the corporations prospects.
56
~ANSWER:
c. the corporation's stock is cheap relative to its recent earnings.
57
~ANSWER:
d. financial institutions through which savers can indirectly provide funds to borrowers.
58
~ANSWER:
c. a mutual fund
59
~ANSWER:
b. Banks borrow money at a low rate and then lend it out at a higher rate.
60
~ANSWER:
c. checking account balances.
61
~ANSWER:
b. 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.
62
~ANSWER:
d. allow people with small amounts of money to diversify.
63
~ANSWER:
a. between 0.5 and 2.0 percent of assets each year.
64
~ANSWER:
c. they give ordinary people access to the skills of professional money managers.
65
~ANSWER:
a. typically have higher rates of return than more actively managed funds.
66
~ANSWER:
d. this belief is unjustified because the recent rise in stock prices reflects a change in the understanding of
stock market risk.
67
~ANSWER:
b. Y = C + I + G + NX.
68
~ANSWER:
b. the equality holds due to the way the variables are defined.
69
~ANSWER:
b. trade with other economies.
70
~ANSWER:
a. trades with other countries.
71
~ANSWER:
a. Y = C + I + G + NX
72
~ANSWER:
d. Y = C + I + G
73
~ANSWER:
c. Y - C - G
74
~ANSWER:
TYPE: M DIFFICUTLY: 3 KEY1: C SECTION: 2 OBJECTIVE: 2 RANDOM: Y
75
~ANSWER:
d. must equal investment.
76
~ANSWER:
a. national saving.
77
~ANSWER:
b. public saving
78
~ANSWER:
d. private saving
79
~ANSWER:
b. 2000
80
~ANSWER:
b. 2000 and 1000

81
~ANSWER:
a. the amount of income that households have left after paying their taxes and paying for their consumption.
82
~ANSWER:
b. the amount of tax revenue that the government has left after paying for its spending.
83
~ANSWER:
d. Private saving equals investment.
84
~ANSWER:
d. runs a budget surplus.
85
~ANSWER:
b. spends more than it receives in tax revenue.
86
~ANSWER:
b. the purchase of new capital.
87
~ANSWER:
c. Arthur buys a new sewing machine for his tailoring business.
88
~ANSWER:
d. Henry is saving; Speedo is investing.
89
~ANSWER:
c. is saving and the source of demand for loanable funds is investment.
90
~ANSWER:
91
~ANSWER:
92
~ANSWER:
a. save more, so the supply of loanable funds slopes upward.
93
~ANSWER:
94
~ANSWER:
d. invest less so the demand of loanable funds slopes downward.
95
~ANSWER:
96
~ANSWER:
a. the quantity of loanable funds demanded will exceed the quantity of loanable funds supplied and the
interest rate will rise.
97
~ANSWER:
d. the quantity of loanable funds supplied will exceed the quantity of loanable funds demanded and the
interest rate will fall.
98
~ANSWER:
99
~ANSWER:
100
~ANSWER:
c. neither curve shifts, but the quantity of loanable funds supplied increases and the quantity demanded
decreases as the interest rate rises to equilibrium.
TYPE: M DIFFICULTY: 3 KEY1: D SECTION: 3 OBJECTIVE: 3 RANDOM: Y
101
~ANSWER:
d. neither curve shifts, but the quantity of loanable funds supplied decreases and the quantity demanded
increases as the interest rate falls to equilibrium.
102
~ANSWER:
103
~ANSWER:
d.
Both a and c are correct.
104
~ANSWER:
c. 4 percent.
105
~ANSWER:
c. 1 percent.
106
~ANSWER:
a. the real interest rate.
107
~ANSWER:
a. interest rates are high and the time until the future payment is received is long.
108
~ANSWER:
c. $50,000/(1.07)3
109
~ANSWER:
b. $1,000 + $2,000/(1 + r).
TYPE: M DIFFICULTY: 3 KEY1: E SECTION: 3 OBJECTIVE: 3 RANDOM: Y
110
~ANSWER:
b. the supply of loanable funds would shift left
111
~ANSWER:
112
~ANSWER:
a. interest rates would rise
113
~ANSWER:
a. There would be an increase in the amount of loanable funds borrowed.
114
~ANSWER:
a. investment and saving would increase.
115
~ANSWER:
c. investment would fall.
116
~ANSWER:
c. lower interest rates and higher investment than other countries.
TYPE: M DIFFICULTY: 3 KEY1: C SECTION: 3 OBJECTIVE: 4 RANDOM: Y
117
~ANSWER:
d. Taxes on interest income do not substantially decrease future payments from current saving.
118
~ANSWER:
a. the demand for loanable funds would shift right
119
~ANSWER:
d. The demand for loanable funds would shift left.
120
~ANSWER:
c. Interest rates would fall.
121
~ANSWER:
a. rise.
122
~ANSWER:
a. The interest rate and the quantity of saving would rise.
123
~ANSWER:
a. The interest rate and investment would rise.
124
~ANSWER:
125
~ANSWER:
126
~ANSWER:
a. changes the supply of loanable funds.
127
~ANSWER:
d. reduces both public and national saving.
128
~ANSWER:
a. shifts the supply of loanable funds left.
129
~ANSWER:
a. reduces public saving and so shifts the supply of loanable funds left.
130
~ANSWER:
a. drives the price of loanable funds higher.
131
~ANSWER:
a. cause a shortage of loanable funds at the original interest rate, which would lead to rising interest rates.
132
~ANSWER:
a. drives investment spending down.
133
~ANSWER:
d. debt would fall, the supply of loanable funds would shift right, and interest rates would fall.
134
~ANSWER:
d. interest rates fall and investment rise.
135
~ANSWER:
b. crowding out.
136
~ANSWER:
137
~ANSWER:
a. The demand for loanable funds curve was very steep.
138
~ANSWER:
b. The ratio of debt to GDP in the US has always been less than one.
139
~ANSWER:
b. 50 percent of GDP.
140
~ANSWER:
b. during the late 1990s.
141
~ANSWER:

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Saving, Investment, and the Financial

When a country saves a larger portion of its GDP, it will have

What are the two basic categories of financial institutions?

Financial markets are

Which of the following is correct?

Alonzo is the principal of this bond.

The length of time until a bond matures is called the

The term of a bond is the

A perpetuity is distinguished from other bonds in that it

Which of the following is correct?

In the United States, there are

Long-term bonds are generally

Which of the following is not a nonsensical headline?

On which bond is default most likely?

Municipal bonds pay a

The sale of stocks

a claim to the profits of a firm.

People who buy stock in a corporation such as Starbucks provide

If Quaker Oats runs into financial difficulty, the stockholders

People who buy stock in a corporation such as Coca Cola become

Compared to bonds, stocks offer the holder

American Stock Exchange

Other things being constant, when a business issues more stock,

Stock indexes are

the average of a group of stock prices.

The most famous stock index is

The Dow-Jones Industrial Average has been computed regularly since

The single most important piece of information about a stock is the

Profits paid out to stockholders are

Profits not paid out to stockholders are

A dividend yield is the

Historically, the typical priceearnings ratio is about

A high priceearnings ratio indicates that

A low P/E for a stock indicates that

Financial intermediaries are

Which of the following is a financial intermediary?

Which of the following is correct?

The primary advantage of mutual funds is that they

As a money management fee, mutual funds usually charge their customers

It is claimed that a secondary advantage of mutual funds is that

A closed economy does not

Which of the following equations represents national saving in a closed economy?

In a closed economy, national saving equals

In a closed economy, national saving

must equal investment.

In a closed economy, what does (T - G) represent?

In a closed economy, what does (Y - T - C) represent?

In a closed economy, private saving is

In a closed economy, public saving is

Which of the following is not always correct in a closed economy?

runs a national debt.

A budget deficit is created when the government

In the language of macroeconomics, investment refers to

Which of the following would a macroeconomist consider as investment?

Henry and Speedo are both saving.

The source of the supply of loanable funds

The slope of the supply of loanable funds curve represents the

A higher interest rate induces people to

invest more so the supply of loanable funds slopes upward.

The supply of loanable funds

A higher interest rate induces people to

The demand of loanable funds