Series 7 Economic Factors Practice Questions
Question 1
The federal government funds a large spending increase by selling substantial new Treasury debt to the public, and the Federal Reserve does not accommodate the borrowing. Which result do economists call crowding out?
- A. Higher Treasury yields raise borrowing costs for businesses, which lowers private investment spending.
- B. A weaker dollar raises import prices, which lowers domestic purchases of foreign goods.
- C. Lower bank reserves force banks to call loans, which reduces the money multiplier.
- D. Higher tax receipts reduce household disposable income, which lowers consumer spending.
Show answer and explanation
Correct answer: A. Higher Treasury yields raise borrowing costs for businesses, which lowers private investment spending.
Crowding out occurs when heavy government borrowing competes for loanable funds and pushes interest rates up. The higher rates make private borrowing and investment less attractive, offsetting part of the fiscal stimulus.
- A. Correct. Deficit financing raises yields and reduces private investment.
- B. Exchange-rate and import effects are separate channels and are not what crowding out means.
- C. Reserve requirements and the money multiplier are monetary policy mechanics, not the result of Treasury borrowing.
- D. This describes a tax effect on consumption, not the effect of government borrowing on interest rates.
Question 2
Which of the following is included in the M2 money supply measure but NOT in the narrower M1 measure?
- A. Physical currency in circulation
- B. Demand deposits (checking accounts)
- C. Savings deposits and retail money market mutual funds
- D. Traveler's checks
Show answer and explanation
Correct answer: C. Savings deposits and retail money market mutual funds
M1 consists of the most liquid forms of money — currency in circulation, demand deposits, and other checkable deposits. M2 is broader, adding savings deposits, small-denomination time deposits, and retail money market mutual funds on top of everything in M1.
- A. Physical currency in circulation is already part of the narrower M1 measure.
- B. Demand deposits (checking accounts) are also already included in M1.
- C. Correct. Savings deposits and retail money market mutual funds are added to M1 to form M2 — they are not part of the narrower M1 measure.
- D. Traveler's checks are counted within M1, not added uniquely at the M2 level.
Question 3
Which formula correctly represents the standard expenditure approach to calculating Gross Domestic Product (GDP)?
- A. GDP = Consumption + Investment + Government Spending + (Exports − Imports)
- B. GDP = Consumption + Savings − Taxes
- C. GDP = Money Supply × Velocity of Money
- D. GDP = Corporate Profits + Wages + Interest + Rent
Show answer and explanation
Correct answer: A. GDP = Consumption + Investment + Government Spending + (Exports − Imports)
The expenditure approach to GDP sums consumption spending, business investment, government spending, and net exports (exports minus imports): GDP = C + I + G + (X − M). The other formulas describe unrelated or partial economic relationships (the equation of exchange, national income components, etc.).
- A. The expenditure approach sums consumption, investment, government spending, and net exports (exports minus imports) to calculate GDP.
- B. This isn't a recognized GDP formula; it resembles a savings/consumption identity rather than the expenditure approach.
- C. Money supply times velocity is the equation of exchange used in monetary theory, not the expenditure approach to GDP.
- D. Summing corporate profits, wages, interest, and rent describes the income approach to GDP, not the expenditure approach.
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When the Federal Reserve wants to decrease the money supply and slow economic growth, it would most likely:
- A. Lower the discount rate
- B. Buy government securities in the open market
- C. Raise the reserve requirement
- D. Lower the reserve requirement
Show answer and explanation
Correct answer: C. Raise the reserve requirement
Raising the reserve requirement forces banks to hold more of their deposits in reserve and lend out less, contracting the money supply and slowing economic activity — a tightening (contractionary) monetary policy tool. Lowering the discount rate, buying securities in the open market, and lowering the reserve requirement are all expansionary (easing) actions that increase the money supply.
- A. Lowering the discount rate makes borrowing cheaper for banks, which is expansionary — the opposite of the stated goal.
- B. Open market purchases inject reserves into the banking system, which is expansionary — the opposite of the stated goal.
- C. Correct — raising the reserve requirement contracts the money supply, consistent with slowing economic growth.
- D. Lowering the reserve requirement frees up more money for lending, which is expansionary — the opposite of the stated goal.