ECON 101: Economics Assignment on Business Cycles and Interest Rates

This economics assignment solution addresses key concepts in macroeconomics and financial markets. It begins with multiple-choice questions covering topics such as the impact of financial markets on economic growth, the effects of interest rates, and the definition of inflation. The solution then...Read More

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Well-functioning financial markets promote
 A. inflation.
 B. deflation.
 C. unemployment.
 D. growth.
The answer is D (growth).
A key factor in producing high economic growth is
 A. eliminating foreign trade.
 B. well-functioning financial markets.
 C. high-interest rates.
 D. stock market volatility.
The answer is B (well-functioning financial markets).
High-interest rates might ________ purchasing a house or car but at the same time, high-
interest rates might ________ saving.
 A. discourage; encourage

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 B. discourage; discourage
 C. encourage; encourage
 D. encourage; discourage
Answer is A (discourage; encourage).
It is true that inflation is a
 A. continuous increase in the money supply.
 B. continuous fall in prices.
 C. decline in interest rates.
 D. continually rising price level.
The answer is D (continually rising price level).
A breakdown of financial markets can result in
 A. financial stability.
 B. rapid economic growth.
 C. political instability.

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 D. stable prices.
The answer is C (political instability).
When I purchase ________, I own a portion of a firm and have the right to vote on issues
important to the firm and to elect its directors.
 A. bonds
 B. bills
 C. notes
 D. stock
The answer is D (stock).
Ranking assets from most liquid to least liquid, the correct order is
 A. savings bonds; house; currency.
 B. currency; savings bonds; house.
 C. currency; house; savings bonds.
 D. house; savings bonds; currency.
The answer is B (currency; savings bonds; house).

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Recent financial innovation makes the Federal Reserve’s job of conducting monetary policy
 A. easier, since the Fed now knows what to consider money.
 B. more difficult, since the Fed now knows what to consider money.
 C. easier, since the Fed no longer knows what to consider money.
 D. more difficult, since the Fed no longer knows what to consider money.
The answer is A (easier, since the Fed now knows what to consider money).
Which of the following are true of fixed payment loans?
 A. The borrower repays both the principal and interest at the maturity date.
 B. Installment loans and mortgages are frequently of the fixed payment type.
 C. The borrower pays interest periodically and the principal at the maturity date.
 D. Commercial loans to businesses are often of this type.
The answer is B (Installment loans and mortgages are frequently of the fixed payment type).
The sum of the current yield and the rate of capital gain is called the
 A. rate of return.

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 B. discount yield.
 C. perpetuity yield.
 D. par value.
The answer is A (rate of return).
When the ________ interest rate is low, there are greater incentives to ________ and fewer
incentives to ________.
 A. nominal; lend; borrow
 B. real; lend; borrow
 C. real; borrow; lend
 D. market; lend; borrow
The answer is C (real; borrow; lend).
Pieces of property that serve as a store of value are called
 A. assets.
 B. units of account.
 C. liabilities.

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 D. borrowings.
The answer is A (assets).
When the price of a bond is above the equilibrium price, there is an excess ________ bonds
and the price will ________.
 A. demand for; rise
 B. demand for; fall
 C. supply of; fall
 D. supply of; rise
The answer is C (supply of; fall).
If prices in the bond market become more volatile, everything else held constant, the demand
curve for bonds shifts ________ and interest rates ________.
 A. left; rise
 B. left; fall
 C. right; rise
 D. right; fall

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The answer is D (right; fall).
The ________ the returns on two securities move together, the ________ benefit there is
from diversification.
 A. less; more
 B. less; less
 C. more; more
 D. more; greater
The answer is A (less; more)
Corporate bonds are not as liquid as government bonds because.
 A. fewer corporate bonds for any one corporation are traded, making them more
costly to sell.
 B. the corporate bond rating must be calculated each time they are traded.
 C. corporate bonds are not callable.
 D. corporate bonds cannot be resold.
The answer is A (fewer corporate bonds for any one corporation are traded, making them
more costly to sell).

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Three factors explain the risk structure of interest rates:
 A. liquidity, default risk, and the income tax treatment of a security.
 B. maturity, default risk, and the income tax treatment of a security.
 C. maturity, liquidity, and the income tax treatment of a security.
 D. maturity, default risk, and the liquidity of a security.
Answer is A (liquidity, default risk, and the income tax treatment of a security).
A sharp decline in the stock market means that the ________ of corporations has fallen
making lenders ________ willing to lend.
 A. net worth; less
 B. net worth; more
 C. liability; less
 D. liability; more
The answer is A (net worth; less).
The reduction in transactions costs per dollar of investment as the size of transactions
increases is
 A. discounting.

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 B. economies of scale.
 C. economies of trade.
 D. diversification.
The answer is B (economies of scale).
Regulation of the financial system
 A. occurs only in the United States.
 B. protects the jobs of employees of financial institutions.
 C. protects the wealth of owners of financial institutions.
 D. ensures the stability of the financial system.
The answer is D (ensures the stability of the financial system).
A substantial decrease in the aggregate price level that reduces firms net worth may stall
recovery from a recession. This process is called
 A. debt deflation.
 B. moral hazard.
 C. insolvency.

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 D. illiquidity.
The answer is A (debt deflation).
Financial crises generally develop along two basic paths:
 A. mismanagement of financial liberalization/globalization and severe fiscal
imbalances.
 B. stock market declines and severe fiscal imbalances.
 C. mismanagement of financial liberalization/globalization and stock market
declines.
 D. stock market declines and unanticipated declines in the value of the domestic
currency.
The answer is A (mismanagement of financial liberalization/globalization and severe fiscal
imbalances).
Because checking accounts are ________ liquid for the depositor than passbook savings, they
earn ________ interest rates.
 A. less; higher
 B. less; lower
 C. more; higher

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 D. more; lower
The answer is D (more; lower).
In general, banks make profits by selling ________ liabilities and buying ________ assets.
 A. long-term; shorter-term
 B. short-term; longer-term
 C. illiquid; liquid
 D. risky; risk-free
Answer is B (short-term; longer-term).
If a bank has $200,000 of checkable deposits, a required reserve ratio of 20 percent, and it
holds $80,000 in reserves, then the maximum deposit outflow it can sustain without altering
its balance sheet is
 A. $50,000.
 B. $40,000.
 C. $30,000.
 D. $25,000.

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The answer is A ($50,000).
What happens to economic growth and unemployment during a business cycle recession?
What is the relationship between the money growth rate and a business cycle recession? (200
words)
Answer
Business cycle recession generally referred to as economic recession, results from a nation’s
economic activity general slowdown which leads to the contraction of the business cycle.
During the business cycle recession, general macroeconomic indicators of a given nation fall
(Koellinger and Roy Thurik 2012, p.1143). Some of these macroeconomic indicators include
gross domestic product, inflation, investment spending and household income among others.
During the business cycle recession, economic growth generally slows down. This is due to
the fact that consumers in the economy tend to save much resulting in lower expenditure.
Lower expenditure lowers consumer spending leading to reduced demand for goods and
services within the economy. Reduction in demand lowers businesses productivity and
consequently reduces their growth. Reduced businesses growth lead to a decline in the
general economic growth. Unemployment during business cycle recession increases. This is
as a result of business sales decline which leads to reduced revenue as the demand for goods
and services in the economy decreases. This means that businesses in the economy stop
expanding and hence adjust accordingly to minimize losses by reducing their costs by
adopting various business decisions such as lowering wages, not hiring new employees and
some even retrench existing employees. This, therefore, leads to increased unemployment in
the economy.

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Money growth rate tends to increase during business cycle recession. During the business
cycle recession inflation tends to fall. This is because consumers save more during this period
and this tightens the supply of money in the economy. Reduction of money supply in the
economy increases the value of money as little cash is available to purchase goods and
services and hence money growth rate tends to increase during business cycle recession.
Using the liquidity preference framework, what will happen to interest rates if the Fed
increases the money supply? Using the liquidity preference framework, what happens to
interest rates during a business cycle recession? (200 words)
Answer
The liquidity preference framework was created by John Maynard Keynes in order to explain
the relationship between interest rates and the demand and supply for money. The framework
states that the demand for money is to remain liquid but not to borrow it (Cochrane 2017,
p.47). The demand for money is influenced by three motives namely the speculative,
transactionary and precautionary motive. The more easily an asset can be converted into cash,
the more liquid it is.
If the Fed increases the supply of money in the economy, the money supply curve shifts to
the right. As a result, the equilibrium point for interest rates in the economy is lowered
decreasing the economy’s interest rates. Therefore, an increase in the supply of money by the
Fed decreases interest rates.
During a business cycle recession, consumers tend to save more than their daily expenditure.
Businesses stop expanding due to decreased demand in the economy resulting from low
consumer expenditure. This, therefore, means that businesses and individuals in an economy

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undergoing recession have little demand for money as they tend to save much than what they
spend. Low demand for money leads to decrease in interest rates especially by the Fed in
order to foster economy as this would attract much borrowing by businesses in order to
expand and investors to invest in different economic sectors. Therefore, interest rates tend to
decrease during business cycle recession.

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References
Cochrane, J.H., 2017. The new-Keynesian liquidity trap. Journal of Monetary Economics, 92,
pp.47-63.
Koellinger, P.D. and Roy Thurik, A., 2012. Entrepreneurship and the business cycle. Review
of Economics and Statistics, 94(4), pp.1143-1156.