Chapter 26

Saving, Investment, and the Financial System

1 The primary economic function of the financial system is to

a. keep interest rates low.
b. provide expert advice to savers and investors.
c. match one person’s consumption expenditures with another person’s capital expenditures.
d. match one person’s saving with another person’s investment.
2 Given that Lekeisha's income exceeds her expenditures, Lekeisha is best described as a
a. saver or as a supplier of funds.
b. saver or as a demander of funds.
c. borrower or as a supplier of funds.
d. borrower or as a demander of funds.
3 We would expect the interest rate on Bond A to be higher than the interest rate on Bond B if the
two bonds have identical characteristics except that
a. the credit risk associated with Bond A is lower than the credit risk associated with Bond B.
b. Bond A was issued by the state of New York and Bond B was issued by the Exxon Mobil
Corporation.
c. Bond A has a term of 20 years and Bond B has a term of 2 years.
d. All of the above are correct.
4 Which of the following is not correct?
a. By saving a larger portion of its GDP, a country can raise its output per worker.
b. Savers supply their money to the financial system with the expectation that they will get it back
with interest at a later date.
c. Financial intermediaries are the only type of financial institution.
d. The financial system helps match people’s saving with other people’s borrowing.
5 You are thinking of buying a bond from Knight Corporation. You know that this bond is long term
and you know that Knight’s business ventures are risky and uncertain. You then consider another bond
with a shorter term to maturity issued by a company with good prospects and an established reputation.
Which of the following is correct?
a. The longer term would tend to make the interest rate on the bond issued by Knight higher, while
the higher risk would tend to make the interest rate lower.
b. The longer term would tend to make the interest rate on the bond issued by Knight lower, while
the higher risk would tend to make the interest rate higher.
c. Both the longer term and the higher risk would tend to make the interest rate lower on the bond
issued by Knight.
d. Both the longer term and the higher risk would tend to make the interest rate higher on the
bond issued by Knight.
6 Financial intermediaries are
a. the same as financial markets.
b. individuals who make profits 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.
7 Which of the following are financial intermediaries?
a. both banks and mutual funds
b. banks but not mutual funds
c. mutual funds but not banks
d. neither banks or mutual funds
8 In a closed economy, what does (Y - T - C) represent?
a. national saving
b. government tax revenue
c. public saving
d. private saving
9 Suppose a closed economy had public saving of $3 trillion and private saving of $2 trillion. What
are national saving and investment for this country?
a. $5 trillion, $5 trillion
b. $5 trillion, $2 trillion
c. $1 trillion, $5 trillion
d. $1 trillion, $2 trillion

10. Assume the following information for an imaginary, closed economy.

GDP = $110,000; consumption = $70,000; private saving = $8,000; national saving = $12,000.
For this economy, investment amounts to
a. $4,000.00
b. $8,000.00
c. $12,000.00
d. $16,000.00
(Investment in a Closed Economy formula)
11 Which of the following would a macroeconomist consider as investment?
a. Charlie purchases a bond issued by Proctor and Gamble Corp.
b. Karlee purchases stock issued by Texas Instruments, Inc.
c. Mariah builds a new coffee shop.
d. All of the above are correct.
12 The Eye of Horus incense company has $10 million in cash which it has accumulated from
retained earnings. It was planning to use the money to build a new factory. Recently, the rate of interest
has increased. The increase in the rate of interest should
a. not influence the decision to build the factory because The Eye of Horus doesn't have to borrow
any money.
b. not influence the decision to build the factory because its stockholders are expecting a new
factory.
c. make it more likely that The Eye of Horus will build the factory because a higher interest rate will
make the factory more valuable.
d. make it less likely that The Eye of Horus will build the factory because the opportunity cost
of the $10 million is now higher.
13 Which of the following could explain a decrease in the equilibrium interest rate and in the
equilibrium quantity of loanable funds?
a. The demand for loanable funds shifted rightward.
b. The demand for loanable funds shifted leftward.
c. The supply of loanable funds shifted rightward.
d. The supply of loanable funds shifted leftward.
14 Suppose the market for loanable funds is in equilibrium. What would happen in the market for
loanable funds, other things the same, if the Congress and President increased the maximum contribution
limits to 401(k) and 403(b) tax-deferred retirement accounts?
a. the interest rate and quantity of loanable funds would increase
b. the interest rate and quantity of loanable funds would decrease.
c. the interest rate would increase and the quantity of loanable funds would decrease.
d. the interest rate would decrease and the quantity of loanable funds would increase.
15 If the government currently has a budget deficit, then
a. it does not necessarily have a debt.
b. its debt is increasing.
c. government expenditures are greater than taxes.
d. All of the above are correct.
16 Which of the following events could explain an increase in interest rates together with a decrease
in investment?
a. The government budget went from surplus to deficit.
b. The government instituted an investment tax credit.
c. The government reduced the tax rate on savings.
d. None of the above is correct.
17 Which of the following are effects of an increased budget deficit?
a. the supply of loanable funds does not change; a higher interest rate reduces private saving
b. the supply of loanable funds does not change; a higher interest rate raises private saving
c. at any interest rate the supply of loanable funds is less; a higher interest rate reduces private
saving
d. at any interest rate the supply of loanable funds is less; a higher interest rate raises private
saving
18. The figure shows two demand-for-loanable-funds curves and two supply-of-loanable-funds curves.
i

S
2

C
S1

B
F

D2
A

D1

A shift of the demand curve from D1 to D2 is called

a. an increase in the demand for loanable funds, and that increase would originate from people who
had some extra income they wanted to lend.
b. an increase in the demand for loanable funds, and that increase would originate from
households and firms who wish to borrow to make investments.
c. a decrease in the demand for loanable funds, and that decrease would originate from people who
had some extra income they wanted to lend.
d. a decrease in the demand for loanable funds, and that decrease would originate from households
and firms who wish to borrow to make investments.