Macroeconomics Policy and Practice, 2nd Edition Frederic S. Mishkin Test Bank

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Test Bank

Resource:

Macroeconomics Policy and Practice

Edition:

2nd Edition

Author(s):

Frederic S. Mishkin

Test Item File for

Macroeconomics: Policy and Practice Second Edition Frederic S. Mishkin

Test Item File by Brian Trinque University of Texas–Austin

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 1 The Policy and Practice of Macroeconomics 1.1 The Practice of Macroeconomics 1) Macroeconomics is the study of ________ while microeconomics studies ________.

A) large biological systems; political implications of nanotechnology B) the overall economic activity and prices; an individual firm, household, or market C) an individual firm; the overall economic performance of a nation D) the overall economic performance of the world; the economy of a single country E) firm behavior; market behavior Answer: B Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 2) Macroeconomics is the study of ________ while microeconomics studies ________.

A) large business enterprises; small business ventures B) the overall household economic activity; market behavior C) an individual firm; the overall economic performance of a nation D) the overall economic performance of the world; the economy of a single country E) none of the above Answer: E Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 3) Macroeconomics is the study of ________ while microeconomics studies ________.

A) an individual firm; the overall economic performance of a nation B) the overall economic performance of the world; the economy of a single country C) the overall economic activity and prices; an individual firm, household, or market D) firm choices; market behavior E) consumer choices; government behavior Answer: C Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 4) An endogenous variable is typically ________.

A) taken as given B) strictly explained outside the model C) strictly explained inside the model D) strictly explained by data E) strictly explained by graphical analysis Answer: C Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking

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5) An endogenous variable is typically ________.

A) strictly explained inside the model B) taken as given C) strictly explained outside the model D) constant inside the model E) explained by unemployment Answer: A Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 6) An exogenous variable is typically ________.

A) not considered in an economic model B) only used to conduct policy analysis C) taken as given D) explained inside the model E) explained by interest rates Answer: C Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 7) Which statement is true of an exogenous variable in an economic model?

A) It has no direct relation to the endogenous variables.

B) Its value within the model cannot be changed.

C) It is often a policy variable.

D) It is explained inside the model.

E) All of the above.

Answer: C Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 8) An exogenous variable is typically ________.

A) calculated by the model B) only used to conduct policy analysis C) explained inside the model D) disregarded in economic models E) none of the above Answer: E Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking

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9) A(n) ________ variable is calculated from within the model. A(n) ________ variable can never be taken as given.

A) endogenous; endogenous B) exogenous; endogenous C) endogenous; exogenous D) exogenous; exogenous E) none of the above Answer: A Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 10) To compare the conclusions of a model with what actually happens, historical data are entered into the model as ________.

A) endogenous variables B) exogenous variables C) equations D) predictions E) policies Answer: B Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 11) A simple macroeconomic model might explain how an increase in the demand for new housing would lead to a decrease in the rate of unemployment. In such a model, which of these variables is likely to be exogenous?

A) the quantity sold of home furnishings B) the degree of unionization of the construction industry C) the wage rate for unskilled workers D) the level of tax revenues E) the demand for concrete Answer: B Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking 12) In a macroeconomic model designed to explain why some countries grow faster than others, which of these variables is likely to be endogenous?

A) investment B) economic policies C) geographic size D) population E) none of the above Answer: A Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking

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13) In a model of the saving rate, which of these relationships is most crucial?

A) the effect of the saving rate on government spending B) the effect of government spending on the saving rate C) the effect of the saving rate on taxes D) the effect of taxes on the saving rate E) the effect of the saving rate on the real wage Answer: D Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking 14) Which of the following sequences best describes the five necessary steps to develop an economic model in the correct order?

A) (1): Identify the endogenous variables; (2): identify the exogenous variables; (3): develop a model; (4): compare the model with the data; (5): conduct prediction and policy analysis.

B) (1): Develop a model; (2): identify the exogenous variables; (3): identify the endogenous variables; (4): compare the model with the data; (5): conduct prediction and policy analysis.

C) (1): Conduct prediction and policy analysis; (2): develop a model; (3): identify the endogenous variables; (4): identify the exogenous variables; (5): compare the model with the data.

D) (1): Conduct prediction and policy analysis; (2): compare the model with the data; (3):identify the endogenous variables; (4): identify the exogenous variables; (5): develop a model.

E) none of the above Answer: A Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 15) If a macroeconomist studying the causes of unemployment suspects that changes in technology might play a role, then this macroeconomist is at which step in the process of developing an economic model?

A) Identify the exogenous variables.

B) Identify the endogenous variables.

C) Compare the model with the data.

D) Conduct prediction and policy analysis.

E) Develop a model.

Answer: A Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking

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16) If a macroeconomist studying the causes of unemployment finds that, historically, changes in technology seem to have caused between five and 15 percent of changes in unemployment, then this macroeconomist is at which step in the process of developing an economic model?

A) Identify the exogenous variables.

B) Identify the endogenous variables.

C) Develop a model.

D) Compare the model with the data.

E) Conduct prediction and policy analysis.

Answer: D Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking 17) If a macroeconomist studying the causes of unemployment asserts that a particular change in technology will cause the rate of unemployment to decrease by ten percent, then this macroeconomist is at which step in the process of developing an economic model?

A) Identify the endogenous variables.

B) Develop a model.

C) Compare the model with the data.

D) Identify the exogenous variables.

E) Conduct prediction and policy analysis.

Answer: E Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking 18) Macroeconomic models particularly focus on the following three economic data series.

A) real GDP, the unemployment rate, and inflation B) endogenous variables, exogenous variables, and GDP per person C) inflation, recessions, and business cycles D) real GDP, the employment rate, and interest rates E) real GDP, the unemployment rate, and depressions Answer: A Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 19) Macroeconomic models particularly focus on the following three economic data series.

A) endogenous variables, exogenous variables, and taxes B) inflation, unemployment, and business cycles C) nominal GDP, the employment rate, and budget deficits D) bankruptcies, the unemployment rate, and depressions E) none of the above Answer: E Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking

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20) Real GDP measures ________.

A) the total hours the average U.S. citizen works a year B) the percentage of income produced by workers and firms C) how slowly interest rates grow D) the total market value of actual goods and services produced in an economy over a year E) how rapidly the overall level of prices is rising Answer: D Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 21) Real GDP measures ________.

A) the total amount of income of every person and firm in the economy B) the percentage of income produced by workers and firms C) how rapidly the overall level of prices is rising D) how many hours the average U.S. citizen works a year E) how many automobiles are produced in a month Answer: A Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 22) From 1900 to 2013, real GDP per person has had two important attributes.

A) It has grown substantially over time and there are small differences from country to country.

B) It has grown unevenly over time in the U.S. but it has grown substantially.

C) It has grown evenly over time in the U.S. and there are huge differences from country to country.

D) It has fluctuated around a trend in the U.S. but it has not grown much for all the Southeast Asian countries.

E) It has doubled in the U.S. but there have been many recession periods.

Answer: B Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 23) From 1900 to 2013 real GDP per person in the U.S. has ________.

A) doubled B) grown by a factor of four C) grown by a factor of nine D) grown by a factor of twenty E) declined Answer: C Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking

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24) The term "business cycle" refers to ________.

A) the opening and eventual closing down of businesses B) the rising and later declining of the purchasing power of the dollar C) the acquiring of raw materials and ultimate selling of a finished product D) the tendency for rich economies to be inevitably out-paced by other economies E) the slowing and eventual accelerating of economic growth Answer: E Topic: 1.1 The Practice of Macroeconomics 25) What explains the rise in income in the U.S. between 1900 and 2013?

A) business cycles B) economic growth C) recessions D) depressions E) the purchasing power of the dollar Answer: B Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking 26) What explains the rise in income in the U.S. between 1900 and 2013?

A) business cycles B) inflation C) recessions D) depressions E) none of the above Answer: E Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking 27) In the Great Depression of the 1930s, the unemployment rate in the U.S. climbed to what percentage?

A) 5 B) 10 C) 15 D) 20 E) 25 Answer: E Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking

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28) The unemployment rate measures, at a point in time, the ________.

A) percentage of workers who do not have a job B) percentage of workers who do not have a job but are looking for work C) percentage of workers who stop working D) percentage of workers who are looking for work E) none of the above Answer: B Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 29) Apart from the Great Depression of the 1930s, which decade saw the largest rise in unemployment in the U.S.?

A) 1950s B) 1970s C) 1980s D) 1990s E) 2000s Answer: E Topic: 1.1 The Practice of Macroeconomics 30) From 1929 to 2013, the unemployment rate in the U.S. ________.

A) has continued to grow but has always remained well above zero B) has fluctuated around zero C) has gone up and down but has always remained well above zero D) has decreased in most recessions E) has grown by a factor of four Answer: C Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 31) Compared to other economies, the unemployment rate in the United States ________.

A) is relatively high B) is relatively low C) is remarkably stable D) is neither particularly high nor low E) varies too much for a reasonable comparison Answer: D Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking

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32) A business manager who observes that prices in general keep rising might infer, correctly, that now is a good time to ________.

A) invest to expand the business B) raise the price of her product C) expect an increase in business profits D) expect a higher return on personal savings E) all of the above Answer: B Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking 33) Up until World War II inflation in the U.S. ________.

A) remained around zero on average B) rose and remained quite high for an extended period of time C) has gone up and down but has always remained well above zero D) increased by a factor of four every year E) decreased by 30% every year Answer: A Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 34) Economists apply the term "Great Inflation" to which decade?

A) 1930s B) 1940s C) 1950s D) 1960s E) 1970s Answer: E Topic: 1.1 The Practice of Macroeconomics 35) Since World War II the U.S. ________.

A) has seen a substantial decrease in the inflation rate B) has seen frequent periods of deflation C) has seen significant variations in unemployment D) has seen real GDP grow slower, on average, than in the pre-war period E) none of the above Answer: C Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking

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36) Since World War II the U.S. ________.

A) has seen a substantial decrease in the inflation rate B) has seen frequent periods of deflation C) has seen a significant upward trend in unemployment D) has seen a significant upward trend in real GDP E) none of the above Answer: D Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking 37) Since World War II the U.S. ________.

A) has seen a substantial increase in the inflation rate B) has seen less frequent periods of deflation C) has seen a significant upward trend in real GDP D) all of the above E) none of the above Answer: D Topic: 1.1 The Practice of Macroeconomics AACSB: Analytical Thinking Figure 1.1

38) Figure 1.1 displays exogenous variables entering a model from which emerge endogenous variables. Yet, in the five-step process to develop an economic model, the macroeconomist specifies the endogenous variables first, then the exogenous variables. Which is the correct sequence? Explain.

Answer: Both are correct. The figure displays a model in use. The five steps describe how to develop and use a model. To develop a model, one begins with an interesting economic question.

That question, that which is to be explained, is (are) the endogenous variable(s). The attempted explanation includes the suspected causes, which are the exogenous variables. The next step is to connect the exogenous causes to the endogenous effects. The model is the set of such connections. Now, to test or use the model, as displayed in Figure 1.1, the exogenous variables are set to specific values which the model uses to produce predicted values for the endogenous variables.

Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking

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39) Assume that a high proportion of recent college graduates decides to stay in school seeking advanced degrees, rather than confront the challenge of landing a good job in the midst of generally high unemployment. What is the direct impact of this behavior on the unemployment rate? In the longer term, what indirect impacts might there be on the unemployment rate?

Answer: Staying in school means that these graduates will not be counted as looking for work, so the unemployment rate will be lower than it would be otherwise. As students, these individuals will probably have lower income and spend less than if they had landed good jobs, so the level of output might be lower, thus unemployment higher than it might otherwise have been.

Eventually, as these individuals bring their advanced skills to the economy as workers or employers, and increase their spending, they will contribute to economic growth and to lower unemployment.

Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking 40) Develop a simple model of inflation by identifying at least two exogenous variables and describing, briefly, how the value of these exogenous variables will impact the rate of increase in the overall level of prices in the economy.

Answer: Answers will vary. The most appropriate exogenous variables to identify are the (growth rate of) the quantity of money and the (growth rate of) output. The former is positively related to inflation; the latter is negatively related.

Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking 41) Common sense suggests (and macroeconomists agree!) that sustained economic growth over extended time periods is more important than the economy's short-term fluctuations. Why, then, do macroeconomists (and policymakers, and the general public) care so much about the business cycle?

Answer: One reason is impatience. Periods of high unemployment are costly in terms of lost output and personal distress. A portion of lost output is investment that would have contributed to long-run growth. The business cycle involves inflation, also, which causes uncertainty and distorts incentives in ways that lower investment and reduce long-run growth. If inflation is allowed to rise, corrective measures are likely to reduce economic activity, reducing or delaying the desired long-run growth.

Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking 42) By 2010, the U.S. economy had emerged from the recession that had begun in 2007. Despite an economic growth rate well above zero, unemployment showed little sign of declining much below ten percent. Focusing on the definition of the unemployment rate, explain how it is possible to have positive economic growth without declining unemployment.

Answer: To lower the unemployment rate, the number of people who are out of work and looking for a job must decline faster than the number of people in the labor force. As growth accelerates at the end of a recession, many people who had left the labor force return as job seekers, which raises the unemployment rate (the effect on the numerator is larger than the effect on the denominator).

Topic: 1.1 The Practice of Macroeconomics AACSB: Reflective Thinking 11 .

1.2 Macroeconomic Policy 1) The percentage of income that Americans save each year ________.

A) is much higher than the percentage the Chinese citizens save B) is higher than the saving rate of most industrialized countries C) is lower than the saving rate of most industrialized countries D) increased by a factor of five every year since the 1970s E) none of the above Answer: C Topic: 1.2 Macroeconomic Policy 2) Which of these is among the principal determinants of economic growth?

A) inflation B) the financial system C) the central bank D) the government budget deficit E) stabilization policy Answer: B Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 3) Which of these is not among the principal determinants of economic growth?

A) institutions B) education C) research and development D) balanced trade E) saving and investment Answer: D Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 4) A good example of a policy to increase an economy's saving rate is ________.

A) to reduce poverty B) to increase the economic growth rate C) to increase government spending D) to reduce interest rates E) to increase sales taxes Answer: E Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking

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5) The U.S. personal saving rate ________.

A) is much higher than the percentage the Chinese citizens save B) is higher than the saving rate of most countries C) cannot fall below zero D) increased by a factor of five every year since the 1970s E) none of the above Answer: E Topic: 1.2 Macroeconomic Policy AACSB: Analytical Thinking 6) Looking at the U.S. personal saving rate over the last sixty years, we can say that ________.

A) it has always been low B) Americans used to spend a lot more than they have in recent years C) Americans used to save a lot more than they have in recent years D) it has always been fairly high E) Americans spend more when concerned about their future earnings Answer: C Topic: 1.2 Macroeconomic Policy AACSB: Analytical Thinking 7) Which of these economies has the highest saving rate?

A) Greece B) China C) United States D) Brazil E) Japan Answer: B Topic: 1.2 Macroeconomic Policy 8) When households have very low savings ________.

A) investment decreases B) they are less able to cope with severe economic downturns C) bankruptcies increase D) all of the above E) none of the above Answer: D Topic: 1.2 Macroeconomic Policy AACSB: Analytical Thinking

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9) When households increase their personal savings ________.

A) investment decreases B) they are better able to cope with severe economic downturns C) interest rates are likely to rise, as well D) all of the above E) none of the above Answer: B Topic: 1.2 Macroeconomic Policy AACSB: Analytical Thinking 10) Raising household savings could be beneficial because ________.

A) it translates into higher investment B) severe economic downturns can be "better-weathered" C) it provides a cushion to avoid bankruptcies D) all of the above E) none of the above Answer: D Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 11) Policies to encourage higher personal saving rates include ________.

A) raising income taxes B) raising sales taxes C) lowering taxes on pension plans D) A and B but not C E) B and C but not A Answer: E Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 12) Policies to encourage higher personal saving rates include ________.

A) lowering income taxes B) lowering sales taxes C) increasing the quantity of money D) raising asset prices E) reducing interest rates Answer: A Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking

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13) Policies to encourage higher personal saving rates include ________.

A) raising income taxes B) lowering sales taxes C) raising taxes on pension plans D) all of the above E) none of the above Answer: E Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 14) Raising taxes and cutting spending are examples of ________.

A) fiscal policy tightening B) fiscal policy expansion C) monetary policy tightening D) monetary policy expansion E) none of the above Answer: A Topic: 1.2 Macroeconomic Policy 15) An increase in government spending might be an example of a ________ policy for the purpose of ________.

A) monetary; lowering unemployment B) monetary; reducing inflation C) monetary; increasing saving D) fiscal; reducing inflation E) fiscal; lowering unemployment Answer: E Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 16) An increase in interest rates might be an example of a ________ policy for the purpose of ________.

A) monetary; reducing inflation B) monetary; lowering unemployment C) monetary; increasing the quantity of money D) fiscal; reducing inflation E) fiscal; lowering unemployment Answer: A Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking

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17) Policies to keep inflation in check ________.

A) are, typically, fiscal policies B) are a potential cause of high unemployment C) are unlikely to be needed, so long as government spending remains high D) include increasing the quantities of money and saving E) are desirable in the short run, but may produce bad long-run outcomes Answer: B Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 18) Fiscal policy involves ________.

A) taxes and government spending B) setting interest rates C) controlling the amount of money in the economy D) all of the above E) none of the above Answer: A Topic: 1.2 Macroeconomic Policy 19) Since 1930 the period of highest government budget deficits for the U.S. took place in ________.

A) the 1930s B) the 1940s C) the 1950s D) the 1980s E) the 1990s Answer: B Topic: 1.2 Macroeconomic Policy 20) Historically, the U.S. government seems to have ________.

A) run budget surpluses as often as budget deficits B) generally spent less than what it collected in taxes each year C) had difficulty running budget surpluses D) not needed to borrow to finance wars E) none of the above Answer: C Topic: 1.2 Macroeconomic Policy 21) Policies to reduce the likelihood of financial crises might include ________.

A) enlarging government budget deficits B) reducing imbalances in global trade and capital flows C) keeping the inflation rate near or below zero D) more aggressive use of stabilization policy E) all of the above Answer: B Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 16 .

22) The Federal Reserve ________.

A) is the U.S. central bank B) controls the amount of money in the economy C) sets interest rates D) all of the above E) none of the above Answer: D Topic: 1.2 Macroeconomic Policy 23) The U.S. central bank ________.

A) usually raises taxes to stabilize a slowing economy B) encourages higher savings rates by raising the national sales tax C) is known as the Federal Reserve D) all of the above E) none of the above Answer: C Topic: 1.2 Macroeconomic Policy 24) The Federal Reserve ________.

A) engages in stabilization policy by setting interest rates B) engages in fiscal policy by setting interest rates C) addresses financial crises by raising taxes D) all of the above E) none of the above Answer: A Topic: 1.2 Macroeconomic Policy 25) Financial crises are typically ________.

A) characterized by sharp declines in asset prices B) associated with increases in business failures C) accompanied by sharp economic downturns D) all of the above E) none of the above Answer: D Topic: 1.2 Macroeconomic Policy 26) Nonactivists propose doing nothing in the face of economic hardship because ________.

A) activist policies can kick in at the wrong time and be counterproductive B) "markets self-correct pretty rapidly anyway" C) in the face of high unemployment, activist policies would likely lead to surges in inflation D) all of the above E) none of the above Answer: D Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking

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27) Nonactivists propose doing nothing in the face of economic hardship because ________.

A) activist policies can kick in at the wrong time and be counterproductive B) markets can take quite a bit of time to self-correct C) while households feel the hardship, firms typically benefit D) all of the above E) none of the above Answer: A Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 28) Nonactivists propose doing nothing in the face of economic hardship because ________.

A) markets can take quite a bit of time to self-correct B) excessive unemployment tends to disappear on its own accord C) while households feel the hardship, firms typically benefit D) all of the above E) none of the above Answer: B Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 29) Activists believe ________.

A) the self-correcting mechanism in the economy is very slow B) in the adoption of policies to eliminate excessive unemployment C) doing nothing will leave too many people out of work for too long D) all of the above E) none of the above Answer: D Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 30) The long-standing debate over rules versus discretion in macroeconomics centers on the following statement ________.

A) "discretionary policy can lead to bad long-run outcomes but rules lack flexibility in the shortrun" B) "the speed with which the self-correcting mechanism in the economy acts is in question" C) "the speed with which unemployment tends to disappear is debatable" D) all of the above E) none of the above Answer: A Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking

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31) The old adage "rules are made to be broken" would typically be associated with economists who might advocate ________.

A) stabilization policy B) monetary policy C) rule-determined policy D) discretionary policy E) fiscal policy Answer: D Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 32) Consider an economic policy regime in which rules are well-known but frequently ignored.

Which of these statements is true?

A) This regime might work in the long-run, but is unlikely to produce good outcomes in the short run.

B) Policymakers in this regime might find that rules are being broken with increasing frequency.

C) This regime is more likely to be supported by nonactivist, than by activist policymakers.

D) This regime is more likely to result in high unemployment than in high inflation.

E) This regime is unlikely to produce large government budget deficits.

Answer: B Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 33) Opponents of rule-determined policies might point out that ________.

A) markets self-correct quickly so rules become obsolete B) unforeseen changes in the structure of the economy may make a rule obsolete C) policies that kick in at the wrong time may lead to undesirable results D) all of the above E) none of the above Answer: B Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 34) An advantage of discretionary policy might be that ________.

A) it has been shown to be more efficient than rules B) it is more flexible than rules C) it requires a binding plan in advance to deal with economic problems D) all of the above E) none of the above Answer: B Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking

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35) An advantage of macroeconomic policy based on pre-specified rules might be that ________.

A) it is easier to stick to long-run considerations and avoid bad long-run outcomes B) it is more flexible than discretionary policy C) it is easier to adapt to short-run changes and avoid a bad short-run outcome D) all of the above E) none of the above Answer: A Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 36) Activist policymakers, compared to nonactivists, are more likely to emphasize ________ considerations and to prefer ________.

A) short-run; rule-determined B) long-run; discretionary policy C) short-run; discretionary policy D) long-run; rule determined E) business; flexible plans Answer: C Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 37) In the 2000s, the U.S. economy had both a ________ and a ________.

A) large trade deficit; large capital inflow B) large trade surplus; large capital inflow C) large trade deficit; high saving rate D) large capital inflow; high saving rate E) large capital inflow; small government budget deficit Answer: A Topic: 1.2 Macroeconomic Policy 38) The low saving rate in the United States is no cause for concern, so long as people in other countries are saving and are willing to send their savings into the U.S. economy by buying our assets. Comment.

Answer: Capital inflow does help to sustain investment in the U.S. above what it would be otherwise. But having savers in other countries finance our investment means that they own a portion of the resulting economic growth, leaving less for U.S. citizens to enjoy. Because capital inflow is an increase in the supply of savings, it can lower the return and thus incentive to save, discouraging U.S. citizens from ever consuming less and saving more. Capital inflow, also, may reflect a global imbalance in which the combination of high consumer demand and low return on saving fuels speculative activities (e.g., housing boom). As long as U.S. citizens consume so much and save so little, our trade deficit and corresponding indebtedness to other economies will persist.

Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking

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39) All governments face a budget constraint: none can spend more than the sum of current government revenues plus the amount that creditors are willing to lend. Why, then, do government budget deficits matter?

Answer: Deficits matter because they are costly, and because they can become unsustainably large. The interest cost of the debt must be paid by spending less on other worthy goods and services, and repayment of principal has the same opportunity cost. Credit extended to the government might have been borrowed and spent in the private sector. While it might be reasonable for a government to borrow to meet crisis needs, it might be reluctant later to raise taxes and/or reduce spending in order to pay down the debt. The next crisis won't wait for repayment of the preceding crisis's debt. The debt makes the economy more vulnerable to crisis and the government less able to respond appropriately. If creditors become reluctant to lend more at a reasonable rate of interest, the government might feel compelled to borrow from the central bank, fueling inflation.

Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 40) Why might most people, as in the United States, save less than is good for themselves and for the economy as a whole? How might policymakers encourage more saving?

Answer: The saving rate is determined by incentives. If the return on saving is too low, people will choose to consume, instead, even though they are vulnerable to economic misfortune and downturns. Individual vulnerability aggregates to macroeconomic vulnerability, while a low saving rate constrains investment and, thus, economic growth. Policies to increase the saving rate include reducing income tax rates, reducing the tax liability of income that is saved, raising sales tax rates, reducing taxes on the income from savings, and reducing the tax liability of business income that is contributed to employee pensions. It is important, also, to create confidence that inflation will not erode the purchasing power of savings, and that financial crises will not destroy the value of assets.

Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking 41) The necessary ingredients for economic growth and poverty reduction are no mystery, really: education, favorable and efficient institutions, research and development, etc. Macroeconomists are unlikely to have anything useful to say. Comment.

Answer: The ingredients are familiar, but implementation is difficult. Citizens, politicians, and policymakers face tough decisions, because each ingredient has costs; resources devoted to education, for example, must mean sacrificing other worthy expenditures, such as health care.

Macroeconomists can help to quantify the relative effectiveness of particular expenditures and policy packages, so that scarce resources are utilized efficiently. Analysis and clarification of the details can help in the design of and to generate public support for the most effective policies.

Topic: 1.2 Macroeconomic Policy AACSB: Reflective Thinking

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1.3 How We Will Study Macroeconomics 1) There are no questions for this section.

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 2 Measuring Macroeconomic Data 2.1 Measuring Economic Activity: National Income Accounting 1) The fundamental identity of national income accounting implies ________.

A) Expenditure = Production + Income B) Expenditure = Production = Income C) Income = Expenditure - Production D) Income = Expenditure / Production E) None of the above Answer: B Topic: 2.1 Measuring Economic Activity: National Income Accounting 2) Who helps calculate GDP in the United States?

A) the Bureau of Economic Analysis B) the Census Bureau C) the Bureau of Labor Statistics D) all of the above E) none of the above Answer: D Topic: 2.1 Measuring Economic Activity: National Income Accounting 3) Which government entity calculates GDP in the United States on a quarterly basis?

A) the Treasury Department B) the Commerce Department C) the Federal Reserve D) all of the above E) none of the above Answer: B Topic: 2.1 Measuring Economic Activity: National Income Accounting 4) The statistic most often used by economists to measure the value of economic activity is ________.

A) GDP B) the CPI C) labor-force participation rate D) the nominal interest rate E) the real interest rate Answer: A Topic: 2.1 Measuring Economic Activity: National Income Accounting

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2.2 Measuring GDP: The Production Approach 1) The production approach to measuring GDP requires ________.

A) that the market value of a given good is a reasonable approximation of its economic value B) that all goods and services be added up before assigning a market value C) that no good or service rendered outside the market be included in GDP D) all of the above E) none of the above Answer: A Topic: 2.2 Measuring GDP: The Production Approach AACSB: Reflective Thinking 2) Which of the following is typically not counted in GDP? A) any nonmarket good and services B) income generated from apartment rentals C) illegal drug sales D) all of the above E) none of the above Answer: C Topic: 2.2 Measuring GDP: The Production Approach 3) The reason only newly produced goods and services are counted in GDP is that ________.

A) it is very difficult to impute a value to used goods B) most expenditures on used goods and services take place outside the market C) it does not help economists make better economic predictions because second-hand goods rarely have any residual value D) it allows economists to avoid double counting the production of goods and services E) none of the above Answer: D Topic: 2.2 Measuring GDP: The Production Approach AACSB: Analytical Thinking 4) To avoid double counting in the calculation of GDP, which types of goods are typically excluded from the calculation?

A) intermediate goods B) capital goods C) inventory goods D) nonmarket goods E) value-added goods Answer: A Topic: 2.2 Measuring GDP: The Production Approach

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5) Capital goods are typically purchased to ________. They get included in GDP ________.

A) replace raw materials; in the year they are produced B) enable the investor to produce other goods and services; in each year they are utilized C) enable the investor to consume less in the current period; as they are used up in the stages of production D) enable the investor to produce other goods and services; in the year they are produced E) none of the above Answer: D Topic: 2.2 Measuring GDP: The Production Approach AACSB: Analytical Thinking 6) The difference between inventories and inventory investment is that typically ________.

A) the first one is a stock of unfinished or unsold goods; the second one is a flow that indicates productive activity B) the first one denotes the change in holdings of capital; the second one includes most final goods C) the first one is measured at the beginning of the year; the second one is measured at the end of the year D) all of the above E) none of the above Answer: A Topic: 2.2 Measuring GDP: The Production Approach AACSB: Analytical Thinking 7) In a two-good economy, the price of video games is $40 and the price of energy drinks is $2.

If the annual output of this economy is 100 video games and 500 drinks, the GDP is ________.

A) $50,080 B) $25,200 C) $5,000 D) $20,200 E) none of the above Answer: C Topic: 2.2 Measuring GDP: The Production Approach AACSB: Analytical Thinking

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8) Consider a firm whose final output (and sales) in a particular year has a value of $1,200. To produce these goods, the firm used $500 worth of intermediate goods it had purchased in previous years plus $200 worth of newly-purchased intermediate goods. In the subsequent year, this same firm again sells $1,200 worth of final goods, but in this year has purchased $700 worth of intermediate goods, of which $100 is not used in current production but, rather, added to the firm's inventory. For each of these two years, calculate the value added by this firm. For each of these two years, calculate the contribution of this firm to the economy's GDP. Answer: Value added in year one equals $1,200 final goods minus $200 purchased intermediates equals $1,000. Value added in year two equals $1,200 final goods minus $700 purchased intermediates equals $500. Contribution to GDP in year one equals $1,000 value added minus $500 decrease in inventory equals $500. Contribution to GDP in year two equals $500 value added plus $100 inventory increase equals $600.

Topic: 2.2 Measuring GDP: The Production Approach AACSB: Analytical Thinking 9) State the fundamental identity of national income accounting. Why is it not possible for this identity to be violated?

Answer: Total production = Total expenditure = Total income. The national income accounts measure economic activity. Any way it's measured, it's the same thing: economic activity. Each specific activity is a good or service that has been produced, has a market value (actual or imputed), and generates income for someone. An individual who produces ten dollars of market value does so in order to receive ten dollars of income, which arrives as the customer's ten dollar expenditure.

Topic: 2.2 Measuring GDP: The Production Approach AACSB: Reflective Thinking

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2.3 Measuring GDP: The Expenditure Approach 1) If C is consumption, I is investment, G is government purchases and NX is net exports, according to the expenditure approach, Y would stand for ________; and the national income identity could be written as ________.

A) transfers; Y = C + I + G - NX B) CPI; Y = C + I + G + NX C) GDP; Y - C - I = G + NX D) income; Y = C - I - G + NX E) the real interest rate; Y = C + I + G + NX Answer: C Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Analytical Thinking 2) Which of the following will be counted as an expenditure in the measurement of GDP? (Assume that none of the transactions is concealed from the relevant authorities.)

A) the value of a used automobile that remains unsold on the dealer's lot B) purchase of a lamp at a neighborhood garage sale C) purchase, using foodstamps, of a loaf of bread D) payment by a parent to her child for doing household laundry E) purchase of flour by a bakery Answer: C Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Analytical Thinking 3) Which of the following will be counted as an investment expenditure in the measurement of GDP? A) purchase of a tractor by a farmer from his neighbor B) purchase of preferred stock in ABC Corporation C) purchase of a newly built tractor by a college fraternity for hay rides at their charity fair D) purchase of an apartment in a newly-built building E) purchase of newly built computers by a municipal government Answer: D Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Analytical Thinking

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Table 2.1 GDP and its components, 2012

4) Assuming that the GDP breakdown shown in Table 2.1 is typical of a given year in the U.S. we can say that ________.

A) we spend twice as much on goods consumption as we do on services B) consumption of durable goods is twice that of nondurables C) government purchases is the largest main component of GDP D) all of the above E) none of the above Answer: E Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Analytical Thinking 5) Assuming that the GDP breakdown shown in Table 2.1 is typical of a given year in the U.S. we can say that ________.

A) we spend twice as much on services as we do on goods consumption B) consumption of nondurable goods is twice that of durables C) private investment is the smallest of the main domestic components of GDP D) all of the above E) none of the above Answer: D Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Analytical Thinking

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6) Assuming that the GDP breakdown shown in Table 2.1 is typical of a given year in the U.S. we can say that ________.

A) federal defense spending is twice that of non-defense spending B) federal spending is twice as large as that of the states and local governments C) government spending constitutes about 40% of GDP D) all of the above E) none of the above Answer: E Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Analytical Thinking 7) Which of the following is a valid characteristic of the U.S. economy over the last sixty years?

A) Investment is more volatile than other components of GDP. B) Government spending has remained around 20% of GDP over much of the postwar period.

C) The U.S. has, for the most part, been running a trade deficit which has trended upward to over 5% of GDP. D) all of the above E) none of the above Answer: D Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Reflective Thinking 8) Which of the following is a valid characteristic of the U.S. economy over the last sixty years?

A) Investment is smoother than most of the other components of GDP, especially consumption.

B) Government spending has remained around 20% of GDP over much of the postwar period.

C) The U.S. has, for the most part, been running a trade surplus which has trended upward to over 5% of GDP. D) all of the above E) none of the above Answer: B Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Reflective Thinking 9) An international comparison of eight major industrialized countries reveals the following about the components of GDP: ________.

A) the U.S. has one of the largest shares of GDP going to investment B) the U.S. has one of the smallest government share of GDP C) the U.S. runs one of the largest trade deficits D) all of the above E) none of the above Answer: C Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Analytical Thinking

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10) An international comparison of eight major industrialized countries reveals the following about the components of GDP: ________.

A) China has the highest share of investment among the eight countries B) India has the largest government share of output C) the U.S. is the largest consumer as a share of GDP D) all of the above E) none of the above Answer: D Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Analytical Thinking 11) Over the past half-century, government transfer payments have increased. As a result ________.

A) interest payments on government debt have declined B) government expenditures have become a larger portion of GDP C) the volatility of investment expenditures has declined D) net exports have been positive in most years E) none of the above Answer: E Topic: 2.3 Measuring GDP: The Expenditure Approach 12) A few economies have the interesting characteristic that exports are more than 100 percent of the economy's GDP. How is this possible?

Answer: An economy's exports and imports can vary independently of the economy's GDP, so long as its exports and imports are closely linked to each other. By the national income identity, Y = C + I + G + exports - imports. Rearranging, Y - exports = C + I + G - imports. If exports > Y, then imports must be greater than C + I + G. This occurs if a sufficient portion of imports either leave the economy as exports or are intermediate goods used in the production of exports.

Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Reflective Thinking 13) Describe how the investment component of GDP is distinct from the other components.

Answer: Investment is distinct from consumption in that the goods are not used up in the current period, but rather survive into at least one subsequent period as final goods awaiting sale, as intermediate goods awaiting further processing, as capital goods that will be used in the production of other goods, or as residences. They are purchases by households and businesses, rather than government. Some investments involve purchase of imports, but these are subtracted in the net export component, so that only domestic production is counted in GDP. Topic: 2.3 Measuring GDP: The Expenditure Approach AACSB: Reflective Thinking

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2.4 Measuring GDP: The Income Approach 1) The income approach to measuring GDP involves adding up the following ________.

A) household income and income generated by firms B) private spending, tax revenues and government spending C) transfer payments and income taxes D) interest income, profits and social security benefits E) wages, benefits and interest income Answer: A Topic: 2.4 Measuring GDP: The Income Approach 2) Which of the following is included in the calculation of national income?

A) compensation of employees B) rental income C) indirect business taxes D) all of the above E) none of the above Answer: D Topic: 2.4 Measuring GDP: The Income Approach 3) In a country with unusually high tax rates, one might expect that ________.

A) GDP might be overstated because the government might avoid running surpluses B) GDP might be understated because its citizens might avoid reporting some of their income C) GDP might be overstated because the government might raise its outlays D) GDP might be understated because its citizens might flee the country E) after tax income should be much higher than that of countries with lower tax rates Answer: B Topic: 2.4 Measuring GDP: The Income Approach AACSB: Reflective Thinking 4) Net national product + ________ = ________.

A) net interest; gross domestic product B) depreciation; gross national product C) depreciation; private disposable income D) private disposable income; gross national product E) none of the above Answer: B Topic: 2.4 Measuring GDP: The Income Approach AACSB: Analytical Thinking

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5) Which of the following is included in net government income?

A) social security benefits B) factor income C) taxes D) all of the above E) none of the above Answer: C Topic: 2.4 Measuring GDP: The Income Approach AACSB: Analytical Thinking 6) Which is the largest category of income in the United States?

A) self-employment income B) corporate profits C) employee compensation D) net interest income E) none of the above Answer: C Topic: 2.4 Measuring GDP: The Income Approach 7) Which component of employee compensation has grown most rapidly in recent decades?

A) net interest income B) benefits C) transfer payments D) wages and salaries E) net factor income Answer: B Topic: 2.4 Measuring GDP: The Income Approach 8) Private disposable income equals GDP ________.

A) minus corporate profits and net factor income B) plus transfer payments and net exports C) plus depreciation, transfer payments, and interest payments on government debt D) plus net factor income minus net government income E) none of the above Answer: D Topic: 2.4 Measuring GDP: The Income Approach 9) The total income earned by residents of an economy is known as A) private disposable income B) gross national product C) gross domestic product D) national income E) none of the above Answer: B Topic: 2.4 Measuring GDP: The Income Approach

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10) Subtraction of ________ from Gross National Product yields Gross Domestic Product.

A) net factor income B) depreciation C) factor income to the rest of the world D) net government income E) none of the above Answer: A Topic: 2.4 Measuring GDP: The Income Approach 11) According to the fundamental identity of national income accounting, income and output are identical. Why, then, is national income not equal to GDP? Answer: National income is net of depreciation, while GDP is a gross measure. National income is earned by residents of the economy, while GDP measures the economic activity that occurs on national territory. Thus, income earned by residents as a result of economic activity abroad is included in national income, but not in GDP. Income arising from domestic production that is paid to foreigners, rather than residents, is included in GDP, but not in national income.

Topic: 2.4 Measuring GDP: The Income Approach AACSB: Reflective Thinking 2.5 Real Versus Nominal GDP 1) All income, production, and expenditure variables that are measured at current market prices are referred to as ________.

A) real variables B) nominal variables C) implicit variables D) index variables E) none of the above Answer: B Topic: 2.5 Real Versus Nominal GDP AACSB: Analytical Thinking 2) An example of a nominal variable is ________.

A) income measured at current market prices B) expenditures in terms of the quantities of actual goods C) the chain weighted measure of GDP D) all of the above E) none of the above Answer: A Topic: 2.5 Real Versus Nominal GDP AACSB: Analytical Thinking

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Real and Nominal GDP video games energy drinks year 1 price 40 2 year 1 output 100 500 year 2 price 40 2.5 year 2 output 120 550 year 3 price 45 2.5 year 3 output 150 600 3) Based on the table "Real and Nominal GDP," if year one is the base year, then the real GDP in year two, is ________.

A) 5000 B) 5250 C) 5900 D) 6175 E) none of the above Answer: C Topic: 2.5 Real Versus Nominal GDP AACSB: Analytical Thinking 4) Based on the table "Real and Nominal GDP," if year one is the base year, then the real GDP in year three, is ________.

A) 7200 B) 8250 C) 1050 D) 7500 E) none of the above Answer: A Topic: 2.5 Real Versus Nominal GDP AACSB: Analytical Thinking 5) Based on the table "Real and Nominal GDP," if year one is the base year, then the nominal GDP in year two, is ________.

A) 8250 B) 5000 C) 7200 D) 7500 E) none of the above Answer: E Topic: 2.5 Real Versus Nominal GDP AACSB: Analytical Thinking

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6) Based on the table "Real and Nominal GDP," if year three is the base year, then the real GDP in year two is ________.

A) 8250 B) 5900 C) 7500 D) 6775 E) none of the above Answer: D Topic: 2.5 Real Versus Nominal GDP AACSB: Analytical Thinking 7) Variables measured at current market prices are nominal, rather than real. In what sense are nominal variables unreal?

Answer: Nominal variables combine a thing being measured, such as economic activity, and the units of measurement, market prices. When prices change, the nominal variable is affected even if there has been no change in economic activity. Since such changes in nominal variables arise from a change in the units of measurement, rather than any change in whatever is being measured, the change is unreal.

Topic: 2.5 Real Versus Nominal GDP AACSB: Reflective Thinking 2.6 Measuring Inflation 1) The most frequently reported price index is ________.

A) the consumer price index (CPI) B) the gross domestic product (GDP) deflator C) the personal consumption expenditure (PCE) deflator D) chain weighted GDP E) the interest income deflator Answer: A Topic: 2.6 Measuring Inflation 2) Nominal GDP =________ where the price level is the ________.

A) Price level ÷ Real GDP; GDP deflator B) Price level × Real GDP; CPI C) Price level ÷ Real GDP; CPI D) Price level × Real GDP; GDP deflator E) none of the above Answer: D Topic: 2.6 Measuring Inflation AACSB: Analytical Thinking

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3) Real GDP =________ where the price level is the ________.

A) Nominal GDP × Price level; GDP deflator B) Nominal GDP ÷ Price level; GDP deflator C) Nominal GDP ÷ Price level; CPI D) Nominal GDP × Price level; CPI E) none of the above Answer: B Topic: 2.6 Measuring Inflation AACSB: Analytical Thinking 4) Examples of deflators are the ________ and ________ deflator A) real; nominal B) private disposable income; gross national product C) personal consumption expenditure; gross domestic product D) gross domestic product; rental income E) private disposable income; personal consumption expenditure Answer: C Topic: 2.6 Measuring Inflation 5) Examples of deflators are the ________ and ________ deflator A) real; nominal B) private disposable income; gross national product C) personal consumption expenditure; rental income D) gross domestic product; private disposable income E) none of the above Answer: E Topic: 2.6 Measuring Inflation 6) The Bureau of Labor Statistics (BLS) reports the CPI ________.

A) every month B) every two months C) every three months D) every year E) twice each month Answer: A Topic: 2.6 Measuring Inflation 7) The Bureau of Economic Analysis calculates the PCE deflator ________.

A) every month B) every two months C) every three months D) every year E) twice each month Answer: A Topic: 2.6 Measuring Inflation

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8) To compute the CPI, the Bureau of Labor Statistics (BLS) compiles a "basket of goods" that ________; each price in the index is weighted by ________.

A) are produced in the United States; an expenditure survey B) the average farmer produces; how long it takes for the particular good to reach the market C) the average urban consumer buys; the quantity of the good that goes into the basket D) only members of congress purchase; a "luxury" score E) is typical of consumers below the poverty line; the perceived quality of the good Answer: C Topic: 2.6 Measuring Inflation AACSB: Analytical Thinking 9) Computing the CPI is important because it provides ________.

A) a rough measure of the cost of living B) it is used as a benchmark in labor negotiations C) government uses it to index entitlements, such as social security benefits, so that beneficiaries do not lose purchasing power in periods of inflation D) all of the above E) none of the above Answer: D Topic: 2.6 Measuring Inflation AACSB: Reflective Thinking 10) Computing the CPI is important because ________.

A) it is a very accurate and error-free measure of the cost of living B) it helps predict spending patterns for particular goods and services C) government uses it to index entitlements, such as social security benefits, so that beneficiaries do not lose purchasing power in periods of inflation D) all of the above E) none of the above Answer: C Topic: 2.6 Measuring Inflation AACSB: Reflective Thinking 11) In 1995, the Boskin commission identified which of the following problems with the computation of the CPI? A) it does not account for the fact that consumers can substitute away from products as they get more expensive B) an increase in price could be the result of quality improvements rather than an increase in the cost of living C) it often does not reflect decreases in the cost of living that occur when new goods are introduced D) all of the above E) none of the above Answer: D Topic: 2.6 Measuring Inflation AACSB: Reflective Thinking 15 .

12) The inflation rate = ________.

A) nominal GDP - real GDP B) growth rate in real GDP - growth rate in nominal GDP C) growth rate in real GDP + growth rate in nominal GDP D) nominal GDP ÷ real GDP E) none of the above Answer: E Topic: 2.6 Measuring Inflation AACSB: Analytical Thinking 13) The inflation rate can be obtained by ________.

A) dividing the nominal GDP by the GDP deflator B) subtracting the real GDP from the nominal GDP C) multiplying the CPI by GDP D) subtracting the growth in real GDP from the growth in nominal GDP E) none of the above Answer: D Topic: 2.6 Measuring Inflation AACSB: Analytical Thinking Real and Nominal GDP video games energy drinks year 1 price 40 2 year 1 output 100 500 year 2 price 40 2.5 year 2 output 120 550 year 3 price 45 2.5 year 3 output 150 600 14) Based on the table "Real and Nominal GDP," if year one is the base year, then the GDP deflator for year two is ________.

A) 95.5 B) 123.5 C) 118 D) 104.7 E) 116.6 Answer: D Topic: 2.6 Measuring Inflation AACSB: Analytical Thinking

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15) Based on the table "Real and Nominal GDP," if year one is the base year, then the GDP deflator for year three is ________.

A) 165 B) 139.8 C) 85.8 D) 133.6 E) 114.6 Answer: E Topic: 2.6 Measuring Inflation AACSB: Analytical Thinking 16) Based on the table "Real and Nominal GDP," if year one is the base year, then the inflation rate in year three is ________.

A) 14.6% B) 9.5% C) 9.9% D) 11.5% E) 16.5% Answer: B Topic: 2.6 Measuring Inflation AACSB: Analytical Thinking 17) In relatively poor economies, modest expenditures on public health (immunization of children) can produce large improvements. What does this imply about the accuracy of the growth rate of real GDP as a measure of national well-being? How is the situation different in rich economies?

Answer: Expenditures on public health are included in GDP, but the resulting improvement in health is not. Indeed, improved public health may reduce some medical expenditures. The result is that GDP understates improvement in national well-being. In rich economies, rapidly rising medical expenditures are counted in GDP, though a portion is then deflated by rising prices in the health sector. To the extent that expenditures result from medical conditions such as obesity, it seems unlikely that well-being is improving faster than expenditures. The tendency for the growth rate of real GDP to underestimate the rate of improvement in the health component of national well-being is less prominent in rich economies than in poor economies.

Topic: 2.6 Measuring Inflation AACSB: Reflective Thinking

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2.7 Measuring Unemployment 1) Which of these represents an example of citizens who would not typically be counted as unemployed?

A) when your economics professor loses his job and gets a new one at McDonald's B) when your fourteen-year-old cousin loses her summer job in September C) when your neighbor has been out of work for so long that he decides to stay at home and write a novel D) all of the above E) none of the above Answer: D Topic: 2.7 Measuring Unemployment AACSB: Reflective Thinking Figure 2.5 Unemployment in the adult civilian population, 2013

2) According to Figure 2.5, the United States civilian labor force in June 2013 was ________.

A) 157.1 million B) 144.8 million C) 245.6 million D) 100.8 million E) none of the above Answer: A Topic: 2.7 Measuring Unemployment AACSB: Analytical Thinking 3) According to Figure 2.5, the United States civilian unemployment rate in June 2013 was ________.

A) 5.0% B) 22.1% C) 7.8% D) 8.5% E) none of the above Answer: C Topic: 2.7 Measuring Unemployment AACSB: Analytical Thinking

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4) According to Figure 2.5, the United States civilian labor force participation rate in June 2013 was ________.

A) 59% B) 43.8% C) 66.7% D) 64.0% E) none of the above Answer: D Topic: 2.7 Measuring Unemployment AACSB: Analytical Thinking 5) According to Figure 2.5, the United States civilian employment ratio in June 2013 was ________.

A) 66.7% B) 43.8% C) 59% D) 64.0% E) none of the above Answer: C Topic: 2.7 Measuring Unemployment AACSB: Analytical Thinking 6) A discouraged worker might ________.

A) be counted as unemployed B) have tried to find a job during the month prior to the household survey, but without success C) have been prevented from working during the week prior to the household survey, due to illness or other temporary circumstances D) be waiting to return to a job from which he or she has been laid off E) none of the above Answer: E Topic: 2.7 Measuring Unemployment AACSB: Reflective Thinking 7) If a large number of people were to leave their civilian jobs and join the military, which of the following would increase?

A) the civilian labor force B) the civilian employment ratio C) the civilian unemployment rate D) the civilian labor-force participation rate E) none of the above Answer: C Topic: 2.7 Measuring Unemployment AACSB: Analytical Thinking

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8) The unemployment rate is computed by ________.

A) dividing labor force by the adult population B) dividing the number of unemployed by the adult population C) multiplying the employment ratio by the adult population D) dividing the labor force by the number of unemployed E) none of the above Answer: E Topic: 2.7 Measuring Unemployment 9) The unemployment rate that is typically reported in the media is ________.

A) based on a survey from 150,000 business establishments on weekly earnings, number of workers and hours worked B) computed every three months C) based on a survey of 60,000 households D) reported by the Treasury Department E) none of the above Answer: C Topic: 2.7 Measuring Unemployment 10) The unemployment rate that is typically reported in the media is ________.

A) based on a survey from 150,000 business establishments on weekly earnings, number of workers and hours worked B) reported on a monthly basis by the Bureau of Labor Statistics (BLS) C) based on a survey of 150,000 households D) reported by the Federal Reserve E) none of the above Answer: B Topic: 2.7 Measuring Unemployment 11) The household and establishment surveys sometimes differ on the labor market conditions.

This is probably because ________.

A) the establishment survey counts a worker who holds two jobs twice and the household survey does not B) the establishment survey only counts employees of a company and the household survey also counts the self employed C) the establishment survey covers more workers than the household survey D) all of the above E) none of the above Answer: D Topic: 2.7 Measuring Unemployment AACSB: Reflective Thinking

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12) The household and establishment surveys sometimes differ on the labor market conditions.

This is probably because ________.

A) the household survey counts a worker who holds two jobs twice and the establishment survey does not B) the household survey only counts employees of a company and the establishment survey also counts the self employed C) the household survey covers more workers than the establishment survey D) all of the above E) none of the above Answer: E Topic: 2.7 Measuring Unemployment 13) Assume that a high proportion of recent college graduates decides to stay in school seeking advanced degrees, rather than confront the challenge of landing a good job in the midst of generally high unemployment. What is the direct impact of this behavior on (a) the labor force participation rate, (b) the employment ratio, and (c) the unemployment rate?

Answer: The decision to stay in school makes the labor force smaller than it would be otherwise, so the labor force participation rate is reduced. Fewer employed persons lowers the employment ratio. If all of these individuals would have been counted as unemployed, then the decline in the number of unemployed equals the decrease in the labor force. The percentage decrease in the number of unemployed would then be greater than the percentage decrease in the labor force, so the unemployment rate is reduced. However, to the extent that some of those who stay in school would, otherwise, have found a job, the size of the decline in the unemployment rate is small.

Topic: 2.7 Measuring Unemployment AACSB: Reflective Thinking 2.8 Measuring Interest Rates 1) There are different interest rates associated with many types of securities. Which of the following statements is correct?

A) they vary depending on the liquidity of the security B) they vary depending on the risk associated with the security C) except in very unusual times, most interest rates move together D) all of the above E) none of the above Answer: D Topic: 2.8 Measuring Interest Rates 2) The Federal Funds Rate is ________.

A) the rate charged on overnight loans between banks B) the rate charged on corporate bank loans to healthy "prime" borrowers C) the rate charged on U.S. Treasury bonds by the Federal Reserve D) the rate charged on U.S securities with maturities of less than a year E) none of the above Answer: A Topic: 2.8 Measuring Interest Rates 21 .

3) The nominal interest rate ________.

A) makes no allowance for inflation B) is a percentage of the amount borrowed C) is the rate that most banks advertise D) all of the above E) none of the above Answer: D Topic: 2.8 Measuring Interest Rates 4) Which of the following is a good indicator of short-term interest rates in international markets?

A) prime rate B) Treasury bill rate C) LIBOR D) Federal funds rate E) none of the above Answer: C Topic: 2.8 Measuring Interest Rates 5) The real interest rate differs from the nominal rate in that ________.

A) it more accurately represents the true cost of borrowing B) it varies negatively with changes in the rate of inflation C) it is the better indicator of credit market conditions D) all of the above E) none of the above Answer: D Topic: 2.8 Measuring Interest Rates AACSB: Reflective Thinking 6) The Fisher equation implies ________.

A) the nominal interest rate equals the real rate of inflation plus expected inflation B) the real interest rate equals expected inflation C) expected inflation equals current inflation D) the rate of inflation equals the real minus the nominal rates of interest E) none of the above Answer: E Topic: 2.8 Measuring Interest Rates AACSB: Analytical Thinking

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7) The Fisher equation implies that an increase in the nominal rate of interest relative to the real rate indicates that ________.

A) inflation is expected to rise B) inflation is expected to decrease C) the real cost of borrowing has increased D) the real cost of borrowing has decreased E) none of the above Answer: A Topic: 2.8 Measuring Interest Rates AACSB: Reflective Thinking 8) An increase in the expected rate of inflation is most likely to cause an increase in ________.

A) the ex post real interest rate B) the ex ante real interest rate C) the nominal interest rate D) the expected real interest rate E) none of the above Answer: C Topic: 2.8 Measuring Interest Rates AACSB: Reflective Thinking 9) An increase in the actual rate of inflation is most likely to cause a decrease in ________.

A) the ex post real interest rate B) the ex ante real interest rate C) the nominal interest rate D) the expected real interest rate E) none of the above Answer: A Topic: 2.8 Measuring Interest Rates AACSB: Reflective Thinking 10) In the 1970s, nominal interest rates in the United States were quite high, while real rates were extremely low. Which group "wins" in this circumstance, lenders or borrowers? What might explain the willingness of the "losers" to accept disadvantageous loan terms?

Answer: Borrowers "win" when the real interest rate is low. The lenders' "generosity" is mostly because lending terms are based on expected inflation. If actual inflation turns out to be higher than expected, the real cost of borrowing is lower than had been expected. Also, most loans are made by financial institutions that are in the business of "selling" money. When expected inflation is high, some lenders might try to attract borrowers by offering a nominal interest rate that does not compensate fully for the expected inflation. That is, the lender accepts a lower real interest rate in order to increase its loan business.

Topic: 2.8 Measuring Interest Rates AACSB: Reflective Thinking

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11) A small business owner has a line of credit from a bank with a nominal interest rate of seven percent. For several years, the price level has been rising at an annual rate of two percent, but the owner has just read in the newspaper that economists expect next year's inflation rate to be four percent or more. Assume that this owner may either continue the line of credit at seven percent, or renegotiate to alter both the size of the credit and the interest rate. What reason might there be for the owner to keep the credit terms as is? What argument might justify changing the credit agreement?

Answer: The expected increase in the inflation rate from two percent to four percent means a decrease in the real interest rate from five percent to three percent. The existing terms of the line of credit have become more favorable to the borrower. Since the bank's loan officers are aware of the change in expected inflation, renegotiation of the agreement must mean an increase in the nominal interest rate. Nonetheless, the bank might consider a new nominal interest rate somewhat lower than nine percent, so the real interest rate would be somewhat lower than five percent. The borrower will renegotiate only if she desires, and the bank is willing, to increase the size of the line of credit.

Topic: 2.8 Measuring Interest Rates AACSB: Reflective Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 3 Aggregate Production and Productivity 3.1 Determinants of Aggregate Production 1) Which of the following constitutes an input to the Cobb-Douglas production function?

A) capital B) labor C) total factor productivity D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production 2) To analyze aggregate productivity, economists typically assume ________.

A) that the hours each person works varies with the wage rate B) that all of the capital and labor in the economy are fully utilized C) that output can increase only if inputs have become more productive D) all of the above E) none of the above Answer: B Topic: 3.1 Determinants of Aggregate Production 3) The output an economy can produce with one unit of capital and one unit of labor is ________.

A) indicated by the A variable in the Cobb-Douglas production function B) commonly referred to as labor productivity C) a variable that depends on how many units of capital and labor are available D) all of the above E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production 4) What does the Cobb-Douglas production function assume about the input shares in the economy?

A) the capital share is larger than the labor share of income B) both the capital and labor shares of income grow over time C) both the capital and labor shares of income remain relatively constant over time D) the capital share of income is equal to the labor share of income E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production

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5) What does the Cobb-Douglas production function assume about the input shares in the economy?

A) the capital share is smaller than the labor share of income B) both the capital and labor shares of income are positive C) both the capital and labor shares of income remain relatively constant over time D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production 6) Which of the following is true about labor productivity?

A) it is the amount of total factor productivity (TFP) per unit of labor B) it is more difficult to measure than TFP C) it is a more general and better measure of productivity than TFP D) all of the above E) none of the above Answer: E Topic: 3.1 Determinants of Aggregate Production 7) Which of the following is true about labor productivity?

A) it is the amount of output produced per unit of labor B) it is easier to measure than total factor productivity (TFP) C) it is more commonly mentioned in the media than total factor productivity (TFP) D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production 8) Which of the following is true about total factor productivity (TFP)?

A) it tells us how productive capital and labor are B) it is a more general and better measure of productivity than labor productivity C) it is not directly measurable D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production

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9) Which of the following is true about total factor productivity (TFP)?

A) it can be measured just like capital and labor B) it cannot be directly measured so it has to be calculated from given values of capital, labor and output C) while it cannot be measured directly, it has an exponent of 0.3 in the Cobb-Douglas production function D) while it cannot be measured directly, it has an exponent of 0.7 in the Cobb-Douglas production function E) none of the above Answer: B Topic: 3.1 Determinants of Aggregate Production 10) Suppose than an economy has output Y = A , that Y equals $12 trillion, capital K is $27 trillion, and labor L is 64 million workers. Given this information, what is the closest approximation of total factor productivity A? A) less than 0.01 B) around 0.25 C) roughly 0.33 D) close to 0.4 E) exactly 144 Answer: B Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 11) Suppose than an economy has output Y = A , that Y equals $19 trillion, capital K is $27 trillion, and labor L is 125 million workers. Given this information, what is the closest approximation of total factor productivity A? A) less than 0.01 B) around 0.25 C) roughly 0.33 D) close to 0.4 E) exactly 144 Answer: B Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking

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12) Suppose than an economy has output Y = A , that Y equals $42 trillion, capital K is $64 trillion, and labor L is 125 million workers. Given this information, what is the closest approximation of total factor productivity A? A) less than 0.01 B) around 0.25 C) roughly 0.33 D) close to 0.4 E) exactly 144 Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 13) Given the production function Y = A , if an economy's capital per worker k is $27 thousand, and its total factor productivity A is 0.5, then output per worker is (approximately) ________.

A) $13,500 B) $40,500 C) $3,000 D) $5,000 E) $1,500 Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 14) Which of the following is true about per capita income?

A) it is an approximate measure of how rich or poor a country is B) it is the same as income per worker only if everyone in the economy is assumed to work C) it is the product of TFP and capital per worker only if everyone in the economy is assumed to work D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 15) From the Cobb-Douglas production function we learn that there are two sources that help explain cross-country differences in per capita income: ________ and ________.

A) capital; labor productivity B) labor share of income; TFP C) TFP; capital per person D) labor per person; capital E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking

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16) If country X has a higher capital per person than country Y, then ________.

A) country X is richer than country Y B) the only way for country X to be richer than country Y is if X is just as productive (has the same TFP) as Y C) the only way for country Y to be richer than country X is if Y is more productive (has a higher TFP) than X D) the only way for country X to be richer than country Y is if X is less productive (has a lower TFP) than Y E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 17) The main cause of low per capita income is ________.

A) a low level of capital B) a small workforce C) low productivity of capital and labor D) slow growth of capital and labor shares of income E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production 18) What do you think would be the Cobb-Douglas single best prescription for poor countries to catch up with the rich?

A) to increase their stock of capital B) to increase their labor force C) to find more efficient ways to allocate and use capital and labor D) to ask help of the rich countries E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 19) Capital per person k is higher in Japan than in the United States. As a result ________.

A) per capita income is higher in Japan B) total factor productivity is higher in Japan C) the marginal product of capital is higher in Japan D) all of the above E) none of the above Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking

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20) A ten percent increase in total factor productivity A will increase ________.

A) the marginal product of capital (MPK) by ten percent B) the marginal product of labor (MPL) by ten percent C) output by ten percent D) all of the above E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 21) Constant returns to scale (CRS) implies that ________.

A) increasing all the factor inputs by the same percentage lead to the same percentage increase in output B) increasing all the factor inputs by the same percentage lead to a higher percentage increase in output C) increasing all the factor inputs by the same percentage lead to a lower percentage increase in output D) increasing all the factor inputs by the same percentage leaves output unchanged E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production 22) Constant returns to scale (CRS) implies that when the firm ________.

A) doubles all inputs, output more than doubles B) doubles all inputs, output doubles C) doubles all inputs, output increases by less than 100 percent D) doubles all inputs, output remains constant E) none of the above Answer: B Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 23) Using the Cobb-Douglas production function, while holding other inputs constant, if the amount of a specific factor is increasing ________.

A) the increased amount of output from an extra unit of input declines B) the increased amount of output from an extra unit of input increases C) that factor's share of output is declining D) that factor's share of output is increasing E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking

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24) Diminishing marginal product means that ________.

A) when adding extra units of a single input, output increases become smaller B) when adding extra units of a single input, output increases become larger C) when adding extra units of a single input, output declines D) the amount of output increases when we add more inputs E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 25) The marginal product of capital (MPK) measures ________.

A) by how much output increases for each additional unit of capital B) by how much capital increases for each additional unit of output C) by how much capital increases for each additional unit of labor D) by how much total factor productivity increases for each additional unit of capital E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 26) Which of the following will cause an increase in the marginal product of capital (MPK)?

A) a decrease in the quantity of labor in use B) an increase in labor productivity C) a decrease in the quantity of capital in use D) all of the above E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 27) As the capital stock increases, ________. This means that the marginal product of capital (MPK) ________.

A) the slope of the production function falls; declines B) the slope of the production function increases; goes up C) the slope of the production function falls; goes up D) the slope of the production function increases; declines E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking

7 .

28) The marginal product of capital (MPK) is given by the ________.

A) capital share of income + average output per unit of capital B) capital share of income - average output per unit of capital C) capital share of income ÷ average output per unit of capital D) capital share of income × average output per unit of capital E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 29) The marginal product of capital (MPK) can be calculated from the following ________.

A) the capital share of income and the average output per unit of capital B) the capital share of income and average capital per worker C) output and capital D) the capital share of income and output E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 30) What do we learn from the shape of the Cobb-Douglas production function?

A) its slope falls as capital gets added B) the marginal product of capital declines as the capital stock increases C) there are diminishing returns to capital D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 31) The marginal product of labor (MPL) measures ________.

A) by how much labor increases for each additional unit of output B) by how much labor increases for each additional unit of capital C) by how much total factor productivity increases for each additional unit of labor D) by how much labor increases for each additional unit of productivity E) by how much output increases for each additional unit of labor Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking

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32) As the amount of labor input increases ________. This means that the marginal product of labor (MPL) ________.

A) the slope of the production function increases; goes up B) the slope of the production function falls; declines C) the slope of the production function falls; goes up D) the slope of the production function increases; declines E) none of the above Answer: B Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 33) What do we learn from the shape of the Cobb-Douglas production function?

A) its slope remains constant as labor input increases B) the marginal product of labor declines as the labor input falls C) there are diminishing returns to labor D) all of the above E) none of the above Answer: C Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 34) The marginal product of labor (MPL) is given by the ________.

A) labor share of income + average output per unit of labor B) labor share of income - average output per unit of labor C) labor share of income ÷ average output per unit of labor D) labor share of income × average output per unit of labor E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 35) The marginal product of labor (MPL) can be calculated from the following ________.

A) the labor share of income and the average output per unit of labor B) the labor share of income and average labor per worker C) output and labor D) the labor share of income and output E) none of the above Answer: A Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking

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36) Constant returns to scale (CRS) implies ________.

A) constant returns to labor B) constant returns to capital C) increasing marginal products D) variable total factor productivity E) diminishing marginal products Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 37) An example of a supply shock could be ________.

A) a technological innovation B) a natural disaster C) an oil price increase D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production 38) A technology shock could have a different impact than a natural catastrophe because ________.

A) the former would likely lower TFP and the latter raise labor productivity B) the former would likely lower output and the latter raise production C) the former would likely raise output and the latter would raise TFP D) the former would likely lower labor productivity and the latter would lower TFP E) the former would likely raise TFP and the latter would curtail production Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 39) Since the 1980s, China's output per person has increased tremendously. Which of these possible contributors to economic growth in China is a good example of a positive supply shock?

A) high levels of saving and investment B) declining rate of population growth C) rising consumption of energy D) all of the above E) none of the above Answer: E Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking

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40) Which of the following is an example of an adverse supply shock?

A) OPEC cuts oil production B) a large oil spill in the Gulf of Mexico C) a devastating hurricane off the Louisiana coast D) all of the above E) none of the above Answer: D Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 41) Suppose that labor productivity in one economy is higher than it is in some other economy.

Does that mean that the first economy is using its productive resources better than the second economy? Explain.

Answer: Higher labor productivity does not necessarily mean better use of resources. The economy may have more capital per worker, but the productivity of capital may be higher in the second economy. To compare use of resources across economies or over time, the correct measure is total factor productivity.

Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 42) Use the Cobb-Douglas production function to explain why even massive movements of labor and capital across national borders may have little impact on differences in per capita income.

Answer: Relatively low per capita income may be due to low total factor productivity or to low capital per worker. In the latter case, migration of capital or of labor could reduce inequality. In the former case, however, rising levels of capital in a low-income economy will do little to raise output per person. Declines in the labor input due to out-migration from a low-income economy might mean more capital for each of the remaining workers but, again, the increase in output per worker will be small if total factor productivity is low.

Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 43) Capital per person in India is about six percent and per capita income is about eight percent of the U.S. level. Given that per capita income y = A , calculate the level of total factor productivity (A), relative to the U.S. level, that would be needed for India to match the U.S. level of per capita income. ( = 0.43) Answer: 1 = A × 0.43 implies A = 2.3 Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking

11 .

44) Use the Cobb-Douglas production function to show that a one-unit increase in the labor input will reduce the marginal product of labor and increase the marginal product of capital. Explain each of these results.

Answer: MPL = =

= =

=

. This ratio will decline when L rises. MPK =

. This ratio increases with L. Adding more labor input causes the

capital input to be spread more thinly (each unit of labor has less capital to work with), so output increases at a diminishing rate. More labor input means, also, that the available capital is being used more intensively (each unit of capital has more labor to work it), so the change in output that would result from a change in the quantity of capital is becoming larger.

Topic: 3.1 Determinants of Aggregate Production AACSB: Reflective Thinking 45) Suppose an economy has an increase in labor input of 60 percent, while output has increased by 100 percent. Assuming no change in total factor productivity, calculate the percentage increase in the capital input. (Use the Cobb-Douglas production function Y = A .)

Answer: 2Y = A . Dividing this by the original production function yields 2 = . Solve for x = 3.37. The capital input has increased by 237 percent.

Topic: 3.1 Determinants of Aggregate Production AACSB: Analytical Thinking 3.2 Determination of Factor Prices 1) The classical framework is based on which of the following assumptions?

A) many firms in the economy B) no single firm can control prices C) in the long-run the quantity of factors supplied must be equal to the quantity of factors demanded D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices 2) In an environment characterized by perfect competition, we expect that ________.

A) there are very few firms in the economy B) there are many firms in the economy but a very few have the lion's share of the industry C) the are many small firms in the economy and every single firm is a price taker D) the government sets prices for all firms E) none of the above Answer: C Topic: 3.2 Determination of Factor Prices

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3) Key determinants of economic profit include ________.

A) the revenue from selling goods and services B) the cost incurred in buying capital C) the cost of hiring labor D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices 4) Key influences on the valuation of economic profits include ________.

A) the average level of the prices of goods and services sold B) the rental price of capital C) the wage rate D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking 5) Economic profits differ from accounting profits because ________.

A) the former is calculated by economists and the latter by accountants B) many firms own their own capital so accounting profits do not factor this cost C) most firms report economic profits once a year and accounting profits every pay period D) all of the above E) none of the above Answer: B Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 6) Profit maximization implies that firms will want to ________.

A) accumulate capital while the MPK is greater than the real wage B) accumulate capital while the MPK is greater than the rental price of capital C) accumulate labor while the MPK is greater than the rental price of capital D) accumulate labor while the MPK is greater than the real wage E) none of the above Answer: B Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking

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7) Profit maximization implies that firms will want to ________.

A) accumulate labor while the MPL is greater than the real wage B) accumulate capital while the MPK is lower than the rental price of capital C) accumulate labor while the MPK is greater than the rental price of capital D) accumulate capital while the MPL is greater than the real wage E) none of the above Answer: A Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking 8) Profit maximization implies that firms will want to ________.

A) accumulate labor while the MPL is greater than the real wage B) accumulate capital while the MPK is greater than the rental price of capital C) not accumulate either input without limit, because of diminishing returns to each factor D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking 9) Firms will continue to increase their purchase of factor inputs as long as ________.

A) the marginal product of a given factor is greater than its real factor price B) the marginal cost of a given factor is lower than its marginal product C) their total revenues are greater than their total costs D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking 10) As firms use more and more of an input, ________.

A) the marginal product of other inputs tends to increase B) the marginal product of the input declines C) the price of the input may increase D) all of the above E) none of the above Answer: D Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking

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11) Which of the following is (are) likely to cause the marginal product of an input to decrease?

A) an increase in the real price of the input B) a decrease in the quantity of the input used in production C) technological advances D) all of the above E) none of the above Answer: E Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking 12) Which of the following is (are) likely to cause the marginal product of an input to decrease?

A) an increase in the real price of the input B) a decrease in the quantity of other inputs used in production C) technological advances D) all of the above E) none of the above Answer: B Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking 13) When a particular firm is fully utilizing its capital, its output is given by Y = 10 × . The cost of labor is $1 per unit. To maximize profit, how many units of labor should this firm use?

A) 25 B) 5 C) 3.16 D) 100 E) 50 Answer: A Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking 14) In an economy with production function Y = 1.5 × , K = 343, and L = 512. If factor markets are in equilibrium, then the rental price of capital is (approximately) ________, and the real wage is (approximately) ________.

A) 0.5; 0.8 B) 7; 8 C) 0.9; 1.35 D) 1.4; 0.4 E) 0.6; 0.9 Answer: E Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking

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15) If the quantities of labor and capital in an economy each increase by the same x percent, which of the following will increase by x percent?

A) marginal product of capital B) economic profits C) share of capital income in national income D) rental price of capital E) none of the above Answer: E Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking 16) Assume that an economy is in equilibrium when the arrival of immigrants causes an increase in the supply of labor. Once the economy has adjusted to its new equilibrium, and assuming that the supply of capital remains unchanged, which of the following has decreased?

A) the share of capital income in national income B) the share of labor income in national income C) national income D) the rental price of capital E) none of the above Answer: E Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 17) Assume that an economy is in equilibrium when technological progress causes an increase in total factor productivity. Once the economy has adjusted to its new equilibrium, and assuming that the supplies of capital and labor remain unchanged, which of the following has increased?

A) the real wage B) the share of capital income in national income C) the share of labor income in national income D) all of the above E) none of the above Answer: A Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 18) Assume that an economy is in equilibrium when there occurs an increase in the supply of capital. The available quantity of labor remains fixed. Once the economy has adjusted to its new equilibrium, which of the following has increased?

A) the real wage B) the rental price of capital C) the share of capital income in national income D) all of the above E) none of the above Answer: A Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 16 .

19) To get the first order conditions in a profit maximization problem, we must ________.

A) set the profit function equal to zero and solve for the production function B) set the partial derivatives of the production function equal to zero and solve for the price C) set the partial derivative of the profit function equal to zero and solve for the marginal products D) set the production function equal to zero and solve for the marginal products E) none of the above Answer: C Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking 20) The marginal product of capital indicates ________. Therefore the MPK curve is also ________.

A) the quantity of capital supplied for a given rental price; the equilibrium price of capital B) the quantity of capital demanded for a given rental price; the demand curve of capital C) the quantity of capital demanded for a given rental price; the equilibrium price of capital D) the quantity of capital supplied for a given rental price; the supply curve of capital E) none of the above Answer: B Topic: 3.2 Determination of Factor Prices 21) The marginal product of labor indicates ________. Therefore the MPL curve is also ________.

A) the quantity of labor supplied for a given wage; the equilibrium price of labor B) the quantity of labor demanded for a given wage; the equilibrium price of labor C) the quantity of labor demanded for a given wage; the demand curve of labor D) the quantity of labor supplied for a given wage; the supply curve of labor E) none of the above Answer: C Topic: 3.2 Determination of Factor Prices 22) When the rental price of capital is above the equilibrium price ________.

A) we have an excess supply of capital and the rental price should fall B) we have an excess demand of capital and the rental price should fall C) we have an excess supply of capital and the rental price should increase D) we have an excess demand of capital and the rental price should increase E) none of the above Answer: A Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking

17 .

23) When the real wage is below the equilibrium price in the labor market ________.

A) we have an excess supply of labor and the real wage should fall B) we have an excess demand of labor and the real wage should fall C) we have an excess demand of labor and the real wage should increase D) we have an excess supply of labor and the real wage should increase E) none of the above Answer: C Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking 24) Given the production function Y = A , if the rental price of capital is 0.133, Y = 690, and K = 1,728, what is the value of the exponent α? If A = 1, and the real wage is 1.15, is this economy in a long-run equilibrium?

Answer: Since the rental price of capital equals the marginal product of capital, we have 0.133 = , so α = one-third. If A = 1, we have 690 = 12 × , so L = 436. Then the real wage is = 1.06 ≠ 1.15. This is not a long-run equilibrium. Equivalently, if the equilibrium real wage is 1.15, L must satisfy 1.15 =

, so L = 400. Then Y = 12 ×

= 651.3 ≠ 690.

This is not a long-run equilibrium. (If the real wage remains 1.15, the quantity demanded of labor will fall to 400. Then, the excess supply of labor will force the real wage to decline to the market equilibrium value of 1.06.)

Topic: 3.2 Determination of Factor Prices AACSB: Reflective Thinking 25) Suppose that reduced barriers to international financial transactions cause an increase in the economy's supply of capital. Explain, step-by-step, how the economy adjusts to arrive at a new long-run equilibrium.

Answer: The increase in the supply of capital (rightward shift of the supply curve) causes an excess supply at the original rental price, and the excess supply causes the price to fall. Since the price of capital falls below its marginal product, firms buy more capital. The increase in capital utilization causes an increase in the marginal product of labor, so the demand for labor increases (the demand curve for labor shifts up). Since the supply of labor is fixed, there is no change in the quantity of labor in use, but the real wage rises to equal the higher marginal product. The rental price of capital stops falling when the quantity of capital in use is equal to the supply of capital. The increase in output is distributed between the capital and labor inputs, so that the share of each factor in total income is unchanged from the original equilibrium. The (unchanged) labor inputs receive a higher wage; each unit of capital receives a reduced payment, but capital's share of total income is increased because of the larger number of capital units receiving payment.

Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking

18 .

26) Suppose that a technological advance raises total factor productivity. Explain, step-by-step, how the economy adjusts to arrive at a new long-run equilibrium.

Answer: The marginal products of both labor and capital increase, so both demand curves shift up. Since the factor supplies are fixed, there can be no increase in factor utilization, but output has risen, because both factors are more productive. At the original factor prices, there is now excess demand, which causes both the real wage and the rental price of capital to rise. These increases in factor prices distribute the increased output to the inputs, so that the income share of each input in total output does not change. The factor prices stop rising when they are equal to the higher marginal product that results from the improved technology.

Topic: 3.2 Determination of Factor Prices AACSB: Analytical Thinking 3.3 Distribution of National Income 1) Real capital income is given by ________.

A) MPK × K B) capital share of income × output per unit of capital × capital C) capital share of income × output D) all of the above E) none of the above Answer: D Topic: 3.3 Distribution of National Income AACSB: Analytical Thinking 2) Real labor income is given by ________.

A) MPL × L B) labor share of income × labor productivity × labor C) labor share of income × output D) all of the above E) none of the above Answer: D Topic: 3.3 Distribution of National Income AACSB: Analytical Thinking 3) A decrease in the growth rate of labor productivity is likely to cause a decrease in ________.

A) the growth rate of the real wage B) the growth rate of the marginal product of capital C) the growth rate of the labor supply D) the share of labor income in national income E) none of the above Answer: A Topic: 3.3 Distribution of National Income AACSB: Analytical Thinking

19 .

4) An economy's total labor income is $2 trillion, and total capital income is $1 trillion. In the Cobb-Douglas production function, the exponent on capital is ________.

A) two-thirds B) one-half C) one-third D) 0.3 E) none of the above Answer: C Topic: 3.3 Distribution of National Income AACSB: Analytical Thinking 5) The three oil shocks the U.S. experienced in 1973-1974, 1979-1980 and 2007-2008 had which of the following consistent results?

A) a decline in real wages due to an upward shift of the production function B) an increase in the rental price of capital along with a healthy stock market response C) a decline in real wages due to a downward shift of the MPL curve D) an increase in the rental price of capital due to an upward shift of the production function E) none of the above Answer: C Topic: 3.3 Distribution of National Income 6) An economy's production function is Y = A , and the economy's total output in equilibrium is $90 billion. Total capital income in this economy is ________.

A) $27 billion B) $30 billion C) $21 billion D) $70 billion E) none of the above Answer: A Topic: 3.3 Distribution of National Income AACSB: Analytical Thinking 7) An economy's production function is Y = A , and the economy's total output in equilibrium is $700 billion. Total labor income in this economy is ________.

A) $300 billion B) $233.3 billion C) $210 billion D) $400 billion E) none of the above Answer: E Topic: 3.3 Distribution of National Income AACSB: Analytical Thinking

20 .

8) An economy's production function is Y = A , and the economy's total output in equilibrium is $800 billion. Total capital income in this economy is ________.

A) $200 billion B) $25 billion C) $750 billion D) $267 billion E) none of the above Answer: A Topic: 3.3 Distribution of National Income AACSB: Analytical Thinking 9) Equilibrium market prices for capital and labor are $10 and $8, respectively. Then, the economy experiences one or more supply shocks, so that the marginal product of capital is $12, and the marginal product of labor is $9. Assuming that the available quantities of capital and labor are fixed, which of the following is (are) likely to decrease as the economy approaches its new equilibrium?

A) real rental price of capital B) total output C) economic profits D) the quantity of capital in use E) none of the above Answer: C Topic: 3.3 Distribution of National Income AACSB: Reflective Thinking 10) Equilibrium market prices for capital and labor are $10 and $8, respectively. Then, the economy experiences one or more supply shocks, so that the marginal product of capital is $9, and the marginal product of labor is $6. Assuming that the available quantities of capital and labor are fixed, which of the following is (are) likely to decrease as the economy approaches its new equilibrium?

A) economic profits B) real rental price of capital C) total output D) the quantity of capital in use E) none of the above Answer: B Topic: 3.3 Distribution of National Income AACSB: Reflective Thinking

21 .

11) The three oil shocks the U.S. experienced in 1973-1974, 1979-1980 and 2007-2008 had a consistent result ________.

A) a decline in the MPK B) a decline in the real rental price of capital C) a decline in stock prices D) all of the above E) none of the above Answer: D Topic: 3.3 Distribution of National Income 12) As an investor, negative supply shocks are not attractive because ________.

A) they tend to lead to lower productivity B) the real rental price of capital tends to decline driving rental incomes down C) with decreases in expected income, claims on those incomes also tend to fall leading to stock market downturns D) all of the above E) none of the above Answer: D Topic: 3.3 Distribution of National Income AACSB: Reflective Thinking 13) Suppose a government tried to mandate a real wage above the equilibrium real wage.

Assuming that factor markets are otherwise free and competitive, explain why the higher real wage would fail to increase the share of labor income in national income.

Answer: Given the Cobb-Douglas production function, the marginal product of labor is and the marginal product of capital is

,

. If each factor's price is equal to its marginal product,

then its share of total income equals its exponent in the production function; 0.7 for labor, and 0.3 for capital. Firms will respond to the mandated higher real wage by reducing the quantity of labor demanded until the marginal product of labor is equal to the real wage. Workers who still have a job will have higher income, but many workers now have no job and no income. The reduced labor input lowers the marginal product of capital. Since the rental price of capital is unregulated, it will fall, so that no capital becomes idle. Since the prices of both labor and capital are equal to their respective marginal products, their shares of the reduced total output are unchanged.

Topic: 3.3 Distribution of National Income AACSB: Reflective Thinking

22 .

14) Consider an economy in which 350 = 3 × . Calculate the long-run equilibrium values of factor prices and incomes.

Answer: Capital's share of income is 30%, so the rental price of capital equals (0.3 × 350)/700 = 0.15. T he quantity of labor input equals

= 54. Labor's share of income is 70%, so the real

wage equal (0.7 × 350)/54 = 4.5.

Topic: 3.3 Distribution of National Income AACSB: Analytical Thinking

23 .

Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 4 Saving and Investment in Closed and Open Economies 4.1 Relationship Between Saving and Wealth 1) Private saving refers to ________.

A) disposable income minus consumption expenditure B) total expenditure minus purchases of capital goods C) taxes plus consumption minus income D) consumption expenditure divided by disposable income E) none of the above Answer: A Topic: 4.1 Relationship Between Saving and Wealth 2) Private saving refers to ________.

A) after-tax income minus consumption expenditures B) a flow variable which adds to the stock of wealth C) the private saving rate times disposable income D) all of the above E) none of the above Answer: D Topic: 4.1 Relationship Between Saving and Wealth 3) Government saving refers to ________.

A) tax revenues minus transfers minus government purchases B) tax revenues plus transfers minus government consumption C) the saving rate times transfers D) national plus private saving E) none of the above Answer: A Topic: 4.1 Relationship Between Saving and Wealth 4) Government saving refers to ________.

A) tax revenues minus transfers minus government consumption minus government investment B) the government's tax receipts minus its outlays C) national saving minus private saving D) all of the above E) none of the above Answer: D Topic: 4.1 Relationship Between Saving and Wealth

1 .

5) How can the U.S. federal government induce increases in the national saving rate?

A) by lowering the sales tax B) by levying taxes on individual retirement (IRA) accounts C) by reducing budget deficits D) all of the above E) none of the above Answer: C Topic: 4.1 Relationship Between Saving and Wealth AACSB: Reflective Thinking 6) How can the U.S. federal government induce increases in the national saving rate?

A) implementing a value added tax B) lowering the capital gains tax C) reducing budget deficits D) all of the above E) none of the above Answer: D Topic: 4.1 Relationship Between Saving and Wealth AACSB: Reflective Thinking 7) Net capital outflows ________.

A) are also known as net foreign investment B) are positive if saving is greater than investment C) are also known as the trade balance D) all of the above E) none of the above Answer: D Topic: 4.1 Relationship Between Saving and Wealth 8) When a U.S. firm sells a good abroad for, say, 100 euros (assume $1=1euro), U.S. net exports increase by $100. These $100 in exports can be accounted for as $100 increase in capital outflow because ________.

A) if the 100 euros are kept in the foreign bank, the U.S. firm is giving a loan to that bank B) if the U.S. firm uses the 100 euros to buy a share of stock in a foreign firm, the firm is supplying U.S. capital to that foreign firm C) if the U.S. firm uses the proceeds to build a new factory in that country, it is supplying U.S. capital to that country D) all of the above E) none of the above Answer: D Topic: 4.1 Relationship Between Saving and Wealth AACSB: Reflective Thinking

2 .

9) When a U.S. firm sells a good abroad for, say, 100 euros (assume $1.5=1euro), U.S. net exports increase by $150. These $150 in exports can be accounted for as $150 increase in capital outflow because ________.

A) private consumption in the foreign country increases by $150 B) if the U.S. firm uses the 100 euros to buy a share of stock in a foreign firm, the firm is supplying U.S. capital to that foreign firm C) if the U.S. firm uses the proceeds to buy a U.S. bond, capital investment in the foreign country has increased D) all of the above E) none of the above Answer: B Topic: 4.1 Relationship Between Saving and Wealth AACSB: Reflective Thinking 10) If a U.S. citizen deposits $10,000 in a foreign bank, and the bank uses the $10,000 to buy assets in the U.S., then ________.

A) the U.S. has experienced a net capital outflow B) the U.S. has experienced an increase in net exports C) the foreign economy has experienced a net capital outflow D) the foreign economy has experienced an increase in net exports E) none of the above Answer: E Topic: 4.1 Relationship Between Saving and Wealth AACSB: Reflective Thinking 11) A foreign bank receives a deposit of $10,000 from a U.S. citizen. As a result, there is a net capital outflow from the U.S., if ________.

A) the bank buys a U.S.-made computer B) the bank buys a bond issued by a U.S. company C) the bank keeps the $10,000 in a vault D) all of the above E) none of the above Answer: A Topic: 4.1 Relationship Between Saving and Wealth AACSB: Reflective Thinking 12) Which of the following is a correct statement?

A) Wealth can increase even if there is no saving.

B) An increase in net foreign assets always increases wealth.

C) Low U.S. national saving is the principal cause of the trade deficits the U.S. has run since the 1980s.

D) The U.S will be a net debtor nation for the foreseeable future.

E) all of the above Answer: E Topic: 4.1 Relationship Between Saving and Wealth AACSB: Reflective Thinking 3 .

13) Which of the four government policies to stimulate saving is essential? That is, which policy can on its own, regardless of the other policies, determine the level of the national saving rate?

Answer: Reduce budget deficits. A higher tax on consumption will increase national saving only if the government doesn't spend all of the increased tax revenue. Tax incentives that reward private saving directly, or encourage private saving by increasing the return on assets, will raise national saving only if government spending is reduced to correspond to the decrease in tax revenues. If nothing is done to promote private saving, national saving can be raised by lowering the government's budget deficit.

Topic: 4.1 Relationship Between Saving and Wealth AACSB: Reflective Thinking 14) Why is it important, for an open economy, that investment not be consistently higher than saving?

Answer: When investment is higher than saving, the difference is a net capital inflow. The extra investment that is financed by foreigners is an addition to their wealth, rather than an increase in the wealth of domestic citizens. The income from such investment must be paid to the foreign owners, thus is not available to contribute to domestic income and saving. The source of the capital inflow is a continual excess of imports over exports (negative trade balance). Imports are being financed through the sale of assets to foreigners. It is not so much investment but consumption that is unsustainably high; saving is unsustainably low.

Topic: 4.1 Relationship Between Saving and Wealth AACSB: Reflective Thinking 4.2 Saving, Investment, and Goods Market Equilibrium in a Closed Economy 1) The real interest rate ________.

A) is the cost of borrowing not adjusted for inflation B) keeps the market for saving and consumption in equilibrium C) describes the real benefit of saving D) all of the above E) none of the above Answer: C Topic: 4.2 Saving, Investment, and Goods Market Equilibrium in a Closed Economy AACSB: Reflective Thinking 2) In the model for desired saving, autonomous is roughly synonymous with ________.

A) policy-determined B) endogenous C) intended D) inflation-adjusted E) exogenous Answer: E Topic: 4.2 Saving, Investment, and Goods Market Equilibrium in a Closed Economy AACSB: Reflective Thinking

4 .

3) The real interest rate ________.

A) is the cost of borrowing adjusted for inflation B) keeps the market for saving and investment in equilibrium C) describes the real benefit of saving D) all of the above E) none of the above Answer: D Topic: 4.2 Saving, Investment, and Goods Market Equilibrium in a Closed Economy AACSB: Reflective Thinking 4) Consumption expenditures are a function of ________.

A) the real interest rate B) disposable income C) autonomous consumption D) all of the above E) none of the above Answer: D Topic: 4.2 Saving, Investment, and Goods Market Equilibrium in a Closed Economy AACSB: Analytical Thinking 5) Increases in ________ typically lead to decreases in consumption A) the interest rate B) disposable income C) autonomous consumption D) all of the above E) none of the above Answer: A Topic: 4.2 Saving, Investment, and Goods Market Equilibrium in a Closed Economy AACSB: Analytical Thinking 6) Increases in ________ typically lead to decreases in private saving.

A) the interest rate B) disposable income C) autonomous consumption D) all of the above E) none of the above Answer: C Topic: 4.2 Saving, Investment, and Goods Market Equilibrium in a Closed Economy AACSB: Analytical Thinking

5 .

7) Increases in ________ typically lead to decreases in ________.

A) the interest rate; saving B) disposable income; consumption C) autonomous consumption; consumption D) all of the above E) none of the above Answer: E Topic: 4.2 Saving, Investment, and Goods Market Equilibrium in a Closed Economy AACSB: Analytical Thinking 8) In the equation S = - - C - , which of the following is an endogenous variable?

A) r B) C) D) all of the above E) none of the above Answer: A Topic: 4.2 Saving, Investment, and Goods Market Equilibrium in a Closed Economy AACSB: Analytical Thinking 9) ________ typically lead to increases in ________.

A) decreases in interest rates; investment B) increases in disposable income; consumption C) increases in autonomous investment; investment D) all of the above E) none of the above Answer: D Topic: 4.2 Saving, Investment, and Goods Market Equilibrium in a Closed Economy AACSB: Analytical Thinking 10) How does a decline in the real interest rate cause an increase in investment?

Answer: The real interest rate is the reward for saving and the cost of borrowing. A reduced interest rate will encourage more spending on both consumption and investment. Business firms, in particular, will use available funds to purchase new capital goods from which to generate future income, instead of holding financial assets (e.g., government bonds) that offer a reduced income. The purchase of capital goods will be financed by borrowing, as well, so long as the expected income from use of the capital goods exceeds the (reduced) cost of borrowing.

Topic: 4.2 Saving, Investment, and Goods Market Equilibrium in a Closed Economy AACSB: Reflective Thinking

6 .

4.3 Response to Changes in Saving and Investment in a Closed Economy 1) Ceteris paribus, in a closed economy, if consumers become more pessimistic ________.

A) autonomous consumption will fall B) investment will fall C) saving will increase D) all of the above E) none of the above Answer: D Topic: 4.3 Response to Changes in Saving and Investment in a Closed Economy AACSB: Analytical Thinking 2) Ceteris paribus, in a closed economy, if consumers become more optimistic ________.

A) autonomous consumption would decrease B) the equilibrium interest rate should increase C) saving should increase D) all of the above E) none of the above Answer: B Topic: 4.3 Response to Changes in Saving and Investment in a Closed Economy AACSB: Analytical Thinking 3) If government cuts taxes ________.

A) national saving goes up B) the equilibrium interest rate would decrease C) discretionary income goes up D) all of the above E) none of the above Answer: C Topic: 4.3 Response to Changes in Saving and Investment in a Closed Economy AACSB: Analytical Thinking 4) In the long run, if government increases spending ________.

A) interest rates decrease B) it crowds out private investment C) saving increases D) all of the above E) none of the above Answer: B Topic: 4.3 Response to Changes in Saving and Investment in a Closed Economy AACSB: Reflective Thinking

7 .

5) "Crowding out" refers to the decrease in ________ that may result from an increase in government spending.

A) private investment B) imports C) private saving D) all of the above E) none of the above Answer: A Topic: 4.3 Response to Changes in Saving and Investment in a Closed Economy 6) In the long run, larger budget deficits lead to ________.

A) higher saving levels B) a fall in investment C) lower interest rates D) all of the above E) none of the above Answer: B Topic: 4.3 Response to Changes in Saving and Investment in a Closed Economy AACSB: Reflective Thinking 7) A budget deficit ________.

A) may have stimulative effects on economic activity in the short run B) contributes to lower interest rates in the long run C) is likely to increase future productive capacity in the long run D) all of the above E) none of the above Answer: A Topic: 4.3 Response to Changes in Saving and Investment in a Closed Economy AACSB: Reflective Thinking 8) An investment tax credit ________.

A) is designed to incentivize higher capital stock expenditures at any given interest rate B) may lead to increases in autonomous investment C) may put upward pressure on the interest rate D) all of the above E) none of the above Answer: D Topic: 4.3 Response to Changes in Saving and Investment in a Closed Economy AACSB: Reflective Thinking

8 .

9) If taxes are reduced, will most people save more or less than before? Does national saving rise or fall? Explain.

Answer: Lower taxes mean higher disposable income, which should encourage increases in both consumption and saving. Reduced government revenue, given government spending, means a decrease in government saving. Since private saving does not rise as much as the decrease in government saving, national saving falls.

Topic: 4.3 Response to Changes in Saving and Investment in a Closed Economy AACSB: Analytical Thinking 4.4 Saving, Investment, and Goods Market Equilibrium in an Open Economy 1) The domestic real interest rate (r) for a given country must be the same as the world real interest rate (rw) ________.

A) if perfect capital mobility is assumed B) because with no barriers to capital flows, if rw > r domestic residents would just borrow abroad putting upward pressures on the domestic rate until both rates equal each other C) because with no barriers to capital flows, if rw < r domestic residents would only lend to foreigners putting downward pressures on the domestic rate until both rates equal each other D) all of the above E) none of the above Answer: A Topic: 4.4 Saving, Investment, and Goods Market Equilibrium in an Open Economy AACSB: Analytical Thinking 2) In the model of the open economy with perfect capital mobility, ________ is an exogenous variable.

A) Y B) C C) I D) S E) r Answer: A Topic: 4.4 Saving, Investment, and Goods Market Equilibrium in an Open Economy AACSB: Analytical Thinking

9 .

3) The domestic real interest rate (r) for a given country must be the same as the world real interest rate (rw) ________.

A) only if capital is not perfectly mobile B) because with no barriers to capital flows, if rw > r domestic residents would just lend abroad putting upward pressures on the domestic rate until both rates equal each other C) because with no barriers to capital flows, if rw < r domestic residents would only lend to foreigners putting downward pressures on the domestic rate until both rates equal each other D) all of the above E) none of the above Answer: B Topic: 4.4 Saving, Investment, and Goods Market Equilibrium in an Open Economy AACSB: Analytical Thinking 4) In an economy open to international trade ________.

A) saving equals investment in equilibrium B) saving is the difference between net exports and investment C) saving equals investment as long as the economy has no exports D) saving equals investment as long as NX=0 E) none of the above Answer: D Topic: 4.4 Saving, Investment, and Goods Market Equilibrium in an Open Economy AACSB: Analytical Thinking 5) In an economy open to international trade ________.

A) saving is net exports added to investment B) saving equals investment as long as NX=0 C) the domestic real interest rate should equal the world real interest rate as long as there is perfect capital mobility D) all of the above E) none of the above Answer: D Topic: 4.4 Saving, Investment, and Goods Market Equilibrium in an Open Economy AACSB: Analytical Thinking 6) In an economy open to international trade ________.

A) saving is the difference between net exports and consumption B) saving equals investment as long as the domestic real interest rate is equal to the world real interest rate C) the domestic real interest rate should equal the world real interest rate as long as the economy is relatively small D) all of the above E) none of the above Answer: E Topic: 4.4 Saving, Investment, and Goods Market Equilibrium in an Open Economy AACSB: Analytical Thinking

10 .

7) In an open economy, Y = C + I + G + NX. From this we may infer that ________.

A) output is greater in an open economy than in a closed economy B) the condition for goods market equilibrium is that S = I + G + NX C) net exports can be zero only if the domestic real interest rate is equal to the world real interest rate D) if saving is greater than zero, NX cannot be zero E) none of the above Answer: E Topic: 4.4 Saving, Investment, and Goods Market Equilibrium in an Open Economy AACSB: Analytical Thinking 8) Suppose an economy has a GDP of $10 trillion, and that its national saving rate is 20%. If investment is 25% of GDP, the value of net exports is ________.

A) negative $500 billion B) $4.5 trillion C) negative $250 billion D) $2 trillion E) none of the above Answer: A Topic: 4.4 Saving, Investment, and Goods Market Equilibrium in an Open Economy AACSB: Analytical Thinking 9) Suppose consumption is $500 billion, investment is $120 billion, government purchases equal $90 billion, and net exports are negative $20 billion. The saving rate is ________.

A) 20% B) 83.3% C) 14.5% D) 3% E) none of the above Answer: C Topic: 4.4 Saving, Investment, and Goods Market Equilibrium in an Open Economy AACSB: Analytical Thinking 10) Suppose GDP is $800 billion, net taxes equal $150 billion, government purchases are $160 billion, investment is $120 billion, and net exports are $5 billion. The private saving rate ________.

A) 19% B) 16% C) 21% D) 18% E) none of the above Answer: C Topic: 4.4 Saving, Investment, and Goods Market Equilibrium in an Open Economy AACSB: Analytical Thinking 11 .

is

4.5 Saving, Investment, and the Trade Balance in a Small Open Economy 1) In an economy open to international trade where the interest rate at which saving and investment would be equal is ________ the world real interest rate ________.

A) above; a trade surplus ensues B) below; a trade deficit ensues C) above; there is a net capital outflow D) below; there is a net capital inflow E) none of the above Answer: E Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Analytical Thinking 2) In an economy open to international trade where the interest rate at which saving and investment would be equal is ________ the world real interest rate ________.

A) above; a trade deficit ensues B) below; there is a net capital outflow C) above; there is a net capital inflow D) all of the above E) none of the above Answer: D Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Analytical Thinking 3) If the world real interest rate were to fall below the rate at which domestic saving and investment would be equal ________.

A) saving would be greater than investment so the economy would be running a trade deficit B) investment would be greater than saving so the economy would be running a trade deficit C) investment would be greater than saving so the economy would be running a trade surplus D) saving would be greater than investment so the economy would be running a trade surplus E) none of the above Answer: B Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Analytical Thinking Saving-Investment Diagram

12 .

4) Based on the Saving-Investment Diagram, if the world real interest rate is indicated by A, then ________.

A) the difference between values G and E measures the trade surplus B) the difference between values G and F measures the trade surplus C) the domestic real interest rate is indicated by B D) desired saving has decreased E) none of the above Answer: A Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Analytical Thinking 5) Based on the Saving-Investment Diagram, if the world real interest rate is indicated by C, then ________.

A) the difference between values H and D measures the net capital outflow B) the difference between values H and D measures the trade deficit C) the domestic real interest rate is indicated by B D) the difference between values H and F measures the trade deficit E) none of the above Answer: B Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Analytical Thinking

13 .

6) Based on the Saving-Investment Diagram, if the difference between values G and E measures the net capital outflow, then ________.

A) the difference between values G and E measures the trade surplus B) the difference between values H and D measures the trade surplus C) the domestic real interest rate is indicated by B D) desired saving has decreased E) none of the above Answer: A Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Analytical Thinking 7) Based on the Saving-Investment Diagram, if the difference between values G and E measures the net capital outflow, then ________.

A) the difference between values G and E measures the trade deficit B) the difference between values H and D measures the trade deficit C) the domestic real interest rate is indicated by C D) desired investment has increased E) none of the above Answer: E Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Analytical Thinking 8) Based on the Saving-Investment Diagram, if the difference between values G and E measures the net capital outflow, then ________.

A) the difference between values H and E measures the trade deficit B) the difference between values F and D measures the trade surplus C) the domestic real interest rate is indicated by A D) the difference between values F and E measures the trade deficit E) none of the above Answer: C Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Analytical Thinking 9) Based on the Saving-Investment Diagram, the difference between values H and E could measure the net capital inflow, if ________.

A) the difference between values H and D measures the trade surplus B) the domestic real interest rate is indicated by A C) desired saving has increased D) desired investment has decreased E) none of the above Answer: C Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Analytical Thinking

14 .

10) Based on the Saving-Investment Diagram, if the domestic real interest rate is indicated by B, then ________.

A) the value of net exports is zero B) the diagram represents a closed economy C) the world real interest rate is indicated by A D) the difference between values F and E measures the net capital inflow E) none of the above Answer: A Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Analytical Thinking 11) Based on the Saving-Investment Diagram, if the world real interest rate declines from A to C, then the change in net exports is measured by the difference between values ________.

A) G and E B) H and G plus E and D C) H and G minus E and D D) G and F plus F and E E) none of the above Answer: B Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Analytical Thinking 12) In a small open economy, goods market equilibrium occurs when desired saving minus desired investment equals net exports. Explain.

Answer: The domestic interest rate equals the world interest rate, regardless of the quantities of saving and investment. If saving is greater than investment at this interest rate, the excess of saving is used to purchase foreign assets. Then, the money paid to acquire foreign assets returns to purchase domestic goods, increasing net exports. If saving is lower than investment, domestic assets are being sold to foreigners, a capital inflow that enables the purchase of imports, reducing net exports.

Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Reflective Thinking 13) If desired saving increases in a small open economy, net exports (net capital outflow) rise.

What happens to net exports if desired saving rises in most of the world's economies at the same time?

Answer: An increase in global saving reduces the world real interest rate, which lowers saving and raises investment in all open economies. This counteracts the initial increase in saving. In some economies, where the initial increase in saving is relatively small, the effect of the reduced interest rate will dominate, so that net exports (net capital outflow) will decline.

Topic: 4.5 Saving, Investment, and the Trade Balance in a Small Open Economy AACSB: Reflective Thinking

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4.6 Response to Changes in Saving and Investment in a Small Open Economy 1) If there is a decline in world autonomous consumption ________.

A) the domestic real interest rate would fall B) domestic investment would rise C) net exports would fall D) all of the above E) none of the above Answer: D Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking 2) If there is a decline in world autonomous consumption ________.

A) domestic investment would decline B) the domestic real interest rate would fall C) net exports would go up D) all of the above E) none of the above Answer: B Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking 3) Which of the following would lead domestic investment to rise?

A) a decline of government spending throughout the world B) an increase in world taxes C) a decrease in world autonomous consumption D) all of the above E) none of the above Answer: D Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking 4) Which of the following would lead domestic investment to rise?

A) an increase in government spending throughout the world B) an increase in world taxes C) an increase in world autonomous consumption D) all of the above E) none of the above Answer: B Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking

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5) If there is a decrease in world taxes ________.

A) domestic investment would fall B) net exports would increase C) domestic interest rates would go up D) all of the above E) none of the above Answer: D Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking 6) If there is an increase in world taxes ________.

A) domestic investment would fall B) net exports would increase C) the domestic interest rate would go down D) all of the above E) none of the above Answer: C Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking 7) If there is a decrease in world investment ________.

A) domestic investment would fall B) net capital outflow would increase C) the domestic interest rate would go up D) all of the above E) none of the above Answer: E Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking 8) If there is a decrease in world investment ________.

A) domestic saving would rise B) net exports would decrease C) domestic output would go up D) all of the above E) none of the above Answer: B Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking

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9) A small open economy would typically enjoy a higher trade balance if, in the domestic economy, ________.

A) autonomous consumption expenditures decrease B) taxes go up C) government spending decreases D) all of the above E) none of the above Answer: D Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking 10) A small open economy would typically enjoy a higher trade balance if, in the domestic economy, ________.

A) autonomous consumption expenditures increase B) taxes decrease C) government spending decreases D) all of the above E) none of the above Answer: C Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking 11) The concept of twin deficits refers to ________.

A) the phenomenon of simultaneous trade and government budget deficits B) the phenomenon of simultaneous government and private budget deficits C) the phenomenon of simultaneous state and federal budget deficits D) all of the above E) none of the above Answer: A Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy 12) An increase in autonomous investment in a small open economy will cause ________.

A) a trade surplus to shrink B) a trade deficit to increase C) lower net capital outflows D) all of the above E) none of the above Answer: D Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking

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13) An increase in autonomous investment in a small open economy will cause ________.

A) a trade surplus to shrink B) a trade deficit to shrink C) higher net capital outflows D) all of the above E) none of the above Answer: A Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking 14) When an economy becomes attractive to global investors, sparking a capital inflow, one result is often a decrease in net exports. Why? Answer: The capital inflow reflects an increase in desired investment in the economy. With no change in desired saving, and total output fixed in the short run, the increase in investment spending must either displace exports or increase spending on imports, causing net exports to fall.

Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Analytical Thinking 15) In an open economy, an increase in saving might not cause an increase in domestic investment. Why not? Does that mean that an increase in saving is undesirable?

Answer: An increase in saving can affect the domestic real interest rate only by changing the world interest rate. If the world interest rate does not change, domestic investment is not affected. More saving means less consumption, which reduces both imports and domestic demand for domestic output, so exports (and net exports) rise. The increase in saving must correspond to investment somewhere, but not necessarily in the economy where the saving originates. Nonetheless, wealth rises for those who accomplish the higher saving.

Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Reflective Thinking 16) If policymakers in an open economy want to increase the wealth of their citizens, should they seek to increase saving, or to increase investment? Explain.

Answer: Policies to increase investment will increase the domestic capital stock. However, this adds nothing to citizens' wealth, unless saving has increased. If saving is fixed, the increase in investment is financed either by foreigners (net capital inflow) or by a diversion of domestic saving from foreign assets to domestic assets (reduced net capital outflow). Policies to increase saving, if effective, will increase domestic wealth, regardless of the level of domestic investment.

Topic: 4.6 Response to Changes in Saving and Investment in a Small Open Economy AACSB: Reflective Thinking

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4.7 Large Versus Small Open Economies 1) The saving-investment analysis for large open economies is somewhat more complicated than the analysis for small open economies mainly because ________.

A) there is more information to keep track of for larger economies B) there are more unknowns in larger economies C) a larger economy may actually affect the world economy D) all of the above E) none of the above Answer: C Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking 2) Which of the following is an exogenous variable in the model of a small open economy, but an endogenous variable in the model of a large open economy?

A) B) C C) Y D) NX E) G Answer: A Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking 3) Which of the following is true of a small open economy, but not of a large open economy?

A) Net exports are unlikely to be close to zero.

B) The domestic real interest rate is equal to the world real interest rate.

C) Changes in desired investment result in changes in the trade balance.

D) Changes in desired investment result in changes in actual investment.

E) none of the above Answer: E Topic: 4.7 Large Versus Small Open Economies AACSB: Reflective Thinking 4) If we observe an economy in which desired saving has changed, but there has been no change in actual investment, we may infer that ________.

A) net exports have changed B) actual saving has changed C) the domestic real interest rate has not changed D) all of the above E) none of the above Answer: D Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking

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5) If we observe an economy in which desired saving has changed, but there has been no change in actual investment, we may infer that ________.

A) this is a closed economy B) this is a large economy C) the trade balance has changed in the same direction as the change in desired saving D) all of the above E) none of the above Answer: C Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking 6) If we observe an economy in which desired saving has changed, but there has been no change in actual investment, we may infer that ________.

A) this is a closed economy B) this is a large economy C) the world real interest rate has not changed D) all of the above E) none of the above Answer: C Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking 7) Suppose the world economy is divided into two halves. In Region A, all economies experience a decrease in desired saving, while desired saving is unchanged in Region B. If there is open trade and perfect capital mobility across the two regions, which of the following is true?

A) Actual saving in Region B has increased.

B) Actual investment in Region A has increased.

C) Region A's imports from Region B have decreased.

D) all of the above E) none of the above Answer: A Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking 8) Suppose the world economy is divided into two halves. In Region A, all economies experience a decrease in desired saving, while desired saving is unchanged in Region B. If there is open trade and perfect capital mobility across the two regions, which of the following is true?

A) Actual investment in Region B has increased.

B) There is a net capital flow from Region B to Region A. C) Actual investment in Region A has increased.

D) all of the above E) none of the above Answer: B Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking

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9) An increase in ________ in an open economy of any size leads to ________.

A) desired saving; an increase in net capital outflows B) desired investment; a decrease in net capital outflows C) desired saving; an increase in the trade balance D) all of the above E) none of the above Answer: D Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking 10) In a large open economy, an increase in ________ leads to ________.

A) desired saving; an increase in the domestic interest rate B) desired investment; an decrease in the domestic interest rate C) desired saving; an increase in desired investment D) desired saving; a decrease in actual investment E) none of the above Answer: E Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking 11) In a large open economy ________.

A) the effect of shifts in saving and investment on the trade balance are in the same direction as in a closed economy B) the effect of shifts in saving and investment on net capital flows are in the same direction as in a closed economy C) the effect of shifts in saving and investment on the domestic real interest rate and the actual levels of saving and investment are in the same direction as in a closed economy D) all of the above E) none of the above Answer: C Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking 12) In a large open economy ________.

A) the effect of shifts in saving and investment on the trade balance are in the same direction as in a small open economy B) the effect of shifts in saving and investment on net capital flows are in the same direction as in a small open economy C) the effect of shifts in saving and investment on the domestic real interest rate and the actual levels of saving and investment are in the same direction as in a closed economy D) all of the above E) none of the above Answer: D Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking

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13) China is a large open economy with an extraordinarily high saving rate. If, as seems likely, there is a decrease in desired saving in the coming years, what effects should we expect to see on China's trade balance (net capital flow), domestic real interest rate, and actual levels of saving and investment?

Answer: A decrease in desired saving leads to a decrease in the trade balance (net capital outflow), and an increase in the domestic real interest rate. The higher interest rate will prevent actual saving from falling as much as it would otherwise, but actual saving does decline. The higher interest rate causes actual investment to decline, reducing the size of the decline in the trade balance (net capital outflow).

Topic: 4.7 Large Versus Small Open Economies AACSB: Analytical Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 5 Money and Inflation 5.1 What Is Money?

1) Money is not ________.

A) income because the former is a stock measure and the latter a flow B) wealth because the latter is generally used to procure the former C) as desirable as barter because the latter is more efficient than the former D) all of the above E) none of the above Answer: A Topic: 5.1 What Is Money?

AACSB: Reflective Thinking 2) Money is not ________.

A) income because the former is a stock measure and the latter a flow B) wealth because the former is generally used to procure the latter C) as inefficient as barter because the latter requires a double coincidence of wants D) all of the above E) none of the above Answer: D Topic: 5.1 What Is Money?

AACSB: Reflective Thinking 3) Money is ________.

A) an asset B) a unit of measure C) a tool D) all of the above E) none of the above Answer: D Topic: 5.1 What Is Money?

AACSB: Reflective Thinking 4) Money serves as ________.

A) a unit of account B) a store of value C) a medium of exchange D) all of the above E) none of the above Answer: D Topic: 5.1 What Is Money?

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5) Wealth ________.

A) may serve the monetary function of store of value B) means essentially the same as money C) differs from money in that wealth is more liquid D) is the flow that corresponds to the stock of income E) none of the above Answer: A Topic: 5.1 What Is Money?

AACSB: Reflective Thinking 6) Someone who has just inherited a "goldmine" has received a great deal of ________.

A) wealth B) money C) income D) currency E) liquidity Answer: A Topic: 5.1 What Is Money?

AACSB: Reflective Thinking 7) Fred has always been known as "the rich kid." Strictly speaking, this must mean that ________.

A) Fred has a lot of cash B) Fred's income is quite high C) Fred won the lottery before he was legally eligible D) Fred has a flashy wardrobe E) Fred has a lot of wealth Answer: E Topic: 5.1 What Is Money?

AACSB: Reflective Thinking 8) The phrase "double coincidence of wants" ________.

A) is useful to explain why barter is an efficient practice B) refers to two people who have similar tastes C) suggests a quite improbable circumstance D) clarifies the distinction between income and wealth E) none of the above Answer: C Topic: 5.1 What Is Money?

AACSB: Reflective Thinking

2 .

9) The most liquid asset is ________.

A) stocks B) bonds C) cash D) real estate E) none of the above Answer: C Topic: 5.1 What Is Money?

10) Subject to a few legal and practical restrictions, anything may be exchanged for anything else. The distinctive advantage of money is that ________.

A) it is likely to retain its value, whether it is kept or exchanged B) it has little, if any, use other than exchange C) it can generate income while it is kept D) it is likely to be accepted by everyone in exchange for anything E) none of the above Answer: D Topic: 5.1 What Is Money?

AACSB: Reflective Thinking 11) Which of the following is most like money?

A) game arcade tokens B) board game "money" C) credit cards D) baseball trading cards E) frequent flyer miles Answer: A Topic: 5.1 What Is Money?

AACSB: Reflective Thinking 12) A prisoner of war camp seems a likely place for "cigarette money," because ________.

A) nearly all prisoners smoke cigarettes B) of the absence of better alternatives C) cigarettes are abundant and easy to count D) the guards can enforce the practice of accepting cigarettes as a medium of exchange E) cigarettes retain their value over time Answer: B Topic: 5.1 What Is Money?

AACSB: Reflective Thinking

3 .

13) Characteristics that enable an item to serve well as money include each of the following, except ________.

A) durable B) abundant C) divisible D) portable E) verifiable Answer: B Topic: 5.1 What Is Money?

AACSB: Reflective Thinking 14) Suppose you have a collection of gold coins from the 19th century. Comment on their suitability to provide for you each of the three functions of money.

Answer: The coins are an exceptional store of value. They would serve well as a medium of exchange, eagerly accepted by most people. They are a poor unit of account, since their value fluctuates a great deal relative to other goods. The face value of the coins is not a reliable indicator of their worth relative to other goods. This is because they are valued primarily as a store of value (and historical/artistic artifacts), rather than as a medium of exchange.

Topic: 5.1 What Is Money?

AACSB: Reflective Thinking 5.2 The Federal Reserve System and the Control of the Money Supply 1) In modern economies, the supply of money depends mainly on the economy's ________.

A) tax rates B) mining of precious metals C) net exports D) growth of output of goods and services E) none of the above Answer: E Topic: 5.2 The Federal Reserve System and the Control of the Money Supply AACSB: Reflective Thinking 2) In addition to the chairman of the Board of Governors, the FOMC consists of ________.

A) six rotating members of the Board of Governors and five presidents of Federal Reserve banks B) six other members of the Board of Governors, four rotating bank presidents and the president of the New York Federal Reserve C) six other members of the Board of Governors and five presidents of Federal Reserve banks; all twelve rotating members D) twelve Federal Reserve Bank presidents E) none of the above Answer: B Topic: 5.2 The Federal Reserve System and the Control of the Money Supply

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3) The Federal Reserve System consists of ________.

A) eleven district banks and a board of governors B) ten district banks and the FOMC C) eleven district banks D) twelve district banks and a board of governors E) none of the above Answer: D Topic: 5.2 The Federal Reserve System and the Control of the Money Supply 4) The FOMC ________.

A) meets four times a year to decide on how to conduct open market operations that influence the money supply B) meets six times a year to decide on how to conduct open market operations that influence the money supply and interest rates C) meets eight times a year to decide on how to conduct open market operations that influence the money supply and interest rates D) meets twelve times a year to decide on how to conduct open market operations that influence interest rates E) none of the above Answer: C Topic: 5.2 The Federal Reserve System and the Control of the Money Supply 5) Open Market operations consist mainly of ________.

A) the government buying and selling private securities in the open market B) the Fed buying and selling government securities in the open market C) the government selling its own securities in the open market D) the Fed setting rates for securities traded in the open market E) none of the above Answer: B Topic: 5.2 The Federal Reserve System and the Control of the Money Supply 6) When the Fed sells government securities in the open market, the money supply ________ because ________.

A) decreases; banks lose liquidity, they make fewer loans and checking account deposits decrease B) increases; banks gain liquidity, they make more loans and checking account deposits increase C) increases; banks lose liquidity, they make more loans and checking account deposits increase D) decreases; banks gain liquidity, they make fewer loans and checking account deposits decrease E) none of the above Answer: A Topic: 5.2 The Federal Reserve System and the Control of the Money Supply AACSB: Analytical Thinking

5 .

7) When the Fed buys government securities in the open market, the money supply ________ because ________.

A) decreases; banks lose liquidity, they make fewer loans and checking account deposits decrease B) increases; banks gain liquidity, they make more loans and checking account deposits increase C) increases; banks lose liquidity, they make more loans and checking account deposits increase D) decreases; banks gain liquidity, they make fewer loans and checking account deposits decrease E) none of the above Answer: B Topic: 5.2 The Federal Reserve System and the Control of the Money Supply AACSB: Analytical Thinking 8) Open market operations alter the money supply by ________.

A) influencing banks' ability to make loans to individuals and corporations B) adding currency to or withdrawing currency from banks' vaults C) adding currency to or withdrawing currency from the checking accounts of individuals and corporations D) influencing banks' ability to make loans to the government E) none of the above Answer: A Topic: 5.2 The Federal Reserve System and the Control of the Money Supply AACSB: Analytical Thinking 9) Which of the following is true for the European Central Bank (ECB)?

A) its executive board meets more often than the FOMC B) each member country's central bank has similar functions to the Federal Reserve Banks C) it is housed in Frankfurt, Germany D) all of the above E) none of the above Answer: D Topic: 5.2 The Federal Reserve System and the Control of the Money Supply 10) Which of the following is true for the European Central Bank (ECB)?

A) its executive board meets less often than the FOMC B) the members of its executive board have lifetime appointments C) it is a more decentralized system than the Federal Reserve D) all of the above E) none of the above Answer: C Topic: 5.2 The Federal Reserve System and the Control of the Money Supply AACSB: Reflective Thinking

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11) Both the Federal Reserve System in the United States and the European Central Bank are comprised of geographically dispersed Banks. How might such decentralization contribute to successful monetary policy?

Answer: The economies of both the U.S. and Europe encompass many regions with distinct economic specializations, income levels, demographics, etc. Policymakers need to be aware of this heterogeneity and of how the policies under consideration might impact some regions differently than others. Having had a role in the design and selection of policies, officials and citizens at the regional level will be more willing and able to support and to implement the policies.

Topic: 5.2 The Federal Reserve System and the Control of the Money Supply AACSB: Reflective Thinking 5.3 Measuring Money 1) The Fed's narrowest measure of money is ________.

A) M1 B) M2 C) M3 D) all of the above E) none of the above Answer: A Topic: 5.3 Measuring Money 2) M1 differs from M2 because ________.

A) M2 includes components that are less liquid than any component of M1 B) M1 does not include savings deposits and M2 does C) M1 is included in M2 but M2 has more components D) all of the above E) none of the above Answer: D Topic: 5.3 Measuring Money AACSB: Analytical Thinking 3) M1 differs from M2 because ________.

A) M1 includes demand deposits and M2 does not B) M1 includes currency held by the nonbank public and M2 includes only currency held by banks C) M2 includes interest bearing time deposit accounts and M1 does not D) all of the above E) none of the above Answer: C Topic: 5.3 Measuring Money AACSB: Analytical Thinking

7 .

4) M1 differs from M2 because ________.

A) M1 is less liquid than M2 B) M1 includes demand deposits and M2 does not C) M1 includes only the most liquid forms of money and M2 includes all of M1 and some less liquid items D) all of the above E) none of the above Answer: C Topic: 5.3 Measuring Money AACSB: Analytical Thinking 5) M1 does not include cash that is held in ATMs or bank vaults, because ________.

A) no one really owns that money B) that money is included in M2 C) that money earns no interest D) the right to access that money is counted already as bank deposits E) none of the above Answer: D Topic: 5.3 Measuring Money AACSB: Analytical Thinking 6) Financial innovations such as direct deposit of paychecks, electronic payment of bills, and automated teller machines (ATMs) have likely ________.

A) had minimal effect on M1 and M2 B) reduced the size of M2 relative to M1 C) increased both M1 and M2 relative to GDP D) caused the growth rates of M1 and M2 to become more stable E) reduced the size of M1 relative to M2 Answer: E Topic: 5.3 Measuring Money AACSB: Reflective Thinking 7) Typically, when someone borrows money from a bank, M2 ________, because ________.

A) increases; the money is held for a while in a liquid form B) decreases; the money is held for a while in a liquid form C) does not change; the loan affects only the subcategories within M2 D) decreases; of the decline in the bank's vault cash E) none of the above Answer: A Topic: 5.3 Measuring Money AACSB: Analytical Thinking

8 .

8) Which of these transactions results in an increase in M1?

A) withdrawal of $100 cash from your checking account B) certificate of deposit matures, adding $520 to your checking account C) depositing a bank loan of $400 into your savings account D) depositing a $300 paycheck into your savings account E) none of the above Answer: B Topic: 5.3 Measuring Money AACSB: Analytical Thinking 9) Which of these transactions results in an increase in M2?

A) certificate of deposit matures, adding $520 to your checking account B) withdrawal of $100 cash from your checking account C) depositing a bank loan of $400 into your savings account D) depositing a $300 paycheck into your savings account E) none of the above Answer: C Topic: 5.3 Measuring Money AACSB: Analytical Thinking 10) If the euro replaces the U.S. dollar as the world's most popular currency, that will likely ________.

A) reduce M1, without affecting M2 B) reduce M2, without affecting M1 C) cause a temporary increase in M1 D) affect neither M1 nor M2 E) none of the above Answer: E Topic: 5.3 Measuring Money AACSB: Reflective Thinking 11) Current Federal Reserve policy focuses on interest rates, rather than on monetary aggregates, because ________.

A) monetary aggregates do not provide clear or consistent signals to guide policymakers B) open market operations affect interest rates more directly than they affect monetary aggregates C) according to the Fisher effect, the interest rate is a key determinant of the inflation rate D) all of the above E) none of the above Answer: A Topic: 5.3 Measuring Money

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12) As of 2013, the outstanding U.S. currency is more than $1 trillion, which suggests that the typical U.S. citizen holds $3,600 in cash. Is this an accurate inference? Why? A) Yes; because dividing total currency by total U.S. population roughly works out to $3,600 per person.

B) No; because criminals and foreigners hold large sums of dollars, so the average citizen holds far less.

C) No; because the average citizen probably does not have $3,600 in her checking account.

D) Yes; because the Fed rarely makes accounting mistakes when computing M1.

E) none of the above Answer: B Topic: 5.3 Measuring Money AACSB: Analytical Thinking 13) The principal reason(s) that so much U.S. currency is held outside the U.S is (are) ________.

A) many people around the world trust the U.S. dollar more than any other currency B) banks all around the world find it convenient to hold large amounts of U.S. dollars C) U.S. citizens and corporations spend a lot of dollars abroad D) all of the above E) none of the above Answer: A Topic: 5.3 Measuring Money 14) Recent financial turmoil has caused many people to increase saving and to prefer assets that are perceived to be relatively safe and liquid. What are the likely effects on M1 and M2?

Answer: Increased saving implies reduced consumption, so holding of the most liquid assets, M1, should decline. Instead, people will hold more of the less liquid, interest-bearing assets within M2. If people are shifting away from illiquid assets like corporate stock in favor of assets like money market mutual fund shares, then M2 should rise.

Topic: 5.3 Measuring Money AACSB: Reflective Thinking 15) Credit cards are a popular means of payment. Why are credit card accounts not included in M1 or M2? Are credit cards of no relevance to these money measures?

Answer: A purchase using a credit card is the same as taking out a loan. In the transaction, no medium of exchange passes between the buyer and the seller. At a later time, the seller receives a payment, and the buyer must give a corresponding amount to the credit card issuer. The use of credit cards does tend to reduce M1 relative to M2, since many transactions can be covered by a single monthly payment on ones credit card account, reducing the desired quantities of cash and checking account balances.

Topic: 5.3 Measuring Money AACSB: Reflective Thinking

10 .

5.4 Quantity Theory of Money 1) The quantity theory of money ________.

A) is the product of classical economists B) links total income to a country's supply of money C) is derived from the equation of exchange D) all of the above E) none of the above Answer: D Topic: 5.4 Quantity Theory of Money 2) The quantity theory of money ________.

A) is the product of Keynesian economists B) links total income to a country's supply of money C) is also known as the equation of exchange D) all of the above E) none of the above Answer: B Topic: 5.4 Quantity Theory of Money 3) The quantity theory of money ________.

A) was best explained by Fisher's book "The Purchasing Power of Money" B) links total money supply to a country's demand for money C) is also known as the equation of exchange D) all of the above E) none of the above Answer: A Topic: 5.4 Quantity Theory of Money 4) The quantity theory of money explains how ________ depends on ________.

A) real GDP; the money supply B) the price level; the demand for money C) the money supply; the velocity of money D) all of the above E) none of the above Answer: E Topic: 5.4 Quantity Theory of Money 5) The velocity of money ________.

A) represents the average number of times a dollar turns over through the year B) provides the link between the money supply and nominal income C) times the money supply should equal total income, according to the equation of exchange D) all of the above E) none of the above Answer: D Topic: 5.4 Quantity Theory of Money 11 .

6) The velocity of money ________.

A) represents the average number of times a dollar is spent in a given year B) indicates the relative importance of cash versus writing checks for purchases C) times the money supply should equal real GDP D) all of the above E) none of the above Answer: A Topic: 5.4 Quantity Theory of Money 7) The equation of exchange ________.

A) states that the quantity of money multiplied by velocity must equal nominal income in a given year B) describes a relationship that is true by definition C) shows that real GDP must equal real money balances times the number of times a dollar turns over in a year D) all of the above E) none of the above Answer: D Topic: 5.4 Quantity Theory of Money 8) The equation of exchange ________.

A) states that the quantity of money divided by velocity must equal nominal income in a given year B) is only an identity if we do not understand the determinants of velocity C) shows that nominal income must equal real money balances times the number of times a dollar turns over in a year D) all of the above E) none of the above Answer: B Topic: 5.4 Quantity Theory of Money 9) According to Irving Fisher, velocity ________.

A) is determined by institutions that affect the way individuals transact B) is affected by institutions only gradually C) is assumed constant in the short run D) all of the above E) none of the above Answer: D Topic: 5.4 Quantity Theory of Money

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10) According to Irving Fisher, velocity ________.

A) is determined by the way banks alone conduct transactions B) equals the number of transactions times the average price per transaction all divided by total money balances C) can change very quickly on short notice D) all of the above E) none of the above Answer: B Topic: 5.4 Quantity Theory of Money 11) The quantity theory of money ________.

A) is formulated in terms of aggregate output because the nominal value of transactions is difficult to measure B) assumes that the nominal value of transactions are a constant portion of aggregate output C) assumes velocity is constant in the short run D) all of the above E) none of the above Answer: D Topic: 5.4 Quantity Theory of Money 12) The quantity theory of money ________.

A) is formulated in terms of aggregate output because the nominal value of transactions is difficult to measure B) tells us how much money is held for a given amount of nominal spending C) implicitly tells us the quantity of money that people want to hold D) all of the above E) none of the above Answer: D Topic: 5.4 Quantity Theory of Money 13) The quantity theory of money tells us that real money balances are proportional to income, since ________.

A) velocity is assumed constant in the short run B) the supply and demand of money are equal in equilibrium C) changes in the quantity of money lead to proportional changes in the price level D) all of the above E) none of the above Answer: D Topic: 5.4 Quantity Theory of Money

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14) From the equation of exchange, if both nominal income and the quantity of money (M) have tripled, while the price level (P) has increased by 50 percent and velocity (V) remains constant, then real output (Y) ________.

A) also triples B) increases by 50 percent C) doubles D) decreases by 50 percent E) none of the above Answer: C Topic: 5.4 Quantity Theory of Money AACSB: Analytical Thinking 15) From the equation of exchange, if both nominal income and the quantity of money (M) have doubled, while the price level (P) has decreased by 50 percent and velocity (V) remains constant, then real output (Y) ________.

A) also doubles B) triples C) quadruples D) decreases by 50 percent E) none of the above Answer: C Topic: 5.4 Quantity Theory of Money AACSB: Analytical Thinking 16) From the equation of exchange, if both real income (Y) and the quantity of money (M) double and the price level (P) remains constant, then velocity (V) ________ and nominal income ________.

A) remains constant; doubles B) doubles; remains constant C) doubles; doubles D) decreases by 50 percent; quadruples E) none of the above Answer: A Topic: 5.4 Quantity Theory of Money AACSB: Analytical Thinking 17) In the quantity theory of money, which of these variables is endogenous?

A) the price level B) the velocity of money C) real output D) the money supply E) none of the above Answer: A Topic: 5.4 Quantity Theory of Money AACSB: Analytical Thinking

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18) In the quantity theory of money, the assumption that aggregate output is fixed is based on the view that ________.

A) wages and prices are perfectly flexible in the long run B) the velocity of money is constant in the short run C) the demand for real money balances is proportional to income D) changes in the quantity of money lead to proportional changes in the price level E) none of the above Answer: A Topic: 5.4 Quantity Theory of Money 19) The quantity theory of money ________.

A) is used by classical economist to explain how changes in the quantity of money lead to proportional changes in the price level B) gives mathematical grounding for the view that a country's central bank determines the general price level through control of the money supply C) implies that changes in the money supply have no long run impact on real variables D) all of the above E) none of the above Answer: D Topic: 5.4 Quantity Theory of Money 20) The quantity theory of money ________.

A) is used by classical economists to explain how frequent changes in velocity lead to infrequent changes in the price level B) gives mathematical grounding for the view that a country's central bank determines the general price level through control of the money supply C) implies that changes in the money supply never have an impact on real variables D) all of the above E) none of the above Answer: B Topic: 5.4 Quantity Theory of Money 21) The proposition that changes in the money supply have no long-run effect on real variables is known as the ________.

A) classical dichotomy B) quantity theory of money C) neutrality of money D) Fisher effect E) none of the above Answer: C Topic: 5.4 Quantity Theory of Money

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22) The proposition that the amount of goods and services produced in an economy in the long run is not affected by the price level is known as the ________.

A) neutrality of money B) classical dichotomy C) quantity theory of money D) Fisher effect E) none of the above Answer: B Topic: 5.4 Quantity Theory of Money 23) The proposition that the velocity of money is fairly constant in the long run is known as the ________.

A) neutrality of money B) classical dichotomy C) quantity theory of money D) Fisher effect E) none of the above Answer: E Topic: 5.4 Quantity Theory of Money 24) The quantity theory of money ________.

A) implies that inflation equals the ratio of the growth rates of the money supply and of real income B) provides central banks with a tool to prevent the rate of inflation from fluctuating C) implies that, in the long run, changes in the money supply will be matched by changes in real income D) all of the above E) none of the above Answer: E Topic: 5.4 Quantity Theory of Money 25) The quantity theory of money ________.

A) focuses mainly on the close link between short run fluctuations in velocity and the price level B) works very well for the U.S. but it does not hold empirically for other countries in the long run C) provides a long run theory of inflation because it is based on the assumption that prices and wages are fully flexible D) all of the above E) none of the above Answer: C Topic: 5.4 Quantity Theory of Money

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26) The quantity theory of money ________.

A) suggests that inflation is always and everywhere a monetary phenomenon which has been shown to always be supported by the data B) validates the classical assumption that wages and prices are completely flexible in the short run C) provides a better description of short run fluctuations in inflation and money growth than the link between these variables in the long run D) all of the above E) none of the above Answer: E Topic: 5.4 Quantity Theory of Money 27) How have financial innovations such as direct deposit of paychecks, electronic payment of bills, and automated teller machines (ATMs) affected the velocity of money and the demand for real money balances?

Answer: Because of these innovations, each unit of money is more quickly and easily available for transactions. Each unit of money is transacted more frequently, so velocity is increased. A given volume of transactions can be accomplished with fewer units of money, so the demand for real balances is reduced.

Topic: 5.4 Quantity Theory of Money AACSB: Reflective Thinking 28) Suppose Y = 100, P = 80, and V = 3.2. If Y rises to 105, and the inflation rate is 10 percent, what is the new value of M? Answer: 105 × 88 = 9,240 = M × 3.2. M = 2,887.5. Equivalently, 100 × 80 = M × 3.2, so M = 2,500. Since P × Y rises from 8,000 to 9,240, an increase of 15.5%, M must rise by 15.5% = 2,500 × 1.155 = 2,887.5 Topic: 5.4 Quantity Theory of Money AACSB: Analytical Thinking

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5.5 Hyperinflation 1) Hyperinflation typically ________.

A) describes periods of extreme price increases of over 50% per month or 1,000% per year B) is a result of extreme periods of money growth that tend to come from large fiscal imbalances C) affects both poor and developed economies D) all of the above E) none of the above Answer: D Topic: 5.5 Hyperinflation 2) Hyperinflation typically ________.

A) describes periods of extreme price increases of over 10% per year B) is a result of extreme periods of money growth that tend to come from large fiscal imbalances C) affects low-income economies, but is rare among more-developed economies D) all of the above E) none of the above Answer: B Topic: 5.5 Hyperinflation 3) The direct cause of the hyperinflation that plagued Zimbabwe in the 2000s is ________.

A) printing of too much money by the central bank B) government expenditures greatly above revenues C) outlawing of price increases on many commodities D) allowing the use of foreign currencies E) the issuance of a $100 billion bank note Answer: A Topic: 5.5 Hyperinflation 4) The root cause of the hyperinflation that plagued Zimbabwe in the 2000s is ________.

A) printing of too much money by the central bank B) government expenditures greatly above revenues C) outlawing of price increases on many commodities D) allowing the use of foreign currencies E) the issuance of a $100 billion bank note Answer: B Topic: 5.5 Hyperinflation

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5) The main reason that hyperinflation renders a currency worthless is that ________.

A) the government cannot print money fast enough to keep up with the rising prices B) laws against raising prices are easily evaded C) reducing government expenditures is politically unpopular D) the government's "official" inflation rate is always a gross understatement E) as soon as inflation seems out of control, everyone knows that the currency will soon lose whatever value it has today Answer: E Topic: 5.5 Hyperinflation AACSB: Reflective Thinking 5.6 Inflation and Interest Rates 1) The real interest rate ________ inflation ________.

A) is unaffected in the long run by; because of the classical dichotomy B) moves one for one with expected; in the long run C) always increases with; but because of the Fisher effect lower expected inflation ensues D) all of the above E) none of the above Answer: A Topic: 5.6 Inflation and Interest Rates AACSB: Reflective Thinking 2) The real interest rate ________ inflation ________.

A) subtracted from the nominal rate yields expected; according to the Fisher equation B) moves one for one, in the long run, with expected; according to the classical dichotomy C) always increases with; but because of the Fisher effect lower expected inflation ensues D) all of the above E) none of the above Answer: A Topic: 5.6 Inflation and Interest Rates AACSB: Reflective Thinking 3) The Fisher effect ________.

A) comes from combining the Fisher equation and the classical dichotomy B) predicts that in the long run nominal rates will rise with increases in expected inflation C) shows that in high inflation we typically see high nominal interest rates D) all of the above E) none of the above Answer: D Topic: 5.6 Inflation and Interest Rates AACSB: Reflective Thinking

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Figure 5.1

4) Figure 5.1 provides support for the Fisher effect, by ________.

A) displaying a positive relationship between the inflation rate and the nominal interest rate B) showing how developed economies like the U.S. and Japan have less inflation than economies like Turkey and Indonesia C) focusing on short-run fluctuations, rather than long run averages D) plotting observed, rather than expected inflation E) showing that output is unaffected by changes in the money supply Answer: A Topic: 5.6 Inflation and Interest Rates AACSB: Reflective Thinking 5) According to Figure 5.1, the real interest rate is relatively high in ________.

A) Brazil B) Turkey C) Argentina D) Japan E) Indonesia Answer: A Topic: 5.6 Inflation and Interest Rates AACSB: Analytical Thinking 6) According to Figure 5.1, the real interest rate is relatively low in ________.

A) Brazil B) Turkey C) Argentina D) Japan E) Indonesia Answer: B Topic: 5.6 Inflation and Interest Rates AACSB: Analytical Thinking 20 .

7) During the Great Inflation of the 1970s, (a) the growth rates of M1 and M2 were higher than previously, and (b) the growth rate of M2 was much higher than the growth rate of M1. Explain how the high inflation of the decade relates to each of these facts.

Answer: By the quantity theory of money, rapid growth of the money supply (relative to the growth rate of aggregate output) causes the inflation rate to be high. When inflation is high, holding cash and non-interest bearing deposits is costly, so people shift as much money as possible into interest-bearing accounts, so the narrow monetary aggregate M1 does not grow as fast as the broader aggregate M2. By the Fisher effect, nominal interest rates rise with expected inflation, so interest-bearing accounts provide some compensation for inflation.

Topic: 5.6 Inflation and Interest Rates AACSB: Reflective Thinking 5.7 The Cost of Inflation 1) Inflation ________.

A) is costly because the classical dichotomy may not always hold B) that is anticipated (or expected) can be costly C) is costly for many reasons but chief among them is that inflation makes it more difficult to plan for the future D) all of the above E) none of the above Answer: D Topic: 5.7 The Cost of Inflation AACSB: Reflective Thinking 2) With increases in inflation demand for money that does not earn a return decreases. Carrying less cash in our pockets means higher ________.

A) shoe-leather costs B) menu costs C) capital gain tax bills D) all of the above E) none of the above Answer: A Topic: 5.7 The Cost of Inflation 3) With high inflation ________.

A) stock market investors are always worse off than consumers and households B) producers are always worse off than consumers C) creditors are always worse off than debtors D) all of the above E) none of the above Answer: C Topic: 5.7 The Cost of Inflation AACSB: Reflective Thinking

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4) Inflation might lead to ________ because ________.

A) lower demand for stocks; of tax distortions B) lower demand for cash; money does not typically yield interest C) uncertain or uneven demand for goods; higher fluctuations in relative prices make it harder for consumers to compare among goods and make rational consumption decisions D) all of the above E) none of the above Answer: D Topic: 5.7 The Cost of Inflation AACSB: Reflective Thinking 5) Inflation might lead to ________ because ________.

A) higher demand for stocks; as the price level increases so do stock prices B) higher production costs; businesses have to advertise more often due to faster price revisions C) lower transaction costs; we would hold less cash D) all of the above E) none of the above Answer: B Topic: 5.7 The Cost of Inflation AACSB: Reflective Thinking 6) Inflation ________.

A) is more costly when it is anticipated than when it comes as a surprise B) makes it more difficult to plan for the future, whether it is a surprise or not C) induces distortions in the money and goods market but not the labor market D) all of the above E) none of the above Answer: B Topic: 5.7 The Cost of Inflation AACSB: Reflective Thinking 7) Inflation leads to ________.

A) increased variability of relative prices only when it is anticipated B) increased variability of relative prices only when it is unanticipated C) increased variability of relative prices whether inflation is anticipated or not D) lower variability of the general price level only when it is very high E) none of the above Answer: C Topic: 5.7 The Cost of Inflation

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8) Inflation may impose little, if any, cost on the economy, if ________.

A) laws against excessive price increases are enforced effectively B) the government subsidizes menu costs C) price increases are fully anticipated D) the Fisher effect holds true E) the rate of price increase is so slow that people do not feel compelled to alter their behavior Answer: E Topic: 5.7 The Cost of Inflation AACSB: Reflective Thinking 9) Inflation interferes with the functions of money. Which of the three functions is impaired, even when the inflation rate is quite low? Considering higher rates of inflation, which function is affected next? Which function of money is the last to suffer substantial damage from inflation?

Answer: A consequence of even low inflation is to undermine money's function as a store of value. At somewhat higher rates, inflation complicates the use of money as a unit of account, because of increased variability of relative prices. As the inflation rate goes higher, money loses its ability to serve as a medium of exchange.

Topic: 5.7 The Cost of Inflation AACSB: Reflective Thinking 10) How might inflation, even if fully anticipated, prevent the classical dichotomy from holding, even in the long run?

Answer: The classical dichotomy asserts that output is determined solely by the aggregate production function and the quantities of factors available. Inflation is like a negative technology shock that lowers productivity. Shoe-leather and menu costs represent uses of resources that add nothing to aggregate output. Because price increases throughout the economy are spread out over time, it is rational to react to the temporary changes in relative prices, even if the changes are known to be temporary. This causes distortions in the allocation of resources, and temporary, rational distortions are distortions, nonetheless.

Topic: 5.7 The Cost of Inflation AACSB: Reflective Thinking 11) Unanticipated inflation always benefits somebody, so the overall cost cannot be higher than it is for anticipated inflation. Comment.

Answer: It is true that mistaken expectations of inflation cause one party to a transaction to get a better deal than intended, at the expense of the other party. But the true value of that better deal is reduced by the fact that neither party knows, in advance, who will win. Few workers, for example, would prefer to be paid on the basis of a lottery in which losing is as likely as winning.

Moreover, unanticipated inflation is difficult to recognize, even after the fact. If the size of your nominal wage increase exceeds your expectation of inflation, does that mean your real wage is higher, or that your expectation was mistaken? By the time you figure it out, you may have made a wrong decision.

Topic: 5.7 The Cost of Inflation AACSB: Reflective Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 6 The Sources of Growth and the Solow Model 6.1 Economic Growth Around the World 1) The economic growth of the United States over the last half-century ________.

A) is best understood as the result of high levels of saving and investment B) is quite unlike the experience of most other economies C) was driven by rising import purchases D) has been faster than in any other economy Answer: B Topic: 6.1 Economic Growth Around the World AACSB: Reflective Thinking 2) The economic growth of the United States over the last half-century ________.

A) is best understood as the result of high levels of saving and investment B) is quite similar to the experience of most other economies C) was driven by rising import purchases D) has been slower than growth in several other economies Answer: D Topic: 6.1 Economic Growth Around the World AACSB: Reflective Thinking 3) Countries with different initial levels of per capita income may gravitate to a similar level of per capita income. Economists call this phenomenon ________.

A) convergence B) simulation C) gravitation D) depreciation Answer: A Topic: 6.1 Economic Growth Around the World 4) In the past 50 years, per capita income in some countries such as ________ and ________ has hardly changed relative to per capita income in the United States.

A) Mexico; Argentina B) Kenya; Nigeria C) South Korea; India D) France; United Kingdom Answer: A Topic: 6.1 Economic Growth Around the World

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6.2 The Solow Growth Model 1) The per-worker production function is ________.

A) upward-sloping B) downward-sloping C) vertical D) horizontal Answer: A Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking 2) The Solow model is ________.

A) the basic model of how technology changes over time B) the foundation for the classical economic thought of Adam Smith C) one of the dominant explanations of the business cycle D) based on the notion of diminishing marginal product of capital and labor Answer: D Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking 3) In the Solow model, which of the following is an exogenous variable?

A) productivity B) the capital-labor ratio C) consumption per worker D) investment per worker Answer: A Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking 4) In the Solow model, which of the following is an endogenous variable?

A) output per worker B) government spending C) the saving rate D) the depreciation rate Answer: A Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking 5) The positive slope of the per-worker production function illustrates the relationship between per-worker output and ________.

A) diminishing marginal returns B) the capital-labor ratio C) the rate of inflation D) the rate of unemployment Answer: B Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking 2 .

6) The per-worker production function flattens out due to ________.

A) the negative relationship between price and quantity demanded B) the positive relationship between price and quantity demanded C) the diminishing marginal product of capital D) an increase in the general level of prices Answer: C Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking 7) With a closed economy and no government spending, the total demand for output is equal to ________.

A) consumption per-worker plus investment per-worker B) consumption per-worker minus investment per-worker C) consumption per-worker times investment per-worker D) consumption per worker divided by investment per-worker Answer: A Topic: 6.2 The Solow Growth Model 8) In a closed economy ________.

A) investment equals consumption B) investment equals savings C) saving equals consumption D) exports are greater than imports Answer: B Topic: 6.2 The Solow Growth Model 9) If depreciation is equal to investment ________.

A) capital per-worker rises over time B) capital per-worker is stable C) capital per-worker falls over time D) capital per worker equals saving Answer: B Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking 10) If capital per-worker is rising, then ________.

A) depreciation is equal to investment B) depreciation is greater than investment C) depreciation is less than investment D) depreciation is less than consumption Answer: C Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking

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11) If depreciation is less than investment ________.

A) capital per-worker is falling B) capital per-worker is rising C) capital per-worker is constant D) capital per worker is greater than saving Answer: B Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking 12) Changes in the capital stock are caused by changes in ________.

A) the quantity of labor B) depreciation and investment C) depreciation and entrepreneurship D) depreciation and the quantity of labor Answer: B Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking 13) If investment per-worker equals some value X, and depreciation per-worker equals some value Z, then the change in the capital stock per-worker is equal to ________.

A) X+Z B) X-Z C) X times Z D) X divided by Z Answer: B Topic: 6.2 The Solow Growth Model AACSB: Reflective Thinking 14) In the bathtub analogy, which of the following is a stock variable?

A) the amount of investment B) the rate of depreciation C) the amount of capital-per worker D) the Cobb-Douglass value Answer: C Topic: 6.2 The Solow Growth Model 15) If an economy invests more than it loses through depreciation ________.

A) the saving rate will fall B) the saving rate will rise C) the quantity of labor will fall D) the capital stock will expand Answer: D Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking

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16) The loss of capital due to the wearing out of machines is known as ________.

A) saving B) investment C) consumption D) depreciation Answer: D Topic: 6.2 The Solow Growth Model 17) If an economy initially starts away from the steady state ________.

A) output will gradually fall over time B) the economy will converge to the steady state in the long-run C) consumption spending must be greater than investment spending D) consumption spending must rise Answer: B Topic: 6.2 The Solow Growth Model 18) The Solow model suggests that economies with the same aggregate production function, ratio of workers to the total population and saving rates will ________.

A) trade with one another B) start with different initial levels of per capita income C) possess the same rate of depreciation D) experience convergence Answer: D Topic: 6.2 The Solow Growth Model 19) Strong evidence of convergence exists for ________.

A) wealthy nations that belong to the Organization for Economic Cooperation and Development B) both rich and poor nations C) sub-Saharan African economies and the economies of North America D) European and Caribbean economies Answer: A Topic: 6.2 The Solow Growth Model 20) Which of the following had the highest rate of growth during the period 1948-72?

A) West Germany B) Vietnam C) Japan D) The United States of America Answer: C Topic: 6.2 The Solow Growth Model

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21) Within rich economies, there is strong evidence of convergence ________.

A) for regions within a country B) with developing economies C) leading to military conflict D) of capital stocks, rather than output Answer: A Topic: 6.2 The Solow Growth Model 22) Evidence that convergence occurs within economies is drawn in part from the example of ________.

A) Hiroshima and Nagasaki Japan B) North and South Korea C) West and East Germany during the Cold War D) Hong Kong and Singapore Answer: A Topic: 6.2 The Solow Growth Model 23) In the typical bathtub, the flow of water into the tub is controlled by a faucet independently of the quantity of water in the tub. How is the bathtub analogy of the steady state in the Solow model different? How does this difference relate to the phenomenon of convergence?

Answer: In the Solow model, the flow of investment is determined by the fixed rate of saving and the variable level of output, which depends on the stock of capital, the labor input, and the available technology. It is as if the faucet on the tub were controlled by the level of water in the tub. The convergence phenomenon is that economies with low per capita income have relatively high growth rates. But for economies to converge, all of the determinants of output must be similar. Thus, it is not surprising that convergence is not found among large groups of countries.

Among suitably similar economies, evidence of convergence is striking testimony of the importance of diminishing returns. Despite the low level of investment that is feasible in a lowincome economy, the growth impact of new capital there is greater than occurs in an otherwise similar high-income economy in which the level of investment is higher.

Topic: 6.2 The Solow Growth Model AACSB: Reflective Thinking

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Solow Diagram

24) On the diagram above, show the quantity of consumption per worker in equilibrium. If the actual capital per worker were greater than k*, would consumption be higher or lower than it is in equilibrium? Describe what would happen in an economy with such a high level of capital per worker.

Answer: When capital per worker is above its equilibrium value, output per worker is higher, so each worker has more to consume. Total saving/investment is higher, as well, but not enough to replace the capital lost to depreciation. As a result, capital per worker is falling, which brings output and consumption down to their equilibrium levels.

Topic: 6.2 The Solow Growth Model AACSB: Reflective Thinking 25) Output per worker = 4 1/3, the saving rate is 30 percent, and the depreciation rate is 0.133. Calculate the steady-state values of capital per worker and consumption per worker.

Answer: The steady-state capital-labor ratio k* = = 27. Consumption per worker is (1 - s) × 4× = 8.4.

Topic: 6.2 The Solow Growth Model AACSB: Analytical Thinking

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6.3 Saving Rate Changes in the Solow Model 1) A higher rate of saving at the national level will, in the long-run ________.

A) cause a decrease in levels of capital and output B) have no effect on levels of capital and output C) lead to an increase in population growth D) cause an increase in levels of capital and output Answer: D Topic: 6.3 Saving Rate Changes in the Solow Model AACSB: Analytical Thinking 2) On the Solow Diagram, an increase in the saving rate is shown by ________.

A) an upward shift of the depreciation line B) an upward shift of the investment function C) an upward shift of the per-worker production function D) a downward shift of the investment function Answer: B Topic: 6.3 Saving Rate Changes in the Solow Model 3) An increase in the saving rate results in a higher steady state ________.

A) growth rate of capital B) growth rate of output per worker C) level of consumption per worker D) level of capital per worker Answer: D Topic: 6.3 Saving Rate Changes in the Solow Model AACSB: Analytical Thinking 4) In the Solow model, the faster growth of output that results from an increase in the saving rate is temporary, because ________.

A) of diminishing marginal product of capital B) with a larger stock of capital, consumption is encouraged more than investment C) the rising capital stock depreciates at a faster rate D) the economy settles into a steady state in which saving no longer rises Answer: A Topic: 6.3 Saving Rate Changes in the Solow Model AACSB: Analytical Thinking 5) Following an increase in the saving rate, consumption per worker ________.

A) increases B) decreases C) is unaffected D) may either rise or fall Answer: D Topic: 6.3 Saving Rate Changes in the Solow Model AACSB: Analytical Thinking 8 .

6) Suppose an economy is in a steady state, then its saving rate falls, once and permanently. As the economy approaches its new long-run steady state, consumption per worker is ________.

A) falling B) rising C) unaffected D) either rising or falling Answer: A Topic: 6.3 Saving Rate Changes in the Solow Model AACSB: Analytical Thinking 7) International evidence on the relationship of per capita income and the saving rate suggests that ________.

A) a high level of income per person requires a high saving rate B) a high saving rate guarantees a high level of income per person C) a high saving rate might result in a high level of income per person D) a high saving rate requires a high level of income per person Answer: C Topic: 6.3 Saving Rate Changes in the Solow Model 8) In a steady-state economy with no population growth, output per worker is 35, the saving rate is 20 percent, and the depreciation rate is 11 percent. The level of capital per worker is ________.

A) 64 B) 19 C) 39 D) 28 Answer: A Topic: 6.3 Saving Rate Changes in the Solow Model AACSB: Analytical Thinking 9) In a steady-state economy with no population growth, capital per worker is 86, the saving rate is 25 percent, and the depreciation rate is 11 percent. The level of output per worker is ________.

A) 195 B) 38 C) 35 D) 47 Answer: B Topic: 6.3 Saving Rate Changes in the Solow Model AACSB: Analytical Thinking

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10) In a steady-state economy with no population growth, consumption per worker is 45, the saving rate is 25 percent, and the depreciation rate is 15 percent. The level of capital per worker is ________.

A) 75 B) 36 C) 100 D) 27 Answer: C Topic: 6.3 Saving Rate Changes in the Solow Model AACSB: Analytical Thinking Solow Diagram

11) On the diagram above, show the new steady-state capital-labor ratio that results from a decrease in the saving rate. Can you say what has happened to the equilibrium level of consumption per worker?

Answer: As saving/investment falls, the equilibrium capital-labor ratio declines along the depreciation line. As the capital-labor ratio falls, output-per-worker declines along the production function. Beginning from the original equilibrium k* on the graph, the production function is clearly flatter than the depreciation line, so the decline in output is smaller than the decline in saving/investment, so that consumption per worker must be rising. Consumption per worker can fall only if k* is so low that the slope of the production function (at that level of capital per worker) is steeper than the depreciation line.

Topic: 6.3 Saving Rate Changes in the Solow Model AACSB: Reflective Thinking

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12) Consumption per worker is 72, depreciation is 12.5%, and capital per worker is 64. Given the production function y = 20 , show that this economy is in a steady state. If the saving rate should double, what is the new steady-state level of consumption per worker?

Answer: The steady-state capital-labor ratio k* = . Plugging the values above into this equation yields s = 0.1. Putting the given value of k into the production function yields y = 80, so the given value of consumption per worker implies s = 0.1. This is a steady state. (As further confirmation, note that 64 × 0.125 = 8 = saving, so the loss of capital due to depreciation is exactly restored by investment.) If s = 0.2, then k* = 181, so y = 113, and consumption per worker is 113 × 0.8 = 90.

Topic: 6.3 Saving Rate Changes in the Solow Model AACSB: Analytical Thinking 6.4 Population Growth in the Solow Model 1) Other things the same, in the Solow model in the steady state, a higher rate of population growth ________ the level of output per worker.

A) leads to an increase in B) has no long-run effect on C) has an ambiguous effect on D) leads to a decrease in Answer: D Topic: 6.4 Population Growth in the Solow Model AACSB: Analytical Thinking 2) Other things the same, in the Solow model in the steady state, a higher rate of population growth ________ growth rate of output.

A) leads to a higher B) leads to a lower C) has no long-run effect on the D) has an ambiguous effect on the Answer: A Topic: 6.4 Population Growth in the Solow Model AACSB: Analytical Thinking 3) Other things the same, in the Solow model in the steady state, a higher rate of population growth ________ growth rate of output per worker.

A) leads to a higher B) leads to a lower C) has no long-run effect on the D) has an ambiguous effect on the Answer: C Topic: 6.4 Population Growth in the Solow Model AACSB: Analytical Thinking

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4) Population growth is similar to depreciation, in that ________.

A) each lowers the capital-labor ratio B) each tends to encourage saving C) capital wears out faster when used by more workers D) each helps to explain how economies can sustain a positive growth rate of output Answer: A Topic: 6.4 Population Growth in the Solow Model AACSB: Reflective Thinking 5) If output per worker in a steady state is $30,000, depreciation is 13%, the population growth rate is two percent, and the saving rate is 20%, what is the steady state capital-labor ratio?

A) $10,500 B) $85,714 C) $22,500 D) $40,000 Answer: D Topic: 6.4 Population Growth in the Solow Model AACSB: Analytical Thinking 6) Output per worker is 50, the saving rate is 15 percent, the population is growing at one percent, depreciation is 9 percent, and the capital-labor ratio is 80. Consumption per worker is ________.

A) 37.5 B) falling C) 75 D) 68 Answer: B Topic: 6.4 Population Growth in the Solow Model AACSB: Analytical Thinking 7) "Capital dilution" refers to ________.

A) the flow of investment in the "bathtub model" B) the depreciation of capital associated with an increase in the percentage of younger workers C) the decline in the marginal product of capital that results from reliance on new, inexperienced workers D) the decrease in capital per worker that is a direct consequence of an increase in the number of workers Answer: D Topic: 6.4 Population Growth in the Solow Model 8) On the Solow Diagram, an increase in population growth is shown by ________.

A) an upward shift of the depreciation plus capital dilution line B) an upward shift of the investment function C) an upward shift of the per-worker production function D) a downward shift of the investment function Answer: A Topic: 6.4 Population Growth in the Solow Model 12 .

9) The impact of immigration on an economy's steady state capital-labor ratio is reduced to the extent that the immigrants tend to ________ than the native population.

A) save more B) have higher fertility C) have lower income D) be younger Answer: A Topic: 6.4 Population Growth in the Solow Model AACSB: Reflective Thinking 10) A One-Child Policy was instituted in 1979 in ________.

A) Brazil B) South Africa C) India D) China Answer: D Topic: 6.4 Population Growth in the Solow Model 11) According to the Solow model, a benefit of policies to limit population growth might be ________.

A) that smaller families are more likely to contribute to technological advances B) that smaller families have better access to birth control methods and devices C) that smaller families might provide each person a larger share of national income D) that smaller families have less need to save, and so enjoy higher consumption Answer: C Topic: 6.4 Population Growth in the Solow Model AACSB: Reflective Thinking 12) Evidence of a negative correlation between income per capita and population growth rates ________.

A) implies that birth control is most effective in low-income countries B) has not been found in the available data C) is consistent with the Solow model D) suggests that population growth stimulates technological progress Answer: C Topic: 6.4 Population Growth in the Solow Model

13 .

Solow Diagram

13) The diagram above shows a steady state with a constant quantity of labor. Show on the graph how the steady state is determined if the labor force is growing at some constant rate. On the graph, show how to measure the change in consumption per worker that results from growth of the labor force.

Answer: Graphing answers will vary.

Topic: 6.4 Population Growth in the Solow Model AACSB: Analytical Thinking 6.5 Productivity Growth in the Solow Model 1) When an economy experiences a one-time increase in productivity, there is an immediate increase in ________.

A) the saving rate B) the capital-labor ratio C) the depreciation rate D) consumption per worker Answer: D Topic: 6.5 Productivity Growth in the Solow Model AACSB: Analytical Thinking 2) When an economy experiences a one-time increase in productivity, there is an increase in the long-run, steady state value of ________.

A) the growth rate of output B) the depreciation rate C) consumption per worker D) the saving rate Answer: C Topic: 6.5 Productivity Growth in the Solow Model AACSB: Analytical Thinking

14 .

3) Comparing steady states, which of the following is a result of a permanent increase in the saving rate, but is not a consequence of a one-time increase in productivity?

A) an increase in consumption per worker B) a decrease in the marginal product of capital C) an increase in output per worker D) an increase in the growth rate of output Answer: B Topic: 6.5 Productivity Growth in the Solow Model AACSB: Analytical Thinking 4) On the Solow Diagram, an increase in productivity is shown by ________.

A) an upward shift of the depreciation plus capital dilution line B) an upward shift of the investment function C) a downward shift of the depreciation plus capital dilution line D) a downward shift of the investment function Answer: B Topic: 6.5 Productivity Growth in the Solow Model 5) If productivity is growing at some sustained rate g, then output and capital per worker ________.

A) are growing at the same rate g, in a stable steady state B) are growing faster than g, because improving technology encourages a higher rate of saving and investment C) are growing slower than g, because some of the new capital is merely replacing obsolete capital D) are growing faster than g, because productivity does not suffer from diminishing marginal product Answer: D Topic: 6.5 Productivity Growth in the Solow Model AACSB: Analytical Thinking 6) The Solow model implies that continuous growth in productivity at a rate of one percent will result in continuous growth of output per worker at a rate of 1.43%. Thus, if at a point in time output per worker is 270 and productivity rises by one percent, the resulting level of output per worker is ________.

A) 386 B) 273 C) 274 D) 277 Answer: C Topic: 6.5 Productivity Growth in the Solow Model AACSB: Analytical Thinking

15 .

7) A major contribution of the Solow model is its ________.

A) insight into what distinguishes rich economies from poor economies B) explanation of why productivity grows over time C) demonstration that the key to sustained growth is a high level of saving D) encouragement of policies to limit population growth Answer: A Topic: 6.5 Productivity Growth in the Solow Model AACSB: Reflective Thinking 8) In theory, differences in output across economies and over time might be the result of differences in either capital input, labor input, or productivity. The evidence points clearly to productivity as a more likely and powerful source of growth differences. Which aspects of the Solow growth model help to explain why the inputs of capital and labor contribute little to growth of output, relative to productivity?

Answer: Diminishing marginal product undermines the impact on output of increases in either capital or labor. As long as the labor input grows, and saving is sufficient to compensate for depreciation and capital dilution, output can grow at the same rate as the labor input. Faster growth is possible during recovery from an event that has reduced the capital-labor ratio, or in response to an increase in the saving rate. But such growth episodes end as the capital-labor ratio approaches a steady state. A growing stock of capital has a diminishing effect on output, on the one hand, and a linearly-increasing reliance on saving from output on the other. Productivity is subject neither to diminishing marginal returns nor to depreciation & dilution, so nothing impedes the connection from productivity growth to output growth.

Topic: 6.5 Productivity Growth in the Solow Model AACSB: Reflective Thinking 6.6 Summing Up the Solow Model 1) There are no questions for this section.

16 .

6.7 Sources of Economic Growth: Growth Accounting 1) National output is a function of ________.

A) capital and saving B) technology, employment and demand C) labor and depreciation D) labor, technology and capital Answer: D Topic: 6.7 Sources of Economic Growth: Growth Accounting 2) The growth accounting equation suggests that the growth rate of output is equal to the growth rate of ________.

A) total factor productivity plus the contributions of both capital and labor B) total factor productivity minus the rate of depreciation C) capital and labor D) the overall population Answer: A Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 3) Capital and labor are distinct from productivity in that ________.

A) productivity is independent of technology changes B) productivity can only increase over time C) productivity is subject to diminishing returns D) capital and labor are subject to diminishing marginal returns Answer: D Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Reflective Thinking 4) Which of the following is the most difficult to measure? Changes in ________.

A) the size of the labor force B) population C) the quantity of labor D) productivity Answer: D Topic: 6.7 Sources of Economic Growth: Growth Accounting 5) Productivity growth can be measured ________.

A) by dividing output by Kt0.3 Lt0.7 B) by adding the contributions from capital growth and labor growth C) by subtracting the contributions from capital growth and labor growth from the growth of output D) by dividing the growth of output by the contributions from capital growth and labor growth Answer: C Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 17 .

6) Productivity is ________.

A) determined by central bank policy B) the combined effect of monetary and fiscal policy C) the residual component of the production function D) driven by changes in the rate of growth of output Answer: C Topic: 6.7 Sources of Economic Growth: Growth Accounting 7) If productivity growth equals 3.0 percent, the contribution from capital growth 1.2 percent and the contribution from labor growth 2.0 percent, then output growth must equal ________.

A) 2.2 percent B) 4.2 percent C) 6.2 percent D) 7.2 percent Answer: C Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 8) If the contribution from capital and labor growth in a given economy equals 4.0 percent and output growth equals 6.4 percent over that same period of time, then productivity growth must equal ________.

A) 25.6 percent B) 10.4 percent C) 2.4 percent D) 1.6 percent Answer: C Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 9) The slowdown in U.S. economic growth in the period 1974-95 was primarily caused by ________.

A) falling labor growth B) falling capital growth C) falling productivity growth D) none of the above Answer: C Topic: 6.7 Sources of Economic Growth: Growth Accounting 10) The highest rate of U.S. growth was recorded in which of the following periods?

A) 1948-73 B) 1967-83 C) 1974-95 D) 1996-2008 Answer: A Topic: 6.7 Sources of Economic Growth: Growth Accounting

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11) Economic growth ________.

A) is driven by different elements in different economies B) is driven primarily by digital technology C) is driven primarily by labor growth D) cannot be explained using economic models Answer: A Topic: 6.7 Sources of Economic Growth: Growth Accounting Figure 6.1

12) According to Figure 6.1, the average annual rate of growth of the U.S. economy in the period 1948-73 equalled ________.

A) 1.8 percent B) 4.0 percent C) 39 percent D) 697 percent Answer: B Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking

19 .

13) According to Figure 6.1, the average annual rate of growth of the U.S. economy in the period 1996-2011 equalled ________.

A) 0.3 percent B) 2.2 percent C) 30 percent D) 300 percent Answer: B Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 14) According to Figure 6.1, in postwar U.S history ________.

A) productivity growth was always exceeded by labor growth B) labor growth has always exceeded capital growth C) productivity growth has always exceeded capital growth D) output growth has always exceeded productivity growth Answer: D Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 15) According to Figure 6.1, the period from 1974 to 1995 is particularly remarkable for the slow growth of ________.

A) output per worker B) labor input C) output D) capital input Answer: A Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 16) According to Figure 6.1, the period from 1996 to 2011 is particularly remarkable for the rapid growth of ________.

A) productivity B) labor input C) output D) capital input Answer: D Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking

20 .

17) According to Figure 6.1, the period from 1996 to 2011 is particularly remarkable for the slow growth of ________.

A) productivity B) labor input C) output D) capital input Answer: B Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 18) Across national economies which of the following is the most important source of variation in growth rates?

A) labor growth B) capital growth C) productivity growth D) government regulation Answer: C Topic: 6.7 Sources of Economic Growth: Growth Accounting 19) The label 'Asian Tigers' describes the following economies ________.

A) China, South Korea, Singapore and Taiwan B) Hong Kong, Taiwan, South Korea and Singapore C) Singapore, Taiwan, Hong Kong, and China D) South Korea, Singapore, China and Hong Kong Answer: B Topic: 6.7 Sources of Economic Growth: Growth Accounting 20) The growth rate of which of the following is not a component of the growth accounting equation?

A) the capital stock B) labor C) depreciation D) available technology Answer: C Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 21) If the contribution from capital growth equals 3 percent and the contribution from productivity growth equals 1.6 percent, GDP will grow by ________.

A) 1.6 percent B) 4.6 percent C) 4.8 percent D) an unknown value Answer: D Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 21 .

22) If the contribution from capital growth equals 2 percent and the contribution from labor growth equals 4 percent, then GDP ________.

A) will grow by 6 percent B) will grow by 8 percent C) will grow by 2 percent D) will change by an unknown percentage Answer: D Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 23) Given the production function Y = A if output grows by five percent, the capital input grows by five percent, and the labor input grows by two percent, calculate the Solow residual. Calculate the growth rates of output per worker and capital per worker.

Answer: The Solow residual = 0.05 - 0.3 × 0.05 - 0.7 × 0.02 = 0.021. The growth rate of output per worker is 0.05 - 0.02 = 0.03, which is also the growth rate of capital per worker.

Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Analytical Thinking 24) Given the production function Y = A and fixed values for the saving rate and depreciation, if productivity is growing at an average rate of three percent, and the labor input grows at two percent, there is a unique growth rate of capital that is sustainable. That is, if the growth rate of capital is either higher or lower than this steady-state value, then it must eventually change, even if nothing else in the economy changes. Calculate this steady-state growth rate of capital, and explain why it alone is a sustainable rate. [Hint: Use the fact that the growth rates of output and capital per worker are 43% higher than the growth rate of productivity.]

Answer: Since productivity is growing at three percent, capital per worker is growing at 4.3% ( = 0.03 × 1.43). Since labor grows at two percent, capital must grow at 4.3% + 2% = 6.3%.

Putting this into the growth accounting equation: = 0.03 + 0.3 × 0.063 + 0.7 * 0.02 = 0.063.

Thus, capital and output grow at the same rate. If capital were to grow at a faster rate, say eight percent, the growth of output could not keep up: 0.03 + 0.3 × 0.08 + 0.7 × 0.02 = 0.068. A growing capital stock requires enough saving to compensate for depreciation and capital dilution, but saving can increase only as fast as output. If the growth rate of capital were too low, say five percent, output would be growing faster than capital, so saving a constant fraction of output would result in investment that is increasingly large relative to depreciation and capital dilution.

The investment needed to keep capital growing at a constant rate can occur only when output grows at the same rate as the capital stock.

Topic: 6.7 Sources of Economic Growth: Growth Accounting AACSB: Reflective Thinking 6.8 Cross-Country Differences in Growth Accounting Rates 1) There are no questions for this section.

22 .

Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 7 Drivers of Growth: Technology, Policy, and Institutions 7.1 Technology as a Production Input 1) The Solow model is used to explain ________.

A) why some economies experience higher rates of growth than others B) the relationship between price and quantity demanded C) the relationship between the rate of inflation and the rate of unemployment D) the notion of opportunity cost Answer: A Topic: 7.1 Technology as a Production Input AACSB: Analytical Thinking 2) Another term for an economic variable whose value is given is ________.

A) endogenous B) exogenous C) autonomous D) ornamental Answer: B Topic: 7.1 Technology as a Production Input 3) Physical objects are rival in the sense that ________.

A) they are necessarily in opposition to one another B) they are nontrivial C) when they are used in one activity, they cannot be used in another D) some countries possess natural resources, e.g. oil, while some do not Answer: C Topic: 7.1 Technology as a Production Input 4) Which of the following is nonrival in character?

A) labor B) capital C) a desk D) technology Answer: D Topic: 7.1 Technology as a Production Input 5) The ability of an owner of a piece of property to deny its use to others is labeled ________.

A) excludability B) rivalry C) non-rivalry D) lugubrious Answer: A Topic: 7.1 Technology as a Production Input

1 .

6) Capital and labor are distinct from technology since ________.

A) technology is exogenous B) technology is rival in its use C) capital and labor are physical things D) technology is a physical thing Answer: C Topic: 7.1 Technology as a Production Input 7) The nonrivalrous character of technological ideas suggests that ________.

A) patent law protection is ultimately inefficient B) technological change follows a logarithmic pattern C) technology developed in one industry, e.g. the vodka industry, cannot be used in another industry, e.g. the automobile industry D) ideas can be used over and over again Answer: D Topic: 7.1 Technology as a Production Input 8) Which of the following is most easily excludable?

A) ideas B) capital C) technology D) a set of designs or instructions Answer: B Topic: 7.1 Technology as a Production Input 9) Because original ideas are likely to become known and used by others, without the inventor's knowledge or consent, ________.

A) technology is the key driver of economic growth B) new ideas contribute little to economic growth C) we refer to ideas as rival D) technology is inherently exogenous Answer: A Topic: 7.1 Technology as a Production Input AACSB: Reflective Thinking

2 .

7.2 Policies to Promote Productivity 1) Investments in public infrastructure ________.

A) are not subject to diminishing returns B) are a misallocation of national savings C) typically decline during periods of rapid economic growth D) may boost productivity and income Answer: D Topic: 7.2 Policies to Promote Productivity 2) Which of the following groups receives the highest wages?

A) high school drop-outs B) college drop-outs C) individuals who complete a bachelor's degree program D) individuals with advanced degrees Answer: D Topic: 7.2 Policies to Promote Productivity 3) Building infrastructure is left to the government since ________.

A) the cost of such projects would not be economical for any individual firm B) borrowing costs make such projects prohibitively expensive C) inflation tends to erode the real value of debt D) a natural monopoly would result if this activity were undertaken by an individual private firm Answer: A Topic: 7.2 Policies to Promote Productivity 4) The U.S. interstate system was begun under ________.

A) President Franklin Delano Roosevelt in 1933 as part of the New Deal B) President Herbert Hoover in 1923 C) President Dwight D. Eisenhower in 1956 D) President George W. Bush in 2002 after the 9/11 attacks Answer: C Topic: 7.2 Policies to Promote Productivity 5) The Interstate Highway system in the U.S. has boosted economic productivity mainly through ________.

A) the positive impact on tourism B) reduction in transportation costs C) increased competition among fast food restaurants D) increased speed of military deployments Answer: B Topic: 7.2 Policies to Promote Productivity

3 .

6) The knowledge and skills that workers have built up through education and training programs is known as ________.

A) the college premium B) human capital C) productivity D) financial torsion Answer: B Topic: 7.2 Policies to Promote Productivity 7) A key difference between human capital and technology is that ________.

A) human capital is excludable B) human capital is nonrival C) scarce resources are used in the production of human capital D) technology is an input in the production of new technology Answer: A Topic: 7.2 Policies to Promote Productivity AACSB: Reflective Thinking 8) For the period 1915 to 2005, educational improvements in the U.S. labor force contributed what percentage of real per-capita GDP growth?

A) 0.01 B) 15 C) 317 D) 34 Answer: B Topic: 7.2 Policies to Promote Productivity 9) U.S. educational achievements ________.

A) began to stagnate in the 1970s B) have always fallen behind our European and Asian counterparts C) have not had a measurable effect on U.S. growth rates D) have not been duplicated outside the U.S. Answer: A Topic: 7.2 Policies to Promote Productivity 10) Education achievements ________.

A) are a sufficient condition for economic development to occur B) are a guarantee of making a poor country wealthy C) cannot raise human capital D) are both rival and nonrival in character Answer: D Topic: 7.2 Policies to Promote Productivity AACSB: Reflective Thinking

4 .

11) Government spending on child development promotes economic productivity by ________.

A) encouraging research and development B) increasing national savings C) increasing human capital D) building infrastructure Answer: C Topic: 7.2 Policies to Promote Productivity 12) Government spending on public health promotes economic productivity by ________.

A) encouraging research and development B) increasing national savings C) increasing human capital D) building infrastructure Answer: C Topic: 7.2 Policies to Promote Productivity 13) Private businesses tend to spend too little on research and development, because ________.

A) investments to increase the capital stock are a better way to boost productivity B) governments tend to spend too much on research and development C) patent laws make it difficult to reap the benefits of such spending D) technology is often nonexcludable Answer: D Topic: 7.2 Policies to Promote Productivity 14) The three ways government can encourage research and development are ________.

A) patents, foreign aid and direct government spending B) foreign aid, direct government spending and tax incentives C) direct government spending, tax incentives and patents D) tax incentives, patents and foreign aid Answer: C Topic: 7.2 Policies to Promote Productivity 15) Intellectual property rights provided by patent systems typically ________.

A) provide tax incentives to encourage research and development B) allow for the depreciation of capital C) compensate the government for building infrastructure D) last about twenty years Answer: D Topic: 7.2 Policies to Promote Productivity

5 .

16) Entities that buy up patents then try to extract large payments from companies that use similar technologies are known as ________.

A) Solow pirates B) tertiary leeches C) Great Googly Mooglies D) patent trolls Answer: D Topic: 7.2 Policies to Promote Productivity 17) Patent trolls ________.

A) are paid by innovative firms to the federal government B) buy up patents then attempt to extract large payments from firms using similar technology C) develop new machines and machine processes in small-scale firms, rather than large corporations D) can evolve into natural monopolies Answer: B Topic: 7.2 Policies to Promote Productivity 18) The Coca-Cola Company has chosen to keep its soda formula a secret, ________.

A) because soda is a non-rival good B) to preserve its patent rights C) because the soda formula is a rival good D) to reap the benefits of excludability Answer: D Topic: 7.2 Policies to Promote Productivity 19) According to the Solow model, which type of government spending is more likely to raise the long-term growth rate of output per person, spending on infrastructure or spending on research and development?

Answer: Spending on research and development. As a production input, infrastructure is much like capital, subject to diminishing returns. Infrastructure investments are likely to raise the level of output per person, but any effect on the growth rate is likely to be temporary. Spending on research and development, when effective, raises productivity directly. There are no diminishing returns, and improvements in technology may stimulate and enable further improvements, including those funded by private businesses.

Topic: 7.2 Policies to Promote Productivity AACSB: Reflective Thinking

6 .

20) Use the distinction between rival and nonrival to explain the college premium.

Answer: College graduates have acquired knowledge and skills that enable their interaction with other inputs — raw materials, capital goods, and other workers — to be quite productive.

Employees working together enhance the contribution of each other's skills without using up anyone's skills. Indeed, the productive application of skills is a way to strengthen and acquire skill. The skills are nonrival among employees and over time (allowing for periods of rest).

Nonetheless, a single worker can, at any one time, perform just one set of tasks for a particular employer. The skills are rival across employers and tasks. Thus, incentives guide the allocation of skilled workers among available employers and tasks. Workers whose skills make a large contribution in productive tasks will be sought by employers eager to offer a wage that is correspondingly high.

Topic: 7.2 Policies to Promote Productivity AACSB: Reflective Thinking 21) Imagine that encryption and related technologies become so advanced that the knowledge produced by research and development are as excludable as any other good, while technology remains nonrival. In a world in which technology is both nonrival and excludable, do the government policies of government spending on R&D, tax incentives for R&D, and patents continue to make sense?

Answer: If technology were inherently excludable, patent protections would be redundant. Laws against theft would suffice. Both government spending and tax incentives would be justified, because private businesses would allocate resources to research and development based on profit expectations. Because new ideas are costly to produce, private R&D efforts will focus on ideas for which users will be willing to pay a high price, excluding all other potential users. The result is that available ideas are underutilized, given that the true resource cost of using them once they exist is near zero. The underutilization of ideas leads, as well, to underproduction of ideas, since technology is a key input in its own production.

Topic: 7.2 Policies to Promote Productivity AACSB: Reflective Thinking

7 .

7.3 Institutions and Property Rights 1) The legal system in which the law is continually reinterpreted by judges is labeled ________.

A) a Napoleonic system of law B) a tropicalismo system C) a common law system D) a constitutional system Answer: C Topic: 7.3 Institutions and Property Rights 2) According to Nobel Prize winner Douglass North, the most important factor in limiting economic growth in developing countries today is ________.

A) the relatively low level of saving B) the relatively high rate of inflation C) the inability to develop effective low-cost contract enforcement D) the inadequate state of the health care system Answer: C Topic: 7.3 Institutions and Property Rights 3) The legal system based on common law derives from the experience of which country?

A) France B) England C) Germany D) Rome Answer: B Topic: 7.3 Institutions and Property Rights 4) English common law is particularly effective because ________.

A) it was derived from the Napoleonic codes of the period of industrialization B) it is the only system that provides protection for personal property rights C) it is able to evolve over time D) of the diverse character of the British Empire Answer: C Topic: 7.3 Institutions and Property Rights 5) The elements of an effective legal system include ________.

A) strict limits on the ability of judges to interpret law B) a temperate climate C) a large body of legislators D) an adequate supply of lawyers Answer: D Topic: 7.3 Institutions and Property Rights

8 .

6) The Doing Business reports provide information on ________.

A) the size of a country's national debt B) the rate of inflation C) the independence of individual central banks D) how easy it is to conduct business in different parts of the world Answer: D Topic: 7.3 Institutions and Property Rights 7) The Doing Business reports are considered by many economists to have contributed to economic growth and poverty reduction. The effectiveness of the reports may be attributed to ________.

A) their encouragement to governments to reduce impediments to business B) their encouragement to businesses to migrate to business-friendly locations C) their deepening of economists' understanding of economic growth D) their exposing of corrupt officials and practices Answer: A Topic: 7.3 Institutions and Property Rights 8) Governments that steal from their own citizens are known as ________.

A) pure democracies B) kleptocracies C) Mugabes D) antediluvians Answer: B Topic: 7.3 Institutions and Property Rights 9) Which of the following is poorest country?

A) Canada B) Mexico C) Haiti D) New Orleans Answer: C Topic: 7.3 Institutions and Property Rights 10) The amount of foreign aid provided by the United States ________.

A) constitutes a major proportion of federal government outlays B) is the highest in percentage terms for any developed market economy C) averages about 2.7 percent of U.S. income per year D) is a very small percentage of gross national income Answer: D Topic: 7.3 Institutions and Property Rights

9 .

11) Extreme global poverty is defined as ________.

A) income of less than one dollar a day B) foreign debt in excess of 100% of GDP C) one percent of U.S. income D) one-fourth of U.S. income Answer: A Topic: 7.3 Institutions and Property Rights 12) Mobutu Sese Seko was President of ________.

A) Canada B) Zaire C) Cote d'Ivoire D) Tajikistan Answer: B Topic: 7.3 Institutions and Property Rights 13) The impact of foreign aid on developing countries has been reduced by ________.

A) the low rate of saving in these countries B) the Marshall Plan C) the misuse of foreign aid funds by corrupt governments D) the low rate of consumption in these countries Answer: C Topic: 7.3 Institutions and Property Rights 14) An example of foreign aid that has improved economic conditions is ________.

A) funding of public health programs B) funding of the U.S. Interstate Highway System C) programs to reduce foreign debt D) the Napoleonic code Answer: A Topic: 7.3 Institutions and Property Rights 15) How does the centrality of institutions and property rights in economic growth help to explain the predominance of rich countries in temperate climates and of poor countries in the tropics?

Answer: Legal systems in most countries throughout the world are a legacy of European colonialism. Economic growth in any country seems to depend a great deal on how the "average person" is treated by the legal system. In the tropics, generally, legal systems were designed to favor the tiny European minority, rather than the "average person." Even now, these systems tend to protect the elite, rather than to provide opportunities for others. By contrast, in temperate locations where large numbers of Europeans and their descendants exceeded the indigenous populations, legal systems were designed to restrict the power of the elite, which has promoted the economic potential and ambitions of the majority of citizens.

Topic: 7.3 Institutions and Property Rights AACSB: Reflective Thinking

10 .

7.4 Endogenous Growth Theory 1) The goal of endogenous growth theory is to explain ________.

A) supply and demand in individual markets B) the causes of technological advance C) the business cycle D) the relationship between economic growth and the rates of inflation and unemployment Answer: B Topic: 7.4 Endogenous Growth Theory 2) The Romer model is distinct from the Solow model in that the former assumes that ________.

A) technology is fixed B) an increase in price affects quantity demanded, rather than demand C) some labor is devoted to producing new technology D) output per worker is fixed Answer: C Topic: 7.4 Endogenous Growth Theory AACSB: Analytical Thinking 3) The key endogenous variable in endogenous growth theory is ________.

A) the level of technology B) the productivity of research and development C) the growth rate of output D) the level of per capita income Answer: A Topic: 7.4 Endogenous Growth Theory AACSB: Analytical Thinking 4) The quote, "If I have seen farther than others, it is because I have stood on the shoulders of giants" is attributed to ________.

A) Albert Einstein B) Paul Romer C) Friedrich Nietszche D) Sir Isaac Newton Answer: D Topic: 7.4 Endogenous Growth Theory 5) A change in which of the following can change the long-run growth rate of the economy in the Romer model?

A) investments in public infrastructure B) the national saving rate C) the fraction of the population engaged in and the productiveness of research and development D) government spending and tax rates Answer: C Topic: 7.4 Endogenous Growth Theory AACSB: Analytical Thinking 11 .

6) A likely way to increase the productivity of workers engaged in research and development is to ________.

A) increase the size of the labor force B) increase the number of workers engaged in research and development C) invest more in the education of scientists D) increase the national saving rate Answer: C Topic: 7.4 Endogenous Growth Theory 7) The key assumption of the Romer model that allows an explanation of sustained growth in output per person is ________.

A) technology is nonrivalrous B) the total amount of labor is fixed C) some labor is devoted to producing new technology D) the saving rate is fixed Answer: A Topic: 7.4 Endogenous Growth Theory 8) Growth of output per person at a constant rate is referred to as ________.

A) a balanced growth path B) a steady state C) a ratio scale D) an amplification effect Answer: A Topic: 7.4 Endogenous Growth Theory 9) The result that the growth rate of output per worker is equal to 1.43 × A) true of the Solow model only B) true of both the Solow model and the Romer model C) true of the Romer model only D) true under the common-law legal system only Answer: B Topic: 7.4 Endogenous Growth Theory

is ________.

10) If the level of technology rises from 8 to 8.2 in one period, the growth rate of technology is ________.

A) 2.5 percent B) 20 percent C) two percent D) 0.2 percent Answer: A Topic: 7.4 Endogenous Growth Theory AACSB: Analytical Thinking

12 .

11) Output per person is 170 in an economy in which 15 percent of the population are engaged in research and development, where their productivity is 0.002, and the total population size is 100 million. If this economy is on a balanced growth path, then output per person in the next period will be ________.

A) 175.1 B) 195.5 C) 176.2 D) 177.3 Answer: D Topic: 7.4 Endogenous Growth Theory AACSB: Analytical Thinking 12) An economy with population 500 million has a research and development productivity of 0.0005, and its output per person has risen from one period to the next along its balanced growth path from 350 to 362.5. The fraction of this economy's population engaged in research and development is ________.

A) 14% B) 2.5% C) 3.6% D) 10 % Answer: D Topic: 7.4 Endogenous Growth Theory AACSB: Analytical Thinking 13) In a logarithmic scale ________.

A) the ratio of capital to labor is constant B) the vertical axis lies along the horizontal axis C) equal distances reflect the same percentage change D) values along the vertical axis correspond to the square root of values along the horizontal axis Answer: C Topic: 7.4 Endogenous Growth Theory 14) Because old ideas are an input in the production of new ideas, nothing prevents the growth rate of output per person from rising without limit. Comment.

Answer: The inference is false. The growth rate of output per person depends on the growth rate of technology:

=x

. Both the productivity of R&D and the quantity of labor engaged in

R&D can change, but are subject to strict limits. The technology-growth equation implies that living standards need never stop improving, but the rate of improvement is always limited by our finite ability to reach a bit higher than our giant forebears.

Topic: 7.4 Endogenous Growth Theory AACSB: Reflective Thinking

13 .

15) An economy has 20 million workers in research and development, where their productivity is 0.004, and the level of technology is 6.75. The depreciation rate is 0.15, and the saving rate is 0.2. The per worker production function is y = A (1-α), and there are 180 million production workers. Show that, in equilibrium, the ratio of capital to output is constant.

Answer: The current equilibrium capital-labor ratio equals = 27. Output per worker is 18.2, so the capital-output ratio is 1.48. After one period, technology has risen to 7.29, and the capital-labor ratio rises to 30.3. Output per worker is now 20.5, so the capital-output ratio is still 1.48.

Topic: 7.4 Endogenous Growth Theory AACSB: Analytical Thinking 16) The growth accounting equation is = + (0.3) + (0.7) . An economy with an initial workforce of 50 million allocates 20 percent of them to research and development, where their productivity is 0.003. If the labor input in this economy is growing at one percent, and the growth rates of capital and output are equal, what is that common growth rate? Is this a realistic scenario?

Answer: The growth rate of technology = 0.003 * 0.2 * 50 = 0.03. Setting = , we have = 0.03 + 0.3 * + 0.007. Solving, = 0.053. If the underlying parameters do not change, the rising labor force will cause continual increases in the growth rates of technology, capital, and output. The growth path is balanced, but implausible, since no real economy can grow at an everaccelerating pace.

Topic: 7.4 Endogenous Growth Theory AACSB: Reflective Thinking 7.5 Factors That Affect Endogenous Growth 1) In the Romer model. as more labor is devoted to research and development ________.

A) there is an immediate decrease in output per capita B) there is an immediate increase in output per capita C) output per capita is unaffected, but the savings rate begins to rise D) output per capita is unaffected, but the savings rate begins to fall Answer: A Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 2) In the Romer model, as more labor is devoted to research and development there is ________.

A) an immediate increase in output per capita and a permanent increase in output per capita B) an immediate decrease in output per capita and a permanent increase in output per capita C) an immediate increase in output per capita and a permanent decrease in output per capita D) an immediate decrease in output per capita and a permanent decrease in output per capita Answer: B Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking

14 .

3) The Romer model suggests that there is a trade-off between ________.

A) the use of resources in research and development and the productiveness of R&D B) the rate of saving and the long-run growth of output C) per capita output in the short-run and long-run D) the size of the total population and the saving rate Answer: C Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 4) Spending on education is likely to raise output per person by ________.

A) increasing the productiveness of R&D B) by increasing the population C) increasing the fraction of the population engaged in productive activities D) increasing the saving rate Answer: A Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Reflective Thinking 5) Endogenous growth theory supports the conclusion that ________.

A) government spending cannot influence the level of research and development B) increased government spending on research and development is counterproductive C) per capita income growth is a function of real factors, such as the supply of money D) increased government spending on research and development is useful Answer: D Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 6) One difference between a policy of direct spending by the government on research and development and an alternative policy of tax incentives to encourage private spending on R&D is ________.

A) the former improves the productivity of R&D, while the latter raises its level B) the former requires a decrease in national saving, while the latter causes an increase C) the former raises the level of R&D spending, while the latter also improves its productivity D) the former requires an increase in national saving, while the latter causes a decrease Answer: C Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Reflective Thinking 7) According to the Romer model, tax incentives to support research and development will lead to ________.

A) higher tax rates in the future B) an increase in the general level of prices C) a decrease in the general level of prices D) increased per capita income Answer: D Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 15 .

Assume that the growth rate of the capital stock in each period is determined by the level of output in the previous period.

8) An economy of 80 million people has ten percent of them engaged in research and development, where their productivity is 0.0035. The economy is on a balanced growth path, when suddenly 2.88 million people move from goods production into R&D, raising the fraction there to 13.6 percent. In the one period that begins with this labor reallocation, the growth rate of output is ________. [Refer to the instruction above.]

A) 2.8% B) 0.0% C) 3.8% D) 2.2% Answer: D Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 9) An economy of 82 million people has twenty percent of them engaged in research and development, where their productivity is 0.003. The economy is on a balanced growth path, when suddenly the productiveness of R&D rises to 0.004. For the one period that begins with this productivity increase, the growth rate of output is ________. [Refer to the instruction above.]

A) 8.7% B) 9.4% C) 6.6% D) 7% Answer: B Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 10) An economy of 25 million people has twenty percent of them engaged in research and development, where their productivity is 0.0056. The economy is on a balanced growth path, when suddenly a wave of immigration raises the population to 27 million. Assume that the new workers are immediately "on the job," and that the fraction engaged in R&D remains twenty percent. For the one period that begins with this population increase, the growth rate of output per person is ________. [Refer to the instruction above.]

A) 4.3% B) 1.8% C) 3% D) 8% Answer: B Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking

16 .

11) According to the Romer model, an increase in population will cause ________.

A) an immediate increase in output per capita and a permanent increase in output per capita B) an immediate decrease in output per capita and a permanent increase in output per capita C) an immediate increase in output per capita and a permanent decrease in output per capita D) an immediate and permanent decrease in output per capita Answer: B Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 12) The Solow model is distinct from the Romer model in that an increase in population tends to cause ________.

A) a permanent decrease in the standard of living in the Romer model B) an increase in spillover effects in the Solow model, but not in the Romer model C) a permanent increase in the standard of living in the Solow model D) a permanent increase in the standard of living in the Romer model Answer: D Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 13) Technological spillover ________.

A) is made possible by the nonrivalry of ideas B) generates an increase in both capital and labor C) is caused by population growth D) is caused by population decline Answer: A Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 14) The observation that countries with high rates of population growth don't have higher per capita income ________.

A) suggests that the Solow model is unrealistic B) implies that technology doesn't work as well in countries where the population is growing rapidly C) is not supported by most empirical studies D) is consistent with the Romer model as applied to the world as a whole Answer: D Topic: 7.5 Factors That Affect Endogenous Growth 15) When technology improves in a country with a fast-growing population ________.

A) output rises, but output per person does not B) output rises in that country, while output per person rises in other countries C) output per person rises in that country and around the world D) output per person rises temporarily, then declines Answer: C Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 17 .

16) The current world population is more than ________.

A) 6 million B) 6 billion C) 6 trillion D) 6 gazillion Answer: B Topic: 7.5 Factors That Affect Endogenous Growth 17) The Romer and Solow models reach the same conclusion with respect to ________.

A) output growth in the long-run B) the impact of changing population C) the effect of an increase in the saving rate D) the general level of prices Answer: C Topic: 7.5 Factors That Affect Endogenous Growth

18) The graph above might represent the ________.

A) response to an increase in the fraction of the population engaged in research and development B) response to a rise in the productiveness of research and development C) response to an increase in the total population D) response to a rise in the saving rate Answer: A Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 19) On the graph above, for a while after t = 0, the growth rate of output per worker is ________ the growth rate prior to time zero, and ________.

A) below; rising B) below; falling C) above; constant D) above; falling Answer: A Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 18 .

20) On the graph above, for a while after t = 0, the growth rate of technology is ________ the growth rate prior to time zero, and ________.

A) below; falling B) below; rising C) above; constant D) above; falling Answer: C Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking 21) On the graph above, the constant value 1.43 is ________.

A) the productivity of labor devoted to research and development B) the logarithmic scale C) the amplification effect of improving technology D) the initial level of technology Answer: C Topic: 7.5 Factors That Affect Endogenous Growth 22) How might technological spillover explain why countries with high rates of population growth don't have higher per-capita income?

Answer: In the Romer model, population increase causes an increase in the rate of technological progress, because there are more people engaged in research and development. Technology, however, is not easily contained within national borders, so the technology available in each economy depends not on the size of its own population but, rather on the world technological frontier. A population increase in any one economy has an imperceptible effect on the technology in use in that economy. Though technological breakthroughs always occur "somewhere," they are quickly available "everywhere," so the growth impact in the economy of origin is not much different from the impact in other economies.

Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Reflective Thinking 23) Suppose a wave of immigration increases the number of workers in research and development without altering the labor input in production. Describe the impact on the level and growth rate of output per worker, immediately, and as time passes.

Answer: This scenario is an increase in both the total population and in the fraction of the population engaged in research and development. One immediate impact is that an unchanged level of output is divided among a larger total workforce, so output per (total) worker is reduced.

A second immediate impact is an increase in the growth rate of technology. Since the capitallabor ratio (in production of goods and services) is not immediately affected, the growth rate of output adjusts all-at-once to equal 1.43 times the higher growth rate of technology.

Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Reflective Thinking

19 .

24) Technology grows at a rate of three percent in an economy in which ten percent of the workforce is engaged in research and development, where their productivity is 0.003. The economy is on a balanced growth path, and the workforce is growing at two percent. Calculate the growth rates of output, capital, and output per worker now, and five years from now.

Answer: The growth rate of output and of capital per worker is 1.43 × 0.03 = 0.043. Since the workforce is growing at two percent, output and capital are growing at 0.063. The three percent growth rate of technology equals 0.003 × 0.1 × N, so N = 100. After five years of growth at the two percent rate, N = 110, so the growth rate of technology has risen to 3.3 percent. The new growth rate of capital and output per worker is 0.047, so output and capital grow at 0.067.

Topic: 7.5 Factors That Affect Endogenous Growth AACSB: Analytical Thinking

20 .

Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 8 Business Cycles: An Introduction 8.1 Business Cycle Basics 1) Arthur Burns and Wesley Mitchell first described business cycles as ________.

A) fluctuations in consumer preferences B) fluctuations in the price of bicycles C) fluctuations in aggregate economic activity D) all of the above E) none of the above Answer: C Topic: 8.1 Business Cycle Basics 2) In a business cycle, a period from peak to trough may be referred to as ________.

A) an expansion B) a recurrence C) a contraction D) all of the above E) none of the above Answer: C Topic: 8.1 Business Cycle Basics 3) In a business cycle, a period from peak to trough may be referred to as ________.

A) a contraction B) a recession C) a depression D) all of the above E) none of the above Answer: D Topic: 8.1 Business Cycle Basics 4) In a business cycle, a period from trough to peak may be referred to as ________.

A) a contraction B) an expansion C) a recurrence D) all of the above E) none of the above Answer: B Topic: 8.1 Business Cycle Basics

1 .

5) A recession can manifest itself with ________.

A) a decrease in consumer spending B) a decrease in industrial production C) a lengthy period of falling GDP D) all of the above E) none of the above Answer: D Topic: 8.1 Business Cycle Basics 6) Examining U.S. business cycles over time reveals that they ________.

A) occur at regular intervals B) are of uniform duration C) are of similar magnitude D) all of the above E) none of the above Answer: E Topic: 8.1 Business Cycle Basics 7) Economists use the term "potential output" to refer to ________.

A) a level of output that has not yet been achieved B) the maximum level of output of which an economy is capable C) the sum of finished goods plus goods in production that will be finished within the year D) the level of output that occurs when all prices are fully adjusted E) none of the above Answer: D Topic: 8.1 Business Cycle Basics 8) Economic activity that is above potential output ________.

A) signals that potential output is about to increase B) is not possible C) results from an economic shock to which the economy has yet to adjust fully D) occurs near the trough, rather than the peak, of a business cycle E) none of the above Answer: C Topic: 8.1 Business Cycle Basics 9) The difference between aggregate economic activity and potential output is called ________.

A) the business cycle B) the output gap C) a recession D) a trough E) a co-movement Answer: B Topic: 8.1 Business Cycle Basics

2 .

10) A procyclical variable ________.

A) moves up during expansions and down during contractions B) moves up during contractions and down during expansions C) moves in the opposite direction of aggregate economic activity D) all of the above E) none of the above Answer: A Topic: 8.1 Business Cycle Basics 11) A countercyclical variable ________.

A) moves up during expansions and down during contractions B) is another term for an acyclical variable C) moves in the same direction as aggregate economic activity D) all of the above E) none of the above Answer: E Topic: 8.1 Business Cycle Basics 12) A leading countercyclical variable ________.

A) reaches a peak before the peak of the business cycle B) reaches a trough before the peak of the business cycle C) reaches a trough along with the trough of a business cycle D) all of the above E) none of the above Answer: B Topic: 8.1 Business Cycle Basics 13) A leading variable ________.

A) reaches a peak or trough before the turning point of the business cycle B) reaches a peak or trough after the turning point of the business cycle C) reaches a peak or trough at the same time as the turning point of the business cycle D) all of the above E) none of the above Answer: A Topic: 8.1 Business Cycle Basics 14) A lagging variable ________.

A) reaches a peak or trough before the turning point of the business cycle B) reaches a peak or trough after the turning point of the business cycle C) reaches a peak or trough at the same time as the turning point of the business cycle D) all of the above E) none of the above Answer: B Topic: 8.1 Business Cycle Basics

3 .

15) According to the graph above, the expansion that began in December 1914 had a duration of ________.

A) 51 months B) 4 years C) 3 years D) 44 months E) 20 months Answer: D Topic: 8.1 Business Cycle Basics AACSB: Analytical Thinking 16) According to the graph above, the last expansion to occur before the outbreak of World War I in 1914 had a duration of ________.

A) 23 months B) 44 months C) 3 years D) 12 months E) 20 months Answer: D Topic: 8.1 Business Cycle Basics AACSB: Analytical Thinking 17) Referring to the graph above, an economic variable that had peaked in December 1911, November 1914, and February 1919 is likely a ________ variable.

A) leading countercyclical B) leading procyclical C) lagging countercyclical D) lagging procyclical E) none of the above Answer: A Topic: 8.1 Business Cycle Basics AACSB: Analytical Thinking

4 .

18) Referring to the graph above, an economic variable that had peaked in December 1912, and July 1918 is likely a ________ variable.

A) leading countercyclical B) leading procyclical C) lagging countercyclical D) lagging procyclical E) none of the above Answer: B Topic: 8.1 Business Cycle Basics AACSB: Analytical Thinking 19) Referring to the graph above, an economic variable that had peaked in December 1912, November 1914, and February 1918 is likely a ________ variable.

A) leading countercyclical B) leading procyclical C) lagging countercyclical D) lagging procyclical E) none of the above Answer: E Topic: 8.1 Business Cycle Basics AACSB: Analytical Thinking 20) The Conference Board does a good job predicting recessions for reasons that include ________.

A) a focus on fewer than five leading variables B) exclusive use of real-time data C) revisions of the components of its monthly index D) all of the above E) none of the above Answer: C Topic: 8.1 Business Cycle Basics 21) Many economic variables are classified according to their relation to the business cycle.

What are the principal categories? Variables in which category(ies) are of greatest help in forecasting changes in the economy?

Answer: Economic variables may be procyclical, countercyclical, or acyclical. Cutting across the first two of these categories, a variable may be leading, lagging, or coincident. The best variables for forecasting are in the leading category, thus either procyclical or countercyclical.

Topic: 8.1 Business Cycle Basics AACSB: Analytical Thinking

5 .

22) To understand what causes the business cycle, leading variables alone are of interest.

Coincident and lagging variables merely display the consequences of changes in the economy.

Respond.

Answer: The comment confuses correlation with causation. A leading variable is not necessarily causing the economy's moving through the cycle. It might, instead, be a result of some underlying process; a result that happens to become evident relatively early. Coincident and lagging variables do not merely appear on the stage after the causation is "done." They may point to powerful processes that happen to become fully evident only after other variables have responded to their effects. The reason that short-run economic fluctuations recur — and so invite the name "cycle" — is that most economic variables are continually affected by and affecting other variables; today's "effect" is tomorrow's "cause."

Topic: 8.1 Business Cycle Basics AACSB: Reflective Thinking 8.2 Macroeconomic Variables and the Business Cycle 1) GDP is a good proxy for the business cycle itself since ________.

A) its real consumption spending component is procyclical and coincident B) its real investment spending component is procyclical and coincident C) it typically goes up in a boom and down in a recession D) all of the above E) none of the above Answer: D Topic: 8.2 Macroeconomic Variables and the Business Cycle 2) A characteristic of the unemployment rate is that ________.

A) it typically goes up in a recession B) it typically goes down in a boom C) it is not clear whether it is a leading or a lagging indicator D) all of the above E) none of the above Answer: D Topic: 8.2 Macroeconomic Variables and the Business Cycle 3) A characteristic of the inflation rate is that ________.

A) it typically goes down in a boom B) it typically goes up in a recession C) it is a lagging indicator D) all of the above E) none of the above Answer: C Topic: 8.2 Macroeconomic Variables and the Business Cycle

6 .

4) A characteristic of stock prices is that ________.

A) they tend to go up on the upswing of the cycle B) they tend to go down on the downswing of the cycle C) they are a leading indicator D) all of the above E) none of the above Answer: D Topic: 8.2 Macroeconomic Variables and the Business Cycle 5) The interest rates paid on Treasury bills ________.

A) go down in booms B) go up in recessions C) are a coincident indicator D) all of the above E) none of the above Answer: E Topic: 8.2 Macroeconomic Variables and the Business Cycle 6) Interest rates spreads between long-term and short-term Treasury bills ________.

A) are countercyclical B) are good predictors of recessions C) are a lagging indicator D) all of the above E) none of the above Answer: B Topic: 8.2 Macroeconomic Variables and the Business Cycle 7) Interest rates spreads between long-term and short-term Treasury bills ________.

A) are procyclical B) are not a good predictor of recessions C) are a lagging indicator D) all of the above E) none of the above Answer: A Topic: 8.2 Macroeconomic Variables and the Business Cycle 8) Interest rates spreads between corporate and government bonds ________.

A) are procyclical B) have the same characteristics as the government interest rate spreads C) are countercyclical D) all of the above E) none of the above Answer: C Topic: 8.2 Macroeconomic Variables and the Business Cycle

7 .

9) Which of these economic variables is procyclical?

A) consumer spending B) stock prices C) the government bond spread D) all of the above E) none of the above Answer: D Topic: 8.2 Macroeconomic Variables and the Business Cycle 10) Which of these economic variables is procyclical and coincident?

A) consumer spending B) stock prices C) the government bond spread D) all of the above E) none of the above Answer: A Topic: 8.2 Macroeconomic Variables and the Business Cycle 11) Which of these economic variables is procyclical?

A) inflation B) unemployment C) the credit spread D) all of the above E) none of the above Answer: A Topic: 8.2 Macroeconomic Variables and the Business Cycle 12) Which of these economic variables is procyclical?

A) unemployment B) the credit spread C) investment spending D) all of the above E) none of the above Answer: C Topic: 8.2 Macroeconomic Variables and the Business Cycle 13) Which of these economic variables is countercyclical?

A) investment spending B) unemployment C) demand for foreign products D) all of the above E) none of the above Answer: B Topic: 8.2 Macroeconomic Variables and the Business Cycle

8 .

14) The credit spread between government bonds and corporate bonds is ________.

A) countercyclical and coincident B) procyclical and coincident C) procyclical and lagging D) countercyclical and leading E) acyclical Answer: A Topic: 8.2 Macroeconomic Variables and the Business Cycle 15) Economic globalization has seen ________.

A) business cycles in the rest of the world synchronize with those of the U.S. B) financial markets become more integrated over time C) financial disruptions spread more easily among countries D) all of the above E) none of the above Answer: D Topic: 8.2 Macroeconomic Variables and the Business Cycle 16) Economic globalization has seen ________.

A) a decoupling of the business cycle among many countries B) financial markets become more integrated over time C) how international financial disruptions can be more easily contained D) all of the above E) none of the above Answer: B Topic: 8.2 Macroeconomic Variables and the Business Cycle 17) If events in a single country cause its economic activity to move up or down through a business cycle, what difference(s) might it make that the economy is closely integrated with other economies in the world?

Answer: One consequence of global integration is that goods and saving can flow to where they seem to offer the highest return, adjusted for risk. An economy with, say, political instability is likely to see a substantial outflow of saving, while imports might flow in where domestic output has been disrupted. Thus, other economies might benefit from the first economy's misfortune.

Or, the decrease in income in one economy might hurt its trading partners by depressing demand for their exports. Similarly, financial disruption in one economy might spread to related economies. In either case, once economic conditions seem to be improving in a globallyconnected economy, the expansion is likely to be strengthened by saving inflows and ready availability of markets for both imports and exports. In sum, the correlation of growth rates in linked economies may be strengthened or weakened when one economy is faltering. When one economy is booming, the effect is to strengthen the correlation.

Topic: 8.2 Macroeconomic Variables and the Business Cycle AACSB: Reflective Thinking

9 .

18) Why is the credit spread countercyclical and coincident?

Answer: The credit spread is the interest rate on corporate bonds minus the interest rate on government bonds. Since the bonds are long term in each case, they are not affected directly by short-term fluctuations. However, during the expansion phase of the business cycle, corporate profits and other indicators of financial strength at many businesses imply a low risk of default on corporate bonds, so their cost of borrowing (interest rate on the bond) declines. During the contraction phase of the cycle, the risk of corporate default is higher for many businesses, so borrowing is more costly (higher interest rate on the bond). Since the perceived zero default risk on government bonds is unaffected by the business cycle, the varying interest rate on corporate bonds causes the spread to move countercyclically. The change in the spread is coincident to the business cycle, because it reflects the impact of current economic conditions on business financials.

Topic: 8.2 Macroeconomic Variables and the Business Cycle AACSB: Reflective Thinking 8.3 A Brief History of U.S. Business Cycles 1) What did the U.S. business cycles in the early 1890s and early 1930s have in common?

A) rapid industrialization B) persistently high inflation C) high consumer confidence D) all of the above E) none of the above Answer: E Topic: 8.3 A Brief History of U.S. Business Cycles 2) What did the U.S. business cycles in the early 1890s and early 1930s have in common?

A) the spread of bank failures B) severe recessions C) high unemployment and low inflation, even deflation D) all of the above E) none of the above Answer: D Topic: 8.3 A Brief History of U.S. Business Cycles 3) What does the U.S. business cycle experience suggest about periods of war?

A) the economy tends to boom during the period of war B) after the war is over, the economy typically experiences a downturn C) they are associated with good economic times D) all of the above E) none of the above Answer: D Topic: 8.3 A Brief History of U.S. Business Cycles

10 .

4) From 1945 until 1973, the U.S. economy experienced ________.

A) rapid inflation B) no major recessions or depressions C) minimal interaction with the global economy D) all of the above E) none of the above Answer: B Topic: 8.3 A Brief History of U.S. Business Cycles 5) In the 1970s, the U.S. economy ________.

A) grew at a faster pace than in the previous decade B) experienced low inflation C) experienced increases in unemployment D) all of the above E) none of the above Answer: C Topic: 8.3 A Brief History of U.S. Business Cycles 6) The "Great Moderation" refers to ________.

A) sharp declines in asset prices B) the long economic expansion of the 1960s C) the mild economic recoveries of the 1970s and early 1980s D) the "oil tax" of the 1970s E) none of the above Answer: E Topic: 8.3 A Brief History of U.S. Business Cycles 7) The years from 1933 to 1937 are notable for ________.

A) high unemployment, despite rapid growth of real output B) low unemployment, despite sluggish output growth C) persistent deflation, despite rising unemployment D) the creation of the Federal Reserve System E) none of the above Answer: A Topic: 8.3 A Brief History of U.S. Business Cycles 8) During the 1970s in the U.S. ________.

A) the inflation rate peaked at over 14% B) oil prices quadrupled C) the unemployment rate rose above 8% D) all of the above E) none of the above Answer: D Topic: 8.3 A Brief History of U.S. Business Cycles

11 .

9) The U.S. economy of the 1970s is typically referred to as ________.

A) "The Great Depression" B) "The Great Inflation" C) "The Great Moderation" D) all of the above E) none of the above Answer: B Topic: 8.3 A Brief History of U.S. Business Cycles 10) The U.S. economy of the late 1920s and early 1930s is typically referred to as ________.

A) "The Great Depression" B) "The Great Inflation" C) "The Great Moderation" D) all of the above E) none of the above Answer: A Topic: 8.3 A Brief History of U.S. Business Cycles 11) The U.S. economy of the mid 1980s through 2007 is typically referred to as ________.

A) "The Great Depression" B) "The Great Inflation" C) "The Great Moderation" D) all of the above E) none of the above Answer: C Topic: 8.3 A Brief History of U.S. Business Cycles 12) During the U.S. Great Moderation, ________.

A) the volatility in the inflation rate declined by 50% B) the volatility in the rate of growth of real output declined by 33% C) the economy stabilized from the higher uncertainty of the 1970s D) all of the above E) none of the above Answer: D Topic: 8.3 A Brief History of U.S. Business Cycles 13) During the Great Recession of 2007-2009, the U.S. ________.

A) experienced unprecedented declines in household wealth B) the unemployment rate more than doubled C) experienced the most severe economic downturn since the Great Depression D) all of the above E) none of the above Answer: D Topic: 8.3 A Brief History of U.S. Business Cycles

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14) The policies of the U.S. Federal Reserve probably helped to cause ________.

A) the long contraction of the 1870s B) the severe recession of the 1890s C) the recession in 1918-1919 D) all of the above E) none of the above Answer: C Topic: 8.3 A Brief History of U.S. Business Cycles 15) The years from 1945 to 1973 are notable for ________.

A) a Great Moderation B) generally low inflation C) brief, but severe, recessions D) all of the above E) none of the above Answer: B Topic: 8.3 A Brief History of U.S. Business Cycles 16) The years from 1945 to 1973 are notable for ________.

A) the Great Inflation B) the creation of the Federal Reserve System C) frequently high unemployment D) all of the above E) none of the above Answer: E Topic: 8.3 A Brief History of U.S. Business Cycles 17) During the period from 1970 to the present, the U.S. economy experienced a Great Inflation, a Great Moderation, and a Great Recession. How does this sequence illustrate the concept of a "business cycle"?

Answer: The sequence runs from bad economic conditions to much better conditions to bad again. The Great Moderation is, in part, the recovery from the preceding bad, and, perhaps, the result of deliberate responses intended to end and to prevent excessive inflation. An economy "strengthened" by its successful struggle against inflation is, perhaps, particularly vulnerable to the opposite problem of recession. And, perhaps, "moderation" inspires a complacency and/or excessive confidence that leads to recession. In any case, the Great Recession is, in part, confirmation that all good things (like all bad things) must come to an end.

Topic: 8.3 A Brief History of U.S. Business Cycles AACSB: Reflective Thinking

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8.4 Time Horizons in Macroeconomics 1) John Maynard Keynes ________.

A) questioned the classical view that economies move quickly to their long run equilibrium levels B) advocated focusing on short run fluctuations C) carved out macroeconomics as a distinct field in the 1930s D) all of the above E) none of the above Answer: D Topic: 8.4 Time Horizons in Macroeconomics 2) The classical view believes that ________.

A) economies move slowly to their long run equilibrium levels B) a rise in the quantity of money leads to increases in saving and investment C) a rise in the quantity of money has no impact on economic activity D) all of the above E) none of the above Answer: C Topic: 8.4 Time Horizons in Macroeconomics 3) Classical economists believe that ________.

A) it takes a long time for economic variables to reach equilibrium B) short-run fluctuations are too infrequent and mild to be of much interest C) real variables like output and investment are not determined by nominal variables D) all of the above E) none of the above Answer: C Topic: 8.4 Time Horizons in Macroeconomics 4) Keynesians believe ________.

A) that economies move quickly to their long run equilibrium levels B) that the government should pursue active policies to stabilize economic fluctuations C) that the long run is more important than short-run fluctuations D) all of the above E) none of the above Answer: B Topic: 8.4 Time Horizons in Macroeconomics 5) According to the flexible price framework ________.

A) economic fluctuations determine long-run outcomes B) a change in the money supply has no effect on real output C) a change in inflation alters the amount of real investment D) all of the above E) none of the above Answer: B Topic: 8.4 Time Horizons in Macroeconomics 14 .

6) According to the flexible price framework ________.

A) an increase in inflation raises real savings B) an increase in the money supply raises real output C) an increase in inflation lowers real investment D) all of the above E) none of the above Answer: E Topic: 8.4 Time Horizons in Macroeconomics 7) According to the flexible price framework ________.

A) aggregate output is determined by the production function with given levels of capital and labor B) the interest rate is solely determined by the interaction of savings and investment C) nominal and real variables are completely independent D) all of the above E) none of the above Answer: D Topic: 8.4 Time Horizons in Macroeconomics 8) Keynesian economists ________.

A) observe that prices respond slowly to changes in supply and demand B) believe that the classical dichotomy does not hold in the short run C) believe that monetary policy affect aggregate output and the real interest rate D) all of the above E) none of the above Answer: D Topic: 8.4 Time Horizons in Macroeconomics 9) Keynesian economists ________.

A) believe that the classical dichotomy does not hold in the long run B) believe that only the interaction between savings and investment affects the real interest rate C) observe that prices are "sticky" D) all of the above E) none of the above Answer: C Topic: 8.4 Time Horizons in Macroeconomics 10) Keynesian economists ________.

A) observe that prices are perfectly flexible B) believe that the classical dichotomy never holds C) believe that only the interaction between savings and investment affects the real interest rate D) all of the above E) none of the above Answer: E Topic: 8.4 Time Horizons in Macroeconomics 15 .

11) Rapid growth of the money supply might seem appropriate to ________ economists, because ________.

A) Keynesian; it can hasten the economy's return to a long-run equilibrium B) Keynesian; the resulting inflation will have no effect on real output C) classical; stabilizing fluctuations contributes to long-run growth D) classical; it will make prices more flexible E) none of the above Answer: A Topic: 8.4 Time Horizons in Macroeconomics AACSB: Reflective Thinking 12) Prices that adjust slowly to their long-run equilibrium ________.

A) help the economy to avoid economic fluctuations B) call for policies that focus on short-run fluctuations C) are conducive to maintaining low inflation D) all of the above E) none of the above Answer: B Topic: 8.4 Time Horizons in Macroeconomics AACSB: Reflective Thinking 13) An increase in the price level that leads to no expansion of economic activity ________.

A) is consistent with classical models B) implies that there has been no change in the money supply C) is a strictly short-run phenomenon D) all of the above E) none of the above Answer: A Topic: 8.4 Time Horizons in Macroeconomics AACSB: Reflective Thinking 14) How does rapid price adjustment, as assumed in classical models, result in separation of real from nominal variables (the classical dichotomy)?

Answer: If an increase in the money supply enables consumers and businesses to spend more, there is upward pressure on equilibrium prices. Producers will raise prices. They might consider increasing output, as well, but will reconsider when they see that labor and other inputs have increased in price. There will be no increase in saving, because the increase in the money supply is needed to fund the same volume of transactions at the higher price level. The nominal interest rate will rise, so long as the price level is expected to continue to rise. The real interest rate is unaffected, as are real output, consumption, and investment.

Topic: 8.4 Time Horizons in Macroeconomics AACSB: Reflective Thinking

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15) How does slow price adjustment, as assumed in Keynesian models, result in real economic variables being affected by nominal variables?

Answer: If an increase in the money supply enables consumers and businesses to spend more, producers will respond by raising output. To do so, they will increase their purchases of labor and other inputs, and increase investment. Prices and wages will rise, but not so much or so quickly as to prevent the increase in real output and investment. The real interest rate may change, or not, depending on the changes in saving, investment, and expected inflation. But, the quantity of saving and investment will increase.

Topic: 8.4 Time Horizons in Macroeconomics AACSB: Reflective Thinking 16) Describe how Keynesian economics is a cyclical phenomenon. Is it leading, lagging, or coincident? Procyclical or countercyclical?

Answer: John Maynard Keynes presented his ideas during, and in response to, the Great Depression, making Keynesian economics a lagging variable, and strongly countercyclical. The Great Inflation of the 1970s is attributed, in part, to Keynesian over-confidence, reinforcing countercyclicality. Interest in Keynesian economics was subdued during the Great Moderation, but has revived markedly during the Great Recession.

Topic: 8.4 Time Horizons in Macroeconomics AACSB: Reflective Thinking 8.5 Price Stickiness 1) In a perfectly competitive market ________.

A) the goods purchased are assumed to be standardized products B) prices adjust quickly to equilibrium C) buyers and sellers are price takers D) all of the above E) none of the above Answer: D Topic: 8.5 Price Stickiness 2) In a perfectly competitive market ________.

A) most goods and services are not standardized B) prices adjust slowly to equilibrium C) buyers and sellers do not set prices and can only decide how much to buy and sell D) all of the above E) none of the above Answer: C Topic: 8.5 Price Stickiness

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3) Under monopolistic competition ________.

A) many goods and services are not standardized B) prices adjust slowly to equilibrium C) even if there is substantial competition in the market, some firms can set prices D) all of the above E) none of the above Answer: D Topic: 8.5 Price Stickiness 4) Under monopolistic competition ________.

A) the goods purchased are assumed to be standardized products B) it is good (or brand) differentiation that likely accounts for some price stickiness C) buyers and sellers do not set prices and can only decide how much to buy and sell D) all of the above E) none of the above Answer: B Topic: 8.5 Price Stickiness 5) Under monopolistic competition ________.

A) prices are flexible, because producers can change them as often as they wish B) prices are flexible, because producers can never set a price other than the market price C) prices are flexible, because producers adopt Keynesian policies D) all of the above E) none of the above Answer: E Topic: 8.5 Price Stickiness 6) Menu costs ________.

A) are the cost a firm bears when it changes its prices B) are one source of price stickiness because changing prices involves many hidden costs C) are one source of price stickiness because firms may not want to change their "menus" too often and risk alienating customers D) all of the above E) none of the above Answer: D Topic: 8.5 Price Stickiness 7) Rational inattention refers to ________.

A) the risk a firm runs when they do not pay attention to their customers B) firms making infrequent price decisions because of the time and effort those decision require C) the cost to the firm of losing sales from alienating customers D) all of the above E) none of the above Answer: B Topic: 8.5 Price Stickiness

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8) Which of these is an example of rational inattention?

A) submitting a paper with a few typos, knowing that they won't affect the grade B) sleeping in later than you had intended C) a firm delaying price changes to avoid losing customers D) a firm being unsure of its competitors' prices E) a firm changing prices so often its customers stop noticing Answer: A Topic: 8.5 Price Stickiness AACSB: Reflective Thinking 9) Menu costs are an important source of price stickiness because ________.

A) printing menus is costly B) putting items "on sale" reduces firms' revenue C) frequent price changes may lead to losing customers D) all of the above E) none of the above Answer: C Topic: 8.5 Price Stickiness AACSB: Reflective Thinking 10) Staggered price setting ________.

A) leads to frequent price adjustments B) occurs when firms fail to consider the behavior of their competitors C) is generally illegal D) all of the above E) none of the above Answer: E Topic: 8.5 Price Stickiness 11) Staggered price setting ________.

A) refers to the lack of coordination by firms in changing prices B) reduces price stickiness C) has been proven to occur in all sectors of the economy D) all of the above E) none of the above Answer: A Topic: 8.5 Price Stickiness 12) Empirical evidence shows that prices are sticky ________.

A) in all sectors of the economy B) in hardly any sectors of the economy C) except in response to changes within individual markets D) all of the above E) none of the above Answer: C Topic: 8.5 Price Stickiness 19 .

13) Empirical evidence that changes in monetary policy do not cause rapid price adjustments ________.

A) is consistent with the Keynesian emphasis on short-run economic fluctuations B) suggests that policymakers need not worry much about inflation C) remains limited and unconvincing D) is consistent with the classical dichotomy E) none of the above Answer: A Topic: 8.5 Price Stickiness 14) Apply the concepts of menu costs and staggered price setting to the labor market.

Answer: Wages are likely to be sticky, if it is costly for employers to monitor changes in the labor market, and if frequent wage adjustments have adverse effects on employee behavior.

Since workers do not change jobs frequently in pursuit of the highest wage, there is little if any short-term penalty for wage persistence, nor reward for prompt wage adjustment. Even when it seems clear that wage adjustments are warranted, employers might hesitate to raise their labor costs above their competitors', or to lose employees by cutting wages before competitors do so.

Topic: 8.5 Price Stickiness AACSB: Reflective Thinking 15) Do you think that prices are more or less sticky today than 50 years ago? Why? Answer: Less sticky. Information technology and rapid introduction of competing substitutes for goods and services enables consumers to be more price sensitive and for producers to avoid/mitigate menu costs. Workers, too, are more price sensitive and accepting of labor market flexibility. The logic of staggered price setting still applies, but rapid and deep common knowledge of market conditions enables some de facto synchronization of pricing decisions.

Topic: 8.5 Price Stickiness AACSB: Reflective Thinking 8.6 Road Map for Our Study of Business Cycles 1) There are no questions for this section.

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 9 The IS Curve 9.1 Planned Expenditure 1) Actual expenditure is to planned expenditure as ________ is to ________.

A) desire; accomplishment B) aggregate demand; aggregate supply C) output; income D) observed; theoretical E) fluctuation; equilibrium Answer: D Topic: 9.1 Planned Expenditure AACSB: Reflective Thinking 2) Only when the goods market is in equilibrium is it true that ________.

A) actual expenditure equals output B) the amount of goods and services produced equals actual expenditure C) planned expenditure equals the amount of goods and services produced D) demand for foreign goods equals foreigners' demand for domestic goods E) none of the above Answer: C Topic: 9.1 Planned Expenditure AACSB: Analytical Thinking 9.2 The Components of Expenditure 1) Total aggregate demand includes ________.

A) planned investment spending B) consumption expenditures C) net exports D) all of the above E) none of the above Answer: D Topic: 9.2 The Components of Expenditure 2) The consumption function shows how ________.

A) the marginal propensity to consume varies with disposable income B) income varies as a result of changes in consumption C) consumption depends on the decision to save D) all of the above E) none of the above Answer: E Topic: 9.2 The Components of Expenditure

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3) Consumption expenditures decrease when ________.

A) the real interest rate falls B) disposable income increases C) autonomous consumption increases D) all of the above E) none of the above Answer: E Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 4) If disposable income falls, consumption expenditure falls ________.

A) by an amount that depends on the real interest rate B) so that planned expenditure remains constant C) by an amount smaller than the decrease in disposable income D) all of the above E) none of the above Answer: C Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 5) Total planned expenditure (equals total output) is 14,000 when autonomous consumption expenditure is 450. When autonomous consumption expenditure falls to 400, total planned expenditure (equals total output) is 13,800. The marginal propensity to consume is ________.

A) 0.89 B) 0.75 C) 0.99 D) 0.44 E) 0.03 Answer: B Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 6) Total planned expenditure (equals income) is 13,500, autonomous consumption expenditure is 600, the marginal propensity to consume is 0.8, government purchases are 2,700, taxes are 2,500 and planned investment spending is 2,900. Net exports is ________.

A) 3,840 B) negative 1,500 C) negative 1,380 D) negative 1,340 E) 2,100 Answer: B Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking

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7) Consumption expenditure is 15,000, government purchases are 5,000, planned investment spending is 4,000 and net exports are 1,500. If total output is 25,000, then unplanned inventory investment is ________.

A) negative 500 B) 2,500 C) 3,500 D) 4,000 E) negative 450 Answer: A Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 8) An increase in the real interest rate will cause an increase in ________.

A) saving B) planned investment C) net exports D) all of the above E) none of the above Answer: A Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 9) An decrease in the real interest rate will cause an increase in ________.

A) consumption B) planned investment C) net exports D) all of the above E) none of the above Answer: D Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 10) When firms spend more on additional holdings of raw materials, parts and finished goods ________.

A) they are increasing their fixed investment B) they are increasing their inventory investment C) they are increasing their private consumption D) all of the above E) none of the above Answer: B Topic: 9.2 The Components of Expenditure

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11) Fixed investment is typically ________.

A) smaller than inventory investment B) calculated as the change in holdings of raw materials and finished goods C) planned spending on equipment, structures, and new residential housing D) all of the above E) none of the above Answer: C Topic: 9.2 The Components of Expenditure 12) Planned investment spending ________.

A) is equal to planned fix investment spending plus the amount of inventory investment planned by firms B) is closely related to the real interest rate C) is heavily influenced by expectations about the future D) all of the above E) none of the above Answer: D Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 13) Planned investment spending ________.

A) is equal to planned fixed investment spending plus government investment B) is unrelated to the real interest rate C) is heavily influenced by expectations about the future D) all of the above E) none of the above Answer: C Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 14) The interest rate at which businesses borrow to fund their investments is higher than the real interest rate for short-term, safe loans, because ________.

A) business borrowers sometimes default on their loans B) autonomous investment is not dependent on borrowed funds C) the central bank controls the short-term, safe interest rate D) the interest rate is negatively-related to business optimism E) all of the above Answer: A Topic: 9.2 The Components of Expenditure

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15) A decrease in "financial frictions" is associated with ________.

A) a decrease in the credit spread B) more efficient functioning of financial markets C) reduced real cost of borrowing for businesses D) an increase in planned investment spending E) all of the above Answer: E Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 16) Investment spending ________.

A) is comprised of fixed and inventory investment B) is negatively related to the real interest rate C) is heavily influenced by what Keynes coined as "animal spirits" D) all of the above E) none of the above Answer: D Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 17) When the U.S. real interest rate falls ________.

A) U.S. dollar assets earn a higher return relative to foreign assets B) it makes U.S. exports more expensive in foreign currencies C) imports will decrease D) all of the above E) none of the above Answer: C Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 18) When the U.S. real interest rate rises ________.

A) U.S. dollar assets earn a lower return relative to foreign assets B) makes U.S. exports more expensive in foreign currencies C) imports will decrease D) all of the above E) none of the above Answer: B Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking

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19) When the U.S. real interest rate rises ________.

A) U.S. dollar assets earn a higher return relative to foreign assets B) makes U.S. exports cheaper in foreign currencies C) imports will decrease D) all of the above E) none of the above Answer: A Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 20) Net exports ________.

A) are heavily determined by foreign demand for domestic goods B) are heavily determined by domestic demand for domestic goods C) are independent of domestic interest rate fluctuations D) all of the above E) none of the above Answer: A Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 21) Planned expenditures ________.

A) are directly affected by government purchases B) increase when there is a reduction in taxes C) decrease when disposable income decreases D) all of the above E) none of the above Answer: D Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking 22) The difference between the interest rate on loans to households and firms and the interest rate on completely safe assets is known as ________.

A) the fed funds rate B) the discount rate C) asymmetric information D) the credit spread Answer: D Topic: 9.2 The Components of Expenditure

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23) What is the meaning of "animal spirits"? How do these relate to planned investment spending and to unplanned investment spending?

Answer: Animal spirits are emotional waves of optimism and pessimism. They influence autonomous investment, changing the amount of planned investment at any real interest rate.

They impact unplanned investment, as well, since each firm's planned investment expenditures are, typically, purchases from other firms. A sudden change from optimism to pessimism will leave businesses with unsold inventory, an increase in inventory investment. Unplanned negative inventory investment results from a change from pessimism to optimism.

Topic: 9.2 The Components of Expenditure 24) The investment function implies that current output does not influence investment. Does that make sense?

Answer: Yes. Planned investment relies mostly on business expectations of future economic activity. Fluctuations in current activity affect investment as unplanned inventory changes and, perhaps, as an updating of expectations, causing a change in autonomous investment.

Topic: 9.2 The Components of Expenditure AACSB: Reflective Thinking 25) Acme Brands invested $5 million in 2010 on new equipment, spent $750 thousand to increase its inventory of intermediate components, and added $25 thousand to its inventory of finished goods. At year's end, the components inventory is found to be $200 thousand above its beginning-of-the- year level, and finished goods inventory is up $30 thousand over its starting level. Calculate planned investment, unplanned investment, and actual (total) investment.

Answer: Planned investment is $5 million plus $750 thousand plus $25 thousand equals $5.775 million. Unplanned investment is $200 thousand minus $750 thousand plus $30 thousand minus $25 thousand equals negative $545 thousand. Actual investment is $5 million plus $200 thousand plus $30 thousand equals $5.23 million (equals $5.775 million minus $545 thousand).

Topic: 9.2 The Components of Expenditure AACSB: Analytical Thinking

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9.3 Goods Market Equilibrium 1) The IS curve ________.

A) shows the relationship between aggregate output and the real interest rate when the goods market is in equilibrium B) tells us that increases in autonomous consumption, investment, government purchases, or net exports raise output for any real interest rate C) tells us that a decrease in taxes or in financial frictions leads to an increase in output for any given real interest rate D) all of the above E) none of the above Answer: D Topic: 9.3 Goods Market Equilibrium AACSB: Analytical Thinking 2) A change in which of the following causes a movement along — not a shift in — the IS curve?

A) autonomous consumption B) government purchases C) financial frictions D) all of the above E) none of the above Answer: E Topic: 9.3 Goods Market Equilibrium AACSB: Analytical Thinking 3) A change in which of the following causes a movement along — not a shift in — the IS curve?

A) autonomous investment B) autonomous net exports C) taxes D) all of the above E) none of the above Answer: E Topic: 9.3 Goods Market Equilibrium AACSB: Analytical Thinking 4) A change in which of the following causes a shift in the IS curve?

A) autonomous investment B) autonomous net exports C) taxes D) all of the above E) none of the above Answer: D Topic: 9.3 Goods Market Equilibrium AACSB: Analytical Thinking 8 .

5) According to the IS equation, a change in which of the following will cause a change in output?

A) real interest rate B) autonomous investment C) marginal propensity to consume D) all of the above E) none of the above Answer: D Topic: 9.3 Goods Market Equilibrium AACSB: Analytical Thinking 6) In the IS equation, which of the following is an endogenous variable?

A) autonomous investment B) autonomous net exports C) taxes D) all of the above E) none of the above Answer: E Topic: 9.3 Goods Market Equilibrium AACSB: Analytical Thinking 7) In the IS equation, which of the following is an endogenous variable?

A) government purchases B) real interest rate C) financial frictions D) all of the above E) none of the above Answer: E Topic: 9.3 Goods Market Equilibrium AACSB: Analytical Thinking

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9.4 Understanding the IS Curve 1) The IS curve ________.

A) traces out the points at which the goods market is in equilibrium B) tells us that consumption expenditures fall as the real interest rises C) tells us that as the real interest rate rises planned expenditures go down leading to decreases in output that satisfy the goods market equilibrium D) all of the above E) none of the above Answer: D Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 2) If aggregate output is below its equilibrium level ________.

A) there is an excess demand for goods B) actual output is below planned expenditure C) firms will tend to replenish their low inventories driving output up toward equilibrium D) all of the above E) none of the above Answer: D Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 3) If aggregate output is above its equilibrium level ________.

A) there is an excess supply of goods B) actual output is below planned expenditure C) firms will tend to replenish their low inventories driving output up toward equilibrium D) all of the above E) none of the above Answer: A Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 4) In the IS curve, if Y falls for any given level of the real interest rate ________.

A) consumption decreases B) output increases C) saving increases D) all of the above E) none of the above Answer: A Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking

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5) In the IS curve, if Y increases for any given level of the real interest rate ________.

A) consumption increases B) output decreases C) saving decreases D) all of the above E) none of the above Answer: A Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 6) In the IS curve, if Y falls for any given level of the real interest rate ________.

A) consumption increases B) output increases C) saving increases D) all of the above E) none of the above Answer: E Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 7) In the IS equation, which of the following is an endogenous variable?

A) government purchases B) real interest rate C) consumption D) all of the above E) none of the above Answer: C Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 8) In the IS equation, which of the following is an exogenous variable?

A) planned investment spending B) real interest rate C) consumption D) all of the above E) none of the above Answer: B Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking

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9) When the goods market is returning to equilibrium following a decrease in the real interest rate, ________.

A) saving and output are both rising B) saving and output are both declining C) saving is rising, while output declines D) all of the above E) none of the above Answer: A Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 10) We may infer from the downward slope of the IS curve that lower interest rates are associated with ________.

A) higher output B) higher saving and/or lower net exports C) higher investment D) all of the above E) none of the above Answer: D Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking IS Curve Exogenous Variables and Parameters Table 1 =2 =3 = 1.45 = 1.6 =1

mpc = 0.75 c = 0.05 d = 0.3 x = 0.15 =2

11) Given the values in the table above, the IS curve is ________.

A) Y = 34.6 - 2r B) Y = 8.65 - 2r C) Y = 22.6 - 2r D) Y = 8.33 - 0.67r E) none of the above Answer: C Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking

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12) Given the values in the table above, equilibrium output Y = ________ when the real interest rate r = 4.

A) 26.6 B) 0.65 C) 14.6 D) 5.65 E) none of the above Answer: C Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 13) Given the values in the table above, the real interest rate r = ________ when equilibrium output Y = 15.

A) 9.8 B) 3.8 C) 3.18 D) 10 E) none of the above Answer: B Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 14) Given the values in the table above, consumption is ________ when equilibrium output is 15.

A) 12.3 B) 11.86 C) 12.05 D) 11.55 E) none of the above Answer: B Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 15) Given the values in the table above, if the real interest rate rises from 5 to 6, the change in household saving is ________.

A) negative 0.5 B) negative 1.55 C) negative 0.45 D) 1.55 E) none of the above Answer: C Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking

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IS Graph 1

16) On the graph above, output is above planned expenditures at point ________.

A) A B) B C) G D) H E) none of the above Answer: C Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 17) On the graph above, assuming that G = 0 and NX = 0, saving is above planned investment at point ________.

A) A B) B C) G D) H E) none of the above Answer: C Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 18) On the graph above, unplanned inventory investment is negative at point ________.

A) A B) B C) G D) H E) none of the above Answer: D Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 14 .

19) On the graph above, the labeled point at which investment — planned plus unplanned — is highest is point ________.

A) A B) B C) G D) H E) not inferable from the information given Answer: B Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 20) On the graph above, assuming that G = 0 and NX = 0, the labeled point at which saving is lowest is point ________.

A) A B) B C) G D) H E) not inferable from the information given Answer: E Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 21) If planned expenditure is below output, as the economy approaches equilibrium, ________.

A) planned expenditure is falling B) output is rising C) saving is rising D) all of the above E) none of the above Answer: A Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 22) If planned expenditure is below output, as the economy approaches equilibrium, ________.

A) planned expenditure is rising B) output is rising C) saving is rising D) all of the above E) none of the above Answer: E Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking

15 .

IS Curve Exogenous Variables and Parameters Table 2 =3 =5 =2 =2 =1

mpc = 0.6 c = 0.08 d = 0.4 x = 0.1 =0

23) Using the values in the table above, and assuming that the real interest rate equals 4, calculate equilibrium values for consumption, household saving, investment, and net exports.

Use these values to confirm that the goods market is in equilibrium.

Answer: Entering the given values in the IS curve equation yields Y = 18.7. Plugging Y and r into the consumption equation yields C = 12.7. Subtracting C + T from Y gives household saving = 4. The investment equation using these values of Y and r yields I = 3.4. The net exports equation yields NX = 0.6. Note that S = NX + I - (G - T), so the goods market is in equilibrium.

Also, Y = C + I + G + NX, so the goods market is in equilibrium.

Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking 24) In the text, the equivalence of the goods market equilibrium in the IS model to the equilibrium in which desired investment equals desired saving is demonstrated, assuming that both government purchases and net exports are zero. Demonstrate the equivalence when both G and NX are non-zero.

Answer: In terms of output and expenditures, the equilibrium condition is Y = C + I + G + NX. Rearranging terms, Y - C - G = I + NX. For households, saving is Y - T - C. Government saving is T - G. National saving S = Y - T - C + T - G = Y - C - G. Substituting into the equilibrium equation, S = I + NX. Now, the combined saving by households and the government may be greater or less than investment, with the difference made up by a capital outflow (NX > 0) or capital inflow (NX < 0), respectively.

Topic: 9.4 Understanding the IS Curve AACSB: Analytical Thinking

16 .

9.5 Factors That Shift the IS Curve 1) The IS curve ________ when the real interest rate increases.

A) shifts to the right B) shifts to the left C) shifts up D) all of the above E) none of the above Answer: E Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 2) The IS curve ________.

A) shifts to the right when autonomous consumption increases B) shifts up when the real interest rate increases C) shifts to the left when autonomous investment increases D) all of the above E) none of the above Answer: A Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 3) The IS curve shifts to the left when ________.

A) autonomous consumption increases B) taxes increase C) autonomous investment increases D) all of the above E) none of the above Answer: B Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 4) The IS curve shifts to the left when ________.

A) autonomous consumption increases B) taxes decrease C) autonomous investment decreases D) all of the above E) none of the above Answer: C Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking

17 .

5) The IS curve shifts to the right when ________.

A) autonomous consumption decreases B) taxes increase C) autonomous investment increases D) all of the above E) none of the above Answer: C Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 6) If the government increases military spending ________.

A) the IS curve would shift to the left B) output will decrease if interest rates remain fixed C) the unemployment rate could fall D) all of the above E) none of the above Answer: C Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 7) If the government reduces spending ________.

A) the IS curve will shift to the right B) output will increase if interest rates remain fixed C) consumption will increase D) all of the above E) none of the above Answer: E Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 8) If the government raises taxes ________.

A) planned expenditures fall B) equilibrium output falls C) the IS curve shifts to the left D) all of the above E) none of the above Answer: D Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking

18 .

9) If the government cuts taxes ________.

A) disposable income falls B) planned expenditures rise C) the IS curve shifts to the left D) all of the above E) none of the above Answer: B Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 10) The 2009 fiscal stimulus package was passed ________.

A) to prevent the real interest rate from rising B) to shift the IS curve to the left C) to raise aggregate output at any interest rate D) all of the above E) none of the above Answer: C Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 11) The 2009 fiscal stimulus package did not work ________.

A) in that the IS curve did not shift to the right B) because most of the intended increase in government spending took too long to kick in C) because the increase in government spending was not enough to offset the decline in autonomous expenditure D) all of the above E) none of the above Answer: D Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 12) The 2009 fiscal stimulus package did not work ________.

A) because rising interest rates nullified increased expenditures B) because government spending rose too quickly and too briefly C) but it probably prevented the IS curve from shifting further to the left D) all of the above E) none of the above Answer: C Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking

19 .

13) Qualitatively, an increase in government purchases has the same impact as an increase in autonomous ________.

A) consumption B) investment C) net exports D) all of the above E) none of the above Answer: D Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 14) In the IS model, assuming that the real interest rate does not change, an increase in autonomous ________ leads to an increase in the equilibrium level of ________.

A) investment; consumption B) consumption; investment C) net exports; investment D) all of the above E) none of the above Answer: A Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 15) In the IS model, assuming that the real interest rate does not change, an increase in autonomous ________ leads to an increase in the equilibrium level of ________.

A) investment; net exports B) consumption; government purchases C) net exports; taxes D) all of the above E) none of the above Answer: E Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 16) In the IS model, assuming that the real interest rate does not change, an increase in autonomous net exports causes total investment, planned plus unplanned, to ________.

A) fall, then rise back to its initial level B) fall, then rise above its initial level C) rise, then fall back to its initial level D) all of the above E) none of the above Answer: A Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking

20 .

17) In the IS model, assuming that the real interest rate does not change, an increase in ________ leads to an increase in equilibrium saving by households.

A) autonomous investment B) government purchases C) autonomous net exports D) all of the above E) none of the above Answer: D Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 18) In the IS model, assuming that the real interest rate does not change, an increase in ________ leads to an increase in equilibrium saving by households.

A) autonomous consumption B) taxes C) financial frictions D) all of the above E) none of the above Answer: E Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 19) In the IS model, assuming that the real interest rate does not change, an increase in autonomous ________ leads to a decrease in equilibrium saving.

A) investment B) consumption C) net exports D) all of the above E) none of the above Answer: E Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 20) An increase in autonomous consumption ________.

A) lowers planned expenditures B) raises equilibrium output for any level of the interest rate C) causes a movement down along the IS curve D) all of the above E) none of the above Answer: B Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking

21 .

21) A decrease in autonomous consumption ________.

A) lowers planned expenditures B) raises equilibrium output for any level of the interest rate C) causes a movement down along the IS curve D) all of the above E) none of the above Answer: A Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 22) A decrease in autonomous consumption ________.

A) raises planned expenditures B) lowers equilibrium output for any level of the interest rate C) shifts the IS curve to the right D) all of the above E) none of the above Answer: B Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 23) An increase in autonomous investment ________.

A) increases equilibrium output at any interest rate B) causes a movement down along the IS curve C) shifts the IS curve to the left D) all of the above E) none of the above Answer: A Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 24) A decrease in autonomous investment ________.

A) increases equilibrium output at any interest rate B) causes a movement down along the IS curve C) shifts the IS curve to the left D) all of the above E) none of the above Answer: C Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking

22 .

25) A decrease in autonomous investment ________.

A) decreases equilibrium output at any interest rate B) lowers planned expenditures C) shifts the IS curve to the left D) all of the above E) none of the above Answer: D Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 26) If people feel optimistic about the future of the economy ________.

A) autonomous consumption might increase B) autonomous investment might increase C) it might shift the IS curve to the right D) all of the above E) none of the above Answer: D Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 27) In a stock market boom ________.

A) autonomous consumption might increase because stock holders might feel richer and consume more B) autonomous investment might increase because a higher stock value for a firm helps firms raise funds for increased investment C) the IS curve might shift to the right D) all of the above E) none of the above Answer: D Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 28) In a stock market boom ________.

A) government spending will decrease B) interest rates will decrease C) saving is likely to decrease D) all of the above E) none of the above Answer: E Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking

23 .

IS Graph 2

29) On the graph above, a possible cause of the rightward shift of the IS curve is an increase in ________.

A) foreign demand for domestic goods B) taxes C) domestic demand for foreign goods D) the exchange rate E) none of the above Answer: A Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 30) On the graph above, unplanned inventory investment occurs if the economy is moving from point ________ to point ________.

A) D; C B) C; B C) B; A D) all of the above E) none of the above Answer: D Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking

24 .

31) On the graph above, the amount of inventory depletion will be greatest if the economy is moving from point ________ to point ________.

A) A; D B) D; A C) D; C D) B; A E) B; C Answer: A Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 32) On the graph above, if the economy is at point A when the real interest rate falls, the economy's new situation might be indicated by point ________.

A) A B) B C) C D) D E) none of the above Answer: B Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 33) On the graph above, if the U.S. economy is at point B in 2009, then the economy in 2010 is best represented by point ________.

A) A B) B C) C D) D E) any of the labeled points is as good as the others Answer: B Topic: 9.5 Factors That Shift the IS Curve AACSB: Analytical Thinking 34) The credit spread is countercyclical and coincident, suggesting that a sudden increase in financial frictions is most likely ________.

A) when the economy has been expanding for some time B) after the economy has turned into a recession C) during the recovery phase of the business cycle D) when expected inflation is declining Answer: A Topic: 9.5 Factors That Shift the IS Curve AACSB: Reflective Thinking

25 .

35) Referring to the graph above, assume that the economy is in equilibrium at point A, then an increase in government purchases shifts the IS curve to the right, while the real interest rate remains constant. Explain, step-by-step, how the components of expenditure adjust to bring the economy to its new equilibrium.

Answer: The increase in G causes negative unplanned inventory investment, so firms respond by increasing output. As output rises, consumption rises, so inventories continue to shrink and output continues to rise. The increase in consumption is always a fraction of the increase in output, because the marginal propensity to consume is less than one. The increase in consumption, the decline in inventories, and the increase in output all converge to zero as the economy approaches its new equilibrium at point C. Topic: 9.5 Factors That Shift the IS Curve AACSB: Reflective Thinking 36) Assume that households decide to save more, so autonomous consumption is reduced.

Explain, step-by-step, how the components of expenditure adjust to bring the economy to its new equilibrium. Using the IS curve equation and the consumption function, compare the initial and new equilibria with respect to saving and the real interest rate.

Answer: Consumption is reduced, so there is unplanned inventory investment that signals firms to reduce output. Declining output causes consumption to decline further; unplanned inventory investment continues and output continues to fall. The decline in consumption is continually shrinking, since households respond to reductions in disposable income by reducing saving, as well as reducing consumption (the marginal propensity to consume is less than one). When the decrease in consumption converges to zero, inventories stop rising and output stops falling. The decline in output ∆Y =

. The change in consumption ∆C = ∆ + mpc ×

- c × ∆r.

Substituting the first of these equations into the second, simplifying, then substituting with the first equation again, reveals that ∆C = ∆Y - c × ∆r. If the real interest rate does not change, then saving in the new equilibrium equals the original saving in the old equilibrium (since output has fallen by the same amount as consumption). And, if saving has not changed, then neither has the real interest rate changed.

Topic: 9.5 Factors That Shift the IS Curve AACSB: Reflective Thinking 26 .

37) Assume that the economy is in equilibrium when the real interest rate rises. Explain, step-bystep, how the components of expenditure adjust to bring the economy to its new equilibrium.

Answer: An increase in the real interest rate reduces consumption, investment, and net exports.

Reduced expenditures cause an unplanned inventory adjustment to which firms respond by reducing output. The economy is moving to the left along the IS curve. The slope of the IS curve reflects the further output declines that occur as consumption falls in response to declining output, until the change in consumption has converged to zero (the marginal propensity to consume is less than one).

Topic: 9.5 Factors That Shift the IS Curve AACSB: Reflective Thinking 38) The IS model implies that a dollar of government spending has a larger impact on equilibrium output than does a dollar of taxes. Explain.

Answer: In the IS equation, government purchases are a component of autonomous spending, no different than autonomous consumption, investment, and net exports. From the perspective of producers, a customer is a customer. Taxes, clearly, are not an expenditure. Taxes affect expenditure by reducing disposable income and, thus, consumption. Since only a fraction of disposable income is spent for consumption — a fraction measured as the marginal propensity to consume — each dollar of taxes corresponds to a fraction of a dollar taken from consumption expenditure.

Topic: 9.5 Factors That Shift the IS Curve AACSB: Reflective Thinking 39) For simplicity, the IS model assumes that neither net exports nor net taxes vary with income.

A more realistic (and complicated) model would drop such assumptions. How would the behavior of the IS curve differ in the more realistic model?

Answer: In a more realistic model, increases in income would result in both more imports being purchased and more taxes being paid. The purchase of imports instead of domestic output lessens the impact of expenditure changes on inventories and, thus, on equilibrium output. Shifts of the IS curve in response to changes in autonomous spending would be smaller. Taxes that rise with income reduce the size of changes in consumption spending in response to output changes, so again shifts of the IS curve are smaller. Changes in the real interest rate change expenditures, but the effect on output is reduced to the extent that imports and taxes are changing, so the more realistic IS curve is steeper than the curve in the text.

Topic: 9.5 Factors That Shift the IS Curve AACSB: Reflective Thinking

27 .

Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 10 Monetary Policy and Aggregate Demand 10.1 The Federal Reserve and Monetary Policy 1) When the Federal Reserve ________.

A) drains liquidity, the federal funds rate falls B) drains liquidity, real interest rates fall C) provides more liquidity, the federal funds rate falls D) all of the above E) none of the above Answer: C Topic: 10.1 The Federal Reserve and Monetary Policy AACSB: Analytical Thinking 2) The Federal Reserve ________.

A) sets the federal funds rate once a year B) controls the interest rate in the short run C) controls the interest rate in the long run D) all of the above E) none of the above Answer: B Topic: 10.1 The Federal Reserve and Monetary Policy 3) The federal funds rate is ________.

A) a real interest rate B) set periodically by Congress C) a nominal interest rate D) all of the above E) none of the above Answer: C Topic: 10.1 The Federal Reserve and Monetary Policy 4) A central bank can control the real interest rate precisely, so long as ________ remains constant.

A) the nominal interest rate B) monetary policy C) expected inflation D) all of the above E) none of the above Answer: C Topic: 10.1 The Federal Reserve and Monetary Policy AACSB: Analytical Thinking

1 .

5) In the very short run ________.

A) the real interest rate will be affected by changes in the nominal rate B) monetary policy has an immediate effect on inflation C) the inflation rate is determined by the federal funds rate D) all of the above E) none of the above Answer: A Topic: 10.1 The Federal Reserve and Monetary Policy 6) Changes in liquidity in the banking system affect ________.

A) the nominal interest rate B) the real interest rate C) the federal funds rate D) all of the above E) none of the above Answer: D Topic: 10.1 The Federal Reserve and Monetary Policy 10.2 The Monetary Policy Curve 1) The MP curve indicates the relationship between ________ and the ________.

A) taxes; price level B) the real interest rate; inflation rate C) monetary policy; IS curve D) all of the above E) none of the above Answer: B Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 2) The exogenous variable in the monetary policy curve is ________.

A) the policy parameter, λ B) the real interest rate C) the autonomous component, D) the federal funds rate E) the inflation rate Answer: E Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking

2 .

3) The endogenous variable in the monetary policy curve is ________.

A) the policy parameter, λ B) the real interest rate C) the autonomous component, D) the federal funds rate E) the inflation rate Answer: B Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 4) Which of the following is true about the Taylor principle?

A) it explains the link between higher inflation and higher real interest rates B) it is the foundation for an upward sloping MP curve C) it reflects the practice of monetary policy D) all of the above E) none of the above Answer: D Topic: 10.2 The Monetary Policy Curve AACSB: Reflective Thinking 5) If the central bank did not follow the Taylor principle, an increase in inflation would lead to a decrease in ________.

A) the nominal interest B) the real interest rate C) aggregate output D) all of the above E) none of the above Answer: B Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 6) If the central bank did not follow the Taylor principle, an increase in inflation would lead to ________.

A) a decrease in the nominal interest rate B) an increase in inflation C) a decrease in aggregate expenditure D) all of the above E) none of the above Answer: B Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking

3 .

7) If expected inflation rises, monetary policy ________.

A) is rendered ineffective B) must be tightened, to prevent further increases in inflation and expected inflation C) will prevent any increase in the real interest rate D) is designed to increase the nominal interest rate by more than the increase in expected inflation E) none of the above Answer: D Topic: 10.2 The Monetary Policy Curve AACSB: Reflective Thinking 8) Autonomous tightening of monetary policy involves ________.

A) raising interest rates and shifting the MP curve to the right B) lowering interest rates and shifting the MP curve to the left C) raising interest rates and shifting the MP curve to the left D) lowering interest rates and shifting the MP curve to the right E) none of the above Answer: C Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 9) Autonomous easing of monetary policy involves ________.

A) raising interest rates and shifting the MP curve to the right B) lowering interest rates and shifting the MP curve to the left C) raising interest rates and shifting the MP curve to the left D) lowering interest rates and shifting the MP curve to the right E) none of the above Answer: D Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 10) A movement along the MP curve ________.

A) implies an automatic adjustment of the interest rate B) implies an autonomous adjustment to the interest rate C) implies an autonomous adjustment of aggregate demand D) all of the above E) none of the above Answer: A Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking

4 .

11) A shift of the MP curve ________.

A) implies an automatic adjustment of the interest rate B) implies a direct policy action of the Federal Reserve C) does not alter the relationship between inflation and the interest rate D) all of the above E) none of the above Answer: B Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 12) The MP curve may be used to represent ________.

A) movements of the real interest rate as a direct policy action of the Federal Reserve B) movements of the real interest rate that are independent of direct Federal Reserve action C) how the real interest rate is related to the inflation rate D) all of the above E) none of the above Answer: D Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 13) The MP curve may be used to represent how ________.

A) movements of the inflation rate are determined by the real interest rate B) monetary policy responds to changes in the real interest rate C) movements of the real interest rate are related to the inflation rate D) all of the above E) none of the above Answer: C Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 14) A decision to increase the parameter λ in the MP curve is an example of ________.

A) autonomous easing B) leftward movement along the curve C) rightward movement along the curve D) endogenous response E) autonomous tightening Answer: E Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking

5 .

15) Before the financial crisis of 2007, inflation was on the rise. According to the MP curve, this would lead to ________.

A) an increase in the real interest rate B) an upward shift of the MP curve, if policymakers opted for autonomous tightening C) a decrease in aggregate output D) all of the above E) none of the above Answer: D Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 16) As the financial crisis became more severe in 2008, the Federal Reserve undertook a(n) ________ of monetary policy, an effect of which is to ________ inflation.

A) contraction; raise B) easing; raise C) contraction; lower D) easing; lower E) none of the above Answer: B Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 17) Throughout 2008, inflation and the real interest rate declined together. The cause is a combination of ________.

A) monetary policy easing and declining autonomous spending B) declining autonomous spending and movement along a fixed MP curve C) monetary policy tightening and inversion of the MP curve D) increased government spending and movement along a fixed MP curve E) none of the above Answer: A Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking

6 .

MP Curve

18) Referring to the graph above, a movement from point H to point I might represent ________.

A) the increase in the inflation rate that occurs when the real interest rate rises B) the automatic response of monetary policy to an increase in the inflation rate C) an autonomous tightening of monetary policy D) any of the above E) none of the above Answer: B Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 19) On the graph above, which pair of points best represents the impacts in the U. S. of the financial crisis and policy response from 2007 through 2008?

A) H to I B) K to G C) I to H D) K to F E) G to J Answer: E Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 20) On the graph above, which pair of points best represents a scenario in which the nominal interest rate and expected inflation decline equally?

A) I to H B) G to K C) I to J D) K to F E) J to H Answer: D Topic: 10.2 The Monetary Policy Curve AACSB: Analytical Thinking 7 .

21) Suppose the nominal interest rate is five percent, and the inflation rate rises from two percent to three percent. Might an increase in the nominal interest rate to 5.5 percent be consistent with the Taylor Principle? If not, what consequences might ensue?

Answer: Yes, it might be. The Taylor Principle requires that the nominal interest rate rise by more than the increase in expected inflation. If expected inflation has not changed, or has increased by less than half a percentage point, then the increase in the nominal interest rate implies an increase in the real interest rate. If expected inflation has increased by more than 0.5%, then the real interest rate has declined, which will encourage more spending that might fuel further increases in inflation.

Topic: 10.2 The Monetary Policy Curve AACSB: Reflective Thinking 22) A key concern of monetary policy makers is credibility. In particular, that people believe that inflation will not deviate far from a rate consistent with a healthy macroeconomy. How might credibility affect the slope of the monetary policy curve?

Answer: Credibility implies that the monetary policy curve will be relatively flat. When inflation expectations rely more on confidence in monetary policy and less on the latest fluctuations, small changes in the real interest rate suffice to prevent changes in inflation from acquiring momentum.

Topic: 10.2 The Monetary Policy Curve AACSB: Reflective Thinking 23) Suppose the economy is just recovering from a recession and all signs now point to robust growth. How might this transition from recovery to expansion be reflected in the monetary policy curve?

Answer: The monetary policy curve will have been relatively low, as policy makers kept interest rates as low as possible to hasten recovery from the recession. Once the recession is over, the monetary policy curve will shift up, since low interest rates are no longer appropriate, and to reduce the danger that spending will climb too rapidly and cause inflation to rise. The curve may become steeper, as well, so that any increases in inflation are countered by substantial increases in the real interest rate.

Topic: 10.2 The Monetary Policy Curve AACSB: Reflective Thinking 24) If the monetary policy curve is correct, then policy makers care only about inflation and not at all about aggregate output and unemployment. Comment.

Answer: The monetary policy curve is a concise expression of monetary policy, highlighting policy makers' concern with inflation stability. Policy concerns other than inflation are represented by shifts of the MP curve, so that the real interest rate may change independently of the inflation rate. Moreover, the goal of inflation stability implies the need to be responsive to macroeconomic conditions in general, since the behavior of inflation is closely linked to changes in aggregate output and unemployment.

Topic: 10.2 The Monetary Policy Curve AACSB: Reflective Thinking

8 .

10.3 The Aggregate Demand Curve 1) The AD Curve ________.

A) demonstrates how central banks respond to changes in interest rates by changing the inflation rate B) shows how changes in equilibrium output affect the inflation rate C) explains long run fluctuations in output and inflation D) all of the above E) none of the above Answer: E Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 2) The MP Curve ________.

A) demonstrates how central banks respond to changes in inflation with changes in the interest rate B) shows how changes in interest rates affect equilibrium output C) explains short run fluctuations in output and inflation D) all of the above E) none of the above Answer: A Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 3) The IS Curve ________.

A) demonstrates how central banks respond to changes in inflation with changes in the interest rate B) shows how changes in interest rates affect equilibrium output C) explains short run fluctuations in output and inflation D) all of the above E) none of the above Answer: B Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 4) The AD Curve ________.

A) indicates the level of aggregate output corresponding to different goods-market-clearing levels of the interest rate B) is downward sloping, because with higher inflation comes higher interest rates and lower spending, so equilibrium aggregate output declines C) explains how inflation affects output in the short run D) all of the above E) none of the above Answer: D Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 9 .

5) The AD Curve ________.

A) indicates the level of aggregate output corresponding to different goods-market-clearing levels of the inflation rate B) is downward sloping, because with higher inflation comes lower interest rates and lower spending, so equilibrium aggregate output declines C) explains how inflation affects output in the short run D) all of the above E) none of the above Answer: C Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 6) Factors that shift the AD Curve include ________.

A) the inflation rate B) aggregate output C) taxes D) all of the above E) none of the above Answer: C Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 7) In the aggregate demand curve, the endogenous variable is ________.

A) output B) inflation C) the real interest rate D) real money balances E) none of the above Answer: A Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 8) An increase in the real interest rate occurs when ________.

A) monetary policy responds automatically to an increase in inflation B) expected inflation increases, relative to the nominal interest rate C) an increase in autonomous spending causes an increase in equilibrium output D) all of the above E) none of the above Answer: A Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking

10 .

9) A decrease in the real interest rate occurs when ________.

A) there is an autonomous tightening of monetary policy B) expected inflation increases, relative to the nominal interest rate C) a decrease in autonomous spending causes a decrease in equilibrium output D) all of the above E) none of the above Answer: B Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 10) Factors that shift the AD Curve include ________.

A) government purchases B) autonomous investment C) taxes D) all of the above E) none of the above Answer: D Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 11) Factors that shift the AD Curve include ________.

A) autonomous net exports B) autonomous inflation C) autonomous interest rates D) all of the above E) none of the above Answer: A Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 12) If people begin to generally feel better about the future ________.

A) autonomous consumption should rise B) autonomous investment should rise C) the AD curve will shift to the right D) all of the above E) none of the above Answer: D Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking

11 .

13) If government cuts taxes ________.

A) after tax income should increase shifting AD to the left to a lower equilibrium level of output B) after tax income should increase shifting AD to the right to a higher equilibrium level of output C) after tax income and the equilibrium level of output remain unchanged D) after tax income remains unchanged but the equilibrium level of output would increase E) none of the above Answer: B Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 14) An increase in autonomous spending leads to higher ________.

A) inflation B) output C) real interest rate D) all of the above E) none of the above Answer: B Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 15) An increase in inflation leads to higher ________.

A) output B) spending C) real interest rate D) all of the above E) none of the above Answer: C Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 16) A change in inflation leads to shifts of the ________ curves.

A) MP, IS, & AD B) MP & IS, but not AD C) IS & AD, but not MP D) MP, but not IS nor AD E) none of the above Answer: E Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking

12 .

17) If the Federal Reserve raises interest rates in an autonomous tightening ________.

A) the MP curve shifts up, there is an upward movement along the IS curve, and the AD curve shifts to the left to a lower level of equilibrium output B) the MP curve shifts down, there is a downward movement along the IS curve and the AD curve shifts to the right to a higher level of equilibrium output C) the MP curve shifts up, there is a downward movement along the IS curve and the AD curve shifts to the right to a lower level of equilibrium output D) the MP curve shifts down, there is an upward movement along the IS curve and the AD curve shifts to the left to a higher level of equilibrium output E) none of the above Answer: A Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 18) If the Federal Reserve raises interest rates in an autonomous tightening ________.

A) the MP curve shifts up, raising the real interest for any given level of the inflation rate B) there is an upward movement along the IS curve C) the AD curve shifts to the left D) all of the above E) none of the above Answer: D Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 19) Shifts of the ________ curves result from autonomous monetary policy.

A) MP, IS, & AD B) MP & IS, but not AD C) IS & AD, but not MP D) MP, but not IS nor AD E) none of the above Answer: E Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 20) The IS curve is Y = 20 - 1.5r, and the aggregate demand curve is Y = 15.5 - 0.3π. The monetary policy curve is ________.

A) r = 4.5 - 1.8π B) r = 20 + 0.3π C) r = 3 + 0.2π D) Y = 17.75 + 0.6π E) none of the above Answer: C Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking

13 .

21) The IS curve is Y = 20 - 1.5r, and the aggregate demand curve is Y = 15.5 - 0.3π. When the interest rate is 7 percent, the inflation rate is ________ percent.

A) 14.6 B) 9.5 C) 3.6 D) 20 E) none of the above Answer: D Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 22) The IS curve is Y = 20 - 1.5r, and the aggregate demand curve is Y = 15.5 - 0.3π. When the inflation rate is 3 percent, output is ________.

A) 20 B) 14.6 C) 9.5 D) 3.6 E) none of the above Answer: B Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 23) The aggregate demand curve is Y = 15 - 0.2π when the inflation rate falls from 6 percent to 5 percent. Then, output increases from 13.8 to 17. The response of monetary policy to the inflation decline has been ________.

A) autonomous tightening B) automatic adjustment C) autonomous easing D) to increase autonomous spending E) none of the above Answer: C Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 24) Suppose the monetary policy curve is r = 5 + 0.8π, and the current values for output and inflation are 16.8 and 2 percent, respectively. An increase in global resource prices pushes the inflation rate to 4 percent. Policy makers estimate that the monetary policy in place, responding to 4 percent inflation, will bring output down to 13.6, a decline considered excessive. Instead, they implement an autonomous easing of monetary policy to lower output from 16.8 to 16.

Assuming no change in the slope of the monetary policy curve, determine the new curve.

Answer: From the given monetary policy curve, the real interest rate was initially 6.6 percent, and would rise to 8.2 percent in response to the increase in inflation from 2 percent to 4 percent.

Since this increase in the real interest rate would cause output to decline from 16.8 to 13.6, we know that the IS curve is Y = 30 - 2r. If output is to be 16, the real interest rate must be 7 percent. The monetary policy curve with slope 0.8 and coordinates 4, 7 is r = 3.8 + 0.8π.

Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 14 .

25) Suppose the demand curve is Y = 38 - 3π, and the current values for output and the real interest rate are 29 and 7 percent, respectively. A decrease in inflation leads to a new output level of 32 and real interest rate at 6 percent. The monetary policy curve is ________.

Answer: The inflation rate falls from 3 percent to 2 percent. The corresponding real interest rates are 7 percent and 6 percent, so the MP curve is r = 4 + π.

Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 26) When the inflation rate falls, what happens, and why, to the MP, IS, and AD curves?

Answer: A decrease in the inflation rate will, typically, raise the real interest rate, given the nominal interest rate, because expected inflation will have fallen. To prevent this increase in the real interest rate, which would cause spending and output to decline, the central bank lowers the nominal interest rate by more than the decrease in expected inflation. This movement down to the left along the MP curve corresponds to movement down to the right along the IS curve, because the lower real interest rate increases consumption, investment, and net exports.

Movement down to the right along the AD curve shows the increase in output that has resulted from the decrease in the inflation rate.

Topic: 10.3 The Aggregate Demand Curve AACSB: Analytical Thinking 10.4 The Money Market and Interest Rates 1) The liquidity preference theory distinguishes between ________.

A) nominal and real quantities B) money and financial assets C) buying goods and earning interest income D) all of the above E) none of the above Answer: D Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 2) "Real money balances" refers to ________.

A) the quantity of goods and services that money can buy B) gold and silver C) money that is actually available to be spent D) all of the above E) none of the above Answer: A Topic: 10.4 The Money Market and Interest Rates

15 .

3) The liquidity preference theory ________.

A) distinguishes between nominal and real quantities B) shows that demand for real balances depends on real income C) shows that demand for real balances depends on the nominal interest rate D) all of the above E) none of the above Answer: D Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 4) ________ is a good measure of the opportunity cost of holding money.

A) The real interest rate B) Liquidity preference C) Real income D) The inflation rate E) none of the above Answer: E Topic: 10.4 The Money Market and Interest Rates 5) Demand for real money balances depends on ________.

A) the price level B) the real interest rate C) the opportunity cost of holding money D) all of the above E) none of the above Answer: C Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 6) According to liquidity preference theory, as real income increases, so does ________.

A) the supply of real money balances B) the demand for real money balances C) the real interest rate D) all of the above E) none of the above Answer: B Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking

16 .

7) According to liquidity preference theory, an increase in the price level would ________.

A) decrease the demand for real money balances B) increase the supply of real money balances C) decrease the real interest rate D) all of the above E) none of the above Answer: E Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 8) According to liquidity preference theory, an increase in the price level would ________.

A) increase the demand for real money balances B) decrease the supply of real money balances C) decrease the real interest rate D) all of the above E) none of the above Answer: B Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 9) The endogenous variable in the liquidity preference function is ________.

A) demand for real money balances B) the nominal interest rate C) real income D) the price level E) none of the above Answer: A Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 10) The liquidity preference function shows that as ________.

A) real income decreases, so does the demand for real money balances B) the nominal interest rate increases, so does the demand for real money balances C) real income decreases, so does the real interest rate D) all of the above E) none of the above Answer: A Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking

17 .

11) As the nominal interest rate increases ________.

A) it becomes more costly to hold money instead of bonds B) the quantity of money demanded falls C) the opportunity cost of holding money rises D) all of the above E) none of the above Answer: D Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 12) As the nominal interest rate increases ________.

A) it becomes more costly to hold bonds instead of money B) the quantity of money demanded rises C) the opportunity cost of holding money rises D) all of the above E) none of the above Answer: C Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 13) As income rises ________.

A) the number of transactions households and firms undertake should increase B) wealth also rises C) demand for real money balances should increase D) all of the above E) none of the above Answer: D Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 14) The demand for real money balances ________.

A) is downward sloping with respect to prices B) is downward sloping with respect to interest rates C) is downward sloping with respect to income D) all of the above E) none of the above Answer: B Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking

18 .

15) Why is the demand for real money balances downward sloping?

A) because the opportunity cost of holding money decreases as interest rates decrease B) because when the interest rate falls the quantity of money demanded increases C) because lower interest rates encourage firms and households to increase their money holdings D) all of the above E) none of the above Answer: D Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 16) The supply curve for money ________.

A) is upward sloping with respect to interest rates B) is fixed to a specified interest rate C) is fixed regardless of the interest rate D) is downward sloping with respect to interest rates E) none of the above Answer: C Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 17) Increased liquidity in the banking system occurs when ________.

A) people buy more bonds B) the demand for real money balances declines C) banks buy more bonds from the central bank D) all of the above E) none of the above Answer: E Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 18) Typically, central banks increase the supply of money by ________.

A) buying bonds from banks B) printing currency C) directing the government to issue more money to banks D) all of the above E) none of the above Answer: A Topic: 10.4 The Money Market and Interest Rates

19 .

19) Which of the following is true with regard to the supply of money?

A) an open market sale of government securities will increase liquidity B) an open market purchase of government securities will decrease liquidity C) liquidity and the money supply are directly related D) all of the above E) none of the above Answer: C Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 20) Which of the following is true with regard to the supply of money?

A) an open market purchase of government securities will increase liquidity B) an open market sale of government securities will decrease liquidity C) liquidity and the money supply are directly related D) all of the above E) none of the above Answer: D Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 21) A decrease in income ________.

A) lowers money demand for any given interest rate B) lowers interest rates ceteris paribus C) leads to a leftward shift of the money demand curve D) all of the above E) none of the above Answer: D Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 22) When people are holding money in excess of their demand for real money balances ________.

A) the nominal interest rate will fall B) they increase their purchases of goods and services C) the central bank buys bonds to correct the imbalance D) all of the above E) none of the above Answer: A Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking

20 .

23) A rightward shift of the money supply ________.

A) may come about from an increase in the quantity of money supplied by the Federal Reserve B) may come about from a decrease in the price level C) leads to a decrease in interest rates ceteris paribus D) all of the above E) none of the above Answer: D Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 24) A leftward shift of the money supply ________.

A) may come about from an increase in the quantity of money supplied by the Federal Reserve B) may come about from an increase in the price level C) leads to a decrease in interest rates ceteris paribus D) all of the above E) none of the above Answer: B Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 25) If the nominal interest rate is above the equilibrium level ________.

A) the supply of real money balances will fall B) the quantity of real money balances people are holding is too low, and is rising C) people are selling financial assets in order to increase real money balances D) all of the above E) none of the above Answer: E Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 26) If the nominal interest rate is above the equilibrium level ________.

A) purchases of bonds and other assets will cause the interest rate to fall B) issuance of bonds and other assets will cause the supply of real money balances to increase C) the opportunity cost of holding money is low, and is rising D) all of the above E) none of the above Answer: A Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking

21 .

27) When the Federal Reserve increases the money supply, people ________.

A) decrease their purchases of bonds and other financial assets B) may, in the short run, increase their purchases of goods and services C) decrease the quantity of money holdings D) all of the above E) none of the above Answer: B Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking 28) Why is the demand for real money balances related to the nominal interest rate, rather than the real interest rate?

Answer: Because expected inflation is irrelevant to deciding between money versus interestbearing assets. Whether expected inflation is high or low, interest-bearing assets generate income at the nominal interest rate, and that income is the opportunity cost of holding money. Expected inflation implies a reduction in the purchasing power of money affecting equally both money held and money received as interest income.

Topic: 10.4 The Money Market and Interest Rates AACSB: Reflective Thinking 29) If your local bank buys a few billion dollars worth of government securities, what happens to the economy's money supply?

Answer: If the seller of the bonds is another private business, there is no effect on the money supply. The money that might have supported spending and lending by the buying bank is now available for lending and spending by the seller(s) of the bonds. However, if the seller of the bonds is the Federal Reserve, then the money supply is reduced, since the decline in liquidity at the buying bank is not offset by an increase in liquidity elsewhere in the economy. (The bank's deposit at the Fed is reduced by the amount of its bond purchase; the money is not transferred to a different account, but ceases to exist.)

Topic: 10.4 The Money Market and Interest Rates AACSB: Reflective Thinking 30) Suppose real output is 12,500, and the demand for real money balances is

=

- 125i. If

the equilibrium interest rate is 7 percent, calculate the money supply. If the central bank sets the interest rate at 8 percent, what is the new money supply?

Answer: Plugging the given output and interest rate in the demand equation, the money supply (equals money demand) is 2,250. When the interest rate is 8 percent, the money supply is 2,125.

Topic: 10.4 The Money Market and Interest Rates AACSB: Analytical Thinking

22 .

Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 11 Aggregate Supply and the Phillips Curve 11.1 The Phillips Curve 1) The idea behind the Phillips curve is that ________.

A) tight labor markets lead to inflationary pressures B) when the unemployment rate is low, wages will increase C) when firms raise wages to attract new workers, prices will also increase D) all of the above E) none of the above Answer: D Topic: 11.1 The Phillips Curve AACSB: Reflective Thinking 2) The idea behind the Phillips curve is that ________.

A) tightness in the labor market raises wages but has little impact on prices B) when the unemployment rate is low, wages will decrease C) when firms raise wages to attract new workers, prices will also increase D) all of the above E) none of the above Answer: C Topic: 11.1 The Phillips Curve AACSB: Reflective Thinking 3) The idea behind the Phillips curve is that ________.

A) when the unemployment rate is low wages will decrease B) tightness in the labor market puts upward pressures on wages and prices C) when firms raise wages to attract new workers, prices decrease D) all of the above E) none of the above Answer: B Topic: 11.1 The Phillips Curve AACSB: Reflective Thinking 4) The idea behind the Phillips curve is that ________.

A) tightness in the labor market puts downward pressures on wages and prices B) when the unemployment rate is low wages will increase C) when firms raise wages to attract new workers, prices decrease D) all of the above E) none of the above Answer: B Topic: 11.1 The Phillips Curve AACSB: Reflective Thinking

1 .

5) ________ is (are) the endogenous variable(s) in the Phillips curve.

A) Expected inflation B) Inflation C) The natural rate of unemployment D) all of the above E) none of the above Answer: B Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 6) In the 1960s, the Phillips curve was ________.

A) a very popular explanation for inflation fluctuations B) consistent with a clear negative relationship between inflation and unemployment C) suggestive of a permanent trade off between inflation and unemployment D) all of the above E) none of the above Answer: D Topic: 11.1 The Phillips Curve 7) In the 1960s, the Phillips curve was ________.

A) consistent with a positive relationship between inflation and unemployment B) suggestive of a temporary trade off between inflation and unemployment C) a very popular explanation for inflation fluctuations D) all of the above E) none of the above Answer: C Topic: 11.1 The Phillips Curve 8) In the 1960s, advocates of the Phillips curve suggested ________.

A) an "optimal" goal of 1% unemployment and 1% to 2% inflation rates could be achieved B) a "realistic" goal of 7% unemployment and 6% to 7% inflation rates could be achieved C) a "nonperfectionist" goal of 3% unemployment and 4% to 5% inflation rates could be achieved D) all of the above E) none of the above Answer: C Topic: 11.1 The Phillips Curve 9) The Phillips curve was ________.

A) never very popular in policy circles B) influential in efforts to bring the unemployment rate down to low levels C) generally confirmed in the 1970s, when low unemployment persisted despite rising inflation D) all of the above E) none of the above Answer: B Topic: 11.1 The Phillips Curve 2 .

10) The Phillips curve was ________.

A) adopted by economic policy teams in the Kennedy and Johnson administrations B) influential in efforts to bring the unemployment rate down to low levels C) discredited in the 1970s, when both inflation and unemployment were relatively high D) all of the above E) none of the above Answer: D Topic: 11.1 The Phillips Curve 11) Milton Friedman and Edmund Phelps contributed which insight(s) to Phillips curve analysis?

A) that firms and workers care about nominal, not real wages B) that wages have a one-to-one relationship with inflation C) that, in the long run, the level of unemployment is independent of inflation D) all of the above E) none of the above Answer: C Topic: 11.1 The Phillips Curve 12) Milton Friedman and Edmund Phelps contributed which insight(s) to Phillips curve analysis?

A) that a "realistic" goal of 7% unemployment and 6% to 7% inflation rates could be achieved B) that, in the long run, sticky wages and staggered prices prevent unemployment from remaining low C) that firms and workers care about real wages D) all of the above E) none of the above Answer: C Topic: 11.1 The Phillips Curve 13) Milton Friedman and Edmund Phelps contributed which insight(s) to Phillips curve analysis?

A) that firms and workers care about nominal, not real wages B) that wage changes have a one-to-one relationship with changes in expected inflation C) that, in the long run, prices are flexible, so unemployment cannot remain above zero D) all of the above E) none of the above Answer: B Topic: 11.1 The Phillips Curve 14) Milton Friedman and Edmund Phelps contributed which insight(s) to Phillips curve analysis?

A) that firms and workers care about real wages B) that inflation and expected inflation influence each other C) that, in the long run, the level of unemployment is independent of inflation D) all of the above E) none of the above Answer: D Topic: 11.1 The Phillips Curve

3 .

15) Milton Friedman and Edmund Phelps contributed which insight(s) to Phillips curve analysis?

A) that inflation is directly related to expectations of future inflation B) that inflation is negatively related to the unemployment gap C) that in the long run unemployment will be at the natural rate D) all of the above E) none of the above Answer: D Topic: 11.1 The Phillips Curve 16) What can be concluded from Milton Friedman and Edmund Phelps' expectations-augmented Phillips curve?

A) that there is no long run tradeoff between unemployment and inflation B) that there is a short run tradeoff between unemployment and inflation C) that there are two types of Phillips curves D) all of the above E) none of the above Answer: D Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 17) What can be concluded from Milton Friedman and Edmund Phelps' expectations-augmented Phillips curve?

A) that there is a long run tradeoff between unemployment and inflation B) that there is a short run tradeoff between unemployment and inflation C) that inflation is positively related to the unemployment gap D) all of the above E) none of the above Answer: B Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 18) In Milton Friedman and Edmund Phelps' expectations-augmented Phillips curve, ________.

A) unemployment will, in the long run, reach the natural rate B) in the long run, expected inflation will reach the NAIRU C) inflation is positively related to the unemployment gap D) all of the above E) none of the above Answer: A Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking

4 .

19) The Long-Run Phillips Curve is vertical, suggesting that ________.

A) allowing inflation to rise will not succeed in keeping unemployment low B) changes in unemployment have no lasting impact on inflation C) shifts of the short-run Phillips curve impact inflation, but have no effect on unemployment D) all of the above E) none of the above Answer: A Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 20) Observations of inflation in the 1970s prompted what further addition to the Phillips curve?

A) price shocks B) expected inflation C) personal consumption expenditures D) all of the above E) none of the above Answer: A Topic: 11.1 The Phillips Curve 21) Which of the following might cause an upward shift of the modern Phillips curve?

A) an increase in oil prices B) an increase in the price of imports C) wage agreements that include compensation for inflation D) all of the above E) none of the above Answer: D Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 22) ________ will cause a movement along the modern Phillips curve.

A) An increase in oil prices B) An increase in the price of imports C) Wage agreements that include compensation for inflation D) all of the above E) none of the above Answer: E Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking

5 .

23) On the modern Phillips curve, the initial impact of an increase in the world price of steel is shown by ________.

A) an upward movement along the Phillips curve to a higher inflation rate B) an upward shift of the Phillips curve leading to higher inflation rates for any unemployment rate C) a downward shift of the Phillips curve leading to lower inflation rates for any unemployment rate D) a downward movement along the Phillips curve to higher unemployment rates E) none of the above Answer: B Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 24) On the modern Phillips curve, the initial impact of government policies to stimulate the economy is shown by ________.

A) an upward movement along the Phillips curve to a higher inflation rate B) an upward shift of the Phillips curve leading to higher inflation rates for any unemployment rate C) a downward shift of the Phillips curve leading to lower inflation rates for any unemployment rate D) a downward movement along the Phillips curve to higher unemployment rates E) none of the above Answer: A Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 25) On the modern Phillips curve, the initial impact of productivity improvements that lower the costs of production is shown by ________.

A) an upward movement along the Phillips curve to a higher inflation rate B) an upward shift of the Phillips curve leading to higher inflation rates for any unemployment rate C) a downward shift of the Phillips curve leading to lower inflation rates for any unemployment rate D) a downward movement along the Phillips curve to higher unemployment rates E) none of the above Answer: C Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking

6 .

26) On the modern Phillips curve, the beginning of a recession is shown by ________.

A) an upward movement along the Phillips curve to a higher inflation rate B) an upward shift of the Phillips curve leading to higher inflation rates for any unemployment rate C) a downward shift of the Phillips curve leading to lower inflation rates for any unemployment rate D) a downward movement along the Phillips curve to higher unemployment rates E) none of the above Answer: D Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 27) As wages and prices become more flexible ________.

A) wages becomes less responsive to unemployment deviations from the natural rate B) it becomes easier to differentiate the short-run from the long-run Phillips curve C) inflation becomes more responsive to unemployment deviations from the natural rate D) all of the above E) none of the above Answer: C Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 28) If wages and prices become extremely flexible ________.

A) there is no trade off between inflation and unemployment B) unemployment can hardly deviate from the natural rate C) it becomes very difficult to differentiate the short-run from the long-run Phillips curve D) all of the above E) none of the above Answer: D Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 29) As wages and prices become more sticky ________.

A) inflation becomes more responsive to unemployment deviations from the natural rate B) wages become less responsive to unemployment deviations from the natural rate C) it becomes more difficult to differentiate the short-run from the long-run Phillips curve D) all of the above E) none of the above Answer: B Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking

7 .

30) As wages and prices become more sticky ________.

A) the short-run Phillips curve gets flatter B) wages become less responsive to unemployment deviations from the natural rate C) it becomes easier to differentiate the short-run from the long-run Phillips curve D) all of the above E) none of the above Answer: D Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 31) If expectations about inflation are adaptive, they are ________.

A) formed by looking at the future B) likely to change rapidly C) based on past inflation D) all of the above E) none of the above Answer: C Topic: 11.1 The Phillips Curve 32) If expectations about inflation are adaptive, they are ________.

A) not based on all available, relevant information B) backward-looking C) likely to change slowly D) all of the above E) none of the above Answer: D Topic: 11.1 The Phillips Curve 33) If expectations about inflation are adaptive, they are ________.

A) quick to respond to price shocks B) consistent with the notion of sticky prices C) based on changes in productivity D) all of the above E) none of the above Answer: B Topic: 11.1 The Phillips Curve 34) According to the accelerationist Phillips curve, ________.

A) expectations adjust continually to the latest information B) increases in inflation cause the unemployment gap to widen C) inflation will change so long as an unemployment gap persists D) all of the above E) none of the above Answer: C Topic: 11.1 The Phillips Curve

8 .

35) An example of a price shock is ________.

A) an increase in wages as a result of higher expected inflation B) the arrival of immigrants seeking employment C) the decline in autonomous spending that results from rising unemployment D) all of the above E) none of the above Answer: E Topic: 11.1 The Phillips Curve 36) Given the accelerationist Phillips curve Δπ = - 0.3 (U - 6) + ρ, suppose that inflation in the preceding period was 3 percent, unemployment is 6 percent, and there is a price shock of 2 percent. The current inflation rate is ________.

A) 3 percent B) 0.2 percent C) 5 percent D) 1 percent E) none of the above Answer: C Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 37) Given the accelerationist Phillips curve Δπ = - 0.3 (U - 6) + ρ, suppose that inflation in the preceding period was 3 percent, unemployment is 7 percent, and there is no price shock. The current inflation rate is ________.

A) 2.7 percent B) 3 percent C) 0.9 percent D) 3.3 percent E) none of the above Answer: A Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 38) Given the accelerationist Phillips curve Δπ = - 0.7 (U - 5) + ρ, suppose that inflation has increased from 8 percent to 10 percent. If the unemployment rate is 4 percent, then the price shock is ________.

A) 2.7 percent B) 0.6 percent C) 1.3 percent D) 1 percent E) none of the above Answer: C Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking

9 .

39) Based on the data in this table,

period 1 period 2 period 3

U 6 8 8

ρ 1 0 2

π 4 2.2 2.4

if the inflation rate in period zero had been 3 percent, then the accelerationist Phillips curve is ________.

A) Δπ = - 1.8 (U - 7) + ρ B) Δπ = - 1.1 (U - 6) + ρ C) Δπ = - 0.9 (U - 6) + ρ D) Δπ = - 0.4 (U - 9) + ρ E) none of the above Answer: C Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 40) Based on the data in this table,

period 1 period 2 period 3

U 6 8 8

ρ 1 0 2

π 4 3.2 4.4

If the natural rate of unemployment is steady at 7 percent, and, in period four, there is no price shock and unemployment is 8 percent, then the inflation rate in period 4 will be ________ percent.

A) 4.4 B) 3.6 C) 3.4 D) 1.6 E) none of the above Answer: B Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking

10 .

41) Based on the data in this table,

period 1 period 2 period 3

U 6 7 6

ρ 1 0 2

π 4 4.5 ??

If the natural rate of unemployment is steady at 8 percent, what is the inflation rate in period 3?

A) 8.5 percent B) 7.5 percent C) 5.5 percent D) 6.3 percent E) none of the above Answer: B Topic: 11.1 The Phillips Curve AACSB: Analytical Thinking 42) Why is there no long-run trade-off between unemployment and inflation?

Answer: Because when the labor market is so tight as to cause wages and prices to rise, the resulting inflation intensifies the pressure on wages and prices (by reducing the real wage and increasing expected inflation). Since the inflation in no way "balances" or "compensates" for the low level of unemployment, the condition of "too low" unemployment is unsustainable in the long run.

Topic: 11.1 The Phillips Curve AACSB: Reflective Thinking 43) What are price shocks? Why were they not included in the original formulation of the Phillips curve? Why were they added to the modern Phillips curve?

Answer: In the Phillips curve, inflation is determined by expected inflation and the unemployment gap. A price shock is anything other than those two factors that has an impact on inflation, such as a change in import prices. At first, Phillips and other economists were interested in the relationship between unemployment and inflation, rather than in devising a comprehensive explanation addressing all causes of inflation. Once it became clear that a persistent unemployment gap will cause inflation to change repeatedly (shifts of the short-run Phillips curve), it was possible to ask how much of inflation is attributable to labor market conditions, which requires recognition of all other factors that influence inflation.

Topic: 11.1 The Phillips Curve AACSB: Reflective Thinking

11 .

44) How do you suppose most people form an expectation of future inflation? Is that method consistent with the assumption of adaptive expectations?

Answer: Like any mechanic in the Bronx, most people distil a "gut opinion" from their personal experience and what they read in the papers, hear from others, etc. While "expert" analysis of projected trends has some influence, greater weight is placed, probably, on whether inflation has seemed recently high, or rising, or declining, or low, and expected inflation is an extrapolation from those observations. Adaptive expectations exaggerates to an exclusive reliance on the past, but seems a reasonable approximation of the actual method.

Topic: 11.1 The Phillips Curve AACSB: Reflective Thinking 45) A. W. Phillips' 1958 paper examined unemployment and wage growth. What role, if any, does wage growth play in the modern Phillips curve?

Answer: The modern Phillips curve relates unemployment to inflation, rather than wages. This allows inclusion of expected inflation and price shocks as causes of inflation, in addition to the unemployment gap. But the central idea remains that changes in inflation are driven by wage changes. When wages are sticky, then unemployment gaps have a small impact on inflation, while flexible wages cause large changes in inflation.

Topic: 11.1 The Phillips Curve AACSB: Reflective Thinking 46) Suppose the government lowers unemployment by hiring more government workers. How does it matter whether wages and prices are sticky?

Answer: As long as wages and prices are sticky, then the decrease in the unemployment rate will not cause a substantial increase in wages. However, if workers throughout the economy perceive an opportunity to seek an increase in their real wage, employers may need to comply in order to retain and attract qualified workers. If nominal wages increase, producers will need to raise prices. The resulting inflation will cause expected inflation to rise, sparking further increases in the nominal wage.

Topic: 11.1 The Phillips Curve AACSB: Reflective Thinking

12 .

11.2 The Aggregate Supply Curve 1) In the long run ________.

A) the amount of output an economy can produce is determined by real variables like capital, labor and technological advances B) aggregate supply is fixed at the potential level of output C) there is enough time for prices to fully adjust so the classical dichotomy holds D) all of the above E) none of the above Answer: D Topic: 11.2 The Aggregate Supply Curve 2) In the long run ________.

A) the aggregate supply is vertical with respect to output B) the Phillips curve is vertical with respect to unemployment C) fluctuations in the inflation rate have no impact on output and unemployment D) all of the above E) none of the above Answer: D Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 3) In the long run ________.

A) the aggregate supply is vertical with respect to unemployment B) the Phillips curve is vertical at a given level of expected inflation C) the economy reaches the potential output level consistent with the natural rate of unemployment D) all of the above E) none of the above Answer: C Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 4) The natural rate of output is ________.

A) independent of the inflation rate B) always lower than potential output C) unrelated to the natural rate of unemployment D) all of the above E) none of the above Answer: A Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking

13 .

5) When wages and prices are completely flexible ________.

A) inflation is determined by expected inflation and price shocks B) labor hoarding occurs C) unemployment is disconnected from the real economy D) all of the above E) none of the above Answer: A Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 6) Which of the following shows a negative relationship between the output and unemployment gaps?

A) the AS curve B) the Phillips curve C) Okun's law D) the classical dichotomy E) none of the above Answer: C Topic: 11.2 The Aggregate Supply Curve 7) Which of the following never assumes, either implicitly or explicitly, independence between nominal and real variables?

A) the AS curve B) the Phillips curve C) Okun's law D) the classical dichotomy E) none of the above Answer: C Topic: 11.2 The Aggregate Supply Curve 8) Which of the following best approximates Okun's law?

A) a 1 percent increase in output leads to a 2 percent decrease in unemployment B) a 1 percent increase in output leads to a 1 percent decrease in unemployment C) a 2 percent increase in output leads to a 4 percent increase in unemployment D) a 2 percent increase in output leads to a 1 percent decrease in unemployment E) none of the above Answer: D Topic: 11.2 The Aggregate Supply Curve

14 .

9) According to Okun's law, an increase in which of the following is associated with an increase in unemployment?

A) inflation B) output C) expected inflation D) autonomous expenditure E) potential output Answer: E Topic: 11.2 The Aggregate Supply Curve 10) Which of the following is true in regards to Okun's law?

A) employment does not increase commensurately with output rises because firms tend to hoard labor B) when demand increases, firms tend to work their employees harder and longer C) it is Okun's prediction of the negative relationship between the output and unemployment gaps that allows the modern Phillips curve to be translated into the AS curve D) all of the above E) none of the above Answer: D Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 11) The short-run aggregate supply curve shows that inflation will change as a result of changes in ________.

A) output B) potential output C) expected inflation D) price shocks E) all of the above Answer: E Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 12) The short-run aggregate supply curve shows that a change in inflation will cause (a) change(s) in ________.

A) output B) potential output C) expected inflation D) price shocks E) all of the above Answer: C Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking

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13) According to the short-run aggregate supply curve, if output minus potential output equals zero, then ________.

A) unemployment might be zero B) inflation might be stable C) expected inflation must be stable D) price shocks must be zero E) none of the above Answer: B Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 14) In the short run ________.

A) inflation is negatively related to the output gap B) if output rises above its potential level, the unemployment rate falls and firms will lower wages C) if the labor market tightens, firms will raise prices more rapidly to keep up with upward wage pressures and inflation will ensue D) all of the above E) none of the above Answer: C Topic: 11.2 The Aggregate Supply Curve 15) Which statement(s) is (are) consistent with a positive relationship between inflation and the output gap?

A) If output rises above its potential level, the unemployment rate falls and firms will raise wages and prices more rapidly.

B) In the short run, the AS curve is upward sloping.

C) Through Okun's law, the negative relationship between the output and unemployment gaps allows the modern Phillips curve to be translated into the AS curve.

D) all of the above E) none of the above Answer: D Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 16) In the short run ________.

A) the more flexible wages and prices are, the more inflation responds to the output gap B) the more sticky wages and prices are, the more difficult to tell the difference between the short run and long run aggregate supply curves C) if wages and prices are sticky, aggregate output is always at its potential level D) all of the above E) none of the above Answer: A Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking

16 .

17) If the output gap is constant at minus 2 and the inflation rate has fallen from 6 percent to 5 percent, then next period's short-run aggregate supply curve might be ________.

A) π = 5 - 0.5 (13 - 15) B) π = 5 + 0.5 (13 - 15) C) π = 4 + 0.5 (13 - 15) D) π = 5 + 2 (11 - 15) E) none of the above Answer: B Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 18) When a price shock occurs, the inflation rate is affected ________.

A) only in the period of the price shock B) only in the period after the price shock C) only if the price shock causes a change in output D) only if the price shock persists for more than one period E) none of the above Answer: E Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 19) When a price shock has occurred, inflation returns to its pre-shock rate ________.

A) in the period following the price shock B) in the period when output has returned to its pre-shock rate C) once the output gap has returned to zero D) only in the long run E) none of the above Answer: E Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 20) Suppose the output gap is zero, and policy makers wish to reduce the inflation rate from 10 percent to 5 percent. Which of these policies seems best?

A) contractionary policies to reduce output at least 5 percent below potential output B) a convincing declaration of the inflation rate target, so that expected inflation falls to 5 percent C) no policy action; inflation will fall on its own, eventually D) no policy action; inflation will converge to its long-run rate, regardless of policy E) price and wage controls to counteract their stickiness Answer: B Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking

17 .

21) If Okun's law is U = - 0.5 (Y - ), and potential output grows at 2% per year, then a recession that causes output to decrease by one percentage point will cause unemployment to increase by ________.

A) 1 percentage point B) 1.5 percentage points C) 2 percentage points D) 3 percentage points E) one-half percentage point Answer: B Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 22) If Okun's law is U = - 0.6 (Y - ), and the Phillips curve is π = then the short-run aggregate supply curve is ________.

A) π = + 1.5 (Y - ) + ρ B) π = + 4.2 (Y - ) + ρ C) π = - 2.5 (Y - ) + ρ D) π = - 2.5 (Y + ) + ρ E) none of the above Answer: A Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking

- 2.5 (U -

) + ρ,

23) If the short-run aggregate supply curve is π = + 1.2 (Y - ) + ρ, output equals potential output and there is a price shock of minus two, then the inflation rate is ________.

A) 2 B) - 2 C) minus 2 D) minus 2.4 E) none of the above Answer: B Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking

18 .

Aggregate Supply Curves (1)

24) Based on the graph above, the short-run aggregate supply curve is ________.

A) π = 2 + 1.5 (Y - 10) + ρ B) Y = 8 + (π) + ρ C) π = 2 + (Y - 11) + ρ D) π = 3.5 + 2 (Y - 10) + ρ E) none of the above Answer: A Topic: 11.2 The Aggregate Supply Curve AACSB: Analytical Thinking 25) Why are changes in the output gap larger than changes in the unemployment gap? Why is the relationship expressed in Okun's law not affected by inflation or expected inflation?

Answer: Common sense suggests that output and unemployment must be negatively-related.

However, the link between the two is employment. Since the productivity of employed workers can vary, output has extra flexibility. Moreover, even when employment is changing along with output, not all of the employment change corresponds to a change in unemployment, since new employees might be new entrants to the labor force, and employees who leave their jobs might leave the labor force and not be counted among the unemployed. All these connections between output, employment, the labor force, and unemployment are real; they do not involve any price adjustments.

Topic: 11.2 The Aggregate Supply Curve AACSB: Reflective Thinking

19 .

26) Unprecedented stimulative policies throughout the global economy have sparked debate over the inflationary implications. Defenders of the policies argue that, even if the policies raise inflationary expectations, actual inflation will remain low. Critics charge that current policies are nearly certain to result in excessive inflation. What does the aggregate supply curve have to say?

Answer: As long as the negative output gap persists, rising expectations of inflation will not translate into much actual inflation. However, if the output gap shrinks in absolute value as policy makers intend, nothing will insulate inflation from expectations. To avoid the critics' prediction of excessive inflation, policy makers must somehow manage expectations (and avoid allowing a positive output gap from emerging).

Topic: 11.2 The Aggregate Supply Curve AACSB: Reflective Thinking 11.3 Shifts in Aggregate Supply Curves 1) Technological advances lead to ________.

A) a shift of the short run AS curve up B) a shift of the long run AS curve to the left C) an upward movement along the long run AS curve D) all of the above E) none of the above Answer: E Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Analytical Thinking 2) If the natural rate of unemployment declines ________.

A) labor is more heavily utilized B) potential output increases C) the long run aggregate supply curve shifts to the right D) all of the above E) none of the above Answer: D Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Analytical Thinking 3) If the Fed were to announce that fighting inflation is not a high priority for the immediate future ________.

A) households might expect higher inflation B) the short run aggregate supply would shift upwards C) firms might begin raising their prices to keep up with expected inflation D) all of the above E) none of the above Answer: D Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Analytical Thinking

20 .

4) In 2005 hurricane Katrina devastated large portions of the Gulf Coast economy. Many refineries went offline disrupting oil refining and distribution. What do you think was a likely result?

A) the restricted supply constituted a cost push shock that would have shifted the long run AS curve to the right B) the restricted supply constituted a cost push shock that would have shifted the short run AS curve to the left C) the restricted supply constituted a cost push shock that would have meant an upward movement along the Phillips curve D) all of the above E) none of the above Answer: B Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Analytical Thinking 5) ________ may cause a shift of the long-run aggregate supply curve.

A) A major earthquake B) A change in expected inflation C) A price shock D) all of the above E) none of the above Answer: A Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Analytical Thinking 6) In the short run, if current output remains persistently above potential ________.

A) inflation will rise causing a movement along the aggregate supply curve B) expected inflation will rise causing an upward shift of the aggregate supply curve C) the aggregate supply curve will shift until current output returns to its potential level D) all of the above E) none of the above Answer: D Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Analytical Thinking

21 .

Aggregate Supply Curves (1)

7) Based on the graph above, if the economy is at point 2, then (assuming no price shocks and no changes in actual and potential output) the inflation rate next period will be ________ percent.

A) 5 B) 3.5 C) 4.5 D) 4 E) none of the above Answer: A Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Analytical Thinking 8) Based on the graph above, a cause of movement from point 1 to point 2 might be ________.

A) a positive price shock B) government policy that lowers unemployment C) an increase in potential output D) an increase in expected inflation E) none of the above Answer: B Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Analytical Thinking

22 .

9) Based on the graph above, suppose the economy is at point 2, then output falls to 10 and there is a price shock of one percent. The inflation rate next period will be ________ percent.

A) 5 B) 3.5 C) 4.5 D) 4 E) none of the above Answer: C Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Analytical Thinking 10) If the short-run aggregate supply curve is shifting down repeatedly, it is rather likely that ________.

A) output is declining repeatedly, relative to potential output B) the long-run aggregate supply curve is shifting to the left C) negative price shocks are recurring D) all of the above E) none of the above Answer: E Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Analytical Thinking 11) What factors cause a shift in the long-run aggregate supply curve? Might any of these cause the short-run aggregate supply curve to shift, also?

Answer: The factors that shift the long-run aggregate supply curve are (1) the size of the capital stock, (2) the labor supply, (3) available technology, and (4) the natural rate of unemployment (which determines how much of the labor supply is employed when wages and prices are flexible). A change in long-run aggregate supply is a change in potential output, which changes the output gap (ceteris paribus), which shifts the short-run aggregate supply curve, so that the rate of inflation at which the long-run and short-run curves intersect does not change.

Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Reflective Thinking 12) The short-run aggregate supply curve is π = + 0.8 (Y - 20) + ρ. Suppose inflation last year was 5 percent, current output is 20, and there is a price shock of 2 percent. Suppose, further, that potential output rises next year to 21, while output remains at 20 and next year's price shock is zero. Calculate and explain next year's inflation.

Answer: Current inflation is 5 + 0.8 (20 - 20) + 2 = 7 percent. Next year, inflation is 7 + 0.8 (20 - 21) + 0 = 6.2. Moving from the current to next year, short-run aggregate supply has shifted up because of the increase in expected inflation from 5 to 7 percent, and shifted down by 0.8 × the increase in potential output = 0.8 × 1 = 0.8. The negative output gap corresponds, thru Okun's law, to an increase in the unemployment gap. Either the natural rate of unemployment has declined (a possible cause of the increase in potential output), or the failure of actual output to grow along with potential means that unemployment has risen. Either way, this loosening of the labor market causes wages and prices to rise less rapidly.

Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Reflective Thinking 23 .

Aggregate Supply Curves (2)

13) On the graph above, (a) draw the new short-run aggregate supply curve that results when the economy has been at point 2 for one period, ceteris paribus (do not label the new output level or inflation rate) (b) on the original AS curve, add a point "3" where output is 10.5. On the vertical axis, label the rate of inflation that corresponds to output of 10.5. (c) draw the new short-run aggregate supply curve that results when the economy has been at point 3 for one period, ceteris paribus (do not label the new output level or inflation rate) Answer:

Topic: 11.3 Shifts in Aggregate Supply Curves AACSB: Analytical Thinking

24 .

Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 12 The Aggregate Demand and Supply Model 12.1 Recap of the Aggregate Demand and Supply Curves 1) Which equation is a plausible aggregate demand curve?

A) π = 2 + 0.3Y B) Y = 50 - 1.25π C) Y = 250 - 80r D) π = 5 - 0.4 (U - 6) E) none of the above Answer: B Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 2) The endogenous variable in the aggregate demand curve is ________.

A) the real interest rate B) output C) inflation D) planned expenditure E) none of the above Answer: B Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 3) Rising inflation causes quantity demanded to decline, because ________.

A) the central bank raises the nominal interest rate by more than the increase in expected inflation B) households and businesses are reluctant to spend when prices rise C) higher inflation causes the IS curve to shift to the left D) all of the above E) none of the above Answer: A Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 4) The aggregate demand curve has a negative slope, because households and businesses respond to an increase in ________ by reducing their expenditures.

A) the inflation rate B) output C) the real interest rate D) all of the above E) none of the above Answer: C Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 1 .

5) If the Federal Reserve raises the real interest rate for any given inflation rate ________.

A) investment spending would increase B) it would lead to higher consumption spending and net exports C) the aggregate demand curve would shift to the left D) all of the above E) none of the above Answer: C Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 6) The aggregate demand curve shifts to the left when there is ________.

A) autonomous tightening of monetary policy B) an increase in the nominal interest rate C) an increase in inflation D) all of the above E) none of the above Answer: A Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 7) The aggregate demand curve shifts to the right when there is ________.

A) a negative price shock B) a decrease in the nominal interest rate C) a decrease in inflation D) all of the above E) none of the above Answer: E Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 8) If for any given inflation rate, the federal government lowered taxes, ________.

A) it would have a similar qualitative result on output as an increase in government purchases B) it would raise disposable income leading to higher consumption spending C) the aggregate demand curve would shift to the right D) all of the above E) none of the above Answer: D Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking

2 .

9) An autonomous increase in net exports for any given inflation rate ________.

A) would add directly to planned expenditures B) would raise the equilibrium level of output C) causes the aggregate demand curve to shift to the right D) all of the above E) none of the above Answer: D Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 10) The effect on the aggregate demand curve of which of the following is most similar to the effect of a decrease in the barriers to efficient functioning of financial markets?

A) a decrease in autonomous investment B) a decrease in the inflation rate C) an autonomous loosening of monetary policy D) a decrease in expected inflation E) a negative price shock Answer: C Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 11) If consumers suddenly became more optimistic ________.

A) they would spend more at any given inflation rate B) planned expenditures would decline C) the aggregate demand curve would shift to the left D) all of the above E) none of the above Answer: A Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 12) Under a favorable business environment and if the economic outlook of the future looked promising ________.

A) firms might spend more for any given inflation rate B) planned investment might increase leading to a higher equilibrium level of output C) the aggregate demand curve would likely shift to the right D) all of the above E) none of the above Answer: D Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking

3 .

13) Which equation is a plausible aggregate supply curve?

A) Y = 50 - 1.25π B) π = 2 + 0.3 (Y - 75) C) Y = 250 - 80r D) π = 5 - 0.4 (U - 6) E) none of the above Answer: B Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 14) The endogenous variable in the aggregate supply curve is ________.

A) output B) the real interest rate C) inflation D) planned expenditure E) none of the above Answer: C Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 15) The assumption that in the long run prices and wages are fully flexible implies that the longrun aggregate supply curve is determined by ________.

A) capital and labor inputs B) technology C) the natural rate of unemployment D) all of the above E) none of the above Answer: D Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 16) The short-run aggregate supply curve shows how ________ cause output to rise.

A) increases in inflation B) decreases in unemployment C) decreases in nominal interest rates D) all of the above E) none of the above Answer: E Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking

4 .

17) A change in the output gap is likely to lead to ________.

A) a change in inflation B) a change in expected inflation C) a shift of the short-run aggregate supply curve D) all of the above E) none of the above Answer: D Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 18) In the long run, we typically assume that ________.

A) capital, labor, and technology are independent of the level of inflation B) the natural rate of unemployment is independent of the level of inflation C) aggregate supply is fixed and independent of the level of inflation D) all of the above E) none of the above Answer: D Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 19) In the short run, as output rises above potential ________.

A) inflation will fall from its current level which explains the upward-sloping nature of the Phillips curve B) inflation will rise from its current level which explains the upward-sloping nature of the aggregate supply curve C) unemployment will rise above the natural rate which explains the upward-sloping nature of both the Phillips curve and the AS curve D) all of the above E) none of the above Answer: B Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 20) In the short run, ________.

A) cost push shocks can cause firms to raise prices B) workers pushing for higher wages may lead to increases in inflation C) the aggregate supply curve may shift to the left with increases in expected inflation D) all of the above E) none of the above Answer: D Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking

5 .

21) In the short run, ________.

A) when expected inflation rises, there is a movement up along the AS curve B) workers pushing for higher wages causes output to rise C) the aggregate supply curve may shift to the right with increases in output D) all of the above E) none of the above Answer: E Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Analytical Thinking 22) How does the aggregate demand curve differ from a demand curve for, say, bananas?

Answer: The demand for bananas expresses the quantities that people are willing to buy at various prices. The aggregate demand curve indicates the level of output that is produced when the goods market is in equilibrium at various rates of inflation. The demand for bananas arises from consumer preferences, while the aggregate demand curve arises from monetary policy and the sensitivity of expenditures to the real interest rate.

Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Reflective Thinking 23) How does the aggregate supply curve differ from a supply curve for, say, bananas?

Answer: The supply curve for bananas indicates the quantities that producers are willing to sell at various prices. The aggregate supply curve indicates the rate of inflation that results from various levels of output, relative to potential output. When output is at potential, the rate of inflation is independent, so the long-run aggregate supply curve is vertical. When output varies from potential output, the tightening or slackening of labor and other input markets causes inflation to rise or fall. The supply curve for bananas reflects costs of production. The aggregate supply curve shows that deviations from potential output cause the cost of production and, thus, the price of output to vary.

Topic: 12.1 Recap of the Aggregate Demand and Supply Curves AACSB: Reflective Thinking

6 .

12.2 Equilibrium in Aggregate Demand and Supply Analysis AD - AS Equilibrium

1) On the graph above, at the point where quantity demanded equals quantity supplied (let's call it point A), the economy has reached its ________.

A) general equilibrium, and barring any shocks, it will not move from A B) long-run equilibrium, and barring any shocks, it will not move from A C) short-run equilibrium, and even without any shocks, it may move away from A D) short-run equilibrium, and barring any shocks, it will not move from A E) none of the above Answer: C Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 2) On the graph above, consider a point A on the aggregate demand curve and above the aggregate supply curve. At this point, ________.

A) quantity demanded equals output, but the inflation rate will fall, so output will rise B) quantity demanded is greater than quantity supplied, so the inflation rate will rise C) output is greater than the quantity demanded, so output will fall D) the aggregate demand curve will shift to the right until quantity demanded is equal to quantity supplied E) none of the above Answer: A Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking

7 .

3) On the graph above, consider a point A on the aggregate supply curve and above the aggregate demand curve. At this point, ________.

A) quantity demanded equals output, but the inflation rate will fall, so output will rise B) quantity demanded is greater than quantity supplied, so the inflation rate will rise C) output is greater than the quantity demanded, so output will fall D) the aggregate demand curve will shift to the right until quantity demanded is equal to quantity supplied E) none of the above Answer: C Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 4) On the graph above, consider a point A at which output is greater than potential output. At this point, ________.

A) the inflation rate will rise B) output will rise C) potential output will rise D) the aggregate demand curve will shift to the left E) none of the above Answer: A Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 5) On the graph above, if output is falling, while the quantity demanded is rising, the economy may be at a point on ________.

A) the aggregate supply curve above the aggregate demand curve B) the aggregate supply curve below the aggregate demand curve C) the aggregate demand curve above the aggregate supply curve D) the aggregate demand curve below the aggregate supply curve E) none of the above Answer: A Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 6) On the graph above, if inflation is falling, while the quantity demanded and output are rising, the economy may be at a point on ________.

A) the aggregate supply curve above the aggregate demand curve B) the aggregate supply curve below the aggregate demand curve C) the aggregate demand curve above the aggregate supply curve D) the aggregate demand curve below the aggregate supply curve E) none of the above Answer: C Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking

8 .

7) On the graph above, if inflation is rising, while the quantity demanded and output are rising, the economy may be at a point on ________.

A) the aggregate supply curve above the aggregate demand curve B) the aggregate supply curve below the aggregate demand curve C) the aggregate demand curve above the aggregate supply curve D) the aggregate demand curve below the aggregate supply curve E) none of the above Answer: E Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 8) In the AD-AS framework, long-run equilibrium implies that ________.

A) quantity demanded equals quantity supplied at a moderate level of equilibrium inflation B) quantity demanded equals quantity supplied at a point consistent with the short-run equilibrium level of inflation C) quantity demanded equals quantity supplied at a point consistent with the natural rate of unemployment D) all of the above E) none of the above Answer: C Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 9) According to the "self-correcting mechanism" in the AD-AS framework, ________.

A) the aggregate demand curve shifts up or down as needed to bring the economy to full employment B) the inflation rate changes as needed to move the economy along the short-run aggregate supply curve until output is at potential output C) the long-run aggregate supply curve shifts until it intersects both the aggregate demand and short-run aggregate supply curves at a single point D) inflation and expected inflation are unaffected by deviations of output from potential output E) none of the above Answer: E Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 10) If the unemployment rate is below its natural rate, then ________.

A) output is above its potential level B) there is excess tightness in the labor market C) wages and prices will rise more rapidly and the AS curve will shift to the left D) all of the above E) none of the above Answer: D Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking

9 .

11) If the unemployment rate is below its natural rate, then ________.

A) output is below its potential level B) there is excess tightness in the labor market C) the AS curve will shift to the right D) all of the above E) none of the above Answer: B Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 12) If the unemployment rate is above its natural rate, then ________.

A) output is below its potential level B) there is excess tightness in the labor market C) wages and prices will rise more rapidly and the AS curve will shift to the left D) all of the above E) none of the above Answer: A Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 13) If the unemployment rate is above its natural rate, then ________.

A) output is below its potential level B) there is excess slack in the labor market which will dive down wages C) inflation will decline until equilibrium output reaches its potential level D) all of the above E) none of the above Answer: D Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 14) Picture an economy that is in general equilibrium. What would happen if the natural rate of unemployment were to experience an increase?

A) according to the Phillips curve, the ensuing negative unemployment gap would exert inflationary pressures B) according to Okun's Law, the ensuing negative unemployment gap would be consistent with a positive output gap C) according to the AD-AS framework, the LRAS curve would shift to the left and the ensuing positive output gap would be closed by subsequent leftward shifts in the AS curve to higher equilibrium levels of inflation D) all of the above E) none of the above Answer: D Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking

10 .

15) Picture an economy that is in general equilibrium. What would happen if the natural rate of unemployment were to experience a decrease?

A) according to the Phillips curve, the ensuing negative unemployment gap would exert inflationary pressures B) according to Okun's Law, the ensuing negative unemployment gap would be consistent with a positive output gap C) according to the AD-AS framework, the LRAS curve would shift to the right and the ensuing output gap would have to be closed by subsequent rightward shifts in the AS curve to a lower equilibrium level of inflation D) all of the above E) none of the above Answer: C Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 16) An economy is in long-run equilibrium when output equals potential output. Why is there no long-run equilibrium rate of "potential inflation"?

Answer: Potential output is a real variable determined by the economy's productive resources.

When output deviates from potential, the temporary tightening or loosening in labor and other input markets causes upward or downward pressure on prices. Barring inflationary or deflationary spirals, changes in inflation cause output to approach potential output. Changes in output do not cause inflation to remain near or to approach any particular rate. On the contrary, inflation will be driven continually higher or lower as long as an output gap persists, and the economy may reach potential output and stable inflation at any inflation rate.

Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Reflective Thinking 17) The aggregate demand curve is Y = 75 - 3π, and the short-run aggregate supply curve is π = 6.2 + 0.8(Y - 70). Assuming adaptive expectations, calculate the inflation rate and output for the next period.

Answer: These curves intersect with Y = 66 and π = 3. By adaptive expectations, the short-run aggregate supply curve for next period is π = 3 + 0.8(Y - 70). This curve intersects aggregate demand where Y = 68.82 and π = 2.06.

Topic: 12.2 Equilibrium in Aggregate Demand and Supply Analysis AACSB: Analytical Thinking

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12.3 Changes in Equilibrium: Aggregate Demand Shocks 1) By the time Paul Volcker took office as the new Federal Reserve chairman in 1979, the inflation rate exceeded 10%. By the end of 1986 the inflation rate had been brought down to 1.9%. Which of the following is true about the Volcker Disinflation?

A) lower inflation resulted from a tightening of monetary policy B) by raising the federal funds rate to over 20%, the Federal Reserve stimulated the economy resulting in lower levels of both inflation and the unemployment rate by the early 1980s C) the unemployment rate was brought down by 1982 but it took longer to reach lower inflation rates D) all of the above E) none of the above Answer: A Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking 2) By the time Paul Volcker took office as the new Federal Reserve chairman in 1979, the inflation rate exceeded 10%. By the end of 1986 the inflation rate had been brought down to 1.9%. Which of the following is true about the Volcker Disinflation?

A) lower inflation resulted from a tightening of monetary policy B) by raising the federal funds rate to over 20%, the Federal Reserve slowed the economy and was able to cut inflation in half by 1982 at the cost of a substantial hike in the unemployment rate causing a recession C) this policy induced a substantial negative output gap D) all of the above E) none of the above Answer: D Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking

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3) By the time Paul Volcker took office as the new Federal Reserve chairman in 1979, the inflation rate exceeded 10%. By 1982 the unemployment rate soared to 9.7% and inflation was cut to 6.2%. By the end of 1986 the unemployment rate was brought down to 7% and the inflation rate was brought further down to 1.9%. Which of the following is an appropriate description of the mechanism behind the Volcker Disinflation?

A) The AD curve shifted right due to the autonomous tightening of monetary policy which explains the lowering of the unemployment rate between 1982 and 1986.

B) With the Federal Reserve raising interest rates, the AD curve shifted to the left lowering the equilibrium level of inflation but inducing a negative output gap, which explains the lower inflation rate between 1979 and 1982 at the cost of a higher unemployment rate over the same period.

C) The LRAS curve shifted left due to the tightening of monetary policy generating a positive output gap or a negative unemployment gap which explains the lowering of the unemployment rate between 1982 and 1986.

D) all of the above E) none of the above Answer: B Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking 4) By the time Paul Volcker took office as the new Federal Reserve chairman in 1979, the inflation rate exceeded 10%. By 1982 the unemployment rate soared to 9.7% and inflation was cut to 6.2%. By the end of 1986 the unemployment rate was brought down to 7% and the inflation rate was brought further down to 1.9%. Which of the following is an appropriate description of the mechanism behind the Volcker Disinflation?

A) The AD curve likely shifted left due to the autonomous tightening of monetary policy which explains the lowering of the inflation rate between 1979 and 1982.

B) Due to the autonomous tightening of monetary policy, a negative output gap ensued which explains the increase in the unemployment rate between 1979 and 1982.

C) By 1982, it is likely that equilibrium output was lower than potential leading the AS curve to shift to the right to close the output gap toward a general equilibrium which explains the reduction in the unemployment rate and the further reduction in inflation between 1982 and 1986.

D) all of the above E) none of the above Answer: D Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking

13 .

5) By the time Paul Volcker took office as the new Federal Reserve chairman in 1979, both the inflation and unemployment rates were higher than during most of the 1950s, 60s and early 70s.

The Federal Reserve implemented an autonomous tightening of monetary policy that resulted in the famous Volker Disinflation which was successful in bringing both problems under control.

Which of the following is an appropriate description had Mr. Volker conducted an expansionary monetary policy instead?

A) The AD curve would have likely shifted right due to the Federal Reserve lowering of interest rates which might have resulted in a temporary decline in the unemployment rate but at the cost of skyrocketing inflation.

B) Due to the autonomous expansion of monetary policy, a temporary positive output gap might have ensued thereby decreasing the unemployment rate while exerting huge inflationary pressures in the economy.

C) Due to the autonomous expansion of monetary policy the unemployment rate might have artificially declined. However, the AS curve would then have shifted left to close the ensuing positive output gap thereby returning the unemployment rate to the levels prior to the Fed's action while, likely, making inflation even worse than before Mr. Volker took office.

D) all of the above E) none of the above Answer: D Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking 6) By the time Paul Volcker took office as the new Federal Reserve chairman in 1979, both the inflation and unemployment rates were higher than during most of the 1950s, 60s and early 70s.

The Federal Reserve implemented an autonomous tightening of monetary policy that resulted in the famous Volker Disinflation which was successful in bringing both problems under control.

What would have been a likely result had Mr. Volker conducted an expansionary monetary policy instead?

A) Inflation would have been made worse right away but unemployment would have been permanently lowered.

B) In the long run the unemployment problem would not have been fixed and the inflation problem would have been made much worse.

C) In the short-run both inflation and unemployment would have declined but in the long-run unemployment would have been worse than before the Fed's action.

D) In the short-run both inflation and unemployment would have been made worse but both would have been lowered in the long-run.

E) none of the above Answer: B Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking

14 .

7) By the time Paul Volcker took office as the new Federal Reserve chairman in 1979, both the inflation and unemployment rates were higher than during most of the 1950s, 60s and early 70s.

The Federal Reserve implemented an autonomous tightening of monetary policy that resulted in the famous Volker Disinflation which was successful in bringing both problems under control.

What would have been a likely short-run result had Mr. Volker conducted an expansionary monetary policy instead?

A) Inflation would have been made worse right away but unemployment would have been lowered.

B) Both inflation and unemployment would have declined.

C) Both inflation and unemployment would have been made worse.

D) There would have been no effect on the unemployment and inflation rates.

E) none of the above Answer: A Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking 8) By the time Paul Volcker took office as the new Federal Reserve chairman in 1979, both the inflation and unemployment rates were higher than during most of the 1950s, 60s and early 70s.

The Federal Reserve implemented an autonomous tightening of monetary policy that resulted in the famous Volker Disinflation which was successful in bringing both problems under control.

What would have been a likely long-run result had Mr. Volker conducted an expansionary monetary policy instead?

A) Eventually, inflation would have been made worse but unemployment would have been lowered.

B) Eventually, both the inflation and unemployment rates would have declined.

C) Eventually, both inflation and unemployment would have been made worse.

D) There would have been no effect on the unemployment and inflation rates.

E) none of the above Answer: E Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking

15 .

9) By the time Paul Volcker took office as the new Federal Reserve chairman in 1979, both the inflation and unemployment rates were higher than during most of the 1950s, 60s and early 70s.

The Federal Reserve implemented an autonomous tightening of monetary policy that resulted in the famous Volker Disinflation which was successful in bringing both problems under control.

What would have been a likely long-run result had Mr. Volker conducted an expansionary monetary policy instead?

A) Eventually, inflation would have been made worse and unemployment would not have been fixed.

B) Eventually, both the inflation and unemployment rates would have declined.

C) Eventually, inflation would have been fixed and unemployment would have been made worse.

D) There would have been no effect on the unemployment and inflation rates.

E) none of the above Answer: A Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking 10) The March 2000 "tech bubble" burst caused the aggregate demand curve to shift to the left by ________.

A) causing an upward spike in the real interest rate B) reducing autonomous spending by households and businesses C) reducing government spending on high-tech equipment D) all of the above E) none of the above Answer: B Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking 11) A likely result of the September 11, 2001 terrorist attacks was ________.

A) weaker consumer confidence B) lower business confidence C) a leftward shift of the AD curve D) all of the above E) none of the above Answer: D Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking

16 .

12) What was(were) the effect(s) of the Enron Bankruptcy in late 2001 and other corporate scandals in 2002?

A) An ensuing lack of confidence in financial accounting.

B) The value of corporate bonds declined.

C) It became more expensive for firms to finance their investments.

D) all of the above E) none of the above Answer: D Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking 13) The "tech bubble" burst of 2000, the terrorist attacks of 2001 and the corporate scandals of 2001 and 2002 all had similar qualitative effects on the economy. Which of the following is an appropriate description of the mechanism that would have ensued?

A) Household and business spending would have been eroded shifting the AD curve to the left.

B) Unemployment would have risen and inflation would have fallen.

C) Output would have declined below potential but through shifts in the AS curve, the selfcorrecting mechanism of the AD-AS framework would have brought the unemployment rate down to the lower levels we saw by 2004.

D) all of the above E) none of the above Answer: D Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking 14) What is the main difference between a demand shock stemming from monetary policy and a demand shock that comes from a change in spending?

A) In the short-run, an autonomous monetary policy easing lowers real interest rates and raises aggregate output whereas a positive spending shock has the opposite effect on both variables.

B) An autonomous monetary policy easing raises inflation permanently whereas a positive spending shock only raises inflation temporarily.

C) An autonomous monetary policy easing has a temporary effect on the real interest rate whereas a positive spending shock has a permanent effect on the real interest rate.

D) all of the above E) none of the above Answer: C Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking

17 .

AD - AS Shocks

15) On the graph above, an example of a positive demand shock is the movement from point ________ to point ________.

A) F; G B) H; I C) F; H D) H; F E) none of the above Answer: A Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking 16) On the graph above, an example of a negative demand shock is the movement from point ________ to point ________.

A) F; G B) H; I C) F; H D) H; F E) none of the above Answer: B Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking

18 .

17) On the graph above, movement from point ________ to point ________ might occur if there is a negative demand shock, followed by updating of expected inflation.

A) F; G B) H; I C) H; F D) F; H E) none of the above Answer: C Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking 18) On the graph above, suppose point G is on the short-run aggregate supply curve π = 2.5 + 2 × (Y - 22) and aggregate demand curve Y = 29.25 - 0.5π. If output at point G is 25, and inflation expectations are adaptive, then the inflation rate next period will be ________.

A) 11.5 B) 14.5 C) 8.5 D) 2.5 E) none of the above Answer: A Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking 19) Consider an economy in a long-run equilibrium with Y = 40 and π = 3. A demand shock in period one causes output to rise to 45 and inflation rises to 4. Then, the updating of expected inflation to equal 4 causes output in period two to decline to 43.85, and inflation to rise to 4.77.

Assuming no further shocks, calculate the values of output and inflation for period three.

Answer: Moving from period one to period two, the change in expected inflation is 1, which causes output to decline by 1.15. Since the next change in expected inflation is 0.77, the resulting change in output will be 0.77 × 1.15 = 0.89, so output in period three is 42.96. Output is falling as the short-run aggregate supply curve shifts along the aggregate demand curve. Moving from period one to period two, a change in inflation of 0.77 caused output to decline by 1.15. Thus, a further output decline of 0.89 implies that inflation has increased by 0.89 × 0.77 ÷ 1.15 = 0.596.

Inflation in period three is 5.36.

Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Analytical Thinking

19 .

20) According to the economy's self-correcting mechanism, how does the economy return to potential output following a negative demand shock? How is the recovery process different, if the government implements a policy of economic stimulus?

Answer: The negative demand shock causes output to decline, which causes a negative output gap, which causes inflation to decline. Then, expected inflation adjusts down, shifting the shortrun aggregate supply curve along the (new) aggregate demand curve: lower inflation causes an automatic response of monetary policy to lower the real interest rate, which stimulates planned expenditures, causing output to rise and the output gap to shrink (in absolute value). The shortrun aggregate supply curve will continue to shift down until the output gap is eliminated. A demand stimulus shifts the aggregate demand curve back to the right, closing the output gap more quickly, so inflation does not fall as much (perhaps, not at all), so the short-run aggregate supply curve does not shift down as much (perhaps, not at all).

Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Reflective Thinking 21) Suppose that households and businesses increase autonomous expenditures, driving output well above potential. Describe, in detail, how monetary policy might react to minimize the increase in inflation.

Answer: A positive output gap puts upward pressure on wages and other input prices, so prices and inflation rise. Rising inflation induces an automatic monetary policy response to increase the real interest rate; the increase in expenditure and output is muted by the response of expenditures to the higher real interest rate. If there is no autonomous monetary policy, the increase in inflation will cause an updating of expected inflation, shifting the aggregate supply curve up.

Even thought the output gap is now shrinking, inflation continues to rise as workers press for nominal wage increases to compensate for inflation (recent, current, and anticipated). An autonomous monetary policy response can short-circuit the expectations driven shifting of the aggregate supply curve by increasing the speed and size of the increase in the real interest rate (the aggregate demand curve shifts to the left). If it is widely believed that the central bank will not tolerate an increase in the inflation rate, then the aggregate supply curve might not shift at all, and the economy will return to potential output and to the original rate of inflation.

Topic: 12.3 Changes in Equilibrium: Aggregate Demand Shocks AACSB: Reflective Thinking

20 .

12.4 Changes in Equilibirum: Aggregate Supply (Price) Shocks 1) When a temporary shock in the economy involves a restriction in supply ________.

A) we refer to it as a negative supply shock B) a rise in commodity prices typically follows C) a reduction in output typically ensues D) all of the above E) none of the above Answer: D Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 2) A fall in import prices or an increase in productivity ________.

A) constitute a positive supply shock B) typically leads to a rise in commodity prices C) typically comes with a reduction in output D) all of the above E) none of the above Answer: A Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 3) Suppose there is a temporary supply shock because of a war in the Middle East, then ________.

A) this would constitute a cost push shock due to a restriction in the supply of oil B) the AS curve would shift to the left C) this could theoretically lead to stagflation D) all of the above E) none of the above Answer: D Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 4) Suppose there is a temporary supply shock because of a war in the Middle East, then, ceteris paribus, the ensuing cost push shock ________.

A) would lead to a temporary increase in prices but a permanent reduction in output B) would lead to a temporary increase in output but a permanent increase in inflation C) would lead to a temporary decrease in output but a permanent increase in inflation D) all of the above E) none of the above Answer: E Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking

21 .

5) Suppose there is a temporary supply shock because of a war in the Middle East, then, ceteris paribus, the ensuing cost push shock ________.

A) would lead to a temporary increase in prices due to a restriction in the supply of oil B) would lead to a temporary decrease in output as the AS curve would shift to the left C) would lead to a temporary shift in the AS curve but ultimately output and inflation would return to the original long-run values D) all of the above E) none of the above Answer: D Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 6) In 1973, the Organization of Petroleum Exporting Countries (OPEC) engineered a quadrupling of oil prices by restricting oil production. Which of the following is an appropriate description of this negative supply shock?

A) The AS curve likely shifted to the left and output likely fell because of this adverse shock.

B) In the short-run there was a movement out of general equilibrium leading to an increase in inflation as a likely result of this adverse shock.

C) In the short-run there was a movement out of general equilibrium leading to an increase in unemployment as a likely result of this adverse shock.

D) all of the above E) none of the above Answer: D Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 7) Which of the following is (are) linked to (an) adverse supply shock(s)?

A) the terrorist attacks of 2001 B) collective bargaining that followed the termination of U.S. wage and price controls in 1973 C) the corporate scandals of 2002 D) all of the above E) none of the above Answer: B Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 8) Which of the following is (are) linked to (an) adverse supply shock(s)?

A) the Arab-Israeli war of 1973 B) the Iranian revolution of 1979 C) the wage renegotiations that followed the termination of U.S. wage and price controls in 1973 D) all of the above E) none of the above Answer: D Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking

22 .

9) If a new government adopted some ill-advised regulations causing the economy to be less efficient ________.

A) the ensuing negative supply shock would lead to an immediate rise in inflation B) in the short-run this would create a negative output gap but eventually the previous general equilibrium would be restored by subsequent rightward shifts of the AS curve C) there would be no permanent changes in output and inflation D) all of the above E) none of the above Answer: A Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 10) If the adoption of a new technology led to gains in productivity ________.

A) the ensuing positive supply shock would lead to an immediate increase in output B) in the short-run, the ensuing increase in supply would lower inflation C) and if this new technology permanently altered the productive capacity of the economy then the increase in output and decrease in inflation would be permanent as well D) all of the above E) none of the above Answer: D Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 11) In the mid-to-late 1990s, changes in the health care industry, substantially reduced health care costs relative to other goods and services. Which of the following is an appropriate description of the mechanism behind this supply shock?

A) The AS curve likely shifted to the right which likely explains the short-run fall in unemployment.

B) The ensuing increase in productive capacity led to the rightward shift of the LRAS which is a likely explanation for the protracted decline in the unemployment rate of the 1990s.

C) A positive output gap would have resulted in the short-run but it was eventually closed by a rightward shift of the LRAS which is a likely explanation for the protracted decline in the inflation rate of the 1990s.

D) all of the above E) none of the above Answer: D Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking

23 .

12) In the 1960s and 1970s, research funding by the U.S. government and some universities led to revolutionary advances in network computing. These advances in communication and network technology remained largely isolated to governmental and academic use. By the mid-to-late 1990s, the Internet began to be widely adopted with massive increases in productivity (which journalists dubbed the "new economy"). Which of the following is an appropriate description of the mechanism behind this supply shock?

A) Since this "new economy" was a new paradigm, the transition from a pre-internet to an internet economy was initially costly. Thus, the AS curve likely shifted to the left and unemployment likely increased in the short-run.

B) The ensuing increase in productive capacity led to the rightward shift of the LRAS which is a likely explanation for the protracted decline in the unemployment rate of the 1990s.

C) A negative output gap would have resulted in the short-run, but it was eventually closed by a rightward shift of the LRAS which is a likely explanation for the protracted decline in the inflation rate of the 1990s.

D) all of the above E) none of the above Answer: B Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 13) What is the main difference between a temporary and permanently negative supply shock?

A) The real interest rate immediately decreases after a temporary shock while it eventually increases after a permanent shock.

B) Output increases right away after a temporary shock but the impact does not last whereas for a permanent shock output permanently decreases.

C) A temporary shock will see a permanent increase in inflation while inflation will only rise temporarily after a permanent shock.

D) all of the above E) none of the above Answer: E Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking

24 .

AD - AS Shocks

14) On the graph above, a movement from point ________ to point ________ might represent a positive supply shock.

A) F; I B) H; G C) H; F D) F; G E) none of the above Answer: B Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 15) On the graph above, a movement from point ________ to point ________ might represent a negative supply shock.

A) H; G B) H; F C) F; I D) F; G E) none of the above Answer: C Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking

25 .

16) On the graph above, suppose the economy is at point F when there is a temporary negative supply shock. The new long-run equilibrium is at point ________.

A) H B) I C) F D) G E) none of the above Answer: C Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 17) On the graph above, suppose the economy is at point F when there is a temporary positive supply shock. The new long-run equilibrium is at point ________.

A) H B) I C) F D) G E) none of the above Answer: C Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 18) On the graph above, suppose the economy is at point F when there is a permanent positive supply shock. The new long-run equilibrium is at point ________.

A) F B) H C) I D) G E) none of the above Answer: E Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 19) On the graph above, suppose the economy has moved from point H to point G. If the shock was temporary and inflation expectations are adaptive, the economy will next ________.

A) return to point H B) move to point F C) move to a point between points G and H D) remain at point G E) none of the above Answer: C Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking

26 .

20) The price of a barrel of oil doubled between 2007 and the middle of 2008. To make matters worse, a financial crisis hit the U.S. economy starting in August of 2007. Which of the following is an appropriate description of the mechanism that would have ensued?

A) The increase in the price of oil would have immediately shifted the AS curve to the right.

B) The financial crisis would have led to a sharp contraction in spending shifting the AD curve to the right.

C) Shifts in both the AD and the AS curve would have ensued in the short-run but as long as neither shock had an impact on potential output, ultimately unemployment will have been unaffected in the long run.

D) all of the above E) none of the above Answer: C Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 21) Describe how changes in expected inflation impact an economy in the wake of a temporary negative supply shock.

Answer: The supply shock causes the short-run aggregate supply curve to shift up. The increase in inflation causes output to fall. Since higher-than-expected inflation is observed, expected inflation rises. At the same time, the negative output gap means there is less upward pressure on wages and prices. Moreover, the shock is now over and not expected to repeat. Thus, the secondround increase in inflation is smaller than expected, so expected inflation now adjusts downward, as observed inflation declines, until the output gap is eliminated.

Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Analytical Thinking 22) The Volcker Disinflation (1980-1986) was costly in terms of output and unemployment.

Would it not have been better to reduce inflation with a positive supply shock, rather than a negative demand shock?

Answer: Probably, but a positive supply shock is a difficult to achieve policy goal. A permanent supply shock — shifting the long-run aggregate supply curve to the right — would require an increase in potential output, which is not a policy variable in the short run. A temporary supply shock was, in fact, attempted: public declarations of anti-inflationary intent to lower expected inflation. Though temporary, such management of expectations would result in a permanent decrease in inflation, since the consequence would be to move the economy to (rather than away from) potential output. In practice, the best one might hope is that adjustment of expectations in the wake of a negative demand shock will reduce the intensity and duration of the declines in output and employment.

Topic: 12.4 Changes in Equilibrium: Aggregate Supply (Price) Shocks AACSB: Reflective Thinking

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12.5 AD/AS Analysis of Foreign Business Cycle Episodes 1) The price of a barrel of oil doubled between 2007 and the middle of 2008. To make matters worse, a financial crisis hit the U.S. economy starting in August of 2007. Which of the following is true of the United Kingdom's experience?

A) The increase in the price of oil immediately shifted the AS curve to the left.

B) The financial crisis did not take hold right away so the AD curve did not immediately shift.

C) Eventually, the Lehman Brothers bankruptcy caused a negative demand shock leading to a further fall in output and an increase in the unemployment rate.

D) all of the above E) none of the above Answer: D Topic: 12.5 AD/AS Analysis of Foreign Business Cycle Episodes AACSB: Analytical Thinking 2) The price of a barrel of oil doubled between 2007 and the middle of 2008. To make matters worse, a financial crisis hit the U.S. economy starting in August of 2007. Which of the following is true of the Chinese experience?

A) The worldwide decline in demand led to a collapse of Chinese exports.

B) Instead of relying solely on the economy's self-correcting mechanism, much more aggressive fiscal expansions than those of the U.S. (in addition to a substantial monetary easing) served to shift the AD curve back to general equilibrium relatively quickly.

C) The Chinese economy was better able than the U.S. economy to weather the financial crisis with output growth starting to grow earlier and more quickly than that of the U.S. D) all of the above E) none of the above Answer: D Topic: 12.5 AD/AS Analysis of Foreign Business Cycle Episodes AACSB: Analytical Thinking 3) Unlike either the United States or the United Kingdom, ________ did not occur in China's economy between 2007 and 2009.

A) a massive monetary and fiscal stimulus B) a negative demand shock C) a negative rate of inflation (i.e., deflation) D) a sharp increase in financial frictions E) a positive supply shock Answer: D Topic: 12.5 AD/AS Analysis of Foreign Business Cycle Episodes AACSB: Analytical Thinking

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4) Between 2007 and 2009, which of the following occurred in the United States, but not in the United Kingdom?

A) an increase in unemployment B) a negative demand shock C) a negative rate of inflation (i.e., deflation) D) a sharp increase in financial frictions E) a negative supply shock Answer: C Topic: 12.5 AD/AS Analysis of Foreign Business Cycle Episodes AACSB: Analytical Thinking AD - AS Shocks

5) On the graph above (and considering the short run only), a combination of a negative demand shock and a negative supply shock may be represented by the movement from point ________ to point ________.

A) G; I B) H; F C) H; I D) G; F E) G; H Answer: A Topic: 12.5 AD/AS Analysis of Foreign Business Cycle Episodes AACSB: Analytical Thinking

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6) In the long run, following a combination of a negative demand shock and a temporary negative supply shock, ________.

A) both inflation and output return to the original long-run equilibrium values B) inflation is permanently increased, while output returns to potential output C) output returns to potential output, while inflation may be higher or lower than its initial value D) inflation is permanently reduced, while output returns to potential output E) none of the above Answer: D Topic: 12.5 AD/AS Analysis of Foreign Business Cycle Episodes AACSB: Analytical Thinking 7) As of 2009, China's economy had recovered from the global recession that began in 2008. Use aggregate demand and aggregate supply analysis to explain why, and to explain the likely consequences for China of an increase in the growth rate of the global economy.

Answer: Policy in China reversed the decline in aggregate demand, substituting fiscal and monetary stimulus for the reduced demand for China's exports. The result was a rapid recovery of output and avoidance of downward shifts of the short-run aggregate supply curve that would have meant declining inflation. With output at or near potential in China, the rise in exports that will accompany faster growth of the global economy will cause a positive output gap and accelerating inflation, unless policy makers in China can again intervene with policies to counteract the positive output gap.

Topic: 12.5 AD/AS Analysis of Foreign Business Cycle Episodes AACSB: Reflective Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 13 Macroeconomic Policy and Aggregate Demand and Supply Analysis 13.1 The Objectives of Macroeconomic Policy 1) Which of the following is a primary objective of macroeconomic policy?

A) achieving a zero rate of unemployment B) achieving a zero rate of inflation C) stabilizing economic activity D) all of the above E) none of the above Answer: C Topic: 13.1 The Objectives of Macroeconomic Policy 2) Which of the following is a primary objective of monetary policy?

A) achieving a zero natural rate of unemployment B) targeting a zero rate of inflation C) achieving price stability D) all of the above E) none of the above Answer: C Topic: 13.1 The Objectives of Macroeconomic Policy 3) Frictional unemployment is to ________ as structural unemployment is to ________.

A) search; mismatch B) temperature; rigidity C) job training; output gap D) all of the above E) none of the above Answer: A Topic: 13.1 The Objectives of Macroeconomic Policy AACSB: Reflective Thinking 4) A good reason for policy makers to pursue a goal of stabilizing economic activity is that ________.

A) high unemployment is always accompanied by high variability of unemployment B) in a stable economy, there is little or no frictional unemployment C) in a stable economy, there is little or no structural inflation D) all of the above E) none of the above Answer: E Topic: 13.1 The Objectives of Macroeconomic Policy AACSB: Reflective Thinking

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5) A good reason for policy makers to pursue a goal of stabilizing economic activity is that ________.

A) high inflation is always accompanied by high variability of inflation B) high unemployment causes human misery and lost output C) in a stable economy, there is little or no structural inflation D) all of the above E) none of the above Answer: B Topic: 13.1 The Objectives of Macroeconomic Policy AACSB: Reflective Thinking 6) The goal of maximum sustainable employment is roughly equivalent to achieving ________.

A) the natural rate of unemployment B) an inflation target that is slightly above zero C) the elimination of frictional and structural unemployment D) all of the above E) none of the above Answer: A Topic: 13.1 The Objectives of Macroeconomic Policy 7) Which of the following is a likely objective of monetary policy?

A) achieving price stability B) stabilizing economic activity C) closing the output gap to zero D) all of the above E) none of the above Answer: D Topic: 13.1 The Objectives of Macroeconomic Policy 8) Which of the following is a likely objective of monetary policy?

A) achieving a zero inflation gap B) stabilizing economic activity C) avoiding large changes in unemployment D) all of the above E) none of the above Answer: D Topic: 13.1 The Objectives of Macroeconomic Policy

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9) Some central banks pursue price stability before they pursue other goals. Which of the following central banks have this kind of hierarchical mandate? i. Bank of England ii. Bank of Canada iii. European Central Bank iv. Federal Reserve (U.S.A.) A) i, ii, and iv only B) i and iii only C) i and iv only D) ii, iii, and iv only E) none of the above Answer: E Topic: 13.1 The Objectives of Macroeconomic Policy 10) A central bank with a hierarchical mandate will seek ________ as a condition of pursuing other goals.

A) stable inflation B) high employment C) moderate interest rates D) the approval of the legislature E) none of the above Answer: A Topic: 13.1 The Objectives of Macroeconomic Policy 11) Suppose that inflation is at the target rate and output has fallen substantially below potential output. A central bank with a primary objective of price stability should ________.

A) do nothing, because inflation cannot rise when unemployment is high B) ease monetary policy, to avoid a decrease in the inflation rate C) do nothing, because stabilizing economic activity is not a primary objective D) ease monetary policy, because avoiding high unemployment is more important than avoiding high inflation E) none of the above Answer: B Topic: 13.1 The Objectives of Macroeconomic Policy AACSB: Analytical Thinking 12) In recent decades, the trend among central banks has been to adopt ________.

A) high employment as a central goal B) a dual mandate that gives equal weight to both price stability and low unemployment.

C) price stability as a central goal D) a target of zero inflation E) none of the above Answer: C Topic: 13.1 The Objectives of Macroeconomic Policy

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13) How do the hierarchical and dual mandates differ in terms of macroeconomic consequences?

Answer: A dual mandate implies more tolerance of inflation than a hierarchical mandate.

Ceteris paribus, the creation and purchasing power of wealth receive more support from a hierarchical mandate. A dual mandate implies less tolerance of positive output gaps and more support for aggregate demand.

Topic: 13.1 The Objectives of Macroeconomic Policy AACSB: Reflective Thinking 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity 1) The equilibrium real interest rate is the rate ________.

A) at which the output gap is zero B) at which the inflation rate is low C) controlled by the central bank D) all of the above E) none of the above Answer: A Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 2) A change in the equilibrium real interest rate may result from ________.

A) an autonomous monetary policy B) a change in the central bank's target inflation rate C) a change in expected inflation D) all of the above E) none of the above Answer: E Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 3) Every six weeks, the Federal Open Market Committee (FOMC) meets to discuss monetary policy. This discussion is mainly focused on ________.

A) information of the equilibrium real interest rate from the past three years B) the current month's release of the CPI by the BLS C) the three year projections of the equilibrium real interest rate D) the past 18 month history and future 18 month projections of the discount rate E) none of the above Answer: C Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity

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4) Shocks to the macroeconomy will cause a change in the equilibrium real interest rate, except ________.

A) permanent supply shocks B) aggregate demand shocks C) temporary supply shocks D) all of the above E) none of the above Answer: C Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 5) Every six weeks, the Federal Open Market Committee (FOMC) meets to discuss how to best adjust ________ to accommodate shocks that shift the level of ________.

A) the equilibrium real interest rate; the target Fed Funds rate B) the target Fed Funds rate; the equilibrium real interest rate C) the 3 month T-bill rate; the inflation gap D) target rate of inflation; money demand E) none of the above Answer: B Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity 6) Ceteris Paribus, if current output has fallen below potential ________.

A) a positive inflation gap will ensue B) it is likely that the equilibrium real rate has fallen below the policy rate C) a negative unemployment gap will ensue D) it is likely that the equilibrium real rate has risen above the policy rate E) none of the above Answer: B Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 7) Many borrowers defaulted on subprime mortgages ultimately disrupting financial markets by August 2007. Which of the following is a likely result of this increase in financial frictions?

A) The AD curve likely shifted left which caused a positive inflation gap.

B) The AD curve likely shifted right which caused a positive inflation gap.

C) The AD curve likely shifted left which caused an upward movement along the MP curve to a higher general equilibrium interest rate.

D) The AD curve likely did not shift.

E) none of the above Answer: E Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking

5 .

8) Many borrowers defaulted on subprime mortgages ultimately disrupting financial markets by August 2007. Which of the following is a likely result of this increase in financial frictions?

A) The AD curve likely shifted left which caused a negative output gap.

B) The AD curve likely shifted left which caused a positive inflation gap.

C) The AD curve likely shifted left which caused an upward movement along the MP curve to a higher general equilibrium interest rate.

D) The AD curve likely did not shift.

E) none of the above Answer: A Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 9) Many borrowers defaulted on subprime mortgages ultimately disrupting financial markets by August 2007. Which of the following is a likely result of this increase in financial frictions?

A) The AD curve likely shifted left which caused a negative output gap.

B) The AD curve likely shifted left causing a negative inflation gap.

C) The AD curve likely shifted left followed by an downward movement along the MP curve to a lower equilibrium interest rate in the short run.

D) all of the above E) none of the above Answer: D Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 10) A negative shock in aggregate demand will likely result in ________.

A) a short run decrease in output B) a permanently lower equilibrium inflation rate if the central bank does not respond by lowering interest rates C) an eventual increase in aggregate supply for any inflation rate if the central bank does not respond by lowering interest rates D) all of the above E) none of the above Answer: D Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 11) A negative shock in aggregate demand will likely result in ________.

A) a permanent change in output, unless the central bank responds by lowering interest rates B) a permanently lower equilibrium inflation rate, unless the central bank responds by lowering interest rates C) an eventual increase in aggregate supply for any inflation rate, if the central bank responds by lowering interest rates D) all of the above E) none of the above Answer: B Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 6 .

12) A negative shock in aggregate demand will likely result in ________.

A) a permanent change in output, if the central bank responds by lowering interest rates B) no permanent change in the equilibrium inflation rate, unless the central bank responds by lowering interest rates C) an eventual increase in aggregate supply for any inflation rate, if the central bank responds by lowering interest rates D) all of the above E) none of the above Answer: E Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 13) A negative shock in aggregate demand will likely result in no permanent change in ________.

A) output B) the equilibrium inflation rate if the central bank responds by lowering interest rates C) aggregate demand, if the central bank responds by lowering interest rates D) all of the above E) none of the above Answer: D Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 14) When an aggregate demand shock hits the economy ________.

A) there is no conflict for the central bank between pursuing price or output stability because of the divine coincidence B) the same long-run equilibrium real interest rate is reached whether the central bank intervenes or not C) the long-run level of output is unaffected D) all of the above E) none of the above Answer: D Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 15) When a permanent negative supply shock hits the economy, a permanently ________.

A) lower equilibrium level of output ensues if the central bank raises interest rates B) lower equilibrium level of output ensues if the central bank does not respond C) higher equilibrium level of inflation ensues if the central bank does not respond D) all of the above E) none of the above Answer: D Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking

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16) When a permanent negative supply shock hits the economy ________.

A) in the long-run, the output gap returns to zero only if the central bank raises interest rates B) the long-run equilibrium level of output depends on whether and how the central bank responds C) there is no permanent effect on inflation if the central bank raises interest rates D) all of the above E) none of the above Answer: C Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 17) When a permanent negative supply shock hits the economy ________.

A) in the long-run, output is permanently lowered whether the central bank reacts or not B) inflation decreases in the short-run C) there is no long-run effect on inflation whether the central bank reacts or not D) all of the above E) none of the above Answer: A Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 18) When a temporary negative supply shock hits the economy ________.

A) the divine coincidence does not always hold B) the divine coincidence holds in the short-run C) the divine coincidence does not hold in the long-run D) all of the above E) none of the above Answer: A Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 19) When a temporary negative supply shock hits the economy, then in the short-run ________.

A) if the central bank focuses on stabilizing output, it cannot stabilize inflation B) if the central bank focuses on stabilizing inflation, it cannot stabilize output C) the divine coincidence does not hold D) all of the above E) none of the above Answer: D Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking

8 .

20) If higher inflation ensues from a temporary negative supply shock, and in response, the central bank raises interest rates, then ________.

A) it is likely adopting a policy to stabilize inflation in the short run B) short-run inflation will fluctuate around (first go higher then go lower than) the long run level of inflation C) it will need to lower interest rates back to their original values to ensure that inflation returns to its original rate D) all of the above E) none of the above Answer: D Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 21) If higher inflation ensues from a temporary negative supply shock, and in response, the central bank raises interest rates, then the resulting decrease in AD will return inflation back to its original level ________.

A) and no further action will be required by the central bank B) but the ensuing positive output gap will lead to higher inflation once again so further interest rate increases will be required by the central bank to return inflation back to its long run level C) but the ensuing negative output gap will lead to short-run increases in AS and the central bank will have to "undo" its original interest rate hike in order to return inflation back to its target rate D) all of the above E) none of the above Answer: C Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 22) If most shocks to the economy are ________ shocks, then ________.

A) aggregate demand; inflation stabilization policy will also stabilize activity in the short-run B) permanent aggregate supply; inflation stabilization policy will also stabilize activity in the short-run C) temporary aggregate supply; inflation stabilization policy has no impact on economic activity in the long-run D) all of the above E) none of the above Answer: D Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking

9 .

23) If most shocks to the economy are ________ shocks, then ________.

A) aggregate demand; there is a tradeoff between the dual objectives in the short-run B) temporary aggregate supply; inflation stabilization policy will not stabilize activity in the short-run C) temporary aggregate supply; output stabilization policy is consistent with no change in inflation in the long-run D) all of the above E) none of the above Answer: B Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 24) What is the divine coincidence? When and why does it not hold true?

Answer: The divine coincidence is the ability to achieve both inflation stability and output stability at the same time. The divine coincidence fails when there is a temporary supply shock.

When the short-run aggregate supply curve shifts along the aggregate demand curve, both output and inflation gaps result. The only policy response is to shift the aggregate demand curve.

Because the SRAS curve has a positive slope, shifting of the AD curve must enlarge one gap in order to reduce the other.

Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking

10 .

Macroeconomic Shocks & Policies

25) Suppose the economy is in a long-run equilibrium when a positive demand shock occurs. On the graphs above, show what happens to bring the economy back to long-run equilibrium, assuming that there is no policy response. In words, describe how the graph would be different, if policy makers did intervene.

Answer: The graphs should be similar to Fig. 13.2, with AD shifting right and AS shifting up. If there is a policy response, the MP curve shifts up and AD shifts back to the left. There is no shift of AS, so inflation returns to its original rate.

Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking

11 .

26) Suppose the economy is in a long-run equilibrium when a temporary, favorable aggregate supply shock occurs. On the graphs above, show what happens to bring the economy back to long-run equilibrium, assuming that there is no policy response. In words, explain why "no response" is the best policy.

Answer: The graphs should be similar to Fig. 13.6, with AS shifting first right and then back to the left, so inflation returns to its original rate. If policy makers respond when the inflation rate falls below target, the output gap is enlarged, so AS will shift up and cause a positive inflation gap. If the policy response is to correct the output gap, the decrease in AD will enlarge the negative inflation gap. With no policy response, both the output and inflation gaps return to zero.

Topic: 13.2 The Relationship Between Stabilizing Inflation and Stabilizing Economic Activity AACSB: Analytical Thinking 13.3 How Actively Should Policy Makers Try To Stabilize Economic Activity?

1) The time it takes for policymakers to obtain and to understand the data and to change the policy instrument based on that information is known as ________, respectively.

A) the data, recognition, and effectiveness lags B) the recognition, data, and effectiveness lags C) the data, recognition, and implementation lags D) the recognition, implementation, and effectiveness lags E) the data, implementation, and effectiveness lags Answer: C Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

2) What do the legislative and implementation lags have in common?

A) They are both more important for monetary than fiscal policy.

B) They are both more important for fiscal than monetary policy.

C) They are both harder to measure but less variable than the effectiveness lag.

D) They both take place before the data and recognition lags.

E) none of the above Answer: B Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

3) Nonactivists believe that ________.

A) there is a very rapid self-correcting mechanism since prices and wages are very flexible B) lags to policy implementation are so long that even the "correct" policies may lead to undesirable consequences C) policy interventions should take place less frequently than what Keynesians advocate D) all of the above E) none of the above Answer: D Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

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4) Activists believe that ________.

A) frictions to the self-correcting mechanism of markets prevent prices and wages from being very flexible B) it takes a very long time to reach the long run C) Keynes was right with his statement "in the long-run, we are all dead" D) all of the above E) none of the above Answer: D Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

5) Which statement is a good argument in support of policy activism?

A) Policy lags are generally longer than the time it takes the self-correcting mechanism to work.

B) Activist policies help to ensure stability of the real interest rate.

C) Well-considered policies can assist the economy's self-correcting mechanism, thus reducing the variability of inflation and unemployment.

D) all of the above E) none of the above Answer: C Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Reflective Thinking 6) An emphasis on inflation stability is compatible with a nonactivist stance only when shocks to the macroeconomy are ________.

A) permanent supply shocks B) temporary supply shocks C) aggregate demand shocks D) all of the above E) none of the above Answer: B Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Analytical Thinking 7) The American Recovery and Reinvestment Act of 2009 ________.

A) was a result of the Obama administration adopting an activist approach to policymaking B) is still being debated after the fact in terms of its effectiveness C) was supported by some economists, and opposed by as many economists D) all of the above E) none of the above Answer: D Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

13 .

8) The American Recovery and Reinvestment Act of 2009 ________.

A) placed greater emphasis on monetary policy than fiscal policy B) finally put an end to the inflationary spiral that had begun in 2005 C) was intended to reverse the sharp increase in the equilibrium real interest rate D) all of the above E) none of the above Answer: E Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

9) Suppose that wages and prices are quite flexible, so that the short-run aggregate supply curve is steep. In that case, ________.

A) policies to stabilize inflation are probably needed more than policies to stabilize economic activity B) supply shocks will destabilize inflation, but have minimal impact on output C) demand shocks will destabilize output, but have minimal impact on inflation D) all of the above E) none of the above Answer: A Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Analytical Thinking 10) Suppose that data for a particular economy over time suggest that its aggregate demand curve is both steep and shifts frequently. We might reasonably infer that ________.

A) the central bank has an activist emphasis on the stability of economic activity B) wages and prices are remarkably flexible C) policy lags are quite long D) all of the above E) none of the above Answer: A Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Analytical Thinking

14 .

Aggregate Demand and Supply Analysis

11) In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion.

If there is no policy intervention, we should expect ________.

A) rightward shifts of IS & AD, so that both output and inflation rise B) a decrease in inflation to shift the MP curve, raising the real interest rate C) declines in both the inflation rate and the real interest rate as output rises D) a decrease in inflation to shift the AD curve, causing output to rise E) none of the above Answer: C Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Analytical Thinking 15 .

12) In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion.

If a fiscal stimulus package is implemented quickly, raising output to $12 trillion, while inflation remains constant at one percent, then the figure implies that the real interest rate will be ________ percent.

A) 1.5 B) zero C) one D) 0.5 E) 2.5 Answer: A Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Analytical Thinking 13) In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion.

If autonomous monetary policy (alone) is used to bring output to $12 trillion, then the figure implies that the real interest rate will be ________ percent, and the inflation rate will be one percent.

A) 1.5 B) zero C) one D) 0.5 E) 2.5 Answer: B Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Analytical Thinking 14) In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion.

If there is no policy intervention, then the figure implies that when output has reached $12 trillion, the real interest rate will be ________ percent, and the inflation rate will be ________ percent.

A) 1.5; one B) one; zero C) zero; minus 2 D) 0.5; minus one E) 2.5; three Answer: C Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Analytical Thinking

16 .

15) In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion.

Suppose that a combination of fiscal stimulus and recovery of consumer and business confidence shifts the IS and AD curves, as shown in the figure, while monetary policy sets the real interest rate at one percent. If the short-run aggregate supply curve is π = Y - 13, then the resulting values of output and inflation are ________.

A) $12 trillion & 3 percent B) $13.5 trillion & 5 percent C) $9.75 trillion & 0 percent D) $13.5 trillion & 0 percent E) $12.5 trillion & 2 percent Answer: B Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Analytical Thinking 16) In the figure above, assume that output is $10.5 trillion, while potential output is $12 trillion.

Suppose that a combination of fiscal stimulus and recovery of consumer and business confidence shifts the IS and AD curves, as shown in the figure. The equilibrium real interest rate is ________ percent.

A) 3 B) one C) 2.5 D) 2 E) zero Answer: C Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Analytical Thinking 17) How might openness to the global economy influence the debate between policy activists and nonactivists?

Answer: An open economy is subject to shocks from abroad, making it hard for nonactivists to claim that macroeconomic stability will occur "naturally." Moreover, activists can argue that the coordination of policies across countries can improve stability for everyone.

Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Reflective Thinking 18) How might long policy lags impact the divine coincidence?

Answer: The divine coincidence applies when policy makers are able to respond to a single shock at a time. If shocks occur at a faster pace than policies can be implemented, then policies may be destabilizing. The argument that the economy's self-correcting mechanism is too slow cannot justify policies that, in practice, are even slower.

Topic: 13.3 How Actively Should Policy Makers Try to Stabilize Economic Activity?

AACSB: Reflective Thinking

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13.4 The Taylor Rule 1) According to the Taylor rule, which of the following will lead to a higher nominal federal funds rate?

A) an increase in inflation B) a positive output gap C) a positive inflation gap D) all of the above E) none of the above Answer: D Topic: 13.4 The Taylor Rule AACSB: Analytical Thinking 2) According to the Taylor rule, which of the following will lead to a higher nominal federal funds rate?

A) a decrease in inflation B) a negative output gap C) a positive inflation gap D) all of the above E) none of the above Answer: C Topic: 13.4 The Taylor Rule AACSB: Analytical Thinking 3) According to the Taylor rule, which of the following will lead to the largest increase in the nominal federal funds rate?

A) a two percentage point increase in the target inflation rate B) a one percentage point decrease in the target inflation rate C) a one percentage point increase in output D) a two percentage point decrease in output E) a one percentage point increase in the inflation rate Answer: E Topic: 13.4 The Taylor Rule AACSB: Analytical Thinking 4) If the inflation rate target is 2%, the current inflation rate is also 2%, and the output gap is zero, then according to the Taylor rule, the nominal federal funds rate should be ________ percent.

A) zero B) two C) four D) three E) none of the above Answer: C Topic: 13.4 The Taylor Rule AACSB: Analytical Thinking 18 .

5) If the inflation rate target is 2%, the current inflation rate is 3%, and the output gap is 2%, then according to the Taylor rule, the nominal federal funds rate should be ________ percent.

A) 4.5 B) 7 C) 6.5 D) 5.5 E) none of the above Answer: C Topic: 13.4 The Taylor Rule AACSB: Analytical Thinking 6) If the inflation rate target is 2%, the current inflation rate is 1%, and the output gap is minus 2%, then according to the Taylor rule, the nominal federal funds rate should be ________ percent.

A) zero B) two C) four D) three E) none of the above Answer: B Topic: 13.4 The Taylor Rule AACSB: Analytical Thinking 7) Since 2010, the federal funds rate has been well below the rate suggested by the Taylor rule. A likely explanation for the discrepancy is that ________.

A) the Fed's dual mandate prevents a close reliance on the Taylor rule B) policy makers decided that instability of the coefficients prevents the Taylor rule from having any role in policy decisions C) in the past, adherence to the Taylor rule led to policy mistakes D) all of the above E) none of the above Answer: E Topic: 13.4 The Taylor Rule AACSB: Reflective Thinking 8) Is the Taylor rule of greater use to activist or to nonactivist policy makers?

Answer: Nonactivist. The Taylor rule is an alternative to discretionary policy that relies on debatable projections to justify arguably ad hoc interventions. The rule is too crude to eliminate discretion entirely, but serves as a restraint on activist tendencies.

Topic: 13.4 The Taylor Rule AACSB: Reflective Thinking

19 .

9) Is the Taylor rule compatible with a hierarchical mandate?

Answer: Yes. Because inflation is affected by output gaps, a central bank committed to inflation stability will not ignore output gaps but, rather, raise or lower its interest rate target, as indicated by the Taylor rule.

Topic: 13.4 The Taylor Rule AACSB: Reflective Thinking 13.5 Inflation: Always and Everywhere A Monetary Phenonenon 1) If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) it would likely conduct an easing of monetary policy by raising the real interest rate for any given inflation rate B) it would likely conduct a tightening of monetary policy by raising the real interest rate for any given inflation rate C) it would likely conduct an easing of monetary policy where the real interest rate would increase due to the ensuing decrease in aggregate demand D) it would likely conduct a tightening of monetary policy where the real interest rate would increase due to the ensuing increase in aggregate demand E) none of the above Answer: E Topic: 13.5 Inflation: Always and Everywhere a Monetary Phenomenon AACSB: Analytical Thinking 2) If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) it would likely conduct a tightening of monetary policy by raising the real interest rate for any given inflation rate B) it would likely conduct an easing of monetary policy by lowering the real interest rate for any given inflation rate C) it would likely conduct an easing of monetary policy where the real interest rate would increase due to the ensuing decrease in aggregate demand D) it would likely conduct a tightening of monetary policy where the real interest rate would increase due to the ensuing increase in aggregate demand E) none of the above Answer: B Topic: 13.5 Inflation: Always and Everywhere a Monetary Phenomenon AACSB: Analytical Thinking

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3) If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) it would likely conduct an easing of monetary policy by lowering the real interest rate for any given inflation rate B) an increase in aggregate demand would ensue generating a positive output gap C) an eventual decrease in short-run AS would drive the long-run equilibrium level of inflation up D) all of the above E) none of the above Answer: D Topic: 13.5 Inflation: Always and Everywhere a Monetary Phenomenon AACSB: Analytical Thinking 4) If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) it would conduct monetary policy consistent with a downward shift of the MP curve B) it would conduct monetary policy that would lead to a rightward shift of the AD curve C) after an easing of monetary policy, an eventual decrease in short-run AS would drive the long-run equilibrium level of inflation up D) all of the above E) none of the above Answer: D Topic: 13.5 Inflation: Always and Everywhere a Monetary Phenomenon AACSB: Analytical Thinking 5) If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) monetary policy would ultimately lead to higher inflation and real interest rates in the long run B) monetary policy would ultimately lead to higher inflation and thus higher potential output C) monetary policy would ultimately lead to higher potential output and real interest rates but no long-run impact on inflation D) all of the above E) none of the above Answer: E Topic: 13.5 Inflation: Always and Everywhere a Monetary Phenomenon AACSB: Analytical Thinking

21 .

6) If the economy is in a long-run equilibrium when the Federal Reserve decides that its inflation target is too low and chooses to raise it, ________.

A) monetary policy would ultimately lead to higher potential output but real interest rates and inflation would be unaffected in the long run B) monetary policy would ultimately lead to higher inflation but real interest rates and potential output would be unaffected in the long run C) monetary policy would ultimately lead to higher interest rates but potential output and inflation would be unaffected in the long run D) monetary policy would ultimately lead to higher interest rates, potential output, and inflation in the long run E) none of the above Answer: B Topic: 13.5 Inflation: Always and Everywhere a Monetary Phenomenon AACSB: Analytical Thinking 7) Which of the following statements is correct?

A) Through autonomous monetary policy adjustments the Federal Reserve can ultimately determine the equilibrium real interest rate in the long run.

B) Through autonomous monetary policy adjustments the Federal Reserve can ultimately determine potential output in the long run.

C) Through autonomous monetary policy adjustments the Federal Reserve can target any inflation rate in the long run.

D) all of the above E) none of the above Answer: C Topic: 13.5 Inflation: Always and Everywhere a Monetary Phenomenon AACSB: Analytical Thinking 8) Which of the following statements is correct?

A) Through autonomous monetary policy adjustments the Federal Reserve can target any inflation rate in the long run.

B) Ultimately, autonomous monetary policy adjustments by the Federal Reserve cannot determine the equilibrium real interest rate in the long run.

C) Ultimately, autonomous monetary policy adjustments by the Federal Reserve cannot determine long run aggregate output.

D) all of the above E) none of the above Answer: D Topic: 13.5 Inflation: Always and Everywhere a Monetary Phenomenon AACSB: Analytical Thinking

22 .

9) "With autonomous changes in the policy interest rate, the Federal Reserve cannot determine the long run equilibrium level of the real interest rate or potential output and will only be able to determine inflation." This statement is consistent with ________.

A) the notion that shifts in the MP curve may lead to shifts in the AD and AS curves but the LRAS remains unchanged B) the notion of long-run independence between nominal and real variables C) the notion of monetary neutrality D) all of the above E) none of the above Answer: D Topic: 13.5 Inflation: Always and Everywhere a Monetary Phenomenon AACSB: Analytical Thinking

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Macroeconomic Shocks & Policies

10) On the graphs above, show how the central bank implements a decrease in the inflation target. In words, explain why the change in the real interest rate is temporary.

Answer: The graphs resemble Fig. 13.10 with all shifts reversed. The increase in the real interest rate causes a decrease in expenditures (AD shifts down). Declining inflation lowers the real interest rate (movement along the MP curve), which increases expenditures (movement along the AD curve). Since there has been no shift of the IS curve, the real interest rate must return to its original value, so that aggregate demand is equal to potential output.

Topic: 13.5 Inflation: Always and Everywhere a Monetary Phenomenon AACSB: Analytical Thinking

24 .

13.6 Causes of Inflationary Monetary Policy 1) Cost-push inflation is to ________ as demand-pull inflation is to ________.

A) impatience; inaccuracy B) entering; exiting C) activism; nonactivism D) fiscal; monetary E) none of the above Answer: A Topic: 13.6 Causes of Inflationary Monetary Policy AACSB: Reflective Thinking 2) An activist policy to promote high employment ________.

A) could lead to inflationary pressures from an ensuing temporary negative supply shock B) might incentivize workers to push for higher wages beyond what productivity gains can justify C) could lead to inflationary pressures from an ensuing increase in aggregate demand D) all of the above E) none of the above Answer: D Topic: 13.6 Causes of Inflationary Monetary Policy AACSB: Analytical Thinking 3) If workers push for wages that are beyond what productivity gains can justify ________.

A) a positive output gap ensues which will lead to lower unemployment if the Federal Reserve does not act B) a temporary negative supply shock ensues driving up prices C) and the Federal Reserve eases monetary policy aimed at increasing aggregate demand to counter the negative supply shock, the inflation rate will decrease D) all of the above E) none of the above Answer: B Topic: 13.6 Causes of Inflationary Monetary Policy AACSB: Analytical Thinking 4) If workers push for wages that are beyond what productivity gains can justify ________.

A) a temporary negative supply shock ensues driving up prices B) a negative output gap ensues which will lead to higher unemployment if the Federal Reserve does not act C) and the Federal Reserve eases monetary policy aimed at increasing aggregate demand to counter the negative supply shock, a price-wage spiral could ensue D) all of the above E) none of the above Answer: D Topic: 13.6 Causes of Inflationary Monetary Policy AACSB: Analytical Thinking 25 .

5) A goal of very high employment may lead to ________.

A) inflationary monetary policy B) inflationary fiscal policy C) demand-pull inflation D) all of the above E) none of the above Answer: D Topic: 13.6 Causes of Inflationary Monetary Policy AACSB: Reflective Thinking 6) High inflation that persists beyond the ending of expansionary policies is probably ________.

A) demand-pull inflation B) Humphrey-Hawkins inflation C) cost-push inflation D) a result of unemployment remaining below the natural rate E) none of the above Answer: C Topic: 13.6 Causes of Inflationary Monetary Policy AACSB: Analytical Thinking 7) In the 1965 to 1973 period, U.S. policymakers ________.

A) targeted an unemployment rate that, in hindsight, was likely too low B) pursued an easing of monetary policy designed to increase aggregate demand C) made some mistakes that led to the most sustained inflationary episode in U.S. history D) all of the above E) none of the above Answer: D Topic: 13.6 Causes of Inflationary Monetary Policy 8) After 1975, the U.S. economy continued to experience high inflation ________.

A) mainly because the public expected policymakers to continue their expansionary efforts, and this led to increases in inflation expectations B) most likely of the cost-push kind C) until a very aggressive commitment to anti-inflationary monetary policy helped end this Great Inflation period D) all of the above E) none of the above Answer: D Topic: 13.6 Causes of Inflationary Monetary Policy

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9) How might strict adherence to the Taylor rule discourage demand-pull inflation? How might demand-pull inflation occur, nonetheless?

Answer: The Taylor rule requires monetary policy to respond to both inflation and output gaps.

If an attempt to lower unemployment results in rising inflation, policy acquires an antiinflationary bias. Though the Taylor rule can prevent the persistence of demand-pull inflation, it might make brief episodes of inflation more likely. If policy makers underestimate the natural rate of unemployment, adherence to the Taylor rule guarantees that inflation will rise.

Topic: 13.6 Causes of Inflationary Monetary Policy AACSB: Reflective Thinking 10) How might strict adherence to the Taylor rule discourage cost-push inflation?

Answer: Cost-push inflation cannot persist without repeated increases in AD to counter declines in output. Constrained by the Taylor rule, monetary policy must tighten as the inflation rate rises, even when that means an increase in the (absolute value of the) output gap. Moreover, public knowledge of the central bank's commitment to an inflation target causes upward shifts of the aggregate supply curve to be relatively infrequent and small.

Topic: 13.6 Causes of Inflationary Monetary Policy AACSB: Reflective Thinking

27 .

13.7 Monetary Policy at the Zero Lower Bound Figure 13.1

1) The aggregate demand curves in Figure 13.1 have a positively-sloped portion. The reason this can happen is ________.

A) sloppy editing B) the monetary policy response to declining inflation causes the real interest rate to fall, which causes output to rise C) a sudden increase in potential output D) changes in expected inflation cause the real interest rate to change in the opposite direction E) rising inflation causes financial frictions to increase Answer: D Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Analytical Thinking 2) In Figure 13.1, "the zero lower bound" is displayed at ________.

A) point 1 B) point 2 C) D) the origin (intersection of the axes) E) none of the above Answer: B Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Analytical Thinking

28 .

3) If the economy is at point 1 in Figure 13.1 and there is no policy intervention, what happens next?

A) the economy moves to point 2 B) the economy remains at point 1 C) the economy moves to the left along the AS curve D) the AS curve shifts down, causing both output and inflation to decline E) the AS curve shifts up, causing both output and inflation to rise Answer: D Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Analytical Thinking 4) If the economy is at point 1 in Figure 13.1 and the central bank issues a credible statement that it can and will cause inflation to rise, what happens next?

A) the economy moves to point 2 B) the economy remains at point 1 C) the economy moves to the left along the AS curve D) the AS curve shifts down, causing both output and inflation to decline E) the AS curve shifts up, causing both output and inflation to rise Answer: E Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Analytical Thinking 5) Which is a plausible cause of the movement in Figure 13.1 from point 1 to point 2?

A) a change in expectations that causes a decline in the real interest rate for investments B) a decrease in expected inflation C) the economy's self-correcting mechanism D) the central bank achieves a negative value for the nominal interest rate E) none of the above Answer: A Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Analytical Thinking 6) Nonconventional monetary policy attempts to reduce financial frictions by ________.

A) correcting the shortage of liquidity that has made it costly for businesses to invest B) purchasing long-term assets, which raises their price and reduces the credit spread C) reducing the expected future short-term interest rate D) all of the above E) none of the above Answer: D Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Analytical Thinking

29 .

7) Nonconventional monetary policy attempts to reduce financial frictions by ________.

A) reversing the expansion of the central bank's balance sheet that has made it costly for businesses to invest B) purchasing short-term assets, which raises their price and reduces the credit spread C) increasing the expected future short-term interest rate D) all of the above E) none of the above Answer: E Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Analytical Thinking 8) The key difference between "quantitative easing" and "credit easing" is that ________.

A) the goal of the former is to raise expected inflation B) the latter refers to a substantial change in the composition of the central bank's balance sheet C) the latter refers to a substantial expansion of the central bank's balance sheet D) the former is endorsed by Federal Reserve Chairman Ben Bernanke, while the latter was devised by Japan's Prime Minister Shinzo Abe E) none of the above Answer: B Topic: 13.7 Monetary Policy at the Zero Lower Bound 9) In the absence of financial frictions, ________.

A) interest rates for different borrowers move closely together B) all loans in the economy are transacted at a common interest rate C) the level of output is not affected by changes in the real interest rate D) an increase in inflation leads to a decrease in the real interest rate Answer: A Topic: 13.7 Monetary Policy at the Zero Lower Bound 10) An increase in financial frictions results in ________.

A) an increase in output and inflation B) a rise in the interest rate set by monetary policy C) a decline in the real interest rates faced by households and firms D) a decline in the interest rate set by monetary policy Answer: D Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Analytical Thinking 11) An increase in financial frictions results in ________.

A) a movement to the left along the AD curve B) a leftward shift of the MP curve C) a decrease in output and increase in inflation D) a leftward shift of the IS curve Answer: D Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Analytical Thinking 30 .

12) An increase in financial frictions results in ________.

A) an increase in the federal funds rate B) a reduced supply of credit to households and businesses C) a decrease in short-run aggregate supply D) an upward shift of the monetary policy curve Answer: B Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Analytical Thinking 13) When the credit spread rises, an effective policy response might be to ________.

A) lower the real interest rate on safe assets B) prevent the real federal funds rate from falling below zero C) pursue nonconventional monetary policies to restore the functioning of financial markets D) announce swift and stern action against those responsible for the financial disruption Answer: C Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Reflective Thinking

31 .

Figure 13.1

14) Suppose the economy is at point 1 in Figure 13.1. With output below potential output, it might not be possible to create any expectation of an increase in inflation. How, then, might output be brought back to potential? What would this look like on the graph?

Answer: The reason output is so low is that the real interest rate at which the goods market is in equilibrium is negative. If expected inflation were high enough, the real interest rate could be low enough. An alternative to raising expected inflation is to persuade businesses and consumers to increase spending at every level of the real interest rate — that is, shift the IS curve to the right. An increase in autonomous spending, and/or a decrease in financial frictions both shifts AD to the right, and removes the kink, restoring the usual negative relationship between output and inflation. Nonconventional monetary policy can provide such a positive demand shock, increasing both output and the long-run equilibrium real interest rate. On the graph, the new aggregate demand curve might intersect the LRAS curve at an inflation rate somewhat lower than .

Topic: 13.7 Monetary Policy at the Zero Lower Bound AACSB: Reflective Thinking

32 .

Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 14 The Financial System and Economic Growth 14.1 The Role of the Financial System 1) Firms can acquire access to savings directly ________.

A) by issuing securities B) through the payment of taxes to the federal government C) by borrowing from banks D) through the depositing of funds in depository institutions Answer: A Topic: 14.1 The Role of the Financial System 2) Firms can acquire access to savings indirectly through ________.

A) issuing securities B) borrowing from banks C) the payment of taxes to the federal government D) the depositing of funds in depository institutions Answer: B Topic: 14.1 The Role of the Financial System 3) The purpose of a financial sector is ________.

A) to minimize the payments firms make to state and local governments B) to maximize the payments firms make to state and local governments C) to channel funds away from households and firms with surplus funds D) to channel monies into socially acceptable causes Answer: C Topic: 14.1 The Role of the Financial System 4) The purpose of a financial sector is ________.

A) to enable consumers to make purchases before receiving income B) to ensure that retirees have a source of income C) to direct available funds to worthy opportunities D) to create and to promote the trading of assets Answer: C Topic: 14.1 The Role of the Financial System 5) If the economy may be likened to a biological organism, then the financial system may be thought of as the ________.

A) brain B) stomach C) lungs D) feet Answer: A Topic: 14.1 The Role of the Financial System AACSB: Reflective Thinking 1 .

6) An asset is ________.

A) equal in value to its corresponding liabilities and net worth B) a debt for the owner of the asset C) a net outflow from the revenues of a producing firm D) anything that can be owned and has value Answer: D Topic: 14.1 The Role of the Financial System 7) Economic agents can raise money capital by ________.

A) issuing liabilities B) repaying a loan C) paying taxes D) providing a subsidy Answer: A Topic: 14.1 The Role of the Financial System 8) A financial market where economic agents meet in one central location is known as ________.

A) an over the counter market B) an exchange C) a bond market D) a money market Answer: B Topic: 14.1 The Role of the Financial System 9) Which of the following is not a financial intermediary?

A) an insurance company B) a pension fund C) a commercial bank D) an organized exchange, e.g. NYSE Answer: D Topic: 14.1 The Role of the Financial System 10) Which of the following is not a depository institution?

A) a savings & loan association B) a mutual savings bank C) an investment bank D) a credit union Answer: C Topic: 14.1 The Role of the Financial System

2 .

11) Equities is to ________ as bond is to ________.

A) ownership; debt B) fairness; constraint C) stock; asset D) banks; exchanges Answer: A Topic: 14.1 The Role of the Financial System AACSB: Reflective Thinking 12) Nonfinancial businesses may acquire funds by borrowing from a commercial bank or by ________.

A) purchasing short-term assets B) issuing securities C) issuing insurance policies D) trading on an exchange Answer: B Topic: 14.1 The Role of the Financial System 13) Commercial banks are financial intermediaries, as are ________.

A) household savers B) state and local governments C) insurance companies D) organized exchanges Answer: C Topic: 14.1 The Role of the Financial System 14) The most important source of funds for nonfinancial businesses is ________.

A) financial intermediaries B) insurance companies C) hedge funds D) state and local governments Answer: A Topic: 14.1 The Role of the Financial System 15) Approximately 60 percent of the funds flowing to nonfinancial businesses come from ________.

A) hedge funds B) financial intermediaries C) organized exchanges, like the New York Stock Exchange D) insurance companies Answer: B Topic: 14.1 The Role of the Financial System

3 .

16) Which of the following statements is correct?

A) assets plus liabilities equal net worth B) assets plus net worth equal liabilities C) assets equal liabilities plus net worth D) liabilities minus net worth equal assets Answer: C Topic: 14.1 The Role of the Financial System 17) Hedge funds ________.

A) acquire access to funds by accepting deposits then using these monies to lend to households and firms B) raise funds by selling commercial paper then lend these funds to consumers C) acquire access to monies through the payment of premiums by employees D) are a special type of mutual fund Answer: D Topic: 14.1 The Role of the Financial System 18) Credit unions ________.

A) acquire access to funds by accepting deposits then use these monies in lending to households and firms B) are a special type of mutual fund C) raise funds by selling commercial paper then lend these funds to consumers D) acquire access to monies through the payment of premiums by employees Answer: A Topic: 14.1 The Role of the Financial System 19) Pension funds ________.

A) acquire access to funds by accepting deposits then using these monies to lend to households and firms B) raise funds by selling commercial paper then lend these funds to consumers C) are a special type of mutual fund D) acquire access to monies through the payment of premiums by employees Answer: D Topic: 14.1 The Role of the Financial System 20) Finance companies ________.

A) acquire access to funds by accepting deposits then using these monies to lend to households and firms B) raise funds by selling commercial paper then lend these funds to consumers C) acquire access to monies through the payment of premiums by employees D) are a special type of mutual fund Answer: B Topic: 14.1 The Role of the Financial System

4 .

21) Mutual funds ________.

A) accept deposits and issue loans B) sell shares and buy financial instruments C) are a special type of commercial bank D) issue policies and receive premiums Answer: B Topic: 14.1 The Role of the Financial System 22) Financial firms whose loans are often $100 or less operate in ________.

A) the microcredit market B) the hedge fund industry C) the macrofinance market D) the credit union sector Answer: A Topic: 14.1 The Role of the Financial System 23) Direct finance involves ________.

A) borrowing monies from commercial banks B) issuing securities in financial markets C) borrowing from the Federal Reserve System D) issuing insurance policies Answer: B Topic: 14.1 The Role of the Financial System 24) The principal buyers in financial markets are ________.

A) financial intermediaries B) nonfinancial businesses C) commercial banks D) individual savers Answer: A Topic: 14.1 The Role of the Financial System 25) The primary source of funds for finance companies is ________.

A) commercial paper B) deposits C) securities D) the central bank Answer: A Topic: 14.1 The Role of the Financial System 26) The primary source of funds for commercial banks is ________.

A) securities B) Federal Reserve Banks C) loans D) deposits Answer: D Topic: 14.1 The Role of the Financial System 5 .

14.2 Information Challenges and the Financial System 1) If one economic agent possesses more information than their fellow transactor ________.

A) economic transactions cannot occur B) the moral hazard problem has been eliminated C) the adverse section problem has been eliminated D) asymmetric information exists Answer: D Topic: 14.2 Information Challenges and the Financial System 2) Asymmetric information discourages the movement of funds from savers to borrowers, because ________.

A) big risks have high payoffs B) the safe choice is always preferable to the risky choice C) taking risks is inefficient D) the loss arising from a failed project must be borne by the borrower, rather than the lender Answer: A Topic: 14.2 Information Challenges and the Financial System AACSB: Reflective Thinking 3) Suppose you have money to lend, but will do so only if you are compensated for the risk of default. If you set a high interest rate on your loan, a likely consequence is that ________.

A) safe borrowers will look elsewhere, and only risky borrowers will find your terms attractive B) risky borrowers will look elsewhere, so your money is more likely to go to a safe borrower C) competition from other lenders will force you to lower your interest rate D) you will be prosecuted for predatory lending Answer: A Topic: 14.2 Information Challenges and the Financial System AACSB: Reflective Thinking 4) Adverse selection exists because ________.

A) moral hazard exists B) asymmetric information exists C) of government regulation D) financial innovation continually occurs Answer: B Topic: 14.2 Information Challenges and the Financial System AACSB: Analytical Thinking 5) Which of the following statement is untrue?

A) assets equal liabilities plus net worth B) households and firms are lenders and borrowers in the flow of funds C) government regulation is the major cause of asymmetric information problems D) pension funds and insurance companies are financial intermediaries Answer: C Topic: 14.2 Information Challenges and the Financial System 6 .

6) Suppose you hear of a great deal on a used car and wonder, "Why is the price so low?" This might be an instance of ________.

A) tyranny of collateral B) adverse selection C) the free rider problem D) moral hazard Answer: B Topic: 14.2 Information Challenges and the Financial System AACSB: Reflective Thinking 7) Providers of health care insurance require applicants to provide information on their medical history. The purpose may be to minimize which of the following problems?

A) moral hazard B) adverse selection C) government taxes D) opportunity cost Answer: B Topic: 14.2 Information Challenges and the Financial System AACSB: Analytical Thinking 8) The incentive to collect information is undermined by the ________.

A) opportunity cost of collecting information B) asymmetric character of information flows C) free rider problem D) Willamette effect Answer: C Topic: 14.2 Information Challenges and the Financial System 9) Which of the following is an example of the free-rider problem?

A) Warren Buffett B) a stow-away C) banks that will not lend to anyone they haven't known for years D) No one takes out the trash, because everyone expects that someone else will.

Answer: D Topic: 14.2 Information Challenges and the Financial System AACSB: Reflective Thinking

7 .

10) Assume that the riskiest individuals in a given population are the ones most likely to apply for health insurance. In this situation a provider of health insurance faces the problem of ________.

A) moral hazard B) opportunity costs C) tertiary impedence D) adverse selection Answer: D Topic: 14.2 Information Challenges and the Financial System AACSB: Analytical Thinking 11) Of all financial intermediaries, which of the following holds the most assets?

A) hedge funds B) the federal government C) commercial banks D) corporations Answer: C Topic: 14.2 Information Challenges and the Financial System 12) Of all financial intermediaries which holds the most assets?

A) pension funds B) commercial banks C) insurance companies D) hedge funds Answer: B Topic: 14.2 Information Challenges and the Financial System 13) Suppose that a provider of health insurance is concerned that a policy holder will eat unhealthy foods during the lifetime of their insurance contract. The insurer faces the problem of ________.

A) Antediluvian intransigence B) opportunity costs C) moral hazard D) adverse selection Answer: C Topic: 14.2 Information Challenges and the Financial System AACSB: Analytical Thinking 14) Which of the following is an example of adverse selection?

A) The foulest-tasting medicine is often the most effective.

B) Having secured a loan, a business manager is more likely to have a lavish office party than to buy new equipment.

C) The clientele at a low-price restaurant are unlikely to leave generous tips.

D) The shiniest packaging often contains disappointment.

Answer: D Topic: 14.2 Information Challenges and the Financial System AACSB: Reflective Thinking 8 .

15) Commercial banks limit the adverse selection problem through ________.

A) monitoring B) restrictive covenants C) screening D) moral hazard Answer: C Topic: 14.2 Information Challenges and the Financial System 16) Which of the following is used by lenders to reduce the problems that arise from asymmetries of information?

A) patent contracts B) collateral C) decreased interest rates D) restrictive contents Answer: B Topic: 14.2 Information Challenges and the Financial System 17) A loan contract that requires the borrower to keep a certain percentage of its assets in cash is an example of ________.

A) screening B) monitoring C) a restrictive covenant D) a patent contract Answer: C Topic: 14.2 Information Challenges and the Financial System 18) Moral hazard and adverse selection are the result of ________.

A) prudential supervision B) any and all government policy C) excessive price fluctuations D) asymmetries of information Answer: D Topic: 14.2 Information Challenges and the Financial System 19) In 2012, U.S. banks held ________.

A) $19.4 million in assets B) $19.4 million in liabilities C) $19.4 billion in assets D) $19.4 trillion in assets Answer: D Topic: 14.2 Information Challenges and the Financial System

9 .

20) Banks are most dominant in the financial markets of ________.

A) Canada and Germany B) Germany and Japan C) Japan and the United States D) the United States and Canada Answer: B Topic: 14.2 Information Challenges and the Financial System 21) In the United States, commercial banks supply about ________% of total credit to nonfinancial businesses.

A) 20 B) 75 C) 50 D) 90 Answer: A Topic: 14.2 Information Challenges and the Financial System 22) From the perspective of households and businesses deciding where to deposit their money, the key advantage of the private loans issued by commercial banks is ________.

A) transparency B) marketability C) incentive for the bank to collect information D) relatively high interest rates Answer: C Topic: 14.2 Information Challenges and the Financial System AACSB: Reflective Thinking 23) Restrictive covenants place constraints on the behavior of ________.

A) borrowers B) lenders C) the central bank D) the executive branch of the federal government Answer: A Topic: 14.2 Information Challenges and the Financial System 24) When property rights are well defined and inexpensive to enforce, ________.

A) collateral is an efficient solution to asymmetric information problems B) little or no collateral is needed to secure a loan C) banks become less dominant among intermediaries D) poor borrowers are at no disadvantage relative to wealthy borrowers Answer: A Topic: 14.2 Information Challenges and the Financial System

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25) The tyranny of collateral ________.

A) suggests that government tax rates are too high in the United States B) gives rise to the twin problems of moral hazard and adverse selection C) implies that when a poor person has a good idea they find it difficult to acquire financing D) attributes moral hazard to excessive government regulation Answer: C Topic: 14.2 Information Challenges and the Financial System 26) In economies with effective accounting standards and low-cost, reliable information, ________.

A) banks become less dominant among intermediaries B) the tyranny of collateral is particularly intense C) funds are available only for activities involving little or no risk D) restrictive covenants are difficult to enforce Answer: A Topic: 14.2 Information Challenges and the Financial System 27) Screening and monitoring are costly activities. Why is it a bad idea to impose these costs on borrowers?

Answer: Imposing extra costs on borrowers exacerbates the adverse selection problem, because "good" borrowers are most likely to feel that the costs are excessive and punitive, while "bad" borrowers — whose intention to repay is questionable — are relatively unaffected. Monitoring that is inconvenient and/or intrusive penalizes good borrowers and undermines their cooperation, while bad borrowers may continue to thwart the monitoring system.

Topic: 14.2 Information Challenges and the Financial System AACSB: Reflective Thinking 28) How do commercial banks solve asymmetric information problems?

Answer: By collecting information to reduce the information asymmetry: screening loan applicants and monitoring borrowers once the loan is approved. Loan assets are retained, rather than sold to third parties, so information accumulates over time and, possibly, over several loans to a single borrower. The bank's "investment" in screening and monitoring allows it to profit from low-risk lending and to provide credit at a lower cost than the borrower can get from a new lender, so the relationship is long-term and mutually beneficial.

Topic: 14.2 Information Challenges and the Financial System AACSB: Reflective Thinking 29) How might asymmetric information cause a well-managed bank to be abandoned by its depositors?

Answer: Bank depositors know little about their bank's lending practices, except when a particular bank fails. Depositor's at other banks have to wonder whether their bank is safe, which comes down to whether other depositors believe the bank to be safe. In the absence of credible deposit insurance, any depositor who is unsure that other depositors will keep their funds in the bank must, rationally, withdraw her funds. If enough depositors do so, the bank has failed.

Topic: 14.2 Information Challenges and the Financial System AACSB: Reflective Thinking 11 .

30) If you invest in an "emerging market fund," your money is probably going to a commercial bank, rather than directly to nonfinancial businesses. Why? Why is that probably a good thing?

Answer: Developing economies are especially dependent on private lending by banks to overcome asymmetric information problems. Few businesses in developing economies can provide information of adequate quantity and quality to issue marketable securities. Banks have a profit incentive to compensate for the rudimentary state of accounting standards, enforcement of property rights, etc. Foreign investors share in the profits of competent bank intermediation.

Topic: 14.2 Information Challenges and the Financial System AACSB: Reflective Thinking 31) Do you think that information technologies will someday eliminate asymmetric information problems?

Answer: No. The most advanced conceivable technologies will not enable one to expose intentions or to predict the future. Rapid, low cost dissemination of verifiable information lowers transaction costs and improves the allocation of funds, but there will remain the challenge of minimizing the funding of borrowers whose incompetence and/or malice is concealed rather than revealed by the available information.

Topic: 14.2 Information Challenges and the Financial System AACSB: Reflective Thinking 14.3 Government Regulation and Supervision of the Financial Sector 1) Government-backed deposit insurance increases the ________.

A) Willamette torsion effect B) adverse selection problem C) moral hazard problem D) the prudential contagion problem Answer: C Topic: 14.3 Government Regulation and Supervision of the Financial Sector 2) Deposit insurance can lead to ________.

A) an increase in adverse selection B) a decrease in bank costs C) a decrease in bank lending rates D) an increase in risks banks take on Answer: D Topic: 14.3 Government Regulation and Supervision of the Financial Sector AACSB: Analytical Thinking 3) Government-backed deposit insurance ________.

A) protects "good" banks from the misdeeds of "bad" banks B) is intended to encourage banks to pursue high-risk activities C) is an example of prudential regulation D) is an example of government-directed credit Answer: A Topic: 14.3 Government Regulation and Supervision of the Financial Sector AACSB: Analytical Thinking 12 .

4) An example of a government-based approach to improve the quality of information in financial markets is ________.

A) financial news networks B) mandatory disclosures C) government-directed credit D) government safety nets Answer: B Topic: 14.3 Government Regulation and Supervision of the Financial Sector 5) Information asymmetries may make it difficult for important sectors of the economy to receive the funding they need to keep the economy growing. In many economies, this problem is addressed with ________.

A) prudential regulation B) government-directed credit C) government-backed deposit insurance D) adverse selection Answer: B Topic: 14.3 Government Regulation and Supervision of the Financial Sector 6) An inherent weakness of ________ is the absence of the profit incentive.

A) government-directed credit B) government-backed deposit insurance C) private loans D) prudential supervision Answer: A Topic: 14.3 Government Regulation and Supervision of the Financial Sector 7) A key objective of a government safety net for the banking system is to ensure ________.

A) that the poor have access to bank services B) an efficient allocation of credit C) bank profitability D) that depositors always believe that their money is safe in the bank Answer: D Topic: 14.3 Government Regulation and Supervision of the Financial Sector 8) The collapse of one bank might lead easily to the failure of several others, because ________.

A) depositors cannot trust each other to keep their money in the bank B) deposit insurance renders all banks equally fragile C) no bank can survive when its competitors cease to operate D) government regulators will step in to punish any bank suspected of poor management Answer: A Topic: 14.3 Government Regulation and Supervision of the Financial Sector AACSB: Reflective Thinking

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9) Prudential regulation ________.

A) requires that banks maintain the confidentiality of loan applications B) is administered by a specific insurance company C) is necessitated by the government's safety net for the banking system D) is an effective substitute for prudential supervision Answer: C Topic: 14.3 Government Regulation and Supervision of the Financial Sector AACSB: Reflective Thinking 10) The U.S. Securities and Exchange Commission ________.

A) oversees lending policies at commercial banks B) directs credit to underserved segments of the financial sector C) promotes transparency in direct finance transactions D) advises households and businesses on the best companies in which to invest Answer: C Topic: 14.3 Government Regulation and Supervision of the Financial Sector 11) The collapse of Enron Corporation is a reminder of the importance of ________.

A) moral hazard B) government-directed credit C) energy trading D) transparency Answer: D Topic: 14.3 Government Regulation and Supervision of the Financial Sector 12) Prudential regulation ________.

A) is an example of government-directed credit B) helps to encourage people to abandon banks that engage in excessively risky behaviors C) provides banking services to economically-disadvantaged households and businesses D) is more prominent for direct than for indirect finance Answer: B Topic: 14.3 Government Regulation and Supervision of the Financial Sector AACSB: Reflective Thinking 13) Prudential supervision is, in essence, the monitoring of ________.

A) borrowers, to enforce restrictive covenants B) intermediaries, to direct credit to preferred sectors of the economy C) holders of an insurance policy, to discourage excessively risky behaviors D) depositors, to discourage sudden withdrawal of funds Answer: C Topic: 14.3 Government Regulation and Supervision of the Financial Sector AACSB: Reflective Thinking

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14) Overall, government intervention in the financial system ________.

A) is both essential and imperfect B) prevents adequate market solutions to market problems C) is continually improving and expanding D) is incompatible with an efficient allocation of resources Answer: A Topic: 14.3 Government Regulation and Supervision of the Financial Sector AACSB: Reflective Thinking 15) What problem is addressed by a government safety net for the banking system? What problem is caused by the safety net?

Answer: The safety net protects good banks from being abandoned by uninformed depositors, so banks can continue to channel funds. The safety net means that bad banks need not worry that depositors will become aware of or care about risky practices, so the incentive to remain prudent is weakened (moral hazard).

Topic: 14.3 Government Regulation and Supervision of the Financial Sector AACSB: Reflective Thinking 16) How might government-directed credit help poor entrepreneurs to escape the "tyranny of collateral"? What side-effects might undermine the effectiveness of such a program?

Answer: A government run or influenced bank can ignore profit motivation and risk aversion to target underserved businesses on favorable terms involving little or no collateral. With competent screening, monitoring, and support services, the outcome can be profitable investments. The danger of moral hazard is acute, however. Markets achieve efficiency by removing resources from people and projects that are underperforming, but a program designed to be friendly to struggling businesses is unlikely to be good at recognizing lost causes and abandoning them. Moreover, the disregard of market standards makes it easy for the allocation of funds to be determined by political and social ties, to the detriment of economic performance.

Topic: 14.3 Government Regulation and Supervision of the Financial Sector AACSB: Reflective Thinking 17) When is a firm more likely to engage in excessively risky behaviors, when business is well, or when it is facing financial distress?

Answer: Financial distress is a cause of moral hazard. Even heretofore prudent managers are tempted to take drastic action with the hope that a big payoff might save the company, and the realization that, if the company is about to fail, there's little to lose by taking big risks. Moreover, managers are understandably reluctant to reveal bad news, and the move away from transparency encourages behaviors that would be dismissed as unacceptable if they were easily observable.

Topic: 14.3 Government Regulation and Supervision of the Financial Sector AACSB: Reflective Thinking

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14.4 Financial Development and Economic Growth: The Evidence 1) Financial deepening is synonymous with ________.

A) issuing equities B) financial development C) borrowing additional funds from world capital markets D) holding a well diversified portfolio Answer: B Topic: 14.4 Financial Development and Economic Growth: The Evidence 2) Evidence suggests that financial deepening is of greatest benefit to ________.

A) industries that are highly dependent on external sources of funds B) family-owned enterprises C) established firms, rather than new firms D) child workers Answer: A Topic: 14.4 Financial Development and Economic Growth: The Evidence 3) An important consequence of financial deepening is ________.

A) an increase in the number of new firms B) a sharp increase in levels of saving & investment C) higher profit rates D) an expansion of bank loans relative to other funding sources Answer: A Topic: 14.4 Financial Development and Economic Growth: The Evidence 4) Economic growth in China ________.

A) would have been impossible in the absence of its impressive record of financial development B) occurred despite limited domestic financial development C) can continue indefinitely without additional financial development D) has occurred despite a relatively low domestic saving rate Answer: B Topic: 14.4 Financial Development and Economic Growth: The Evidence 5) Per capita income in China is approximately ________% of the U.S. level.

A) 17 B) 80 C) 40 D) 5 Answer: A Topic: 14.4 Financial Development and Economic Growth: The Evidence

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6) Over the past two decades, the saving rate in China has been approximately ________%.

A) 17 B) 80 C) 40 D) 5 Answer: C Topic: 14.4 Financial Development and Economic Growth: The Evidence 7) China's recent economic performance is most similar to the experience of ________.

A) the United States in the 1890s B) Japan in the 1960s & 1970s C) Cuba in the 1990s D) the Soviet Union in the 1950s & 1960s Answer: D Topic: 14.4 Financial Development and Economic Growth: The Evidence 8) The single most important contributor to China's economic growth has been ________.

A) government-directed credit to key economic sectors B) strong demand for China's exports C) rapid improvements in worker productivity D) a substantial increase in the utilization of labor and capital inputs Answer: D Topic: 14.4 Financial Development and Economic Growth: The Evidence 9) ________ is among the ingredients of "a first-rate financial system."

A) Government-directed credit to key economic sectors B) Greater efficiency of state-owned banks C) Legal reform to strengthen financial contracts D) Saving rates of 20% or more Answer: C Topic: 14.4 Financial Development and Economic Growth: The Evidence 10) What are the benefits of bankruptcy laws that enable lenders to seize the assets of firms that default on loan contracts?

Answer: When borrowers are aware that default will lead to asset seizure, they will work harder to avoid default. When lenders know that borrowers will do all they can to avoid default, they will offer more funds at lower cost. The result is more and more-productive economic activity.

When default occurs, the seizure of assets is a reallocation of resources that raises their value and supports economic growth.

Topic: 14.4 Financial Development and Economic Growth: The Evidence AACSB: Reflective Thinking

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11) How might financial deepening contribute to poverty reduction?

Answer: Though the poor are rarely primary beneficiaries of financial deepening, they do benefit from improved performance of the macroeconomy. Moreover, because financial deepening benefits new firms, especially, and all firms that rely on external funding, it strengthens economic and political elements with a strong interest in sustaining the financial development. Poverty reduction will proceed, so long as financial development contributes to economic growth, and economic growth creates expanding opportunities for people to rise out of poverty.

Topic: 14.4 Financial Development and Economic Growth: The Evidence AACSB: Reflective Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 15 Financial Crises and the Economy 15.1 Asymmetric Information and Financial Crises 1) The notion that lenders must select from a pool of bad credit risks, because the most undesirable borrowers are those that most actively seek out a loan is known as the ________.

A) moral hazard problem B) ornamental torsion problem C) adverse selection problem D) asymmetric innovation problem Answer: C Topic: 15.1 Asymmetric Information and Financial Crises AACSB: Analytical Thinking 2) Channeling funds to individuals with productive investment opportunities is the function of ________.

A) the financial sector B) state and local governments C) the central bank D) state, local and federal governments Answer: A Topic: 15.1 Asymmetric Information and Financial Crises 3) The risk that a borrower has more information about their previous behavior than a potential lender is known as the ________.

A) moral hazard problem B) adverse selection problem C) time-space discontinuity D) tertiary behavior problem Answer: B Topic: 15.1 Asymmetric Information and Financial Crises AACSB: Analytical Thinking 4) The risk that a borrower has a greater understanding about their potential future behavior than a potential lender is known as ________.

A) the problem of adverse selection B) the problem of moral hazard C) ornamental torsion D) the asymmetric innovation problem Answer: B Topic: 15.1 Asymmetric Information and Financial Crises AACSB: Analytical Thinking

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5) Which of the following best illustrates the adverse selection problem?

A) a professional football team that consistently drafts poor players B) an economic agent who engages in risky behavior once a loan is received C) an individual who hides a pre-existing condition from a health insurer D) an individual who experiences a lost of income by not working while attending college Answer: C Topic: 15.1 Asymmetric Information and Financial Crises AACSB: Analytical Thinking 6) Which of the following best illustrates the problem of moral hazard?

A) a professional baseball team that consistently drafts poor players B) an individual that is hiding a pre-existing condition from a health insurance provider C) an increase in the level of one's income will lead to a decrease in demand for inferior goods D) an economic agent that engages in risky behavior once a loan contract is signed Answer: D Topic: 15.1 Asymmetric Information and Financial Crises AACSB: Analytical Thinking 7) The analysis of asymmetric information problems is called ________.

A) adverse selection B) microeconomics C) cybernetics D) agency theory Answer: D Topic: 15.1 Asymmetric Information and Financial Crises 8) According to agency theory, a financial crisis results from ________ that disrupts the flow of funds from lender-savers to borrower-spenders.

A) an increase in asymmetric information B) a macroeconomic shock C) the existence of asymmetric information D) a decrease in saving Answer: A Topic: 15.1 Asymmetric Information and Financial Crises

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15.2 Dynamics of Financial Crises 1) Financial institutions that cut back on their lending are engaged in ________.

A) liability management B) deleveraging C) financial innovation D) torsion control Answer: B Topic: 15.2 Dynamic of Financial Crises 2) The main objective of financial liberalization is ________.

A) to encourage financial innovation B) to improve the allocation of financial capital C) to discourage volatility in financial markets D) to reduce the likelihood of a credit boom Answer: B Topic: 15.2 Dynamic of Financial Crises 3) Prior to World War II, in the United States, financial crises occurred every ________ years or so.

A) twenty B) seven C) fifty D) three Answer: A Topic: 15.2 Dynamic of Financial Crises 4) In the period from 1929 through 1933, there were successive ________ in aggregate demand and ________ in short-run aggregate supply.

A) increases; decreases B) decreases; increases C) decreases; no change D) increases; increases Answer: B Topic: 15.2 Dynamic of Financial Crises 5) The failure of a major financial company is often a trigger for a financial crisis. The main reason for trouble at a single firm to become a crisis for the entire economy is that ________.

A) the central bank will suspend operations until the failed firm is restructured B) it is unclear whether the firm's collapse will remain an isolated event C) customers of the failed company will organize a boycott to protest their losses D) employees and owners of the failed company reduce their spending, with adverse effects on other businesses Answer: B Topic: 15.2 Dynamic of Financial Crises AACSB: Reflective Thinking 3 .

6) An early sign that financial innovation might be leading toward a financial crisis is ________.

A) deleveraging B) a bank panic C) a credit boom D) debt deflation Answer: C Topic: 15.2 Dynamic of Financial Crises 7) The adverse consequences of debt deflation are most evident ________.

A) in the expansion of credit to high-risk borrowers B) on the balance sheets of nonfinancial businesses C) in a sharp decline in the real interest rate D) on the balance sheets of financial businesses Answer: B Topic: 15.2 Dynamic of Financial Crises 8) ________ refers to a decrease in the willingness of banks to lend, while an impairment of the ability of nonfinancial firms to borrow is a consequence of ________.

A) Adverse selection; moral hazard B) Deleveraging; debt deflation C) Fire sales; a bank panic D) The shadow banking system; agency theory Answer: B Topic: 15.2 Dynamic of Financial Crises 9) A rapid increase in the availability of credit to previously underserved borrowers is likely ________.

A) to result from financial liberalization B) to improve the allocation of capital C) to confirm the merits of microcredit D) to result from deleveraging Answer: A Topic: 15.2 Dynamic of Financial Crises 10) A likely consequence of deposit insurance, ceteris paribus, is ________.

A) an increase in risk-taking by banks B) a bank panic C) a credit boom D) a reduction in the severity of adverse selection Answer: A Topic: 15.2 Dynamic of Financial Crises

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11) When banks fail during a financial crisis, ________.

A) the removal of these weak institutions serves to strengthen the financial system B) the elimination of competitors is likely to spark a credit boom C) there is a loss of information that can cause the crisis to worsen D) surviving banks resort to financial engineering to retain customers Answer: C Topic: 15.2 Dynamic of Financial Crises 12) Assume that a firm has $100 million in real assets and $90 in real liabilities. The value of its net worth would be ________.

A) a negative $10 million.

B) $190 million.

C) $4190 billion.

D) $10 million.

Answer: D Topic: 15.2 Dynamic of Financial Crises AACSB: Analytical Thinking 13) Assume that a firm has $100 million in real assets and $90 in real liabilities. If the price level rise by ten percent, the real value of its assets would ________.

A) fall B) rise C) change, but more information must be provided to determine their exact movement D) remain unchanged Answer: D Topic: 15.2 Dynamic of Financial Crises AACSB: Analytical Thinking 14) Assume that a firm has $100 million in real assets and $90 in real liabilities. If the price level falls by ten percent, the real value of liabilities would ________.

A) fall to $81 million B) change, but more information must be provided to determine the exact movement C) remain unchanged D) rise to $99 million Answer: D Topic: 15.2 Dynamic of Financial Crises AACSB: Analytical Thinking 15) An asset-price bubble entails ________.

A) increasing the value of one's assets to cover liability losses B) an increase in asset prices above their fundamental economic value C) reducing the number of participants in the underlying financial derivatives market D) an economic skins game Answer: B Topic: 15.2 Dynamic of Financial Crises

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16) The main reason that many businesses fail when the price level is falling is that ________.

A) deflation causes a decline in short-run aggregate supply B) as prices fall, businesses are unable to predict the quantity of output they will be able to sell C) the real value of the firms assets declines in proportion to the decrease in the price level D) falling prices mean that regular loan payments become increasingly difficult Answer: D Topic: 15.2 Dynamic of Financial Crises AACSB: Reflective Thinking 17) When banks and other financial institutions become insolvent, ________.

A) the problem of asymmetric information becomes more acute B) it is easier to distinguish the good creditors and borrowers from the bad C) surviving creditors will attract borrower-spenders by lowering the real interest rate D) the resulting increase in short-run aggregate supply will discourage investment Answer: A Topic: 15.2 Dynamic of Financial Crises 18) U.S. financial crises begin in a period of ________.

A) rising incomes B) adverse selection C) rising uncertainty D) moral hazard Answer: C Topic: 15.2 Dynamic of Financial Crises 19) An individual firm is insolvent when ________.

A) its assets exceed the value of its liabilities B) its average costs per unit are greater than its marginal cost C) its average costs per unit are less than its marginal cost D) its liabilities exceed the value of its assets Answer: D Topic: 15.2 Dynamic of Financial Crises 20) The decline in net worth that can result from an unanticipated decline in the price level is known as ________.

A) a credit boom B) deleveraging C) a debt deflation D) federal funds rationing Answer: C Topic: 15.2 Dynamic of Financial Crises

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21) Which of the following statements is correct?

A) assets plus liabilities equal net worth B) liabilities plus net worth equal assets C) assets plus net worth equal liabilities D) liabilities minus net worth equal assets Answer: B Topic: 15.2 Dynamic of Financial Crises 22) The most severe financial crisis in U.S history occurred in the years ________.

A) 2006-2008 B) 1997-98 C) 1929-33 D) 1873-93 Answer: C Topic: 15.2 Dynamic of Financial Crises 23) A prominent aspect of the Great Depression of the 1930s, but not of the recent Great Recession, is ________.

A) bank panics B) mortgage defaults C) an increase in the credit spread D) nonconventional monetary policy Answer: A Topic: 15.2 Dynamic of Financial Crises 24) A prominent aspect of the recent Great Recession, but not of the Great Depression of the 1930s, is ________.

A) bank panics B) mortgage defaults C) an increase in the credit spread D) nonconventional monetary policy Answer: D Topic: 15.2 Dynamic of Financial Crises 25) An increase in the general level of prices will tend to cause, other things the same ________.

A) an increase in the real value of assets B) an increase in the real value of liabilities C) no change in the real value of liabilities D) a decrease in the real value of liabilities Answer: D Topic: 15.2 Dynamic of Financial Crises AACSB: Analytical Thinking

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26) The Great Crash on the New York Stock Exchange occurred in ________.

A) October 1929 B) July 1776 C) September 2001 D) March 1933 Answer: A Topic: 15.2 Dynamic of Financial Crises 27) President Franklin Delano Roosevelt declared a bank holiday, closing all U.S. banks in ________.

A) July 1776 B) October 1929 C) March 1933 D) September 2001 Answer: C Topic: 15.2 Dynamic of Financial Crises 28) The difference between the interest rate on loans to households and firms and the rate on completely safe assets is known as ________.

A) the discount rate B) the FICO score C) the credit spread D) the prime rate Answer: C Topic: 15.2 Dynamic of Financial Crises 29) The credit spread refers to ________.

A) the extent to which financial instruments are distributed among households at different income levels in a given society B) the difference between the London Inter-Bank Offered Rate (LIBOR) and the fed funds rate C) the price elasticity of household debt D) the interest-rate differential between risky bonds and U.S. Treasury bonds Answer: D Topic: 15.2 Dynamic of Financial Crises 30) Most likely, the stock market crash in 1929 was triggered by ________.

A) an autonomous tightening of monetary policy B) an unexpected increase in tax rates C) the rise of fascist political parties in Europe D) a decline in consumer spending Answer: A Topic: 15.2 Dynamic of Financial Crises

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31) In the Great Depression, investment spending fell by ________.

A) nine-tenths of one percent B) nine percent C) ninety percent D) nine hundred percent Answer: C Topic: 15.2 Dynamic of Financial Crises 32) The Great Depression ________.

A) was largely confined to the United States B) was largely confined to European markets C) was largely confined to Asian markets D) was worldwide in scope Answer: D Topic: 15.2 Dynamic of Financial Crises 33) During the Great Depression, as real interest rates rose, good credit risks were less likely to seek loans. This process illustrates the phenomenon of ________.

A) adverse selection B) moral hazard C) poor monetary policy D) debt deflation Answer: A Topic: 15.2 Dynamic of Financial Crises 34) Subprime borrowers ________.

A) are those individuals who owe more on their mortgage than the value of their home B) possess a relatively low FICO score C) rely on mortgage-backed securities to support their mortgage applications D) are those with an income level below the value of their mortgage Answer: B Topic: 15.2 Dynamic of Financial Crises 35) The financial innovation of numerical credit scoring contributed to the ________.

A) "democratization of credit" B) reduction of loan-to-value ratios C) "depersonalization of credit" D) reduction of information asymmetries Answer: A Topic: 15.2 Dynamic of Financial Crises

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36) Financial innovations may be expected to cause a decline in ________.

A) financial frictions B) the credit spread C) the real interest rate on investments D) all of the above E) none of the above Answer: D Topic: 15.2 Dynamic of Financial Crises AACSB: Reflective Thinking 37) Financial innovations may be expected to cause a decline in ________.

A) aggregate demand B) asset prices C) the real interest rate on investments D) all of the above E) none of the above Answer: C Topic: 15.2 Dynamic of Financial Crises AACSB: Reflective Thinking 38) Financial innovations may be expected to cause a decline in ________.

A) the ability of lenders and borrowers to fully understand the latest financial opportunities B) the ability of government regulators to foresee emerging threats to financial stability C) incentives for financial intermediaries to avoid high-risk loans D) all of the above E) none of the above Answer: D Topic: 15.2 Dynamic of Financial Crises AACSB: Reflective Thinking 39) Instruments which provide payments to holders of bonds in the event of default are known as ________.

A) collateralized bond obligations B) tertiary payment devices C) credit default swaps D) mortgage-backed securities Answer: C Topic: 15.2 Dynamic of Financial Crises 40) The practice of approving mortgages in order to sell them as mortgage-backed securities is known as ________.

A) originate-to-distribute B) principal-agent engineering C) predatory lending D) a credit default swap Answer: A Topic: 15.2 Dynamic of Financial Crises 10 .

41) Hedge funds, investment banks, and other non-depository financial firms are known as ________.

A) the shadow banking system B) repurchasers C) subprime lenders D) CDOs Answer: A Topic: 15.2 Dynamic of Financial Crises 42) If the value of a home falls below the amount owed on the mortgage for that property, the house is said to be ________.

A) underwater B) collateralized C) swamped D) in short sale Answer: A Topic: 15.2 Dynamic of Financial Crises 43) A haircut (in finance) is ________.

A) the payment of a block of funds as part of a refinancing arrangement B) the percentage by which the value of collateral exceeds the value of the loan C) the issue of equities rather than debt in acquiring access to money capital D) the immediate end of lending to subprime borrowers Answer: B Topic: 15.2 Dynamic of Financial Crises 44) A $100 million loan with a haircut of four percent requires collateral valued at ________.

A) $104 million B) $96 million C) $4 million D) $400,000 Answer: A Topic: 15.2 Dynamic of Financial Crises AACSB: Analytical Thinking 45) From 1995-2007, the Irish economy ________.

A) suffered from severe unemployment, famine and labor migration B) witnessed a boom in the real economy, but suffered through a collapse in asset prices C) enjoyed one of the highest growth rates in the world D) suffered through a period of prolonged deflation Answer: C Topic: 15.2 Dynamic of Financial Crises

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46) The worst weekly decline in U.S. stock market history occurred during the week beginning with ________.

A) March 20, 1933 B) December 7, 1941 C) September 12, 2001 D) October 6, 2008 Answer: D Topic: 15.2 Dynamic of Financial Crises 47) An increase in asymmetric information that increases financial frictions will tend to ________.

A) increase the moral hazard and adverse selection problems in credit markets B) decrease financial frictions C) improve market efficiency D) decrease the moral hazard problem Answer: A Topic: 15.2 Dynamic of Financial Crises 48) The most direct and important consequence of an increase in asymmetric information problems is ________.

A) a decrease in the probability of loan repayment B) inability to assess the probability of loan repayment C) unwillingness of borrowers to accept the market rate of interest D) inability of creditors to acquire enough funds to meet borrowers' demand Answer: B Topic: 15.2 Dynamic of Financial Crises AACSB: Reflective Thinking 49) The financial market events of September and October 2008 ________.

A) sparked a sharp widening of the credit spread B) signalled the success of the policy response to the financial crisis C) reduced some of the uncertainty that had paralyzed financial markets D) resulted from the federal funds rate having fallen below zero Answer: A Topic: 15.2 Dynamic of Financial Crises 50) How is a financial crisis like a power blackout?

Answer: A blackout occurs when a breakdown at one or more points in the power grid causes strain at other points. As these fail, the entire system can collapse. The failure of a single financial institution disrupts the functioning of others, with an inherent tendency for the weakening to spread and intensify. The deterioration of financial institutions' balance sheets, in particular, is contagious. Restoring power requires both removing the initial cause (e.g., power lines downed in a storm) and reestablishing normal operations at all the points affected indirectly.

Topic: 15.2 Dynamic of Financial Crises AACSB: Reflective Thinking 12 .

51) Describe the role of uncertainty at the beginning of and in the unfolding of a financial crisis.

Answer: Regardless of the initial spark, an adverse event within and/or affecting the financial sector becomes a systemic crisis when it gives rise to substantial uncertainty. Because the gathering, analysis, and strategic use of information is a core function of financial institutions, an increase in uncertainty can disrupt the very mechanisms that, under normal circumstances, reduce and manage uncertainty. Thus, the key impacts of an increase in uncertainty are impairment of abilities to deal with uncertainty and further increases in uncertainty. The spiral of rising uncertainty will end only when the loss of value and the paralysis of financial operations is so complete as to inspire confidence that it cannot get worse.

Topic: 15.2 Dynamic of Financial Crises AACSB: Reflective Thinking 52) How can improvements in statistical analysis of financial data cause the amount of information in financial markets to decline?

Answer: Statistical analysis is a process of drawing inferences from (preferably) large sets of data.

When it is possible to predict outcomes such as the overall default rate within a pool of loans, constructing such pools is cheaper and more profitable than attempting to analyze and manage each loan individually. Quantitative scores and rough categorizations replace detailed and largely qualitative "dossier" for each borrower. Since ownership of the loan assets is both aggregated and dispersed, no one has incentive nor ability to monitor the behavior of borrowers. Lenders receive less information about borrowers, and less information about their fellow lenders.

Topic: 15.2 Dynamic of Financial Crises AACSB: Reflective Thinking 53) What are the effects of a financial crisis on short-run aggregate supply? How might long-run aggregate supply be affected?

Answer: A financial crisis affects short-run aggregate supply by first affecting aggregate demand. The decline in economic activity that results from disruption of credit markets causes output to fall below potential output. The resulting slack in the economy prevents producers from raising prices as much as they otherwise would, so both inflation and expected inflation decline, shifting the SRAS curve down. If the financial sector's ability to channel funds to productive opportunities is not quickly restored, businesses will be unable to utilize resources as efficiently as before; the long-run aggregate supply curve has shifted to the left.

Topic: 15.2 Dynamic of Financial Crises AACSB: Analytical Thinking 54) How might the globalization of financial markets affect the role of financial frictions in business fluctuations?

Answer: Globalization entails a global business cycle in which an increasing number of economies are swept along in fluctuations associated with the strategies and mechanisms of financial intermediation. When a nation's economy faces an economic disruption, whether or not associated with financial frictions, that is clearly localized (e.g., a business or political scandal) and does not call into question global financial instruments and markets, the effect of global integration is likely to be positive, supporting resource reallocation to move the affected economy beyond the crisis.

Topic: 15.2 Dynamic of Financial Crises AACSB: Reflective Thinking 13 .

15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 1) The rate targeted by the Federal Reserve System as it conducts monetary policy is the ________.

A) discount rate B) prime rate C) Treasury bill rate D) fed funds rate Answer: D Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 2) Which of the following is among the possible reasons that the 2007-2009 financial crisis did not result in an economic depression?

A) the declaration of a bank holiday by the nation's President B) international policy coordination C) strict reliance on conventional monetary policy D) government spending restraint Answer: B Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 3) Which of the following is among the possible reasons that the 2007-2009 financial crisis did not result in an economic depression?

A) tax cuts B) elimination of nonessential government spending C) rapid prosecution of predatory lenders D) closure of the shadow banking system Answer: A Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 4) Which of the following is among the possible reasons that the 2007-2009 financial crisis did not result in an economic depression?

A) new lending programs by the central bank B) privatization of Fannie Mae and Freddie Mac C) a substantial increase in exports to China D) rapid foreclosure of "underwater" properties Answer: A Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 5) Monetary policy in the United States is primarily the responsibility of ________.

A) the President and Congress B) the Federal Reserve System C) the U.S. Treasury D) the Comptroller of the Currency Answer: B Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 14 .

6) Fiscal policy involves the manipulation of ________.

A) U.S. interest rates B) wages and prices C) federal government spending and tax revenues D) the supply of money Answer: C Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 7) The key objective of purchases by the Federal Reserve of over $1 trillion worth of debt issued by private firms was ________.

A) to avoid the bankruptcy of the issuing firms B) to manage expectations C) to prevent such firms from being acquired by foreign companies D) to stimulate spending by firms and households Answer: D Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 8) The zero-lower-bound problem eliminates the ability of the central bank to use which of the following in implementing policy?

A) open market operations B) discount lending C) the federal funds rate D) the required reserve ratio Answer: C Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 9) In the event that nominal short-term interest rates cannot be lowered further, the Federal Reserve might rely on ________.

A) federal government fiscal policy B) targeting the fed funds rate C) quantitative easing D) targeting the inflation rate Answer: C Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 10) Attempts by a central bank to increase bank deposits without a decrease in nominal shortterm interest rates are referred to as ________.

A) quantitative easing B) credit channeling C) open market operations D) liquidity provision Answer: A Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression

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11) Management of expectations by a central bank is based on the view that ________.

A) decreasing the federal funds rate will lead to a reduction in the discount rate B) if economic agents believe that the price of an individual asset will rise in the future, they will buy that asset today, contributing to its eventual price increase C) if households expect an increase in prices in the future, they will engage in spending today D) households will increase their spending today if they believe that the monetary authorities are committed to maintaining low interest rates Answer: D Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 12) In an attempt to manage expectations, a central bank may prefer to announce an unconditional commitment, because an unconditional commitment ________ than a conditional commitment.

A) is inherently more credible B) may have an impact on expectations that is stronger C) places fewer constraints on policy makers D) is less likely to have unintended consequences Answer: B Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 13) The most important component of the Economic Recovery Act passed by the Bush Administration was ________.

A) the creation of the Federal Reserve discount window B) the establishment of the Troubled Asset Relief Program (TARP) C) the decrease in taxes for the wealthiest one percent of all Americans D) the creation of the Federal Reserve Answer: B Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 14) The Troubled Asset Relief Program ________.

A) led to the creation of the Federal Reserve System B) helped contribute to the stock market crash of 2006-2007 C) shifted non-performing assets off the balance sheet of the Federal Deposit Insurance Corporation onto the balance sheet of Fannie Mae and Freddie Mac D) authorized the Treasury to by mortgages from troubled financial institutions Answer: D Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 15) The Economic Recovery Act of 2008 included a temporary increase in the federal deposit insurance ceiling from $100,000 to $250,000. The likely objective was to ________.

A) boost bank profitability B) increase the money supply C) discourage withdrawals from banks D) bail out the Federal Deposit Insurance Corporation (FDIC) Answer: C Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression AACSB: Reflective Thinking 16 .

16) Following the collapse of its housing and stock markets around 1990, the Japanese government ________.

A) effectively managed the crisis, limiting the damage to the Japanese economy B) took only limited action in response to the crisis C) was able to rely on private initiatives in quickly reversing the course of GDP in the 1990s D) fixed the value of the yen to the Euro and pursued an aggressive monetary policy Answer: B Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 17) Central bank lending to bail out troubled firms is known as ________, while allowing troubled firms to conceal the true value of their assets is called ________.

A) crony capitalism; larceny B) liquidity provision; regulatory forbearance C) securitization; nonconventional monetary policy D) subprime lending; regulatory arbitrage Answer: B Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression 18) Compared to the central bank response to the financial crisis in 2007-2009, the response to the Great Depression of the 1930s may be characterized as ________, while the response of Japan's central bank to the banking crisis in the early 1990s merits the label ________.

A) hasty; sluggish B) intrusive; tenacious C) complacent; indulgent D) corrupt; technocratic Answer: C Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression AACSB: Reflective Thinking 19) Why is responding to a financial crisis by bailing out financial institutions more effective than direct support of nonfinancial businesses?

Answer: In the wake of a financial crisis, many businesses find it difficult to cover operating expenses and would welcome direct financial support. However, business subsidies or tax credits and measures to stimulate demand address only the symptoms of the economic downturn. Direct aid to businesses may allow them to survive, but does not bring the economy beyond the crisis.

The underlying problem is the inability of financial institutions to identify productive opportunities worthy of financial support. The value of financial assets and, especially, the viability of surviving financial institutions must be clarified to bring the crisis to an end.

Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression AACSB: Reflective Thinking

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20) How did international policy coordination contribute to the avoidance of an economic depression in 2008 - 2010?

Answer: The shadow banking system had become an important source of liquidity in the global economy prior to the crisis. The discovery that collateral was worth far less than it had seemed caused a dramatic reduction in credit everywhere. While central banks and governments sought primarily to aid their own economies, the effectiveness of their interventions was increased by the demonstration that no single economy would be expected to bear alone the burden of restoring liquidity and reducing uncertainty. Rather, the recovery of each economy would be supported by the containment of financial collapse and the recovery of aggregate demand in all affected economies.

Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression AACSB: Reflective Thinking 21) Describe how a central bank can increase aggregate demand by influencing expectations.

Answer: When households and businesses expect interest rates to remain low, they are more willing to spend now and, even, to borrow, knowing that they will earn little on saving and be able to borrow in the future, at low cost, if they so choose. This willingness to spend and borrow, combined with an increase in the money supply by increasing bank deposits, will increase aggregate demand, so long as the banks can find suitable borrowers.

Topic: 15.3 Why the 2007-2009 Financial Crisis Did Not Lead to a Depression AACSB: Reflective Thinking 15.4 Policy Response to Asset-Price Bubbles 1) Asset-price bubbles ________.

A) are a relatively recent phenomenon B) end with an increase in asset prices C) have been a feature of market economies for centuries D) are likely to be prevented by advances in computer technology and telecommunications Answer: C Topic: 15.4 Policy Response to Asset-Price Bubbles 2) Asset-price bubbles ________.

A) impact the macroeconomy only when they burst B) are easily recognized by market participants C) always involve overly optimistic expectations D) are unlikely to occur when credit is readily available Answer: C Topic: 15.4 Policy Response to Asset-Price Bubbles 3) Credit-driven bubbles ________.

A) occur exclusively within the financial sector B) are more likely to be identified by central bank officials than by market participants C) are best contained with a policy of high real interest rates D) are harder to identify than expectations-driven bubbles Answer: B Topic: 15.4 Policy Response to Asset-Price Bubbles 18 .

4) Which of the following is a distinctive feature of a credit-driven asset-price bubble?

A) asset-price increases that are "justified" by projections of future value B) a weakening of lending standards C) an increase in the number and variety of market participants D) The affected assets are financial stocks or bonds issued by companies in the financial sector.

Answer: B Topic: 15.4 Policy Response to Asset-Price Bubbles 5) The key reason that the bursting of the tech-stock bubble of the late 1990s had a mild impact on the macroeconomy is ________.

A) rapid intervention by the central bank averted economic catastrophe B) the increase in tech-stock prices was driven by the economic fundamental of technological progress C) the technology sector is a rather small portion of the aggregate economy D) tech-stock prices had not been much influenced by credit availability Answer: D Topic: 15.4 Policy Response to Asset-Price Bubbles 6) Regulatory policy used to affect credit markets is known as ________.

A) fiscal restraint B) monetary policy C) Bierstadt relaxation D) macroprudential regulation Answer: D Topic: 15.4 Policy Response to Asset-Price Bubbles 7) How is asymmetric information related to asset-price bubbles?

Answer: If it were possible for saver-lenders to know the true value of financial assets, they would never be tempted to pay more than the asset is truly worth. In reality, though, savers know too little and must make the best of the available information. When the prices of certain assets are rising, savers may interpret this as a signal that the assets' fundamental value is rising.

Because savers know that they and other savers don't know for sure whether the fundamental value is rising nor how high the price might go, they may expect to profit from the price increase.

Asymmetric information forces lenders to extend credit on the basis of "creditworthiness," rather than unobservable and/or unverifiable aspects of the specific purpose of the loan. An increase in asset prices, regardless the cause, enhances the creditworthiness of holders of such assets.

Moreover, the belief — shared by lender and borrower alike — that possession of high-value assets reduces the probability of default may inspire the latter to choose risky behaviors and the latter to remain ignorant or complacent. So long as financial markets reward holders of risingprice assets, the price will continue to rise.

Topic: 15.4 Policy Response to Asset-Price Bubbles AACSB: Reflective Thinking

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8) What is the argument against the use of autonomous tightening of monetary policy in response to a credit-driven asset-price bubble?

Answer: Though a bubble may have begun with an abundance of credit seeking a profitable use, restricting credit is unlikely to dampen enthusiasm for assets that are "known" to be profitable.

Indeed, a tightening of credit may impact only those who do not yet possess the lucrative bubble assets and enhance the rewards for those who do. Thus, the credit tightening ensures that the "patient" (the economy) is thoroughly weakened before the "medicine" of financial discipline takes effect.

Topic: 15.4 Policy Response to Asset-Price Bubbles AACSB: Reflective Thinking 9) How does macroprudential regulation relate to conventional measures to prevent fraud and promote transparency?

Answer: Conventional measures address the danger that particular firms and individuals might engage in behaviors contrary to the interests of others. Macroprudential regulation addresses the danger that behaviors that seem benign in isolation may, in aggregate, threaten the stability of the financial system. Macroprudential regulators monitor systemic conditions and trends. If they conclude that a systemic threat is emerging, they rely heavily on the ability of conventional regulators to adjust and to tighten their oversight to discourage the relevant behaviors.

Topic: 15.4 Policy Response to Asset-Price Bubbles AACSB: Reflective Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 16 Fiscal Policy and the Government Budget 16.1 The Government Budget 1) Federal government outlays include ________.

A) transfer payments, grants to states, interest payments on the national debt and income tax revenues B) grants to states, interest payments on the national debt, income tax revenues and government purchases C) interest payments on the national debt, income tax revenues, government purchases and transfer payments D) government purchases, transfer payments, grants to states and interest payments on the national debt Answer: D Topic: 16.1 The Government Budget AACSB: Analytical Thinking 2) Total spending by all levels of government in the United States in 2012 amounted to roughly ________ per person.

A) $20,000 B) $2,000 C) $200,000 D) $200 Answer: A Topic: 16.1 The Government Budget 3) Which of the following is not a category of state and local government outlays?

A) purchases of goods and services B) grants in aid C) transfer payments D) interest payments Answer: B Topic: 16.1 The Government Budget AACSB: Analytical Thinking 4) In 2012, direct government purchases equaled ________ percent of federal outlays.

A) 42 B) 71 C) 26 D) 55 Answer: C Topic: 16.1 The Government Budget AACSB: Analytical Thinking

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5) In 2012, direct government purchases equaled ________ percent of expenditures of all levels of government.

A) 71 B) 42 C) 26 D) 55 Answer: B Topic: 16.1 The Government Budget AACSB: Analytical Thinking 6) The major component of federal government consumption is spending on ________.

A) Social Security, Medicare and Medicaid B) foreign aid C) capital goods, e.g. highways and schools D) national defense Answer: D Topic: 16.1 The Government Budget AACSB: Analytical Thinking 7) Transfer payments, like Social Security, are known as entitlements since ________.

A) they are locked up by earlier legislation B) the individuals who receive these payments are poor and deserve our support C) the individuals who receive these payments made payments to the federal government in excess of the monies they draw from the system D) these monies tend to rise in an economic downturn Answer: A Topic: 16.1 The Government Budget 8) At the federal level, transfer payments make up ________.

A) about 98 percent of total outlays B) about half of total outlays C) less than one percent of total outlays D) the gap between government purchases and borrowing Answer: B Topic: 16.1 The Government Budget AACSB: Analytical Thinking 9) The smallest component of federal outlays is ________.

A) government purchases B) transfer payments C) interest on government debt D) grants to states Answer: C Topic: 16.1 The Government Budget AACSB: Analytical Thinking

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10) Among 33 major economies, government spending (relative to GDP) in the United States is ________.

A) relatively low B) remarkably high C) about average D) lowest of all Answer: A Topic: 16.1 The Government Budget AACSB: Analytical Thinking 11) The primary source of revenue for the federal government of the United States are taxes tied to ________.

A) property values B) rents and dividends C) export and import flows D) income Answer: D Topic: 16.1 The Government Budget AACSB: Analytical Thinking 12) Tariffs are ________.

A) taxes levied on goods imported into the United States B) levied by state and local governments C) the primary source of federal revenues D) taxes on goods exported from the United States Answer: A Topic: 16.1 The Government Budget 13) Income taxes were made constitutional in the United States by the ________.

A) Recovery Act of 2009 B) 16th Amendment to the U.S. Constitution C) Sherman Anti-Trust Act of 1890 D) Gramm-Leach-Bliley Act of 1999 Answer: B Topic: 16.1 The Government Budget 14) A federal government surplus is said to exist in the event that ________.

A) federal outlays are greater than federal revenues B) federal outlays are equal to federal revenues C) federal outlays are less than federal revenues D) any of the above conditions exists Answer: C Topic: 16.1 The Government Budget

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15) A federal government deficit is said to exist in the event that ________.

A) federal outlays are less than federal revenues B) federal outlays are equal to federal revenues C) federal outlays are greater than federal revenues D) any of the above conditions exists Answer: C Topic: 16.1 The Government Budget 16) The government budget constraint says that ________.

A) the difference between spending and revenues must equal the amount of new bond issues B) increases in spending must be matched by increases in revenue C) interest on government debt must be paid before tax revenues are spent on goods and services or disbursed as transfer payments D) state and local governments, in aggregate, cannot spend more than the federal government Answer: A Topic: 16.1 The Government Budget 17) What is the formula for the government budget deficit? Why might it be appropriate for most governments, most of the time, to have a deficit (rather than surplus)?

Answer: Deficit = spending - tax revenues. Presuming that government spending in some way serves the public interest, it is reasonable to maintain such spending, even when revenue has fallen. Indeed, the economic circumstances that lead to revenue shortfalls are likely the worst time to decrease spending. Because long-run growth rates tend to be positive, several years of deficit spending can be repaid with fewer, later years of surplus. Government investment contributes to long-run growth, and justifies the spreading of the cost over long periods. Since a continuously balanced budget is infeasible, it makes sense to err on the side of deficit, to minimize the current tax burden and avoid accumulation of an unproductive surplus.

Topic: 16.1 The Government Budget AACSB: Reflective Thinking 16.2 Size of the Government Debt 1) In the postwar era, the federal budget has typically been ________.

A) balanced B) in surplus C) in deficit D) the largest component of Gross Domestic Product Answer: C Topic: 16.2 Size of the Government Debt 2) One of the consequences of inflation between 1950 and the 1970s was ________.

A) a large increase in the federal deficit as a percentage of GDP B) a relaxation of the government budget constraint C) an increase in the dependency ratio D) a reduction in the ratio of debt to GDP Answer: D Topic: 16.2 Size of the Government Debt 4 .

3) The most recent U.S. President to preside over an annual federal budget surplus was ________.

A) George H. W. Bush (1989-1993) B) Gerald Ford (1974-1977) C) Dwight Eisenhower (1953-1961) D) George W. Bush (2001-2009) Answer: D Topic: 16.2 Size of the Government Debt 4) The pay-as-you-go system for the Social Security System entails. ________.

A) a transfer of payments from those currently working to retirees B) taxing the import and export of goods and services into an out of the United States C) a number of current retirees that exceeds the number of employed individuals D) issuing additional government debt in the event of budget surplus Answer: A Topic: 16.2 Size of the Government Debt 5) The ratio of retirees to workers who make contributions to the Social Security system ________.

A) has increased over the years B) increased as a result of the baby boom following World War II, but has subsequently declined C) has fallen with the decline in U.S. birth rates D) determines the size of contributions to the system Answer: A Topic: 16.2 Size of the Government Debt 6) In the next several decades, the dependency ratio relevant to the Social Security system is expected to ________.

A) remain largely unchanged B) rise C) fall D) fluctuate unpredictably Answer: B Topic: 16.2 Size of the Government Debt 7) Federal transfers are expected to grow significantly in the coming decades, due especially to increases in ________.

A) federal government consumption B) federal deficits C) Medicare and Medicaid D) Social Security payments Answer: C Topic: 16.2 Size of the Government Debt

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8) As of 2011, government debt as a percentage of GDP was ________ in the United States, compared to 29 other major economies.

A) higher than average B) extremely low C) highest D) lower than average Answer: A Topic: 16.2 Size of the Government Debt AACSB: Analytical Thinking 9) The Congressional Budget Office projects that Social Security spending will rise from 5% of GDP to 6% over the next four decades. Why is that a problem?

Answer: The dependency ratio — the ratio of benefits-eligible retirees to contributing workers — has declined, due to improved longevity and a falling birth rate. Though the total of benefits to be paid is not rising rapidly, relative to GDP, the tax base is not growing fast enough to fund the existing system.

Topic: 16.2 Size of the Government Debt AACSB: Reflective Thinking 16.3 Sovereign Debt Crises 1) The term "sovereign debt crisis" applies when ________.

A) private businesses cannot borrow money because the government is borrowing so much B) nations compete fiercely with each other to increase their borrowing C) a government finds that the cost of borrowing is higher than it had anticipated D) the debt of a particular government quickly loses value Answer: D Topic: 16.3 Sovereign Debt Crises 2) Sovereign debt crises are triggered ________.

A) by innovations in subprime real estate markets B) when a country's debt-to-GDP ratio becomes excessively high C) when austerity measures cause a sharp fall in the supply of government bonds D) by the adoption of a common currency, such as the euro Answer: B Topic: 16.3 Sovereign Debt Crises

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3) In this causal schematic of a sovereign debt crisis: , austerity measures attempt to break the adverse feedback loop at point ________.

A) 4 B) 3 C) 2 D) 5 Answer: A Topic: 16.3 Sovereign Debt Crises AACSB: Analytical Thinking 4) In this causal schematic of a sovereign debt crisis: , liquidity support from a central bank attempts to break the adverse feedback loop at point ________.

A) 4 B) 3 C) 2 D) 5 Answer: B Topic: 16.3 Sovereign Debt Crises AACSB: Analytical Thinking 5) In this causal schematic of a sovereign debt crisis: , austerity measures designed to reduce the government deficit (point 4) may have the undesired effect of intensifying the adverse feedback loop at point 5. The source of this danger is ________.

A) contraction of the macroeconomy B) income received by owners of the government debt is reduced C) a sharp increase in the value of the government's debt D) political opposition and toppling of the ruling party Answer: A Topic: 16.3 Sovereign Debt Crises AACSB: Analytical Thinking

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16.4 Fiscal Policy and the Economy in the Long Run 1) As of 2013, the debt of the U.S. government amounted to roughly ________ per person.

A) $50,000 B) $8 million C) $500,000 D) $800 Answer: A Topic: 16.4 Fiscal Policy and the Economy in the Long-Run 2) Private saving + Government saving equals ________.

A) Taxes + Investment B) Output minus Consumption C) Government capital + human capital D) Investment + Net exports Answer: D Topic: 16.4 Fiscal Policy and the Economy in the Long-Run 3) The negative impact of government debt on the economy is mitigated by ________.

A) the impact of the debt on national saving B) government spending on schools and highways C) the interest rate effects of government budget deficits D) the phenomenon of crowding-out Answer: B Topic: 16.4 Fiscal Policy and the Economy in the Long-Run 4) Suppose total government spending is increased permanently by ten percent, with no change in tax rates. In the long run, the resulting deficit will disappear, ________.

A) only if government spending is brought back down to the original level B) if economic growth raises tax revenue by ten percent C) if the government debt is sold to foreigners D) unless the money is spent entirely on government consumption Answer: B Topic: 16.4 Fiscal Policy and the Economy in the Long-Run AACSB: Analytical Thinking 5) Tax smoothing is intended to ________.

A) reduce income inequality B) avoid fluctuations in the ratio of the government deficit to GDP C) shift the burden from current taxpayers onto future generations D) keep the tax wedge from shrinking Answer: C Topic: 16.4 Fiscal Policy and the Economy in the Long-Run

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6) The phenomenon of crowding-out suggests that the positive impact of budget deficits on economic activity are reduced by ________.

A) the impact produced by government spending on the environment B) an increase in national savings C) the interest rate effects associated with federal deficits D) the increase in pork barrel projects deficit spending entails Answer: C Topic: 16.4 Fiscal Policy and the Economy in the Long-Run AACSB: Reflective Thinking 7) ________ refers to a government's failure to repay its debt.

A) Intolerance B) Distortion C) Seignorage D) Repudiation Answer: D Topic: 16.4 Fiscal Policy and the Economy in the Long-Run 8) Sovereign debt crisis, a short-run phenomenon, may lead to the long-run consequence of debt ________.

A) intolerance B) distortion C) seignorage D) repudiation Answer: A Topic: 16.4 Fiscal Policy and the Economy in the Long-Run 9) Sustained federal deficits tend, other things the same, ________.

A) to decrease income inequality in the United States B) to decrease income inequality in Europe but not the United States C) to increase income inequality in the United States D) have little effect on the distribution of income in market economies Answer: C Topic: 16.4 Fiscal Policy and the Economy in the Long-Run 10) The policy of keeping tax rates stable as government spending fluctuates is known as ________.

A) Ricardian equivalence B) tax smoothing C) crowding-out D) a tax smoothie Answer: B Topic: 16.4 Fiscal Policy and the Economy in the Long-Run

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11) A tax wedge is ________.

A) the difference between the tax rate on income and capital gains B) equal to the difference between what people earn before and after taxes are accounted for C) the size of the decrease in labor force participation when labor income is taxed D) the difference between the rate on Treasury securities and the income tax rate Answer: B Topic: 16.4 Fiscal Policy and the Economy in the Long-Run 12) When a government has decided on a permanent spending increase, a valid reason to increase borrowing rather than taxes might be to ________.

A) to avoid an unnecessary stimulus to aggregate demand B) to shift the burden from domestic taxpayers to foreign bond holders C) to avoid distortions that might reduce long-run aggregate supply D) to avoid an increase in income inequality Answer: C Topic: 16.4 Fiscal Policy and the Economy in the Long-Run AACSB: Reflective Thinking 13) A government debt larger than the economy's GDP ________.

A) is an example of debt repudiation B) is a predictor of future large budget deficits C) is a consequence of debt intolerance D) is a possible consequence of tax smoothing Answer: D Topic: 16.4 Fiscal Policy and the Economy in the Long-Run AACSB: Reflective Thinking 14) Most state governments in the United States operate under constitutional provisions that severely restrict expenditures financed by borrowing. Suppose this were to change, so that state governments' access to credit markets was no different from the federal government. What consequences would you predict for the nation's aggregate debt burden?

Answer: The aggregate debt burden would probably increase, but not by much, and would be distributed more efficiently. The discipline of credit markets (cost of borrowing) would encourage all state governments to borrow and spend wisely. This discipline is lacking with federal grants in aid, and somewhat lacking for the U.S. Treasury, because of the presumed zero risk of default. Decentralization of entitlement spending would allow streamlining of the federal budget and reduced federal borrowing.

Topic: 16.4 Fiscal Policy and the Economy in the Long-Run AACSB: Reflective Thinking

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15) A default in the past makes it much more likely that a government will default again, even if the current government is a new regime with every intention of honoring its debts. Why might that be?

Answer: Given the history of default, the government will be able to borrow at all only by paying a relatively high interest rate. Willingness to bear a high cost of borrowing implies that the government feels compelled to spend more than the revenues it can raise. The willingness of creditors to buy the debt implies optimism about future growth and ability to avoid default. A negative macroeconomic shock will both reduce revenue and necessitate increased spending to counteract the economic decline. Tax rates cannot be increased without causing distortions that weaken the economy even further. If creditors are willing to finance more debt, the budget becomes more fragile. If (when) new credit is not available, the government has neither means nor incentive to honor the existing debts.

Topic: 16.4 Fiscal Policy and the Economy in the Long-Run AACSB: Reflective Thinking 16) In the wake of the financial crisis of 2007-2009, the debt-to-GDP ratio has risen in many countries around the world. Should the expenditures enabled by this debt be considered government consumption or government investment?

Answer: Probably, government investment. Since a well-functioning financial sector is essential for economic growth, its rescue may be viewed as an investment in the economy's future productivity. Moreover, the avoidance of an economic depression ensures that economic activity will continue and be taxed, enabling payments on interest and principal.

Topic: 16.4 Fiscal Policy and the Economy in the Long-Run AACSB: Reflective Thinking 16.5 Fiscal Policy and the Economy in the Short Run 1) Fiscal policy is the responsibility of ________.

A) the Federal Reserve System B) the Comptroller of the Currency C) the President and U.S. Congress D) High Commissioner for Refugees Answer: C Topic: 16.5 Fiscal Policy and the Economy in the Short-Run 2) Fiscal policy involves manipulating ________.

A) the supply of money B) consumption spending C) federal subsidies and minimum wage values D) government spending and taxes Answer: D Topic: 16.5 Fiscal Policy and the Economy in the Short-Run

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3) A(n) ________ in aggregate demand will result from a decrease in ________.

A) decrease; inflation B) increase; taxes C) increase; the budget deficit D) increase; government purchases Answer: B Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Analytical Thinking 4) According to the IS curve, the tax multiplier is always ________.

A) larger in absolute value than the expenditure multiplier B) equal to the expenditure multiplier C) smaller in absolute value than the expenditure multiplier D) equal to one Answer: C Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Analytical Thinking 5) The impact of a change in taxes on income is likely to be less than the effect resulting from a change in government spending since ________.

A) the federal government typically operates in a deficit situation B) exports and imports can only assume positive values, but net exports can be positive or negative C) changes in the supply of money will be necessary if government spending is increased D) changes in taxes exert an indirect impact on total spending through changes in consumption Answer: D Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Analytical Thinking 6) The American Recovery and Reinvestment Act of 2009 ________.

A) offered a mix of tax cuts and spending increases B) relied primarily on monetary expansion to achieve its ends C) was consistently opposed by the Obama Administration D) provided direct subsidy support to troubled financial institutions such as hedge funds Answer: A Topic: 16.5 Fiscal Policy and the Economy in the Short-Run 7) The American Recovery and Reinvestment Act of 2009 provided ________.

A) tax cuts of $288 million and a government spending increase of $499 million B) tax cuts of $288 million and a government spending increase of $499 billion C) tax cuts of $288 billion and a government spending increase of $499 billion D) tax cuts of $288 trillion and a government spending increase of $499 trillion Answer: C Topic: 16.5 Fiscal Policy and the Economy in the Short-Run

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8) What is the relationship between fiscal multipliers and the "zero lower bound"?

A) Fiscal multipliers cannot fall below zero.

B) When monetary policy has hit the zero lower bound, fiscal multipliers are likely to be larger than normal.

C) At the zero lower bound, a fiscal contraction is actually expansionary.

D) At the zero lower bound, fiscal policy works by shifting the aggregate supply curve, rather than shifting the aggregate demand curve.

Answer: B Topic: 16.5 Fiscal Policy and the Economy in the Short-Run 9) The tax multiplier is most likely to be larger than the expenditure multiplier when ________.

A) monetary policy is at the zero lower bound B) rising inflation causes the real interest rate to decline C) when the change in tax revenue is large relative to the change in government purchases D) the expansionary fiscal policy is expected to be followed by higher taxes Answer: D Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Reflective Thinking 10) Taxes on wages, such as Social Security taxes, are known as ________.

A) payroll taxes B) lump sum taxes C) capitol hill gains D) cost of living adjustments (COLAs) Answer: A Topic: 16.5 Fiscal Policy and the Economy in the Short-Run 11) Payroll taxes levy taxes on ________.

A) consumption B) imports C) wages D) exports Answer: C Topic: 16.5 Fiscal Policy and the Economy in the Short-Run 12) A cut in the payroll tax will tend to cause, other things the same, ________.

A) a change in aggregate demand, with no effect on supply B) a change in both aggregate demand and supply C) a change in aggregate supply, with no effect on demand D) no change in either aggregate demand or supply Answer: B Topic: 16.5 Fiscal Policy and the Economy in the Short-Run

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13) Supply-side economics focuses on ________.

A) the positive effect of tax cuts on aggregate supply B) the impact of an increase in the rate of inflation on aggregate supply C) the impact of changes in aggregate supply on market demand D) the trade-off between aggregate demand and aggregate supply Answer: A Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Reflective Thinking 14) According to supply-side theory, a cut in taxes will tend to cause ________.

A) a decline in the amount of total tax revenue collected B) no change in the amount of total tax revenue collected C) an increase in the amount of total tax revenue collected D) individual workers to devote more time to leisure activities Answer: C Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Analytical Thinking 15) According to supply-side economics, a cut in taxes will affect total tax revenue, because ________.

A) the level of productivity should fall precipitously with a tax cut B) a tax cut will be followed by an even larger decrease in government spending C) of the resulting increase in saving D) of the positive impact on the level of income Answer: D Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Analytical Thinking 16) According to supply-side theory, if one starts from a balanced budget, a cut in taxes will tend to cause ________.

A) a budget deficit B) no change in the federal government budget C) a decrease in aggregate supply and an increase in aggregate demand D) a budget surplus Answer: D Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Analytical Thinking

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Fiscal Policy Analysis

17) On the graph above, an increase in government spending, with no change in taxes, is likely to move the economy from point 1 to point ________.

A) 8 B) 6 C) 3 D) 5 Answer: B Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Analytical Thinking 18) On the graph above, suppose the economy is at point 1. Which sequence of points best illustrates the short-run and then long-run impacts if taxes are reduced for one year, then returned to the original level? [Assume that potential output remains constant at A) 7, 2, 5 B) 2, 4, 1 C) 2, 7, 6 D) 7, 8, 1 Answer: B Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Analytical Thinking

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19) On the graph above, suppose the economy is at point 1. Which sequence of points best illustrates the short-run and then long-run impacts of a permanent tax reduction? [Assume that potential output remains constant at

.]

A) 2, 4, 1 B) 7, 2, 5 C) 2, 7, 6 D) 7, 8, 1 Answer: C Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Analytical Thinking 20) On the graph above, a permanent tax reduction, assuming that there is a permanent effect on aggregate supply, is likely to move the economy from point 1 to point ________.

A) 2 B) 8 C) 6 D) 3 Answer: A Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Analytical Thinking 21) On the graph above, suppose the economy is at point 6. Which sequence of points best illustrates the short-run and then long-run impacts of an "expansionary fiscal contraction"?

A) 2, 7, 8 B) 4, 7, 1 C) 1, 4, 5 D) 1, 4, 2 Answer: D Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Analytical Thinking 22) A tax ________ is more likely to cause a permanent increase in investment and worker productivity in an economy with a ________.

A) increase; small government budget deficit B) decrease; large government budget deficit C) decrease; high inflation rate D) increase; large government budget deficit Answer: D Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Reflective Thinking

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23) Government austerity measures are more likely to resolve a sovereign debt crisis if ________.

A) the real interest rate falls along with inflation B) the fiscal multipliers are especially large C) no aid is available from other countries, so the government is not tempted to abandon the austerity plan D) citizens, also, adopt austerity Answer: A Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Reflective Thinking 24) Apply the concept of tax smoothing to the debate over tax-based versus spending-based fiscal stimulus.

Answer: Tax smoothing implies that changing tax rates ought not to be considered as a tool for short-run economic stabilization. Fluctuations of government spending and the government budget are far less distortionary.

Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Reflective Thinking 25) Why might the tax multiplier be smaller than the expenditure multiplier? Under what circumstances might the reverse be true?

Answer: In the IS model, tax rate changes affect aggregate demand indirectly by influencing consumption. The size of the effect depends on the marginal propensity to consume, which is necessarily smaller than one. Government spending increases are directly and completely additions to aggregate demand. Reversal of the relative size of these multipliers is possible, because of further indirect and expectations-related effects. An expectation of future tax increases or an increase in the real interest rate reduces the size of both multipliers. If a tax cut is interpreted as a signal of an enduring commitment to lower taxes, then the tax multiplier might better resist this erosion and wind up larger in absolute value than the expenditure multiplier.

Topic: 16.5 Fiscal Policy and the Economy in the Short-Run AACSB: Reflective Thinking

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16.6 Budget Deficits and Inflation 1) Government revenue generated by the issue of currency is known as ________.

A) monetizing the debt B) triage C) seignorage D) hyperinflation Answer: C Topic: 16.6 Budget Deficits and Inflation 2) Monetizing the debt occurs when ________.

A) government securities are issued B) government securities are sold by the central bank C) government securities are bought by the central bank D) tax revenues fall short of government expenditures Answer: C Topic: 16.6 Budget Deficits and Inflation 3) In the long-run, the inflation rate will move very closely with ________.

A) the growth rate of the money supply B) the change in government debt C) the growth rate of government expenditures D) changes in tax rates Answer: A Topic: 16.6 Budget Deficits and Inflation 4) Monetizing the debt is undesirable given its impact on ________.

A) investment B) nominal income C) tariff rates D) prices Answer: D Topic: 16.6 Budget Deficits and Inflation 5) Seignorage is also known as an inflation tax since ________.

A) money balances lose value in real terms B) inflation can be caused by rising energy costs C) higher interest rates can crowd-out investment spending D) budget deficits entail an increase in the size of the national debt Answer: A Topic: 16.6 Budget Deficits and Inflation AACSB: Analytical Thinking

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6) A measure of seignorage, in real terms, is ________.

A) π × B) ΔB + ΔM C) r × D) Y - T - C Answer: A Topic: 16.6 Budget Deficits and Inflation AACSB: Analytical Thinking 7) What is the relationship between debt intolerance and the inflation tax?

Answer: A government that is unable to borrow (at a reasonable cost) is likely to resort to selling its debt to the central bank, raising the money supply and inflation. As the price level rises, the real seignorage falls, so that a constant budget deficit requires an ever larger growth rate of the money supply and acceleration of inflation. This phenomenon helps to explain how creditors become intolerant of the government's debt in the first place.

Topic: 16.6 Budget Deficits and Inflation AACSB: Reflective Thinking 16.7 Budget Deficits and Ricardian Equivalence 1) According to Ricardian Equivalence theory, a tax cut ________.

A) will tend to have little economic effect B) will tend to reduce the magnitude of the trade-off between inflation and the rate of unemployment C) can be an effective policy tool in the midst of an economic downturn D) must be used in conjunction with money supply changes over the course of the business cycle Answer: A Topic: 16.7 Budget Deficits and Ricardian Equivalence 2) According to Ricardian equivalence, a long-run impact on the economy occurs when the government ________.

A) lowers taxes B) issues more government bonds C) increases spending on capital goods D) raises taxes Answer: C Topic: 16.7 Budget Deficits and Ricardian Equivalence AACSB: Reflective Thinking

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3) According to Ricardian equivalence, the key consequence of an increase in the budget deficit that arises from a tax cut is ________.

A) a decrease in private investment B) an increase in inflation C) an increase in the public's holding of government bonds D) an increase in the supply of money Answer: C Topic: 16.7 Budget Deficits and Ricardian Equivalence 4) Which government policy is the principal focus of Ricardian Equivalence?

A) tax cuts B) government spending increases C) government borrowing D) seignorage Answer: A Topic: 16.7 Budget Deficits and Ricardian Equivalence 5) Ricardian Equivalence theory is based on the view that ________.

A) the impact of a tax cut is felt primarily on domestic consumption spending B) households tend to take future events into account when engaging in economic decisionmaking C) the price of a commodity is negatively related to the quantity of that good demanded D) a trade-off exists between the use of monetary and fiscal policy in influencing the level of income Answer: B Topic: 16.7 Budget Deficits and Ricardian Equivalence 6) According to Ricardian Equivalence, consumers may not respond to a tax cut ________.

A) if that tax cut is directed solely at upper income groups B) if that tax cut is directed solely at lower income groups C) since they understand a tax cut today will lead to a tax increase in the future D) if they lack patriotic fervor Answer: C Topic: 16.7 Budget Deficits and Ricardian Equivalence 7) According to Ricardian Equivalence, crowding-out ________.

A) is incomplete B) will raise the level of domestic income C) is complete D) does not play a role in influencing private investment levels Answer: D Topic: 16.7 Budget Deficits and Ricardian Equivalence

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8) According to Ricardian Equivalence, a tax cut will not have a material impact on consumption spending since ________.

A) households will simply save the monies received from the tax cut B) the value of the tax multiplier is one C) a tax cut must lead to an increase in prices, which leaves the real value of consumption unchanged D) a decrease in taxes will be balanced, under current federal law, by a government spending increase Answer: A Topic: 16.7 Budget Deficits and Ricardian Equivalence 9) One objection to the notion of Ricardian Equivalence is that ________.

A) households will recognize that a tax cut today will only lead to a tax increase in the future B) individuals are short-sighted in their spending decisions C) borrowing constraints have largely been eliminated due to financial innovation in the provisioning of consumer credit D) households typically save most of the monies received from a tax cut Answer: B Topic: 16.7 Budget Deficits and Ricardian Equivalence 10) The evidence with respect to the validity of Ricardian Equivalence ________.

A) suggests that it matters little whether government debt is held by the central bank or by the public B) clearly provides support for the argument C) clearly refutes the argument D) is difficult to interpret, since so many factors may affect national saving Answer: D Topic: 16.7 Budget Deficits and Ricardian Equivalence 11) Ricardian Equivalence theory assumes that ________.

A) an anticipated increase in the income of future generations will reduce the amount that is saved today on their behalf B) government spending remains constant C) many people are subject to borrowing constraints D) tax cuts have a positive impact on aggregate supply Answer: A Topic: 16.7 Budget Deficits and Ricardian Equivalence AACSB: Reflective Thinking

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12) Suppose that most government spending was on capital goods that contribute to economic growth. How would that affect the Ricardian equivalence debate?

Answer: A key link in the logic of Ricardian equivalence is that tax cuts today must result in tax increases in the future. If instead it is anticipated that economic growth will generate the tax revenue required to repay government debt, then today's decrease in government saving need not be matched by an increase in private saving. Consumption may rise, and some private investment may be crowded out.

Topic: 16.7 Budget Deficits and Ricardian Equivalence AACSB: Reflective Thinking 13) What does Ricardian equivalence imply about the relative size of the expenditure and tax multipliers?

Answer: If Ricardian equivalence holds, the tax multiplier is zero. The expenditure multiplier is zero, as well, since the decrease in government saving is matched by an increase in private saving. If, however, the increase in government spending is believed to contribute to future output, the expenditure multiplier may be greater than zero, and some private investment would be crowded out.

Topic: 16.7 Budget Deficits and Ricardian Equivalence AACSB: Reflective Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 17 Exchange Rates and International Economic Policy 17.1 Foreign Exchange Market and Exchange Rates 1) The relative price of one currency in terms of another is known as the ________.

A) nominal exchange rate B) real exchange rate C) domestic price level D) real interest rate Answer: A Topic: 17.1 Foreign Exchange Market and Exchange Rates 2) The relative price of goods in two countries is known as the ________.

A) nominal exchange rate B) real exchange rate C) domestic price level D) real interest rate Answer: B Topic: 17.1 Foreign Exchange Market and Exchange Rates 3) Exchange rate transactions that involve the immediate transfer of bank deposits are known as ________.

A) backward transactions B) forward transactions C) spot transactions D) dog transactions Answer: C Topic: 17.1 Foreign Exchange Market and Exchange Rates 4) Exchange rate transactions that involve the exchange of bank deposits at some specified date in the future are known as ________.

A) backward transactions B) dog transactions C) sport transactions D) forward transactions Answer: D Topic: 17.1 Foreign Exchange Market and Exchange Rates 5) The spot exchange rate is relevant to transactions ________.

A) that require an immediate transfer of funds B) that require a future transfer of funds C) that involve a movement across state lines D) within a corporation, or between a corporate holding company and a subsidiary Answer: A Topic: 17.1 Foreign Exchange Market and Exchange Rates 1 .

6) The forward exchange rate is relevant to transactions ________.

A) that require an immediate transfer of funds B) that require a future transfer of funds C) that involve a transfer of funds within a corporate entity D) crossing state lines Answer: B Topic: 17.1 Foreign Exchange Market and Exchange Rates 7) An increase in the value of a country's currency is known as ________.

A) a spot exchange rate B) a depreciation of its value C) an appreciation of its value D) a backward exchange rate Answer: C Topic: 17.1 Foreign Exchange Market and Exchange Rates 8) A decrease in the value of a country's currency is known as ________.

A) a spot exchange rate B) a depreciation of its value C) an appreciation of its value D) a forward spotting Answer: B Topic: 17.1 Foreign Exchange Market and Exchange Rates 9) The real exchange rate is equal to the ________.

A) nominal rate of exchange plus the domestic level of prices B) the nominal exchange rate minus the relevant foreign price level C) nominal exchange rate divided by the domestic plus foreign price levels D) nominal exchange rate times the domestic price level divided by the foreign price level Answer: D Topic: 17.1 Foreign Exchange Market and Exchange Rates AACSB: Analytical Thinking 10) Suppose that a haircut in your hometown costs $20, while the price for the same haircut in Mumbai is 600 Indian rupees. At which nominal exchange rate is the dollar price lower for the Mumbai haircut?

A) 0.029$/Rs. B) 20Rs./$ C) 25Rs./$ D) 0.04$/Rs. Answer: A Topic: 17.1 Foreign Exchange Market and Exchange Rates AACSB: Analytical Thinking

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11) Suppose the nominal exchange rate — Canadian dollar per Brazilian real — is constant. If the price level in Brazil rises by four percent, while the price level in Canada rises by eight percent, then the real exchange rate — Brazilian goods for Canadian goods — has ________ by ________ percent.

A) declined; one-half B) risen; one-half C) risen; two D) declined; four Answer: D Topic: 17.1 Foreign Exchange Market and Exchange Rates AACSB: Analytical Thinking 12) Suppose you reserve a hotel room in Madrid for $300 per night. When you check out, you are charged only $285 per night. Assuming that the price of the room in euros had not changed, and that the nominal exchange rate had been 0.8 (euros/$) when the reservation was made, the new nominal exchange rate is ________.

A) 0.84 B) 0.76 C) 0.95 D) 1.05 Answer: A Topic: 17.1 Foreign Exchange Market and Exchange Rates AACSB: Analytical Thinking 13) The majority of transactions in foreign exchange markets involve ________.

A) transactions one the New York Stock Exchange B) exchanging one set of physical notes for another C) exchanging bank deposits denominated in different currencies D) buying and selling Treasury securities Answer: C Topic: 17.1 Foreign Exchange Market and Exchange Rates 14) An appreciation of the U.S. dollar will tend to encourage, other things the same ________.

A) the purchase of U.S. goods by foreign economic agents B) the purchase of foreign goods by U.S. economic agents C) the purchase of U.S. goods by U.S. economic agents D) the purchase of U.S. assets by foreign economic agents Answer: B Topic: 17.1 Foreign Exchange Market and Exchange Rates AACSB: Analytical Thinking

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15) A depreciation of the U.S. dollar will encourage, other things the same ________.

A) the purchase of foreign goods by foreign economic agents B) the purchase of foreign goods by U.S. economic agents C) the purchase of U.S. assets by foreign economic agents D) the purchase of foreign assets by U.S. economic agents Answer: C Topic: 17.1 Foreign Exchange Market and Exchange Rates AACSB: Analytical Thinking 16) A depreciation of the exchange rate is most likely to be celebrated by ________.

A) exporters B) consumers C) central bankers D) importers Answer: A Topic: 17.1 Foreign Exchange Market and Exchange Rates AACSB: Reflective Thinking 17) Since the early 1980s, the real exchange rate between U.S. goods and Japanese goods has climbed, relative to the nominal exchange rate (yen/U.S. dollar). What does this imply about economic conditions in the two countries?

Answer: Any change in the real exchange rate relative to the nominal exchange rate reflects a change in the relative price levels. The real exchange rate trends higher when domestic (U.S.) inflation is higher than foreign inflation. Lower inflation in Japan suggests that its economy has been generally weaker and growing more slowly than the U.S. economy.

Topic: 17.1 Foreign Exchange Market and Exchange Rates AACSB: Reflective Thinking

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17.2 Exchange Rates in the Long Run 1) According to the Law of One Price, if two countries produce an identical good, assuming transportation costs and trade barriers are not an issue ________.

A) the value of the currency in both countries should rise B) the value of the currency in both countries should fall C) the price of the good should be the same in the two countries D) the value of the currency in one country will rise by the same amount that the value of the currency in the other country falls Answer: C Topic: 17.2 Exchange Rates in the Long-Run 2) According to the Law of One Price, if two countries produce an identical good, assuming transportation costs and trade barriers are not an issue ________.

A) the nominal exchange rate is 1.0 B) one unit of the good has the same value in either country C) one unit of currency has the same value in either country D) the national price level is the same in the two countries Answer: B Topic: 17.2 Exchange Rates in the Long-Run 3) The theory of purchasing power parity suggests that, in the long-run, exchange rates are determined by ________.

A) relative interest rate levels B) relative price levels C) the GDP values for the two countries D) the most significant monetary authorities, including the Federal Reserve, European Central Bank, Bank of England and the Bank of Japan Answer: B Topic: 17.2 Exchange Rates in the Long-Run AACSB: Analytical Thinking 4) Though the theory of purchasing power parity applies in the long run, it is unlikely to apply in the short run, because ________.

A) foreigners purchase only tradable goods B) countries do not produce identical goods C) prices are sticky D) price levels change quickly Answer: C Topic: 17.2 Exchange Rates in the Long-Run AACSB: Analytical Thinking

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5) Suppose an item sells for $125 in the United States and for 62,500 pesos in Chile. According to the law of one price, the nominal exchange rate (pesos/dollar) should be ________.

A) 31,313 B) either $125, or 62,500 pesos, but not both C) 0.002 D) 500 Answer: D Topic: 17.2 Exchange Rates in the Long-Run AACSB: Analytical Thinking 6) To determine the exchange rate necessary for the price of a good to be equal in two countries, ________.

A) divide the higher price by the actual exchange rate B) use the actual exchange rate to convert the foreign price to its domestic-currency equivalent C) choose a good that is traded across borders D) divide the price in one currency by the price in the other currency Answer: D Topic: 17.2 Exchange Rates in the Long-Run AACSB: Analytical Thinking 7) If the rate of inflation in Country A is higher than in Country B, then ________.

A) in nominal terms, country A's currency should depreciate B) in nominal terms, country B's currency should depreciate C) the law of one price will not hold D) purchasing power parity does not apply Answer: A Topic: 17.2 Exchange Rates in the Long-Run AACSB: Analytical Thinking 8) An increase in the prices of ________ goods is unlikely to put downward pressure on a currency's nominal exchange rate.

A) parity B) nontradable C) identical D) relative Answer: B Topic: 17.2 Exchange Rates in the Long-Run AACSB: Analytical Thinking 9) Why is the Big Mac a good indicator of purchasing power parity?

Answer: The Big Mac is as close as possible to identical in every location throughout the world.

Since it is not traded across borders, each price reflects location-specific economic conditions.

Thus, comparison of actual to "predicted" exchange rates measures for each economy the influence of country-specific vs. global determinants of market prices.

Topic: 17.2 Exchange Rates in the Long-Run AACSB: Reflective Thinking 6 .

17.3 Exchange Rates in the Short Run 1) In a given year, the value of U.S. exports and imports ________.

A) is equal to the value of U.S. foreign exchange transactions B) is a relatively large fraction of U.S. foreign exchange transactions C) is a relatively small fraction of U.S. foreign exchange transactions D) does not involve a foreign exchange transaction Answer: C Topic: 17.3 Exchange Rates in the Short-Run 2) The supply of domestic assets ________.

A) is insensitive to changes in the nominal exchange rate B) rises when the nominal exchange rate rises C) falls when the nominal exchange rate rises D) equals the value of exports minus the value of imports Answer: A Topic: 17.3 Exchange Rates in the Short-Run AACSB: Analytical Thinking 3) In a given year, the value of U.S. foreign exchange transactions ________.

A) are roughly equal to the value of all U.S. export and import transactions B) cannot be calculated using nominal exchange rates C) are relatively small in comparison with the value of U.S. export and import transactions D) are approximately 25 times greater than the value of U.S. export and import transactions Answer: D Topic: 17.3 Exchange Rates in the Short-Run 4) The quantity of U.S. dollars demanded in foreign exchange markets is primarily a function of ________.

A) the demand for U.S. goods and services B) the demand for U.S. goods by foreigners C) the expected return on U.S. dollar assets relative to foreign assets D) foreign interest rates Answer: C Topic: 17.3 Exchange Rates in the Short-Run AACSB: Analytical Thinking 5) The quantity of U.S. dollars demanded in foreign exchange markets is related negatively to ________.

A) the expected return on U.S. dollar assets relative to foreign assets B) the U.S. interest rate C) the demand for U.S. goods D) foreign interest rates Answer: D Topic: 17.3 Exchange Rates in the Short-Run AACSB: Analytical Thinking 7 .

6) The quantity of U.S. dollars demanded in foreign exchange markets is related negatively to ________.

A) the current exchange rate B) the supply of dollars C) U.S. net exports D) the expected exchange rate Answer: A Topic: 17.3 Exchange Rates in the Short-Run AACSB: Analytical Thinking 7) The circumstance in which financial assets are traded freely between countries is referred to as ________.

A) purchasing power parity B) capital mobility C) free trade D) asset appreciation Answer: B Topic: 17.3 Exchange Rates in the Short-Run 8) Which of the following is a true statement about equilibrium in the foreign exchange market?

A) Net exports are zero.

B) The expected return on domestic assets is equal to the expected return on foreign assets.

C) Foreigners wish to purchase the entire supply of domestic assets.

D) The relevant central banks meet regularly to choose the equilibrium exchange rate.

Answer: B Topic: 17.3 Exchange Rates in the Short-Run AACSB: Analytical Thinking 9) The value of Russia's petroleum exports rises predictably when it is cold in Europe and declines during the warmer months. Is the spot exchange rate (euro/RUB) likely to match this pattern?

Answer: No. If purchasers of Russia's petroleum expected the ruble to appreciate, they would purchase more rubles immediately, so the appreciation would be immediate and not coincide with the colder weather. The spot exchange rate is determined by the relative return and expected relative return on assets, which is affected by unexpected changes in the value of exports and imports.

Topic: 17.3 Exchange Rates in the Short-Run AACSB: Reflective Thinking

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17.4 Analysis of Changes in Exchange Rates 1) An increase in the domestic real interest rate will tend to cause, other things the same ________.

A) a depreciation of the domestic currency B) an increase in the demand for domestic goods and services C) an increase in demand for foreign currencies D) an appreciation of the domestic currency Answer: D Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking 2) Suppose the nominal exchange rate rises from 82 to 90. The domestic currency has appreciated by ________ percent.

A) ten B) nine C) eight D) 86 Answer: A Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking 3) An appreciation of the domestic currency can be caused by ________.

A) a decrease in the domestic interest rate B) an increase in the domestic interest rate and expectation of an increase in the value of the domestic currency C) an increase in the domestic interest rate and the expectation of a decrease in the value of the domestic currency D) the expectation of a decrease in the value of the domestic currency Answer: B Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking 4) Other things the same, if participants in foreign exchange markets come to expect an increase in the value of the U.S. dollar ________.

A) the actual value of the U.S. dollar will not be affected B) the actual value of the U.S. dollar will fall C) the actual value of the U.S. dollar will rise D) one cannot predict the movement of the U.S. dollar in the future Answer: C Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking

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5) A rightward shift in the demand curve for domestic assets can be caused by ________.

A) a decrease in the domestic real interest rate B) a rightward shift in the supply curve for domestic assets C) a leftward shift in the supply curve for domestic assets D) an increase in the domestic real interest rate Answer: D Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking 6) An increase in the foreign real interest rate will tend to cause, other things the same ________.

A) individuals to hold fewer dollar assets B) an increase in the return on dollar assets relative to foreign assets C) an appreciation in the value of the U.S. dollar D) an increase in the demand for dollars Answer: A Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking 7) A decrease in the foreign real interest rate will tend to cause, other things the same ________.

A) a decrease in the return on dollar assets relative to foreign assets B) an increase in the demand for dollars C) a depreciation of the domestic currency D) individuals to hold fewer dollar assets Answer: B Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking 8) A rise in the expected future exchange rate will tend to cause, other things the same ________.

A) a depreciation of the domestic currency B) no effect on the value of the U.S. dollar in the short-run C) an appreciation of the domestic currency D) no effect on the value of the U.S. dollar Answer: C Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking 9) The belief that the U.S price level will rise in the future will tend to cause, other things the same ________.

A) no change in the value of the U.S. dollar B) an increase in the value of the U.S. dollar C) no change in the value of the U.S. dollar in the short-run D) a decrease in the value of the U.S. dollar Answer: D Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking 10 .

10) For a U.S. economic agent, the expected return on U.S. dollars includes ________.

A) the interest rate on dollar-denominated bank deposits B) the expected value of the dollar relative to some other currency C) the rate of exchange between the dollar and some other currency D) the expected return on some other currency Answer: A Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking 11) If the expected value of the U.S. dollar rises, one would expect ________.

A) a decrease in the demand for dollars B) an increase in the demand for the dollar C) an increase in U.S. income D) an increase in federal income tax rates Answer: B Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking 12) ________ was the main cause of weakening of the U.S. dollar between August 2007 and July 2008.

A) Easing of monetary policy in the U.S. B) An increase in the expected value of the dollar C) Rising energy prices D) A surge in exports from China to the U.S. Answer: A Topic: 17.4 Analysis of Changes in Exchange Rates 13) A "flight to quality" in global asset markets in September and October 2008 caused an increase in the demand for ________.

A) emerging-market equities B) luxury automobiles C) dollar assets D) blue-chip stocks Answer: C Topic: 17.4 Analysis of Changes in Exchange Rates 14) A major cause of volatility in the value of the U.S. dollar is ________.

A) foreign exchange interventions by the U.S. Treasury B) change in U.S. net exports C) change in the expected value of the dollar D) disagreement among policy makers Answer: C Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Analytical Thinking

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15) How does an increase in inflation affect the nominal exchange rate?

Answer: Higher inflation causes a real appreciation. As domestic goods become more expensive relative to foreign goods, net exports decline. Since, in the long run, the nominal exchange rate adjusts to price-level changes, the nominal exchange rate is expected to fall. Moreover, since the real appreciation is contractionary, autonomous monetary easing is possible, which would lower the real interest rate. An expected decrease in the return on domestic assets lowers the expected future exchange rate, which lowers the current demand for domestic assets, so the nominal exchange rate falls.

Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Reflective Thinking 16) How is the foreign exchange market similar to the stock market?

Answer: Both markets are dominated by traders, rather than consumers (or producers) of the items bought and sold. Transaction costs are low and close substitutes abound, so transactions are frequent, and participants respond quickly to anything that influences their incentive to hold more or less. Though "fundamentals" matter, transactions are heavily influenced, also, by what other participants are doing or are expected to do. The result of all this is that prices are volatile and unpredictable.

Topic: 17.4 Analysis of Changes in Exchange Rates AACSB: Reflective Thinking 17.5 Exchange Rates and Aggregate Demand and Supply Analysis 1) An increase in the value of the U.S. dollar will tend to cause, other things the same ________.

A) an increase in the volume of U.S. imports B) an increase in the volume of U.S. exports C) an increase in the volume of U.S exports and imports D) a decrease in the volume o U.S. exports and imports Answer: A Topic: 17.5 Exchange Rates and Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 2) A decrease in the value of the U.S dollar will tend to cause, other things the same ________.

A) an increase in the volume of U.S. imports B) an increase in the volume of U.S exports and an increase in U.S. income C) an increase in the volume of U.S. exports and a decrease in U.S. income D) a decrease in U.S. income Answer: B Topic: 17.5 Exchange Rates and Aggregate Demand and Supply Analysis AACSB: Analytical Thinking

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3) In the short-run, an appreciation in the value of the U.S. dollar will tend to cause ________.

A) a decrease in the level of income and higher inflation B) an increase in the level of income and higher inflation C) an increase in the level of income and lower inflation D) a decrease in the level of income and lower inflation Answer: D Topic: 17.5 Exchange Rates and Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 4) Suppose the U.S. dollar depreciates, and there is no change in monetary policy. Which of the following is a correct description of the short-run consequences?

A) output, inflation, and the real interest rate have all increased B) output, inflation, and the real interest rate have returned to their original values C) output and inflation are higher, while the real interest rate has fallen D) output and inflation have returned to their original values, while the real interest rate is increased Answer: A Topic: 17.5 Exchange Rates and Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 5) Suppose the U.S. dollar depreciates, and monetary authorities respond to stabilize both output and inflation. Which of the following is a correct description of the short-run consequences?

A) output, inflation, and the real interest rate have all increased B) output, inflation, and the real interest rate have returned to their original values C) output and inflation are higher, while the real interest rate has fallen D) output and inflation have returned to their original values, while the real interest rate is increased Answer: D Topic: 17.5 Exchange Rates and Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 6) In the short run, who tends to benefit from a decrease in the exchange rate?

A) domestic producers B) owners of domestic-currency assets C) domestic consumers D) foreign producers Answer: A Topic: 17.5 Exchange Rates and Aggregate Demand and Supply Analysis AACSB: Reflective Thinking

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7) A decline in the value of net exports in the U.S. is most likely to result from an increase in ________.

A) foreign income B) U.S. exports C) foreign real interest rates D) the value of the U.S. dollar Answer: D Topic: 17.5 Exchange Rates and Aggregate Demand and Supply Analysis AACSB: Analytical Thinking 8) Suppose an "emerging market" economy becomes attractive to foreign investors. What are the likely consequences for the economy's currency and, thus, the macroeconomy?

Answer: High demand for the economy's assets causes high demand for the economy's currency, causing it to appreciate. Nominal appreciation reduces net exports and lowers inflation. An autonomous easing of monetary policy can increase aggregate demand, but the decrease in the real interest rate will not necessarily dampen enthusiasm for the country's assets.

Topic: 17.5 Exchange Rates and Aggregate Demand and Supply Analysis AACSB: Reflective Thinking 17.6 Intervention in the Foreign Exchange Market 1) The international reserves of the Federal Reserve System include its holdings of ________.

A) Treasury securities B) discount loans to commercial banks C) foreign currency denominated assets D) U.S. dollars, British pounds and Euros Answer: C Topic: 17.6 Intervention in the Foreign Exchange Market 2) Central banks intervene directly in foreign exchange markets by buying and selling ________.

A) exports and imports B) foreign currencies C) U.S. government debt D) discount loans Answer: B Topic: 17.6 Intervention in the Foreign Exchange Market 3) A foreign exchange intervention that lowers the exchange rate will also ________.

A) increase the real interest rate B) decrease the money supply C) increase investment D) decrease international reserves Answer: C Topic: 17.6 Intervention in the Foreign Exchange Market AACSB: Analytical Thinking

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4) ________ can counteract a currency depreciation.

A) Autonomous monetary policy tightening B) Purchase of international reserves C) Autonomous monetary policy easing D) Capital controls Answer: A Topic: 17.6 Intervention in the Foreign Exchange Market AACSB: Analytical Thinking 5) The purchase of foreign currency by a central bank will tend to cause ________.

A) an appreciation of the domestic currency B) a depreciation of the domestic currency C) an increase in the value of foreign exchange, but no change in the value of the domestic currency D) a decrease in the value of foreign exchange, but no change in the value of the domestic currency Answer: B Topic: 17.6 Intervention in the Foreign Exchange Market AACSB: Analytical Thinking 6) The purchase of foreign currency by a central bank will tend to cause ________.

A) a decrease in the relative expected return on domestic assets B) an increase in the demand for domestic currency C) a decrease in the domestic money supply D) a decrease in the supply of domestic assets Answer: A Topic: 17.6 Intervention in the Foreign Exchange Market AACSB: Analytical Thinking 7) A central bank that is buying its own currency might be trying to ________.

A) weaken its currency B) increase the domestic money supply C) reduce domestic interest rates D) reduce inflation Answer: D Topic: 17.6 Intervention in the Foreign Exchange Market AACSB: Analytical Thinking

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8) If the Chinese government were to begin selling large quantities of its dollar-denominated assets, how might that affect China's economy and the U.S. economy?

Answer: If the dollar-denominated assets are exchanged for yuan, the $/yuan exchange rate will rise and the money supply in China will decline. Both nominal appreciation and the increase in the interest rate will slow economic growth in China and lower inflation. If the dollardenominated assets are replaced by other foreign assets (e.g., euro- or yen-denominated), then only the dollar depreciation will occur. Depreciation of the dollar will boost U.S. exports and increase inflation in the U.S. Topic: 17.6 Intervention in the Foreign Exchange Market AACSB: Reflective Thinking 17.7 Fixed Exchange Rate Regimes 1) In a fixed exchange rate regime, the value of a currency is pegged to ________.

A) an anchor currency B) a currency board C) a dirty float D) an interest rate standard such as the Treasury bill rate in the U.S. Answer: A Topic: 17.7 Fixed Exchange Rate Regimes 2) A dirty float is an example of ________.

A) a fixed exchange rate system B) a flexible exchange rate system C) a revaluation D) a currency board Answer: B Topic: 17.7 Fixed Exchange Rate Regimes 3) Under a dirty float, the value of a country's currency is ________.

A) fixed B) determined by the relevant currency board C) influenced by the monetary authorities D) unmanageable Answer: C Topic: 17.7 Fixed Exchange Rate Regimes 4) Under a fixed exchange rate system, if an appreciation in the value of a country's currency develops, the monetary authorities must intervene by ________.

A) selling foreign exchange B) buying and selling the domestic currency C) raising the foreign interest rate D) buying foreign exchange Answer: D Topic: 17.7 Fixed Exchange Rate Regimes AACSB: Analytical Thinking 16 .

5) Under a fixed exchange rate system, if an appreciation in the value of a country's currency develops, the monetary authorities ________.

A) will gain international reserves B) buy the domestic currency in foreign exchange markets C) sell foreign exchange in foreign exchange markets D) will lose international reserves Answer: A Topic: 17.7 Fixed Exchange Rate Regimes AACSB: Analytical Thinking 6) The devaluation of a currency develops once ________.

A) an increase in the value of a country's currency develops B) a monetary authority runs out of international reserves C) the level of domestic income falls D) an increase in the domestic price level develops Answer: B Topic: 17.7 Fixed Exchange Rate Regimes AACSB: Analytical Thinking 7) A central bank with a fixed exchange rate must, in response to an interest rate decline in the anchor-currency economy, ________.

A) purchase the anchor currency B) sell the anchor currency C) convene a currency board D) revalue its currency Answer: A Topic: 17.7 Fixed Exchange Rate Regimes AACSB: Analytical Thinking 8) The impossible trinity includes ________.

A) capital controls, a fixed exchange rate and an independent monetary policy B) free capital mobility, a flexible exchange rate and an independent monetary policy C) free capital mobility, a fixed exchange rate and an independent monetary policy D) free capital mobility, a flexible exchange rate and constraints on monetary policy Answer: C Topic: 17.7 Fixed Exchange Rate Regimes 9) If a country chooses to establish fixed exchange rates and an independent monetary policy, it gives up the ability to have ________.

A) free capital mobility B) an independent fiscal policy C) capital controls D) an independent physical policy Answer: A Topic: 17.7 Fixed Exchange Rate Regimes AACSB: Analytical Thinking 17 .

10) The individual countries of the Eurozone are on which side of the "policy trilemma"?

A) free capital mobility and independent monetary policy B) free capital mobility and fixed exchange rate C) fixed exchange rate and independent monetary policy D) fixed exchange rate and capital controls Answer: B Topic: 17.7 Fixed Exchange Rate Regimes AACSB: Analytical Thinking 11) Consequences of the European Monetary Union include ________.

A) a global financial crisis in 2007-2008 B) tightening of capital controls in several economies C) convergence of unemployment rates across the member economies D) consistent monetary policy across the member economies Answer: D Topic: 17.7 Fixed Exchange Rate Regimes AACSB: Analytical Thinking 12) If any country decides to exit from the Eurozone, it will gain ________.

A) free capital mobility B) a fixed exchange rate C) reduced transactions costs D) monetary policy independence Answer: D Topic: 17.7 Fixed Exchange Rate Regimes AACSB: Analytical Thinking 13) How might China benefit from adopting a flexible exchange rate policy?

Answer: With a flexible exchange rate, China can stop adding to its reserve of low-yielding U.S. assets. Strengthening of the yuan will reduce inflationary pressures and, perhaps, reduce conflicts over trade policies with other nations. With a flexible exchange rate, China can relax its capital controls while retaining its independent monetary policy.

Topic: 17.7 Fixed Exchange Rate Regimes AACSB: Reflective Thinking

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17.8 To Peg or Not to Peg 1) One of the chief advantages of exchange rate pegging is that ________.

A) a country is able to pursue an independent monetary policy over the course of the business cycle B) it can be an effective means of reducing inflation C) the currency can be used to promote export growth D) it allows the monetary authorities to actively respond to the problems of inflation and unemployment Answer: B Topic: 17.8 To Peg or Not to Peg AACSB: Reflective Thinking 2) In many countries, an exchange-rate peg substitutes for ________.

A) speculative attacks B) an export-oriented sector C) discretionary monetary policy D) capital controls Answer: C Topic: 17.8 To Peg or Not to Peg AACSB: Reflective Thinking 3) When the real interest rate rises in the anchor country, ________.

A) expansionary monetary policy will be used to maintain the interest rate peg B) an economic stimulus is transmitted to pegged economies C) there will be downward pressure on the value of pegged currencies D) the anchor currency becomes vulnerable to a speculative attack Answer: C Topic: 17.8 To Peg or Not to Peg AACSB: Analytical Thinking 4) In a "crawling peg" regime, ________.

A) the value of the currency is fixed to a basket of commodities B) higher inflation is permitted C) several anchor currencies are used in succession D) the currency may gain value, but cannot lose value Answer: B Topic: 17.8 To Peg or Not to Peg

19 .

5) One purpose of the currency board adopted in Argentina in 1991 was to ________.

A) encourage capital mobility B) make monetary policy more effective C) stabilize the exchange rate between the Argentine peso and the currencies of Argentina's major trading partners D) put an end to speculative attacks on the Argentine peso Answer: A Topic: 17.8 To Peg or Not to Peg AACSB: Analytical Thinking 6) If the nominal expected return on foreign assets is higher than on dollar assets ________.

A) foreigners will want to hold additional dollar assets B) Americans will want to hold additional dollar assets C) foreigners will want to hold fewer foreign assets D) foreigners will want to hold additional foreign assets Answer: D Topic: 17.8 To Peg or Not to Peg AACSB: Analytical Thinking 7) The key danger facing a country with an exchange rate peg is ________.

A) loss of credibility B) loss of export markets C) monetary policy mistakes D) capital controls Answer: A Topic: 17.8 To Peg or Not to Peg 8) When an exchange-rate crisis befalls a pegged currency, experience suggests that damage to the economy may be minimized by ________.

A) appealing to creditors to provide more liquidity B) rapid adoption of a currency board C) abandoning the peg D) launching speculative counter-attacks Answer: C Topic: 17.8 To Peg or Not to Peg AACSB: Reflective Thinking

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9) What are some reasons that an "emerging market" country may choose a fixed exchange rate regime?

Answer: While political and monetary institutions are developing, the best monetary policy might be to peg the exchange rate to the currency of a low-inflation economy. Since, in the absence of capital controls, savings will flow into and out of the economy, a credible commitment to low inflation and financial stability is important. Typically, economic growth relies heavily on export performance, which suffers from excessive volatility of the exchange rate. Similarly, a relatively stable exchange rate supports the availability of critical imports. With an exchange-rate peg, domestic economic fluctuations will not be transmitted to the exchange rate, so adverse expectations-driven feedback loops may be avoided.

Topic: 17.8 To Peg or Not to Peg AACSB: Reflective Thinking 10) How does the policy trilemma help to explain the failure of Argentina's currency board?

Answer: In the early 1990s, Argentina's commitment to capital mobility and to the one-pesoequals-one-dollar exchange rate fostered optimism. When that optimism was challenged by the peso crisis in Mexico, the Argentine people became aware that the soundness of the banking system was in their hands. The combination of fixed exchange rate and capital mobility prevents the central bank from conducting an independent monetary policy, such as providing needed liquidity to protect bank deposits. Instead, the regime relies on foreign creditors to step in when citizens lose confidence in the banks. This worked well enough in the mid-1990s, but it became increasingly obvious that Argentina's economy could not grow unless the peso was devalued, so that exports and domestically-produced import substitutes could compete with global products.

Because the currency board did not allow for devaluation, either it or capital mobility would have to end.

Topic: 17.8 To Peg or Not to Peg AACSB: Reflective Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 18 Consumption and Saving 18.1 The Relationship Between Consumption and Saving 1) Consumption spending comprises what percentage of total spending?

A) 0.7 percent B) 7 percent C) 70 percent D) 700 percent Answer: C Topic: 18.1 The Relationship Between Consumption and Saving 2) A theory of saving is necessarily a theory of consumption, because ________.

A) by definition, any unit of disposable income that is not a consumption expenditure is a unit of saving B) consumption decisions are made after saving has occurred C) private saving is equal to private investment D) the goal of consumption choices is to achieve the desired level of savings Answer: A Topic: 18.1 The Relationship Between Consumption and Saving AACSB: Analytical Thinking 3) Gross income net of taxes is known as ________.

A) Gross Domestic Product, or GDP B) disposable income C) Gross Domestic Product per capita D) retained earnings Answer: B Topic: 18.1 The Relationship Between Consumption and Saving 4) The after-tax income received by the household sector is known as ________.

A) disposable income B) retained earnings C) net national product per capita D) Gross Domestic Product Answer: A Topic: 18.1 The Relationship Between Consumption and Saving 5) Disposable income represents ________.

A) the income received by firms, e.g. corporations B) an increase in GDP C) a decrease in GDP D) the after-tax income received by the household Answer: D Topic: 18.1 The Relationship Between Consumption and Saving 1 .

6) In the equation S = Y - C, in order to interpret Y as disposable income, it is necessary to interpret S as ________ saving.

A) private B) national C) government D) business Answer: A Topic: 18.1 The Relationship Between Consumption and Saving AACSB: Analytical Thinking 18.2 Intertemporal Choice and Consumption 1) An intertemporal budget constraint ________.

A) describes how much time an individual consumer has to spend their disposable net national product B) is independent of the real interest rate and wealth of the household C) divides consumption spending into three categories: spending on durables, non-durables and services D) describes how much a person can consume today versus tomorrow Answer: D Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 2) An intertemporal budget constraint is downward sloping due to ________.

A) the trade-off between current and future consumption B) the law of diminishing marginal productivity C) the law of supply D) the law of demand Answer: A Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 3) The theory of intertemporal choice was presented by ________.

A) Adam Smith in 1776 B) Alfred Marshall in 1871 C) Irving Fisher in 1930 D) John Maynard Keynes in 1936 Answer: C Topic: 18.2 Intertemporal Choice and Consumption

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Intertemporal Budget Constraint r

W

0.04 $10,000 $40,000 $20,000

4) Referring to the table above, if consumption in period one is zero, then consumption in period two cannot be greater than ________.

A) $72,800 B) $70,400 C) $71,200 D) $70,800 Answer: C Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 5) Referring to the table above, if consumption in period one is $20,000, then consumption in period two cannot be greater than ________.

A) $52,800 B) $50,400 C) $49,600 D) $50,000 Answer: B Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 6) Referring to the table above, the present discounted value of initial wealth plus total income is ________.

A) $67,308 B) $71,200 C) $70,400 D) $68,462 Answer: D Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 7) Which of the following is the correct statement of an intertemporal budget constraint?

A) = - + B) = + C) W = -( + ) D) = Answer: B Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 3 .

8) Discounting involves dividing next-period income by ________.

A) one plus the real rate of interest B) the nominal rate of interest C) current income D) the real rate of interest Answer: A Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 9) Assuming no bequests, with a real interest rate of 10 percent, wealth of $60,000, current income of $70,000, current consumption of $30,000 and future income of $100,000, future consumption equals ________.

A) $30,000 B) $70,000 C) $100,000 D) $210,000 Answer: D Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 10) Assuming no bequests, with a real rate of interest of 10 percent, wealth of $60,000, current income of $70,000, future income of $180,000 and future consumption of $158,000, current consumption must equal ________.

A) $158,000 B) $150,000 C) $152,000 D) $130,000 Answer: B Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 11) The farther an indifference curve lies from the origin ________.

A) the greater the level of individual income B) the lower its utility C) the lower the level of individual income D) the higher its utility Answer: D Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking

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12) Which of the following is not true of all indifference curves?

A) they slope downward B) the point at which one indifference curve intersects another represents an optimal consumption basket C) they are bowed toward the origin D) they can intersect with a budget constraint one or more times Answer: B Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 13) If an indifference curve intersects the budget constraint at two points, then ________.

A) the consumer would be equally happy at either of those two points B) optimal consumption is found by moving to a lower indifference curve C) optimal consumption is found by moving to a lower budget constraint D) the consumer will choose the point that minimizes consumption expenditure Answer: A Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 14) The optimal level of consumption is achieved when ________.

A) consumption in one period is equal to consumption in the next period B) utility in one period is equal to utility in the next period C) all income and wealth has been spent D) the slope of the indifference curve is equal to the slope of the budget line Answer: D Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 15) Indifference curves tend to be convex because ________.

A) they are bowed inwards toward the origin B) consumers dislike large fluctuations in consumption from one period to the next C) of the gap between real and nominal interest rates D) the marginal rate of substitution exceeds the price effect Answer: B Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 16) Along any single indifference curve the ________.

A) consumer is equally satisfied with any of the combinations of goods B) level of current income is unchanged C) level of future income is unchanged D) level of current and future income is unchanged Answer: A Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking

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17) Indifference curves describe ________.

A) the relationship between current and future income B) the utility received by an individual consumer C) the relationship between utility and income D) productivity levels Answer: B Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 18) The rate at which a consumer is willing to give up consumption in one period for additional consumption in another is known as ________.

A) the marginal propensity to save B) the marginal propensity to consume C) the marginal rate of substitution D) the average propensity to consume Answer: C Topic: 18.2 Intertemporal Choice and Consumption 19) The equation MRS = 1 + r means that ________.

A) consumers prefer to avoid fluctuations in consumption B) at the margin, consumption grows at the real interest rate C) any movement along the budget constraint would cause a decrease in the consumer's utility D) consumer utility is a positive function of the real interest rate Answer: C Topic: 18.2 Intertemporal Choice and Consumption AACSB: Analytical Thinking 18.3 The Intertemporal Choice Model in Practice: Income and Wealth 1) A rightward shift in the intertemporal budget line would be caused by ________.

A) an increase in future income and wealth B) an increase in future income and a decrease in wealth C) a decrease in future income and an increase in wealth D) a decrease in future income and wealth Answer: A Topic: 18.3 The Intertemporal Choice Model in Practice: Income and Wealth AACSB: Analytical Thinking 2) Consumption smoothing is a logical consequence of ________.

A) basing decision-making on real rather than nominal interest rates B) the convexity of indifference curves and the ability to borrow and lend C) the negative slope fo the intertemporal budget constraint D) rational expectations Answer: B Topic: 18.3 The Intertemporal Choice Model in Practice: Income and Wealth AACSB: Analytical Thinking 6 .

3) Consumption smoothing refers to ________.

A) the impact of future income on current consumption and of current income on future consumption B) the constancy of consumption over time C) the impact of current consumption on future income and of future consumption on current income D) the tendency of consumers to adopt similar spending habits Answer: A Topic: 18.3 The Intertemporal Choice Model in Practice: Income and Wealth AACSB: Analytical Thinking 4) Typically, consumers respond to an increase in (expected) future income by ________.

A) shifting the budget constraint to the left B) increasing both current and future consumption C) saving more to increase future wealth D) waiting until the income is received before changing their consumption behavior Answer: B Topic: 18.3 The Intertemporal Choice Model in Practice: Income and Wealth 5) Assuming a real interest rate of four percent, which of these causes the largest increase in the present value of lifetime resources?

A) a winning lottery ticket that pays $9,600 today B) an additional $10,000 of income in the future period C) a salary increase of $5,000 both today and in the future period D) an additional $10,000 of current wealth Answer: D Topic: 18.3 The Intertemporal Choice Model in Practice: Income and Wealth AACSB: Analytical Thinking Intertemporal Budget Constraint r

W

0.04 $10,000 $40,000 $20,000

6) Using the table above, and assuming no bequest, what amount of consumption is chosen in period 1, if the consumer wants consumption in the two periods to be equal? If initial wealth is $40,000, what amount of consumption is equal over the two periods?

Answer: Use equation (2), setting = - $34,902; $45,098 Topic: 18.3 The Intertemporal Choice Model in Practice: Income and Wealth AACSB: Analytical Thinking

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18.4 The Intertemporal Choice Model in Practice: Interest Rates 1) ________ will increase current consumption, saving, and future consumption.

A) an increase in future income B) an increase in initial wealth C) an increase in current income D) a decrease in the real interest rate Answer: C Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking 2) Real world economic data supports the view that higher interest rates are associated with ________.

A) higher saving and consumption B) lower saving and higher consumption C) higher saving and lower consumption D) lower saving and consumption Answer: C Topic: 18.2 Intertemporal Choice and Consumption 3) The substitution effect that occurs when interest rates change involves a change in consumption that develops from ________.

A) a change in the general level of prices B) a period of increasing productivity C) a change in the level of income D) a change in the relative prices of consumption in the two periods Answer: D Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking 4) In practice, it is usual to assume that, in explaining the impact of a change in interest rates ________.

A) the substitution effects outweigh the income effects B) the income effect outweighs the substitution effect C) the income and substitution effects cancel out with one another D) the income effect increases the severity of the substitution effect Answer: A Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates

8 .

Intertemporal Budget Constraint r

W

0.04 $10,000 $40,000 $20,000

5) Given the table above, the present value of lifetime resources ________ when the real interest rate rises to five percent.

A) falls by $367 B) rises by $200 C) rises by $300 D) falls by $275 Answer: A Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking 6) Given the table above, suppose consumption in period two is $35,000. Then, the interest rate rises to five percent, and period-two consumption falls to $34,900. We may infer that ________.

A) the income effect is stronger than the substitution effect B) the substitution effect is stronger than the income effect C) the substitution and income effects cancel out D) this consumer has a binding borrowing constraint Answer: A Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking 7) Given the table above, suppose consumption in period two is $40,000. Then, the interest rate rises to five percent, and period-two consumption rises to $41,050. We may infer that ________.

A) the income effect is stronger than the substitution effect B) the substitution effect is stronger than the income effect C) the substitution and income effects cancel out D) this consumer has a binding borrowing constraint Answer: B Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking 8) Given the table above, suppose consumption in period two is $40,000. Then, the interest rate rises to five percent, and period-two consumption does not change. We may infer that ________.

A) the income effect is stronger than the substitution effect B) the substitution effect is stronger than the income effect C) the substitution and income effects cancel out D) this consumer has a binding borrowing constraint Answer: D Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking 9 .

9) For the majority of the U.S. population ________.

A) consumption is driven solely by current income B) consumption smoothing is possible C) a change in lifetime resources will not change current consumption D) a change in lifetime resources will not change future consumption Answer: B Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates 10) For consumers with a binding borrowing constraint, a decrease in the real interest rate ________.

A) decreases consumption now, and in the future B) increases consumption now, and in the future C) decreases consumption now, and increases future consumption D) has no impact on consumption Answer: D Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking 11) When the borrowing constraint is binding, ________.

A) wealth is zero B) current consumption is lower than future consumption C) future consumption is lower than current consumption D) consumption smoothing is not possible Answer: D Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking 12) When the borrowing constraint is binding, ________.

A) wealth is zero B) = C) = D) current and future consumption are equal Answer: C Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking 13) ________ might cause the borrowing constraint to become non-binding, even though the consumer still cannot borrow.

A) An increase in future (expected) income B) An increase in the real interest rate C) A decrease in current income D) A decrease in the real interest rate Answer: B Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking

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14) For many consumption activities — skiing, for example — the activity becomes more enjoyable as the consumer becomes more experienced. Assuming that "training consumption" is inexpensive relative to "proficient consumption," do such activities make it more or less likely that a borrowing constraint will be binding?

Answer: Such activities encourage a shift of consumption into the future. The decrease in current consumption makes a binding borrowing constraint less likely.

Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Reflective Thinking 15) Use the intertemporal budget constraint — equation (2) — to explain how an increase in the real interest rate causes two distinct effects, an income effect and a substitution effect, and how those effects differ depending on whether the consumer is a saver or a borrower.

Answer: An increase in the real interest rate affects the first term on the RHS. For savers, the term is positive: the higher interest rate increases the value of lifetime resources, enabling more consumption in either period. For borrowers, the term is negative, so the higher interest rate reduces the value of lifetime resources. This is the income effect. For both savers and borrowers, the higher interest rate (because it is multiplied by ) makes current consumption relatively more expensive compared to future consumption. That is, reducing current consumption by one unit at the higher interest rate enables a larger increase in future consumption than at a lower interest rate. This is the substitution effect.

Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking 16) During the 2007-2009 financial crisis, many households found themselves with negative wealth (debts to repay) and a binding borrowing constraint. Describe the income and substitution effects of a decrease in the real interest rate.

Answer: With a binding borrowing constraint, a decrease in the real interest rate does not cause a substitution effect, because the MRS remains greater than 1 + r. However, there is an income effect, because the decrease in the interest cost of debt raises the value of lifetime resources.

Thus, both current and future consumption rise.

Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Analytical Thinking 17) How might consumers for whom the borrowing constraint is binding benefit from access to relatively expensive forms of credit (e.g., pawn shops and "payday" loans)?

Answer: A binding borrowing constraint means that the marginal rate of substitution is greater than 1 + r. This means that such consumers might pay an interest rate greater than r in order to shift some consumption from the future to the present. So long as (1 + the interest rate they pay) does not exceed the MRS, the utility gained from the increase in current consumption is greater than the utility lost from reduced future consumption.

Topic: 18.4 The Intertemporal Choice Model in Practice: Interest Rates AACSB: Reflective Thinking

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18.5 The Keynesian Theory of Consumption 1) The ratio of consumption to income is known as ________.

A) the average propensity to consume B) the borrowing constraint C) the marginal propensity to consume D) subprime accommodation Answer: A Topic: 18.5 The Keynesian Theory of Consumption 2) The marginal propensity to consume describes ________.

A) the tendency to consume fringe, or unusual items B) the impact of a change in spending on income C) the impact on consumption resulting from a change in income D) lifetime consumption resources Answer: C Topic: 18.5 The Keynesian Theory of Consumption 3) The value of the marginal propensity to consume is ________.

A) equal to one B) between zero and one C) greater than one D) less than zero Answer: B Topic: 18.5 The Keynesian Theory of Consumption 4) The schedule describing the Keynesian consumption function will become steeper with an increase in ________.

A) consumption spending B) autonomous consumption C) the marginal propensity to consume D) the marginal propensity to save Answer: C Topic: 18.5 The Keynesian Theory of Consumption AACSB: Analytical Thinking 5) In the Keynesian consumption function, if current income is equal to zero, consumption spending is equal to ________.

A) the marginal propensity to consume B) the average propensity to save C) autonomous consumption D) exogenous consumption Answer: C Topic: 18.5 The Keynesian Theory of Consumption AACSB: Analytical Thinking

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6) If high incomes inspire more saving than low incomes ________.

A) the average propensity to consume falls as income rises B) the marginal propensity to consume rises as income rises C) autonomous consumption falls as income rises D) the average propensity to consume rises as wealth rises Answer: A Topic: 18.5 The Keynesian Theory of Consumption AACSB: Analytical Thinking 7) The Keynesian consumption function does not display consumption smoothing, because ________.

A) the average propensity to consume rises with income B) the marginal propensity to consume is constant C) consumption is not affected by the real interest rate D) consumption is not affected by future income Answer: D Topic: 18.5 The Keynesian Theory of Consumption AACSB: Analytical Thinking 8) The Keynesian consumption function and the theory of intertemporal choice are consistent for households ________.

A) with a binding budget constraint B) with little or no initial wealth C) whose consumption remains positive, even if income is zero D) whose consumption cannot exceed current income Answer: D Topic: 18.5 The Keynesian Theory of Consumption AACSB: Analytical Thinking 9) Autonomous consumption is 700 and the marginal propensity to consume is 0.6. Calculate the average propensity to save when disposable income is (a) 10,000, (b) 12,000, and (c) 15,000.

Answer: (a) 0.33; (b) 0.342; (c) 0.353 Topic: 18.5 The Keynesian Theory of Consumption AACSB: Analytical Thinking

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18.6 The Permanent Income Hypothesis 1) According to the permanent income hypothesis, consumption spending depends largely on ________.

A) current income B) the savings rate C) a consumer's lifetime resources D) the level of current income plus the value of the assets owned by the household Answer: C Topic: 18.6 The Permanent Income Hypothesis 2) The permanent income hypothesis highlights the phenomenon of ________.

A) the intertemporal budget constraint B) a binding borrowing constraint C) autonomous consumption D) consumption smoothing Answer: D Topic: 18.6 The Permanent Income Hypothesis AACSB: Reflective Thinking 3) According to the permanent income hypothesis, permanent income is to ________ as transitory income is to ________.

A) consumption; saving B) certain; hypothetical C) wealth; gambling D) saving; borrowing Answer: A Topic: 18.6 The Permanent Income Hypothesis AACSB: Reflective Thinking 4) If households come to believe that permanent income has not changed ________.

A) the impact of a change in taxes on spending will be limited B) they will consume on the basis of their current income C) their life-cycle will be affected D) the impact of a given change in taxes on spending will be enhanced Answer: A Topic: 18.6 The Permanent Income Hypothesis AACSB: Analytical Thinking 5) In the permanent income hypothesis, income that does not persist for a long period of time is known as ________.

A) current income B) transitory income C) insufficient income D) limited income Answer: B Topic: 18.6 The Permanent Income Hypothesis 14 .

6) In the permanent income hypothesis, income is divided into ________.

A) current and future income B) future and transitory income C) transitory and permanent income D) permanent and current income Answer: C Topic: 18.6 The Permanent Income Hypothesis 7) According to the permanent income hypothesis, the impact of ________.

A) a change in permanent income on consumption is greater than the impact resulting from a change in transitory income B) a change in transitory income on consumption is greater than the impact resulting from a change in permanent income C) a change in transitory income is felt primarily through changes in the total tax revenue paid to the federal government D) a change in permanent income on consumption is larger than the impact resulting from a change in future income Answer: A Topic: 18.6 The Permanent Income Hypothesis AACSB: Analytical Thinking 8) Intertemporal choice theory is more consistent with ________.

A) Keynesian theory than the permanent income hypothesis of Friedman B) the permanent income hypothesis than Keynesian theory C) Keynesian theory than the life-cycle hypothesis D) Keynesian theory than the Gini coefficient theory Answer: B Topic: 18.6 The Permanent Income Hypothesis AACSB: Reflective Thinking 9) The effect of the February 2008 tax rebate on spending was reduced due to ________.

A) the simultaneous missteps in monetary policy B) the negative impact of the policy on saving rates C) the recognition that the rebate did not constitute a permanent change in income D) the small size of the program Answer: C Topic: 18.6 The Permanent Income Hypothesis

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10) During the 2007-2009 financial crisis, many households found themselves with debts to repay. How might this explain the consumer response to the 2008 Tax Rebate?

Answer: The temporary tax rebate did not add much to permanent income, so it's no surprise that most of the money was not added to current spending. However, the immediate reduction in household debt increases lifetime resources. Generally, the cost of debt service is higher than the expected return on saving, so permanent income rose further and gave some boost to current consumption.

Topic: 18.6 The Permanent Income Hypothesis AACSB: Reflective Thinking 18.7 The Life-Cycle Hypothesis 1) According to the life-cycle hypothesis ________.

A) households consume on the basis of their current income and liabilities B) household consumption as a percentage of income varies over one's lifetime C) current income is a function of future income D) cycling to work everyday allows one to live a longer life Answer: B Topic: 18.7 The Life-Cycle Hypothesis AACSB: Analytical Thinking 2) According to the life-cycle hypothesis, as consumers get older ________.

A) the marginal propensity to consume out of wealth and income rise B) the marginal propensity to consume out of wealth falls and the marginal propensity to consume out of income rises C) the marginal propensity to consume out of wealth rises and the marginal propensity to consume out of income falls D) the marginal propensity to consume out of wealth and income fall Answer: C Topic: 18.7 The Life-Cycle Hypothesis AACSB: Analytical Thinking 3) According to the life-cycle hypothesis, as people grow older ________.

A) their wealth grows before and after retirement B) their wealth declines before and after retirement C) their wealth grows before retirement, then declines after retirement D) their wealth falls before retirement, then rises after retirement Answer: C Topic: 18.7 The Life-Cycle Hypothesis AACSB: Analytical Thinking

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4) Suppose consumers anticipate that their wealth will grow over time, because of interest earnings and capital gains. According to the life-cycle hypothesis, such optimism should cause current consumption to be ________.

A) relatively low B) relatively insensitive to changes in income C) rising as individuals near retirement age D) relatively high Answer: D Topic: 18.7 The Life-Cycle Hypothesis AACSB: Analytical Thinking 5) The life-cycle hypothesis applies the concept of ________ to retirement.

A) income & substitution effects B) transitory income C) autonomous consumption D) consumption smoothing Answer: D Topic: 18.7 The Life-Cycle Hypothesis AACSB: Reflective Thinking 6) The life-cycle hypothesis predicts what consequence of aging of the overall population? [That is, an increase in T, relative to R & L.] A) a decrease in the marginal propensity to consume out of wealth B) an increase in aggregate saving C) a decrease in the marginal propensity to consume out of income D) an increase in aggregate wealth Answer: C Topic: 18.7 The Life-Cycle Hypothesis AACSB: Reflective Thinking 7) The recession of 2008-2009 demonstrated that ________.

A) consumption is especially sensitive to changes in the retirement age B) changes in wealth can be a major source of fluctuations in consumption C) as consumers get older, they tend to exhaust all their savings D) permanent income is something of a misnomer Answer: B Topic: 18.7 The Life-Cycle Hypothesis 8) In 2008, the wealth of U.S. households fell by ________.

A) $11 million B) $11 billion C) $11 trillion D) $11 gajillion Answer: C Topic: 18.7 The Life-Cycle Hypothesis

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9) Current estimates of the marginal propensity to consume out of wealth are in the neighborhood of ________.

A) three and one-half cents per dollar of wealth B) 45 cents per dollar of wealth C) 98 cents per dollar of wealth D) $4.87 per dollar of wealth Answer: A Topic: 18.7 The Life-Cycle Hypothesis 10) Advances in medical practice have increased both expected lifespans and medical expenditures. What does the life-cycle hypothesis predict as the macroeconomic consequences?

Answer: An extended lifespan implies more years in retirement. The high cost of medical care implies that those years will, on average, be more expensive. For both reasons, workers will increase saving now (reduce consumption) and accumulate more wealth before retirement.

Topic: 18.7 The Life-Cycle Hypothesis AACSB: Reflective Thinking 18.8 Two Modifications Of The Theory: The Random Walk Hypothesis and Behavioral Economics 1) The observation that changes in an economic variable are unpredictable suggests that the relevant variable follows ________.

A) a random walk B) tertiary unpredictability C) the life-cycle hypothesis D) the Tequila effect Answer: A Topic: 18.8 Two Modifications of the Theory: The Random Walk Hypothesis and Behavioral Economics 2) The theory of intertemporal choice, and the life-cycle and permanent income hypotheses have in common the assumption that ________.

A) consumption decisions are affected by current expectations about lifetime resources B) consumption decisions are based on all available information C) current income, rather than expected income, has the greater influence on consumption decisions D) decisions to borrow and save are influenced much more by immediate circumstances than by long-term consequences Answer: A Topic: 18.8 Two Modifications of the Theory: The Random Walk Hypothesis and Behavioral Economics AACSB: Reflective Thinking

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3) According to rational expectations, expectations will only change in the event that ________.

A) wealth changes B) current income changes C) permanent income changes D) unanticipated new information arises Answer: D Topic: 18.8 Two Modifications of the Theory: The Random Walk Hypothesis and Behavioral Economics 4) The idea that consumers will not consistently discount the future over time is known as ________.

A) intertemporal choice B) tertiary inversion C) hyperbolic discounting D) antediluvian Machiavellianism Answer: C Topic: 18.8 Two Modifications of the Theory: The Random Walk Hypothesis and Behavioral Economics 5) Consumers who do not consistently discount the future over time behave in a fashion that is most consistent with ________.

A) the theory of intertemporal choice B) the Keynesian theory of consumption C) the permanent income hypothesis D) the life-cycle hypothesis Answer: B Topic: 18.8 Two Modifications of the Theory: The Random Walk Hypothesis and Behavioral Economics AACSB: Reflective Thinking 6) Consumers who do not consistently discount the future over time are likely to ________.

A) under-report their taxable income B) be unprepared financially for retirement C) opt in to employer-sponsored savings plans D) make excessive sacrifices on behalf of their children Answer: B Topic: 18.8 Two Modifications of the Theory: The Random Walk Hypothesis and Behavioral Economics AACSB: Reflective Thinking

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7) The view that the choices consumers face should be limited for their own good is known as ________.

A) Keynesian theory B) institutionalist theory C) rational adaptations D) libertarian paternalism Answer: D Topic: 18.8 Two Modifications of the Theory: The Random Walk Hypothesis and Behavioral Economics 8) ________ is to the random walk hypothesis as ________ is to behavioral economics.

A) Sober calculation; paternal guidance B) Surprise; gratification C) Rational ignorance; studied optimization D) Unpredictability; regret Answer: D Topic: 18.8 Two Modifications of the Theory: The Random Walk Hypothesis and Behavioral Economics AACSB: Reflective Thinking 9) How consistent is the Keynesian consumption function with the random walk hypothesis?

Answer: For changes in aggregate income that are unexpected, the Keynesian consumption function captures the impact on current consumption. If economic behavior is guided by rational expectations, and there are no surprises, then aggregate income reflects all available information so, again, the Keynesian consumption function is a good model.

Topic: 18.8 Two Modifications of the Theory: The Random Walk Hypothesis and Behavioral Economics AACSB: Reflective Thinking 10) Would the Keynesian consumption function work well in a world of libertarian paternalists?

Answer: If consumption behavior depends mostly on current constraints and immediate consequences, then current consumption is driven by current income, as the Keynesian consumption function says. Libertarian paternalism seeks to tighten the constraints. More effective inducements to save might lower the marginal propensity to consume, but it will be as true as ever that changes in current consumption will be driven principally by changes in current income.

Topic: 18.8 Two Modifications of the Theory: The Random Walk Hypothesis and Behavioral Economics AACSB: Reflective Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 19 Investment 19.1 Data on Investment Spending 1) Investment spending in the U.S. ________.

A) comprises the majority of total spending B) is equal to approximately 15 percent of total spending C) is equal to approximately 81 percent of total spending D) is the smallest component part of household consumption spending Answer: B Topic: 19.1 Data on Investment Spending 2) Investment spending is a potent force in the macroeconomy, because ________.

A) it is subject to large fluctuations B) it is larger than other spending categories C) it is the focus of macroeconomic policies D) it expresses entrepreneurial talent Answer: A Topic: 19.1 Data on Investment Spending 3) The elements of investment spending are ________.

A) calculated only in real terms B) equivalent to their corresponding international transactions C) consumption, government, exports and imports D) highly procyclical Answer: D Topic: 19.1 Data on Investment Spending 4) Which of the following is not a component of investment spending?

A) spending by firms on equipment B) the purchase of 1000 shares of corporate stock C) residential construction D) changes in inventories Answer: B Topic: 19.1 Data on Investment Spending 5) Which of the following is a component part of investment spending?

A) the purchase of a new microwave by a fast food restaurant B) the purchase of 500 shares of corporate stock C) the sale of 500 shares of corporate stock D) all of the above Answer: A Topic: 19.1 Data on Investment Spending AACSB: Reflective Thinking

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6) The purchase and sale of financial instruments is not included in calculations of investment spending because ________.

A) not all of these transactions are reported to the federal government B) both foreign and domestic economic agents can engage in the described transactions, but only U.S. economic agents can engage in investment C) they do not necessarily lead to a change in the amount of output produced in the United States D) they are already including in consumption spending Answer: C Topic: 19.1 Data on Investment Spending AACSB: Reflective Thinking 19.2 The Neoclassical Theory of Investment 1) Once the marginal product of capital is equal to the real rental cost of capital ________.

A) inventories will stabilize B) depreciation will equal the marginal rate of substitution C) the economy will reach full employment D) a profit-seeking firm will stop acquiring capital Answer: D Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 2) If the marginal product of capital is greater than the rental cost of capital in terms of goods and services, then ________.

A) the firm should continue to produce using that same amount of capital B) the firm should add additional capital C) the firm should reduce the amount of capital is using D) diminishing returns have been avoided Answer: B Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 3) A firm possesses too much capital if ________.

A) the real rental cost of capital is equal to the marginal product of capital B) the real rental cost of capital is less than the marginal product of capital C) its investment spending exceeds its consumption outlays D) the real rental cost of capital is more than the marginal product of capital Answer: D Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking

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4) User cost is equal to ________.

A) interest cost plus the expected rate of change in the real price of capital plus depreciation B) interest cost minus the rate of depreciation C) interest cost minus the expected rate of change of the real price of capital plus depreciation D) interest cost plus depreciation Answer: C Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 5) Suppose that a machine costs $10,000 in constant dollars and the real rate of interest is 12 percent. If the machine is expected to increase in price by 2 percent and the rate of depreciation is 5 percent, then the user cost of capital for that machine over one year is equal to ________.

A) $150 B) $1,500 C) $10,000 D) $102,500 Answer: B Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 6) A machine cost $15,000 to install, and has a resale value one year later of $12,000. If the real interest rate is 10%, then the user cost of capital is ________.

A) $4,500 B) $1,500 C) $3,000 D) $1,200 Answer: A Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 7) The user cost of capital is negatively related to ________.

A) the real rate of interest B) the depreciation rate C) the expected rate of change of the real price of capital D) the tertiary log of the nominal price of capital Answer: C Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 8) The expected real cost of using a unit of capital over a given period of time is known as ________.

A) the real rate of interest B) the nominal rate of interest C) depreciation D) the user cost of capital Answer: D Topic: 19.2 The Neoclassical Theory of Investment 3 .

9) Gross investment is equal to ________.

A) net investment plus depreciation B) net investment divided by depreciation C) net investment minus depreciation D) net investment times depreciation Answer: A Topic: 19.2 The Neoclassical Theory of Investment 10) The fraction of capital that wears out every year is known as ________.

A) gross investment B) depreciation C) net investment D) devaluation Answer: B Topic: 19.2 The Neoclassical Theory of Investment 11) Except during the Great Depression, net investment has always been ________.

A) equal to depreciation B) equal to zero C) positive D) negative Answer: C Topic: 19.2 The Neoclassical Theory of Investment 12) An increase in the rate of depreciation is associated with ________.

A) a decrease in the rate of productivity B) a decrease in gross investment C) a decrease in net investment D) an increase in net investment Answer: C Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 13) A higher desired level of capital and investment will result from ________.

A) a decrease in productivity B) a fall in expected future output C) a depressed economy D) a booming economy Answer: D Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking

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14) A decline in the desired level of capital and investment will result from ________.

A) a rise in the real price of capital B) a decrease in the rate of depreciation C) a decrease in the real interest rate D) a decrease in the real price of capital Answer: A Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 15) A rise in the tax rate on businesses leads to ________.

A) a decline the desired level of capital and an increase in investment B) a decline in the desired level of capital and a decrease in investment C) an increase in the desired level of capital and a decrease in investment D) an increase in the desired level of capital and an increase in investment Answer: B Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 16) Based on the neoclassical theory of investment, which aspect of a booming economy helps to explain the procyclicality of investment?

A) Tax revenues are likely to be rising.

B) The real interest rate is likely to be rising.

C) Capital goods are becoming more expensive.

D) Financing constraints are likely to be relaxed for many businesses.

Answer: D Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking

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Desired Level of the Capital Stock

17) Consider the two graphs above. Suppose that allowable deductions from taxable business income are increased. This would ________ the desired level of the capital stock, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: A Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 18) Consider the two graphs above. Suppose that financial liberalization enables more businesses to access credit markets. This would ________ the desired level of the capital stock, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: A Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 19) Consider the two graphs above. Suppose that businesses expect to hire more workers. This would ________ the desired level of the capital stock, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: B Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 6 .

20) Consider the two graphs above. Suppose that the domestic currency is expected to strengthen. This would ________ the desired level of the capital stock, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: D Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 21) Consider the two graphs above. Suppose there is an increase in the real interest rate. This would ________ the desired level of the capital stock, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: C Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 22) Consider the two graphs above. Suppose that technological progress is expected to reduce the future cost of capital goods. This would ________ the desired level of the capital stock, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: C Topic: 19.2 The Neoclassical Theory of Investment AACSB: Analytical Thinking 23) Use the neoclassical theory of investment to explain why technological progress that reduces the price of computers (and related information technology) impacts investment differently than technological progress that makes computers more productive.

Answer: Expected improvements in productivity cause the marginal product of capital curve to shift up. Reductions in the price of capital goods (such as computers) cause the user cost of capital curve to shift down. In either case, the desired level of capital and of investment increase.

Expected reductions in the price of capital goods increase the user cost of capital. The size of the increase in the desired level of capital depends on the size of the expected productivity increase and the actual price decrease relative to the expected price decrease.

Topic: 19.2 The Neoclassical Theory of Investment AACSB: Reflective Thinking

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24) Investment spending is procyclical. In the short run, are changes in investment affected more by changes in the expected marginal product of capital, or by changes in the user cost of capital?

Answer: More by changes in the expected marginal product of capital. Investment spending is positively related to the expected marginal product of capital. In the short run, the expected MPK depends mostly on the expected level of output. The level of investment will conform to gloomy or optimistic forecasts, thus reinforcing them. The user cost of capital is positively related to both the real interest rate and the real price of capital, which are procyclical. Changes in the user cost of capital impact investment in the opposite (countercyclical) direction, but this effect is overwhelmed by the changes in the expected marginal product of capital.

Topic: 19.2 The Neoclassical Theory of Investment AACSB: Reflective Thinking 25) Should you stay in school beyond the current semester? Describe how you might use the neoclassical theory of investment to help you decide.

Answer: Additional schooling makes sense, if the expected marginal benefit is at least as large as the user cost. If I am close to graduation, and "diploma capital" contributes much to my expected income and/or valued competencies, the additional investment may be warranted. Even if graduation is a distant (or irrelevant) goal, the human capital I've acquired this semester might enhance the expected benefit of further schooling. I know the explicit and implicit costs of an additional semester, but will the knowledge I might acquire increase in value over time, or depreciate?

Topic: 19.2 The Neoclassical Theory of Investment AACSB: Reflective Thinking 19.3 Inventory Investment 1) The most volatile component of total investment spending is ________.

A) construction spending by firms B) spending by firms on equipment C) residential construction by households D) inventory investment Answer: D Topic: 19.3 Inventory Investment AACSB: Analytical Thinking 2) The order of inventories for production as they are needed is known as ________.

A) just-in-time production B) production smoothing C) work in process D) stock out avoidance Answer: A Topic: 19.3 Inventory Investment

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3) Retail stores that dedicate one or more aisles to "seasonal" items are engaging in ________.

A) just-in-time production B) production smoothing C) work in process D) first degree price discrimination Answer: A Topic: 19.3 Inventory Investment AACSB: Analytical Thinking 4) Holdings of partially finished components involve inventories of ________.

A) Tobin's q B) work in process C) production smoothing D) stock-out components Answer: B Topic: 19.3 Inventory Investment 5) A car dealer that maintains a large number of automobiles on their lot so that they avoid losing a sale to another dealer who has the make and model a given customer wants is engaged in ________.

A) production smoothing B) work in process C) stock-out avoidance D) first degree price discrimination Answer: C Topic: 19.3 Inventory Investment 6) Firms that continue to produce when sales are temporarily low in an effort to avoid costly fluctuations in production are engaging in ________.

A) second degree price discrimination B) stock out avoidance C) work in progress D) production smoothing Answer: D Topic: 19.3 Inventory Investment 7) One explanation for the sharp decline in inventory investment during the 2007-2009 financial crisis was ________.

A) financing constraints B) the rise in the level of income C) the volatility of interest rates D) the increase in total spending and therefore costs Answer: A Topic: 19.3 Inventory Investment

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Desired Level of the Capital Stock

8) Consider the two graphs above. Suppose that firms are able to use inventories as collateral for low-interest loans. This would ________ the desired level of inventories, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: A Topic: 19.3 Inventory Investment AACSB: Analytical Thinking 9) Consider the two graphs above. Suppose that improvements in storage technology reduce inventory losses. This would ________ the desired level of inventories, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: A Topic: 19.3 Inventory Investment AACSB: Analytical Thinking 10) Consider the two graphs above. Suppose producers forecast a decrease in sales. This would ________ the desired level of inventories, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: D Topic: 19.3 Inventory Investment AACSB: Analytical Thinking 10 .

11) Consider the two graphs above. Suppose that improvements in technology enable farmers to produce two or more harvests of the same crop each year. This would ________ the desired level of inventories, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: D Topic: 19.3 Inventory Investment AACSB: Analytical Thinking 12) Consider the two graphs above. Suppose that final goods are assembled only when ordered and to satisfy the precise preferences of each consumer. This would ________ the desired level of inventories, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: B Topic: 19.3 Inventory Investment AACSB: Analytical Thinking 13) Consider the two graphs above. Suppose there is increased concentration in the retail sector (that is, fewer, larger companies). This would ________ the desired level of inventories, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: D Topic: 19.3 Inventory Investment AACSB: Analytical Thinking 14) Consider the two graphs above. Suppose rising fuel costs makes it more expensive to move goods to and from warehouses. This would ________ the desired level of inventories, as depicted in graph ________.

A) increase; B B) increase; A C) decrease; B D) decrease; A Answer: C Topic: 19.3 Inventory Investment AACSB: Analytical Thinking

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Figure 19.1

15) Which of the following is the most likely explanation for the behavior of private inventories between September 2007 and September 2009, as depicted in Figure 19.1?

A) a substantial decline in the desired level of inventories, due to a slump in aggregate demand B) a substantial decline in the desired level of inventories, as improvements in technology have reduced the size of inventories needed to support both production and customer deliveries C) an unanticipated draw-down of inventories as the economy was growing much faster than expected D) a substantial decline in the desired level of inventories, as changes in the tax code increased the cost of holding inventories Answer: A Topic: 19.3 Inventory Investment AACSB: Analytical Thinking 16) Between September 2009 and September 2010, the recovery of private inventories, as shown in Figure 19.1, was far stronger than the overall economy's recovery from the Great Recession.

Which is the most reasonable inference?

A) Persistently weak aggregate demand gave producers no alternative but to place current output into storage.

B) Businesses overestimated the strength of the recovery, which lead to overstocking of inventories.

C) Financial constraints had forced businesses to contract inventories by more than they otherwise would have chosen. The period beginning in September 2009 reflects the attempt by businesses to correct this.

D) Generally poor weather conditions in the final months of the year in the northern hemisphere make it less costly to store goods than to transport them to consumers.

Answer: C Topic: 19.3 Inventory Investment AACSB: Analytical Thinking

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17) Figure 19.1 displays changes in the size of private inventories. Based on the figure, in which month is the size of private inventories likely to have been lowest?

A) September 2010 B) September 2011 C) September 2009 D) March 2010 Answer: D Topic: 19.3 Inventory Investment AACSB: Analytical Thinking 18) Figure 19.1 shows the actual behavior of inventories. Based on the figure, in which month is the discrepancy between the actual level of inventories and the desired level of inventories likely to have been smallest?

A) March 2012 B) September 2009 C) March 2010 D) September 2010 Answer: A Topic: 19.3 Inventory Investment AACSB: Reflective Thinking 19) Four reasons for firms to hold inventories are given in the text. For each reason, indicate briefly whether and how it helps to explain the high volatility of inventory investment.

Answer: The role of inventories as a factor of production and as work in process does not vary much in the short run. Inventories of finished goods that result from production smoothing and stock-out avoidance are a source of short-run volatility, because expected demand is procyclical.

Optimistic expectations cause inventories to swell in anticipation of robust sales. When demand slumps, inventories grow even larger, until production is cut back. Then pessimistic forecasts imply inventory reduction, and inventories can fall precipitously as demand recovers, until production accelerates.

Topic: 19.3 Inventory Investment AACSB: Reflective Thinking

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19.4 Tobin's q and Investment 1) Tobin's q is equal to ________.

A) the market value of a firm times the replacement cost of installed capital B) the market value of a firm plus the replacement cost of installed capital C) the market value of a firm divided by the replacement cost of installed capital D) the market value of a firm minus the replacement cost of installed capital Answer: C Topic: 19.4 Tobin's q and Investment 2) If the market value of a firm is $6 billion and the replacement cost of installed capital is equal to $3 billion, then Tobin's q is equal to ________.

A) 9 B) 3 C) 18 D) 2 Answer: D Topic: 19.4 Tobin's q and Investment AACSB: Analytical Thinking 3) If the market value of a firm is $6 billion and Tobin's q is equal to 2, then the replacement cost of installed capital must be ________.

A) $2 billion B) $3 billion C) $9 billion D) $18 billion Answer: B Topic: 19.4 Tobin's q and Investment AACSB: Analytical Thinking 4) A rise in stock prices leads to ________.

A) an increase in income B) an increase in Tobin's q C) a decrease in Tobin's q D) a decrease in income Answer: B Topic: 19.4 Tobin's q and Investment AACSB: Analytical Thinking 5) A decline in Tobin's q can be caused by ________.

A) a rise in the market value of a firm B) an increase in stock prices C) a decline in stock prices D) a decline in the replacement cost of capital Answer: C Topic: 19.4 Tobin's q and Investment AACSB: Analytical Thinking 14 .

6) Fluctuations in Tobin's q are ________, because ________.

A) frequent and substantial; asset prices are volatile B) frequent and substantial; replacement costs are volatile C) infrequent and mild; replacement costs are relatively stable D) infrequent and mild; the marginal product of capital does not change quickly Answer: A Topic: 19.4 Tobin's q and Investment AACSB: Analytical Thinking 7) When Tobin's q is greater than one, ________.

A) a unit of a firm's stock (equity) is worth more than a unit of the firm's capital B) a new unit of capital has more value than a new unit of stock (equity) C) installed capital is worth less than new capital D) a unit of capital that a firm owns has more value than a unit it might buy Answer: D Topic: 19.4 Tobin's q and Investment AACSB: Analytical Thinking 8) According to Tobin's q theory, the principal objective of investment is ________.

A) to increase eligibility for the investment tax credit B) to expand production C) to increase the market value of the firm D) to lower the replacement cost of installed capital Answer: C Topic: 19.4 Tobin's q and Investment 9) Which ratio correctly highlights the similarity between neoclassical theory and Tobin's q theory?

A) the marginal product of capital divided by the user cost of capital B) a firm's stock value divided by the value of its capital stock C) a firm's capital stock divided by the value of its inventories D) a firm's investment spending divided by the user cost of capital Answer: A Topic: 19.4 Tobin's q and Investment AACSB: Reflective Thinking 10) Tobin's q theory adds to neoclassical theory because it ________.

A) illustrates the important relationship between tax rates and the incentive to labor B) emphasizes the role played by asset price fluctuations on investment spending C) highlights the impact of a tax increase on business investment D) underlines the relationship between financial innovation and the financial crisis of 2007-2009 Answer: B Topic: 19.4 Tobin's q and Investment

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11) Use Tobin's q theory and the neoclassical theory of investment to explain how optimistic scenarios of the "information age" would cause overinvestment in computer-related capital goods, and how that overinvestment would cause a sudden reversal.

Answer: A high expected marginal product of capital causes a high demand for "information age" capital goods. Both producers and buyers of capital goods are rewarded with rising stock market valuations, which inspires increased investment. Though productivity improves — the marginal product of capital curve shifts up — the rapid increase in the capital stock is subject to diminishing returns — the marginal product of capital declines due to the rightward movement along the curve. Increasing supply and technological progress among the capital-producing firms prevents an increase in the real price of capital, so the user cost remains low and the capital stock continues to rise. When diminishing returns to capital meets "exuberance" driven stock prices, the latter begin to fall, which softens the demand for capital goods. The market valuation of firms in the tech sector drops dramatically, because they have both excess capital and depressed demand.

Topic: 19.4 Tobin's q and Investment AACSB: Reflective Thinking 12) In many economies, a substantial fraction of investment is by multinational corporations (MNCs) whose stock value is determined on global markets. Based on Tobin's q theory, how might we expect MNC investment to affect the volatility of aggregate investment in an economy?

Answer: If investment is sensitive to global market valuation, then it is less sensitive to economic conditions in a particular economy. The economy's business cycle should have lower amplitude, and investment should be less volatile. Unless the (global) market valuation of the MNCs is more volatile than the economy's aggregate investment, or happens to be closely correlated with the economy's business cycle.

Topic: 19.4 Tobin's q and Investment AACSB: Reflective Thinking 13) Use Tobin's q theory and the neoclassical theory of investment to explain why investment rises so rapidly once the economy has passed the trough of a business cycle.

Answer: As an economy enters the recovery phase of the business cycle, investment is encouraged by a low real interest rate, relatively low real price of capital, relatively low inventories, and improving expectations of future output that raise the desired level of the capital stock. The increased expected marginal product of capital raises the market value of firms, which inspires more investment and boosts the expected price of capital, lowering the user cost. So long as new capital is seen as augmenting the value of the firm, investment is self-propelling.

Topic: 19.4 Tobin's q and Investment AACSB: Reflective Thinking

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19.5 Residential Investment 1) Applying neoclassical theory to the housing market, a higher marginal product of (housing) capital may be caused by ________.

A) higher expected household income B) the inability to buy as much housing at a higher price C) an expected increase in the relative price of housing D) a decrease in the cost of building new houses Answer: A Topic: 19.5 Residential Investment AACSB: Analytical Thinking 2) Applying neoclassical theory to the housing market, the idea that "housing is a good investment" refers to ________.

A) higher expected household income B) the inability to buy as much housing at a higher price C) an expected increase in the relative price of housing D) a decrease in the cost of building new houses Answer: C Topic: 19.5 Residential Investment AACSB: Analytical Thinking 3) Applying neoclassical theory to the housing market, ________ cause a decrease in the desired stock of houses.

A) higher expected household incomes B) higher rates of household formation C) increases in the expected relative price of housing D) tighter constraints on mortgage financing Answer: D Topic: 19.5 Residential Investment AACSB: Analytical Thinking 4) Applying neoclassical theory to the housing market, ________ cause a decrease in the user cost of housing.

A) higher expected household incomes B) higher rates of household formation C) increases in the expected relative price of housing D) tighter constraints on mortgage financing Answer: C Topic: 19.5 Residential Investment AACSB: Analytical Thinking

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5) An increase in the desired stock of housing would be caused by ________.

A) an increase in household formation B) higher residential consumption C) a decrease in expected future income D) an increase in home prices Answer: A Topic: 19.5 Residential Investment AACSB: Analytical Thinking 6) Through its impact on the desired stock of housing, higher expected income would lead to ________.

A) an increase in residential investment B) a decrease in expected house price appreciation C) a decrease in residential investment D) a decrease in single-family dwellings Answer: A Topic: 19.5 Residential Investment AACSB: Analytical Thinking 7) A decline in real mortgage rates will lead, other things the same, to ________.

A) lower demand for housing B) tighter financing constraints C) an increase in residential investment D) a lower relative price of housing Answer: C Topic: 19.5 Residential Investment AACSB: Analytical Thinking 8) The provision of funds to the mortgage market through the purchase of mortgage-backed securities and mortgages is performed by ________.

A) Fannie Mae and Freddie Mac B) the Federal Housing Administration C) the Federal Reserve System D) subprime borrowers Answer: A Topic: 19.5 Residential Investment 9) The federal government has encouraged home ownership through ________.

A) an increase in home prices B) an increase in domestic interest rates C) a decrease in the implicit rent on residential housing D) allowing mortgage interest to be tax deductible Answer: D Topic: 19.5 Residential Investment

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10) The federal government of the United States has ________.

A) proven itself unable to significantly influence U.S. home ownership B) has been able to increase the volume of home ownership in the U.S. C) proven itself able to effectively control monetary policy D) has been unable to increase the volume of government spending since WWII Answer: B Topic: 19.5 Residential Investment 11) Why is residential investment procyclical?

Answer: Cyclical fluctuations of income and expected income dominate the demand for housing. The user cost of housing is composed of procyclical elements — the real interest rate and the relative price of housing — which would counter the cyclicality of residential investment. But these cost determinants (as well as the procyclical cost of construction) are overwhelmed by expected changes in the relative price of housing. Residential investment is neither deterred by a boom nor revived during a slump. Rather, it thrives during a boom and languishes until the slump has passed.

Topic: 19.5 Residential Investment AACSB: Reflective Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 20 The Labor Market, Employment, and Unemployment 20.1 Developments in the U.S. Labor Market 1) The employment ratio is the ________.

A) labor force divided by the population B) proportion of the civilian working-age population that is employed C) number of individuals employed divided by the size of the labor force D) number of individuals employed divided by the number of the unemployed Answer: B Topic: 20.1 Developments in U.S. Labor Market 2) The unemployment rate in the U.S. is equal to ________.

A) the number of individuals unemployed in the U.S. divided by the U.S. population B) the number of individuals unemployed divided by the U.S. labor force C) the size of the U.S. population divided by the number of individuals unemployed D) the size of the U.S. labor force divided by the number of individuals unemployed Answer: B Topic: 20.1 Developments in U.S. Labor Market 3) Over the last 50 years, the employment ratio has risen most significantly among ________.

A) men B) women C) blacks D) Hispanics Answer: B Topic: 20.1 Developments in U.S. Labor Market 4) Over the last 50 years, the employment ratio has fallen most significantly among ________.

A) men B) women C) blacks D) Hispanics Answer: A Topic: 20.1 Developments in U.S. Labor Market 5) In the U.S., the employment ratio is highest among ________, and lowest among ________.

A) women; both sexes combined B) men; college-educated workers C) women; men D) men; women Answer: D Topic: 20.1 Developments in U.S. Labor Market

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6) Over the past five decades, the U.S. civilian unemployment rate has varied between, roughly, ________.

A) 3% and 11% B) 55% and 60% C) 6% and 8% D) 0.2% to 0.4% Answer: A Topic: 20.1 Developments in U.S. Labor Market AACSB: Analytical Thinking 7) The highest unemployment rate recorded since World War II came in ________.

A) September 1929 B) January 1961 C) December 1982 D) October 2009 Answer: C Topic: 20.1 Developments in U.S. Labor Market 8) From 1965 to 2013, the average real wage for all workers has ________.

A) fallen B) risen C) remained essentially unchanged D) risen in economic contractions and fallen in economic expansions Answer: C Topic: 20.1 Developments in U.S. Labor Market 9) Over the past 50 years, the average real wage for males who do not have a college diploma has ________.

A) fallen B) risen C) remained essentially unchanged D) risen in economic contractions and fallen in economic expansions Answer: A Topic: 20.1 Developments in U.S. Labor Market AACSB: Analytical Thinking 10) Over the past 50 years, the largest increase in average real wage has occurred among ________.

A) male college graduates B) female college graduates C) males with post-college education D) females with post-college education Answer: D Topic: 20.1 Developments in U.S. Labor Market AACSB: Analytical Thinking

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11) The unemployment rate ________.

A) is essentially unchanged over the business cycle B) rises in economic expansions and falls in economic contractions C) falls consistently over both economic expansions and recessions D) varies over the course of the business cycle Answer: D Topic: 20.1 Developments in U.S. Labor Market 20.2 Supply and Demand in the Labor Market 1) The demand for labor schedule is the same as ________.

A) real wage line B) supply of labor schedule C) the minimum wage rate in that economy D) the marginal product of labor schedule Answer: D Topic: 20.2 Supply and Demand in the Labor Market AACSB: Analytical Thinking 2) The equation Y = A is known as the ________.

A) Cobb-Douglas production function B) labor supply curve C) marginal product of labor D) capital-to-employment function Answer: A Topic: 20.2 Supply and Demand in the Labor Market 3) If the marginal product of labor exceeds that cost of hiring an additional worker, the firm should ________.

A) fire some workers B) raise the wage rate C) add more workers D) lower the wage rate Answer: C Topic: 20.2 Supply and Demand in the Labor Market AACSB: Analytical Thinking 4) Moving along the supply curve for labor, increases in the quantity of labor result from ________.

A) diminishing returns to labor effort B) a rising cost of leisure C) a reduced preference for leisure D) more efficient recruitment of workers Answer: B Topic: 20.2 Supply and Demand in the Labor Market AACSB: Analytical Thinking 3 .

5) The upward-sloping character of the labor supply schedule assumes that the ________.

A) the substitution effect is equal to the income effect B) the substitution effect is larger than the income effect C) the substitution effect is smaller than the income effect D) the ratio of real wages to the marginal product of labor is equal to the equilibrium nominal wage Answer: B Topic: 20.2 Supply and Demand in the Labor Market AACSB: Analytical Thinking 6) In the market for their services, workers face a trade-off between ________.

A) higher and lower wage jobs B) equilibrium and non-equilibrium solutions C) labor and leisure D) diminishing and increasing marginal productivity Answer: C Topic: 20.2 Supply and Demand in the Labor Market AACSB: Analytical Thinking 7) Suppose the marginal product of labor (MPL) is greater than the real wage. If the real wage remains constant, then we should expect ________.

A) an increase in employment and decrease in the MPL B) an increase in the supply of labor and decrease in the MPL C) an increase in leisure and no change in the MPL D) an increase in the supply of labor and no change in the MPL Answer: A Topic: 20.2 Supply and Demand in the Labor Market AACSB: Analytical Thinking 8) Suppose the marginal product of labor is

, where Y is 12, and L is the quantity of

workers. The supply of labor is given by L = 110 + 2.5 × w. If the real wage is 50, what is the unemployment rate?

Answer: Setting MPL = 50, L = 168. At w = 50, labor supply is 235. The quantity of unemployment is 67, so the unemployment rate is 67 ÷ 235 = 28.5%.

Topic: 20.2 Supply and Demand in the Labor Market AACSB: Analytical Thinking

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20.3 Response of Employment and Wages to Changes in Labor Demand and Labor Supply 1) An increase in output due to either a positive supply or demand shock to production will lead to ________.

A) an increase in the demand for labor and higher real wages B) a decrease in the demand for labor and higher real wages C) an increase in the demand for labor and lower real wages D) a decrease in the demand for labor and lower real wages Answer: A Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Analytical Thinking 2) An increase in labor supply will cause, other things the same ________.

A) real wages and employment to rise B) real wages to fall and employment to rise C) real wages to rise and employment to fall D) real wages and employment to fall Answer: B Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Analytical Thinking 3) Among the causes of an increase in labor supply is ________.

A) a relaxation of restrictions on child labor B) an increase in enrollment at colleges C) an improvement in worker productivity D) a contraction of economic activity Answer: A Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Analytical Thinking 4) Among the causes of an increase in labor demand is ________.

A) a relaxation of restrictions on child labor B) an increase in enrollment at colleges C) an improvement in worker productivity D) a contraction of economic activity Answer: C Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Analytical Thinking 5) Among the causes of an increase in labor demand is ________.

A) improved availability and affordability of day care for children B) an increase in enrollment at colleges C) an increase in the college wage premium D) an expansion of economic activity Answer: D Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Analytical Thinking 5 .

6) Among the causes of an increase in labor supply is ________.

A) improved availability and affordability of day care for children B) an increase in enrollment at colleges C) an increase in the college wage premium D) an expansion of economic activity Answer: A Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Analytical Thinking 7) Having observed that both the real wage and the quantity of employment are increasing, we may conclude that ________ is not ________.

A) demand; decreasing B) supply; decreasing C) demand; increasing D) supply; increasing Answer: C Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Analytical Thinking 8) Prior to the 1980s ________.

A) the hourly wage of women exceeded that of their male counterparts B) the employment ratio for women was equal to that of men C) a majority of women were not in the labor force D) the majority of men were not in the labor force Answer: C Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply 9) The increased labor force participation rates for women since the 1970s led most directly to ________.

A) an increase in labor demand B) a decrease in labor demand C) a decrease in labor supply D) an increase in labor supply Answer: D Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Analytical Thinking 10) A decrease in discrimination against women after the 1970s led most directly to ________.

A) an increase in labor demand B) a decrease in labor demand C) a decrease in education D) a decrease in labor supply Answer: A Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Analytical Thinking 6 .

11) Which of these is not a good example of skill-biased technical change?

A) GPS navigation equipment in delivery trucks B) web-enabled virtual classrooms C) self-service check out scanners D) use of robots in automobile assembly Answer: B Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Reflective Thinking 12) Over the course of recent years, the college premium has ________.

A) remained essentially unchanged B) risen C) fallen D) excluded civilians from calculations of the labor force Answer: B Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply 13) The percentage of hours worked by college educated workers since the 1960s has ________.

A) fallen B) stayed essentially unchanged C) increased D) moved in the opposite direction of the college premium Answer: C Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply 14) The wage gap between high school and college graduates can be explained, other things the same, by ________.

A) a greater increase in the demand for high school educated labor than college-educated labor B) a greater increase in the supply of college-educated labor than high school educated labor C) a greater increase in the demand for high school educated labor than in the supply of high school educated labor D) a greater increase in the demand for college-educated labor than high school educated labor Answer: D Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Analytical Thinking 15) The skill-biased character of technological change in recent decades has tended to cause ________.

A) a decrease in the demand for college-educated labor B) a higher rate of unemployment among college-educated labor C) a lower rate of unemployment among unskilled labor D) an increase in demand for college-educated labor Answer: D Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Analytical Thinking

7 .

16) The process of globalization has ________.

A) decreased inequality B) increased inequality C) had little measurable effect on income inequality D) has increased income inequality in developing countries but decreased inequality in developed countries Answer: B Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply 17) Assume that college-educated labor and high school-educated labor are complements in production. That is, the two types of labor work together, so that an increase in the quantity of either type increases the productivity of the other type of labor. Is this consistent with the observed increase in the college wage premium?

Answer: Yes. Labor complementarity helps to explain why the wage for college-educated workers continues to rise, even while the supply is rising. The marginal product of collegeeducated workers does not fall, so long as their skills can be combined with the input of lesseducated workers. An important aspect of skill-biased technical change is to allow a given quantity of relatively uneducated workers to support rising productivity among an increasing quantity of highly educated workers. Complementarity helps to explain how the wage for uneducated workers remains relatively stable, rather than declining toward zero as the wage for college-educated workers continues to rise.

Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Reflective Thinking 18) How might a decrease in the labor force participation of males be related to the increase in the participation rate for females?

Answer: To some extent, increased female employment means fewer job openings available to male workers. An increase in the number of female job seekers reduces the expected benefit of job search for a male. More significantly, both higher income and reduced "leisure" time among females raise the value of "leisure" among males.

Topic: 20.3 Response of Employment and Wages to Changes in Labor Demand and Supply AACSB: Reflective Thinking

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20.4 Dynamics of Unemployment 1) Those who just stop looking for employment are known as ________.

A) cyclically unemployed B) discouraged workers C) frictionally unemployed D) chronically unemployed Answer: B Topic: 20.4 Dynamics of Unemployment 2) During a recession, when unemployment is rising, the number of new jobs created is, typically, ________.

A) large, but smaller than the number of jobs lost B) small, and below the number of jobs lost C) small, but higher than the number of jobs lost D) large, but smaller than net entrants to the labor force Answer: A Topic: 20.4 Dynamics of Unemployment AACSB: Analytical Thinking 3) During a recession, when unemployment is rising, the number of new jobs created is, typically, ________.

A) large, and higher than the number of jobs lost B) small, and below the number of jobs lost C) small, but higher than the number of jobs lost D) large, and higher than net entrants to the labor force Answer: D Topic: 20.4 Dynamics of Unemployment AACSB: Analytical Thinking 4) Net entrants to the labor force is likely to be highest when the economy ________.

A) is entering a recession B) nears the peak of an expansion C) has passed the peak of an expansion D) begins to recover from a recession Answer: D Topic: 20.4 Dynamics of Unemployment AACSB: Analytical Thinking 5) The principal cause of falling unemployment is ________.

A) an increase in net entrants to the labor force B) a decrease in net entrants to the labor force C) an increase in the number of new jobs created D) a decrease in the number of jobs lost Answer: C Topic: 20.4 Dynamics of Unemployment AACSB: Reflective Thinking 9 .

6) The employment ratio is always ________ than labor force participation, because only the latter ________ A) larger; omits discouraged workers B) smaller; includes the unemployed C) smaller; omits people too young to work D) larger; includes people looking for work Answer: B Topic: 20.4 Dynamics of Unemployment AACSB: Analytical Thinking 7) The label "discouraged worker" refers to a change of status from ________.

A) employed to actively seeking employment B) unemployed to employed C) unemployed to not in the labor force D) not in the labor force to unemployed Answer: C Topic: 20.4 Dynamics of Unemployment 8) The largest number of individuals of working age in the U.S. population are ________.

A) discouraged workers B) unemployed C) employed D) not in the U.S. labor force Answer: C Topic: 20.4 Dynamics of Unemployment 9) For most of the unemployed, unemployment spells are ________.

A) longer than a year B) longer than 10 years C) permanent D) shorter than three months Answer: D Topic: 20.4 Dynamics of Unemployment 10) Individuals who suffer from unemployment spells lasting more than six months are ________.

A) chronically unemployed B) frictionally unemployed C) discouraged workers D) no longer counted as part of the labor force Answer: A Topic: 20.4 Dynamics of Unemployment

10 .

11) Suppose the marginal product of labor is

, where Y is 12, and L is the quantity of

workers. The supply of labor is given by L = 110 + 2.5 × w. Calculate the changes that occur in (a) employment, (b) unemployment, and (c) the size of the labor force, when the real wage declines from 45 to 42.

Answer: When the real wage is 45, labor demand is 187 and labor supply is 222.5, so unemployment is 35.5. At a real wage of 42, labor demand rises to 200, an increase of 13. Labor supply falls to 215, a decrease of 7.5. The number of unemployed is reduced to 15, a decrease of 20.5.

Topic: 20.4 Dynamics of Unemployment AACSB: Analytical Thinking 12) Technical and "junior" colleges offering full-time degree programs that may be completed in two years or less are a rapidly growing segment of the U.S. economy. What are some likely impacts on aggregate flows into and out of employment status?

Answer: For workers who lose (or leave) a job and opt for technical college, the status change is from "employed" to "not in the labor force," rather than to "unemployed." Workers who go to technical college before beginning to search for their first job are likely to transition from "not in the labor force" to "employed," with no interval of "unemployed." Thus, flows between "employed" and "not in the labor force" are enlarged, relative to flows from either status into "unemployed." As an alternative to unemployment, technical colleges increase the flow from "unemployed" to "not in the labor force," relative to the flow from "unemployed" to "employed."

Topic: 20.4 Dynamics of Unemployment AACSB: Reflective Thinking 20.5 Causes of Unemployment 1) Unemployment related to job search is known as ________.

A) cyclical unemployment B) frictional unemployment C) structural unemployment D) tertiary unemployment Answer: B Topic: 20.5 Causes of Unemployment 2) Researchers have found that once workers become ineligible for unemployment insurance, they become twice as likely to take a job. From this finding we may infer that unemployment insurance causes a(n) ________ in ________ unemployment.

A) decrease; structural B) increase; frictional C) increase; structural D) decrease; cyclical Answer: B Topic: 20.5 Causes of Unemployment AACSB: Analytical Thinking

11 .

3) Empirical evidence strongly supports the view that unemployment insurance ________.

A) decreases unemployment B) has little effect on employment C) increases unemployment D) has little effect on unemployment Answer: C Topic: 20.5 Causes of Unemployment 4) Unemployment that arises from a lack of skills is known as ________.

A) seasonal unemployment B) cyclical unemployment C) discouraged unemployment D) structural unemployment Answer: D Topic: 20.5 Causes of Unemployment 5) Unemployment that emerges during sectoral shifts in the economy is known as ________.

A) structural unemployment B) discouraged unemployment C) cyclical unemployment D) frictional unemployment Answer: A Topic: 20.5 Causes of Unemployment 6) Unemployment that develops as old industries die off is known as ________.

A) cyclical unemployment B) structural unemployment C) frictional unemployment D) voluntary unemployment Answer: B Topic: 20.5 Causes of Unemployment 7) One source of structural unemployment is ________.

A) the seasonal character of production in some industries, e.g. agriculture in Alaska during winter months B) falling sales in an economic downturn C) wage rigidity D) high search costs Answer: C Topic: 20.5 Causes of Unemployment

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8) An increase in an effective federal minimum wage would tend to cause ________.

A) a decrease in wage rates and an increase in employment B) an increase in wage rates and employment C) a decrease in wage rates and employment D) an increase in wage rates and a decrease in employment Answer: D Topic: 20.5 Causes of Unemployment AACSB: Analytical Thinking Labor Market

9) On the graph above, the wage level at point ________ might represent a binding minimum wage.

A) 2 B) 4 C) 6 D) 5 Answer: A Topic: 20.5 Causes of Unemployment AACSB: Analytical Thinking 10) On the graph above, the wage level at point ________ might represent an efficiency wage.

A) 2 B) 4 C) 6 D) 5 Answer: A Topic: 20.5 Causes of Unemployment AACSB: Analytical Thinking

13 .

11) On the graph above, suppose the labor market is in equilibrium at point 2, then the demand curve shifts down to the position shown on the graph. If the real wage has not changed, then the horizontal distance between points ________ measures the unemployment that results.

A) 2 & 4 B) 2 & 1 C) 3 & 4 D) 6 & 4 Answer: B Topic: 20.5 Causes of Unemployment AACSB: Analytical Thinking 12) Referring to the graph above, assume that, at first, the labor market is in equilibrium at point 4. In which scenario does unemployment rise, with no change in the quantity of employment?

A) real wage rises to the level of points 1 and 2 B) supply shifts to pass through point 5, with no change in the real wage C) demand shifts to pass through point 3, with no change in the real wage D) supply shifts to pass through point 3, with no change in the real wage Answer: B Topic: 20.5 Causes of Unemployment AACSB: Analytical Thinking 13) Referring to the graph above, assume that, at first, the labor market is in equilibrium at point 4. Then, demand shifts to pass through point 3, and the real wage adjusts to the new equilibrium. ________ is ________ at the new equilibrium, compared to the original equilibrium.

A) unemployment; larger B) unemployment; smaller C) the labor force; smaller D) employment; larger Answer: C Topic: 20.5 Causes of Unemployment AACSB: Analytical Thinking 14) The setting of minimum wages in the U.S. began with the ________.

A) Sherman Anti-Trust Act of 1890 B) Garn St. Germain Act of 1982 C) Depository Institutions Deregulation and Monetary Control Act of 1980 D) Fair Labor Standards Act of 1938 Answer: D Topic: 20.5 Causes of Unemployment 15) Efficiency wages are ________.

A) market clearing wages B) wages that are above the market-clearing level C) equal to the real wage rate minus the nominal wage rate D) equal to the nominal wage rate divided by some measure of the general price level Answer: B Topic: 20.5 Causes of Unemployment 14 .

16) A classic early example of efficiency wages came in ________.

A) Nazi Germany B) 1973 with the increase in OPEC-determined oil prices C) 1914 at the Ford Motor Company D) 1890 with the Sherman Antitrust Act Answer: C Topic: 20.5 Causes of Unemployment 17) In the wake of Henry Ford's payment of efficiency wages in 1914 ________.

A) absenteeism and productivity fell B) absenteeism and productivity rose C) absenteeism rose and productivity fell D) absenteeism fell and productivity rose Answer: D Topic: 20.5 Causes of Unemployment 18) The process of bargaining for a large group of workers at one time rather than individually is known as ________.

A) collective bargaining B) autarky C) tertiary negotiations D) ornamental horticulture Answer: A Topic: 20.5 Causes of Unemployment 19) Suppose researchers discover that a government program to match job seekers and employers has caused an increase in the unemployment rate. Does this mean that the program has failed?

Answer: No. A program to facilitate good job matches will increase frictional unemployment, if it inspires enough of either discouraged workers (who had given up their job search) or discontented workers (who have a job) to join the unemployed in the program. If the program improves job placements, it enhances the economic benefit of frictional unemployment, regardless its impact on the rate of unemployment.

Topic: 20.5 Causes of Unemployment AACSB: Reflective Thinking

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20) Katz and Krueger found that minimum wage laws had a negligible impact on teenage unemployment in the fast-food industry. Describe the characteristics of labor demand and supply that might produce such a result.

Answer: If worker productivity is sensitive to changes in the quantity of labor input, the marginal product of labor (demand) curve is quite steep. A small decrease in labor input makes the remaining workers much more productive — they can easily "take up the slack." In that case, a wage increase has a small impact on employment. For a minimum wage to have a small impact on unemployment, the wage must not be too attractive to potential job seekers (many of whom would fail to get a job). For many teens, the reason to get a job is either to have "some" income (rather than no income) and/or because job experience seems more valuable than alternative activities. These motivations suggest a lack of sensitivity to the real wage; a higher wage has little effect on those who were not already in the labor force.

Topic: 20.5 Causes of Unemployment AACSB: Reflective Thinking 21) Typically, employers compete with each other in the labor market to get and to retain the best possible workers. Explain how such competition might prevent the unemployment rate from ever being close to zero.

Answer: When the unemployment rate is low, employers will offer a relatively high wage to attract high-quality job applicants and to counter poaching of their high-quality employees. Since the cost of labor is high, employers will create as few jobs as possible. The high wage, as intended, will attract a fair number of job seekers, many of whom will remain unemployed.

Topic: 20.5 Causes of Unemployment AACSB: Reflective Thinking 20.6 Natural Rate of Unemployment 1) The actual unemployment rate is equal to ________.

A) the natural rate of unemployment plus the cyclical rate B) the natural rate of unemployment minus the cyclical rate C) the natural rate of unemployment times the cyclical rate D) the natural rate of unemployment divided by the cyclical rate Answer: A Topic: 20.6 Natural Rate of Unemployment 2) The natural rate of unemployment ________.

A) is equal to 0.078 percent B) is a constant C) varies across time and countries D) is equal to the cyclical rate of unemployment divided by the actual rate Answer: C Topic: 20.6 Natural Rate of Unemployment

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3) Many economists view ________ as explaining most of the increase in the natural rate of unemployment in the U.S. from 1960 to 1980.

A) the rise in the percentage of young workers in the labor force B) an increase in the percentage of the working-age population receiving disability insurance C) a decrease in the size of the prison population D) increased use of temporary workers Answer: A Topic: 20.6 Natural Rate of Unemployment 4) Which of the following does not influence the natural rate of unemployment in the U.S.?

A) demographics B) the natural rate in Europe and Japan C) the composition of the labor force D) surprises in productivity growth Answer: B Topic: 20.6 Natural Rate of Unemployment 5) Which of the following is not an aspect of the composition of the labor force?

A) the prison population B) workers taking disability C) the use of temporary workers D) the natural rate of unemployment Answer: D Topic: 20.6 Natural Rate of Unemployment 6) People who end up in prison are particularly subject to ________.

A) higher cyclical unemployment B) higher structural unemployment C) lower cyclical unemployment D) lower seasonal unemployment Answer: B Topic: 20.6 Natural Rate of Unemployment 7) Workers who suffer disability are likely to suffer higher ________.

A) cyclical unemployment B) tertiary unemployment C) structural unemployment D) natural unemployment Answer: C Topic: 20.6 Natural Rate of Unemployment

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8) An increase in the prison population would tend to cause, other things the same, a decrease in ________.

A) federal disabilities benefits B) the use of temporary workers C) the college premium D) the natural rate of unemployment Answer: D Topic: 20.6 Natural Rate of Unemployment AACSB: Analytical Thinking 9) Which of the following is likely to cause a decrease in the natural rate of unemployment?

A) an increase in the percentage of the working-age population receiving disability insurance B) a decrease in the use of temporary workers C) a growing percentage of young workers in the labor force D) generous unemployment insurance benefits Answer: A Topic: 20.6 Natural Rate of Unemployment AACSB: Analytical Thinking 10) Since 1980, the share of temporary workers in total U.S. employment has ________.

A) declined B) increased C) remained essentially unchanged D) been impossible to determine Answer: B Topic: 20.6 Natural Rate of Unemployment 11) When productivity growth has been rapid and then slows, the natural rate of unemployment is likely to ________.

A) decrease B) be unaffected C) increase D) vary unpredictably Answer: C Topic: 20.6 Natural Rate of Unemployment AACSB: Analytical Thinking 12) The natural rate of unemployment ________.

A) is roughly the same in the U.S. and Europe B) is higher in the U.S. than in Europe C) cannot be calculated for European economies given their generous system of transfer payments D) is higher in Europe than in the U.S. Answer: D Topic: 20.6 Natural Rate of Unemployment

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13) If productivity growth accelerates, but workers do not realize it ________.

A) they will expect large wage hikes B) they will not expect large wage hikes C) the natural rate of unemployment will rise D) the number of discouraged workers will rise Answer: B Topic: 20.6 Natural Rate of Unemployment AACSB: Analytical Thinking 14) When workers expect the real wage to rise at a rate similar to productivity improvements, ________.

A) the decrease in labor supply raises the real wage B) the increase in labor supply lowers the real wage C) the increase in labor supply raises the real wage D) the decrease in labor supply lowers the real wage Answer: A Topic: 20.6 Natural Rate of Unemployment AACSB: Analytical Thinking 15) Over long periods of time, the cyclical rate of unemployment, on average, ________.

A) approaches infinity B) approaches a value of one C) should be close to zero D) approaches the natural rate Answer: C Topic: 20.6 Natural Rate of Unemployment 16) The natural rate of unemployment is higher in Europe than in the U.S. due to ________.

A) the greater relative strength of American unions B) the greater relative generosity of U.S. unemployment benefits C) the greater severity of the business cycle in Europe relative to the U.S. D) stricter European work rules Answer: D Topic: 20.6 Natural Rate of Unemployment 17) How might the increase in the natural rate of unemployment in Europe be related to the increase in income inequality in the United States?

Answer: The link is the skill-biased technical change that occurred in the 1980s and 90s. The result in Europe was that unskilled workers came to rely increasingly on government benefits and work rules. The result in the U.S. is that unskilled workers have stagnant real income and deteriorating job prospects, unless they are able to access the educational path to skilled employment.

Topic: 20.6 Natural Rate of Unemployment AACSB: Reflective Thinking

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18) Suppose the marginal product of labor is

, where Y is 12, and L is the quantity of

workers. The supply of labor is given by L = 110 + 2.5 × w, and the real wage is 41. Assume there has been steady technological progress, increasing the real wage by five percent per year, with no changes in employment or unemployment. This year, however, the rate of productivity growth is an unexpected zero percent. Calculate the rate of unemployment that results when the labor supply has decreased by five percent and the real wage is 43.

Answer: The quantity supplied at a real wage of 41 is 212.5. Labor supply adjusts so that the quantity supplied does not change when the real wage rises as expected to 43. The demand for labor (unexpectedly) does not shift. The quantity demanded of labor when the real wage is 43 is 195.35, so the unemployment rate is (212.5 - 195.35) ÷ 212.5 = 0.08.

Topic: 20.6 Natural Rate of Unemployment AACSB: Analytical Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 21 The Role of Expectations in Macroeconomic Policy 21.1 Rational Expectations and Policy Making 1) Adaptive expectations are formed ________.

A) from experience B) from best guesses about the future C) as new information becomes available D) as a weighted average of expert forecasts Answer: A Topic: 21.1 Rational Expectations and Policy Making AACSB: Analytical Thinking 2) Assume that prices have risen in a given economy by an average of 5 percent over the last nine years. If consumers base their expectations about future price movements on that knowledge alone their forecasts rely on ________.

A) reverse expectations B) adaptive expectations C) rational expectations D) monetary expectations Answer: B Topic: 21.1 Rational Expectations and Policy Making AACSB: Analytical Thinking 3) The notion that expectations will be identical to optimal forecasts using all available information is known as ________.

A) adaptive expectations B) irrational expectations C) rational expectations D) tertiary expectations Answer: C Topic: 21.1 Rational Expectations and Policy Making 4) A prediction based on rational expectations ________.

A) relies solely on past experience B) will always be superior to one based on adaptive expectations C) is based on real, rather than nominal variables D) will not always be accurate Answer: D Topic: 21.1 Rational Expectations and Policy Making AACSB: Analytical Thinking

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5) Rational expectations are more accurate than adaptive expectations, ________.

A) on average B) always C) because they require less information D) except when policies have changed Answer: A Topic: 21.1 Rational Expectations and Policy Making AACSB: Analytical Thinking 6) If households have information that monetary policy is likely to change in the future, that information will play a role in forming ________.

A) adaptive expectations B) rational expectations C) tertiary expectations D) non-adaptive expectations Answer: B Topic: 21.1 Rational Expectations and Policy Making AACSB: Analytical Thinking 7) Rational expectations theory suggests that ________.

A) consumers base their expectations about the future largely on past experience B) economic agents will always alter their decision-making when a new piece of information becomes available C) economic agents will not be influenced by a piece of information if that information has already been anticipated D) consumers need not form expectations about the far flung future since most consumption decisions involve satisfying an immediate impulse, e.g. hunger Answer: C Topic: 21.1 Rational Expectations and Policy Making 8) Rational expectations theory suggests that ________.

A) policy announcements can impact behavior B) policy announcements have no impact on behavior C) unannounced policies have no impact on behavior D) the optimal forecast is identical to the announced policy Answer: A Topic: 21.1 Rational Expectations and Policy Making AACSB: Reflective Thinking 9) Expectations about the future will always be accurate if formed under ________.

A) rational expectations B) adaptive expectations C) natural selection D) none of the above Answer: D Topic: 21.1 Rational Expectations and Policy Making AACSB: Analytical Thinking 2 .

10) New information ought not to influence economic decision-making if ________.

A) consumers rely on rational expectations B) monetary policy changes C) monetary and/or fiscal policy changes D) that information has already been anticipated Answer: D Topic: 21.1 Rational Expectations and Policy Making AACSB: Analytical Thinking 11) The "rational expectations revolution" refers to a substantial change in the thinking of ________.

A) households and businesses B) policy makers C) macroeconomists D) elected officials Answer: C Topic: 21.1 Rational Expectations and Policy Making 12) ________ rational expectations, ________.

A) Most people have always formed; but macroeconomists have only recently come to recognize this fact B) Macroeconomists have invented; and are trying to teach them to the general public C) Policy makers have devised; in search of more effective policies D) The latest information is an important input in; so most people must make do with adaptive expectations Answer: A Topic: 21.1 Rational Expectations and Policy Making AACSB: Reflective Thinking 13) Suppose you need an estimate of future inflation (to decide, for example, whether a particular security is a good investment). How might you formulate a rational expectation?

Answer: A rational expectation is a best possible guess using all available information. Since any prediction is prone to error, the best strategy is to collect several predictions and, as much as possible, assess the plausibility of the underlying methods, paying particular attention to assumptions about future economic conditions.

Topic: 21.1 Rational Expectations and Policy Making AACSB: Reflective Thinking

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14) Under what circumstances might it be "rational" to rely on adaptive expectations?

Answer: Adaptive expectations are based on the past. An adaptive expectation is irrational only if there is reason to believe that it is possible to formulate a better guess. Though one can never be sure that the trends of the past will continue unaltered into the future, it may not be possible — without undue expense — to acquire enough information and understanding to justify the conclusion that the known trend will fail to persist. If the known trend has been reliable, there is no obvious reason to doubt its persistence, and there is no inexpensive way to conduct a forwardlooking assessment, the adaptive expectation is rational.

Topic: 21.1 Rational Expectations and Policy Making AACSB: Reflective Thinking 15) Both adaptive expectations and rational expectations are prone to error (a discrepancy between the expectation and the actual experience). In each case, how does error affect the formation of new expectations?

Answer: With adaptive expectations, the newest information is considered neither more nor less significant than the oldest available data. Rational expectations augment data with one or more hypotheses regarding the underlying mechanisms. Each new discrepancy is an opportunity to assess the accuracy of the presumed mechanisms. Given all available, relevant information, the latest discrepancy might be dismissed as an anomaly to be ignored when forming subsequent expectations. Or, the discrepancy might prompt a revision of hypotheses, such that new expectations are affected profoundly.

Topic: 21.1 Rational Expectations and Policy Making AACSB: Reflective Thinking 21.2 Lucas Critique of Policy Evaluation 1) Economists use ________ to forecast economic activity and to evaluate policy options.

A) macroeconometric models B) educated guesses C) cost-benefit analysis D) constrained discretion Answer: A Topic: 21.2 Lucas Critique of Policy Evaluation 2) Forecasts based on the extrapolation of observed trends and relationships are likely to be accurate, if ________.

A) changes in expectations are properly considered B) policy actions are anticipated C) economic behavior is guided by rational expectations D) policy changes are understood to be permanent Answer: A Topic: 21.2 Lucas Critique of Policy Evaluation AACSB: Reflective Thinking

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3) Robert Lucas spurred the rational expectations revolution in ________.

A) the 1960s B) the 1970s C) the 2000s D) the 1880s Answer: B Topic: 21.2 Lucas Critique of Policy Evaluation 4) The danger in using data to estimate the consequences of a proposed policy is that ________.

A) the data can reveal only the benefits of a policy, while estimating the policy's costs is important, also B) policies change so often that data can never reveal which policies are the cause of which consequences C) the public's expectations about the policy might influence the data, making the policy seem more or less appropriate than is actually the case D) the proposed policy, if implemented, might cause unforeseeable changes in the relationships that were in operation when the data were produced Answer: D Topic: 21.2 Lucas Critique of Policy Evaluation AACSB: Reflective Thinking 5) An economic policy has a decent chance of working as intended, if ________.

A) the policy causes no change in expectations B) if mistaken expectations are not very costly C) the rationale behind the policy is well-understood by the public D) expectations are formed in the same way by both the public and the policymakers Answer: D Topic: 21.2 Lucas Critique of Policy Evaluation AACSB: Reflective Thinking 6) According to the Lucas critique, what is the proper way to evaluate a proposal that reduces government borrowing by raising taxes and reducing government spending?

Answer: The Lucas critique emphasizes that changes in economic policy are likely to affect expectations of future policy and economic conditions, and such expectations have a strong impact on the behavioral response to the policy. Though aggregate income is reduced when taxes rise and government spending is reduced, people might expect that the reduction in government borrowing will lead to better economic conditions in the future. Proper policy evaluation must recognize that such optimism can counter the decrease in aggregate demand that might otherwise occur.

Topic: 21.2 Lucas Critique of Policy Evaluation AACSB: Reflective Thinking

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21.3 Policy Conduct: Rules or Discretion?

1) The time-inconsistency problem involves the ________.

A) difficulties of traveling across time zones B) tendency to deviate from good long-run plans in the short-run C) use of adaptive expectations in building an economic model D) time lag between the implementation of policy and its ultimate and complete results Answer: B Topic: 21.3 Policy Conduct: Rules or Discretion 2) The tendency to deviate from sound long-run plans in the short-run is known as ________.

A) the failure of adaptive expectations B) the failure of rational expectations C) the time inconsistency problem D) the NIMBY, or not in my backyard problem Answer: C Topic: 21.3 Policy Conduct: Rules or Discretion 3) Which of the following is most consistent with the time-inconsistency problem?

A) while it is ten o'clock in the morning in Chicago, it will be eleven o'clock in New York City B) a monetary policy action that is implemented in January will not begin to influence economic variables for several months C) a parent who acquiesces to a child's demand just to keep them quiet in a public setting D) an economic model with adaptive expectations Answer: C Topic: 21.3 Policy Conduct: Rules or Discretion AACSB: Reflective Thinking 4) According to monetarists, such as Milton Friedman ________.

A) the central bank should have discretionary authority to respond to economic problems that develop over the course of the business cycle B) the Taylor rule should effectively address the problem of inflation C) an increase in government spending has substantially the same effects as an unanticipated increase in the money supply on domestic interest rates D) the money supply should grow at a constant rate regardless of the state of the economy Answer: D Topic: 21.3 Policy Conduct: Rules or Discretion 5) The notion that the central bank should set its federal funds target by a formula that puts weight on both output and inflation gaps is known as ________.

A) the Taylor rule B) the constant growth rate rule for money C) the equation of exchange D) the Lucas rule Answer: A Topic: 21.3 Policy Conduct: Rules or Discretion 6 .

6) According to the Taylor rule ________.

A) expectations are formed in an adaptive fashion B) the central bank should set its federal funds rate target by a formula that puts weight on both output and inflation gaps C) a constant growth rate rule for money should be adopted D) expectations should be formed consistent with the model of rational expectations Answer: B Topic: 21.3 Policy Conduct: Rules or Discretion 7) For monetarists, the sole source of fluctuations in aggregate demand is ________.

A) government spending and tax rates B) the velocity of money C) the supply of money D) international trade variables, i.e. exports and imports Answer: C Topic: 21.3 Policy Conduct: Rules or Discretion 8) The constant growth rate rule for money, as initially proposed by Milton Friedman, has been adjusted ________.

A) to take the problem of moral hazard in account B) to account for the role played by adaptive expectations in policy formation C) for the difference between real and nominal economic variables D) to allow for possible short-run movements in velocity Answer: D Topic: 21.3 Policy Conduct: Rules or Discretion 9) According to monetarist theory, responsibility for the Great Depression lays with ________.

A) the Federal Reserve System B) the liberal rulings of the Supreme Court C) the President and Congress of the United States D) unfair trade practices Answer: A Topic: 21.3 Policy Conduct: Rules or Discretion 10) The Swiss National Bank established the practice of targeting monetary aggregates in ________.

A) 1929 B) 1975 C) 2001 D) 2008 Answer: B Topic: 21.3 Policy Conduct: Rules or Discretion

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11) The political business cycle involves the ________.

A) expenditure of substantial funds by industry lobbyists to manipulate government regulation B) movement of individuals from government employment to positions within the industry they had previously participated in regulating C) use of expansionary fiscal policy just prior to elections D) election of government officials who are supportive of the government sector Answer: C Topic: 21.3 Policy Conduct: Rules or Discretion 12) An example of the political business cycle in action came during the ________.

A) Roosevelt administration of the 1920s B) Nixon administration of the 1970s C) Reagan administration of the 1980s D) Bush administration of the 2000s Answer: B Topic: 21.3 Policy Conduct: Rules or Discretion 13) The use of expansionary fiscal and monetary policy just prior to elections is known as the ________.

A) electoral college B) time-inconsistency problem C) Watergate scandal D) political business cycle Answer: D Topic: 21.3 Policy Conduct: Rules or Discretion 14) When monetary policies result in a worsening of economic performance, the least likely explanation is ________.

A) a political business cycle B) changes in one or more key structural parameters of the economy C) a policy-induced change in the expectations and behaviors of households and businesses D) faulty interpretation of incomplete and ambiguous economic data Answer: A Topic: 21.3 Policy Conduct: Rules or Discretion AACSB: Reflective Thinking 15) The argument that ________ receives strong support from the innovative policy response to the recent financial crisis.

A) rules can be too rigid B) discretionary policies are vulnerable to the time-inconsistency problem C) money is the sole source of fluctuations in aggregate demand D) changes in policies can change the coefficients in macroeconometric models Answer: A Topic: 21.3 Policy Conduct: Rules or Discretion

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16) Which of the following provides support for the use of discretion in economic policymaking?

A) any policy rule that is based on a particular model will prove wrong if that model is wrong B) the existence of a political business cycle C) the conclusions of Friedman and Schwartz with respect to monetary and fiscal policy D) the Watergate scandal Answer: A Topic: 21.3 Policy Conduct: Rules or Discretion AACSB: Reflective Thinking 17) In 1975 the Swiss National Bank announced a policy of targeting ________.

A) the level of income B) interest rates C) rational expectations D) monetary aggregates Answer: D Topic: 21.3 Policy Conduct: Rules or Discretion 18) Swiss attempts to target monetary aggregates ended in the 1990s because ________.

A) the expectations of Swiss households had evolved from being adaptive to rational B) structural changes in the economy had rendered existing practices inflationary C) of the resulting increase in interest rates D) the ensuing deflation increased the real value of debt held by Swiss manufacturing firms Answer: B Topic: 21.3 Policy Conduct: Rules or Discretion 19) Swiss experience in the 1980s evidences the ________.

A) effectiveness of targeting monetary aggregates B) need for discretion in the face of structural changes in the economy C) value of fiscal policy over monetary policy D) ascendancy of flexible exchange rate regimes over fixed exchange rate systems Answer: B Topic: 21.3 Policy Conduct: Rules or Discretion 20) Constrained discretion ________.

A) eliminates all discretion in policymaking B) imposes an inherent discipline on consumers C) imposes an inherent discipline on policymakers but does not eliminate all flexibility D) requires policymakers follow a constant growth rate rule for money Answer: C Topic: 21.3 Policy Conduct: Rules or Discretion

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21) Of these policies, which is the best example of constrained discretion?

A) the annual federal budget deficit shall not exceed three percent of the GDP B) the growth rate of the money supply shall be between two percent and five percent C) macroeconomic policies shall promote rapid economic growth and low inflation D) macroeconomic policies shall aim to keep inflation — on average over each five-year interval — within a range of two percent to four percent Answer: D Topic: 21.3 Policy Conduct: Rules or Discretion AACSB: Reflective Thinking 22) Evidence suggests that, with rare exceptions, economic policies are not manipulated in an effort to influence electoral outcomes. Use the Lucas critique to explain why not.

Answer: The strategy that would generate a political business cycle relies on naive voters to reward office holders for a short-term improvement in economic conditions. Once the strategy is implemented, however, voters get to experience the negative consequences of rising inflation and contractionary policies. Policy makers (and influencers) wise enough to recognize the change in expectations will not be tempted to attempt such a strategy.

Topic: 21.3 Policy Conduct: Rules or Discretion AACSB: Reflective Thinking 23) How are rule-based policies similar to adaptive expectations?

Answer: Rule-based policies are tied to past information and understandings. They embody the wisdom and limitations of the past. Rules are immune to new information and judgment. Rulebased policies are immune to short-sighted influences, fads, and conceptual "breakthroughs."

Topic: 21.3 Policy Conduct: Rules or Discretion AACSB: Reflective Thinking 21.4 The Role of Credibility and a Nominal Anchor 1) The tying down of the price level to a nominal variable by the central bank is known as committing to ________.

A) a nominal anchor B) rational expectations C) a customs union D) a positive aggregate demand shock Answer: A Topic: 21.4 The Role of Credibility and a Nominal Anchor 2) In the equation for the short-run aggregate supply curve, π = + γ + ρ, an improvement in the credibility of monetary policy is represented by a change in ________.

A) expected inflation B) the price shock C) the sensitivity of inflation to the output gap D) the output gap Answer: A Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Analytical Thinking 10 .

3) One requirement for an effective nominal anchor is ________.

A) price stability B) credibility C) fixed exchange rates D) rational expectations Answer: B Topic: 21.4 The Role of Credibility and a Nominal Anchor 4) The "anchor" that sustains the credibility of monetary policy is ________.

A) easily weighed during the slightest of macroeconomic storms B) composed of some indestructible substance C) necessary to avoid central bank independence D) available for scrutiny to all who care to observe Answer: D Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Reflective Thinking 5) A nominal anchor helps policy makers to avoid ________.

A) adaptive expectations B) constrained discretion C) negative demand shocks D) the time-inconsistency problem Answer: D Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Reflective Thinking 6) The immediate objective of a nominal anchor is to reduce the variability of ________.

A) monetary policy targets B) expected inflation C) aggregate demand D) central bank credibility Answer: B Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Reflective Thinking 7) For the most part, central bank credibility, or lack thereof, is reflected in the behavior of ________.

A) short-run aggregate supply B) short-run aggregate demand C) long-run aggregate supply D) aggregate price shocks Answer: A Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Analytical Thinking

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8) If the public believes the commitment to a nominal anchor to be credible, the effect of a positive aggregate demand shock is for ________.

A) short-run aggregate supply to shift up B) short-run aggregate supply to be unaffected C) short-run aggregate supply to shift down D) inflation, but not economic activity, to increase Answer: B Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Analytical Thinking 9) If the public believes that the commitment to a nominal anchor is not credible, the effect of a positive aggregate demand shock is for ________.

A) short-run aggregate supply to shift down B) short-run aggregate supply to remain unchanged C) short-run aggregate supply to shift up D) inflation, but not economic activity, to increase Answer: C Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Analytical Thinking 10) If the public believes the commitment to a nominal anchor to be credible, the effect of a negative aggregate demand shock is for ________.

A) short-run aggregate supply to shift up B) short-run aggregate supply to be unaffected C) short-run aggregate supply to shift down D) inflation, but not economic activity, to decrease Answer: B Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Analytical Thinking 11) If the public believes that the commitment to a nominal anchor is not credible, the effect of a negative aggregate demand shock is for ________.

A) short-run aggregate supply to shift down B) short-run aggregate supply to remain unchanged C) short-run aggregate supply to shift up D) inflation, but not economic activity, to decrease Answer: C Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Analytical Thinking

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12) Monetary policy credibility has the benefit of ________.

A) stabilizing inflation in the short run when faced with positive demand shocks B) stabilizing economic activity in the short run when faced with positive demand shocks C) transmitting the effect of aggregate demand shocks onto short-run aggregate supply D) enhancing the job opportunities of Federal Reserve officials after they leave the central bank Answer: A Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Analytical Thinking 13) The strength of the movement in the short-run aggregate supply schedule, in response to an aggregate demand shock is determined by ________.

A) the price elasticity of demand B) the credibility of the monetary authorities C) the underlying state of the economy D) the choice of nominal anchors Answer: B Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Analytical Thinking 14) Consider two similar economies hit by the same temporary negative supply shock. In the economy with the more credible monetary policy, there will be ________.

A) smaller increases in both inflation and the real interest rate B) a smaller increase in inflation and larger increase in the real interest rate C) a smaller increase in inflation and larger decrease in output D) a smaller increase in output and larger increase in the real interest rate Answer: A Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Analytical Thinking 15) In 1973, 1979 and 2007, the U.S. economy was hit by ________.

A) the collapse of the financial sector B) the assassination of a Federal Reserve Board member C) three major aggregate supply shocks D) the after-effects of the process of creative destruction Answer: C Topic: 21.4 The Role of Credibility and a Nominal Anchor 16) The effects of the negative supply shocks of 1973, 1979 and 2007 were different due to the ________.

A) role played by rational expectations in the 1979 event B) different sources of the supply shocks C) credibility of the monetary authorities D) different individuals who led the Federal Reserve System Answer: C Topic: 21.4 The Role of Credibility and a Nominal Anchor

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17) The effects of the negative supply shocks of 1973, 1979 and 2007 were different due to the ________.

A) willingness of policy makers, in the earlier episodes, to cause a sharp increase in unemployment, in order to keep inflation low B) coincidence, in 2007, of politically-motivated expansionary policies to lower unemployment C) collapse of savings banks and real estate markets in the 1970s D) need, in the earlier episodes, to resort to severely contractionary monetary policy Answer: D Topic: 21.4 The Role of Credibility and a Nominal Anchor 18) The negative supply shock of 2007, compared to the shocks in 1973 & 1979, involved ________.

A) a larger decrease in aggregate demand B) larger decreases in the real interest rate C) smaller decreases in aggregate supply D) larger increases in the real interest rate Answer: C Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Analytical Thinking 19) Comment on the ability of a credible nominal anchor to allow policy makers to exploit a short-run trade-off between unemployment and inflation.

Answer: In the wake of a negative supply shock, policy makers may wish to implement expansionary policy to reverse the decline in economic activity. If this is understood as a temporary, "emergency" measure, rather than an abandonment of a commitment to price stability, expected inflation may decline even as aggregate demand is rising. However, under normal circumstances, any attempt to reduce unemployment and tolerate an increase in inflation will not be supported by credibility. On the contrary, such a policy must signal a lack of commitment to price stability; the loss of credibility confirms the illusory nature of the trade-off.

Topic: 21.4 The Role of Credibility and a Nominal Anchor AACSB: Reflective Thinking

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21.5 Approaches to Establishing Central Bank Credibility 1) The adoption of inflation targeting in the United States ________.

A) brought an end to the "dual mandate" regime B) resulted from legislation enacted in 1914 C) occurred after its adoption in more than a dozen other countries D) was blocked by its staunch opponent, Ben Bernanke Answer: C Topic: 21.5 Approaches to Establishing Central Bank Credibility 2) Inflation targeting makes more sense than unemployment targeting, because ________.

A) monetary policies affect inflation, not unemployment B) expected unemployment is not a key determinant of the unemployment rate C) a commitment to avoid high inflation is inherently more credible than a commitment to avoid high unemployment D) most voters and most elected officials are more concerned about inflation Answer: B Topic: 21.5 Approaches to Establishing Central Bank Credibility AACSB: Reflective Thinking 3) Which of the following is not, in general, an aspect of inflation targeting?

A) institutional commitment to a dual mandate B) the public announcement of medium-term numerical inflation targets C) increased accountability of the central bank D) increased transparency of monetary policy Answer: A Topic: 21.5 Approaches to Establishing Central Bank Credibility 4) In the United States, the long-run inflation target is ________.

A) undisclosed B) currently set at 7% C) currently set at 2% D) currently set at minus 1% Answer: C Topic: 21.5 Approaches to Establishing Central Bank Credibility 5) Inflation targeting involves public disclosure of each of the following, except ________.

A) policy makers' plans and objectives B) explanation of discrepancies between target inflation and actual inflation C) the federal government debt ceiling D) projections of macroeconomic conditions Answer: C Topic: 21.5 Approaches to Establishing Central Bank Credibility

15 .

6) Nominal GDP targeting ________.

A) is consistent with a dual mandate B) has been adopted in more countries than have adopted inflation targeting C) is, compared to inflation targeting, easier both to implement and to explain D) is preferred strongly by "conservative" central bankers Answer: A Topic: 21.5 Approaches to Establishing Central Bank Credibility 7) The country with the highest degree of central bank independence in the period 1973-88 was ________.

A) the United States B) New Zealand C) Spain D) Germany Answer: D Topic: 21.5 Approaches to Establishing Central Bank Credibility AACSB: Analytical Thinking 8) The country with the lowest degree of central bank independence in the period 1973-88 was ________.

A) Germany B) Japan C) The United States D) Spain Answer: D Topic: 21.5 Approaches to Establishing Central Bank Credibility AACSB: Analytical Thinking 9) The academic work of Ben Bernanke, recent Chairman of the Board of Governors of the Federal Reserve System, suggests that he is a firm advocate of ________.

A) fixed exchange rates B) inflation targeting C) decreased central bank transparency D) nominal GDP targeting Answer: B Topic: 21.5 Approaches to Establishing Central Bank Credibility 10) Which of the following has served most recently as Chairman of the Board of Governors of the Federal Reserve System?

A) Nancy Pelosi B) Alan Greenspan C) Ben Bernanke D) Paul Volcker Answer: C Topic: 21.5 Approaches to Establishing Central Bank Credibility

16 .

11) The dual mandate of the Federal Reserve System is to maintain ________.

A) exchange rate and price stability B) price stability and maximum sustainable employment C) maximum sustainable employment and GDP growth D) GDP growth and exchange rate stability Answer: B Topic: 21.5 Approaches to Establishing Central Bank Credibility 12) Central bank credibility may be established by ________.

A) the appointment of individuals to the Fed with a strong aversion to inflation B) quicker responses to negative aggregate supply shocks C) greater coordination between monetary and fiscal policy D) the appointment of central bankers who are hawkish on defense Answer: A Topic: 21.5 Approaches to Establishing Central Bank Credibility 13) Which of the following is least likely to enhance central bank credibility?

A) "town meetings" on the topic of monetary policy B) policy makers' expertise C) independence from short-run political influences D) accurate measurement of macroeconomic variables Answer: A Topic: 21.5 Approaches to Establishing Central Bank Credibility AACSB: Reflective Thinking 14) Paul Volcker was appointed to head the Federal Reserve System by ________.

A) Richard Nixon in 1969 B) Jimmy Carter in 1979 C) Ronald Reagan in 1992 D) Barack Obama in 2009 Answer: B Topic: 21.5 Approaches to Establishing Central Bank Credibility 15) During his tenure at the helm of the Federal Reserve System, Paul Volcker reestablished ________.

A) a system of fixed exchange rates B) the role of open market operations in the monetary policy actions of the Fed C) the credibility of the Federal Reserve as an inflation fighting institution D) the targeting of monetary aggregates, like the fed funds rate Answer: C Topic: 21.5 Approaches to Establishing Central Bank Credibility

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16) Greater central bank independence is positively related to ________.

A) a low rate of unemployment B) the length of terms of Governors on the Board of Governors C) a higher level of GDP D) the ability to fight inflation Answer: D Topic: 21.5 Approaches to Establishing Central Bank Credibility 17) Central bank independence ________.

A) is receding as democratic movements gain influence around the world B) is correlated with relatively high unemployment C) remains an obstacle to policy transparency D) is the norm in a growing number of countries Answer: D Topic: 21.5 Approaches to Establishing Central Bank Credibility 18) The expected benefits of central bank independence include avoidance of ________.

A) Ben Bernanke B) public scrutiny of central bank policies C) the time-inconsistency problem D) serious policy errors Answer: C Topic: 21.5 Approaches to Establishing Central Bank Credibility 19) Policy independence for the Federal Reserve is logically similar to allowing the ________.

A) National Oceanographic and Atmospheric Administration to select the nation's weather B) Congressional Budget Office to estimate the government's expenditures C) individual states to set highway speed limits D) Social Security Administration to determine benefit levels and eligibility requirements Answer: D Topic: 21.5 Approaches to Establishing Central Bank Credibility AACSB: Reflective Thinking 20) The non-democratic character of the Board of Governors of the Federal Reserve System helps support ________.

A) the political business cycle B) the time-inconsistency problem C) its independence D) rational expectations of Federal Reserve behavior Answer: C Topic: 21.5 Approaches to Establishing Central Bank Credibility AACSB: Reflective Thinking

18 .

21) How is inflation targeting consistent with the "dual mandate" of price stability and maximum employment?

Answer: Inflation targeting is based on targets defined over a long-enough time period so that policy can respond flexibly to avoid high unemployment. Credible commitment to an inflation target, also, supports policy flexibility, so that expansionary policies may be pursued as needed, without causing an increase in expected inflation. Nothing is more crucial to maintaining low unemployment than effective management of expected inflation.

Topic: 21.5 Approaches to Establishing Central Bank Credibility AACSB: Reflective Thinking 22) How does central bank independence cause lower inflation?

Answer: Central bank independence implies low expected inflation, which ensures that the short-run aggregate supply curve is always in or moving toward a position consistent with low inflation. An independent central bank has little if any incentive to allow inflation to rise uncontrollably. Though inflation may rise for many reasons beyond central bank control, expected inflation will not remain high, so long as it is known that the central bank will not knowingly pursue an inflationary policy.

Topic: 21.5 Approaches to Establishing Central Bank Credibility AACSB: Reflective Thinking 23) What might an "anti-inflation hawk" do so that good macroeconomic performance is likely to continue under his or her successors as head of the central bank?

Answer: To institutionalize good policy making, the central bank head should encourage elected officials to demand that monetary policy objectives and strategies be publicly announced and explained. As an alternative to political influence, the head of the central bank should be required to report and to "justify" discrepancies between announced objectives and observed performance.

Topic: 21.5 Approaches to Establishing Central Bank Credibility AACSB: Reflective Thinking

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Macroeconomics: Policy and Practice, 2e (Mishkin) Chapter 22 Modern Business Cycle Theory 22.1 Real Business Cycle Model 1) The New Keynesian model, is Keynesian in that ________.

A) it assumes wages and prices are sticky B) changes in the money supply are taken to be the single most important influence on business movements C) the velocity of money is a constant D) expectations are assumed to be rational Answer: A Topic: 22.1 Real Business Cycle Model 2) The real business cycle model begins with the assumption that ________.

A) wages and prices are sticky B) wages and prices are completely flexible C) the velocity of money is a constant D) nominal variables are superior to real variables in describing economic activity Answer: B Topic: 22.1 Real Business Cycle Model 3) Among the pioneers of real business cycle theory is ________.

A) Edward Prescott B) Robert Lucas C) Robert Solow D) Paul Volcker Answer: A Topic: 22.1 Real Business Cycle Model 4) The complete wage and price flexibility of the real business cycle framework implies that ________.

A) the velocity of money is a constant B) the velocity of money times the money supply is equal to the nominal value of transactions over a given period of time C) aggregate output always equals potential output D) sustained economic contractions, like the Great Depression, cannot occur in real, historical time Answer: C Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking

1 .

5) In real business cycle models, a change in willingness to work ________.

A) is associated with productivity shocks B) causes a shift of the aggregate demand curve C) would violate the market-clearing assumption D) has no effect on potential output Answer: A Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking 6) In real business cycle models, shifts of the aggregate demand curve ________.

A) cause changes in inflation, but have no effect on output B) cannot occur C) result from changes in the willingness to work D) result from Solow residuals Answer: A Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking 7) The primary source of shocks to potential output and long-run supply for real business cycle theorists is ________.

A) changes in the money supply B) a change in the price of complements C) a change in any of the components of aggregate demand D) shocks to productivity Answer: D Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking 8) Which of the following would be considered a negative real supply shock?

A) a relaxation of government environmental regulations B) a permanent increase in the price of energy C) a decrease in the money supply D) a decrease in aggregate demand Answer: B Topic: 22.1 Real Business Cycle Model 9) Which of the following would be considered a negative real supply shock?

A) an increase in expected inflation B) a disruption of financial markets C) a decrease in government spending D) a decrease in guaranteed pension benefits Answer: B Topic: 22.1 Real Business Cycle Model

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10) In the real business cycle model, the short-run aggregate supply curve is always the same as ________.

A) long-run aggregate supply B) the long-run aggregate demand schedule C) the velocity of money D) the real rate of interest Answer: A Topic: 22.1 Real Business Cycle Model 11) According to the real business cycle model, a rightward shift in the long-run aggregate supply schedule would be caused by ________.

A) a negative supply shock B) an increase in aggregate demand C) a positive supply shock D) a decrease in aggregate demand Answer: C Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking 12) Solow residuals are estimates of ________.

A) deadweight loss B) the natural rate of unemployment C) aggregate productivity D) labor hoarding Answer: C Topic: 22.1 Real Business Cycle Model 13) Given the aggregate production function Y = A when Y is 60, K = 5 and L = 5.

A) 2.4 B) 35 C) 25 D) 12 Answer: D Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking

, the Solow residual equals ________

14) If output begins to grow substantially faster than capital and labor inputs, then the real business cycle model predicts, ceteris paribus, ________.

A) an increase in inflation B) a decrease in employment C) a decrease in investment D) a business cycle expansion Answer: D Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking 3 .

15) In the aggregate production function Y = A ________ as the key independent variable.

A) potential output B) productivity C) the capital stock D) the labor input Answer: B Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking

, real business cycle theory treats

16) Real business cycle theorists take the comovement of aggregate output and Solow residuals as strong confirmation that economic fluctuations are caused by ________.

A) changes in aggregate demand B) changes in the money supply C) changes in the rate of inflation D) productivity shocks Answer: D Topic: 22.1 Real Business Cycle Model 17) During business contractions, the growth rate of Solow residuals is ________.

A) near or below zero B) well above zero C) approaching infinity D) impossible to calculate Answer: A Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking 18) In the real business cycle model, fluctuations in employment are explained by ________.

A) changes in the composition of household assets B) intertemporal substitution as real wages and real interest rates changes C) changes in the marginal propensity to consume D) the impact of a change in price on quantity demand and quantity supplied in goods markets Answer: B Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking 19) According to real business cycle theory, a likely cause of an increase in employment is ________.

A) an increase in the real wage B) an increase in aggregate demand C) a decrease in the real wage D) a decrease in the real interest rate Answer: A Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking 4 .

20) In the real business cycle model, unemployment is ________.

A) costless to individual workers B) the result of higher productivity C) voluntary D) the result of higher wages Answer: C Topic: 22.1 Real Business Cycle Model AACSB: Reflective Thinking 21) Critics of real business cycle analysis suggest that the persuasiveness of the model may be limited by the existence of ________.

A) flexible wages and prices B) rising wages C) voluntary unemployment D) labor hoarding Answer: D Topic: 22.1 Real Business Cycle Model 22) If workers sit idly by for a portion of their workday, but are still employed, firms may be engaged in ________.

A) intertemporal substitution B) voluntary unemployment C) labor hoarding D) real business Answer: C Topic: 22.1 Real Business Cycle Model 23) If workers sit idly by for a portion of their workday, but are still employed, ________.

A) the negative productivity shock has no effect on output B) it is unlikely that a decrease in aggregate demand is the cause C) aggregate data may create a false illusion of a negative productivity shock D) a negative productivity shock is the most plausible explanation Answer: C Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking 24) Critics of real business cycle theory doubt the plausibility of ________.

A) intertemporal substitution B) negative productivity shocks C) adaptive expectations D) a trade-off between work and leisure Answer: B Topic: 22.1 Real Business Cycle Model

5 .

25) The real business cycle model suggests that, with aggregate demand unchanged, increases in output would be associated with ________.

A) an increase in inflation B) a decline in inflation C) and unchanged price level D) procyclical inflation Answer: B Topic: 22.1 Real Business Cycle Model 26) According to real business cycle theory, an increase in financial frictions might lead to ________, if ________.

A) a decrease in output; the rise in the credit spread causes a leftward shift of aggregate demand B) a decrease in inflation; the disruption of capital markets results in a leftward shift of long-run aggregate supply C) a decrease in output; the disruption of capital markets results in a leftward shift of long-run aggregate supply D) a decrease in output; a decline in expected output causes a leftward shift of aggregate demand Answer: C Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking 27) Use the concept of intertemporal substitution to explain how, in real business cycle models, a change in potential output causes an immediate change in actual output.

Answer: A productivity shock shifts the production function. At the prevailing levels of input use, output rises or falls, accordingly. Output changes further, as input suppliers adjust to changes in the marginal products of labor and capital. Specifically, an increase (decrease) in the marginal product of an input causes an increase (decrease) in factor payment. In response, the quantities of labor and capital supplied increase (decrease).

Topic: 22.1 Real Business Cycle Model AACSB: Analytical Thinking 28) How might a real business cycle theorist explain the "Volcker recession" of the early 1980s?

Answer: Volcker took office in October 1979 in the midst of high inflation and unemployment.

Clearly, the long-run aggregate supply curve had shifted to the left. High and unpredictable inflation was undermining incentives to work and to invest. At first, Volcker's appointment only added to the uncertainty: maybe inflation would now come down, maybe not. The decision to lower the federal funds rate in mid-1980 merely stimulated aggregate demand and did nothing to encourage output to recover, so inflation and unemployment remained high. It took more than another year for convincing anti-inflationary policy to allow economic distortions to abate and potential output to rise.

Topic: 22.1 Real Business Cycle Model AACSB: Reflective Thinking

6 .

29) How might real business cycle theorists respond to evidence of procyclical inflation?

Answer: Since the aggregate demand curve is negatively-sloped, changes in potential output should relate negatively to inflation. Rising potential (actual) output should put downward pressure on prices, while negative productivity shocks should force prices up. Defenders of real business cycle theory may point to evidence that inflation is not consistently procyclical. Also, if aggregate demand shifts are correlated with changes in potential output, that might account for procyclical changes in inflation.

Topic: 21.1 Rational Expectations and Policy Making AACSB: Reflective Thinking 22.2 New Keynesian Model 1) The new Keynesian model has ________ in common with the real business cycle model.

A) wage and price stickiness B) a theory of aggregate demand C) procyclical inflation D) a microeconomic foundation Answer: D Topic: 22.2 New Keynesian Model 2) In the new Keynesian model, sticky prices may be due to ________.

A) involuntary unemployment B) negative productivity shocks C) positive productivity shocks D) staggered prices Answer: D Topic: 22.2 New Keynesian Model 3) In the new Keynesian model, expected inflation is a function of ________.

A) expected future output gaps and markup shocks B) current and past inflation C) unanticipated aggregate demand shocks D) expected growth of the money supply Answer: A Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 4) The standard IS curve is adjusted in new Keynesian theory to account for ________.

A) the forward-looking behavior of households and firms B) the difference between real and nominal variables C) changes in GDP, or Gross Domestic Product D) the impact of a rising national debt Answer: A Topic: 22.2 New Keynesian Model

7 .

5) In the new Keynesian model, an increase in productivity will cause ________.

A) a leftward shift in short-run and long-run aggregate supply B) a rightward shift in short-run and long-run aggregate supply C) a leftward shift in short-run aggregate supply and rightward shift in long-run aggregate supply D) a rightward shift in short-run aggregate supply and a leftward shift in long-run aggregate supply Answer: B Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 6) In the new Keynesian model, an ________ increase in productivity will impact ________.

A) unanticipated; both aggregate demand and aggregate supply B) anticipated; both aggregate demand and aggregate supply C) anticipated; aggregate demand, but not aggregate supply D) unanticipated; aggregate demand, but not aggregate supply Answer: B Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 7) Shocks to long-run aggregate supply can be a source of business fluctuations ________.

A) only in real business cycle models B) only in new Keynesian models C) in both real business cycle and new Keynesian models D) only if the money supply rises Answer: C Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 8) In the new Keynesian model, a positive, permanent supply shock will result in ________.

A) an increase in aggregate demand B) a decrease in aggregate demand C) no change in aggregate demand D) a change in aggregate demand, only if the shock is anticipated Answer: A Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 9) In the new Keynesian model, if an aggregate demand increase is unanticipated, then ________.

A) aggregate demand will not change B) short-run aggregate supply will shift up immediately C) short-run aggregate supply will shift down immediately D) there is no immediate effect on the short-run supply curve Answer: D Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 8 .

10) In the new Keynesian model, if an aggregate demand increase is anticipated, then ________.

A) aggregate demand will not change B) short-run aggregate supply will shift up immediately C) short-run aggregate supply will shift down immediately D) there is no immediate effect on the short-run supply curve Answer: B Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 11) In the new Keynesian model, if an aggregate demand increase is unanticipated, then ________.

A) aggregate demand will not change B) short-run aggregate supply will shift up immediately C) short-run aggregate supply will shift down immediately D) there is no immediate effect on expectations about future inflation Answer: D Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 12) In the new Keynesian model, the effects on output of an anticipated aggregate demand shock are ________.

A) less than if that event was unanticipated B) greater than if that event was unanticipated C) the same as would develop if that event was unanticipated D) independent of whether or not that event is anticipated or unanticipated Answer: A Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 13) In the new Keynesian model, the immediate effect on inflation of an anticipated aggregate demand shock is ________.

A) less than if that event was unanticipated B) greater than if that event was unanticipated C) the same as would develop if that event was unanticipated D) independent of whether or not that event is anticipated or unanticipated Answer: B Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking

9 .

14) In the new Keynesian model, the ultimate effect on inflation of an anticipated aggregate demand shock is ________.

A) less than if that event was unanticipated B) greater than if that event was unanticipated C) the same as would develop if that event had never occurred D) independent of whether or not that event is anticipated or unanticipated Answer: D Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 15) In the new Keynesian model, the ultimate effect on output of an anticipated aggregate demand shock is ________.

A) less than if that event was unanticipated B) greater than if that event was unanticipated C) the same as would develop if that event had never occurred D) dependent on whether or not that event is temporary or permanent Answer: C Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 16) Research supporting the new Keynesian model finds that prices are ________.

A) slow to adjust to aggregate demand shocks B) changed very frequently C) changed only infrequently D) not as flexible as wages Answer: A Topic: 22.2 New Keynesian Model 17) Suppose a tax cut that had been anticipated by households and businesses doesn't happen.

Describe a new Keynesian analysis of the consequences of this "event."

Answer: The non-occurrence of an anticipated tax cut has the same effect as an unanticipated tax increase: the aggregate demand curve shifts to the left. As output falls below potential and inflation falls, the decrease in expected inflation increases aggregate supply, so output begins to recover and inflation falls further. Eventually, output returns to potential. Aggregate demand may or may not shift back to the right, depending on the response of monetary policy to the lower inflation rate.

Topic: 22.2 New Keynesian Model AACSB: Analytical Thinking 18) In the long run, does it matter whether a policy action was anticipated or not?

Answer: In the long run, output is potential output. The response to an anticipated policy action comes sooner, but is ultimately no different than the delayed response to a "recognized" policy.

Nonetheless, it does matter whether or not the policy had been anticipated, because anticipated policies are less destabilizing to output.

Topic: 22.2 New Keynesian Model AACSB: Reflective Thinking 10 .

22.3 A Comparison of Business Cycle Models 1) Expectations are adaptive in ________.

A) traditional Keynesian models B) the Lucas Model C) new Keynesian theory D) the real business cycle model Answer: A Topic: 22.3 A Comparison of Business Cycle Models 2) Expectations are taken to be rational in ________.

A) traditional Keynesian and new Keynesian theory B) new Keynesian and real business cycle theory C) real business cycle and traditional Keynesian theory D) traditional Keynesian, new Keynesian and real business cycle theory Answer: B Topic: 22.3 A Comparison of Business Cycle Models 3) The three business cycle models differ mostly in their treatment of ________.

A) aggregate demand B) short-run aggregate supply C) long-run aggregate supply D) productivity shocks Answer: B Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 4) ________ highlights the importance of fiscal policy as a determinant of good macroeconomic performance.

A) The real business cycle model B) The traditional Keynesian model C) The new Keynesian model D) Rational expectations Answer: A Topic: 22.3 A Comparison of Business Cycle Models AACSB: Reflective Thinking 5) Long-run aggregate supply shocks are a source of business cycle fluctuations in ________.

A) traditional Keynesian and new Keynesian theory B) new Keynesian and real business cycle theory C) real business cycle and traditional Keynesian theory D) traditional Keynesian, new Keynesian and real business cycle theory Answer: B Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking

11 .

6) Long-run aggregate supply shocks are not a source of business cycle fluctuations in the ________, because ________.

A) traditional Keynesian model; long-run supply shocks are incompatible with adaptive expectations B) traditional Keynesian model; demand fluctuations are considered of dominant importance C) real business cycle model; shocks cannot persist in the long run, when prices and wages are flexible D) new Keynesian model; such shocks are anticipated by forward-looking consumers and firms Answer: B Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 7) A belief that demand shocks are an important source of business cycle fluctuations implies a preference of ________.

A) the new Keynesian model over the traditional Keynesian model B) the real business cycle model over the traditional Keynesian model C) the real business cycle model over the new Keynesian model D) the new Keynesian model over the real business cycle model Answer: D Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 8) Prices are regarded as sticky in ________.

A) new Keynesian and traditional Keynesian theory B) real business cycle and new Keynesian theory C) real business cycle and traditional Keynesian theory D) traditional Keynesian, new Keynesian and real business cycle theory Answer: A Topic: 22.3 A Comparison of Business Cycle Models 9) Price flexibility is a key feature of ________.

A) traditional Keynesian theory B) new Keynesian theory C) real business cycle theory D) traditional Keynesian, new Keynesian and real business cycle theory Answer: C Topic: 22.3 A Comparison of Business Cycle Models 10) Discretionary economic policy is not beneficial in the ________.

A) traditional Keynesian theory B) new Keynesian theory C) Luka Brazzi model D) real business cycle theory Answer: D Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 12 .

11) Credibility is important to successful anti-inflationary policy in ________.

A) new Keynesian theory B) traditional Keynesian theory C) real business cycle theory D) post classical theory Answer: A Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 12) Credibility is not important in ________.

A) new Keynesian and traditional Keynesian theory B) real business cycle and traditional Keynesian theory C) real business cycle and new Keynesian theory D) traditional Keynesian, new Keynesian and real business cycle theory Answer: B Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 13) The level of income is unchanged in response to unanticipated anti-inflation policy in ________.

A) real business cycle theory B) traditional Keynesian theory C) new Keynesian theory D) post classical theory Answer: A Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 14) The level of income is unchanged in response to anticipated anti-inflation policy in ________.

A) real business cycle theory B) traditional Keynesian theory C) new Keynesian theory D) post classical theory Answer: A Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 15) In macroeconomic modelling, as price flexibility increases ________.

A) the short-run aggregate supply schedule will get flatter B) the short-run aggregate supply schedule will get steeper C) the short-run aggregate supply schedule will shift to the right D) the short-run aggregate supply schedule will shift to the left Answer: B Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 13 .

16) Expansionary policy only leads to inflation, but does not raise output in ________.

A) traditional Keynesian theory B) new Keynesian theory C) real business cycle theory D) traditional Keynesian, new Keynesian and real business cycle theory Answer: C Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 17) The management of expectations has increased in importance in policymaking in recent decades with the rise of ________.

A) traditional Keynesian theory B) institutionalist theory C) torsion theory D) new Keynesian theory Answer: D Topic: 22.3 A Comparison of Business Cycle Models 18) No distinction is made between the effects of anticipated and unanticipated policy in ________.

A) traditional Keynesian theory B) new Keynesian theory C) real business cycle theory D) traditional Keynesian and real business cycle theory Answer: D Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 19) Reductions in inflation have no cost in terms of lower output in ________.

A) traditional Keynesian theory B) new Keynesian theory C) real business cycle theory D) traditional and new Keynesian theory Answer: C Topic: 22.3 A Comparison of Business Cycle Models 20) Anti-inflationary policy is less costly when that policy is anticipated in ________.

A) traditional Keynesian theory B) new Keynesian theory C) real business cycle theory D) institutionalist theory Answer: B Topic: 22.3 A Comparison of Business Cycle Models

14 .

21) The possibility that unanticipated policy changes are an important source of output fluctuations is most consistent with ________.

A) traditional Keynesian theory B) new Keynesian theory C) real business cycle theory D) institutionalist theory Answer: B Topic: 22.3 A Comparison of Business Cycle Models AACSB: Reflective Thinking 22) Suppose the U.S. government announces that it will bring the federal budget deficit to zero, over the next ten years, with no change in tax rates. Describe the effects of such a policy according to the three business cycle models, assuming that the policy is fully credible.

Answer: In the traditional Keynesian model, anticipated policy has no effect on expectations, so neither aggregate supply nor aggregate demand is affected. In the new Keynesian model, AS shifts down with the expectation of lower inflation, and AD shifts left with the expectation of lower output (negative demand shock of reduced government purchases). However, the size of both shifts is limited by the size of the expected decrease in the real interest rate and the size of the output response to a lower interest rate. Also, expectations on the real interest rate are affected by expected potential output. If some combination of the content of government purchases, the level of government purchases, and the amount of government borrowing is seen as having an adverse affect on aggregate production, then the anticipated policy creates an expectation of rising productivity. In the extreme, it is possible for the expected decrease in inflation and (thus) in the real interest rate to counteract the decrease in AD. The real business cycle model emphasizes this possibility of a positive productivity shock. If no productivity shock is expected, then the decrease in aggregate demand will lower inflation, while having no effect on output. If a productivity shock is expected, then the decrease in inflation will be smaller, at least until productivity actually rises.

Topic: 22.3 A Comparison of Business Cycle Models AACSB: Analytical Thinking 23) How do the new Keynesian and real business cycle models differ on the ability of inflationary expectations to affect output?

Answer: Both models recognize the influence of expectations on aggregate demand and, thus, on inflation. Both models imply that expected high inflation is a self-fulfilling prophecy, which is likely to have a negative effect on output. In the new Keynesian model, an upward shift of the short-run aggregate supply curve causes output to fall below potential output. In the real business cycle framework, high inflation distorts incentives and disrupts capital markets, causing a decrease in (potential) output.

Topic: 22.3 A Comparison of Business Cycle Models AACSB: Reflective Thinking

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24) As the U.S. economy recovers from the recession of 2007-2009, stubbornly high unemployment is a concern. For each of the three business cycle models, identify the appropriate policy regime.

Answer: The traditional Keynesian model advises a low real interest rate and a large fiscal deficit to stimulate aggregate demand. The new Keynesian model recommends a moderate stimulus and public announcement of policy makers' commitment to achieving the lowest possible rate of unemployment consistent with price stability. The real business cycle model cautions that policies to promote high employment must operate through incentives to work and to invest, so that aggregate productivity is improved.

Topic: 22.3 A Comparison of Business Cycle Models AACSB: Reflective Thinking 25) What insights into the macroeconomic consequences of financial frictions arise from the new Keynesian model?

Answer: The new Keynesian model highlights the dependence of aggregate demand and shortrun aggregate supply on expectations. When financial institutions seem to be dealing well with asymmetric information, the availability of low-cost credit inspires optimism. A disruption of financial markets causes a decrease in aggregate demand, due to an immediate widening of the credit spread and the expectation of reduced future output and a higher future real interest rate for households and businesses. Expected increases in aggregate supply might exacerbate the expectations-driven decreases in aggregate demand, unless the zero-lower-bound problem is addressed. With economic activity so heavily dependent on expectations, recovery from a financial-crisis-induced recession can be quite rapid.

Topic: 22.3 A Comparison of Business Cycle Models AACSB: Reflective Thinking 22.4 Web Appendix: The New Classical Model 1) In the new classical model, all wages and prices ________.

A) are completely flexible with respect to expected changes in the price level B) are fixed with respect to expected changes in the price level C) are flexible with respect to the value of the dollar D) are fixed with respect to the money supply Answer: A Topic: 22.4 The New Classical Model AACSB: Analytical Thinking 2) In the new classical model, workers and firms try to keep their real wages and relative prices from falling when ________.

A) income falls B) they expect inflation to rise C) they expect inflation to fall D) they expect aggregate demand to fall Answer: B Topic: 22.4 The New Classical Model AACSB: Analytical Thinking 16 .

3) The policy ineffectiveness proposition of the new classical model suggests that ________.

A) unanticipated policy has no effect on the business cycle B) anticipated policy can have an effect on the business cycle C) anticipated policy has no effect on the business cycle D) legislative policy initiatives have little effect if the executive branch of government is in the hands of another political party Answer: C Topic: 22.4 The New Classical Model AACSB: Analytical Thinking 4) Which of the following demonstrates that policymakers cannot know the outcome of their decisions without knowing the public's expectations of them?

A) traditional Keynesian theory B) Post Keynesian theory C) real business cycle theory D) new classical theory Answer: D Topic: 22.4 The New Classical Model AACSB: Analytical Thinking 5) One of the primary objections to the new classical model is that ________.

A) firms could easily get information about price movements and so would not be fooled for very long B) price is negatively related to quantity demanded, but positively related to quantity supplied C) business cycles are relatively brief in duration D) it failed to incorporate rational expectations into its presentation Answer: A Topic: 22.4 The New Classical Model AACSB: Analytical Thinking

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