Chapter 1: Introduction

Difficulty: Easy 1. Which of the following is NOT a central issue in macroeconomics? A) How should the central bank of a country fight inflation? B) What is responsible for high and persistent unemployment? C) How do tax changes influence consumers' choices of what to buy? D) What factors determine economic growth? E) What can or should the government do to stabilize the economy? Ans: C

Difficulty: Easy 2. Macroeconomics does NOT focus on A) policies that affect consumption and saving B) policies that affect the performance of the health care sector C) the determination of changes in wages and prices D) the determination of interest rates E) none of the above, all of them are macroeconomic issues Ans: B

Difficulty: Easy 3. Which of the following is NOT dealt with in microeconomics? A) the effect of agricultural subsidies on the price of milk B) differences between the market for skilled labor versus the market for unskilled labor C) issues related to the structure and performance of the health care sector D) policies that affect the level of aggregate consumption E) issues related to the deregulation of the telecommunications industry Ans: D

Difficulty: Easy 4. Which of the economists below most likely advocated activist government policies? A) Milton Friedman B) John Maynard Keynes C) Robert Lucas D) Thomas Sargent
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E) Adam Smith Ans: B

Difficulty: Easy 5. In studying growth theory, we A) assume that labor, capital, and raw materials are all used efficiently B) assume that increased use of inputs cannot lead to a higher living standard C) assume that technological advances cannot affect living standards D) try to explain the reasons for recessions and booms E) all of the above Ans: A

Difficulty: Easy 6. Which of the following factors does NOT contribute to economic growth? A) the availability of resources such as labor and capital B) increases in the size of the population C) the availability of new and better technology D) increased knowledge gained through education or work experience E) all of the above can increase economic growth Ans: E

Difficulty: Easy 7. Which of the following is a FALSE statement? A) the very long run focuses on the growth of productive capacity B) in the very long run, the productive capacity is assumed to be given C) in the very short run, shifts in aggregate demand determine how much output is produced D) fluctuations in inflation and unemployment are important long-run issues E) at the full-employment level of output, capital is not used 100 percent Ans: D

Difficulty: Easy 8. Government intervention into economic activity will NOT lead to a change in the price level A) in the very short-run model B) in the medium-run model C) in the very long-run model D) in the classical model
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E) assuming a macro-model that focuses on the growth of productive capacity Ans: A

Difficulty: Easy 9. In the very short run, the level of A) output is determined by both aggregate demand and aggregate supply B) output is determined by aggregate demand alone C) prices will change if aggregate demand shifts D) prices is determined by aggregate demand alone E) both A) and C) Ans: B

Difficulty: Easy 10. In the simple macro model of this chapter, the long-run AS-curve is A) horizontal B) vertical C) upward-sloping D) assumed to be completely price elastic E) either B) or C), depending on how fast prices adjust Ans: B

Difficulty: Easy 11. In the very long-run AD-AS model, if the AD-curve shifts to the left, then A) prices and output will both decrease B) prices and output will both increase C) prices will decrease but output will remain the same D) output will decrease but prices will remain the same E) output will increase but prices will decrease Ans: C

Difficulty: Easy 12. If an increase in aggregate demand causes prices to increase slightly but output to increase significantly, then A) the AS-curve must be very flat B) the AD-curve must be very steep C) the AD- and AS-curves must both be very steep
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D) we must be looking at the very long-run AD-AS model E) we must be looking at the very short-run AD-AS model Ans: A

Difficulty: Medium 13. In the very long-run AD-AS model, A) only fiscal policy can affect both output and prices B) only monetary policy can affect both output and prices C) monetary policy can affect output but not prices D) active stabilization policy is ineffective in changing output E) the unemployment rate is always assumed to be zero Ans: D

Difficulty: Easy 14. If a shift in the AD-curve has no impact on the price level, then A) the unemployment rate must be extremely low B) the AD-curve must be vertical C) the AS-curve must be horizontal D) the AS-curve must be vertical E) both A) and D) Ans: C

Difficulty: Easy 15. In the medium run, if GDP goes down but the price level goes up, A) the AD-curve must have shifted to the right B) the AD-curve must have shifted to the left C) the AS-curve must have shifted to the right D) the AS-curve must have shifted to the left E) the AD-curve and the AS-curve must have both shifted to the right Ans: D

Difficulty: Medium 16. Which of the following is FALSE in the medium run? A) a change in monetary policy can shift the AD-curve B) a change in fiscal policy can shift the AD-curve C) a change in fiscal policy can change output and prices
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D) a change in monetary policy can change prices but not output E) a change in labor productivity can shift the AS-curve Ans: D

Difficulty: Easy 17. The AD-curve will shift if there is a change in A) monetary or fiscal policy B) the level of consumer confidence C) the productive capacity of our economy D) all of the above E) only A) and B) Ans: E

Difficulty: Easy 18. The position of the AS-curve depends on A) fiscal policy B) monetary policy C) consumer confidence D) the productive capacity of the economy E) all of the above Ans: D

Difficulty: Easy 19. Nominal GDP is correctly defined as A) the monetary value of all goods and services, final and intermediate, produced in a given year B) the monetary value of all wealth that is accumulated in a given year C) the national income minus all non-income charges against output D) the monetary value of all final goods and services currently produced in our economy in a given year E) the market value of all goods produced by domestically-owned resources in a given year Ans: D

Difficulty: Medium
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20. Which of the following transactions has a direct and immediate effect on GDP? A) an unemployed worker gets unemployment compensation B) you sell your used car to a friend C) you buy some IBM stock D) a German tourist drinks Canadian beer in a New York City restaurant E) the value of your Enron stock holdings drops drastically Ans: D

Difficulty: Easy 21. Which of the following does NOT directly affect GDP? A) a car dealer liquidates his inventory at a loss of $100 per car B) Wal-Mart buys 100 Korean-made VCRs and sells them in Roanoke, Virginia C) stock market values drop sharply D) a Canadian tourist visits New York to see the Blue Jays play in Yankee stadium E) both A) and C) Ans: C

Difficulty: Medium 22. If nominal GDP, prices, and population all increase but real GDP remains the same then A) real GDP per capita will decrease B) real GDP per capita will increase C) we cannot tell what will happen to real GDP per capita D) the standard of living will increase E) the standard of living will remain the same Ans: A

Difficulty: Medium 23. If the base year was last year, which of the following statements has to be FALSE for next year? A) real GDP will be greater than nominal GDP if prices are falling B) real GDP will be greater than nominal GDP if prices are rising C) real GDP cannot increase if prices are falling D) real GDP cannot decrease if prices are rising E) nominal GDP cannot decrease if prices are rising Ans: B

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Difficulty: Easy 24. Assume an economy that is currently at the full-employment level of output. If aggregate demand decreases, what should we expect in the median run? A) a decrease in potential GDP and the price level B) an increase in unemployment and the price level C) a decrease in unemployment and the price level D) an increase in unemployment and a decrease in the price level E) a decrease in potential GDP and an increase in unemployment Ans: D

Difficulty: Easy 25. Potential GDP is the value of GDP that can be calculated if we assume that A) there are no measurement errors B) the unemployment rate is zero C) the inflation rate is zero D) GDP has been adjusted for inflation E) the capital stock is working at full capacity and we have full employment Ans: E

Difficulty: Easy 26. The full-employment level of output is defined as A) actual output plus the output gap B) potential output plus the output gap C) potential output minus the output gap D) the level of output at a zero unemployment rate E) both A) and D) Ans: A

Difficulty: Medium 27. Which of the following is the most important variable for judging an economy's long-run performance? A) growth in nominal GDP B) growth in real GDP C) growth in real GDP per capita D) growth in potential GDP E) growth in the capital stock Ans: C

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Difficulty: Easy 28. Real GDP can grow over time because of A) an increase in the amount of labor used in the production process B) an increase in the capital stock C) efficiency improvements D) all of the above E) only A) and B) Ans: D

Difficulty: Medium 29. The trend path of GDP can change because of efficiency improvements, which can result from A) decreases in the unemployment rate B) increases in the rate of capacity utilization C) changes in knowledge D) decreases in waste E) all of the above Ans: C

Difficulty: Easy 30. The output gap shows the deviation of actual output from potential output and it A) may be either positive or negative B) will always be positive C) increases as the unemployment rate decreases D) becomes negative if the labor force grows faster than actual output E) increases if inflation increases Ans: A

Difficulty: Easy 31. Which of the following can be responsible for a change in the output gap? A) an increase in potential GDP B) a decrease in actual GDP C) a decrease in aggregate demand D) all of the above E) only A) and B) Ans: D
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Difficulty: Medium 32. If real GDP increases from $13.5 trillion one year to $13.6 trillion in the next year, which will be true? A) the GDP gap has probably become smaller B) economic growth is below the long-term trend rate C) economic growth is above the long-term trend rate D) economic growth is about the same as the long-term trend rate E) both A) and C) Ans: B

Difficulty: Easy 33. Which of the following countries had the highest average annual per-capita real income growth rate from 1965 to 2008? A) Brazil B) China C) Japan D) United Kingdom E) United States Ans: B

Difficulty: Easy 34. Which of the following countries had the lowest average annual per-capita income growth rate from 1965 to 2008? A) Brazil B) India C) Japan D) Spain E) United States Ans: E

Difficulty: Easy 35. Japans average growth rate of real GDP per capita from 1965 to 2008 was A) more than twice as high as that of the U.S. B) about the same as that of the U.S. C) less than half as high as that of the U.S.
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D) higher than that of the U.S. but lower than that of China E) lower than that of the U.S. but higher than that of China Ans: D

Difficulty: Easy 36. The average growth rate of real GDP per capita in the U.S. from 1965 to 2008 was about A) 1.7 percent B) 2.0 percent C) 2.7 percent D) 3.0 percent E) 3.3 percent Ans: B

Difficulty: Easy 37. The official unemployment rate for the U.S. includes A) people actively looking for jobs B) people only marginally attached to the work force C) discouraged workers who are not actively looking for jobs D) only A) and B) E) all of the above Ans: A

Difficulty: Easy 38. The unemployment rate is defined as A) the number of unemployed divided by total population B) the number of people not looking for jobs divided by the labor force C) the fraction of the labor force that cannot find jobs but who are actively looking D) the fraction of total population that cannot find jobs E) total population minus the number of employed workers Ans: C

Difficulty: Easy 39. Labor is fully employed when A) everyone is working eight hours per day five days per week each year B) everyone who wants to work can find a job within a reasonable amount of time C) the unemployment rate is zero
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D) the unemployment rate is below 3 percent E) none of the above Ans: B

Difficulty: Easy 40. Looking at how the rate of inflation and unemployment have behaved over the last three decades we can see that A) unemployment and inflation have always increased together B) unemployment has always increased when inflation decreased C) there is no simple relationship between unemployment and inflation D) low unemployment always implies high inflation E) high unemployment always implies high inflation Ans: C

Difficulty: Easy 41. The Phillips curve is often used to show the relationship between A) GDP and unemployment in a given year B) the rate of inflation and unemployment over time C) employment and GDP D) changes in GDP and the rate of inflation E) unemployment and GDP growth Ans: B

Difficulty: Easy 42. When the economy goes into a recession, we can generally expect that A) inflation will decrease while output will increase B) inflation will increase while unemployment will decrease C) inflation and output will increase D) inflation will decrease while unemployment will increase E) none of the above Ans: D

Difficulty: Easy 43. As the economy enters a boom we can generally expect that A) inflation will decrease with little change in the unemployment rate B) unemployment will increase and inflation will decrease
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C) nominal GDP will increase but only because of an increase in the price level D) inflation will increase and the unemployment rate will decrease E) output will increase with little change in unemployment or inflation Ans: D

Difficulty: Medium 44. Looking at the performance of the U.S. economy over the last three decades we realize that A) whenever the inflation rate has decreased, the unemployment rate has also decreased B) whenever the unemployment rate has increased, the inflation rate has decreased C) unemployment and inflation are not necessarily inversely related D) both inflation and unemployment have remained fairly stable over time E) neither unemployment nor inflation has ever exceeded 10 percent Ans: C

Difficulty: Easy 45. Prices usually adjust fairly slowly; the speed of price adjustment can be summarized by A) the Phillips curve B) the AD-curve C) the long-run AS-curve D) the output gap E) the trend path of GDP Ans: A

Difficulty: Easy 46. The CPI is defined as A) the cost-price index, measuring cost increases to producers B) the cross-price index, measuring the increase in relative prices of two different inputs used in the production process C) a price index that measures the average price increase of all final goods and services produced D) a price index that measures the cost of a given market basket of intermediate goods and raw materials E) a price index that measures the cost of a market basket of goods representing the purchases of a typical urban consumer Ans: E

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Difficulty: Easy 47. If we look at the inflation rate (as measured by the CPI) in the U.S. from 1960 to 2010, we see that inflation was at its highest in the year A) 1960 B) 1970 C) 1980 D) 1990 E) 2000 Ans: C

Difficulty: Medium 48. Since 1960 the U.S. inflation rate measured by the CPI has A) increased at a steady rate B) remained remarkably constant C) fluctuated widely and always been positive D) fluctuated widely and usually been positive although it has occasionally been negative E) always increased as the unemployment rate has declined Ans: C Difficulty: Easy 49. If we look at inflation as measured by the CPI in the U.S. over the last four decades, we realize that the rate of inflation A) varied much more in the 1960s than in the 1970s or 1980s B) was much lower in the 1970s than in any other decade C) varied greatly over time but has continued to decrease on average since 1969 D) reached an all-time low in 1981 E) none of the above Ans: E

Difficulty: Easy 50. Even small increases in the inflation rate add up. For example, how much would an item you bought for $1.00 in 1960 have cost on average in 2009? A) $3.23 B) $4.34 C) $5.15

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D) $7.27 E) $9.69
Ans: D

CHAPTER 2 Technical Problems 1. The text calculates the change in real GDP in 1996 prices in the following way: [RGDP06 - RGDP00]/RGDP00 = [3.50 - 1.50]/1.50 = 1.33 = 133%. To calculate the change in real GDP in 2006 prices, we first have to calculate the GDP of 2000 in 2006 prices. Thus we take the quantities consumed in 2000 and multiply them by the prices of 2006, as follows: Beer 1 at $2.00 = $2.00 Skittles 1 at $0.75 = $0.75 _______________________________ Total $2.75 The change in real GDP can now be calculated as [6.25 - 2.75]/2.75 = 1.27 = 127%. We can see that the growth rate of real GDP calculated this way is roughly the same as the growth rate calculated above.

2.a. The relationship between private domestic saving, private domestic investment, the budget deficit, and net exports is shown by the following identity: S - I (G + TR - TA) + NX. Therefore, if we assume that transfer payments (TR) remain constant, an increase in taxes (TA) has to be offset either by an increase in government purchases (G), an increase in net exports (NX), or a decrease in the difference between private domestic saving (S) and private domestic investment (I). 2.b. From the equation YD C + S it follows that an increase in disposable income (YD) will be reflected in an increase in consumption (C), saving (S), or both. 2.c. From the equation YD C + S it follows that when either consumption (C) or saving (S) increases, disposable income (YD) must increase as well.

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3.a. Since depreciation is defined as D = Ig - In = 800 - 200 = 600 ==> NDP = GDP - D = 6,000 - 600 = 5,400. 3.b. From GDP = C + Ig + G + NX ==> NX = GDP - C Ig - G ==> NX = 6,000 - 4,000 - 800 - 1,100 = 100. 3.c. BS = TA - G - TR ==> (TA - TR) = BS + G ==> (TA - TR) = 30 + 1,100 = 1,130 3.d. YD = Y - (TA - TR) = 6,000 - 1,130 = 4,870 3.e. S = YD - C = 4,870 - 4,000 = 870

4.a. S = YD - C = 5,100 - 3,800 = 1,300 4.b. From S - I = (G + TR - TA) + NX ==> I = S - (G + TR - TA) - NX = 1,300 - 200 - (-100) == > I = 1,200. 4.c. From Y = C + I + G + NX ==> G = Y - C - I - NX ==> G = 6,000 - 3,800 - 1,200 - (-100) = 1,100. Also: YD = Y - TA + TR ==> TA - TR = Y - YD = 6,000 - 5,100 ==> TA - TR = 900 From BS = TA - TR - G ==> G = (TA - TR) - BS = 900 - (-200) ==> G = 1,100.

5.

According to Equation (2) in the text, the value of total output (in billions of dollars) can be calculated as: Y = labor payments + capital payments + profits = $6 + $2 + $0 = $8.

7.

If the CPI increases from 2.1 to 2.3 in the course of one year, the rate of inflation can be calculated in the following way: rate of inflation = (2.3 - 2.1)/2.1 = 0.095 = 9.5%. The CPI often overstates inflation, since it is calculated by using a fixed market basket of goods and services. But the fixed weights in the CPIs market basket cannot
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capture the tendency of consumers to substitute away from goods whose relative prices have increased. Quality improvements in goods also often are not adequately taken into account. Therefore, the CPI will overstate the increase in consumers' expenditures.

Chapter 2: National Income Accounting

Difficulty: Easy 1. In calculating this year's GDP, national income accountants A) include any increase in stock values B) include an estimate for income from illegal activities C) exclude Social Security payments to retirees D) exclude the value of any repairs made on existing property E) exclude the value of new pollution control equipment that is being installed Ans: C

Difficulty: Medium 2. Assume you built a new house, bought a used car, and bought some government bonds. Which of the following is true? A) consumption and government purchases went up since you bought a used car and government bonds B) consumption and investment went up since you bought a used car and government bonds C) investment and government purchases went up since you built a new house and bought government bonds D) investment went up since you built a new house E) consumption went up since you built a new house Ans: D

Difficulty: Medium 3. Which of the following is FALSE? A) U.S. GDP underestimates actual economic activity because it does not include underground activity B) an increase in the ratio of currency holdings to bank deposits may be seen as evidence for an

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increase in underground activity C) if the underground economy grows rapidly, then the rate of economic growth will be underestimated D) if the underground economy grows, people's standard of living will decline E) underground activity includes income from services produced at home but not reported, such as typing someone else's term paper Ans: D

Difficulty: Easy 4. Which of the following statements is true? A) NDP is greater than GDP if prices are falling B) NDP is greater than GDP if prices are rising C) NDP can be greater than GDP but only if the economy is growing D) NDP cannot be greater than GDP E) NDP must always be greater than GDP Ans: D

Difficulty: Easy 5. Increases in unwanted business inventories are counted as A) a decrease in the capital stock B) an increase in consumption C) an increase in investment D) an increase in depreciation E) none of the above Ans: C

Difficulty: Easy 6. The difference between gross domestic investment and net domestic investment is equal to A) unwanted inventory changes B) the difference between NDP and national income C) the addition to the capital stock D) the difference between GDP and NDP E) none of the above Ans: D

Difficulty: Medium
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7. Assume nominal GDP increased by 4.2% in the U.S. but by only 3.4% in Germany. We can definitely conclude that A) the standard of living of the people in the U.S. went up more than the standard of living of the people in Germany B) real economic growth in the U.S. was higher than in Germany C) inflation in the U.S. was 0.8% higher than in Germany D) productivity growth in the U.S. was higher than in Germany E) none of the above Ans: E

Difficulty: Easy 8. Assume you deplete your savings to buy a new sofa and some government bonds and then take a vacation in a foreign country. Which of the following is true? A) consumption will increase B) net exports will increase C) government purchases will increase D) investment will increase E) all of the above Ans: A

Difficulty: Easy 9. If gross investment were zero, which of the following would be true? A) the existing capital stock would stay the same B) net investment would be positive C) net investment would be negative D) depreciation would be zero E) depreciation would be negative Ans: C

Difficulty: Easy 10. Depreciation is A) the difference between gross investment and net investment B) the difference between GDP and NDP

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C) the difference between GNP and NNP D) another word for capital consumption allowances E) all of the above Ans: E

Difficulty: Medium 11. If we counted the value of autoworkers' salaries, wheels, tires, steel, body parts, and final car sales in calculating GDP, then we would be A) understating GDP by overlooking car dealers' profits B) ignoring the contribution of capital to output C) overstating GDP through double counting D) using the value-added technique for calculating GDP E) calculating GDP correctly only if we excluded any imported cars Ans: C

Difficulty: Medium 12. The difference between gross investment and net investment is A) the same as the difference between GDP and disposable income B) the same as the difference between disposable income and consumption C) the same as the difference between NDP and national income D) the same as the difference between net and gross exports E) equal to capital consumption allowances Ans: E

Difficulty: Easy 13. In the United States, annual per-capita GDP in 2009 was around A) $32,300 B) $38,400 C) $46,500 D) $48,200 E) $52,600 Ans: C

Difficulty: Easy 14. As defined in our text, private domestic investment (I) does NOT include A) new residential construction except on farms
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B) movable machinery such as trucks or tractors C) inventory accumulation, unless it was planned or intended D) investment in labor productivity through education and training E) new additions to existing factories Ans: D

Difficulty: Medium 15. Assume a U.S. dealer bought 100 TVs from South Korea for $250 each in 2009. He subsequently sold 80 of them in 2006 for $450 each, and the rest in 2010 for $400 each. By how much was the U.S. GDP affected in 2009? A) $45,000 B) $36,000 C) $19,000 D) $16,000 E) $11,000 Ans: D

Difficulty: Easy 16. In 1994, U.S. GDP was $6,931, GNP was $6,922, NNP was $6,104, and national income was $5,495 (all numbers are in billions of dollars). We can conclude that A) depreciation was $818 billion B) depreciation was $1,436 billion C) the addition to the capital stock was $1,436 billion D) the addition to the capital stock was $1,427 billion E) indirect business taxes were $9 billion Ans: A

Difficulty: Medium 17. In a simple economy with no depreciation, no government, and no foreign sector, it is correct to say that for any specified time period (say the month of June) A) Y C B) C I S C) Y C S

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D) Y C S + I E) Y C + S I Ans: C

Difficulty: Medium 18. Which of the following identities is FALSE? A) Y C + I + G + NX B) YD Y - TA + TR C) BS TA - TR - G D) I - S (G - TA + TR) + NX E) S + TA - TR I + G + NX Ans: D

Difficulty: Easy 19. If private domestic saving in an economy increases, which is the most likely to occur? A) a decrease in the budget deficit B) a decrease in net exports C) an increase in consumption D) an increase in imports E) an increase in private domestic investment Ans: E

Difficulty: Medium 20. Assume the budget deficit increases. Which of the following can happen? A) private domestic saving can increase B) private domestic investment can decrease C) imports can increase D) exports can decrease E) all of the above Ans: E

Difficulty: Medium 21. If the government increases taxes, which of the following is LEAST likely to occur? A) a decrease in private domestic saving B) a decrease in consumption C) an increase in private domestic investment
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D) a decrease in net exports E) a decrease in national income Ans: D

Difficulty: Medium 22. Assume that GDP = 4,800, consumption = 3,400, private domestic savings = 400, government purchases = 1,200, and net exports = -120. Which of the following is true? A) disposable income is 3,800 B) private domestic investment is 320 C) the budget deficit is 200 D) all of the above E) only A) and C) Ans: D

Difficulty: Medium 23. If private domestic saving is 960, private domestic investment is 780, and the government spends 300 more than it receives in tax revenues, then it follows that A) the trade deficit is 120 B) the trade deficit is 300 C) the trade deficit is 420 D) the trade surplus is 120 E) the trade surplus is 180 Ans: A

Difficulty: Medium 24. Assume that GDP = 8,100, consumption = 5,400, gross private domestic investment = 1,200, government purchases = 1,600. Which of the following is true? A) B) C) D) imports exceed exports by 100 exports exceed imports by 100 depreciation is 100 the trade surplus is 100
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E) both B) and D) Ans: A

Difficulty: Medium 25. Assume exports = 300, imports = 400, tax revenues = 1,100, government purchases = 1,400, private domestic saving = 900. Then the level of private domestic investment is A) 600 B) 700 C) 900 D) 1,100 E) 1,300 Ans: B

Difficulty: Easy 26. If imports increase by $15 billion, which of the following has to happen for GDP to rise? A) consumption has to increase by more than $15 billion B) government purchases have to increase by more than $15 billion C) private domestic investment has to increase by more than $15 billion D) private domestic saving has to increase by more than $15 billion E) either A), B), or C) would be sufficient to increase GDP Ans: E

Difficulty: Medium 27. As a percentage of GNP, the U.S. federal debt A) sharply increased in the 1980s and then decreased in the 1990s B) has decreased steadily since World War II C) has increased steadily since 1960 D) was never lower than 20 percent E) never exceeded 100 percent Ans: A

Difficulty: Medium 28. If private domestic saving exceeds private domestic investment by $220 billion and government spending exceeds tax revenue by $340 billion, then

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A) the trade deficit is $560 billion B) the trade surplus is $560 billion C) the trade deficit is $120 billion D) the trade surplus is $120 billion E) the trade deficit is $340 billion Ans: C

Difficulty: Medium 29. If national income is 5,200, disposable income is 4,400, consumption is 4,100, the trade deficit is 110, and the budget deficit is 150, what is the level of private domestic investment? A) 1,060 B) 540 C) 300 D) 260 E) 40 Ans: D

Difficulty: Difficult 30. Assume government purchases = $1,500, the budget deficit = $120, consumption = $4,800, private domestic saving = $1,220, the trade deficit = $90, and transfer payments = $0. Which of the following is true? A) private domestic investment is $1,190 B) national income is $7,400 C) disposable income is $6,020 D) all of the above E) only A) and C) Ans: D

Difficulty: Medium 31. If the U.S. budget deficit increased substantially while private domestic saving and private domestic investment remained roughly the same, then

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A) the U.S. imported more than it exported B) the U.S. exported more than it imported C) the U.S. must have experienced a major recession D) there must have been a major drop in U.S. interest rates E) all of the above Ans: A

Difficulty: Difficult 32. Assume the budget deficit decreased by $15 billion, private domestic saving decreased by $20 billion, exports increased by $10 billion, and imports increased by $15 billion. By how much did private domestic investment change? A) private domestic investment decreased by $10 billion B) private domestic investment increased by $10 billion C) private domestic investment did not change at all D) private domestic investment decreased by $20 billion E) the change in private domestic investment cannot be determined from this information Ans: C

Difficulty: Medium 33. The budget deficits in the early 1980s were largely financed through A) an increase in private domestic saving B) an increase in private domestic investment C) an increase in net exports D) a decrease in net exports E) none of the above Ans: D

Difficulty: Medium 34. If the budget surplus increases, which of the following is likely to happen? A) imports will increase more than exports B) exports will increase more than imports C) private domestic saving will increase more than private domestic investment D) private domestic investment will remain the same while private domestic saving will increase E) private domestic investment will decrease

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Ans: B

Difficulty: Easy 35. If we look at U.S. net exports over the last four decades, we realize that A) the U.S. had consistent large trade deficits in the 1960s B) the U.S. never had a trade imbalance in the 1970s C) U.S. trade deficits decreased greatly in the early and mid 1980s D) the U.S. never had a trade surplus until after the year 2000 E) U.S. trade deficits decreased substantially between 1997 and 2000 Ans: C

Difficulty: Medium 36. If the U.S. unemployment rate has increased, which of the following must have occurred? A) more workers have become discouraged and stopped looking for jobs B) more people have been forced to work in part-time rather than full-time jobs C) there has been an decrease in the work force as fewer job openings were listed D) more people have become only "marginally attached" to the work force E) none of the above Ans: E

Difficulty: Easy 37. The PCE deflator measures A) the average price increase of raw materials purchased by producers B) the average price increase of energy prices C) price changes in consumer expenditures based on national income accounts D) price changes of final as well as semi-finished goods E) the average price increase of all final goods excluding energy Ans: C

Difficulty: Easy 38. The GDP-deflator and the producer price index (PPI) differ since A) the PPI measures a fixed market basket but the GDP-deflator doesn't B) the GDP-deflator includes imported goods but the PPI doesn't C) the PPI includes more goods than the GDP-deflator

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D) the GDP-deflator does not include services but the PPI does E) the GDP-deflator measures increases in inflation earlier than the PPI Ans: A

Difficulty: Easy 39. Assume that the prices of cars manufactured in the U.S. increases due to an increase in quality. Which of the following should happen if the same number of cars is produced? A) real GDP should increase but nominal GDP should stay the same B) nominal GDP should increase C) the GDP-deflator should decrease D) real GDP and the GDP-deflator should decrease E) all of the above Ans: B

Difficulty: Medium 40. If nominal GDP was $9,200 billion in Year 1 and $9,420 billion in Year 2 and prices increased from Year 1 to Year 2, then A) real GDP was larger in Year 1 than in Year 2 B) real GDP was larger in Year 2 than in Year 1 C) the GDP-deflator must have been 122 D) the GDP-deflator must have been 102 E) we cannot determine the value of the GDP-deflator or real GDP in Year 2 Ans: E

Difficulty: Medium 41. If nominal GDP is $8,820 billion and the GDP-deflator is 105, then real GDP is A) $9,261 billion B) $8,925 billion C) $8,715 billion D) $8,400 billion E) $8,000 billion Ans: D

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Difficulty: Medium 42. If nominal GDP increased from $8,000 billion in the base year to $8,400 billion in the following year and real GDP stayed the same, which is true? A) the GDP-deflator increased from 100 to 110 B) the GDP-deflator increased from 80 to 100 C) the GDP-deflator increased from 100 to 120 D) prices increased on average by 5 percent E) prices increased on average by 10 percent Ans: D

Difficulty: Easy 43. Assume that in 1962 nominal GDP was about $600 billion and real GDP was about $2,400 billion. The GDP-deflator for that year was A) 1.25 B) 1.4 C) 2.5 D) 4 E) 25 Ans: E

Difficulty: Easy 44. Assume nominal GDP was $8.0 trillion in Year 1 and $8.8 trillion in Year 2. If Year 1 is the base year, then A) the GDP-deflator is 110 B) prices increased on average by 10 percent C) real GDP has not changed D) none of the above can be true E) both A) and B) are true, but only if C) is true Ans: E

Difficulty: Easy 45. The unemployment rate is most likely to decrease if A) the number of people who are out of work but expecting to be recalled from a layoff

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increases B) the number of people living in the country increases C) the labor force decreases more than the overall population D) more people who are currently out of work decide to give up looking for a job E) none of the above Ans: D

Difficulty: Easy 46. Which of the following is TRUE? A) core inflation excludes price changes for food and energy B) core inflation only includes price changes for food and energy C) core inflation is reported for the CPI but not the for the PCE deflator D) the PCE deflator measures the average price change of a market basket of consumer goods E) the PCE deflator only measures price changes in energy Ans: A

Difficulty: Easy 47. The CPI, a price index used to measure inflation, is imperfect since A) it only measures those goods that are included in the market basket B) it does not take into account quality improvements C) many payments are already indexed for inflation D) it does not include services E) only A) and B) Ans: E

Difficulty: Easy 48. The consumer price index (CPI) and the producer price index (PPI) differ from each other since A) the PPI includes import goods but the CPI doesn't B) the CPI usually rises sooner than the PPI C) the composition of their market baskets is different D) the PPI does not measure price increases of a fixed market basket E) the CPI never overestimates inflation but the PPI often does Ans: C

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Difficulty: Easy 49. If the nominal interest rate on a government bond is 6% and the rate of inflation is 4%, what is your real rate of return on this government bond? A) -2% B) +2% C) +4% D) +6% E) +10% Ans: B

Difficulty: Easy 50. Assume you can exchange 10 Mexican pesos for one U.S. dollar, but you need only 0.64 British pounds to get one U.S dollar. What does this imply? A) product prices in Great Britain are much cheaper than in Mexico B) product prices in Great Britain are much more expensive than in Mexico C) you can get about 36 Mexican pesos for one British pound D) you can get about 64 Mexican pesos for one British pound E) none of the above Ans: E

Chapter 3: Growth and Accumulation

Difficulty: Medium 1. Growth accounting explains A) how economic decisions control the accumulation of capital B) how the current savings rate affects the stock of capital in the future C) what part of growth in total output is due to growth in different factors of production D) all of the above E) only A) and B) Ans: C

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Difficulty: Easy 2. The relationship between the output produced in an economy, the input of factors of production, and the state of technological knowledge is called the A) the aggregate supply function B) aggregate production function C) aggregate investment function D) marginal product of labor E) marginal product of capital Ans: B

Difficulty: Medium 3. Given the production function Y = AF(K,N) and assuming constant returns to scale, the contribution of capital to output growth can be estimated by A) adding the growth rate of capital to the term A B) multiplying the growth rate of capital by capital's share in production C) subtracting the growth rate of labor from the rate of technological advancement D) multiplying the capital-labor ratio by the level of output E) multiplying total factor productivity with capitals share in production Ans: B

Difficulty: Easy 4. For the U.S. economy, we can assume that A) output grows at the same rate as both capital and labor B) capital is a larger source of growth than labor C) labor is a larger source of growth than capital D) capital and labor both contribute equally to output growth E) both A) and D) Ans: C

Difficulty: Easy 5. Which of the following is NOT a source of long-term output growth? A) growth in consumption expenditures B) growth in labor inputs

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C) growth in capital inputs D) improved technological efficiency E) growth in the stock of knowledge Ans: A

Difficulty: Medium 6. Which of the following is NOT a source of increased factor productivity? A) advances in knowledge B) growth in the size of the labor force C) more efficient resource allocation D) improved methods of production E) technological progress Ans: B

Difficulty: Easy 7. Which of the following economists contributed greatly to neoclassical growth theory in the 1950s and 1960s? A) Robert Barro B) Robert Lucas C) Gregory Mankiw D) Paul Romer E) Robert Solow Ans: E

Difficulty: Easy 8. Changes in total factor productivity are also called A) the marginal product of labor B) the marginal product of capital C) changes in input costs D) the Cobb-Douglas residual E) the Solow residual Ans: E

Difficulty: Easy 9. Which of the following is NOT a source of increased factor productivity? A) an increase in average years of schooling
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B) an increase in on-the-job training C) increased investment in health D) an increase in the size of the capital stock E) an increase in the rate of innovation Ans: D

Difficulty: Easy 10. According to Solow's estimate, out of the average annual economic growth rate of 2.9% for the U.S. from 1909 to 1949, how much was attributable to the accumulation of capital? A) 0.12% B) 0.32% C) 0.75% D) 1.22% E) 1.55% Ans: B

Difficulty: Easy 11. The Cobb-Douglas aggregate production function provides a fairly good approximation of the U.S. economy if we assume that A) the shares of capital and labor are equal B) the share of capital is 0.65 and the share of labor is 0.35 C) the share of capital is 0.45 and the share of labor is 0.55 D) the share of capital is 0.25 and the share of labor is 0.75 E) the share of capital is 0.15 and the share of labor is 0.85 Ans: D

Difficulty: Medium 12. If we assume a Cobb-Douglas production function, where the share of capital is 0.25 and the share of labor is 0.75, then the marginal product of labor is equal to A) Y/N B) 3Y/4N C) (3/4)N D) 3K/4N E) 3N/4Y Ans: B

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Difficulty: Medium 13. If we assume a Cobb-Douglas production function where the share of capital is equal to 0.2 and the share of labor is equal to 0.8, then the marginal product of capital is equal to A) 5N/K B) 5Y/K C) Y/4K D) Y/5K E) Y/K Ans: D

Difficulty: Difficult 14. Assume a Cobb-Douglas production function where the share of capital and labor is each 1/2. If the growth in total factor productivity is zero and labor and capital each grow by 2%, then A) output growth is 4% and the marginal product of capital is Y/K B) output growth is 2% and the marginal product of capital is Y/(2K) C) output growth is 2% and the marginal product of labor is (2Y)/N D) output growth is 1% and the marginal product of labor is Y/(2N) E) output growth is 1% and the marginal product of capital is (2Y)/K Ans: B

Difficulty: Difficult 15. Assume a Cobb-Douglas production function where the share of capital is 0.3 and the share of labor is 0.7. If capital grows by 1.5%, labor grows by 2%, and growth of total factor productivity is 1.2%, by how much does total output grow? A) 4.70% B) 3.50% C) 3.05% D) 2.85% E) 1.20% Ans: C

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Difficulty: Difficult 16. Assume a Cobb-Douglas production function where the share of labor is 0.7 and the share of capital is 0.3. If there is no technological progress, capital grows at 1.5%, and labor doesn't grow at all, what is the growth rate of output? A) 0.45% B) 0.60% C) 1.05% D) 1.50% E) 2.00% Ans: A

Difficulty: Difficult 17. Assume a Cobb-Douglas production function where the share of labor is 0.7 and the share of capital is 0.3. If there is no technological progress, labor grows at 2%, and capital grows at 1.5%, then real output will grow by A) 0.45% B) 1.50% C) 1.85% D) 2.85% E) 3.05% Ans: C

Difficulty: Medium 18. Assume that the rate of technological advance is 1.5% and both labor and capital grow at a rate of 2%. What is the rate of output growth if labor's share of income is three times as high as capitals share and there are constant returns to scale? A) B) C) D) 1.5% 2.0% 3.0% 3.5%
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E) 5.5% Ans: D

Difficulty: Medium 19. Assume labor's share of income is 80% and capital's share of income is 20%. If we assume constant returns to scale, there are no technological advances, and both labor and capital grow at an annual rate of 3%, then the growth rate of output will be A) 0.6% B) between 0.6% and 2.4% C) between 2.4% and 3% D) 3% E) greater than 3% Ans: D

Difficulty: Medium 20. Assume a production function with constant returns to scale. The share of capital in production is 1/4 and the share of labor is 3/4. If both labor and capital grow at 1.6% and the rate of technological progress is 1.2%, what is the rate of growth of real output? A) 1.2% B) 1.6% C) 2.8% D) 3.2% E) 4.8% Ans: C

Difficulty: Difficult 21. Assume a production function with constant returns to scale. Labor's share of income is 4/5 and capital's share is 1/5. If labor grows at 3%, capital at 2%, and the rate of technological advance is 1.2%, roughly how many years would it take to double the current level of output? A) 12 B) 18

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C) 23 D) 35 E) 48 Ans: B

Difficulty: Difficult 22. Assume a production function with constant returns to scale. Labor's share of income is 0.7 and capital's share is 0.3. If labor grows at 4% and capital grows at 3%, how many years would it take to double the current level of output if no technological advances are made? A) 7 B) 10 C) 19 D) 23 E) 33 Ans: C

Difficulty: Difficult 23. Assume a Cobb-Douglas production function, where the share of labor (N) and capital (K) is each 1/2 and A = 1. If the growth rate of labor is n = 0.06, the rate of depreciation is d = 0.04, and the savings rate is s = 0.2, what is the value of the steady-state capital-labor ratio? A) 0.5 B) 1 C) 2 D) 4 E) 5 Ans: D

Difficulty: Easy 24. From 1973 to 1992, by how much more did GDP grow in Japan than in the United States? A) 10% B) 22% C) 36% D) 54% E) 66%

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Ans: C

Difficulty: Easy 25. Which of the following countries had the lowest ratio of investment to GDP in 1992? A) Japan B) Norway C) Singapore D) Taiwan E) United States Ans: E

Difficulty: Easy 26. If we compare the annual growth rates in the U.S. and Japan, we see that from 1950 to 1992, the difference in average annual growth in GDP per capita between Japan and the U.S. was about A) 1.2% B) 2.2% C) 2.8% D) 3.8% E) 5.2% Ans: D

Difficulty: Easy 27. Which of the following is FALSE? A) a high level of investment generally does not lead to a higher living standard B) in industrial countries the amount of labor is less important than the skills and talent of the work force C) a country that possesses rich natural resources should have a high standard of living D) countries with fewer average years of schooling often have lower living standards E) if a poor country invests in health it can significantly increase the quality of human capital and thus raise overall living standards Ans: A

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Difficulty: Medium 28. If two countries have the same aggregate production function, rate of technological growth, and savings rate, then A) they will always have the same per-capita income B) the country with the higher rate of population growth will have a higher per-capita income C) the country with the lower rate of population growth will have a higher per-capita income D) the country with the highest depreciation rate will have the highest per-capita income E) both C) and D) Ans: C

Difficulty: Medium 29. In the neoclassical growth model, an increase in the savings rate A) raises the steady-state level of output B) lowers the steady-state level of output C) raises the long-term economic growth rate D) lowers total factor productivity E) both A) and C) Ans: A

Difficulty: Medium 30. In the neoclassical growth model, if a nation's savings rate decreases, we should expect that A) the long-run income per capita will increase B) the long-run capital-labor ratio will increase C) the growth rate of output will temporarily decrease but eventually return to its long-run trend D) all of the above E) none of the above Ans: C

Difficulty: Medium 31. In the neoclassical growth model, an increase in the rate of population growth will A) raise the growth rate of output B) increase the level of output per capita C) increase the steady-state capital-labor ratio D) all of the above

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E) only B) and C) Ans: A

Difficulty: Medium 32. In a neoclassical growth model, a decline in population growth will A) shift the production function down B) shift the savings function down C) decrease the slope of the investment requirement line D) all of the above E) only A) and C) Ans: C

Difficulty: Medium 33. In the neoclassical growth model, if the capital-labor ratio is below the (optimal) steady-state level, we should expect that A) economic growth will continue to decline unless technological advances are made B) income per capita will decrease since gross investment is not sufficient to supply new workers with adequate capital C) the savings rate will decline due to the lack of economic growth D) all of the above E) none of the above Ans: E

Difficulty: Medium 34. In a neoclassical growth model, if the capital-labor ratio is lower than the (optimal) steady-state level, we should expect that A) B) C) D) saving is smaller than the investment requirement output per capita will temporarily grow at a rate lower than population growth income per capita will decrease there will be a temporary increase in the capital stock that is greater than the increase in population E) all of the above Ans: D

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Difficulty: Medium 35. The convergence to a steady-state capital-labor ratio k* is ensured by the fact that if k is at a level A) lower than k*, saving will exceed the investment required to maintain a constant k, causing k to rise B) lower than k*, investment will exceed saving, leading to an increase in the capital stock C) lower than k*, saving will exceed the investment required to maintain a constant k, causing output per capita to decline D) higher than k*, the rate of depreciation will be higher than the savings rate, causing k to decrease E) higher than k*, output per capita will continue to increase until a new steady-state equilibrium is reached Ans: A

Difficulty: Difficult 36. An economy with a capital-labor ratio that is lower than the steady-state level can achieve a steady-state equilibrium at this lower capital-labor ratio only if A) the savings rate decreases B) the rate of depreciation decreases C) the rate of population growth decreases D) technological advances are made E) all of the above Ans: A

Difficulty: Medium 37. In a neoclassical growth model, a nation with a declining population growth rate will experience A) a decrease in living standards B) an increase in living standards C) a lower savings rate D) an increase in long-term growth E) a decrease in the steady-state capital-labor ratio Ans: B

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Difficulty: Medium 38. A neoclassical growth model would predict that if the rates of both population growth and saving increase, then the steady-state capital-labor ratio will A) increase B) decrease C) stay the same D) temporarily increase, but then go back to its original level E) most likely change but we cannot say for sure how Ans: E

Difficulty: Medium 39. Assume a neoclassical growth model with constant returns to scale. Which of the following statements is TRUE? A) a declining population growth rate will increase per-capita income B) an increase in the savings rate will permanently increase the growth rate of output C) an increase in the depreciation rate will increase the capital-labor ratio D) technological advances will have no effect on the long-run growth rate of output E) none of the above Ans: A

Difficulty: Medium 40. The idea of a steady state is that A) the capital-labor ratio grows at a constant rate B) output per capita grows at a constant rate C) output, capital, and labor all grow at the same rate D) an increase in the savings rate will not affect the capital-labor ratio E) real output cannot grow Ans: C

Difficulty: Easy 41. According to the neoclassical growth model, a one-time technological advance will

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A) shift the investment requirement line up B) increase the long-term growth rate of output C) have no effect on the steady-state capital-labor ratio D) lead to a decrease in the rate of depreciation E) none of the above Ans: E

Difficulty: Medium 42. The steady state is defined as a long-run equilibrium at which capital, labor, and output all grow at the same rate. To be in a steady state in a neoclassical model, which of the following equations has to be satisfied? A) y = (n - d)k B) sy = (n + d)k C) sf(k) = (n - d)k D) sy = nk + d E) y = f(k) = sk + nd Ans: B

Difficulty: Medium 43. In the neoclassical growth model, the steady-state capital-labor ratio is determined by the equation A) k = (n + d)y B) k = s(n + d) C) k = sy/(n + d) D) k = y/(n - d) E) k = (n + d)/sy Ans: C

Difficulty: Easy 44. In a neoclassical growth model in which a one-time advance in technology occurs we could expect A) the level of saving and investment to increase until a new and higher steady-state capital-labor ratio is reached

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B) the level of income per capita to increase but the steady-state growth rate of output to remain unaffected C) the level of output for any given capital-labor ratio to increase D) all of the above E) none of the above Ans: D

Difficulty: Easy 45. When current saving and investment are just enough to equip new entrants into the labor force with the same amount of capital that the average person already in the work force uses, then A) the economy is in a steady state B) output per head is constant C) capital per head is constant D) capital is growing at the same rate as the population E) all of the above Ans: E

Difficulty: Medium 46. For a neoclassical growth model, which of the following statements is FALSE? A) an increase in the savings rate will increase the steady-state growth rate of aggregate output B) an increase in population growth will increase the steady-state growth rate of aggregate output C) an increase in population growth will reduce the steady-state level of income per capita D) if poor countries save at the same rate as rich countries and have access to the same technology, they will eventually catch up E) long-run growth results from improvements in technology Ans: A

Difficulty: Medium 47. According to neoclassical growth theory which of the following does NOT affect a nation's long-term growth rate?

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A) the savings rate B) technological progress C) the rate of depreciation D) population growth E) both A) and C) Ans: E

Difficulty: Medium 48. In a neoclassical growth model, steady-state consumption is maximized when the marginal increase in the capital-labor ratio (k) produces just enough extra output per capita (y) that the marginal product of k is equal to A) n + d B) sy/(n d) C) sy/(n + d) D) sa - (n + d) E) s - (n + d) Ans: A

Difficulty: Medium 49. The golden-rule capital stock (k**) ensuring that steady-state consumption is maximized is at the point on the production function f(k) where the marginal product of capital (k) is equal to A) n + d B) n - d C) s(n + d) D) sa/(n + d) E) sa/(n - d) Ans: A

Difficulty: Medium 50. The golden-rule capital stock (k**) corresponds to A) the highest permanently sustainable level of steady-state consumption B) the point at which a marginal increase in capital produces just enough extra output to cover the increased investment requirement C) the point on the production function y = f(k), where the slope of f(k) is equal to (n + d) D) all of the above E) none of the above Ans: D

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Chapter 4: Growth and Policy

Difficulty: Medium 1. Assume a production function with only two inputs, capital and labor. In this case, the concept of a diminishing marginal product of capital implies that A) as less capital is being used, more and more labor has to be employed to increase output B) as both labor and capital inputs are increased, output increases but at a decreasing rate C) as the amount of capital is increased and the amount of labor remains fixed, output increases but at a decreasing rate D) as the amount of capital increases and the amount of labor remains fixed, output cannot increase E) labor inputs have a bigger impact on increasing output than capital inputs Ans: C

Difficulty: Easy 2. Which of the following countries had the HIGHEST average annual growth rate of GDP per capita between 1988 and 2007? A) China B) India C) Mexico D) South Korea E) United States Ans: A

Difficulty: Easy 3. Which of the following countries had the LOWEST average annual growth rate of GDP per capita between 1988 and 2007? A) B) C) D) E) Bangladesh Egypt Indonesia Thailand United States

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Ans: E

Difficulty: Easy 4. Which of the following countries annual growth rate of GDP per capita between 1988 and 2007 was closest to that of the United States? A) China B) Egypt C) Mexico D) Taiwan E) Thailand Ans: C

Difficulty: Easy 5. Which of the following economists did NOT significantly contribute to the debate on exogenous versus endogenous growth? A) Robert Barro B) Gregory Mankiw C) Robert Lucas D) David Ricardo E) Paul Romer Ans: D

Difficulty: Medium 6. A production function that assumes a diminishing marginal product of capital A) generates a straight savings line B) ensures that the savings line is always above the investment requirement line C) ensures that the savings line and the investment requirement line cross D) is essential to the endogenous growth model E) violates important microeconomic principles Ans: C

Difficulty: Medium

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7. A) B) C)

The concept of diminishing marginal returns implies that output cannot decrease as long as labor is substituted for capital output decreases if either labor or capital is decreased output increases but at a decreasing rate as the amount of labor is increased and the amount of capital remains fixed D) if the capital stock is kept constant, output cannot increase even if more labor is available E) output increases but only if the amounts of both labor and capital increase Ans: C

Difficulty: Medium 8. The assumption of constant returns to capital alone implies that larger firms should be more efficient than smaller firms. The reason this doesn't necessarily imply a tendency toward monopolization is that A) most industries are perfectly competitive in nature B) firms have more inputs than just capital C) constant returns to capital alone still implies decreasing returns to all factors of production taken together D) if one firms increases its use of capital, other firms can also capture some of the production benefits of the new capital through spillover effects E) none of the above Ans: D

Difficulty: Easy 9. Which of the following statements is FALSE? A) endogenous growth theory relies on constant returns to scale of capital alone to generate ongoing growth B) endogenous growth theory predicts that an increase in population growth will always lead to an increase in the overall growth rate C) the microeconomics underlying endogenous growth theory emphasizes the existence of substantial external returns to capital D) endogenous growth theory predicts that a high savings rate can generate a high growth rate E) empirical evidence suggests that endogenous growth theory is not very important for explaining differences in growth among countries Ans: B

Difficulty: Easy 10. According to the endogenous growth theory A) countries with the same technology and population growth eventually converge to the same
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steady-state growth rate independent of the savings rate B) the steady-state growth rate decreases as the rate of accumulation of factors of production increases C) the long-term growth rate of capital is not affected by the savings rate D) the steady-state growth rate is affected by the rate at which the factors of production are accumulated E) none of the above Ans: D

Difficulty: Medium 11. A production function with constant returns to scale for capital alone implies that A) there are increasing returns to scale for all factors of production taken together B) if all inputs are doubled then output will more than double C) smaller firms are more efficient than larger firms D) technological advances cannot take place E) both A) and B) Ans: E

Difficulty: Medium 12. If we have an aggregate production function of the form Y = aK, at what capital-labor ratio can a steady-state equilibrium be reached? A) k = sa - (n + d) B) k = sa + (n - d) C) k = sa/(n + d) D) k = ay/(n + d) E) never Ans: E

Difficulty: Difficult 13. Assume we have a simple endogenous growth model where technology is labor augmenting, that is, Y = F(K,AN), and also proportional to the capital-labor ratio, such that y = ak. In this case, the growth rate of GDP per capita can be expressed by A) sa + (n + d) B) sa - (n + d) C) sa - (n + d)k D) sa + (n - d)k E) sk - (n + d)a
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Ans: B

Difficulty: Medium 14. Assume an endogenous growth model with labor augmenting technology. The production function is Y = F(K,AN) with A = 2(K/N), so y = 2k. If the savings rate is s = 0.05 and there is neither population growth nor depreciation of capital, what is the growth rate of output? A) 0% B) 2.5% C) 5% D) 10% E) it cannot be determined Ans: D

Difficulty: Medium 15. Assume an endogenous growth model with labor augmenting technology. The production function is Y = F(K,AN), with A = 2(K/N) such that y = 2k. If the savings rate is s = 0.08, the rate of population growth is n = 0.03, and the rate of depreciation is d = 0.04, what is the growth rate of output per capita? A) 1% B) 3% C) 4% D) 7% E) 9% Ans: E

Difficulty: Medium 16. Assume an endogenous growth model with labor augmenting technology. The production function is Y = F(K,AN), where A = 2(K/N) such that y = 2k. If the savings rate is s = 0.06, the rate of population growth is n = 0.05, and the rate of depreciation is d = 0.04, then the growth rate of real output per capita is A) 1% B) 3% C) 5% D) 6% E) 9% Ans: B

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Difficulty: Medium 17. Assume an endogenous growth model with labor augmenting technology and a production function of the form Y = F(K,AN), where A = 1.2(K/N) such that y = (1.2)k. If the rate of population growth is n = 0.06 and the rate of depreciation is d = 0.04, how large does the savings rate (s) have to be to achieve a per-capita growth rate of 8 percent? A) 6% B) 10% C) 15% D) 24% E) 30% Ans: C

Difficulty: Medium 18. Assume an endogenous growth model with labor augmenting technology and a production function of the form Y = F(K,AN), where A = 1.2(K/N) such that y = (1.2)k. If the savings rate is s = 0.15 and the rate of depreciation is d = 0.05, how high does population growth (n) have to be to achieve a growth rate of 10 percent? A) 15% B) 12% C) 10% D) 5% E) 3% Ans: E

Difficulty: Medium 19. Assume an endogenous growth model with labor augmenting technology. The production function is Y = F(K,AN), where A = a(K/N) such that y = ak. If the savings rate is s = 0.1, the rate of population growth is n = 0.04, and the depreciation rate is d = 0.02, how much would "a" have to be to achieve a 12% growth rate of output? A) 0.6 B) 1.2 C) 1.8 D) 2.0 E) 2.4 Ans: C

Difficulty: Medium
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20. If we consider the per-capita GDP of China and India over the last three decades, we realize that A) despite vast differences in population growth, both countries' per-capita GDP grew at approximately the same rate B) while investment in human capital is important for economic growth, so are institutional changes and openness to trade C) Indias growth in per-capita GDP was higher than Chinas due to more investment in human capital D) neither countrys per-capita GDP grew significantly until the 1990s E) the difference in growth rates between these countries can largely be explained by the difference in years of schooling Ans: B

Difficulty: Medium 21. A comparison of per-capita GDP in China and India over the last three decades indicates that A) neither countrys per-capita GDP grew much until the mid-1990s B) India has a higher per-capita GDP than China since it experienced its growth spurt earlier C) both countries started poor in 1960, but by the year 2000 Chinas per-capita GDP was almost twice as high as Indias D) both countrys per-capita GDP grew significantly and at about the same rate E) Indias per-capita GDP grew more than Chinas due to more investment in human capital Ans: C

Difficulty: Easy 22. A comparison of per-capita GDP in China and India over the last three decades indicates that A) increases in physical capital contributed more to growth in China than in India B) increases in physical capital contributed more to growth in India than in China C) India's per-capita GDP grew more than Chinas due to lower population growth D) while per-capita GDP of the two countries increased at about the same rate, India's total factor productivity increased much more than China's E) while China's total factor productivity increased much more than India's, the per-capita GDP in both countries increased at about the same rate Ans: A

Difficulty: Medium 23. The neoclassical growth model predicts conditional convergence for countries with the same population growth, level of technology, and A) a higher savings rate
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B) a lower savings rate C) the same savings rate D) all of the above E) none of the above Ans: D

Difficulty: Medium 24. The neoclassical growth model predicts absolute convergence for countries with the A) same technology, savings rate, and population growth B) same technology and savings rate, but different rates of population growth C) same technology and population growth, but different savings rates D) same population growth and savings rate, but different levels of technology E) same population growth, but different levels of technology or savings rates Ans: A

Difficulty: Medium 25. Countries with higher saving rates may have higher equilibrium growth rates since A) people who save more also are more industrious B) higher income allows for more savings C) a higher saving rate allows for more investment in human capital which ultimately enhances economic growth D) having more capital equipment is more important than having better capital equipment E) none of the above Ans: C

Difficulty: Difficult 26. In a growth model with endogenous population growth and an investment requirement that rises slowly at first then rises sharply and eventually flattens out, we can get A) three steady-state equilibria, only one of which is stable B) three steady-state equilibria, only two of which are stable C) three steady-state equilibria, all of which are stable D) one stable steady-state equilibrium, but only if the savings rate is high enough E) both B) and D) are possible Ans: E

Difficulty: Medium
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27. An endogenous growth model predicts that if the rates of both population growth and saving increase, then the growth rate of GDP per capita will A) increase B) decrease C) stay the same D) temporarily increase, but then go back to its original level E) either increase, decrease, or stay the same (we cannot say for sure) Ans: E

Difficulty: Easy 28. Which of the following policies does NOT affect the long-term growth rate of a nation? A) investment tax credits or any other policy that reduces the cost of capital B) an expansionary fiscal/expansionary monetary policy mix C) increased funding for primary education D) incentives to increase saving E) more funding for research and development Ans: B

Difficulty: Medium 29. Separating private returns to capital from social returns to capital, that is, the idea that investment in capital may have positive spillover effects as new ideas and new ways of doing things can be easily copied by others, was first advocated by A) Robert Barro B) Robert Lucas C) Robert Samuelson D) Paul Solow E) Paul Romer Ans: E

Difficulty: Easy 30. Assume India's income level is now roughly 5% of that of the United States. Assuming there is no change in the savings rates and the levels of technology of these two countries, how many years will it take for India to reach 10% of the U.S.'s income level? A) 10 B) 20 C) 25 D) 35 E) 50
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Ans: D

Difficulty: Medium 31. The notion of conditional convergence states that two countries that have the same population growth and access to the same level of technology will reach a steady-state equilibrium at A) different levels of output but the same growth rate, if their savings rates are different B) different levels of output and different economic growth rates if their savings rates are different C) the same level of output and the same economic growth rate, even if their savings rates are different D) the same level of output but different economic growth rates if their savings rates are different E) the same level of output and the same economic growth rate if their savings rates are the same but their rates of depreciation differ Ans: A

Difficulty: Easy 32. A key assumption in an endogenous growth model with both labor and capital inputs in the production function is that A) the share of capital is larger than the share of labor B) the share of capital and labor have to be equal C) better technology is a byproduct of more capital investment D) there are no external returns to capital E) long-run growth comes solely from technological progress Ans: C

Difficulty: Easy 33. In a simple version of the Solow growth model with endogenous population growth, a country can escape the poverty trap by A) lowering the savings rate and devoting more resources to consumption B) lowering population growth C) raising the savings rate D) both A) and B) E) both B) and C) Ans: E

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Difficulty: Medium 34. Which of the following is NOT an important factor in establishing high growth in GDP per capita for a country? A) a stable monetary growth rate B) a high savings rate C) low population growth D) a predictable economic and political environment E) policies to encourage industries to compete in world markets Ans: A

Difficulty: Easy 35. Which of the following policy options is likely to be most successful in getting a poor country out of the poverty trap? A) expansionary fiscal policy B) expansionary monetary policy C) labor market policies D) programs to limit population growth E) investment subsidies Ans: D

Difficulty: Easy 36. Countries can achieve continued economic growth as long as A) technological advances continue B) educational progress continues C) intelligent resource management is practiced D) all of the above E) only A) and B) Ans: D

Difficulty: Easy 37. Robert Barro's empirical findings that countries with higher levels of investment will achieve a steady state with a higher per-capita income but not with a higher growth rate supports A) the notion of absolute convergence B) the notion of conditional convergence C) the predictions of the endogenous growth theory D) the belief that a high savings rate is not beneficial for any nation E) the belief that technology is not very important
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Ans: B

Difficulty: Medium 38. Developed countries that direct their investment towards physical capital rather than research and development can expect to A) have a higher level of output in the short run and a higher long-run growth rate B) have a lower level of output in the short run and lower long-run growth rate C) have a lower level of output in the short run but a higher long-run growth rate D) have a higher level of output in the short run but a lower long-run growth rate E) achieve A) but only if the level of investment exceeds 1/3 of GDP Ans: D

Difficulty: Easy 39. For a developing country that wants to increase its stock of real capital fairly quickly, which of the following is NOT a valid option? A) implementing policies designed to increase educational levels B) asking foreign firms for direct investments in the country C) borrowing funds from the World Bank for real capital investments D) asking other countries for foreign aid to buy new machines E) increasing private domestic saving Ans: A

Difficulty: Easy 40. How many years will it take a country that grows at an average rate of 2% per year to double the size of its GDP? A) 100 B) 50 C) 35 D) 20 E) 15 Ans: C

Difficulty: Easy 41. If two countries have the same share of investment to GDP, the one that experiences a faster growth rate is most likely the one that A) emphasizes free market policies and encourages foreign trade
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B) protects domestic industry from foreign competition with trade barriers C) invests less in government infrastructure D) has a higher share of government spending to GDP E) has more government regulations and spends more funds to protect the environment Ans: A

Difficulty: Easy 42. Which of the following countries is NOT one of the "Asian Tigers"? A) Hong Kong B) Japan C) Singapore D) South Korea E) Taiwan Ans: B

Difficulty: Easy 43. The "Asian Tigers" achieved high economic growth from 1966 to 1990 in part because they A) had very high savings rates B) successfully controlled their population growth C) devoted many resources to education D) both B) and C) E) both A) and C) Ans: C

Difficulty: Easy 44. Which of the following was NOT a common element contributing to the growth of the four "Asian Tigers" between 1966 and 1990? A) an increase in the labor force participation rate B) high educational achievement C) a high savings rate D) emphasis on laissez-faire economics E) an increase in total factor productivity achieved by higher levels of inputs Ans: D

Difficulty: Easy 45. Between 1966 and 1990, all four "Asian Tigers" achieved economic growth mostly through
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A) hard work and sacrifice B) protecting domestic industries through tariffs C) substantially increasing growth in total factor productivity D) controlling population growth E) a large degree of government intervention Ans: A

Difficulty: Medium 46. Hong Kong and Singapore achieved high economic growth between 1966 and 1990. Which of the following characteristics did these two countries NOT have in common? A) a fairly stable government B) a very low degree of government intervention C) industries were encouraged to export and compete in world markets D) increases in labor force participation rates E) great investments in human capital Ans: B

Difficulty: Easy 47. The four "Asian Tigers" achieved high economic growth between 1960 and 1990 since they A) initially protected domestic firms, but then exposed them to foreign competition B) had very high savings rates C) had large increases in the labor force participation rates of women D) increased inputs substantially, although total factor productivity did not increase substantially E) all of the above Ans: E

Difficulty: Easy 48. Between 1966 and 1990 Singapore's GDP per capita grew at an average annual rate of 6.8%. During the same time frame its growth rate in total factor productivity was A) 0.2% B) 1.2% C) 2.2% D) 3.2% E) 4.2% Ans: A

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Difficulty: Easy 49. Between 1966 and 1990 Hong Kong experienced a much higher growth rate of output than Singapore. This was at least partially due to the fact that Singapore had a government that A) emphasized a laissez-faire attitude towards market activities B) maintained much tighter control over market activities C) discouraged a rapid pace of foreign investment in new technology D) imposed strict population control programs E) none of the above Ans: B

Difficulty: Medium 50. There is no simple relationship between the proportion of investment to output and the growth rate of per-capita output since A) population growth rates differ among countries B) income growth rates differ among countries C) the efficiency of investment among countries can vary widely D) the savings rates among countries can vary widely E) none of the above Ans: C CHAPTER 5 Technical Problems 1.a. As Figure 5-11 shows, a decrease in income taxes shifts both the AD-curve and the AScurve to the right. The shift in the AD-curve tends to be fairly large and, in the very short run (when prices are fixed), leads to a significant increase in output without a change in prices. But in the long run, the AS-curve will also shift to the right. Since lower income tax rates provide an incentive to work more, output will increase, but only by a fairly small amount. Therefore we see a large increase in the price level with a slightly higher level of real GDP in the long run. 1.b. Supply-side economics includes any policy measure that will increase potential GDP by shifting the long-run (vertical) AS-curve to the right. Supply-side economists put forth the view that a cut in income tax rates will increase the incentive to work, save, and invest. Some economists claimed that this would increase aggregate supply so much that the inflation and unemployment rates would simultaneously decrease, and that the resulting high economic growth might even lead to an increase in tax revenues, despite lower tax rates. However, when these policies were implemented in the early 1980s, they did not have the predicted effects. As seen in Figure 5-11, the long-run effect of a tax cut on output is small, but the price level may increase substantially.

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2.a.

ADo

AD1

AS

P1 Po

0 Yo Y1 Y

According to the balanced budget theorem, a simultaneous and equal increase in government purchases and taxes will shift the AD-curve to the right, as the positive impact of the increase in government spending is greater than the negative impact of the tax increase. But if the AS-curve is upward sloping, then the balanced budget multiplier will be less than one, that is, the increase in output will be less than the increase in government purchases. This occurs because part of the fiscal expansion will be crowded out, that is, the level of private spending will decrease, due to a higher price level, lower real money balances, and the resulting rise in interest rates. 2.b. In the Keynesian case, the AS-curve is horizontal and the price level remains unchanged. There is no real balance effect and therefore income increases more than in 2.a., that is, output increases by the whole shift in the AD-curve. However, the interest rate still increases and therefore the balanced budget multiplier is less than one (but greater than in 2.a.). P ADo AD1

Po

AS

Yo

Y1

2.c. In the classical case, the AS-curve is vertical and the output level remains unchanged. In this case, a shift in the AD-curve leads to a price increase and real money balances decline. Therefore interest rates increase further than in 2.b. or even 2.a., leading to full crowding out of investment. Hence the balanced budget
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multiplier is zero in the classical case.

P AD1 AD0 P1 P0 0 Y* Y AS

Chapter 5: Aggregate Supply and Demand

Difficulty: Easy 1. If factor markets were perfectly competitive, then full employment would be the normal condition and A) inflation would always be zero B) output would rise steadily with price increases C) there would never be any reason for prices to change D) the AS-curve would be horizontal E) the AS-curve would be vertical Ans: E

Difficulty: Easy 2. Assume you buried a $100 bill in a time capsule in 1970 and dug it up 40 years later. What would be its purchasing power in 2010? A) $122 B) $100 C) $88 D) $44 E) $22 Ans: E

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Difficulty: Medium 3. The AS-curve is horizontal or very flat if A) additional resources (especially labor) can be hired to produce additional output with little or no increase in existing prices B) wages fall rapidly with an increase in unemployment, reducing spending and income to restore equilibrium C) firms lower wages less than prices to avoid a loss in profit during a recession D) the nominal wage adjustment occurs fairly rapidly E) nominal wages and prices always change proportionally, leaving the real wage rate unchanged Ans: A

Difficulty: Medium 4. Which of the following was NOT true during the Great Depression? A) investment as a share of GDP was below 3 percent B) unemployment averaged about 18.8 percent C) prices dropped by one-fourth D) output fell by nearly 30 percent E) both B) and C) Ans: A

Difficulty: Easy 5. The level of GDP that corresponds to full employment in the labor market is called A) potential GDP B) real GDP C) nominal GDP D) natural GDP E) GDP per capita Ans: A

Difficulty: Easy 6. Most economists prior to Keynes thought that A) unemployment could be eliminated by active fiscal policies B) the economy always adjusted rapidly to full employment C) the economy always adjusted to a natural rate of inflation D) monetary policy could be employed to eliminate the business cycle E) government intervention was needed to avoid persistent unemployment Ans: B
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Difficulty: Medium 7. The Keynesian AS-curve differs from the classical AS-curve, since Keynes A) thought that labor markets worked smoothly to always establish full employment B) thought that nominal wages were flexible even when there was unemployment C) thought that nominal wages were rigid even when there was unemployment D) described the AS-curve as completely vertical E) assumed that firms tried to exploit the work force by paying them substandard wages Ans: C

Difficulty: Easy 8. The Keynesian aggregate supply curve implies that A) the economy is always at the full-employment level of output B) the price level is unaffected by current levels of GDP C) wages are perfectly flexible D) real money balances decrease as the AD-curve shifts to the right E) an increase in nominal money supply will not affect the level of real GDP Ans: B

Difficulty: Medium 9. In the Keynesian aggregate supply curve case, A) firms will always supply the amount of goods demanded at the existing price level B) consumers will demand whatever is supplied by firms at each price C) the economy is always at full employment D) unemployment is always at its natural rate E) none of the above Ans: A

Difficulty: Medium 10. In which of the following cases will the AS-curve be horizontal? A) if nominal wages and prices always change proportionally, leaving real wages unchanged B) if nominal wages do not change even if there is high unemployment C) if nominal wages are completely flexible D) if the economy is always in a full-employment equilibrium E) if fiscal policy has no impact on the output level Ans: B
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Difficulty: Easy 11. Given the Keynesian AS-curve, expansionary monetary policy will A) increase the level of output but leave the price level unchanged B) increase the price level but leave the level of output unchanged C) increase both the level of output and the price level D) leave the level of output and the price level unchanged E) increase the level of output but decrease the price level Ans: A

Difficulty: Easy 12. In the Keynesian supply curve case, a fiscal expansion will A) have no impact on equilibrium income or prices B) increase prices but have no impact on equilibrium income C) increase prices more than income D) increase income more than prices E) increase equilibrium income but have no impact on prices Ans: E

Difficulty: Medium 13. Which of the following is FALSE? A) the AS-curve is horizontal in the Keynesian case B) the AS-curve is vertical in the classical case C) the AS-curve is upward sloping in the medium run D) the AS-curve is more price elastic in the long run than in the short run E) none of the above Ans: D

Difficulty: Easy 14. The AD-AS diagram used in this chapter A) is unrelated to the demand and supply diagram used in microeconomics B) uses the average price level of all goods and services we buy as price C) uses an AS-curve that is relatively more price elastic in the medium run than in the long run D) uses an AS-curve that is vertical in the long run and horizontal in the very short run
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E) all of the above Ans: E

Difficulty: Easy 15. Which of the following is NOT reflected in a shift of the AD-curve? A) a change in real money balances due to a change in the price level B) a change in real money balances due to a change in nominal money supply C) a change in government transfer payments D) a change in the confidence of consumers and businesses E) all of the above will shift the AD-curve Ans: A

Difficulty: Easy 16. The slope of the AS-curve becomes steeper A) as nominal wages become more flexible B) as nominal wages become more rigid C) as the actual level of output moves further away from potential output D) as the economy approaches full employment E) both A) and D) Ans: E

Difficulty: Medium 17. A decrease in real money supply caused by an increase in the price level is graphically represented by A) a shift of the AD-curve to the right B) a shift of the AD-curve to the left C) movement along the AD-curve to the right D) movement along the AD-curve to the left E) a shift of the AS-curve to the right Ans: D

Difficulty: Easy 18. The natural rate of unemployment is A) always zero B) the unemployment rate that exists when inflation is zero C) the unemployment rate that exists when output is assumed to be at its full-employment level
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D) the unemployment rate that exists above frictional unemployment E) none of the above Ans: C

Difficulty: Easy 19. Frictional unemployment is defined as A) all unemployment above the natural rate B) unemployment that is cyclical in nature C) the natural unemployment rate minus cyclical unemployment D) unemployment resulting from people shifting between jobs and looking for new jobs E) any unemployment that is below 4% Ans: D

Difficulty: Easy 20. If output is at its full-employment level, then A) the actual unemployment rate is zero B) the natural rate of unemployment is zero C) there are no frictions in the labor market since wages have reached their market-clearing level D) there is still some positive level of unemployment due to frictions in the labor market E) nobody who is currently employed is looking for a new job Ans: D

Difficulty: Medium 21. A shift of the AD-curve to the left can be caused by A) a decrease in taxes B) an increase in business and consumer confidence C) an increase in nominal money supply D) a decrease in government transfer payments E) a decrease in money demand Ans: D

Difficulty: Difficult 22. In the medium run, if government purchases are increased and nominal money supply is decreased, we can expect that A) aggregate demand and prices will increase but interest rates will not change
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B) C) D) E)

aggregate demand, prices, and the interest rate will all decrease aggregate demand and interest rates will decrease but prices will increase the AD-curve will shift to the right and the AS-curve will shift to the left the interest rate will increase while aggregate demand and prices may increase, decrease, or remain the same Ans: E

Difficulty: Easy 23. The AD-curve has a negative slope since A) firms will produce less if they have to lower their prices B) lower prices mean higher real wages so firms can no longer afford to produce as many goods and services C) a decrease in the price level increases real money balances, leading to lower interest rates and increased spending D) lower prices drive up the demand for goods since buyers fear future market shortages E) lower prices increase consumer confidence, which encourages spending Ans: C

Difficulty: Medium 24. A shift of the AD-curve to the right could be caused by A) a decrease in taxes B) a decrease in government transfer payments C) an increase in money demand D) a decrease in defense spending E) both A) and C) Ans: A

Difficulty: Easy 25. An increase in aggregate demand can be caused by A) an increase in government expenditures B) an increase in nominal money supply C) a decrease in taxes D) an increase in business and consumer confidence E) all of the above Ans: E

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Difficulty: Medium 26. To maintain a fixed level of aggregate demand, the Fed would have to respond to a tax increase by A) increasing reserve requirements B) increasing the discount rate C) buying bonds in the open market D) selling bonds in the open market E) urging banks to ration credit Ans: C

Difficulty: Medium 27. In a normal AD-AS diagram with an upward-sloping AS-curve, if the government wanted to maintain a fixed level of output, it would need to respond to a decrease in money supply by A) decreasing government expenditures B) increasing government spending C) urging the Fed to sell bonds in the open market D) increasing income taxes E) decreasing taxes and government spending by the same amount Ans: B

Difficulty: Medium 28. In the medium run, if government purchases are decreased and nominal money supply is increased, then we can expect that A) aggregate demand will decrease and aggregate supply will increase, leaving the level of output the same B) output, prices, and interest rates will all increase C) output and prices will decrease, while interest rates will increase D) interest rates will decrease, while output and prices may increase, decrease, or remain the same E) none of the above Ans: D

Difficulty: Medium 29. In an AD-AS diagram with an upward-sloping AS-curve, if a tax decrease is combined with money expansion, A) output will remain relatively unaffected but interest rates will decrease B) output will remain relatively unaffected but interest rates will definitely increase C) aggregate demand, the price level, and output will all decrease
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D) aggregate demand, the price level, and output will all increase E) the price level will increase but we can't say what will happen to output or interest rates Ans: D

Difficulty: Difficult 30. If government purchases and taxes are both increased by the same lump sum, we can expect the following in the medium run: A) output, prices, and interest rates will all remain unchanged B) output, prices, and interest rates will all decrease C) output, prices, and interest rates will all increase D) output and prices will remain the same but interest rates will increase E) output and prices will increase but interest rates will remain the same Ans: C

Difficulty: Medium 31. In an AD-AS diagram with an upward-sloping AS-curve, an increase in money supply will A) increase output and the price level but not affect the interest rate B) increase output, the price level, and the interest rate C) increase output and the price level but lower the interest rate D) decrease the interest rate, increase the price level, but leave output unchanged E) increase the price level but leave output and the interest rate unchanged Ans: C

Difficulty: Medium 32. When nominal money supply is held constant and the price level increases, then A) real money balances increase and real interest rates decrease B) real money balances decrease and real interest rates increase C) real money balances decrease and real interest rates remain the same D) the AS-curve must have shifted to the right E) both B) and D) Ans: B

Difficulty: Easy 33. A decrease in nominal money supply will be reflected in A) a shift of the AD-curve to the right B) a shift of the AD-curve to the left
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C) movement along the AD-curve from right to left D) movement along the AD-curve from left to right E) a shift of the AS-curve to the left Ans: B

Difficulty: Medium 34. Expansionary fiscal policy is very effective in significantly increasing the level of output A) if the AS-curve is totally price inelastic B) in the classical case C) if the economy is close to full employment D) if the economy is in a recession E) both A) and D) Ans: D

Difficulty: Easy 35. Expansionary monetary policy will increase nominal GDP A) in the Keynesian case B) in the classical case C) in the medium run D) all of the above E) only A) and C) Ans: D

Difficulty: Difficult 36. In the classical supply curve case, monetary expansion will A) increase P, lower i, and leave Y unchanged B) increase Y, lower i, and leave P unchanged C) leave Y and i unchanged but increase P D) leave Y, i, and P unchanged E) increase Y, i, and P Ans: C

Difficulty: Medium 37. Assume investment is very interest sensitive and wages always adjust immediately to maintain an equilibrium in the labor market. Which of the following would be most effective in significantly increasing the level of output?
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A) expansionary fiscal policy B) expansionary monetary policy C) increased government spending accompanied by monetary expansion D) an increase in government transfer payments E) none of the above policies would succeed in significantly increasing the level of output Ans: E

Difficulty: Medium 38. In which of the following cases is expansionary fiscal policy LEAST effective in increasing output? A) if wages adjust rapidly to maintain equilibrium in the labor market B) if wages do not change much even when there is high unemployment C) if it is combined with expansionary monetary policy D) if we have a Keynesian AS-curve E) if the Fed is trying hard to keep interest rates from rising Ans: A

Difficulty: Medium 39. An increase in government purchases will not increase the level of output if A) the AS-curve is totally price elastic B) the price level is fixed C) wages and prices are completely rigid D) wages and prices are completely flexible E) real money balances are not affected Ans: D

Difficulty: Medium 40. Fiscal policy will affect prices and interest rates but not the level of output if A) the AD-curve is vertical B) the AS-curve is vertical C) the AD-curve is horizontal D) the AS-curve is horizontal E) both A) or D) Ans: B

Difficulty: Medium
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41. In the AD-AS model, fiscal or monetary policy cannot affect the level of output in A) the medium run and the long run B) the medium run and the short run C) the short run only D) the medium run only E) the long run only Ans: E

Difficulty: Medium 42. The income velocity of money can be calculated using the following formula A) V = M/(PY) B) V = (MY)/P C) V = (PY)/M D) V = MY E) none of the above Ans: C

Difficulty: Medium 43. If nominal GDP is $12,600 billion and nominal money supply is $6,300 billion, then the income velocity of money is A) V = 6,300 B) V = 0.5 C) V = 2 D) V can only be determined if the price level is known E) none of the above Ans: C

Difficulty: Medium 44. If restrictive monetary policy leads to a lower price level but leaves real output, employment, and real interest rates unchanged, then A) real money balances must be unchanged B) it must have been accompanied by expansionary fiscal policy C) it must have been accompanied by restrictive fiscal policy D) money is said to be neutral E) both A) and D)

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Ans: E

Difficulty: Easy 45. A large decrease in the income tax rate will most likely cause A) a fairly large increase in aggregate demand B) a fairly small increase in aggregate supply C) an increase in the price level D) all of the above E) none of the above Ans: D

Difficulty: Easy 46. Supply-side economics involves policy measures designed to A) encourage technological progress B) remove unnecessary government regulations C) give investment tax credits to stimulate specific capital investments D) all of the above E) none of the above Ans: D

Difficulty: Medium 47. Cutting income tax rates will most likely cause A) a large shift in the AD-curve but a small shift in the AS-curve B) a small shift in the AD-curve but a large shift in the AS-curve C) a large increase in output resulting in a large increase in tax revenues D) a budget deficit so large that income growth is no longer possible E) both B) and C) Ans: A

Difficulty: Easy 48. When we say that potential GDP is exogenous with respect to the price level, we refer to A) the fact that changes in real money balances cause output to rise B) the fact that the long-run AS-curve shifts to the right over time C) the short-run AS-curve D) the medium-run AS-curve E) the Keynesian AS-curve
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Ans: B

Difficulty: Medium 49. In the long run, as potential GDP grows at a steady pace and nominal money supply is continuously increased over time A) the level of output is essentially determined by shifts in the AS-curve B) the level of output is essentially determined by shifts in the AD-curve C) the price level will not change since the AS-curve is horizontal D) real money balances continuously decrease as the AD-curve remains constant E) the price level is determined solely by the shift in the AS-curve Ans: A

Difficulty: Medium 50. As nominal money supply is steadily increased and the long-run AS-curve shifts to the right over time, we realize that A) the price level decreases since the AS-curve shifts right while the AD-curve remains constant B) the price level stays the same, while output continuously increases C) the price level increases or decreases depending on the respective shifts in the AD-curve and the AS-curve, but the level of output is essentially determined by the shifts in the AS-curve D) we will experience a substantial increase in inflation with very little increase in output E) none of the above Ans: C

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CHAPTER 6 Technical Problems 1. A reduction in the supply of money leads to excess demand for money and increased interest rates, reducing the level of private spending (especially investment). Therefore the AD-curve shifts to the left. This causes an excess supply of goods and services at the original price level so the price level starts to decrease. Since the AS-curve is upward sloping, a new short-run macro-equilibrium is reached at a lower level of output (and thus a higher level of unemployment) and a lower price level. However, the higher level of unemployment eventually provides downward pressure on wages, reducing the cost of production and shifting the upward-sloping AS-curve to the right. Alternatively, since this short-run equilibrium output level is below the fullemployment level, prices will continue to fall and the upward-sloping AS-curve will shift to the right. As long as output is below the full-employment level Y*, the upwardsloping AS-curve will continue to shift to the right, which means that the price level will continue to decline. Eventually a new long-run equilibrium will be reached at the fullemployment level of output (Y*) and a lower price level. ASo P AD1 P1 P2 P3 0 Y1 Y* 1.->2.. Ms i I Y AD Ex.S. Y P real ms i I Y 2 3 1 ADo AS1

Short-run Effect: Y UR P i 2.->3. UR W cost of prod. AS Ex.S. P real ms P i = const. i I Y

Long-run Effect: Y = const.

UR = const.

1.

The rational expectations theory predicts that an announced change in monetary policy will immediately change peoples expectations about the inflation rate. If people could adjust immediately to this change in inflationary expectations, the rate of
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unemployment and output would remain at the full-employment level. In this hypothetical situation, any announced monetary policy change would not affect the unemployment rate. In other words, we would move immediately from point 1 to point 3 in the diagram that was used to explain the previous question. In reality, however, even if people have rational expectations and can anticipate the effects of a policy change correctly, they may not be able to immediately adjust due to wage contracts, etc. Thus, there will always be some deviation from the full-employment output level Y*. In the above diagram, the AS-curve would start shifting to the right much earlier and we would end up somewhere between points 1 and 3 and even with an anticipated policy change we would have some increase in unemployment.

3.a. A favorable supply shock, such as a decline in material prices, shifts the upward-sloping AS-curve to the right, leading to excess supply at the existing price level. A new shortrun equilibrium is reached at a higher level of output and a lower price level. But since output is now above the full-employment level, there is upward pressure on wages and prices and the upward-sloping AS-curve starts shifting back to the left. A new long-run equilibrium is reached back at the original position at Y* and the original price level (assuming that the change in material prices did not affect the full-employment level of output). Since nominal wages (W) will have risen but the price level (P) will not have changed, real wages (W/P) will have increased. P AD ASo AS1 Po P1 0 Y* Y1 1 2

3.b. Lower material prices lower the cost of production, shifting the upward-sloping AScurve to the right. This leads to an increase in output and a lower price level. Since unemployment is below its natural rate, there is a shortage of labor, providing upward pressure on wages. But higher wages will increase the cost of production again, so the upward-sloping AS-curve will eventually shift back to the original long-run equilibrium (assuming that potential GDP has not been affected). The adjustment process can be described as follows: 1==>2: material prices ==> cost of production ==> the AS-curve shifts right

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== > excess supply ==> P ==> real ms ==> i ==> I ==> Y Short-run effect: Y , i , P 2==>1: Since Y > Y* ==> nominal wages ==> the AS-curve shifts left ==> excess demand == > P ==> real ms ==> i ==> I ==> Y Short-run effect: Y , i , P Long-run effect: Y back at Y*, i remains the same, P remains the same.

Chapter 6: Aggregate Supply: Wages, Prices, and Unemployment

Difficulty: Medium 1. The theory of aggregate supply is one of the most controversial in macroeconomics because A) modern models, while similar in their starting points, reach widely different results in explaining the AS-curve B) economists cannot agree whether the Keynesian or the classical AS-curve is a better reflection of reality C) economists cannot agree whether wages are completely flexible or rigid in the long run D) economists cannot agree whether wages are completely flexible or rigid in the very short run E) economists do not completely agree on the reasons for the slow adjustment of wages and prices after demand-side disturbances Ans: E

Difficulty: Medium 2. Friedman and Phelps argued that the Phillips curve is not stable over time because A) any kind of stabilization policy immediately affects nominal wages B) any shift in aggregate demand will immediately also shift the Phillips curve C) workers' expectations about price changes are only wrong temporarily D) firms change wage rates for workers as soon as product prices change, so profits will not suffer E) firms always immediately change their product prices in response to a change in money supply Ans: C

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Difficulty: Easy 3. For many government decision makers, the original Phillips curve implied A) a trade-off between lowering unemployment at the cost of higher inflation or lowering inflation at the cost of higher unemployment B) that active stabilization policy will always work if applied correctly C) that severe recessions were a thing of the past, as unemployment could easily adjust to its natural rate D) that the natural rate of unemployment can be lowered by expansionary monetary policy E) all of the above Ans: A

Difficulty: Easy 4. If we look at the annual U.S. unemployment rates over the last three decades, we see A) peaks in 1982, 1992, and 2002, with each peak higher than the last B) only very small variations around the natural rate of 5.2% C) large variations, but after each peak the rate returned to about 4.5% D) that the unemployment rate exceeded 10% in 1982 E) that the unemployment rate never exceeded 8% Ans: D

Difficulty: Easy 5. The Phillips curve shows a relationship between A) the level of output and prices B) the level of output and unemployment C) the level of prices and employment D) the rate of change in prices and the rate of unemployment E) the level of prices and wage rate changes Ans: D

Difficulty: Easy 6. According to the Phillips curve relationship, if unemployment is at the natural rate, then A) the rate of inflation is zero B) nominal wages will always be equal to real wages C) the labor supply will be totally price elastic D) prices will always immediately adjust to changes in money supply E) none of the above
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Ans: E

Difficulty: Medium 7. The newer view of the Phillips curve implies that A) the natural rate of unemployment can be reduced by expansionary monetary policy B) in the long run unemployment does not move towards a natural rate if there is frictional unemployment C) an increase in monetary growth affects unemployment and inflation in the short run, but only affects inflation in the long run D) there is a clear inverse relationship between unemployment and output E) stagflation can best be addressed by implementing expansionary fiscal policies Ans: C

Difficulty: Medium 8. The coordination approach to the Phillips curve focuses on the fact that A) administrations have problems coordinating fiscal policy with the monetary policy of the central bank B) long-term labor contracts tend to expire at different times, so firms cannot coordinate their hiring C) unemployed workers are not organized enough to influence wage negotiations D) firms are unsure about their competitors' behavior and are therefore reluctant to change wages and prices following a change in aggregate demand E) workers have only imperfect information about their real wages Ans: D

Difficulty: Medium 9. The inflation-expectations-augmented Phillips curve implies that A) unemployment is at its natural rate when expected inflation is equal to actual inflation B) stagflation occurs when expected inflation is below actual inflation C) stagflation occurs when the short-run Phillips curve shifts left D) the inflation rate is equal to the real output growth rate plus the monetary growth rate E) the expected inflation rate is always equal to the monetary growth rate Ans: A

Difficulty: Medium 10. Stagflation, that is, high unemployment combined with high inflation
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A) cannot persist, since the economy eventually will return to full employment B) can only occur if expansionary monetary policy is combined with restrictive fiscal policy C) is inconsistent with the inflation-expectations-augmented Phillips curve D) cannot occur as long as the expected inflation rate is above the actual inflation rate E) none of the above Ans: A

Difficulty: Easy 11. The natural rate of unemployment is A) zero since everyone who is unemployed is so voluntarily B) the result of labor market friction--people entering the labor force, changing careers, etc. C) rarely more than 3 percent D) the amount of unemployment caused by an average recession E) mostly the result of misguided government policy Ans: B

Difficulty: Medium 12. A difference between the inflation-expectations-augmented Phillips curve and the Phillips curve that is based on rational expectations is that A) in the latter people never make incorrect forecasts B) in the latter monetary policy changes cannot affect the rate of inflation C) in the former a change in monetary policy causes an immediate shift in the Phillips curve D) in the former expected inflation is always equal to actual inflation E) none of the above Ans: E

Difficulty: Easy 13. The rational expectations hypothesis predicts that A) an announced change in monetary policy will not affect the unemployment rate B) the short-run Phillips curve will shift as soon as new information about future inflation becomes available C) the level of output will not be affected by any predictable change in monetary policy D) all of the above E) only A) and C) Ans: D

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Difficulty: Easy 14. If nominal wage rates were completely flexible, then A) fiscal policy would affect real money balances but not output B) there would be a clear trade-off between unemployment and inflation C) periods of unemployment would be much more frequent D) frictional unemployment would not exist E) monetary policy would be ineffective in changing the price level Ans: A

Difficulty: Medium 15. The insider-outsider model refers to A) policy making in White House B) the fact that the unemployed do not take part in collective bargaining C) the fact that wages do not respond significantly to changes in the unemployment rate D) slow price adjustments in an imperfectly competitive business environment E) both B) and C) Ans: E

Difficulty: Easy 16. Wages are considered to be sticky rather than flexible since A) firms encounter menu costs when changing wages but not when changing prices B) labor contracts contain cost-of-living adjustments C) firms tend to look at labor as an expendable resource D) firms are unsure about their competitors' behavior and only reluctantly change prices and wages following a change in aggregate demand E) all of the above Ans: D

Difficulty: Medium 17. The efficiency wage theory of aggregate supply implies that A) the AS-curve is vertical B) paying employees higher wages won't induce them to work harder C) even unanticipated changes in monetary or fiscal policy have no effect on the level of output D) since the cost of changing wages and prices is low, wages can easily be adjusted in proportion to price changes to maintain full employment E) none of the above Ans: E

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Difficulty: Easy 18. The inverse relationship between inflation and unemployment is called A) Okun's law B) the Lucas curve C) the Phillips curve D) the replacement ratio E) the sacrifice ratio Ans: C

Difficulty: Easy 19. Okun's law states that one extra percentage point in unemployment causes A) real GDP to fall by about 2 percent B) real GDP to fall by about 0.5 percent C) the rate of inflation to decline by about 2 percent D) the rate of inflation to decline by about 0.5 percent E) both GDP and the rate of inflation to decline by about 2 percent Ans: A

Difficulty: Easy 20. Robert Lucas modified the rational expectations argument by A) allowing for the role of forecasting errors B) assuming that people always have perfect foresight C) asserting that economic models should always allow for people making easily avoidable mistakes D) redefining Okun's law E) proving that a permanent change in monetary growth has a long-run effect on the unemployment rate Ans: A

Difficulty: Medium 21. Restrictive monetary policy will eventually affect the upward-sloping AS-curve since A) higher interest rates will increase the cost of production B) higher interest rates will reduce the capital stock which will, in turn, reduce potential GDP C) the resulting unemployment will cause downward pressure on nominal wages, so the cost of production will decrease D) real wages will decline in proportion to the change in money supply and this will cause a
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change in unemployment E) firms will start laying off workers in anticipation of a decline in aggregate demand Ans: C

Difficulty: Medium 22. In the medium run the aggregate supply curve is upward sloping since A) workers immediately realize that nominal wage increases are really the result of price increases B) firms encounter costs in resetting prices and are reluctant to change wages following a change in aggregate demand C) wages and prices always immediately change in proportion to the money stock D) there is always natural friction in the labor market that prevents unemployment from reaching zero E) none of the above Ans: B

Difficulty: Medium 23. The fact that nominal wages are fixed by a contract at the beginning of a period while prices of goods may change within that period, implies that A) unanticipated changes in the money supply do not affect the level of output B) there is no trade-off between unemployment and inflation C) firms want to supply more output when prices increase since the real wage rate is lower D) anticipated monetary policy changes will not affect the level of inflation E) money supply changes affect prices but not unemployment in the short run Ans: C

Difficulty: Medium 24. The unemployment gap A) always grows twice as fast as the output gap B) always is negative C) always increases as the rate of inflation increases D) always stays at its natural level E) none of the above Ans: E

Difficulty: Medium
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25. Which of the following is NOT used in deriving the AS-curve in Chapter 6? A) the link between output and employment B) the price-cost relation C) the Phillips curve D) the quantity theory of money E) all of the above are used Ans: D

Difficulty: Medium 26. The upward-sloping AS-curve will shift eventually to the left if A) labor productivity increases B) actual output is lower than the full-employment level C) actual output is higher than the full-employment level D) the markup over labor cost falls E) the level of potential output increases Ans: C

Difficulty: Medium 27. Which of the following is NOT true? A) the Phillips curve shifts as soon as actual inflation changes B) the position of the Phillips curve depends on the expected rate of inflation C) if actual inflation is equal to expected inflation, we are at full-employment D) if unemployment is below its natural rate, the Phillips curve will shift to the right E) if wages and prices respond very little to changes in unemployment, the short-run Phillips curve is very flat Ans: A

Difficulty: Medium 28. Assume the Fed implements restrictive monetary policy. Which of the following is the most likely result in an AD-AS framework with an upward sloping AS-curve? A) the interest rate will increase but output, prices, and real money balances will fall B) the interest rate, output, and prices will all decline C) prices and output will fall, but real money balances will increase D) real money balances will remain unchanged, since money supply and prices will decrease proportionally E) real money balances and prices will fall proportionally Ans: A

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Difficulty: Medium 29. In an AD-AS model with an upward-sloping AS-curve, the most likely effects of fiscal expansion would be A) an increase in prices and interest rates, but a decrease in real money balances B) an increase in output, prices, and real money balances C) an increase in consumption and a decrease in investment with no change in output D) a decrease in unemployment but an increase in interest rates and real money balances E) a decrease in consumption, but an increase in net exports and investment Ans: A

Difficulty: Easy 30. In the medium run, a price increase combined with a decrease in the unemployment rate is most likely the result of A) an adverse supply shock B) an adverse supply shock followed by restrictive monetary policy C) a favorable supply shock D) a decrease in money supply E) expansionary fiscal or monetary policy Ans: E

Difficulty: Medium 31. Assume output is at its full-employment level and the Fed restricts money supply. What is the most likely outcome? A) an immediate decrease in prices, with no impact on output B) no change in nominal wages in the short run, but a decline in output and prices in the medium run C) no change in real wages, but a decline in output and prices in the medium run D) a decrease in nominal wages and prices in proportion to money supply, but no change in output and real interest rates in the long run E) both B) and D) Ans: E

Difficulty: Medium 32. Assume the economy is at full employment. Which is the most likely effect of a decrease in government spending? A) output, prices, and interest rates will all increase in the medium run
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B) output, prices, and interest rates will all decrease in the long run C) prices and interest rates will decrease in the medium and long run while output will be negatively affected in the medium run but not in the long run D) output and prices will remain the same in the long run, but interest rates will increase both in the medium and long run E) output, prices and interest rates will all decline in the medium run but only output will be negatively affected in the long run Ans: C

Difficulty: Medium 33. Assume the economy is at full employment and the Fed restricts money supply. What will be the effects on output and prices? A) in the medium run output and prices will both decrease, but in the long run output will remain the same, while prices will decrease B) output will not be affected in the medium or long run, but prices will decrease in the long run C) output will decrease but only in the long run, while prices will decrease in the medium run and the long run D) in the medium run output will remain the same, but in the long run both output and prices will decline E) output and prices will decline in the medium and long run Ans: A

Difficulty: Medium 34. The most likely long-run result of a tax cut would be A) lower unemployment but higher prices and interest rates B) lower interest rates but no change in unemployment C) higher levels of consumption, investment, and employment D) more consumption and less investment, with output remaining unchanged E) higher prices and interest rates, resulting in a less consumption and investment Ans: D

Difficulty: Difficult 35. In the long run, real money balances A) are not affected by expansionary fiscal policy but increase if expansionary monetary policy is employed B) are not affected by expansionary monetary policy but increase if expansionary fiscal policy is employed C) are not affected by restrictive monetary policy, but increase if restrictive fiscal policy is
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employed D) are not affected by fiscal or monetary policy E) decrease if either restrictive fiscal or monetary policy is employed Ans: C

Difficulty: Medium 36. In the long run, monetary expansion should have the following result: A) nominal wages change in proportion to nominal money supply B) real interest rates remain constant C) real wages remain constant D) nominal wages and prices change in proportion to nominal money supply E) all of the above Ans: E

Difficulty: Easy 37. In an AD-AS model with an upward sloping AS-curve, what would happen if oil prices increased and the Fed responded by restricting money supply? A) real output would increase and the price level would remain the same B) real output would remain the same but the price level would decrease C) real output would decrease and the price level would increase sharply D) real output would decrease and the price level would decrease sharply E) real output would decrease but we can't tell what would happen to the price level Ans: E

Difficulty: Medium 38. What sort of event could lead to a simultaneous decrease in the rates of inflation and unemployment? A) a decrease in money supply B) an increase in money supply C) an adverse supply shock D) a decrease in material prices E) restrictive monetary policy following an adverse supply shock Ans: D

Difficulty: Medium 39. In the static AD-AS model, what is the most likely long-run outcome of an oil price increase,
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if no policy change is implemented? A) real wages will decline while the levels of output and prices will remain unchanged B) the level of prices will increase while the level of output will remain unchanged C) the natural unemployment rate and the price level will both increase D) nominal wages and prices will increase, but real wages will remain unchanged E) real money balances and real wages will decline while nominal wages will remain unchanged Ans: A

Difficulty: Easy 40. In the AD-AS model with an upward-sloping AS-curve, a decrease in oil prices will A) increase prices and output B) decrease prices and increase output C) increase prices and decrease output D) decrease prices and output E) decrease prices but have no effect on output Ans: B

Difficulty: Easy 41. Which of the following is the most likely medium-run outcome of an adverse supply shock? A) an increase in consumer prices and a higher level of real GDP B) a decrease in real GDP C) an increase in real wage rates D) an increase in frictional unemployment E) an increase in nominal GDP with real GDP remaining the same Ans: B

Difficulty: Medium 42. Suppose an increase in oil prices is accompanied by a decline in the level of potential output. Which of the following is the most likely long-run effect? A) real GDP will decrease but prices will increase B) real GDP and prices will both decline C) real GDP will remain the same but prices will increase D) real GDP will remain the same but nominal GDP will decrease E) the unemployment rate and prices will both decrease Ans: A

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Difficulty: Medium 43. If policy makers want to get the price level quickly back to its original level following an adverse supply shock, they need to A) implement restrictive monetary policy B) decrease taxes C) increase government transfer payments D) combine a tax increase with an increase in government spending of equal magnitude E) levy a tariff on imported oil Ans: A

Difficulty: Easy 44. In the 1990s, the consumer price index A) steadily declined, primarily due to reduced oil prices B) was fairly constant due to cheap oil and computer prices C) increased slightly despite a drastic decrease in computer prices D) increased despite stable prices for oil and computers E) decreased drastically due to much cheaper prices for oil and computers Ans: C

Difficulty: Medium 45. If the government stimulates aggregate demand in response to an adverse supply shock, A) the inflation rate will increase but frictional unemployment will decrease B) the unemployment rate will increase but the inflation rate will decline C) an increase in unemployment can be avoided but only at the cost of increased inflation D) high inflation can be avoided but the rate of unemployment will increase E) the inflation and unemployment rates will be reduced simultaneously Ans: C

Difficulty: Medium 46. Assume the economy is at full employment. If the Fed accommodates an increase in oil prices by expansionary monetary policy, what will be the long-run effects on unemployment and prices? A) unemployment and prices will both increase B) unemployment will decrease and prices will remain the same C) unemployment will increase but prices will remain the same D) unemployment and prices will both remain unchanged E) unemployment will remain the same but prices would increase Ans: E
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Difficulty: Easy 47. When we look at the real (inflation adjusted) price of crude oil over the last four decades, we realize that A) oil prices doubled between 1971 and 1974 B) oil prices did not change much between 1974 and 1978 C) oil prices more than doubled between 1978 and 1981 D) oil prices were lower in 1998 than in 1978 E) all of the above Ans: E

Difficulty: Medium 48. In the long run, an increase in nominal money supply will A) cause both the nominal wage rate and the price level to rise proportionately, leaving the real wage rate and output unchanged B) cause prices to rise more than nominal wages, lowering real wages and creating more job opportunities C) affect prices but not nominal wages or unemployment D) increase nominal wages more than the price level so workers will spend more and aggregate demand will increase E) increase real wages, output, and prices proportionally Ans: A

Difficulty: Medium 49. In the long run, what event(s) can lead to an increase in inflation without changing the unemployment rate above its natural level? A) a tax decrease combined with a government spending decrease B) an increase in government spending combined with restrictive monetary policy C) an adverse supply shock D) an adverse supply shock accommodated by expansionary monetary policy E) a favorable supply shock Ans: D

Difficulty: Medium 50. Which of the following event(s) most likely will leave prices relatively unchanged while increasing output?
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A) an increase in money supply combined with an income tax increase B) expansionary monetary policy in response to an adverse supply shock C) expansionary fiscal policy employed after a favorable supply shock D) restrictive monetary policy in response to an oil price decrease E) none of these Ans: C

CHAPTER 7 Technical Problems 1.a. The aggregate unemployment rate can be calculated by adding the unemployment rates of different groups weighted by their share of the labor force. The data in the problem indicate that teenagers constitute 10% of the labor force. The adult work force (the other 90%) is divided into 35% females and 65% males. Thus we can calculate the overall unemployment rate as: u = (0.1)(0.19) + (0.9)[(0.35)(0.06) + (0.65)(0.07)] = 0.019 + (0.9)(0.021 + 0.0455) = 0.019 + 0.05985 = 0.07885 = 7.9%. 1.b. If the labor force participation rate of teenagers increases to 15%, the overall unemployment rate changes to: u1 = (0.15)(0.19) + (0.85)[(0.35)(0.06) + (0.65)(0.07)] = 0.0285 + (0.85)(0.021 + 0.0455) = 0.0285 + 0.056525 = 0.085025 = 8.5%.

Chapter 7: The Anatomy of Inflation and Unemployment

Difficulty: Easy 1. Based on what we know about the average annual unemployment and inflation rates since 1981, which of the following is true? A) inflation decreased steadily, while unemployment varied widely B) unemployment decreased steadily since 1982 while inflation varied C) on average, both inflation and unemployment were lower in the 1980s than in the 1990s D) unemployment was considered a bigger problem than inflation in almost every year
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E) none of the above Ans: D

Difficulty: Easy 2. The sacrifice ratio is defined as A) the percentage increase in the inflation rate for every 1 percent reduction in the unemployment rate B) the percentage of output lost for each 1 percent reduction in the rate of inflation C) the percentage increase in the unemployment rate for every 1 percent reduction in GDP D) the inflation rate plus the unemployment rate E) the inflation rate divided by the unemployment rate Ans: B

Difficulty: Easy 3. Which of these people could officially be counted as unemployed? A) a garage attendant who got fired from his old job two months ago but will start a new job in two weeks B) a busboy who works only four hours a day, five days a week, but would prefer to work fulltime as a waiter C) an accountant who quit her job when she had a baby two months ago D) a woman who joined the babysitters' union several months ago and averages about five customers a week at her $10/hour rate E) none of the above Ans: A

Difficulty: Medium 4. If we look at the sacrifice ratios across countries, we find that A) all industrial nations have approximately the same ratio B) Japan has a smaller ratio than Germany, France, or the U.S. C) Germany has a higher ratio than Italy, Australia, or the U.S. D) no country has a ratio below 1 E) no country has a ratio above 1 Ans: C

Difficulty: Easy 5. Okun's law states that one extra percentage point in unemployment causes

A) a 2 percent fall in GDP B) a 0.5 percent fall in GDP C) a 2 percent fall in the rate of inflation D) a 0.5 percent fall in the rate of inflation E) a 2 percent increase in the sacrifice ratio Ans: A

Difficulty: Easy 6. An employed person is defined as a person who during a reference week A) had a job but was not working due to family or personal reasons B) had a job but was not working due to maternity or paternity leave C) did at least one hour of work as a paid employee D) all of the above E) none of the above Ans: D

Difficulty: Easy 7. Which of the following people is in the unemployment pool? A) Chris, who quit her job to look for other employment B) Jack, who has been temporarily laid off by his employer, but who expects to be called back after one or two months C) Lesley, who lost her job because her firm had to shut down D) all of the above E) only A) and C) Ans: D

Difficulty: Easy 8. Which of the following people has moved out of the pool of unemployment? A) Peter, who just got hired as a part-time security guard B) Paul, who was laid off two months ago but just got a recall notice to resume his job at the assembly line starting the week after next C) Mary, who has given up looking for a job, leaving the work force permanently D) all of the above E) both Peter and Mary Ans: E

Difficulty: Medium 9. Which of the following statements is FALSE? A) there is a high turnover rate in the labor market B) a significant amount of the turnover rate in the labor market is cyclical C) there are large variations in unemployment rates across groups defined by age, race, and sex D) most workers who became unemployed in 2000 or 2009 remained unemployed for half a year or more E) many workers who are counted as unemployed will be (or have been) unemployed for several weeks Ans: D

Difficulty: Easy 10. The spell of unemployment is A) defined as the period during which a person remains continuously unemployed B) defined as the average length of time a person remains unemployed C) defined as the time it takes for the economy to reduce unemployment to its natural rate D) the same as the average duration of unemployment E) the average number of times a worker is laid off within a year Ans: A

Difficulty: Easy 11. The duration of unemployment depends on A) how organized the labor market is in matching potential workers with jobs B) the age, sex, and racial mix of the labor force C) the ability and desire of those who are unemployed to hold out for a better job D) the availability of jobs that match workers' skills E) all of the above Ans: E

Difficulty: Medium 12. Some evidence suggests that prolonged periods of high unemployment actually increase the natural unemployment rate. This phenomenon is known as A) structural unemployment B) the misery effect C) Okun's law D) unemployment hysteresis E) the unemployment duration effect

Ans: D

Difficulty: Easy 13. Unemployment hysteresis refers to the fact that A) high rates of unemployment tend to perpetuate themselves B) when unemployed, individuals reduce their consumption, causing firms to lay off more workers and therefore cyclical unemployment increases even more C) individuals who experience long spells of unemployment often get desperate and take jobs for which they are overqualified D) politicians often react irrationally to news of high unemployment and stimulate the economy causing unnecessary political cycles E) none of the above Ans: A

Difficulty: Easy 14. If we look at U.S. unemployment by duration we can see that in 2009 A) more than half of the unemployed stayed unemployed for more than half a year B) less than 20 percent of the unemployed were unemployed for more than half a year C) the mean duration of unemployment was less than 12 weeks D) the mean duration of unemployment was more than 24 weeks E) none of the above Ans: D

Difficulty: Easy 15. Which of the following does NOT affect the duration of unemployment? A) the availability of unemployment benefits B) the rate at which new workers enter the work force C) the demographic make-up of the labor force D) the organization of the labor market E) none of the above Ans: B

Difficulty: Easy 16. Which of the following statements is TRUE for the United States? A) the unemployment rate consistently tends to be slightly higher among males than among females

B) the unemployment rate of teenagers tends to be much higher and more variable than that of people 20 years and older C) during the 1981/1982 recession, the unemployment rate among teenagers was nearly the same as the unemployment rate among workers over 20 D) the highest unemployment rate in the post World War II period occurred in the 1974/75 recession E) the unemployment rate among minorities consistently remained above 10 percent over the last 5 decades Ans: B

Difficulty: Easy 17. Which of the following statements is FALSE? A) the availability of unemployment benefits reduces the natural rate of unemployment B) the natural rate of unemployment can be reduced by policies designed to affect the composition of the labor force C) high rates of unemployment often have a way of perpetuating themselves D) the unemployment rate among white males 20 years and older is lower than the overall unemployment rate E) even when the economy is at the full-employment level of output, some frictional unemployment still exists Ans: A

Difficulty: Easy 18. Unemployment benefits add to the measured unemployment rate since A) people who are not really looking for jobs may report themselves as unemployed to collect unemployment benefits B) receiving unemployment benefits reduces the opportunity costs of looking for a better job even after a job offer may have been made C) firms are more likely to lay off workers knowing that the consequences of being unemployed are not too severe D) unemployment benefits increase the replacement ratio and that, in turn, affects the reservation wage E) all of the above Ans: E

Difficulty: Medium 19. Which of the following can affect the frequency of unemployment? A) the availability of unemployment benefits

B) the variability of the demand for labor across different employers C) the rate at which new workers enter the labor force D) both A) and B) E) both B) and C) Ans: E

Difficulty: Easy 20. Over the last five decades, the natural rate of unemployment has A) always been around 4% B) declined from about 5.5% in the 1950s to about 4% in 2009 C) changed as the composition of the labor force has changed D) consistently declined as more women entered the labor force E) increased from 3% in the 1950s to 8% in the 1980s, but decreased ever since Ans: C

Difficulty: Easy 21. Frictional unemployment is A) the unemployment that exists even at the full-employment level of output B) unemployment that results from an increase in the GDP gap C) unemployment that occurs as a result of a supply shock D) the result of discouraged workers leaving the work force E) mostly the result of a high minimum wage rate Ans: A

Difficulty: Medium 22. The natural rate of unemployment will most likely increase if A) the minimum wage rate is decreased B) unemployment benefits are increased C) monetary growth is decreased D) income taxes are increased E) all of the above Ans: B

Difficulty: Easy 23. Which country below had the lowest unemployment rate in 2008? A) France

B) Germany C) Spain D) Sweden E) United States Ans: E

Difficulty: Easy 24. In 2009, the high unemployment rate in the U.S. caused a loss in real GDP of roughly A) $68 billion B) $168 billion C) $680 billion D) $1,168 billion E) none of the above Ans: D

Difficulty: Medium 25. Assume the share of whites in the labor force is 86% and their unemployment rate is 6%; the share of non-whites in the labor force is 14% with an unemployment rate of 11%. What is the overall unemployment rate? A) 6.3% B) 6.7% C) 7.4% D) 8.2% E) 8.5% Ans: B

Difficulty: Difficult 26. Assume the overall unemployment rate is 7.5%, and whites constitute 82% of the labor force. If the unemployment rate among whites is 6.5%, what is the unemployment rate among nonwhites? A) 8.5% B) 9.5% C) 10.0% D) 12.0% E) 14.5% Ans: D

Difficulty: Medium 27. Assume adult males have a 48% share of the work force and their unemployment rate is 7.0%; adult females' share is 45% and their unemployment rate is 6.8%; teenagers' share of the work force is 7% with an unemployment rate of 18.0%. What is the overall unemployment rate? A) 7.0% B) 7.2% C) 7.7% D) 8.4% E) 9.6% Ans: C

Difficulty: Easy 28. The replacement ratio is A) the reservation wage divided by the wage rate offered on a new job B) the reduction in real GDP caused by a 1 percent reduction in unemployment benefits C) after-tax income while unemployed divided by after-tax income while employed D) the wage rate offered on a new job divided by unemployment benefits E) the increase in the unemployment rate caused by a 1 percent increase in the inflation rate Ans: C

Difficulty: Easy 29. The natural rate of unemployment can be reduced by A) expansionary monetary policies, but this would create more inflation B) expansionary fiscal policies, such as an income tax decrease C) restrictive fiscal policies designed to balance the federal budget D) training and skills programs that focus on teenagers and the long-term unemployed E) none of the above Ans: D

Difficulty: Easy 30. In a "jobless recovery," A) no new jobs are created during a recession or in the early stages of recovery B) firms do not hire new workers until they see the economy has recovered from the recession C) unemployment must go back to its natural rate before the upswing can start D) there is a lag between GDP growth and a drop in unemployment E) none of the above

Ans: D

Difficulty: Medium 31. The ill effects of unemployment are often more severe than is evident from the official data since A) the natural rate of unemployment is not accounted for B) the incidence of unemployment, both in frequency and duration, is spread unevenly throughout the economy C) the turnover rate in the labor market is fairly high as many people move quickly into and out of the unemployment pool D) much of the unemployment that is reported is structural E) workers who enter the labor force for the first time are not counted as unemployed Ans: B

Difficulty: Easy 32. Over the last decade, unemployment rates in many European countries have been much higher than those in the United States. This is partially due to the fact that these European countries have A) laws that make the costs of firing workers lower for European firms than for U.S. firms B) more generous unemployment benefits C) a higher incidence of work sharing D) a system that allows firms to pay workers a part of their wages in bonuses once or twice a year E) a much lower share of young people in the labor force Ans: B

Difficulty: Medium 33. Both unemployment and inflation are matters of concern, but A) inflation is of greatest concern since it hurts everyone while unemployment does not B) they both can be eliminated easily with demand-side policies C) unemployment has real costs in terms of lost output, while inflation mostly redistributes income or wealth D) most inflation is anticipated in advance so it is really the anticipation rather than the actual inflation which causes concern E) unemployment shouldn't be, since the economy always adjusts to the natural rate of unemployment Ans: C

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Difficulty: Easy 34. Unemployment rates tend to be higher in European countries than in Japan. This is most likely due to the fact that A) the minimum wage rate in Japan is much lower than in Europe B) the Japanese are harder working people than the Europeans C) a large part of Japanese wages are paid in bonuses, making wages more flexible D) there is no structural unemployment in Japan E) none of the above Ans: C

Difficulty: Easy 35. If inflation were always perfectly anticipated, then A) its real costs would exactly equal the inflation rate B) people would hold less cash but would still suffer losses since money balances are always positive C) the yield on interest-bearing assets would exactly compensate for losses on non-interest bearing assets D) unemployment would always be at 4 percent E) wage indexation would not work Ans: B

Difficulty: Medium 36. The menu cost of inflation arises since A) people hold less currency if inflation is positive and thus they take more trips to the bank B) the central bank eventually has to restrict money supply and this causes an increase in the unemployment rate C) lenders are less likely to give out loans and this has a negative impact on economic activity D) resources have to be devoted to marking up prices and changing vending machines and cash registers E) real wages and real money holdings lose purchasing power Ans: D

Difficulty: Easy 37. If inflation were always perfectly anticipated and contracts were written in real terms, then A) there would only be a transfer of wealth from debtors to creditors B) there would only be a transfer of wealth from creditors to debtors

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C) there would only be a transfer of wealth from the poor to the rich D) there would only be a transfer of wealth from households to firms E) currency holders would have a negative rate of return Ans: E

Difficulty: Medium 38. The concern over inflation A) is not justified since gains and losses from real wealth transfers cancel out over time for the economy as a whole B) is irrational since high inflation generally means high growth C) is attributable primarily to increased transfers arising from cost-of-living adjustments D) stems from the fact that inflation is rarely predictable and those households who hold fixed dollar assets will experience a loss in wealth E) none of the above Ans: D

Difficulty: Easy 39. If inflation this year is higher than expected, then A) borrowers will gain at the expense of lenders B) lenders will gain at the expense of borrowers C) both lenders and borrowers will gain and the government will lose D) both lenders and borrowers will lose E) the government will lose unless it has implemented an indexed tax system Ans: A

Difficulty: Easy 40. The unanticipated inflation of the last three decades benefited largely A) elderly people whose major source of income comes from private pension plans B) lending institutions, especially savings and loans C) homeowners with fixed mortgage rates D) taxpayers E) all of the above Ans: C

Difficulty: Easy 41. In an adverse supply shock, wage indexation is likely to

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A) prevent any increase in inflation B) limit inflation to 1% or 2% C) shift the AS-curve back to the right almost immediately D) lead to a wage-price spiral E) none of the above Ans: D

Difficulty: Medium 42. If wages and prices were fully indexed, A) there would be less inflation following an adverse supply shock B) inflation could always be perfectly anticipated C) inflation arising from money expansion could be prevented D) the economy would have difficulty adjusting to supply shocks since real wages could not adjust easily E) politicians would be more likely to fight inflation vigorously Ans: D

Difficulty: Medium 43. The misery index is constructed by A) adding the inflation rate and the unemployment rate B) multiplying the inflation rate with the unemployment rate C) dividing the inflation rate by the unemployment rate D) adding the sacrifice ratio and the replacement rate E) combining the sacrifice ratio with Okun's law Ans: A

Difficulty: Easy 44. The misery index for the United States A) increased steadily from 1950 to 1990, but has since declined B) is closely but inversely related to the successes of the incumbent party C) is closely and positively related to the successes of the incumbent party D) is only loosely and inversely related to the successes of the incumbent party E) none of the above Ans: D

Difficulty: Easy

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45. Political business cycles consist of fluctuations caused by A) misguided foreign policies designed to increase political pressure over our trade partners B) economic policies designed to help win elections C) the Fed trying to support every policy proposed by the president D) our trade partners trying to react to changes in U.S. policies E) the inability of politicians to agree on the right policy mix Ans: B

Difficulty: Medium 46. Predictions based on the theory of political business cycles suggest that A) presidents who succeed in reducing inflation sharply before an election have the best chance to be re-elected even if unemployment increases B) achieving a low rate of unemployment before an election is less important than achieving a low rate of inflation C) presidents who want to be re-elected should aim for low inflation early in their terms and then try to achieve strong economic growth before the next election D) the practice of manipulating the economy before an election seldom pays off since voter behavior is not significantly affected by economic issues E) none of the above Ans: C

Difficulty: Difficult 47. Policy makers should be aware that they A) can never lower the unemployment rate without causing a rapid increase in the rate of inflation B) can reduce unemployment without causing inflation if they start off slowly but intensify their efforts as the economy approaches full employment C) can pursue growth policies in deep recessions without much risk of accelerating inflation D) always face a long-run tradeoff between inflation and unemployment E) can announce a policy change, which will create more rational expectations and enable them to reduce inflation without any costs to society Ans: C

Difficulty: Easy 48. Wage indexation A) increases nominal wages periodically in accordance with the increase in prices over a given time period B) helps the economy adjust more rapidly back to the natural unemployment rate after a supply

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shock C) is a method of preventing inflation by taxing away what workers may have gained from unanticipated inflation D) provides protection against purchasing power loss for over half of the U.S. work force E) is most prevalent n countries with a history of low inflation rates Ans: A

Difficulty: Easy 49. Which of the following statements is FALSE? A) homeowners with fixed-rate mortgages benefit from unanticipated high inflation B) the costs of unanticipated inflation can be ignored, since the gains and losses of induced wealth transfers tend to cancel each other out over the economy as a whole C) Social Security beneficiaries are better protected against unanticipated inflation than workers with long-term contracts D) at least until 1985, the U.S. government gained from unanticipated inflation at the expense of U.S. taxpayers E) workers who received the minimum wage greatly suffered from unanticipated inflation Ans: B

Difficulty: Medium 50. A zero inflation target A) eliminates the short-run unemployment-inflation tradeoff B) is almost impossible to achieve since it would require an extremely high natural rate of unemployment C) can only be achieved if wage indexation is implemented nationwide D) will have much lower costs than an explicit target of achieving a 4% long-term inflation rate E) may not be as good as a positive inflation target, because it makes it more difficult to achieve full employment Ans: E . Chapter 8: Policy Preview

Difficulty: Easy 1. Which of the following is NOT a way in which a central bank can conduct its monetary policy? A) by establishing target interest rates and then undertaking open market operations to maintain them

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B) by buying and selling government bonds C) by making small policy changes and readjusting policies as needed D) by changing the rate of capital accumulation to influence aggregate supply E) by changing interest rates to influence spending on durable goods and investment Ans: D

Difficulty: Easy 2. A central bank that wants to stabilize the economy in the short run should try to A) establish a clear inflation target and stick to it no matter what B) affect aggregate supply through open market operations C) affect aggregate demand through open market operations D) maintain a stable growth rate of money supply E) concentrate only on long-run goals Ans: C

Difficulty: Medium 3. If a central bank is uncertain about whether an economic disturbance is temporary or permanent, it should A) always wait until the full effect of the disturbance is felt before undertaking a policy change B) make frequent and modest policy changes and adjust policies based on feedback C) announce and then implement major policy changes right away to signal to financial markets that it will address the disturbance vigorously D) announce a policy change and then wait for financial markets to react, which is often all that is needed to calm economic activity E) none of the above Ans: B

Difficulty: Easy 4. In the short run, a central bank can most easily stimulate economic activity by A) selling government bonds to the public B) raising interest rates to make investments more profitable C) lowering the inflation rate though monetary restriction D) influencing aggregate supply through monetary expansion E) influencing aggregate demand and accepting a higher price level in the future Ans: E

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Difficulty: Easy 5. The U.S. Federal Reserves Open Market Committee (the FOMC) A) meets regularly to decide on its monetary policy actions B) formally makes decision by voting on monetary policy changes C) sometimes reveals its intentions in advance to increase transparency D) does not follow a clearly established policy rule E) all of the above Ans: E

Difficulty: Easy 6. Which of the following is true about Ben Bernanke as Chair of the Board of Governors of the U.S. Federal Reserve? A) he succeeded Paul Volcker as the Chair in 2002 B) his first term started in 2006 and he was reappointed in 2010 by President Obama C) he succeeded Alan Greenspan at the start of the financial crisis in 2008 D) he was originally appointed by President Obama after Obama took office in January, 2009 E) he first became Chair in 2010, succeeding Alan Greenspan Ans: B

Difficulty: Medium 7. If it is clear that an economic disturbance is only transitory, a central banks best policy response may be to A) react moderately or not at all because a major policy change may itself be destabilizing B) recommend fiscal policy changes, which will have less powerful effects than monetary policy changes C) act quickly and vigorously so financial markets do not overreact D) announce a policy change and then wait to see the reaction of financial markets before deciding whether or not to actually implement it E) avoid a potential increase in inflation by asking banks to ration credit Ans: A

Difficulty: Medium 8. If a central bank wants to avoid high inflation in an economic boom it can A) try to lower investment spending though open market purchases B) raise interest rates in an effort to affect aggregate supply C) lower bank reserves by buying government bonds D) decrease the level of potential GDP by permanently restricting money supply growth E) none of the above

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Ans: E

Difficulty: Easy 9. Central banks generally conduct their monetary policy with two goals in mind: to keep economic activity high and to keep inflation low; however, they have to recognize that A) there is an inherent conflict between these goals B) monetary policy can affect economic activity only in the short run C) they can control inflation fairly effectively but may not be able to influence GDP growth D) a lower interest rate now may mean higher a inflation rate in the future E) all of the above Ans: E

Difficulty: Medium 10. If the inflation rate starts to increase, a central bank most likely will A) try to stimulate aggregate supply through open market purchases B) change short-term interest rates though open market sales C) increase short-term interest rates by buying government bonds D) send signals to financial markets about upcoming open market purchases E) ask banks to ration credit Ans: B

Difficulty: Easy 11. An appropriate policy response by a central bank to an increase in the inflation rate is to A) increase bank reserves B) lower the federal funds rate C) buy government bonds from the public D) sell government bonds to the public E) none of the above Ans: D

Difficulty: Medium 12. The U.S. Fed can most effectively achieve an established federal funds rate target by A) leaking information about its future intentions to financial markets B) maintaining a stable monetary growth rate C) undertaking open market operations to influence bank reserves D) adjusting monetary growth to maintain a stable inflation rate

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E) selling Treasury bills whenever short-term interest rates increase Ans: C

Difficulty: Easy 13. The federal funds rate is the interest rate that A) banks charge their best corporate customers B) banks have to pay when they get a loan from the Fed C) banks have to pay when they get a loan from another bank D) banks receive from the Fed for the reserves they hold as deposits at the Fed E) the federal government pays on its three-month Treasury bills Ans: C

Difficulty: Easy 14. By lowering short-term interest rates, a central bank can stimulate economic activity A) since it encourages more investment spending B) since more durable consumption goods will be bought C) but only in the short run D) but it may lead to a higher price level E) all of the above Ans: E

Difficulty: Medium 15. Which of the following is NOT a result of monetary policy? A) aggregate demand is affected, leading to a change in nominal GDP B) the level of potential GDP will change C) spending on investment and durable consumption goods is affected D) the rates of unemployment and inflation are affected in the short run E) real interest rates will remain unaffected in the long run Ans: B

Difficulty: Easy 16. When conducting expansionary monetary policy, central banks have to keep in mind that A) there is a conflict between keeping inflation low and economic activity high B) unemployment can be lowered in the short run but at the cost of higher prices in the long run C) spending on durable consumption goods will probably not be significantly affected D) all of the above

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E) only A) and B) Ans: E

Difficulty: Medium 17. Which of the following is FALSE? A) in the long run, a central bank can effectively limit inflation B) in the long run, a central bank can do fairly little to stimulate real GDP C) in the long run, monetary policy has no effect on nominal GDP D) unless inflation is very high, stimulating the economy does more to enhance economic welfare than controlling inflation E) a central bank can lower the inflation rate but only by allowing for a loss in real GDP, at least in the short run Ans: C

Difficulty: Medium 18. Many economists believe that A) most short-term stabilization of the economy should be done through monetary policy B) fiscal policy has no short-run effect on either output or inflation C) monetary policy affects inflation but not output, even in the short run D) monetary policy can effectively increase GDP with little or no effect on inflation E) none of the above is true Ans: A

Difficulty: Medium 19. The U.S. Fed sets interest rates by A) announcing a desired discount rate and then attempting to keep the federal funds rate two percentage points above it B) announcing a desired monetary growth rate designed to keep inflation stable C) buying or selling Treasury bills D) announcing its intentions far in advance since transparency allows financial markets to adjust before any action is taken E) trying to keep bank reserves stable Ans: C

Difficulty: Easy 20. Monetary policy is best conducted by

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A) focusing on a sustainable goal rather than maintaining full employment at all times B) decisive major policy changes rather than modest steps C) changing policies frequently to keep financial markets guessing what will happen next D) keeping the interest rate at the lowest sustainable level no matter what E) none of the above Ans: A

Difficulty: Easy 21. When a central bank engages in inflation targeting A) unemployment isnt affected since nominal interest rates are kept very low B) interest rates are raised substantially as soon as the output gap increases C) interest rate stability is an explicit policy goal D) little weight is give to transparency E) little or no weight is given to the output gap Ans: E

Difficulty: Easy 22. When a central bank engages in inflation targeting, then A) interest rate stability will automatically result B) interest rates need to be raised as soon as the output gap starts to shrink C) the Taylor rule can still be used as a guide as long as the output coefficient is set to zero D) the Taylor rule can still be used as a guide as long as the output coefficient has a lot of weight E) none of the above Ans: C

Difficulty: Medium 23. If a central bank follows an activist monetary policy rule, A) full employment can always be maintained with little or no inflation B) financial markets always need advance notice of any policy change so the central bank does not lose its credibility C) the focus is generally on expected future economic conditions while current economic conditions are ignored D) the focus is generally on the long-run inflation rate with little concern about unemployment E) none of the above Ans: E

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Difficulty: Medium 24. Assume the Fed wants to stimulate economic activity through expansionary monetary policy. Which of the following is FALSE? A) investment spending will increase B) spending on durable goods will increase C) aggregate demand will be stimulated D) the expansionary effect will only be temporary E) real money balances will increase as we move along the AD-curve from left to right Ans: E

Difficulty: Medium 25. The Taylor rule A) advocates lowering interest rates in response to a higher output level B) advocates a strict monetary growth rate C) advocates stable interest rates D) helps a central bank in setting its target interest rates based on current economic conditions E) is of little help in the short-term stabilization of the economy Ans: D

Difficulty: Easy 26. The Taylor rule implies that a central bank should adjust interest rates frequently A) with particular emphasis on capital movements across borders B) but only in response to changes in the inflation rate C) but only in response to changes in the output gap D) whenever output or inflation deviates from the desired levels E) none of the above Ans: D

Difficulty: Easy 27. The rule that tells a central bank how to set interest rates in response to changes in economic activity is known as the A) federal funds rule B) interest rate rule C) monetary growth rule D) Taylor rule E) Friedman rule Ans: D

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Difficulty: Medium 28. Which of the following equations most accurately describes the Taylor rule? A) t = mt yt + vt B) mt = 0.04 + 2(ut 0.052) C) mt = t + 0.5(t *t) + 0.5(Yt Y*t) D) it = 2 + t + 0.5(t *t) + 0.5[100(Yt Y*t)/Y*t] E) it = 2 + 0.5[(t *t)/t] + 0.5[(Yt Y*t)/Y*t] Ans: D

Difficulty: Medium 29. If a central bank wants to make sure that its policy actions are successful in manipulating interest rates to stabilize the economy around its full-employment level it should A) be prepared to make modest and frequent adjustments after receiving feedback on how its actions affect the economy B) never announce its intentions, because financial markets will always overreact C) frequently change its policies to keep financial markets guessing D) react to excess inflation but not to economic booms E) all of the above Ans: A

Difficulty: Medium 30. A central bank that follows the Taylor rule A) will not react to economic disturbances until its full effects are felt B) assumes there is no tradeoff between unemployment and inflation C) keeps the growth rate of money supply constant D) sets interest rates based on current economic conditions E) will start selling government bonds as soon as interest rates start to rise Ans: D

Difficulty: Easy 31. The Taylor rule suggests to a central bank A) how to set interest rates in response to a change in economic activity B) that interest rates should be raised by 1.5% if inflation goes 1% above its announced target C) that interest rates should be raised by 0.5% if the GDP gap rises by 1% D) that real interest rates should be increased to cool off the economy whenever inflation rises E) all of the above

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Ans: E

Difficulty: Medium 32. Slowing economic activity by increasing interest rates will generally be successful since A) investment spending will be reduced B) spending on durable goods will be reduced C) aggregate supply will decrease D) all of the above E) only A) and B) Ans: E

Difficulty: Medium 33. Assume that the inflation coefficient is negative in the Taylor rule, This implies that A) there is an implicit monetary policy tradeoff between inflation and unemployment B) the Fed will have to lower money supply whenever aggregate demand decreases C) the Fed will not have to make adjustments in interest rates if output changes D) the economy is likely to experience runaway inflation E) all of the above Ans: D

Difficulty: Medium 34. The Taylor rule A) allows for strict inflation targeting as long as the output coefficient is zero B) should only be followed if the economy is growing strongly C) suggests changes in money growth in response to changes in the inflation rate D) does not allow for strict inflation targeting E) implies a strict monetary growth rule Ans: A

Difficulty: Medium 35. The Taylor rule A) is an activist monetary policy rule B) states that monetary growth should be decreased by 1% for every 1.5% increase in inflation C) states that real interest rates should be increased by 0.5% for every 1% increase in inflation D) both A) and B) E) both A) and C)

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Ans: A

Difficulty: Medium 36. According to the Taylor rule, if the current inflation rate is 2.8%, output is 2% below the fullemployment level, and the central banks announced inflation target is 2%, at what level should the central bank set the nominal interest rate? A) 2.8% B) 4.2% C) 5.2% D) 5.8% E) 6.8% Ans: B

Difficulty: Medium 37. The Taylor rule allows for strict inflation targeting as long as A) the output coefficient is zero B) the inflation coefficient is zero C) the output coefficient is negative D) the inflation coefficient is negative E) none of the above Ans: A

Difficulty: Medium 38. According to the Taylor rule, if the central banks announced inflation target is 2%, the current inflation rate is 2%, and output is 1% below the full-employment level, at what level should the central bank set the nominal interest rate? A) 1% B) 2% C) 3.5% D) 4% E) 5.5% Ans: C

Difficulty: Medium 39. In the Taylor rule, if the output coefficient is set to zero, then the central bank A) is mostly concerned with maintaining full employment

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B) always sets interest rates 2% above its inflation target C) will aggressively lower interest rates as soon as output declines D) engages in strict inflation targeting E) none of the above Ans: D

Difficulty: Medium 40. In the Taylor rule, if the output coefficient is set to zero, then the central bank A) is mostly concerned with maintaining a low inflation rate B) will lower interest rates whenever it goes above 2 percent C) will aggressively increase interest rates as soon as inflation rises D) engages in real GDP targeting E) none of the above Ans: D

Difficulty: Medium 41. If a central bank engages in inflation targeting, then A) it will not change interest rates in response to output fluctuations B) it will change interest rates aggressively as soon as inflation or output changes C) it will lower interest rates aggressively as soon as inflation heats up D) it will increase interest rates aggressively as soon as aggregate supply increases E) none of the above Ans: A

Difficulty: Difficult 42. Assume the central banks announced inflation target is 2%, output is 2% below the fullemployment level, and the Taylor rule suggests that the central bank sets the nominal interest rate at 4.5%. What is most likely the current inflation rate? A) 3.0% B) 3.6% C) 4.0% D) 4.5% E) 6.0% Ans: B

Difficulty: Medium

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43. In the Taylor rule, if the inflation coefficient is much larger than the output coefficient , then the central bank A) is mostly concerned with maintaining full-employment B) will raise interest rates more aggressively when output declines than when inflation heats up C) will lower interest rates more aggressively when output declines than when inflation heats up D) is engaging in strict inflation targeting E) none of the above Ans: E

Difficulty: Medium 44. According to the Taylor rule, if the current inflation rate is 3.2%, output is 1% above the fullemployment level, and the central banks announced inflation target is 2%, at what level should the central bank set the nominal interest rate? A) 2.2% B) 3.3% C) 4.4% D) 5.8% E) 6.3% Ans: E

Difficulty: Difficult 45. Assume the current inflation rate is 2.4% and output is at the full-employment level. If the central bank has set nominal interest rates at 5.6%, what is the central banks inflation target if it follows the Taylor rule? A) 0% B) 1% C) 2% D) 3% E) 4% Ans: A

Difficulty: Medium 46. Assume a central bank announced a zero percent inflation target. If the current inflation rate is 2.4%, and output is at the full-employment level, at what level should the central bank set the nominal interest rate according to the Taylor rule? A) 1.2% B) 1.8% C) 2.4%

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D) 3.0% E) 3.6% Ans: E

Difficulty: Difficult 47. Assume the central bank announced a 2% inflation target and has set the nominal interest rate at 5.0%. If actual inflation is 2.8%, by how much is output off the full-employment level? A) -1.2% B) -0.8% C) -0.4% D) +0.4% E) +1.2% Ans: C

Difficulty: Medium 48. According to the Taylor rule, if the central bank announced a zero percent inflation target but the current inflation rate is 2% and output is 2% below the full-employment level, at what level should the central bank set the nominal interest rate? A) 1% B) 2% C) 3% D) 4% E) 5% Ans: D

Difficulty: Medium 49. According to the Taylor rule, if the central bank announced a zero percent inflation target but the current inflation rate is 2% and output is at the full-employment level, at what level should the central bank set the nominal interest rate? A) 1% B) 2% C) 3% D) 4% E) 5%

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Ans: E

Difficulty: Medium 50. Short-run monetary policy changes should A) ignore any fiscal policy changes that the administration has implemented B) allow for modest adjustments once feedback from previous changes is available C) never be implemented if uncertainty exists about the exact effects on key variables D) requires the central bank to stick to its announced policy target no matter what E) none of the above Ans: B

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