1. Which of the following is (are) not an essential feature of new classical economics?
[1] Perfect information. [2] Continuous market clearing. [3] Perfectly flexible prices and wages. [4] Rational expectations. [5] None of the above.
2. Which of the following is (are) a feature of Lucas's theory of the business cycle?
[1] Involuntary unemployment. [2] Adaptive expectations. [3] Only announced changes in monetary policy can have an effect on real output. [4] Only unexpected changes in inflation lead to changes in employment and output. [5] All of the above.
3. Which of the following is a feature of new classical economics but not orthodox monetarism?
[1] The possibility of a short-run trade-off between inflation and unemployment. [2] A vertical long-run aggregate supply curve at the natural rate of unemployment. [3] Adaptive expectations. [4] Continuous market clearing equilibrium. [5] All of the above.
4. In the context of new classical models, Walrasian general equilibrium means that:
[1] goods are always traded at equilibrium prices in all markets. [2] voluntary unemployment cannot occur. [3] no trade-off between inflation and unemployment is possible. [4] money is always neutral. [5] None of the above.
5. The weak version of the rational expectations hypothesis implies that:
[1] expectations change only if the central bank changes monetary policy unpredictably. [2] forecasts of the inflation rate may be biased in a certain direction because workers, consumers and firms do not have complete knowledge of how the economy works. [3] no information is ignored in forming expectations. [4] there is no serial correlation of forecast errors over time. [5] All of the above.
6. The weak version of the rational expectations hypothesis implies that workers, consumers and firms:
[1] do not make systematic forecasting mistakes. [2] know the true model of the economy (or relevant part thereof). [3] have perfect foresight. [4] know the full probability distribution of outcomes following relevant events (such as a change in monetary policy). [5] All of the above.
7. The strong version of the rational expectations hypothesis implies that workers, consumers and firms:
[1] make choices based on perfect information. [2] form expectations that coincide with the outcomes predicted by the relevant model of the economy. [3] have perfect foresight. [4] do not make forecast errors based on publicly available information. [5] All of the above.
8. Which of the following describes how people acquire information according to the rational expectations hypothesis?
[1] They do not ignore historic data. [2] They do not ignore publicly available information. [3] They search for information up to the point where the expected marginal cost of further information equals the expected marginal value thereof. [4] All of the above. [5] None of the above.
9. The new classical assumption of continuous market clearing implies that:
[1] supply is constrained by demand in all markets. [2] there are never any unexploited opportunities to increase profits or utility. [3] both the producer and consumer surplus are minimized. [4] voluntary unemployment can never occur. [5] All of the above.
10. In terms of Lucas's intertemporal substitution model of the labour market:
[1] workers choose how much they want to work based on changes in real wages. [2] lower real wages lead workers to allocate less time to leisure now and more time to work in the future. [3] differences between the demand for and supply of labour are gradually eliminated by changes in flexible wages and prices. [4] All of the above. [5] None of the above.
11. Lucas's "surprise" supply function implies that:
[1] firms may mistake a change in the price level for a change in the relative price of their own goods. [2] output and unemployment cannot deviate from their natural rates in the long run. [3] output is less elastic, the greater has been the variability of the price level in the past. [4] All of the above. [5] None of the above.
12. Lucas's monetary theory of the business cycle:
[1] helps to explain why output and inflation are negatively correlated. [2] assumes that economic agents have perfect information about the economy. [3] helps to explain why output and inflation tend to move in the opposite direction over the course of the business cycle. [4] relies on the signal extraction problem. [5] All of the above.
13. According to Lucas's theory of the business cycle, an expansionary monetary policy will:
[1] only influence the level of output and unemployment if it is anticipated. [2] only influence the natural rate of unemployment if it is unanticipated. [3] have a greater influence on output, the greater is the historic deviation of the actual from the expected price level. [4] All of the above. [5] None of the above.
14. Which of the following is (are) a policy implication(s) of new classical theory?
[1] Only transparent and well-communicated changes in monetary policy will have any influence on output and unemployment in the short run. [2] Only a rule-based framework for monetary policy (such as inflation targeting) can have any influence on output and unemployment in the short run. [3] The more credible is the central bank, the less is the output sacrifice necessary to bring down inflation. [4] Fiscal policy is less effective than monetary policy in influencing output and unemployment in the short run. [5] All of the above.
15. According to the dynamic time inconsistency analysis of Kydland and Prescott, a monetary policy rule:
[1] may tempt the central bank to deviate from announced policy commitments in the future. [2] is more likely than discretionary monetary policy to achieve the optimal combination of inflation and unemployment over time. [3] helps to achieve low inflation at the natural rate of unemployment. [4] will lead to lower inflation and lower unemployment over time than would be the case under discretionary monetary policy. [5] All of the above.
16. According to the time inconsistency model of Barro and Gordon, discretionary monetary policy is constrained by:
[1] the central bank's preference for lower unemployment now at the cost of higher inflation and unemployment in the future. [2] the trade-off between current output gains from cheating and the future costs thereof. [3] the central bank's desire to maintain credibility. [4] the rate at which the policy maker discounts the future costs of higher inflation and unemployment [5] All of the above.
17. The inflation targeting framework for monetary policy used by the South African Reserve Bank (SARB) is an example of:
[1] discretionary policy. [2] instrument independence. [3] a money supply growth rule. [4] goal independence. [5] All of the above.
18. The empirical evidence over the long run suggests that greater central bank independence is associated with:
[1] higher inflation and higher economic growth. [2] lower inflation and lower economic growth. [3] lower inflation and higher economic growth. [4] no significant difference in either inflation or economic growth. [5] None of the above.
19. According to new classical economists, the best way to lower unemployment is to:
[1] increase aggregate demand by coordinating monetary and fiscal policies. [2] lower the supply of labour. [3] regulate labour markets more effectively. [4] increase the demand for labour. [5] None of the above.
20. The Lucas critique of econometric models as a guide to policy argues that:
[1] because expectations change with changes in policy, econometric policy evaluation is impossible. [2] only announced or systematic changes in monetary policy have any real effects on the economy. [3] policy changes lead to changes in expectations and thus changes in the parameters of the equations being estimated such that the forecasts of models that do not take account of this are unreliable. [4] because rational economic agents react unpredictably to unannounced policy changes, the effects of such changes on the economy cannot be estimated econometrically. [5] uncertainty about policymakers intentions renders such econometric models fundamentally flawed and wildly incorrect.
21. Which of the following has proved to be the most problematic and contested feature of new classical economics?
[1] The rational expectations hypothesis. [2] The aggregate supply hypothesis. [3] Continuous optimising market clearing equilibrium. [4] The neutrality of money. [5] The policy ineffectiveness proposition.
22. The outcomes of the Reagan (USA) and Thatcher (UK) deflations in 1980-82 do not support which of the following features of new classical economics?
[1] The policy ineffectiveness proposition. [2] A zero sacrifice ratio. [3] The neutrality of money. [4] The aggregate supply hypothesis. [5] All of the above.
23. The main contribution of new classical economics to the development of macroeconomics appears to have been:
[1] the policy ineffectiveness proposition. [2] rational expectations and dynamic time inconsistency policy analysis. [3] monetary equilibrium business cycle theory. [4] the concept of the natural rate of unemployment. [5] the signal extraction problem.
24. Krugman (2000) [see Reader (E-Reserves)] explains how the development of microfoundations for the aggregate supply function included:
a. the permanent income/life-cycle approach. b. menu cost models. c. the natural rate hypothesis. d. the Lucas signal extraction confusion model.
[1] a b [2] b c [3] b d [4] b c d [5] a b c
25. Krugman (2000) argues that macroeconomic models that are more fully specified with regard to the rationality postulate and their micro-foundations:
[1] are more realistic and thus a better guide to policy than cruder ad hoc models. [2] are not necessarily more accurate than simpler ad hoc models such as the IS-LM model. [3] are more rigorous theoretically and should thus replace simpler ad hoc models such as the IS-LM model. [4] have not succeeded because they are too complicated and thus contain logical inconsistencies. [5] None of the above.
26. A fundamental challenge faced by Keynesians during the 1970s was:
[1] the incorporation of expectations in their models. [2] providing microeconomic explanations of price and wage rigidities. [3] the incorporation of supply shocks in their models. [4] the modification of the standard Phillips curve. [5] None of the above.
27. Which of the following orthodox Keynesian propositions is/are supported by new Keynesians?
[1] Countercyclical stabilisation policies can be used to lessen the severity of the business cycle. [2] Fiscal policies can be used to permanently increase output and employment. [3] Monetary policy can be used to permanently increase output and employment. [4] All of the above. [5] None of the above.
28. Which of the following propositions is/are compatible with new Keynesian economics?
[1] Continuous market clearing. [2] The strong version of Say's Law. [3] The weak version of Say's Law. [4] Confusion by workers and firms of a change in the general price level with a change in their own relative wage and product prices. [5] Perfectly flexible prices and wages.
29. Which of the following may be considered part of new Keynesian economics?
[1] Rational expectations. [2] The natural rate of output and unemployment. [3] Sticky prices and wages. [4] Neutrality of money in the long run. [5] All of the above.
30. The main aim of the new Keynesian research effort was to:
[1] find empirical evidence to support price and wage rigidity. [2] prove that money is non-neutral. [3] show that price and wage rigidity can be explained in terms of optimising behaviour. [4] show that demand and supply shocks have an impact on output. [5] show that both monetary and fiscal policies can stabilise the economy.
Questions 31 to 42 are based on the following:
The Great Recession
The Great Recession originated in the financial markets of the United States of America in 2007. It was triggered by falling house prices which led to the so-called "subprime mortgage" crisis. Preceding the crisis there was a rapid increase in mortgages to less creditworthy borrowers. A combination of falling house prices and default mortgage payments led to the failure and near failure of major financial institutions in America. This sent shockwaves across the financial markets of the world and resulted in a loss of confidence in financial markets and institutions, with the result that share prices fell sharply, investor confidence plunged and the availability of credit to firms and households was severely curtailed. This had the result that consumption spending by households and investment spending by firms declined which had a major impact on the level of output and unemployment.
Questions 31 to 40 refer to the diagrams in Figure 7.8 on page 397 of the prescribed textbook.
31. According to the new Keynesian theory of the business cycle, the above events led to:
[1] a leftward shift of the aggregate demand curve. [2] a rightward shift of the aggregate demand curve. [3] a leftward shift of the long-run aggregate supply curve. [4] a rightward shift of the short-run aggregate supply curve. [5] an increase in the natural rate of unemployment.
32. If prices and wages are fully flexible:
[1] the aggregate demand curve shifts to the left and the economy moves to point E2 in diagram (a). [2] the short-run aggregate supply curve shifts downwards and the economy moves to point E2 in diagram (a). [3] the aggregate demand curve shifts to the left and the economy moves to point E1 in diagram (a). [4] the aggregate demand curve does not shift and the economy stays at point E0 in diagram (a). [5] the long-run aggregate supply curve shifts to the left and the economy moves to point E1 in diagram (a).
33. Nominal price rigidity arises at point E1:
[1] due to the existence of menu costs. [2] due to price-taking behaviour by firms. [3] due to collusion between firms. [4] because firms have no control over the price of their products. [5] All of the above.
34. The reason firms move off their notional demand for labour curve is because:
[1] prices and real wages are not fully flexible. [2] prices and real wages are fixed in the long run. [3] the effective demand for labour is higher than the notional demand for labour. [4] the notional demand for labour is lower than the effective demand for labour. [5] None of the above.
35. Involuntary unemployment increases:
[1] due to nominal wage rigidity at w0. [2] since the decrease in output decreases the demand for labour. [3] since the lower real wage increases the supply of labour. [4] All of the above. [5] None of the above.
36. Given the decline in consumer and investor confidence, a decrease in the real wage rate in the labour market diagram (d) would have the following effect(s):
[1] The quantity of labour supplied would increase. [2] The employment of labour would increase. [3] There would be no change in the effective demand for labour since the demand for labour is constrained by the demand for goods. [4] The amount of involuntary unemployment would increase. [5] All of the above.
37. Given the decline in consumer and investor confidence, any increase in the wage rate in the labour market diagram (d) would have the following effect(s):
[1] The employment of labour would be unchanged since the demand for labour is constrained by the supply of labour. [2] Firms would employ less labour since the cost of labour is higher. [3] The quantity of labour supplied would decrease. [4] The amount of involuntary unemployment would decrease. [5] None of the above.
38. According to the above model, the severity of the recession was intensified by:
[1] the mispricing of risk. [2] the unwillingness of banks to lend money. [3] sticky prices and wages. [4] rational expectations. [5] All of the above.
39. In the short run:
[1] price and wage flexibility ensure that the economy moves back to output level Y0. [2] the fall in aggregate demand leads an increase in the price level and a decrease in real wages. [3] there is involuntary unemployment L0-L1. [4] there is voluntary unemployment L0-L1. [5] None of the above.
40. According to the above model, which of the following is an appropriate policy in the short run to deal with the increase in involuntary unemployment during the Great Recession?
[1] Increased price competition between firms. [2] Creation of a more flexible labour market. [3] Increasing the budget deficit. [4] Increasing interest rates. [5] None of the above.
41. Skidelsky (2011) [see Reader (E-Reserves)] emphasized the following factor(s) as contributing to the severity of the Great Recession:
[1] the rigidity of prices and wages that impeded the adjustment of the economy. [2] a decrease in the marginal efficiency of investment due to a loss of confidence. [3] mispricing of risky assets. [4] decreased liquidity preference. [5] None of the above.
42. The severity of a recession can be magnified by credit market imperfections in which:
[1] there is asymmetric information about creditors. [2] financial institutions take on too much risk. [3] the cost of credit decreases. [4] All of the above. [5] None of the above.
43. In considering the effect of menu costs on the economy, Mankiw argues that:
[1] they represent a significant cost to the individual firm. [2] they are an insignificant cost for the firm and therefore have very little effect on the economy. [3] menu costs help to explain nominal and real price rigidities. [4] they have no effect on the duration and severity of recessions. [5] None of the above.
44. Regarding the natural rate of unemployment, Mankiw explains that:
[1] the concept of voluntary unemployment is more useful in practice. [2] it can be influenced by monetary policy. [3] it is not influenced by labour market policies. [4] it is disputed by some new Keynesians who emphasize the presence of hysteresis effects. [5] the economy automatically moves to it in the short run.
45. Which of the following is/are not part of new Keynesian policies?
[1] A more flexible labour market where the power of labour is reduced. [2] Flexible monetary and fiscal policy rules in order to anchor the economy. [3] Smoothing out the upswings and downswings of the business cycle. [4] Inflation targeting. [5] Monetary policy interventions to combat severe aggregate demand or supply shocks to the economy.
46. Which of the following can be regarded as a major contribution of new Keynesian economics?
[1] Demonstrating the validity of rational expectations. [2] Demonstrating the importance of effective demand. [3] Explaining the existence of price and wage rigidities. [4] Strengthening the forecasting accuracy of macroeconomic models. [5] All of the above.
47. Both new classical economists and (some) new Keynesians make use of rational expectations. The main difference between the two is:
[1] the way in which rational expectations are formed. [2] that new classical economists combine it with the neutrality of money while new Keynesians combine it with the non-neutrality of money. [3] that new classical economists combine it with perfectly flexible prices and wages while new Keynesians combine it with sticky wages and prices. [4] All of the above. [5] None of the above.
48. New classical economists argue that anticipated and systematic changes in the money supply will be reflected entirely in corresponding changes to the price level and inflation without any effect on real variables. New Keynesians:
[1] fully agree with new classical economists in this regard. [2] disagree since this may affect nominal variables in the long run. [3] disagree since expectations are adaptive and not rational in the short run. [4] disagree since this may affect real variables in the short run. [5] disagree since the credibility of the monetary authority is an important issue not considered by new classical economists.
49. New Keynesians regard the sacrifice ratio as positive:
[1] since there is a positive relationship between inflation and output in the long run. [2] since prices and wages are flexible in the long run. [3] since contractionary policies are required to bring down inflation. [4] only when the monetary authority has established its credibility sufficiently to make its policies effective. [5] None of the above.
50. Which of the following is a new Keynesian explanation of the rise in unemployment in South Africa following the financial crisis of 2007/2008?
[1] The mispricing of risky financial assets. [2] A sharp increase in the natural rate of unemployment. [3] An increase in menu costs contributing to wage rigidity and excess supply of labour. [4] Sharply lower foreign demand for exports from South Africa. [5] All of the above.