Advanced Macroeconomics
ASSIGNMENT 01
1. Which of the following is/are implied by the strong version of Say's Law?
[1] Output generates an equivalent level of spending.
[2] Output is determined at its full employment level.
[3] Desired saving always equals desired investment spending.
[4] E = C(r) + I(r) = Y.
[5] All of the above.
2. In the classical model of the labour market, voluntary unemployment will increase if:
[1] the leisure preference of workers decreases.
[2] technological progress shifts the production function upwards.
[3] real wages are set below the market equilibrium level.
[4] All of the above.
[5] None of the above.
3. Which of the following is/are an example of involuntary unemployment?
[1] A housewife.
[2] A student.
[3] A subsistence farmer.
[4] A pensioner.
[5] None of the above.
4. Which of the following contradict(s) the classical explanation of the economy?
[1] Voluntary unemployment.
[2] Frictional unemployment.
[3] Full employment.
[4] Search unemployment.
[5] None of the above.
5. In Keynes's theory of employment and output:
[1] output and employment determine aggregate demand.
[2] output and aggregate demand determine employment.
[3] aggregate demand determines output and employment.
[4] employment determines output and aggregate demand.
[5] None of the above.
In questions 6-10, according to the classical theory:
6. The demand for money will decrease if:
[1] nominal output increases.
[2] the price level increases.
[3] real output increases.
[4] the interest rate increases.
[5] None of the above.
7. Increases in the money supply will lead to:
[1] a decrease in the nominal interest rate.
[2] a decrease in the real interest rate.
[3] an increase in the real interest rate.
[4] an increase in the nominal interest rate.
[5] None of the above.
8. Decreases in the money supply will lead to:
[1] higher prices and higher real output.
[2] lower prices and lower real output.
[3] higher nominal wages and higher nominal output.
[4] higher real wages and lower nominal output.
[5] None of the above.
9. The real rate of interest will decrease if the desire to save ( ) or the return on investment ( ).
[1] increases ; increases.
[2] decreases ; decreases.
[3] increases ; decreases.
[4] decreases ; increases.
[5] None of the above.
10. An increase in desired saving leads to:
[1] an equivalent decrease in investment spending.
[2] a decrease in the real interest rate.
[3] an equivalent increase in consumption spending.
[4] a decrease in real output by a multiple of the increase in saving.
[5] None of the above.
11. Keynes accepted what he called the first postulate of classical economics but rejected the second postulate. Keynes thus accepted the classical belief that:
a. the supply of labour is solely a function of the real wage.
b. more workers will only be employed if the real wage decreases.
c. the equilibrium wage equals the marginal product of labour.
[1] All of the above.
[2] None of the above.
[3] a b
[4] c
[5] b
12. Given that the first postulate of classical economics holds, a decrease in employment is associated with:
[1] a decrease in the real wage.
[2] an increase in the real wage.
[3] an increase in nominal wages.
[4] no change in real wages.
[5] None of the above.
13. According to Tobin (1993), examples of Keynesian unemployment include situations where:
[1] trade unions increase real wages above their market clearing rates.
[2] expectations of being unemployed increase current spending of households.
[3] unemployment benefits increase the reservation wages of workers.
[4] there is an excess supply of unskilled labour.
[5] None of the above.
14. According to Tobin (1993), Keynesian macroeconomics relies on the idea that:
[1] nominal wages and/or prices are rigid.
[2] individuals are often irrational and suffer from "money illusion".
[3] output and employment are constrained by aggregate demand.
[4] less than desired sales in one market will increase demand in other markets.
[5] None of the above.
15. Which of the following does Skidelsky (2011) emphasize as supporting the relevance of Keynes's ideas in analyzing the 2007-8 financial crisis and the recession that followed it?
[1] Sticky wages and prices preventing the adjustment of employment to lower aggregate demand.
[2] Global imbalances in the desire to save and invest.
[3] Excessive budget deficits and increases in public debt.
[4] The mispricing of risky financial assets.
[5] Expansion of the money supply through Quantitative Easing.
16. According to Keynes, involuntary unemployment can be dealt with by:
a. decreasing real wages through an increase in the price level brought about by an increase in aggregate demand.
b. ensuring that there is nominal wage flexibility in the economy.
c. decreasing nominal wages which causes a decrease in real wages and consequently firms employ more workers.
[1] All of the above.
[2] None of the above.
[3] a
[4] b
[5] c
17. Which of the following classical interpretations of Say's Law was rejected by Keynes?
a. The act of saving leads to a corresponding increase in investment.
b. The interest rate is determined in the loanable funds market.
c. Supply creates its own demand at a less than full employment level of output.
[1] All of the above.
[2] None of the above.
[3] a b
[4] b c
[5] a c
18. Which of the following supports Say's Law?
a. Investment spending is a negative function of the interest rate.
b. An increase in saving causes a decrease in the interest rate and consequently investment spending increases and the total demand for goods is unchanged.
c. The interest rate is determined in the money market and not by differences in the desire to save and invest.
[1] a b
[2] b c
[3] a
[4] b
[5] c
19. In considering the nominal interest rate as an equilibrating mechanism, Tobin (1993) argues that:
a. the nominal interest rate might not fall far enough to ensure full employment.
b. an increase in the money supply is necessary to ensure that the interest rate falls far enough to help maintain full employment.
c. in the liquidity trap case the fall in the interest rate may not be enough to restore full employment.
[1] All of the above.
[2] None of the above.
[3] a b
[4] a c
[5] b c
20. In explaining the principle of effective demand, Keynes argued that:
a. an increase in employment increases household income.
b. as household income increases, consumption spending increases by less than the increase in income.
c. if an increase in employment were devoted to the production of consumer goods then the demand for consumer goods will be greater than the supply of consumer goods.
[1] All of the above.
[2] None of the above.
[3] a b
[4] a c
[5] b c
21. According to Keynes, the volatility of investment spending is due to:
[1] the marginal efficiency of investment.
[2] changes in expectations of the future interest rate.
[3] expected changes in monetary policy.
[4] changes in expectations of the future rate of return of investment.
[5] All of the above.
22. According to Keynes, an increase in desired saving will have the following consequences:
a. Investment will increase.
b. Income will increase.
c. Output will increase by more than the increase in investment spending.
d. Employment will increase.
[1] All of the above.
[2] None of the above.
[3] a b d
[4] a c d
[5] b c d
23. The behavioural function for consumption C = a + cY indicates that consumption spending:
[1] is a negative function of output and income.
[2] is a positive function of the interest rate.
[3] is a positive function of the marginal propensity to save.
[4] increases by less than a given increase in income.
[5] None of the above.
24. Regarding investment, Keynes argued that:
[1] investment spending will increase if there is an increase in saving.
[2] expectations of future profitability leads to stability in investment spending.
[3] higher interest rates lead to greater investment spending.
[4] low interest rates may not provide sufficient inducement to investment spending.
[5] None of the above.
25. According to Keynes, the following actions may lead to an increase in the level of output and employment:
[1] The money supply can be decreased, leading to higher interest rates and lower inflation.
[2] Both taxation and government spending can be increased by the same amount.
[3] Decreasing the budget deficit and less borrowing by the government.
[4] All of the above.
[5] None of the above.
26. In the IS-LM model, a contractionary monetary policy leads to:
a. an increase in government spending and the level of output.
b. an increase in the demand for money, an increase in the interest rate and a decrease in government spending.
c. a decrease in the supply of money, an increase in the interest rate and an increase in investment spending.
[1] None of the above.
[2] a
[3] c
[4] b c
[5] a b
27. In the IS-LM model, when comparing the result of an expansionary monetary policy to an expansionary fiscal policy:
[1] in both instances the demand for goods and the level of output are higher.
[2] for monetary policy investment spending is higher while for fiscal policy it is lower.
[3] for monetary policy the interest rate is lower while for fiscal policy it is higher.
[4] All of the above.
[5] None of the above.
28. Crowding out occurs in the IS-LM model since increases in government spending lead to:
[1] increases in the interest rate and higher inflation.
[2] increases in the interest rate which decrease investment spending
[3] increases in tax revenue which decrease consumption spending.
[4] increases in the interest rate which decrease consumption spending.
[5] increases in the interest rate and lower inflation.
29. Which of the following will lower the impact of an expansionary monetary policy on the level of output?
a. A low interest elasticity of investment spending.
b. A high interest elasticity of the demand for money.
c. A large multiplier.
[1] a b
[2] a c
[3] b c
[4] All of the above.
[5] None of the above.
30. If the IS-LM model is modified by including perfectly flexible wages and prices, the following general results are obtained:
[1] Full employment equilibrium is achievable.
[2] The Keynes effect helps to ensure that full employment is reached.
[3] There is no involuntary unemployment.
[4] The demand determined level of employment will be at the full employment level.
[5] All of the above.
31. In the IS-LM model with perfectly flexible wages and prices, involuntary unemployment may occur due to:
[1] the Pigou effect .
[2] a low interest elasticity of investment spending.
[3] a low interest elasticity of the demand for money.
[4] the Keynes effect.
[5] All of the above.
32. Coddington (1976) classifies the IS-LM model as part of:
[1] Hydraulic Keynesianism since it embodies the idea that there are stable relationships between macroeconomic flows.
[2] Fundamentalist Keynesianism since it incorporates adaptive expectations.
[3] Reconstituted reductionism since it embraces equilibrium theorizing.
[4] New Keynesian economics since it explains inflexible wages and prices as part of rational behaviour.
[5] None of the above.
33. According to the original Phillips curve analysis:
[1] policy makers are faced with a choice between higher inflation and higher unemployment.
[2] a rightward shift of the Phillips curve shows that a given unemployment rate is associated with a higher inflation rate.
[3] the more inflexible the labour market, the less the trade-off between inflation and unemployment.
[4] the use of activist policies such as fiscal policy to decrease unemployment will cause a decrease in the price level.
[5] a positive relationship exists between changes in money wages and unemployment.
34. The orthodox Keynesian interpretation of the Phillips curve is that:
[1] a permanently lower unemployment rate can be achieved through temporarily higher rates of inflation.
[2] the rate of increase in money wage rates will be greater the lesser the excess demand for labour.
[3] it provides the authorities with a menu of possible inflation-wage rate combinations.
[4] a permanently lower unemployment rate can be achieved through permanently lower rates of inflation.
[5] None of the above.
35. Which of the following is a central proposition of orthodox Keynesianism?
[1] Output is constrained by aggregate supply.
[2] The existence of voluntary unemployment.
[3] Aggregate demand is constrained by output.
[4] Flexible prices and wages.
[5] The non-neutrality of money.
36. In Friedman's restatement of the quantity theory of money, the demand for real money balances will increase if:
[1] inflation is expected to decrease.
[2] interest rates increase.
[3] liquidity preference decreases.
[4] the expected return on equities decreases.
[5] None of the above.
37. Which of the following do not accord with the quantity theory of money?
[1] Changes in the money supply largely determine changes in real income.
[2] Changes in the demand for money depend on changes in nominal income.
[3] Changes in the demand for money are a stable function of variables other than those determining the money supply.
[4] Changes in the demand for money are largely independent of changes in the supply of money over the short to medium term.
[5] Changes in the money supply largely determine changes in nominal income.
38. According to orthodox monetarists like Milton Friedman:
[1] the velocity of circulation of the money stock (V) is unstable.
[2] an increase in the money supply leads to a fall in the interest rate and hence an increase in the price level.
[3] increases in the real money supply lead to increases in real income.
[4] the money supply is mainly a function of the demand for credit.
[5] None of the above.
39. Orthodox monetarists like Milton Friedman assert that changes in the price level are the result of prior changes in:
[1] nominal income.
[2] the money supply.
[3] adaptive expectations.
[4] the demand for money.
[5] rational expectations.
40. In terms of the IS-LM model, the extreme monetarist argument is that the:
[1] IS curve is horizontal.
[2] IS curve is downward sloping.
[3] LM curve is upward sloping.
[4] LM curve is horizontal.
[5] None of the above.
41. Which of the following summaries of empirical evidence best supports the orthodox monetarist position?
[1] Changes in the money supply bear no clear relationship to changes in the business cycle.
[2] The money supply rises on average during both economic contractions and expansions.
[3] The money supply increases at a faster rate during economic contractions than expansions.
[4] The money supply increases at a slower rate during economic expansions than contractions.
[5] The money supply increases at a slower rate during economic contractions than expansions.
42. At the natural rate of unemployment:
[1] the inflation rate is zero.
[2] real wage rates are falling.
[3] the inflation rate is accelerating.
[4] the real interest rate is constant.
[5] the inflation rate is decelerating.
43. Friedman's concept of the natural rate of unemployment implies that it can be lowered:
[1] by stable monetary policies such as a fixed rate of monetary growth rule.
[2] by lowering real wages.
[3] by removing restrictions and allowing greater flexibility in the labour market.
[4] in the short run but not in the long run.
[5] All of the above.
44. Which of the following statements best summarizes Friedman's view of how expectations of inflation are formed?
[1] The expected inflation rate adjusts gradually to changes in the actual inflation rate, with greater weight given to the most recent changes in the inflation rate.
[2] An increase in the actual inflation rate leads to a rapid acceleration in the expected inflation rate.
[3] The expected inflation rate adjusts rapidly in response to new information about changes in monetary policy.
[4] A change in the expected inflation rate equals the most recent change in the actual inflation rate.
[5] The expected inflation rate adjusts quickly to changes in the actual inflation rate, with greater weight given to the more distant changes in the inflation rate.
45. In Friedman's interpretation of the Phillips curve, an expansionary monetary policy will:
[1] increase both inflation and nominal output in the short run and the long run.
[2] decrease real interest rates in the short run but not in the long run.
[3] lower the natural rate of unemployment in the short run but not in the long run.
[4] increase real output in the long run.
[5] None of the above.
46. In Friedman's interpretation of the Phillips curve, following an expansionary monetary policy:
[1] both money and real wages increase initially and then decrease.
[2] money wages increase initially and then decrease.
[3] money wages increase initially while real wages remain unchanged.
[4] real wages increase initially and then decrease.
[5] money wages increase initially while real wages decrease.
47. Monetary policies aimed at a sharp reduction in the inflation rate will:
[1] lead to a similarly sharp increase in unemployment in the short run.
[2] not have any effect in either the short or the long run.
[3] lead to a similarly sharp increase in output and employment in the short run.
[4] be successful in the long run but not in the short run.
[5] None of the above.
In questions 48-50, which statement best summarizes Friedman's views on the role of monetary policy?
48. Monetary policy should best be conducted by:
[1] controlling the price level.
[2] controlling the interest rate.
[3] controlling the exchange rate.
[4] targeting the inflation rate.
[5] None of the above.
49. Monetary policy can:
[1] only cushion the effect of aggregate supply shocks to the economy.
[2] only cushion the effect of aggregate demand shocks to the economy.
[3] cushion the effect of both aggregate demand and supply shocks to the economy.
[4] prevent the occurrence of contractions in output and employment if used sensibly, such as following a fixed monetary growth rate rule.
[5] stabilize the business cycle over time.
50. Monetary policy cannot:
[1] lower real interest rates in the short run.
[2] lower nominal interest rates in the long run.
[3] lower nominal interest rates in the short run.
[4] avoid engaging in successively larger open market operations.
[5] All of the above.
ASSIGNMENT 02
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 micro- foundations 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.
ASSIGNMENT 03
Each essay should be a maximum of 10 pages (excluding your list of references), using double-spacing and a minimum 12 font print size (about 3 500 words). At the beginning of your essay you must state, using ‘word count', the exact number of words you in fact used in your essay (excluding references).
The essay questions for Assignment
(1) Although economists generally agree about the importance of expectations, there are different explanations of the way in which expectations are formed and how to include them in economic analysis. Compare and contrast the way in which Keynes, Friedman and Lucas treated expectations and how they included them in their theories of output and employment.
(2) Is there a consensus on key macroeconomic issues? Explain what you think are the main areas of both agreement and disagreement in macroeconomics.
(3) Answering the following questions is voluntary but will give us valuable feedback on the module and help us to improve it where necessary. Please include this with your assignment if possible.
(a) What aspects of the course, study material and your learning experience would you like to improve? How?
(b) Do the assignment tasks reflect the learning outcomes and assessment criteria?
(c) Did completing the assignments and consulting the relevant sources improve your competence? Name a few areas that you think could be developed further to enhance your competence and employability as a graduate.