Practice Questions 6-
I. True/False Questions:
1. An increase in the money supply, and increase in government purchases, and a cut in personal taxes all cause the aggregate demand curve to shift to the right.
2. One reason the aggregate supply curve has a positive slope in the short-run is that wage rates and the general price level change at exactly the same rate.
3. When the aggregate demand and aggregate supply curves intersect, there is equilibrium in the goods market, but not necessarily equilibrium in the money (financial) market.
4. Sustained inflation can only occur with monetary expansion, not with fiscal expansion.
5. If the AS curve is vertical in the long-run, neither monetary nor fiscal policy has any effect on aggregate output (income) in the long-run.
6. When aggregate output (income) falls, employment falls.
7. If the going wage rate for someone of John's education, training, and ability is $20 per hour and John refuses to accept a job, economists regard John as just plain lazy.
8. When economists say that labor markets clear they mean that the supply of labor equals the demand for labor.
9. Economists who hold the classical view of the labor market tend to believe that monetary policy, but not fiscal policy, can affect the level of aggregate output (income) in the economy.
10. A law requiring that the U. S. government always have a budget deficit of zero would destabilize the economy.
II. Multiple Choice Questions:
1. What would be the effect on aggregate demand of a increase in the exchange rate of the dollar and an increase in the real interest rate?
a. Both changes would reduce aggregate demand.
b. Both changes would increase aggregate demand.
c. The increase in the exchange rate of the dollar would increase aggregate demand and the increase in the real interest rate would decrease aggregate demand.
d. The increase in the exchange rate of the dollar would decrease aggregate demand and the increase in the real interest rate would increase aggregate demand.
2. Which of the following will shift the aggregate demand curve for the U.S. from AD1 to AD2?
a. An economic boom in Europe.
b. A drop in the price level.
c. An increase in the exchange rate for the dollar.
d. An increase in the interest rate.
3. Which of the following will cause a decrease in aggregate demand in the United States?
a. An increase in the stock market share prices.
b. An decrease in the real interest rate.
c. Improved expectations regarding the future of the economy.
d. A decrease in the expected rate of inflation.
4. If an economy is in a long-run equilibrium and an unexpected increase in aggregate demand occurs, there will be a
a. temporary decrease output and a permanent increase in prices.
b. temporary increase in output and a permanent decrease in prices.
c. permanent decrease output and a permanent increase in prices.
d. temporary increase in output and a permanent increase in prices.
5. If the intersection of aggregate demand and short-run aggregate supply is to the right of long-run aggregate supply, in the long run there will be a decrease in
a. output prices.
b. resource prices.
c. output.
d. all of the above.
6. If the economy is initially at point A and there is no shift in aggregate demand, in the long run
a. resource prices will fall and short-run aggregate supply will increase.
b. resource prices will increase and short-run aggregate supply will fall.
c. resource prices will fall and short-run aggregate supply will fall.
d. resource prices will increase and short-run aggregate supply will increase.
7. Which of the following will shift the LRAS curve from LRAS1 to LRAS2?
a. An increase in the supply of resources.
b. Improved technology.
c. A substantial increase in the minimum wage for young workers.
d. All of the above.
8. Other things constant, a decrease in resource prices will cause,
a. an increase aggregate demand and higher output.
b. a decrease aggregate demand and lower output.
c. a decrease short-run aggregate supply and lower output.
d. an increase short-run aggregate supply and higher output.
9. An improvement in people's inflation expectations will
a. have no effect on short-run aggregate supply.
b. increase short-run aggregate supply.
c. decrease short-run aggregate supply.
d. All of the above are possible as long as long-run aggregate supply is unchanged.
10. A recession is likely to follow if there is a temporary but unanticipated
a. increase or decrease in aggregate demand.
b. increase or decrease in aggregate supply.
c. decrease in aggregate demand or aggregate supply.
d. increase in aggregate demand or aggregate supply.
11. The permanent income hypothesis implies that the consumption component of aggregate demand will
a. increase less rapidly than income during a business expansion.
b. decrease less rapidly than income during a recession.
c. be determined by a long-run measure of income rather than current income.
d. all of the above.
12. If the economy is producing at less than the full-employment output level, which of the following combination of changes will be most likely to move the economy toward the full-employment output level?
a. an increase in the real interest rate and an increase in resource prices.
b. a decrease in the real interest rate and a decrease in resource prices.
c. an increase in the real interest rate and a decrease in resource prices.
d. a decrease in the real interest rate and an increase in resource prices.
13. If the economy is at a an output level above the full-employment level, the economy's self-corrective mechanism will cause
a. the aggregate demand curve to shift to the left and the short-run aggregate supply curve to shift to the right.
b. the aggregate demand curve to shift to the left and the short-run aggregate supply curve to shift to the left.
c. the aggregate demand curve to shift to the right and the short-run aggregate supply curve to shift to the right.
d. the aggregate demand curve to shift to the right and the short-run aggregate supply curve to shift to the left.
III. Short Answer Question:
Assume the following simple economy:
MS = 10
MD = 70 - 200r
G = 200
T = 100
I = 50 - 100r
C = 250 + 0.6(Y-T)
where r is the interest rate expressed as a decimal (i.e., 5% is 0.05 in the equations).
a) What is the equilibrium level of the money stock (M) and the interest rate (r) in the money market?
b) What is the equilibrium level of income (Y) in the output market?
Now suppose that the Fed increases the MS to 20 (new MS = 20).
c) Find the new equilibrium levels of the money stock (M) and the interest rate (r) in the money market.
d) What is the new equilibrium level of income (Y) after the Fed increases the MS to 20?
e) The classical economist then suggests the following model:
MS = 10
C = 250 + 0.6(Y-T) - 4P
MD = 70 - 200r
I = 50 - 100r
G = 200
AS: Y = 500
T = 100 + 0.1Y
AD: Y = C+I+G
After the Fed increases the MS to 20 (new MS = 20), the new equilibrium level of income (Y) in the output market of the classical model will increase, decrease, not change, be indeterminate? The new equilibrium price (P) will increase, decrease, not change, be indeterminate?.
f) A Keynesian economist suggests the following model:
MS = 10
C = 250 + 0.6(Y-T) - 4P
MD = 70 - 200r
I = 50 - 100r
G = 200
AS: P = 45
T = 100 + 0.1Y
AD: Y = C+I+G
Now suppose that government decides to change government spending in order to increase the level of GDP to 1500. Then by how much will the government increase G? Does the equilibrium price increase or decrease? Why?