Deck 12: The Economic Fluctuations Model

Question 1

In order for the aggregate demand (AD) curve to be downward-sloping,

A) there has to be an inverse relationship between the real interest rate and real GDP and a positive relationship between inflation and the real interest rate.
B) there has to be a positive relationship between the real interest rate and real GDP and a negative relationship between inflation and the real interest rate.
C) there has to be an inverse relationship between the real interest rate and real GDP and an inverse relationship between inflation and the real interest rate.
D) there has to be a positive relationship between the real interest rate and real GDP and a positive relationship between inflation and the real interest rate.
E) there has to be an inverse relationship between the real interest rate and real GDP but there cannot be a relationship between inflation and the real interest rate.

Answer 1

there has to be an inverse relationship between the real interest rate and real GDP and a positive relationship between inflation and the real interest rate.

Question 2

The economic fluctuations model is used to determine

A) real GDP and inflation.
B) potential GDP and inflation.
C) inflation and unemployment.
D) potential GDP and real GDP.
E) real GDP and unemployment.

Answer 2

real GDP and inflation.

Question 3

Exhibit 24-1
According to the data in Exhibit 24-1, the rate of inflation for 1975 was

A) 4.3 percent.
B) 49 percent.
C) 9.6 percent.
D) 4.9 percent.
E) 6.3 percent.

Answer 3

9.6 percent.

Question 4

According to the aggregate demand curve, there is a(n)

A) positive relationship between inflation and real GDP.
B) inverse relationship between the price level and the percentage deviation of real GDP from potential GDP.
C) positive relationship between inflation and the percentage deviation of real GDP from potential GDP.
D) positive relationship between the price level and the percentage deviation of real GDP from potential GDP.
E) inverse relationship between inflation and the percentage deviation of real GDP from potential GDP.

Question 5

Exhibit 24-1

-According to the data in Exhibit 24-1, the percentage deviation of real GDP from potential GDP in 1976 was

A) 1.7 percent.
B) -5.8 percent.
C) 2.7 percent.
D) -4.9 percent.
E) -1.7 percent.

Question 6

When interest rates increase,

A) government purchases will increase to offset the decline in consumption, investment, and net exports.
B) expenditures may increase or decrease.
C) investment will increase.
D) expenditures increase.
E) expenditures decrease.

Question 7

Which of the following is NOT an element of the economic fluctuations model?

A) An aggregate demand curve.
B) An inflation adjustment line.
C) An equilibrium at the intersection between an aggregate demand curve and an inflation adjustment line.
D) Productivity curve.
E) None of these: All are elements of the economic fluctuations model.

Question 8

The real rate of interest is

A) the difference between the stated interest rate and the rate of growth of real GDP.
B) the difference between the stated interest rate and the expected rate of inflation.
C) the rate of interest on Treasury bills.
D) the sum of the stated interest rate plus the expected inflation rate.
E) the same as the federal funds rate.

Question 9

The economic fluctuations model is older than the supply and demand model.

Question 10

John Maynard Keynes developed the economic fluctuations model.

Question 11

Unlike the demand for bananas in a supermarket, aggregate demand slopes upward.

Question 12

The economic fluctuations model is used

A) for all of these.
B) by the Fed to make decisions about monetary policy.
C) to explain how fluctuations in aggregate supply cause departures of real GDP from potential GDP.
D) primarily by stock market analysts.
E) to explain how real GDP grows over a long period of time.

Question 13

When interest rates decrease,

A) investment will decrease, and consumption and net exports will increase, causing expenditures to increase.
B) government purchases will increase to offset the decline in consumption, investment, and net exports.
C) investment and consumption will increase, and net exports will decrease, causing expenditures to increase.
D) investment will decrease.
E) investment, consumption, and net exports will increase, causing expenditures to increase.

Question 14

The aggregate demand curve depends on the relationship between inflation and interest rates as well as the relationship between interest rates and real GDP.

Question 15

The purpose of the AD curve and the IA line is to

A) derive potential GDP.
B) show the relationship between interest rates and potential GDP.
C) explain how movements in real GDP and the rate of inflation are related.
D) show the relationship between real GDP and interest rates.
E) explain spending balance.

Question 16

The aggregate demand curve shows the relationship between

A) real GDP and interest rates.
B) spending and the price level.
C) real GDP and inflation.
D) interest rates and inflation.
E) spending and interest rates.

Question 17

The aggregate demand curve shows the level of spending for each price level in the economy.

Question 18

Since inflation tends to rise when the percentage deviation of real GDP from potential GDP is positive, the aggregate demand curve must be upward-sloping.

Question 19

The best way to approach the debate in Congress over the 2009 stimulus bill is

A) to side with the Democrats' position.
B) to side with the Republicans' position.
C) to evaluate the underlying economic arguments used by each party and come to your own informed conclusion as to whose arguments are more valid.
D) to consider the position of both parties as equally valid, because that is how democracies work.
E) to support the bill because it was prepared by the President's able advisers.

Question 20

The aggregate demand curve shows the relation between two economic variables: real GDP and unemployment.

Question 21

A higher value of the domestic currency

A) means cheaper exports and more expensive imports.
B) means more expensive exports and cheaper imports.
C) means cheaper exports and cheaper imports.
D) means more expensive exports and more expensive imports.
E) has no effect on exports and imports.

Question 22

Which of the following best explains why consumption expenditures are affected by real interest rates?

A) Higher real interest rates make it more expensive to finance the purchase of a new home.
B) When interest rates are high, banks stop lending to households.
C) An increase in real interest rates encourages people to save a larger proportion of their income, which means there is less income for consumption.
D) When real interest rates are low, it is more difficult for households to borrow money because the supply of savings is low.
E) When real interest rates are high, it is more difficult for households to borrow money because the supply of savings is low.

Question 23

The relationship between real interest rates and net exports is

A) positive.
B) not predictable.
C) negative if imports are larger than exports.
D) negative.
E) positive if exports are larger than imports.

Question 24

An increase in real interest rates leads to

A) a decrease in exports and an increase in imports.
B) an increase in both exports and imports.
C) a decrease in both exports and imports.
D) an increase in exports and a decrease in imports.
E) no change in either exports or imports.

Question 25

If real interest rates increase, the expenditure line

A) does not change.
B) becomes steeper.
C) becomes flatter.
D) shifts down in a parallel way.
E) shifts up in a parallel way.

Question 26

Which of the following explains a downward shift in the expenditure line along the vertical axis?

A) A decrease in the MPC
B) An increase in real interest rates
C) A decrease in taxes
D) A decrease in real interest rates
E) A weaker value of the domestic currency

Question 27

A rise in world real interest rates relative to U.S. interest rates

A) will have no effect on the demand for dollar-denominated assets because investors always prefer dollar-denominated assets.
B) will have no effect on the demand for dollar-denominated assets but will cause a decrease in the demand for assets denominated in other currencies.
C) will have no effect on the demand for dollar-denominated assets but will cause an increase in the demand for assets denominated in other currencies.
D) will cause international investors to increase their demand for dollar-denominated assets.
E) will cause international investors to decrease their demand for dollar-denominated assets.

Question 28

If real interest rates in the rest of the world increase relative to the United States, the expenditure line will

A) become flatter.
B) shift up.
C) shift down.
D) become steeper.
E) not be affected.

Question 29

A lower real interest rate in the United States relative to the rest of the world will tend to

A) increase the value of the dollar and increase net exports.
B) decrease the value of the dollar and have an indeterminate effect on net exports.
C) decrease the value of the dollar and increase net exports.
D) increase the value of the dollar and decrease net exports.
E) decrease the value of the dollar and decrease net exports.

Question 30

Real interest rates and investment are

A) negatively correlated because higher real interest rates make it easier for the firm to borrow funds.
B) negatively correlated because higher real interest rates will increase the firm's profits.
C) positively correlated because higher real interest rates make it easier for the firm to borrow funds.
D) negatively correlated because higher real interest rates make borrowing by firms more costly.
E) positively correlated because higher real interest rates make borrowing by firms less costly.

Question 31

Economists refer to the purchase of a new home as

A) fixed structure investment.
B) residential consumption.
C) building investment.
D) inventory investment.
E) residential investment.

Question 32

When real interest rates decrease,

A) the firm's profits will decrease.
B) the opportunity cost of borrowing has increased.
C) the firm's profits will increase.
D) there are fewer profitable investment opportunities for the firm.
E) there are more profitable investment opportunities for the firm.

Question 33

Which of the following is the best measure of the effects of interest rates on aggregate expenditure?

A) The real interest rate
B) The nominal interest rate
C) The discount rate
D) The Treasury bill rate
E) The federal funds rate

Question 34

Which of the following facts about investment is not true?

A) Investment is the component of expenditure that is least sensitive to the real interest rate.
B) Investment represents the purchase of new equipment or a new factory by a business firm.
C) Investment generally decreases when the real interest rate increases.
D) All of the above represent true facts about investment.
E) None of the above represent true facts about investment.

Question 35

The equation for the real interest rate indicates that, other being things equal,

A) as inflation increases, the nominal interest rate will fall.
B) as inflation increases, the real interest rate will rise.
C) as inflation decreases, real income will fall.
D) as inflation changes, the real interest rate will not change.
E) as inflation decreases, the real interest rate will rise.

Question 36

Which of the following is probably the least sensitive to changes in real interest rates?

A) Consumption expenditures
B) Gross investment
C) Net exports
D) Residential investment
E) Net investment

Question 37

If the nominal interest rate exceeds the rate of inflation, the real interest rate will

A) not be affected.
B) rise.
C) be greater than zero.
D) be less than zero.
E) fall.

Question 38

Which of the following is probably the most sensitive to changes in real interest rates?

A) Government purchases
B) Exports
C) Consumption
D) Imports
E) Investment

Question 39

The housing boom that took place during the first half of the 2000s best illustrates how

A) investment spending by households is insensitive to changes in the real interest rate.
B) fixed investment spending by businesses is sensitive to changes in the real rate of interest.
C) investment spending by households is sensitive to changes in the real rate of interest.
D) consumption expenditures are sensitive to changes in the real rate of interest.
E) fixed investment spending by businesses is insensitive to changes in the real rate of interest.

Question 40

A reduction in real interest rates will cause the demand for new homes to

A) increase, which results in an increase in investment expenditures.
B) increase, which results in an increase in consumption expenditures.
C) decrease, which results in a decrease in investment expenditures.
D) decrease, which results in a decrease in consumption expenditures.
E) increase, which will result in an increase in business fixed investment.

Question 41

A rise in inflation will

A) reduce interest rates and increase real GDP.
B) decrease interest rates and real GDP.
C) increase interest rates and increase spending.
D) increase interest rates and reduce real GDP.
E) increase interest rates and real GDP.

Question 42

When inflation rises, the Federal Reserve will

A) act to decrease interest rates.
B) recommend that the Treasury raise interest rates.
C) recommend that Congress raise interest rates.
D) do nothing.
E) act to increase interest rates.

Question 43

Exhibit 24-2
Which of the following factors cannot explain the rise in income from Y_a to Y_b in Exhibit 24-2?

A) An increase in investment
B) A weaker value of the domestic currency
C) A decline in household savings
D) An increase in interest rates
E) A decline in taxes

Question 44

If net exports become less sensitive to changes in the value of the domestic currency, they will be less sensitive to changes in interest rates.

Question 45

In the United States, inflation is the responsibility of

A) the market.
B) the president.
C) the Federal Reserve.
D) Congress.
E) the U.S. Treasury.

Question 46

If inflation increases, the central bank acts to raise interest rates in order to

A) increase the money supply.
B) reduce real GDP.
C) increase real GDP.
D) increase potential GDP.
E) reduce potential GDP.

Question 47

The flatter the aggregate expenditure line, the less sensitive real GDP is to changes in the interest rate.

Question 48

When interest rates increase, the opportunity cost of borrowing will decrease.

Question 49

The positive correlation between real interest rates and inflation is best explained by examining

A) the behavior of the government.
B) forces of supply and demand.
C) the behavior of the market.
D) the behavior of central banks.
E) equilibrium in the economic fluctuations model.

Question 50

Higher real interest rates in the United States compared with other countries increases the demand for U.S. dollar bank accounts and other American interest-bearing assets.

Question 51

When the rate of inflation is low and stable, the real and nominal interest rates are not very different.

Question 52

Consumption expenditures are sensitive to interest rates mainly because the decision to purchase a new home depends on the mortgage rate.

Question 53

Unlike business investment, housing investment declines when the real interest rate falls.

Question 54

If interest rates increase, savings will increase, and the marginal propensity to consume will decrease.

Question 55

When the rate of inflation rises, the central bank should

A) raise the real rate of interest.
B) raise the nominal rate of interest.
C) lower the nominal rate of interest.
D) increase aggregate expenditures.
E) lower the real rate of interest.

Question 56

Ceteris paribus, a rise in U.S. interest rates will cause exports to increase.

Question 57

Exhibit 24-2
Which of the following is a valid explanation of the expenditure line shift from E₁ to E₂ in Exhibit 24-2?

A) A decline in government purchases
B) An increase in taxes
C) An increase in the interest rate
D) A decline in the value of the dollar
E) A fall in world interest rates

Question 58

When inflation is rising, the Fed will

A) lower nominal interest rates to increase potential GDP and bring it in line with aggregate demand.
B) raise nominal interest rates to reduce aggregate demand.
C) raise nominal interest rates to stimulate spending.
D) lower nominal interest rates to stimulate production and bring it in line with aggregate demand.
E) raise nominal interest rates to stimulate production.

Question 59

The central bank's monetary policy rule shows that

A)the real interest rate must increase to match the increase in inflation.
B) the nominal interest rate must increase to match the increase in inflation.
C) the nominal interest rate must increase by more than the increase in inflation.
D) the real interest rate must increase by less than the increase in inflation.
E) the nominal interest rate must increase by less than the increase in inflation.

Question 60

Aggregate expenditures depend on the nominal interest rate because that is the rate that must be paid to the borrower.

Question 61

When the Fed wants to raise nominal interest rates, it

A) increases bank reserves.
B) orders all banks to increase interest rates.
C) recommends that Congress raise the federal funds rate.
D) recommends that Congress conduct open market operations.
E) sells government bonds.

Question 62

When the Fed takes action to change nominal interest rates, it does so by

A) buying and selling bonds.
B) mandating that banks change the prime rate.
C) recommending that the president change the interest rate.
D) recommending that Congress change the interest rate.
E) increasing the required reserve ratio.

Question 63

If the slope of the monetary policy rule line is 2, then when inflation rises by 1 percent, the

A) nominal interest rate rises by 2 percent.
B) nominal interest rate rises by 1 percent.
C) nominal interest rate rises by 3 percent.
D) real interest rate rises by 2 percent.
E) real interest rate rises by 3 percent.

Question 64

When the Fed is worried that the economy is heading into a recession, it

A) decreases bank reserves.
B) buys government bonds.
C) orders all banks to decrease interest rates.
D) recommends that Congress lower the federal funds rate.
E) recommends that Congress conduct open market operations.

Question 65

An inflation target is

A) the difference between the current federal funds rate and the current real interest rate.
B) what the rate of inflation equals when the real interest rate equals zero.
C) what the rate of inflation equals when the nominal interest rate equals zero.
D) the rate of inflation the central bank tries to maintain, on average, over the long run.
E) what the rate of inflation equals when the real and nominal interest rates equal each other.

Question 66

The Fed uses the term target when it announces how it intends to change the federal funds rate because

A) the change in the interest rate is a new law that all banks must adhere to.
B) the Fed has no influence over the federal funds rate.
C) the Fed can control the real interest rate but has no control over the nominal interest rate.
D) the Fed expects the U.S. Treasury to conform with its monetary policy.
E) the Fed has no direct control over interest rates and can only influence rates toward a target value.

Question 67

Inflation and the rate of interest are positively correlated.

Question 68

The text defines the monetary policy rule as the systematic response of the real interest rate to the

A) exchange rate as decided by the Treasury.
B) rate of inflation as decided by the central bank.
C) rate of inflation as decided by the Treasury.
D) exchange rate as decided by the central bank.
E) exchange rate as decided by the banking system.

Question 69

In order for the Fed to respond correctly to changes in the inflation rate, the slope of the monetary policy rule line (showing the relationship between the inflation rate and the real interest rate) must be

A) greater than 1.
B) less than 1.
C) greater than zero.
D) equal to 1.
E) negative.

Question 70

The slope of the monetary policy rule line shows that the Fed will seek to change the nominal rate of interest

A) by less than the change in the rate of inflation.
B) only when there is an increase in the rate of inflation.
C) by more than the change in the rate of inflation.
D) by an amount equal to the change in the rate of inflation.
E) only when there is a decrease in the rate of inflation.

Question 71

The target inflation rate for many central banks is about

A) 10 percent.
B) 2 percent.
C) 8 percent.
D) 0 percent.
E) 5 percent.

Question 72

Of the Fed, the Bank of England, and the Reserve Bank of New Zealand, which of the following statements is true?

A) Only the Fed does not have an explicit inflation target.
B) None of these three central banks have an explicit inflation target.
C) All of these three central banks have an explicit inflation target.
D) Only the Reserve Bank of New Zealand does not have an explicit inflation target.
E) Only the Bank of England does not have an explicit inflation target.

Question 73

Suppose that at the target inflation rate of 2.5 percent the nominal interest rate is 4 percent. This means that at the target inflation rate, the central bank wants the real interest rate to equal

A) 6.5 percent.
B) 4.0 percent.
C) 2.5 percent.
D) 1.5 percent.
E) Not enough information is given to answer this question.

Question 74

The slope of the monetary policy rule line when the nominal interest rate is measured on the vertical axis is

A) less than 1.
B) zero.
C) greater than 1.
D) equal to 1.
E) equal to -1.

Question 75

The inflation rate the central bank tries to maintain, on average, over the long run is referred to as the

A) nominal inflation rate.
B) target inflation rate.
C) quantity inflation rate.
D) real inflation rate.
E) natural inflation rate.

Question 76

When the Fed raises interest rates, it expects

A) a decrease in potential GDP.
B) a decrease in the growth rate of real GDP.
C) an increase in the growth rate of real GDP.
D) an increase in potential GDP.
E) no change in either potential or real GDP.

Question 77

Which of the following is an appropriate definition of the target inflation rate?

A) The inflation rate at which unemployment is zero
B) The central bank's goal for the average rate of inflation over the short run
C) The central bank's goal for the average rate of inflation over the long run
D) The inflation rate at which net exports are maximized
E) None of these

Question 78

If the economy is in a recession, inflation will be ____, and the Fed will want to ____ the interest rate in order to ____ real GDP.

A) rising; increase; decrease
B) rising; increase; increase
C) falling; increase; increase
D) falling; decrease; increase
E) falling; decrease; decrease

Question 79

According to the monetary policy rule, the Fed raises interest rates only when

A) inflation is high.
B) the rate of inflation is above its target inflation rate.
C) the interest rate is below its target rate of interest.
D) the rate of inflation is rising.
E) real GDP is greater than potential GDP.

Question 80

If the central bank determines that aggregate demand is not very sensitive to changes in the interest rate,

A) the monetary policy rule line will shift up.
B) the monetary policy rule line will become steeper.
C) the monetary policy rule line will shift down.
D) there will be movement along the monetary policy rule line.
E) the monetary policy rule line will become flatter.