Deck 13: Using the Economic Fluctuations Model

Question 1

When government purchases decrease, the short-run effect can be described as the period of time when

A) there is no spending balance.
B) inflation is constant.
C) real GDP and inflation are adjusting to their new long-run levels.
D) real GDP is below potential GDP.
E) the inflation adjustment line has not reached the new intersection of aggregate demand at the level of potential GDP.

Answer 1

inflation is constant.

Question 2

The short run is usually

A) less than half a year.
B) one to three years.
C) two to three years.
D) one year.
E) four to five years.

Answer 2

one year.

Question 3

If real GDP stays below potential GDP,

A) the AD curve will begin to shift to the left.
B) the IA line will shift down.
C) potential GDP will decline.
D) the IA line will shift up.
E) the AD curve will begin to shift to the right.

Answer 3

the IA line will shift down.

Question 4

The medium run is usually

A) two to three years.
B) four to five years.
C) more than five years.
D) one-half to one year.
E) one year.

Question 5

The long-run effect of a decrease in government purchases can be described as the period of time when

A) the inflation adjustment line intersects the aggregate demand curve at the level of potential GDP.
B) firms are adjusting their prices and inflation is increasing to its new level.
C) real GDP is below potential GDP.
D) there is no spending balance.
E) firms are adjusting their prices and inflation is decreasing to its new level.

Question 6

Exhibit 25-1
Suppose the economy is initially at point A in Exhibit 25-1. If government purchases increase, which point best depicts where the economy will be in the long run as a result of the change in spending?

A) F
B) D
C) B
D) E
E) C

Question 7

Exhibit 25-1
Suppose the economy is initially at point A in Exhibit 25-1. If government purchases increase, which point best depicts where the economy will be in the medium run as a result of the change in spending?

A) F
B) D
C) B
D) E
E) C

Question 8

The initial response of real GDP to a change in aggregate spending is referred to as

A) a depression.
B) a boom.
C) a recession.
D) the short run.
E) a recovery.

Question 9

If real GDP is below potential GDP,

A) long-run equilibrium will be achieved once the aggregate demand curve shifts to the right.
B) the economy is in a short-run equilibrium.
C) long-run equilibrium will be achieved once inflation has stopped declining.
D) the economy is in a medium-run equilibrium.
E) long-run equilibrium will be achieved once prices have stopped declining.

Question 10

The short-run effect of an increase in government purchases is

A) a rightward shift of the aggregate demand curve and an upward shift of the inflation adjustment line.
B) a leftward shift of the aggregate demand curve and an upward shift of the inflation adjustment line.
C) a rightward shift of the aggregate demand curve and a downward shift of the inflation adjustment line.
D) a rightward shift of the aggregate demand curve and movement along the inflation adjustment line.
E) a leftward shift of the aggregate demand curve and movement along the inflation adjustment line.

Question 11

If a shock to aggregate demand occurs, the period of the initial change in real GDP is called

A) the short run.
B) the medium run.
C) the long run.
D) a recovery.
E) the steady state.

Question 12

Which of the following is another term for the recovery period?

A) Medium run
B) Recession
C) Short run
D) Boom
E) Long run

Question 13

The long run is usually

A) ten years or more.
B) two to three years.
C) one to two years.
D) four to five years or more.
E) one year.

Question 14

The long-run effect of a change in expenditures occurs when

A) a spending balance is achieved.
B) the recovery period begins.
C) interest rates begin to adjust.
D) real GDP is nearly back to equaling potential GDP.
E) the AD line intersects the IA line.

Question 15

In the economic fluctuations model, the so-called short run normally refers to

A) the first couple of days after a shock to aggregate demand.
B) the first month after a shock to aggregate demand.
C) the initial departure of real GDP from potential GDP after a shock to aggregate demand.
D) the time it takes for a full recovery to take place after a shock to aggregate demand.
E) None of these

Question 16

In a diagram that includes both the IA line and the AD curve, the price adjustment resulting from an increase in spending is shown by

A) the AD curve shifting to the left.
B) the AD curve shifting to the right.
C) the IA line shifting down.
D) the IA line shifting up.
E) the movement along the IA line.

Question 17

The economic fluctuations model is used by economists to determine the path the economy takes after a shift in aggregate demand.

Question 18

Exhibit 25-1
Suppose the economy is initially at point A in Exhibit 25-1. If government purchases increase, which point best depicts where the economy will be in the short run as a result of the change in spending?

A) F
B) D
C) B
D) E
E) C

Question 19

The short-run effects of an increase in government purchases are that inflation will ____, and real GDP will ____.

A) decrease; increase
B) increase; remain unchanged
C) remain unchanged; decrease
D) remain unchanged; increase
E) increase; increase

Question 20

The long-run effects of an increase in government purchases are that interest rates will ____, inflation will ____, and real GDP will ____.

A) decrease; decrease; remain unchanged
B) increase; increase; remain unchanged
C) remain unchanged; increase; remain unchanged
D) increase; increase; increase
E) decrease; increase; remain unchanged

Question 21

In economics, the short run is an expression used to describe events that take at least two to three weeks to unfold.

Question 22

The tendency of prices to adjust over time is shown by an upward movement along the IA line.

Question 23

The short-run effect of a change in autonomous expenditures is shown by the AD curve moving along the IA line.

Question 24

In the short run, when government purchases decrease, real GDP falls by more than the change in government purchases because

A) prices increase.
B) taxes increase.
C) consumption decreases.
D) investment decreases.
E) taxes decrease.

Question 25

An economic recovery occurs only if the Fed shifts its policy.

Question 26

If government purchases decrease, in the short run

A) consumption will increase as income increases.
B) consumption, investment, and net exports will increase as income increases.
C) consumption and investment will increase as income increases.
D) consumption will fall and net exports will increase as income falls.
E) consumption will increase, and real GDP will remain at potential GDP.

Question 27

The long-run effect of a decline in exports is

A) an ambiguous change in net exports and a decline in both investment and consumption.
B) for there to be no change in any of the aggregate expenditure categories.
C) for net exports to decline, with no change in investment or consumption.
D) an ambiguous change in net exports and an increase in both consumption and investment.
E) an increase in net exports, consumption, and investment.

Question 28

The long-run income effect (the effect of real GDP changes on spending) of decreased government purchases is that consumption

A) is higher.
B) is the same, investment is higher, and net exports are lower.
C) and net exports are the same.
D) and net exports are lower.
E) is higher, and investment is higher.

Question 29

The long-run interest rate effect of decreased government purchases is that

A) consumption is lower, and investment is higher.
B) consumption and net exports are the same, and investment is higher.
C) investment is higher.
D) consumption, investment, and net exports are all higher.
E) consumption and net exports are higher.

Question 30

Suppose government purchases have decreased. Which of the following is true?

A) If inflation is lower in the new equilibrium, the Fed has allowed the target rate of inflation to drift up.
B) If inflation is constant in the new equilibrium, the Fed has decreased the target rate of inflation.
C) If inflation is lower in the new equilibrium, the Fed has allowed the target rate of inflation to drift down.
D) If inflation is lower in the new equilibrium, there has been no change in the target rate of inflation.
E) If inflation is constant in the new equilibrium, the Fed has increased the target rate of inflation.

Question 31

Suppose government purchases have decreased and the economy has reached a new long-run equilibrium. Which of the following best describes the new equilibrium?

A) Nothing has changed because real GDP is again equal to potential GDP.
B) Consumers are better off because taxes are lower.
C) The economy is growing more rapidly because investment is higher.
D) The economy is better off because consumption is higher.
E) The economy is growing more slowly because consumption is higher.

Question 32

The long-run effect of a decrease in government purchases is represented by a rightward shift of the aggregate demand curve as interest rates decline and spending increases.

Question 33

In the short run, when government purchases fall, income and hence consumption fall, so

A) real GDP falls by more than the fall in government purchases.
B) both real GDP and potential GDP fall by the same amount as the fall in government purchases.
C) real GDP falls by the same amount as the fall in government purchases.
D) real GDP falls by less than the fall in government purchases.
E) both real GDP and potential GDP fall by more than the fall in government purchases.

Question 34

The long-run overall effect of decreased government purchases is that

A) investment is higher.
B) consumption and net exports are the same, and investment is higher.
C) consumption is lower, and investment is higher.
D) consumption and net exports are higher.
E) consumption, investment, and net exports are all higher.

Question 35

The IA line does not shift in the short run because

A) real and potential GDP are not equal.
B) potential GDP does not change.
C) of expectations and staggered wage and price adjustment.
D) real GDP does not change.
E) there is no spending balance.

Question 36

If exports permanently decline, we would expect, in the medium run,

A) interest rates to increase and the rate of inflation to fall.
B) interest rates to fall and the rate of inflation to increase.
C) a decline in both the rate of inflation and interest rates.
D) no change in interest rates or the rate of inflation.
E) a decline in both the price level and interest rates.

Question 37

Suppose real and potential GDP are initially equal. If government purchases change, which of the following best explains what will happen first?

A) Potential GDP will change by the same amount as aggregate expenditure.
B) The AD curve will shift.
C) Both the AD curve and the IA line will shift.
D) The IA line will shift.
E) There will be movement along the AD curve.

Question 38

In the economic fluctuations model, the so-called long run normally refers to the time it takes for the economy to return to full employment or, in other words, for real GDP to be back to potential GDP.

Question 39

If government purchases change, which variable is fixed in the short run as a result of the change?

A) Saving
B) All of these
C) Consumption
D) Net exports
E) Inflation

Question 40

The difference between the medium run and the long run is that inflation is constant in the long run.

Question 41

Assume that real and potential GDP are initially equal. If government purchases permanently increase, we would expect that in the short run

A) consumption and investment will be higher than baseline, and net exports will be lower.
B) consumption will be higher than baseline, and net exports and investment will be the same.
C) consumption, investment, and net exports will be higher than baseline.
D) consumption and net exports will be higher than baseline, and investment will be the same.
E) consumption will be higher than baseline, net exports will be lower, and investment will be the same.

Question 42

If exports increase, investment and consumption will be lower in the long run.

Question 43

Suppose, for a certain economy, real and potential GDP are initially equal. Then government purchases permanently increase. Compared to the baseline, we would expect to see, in the long run,

A) an increase in consumption, a decrease in net exports, and no change in investment.
B) no change in consumption, investment, or net exports.
C) no change in consumption and a decrease in both net exports and investment.
D) a decrease in the sum of consumption, investment, and net exports.
E) an increase in consumption, a decrease in investment, and a decrease in net exports.

Question 44

Which of the following would be a direct result of real GDP being above potential GDP?

A) Firms would raise their prices and there would be a subsequent rise in inflation.
B) Firms would lower their prices and there would be a subsequent decrease in inflation.
C) Government spending would decline.
D) None of the above would be a result.
E) Real GDP can never be above potential GDP.

Question 45

What is meant by a baseline?

Question 46

The long-run effect of increased government purchases is that the sum of consumption, investment, and net exports will be lower than it would be in the baseline case.

Question 47

Which of the following would lead to lower inflation in the long run?

A) An increase in business confidence
B) An increase in government spending
C) An increase in oil prices
D) A decrease in imports
E) A decrease in consumer confidence

Question 48

Suppose, for a certain economy, real and potential GDP are initially equal. Then government purchases permanently increase. Compared to the baseline, we would expect to see, in the medium run,

A) a decrease in consumption and an increase in both net exports and investment.
B) a decrease in consumption, investment, and net exports.
C) an increase in consumption, a decrease in net exports, and no change in investment.
D) an increase in consumption and net exports and a decrease in investment.
E) an increase in consumption and a decrease in both net exports and investment.

Question 49

The long-run effect of increased government purchases is crowding out.

Question 50

An increase in government purchases

A) has a positive effect on real GDP in the long run.
B) has a negative effect on real GDP in the long run.
C) results in a lower rate of inflation in the long run.
D) results in lower interest rates in the long run.
E) results in a higher rate of inflation in the long run.

Question 51

A decrease in government purchases causes the interest-sensitive components of aggregate expenditure to increase in the short run.

Question 52

If government purchases decline, during the medium run consumption will be below its baseline level while net exports and investment will be above their baseline levels.

Question 53

When government purchases decline, the Fed can prevent a change in inflation or real GDP by increasing the target rate of inflation.

Question 54

If ever real GDP is above potential real GDP, the inflation adjustment line (IA) must shift downward.

Question 55

If ever real GDP is above potential real GDP, the inflation adjustment line (IA) must

A) remain the same, as this represents a movement along the IA line.
B) shift upward.
C) shift downward.
D) That could never happen.
E) None of these

Question 56

By definition, real GDP can never be above potential GDP.

Question 57

Suppose government purchases have increased and the economy has reached a new long-run equilibrium. Which of the following best describes the new equilibrium?

A) Consumers are worse off because taxes are higher.
B) Nothing has changed because real GDP is again equal to potential GDP.
C) The economy is growing more slowly because consumption is higher.
D) The economy is better off because consumption is higher.
E) The economy is growing more slowly because investment is lower.

Question 58

If government spending decreases, the long-run income effect on net exports and consumption will be the same as in the baseline case.

Question 59

A decrease in government purchases causes the interest-sensitive components of GDP to increase in the long run.

Question 60

Which of the following would lead to higher inflation in the long run?

A) A decrease in consumer confidence
B) An increase in imports
C) An increase in taxes
D) An increase in government spending
E) An increase in the savings rate

Question 61

According to the spending allocation model, what happens if there is an increase in the share of GDP allocated to government purchases? What happens to the other spending shares?

According to the economic fluctuations model, what happens if there is an increase in government purchases as a share of GDP? What happens to the other spending shares?

Are the two models the same? What additional insight does the economic fluctuations model introduce?

Question 62

The long-run effect of a change in government spending will not cause real GDP to differ from its baseline value. However, in the long run, the values of the individual components of aggregate expenditure will differ from their baseline values. Why is this the case?

Question 63

Suppose the relationship between real GDP and inflation is depicted as shown in the table below. Assume that real and potential GDP are equal to each other at $5,400 billion. Suppose government purchases decline by $100 billion and the slope of the aggregate expenditure line is 0.5. (A)Explain how the AD curve is affected by this change. In the short run, what will real GDP and the rate of inflation be?
(B)Using the AD and IA curves, show what will happen in the medium run. Be sure to give an economic explanation for what is happening.
(C)Using the AD and IA curves, show what will happen in the long run.

Question 64

Why do net exports increase when government purchases decline?

Question 65

If the Fed is worried about inflation and raises interest rates, then in the short run

A) the aggregate demand curve will shift to the left.
B) the aggregate demand curve will shift to the left, and the inflation adjustment line will shift down because the target inflation rate has decreased.
C) the inflation adjustment line will shift down because the target inflation rate has decreased.
D) the inflation adjustment line will shift up because the target inflation rate has increased.
E) the aggregate demand curve will shift to the right.

Question 66

If the Fed raises interest rates because inflation is too high, this will cause

A) a long-term recession.
B) a temporary slowdown in growth but not a recession.
C) a permanent slowdown in growth.
D) either a temporary slowdown in growth or a recession.
E) a temporary recession.

Question 67

Which of the following is the best definition of disinflation?

A) A reduction in the inflation rate
B) A reduction in the overall price level of the economy
C) A surprisingly high rate of inflation
D) None of these

Question 68

If the Fed thinks inflation is too high, it will

A) lower the target inflation rate and lower interest rates.
B) lower the target inflation rate and raise interest rates.
C) lower the target inflation rate and leave interest rates unchanged.
D) raise the target inflation rate and raise interest rates.
E) raise the target inflation rate and lower interest rates.

Question 69

Suppose the economy is initially at potential GDP.
(A)Draw an aggregate demand curve and price adjustment line, and label the initial equilibrium with an A.
(B)Suppose government purchases increase. Illustrate the short-run effect on your diagram. Label the new equilibrium with a B.
(C)Explain the short-run effect on C, I, G, X, R, and inflation, as compared to baseline.
(D)Illustrate the long-run effect on your diagram, and label the long-run equilibrium with a C.
(E)Explain the long-run effect on C, I, G, X, R, and inflation, as compared to baseline.

Question 70

The figure below shows the effect of a 2001 increase in government purchases on the hypothetical path of real GDP compared to the path of potential GDP (the baseline) between 2001 and 2005. (A)Using the AD curve and IA line analysis, explain what is occurring between 2001 and 2002.
(B)Using the AD curve and IA line analysis, explain what is occurring between 2002 and 2004.
(C)Using the AD curve and IA line analysis, explain what is occurring between 2004 and 2005.

Question 71

A reduction in the inflation rate is called

A) disinflation.
B) a recession.
C) reinflation.
D) deflation.
E) a price shock.

Question 72

What is the difference between deflation and disinflation?

A) Deflation is used in microeconomics, whereas disinflation is used in macroeconomics.
B) Deflation refers to changes in expected inflation, while disinflation refers to changes in the actual rate of inflation.
C) Deflation refers to a decrease in the overall price level, or negative inflation, while disinflation simply refers to a decrease in the inflation rate.
D) There is no difference between these two concepts; they are synonyms.

Question 73

According to the economic fluctuations model, what would happen if real GDP went above potential GDP?

Question 74

A fall in the overall price level is called

A) a price shock.
B) reinflation.
C) a recession.
D) deflation.
E) disinflation.

Question 75

Disinflation most likely occurs when

A) output grows at an increasing rate over time..
B) output grows at a decreasing rate over time.
C) output growth becomes negative.
D) the overall price level declines over time.
E) the overall price level is negative.

Question 76

The medium-run effect of a monetary policy that seeks to lower the rate of inflation is best depicted by

A) the AD curve shifting to the right.
B) an upward movement of the IA line.
C) an upward movement along the AD curve.
D) a downward movement along the AD curve.
E) the AD curve shifting to the left.

Question 77

Compared to the baseline, the short-run effect of a monetary policy change to lower inflation is for

A) consumption and net exports to decline, while investment stays constant.
B) consumption, investment, net exports, and government purchases to decline.
C) consumption, investment, and net exports to decline.
D) consumption and investment to decline while net exports increase.
E) consumption and net exports to increase while investment falls.

Question 78

Which of the following descriptions best depicts the short-run effect of a leftward shift of the monetary policy line?

A) An increase in the rate of interest and a decline in both the rate of inflation and real GDP
B) A decline in both the rate of inflation and the rate of interest, along with an increase in real GDP
C) An increase in the rate of interest, no change in the rate of inflation, and a decline in real GDP
D) A decline in real GDP and no change in either the rate of inflation or the rate of interest
E) A decline in the rate of inflation, the rate of interest, and real GDP

Question 79

A temporary growth slowdown results in a

A) disinflation.
B) deflation.
C) boom.
D) fall in the price level.
E) recession.

Question 80

Suppose the Fed engages in a policy to reduce the inflation rate for any given level of real GDP. This would be depicted by a(n)

A) downward movement along the monetary policy line.
B) leftward shift of the monetary policy line.
C) upward movement along the monetary policy line.
D) rightward shift of the monetary policy line.
E) rightward shift of the AD curve.