Deck 14: Aggregate Supply and the Short-Run Tradeoff Between Inflation and Unemployment

Question 1

After examining international data, the economist Robert Lucas found that aggregate demand has the biggest effect on output in countries where aggregate demand:

A)and prices are most stable.
B)and prices are most variable.
C)is most stable but prices are most variable.
D)is most variable but prices are most stable.

Answer 1

and prices are most stable.

Question 2

According to the imperfect-information model, in countries in which there is a great deal of variability of prices:

A)the response of output to unexpected changes in prices will be relatively large.
B)the response of output to unexpected changes in prices will be relatively small.
C)output will respond negatively to an unexpected rise in prices.
D)output will not respond to an unexpected change in prices.

Answer 2

the response of output to unexpected changes in prices will be relatively small.

Question 3

The basic aggregate supply equation implies that output exceeds natural output when the price level is:

A)low.
B)high.
C)less than the expected price level.
D)greater than the expected price level.

Answer 3

greater than the expected price level.

Question 4

According to the sticky-price model:

A)all firms announce their prices in advance.
B)all firms set their prices in accord with observed prices and output.
C)some firms set their prices according to the aggregate supply equation.
D)some firms announce their prices in advance, and some firms set their prices in accord with observed prices and output.

Question 5

Each of the two models of short-run aggregate supply is based on some market imperfection. In the sticky-price model, the imperfection is that:

A)some firms do not adjust their prices instantly to changes in demand.
B)expectations are formed adaptively rather than rationally.
C)firms confuse changes in the overall level of prices with changes in relative prices.
D)the real wage adjusts to bring labour supply and labour demand into equilibrium.

Question 6

Along an aggregate supply curve, if the level of output is less than the natural level of output, then the price level is:

A)greater than the expected price level.
B)less than the expected price level.
C)equal to the natural price level.
D)stuck at the existing price level.

Question 7

Which of the following will shift the aggregate supply curve up to the left?

A)an increase in the price level
B)a decrease in the level of output
C)an increase in the expected price level
D)a decrease in the price level

Question 8

The short-run aggregate supply curve is drawn for a given:

A)output level.
B)price level.
C)expected price level.
D)level of aggregate demand.

Question 9

Some firms do not instantly adjust the prices they charge in response to changes in demand for all of the following reasons except:

A)it is costly to alter prices.
B)they do not want to annoy their frequent customers.
C)prices do not adjust when there is perfect competition.
D)some prices are set by long-term contracts between firms and customers.

Question 10

According to the sticky-price model, output will be at the natural level if:

A)firms expect a high price level and the demand for goods is high.
B)the proportion of firms with flexible prices equals the proportion of firms with sticky prices.
C)the price level equals the expected price level.
D)expectations are formed adaptively, but not if expectations are formed rationally.

Question 11

According to the imperfect-information model, when the price level falls but the producer did not expect it to fall, the producer:

A)increases production.
B)does not change production.
C)decreases production.
D)hires more workers.

Question 12

Based on the sticky-price model, the short-run aggregate supply curve will be steeper the greater the:

A)target nominal-wage rate.
B)target real-wage rate.
C)proportion of firms with flexible prices.
D)proportion of firms with sticky prices.

Question 13

According to the sticky-price model, other things being equal, the greater the proportion s of firms that follow the sticky-price rule, the _____ the _____ in output in response to an unexpected price increase.

A)greater; increase
B)smaller; increase
C)greater; decrease
D)smaller; decrease

Question 14

According to the imperfect-information model, when the price level rises by the amount the producer expected it to rise, the producer:

A)increases production.
B)does not change production.
C)decreases production.
D)hires more workers.

Question 15

The imperfect-information model assumes that producers find it difficult to distinguish between changes in:

A)real wages and nominal wages.
B)the overall level of prices and relative prices.
C)the overall level of prices and the expected level of prices.
D)cost-push inflation and demand-pull inflation.

Question 16

According to the sticky-price model, deviations of output from the natural level are _____ deviations of the price level from the expected price level.

A)positively associated with
B)negatively associated with
C)not related to
D)equal to

Question 17

Both models of aggregate supply discussed in Chapter 14 imply that if the price level is higher than expected, then output _____ natural rate of output.

A)exceeds the
B)falls below the
C)equals the
D)moves to a different

Question 18

In the context of the sticky-price model, the higher the average rate of inflation, the more frequently firms must adjust their prices, which implies that a high rate of inflation:

A)has no effect on the slope of the short-run aggregate supply curve.
B)should make the short-run aggregate supply curve flatter.
C)makes the short-run aggregate supply curve steeper.
D)causes prices to be sticky.

Question 19

Starting from the natural level of output, an unexpected monetary contraction will cause output and the price level to _____ in the short run; and in the long run the expected price level will _____, causing the level of output to return to the natural level.

A)increase; increase
B)increase; decrease
C)decrease; decrease
D)decrease; increase

Question 20

The model of aggregate demand and aggregate supply is consistent with short-run monetary _____ and long-run monetary _____.

A)neutrality; neutrality
B)nonneutrality; nonneutrality
C)neutrality; nonneutrality
D)nonneutrality; neutrality

Question 21

In the case of demand-pull inflation, other things being equal:

A)both the inflation rate and the unemployment rate rise at the same time.
B)the unemployment rate rises, but the inflation rate falls.
C)the inflation rate rises, but the unemployment rate falls.
D)both the inflation rate and the unemployment rate fall.

Question 22

In the case of cost-push inflation, other things being equal:

A)both the inflation rate and the unemployment rate rise at the same time.
B)the unemployment rate rises, but the inflation rate falls.
C)the inflation rate rises, but the unemployment rate falls.
D)both the inflation rate and the unemployment rate fall.

Question 23

Exhibit: AD-AS Shifts Starting from long-run equilibrium at A with output equal to and the price level equal to P₁, a demand-pull inflation would be represented by a shift from:

A)AD₁ to AD_2.
B)AD₁ to AD_3.
C)AS₁ to AS_2.
D)AS₁ to AS_3.

Question 24

The assumption of adaptive expectations for inflation means that people will form their expectations of inflation by:

A)taking all information into account using the best economic model available.
B)asking the opinions of experts.
C)basing their opinions on recently observed inflation.
D)flipping a coin.

Question 25

In the short run, if the price level is greater than the expected price level, then in the long run the aggregate:

A)demand curve will shift leftward.
B)demand curve will shift rightward.
C)supply curve will shift upward.
D)supply curve will shift downward.

Question 26

To illustrate inflation inertia in an aggregate demand-aggregate supply model, the short-run aggregate supply curve shifts upward because of increases in _____, and the aggregate demand curve shifts upward because of increases in _____.

A)the expected price level; the money supply
B)the money supply; the expected price level
C)output; the price level
D)the price level; output

Question 27

The NAIRU is the:

A)North American institutional rate of unemployment.
B)natural aggregate investment return on utilization.
C)nonaccelerating inflation rate of unemployment.
D)normal American inelastic rate of unemployment.

Question 28

The short-run Phillips curve:

A)shifts upward if expected inflation increases.
B)shifts upward if expected inflation decreases.
C)shifts downward if expected inflation increases.
D)is vertical.

Question 29

Inflation inertia is represented in the aggregate supply-aggregate demand model by continuing upward shifts in the:

A)aggregate demand curve.
B)short-run aggregate supply curve.
C)long-run aggregate supply curve.
D)aggregate demand and short-run aggregate supply curves.

Question 30

According to the Phillips curve, other things being equal, inflation depends positively on:

A)expected inflation.
B)the unemployment rate.
C)the rate of technological change.
D)the quantities of capital and labour.

Question 31

The tradeoff between inflation and unemployment does not exist in the long run because people will adjust their expectations so that expected inflation:

A)exceeds the inflation rate.
B)equals the inflation rate.
C)is below the inflation rate.
D)equals the inflation rate of the previous year.

Question 32

The Phillips curve analysis described in Chapter 14 implies that there is a negative tradeoff between inflation and unemployment in:

A)both the short run and the long run.
B)the short run only.
C)the long run only.
D)neither the short run nor the long run.

Question 33

Exhibit: AD-AS Shifts ​ Starting from long-run equilibrium at A with output equal to and the price level equal to P₁, a cost-push inflation would be represented by a shift from:

A)AD₁ to AD_2.
B)AD₁ to AD_3.
C)AS₁ to AS_2.
D)AS₁ to AS_3.

Question 34

If the equation for a country's Phillips curve is π = 0.02 - 0.8(u - 0.05), where π is the rate of inflation and u is the unemployment rate, what is the short-run inflation rate when unemployment is 4 percent (0.04)?

A)above 2 percent (0.02)
B)below 2 percent (0.02)
C)2 percent (0.02)
D)-2 percent (-0.02)

Question 35

Exhibit: AD-AS Shifts Starting from long-run equilibrium at A with output equal to and the price level equal to P₁, if there is an unexpected monetary contraction that shifts aggregate demand from AD₁ to AD₃, then the short-run nonneutrality of money is represented by the movement from:

A)A to B
B)A to G
C)A to C
D)A to D

Question 36

Exhibit: AD-AS Shifts Starting from long-run equilibrium at A with output equal to and the price level equal to P₁, if there is an unexpected monetary contraction that shifts aggregate demand from AD₁ to AD₃, then the long-run neutrality of money is represented by the movement from:

A)A to B
B)A to G
C)A to C
D)A to D

Question 37

All of the following are ways that the modern Phillips curve differs from the relationship observed by A. W. Phillips in 1958 except that the modern Phillips curve:

A)substitutes the output gap for unemployment.
B)includes supply shocks.
C)includes expected inflation.
D)substitutes price inflation for wage inflation.

Question 38

The Phillips curve shows a _____ relationship between inflation and unemployment, and the short-run aggregate supply curve shows a _____ relationship between the price level and output.

A)positive; positive
B)positive; negative
C)negative; negative
D)negative; positive

Question 39

Along a short-run aggregate supply curve, output is related to unexpected movements in the _____. Along a Phillips curve, unemployment is related to unexpected movements in the _____.

A)price level; inflation rate
B)inflation rate; price level
C)unemployment rate; price level
D)price level; level of output

Question 40

If the short-run aggregate supply curve is steep, the Phillips curve will be:

A)flat.
B)steep.
C)backward bending.
D)unrelated to the slope of the short-run aggregate supply curve.

Question 41

Analysis of the short-run Phillips curve suggests that policymakers who want to reduce unemployment in the short run should _____ aggregate demand at a cost of generating _____ inflation.

A)increase; higher
B)increase; lower
C)decrease; higher
D)decrease; lower

Question 42

Exhibit: Short-Run Phillips Curve As the short-run Phillips curve shifts from A to B to C to D:

A)the expected rate of inflation is unchanged at every level of unemployment.
B)there is a lower-than-expected rate of inflation at every level of unemployment.
C)there is a higher-than-expected rate of inflation for every level of unemployment.
D)the natural rate of unemployment increases.

Question 43

The endogenous variables of "A Big, Comprehensive Model" in the appendix to Chapter 14 include the level of output, the natural rate of output, the price level, and:

A)the real and nominal interest rates.
B)the money supply.
C)the world price level.
D)government purchases.

Question 44

If the hypothesis of hysteresis is correct and output is lost even after a period of disinflation, the sacrifice ratio for an economy will:

A)increase.
B)decrease.
C)remain unchanged.
D)be zero.

Question 45

Each of the following conditions will tend to reduce the sacrifice ratio except when:

A)workers and firms set wages and prices based on rational expectations.
B)policymakers make credible commitments to policy changes.
C)announcements of policy changes are made before workers and firms have formed expectations.
D)the concept of hysteresis accurately describes the impact of history on the natural rate of unemployment.

Question 46

According to the natural-rate hypothesis, output will be at the natural rate:

A)if inflation exceeds expected inflation.
B)if inflation falls below expected inflation.
C)if inflation meets expectations in the short run.
D)if aggregate demand affects output in the long run.

Question 47

All of the following are requirements for reducing inflation without causing a recession except:

A)workers and firms must form expectations rationally.
B)the plan must be announced before expectations are formed.
C)the plan must be believed by workers and firms.
D)the government's budget must be balanced.

Question 48

The idea that the natural rate of unemployment is increased following extended periods of unemployment is called:

A)Okun's law.
B)the Phillips curve.
C)the natural-rate hypothesis.
D)hysteresis.

Question 49

According to the natural-rate hypothesis, the levels of output and unemployment depend on:

A)aggregate demand in the short run but not in the long run.
B)aggregate demand in the long run but not in the short run.
C)the natural rate of unemployment in the short run but the natural rate of inflation in the long run.
D)the natural rate of inflation in the short run but the natural rate of unemployment in the long run.

Question 50

Assume that the sacrifice ratio for an economy is 4. If the central bank wishes to reduce inflation from 10 percent to 5 percent, this will cost the economy _____ percent of one year's GDP.

A)4
B)5
C)20
D)40

Question 51

The sacrifice ratio measures the:

A)number of percentage points of the money supply that must be reduced to reduce inflation by 1 percentage point.
B)extra taxes that must be paid to balance the budget.
C)number of months of real gross domestic product (GDP) that must be forgone to reduce the inflation rate by 1 percentage point.
D)percentage of a year's real gross domestic product (GDP) that must be forgone to reduce inflation by 1 percentage point.

Question 52

According to the natural-rate hypothesis, fluctuations in aggregate demand affect output in:

A)both the short run and the long run.
B)only in the short run.
C)only in the long run.
D)in neither the short run nor the long run.

Question 53

The percentage of a year's real GDP that must be forgone to reduce inflation by 1 percentage point is called the:

A)NAIRU.
B)short-run Phillips curve.
C)sacrifice ratio.
D)Okun's law.

Question 54

Exhibit: Short-Run Phillips Curve As the short-run Phillips curve shifts from A to B to C to D, policymakers face:

A)the same tradeoff between inflation and unemployment.
B)a lower rate of inflation for any level of unemployment.
C)a higher rate of inflation for any level of unemployment.
D)higher than expected inflation rates and lower unemployment rates.

Question 55

All of the following are exogenous variables in "A Big, Comprehensive Model" in the appendix to Chapter 14 except the:

A)world interest rate.
B)labour force.
C)world real interest rate.
D)price level.

Question 56

The estimate of the sacrifice ratio from the 1980s disinflation in Canada is approximately:

A)5-6.
B)3-4.
C)1-1.5.
D)0-0.5.

Question 57

The hypothesis that hysteresis may play an important role in macroeconomics implies, among other things, that:

A)the history of economic thought is important to macroeconomics.
B)workers get hysterical during long depressions.
C)hysteresis lowers the sacrifice ratio.
D)the natural rate of unemployment may increase if unemployment is high for a long period of time.

Question 58

A recession may alter an economy's natural rate of unemployment in all of the following ways except by:

A)changing an unemployed individual's attitude toward work.
B)reducing an unemployed worker's job skills.
C)permanently reducing the money supply.
D)altering the wage-setting process.

Question 59

The rational-expectations point of view, in the most extreme case, holds that if policymakers are credibly committed to reducing inflation, and rational people understand that commitment and quickly lower their inflation expectations, then the sacrifice ratio will be approximately:

A)5.
B)2.8.
C)1.
D)0.

Question 60

Advocates of the rational-expectations approach predict that a credible policy to lower inflation will result in a loss of output that is _____ than expected based on the sacrifice ratio.

A)larger
B)smaller
C)the same
D)sometimes larger and sometimes slower

Question 61

Assume that an economy is initially operating at the natural rate of output. Use the model of aggregate demand and aggregate supply (using the upward-sloping short-run aggregate supply curve) to illustrate graphically the short-run and long-run effects on price and output of a reduction in government spending that produces a budget surplus.

Question 62

The government can lower inflation with a low sacrifice ratio if the:

A)money supply is reduced slowly.
B)public has adaptive expectations.
C)short-run aggregate supply schedule is relatively flat.
D)public rationally believe that policymakers are committed to reducing inflation.

Question 63

If only unanticipated changes in the money supply affect real GDP, the public has rational expectations, and everyone has the same information about the state of the economy, then:

A)monetary policy can be used to systematically stabilize output.
B)monetary policy cannot be used to systematically stabilize output.
C)a policy of keeping the money supply constant is optimal.
D)a policy of adjusting the money supply in response to the state of the economy is optimal.

Question 64

Assume that an economy is governed by the Phillips curve π = π^e - 0.5 (u - 0.06), where π = (P - P_-1) / P_-1, π^e = π_-1, and 0.06 is the natural rate of unemployment. Suppose that, in period zero, π = 0.03 and π^e = 0.03-that is, that the economy is experiencing steady inflation at a 3-percent rate.
a.Now assume that the government decides to impose whatever demand is necessary to cut unemployment to 0.04. Suppose the government follows this policy for periods 1 through 5. Create a table of π and π^e for these five periods.
b.Assume that, for periods 6 through 10, the government decides to hold unemployment at 0.06. Create another table of π andπ^e for these five periods. Is there any reason to expect the inflation rate to go back to 0.03?
c.If the government persisted in its behaviour under part a, do you think the public would continue for long forming expectations according to π^e = π_-1? Why?

Question 65

If the short-run aggregate supply curve is assumed to be horizontal, international capital flows are infinitely elastic, and the nominal exchange rate is fixed, then the big, comprehensive model in the appendix to Chapter 14 corresponds to which of the following special cases?

A)classical open economy
B)IS-LM model
C)Mundell-Fleming model with floating exchange rate
D)Mundell-Fleming model with fixed exchange rate

Question 66

For each of the two models of short-run aggregate supply (sticky price and imperfect information) compare the following characteristics:
a.the nature of the market imperfection that generates the short-run movements in output associated with unexpected movements in the price level.
b.whether prices are flexible or fixed.

Question 67

Assume that an economy has the Phillips curve π = π_-1 - 0.5 (u - 0.06). Then the natural rate of unemployment is:

A)0.5.
B)0.12.
C)0.06.
D)0.03.

Question 68

If price expectations are assumed to be correct, money demand is proportional to income, and net capital flow is infinitely elastic, then the big, comprehensive model in the appendix to Chapter 14 corresponds to which of the following special cases?

A)classical closed economy
B)classical open economy
C)IS-LM model
D)Mundell-Fleming model with floating exchange rate

Question 69

If price expectations are assumed to be correct, money demand is proportional to income, and there are no international capital flows, then the big, comprehensive model in the appendix to Chapter 14 corresponds to which of the following special cases?

A)classical closed economy
B)classical open economy
C)IS-LM model
D)Mundell-Fleming model with floating exchange rate

Question 70

An economy is initially in equilibrium at the natural level. The central bank increases the money supply. Graphically illustrate and explain short-run monetary nonneutrality and long-run monetary neutrality using the AD-AS model.

Question 71

Explain economist Robert Lucas's arguments justifying the imperfect-information model?

Question 72

In the sticky-price model, if no firms have flexible prices, the short-run aggregate supply schedule will:

A)be vertical.
B)be steeper than it would be if some firms had flexible prices.
C)slope upward to the right.
D)be horizontal.

Question 73

Assume that people form expectations rationally and that the sticky-price model describes the aggregate supply curve in the economy. For each of the following scenarios explain whether or not monetary policy can have real effects on the economy.
a.The central bank determines monetary policy using the same information available to all firms and at the same time firms are setting prices, so that both firms and policymakers have all of the same information.
b.The central bank determines monetary policy after firms have set prices using information not available at the time prices were set.

Question 74

What is the shape of the short-run supply curve? Explain.

Question 75

Assume that an economy has the Phillips curve π = π_-1 - 0.5 (u - 0.06). How many percentage-point-years of cyclical unemployment are needed to reduce inflation by 5 percentage points?

A)20
B)10
C)5
D)2.5

Question 76

If the short-run aggregate supply curve is assumed to be horizontal and money demand is proportional to income, then the big, comprehensive model in the appendix to Chapter 14 corresponds to which of the following special cases?

A)classical closed economy
B)aggregate demand and aggregate supply
C)IS-LM model
D)Mundell-Fleming model with floating exchange rate

Question 77

If the short-run aggregate supply curve is assumed to be horizontal and international capital flows are infinitely elastic, then the big, comprehensive model in the appendix to Chapter 14 corresponds to which of the following special cases?

A)classical closed economy
B)aggregate demand and aggregate supply
C)IS-LM model
D)Mundell-Fleming model with floating exchange rate

Question 78

The firms and workers in Alpha form expectations adaptively. The firms and workers in Omega form expectations rationally. Their otherwise identical economies are initially in equilibrium at the natural level of output with 10 percent inflation. The central banks of both Alpha and Omega make credible commitments to reduce the growth rates of money until they achieve 2 percent inflation. Compare and contrast the adjustment process to the new equilibrium at the lower rate of inflation in both countries.

Question 79

How is demand-pull inflation different from cost-push inflation?

Question 80

If the short-run aggregate supply curve is assumed to be horizontal and there are no international capital flows, then the big, comprehensive model in the appendix to Chapter 14 corresponds to which of the following special cases?

A)classical closed economy
B)aggregate demand and aggregate supply
C)IS-LM model
D)Mundell-Fleming model with floating exchange rate