Deck 11: Classical Business Cycle Analysis: Market-Clearing Macroeconomics

Question 1

By real shock, economists mean

A) shocks to money supply.
B) shocks to money demand.
C) shock to real side of the economy.
D) shocks the shift LM curve.

Answer 1

C

Question 2

A temporary adverse productivity shock would

A) shift the labour supply curve upward.
B) reduce the level of employment.
C) decrease future income.
D) decrease the expected future marginal product of capital.

Answer 2

B

Question 3

Which of the following would not be an example of a productivity shock?

A) the introduction of new management techniques
B) a change in government regulations affecting production
C) a change in the level of government transfer programs
D) a spell of unusually good or unusually bad weather

Answer 3

C

Question 4

What do RBC economists mean by the term calibration?

A) modifying the structure of an economic theory to strengthen its logic
B) changing a theory as the economy changes
C) working out a detailed numerical example of a more general theory
D) writing out the implication of a theory for all the main economic variables

Question 5

Real business cycle theory is unable to predict that

A) employment is procyclical.
B) the price level is procyclical
C) the real wage is mildly procyclical.
D) investment is more volatile than consumption.

Question 6

Which one of the following is an example of a real shock?

A) shock to money supply
B) shock to money demand
C) shock to production function
D) shock to price level

Question 7

A business cycle fact that does not seem to be consistent with the simple RBC theory is that

A) inflation tends to slow during or immediately after a recession.
B) inflation tends to increase during or immediately after a recession.
C) inflation tends to remain the same during or immediately after an expansion.
D) inflation tends to slow during or immediately after an expansion.

Question 8

When RBC economists compare the correlations in their models to the data, what are they looking at?

A) the degree to which variables lead output over the business cycle
B) the strength of procyclicality of different variables
C) the amount of random variation in economic variables
D) the degree to which different economic variables move together

Question 9

Which of the following is not an example of the productivity shock?

A) an increase in oil price because of oil supply disruption that came after a political turmoil in a major oil-exporting country
B) severe weather that caused an adverse effect on farming
C) development of new software that allows firms to keep track of their services
D) a 2 percent rise in nominal wages

Question 10

A real shock to an economy will shift

A) IS curve.
B) LM curve.
C) both IS and LM curves.
D) neither IS nor LM curve.

Question 11

When RBC economists compare the volatility in their models to the data, what are they looking at?

A) the degree to which variables lead output over the business cycle
B) the strength of procyclicality of different variables
C) the amount of random variation in economic variables
D) the degree to which different economic variables move together

Question 12

A temporary adverse productivity shock would not

A) shift the labour demand curve downward.
B) shift the labour supply curve upward.
C) reduce the level of employment.
D) reduce the amount of output that can be produced at any level of employment.

Question 13

The distinction between real and nominal shocks is that

A) real shocks directly affect only the IS curve, but not the FE line or LM curve.
B) real shocks directly affect only the FE line, but not the LM curve.
C) real shocks directly affect only the IS curve or the FE line, but not the LM curve.
D) real shocks have a large direct effect on the IS curve and the FE line, but only a small direct effect on the LM curve.

Question 14

Real business cycle theorists think that most business cycle fluctuations are caused by shocks to

A) the production function.
B) the size of the labour force.
C) the real quantity of government purchases.
D) the spending and saving decisions of consumers.

Question 15

Which of the following is not a primary cause of business cycle fluctuations, according to real business cycle theory?

A) a change in the production function
B) a change in the size of the labour force
C) a change in the money supply
D) a change in the real quantity of government purchases

Question 16

An adverse supply shock would directly ________ labour productivity by changing the amount of output that can be produced with any given amount of capital and labour. It would also indirectly ________ average labour productivity through changes in the level of employment.

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

Question 17

A beneficial productivity shock would ________ output, ________ the real interest rate, and ________ the price level.

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

Question 18

Which of the following is an example of a real shock?

A) an increase in money supply
B) a stock market crash
C) a rise in oil price
D) a decrease in money supply

Question 19

Which of the following is an example of a nominal shock?

A) an increase in money supply
B) an increase in population growth
C) a rise in oil price
D) a decline in demand for labour

Question 20

Which of the following observed procyclical behaviour of variables can be accounted for by the real business cycles theory?

A) real wages
B) employment
C) productivity
D) all of the above

Question 21

The most common measure of productivity shocks is known as

A) the Solow residual.
B) the Lucas supply curve.
C) the Prescott productivity parameter.
D) the Kydland factor.

Question 22

If the utilization rates of capital and labour are procyclical, then

A) output will rise in recessions and decline in expansions.
B) measured productivity will be constant.
C) the Solow residual will be procyclical.
D) prices will be countercyclical.

Question 23

Given data on capital (K), labour (N), and output (Y), and estimates of capital's share of output (a), the Solow residual is measured as

A) YK^aN1-a
B) (YK^a) / N^1-a
C) Y/(K^aN1-a)
D) 1/(YK^aN1-a)

Question 24

According to classical economists, the increase in unemployment in recessions is caused by

A) slack aggregate demand.
B) the failure of wages to adjust to restore equilibrium in the labour market.
C) the power of labour unions, which prevent firms from cutting wages.
D) a mismatch of workers and jobs.

Question 25

The formula Y/(K^aN^1-a) provides a calculation of

A) x-efficiency.
B) dynamic efficiency.
C) economywide monopoly power.
D) the Solow residual.

Question 26

An increase in government purchases in the classical model would

A) shift the production function.
B) shift the marginal product of labour curve.
C) shift the labour demand curve.
D) shift the labour supply curve.

Question 27

In the classical model, a temporary increase in government purchases causes

A) a decrease in output and the real interest rate.
B) a decrease in output and an increase in the real interest rate.
C) an increase in output and a decrease in the real interest rate.
D) an increase in output and the real interest rate.

Question 28

The Solow residual is

A) the waste from the production process.
B) the most common measure of productivity shocks.
C) a measure of the efficiency of the production process.
D) a measure of the proportion of involuntarily unemployed workers.

Question 29

Labour hoarding occurs

A) when firms keep good workers so other firms can't hire them.
B) when the unemployment rate exceeds the natural rate of unemployment.
C) when involuntary unemployment exceeds voluntary unemployment.
D) when, because of hiring and firing costs, firms retain workers in a recession that they would otherwise lay off.

Question 30

Assuming that money is neutral, a reduction in the nominal money supply would cause

A) an excess demand for goods.
B) a decrease in the real money supply.
C) a fall in the price level.
D) a rise in nominal wages.

Question 31

According to classical economists, the government should increase government purchases when

A) the benefits of the spending exceed the costs.
B) the economy is in a recession.
C) the economy is likely to go into a recession in the next six months to a year.
D) inflation is lower than its targeted level.

Question 32

Why does a temporary increase in government purchases increase labour supply in the classical model?

A) The rise in government spending increases labour demand, increasing the real wage, and so people increase their labour supply.
B) Increased government purchases make people better off, so they work more hours.
C) The increase in current or future taxes needed to pay for the increase in government purchases reduces people's wealth.
D) People prefer to work harder when the government is doing more for them.

Question 33

In the classical model, a temporary decrease in government spending would cause a decrease in

A) output, the real interest rate, real wages, and the price level.
B) employment, the real interest rate, real wages, and the price level.
C) output, employment, the real interest rate, and the price level.
D) output, employment, real wages, and the price level.

Question 34

Critics of the RBC approach argue that it's hard to find productivity shocks large enough to cause business cycles. What is the RBC counterargument to this criticism?

A) Business cycles are always and everywhere a monetary phenomenon.
B) Wars and military buildups could be considered productivity shocks.
C) Business cycles could be caused by the accumulation of small productivity shocks.
D) Business cycles are often caused by unobservable productivity shocks, which aren't apparent at the time they occur.

Question 35

Classical economists would cite all of the following as reasons why the government cannot smooth out the business cycle except that

A) only productivity shocks can cause real fluctuations in the business cycle.
B) the government has imperfect knowledge of the economy.
C) political constraints on policy actions prevent the government from carrying out effective policies.
D) time lags between the onset of a recession and the implementation of effective countermeasures make anti-recessionary macroeconomic policies impractical.

Question 36

According to classical economists, unemployment rises in recessions due to an increase in ________ unemployment, not ________ unemployment.

A) cyclical; frictional and structural
B) frictional and cyclical; structural
C) structural; frictional and cyclical
D) frictional and structural; cyclical

Question 37

When, because of hiring and firing costs, firms retain workers in a recession that they would otherwise lay off, there is said to be

A) labour hoarding.
B) a decline in capacity utilization.
C) voluntary unemployment.
D) involuntary unemployment.

Question 38

Classical economists oppose government intervention in the economy for all the reasons below except that

A) policies to smooth out the business cycle are undesirable in principle.
B) increased government expenditures will lower the real wages of workers.
C) government policy is incapable of smoothing out the business cycle.
D) increases in government spending cannot increase the level of output and employment in the economy.

Question 39

One important reason why the Solow residual may be strongly procyclical even if the actual technology used in production doesn't change is that

A) employment is procyclical.
B) resource utilization is procyclical.
C) demand shocks are the dominant force determining the business cycle.
D) the coefficients (a and l-a) on capital and labour in the production function are procyclical.

Question 40

Measures of the Solow residual show it to be

A) strongly procyclical.
B) mildly procyclical.
C) mildly countercyclical.
D) strongly countercyclical.

Question 41

According to the misperceptions theory, an anticipated decline in the money supply leads to a shift of the AD curve to the ________ and a shift of the SRAS curve to the ________.

A) left; right
B) left; left
C) right; right
D) right; left

Question 42

Which of the following equations is most likely to represent short-run aggregate supply according to the misperceptions theory?

A) Y = 6000
B) Y = 6000 + 50(P - P^e)
C) P = 2
D) PY = 12,000

Question 43

Assuming money neutrality in the classical model, a 10% increase in the nominal money supply would cause

A) a 10% increase in the real money supply.
B) a 10% decrease in the real money supply.
C) no change in the real money supply.
D) a less than 10% change in the price level due to a shift in the aggregate supply curve.

Question 44

Friedman and Schwarz argue that money is not neutral because

A) theoretical models of the economy don't show monetary neutrality.
B) money is a leading, procyclical variable.
C) they found several historical incidents in which changes in the money supply were not responses to macroeconomic conditions, and output moved in the same direction as money.
D) they found no evidence that productivity changes or changes in government spending contributed to business cycles; only monetary changes preceded every recession.

Question 45

According to the misperceptions theory, when the aggregate price level is higher than expected, the aggregate quantity of ________ the full-employment level.

A) output supplied rises above
B) output supplied falls below
C) output demanded falls below
D) output demanded rises above

Question 46

If producers have imperfect information about the general price level and sometimes misinterpret changes in the general price level as changes in relative prices, then

A) the short-run aggregate supply curve is vertical.
B) the short-run aggregate supply curve slopes upward.
C) the aggregate demand curve is vertical.
D) the aggregate demand curve is horizontal.

Question 47

According to the misperceptions theory, after an unanticipated increase in the money supply has occurred, the SRAS must shift to the ________ to restore general equilibrium; as it does so, the price level ________.

A) right; rises
B) right; falls
C) left; rises
D) left; falls

Question 48

Which of the following restates the basic business cycle fact that money is procyclical?

A) Changes in the behaviour of the money stock has been closely associated with changes in economic activity, nominal income, and prices.
B) Monetary changes have often had an independent origin; they have not been a reflection of changes in economic activity.
C) The interrelation between monetary and economic changes have been highly stable.
D) Both A and C are correct.

Question 49

Classical economists would explain the fact that money is a leading, procyclical macroeconomic variable by pointing out that

A) money is not neutral, and changes in the nominal money supply affect real variables.
B) increasing the money supply shifts the LM curve, reducing real interest rates and causing an economic expansion.
C) increasing the money supply increases aggregate demand, causing higher levels of employment and output.
D) when money demand rises because of a beneficial productivity shock, the Central Bank increases the money supply to prevent the price level from falling.

Question 50

You are likely to think that the relative price of your good has declined and you should decrease your output if

A) you expected inflation of 10% and the price of your good rose 7%.
B) you expected inflation of 10% and the price of your good rose 10%.
C) you expected inflation of 10% and the price of your good rose 13%.
D) you expected inflation of 0% and the price of your good rose 10%.

Question 51

According to the misperceptions theory, when the price level falls below the expected price level,

A) the economy's SRAS curve shifts to the left.
B) the economy moves along its AD curve.
C) the economy moves along its LRAS curve.
D) the economy moves along its SRAS curve.

Question 52

Reverse causation means that

A) expected future increases in output cause increases in the current employment.
B) expected future increases in output cause increases in the current money supply.
C) expected future increases in money supply cause increases in the current output.
D) expected future increases in employment cause increases in the current output.

Question 53

If you expect a general price increase of 5% this year and the price of the hamburgers you sell increases by 10%, you would conclude that the relative price of your good has

A) declined, and you would increase your output.
B) declined, and you would decrease your output.
C) increased, and you would increase your output.
D) increased, and you would decrease your output.

Question 54

Which of the following can be taken as an evidence for the reverse causation between the money growth and the changes in output?

A) Bank of Canada regularly increases money supply during the Christmas shopping season.
B) Bank of Canada regularly adjusts the level of money supply based on its forecast of the economic activity.
C) Prices are procyclical.
D) Productivity is procyclical.

Question 55

You and a friend are arguing over the issue of the nonneutrality of money. You believe that money is not neutral, and to prove your point you would cite all of the following except

A) large gold discoveries that increased the money supply preceded an economic boom.
B) a change in monetary institutions preceded a boom or recession.
C) a change in the leadership of the Central Bank and its policy was followed by noticeable changes in the money supply and a recession or inflation.
D) the fact that every recession was preceded by a drop in the money supply.

Question 56

The basic classical model can account for the procyclical behaviour of money if there

A) are real business cycles caused by productivity shocks.
B) is reverse causation from future output to money.
C) are rational expectations among the public.
D) are propagation mechanisms in the economy.

Question 57

According to the misperceptions theory, an unanticipated decrease in the money supply shifts the AD curve to the ________, causing output to ________ in the short run.

A) right; rise
B) right; fall
C) left; rise
D) left; fall

Question 58

According to the misperceptions theory, when P < P^e, output is ________ its full-employment level and the short-run aggregate supply curve must shift to the ________ to restore full employment.

A) below; left
B) below; right
C) above; left
D) above; right

Question 59

Short-run aggregate supply is greater than long-run aggregate supply in the misperceptions theory if

A) the actual price level is greater than the expected price level.
B) the actual price level equals the expected price level.
C) the actual price level is less than the expected price level.
D) output is less than its full-employment level.

Question 60

The short-run aggregate supply curve can slope upward because

A) prices are fixed in the short run.
B) wages adjust immediately to changing economic circumstances.
C) producers have misperceptions about the aggregate price level.
D) prices adjust instantaneously.

Question 61

Use the classical (RBC) IS-LM-FE model to show the effects on the economy of a temporary beneficial supply shock-for example, a decrease in the price of oil. You should show the impact on the real wage, employment, output, the real interest rate, consumption, investment, and the price level.

Question 62

The Central Bank had announced that it would allow M2 to grow by 8% this year, and M2 did grow by 8% this year. You would not expect

A) money to be neutral in the short run.
B) money to be neutral in the long run.
C) output to remain unchanged.
D) a movement along the short-run aggregate supply curve.

Question 63

Suppose the economy's production function is Y = A(300N - N²). The marginal product of labour is MPN = A(300 - 2N). Suppose that A = 10. The supply of labour is NS = 0.05w + 0.005G.
a. If G is 26,000, what are the real wage, employment, and output?
b. If G rises to 26,400, what are the real wage, employment, and output?
c. If G falls to 25,600, what are the real wage, employment, and output?
d. In cases (b) and (c), what is the government purchases multiplier; that is, what is the change in output divided by the change in government purchases?

Question 64

The reason why some economists believe that attempts by the Central Bank to surprise the public in a systematic way cannot be successful is that

A) information about the Bank's plans will inevitably be leaked to the public.
B) the Bank announces its goals and publishes its policy actions six weeks after they take place.
C) the public would eventually figure out what the Bank's policies were, negating the Bank's surprise.
D) competition in the money markets would neutralize the Bank's intervention.

Question 65

The theory of rational expectations suggests that

A) people never make forecast errors.
B) people make intelligent use of available information.
C) people make systematic forecast errors.
D) people are slow to incorporate new information into their forecasts.

Question 66

The primary reason why the Central Bank cannot systematically surprise the public with its monetary policy is

A) the nonneutrality of money.
B) the presence of productivity shocks that generate real business cycles independently of the monetary side of the economy.
C) the presence of rational expectations among the public.
D) the presence of propagation mechanisms within the economy.

Question 67

According to the misperceptions theory, if the Bank wanted to use monetary policy to influence the real economy, it would have to

A) increase the money supply whenever the economy was in a recession.
B) decrease the money supply whenever the economy was in an inflationary boom.
C) surprise the public with unexpected changes in monetary policy.
D) abide by its announced monetary targets.

Question 68

According to the misperceptions theory, an anticipated 10% decrease in the money supply leads to a short-run reduction in the price level of

A) 0%.
B) 5%.
C) some amount between 0% and 10%.
D) 10%.

Question 69

Suppose the economy is characterized by the following equations:
IS curve: r = 10.10 - 0.002Y
LM curve: M/P = Y - 250(r + π^e)
SRAS curve: Y = Y + 50(P - P^e)
The nominal money supply is M = 9,900, expected inflation is π^e = .10, and full-employment output is Y = 5000.
a. If the economy begins in general equilibrium, what are the equilibrium values of the price level, output, and the real interest rate?
b. If the expected price level is the price level you found in part (a), what happens to the price level, output, and the real interest rate in the short run if there's an unanticipated decrease in the nominal money supply to 7368.75?
c. If the expected price level is the price level you found in part (a), what happens to the price level, output, and the real interest rate in the short run if there's an unanticipated increase in the nominal money supply to 12,468.75?

Question 70

Suppose the money demand of individuals and firms depends on what they perceive to be the probabilities that the economy will expand or contract over the following six months. Suppose their money demand is given by the equation L = 0.5Y - 100i + 20z, where z is the probability that the economy is expanding six months in the future. If z = 1 the economy will certainly be in recovery; if z = 0 the economy will certainly be in recession, and for z between 0 and 1 there is some uncertainly about the future state of the economy. Use a classical (RBC) model of the economy. If the Central Bank moves the money supply to target the price level, how does the money supply relate to the expected future state of the economy? Is this an example of reverse causation?

Question 71

A classical economy is described by the following equations:
C^d = 500 + 0.5(Y - T) - 100r
I^d = 350 - 100r
L = 0.5Y - 200I
Y = 1850
π^e = 0.05
Government spending and taxes are equal where T = G = 200. The nominal money supply M = 3560.
a. What are the equilibrium values of the real interest rate, the price level, consumption, and investment?
b. Suppose an economic shock increases desired investment by 10, so it is now I^d = 360 - 100r. How does this affect the equilibrium values of the real interest rate, the price level, consumption, and investment?
c. Returning to the initial situation in part (a), suppose an economic shock increases desired consumption by 10, so it is now C^d = 510 + 0.5 (Y - T) - 100r. How does this affect the equilibrium values of the real interest rate, the price level, consumption, and investment?

Question 72

The primary reason that short-lived shocks can have long-run effects is

A) the nonneutrality of money.
B) misperceptions by the public over the actual price level and the expected price level.
C) the presence of rational expectations among the public.
D) the presence of propagation mechanisms.

Question 73

According to rational expectations,

A) people never make mistake when forecast future.
B) people never make systematic mistake when forecast future.
C) people always overestimate the inflation rate.
D) people always underestimate the money supply effects.

Question 74

Dynamic Stochastic General Equilibrium (DSGE) models are models that allows analysis of

A) productivity shocks only.
B) productivity as well other shocks that have impacts on the economy.
C) fiscal policy shocks only.
D) monetary policy shocks only.

Question 75

Use the classical (RBC) IS-LM-FE model to show the effects on the economy of a temporary decrease in government spending. You should show the impact on the real wage, employment output, the real interest rate, consumption, investment, and the price level.

Question 76

Why do many economists believe that money affects output? What is the empirical evidence in support of that belief?

Question 77

How is the Solow residual measured? What problems arise in its measurement when resource utilization varies over the business cycle? What implications do these measurement issues have for evidence supporting the RBC model?

Question 78

According to the misperceptions theory, short-lived shocks may have long-term effects on the economy because of

A) multiplier effects.
B) propagation mechanisms.
C) accelerator effects.
D) automatic stabilizers.

Question 79

Which of the following statements is true about the misperceptions theory?

A) Both anticipated and unanticipated changes in the nominal money supply have real effects on the economy.
B) Neither anticipated nor unanticipated changes in the nominal money supply has real effects on the economy.
C) Unanticipated changes in the nominal money supply have real effects, but anticipated changes are neutral.
D) Anticipated changes in the nominal money supply have real effects, but unanticipated changes are neutral.

Question 80

Money is neutral in both the short and long runs, if we assume

A) people form their expectations based on the rational expectations hypothesis.
B) people forecast the effect of the money supply correctly.
C) people never make mistake when they make forecast.
D) the change of money supply is unanticipated.