Deck 12: Keynesian Business Cycle Analysis: Non-Market-Clearing Macroeconomics

Question 1

When consumption and investment is reduced because of the higher interest rates induced by the government expansionary fiscal policy, the effect is called

A) the crowding-in effect.
B) the crowding-out effect.
C) the multiplier effect.
D) the budget effect.

Answer 1

B

Question 2

Unanticipated increase in the government expenditures would

A) shift the LM curve to the right, and the AD curve up and to the right.
B) shift the IS curve to the right, and the AD curve up and to the right.
C) shift the IS curve to the left, and the AD curve up and to the right.
D) shift the IS curve to the right, and the AD curve down and to the left.

Answer 2

B

Question 3

Anticipated changes in the aggregate demand, in the Keynesian model,

A) would affect the output in the short run.
B) would affect the output in the long run.
C) would not affect the output in the short and long runs.
D) would affect the output in the case of the money supply changes.

Answer 3

C

Question 4

According to Keynesian theory, SRAS curve is positively sloped, because

A) employers and employees fail to predict prices correctly.
B) employers and employees have misperception about the change in relative price level.
C) labour contracts are signed for a period in which labour market conditions are not known.
D) wages are flexible, but prices are not.

Question 5

The main difference between classical economists and the Keynesians in explaining the SRAS curve is that

A) classicals argue that prices are rigid, but Keynesians argue that wages are rigid.
B) classicals argue that wages are rigid, but Keynesians argue that prices are rigid.
C) classicals argue that output changes with price changes as long as there is misperception about relative price levels, but Keynesians argue that SRAS is positively sloped for the term of the labour contracts.
D) classicals argue that SRAS is positively sloped because of rational expectations, but Keynesians argue that it is because of the failure of rational expectations.

Question 6

The Keynesian theory of nominal wage rigidity predicts that

A) the real wage is countercyclical.
B) the real wage is procyclical.
C) the real wage is acyclical.
D) the real wage is constant.

Question 7

In the Keynesian model, the economy can be off the FE line and the LRAS in the short run, because

A) the interest rate is slow to adjust.
B) the unemployment rate is high during recession.
C) the actual price level differs from what was expected when nominal wage contracts were signed.
D) real wage is sticky in short run.

Question 8

The crowing-out effect occurs because of

A) higher prices induced by the expansionary fiscal policy.
B) higher interest rates induced by the expansionary fiscal policy.
C) higher inflation induced by the expansionary fiscal policy.
D) higher output induced by the expansionary fiscal policy.

Question 9

Keynesians are skeptical of the classical theory that recessions are periods of increased mismatch between workers and jobs because

A) help-wanted advertising falls during recessions.
B) help-wanted advertising rises during recessions.
C) workers spend a lot of time searching for work in recessions.
D) people are indifferent between being employed or not.

Question 10

Keynesian business cycle theory cannot account for the procyclical behaviour of

A) employment, money, inflation, and labour productivity with the labour hoarding assumption.
B) unemployment, money, inflation, and labour productivity with the labour hoarding assumption.
C) employment, money, real interest rates, and real wages with sticky wages.
D) unemployment, money, inflation, and real wages.

Question 11

Which of the following statements about the behaviour of the real wages in the business cycles is true?

A) The sticky wage theory can produce procyclical real wages.
B) The sticky wage theory along with the price rigidity theory can explain the fact that the real wages are procyclical.
C) The sticky wage theory along with the price rigidity theory can explain the fact that the real wages are countercyclical.
D) The sticky wage theory can explain the fact that the real wages are acyclical.

Question 12

Which one of the following describes Keynesians' rationale for the positively sloped SRAS?

A) Nominal wages are fixed for the term of labour contracts, but price level changes, leading to a change in real wages and output.
B) Demand for labour increases as prices and therefore profits increase.
C) Workers prefer longer term contracts because of job security.
D) There is misperception about the relative price levels.

Question 13

Which of the following is true in the Keynesian model?

A) An easy fiscal policy affects output despite the effect of fiscal policy on the interest rates.
B) An easy monetary policy is associated with an increase in interest rates.
C) An easy fiscal policy is associated with a decrease in interest rates.
D) An easy monetary policy will lead to crowding-out effect.

Question 14

Which of the following statements is false?

A) Keynesians, like classicals, believe that people's expectations are formed based on the rational expectations hypothesis.
B) Keynesians, like classicals, recognize the effect of productivity shocks on the business cycles.
C) Keynesians, like classicals, believe that the free market is able to respond quickly and efficiently to the aggregate demand shocks.
D) Keynesians, unlike classicals, believe that aggregate demand shocks are the main source of the business cycles.

Question 15

The crowding-out effect will probably occur, when

A) the government budget is in surplus.
B) the government follows an easy fiscal policy.
C) the government follows a tight fiscal policy.
D) the government crowds out the economy by lowering the interest rate.

Question 16

The crowding-out effect refers to a situation where

A) an easy fiscal policy reduces interest rate and increases investment.
B) an easy monetary policy reduces interest rate and increases investment.
C) an easy fiscal policy increases interest rate and decreases investment.
D) an easy monetary policy increases interest rate and decreases investment.

Question 17

In the Keynesian model, wages and prices are

A) sticky in the short run, but flexible in the long run.
B) sticky in the long run, but flexible in the short run.
C) forecast accurately by both employees and employers.
D) flexible in the short run and the long run.

Question 18

In the Keynesian model of the business cycles,

A) unanticipated changes in government expenditures cause output to change by change in real wage.
B) anticipated changes in government expenditures cause output to change by changes in real wage.
C) anticipated changes in money supply cause output to change by changes in real wage.
D) anticipated or unanticipated changes in money supply cause output to change by changes in real wage.

Question 19

In the Keynesian model,

A) the short-run aggregate supply slopes upward because of price misperception by firms.
B) the short-run aggregate supply slopes upward because the actual price may be different from the expected price during the term of wage contract.
C) the short-run aggregate supply is horizontal because of price misperception by firms.
D) the short-run aggregate supply is horizontal because the actual price may be different from the expected price during the term of wage contract.

Question 20

An unanticipated increase in the money supply would

A) shift the LM curve to the right and the AD curve up and to the right.
B) shift the LM curve to the left and the AD curve up and to the right.
C) shift the LM curve to the right and the AD curve down and to the left.
D) shift the IS curve to the right and the AD curve up and to the right.

Question 21

Consider the following short run aggregate supply equation: Y= + b (P - P^e), where Y is the real output, is the full employment output, P and P^e are the actual and expected price levels, respectively^. Which of the following is correct?

A) In the Keynesian model, P is always equal to P^e because of sticky-wage assumption.
B) In the Keynesian model, P may be different than P^e because of sticky-wage assumption^.
C) In the Keynesian model, P is always greater than P^e because of sticky-wage assumption.
D) In the Keynesian model, P is always less than P^e because of sticky-wage assumption.

Question 22

When the demand for an imperfect competitor's product is greater than it planned, the firm will

A) increase the price of the product until supply equals demand.
B) meet the demand at its set price.
C) reduce the price until supply equals demand.
D) allow a shortage of the product to develop, without changing the product's price.

Question 23

Which of the following is true about the long run effects of a contractionary monetary policy in Keynesian model?

A) Output declines, price level declines, real interest rate rises.
B) Output increases, price level increases, real interest rate declines.
C) Output does not change, price level decreases, real interest rate does not change.
D) Output declines, price level declines, real interest rate declines.

Question 24

If the menu cost theory is true, then firms that change prices less frequently than other firms are likely to be in

A) more competitive industries.
B) service, rather than manufacturing, industries.
C) growing, rather than declining, industries.
D) less competitive industries.

Question 25

In the Keynesian model in the short run, the amount of employment is determined by the effective labour demand curve and the level of

A) prices.
B) output.
C) the real interest rate.
D) the supply of labour.

Question 26

In the Keynesian model in the long run, an increase in the money supply will cause ________ in the real interest rate and ________ the price level.

A) an increase; an increase
B) a decrease; an increase
C) no change; an increase
D) no change; no change

Question 27

In the Keynesian model, money is

A) neutral in both the short run and the long run.
B) neutral in neither the short run nor the long run.
C) neutral in the short run, but not in the long run.
D) neutral in the long run, but not in the short run.

Question 28

The theory that firms will be slow to change their products' prices in response to changes in demand because there are costs to changing prices is called

A) transactions cost theory.
B) cost-benefit theory.
C) menu cost theory.
D) gift exchange theory.

Question 29

In the Keynesian model, a decrease in the money supply would cause prices to ________ in the short run and ________ in the long run.

A) remain unchanged; remain unchanged.
B) remain unchanged; decrease
C) decrease; remain unchanged
D) decrease; decrease

Question 30

Consider the following short run aggregate supply equation: Y= + b (P - P^e), where Y is the real output, is the full employment output, P and P^e are the actual and expected price levels, respectively^. Which of the following is correct?

A) In the Keynesian model, b is positive because of the sticky wage assumption.
B) In the Keynesian model, b is zero because of the sticky wage assumption.
C) In the classical model, b is zero because of the price misperception assumption.
D) Both A and C are correct.

Question 31

A model in which individual producers act as price setters, because there are only a few sellers and the product they sell is not standardized, is called

A) imperfect competition.
B) perfect competition.
C) monopoly.
D) monopsony.

Question 32

Which of the following is true about the short run effects of a contractionary monetary policy in Keynesian model?

A) Output declines, price level declines, real interest rate rises.
B) Output increases, price level increases, real interest rate declines.
C) Output increases, price level increases, real interest rate increases.
D) Output declines, price level declines, real interest rate declines.

Question 33

In the Keynesian model, the short run aggregate supply curve is

A) perfectly horizontal.
B) upward sloping, but relatively flat.
C) upward sloping, but relatively steep.
D) perfectly vertical.

Question 34

In the Keynesian model in the long run, an increase in the money supply will cause

A) an increase in output and a decrease in the real interest rate.
B) a decrease in the real interest rate but no change in output.
C) an increase in the real interest rate and an increase in output.
D) no change in either the real interest rate or output.

Question 35

In the Keynesian model, short-run equilibrium occurs

A) where the IS and LM curves intersect.
B) where the IS curve, LM curve, and FE lines intersect.
C) where the IS curve intersects the FE line.
D) where the LM curve intersects the FE line.

Question 36

In the Keynesian model in the short run, an increase in the money supply will cause

A) an increase in output and a decrease in the real interest rate.
B) a decrease in the real interest rate but no change in output.
C) an increase in the real interest rate and an increase in output.
D) no change in either the real interest rate or output.

Question 37

The short run aggregate supply curve is

A) positively sloped in both Keynesian and the classical models.
B) positively sloped in the Keynesian model, but horizontal in the classical model.
C) positively sloped in the classical model, but horizontal in the Keynesian model.
D) horizontal in both Keynesian and the classical models.

Question 38

Consider the following short run aggregate supply equation: Y= + b (P - P^e), where Y is the real output, is the full employment output, P and P^e are the actual and expected price levels, respectively^. Which of the following is correct?

A) In the classical model, P is always equal to P^e because of price misperception assumption.
B) In the classical model, P may be different than P^e because of price misperception assumption.
C) In the classical model, P is always greater than P^e because of price misperception assumption.
D) In the classical model, P is always less than P^e because of price misperception assumption.

Question 39

In setting the price of its product, a monopolistic competitor sets the price equal to its marginal cost plus an amount called the

A) markup.
B) profit.
C) rent.
D) menu cost.

Question 40

According to the menu cost theory, firms will be slow in changing their prices because

A) if prices changed frequently, individuals would reduce their demand for that good because of uncertainty.
B) frequent price changes would be a sign of monopolistic behaviour.
C) the cost of changing the price might exceed the additional revenue the price change would generate.
D) demand for their product would fall because consumers would purchase goods from firms that had not raised their prices.

Question 41

In the Keynesian model, the difference between no intervention by the government during a recession and intervention using expansionary monetary or fiscal policy is that no intervention will return the economy to its equilibrium level of output ________ than intervention will and at a ________ price level.

A) faster; lower
B) slower; higher
C) slower; lower
D) faster; higher

Question 42

Suppose the government decided to ease monetary policy, then increase taxes. In the short run in the Keynesian model, the effect of these policies would be to ________ the real interest rate and ________ the level of output.

A) lower; increase
B) lower; decrease
C) lower; have an ambiguous effect on
D) have an ambiguous effect on; increase

Question 43

In the Keynesian model, an increase in government purchases affects output by

A) increasing labour supply, because workers feel effectively poorer.
B) increasing saving to pay for future taxes, lowering the real interest rate and shifting the IS curve to the left.
C) increasing the real interest rate due to crowding out, reducing aggregate demand.
D) increasing aggregate demand as national saving declines.

Question 44

In the Keynesian model in the long run, an increase in the money supply will

A) raise the price level but not the level of output.
B) raise the level of output but not the price level.
C) raise both the level of output and the price level.
D) raise neither the level of output nor the price level.

Question 45

The economy is currently in a recession due to a reduction in consumer confidence. Output and the real interest rate are below their levels prior to the recession. Six months later the economy has returned to its equilibrium level of output and the previous interest rate. Which of the following must have happened?

A) The government did not intervene in the economy.
B) The government increased the money supply.
C) The government decreased the money supply.
D) The government increased purchases of goods.

Question 46

To use fiscal expansion to fight a recession without discouraging investment, we must have ________ monetary policy and ________ fiscal policy

A) tight; easy
B) tight; tight
C) easy; easy
D) easy; tight

Question 47

According to Keynesians, the primary source of business cycle fluctuations is

A) aggregate demand shocks.
B) productivity shocks.
C) oil price shocks.
D) consumer confidence shocks.

Question 48

Using the Keynesian model, the effect of an increase in corporate taxes would be to cause ________ in the real interest rate and ________ in output in the short run.

A) a decrease; a decrease
B) a decrease; no change
C) a decrease; an increase
D) no change; a decrease

Question 49

In the Keynesian model in the long run, a decrease in taxes causes the price level to ________ and the real interest rate to ________.

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

Question 50

In the Keynesian model in the short run, a decrease in government purchases causes output to ________ and the real interest rate to ________.

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

Question 51

In the long run in the Keynesian model, a beneficial supply shock would leave the economy with a higher level of output, but also a ________ real interest rate and a ________ price level.

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

Question 52

According to Keynesians, the primary reason money is not neutral is

A) rational expectations.
B) price stickiness.
C) reverse causation.
D) misperceptions over the aggregate price level.

Question 53

Keynesians explain the procyclical behaviour of average labour productivity by introducing the concept of

A) menu costs.
B) sticky prices.
C) sticky wages.
D) labour hoarding.

Question 54

The recent experience in Japan was characterized by ________ monetary policy and ________ fiscal policy.

A) tight; easy
B) tight; tight
C) easy; easy
D) easy; tight

Question 55

The Keynesian theory is consistent with the business cycle fact that inflation is

A) procyclical and leading.
B) procyclical and lagging.
C) countercyclical and leading.
D) countercyclical and lagging.

Question 56

In the Keynesian model, the difference between using monetary and fiscal policy to eliminate a recession is that

A) monetary policy will eliminate a recession quicker than fiscal policy will.
B) fiscal policy will eliminate a recession quicker than monetary policy will.
C) an expansionary monetary policy will leave the economy with a lower real interest rate than an expansionary fiscal policy.
D) an expansionary fiscal policy will leave the economy with a lower real interest rate than an expansionary monetary policy.

Question 57

Suppose the government decided to tighten monetary policy and decrease government expenditures. In the short run in the Keynesian model, the effect of these policies would be to ________ the real interest rate and ________ the level of output.

A) lower; decrease
B) lower; have an ambiguous effect on
C) have an ambiguous effect on; decrease
D) raise; decrease

Question 58

The idea that firms retain some workers in a recession, whom they would otherwise lay off, to avoid the costs of hiring and training, is called

A) the gift exchange motive.
B) worker pooling.
C) labour hoarding.
D) union busting.

Question 59

Using the Keynesian model, the effect of a government-imposed ceiling on interest rates paid on personal chequing accounts that is lower than the current market interest rate would be to cause ________ in the real interest rate and ________ in output in the short run.

A) a decrease; a decrease
B) a decrease; no change
C) a decrease; an increase
D) an increase; a decrease

Question 60

A problem with the use of aggregate demand management to stabilize the business cycle is that

A) monetary policy isn't available to use when interest rates are already rising because of higher inflation.
B) fiscal policy takes a long time to have any impact on the economy.
C) monetary policy is difficult to use, because the decision-making process is long and complicated.
D) the precise amount that output will change in response to monetary or fiscal policy isn't known.

Question 61

The effort of a firm's workers depends on their real wage according to the following schedule: The marginal product of labour is MPN = E(400 - 4N)/30.
a. What is the efficiency wage?
b. How many workers will the firm hire?
c. Suppose an adverse productivity shock reduces the marginal product of labour to
MPN = E(360 - 4N)/30. How would your answers to parts (a) and (b) change?

Question 62

You are the governor of the Central Bank of Atlantis. You believe in a Keynesian model of the economy, and your goal is to keep the economy at the full-employment level of output. How would you respond (tightening or easing policy) in each of the following cases?
a. Government purchases increase.
b. Corporate tax rates increase.
c. Expected inflation increases.
d. There's a beneficial oil price shock (and the LM curve shifts more to the right than the FE line).

Question 63

Japan experienced a near zero, even negative, economic growth for most of the 1990s. One of the solutions suggested by the Keynesian economists to the deep Japanese recession was to use an expansionary monetary policy. Japanese government followed this advice by announcing increasing money supply and lowering the interest rates to a near zero. Unfortunately, the economy did not recover. Using the IS-LM model, explain why the expansionary monetary policy did not work in Japan? What are the alternative Keynesian solutions to the Japanese recession?

Question 64

A monopolistically competitive firm prices its product using the markup pricing formula P = 1.25MC, where MC is the marginal cost of producing an additional unit. Suppose the demand for the firm's product is given by Q = 2000 - 0.1P, so the revenue from selling Q units of the product is PQ = 2000P - 0.1P².
a. If the marginal cost of producing each unit of the product is $10,000, calculate the price of the product, the quantity produced, and the firm's revenues, costs, and profits.
b. Now suppose the marginal cost rises to $11,000. The firm can keep the price of the product unchanged, or it can change the product's price at a total cost of $700,000. Calculate the price, quantity, revenues, costs, and profits as in part (a) both for changing the price and leaving the price unchanged. Should the firm change the price of its product?

Question 65

You are the liaison between the Bank of Canada and the Department of Finance. Your goal is to coordinate policy efforts to achieve full-employment output in the economy while keeping a fixed real interest rate. You must recommend tightening or easing both monetary and fiscal policies to do this. What would your recommendation be in each of the following situations?
a. People decide to increase saving.
b. Expected inflation declines.
c. The future marginal productivity of capital declines.
d. There's an adverse oil price shock in which the LM curve moves farther to the left than does the FE line

Question 66

According to the Keynesian IS-LM model, what is the effect of each of the following on output, the real interest rate, employment, and the price level? Distinguish between the short run and the long run.
a. expected inflation declines
b. wealth declines
c. labour supply increases due to a change in demographics
d. the future marginal product of capital increases

Question 67

A Keynesian economy is described by the following equations:
C^d = 250 + 0.5(Y - T) - 250r
I^d = 250 - 250r
G = 300
T = 300
L = 0.5Y - 500r + π^e
M = 3000
Y = 1250
π^e = 0
a. Calculate the values of the real interest rate, the price level, consumption, and investment for the economy in general equilibrium.
b. Now suppose government purchases increase to 350 with no change in taxes. What will be the real interest rate, the price level, output, consumption, and investment in the short run?
c. What will be the real interest rate, the price level, output, consumption, and investment in the long run?

Question 68

Discuss the major problems that arise in practice in attempting to use aggregate demand management to stabilize the economy.

Question 69

Describe the effects of an oil price shock in a Keynesian model; why are such supply shocks difficult to handle using macroeconomic stabilization policies?

Question 70

In the short run in the Keynesian model, an oil price shock would leave the economy with a ________ level of output and a ________ real interest rate.

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

Question 71

The following equations describe a Keynesian model of the economy:
C^d = 500 - 0.5(Y - T) - 100r
I^{d =} 350 - 100r
L = 0.5Y - 200i
π^e = 0.05, G = T = 200, Y = 1850
M = 3560
a. Find the full-employment equilibrium values of the real interest rate, consumption, investment, and the price level.
b. Suppose government purchases decline to 175, with no change in taxes. What happens to the real interest rate, output, consumption, and investment in the short run (in which the price level is fixed)? What happens in the long run to the real interest rate, consumption, investment, and the price level?
c. Suppose instead that government purchases rise to 225, with no change in taxes, starting from the equilibrium in part (a). What happens to the real interest rate, output, consumption, and investment in the short run (in which the price level is fixed)? What happens in the long run to the real interest rate, consumption, investment, and the price level?

Question 72

a. Draw a figure, using the Keynesian IS-LM framework, of an economy in recession.
b. Now suppose the IS curve shifts to the right far enough that if the real interest rate is unchanged, output will increase beyond full employment. If the Central Bank's goal is to move output to its full-employment level, what must happen to the real interest rate? What is the effect on the price level?
c. Suppose, before the Bank can act, that the government announces a restrictive fiscal policy, shifting the IS curve to the left relative to its position in part (b). What is the Bank likely to do (relative to what it would do if fiscal policy wasn't restrictive) if its goal is to target full-employment output? What happens to the real interest rate relative to what it is in part (b)?