Deck 15: Modern Macroeconomics: From the Short Run to the Long Run

Question 1

When the economy is producing above full employment, the unemployment rate is below the natural rate. This makes it more difficult for:

A) firms to hire workers, causing the wages to rise.
B) workers to find jobs, causing the wages to rise.
C) firms to hire workers, causing the wages to drop.
D) workers to quit jobs, causing the wages to drop.

Answer 1

firms to hire workers, causing the wages to rise.

Question 2

According to Say's law:

A) because households save some of their income, not all goods and services produced will be purchased.
B) the demand for products creates the supply of products.
C) recessions occur because income from the production of goods is insufficient to ensure full employment.
D) the act of producing goods and services generates income that is equivalent to the value of goods and services produced enabling buyers to purchase those goods.

Answer 2

the act of producing goods and services generates income that is equivalent to the value of goods and services produced enabling buyers to purchase those goods.

Question 3

The classical aggregate supply curve is:

A) vertical.
B) horizontal.
C) downward sloping.
D) upward sloping.

Answer 3

vertical.

Question 4

The aggregate demand curve shows the relationship between prices and the

A) level of real GDP demanded.
B) level of real GDP produced.
C) level of nominal GDP demanded.
D) level of nominal GDP produced.

Question 5

Patinkin and Modigliani argue that Keynes' argument that demand could fall below production would hold only if:

A) inputs are fully flexible.
B) prices are fully flexible while wages are not.
C) prices and wages are fully flexible.
D) prices and wages are not fully flexible.

Question 6

Recall Application 1, "Avoiding a Liquidity Trap," to answer the following questions:
What was the policy adopted by the Fed in response to the looming liquidity trap?

A) Do nothing and wait for interest rates to rise.
B) Increase the money supply.
C) Pay interest on bank reserves.
D) Increase the reserve requirement.

Question 7

Rising wages and input prices:

A) cause the aggregate supply curve to shift to the right.
B) cause the aggregate demand curve to shift to the left.
C) cause the aggregate demand curve to shift to the right.
D) cause the aggregate supply curve to shift to the left.

Question 8

AN UNFORTUNATE GAMBLE
What explained the decision by the Japanese government to increase taxes in the 1990s when the economy
was still suffering from a recession?
The Japanese government sharply increased taxes on consumption in 1997—just as Japan was in the midst of its prolonged
recession. Why did the government do this?
The reasons were clear. As the economy slumped, fiscal deficits were increasing, as taxes fell and government spending rose.
Policy makers understood that their society was aging rapidly and that this would mean even more demands on the public
sector in the near future. They became convinced that the current fiscal deficits plus the inevitable future demands on the
government would lead to long-run increases in government spending. To avoid crowding out of investment in the future,
they decided to tax consumption in order to reduce it. Their goal was to match the increases in government spending with
decreases in consumption spending and therefore not experience crowding out of investment.
Although policy makers were right to consider the long-run consequences of increases in government spending, they made
the unfortunate gamble that the short-run effects of the tax increase would not hinder the economy’s recovery. They were
wrong, because the tax increase prolonged the recession. Although it is important to consider the long-run consequences of
policy, it is important to understand the short-run consequences as well.
According to the application, what was the reason why the Japanese government increased consumption taxes in the 1990s?

A) They wanted to make the economy to spiral into a depression.
B) They wanted to decrease net exports.
C) They wanted to decrease consumption spending because they expected government spending to increase in the future.
D) They wanted to decrease consumption spending as they expected government spending will decrease.

Question 9

Say's Law states that:

A) people are motivated by self- interest.
B) demand always creates its own supply.
C) supply creates its own demand.
D) economic markets are unstable.

Question 10

The process by which changes in wages and prices causing further changes in wages and prices is called:

A) the snowball effect.
B) the vicious cycle.
C) a wage - price spiral.
D) the business cycle.

Question 11

Which of the following curves is drawn as a vertical line?

A) the long- run aggregate demand curve
B) the short- run aggregate supply curve
C) the short- run aggregate demand curve
D) the long- run aggregate supply curve

Question 12

The reduction in investment spending in the long run results from an increase in government expenditures because:

A) the tax rate increases.
B) real interest rates increase.
C) real interest rates decrease.
D) nominal interest rates decrease.

Question 13

Classical economists believed that:

A) government could intervene in the economy and increase the level of output and employment.
B) recessions were not self- correcting.
C) unemployment could not persist for extended periods of time.
D) the government could lift the economy out of recession.

Question 14

The view that the labor market quickly adjusts to reach equilibrium is consistent with the assumption of _______ aggregate supply curve.

A) a vertical
B) an upward- sloping
C) a downward- sloping
D) a horizontal

Question 15

Assuming that the economy is in the long run equilibrium at full employment, an expansionary monetary policy _______ the price level and _______ output.

A) increases; doesn't change
B) increases; increases
C) doesn't change; doesn't change
D) decreases; increases

Question 16

Those who believe that wages adjust quickly to clear the labor market also believe that:

A) the AS curve is upward sloping.
B) the AS curve is vertical.
C) the AD curve is steep.
D) the AD curve is flat.

Question 17

Figure 15.2
Refer to Figure 15.2. For this economy to produce Y₁ and sustain that level of output without inflation:

A) potential output must increase.
B) the government must implement an expansionary fiscal policy.
C) the government must implement an expansionary monetary policy.
D) the price of oil must decrease.

Question 18

Which of the following sequence of events occurs in response to an expansionary fiscal policy?

A) Real GDP increases, causing money demand to increase, causing interest rates to increase and investment to decrease.
B) Real GDP decreases, causing the demand for money to increase, causing interest rates to increase and investment to increase.
C) Real GDP increases, causing money demand to increase, causing interest rates to decrease and investment to increase.
D) Real GDP increases, causing money demand to decrease, causing the interest rate to decrease and investment to increase.

Question 19

If left alone, the boom experienced by an economy will cause the short- run

A) aggregate demand curve to shift downward until the equilibrium GDP is back to full employment.
B) aggregate supply curve to shift downward until the equilibrium GDP is back to full employment.
C) aggregate supply curve to shift upward until the equilibrium GDP is back to full employment.
D) aggregate demand curve to shift upward until the equilibrium GDP is back to full employment.

Question 20

Monetary neutrality:

A) means that a change in the money supply will affect both real GDP and the price level.
B) definitely applies in the short run.
C) means that a change in the money supply will affect real GDP, but will not affect the price level.
D) none of the above

Question 21

In the long run, without government intervention, the economy responds to a decrease in aggregate demand with:

A) an increase in short- run aggregate supply.
B) a decrease in short- run aggregate supply.
C) a second decrease in aggregate demand.
D) an increase in aggregate demand.

Question 22

Suppose the economy is at full employment. An increase in the money supply will _______ in the short run and _______ in the long run.

A) increase interest rates, increase the price level
B) decrease interest rates, increase the price level
C) decrease interest rates, decrease the price level
D) increase interest rate, have no effect on the price level.

Question 23

When the aggregate demand pushes production above full employment in the short run, then:

A) firms find it easy to hire and retain workers, so wages rise.
B) firms find it hard to hire and retain workers, so wages drop.
C) firms find it easy to hire and retain workers, so wages drop.
D) firms find it hard to hire and retain workers, so wages rise.

Question 24

Figure 15.1
Refer to Figure 15.1. If the wage rate can easily adjust to clear the market, then if the wage rate is currently at $12:

A) the wage rate will decrease to eliminate the shortage.
B) the wage rate will decline to eliminate the surplus.
C) the wage rate will decline to eliminate the shortage.
D) the wage rate will increase to eliminate the shortage.

Question 25

According to classical economists, an increase in aggregate demand should result in:

A) no reduction in the unemployment rate.
B) no change in the level of real GDP.
C) an increase in the price level.
D) all of the above

Question 26

According to the classical economists, the economy:

A) requires fine- tuning to reach full employment.
B) will never be at full employment.
C) can never deviate from full employment.
D) is self- correcting.

Question 27

Of the economists listed below, who is not considered a "classical" economist?

A) John Maynard Keynes
B) David Ricardo
C) Thomas Malthus
D) Jean- Baptiste Say

Question 28

The wage- price spiral occurs when:

A) the economy is producing a level of output above or below full employment.
B) the economy is producing a level of output exactly at full employment.
C) the economy is producing a level of output below full employment.
D) the economy is producing a level of output above full employment.

Question 29

If wages are sticky downward, then a decrease in the demand for labor

A) will bring the economy back to full employment.
B) will cause more unemployment in the short run.
C) will cause an increase in production in the short run.
D) will cause wages to drop in the short run.

Question 30

Which of the following will cause investments to decrease?

A) an increase in the price level
B) a decrease in the level of income
C) a decrease in both income and the price level
D) a decrease in the price level

Question 31

In order to prevent a wage- price spiral from emerging when the economy is producing above full employment, the monetary authority could:

A) contract the money supply.
B) lower taxes.
C) expand the money supply.
D) increase government spending.

Question 32

Fiscal policy affects the real interest rate through its impact on:

A) money supply and the price level.
B) real GDP and money demand.
C) money supply and money demand.
D) real GDP and money supply.

Question 33

Suppose that potential output is $5 trillion and real GDP is currently $5.5 trillion. In the long run, we would expect that:

A) real GDP will rise.
B) wages and input prices will fall.
C) the price level will rise.
D) all of the above

Question 34

Recall Application 1, "Avoiding a Liquidity Trap," to answer the following questions:
Which of the following most likely caused the low short- term interest rates in 2008?

A) The recession caused by the financial crisis forced the Fed to raise the interest rates.
B) The inflation caused by the financial crisis forced the Fed to raise the interest rates.
C) The recession caused by the financial crisis forced the Fed to lower the interest rates.
D) The inflation caused by the financial crisis forced the Fed to lower the interest rates.

Question 35

Active economic policies are more likely to destabilize the economy if:

A) the wage- price spiral is downward sloping.
B) policy lags are short.
C) Say's law prevails.
D) the wage- price adjustment is quick enough.

Question 36

Whenever the unemployment rate is pushed _______ the natural rate, wages begin to _______ , thus pushing _______.

A) below; fall; down costs
B) above; rise; up costs
C) above; fall; down aggregate output
D) above; fall; down costs

Question 37

When the economy is in a liquidity trap, one way to get the economy out of a recession is to:

A) increase taxes.
B) increase government expenditures.
C) contract the money supply.
D) expand the money supply.

Question 38

Figure 15.2
Refer to Figure 15.2. If the economy is currently at Point D producing output level Y₂:

A) aggregate supply shifts to the left and the economy ends up at Point E.
B) the economy is operating above full employment.
C) input prices are likely to fall eventually.
D) the economy will experience inflation.

Question 39

The adjustment- process model used in this chapter, which highlights the speed at which the economy goes back to potential GDP, was first developed by:

A) Milton Friedman.
B) Modigliani and Patinkin.
C) Keynes.
D) Say

Question 40

If left alone, the recession experienced by an economy will cause the short- run

A) aggregate demand curve to shift downward until the equilibrium GDP is back at full employment.
B) aggregate supply curve to shift upward until the equilibrium GDP is back at full employment.
C) aggregate supply curve to shift downward until the equilibrium GDP is back at full employment.
D) aggregate demand curve to shift upward until the equilibrium GDP is back at full employment.

Question 41

According to Keynes, the level of employment is determined by:

A) price and wages.
B) technological progress.
C) interest rates.
D) the level of aggregate demand for goods and services.

Question 42

Figure 15.2
Refer to Figure 15.2. If the economy is currently producing at point A and the Fed decreases the money supply, the economy will move to Point _______ in the short run and to Point _______ in the long run.

A) E; D
B) D; E
C) C; B
D) B; C

Question 43

Recall Application 2, "Elections, Political Parties, and Voter Expectations," to answer the following questions:
According to the application, economic growth is expected to be _______ when a _______ is president.

A) higher; Democrat
B) higher; Libertarian
C) higher; Republican
D) lower; Democrat

Question 44

Recall Application 3, "Increasing Health-Care Expenditures and Crowding Out," to answer the following questions:
According to the application, health- care expenditures as a proportion of GDP has risen from 1950- 2000 from:

A) 5.4% - 9.2%.
B) 5.2% - 15.4%.
C) 2.3% - 5.2 %.
D) 23.9%- 51.3%.

Question 45

If the investment curve is steep (i.e., investment is less sensitive to changes in the real interest rate), then an increase in government spending by $100 billion will cause:

A) a decrease in investments larger than $100 billion.
B) a decrease in investments equal to $100 billion.
C) an increase in investments equal to $100 billion.
D) an increase in investments larger than $100 billion.

Question 46

Which of the following sequence of events follows an increase in taxes?

A)
B)
C)
D)

Question 47

When the economy is not at full employment, which component of GDP adjusts automatically in the long run to bring the economy back to full employment?

A) consumption
B) net exports
C) government spending
D) investment

Question 48

Recall Application 2, "Elections, Political Parties, and Voter Expectations," to answer the following questions:
Does the performance of the economy in 2007 support the theory expressed in the application?

A) Yes, the president was a Democrat, and the economy is slumping.
B) Yes, the president was a Republican and the inflation is low.
C) Yes, the president was a Democrat, and the economy is growing fast.
D) Yes, the president was a Republican and the economy is growing fast.

Question 49

In order to shorten a recession when the economy is producing below full employment, the monetary authority could:

A) expand the money supply.
B) raise taxes in order to close the budget deficit.
C) contract the money supply.
D) decrease government spending.

Question 50

If wages are sticky downward, an increase in labor:

A) supply increases the wage rate.
B) demand decreases the wage rate.
C) demand increases the wage rate.
D) none of the above

Question 51

Because the long- run aggregate supply curve is vertical, firms will produce all they can in the long run

A) when the price level is high.
B) at any given price level.
C) when the price level is moving downwards.
D) when the price level is low.

Question 52

The long- run aggregate supply curve is vertical because:

A) prices are sticky in the long run.
B) the labor market is always in shortage.
C) wages are flexible and they always change quickly to clear the labor market.
D) unemployment exists.

Question 53

In macroeconomics, the "long run" denotes the time period:

A) within the same fiscal year.
B) when all prices fully adjust.
C) when some prices are sticky.
D) less than one year.

Question 54

A situation where expansionary monetary policies are ineffective because nominal interest rates are already low is called:

A) a liquidity drop.
B) a liquidity trap.
C) a illiquidity drop.
D) an illiquidity trap.

Question 55

The reduction in investment demand that results when an expansionary fiscal policy raises the real interest rate is called the:

A) multiplier effect.
B) accelerator effect.
C) crowding- out effect.
D) Ricardian effect.

Question 56

If the equilibrium output exceeds potential output:

A) inflation usually increases.
B) aggregate demand increases.
C) unemployment rises.
D) the price level decreases.

Question 57

Those who believed in Say's Law believe that saving will:

A) cause the economy to have more spending than production.
B) find its way to investors and ultimately will also be spent.
C) never be spent.
D) cause the economy to have more production than spending.

Question 58

Increased government spending will not cause investments to not drop as much if:

A) the Fed does not change the money supply when the government increases government spending.
B) the Fed increases the money supply at the same time the federal government increases government spending.
C) business firms become pessimistic about the future.
D) the Fed decreases the money supply at the same time the federal government increases government spending.

Question 59

When generating a political business cycle, a politician chooses lower unemployment in the _______ over inflation and crowding out in the _______.

A) short run; long run
B) long run; long run
C) long run; short run
D) short run; short run

Question 60

Monetary neutrality implies that a decrease in the money supply will:

A) not affect the price level.
B) increase real GDP.
C) decrease real interest rates.
D) not affect unemployment.

Question 61

AN UNFORTUNATE GAMBLE
What explained the decision by the Japanese government to increase taxes in the 1990s when the economy
was still suffering from a recession?
The Japanese government sharply increased taxes on consumption in 1997—just as Japan was in the midst of its prolonged
recession. Why did the government do this?
The reasons were clear. As the economy slumped, fiscal deficits were increasing, as taxes fell and government spending rose.
Policy makers understood that their society was aging rapidly and that this would mean even more demands on the public
sector in the near future. They became convinced that the current fiscal deficits plus the inevitable future demands on the
government would lead to long-run increases in government spending. To avoid crowding out of investment in the future,
they decided to tax consumption in order to reduce it. Their goal was to match the increases in government spending with
decreases in consumption spending and therefore not experience crowding out of investment.
Although policy makers were right to consider the long-run consequences of increases in government spending, they made
the unfortunate gamble that the short-run effects of the tax increase would not hinder the economy’s recovery. They were
wrong, because the tax increase prolonged the recession. Although it is important to consider the long-run consequences of
policy, it is important to understand the short-run consequences as well.
According to the application, what was the Japanese government's gamble?

A) They imposed a tax on consumption, but hoped that it did not interfere with the economy's net import sector.
B) They imposed a tax on investment, but hoped that it did not interfere with the economy's recovery.
C) They imposed a tax on consumption, but hoped that it did not interfere with the economy's recovery.
D) They imposed a tax on consumption, but hoped that it did not interfere with the economy's inflation rate.

Question 62

In the long run, the level of output:

A) depends on the price level.
B) depends on the money supply.
C) is determined by the supply of resources and the level of technological progress.
D) all of the above

Question 63

In the long run:

A) real GDP is determined by the aggregate supply.
B) increases in the supply of money lead to increases in real GDP.
C) prices are sticky.
D) real GDP is completely demand- determined.

Question 64

Suppose the economy is at full employment. An increase in the money supply will _______ in the short run and _______ in the long run.

A) increase investment, increase investment
B) increase investment, leave investment unchanged
C) decrease investment, decrease investment
D) leave investment unchanged, leave investment unchanged

Question 65

Monetary neutrality implies that an increase in the money supply will:

A) increase the price level.
B) increase real interest rates.
C) lower real GDP.
D) lower the unemployment rate.

Question 66

In order for the long- run neutrality of money to hold, an increase in money supply must cause:

A) the money demand curve to shift upwards enough to raise the interest rate.
B) the money demand curve to shift down to keep the interest rate constant.
C) the money demand curve to shift downwards enough to lower the interest rate.
D) the money demand curve to shift up to keep the interest rate constant.

Question 67

The term "classical economics" was first used by _______ to refer to economic literature developed in the _______.

A) Paul Samuelson; 19th and early 20th centuries.
B) Adam Smith; 16th and 17th centuries.
C) Keynes; 18th and 19th centuries.
D) David Ricardo; 17th and 18th centuries.

Question 68

When an incumbent politician uses expansionary fiscal and monetary policy to increase the chance of re- election, that politician is generating a/an:

A) political dynasty.
B) political business cycle.
C) a sociological depression.
D) economically sound campaign.

Question 69

One possible explanation for the existence of unemployment is:

A) that the wage does not adjust immediately to changes in labor demand.
B) the quantity of labor is sticky downward and does not adjust to an increase in wages.
C) the labor market is perfectly competitive.
D) labor supply always shifts in such a way as to lead to unemployment.

Question 70

Recall Application 1, "Avoiding a Liquidity Trap," to answer the following questions:
Which of the following is the warning sign that the economy was facing a looming liquidity trap?

A) The short- term interest rates were already at 0.5 percent.
B) The 30- year mortgage rate was approaching 5 percent.
C) The US national debt was approaching $10 trillion.
D) The bank reserves were approaching zero percent.

Question 71

What causes investments to increase when the production in the economy is below full employment?

A) When the economy is below full employment, the price level drops, resulting in a decrease in the demand for money and a decrease in interest rates.
B) When the economy is below full employment, the price level rises, resulting in an increase in the demand for money and a decrease in interest rates.
C) When the economy is below full employment, the price level drops, resulting in an increase in the demand for money and an increase in interest rates.
D) When the economy is below full employment, the price level drops, resulting in a decrease in the demand for money and an increase in interest rates.

Question 72

Figure 15.2
Refer to Figure 15.2. Suppose the economy is currently at Point A producing potential output Y₀. If the government increases spending, the economy moves to Point _______ in the short- run and to Point _______ in the long- run.

A) B; C
B) C; B
C) B; D
D) D; E

Question 73

Which of the following curves is illustrated as an upward sloping line?

A) the long- run aggregate demand curve
B) the short- run aggregate supply curve
C) the long- run aggregate supply curve
D) the short- run aggregate demand curve

Question 74

For crowding out to occur in the long run, an increase in government spending must cause the money demand curve to _______ in order to _______ the interest rate.

A) downwards; decrease
B) downwards; have no effect
C) upwards; increase
D) upwards; have no effect

Question 75

Refer to Figure 15.3. At full employment equilibrium, investment would increase from $10 million to $15 million if:

A) the government increases taxes.
B) the Fed sells bonds in the open market.
C) the government increases government spending.
D) both B and C

Question 76

_______ are the largest cost of production for most firms.

A) Depreciation
B) Rent
C) Interest payments
D) Wages

Question 77

The concept of "market clearing" is adopted and defended by:

A) fine- tuning economists.
B) Keynesian economists.
C) demand- side economists.
D) classical economists.

Question 78

If Say's Law holds true, then if households save more of their incomes,

A) the economy will experience a recession.
B) firms will increase spending by the same amount.
C) the government will increase taxes on savings to discourage it.
D) government spending will increase.

Question 79

Friedman and Keynes:

A) disagreed on how the Fed changes money supply.
B) agreed on the short- run impact of monetary policy.
C) disagreed on the speed at which wages change.
D) agreed on the impact of fiscal policy on the economy.

Question 80

The Keynesian aggregate supply curve is:

A) vertical.
B) downward sloping.
C) horizontal.
D) upward sloping.