Deck 14: Aggregate Demand, aggregate Supply, and Monetary Policy

Question 1

Figure 14.1

Refer to Figure 14.1.Other things equal,an increase in the Bank of Canada's concern about deviations of inflation from the target inflation rate is best represented as a movement from

A) point X to point Z.
B) point Z to point X.
C) point Z to point Y.
D) point Y to point X.

Answer 1

D

Question 2

Use a graph to show the differences in the central bank reaction function if the Bank of Canada is more tolerant or less tolerant of deviations from inflation in the short run.

Answer 2

If the central bank reaction function is relatively flat,as is represented by Central bank reaction function₁,the Bank of Canada is more tolerant of deviations from inflation in the short run,and therefore will change the interest rate by a smaller amount in response to the deviation between the current inflation rate and the target inflation rate.
If the central bank reaction function is relatively steep,as is represented by Central bank reaction function₂,the Bank of Canada is less tolerant of deviations from inflation in the short run,and therefore will change the interest rate by a larger amount in response to the deviation between the current inflation rate and the target inflation rate.

Question 3

The slope of the aggregate demand curve indicates that ________ in the inflation rate leads to ________ of real GDP demanded by households and firms.

A) an increase; a higher level
B) a decrease; a lower level
C) a decrease; a higher level
D) an increase; no change in the level

Answer 3

C

Question 4

Figure 14.1

Refer to Figure 14.1.Other things equal,an increase in the inflation rate is best represented as a movement from

A) point A to point B.
B) point C to point A.
C) point C to point B.
D) point B to point C.

Question 5

Figure 14.1

Refer to Figure 14.1.Assume that the economy is originally in equilibrium where real GDP equals potential GDP.Other things equal,an increase in government purchases would best be represented as a movement from ________ in the short run and from ________ in the long run.

A) point Y to point X; point X to point Z
B) point Y to point X; point X to point Y
C) point Y to point Z; point Z to point X
D) point Z to point X; point X to point Z

Question 6

An increase in the inflation rate results in ________ in the quantity of real GDP demanded because a higher price level ________.

A) an increase; increases consumption and investment
B) a decrease; increases consumption and investment
C) a decrease; reduces consumption and investment
D) an increase; reduces consumption and investment

Question 7

Figure 14.1

Refer to Figure 14.1.Other things equal,a decrease in taxes is best represented as a movement from

A) point Y to point Z.
B) point Z to point X.
C) point Z to point Y.
D) point Y to point X.

Question 8

Figure 14.1

Refer to Figure 14.1.Other things equal,an increase in transfer payments is best represented as a movement from

A) point A to point B.
B) point B to point A.
C) point C to point A.
D) point B to point C.

Question 9

Figure 14.1

Refer to Figure 14.1.Other things equal,if the Canadian dollar increases in value relative to other currencies,this is best represented as a movement from

A) point X to point Y.
B) point X to point Z.
C) point Y to point Z.
D) point Y to point X.

Question 10

In general,a formula that a central bank uses to set interest rates in response to changing economic conditions is called a

A) rate-of-return equation.
B) Taylor rule.
C) central bank reaction function.
D) market adaptation identity.

Question 11

Shifts in the IS curve ________ the AD curve,and changes to the reaction function ________ the AD curve.

A) cause a movement along; shift
B) shift; cause a movement along
C) temporarily shift; permanently shift
D) permanently shift; temporarily shift

Question 12

For each of the following scenarios,state the short-run effect on the AD curve.
a. The price level decreases.
b. The target inflation rate increases.
c. The Canadian dollar falls in value relative to other currencies.
d. Government spending increases.
e. The Bank of Canada becomes more tolerant of deviations from the target inflation rate.

Question 13

Figure 14.1

Refer to Figure 14.1.Assume that the economy is originally in equilibrium where real GDP equals potential GDP.Other things equal,an increase in the target inflation rate would best be represented as a movement from ________ in the short run and ________ in the long run.

A) point Y to point X; point X to point Y
B) point Y to point X; will remain at point X
C) point Y to point Z; remain at point Z
D) point Z to point X; point X to point Z

Question 14

If the Bank of Canada increases the real interest rate as a response to a decrease in the inflation rate,the ________,which results in a ________.

A) MP curve shifts up; movement down the AD curve
B) MP curve shifts up; movement up the AD curve
C) IS curve shifts up; movement down the AD curve
D) IS curve shifts up; movement up the AD curve

Question 15

The steeper the central bank reaction function,the ________ the central bank increases the interest rate in response to the current inflation rate being above the target inflation rate and the ________ the central bank decreases the interest rate in response to the actual inflation rate being below the target inflation rate.

A) more; more
B) more; less
C) less; more
D) less, less

Question 16

Figure 14.1

Refer to Figure 14.1.Other things equal,an increase in government spending on infrastructure projects is best represented as a movement from

A) point X to point Y.
B) point Z to point X.
C) point Z to point Y.
D) point Y to point X.

Question 17

Figure 14.1

Refer to Figure 14.1.Other things equal,which of the following will cause a movement from point Y to point X?

A) an increase in the real interest rate
B) a decrease in disposable income
C) a decrease in expected profits for firms
D) an increase in net exports

Question 18

Figure 14.1

Refer to Figure 14.1.Other things equal,a decrease in government spending on infrastructure projects is best represented as a movement from

A) point A to point B.
B) point C to point A.
C) point C to point B.
D) point B to point C.

Question 19

If the Bank of Canada focuses on price stability,the aggregate demand curve will be relatively ________,which shows that aggregate expenditure is ________ to changes in the inflation rate.

A) flat; very sensitive
B) flat; very insensitive
C) steep; very sensitive
D) steep; very insensitive

Question 20

Other things equal,if the central bank raises the target inflation rate,this would result in the

A) AD curve shifting temporarily to the right.
B) AD curve shifting permanently to the right.
C) AS curve shifting temporarily to the left.
D) AS curve shifting permanently to the left.

Question 21

A combination of high inflation and recession,usually resulting from a supply shock,is known as

A) hyperinflation.
B) disinflation.
C) stagflation.
D) depression.

Question 22

Suppose the Bank of Canada announced that it has chosen to accept a temporary period of above-target inflation.Assuming that the announcement is seen as credible,this will tend to increase inflationary expectations,which will result in

A) the AD curve shifting to the right.
B) the AD curve shifting to the left.
C) the AS curve shifting to the right.
D) the AS curve shifting to the left.

Question 23

Figure 14.2

Refer to Figure 14.2.Other things equal,technological innovation would best be represented by a movement from

A) point A to point B.
B) point B to point A.
C) point C to point B.
D) point B to point C.

Question 24

The short-run effect of a negative supply shock is

A) lower inflation and a declining output gap.
B) lower inflation and an increasing output gap.
C) higher inflation and a declining output gap.
D) higher inflation and an increasing output gap.

Question 25

Explain why some shifts to the aggregate demand curve are temporary and why some are permanent.

Question 26

Figure 14.2

Refer to Figure 14.2.Other things equal,an increase in the expected price of an important natural resource would best be represented by a movement from

A) point A to point B.
B) point B to point A.
C) point B to point C.
D) point A to point C.

Question 27

Figure 14.2

Refer to Figure 14.2.Hurricane Katrina was responsible for destroying a large portion of oil and natural gas refining capacity on the Gulf coast in 2005.Other things equal,this would best be represented by a movement from

A) point A to point B.
B) point B to point A.
C) point B to point C.
D) point A to point C.

Question 28

If the central bank is facing the zero bound constraint and announces a higher inflation target,

A) the real interest rate will increase, which will decrease aggregate expenditure.
B) the real interest rate will decrease, which will increase aggregate expenditure.
C) the nominal interest rate will increase, which will decrease aggregate expenditure.
D) the nominal interest rate will decrease, which will increase aggregate expenditure.

Question 29

For each of the following scenarios,state the short-run effect on the AS curve.
a. The price level decreases.
b. Lower inflation is expected in the future.
c. Worker productivity declines.
d. Oil prices increase.
e. The size of the labour force decreases.

Question 30

The economy is in long-run equilibrium when ________ and ________.

A) real GDP equals potential GDP; the unemployment rate equals zero
B) the output gap equals zero; the inflation rate equals the target inflation rate and the expected inflation rate
C) the output gap is at its maximum; the inflation rate equals the target inflation rate and the expected inflation rate
D) the unemployment rate equals the natural rate of unemployment; the inflation rate equals zero

Question 31

Figure 14.3

Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the Bank of Canada increases the target inflation rate,and to hit this rate,it must reduce the real interest rate.This is best represented by an initial movement from

A) point A to point B.
B) point A to point D.
C) point A to point C.
D) point B to point C.

Question 32

Figure 14.2

Refer to Figure 14.2.Suppose workers expect inflation to rise from 1% to 3% next year.Other things equal,this would best be represented by a movement from

A) point A to point B.
B) point B to point A.
C) point B to point C.
D) point A to point C.

Question 33

The aggregate supply curve shows the total quantity of output that firms are willing and able to supply at a given inflation rate.This is the same relationship that is shown by the

A) aggregate expenditure curve.
B) Phillips curve.
C) MP curve.
D) IS curve.

Question 34

When the economy responds to a supply shock,there is ________ in the short run and ________ in the long run between inflation and unemployment

A) an inverse relationship; no trade-off
B) no trade-off; an inverse relationship
C) an inverse relationship; an inverse relationship
D) no trade-off; no trade-off

Question 35

Figure 14.2

Refer to Figure 14.2.Other things equal,a decrease in inflationary expectations would best be represented by a movement from

A) point A to point B.
B) point B to point A.
C) point C to point B.
D) point B to point C.

Question 36

Figure 14.2

Refer to Figure 14.2.Suppose that,due to a recession,foreign workers begin to leave Canada to search for work in their home countries.Other things equal,this would best be represented in Canada by a movement from

A) point A to point B.
B) point B to point A.
C) point B to point C.
D) point A to point C.

Question 37

Figure 14.2

Refer to Figure 14.2.Other things equal,an increase in worker productivity would best be represented by a movement from

A) point A to point B.
B) point B to point A.
C) point C to point A.
D) point C to point B.

Question 38

Explain the relationship between the aggregate supply curve and the Phillips curve.

Question 39

Other things equal,a decrease in the price level will

A) shift the AS curve to the left.
B) shift the AS curve to the right.
C) cause a movement up the AS curve.
D) cause a movement down the AS curve.

Question 40

Figure 14.2

Refer to Figure 14.2.Other things equal,a movement from point C to point B would be caused by

A) an increase in the price level.
B) a decrease in the price level.
C) a positive supply shock.
D) a negative supply shock.

Question 41

Assume the economy is initially in equilibrium with real GDP equal to potential GDP and the inflation rate at its target.Use the aggregate demand and aggregate supply model to analyze the short-run and long-run effects on real GDP and inflation when the economy experiences a positive demand shock.

Question 42

Suppose the economy is initially in equilibrium where real GDP equals potential GDP and the inflation rate is at the target rate.Other things equal,a housing boom will cause aggregate expenditures to increase,which will result in a new,short-run equilibrium.To return GDP to its potential level,the inflation rate will adjust.With adaptive expectations,this moves the economy to another new short-run equilibrium point.Since the housing boom is temporary,the end of the housing boom will now cause

A) a decrease in aggregate demand and an increase in the inflation rate.
B) a decrease in aggregate supply and an increase in the inflation rate.
C) a decrease in aggregate demand and a decrease in the inflation rate.
D) a decrease in aggregate supply and a decrease in the inflation rate.

Question 43

What is stagflation,and how does it occur? How is stagflation represented in the aggregate demand-aggregate supply model?

Question 44

Suppose the Bank of Canada has a target inflation rate of 3%,always hits its target,and the inflation rate has been 3% for several years.Furthermore,assume Amazon sets the price of its Kindle Fire at $140 in 2012 and wants to keep the real price of the Kindle constant in order to maximize profits.Now suppose that the Bank of Canada announces on January 1,2013 that it will decrease its target rate for inflation to 1%.The profit-maximizing price for the Kindle in 2013 will be

A) $137.20.
B) $140.00.
C) $141.40.
D) $144.20.

Question 45

Suppose the economy is initially in equilibrium where real GDP equals potential GDP and the inflation rate is at the target rate.Other things equal,a housing boom will cause aggregate expenditures to increase,which will result in

A) an increase in aggregate demand and an increase in the inflation rate.
B) an increase in aggregate supply and an increase in the inflation rate.
C) an increase in aggregate demand and a decrease in the inflation rate.
D) an increase in aggregate supply and a decrease in the inflation rate.

Question 46

Figure 14.3

Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the economy experiences a demand shock such as a stock market crash.Other things equal,following the effect of the stock market crash,the economy will ultimately end up at a new long-run equilibrium ________ the initial long-run equilibrium.

A) that is the same as
B) with a higher real GDP and a higher inflation rate than
C) with a higher real GDP than, and the same inflation rate as
D) with a higher inflation rate than, and the same real GDP as

Question 47

Figure 14.3

Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the Bank of Canada increases the target inflation rate,and to hit this rate,it must reduce the real interest rate.The economy then reaches a new,short-run equilibrium point.Assuming expectations are adaptive,the next movement is best represented as a movement from

A) point C to point B.
B) point C to point A.
C) point D to point C.
D) point B to point C.

Question 48

By announcing a higher inflation target,a central bank can

A) permanently increase real GDP and permanently decrease the unemployment rate.
B) temporarily increase real GDP and permanently decrease the unemployment rate.
C) permanently increase real GDP and temporarily decrease the unemployment rate.
D) temporarily increase real GDP and temporarily decrease the unemployment rate.

Question 49

Figure 14.3

Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the economy experiences a demand shock such as a stock market crash.The economy then reaches a new,short-run equilibrium point.Assuming expectations are adaptive,this will allow the central bank to decrease the real interest rate,moving the economy to a another new equilibrium point.The stock market crash is temporary,so as the economy works its way back to long-run equilibrium,real GDP will increase.As the expected rate of inflation changes,the economy will move from

A) point A to point C.
B) point D to point C.
C) point A to point D.
D) point B to point C.

Question 50

Figure 14.3

Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the economy experiences a demand shock such as a stock market crash.The economy then reaches a new,short-run equilibrium point.Assuming expectations are adaptive,this will allow the central bank to decrease the real interest rate,moving the economy to another new equilibrium point.The stock market crash is temporary,so the next movement on the path to the long-run equilibrium will be from

A) point A to point B.
B) point A to point C.
C) point A to point D.
D) point B to point C.

Question 51

Suppose the economy is initially in equilibrium where real GDP equals potential GDP and the inflation rate is at the target rate.Other things equal,a housing boom will cause aggregate expenditures to increase,which will result in a new,short-run equilibrium.To return GDP to its potential level,the inflation rate will adjust.With adaptive expectations,this will result in

A) an increase in aggregate demand and an increase in the inflation rate.
B) a decrease in aggregate supply and an increase in the inflation rate.
C) a decrease in aggregate demand and a decrease in the inflation rate.
D) an increase in aggregate supply and a decrease in the inflation rate.

Question 52

Suppose the Bank of Canada has a target inflation rate of 3%,always hits its target,and the inflation rate has been 3% for several years.Furthermore,assume Amazon sets the price of its Kindle Fire at $140 in 2012 and wants to keep the real price of the Kindle constant in order to maximize profits.Now suppose that the Bank of Canada announces on January 1,2013 that it will decrease its target rate for inflation to 1%.If Amazon has adaptive expectations,it will set its price for the Kindle in 2013 at

A) $137.20.
B) $140.00.
C) $141.40.
D) $144.20.

Question 53

Figure 14.3

Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the Bank of Canada increases the target inflation rate,and to hit this rate,it must reduce the real interest rate.The economy then reaches a new,short-run equilibrium point.Assuming expectations are adaptive,the next movement will result in the inflation rate

A) rising to π₂, the new long-run inflation rate.
B) falling to π₂, the new long-run inflation rate.
C) rising to π₃, the new long-run inflation rate.
D) falling back to π₁, the original long-run inflation rate.

Question 54

Assume the economy is initially in equilibrium with real GDP equal to potential GDP and the inflation rate at its target.Use aggregate demand and aggregate supply graphs to show the short-run and long-run effects of a sudden increase in the price of oil,with the Bank of Canada following its reaction function.Explain what is happening in each graph.

Question 55

Figure 14.3

Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the Bank of Canada increases the target inflation rate,and to hit this rate,it must reduce the real interest rate.The economy then reaches a new,short-run equilibrium point.Assuming expectations are adaptive,the next movement will result in real GDP

A) decreasing back to potential GDP.
B) increasing beyond potential GDP.
C) increasing back to potential GDP.
D) declining below potential GDP.

Question 56

Suppose the economy is initially in equilibrium where real GDP equals potential GDP and the inflation rate is at the target rate.Other things equal,a housing boom will cause aggregate expenditures to increase,which will result in a new,short-run equilibrium.To return GDP to its potential level,the inflation rate will adjust.With adaptive expectations,this moves the economy to another new short-run equilibrium point.Since the housing boom is temporary,the end of the housing boom will move the economy to yet another new equilibrium point.From this point,since expectations are adaptive,the economy will experience ________ as it moves back to long-run equilibrium.

A) a decrease in aggregate demand and an increase in the inflation rate
B) an increase in aggregate supply and an increase in the inflation rate
C) a decrease in aggregate demand and a decrease in the inflation rate
D) an increase in aggregate supply and a decrease in the inflation rate

Question 57

Figure 14.3

Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the economy experiences a demand shock such as a stock market crash.This is best represented by an initial movement from

A) point C to point A.
B) point C to point B.
C) point C to point D.
D) point D to point A.

Question 58

Figure 14.3

Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the Bank of Canada increases the target inflation rate,and to hit this rate,it must reduce the real interest rate.The economy then reaches a new,short-run equilibrium point.Assuming expectations are adaptive,the next movement will result in the economy reaching a new,long-run equilibrium at

A) point A.
B) point B.
C) point C.
D) point D.

Question 59

Figure 14.3

Refer to Figure 14.3.Suppose the economy is initially at long-run equilibrium and the economy experiences a demand shock such as a stock market crash.The economy then reaches a new,short-run equilibrium point.Assuming expectations are adaptive,this will allow the central bank to decrease the real interest rate,so the next movement is best represented as a movement from

A) point B to point D.
B) point D to point B.
C) point C to point D.
D) point D to point A.

Question 60

Suppose the Bank of Canada has a target inflation rate of 3%,always hits its target,and the inflation rate has been 3% for several years.Furthermore,assume Amazon sets the price of its Kindle Fire at $140 in 2012 and wants to keep the real price of the Kindle constant in order to maximize profits.Now suppose that the Bank of Canada announces on January 1,2013 that it will decrease its target rate for inflation to 1%.If Amazon has rational expectations,it will set its price for the Kindle in 2013 at

A) $137.20.
B) $140.00.
C) $141.40.
D) $144.20.

Question 61

There is no trade-off between inflation and unemployment when expectations are ________ and policy changes are ________.

A) adaptive; anticipated
B) adaptive; unanticipated
C) rational; anticipated
D) rational; unanticipated

Question 62

If the economy experiences an unanticipated demand shock and households and firms have rational expectations,there is

A) no trade-off between unemployment and inflation in either the short run or the long run.
B) a trade-off between unemployment and inflation in the long run, but not in the short run.
C) a trade-off between unemployment and inflation in the short run, but not in the long run.
D) a trade-off between unemployment and inflation in both the short run and the long run.

Question 63

Many economists believe the central banks were in large part responsible for bringing about the Great Moderation,especially by the focus of the Bank of Canada and the Federal Reserve on

A) monetary policy.
B) low and stable inflation.
C) discretionary rules.
D) targeting unemployment.

Question 64

Explain the difference between the Bank of Canada following discretionary policy as opposed to following a rules strategy.

Question 65

If a policy change by the Bank of Canada is ________,then the change in policy has exactly the same result on the economy as it does when we assume that households and firms have adaptive expectations.

A) unannounced or not credible
B) unannounced or credible
C) announced or credible
D) announced or not credible

Question 66

Assume that the Bank of Canada has a target inflation rate of 2% and that the values for how much the nominal target overnight rate responds to a deviation of inflation from its target,g,and how much the nominal target overnight rate responds to real GDP,h,are both 0.5.According to the Taylor rule,if inflation decreases by 2%,the real interest rate will decrease by

A) 1%.
B) 2%.
C) 3%.
D) 4%.

Question 67

A study by economists at the International Monetary Fund compared increases in inflation rates in countries with and without specific inflation targets based on the surge in oil prices in 2007.The results provide

A) no evidence that countries with specific inflation targets were any better off than countries without specific inflation targets.
B) evidence that countries with specific inflation targets actually experienced greater increases in inflation than did countries without specific inflation targets.
C) evidence that countries with specific inflation targets did experience lower increases in inflation than did countries without specific inflation targets.
D) evidence that countries with specific inflation targets experienced no increases in inflation, whereas countries without specific inflation targets experienced significant increases in inflation.

Question 68

The Fed (which is the central bank in the U.S.)greatly increased the monetary base in 2009 and 2010 by purchasing assets in an attempt to boost the economy,while making it known that they intended on selling these assets once the economy showed signs of stability,and at the same time keep a watchful eye on possible inflation.The Fed's inflation expectations would most likely be considered as ________,and the Fed was able to increase the monetary base without causing expected inflation to increase because their intentions and statements were generally considered ________.

A) adaptive; not credible
B) adaptive; credible
C) rational; not credible
D) rational; credible

Question 69

Assume that the Bank of Canada has a target inflation rate of 2% and that the values for how much the nominal target overnight rate responds to a deviation of inflation from its target,g,and how much the nominal target overnight rate responds to real GDP,h,are both 0.5.According to the Taylor rule,if inflation increases by 6%,the real interest rate will increase by

A) 3%.
B) 4%.
C) 6%.
D) 9%.

Question 70

What are rational expectations,and how might rational expectations make monetary policy ineffective?

Question 71

Assume that the Bank of Canada has a target inflation rate of 2% and that the values for how much the nominal target overnight rate responds to a deviation of inflation from its target,g,and how much the nominal target overnight rate responds to real GDP,h,are both 0.5.According to the Taylor rule,if inflation increases by 6%,the Bank of Canada should increase the target nominal overnight rate by

A) 3%.
B) 4%.
C) 6%.
D) 9%.

Question 72

Suppose the central bank announces that it will permanently increase the inflation rate and there is central bank credibility.With adaptive expectations,expectations of inflation will adjust ________,and with rational expectations,expectations of inflation adjust ________.

A) slowly; slowly
B) slowly; immediately
C) immediately; immediately
D) immediately; slowly

Question 73

The Taylor rule is most suitable to study the behaviour of a central bank with the dual mandate of

A) stable exchange rates and price stability.
B) price stability and maximum sustainable employment.
C) financial market stability and stable exchange rates.
D) maximum sustainable employment and financial market stability.

Question 74

What are the primary arguments in favour of a rules approach,and what are the primary arguments in favour of a discretionary approach?

Question 75

Assume that the Bank of Canada has a target inflation rate of 2% and that the values for how much the nominal target overnight rate responds to a deviation of inflation from its target,g,and how much the nominal target overnight rate responds to real GDP,h,are both 0.5.According to the Taylor rule,if inflation decreases by 2%,the Bank of Canada should decrease the target nominal overnight rate by

A) 0%.
B) 2%.
C) 3%.
D) 4%.