1 of 21 10/18/2013 1:22 PM

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1 1 of 21 10/18/2013 1:22 PM The study of aggregate economic activity for the economy as a whole is Opportunity cost. Scarcity. Macroeconomics. Microeconomics. In macroeconomics, the focus is on the big picture how the economy is affected by various events. Learning Objective: The major macro outcomes and their determinants. Alternating periods of economic growth and contraction in real GDP define Capitalism. The business cycle. Macro equilibrium. Say's Law. The business cycle is a repetition of expansion followed by contraction, then expansion again. Learning Objective: The major macro outcomes and their determinants. Unlike the classical economists, Keynes asserted that The economy was inherently unstable. Laissez faire policies would lead to macro equilibrium. Prices and wages were flexible. Markets would naturally self-adjust. The Keynesian model holds that the government should intervene to ensure stability. Learning Objective: Why the debate over macro stability is important.

2 2 of 21 10/18/2013 1:22 PM A recession can be represented by a point Inside the production possibilities curve. Outside the production possibilities curve. On the production possibilities curve. At either end of the production possibilities curve. During a recession, the underutilized resources cause the economy to be operating below its production possibilities curve. Learning Objective: The major macro outcomes and their determinants. Which of the following was not true for the U.S. economy during the period from the late 1990s to 2000? Economic expansion set a record for longevity. The unemployment rate was low. Millions of new jobs were created. Real GDP declined. Real GDP expanded for a record number of months during the 1990s to Learning Objective: The major macro outcomes and their determinants. Which of the following is illustrated by the aggregate demand curve? How real personal income varies with the inflation rate. How total quantity of output demanded varies with the average price level. How real output varies with the inflation rate. How real personal income varies with the price level. The aggregate demand curve shows the relationship between the price level and the total amount of real output demanded in the economy. Learning Objective: The nature of aggregate demand (AD) and aggregate supply (AS).

3 3 of 21 10/18/2013 1:22 PM Assume you have $2,000 in a savings account at the beginning of the year and the price level is equal to 100. If the price level is equal to 95 at the end of the year, the real value of your savings is closest to $1,900. $1,905. $2,095. $2,105. Take the nominal savings balance of $2,000 and divide it by the new price level over the old price level; this results in an answer close to $2,105. The real value of the money will be worth $2,000 (95 100) or approximately $2,105. Difficulty: 3 Hard Learning Objective: The nature of aggregate demand (AD) and aggregate supply (AS). A positively sloped aggregate supply curve reflects The idea that greater production lowers profit margins, which raises quantity demanded. The decrease in the real value of money as the price level rises. The rising costs associated with increased capacity utilization. None or the other choices. As resources become fully utilized, inflationary pressures develop as competition for the resources ensues; this leads to a higher price level being required for firms to produce higher levels of output. Learning Objective: The nature of aggregate demand (AD) and aggregate supply (AS). The cost effect implies that Higher costs are reflected in higher average prices. The aggregate supply curve is linear. Lower average prices result in greater quantity supplied. The aggregate demand curve is downward-sloping. This is because competition for resources that are being fully utilized creates inflationary pressure. Learning Objective: The nature of aggregate demand (AD) and aggregate supply (AS).

4 4 of 21 10/18/2013 1:22 PM If aggregate demand decreases and aggregate supply decreases, the level of real output will Decrease, and the price level will definitely decrease. Decrease, and the price level will definitely increase. Either increase or decrease, but the price level will stay the same. Decrease, but the price level is indeterminate. Since both the aggregate demand and aggregate supply curves shift to the left, the output, which is on the horizontal axis, must be lower; but the price level could rise, fall, or stay the same depending on the relative changes in aggregate demand and aggregate supply. Alternating periods of economic growth and contraction are The result of government intervention according to Keynes. The result of recurrent shifts of aggregate demand and aggregate supply. Indicative of an unstable economy and require government intervention according to classical economists. Not typical of the U.S. economy. A shift in either aggregate demand or aggregate supply could put the new macro equilibrium below the level of full employment. Ceteris paribus, the price level will decrease if the aggregate Supply curve shifts to the left. Demand curve shifts to the left. Demand curve shifts to the right. Supply and demand curves both shift to the right. If aggregate demand decreases, people are purchasing less. So surpluses build up, thereby leading to a falling price level.

5 5 of 21 10/18/2013 1:22 PM Which of the following economic perspectives focuses on the need for government to shift aggregate supply to correct problems of unemployment and inflation? Supply-side. Keynesian. Classical. Monetary. If aggregate supply intersects aggregate demand at a level below full employment, tax cuts could shift the aggregate supply curve to the right and restore full employment. Supply-side economists prefer using levers that impact aggregate supply, versus Keynesian economists, who prefer policies that impact aggregate demand. Classical economists prefer to allow the economy to fix itself. Learning Objective: Why the debate over macro stability is important. A tax cut can best be characterized as Monetary policy only. Fiscal policy only. Supply-side policy only. Either fiscal or supply-side policy. Changing taxes affects macro equilibrium through either a change in aggregate demand or aggregate supply, depending on the nature of the tax cut. Learning Objective: Why the debate over macro stability is important. From the supply-side perspective, the economy may fail to reach full employment because of Production incentives. Declining costs. Lack of government regulation. Taxes that are too high. High taxes discourage work, saving, and investment. Learning Objective: The nature of aggregate demand (AD) and aggregate supply (AS).

6 6 of 21 10/18/2013 1:22 PM Which of the following is the best example of supply-side policy? The government response to the Great Depression. Inflation during the 1970s. The Reagan tax cuts in Government policy before The Reagan tax cuts in 1981 reduced income and corporate taxes to encourage more production. Learning Objective: Why the debate over macro stability is important. Which group of economists believes that there is a natural rate of output that is relatively immune to short-run fluctuations in aggregate demand? Supply-siders. Keynesians. Monetarists. Fiscal economists. Monetarists believe the money supply can be manipulated to maintain an output level close to full employment, but that in the longer term, increasing the money supply leads to an increase in the price level. Learning Objective: Why the debate over macro stability is important. In the long run, an increase in aggregate demand will lead to A higher price level and an increase in real GDP. A higher price level only. An increase in real GDP only. A decrease in real GDP. In the long run, the economy will always adjust back to full employment. So changes in aggregate demand will have a permanent effect only on the price level.

7 7 of 21 10/18/2013 1:22 PM Which of the following is a basic macro policy strategy? A laissez faire approach. Shifting the aggregate supply curve. Shifting the aggregate demand curve. All of the choices are correct. Any of these policies are macro policy strategies. Even a laissez faire approach, which is "no action," is a potential policy choice. Learning Objective: Why the debate over macro stability is important.

8 8 of 21 10/18/2013 1:22 PM Using Figure 8.1, a decrease in the quantity of aggregate demand resulting from the interest rate effect would be depicted as a movement from point B to point A. A to point C. B to point C. C to point A. When the interest rate rises because prices have risen, some spending is reduced since borrowing costs are higher. This is known as the interest rate effect, which explains why the aggregate demand is downward-sloping.

9 9 of 21 10/18/2013 1:22 PM Using Figure 8.2, a decrease in real output resulting from the profit effect would be depicted as a movement from point A to point C. B to point A. B to point C. C to point B. As the price level falls, some costs would remain fixed temporarily, such that profit would shrink and output would fall along the aggregate supply curve.

10 10 of 21 10/18/2013 1:22 PM Given AD and AS, the equilibrium price level in Figure 8.3 is 2 1 P. 1 P. 2 P. 3 P. 4 The equilibrium price level can be found along the vertical axis corresponding to the intersection of the AD and AS curves. Difficulty: 3 Hard

11 11 of 21 10/18/2013 1:22 PM Using Figure 8.5, if the equilibrium real output is Q 2 then Aggregate demand must be AD 1. Aggregate demand could be either AD 1 or AD 2 depending on the level of aggregate supply. The equilibrium price level is P 2. Aggregate supply must be AS 1 and the equilibrium price level must be P 1. At an output of Q 2, the equilibrium price level could be either P 1 or P 3, depending on AD and AS. Difficulty: 3 Hard

12 12 of 21 10/18/2013 1:22 PM In Figure 8.5, if equilibrium real output is Q and full-employment real output is Q, an appropriate monetarist policy 1 2 lever would be to increase AD by decreasing income taxes. AS by increasing the money supply. AD by reducing interest rates. AD by reducing government regulations. If interest rates are lowered, consumption spending will rise on big-ticket items, and businesses will invest more. Difficulty: 3 Hard Learning Objective: Why the debate over macro stability is important.

13 13 of 21 10/18/2013 1:22 PM In Figure 8.5, if this economy's inflation goal is a price level of P but the equilibrium price level is P, one way to 2 3 accomplish this using fiscal policy would be to Decrease AD by decreasing income taxes. Decrease AS by decreasing the money supply. Decrease AD by reducing transfer payments. Increase AS by reducing government regulations. If the amount of funds available to households is reduced, AD will decrease, leading to a lower equilibrium price level. Difficulty: 3 Hard Learning Objective: Why the debate over macro stability is important.

14 14 of 21 10/18/2013 1:22 PM Using Figure 8.5, if the equilibrium price level is P, then aggregate demand is 1 AD, and the equilibrium output level is Q. 2 2 AD, and the equilibrium output level is Q. 2 1 AD, and the equilibrium output level is Q. 1 3 AD, and the equilibrium output level is Q. 1 2 At price level P 1, the AD 1 curve intersects the AS 1 curve with an equilibrium output of Q 2. Difficulty: 3 Hard

15 15 of 21 10/18/2013 1:22 PM Choose the letter below that best represents the type of shift that would occur in each situation in the United States: A technological breakthrough significantly reduces the cost of computerizing production lines. (See Figure 8.6.) A. B. C. D. Any technological advance that reduces the cost of production will increase aggregate supply, thereby shifting the curve to the right. Difficulty: 3 Hard

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17 17 of 21 10/18/2013 1:22 PM Choose the letter below that best represents the type of shift that would occur in each situation in the United States: On October 24, 1929, the U.S. stock market crashed. By the end of the year, over $40 billion of wealth had vanished. (See Figure 8.6.) A. B. C. D. The large drop in the value of financial assets caused households to significantly reduce spending, thereby causing the AD curve to shift to the left.

18 18 of 21 10/18/2013 1:22 PM Difficulty: 3 Hard Using Figure 8.7, a shift in aggregate demand from AD 4 to AD 5 is most likely to cause An increase in real output and an increase in the price level. An increase in real output but no change in the price level. An increase in price level but no change in real output. A decrease in price level but no change in real output. Along the vertical portion of the AS curve, an increase in AD leads to an increase in the price level but no change in output.

19 19 of 21 10/18/2013 1:22 PM Assuming full employment is at the intersection of AD with the aggregate supply curve for the economy depicted in 3 Figure 8.7, the worst unemployment problem would exist when AD is located at AD. 1 AD. 2 AD. 3 AD. 5 At AD 1, the output will be far below that of full employment, resulting in high levels of unemployment.

20 20 of 21 10/18/2013 1:22 PM One World View article is titled "Global Depression." The countries that experienced the Depression Experienced GDP growth but at a rate below the long-term trend. Experienced higher employment levels than previously recorded. Suffered substantial losses of output and employment. Experienced high unemployment but an increase in output. With output far below the production possibilities curve, countries during the Great Depression experienced high unemployment and huge amounts of forgone production. Learning Objective: The major macro outcomes and their determinants. One In the News article titled "Economy: Sharpest Decline in 26 Years" states that Real GDP fell by 6.8 percent in the last quarter of Real GDP fell by 3.8 percent in the last quarter of The drop in real GDP in 2008 was the greatest in 50 years. The drop in real GDP in 2008 was the greatest since the Great Depression. Real GDP fell at an annual rate of 3.8 percent in the last quarter of This was the largest drop in real GDP since the first quarter of Learning Objective: The major macro outcomes and their determinants. The laissez faire view of government involvement in the economy is most consistent with the Classical theory. Keynesian theory. Monetary theory. Supply-side theory. According to classical theory, there is little or no need for government involvement in the economy; and if the market left alone, it will adjust on its own to the optimal outcome. Learning Objective: Why the debate over macro stability is important.

21 21 of 21 10/18/2013 1:22 PM Internal market forces include all of the following except Population growth. Spending behavior. Innovation. Trade disruptions. Trade disruptions are an external shock, not an internal market force. Learning Objective: The major macro outcomes and their determinants. The growth path of the US economy is considered to be Smooth and predictable. Consistent and reliable. Old and steady. Stumbles and setbacks. The growth path of the US economy is not a smooth-rising trend but a series of steps, stumbles, and setbacks. Learning Objective: The major macro outcomes and their determinants.