1) GDP is an accurate measure of the social well being of a country.

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1 Macro Problem Set 2 WCC Fall 2014 Directions: The True/False and multiple choice questions do not have to be turned in for credit. It would be foolish, however, not to spend a great deal of time working on these questions. They are your best preparation for the next exam. We will go over the answers to all of the questions in class. True/false A=True/B=False 20 points 1) GDP is an accurate measure of the social well being of a country. 2) A strong dollar tends to reduce the U.S. trade deficit. 3) For economists, disposable income refers only to those dollars we are free to spend on movies and recreational pursuits after we have taken care of necessities. 4) The output from a BMW plant in Alabama would be counted as part of Germany s GNP. 5) An increase in input prices is likely to push the AD curve backwards. 6) An increase in the unemployment rate decreases the labor force participation rate. 7) An increase interest rates is likely to push the AD curve outwards. 8) Raising the eligibility age for collecting Social Security benefits from 65 to 67 is likely to reduce the labor force participation rate.. 9) Last year prices rose 6%. This year they rose 4%. One can correctly say that disinflation has occurred between last year and this year. 10) Stagflation is the result of a sharp decrease in aggregate demand. 11) When foreign countries suffer recessions, this gives the U.S. a chance to "catch up" and reduce our trade deficit. 12) Inflation that affects both product and resource markets equally will increase the nominal wage, but decrease the real wage

2 13) Goods produced by a company in 1989, but not sold until 1990 are counted towards GDP for ) When a country is at full employment, it may still have significant structural and frictional unemployment. 15) A significant inflationary gap would indicate that wages are currently lower than the equilibrium level. 16) The Classical view of the economy is that flexible wages, prices, and interest rates lead to a self-correcting mechanism that works quickly to close contractionary (recessionary) gaps. 17) Fiscal stabilization policy consists of the actions the government takes to adjust the money supply and interest rate in order fight inflation and unemployment. 18) When an officially unemployed worker quits actively seeking work the unemployment rate actually drops. 19) If RGDP increases from one year to the next, we can definitely say that output has increased. 20) In a Classical world, an increase in AD will result mainly in an increase in the price level and little, or no, increase in output. Multiple Choice Select the best answer. 25 points 21) In 1989 the consumer price index stood at 150 (1982 = 100) compared with 125 in Which of the following is closest to the inflation rate between 1988 and 1989? a. 20% b. 25% c. 50% d. 150% 22) Which of the following would be counted towards U.S. GDP this year? a. your purchase of 10,000 shares of AIG stock b. the money your family saved by having your mother cut your hair with a bowl c. the cost of the Van Gogh which sold at auction this year for 26 million dollars d. the cost of the cleaning up this Spring's California mud slides

3 23) Conceptually, GDP can be viewed as a. the sum of all incomes generated by the production of goods and services. b. the market value of all final goods produced by the economy during a given period of time. c. the sum of expenditures on output by firms, households, the government, and foreigners. d. all of the above. 24) The economy's self-correcting mechanism works through a. shifts in the LRAS curve. b. shifts in the SRAS curve. c. shifts in the AD curve. d. shifts in PGDP. e. None of the above 25) Which of the following situations best falls under the heading of cyclical unemployment? a. John is laid off from work at an auto assembly because people just aren t spending during the current recession. b. Trish is laid off from her work as a typist because word processors have reduced the need for secretarial support. c. Ellen sees a commercial on afternoon television and quits her job at Burger King to train for the joys of driving the big rigs on the open roads. d. George is let go from his job as a roofer because the construction business is slow during the winter. 26) If an oil embargo by OPEC shifts the AS curve backwards, this will result in a. stagflation. b. disinflation. c. deflation. d. demand-pull inflation. e. all of the above. 27) If the unemployment rate is currently six percent and the number of persons unemployed is six million, then the number employed is a. 100 million b. 94 million c. 106 million d. also 6 million 28) Transfer payments a. are a component of AD. b. count towards GDP. c. remove all of the costs of unemployment to society. d. increase incentives to work. e. none of the above

4 29) An increase in the GDP deflator from one year to the next means that a. output has increased. b. prices have increased. c. output has fallen. d. AD has shifted outward. e. None of the above. 30) In 1983, real GDP was $1,535 billion whereas nominal GDP was $3,311 billion. From these figures one can calculate that the GDP deflator was approximately a. $4,846 billion b. -$1,776 billion c. 46 d ) One of the following will not cause a shift of the aggregate supply schedule directly. a. an increase in wages b. an increase in the price of imported oil c. improved technology d. a lower exchange rate 32) Until the 1930s, prevailing economic theory held that a capitalist economy: a. would generally experience constant inflation. b. had a natural tendency to cure recessions quickly. c. had a general tendency toward great prolonged depressions. d. had a tendency to grow except during wartime. 33) Keynesians do not believe that a. wages and prices are sticky. b. long-term unemployment is a real possibility. c. government policies to stimulate AD can shorten recessions. d. markets always clear quickly. 34) When used by economists speaking of aggregate demand, "investment" means money that a. people put in the stock market or a bank account. b. firms spend on new machinery and factories, money that families spend on new houses, and the additions firms make to inventories. c. families spend on new cars and old houses. d. pension fund managers put away in interest-bearing bonds and dividend-paying stocks. e. none of the above.

5 Table I Amount (billions) Personal Consumption Expenditures 600 Depreciation 50 Wages 800 Indirect Business Taxes 10 Rental Income 25 Gross Private Domestic Investment 150 Corporate Profits 75 Net Exports 5 Government Purchases of Goods and Services 200 Government Transfer Payments 50 35) According to the data in Table I, the value of AD is a. 800 b. 955 c. 805 d ) AD measures total spending on U.S. RGDP by different groups. When calculating AD, one must remember to a. add exports and subtract imports. b. add imports and subtract exports. c. add imports since they are sold in the U.S. d. subtract exports since they are sold to foreigners. e. none of the above. 37) The effect of interest rates on business investment is such that a. the higher the rate of interest, the larger the amount of investment. b. the higher the rate of interest, the smaller the amount of investment. c. econometric studies show that the rate of interest has no effect on investment. d. higher interest rates encourage investment during expansions and discourage investment during recessions.

6 38) In Figure A, a decline in the stock market will likely cause a movement from a. A to C b. A to D c. A to B d. A to E 39) In Figure A, an increase in the price level will cause a movement from a. A to C b. A to D c. A to B d. A to E 40) The typical result of an adverse supply shock is for a. falling output to accompany accelerating deflation. b. falling output to accompany acceleration inflation. c. rising output to accompany accelerating deflation. d. rising output to accompany accelerating inflation.

7 Short answer 20 points Directions: Answers to these short answer questions do need to be turned in. Written answers must be neat, complete, coherent, and cogent. Any graphs must be fully labeled. Do not put your answers on this sheet; use a separate sheet or sheets of paper as needed. No fringes, and if you use multiple sheets of paper, please staple them together. 1) Can a fixed-basket CPI overstate the impact of inflation? If so, how? 2) Economies can experience recessionary and inflationary gaps. Keynesians sometimes argue that the self-correcting mechanism (SCM) has a tough time correcting one of these situations. Which gap do they believe is problematic for the SCM and why? What are the consequences of failing to close this gap? What government policies might Keynesians recommend to close such a gap and how would they help? 3) Briefly explain and illustrate how the unemployment rate and labor force participation rate relate to the production possibilities frontier. Give several examples of demographic, cultural, or personal decisions that might change the LFPR. 4) Explain and illustrate how the interest rate effect supports the idea of a negatively sloped AD curve.