Use the following to answer question 9: Exhibit: Keynesian Cross

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1 1. Leading economic indicators are: A) the most popular economic statistics. B) data that are used to construct the consumer price index and the unemployment rate. C) variables that tend to fluctuate in advance of the overall economy. D) standardized statistics compiled by the National Bureau of Economic Research. 2. The aggregate demand curve is the relationship between the quantity of output demanded and the. A) positive; money supply B) negative; money supply C) positive; price level D) negative; price level 3. When the Federal Reserve increases the money supply, at a given price level the amount of output demanded is and the aggregate demand curve shifts. A) greater; inward B) greater; outward C) lower; inward D) lower; outward 4. The natural level of output is: A) affected by aggregate demand. B) the level of output at which the unemployment rate is zero. C) the level of output at which the unemployment rate is at its natural level. D) permanent and unchangeable. 5. In the short run, a favorable supply shock causes: A) both prices and output to rise. B) prices to rise and output to fall. C) prices to fall and output to rise. D) both prices and output to fall. 6. Starting from long-run equilibrium, without policy intervention, the long-run impact of an adverse supply shock is that prices will: A) be permanently higher and output will be restored to the natural rate. B) return to the old level and output will be restored to the natural rate. C) be permanently higher and output will be permanently lower. D) return to the old level, but output will be permanently lower. Page 1

2 7. The IS curve plots the relationship between the interest rate and that arises in the market for. A) national income; goods and services B) the price level; goods and services C) national income; money D) the price level; money 8. In the Keynesian-cross model, actual expenditures differ from planned expenditures by the amount of: A) liquidity preference. B) the government-purchases multiplier. C) unplanned inventory investment. D) real money balances. Use the following to answer question 9: Exhibit: Keynesian Cross 9. (Exhibit: Keynesian Cross) In this graph, if firms are producing at level Y 1, then inventories will inducing firms to production. A) rise; increase B) rise; decrease C) fall; increase D) fall; decrease Page 2

3 10. The government-purchases multiplier indicates how much change(s) in response to a $1 change in government purchases. A) the budget deficit B) consumption C) income D) real balances 11. Based on the Keynesian model, one reason to support spending increases over tax cuts as measures to increase output is that: A) government spending increases the MPC more than tax cuts. B) the government-spending multiplier is larger than the tax multiplier. C) government-spending increases do not lead to unplanned changes in inventories, but tax cuts do. D) increases in government spending increase planned spending, but tax cuts reduce planned spending. 12. According to the theory of liquidity preference, if the supply of real money balances exceeds the demand for real money balances, individuals will: A) sell interest-earning assets in order to obtain non-interest-bearing money. B) purchase interest-earning assets in order to reduce holdings of non-interest-bearing money. C) purchase more goods and services. D) be content with their portfolios. Page 3

4 Use the following to answer question 13: Exhibit: Market for Real Money Balances 13. (Exhibit: Market for Real Money Balances) Based on the graph, if the interest rate is r 1, then people will bonds and the interest rate will. A) sell; rise B) sell; fall C) buy; rise D) buy; fall 14. The interaction of the IS curve and the LM curve together determine: A) the price level and the inflation rate. B) the interest rate and the price level. C) investment and the money supply. D) the interest rate and the level of output. 15. In the IS-LM analysis, the increase in income resulting from a tax cut is usually the increase in income resulting from an equal rise in government spending. A) less than B) greater than C) equal to D) sometimes less and sometimes greater than Page 4

5 Use the following to answer question 16: Exhibit: Policy Interaction 16. (Exhibit: Policy Interaction) Based on the graph, starting from equilibrium at interest rate r 3, income Y 2, IS 1, and LM 1, if there is an increase in government spending that shifts the IS curve to IS 2 and the Federal Reserve does not change the money supply, the new equilibrium combination of interest and income will be. A) r 1, Y 2 B) r 2, Y 3 C) r 3, Y 3 D) r 3, Y One policy response to the U.S. economic slowdown of 2001 was to increase money growth. This policy response can be represented in the IS-LM model by shifting the curve to the. A) LM; right B) LM; left C) IS; right D) IS; left Page 5

6 18. Analysis of the short and long runs indicates that the assumptions are most appropriate in. A) classical; both the short and long runs B) Keynesian; both the short and long runs C) classical; the short run whereas the Keynesian assumptions are most appropriate in the long run D) Keynesian; the short run whereas the classical assumptions are most appropriate in the long run 19. Each of the two models of short-run aggregate supply is based on some market imperfection. In the imperfect-information model, the imperfection is that: A) some firms do not adjust their prices instantly to changes in demand. B) contracts and arrangements may prevent nominal wages from adjusting rapidly to changing economic conditions. C) firms confuse changes in the overall level of prices with changes in relative prices. D) the real wage adjusts to bring labor supply and labor demand into equilibrium. 20. According to the imperfect-information model, when the price level falls but the producer did not expect it to fall, the producer: A) increases production. B) does not change production. C) decreases production. D) hires more workers. 21. Both models of aggregate supply discussed in Chapter 13 imply that if the price level is higher than expected, then output natural rate of output. A) exceeds the B) falls below the C) equals the D) moves to a different 22. Along a short-run aggregate supply curve, output is related to unexpected movements in the. Along a Phillips curve, unemployment is related to unexpected movements in the. A) price level; inflation rate B) inflation rate; price level C) unemployment rate; price level D) price level; level of output Page 6

7 23. Analysis of the short-run Phillips curve suggests that policymakers who want to reduce unemployment in the short run should aggregate demand at a cost of generating inflation. A) increase; higher B) increase; lower C) decrease; higher D) decrease; lower 24. Which of the following would be represented by a positive value of the random demand shock, t? A) an irrational wave of optimism among investors B) a decrease in government spending C) an aggressive increase in oil prices by a cartel D) an increase in the central bank's inflation target 25. To follow a monetary policy rule, the central bank raises the nominal interest rate by: A) raising the inflation target. B) decreasing the money supply. C) increasing the GDP gap. D) decreasing inflation expectations. 26. All of the following are endogenous variables in the dynamic model of aggregate demand and aggregate supply except: A) Y t, output. B) * t, central bank's inflation target. C) r t, real interest rate. D) E t t + 1, expected inflation. 27. Frictional unemployment is unemployment caused by: A) wage rigidity. B) minimum-wage legislation. C) the time it takes workers to search for a job. D) clashes between the motives of insiders and outsiders. 28. Frictional unemployment is inevitable because: A) different sectors do not shift. B) the economy needs to be lubricated. C) workers never quit their jobs to change careers. D) the demand for different goods always fluctuates. Page 7

8 29. According to efficiency-wage theories, firms benefit by paying higher-than-equilibrium wages because worker increases. A) productivity B) turnover C) unionization D) shirking 30. Entry into and exit from the labor force are important to the determination of the unemployment rate because: A) more than one-half of the unemployed have only recently entered the labor force. B) most of the unemployed are young workers still looking for their first job. C) discouraged workers are counted as part of the labor force. D) almost one-half of all spells of unemployment end in the unemployed person's withdrawal from the labor market. 31. Assume that the long-run aggregate supply curve is vertical at Y = 3,000 while the short-run aggregate supply curve is horizontal at P = 1.0. The aggregate demand curve is Y = 2(M/P) and M = 1,500. a. If the economy is initially in long-run equilibrium, what are the values of P and Y? b. What is the velocity of money in this case? c. Suppose because banks start paying interest on checking accounts, the aggregate demand function shifts to Y = (1.5)(M/P). What are the short-run values of P and Y? d. What is the velocity of money in this case? e. With the new aggregate demand function, once the economy adjusts to long-run equilibrium, what are P and Y? f. What is the velocity now? Page 8

9 32. Assume that an economy is characterized by the following equations: C = (2/3)(Y T) T = 600 G = 500 I = 800 (50/3)r M s /P = M d /P = 0.5Y 50r a. Write the numerical IS curve for the economy, expressing Y as a numerical function of G, T, and r. b. Write the numerical LM curve for this economy, expressing r as a function of Y and M/P. c. Solve for the equilibrium values of Y and r, assuming P = 1.0 and M = 1,200. How do they change when P = 2.0? Check by computing C, I, and G. d. Write the numerical aggregate demand curve for this economy, expressing Y as a function of G, T, and M/P. Page 9

10 33. Let the monetary rule be i Output Gap t t t Yt Yt Output Gap, natural output = 100 Y t a) What does 1 represent in this equation? b) Would the monetary authority that uses this rule be satisfied with 2% inflation? Why or why not? c) What do the 0.75 and 0.25 coefficients represent? What's the interpretation of one being higher than the other? d) Complete the following table. Y output gap i r e) For this part, assume instead of 0.75, p was Describe what happens to i t, r t, S t+, C t+, I t+, Y t+, and t+ if the inflation rate jumps to 5%. (The subscript t+ indicates periods after period t; explanation is sufficient values are not necessary) 34. Assume that the real wage in an economy is held above equilibrium. a. Graphically illustrate how an increase in the supply of labor will change the number of unemployed workers. Be sure to label the axes and the quantities of labor hired before and after the technological progress. b. Explain in words what happens to the number of unemployed as a result of this change. Page 10

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