Chapter 20 Study

If policymakers choose to try to move the economy out of a recession, they should use their policy tools to decrease aggregate demand

FALSE policymakers should increase aggregate demand

Suppose the economy is initially in long-run equilibrium. Then suppose there is a drought that destroys much of the wheat crop. If policymakers allow the economy to adjust to long-run equilibrium on its own, according to the model of aggregate demand and aggregate supply, what happens to prices and output in the long run?

Output and the price level are unchanged from their initial values.

Suppose the economy is initially in long-run equilibrium. Then suppose there is a reduction in military spending due to the end of the Cold War. According to the model of aggregate demand and aggregate supply, what happens to prices and output in the short run?

Prices fall; output falls.

Suppose the economy is initially in long-run equilibrium. Then suppose there is a reduction in military spending. According to the model of aggregate demand and aggregate supply, what happens to prices and output in the long run?

Prices fall; output is unchanged from its initial value.

sticky price theory

an unexpectedly low price level leaves some firms with higher than desired prices, which depresses their sales and leads them to cut back production

According to the wealth effect, aggregate demand slopes downward (negatively) because Answer

lower prices increase the value of money holdings and consumer spending increases.

According to the interest-rate effect, aggregate demand slopes downward (negatively) because

lower prices reduce money holdings, increase lending, interest rates fall, and investment spending increases.

Policymakers are said to "accommodate" an adverse supply shock if they

respond to the adverse supply shock by increasing aggregate demand, which further raises prices.

sticky wage theory

short run aggregate supply curve slopes upward because nominal wages are slow to adjust to changing economic conditions

Suppose the price level falls. Because of fixed nominal wage contracts, firms become less profitable, and they cut back on production. This is a demonstration of the Answer

sticky-wage theory of the short-run aggregate-supply curve.

Which of the following is not a reason why the aggregate-demand curve slopes downward? Answer

the classical dichotomy/monetary neutrality effects

model of aggregate demand and aggregate supply

the model that most economists use to explain short-run fluctuations in economic activity around its long-run trend

monetary neutrality

the proposition that changes in the money supply do not affect real variables

classical dichotomy

the theoretical separation of nominal and real variables

The natural level of output is the amount of real GDP produced

when the economy is at the natural rate of unemployment.

Stagflation

A period of falling output and rising prices

Which of the following would not cause a shift in the long-run aggregate-supply curve? Answer

An increase in price expectations

If the economy is in a recession, the economy will adjust to long-run equilibrium on its own as wages and price expectations rise.

FALSE in a recession, the economy adjusts to long-run equilibrium as wages and prices fall

An increase in price expectations shifts the long-run aggregate-supply curve to the left.

FALSE changes in price expectations shift the short-run aggregate-supply curve.

Economists refer to fluctuations in output as the "business cycle" because movements in output are regular and predictable.

FALSE fluctuations in output are irregular.

In the long run, an increase in government spending tends to increase output and prices

FALSE in the long run, it tends to increase prices, but it has no impact on output.

Over the last 50 years, U.S. real GDP has grown at about 5 percent per year

FALSE the U.S. economy has grown at about 3 percent per year

The misperceptions theory explains why the long-run aggregate-supply curve is downward sloping

FALSE it explains why the short-run aggregate-supply curve is upward sloping

Suppose the economy is initially in long-run equilibrium. Then suppose there is a drought that destroys much of the wheat crop. According to the model of aggregate demand and aggregate supply, what happens to prices and output in the short run? Answer

Prices rise; output falls

A rise in price expectations that causes wages to rise causes the short-run aggregate-supply curve to shift left.

TRUE

A rise in the price of oil tends to cause stagflation. Answer

TRUE

A variety of spending, income, and output measures can be used to measure economic fluctuations because most macroeconomic quantities tend to fluctuate together.

TRUE

If the classical dichotomy and monetary neutrality hold in the long run, then the long-run aggregate-supply curve should be vertical.

TRUE

In the short run, if the government cuts back spending to balance its budget, it will likely cause a recession.

TRUE

Investment is a particularly volatile component of spending across the business cycle.

TRUE

One reason aggregate demand slopes downward is the wealth effect: A decrease in the price level increases the value of money holdings and consumer spending rises.

TRUE

The short-run effect of an increase in aggregate demand is an increase in output and an increase in the price level.

TRUE

wealth effect

The tendency for people to increase their consumption spending when the value of their financial and real assets rises and to decrease their consumption spending when the value of those assets falls.

Which of the following statements is true regarding the long-run aggregate-supply curve? The long-run aggregate-supply curve

is vertical because an equal change in all prices and wages leaves output unaffected.

Suppose the price level falls but suppliers only notice that the price of their particular product has fallen. Thinking there has been a fall in the relative price of their product, they cut back on production. This is a demonstration of the

misperceptions theory of the short-run aggregate-supply curve.

interest rate effect

occurs when a change in the price level leads to a change in interest rates and, therefore, in the quantity of aggregate demand

According to the model of aggregate supply and aggregate demand, in the long run, an increase in the money supply should cause

prices to rise and output to remain unchanged.