Econ 106 - Quiz 6

Short-Run Phillips Curve (SRPC)

the negative short-run relationship between the unemployment rate and the inflation rate Each SRPC reflects a particular expected rate of inflation. As a result, there is a different SRPC for each level of expected inflation

sacrifice ratio

the number of percentage points of annual output lost in the process of reducing inflation by 1 percentage point

total change in demand

= initial change in spending x spending multiplier

economic expansion

the situation that occurs when an economy is growing and people are spending more money; their purchases stimulate the production of goods and services, which in turn stimulates employment. During these periods, firms find that customers are plentiful and that profits are growing.

nominal variables

variables measured in monetary units

a lower interest rate

will increase aggregate demand

increase money supply

will lower the equilibrium interest rate will increase the aggregate demand which can push the economy back to its nature rate of output

reduction in aggregate demand

will reduce output and lower price level

A decrease in aggregate demand will cause

will reduce output and reduce price level lower inflation at the expense of higher unemployment

Investment

it averages about 1/6 of GDP, declines in investment account for about 2/3 of the declines in GDP during recession.

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

Fed decreases money supply

-Money-supply curve shifts left -Interest rate increases -At any given price level •Decrease in quantity demanded of goods and services -Aggregate-demand curve shifts left

Fed increases money supply

-Money-supply curve shifts right -Interest rate falls -At any given price level •Increase in quantity demanded of goods and services -Aggregate-demand curve shifts right/increase (to stimulate aggregate demand)

Consider a hypothetical closed economy in which households spend $0.60 of each additional dollar they earn and save the remaining $0.40. The marginal propensity to consume (MPC) for this economy is_________ and the spending multiplier for this economy is_____________

.06 2.5 If households spend 0.6 of each additional dollar they earn, the marginal propensity to consume (MPC) is 3/5, or 0.6 in decimal form he formula for the spending multiplier is: Multiplier = 1 / 1−MPC= 1/0.4 = 2.5

Multiplier formula

1/(1-MPC)

depression

A long-term economic state characterized by unemployment and low prices and low levels of trade and investment. A several recession

Long-Run Phillips Curve (LRPC)

is vertical at the national rate of unemployment. This implies that, in the long run, the rate of inflation and the rate of unemployment are unrelated.

The following table lists several determinants of aggregate demand. Consumer expectations about future profitability Government spending Expected rate of return on investment Incomes in other countries

Improve increase increase increase

In the following table, determine how each event affects the position of the long-run aggregate supply (LRAS) curve. a. Many workers leave to pursue more lucrative careers in foreign economies. b. A scientific breakthrough significantly increases food production per acre of farmland. c. A government-sponsored training program increases the skill level of the workforce.

Direction of LRAS Curve Shift a. Left b. Right c. Right

Like real GDP, investment fluctuates, but it fluctuates much less than real GDP. a. True b. False

False

business cycle

Fluctuations in economic activity, such as employment and production. Economic fluctuations are not at all regular, and they are almost impossible to predict with much accuracy

GDP

Gross Domestic Product- the total market value of all final goods and services produced annually in an economy Y = C + I + G C = Consuption I = Investment G = government purchases NX = Net exports

MPC (marginal propensity to consume)

Is the fraction of extra income that a household consumes rather than saves

Classical Theory

Most economics believe that classical theory describes the world in the long run but not in the short run. Supply affect prices and other nominal variables but do not affect real GDP, Unemployment, and other variables.

An increase in the money supply, a_____________ variable, will cause the price level, a____________ variable, to increase but will have no long-run effect on the quantity of goods and services the economy can produce, a_______ variable. The distinction between real variables and nominal variables is known as the______________ .

Nominal Nominal Real the classical dichotomy

The downward sloping short run Phillips curve and the vertical long Phillips curve intersect at the expected ___________________

Rate of inflation

The short-run quantity of output supplied by firms will rise above the natural level of output when the actual price level________________ the price level that people expected.

Rises above

Advocates of stabilization policy argue that when there is a recession, the government should increase the money supply and increase government expenditures.

T

Technological progress shifts the long-run aggregate supply curve to the right.

T

To stimulate aggregate demand

The Fed can increase the money supply

contradictory monetary policy to reduce inflation

The economy moves along a short run phillips curve to a lower rate of inflation at the expense of higher unemployment.

quantity of output

The horizontal axis of the aggregate demand and aggregate supply model measures the overall

Stagflation

The short-run economic outcome resulting from the increase in production costs

Temporary tax cut

The tax cut will have a smaller impact on aggregate demand in the economy with the

exchange rate effect

The tendency for a fall in the price level to decrease the real exchange rate and increase net exports

Liquidity Preference Theory

The theory that, all else being equal, lenders prefer to make short-term loans rather than long-term loans; hence, they will lend short-term funds at lower rates than they lend long-term funds.

GDP measures

The value of all final goods and services produced within a given period. It also measures the total income (adjusted for inflation) of everyone in the economy.

During a recession unemployment benefits rise. This rise in benefits makes aggregate demand higher than otherwise. a. True b. False

True

Short-run outcomes in the economy can be expressed in terms of output and the price level, or in terms of unemployment and inflation. a. True b. False

True

Short-term fluctuations in real GDP are irregular and unpredictable.

True

aggregate supply curve

a curve that shows the quantity of goods and services that firms choose to produce and sell at each price level. Curve slopes upward

aggregate demand curve

a curve that shows the quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level. Curve slopes downward

Economic Contractions

a decline in national output as measured by gross domestic product. Most firms experience declining sales and dwindling profits.

Recession

a period of temporary economic decline during which trade and industrial activity are reduced, generally identified by a fall in GDP in two successive quarters.

Stagflation occurs when

a supply shock shifts the SRAS to the left, increasing the price level and decreasing actual GDP

The government has the ability to influence the level of output in the short run using monetary and fiscal policy. There is some disagreement as to whether the government should attempt to stabilize the economy. Which of the following are arguments in favor of active stabilization policy by the government? Check all that apply.

a. The Fed can effectively respond to excessive pessimism by expanding the money supply and lowering interest rates. c. Shifts in aggregate demand are often the result of waves of pessimism or optimism among consumers and businesses.

Which of the following probably occurred as the U.S. economy experienced increasing real GDP in 1954? Check all that apply. a. The unemployment rate declined. b. Industrial production declined. c. Retail sales increased. d. Home sales declined.

a. The unemployment rate declined. c. Retail sales increased.

According to liquidity preference theory, if the quantity of money supplied is greater than the quantity demanded, then the interest rate will a. increase and the quantity of money demanded will decrease. b. increase and the quantity of money demanded will increase. c. decrease and the quantity of money demanded will decrease. d. decrea e and the quantity of money demanded will increase.

a. increase and the quantity of money demanded will decrease.

A tax cut shifts the aggregate demand curve the farthest if a. the MPC is large and if the tax cut is permanent. b. the MPC is large and if the tax cut is temporary. c. the MPC is small and if the tax cut is permanent. d. the MPC is small and if the tax cut is temporary.

a. the MPC is large and if the tax cut is permanent.

An economist would be more likely to argue against reducing inflation if she thought that a. the central bank lacked credibility and if bonds were usually not indexed for inflation. b. the central bank lacked credibility and if bonds were usually indexed for inflation. c. the central bank had credibility and if bonds were usually not indexed for inflation. d. the central bank had credibility and if bonds were usually indexed for inflation

a. the central bank lacked credibility and if bonds were usually not indexed for inflation.

During the transition from the short run to the long run, price-level expectations will _______________ and the____________curve will shift to the

adjust downward short-run aggregate supply right

Suppose the government decides to intervene to bring the economy back to the natural level of output by using____________ Policy

an expansionary

misperceptions theory

asserts that changes in the price level can temporarily mislead firms about what is happening to their output prices.

Which of the following are examples of automatic stabilizers? Check all that apply. a. The discount rate b. Personal income taxes c. Unemployment insurance benefits

b. Personal income taxes c. Unemployment insurance benefits

Suppose the Fed doubles the growth rate of the quantity of money in the economy. In the long run, the increase in money growth will change which of the following? Check all that apply. a. The level of technological knowledge b. The price level c. The size of the labor force d. The quantity of physical capital

b. The price level

Most economists believe that the classical model is the appropriate model for analysis of the economy in the a. long run, because evidence indicates that money is not neutral in the long run. b. long run, because real and nominal variables are essentially determined separately in the long run. c. short run, because money is neutral in the short run. d. short run, because real and nominal variables are not highly intertwined in the short run.

b. long run, because real and nominal variables are essentially determined separately in the long run.

Shifts in aggregate demand affect the price level in a. the short run but not in the long run. b. the long run but not in the short run. c. both the short and long run. d. neither the short nor long run.

c. both the short and long run.

The positive feedback from aggregate demand to investment is called a. the investment multiplier. b. the crowding-out effect. c. the investment accelerator. d. the crowding-in multiplier.

c. the investment accelerator.

A decrease in the price level

causes a downward movement along the existing AD curve. Raises the real value of money and makes consumer wealthier, which in turn encourages them to spend more. The increase in consumer spending means a larger quantity of goods and services demanded. Reduces the interest rate, encourages greater spending on spending goods, and thereby increases the quantity of goods and services demanded. US interest rates fall, the real value of the dollar declines in foreign exchange markets. This depreciation stimulates US net exports and thereby increases the quantity of good and services demanded.

Classical Macroeconomic Theory

changes in the money supply affect nominal variable but not real variables.

Other things the same, which of the following responses would we expect to result from a decrease in U.S. interest rates? a. U.S. citizens decide to hold more foreign bonds. b. People choose to hold more currency. c. You decide to purchase a new oven for your cookie factory. d. All of the above are correct

d. All of the above are correct

Refer to Figure 34-4. Suppose the current equilibrium interest rate is r3. Which of the following events would cause the equilibrium interest rate to decrease? a. The Federal Reserve increases the money supply. b. Money demand decreases. c. The price level decreases. d. All of the above are correct

d. All of the above are correct

If a central bank reduced inflation by 2 percentage points and that made output fall by 3 percentage points for 2 years and the unemployment rate rise from 3 percent to 5 percent for 2 years, the sacrifice ratio is a. 1. b. 2. c. 3. d. None of the above is correct.

d. None of the above is correct.

In the long run, a decrease in the money supply growth rate a. increases inflation and shifts the short-run Phillips curve right. b. increases inflation and shifts the short-run Phillips curve left. c. decreases inflation and shifts the short-run Philips curve right. d. decreases inflation and shifts the short-run Phillips curve left

d. decreases inflation and shifts the short-run Phillips curve left

Other things the same, if prices fell when firms and workers were expecting them to rise, then a. employment and production would rise. b. employment would rise and production would fall. c. employment would fall and production would rise. d. employment and production would fall.

d. employment and production would fall.

If the inflation rate is zero, then a. both the nominal interest rate and the real interest rate can fall below zero. b. the nominal interest rate can fall below zero, but the real interest rate cannot fall below zero. c. the real interest rate can fall below zero, but the nominal interest rate cannot fall below zero. d. neither the nominal interest rate nor the real interest rate can fall below zero.

d. neither the nominal interest rate nor the real interest rate can fall below zero.

If the interest rate is below the Fed's target, the Fed would a. buy bonds to increase the money supply. b. buy bonds to decrease the money supply. c. sell bonds to increase the money supply. d. sell bonds to decrease the money supply

d. sell bonds to decrease the money supply.

During periods of expansion, automatic stabilizers cause government expenditures a. and taxes to fall. b. and taxes to rise. c. to rise and taxes to fall. d. to fall and taxes to rise

d. to fall and taxes to rise

A favorable supply shock will cause a. unemployment to rise and the short-run Phillips curve to shift right. b. unemployment to rise and the short-run Phillips curve to shift left. c. unemployment to fall and the short-run Phillips curve to shift right. d. unemployment to fall and the short-run Phillips curve to shift left.

d. unemployment to fall and the short-run Phillips curve to shift left.

In the long run, as a result of the business pessimism, the price level____________the quantity of output_____________the natural level of output, and the unemployment rate_____________ the natural rate of unemployment

decrease returns to returns to

As in the United States, this economy has a central bank called the Fed, but unlike in the United States, the economy is closed (that is, the economy does not interact with other economies in the world). The money market is currently in equilibrium at an interest rate of 6% and a quantity of money equal to $0.4 trillion, as indicated by the grey star. Suppose the Fed announces that it is raising its target interest rate by 25 basis points, or 0.25 percentage point. To do this, the Fed will use open-market operations to__________ the ___________ money by__________the public

decrease supply of selling bonds

Fed's reserves requirements

decrease in Fed's reserves requirement cause: The aggregate demand & aggregate supply curve to: 1. increases the money multiplier 2. increase the money supply 3. decreases the interest rate 4. increases the investment in the economy 5. Expand aggregate demand - which shift the AD curve to the right The phillips curve 1. unemployment rate to fall 2. increase in the inflation rate

wealth effect

decreases in the price level increase the quantity of output demanded.

Consider a soybean farmer who expects a price level of 100 in the coming year. If the actual price level turns out to be 90, soybean prices will___________ and if the farmer mistakenly assumes that the price of soybeans declined relative to other prices of goods and services, she will respond by____________ the quantity of soybeans supplied. If other producers in this economy mistake changes in the price level for changes in their relative prices, the unexpected decrease in the price level causes the quantity of output supplied to___________ the natural level of output in the short run.

fall reducing fall below

As the price level falls, the impact on the domestic interest rate will cause the real value of the dollar to___________ in foreign exchange markets. The number of domestic products purchased by foreigners (exports) will therefore__________ and the number of foreign products purchased by domestic consumers and firms (imports) will___________ Net exports will therefore__________ causing the quantity of domestic output demanded to______________ This phenomenon is known as the __________ effect

fall rise fall rise rise Exchange rate

increase in aggregate demand

in the short run it will increase output and raise the price level In the long run, the Economy will return to its natural rate of output but a higher price than in the initial equilibrium will lower unemployment at the expense of higher inflation

he long-run aggregate supply curve

is a vertical line at the economy's natural rate of output. The natural rate of output is the level of output consistent with the economy's natural unemployment rate. It is the level of real GDP that the economy gravitates toward in the long run. The long-run aggregate supply curve is vertical at the natural rate of output because the price level has no bearing on the economy's long-run level of real output.

supply shock

is an event that directly alters firms costs and prices, shifting the economy's aggregate supply curve and thus the phillips curve

classica dichotomy

is the classical separation of variables into real variables (those that measure quantities or relatives prices)

Suppose that in March the government undertakes the type of policy that is necessary to bring the economy back to the natural level of output in the preceding scenario. In July 2023, consumer confidence increases, leading to an increase in consumer spending. Because of the ___________ associated with implementing monetary and fiscal policy, the impact of the government's new policy will likely _________________ once the effects of the policy are fully realized.

lags push the economy beyond the natural level of output

expansionary monetary policy

monetary policy that increases aggregate demand

contractionary monetary policy

monetary policy that reduces aggregate demand

quantity of output supplied

natural level of output + a(actual price level - expected price level)

Increase in the price level

reduces the real value of money and makes consumers poorer, which in turn reduces consumer spending and the quantity of goods and services demanded. Raises the interest rate, discourages investment spending, and decrease the quantity of goods, and services demanded. causes US interest rates to rise, the rea value of the dollar increases, and this appreciation reduces US net exports and the quantity of goods and services demanded

Adverse Supply Shocks

results in falling output and higher prices. This in turn results in higher unemployment and higher inflation After an adverse supply shock, policy makers are left with a worse set of options for inflation and unemployment

Suppose the government passes a law that significantly increases the minimum wage. The policy will cause the natural rate of unemployment to _________________ which will Shift the long-run aggregate supply curve to the left

rise

At point A, the price level is 140, and the quantity of output demanded is $300 billion. Moving down along the aggregate demand curve from point A to point B, the price level falls to 120, and the quantity of output demanded rises to $500 billion. As the price level falls, the purchasing power of households' real wealth will____________ causing the quantity of output demanded to_______________This phenomenon is known as the

rise rise wealth effect

In the short run, the decrease in investment spending associated with business pessimism causes the price level to_______________ the price level people expected and the quantity of output to_________________ the natural level of output. The business pessimism will cause the unemployment rate to________________ the natural rate of unemployment in the short run.

rise above fall below rise above

sticky wage theory

short run aggregate supply curve slopes upward because nominal wages are based on expected prices and do not respond immediately when the actual price level turns out to be different from what was expected. When the price level is above the expected price level workers will eventually demand higher nominal wages to compensate for the higher level price.

The aggregate supply curve

shows the quantity of goods and services that firms produce and sell at each price level.

multiplier effect

the additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending

accommodative policy

the government accepts a permanently higher price level in order to immediately return the economy to the natural level of output and the natural rate of unemployment. Exp: In the long run, the price level rises (from 100 to 110 in this case), and the quantity of output returns to the natural level of output of $100 billion.