Macroeconomics-Chapter 5 Test Study

(LO 1) What are the four sources of economic growth?

a) Improved levels of human capital (an increase in the quantity or quality of labour employed); b) an increase in the capital stock; c) technological change; d) additional quantities of natural resources.

(LO 3, 4) What could cause a movement from point a to point b? An increase in government spending A decrease in labour productivity The discovery of new oil fields A decrease in taxes A decrease in the prevailing nominal wage

18. b

(LO 2) T or F The aggregate supply curve is upward sloping.

3. True

(LO 5) T or F According to Keynes, the aggregate supply curve is vertical.

9. False: to Keynes, it is horizontal.

(LO 4) T or F An increase in wage rates will cause an increase in both real GDP and the price level.

8. False: it will cause a decrease in real GDP.

(LO 1) Suppose the real GDP of an economy is $480 billion dollars and its unemployment rate is 7 percent. If the natural rate of unemployment is estimated at 5 percent, what is the value of the country's potential GDP in billions of dollars? $

$504 billion. (the GDP gap is equal to cyclical unemployment of 2% x 2.5 x actual GDP of $480 = $24 billion. Potentail GDP is equal to actual GDP of $480 + GDP gap of $24 = $504)

(LO 2) T or F Aggregate demand is the total quantity of final goods and services that consumers, businesses, government, and those living outside the country would buy at different price levels.

1. True

(LO 5) T or F According to neoclassicists, an increase in aggregate demand will have no effect upon real GDP but will cause the price level to increase.

10. True

(LO 2) Why is the AD curve downward sloping? Because production costs decline as real GDP increases Because higher prices cause an increase in wealth, which increases spending Because lower prices cause an increase in real balances, which increases spending Because lower prices cause interest rates to increase, which increases spending

11. c

(LO 2) Why is the AS curve upward sloping? Because firms will produce more if prices are higher, despite a lack of increase in profits Because firms will experience higher profits at higher prices and will therefore produce more Because aggregate demand rises with higher prices Because the potential GDP curve is also upward sloping

12. b

(LO 3) Which of the following will cause the aggregate demand curve to shift to the right? A decrease in the money supply A decrease in the interest rate An increase in the exchange rate A decrease in government spending

13. b

(LO 2) When does macroeconomic equilibrium occur? When aggregate supply equals potential GDP When the aggregate demand curve intersects the aggregate supply curve When the aggregate demand curve intersects the potential GDP curve When full employment occurs

14. b

(LO 4) What could cause the level of real GDP to rise but the price level to fall? A rightward shift in the aggregate demand curve A leftward shift in the aggregate demand curve A rightward shift in the aggregate supply curve A leftward shift in the aggregate supply curve

15. c

(LO 3) What can cause an increase in potential GDP? An increase in nominal wage rates A decrease in taxes Technological improvement A leftward shift in the AS curve

16. c

(LO 2) What does the real-balances effect mean? A higher price level will lead to an increase in the rate of interest thereby causing a decrease in consumption. A lower price level will lead to an increase in the rate of interest thereby causing a decrease in consumption. A higher price will increase the real value of financial assets thereby causing an increase in consumption. A higher price will decrease the real value of financial assets thereby causing an increase in consumption. A higher price will decrease the real value of financial assets thereby causing a decrease in consumption.

17. e

(LO 4) What effect will a decrease in aggregate demand have if the economy is in a recession? The price level will drop a great deal, but real GDP will fall only a little. The price level will drop a little, but real GDP will fall a great deal. The price level will drop a little, but real GDP will increase a great deal. The price level will drop a little, and real GDP will increase a little. Both the price level and real GDP will increase by the same amount.

19. b

(LO 2) T or F The foreign-trade effect is the effect that a change in exports and imports has on the price level.

2. False: it is the effect which a change in the price level has upon exports and imports.

(LO 3) What is the result of an increase in labour productivity? A decrease in aggregate supply An increase in potential GDP An increase in aggregate demand An increase in aggregate demand and aggregate supply

20. b

(LO 1) What is the business cycle? The periodic cycles of profits and losses that all firms experience The natural evolution of new firms growing quickly at first, then slowing and fading into obsolescence The fact that real GDP falls as often as it rises The expansionary and contractionary phases in the growth rate of real GDP

21. d

(LO 1) What is meant by the term human capital? The sum of all financial assets owned by people The accumulated skills and knowledge of human beings The total amount of machines and physical overhead a country possesses The amount of physical capital that each worker has to work with

22. b

(LO 1) All of the following, except one, will contribute to economic growth. Which is the exception? Increased levels of human capital Higher prices Increases in the capital stock Technological improvement Increased quantities of natural resources

23. b

(LO 3) What are the four components of aggregate demand? Consumption, investment, government spending, and net exports Consumption, investment, productivity, and net exports Consumption, investment, productivity, and human capital Potential GDP, AD, AS, and the GDP deflator

24. a

(LO 3) What will be the effect on trade of an increase in the Canadian price level? It will increase the volume of both Canadian exports and imports It will decrease the volume of both Canadian exports and imports It will increase the volume of Canadian exports but decrease the volume of imports It will decrease the volume of Canadian exports but increase the volume of imports

25. d

(LO 3) What is the domestic effect of an increase in the incomes of a country's major international trading partners? The aggregate demand curve will shift to the right. The aggregate demand curve will shift to the left. The aggregate supply curve will shift to the right. The aggregate supply curve will shift to the left.

26. a

(LO 4) All of the following, except one, would cause a movement from a to b. Which is the exception? An increase in the price level An increase in wealth holdings An increase in government spending A decrease in the interest rate An increase in foreign incomes

27. a

(LO 3, 4) Which of the following would cause a movement from point a to point c? A decrease in the price level An increase in wealth holdings An increase in government spending An increase in the interest rate An increase in foreign incomes

28. d

(LO 4) What are the implications if the price level is 100? The price level is above equilibrium. There is a shortage of real output of $250. There is a surplus of real output of $250. There is a surplus of real output of $150.

29. b

(LO 4) If the aggregate quantity demanded falls by $100 at every price level, what will be the new equilibrium price level and real output, respectively? 100 and $550 105 and $650 110 and $650 115 and $500

30. b

(LO 4) At what level of real output will full employment occur in this economy? $600 $650 $700 Cannot be determined from the information

31. d

(LO 5) What is the slope of the aggregate supply curve, according to neoclassical economists? Vertical, because prices tend to be inflexible Vertical, at the capacity level of output in the economy Horizontal, because wages are flexible Horizontal, because prices are flexible

32. b

(LO 6) Which of the following statements is true if the economy is at point a? Firms will find it hard to hire labour, and people will find it easy to find jobs. Wages will eventually be forced down. An inflationary gap exists. Unemployment is at its natural rate. The achievement of full employment must await a decrease in aggregate demand.

33. b

(LO 6) If the economy was initially at point a, then what would a movement to point b suggest? The movement could be the result of an increase in aggregate demand. The movement could be the result of a decrease in prices. The movement could be the result of a decrease in wages. It is a movement from one full-employment level of real GDP to another. The movement could be the result of expansionary monetary policy.

34. c

(LO 5) What is the slope of the AS curve according to Keynesians? Vertical, because prices tend to be inflexible Vertical, at the level of potential GDP Horizontal, because wages are inflexible Downward sloping, because wages are inflexible

35. c

(LO 2) T or F Macroeconomic equilibrium occurs where the aggregate demand is equal to potential GDP.

4. False: where aggregate demand equals the short-run aggregate supply.

A.(LO 4) Assume that the potential GDP of the economy of Arion is $1000 and that the aggregate demand and the aggregate supply are as shown in Table 5.4. What is the value of equilibrium real GDP and the price level? Is there a recessionary gap or an inflationary gap? Real GDP: Price level: There is a(n) gap of $ If firms become more optimistic and aggregate demand increases by $65, what will be the new values of equilibrium real GDP and the price level? Real GDP: Price level: Is there a recessionary gap or an inflationary gap? What is the size of the gap? There is a(n) gap of $

42A. a) Real GDP: $1000; price level: 100; There is no gap. (Actual GDP is the same as potential GDP). b) Real GDP: $1025; price level: 102; c) There is an inflationary gap of $25 (Actual GDP is $25 greater than potential GDP)..

(LO 2) Assume that the nominal wage rate increases from $18 to $20.80 per hour and, at the same time, the price index increases from 120 to 130. By how much has the real wage rate changed?

43A The real wage has increased by $1 from $15 (18/120 x 100) to $16 (20.8/130 x 100).

(LO 1) What does the term potential GDP mean?

44A Potential GDP refers to the total amount that the economy is capable of producing when all of its resources are being fully utilized. (It is also referred to as capacity GDP or full-employment GDP).

(LO 1) Assume that the size of the labour force in the economy of Mersin remained unchanged in the year 2011, while labour productivity increased. If real GDP also remained unchanged, what change in the labour market must have occurred?

48A There must have been an increase in unemployment in Mersin.

(LO 1) Figure 5.29 depicts the economy of Altrua, which is presently in equilibrium. What is the size of its recessionary gap? $ What is the size of this gap as a percentage of its actual GDP$? $ If the natural rate of unemployment is 6 percent, use Okun's law to calculate the amount of actual unemployment in Altrua. %

49A a) $20; b) 5 percent (20/400 x 100); c) Since the GDP gap is 2 ½ times the amount of cyclical unemployment, the latter must equal 2% (5/2.5). Therefore the unemployment rate must be 8 percent (natural rate of 2% plus cyclical unemployment of 2%).

(LO 3) T or F A change in resource prices will shift both the aggregate supply and the potential GDP curves.

5. False: it will not shift the potential GDP curve.

You are given the following options: ↑ aggregate demand ↓ aggregate demand ↑ aggregate supply ↓ aggregate supply ↑ aggregate supply and potential GDP ↓ aggregate supply and potential GDP Which of options 1-6 will occur as the result of the following changes? An increase in investment spending A decrease in imports An increase in factor prices A decrease in productivity A decrease in factor prices An increase in human capital

50A. a) 1; b) 1; c) 4; d) 6; e) 3; f) 5

(LO 2) What are the three reasons for the downward slope of the aggregate demand curve?

51A. The aggregate demand curve is downward-sloping because of: real-balances effect which refers to the fact that a lower price level increases the value of real balances which will cause an increase in consumption; interest-rate effect which means that a lower price level will reduce interest rates and thereby causing an increase in investment; foreign-trade effect which means that a lower price level will make domestic products more competitive on world markets thus increasing exports and decreasing imports.

(LO 4) Starting from full-employment equilibrium, explain what effect an increase in aggregate demand will have on price, real GDP, and equilibrium.

52A. An increase in aggregate demand will lead to an increase in both real GDP and in the price level. As a result the economy will be above potential, full-employment GDP, i.e. an inflationary gap will exist.

(LO 4) T or F An increase in potential GDP has no effect on macroeconomic equilibrium.

6. False: it will, because any change in potential GDP will also affect the aggregate supply and, therefore, equilibrium.

(LO 4) T or F An increase in aggregate demand will cause an increase in both real GDP and the price level.

7. True

(LO 6) Explain, in terms of a graph, how an increase in aggregate demand could have no effect on the price level.

If the AS was horizontal.

Try this (see 53 for answer)

The plotting is fairly straightforward, though you will appreciate that the AS is not a straight line and therefore needs a little care in drawing it. The potential GDP curve is a vertical straight line at $200. Since Everton is in equilibrium and at full employment, the potential GDP is located at the intersection of the AD1 and AS1 curves. See the following figure at q53 b) Price: 80; real GDP: $200 The equilibrium values can be read off the graph or by glancing at Table 5.3 and locating the price at which the quantity demanded is equal to the quantity supplied. c) See Figure 5.26 (completed) above. The new AD2 curve is 3 squares to the left of AD1. Price: 75; real GDP: $160 d) Recessionary gap of $40. (The difference between the new equilibrium GDP and potential GDP.) e) increased exports higher taxes X higher interest rates X lower government spending X f) See Figure 5.26 (completed) above. Price: 75; real GDP: $220 g) Inflationary gap of $20. (The difference between the new equilibrium GDP and potential GDP.)

(LO 4) In Figure 5.28, show a new equilibrium on the graph illustrating demand-pull inflation, and then name three things that could have caused the change.

see answer at q 56

(LO 3, 4) Starting from full-employment equilibrium, indicate whether each of the following factors will affect aggregate demand (AD) or aggregate supply (AS) and whether the effect would be an increase or a decrease. Then, indicate what will happen to the price level and the level of real GDP and what type of equilibrium will result. A decrease in interest rates: Price level: Real GDP: Type of equilibrium An improvement in technology: Price level: Real GDP: Type of equilibrium An increase in the exchange rate: Price level: Real GDP: Type of equilibrium . A decrease in government spending: Price level: Real GDP: Type of equilibrium An increase in the money supply: Price level: Real GDP: Type of equilibrium An increase in the nominal wage rate: Price level: Real GDP: Type of equilibrium

see answers q54

46A.(LO 4) Use the graph in Figure 5.27 to illustrate the effect of the Great Depression on the Canadian economy, when prices, production, and employment all decreased dramatically in the 1930s. (Assume the economy was originally at full-employment equilibrium.)

see q 55