chapter 13

When actual output is less than potential output, there is ______ output gap and the inflation rate will ____.

a recessionary; to be lower than the expected rate of inflation

An example of an negative inflation shock is:

a significant rise in oil prices.

An inflation shock is:

a sudden change in the normal behavior of inflation, unrelated to the nation's output gap.

When the economy is in short-run equilibrium, there will be ______ output gap.

either a recessionary or an expansionary

Shifts in _____ can push the economy out of long-run equilibrium.

either the AD curve or the AS curve

High expected inflation leads to ____ increases in wages and costs and to ____ actual inflation.

large; high

If the interest rate in the U.S. falls, U.S. financial assets become ______ attractive to buyers and the ______ U.S. dollars will fall.

less; demand for

Graphically, short-run equilibrium occurs at the intersection of the aggregate demand curve and:

the aggregate supply curve.

The AD curve slopes downward because an increase in ______ causes ______ to fall, which in turn causes real GDP to fall.

the inflation rate; planned spending

The Great Recession was the result of:

two negative demand shocks.

The economy is in short-run equilibrium:

when the AD and AS curves intersect at a level of real GDP that is above or below Y*.

The economy is in long-run equilibrium:

when the AD and AS curves intersect at potential output Y*.

When using the AD-AS model to understand business cycles, the question, "what are the fundamental causes of business cycles?" can be thought of as the question:

"what factors move the economy away from long-run

A negative demand shock will shift the ______ curve to the ______.

AD; left

If households and firms increase their expectation for the rate of inflation, the ______ curve will shift _____.

AS; upward

Refer to the figure above. The current level of GDP in this economy is ______; the potential level of GDP is ______.

Y1; Y2

Refer to the figure above. The current level of GDP in this economy is ______; the potential level of GDP is ______.

Y2; Y1

A leftward shift of the AS curve indicates:

a decrease in aggregate supply.

The aggregate supply curve will shift downward in response to:

a decrease in the expected rate of inflation.

Suppose the economy is currently operating at potential output; a recessionary gap may be caused by each of the following EXCEPT:

a increase/decrease in the inflation rate or a positive/negative inflation shock

A large increase in oil prices is an example of:

a negative inflation shock.

A large decrease in oil prices is an example of:

a positive inflation shock.

Refer to the figure above. Suppose the economy is in a short-run equilibrium at output Y1 and inflation rate π2. The economy is currently experiencing ______, and the correct fiscal policy response to this situation, to return the economy to potential GDP, is to ______.

a recessionary gap; increase government spending

Refer to the figure above. Suppose the economy is in a short-run equilibrium at output Y1 and inflation rate π2. The economy is currently experiencing ______, and the correct monetary policy response to this situation, to return the economy to potential GDP, is to ______.

a recessionary gap; increase the money supply

When actual output is less than potential output, there is ____ output gap and the rate of inflation will tend to ____.

a recessionary; decrease

Changes in planned spending not caused by changes in output or the inflation rate will shift the:

aggregate demand curve

For a given inflation rate if a resolution of international disputes leads to a cutback in government military spending, then the ______ shifts _____.

aggregate demand curve; left

For a given inflation rate, if a stock market crash makes consumers less willing to spend, then the ______ shifts _____.

aggregate demand curve; left

For a given inflation rate, if concerns about future weakness in the economy cause businesses to reduce their spending on new capital, then the ______ shifts _____.

aggregate demand curve; left

For a given inflation rate, if a rise in the stock market makes consumers more willing to spend, then the ______ shifts _____.

aggregate demand curve; right

For a given inflation rate, if an increase in threats to domestic security causes the government to increase military spending, then the ______ shifts _____.

aggregate demand curve; right

For a given inflation rate, if bright prospects for the future of the economy cause businesses to increase their spending on new capital, then the ______ shifts _____.

aggregate demand curve; right

Starting from potential output, if consumer confidence decreases and consumers decide to spend less, then this will shift the ______ curve to the left and generate ______.

aggregate demand; a recessionary output gap

Starting from potential output, if firms become less optimistic about the future and decide to decrease their investment in new capital, then this will shift the ______ curve to the left and generate ______.

aggregate demand; a recessionary output gap

Starting from potential output, if consumer confidence increases and consumers decide to spend more, then this will shift the ______ curve to the right and generate ______.

aggregate demand; an expansionary output gap

Starting from potential output, if firms become more optimistic about the future and decide to increase their investment in new capital, then this will shift the ______ curve to the right and generate ______.

aggregate demand; an expansionary output gap

As the quality of available resources becomes worse:

aggregate supply falls.

As the available technology improves, ______ shifts to the _____.

aggregate supply; right

As the number or quality of available resources improves, ______ shifts to the _____.

aggregate supply; right

Refer to the figure above. Suppose that the economy is initially in equilibrium with output Y2 and inflation rate of π3. An increase in military spending will generate:

an expansionary gap.

Refer to the figure above. Suppose the economy is in a short-run equilibrium at output Y3 and inflation rate π2. The economy is currently experiencing ______, and the correct fiscal policy response to this situation, to return the economy to potential GDP, is to ______.

an expansionary gap; decrease government spending

When actual output exceeds potential output, there is ______ output gap and the inflation rate will ____.

an expansionary; exceed the expected rate of inflation

When actual output exceeds potential output there is ____ output gap and the rate of inflation will tend to ____.

an expansionary; increase

An increase in the aggregate demand for goods and services will result in an increase in the amount of output firms are willing to produce, and this increase in output will be accompanied by:

an increase in the inflation rate.

A sudden change in the normal behavior of inflation, unrelated to the nation's output gap is called:

an inflation shock.

Due to menu costs, many firms in the economy will increase their output:

and then raise the price at which they are willing to sell their output

When the interest rate in the U.S. falls, U.S. financial assets:

become less attractive to both foreign and domestic buyers.

When the interest rate in the U.S. rises, U.S. financial assets:

become more attractive to both foreign and domestic buyers.

The AD curve can be shifted by:

both fiscal and monetary policy

Refer to the figure above. Long-run equilibrium in this economy:

could occur if AS shifts downward and to the right

Refer to the figure above. Long-run equilibrium in this economy:

could occur if AS shifts upward and to the left.

The two negative demand shocks that caused the Great Recession were:

declining housing prices and the 2008 financial panic.

To achieve long-run equilibrium in an economy with a recessionary gap, without the use of stabilization policy, the inflation rate must:

decrease.

Refer to the figure above. Suppose the economy is in a short-run equilibrium at output Y3 and inflation rate π2. The economy is currently experiencing ______, and the correct monetary policy response to this situation, to return the economy to potential GDP, is to ______.

expansionary gap; decrease the money supply

The self-correcting tendency of the economy means that rising inflation eventually eliminates:

expansionary/recessionary gaps.

Refer to the figure above. The economy pictured in the figure has a(n) ______ gap with a short-run equilibrium combination of the price level and output indicated by point ___.

expansionary; A

Starting from long-run equilibrium, a large increase in government purchases will result in a(n) ______ gap in the short-run and ____ inflation and ____ output in the long-run

expansionary; higher; potential

Starting from potential output, if consumer confidence increases and consumers decide to spend more, then this will generate a(n) _____ gap and inflation will _____.

expansionary; increase

Starting from potential output, if firms become more optimistic about the future and decide to increase their investment in new capital, then this will generate a(n) _____ gap and inflation will _____.

expansionary; increase

When the inflation rate increases, PAE ______, which in turn causes Y to ______ because of ______.

falls; fall; the income-expenditure multiplier

Starting from long-run equilibrium, a negative inflation shock results in a short-run equilibrium with ___ inflation and ____ output.

higher; lower

Technological improvements:

increase aggregate supply.

An economy with an expansionary gap will, in the absence of stabilization policy, eventually experience a(n) ______ in the inflation rate, leading to a(n) ______ in output.

increase; decrease

Firms that face menu costs react to a sustained increase in demand by:

increasing output and then raising the price at which they are willing to sell their output.

Inflation inertia is the result of the behavior of ____ and the existence of ______.

inflation expectations; long-term wage and price contracts

The tendency for inflation to change relatively slowly from year to year in industrial countries is called:

inflation intertia

The aggregate demand curve shows the relationship between planned spending and the _____>

inflation rate

The aggregate supply curve shows the relationship between the amount of output firms want to produce and the

inflation rate

When actual output equals potential output and the inflation rate is equal to the expected rate of inflation, the economy is said to be in ______ equilibrium.

long-run

A low rate of expected inflation tends to lead to a ___ rate of actual inflation and a high rate of expected inflation tends to lead to a ____ rate of actual inflation.

low; high

Starting from long-run equilibrium, a positive inflation shock results in a short-run equilibrium with ___ inflation and ____ output.

lower; higher

If the interest rate in the U.S. rises, U.S. financial assets become ______ attractive to buyers and the ______ U.S. dollars will rise.

more; demand for

Firms suddenly becoming pessimistic about future business prospects is an example of a ______ demand shock, which

negative; left

When actual output equals potential output, there is ______ output gap and the inflation rate will ____.

no; be equal to the expected rate of inflation

When actual output equals potential output there is ____ output gap and the rate of inflation will tend to ____.

no; remain the same

A demand shock is a change in planned spending that is:

not caused by changes in output or changes in the inflation rate

An increase in the interest rate directly affects ______, but also has an indirect effect on ______ because of its effect on exchange rates.

planned consumption and investment; net exports

The aggregate demand curve shifts when there are changes in:

planned spending that are not caused by changes in output or the inflation rate

A sudden increase in household wealth is an example of a ______ demand shock, which would shift the AD curve to the ______.

positive; right

Refer to the figure above. The economy pictured in the figure has a(n) ______ gap with a short-run equilibrium indicated by point ___.

recessionary; A

Starting from potential output, if consumer confidence decreases and consumers decide to spend less, then this will generate a(n) _____ gap and inflation will _____.

recessionary; decrease

Starting from potential output, if firms become less optimistic about the future and decide to decrease their investment in new capital, then this will generate a(n) _____ gap and inflation will _____.

recessionary; decrease

Starting from long-run equilibrium, a large decrease in government purchases will result in a(n) ______ gap in the short-run and ____ inflation and ____ output in the long-run

recessionary; lower; potential

An increase in aggregate supply is usually shown by a ______ shift of the AS curve.

rightward

When the inflation rate decreases, PAE ______, which in turn causes Y to ______ because of ______.

rises; rise; the

The self-correcting property of the economy means that output gaps are eventually eliminated by:

rising or falling prices.

Graphically, long-run equilibrium occurs at the intersection of the aggregate demand curve and:

the aggregate supply curve and potential output.

The fact that output gaps will not last indefinitely, but will be closed by rising or falling prices is the economy's:

self-correcting property.

Refer to the figure above. Suppose that the economy is initially in equilibrium with output Y2 and inflation rate of π3. An increase in military spending will:

shift AD from AD2 to AD1.

Changes in the expected rate of inflation will:

shift the AS curve upward or downward.

The AD curve ______ because, holding all else constant, an increase in ______ causes C, IP and NX to fall.

slopes downward; the inflation rate

A circle of low expected inflation leads to ____ increases in wages and costs and to ____ actual inflation.

small; low

The AS curve slopes upward because:

some firms will increase their prices and their output in response to an increase in aggregate demand.