Chapter 14

According to the sticky-price model:

D) some firms announce their prices in advance, and some firms set their prices in accord with observed prices and output.

70. All of the following are requirements for reducing inflation without causing a recession except:

D) the government's budget must be balanced.

33. According to the Phillips curve, other things being equal, inflation depends positively on:

A) expected inflation.

According to the sticky-price model, deviations of output from the natural level are _____ deviations of the price level from the expected price level.

A) positively associated with

Each of the two models of short-run aggregate supply is based on some market imperfection. In the sticky-price model, the imperfection is that:

A) some firms do not adjust their prices instantly to changes in demand.

In the sticky-price model, the relationship between output and the price level depends on:

A) the proportion of firms with flexible prices.

61. (Exhibit: Short-Run Phillips Curve) As the short-run Phillips curve shifts from A to B to C to D:

B) there is a lower-expected rate of inflation at every level of unemployment.

90. Assume that an economy has the Phillips curve π = π-1 - 0.5(u - 0.06). Then the natural rate of unemployment is:

C) 0.06.

66. Assume that the sacrifice ratio for an economy is 4. If the central bank wishes to reduce inflation from 10 percent to 5 percent, this will cost the economy ______ percent of one year's GDP.

C) 20

51. (Exhibit: AD-AS Shifts) Starting from long-run equilibrium at A with output equal to and the price level equal to P1, a cost-push inflation would be represented by a shift from:

C) AS1 to AS2

26. Which of the following will shift the aggregate supply curve up to the left?

C) an increase in the expected price level

43. The assumption of adaptive expectations for inflation means that people will form their expectations of inflation by:

C) basing their opinions on recently observed inflation.

14. According to the imperfect-information model, when the price level falls but the producer did not expect it to fall, the producer:

C) decreases production.

19. The short-run aggregate supply curve is drawn for a given:

C) expected price level

13. 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:

C) firms confuse changes in the overall level of prices with changes in relative prices.

75. According to the natural-rate hypothesis, output will be at the natural rate:

C) in the long run.

38. The classical dichotomy breaks down for a Phillips curve, which shows the relationship between a nominal variable, ______, and a real variable, ______.

C) inflation, unemployment

17. Using the sticky-price model, the higher the average rate of inflation, the more frequently firms must adjust their prices, which implies that a high rate of inflation:

C) makes the short-run aggregate supply curve steeper.

76. A recession may alter an economy's natural rate of unemployment in all of the following ways except by:

C) permanently reducing the money supply.

114. How is demand-pull inflation different from cost-push inflation?

Demand-pull inflation is caused by the increase in demand for goods in an economy, which in fact is an indicator of high employment. Cost-push inflation is the result of supply change that increase production costs.

108. Are relative prices or nominal prices the right indicators in the context of supply changes?

Relative prices are the right indicators in the context of supply changes as they take into account the effect of overall price changes in an economy.

112. What is meant by the "cold turkey solution" to inflation?

When the inflation is reduced rapidly with a fall in output it is called as a cold turkey solution.

49. Cost-push inflation is the result of:

D) adverse supply shocks.

115. What is the natural rate hypothesis? Explain the term NAIRU.

The natural rate hypothesis states that fluctuations in demand only have a short run effect on output and employment. The term NAIRU is an acronym for non-accelerating inflation rate of unemployment.

20. Both models of aggregate supply discussed in Chapter 14 imply that if the price level is higher than expected, then output ______ natural rate of output.

A) exceeds the

29. (Exhibit: AD-AS Shifts) Starting from long-run equilibrium at A with output equal to and the price level equal to P1, if there is an unexpected monetary contraction that shifts aggregate demand from AD1 to AD3, then the long-run neutrality of money is represented by the movement from:

A) A to B

52. (Exhibit: AD-AS Shifts) Starting from long-run equilibrium at A with output equal to and the price level equal to P1, a demand-pull inflation would be represented by a shift from:

A) AD1 to AD2

94. Assume that an economy has the usual type of Phillips curve except that the natural rate of unemployment in an economy is given by an average of the unemployment rates in the last two years. Then, there is:

A) a long-run tradeoff between inflation and unemployment.

42. If the equation for a country's Phillips curve is π = 0.02 - 0.8(u - 0.05), where π is the rate of inflation and u is the unemployment rate, what is the short-run inflation rate when unemployment is 4 percent (0.04)?

A) above 2 percent (0.02)

79. According to the natural-rate hypothesis, the levels of output and unemployment depend on:

A) aggregate demand in the short run, but not in the long run.

15. After examining international data, the economist Robert Lucas found that aggregate demand has the biggest effect on output in countries where aggregate demand:

A) and prices are most stable.

18. According to the imperfect-information model, when the price level is greater than the expected price level, output will _____ the natural level of output

A) be greater than

83. If price expectations are assumed to be correct, money demand is proportional to income, and there are no international capital flows, then the mother of all models in the Appendix to Chapter 14 corresponds to which of the following special cases

A) classical closed economy

47. Demand-pull inflation is the result of:

A) high aggregate demand.

59. 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

78. If the hypothesis of hysteresis is correct and output is lost even after a period of disinflation, the sacrifice ratio for an economy will:

A) increase.

68. The assumption of rational expectations for inflation means that people will form their expectations of inflation by:

A) optimally using all available information, including information about current policies, to forecast the future.

36. 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

56. The short-run Phillips curve:

A) shifts upward if expected inflation increases

37. All of the following are ways that the modern Phillips curve differs from the relationship observed by A. W. Phillips in 1958 except that the modern Phillips curve:

A) substitutes the output gap for unemployment.

32. The Phillips curve depends on all of the following forces except:

A) the current exchange rate.

46. To illustrate inflation inertia in an aggregate demand-aggregate supply model, the short-run aggregate supply curve shifts upward because of increases in ______, and the aggregate demand curve shifts upward because of increases in ______.

A) the expected price level

81. The endogenous variables of the mother of all models in the Appendix to Chapter 14 include the level of output, the natural rate of output, the price level, and

A) the real and nominal interest rates.

According to the sticky-price model, other things being equal, the greater the proportion, s, of firms that follow the sticky-price rule, the ______ the ______ in output in response to an unexpected price increase.

A) greater, increase

91. Assume that an economy has the Phillips curve π = π-1 - 0.5(u - 0.06). How many percentage-point-years of cyclical unemployment are needed to reduce inflation by 5 percentage points?

B) 10

72. The estimate of the sacrifice ratio from the Volcker disinflation is approximately:

B) 2.5-3.

28. (Exhibit: AD-AS Shifts) Starting from long-run equilibrium at A with output equal to and the price level equal to P1, if there is an unexpected monetary contraction that shifts aggregate demand from AD1 to AD3, then the short-run nonneutrality of money is represented by the movement from:

B) A to G

60. (Exhibit: Short-Run Phillips Curve) As the short-run Phillips curve shifts from A to B to C to D, policymakers face:

B) a lower rate of inflation for any level of unemployment.

84. If price expectations are assumed to be correct, money demand is proportional to income, and net capital flow is infinitely elastic, then the mother of all models in the Appendix to Chapter 14 corresponds to which of the following special cases?

B) classical open economy

54. The most prominent feature of the U.S. economy in the 1970s was:

B) cost-push inflation.

12. According to the imperfect-information model, when the price level rises by the amount the producer expected it to rise, the producer:

B) does not change production.

58. The tradeoff between inflation and unemployment does not exist in the long run because people will adjust their expectations so that expected inflation:

B) equals the inflation rate.

25. Along any aggregate supply curve, there is only one:

B) expected price level.

21. Both models of aggregate supply discussed in Chapter 14 imply that if the price level is lower than expected, then output ______ natural rate of output.

B) falls below the

63. Economists are able to estimate the natural rate of unemployment in the United States:

B) in a 95 percent confidence interval of 2 to 3 percentage points.

57. The Phillips curve analysis described in Chapter 14 implies that there is a negative tradeoff between inflation and unemployment in:

B) in the short run only.

45. Inflation inertia refers to the idea that inflation:

B) keeps on going unless something acts to stop it.

24. Along an aggregate supply curve, if the level of output is less than the natural level of output, then the price level is:

B) less than the expected price level.

71. Advocates of the rational-expectations approach predict that a credible policy to lower inflation will ______ the sacrifice ratio.

B) lower

93. If only unanticipated changes in the money supply affect real GDP, the public has rational expectations, and everyone has the same information about the state of the economy, then:

B) monetary policy cannot be used to systematically stabilize output.

74. According to the natural-rate hypothesis, fluctuations in aggregate demand affect output in:

B) only in the short run.

35. If the short-run aggregate supply curve is steep, the Phillips curve will be:

B) steep.

11. The imperfect-information model assumes that producers find it difficult to distinguish between changes in:

B) the overall level of prices and relative prices.

16. According to the imperfect-information model, in countries in which there is a great deal of variability of prices:

B) the response of output to unexpected changes in prices will be relatively small.

65. The percentage of a year's real GDP that must be foregone to reduce inflation by 1 percentage point is called the:

C) sacrifice ratio.

27. In the short-run, if the price level is greater than the expected price level, then in the long run the aggregate:

C) supply curve will shift upward.

The imperfect-information model bases the difference in the short-run and long-run aggregate supply curve on:

C) temporary misperceptions about prices.

48. In the case of demand-pull inflation, other things being equal:

C) the inflation rate rises but the unemployment rate falls.

50. In the case of cost-push inflation, other things being equal:

C) the inflation rate rises but the unemployment rate falls.

53. In the 1960s, in the United States:

C) the inflation rate rose but the unemployment rate fell.

22. Starting from the natural level of output, an unexpected monetary contraction will cause output and the price level to ______ in the short run, and in the long run the expected price level will ______, causing the level of output to return to the natural level.

C) decrease, decrease

Some firms do not instantly adjust the prices they charge in response to changes in demand for all of the following reasons except:

C) prices do not adjust when there is perfect competition.

Based on the sticky-price model, the short-run aggregate supply curve will be steeper, the greater the:

C) proportion of firms with flexible prices.

According to the sticky-price model, output will be at the natural level if:

C) the price level equals the expected price level.

77. The idea that the natural rate of unemployment is increased following extended periods of unemployment is called:

D) hysteresis.

69. The rational-expectations point of view, in the most extreme case, holds that if policymakers are credibly committed to reducing inflation, and rational people understand that commitment and quickly lower their inflation expectations, then the sacrifice ratio will be approximately:

D) 0.

67. An economy must sacrifice 12 percent of GDP to reduce inflation. Which of the following plans represents the "cold turkey" solution to inflation?

D) Reduce output by 12 percent for 1 year.

44. Inflation inertia is represented in the aggregate supply-aggregate demand model by continuing upward shifts in the:

D) aggregate demand and short-run aggregate supply curves.

89. In the sticky-price model, if no firms have flexible prices, the short-run aggregate supply schedule will:

D) be horizontal.

34. The Phillips curve expresses a short-run link:

D) between nominal and real variables.

62. Each of the following phenomena hinders the precise estimation of the natural rate of unemployment except:

D) introduction of new products such as DVD players.

31. The relationship between short-run aggregate supply curves and Phillips curves is that there:

D) is exactly one Phillips curve corresponding to each short-run aggregate supply curve.

30. The Phillips curve shows a ______ relationship between inflation and unemployment, and the short-run aggregate supply curve shows a ______ relationship between the price level and output.

D) negative, positive

41. When adaptive expectations are used to model inflation expectations in the Phillips curve, then the natural rate of unemployment is called the ______ rate of unemployment.

D) nonaccelerating inflation

23. The model of aggregate demand and aggregate supply is consistent with short-run monetary ______ and long-run monetary ______.

D) nonneutrality, neutrality

64. The sacrifice ratio measures the:

D) percentage of a year's real gross domestic product (GDP) that must be foregone to reduce inflation by 1 percentage point.

82. All of the following are exogenous variables in the mother of all models in the Appendix to Chapter 14 except the:

D) price level.

92. The government can lower inflation with a low sacrifice ratio if the:

D) public believes that policymakers are committed to reducing inflation.

80. Each of the following conditions will tend to reduce the sacrifice ratio except when:

D) the concept of hysteresis accurately describes the impact of history on the natural rate of unemployment.

73. The hypothesis that hysteresis may play an important role in macroeconomics implies, among other things, that:

D) the natural rate of unemployment may increase if unemployment is high for a long period of time.

39. Based on the Phillips curve, unexpected movements in inflation are related to ______, and based on the short-run aggregate supply curve, unexpected movements in the price level are related to ______.

D) unemployment, output 40. The NAIRU is the:/C) nonaccelerating inflation rate of unemployment.

The basic aggregate supply equation implies that output exceeds natural output when the price level is:

D) greater than the expected price level.

113. How is hysteresis related to recession? Explain.

Hysteresis is the term used to explain the long-lasting effect of recession on unemployment. The recession could permanently affect the unemployment scene in the economy

109. Explain the economist Robert Lucas's view on the imperfect-information model?

Lucas pointed out that it is the limited ability of people to absorb and process widely available information that that causes price setters to respond slowly to changes in macroeconomic situations.

110. How does the Phillip curve explain the tradeoff between the unemployment and inflation? Illustrate with a graph.

The Phillips curve is used to analyze unemployment and inflation in an economy. It shows a negative relationship between them. One could choose a higher inflation with lower unemployment or vice versa.

111. Does the Phillips curve relationship between unemployment and inflation hold in the long run? Explain.

The Phillips curve tradeoff between unemployment and inflation does not hold in the long run, as in the long run people adjust their expectations of inflation.

107. What is the shape of the short-run supply curve? Explain.

The short-run supply curve is upward sloping. It reflects that if output deviates from natural level, prices deviate from expected price levels.

55. The most prominent feature of the U.S. economy in the 1980s was:

demand-pull deflation.