ECON 3130 Final

Using the Keynesian-cross analysis, assume that the consumption function is given by C = 100 + 0.6(Y - T). If planned investment is 100 and T is 100, then the level of G needed to make equilibrium Y equal 1,000 is:

260

If the money supply increases 12 percent, velocity decreases 4 percent, and the price level increases 5 percent, then the change in real GDP must be ______ percent.

5+4=9 12-9=3

Suppose that an economy is currently experiencing 10 percent unemployment and 15 percent inflation. If in the process of bringing inflation down by 2 percentage points real GDP falls by 8 percent for a year, the sacrifice ratio is ...

8%/2% = 4% GDP growth forgone to reduce inflation by 1%

AD-AS versus IS-LM model

AD-AS model focuses on the dynamics of output and price level (Y & P) IS-LM model focuses on the dynamics of output and interest rate (Y & i)

What happens to the IS-LM and AD-AS graphs during the following 2001 events: 1. Stock market crash 2. 9/11 3. Corporate Enron fraud accounting

All of these events translate into contractionary policy of the IS curve, affecting the AD curve similarly, due to fall of consumption and investment

Why is the LM curve upward sloping?

An increase in income raised money demand

Natural Rate Hypothesis

Unemployment in the long run eventually returns to its natural rate (Un) regardless of inflation rate

How do we find information of Y, P, and i all at once?

Use complementary ISLM and ADAS curves

When a long-term aggregate supply curve is drawn with real GDP (Y) along the horizontal axis and the price level (P) along the vertical axis, this curve is horizontal or vertical?

Vertical

Investment-Savings Curve (IS) equation

Y=C(Y-T)+G+I(i)+NX T and G are fixed, showing the IS curve taking fiscal policy as a given Movement along IS curve only occur when interest rate i changes

Are business cycles irregular and unpredictable?

Yes

Modified Phillips Curve

Yes there is a short-run relationship between inflation and unemployment but it breaks down in the long-run. The relationship is negative sloping

A favorable supply shock occurs when: a. an oil cartel breaks up and oil prices fall. b. environmental protection laws raise costs of production. c. the Fed increases the money supply. d. unions push wages up.

a. an oil cartel breaks up and oil prices fall.

When planned expenditure is drawn on a graph as a function of income, the slope of the line is: a between zero and one. b zero. c one. d greater than one.

a. between zero and one

The IS and LM curves together generally determine: a. both income and the interest rate. b. the interest rate only. c. income, the interest rate, and the price level. d. income only.

a. both income and the interest rate

Assume that the market basket of goods and services purchased in 2004 by the average family in the United States costs $14,000 in 2004 prices, whereas the same basket costs $21,000 in 2009 prices. However, the basket of goods and services actually purchased by the average family in 2009 costs $20,000 in 2009 prices, whereas this same basket would have cost $15,000 in 2004 prices. Given this data, a Laspeyres price index of 2009 prices using 2004 as the base year would be:

($21,000/$14,000) 1.50

Is change in unemployment due to inflation per se, or just anticipation of unemployment?

Anticipation of unemployment

How can Fed achieve disinflation without increasing unemployment?

By creating credible monetary policy (Mp) aimed at reducing π expectations, i.e. E[π]

In the short-run, how can the Fed decrease unemployment below the natural rate?

By making inflation greater than what is expected by firms and workers

Expected/planned output E[Y]

C0+C(Y-T)+I+G+NX-UII

Keynesian Cross consumption function

C=C0+C(Y-T) Where C is an increasing function of Y-T, disposable income The slope of the consumption function is the marginal propensity to consume (MPC)

Assume that apples cost $0.50 in 2002 and $1 in 2009, whereas oranges cost $1 in 2002 and $0.50 in 2009. If 10 apples and 5 oranges were purchased in 2002, and 5 apples and 10 oranges were purchased in 2009, the CPI for 2009, using 2002 as the base year, is:

CPI 2009: ($1*10)+($0.50*5)=12.5 CPI 2002: ($0.50*10)+($1*5)=10 12.5/10=1.25 CPI= Current/Base year

Sacrifice ratio

Change in growth / change in inflation

IS Shocks

Exogenous changes in demand for g&s, or any components of AD Caused by stock market boom/crash, change in consumer or expectations (change in I or C)

How does expansionary fiscal policy shift the IS an AD curve?

Expansionary fiscal policy shits IS curve right, raising income, raising consumption, shifting AD curve right

How does expansionary monetary policy shift the LM an AD curve?

Expansionary monetary policy shifts the LM curve right, raising income and consumption, shifting the AD curve right

In the long-run, what happens to expected inflation?

Expected inflation catches up to reality π=E[π], and unemployment goes back to its natural rate whether inflation is high or low

What is on the vertical axis of the Keynesian Cross?

Expected/planned output E[Y] which is: actual output-unplanned inventory investment All KC variables are exogenous, meaning that change of any AD component results in a shift of E[Y] curve

When does the IS curve shift, and when do we move along the curve?

Fiscal policy shifts the IS curve, i.e. G or T. Interest rate changed corresponds with movement along the curve

IS curve

Goods and services market, shows investment-savings curve Built on the Keynesian Cross, using fact that planned investment is a negative function of interest rate

The Keynesian Cross is used to illustrate multiplier effects on fiscal policy, which include which two variables?

Government spending and taxes

If congress raises government spending, the Fed might hold M (money supply) constant. In this case, what happens to the LM curve? Remember M/P=L(i;Y)

If Fed holds M constant, then LM curve doesn't shift

What are the Okun costs of reducing inflation?

In the short-run, output falls and unemployment rises In the long-run, output and unemployment return to natural rates

Liquidity-Money (LM Curve) equation

M/P=L(i;Y)

Keynesian Cross

Model of income determination with expenditures Illustrates multiplier effects of: -fiscal policy on income -GDP expenditure category on income

Monetary neutrality

Proposition that changes in money supply do not affect real variables, which holds in the long-run but does not hold in the short-run

How does the fed use disinflation?

Reduce money supply, which reduces aggregate demand (AD), slowing money growth and inflation

According to the popular definition, recessions are periods of at least ______ consecutive quarters of declining real GDP.

Two; 6 mo.

For the IS ``--.. curve, when does the curve shift and when do we move along the curve?

Shift curve when fiscal policy changes G or T, if the curve shifts right it is expansionary policy, if it shifts left it is contractionary policy. Move along curve when interest rate i changes

For the LM ..--`` curve, when does the curve shift and when do we move along the curve?

Shift curve when monetary policy changes, if the curve shifts right it is expansionary policy, if it shifts left it is contractionary policy. Move along curve when interest rate i changes

Which is larger, tax multiplier or government expenditure multiplier?

Tax multiplier is much smaller than the government expenditure multiplier

How MPC of a part time employed student will differ from MPC of a full-time employed professional, if any? How MPC of a Oprah Winfrey will differ from MPC of a full-time employed professor of economics? Bonus: if consumption function is C=100+0.6(Y-T) what is its slope and what is C0?

The MPC is probably higher for a part-time student, and it is also higher for a full-time employed economics professor. This is because higher income=less MPC. The slope would be dC/dY=MPC=0.6 and C0 would be 100.

Keynes liquidity theory of preference

Theory in which interest rate is determined by money supply and money demand

If congress raises government spending, the Fed might hold Y (output) constant. In this case, what happens to the LM curve? Remember M/P=L(i;Y)

To keep Y constant, the Fed will have to decrease M, which shift the LM curve left.

If congress raises government spending, the Fed might hold i (interest rate) constant. In this case, what happens to the LM curve? Remember M/P=L(i;Y)

To keep i constant, the Fed will have to increase M, which would shift the LM curve right.

What does a sacrifice ratio alpha=5 mean? What does it mean for unemployment?

To reduce inflation by 1%, you must sacrifice 5% of a year's output Essentially, disinflation requires an economy enduring a period of low output (Y) and high unemployment (U)

According to the classical dichotomy, when the money supply decreases, _____ will decrease.

a. consumption spending b. the price level c. real GDP d. investment spending

In the IS-LM model, which two variables are influenced by interest rate? a. demand for real money balances and investment spending b. supply of nominal money balances and investment spending c. demand for real money balances and government purchases d. supply of nominal money balances and demand for real balances

a. demand for real money balances and investment spending

An increase in taxes shifts the IS curve, drawn with income along the horizontal axis and the interest rate along the vertical axis: a. downward and to the left b. downward and to the right. c. upward and to the right. d. upward and to the left.

a. downward and to the left

An increase in the saving rate starting from a steady state with less capital than the Golden Rule causes investment to ______ in the transition to the new steady state. a. increase b. decrease c. first increase, then decrease d. first decrease, then increase

a. increase

Over the business cycle, investment spending ______ consumption spending. a. is more volatile than b. has about the same volatility as c. is less volatile than d. is inversely correlated with

a. is more volatile than

If the short-run aggregate supply curve is horizontal, then changes in aggregate demand affect: a. level of output but not prices. b. prices but not level of output. c. neither prices nor level of output. d. both prices and level of output.

a. level of output but not prices.

Monetary neutrality, the irrelevance of the money supply in determining values of _____ variables, is generally thought to be a property of the economy in the long run. a. real b. nominal c. real and nominal d. neither real or nominal

a. real

Stabilization policy refers to policy actions aimed at: a. reducing the severity of short-run economic fluctuations. b. equalizing incomes of households in the economy. c. ensuring free flow of goods and services across states. d. balancing government budget.

a. reducing the severity of short-run economic fluctuations.

John Maynard Keynes wrote that responsibility for low income and high unemployment in economic downturns should be placed on low_________ ___________

aggregate demand

The relationship between the quantity of goods and services supplied and the price level is called:

aggregate supply

In the Keynesian-cross model, fiscal policy has a multiplied effect on income because fiscal policy: a. increases the amount of money in the economy. b. changes income, which changes consumption, which further changes income. c. changes the interest rate. d. is government spending and, therefore, more powerful than private spending.

b. changes income, which changes consumption, which further changes income

Two economies are identical except that the level of capital per worker is higher in Highland than in Lowland. The production functions in both economies exhibit diminishing marginal product of capital. An extra unit of capital per worker increases output per worker: a. more in Highland. b. more in Lowland. c. by the same amount in Highland and Lowland. d. in Highland, but not in Lowland.

b. more in Lowland

For the purposes of the Keynesian cross, planned expenditure consists of: a.planned investment. b. planned investment, government spending, and consumption expenditures. c. planned government spending. d. planned investment and government spending.

b. planned investment, government spending, and consumption expenditures

Consider the IS-LM model. For any given interest rate and price level, an increase in the money supply: a. lowers velocity b. raises income c. lowers income d. has no effect on income

b. raises income

The IS-LM model takes ______ as exogenous. a. the price level and national income b. the price level c. the interest rate d. national income

b. the price level

The CPI is determined by computing: a. the price of a basket of goods and services that changes every year, relative to the same basket in a base year. b. the price of a fixed basket of goods and services, relative to the price of the same basket in a base year. c. an average of prices of all goods and services. d. nominal GDP relative to real GDP.

b. the price of a fixed basket of goods and services, relative to the price of the same basket in a base year.

In the Keynesian-cross model, if the MPC equals 0.75, then a $1 billion increase in government spending increases planned expenditures by ______ and increases the equilibrium level of income by ______. a. $0.75 billion; $0.75 billion b. $1 billion; $1 billion c. $1 billion; more than $1 billion d. $0.75 billion; more than $0.75 billion

c. $1 billion; more than $1 billion

In the Keynesian-cross model, actual expenditures equal: a. the supply of real balances b. the money supply c. GDP d. unplanned inventory investment

c. GDP

According to the Keynesian-cross analysis, if MPC stands for marginal propensity to consume, then a rise in taxes of ΔT will: a. not affect equilibrium income at all. b. decrease equilibrium income by ΔT/(1 - MPC). c. decrease equilibrium income by (ΔT)(MPC)/(1 - MPC). d. decrease equilibrium income by ΔT.

c. decrease equilibrium income by (ΔT)(MPC)/(1 - MPC)

The IS curve shifts when any of the following economic variables change except: a. government spending b. tax rates c. the interest rate d. the marginal propensity to consume

c. the interest rate

The simple investment function shows that investment ______ as ______ increases. a. decreases; government spending b. increases; the interest rate c. decreases; the interest rate d. increases; government spending

c. decreases; the interest rate

In the Keynesian-cross model, if taxes are reduced by 250, then the equilibrium level of income: a. increases by 250. b. decreases by 250. c. increases by more than 250. d. increases, but by less than 250.

c. increases by more than 250

The production function y=f(k) means: a. labor is not a factor of production. b. output per worker is a function of labor productivity. c. output per worker is a function of capital per worker. d. the production function exhibits increasing returns to scale.

c. output per worker is a function of capital per worker

The quantity theory of money assumes that: a. prices are constant. b. the money supply is constant. c. velocity is constant. d. income is constant.

c. velocity is constant

A country is likely to have a lower sacrifice ratio if ... a) contracts are longer, and people believe the central bank will reduce inflation. b) contracts are longer, and people believe the central bank will not reduce inflation. c) contracts are shorter, and people believe the central bank will reduce inflation. d) contracts are shorter, and people believe the central bank will not reduce inflation.

c.) contracts are shorter, and people believe the central bank will reduce inflation

Which of the following would we not expect if government policy moved the economy up along a given short-run Phillips curve? a) Joe makes larger increases in the prices at his health food store b) Jessica's nominal wage increase is larger c) Paul reads in the newspaper that the central bank recently raised the money supply d) Louisa gets fewer job offers

d) Louisa gets fewer job offers

Changes in fiscal policy shift the: a. LM curve b. money demand curve (M/P D) c. money supply curve (M/P S) d. IS curve

d. IS curve

According to the Keynesian-cross analysis, when there is a shift upward in the government-purchases schedule by an amount ΔG and the planned expenditure schedule by an equal amount, then equilibrium income rises by: a. change in G multiplied by the quantity one plus the marginal propensity to consume b. one unit c. change in G d. change in G divided by the quantity one minus the marginal propensity to consume

d. change in G divided by the quantity one minus the marginal propensity to consume

Two reasons why capital may not flow to poor countries are that the poorer countries may: a. have economies unlike those described by a Cobb-Douglas production function and not be subject to diminishing returns to capital. b. have already accumulated high levels of capital c. legally prevent the inflow of foreign capital and provide strong legal protection of private property. d. have inferior production capabilities and not enforce property rights.

d. have inferior production capabilities and not enforce property rights

If the real interest rate and real national income are constant, according to the quantity theory and the Fisher effect, a 1 percent increase in money growth will lead to rises in: a. inflation of 1 percent and the nominal interest rate of more than 1 percent. b. both inflation and the nominal interest rate of less than 1 percent. c. inflation of 1 percent and the nominal interest rate of less than 1 percent. d. inflation of 1 percent and the nominal interest rate of 1 percent.

d. inflation of 1 percent and the nominal interest rate of 1 percent.

In the Solow growth model with no population growth and no technological progress, the higher the steady capital-per-worker ratio, the higher the steady-state: a. growth rate of total output. b. level of consumption per worker. c. growth rate of output per worker. d. level of output per worker.

d. level of output per worker

When the Federal Reserve reduces the money supply, at a given price level the amount of output demanded is ______ and the aggregate demand curve shifts ______. a. lower; right b. greater; right c. greater; left d. lower; left

d. lower; left

The IS-LM model is generally used: a. only in the long run b. both in the short run and long run c. in determining price level d. only in the short run

d. only in the short run

The rate of inflation is the: a. average level of prices. b. median level of prices. c. measure of the overall level of prices. d. percentage change in the level of prices.

d. percentage change in the level of prices.

The best measure of the economic satisfaction (well-being) of the members of a society is: a. the rate of inflation. b. nominal GDP. c. the value of corporate profits. d. real GDP.

d. real GDP.

An increase in the price of imported goods will show up in: a. the GDP deflator but not in the CPI. b. neither the CPI nor the GDP deflator. c. both the CPI and the GDP deflator. d. the CPI but not in the GDP deflator.

d. the CPI but not in the GDP deflator.

In 2001, Congress and President Bush instituted tax cuts. According to the short-run Phillips curve, in the short run this change should have... a) reduced inflation and unemployment. b) raised inflation and unemployment. c) reduce inflation and raised unemployment. d) raised inflation and reduced unemployment.

d.) raised inflation and reduced unemployment

The core inflation rate excludes...

food and energy prices.

Between 1880 and 1896, the price level in the United States fell 23 percent. This movement was ______ for bankers of the Northeast and ______ for farmers of the South and West.

good; bad

If nominal GDP increased by 5 percent and the GDP deflator increased by 3 percent, then real GDP ______ by ______ percent

increased; 2

In the Keynesian-cross model with a given MPC, the government-expenditure multiplier ______ the tax multiplier.

is larger than

Most economists believe that prices are flexible in the _____ run but sticky in the _____ run

long; short

If nominal GDP in 2009 equals $14 trillion and real GDP in 2009 equals $11 trillion, what is the value of the GDP deflator?

nom GDP/real GDP = GDP deflator $14T/$11T=1.27

If the short-run aggregate supply curve is horizontal and the long-run aggregate supply curve is vertical, then a change in the money supply will change ______ in the short run and change ______ in the long run. a. only prices; only output b. only output; only prices c. both prices and output; only prices d. both prices and output; both prices and output

only output; only prices

Starting from long-run equilibrium, an increase in aggregate demand increases ______ in the short run, but only increases ______ in the long run.

output; price

Variables expressed in terms of physical units or quantities are called ______ variables.

real