ECON Final

Change of unemployment rate =

-1/2 x (% change real GDP - 3%)

The Federal Reserve decreases the money supply

AD left

Americans feel more secure in their jobs and become more optimistic

AD right

The government repairs aging roads and bridges

AD right

Theory of Liquidity Preference

Keynes's theory that the interest rate adjusts to bring money supply and money demand into balance

Because price expectations are reduced, wage demands of new college graduates fall

SRAS right

The government increases the minimum wage

SRAS/LRAS left

The government raises unemployment benefits, which raises the natural rate of unemployment

SRAS/LRAS left

A technological advance take place in the application of computers to the manufacturing of steel

SRAS/LRAS right

A drought destroys much of the Midwest corn crop

SRAS; left LRAS; "it depends"

Which of the following is not an argument in support of using tax cuts to fight recessions? a. tax cuts have a more direct impact on aggregate demand than government spending b. tax cuts decentralize spending decisions by allowing households to spend on things they have c. tax cuts shift aggregate supply to the right, relieving inflationary pressures d. tax cuts can provide incentives for the unemployed to find work and the employed to work longer hours

a. tax cuts have a more direct impact on aggregate demand than government spending

When an increase in government purchases increases the income of some people, and those people spend some of that increase in income on additional consumer goods, we have seen a demonstration of a. the multiplier effect b. the investment accelerator c. the crowding-out effect d. supply-side economics e. none of the above

a. the multiplier effect

Wealth Effect

at a lower price level, all assets with fixed face value are worth more. Consumers spend more

Interest-Rate Effect

at a lower price level, interest rates are lower and there is more interest-sensitive expenditure

If the marginal propensity to consume (MPC) is 0.75, the value of the multiplier is a. 0.75 b. 4 c. 5 d. 7.5 e. none of the above

b. 4

Which of the following statements regarding taxes is correct? a. most economists believe that, in the short run, the greatest impact of a change in taxes is on aggregate supply, not aggregate demand b. a permanent change in taxes has a greater effect on aggregate demand than a temporary change in taxes c. an increase in taxes shifts the aggregate-demand curve to the right d. a decrease in taxes shifts the aggregate-supply curve to the left

b. a permanent change in taxes has a greater effect on aggregate demand than a temporary change in taxes

The discrepancy between policy announcements and policy actions is known as the a. political business cycle b. time inconsistency of policy c. discretionary effect d. substitution effect e. income effect

b. time inconsistency of policy

When actual inflation exceeds expected inflation, a. unemployment is greater than the natural rate of unemployment b. unemployment is less than the natural rate of unemployment c. unemployment is equal to the natural rate of unemployment d. people will reduce their expectations of inflation in the future

b. unemployment is less than the natural rate of unemployment

Sticky-Wage Theory

because wages are stuck by custom or contract in the short run, production is profitable when prices rise suddenly OR when price level falls, production is unusually profitable because wages don't adjust downwards fast as prices

A decrease in the price of foreign oil a. shifts the short-run Philips curve upward, and the unemployment-inflation trade-off is more favorable b. shifts the shot-run Phillips curve upward, and the unemployment-inflation trade-off is less favorable c. shifts the sort-run Phillips curve downward, and the unemployment-inflation trade-off is more favorable d. shifts the short-run Phillips curve downward, and the unemployment-inflation trade-off is less favorable

c. shifts the short-run Phillips curve downward, and the unemployment-inflation trade-off is more favorable

In the model of aggregate demand and aggregate supply, the initial impact of an increase in consumer optimism is to a. shift short-run aggregate supply to the right b. shift short-run aggregate supply to the left c. shift aggregate demand to the right d. shift aggregate demand to the left e. shift long-run aggregate supply to the left

c. sift aggregate demand to the right

What shifts AD?

consumption, investment, government purchases, net exports

Aggregate-Supply Curve

curve that shows the quantity of goods and services that firms choose to produce and sell at each price level

Aggregate-Demand Curve

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

Phillips Curve

curve that shows the short-run trade-off between inflation and unemployment

Suppose the economy is initially in long-run equilibrium. Then suppose there is a drought that destroys much of the wheat crop. If policymakers allow the economy to adjust to long-run equilibrium on its own, according to the model of aggregate demand and aggregate supply, what happens to prices and output in the long run? a. prices rise; output is unchanged from its initial value b. prices fall; output is unchanged from its initial value c. output rises; prices are unchanged from the initial value d. output falls; prices are unchanged from the initial value e. output and the price level are unchanged from their initial values

e. output and price level are unchanged from their initial values

Marginal Propensity to Consume (MPC)

fraction of extra income that a household consumes rather than saves

Misery Index

measures the health of the economy (added together the inflation rate and the unemployment rate)

Model of Aggregate Demand and Aggregate Supply

model that most economists use to explain short-run fluctuations in economic activity around its long-run trend

Sacrifice Ratio

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

Crowding-Out Effect

offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending

Sticky Price Theory

prices slow to adjust because of menu costs, so firs hire and produce more to meet quantity demanded when AD surges

Natural Level of Output

production of goods and services that an economy achieves in the long run when unemployment is at its normal rate

Fiscal Policy

setting of the level of government spending and taxation by government policymakers

Misperceptions Theory

when AD pushes all prices up, producers at first misperceive this as a relative price increase and produce more

Recession

period of declining real incomes and rising unemployment

Stagflation

period of falling output and rising prices

Rational Expectations

theory that people optimally use all the information they have, including information about government policies, when forecasting the future

What shifts LRAS?

- anything that changed potential output or the natural rate of unemployment - labor, capital, resources, technological knowledge

What shifts SRAS?

- change in price level expectations - change in input prices

"Leaning Against the Wind"

- economy is fast = fed tries to slow it down - economy is slow = fed tries to speed it up

OPEC raises oil prices

SRAS left

Depression

a severe recession

According to the wealth effect, aggregate demand slopes downward (negatively) because a. lower prices increase the value of money holdings and consumer spending increases b. lower prices decrease the value of money holdings and consumer spending decreases c. lower prices reduce money holdings, increase lending, interest rates fall, and investment spending increases d. lower prices increase money holdings, decrease lending, interest rates rise, and investment spending falls

a. lower prices increase the value of money holdings and consumer spending increases

Fluctuations in the economy caused by policymakers' manipulation of the economy for the purpose of affecting electoral outcomes is known as the a. political business cycle b. time inconsistency of policy c. discretionary effect d. inflation targeting effect e. income effect

a. political business cycle

Policymakers are said to "accommodate" an adverse supply shock if they a. respond to the adverse supply shock by increasing aggregate demand, which further raises prices b. respond to the adverse supply shock by decreasing aggregate demand, which lowers prices c. respond to the adverse supply shock by decreasing short-run aggregate supply d. fail to respond to the adverse supply shock and allow the economy to adjust on its own

a. respond to the adverse supply shock by increasing aggregate demand, which further raises prices

An increase in the marginal propensity to consume (MPC) a. raises the value of the multiplier b. lowers the value of the multiplier c. has no impact on the value of the multiplier d. rarely occurs because the MPC is set by congressional legislation

a. rises the value of the multiplier

Suppose the economy is operating in a recession such as point B in Exhibit 4. If policymakers wished to move output to its long-run natural level, they should attempt to a. shift aggregate demand to the right b. shift aggregate demand to the left c. shift short-run aggregate supply to the right d. shift short-run aggregate supply to the left

a. shift aggregate demand to the right

When the supply and demand for money are expressed in a graph with the interest rate on the vertical axis and the quantity of money on the horizontal axis, an increase in the price level a. shifts money demand to the right and increases the interest rate b. shifts money demand to the left and increases he interest rate c. shifts money demand to the right and decreases the interest rate d. shifts money demand to the left and decreases the interest rate e. does none of the above

a. shifts money demand to the right and increases the interest rate

An increase in expected inflation a. shifts the short-run Philips curve upward, and the unemployment-inflation trade-off is less favorable b. shifts the short-run Philips curve downward, and the unemployment-inflation trade-off is more favorable c. shifts the short-run Phillips curve upward, and the unemployment-inflation trade-off is more favorable d. shifts the short-run Phillips curve downward, and the unemployment-inflation trade-off is less favorable

a. shifts the short-run Phillips curve upward, and the unemployment-inflation trade-off is less favorable

Suppose the price level falls. Because of fixed nominal wage contracts, firms become less profitable, and they cut back on production. This is a demonstration of the a. sticky-wage theory of the short-run aggregate-supply curve b. sticky-price theory of the sort-run aggregate-supply curve c. misperceptions theory of the short-run aggregate-supply curve d. classical dichotomy theory of the short-run aggregate-supply curve

a. sticky-wage theory of the short-run aggregate-supply curve

The original Phillips curve illustrates a. the trade-off between inflation and unemployment b. the positive relationship between inflation and unemployment c. the trade-off between output and unemployment d. the positive relationship between output and unemployment

a. the trade-off between inflation and unemployment

Multiplier Effect

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

Exchange-Rate Effect

at a lower price level with lower interest rates, the real exchange rate depreciates, causing more spending on net exports

Economists who support a zero inflation target for monetary policy make all of the following arguments except: a. even small levels of inflation impose permanent costs on the economy such as shoeleather costs and menu costs b. inflation erodes peoples' incomes, and zero inflation eliminates this problem c. the cost of reducing inflation to zero is temporary while the benefits are permanent d. the cost of reducing inflation to zero could be nearly eliminated if a zero inflation policy were credible

b. inflation erodes peoples' incomes, and zero inflation eliminated this problem

Which of the following statements is true regarding the long-run aggregate-supply curve? The long-run aggregate-supply curve a. shifts left when the natural rate of unemployment falls b. is vertical because an equal change in all prices and wages leaves output unaffected c. is positively sloped because price expectations and wages tend to be fixed in the long run d. shifts right when the government raises the minimum wage

b. is vertical because an equal change in all prices and wages leaves output unaffected

Suppose the economy is operating in a recession such as point B in Exhibit 4. If policymakers allow the economy to adjust to the long-run natural level on its own, a. people will raise their price expectations, and the sort-run aggregate supply will shift left b. people will reduce their price expectations, and the sort-run aggregate supply will shift right c. people will raise their price expectations, and aggregate demand will shift left d. people will reduce their price expectations, aggregate demand will shift right

b. people will reduce their price expectations, and the short-run aggregate supply will shift right

Suppose the economy is initially in long-run equilibrium. Then suppose there is a reduction in military spending due to the end of the Cold War. According to the model of aggregate demand and aggregate supply, what happens to prices and output in the long run? a. prices rise; output is unchanged from its initial value b. prices fall; output is unchanged from its initial value c. output rises; prices are unchanged from the initial value d. output falls; prices are unchanged from the initial value e. output and price level are unchanged from their initial values

b. prices fall; output is unchanged from its initial value

Suppose the economy is initially in long-run equilibrium. Then suppose there is a drought that destroys much of the wheat crop. According to the model of aggregate demand and aggregate supply, what happens to prices and output in the short run? a. prices rise; output rises b. prices rise; output falls c. prices fall; output falls d. prices fall; output rises

b. prices rise; output falls

Time Inconsistency of Policy

discrepancy between announcements and actions

If people have rational expectations, a monetary policy contraction that is announced and is credible could a. reduce inflation, but it would increase unemployment by an unusually large amount b. reduce inflation with little or no increase in unemployment c. increase inflation, but it would decrease unemployment by n unusually large amount d. increase inflation with little or no decrease in unemployment

b. reduce inflation with little or no increase in unemployment

Tax reform that encourages saving tends to a. shift the tax burden toward high-income people away from low-income people b. shift the tax burden toward low-income people away from high-income people c. reduce the rate of growth of output d. reduce the deficit

b. shift the tax burden toward low-income people away from high-income people

According to the Phillips curve, in the short run, if policymakers choose an expansionary policy to lower the rate of unemployment, a. the economy will experience a decrease in inflation b. the economy will experience an increase in inflation c. inflation will be unaffected if price expectations are unchanging d. none of the above is true

b. the economy will experience an increase in inflation

When an increase in government purchases causes firms to purchase additional plant and equipment, we have seen a demonstration of a. the multiplier effect b. the investment accelerator c. the crowding-out effect d. supply-side economics e. none of the above

b. the investment accelerator

Which of the following best describes how an increase in the money supply shifts the aggregate demand? a. the money supply shifts right, the interest rate rises, investment decreases, and aggregate demand shifts left b. the money supply shifts right, the interest rate falls, investment increases and aggregate demand shifts right c. the money supply shifts right, prices rise, spending falls, and aggregate demand shifts left d. the money supply shifts right, prices fall, spending increases, and aggregate demand shifts right

b. the money supply shifts right, the interest rate falls, investment increases and aggregate demand shifts right

The misery index, which some commentators suggest measures the health of the economy, is a. the sum of the growth rate of output and the inflation rate b. the sum of the unemployment rate and the inflation rate c. the sum of the Dow Jones Industrial Average and the federal funds rate d. the sum of the natural rate of unemployment and the actual rate of unemployment

b. the sum of the unemployment rate and the inflation rate

Keynes's liquidity preference theory of the interest rate suggests that the interest rate is determined by a. the supply and demand for loanable funds b. the supply and demand for money c. the supply and demand for labor d. aggregate supply and aggregate demand

b. the supply and demand for money

Which of the following events shifts the short-run aggregate-supply curve to the right? a. an increase in government sending on military equipment b. an increase in price expectations c. a drop in oil prices d. a decrease in the money supply e. none of the above

c. a drop in oil prices

Along a short-run Phillips curve a. a higher rate of growth in output is associated it a lower unemployment rate b. a higher rate of growth in output is associated with a higher unemployment rate c. a higher rate of inflation is associated with a lower unemployment rate d. a higher rate of inflation is associated with a higher unemployment rate

c. a higher rate of inflation is associated with a lower unemployment rate

Economists who argue that monetary policy should be made by a rule make all of the following arguments except: a. a policy rule limits the incompetence of policymakers b. a policy rule limits the abuse of power of policymakers c. a policy rule is more flexible than discretionary policy d. a policy rule eliminates the time inconsistency problem

c. a policy rule is more flexible than discretionary policy

The initial impact of an increase in government spending is to shift a. aggregate supply to the right b. aggregate supply to the left c. aggregate demand to the right d. aggregate demand to the left

c. aggregate demand to the right

If the Fed were to continuously use expansionary monetary policy in an attempt to hold unemployment below the natural rate, the long-run result would be a. an increase in the level of output b. a decrease in the unemployment rate c. an increase in the rate of inflation d. all of the above

c. an increase in the rate of inflation

Which of the following is not true with regard to government budget deficits? a. budget deficits place the burden of current spending on future taxpayers b. budget deficits reduce national saving c. budget deficits should be scrutinized because they are the only way to transfer wealth across generations of taxpayers d. budget deficits reduce capital investment, future productivity, and therefore, future incomes

c. budget deficits should be scrutinized because they are the only way to transfer wealth across generations of taxpayers

Suppose a wave of investor and consumer pessimism causes a reduction in spending. If the Federal Reserve chooses to engage in activist stabilization policy, it should a. increase government spending and decrease taxes b. decrease government spending and increase taxes c. increase the money supply and decrease interest rates d. decrease the money supply and increase interest rates

c. increase the money supply and decrease interest raates

If, in the long run, people adjust their price expectations so that all prices and incomes move proportionately to an increase in the price level, then the long-run Phillips curve a. is positively sloped b. is negatively sloped c. is vertical d. has a slope that is determined by how fast people adjust their price expectations

c. is vertical

Suppose the price level falls but suppliers only notice that the price of their particular product has fallen. Thinking there has been a fall in the relative price of their product, they cut back on production. This is a demonstration of the a. sticky-wage theory of the short-run aggregate-supply curve b. sticky-price theory of the short-run aggregate-supply curve c. misperceptions theory of the short-run aggregate-supply curve d. classical dichotomy theory of the short-run aggregate-supply curve

c. misperceptions theory of the short-run aggregate-supply curve

Suppose the economy is initially in long-run equilibrium. Then suppose there is a reduction in military spending due to the end of the Cold War. According to the model of aggregate demand and aggregate supply, what happens to prices and output in the short run? a. prices rise; output rises b. prices rise; output falls c. prices fall; output falls d. prices fall; output rises

c. prices fall; output falls

According to the model of aggregate supply and aggregate demand, in the long run, an increase in the money supply should cause a. prices to rise and output to rise b. prices to fall and output to fall c. prices to rise and output to remain unchanged d. prices to fall and output to remain unchanged

c. prices to rise and output to remain unchanged

Fallacy of Composition

incorrectly reasoning that hat is true for the individual is true for the group

Economists who argue that policymakers should not try to stabilize the economy make all of the following arguments except: a. since stabilization policy affects the economy with a lag, well-intended policy could be destabilizing b. since forecasting shocks to the economy is difficult, well-intended policy could be destabilizing c. stabilization policy has no effect on the economy in the short run or the long run d. the first rule of policymaking should be "do no harm"

c. stabilization policy has no effect on the economy in the sort run or the long run

Suppose the government increases its purchases by $16 billion. If the multiplier effect exceeds the crowding-out effect, then a. the aggregate-supply curve shifts to the right by more than $16 billion b. the aggregate-supply curve shifts to the left by more than $16 billion c. the aggregate-demand curve shifts to the right by more than $16 billion d. the aggregate-demand curve shifts to the left by more than $16 billion

c. the aggregate-demand cure shifts to the right by more than $16 billion

Which of the following is NOT a reason why aggregate-demand curve slopes downward? a. the wealth effect b. the interest-rate effect c. the classical dichotomy/monetary neutrality effects d. the exchange-rate effect e. all of the above are reasons why the aggregate-demand curve slopes downward

c. the classical dichotomy/monetary neutrality effects

When an increase in government purchases raises incomes, shifts money demand to the right, raises the interest rate, and lowers investment, we have seen a demonstration of a. the multiplier effect b. the investment accelerator c. the crowding-out effect d. supply-side economics e. the liquidity trap

c. the crowding-out effect

Which of the following is an automatic stabilizer? a. military spending b. spending on public schools c. unemployment benefits d. spending on the space shuttle e. all of the above are automatic stabilizers

c. unemployment benefits

Automatic Stabilizers

changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action

Natural-Rate Hypothesis

claim that unemployment eventually returns to its normal, or natural, rate regardless of the rate of inflation

Which of the following statements about economic fluctuations is true? a. a recession is when output rises above the natural level of output b. a depression is a mild recession c. economic fluctuations have been termed the "business cycle" because the movements in output are regular and predictable d. a variety of spending, income, and output measures can be used to measure economic fluctuations because most macroeconomic quantities tend to fluctuate together e. none of the above

d. a variety of spending, income, and output measures can be used to measure economic fluctuations because most macroeconomic quantities tend to fluctuate together

Which of the following would NOT cause a sift in the long-run aggregate-supply curve? a. an increase in the available labor b. an increase in the available capital c. an increase in the available technology d. an increase in price expectations e. all of the above shift the long-run aggregate-supply curve

d. an increase in price expectations

Which of the following would sift the long-run Phillips curve to the right? a. an increase in the price of foreign oil b. an increase in expected inflation c. an increase in aggregate demand d. an increase in the minimum wage

d. an increase in the minimum wage

Which of the following is an example of a discretionary policy action that further destabilizes the economy? a. investors become pessimistic, and the Fed responds with a reduction in interest rates b. Consumers become pessimistic, and fiscal policymakers respond with a reduction in taxes c. investors become excessively optimistic, and the Fed responds with a reduction in the money supply d. consumers become pessimistic, and fiscal policymakers respond with a reduction in government spending

d. consumers become pessimistic, and fiscal policymakers respond with a reduction in government spending

Suppose a wave in investor and consumer optimism has increased spending so that the current level of output exceeds the long-run natural rate. If policymakers choose to engage in activist stabilization policy, they should a. decrease taxes, which sifts aggregate demand to the right b. decrease taxes, which shifts aggregate demand to the left c. decrease government spending, which shifts aggregate demand to the right d. decrease government spending, which shifts aggregate demand to the left

d. decrease government spending, which sifts aggregate demand to the left

The Phillips curve is an extension of the model of aggregate supply and aggregate demand because, in the short run, an increase in aggregate demand increases prices and a. decreases growth b. decreases inflation c. increases unemployment d. decreases unemployment

d. decreases unemployment

The natural-rate hypothesis argues that a. unemployment is always above the natural rate b. unemployment is always below the natural rate c. unemployment is always equal to the natural rate d. in the long run, the unemployment rate returns to the natural rate, regardless of inflation

d. in the long run, the unemployment rate returns to the natural rate, regardless of inflation

Suppose that the economy is suffering from pessimism on the part of consumers and firms. Which of the following is an activist stabilization policy that "leans against the wind"? a. policymakers should decrease the money supply b. policymakers should increase taxes c. policymakers should decrease government spending d. policymakers should decrease interest rates e. none of the above is true

d. policymakers should decrease interest rates

Stagflation occurs when the economy experiences a. falling prices and falling output b. falling prices and rising output c. rising prices and rising output d. rising prices and falling output

d. rising prices and falling output

The natural level of output in the amount of real GDP produced a. when there is no unemployment b. when the economy is at the natural level of investment c. when the economy is at the natural level of aggregate demand d. wen the economy is at the natural rate of unemployment

d. when the economy is at the natural rate of unemployment

Which of the following changes to tax laws would encourage more saving but also increase the tax burden on low-income people? a. reduce taxes on the return to saving b. remove the double taxation on capital income from stocks c. reduce inheritance taxes d. replace the income tax with a consumption tax e. all of the above

e. all of the above

Supply Shock

event that directly alters firms' costs and prices, sifting the economy's aggregate supply curve and thus the Phillips curve

Business Cycle

fluctuations in the economy

Nominal Interest Rate

interest rate as usually reported

Real Interest Rate

interest rate corrected for the effects of inflation

Federal Funds Rate

interest rate that banks charge one another for short-term loans