EC 202 Lesson 6

Recessions tend to _____.

be preceded by increases in the inflation rate

An expansionary gap implies resources are _____.

being utilized at above-normal rates and cyclical unemployment is negative.

The difference between the actual unemployment rate and the natural rate of unemployment _____.

is negative when there is an expansionary gap

The difference between the economy's potential output and its actual output at some point in time

output gap

The beginning of a recession is called a(n) _____.

peak

The beginning of a recession, the high point of economic activity prior to a downturn

peak

In the model of the economy used in the course, long-run output is determined by _____.

potential output

The amount of output (real GDP) that an economy can produce when using its resources, such as capital and labor, at normal rates

potential output

It is assumed that, in the LONG-RUN, ________ .

price adjusts so output is at potential output

When the interest rate on newly issued bonds decreases, then for most existing bonds:

price increases

The SHORT-RUN and LONG-RUN effects of an increase in the money supply involve a path during part of which, at the same time, _____.

price remains the same and output increases

A period in which the economy is growing at a rate significantly below normal

recession

A positive output gap, which occurs when potential output exceeds actual output

recessionary gap

If the actual unemployment rate is 5% and if the natural unemployment rate is 4% with potential output equal to $3000 billion, then Okun's law tells us that there is a(n) _______.

recessionary gap equal to $60 billion

If output is at potential output, then _____.

resources are being used at normal rates

Structural unemployment occurs because:

there are long-term mismatches between workers skills and jobs available.

A positive output gap occurs when _____.

there is a recessionary gap

The end of a recession, the low point of economic activity prior to a recovery

trough

If consumption spending is $600 when income, Y, is $800, then the marginal propensity to consume out of income, Y, is _______.

unknown since there is not enough information provided

Nominal GDP divided by the quantity of money

velocity of money

Frictional unemployment is _____.

voluntary unemployment

An output gap in the course is defined as _____.

Y* - Y

If the principal amount of a bond is $2,000, the coupon rate is 6%, the inflation rate is 4%, and the return (yield-to-maturity) to a current holder of the bond is 8%, then the annual interest payments made to the holder of the bond are _____ per year.

$120 The annual interest payment is equal to the coupon rate multiplied by the principal value of the bond; that is, $2000*.06 = $120.

You have just won $20 million in the Michigan lottery! The state promises to pay you $20 million at the end of one year. How much money would the state be willing to offer and you be willing to accept today in exchange for the $20 million payment one year from now if the market rate of interest is 25 percent (ignoring taxes)?

$16 million Present value, V0, is determined by: V1 = V0*(1+i), where V1 is the future value one year into the future and i is the promised interest rate. In this case, $20m = V0*(1+.25), or V0 = ($20m/1.25) = $16m.

In Macroland, a country that operates according to Okun's law, if the cyclical unemployment rate is 2.5% and potential output (GDP) equals $9,000 billion, the actual or equilibrium level of output would equal _____ billion.

$8,550 Start by finding the output gap, which is positive here since cyclical unemployment is positive. A gap is defined equal to Y* - Y, or potential output minus actual output, measuring how much actual output is below potential output. Therefore, actual output will be found by subtracting the gap from potential output. Okun's law tells us the output gap is twice the cyclical unemployment rate multiplied by potential output, or is 5% of $9,000 billion, or $450 billion. As a consequence, actual output is $450 billion below potential output, or $9,000 billion - $450 billion, or $8550 billion. With actual output at $8550 billion and potential output at $9000 billion, this recessionary gap will be the difference or $450 billion confirming that a gap is equal to Y* - Y.

Assuming equilibrium, or actual output, is 10500, and there is a recessionary gap of 1000, then potential output, Y*, is equal to _____ .

11500

Assuming equilibrium, or actual, output is 12500, and there is an expansionary gap of -1000, then potential output, Y*, is equal to _____ .

11500

If C = 400 + (4/5)(Y-T), G = 300, NX = -100, T = 500, and Ip = 1000, then the autonomous component of planned expenditure is ______.

1200

If C = 400 + (2/3)(Y-T), G = 300, NX = -100, T = 500, and Ip = 1000, then the marginal propensity to consume out of income, Y, is ____ .

2/3

If C = 400 + (2/3)(Y-T), G = 300, NX = -100, T = 500, and Ip = 1000, then the marginal expenditure rate is _____ and the value of the income-expenditure multiplier is _____.

2/3; 3

If the actual rate of unemployment equals 9 percent when the frictional rate of unemployment equals 2 percent, and the structural rate of unemployment equals 3 percent, then the cyclical rate of unemployment is _____%.

4

If C = 400 + (4/5)(Y-T), G = 300, NX = -100, T = 500, and Ip = 1000, then at output, Y, equal to 8000, unintended investment, Iu, is equal to _____.

400

If C = 400 + (4/5)(Y-T), G = 300, NX = -100, T = 500, and Ip = 1000, then equilibrium income, Y, is equal to _____ .

6000

If the natural rate of unemployment equals 5%, the frictional rate of unemployment equals 2%, and the cyclical rate of unemployment equals 3%, then the actual rate of unemployment equals _____%.

8

In Macroland, a country that operates according to Okun's law, potential real GDP is equal to $800 billion while the actual rate of unemployment is 4% and the natural rate of unemployment is 6%. Macroland has an actual real output level of $_____ billion.

832

A particularly strong and long expansion is called a(n) _____.

Boom

The velocity of money is defined as _____.

P*Y/M

When the actual unemployment rate is equal to the natural rate of unemployment, then output is at potential output.

True

According to our model, in the short-run, firms will adjust prices to meet demand.

False

An equal decrease in government expenditures and taxes has no effect on planned aggregate expenditures.

False

An increase in the money supply raises price in the short-run.

False

Autonomous planned expenditures is the part of planned expenditures that changes when the income changes.

False

Frictional unemployment is long-term in nature.

False

If a firm sells more than it expected, its actual investment will be greater than its planned investment.

False

In the basic Keynesian model, in the SHORT-RUN, output will always adjust to potential output.

False

In the short-run basic Keynesian model, planned expenditures are determined primarily by the price level.

False

Recessions are often preceded by a decrease in inflation.

False

Recessions cannot occur when output is at potential output.

False

Structural unemployment is zero when output is at potential output.

False

The long-run aggregate supply curve is horizontal.

False

The natural rate of unemployment is less than the actual unemployment rate when there is an expansionary gap.

False

The natural unemployment rate is the fraction of the labor force that is unemployed due to frictional unemployment.

False

The only way a recession can occur is if output falls below potential output.

False

The unemployment rate is zero at potential output.

False

The equation of exchange

M*V = P*Y

Each one percentage point of cyclical unemployment is associated with an output gap equal to 2 percent of potential output

Okun's Law

A recession ends at a(n) _____.

Trough

A business cycle expansion begins at a trough.

True

A recessionary gap is positive.

True

Cyclical unemployment is negative during an inflationary gap.

True

Expansions normally last longer than recessions.

True

In our basic Keynesian model, the four components of planned aggregate expenditures are actual Consumer Expenditure (C), planned Investment (Ip), actual Government spending (G) and actual Net Exports (X-IM).

True

In the aggregate, within the short-run basic Keynesian model, when output equals PLANNED expenditures, there is no unintended change in inventories.

True

In the basic Keynesian model, an expenditure is induced if it changes when income changes

True

In the short-run, firms meet demand by adjusting output rather than price.

True

Long-run output is determined by potential output.

True

The Keynesian model assumes aggregate consumption spending is determined primarily by income.

True

The cyclical unemployment rate is equal to the difference between the actual unemployment rate and the natural unemployment rate.

True

The equation of exchange states that the quantity of money multiplied by the velocity of money equals nominal GDP.

True

The equation of exchange can be expressed as _____.

V = P*Y/M

Barter can definitely occur if there is

a double coincidence of wants

Starting from long-run equilibrium, the LONG-RUN equilibrium effects of an increase in the money supply is _____.

a increase in price and no change in output

A recession occurs when _____.

actual output equals potential output, but potential output is not growing or falling. A recession occurs either when actual output is below potential or when actual output equals potential output, but potential output is not growing or contracting.

In Okunland, the unemployment rate is 6% and the natural unemployment rate is 4%. If potential output is $1000, Okun's law predicts _____.

actual output is $960

In the short run starting from full employment, an increase in the money supply results in _____.

an increase in the level of output

In the long-run, starting from full employment, an increase in the money supply results in _____.

an increase in the price level OR no change in the level of output

A particularly strong and protracted expansion

boom

The unemployment resulting from a recession is called _____ unemployment.

cyclical

The actual unemployment rate minus the natural unemployment rate

cyclical unemployment rate

If the actual unemployment rate is 5.5% and if the natural unemployment rate is 4%, then the ____.

cyclical unemployment rate is 1.5%

An extremely severe or protracted great recession

depression

A period in which the economy is growing at a rate that is significantly above normal

expansion

A negative output gap, which occurs when actual output is above potential output

expansionary (inflationary) gap

In the short-run, it is assumed _____.

firms adjust output to meet demand

The firm behavior known as "meeting the demand " refers to _____.

firms adjusting output in the short run at a preset price

Our SHORT-RUN aggregate supply curve is horizontal to indicate _____.

firms are assumed to be able to sell as much as buyers demand at the existing price level in the short-run

A positive output gap _____.

has positive cyclical unemployment

PRIOR to recent recessions it has been usual for there to be ____

increasing inflation rates

The actual unemployment rate that prevails when cyclical unemployment is zero is called the _____ unemployment rate.

natural

The part of the total unemployment rate that is attributable to frictional and structural unemployment

natural rate of unemploymeny

Money supply is to GDP as

stock is to flow

A trough is _____.

the beginning of an expansion

At potential output, _____.

the inflation rate (or price level) remains constant