ECONOMICS QUIZ #4

What were two big AD shifts?

The Great Depression and WWII

What is Marginal Propensity to Consume (MPC)?

The fraction of extra income that households consume rather than save e.g. if MPC=.8 and income rises $100, C rises $80

What two effects does fiscal policy have?

The multiplier effect, and the crowding-out effect

What is the natural rate of output (Yn)?

The output the economy produces when unemployment is at its natural rate

What does the aggregate demand (AD) curve represent?

The quantity of all goods and services demanded in the economy at any given price level

What is fiscal policy?

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

What does the aggregate supply (AS) curve show?

The total quantity of goods and services firms produce and sell at any given price level

What did John Maynard Keynes argue about recessions and depressions?

They resulted from inadequate demand

Do most macroeconomic quantities fluctuate together, or separately?

Together

The short run aggregate supply (SRAS) curve is ______

Upward sloping

AS is _____ in the short run

Upward-sloping

AS is _____ in the long run

Vertical

If AS is _____, fluctuations in AD do not cause fluctuations in output or employment

Vertical

What leads to shifts in AD and fluctuations in output and employment?

Waves of pessimism and optimism among households and firms, as well as booms and recessions abroad, and stock market booms and crashes

Liquidity preference theory is most relevant to the ____ run and supposes that the ___________ adjusts to bring money supply and money demand into balance

Short, interest rate

If AS ____ ____, then shifts in AD affect output and employment

Slopes up

Since WWII, the US has almost always had rising prices and an upward trend in real GDP. This can be explained by what?

Technological progress and money supply growth

The imperfections of these theories are _____

Temporary

What are some changes in NX that would make the AD curve shift?

1) booms/recessions in countries that buy our exports 2) appreciation/depreciation resulting from international speculation in foreign exchange market

What changes in natural resources could shift the LRAS curve?

1) discovery of new mineral deposits 2) reduction in supply of imported oil 3) changing weather patterns that affect agricultural production

What are some changes in G that would make the AD curve shift?

1) federal spending, e.g. defense 2) state and local spending, e.g. roads and schools

What are some changes in I that would make the AD curve shift?

1) firms buy new computers, equipment, factories 2) expectations, optimism/pessimism 3) interest rates, monetary policy 4) investment tax credit or other tax incentives

What changes in L or the natural rate of unemployment could shift the LRAS curve?

1) immigration 2) baby-boomers retire 3) government policies reduce natural u-rate

What changes in K or H could shift the LRAS curve?

1) investment in factories, equipment 2) more people get college degrees 3) factories destroyed by a hurricane

What are the three theories of SRAS?

1) sticky wage theory 2) sticky price theory 3) misperceptions theory

What are some changes in C that would make the AD curve shift?

1) stock market boom/crash 2) preferences towards consumption/saving 3) tax hikes/cuts

Why does an increase in P reduce AD?

1) the wealth effect: consumption (C) falls 2) the interest rate effect: I falls 3) the exchange rate effect: NX falls

What are the four steps to analyzing economic fluctuations?

1) what shifts, AD or AS? 2) how does it shift, left or right? 3) use the AD-AS diagram to see how the shift changes Y and P in the short run 4) use the AD-AS diagram to see how economy moves from new short run equilibrium to new long run equilibrium

What does a bigger MPC mean in regards to Y?

A bigger MPC means changes in Y cause bigger changes in C, which in turn cause more changes in Y

How does government purchases (fiscal policy) affect aggregate supply?

A cut in the tax rate gives workers incentive to work more, so it might increase the output supplied and shift AS to the right

What is contractionary fiscal policy?

A decrease in G and/or increase in T Shifts AD left

Explain the crowding-out effect

A fiscal expansion raises r, which reduces investment, which reduces the net increase in aggregate demand. The size of the AD shift may be smaller than the initial fiscal expansion. This is called the crowding-out effect

What is a recession?

A period of falling real incomes and rising unemployment

What is a depression?

A severe recession, which is very rare

What is the Theory of the Liquidity Preference?

A simple theory of the interest rate (r), where r adjusts to balance supply and demand for money Money supply: assume it is fixed by the central bank, and does not depend on the interest rate (r)

How much, on average, does GDP grow in the long run?

About 3 percent

Output deviates from its natural rate when the ____ price level ____ from the price level people expected

Actual, deviates

Which of the following would cause prices and real GDP to rise in the short run?

Aggregate demand shifts right

What is expansionary fiscal policy?

An increase in G and/or decrease in T Shifts AD to the right

What will make the AD curve shift?

Any change in C, I, G, or NX (but not P) i.e. a stock market boom makes households feel wealthier, C rises, and the AD curve shifts right

What will shift long-run aggregate supply (LRAS)?

Any event that changes any of the determinants of Yn, such as L, K, H, technology, or natural resources i.e. immigration increases L, causing Yn to rise

People had been expecting the price level to be 220 but it turns out to be 223. In response Green Leaf Paper Company increases the number of workers it employs. What could explain this?

Both sticky price theory and sticky wage theory

What are short-run economic fluctuations often called?

Business cycles

Suppose there were a large decline in net exports. If the Fed wanted to stabilize output, it could do what?

Buy bonds to lower interest rates

What is the neutrality of money?

Changes in the money supply affect nominal but not real variables

In the short run, an increase in the money supply causes interest rates to _____, and aggregate demand to shift _____

Decrease, right

If a dramatic rise in the price of houses makes people feel wealthier, then it would shift aggregate ______ to the _____

Demand, right

What are economic fluctuations caused by?

Events that shift the AD and/or the AS curves

An economic contraction caused by a shift in aggregate demand remedies itself over time as the expected price level ___, shifting aggregate supply ____

Falls, right

Over time, sticky wages and sticky prices become _____, and misperceptions are ______

Flexible, corrected

The sticky price theory of the short run aggregate supply curve says that when the price level is higher than expected, some firms will have ____ than desired prices which leads to an ____ in the aggregate quantity of goods and services supplied

Higher, increase

What determines how big the multiplier effect is?

How much consumers respond to increases in income

Suppose real income (Y) rises. Other things equal, what happens to money demand?

If Y rises, households want to buy more goods and services, so they need more money. To get this money, they attempt to sell some of their bonds An increase in Y causes an increase in money demand

Open market purchases _____ investment and _____ real GDP

Increase and increase

What do supply-side economists believe that a reduction in the tax rate does?

Shifts the AS curve to the right

The misperceptions theory of the short run aggregate supply curve says that the quantity of output supplied will increase if the price level...

Increases by more than expected so that firms believe the relative price of their output has increased

Which part of real GDP fluctuates most over the course of the business cycle?

Investment expenditures

Are economic fluctuations regular or irregular?

Irregular

What happens to monetary policy during a liquidity trap?

It becomes ineffective and may not work, since nominal interest rates cannot be reduced further

In the short run, what does GDP do?

It fluctuates around its trend

What does a tax cut do?

It increases households' take-home pay. Households respond by spending a portion of this extra income, shifting AD to the right A permanent tax cut causes a bigger increase in C, and a bigger shift in the AD curve, than a temporary cut

The sticky wage theory of the short run aggregate supply curve says that when the price level is lower than expected, production is ____ profitable and employment ____

Less, falls

What is the case against active stabilization policy?

Monetary policy affects the economy with a long lag. It takes at least 6 months for monetary policy to affect output and employment, and firms make investment plans in advance, so I takes time to respond to changes in r Fiscal policy also works with a long lag, as changes in G and T require acts of Congress, and the legislative process can take months or years

What does the Theory of Liquidity Preference say?

Money demand reflects how much wealth people want to hold in liquid form (money versus bonds). A household's "money demand" reflects its preference for liquidity

What is the result of the LRAS and AD shifting to the right?

Ongoing inflation and growth in output

Over the period of 1-2 years, an increase in ___ causes an increase in the quantity of goods and services supplied

P

What else shifts SRAS?

Pe If Pe rises, workers and firms set higher wages. At each P, production is less profitable, Y falls, SRAS shifts left

What happens to Pe and the AS curve in the long run?

Pe=P AS curve is vertical

What happens to Pe and Y and unemployment in the "long run equilibrium"?

Pe=P Y=Yn Unemployment is at its natural rate

What is the natural rate of output (Yn) also called?

Potential output, or full-employment output

The long run aggregate supply curve shows that by itself a permanent change in aggregate demand would lead to a long run change in the _____, but not _____

Price level, output

What changes in technology could shift the LRAS curve?

Productivity improvements from technological progress

The Classical Dichotomy separates what?

Real variables (quantities, relative prices) and nominal variables (measured in terms of money)

An increase in P does what to the quantity of goods and services demanded?

Reduces it

The price level rises in the short run if aggregate demand shifts ____ or aggregate supply shifts ____

Right, left

Over the long run, technological progress shifts LRAS to the _____, and growth in the money supply shifts AD to the _____

Right, right

Economic expansions in Germany and Japan would cause the US price level and real GDP to ____

Rise

When the price level falls the quantity of consumption goods demanded and the quantity of net exports demanded both _____

Rise

As output falls, unemployment _____

Rises

As income rises, money demand _____, so the interest rate _____

Rises, rises

Everything that shifts LRAS shifts ____ too

SRAS

If there is a natural disaster, the long run aggregate supply curve does what?

Shifts left

What is a liquidity trap?

When the interest rate is zero

What do the theories of sticky wage, sticky price, and misperceptions all have in common?

Y deviates from Yn when P deviates from Pe

What variables influence money demand?

Y, r, and P

Does the crowding-out effect tend to make the size of a shift in AD resulting from a tax cut smaller than it otherwise would be?

Yes