Test Bank Chapter 8 9 12

Macroeconomics, 9e, Global Edition (Abel/Bernanke/Croushore)
Chapter 8
Business Cycles
8.1
1) One of the first organizations to investigate the business cycle was
A) the Federal Reserve System.
B) the National Bureau of Economic Research.

C) the Council of Economic Advisors.
D) the Brookings Institution.
Answer: B
2) The entire sequence of a decline in aggregate economic activity followed by recovery, measured
from peak to peak or trough to trough is a
A) long-run trend.
B) potential output path.
C) business cycle.
D) recurrent comovement.
Answer: C
3) A detailed history of business cycles is known as a
A) historical decomposition.
B) trend analysis.
C) Hodrick—Prescott filter.
D) business cycle chronology.
Answer: D
4) The dates of turning points are determined by a committee
from the A) FBI. B) BLS. C) BEA. D) NBER.

Answer: D
5) Business cycles all display the following characteristics except

A) a period of expansion followed by one of contraction.
B) comovement of many economic variables.
C) rising prices during an expansion and falling prices during the contraction.
D) they last a period of one to twelve years.
Answer: C
6) The trough of a business cycle occurs when ________ hits its lowest point.
A) inflation B) the money supply C) aggregate economic activity D) the unemployment rate Answer:
7) The low point in the business cycle is referred to as the

A) expansion. B) boom. C) trough. D) peak.
Answer: C
8) When aggregate economic activity is increasing, the economy is

said to be in
A) an expansion. B) a contraction. C) a peak. D) a turning point.
Answer: A
9) The high point in the business cycle is referred to as the
A) turning point. B) peak. C) boom. D) trough.

Answer: B
10) When aggregate economic activity is declining, the economy is said
to be in
A) a contraction. B) an expansion. C) a trough. D) a turning point. Answer:
11) Peaks and troughs of the business cycle are known collectively as
A) volatility. B) turning points. C) equilibrium points. D) real business cycle events. Answer:
B
12) Turning points in business cycles occur when

A) a new business cycle is initiated at the trough.
B) the economy hits the peak or trough in the business cycle.
C) the business cycle begins to follow a new pattern that differs from previous business cycles.
D) a new business cycle is initiated at the peak.
Answer: B
13) Who officially determines whether the economy is in a recession or expansion?

A) The president of the United States
B) The U.S. Congress
C) The Federal Reserve Board of Governors
D) The National Bureau of Economic Research
Answer: D
14) Which group within the National Bureau of Economic Research officially determines whether the
economy is in a recession or expansion?
A) The G-4
B) The Business Cycle Dating Committee
C) The Business Cycle Governors
D) The Turning Point Group
Answer: B
15) Research on the effects of recessions on the real level of GDP shows that
A) recessions cause only temporary reductions in real GDP, which are offset by growth during the
expansion phase.
B) recessions cause large, permanent reductions in the real level of GDP.
C) recessions cause both temporary and permanent declines in real GDP, but most of the decline is
temporary.
D) recessions cause both temporary and permanent declines in real GDP, but most of the decline is
permanent.
Answer: C
16) The tendency of many different economic variables to have regular and predictable patterns over
the business cycle is called
A) persistence. B) comovement. C) periodicity. D) recurrence.
Answer: B
17) Comovement is
A) the tendency for declines in economic activity to be followed by further declines, and for growth
in economic activity to be followed by more growth.
B) the idea that the standard pattern of contraction—trough—expansion—peak occurs again and
again in industrial economies.
C) the tendency of many economic variables to move together in a predictable way over the
business cycle.
D) the idea that peaks and troughs of the business cycle occur at regular intervals. Answer: C
18) The tendency of many economic variables to move together in a predictable way over the business
cycle is called
A) recurrence. B) persistence. C) comovement. D) inflation.
Answer: C
19) The fact that business cycles are recurrent but not periodic means that
A) business cycles occur at predictable intervals, but do not last a predetermined length of time.
B) the business cycle's standard contraction—trough—expansion—peak pattern has been observed to

occur over and over again, but not at predictable intervals.
C) business cycles occur at predictable intervals, but do not all follow a standard contraction—trough—
expansion—peak pattern.
D) business cycles last a predetermined length of time, but do not all follow a standard contraction—
trough—expansion—peak pattern.
Answer: B
20) The tendency for declines in economic activity to be followed by further declines, and for growth in
economic activity to be followed by more growth is called
A) persistence. B) comovement. C) periodicity. D) recurrence.
Answer: A
21) Persistence is
A) the tendency for declines in economic activity to be followed by further declines, and for growth
in economic activity to be followed by more growth.
B) the idea that the standard pattern of contraction—trough—expansion—peak occurs again and
again in industrial economies.
C) the tendency of many economic variables to move together in a predictable way over the
business cycle.
D) the idea that peaks and troughs of the business cycle occur at regular intervals. Answer: A
22) The idea that the business cycle is recurrent means that
A) declines in economic activity tend to be followed by further declines, and growth in economic activity
tends to be followed by more growth.
B) the standard pattern of contraction—trough—expansion—peak occurs again and again in industrial

economies.
C) many economic variables to move together in a predictable way over the business cycle.
D) peaks and troughs of the business cycle occur at regular intervals. Answer: B
23) Define the following characteristics of business cycles: recurrence and persistence.
Answer: Business cycles exhibit recurrence and persistence:
(1) Recurrence means that each complete cycle is followed by another complete cycle.
(2) Persistence means that, once begun, each contraction tends to continue. Likewise, once begun,
each expansion tends to continue.
For example, the 1981-1982 contraction lasted for 16 months, and the 1982-1990 expansion lasted for
93 months. These are persistent events.
24) Describe the major features of the business cycle. Be sure to discuss what variables are affected
by the cycle, a description of the key features that are apparent in the data, how variables are related
to one another, how regular the cycle is, and how predictable the cycle is.
Answer: The business cycle is defined as a fluctuation of aggregate economic activity. There are
recurrent but not periodic movements of aggregate activity, with many variables moving in the same
direction at the same time (comovement). Increases in aggregate economic activity are expansions,
while reductions in aggregate economic activity are contractions, or recessions. Both expansions and
contractions exhibit persistence, so once an expansion or contraction begins, it tends to last some time.
25) When a recession occurs, do economists expect it to be a temporary phenomenon? Or is there

some degree of permanence? What is the empirical evidence?
Answer: Recent research suggests that recessions may contain permanent components. Some
economists argue that only the 1973-1975 recession led to a permanent change in the U.S. economy,
because it changed the economy's use of oil permanently. Other studies suggest that perhaps 30% of
changes in real output are permanent and 70% are temporary for the postwar United States.
8.2 1)
The longest contraction in American history occurred
A) during the 1870s.
B) in the years right before World War I began.
C) during the 1930s.
D) during the 1970s.
Answer: A
2) In the Great Depression, the financial sector collapsed, as A)

banks engaged in ruinous competition.
B) the stock market boomed, so people withdrew most of their funds from banks and invested heavily
in stocks.
C) the bond market boomed, so people withdrew most of their funds from banks and invested heavily
in bonds.
D) many banks closed.
Answer: D
3) The deep recession of 1973-1975 was mainly caused by A)

flawed technology that caused a drop in TFP.
B) an unexplained drop in business optimism.
C) slower money growth.
D) higher oil prices.
Answer: D
4) The long boom occurred in the

A) 1920s and 1930s. B) 1940s and 1950s. C) 1960s and 1970s. D) 1980s and 1990s. Answer:
5) The long boom ended in

A) 1999. B) 2001. C) 2008. D) 2012.
Answer: B
6) The Great Depression consisted of how many business cycles?
A) 1 B) 2 C) 3 D) 4
Answer: B
7) By 1937, when a new recession began in the midst of the Great Depression,
A) GDP had almost recovered to its 1929 level, but unemployment was still above the 1929 level.
B) unemployment had almost fallen back to its 1929 level, but GDP had yet to recover to its 1929 level.
C) neither GDP nor unemployment had returned to near their 1929 levels.
D) both GDP and unemployment had returned to near their 1929 levels.
Answer: A
8) The worst recessions after World War II occurred A)

during 1945-1946 and 1973-1975.
B) during 1957-1958 and 1973-1975.
C) during 1973-1975 and 1981-1982.
D) during 1945-1946 and 1981-1982.
Answer: C
9) The 1973-1975 recession was caused by A)
the Fed's easy monetary policy.

B) the Fed's tight monetary policy.
C) business pessimism about investment caused by high tax rates on capital.
D) the quadrupling of oil prices by OPEC.
Answer: D
10) The longest economic expansion in the United States occurred during the A) 1940s. B)
1960s. C) 1980s. D) 1990s.
Answer: D
11) The Great Recession began in ________ and ended in ________.

A) December 2007; June 2009
B) December 2007; December 2011
C) October 2008; June 2009
D) October 2008; December 2011
Answer: A
12) Christina Romer's criticism of the belief that business cycles had moderated since World War II
depended on the fact that
A) estimates of the timing of business cycles since World War II had been inaccurate.
B) misuse of historical data had caused economists to understate the size of cyclical fluctuations in the
post-World War II era.
C) economists had ignored the roles of the government and international trade in mitigating economic
fluctuations prior to World War II.
D) economists had left out important components of GDP, such as wholesale and retail distribution,
transportation, and services, in their pre-World War II estimates. Answer: D
13) Christina Romer argued that
A) measured properly, GNP before 1929 varied substantially less over time than the official statistics
showed.
B) measured properly, GNP after 1929 varied substantially more over time than the official statistics
showed.
C) measured properly, economic expansions after 1929 were shorter than the official statistics showed.
D) measured properly, economic expansions before 1929 were shorter than the official statistics
showed.
Answer: A
18) Stock and Watson found that monetary policy was responsible for about ________% of the
reduction in output volatility that occurred in the mid-1980s.
A) 0 to 10 B) 10 to 20 C) 20 to 30 D) 30 to 40
Answer: C
19) Stock and Watson found that ________ was responsible for about 20—30 % of the reduction in
output volatility that occurred in the mid-1980s.
A) reduced shocks to productivity B) reduced shocks to food and commodity prices
C) better monetary policy D) better inventory control
Answer: C
20) The widespread decline in the volatility of many macroeconomic variables after 1984 led
economists to term this period the A) Great Moderation.
B) Low Volatility Era.
C) Steady State.
D) Long Boom.
Answer: A
21) How has the severity and duration of business cycles changed over time in the United States?
Answer: Though it is a controversial subject, it appears that business cycles have become less severe
over time. Recessions have certainly been shorter since World War II than they were before 1929.
There is some disagreement about how severe they were before 1929, with Christina Romer arguing
that measurement problems in the old data misled economists about how severe those recessions
were. But others find that the old data is just about right and conclude that the business cycle is much
less severe today.
22) If you were a member of the NBER business-cycle dating committee, would you declare that the
U.S. economy is now in a recession? Why? Describe the major variables that you would look at to
determine whether the economy is in a recession or not, and what features of the data you would
look for.
Answer: Many answers are possible. You should discuss GDP and other major macroeconomic
variables. You should note that you are looking for co-movement and persistence. Diff: 1 Topic:
Section: 8.2 Question Status: Previous Edition
23) Use the NBER data in Table 8.1 in the textbook on U.S. business cycle turning points to calculate: a)
the shortest business cycle from peak to peak;
b) the shortest business cycle from trough to trough;

c) the longest business cycle from peak to peak; and
d) the longest business cycle from trough to trough.
Answer:
(a) The shortest business cycle from peak to peak is 17 months, which extended from August 1918
to December 1919. This includes 7 months of contraction followed by 10 months of expansion.
(b) The shortest business cycle from trough to trough is 28 months, which extended from July 1980
to October 1982. This includes 12 months of expansion followed by 16 months of contraction.
(c) The longest business cycle from peak to peak is 128 months, which extended from July 1990 to
March 2001. This includes 8 months of contraction followed by 120 months of expansion.
(d) The longest business cycle from trough to trough is 128 months, which extended from March
1991 to November 2001. This includes 120 months of expansion followed by 8 months of contraction.
8.3
1) An economic variable that moves in the same direction as aggregate economic activity (up in
expansions, down in contractions) is called
A) procyclical. B) countercyclical. C) acyclical. D) a leading variable. Answer:
2) An economic variable that moves in the opposite direction as aggregate economic activity (down in
expansions, up in contractions) is called A) procyclical.
B) countercyclical.
C) acyclical.
D) a leading variable.
Answer: B
3) An economic variable that doesn't move in a consistent pattern with aggregate economic activity is
called
A) procyclical. B) countercyclical. C) acyclical. D) a leading variable. Answer:
4) A variable that tends to move in advance of aggregate economic activity is called A)

a leading variable. B) a coincident variable.
C) a lagging variable. D) an acyclical variable.
Answer: A
5) A variable that tends to move at the same time as aggregate economic activity is called
A) a leading variable. B) a coincident variable. C) a lagging variable. D) an acyclical variable. Answer:

B
6) A variable that tends to move later than aggregate economic activity is called
A) a leading variable. B) a coincident variable. C) a lagging variable. D) an acyclical variable. Answer:
7) Lagging variables are aggregate economic variables that

A) reach a peak after leading variables but before coincident variables reach a peak.
B) reach a peak after coincident variables reach a peak.
C) reach a peak two or more years after aggregate economic activity reaches a peak.
D) are insensitive to business cycles.
Answer: B
8) The CFNAI is a
A) leading index based on variables released with different frequencies.
B) coincident index based on variables released with different frequencies.
C) leading index based on 85 monthly variables.
D) coincident index based on 85 monthly variables.
Answer: D
9) The ADS Business Conditions Index is a

A) leading index based on variables released with different frequencies.
B) coincident index based on variables released with different frequencies.
C) leading index based on 85 monthly variables.
D) coincident index based on 85 monthly variables.
Answer: B
10) Diebold and Rudebusch showed that the composite index of leading indicators did not improve
forecasts of industrial production because
A) the index is not produced in a timely manner.
B) the government manipulates the index so it never predicts a recession.
C) the index is not designed for forecasting.
D) data on the components of the index are revised.
Answer: D
11) Which of the following macroeconomic variables is procyclical and coincident with the business
cycle?
A) Residential investment
B) Nominal interest rates
C) Industrial production
D) Unemployment
Answer: C
12) Which of the following macroeconomic variables is procyclical and leads the business cycle?
A) Business fixed investment B) Residential investment C) Nominal interest rates D) Unemployment
Answer: B
13) Which of the following macroeconomic variables is acyclical?

A) Real interest rates B) Unemployment C) Money supply D) Consumption Answer:
A
14) Real interest rates are

A) procyclical, just like nominal interest rates.
B) acyclical, while nominal interest rates are procyclical.
C) acyclical, just like nominal interest rates.
D) countercyclical, while nominal interest rates are procyclical.
Answer: B
15) Which of the following macroeconomic variables is procyclical and lags the business cycle?
A) Business fixed investment B) Employment C) Stock prices D) Nominal interest rates Answer:
16) Which of the following macroeconomic variables would you include in an index of leading economic
indicators?
A) Employment B) Inflation C) Real interest rates D) Residential investment Answer:
D
17) Which of the following is not a leading variable?

A) Inflation B) Stock prices C) Average labor productivity D) Residential investment Answer:
A
18) Which of the following macroeconomic variables would you exclude from an index of leading
economic indicators?
A) Money supply B) Industrial production C) Inventory investment D) Residential investment Answer:
B
19) Which of the following macroeconomic variables could not be used as a leading economic
indicator?
A) Residential investment B) Employment C) The money supply D) Stock prices Answer:

B
20) Industries that are extremely sensitive to the business cycle are the
A) durable goods and service sectors. B) nondurable goods and service sectors.
C) capital goods and nondurable goods sectors. D) capital goods and durable goods sectors.
Answer: D
21) You want to invest in a firm whose profits show large fluctuations throughout the business cycle.
Which of the following would you invest in?
A) A corporation that depends heavily on business fixed investment
B) A corporation that depends heavily on consumer services
C) A corporation that depends heavily on consumer nondurables
D) A corporation that depends heavily on government purchases
Answer: A
22) You want to invest in a firm whose profits show small fluctuations throughout the business cycle.
Which of the following would you invest in?
A) A corporation that depends heavily on business fixed investment
B) A corporation that depends heavily on residential investment
C) A corporation that depends heavily on consumer nondurables
D) A corporation that depends heavily on consumer durables
Answer: C
23) Which of the following macroeconomic variables is countercyclical?
A) Real interest rates B) Unemployment C) Money growth D) Consumption Answer:

B
24) Which of the following is true?

A) Employment and unemployment are both coincident with the business cycle.
B) Employment and unemployment are both procyclical.
C) Employment is procyclical and unemployment is coincident with the business cycle.
D) Employment is procyclical and unemployment is countercyclical.
Answer: D
25) The job finding rate is defined as
A) the probability that someone who has been unemployed for over a year will find a job in the next
month.
B) the probability that someone who is not in the labor force will enter the labor force in the next
month.
C) the probability that someone who is employed will change jobs in the next month.
D) the probability that someone who is unemployed will find a job in the next month. Answer: D
26) The job finding rate

A) equals 1 minus the job loss rate. B) remains constant over the business cycle.
C) rises in recessions. D) rises in expansions.
Answer: D
27) The probability that an employed worker will lose his or her job in the next month is known as A)
the unemployment rate.

B) the job finding rate.
C) the underemployment rate.
D) the job loss rate.
Answer: D
28) The job loss rate

A) equals 1 minus the job finding rate. B) remains constant over the business cycle.
C) rises in recessions. D) rises in expansions.
Answer: C
29) Which of the following statements is true?

A) Both nominal and real interest rates are procyclical and leading.
B) Both nominal and real interest rates are procyclical and lagging.
C) Nominal interest rates are procyclical and real interest rates are countercyclical.
D) Nominal interest rates are procyclical and real interest rates are acyclical. Answer: D
30) Using the seasonal business cycle as your guide, during which quarter would you be most likely to
expect an increase in your corporation's sales?
A) The first quarter of the year (January-March) B) The second quarter of the year (April-June)
C) The third quarter of the year (July-September) D) The fourth quarter of the year
(OctoberDecember)
Answer: D
31) Which of the following macroeconomic variables is the most seasonally procyclical?
A) Expenditure on services B) The unemployment rate C) Expenditure on durable goods D) The real
wage
Answer: C
32) Which of the following macroeconomic variables does not vary much over the seasons?
A) The nominal money stock B) The unemployment rate C) The real wage D) Average labor productivity
Answer: C
33) Identify the comovement (i.e., direction and timing) of the following variables over a business
cycle:
(a) industrial production; (b) unemployment; (c) nominal interest rates; (d) nominal money supply
growth; and (e) investment
Answer:
(a) Industrial production is a procyclical and coincident variable.
(b) Unemployment is a countercyclical variable whose timing is unclassified by the Conference Board.
(c) Nominal interest rates are procyclical and lagging.
(d) Nominal money supply growth is a procyclical and leading variable.
(e) Investment includes inventory investment and residential investment, which are procyclical and
leading variables; it also includes business fixed investment, which is a procyclical and coincident
variable.
34) What are some of the problems with using the leading indicators to forecast recessions? If you were
a policymaker, would you rely on them?
Answer: Although the leading indicators seem to be useful for forecasting the future state of the
economy, there are a number of problems in using them. First, the data is usually revised, sometimes
substantially, so a signal from the leading indicators may be reversed later. Second, they sometimes
give incorrect signals. Third, they don't provide much information on the severity or exact timing of the
coming recession. Finally, structural changes in the economy mean the set of indicators must be revised
periodically. Policymakers should use the leading indicators as additional information, but should not
rely on them alone.
8.4
1) What are the two main components of business cycle theories?
A) A description of shocks and a model of how the economy responds to them
B) A model of how people decide to spend and a description of the government's role in the economy
C) A model of how equilibrium is reached and a description of the government's role in the economy
D) A description of shocks and a description of the government's role in the economy Answer: A
2) Economists use the term shocks to mean

A) unexpected government actions that affect the economy.
B) typically unpredictable forces that have major impacts on the economy.
C) sudden rises in oil prices.
D) the business cycle.
Answer: B
3) Wars, new inventions, harvest failures, and changes in government policy are examples of A)
the business cycle. B) economic models. C) shocks. D) opportunity costs. Answer: C
4) The three main components of the aggregate demand—aggregate supply model include
A) AD, SRAS, LM. B) SRAS, LRAS, IS. C) AD, IS, LM. D) AD, SRAS, LRAS. Answer:
5) The AD, SRAS, and LRAS curves each show a relationship between which two economic variables?
A) The aggregate price level and output B) The aggregate price level and the interest rate
C) Output and unemployment D) Output and the interest rate Answer:

A
6) When plotted with the aggregate price level on the vertical axis and output on the horizontal axis,
which of the following curves slopes downward?
A) SRAS B) AD C) LRAS D) None of the above
Answer: B
which of the following curves is vertical?
A) SRAS B) AD C) LRAS D) None of the above
Answer: C
the long-run aggregate supply curve
A) slopes upward. B) slopes downward. C) is vertical. D) is horizontal. Answer:

C
the aggregate demand curve
A) slopes upward. B) slopes downward. C) is vertical. D) is horizontal. Answer:
B
10) An increase in consumer spending caused by an increase in consumer confidence would cause A)
the aggregate demand curve to shift up and to the right.

B) the aggregate demand curve to shift down and to the left.
C) a movement down and to the right along the aggregate demand curve.
D) a movement up and to the left along the aggregate demand curve. Answer: A
11) A decrease in government spending on the park system would cause A)
the aggregate demand curve to shift to the right.
B) the aggregate demand curve to shift to the left.

D) a movement up and to the left along the aggregate demand curve. Answer: B
12) A decline in the stock market, which makes consumers poorer, would cause A)
the aggregate demand curve to shift to the right.
B) the aggregate demand curve to shift to the left.
D) a movement up and to the left along the aggregate demand curve. Answer: B
13) In the short run, an increase in export sales would cause output to ________ and the price level to
________.
A) rise; rise B) rise; stay constant C) fall; stay constant D) fall; rise Answer:
B
14) After a shift in the aggregate demand curve, which variable adjusts to restore general equilibrium?
A) price level B) real interest rate C) consumption spending D) investment spending
Answer: A
15) In the long run, an increase in consumer spending would cause output to ________ and the price
level to ________.
A) rise; rise B) rise; stay constant C) stay constant; stay constant D) stay constant; rise Answer:
16) In the long run, an increase in government purchases of military equipment would cause output to
________ and the aggregate price level to ________.
A) stay constant; fall B) fall; fall C) fall; stay constant D) stay constant; rise Answer:
D
17) According to classical macroeconomists, prices adjust ________ to shocks, so the government
should ________.
A) slowly; do little B) rapidly; do little C) rapidly; fight recessions D) slowly; fight recessions Answer:
B
18) According to Keynesian macroeconomists, prices adjust ________ to shocks, so the government
should ________.
A) slowly; do little B) rapidly; do little C) rapidly; fight recessions D) slowly; fight recessions Answer:
19) In the long run, an increase in productivity would cause output to ________ and the aggregate price
level to ________.
A) fall; rise B) fall; fall C) rise; fall D) rise; rise
Answer: C
20) In the long run, a reduction in labor supply would cause output to ________ and the aggregate
price level to ________.
A) fall; rise B) fall; fall C) rise; fall D) rise; rise
Answer: A
21) The key difference between classical and Keynesian macroeconomists is their differing beliefs about
A) the slope of the aggregate demand curve.
B) the speed at which prices adjust.
C) the natural rate of unemployment.
D) the full-employment level of output.
Answer: B
22) Suppose labor supply declined. Would this affect the aggregate demand curve or the aggregate
supply curve? What would be the effect on output and the price level?
Answer: The decline in the labor supply shifts the long-run aggregate supply curve to the left, causing
the price level to increase and output to decline.
23) Suppose the economy is initially in long-run equilibrium. For each of the shocks listed below,
explain the short-run effects on output and the price level.
(a) A stock market crash reduces consumers' wealth.
(b) Businesses decide to hold larger inventories.

(c) The government cuts defense spending.
(d) Foreign countries buy more U.S. goods.

Answer:
(a) Output declines and the price level is unchanged.
(b) Output rises and the price level is unchanged.
(c) Output declines and the price level is unchanged.
(d) Output rises and the price level is unchanged.
24) Suppose the economy is initially in long-run equilibrium. For each of the shocks listed below, explain
the long-run effects on output and the price level. (a) Labor supply decreases.
(b) The government shuts down the Bureau of Economic Analysis.
(c) Productivity increases.

Answer:
(a) Output declines and the price level rises.
(b) Output is unchanged and the price level falls.
(c) Output rises and the price level falls.
25) For each outcome below, tell what type of shift must have taken place in either the aggregate
demand curve or the long-run aggregate supply curve. (a) In the short run, the price level is
unchanged and output rises.
(b) In the long run, the price level declines and output is unchanged.
(c) In the long run, the price level rises and output declines.
Answer:
(a) The aggregate demand curve shifts to the right.
(b) The aggregate demand curve shifts to the left.
(c) The long-run aggregate supply curve shifts to the left.
Chapter 9 The IS-LM/AD-AS Model
9.1 The FE Line
1) The FE line shows the level of output at which the ________ market is in equilibrium.
A) Goods
B) Asset
C) Labor
D) Money
Answer: C
2) The FE line
A) is horizontal.
B) is vertical.
C) slopes downward.
D) slopes upward.
Answer: B
3) Which of the following curves in the IS—LM model is vertical?
A) The IS curve
B) The LM curve
C) The FE line
D) The AD curve
Answer: C
4) The FE line is vertical because the level of output at full employment doesn't depend on the A) real
wage rate.
B) level of employment.
C) marginal product of labor.
D) real interest rate. Answer: D
5) Which of the following would shift the FE line to the right?
A) An adverse supply shock
B) An increase in labor supply

C) A decrease in the capital stock
D) An increase in the future marginal productivity of capital Answer: B
6) Which of the following would shift the FE line to the right?
A) An adverse supply shock

B) A decrease in labor supply
C) An increase in the capital stock
D) An increase in the future marginal productivity of capital Answer: C
7) Which of the following would shift the FE line to the left?
A) A beneficial supply shock

B) An increase in labor supply
C) A decrease in the capital stock
D) A decrease in the future marginal productivity of capital Answer: C
8) Which of the following would shift the FE line to the left?
A) A beneficial supply shock

B) A decrease in labor supply
C) An increase in consumer spending
D) An increase in the money supply Answer: B
9) An increase in the money supply would cause the FE line to A) shift to the
right.
B) shift to the left.

C) remain unchanged.
D) remain unchanged if Ricardian equivalence holds; otherwise, shift to the right. Answer: C
10) An increase in investment spending would cause the FE line to A) shift to the
right.

D) remain unchanged if Ricardian equivalence holds; otherwise, shift to the right. Answer: C
11) An adverse supply shock would cause the FE line to A) shift to the
right.

D) remain unchanged if the shock is temporary; shift to the right if the shock is permanent. Answer: B
12) A beneficial supply shock would cause the FE line to A)

shift to the right.

D) remain unchanged if the shock is temporary; shift to the right if the shock is permanent. Answer: A
13) Identify changes in three variables that would cause the FE line to shift to the right.
Answer: An increase in productivity, an increase in the supply of capital, or an increase in the supply of
labor would increase the full-employment level of output, as illustrated by a rightward shift in the FE
line.
14) Describe what happens to the FE line if government purchases increase.
Answer: In the classical model of the labor market, the rise in government purchases reduces people's
perceived wealth, so they increase their labor supply. The increase in labor supply results in a new labor
market equilibrium with increased employment and a lower real wage. The higher level of employment
shifts the FE line to the right.
9.2 The IS Curve
1) The IS curve shows the combinations of output and the real interest rate for which A) the goods
market is in equilibrium.
B) the labor market is in equilibrium.

C) the financial asset market is in equilibrium.
D) an increase in output will cause the market-clearing interest rate to be bid up. Answer: A
2) The IS curve A) is horizontal.
B) is vertical.
C) slopes downward.
D) slopes upward.
Answer: C
3) Any change that reduces desired saving relative to desired investment (for a given level of output)
causes the real interest rate to ________ and shifts the IS curve ________.
A) increase; down and to the left

B) increase; up and to the right
C) decrease; down and to the left
D) decrease; up and to the right
Answer: B
.
.
4) At a given output level, a temporary reduction in government purchases will A)

increase desired saving, causing the IS curve to shift down and to the left.
B) increase desired saving, causing the IS curve to shift up and to the right.
C) decrease desired saving, causing the IS curve to shift down and to the left.
D) decrease desired saving, causing the IS curve to shift up and to the right. Answer: A
.
. .
5)
A
d
ec
li
n
e
in
ex
p
ec
te
d
fu
tu
re
o
ut
p
ut
w
o
ul
d
ca
us
e
th
e
IS
c
ur
v
e
to
A)
sh
ift
u
p
a
n
d
to
th
e
ri
g
ht
.
B) shift down and to the left.

D) shift up and to the right only if people face borrowing constraints. Answer: B
.
. .
6) A decrease in the effective tax rate on capital would cause the IS curve to A) shift up
and to the right.

D) remain unchanged if taxes are fully deductible from income; otherwise, shift up and to the right.
Answer: A
.
. .
7) An increase in the effective tax rate on capital would cause the IS curve to A) shift up
and to the right.

D) remain unchanged if taxes are fully deductible from income; otherwise, shift up and to the right.
Answer: B
.
.
.
8) An increase in labor supply would cause the IS curve to A) shift up and

to the right.

D) shift up and to the right only if people face borrowing constraints. Answer: C
.
.
.
9) An increase in the money supply would cause the IS curve to A) shift up

and to the right.

.
.
.
10) A temporary decline in productivity would cause the IS curve to A) shift up

and to the right.

.
. .
11) A decrease in wealth would cause the IS curve to A) shift up

and to the right.

D) shift up and to the right only if people face borrowing constraints. Answer: B
.
.
.
12) An increase in wealth would cause the IS curve to A) shift up

and to the right.

D) shift up and to the right only if people face borrowing constraints. Answer: A
.
.
.
13) An increase in the expected future marginal product of capital would cause the IS curve to A) shift
up and to the right.

D) remain unchanged if firms face borrowing constraints; otherwise, shift down and to the left. Answer:
A
.
.
.
14) The IS curve will shift down and to the left when A) desired saving
declines.
B) government purchases increase.

C) consumption increases.
D) the expected future marginal product of capital declines. Answer: D
.
.
.
15) The IS curve would unambiguously shift up and to the right if there were A) an increase
in both government purchases and corporate taxes.
B) an increase in both government purchases and the expected future marginal product of capital. C)
an increase in the expected future marginal product of capital and a decrease in expected future
output.
D) a decrease in both corporate taxes and the expected future marginal product of capital. Answer: B
.
. .
16) Draw a saving—investment diagram to show how each of the following changes shifts the IS curve.
(a) Future income rises.

(b) The future marginal productivity of capital increases.
(c) Government purchases decrease temporarily.
(d) The effective corporate tax rate increases. Answer:
(a) IS shifts up and to the right.

(b) IS shifts up and to the right.
(c) IS shifts down and to the left.
(d) IS shifts down and to the left.
.
.
.
9.3 The LM Curve

1) A rise in the price of a bond causes the yield of the bond to A) rise.
B) fall.
D) rise if it's a short-term bond, fall if it's a long-term bond. Answer: B
.
.
.
2) A decline in the price of a bond causes the yield of the bond to A) rise.
B) fall.
D) rise if it's a short-term bond, fall if it's a long-term bond. Answer: A
.
.
.
3) A rise in the price of a bond causes the yield of the bond to A) rise.
B) fall.
D) rise if it's a short-term bond, fall if it's a long-term bond. Answer: B
.
.
.
4) The LM curve A) is horizontal.
B) is vertical.
C) slopes downward.
D) slopes upward.
Answer: D
.
.
.
5) Looking only at the asset market, an increase in output would cause A) the LM
curve to shift down and to the right.
B) the LM curve to shift up and to the left.

C) an increase in the real interest rate along the LM curve.
D) a decrease in the real interest rate along the LM curve.
Answer: C
.
.
.
6) The LM curve illustrates that when income increases, the A) price level
must increase to clear the asset market.
B) real interest rate on nonmonetary assets must increase to clear the asset market.
C) price level must increase to clear the goods market.
D) real interest rate on nonmonetary assets must increase to clear the goods market. Answer: B
.
.
.
7) A change that increases the real money supply relative to real money demand causes A) the LM

C) the IS curve to shift down and to the left.
D) the IS curve to shift up and to the right. Answer: A
.
.
.
8) A change that increases real money demand relative to the real money supply causes A) the LM

C) the IS curve to shift down and to the left.
D) the IS curve to shift up and to the right. Answer: B
.
.
9) Banks decide to raise the interest rate they pay on checking accounts from 1% to 2%. This action
would
A) increase money demand, shifting the LM curve up and to the left.

B) increase money demand, shifting the LM curve down and to the right.
C) decrease money demand, shifting the LM curve up and to the left.
D) decrease money demand, shifting the LM curve down and to the right. Answer: A
.
.
.
10) You have just read that the Federal Reserve has increased the money supply to avoid
a recession. For a given price level, you would expect the LM curve to A) shift up and to
the left as the real money supply falls.
B) shift up and to the left as the real money supply rises.

C) shift down and to the right as the real money supply falls.
D) shift down and to the right as the real money supply rises. Answer: D
.
.
.
11) The Fed has announced that it plans to lower the rate of monetary growth from 10% per year to 2%
per year. You would expect this announcement to directly
A) increase money demand, shifting the LM curve up and to the left.
D) decrease money demand, shifting the LM curve down and to the right. Answer: A
.
.
.
12) The probably effect of introducing an increased number of automatic teller machines is to A)
increase money demand, shifting the LM curve up and to the left.
D) decrease money demand, shifting the LM curve down and to the right. Answer: D
.
. .
13) Looking at the macroeconomic statistics for Friedmanland, you discover that at the beginning of the
year, the national money supply was equal to $400 million and by the end of the year it was equal to
$420 million. You also found out that the inflation rate in Friedmanland was
7%. In this case, you would expect the LM curve to
A) shift up and to the left as the real money supply falls.

B) shift up and to the left as the real money supply rises.
C) shift down and to the right as the real money supply falls.
D) shift down and to the right as the real money supply rises. Answer: A
.
.
.
14) If the money supply is increased, which curve shifts in the IS—LM model? What direction does
it shift? What is the intuition behind this shift?
Answer: An increase in the money supply shifts the LM curve down and to the right. Because the
nominal money supply has risen, real money supply is higher. To get an increase in real money
demand to restore equilibrium in the asset market, either income must rise or the real interest rate
must fall, which can be seen as a shift of the LM curve down and to the right. .
.
.
15) Calculate the real money supply growth rate when the nominal money supply increases by 10%
and the price level increases by each of the following percentages: a) 2%; b) 8%; c) 10%; d) 15%.
Answer: Real money supply growth rate = nominal money supply growth rate minus the price level
growth rate. (The price level growth rate is the inflation rate.) (a) Real money supply growth rate = 10%
- 2% = 8%.
(b) Real money supply growth rate = 10% - 8% = 2%.

(c) Real money supply growth rate = 10% - 10% = 0%.
(d) Real money supply growth rate = 10% - 15% = -5%.
.
.
.
9.4 General Equilibrium
1) An increase in wealth that doesn't affect labor supply would cause the IS curve to ________ and the
FE line to ________.
A) shift down and to the left; be unchanged

B) shift down and to the left; shift left
C) shift up and to the right; be unchanged
D) shift up and to the right; shift left Answer: C
.
. .
2) An increase in the effective tax rate on capital would cause the IS curve to ________ and the
LM curve to ________.

B) shift down and to the left; shift up and to the left
C) shift up and to the right; be unchanged
D) shift up and to the right; shift up and to the left Answer: A
.
.
.
3) A decrease in the money supply would cause the IS curve to ________ and the LM curve to
________.

B) shift down and to the left; shift up and to the left
C) be unchanged; shift up and to the left
D) be unchanged; shift down and to the right Answer: C
.
.
.
4) When all markets in the economy are simultaneously in equilibrium, we say A) markets
are complete.
B) markets are perfect.

C) there is disequilibrium.
D) there is general equilibrium. Answer: D
.
.
.
5) To reach general equilibrium, the price level adjusts to shift the ________ until it intersects with the
________.
A) IS curve; FE line and LM curve

B) FE line; LM and IS curves
C) LM curve; FE line and IS curve
D) ND curve; FE line and NS curve Answer: C
.
.
.
6) What adjusts to restore general equilibrium after a shock to the economy?
A) The LM curve
B) The IS curve
C) The FE line
D) The labor supply curve Answer: A
.
. .
7) The IS—LM model predicts that a temporary beneficial supply shock
A) increases output, national saving, and investment, but not the real interest rate. B)
increases output, national saving, and the real interest rate, but not investment.
C) increases the real interest rate, investment, and output, but not national saving.
D) increases output, national saving, investment, and the real interest rate. Answer: A
.
.
.
8) A temporary supply shock, such as a bumper crop, would
A) shift the FE line to the right and leave the IS curve unchanged.
B) shift the FE line to the left and shift the IS curve up and to the right.
C) shift the FE line to the left and leave the IS curve unchanged.
D) have no effect on the FE line. Answer: A
.
.
.
9) A temporary supply shock, such as an increase in oil prices, would A) shift the IS
curve down and to the left and leave the FE line unchanged.
B) shift the IS curve down and to the left and shift the FE line to the left.
C) shift the IS curve up and to the right, but leave the FE line unchanged.
D) have no effect on the IS curve. Answer: D
.
.
.
10) You have just read that Australia has suffered a drought, destroying its wheat crop for
this year. The effect of this adverse supply shock on Australia would probably be A) an
increase in prices and an increase in real interest rates.
B) an increase in prices, an increase in nominal interest rates, but a decrease in real interest rates.
C) a decrease in prices and a decrease in real interest rates.
D) a decrease in prices, a decrease in nominal interest rates, but an increase in real interest rates.
Answer: A
.
.
.
11) A temporary adverse supply shock directly causes A) a shift down

and to the left of the IS curve.
B) a shift to the left of the FE line.

C) a shift down and to the right of the LM curve.
D) a shift up and to the right of the IS curve. Answer: B
.
. .
12) After a temporary beneficial supply shock hits the economy, general equilibrium is restored by A)
a shift down and to the left of the IS curve.

B)
a shift to the left of the FE line.
C) a shift up and to the left of the LM curve.
D) a shift down and to the right of the LM curve. Answer: D
.
.
.
13) An adverse supply shock that is permanent shifts which curve in addition to the curves shifted by
one that is temporary?
A) The LM curve
B) The IS curve
C) The FE line
D) The labor demand curve Answer: B
.
.
.
14) Which market adjusts the quickest in response to shocks to the economy?
A) The asset market

B) The labor market
C) The goods market
D) The asset, labor, and goods markets adjust at about the same speed to eliminate a disequilibrium
in the macroeconomy. Answer: A
.
.
.
15) A temporary decrease in government purchases causes the real interest rate to ________
and output to ________ in the short run, before prices adjust to restore equilibrium. A) rise; rise B)
rise; fall
C)
fall; rise
D) fall; fall
Answer: D
.
.
.
16) An increase in expected inflation causes the real interest rate to ________ and output to
________ in the short run, before prices adjust to restore equilibrium.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
Answer: C
.
. .
17) An increase in money supply causes the real interest rate to ________ and output to ________ in
the short run, before prices adjust to restore equilibrium.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
Answer: C
.
.
.
18) Suppose the intersection of the IS and LM curves is to the left of the FE line. A decrease in the
price level would most likely eliminate a disequilibrium among the asset, labor, and goods markets by
A) shifting the LM curve down and to the right.

B) shifting the IS curve up and to the right.
D)
C) shifting the IS curve down and to the left.
shifting the FE curve to the left. Answer:

A
.
.
.
19) Suppose the intersection of the IS and LM curves is to the left of the FE line. What would most
likely eliminate a disequilibrium among the asset, labor, and goods markets?
A) A rise in the price level, shifting the LM curve up and to the left
B) A fall in the price level, shifting the LM curve down and to the right C) A rise in the price level,
shifting the IS curve up and to the right
D) A fall in the price level, shifting the IS curve down and to the left
Answer: B
.
.
.
20) Suppose the intersection of the IS and LM curves is to the right of the FE line. What would most
likely eliminate a disequilibrium among the asset, labor, and goods markets? A) A rise in the price
level, shifting the LM curve up and to the left.
B) A fall in the price level, shifting the LM curve down and to the right.
C) A rise in the price level, shifting the IS curve up and to the right.
D) A fall in the price level, shifting the IS curve down and to the left. Answer: A
.
. .
21) A temporary decrease in government purchases causes the real interest rate to ________ and the
price level to ________ in general equilibrium.
A) rise; rise
B) rise; fall
E)
C) fall; rise
D) fall; fall Answer: D
.
.
.
22) An increase in taxes (when Ricardian equivalence doesn't hold) causes the real interest rate to
________ and the price level to ________ in general equilibrium.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall Answer: D
.
.
.
23) For each of the following changes, which equilibrium curve (IS, LM, or FE) is shifted? Draw the
change in the underlying demand or supply curves (for example, money demand and supply for the LM
curve) and show how the equilibrium curve changes.
(a) Expected inflation increases.

(b) The future marginal productivity of capital increases.
(c) Labor supply decreases.
(d) Future income declines.
(e) There's a temporary beneficial supply shock.
(f) The nominal interest rate on money rises. Answer:
(a) LM shifts down and to the right.

(b) IS shifts up and to the right.
(c) FE shifts left.
(d) IS shifts down and to the left.
(e) FE shifts right.
(f) LM shifts up and to the left.
.
.
.
24) Oil prices have risen temporarily, due to political uncertainty in the Middle East. An advisor to
the Fed suggests, "Higher oil prices reduce aggregate demand. To offset this we must increase the
money supply. Then the price level won't need to adjust to restore equilibrium, and we'll prevent a
recession." Analyze this statement using the IS—LM model.
Answer: This is a change in the FE line, not aggregate demand, so the policy is incorrect. Instead, to
keep the price level fixed, money supply should decrease, so output falls and the real interest rate
rises.
.
. .
25) For each of the following changes, what happens to the real interest rate and output in the
very short run, before the price level has adjusted to restore general equilibrium? (a) Wealth rises. (b)
Money supply rises.
(c) The future marginal productivity of capital increases.
(d) Expected inflation declines.
(e) Future income declines. Answer:
(a) The IS curve shifts up and to the right, so r rises and Y rises.
(b) The LM curve shifts down and to the right, so r falls and Y rises.
(c) The IS curve shifts up and to the right, so r rises and Y rises.
(d) The LM curve shifts up and to the left, so r rises and Y falls.
(e) The IS curve shifts down and to the left, so r falls and Y falls.
.
.
26) Desired consumption is Cd = 2000 + 0.9Y - 100,000r - G, and desired investment is Id = 1000 -
45,000r. Real money demand is Md/P = Y - 6000i. Other variables are πe = 0.03, G = 500, = 1000, and
M = 2100.
(a) Find the equilibrium values of the real interest rate, consumption, investment, and the price
level.
(b) Suppose government purchases decline to 400. What happens to the variables listed in part
(a)?
(c) Suppose government purchases rise to 600. What happens to the variables listed in part (a)?
(d) What feature in this example leads to the result that you don't need to know the amount of
taxes collected by the government to find the equilibrium? Answer:
(a) r = 0.02, C = 400, I = 100, P = 3.

(b) C = 500, other variables are unchanged. (c) C = 300, other variables are
unchanged.
(d) Desired consumption depends on the level of government purchases, not taxes. This is an example
of a classical view in which people realize that government purchases must be paid for by taxes
today or in the future, so it's the level of government purchases that affects consumption
decisions, not the level of taxes.
.
. .
27) Desired consumption is Cd = 100 + 0.8Y - 500r - 0.5G, and desired investment is Id = 100 -
500r. Real money demand is Md/P = Y - 2000i. Other variables are πe = 0.05, G = 200, =
1000, and M = 2100.
(a) Find the equilibrium values of the real interest rate, consumption, investment, and the price
level.
(b) Suppose the money supply increases to 2800. Find the equilibrium values of the real interest
rate, consumption, investment, and the price level. (Assume that the expected inflation rate is
unchanged.) Answer:
(a) Use the equation Y = Cd + Id + G = 300 + 0.8Y - 1000r, so 0.2 Y = 300 - 1000r, so Y = 1500 -
5000r. This is the IS curve. Because full-employment output equals 1000, then 1000 = 1500 - 5000r, so
r = 500/5000 = 0.10. Plug this into the consumption and investment functions to get C = 750 and I = 50.
To find the price level, use the equation M/P = L and plug the values in to get 2100/P = 1000 - 2000(0.1
+ 0.05) = 700, so P = 3.
(b) The increase in the money supply to 2800 does not change anything except the price level. The
new equation is 2800/P = 700, so P = 4.
.
.
.
28) Analyze the following statement, and show what would happen in the long run if such advice
were followed by the Fed: "The increase in the stock market has increased people's wealth. As a result,
their consumption has increased, increasing aggregate demand and output. So the Fed needs to
increase the money supply, since with higher income, people's demand for real money balances will be
higher."
Answer: Assuming resources are fully utilized, there will be no increase in output. Higher wealth will
reduce saving, shifting the IS curve up and to the right. Increasing the money supply shifts the LM
curve down and to the right. But general equilibrium will require the LM curve to shift up and to the
left. So the price level must rise, and it rises even more because of the monetary policy suggested by
the statement. The correct monetary policy for preventing inflation is to reduce, not increase, the
money supply.
.
. .
29) Use the IS—LM model to determine the effects of each of the following on the general
equilibrium values of the real wage, employment, output, the real interest rate, consumption,
investment, and the price level.
(a) Tougher immigration laws reduce the working-age population.
(b) There's increased volatility in the prices of stocks and bonds.
(c) The government tries to achieve tax equity by an increase in the corporate tax rate. (d) Increased
computerization reduces stock market brokerage costs.
Answer:
(a) The decline in labor supply increases the real wage and reduces employment and output,
shifting the FE line to the left. The LM curve shifts up and to the left as the price level rises to restore
equilibrium. As a result, the real interest rate rises, reducing consumption and investment.
(b) Real money demand rises, which shifts the LM curve up and to the left. To restore equilibrium,
the price level must decline, shifting the LM curve down and to the right. There's no effect on any
other variable.
(c) The higher tax rate reduces investment, shifting the IS curve down and to the left. To restore
equilibrium, the LM curve shifts down and to the right as the price level falls. As a result, the real
interest rate declines, so consumption increases. There's no change in the real wage, employment, or
output.
(d) Increased liquidity on nonmoney assets reduces money demand, shifting the LM curve down
and to the right. The price level rises, to restore equilibrium by shifting the LM curve back up and to
the left. There's no effect on the other variables.
.
.
.
30) Suppose the Federal Reserve's short-run response to any change in the economy is to change
the money supply to maintain the existing real interest rate. What would happen to money supply if
there were a reduction in government purchases? Given the Fed's policy, what would happen in the
very short run (before general equilibrium is restored) to output and the real interest rate? What
must happen to the LM curve and the price level to restore general equilibrium? Answer: The
decrease in G shifts the IS curve down and to the left. The Fed's policy decreases the money supply
and shifts the LM curve up and to the left, so the real interest rate doesn't change. But output
declines in the very short run. To restore general equilibrium, the price level must decline to shift the
LM curve down and to the right. If the Fed wanted to keep the price level from changing so much, its
correct policy would have been to increase the money supply, not decrease it.
.
. .
31) Suppose you were a forecaster of the real wage rate, employment, output, the real interest
rate, consumption, investment, and the price level. A shock hits the economy, which you think is a
temporary adverse supply shock.
(a) What are your forecasts for each of the variables listed above (rise, fall, and no change)?
(b) What if the shock was really due to people's reduced expectations about their future income.
Which variables did you forecast correctly, and which did you forecast incorrectly?
Answer:
(a) The real wage rate, employment, output, consumption, and investment decline, while the real
interest rate and the price level rise.
(b) The IS curve shifts down and to the left, instead of the FE line shifting left, so you are wrong
about every variable except consumption. The real wage, employment, and output won't change, the
real interest rate and the price level will decline, and investment will rise.
.
.
.
9.5 Price Adjustment and the Attainment of General Equilibrium
1) A decrease in money supply causes the real interest rate to ________ and output to ________ in the
short run, before prices adjust to restore equilibrium.
A) rise; rise
B) rise; fall
C) fall; rise
D) fall; fall
Answer: B
.
.
.
2) An increase in money supply causes the real interest rate to ________ and the price level to
________ in general equilibrium.
A) rise; rise
B) remain unchanged; fall
C) remain unchanged; rise
D) fall; fall
Answer: C
.
.
.
3) A decrease in money supply causes the real interest rate to ________ and the price level to
________ in general equilibrium.
A) rise; rise
B) remain unchanged; fall
C) remain unchanged; rise
D) fall; fall
Answer: B
.
. .
4) After a temporary adverse supply shock hits the economy, general equilibrium is restored by A)
a shift down and to the left of the IS curve. B) a shift to the left of the FE line.
C) a shift up and to the left of the LM curve.
D) a shift down and to the right of the IS curve. Answer: C
.
.
.
5) Suppose the intersection of the IS and LM curves is to the right of the FE line. An increase in the
price level would most likely eliminate a disequilibrium among the asset, labor, and goods markets by
A) shifting the LM curve up and to the left.

B) shifting the IS curve up and to the right.
C) shifting the IS curve down and to the left.
D) shifting the FE curve to the left. Answer: A
.
.
.
6) In classical IS—LM analysis, the effects of a decline in desired investment include A) a

decline in output.
B) an increase in the price level.

C) a decline in the real interest rate.
D) an increase in unemployment. Answer: C
.
.
.
7) Classical economists think general equilibrium is attained relatively quickly because A) the
real interest rate adjusts quickly.
B) the level of output adjusts quickly.

C) the real wage rate adjusts quickly.
D) the price level adjusts quickly.
Answer: D
.
.
.
8) Keynesian economists think general equilibrium is not attained quickly because A) the
real interest rate adjusts slowly.
B) the level of output adjusts slowly.

C) the real wage rate adjusts slowly.
D) the price level adjusts slowly. Answer: D
.
. .
9) Classical economists believe that a market economy will normally A) suffer

from extended periods of sustained unemployment.
B) achieve full-employment output.

C) degenerate into pure monopolies in most industries.
D) eliminate the problem of economic scarcity. Answer: B
.
.
.
10) Keynesian economists believe that in the short run A)

money neutrality exists and prices adjust rapidly.
B) money neutrality does not exist and prices adjust rapidly.

C) money neutrality exists and prices do not adjust rapidly.
D) money neutrality does not exist and prices do not adjust rapidly. Answer: D
.
.
11) Classical economists believe that in the short run A)
money neutrality exists and prices adjust rapidly.
B) money neutrality does not exist and prices adjust rapidly.

C) money neutrality exists and prices do not adjust rapidly.
D) money neutrality does not exist and prices do not adjust rapidly. Answer: A
.
.
.
12) Under monetary neutrality, an increase in the money supply causes output to ________ and the
price level to ________.
A) rise; rise
B) rise; not change
C) not change; not change
D) not change; rise
Answer: D
.
.
.
13) Under an assumption of monetary neutrality, a change in the nominal money supply has A) no
effect on the price level.
B) a less than proportionate effect on the price level.

C) a proportionate effect on the price level.
D) a more than proportionate effect on the price level. Answer: C
.
.
.
14) Describe the .erences between classical and Keynesian economists in terms of their views
about monetary neutrality.
.
Answer: Keynesians believe that monetary neutrality holds in the long run but not in the short run.
Classical economists are more accepting of the view that money is neutral even in the relatively short
run.
.
.
.
15) For each of the following changes, what happens to the real interest rate and output in the very
short run, before the price level has adjusted to restore general equilibrium?
(a) Wealth declines.
(b) Money supply declines.
(c) The future marginal productivity of capital declines.
(d) Expected inflation rises.
(e) Future income rises. Answer:
(a) The IS curve shifts down and to the left, so r falls and Y falls. (b) The LM
curve shifts up and to the left, so r rises and Y falls.
(c) The IS curve shifts down and to the left, so r falls and Y falls.
(d) The LM curve shifts down and to the right, so r falls and Y rises. (e) The IS curve shifts up and
to the right, so r rises and Y rises. .
.
.
9.6 Aggregate Demand and Aggregate Supply
1) The aggregate demand curve shows
A) the demand for goods depending on the relative price of goods compared to financial assets. B) the
amount of output that can be obtained given the current production function in the economy.
C) the relation between the aggregate quantity of goods demanded and the price level.
D) the relation between the real interest rate and output when the goods market clears. Answer: C
.
.
2) The aggregate demand curve shows the combinations of output and the price level that put the
economy on
A) the FE line and the IS curve.

B) the FE line, the IS curve, and the LM curve.
C) the IS curve.
D) the IS curve and the LM curve. Answer: D
.
.
.
3) The aggregate demand curve A) is

vertical.
B) slopes upward.
C) is horizontal.
D) slopes downward.
Answer: D
.
.
.
4) Which of the following changes shifts the AD curve down and to the left?
A) A temporary increase in government purchases

B) A rise in the nominal money supply
C) A decrease in corporate taxes
D) A decrease in consumer confidence Answer: D
.
.
.
5) Which of the following changes shifts the AD curve down and to the left?
A) A decline in the nominal money supply

B) A decrease in income taxes
.
C) A decrease in the risk on nonmonetary assets

D) An increase in the future marginal productivity of capital Answer: A
.
.
.
6) Which of the following changes shifts the AD curve up and to the right?
A) A rise in the nominal money supply

B) An increase in income taxes
C) An increase in the risk on nonmonetary assets
D) A decrease in the future marginal productivity of capital Answer: A
.
.
.
7) Which of the following changes shifts the AD curve up and to the right?
A) A temporary decrease in government purchases

B) A decline in the nominal money supply
C) An increase in corporate taxes
D) An increase in consumer confidence Answer: D
.
.
8) The aggregate supply curve shows the relation between
A) the real interest rate and the aggregate amount of output that firms supply.
B) the price level and the aggregate amount of output that firms supply.
C) the supply of goods by firms and the price of goods relative to the price of nonmonetary assets.
D) the inflation rate and the unemployment rate.
Answer: B
.
.
9) The short-run aggregate supply curve (in the absence of misperceptions) A) is
vertical.
B) slopes upward.
C) is horizontal.
D) slopes downward. Answer: C
.
.
.
10) The long-run aggregate supply curve A) is

vertical.
B) slopes upward.
C) is horizontal.
D) slopes downward. Answer: A
.
.
.
11) Which of the following changes shifts the SRAS curve up?
A) An increase in the labor force

B) An increase in firms' costs
C) A decrease in government purchases
D) An increase in the money supply Answer: B
.
.
.
12) Which of the following changes shifts the SRAS curve up?
A) A decrease in the labor force

B) A decrease in the money supply
C) An increase in government purchases
.
D) An increase in firms' costs Answer: D

.
. .
13) Which of the following changes shifts the long-run aggregate supply curve to the right?
A) A demographic change that increases the labor supply

B) A decrease in the demand for labor
C) An increase in consumer confidence
D) A decrease in taxes (assuming Ricardian equivalence doesn't hold) Answer: A
. .
14) Which of the following changes shifts the SRAS curve down?
A) An increase in the labor force

B) An increase in the money supply
C) A decrease in government purchases
D) A decrease in firms' costs Answer: D
. .
15) When the money supply rises by 10%, in the short run, output ________ and the price level
________.
A) rises; is unchanged
B) declines; falls
C) is unchanged; falls
D) declines; is unchanged
Answer: A
.
.
.
16) When the money supply declines by 10%, in the long run, output ________ and the price level
________.
A) is unchanged; is unchanged
B) declines; falls
C) is unchanged; falls
D) declines; is unchanged Answer: C
.
.
.
17) Describe the effects, in both the short run and the long run, of an increase in the money
supply. Explain what happens to real output and the price level.
Answer: In the short run, an increase in the money supply increases output and has no effect on the
price level. In the long run, an increase in the money supply has no effect on output and increases the
price level.
.
. .
18) For each outcome below, tell what type of shift must have taken place in either the aggregate
demand curve or the long-run aggregate supply curve.
(a) In the short run, the price level is unchanged and output rises.
(b) In the long run, the price level declines and output is unchanged.
(c) (c) In the long run, the price level rises and output declines.
Answer:
(a) The aggregate demand curve shifts to the right.

(b) The aggregate demand curve shifts to the left.
(c) The long-run aggregate supply curve shifts to the left.
.
Chapter 12 Unemployment and Inflation
12.1 Unemployment and Inflation: Is There a Trade-Off?
1) The origin of the idea of a trade-off between inflation and unemployment was a 1958 article
by
A) A.W. Phillips.
B) Edmund Phelps.
C) Milton Friedman.
D) Robert Gordon.
Answer: A
Diff: 1
Topic: Section: 12.1
Question Status: Previous Edition
2) Phillips's research looked at British data on

A) unemployment and inflation.
B) unemployment and nominal wage growth.
C) inflation and nominal wage growth.
D) unemployment and output.
Answer: B
Diff: 1
3) The negative relationship between unemployment and inflation is known as the

A) aggregate supply curve.
B) aggregate demand curve.
C) Phillips curve.
D) efficiency wage line.
Answer: C
Diff: 1
4) The Phillips curve is a negative empirical relationship between

A) bond prices and interest rates.
B) unemployment and output.
C) inflation and the real interest rate.
D) unemployment and inflation.
Answer: D
Diff: 1
5) The Phillips curve appeared to fit the data well for the United States in the
A) 1960s.
B) 1970s.
C) 1980s.
D) 1990s.
Answer: A
Diff: 1
6) Friedman and Phelps suggested that there should not be a stable relationship between
inflation
and unemployment, but there should be a stable relationship between
A) anticipated inflation and frictional unemployment.
B) anticipated inflation and cyclical unemployment.
C) unanticipated inflation and frictional unemployment.
D) unanticipated inflation and cyclical unemployment.
Answer: D
Diff: 1
7) Milton Friedman and Edmund Phelps questioned

A) the use of expectations in the Phillips curve.
B) the stability of the relationship between inflation and unemployment.
C) the existence of a natural rate of unemployment.
D) the existence of a full-employment level of output.
Answer: B
Diff: 1
8) In the extended classical model, an anticipated decrease in the money supply would cause
output to ________ and the price level to ________ in the short run.
A) increase; decrease
B) increase; remain unchanged
C) remain unchanged; increase
D) remain unchanged; decrease
Answer: D
Diff: 1
9) In the extended classical model, an unanticipated increase in the money supply would cause
output to ________ and the price level to ________ in the short run.
A) increase; increase
B) decrease; remain unchanged
C) remain unchanged; increase
D) decrease; decrease
Answer: A
Diff: 1
10) In the extended classical model, an unexpected decrease in aggregate demand would
cause unanticipated inflation to be ________ and cyclical unemployment to be ________.
A) positive; negative
B) positive; positive
C) negative; negative
D) negative; positive
Answer: D
Diff: 2
11) Based on the theory of the expectations-augmented Phillips curve, if the expected
inflation rate is 2%, the short-run Phillips curve will
A) have a kink at an inflation rate of 2%.
B) be the same as the long-run Phillips curve.
C) intersect the long-run Phillips curve at the natural unemployment rate, when the inflation
rate is 2%.
D) be horizontal at an expected inflation rate of 2%.
Answer: C
Diff: 1
12) In the expectations-augmented Phillips curve, π = πe - 3(u - ). If π = 0.03 when πe = 0.06
and u = 0.06, then =
A) 0.02.
B) 0.03.
C) 0.04.
D) 0.05.
Answer: D
Diff: 2

A) 0.02.
B) 0.03.
C) 0.04.
D) 0.05.
Answer: C
Diff: 2

A) 0.02.
B) 0.03.
C) 0.04.
D) 0.05.
Answer: B
Diff: 2
15) In the expectations-augmented Phillips curve, π = πe - 3(u - 0.06). When π = 0.06 and πe =
0.03, the unemployment rate is
A) 0.04.
B) 0.05.
C) 0.06.
D) 0.07.
Answer: B
Diff: 2
A) 0.04.
B) 0.05.
C) 0.06.
D) 0.07.
Answer: A
Diff: 2
A) 0.04.
B) 0.05.
C) 0.06.
D) 0.07.
Answer: C
Diff: 2
18) Based on the expectations-augmented Phillips curve, if the natural rate of unemployment
is 0.06, and if the actual inflation rate exceeds the expected inflation rate, then the
unemployment rate is
A) less than 0.06.
B) 0.06.
C) more than 0.06.
D) 0.06 plus 0.5 times the difference between actual and expected inflation.
Answer: A
Diff: 2
19) The short-run Phillips curve is the relation between inflation and unemployment that
holds for a given natural rate of unemployment and a
A) given rate of inflation.
B) given expected rate of inflation.
C) given level of unemployment.
D) given expected level of unemployment.
Answer: B
Diff: 1
Question Status: Revised
20) Suppose most people had anticipated that inflation would be 3% in the coming year
because the Fed would increase the money supply by 3%. Instead, the Fed increases the
money supply by 5%. In the short run, this would cause actual output to be ________ full-
employment output and prices to increase by ________ 3%.
A) above; more than B)
above; less than
C) below; more than
D) below; less than
Answer: A
Diff: 1
21) An increase in the expected rate of inflation would

A) shift the short-run Phillips curve upward.
B) shift the short-run Phillips curve downward.
C) shift the long-run Phillips curve to the right.
D) shift the long-run Phillips curve to the left.
Answer: A
Diff: 1
22) If the expected inflation rate is unchanged, a fall in the natural rate of unemployment
would A) shift the short-run Phillips curve to the right.
B) not shift the short-run Phillips curve.
C) shift the short-run Phillips curve to the left.
D) shift the short-run Phillips curve to the left and shift the long-run Phillips curve to the right.
Answer: C
Diff: 1
23) If the expected rate of inflation rose at the same time the natural rate of unemployment
rose, the short-run Phillips curve
A) would shift down.
B) would shift up.
C) would not move.
D) might shift up or down or not move, depending on which effect was larger.
Answer: B
Diff: 1
24) A beneficial supply shock would cause

A) a movement up the short-run Phillips curve.
B) a movement down the short-run Phillips curve.
C) the short-run Phillips curve to shift upward and to the right.
D) the short-run Phillips curve to shift downward and to the left.
Answer: D
Diff: 1
25) Classicals argue that an adverse supply shock would

A) raise neither the natural rate of unemployment nor the actual rate of unemployment.
B) raise the actual rate of unemployment, but not the natural rate of unemployment.
C) raise the natural rate of unemployment, but not the actual rate of unemployment.
D) raise both the natural rate of unemployment and the actual rate of unemployment.
Answer: D
Diff: 2
26) Historically, Brazil has suffered higher and more variable rates of inflation than
Venezuela. You would expect the short-run aggregate supply curve of Brazil to be ________
than that of Venezuela, and the short-run Phillips curve of Brazil to be ________ than that of
Venezuela.
A) flatter; flatter
B) flatter; steeper
C) steeper; flatter
D) steeper; steeper
Answer: D
Diff: 2
27) The Friedman—Phelps analysis shows that a negative relationship between inflation and
unemployment holds
A) even when expected inflation changes.
B) even when the natural rate of unemployment changes.
C) even if both the expected inflation rate and the natural rate of unemployment change.
D) as long as the expected inflation rate and the natural rate of unemployment are
approximately constant. Answer: D
Diff: 1
28) The short-run Phillips curve shifted during the 1970s primarily because of A)
the two large oil price shocks.
B) the changing demographics of the population.
C) tight monetary policy.
D) easy fiscal policy.
Answer: A
Diff: 1
29) Examining data on cyclical unemployment plotted against unanticipated inflation shows
A) a positive relationship.
B) a negative relationship.
C) no significant relationship.
D) a relationship only during the 1960s.
Answer: B
Diff: 1
30) The Friedman—Phelps analysis suggests that there is a long-term relationship between
A) inflation and unemployment.
B) cyclical inflation and structural unemployment.
C) unanticipated inflation and cyclical unemployment.
D) anticipated inflation and structural unemployment.
Answer: C
Diff: 1
31) An analysis of the American economy since 1960 shows that there is a stable
relationship between inflation and unemployment
A) only in the short run.
B) only in the long run.
C) in neither the short run nor the long run.
D) in both the short run and the long run.
Answer: A
Diff: 1
32) State and briefly explain whether or not the empirical evidence generally supports
the belief that there is a fixed trade-off between unemployment and inflation, such that
monetary policymakers can achieve the combination they prefer.
Answer: The Phillips curve suggests that there is a stable set of unemployment rate and
inflation rate combinations, and that monetary policymakers could achieve the combination
they prefer. The macroeconomic data for the 1950s and 1960s for many countries seemed
consistent with this view, but further research using data for the 1970s and 1980s failed to
show that a stable tradeoff exists. The empirical evidence suggests that a stable trade-off
exists only during the time period in which expected inflation and the natural unemployment
rate remain unchanged. The extended classical model suggests that a nonsystematic
expansionary monetary policy attempt to move up a fixed expectations-augmented Phillips
curve to a lower unemployment rate and higher inflation rate will achieve its objective only for
the short-run period in which the increase in inflation is not anticipated. Systematic monetary
policies will be anticipated, so they cannot achieve their objective of temporarily reducing
unemployment below the natural unemployment rate. Diff: 2
33) Suppose Okun's law holds and a one percentage point increase in the unemployment
rate reduces real output by 2% of full-employment output. The expectations-augmented
Phillips curve is given by π = πe - 2.5 (u - 0.04).
Suppose π = 0.08 and πe = 0.03.
(a) What is the natural rate of unemployment?
(b) What is the actual rate of unemployment?
(c) How much is actual GDP compared with full-employment GDP? Answer:
(a) 0.04 (b) 0.02
(c) 4% higher
Diff: 2
34) You are given the following information about the economy.
The natural rate of unemployment is 0.04, Okun's Law is that ( - Y)/ = 2(u - ), and the Phillips
curve relationship is π = πe - 2 (u - 0.04).
(a) What was the full-employment level of output in each year?

(b) Calculate the growth rate of full-employment output each year.
(c) If expected inflation was 0.04 for all four years, what was the inflation rate each year?
Answer:
Diff: 2
35) Consider the following misperceptions model of the economy.

AD: Y = 600 + 10(M/P)
SRAS: Y = + P - Pe
Okun's Law: (Y - )/ = -2(u - )
Let = 750, = 0.05, M = 600, and Pe = 40.
(a) What is the price level?
(b) Suppose there is an unanticipated increase in the nominal money supply to 800. What is
the short-run equilibrium level of output, the unemployment rate, and the price level? (c)
When price expectations adjust fully, what is the price level? Answer:
(a) 40
(b) Y = 760, u = .0433, P = 50
(c) P = 53 1/3
Diff: 3
36) The relationship between inflation and unemployment is given by

π = πe - 3(u - 0.06).
(a) Graph the long-run Phillips curve and three short-run Phillips curves.
(b) What is the value of the natural rate of unemployment?
(c) If actual inflation is 0.02 and expected inflation is 0.05, what is the unemployment rate? (d)
If actual inflation is 0.08 and expected inflation is 0.05, what is the unemployment rate?
Answer:
(a) Long run: vertical line at u = = 0.06.

Short run: downward sloping line (curve) crossing the long-run curve at π = πe.
(b) 0.06 (c) 0.07 (d) 0.05
Diff: 2

π = πe - 2(u - ).
(a) Draw a diagram showing a long-run Phillips curve and two short-run Phillips curves that
contain the following points:
A: π = .03, πe = .03
B: π = .06, πe = .06
C: π = .03, πe = .06 D: π =
.06, πe = .03
Label points A, B, C, and D in your diagram.

The unemployment rate at point A equals .05.
(b) What are the values of the natural rate of unemployment and the unemployment rates
at points B, C, and D?
Answer:

Short run: downward sloping line (curve) crossing the long-run curve at π = πe. Points A and D
are on the same short-run Phillips curve; points B and C are both on a higher short-run Phillips
curve.
(b) = 0.05.; B: u = .05; C: u = .065; D: u = .035

Diff: 2

π = πe - 4(u - ).
(a) Draw a diagram showing a long-run Phillips curve and two short-run Phillips curves that
contain the following points:
A: π = .04, πe = .04
B: π = .08, πe = .08
C: π = .04, πe = .08 D: π =
.08, πe = .04
Label points A, B, C, and D in your diagram.

The unemployment rate at point A equals .05.
(b) What are the values of the natural rate of unemployment and the unemployment rates
at points B, C, and D?
Answer:

Short run: downward sloping line (curve) crossing the long-run curve at π = πe. Points A and D
are on the same short-run Phillips curve; points B and C are both on a higher short-run Phillips
curve.
(b) = 0.05.; B: u = .05; C: u = .06; D: u = .04

Diff: 2
39) The expectations-augmented Phillips curve is π = πe - 3(u - 0.05).
(a) Graph the long-run Phillips curve and the short-run Phillips curve for an expected
inflation rate of 0.03. If the Fed chooses to keep the actual inflation rate at 0.03, what will be
the unemployment rate? Label the equilibrium point "A". What is the numerical value of the
natural rate of unemployment?
(b) An aggregate demand shock (resulting from increased exports of goods) raises the
inflation rate to 0.06 (the natural rate of unemployment and the expected inflation rate are
not affected). Show what happens on your graph. Label the equilibrium point "B". What is the
numerical value of the unemployment rate?
(c) In response to the aggregate demand shock, suppose the Fed allows the inflation rate
of 0.06 to persist. Show what happens on your graph, labeling the equilibrium point "C". In the
long run, what is the numerical value of the unemployment rate?
(d) From the situation in part (c), suppose a supply shock (an oil price increase) raises the
natural rate of unemployment by .01 from its original value. If the expected inflation rate does
not change, show what happens in your graph, labeling the equilibrium point "D".
Answer:
(a) Point A is on the SRPC with expected inflation = .03 and on the LRPC with the natural rate
of unemployment = .05, with inflation = .03.
(b) Point B is on the same SRPC as A, but has inflation = .06, so unemployment = .04.
(c) Point C is on the LRPC with the natural rate = .05 and on the SRPC with inflation = expected
inflation = .06, so the unemployment rate = .05.
(d) Point D is on the LRPC with the natural rate = .06 and on a new SRPC with expected
inflation = .06, and inflation = .06 as well.
Diff: 2
40) The expectations-augmented Phillips curve is
π = πe - 2(u - 0.06).
(a) Graph the long-run Phillips curve and the short-run Phillips curve for an expected
inflation rate of 0.04. If the Fed chooses to keep the actual inflation rate at 0.04, what will be
the unemployment rate? Label the equilibrium point "A". What is the numerical value of the
natural rate of unemployment?
(b) An aggregate demand shock (resulting from increased exports of goods) raises the
inflation rate to 0.06 (the natural rate of unemployment and the expected inflation rate are
not affected). Show what happens on your graph. Label the equilibrium point "B". What is the
numerical value of the unemployment rate?
(c) In response to the aggregate demand shock, suppose the Fed allows the inflation rate
of 0.06 to persist. Show what happens on your graph, labeling the equilibrium point "C". In the
long run, what is the numerical value of the unemployment rate?
(d) From the situation in part (c), suppose a supply shock raises the natural rate of
unemployment by .01 from its original value. If both the inflation rate and the expected
inflation rate do not change, show what happens in your graph, labeling the equilibrium point
"D". What is the numerical value of the unemployment rate?
Answer:
(a) Long run: vertical line at u = 0.06. Short run: downward sloping line (curve) crossing the
long-run curve at π = 0.04. The natural rate of unemployment is 0.06.
(b) Move up along same short-run Phillips curve; now unemployment rate = 0.05.
(c) Now, expected inflation rises to 0.06, with a shift to a higher short-run Phillips curve. The
unemployment rate rises to 0.06 as well.
(d) The long-run Phillips curve now shifts to the right at an unemployment rate of 0.07. With
inflation and expected inflation remaining the same, the short-run Phillips curve shifts to
the right. Diff: 2
12.2 Macroeconomic Policy and the Phillips Curve
1) Can macroeconomic policy be used systematically to create unanticipated inflation?

A) No, according to Keynesian economists.
B) Yes, according to classical economists.
C) No, according to classical economists.
D) Yes, according to Keynesian economists, if Ricardian equivalence holds.
Answer: C
Diff: 2
Question Status: New
2) Can macroeconomic policy be used systematically to create unanticipated inflation?
A) Yes, according to Keynesian economists.
B) Yes, according to classical economists.
C) No, according to Keynesian economists.
D) Yes, according to classical economists, if Ricardian equivalence holds.
Answer: A
Diff: 2
3) Classical macroeconomists argue that the short-run Phillips curve ________ represent a
usable trade-off for policymakers because ________.
A) does; people have rational expectations
B) does; people do not have rational expectations
C) does not; people do not have rational expectations
D) does not; people have rational expectations
Answer: D
Diff: 2
4) Keynesian macroeconomists argue that the short-run Phillips curve ________ represent a
usable trade-off for policymakers because ________.
A) does; prices are sticky
B) does; prices are not sticky
C) does not; prices are not sticky
D) does not; prices are sticky
Answer: A
Diff: 2
5) Both classicals and Keynesians agree that policymakers
A) can exploit the Phillips curve in the short run.
B) cannot exploit the Phillips curve in the short run.
C) can keep the unemployment rate permanently below the natural rate by permanently
running a high rate of inflation.
D) cannot keep the unemployment rate permanently below the natural rate by permanently
running a high rate of inflation.
Answer: D
Diff: 1
6) The Lucas critique is an objection to the assumption that
A) inflation is always and everywhere a monetary phenomenon.
B) there is a negative relationship between inflation and unemployment.
C) historical relationships between macroeconomic variables will continue to hold after new
policies are in place.
D) people form expectations rationally.
Answer: C
Diff: 1
7) The argument that when policy changes, people's behavior changes so that
historical relationships between macroeconomic variables will no longer hold is
known as
A) the Phillips curve.
B) the policy irrelevance hypothesis.
C) hysteresis.
D) the Lucas critique.
Answer: D
Diff: 1
8) The idea that new policies change the economic rules and affect economic behavior, so that
no one can safely assume that historical relationships between variables will hold when
policies change, is known as
A) Okun's Law.
B) Say's Law.
C) the equation of exchange.
D) the Lucas critique.
Answer: D
Diff: 1
9) The long-run Phillips curve is

A) vertical.
B) horizontal.
C) upward sloping.
D) downward sloping.
Answer: A
Diff: 1
10) The fact that the long-run Phillips curve is vertical implies that A)
monetary policy can't affect unemployment.
B) money is neutral in the long run.
C) there is a natural rate of inflation.
D) money can't affect inflation in the long run.
Answer: B
Diff: 1
11) Starting on a Phillips curve with expected inflation equal to 5% and unemployment at its
natural rate, show what happens to unemployment if the Fed tries to reduce inflation, but has
no credibility. As time passes and people realize that the inflation rate is now lower, what
happens to the short-run Phillips curve?
Answer: The unemployment rate rises as the economy moves along the Phillips curve and as
inflation declines. As time passes, inflation expectations begin to decline, shifting the Phillips
curve down and to the left until the unemployment rate returns to its natural rate and
inflation and expected inflation are equal at a lower level.
Diff: 2
12) Why did the government use expansionary monetary policies in the late 1970s, and
what was the principal negative macroeconomic effect of these policies?
Answer: In the late 1970s the U.S. government used expansionary monetary policies in an
attempt to reduce the unemployment rate and to increase the growth rate of output. Relying
on the Keynesian model to explain the slowdown in economic growth, policymakers concluded
that aggregate demand had declined and that expansionary monetary stabilization policies
could pull aggregate demand back to the full-employment level of output. However, aggregate
demand had not declined. The recession was created by a decline in aggregate supply caused
by an increase in the price of oil. Expansionary monetary policies caused aggregate demand to
increase along the new aggregate supply curve, which caused inflation to increase further.
Diff: 2
13) What is the Lucas critique, and why was it so important to macroeconomists in the 1970s?
Answer: The Lucas critique suggests that historical relationships between economic variables
will be changed significantly when there are significant changes in the economy such as new
policies. In the 1970s this was important as it explained the movement of the Phillips curve.
Diff: 1
12.3 The Problem of Unemployment
1) When the economy goes into a recession, there's an increase in

A) frictional unemployment.
B) structural unemployment.
C) cyclical unemployment.
D) voluntary unemployment.
Answer: C
Diff: 1
2) Which of the following forms of unemployment probably imposes the greatest personal
costs?
A) frictional unemployment.
B) structural unemployment.
C) cyclical unemployment.
D) voluntary unemployment.
Answer: B
Diff: 2
3) According to Okun's law, if full-employment output is $5000 billion, then each percentage
point of unemployment sustained for one year reduces output by
A) $50 billion.
B) $100 billion.
C) $150 billion.
D) $200 billion.
Answer: B
Diff: 2
4) Some economists argue that Okun's Law overstates the cost of cyclical unemployment
because
A) the cost of retraining workers must be offset against the loss in output that occurs when
workers are unemployed.
B) if efficiency wages prevail, and workers are paid their real wage, already employed workers
will reduce their effort, reducing output.
C) it ignores the fact that leisure increases during a recession.
D) it ignores the loss of government revenue and additional government expenditures that
occur when unemployment rises.
Answer: C
Diff: 2
5) The natural rate of unemployment in the United States generally ________ from 1960 to
1980 and ________ from 1980 to 2000.
A) fell; rose
B) fell; fell
C) rose; fell
D) rose; rose
Answer: C
Diff: 2
6) One reason for the fall in the natural rate of unemployment from 1980 to 2000 is
A) changes in the demographic composition of the work force.
B) the decline in inflation.
C) increased competition from foreign workers.
D) the depreciation of the dollar relative to foreign currencies.
Answer: A
Diff: 1
7) One reason for the rise in the natural rate of unemployment from 1960 to 1980 is
A) changes in the demographic composition of the work force.
B) the decline in inflation.
Answer: A
Diff: 1
8) The bulk of the decline in the natural rate of unemployment from 1980 to 2000 is because
of A) a decline in the inflation rate.
B) a decline in the share of young workers in the labor force.
Answer: B
Diff: 1
9) In years when teenagers become a greater percentage of the labor force,
A) the natural rate of unemployment falls.
B) the natural rate of unemployment rises.
C) the inflation rate rises.
D) the inflation rate falls.
Answer: B
Diff: 2
10) A difficulty faced by policymakers who wish to use the unemployment rate as a guide to
whether the economy is weak or strong is that
A) the natural rate of unemployment is hard to measure.
B) the natural rate of unemployment almost never changes.
C) policymakers must use data on output to tell whether the unemployment rate is too high or
too low.
D) the impact of policy on the economy is subject to long and variable lags.
Answer: A
Diff: 1
11) Because the natural rate of unemployment is not known precisely, policymakers who use it
as a guide for policy must be
A) less aggressive with policy changes than they would be if they knew the value of the natural
rate.
B) more aggressive with policy changes than they would be if they knew the value of the
natural rate.
C) ready to change policy more quickly.
D) aware of other data.
Answer: A
Diff: 1
12) What is the relation between the unemployment rate and the proportion of
unemployed workers who have been unemployed for 15 weeks or longer?
A) Both rise in recessions.
B) Both rise in expansions.
C) The unemployment rises in recessions but the proportion of unemployed workers who have
been unemployed for 15 weeks or longer declines in recessions.
D) The unemployment falls in recessions but the proportion of unemployed workers who have
been unemployed for 15 weeks or longer rises in recessions.
Answer: A
Diff: 1
13) Describe the principal costs of unemployment. Are there any benefits to
unemployment? Answer: The costs of unemployment are the loss of output because of idle
resources and the personal or psychological cost faced by unemployed workers and their
families. There are benefits from unemployment: (1) unemployed workers engage in useful
activities, such as searching for a better job match or acquiring new skills; and (2) increased
leisure time. But the benefits are likely to be small compared to the costs.
Diff: 1
14) If you were president of the United States, what would you do to reduce the natural
rate of unemployment? Propose at least three different methods.
Answer: Provide support for job training and worker relocation; increase labor-market
flexibility by reducing the minimum wage; reform the unemployment insurance system; run a
highpressure economy (if there is hysteresis).
Diff: 1
12.4 The Problem of Inflation
1) One cost of a perfectly anticipated inflation is that it

A) transfers wealth from lenders to borrowers.
B) transfers wealth from borrowers to lenders.
C) increases menu costs.
D) damages the role of prices as signals in the economy.
Answer: C
Diff: 1
2) The costs in time and effort incurred by people and firms who are trying to minimize
their holdings of cash because of inflation are called A) menu costs.
B) shoe leather costs.
C) transactions costs.
D) imperfect competition costs.
Answer: B
Diff: 1
3) Shoe leather costs are

A) the costs in time and effort incurred by people and firms who are trying to minimize their
holdings of cash because of inflation.
B) the costs of changing prices, such as printing and mailing catalogues.
C) the costs of the redistribution of wealth between lenders and borrowers.
D) the costs associated with the confusion of prices as signals.
Answer: A
Diff: 1
4) When actual inflation is greater than expected inflation

A) the natural rate of unemployment rises, according to Phillips-curve analysis.
B) cyclical unemployment rises, according to Phillips-curve analysis.
C) there are transfers from borrowers to lenders.
D) there are transfers from lenders to borrowers.
Answer: D
Diff: 1
5) When actual inflation is less than expected inflation

A) the natural rate of unemployment falls, according to Phillips-curve analysis.
B) cyclical unemployment falls, according to Phillips-curve analysis.
C) there are transfers from borrowers to lenders.
D) there are transfers from lenders to borrowers.
Answer: C
Diff: 1
6) One cost of an unanticipated inflation is that it A)

transfers wealth from lenders to borrowers.
B) transfers wealth from borrowers to lenders.
C) decreases menu costs.
D) increases the purchasing power of money.
Answer: A
Diff: 1
7) A COLA is
A) a center of labor activity.
B) a cost of living adjustment.
C) a contract on long-term assets.
D) a crisis of labor analysis.
Answer: B
Diff: 1
8) Hyperinflation occurs when

A) the inflation rate rises.
B) the inflation rate declines.
C) the inflation rate is extremely high.
D) the inflation rate is extremely low.
Answer: C
Diff: 1
9) With fixed interest rates, unanticipated deflation hurts ________ because ________.
A) lenders; they get paid back in less valuable dollars
B) lenders; they get paid back in more valuable dollars
C) borrowers; they repay the loan in more valuable dollars
D) borrowers; they repay the loan in less valuable dollars
Answer: C
Diff: 2
10) Unanticipated deflation can create unemployment if

A) nominal wages are sticky, causing real wages to rise over time.
B) nominal wages are flexible, causing people's real incomes to decline.
C) banks refuse to make loans at low nominal interest rates.
D) nominal interest rates remain positive.
Answer: A
Diff: 2
11) If nominal interest rates have a lower bound of zero and deflation occurs at 3% (i.e., the
inflation rate equals -3%, then the lowest real interest rate possible is
A) -3%.
B) 0%.
C) 3%.
D) 6%.
Answer: C
Diff: 2
12) Many central banks around the world target an inflation rate of about ________,
because of upward bias in measured inflation and to reduce the risk of deflation.
A) -2%.
B) 0%.
C) 2%.
D) 5%.
Answer: C
Diff: 2
13) Describe the major costs of inflation, being sure to distinguish between anticipated and
unanticipated inflation.
Answer: Costs of anticipated inflation include an erosion of the value of currency, which leads
to shoe-leather costs, and the costs of changing prices. Costs of unanticipated inflation arise
because unanticipated inflation transfers wealth between people and because it disturbs the
role of prices as signals in the economy.
Diff: 1
14) Suppose expected inflation in the economy is 5%. Banks set nominal interest rates so
they'll earn a 2% expected real return. Employers set nominal wages based on a 2% expected
real wage increase. Suppose the nominal interest rate and nominal wages are determined this
way, but actual inflation turns out to differ from the expected inflation rate. Calculate the
actual real interest rate and the percent increase in the real wage for each of the following
actual inflation rates: a) 2%; b) 5%; c) 10%.
Answer: The real interest rate (r) = the nominal interest rate minus the inflation rate. In
percentage terms, the percentage increase in the real wage (w) = the percentage increase in
the nominal wage minus the inflation rate. It is given that the expected inflation rate = 5%, so
the nominal interest rate on bank savings deposits = 7%, and the percentage increase in the
nominal wage = 7%. When inflation is
(a) When inflation is 2%, then r = 7% - 2% = 5%, and the percentage increase in w equals
7% - 2% = 5%.
(b) When inflation is 5%, then r = 7% - 5% = 2%, and the percentage increase in w equals
7% - 5% = 2%.
(c) When inflation is 10%, then r = 7% - 10% = -3%, and the percentage increase in w equals
7% - 10% = -3%.
Diff: 2
12.5 Fighting Inflation: The Role of Inflation Expectations
1) The reduction of the inflation rate is called

A) deflation.
B) disinflation.
C) unflation.
D) reflation.
Answer: B
Diff: 1
2) The costs of disinflation would be low if

A) expected inflation falls as inflation falls.
B) wage and price controls were used.
C) the Phillips curve were nearly horizontal.
D) the Phillips curve adjusted slowly to changes in inflation.
Answer: A
Diff: 2
3) A rapid and decisive reduction in the rate of growth of the money supply for the purpose of
disinflation is called
A) a salt water policy.
B) a cold shower policy.
C) gradualism.
D) a cold turkey policy.
Answer: D
Diff: 1
4) Keynesians prefer a disinflation policy of

A) cold turkey.
B) stabilization.
C) gradualism.
D) aggregate demand management.
Answer: C
Diff: 1
5) Which of the following disinflationary monetary policies would classical economists prefer?
A) A cold turkey approach that is announced and credible.
B) A cold turkey approach that is announced, but not credible.
C) A gradual approach that is announced and credible.
D) A gradual approach that is unannounced.
Answer: A
Diff: 1
6) The sacrifice ratio is

A) the amount of output lost when the inflation rate is reduced by one percentage point.
B) the percentage reduction in inflation when output falls one percentage point below
potential.
C) the percentage change in employment when output declines by one percentage point.
D) the number of percentage points that the unemployment rate rises when output declines
by one percentage point.
Answer: A
Diff: 1
7) The amount of output lost when the inflation rate is reduced by one percentage point is
called A) Okun's law.
B) the sacrifice ratio.
C) the Solow residual.
D) Planck's constant.
Answer: B
Diff: 1
8) Ball found that the disinflation of the early 1980s in the United States had a sacrifice ratio
of about
A) 0.
B) 1.
C) 2.
D) 3.
Answer: C
Diff: 1
9) Ball's research showed that the sacrifice ratio

A) was the same for all countries.
B) was nearly zero for most countries.
C) was about 10 for all countries except the United States, where it was about 2.
D) varied considerably across countries.
Answer: D
Diff: 1
10) Ball found that an important factor affecting the sacrifice ratio is A)
the flexibility of the labor market.
B) the shape of the yield curve.
C) the real interest rate.
D) the tightness of fiscal policy.
Answer: A
Diff: 1
11) Countries in which wages adjust slowly to changes in the supply of and demand for labor
are likely to have ________ sacrifice ratio.
A) an infinite
B) a high C) a low
D) a zero
Answer: B
Diff: 1
12) Countries in which wages adjust rapidly to changes in the supply and demand for labor are
likely to have ________ sacrifice ratio.
A) an infinite
B) a high
C) a low
D) a negative
Answer: C
Diff: 1
13) Countries in which the government does not regulate the labor market are likely to have
________ sacrifice ratio.
A) an infinite
B) a high
C) a low
D) a negative
Answer: C
Diff: 1
14) Ball's research on disinflation across different countries found that

A) costs of disinflation were smaller for rapid disinflation than for gradual disinflation.
B) costs of disinflation were larger for rapid disinflation than for gradual disinflation.
C) costs of disinflation were about the same for both rapid and gradual disinflation.
D) costs of disinflation were smaller when the central bank had a strong inflation-fighting
reputation.
Answer: A
Diff: 1
15) If a rapid disinflation has a lower sacrifice ratio than a slow disinflation, then
reducing inflation is best accomplished by
A) gradualism.
B) increasing money growth.
C) reducing interest rates.
D) a cold-turkey approach.
Answer: D
Diff: 1
16) The main determinant of how quickly expected inflation adjusts to changes in monetary
policy is
A) the slope of the Phillips curve.
B) the slope of the short-run aggregate supply curve.
C) the credibility of the central bank.
D) the degree of indexation in the economy.
Answer: C
Diff: 1
17) Inflation expectations in the United States generally

A) fell from 1971 to 1976, rose from 1977 to 1985, then fell from 1985 to 1995, and have been
stable since then.
B) fell from 1971 to 1985, then rose from 1985 to 2000, and have been stable since then.
C) rose from 1971 to 1987, then fell from 1987 to 2006.
D) rose from 1971 to 1982, then fell from 1982 to 2000, and have been stable since then.
Answer: D
Diff: 1
18) What are the pros and cons of using cold turkey disinflation compared to a policy of
gradualism?
Answer: Cold turkey disinflation reduces inflation quickly and could be successful if expected
inflation fell at the same time; that requires that policy be credible, however. But Keynesians
suggest that menu costs and nominal wage contracts will prevent prices and wages from
adjusting quickly, so a cold turkey strategy will cause a recession. Further, if a cold turkey
strategy is begun, but people think the costs will be so large that the strategy will be
abandoned, then expected inflation will not decline. For this reason, Keynesians prefer a
gradualist approach to allow wages and prices more time to adjust to policy changes. Such a
policy is more likely to be sustainable politically.
Diff: 2
19) How is the sacrifice ratio measured? How big is the sacrifice ratio in the United States?
In other countries? What problems are there in measuring the sacrifice ratio?
Answer: The sacrifice ratio is measured as the percentage by which output falls below
potential for every percentage point decline in inflation. In the United States, the sacrifice ratio
is about 2, while other countries have sacrifice ratios ranging from 3/4 to 3. The sacrifice ratio
is difficult to measure because it's hard to calculate what output would have been in the
absence of disinflation and because supply shocks may distort the calculation.
Diff: 1
20) Consider an economy in long-run equilibrium with an inflation rate (π) of 0.08 per year
and a natural unemployment rate of 0.05. Suppose Okun's law holds and a one percentage
point increase in the unemployment rate reduces real output by 2% of full-employment
output. The expectations-augmented Phillips curve is given by π = πe - 2.5 (u - 0.05).
Consider a two-year disinflation. In the first year, π = 0.06 and πe = 0.08. In the second year, π
=
0.04 and πe = 0.05.
(a)In the first year, what is the value of the unemployment rate?
(b)In the first year, by what percentage does output fall short of full-employment output?
(c)In the second year, what is the value of the unemployment rate?
(d)In the second year, by what percentage does output fall short of full-employment output?
(e) What is the sacrifice ratio for this disinflation?
Answer:
(a) .06 = .08 - 2.5(u - .05), so u = .058.
(b) .058 - .05 = .008 = 0.8%; 0.8 × 2% = 1.6%. (c) .04 = .05 - 2.5(u - .05), so
u = .054.
(d) .054 - .05 = .004 = 0.4%; 0.4 × 2% = 0.8%.
(e) sacrifice ratio = output shortfall/change in inflation rate = (1.6% + 0.8%)/(8% - 4%) = 2.4/4 =
0.6.
Diff: 2

Test Bank Chapter 8 9 12

Uploaded by

Copyright:

Available Formats

Test Bank Chapter 8 9 12

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Test Bank Chapter 8 9 12

Uploaded by

Copyright:

Available Formats

What are business cycles and their characteristics?

What are business cycles and their characteristics?

What are the phases of a business cycle?

What are the phases of a business cycle?

Macroeconomics, 9e, Global Edition (Abel/Bernanke/Croushore)

A) the Federal Reserve System.

B) the National Bureau of Economic Research.

3) A detailed history of business cycles is known as a

from the A) FBI. B) BLS. C) BEA. D) NBER.

5) Business cycles all display the following characteristics except

7) The low point in the business cycle is referred to as the

8) When aggregate economic activity is increasing, the economy is

A) turning point. B) peak. C) boom. D) trough.

12) Turning points in business cycles occur when

13) Who officially determines whether the economy is in a recession or expansion?

B) the business cycle's standard contraction—trough—expansion—peak pattern has been observed to

B) the standard pattern of contraction—trough—expansion—peak occurs again and again in industrial

25) When a recession occurs, do economists expect it to be a temporary phenomenon? Or is there

2) In the Great Depression, the financial sector collapsed, as A)

3) The deep recession of 1973-1975 was mainly caused by A)

4) The long boom occurred in the

5) The long boom ended in

8) The worst recessions after World War II occurred A)

9) The 1973-1975 recession was caused by A)

the Fed's easy monetary policy.

1960s. C) 1980s. D) 1990s.

11) The Great Recession began in ________ and ended in ________.

13) Christina Romer argued that

b) the shortest business cycle from trough to trough;

4) A variable that tends to move in advance of aggregate economic activity is called A)

A) a leading variable. B) a coincident variable. C) a lagging variable. D) an acyclical variable. Answer:

A) a leading variable. B) a coincident variable. C) a lagging variable. D) an acyclical variable. Answer:

7) Lagging variables are aggregate economic variables that

9) The ADS Business Conditions Index is a

A) Business fixed investment B) Residential investment C) Nominal interest rates D) Unemployment

13) Which of the following macroeconomic variables is acyclical?

14) Real interest rates are

17) Which of the following is not a leading variable?

A) Residential investment B) Employment C) The money supply D) Stock prices Answer:

23) Which of the following macroeconomic variables is countercyclical?

A) Real interest rates B) Unemployment C) Money growth D) Consumption Answer:

24) Which of the following is true?

25) The job finding rate is defined as

26) The job finding rate

the unemployment rate.

28) The job loss rate

29) Which of the following statements is true?

2) Economists use the term shocks to mean

the business cycle. B) economic models. C) shocks. D) opportunity costs. Answer: C

C) Output and unemployment D) Output and the interest rate Answer:

A) slopes upward. B) slopes downward. C) is vertical. D) is horizontal. Answer:

the aggregate demand curve to shift up and to the right.

11) A decrease in government spending on the park system would cause A)

the aggregate demand curve to shift to the right.

B) the aggregate demand curve to shift to the left.

(a) A stock market crash reduces consumers' wealth.

(b) Businesses decide to hold larger inventories.

(d) Foreign countries buy more U.S. goods.

(c) Productivity increases.

11) The Great Recession began in and ended in .