Chapter 1: Introduction

Difficulty: Easy1. Which of the following is NOT a central issue in macroeconomics?A) How should the central bank of a country fight inflation?B) What is responsible for high and persistent unemployment?C) How do tax changes influence consumers' choices of what to buy?D) What factors determine economic growth?E) What can or should the government do to stabilize the economy?Ans: C

Difficulty: Easy2. Macroeconomics does NOT focus on A) policies that affect consumption and saving B) policies that affect the performance of the health care sectorC) the determination of changes in wages and prices D) the determination of interest rates E) none of the above, all of them are macroeconomic issuesAns: B

Difficulty: Easy3. Which of the following is NOT dealt with in microeconomics?A) the effect of agricultural subsidies on the price of milkB) differences between the market for skilled labor versus the market for unskilled laborC) issues related to the structure and performance of the health care sectorD) policies that affect the level of aggregate consumption E) issues related to the deregulation of the telecommunications industryAns: D

Difficulty: Easy4. Which of the economists below most likely advocated activist government policies? A) Milton FriedmanB) John Maynard Keynes C) Robert Lucas D) Thomas Sargent

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E) Adam Smith Ans: B

Difficulty: Easy5. In studying growth theory, we A) assume that labor, capital, and raw materials are all used efficientlyB) assume that increased use of inputs cannot lead to a higher living standardC) assume that technological advances cannot affect living standards D) try to explain the reasons for recessions and boomsE) all of the aboveAns: A

Difficulty: Easy6. Which of the following factors does NOT contribute to economic growth?A) the availability of resources such as labor and capitalB) increases in the size of the populationC) the availability of new and better technologyD) increased knowledge gained through education or work experienceE) all of the above can increase economic growthAns: E

Difficulty: Easy7. Which of the following is a FALSE statement? A) the very long run focuses on the growth of productive capacityB) in the very long run, the productive capacity is assumed to be givenC) in the very short run, shifts in aggregate demand determine how much output is producedD) fluctuations in inflation and unemployment are important long-run issuesE) at the full-employment level of output, capital is not used 100 percent Ans: D

Difficulty: Easy8. Government intervention into economic activity will NOT lead to a change in the price level A) in the very short-run modelB) in the medium-run model C) in the very long-run model D) in the classical model

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E) assuming a macro-model that focuses on the growth of productive capacityAns: A

Difficulty: Easy9. In the very short run, the level of A) output is determined by both aggregate demand and aggregate supplyB) output is determined by aggregate demand alone C) prices will change if aggregate demand shiftsD) prices is determined by aggregate demand alone E) both A) and C) Ans: B

Difficulty: Easy10. In the simple macro model of this chapter, the long-run AS-curve is A) horizontal B) vertical C) upward-sloping D) assumed to be completely price elasticE) either B) or C), depending on how fast prices adjustAns: B

Difficulty: Easy11. In the very long-run AD-AS model, if the AD-curve shifts to the left, thenA) prices and output will both decreaseB) prices and output will both increaseC) prices will decrease but output will remain the sameD) output will decrease but prices will remain the sameE) output will increase but prices will decreaseAns: C

Difficulty: Easy12. If an increase in aggregate demand causes prices to increase slightly but output to increase

significantly, thenA) the AS-curve must be very flatB) the AD-curve must be very steepC) the AD- and AS-curves must both be very steep

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D) we must be looking at the very long-run AD-AS modelE) we must be looking at the very short-run AD-AS modelAns: A

Difficulty: Medium13. In the very long-run AD-AS model, A) only fiscal policy can affect both output and pricesB) only monetary policy can affect both output and prices C) monetary policy can affect output but not prices D) active stabilization policy is ineffective in changing outputE) the unemployment rate is always assumed to be zeroAns: D

Difficulty: Easy14. If a shift in the AD-curve has no impact on the price level, thenA) the unemployment rate must be extremely lowB) the AD-curve must be vertical C) the AS-curve must be horizontalD) the AS-curve must be verticalE) both A) and D) Ans: C

Difficulty: Easy15. In the medium run, if GDP goes down but the price level goes up,A) the AD-curve must have shifted to the rightB) the AD-curve must have shifted to the leftC) the AS-curve must have shifted to the rightD) the AS-curve must have shifted to the leftE) the AD-curve and the AS-curve must have both shifted to the rightAns: D

Difficulty: Medium16. Which of the following is FALSE in the medium run?A) a change in monetary policy can shift the AD-curveB) a change in fiscal policy can shift the AD-curveC) a change in fiscal policy can change output and prices

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D) a change in monetary policy can change prices but not outputE) a change in labor productivity can shift the AS-curveAns: D

Difficulty: Easy17. The AD-curve will shift if there is a change in A) monetary or fiscal policyB) the level of consumer confidenceC) the productive capacity of our economyD) all of the above E) only A) and B) Ans: E

Difficulty: Easy18. The position of the AS-curve depends on A) fiscal policy B) monetary policy C) consumer confidenceD) the productive capacity of the economy E) all of the aboveAns: D

Difficulty: Easy19. Nominal GDP is correctly defined as A) the monetary value of all goods and services, final and intermediate, produced in a given

yearB) the monetary value of all wealth that is accumulated in a given yearC) the national income minus all non-income charges against outputD) the monetary value of all final goods and services currently produced in our economy in a

given yearE) the market value of all goods produced by domestically-owned resources in a given yearAns: D

Difficulty: Medium

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20. Which of the following transactions has a direct and immediate effect on GDP?A) an unemployed worker gets unemployment compensationB) you sell your used car to a friendC) you buy some IBM stockD) a German tourist drinks Canadian beer in a New York City restaurantE) the value of your Enron stock holdings drops drasticallyAns: D

Difficulty: Easy21. Which of the following does NOT directly affect GDP?A) a car dealer liquidates his inventory at a loss of $100 per car B) Wal-Mart buys 100 Korean-made VCRs and sells them in Roanoke, VirginiaC) stock market values drop sharply D) a Canadian tourist visits New York to see the Blue Jays play in Yankee stadiumE) both A) and C) Ans: C

Difficulty: Medium22. If nominal GDP, prices, and population all increase but real GDP remains the same thenA) real GDP per capita will decreaseB) real GDP per capita will increaseC) we cannot tell what will happen to real GDP per capitaD) the standard of living will increaseE) the standard of living will remain the sameAns: A

Difficulty: Medium23. If the base year was last year, which of the following statements has to be FALSE for next

year?A) real GDP will be greater than nominal GDP if prices are fallingB) real GDP will be greater than nominal GDP if prices are risingC) real GDP cannot increase if prices are fallingD) real GDP cannot decrease if prices are risingE) nominal GDP cannot decrease if prices are risingAns: B

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Difficulty: Easy24. Assume an economy that is currently at the full-employment level of output. If aggregate

demand decreases, what should we expect in the median run?A) a decrease in potential GDP and the price levelB) an increase in unemployment and the price levelC) a decrease in unemployment and the price levelD) an increase in unemployment and a decrease in the price levelE) a decrease in potential GDP and an increase in unemploymentAns: D

Difficulty: Easy25. Potential GDP is the value of GDP that can be calculated if we assume thatA) there are no measurement errorsB) the unemployment rate is zeroC) the inflation rate is zeroD) GDP has been adjusted for inflationE) the capital stock is working at full capacity and we have full employment Ans: E

Difficulty: Easy26. The full-employment level of output is defined as A) actual output plus the output gapB) potential output plus the output gapC) potential output minus the output gap D) the level of output at a zero unemployment rateE) both A) and D)Ans: A

Difficulty: Medium27. Which of the following is the most important variable for judging an economy's long-run

performance?A) growth in nominal GDPB) growth in real GDPC) growth in real GDP per capitaD) growth in potential GDPE) growth in the capital stockAns: C

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Difficulty: Easy28. Real GDP can grow over time because of A) an increase in the amount of labor used in the production processB) an increase in the capital stockC) efficiency improvementsD) all of the aboveE) only A) and B)Ans: D

Difficulty: Medium29. The trend path of GDP can change because of efficiency improvements, which can result

from A) decreases in the unemployment rateB) increases in the rate of capacity utilizationC) changes in knowledgeD) decreases in waste E) all of the above Ans: C

Difficulty: Easy30. The output gap shows the deviation of actual output from potential output and itA) may be either positive or negativeB) will always be positive C) increases as the unemployment rate decreasesD) becomes negative if the labor force grows faster than actual outputE) increases if inflation increasesAns: A

Difficulty: Easy31. Which of the following can be responsible for a change in the output gap?A) an increase in potential GDPB) a decrease in actual GDPC) a decrease in aggregate demandD) all of the aboveE) only A) and B) Ans: D

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Difficulty: Medium32. If real GDP increases from $13.5 trillion one year to $13.6 trillion in the next year, which

will be true?A) the GDP gap has probably become smaller B) economic growth is below the long-term trend rateC) economic growth is above the long-term trend rateD) economic growth is about the same as the long-term trend rateE) both A) and C) Ans: B

Difficulty: Easy33. Which of the following countries had the highest average annual per-capita real income

growth rate from 1965 to 2008? A) BrazilB) China C) JapanD) United Kingdom E) United StatesAns: B

Difficulty: Easy34. Which of the following countries had the lowest average annual per-capita income growth

rate from 1965 to 2008? A) Brazil B) India C) JapanD) SpainE) United StatesAns: E

Difficulty: Easy35. Japan’s average growth rate of real GDP per capita from 1965 to 2008 was A) more than twice as high as that of the U.S.B) about the same as that of the U.S.C) less than half as high as that of the U.S.

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D) higher than that of the U.S. but lower than that of ChinaE) lower than that of the U.S. but higher than that of ChinaAns: D

Difficulty: Easy36. The average growth rate of real GDP per capita in the U.S. from 1965 to 2008 was aboutA) 1.7 percent B) 2.0 percent C) 2.7 percent D) 3.0 percent E) 3.3 percent Ans: B

Difficulty: Easy37. The official unemployment rate for the U.S. includes A) people actively looking for jobs B) people only marginally attached to the work forceC) discouraged workers who are not actively looking for jobs D) only A) and B)E) all of the above Ans: A

Difficulty: Easy38. The unemployment rate is defined asA) the number of unemployed divided by total populationB) the number of people not looking for jobs divided by the labor forceC) the fraction of the labor force that cannot find jobs but who are actively lookingD) the fraction of total population that cannot find jobsE) total population minus the number of employed workersAns: C

Difficulty: Easy39. Labor is fully employed when A) everyone is working eight hours per day five days per week each yearB) everyone who wants to work can find a job within a reasonable amount of timeC) the unemployment rate is zero

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D) the unemployment rate is below 3 percentE) none of the above Ans: B

Difficulty: Easy40. Looking at how the rate of inflation and unemployment have behaved over the last three

decades we can see thatA) unemployment and inflation have always increased togetherB) unemployment has always increased when inflation decreasedC) there is no simple relationship between unemployment and inflationD) low unemployment always implies high inflationE) high unemployment always implies high inflationAns: C

Difficulty: Easy41. The Phillips curve is often used to show the relationship betweenA) GDP and unemployment in a given yearB) the rate of inflation and unemployment over timeC) employment and GDPD) changes in GDP and the rate of inflationE) unemployment and GDP growthAns: B

Difficulty: Easy42. When the economy goes into a recession, we can generally expect thatA) inflation will decrease while output will increaseB) inflation will increase while unemployment will decreaseC) inflation and output will increaseD) inflation will decrease while unemployment will increaseE) none of the aboveAns: D

Difficulty: Easy43. As the economy enters a boom we can generally expect thatA) inflation will decrease with little change in the unemployment rateB) unemployment will increase and inflation will decrease

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C) nominal GDP will increase but only because of an increase in the price levelD) inflation will increase and the unemployment rate will decreaseE) output will increase with little change in unemployment or inflationAns: D

Difficulty: Medium44. Looking at the performance of the U.S. economy over the last three decades we realize that A) whenever the inflation rate has decreased, the unemployment rate has also decreased B) whenever the unemployment rate has increased, the inflation rate has decreasedC) unemployment and inflation are not necessarily inversely related D) both inflation and unemployment have remained fairly stable over timeE) neither unemployment nor inflation has ever exceeded 10 percentAns: C

Difficulty: Easy45. Prices usually adjust fairly slowly; the speed of price adjustment can be summarized by A) the Phillips curve B) the AD-curveC) the long-run AS-curveD) the output gapE) the trend path of GDP Ans: A

Difficulty: Easy46. The CPI is defined as A) the cost-price index, measuring cost increases to producersB) the cross-price index, measuring the increase in relative prices of two different inputs used in

the production process C) a price index that measures the average price increase of all final goods and services

producedD) a price index that measures the cost of a given market basket of intermediate goods and raw

materialsE) a price index that measures the cost of a market basket of goods representing the purchases of

a typical urban consumerAns: E

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Difficulty: Easy47. If we look at the inflation rate (as measured by the CPI) in the U.S. from 1960 to 2010,

we see that inflation was at its highest in the year

A) 1960B) 1970C) 1980D) 1990E) 2000Ans: C

Difficulty: Medium48. Since 1960 the U.S. inflation rate measured by the CPI hasA) increased at a steady rateB) remained remarkably constantC) fluctuated widely and always been positiveD) fluctuated widely and usually been positive although it has occasionally been negative E) always increased as the unemployment rate has declinedAns: C

Difficulty: Easy49. If we look at inflation as measured by the CPI in the U.S. over the last four decades, we

realize that the rate of inflation

A) varied much more in the 1960s than in the 1970s or 1980sB) was much lower in the 1970s than in any other decadeC) varied greatly over time but has continued to decrease on average since 1969 D) reached an all-time low in 1981E) none of the aboveAns: E

Difficulty: Easy50. Even small increases in the inflation rate add up. For example, how much would an item you

bought for $1.00 in 1960 have cost on average in 2009? A) $3.23B) $4.34C) $5.15

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D) $7.27E) $9.69

Ans: D

CHAPTER 2

Technical Problems

1. The text calculates the change in real GDP in 1996 prices in the following way:

[RGDP06 - RGDP00]/RGDP00 = [3.50 - 1.50]/1.50 = 1.33 = 133%.

To calculate the change in real GDP in 2006 prices, we first have to calculate the GDP of 2000 in 2006 prices. Thus we take the quantities consumed in 2000 and multiply them by the prices of 2006, as follows:

Beer 1 at $2.00 = $2.00Skittles 1 at $0.75 = $0.75

_______________________________ Total $2.75

The change in real GDP can now be calculated as [6.25 - 2.75]/2.75 = 1.27 = 127%.

We can see that the growth rate of real GDP calculated this way is roughly the same as the growth rate calculated above.

2.a. The relationship between private domestic saving, private domestic investment, the budget deficit, and net exports is shown by the following identity:

S - I (G + TR - TA) + NX.

Therefore, if we assume that transfer payments (TR) remain constant, an increase in taxes (TA) has to be offset either by an increase in government purchases (G), an increase in net exports (NX), or a decrease in the difference between private domestic saving (S) and private domestic investment (I).

2.b. From the equation YD C + S it follows that an increase in disposable income (YD) will be reflected in an increase in consumption (C), saving (S), or both.

2.c. From the equation YD C + S it follows that when either consumption (C) or saving (S) increases, disposable income (YD) must increase as well.

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3.a. Since depreciation is defined as D = Ig - In = 800 - 200 = 600 ==>

NDP = GDP - D = 6,000 - 600 = 5,400.

3.b. From GDP = C + Ig + G + NX ==> NX = GDP - C – Ig - G ==>

NX = 6,000 - 4,000 - 800 - 1,100 = 100.

3.c. BS = TA - G - TR ==> (TA - TR) = BS + G ==> (TA - TR) = 30 + 1,100 = 1,130 3.d. YD = Y - (TA - TR) = 6,000 - 1,130 = 4,870

3.e. S = YD - C = 4,870 - 4,000 = 870

4.a. S = YD - C = 5,100 - 3,800 = 1,300

4.b. From S - I = (G + TR - TA) + NX ==> I = S - (G + TR - TA) - NX = 1,300 - 200 - (-100)

== > I = 1,200.

4.c. From Y = C + I + G + NX ==> G = Y - C - I - NX ==>

G = 6,000 - 3,800 - 1,200 - (-100) = 1,100.

Also: YD = Y - TA + TR ==> TA - TR = Y - YD = 6,000 - 5,100 ==> TA - TR = 900

From BS = TA - TR - G ==> G = (TA - TR) - BS = 900 - (-200) ==> G = 1,100.

5. According to Equation (2) in the text, the value of total output (in billions of dollars) can be calculated as: Y = labor payments + capital payments + profits = $6 + $2 + $0 = $8.

7. If the CPI increases from 2.1 to 2.3 in the course of one year, the rate of inflation can be calculated in the following way:

rate of inflation = (2.3 - 2.1)/2.1 = 0.095 = 9.5%.

The CPI often overstates inflation, since it is calculated by using a fixed market basket of goods and services. But the fixed weights in the CPI’s market basket cannot

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capture the tendency of consumers to substitute away from goods whose relative prices have increased. Quality improvements in goods also often are not adequately taken into account. Therefore, the CPI will overstate the increase in consumers' expenditures.

Chapter 2: National Income Accounting

Difficulty: Easy1. In calculating this year's GDP, national income accountantsA) include any increase in stock values B) include an estimate for income from illegal activities C) exclude Social Security payments to retireesD) exclude the value of any repairs made on existing propertyE) exclude the value of new pollution control equipment that is being installed Ans: C

Difficulty: Medium2. Assume you built a new house, bought a used car, and bought some government bonds.

Which of the following is true?

A) consumption and government purchases went up since you bought a used car and government bonds

B) consumption and investment went up since you bought a used car and government bondsC) investment and government purchases went up since you built a new house and bought

government bondsD) investment went up since you built a new houseE) consumption went up since you built a new house Ans: D

Difficulty: Medium3. Which of the following is FALSE?A) U.S. GDP underestimates actual economic activity because it does not include underground

activityB) an increase in the ratio of currency holdings to bank deposits may be seen as evidence for an

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increase in underground activityC) if the underground economy grows rapidly, then the rate of economic growth will be

underestimatedD) if the underground economy grows, people's standard of living will decline E) underground activity includes income from services produced at home but not reported, such

as typing someone else's term paperAns: D

Difficulty: Easy4. Which of the following statements is true?A) NDP is greater than GDP if prices are fallingB) NDP is greater than GDP if prices are risingC) NDP can be greater than GDP but only if the economy is growingD) NDP cannot be greater than GDPE) NDP must always be greater than GDPAns: D

Difficulty: Easy5. Increases in unwanted business inventories are counted asA) a decrease in the capital stockB) an increase in consumptionC) an increase in investmentD) an increase in depreciationE) none of the aboveAns: C

Difficulty: Easy6. The difference between gross domestic investment and net domestic investment is equal toA) unwanted inventory changesB) the difference between NDP and national incomeC) the addition to the capital stockD) the difference between GDP and NDPE) none of the aboveAns: D

Difficulty: Medium

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7. Assume nominal GDP increased by 4.2% in the U.S. but by only 3.4% in Germany. We can definitely conclude that

A) the standard of living of the people in the U.S. went up more than the standard of living of

the people in Germany

B) real economic growth in the U.S. was higher than in GermanyC) inflation in the U.S. was 0.8% higher than in GermanyD) productivity growth in the U.S. was higher than in GermanyE) none of the above Ans: E

Difficulty: Easy8. Assume you deplete your savings to buy a new sofa and some government bonds and then

take a vacation in a foreign country. Which of the following is true?

A) consumption will increaseB) net exports will increaseC) government purchases will increaseD) investment will increaseE) all of the above Ans: A

Difficulty: Easy9. If gross investment were zero, which of the following would be true?A) the existing capital stock would stay the same B) net investment would be positive C) net investment would be negativeD) depreciation would be zero E) depreciation would be negative Ans: C

Difficulty: Easy10. Depreciation isA) the difference between gross investment and net investmentB) the difference between GDP and NDP

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C) the difference between GNP and NNPD) another word for capital consumption allowancesE) all of the aboveAns: E

Difficulty: Medium11. If we counted the value of autoworkers' salaries, wheels, tires, steel, body parts, and final car

sales in calculating GDP, then we would beA) understating GDP by overlooking car dealers' profitsB) ignoring the contribution of capital to outputC) overstating GDP through double countingD) using the value-added technique for calculating GDPE) calculating GDP correctly only if we excluded any imported cars Ans: C

Difficulty: Medium12. The difference between gross investment and net investment isA) the same as the difference between GDP and disposable incomeB) the same as the difference between disposable income and consumptionC) the same as the difference between NDP and national incomeD) the same as the difference between net and gross exportsE) equal to capital consumption allowances Ans: E

Difficulty: Easy13. In the United States, annual per-capita GDP in 2009 was around A) $32,300 B) $38,400C) $46,500D) $48,200E) $52,600Ans: C

Difficulty: Easy14. As defined in our text, private domestic investment (I) does NOT includeA) new residential construction except on farms

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B) movable machinery such as trucks or tractorsC) inventory accumulation, unless it was planned or intendedD) investment in labor productivity through education and trainingE) new additions to existing factories Ans: D

Difficulty: Medium15. Assume a U.S. dealer bought 100 TVs from South Korea for $250 each in 2009. He

subsequently sold 80 of them in 2006 for $450 each, and the rest in 2010 for $400 each. By how much was the U.S. GDP affected in 2009?

A) $45,000B) $36,000C) $19,000D) $16,000E) $11,000Ans: D

Difficulty: Easy16. In 1994, U.S. GDP was $6,931, GNP was $6,922, NNP was $6,104, and national income was

$5,495 (all numbers are in billions of dollars). We can conclude that

A) depreciation was $818 billionB) depreciation was $1,436 billionC) the addition to the capital stock was $1,436 billionD) the addition to the capital stock was $1,427 billionE) indirect business taxes were $9 billionAns: A

Difficulty: Medium17. In a simple economy with no depreciation, no government, and no foreign sector, it is correct

to say that for any specified time period (say the month of June)

A) Y ≡ CB) C – I ≡ SC) Y – C ≡ S

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D) Y – C ≡ S + IE) Y ≡ C + S – IAns: C

Difficulty: Medium18. Which of the following identities is FALSE?A) Y C + I + G + NXB) YD Y - TA + TRC) BS TA - TR - GD) I - S (G - TA + TR) + NXE) S + TA - TR I + G + NXAns: D

Difficulty: Easy19. If private domestic saving in an economy increases, which is the most likely to occur?A) a decrease in the budget deficitB) a decrease in net exportsC) an increase in consumptionD) an increase in importsE) an increase in private domestic investmentAns: E

Difficulty: Medium20. Assume the budget deficit increases. Which of the following can happen?A) private domestic saving can increaseB) private domestic investment can decreaseC) imports can increaseD) exports can decreaseE) all of the aboveAns: E

Difficulty: Medium21. If the government increases taxes, which of the following is LEAST likely to occur?A) a decrease in private domestic savingB) a decrease in consumptionC) an increase in private domestic investment

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D) a decrease in net exportsE) a decrease in national incomeAns: D

Difficulty: Medium22. Assume that GDP = 4,800, consumption = 3,400, private domestic savings = 400,

government purchases = 1,200, and net exports = -120. Which of the following is true?

A) disposable income is 3,800B) private domestic investment is 320C) the budget deficit is 200D) all of the above E) only A) and C)Ans: D

Difficulty: Medium23. If private domestic saving is 960, private domestic investment is 780, and the government

spends 300 more than it receives in tax revenues, then it follows that

A) the trade deficit is 120B) the trade deficit is 300C) the trade deficit is 420D) the trade surplus is 120 E) the trade surplus is 180Ans: A

Difficulty: Medium24. Assume that GDP = 8,100, consumption = 5,400, gross private domestic investment = 1,200,

government purchases = 1,600. Which of the following is true?

A) imports exceed exports by 100B) exports exceed imports by 100C) depreciation is 100D) the trade surplus is 100

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E) both B) and D)Ans: A

Difficulty: Medium25. Assume exports = 300, imports = 400, tax revenues = 1,100, government purchases = 1,400,

private domestic saving = 900. Then the level of private domestic investment isA) 600B) 700C) 900D) 1,100E) 1,300Ans: B

Difficulty: Easy26. If imports increase by $15 billion, which of the following has to happen for GDP to rise? A) consumption has to increase by more than $15 billionB) government purchases have to increase by more than $15 billionC) private domestic investment has to increase by more than $15 billionD) private domestic saving has to increase by more than $15 billionE) either A), B), or C) would be sufficient to increase GDPAns: E

Difficulty: Medium27. As a percentage of GNP, the U.S. federal debt A) sharply increased in the 1980s and then decreased in the 1990s B) has decreased steadily since World War IIC) has increased steadily since 1960 D) was never lower than 20 percentE) never exceeded 100 percentAns: A

Difficulty: Medium28. If private domestic saving exceeds private domestic investment by $220 billion and

government spending exceeds tax revenue by $340 billion, then

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A) the trade deficit is $560 billionB) the trade surplus is $560 billionC) the trade deficit is $120 billionD) the trade surplus is $120 billionE) the trade deficit is $340 billionAns: C

Difficulty: Medium29. If national income is 5,200, disposable income is 4,400, consumption is 4,100, the trade

deficit is 110, and the budget deficit is 150, what is the level of private domestic investment?

A) 1,060B) 540C) 300D) 260E) 40Ans: D

Difficulty: Difficult30. Assume government purchases = $1,500, the budget deficit = $120, consumption = $4,800,

private domestic saving = $1,220, the trade deficit = $90, and transfer payments = $0. Which of

the following is true?

A) private domestic investment is $1,190B) national income is $7,400C) disposable income is $6,020D) all of the above E) only A) and C)Ans: D

Difficulty: Medium31. If the U.S. budget deficit increased substantially while private domestic saving and private

domestic investment remained roughly the same, then

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A) the U.S. imported more than it exportedB) the U.S. exported more than it importedC) the U.S. must have experienced a major recession D) there must have been a major drop in U.S. interest ratesE) all of the aboveAns: A

Difficulty: Difficult32. Assume the budget deficit decreased by $15 billion, private domestic saving decreased by

$20 billion, exports increased by $10 billion, and imports increased by $15 billion. By how much

did private domestic investment change?

A) private domestic investment decreased by $10 billionB) private domestic investment increased by $10 billionC) private domestic investment did not change at allD) private domestic investment decreased by $20 billionE) the change in private domestic investment cannot be determined from this informationAns: C

Difficulty: Medium33. The budget deficits in the early 1980s were largely financed throughA) an increase in private domestic savingB) an increase in private domestic investmentC) an increase in net exportsD) a decrease in net exportsE) none of the aboveAns: D

Difficulty: Medium34. If the budget surplus increases, which of the following is likely to happen?A) imports will increase more than exportsB) exports will increase more than importsC) private domestic saving will increase more than private domestic investmentD) private domestic investment will remain the same while private domestic saving will increase E) private domestic investment will decrease

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Ans: B

Difficulty: Easy35. If we look at U.S. net exports over the last four decades, we realize thatA) the U.S. had consistent large trade deficits in the 1960s B) the U.S. never had a trade imbalance in the 1970sC) U.S. trade deficits decreased greatly in the early and mid 1980sD) the U.S. never had a trade surplus until after the year 2000E) U.S. trade deficits decreased substantially between 1997 and 2000 Ans: C

Difficulty: Medium36. If the U.S. unemployment rate has increased, which of the following must have occurred?

A) more workers have become discouraged and stopped looking for jobs B) more people have been forced to work in part-time rather than full-time jobs C) there has been an decrease in the work force as fewer job openings were listed D) more people have become only "marginally attached" to the work force E) none of the aboveAns: E

Difficulty: Easy37. The PCE deflator measuresA) the average price increase of raw materials purchased by producers B) the average price increase of energy pricesC) price changes in consumer expenditures based on national income accountsD) price changes of final as well as semi-finished goodsE) the average price increase of all final goods excluding energyAns: C

Difficulty: Easy38. The GDP-deflator and the producer price index (PPI) differ sinceA) the PPI measures a fixed market basket but the GDP-deflator doesn'tB) the GDP-deflator includes imported goods but the PPI doesn'tC) the PPI includes more goods than the GDP-deflator

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D) the GDP-deflator does not include services but the PPI doesE) the GDP-deflator measures increases in inflation earlier than the PPIAns: A

Difficulty: Easy39. Assume that the prices of cars manufactured in the U.S. increases due to an increase in

quality. Which of the following should happen if the same number of cars is produced?

A) real GDP should increase but nominal GDP should stay the sameB) nominal GDP should increase C) the GDP-deflator should decreaseD) real GDP and the GDP-deflator should decreaseE) all of the above Ans: B

Difficulty: Medium40. If nominal GDP was $9,200 billion in Year 1 and $9,420 billion in Year 2 and prices

increased from Year 1 to Year 2, thenA) real GDP was larger in Year 1 than in Year 2B) real GDP was larger in Year 2 than in Year 1C) the GDP-deflator must have been 122 D) the GDP-deflator must have been 102 E) we cannot determine the value of the GDP-deflator or real GDP in Year 2Ans: E

Difficulty: Medium41. If nominal GDP is $8,820 billion and the GDP-deflator is 105, then real GDP isA) $9,261 billionB) $8,925 billionC) $8,715 billionD) $8,400 billionE) $8,000 billionAns: D

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Difficulty: Medium42. If nominal GDP increased from $8,000 billion in the base year to $8,400 billion in the

following year and real GDP stayed the same, which is true?

A) the GDP-deflator increased from 100 to 110B) the GDP-deflator increased from 80 to 100C) the GDP-deflator increased from 100 to 120D) prices increased on average by 5 percentE) prices increased on average by 10 percentAns: D

Difficulty: Easy43. Assume that in 1962 nominal GDP was about $600 billion and real GDP was about $2,400

billion. The GDP-deflator for that year was

A) 1.25B) 1.4C) 2.5D) 4E) 25Ans: E

Difficulty: Easy44. Assume nominal GDP was $8.0 trillion in Year 1 and $8.8 trillion in Year 2. If Year 1 is the

base year, thenA) the GDP-deflator is 110B) prices increased on average by 10 percentC) real GDP has not changedD) none of the above can be trueE) both A) and B) are true, but only if C) is trueAns: E

Difficulty: Easy45. The unemployment rate is most likely to decrease ifA) the number of people who are out of work but expecting to be recalled from a layoff

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increasesB) the number of people living in the country increasesC) the labor force decreases more than the overall populationD) more people who are currently out of work decide to give up looking for a jobE) none of the above Ans: D

Difficulty: Easy46. Which of the following is TRUE?

A) core inflation excludes price changes for food and energyB) core inflation only includes price changes for food and energyC) core inflation is reported for the CPI but not the for the PCE deflatorD) the PCE deflator measures the average price change of a market basket of consumer goods E) the PCE deflator only measures price changes in energy Ans: A

Difficulty: Easy47. The CPI, a price index used to measure inflation, is imperfect sinceA) it only measures those goods that are included in the market basketB) it does not take into account quality improvementsC) many payments are already indexed for inflationD) it does not include servicesE) only A) and B)Ans: E

Difficulty: Easy48. The consumer price index (CPI) and the producer price index (PPI) differ from each other

sinceA) the PPI includes import goods but the CPI doesn'tB) the CPI usually rises sooner than the PPIC) the composition of their market baskets is differentD) the PPI does not measure price increases of a fixed market basketE) the CPI never overestimates inflation but the PPI often doesAns: C

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Difficulty: Easy49. If the nominal interest rate on a government bond is 6% and the rate of inflation is 4%, what

is your real rate of return on this government bond?

A) -2%B) +2%C) +4%D) +6%E) +10%Ans: B

Difficulty: Easy50. Assume you can exchange 10 Mexican pesos for one U.S. dollar, but you need only 0.64

British pounds to get one U.S dollar. What does this imply?

A) product prices in Great Britain are much cheaper than in MexicoB) product prices in Great Britain are much more expensive than in Mexico C) you can get about 36 Mexican pesos for one British pound D) you can get about 64 Mexican pesos for one British pound E) none of the above Ans: E

Chapter 3: Growth and Accumulation

Difficulty: Medium1. Growth accounting explains A) how economic decisions control the accumulation of capital B) how the current savings rate affects the stock of capital in the futureC) what part of growth in total output is due to growth in different factors of production D) all of the above E) only A) and B) Ans: C

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Difficulty: Easy2. The relationship between the output produced in an economy, the input of factors of

production, and the state of technological knowledge is called the

A) the aggregate supply functionB) aggregate production functionC) aggregate investment functionD) marginal product of laborE) marginal product of capital Ans: B

Difficulty: Medium3. Given the production function Y = AF(K,N) and assuming constant returns to scale, the

contribution of capital to output growth can be estimated by

A) adding the growth rate of capital to the term AB) multiplying the growth rate of capital by capital's share in productionC) subtracting the growth rate of labor from the rate of technological advancementD) multiplying the capital-labor ratio by the level of outputE) multiplying total factor productivity with capital’s share in productionAns: B

Difficulty: Easy4. For the U.S. economy, we can assume thatA) output grows at the same rate as both capital and laborB) capital is a larger source of growth than laborC) labor is a larger source of growth than capitalD) capital and labor both contribute equally to output growthE) both A) and D)Ans: C

Difficulty: Easy5. Which of the following is NOT a source of long-term output growth?A) growth in consumption expendituresB) growth in labor inputs

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C) growth in capital inputsD) improved technological efficiencyE) growth in the stock of knowledgeAns: A

Difficulty: Medium6. Which of the following is NOT a source of increased factor productivity?A) advances in knowledgeB) growth in the size of the labor forceC) more efficient resource allocationD) improved methods of productionE) technological progressAns: B

Difficulty: Easy7. Which of the following economists contributed greatly to neoclassical growth theory in the

1950s and 1960s?A) Robert BarroB) Robert LucasC) Gregory Mankiw D) Paul Romer E) Robert Solow Ans: E

Difficulty: Easy8. Changes in total factor productivity are also called A) the marginal product of labor B) the marginal product of capitalC) changes in input costsD) the Cobb-Douglas residual E) the Solow residualAns: E

Difficulty: Easy9. Which of the following is NOT a source of increased factor productivity?A) an increase in average years of schooling

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B) an increase in on-the-job trainingC) increased investment in healthD) an increase in the size of the capital stock E) an increase in the rate of innovationAns: D

Difficulty: Easy10. According to Solow's estimate, out of the average annual economic growth rate of

2.9% for the U.S. from 1909 to 1949, how much was attributable to the accumulation of capital?

A) 0.12%B) 0.32%C) 0.75%D) 1.22%E) 1.55%Ans: B

Difficulty: Easy11. The Cobb-Douglas aggregate production function provides a fairly good approximation of

the U.S. economy if we assume that A) the shares of capital and labor are equal B) the share of capital is 0.65 and the share of labor is 0.35C) the share of capital is 0.45 and the share of labor is 0.55D) the share of capital is 0.25 and the share of labor is 0.75 E) the share of capital is 0.15 and the share of labor is 0.85 Ans: D

Difficulty: Medium12. If we assume a Cobb-Douglas production function, where the share of capital is 0.25 and the

share of labor is 0.75, then the marginal product of labor is equal to A) Y/N B) 3Y/4NC) (3/4)N D) 3K/4N E) 3N/4Y Ans: B

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Difficulty: Medium13. If we assume a Cobb-Douglas production function where the share of capital is equal to 0.2

and the share of labor is equal to 0.8, then the marginal product of capital is equal toA) 5N/KB) 5Y/K C) Y/4KD) Y/5KE) Y/KAns: D

Difficulty: Difficult14. Assume a Cobb-Douglas production function where the share of capital and labor is each 1/2.

If the growth in total factor productivity is zero and labor and capital each grow by 2%, thenA) output growth is 4% and the marginal product of capital is Y/K B) output growth is 2% and the marginal product of capital is Y/(2K)C) output growth is 2% and the marginal product of labor is (2Y)/N D) output growth is 1% and the marginal product of labor is Y/(2N)E) output growth is 1% and the marginal product of capital is (2Y)/K Ans: B

Difficulty: Difficult15. Assume a Cobb-Douglas production function where the share of capital is 0.3 and the

share of labor is 0.7. If capital grows by 1.5%, labor grows by 2%, and growth of total factor

productivity is 1.2%, by how much does total output grow?

A) 4.70%B) 3.50%C) 3.05%D) 2.85%E) 1.20%Ans: C

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Difficulty: Difficult16. Assume a Cobb-Douglas production function where the share of labor is 0.7 and

the share of capital is 0.3. If there is no technological progress, capital grows at 1.5%, and labor

doesn't grow at all, what is the growth rate of output?

A) 0.45%B) 0.60%C) 1.05%D) 1.50%E) 2.00%Ans: A

Difficulty: Difficult17. Assume a Cobb-Douglas production function where the share of labor is 0.7 and the

share of capital is 0.3. If there is no technological progress, labor grows at 2%, and capital grows

at 1.5%, then real output will grow by

A) 0.45%B) 1.50%C) 1.85%D) 2.85%E) 3.05%Ans: C

Difficulty: Medium18. Assume that the rate of technological advance is 1.5% and both labor and capital grow at

a rate of 2%. What is the rate of output growth if labor's share of income is three times as high as

capital’s share and there are constant returns to scale?

A) 1.5%B) 2.0%C) 3.0%D) 3.5%

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E) 5.5%Ans: D

Difficulty: Medium19. Assume labor's share of income is 80% and capital's share of income is 20%. If we

assume constant returns to scale, there are no technological advances, and both labor and capital

grow at an annual rate of 3%, then the growth rate of output will be

A) 0.6%B) between 0.6% and 2.4%C) between 2.4% and 3%D) 3%E) greater than 3%Ans: D

Difficulty: Medium20. Assume a production function with constant returns to scale. The share of capital in

production is 1/4 and the share of labor is 3/4. If both labor and capital grow at 1.6% and the rate of technological progress is 1.2%, what is the rate of growth of real output?

A) 1.2%B) 1.6%C) 2.8%D) 3.2%E) 4.8%Ans: C

Difficulty: Difficult21. Assume a production function with constant returns to scale. Labor's share of income is

4/5 and capital's share is 1/5. If labor grows at 3%, capital at 2%, and the rate of technological

advance is 1.2%, roughly how many years would it take to double the current level of output?

A) 12B) 18

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C) 23D) 35E) 48Ans: B

Difficulty: Difficult22. Assume a production function with constant returns to scale. Labor's share of income is

0.7 and capital's share is 0.3. If labor grows at 4% and capital grows at 3%, how many years

would it take to double the current level of output if no technological advances are made?

A) 7B) 10C) 19D) 23E) 33Ans: C

Difficulty: Difficult23. Assume a Cobb-Douglas production function, where the share of labor (N) and capital (K) is

each 1/2 and A = 1. If the growth rate of labor is n = 0.06, the rate of depreciation is d = 0.04, and the savings rate is s = 0.2, what is the value of the steady-state capital-labor ratio?

A) 0.5B) 1 C) 2D) 4E) 5Ans: D

Difficulty: Easy24. From 1973 to 1992, by how much more did GDP grow in Japan than in the United States? A) 10%B) 22%C) 36%D) 54%E) 66%

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Ans: C

Difficulty: Easy25. Which of the following countries had the lowest ratio of investment to GDP in 1992?A) JapanB) NorwayC) SingaporeD) Taiwan E) United StatesAns: E

Difficulty: Easy26. If we compare the annual growth rates in the U.S. and Japan, we see that from

1950 to 1992, the difference in average annual growth in GDP per capita between Japan and the

U.S. was about

A) 1.2% B) 2.2%C) 2.8%D) 3.8%E) 5.2%Ans: D

Difficulty: Easy27. Which of the following is FALSE? A) a high level of investment generally does not lead to a higher living standardB) in industrial countries the amount of labor is less important than the skills and talent of the

work forceC) a country that possesses rich natural resources should have a high standard of livingD) countries with fewer average years of schooling often have lower living standards E) if a poor country invests in health it can significantly increase the quality of human capital

and thus raise overall living standards Ans: A

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Difficulty: Medium28. If two countries have the same aggregate production function, rate of technological

growth, and savings rate, then

A) they will always have the same per-capita incomeB) the country with the higher rate of population growth will have a higher per-capita incomeC) the country with the lower rate of population growth will have a higher per-capita incomeD) the country with the highest depreciation rate will have the highest per-capita incomeE) both C) and D)Ans: C

Difficulty: Medium29. In the neoclassical growth model, an increase in the savings rateA) raises the steady-state level of outputB) lowers the steady-state level of outputC) raises the long-term economic growth rateD) lowers total factor productivityE) both A) and C)Ans: A

Difficulty: Medium30. In the neoclassical growth model, if a nation's savings rate decreases, we should expect thatA) the long-run income per capita will increaseB) the long-run capital-labor ratio will increaseC) the growth rate of output will temporarily decrease but eventually return to its long-run trendD) all of the aboveE) none of the aboveAns: C

Difficulty: Medium31. In the neoclassical growth model, an increase in the rate of population growth willA) raise the growth rate of outputB) increase the level of output per capitaC) increase the steady-state capital-labor ratioD) all of the above

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E) only B) and C)Ans: A

Difficulty: Medium32. In a neoclassical growth model, a decline in population growth will A) shift the production function down B) shift the savings function down C) decrease the slope of the investment requirement line D) all of the above E) only A) and C) Ans: C

Difficulty: Medium33. In the neoclassical growth model, if the capital-labor ratio is below the (optimal)

steady-state level, we should expect that

A) economic growth will continue to decline unless technological advances are madeB) income per capita will decrease since gross investment is not sufficient to supply new

workers with adequate capital C) the savings rate will decline due to the lack of economic growthD) all of the aboveE) none of the aboveAns: E

Difficulty: Medium34. In a neoclassical growth model, if the capital-labor ratio is lower than the (optimal)

steady-state level, we should expect that

A) saving is smaller than the investment requirementB) output per capita will temporarily grow at a rate lower than population growthC) income per capita will decreaseD) there will be a temporary increase in the capital stock that is greater than the increase in

populationE) all of the aboveAns: D

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Difficulty: Medium35. The convergence to a steady-state capital-labor ratio k* is ensured by the fact that if k is at a

levelA) lower than k*, saving will exceed the investment required to maintain a constant k, causing k

to rise

B) lower than k*, investment will exceed saving, leading to an increase in the capital stockC) lower than k*, saving will exceed the investment required to maintain a constant k, causing

output per capita to declineD) higher than k*, the rate of depreciation will be higher than the savings rate, causing k to

decreaseE) higher than k*, output per capita will continue to increase until a new steady-state

equilibrium is reachedAns: A

Difficulty: Difficult36. An economy with a capital-labor ratio that is lower than the steady-state level can achieve

a steady-state equilibrium at this lower capital-labor ratio only if

A) the savings rate decreasesB) the rate of depreciation decreasesC) the rate of population growth decreasesD) technological advances are madeE) all of the aboveAns: A

Difficulty: Medium37. In a neoclassical growth model, a nation with a declining population growth rate will

experience A) a decrease in living standards B) an increase in living standards C) a lower savings rate D) an increase in long-term growth E) a decrease in the steady-state capital-labor ratio Ans: B

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Difficulty: Medium38. A neoclassical growth model would predict that if the rates of both population

growth and saving increase, then the steady-state capital-labor ratio will

A) increaseB) decreaseC) stay the sameD) temporarily increase, but then go back to its original level E) most likely change but we cannot say for sure how Ans: E

Difficulty: Medium39. Assume a neoclassical growth model with constant returns to scale. Which of the

following statements is TRUE?

A) a declining population growth rate will increase per-capita incomeB) an increase in the savings rate will permanently increase the growth rate of outputC) an increase in the depreciation rate will increase the capital-labor ratioD) technological advances will have no effect on the long-run growth rate of outputE) none of the aboveAns: A

Difficulty: Medium40. The idea of a steady state is thatA) the capital-labor ratio grows at a constant rateB) output per capita grows at a constant rateC) output, capital, and labor all grow at the same rateD) an increase in the savings rate will not affect the capital-labor ratio E) real output cannot growAns: C

Difficulty: Easy41. According to the neoclassical growth model, a one-time technological advance will

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A) shift the investment requirement line up B) increase the long-term growth rate of outputC) have no effect on the steady-state capital-labor ratioD) lead to a decrease in the rate of depreciationE) none of the aboveAns: E

Difficulty: Medium42. The steady state is defined as a long-run equilibrium at which capital, labor, and output

all grow at the same rate. To be in a steady state in a neoclassical model, which of the following

equations has to be satisfied?

A) y = (n - d)k B) sy = (n + d)k C) sf(k) = (n - d)kD) sy = nk + dE) y = f(k) = sk + ndAns: B

Difficulty: Medium43. In the neoclassical growth model, the steady-state capital-labor ratio is determined by the

equation A) k = (n + d)y B) k = s(n + d)C) k = sy/(n + d) D) k = y/(n - d) E) k = (n + d)/sy Ans: C

Difficulty: Easy44. In a neoclassical growth model in which a one-time advance in technology occurs we could

expectA) the level of saving and investment to increase until a new and higher steady-state

capital-labor ratio is reached

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B) the level of income per capita to increase but the steady-state growth rate of output to remain unaffected

C) the level of output for any given capital-labor ratio to increaseD) all of the above E) none of the aboveAns: D

Difficulty: Easy45. When current saving and investment are just enough to equip new entrants into the labor

force with the same amount of capital that the average person already in the work force uses,

then

A) the economy is in a steady stateB) output per head is constantC) capital per head is constantD) capital is growing at the same rate as the populationE) all of the aboveAns: E

Difficulty: Medium46. For a neoclassical growth model, which of the following statements is FALSE?A) an increase in the savings rate will increase the steady-state growth rate of aggregate outputB) an increase in population growth will increase the steady-state growth rate of aggregate

output C) an increase in population growth will reduce the steady-state level of income per capitaD) if poor countries save at the same rate as rich countries and have access to the same

technology, they will eventually catch upE) long-run growth results from improvements in technology Ans: A

Difficulty: Medium47. According to neoclassical growth theory which of the following does NOT affect a

nation's long-term growth rate?

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A) the savings rate B) technological progress C) the rate of depreciation D) population growthE) both A) and C)Ans: E

Difficulty: Medium48. In a neoclassical growth model, steady-state consumption is maximized when the marginal

increase in the capital-labor ratio (k) produces just enough extra output per capita (y) that the marginal product of k is equal to

A) n + dB) sy/(n – d)C) sy/(n + d)D) sa - (n + d)E) s - (n + d)Ans: A

Difficulty: Medium49. The golden-rule capital stock (k**) ensuring that steady-state consumption is maximized is at

the point on the production function f(k) where the marginal product of capital (k) is equal to A) n + dB) n - dC) s(n + d)D) sa/(n + d)E) sa/(n - d)Ans: A

Difficulty: Medium50. The golden-rule capital stock (k**) corresponds to A) the highest permanently sustainable level of steady-state consumptionB) the point at which a marginal increase in capital produces just enough extra output to cover

the increased investment requirementC) the point on the production function y = f(k), where the slope of f(k) is equal to (n + d)D) all of the aboveE) none of the aboveAns: D

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Chapter 4: Growth and Policy

Difficulty: Medium1. Assume a production function with only two inputs, capital and labor. In this case, the

concept of a diminishing marginal product of capital implies that A) as less capital is being used, more and more labor has to be employed to increase output B) as both labor and capital inputs are increased, output increases but at a decreasing rateC) as the amount of capital is increased and the amount of labor remains fixed, output increases

but at a decreasing rate D) as the amount of capital increases and the amount of labor remains fixed, output cannot

increaseE) labor inputs have a bigger impact on increasing output than capital inputsAns: C

Difficulty: Easy2. Which of the following countries had the HIGHEST average annual growth rate of GDP

per capita between 1988 and 2007?

A) ChinaB) India C) MexicoD) South KoreaE) United StatesAns: A

Difficulty: Easy3. Which of the following countries had the LOWEST average annual growth rate of GDP

per capita between 1988 and 2007?

A) Bangladesh B) Egypt C) IndonesiaD) Thailand E) United States

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Ans: E

Difficulty: Easy4. Which of the following countries annual growth rate of GDP per capita between 1988 and

2007 was closest to that of the United States? A) China B) EgyptC) Mexico D) Taiwan E) Thailand Ans: C

Difficulty: Easy5. Which of the following economists did NOT significantly contribute to the debate on

exogenous versus endogenous growth?

A) Robert Barro B) Gregory Mankiw C) Robert Lucas D) David RicardoE) Paul Romer Ans: D

Difficulty: Medium6. A production function that assumes a diminishing marginal product of capital A) generates a straight savings lineB) ensures that the savings line is always above the investment requirement lineC) ensures that the savings line and the investment requirement line crossD) is essential to the endogenous growth modelE) violates important microeconomic principlesAns: C

Difficulty: Medium

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7. The concept of diminishing marginal returns implies that A) output cannot decrease as long as labor is substituted for capital B) output decreases if either labor or capital is decreasedC) output increases but at a decreasing rate as the amount of labor is increased and the amount

of capital remains fixedD) if the capital stock is kept constant, output cannot increase even if more labor is availableE) output increases but only if the amounts of both labor and capital increaseAns: C

Difficulty: Medium8. The assumption of constant returns to capital alone implies that larger firms should be more

efficient than smaller firms. The reason this doesn't necessarily imply a tendency toward monopolization is that

A) most industries are perfectly competitive in natureB) firms have more inputs than just capital C) constant returns to capital alone still implies decreasing returns to all factors of production

taken togetherD) if one firms increases its use of capital, other firms can also capture some of the production

benefits of the new capital through spillover effects E) none of the above Ans: D

Difficulty: Easy9. Which of the following statements is FALSE? A) endogenous growth theory relies on constant returns to scale of capital alone to generate

ongoing growth B) endogenous growth theory predicts that an increase in population growth will always lead to

an increase in the overall growth rateC) the microeconomics underlying endogenous growth theory emphasizes the existence of

substantial external returns to capitalD) endogenous growth theory predicts that a high savings rate can generate a high growth rateE) empirical evidence suggests that endogenous growth theory is not very important for

explaining differences in growth among countriesAns: B

Difficulty: Easy10. According to the endogenous growth theoryA) countries with the same technology and population growth eventually converge to the same

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steady-state growth rate independent of the savings rateB) the steady-state growth rate decreases as the rate of accumulation of factors of production

increases C) the long-term growth rate of capital is not affected by the savings rate D) the steady-state growth rate is affected by the rate at which the factors of production are

accumulatedE) none of the aboveAns: D

Difficulty: Medium11. A production function with constant returns to scale for capital alone implies thatA) there are increasing returns to scale for all factors of production taken togetherB) if all inputs are doubled then output will more than double C) smaller firms are more efficient than larger firmsD) technological advances cannot take placeE) both A) and B) Ans: E

Difficulty: Medium12. If we have an aggregate production function of the form Y = aK, at what capital-labor ratio

can a steady-state equilibrium be reached?A) k = sa - (n + d) B) k = sa + (n - d) C) k = sa/(n + d) D) k = ay/(n + d)E) never Ans: E

Difficulty: Difficult13. Assume we have a simple endogenous growth model where technology is labor augmenting,

that is, Y = F(K,AN), and also proportional to the capital-labor ratio, such that y = ak. In this case, the growth rate of GDP per capita can be expressed by

A) sa + (n + d)B) sa - (n + d)C) sa - (n + d)kD) sa + (n - d)kE) sk - (n + d)a

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Ans: B

Difficulty: Medium14. Assume an endogenous growth model with labor augmenting technology. The production

function is Y = F(K,AN) with A = 2(K/N), so y = 2k. If the savings rate is s = 0.05 and there is neither population growth nor depreciation of capital, what is the growth rate of output?

A) 0%B) 2.5%C) 5%D) 10%E) it cannot be determinedAns: D

Difficulty: Medium15. Assume an endogenous growth model with labor augmenting technology. The production

function is Y = F(K,AN), with A = 2(K/N) such that y = 2k. If the savings rate is s = 0.08, the rate of population growth is n = 0.03, and the rate of depreciation is d = 0.04, what is the growth rate of output per capita?

A) 1%B) 3%C) 4%D) 7%E) 9%Ans: E

Difficulty: Medium16. Assume an endogenous growth model with labor augmenting technology. The production

function is Y = F(K,AN), where A = 2(K/N) such that y = 2k. If the savings rate is s = 0.06, the rate of population growth is n = 0.05, and the rate of depreciation is d = 0.04, then the growth rate of real output per capita is

A) 1%B) 3%C) 5%D) 6%E) 9%Ans: B

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Difficulty: Medium17. Assume an endogenous growth model with labor augmenting technology and a production

function of the form Y = F(K,AN), where A = 1.2(K/N) such that y = (1.2)k. If the rate of population growth is n = 0.06 and the rate of depreciation is d = 0.04, how large does the savings rate (s) have to be to achieve a per-capita growth rate of 8 percent?

A) 6%B) 10%C) 15%D) 24%E) 30%Ans: C

Difficulty: Medium18. Assume an endogenous growth model with labor augmenting technology and a production

function of the form Y = F(K,AN), where A = 1.2(K/N) such that y = (1.2)k. If the savings rate is s = 0.15 and the rate of depreciation is d = 0.05, how high does population growth (n) have to be to achieve a growth rate of 10 percent?

A) 15%B) 12%C) 10%D) 5%E) 3%Ans: E

Difficulty: Medium19. Assume an endogenous growth model with labor augmenting technology. The production

function is Y = F(K,AN), where A = a(K/N) such that y = ak. If the savings rate is s = 0.1, the rate of population growth is n = 0.04, and the depreciation rate is d = 0.02, how much would "a" have to be to achieve a 12% growth rate of output?

A) 0.6 B) 1.2 C) 1.8 D) 2.0 E) 2.4 Ans: C

Difficulty: Medium

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20. If we consider the per-capita GDP of China and India over the last three decades, we realize that

A) despite vast differences in population growth, both countries' per-capita GDP grew at approximately the same rate

B) while investment in human capital is important for economic growth, so are institutional changes and openness to trade

C) India’s growth in per-capita GDP was higher than China’s due to more investment in human capital

D) neither country’s per-capita GDP grew significantly until the 1990s E) the difference in growth rates between these countries can largely be explained by the

difference in years of schoolingAns: B

Difficulty: Medium21. A comparison of per-capita GDP in China and India over the last three decades indicates that A) neither country’s per-capita GDP grew much until the mid-1990sB) India has a higher per-capita GDP than China since it experienced its growth spurt earlierC) both countries started poor in 1960, but by the year 2000 China’s per-capita GDP was almost

twice as high as India’s D) both country’s per-capita GDP grew significantly and at about the same rate E) India’s per-capita GDP grew more than China’s due to more investment in human capitalAns: C

Difficulty: Easy22. A comparison of per-capita GDP in China and India over the last three decades indicates that A) increases in physical capital contributed more to growth in China than in India B) increases in physical capital contributed more to growth in India than in ChinaC) India's per-capita GDP grew more than China’s due to lower population growth D) while per-capita GDP of the two countries increased at about the same rate, India's total

factor productivity increased much more than China's E) while China's total factor productivity increased much more than India's, the per-capita GDP

in both countries increased at about the same rateAns: A

Difficulty: Medium23. The neoclassical growth model predicts conditional convergence for countries with the same

population growth, level of technology, and A) a higher savings rate

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B) a lower savings rate C) the same savings rateD) all of the above E) none of the above Ans: D

Difficulty: Medium24. The neoclassical growth model predicts absolute convergence for countries with the A) same technology, savings rate, and population growthB) same technology and savings rate, but different rates of population growth C) same technology and population growth, but different savings ratesD) same population growth and savings rate, but different levels of technologyE) same population growth, but different levels of technology or savings rates Ans: A

Difficulty: Medium25. Countries with higher saving rates may have higher equilibrium growth rates sinceA) people who save more also are more industriousB) higher income allows for more savingsC) a higher saving rate allows for more investment in human capital which ultimately enhances

economic growth D) having more capital equipment is more important than having better capital equipmentE) none of the aboveAns: C

Difficulty: Difficult26. In a growth model with endogenous population growth and an investment requirement that

rises slowly at first then rises sharply and eventually flattens out, we can getA) three steady-state equilibria, only one of which is stable B) three steady-state equilibria, only two of which are stable C) three steady-state equilibria, all of which are stable D) one stable steady-state equilibrium, but only if the savings rate is high enoughE) both B) and D) are possibleAns: E

Difficulty: Medium

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27. An endogenous growth model predicts that if the rates of both population growth and saving increase, then the growth rate of GDP per capita will

A) increaseB) decreaseC) stay the sameD) temporarily increase, but then go back to its original level E) either increase, decrease, or stay the same (we cannot say for sure)Ans: E

Difficulty: Easy28. Which of the following policies does NOT affect the long-term growth rate of a nation?A) investment tax credits or any other policy that reduces the cost of capitalB) an expansionary fiscal/expansionary monetary policy mixC) increased funding for primary education D) incentives to increase savingE) more funding for research and developmentAns: B

Difficulty: Medium29. Separating private returns to capital from social returns to capital, that is, the idea that

investment in capital may have positive spillover effects as new ideas and new ways of doing things can be easily copied by others, was first advocated by

A) Robert BarroB) Robert Lucas C) Robert SamuelsonD) Paul SolowE) Paul RomerAns: E

Difficulty: Easy30. Assume India's income level is now roughly 5% of that of the United States. Assuming there

is no change in the savings rates and the levels of technology of these two countries, how many years will it take for India to reach 10% of the U.S.'s income level?

A) 10B) 20C) 25 D) 35E) 50

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Ans: D

Difficulty: Medium31. The notion of conditional convergence states that two countries that have the same

population growth and access to the same level of technology will reach a steady-state equilibrium at

A) different levels of output but the same growth rate, if their savings rates are different B) different levels of output and different economic growth rates if their savings rates are

differentC) the same level of output and the same economic growth rate, even if their savings rates are

different D) the same level of output but different economic growth rates if their savings rates are

different E) the same level of output and the same economic growth rate if their savings rates are the

same but their rates of depreciation differAns: A

Difficulty: Easy32. A key assumption in an endogenous growth model with both labor and capital inputs in the

production function is thatA) the share of capital is larger than the share of laborB) the share of capital and labor have to be equalC) better technology is a byproduct of more capital investmentD) there are no external returns to capital E) long-run growth comes solely from technological progressAns: C

Difficulty: Easy33. In a simple version of the Solow growth model with endogenous population growth, a

country can escape the poverty trap by A) lowering the savings rate and devoting more resources to consumptionB) lowering population growthC) raising the savings rate D) both A) and B)E) both B) and C)Ans: E

55

Difficulty: Medium34. Which of the following is NOT an important factor in establishing high growth in GDP per

capita for a country?A) a stable monetary growth rate B) a high savings rate C) low population growth D) a predictable economic and political environment E) policies to encourage industries to compete in world marketsAns: A

Difficulty: Easy35. Which of the following policy options is likely to be most successful in getting a poor

country out of the poverty trap? A) expansionary fiscal policy B) expansionary monetary policy C) labor market policies D) programs to limit population growth E) investment subsidiesAns: D

Difficulty: Easy36. Countries can achieve continued economic growth as long asA) technological advances continue B) educational progress continuesC) intelligent resource management is practicedD) all of the aboveE) only A) and B)Ans: D

Difficulty: Easy37. Robert Barro's empirical findings that countries with higher levels of investment will achieve

a steady state with a higher per-capita income but not with a higher growth rate supportsA) the notion of absolute convergence B) the notion of conditional convergence C) the predictions of the endogenous growth theory D) the belief that a high savings rate is not beneficial for any nation E) the belief that technology is not very important

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Ans: B

Difficulty: Medium38. Developed countries that direct their investment towards physical capital rather than research

and development can expect to A) have a higher level of output in the short run and a higher long-run growth rateB) have a lower level of output in the short run and lower long-run growth rateC) have a lower level of output in the short run but a higher long-run growth rate D) have a higher level of output in the short run but a lower long-run growth rateE) achieve A) but only if the level of investment exceeds 1/3 of GDPAns: D

Difficulty: Easy39. For a developing country that wants to increase its stock of real capital fairly quickly, which

of the following is NOT a valid option?A) implementing policies designed to increase educational levelsB) asking foreign firms for direct investments in the countryC) borrowing funds from the World Bank for real capital investmentsD) asking other countries for foreign aid to buy new machinesE) increasing private domestic savingAns: A

Difficulty: Easy40. How many years will it take a country that grows at an average rate of 2% per year to double

the size of its GDP? A) 100B) 50 C) 35D) 20E) 15Ans: C

Difficulty: Easy41. If two countries have the same share of investment to GDP, the one that experiences a faster

growth rate is most likely the one that A) emphasizes free market policies and encourages foreign trade

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B) protects domestic industry from foreign competition with trade barriersC) invests less in government infrastructureD) has a higher share of government spending to GDP E) has more government regulations and spends more funds to protect the environmentAns: A

Difficulty: Easy42. Which of the following countries is NOT one of the "Asian Tigers"? A) Hong KongB) Japan C) SingaporeD) South KoreaE) Taiwan Ans: B

Difficulty: Easy43. The "Asian Tigers" achieved high economic growth from 1966 to 1990 in part because they A) had very high savings rates B) successfully controlled their population growth C) devoted many resources to education D) both B) and C) E) both A) and C)Ans: C

Difficulty: Easy44. Which of the following was NOT a common element contributing to the growth of the four

"Asian Tigers" between 1966 and 1990? A) an increase in the labor force participation rateB) high educational achievementC) a high savings rateD) emphasis on laissez-faire economicsE) an increase in total factor productivity achieved by higher levels of inputs Ans: D

Difficulty: Easy45. Between 1966 and 1990, all four "Asian Tigers" achieved economic growth mostly through

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A) hard work and sacrificeB) protecting domestic industries through tariffsC) substantially increasing growth in total factor productivityD) controlling population growth E) a large degree of government interventionAns: A

Difficulty: Medium46. Hong Kong and Singapore achieved high economic growth between 1966 and 1990. Which

of the following characteristics did these two countries NOT have in common?A) a fairly stable governmentB) a very low degree of government interventionC) industries were encouraged to export and compete in world markets D) increases in labor force participation ratesE) great investments in human capitalAns: B

Difficulty: Easy47. The four "Asian Tigers" achieved high economic growth between 1960 and 1990 since theyA) initially protected domestic firms, but then exposed them to foreign competitionB) had very high savings ratesC) had large increases in the labor force participation rates of womenD) increased inputs substantially, although total factor productivity did not increase substantiallyE) all of the aboveAns: E

Difficulty: Easy48. Between 1966 and 1990 Singapore's GDP per capita grew at an average annual rate of 6.8%.

During the same time frame its growth rate in total factor productivity wasA) 0.2% B) 1.2%C) 2.2%D) 3.2%E) 4.2%Ans: A

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Difficulty: Easy49. Between 1966 and 1990 Hong Kong experienced a much higher growth rate of output than

Singapore. This was at least partially due to the fact that Singapore had a government that A) emphasized a laissez-faire attitude towards market activitiesB) maintained much tighter control over market activitiesC) discouraged a rapid pace of foreign investment in new technologyD) imposed strict population control programsE) none of the aboveAns: B

Difficulty: Medium50. There is no simple relationship between the proportion of investment to output and the

growth rate of per-capita output sinceA) population growth rates differ among countriesB) income growth rates differ among countriesC) the efficiency of investment among countries can vary widelyD) the savings rates among countries can vary widelyE) none of the above

Ans: C

CHAPTER 5

Technical Problems

1.a. As Figure 5-11 shows, a decrease in income taxes shifts both the AD-curve and the AS-curve to the right. The shift in the AD-curve tends to be fairly large and, in the very short run (when prices are fixed), leads to a significant increase in output without a change in prices. But in the long run, the AS-curve will also shift to the right. Since lower income tax rates provide an incentive to work more, output will increase, but only by a fairly small amount. Therefore we see a large increase in the price level with a slightly higher level of real GDP in the long run.

1.b. Supply-side economics includes any policy measure that will increase potential GDP by shifting the long-run (vertical) AS-curve to the right. Supply-side economists put forth the view that a cut in income tax rates will increase the incentive to work, save, and invest. Some economists claimed that this would increase aggregate supply so much that the inflation and unemployment rates would simultaneously decrease, and that the resulting high economic growth might even lead to an increase in tax revenues, despite lower tax rates. However, when these policies were implemented in the early 1980s, they did not have the predicted effects. As seen in Figure 5-11, the long-run effect of a tax cut on output is small, but the price level may increase substantially.

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2.a. P ADo AD1 AS

P1

Po

0 Yo Y1 Y

According to the balanced budget theorem, a simultaneous and equal increase in government purchases and taxes will shift the AD-curve to the right, as the positive impact of the increase in government spending is greater than the negative impact of the tax increase. But if the AS-curve is upward sloping, then the balanced budget multiplier will be less than one, that is, the increase in output will be less than the increase in government purchases. This occurs because part of the fiscal expansion will be crowded out, that is, the level of private spending will decrease, due to a higher price level, lower real money balances, and the resulting rise in interest rates.

2.b. In the Keynesian case, the AS-curve is horizontal and the price level remains unchanged. There is no real balance effect and therefore income increases more than in 2.a., that is, output increases by the whole shift in the AD-curve. However, the interest rate still increases and therefore the balanced budget multiplier is less than one (but greater than in 2.a.).

P ADo AD1

Po AS

0 Yo Y1 Y

2.c. In the classical case, the AS-curve is vertical and the output level remains unchanged. In this case, a shift in the AD-curve leads to a price increase and real money balances decline. Therefore interest rates increase further than in 2.b. or even 2.a., leading to full crowding out of investment. Hence the balanced budget

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multiplier is zero in the classical case.

P AD1 ASAD0

P1

P0

0 Y* Y

Chapter 5: Aggregate Supply and Demand

Difficulty: Easy1. If factor markets were perfectly competitive, then full employment would be the normal

condition andA) inflation would always be zeroB) output would rise steadily with price increases C) there would never be any reason for prices to changeD) the AS-curve would be horizontalE) the AS-curve would be verticalAns: E

Difficulty: Easy2. Assume you buried a $100 bill in a time capsule in 1970 and dug it up 40 years later. What

would be its purchasing power in 2010?A) $122B) $100C) $88D) $44E) $22Ans: E

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Difficulty: Medium3. The AS-curve is horizontal or very flat ifA) additional resources (especially labor) can be hired to produce additional output with little or

no increase in existing pricesB) wages fall rapidly with an increase in unemployment, reducing spending and income to

restore equilibriumC) firms lower wages less than prices to avoid a loss in profit during a recessionD) the nominal wage adjustment occurs fairly rapidlyE) nominal wages and prices always change proportionally, leaving the real wage rate

unchangedAns: A

Difficulty: Medium4. Which of the following was NOT true during the Great Depression?A) investment as a share of GDP was below 3 percent B) unemployment averaged about 18.8 percent C) prices dropped by one-fourthD) output fell by nearly 30 percentE) both B) and C) Ans: A

Difficulty: Easy5. The level of GDP that corresponds to full employment in the labor market is calledA) potential GDP B) real GDP C) nominal GDP D) natural GDP E) GDP per capita Ans: A

Difficulty: Easy6. Most economists prior to Keynes thought thatA) unemployment could be eliminated by active fiscal policiesB) the economy always adjusted rapidly to full employment C) the economy always adjusted to a natural rate of inflationD) monetary policy could be employed to eliminate the business cycleE) government intervention was needed to avoid persistent unemploymentAns: B

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Difficulty: Medium7. The Keynesian AS-curve differs from the classical AS-curve, since KeynesA) thought that labor markets worked smoothly to always establish full employmentB) thought that nominal wages were flexible even when there was unemploymentC) thought that nominal wages were rigid even when there was unemploymentD) described the AS-curve as completely vertical E) assumed that firms tried to exploit the work force by paying them substandard wagesAns: C

Difficulty: Easy8. The Keynesian aggregate supply curve implies thatA) the economy is always at the full-employment level of outputB) the price level is unaffected by current levels of GDPC) wages are perfectly flexible D) real money balances decrease as the AD-curve shifts to the rightE) an increase in nominal money supply will not affect the level of real GDPAns: B

Difficulty: Medium9. In the Keynesian aggregate supply curve case, A) firms will always supply the amount of goods demanded at the existing price levelB) consumers will demand whatever is supplied by firms at each priceC) the economy is always at full employmentD) unemployment is always at its natural rateE) none of the above Ans: A

Difficulty: Medium10. In which of the following cases will the AS-curve be horizontal?A) if nominal wages and prices always change proportionally, leaving real wages unchangedB) if nominal wages do not change even if there is high unemploymentC) if nominal wages are completely flexibleD) if the economy is always in a full-employment equilibrium E) if fiscal policy has no impact on the output levelAns: B

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Difficulty: Easy11. Given the Keynesian AS-curve, expansionary monetary policy willA) increase the level of output but leave the price level unchangedB) increase the price level but leave the level of output unchangedC) increase both the level of output and the price level D) leave the level of output and the price level unchangedE) increase the level of output but decrease the price levelAns: A

Difficulty: Easy12. In the Keynesian supply curve case, a fiscal expansion willA) have no impact on equilibrium income or pricesB) increase prices but have no impact on equilibrium incomeC) increase prices more than incomeD) increase income more than pricesE) increase equilibrium income but have no impact on pricesAns: E

Difficulty: Medium13. Which of the following is FALSE? A) the AS-curve is horizontal in the Keynesian case B) the AS-curve is vertical in the classical case C) the AS-curve is upward sloping in the medium run D) the AS-curve is more price elastic in the long run than in the short run E) none of the above Ans: D

Difficulty: Easy14. The AD-AS diagram used in this chapterA) is unrelated to the demand and supply diagram used in microeconomics B) uses the average price level of all goods and services we buy as “price” C) uses an AS-curve that is relatively more price elastic in the medium run than in the long runD) uses an AS-curve that is vertical in the long run and horizontal in the very short run

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E) all of the above Ans: E

Difficulty: Easy15. Which of the following is NOT reflected in a shift of the AD-curve?A) a change in real money balances due to a change in the price level B) a change in real money balances due to a change in nominal money supplyC) a change in government transfer payments D) a change in the confidence of consumers and businessesE) all of the above will shift the AD-curveAns: A

Difficulty: Easy16. The slope of the AS-curve becomes steeper A) as nominal wages become more flexible B) as nominal wages become more rigidC) as the actual level of output moves further away from potential outputD) as the economy approaches full employment E) both A) and D) Ans: E

Difficulty: Medium17. A decrease in real money supply caused by an increase in the price level is graphically

represented byA) a shift of the AD-curve to the rightB) a shift of the AD-curve to the left C) movement along the AD-curve to the rightD) movement along the AD-curve to the leftE) a shift of the AS-curve to the rightAns: D

Difficulty: Easy18. The natural rate of unemployment is A) always zero B) the unemployment rate that exists when inflation is zero C) the unemployment rate that exists when output is assumed to be at its full-employment level

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D) the unemployment rate that exists above frictional unemploymentE) none of the aboveAns: C

Difficulty: Easy19. Frictional unemployment is defined as A) all unemployment above the natural rate B) unemployment that is cyclical in nature C) the natural unemployment rate minus cyclical unemployment D) unemployment resulting from people shifting between jobs and looking for new jobsE) any unemployment that is below 4%Ans: D

Difficulty: Easy20. If output is at its full-employment level, thenA) the actual unemployment rate is zero B) the natural rate of unemployment is zeroC) there are no frictions in the labor market since wages have reached their market-clearing

levelD) there is still some positive level of unemployment due to frictions in the labor marketE) nobody who is currently employed is looking for a new jobAns: D

Difficulty: Medium21. A shift of the AD-curve to the left can be caused byA) a decrease in taxesB) an increase in business and consumer confidenceC) an increase in nominal money supplyD) a decrease in government transfer paymentsE) a decrease in money demandAns: D

Difficulty: Difficult22. In the medium run, if government purchases are increased and nominal money supply is

decreased, we can expect that A) aggregate demand and prices will increase but interest rates will not change

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B) aggregate demand, prices, and the interest rate will all decreaseC) aggregate demand and interest rates will decrease but prices will increase D) the AD-curve will shift to the right and the AS-curve will shift to the leftE) the interest rate will increase while aggregate demand and prices may increase, decrease, or

remain the same Ans: E

Difficulty: Easy23. The AD-curve has a negative slope sinceA) firms will produce less if they have to lower their pricesB) lower prices mean higher real wages so firms can no longer afford to produce as many goods

and servicesC) a decrease in the price level increases real money balances, leading to lower interest rates and

increased spendingD) lower prices drive up the demand for goods since buyers fear future market shortagesE) lower prices increase consumer confidence, which encourages spendingAns: C

Difficulty: Medium24. A shift of the AD-curve to the right could be caused byA) a decrease in taxesB) a decrease in government transfer paymentsC) an increase in money demandD) a decrease in defense spending E) both A) and C) Ans: A

Difficulty: Easy25. An increase in aggregate demand can be caused byA) an increase in government expendituresB) an increase in nominal money supplyC) a decrease in taxesD) an increase in business and consumer confidenceE) all of the aboveAns: E

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Difficulty: Medium26. To maintain a fixed level of aggregate demand, the Fed would have to respond to a tax

increase byA) increasing reserve requirementsB) increasing the discount rateC) buying bonds in the open marketD) selling bonds in the open marketE) urging banks to ration creditAns: C

Difficulty: Medium27. In a normal AD-AS diagram with an upward-sloping AS-curve, if the government wanted to

maintain a fixed level of output, it would need to respond to a decrease in money supply byA) decreasing government expendituresB) increasing government spendingC) urging the Fed to sell bonds in the open marketD) increasing income taxesE) decreasing taxes and government spending by the same amountAns: B

Difficulty: Medium28. In the medium run, if government purchases are decreased and nominal money supply is

increased, then we can expect that A) aggregate demand will decrease and aggregate supply will increase, leaving the level of

output the sameB) output, prices, and interest rates will all increaseC) output and prices will decrease, while interest rates will increase D) interest rates will decrease, while output and prices may increase, decrease, or remain the

sameE) none of the above Ans: D

Difficulty: Medium29. In an AD-AS diagram with an upward-sloping AS-curve, if a tax decrease is combined with

money expansion, A) output will remain relatively unaffected but interest rates will decreaseB) output will remain relatively unaffected but interest rates will definitely increaseC) aggregate demand, the price level, and output will all decrease

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D) aggregate demand, the price level, and output will all increaseE) the price level will increase but we can't say what will happen to output or interest ratesAns: D

Difficulty: Difficult30. If government purchases and taxes are both increased by the same lump sum, we can expect

the following in the medium run:A) output, prices, and interest rates will all remain unchangedB) output, prices, and interest rates will all decreaseC) output, prices, and interest rates will all increaseD) output and prices will remain the same but interest rates will increaseE) output and prices will increase but interest rates will remain the sameAns: C

Difficulty: Medium31. In an AD-AS diagram with an upward-sloping AS-curve, an increase in money supply willA) increase output and the price level but not affect the interest rateB) increase output, the price level, and the interest rateC) increase output and the price level but lower the interest rateD) decrease the interest rate, increase the price level, but leave output unchangedE) increase the price level but leave output and the interest rate unchangedAns: C

Difficulty: Medium32. When nominal money supply is held constant and the price level increases, thenA) real money balances increase and real interest rates decreaseB) real money balances decrease and real interest rates increaseC) real money balances decrease and real interest rates remain the sameD) the AS-curve must have shifted to the rightE) both B) and D) Ans: B

Difficulty: Easy33. A decrease in nominal money supply will be reflected in A) a shift of the AD-curve to the rightB) a shift of the AD-curve to the left

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C) movement along the AD-curve from right to left D) movement along the AD-curve from left to right E) a shift of the AS-curve to the leftAns: B

Difficulty: Medium34. Expansionary fiscal policy is very effective in significantly increasing the level of output A) if the AS-curve is totally price inelastic B) in the classical case C) if the economy is close to full employmentD) if the economy is in a recession E) both A) and D) Ans: D

Difficulty: Easy35. Expansionary monetary policy will increase nominal GDPA) in the Keynesian case B) in the classical case C) in the medium run D) all of the above E) only A) and C)Ans: D

Difficulty: Difficult36. In the classical supply curve case, monetary expansion willA) increase P, lower i, and leave Y unchangedB) increase Y, lower i, and leave P unchangedC) leave Y and i unchanged but increase PD) leave Y, i, and P unchangedE) increase Y, i, and PAns: C

Difficulty: Medium37. Assume investment is very interest sensitive and wages always adjust immediately to

maintain an equilibrium in the labor market. Which of the following would be most effective in significantly increasing the level of output?

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A) expansionary fiscal policyB) expansionary monetary policyC) increased government spending accompanied by monetary expansionD) an increase in government transfer paymentsE) none of the above policies would succeed in significantly increasing the level of outputAns: E

Difficulty: Medium38. In which of the following cases is expansionary fiscal policy LEAST effective in increasing

output? A) if wages adjust rapidly to maintain equilibrium in the labor marketB) if wages do not change much even when there is high unemploymentC) if it is combined with expansionary monetary policy D) if we have a Keynesian AS-curve E) if the Fed is trying hard to keep interest rates from risingAns: A

Difficulty: Medium39. An increase in government purchases will not increase the level of output if A) the AS-curve is totally price elastic B) the price level is fixedC) wages and prices are completely rigidD) wages and prices are completely flexibleE) real money balances are not affected Ans: D

Difficulty: Medium40. Fiscal policy will affect prices and interest rates but not the level of output ifA) the AD-curve is verticalB) the AS-curve is verticalC) the AD-curve is horizontalD) the AS-curve is horizontal E) both A) or D) Ans: B

Difficulty: Medium

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41. In the AD-AS model, fiscal or monetary policy cannot affect the level of output inA) the medium run and the long run B) the medium run and the short run C) the short run only D) the medium run onlyE) the long run onlyAns: E

Difficulty: Medium42. The income velocity of money can be calculated using the following formulaA) V = M/(PY)B) V = (MY)/PC) V = (PY)/MD) V = MYE) none of the above Ans: C

Difficulty: Medium43. If nominal GDP is $12,600 billion and nominal money supply is $6,300 billion, then the

income velocity of money is

A) V = 6,300B) V = 0.5C) V = 2D) V can only be determined if the price level is knownE) none of the above Ans: C

Difficulty: Medium44. If restrictive monetary policy leads to a lower price level but leaves real output, employment,

and real interest rates unchanged, thenA) real money balances must be unchangedB) it must have been accompanied by expansionary fiscal policyC) it must have been accompanied by restrictive fiscal policyD) money is said to be neutral E) both A) and D)

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Ans: E

Difficulty: Easy45. A large decrease in the income tax rate will most likely causeA) a fairly large increase in aggregate demandB) a fairly small increase in aggregate supplyC) an increase in the price levelD) all of the above E) none of the aboveAns: D

Difficulty: Easy46. Supply-side economics involves policy measures designed to A) encourage technological progress B) remove unnecessary government regulations C) give investment tax credits to stimulate specific capital investments D) all of the aboveE) none of the above Ans: D

Difficulty: Medium47. Cutting income tax rates will most likely cause A) a large shift in the AD-curve but a small shift in the AS-curveB) a small shift in the AD-curve but a large shift in the AS-curveC) a large increase in output resulting in a large increase in tax revenues D) a budget deficit so large that income growth is no longer possibleE) both B) and C) Ans: A

Difficulty: Easy48. When we say that potential GDP is exogenous with respect to the price level, we refer toA) the fact that changes in real money balances cause output to riseB) the fact that the long-run AS-curve shifts to the right over timeC) the short-run AS-curve D) the medium-run AS-curve E) the Keynesian AS-curve

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Ans: B

Difficulty: Medium49. In the long run, as potential GDP grows at a steady pace and nominal money supply is

continuously increased over timeA) the level of output is essentially determined by shifts in the AS-curveB) the level of output is essentially determined by shifts in the AD-curveC) the price level will not change since the AS-curve is horizontalD) real money balances continuously decrease as the AD-curve remains constantE) the price level is determined solely by the shift in the AS-curveAns: A

Difficulty: Medium50. As nominal money supply is steadily increased and the long-run AS-curve shifts to the right

over time, we realize that A) the price level decreases since the AS-curve shifts right while the AD-curve remains constantB) the price level stays the same, while output continuously increases C) the price level increases or decreases depending on the respective shifts in the AD-curve and

the AS-curve, but the level of output is essentially determined by the shifts in the AS-curveD) we will experience a substantial increase in inflation with very little increase in outputE) none of the aboveAns: C

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CHAPTER 6

Technical Problems

1. A reduction in the supply of money leads to excess demand for money and increased interest rates, reducing the level of private spending (especially investment). Therefore the AD-curve shifts to the left. This causes an excess supply of goods and services at the original price level so the price level starts to decrease. Since the AS-curve is upward sloping, a new short-run macro-equilibrium is reached at a lower level of output (and thus a higher level of unemployment) and a lower price level.

However, the higher level of unemployment eventually provides downward pressure on wages, reducing the cost of production and shifting the upward-sloping AS-curve to the right. Alternatively, since this short-run equilibrium output level is below the full-employment level, prices will continue to fall and the upward-sloping AS-curve will shift to the right. As long as output is below the full-employment level Y*, the upward-sloping AS-curve will continue to shift to the right, which means that the price level will continue to decline. Eventually a new long-run equilibrium will be reached at the full-employment level of output (Y*) and a lower price level.

ASo

P ADo AD1 AS1

P1 1

P2 2

P3 3 0 Y1 Y* Y

1.->2.. Ms i I Y AD Ex.S. P real ms i I Y Short-run Effect: Y UR P i

2.->3. UR W cost of prod. AS Ex.S. P real ms i I Y

Long-run Effect: Y = const. UR = const. P i = const.

1. The rational expectations theory predicts that an announced change in monetary policy will immediately change people’s expectations about the inflation rate. If people could adjust immediately to this change in inflationary expectations, the rate of

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unemployment and output would remain at the full-employment level. In this hypothetical situation, any announced monetary policy change would not affect the unemployment rate. In other words, we would move immediately from point 1 to point 3 in the diagram that was used to explain the previous question. In reality, however, even if people have rational expectations and can anticipate the

effects of a policy change correctly, they may not be able to immediately adjust due to wage contracts, etc. Thus, there will always be some deviation from the full-employment output level Y*. In the above diagram, the AS-curve would start shifting to the right much earlier and we would end up somewhere between points 1 and 3 and even with an anticipated policy change we would have some increase in unemployment.

3.a. A favorable supply shock, such as a decline in material prices, shifts the upward-sloping AS-curve to the right, leading to excess supply at the existing price level. A new short-run equilibrium is reached at a higher level of output and a lower price level. But since output is now above the full-employment level, there is upward pressure on wages and prices and the upward-sloping AS-curve starts shifting back to the left. A new long-run equilibrium is reached back at the original position at Y* and the original price level (assuming that the change in material prices did not affect the full-employment level of output). Since nominal wages (W) will have risen but the price level (P) will not have changed, real wages (W/P) will have increased.

P AD ASo

AS1

Po 1

P1 2

0 Y* Y1 Y 3.b. Lower material prices lower the cost of production, shifting the upward-sloping AS-

curve to the right. This leads to an increase in output and a lower price level. Since unemployment is below its natural rate, there is a shortage of labor, providing upward pressure on wages. But higher wages will increase the cost of production again, so the upward-sloping AS-curve will eventually shift back to the original long-run equilibrium (assuming that potential GDP has not been affected). The adjustment process can be described as follows:

1==>2: material prices ↓ ==> cost of production ↓ ==> the AS-curve shifts right

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== > excess supply ==> P ↓ ==> real ms ↑ ==> i ↓ ==> I ↑ ==> Y ↑

Short-run effect: Y ↑ , i ↓, P ↓

2==>1: Since Y > Y* ==> nominal wages ↑ ==> the AS-curve shifts left

==> excess demand == > P ↑ ==> real ms ↓ ==> i ↑ ==> I ↓ ==> Y ↓

Short-run effect: Y↓ , i ↑, P ↑

Long-run effect: Y back at Y*, i remains the same, P remains the same.

Chapter 6: Aggregate Supply: Wages, Prices, and Unemployment

Difficulty: Medium1. The theory of aggregate supply is one of the most controversial in macroeconomics because A) modern models, while similar in their starting points, reach widely different results in

explaining the AS-curveB) economists cannot agree whether the Keynesian or the classical AS-curve is a better

reflection of realityC) economists cannot agree whether wages are completely flexible or rigid in the long runD) economists cannot agree whether wages are completely flexible or rigid in the very short run E) economists do not completely agree on the reasons for the slow adjustment of wages and

prices after demand-side disturbancesAns: E

Difficulty: Medium2. Friedman and Phelps argued that the Phillips curve is not stable over time becauseA) any kind of stabilization policy immediately affects nominal wagesB) any shift in aggregate demand will immediately also shift the Phillips curve C) workers' expectations about price changes are only wrong temporarilyD) firms change wage rates for workers as soon as product prices change, so profits will not

suffer E) firms always immediately change their product prices in response to a change in money

supplyAns: C

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Difficulty: Easy3. For many government decision makers, the original Phillips curve implied A) a trade-off between lowering unemployment at the cost of higher inflation or lowering

inflation at the cost of higher unemploymentB) that active stabilization policy will always work if applied correctlyC) that severe recessions were a thing of the past, as unemployment could easily adjust to its

natural rateD) that the natural rate of unemployment can be lowered by expansionary monetary policyE) all of the aboveAns: A

Difficulty: Easy4. If we look at the annual U.S. unemployment rates over the last three decades, we see A) peaks in 1982, 1992, and 2002, with each peak higher than the lastB) only very small variations around the natural rate of 5.2%C) large variations, but after each peak the rate returned to about 4.5%D) that the unemployment rate exceeded 10% in 1982 E) that the unemployment rate never exceeded 8% Ans: D

Difficulty: Easy5. The Phillips curve shows a relationship betweenA) the level of output and pricesB) the level of output and unemploymentC) the level of prices and employmentD) the rate of change in prices and the rate of unemploymentE) the level of prices and wage rate changes Ans: D

Difficulty: Easy6. According to the Phillips curve relationship, if unemployment is at the natural rate, thenA) the rate of inflation is zeroB) nominal wages will always be equal to real wages C) the labor supply will be totally price elasticD) prices will always immediately adjust to changes in money supplyE) none of the above

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Ans: E

Difficulty: Medium7. The newer view of the Phillips curve implies thatA) the natural rate of unemployment can be reduced by expansionary monetary policyB) in the long run unemployment does not move towards a natural rate if there is frictional

unemploymentC) an increase in monetary growth affects unemployment and inflation in the short run, but only

affects inflation in the long runD) there is a clear inverse relationship between unemployment and outputE) stagflation can best be addressed by implementing expansionary fiscal policiesAns: C

Difficulty: Medium8. The coordination approach to the Phillips curve focuses on the fact thatA) administrations have problems coordinating fiscal policy with the monetary policy of the

central bankB) long-term labor contracts tend to expire at different times, so firms cannot coordinate their

hiringC) unemployed workers are not organized enough to influence wage negotiationsD) firms are unsure about their competitors' behavior and are therefore reluctant to change

wages and prices following a change in aggregate demandE) workers have only imperfect information about their real wagesAns: D

Difficulty: Medium9. The inflation-expectations-augmented Phillips curve implies that A) unemployment is at its natural rate when expected inflation is equal to actual inflationB) stagflation occurs when expected inflation is below actual inflationC) stagflation occurs when the short-run Phillips curve shifts leftD) the inflation rate is equal to the real output growth rate plus the monetary growth rateE) the expected inflation rate is always equal to the monetary growth rateAns: A

Difficulty: Medium10. Stagflation, that is, high unemployment combined with high inflation

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A) cannot persist, since the economy eventually will return to full employmentB) can only occur if expansionary monetary policy is combined with restrictive fiscal policyC) is inconsistent with the inflation-expectations-augmented Phillips curveD) cannot occur as long as the expected inflation rate is above the actual inflation rate E) none of the aboveAns: A

Difficulty: Easy11. The natural rate of unemployment isA) zero since everyone who is unemployed is so voluntarilyB) the result of labor market friction--people entering the labor force, changing careers, etc.C) rarely more than 3 percent D) the amount of unemployment caused by an average recessionE) mostly the result of misguided government policyAns: B

Difficulty: Medium12. A difference between the inflation-expectations-augmented Phillips curve and the Phillips

curve that is based on rational expectations is thatA) in the latter people never make incorrect forecastsB) in the latter monetary policy changes cannot affect the rate of inflationC) in the former a change in monetary policy causes an immediate shift in the Phillips curve D) in the former expected inflation is always equal to actual inflationE) none of the aboveAns: E

Difficulty: Easy13. The rational expectations hypothesis predicts thatA) an announced change in monetary policy will not affect the unemployment rate B) the short-run Phillips curve will shift as soon as new information about future inflation

becomes availableC) the level of output will not be affected by any predictable change in monetary policy D) all of the aboveE) only A) and C)Ans: D

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Difficulty: Easy14. If nominal wage rates were completely flexible, thenA) fiscal policy would affect real money balances but not output B) there would be a clear trade-off between unemployment and inflationC) periods of unemployment would be much more frequent D) frictional unemployment would not exist E) monetary policy would be ineffective in changing the price levelAns: A

Difficulty: Medium15. The insider-outsider model refers toA) policy making in White HouseB) the fact that the unemployed do not take part in collective bargaining C) the fact that wages do not respond significantly to changes in the unemployment rate D) slow price adjustments in an imperfectly competitive business environment E) both B) and C) Ans: E

Difficulty: Easy16. Wages are considered to be sticky rather than flexible sinceA) firms encounter menu costs when changing wages but not when changing pricesB) labor contracts contain cost-of-living adjustmentsC) firms tend to look at labor as an expendable resource D) firms are unsure about their competitors' behavior and only reluctantly change prices and

wages following a change in aggregate demand E) all of the aboveAns: D

Difficulty: Medium17. The efficiency wage theory of aggregate supply implies thatA) the AS-curve is verticalB) paying employees higher wages won't induce them to work harder C) even unanticipated changes in monetary or fiscal policy have no effect on the level of outputD) since the cost of changing wages and prices is low, wages can easily be adjusted in

proportion to price changes to maintain full employmentE) none of the aboveAns: E

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Difficulty: Easy18. The inverse relationship between inflation and unemployment is calledA) Okun's law B) the Lucas curve C) the Phillips curve D) the replacement ratio E) the sacrifice ratioAns: C

Difficulty: Easy19. Okun's law states that one extra percentage point in unemployment causesA) real GDP to fall by about 2 percent B) real GDP to fall by about 0.5 percent C) the rate of inflation to decline by about 2 percent D) the rate of inflation to decline by about 0.5 percentE) both GDP and the rate of inflation to decline by about 2 percentAns: A

Difficulty: Easy20. Robert Lucas modified the rational expectations argument by A) allowing for the role of forecasting errorsB) assuming that people always have perfect foresight C) asserting that economic models should always allow for people making easily avoidable

mistakes D) redefining Okun's lawE) proving that a permanent change in monetary growth has a long-run effect on the

unemployment rateAns: A

Difficulty: Medium21. Restrictive monetary policy will eventually affect the upward-sloping AS-curve since A) higher interest rates will increase the cost of productionB) higher interest rates will reduce the capital stock which will, in turn, reduce potential GDPC) the resulting unemployment will cause downward pressure on nominal wages, so the cost of

production will decreaseD) real wages will decline in proportion to the change in money supply and this will cause a

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change in unemployment E) firms will start laying off workers in anticipation of a decline in aggregate demandAns: C

Difficulty: Medium22. In the medium run the aggregate supply curve is upward sloping sinceA) workers immediately realize that nominal wage increases are really the result of price

increasesB) firms encounter costs in resetting prices and are reluctant to change wages following a

change in aggregate demandC) wages and prices always immediately change in proportion to the money stockD) there is always natural friction in the labor market that prevents unemployment from

reaching zeroE) none of the aboveAns: B

Difficulty: Medium23. The fact that nominal wages are fixed by a contract at the beginning of a period while prices

of goods may change within that period, implies thatA) unanticipated changes in the money supply do not affect the level of outputB) there is no trade-off between unemployment and inflationC) firms want to supply more output when prices increase since the real wage rate is lowerD) anticipated monetary policy changes will not affect the level of inflationE) money supply changes affect prices but not unemployment in the short runAns: C

Difficulty: Medium24. The unemployment gap A) always grows twice as fast as the output gap B) always is negativeC) always increases as the rate of inflation increases D) always stays at its natural level E) none of the aboveAns: E

Difficulty: Medium

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25. Which of the following is NOT used in deriving the AS-curve in Chapter 6?A) the link between output and employment B) the price-cost relationC) the Phillips curveD) the quantity theory of moneyE) all of the above are usedAns: D

Difficulty: Medium26. The upward-sloping AS-curve will shift eventually to the left ifA) labor productivity increasesB) actual output is lower than the full-employment levelC) actual output is higher than the full-employment levelD) the markup over labor cost falls E) the level of potential output increasesAns: C

Difficulty: Medium27. Which of the following is NOT true?A) the Phillips curve shifts as soon as actual inflation changes B) the position of the Phillips curve depends on the expected rate of inflationC) if actual inflation is equal to expected inflation, we are at full-employmentD) if unemployment is below its natural rate, the Phillips curve will shift to the rightE) if wages and prices respond very little to changes in unemployment, the short-run Phillips

curve is very flat Ans: A

Difficulty: Medium28. Assume the Fed implements restrictive monetary policy. Which of the following is the most

likely result in an AD-AS framework with an upward sloping AS-curve?A) the interest rate will increase but output, prices, and real money balances will fall B) the interest rate, output, and prices will all declineC) prices and output will fall, but real money balances will increaseD) real money balances will remain unchanged, since money supply and prices will decrease

proportionallyE) real money balances and prices will fall proportionallyAns: A

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Difficulty: Medium29. In an AD-AS model with an upward-sloping AS-curve, the most likely effects of fiscal

expansion would be A) an increase in prices and interest rates, but a decrease in real money balancesB) an increase in output, prices, and real money balancesC) an increase in consumption and a decrease in investment with no change in outputD) a decrease in unemployment but an increase in interest rates and real money balancesE) a decrease in consumption, but an increase in net exports and investmentAns: A

Difficulty: Easy30. In the medium run, a price increase combined with a decrease in the unemployment rate is

most likely the result ofA) an adverse supply shockB) an adverse supply shock followed by restrictive monetary policyC) a favorable supply shock D) a decrease in money supplyE) expansionary fiscal or monetary policy Ans: E

Difficulty: Medium31. Assume output is at its full-employment level and the Fed restricts money supply. What is

the most likely outcome? A) an immediate decrease in prices, with no impact on outputB) no change in nominal wages in the short run, but a decline in output and prices in the

medium runC) no change in real wages, but a decline in output and prices in the medium runD) a decrease in nominal wages and prices in proportion to money supply, but no change in

output and real interest rates in the long runE) both B) and D)Ans: E

Difficulty: Medium32. Assume the economy is at full employment. Which is the most likely effect of a decrease in

government spending? A) output, prices, and interest rates will all increase in the medium run

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B) output, prices, and interest rates will all decrease in the long runC) prices and interest rates will decrease in the medium and long run while output will be

negatively affected in the medium run but not in the long run D) output and prices will remain the same in the long run, but interest rates will increase both in

the medium and long run E) output, prices and interest rates will all decline in the medium run but only output will be

negatively affected in the long runAns: C

Difficulty: Medium33. Assume the economy is at full employment and the Fed restricts money supply. What will be

the effects on output and prices?A) in the medium run output and prices will both decrease, but in the long run output will

remain the same, while prices will decreaseB) output will not be affected in the medium or long run, but prices will decrease in the long runC) output will decrease but only in the long run, while prices will decrease in the medium run

and the long runD) in the medium run output will remain the same, but in the long run both output and prices

will declineE) output and prices will decline in the medium and long runAns: A

Difficulty: Medium34. The most likely long-run result of a tax cut would beA) lower unemployment but higher prices and interest ratesB) lower interest rates but no change in unemployment C) higher levels of consumption, investment, and employmentD) more consumption and less investment, with output remaining unchangedE) higher prices and interest rates, resulting in a less consumption and investment Ans: D

Difficulty: Difficult35. In the long run, real money balances A) are not affected by expansionary fiscal policy but increase if expansionary monetary policy is

employedB) are not affected by expansionary monetary policy but increase if expansionary fiscal policy is

employed C) are not affected by restrictive monetary policy, but increase if restrictive fiscal policy is

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employed D) are not affected by fiscal or monetary policyE) decrease if either restrictive fiscal or monetary policy is employedAns: C

Difficulty: Medium36. In the long run, monetary expansion should have the following result: A) nominal wages change in proportion to nominal money supplyB) real interest rates remain constantC) real wages remain constantD) nominal wages and prices change in proportion to nominal money supplyE) all of the aboveAns: E

Difficulty: Easy37. In an AD-AS model with an upward sloping AS-curve, what would happen if oil prices

increased and the Fed responded by restricting money supply?A) real output would increase and the price level would remain the sameB) real output would remain the same but the price level would decrease C) real output would decrease and the price level would increase sharplyD) real output would decrease and the price level would decrease sharply E) real output would decrease but we can't tell what would happen to the price levelAns: E

Difficulty: Medium38. What sort of event could lead to a simultaneous decrease in the rates of inflation and

unemployment?A) a decrease in money supplyB) an increase in money supplyC) an adverse supply shockD) a decrease in material prices E) restrictive monetary policy following an adverse supply shockAns: D

Difficulty: Medium39. In the static AD-AS model, what is the most likely long-run outcome of an oil price increase,

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if no policy change is implemented?A) real wages will decline while the levels of output and prices will remain unchanged B) the level of prices will increase while the level of output will remain unchangedC) the natural unemployment rate and the price level will both increase D) nominal wages and prices will increase, but real wages will remain unchangedE) real money balances and real wages will decline while nominal wages will remain unchangedAns: A

Difficulty: Easy40. In the AD-AS model with an upward-sloping AS-curve, a decrease in oil prices willA) increase prices and outputB) decrease prices and increase outputC) increase prices and decrease outputD) decrease prices and outputE) decrease prices but have no effect on outputAns: B

Difficulty: Easy41. Which of the following is the most likely medium-run outcome of an adverse supply shock? A) an increase in consumer prices and a higher level of real GDP B) a decrease in real GDP C) an increase in real wage ratesD) an increase in frictional unemploymentE) an increase in nominal GDP with real GDP remaining the sameAns: B

Difficulty: Medium42. Suppose an increase in oil prices is accompanied by a decline in the level of potential output.

Which of the following is the most likely long-run effect?A) real GDP will decrease but prices will increaseB) real GDP and prices will both declineC) real GDP will remain the same but prices will increaseD) real GDP will remain the same but nominal GDP will decrease E) the unemployment rate and prices will both decrease Ans: A

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Difficulty: Medium43. If policy makers want to get the price level quickly back to its original level following an

adverse supply shock, they need toA) implement restrictive monetary policyB) decrease taxesC) increase government transfer paymentsD) combine a tax increase with an increase in government spending of equal magnitudeE) levy a tariff on imported oil Ans: A

Difficulty: Easy44. In the 1990s, the consumer price indexA) steadily declined, primarily due to reduced oil prices B) was fairly constant due to cheap oil and computer pricesC) increased slightly despite a drastic decrease in computer pricesD) increased despite stable prices for oil and computersE) decreased drastically due to much cheaper prices for oil and computers Ans: C

Difficulty: Medium45. If the government stimulates aggregate demand in response to an adverse supply shock,A) the inflation rate will increase but frictional unemployment will decrease B) the unemployment rate will increase but the inflation rate will decline C) an increase in unemployment can be avoided but only at the cost of increased inflationD) high inflation can be avoided but the rate of unemployment will increaseE) the inflation and unemployment rates will be reduced simultaneouslyAns: C

Difficulty: Medium46. Assume the economy is at full employment. If the Fed accommodates an increase in oil

prices by expansionary monetary policy, what will be the long-run effects on unemployment and prices?

A) unemployment and prices will both increase B) unemployment will decrease and prices will remain the sameC) unemployment will increase but prices will remain the same D) unemployment and prices will both remain unchanged E) unemployment will remain the same but prices would increaseAns: E

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Difficulty: Easy47. When we look at the real (inflation adjusted) price of crude oil over the last four decades, we

realize thatA) oil prices doubled between 1971 and 1974B) oil prices did not change much between 1974 and 1978C) oil prices more than doubled between 1978 and 1981 D) oil prices were lower in 1998 than in 1978E) all of the aboveAns: E

Difficulty: Medium48. In the long run, an increase in nominal money supply willA) cause both the nominal wage rate and the price level to rise proportionately, leaving the real

wage rate and output unchangedB) cause prices to rise more than nominal wages, lowering real wages and creating more job

opportunitiesC) affect prices but not nominal wages or unemploymentD) increase nominal wages more than the price level so workers will spend more and aggregate

demand will increaseE) increase real wages, output, and prices proportionallyAns: A

Difficulty: Medium49. In the long run, what event(s) can lead to an increase in inflation without changing the

unemployment rate above its natural level?A) a tax decrease combined with a government spending decreaseB) an increase in government spending combined with restrictive monetary policyC) an adverse supply shockD) an adverse supply shock accommodated by expansionary monetary policy E) a favorable supply shockAns: D

Difficulty: Medium50. Which of the following event(s) most likely will leave prices relatively unchanged while

increasing output?

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A) an increase in money supply combined with an income tax increase B) expansionary monetary policy in response to an adverse supply shockC) expansionary fiscal policy employed after a favorable supply shock D) restrictive monetary policy in response to an oil price decrease E) none of theseAns: C

CHAPTER 7Technical Problems

1.a. The aggregate unemployment rate can be calculated by adding the unemployment rates of different groups weighted by their share of the labor force. The data in the problem indicate that teenagers constitute 10% of the labor force. The adult work force (the other 90%) is divided into 35% females and 65% males. Thus we can calculate the overall unemployment rate as:

u = (0.1)(0.19) + (0.9)[(0.35)(0.06) + (0.65)(0.07)] = 0.019 + (0.9)(0.021 + 0.0455)

= 0.019 + 0.05985 = 0.07885 = 7.9%.

1.b. If the labor force participation rate of teenagers increases to 15%, the overall unemployment rate changes to:

u1 = (0.15)(0.19) + (0.85)[(0.35)(0.06) + (0.65)(0.07)] = 0.0285 + (0.85)(0.021 + 0.0455)

= 0.0285 + 0.056525 = 0.085025 = 8.5%.

Chapter 7: The Anatomy of Inflation and Unemployment

Difficulty: Easy1. Based on what we know about the average annual unemployment and inflation rates since

1981, which of the following is true?A) inflation decreased steadily, while unemployment varied widelyB) unemployment decreased steadily since 1982 while inflation variedC) on average, both inflation and unemployment were lower in the 1980s than in the 1990sD) unemployment was considered a bigger problem than inflation in almost every year

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E) none of the above Ans: D

Difficulty: Easy2. The sacrifice ratio is defined as A) the percentage increase in the inflation rate for every 1 percent reduction in the

unemployment rate B) the percentage of output lost for each 1 percent reduction in the rate of inflation C) the percentage increase in the unemployment rate for every 1 percent reduction in GDPD) the inflation rate plus the unemployment rate E) the inflation rate divided by the unemployment rate Ans: B

Difficulty: Easy3. Which of these people could officially be counted as unemployed?A) a garage attendant who got fired from his old job two months ago but will start a new job in

two weeksB) a busboy who works only four hours a day, five days a week, but would prefer to work full-

time as a waiterC) an accountant who quit her job when she had a baby two months agoD) a woman who joined the babysitters' union several months ago and averages about five

customers a week at her $10/hour rateE) none of the aboveAns: A

Difficulty: Medium4. If we look at the sacrifice ratios across countries, we find thatA) all industrial nations have approximately the same ratio B) Japan has a smaller ratio than Germany, France, or the U.S. C) Germany has a higher ratio than Italy, Australia, or the U.S. D) no country has a ratio below 1E) no country has a ratio above 1Ans: C

Difficulty: Easy5. Okun's law states that one extra percentage point in unemployment causes

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A) a 2 percent fall in GDP B) a 0.5 percent fall in GDPC) a 2 percent fall in the rate of inflation D) a 0.5 percent fall in the rate of inflation E) a 2 percent increase in the sacrifice ratioAns: A

Difficulty: Easy6. An employed person is defined as a person who during a reference week A) had a job but was not working due to family or personal reasonsB) had a job but was not working due to maternity or paternity leaveC) did at least one hour of work as a paid employeeD) all of the aboveE) none of the aboveAns: D

Difficulty: Easy7. Which of the following people is in the unemployment pool?A) Chris, who quit her job to look for other employmentB) Jack, who has been temporarily laid off by his employer, but who expects to be called back

after one or two months C) Lesley, who lost her job because her firm had to shut down D) all of the aboveE) only A) and C)Ans: D

Difficulty: Easy8. Which of the following people has moved out of the pool of unemployment?A) Peter, who just got hired as a part-time security guardB) Paul, who was laid off two months ago but just got a recall notice to resume his job at the

assembly line starting the week after nextC) Mary, who has given up looking for a job, leaving the work force permanentlyD) all of the aboveE) both Peter and MaryAns: E

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Difficulty: Medium9. Which of the following statements is FALSE?A) there is a high turnover rate in the labor marketB) a significant amount of the turnover rate in the labor market is cyclicalC) there are large variations in unemployment rates across groups defined by age, race, and sexD) most workers who became unemployed in 2000 or 2009 remained unemployed for half a

year or moreE) many workers who are counted as unemployed will be (or have been) unemployed for

several weeksAns: D

Difficulty: Easy10. The spell of unemployment isA) defined as the period during which a person remains continuously unemployedB) defined as the average length of time a person remains unemployedC) defined as the time it takes for the economy to reduce unemployment to its natural rateD) the same as the average duration of unemploymentE) the average number of times a worker is laid off within a yearAns: A

Difficulty: Easy11. The duration of unemployment depends onA) how organized the labor market is in matching potential workers with jobsB) the age, sex, and racial mix of the labor forceC) the ability and desire of those who are unemployed to hold out for a better jobD) the availability of jobs that match workers' skillsE) all of the aboveAns: E

Difficulty: Medium12. Some evidence suggests that prolonged periods of high unemployment actually increase the

natural unemployment rate. This phenomenon is known as A) structural unemploymentB) the misery effect C) Okun's law D) unemployment hysteresisE) the unemployment duration effect

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Ans: D

Difficulty: Easy13. Unemployment hysteresis refers to the fact thatA) high rates of unemployment tend to perpetuate themselvesB) when unemployed, individuals reduce their consumption, causing firms to lay off more

workers and therefore cyclical unemployment increases even moreC) individuals who experience long spells of unemployment often get desperate and take jobs

for which they are overqualifiedD) politicians often react irrationally to news of high unemployment and stimulate the economy

causing unnecessary political cyclesE) none of the aboveAns: A

Difficulty: Easy14. If we look at U.S. unemployment by duration we can see that in 2009A) more than half of the unemployed stayed unemployed for more than half a yearB) less than 20 percent of the unemployed were unemployed for more than half a year C) the mean duration of unemployment was less than 12 weeks D) the mean duration of unemployment was more than 24 weeks E) none of the aboveAns: D

Difficulty: Easy15. Which of the following does NOT affect the duration of unemployment?A) the availability of unemployment benefitsB) the rate at which new workers enter the work force C) the demographic make-up of the labor forceD) the organization of the labor marketE) none of the aboveAns: B

Difficulty: Easy16. Which of the following statements is TRUE for the United States?A) the unemployment rate consistently tends to be slightly higher among males than among

females

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B) the unemployment rate of teenagers tends to be much higher and more variable than that of people 20 years and older

C) during the 1981/1982 recession, the unemployment rate among teenagers was nearly the same as the unemployment rate among workers over 20

D) the highest unemployment rate in the post World War II period occurred in the 1974/75 recession

E) the unemployment rate among minorities consistently remained above 10 percent over the last 5 decades

Ans: B

Difficulty: Easy17. Which of the following statements is FALSE?A) the availability of unemployment benefits reduces the natural rate of unemploymentB) the natural rate of unemployment can be reduced by policies designed to affect the

composition of the labor forceC) high rates of unemployment often have a way of perpetuating themselvesD) the unemployment rate among white males 20 years and older is lower than the overall

unemployment rateE) even when the economy is at the full-employment level of output, some frictional

unemployment still existsAns: A

Difficulty: Easy18. Unemployment benefits add to the measured unemployment rate sinceA) people who are not really looking for jobs may report themselves as unemployed to collect

unemployment benefitsB) receiving unemployment benefits reduces the opportunity costs of looking for a better job

even after a job offer may have been madeC) firms are more likely to lay off workers knowing that the consequences of being unemployed

are not too severeD) unemployment benefits increase the replacement ratio and that, in turn, affects the

reservation wage E) all of the aboveAns: E

Difficulty: Medium19. Which of the following can affect the frequency of unemployment?A) the availability of unemployment benefits

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B) the variability of the demand for labor across different employersC) the rate at which new workers enter the labor forceD) both A) and B)E) both B) and C)Ans: E

Difficulty: Easy20. Over the last five decades, the natural rate of unemployment hasA) always been around 4%B) declined from about 5.5% in the 1950s to about 4% in 2009C) changed as the composition of the labor force has changedD) consistently declined as more women entered the labor forceE) increased from 3% in the 1950s to 8% in the 1980s, but decreased ever sinceAns: C

Difficulty: Easy21. Frictional unemployment isA) the unemployment that exists even at the full-employment level of outputB) unemployment that results from an increase in the GDP gapC) unemployment that occurs as a result of a supply shockD) the result of discouraged workers leaving the work forceE) mostly the result of a high minimum wage rateAns: A

Difficulty: Medium22. The natural rate of unemployment will most likely increase if A) the minimum wage rate is decreasedB) unemployment benefits are increasedC) monetary growth is decreasedD) income taxes are increasedE) all of the aboveAns: B

Difficulty: Easy23. Which country below had the lowest unemployment rate in 2008?A) France

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B) Germany C) Spain D) Sweden E) United States Ans: E

Difficulty: Easy24. In 2009, the high unemployment rate in the U.S. caused a loss in real GDP of roughly A) $68 billionB) $168 billionC) $680 billionD) $1,168 billionE) none of the aboveAns: D

Difficulty: Medium25. Assume the share of whites in the labor force is 86% and their unemployment rate is 6%; the

share of non-whites in the labor force is 14% with an unemployment rate of 11%. What is the overall unemployment rate?

A) 6.3%B) 6.7%C) 7.4%D) 8.2%E) 8.5%Ans: B

Difficulty: Difficult26. Assume the overall unemployment rate is 7.5%, and whites constitute 82% of the labor force.

If the unemployment rate among whites is 6.5%, what is the unemployment rate among non-whites?

A) 8.5%B) 9.5%C) 10.0%D) 12.0%E) 14.5%Ans: D

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Difficulty: Medium27. Assume adult males have a 48% share of the work force and their unemployment rate is

7.0%; adult females' share is 45% and their unemployment rate is 6.8%; teenagers' share of the work force is 7% with an unemployment rate of 18.0%. What is the overall unemployment rate?

A) 7.0%B) 7.2%C) 7.7%D) 8.4%E) 9.6%Ans: C

Difficulty: Easy28. The replacement ratio isA) the reservation wage divided by the wage rate offered on a new jobB) the reduction in real GDP caused by a 1 percent reduction in unemployment benefitsC) after-tax income while unemployed divided by after-tax income while employedD) the wage rate offered on a new job divided by unemployment benefits E) the increase in the unemployment rate caused by a 1 percent increase in the inflation rateAns: C

Difficulty: Easy29. The natural rate of unemployment can be reduced byA) expansionary monetary policies, but this would create more inflationB) expansionary fiscal policies, such as an income tax decreaseC) restrictive fiscal policies designed to balance the federal budgetD) training and skills programs that focus on teenagers and the long-term unemployedE) none of the aboveAns: D

Difficulty: Easy30. In a "jobless recovery," A) no new jobs are created during a recession or in the early stages of recoveryB) firms do not hire new workers until they see the economy has recovered from the recession C) unemployment must go back to its natural rate before the upswing can start D) there is a lag between GDP growth and a drop in unemploymentE) none of the above

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Ans: D

Difficulty: Medium31. The ill effects of unemployment are often more severe than is evident from the official data

sinceA) the natural rate of unemployment is not accounted forB) the incidence of unemployment, both in frequency and duration, is spread unevenly

throughout the economyC) the turnover rate in the labor market is fairly high as many people move quickly into and out

of the unemployment poolD) much of the unemployment that is reported is structuralE) workers who enter the labor force for the first time are not counted as unemployedAns: B

Difficulty: Easy32. Over the last decade, unemployment rates in many European countries have been much

higher than those in the United States. This is partially due to the fact that these European countries have

A) laws that make the costs of firing workers lower for European firms than for U.S. firmsB) more generous unemployment benefitsC) a higher incidence of work sharingD) a system that allows firms to pay workers a part of their wages in bonuses once or twice a

yearE) a much lower share of young people in the labor force Ans: B

Difficulty: Medium33. Both unemployment and inflation are matters of concern, butA) inflation is of greatest concern since it hurts everyone while unemployment does notB) they both can be eliminated easily with demand-side policiesC) unemployment has real costs in terms of lost output, while inflation mostly redistributes

income or wealthD) most inflation is anticipated in advance so it is really the anticipation rather than the actual

inflation which causes concernE) unemployment shouldn't be, since the economy always adjusts to the natural rate of

unemploymentAns: C

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Difficulty: Easy34. Unemployment rates tend to be higher in European countries than in Japan. This is most

likely due to the fact thatA) the minimum wage rate in Japan is much lower than in Europe B) the Japanese are harder working people than the EuropeansC) a large part of Japanese wages are paid in bonuses, making wages more flexible D) there is no structural unemployment in JapanE) none of the aboveAns: C

Difficulty: Easy35. If inflation were always perfectly anticipated, thenA) its real costs would exactly equal the inflation rateB) people would hold less cash but would still suffer losses since money balances are always

positiveC) the yield on interest-bearing assets would exactly compensate for losses on non-interest

bearing assetsD) unemployment would always be at 4 percentE) wage indexation would not workAns: B

Difficulty: Medium36. The menu cost of inflation arises sinceA) people hold less currency if inflation is positive and thus they take more trips to the bankB) the central bank eventually has to restrict money supply and this causes an increase in the

unemployment rate C) lenders are less likely to give out loans and this has a negative impact on economic activityD) resources have to be devoted to marking up prices and changing vending machines and cash

registers E) real wages and real money holdings lose purchasing powerAns: D

Difficulty: Easy37. If inflation were always perfectly anticipated and contracts were written in real terms, then A) there would only be a transfer of wealth from debtors to creditorsB) there would only be a transfer of wealth from creditors to debtors

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C) there would only be a transfer of wealth from the poor to the richD) there would only be a transfer of wealth from households to firmsE) currency holders would have a negative rate of returnAns: E

Difficulty: Medium38. The concern over inflation A) is not justified since gains and losses from real wealth transfers cancel out over time for the

economy as a wholeB) is irrational since high inflation generally means high growthC) is attributable primarily to increased transfers arising from cost-of-living adjustmentsD) stems from the fact that inflation is rarely predictable and those households who hold fixed

dollar assets will experience a loss in wealthE) none of the aboveAns: D

Difficulty: Easy39. If inflation this year is higher than expected, thenA) borrowers will gain at the expense of lendersB) lenders will gain at the expense of borrowersC) both lenders and borrowers will gain and the government will loseD) both lenders and borrowers will loseE) the government will lose unless it has implemented an indexed tax systemAns: A

Difficulty: Easy40. The unanticipated inflation of the last three decades benefited largelyA) elderly people whose major source of income comes from private pension plansB) lending institutions, especially savings and loansC) homeowners with fixed mortgage ratesD) taxpayersE) all of the aboveAns: C

Difficulty: Easy41. In an adverse supply shock, wage indexation is likely to

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A) prevent any increase in inflationB) limit inflation to 1% or 2%C) shift the AS-curve back to the right almost immediatelyD) lead to a wage-price spiralE) none of the aboveAns: D

Difficulty: Medium42. If wages and prices were fully indexed, A) there would be less inflation following an adverse supply shockB) inflation could always be perfectly anticipatedC) inflation arising from money expansion could be preventedD) the economy would have difficulty adjusting to supply shocks since real wages could not

adjust easily E) politicians would be more likely to fight inflation vigorouslyAns: D

Difficulty: Medium43. The misery index is constructed byA) adding the inflation rate and the unemployment rate B) multiplying the inflation rate with the unemployment rateC) dividing the inflation rate by the unemployment rate D) adding the sacrifice ratio and the replacement rateE) combining the sacrifice ratio with Okun's lawAns: A

Difficulty: Easy44. The misery index for the United States A) increased steadily from 1950 to 1990, but has since declinedB) is closely but inversely related to the successes of the incumbent partyC) is closely and positively related to the successes of the incumbent partyD) is only loosely and inversely related to the successes of the incumbent partyE) none of the aboveAns: D

Difficulty: Easy

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45. Political business cycles consist of fluctuations caused byA) misguided foreign policies designed to increase political pressure over our trade partners B) economic policies designed to help win electionsC) the Fed trying to support every policy proposed by the presidentD) our trade partners trying to react to changes in U.S. policiesE) the inability of politicians to agree on the right policy mixAns: B

Difficulty: Medium46. Predictions based on the theory of political business cycles suggest thatA) presidents who succeed in reducing inflation sharply before an election have the best chance

to be re-elected even if unemployment increases B) achieving a low rate of unemployment before an election is less important than achieving a

low rate of inflationC) presidents who want to be re-elected should aim for low inflation early in their terms and

then try to achieve strong economic growth before the next electionD) the practice of manipulating the economy before an election seldom pays off since voter

behavior is not significantly affected by economic issuesE) none of the aboveAns: C

Difficulty: Difficult47. Policy makers should be aware that theyA) can never lower the unemployment rate without causing a rapid increase in the rate of

inflationB) can reduce unemployment without causing inflation if they start off slowly but intensify their

efforts as the economy approaches full employmentC) can pursue growth policies in deep recessions without much risk of accelerating inflationD) always face a long-run tradeoff between inflation and unemploymentE) can announce a policy change, which will create more rational expectations and enable them

to reduce inflation without any costs to societyAns: C

Difficulty: Easy48. Wage indexationA) increases nominal wages periodically in accordance with the increase in prices over a given

time periodB) helps the economy adjust more rapidly back to the natural unemployment rate after a supply

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shockC) is a method of preventing inflation by taxing away what workers may have gained from

unanticipated inflationD) provides protection against purchasing power loss for over half of the U.S. work forceE) is most prevalent n countries with a history of low inflation ratesAns: A

Difficulty: Easy49. Which of the following statements is FALSE?A) homeowners with fixed-rate mortgages benefit from unanticipated high inflationB) the costs of unanticipated inflation can be ignored, since the gains and losses of induced

wealth transfers tend to cancel each other out over the economy as a wholeC) Social Security beneficiaries are better protected against unanticipated inflation than workers

with long-term contractsD) at least until 1985, the U.S. government gained from unanticipated inflation at the expense of

U.S. taxpayers E) workers who received the minimum wage greatly suffered from unanticipated inflationAns: B

Difficulty: Medium50. A zero inflation targetA) eliminates the short-run unemployment-inflation tradeoffB) is almost impossible to achieve since it would require an extremely high natural rate of

unemploymentC) can only be achieved if wage indexation is implemented nationwideD) will have much lower costs than an explicit target of achieving a 4% long-term inflation rateE) may not be as good as a positive inflation target, because it makes it more difficult to achieve

full employment Ans: E

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Chapter 8: Policy Preview

Difficulty: Easy1. Which of the following is NOT a way in which a central bank can conduct its monetary

policy?A) by establishing target interest rates and then undertaking open market operations to maintain

them

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B) by buying and selling government bonds C) by making small policy changes and readjusting policies as neededD) by changing the rate of capital accumulation to influence aggregate supply E) by changing interest rates to influence spending on durable goods and investmentAns: D

Difficulty: Easy2. A central bank that wants to stabilize the economy in the short run should try to A) establish a clear inflation target and stick to it no matter whatB) affect aggregate supply through open market operations C) affect aggregate demand through open market operationsD) maintain a stable growth rate of money supplyE) concentrate only on long-run goals Ans: C

Difficulty: Medium3. If a central bank is uncertain about whether an economic disturbance is temporary or

permanent, it should A) always wait until the full effect of the disturbance is felt before undertaking a policy change B) make frequent and modest policy changes and adjust policies based on feedback C) announce and then implement major policy changes right away to signal to financial markets

that it will address the disturbance vigorously D) announce a policy change and then wait for financial markets to react, which is often all that

is needed to calm economic activity E) none of the aboveAns: B

Difficulty: Easy4. In the short run, a central bank can most easily stimulate economic activity byA) selling government bonds to the public B) raising interest rates to make investments more profitable C) lowering the inflation rate though monetary restriction D) influencing aggregate supply through monetary expansion E) influencing aggregate demand and accepting a higher price level in the futureAns: E

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Difficulty: Easy5. The U.S. Federal Reserve’s Open Market Committee (the FOMC)A) meets regularly to decide on its monetary policy actions B) formally makes decision by voting on monetary policy changes C) sometimes reveals its intentions in advance to increase transparency D) does not follow a clearly established policy ruleE) all of the aboveAns: E

Difficulty: Easy6. Which of the following is true about Ben Bernanke as Chair of the Board of Governors of the

U.S. Federal Reserve? A) he succeeded Paul Volcker as the Chair in 2002B) his first term started in 2006 and he was reappointed in 2010 by President Obama C) he succeeded Alan Greenspan at the start of the financial crisis in 2008D) he was originally appointed by President Obama after Obama took office in January, 2009E) he first became Chair in 2010, succeeding Alan Greenspan Ans: B

Difficulty: Medium7. If it is clear that an economic disturbance is only transitory, a central bank’s best policy

response may be toA) react moderately or not at all because a major policy change may itself be destabilizingB) recommend fiscal policy changes, which will have less powerful effects than monetary

policy changesC) act quickly and vigorously so financial markets do not overreactD) announce a policy change and then wait to see the reaction of financial markets before

deciding whether or not to actually implement it E) avoid a potential increase in inflation by asking banks to ration creditAns: A

Difficulty: Medium8. If a central bank wants to avoid high inflation in an economic boom it can A) try to lower investment spending though open market purchasesB) raise interest rates in an effort to affect aggregate supply C) lower bank reserves by buying government bonds D) decrease the level of potential GDP by permanently restricting money supply growthE) none of the above

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Ans: E

Difficulty: Easy9. Central banks generally conduct their monetary policy with two goals in mind: to keep

economic activity high and to keep inflation low; however, they have to recognize thatA) there is an inherent conflict between these goalsB) monetary policy can affect economic activity only in the short runC) they can control inflation fairly effectively but may not be able to influence GDP growthD) a lower interest rate now may mean higher a inflation rate in the futureE) all of the above Ans: E

Difficulty: Medium10. If the inflation rate starts to increase, a central bank most likely willA) try to stimulate aggregate supply through open market purchasesB) change short-term interest rates though open market salesC) increase short-term interest rates by buying government bondsD) send signals to financial markets about upcoming open market purchasesE) ask banks to ration creditAns: B

Difficulty: Easy11. An appropriate policy response by a central bank to an increase in the inflation rate is toA) increase bank reservesB) lower the federal funds rate C) buy government bonds from the publicD) sell government bonds to the publicE) none of the aboveAns: D

Difficulty: Medium12. The U.S. Fed can most effectively achieve an established federal funds rate target by A) leaking information about its future intentions to financial marketsB) maintaining a stable monetary growth rateC) undertaking open market operations to influence bank reserves D) adjusting monetary growth to maintain a stable inflation rate

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E) selling Treasury bills whenever short-term interest rates increaseAns: C

Difficulty: Easy13. The federal funds rate is the interest rate thatA) banks charge their best corporate customersB) banks have to pay when they get a loan from the FedC) banks have to pay when they get a loan from another bankD) banks receive from the Fed for the reserves they hold as deposits at the FedE) the federal government pays on its three-month Treasury billsAns: C

Difficulty: Easy14. By lowering short-term interest rates, a central bank can stimulate economic activity A) since it encourages more investment spendingB) since more durable consumption goods will be boughtC) but only in the short runD) but it may lead to a higher price levelE) all of the aboveAns: E

Difficulty: Medium15. Which of the following is NOT a result of monetary policy? A) aggregate demand is affected, leading to a change in nominal GDP B) the level of potential GDP will change C) spending on investment and durable consumption goods is affected D) the rates of unemployment and inflation are affected in the short runE) real interest rates will remain unaffected in the long runAns: B

Difficulty: Easy16. When conducting expansionary monetary policy, central banks have to keep in mind that A) there is a conflict between keeping inflation low and economic activity high B) unemployment can be lowered in the short run but at the cost of higher prices in the long run C) spending on durable consumption goods will probably not be significantly affected D) all of the above

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E) only A) and B) Ans: E

Difficulty: Medium17. Which of the following is FALSE? A) in the long run, a central bank can effectively limit inflation B) in the long run, a central bank can do fairly little to stimulate real GDP C) in the long run, monetary policy has no effect on nominal GDPD) unless inflation is very high, stimulating the economy does more to enhance economic

welfare than controlling inflationE) a central bank can lower the inflation rate but only by allowing for a loss in real GDP, at least

in the short runAns: C

Difficulty: Medium18. Many economists believe thatA) most short-term stabilization of the economy should be done through monetary policy B) fiscal policy has no short-run effect on either output or inflationC) monetary policy affects inflation but not output, even in the short runD) monetary policy can effectively increase GDP with little or no effect on inflation E) none of the above is trueAns: A

Difficulty: Medium19. The U.S. Fed “sets” interest rates by A) announcing a desired discount rate and then attempting to keep the federal funds rate two

percentage points above itB) announcing a desired monetary growth rate designed to keep inflation stable C) buying or selling Treasury bills D) announcing its intentions far in advance since transparency allows financial markets to adjust

before any action is taken E) trying to keep bank reserves stable Ans: C

Difficulty: Easy20. Monetary policy is best conducted by

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A) focusing on a sustainable goal rather than maintaining full employment at all times B) decisive major policy changes rather than modest steps C) changing policies frequently to keep financial markets guessing what will happen nextD) keeping the interest rate at the lowest sustainable level no matter whatE) none of the aboveAns: A

Difficulty: Easy21. When a central bank engages in inflation targetingA) unemployment isn’t affected since nominal interest rates are kept very low B) interest rates are raised substantially as soon as the output gap increases C) interest rate stability is an explicit policy goalD) little weight is give to transparencyE) little or no weight is given to the output gap Ans: E

Difficulty: Easy22. When a central bank engages in inflation targeting, then A) interest rate stability will automatically result B) interest rates need to be raised as soon as the output gap starts to shrinkC) the Taylor rule can still be used as a guide as long as the output coefficient is set to zeroD) the Taylor rule can still be used as a guide as long as the output coefficient has a lot of weightE) none of the aboveAns: C

Difficulty: Medium23. If a central bank follows an activist monetary policy rule, A) full employment can always be maintained with little or no inflationB) financial markets always need advance notice of any policy change so the central bank does

not lose its credibility C) the focus is generally on expected future economic conditions while current economic

conditions are ignored D) the focus is generally on the long-run inflation rate with little concern about unemployment E) none of the aboveAns: E

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Difficulty: Medium24. Assume the Fed wants to stimulate economic activity through expansionary monetary policy.

Which of the following is FALSE? A) investment spending will increase B) spending on durable goods will increaseC) aggregate demand will be stimulatedD) the expansionary effect will only be temporary E) real money balances will increase as we move along the AD-curve from left to right Ans: E

Difficulty: Medium25. The Taylor rule A) advocates lowering interest rates in response to a higher output level B) advocates a strict monetary growth rate C) advocates stable interest rates D) helps a central bank in setting its target interest rates based on current economic conditions E) is of little help in the short-term stabilization of the economy Ans: D

Difficulty: Easy26. The Taylor rule implies that a central bank should adjust interest rates frequentlyA) with particular emphasis on capital movements across borders B) but only in response to changes in the inflation rateC) but only in response to changes in the output gap D) whenever output or inflation deviates from the desired levelsE) none of the aboveAns: D

Difficulty: Easy27. The rule that tells a central bank how to set interest rates in response to changes in economic

activity is known as theA) federal funds ruleB) interest rate ruleC) monetary growth rule D) Taylor rule E) Friedman rule Ans: D

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Difficulty: Medium28. Which of the following equations most accurately describes the Taylor rule? A) πt = mt – yt + vt

B) mt = 0.04 + 2(ut – 0.052)C) mt = πt + 0.5(πt – π*

t) + 0.5(Yt –Y*t)

D) it = 2 + πt + 0.5(πt – π*t) + 0.5[100(Yt –Y*

t)/Y*t]

E) it = 2 + 0.5[(πt – π*t)/πt] + 0.5[(Yt –Y*

t)/Y*t]

Ans: D

Difficulty: Medium29. If a central bank wants to make sure that its policy actions are successful in manipulating

interest rates to stabilize the economy around its full-employment level it shouldA) be prepared to make modest and frequent adjustments after receiving feedback on how its

actions affect the economyB) never announce its intentions, because financial markets will always overreactC) frequently change its policies to keep financial markets guessingD) react to excess inflation but not to economic boomsE) all of the aboveAns: A

Difficulty: Medium30. A central bank that follows the Taylor ruleA) will not react to economic disturbances until its full effects are felt B) assumes there is no tradeoff between unemployment and inflationC) keeps the growth rate of money supply constantD) sets interest rates based on current economic conditionsE) will start selling government bonds as soon as interest rates start to riseAns: D

Difficulty: Easy31. The Taylor rule suggests to a central bank A) how to set interest rates in response to a change in economic activityB) that interest rates should be raised by 1.5% if inflation goes 1% above its announced targetC) that interest rates should be raised by 0.5% if the GDP gap rises by 1%D) that real interest rates should be increased to cool off the economy whenever inflation risesE) all of the above

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Ans: E

Difficulty: Medium32. Slowing economic activity by increasing interest rates will generally be successful sinceA) investment spending will be reduced B) spending on durable goods will be reduced C) aggregate supply will decrease D) all of the aboveE) only A) and B)Ans: E

Difficulty: Medium33. Assume that the inflation coefficient is negative in the Taylor rule, This implies that A) there is an implicit monetary policy tradeoff between inflation and unemployment B) the Fed will have to lower money supply whenever aggregate demand decreasesC) the Fed will not have to make adjustments in interest rates if output changes D) the economy is likely to experience runaway inflation E) all of the aboveAns: D

Difficulty: Medium34. The Taylor rule A) allows for strict inflation targeting as long as the output coefficient is zeroB) should only be followed if the economy is growing stronglyC) suggests changes in money growth in response to changes in the inflation rate D) does not allow for strict inflation targeting E) implies a strict monetary growth rule Ans: A

Difficulty: Medium35. The Taylor rule A) is an activist monetary policy rule B) states that monetary growth should be decreased by 1% for every 1.5% increase in inflation C) states that real interest rates should be increased by 0.5% for every 1% increase in inflationD) both A) and B) E) both A) and C)

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Ans: A

Difficulty: Medium36. According to the Taylor rule, if the current inflation rate is 2.8%, output is 2% below the full-

employment level, and the central bank’s announced inflation target is 2%, at what level should the central bank set the nominal interest rate?

A) 2.8% B) 4.2%C) 5.2%D) 5.8%E) 6.8%Ans: B

Difficulty: Medium37. The Taylor rule allows for strict inflation targeting as long asA) the output coefficient is zeroB) the inflation coefficient is zeroC) the output coefficient is negativeD) the inflation coefficient is negativeE) none of the aboveAns: A

Difficulty: Medium38. According to the Taylor rule, if the central bank’s announced inflation target is 2%, the

current inflation rate is 2%, and output is 1% below the full-employment level, at what level should the central bank set the nominal interest rate?

A) 1%B) 2% C) 3.5%D) 4%E) 5.5%Ans: C

Difficulty: Medium39. In the Taylor rule, if the output coefficient β is set to zero, then the central bank A) is mostly concerned with maintaining full employment

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B) always sets interest rates 2% above its inflation target C) will aggressively lower interest rates as soon as output declines D) engages in strict inflation targeting E) none of the aboveAns: D

Difficulty: Medium40. In the Taylor rule, if the output coefficient is set to zero, then the central bank A) is mostly concerned with maintaining a low inflation rateB) will lower interest rates whenever it goes above 2 percent C) will aggressively increase interest rates as soon as inflation rises D) engages in real GDP targeting E) none of the aboveAns: D

Difficulty: Medium41. If a central bank engages in inflation targeting, then A) it will not change interest rates in response to output fluctuations B) it will change interest rates aggressively as soon as inflation or output changesC) it will lower interest rates aggressively as soon as inflation heats up D) it will increase interest rates aggressively as soon as aggregate supply increases E) none of the aboveAns: A

Difficulty: Difficult42. Assume the central bank’s announced inflation target is 2%, output is 2% below the full-

employment level, and the Taylor rule suggests that the central bank sets the nominal interest rate at 4.5%. What is most likely the current inflation rate?

A) 3.0% B) 3.6%C) 4.0%D) 4.5%E) 6.0%Ans: B

Difficulty: Medium

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43. In the Taylor rule, if the inflation coefficient α is much larger than the output coefficient β, then the central bank

A) is mostly concerned with maintaining full-employmentB) will raise interest rates more aggressively when output declines than when inflation heats up C) will lower interest rates more aggressively when output declines than when inflation heats up D) is engaging in strict inflation targeting E) none of the aboveAns: E

Difficulty: Medium44. According to the Taylor rule, if the current inflation rate is 3.2%, output is 1% above the full-

employment level, and the central bank’s announced inflation target is 2%, at what level should the central bank set the nominal interest rate?

A) 2.2% B) 3.3%C) 4.4%D) 5.8%E) 6.3%Ans: E

Difficulty: Difficult45. Assume the current inflation rate is 2.4% and output is at the full-employment level. If the

central bank has set nominal interest rates at 5.6%, what is the central bank’s inflation target if it follows the Taylor rule?

A) 0% B) 1%C) 2%D) 3%E) 4%Ans: A

Difficulty: Medium46. Assume a central bank announced a zero percent inflation target. If the current inflation rate

is 2.4%, and output is at the full-employment level, at what level should the central bank set the nominal interest rate according to the Taylor rule?

A) 1.2%B) 1.8% C) 2.4%

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D) 3.0%E) 3.6%Ans: E

Difficulty: Difficult47. Assume the central bank announced a 2% inflation target and has set the nominal interest rate

at 5.0%. If actual inflation is 2.8%, by how much is output off the full-employment level?A) -1.2%B) -0.8% C) -0.4%D) +0.4%E) +1.2%Ans: C

Difficulty: Medium48. According to the Taylor rule, if the central bank announced a zero percent inflation target but

the current inflation rate is 2% and output is 2% below the full-employment level, at what level should the central bank set the nominal interest rate?

A) 1%B) 2% C) 3%D) 4%E) 5%Ans: D

Difficulty: Medium49. According to the Taylor rule, if the central bank announced a zero percent inflation target but

the current inflation rate is 2% and output is at the full-employment level, at what level should the central bank set the nominal interest rate?

A) 1%B) 2% C) 3%D) 4%E) 5%

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Ans: E

Difficulty: Medium50. Short-run monetary policy changes should A) ignore any fiscal policy changes that the administration has implemented B) allow for modest adjustments once feedback from previous changes is availableC) never be implemented if uncertainty exists about the exact effects on key variables D) requires the central bank to stick to its announced policy target no matter whatE) none of the aboveAns: B

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