Test Bank For Macroeconomics 9th Edition by Olivier Blanchard | With Appendix (A B C) by ACADEMIAMILL

Macroeconomics, 9e (Blanchard) Chapter 1: A Tour of the World 1.1

The Covid-19 Crisis, Inflation, and Interest Rates

1) The Covid-19 crisis of 2020 started in ________. A) the United Kingdom B) the Euro Zone C) San Diego, California D) Wuhan, China Answer: D AACSB: Application of knowledge Status: New question 9e 2) U.S. inflation peaked at ________ following the Covid-19 pandemic. A) 9.9% B) 12.1% C) 7.2% D) 10.6% Answer: A AACSB: Application of knowledge Status: New question 9e 3) What was the initial response of most central banks to the Covid-19 pandemic and subsequent lockdowns of most nation's economies? A) Central banks reduced interest rates to near zero. B) Central banks increased interest rates dramatically. C) Central banks began selling financial assets immediately. D) Central banks sent cash to the citizens of their respective nations. Answer: A AACSB: Analytical thinking Status: New question 9e 4) Why did inflation surge in the years immediately following the Covid-19 pandemic? Answer: Economies overheated. In 2020 and 2021, governments put in place programs to protect people who were no longer working and receiving income, and to protect firms that could not sell and would have gone bankrupt without government support. These programs were generous, especially so in the United States. The extra cash in consumers' pockets resulted in very strong consumer demand leading to overheating in both labor and goods markets. In the labor market, unemployment, which had peaked during lockdowns, decreased rapidly, putting pressure on wages. In the goods markets, high demand led to high demand for commodities, leading to large increases in the world prices of energy and food, thus affecting inflation even in countries and regions that had more limited fiscal programs, such as the euro area. Firms struggled to get inputs and bid prices even higher. AACSB: Written and oral communication Status: New question 9e 1 Copyright © 2025 Pearson Education, Inc.

5) How did supply chain restrictions impact inflation following the Covid-19 pandemic? Answer: The Covid-19 pandemic led to a breakdown in supply chains which kept firms from getting necessary inputs. For example, automobile manufacturers could not get the computer chips they needed to make vehicles. They were forced to ration the cars and trucks they were able to make and send to dealers. The result was a severe reduction in supply. This same process happened in most sectors of the economy. AACSB: Written and oral communication Status: New question 9e 6) Why were central banks slow to react to the inflation immediately following the Covid-19 pandemic? Answer: Central banks initially believed the inflation was temporary, or transitory. Since they believed the inflation would be short-lived they opted to leave interest rates low to stimulate growth. However, by early 2022 central banks began to realize the inflation would require contractionary monetary policy to get under control. AACSB: Written and oral communication Status: New question 9e 1.2

The Increase in Public Debt

1) The ratio of public debt to GDP (the debt ratio) increased in Japan to ________ of GDP in 2023. A) 74% B) 95% C) 126% D) 161% Answer: D AACSB: Application of knowledge Status: New question 9e 2) How do high debt levels affect future taxpayers? A) The high debt will not affect future taxpayers at all since the government can print money to pay the debt. B) Taxes will eventually have to increase to reduce deficits and begin paying down debt. C) The debt ratio will fall on its own as GDP rises so tax policy will not change for this reason. D) Government spending will fall to lower the deficit and taxes will increase slightly. Answer: B AACSB: Reflective thinking Status: New question 9e

3) Politicians are very shortsighted and prefer to run deficits rather than increase taxes. This is known as ________. A) logrolling B) deficit bias C) deficit stacking D) a perpetual deficit Answer: B AACSB: Application of knowledge Status: New question 9e 4) Many nations are considering adopting ________ to control the high debt levels. A) new currencies B) deficit bans C) fiscal rules D) monetary restrictions Answer: C AACSB: Analytical thinking Status: New question 9e 5) Why do some economists and politicians favor a very gradual reduction in deficit spending? Answer: Some experts argue that while debt reduction is desirable, the cost of high debt is not that high, whereas the macroeconomic cost of running surpluses to reduce the debt may be very high. They contend that what matters is not so much debt as debt service, the interest payments on the debt. They point out that before Covid-19, interest rates were very low, and although the fight against inflation has temporarily increased them, the rates are likely to return to low levels in the future. For this reason, drastically reducing deficit spending could do more harm than good. AACSB: Written and oral communication Status: New question 9e 6) Inflation represents ________. A) an increase in output B) an increase in the aggregate price level C) an increase in the unemployment rate D) a recession Answer: B AACSB: Reflective thinking Status: 8e question

1.3

The Growth of China

1) In 2019, output per capita in China was approximately equal to ________ of U.S. output per capita. A) 5% B) 11% C) 23% D) 45% Answer: C AACSB: Application of knowledge Status: New question 9e 2) China's current ratio of investment to GDP is about ________. A) l0% B) 40% C) 75% D) 125% Answer: B AACSB: Application of knowledge Status: New question 9e 3) Which of the following data types does the author used to compare GDP across countries? A) Real data (adjusted for inflation) B) Nominal data C) Purchasing power parity (PPP) numbers D) Foreign exchange adjusted numbers Answer: C AACSB: Analytical thinking Status: New question 9e 4) From 1960 to 2019 China's growth rate has averaged ________ per year. A) 5.6% B) 3.1% C) 2.4% D) 1.8% Answer: A AACSB: Analytical thinking Status: New question 9e

5) Which of these is NOT one of the reasons China has experienced high annual growth rates that are much higher than U.S. growth rates over the same 40-year time period? A) China has had significant increase in human capital. B) China invested heavily in physical capital such as equipment and machines. C) China has adapted and learned new technologies developed by other nations. D) China's growth is not verifiable so it is likely not as high as China reports. Answer: D AACSB: Reflective thinking Status: New question 9e 6) Why has China's growth rate been so much higher than the growth rate of the United States over the past 40 years? Answer: First, large increases of physical capital, from machines to infrastructure, enable workers to be more productive. Indeed, the ratio of investment to GDP in China is around 40%, twice that of the United States. Second, large increases of what economists call human capital— —that is, more and better education and training——allow workers to get better jobs and be more productive. Here again, the numbers are striking. The average number of years of formal education among those older than 25 in China has risen from 1.6 years in 1960 to nearly 8 years today. FInally, technological progress enables more output given physical and human capital. Countries like the United States that are at the technological frontier must innovate, finding new and more efficient ways of producing. For countries behind the technological frontier, such as China, the task is instead to follow, to learn and adapt the technologies of more advanced countries. Adapting existing technologies has clearly played an important role in China, which has been accused of forcing foreign firms to share their technology and even, sometimes, of stealing patents from firms in other countries. AACSB: Written and oral communication Status: New question 9e 7) Can China's high growth be replicated in other countries? Answer: The experience of the other large nation in the world, India, suggests that the Chinese growth recipe may be difficult to apply. India's GDP per person, which was also equal to 5% of the United States in 1960, is now equal to 10%, less than half of the Chinese number. And many other poor countries have seen very low growth. What determines growth in rich and poor countries and whether and how policies can help are central issues in macroeconomics. AACSB: Written and oral communication Status: New question 9e

1.4

Growth and Inequality

1) Overall, inequality across countries has ________ over the past 40 years. A) decreased B) increased C) remained the same D) been extremely volatile Answer: A AACSB: Application of knowledge Status: New question 9e 2) Which of these is NOT one of the dimensions of poverty that economists and policymakers are concerned with? A) The number of people living in poverty B) The income level of the top earners C) The average age of those in poverty D) The size of the middle class Answer: C AACSB: Analytical thinking Status: New question 9e 3) In 2021 the top 10% of U.S. wage earners received ________ of the total pretax income. A) 45% B) 31% C) 15% D) 7% Answer: A AACSB: Application of knowledge Status: New question 9e 4) In 2021 the top 10% of French wage earners received ________ of the total pretax income. A) 48% B) 31% C) 15% D) 7% Answer: B AACSB: Application of knowledge Status: New question 9e

5) In 2021 the bottom 50% of French wage earners received ________ of the total pretax income. A) 9% B) 14% C) 23% D) 36% Answer: C AACSB: Application of knowledge Status: New question 9e 6) In 2021 the bottom 50% of U.S. wage earners received ________ of the total pretax income. A) 9% B) 14% C) 23% D) 36% Answer: B AACSB: Application of knowledge Status: New question 9e 7) Since 1960 inequality in the United States has ________. A) increased B) decreased C) not changed D) fallen significantly Answer: A AACSB: Application of knowledge Status: New question 9e 8) How might artificial intelligence (AI) impact income inequality? Answer: There are two extreme scenarios mentioned in the text: one in which AI-based robots and programs eventually replace middle-skill workers, leaving many of them unemployed or having to accept lower paying jobs; the other in which AI robots and programs allow low-skilled workers to do more complex tasks and get better jobs. The first leads to more inequality, the second to less. AACSB: Written and oral communication Status: New question 9e

1.5

Global Warming

1) Which of these statements is the most accurate with respect to global warming? A) Global warming is not significant enough to warrant major changes in production and energy generation methods. B) Global warming is a temporary phenomenon that will have limited impact on future generations. C) There is overwhelming evidence that shows that global warming does exist. D) Developed nations can easily make adjustments to begin reducing the earth's temperature. Answer: C AACSB: Reflective thinking Status: New question 9e 2) The earth's temperature has ________ since the 1960s. A) not changed B) increased by almost 5 degrees celsius C) decreased by about 2 degrees celsius D) increased by about 1 degree celsius Answer: D AACSB: Application of knowledge Status: New question 9e 3) Forecasts show that the earth's temperature will increase by another ________ degrees celsius by the end of the century if we elect to do nothing to stop global warming. A) 1 B) 2 C) 3 D) 4 Answer: C AACSB: Application of knowledge Status: New question 9e 4) An increase of another 3 degrees celsius by 2100 would result in a ________ increase in sea level. A) 2 to 5 feet B) 6 to 12 feet C) 15 to 20 feet D) 22 to 26 feet Answer: B AACSB: Application of knowledge Status: New question 9e 5) Global warming is not significant enough for to make an economic impact. Answer: FALSE AACSB: Reflective thinking Status: New question 9e 8 Copyright © 2025 Pearson Education, Inc.

6) The cost of producing a watt using solar panels, for example, has fallen from $100 in 1975 to $5 in 2000 to 25¢ in 2021. Answer: TRUE AACSB: Application of knowledge Status: New question 9e 7) Is a goal of zero emissions consistent with positive economic growth? Answer: While we don't know for certain, the answer is probably yes. Advanced economies have been able to reduce emissions substantially while continuing to grow. Both the United States and Europe have reduced emissions by 25% since 2000 while maintaining growth. Nonetheless, the shift to new and less proven technologies may imply lower growth for some time. And even if output continues to grow, the higher investment may reduce what is left for consumption. Fighting global warming has a cost. But the alternative is worse. AACSB: Ethical understanding and reasoning Status: New question 9e

Macroeconomics, 9e (Blanchard) Chapter 2: A Tour of the Book 2.1

Aggregate Output

1) Fill in the blank for the following: GDP is the value of all ________ produced in a given period. A) final and intermediate goods and services produced by the private sector only B) final goods and services C) final and intermediate goods and services, plus raw materials D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 2) When using the income approach to measure GDP, the largest share of GDP generally consists of ________. A) interest income B) labor income C) indirect taxes D) profits E) capital income Answer: B AACSB: Application of knowledge Status: 8e question 3) Between 1960 and 2022 nominal GDP increased by a factor of ________. A) 12 times B) 28 times C) 33 times D) 47 times E) 55 times Answer: D AACSB: Application of knowledge Status: New question 9e 4) Suppose nominal GDP increased in a given year. Based on this information, we know with certainty that ________. A) real output has increased B) the price level (GDP deflator) has increased C) real output and the price level (GDP deflator) have both increased D) either real output or the price level (GDP deflator) have increased E) real output has increased and the price level has decreased Answer: D AACSB: Reflective thinking Status: 8e question 1 Copyright © 2025 Pearson Education, Inc.

5) Use the following information to answer this question. If nominal GDP rises from $100 trillion to $120 trillion, while the GDP deflator rises from 2.0 to 2.2, the percentage change in real GDP is approximately equal to ________. A) -10% B) 10% C) 20% D) 9.1% E) 0% Answer: D AACSB: Analytical thinking Status: 8e question 6) Hedonic pricing is ________. A) the way that luxury goods are priced in a market economy B) the tendency for the inflation rate to rise by greater and greater amounts C) the tendency for nominal GDP to rise when the price level rises D) the process of translating nominal GDP into real GDP E) the process of adjusting the price of a good for changes in quality Answer: E AACSB: Application of knowledge Status: 8e question 7) In a given year, suppose a company spends $100 million on intermediate goods and $200 million on wages, with no other expenses. Also assume that its total sales are $800 million. The value added by this company equals ________. A) $200 million B) $300 million C) $500 million D) $700 million E) $800 million Answer: D AACSB: Analytical thinking Status: 8e question 8) A firms value added equals ________. A) its revenue minus all of its costs B) its revenue minus its wages C) its revenue minus its wages and profit D) its revenue minus its cost of intermediate goods E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

9) Suppose nominal GDP in 2023 does not change (compared its previous level in 2022). Given this information, we know with certainty that ________. A) real GDP increased during 2023 B) the GDP deflator increased during 2023 C) both the GDP deflator and real GDP fell during 2023 D) more information is needed to answer this question Answer: D AACSB: Reflective thinking Status: Modified 8e 10) Hedonic pricing is used to ________. A) convert nominal values to real values B) calculate the difference between nominal GDP and real GDP C) measure the rate of change in real GDP D) obtain chain-weight indexes E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 11) GDP in current dollars is equivalent to which of the following? A) real GDP B) GDP in terms of goods C) GDP in 2000 dollars D) GDP in constant dollars E) none of these Answer: E AACSB: Application of knowledge Status: Modified 8e 12) Which of the following does not represent real GDP? A) GDP in current dollars B) GDP in terms of goods C) GDP in base year dollars D) GDP in constant dollars Answer: A AACSB: Application of knowledge Status: 8e question 13) Which of the following represents real GDP? A) GDP in constant dollars B) GDP in terms of goods C) GDP in base year dollars D) all of these Answer: D AACSB: Application of knowledge Status: 8e question 3 Copyright © 2025 Pearson Education, Inc.

14) A recession is defined as ________. A) a decrease in nominal output B) at least 30 days of negative growth C) at least four quarters of negative growth D) a decrease in real output Answer: D AACSB: Application of knowledge Status: New question 9e 15) Based on the notation presented in Chapter 2, which of the following expressions represents real GDP? A) Yt B) PtYt C) Yt/Pt D) $Yt/Pt Answer: A AACSB: Application of knowledge Status: 8e question 16) Measures of aggregate output have been published on a regular basis in the United States since ________. A) 1947 B) 1933 C) 1917 D) 1946 Answer: A AACSB: Application of knowledge Status: 8e question 17) Which of the following statements about capital income is not correct? A) It refers to a firm's revenue. B) It is also called profit income. C) It goes to the firms. D) Capital income is remuneration for the owners of capital. Answer: A AACSB: Application of knowledge Status: 8e question 18) How much was U.S. nominal GDP in 2022? A) $19,298 billion B) $21,255 billion C) $25,460 billion D) $29,321 billion Answer: C AACSB: Application of knowledge Status: New question 9e 4 Copyright © 2025 Pearson Education, Inc.

19) Periods of negative GDP growth are known as ________. A) expansions B) recessions C) inflation D) deflation Answer: B AACSB: Application of knowledge Status: New question 9e 20) Nominal GDP is real GDP adjusted for foreign exchange rates. Answer: FALSE AACSB: Application of knowledge Status: New question 9e 21) When we look at the real GDP in chained (2012) dollars the nominal and the real GDP were equal in 2012. Answer: TRUE AACSB: Application of knowledge Status: New question 9e 22) Explain the three ways GDP can be measured. Answer: GDP can be measured three ways. First, GDP represents the market value of the final goods and services produced in the economy during a given period. This would be obtained by adding C, I, G, and NX. Second, GDP is the sum of the value added by firms. The value added for a firm equals the value of the production (at that stage of the production process) minus the value of the intermediate goods (excluding labor services). And finally, GDP is also the sum of all incomes earned in a given period. AACSB: Written and oral communication Status: Modified 8e 23) First, define nominal GDP and real GDP. Second, is it possible for nominal GDP in a year to be less than real GDP in the same year? Explain. Answer: Nominal GDP represents the value of goods and services produced using current prices. Real GDP measures the value of the same goods and services using some base year prices. It is possible for nominal GDP to be less than real GDP in a given year. Given the definitions of the two variables, this will occur if prices in that year are simply less than prices in the base year. If, for example, the base year is 2012, it will generally be the case that nominal GDP will be less than real GDP for those years prior to 2012 given that prices have generally risen in all years. AACSB: Written and oral communication Status: Modified 8e

24) Explain whether it is possible for nominal GDP to increase and real GDP to decrease in the same period. Answer: Nominal GDP can rise because either the price level is rising or the real quantity of goods and services produced has increased. Nominal GDP can increase while real GDP falls if the increase in the aggregate price level is larger (in a proportionate sense) than the drop in real economic activity. AACSB: Written and oral communication Status: 8e question 2.2

The Unemployment Rate

1) Suppose you are provided with the following data for your country for a particular month: 200 million people are working, 20 million are not working but are looking for work, and 40 million are not working and have given up looking for work. The official unemployment rate for that month is ________. A) 7.7% B) 9.1% C) 10% D) 23% E) 30% Answer: B AACSB: Analytical thinking Status: 8e question 2) In the United States, which of these persons would be classified as unemployed? A) Someone who does not have a job. B) Someone who has a job but is looking for a different one while continuing to work. C) Someone who does not have a job, has recently looked for work, and is collecting unemployment insurance. D) Someone who does not have a job and has quit looking for work. E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 3) An individual is said to be a discouraged worker if he or she ________. A) is working, but prefers not to work B) is working part time, but would prefer a full time job C) is working in jobs she/he is not suited for D) wants to work, and is actively searching for a job E) wants to work, but has given up searching for a job Answer: E AACSB: Application of knowledge Status: 8e question

4) Which of the following tends to occur when the unemployment rate increases? A) a reduction in the labor force participation rate B) a reduction in the number of discouraged workers C) an increase in the number of employed workers D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 5) In December 2022 the U.S. unemployment rate was ________. A) 3.6% B) 4.5% C) 5.9% D) 10.2% E) 12.4% Answer: A AACSB: Application of knowledge Status: New question 9e 6) The labor force in the United States is defined as ________. A) the total number of individuals who are employed B) the sum of individuals who are employed and those who are officially unemployed C) the sum of the total number of individuals who are employed, the officially unemployed, and discouraged workers D) the total number of individuals who are 16 years old and older, but not retired E) none of these Answer: B AACSB: Application of knowledge Status: 8e question Use the information provided below to answer the following question(s). Suppose a country using the United States' system of calculating official unemployment statistics has 100 million people, of whom 50 million are working age. Of these 50 million, 20 million have jobs. Of the remainder: 10 million are actively searching for jobs; 10 million would like jobs but are not searching; and 10 million do not want jobs at all. 7) Refer to the information above. The labor force is ________. A) 20 million B) 30 million C) 60 million D) 80 million E) 100 million Answer: B AACSB: Analytical thinking Status: 8e question 7 Copyright © 2025 Pearson Education, Inc.

8) Refer to the information above. The labor force participation rate is ________. A) .2 B) .3 C) .4 D) .6 E) .8 Answer: D AACSB: Analytical thinking Status: 8e question 9) Refer to the information above. The official unemployment rate is ________. A) .1 B) .2 C) .33 D) .4 E) .66 Answer: C AACSB: Analytical thinking Status: 8e question 10) Macroeconomists are concerned about changes in the unemployment rate because changes in the unemployment rate provide information about ________. A) the state of the economy B) the welfare of those who are unemployed C) none of these D) the state of the economy and the welfare of those who are unemployed Answer: D AACSB: Application of knowledge Status: 8e question 11) Explain the difference between the unemployment rate and the labor force participation rate. Answer: The unemployment rate is the percentage of the labor force (those employed and unemployed) that is unemployed. The participation rate is the ratio of the labor force percentage to the total population of working age. AACSB: Written and oral communication Status: Modified 8e 12) Explain how the existence of discouraged workers alters the extent to which the official unemployment provides an accurate measure of the use of labor resources. Answer: Discouraged workers are those individuals who have decided to stop searching for employment because they have become "discouraged" about employment opportunities. When these individuals cease looking for work they are no longer considered as part of the labor force. The existence of discouraged workers will cause the official unemployment rate to be lower than it would be if they remained in the labor force and continued to look for work. AACSB: Application of knowledge Status: 8e question 8 Copyright © 2025 Pearson Education, Inc.

13) What are the social and economic implications of unemployment? Explain. Answer: Economic implications: signal of economic activity and measure of the utilization of labor. Social implications: the emotional and psychological suffering that occurs as a result of being unemployed. AACSB: Integration of real-world business experiences Status: 8e question 14) Explain why economists care about unemployment. Answer: First, they care about unemployment because of its direct effect on the welfare of the unemployed. Unemployment is often associated with financial and psychological suffering. Second, they care about unemployment because it provides a signal that the economy may not be using some of its resources efficiently. AACSB: Written and oral communication Status: 8e question 2.3

The Inflation Rate

1) The GDP deflator provides a measure of which of the following? A) the ratio of GDP to the size of the population B) the ratio of GDP to the number of workers employed C) the ratio of nominal GDP to real GDP D) the price of a typical consumer's basket of goods E) real GDP divided by the aggregate price level Answer: C AACSB: Application of knowledge Status: 8e question 2) Which of these calculations will yield the GDP deflator? A) divide nominal GDP by the real GDP B) divide the real GDP by the consumer price index C) multiply nominal GDP by the consumer price index D) multiply nominal GDP by the real GDP Answer: A AACSB: Analytical thinking Status: New question 9e 3) The prices for which of the following goods are included in both the GDP deflator and the consumer price index? A) goods bought by households B) goods bought by firms C) good bought by governments D) goods bought by foreign households (i.e., exports) Answer: A AACSB: Application of knowledge Status: Modified 8e 9 Copyright © 2025 Pearson Education, Inc.

4) Suppose we switch the base year from 2008 to 2012. This change in the base year will cause ________. A) nominal GDP in every year to increase B) nominal GDP in every year to decrease C) both nominal and real GDP in every year to decrease D) real GDP in every year to decrease E) none of these Answer: E AACSB: Reflective thinking Status: Modified 8e 5) Pure inflation occurs when ________. A) nominal wages rise faster than all prices B) all prices rise faster than nominal wages C) all prices and nominal wages rise by the same percentage D) the GDP deflator and Consumer Price Index rise by the same percentage E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 6) One of the reasons macroeconomists have concerns about inflation is that inflation causes ________. A) real GDP to rise B) nominal GDP to fall C) wages to rise as fast as prices D) real GDP to exceed nominal GDP E) changes in income distribution Answer: E AACSB: Application of knowledge Status: Modified 8e 7) When the rate of inflation declines it is known as ________. A) hyperinflation B) disinflation C) deflation D) pure inflation Answer: B AACSB: Application of knowledge Status: New question 9e

8) Prices for which of the following are included in the GDP deflator, but not included in the Consumer Price Index? A) firms' purchases of new equipment B) intermediate goods and services C) consumption of goods D) consumption of services Answer: A AACSB: Reflective thinking Status: 8e question 9) Based on the notation presented in Chapter 2, which of the following expressions represents nominal GDP? A) Yt B) PtYt C) Yt/Pt D) $Yt/Pt Answer: B AACSB: Application of knowledge Status: 8e question 10) Deflation generally occurs when which of the following occurs? A) the consumer price index is greater than the GDP deflator B) the consumer price index decreases C) the rate of inflation falls, for example, from 4% to 2% D) nominal GDP does not change Answer: B AACSB: Application of knowledge Status: 8e question 11) During the late 1990s, Japan experienced reductions in the GDP deflator. Given this information, we know with certainty that ________. A) real GDP fell during these periods B) real GDP did not change during these periods C) the overall price level in Japan decreased during these periods D) both real GDP and the overall price level decreased during these periods Answer: C AACSB: Analytical thinking Status: 8e question

12) During the mid-1980s, we observed a significant reduction in oil prices. In the United States, we would expect that this reduction in oil prices would cause ________. A) a larger reduction in the CPI compared to the GDP deflator B) an equal reduction in the CPI and GDP deflator C) a larger reduction in the GDP deflator compared to the CPI D) no change in the CPI and a reduction in the GDP deflator Answer: A AACSB: Integration of real-world business experiences Status: 8e question 13) Will the CPI and GDP deflator always move together? Explain. Answer: No they will not. Some of the goods included in the GDP deflator (some investment goods) are not included in the CPI. Some of the goods included in the CPI (foreign goods) are not included in the GDP deflator. AACSB: Reflective thinking Status: 8e question 14) Explain how inflation can lead to distortions. Answer: First, not all prices and wages adjust automatically when inflation occurs. Second, variations in relative prices (which occur when there is not pure inflation) can lead to uncertainty. Inflation can also lead to distortions if the tax system is not adjusted when inflation occurs (e.g. nominal income tax brackets). AACSB: Written and oral communication Status: 8e question 15) Explain why economists care about inflation. Answer: Inflation will cause relative prices to change. It will also cause changes in the distribution of income. Inflation will lead to other distortions such as tax distortions and uncertainty. AACSB: Written and oral communication Status: 8e question 2.4

Output, Unemployment, and the Inflation Rate: Okun's Law and the Phillips Curve

1) The Okun's law shows the relationship between ________. A) inflation and unemployment rate B) output growth and unemployment C) inflation and output growth D) output growth and money supply Answer: B AACSB: Application of knowledge Status: 8e question

2) The Phillips curve describes the relationship between ________. A) output growth and unemployment B) inflation and output growth C) output growth and money supply D) inflation and unemployment Answer: D AACSB: Application of knowledge Status: 8e question 3) Which of the following about the Phillips curve is not correct? A) It shows the relation between GDP growth and unemployment. B) It has been redefined as a relation between the change in the rate of inflation and the unemployment rate. C) It was first explored by A. W. Phillips. D) The curve is downward sloping. Answer: A AACSB: Reflective thinking Status: 8e question 4) ________ is the inflation rate constructed by leaving out volatile food and energy prices. A) Deflation B) Pure inflation C) Core inflation D) Disinflation Answer: C AACSB: Application of knowledge Status: New question 9e 5) Explain Okun's Law. Answer: It shows the relationship between GDP growth and unemployment rate. If output growth is high, unemployment will decrease. AACSB: Reflective thinking Status: 8e question 6) Explain the Phillips curve. Answer: It shows the negative relationship between inflation rate and unemployment rate. After 1970s, it was redefined as the relationship between the change in the rate of inflation and the unemployment rate. AACSB: Written and oral communication Status: 8e question 7) Explain why the Phillips curve on average is downward sloping. Answer: When unemployment becomes very low, the economy is likely to overheat and this will lead to upward pressure on inflation. AACSB: Reflective thinking Status: 8e question 13 Copyright © 2025 Pearson Education, Inc.

8) Can an economy maintain high output growth, low unemployment, and low inflation at the same time? Explain. Answer: It would be very hard to achieve the three objectives at the same time. High output growth leads to low unemployment, which is likely to put pressure on inflation. AACSB: Reflective thinking Status: 8e question 2.5

The Short Run, the Medium Run, and the Long Run

1) Changes in GDP in the short run are caused primarily by ________. A) demand factors B) supply factors C) technology D) capital accumulation E) all of these Answer: A AACSB: Application of knowledge Status: 8e question 2) Changes in GDP in the medium run are determined primarily by ________. A) demand factors B) supply factors C) monetary policy D) all of these Answer: B AACSB: Application of knowledge Status: 8e question 3) Changes in GDP in the long run are determined primarily by ________. A) monetary policy B) fiscal policy C) demand D) all of these E) none of these Answer: E AACSB: Reflective thinking Status: 8e question 4) Explain what factors cause changes in output in: (1) the short run; (2) medium run; and (3) long run. Answer: In the short run, demand factors primarily cause changes in output. In the medium run, factors such as the technology, amount of capital, and the skill and size of the labor force (supply factors) affect output. And in the long run, the education system, saving rate, and role of government all affect economic activity. AACSB: Written and oral communication Status: 8e question 14 Copyright © 2025 Pearson Education, Inc.

Macroeconomics, 9e (Blanchard) Chapter 3: The Goods Market 3.1

The Composition of GDP

1) For the U.S. economy, which of the following represents the largest component of GDP? A) imports B) investment C) government spending D) exports E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 2) Which of the following types of government spending is included when calculating GDP? A) spending at the federal level B) spending at the state level C) spending at the municipal level D) all of these E) spending at the federal and sate level Answer: D AACSB: Application of knowledge Status: 8e question 3) Which of the following would not be considered part of fixed investment spending (I)? A) Toyota buys a new robot for its automobile assembly line. B) Apple computer builds a new factory. C) Exxon increases its inventories of unsold gasoline. D) An accountant buys a newly built home for herself and her family. E) all of these Answer: C AACSB: Application of knowledge Status: 8e question 4) Which of the following is true for a "closed economy"? A) government spending equals taxes B) there are no imports or exports C) exports equal imports D) there is no saving E) there is no government spending or taxes Answer: B AACSB: Application of knowledge Status: 8e question

5) Which of these components of GDP does buying a new home fall under? A) consumption (C) B) saving (S) C) disposable income (YD) D) government spending (G) E) investment Answer: E AACSB: Application of knowledge Status: New question 9e 6) Which of the following is an example of a government transfer payment? A) Military spending B) Salaries of government employees C) Social Security payments D) Infrastructure spending Answer: C AACSB: Application of knowledge Status: New question 9e 7) The purchase of foreign goods by U.S. consumers are called ________. A) substitutes B) net exports C) imports D) exports Answer: C AACSB: Application of knowledge Status: New question 9e 8) The ________ is difference between exports and imports . A) trade balance B) consumer surplus C) inventory investment D) transfer payment Answer: A AACSB: Application of knowledge Status: New question 9e 9) The difference between goods produced and goods sold in a given year is called ________. A) nonresidential investment B) consumption C) a transfer payment D) inventory investment Answer: D AACSB: Application of knowledge Status: New question 9e

10) Discuss the two components of fixed investment. Answer: Nonresidential investment represents the purchase of new equipment and structures. Residential investment represents the purchase of new homes, condos, and apartments by individuals. AACSB: Written and oral communication Status: 8e question 11) Inventory investment refers to ________. A) the difference between production and sales in a given year B) fixed investment C) nonresidential investment D) the purchase by firms of new machines Answer: A AACSB: Application of knowledge Status: 8e question 3.2

The Demand for Goods

1) Disposable income equals ________. A) income minus saving B) income minus both saving and taxes C) consumption minus taxes D) the sum of consumption and saving E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) The marginal propensity to consume represents ________. A) the level of consumption that occurs if disposable income is zero B) the ratio of total consumption to disposable income C) total income minus total taxes D) the change in output caused by a one-unit change in autonomous demand E) the change in consumption caused by a one-unit change in disposable income Answer: E AACSB: Application of knowledge Status: 8e question

3) Let the consumption function be represented by the following equation: C = c0 + c1YD. For this equation, we assume that c1 is ________. A) negative B) larger than c0 C) different at different levels of income D) equal to one E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 4) Suppose the consumption equation is represented by the following: C = 250 + .75YD. The multiplier in this economy is ________. A) .25 B) .75 C) 1 D) 4 E) 5 Answer: D AACSB: Analytical thinking Status: 8e question 5) Suppose the consumption equation is represented by the following: C = 250 + .75YD. Given this information, the marginal propensity to save is ________. A) .25 B) .7 C) 1 D) 4 E) none of these Answer: A AACSB: Analytical thinking Status: 8e question 6) Which of the following occurs when disposable income is zero? A) consumption must be zero B) saving must be zero C) saving must be positive D) consumption is negative E) none of these Answer: E AACSB: Reflective thinking Status: 8e question

7) Which of the following is an exogenous variable in our model of the goods market in Chapter 3? A) consumption (C) B) saving (S) C) disposable income (YD) D) government spending (G) E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 8) Which of the following is an endogenous variable in our model of the goods market in Chapter 3? A) consumption (C) B) disposable income (YD) C) saving (S) D) total income (Y) E) all of these Answer: E AACSB: Application of knowledge Status: Modified 8e 9) Changes in government spending and taxes are known as ________. A) fiscal policy B) monetary policy C) endogenous variables D) government transfers Answer: A AACSB: Application of knowledge Status: New question 9e 10) Variables depend on other variables in the model and are therefore explained within the model are called exogenous variables. Answer: FALSE AACSB: Application of knowledge Status: New question 9e 11) In the model discussed in Chapter 3, why do we assume G and T are exogenous? Answer: It is based on two arguments: First, government do not behave with the same regularity as consumers or firms, so there is no reliable rule we could write for G or T. Second, treating G and T as exogenous help us explore the implications of alternative spending and tax decisions. AACSB: Reflective thinking Status: 8e question

3.3

The Determination of Equilibrium Output

1) Equilibrium in the goods market requires that ________. A) production equals income B) production equals demand C) consumption equals saving D) consumption equals income E) government spending equals taxes minus transfers Answer: B AACSB: Application of knowledge Status: 8e question 2) An economy is in equilibrium when which of the following conditions is satisfied? A) consumption equals saving B) output equals consumption C) total saving equals zero D) total saving equals investment E) all of these Answer: D AACSB: Application of knowledge Status: 8e question 3) Which of the following is included in G? A) Medicare B) social security payments C) interest payments on the government debt D) government purchases E) all of these Answer: D AACSB: Application of knowledge Status: 8e question 4) Suppose the consumption equation is represented by the following: C = 250 + .8YD. The multiplier for the above economy equals ________. A) 2 B) 3 C) 4 D) 5 E) none of these Answer: D AACSB: Analytical thinking Status: 8e question

5) Suppose the consumption equation is represented by the following: C = 250 + .75YD. Now assume government spending increases by 100 for the above economy. Given the above information, we know that equilibrium output will increase by ________. A) 200 B) 400 C) 800 D) 1000 E) none of these Answer: B AACSB: Analytical thinking Status: 8e question 6) Which of the following will not increase equilibrium output in the short run? A) increases in R&D B) increases in consumer confidence C) increases in investment demand D) increases in government spending E) decreases in taxes Answer: A AACSB: Application of knowledge Status: 8e question 7) Which of the following would tend to make the multiplier smaller? A) an increase in the marginal propensity to consume B) a decrease in the marginal propensity to consume C) a reduction in taxes D) a reduction in government spending E) none of these Answer: B AACSB: Reflective thinking Status: Modified 8e 8) Which of the following events will cause a reduction in equilibrium output? A) an increase in the marginal propensity to save B) an increase in taxes C) a reduction in the marginal propensity to consume D) all of these E) none of these Answer: D AACSB: Reflective thinking Status: 8e question

9) Based on our understanding of consumption and saving, we know that the marginal propensity to consume and the (marginal) propensity to save must ________. A) be equal to each other B) sum to exactly one C) sum to less than one D) sum to more than one E) be equal to the multiplier Answer: B AACSB: Analytical thinking Status: Modified 8e 10) Suppose there is an increase in autonomous spending. Specifically, suppose c0 increases where C = c0 + c1YD. This increase in autonomous spending will cause which of the following to increase? A) equilibrium income B) equilibrium disposable income C) demand D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: Modified 8e 11) If C = 2000 + .9YD, what increase in government spending must occur for equilibrium output to increase by 1000? A) 100 B) 200 C) 250 D) 500 E) 1000 Answer: A AACSB: Analytical thinking Status: 8e question 12) Which of the following equals demand in an open economy? A) C + I + G + X B) C + I + G + X - IM C) C + I + G + IM - X D) C + I + G Answer: B AACSB: Application of knowledge Status: 8e question

13) Which of the following equals demand in a closed economy? A) C + I + G + X B) C + I + G + X - IM C) C + I + G + IM - X D) none of these Answer: D AACSB: Analytical thinking Status: 8e question 14) Suppose an open economy is in equilibrium. Given this information, we know with certainty that ________. A) G = T B) X = IM C) S = I D) Y = Z Answer: D AACSB: Analytical thinking Status: 8e question 15) For a closed economy, which of the following conditions must be satisfied for equilibrium to be maintained? A) G = T B) X = IM = 0 C) C = S D) none of these Answer: D AACSB: Analytical thinking Status: 8e question 16) Autonomous spending in a closed economy equals which of the following? A) c0 + I + G - c1T B) C + I + G C) Z D) c0 + I + G + c1T Answer: A AACSB: Application of knowledge Status: 8e question

17) Based on our understanding of the model presented in Chapter 3, we know that an increase in c1 (where C = c0 + c1YD) will cause ________. A) the ZZ line to become steeper and a given change in autonomous consumption (c0) to have a smaller effect on output B) the ZZ line to become steeper and a given change in autonomous consumption (c0) to have a larger effect on output C) the ZZ line to become flatter and a given change in autonomous consumption (c0) to have a smaller effect on output D) the ZZ line to become flatter and a given change in autonomous consumption (c0) to have a larger effect on output Answer: B AACSB: Reflective thinking Status: 8e question 18) Based on our understanding of the model presented in Chapter 3, we know that a reduction in c1 (where C = c0 + c1YD) will cause ________. A) the ZZ line to become steeper and a given change in autonomous consumption (c0) to have a smaller effect on output B) the ZZ line to become steeper and a given change in autonomous consumption (c0) to have a larger effect on output C) the ZZ line to become flatter and a given change in autonomous consumption (c0) to have a smaller effect on output D) the ZZ line to become flatter and a given change in autonomous consumption (c0) to have a larger effect on output Answer: C AACSB: Reflective thinking Status: 8e question 19) An increase in the propensity to save from .3 to .4 will cause ________. A) the ZZ line to become steeper and a given change in autonomous consumption (c0) to have a smaller effect on output B) the ZZ line to become steeper and a given change in autonomous consumption (c0) to have a larger effect on output C) the ZZ line to become flatter and a given change in autonomous consumption (c0)) to have a smaller effect on output D) the ZZ line to become flatter and a given change in autonomous consumption (c0) to have a larger effect on output Answer: B AACSB: Reflective thinking Status: 8e question

20) A reduction in the propensity to save from .4 to .3 will cause ________. A) the ZZ line to become steeper and a given change in autonomous consumption (c0) to have a smaller effect on output B) the ZZ line to become steeper and a given change in autonomous consumption (c0) to have a larger effect on output C) the ZZ line to become flatter and a given change in autonomous consumption (c0) to have a smaller effect on output D) the ZZ line to become flatter and a given change in autonomous consumption (c0) to have a larger effect on output Answer: C AACSB: Analytical thinking Status: Modified 8e 21) An increase in the propensity to save from .1 to .2 will cause ________. A) an increase in the multiplier and a given change in autonomous consumption (c0) to have a smaller effect on output B) an increase in the multiplier and a given change in autonomous consumption (c0) to have a larger effect on output C) a reduction in the multiplier and a given change in autonomous consumption (c0) to have a smaller effect on output D) a reduction in the multiplier and a given change in autonomous consumption (c0) to have a larger effect on output Answer: C AACSB: Reflective thinking Status: Modified 8e 22) When the economy is in equilibrium, we know with certainty that ________. A) public saving equals investment B) private saving equals investment C) G = T D) none of these Answer: D AACSB: Application of knowledge Status: 8e question 23) When a closed economy is in equilibrium, we know with certainty that ________. A) I = S + (T - G) B) I = S C) I = S + (G - T) D) G = T and S = I Answer: A AACSB: Analytical thinking Status: 8e question

24) An increase in the desire to save by households will cause ________. A) a reduction in output B) a reduction in investment C) an increase in output D) no change in investment and no change in output Answer: A AACSB: Application of knowledge Status: 8e question 25) An increase in taxes will cause ________. A) a reduction in investment B) an increase in investment C) no change in investment D) no change in autonomous spending Answer: C AACSB: Application of knowledge Status: 8e question 26) A tax cut will cause ________. A) a reduction in autonomous investment B) an increase in autonomous investment C) no change in autonomous investment D) no change in autonomous spending Answer: C AACSB: Application of knowledge Status: 8e question 27) Based on our understanding of the model presented in Chapter 3, we know with certainty that an equal and simultaneous increase in G and T will cause ________. A) an increase in output B) no change in output C) a reduction in output D) an increase in investment Answer: A AACSB: Reflective thinking Status: 8e question 28) Based on our understanding of the model presented in Chapter 3, we know with certainty that an equal and simultaneous reduction in G and T will cause ________. A) an increase in output B) no change in output C) a reduction in output D) an increase in investment Answer: C AACSB: Reflective thinking Status: 8e question 12 Copyright © 2025 Pearson Education, Inc.

29) Based on our understanding of the model presented in Chapter 3, a reduction in investment will cause ________. A) an increase in the multiplier B) a reduction in the multiplier C) a reduction in the marginal propensity to save D) a reduction in output E) a reduction in the multiplier and output Answer: D AACSB: Reflective thinking Status: 8e question 30) Suppose business confidence decreases causing a reduction in investment. Based on our understanding of the model presented in Chapter 3, we know with certainty that a reduction in investment will cause ________. A) an increase in the multiplier B) a reduction in the multiplier C) a reduction in the marginal propensity to save D) a reduction in consumption as the economy adjusts to this decrease in investment Answer: D AACSB: Reflective thinking Status: 8e question 31) Suppose the marginal propensity to consume equals .8 (i.e., c1 = .8). Given this information, which of the following events will cause the largest increase in output? A) G increases by 200 B) T decreases by 200 C) I increases by 150 D) G increases by 200 and T decreases by 200 Answer: A AACSB: Application of knowledge Status: 8e question 32) If C = 2000 + .9YD, what decrease in taxes must occur for equilibrium output to increase by 1000? A) 111 B) 100 C) 1000 D) 500 Answer: A AACSB: Analytical thinking Status: 8e question

33) Suppose the United States economy is represented by the following equations: Z=C+I+G YD = Y - T G = 2000

C = 500 + .5YD

T = 600

I = 300

a. Given the above variables, calculate the equilibrium level of output. Hint: First specify (using the above numbers) the demand equation (Z) for this economy. Second, using the equilibrium condition, equate this expression with Y. Once you have done this, solve for the equilibrium level of output. Using the ZZ-Y graph (i.e., a graph that includes the ZZ line and 45-degree line with Z on the vertical axis, and Y on the horizontal axis), illustrate the equilibrium level of output for this economy. b. Now, assume that consumer confidence decreases causing a reduction in autonomous consumption (c0) from 500 to 400. What is the new equilibrium level of output? How much does income change as a result of this event? What is the multiplier for this economy? c. Graphically illustrate the effects of this change in autonomous consumption on the demand line (ZZ) and Y. Clearly indicate in your graph the initial and final equilibrium levels of output. d. Briefly explain why this reduction in output is greater than (in absolute terms) the initial reduction in autonomous consumption. Answer: a. Y = 5000. The graph is easy to show. b. Y = 4800; the multiplier is 2. c. Graph. d. When demand falls by 100, firms cut production by 100. As production falls by 100, income falls which causes a subsequent reduction in consumption and demand. This Y-induced fall in demand causes another reduction in production. This continues and we observe a final change in Y that exceeds the initial change in autonomous demand. AACSB: Analytical thinking Status: 8e question 34) Explain what the multiplier represents. Answer: The multiplier illustrates the extent to which equilibrium output will change as a result of a given change in autonomous demand. AACSB: Written and oral communication Status: 8e question 35) Discuss and explain what effect a reduction in the marginal propensity to consume has on the size of the multiplier. Answer: A reduction in the marginal propensity to consume will cause a reduction in the multiplier. When firms increase production in response to some initial change in demand, households will increase their consumption by a smaller amount when the mpc falls. So, the income-induced change in demand will be that much smaller causing a smaller multiplier effect. AACSB: Written and oral communication Status: 8e question

36) Use the ZZ-Y model presented in chapter 3 to illustrate the effects of a reduction in consumer confidence on the economy. Also, explain what effect this reduction in consumer confidence has on the economy. Answer: The graph is easy. The reduction in consumer confidence will cause a reduction in consumption and demand. As demand falls, firms will cut production. So, this event will cause a lower level of equilibrium output. AACSB: Written and oral communication Status: 8e question 37) Explain the difference between endogenous and exogenous variables. Answer: Endogenous variables are determined by the model. Exogenous variables are taken as given and do not change as income changes. AACSB: Written and oral communication Status: 8e question 38) For this question, assume that taxes are independent of income (i.e., the income tax rate is zero). Now suppose that fiscal policy makers wish to decrease equilibrium output by $500 billion. Further suppose that policy makers can choose one of the following two options: (1) change in government spending; or (2) change in taxes. Compare and explain the relative size of the changes in government spending and taxes needed to obtain this desired change in output. Answer: The change in taxes will have to be larger because part of any tax increase will cause saving to fall. So, to cause the same reduction in demand, the size of the tax cut will have to be larger than the size of any reduction in government spending. AACSB: Reflective thinking Status: 8e question 39) Explain what factors cause shifts and changes in the slope of the ZZ curve presented in chapter 3. Answer: The ZZ curve is upward sloping. The ZZ curve illustrates the level of demand at each level of income. As Y increases, households consume more causing an increase in demand. So, as Y rises, so does demand. The marginal propensity to consume will determine the size of the slope. The ZZ curve will shift when any autonomous component of demand changes. This will include changes in T, G, I and c0. AACSB: Written and oral communication Status: 8e question 40) Graphically illustrate the effects of an increase in autonomous consumption on the demand line (ZZ) and Y. Clearly indicate in your graph the initial and final equilibrium levels of output. Briefly explain why this increase in output is greater than (in absolute terms) the initial change in autonomous consumption. Answer: ZZ line will shift upward and Y will increase. The increase in output is greater than the initial change in autonomous consumption is due to the multiplier effect. AACSB: Reflective thinking Status: 8e question

41) Why would consumers decrease consumption even if their disposable income has not changed? Answer: If consumers start worrying about the future and decide to save more, they will decrease c0 and hence consumption. This is what happened at the start of the most recent financial crisis. AACSB: Reflective thinking Status: 8e question 42) Suppose the United States economy is represented by the following equations: Z=C+I+G YD = Y - T G = 2000

C = 500 + .5YD

T = 600

I = 300

a. Given the above variables, calculate the equilibrium level of output. b. Now, assume that government spending decreases from 2000 to 1900. What is the new equilibrium level of output? How much does income change as a result of this event? What is the multiplier for this economy? Answer: a. Y = 5000 b. Y = 4800, multiplier = 2. AACSB: Analytical thinking Status: 8e question 43) Suppose the United States economy is represented by the following equations: Z=C+I+G YD = Y - T G = 2000

C = 500 + .5YD

T = 600

I = 300

a. Given the above variables, calculate the equilibrium level of output. b. Now, assume that taxes increase from 600 to 700. What is the new equilibrium level of output? How much does income change as a result of this event? What is the multiplier for this economy? Answer: a. Y = 5000. b. Y = 4900, multiplier = 2. AACSB: Analytical thinking Status: 8e question

3.4 Investment Equals Saving: An Alternative Way of Thinking about Goods-Market Equilibrium 1) Which of the following about IS relation is not correct? A) It is the relation between interest rate and savings. B) It is the equilibrium condition for the goods market. C) It stands for "Investment equals saving." D) It shows what firms want to invest must be equal to what people and the government want to save. Answer: A AACSB: Application of knowledge Status: 8e question 2) Based on our understanding of the paradox of saving, we know that a reduction in the desire to save will cause ________. A) an increase in equilibrium GDP B) a reduction in GDP C) an increase in the desire to invest D) no change in equilibrium GDP E) a permanent reduction in the level of saving Answer: A AACSB: Application of knowledge Status: 8e question 3) Discuss what is meant by the paradox of saving. Answer: The paradox of saving refers to the effects of an increased desire to save on output and on the final level of saving. The increased desire to save is equivalent to a reduction in consumption. This drop in demand will cause a drop in output. Furthermore, in this simple economy, the final level of saving will equal the initial level of saving. So, an increased desire to save has a negative effect on the economy and has no permanent effect on the level of saving (because S = I in the simple model). AACSB: Application of knowledge Status: 8e question 4) Suppose that, at a given level of disposable income, consumers decide to save more. Explain what effect this decision will have on equilibrium income. Also, explain what effect this decision will have on the level of saving once the economy has reached the new equilibrium. Answer: This is the paradox of saving. Consumption will fall causing a reduction in demand and a reduction in output. Despite the initial increase in saving at the initial level of income, saving will return to the initial level as income falls in order to maintain the alternative equilibrium condition: S = I. So, the initial increase in the desire to save will have no permanent effect on the level of saving. AACSB: Application of knowledge Status: 8e question

5) Suppose the consumption equation is represented by the following: C = 250 + .75YD, then private savings is ________. A) -250+0.25YD B) -250+0.75YD C) -1000+0.25YD D) -1000+0.75YD Answer: A AACSB: Analytical thinking Status: 8e question 3.5

Is the Government Omnipotent? A Warning

1) Which of the following is correct? A) Governments can not achieve the level of output they want. B) Changing government spending or taxes is easy. C) Investment will remain constant. D) Expectations do not matter for government to change spending or taxes. Answer: A AACSB: Application of knowledge Status: 8e question

Macroeconomics, 9e (Blanchard) Chapter 4: Financial Markets I 4.1

The Demand for Money

1) Which of the following is a characteristic of bonds? A) pay zero nominal interest in most cases B) can be used for transactions and to settle accounts C) price of outstanding bonds varies inversely with changes in market interest rates D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 2) Which of the following is a flow variable? A) income B) money C) financial wealth D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 3) Which of the following is a component of money? A) bonds B) saving C) income D) stocks E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 4) Which of the following is a component of money? A) coins held by the nonbank public B) bills held by banks C) checkable deposits D) all of these Answer: D AACSB: Application of knowledge Status: 8e question

5) Which of the following will cause an increase in the amount of money that one wishes to hold? A) an increase in the interest rate B) a reduction in the interest rate C) a reduction in income D) none of these Answer: B AACSB: Application of knowledge Status: 8e question 6) The money demand curve will shift to the right when which of the following occurs? A) an increase in income B) an increase in the interest rate C) an increase in the money supply D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 7) The money demand curve will shift to the left when which of the following occurs? A) a reduction in the interest rate B) an increase in the interest rate C) an open market sale of bonds by the central bank D) an increase in income E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 8) Which of the following affects demand for money? A) prices B) nominal income C) interest rate D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

9) First, explain why the money demand curve is downward sloping. Second, explain what factor(s) will cause shifts in the money demand curve. Answer: The money demand curve is downward sloping (with the interest rate on the vertical axis). It is assumed that money pays no interest. However, individuals do earn interest when they hold bonds. So, as the interest rate increases, individuals will hold more wealth in bonds to earn higher interest rates and therefore less wealth in money. So, an increase in the interest rate causes a reduction in money demand. Money demand depends on the level of transactions and on the interest rate. As the level of transactions increases, individuals will increase money demand. Assuming that nominal income is correlated with nominal transactions, an increase in nominal income will cause an increase in money demand and shifts in the curve. AACSB: Written and oral communication Status: 8e question 10) What type of financial vehicle pools investor funds and buys short-term , typically government bonds? A) Money demand fund B) Currency fund C) Money market mutual fund D) Dow Jones Industrial Average Answer: C AACSB: Application of knowledge Status: New question 9e 11) Which of these is NOT a component of money? A) Checkable deposits B) Currency C) Coins D) Bonds Answer: D AACSB: Application of knowledge Status: New question 9e 12) Which of these is a true statement about bonds? A) Bonds pay an interest rate. B) Bonds can be used to settle transactions. C) Bonds are more liquid than currency. D) Selling a bond does not incur a cost. Answer: A AACSB: Application of knowledge Status: New question 9e

4.2

Determining the Interest Rate: I

1) At the current interest rate, suppose the supply of money is less than the demand for money. Given this information, we know that ________. A) the price of bonds will tend increase B) the price of bonds will tend to fall C) production equals demand D) the goods market is also in equilibrium E) the supply of bonds also equals the demand for bonds Answer: B AACSB: Reflective thinking Status: 8e question 2) The interest rate will increase as a result of which of the following events? A) an increase in income B) an open market purchase of bonds by the central bank C) a reduction in income D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 3) Which of the following is not an asset on a bank's balance sheet? A) reserves B) loans C) checkable deposits D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 4) Which of the following is a liability on a bank's balance sheet? A) checkable deposits B) reserves C) loans D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

5) Which of the following is a liability for the central bank? A) currency B) bonds C) savings accounts D) loans E) checkable deposits Answer: A AACSB: Application of knowledge Status: 8e question 6) Suppose a one-year discount bond offers to pay $1000 in one year and currently sells for $950. Given this information, we know that the interest rate on the bond is ________. A) 5.3% B) 9.5% C) 10% D) 90% E) 110% Answer: A AACSB: Analytical thinking Status: 8e question 7) Suppose a one-year discount bond offers to pay $1000 in one year and currently has a 15% interest rate. Given this information, we know that the bond's price must be ________. A) $869.56 B) $1150 C) $850 D) $950 E) none of these Answer: A AACSB: Analytical thinking Status: 8e question 8) Banks are different from other financial intermediaries because ________. A) banks can invest in the stock market B) some of a bank's deposits are money C) banks can conduct open market operations on their own D) banks do not need to hold reserves against their deposits E) banks are open longer hours Answer: B AACSB: Application of knowledge Status: 8e question

9) Which of the following generally occurs when a central bank pursues expansionary monetary policy? A) The central bank purchases bonds and the interest rate increases. B) The central bank purchases bonds and the interest rate decreases. C) The central bank sells bonds and the interest rate increases. D) The central bank sells bonds and the interest rate decreases. Answer: B AACSB: Application of knowledge Status: 8e question 10) Which of the following generally occurs when a central bank pursues contractionary monetary policy? A) The central bank purchases bonds and the interest rate increases. B) The central bank purchases bonds and the interest rate decreases. C) The central bank sells bonds and the interest rate increases. D) The central bank sells bonds and the interest rate decreases. Answer: C AACSB: Application of knowledge Status: 8e question 11) Which of the following will occur when the central bank pursues expansionary monetary policy? A) a leftward shift in the money demand curve and a leftward shift in the money supply curve B) a rightward shift in the money demand curve and a leftward shift in the money supply curve C) a leftward shift in the money demand curve and a rightward shift in the money supply curve D) a rightward shift in the money demand curve and a rightward shift in the money supply curve E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 12) Suppose a one-year discount bond offers to pay $100 in one year and currently sells for $90. Given this information, we know that the interest rate on the bond is ________. A) 11.1% B) 10% C) 5.3% D) 9.9% Answer: A AACSB: Analytical thinking Status: 8e question

13) Which of the following is an asset of a central bank? A) currency B) bonds C) reserves D) none of these Answer: B AACSB: Application of knowledge Status: 8e question 14) Which of the following is an asset for both a bank and a central bank? A) currency B) deposits C) bonds D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 15) Explain what types of policies a central bank can implement to reduce the interest rate. Answer: Central banks have two options to reduce the interest rate: a central bank purchase of bonds or decrease the required reserve ratio. Both policies result in an increase in the money supply and a reduction in the interest rate. AACSB: Written and oral communication Status: 8e question 16) Graphically illustrate and explain what effect an increase in real income will have on the money market. Answer: An increase in income will cause an increase in transactions and an increase in money demand. The money demand curve will shift to the right causing an excess demand for money and excess demand for bonds. The interest rate will rise to restore money market equilibrium. There is no change in money supply as a result of this. AACSB: Analytical thinking Status: 8e question 17) Graphically illustrate and explain what effect a purchase of bonds by the Federal Reserve will have on the money market. Answer: A Fed purchase of bonds will cause an increase in H and an increase in the money supply. At the initial interest rate, there will be an excess supply of money. The interest rate will fall to restore money market equilibrium. All else fixed, there will be no change in money demand. AACSB: Analytical thinking Status: 8e question

18) Use the market for central bank money to answer this question. Graphically illustrate and explain what effect a Federal Reserve purchase of bonds will have on this market and on the equilibrium interest rate. Answer: A Fed purchase of bonds will cause an increase in the supply of central bank money. To restore equilibrium in this market, the interest rate will have to fall. As it does, the quantity demanded for central bank money will rise and, therefore, restore equilibrium. AACSB: Reflective thinking Status: 8e question 4.3

Determining the Interest Rate: II

1) Which of the following is a component of high powered money? A) bonds held by banks, loans, and bank reserves B) currency in circulation plus bank reserves C) currency in circulation plus checkable deposits D) bonds held by banks plus checkable deposits E) the sum of currency in circulation, bank reserves, and checkable deposits Answer: B AACSB: Application of knowledge Status: 8e question 2) For this question, assume that individuals do not hold currency (i.e., c = 0). If the ratio of reserves to deposits is .10, the money multiplier is ________. A) .1 B) .9 C) 4 D) 5 E) 10 Answer: E AACSB: Analytical thinking Status: 8e question 3) The money supply will tend to fall when which of the following occurs? A) a central bank sale of bonds B) a decrease in the ratio of reserves to deposits C) a shift in public preferences away from currency to checkable deposits D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

4) Which of the following events will cause the interest rate to increase? A) an open market sale of bonds B) an increase in the reserve deposit ratio (i.e., θ) C) an increase in income D) all of these Answer: D AACSB: Reflective thinking Status: 8e question 5) The federal funds rate is determined in which of the following markets? A) the market for U.S. treasury securities B) the money market C) the bond market D) the market for central bank money E) none of these Answer: D AACSB: Reflective thinking Status: 8e question 6) We would expect which of the following to occur when the central bank pursues expansionary monetary policy? A) an increase in bond prices and an increase in the interest rate (i) B) a reduction in bond prices and an increase in i C) an increase in bond prices and a reduction in i D) a reduction in bond prices and a reduction in i E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 7) We would expect which of the following to occur when the central bank pursues contractionary monetary policy? A) an increase in bond prices and an increase in the interest rate (i) B) a reduction in bond prices and an increase in i C) an increase in bond prices and a reduction in i D) a reduction in bond prices and a reduction in i E) none of these Answer: B AACSB: Application of knowledge Status: 8e question

8) Based on our understanding of the determinants of the interest rate and bond prices, we know that a reduction in income will cause ________. A) an increase in bond prices and an increase in the interest rate (i) B) a reduction in bond prices and an increase in i C) an increase in bond prices and a reduction in i D) a reduction in bond prices and a reduction in i E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 9) We would expect which of the following to occur when the central bank conducts an open market sale of bonds? A) a reduction in the monetary base (H) B) a reduction in bank reserves C) an increase in H D) an increase in bank reserves E) an increase in H and bank reserves Answer: A AACSB: Application of knowledge Status: 8e question 10) We would expect which of the following to occur when the central bank conducts an open market purchase of bonds? A) a reduction in the monetary base (H) B) a reduction in bank reserves C) an increase in bank reserves D) an increase in the money supply Answer: D AACSB: Application of knowledge Status: 8e question 11) The market for bank reserves is called the ________. A) money market B) bond market C) fed funds market D) open market Answer: C AACSB: Application of knowledge Status: New question 9e

12) An increase in income will tend to cause which of the following? A) an increase in the monetary base (H) B) a reduction in H C) an increase in the interest rate D) a reduction in bank reserves E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 13) If individuals do not hold currency, we know that ________. A) M = D B) H = M C) bank reserves are zero D) all of these Answer: A AACSB: Application of knowledge Status: 8e question 14) If individuals do not hold checkable deposits, we know that ________. A) M = CU B) H = M C) bank reserves are zero D) all of these Answer: A AACSB: Application of knowledge Status: 8e question 15) An increase in the interest rate will cause ________. A) a reduction in the supply of central bank money B) a reduction in the demand for currency C) a reduction in the demand for reserves D) all of these E) a reduction in the demand for currency and for reserves Answer: E AACSB: Reflective thinking Status: 8e question 16) An increase in income will cause ________. A) a reduction in the supply of central bank money B) a reduction in the demand for currency C) a reduction in the demand for reserves D) none of these E) a reduction in the demand for currency and for reserves Answer: D AACSB: Application of knowledge Status: 8e question 11 Copyright © 2025 Pearson Education, Inc.

17) An increase in income will cause ________. A) a reduction in the supply of central bank money B) a reduction in the demand for currency C) an increase in the demand for reserves D) none of these Answer: C AACSB: Application of knowledge Status: 8e question 18) An open market sale of securities will cause ________. A) a reduction in the supply of central bank money B) a reduction in the demand for currency C) a reduction in the demand for reserves D) none of these Answer: A AACSB: Application of knowledge Status: 8e question 19) Use the market for central bank money to answer this question. Graphically illustrate and explain what effect an increase in the reserve deposit ratio (θ) will have on this market and on the equilibrium interest rate. Answer: An increase in the parameter θ will cause an increase in banks' demand for reserves and, therefore, an increase in the demand for central bank money. This will cause an excess demand for central bank money at the initial interest rate. In this case, the interest rate will rise to restore equilibrium. AACSB: Analytical thinking Status: 8e question 20) Explain what effect changes in each of the following variables has on the demand for central bank money: (1) the interest rate, i; and (b) real income, Y. Answer: Interest rate. A reduction in the interest rate will cause an increase in money demand (movement along the demand curve). This will cause an increase in the demand for currency that will cause an increase in the demand for central bank money. The increase in the demand for money will also cause an increase in the demand for deposits and, therefore, an increase in banks' demand for reserves. This will also cause an increase in the demand for central bank money. In this case, we only move along the demand curve. Real income. An increase in Y will cause an increase in money demand and, as described above, an indirect increase in the demand for currency and reserves. So, this increase in Y will cause an increase in the demand for central bank money and a shift in the curve. AACSB: Reflective thinking Status: 8e question

21) Discuss the tools of the Federal Reserve and explain how each can be used to change the money supply and equilibrium interest rate. Answer: The Fed has three tools: discount rate, open market operations, and the reserve ratio. An open market sale or purchase will cause a change in H and M. This will in turn cause a change in the money supply. A change in the required reserve ratio will cause a change in the money multiplier and, therefore, the money supply. The Fed rarely changes the reserve ratio so this tool is not discussed in detail. When the money supply changes, the interest rate will change. Changes in the discount rate do not directly cause changes in the money supply. AACSB: Written and oral communication Status: 8e question 22) Use the money market to answer this question. Suppose there is a reduction in income. First, briefly explain what effect this will have on the interest rate. Second, explain all types of policies the central bank could implement to prevent this reduction in income from affecting the interest rate. Answer: The reduction in income will cause a reduction in money demand, a leftward shift in the money demand curve, and a reduction in the interest rate. To prevent the drop in the interest rate, the central bank could pursue an open market sale of securities (to reduce the money supply) or it could increase the required reserve ratio (which would also reduce the money supply). AACSB: Written and oral communication Status: 8e question 23) Graphically illustrate and explain what effect a sale of bonds by the Federal Reserve will have on the money market. Answer: A Fed sale of bonds will cause a decrease in H and an decrease in the money supply. At the initial interest rate, there will be an excess demand for money. The interest rate will increase to restore money market equilibrium. All else fixed, there will be no change in money demand. AACSB: Analytical thinking Status: 8e question 24) What is the difference between saving and savings? Answer: Saving is the part of after-tax income that one does not spend. It is a flow variable. Savings is used as a synonym for wealth. It is a stock variable. AACSB: Application of knowledge Status: 8e question 25) Explain what types of policies a central bank can implement to raise the interest rate. Answer: Central banks have two options to raise the interest rate: a central bank sale of bonds or a n increase in the required reserve ratio. Both policies result in a decrease in the money supply and an increase in the interest rate. AACSB: Application of knowledge Status: 8e question

26) The demand for money is given by Md = $Y (0.3 - i), where $Y = 120 and the supply of money is $30. a. What is the equilibrium interest rate? b. If the central bank wants to decrease i by 2%, at what level should it set the supply of money? Answer: a. i = .05, or 5%. b. Ms = 32.4. AACSB: Analytical thinking Status: 8e question 27) The demand for money is given by Md = $Y (0.3 - i), where $Y = 100 and the supply of money is $20. a. What is the equilibrium interest rate? b. What is the impact on the interest rate if central bank money is increased to $25? Answer: a. i = .10, or 10% b. Interest rate will decrease to .05, or 5%. AACSB: Analytical thinking Status: 8e question 4.4

The Liquidity Trap

1) Which of the following conditions will most likely coincide with the existence of a liquidity trap? A) inflation is rising B) inflation is constant C) inflation is zero D) individuals prefer to hold only money and not bonds E) the real interest rate is negative Answer: D AACSB: Reflective thinking Status: 8e question 2) When a liquidity trap situation exists, we know that ________. A) an open market operation will have no effect on the supply of money B) an open market operation will have no effect on the monetary base C) fiscal policy will have no effect on the demand for goods D) expansionary monetary policy will be deflationary E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

3) Suppose a liquidity trap situation exists. Which of the following is most likely to occur if taxes are cut? A) no change in output and no change in the interest rate B) an increase in output and an increase in the interest rate C) an increase in output and little change in the interest rate D) an increase in output and a reduction in the interest rate E) none of these Answer: C AACSB: Reflective thinking Status: 8e question 4) An open market purchase of bonds by the central bank will cause which of the following when a liquidity trap situation exists? A) The interest rate will decrease. B) The interest rate will not change. C) Output will increase. D) The money supply, M, will not change. E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 5) An open market sale of bonds by the central bank will cause which of the following when a liquidity trap situation exists? A) The interest rate will increase. B) The interest rate will not change. C) Output will decrease. D) The money supply, M, will not change. E) none of these Answer: E AACSB: Reflective thinking Status: 8e question 6) Which of the following will occur when an economy is faced with a liquidity trap situation? A) A reduction in the price level will cause a rightward shift in the aggregate demand curve. B) A reduction in the price level will cause a leftward shift in the aggregate demand curve. C) The aggregate demand curve is now vertical. D) The aggregate demand curve is now upward sloping. Answer: C AACSB: Application of knowledge Status: 8e question

7) When a liquidity trap situation exists, the most appropriate policy to increase output would be ________. A) a central bank sale of bonds B) an increase in government spending C) a central bank purchase of bonds D) none of these Answer: B AACSB: Application of knowledge Status: 8e question 8) The ________ is the constraint that states the interest rate cannot be negative. A) zero lower bound B) liquidity trap C) contractionary policy D) fed funds rate Answer: A AACSB: Application of knowledge Status: New question 9e

Macroeconomics, 9e (Blanchard) Chapter 5: Goods and Financial Markets: The IS-LM Model 5.1

The Goods Market and the IS Relation

1) The IS curve represents ________. A) the single level of output where the goods market is in equilibrium B) the single level of output where financial markets are in equilibrium C) the combinations of output and the interest rate where the money market is in equilibrium D) the combinations of output and the interest rate where the goods market is in equilibrium E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) The IS curve will shift to the right when which of the following occurs? A) an increase in the money supply B) an increase in government spending C) a reduction in the interest rate D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 3) Which of the following occurs as the economy moves leftward along a given IS curve? A) An increase in the interest rate causes a reduction in the demand for goods. B) An increase in the interest rate causes money demand to increase. C) An increase in the interest rate causes a reduction in the money supply. D) A reduction in government spending causes a reduction in demand for goods. E) An increase in taxes causes a reduction in demand for goods. Answer: A AACSB: Reflective thinking Status: 8e question 4) Which of these shifts can result from a decline in consumer confidence? A) The LM curve will shift up. B) The LM curve will shift down. C) The IS curve will shift rightward. D) The IS curve will shift leftward. E) The IS curve will shift rightward, and the LM curve will shift up. Answer: D AACSB: Application of knowledge Status: New question 9e

5) Suppose policy makers decide to reduce taxes. This fiscal policy action will cause which of the following to occur? A) The LM curve shifts and the economy moves along the IS curve. B) The IS curve shifts and the economy moves along the LM curve. C) Both the IS and LM curves shift. D) Neither the IS nor the LM curve shifts. E) Output will change causing a change in money demand and a shift of the LM curve. Answer: B AACSB: Application of knowledge Status: 8e question 6) Suppose fiscal policy makers implement a policy to reduce the size of a budget deficit. Based on the IS-LM model, we know with certainty that the following will occur as a result of this fiscal policy action. A) Investment spending will decrease. B) Investment spending will increase. C) There will be no change in investment spending. D) Investment spending may increase, decrease, or not change. E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 7) For this question, assume that investment spending depends only on the interest rate and no longer depends on output. Given this information, a reduction in government spending ________. A) will cause investment to decrease B) will cause investment to increase C) may cause investment to increase or to decrease D) will have no effect on output E) will cause a reduction in output and have no effect on the interest rate Answer: B AACSB: Application of knowledge Status: 8e question 8) Suppose investment spending is not very sensitive to the interest rate. Given this information, we know that ________. A) the IS curve should be relatively flat B) the IS curve should be relatively steep C) the LM curve should be relatively flat D) the LM curve should be relatively steep E) neither the IS nor the LM curve will be affected Answer: B AACSB: Interpersonal relations and teamwork Status: 8e question

9) Explain the determinants of investment. Include in your answer an explanation of how a change in each determinant affects investment. Answer: Investment depends on the level of sales/output and on the interest rate. As output changes, the demand for goods will change and firms will change investment so that their capacity changes with the level of economic activity (and demand). It also depends on the interest rate. As the interest rate rises, the cost of borrowing rises. Firms will cut back on investment as borrowing costs rise. AACSB: Written and oral communication Status: 8e question 10) What is the IS relation? Explain why IS curve is downward sloping. Answer: The IS relation shows the combinations of the interest rate and the level of output that are consistent with equilibrium in the goods market. An increase in the interest rate leads to a decline in output. Consequently, the IS curve is downward sloping. AACSB: Reflective thinking Status: 8e question 11) Graphically derive the IS curve from the goods market equilibrium. Answer: Suppose the initial equilibrium in the goods market is at point A with interest rate i. Suppose now that the interest rate increases from its initial value i to a higher value i'. The increase in the interest rate decreases investment. The decrease in investment leads to a decrease in output. Now the new equilibrium point is at A', with a higher value of i and lower value of Y. After we plot the combinations of i and Y when the goods market is in equilibrium, we can connect these two points (A and A') to get a downward sloping IS curve. AACSB: Analytical thinking Status: 8e question 5.2

Financial Markets and the LM Relation

1) For each interest rate, the LM curve illustrates the level of output where ________. A) the goods market is in equilibrium B) inventory investment equals zero C) money supply equals money demand D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question

2) The LM curve shifts down (or, equivalently, to the right) when which of the following occurs? A) an increase in taxes B) an increase in output C) an open market sale of bonds by the central bank D) an increase in consumer confidence E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 3) Which of the following statements is consistent with a given (i.e., fixed) LM curve? A) A reduction in the interest rate causes investment spending to increase. B) A reduction in the interest rate causes money demand to decrease. C) A reduction in the interest rate causes an increase in the money supply. D) An increase in output causes an increase in demand for goods. E) An increase in output causes an increase in money demand. Answer: E AACSB: Application of knowledge Status: 8e question 4) In late 2007 and early 2008, the U.S. Federal Reserve pursued expansionary monetary policy. Which of the following will occur as a result of this monetary policy action? A) The LM curve shifts down. B) The LM curve shifts up. C) The IS curve shifts rightward as the interest rate falls. D) The IS curve shifts leftward as the interest rate increases. E) none of these Answer: A AACSB: Integration of real-world business experiences Status: 8e question 5) Suppose the demand for money is not very sensitive to the interest rate. Given this information, we know that ________. A) the IS curve should be relatively flat B) the IS curve should be relatively steep C) the LM curve should be relatively flat D) the LM curve should be relatively steep E) neither the IS nor the LM curve will be affected Answer: D AACSB: Application of knowledge Status: 8e question

6) Which of the following is the definition for the real supply of money? A) The stock of money measured in terms of goods, not dollars. B) The stock of high powered money only. C) The real value of currency in circulation only. D) The actual quantity of money, rather than the officially reported quantity. E) The ratio of the real GDP to the nominal money supply. Answer: A AACSB: Application of knowledge Status: 8e question 7) What two factors determine business investment? Answer: The first factor is the level of sales. Consider a firm facing an increase in sales and needing to increase production. To do so, it may need to buy additional machines or build an additional plant. A firm facing low sales will feel no such need and will spend little, if anything, on investment. The second factor is the interest rate. Consider a firm deciding whether to buy a new machine. Suppose that to buy the new machine, the firm must borrow. The higher the interest rate, the less attractive it is to borrow and buy the machine. If interest fall it makes it more likely the firm will borrow money to invest. AACSB: Written and oral communication Status: 8e question 5.3

Putting the IS and the LM Relations Together

1) Suppose the economy is currently operating on both the LM curve and the IS curve. Which of the following is true for this economy? A) Production equals demand. B) The quantity supplied of bonds equals the quantity demanded of bonds. C) The money supply equals money demand. D) Financial markets are in equilibrium. E) all of these Answer: E AACSB: Application of knowledge Status: 8e question 2) Suppose the economy is operating on the LM curve but not on the IS curve. Given this information, we know that ________. A) the goods market is in equilibrium and the money market is not in equilibrium B) the money market and bond markets are in equilibrium and the goods market is not in equilibrium C) the money market and goods market are in equilibrium and the bond market is not in equilibrium D) the money, bond and goods markets are all in equilibrium E) neither the money, bond, nor goods markets are in equilibrium Answer: B AACSB: Application of knowledge Status: 8e question 5 Copyright © 2025 Pearson Education, Inc.

3) Suppose the current level of output and the interest rate are such that the economy is operating on neither the IS nor LM curve. Which of the following is true for this economy? A) Production does not equal demand. B) The money supply does not equal money demand. C) The quantity supplied of bonds does not equal the quantity demanded of bonds. D) Financial markets are not in equilibrium. E) all of these Answer: E AACSB: Application of knowledge Status: 8e question 4) An increase in the money supply will cause an increase in which of the following variables? A) output B) investment C) consumption D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 5) Suppose there is an increase in consumer confidence. Which of the following represents the complete list of variables that must increase in response to this increase in consumer confidence? A) consumption B) consumption and investment C) consumption, investment and output D) consumption and output E) consumption, output and the interest rate Answer: E AACSB: Application of knowledge Status: 8e question 6) Suppose there is a fiscal contraction. Which of the following is a complete list of the variables that must decrease? A) consumption B) consumption and investment C) consumption and output D) consumption, output and the interest rate E) consumption, output and investment Answer: C AACSB: Application of knowledge Status: 8e question

7) We know with certainty that a tax increase must cause which of the following? A) an increase in investment B) a reduction in investment C) no change in investment D) none of these Answer: D AACSB: Application of knowledge Status: 8e question 8) A fiscal contraction will tend to cause which of the following to occur? A) a reduction in the interest rate and a reduction in investment B) a reduction in the interest rate and an upward shift in the LM curve C) no change in the interest rate and no change in investment D) no change in output if the Fed simultaneously pursues contractionary monetary policy Answer: C AACSB: Application of knowledge Status: 8e question 9) An increase in the money supply must cause which of the following? A) a leftward shift in the IS curve B) a reduction in the interest rate and ambiguous effects on investment C) an increase in investment and a rightward shift in the IS curve D) no change in the interest rate if investment is independent of the interest rate E) an increase in output if the LM curve is horizontal Answer: E AACSB: Application of knowledge Status: 8e question 10) An increase in consumer confidence will tend to cause which of the following to occur? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve Answer: A AACSB: Application of knowledge Status: 8e question 11) Assume that investment does not depend on the interest rate. A reduction in government spending will cause which of the following for this economy? A) no change in the interest rate B) no change in output C) no change in investment D) an increase in investment E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 7 Copyright © 2025 Pearson Education, Inc.

12) Assume that investment does not depend on the interest rate. A reduction in the money supply will cause which of the following for this economy? A) no change in the interest rate B) no change in output C) a reduction in investment D) an increase in investment Answer: B AACSB: Application of knowledge Status: 8e question 13) For this question, assume that investment spending depends only on output and no longer depends on the interest rate. Given this information, an increase in the money supply ________. A) will cause investment to decrease B) will cause investment to increase C) will cause a reduction in the interest rate D) will have no effect on output or the interest rate E) will cause an increase in output and have no effect on the interest rate Answer: C AACSB: Application of knowledge Status: 8e question 14) A reduction in consumer confidence will likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve Answer: B AACSB: Application of knowledge Status: 8e question 15) An increase in the reserve deposit ratio, θ, will most likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve Answer: C AACSB: Application of knowledge Status: 8e question

16) A Fed purchase of securities will most likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve Answer: D AACSB: Application of knowledge Status: 8e question 17) A reduction in the aggregate price level, P, will most likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve Answer: D AACSB: Application of knowledge Status: 8e question 18) An increase in the aggregate price level, P, will most likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve Answer: C AACSB: Application of knowledge Status: 8e question 19) The IS curve will not shift when which of the following occurs? A) a reduction in government spending B) a reduction in the interest rate C) a reduction in consumer confidence D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 20) Which of the following best defines the IS curve? A) the combinations of i and Y that maintain equilibrium in the goods market B) illustrates the effects of changes in i on investment C) illustrates the effects of changes in i on desired money holdings by individuals D) the combinations of i and Y that maintain equilibrium in financial markets Answer: A AACSB: Application of knowledge Status: 8e question 9 Copyright © 2025 Pearson Education, Inc.

21) Which of the following best defines the LM curve? A) the combinations of i and Y that maintain equilibrium in the goods market B) illustrates the effects of changes in i on investment C) illustrates the effects of changes in i on desired money holdings by individuals D) the combinations of i and Y that maintain equilibrium in financial markets Answer: D AACSB: Application of knowledge Status: 8e question 22) Based on our understanding of the IS-LM model that takes into account dynamics, we know that a reduction in the money supply will cause ________. A) an immediate drop in Y and immediate increase in i B) an immediate increase in i and no initial change in Y C) a gradual increase in i and gradual reduction in Y D) none of these Answer: B AACSB: Reflective thinking Status: 8e question 23) Based on our understanding of the IS-LM model that takes into account dynamics, we know that a reduction in government spending will cause ________. A) an immediate drop in Y and immediate increase in i B) an immediate reduction in i and no initial change in Y C) a gradual reduction in i and gradual reduction in Y D) a gradual reduction in i and an immediate reduction in Y Answer: C AACSB: Reflective thinking Status: 8e question 24) Based on our understanding of the IS-LM model that takes into account dynamics, we know that an increase in the money supply will cause ________. A) an immediate increase in i and no initial change in Y B) an immediate decrease in i and no initial change in Y C) a gradual decrease in i and gradual increase in Y D) none of these Answer: B AACSB: Reflective thinking Status: 8e question

25) Based on our understanding of the IS-LM model that takes into account dynamics, we know that an increase in government spending will cause ________. A) a gradual increase in i and gradual increase in Y B) an immediate increase in Y and immediate drop in i C) an immediate increase in i and no initial change in Y D) a gradual increase in i and an immediate increase in Y Answer: A AACSB: Reflective thinking Status: 8e question 26) An increase in government spending will likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve Answer: A AACSB: Reflective thinking Status: 8e question 27) A reduction in the reserve deposit ratio, θ, will most likely have which of the following effects? A) a rightward shift in the IS curve B) a leftward shift in the IS curve C) an upward shift in the LM curve D) a downward shift in the LM curve Answer: D AACSB: Application of knowledge Status: 8e question 28) If government spending and taxes increase by the same amount, ________. A) the IS curve does not shift B) the IS curve shift leftward C) the IS curve shifts rightward D) the LM curve shifts downward Answer: C AACSB: Application of knowledge Status: 8e question 29) If government spending and taxes decrease by the same amount, ________. A) the IS curve does not shift B) the IS curve shift leftward C) the IS curve shifts rightward D) the LM curve shifts downward Answer: B AACSB: Application of knowledge Status: 8e question 11 Copyright © 2025 Pearson Education, Inc.

30) Which of the following triggered the U.S. recession of 2001? A) decline in investment demand B) decline in consumption demand C) increase in budget deficit D) increase in trade deficit Answer: A AACSB: Application of knowledge Status: 8e question 31) The IS curve will shift to the left when which of the following occurs? A) a reduction in the money supply B) a reduction in government spending C) an increase in the interest rate D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 32) Which of the following occurs as the economy moves rightward along a given IS curve? A) A reduction in the interest rate causes investment spending to decrease. B) A reduction in the interest rate causes money demand to increase. C) A reduction in the interest rate causes a reduction in the money supply. D) An increase in government spending causes a reduction in demand for goods. E) A reduction in taxes causes a reduction in demand for goods. Answer: B AACSB: Application of knowledge Status: 8e question 33) When the central bank pursues contractionary monetary policy, we know that this policy will result in an increase in the interest rate, a reduction in investment, a reduction in demand, and a lower level of equilibrium output. Explain what happens to the position of the IS curve as the central bank pursues contractionary monetary policy. Answer: Changes in the interest rate do cause changes in investment, demand, and output. However, they do not cause shifts of the IS curve. Changes in the interest rate cause movements along the IS curve. AACSB: Written and oral communication Status: 8e question 34) A fiscal expansion (e.g. a tax cut) will result in an increase in income, an increase in money demand, and an increase in the equilibrium interest rate in financial markets. Explain what happens to the position of the LM curve as policy makers pursue expansionary fiscal policy. Answer: In reality the LM curve is a horizontal line that intersects the y-axis at the interest rate selected by the central bank. Therefore, fiscal expansion will not affect the LM curve. AACSB: Written and oral communication Status: 8e question 12 Copyright © 2025 Pearson Education, Inc.

35) Explain in detail what effect a Fed sale of bonds will have on: (1) the LM curve; and (2) the IS curve. Answer: A Fed sale of bonds will cause a reduction in H and a reduction in the money supply. This will cause an excess demand for money and the interest rate must increase to restore money market equilibrium. The LM curve will shift up as a result of this to reflect the now higher interest rate. The IS curve does not shift as a result of this. We would simply observe a movement along the IS curve. AACSB: Written and oral communication Status: 8e question 36) Explain in detail what effect a reduction in government spending will have on: (1) the LM curve; and (2) the IS curve. Answer: A reduction in taxes will cause an increase in disposable income and an increase in consumption. The rise in C will cause an increase in demand and the equilibrium level of output in the goods market will be higher. This is reflected in a rightward shift in the IS curve. Goods market events such as this will not cause a shift in the LM curve (only a movement along it). AACSB: Written and oral communication Status: 8e question 37) Based on your understanding of the IS-LM model, graphically illustrate and explain what effect a reduction in consumer confidence will have on output, the interest rate, and investment. Answer: A reduction in consumer confidence will cause a reduction in consumption and, therefore, a reduction in demand and a leftward shift in the IS curve. As Y decreases, money demand will decrease causing the interest rate to fall. The effects on I are ambiguous. The lower Y will cause I to fall while the lower interest rate will cause I to increase. AACSB: Analytical thinking Status: 8e question 38) Based on your understanding of the IS-LM model, graphically illustrate and explain what effect a monetary expansion will have on output, the interest rate, and investment. Answer: An increase in M will cause the LM curve to shift down and the interest rate to fall. As the interest rate falls, firms will increase investment causing an increase in demand and subsequent increase in output. So, the interest rate will fall and Y will rise. I will be higher due to the rise in Y and the drop in the interest rate. AACSB: Analytical thinking Status: 8e question 39) Increases in the budget deficit are believed to cause reductions in investment. Based on your understanding of the IS-LM model, will a fiscal policy action that causes a reduction in the budget deficit cause an increase in investment? Explain. Answer: A policy that causes a reduction in the budget deficit will have an ambiguous effect on investment. Output will fall which will tend to depress I. However, the interest rate will also fall which will tend to increase I. I could increase, decrease, or remain unchanged. AACSB: Reflective thinking Status: 8e question

40) Explain in detail what effect a Fed purchase of bonds will have on: (1) the LM curve; and (2) the IS curve. Answer: A Fed purchase of bonds will cause an increase in H and an increase in the money supply. This will cause an excess supply of money and the interest rate must decline to restore money market equilibrium. The LM curve will shift down as a result of this to reflect the now lower interest rate. The IS curve does not shift as a result of this. We would simply observe a movement along the IS curve. AACSB: Written and oral communication Status: 8e question 41) Explain in detail what effect an increase in government spending will have on: (1) the LM curve; and (2) the IS curve. Answer: An increase in government spending will cause an increase in demand and the equilibrium level of output in the goods market will be higher. This is reflected in a rightward shift in the IS curve. Goods market events such as this will not cause a shift in the LM curve (only a movement along it). AACSB: Written and oral communication Status: 8e question 5.4

Using a Policy Mix

1) Suppose there is a simultaneous fiscal expansion and monetary expansion. We know with certainty that ________. A) output will increase B) output will decrease C) the interest rate will increase D) the interest rate will decrease E) both output and the interest rate will increase Answer: A AACSB: Application of knowledge Status: 8e question 2) Suppose there is a simultaneous fiscal expansion and monetary contraction. We know with certainty that ________. A) output will increase B) output will decrease C) the interest rate will increase D) the interest rate will decrease E) both output and the interest rate will increase Answer: C AACSB: Application of knowledge Status: 8e question

3) For this question, assume that investment spending depends only on output and no longer depends on the interest rate. Given this information, an increase in government spending ________. A) will cause investment to decrease B) will cause investment to increase C) may cause investment to increase or to decrease D) will have no effect on output E) will cause an increase in output and have no effect on the interest rate Answer: B AACSB: Application of knowledge Status: 8e question 4) A reasonable dynamic assumption for the IS-LM model is that ________. A) the economy is always on both the IS and LM curves B) the economy is always on the IS curve, but moves only slowly to the LM curve C) the economy is always on the LM curve, but moves only slowly to the IS curve D) the money market is quick to adjust, but the bond market adjusts more slowly E) adjustment to the new IS-LM equilibrium is instantaneous after an LM shift, but not after an IS shift Answer: C AACSB: Application of knowledge Status: 8e question 5) Under the reasonable dynamic assumptions discussed in the text, a monetary contraction should result in ________. A) an immediate rise in the interest rate, and no further interest rate changes B) an immediate rise in the interest rate, and then a fall in the interest rate over time C) an immediate rise in the interest rate, and then a further rise over time D) a very gradual but steady rise in the interest rate to its new equilibrium level E) no change in the interest rate initially, and then a sudden rise to its new equilibrium value Answer: B AACSB: Application of knowledge Status: 8e question 6) For this question, assume that investment spending depends only on the interest rate and no longer depends on output. Given this information, a reduction in the money supply ________. A) will cause investment to decrease B) will cause investment to increase C) may cause investment to increase or to decrease D) will have no effect on output E) will cause a reduction in output and have no effect on the interest rate Answer: A AACSB: Application of knowledge Status: 8e question

7) Suppose there is a Fed purchase of bonds and simultaneous tax cut. We know with certainty that this combination of policies must cause ________. A) an increase in the interest rate (i) B) a reduction in i C) an increase in output (Y) D) a reduction in Y Answer: C AACSB: Reflective thinking Status: 8e question 8) Suppose there is a simultaneous Fed sale of bonds and increase in consumer confidence. We know with certainty that these two simultaneous events will cause ________. A) an increase in the interest rate (i) B) a reduction in i C) an increase in output (Y) D) a reduction in Y Answer: A AACSB: Reflective thinking Status: 8e question 9) Suppose there is a simultaneous central bank purchase of bonds and increase in taxes. We know with certainty that this combination of policies must cause ________. A) an increase in the interest rate (i) B) a reduction in i C) an increase in output (Y) D) a reduction in Y Answer: B AACSB: Reflective thinking Status: 8e question 10) Suppose there is a simultaneous central bank sale of bonds and tax increase. We know with certainty that this combination of policies must cause ________. A) an increase in the interest rate (i) B) a reduction in i C) an increase in output (Y) D) a reduction in Y Answer: D AACSB: Reflective thinking Status: 8e question

11) First, briefly explain what is meant by the policy mix. Second, explain what effect different policy mixes might have on the level of output, investment, and the interest rate. Answer: The policy mix refers to the possible combinations of monetary (exp. or contr.) and fiscal (exp. or contr.) that can be simultaneously implemented. There are a number of different answers that could be given to the latter part of the question. The effects on output, the interest rate, and investment will depend on the type of mix. AACSB: Written and oral communication Status: 8e question 12) Use the IS-LM model to answer this question. Suppose there is a simultaneous increase in government spending and reduction in the money supply. Explain what effect this particular policy mix will have on output and the interest rate. Based on your analysis, do we know with certainty what effect this policy mix will have on investment? Explain. Answer: In this case, the LM curve shifts up and the IS curve shifts to the right. The interest rate will clearly be higher. The effects on output depend on the relative magnitude of the two policies. The effects on I are also ambiguous. If output falls, I will be lower. However, it is possible that output will rise here which creates the ambiguity. AACSB: Analytical thinking Status: 8e question 13) Use the IS-LM model to answer this question. Suppose there is a simultaneous increase in taxes and reduction in the money supply. Explain what effect this particular policy mix will have on output and the interest rate. Based on your analysis, do we know with certainty what effect this policy mix will have on investment? Explain. Answer: In this case, the LM curve shifts up and the IS curve shifts to the left. In this case, output will clearly fall. What happens to the interest rate depends on the relative magnitude of the two policies. The effects on I are again ambiguous. AACSB: Analytical thinking Status: 8e question 14) Use the IS-LM model to answer this question. Suppose there is a simultaneous increase in government spending and increase in the money supply. Explain what effect this particular policy mix will have on output and the interest rate. Based on your analysis, do we know with certainty what effect this policy mix will have on investment? Explain. Answer: In this case, the LM curve shifts down and the IS curve shifts to the right. The output will clearly be higher. The effects on interest rate depend on the relative magnitude of the two policies. The effects on I are also ambiguous. If interest rate falls, I will be higher. However, it is possible that interest rate will rise here which creates the ambiguity. AACSB: Analytical thinking Status: 8e question

5.5

How does the IS-LM Model Fit the Facts?

1) Empirically it takes nearly ________ years for monetary policy to have its full effect on output. A) 2 B) 1 C) 3 D) 4 Answer: A AACSB: Application of knowledge Status: 8e question 2) The largest decrease in retail sales from an increase in federal funds rate occurs after ________ quarters. A) 5 B) 1 C) 2 D) 4 Answer: A AACSB: Application of knowledge Status: 8e question 3) The largest decrease in output from an increase in federal funds rate occurs after ________ quarters. A) 8 B) 7 C) 5 D) 3 Answer: A AACSB: Application of knowledge Status: 8e question

Macroeconomics, 9e (Blanchard) Chapter 6: Financial Markets II: The Extended IS-LM Model 6.1

Nominal versus Real Interest Rates

1) Which of the following best defines the real interest rate (r)? A) the amount of goods we must give up next year in order to consume more goods today B) the amount of dollars we must give up next year in order to consume more goods today C) the amount of dollars we must give up next year in order to have more dollars today D) the amount of dollars we must give up today in order to have more dollars next year E) the amount of dollars we must give up today in order to consume more goods today Answer: A AACSB: Application of knowledge Status: 8e question 2) The nominal interest rate is ________. A) the interest rate measured in terms of goods B) always less than the real interest rate C) equal to the real interest rate minus the rate of inflation D) the type of interest rate typically reported in the financial pages of newspapers E) equal to the expected rate of inflation Answer: D AACSB: Application of knowledge Status: 8e question 3) If the nominal interest rate 8% and expected inflation 3%, the expected real interest rate in year t is approximately ________. A) 2% B) 3% C) 5% D) 8% E) 11% Answer: C AACSB: Analytical thinking Status: 8e question 4) Whenever the expected inflation rate is positive ________. A) the real interest rate is greater than the nominal interest rate B) the real interest rate is negative C) the real interest rate is positive D) the nominal interest rate must be equal to the real interest rate E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

5) Suppose that the nominal interest rate increases while the expected inflation rate rises. Given this information, we know with certainty that the real interest rate ________. A) will not change B) will fall C) will fall, but only if the increase in the nominal rate is smaller than the increase in expected inflation D) will fall, but only if the increase in the nominal rate is greater than the increase in expected inflation E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 6) Under which of the following assumptions would the nominal interest rate be equal to the real interest rate? A) Expected inflation is equal to the nominal interest rate. B) Expected inflation is equal to the real interest rate. C) Expected inflation is negative. D) Expected inflation is equal to zero. E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 7) If the nominal interest rate is less than the real interest rate, we know that ________. A) both the nominal or real interest rate must be negative B) the nominal interest rate must be equal to expected inflation C) expected deflation must be occurring D) expected inflation must be positive E) expected inflation must be zero Answer: C AACSB: Application of knowledge Status: 8e question 8) If the expected inflation rate is negative, the expected real interest rate must be ________. A) negative B) less than the nominal interest rate C) equal to the nominal interest rate D) greater than the nominal interest rate E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

9) Data on real and nominal interest rates of one-year U.S. T-Bills show that, over the past twenty years, ________. A) the nominal rate has always been less than the real rate B) whenever the nominal rate rises, the real rate falls, and vice versa C) the nominal rate has varied, but the real rate has not D) the real rate has varied, but the nominal rate has not E) the real rate has always been less than the nominal rate Answer: E AACSB: Application of knowledge Status: 8e question 10) With a nominal interest rate of 10%, the present discounted value of $200 to be received in one year is ________. A) $90.91 B) $165.29 C) $181.82 D) $190.00 E) $220.00 Answer: C AACSB: Analytical thinking Status: 8e question 11) With a nominal interest rate of 10% per year, the present discounted value of $200 to be received in two years is ________. A) $82.64 B) $90.91 C) $165.29 D) $181.82 E) $220.00 Answer: C AACSB: Analytical thinking Status: 8e question 12) If the nominal interest rate is 20% per year, how much money can an individual borrow today if she wants to repay $100 in one year? A) $80.00 B) $83.33 C) $120.00 D) $78.00 E) $121.00 Answer: B AACSB: Analytical thinking Status: 8e question

13) With a nominal interest rate of 5% per year, the present discounted value of $100 to be received in 10 years is ________. A) $50.00 B) $61.39 C) $95.24 D) $150.00 E) $163.89 Answer: B AACSB: Analytical thinking Status: 8e question 14) With a constant nominal interest rate equal to i, the present discounted value of $1.00 to be received 4 years from today is equal to ________. A) 1 + i B) i4 C) (1 + i)4 D) 1/(1 + i) 4 E) 4(1 + i) Answer: D AACSB: Analytical thinking Status: 8e question 15) An increase in the nominal interest rate, all else held constant, will always cause which of the following? A) the real interest rate to decrease B) the expected inflation rate to decrease C) the demand for money to increase D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 16) The present discounted value of a future payment becomes smaller when ________. A) the nominal interest rate decreases B) the payment is made sooner rather than later C) the payment itself decreases D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question

17) Suppose the nominal interest rate is zero. In this situation, the present discounted value of a finite sequence of future payments is equal to which of the following? A) zero B) the sum of the all payments divided by the rate of inflation C) the average value of each payment D) the sum of all payments E) the square of the sum of all payments Answer: D AACSB: Reflective thinking Status: 8e question 18) For this question, assume that the interest rate is greater than 0. Given this information and the information about the payments provided below, rank the following three sequences of payments according to their present value. 2005 2006 2007

"A" $190 $200 $210

"B" $200 $200 $200

"C" $210 $200 $190

A) A > B > C B) A > C > B C) C > B > A D) C > A > B E) B > A > C Answer: C AACSB: Analytical thinking Status: 8e question 19) For this question, assume that expected inflation is zero. In this situation, we know that ________. A) the nominal and real interest rates are equal B) the nominal interest rate will exceed the real interest rate C) the real interest rate will exceed the nominal interest rate D) the real interest will be zero E) the real interest rate is negative Answer: A AACSB: Application of knowledge Status: 8e question

20) When individuals make decisions about how much money and bonds to hold, which of the following variables affects those decisions? A) the real interest rate only B) the nominal interest rate only C) the expected inflation rate only D) either the real interest rate or the expected inflation rate E) both the nominal and real interest rates Answer: A AACSB: Application of knowledge Status: 8e question 21) Because expected inflation is typically positive, we know that ________. A) the nominal interest rate is generally less than the real interest rate B) the real interest rate is generally less than the nominal interest rate C) the nominal and real interest rates are generally equal D) the real interest rate is approximately equal to zero Answer: B AACSB: Application of knowledge Status: 8e question 22) For a given nominal interest rate, a reduction in expected inflation will cause ________. A) a reduction in the real interest rate B) an increase in the real interest rate C) an increase in investment D) an increase in money demand Answer: B AACSB: Application of knowledge Status: 8e question 23) Suppose that the nominal interest rate and expected inflation both decrease by 2%. Given this information, we would expect which of the following to occur? A) an increase in the real interest rate B) a reduction in the real interest rate C) a reduction in investment D) an increase in money demand E) an increase in the real interest rate and a reduction in investment Answer: D AACSB: Application of knowledge Status: 8e question

24) For this question, assume that expected inflation is equal to the nominal interest rate. In this situation, which of the following is correct? A) The real interest rate is negative. B) The real interest rate is positive. C) The real interest rate is higher than the nominal interest rate. D) The real interest rate is zero. Answer: D AACSB: Reflective thinking Status: 8e question 25) Because the nominal interest rate is always positive, the discount factor is always ________. A) negative B) greater than one C) zero D) less than one Answer: D AACSB: Application of knowledge Status: 8e question 26) Which of the following will not cause an increase in the present value of a sequence of payments? A) a reduction in the current interest rate B) a reduction in expected future interest rates C) an increase in a future expected payment D) none of these Answer: D AACSB: Analytical thinking Status: 8e question 27) Let: (1) Pt be the price of one unit of a market basket of goods (i.e., a composite commodity) in year t; (2) Pet+1 be the expected price of one unit of a market basket of goods in year t + 1; (3) πet+1 be the expected rate of inflation between period t and t + 1; and (4) it be the one-year nominal interest rate. Suppose an individual borrows the equivalent of one unit of a composite commodity today. Given this information, which of the following expressions represents (i.e., is equal to) the amount of the composite commodity one must repay in one year? A) (1 + it)(Pet+1)/(Pt) B) (1 + πet+1)/(1 + it) C) {(1 + πet+1)/(1 + it)} - 1 D) {(1 + it)(Pt)/(Pet+1)} - 1 E) none of these Answer: A AACSB: Analytical thinking Status: 8e question

28) Let: (1) Pt be the price of one unit of a market basket of goods (i.e., a composite commodity) in year t; (2) Pet + 1 be the expected price of one unit of a market basket of goods in year t + 1; (3) πet + 1 be the expected rate of inflation between period t and t + 1; and (4) it be the one-year nominal interest rate. Suppose an individual borrows the equivalent of one unit of a composite commodity today. Given this information, which of the following expressions represents (i.e., is equal to) the real interest rate (rt)? A) (1 + it)(Pet+1)/(Pt) B) (1 + πet+1)/(1 + it) C) {(1 + πet+1)/(1 + it)} - 1 D) {(1 + it)(Pt)/(Pet+1)} - 1 E) none of these Answer: D AACSB: Analytical thinking Status: 8e question 29) If the expected real interest rate 5% and expected inflation 3%, the nominal interest rate in year t is approximately ________. A) 2% B) 3% C) 5% D) 8% E) 11% Answer: D AACSB: Analytical thinking Status: 8e question 30) With a nominal interest rate of 5%, the present discounted value of $100 to be received in one year is ________. A) $90.91 B) $95.23 C) $181.82 D) $190.00 E) $220.00 Answer: B AACSB: Analytical thinking Status: 8e question

31) With a nominal interest rate of 5%, the present discounted value of $100 to be received in two years is ________. A) $85.00 B) $90.70 C) $95.23 D) $110.00 Answer: B AACSB: Analytical thinking Status: 8e question 6.2

Risk and Risk Premia

1) The risk that interest payments will not be made, or that the face value of a bond is not repaid when a bond matures is ________. A) interest rate risk B) inflation risk C) liquidity risk D) default risk Answer: D AACSB: Application of knowledge Status: 8e question 2) Which of the following bonds are considered to be default-risk free? A) municipal bonds B) investment-grade bonds C) U.S. Treasury bonds D) junk bonds Answer: C AACSB: Application of knowledge Status: 8e question 3) The spread between the interest rates on bonds with default risk and default-free bonds is called the ________. A) risk premium B) junk margin C) bond margin D) default premium Answer: A AACSB: Application of knowledge Status: 8e question

4) Which of the following long-term bonds has the highest interest rate? A) corporate BBB bonds B) U.S. Treasury bonds C) corporate AAA bonds D) municipal bonds Answer: A AACSB: Application of knowledge Status: 8e question 5) Which of the following long-term bonds has the lowest interest rate? A) corporate BBB bonds B) U.S. Treasury bonds C) corporate AAA bonds D) municipal bonds Answer: B AACSB: Application of knowledge Status: 8e question 6) Risk premiums on corporate bonds tend to ________ during business cycle expansions and ________ during recessions, everything else held constant. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: C AACSB: Application of knowledge Status: 8e question 7) Firms with ________ ratings are considered the safest. A) AAA B) BBB C) CCC D) BB Answer: A AACSB: Application of knowledge Status: 8e question 6.3

The Role of Financial Intermediaries

1) The process of indirect finance using financial intermediaries is called ________. A) direct lending B) financial intermediation C) resource allocation D) financial liquidation Answer: B AACSB: Application of knowledge Status: 8e question 10 Copyright © 2025 Pearson Education, Inc.

2) Which of the following statements are true? A) A bank's assets are its sources of funds. B) A bank's liabilities are its uses of funds. C) A bank's balance sheet shows that total assets equal total liabilities plus equity capital. D) A bank's balance sheet indicates whether or not the bank is profitable. Answer: C AACSB: Application of knowledge Status: 8e question 3) Which of the following statements is false? A) A bank's assets are its uses of funds. B) A bank issues liabilities to acquire funds. C) The bank's assets provide the bank with income. D) Bank capital is recorded as an asset on the bank balance sheet. Answer: D AACSB: Application of knowledge Status: 8e question 4) Which of the following are reported as liabilities on a bank's balance sheet? A) reserves B) checkable deposits C) consumer loans D) deposits with other banks Answer: B AACSB: Application of knowledge Status: 8e question 5) The leverage ratio is the ratio of a bank's ________. A) assets divided by its liabilities B) income divided by its assets C) assets divided by capital D) capital divided by its total liabilities Answer: C AACSB: Application of knowledge Status: 8e question 6) The capital ratio is the ratio of a bank's ________. A) assets divided by its liabilities B) income divided by its assets C) capital divided by its assets D) capital divided by its total liabilities Answer: C AACSB: Application of knowledge Status: 8e question

7) Channeling funds from individuals with surplus funds to those desiring funds when the saver does not purchase the borrower's security is known as ________. A) barter B) redistribution C) financial intermediation D) taxation Answer: C AACSB: Application of knowledge Status: 8e question 8) Securitization is a process of asset transformation that involves a number of different financial institutions working together. These financial institutions are known collectively as the ________. A) transformers B) amalgamation C) movers and shakers D) shadow banking system Answer: D AACSB: Application of knowledge Status: 8e question 9) Depositors lack of information about the quality of bank assets can lead to ________. A) bank panics B) bank booms C) sequencing D) asset transformation Answer: A AACSB: Application of knowledge Status: 8e question 10) Banks with higher leverage ________. A) are lower risk intermediaries B) have higher risk of insolvency C) almost always fail D) tend to have frequent bank panics Answer: B AACSB: Application of knowledge Status: New question 9e 11) A bank is insolvent when ________. A) its liabilities exceed its assets B) its assets exceed its liabilities C) its capital exceeds its liabilities D) its assets increase in value Answer: A AACSB: Application of knowledge Status: 8e question 12 Copyright © 2025 Pearson Education, Inc.

12) Holding large amounts of bank capital helps prevent bank failures because ________. A) it means that the bank has a higher income B) it makes loans easier to sell C) it can be used to absorb the losses resulting from bad loans D) it makes it easier to call in loans Answer: C AACSB: Application of knowledge Status: 8e question 13) If assets are difficult to sell quickly for their true value they are said to be ________. A) shadow assets B) insolvent C) liquid D) illiquid Answer: D AACSB: Application of knowledge Status: New question 9e 14) This difference between the maturity of the assets and the maturity of the liabilities, called the ________. A) maturity mismatch B) illiquid spread C) fire sale situation D) bank run Answer: A AACSB: Application of knowledge Status: New question 9e 15) Federal deposit insurance insures each checkable deposit up to ________. A) $50,000 B) $100,000 C) $250,000 D) $500,000 Answer: C AACSB: Application of knowledge Status: New question 9e 16) In March 2023 Silicon Valley Bank ________. A) failed due to a bank run B) became independent from the Fed C) branched into neighboring states D) converted to an investment bank Answer: A AACSB: Application of knowledge Status: New question 9e 13 Copyright © 2025 Pearson Education, Inc.

17) To prevent bank runs and the consequent bank failures, the United States established the ________ in 1934 to provide deposit insurance. A) FDIC B) SEC C) Federal Reserve D) ATM Answer: A AACSB: Application of knowledge Status: 8e question 18) Although the FDIC was created to prevent bank failures, its existence encourages banks to ________. A) take too much risk B) hold too much capital C) open too many branches D) buy too much stock Answer: A AACSB: Application of knowledge Status: 8e question 19) Which of the followings is not a bank's assets? A) reserves B) loans C) government bonds D) checkable deposits Answer: D AACSB: Application of knowledge Status: 8e question 20) Suppose bank A has assets of 100, liabilities of 80, and capital of 20. Its capital ratio is ________. A) 20% B) 25% C) 11% D) 10% Answer: A AACSB: Analytical thinking Status: 8e question

21) Suppose bank A has assets of 100, liabilities of 80, and capital of 20. Its leverage ratio is ________. A) 4 B) 5 C) 10 D) 9 Answer: B AACSB: Analytical thinking Status: 8e question 22) Suppose bank A has assets of 100, liabilities of 60, and capital of 40. Its capital ratio is ________. A) 40% B) 66% C) 25% D) 60% Answer: A AACSB: Analytical thinking Status: 8e question 23) Suppose bank A has assets of 100, liabilities of 60, and capital of 40. Its leverage ratio is ________. A) 1.5 B) 2.5 C) 0.6 D) 0.4 Answer: B AACSB: Analytical thinking Status: 8e question 6.4

Extending the IS-LM Model

1) How many interest rates were there in the IS-LM model in Chapter 5? A) one B) two C) three D) zero Answer: A AACSB: Application of knowledge Status: 8e question

2) The new term introduced in the extended IS-LM model is ________. A) risk premium B) nominal interest rate C) taxes D) G Answer: A AACSB: Application of knowledge Status: 8e question 3) The policy rate is ________. A) determined by monetary policy B) a real interest rate C) a risk premium D) entering the IS equation Answer: A AACSB: Application of knowledge Status: 8e question 4) The borrowing rate is ________. A) the rate at which consumers and firms can borrow B) a nominal interest rate C) determined by monetary policy D) a risk premium Answer: A AACSB: Application of knowledge Status: 8e question 5) When the risk premium (x) increases ________. A) IS curve shifts to the left. B) IS curve shifts to the right. C) LM curve shifts upward. D) LM curve shifts downward. Answer: A AACSB: Application of knowledge Status: 8e question 6) When the risk premium (x) decreases ________. A) IS curve shifts to the left B) IS curve shifts to the right C) LM curve shifts upward D) LM curve shifts downward Answer: B AACSB: Application of knowledge Status: 8e question

7) When the risk premium (x) increases leading decrease in output, a better policy tool is ________. A) decrease in policy rate B) increase in policy rate C) increase in government spending D) decrease in government spending Answer: A AACSB: Application of knowledge Status: 8e question 8) Given the zero lower bound on the nominal rate, the lowest real interest rate the central bank can achieve is ________. A) B) C) 0 D) i Answer: A AACSB: Application of knowledge Status: 8e question 6.5

The Global Financial Crisis: From a Housing Problem to a Financial Crisis

1) Looking at data through 2019, the Case-Shiller index is normalized to equal 100 in January ________. A) 1999 B) 1990 C) 2000 D) 2001 Answer: C AACSB: Application of knowledge Status: Modified 8e 2) The Case-Shiller index reached its peak in ________. A) 2006 B) 2007 C) 2005 D) 2008 Answer: A AACSB: Application of knowledge Status: 8e question

3) By 2006, about ________ of all U.S mortgages were subprimes. A) 10% B) 20% C) 30% D) 25% Answer: B AACSB: Application of knowledge Status: 8e question 4) The mortgage is said to be underwater when ________. A) the value of the house exceeds the value of the mortgage B) the house is flooded C) the value of the mortgage exceeds the value of the house D) none of these Answer: C AACSB: Application of knowledge Status: 8e question 5) In mid-2008, estimated losses on mortgages were estimated to be about ________ of U.S. GDP. A) 2% B) 5% C) 7% D) 9% Answer: A AACSB: Application of knowledge Status: 8e question 6) The first structured investment vehicle (SIV) was set up by ________ in 1988. A) J.P. Morgan B) Chase C) Citigroup D) Goldman Sachs Answer: C AACSB: Application of knowledge Status: 8e question 7) When the Federal Reserve buys assets other than U.S. Treasury securities it is known as ________. A) open market operations B) unconventional monetary policy C) TARP D) none of these Answer: B AACSB: Application of knowledge Status: 8e question 18 Copyright © 2025 Pearson Education, Inc.

8) Securitization can not help financial intermediaries ________. A) diversify their portfolios B) avoid bankruptcy C) attract more investors to buy and hold their securities D) decrease the cost of borrowing Answer: B AACSB: Application of knowledge Status: 8e question 9) Collateralized debt obligations (CDOs) were first issued in ________. A) 1980s B) 1990s C) 2000 D) 2001 Answer: A AACSB: Application of knowledge Status: 8e question 10) The spread is ________. A) the difference between the riskless rate and the rate at which banks are willing to lend to each other B) the difference between the riskless rate and the yield on corporate bonds C) the difference between the riskless rate and return on stocks D) none of these Answer: A AACSB: Application of knowledge Status: 8e question 11) When banks rely on borrowing from other banks or other investors, in the form of short-term debt, to finance the purchase of their assets, it is known as ________. A) narrow banking B) shadow banking C) illiquidity D) wholesale funding Answer: D AACSB: Application of knowledge Status: New question 9e 12) ________ was introduced in October 2008 to clean up banks. A) Liquidity facilities B) Wholesale funding C) TARP D) Fire sale Answer: C AACSB: Application of knowledge Status: 8e question 19 Copyright © 2025 Pearson Education, Inc.

13) American Recovery and Reinvestment Act 2009 calls for ________. A) both tax reductions and government spending reductions B) both tax reductions and government spending increases C) both tax increases and government spending increases D) both tax increases and government spending reductions Answer: B AACSB: Application of knowledge Status: 8e question 14) The collapse of the subprime mortgage market ________. A) did not affect the corporate bond market B) increased the perceived riskiness of Treasury securities C) reduced the BBB-AAA spread D) increased the BBB-AAA spread Answer: D AACSB: Application of knowledge Status: 8e question 15) The collapse of the subprime mortgage market increased the spread between BBB and default-free U.S. Treasury bonds. This is due to ________. A) a reduction in risk B) a reduction in maturity C) a flight to quality D) a flight to liquidity Answer: C AACSB: Application of knowledge Status: 8e question

Macroeconomics, 9e (Blanchard) Chapter 7: The Labor Market 7.1

A Tour of the Labor Market

1) Which of the following is considered out of the labor force? A) the unemployed B) those temporarily laid off who will soon be recalled C) those who worked full time, but in a family business D) those individuals who have started searching for employment for the first time E) none of these Answer: E AACSB: Application of knowledge Status: 8e question Use the information provided below to answer the following question(s). The non-institutional civilian population is 250 million, of which 100 million are employed and 10 million are unemployed. 2) Based on the information above, the unemployment rate is ________. A) 4% B) 6.6% C) 9.1% D) 10% E) 11.1% Answer: C AACSB: Analytical thinking Status: 8e question 3) Based on the information above, the labor force participation rate is ________. A) 36%. B) 40%. C) 44%. D) 90.1%. E) 66%. Answer: C AACSB: Analytical thinking Status: 8e question

4) Based on the information above, the nonparticipation rate is ________. A) 4% B) 9.1% C) 10% D) 56% E) 66% Answer: D AACSB: Analytical thinking Status: 8e question 5) Which of the following individuals would be considered unemployed? A) an individual who works only part-time B) an individual who works full-time in a family business, but is not paid C) an individual who is not working and is not looking for work D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 6) Based on the data provided in the chapter, which of the following represents the largest component of the labor force? A) discouraged workers B) retired individuals C) employed D) unemployed Answer: C AACSB: Application of knowledge Status: 8e question 7) The labor force is defined as ________. A) the sum of the employed and unemployed B) the total number employed C) the total number of working age individuals in the population D) the sum of the number of employed, unemployed and discouraged individuals Answer: A AACSB: Application of knowledge Status: 8e question

8) The participation rate in the United States in 2022 was approximately equal to ________. A) 96% B) 90% C) 62% D) 26% E) 5% Answer: C AACSB: Application of knowledge Status: Modified 8e 9) Which of the following represents the participation rate? A) the ratio of the number employed to the size of the labor force B) the ratio of the number employed to the civilian noninstitutional population C) the ratio of the labor force to the civilian noninstitutional population D) the ratio of the labor force to the total number of employed and unemployed workers Answer: C AACSB: Application of knowledge Status: 8e question 10) The average amount of time people spend unemployed is approximately ________. A) 1 month B) 6 months C) 12 months D) none of these Answer: D AACSB: Application of knowledge Status: 8e question 11) The Current Population Survey interviews approximately how many households each month? A) 5,000 B) 10,000 C) 60,000 D) 100,000 Answer: C AACSB: Application of knowledge Status: 8e question 12) In the United States, how many workers retire, on average, every day? A) 25,000 B) 100,000 C) 260,000 D) 350,000 Answer: D AACSB: Application of knowledge Status: New question 9e 3 Copyright © 2025 Pearson Education, Inc.

13) In the United States, on average ________ people quit looking for work each month. A) 500,000 B) 1.9 million C) 3.9 million D) more than 5 million Answer: B AACSB: Application of knowledge Status: New question 9e 14) A reduction in the unemployment rate will tend to cause which of the following? A) an increase in the separation rate B) a reduction in the nominal wage C) a reduction in the duration that one is unemployed D) none of these Answer: C AACSB: Application of knowledge Status: 8e question 15) When the unemployment rate is low, we would expect that ________. A) the probability of losing a job is high B) the probability of losing a job is low C) the probability an unemployed individual will find another job is low D) the separation rate will increase Answer: B AACSB: Application of knowledge Status: 8e question 16) The participation rate in the U.S. has increased steadily over time. First, explain what the participation rate represents. Second, explain why the participation rate has increased. Answer: The participation rate is the ratio of the labor force to the noninstitutional civilian population. One of the reasons for the significant increase in the participation rate is the increasing participation of women in the labor force. AACSB: Written and oral communication Status: 8e question 17) What effect does the existence of discouraged workers have on the ability of the official unemployment rate to provide accurate information about the extent to which labor is employed? Answer: Discouraged workers are individuals who have stopped searching for employment because, for example, they have become "discouraged" with the prospects of finding employment. Once they stop searching (after 4 weeks), they are no longer counted as unemployed and, therefore, in the labor force. Such a dynamic would cause the official unemployment to fall. Alternatively, the existence of discouraged workers implies that the official unemployment rate underestimates the extent to which labor is being is not being used. This explains why the existence of discouraged workers can cause the unemployment rate to be an imperfect measure of the utilization of labor. AACSB: Written and oral communication Status: 8e question 4 Copyright © 2025 Pearson Education, Inc.

18) First, provide a brief explanation of what the unemployment rate measures. Second, explain how changes in each of the components of the unemployment rate can cause changes in the unemployment rate. Answer: The unemployment rate measures the percentage of the labor force that is unemployed. The unemployment rate is based on a monthly survey of households. Individuals are classified as employed, unemployed, or out of the labor force. Individuals employed or unemployed are in the labor force. Suppose individuals decide to enter the labor force for the first time. This increase in the size of the labor force, all else fixed, would cause an increase in the unemployment rate. On the other hand, if there were an increase in the number of individuals unemployed (caused by, for example, firms laying off workers as demand for their products falls), we would observe no change in the labor force but an increase in the unemployment rate. AACSB: Written and oral communication Status: 8e question 7.2

Movements in Unemployment

1) Data on labor-force flows show that ________. A) almost all separations are due to death B) almost all separations are due to serious illness C) almost all separations are quits D) almost all separations are layoffs E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 2) Data on labor-force flows show that ________. A) in any given month, almost none of the unemployed gets jobs B) in any given month, almost all of the unemployed gets jobs C) the average duration of unemployment is about 2 weeks D) the average duration of unemployment is about 2 years E) in any given month, about one-fourth of the unemployed get jobs Answer: E AACSB: Application of knowledge Status: 8e question 3) When the unemployment rate is high ________ workers become employed within a month. A) more B) fewer C) a stable number of D) There is no relationship between duration of unemployment and the unemployment rate E) none of these Answer: B AACSB: Application of knowledge Status: New question 9e 5 Copyright © 2025 Pearson Education, Inc.

4) When the Current Population Survey (CPS) was introduced in 1940, it was based on a survey of approximately 8,000 households. The CPS survey is now based on a survey of how many households? A) 8,000 B) 10,000 C) 12,000 D) 20,000 E) 60,000 Answer: E AACSB: Application of knowledge Status: 8e question 5) As the unemployment rate falls, ________. A) the proportion of the unemployed finding a job decreases B) the separation rate increases C) the young and unskilled experience larger-than-average decreases in unemployment D) the separation rate decreases Answer: C AACSB: Application of knowledge Status: 8e question 7.3

Wage Determination

1) Which of the following statements about wage setting is true? A) Most workers in the U.S. have their wages set by formal contracts. B) Formal contracts play a more important role in Japan and Western Europe than in the United States. C) The minimum wage in the U.S. is about 75% of the average wage. D) all of these Answer: B AACSB: Application of knowledge Status: 8e question 2) The reservation wage is ________. A) the wage that an employer must pay workers to reduce turnover to a reasonable level B) the wage that ensures a laid-off individual will wait for re-hire, rather than find another job C) the lowest wage firms are allowed by law to pay workers D) the wage offer that will end a labor-strike E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

3) Efficiency wage theory suggests that ________. A) workers will be paid less than their reservation wage B) productivity might drop if the wage rate is too low C) the government can only set tax rates so high before people will prefer not to work D) unskilled workers will have a lower turnover rate than skilled workers E) firms will be more resistant to wage increases as the labor market tightens Answer: B AACSB: Application of knowledge Status: 8e question 4) If efficiency wage theory is valid, we would expect a relatively low premium over the reservation wage when ________. A) the unemployment rate is low B) the job requires very little training C) workers can easily find other work D) workers have few other options for employment in the area E) all of these Answer: D AACSB: Application of knowledge Status: 8e question 5) Henry Ford's experiment with efficiency wages resulted in ________. A) a dramatic drop in productivity B) a dramatic increase in the turnover rate C) a reduction in the layoff rate D) new problems with the work force, like drunkenness and reckless driving E) no noticeable effects Answer: C AACSB: Application of knowledge Status: 8e question 6) In the wage-setting relation, the nominal wage tends to decrease when ________. A) the price level increases B) the unemployment rate decreases C) unemployment benefits decrease D) the minimum wage increases E) all of these Answer: C AACSB: Application of knowledge Status: 8e question

7) In the wage setting relation W = PeF(u,z), the variable z does not include which of the following variables? A) the minimum wage B) unemployment benefits C) the extent to which firms mark up prices over their marginal cost D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 8) Labor productivity is represented by which of the following? A) the ratio of output per worker B) workers per unit of capital C) capital per worker D) the ratio of output to population E) the ratio of output to the labor force Answer: A AACSB: Application of knowledge Status: 8e question 9) Today, about ________ of U.S. workers have their wages set by collective bargaining agreements. A) 10% B) 15% C) 20% D) 25% Answer: A AACSB: Application of knowledge Status: 8e question 10) Explain several implications and characteristics of efficiency wage theories. Answer: The efficiency wage theory suggests that firms will pay workers a wage in excess of the workers' reservation wage to minimize quits and to increase productivity. The efficiency wage theory also suggests that nominal wages will be a function of labor market conditions. As the unemployment rate falls, the nominal wage will rise. AACSB: Written and oral communication Status: 8e question

11) Explain how an increase in the unemployment rate will affect bargaining power and nominal wages. Answer: As the unemployment rate increases, it is more difficult for individuals to find employment at other firms. So, workers' bargaining power will fall. As bargaining power falls, the nominal wage will fall. AACSB: Analytical thinking Status: 8e question 12) First, explain what the WS relation represents. Second, explain why it has its particular shape. Answer: The WS relation illustrates the effect of changes in the unemployment rate on the real wage implied by the wage-setting behavior of firms and workers. The WS curve (or relation) is downward sloping because as the unemployment rate increases, workers have less bargaining power so the nominal wage will decrease. This decrease in W, given P, implies that the real wage will also fall. Hence, the WS curve is downward sloping. AACSB: Written and oral communication Status: 8e question 7.4

Price Determination

1) The price setting equation is represented by the following: P = (1 + m)W. When there is perfect competition, we know that m will equal ________. A) W B) P C) 1 D) W/P E) 0 Answer: E AACSB: Application of knowledge Status: 8e question 2) Explain why nominal wages are a function of the expected price level. Answer: Workers and firms care about the real wage. Nominal wages are typically set for a period of time by contracts. Individuals will, therefore, be concerned about what the future price level will be when determining the nominal wage. When setting the nominal wage, individuals will form expectations of what the future price level will be. They will use this to help determine the nominal wage. AACSB: Written and oral communication Status: 8e question

3) ________ is the relation between the inputs used in production and the quantity of output produced, and on the prices of these inputs. A) The production function B) Labor demand C) Labor productivity D) The markup Answer: A AACSB: Application of knowledge Status: New question 9e 4) When firms have market power the m in P = (1 + m) W is ________. A) negative B) zero C) positive D) none of these Answer: C AACSB: Application of knowledge Status: New question 9e 7.5

The Natural Rate of Unemployment

1) The natural rate of unemployment is the rate of unemployment ________. A) that occurs when the money market is in equilibrium B) that occurs when the markup of prices over costs is zero C) where the markup of prices over costs is equal to its historical value D) that occurs when both the goods and financial markets are in equilibrium E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 2) The natural level of output is the level of output that occurs when ________. A) the goods market and financial markets are in equilibrium B) the economy is operating at the unemployment rate consistent with both the wage-setting and price-setting equations C) the markup (m) is zero D) the unemployment rate is zero E) there are no discouraged workers in the economy Answer: B AACSB: Application of knowledge Status: 8e question

3) Suppose we wish to examine the determinants of the equilibrium real wage and equilibrium level of employment (N). In a graph with the real wage on the vertical axis, and the level of employment on the horizontal axis, the price-setting relation will now be ________. A) a vertical line B) a horizontal line C) an upward sloping line D) a downward sloping line E) kinked at the natural rate of unemployment Answer: B AACSB: Application of knowledge Status: 8e question 4) Suppose we wish to examine the determinants of the equilibrium real wage and equilibrium level of employment (N). In a graph with the real wage on the vertical axis, and the level of employment on the horizontal axis, the wage-setting relation will now be ________. A) a vertical line B) a horizontal line C) an upward sloping line D) a downward sloping line E) a curve that first slopes upward, then downward Answer: D AACSB: Application of knowledge Status: 8e question 5) The natural level of employment (N) will increase when which of the following occurs? A) an increase in the markup of prices over costs B) an increase in unemployment benefits C) an increase in the actual unemployment rate D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 6) Suppose workers and firms expect the overall price level to increase by 5%. Given this information, we would expect that ________. A) the nominal wage will increase by less than 5% B) the nominal wage will increase by exactly 5% C) the nominal wage will increase by more than 5% D) the real wage will increase by 5% E) the real wage will increase by less than 5% Answer: B AACSB: Application of knowledge Status: 8e question

7) Suppose the actual unemployment rate decreases. This will cause ________. A) an upward shift in the WS curve B) a downward shift in the WS curve C) an upward shift in the PS curve D) a downward shift in the PS curve E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 8) Suppose the actual unemployment rate increases. This will cause ________. A) an upward shift in the WS curve B) a downward shift in the WS curve C) an upward shift in the PS curve D) a movement along the WS and the PS curves E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 9) With the real wage on the vertical axis and the unemployment rate on the horizontal axis, we know that ________. A) the WS curve is upward sloping B) the WS curve is downward sloping C) the PS curve is upward sloping D) the PS curve is downward sloping Answer: B AACSB: Application of knowledge Status: 8e question 10) Based on wage setting behavior, we know that a reduction in the unemployment rate will cause ________. A) no change in the real wage B) a reduction in the real wage C) an increase in the real wage D) an upward shift of the WS curve Answer: C AACSB: Application of knowledge Status: 8e question

11) Based on price setting behavior, we know that a reduction in the unemployment rate will cause ________. A) no change in the real wage B) a reduction in the real wage C) an increase in the real wage D) an upward shift of the PS curve Answer: A AACSB: Reflective thinking Status: 8e question 12) A reduction in unemployment benefits will tend to cause which of the following? A) an upward shift in the WS curve B) a downward shift in the WS curve C) an upward shift in the PS curve D) a downward shift in the PS curve E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 13) An increase in the minimum wage will tend to cause which of the following? A) an upward shift in the WS curve B) a downward shift in the WS curve C) an upward shift in the PS curve D) a downward shift in the PS curve E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 14) Suppose that increased international trade makes product markets more competitive in the U.S. Given this information, we would expect to observe which of the following? A) an upward shift in the WS curve B) a downward shift in the WS curve C) an upward shift in the PS curve D) a downward shift in the PS curve E) none of these Answer: C AACSB: Reflective thinking Status: 8e question

15) With the real wage on the vertical axis and unemployment rate (u) on the horizontal axis, we know that ________. A) the WS curve is upward sloping B) the WS curve is downward sloping C) the PS curve is upward sloping D) the PS curve is downward sloping Answer: B AACSB: Application of knowledge Status: 8e question 16) Based on our understanding of the labor market model presented in Chapter 7, we know that an increase in the minimum wage will cause ________. A) an increase in the equilibrium real wage B) a reduction in the equilibrium real wage C) a reduction in the natural rate of unemployment D) a reduction in the equilibrium real wage and natural rate of unemployment Answer: A AACSB: Reflective thinking Status: 8e question 17) Based on our understanding of the labor market model presented in Chapter 7, we know that an increase in the markup will cause ________. A) an increase in the equilibrium real wage B) a reduction in the equilibrium real wage C) a reduction in the natural rate of unemployment D) a reduction in the equilibrium real wage and natural rate of unemployment Answer: B AACSB: Reflective thinking Status: 8e question 18) Based on our understanding of the labor market model presented in Chapter 7, we know that a reduction in the markup will cause ________. A) an increase in the equilibrium real wage B) a reduction in the equilibrium real wage C) an increase in the natural rate of unemployment D) a reduction in the natural rate of unemployment and no change in the real wage Answer: A AACSB: Reflective thinking Status: 8e question

19) For this question, assume that Y = N. Based on our understanding of the labor market model presented in Chapter 7, we know that an increase in the minimum wage will cause ________. A) an increase in the natural level of output B) a reduction in the natural level of output C) no change in the natural level of output D) an increase in the natural level of employment Answer: B AACSB: Application of knowledge Status: 8e question 20) For this question, assume that Y = N. Based on our understanding of the labor market model presented in Chapter 7, we know that a reduction in the markup will cause ________. A) an increase in the natural level of output B) a reduction in the natural level of output C) no change in the natural level of output D) a reduction in the natural level of employment Answer: A AACSB: Application of knowledge Status: 8e question 21) Based on wage setting behavior, we know that an increase in the unemployment rate will cause ________. A) no change in the real wage B) a reduction in the real wage C) an increase in the real wage D) an upward shift of the WS curve Answer: B AACSB: Application of knowledge Status: 8e question 22) Based on price setting behavior, we know that an increase in the unemployment rate will cause ________. A) no change in the real wage B) a reduction in the real wage C) an increase in the real wage D) an upward shift of the PS curve Answer: A AACSB: Application of knowledge Status: 8e question

23) An increase in unemployment benefits will tend to cause which of the following? A) a downward shift in the WS curve B) an upward shift in the PS curve C) an upward shift in the WS curve D) a downward shift in the PS curve E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 24) A reduction in the minimum wage will tend to cause which of the following? A) an upward shift in the WS curve B) a downward shift in the WS curve C) an upward shift in the PS curve D) a downward shift in the PS curve E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 25) Explain what effect a reduction in the unemployment rate will have on the real wage based on: (1) the WS relation; and (2) the PS relation. Answer: A reduction in the unemployment rate will increase bargaining power, increase the nominal wage, and therefore increase the real wage based on wage setting behavior. Changes in the unemployment rate have no effect on the real wage based on price setting behavior. AACSB: Written and oral communication Status: 8e question 26) First, explain what the PS relation represents. Second, explain why it has its particular shape. Answer: The PS relation illustrates the effect of changes in the unemployment rate on the real wage implied by the price-setting behavior of firms. Firms set prices as a markup over their marginal cost of producing goods. Given that the marginal cost is assumed to be independent of the level of employment (and, therefore, the unemployment rate), changes in u will have no effect on the price firms set and, therefore, on the real wage based on PS behavior. AACSB: Written and oral communication Status: 8e question 27) Graphically illustrate (using the WS and PS relations) and explain the effects of an increase in the markup on the equilibrium real wage, the natural rate of unemployment, the natural level of employment, and the natural level of output. Answer: An increase in the markup will cause firms to raise the price given the nominal wage. This will cause the real wage based on price setting behavior to decrease; this is represented by a downward shift in the PS curve. This reduction in the real wage will also occur with an increase in the unemployment rate. So, the natural rate of unemployment will rise and the natural level of employment and, therefore, output will fall. The equilibrium real wage will also be lower. AACSB: Written and oral communication Status: 8e question 16 Copyright © 2025 Pearson Education, Inc.

28) Graphically illustrate (using the WS and PS relations) and explain the effects of an increase in the minimum wage on the equilibrium real wage, the natural rate of unemployment, the natural level of employment, and the natural level of output. Answer: An increase in the minimum wage will cause the nominal wage based on wage setting behavior to increase; this is represented as an upward shift in the WS relation. As the nominal wage increases, firms will respond by increasing the price level so we will observe no change in the equilibrium real wage. We will observe an increase in the natural rate of unemployment and a reduction in both the natural level of employment and output. AACSB: Written and oral communication Status: 8e question 29) Based on your understanding of the labor market model presented by Blanchard (i.e., the WS and PS relations), explain what types of policies could be implemented to cause a reduction in the natural rate of unemployment. Answer: The natural rate of unemployment will change whenever either the PS or WS relations change. To reduce the natural rate, policy makers could implement polices that: (1) reduce unemployment benefits; (2) reduce the minimum wage; or (3) increase competition in product markets. AACSB: Application of knowledge Status: 8e question 30) Explain how a reduction in the unemployment rate will affect bargaining power and nominal wages. Answer: As the unemployment rate decreases, it is easier for individuals to find employment at other firms. So, workers' bargaining power will increase. As bargaining power increases, the nominal wage will increase. AACSB: Reflective thinking Status: 8e question 31) Graphically illustrate (using the WS and PS relations) and explain the effects of a reduction in the markup on the equilibrium real wage, the natural rate of unemployment, the natural level of employment, and the natural level of output. Answer: A reduction in the markup will cause firms to reduce the price given the nominal wage. This will cause the real wage based on price setting behavior to increase; this is represented by a upward shift in the PS curve. This increase in the real wage will also occur with an decrease in the unemployment rate. So, the natural rate of unemployment will decrease and the natural level of employment and, therefore, output will increase. The equilibrium real wage will also be higher. AACSB: Analytical thinking Status: 8e question

32) Graphically illustrate (using the WS and PS relations) and explain the effects of a reduction in the minimum wage on the equilibrium real wage, the natural rate of unemployment, the natural level of employment, and the natural level of output. Answer: A reduction in the minimum wage will cause the nominal wage based on wage setting behavior to decrease; this is represented as an downward shift in the WS relation. As the nominal wage deceases, firms will respond by reducing the price level so we will observe no change in the equilibrium real wage. We will observe a decrease in the natural rate of unemployment and an increase in both the natural level of employment and output. AACSB: Analytical thinking Status: 8e question 33) Explain what effect an increase in the unemployment rate will have on the real wage based on: (1) the WS relation; and (2) the PS relation. Answer: An increase in the unemployment rate will decrease bargaining power, decrease the nominal wage, and therefore decrease the real wage based on wage setting behavior. Changes in the unemployment rate have no effect on the real wage based on price setting behavior. AACSB: Written and oral communication Status: 8e question

Macroeconomics, 9e (Blanchard) Chapter 8: The Phillips Curve, the Natural Rate of Unemployment, and Inflation 8.1

Inflation, Expected Inflation, and Unemployment

1) In which of the following periods was the relationship between the U.S. unemployment rate and U.S. inflation rate unstable? A) 1901 to 1909 B) 1911 to 1919 C) 1921 to 1929 D) 1931 to 1939 E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) In the Phillips curve equation, which of the following will cause an increase in the current inflation rate? A) an increase in the expected inflation rate B) a reduction in the unemployment rate C) an increase in the markup, m D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 3) Data for which country were first used to illustrate the relationship between unemployment and inflation (i.e., the original Phillips curve)? A) France B) United States C) Canada D) Germany E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 4) Which of the following individuals first discovered the relationship between unemployment and inflation? A) Solow B) Samuelson C) Friedman D) Phillips Answer: D AACSB: Application of knowledge Status: 8e question 1 Copyright © 2025 Pearson Education, Inc.

5) Which of the following individuals first discovered the relationship between unemployment and inflation for the United States? A) Solow and Friedman B) Samuelson and Solow C) Friedman and Phillips D) Friedman and Phelps Answer: B AACSB: Application of knowledge Status: 8e question 6) An increase in the markup, or any other factor that affects wages, will ________. A) lead to an increase in inflation B) lower the overall price level C) force firms to produce fewer units D) increase employment Answer: A AACSB: Application of knowledge Status: New question 9e 7) Based on the "early incarnation" of the Phillips curve, explain what effect an increase in the unemployment rate will have on the inflation rate. Answer: An increase in u will cause a reduction in W. As W falls, firms' costs fall. As firms' costs fall, they will reduce the price level. This reduction in the price level represents, in this case, deflation. AACSB: Application of knowledge Status: 8e question 8.2

The Role of Inflation Expectations

1) Since approximately 1970, the most stable Phillips-type relationship for the United States has been between which of the following? A) the rate of inflation and the change in the unemployment rate B) the unemployment rate and the change in the rate of inflation C) the change in the unemployment rate and the change in the rate of inflation D) the inverse of the unemployment rate and the rate of inflation E) the unemployment rate and the rate of inflation Answer: B AACSB: Application of knowledge Status: 8e question

2) Which of the following assumptions best characterized the assumption about how individuals formed expectations of inflation by the early 1970s? A) Expected inflation for the current year was smaller than the previous year's inflation rate. B) Expected inflation for the current year was approximately equal to the previous year's inflation rate. C) Expected inflation for the current year was less than the previous year's inflation rate. D) Expected inflation for the current year equal to the average inflation rate over the past five years. E) Expected inflation for the current year equal to the average inflation rate over the past ten years. Answer: B AACSB: Analytical thinking Status: 8e question 3) When inflation has not been very persistent, as was the case in the United States before the mid-1960s, we can expect that ________. A) the expected price level for a given year will equal the previous year's actual price level B) the current inflation rate will not depend heavily on past years' inflation rates C) lower unemployment rates will be associated with higher inflation rates D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 4) When inflation has been persistent, as was the case in the United States during the 1970s, low unemployment rates will likely be associated with ________. A) low natural rates of unemployment B) high natural rates of unemployment C) low but stable rates of inflation D) high but stable rates of inflation E) increases in the inflation rate Answer: E AACSB: Application of knowledge Status: 8e question 5) For this question, assume that individuals form expectations of inflation according to the following equation πet = θπt-1. From 1970 on, the value of θ for this equation ________. A) increased over time and approached 1 B) decreased over time and approached zero C) remained constant at zero D) remained constant at negative one E) none of these Answer: A AACSB: Analytical thinking Status: 8e question 3 Copyright © 2025 Pearson Education, Inc.

6) For this question, assume that the Phillips curve equation is represented by the following equation: πt - πt-1 = (m + z) - αut. A reduction in the unemployment rate will cause ________. A) a reduction in the markup over labor costs (i.e., a reduction in m) B) an increase in the markup over labor costs C) an increase in the inflation rate over time D) a decrease in the inflation rate over time E) none of these Answer: C AACSB: Analytical thinking Status: 8e question 7) For this question, assume that the expected rate of inflation is a function of past year's inflation. Also assume that the unemployment rate has greater than the natural rate of unemployment for a number of years. Given this information, we know that ________. A) the rate of inflation will approximately be equal to zero B) the rate of inflation should neither increase nor decrease C) the rate of inflation should steadily increase over time D) the rate of inflation should steadily decrease E) the inflation rate will be approximately equal to the natural rate of unemployment Answer: D AACSB: Analytical thinking Status: 8e question 8) The original Phillips curve implied or assumed that ________. A) the markup over labor costs was zero B) the expected rate of inflation would be zero C) the actual and expected rates of inflation would always be equal D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 9) For this question, assume that the Phillips curve equation is represented by the following equation: πt - πt-1 = (m + z) - αut. Given this information, the natural rate of unemployment will be equal to ________. A) m + z B) (m + z - α) C) α(m + z) D) 0 E) none of these Answer: E AACSB: Analytical thinking Status: 8e question

10) For this question, assume that the Phillips curve equation is represented by the following: πt πt-1 = (m + z) - αut. Which of the following will cause a reduction in the natural rate of unemployment? A) an increase in m B) an increase in z C) an increase in α D) an increase in actual inflation E) an increase in expected inflation Answer: C AACSB: Analytical thinking Status: 8e question 11) For this question, assume that the Phillips curve equation is represented by the following: πt πt-1 = (m + z) - αut. Which of the following will not cause an increase in the natural rate of unemployment? A) a reduction in m B) a reduction in z C) an increase in α D) an increase in the expected rate of inflation E) all of these Answer: D AACSB: Analytical thinking Status: 8e question 12) Use the following Phillips curve equation to answer this question: πt - πt-1 = (m + z) - αut. Which of the following will cause an increase in the natural rate of unemployment? A) a reduction in m B) an increase in z C) an increase in α D) a reduction in expected inflation E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 13) In which of the following decades did the Phillips curve break down for the U.S.? A) 1940s B) 1950s C) 1960s D) none of these Answer: D AACSB: Application of knowledge Status: 8e question

14) Assume that expected inflation is based on the following: πet = θπt-1. An increase in θ will cause ________. A) an increase in the natural rate of unemployment B) a reduction in the natural rate of unemployment C) no change in the natural rate of unemployment D) inflation in period t to be more responsive to changes in unemployment in period t Answer: C AACSB: Application of knowledge Status: 8e question 15) Assume that expected inflation is based on the following: πet = θπt-1. If θ = 0, we know that ________. A) a reduction in the unemployment rate will have no effect on inflation B) low rates of unemployment will cause steadily increasing rates of inflation C) high rates of unemployment will cause steadily declining rates of inflation D) the Phillips curve illustrates the relationship between the level of inflation rate and the level of the unemployment rate Answer: D AACSB: Application of knowledge Status: 8e question 16) Assume that expected inflation is based on the following: πet = θπt-1. If θ = 1, we know that ________. A) a reduction in the unemployment rate will have no effect on inflation B) low rates of unemployment will cause steadily increasing rates of inflation C) the actual unemployment rate will not deviate from the natural rate of unemployment D) the Phillips curve illustrates the relationship between the level of inflation rate and the level of the unemployment rate Answer: B AACSB: Application of knowledge Status: 8e question 17) Suppose policy makers underestimate the natural rate of unemployment. In a situation like this, policy makers might implement a policy that ________. A) attempts to maintain output below the natural level of output B) results in deflation C) attempts to maintain output below the natural level of output and results in deflation D) results in steadily rising inflation Answer: D AACSB: Application of knowledge Status: 8e question

18) During which decade did the original Phillips curve break down? Also, briefly explain why the original Phillips curve broke during this period. Answer: The original Phillips curve broke down in the United States in the 1970s. First, the United States was affected by oil shocks that would cause an increase in both inflation and the unemployment rate. Second, individuals changed the way they formed expectations of prices. Rather than assume that this year's price level would be equal to last year's price level (i.e., zero expected inflation), individuals started to assume that previous inflation would persist. AACSB: Written and oral communication Status: 8e question 19) Explain how the original Phillips curve differs from the expectations-augmented Phillips curve (or the modified, or accelerationist Phillips curve). Answer: The original Phillips curve did not take into account the effects of changes in expected inflation on inflation. The expectations-augmented Phillips curve did allow for changes in expected inflation to affect actual inflation. AACSB: Application of knowledge Status: 8e question 20) By the mid-1970s, the Phillips curve relation became a relation between the change in the rate of inflation and the difference between the unemployment rate and the natural rate. To distinguish it from the original Phillips curve, it became known as the ________. A) anchored Phillips curve B) Solow growth curve C) accelerationist Phillips curve D) deanchored Phillips curve Answer: C AACSB: Application of knowledge Status: New question 9e 21) Expectations of inflation that had become ________ during the 1970s and the 1980s became ________, reacting little or not at all to movements in actual inflation. A) de-anchored; re-anchored B) re-anchored; de-anchored C) re-anchored; stable D) de-anchored; unstable Answer: A AACSB: Application of knowledge Status: New question 9e 22) Briefly comment on the predictions of economists Milton Friedman and Edmund Phelps about the ability to exploit a trade-off between inflation and unemployment. Answer: Both Friedman and Phelps (separately) argued that there might be a temporary tradeoff between inflation and unemployment. However, both argued that this trade-off could not be exploited permanently. Eventually, expectations of inflation would adjust. AACSB: Application of knowledge Status: 8e question 7 Copyright © 2025 Pearson Education, Inc.

23) A number of factors are believed to have caused changes in the natural rate of unemployment in the United States during the 1990s. Briefly comment on each of these factors. Answer: There are a number of candidates here: decrease in monopoly power, decreasing role of unions, aging U.S. population, increased prison population, increased number of workers on disability, and unexpectedly high rate of productivity growth. AACSB: Written and oral communication Status: 8e question 24) Based on your understanding of the Phillips curve, is it possible for the unemployment rate to increase while inflation increases? Explain. Answer: This can occur when negative supply shocks occur. That is, we would observe this when factors cause the natural rate of unemployment to rise (e.g. during the 1970s). This would cause an increase in u and an increase in inflation. AACSB: Written and oral communication Status: 8e question 8.3

The Role of Supply Shocks and Covid-19 Inflation

1) An increase in the price of oil will likely cause which of the following? A) increase the markup in the Phillips curve equation B) increase the sum "m + z" in the Phillips curve equation C) increase the natural rate of unemployment D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) In the 1970s the formation of OPEC (the Organization of Petroleum Exporting Countries), a cartel of oil producers that was able to act as a monopolist, led to a ________ in the price of oil. A) fivefold increase B) fourfold C) threefold D) doubling Answer: A AACSB: Application of knowledge Status: New question 9e 3) The Covid-19 pandemic led to ________. A) a major decline in oil prices and other commodities B) falling wages across all sectors of the economy C) a major increase in the price of commodities D) a slight decline in overall prices Answer: C AACSB: Application of knowledge Status: New question 9e 8 Copyright © 2025 Pearson Education, Inc.

4) When the cost of nonlabor inputs increases, firms pass on the higher costs in prices, leading to an increase in the price level given wages, thus leading to an increase in ________. A) the money supply B) markup C) unemployment D) consumption Answer: B AACSB: Application of knowledge Status: New question 9e 5) What happens to inflation over time when a supply shock occurs depends on ________. A) how fast m + z returns to its initial value and how rapidly inflation expectations adjust B) how soon consumers respond to the supply shock by reducing spending C) whether the supply of goods and services exceeds the demand for goods and services D) whether demand bottlenecks occur Answer: A AACSB: Application of knowledge Status: New question 9e 6) The start of the Covid-19 crisis in the first quarter of 2020 was associated, in the United States, with lockdowns, a large increase in the ________, and an initial decrease in the ________. A) commodity prices; unemployment rate B) inflation rate; unemployment rate C) unemployment rate; inflation rate D) unemployment rate; natural rate of employment Answer: C AACSB: Application of knowledge Status: New question 9e 7) Two factors played a role in the post-Covid-19 inflation. The first was ________, since consumers had been unwilling (because of the uncertainty) and often unable (because of the lockdowns) to spend. A) kinked consumer demand B) shortages of some goods C) limited consumer demand D) pent-up demand from consumers Answer: D AACSB: Application of knowledge Status: New question 9e

8) The Trump administration and the Biden administration both passed fiscal stimulus during and after the pandemic that represented ________ of the 2020 GDP. A) 10% B) 15% C) 20% D) 25% Answer: B AACSB: Application of knowledge Status: New question 9e 9) The OPEC supply shock of the 1970 pushed inflation up to a peak of a ________ annual rate in the first quarter of 1980. A) 11% B) 14% C) 17% D) 21% Answer: C AACSB: Application of knowledge Status: New question 9e 10) What two factors led to an increase in inflation following the Covid-19 pandemic? Answer: First, the world demand for commodities, from food to raw materials to oil, went up, partly because of high US demand, partly from higher demand worldwide as economies recovered from their initial drop. Second, supply chains were disrupted. Even when lockdowns were lifted, they had lasting effects on supply chains, both international and national. Critical intermediate inputs were not available, leading to shortages and higher prices. AACSB: Written and oral communication Status: New question 9e 11) Why did inflation expectations remain anchored following the high post-Covid-19 inflation? Answer: The most likely answer the increased credibility of central banks' commitment to meeting their target inflation, which led wage and price setters to assume that the high inflation would decrease to go back to target over time. AACSB: Written and oral communication Status: New question 9e 12) What is the major reason for oil price to go up in the 1970s? A) formation of the OPEC B) fast of growth of emerging economies C) new energy D) higher demand from the US Answer: A AACSB: Application of knowledge Status: 8e question

13) From 1970 to the mid-1990s, the relative price of crude petroleum ________. A) steadily increased B) steadily decreased C) increased dramatically, then decreased dramatically D) decreased dramatically, then increased dramatically E) remained more or less the same Answer: C AACSB: Application of knowledge Status: 8e question 14) In the short run, a reduction in the price of oil may lead to ________. A) a reduction in output B) an increase in the price level C) a reduction in the interest rate D) all of these E) none of these Answer: C AACSB: Analytical thinking Status: 8e question 15) What is the major reason for oil price to go up in the 2000s? A) formation of the OPEC B) fast of growth of emerging economies C) new energy D) higher demand from the US Answer: B AACSB: Application of knowledge Status: 8e question 16) The wage setting relation is ________. A) downward sloping B) upward sloping C) vertical D) horizontal Answer: A AACSB: Application of knowledge Status: 8e question 17) The price setting relation is ________. A) horizontal B) upward sloping C) downward sloping D) vertical Answer: A AACSB: Application of knowledge Status: 8e question 11 Copyright © 2025 Pearson Education, Inc.

18) An increase in the price of oil will cause which of the following in the medium run? A) no change in the level of output B) no change in the price level C) an increase in the unemployment rate D) a reduction in the interest rate E) none of these Answer: C AACSB: Analytical thinking Status: 8e question 19) For this question, assume that the economy is initially operating at the natural level of output. An increase in the price of oil will cause which of the following in the medium run? A) a reduction in the interest rate B) a reduction in output and an increase in the aggregate price level C) a reduction in output and a reduction in the interest rate D) a reduction in unemployment, an increase in the nominal wage and an increase in the aggregate price level E) a reduction in the aggregate price level and no change in output Answer: B AACSB: Analytical thinking Status: 8e question 20) For this question, assume that the economy is initially operating at the natural level of output. A reduction in consumer confidence will cause ________. A) an increase in the real wage in the medium run B) a reduction in the real wage in the medium run C) no change in the real wage in the medium run D) ambiguous effects on the real wage in the medium run Answer: C AACSB: Analytical thinking Status: 8e question 21) For this question, assume that the economy is initially operating at the natural level of output. A reduction in taxes will cause ________. A) an increase in the real wage in the medium run B) a reduction in the real wage in the medium run C) no change in the nominal wage in the medium run D) ambiguous effects on the real wage in the medium run E) none of these Answer: E AACSB: Analytical thinking Status: 8e question

22) For this question, assume that the economy is initially operating at the natural level of output. An increase in unemployment benefits will cause ________. A) an increase in the real wage in the medium run B) a reduction in the real wage in the medium run C) no change in the real wage in the medium run D) ambiguous effects on the real wage in the medium run Answer: C AACSB: Analytical thinking Status: 8e question 23) For this question, assume that the economy is initially operating at the natural level of output. A monetary expansion will cause ________. A) no change in the real wage in the medium run B) an increase in investment in the medium run C) a reduction in the interest rate in the medium run D) no change in the nominal wage in the medium run Answer: A AACSB: Analytical thinking Status: 8e question 24) In the short run, an increase in the price of oil may lead to ________. A) an increase in output B) a reduction in the price level C) an increase in the interest rate D) all of these E) none of these Answer: C AACSB: Analytical thinking Status: 8e question 25) For this question, assume that the economy is initially operating at the natural level of output. An increase in consumer confidence will cause ________. A) a reduction in the real wage in the medium run B) an increase in the real wage in the medium run C) no change in the real wage in the medium run D) ambiguous effects on the real wage in the medium run Answer: C AACSB: Analytical thinking Status: 8e question

8.4

A Summary and Many Warnings

1) During the Great Depression, the actual unemployment rate in the U.S. ________, and the natural rate apparently ________. A) increased; decreased B) increased; remain unchanged C) increased; increased as well D) decreased; increased E) decreased; remained unchanged Answer: C AACSB: Application of knowledge Status: 8e question 2) Which of the following situations generally exists when deflation occurs? A) Inflation and unemployment are both increasing. B) Inflation and unemployment are both decreasing. C) The price level is decreasing. D) The rate of inflation is falling from, for example, 10% to 3%. E) The natural rate of unemployment is zero. Answer: C AACSB: Application of knowledge Status: 8e question 3) In the Phillips curve equation, which of the following will cause a reduction in the current inflation rate? A) a reduction in the expected inflation rate B) an increase in the unemployment rate C) a reduction in the markup, m D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 4) Suppose policy makers underestimate the natural rate of unemployment. In situations like these, policy makers will likely implement policies that result in ________. A) more unemployment than necessary B) an unemployment rate that is "too high" C) a higher inflation rate than necessary D) a steadily decreasing inflation rate E) overly contractionary monetary and fiscal policy Answer: C AACSB: Application of knowledge Status: 8e question

5) Explain how a reduction in the proportion of contracts that are indexed affects the relationship between changes in the unemployment rate and inflation. Answer: As the proportion of labor contracts that are indexed falls, the effects of changes in unemployment on inflation would fall. A reduction in u will cause an increase in inflation. When inflation rises in a period, some contracts (those that are indexed) will call for an immediate increase in wages further increasing inflation within that period. As indexation becomes less prevalent, that secondary effect (caused by the indexed contracts) on inflation will be reduced. AACSB: Written and oral communication Status: 8e question 6) Explain how changes in the proportion of contracts that are indexed affect how a given change in monetary policy will affect economic activity. Answer: An increase in nominal money growth will increase the real money supply causing an increase in economic activity. As the proportion of labor contracts that are indexed increases, the effects of changes in unemployment on inflation would increase. A reduction in u will cause an increase in inflation. When inflation rises in a period, some contracts (those that are indexed) will call for an immediate increase in wages further increasing inflation within that period. As indexation becomes more prevalent, that secondary effect on inflation will be magnified. This magnification of the inflation effect will cause the real money supply to increase by a smaller amount and, therefore, reduce the output effects of a given monetary expansion. AACSB: Written and oral communication Status: 8e question 7) As the proportion of labor contracts that index wages to prices declines, we would expect that ________. A) a reduction in the unemployment rate will now have a smaller effect on inflation B) the natural rate of unemployment will increase C) the natural rate of unemployment will decrease D) nominal wages will become more sensitive to changes in unemployment Answer: A AACSB: Application of knowledge Status: 8e question 8) When a worker's nominal wage is indexed, the nominal wage is usually automatically adjusted based on movements in which of the following variables? A) productivity B) the price of the firm's product C) the average wage in the country D) the average wage in the industry E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

9) If a country experiences persistently low inflation, which of the following tends NOT to occur? A) wage indexation will become more important B) nominal wages will be set for shorter periods of time C) the markup over labor costs will decrease D) all of these Answer: A AACSB: Application of knowledge Status: 8e question 10) Which of the following will tend to occur as a result of a reduction in the proportion of a country's workers who have indexed wages? A) The unemployment rate will be relatively low. B) The unemployment rate will be relatively high. C) The inflation rate will be relatively low. D) A given change in the unemployment rate will cause a relatively smaller change in the inflation rate. E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 11) Portugal's inflation rate reached 27% in 1984. Answer: TRUE AACSB: Application of knowledge Status: New question 9e 12) When the economy experiences deflation, the Phillips curve relation becomes stronger. Answer: FALSE AACSB: Application of knowledge Status: New question 9e

Macroeconomics, 9e (Blanchard) Chapter 9: From the Short to the Medium Run: The IS-LM-PC Model 9.1

The IS-LM-PC Model

1) The Phillips curve shows that when the unemployment rate is lower than the natural rate, ________. A) inflation is higher than expected B) inflation is lower than expected C) policy rate is higher than expected D) policy rate is lower than expected Answer: A AACSB: Application of knowledge Status: 8e question 2) The Phillips curve shows that when the unemployment rate is higher than the natural rate, ________. A) inflation is higher than expected B) inflation is lower than expected C) policy rate is higher than expected D) policy rate is lower than expected Answer: B AACSB: Application of knowledge Status: 8e question 3) Okun's law shows that when the unemployment rate is above the natural rate, ________. A) inflation is higher than expected B) inflation is lower than expected C) output is below potential D) output is above potential Answer: C AACSB: Application of knowledge Status: 8e question 4) Okun's law shows that when the unemployment rate is below the natural rate, ________. A) inflation is higher than expected B) inflation is lower than expected C) output is below potential D) output is above potential Answer: D AACSB: Application of knowledge Status: 8e question

5) Disposable income equals ________. A) income minus saving B) income minus both saving and taxes C) consumption minus taxes D) the sum of consumption and saving E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 6) In the IS-LM-PC model, which of the following is assumed to be exogenous? A) G B) C C) I D) Y Answer: A AACSB: Application of knowledge Status: 8e question 7) In the IS-LM-PC model, investment does not depend on ________. A) T B) Y C) r D) x Answer: A AACSB: Application of knowledge Status: 8e question 8) In the IS-LM-PC model, LM curve is ________. A) flat B) upward sloping C) downward sloping D) vertical Answer: A AACSB: Application of knowledge Status: 8e question 9) The change in the unemployment rate is approximately equal to ________. A) the negative of the growth rate of output B) the negative policy rate C) the negative inflation rate D) the negative of the growth rate of money supply Answer: A AACSB: Application of knowledge Status: Modified 8e

10) Empirically output growth 1% above normal for one year leads to a ________ in the employment rate. A) 0.6% increase B) 0.7% increase C) 0.8% decrease D) 0.5% decrease Answer: A AACSB: Analytical thinking Status: 8e question 11) The difference between output and potential output is called the output gap. Answer: TRUE AACSB: Application of knowledge Status: 8e question 9.2

From the Short to the Medium Run

1) The natural rate of interest is not ________. A) zero B) the neutral rate of interest C) Wicksellian rate of interest D) associated with the natural rate of unemployment Answer: A AACSB: Application of knowledge Status: 8e question 2) If the output is too high, to achieve the medium run equilibrium, the central bank will ________. A) increases policy rate B) reduces policy rate C) increase money supply D) increases inflation rate Answer: A AACSB: Application of knowledge Status: 8e question 3) If the output is too low, to achieve the medium run equilibrium, the central bank will ________. A) increases policy rate B) reduces policy rate C) increase money supply D) increases inflation rate Answer: B AACSB: Application of knowledge Status: Modified 8e

4) The fact that monetary policy does not affect real variables in the medium run is referred to as the ________. A) neutrality of money B) Wicksellian rate of interest C) Okun's law D) output gap Answer: A AACSB: Application of knowledge Status: 8e question 9.3

Complications, and How Things Can Go Wrong

1) The zero lower bound refers to the situation that ________. A) the lowest the central bank can decrease the nominal policy rate is 0% B) real interest rate is 0% C) inflation rate is 0% D) risk premium is 0% Answer: A AACSB: Application of knowledge Status: 8e question 2) When the policy rate increases, ________. A) IS curve does not change B) IS curve shifts to the right C) IS curve shifts to the left D) LM curve shifts upward E) LM curve shifts downward Answer: A AACSB: Application of knowledge Status: 8e question 3) When the policy rate decreases, ________. A) IS curve does not change B) IS curve shifts to the right C) IS curve shifts to the left D) LM curve shifts upward E) LM curve shifts downward Answer: A AACSB: Application of knowledge Status: 8e question

4) So long as output exceeds potential output, inflation ________. A) remains stable B) spirals downward C) increases D) decreases Answer: C AACSB: Application of knowledge Status: New question 9e 5) What is a deflation trap or deflation spiral? Answer: When people see that inflation is below target and the economy is experiencing deflation, they start changing the way they form expectations and start anticipating deflation. Expectations become de-anchored on the downside, and the negative output gap now leads not just to deflation but to larger and larger deflation. Not only that, but as deflation becomes larger, the real interest rate, which is equal to the deflation rate if the nominal rate is equal to zero, increases. The larger the deflation, the higher the real interest rate, the lower output, and so on, a situation known as a deflation spiral or a deflation trap. Instead of returning to its medium-run equilibrium, the economy moves further away, with lower and lower output and larger and large deflation. AACSB: Written and oral communication Status: New question 9e 9.4

Fiscal Consolidation Revisited

1) When a government reduces its deficits by increasing taxes, in the medium run, ________. A) output returns to potential B) output increases C) interest rate is higher D) IS curve shifts inward to the left Answer: A AACSB: Application of knowledge Status: 8e question 2) When a government reduces its deficits by increasing taxes, in the short run, ________. A) output returns to potential B) output increases C) interest rate is higher D) IS curve shifts inward to the left Answer: D AACSB: Application of knowledge Status: 8e question

3) As fiscal consolidation takes place, the central bank should ________. A) decrease the policy rate B) increase the policy rate C) increase inflation rate D) decrease money supply Answer: A AACSB: Application of knowledge Status: 8e question 4) Use the IS-LM-PC model to illustrate how the economy adjusts to an increase in taxes both in the short run and in the medium run. Answer: Refer to figure 9-4 of the textbook. AACSB: Application of knowledge Status: 8e question 9.5

Conclusions

1) which of the following is not an example of a shock to the economy? A) a firm shuts down B) an increase in oil price C) a sudden decline in consumer confidence D) a sharp drop in investment spending Answer: A AACSB: Application of knowledge Status: 8e question 2) Output fluctuations are also known as ________. A) output gaps B) Okun's law C) the business cycle D) supply shocks Answer: C AACSB: Application of knowledge Status: New question 9e 3) Which of these is an example of an economic shock? A) shifts in consumption coming from changes in consumer confidence B) shifts in investment C) shifts in the risk premium due to a financial crisis D) All of these are shocks Answer: D AACSB: Application of knowledge Status: New question 9e

4) An economic shock has a dynamic effect on output and its components that is called the ________ of the shock. A) output fluctuation B) propagation mechanism C) risk premia D) consolidation mechanism Answer: A AACSB: Application of knowledge Status: New question 9e

Macroeconomics, 9e (Blanchard) Chapter 10: The Facts of Growth 10.1

Measuring the Standard of Living

1) Of the following, the most often used measure of changing living standards is ________. A) the growth rate of nominal GDP B) the growth rate of real GDP C) the growth rate of nominal GDP per capita D) the growth rate of real GDP per capita E) unemployment per capita Answer: D AACSB: Application of knowledge Status: 8e question 2) Over the last hundred years, ________. A) movements in output due to recessions and recoveries dominate the movement caused by long-run growth B) output has decreased in as many years as it has increased C) U.S. output has approximately doubled D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 3) Suppose individuals wish to obtain the most accurate comparison of living standards between the Canada and Saudi Arabia. To do so, one would convert Saudi Arabian output into dollars using ________. A) the current nominal exchange rate B) the current real exchange rate C) the prior year's real exchange rate D) an average of the last five years' exchange rates E) purchasing power parity methods Answer: E AACSB: Application of knowledge Status: 8e question 4) Using current exchange rates, the U.S. standard of living is ranked ________. A) higher than it would be under the purchasing power parity method B) lower than it would be under the purchasing power parity method C) number one in the world D) among the lowest in the world E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 1 Copyright © 2025 Pearson Education, Inc.

5) Explain why economists do not use exchange rates to compare standards of living across countries. Also, discuss what economists do to avoid these problems. Answer: Answers should include discussions about the effects of variations in exchange rates and of systematic differences in prices across countries. The use of PPP numbers reduces the problems associated with these two issues. AACSB: Written and oral communication Status: 8e question 6) When switching from the "current exchange rate" method to the "purchasing power parity" method, India's standard of living in dollars ________. A) decreases B) remains essentially the same C) rises, but still remains far below that of the U.S. D) rises almost to the level of the U.S. E) leapfrogs over that of the U.S. Answer: C AACSB: Application of knowledge Status: 8e question 10.2

Growth in Rich Countries since 1950

1) Which of the following is a main conclusion about growth for OECD countries and the four rich countries examined in the chapter? A) There has been a large increase in the standard of living since 1950. B) The growth rates have decreased since the mid-1970s. C) There has been a convergence of output per capita since 1950. D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) Which of the following best characterizes the economic growth for OECD countries since the mid-1970s? A) Growth has come to a complete halt. B) Growth has slowed down. C) Growth has not changed since the 1950s and 1960s. D) Growth has increased slightly. E) Growth has increased dramatically. Answer: B AACSB: Application of knowledge Status: 8e question

3) Between 1950 and 2017, standards of living in the OECD countries ________. A) did not change at all B) were converging C) all increased at the same rate D) decreased at the same rate E) decreased, but at different rates Answer: B AACSB: Application of knowledge Status: 8e question 4) In the OECD countries, there is a negative relationship between output per capita in 1950 and ________. A) growth since 1950 B) output per capita in the 1990s C) distance from the equator D) population E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 5) Over the last half-century, which of the following countries has had the highest growth rate of output per capita? A) Japan B) France C) United Kingdom D) United States Answer: A AACSB: Application of knowledge Status: 8e question 6) Which of the following countries had the highest level of output per capita in 1950? A) United States B) France C) Japan D) United Kingdom Answer: A AACSB: Application of knowledge Status: 8e question

7) Which of the following countries had the lowest level of output per capita in 1950? A) United States B) France C) Japan D) United Kingdom Answer: C AACSB: Application of knowledge Status: 8e question 8) Which of the following countries experienced the lowest level of output per capita in 2019? A) United States B) France C) Japan D) United Kingdom Answer: C AACSB: Application of knowledge Status: Modified 8e 9) Which of the following countries had the highest rate of growth of output per capita between 1950 and 2019? A) United States B) France C) Japan D) United Kingdom Answer: C AACSB: Application of knowledge Status: Modified 8e 10) By 2019, which of the following countries had the highest level of real output per capita? A) United States B) France C) Japan D) United Kingdom Answer: A AACSB: Application of knowledge Status: Modified 8e 11) Convergence refers to what phenomenon regarding growth theory? Answer: Convergence refers to the phenomenon where the levels of output per capita for countries tend to move closer to one another over time. This implies that countries that start with relatively lower levels of output per worker catch up to other countries and, in some cases, actually pass other countries. AACSB: Written and oral communication Status: 8e question

12) If output per capita grows by a constant 6% per year, then the standard of living would grow by about ________ over 3 years. A) 12% B) 17% C) 18% D) 19% E) 20% Answer: D AACSB: Analytical thinking Status: 8e question 13) What are the three main conclusions that can be drawn from an analysis of growth rates for developed countries? Answer: 1) Standards of living have increased significantly since 1950. 2) Growth rates of output per capita decreased starting in the mid 1970s. And 3) The levels of output per capita have tended to converge over time. AACSB: Application of knowledge Status: Modified 8e 14) To what extent have the three main facts of growth not held for certain countries? For which countries have they not generally held? Answer: There are three main conclusions. First, standards of living have increased significantly since 1950. Second, growth rates of output per capita decreased starting in the mid 1970s. And third, the levels of output per capita have tended to converge over time. These three main conclusions do not apply to many African countries. For example, standards of living have actually decreased for some countries. AACSB: Written and oral communication Status: 8e question 10.3

A Broader Look across Time and Space

1) Which of the following is not among the four tigers? A) China B) Taiwan C) Hong Kong D) Singapore Answer: A AACSB: Application of knowledge Status: 8e question

2) "Convergence" has been occurring among the OECD countries because ________. A) the richer countries give away more of their output than the poorer ones B) the poorer countries have had higher growth rates than the richer ones C) the richer countries have had higher growth rates than the poorer ones D) the poorer countries have had positive growth rates, while the richer ones have had negative growth rates E) the procedures for measuring output per capita have been changing Answer: B AACSB: Application of knowledge Status: 8e question 3) Explain Mathusian trap. Answer: Thomas Robert Malthus, an English economist, argued that an increase in output would lead to a decrease in mortality, leading to an increase in population until output per person was back to its initial level. The stagnation of output per person is called a Malthusian trap. AACSB: Written and oral communication Status: 8e question 4) In 1960, the average output per person of the four tigers was about ________ of U.S. output per person. A) 10% B) 15% C) 20% D) 25% Answer: B AACSB: Application of knowledge Status: New question 9e 5) By 2017, he average output per person of the four tigers was about ________ of U.S. output per person. A) 10% B) 36% C) 85% D) 92% Answer: C AACSB: Application of knowledge Status: New question 9e

6) For much of the first millennium, and until the 15th century, ________ probably had the world's highest level of output per person. A) China B) Spain C) Portugal D) Great Britain Answer: A AACSB: Application of knowledge Status: New question 9e 10.4

Thinking about Growth: A Primer

1) For this question, assume that there are decreasing returns to capital, decreasing returns to labor, and constant returns to scale. Now suppose that both capital and labor decrease by 5%. Given this information, we know that output (Y) will ________. A) not change B) decrease by less than 5% C) decrease by 5% D) decrease by more than 5% but less than 10% E) none of these Answer: C AACSB: Analytical thinking Status: 8e question 2) For this question, assume that there are decreasing returns to capital, decreasing returns to labor, and constant returns to scale. A reduction in the capital stock will cause which of the following? A) a reduction in output B) no change in output C) an increase in output per capita D) increase the capital-labor ratio E) none of these Answer: A AACSB: Analytical thinking Status: 8e question

3) For this question, assume that the production function exhibits the same characteristics as those presented in the textbook. Based on these characteristics (i.e., assumptions), successive and equal increases in capital per worker will cause which of the following to occur? A) Output per worker will decline. B) Output per worker will not change. C) Output per worker will increase by a constant amount. D) Output per worker will increase by a larger amount. E) none of these Answer: A AACSB: Reflective thinking Status: 8e question 4) Which of the following will cause a reduction in output per worker in the long run run? A) capital accumulation or technological progress B) capital accumulation C) an increase in the number of workers D) expansionary monetary policy E) none of these Answer: C AACSB: Reflective thinking Status: 8e question 5) For this question, assume that a country experiences a permanent increase in its saving rate. Which of the following will occur as a result of this increase in the saving rate? A) a permanently faster growth rate of output B) a permanently higher level of output per capita C) a permanently higher level of capital per worker D) all of these E) a permanently higher level of output per capita and capital per worker Answer: E AACSB: Reflective thinking Status: 8e question 6) For this question, assume that a country experiences a permanent reduction in its saving rate. Which of the following will occur as a result of this reduction in the saving rate? A) a permanently slower growth rate of output B) no permanent effect on the level of output per capita C) a permanently lower level of output per worker D) a permanently slower growth rate of output but no permanent effect on the level of output per capita Answer: C AACSB: Reflective thinking Status: 8e question

7) When using a logarithmic scale to plot output per capita over time, an upward-sloping curve that becomes increasingly steep indicates ________. A) output per capita is not changing B) output per capita is growing by a constant amount each year C) output per capita is growing by a constant percentage each year D) output per capita is growing by an increasing percentage each year E) output per capita is not defined Answer: D AACSB: Reflective thinking Status: 8e question 8) Which of the following must occur to sustain economic growth in the long run? A) technological progress B) capital accumulation C) a higher saving rate D) all of these Answer: A AACSB: Application of knowledge Status: 8e question 9) Given the broadest interpretation of technology, technology will include which of the following? A) how well firms are run B) the organization and sophistication of markets C) the political environment D) the list of blueprints defining the types of products and the techniques available to produce them E) all of these Answer: E AACSB: Application of knowledge Status: 8e question 10) Given the narrow interpretation of technology, technology will include which of the following? A) how well firms are run B) the organization and sophistication of markets C) the political environment D) none of these Answer: D AACSB: Application of knowledge Status: 8e question

11) Suppose there are two countries that are identical with the following exception. The saving rate in country A is greater than the saving rate in country B. Given this information, we know that in the long run ________. A) the growth rate of output per capita will be greater in B than in A B) the growth rate of output per capita will be greater in A than in B C) the capital-labor ratios (K/N) will be the same in both countries D) the growth rate of output per capita will be the same in both countries Answer: D AACSB: Application of knowledge Status: 8e question 12) Suppose there are two countries that are identical with the following exception. The saving rate in country A is greater than the saving rate in country B. Given this information, we know that in the long run ________. A) the capital-labor ratio (K/N) will be greater in B than in A B) the capital-labor ratio (K/N) will be greater in A than in B C) the capital-labor ratio (K/N) will be the same in the two countries D) economic growth will be higher in A than in B Answer: B AACSB: Application of knowledge Status: 8e question 13) Suppose there are two countries that are identical with the following exception. The saving rate in country A is greater than the saving rate in country B. Given this information, we know that in the long run ________. A) output per capita will be greater in B than in A B) output per capita will be greater in A than in B C) economic growth will be higher in A than in B D) more information is needed to answer this question Answer: B AACSB: Application of knowledge Status: 8e question 14) Which of the following will not cause an increase in aggregate output (Y) in the long run? A) an increase in N B) an increase in K C) an increase in technology D) a reduction in the saving rate E) none of these Answer: D AACSB: Reflective thinking Status: 8e question

15) Over the past fifty years, convergence has generally occurred for all of the following groups of countries with the exception of ________. A) the five richest countries B) European countries C) the "four tigers" in Asia D) OECD countries E) none of these Answer: E AACSB: Reflective thinking Status: 8e question 16) Assume that constant returns to scale exists and that N and K both increase by 2%. Given this information, we know that ________. A) output (Y) will increase by 4% B) Y will increase by 2% C) Y will increase by less than 2% D) Y will increase by less than 4% and more than 2% Answer: B AACSB: Reflective thinking Status: 8e question 17) Assume that constant returns to scale exists and that N and K both decrease by 3%. Given this information, we know that ________. A) output (Y) will decrease 6% B) Y will decrease by 3% C) Y will decrease by less than 3% D) the capital-labor ratio (K/N) will decrease Answer: B AACSB: Reflective thinking Status: 8e question 18) Constant returns to scale implies that if N and K both increase by 3% that ________. A) output (Y) will increase by 3% B) Y/N will increase by 3% C) Y/N will increase by less than 3% D) the capital-labor ratio will increase by 3% Answer: A AACSB: Reflective thinking Status: 8e question

19) For this question, assume that the saving rate increases. We know that this increase in the saving rate will cause which of the following? A) a temporary increase in the level of output per capita B) no permanent change in the level of output per capita C) a temporary increase in the rate of growth of output per capita D) a permanently higher rate of growth of output per capita E) none of these Answer: C AACSB: Reflective thinking Status: 8e question 20) Which of the following will cause a reduction in output per worker (Y/N)? A) a reduction in the capital stock (K) B) a reduction in the saving rate C) a reduction in K/N D) all of these Answer: D AACSB: Application of knowledge Status: 8e question 21) Assume that employment increases by 3%. Holding all other factors constant, we know with certainty that which of the following will occur? A) output will increase by 3% B) output per capita will increase by 3% C) output will increase by less than 3% D) the capital labor ratio will increase E) none of these Answer: C AACSB: Reflective thinking Status: 8e question 22) Suppose the stock of capital increases by 2% and employment increases by 2%. Given this information, we know that ________. A) output per capita will increase by 6% B) output will increase by 4% C) output per capita will increase by less than 4% and more than 2% D) none of these Answer: D AACSB: Reflective thinking Status: 8e question

23) Decreasing returns to capital (K) implies that a 4% increase in K will cause ________. A) a reduction in output per worker (Y/N) B) a reduction in K/N C) Y to increase by exactly 4% D) Y to increase by less than 4% E) no change in Y/N Answer: D AACSB: Reflective thinking Status: 8e question 24) For this question, assume that the saving rate decreases. We know that this decrease in the saving rate will cause which of the following? A) a temporary decrease in the level of output per capita B) no permanent change in the level of output per capita C) a temporary decrease in the rate of growth of output per capita D) a permanently lower rate of growth of output per capita E) none of these Answer: C AACSB: Reflective thinking Status: 8e question 25) Which of the following will cause an increase in output per worker (Y/N)? A) an increase in the capital stock (K) B) an increase in the saving rate C) an increase in K/N D) all of these Answer: D AACSB: Reflective thinking Status: 8e question 26) Decreasing returns to capital (N) implies that a 4% increase in N will cause ________. A) Y to increase by more than 4% B) Y to increase by exactly 4% C) Y to increase by less than 4% D) no change in Y/N Answer: C AACSB: Reflective thinking Status: 8e question

27) Assume that employment decreases by 3%. Holding all other factors constant, we know with certainty that which of the following will occur? A) output will decrease by 3% B) output per capita will decrease by 3% C) output will decrease by less than 3% D) the capital labor ratio will decrease E) none of these Answer: C AACSB: Reflective thinking Status: 8e question 28) If output per capita grows by a constant 5% per year, then the standard of living would grow by about ________ over 3 years. A) 12% B) 16% C) 17% D) 18% E) 20% Answer: B AACSB: Analytical thinking Status: 8e question 29) If output per capita grows by a constant 3% per year, then the standard of living would grow by about ________ over 4 years. A) 13% B) 14% C) 15% D) 16% E) 17% Answer: A AACSB: Analytical thinking Status: 8e question 30) Discuss and explain what is meant by the "state of technology." Answer: The state of technology can be defined either narrowly or more broadly. In a narrow sense, it allows firms to convert resources into goods and services. A broader interpretation would allow it to include/take into account the organization of firms, the organization of markets, and so on. AACSB: Written and oral communication Status: 8e question

31) Explain each of the following: (1) constant returns to scale; (2) decreasing returns to capital; and (3) decreasing returns to labor. Answer: All three of these things refer to characteristics of the production function. CRS means that if all inputs change by the same proportion, the level of output will change by the same proportion. Decreasing returns to capital and labor indicates that increases in either resource will cause output to increase but at a decreasing rate. AACSB: Written and oral communication Status: 8e question 32) Suppose the capital stock increases by 10% and the number of employed workers increases by 5%. Given this information, explain what will happen to output and to output per worker. Answer: The level of output will obviously increase because the amount of inputs has increased. Given that the capital stock increases by an amount greater than the amount of workers, we know that the capital labor ratio has increased. This implies that output per worker has also increased. AACSB: Written and oral communication Status: 8e question 33) First, what are the primary determinants of output per worker? And second, to what extent can each cause a permanent change in economic growth? Answer: The two primary determinants of growth are capital accumulation and technological progress. Capital changes when there are changes in investment and, therefore, the saving rate. Because the saving rate cannot increase forever, capital accumulation cannot cause permanent changes in economic growth. Technological progress, on the other hand, can result in permanent changes in economic growth. AACSB: Written and oral communication Status: 8e question 34) Briefly explain what effect a reduction in the saving rate will have on growth. Answer: A reduction in the saving rate will reduce investment, capital and output. During the adjustment process, the rate of growth of output will be negative. However, at some point, I, K and Y will no longer fall. So, the reduction in the saving rate will not have a permanent effect on the rate of growth of output. AACSB: Written and oral communication Status: 8e question 35) Is it possible for a country to experience a permanent increase in output per worker over time? If so, how can this occur? Answer: Yes, it is possible for sustained growth to occur. For sustained growth to occur, technological progress must occur. Changes in the saving rate will not cause sustained changes in growth rates. AACSB: Written and oral communication Status: 8e question

36) Briefly explain the relationship between output per capita and happiness. Specifically, to what extent are these two variables related? Answer: Research by Richard Layard indicates that the proportion of very happy people is higher among the rich than among the poor. At the country level, at low levels of output per capita, increases in output per capita do seem to cause increases in happiness. However, this relation is not as strong for those countries with higher levels of output per capita. AACSB: Written and oral communication Status: 8e question 37) Briefly explain what effect an increase in the saving rate will have on growth. Answer: An increase in the saving rate will increase investment, capital and output. During the adjustment process, the rate of growth of output will be positive. However, at some point, I, K and Y will no longer increase. So, the increase in the saving rate will not have a permanent effect on the rate of growth of output. AACSB: Written and oral communication Status: 8e question 38) Graphically show and explain the effects of an improvement in the state of technology. Answer: An improvement in technology shifts the production function up, leading to an increase in output per worker for a given level of capital per worker. AACSB: Analytical thinking Status: 8e question 39) Consider the production function Y= a. Compute output when K = 81 and N = 100. b. Is this production function characterized by constant returns to scale? Explain. Answer: a. Y = 9 * 10 = 90 b. If both K and N double, Y also doubles. Yes, this production function is characterized by constant returns to scale. AACSB: Analytical thinking Status: 8e question 40) Consider the production function, Y = , write the production function as a relation between output per worker and capital per worker. Answer:

AACSB: Analytical thinking Status: 8e question

Macroeconomics, 9e (Blanchard) Chapter 11: Saving, Capital Accumulation, and Output 11.1

Interactions between Output and Capital

1) An increase in the saving rate will affect which of the following variables in the long run? A) output per worker B) capital per worker C) the level of investment D) all of these Answer: D AACSB: Application of knowledge Status: 8e question 2) A reduction in the saving rate will not affect which of the following variables in the long run? A) output per worker B) the growth rate of output per worker C) the amount of capital in the economy D) capital per worker E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 3) Which of the following will cause an increase in output per worker in the long run? A) an increase in the saving rate B) a reduction in the depreciation rate C) an increase in the stock of human capital D) all of these Answer: D AACSB: Application of knowledge Status: 8e question 4) Which of the following statements is always true? A) Investment equals depreciation. B) Investment equals the capital stock minus depreciation. C) The capital stock is equal to investment minus depreciation. D) Any change in the capital stock is equal to investment minus depreciation. E) The increase in investment is equal to the capital stock minus depreciation. Answer: D AACSB: Application of knowledge Status: 8e question

5) Which of the following is not a flow variable? A) investment B) saving C) the money supply D) output E) all of these Answer: C AACSB: Application of knowledge Status: 8e question 6) The capital to labor ratio will tend to decrease over time when ________. A) investment per worker equals saving per worker B) investment per worker is less than saving per worker C) investment per worker exceeds depreciation per worker D) saving per worker equals depreciation per worker E) output per worker exceeds capital per worker Answer: B AACSB: Application of knowledge Status: Modified 8e 7) In the absence of technological progress, which of the following remains constant in the steady state equilibrium? A) investment per worker B) output per worker C) saving per worker D) all of these E) investment per worker and output per worker Answer: D AACSB: Application of knowledge Status: 8e question 8) Suppose, due to the effects of a military conflict that has ended, that a country experiences a large reduction in its capital stock. Assume no other effects of this event on the economy. Which of the following will tend to occur as the economy adjusts to this situation? A) a relatively low growth rate for some time B) a relative high growth rate for some time C) zero growth for some time, followed by a gradually increasing growth rate D) positive growth, followed by negative growth, and then zero growth E) none of these Answer: B AACSB: Reflective thinking Status: 8e question

9) In the model where it is assumed that the state of technology does not change, what parameters and/or variables cause changes in steady state output per worker. Answer: In general, output per worker will depend on the capital-labor ratio. The equilibrium capital-labor ratio will depend on the saving rate and on the rate of depreciation. Output will also depend on the amount of human capital per worker. So, changes in s, δ, and H will cause changes in output per worker. AACSB: Written and oral communication Status: 8e question 10) Explain the relationship among output, saving, and investment. Answer: The level of output (per worker) will depend on the capital-labor ratio. The amount of capital will depend on investment (and depreciation). Investment will, in turn, depend on the amount of saving. Changes in saving will cause changes in investment, capital, and, therefore, output. AACSB: Written and oral communication Status: 8e question 11) Explain what condition must occur for each of the following to occur: (1) the capital stock to increase; (2) the capital stock to decrease; and (3) the capital stock to remain constant. Answer: The equation for the change in the capital stock (per worker) is given by the following: (Kt+1/N) - (Kt/N) = s(Yt/N) - δ(Kt/N). The capital stock will not change when investment equals depreciation. If investment/saving exceeds (is less than) depreciation, the capital stock will grow (decline). AACSB: Analytical thinking Status: 8e question 12) Suppose depreciation per worker is less than saving per worker. Given this situation, explain what will happen to each of the following variables over time: capital per worker, output per worker, saving per worker, and consumption per worker. Answer: If depreciation is less than saving, it is also less than investment. Alternatively, there is excess investment to offset the amount of capital that wears out. So, the capital stock will increase. This will cause an increase in K/N, Y/N, and S/N. As Y/N rises, so will C/N. AACSB: Written and oral communication Status: 8e question 13) For an economy in which there is no technological progress, explain what must occur for the steady state to occur. Also explain what this implies about the rate of growth of output, output per worker, and the capital stock. Answer: The steady occurs when the economy is in equilibrium. Specifically, the steady state refers to the situation where K/N and Y/N are constant. K/N will not change when investment per worker equals depreciation per worker. During the adjustment process, the growth rates of Y, Y/N, and K/N will all be negative. Once the steady state is reached, these variables are constant and the growth rates will be zero. AACSB: Written and oral communication Status: 8e question

11.2

The Implications of Alternative Saving Rates

1) For this question assume that technological progress does not occur. The rate of saving in Canada has generally been greater than the saving rate in the U.S. Given this information, we know that in the long run ________. A) Canada's growth rate will be greater than the U.S. growth rate B) investment per worker in Canada will be no different than U.S. investment per worker C) capital per worker in Canada will be no different than U.S. capital per worker D) all of these E) none of these Answer: E AACSB: Analytical thinking Status: 8e question 2) When an economy is operating at the steady state, we know that ________. A) steady state saving equals consumption B) steady state saving is less than total consumption C) steady state saving is equal to depreciation per worker D) steady state saving exceeds depreciation each year by a constant amount E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 3) In the absence of technological progress, which of the following is true when the economy is operating at the steady state? A) The growth of output per worker is zero. B) The growth of output per worker is equal to the saving rate. C) The growth of output per worker is equal to the rate of investment. D) The growth of output per worker is equal to the rate of depreciation. E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 4) In the absence of technological progress, an increase in the saving rate will cause which of the following? A) increase temporarily the growth of output per worker B) increase the steady state growth of output per worker C) decrease temporarily the growth of output per worker D) decrease the steady state growth of output per worker E) have an ambiguous effect on the growth of output per worker Answer: A AACSB: Analytical thinking Status: 8e question

5) In the absence of technological progress, we know with certainty that an increase in the saving rate will cause which of the following? A) increase steady state consumption B) decrease steady state consumption C) have no effect on steady state consumption D) increase steady state consumption only if the increase in saving exceeds the increase in depreciation E) increase steady state consumption only if the increase in saving is less than the increase in depreciation Answer: E AACSB: Application of knowledge Status: 8e question 6) In the absence of technological progress, we know that the level of output per worker in the steady state will ________. A) increase over time B) remain constant C) decrease as a result of decreasing returns to scale D) increase or decrease, depending on the rate of saving E) increase or decrease, depending on the rate of depreciation Answer: B AACSB: Application of knowledge Status: 8e question 7) As an economy adjusts to an increase in the saving rate, we would expect output per worker ________. A) to increase at a constant rate and continue increasing at that rate in the steady state B) to increase at a permanently higher rate C) to decrease at a permanently higher rate D) to return to its original level E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 8) Our model of long-run economic growth suggests that ________. A) the U.S. growth slowdown since 1950 has been caused largely by low saving in the U.S. B) a higher rate of saving in the U.S. cannot do much to increase the U.S. growth rate over the next two decades C) saving in the U.S. has exceeded the golden-rule level D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

9) The Social Security system in the United States was introduced in which year? A) 1915 B) 1935 C) 1945 D) 1955 E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 10) Suppose there is an increase in the saving rate. This increase in the saving rate must cause an increase in consumption per capita in the long run when ________. A) capital per worker approaches the golden-rule level of capital per worker B) the saving is used for education rather than physical capital C) the rate of saving exceeds the rate of depreciation D) there is no technological progress E) technological progress depends on human capital Answer: A AACSB: Reflective thinking Status: 8e question 11) When steady state capital per worker is above the golden-rule level, we know with certainty that an increase in the saving rate will ________. A) increase consumption in both the short run and the long run B) decrease consumption in both the short run and the long run C) decrease consumption in the short run, and increase it in the long run D) increase consumption in the short run, and decrease it in the long run E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 12) Suppose two countries are identical in every way with the following exception. Economy A has a higher saving rate than economy B. Given this information, we know with certainty that ________. A) steady state consumption in A is higher than in B B) steady state consumption in A is lower than in B C) steady state consumption in A and in B are equal D) steady state growth of output per worker is higher in A than in B E) none of these Answer: E AACSB: Reflective thinking Status: 8e question

13) Suppose two countries are identical in every way with the following exception. Economy A has a greater quantity of human capital than economy B. Given this information, we know with certainty that ________. A) steady state consumption in A is higher than in B B) steady state consumption in A is lower than in B C) steady state consumption in A and in B are equal D) steady state growth of output per worker is higher in A than in B Answer: A AACSB: Reflective thinking Status: 8e question 14) Suppose two countries are identical in every way with the following exception. Economy A has a higher rate of depreciation (δ) than economy B. Given this information, we know with certainty that ________. A) steady state consumption in A is higher than in B B) steady state consumption in A is lower than in B C) steady state consumption in A and in B are equal D) steady state growth of output per worker is higher in A than in B E) none of these Answer: B AACSB: Reflective thinking Status: 8e question 15) The countries with the lowest output per capita ________. A) are rich with human capital, but have little physical capital B) are rich with physical capital, but have little human capital C) are poor in both human and physical capital D) have low living standards in spite of relatively high levels of both human and physical capital E) may or may not be poor in human capital, depending on whether the exchange rate or purchasing power parity method is used for comparison Answer: C AACSB: Application of knowledge Status: 8e question 16) If endogenous growth models are correct, a lower rate of growth in the long run could occur as a result of which of the following? A) a lower rate of saving B) a lower rate of depreciation C) a redefinition of depreciation D) a redefinition of the steady state E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

17) Suppose the following situation exists for an economy: Kt+1/N > Kt/N. Given this information, we know that ________. A) saving per worker equals depreciation per worker in period t B) saving per worker is less than depreciation per worker in period t C) saving per worker is greater than depreciation per worker in period t D) the saving rate fell in period t E) none of these Answer: C AACSB: Analytical thinking Status: 8e question 18) Suppose the following situation exists for an economy: Kt+1/N = Kt/N. Given this information, we know that ________. A) saving per worker equals depreciation per worker in period t B) saving per worker is less than depreciation per worker in period t C) saving per worker is greater than depreciation per worker in period t D) the saving rate fell in period t E) steady state consumption is equal to the golden rule level of steady state consumption Answer: A AACSB: Analytical thinking Status: 8e question 19) At the current steady state capital-labor ratio, assume that the steady state level of per capita consumption, (C/N)*, is less than the golden rule level of steady state per capita consumption. Given this information, we can be certain that ________. A) an increase in the saving rate will cause an increase in the steady state level of per capita consumption ((C/N)*) B) a reduction in the capital-labor ratio will cause a reduction in (C/N)* C) the capital labor ratio will tend to increase over time D) the capital labor ratio will tend to decrease over time E) a reduction in the saving rate will have an ambiguous effect on (C/N)* Answer: E AACSB: Analytical thinking Status: 8e question 20) Suppose the following situation exists for an economy: Kt+1/N < Kt/N. Given this information, we know that ________. A) saving per worker equals depreciation per worker in period t B) consumption per worker will tend to fall as the economy adjusts to this situation C) saving per worker is greater than depreciation per worker in period t D) the saving rate increased in period t E) none of these Answer: E AACSB: Analytical thinking Status: 8e question

21) The golden rule level of capital refers to ________. A) the level of capital that maximizes output per worker B) the level of capital that maximizes the standard of living C) the level of capital that maximizes consumption per worker in the steady state D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 22) Suppose the following situation exists for an economy: Kt+1/N = Kt/N. Given this information, we know with certainty that ________. A) the economy is operating at the golden rule equilibrium in period t B) saving per worker is less than depreciation per worker in period t C) saving per worker is greater than depreciation per worker in period t D) investment per worker equals depreciation per worker in period t Answer: D AACSB: Analytical thinking Status: 8e question 23) Suppose the saving rate is initially less than the golden rule saving rate. We know with certainty that a reduction in the saving rate will cause ________. A) a reduction in the capital labor ratio B) a reduction in output per worker C) a reduction in consumption per worker D) all of these E) none of these Answer: D AACSB: Analytical thinking Status: 8e question 24) Suppose the saving rate is initially greater than the golden rule saving rate. We know with certainty that a reduction in the saving rate will cause ________. A) a reduction in the rate of growth in the long run B) a reduction in output per worker C) a reduction in consumption per worker D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question

25) Suppose the saving rate is initially greater than the golden rule saving rate. We know with certainty that an increase in the saving rate will cause ________. A) an increase in the rate of growth in the long run B) a reduction in output per worker C) a reduction in consumption per worker D) all of these E) none of these Answer: C AACSB: Analytical thinking Status: 8e question 26) Which of the following represents the change in the capital stock? A) consumption minus depreciation B) output minus depreciation C) investment minus saving D) investment minus depreciation Answer: D AACSB: Application of knowledge Status: 8e question 27) When the economy is in the steady state, we know with certainty that ________. A) investment per worker is equal to depreciation per worker B) consumption per worker is maximized C) output per worker is maximized D) the growth rate is maximized E) all of these Answer: A AACSB: Application of knowledge Status: 8e question 28) Which of the following represents the effects in period t of an increase in the saving rate in period t? A) no change in K/N B) no change in Y/N C) a reduction in C/N D) all of these Answer: D AACSB: Application of knowledge Status: 8e question

29) Suppose there are two countries that are identical in every way with the following exception: Country A has a lower depreciation rate (δ) than country B. Given this information, we know with certainty that ________. A) the growth rate will be the same in the two countries B) the growth rate will be higher in A than in B C) K/N will be higher in B D) Y/N will be higher in B Answer: A AACSB: Reflective thinking Status: 8e question 30) Suppose the economy is initially in the steady state. An increase in the depreciation rate (δ) will cause ________. A) a reduction in K/N B) a reduction in Y/N C) a reduction in C/N D) all of these E) none of these Answer: D AACSB: Reflective thinking Status: 8e question 31) Suppose the economy is initially in the steady state. A reduction in the depreciation rate (δ) will cause ________. A) an increase in K/N B) an increase in the growth rate in the long run C) a reduction in C/N D) all of these Answer: A AACSB: Reflective thinking Status: 8e question 32) Which of the following will likely cause an increase in output per worker? A) an increase in education expenditures B) an increase in the saving rate C) an increase in on-the-job training D) all of these Answer: D AACSB: Application of knowledge Status: 8e question

33) Based on our understanding of the model presented in chapter 11, which of the following will cause a permanent increase in growth? A) an increase in education spending B) an increase in the saving rate C) an increase in capital accumulation D) all of these E) none of these Answer: E AACSB: Reflective thinking Status: 8e question 34) An increase in the saving rate will not affect which of the following variables in the long run? A) output per worker B) the growth rate of output per worker C) the amount of capital in the economy D) capital per worker E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 35) The capital to labor ratio will tend to increase over time when ________. A) investment per worker equals saving per worker B) investment per worker exceeds saving per worker C) investment per worker is less than depreciation per worker D) saving per worker equals depreciation per worker E) output per worker is less than capital per worker Answer: B AACSB: Reflective thinking Status: Modified 8e 36) In the absence of technological progress, a decrease in the saving rate will cause which of the following? A) decrease temporarily the growth of output per worker B) decrease the steady state growth of output per worker C) increase temporarily the growth of output per worker D) increase the steady state growth of output per worker E) have an ambiguous effect on the growth of output per worker Answer: A AACSB: Application of knowledge Status: 8e question

37) In the absence of technological progress, we know with certainty that an decrease in the saving rate will cause which of the following? A) decrease steady state consumption B) increase steady state consumption C) have no effect on steady state consumption D) decrease steady state consumption only if the decrease in saving exceeds the increase in depreciation E) decrease steady state consumption only if the decrease in saving is less than the decrease in depreciation Answer: E AACSB: Application of knowledge Status: 8e question 38) As an economy adjusts to an decrease in the saving rate, we would expect output per worker A) to decrease at a constant rate and continue decreasing at that rate in the steady state B) to decrease at a permanently higher rate C) to increase at a permanently higher rate D) to return to its original level E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 39) Suppose the following situation exists for an economy: Kt+1/N < Kt/N. Given this information, we know that ________. A) saving per worker equals depreciation per worker in period t B) saving per worker is less than depreciation per worker in period t C) saving per worker is greater than depreciation per worker in period t D) the saving rate fell in period t E) none of these Answer: B AACSB: Analytical thinking Status: 8e question 40) At the current steady state capital-labor ratio, assume that the steady state level of per capita consumption, (C/N)*, is greater than the golden rule level of steady state per capita consumption. Given this information, we can be certain that ________. A) a reduction in the saving rate will cause a decrease in the steady state level of per capita consumption ((C/N)*) B) an increase in the capital-labor ratio will cause an increase in (C/N)* C) the capital labor ratio will tend to decrease over time D) the capital labor ratio will tend to increase over time E) a reduction in the saving rate will have an ambiguous effect on (C/N)* Answer: E AACSB: Analytical thinking Status: 8e question 13 Copyright © 2025 Pearson Education, Inc.

41) Suppose the economy is initially in the steady state. A reduction in the depreciation rate (δ) will cause ________. A) an increase in K/N B) an increase in Y/N C) an increase in C/N D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 42) Which of the following will likely cause a reduction in output per worker? A) a reduction in education expenditures B) a reduction in the saving rate C) a reduction in on-the-job training D) all of these Answer: D AACSB: Application of knowledge Status: 8e question 43) In the model where it is assumed that the state of technology does not change, what parameters and/or variables cause changes in steady state output per worker? A) savings rate B) depreciation rate C) human capital per worker D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 44) Suppose there is an increase in the saving rate. Explain what effect this will have on output, output per worker, the rate of growth of output, and the rate of growth of output per worker. Answer: The increase in s will cause an increase in S/N and I/N. At the initial K/N, depreciation is less than investment. Alternatively, there is excess investment to offset the amount of capital that wears out. So, the capital stock will increase. This will cause an increase in K/N, Y/N, and S/N. As Y/N rises, so will C/N. AACSB: Written and oral communication Status: 8e question 45) During the latter half of the 1990s, the U.S. saving rate decreased. Will this reduction in the saving rate have a permanent effect on the rate of growth of output per worker? Explain. Answer: Changes in the saving rate can only cause temporary changes in the growth rate. Once the new steady state is reached (caused by the drop in s), the growth rates would return to zero. AACSB: Reflective thinking Status: 8e question 14 Copyright © 2025 Pearson Education, Inc.

46) Suppose policy makers wish to increase steady state consumption per worker. Explain what must happen to the saving rate to achieve this objective. Answer: Answer: it depends! Whether the saving rate must increase, decrease, or remain constant depends on what the current saving rate is compared to the golden rule saving rate. If s < sg, the saving rate must increase to increase steady state consumption. If s > sg, the opposite must occur. AACSB: Written and oral communication Status: 8e question 47) Suppose the saving rate is greater than the golden rule saving rate (sG). First, explain what must happen to the saving rate in order to increase steady state consumption. Second, what are the advantages and disadvantages of this policy to increase steady state consumption. Answer: The saving rate must decrease. This will cause an initial increase in consumption per worker. As the economy responds to this reduction in s, K/N and Y/N will fall. In fact, C/N will rise (as long as the drop in s does not go past the golden rule rate) as well and eventually exceed its initial level. The advantage of such a policy is that it will increase C/N initially and in the long run (given the previous qualifier). The are few if any disadvantages. It is possible to cut s too much (this has not been discussed here). AACSB: Written and oral communication Status: 8e question 48) Suppose there is a reduction in the saving rate. Explain what effect this will have on output, output per worker, the rate of growth of output, and the rate of growth of output per worker. Answer: The reduction in s will cause a decrease in S/N and I/N. At the initial K/N, depreciation is more than investment. Alternatively, there is not enough investment to offset the amount of capital that wears out. So, the capital stock will decrease. This will cause a decrease in K/N, Y/N, and S/N. As Y/N falls, so will C/N. AACSB: Written and oral communication Status: 8e question 49) Explain the difference between fully funded social security system and pay-as-you-go social security system. Answer: Fully funded social security system taxes workers, invests their contributions in financial assets, and pays back the principal plus the interest to the workers when they retire. Pay-as-you-go system taxes workers and redistributes the tax contribution as benefits to the current retirees. There are two major differences between the two systems. First, what retirees receive is different in each case. Second, the two systems have different macroeconomic implications. In both systems private saving goes down. But in the fully funded system, public saving goes up and it has no effect on total saving and no effect on capital accumulation. In the pay-as-you-go system, the decrease in private saving is not compensated by an increase in public saving. Total saving goes down, and so does capital accumulation. AACSB: Written and oral communication Status: 8e question

50) Explain the two relations that determine the evolution of output in the long run. Answer: The amount of capital determines the amount of output being produced. The amount of output determines the amount of saving and in turn, the amount of capital being accumulated over time. AACSB: Application of knowledge Status: 8e question 11.3

Getting a Sense of Magnitudes

1) If the saving rate is 1 (i.e., s = 1), we know that ________. A) K/N will be at its highest level B) Y/N will be at its highest level C) C/N = 0 D) all of these Answer: D AACSB: Analytical thinking Status: 8e question 2) Suppose an economy experiences a 5% increase in human capital. We know that this will cause ________. A) Y/N to increase by more than 5% B) Y/N to increase by exactly 5% C) Y/N to increase by less than 5% D) no change in Y/N E) a reduction in output per worker Answer: C AACSB: Application of knowledge Status: 8e question 3) Suppose an economy experience a 4% increase in each of the following variables: N, K, and H (human capital). Given this information, we know with certainty that ________. A) Y will increase by more than 4% B) Y will increase by exactly 4% C) Y will increase by less than 4% D) Y will increase by less than 12% but by more than 4% E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

4) Suppose there are two countries that are identical in every way with the following exception: Country A has a higher saving rate than country B. Given this information, we know with certainty that ________. A) the growth rate will be higher in A than in B B) the growth rate will be the same in the two countries C) the level of consumption per worker will be higher in A D) the level of consumption per worker will be higher in B Answer: B AACSB: Application of knowledge Status: 8e question 11.4

Physical versus Human Capital

1) Suppose there are two countries that are identical in every way with the following exception: Country A has a higher stock of human capital than country B. Given this information, we know with certainty that ________. A) the growth rate will be higher in A than in B B) the growth rate will be the same in the two countries C) output per worker will be the same in the two countries D) K/N will be higher in B Answer: B AACSB: Application of knowledge Status: 8e question 2) Explain what human capital is and discuss how changes in human capital can affect output per worker. Answer: Human capital represents the set of skills possessed by labor. In addition to physical capital, changes in H will also cause changes in output. So, an increase in H/N will also cause an increase in Y/N. AACSB: Reflective thinking Status: 8e question 3) Which of the following are reasons to suspect spending on education might overestimate human capital investment? A) Education spending leaves out foregone wages. B) Part of total spending on education is really consumption. C) Much human capital investment comes from on-the-job training. D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question

4) Economists call the skills workers possess ________. A) human capital B) economic capital C) physical capital D) education Answer: A AACSB: Application of knowledge Status: New question 9e 5) What percentage of children get a primary education in today's modern OECD nations? A) Almost 70% B) Approximately 80% C) 90% D) Nearly 100% Answer: D AACSB: Application of knowledge Status: New question 9e 6) In the United States, spending on formal education is about ________ of GDP. A) 6.5% B) 7.4% C) 10.1% D) 15.2% Answer: A AACSB: Application of knowledge Status: New question 9e 7) Which of these costs is the main opportunity cost of higher education? A) Cost of tuition B) Cost of books and supplies C) Foregone wages while pursuing education D) Room and board while attending college Answer: C AACSB: Application of knowledge Status: New question 9e 8) Models that generate steady growth even without technological progress are called ________. A) models of exogenous growth B) models of endogenous growth C) Solow growth models D) human capital models Answer: B AACSB: Application of knowledge Status: New question 9e

Macroeconomics, 9e (Blanchard) Chapter 12: Technological Progress and Growth 12.1

Technological Progress and the Rate of Growth

1) In the following production function, Y = f(K, AN), a 20% increase in A will cause which of the following variables to increase by 20%? A) labor B) effective labor C) output D) output per worker E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 2) In the following production function, Y = f(K, AN), suppose A increases by 20%. This 20% increase in A implies that ________. A) the same output can be produced with 20% less labor B) the effective quantity of labor has increased by 20% C) output will increase by less than 20% D) all of these Answer: D AACSB: Application of knowledge Status: 8e question 3) In the production function Y = f(K, AN), for a given state of technology, constant returns to scale implies that output (Y) will increase by 7% when ________. A) K or AN increase by 7% B) K and N increase by 7% C) N or A increase by 7% D) N and A increase by 7% E) all of these Answer: B AACSB: Application of knowledge Status: 8e question 4) Which of the following will cause an increase in output per effective worker? A) an increase in population growth B) an increase in the rate of depreciation C) a reduction in the saving rate D) an increase in the rate of technological progress E) an increase in the saving rate Answer: E AACSB: Application of knowledge Status: 8e question 1 Copyright © 2025 Pearson Education, Inc.

Use the following information to answer the question(s) below: (1) the rate of depreciation is 10% per year, (2) the population growth rate is 2% per year, and (3) the growth rate of technology is 3% per year. 5) Refer to the information above. Which of the following equals the annual growth rate of "effective labor" in the steady state in this economy? A) 2% B) 3% C) 5% D) 10% E) 15% Answer: C AACSB: Analytical thinking Status: 8e question 6) Refer to the information above. Which of the following represents the level of investment needed to maintain a constant capital stock (K) in this economy? A) .02K B) .03K C) .05K D) .10K E) .15K Answer: D AACSB: Analytical thinking Status: 8e question 7) Refer to the information above. Which of the following represents the level of investment needed to maintain constant capital per effective worker (K/AN) in this economy? A) .02K B) .03K C) .05K D) .10K E) .15K Answer: E AACSB: Analytical thinking Status: 8e question

8) Refer to the information above. Which of the following represents the steady-state growth rate of output in this economy? A) 2% B) 3% C) 5% D) 10% E) 15% Answer: C AACSB: Analytical thinking Status: 8e question 9) Refer to the information above. Which of the following represents the steady-state growth rate of output per worker in this economy? A) 2% B) 3% C) 5% D) 10% E) 15% Answer: B AACSB: Analytical thinking Status: 8e question 10) Which of the following will cause an increase in the steady-state growth rate of capital? A) an increase in the saving rate B) an increase in the population growth rate C) a temporary increase in technological progress D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 11) Which of the following will cause a reduction in the steady-state growth rate of output per worker? A) a reduction in the saving rate B) an increase in the population growth rate C) an increase in the rate of depreciation D) an increase in the saving rate E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

12) Which of the following is always true after an economy reaches a balanced growth equilibrium? A) the growth rate of output equals the rate of depreciation B) population growth is zero C) the growth rate of capital is equal to the growth rate of the effective work force D) the growth rate of capital is equal to the savings rate E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 13) Suppose there is an increase in the saving rate. This increase in the saving rate will cause an increase in which of the following once the economy reaches its new steady state equilibrium? A) growth rate of output B) growth rate of capital C) growth rate of capital per worker D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 14) Suppose output per worker in a country has grown at the same rate as technology over for many years. This country's growth would be described as ________. A) "appropriable" growth B) "balanced" growth C) "effective" growth D) "diffuse" growth E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 15) Which of the following represents a dimension of technological progress? A) larger quantities of output for given quantities of capital and labor B) better products C) a larger variety of products D) new products E) all of these Answer: E AACSB: Application of knowledge Status: 8e question

16) Assume that an economy experiences both positive population growth and technological progress. In this economy, which of the following is constant when balanced growth is achieved? A) K B) AN C) K/N D) Y/AN E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 17) Assume that an economy experiences both positive population growth and technological progress. In this economy, which of the following is constant when balanced growth is achieved? A) I B) S C) Y/N D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 18) Which of the following is not constant when balanced growth is obtained? A) Y/AN B) AN C) K/AN D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 19) Assume that an economy experiences both positive population growth and technological progress. Once the economy has achieved balanced growth, we know that the capital stock is ________. A) constant B) growing at a rate of gA C) growing at a rate of gN D) growing at a rate of gA + gN E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

20) Assume that an economy experiences both positive population growth and technological progress. Once the economy has achieved balanced growth, we know that output (Y) is ________. A) constant B) growing at a rate of gA + gN C) growing at a rate of gN D) growing at a rate of gA E) growing at a rate of gA - gN Answer: B AACSB: Application of knowledge Status: 8e question 21) Assume that an economy experiences both positive population growth and technological progress. Once the economy has achieved balanced growth, we know that the capital per effective worker ratio (K/AN) is ________. A) growing at a rate of δ + gA + gN B) growing at a rate of gA + gN C) growing at a rate of gN D) growing at a rate of gA E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 22) Assume that an economy experiences both positive population growth and technological progress. Once the economy has achieved balanced growth, we know that the output per effective worker ratio (Y/AN) is ________. A) growing at a rate of 0 B) growing at a rate of gA + gN C) growing at a rate of gN D) growing at a rate of gA E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

23) Assume that an economy experiences both positive population growth and technological progress. Once the economy has achieved balanced growth, we know that the capital per effective worker ratio (K/AN) is ________. A) constant B) growing at a rate of gA - gN C) growing at a rate of gN D) growing at a rate of gA E) growing at a rate of δ + gA + gN Answer: D AACSB: Application of knowledge Status: 8e question 24) Assume that an economy experiences both positive population growth and technological progress. Once the economy has achieved balanced growth, we know that the capital per effective worker ratio (K/AN) is ________. A) constant B) growing at a rate of gA - gN C) growing at a rate of gN D) growing at a rate of gA E) growing at the same rate as Y/AN Answer: E AACSB: Application of knowledge Status: 8e question 25) Assume that an economy experiences both positive population growth and technological progress. Once the economy has achieved balanced growth, we know that ________. A) S/AN = (δ + gA + gN)K/AN B) S/AN = (gA + gN)K/AN C) I/AN = (δ)K/AN D) I = δK E) none of these Answer: A AACSB: Analytical thinking Status: 8e question

26) Assume that an economy experiences both positive population growth and technological progress. Once the economy has achieved balanced growth, we know that growth rate of K/AN is ________. A) gA gN B) gA + gN C) 0 D) gA E) none of these Answer: C AACSB: Analytical thinking Status: 8e question 27) Let α represent labor's share of total output. The Solow residual is represented by ________. A) gy - [αgN + (1 - α)gK] B) gy C) gK D) αgN E) 1/(1 - α) Answer: A AACSB: Analytical thinking Status: 8e question 28) Let α represent labor's share of total output. The Solow residual is, therefore, represented by ________. A) αgy B) αgA C) αgK D) αgN E) 1/α Answer: B AACSB: Analytical thinking Status: 8e question

Use the information provided below to answer the following question(s). δ = .11 gA = .03 gN = .02 29) Refer to the information above. Given this information, we know that effective labor (NA) grows at which rate? A) 0 B) 1% C) 4% D) 5% E) 15% Answer: D AACSB: Analytical thinking Status: 8e question 30) Refer to the information above. Which of the following represents the amount of investment per effective worker needed to maintain a constant level of capital per effective worker (K/AN)? A) .02(K/AN) B) .03(K/AN) C) .05(K/AN) D) .13(K/AN) E) .16(K/AN) Answer: E AACSB: Analytical thinking Status: 8e question 31) Refer to the information above. Given this information, the steady state rate of growth of Y/AN is ________. A) 0 B) 2% C) 3% D) 5% E) 16% Answer: A AACSB: Analytical thinking Status: 8e question

32) Refer to the information above. Given this information, the steady state rate of growth of output per worker is ________. A) 0 B) 2% C) 3% D) 5% E) 16% Answer: C AACSB: Analytical thinking Status: 8e question 33) Refer to the information above. Given this information, the steady state rate of growth of output is ________. A) 0 B) 2% C) 3% D) 5% E) 16% Answer: D AACSB: Analytical thinking Status: 8e question 34) Assume that an economy experiences both positive population growth and technological progress. A reduction in the saving rate will cause ________. A) no change in K/AN B) a permanent reduction in the rate of growth of output per worker C) a permanent reduction in the rate of growth of output D) no change in Y/AN E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 35) Which of the following will cause an increase in the steady-state growth rate of output per worker? A) an increase in the saving rate B) a reduction in the population growth rate C) a reduction in the rate of depreciation D) a reduction in the saving rate E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

36) Suppose there is a reduction in the saving rate. This decrease in the saving rate will cause a reduction in which of the following once the economy reaches its new steady state equilibrium? A) growth rate of output B) growth rate of capital C) growth rate of capital per worker D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 37) Explain the different dimensions of technological progress. Answer: There are several dimensions of technological progress: more output for a given amount of inputs, better products, new products, a larger variety of products. AACSB: Written and oral communication Status: 8e question 38) Explain what factors determine how much investment is required to maintain a given level of capital per effective worker. Answer: There are three factors that will affect the amount of required investment: depreciation, population growth, and rate of technological progress. AACSB: Written and oral communication Status: 8e question 39) Explain what factors determine the slope of the required investment line. Answer: The slope of the required investment line will depend on: the rate of depreciation, population growth, and rate of technological progress. AACSB: Written and oral communication Status: 8e question 40) Assume the economy has achieved the balanced growth steady state. Explain what factors determine the rates of growth of each of the following variables when balanced growth is achieved: output per effective worker, capital per effective worker, output per worker, output, and consumption per worker. Answer: When balanced growth is achieved, K/NA and Y/NA are constant so their rates of growth are 0. K and Y must, therefore, grow at the same rate as NA which equals the sum of population growth and rate of TP. The rate of growth of Y/N will equal the rate of growth of TP. C will grow at the same rate as Y. AACSB: Written and oral communication Status: 8e question

41) Suppose there is an increase in the saving rate. Explain what effect this increase in the saving rate will have on the rate of growth of output per worker. Answer: As described in answers for the previous chapter, an increase in the saving rate will only temporarily affect the growth rates of Y and Y/N. Once the new balanced growth equilibrium is achieved, the growth rates of Y and Y/N will return to their original levels. AACSB: Written and oral communication Status: 8e question 42) Graphically illustrate and explain the effects of an increase in the saving rate on the Solow growth model. In your answer, you must clearly label all curves and the initial and final equilibria. In your answer, explain what happens to the rate of growth of output per worker and the rate of growth of output as the economy adjusts to this increase in the saving rate. Answer: The graph is easy. The saving rate increases causing the saving/investment function to shift up. K/AN and Y/AN will rise to some permanently higher level. The growth rates of Y and Y/N will temporarily increase and then return to their original levels. AACSB: Analytical thinking Status: 8e question 43) Suppose policy makers pass a budget that results in an increase in the budget deficit. Also assume that this fiscal policy action results in a reduction in the saving rate. To what extent will this reduction in the saving rate cause permanent changes in the rate of growth of output per worker? Explain. Answer: A budget that causes an increase in the budget deficit will cause a reduction in the saving rate. Reductions in the saving rate will only temporarily affect the growth rates of Y and Y/N. Once the new balanced growth equilibrium is achieved, the growth rates of Y and Y/N will return to their original levels. AACSB: Reflective thinking Status: 8e question 44) To what extent can changes in the rate of technological progress cause permanent changes in the rate of growth of output per worker? Explain. Answer: For example, an increase in the rate of TP will cause the required investment line to become steeper. K/AN and Y/AN will fall over time to some permanently lower level. The increase in the rate of TP will cause the rate of growth of Y and Y/N to increase over time and to reach a permanently higher level. AACSB: Reflective thinking Status: 8e question

12.2

The Determinants of Technological Progress

1) Which of the following best describes a situation where research is considered relatively fertile? A) research that translates into many new products B) research that costs the firms relatively little money C) research that cannot be easily copied by other firms D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 2) Which of the following best describes a situation where research is considered appropriable? A) research that is well suited to its commercial purpose B) research that is easily copied by another firm C) research that translates into many new products D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 3) Patent protection is important in affecting technological progress because it makes research and development ________. A) diffuse more quickly B) more fertile C) more easily available D) more appropriable E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 4) Which of the following represents the appropriability of research? A) the protection given to new products by the law B) how R&D spending translates into new ideas C) the extent to which firms benefit from the results of their own R&D spending D) the rate of technological progress Answer: C AACSB: Application of knowledge Status: 8e question

5) Which of the following represents the fertility of research? A) the protection given to new products by the law B) how R&D spending translates into new ideas C) the extent to which firms benefit from the results of their own R&D spending D) the rate of technological progress Answer: B AACSB: Application of knowledge Status: 8e question 6) Patents represent ________. A) the protection given to new products by the law B) how R&D spending translates into new ideas C) the extent to which firms benefit from the results of their own R&D spending D) the rate of technological progress Answer: A AACSB: Application of knowledge Status: 8e question 7) Most technological progress in modern advanced economies is the result of the outcome of ________. A) firms' investment in research and development B) a convergence of the accumulation of capital C) university research D) all of these Answer: A AACSB: Application of knowledge Status: 8e question 8) Which of the following is hypothesized to explain the reduction in the rate of technological progress? A) ineffective labor B) the increase in the size of the tech sector C) a reduction in R&D spending D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question

9) Based on recent research, which of the following is the most likely cause of the reduction in the rate of technological progress? A) measurement error B) the increase in the size of the service sector C) a reduction in R&D spending D) a reduction in the fertility of research E) all of these Answer: D AACSB: Application of knowledge Status: 8e question 10) The method of constructing a measure of technological progress relies on which of the following assumptions? A) each factor of production is paid its marginal product B) population growth does not change C) population growth is zero D) the saving rate does note change Answer: A AACSB: Application of knowledge Status: 8e question 11) Explain what is meant by the fertility and appropriability of the research process. Answer: The fertility of research indicates the extent to which research yields new ideas. The appropriability refers to the extent to which firms can benefit from these new ideas. AACSB: Written and oral communication Status: 8e question 12) What factors determine technological progress? Answer: Technological progress depends on (1) the fertility of research and development-how spending on R&D translates into new ideas and new products, and (2) the appropriability of the results of R&D-the extent to which firms benefit from the results of their R&D. AACSB: Written and oral communication Status: 8e question 13) To sustain growth, advanced countries, which are at the technology frontier , must ________. A) innovate B) imitate C) reduce spending on human capital D) reduce spending on global warming Answer: A AACSB: Application of knowledge Status: New question 9e

12.3

Institutions, Technological Progress, and Growth

1) When was the last year that GDP per capita in North Korea was approximately equal to GDP per capita in South Korea? A) 1950 B) 1970 C) 1990 D) 2000 E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 2) Graphically illustrate and explain the effects of a reduction in the saving rate on the Solow growth model. In your answer, you must clearly label all curves and the initial and final equilibria. In your answer, explain what happens to the rate of growth of output per worker and the rate of growth of output as the economy adjusts to this decrease in the saving rate. Answer: The graph is easy. The saving rate reduction causing the saving/investment function to shift down. K/AN and Y/AN will fall to some permanently lower level. The growth rates of Y and Y/AN will temporarily decrease and then return to their original levels. AACSB: Analytical thinking Status: 8e question 3) Suppose policy makers pass a budget that results in a reduction in the budget deficit. Also assume that this fiscal policy action results in an increase in the saving rate. To what extent will this increase in the saving rate cause permanent changes in the rate of growth of output per worker? Explain. Answer: A budget that causes a reduction in the budget deficit will cause an increase in the saving rate. Increases in the saving rate will only temporarily affect the growth rates of Y and Y/N. Once the new balanced growth equilibrium is achieved, the growth rates of Y and Y/N will return to their original levels. AACSB: Written and oral communication Status: 8e question 4) Which of the following can help explain the technology gap that exists between some countries? A) poorly established property rights B) political instability C) the relative absence of entrepreneurs D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

5) Perhaps the most important institution that leads to economic growth is ________. A) property rights B) educational system C) financial system D) wealth transfer Answer: A AACSB: Reflective thinking Status: New question 9e

Macroeconomics, 9e (Blanchard) Chapter 13: The Challenges of Growth 13.1

The Future of Technological Progress

1) ________ allows computers and robots to perform even more complex tasks based on simple prompts, ranging from coding to text analysis to the creation of images or music. A) Generative artificial intelligence B) Machine learning C) Design thinking D) Deep learning and big data Answer: A AACSB: Application of knowledge Status: New question 9e 2) Which of the following statements about the United States during the twentieth century is correct? A) Output growth has been approximately equal to employment growth. B) Output growth has been slower than employment growth. C) Output growth has been faster than employment growth. D) Output has increased largely due to monetary and fiscal policy. E) Output has decreased largely due to monetary and fiscal policy. Answer: C AACSB: Application of knowledge Status: 8e question 3) Suppose an economy experiences an increase in technological progress. This increase in technological progress will ________. A) allow more output to be produced with the same number of workers B) allow the same amount of output to be produced with fewer workers C) lead to changes in the types of goods produced D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

4) Some believe that technological progress leads to higher unemployment in the medium run. This claim that technological progress results in an increase in unemployment in the medium is supported by ________. A) economic theory, but contradicted by the evidence B) theory and evidence C) the evidence, but contradicted by theory D) neither theory nor evidence E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 5) In most advanced economies, since the early 2000s, productivity growth, measured as the rate of growth of output per worker, has been ________. A) lower than it was in earlier decades B) higher than it was in earlier decades C) more erratic than in earlier decades D) negative Answer: A AACSB: Application of knowledge Status: New question 9e 6) When the production function is represented by Y = AN, labor productivity is represented by which of the following expressions? A) 1/A B) NA C) A/Y D) Y/A E) none of these Answer: E AACSB: Analytical thinking Status: 8e question 7) The number of workers employed will not change as a result of an increase in productivity when which of the following occurs? A) The AS curve shifts downward. B) Output growth exceeds productivity growth. C) Productivity growth is equal to output growth. D) The AD curve shifts to the right. E) none of these Answer: C AACSB: Application of knowledge Status: 8e question

8) An increase in productivity will cause which of the following according to the price-setting behavior of firms? A) a reduction in prices set by firms B) an increase in the real wage paid by firms C) a reduction in the markup set by firms D) all of these E) none of these Answer: D AACSB: Reflective thinking Status: 8e question 9) Based on price-setting behavior, which of the following will cause an increase in the price level? A) a reduction in productivity B) an increase in the nominal wage C) an increase in the markup D) all of these E) none of these Answer: D AACSB: Reflective thinking Status: 8e question 10) Based on our understanding of the wage-setting equation, which of the following will not cause a reduction in the nominal wage? A) an increase in unemployment B) a reduction in the expected price level C) a reduction in expected productivity D) all of these E) none of these Answer: E AACSB: Reflective thinking Status: 8e question 11) The empirical evidence suggests that periods of high productivity growth will cause which of the following in the short run? A) higher markups B) lower unemployment C) constant real wages D) greater equality in wages E) none of these Answer: B AACSB: Application of knowledge Status: 8e question

12) Assume an economy experiences, for a given period, a 4% increase in output and a 2% increase in productivity. Given this information, we know that which of the following occurred for this economy during this period? A) The unemployment rate increased during this period. B) The unemployment rate decreased during this period. C) The unemployment rate did not change during this period. D) The effects on the unemployment rate are ambiguous. E) none of these Answer: B AACSB: Analytical thinking Status: 8e question 13) Assume an economy experiences, for a given period, a 4% increase in output and a 4% increase in productivity. Given this information, we know that which of the following occurred for this economy during this period? A) The unemployment rate increased during this period. B) The unemployment rate decreased during this period. C) The unemployment rate did not change during this period. D) The effects on the unemployment rate are ambiguous. E) none of these Answer: C AACSB: Analytical thinking Status: 8e question 14) Assume an economy experiences, for a given period, a 1% increase in output and a 5% increase in productivity. Given this information, we know that which of the following occurred for this economy during this period? A) The unemployment rate increased during this period. B) The unemployment rate decreased during this period. C) The unemployment rate did not change during this period. D) The effects on the unemployment rate are ambiguous. E) none of these Answer: A AACSB: Analytical thinking Status: 8e question 15) Suppose the aggregate production function is represented by Y = AN. Which of the following expressions represents the number of additional workers required to increase production by one unit? A) 1/A B) Y/N C) 1/N D) 1/Y E) none of these Answer: A AACSB: Analytical thinking Status: 8e question 4 Copyright © 2025 Pearson Education, Inc.

16) For this question, assume that the aggregate production function is represented by Y = AN. Which of the following represents the marginal cost of producing an additional unit of output? A) W B) W/A C) A/W D) (1 + A)W E) 1/W Answer: B AACSB: Analytical thinking Status: 8e question 17) For this question, assume that the aggregate production function is represented by Y = AN. Which of the following represents the price setting relation for this economy? A) (1 + m)A B) (1 + m)A/W C) (1 + m)W D) W/A E) none of these Answer: E AACSB: Analytical thinking Status: 8e question 18) Which of the following represents the wage setting relation when changes in labor productivity are allowed to occur? A) W = PeF(u,z) B) W = P(1 + m) C) W = PeF(u,z)/A D) W = AP/(1 + m) E) none of these Answer: E AACSB: Analytical thinking Status: 8e question 19) For this question, assume that expectations of P and A are correct. Based on price setting behavior, the real wage will be equal to which of the following? A) A/(1 + m) B) AP/(1 + m) C) APF(u,z) D) P(1 + m) E) none of these Answer: A AACSB: Analytical thinking Status: 8e question

20) For this question, assume that expectations of P and A are correct. Now suppose that there is a 4% increase in A. Given this information, which of the following will occur? A) The PS relation will shift up by 4%. B) The WS relation will shift up by less than 4%. C) The WS relation will shift down by 4%. D) The PS relation will shift down by 4%. Answer: A AACSB: Reflective thinking Status: 8e question 21) For this question, assume that expectations of P and A are correct. Now suppose that there is a 1% increase in A. Given this information, which of the following will occur? A) a 1% increase in the real wage and a reduction in the natural rate of unemployment B) a 1% increase in the real wage and no change in the natural rate of unemployment C) no change in the real wage and an increase in the natural rate of unemployment D) no change in the real wage and a reduction in the natural rate of unemployment Answer: B AACSB: Reflective thinking Status: 8e question 22) For this question, assume expectations of P and A are correct. Now suppose that there is a 3% reduction in A. Given this information, which of the following will occur? A) The PS relation will shift up by 2%. B) The WS relation will shift down by less than 2%. C) The WS relation will shift down by 2%. D) There will be no change in the real wage. Answer: C AACSB: Reflective thinking Status: 8e question 23) For this question, assume that expectations of productivity are slow to adjust. Further assume that A had been increasing by 6% a year. Now suppose that A only increases by 2% in period t. This slowdown in productivity growth will cause ________. A) the PS relation to shift up more than the WS relation B) the WS relation to shift up more than the PS relation C) the natural rate of unemployment to fall D) the real wage to fall Answer: B AACSB: Reflective thinking Status: 8e question

24) For this question, assume that expectations of productivity are slow to adjust. Further assume that A had been increasing by 2% a year. Now suppose that A increases by 5% in period t. This increase in productivity growth will cause ________. A) the real wage to rise and no change in the natural rate of unemployment B) the WS relation to shift up more than the PS relation C) the natural rate of unemployment to fall D) the real wage to fall Answer: C AACSB: Reflective thinking Status: 8e question 25) For this question, assume that expectations of productivity are slow to adjust. An increase in productivity growth from 1% to 3% will cause ________. A) an increase in the real wage of 1% and an increase in un B) an increase in the real wage of 1% and a reduction in un C) an increase in the real wage of 3% and an increase in un D) an increase in the real wage of 3% and a reduction in un Answer: D AACSB: Reflective thinking Status: 8e question 26) Based on price setting behavior, which of the following will cause a reduction in the price level? A) an increase in productivity B) a reduction in the nominal wage C) a reduction in the markup D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 27) For this question, assume that expectations of productivity growth adjust slowly. Now, suppose that there is a 3% reduction in productivity. Explain how this 3% reduction in productivity can cause changes in the unemployment rate. Answer: The PS curve will shift up as productivity growth occurs; however, it will not shift up as much. If expectations of productivity are slow to adjust, the WS curve continues to shift up by a larger amount (based on past increases in A). The real wage will rise by the actual change in productivity. The unemployment rate will, however, increase because of the larger shift in the WS curve. AACSB: Written and oral communication Status: 8e question

28) For this question, assume that expectations of productivity growth adjust slowly. Now, suppose that there is a 5% increase in productivity. Explain how this 5% increase in productivity can cause changes in the unemployment rate. Answer: The PS curve will shift up as productivity growth occurs; however, it will now shift up by a greater amount. If expectations of productivity are slow to adjust, the WS curve continues to shift up by a smaller amount (based on past increases in A). The real wage will rise by the actual change in productivity. The unemployment rate will, however, decrease because of the smaller shift in the WS curve. AACSB: Written and oral communication Status: 8e question 29) Briefly describe how artificial intelligence can lead to higher productivity. Answer: Progress in GenAI is extremely rapid, and it is clear that computers and robots will be able to do many of the tasks done by humans today. The results of a McKinsey study about how much time could be saved by the use of GenAI in different sectors are shown in Figure 13-1 in the text. Based on the study, the average share of time potentially saved is about 30%. It varies across sectors (and likely even more so, across jobs within a sector), from 20% for builders, to 40% in office support. The scope for GenAI itself (the move from the black dots to the blue dots) also varies, from 16% in education to less than 3% in agriculture. The size of these numbers is impressive. If we assume that a worker will produce in (1—30%) units of time what they produce in 1 unit of time today, this implies an increase in productivity of 1 0.7—1.0, or 42%. If this were to happen over the 2022—2030 period, a rate of growth of productivity of 4.7% per year would be implied, more than 3 times the current rate of productivity growth. AACSB: Written and oral communication Status: New question 9e 13.2

Technological Progress and Unemployment

1) For this question, assume that workers expectations of the price level and productivity are accurate. Now suppose that the economy experiences an increase in productivity. Which of the following will occur in the medium run? A) no change in unemployment B) an increase in unemployment C) a reduction in unemployment D) no change in the natural level of output if the unemployment rate does not change E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

2) In recent years, the increasing relative wage of skilled labor has been mostly due to ________. A) a decrease in the supply of skilled labor that exceeds the decrease in demand B) an increase in the demand for skilled labor that exceeds the increase in supply C) a decrease in the supply of, and increase in the demand for, skilled labor D) government laws promoting the hiring of skilled labor E) government subsidies provided to college students Answer: B AACSB: Application of knowledge Status: 8e question 3) Which of the following would increase the gap in wages between skilled and unskilled workers? A) less technological progress of the kind we've experienced in the past 15 years B) new types of production technology that require workers to have more skills C) an increase in the costs of going to college D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 4) Which of the following is not true about technological progress? A) allow for the production of a larger quantity of goods using the same number of workers B) lead to the production of new goods C) lead to the disappearance of old goods D) cause a reduction in employment in the short run E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 5) Suppose the aggregate production function is represented by the following: Y = AN. Given this information, labor productivity is given by ________. A) Y B) N/A C) A/N D) A E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

6) Assume an economy experiences an increase in productivity that occurs as a result of a more widespread implementation of a major technological breakthrough. Given this information, we would expect which of the following to occur? A) aggregate demand would not change B) aggregate demand would shift to the right C) aggregate demand would shift to the left D) both the aggregate demand and aggregate supply curves would shift to the left Answer: B AACSB: Application of knowledge Status: 8e question 7) Assume an economy experiences an increase in productivity that occurs as a result of the more efficient use of existing technologies. Given this information, we would expect which of the following to occur? A) aggregate demand would not change B) aggregate demand would shift to the right C) aggregate demand would shift to the left D) both the aggregate demand and aggregate supply curves would shift to the left Answer: C AACSB: Application of knowledge Status: 8e question 8) When the unemployment rate is on the horizontal axis and the real wage is on the vertical axis, a reduction in productivity will cause which of the following to occur? A) The wage-setting and price-setting curves will both shift downward. B) The wage-setting and price-setting curves will both shift upward. C) The price-setting curve to shift downward, and no shift in the wage-setting curve. D) The wage-setting curve to shift upward, and the price-setting curve to shift downward. E) The wage-setting curve to shift downward, and the price-setting curve to shift upward. Answer: A AACSB: Application of knowledge Status: 8e question 9) Based on price setting behavior, which of the following will cause a reduction in the price level? A) an increase in productivity B) a reduction in the nominal wage C) a reduction in the markup D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

10) Suppose workers' and firms' expectations of the price level and productivity are accurate. In this case, a reduction in productivity will cause which of the following? A) a decrease in both the real wage and the natural rate of unemployment B) an increase in both the real wage and the natural rate of unemployment C) a decrease in the real wage and no change in the natural rate of unemployment D) an increase in the real wage and a decrease in the natural rate of unemployment E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 11) Assume an economy experiences, for a given period, a 5% increase in output and a 1% increase in productivity. Given this information, we know that which of the following occurred for this economy during this period? A) The unemployment rate increased during this period. B) The unemployment rate decreased during this period. C) The unemployment rate did not change during this period. D) The effects on the unemployment rate are ambiguous. E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 12) Suppose an economy experiences a reduction in productivity. Explain both the short-run and medium-run effects of this reduction in productivity on output, employment, and the unemployment rate. Answer: In both the short run and medium run, TP will cause a reduction in output (assuming, of course, that any change in AD, if it occurs, is offset by the shift in the AS curve). What happens to employment in the medium? Given that Y will fall by the full change in TP in the medium, we know that N and u will not be affected in the medium run. In the short run, N will fall and u will rise if the percentage change in Y is less than the percentage change in TP. AACSB: Written and oral communication Status: 8e question 13) Some commentators will argue that increases in productivity may have no effect or even a negative effect on employment in the short run. Explain what must occur for an increase in productivity to have no effect or even a negative effect on employment in short run. Answer: An increase in productivity will have no effect on employment if the percentage change in output equals the percentage change in productivity. Employment will fall if the percentage change in output is less than the percentage change in productivity. This can be seen from Y = AN which implies that N = Y/A. AACSB: Written and oral communication Status: 8e question

14) Explain what effect a reduction in productivity has on wage setting behavior, price setting behavior, the equilibrium real wage, the natural rate of unemployment, and the natural level of output. Answer: A reduction in A will cause a reduction in the real wage based on WS behavior; therefore, the WS curve shifts down by the change in A. The reduction in A increases the marginal cost of an additional unit of output so firms will raise the price. Hence, the real wage based on PS behavior will fall by A and the PS curve shifts down by A. Given the size of the shifts in the WS and PS curves, u does not change; however, the real wage does fall. AACSB: Written and oral communication Status: 8e question 15) Suppose an economy experiences an increase in productivity. Explain both the short-run and medium-run effects of this increase in productivity on output, employment, and the unemployment rate. Answer: In both the short run and medium run, TP will cause an increase in output (assuming, of course, that any change in AD, if it occurs, is offset by the shift in the AS curve). What happens to employment in the medium? Given that Y will rise by the full change in TP in the medium, we know that N and u will not be affected in the medium run. In the short run, N will rise and u will fall if the percentage change in Y is greater than the percentage change in TP. AACSB: Written and oral communication Status: 8e question 16) Assume expectations of both prices and productivity are accurate,use the PS/WS relations, graphically illustrate and explain the effects of an increase in the productivity on the natural rate of unemployment. Answer: An increase in productivity shifts both the wage and the price-setting curves by the same proportion and thus has no effect on the natural rate. AACSB: Written and oral communication Status: 8e question 17) Assume expectations of prices are correct but expectations of productivity adjust slowly. Use the PS/WS relations, graphically illustrate and explain the effects of a decrease in productivity growth on the natural rate of unemployment. Answer: The PS relation shifts up by a factor A. The WS relation shifts up by a factor Ae. If Ae>A, the PS curve shifts up by less than the WS relation shifts up, leading to an increase in the natural rate of unemployment for some time. AACSB: Written and oral communication Status: 8e question

18) Suppose an economy is characterized by the equations below: Price setting: P= (1 + m) (W/A) Wage setting: W=AP(1 - u) Solve for the natural rate of unemployment if the markup (m) is equal to 4%. Answer: u = 4% AACSB: Written and oral communication Status: 8e question 19) Technological unemployment is a macroeconomic phenomenon that occurs when ________. A) unemployment changes due to the effects of technology in high-technology industries B) unemployment changes due to the effects of monetary and fiscal policy in the New Economy C) people switch jobs when moving across country D) changes in technology increase the number of people employed E) unemployment changes as a result of technological change Answer: E AACSB: Analytical thinking Status: 8e question 20) Among the reasons that the poor countries have been unable to close the "technology gap" with the rich countries is ________. A) poorly established property rights B) poorly developed financial markets C) low education levels D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 21) There are some concerns that technological progress can lead to an increase in unemployment. Explain the two related but separate dimensions of technological progress. Answer: First, TP allows for a greater quantity of goods produced with the same inputs. Second, TP results in the production of new goods and the disappearance of old ones. AACSB: Written and oral communication Status: 8e question

13.3

Growth, Churn, and Inequality

1) "Churning" refers to ________. A) changes in the real wage over the business cycle B) changes in the markup over the business cycle C) structural change associated with technological progress D) the increase in productivity caused by an increase in output E) the increase in output caused by an increase in productivity Answer: C AACSB: Application of knowledge Status: 8e question 2) A large increase in wage inequality in the U.S. in the past 35 years is due to ________. A) technological change B) budget deficits C) trade deficits D) schooling Answer: A AACSB: Application of knowledge Status: 8e question 3) The share of income going into households in the top 1% is about ________ today. A) 19% B) 9% C) 50% D) 13% Answer: A AACSB: Application of knowledge Status: 8e question 4) A Gini coefficient of 0 means ________. A) complete equality B) complete inequality C) one person receiving all the income D) none of these Answer: A AACSB: Application of knowledge Status: 8e question 5) A Gini coefficient of 1 means ________. A) complete equality B) complete inequality C) everybody having the same income D) none of these Answer: B AACSB: Application of knowledge Status: 8e question 14 Copyright © 2025 Pearson Education, Inc.

6) The evidence suggests that recent technological change ________. A) permanently increased the natural rate of unemployment B) is different from past technological change, in that it has no impact on productivity C) has increased productivity in the service sector only D) has increased productivity in the manufacturing sector only E) has increased the wage gap between skilled and unskilled workers Answer: E AACSB: Application of knowledge Status: 8e question 7) Which of the following is not believed to cause recent increases in wage inequality? A) international trade B) contractionary monetary policy C) skill-biased technological progress D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 8) In recent years, real wages of the least educated workers ________. A) have increased faster than the real wages of college-educated workers B) have increased, but by less than the real wages of college-educated workers C) have decreased, but by less than the real wages of college-educated workers D) have decreased, while the real wages of college-educated workers have increased E) have decreased at about the same rate as the real wages of college-educated workers Answer: D AACSB: Application of knowledge Status: 8e question 9) Joseph Schumpeter argued that growth was a process of creative destruction. Explain what is meant by the phrase, "creative destruction." Answer: When TP occurs and new goods are developed, old goods will disappear. In those industries that produced these "old" goods, employment will decrease. It is this process of technological progress causing the destruction of old jobs that is referred to as "creative destruction." AACSB: Written and oral communication Status: 8e question 10) Explain how technological change can cause changes in wage inequality. Answer: If the technological progress favors skilled workers, the demand for skilled workers will rise and the demand for relatively unskilled workers will fall. This would cause the wage gap to increase. AACSB: Written and oral communication Status: 8e question 15 Copyright © 2025 Pearson Education, Inc.

11) Explain some of the causes of increased wage inequality. Answer: Possible causes: skill-biased technological progress and international trade. AACSB: Written and oral communication Status: 8e question 12) ________ is income inequality before taxes and transfers. A) Market income inequality B) Disposable income inequality C) The Gini coefficient D) Posttax inequality Answer: A AACSB: Application of knowledge Status: New question 9e 13) ________ is income inequality after taxes and transfers. A) Market income inequality B) Disposable income inequality C) Pretax inequality D) The Gini coefficient Answer: B AACSB: Application of knowledge Status: New question 9e 14) Growth that limits income inequality is known as inclusive growth. Answer: TRUE AACSB: Ethical understanding and reasoning Status: New question 9e 13.4

Climate Change and Global Warming

1) ________ is now the main source of CO2. A) China B) U.S. C) Europe D) India Answer: A AACSB: Application of knowledge Status: 8e question 2) Global average temperature has increased by roughly ________ degrees Celsius since 1880. A) 1.2 B) 1.4 C) 0.8 D) 0.6 Answer: A AACSB: Application of knowledge Status: Modified 8e 16 Copyright © 2025 Pearson Education, Inc.

3) Energy sources that emit large amounts of CO2 such as coal, oil, and gas are known as ________ energy. A) brown B) black C) green D) deadly Answer: A AACSB: Application of knowledge Status: New question 9e 4) What strategies can governments use to make the transition to green energy sources? Answer: The cost of the transition from brown to green energy is likely to be high, with additional investment estimated to be around 2% of GDP annually if we are to limit the increase in temperature to 1.5%. Not surprisingly, governments are reluctant to raise taxes, and polls suggest a strong opposition to a high carbon tax. Thus, governments may not increase carbon taxes sufficiently, or else, they may have recourse to subsidies to green energy rather than taxes on brown energy: Subsidies are obviously more popular than taxes, although, sooner or later, they will require higher taxes to limit the increase in debt. AACSB: Written and oral communication Status: New question 9e 5) How can poor nations afford to switch to more costly green energy sources? Answer: Global warming imposes large costs to many poor countries, notably in Africa, and that, anyway, many poor countries do not have the resources to embark on major investment programs. The notion that advanced economies should help poor countries through large transfers is, not surprisingly, politically popular in advanced economies. Absent such transfers, however, low-income countries will often be unable to finance their transition, and the goal will not be reached. AACSB: Ethical understanding and reasoning Status: 8e question

Macroeconomics, 9e (Blanchard) Chapter 14: Financial Markets and Expectations 14.1

Expected Present Discounted Values

1) Assume that the current one-year rate is 5% and the two-year rate is 7%. Given this information, the one-year rate expected one year from now is ________. A) 5% B) 6% C) 7% D) 9% E) 12% Answer: D AACSB: Analytical thinking Status: 8e question 2) A consol bond promises to pay $1000 each year, forever, starting next year. If the nominal interest rate is 5%, the present discounted value of this consol is ________. A) $900.00 B) $995.00 C) $2,500.00 D) $20,000.00 E) $25,000.00 Answer: D AACSB: Analytical thinking Status: 8e question 3) The ________ is nominal interest rate used to convert a future value into a present value. A) discount rate B) compound rate C) prime rate D) fed funds rate Answer: A AACSB: Analytical thinking Status: New question 9e 4) What is the expected discounted value of $1000 payments that will be received at the end of this year and the next year if the discount rate is 8%? A) $1,658 B) $1,783 C) $1,898 D) $2,000 Answer: B AACSB: Analytical thinking Status: New question 9e

5) What is the present value of $5,000 that you will receive in 5 years if the discount rate is 11%? A) $2,512 B) $2,781 C) $2,967 D) $3,554 Answer: C AACSB: Analytical thinking Status: New question 9e 6) What is the present value of $500 annual payments that you will receive for the next nine years if the discount rate is zero? A) $3,955 B) $4,250 C) $4,350 D) $4,500 Answer: D AACSB: Analytical thinking Status: New question 9e 7) Bonds pay the bondholder each year based on a ________ interest rate and the bond's face value. A) nominal B) real C) fed funds D) prime Answer: A AACSB: Analytical thinking Status: New question 9e 8) The real interest rate is the nominal interest rate ________. A) discounted back to the present B) multiplied by the inflation rate C) adjusted for changes in the price level D) compounded by the number of periods until maturity Answer: C AACSB: Analytical thinking Status: New question 9e

9) If we want to compute the present value of a sequence of real payments we need to use ________. A) the fed funds rate B) nominal interest rates C) a zero interest rate D) real interest rates Answer: D AACSB: Analytical thinking Status: New question 9e 10) A present value will always be worth ________ than a future value as long as the discount rate ________. A) less; is greater than zero B) more; is zero C) less; is zero D) more; is greater than zero Answer: A AACSB: Analytical thinking Status: New question 9e 14.2

Bond Prices and Bond Yields

1) The length of time over which a bond promises to make payments to the holder is called which of the following? A) the term structure of interest rates B) the face value C) the yield to maturity D) the holding period E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 2) A "junk bond" is a bond with a ________. A) low yield to maturity B) value of zero C) low face value, but high coupon rate D) high default risk E) very low maturity Answer: D AACSB: Application of knowledge Status: 8e question

3) A bond has a face value of $10,000, a price of $12,000, and coupon payments of $2000 for two years. The coupon rate of this bond is ________. A) 10% B) 16.7% C) 20% D) 30% E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 4) A discount bond is a bond ________. A) with no coupon payments B) where the price of the bond is greater than its face value C) where the interest rate is zero D) where the face value is zero E) that never matures Answer: A AACSB: Application of knowledge Status: 8e question 5) For this question, assume that one-year and two-year bonds have the same risk; therefore, you can ignore risk here. Assuming that there is arbitrage between one-year bonds and two-year bonds, we know that the expected rate of return on two-year bonds ________. A) will equal the expected rate of return from holding a one-year bond for one year B) will equal the expected rate of return from holding a one-year bond for two years C) will be larger than the expected rate of return from holding a one-year bond for one year D) will be smaller than the expected rate of return from holding a one-year bond for one year E) will be exactly half the rate of return on one-year bonds Answer: A AACSB: Application of knowledge Status: 8e question 6) A bond has a face value of $1,000, a price of $1,200, and coupon payments of $100 for two years. The "current yield" of this bond is ________. A) 8.33% B) 10% C) 12% D) 83% E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

7) An upward-sloping yield curve suggests that financial market participants expect short-term interest rates will ________. A) rise in the future B) fall in the future C) be unstable in the future D) not change in the future E) be equal to zero in the future Answer: A AACSB: Application of knowledge Status: 8e question 8) Suppose financial market participants expect short-term rates in the future to be less than current short-term interest rates. Given this information, we would expect ________. A) an upward sloping yield curve B) a downward sloping yield curve C) an upward shifting yield curve D) a downward shifting yield curve E) a horizontal yield curve Answer: B AACSB: Application of knowledge Status: 8e question 9) Which of the following represents the ratio of coupon payments to the face value of a bond? A) the interest rate B) the discount rate C) the coupon rate D) the risk premium E) the current yield Answer: C AACSB: Application of knowledge Status: 8e question 10) Suppose a bond promises to make a single payment at maturity. These types of bond are called ________. A) junk bonds B) indexed bonds C) corporate bonds D) discount bonds E) constant maturity bonds Answer: D AACSB: Application of knowledge Status: 8e question

11) Assume that the one-year interest rate is on the vertical axis of the IS-LM model and that the yield curve is initially upward sloping. Suppose that financial market participants expect that the central bank will pursue a monetary contraction in the future. Given this information, we would expect which of the following to occur? A) The yield curve will become steeper. B) The yield curve will become flatter. C) The yield curve will become horizontal. D) The yield curve will become downward sloping. Answer: A AACSB: Application of knowledge Status: 8e question 12) Suppose that financial market participants expect that the central bank will pursue a monetary expansion in the future. Also assume that the yield curve is initially upward sloping. Given this information, we would expect which of the following to occur? A) The yield curve will become steeper. B) i2t will increase. C) i2t will decrease. D) The yield curve will become downward sloping. Answer: C AACSB: Application of knowledge Status: 8e question 13) Suppose that financial market participants now expect a future tax increase in one year. Also assume that the yield curve is initially upward sloping. Given this information, we would expect which of the following to occur? A) The yield curve will become steeper. B) i2t will increase C) i2t will decrease D) The yield curve will become downward sloping. Answer: C AACSB: Application of knowledge Status: 8e question 14) Suppose that financial market participants now expect a future tax cut and that the yield curve is initially upward sloping. Given this information, we would expect which of the following to occur? A) The yield curve will become steeper. B) The yield curve will become flatter. C) The yield curve will become horizontal. D) The yield curve will become downward sloping. Answer: A AACSB: Application of knowledge Status: 8e question

15) A bond has a face value of $10,000, a price of $12,000, and coupon payments of $2000 for two years. The current yield of this bond is ________. A) 10% B) 16.7% C) 20% D) 30% E) none of these Answer: B AACSB: Analytical thinking Status: 8e question 16) Assume that the current one-year rate is 3% and the two-year rate is 5%. Given this information, the one-year rate expected one year from now is ________. A) 5% B) 6% C) 7% D) 9% E) 12% Answer: C AACSB: Analytical thinking Status: 8e question 17) Suppose the current one-year interest rate is 3%, and financial markets expect the one-year interest rate next year to be 5%. Given this information, the yield to maturity on a two-year bond will be approximately ________. A) 4% B) 6% C) 8% D) 12% E) none of these Answer: A AACSB: Analytical thinking Status: 8e question 18) Which of the following represents the ratio of coupon payments to the price of a bond? A) the interest rate B) the discount rate C) the coupon rate D) the risk premium E) the current yield Answer: E AACSB: Application of knowledge Status: 8e question

19) The yield curve is ________. A) the term structure of interest rates B) yield of a bond C) maturity D) all of these Answer: A AACSB: Application of knowledge Status: 8e question 20) Bonds with relatively high risk of default are called ________. A) Brady bonds B) junk bonds C) zero coupon bonds D) investment grade bonds Answer: B AACSB: Application of knowledge Status: 8e question 21) Junk bonds, bonds with a low bond rating, are also known as ________. A) high-yield bonds B) investment grade bonds C) high quality bonds D) zero-coupon bonds Answer: A AACSB: Application of knowledge Status: 8e question 22) Explain what the term structure of interest rates represents. Answer: The term structure of interest rates illustrates the relationship between the yield to maturity on bonds (with the same risk characteristics) and maturity. AACSB: Written and oral communication Status: 8e question 23) When interpreting bond prices as present values, discuss what factors determine the price of a two-year discount bond. Include in your answer an explanation of how changes in each of these factors affects the price of a two-year discount bond. Answer: The price of the two-year bond will be a function of the face value, the current oneyear rate and the future expected one-year rate. An increase in either of the one-year rates will reduce the present value of the bond and, therefore, reduce its price. An increase in the face value (constant) would increase the price. AACSB: Written and oral communication Status: 8e question

24) The yield curve indicates that the two-year interest rate will be a function of what variables? Include in your answer an explanation of how changes in these variables will affect the two-year interest rate. Answer: The two-year rate will be a function of the current one-year rate and the future expected one-year rate. In fact, it will be approximately equal to the average of these two rates. So, an increase in either rate will cause the two-year rate to rise. AACSB: Written and oral communication Status: 8e question 25) Suppose the yield curve is downward sloping. How should one interpret this particular yield curve? Answer: Downward sloping yield curve implies that the future expected one-year rate is lower than the current one-year rate. AACSB: Written and oral communication Status: 8e question 26) Suppose the central bank implements a monetary expansion in the current period and is not expected to continue this policy in the future. Explain what effect this policy will have on the shape of the yield curve and on stock prices. Answer: The current one-year rate will fall with no change in the expected future rate. The twoyear rate, given that it is an average of the two one-year rates, will fall. The change in the twoyear rate will approximately equal half the change in the one-year rate. The yield curve will shift down and get steeper. What happens to stock prices depends on whether this was fully or partially expected? If fully anticipated, stock prices do not change. If at least partially unexpected, stock prices will rise because of the interest rate effect and the higher output (changes in which were unexpected). AACSB: Written and oral communication Status: 8e question 27) Suppose the yield curve is upward sloping. How should one interpret this particular yield curve? Answer: Upward sloping yield curve implies that the future expected one-year rate is higher than the current one-year rate. AACSB: Written and oral communication Status: 8e question 28) Suppose the current one-year interest rate is 4%, and financial markets expect the one-year interest rate next year to be 8%. Given this information, the yield to maturity on a two-year bond will be approximately ________. A) 4% B) 6% C) 8% D) 12% E) none of these Answer: B AACSB: Analytical thinking Status: 8e question 9 Copyright © 2025 Pearson Education, Inc.

29) Suppose the current one-year interest rate is 4%. Also assume that financial markets expect the one-year interest rate next year to be 5%, and expect the one-year rate to be 6% the year after that. Given this information, the yield to maturity on a three-year bond will be approximately ________. A) 4% B) 5% C) 6% D) 15% Answer: B AACSB: Analytical thinking Status: 8e question 30) Which of the following bonds (of equal maturity) would have the largest risk premium? A) U.S. government bonds B) German government bonds C) the bonds of a financially stable corporation, like IBM D) Bonds rated AAA by Moody's E) junk bonds Answer: E AACSB: Application of knowledge Status: 8e question 31) Suppose there is a decrease in the short-term interest rate. Give this reduction in the current short-term interest rate, which of the following will most likely occur? A) The long-term interest rate will increase. B) The long-term interest rate will remain the same. C) The long-term interest rate will decrease by more than the short-term rate. D) The long-term interest rate will decrease by the same amount as the short-term rate. E) The long-term interest rate will decrease, but by less than the short-term rate. Answer: E AACSB: Application of knowledge Status: 8e question 32) Which of the following statements about indexed bonds is correct? A) They were relatively recently introduced in the United States. B) They exist in the United Kingdom. C) They have a nominal interest rate that rises when the inflation rate rises. D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

33) Which of the following best explains why the long-term interest rate will generally change by less than 1% when the short-term interest rate changes by 1%? A) The mathematical calculations are more difficult for analysts in the case of long-term bonds. B) Long-term rates are always lower than short-term rates, so there is less room for them to change. C) Financial market participants will not expect this increase in the short-term interest rate to persist fully in the future. D) Financial markets are often affected by bubbles and fads. E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 34) Suppose the yield curve is initially horizontal. Suppose the current one-year interest rate increases by 4% while the expected future one-year interest rate does not change. Which of the following will tend to occur? A) i2t will increase by 4% B) i2t will increase by 2% C) i2t will increase by less than 2% D) i2t will decrease by 2% Answer: B AACSB: Analytical thinking Status: 8e question 35) Which of the following bonds (of equal maturity) would have the lowest risk premium? A) U.S. government bonds B) German government bonds C) the bonds of a financially stable corporation, like IBM D) Bonds rated AAA by Moody's E) junk bonds Answer: A AACSB: Application of knowledge Status: 8e question 14.3

The Stock Market and Movements in Stock Prices

1) Equity finance is represented by which of the following? A) when a firm borrows money from banks B) when a firm sells bonds C) when a firm sells shares of stock D) when a firm draws down retained earnings E) when a firm sells off part of its capital stock Answer: C AACSB: Application of knowledge Status: 8e question

2) Among the following, which is the broadest measure of stock prices in the United States? A) Dow Jones Index B) FT index C) Nikkei Index D) Term Structure Index E) Standard and Poor's 500 Composite Index Answer: E AACSB: Application of knowledge Status: 8e question 3) The fundamental value of a share of stock is equal to which of the following? A) the sum of expected dividends B) the present value of expected dividends C) the sum of coupon payments D) the present value of coupon payments E) the present value of the expected yield Answer: B AACSB: Application of knowledge Status: 8e question 4) A share of stock will pay a dividend of $25 in one year, and will be sold for an expected price of $500 at that time. If the current one-year interest rate is 5%, the current price of the stock will be approximately equal to ________. A) $100 B) $475 C) $500 D) $525 E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 5) For this question, assume that there is perfect arbitrage in the stock market. Given this assumption, economists believe that ________. A) movements in stock prices can be easily predicted B) movements in stock prices are largely unpredictable C) most stocks will diverge from their fundamental value D) stocks will generally earn a lower rate of return than bonds E) the rate of return on stocks will be equal to the rate of return on bonds Answer: B AACSB: Application of knowledge Status: 8e question

6) Suppose the central bank implements a monetary contraction that is fully expected by financial market participants. Given this information, we would expect ________. A) stock prices to rise B) stock prices to fall C) stock prices to remain unchanged D) an ambiguous effect on stock prices E) stock prices to fall and the interest rate to rise Answer: C AACSB: Application of knowledge Status: 8e question 7) Suppose the central bank implements a monetary expansion that is not fully anticipated by financial markets. Given this information, we would expect ________. A) stock prices to rise B) stock prices to fall C) stock prices to remain unchanged D) an ambiguous effect on stock prices E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 8) Suppose policy makers implement a fiscal expansion that is not fully anticipated by financial market participants. We know that this will ________. A) always cause stock prices to fall B) always cause stock prices to rise C) tend to cause stock prices to rise if the LM curve is very flat D) tend to cause stock prices to rise if the LM curve is vertical Answer: C AACSB: Application of knowledge Status: 8e question 9) Suppose policy makers implement an unexpected fiscal expansion. Further assume that monetary policy is expected to keep interest rates constant in response to this unexpected fiscal expansion. Given this information, we would expect that ________. A) stock prices will rise B) stock prices will remain constant C) this policy will have an ambiguous effect on stock prices D) the effect on stock prices will depend on the slope of the IS curve Answer: A AACSB: Reflective thinking Status: 8e question

10) Which of the following represents a stock's fundamental value? A) the price the stock would sell at in the midst of a rational bubble B) the price the stock would sell at if the interest rate were zero C) the present value of its expected future dividend payments D) the simple sum of its future dividend payments E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 11) Which of the following does not represent a form of debt finance? A) bonds B) loans C) stock D) all of these Answer: C AACSB: Application of knowledge Status: 8e question 12) Which of the following represents a form of equity finance? A) stock B) loans C) bonds D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 13) Which of the following variables would not influence the ex-dividend price of a share of stock at time t? A) i1et+1 B) i1t C) $Det+1 D) none of these Answer: D AACSB: Analytical thinking Status: 8e question 14) An expected reduction in the money supply will tend to cause ________. A) an increase in stock prices B) a reduction in stock prices C) no change in stock prices D) an ambiguous effect on stock prices Answer: C AACSB: Application of knowledge Status: 8e question 14 Copyright © 2025 Pearson Education, Inc.

15) An expected increase in the money supply will tend to cause ________. A) an increase in stock prices B) a reduction in stock prices C) no change in stock prices D) an ambiguous effect on stock prices Answer: C AACSB: Application of knowledge Status: 8e question 16) An expected tax cut will tend to cause ________. A) an increase in stock prices B) a reduction in stock prices C) no change in stock prices D) an ambiguous effect on stock prices Answer: C AACSB: Application of knowledge Status: 8e question 17) An expected tax increase will tend to cause ________. A) an increase in stock prices B) a reduction in stock prices C) no change in stock prices D) an ambiguous effect on stock prices Answer: C AACSB: Application of knowledge Status: 8e question 18) An unexpected reduction in the money supply will tend to cause ________. A) an increase in stock prices B) a reduction in stock prices C) no change in stock prices D) an ambiguous effect on stock prices Answer: B AACSB: Application of knowledge Status: 8e question 19) An unexpected increase in the money supply will tend to cause ________. A) an increase in stock prices B) a reduction in stock prices C) no change in stock prices D) an ambiguous effect on stock prices Answer: A AACSB: Application of knowledge Status: 8e question

20) Suppose households unexpectedly increase consumption. Which of the following will occur as a result of this unexpected increase in consumption? A) an increase in stock prices B) a reduction in stock prices C) no change in stock prices D) an ambiguous effect on stock prices Answer: D AACSB: Application of knowledge Status: 8e question 21) Suppose households unexpectedly decrease consumption. Which of the following will occur as a result of this unexpected reduction in consumption? A) an increase in stock prices B) a reduction in stock prices C) no change in stock prices D) an ambiguous effect on stock prices Answer: D AACSB: Application of knowledge Status: 8e question 22) Suppose there are two types of bonds (one-year bonds and two-year bonds) and that the yield curve is initially upward sloping in period t. Note: For this question assume that: (1) expected inflation is zero; and (2) the relevant interest rate on the vertical axis of the IS-LM model is the one-year interest rate. Based on our understanding of the IS-LM model, of the yield curve and of financial markets, we know with certainty that an announcement in period t of a partially unexpected future increase in taxes (to be implemented in period t + 1) will have which of the following effects? A) stock prices will increase in period t B) stock prices will fall in period t C) the yield curve will become steeper in period t D) none of these Answer: D AACSB: Application of knowledge Status: 8e question 23) For this question, assume that the Fed is expected to respond to any event by keeping the interest rate constant (i.e., equal to its initial level). An unexpected tax increase will cause ________. A) stock prices to fall B) stock prices to rise C) no change in stock prices D) an ambiguous effect on stock prices Answer: A AACSB: Reflective thinking Status: 8e question

24) For this question, assume that the Fed is expected to respond to any event by keeping the interest rate constant (i.e., equal to its initial level). An unexpected tax cut will cause ________. A) stock prices to fall B) stock prices to rise C) no change in stock prices D) an ambiguous effect on stock prices Answer: B AACSB: Reflective thinking Status: 8e question 25) For this question, assume that the Fed is expected to respond to any event by keeping output constant (i.e., equal to its initial level). An unexpected increase in taxes will cause ________. A) stock prices to fall B) stock prices to rise C) no change in stock prices D) an ambiguous effect on stock prices Answer: B AACSB: Reflective thinking Status: 8e question 26) For this question, assume that the Fed is expected to respond to any event by keeping output constant (i.e., equal to its initial level). An unexpected increase in government spending will cause ________. A) stock prices to fall B) stock prices to rise C) no change in stock prices D) an ambiguous effect on stock prices Answer: A AACSB: Reflective thinking Status: 8e question 27) As the LM curve becomes steeper, an unexpected increase in consumer confidence ________. A) will cause a relatively large increase in output and relatively large increase in the interest rate B) will cause a relatively small increase in output and relatively small increase in the interest rate C) is more likely to cause stock prices to rise D) is more likely to cause stock prices to fall Answer: D AACSB: Application of knowledge Status: 8e question

28) As the LM curve becomes steeper, an unexpected decrease in consumer confidence ________. A) will cause a relatively large increase in output and relatively large increase in the interest rate B) will cause a relatively small increase in output and relatively small increase in the interest rate C) is more likely to cause stock prices to rise D) is more likely to cause stock prices to fall Answer: C AACSB: Application of knowledge Status: 8e question 29) A share of stock will pay a dividend of $20 in one year, and will be sold for an expected price of $500 at that time. If the current one-year interest rate is 5%, the current price of the stock will be approximately equal to ________. A) $100 B) $495 C) $500 D) $525 E) none of these Answer: B AACSB: Analytical thinking Status: 8e question 30) Suppose individuals expect an increase in future taxes. Explain what effect this expected increase in future taxes will have on the yield curve and on stock prices in the current period. Answer: The increase in future taxes will cause the future one-year rate to fall. This reduction in the expected one-year rate will cause the two-year rate to fall by approximately half the change in the future expected rate. The current one-year rate does not change. So, the yield curve pivots; it gets flatter (as the long-term rate falls). The effects on stock prices again depend on whether it is anticipated or not. If anticipated, stock prices do not change. If partially unexpected, the effect on stock prices is ambiguous: the drop in future i will increase stock prices while the drop in future Y will depress stock prices. AACSB: Written and oral communication Status: 8e question 31) Explain what is meant by the fundamental value of a share of stock. Answer: The fundamental value of a share of stock is simply the discounted present value of any current and future expected dividends. AACSB: Written and oral communication Status: 8e question 32) Give two explanations why stock prices might deviate from their fundamental values. Answer: Answers should discuss speculative bubbles and fads. AACSB: Written and oral communication Status: 8e question

33) Suppose the Fed implements a monetary expansion that is at least partially unexpected. Explain what effect this will have on stock prices. Answer: This will cause the interest rate to fall and output to rise. The lower interest rate will increase the present value of future dividends. The increase in output will cause an increase in expected dividends because profits are now expected to be higher. Both of these effects cause stock prices to rise. AACSB: Written and oral communication Status: 8e question 34) Suppose a cut in government spending occurs that is at least partially unexpected. Explain what effect this will have on stock prices. Answer: Output falls and interest rates fall. Here, the effects are ambiguous. The drop in the interest rate will raise stock prices while the drop in Y will lower them. AACSB: Written and oral communication Status: 8e question 35) Suppose there is a report that the unemployment rate unexpectedly increased in the previous month. To what extent will the expected central bank response to this news affect how stock prices will respond to this report of a higher than expected unemployment rate? Explain. Answer: The effect on stock prices will be ambiguous, all else fixed. What the Fed is expected to do in response can change this. If the Fed is expected to act to keep interest rates constant, Y will fall and stock prices will fall. If the Fed is expected to offset any output effects by reducing rates, stock prices will rise. AACSB: Written and oral communication Status: 8e question 36) Suppose the central bank implements a monetary contraction in the current period and is not expected to continue this policy in the future. Explain what effect this policy will have on the shape of the yield curve and on stock prices. Answer: The current one-year rate will rise with no change in the expected future rate. The two-year rate, given that it is an average of the two one-year rates, will rise. The change in the two-year rate will approximately equal half the change in the one-year rate. The yield curve will shift up and get flatter. What happens to stock prices depends on whether this was fully or partially expected? If fully anticipated, stock prices do not change. If at least partially unexpected, stock prices will fall because of the interest rate effect and the higher output (changes in which were unexpected). AACSB: Written and oral communication Status: 8e question

37) Suppose individuals expect a cut in future taxes. Explain what effect this expected reduction in future taxes will have on the yield curve and on stock prices in the current period. Answer: The reduction in future taxes will cause the future one-year rate to rise. This increase in the expected one-year rate will cause the two-year rate to rise by approximately half the change in the future expected rate. The current one-year rate does not change. So, the yield curve gets steeper (as the long-term rate rises). The effects on stock prices again depend on whether it is anticipated or not. If anticipated, stock prices do not change. If partially unexpected, the effect on stock prices is ambiguous: the rise in future i will decrease stock prices while the increase in future Y will increase stock prices. AACSB: Written and oral communication Status: 8e question 38) Suppose an increase in government spending occurs that is at least partially unexpected. Explain what effect this will have on stock prices. Answer: Output rises and interest rates rise. Here, the effects are ambiguous. The rise in the interest rate will reduce stock prices while the increase in Y will increase them. AACSB: Written and oral communication Status: 8e question 14.4

Risk, Bubbles, Fads, and Asset Prices

1) Some economists argue that there were good reasons for housing price to rise. Explain their argument. Answer: First, the real interest rate was decreasing, increasing the present value of rents. Second, the nominal interest rate was also decreasing, and this mattered because nominal interest payments are tax deductible. Third, the mortgage market was changing: More people was able to borrow and buy a house; people who borrowed were able to borrow a larger proportion of the value of the house. Both of these factors led to an increase in demand, and thus an increase in house prices. AACSB: Written and oral communication Status: 8e question 2) When stock prices increase just because investors expect them to it is called a ________. A) market fad B) rational speculative bubble C) irrational bubble D) fundamental valuation Answer: B AACSB: Application of knowledge Status: New question 9e

3) Do stock prices always reflect their fundamental value? Answer: Most economists doubt it. They point to Black October in 1929, when the US stock market fell by 23% in two days, and to October 19, 1987, when the Dow Jones index fell by 22.6% in a single day. They point to the amazing rise in the Nikkei index (an index of Japanese stock prices) from around 13,000 in 1985 to around 35,000 in 1989, followed by a decline to 16,000 in 1992. In each of these cases, economists point to a lack of obvious news or at least of news important enough to cause such enormous movements. Instead, they argue that stock prices are not always equal to their fundamental value, defined as the present value of expected dividends and that stocks are sometimes underpriced or overpriced. AACSB: Written and oral communication Status: New question 9e 4) Which of these events is an example of an asset bubble? A) The Dutch tulipmania B) The Great Depression C) The post-Covid-19 inflation D) All of these are examples of bubbles Answer: A AACSB: Application of knowledge Status: New question 9e 5) The stock market is generally assumed to have a constant level of risk over time. Answer: FALSE AACSB: Application of knowledge Status: New question 9e

Macroeconomics, 9e (Blanchard) Chapter 15: Expectations, Consumption, and Investment 15.1

Consumption

1) Human wealth is ________. A) the present discounted value of expected future after-tax labor income B) the sum of financial and housing wealth C) the discounted present value of all financial assets D) financial wealth minus housing wealth E) total wealth minus housing wealth Answer: A AACSB: Application of knowledge Status: 8e question 2) Which of the following represents non-human wealth? A) total wealth minus housing wealth B) total wealth minus financial wealth C) wealth that cannot be taken from a person, by law D) financial wealth minus housing wealth E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 3) Which of the following best defines total wealth? A) financial wealth only B) financial wealth and housing wealth only C) human wealth only D) non-human wealth and human wealth E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 4) Which of the following would cause an increase in human wealth? A) a permanent increase in salary B) an increase in the value of one's house C) an increase in the value of one's stock portfolio D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

5) An economist conducts a "natural experiment" by ________. A) choosing two groups of people — a control group and a test group — and providing special treatment for the test group B) using animal behavior to make inferences about human behavior C) using his or her own intuition to surmise what people will do in a given situation D) polling other economists to see if they believe a theory E) taking real-world data as it is given, and using it to test a theory Answer: E AACSB: Application of knowledge Status: 8e question 6) Consumption is most likely to respond one-for-one with changes in current income when ________. A) the change in current income results from a one-time bonus B) people believe the change in their current income is temporary C) people are able to borrow as much as they wish, as long as they pay it back D) the change in current income is caused by the business cycle E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 7) Which of the following is evidence that consumption depends on total wealth, and not just on current income? A) People save very little for their retirement. B) The pre-announced phased-in tax cuts of 1981-83 caused little change in consumption in 1981. C) A drop in consumer confidence, with unchanged current income, often causes total consumption spending to fall. D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 8) Which of the following is a reason that consumption depends on current income, and not just on total wealth? A) Banks will not always lend money to those who want to consume more than their income. B) The anticipation of future financial distress makes some people reluctant to borrow. C) Low income people may prefer to postpone some consumption until later years, when their incomes are higher. D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2 Copyright © 2025 Pearson Education, Inc.

9) Which of the following people—none of whom has any financial or housing wealth—is most likely to be spending all of their current income? A) a low income person expecting continued low income throughout life B) a low income person expecting a dramatic rise in income in the future C) a high income person expecting continued high income throughout life D) a high income person expecting a dramatic drop in income in the future E) a high income person expecting to retire soon, and live for a long time afterward Answer: B AACSB: Application of knowledge Status: 8e question 10) Figures on "mean wealth" of the elderly (ages 65-69) show that most wealth consists of ________. A) home equity B) personal savings C) stocks and bonds D) social security benefits E) collectibles, like stamps, coins and art Answer: D AACSB: Application of knowledge Status: 8e question 11) For this question, ignore tax considerations of each of the following. Assume that consumption decisions are made according to the permanent income theory. Which of the following would lead to the smallest increase in current consumption? A) winning $10,000 in the lottery B) inheriting $10,000 from a relative C) obtaining $10,000 by winning a lawsuit D) getting a one-time $10,000 bonus from your employer E) all of these Answer: E AACSB: Application of knowledge Status: 8e question 12) The "life cycle" and "permanent income" theories of consumption share which of the following features? A) Consumption spending depends on income, rather than wealth. B) Consumption spending should fluctuate widely from year to year. C) Consumers look ahead to the future in making current spending decisions. D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question

13) Suppose you are given a rare antique by a long-lost relative. The value of this rare antique would be included in which of the following types of wealth? A) financial wealth B) housing wealth C) human wealth D) none of these Answer: A AACSB: Application of knowledge Status: 8e question 14) As of 2005, some analysts were concerned that there was a "bubble" in the U.S. housing market. Suppose there is a reduction in real estate prices. This reduction in real estate prices would have the most direct effect on which of the following types of wealth? A) financial wealth B) housing wealth C) human wealth D) none of these Answer: B AACSB: Application of knowledge Status: 8e question 15) The reduction in stock prices will have the most direct effect on which of the following types of wealth? A) financial wealth B) housing wealth C) human wealth D) none of these Answer: A AACSB: Application of knowledge Status: 8e question 16) Suppose there is a tax cut. This tax cut would have a direct effect on which of the following? A) financial wealth B) housing wealth C) human wealth D) none of these Answer: C AACSB: Application of knowledge Status: 8e question

17) Suppose there is an increase in income. This increase in income would have a direct effect on which of the following? A) financial wealth B) housing wealth C) human wealth D) all of these Answer: C AACSB: Application of knowledge Status: 8e question 18) Human wealth is a function (i.e., affected by changes in) of which of the following variables? A) future expected income B) future expected taxes C) current interest rates D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 19) Explain what decisions and calculations a very foresighted consumer must make to determine her consumption decisions in any period. Answer: An individual would have to calculate her financial wealth, housing wealth, and human wealth. Of course, this implies that the individual would have to form expectations of future interest rates, income, and taxes for the remainder of her working life. Once done, the individual would then calculate the amount of consumption per year she preferred given this total wealth. If in the current period, current disposable income is less than this level of C, she would borrow the difference. AACSB: Written and oral communication Status: 8e question 20) Discuss the various components of wealth. Answer: Housing, financial, and human wealth. AACSB: Application of knowledge Status: 8e question 21) Explain why current consumption is likely to respond less than one for one to changes in current income. Answer: A change in current income is not likely to be viewed with certainty as permanent. So, part of any change in temporary income will be saved and, therefore, consumption will increase by an amount less than the change in income. If the change were permanent, the change in C would be greater. AACSB: Written and oral communication Status: 8e question

22) Explain why current consumption might change even if current income does not change. Answer: C also depends on wealth. If any of the determinants of wealth change, without current disposable income changing, individuals will change current consumption. In short, there are other determinants of current consumption. AACSB: Written and oral communication Status: 8e question 23) Suppose individuals expect future output to be higher and future interest rates to be higher. Given this information, how will individuals alter consumption in the current period? Explain. Answer: The effects are ambiguous. The increase in future Y will increase human wealth and cause C to increase. The increase in future rates will reduce the present value of future disposable income and reduce C. AACSB: Written and oral communication Status: 8e question 24) Suppose individuals expect future output to be lower and future interest rates to be lower. Given this information, how will individuals alter consumption in the current period? Explain. Answer: The effects are ambiguous. The reduction in future Y will reduce human wealth and cause C to decrease. The decrease in future rates will increase the present value of future disposable income and increase C. AACSB: Written and oral communication Status: 8e question 25) Explain how expectations affect consumption. Answer: Expectations affect consumption in two ways. First, expectations affect consumption directly through human wealth: To compute their human wealth, consumers have to form their own expectations about future labor income, real interest rates, and taxes. Second, expectations affect consumption indirectly, through nonhuman wealth-stocks, bonds and housing: The prices of these assets depend on expectations of future cash flows and interest rates. AACSB: Written and oral communication Status: 8e question 26) Suppose an individual experiences a $20,000 increase in real income and the individual believes this increase in income is permanent. Economic theory suggests that this individual's current consumption will ________. A) remain unchanged B) increase by more than $20,000 C) increase by at most $20,000 D) decrease or remain unchanged, depending on the value of the real interest rate E) decrease, remain unchanged, or increase, depending on the value of the real interest rate Answer: C AACSB: Application of knowledge Status: 8e question

27) Suppose current sales increase by $100 million. Investment theory suggests that current investment must ________. A) decrease exactly by $100 million B) increase by exactly $100 million C) increase by less than $100 million D) decrease, but by less than $100 million E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 28) Which of the following individuals is responsible for developing the permanent income theory of consumption? A) Friedman B) Modigliani C) Keynes D) Lucas Answer: A AACSB: Application of knowledge Status: 8e question 29) Which of the following individuals is responsible for developing the life cycle theory of consumption? A) Friedman B) Modigliani C) Keynes D) Lucas Answer: B AACSB: Application of knowledge Status: 8e question 30) Which of the following events would likely cause the largest reduction in current consumption? A) a permanent reduction in annual salary of $2000 B) a one-time tax increase of $4000 C) a one-time reduction in income (e.g. a bonus) of $4000 D) none of these Answer: A AACSB: Application of knowledge Status: 8e question

31) Which of the following will cause a reduction in current consumption? A) a reduction in current disposable income B) a reduction in financial wealth C) a reduction in human wealth D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 32) Which of the following would cause a reduction in human wealth? A) a permanent reduction in salary B) a reduction in the value of one's house C) a reduction in the value of one's stock portfolio D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 33) Which of the following events would likely cause the largest increase in current consumption? A) a permanent increase in annual salary of $2000 B) a one-time tax cut of $4000 C) a one-time increase in income (e.g. a bonus) of $4000 D) none of these Answer: A AACSB: Application of knowledge Status: 8e question 34) Which of the following will cause an increase in current consumption? A) an increase in current disposable income B) an increase in financial wealth C) an increase in human wealth D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

15.2

Investment

1) Which of the following will cause an increase in the rental cost/user cost of capital? A) The rate of depreciation increases. B) The real interest rate decreases. C) The expected profit from the machine decreases. D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 2) The "depreciation rate" tells us ________. A) the interest rate that should be used in present discounted value calculations B) the rate at which consumers deplete their total wealth in retirement C) the difference between current and expected income D) the difference between current and expected profits E) how much usefulness a machine loses from year to year Answer: E AACSB: Application of knowledge Status: 8e question 3) Which of the following will cause the rental cost/user cost of capital to decrease? A) The rate of depreciation decreases. B) The real interest rate increases. C) The expected profit from the machine decreases. D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 4) Assume the following: (1) the real cost of a unit of capital is one; (2) the unit of capital is expected to increase a firm's real profit by $10,000 each year, and depreciate by 8% each year (δ = .08); and (3) The real interest rate is 2% (r = .02). What is the "user cost" or "rental cost" of this unit of capital? A) .02 B) .06 C) .10 D) .08/.02 = 4 E) none of these Answer: C AACSB: Analytical thinking Status: 8e question

5) A painting is currently worth $100,000, and is expected to maintain its real value for three years. The real interest rate is expected to remain constant at 10%. What is the present value of the painting's expected price at the end of the third year? A) $75,131 B) $88,899 C) $96,153 D) $100,000 E) $70,000 Answer: D AACSB: Analytical thinking Status: 8e question 6) The data for the U.S. show that investment and profits ________. A) have a strong negative relationship B) are positively related during recessions, and negatively related during expansions C) move independently D) are positively related during expansions, and negatively related during recessions E) none of these Answer: E AACSB: Analytical thinking Status: 8e question 7) A change in which of the following variables would affect the cash flow for a firm? A) changes in the nominal interest rate B) expected future profit C) changes in the real interest rate D) changes in expected inflation E) none of these Answer: E AACSB: Analytical thinking Status: 8e question 8) The data shows that total profit in the U.S. economy ________. A) has decreased steadily over time B) is not influenced by the business cycle C) tends to decrease in recessions, increase in expansions D) tends to increase in recessions, decrease in expansions E) tends to increase in even years, and decrease in odd years, although no one can explain why Answer: C AACSB: Analytical thinking Status: 8e question

9) Suppose that, when the price of steel drops, steel companies tend to cut back on investment in their non-steel activities more than other firms in these same non-steel activities. This would support the idea that ________. A) cash flow matters for investment B) cash flow does not matter for investment C) business firms do not care about profit D) business firms do not care about interest rates E) business firms do not use discounting Answer: A AACSB: Analytical thinking Status: 8e question 10) An increase in which of the following variables should cause an increase in profit per unit of capital? A) total wages and salaries B) total sales C) the capital stock D) the ratio of total sales to the capital stock E) the ratio of total sales to total wages and salaries Answer: D AACSB: Analytical thinking Status: 8e question 11) Which of the following statements is true? A) A change in sales should have more impact on current investment if it is expected to be permanent rather than temporary. B) On a percentage basis, investment is more volatile than consumption. C) In terms of dollars, investment and consumption are about equally volatile. D) all of these E) none of these Answer: D AACSB: Analytical thinking Status: 8e question 12) The user cost of capital is represented by which of the following variables? A) Πt B) rt C) 1/(rt + δ) D) Πt /( rt + δ) E) none of these Answer: E AACSB: Analytical thinking Status: 8e question

13) An increase in which of the following variables will cause an increase in the user cost of capital? A) δ B) Πt C) Πet D) all of these E) none of these Answer: A AACSB: Analytical thinking Status: 8e question 14) An in increase in which of the following variables will cause an increase in the user cost of capital? A) rt B) Πt C) Πet D) all of these E) none of these Answer: A AACSB: Analytical thinking Status: 8e question 15) Which of the following will occur when the capital stock increases? A) profit per unit of capital will increase B) profit per unit of capital will decrease C) there will be no change in profit per unit of capital D) there will be an ambiguous effect on profit per unit of capital E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 16) Which of the following will occur when the capital stock falls? A) profit per unit of capital will increase B) profit per unit of capital will decrease C) there will be no change in profit per unit of capital D) there will be an ambiguous effect on profit per unit of capital E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

17) For this question, assume that firms experience an increase in sales. We would expect that this increase in sales will cause ________. A) an increase in profit per unit of capital B) a decrease in profit per unit of capital C) no change in profit per unit of capital D) ambiguous effects on profit per unit of capital E) none of these Answer: A AACSB: Reflective thinking Status: 8e question 18) A reduction in sales will generally cause ________. A) an increase in profit per unit of capital B) a decrease in profit per unit of capital C) no change in profit per unit of capital D) ambiguous effects on profit per unit of capital E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 19) A reduction in which of the following variables will cause a reduction in the user cost of capital? A) δ B) Πt C) Πet D) all of these E) none of these Answer: A AACSB: Analytical thinking Status: 8e question 20) A reduction in which of the following variables will cause a reduction in the user cost of capital? A) rt B) Πt C) Πet D) all of these E) none of these Answer: A AACSB: Analytical thinking Status: 8e question

21) Explain what decisions and calculations a firm must make when it is considering the purchase of new capital (i.e., making an investment decision). Answer: A firm must form expectations of future expected profits (per unit of capital). This implies that they must also form expectations of future output which are correlated with future profit. They must also form expectations of future interest rates to calculate present values. And finally, they must know the current price of the project and the rate of depreciation. Once they do all of this, they calculate the discounted present value of the project and compare that with its price. AACSB: Written and oral communication Status: 8e question 22) Explain each of the determinants of the present value of expected profits from a buying a new machine. Answer: A firm must form expectations of future expected profits (per unit of capital). This implies that they must also form expectations of future output which are correlated with future profit. They must also form expectations of future interest rates to calculate present values. And finally, they must know the current price of the project and the rate of depreciation. Once they do all of this, they calculate the discounted present value of the project and compare that with its price. AACSB: Written and oral communication Status: 8e question 23) First, briefly explain what the user cost or rental cost of capital represents. Second, explain what factors would cause an increase in the user cost or rental cost of capital. Answer: The user cost of capital is the sum of the real rate and rate of depreciation. If a rental agency rented capital, it would have to charge enough to cover any depreciation that occurs plus an amount equal to what it could get if it simply bought bonds (the real rate). Therefore, either an increase in the real interest rate or an increase in depreciation will cause an increase in the user cost of capital. AACSB: Written and oral communication Status: 8e question 24) Explain the difference between "profitability" and "cash flow." Answer: Some firms are borrowing constrained. Their only source of funds to buy investment is current profit. So, when current profit rises, those borrowing constrained firms increase investment. This summarizes how "cash flow" can affect a firm's investment decision. "Profitability" simply refers to how changes in the expected present value of future profits affect investment. AACSB: Written and oral communication Status: 8e question

25) Explain how a change in expected future output could affect current output. Answer: There are two channels here. An increase in future expected output will increase future expected profits. When future expected profits rise, the discounted present value of profits will be higher. More projects will now occur. As investment today rises, demand rises, and, therefore, current output will rise. An increase in future expected output will also increase human wealth and, therefore, cause consumption to increase. The rise in consumption will increase demand and current output. AACSB: Written and oral communication Status: 8e question 26) Suppose firms expect future output to be higher and future interest rates to be higher. Given this information, how will firms alter investment in the current period? Explain. Answer: The increase in expected future output will cause firms to revise upwards their expectations of future profits. This, all else fixed, will cause an increase in the present value of future expected profits and will tend to increase investment. The increase in the interest rate, however, will tend to decrease investment because it will reduce the discounted present value of future expected profits. The effects, therefore, on investment are ambiguous. AACSB: Written and oral communication Status: 8e question 27) Suppose firms expect future output to be lower and future interest rates to be lower. Given this information, how will firms alter investment in the current period? Explain. Answer: The reduction in expected future output will cause firms to revise downwards their expectations of future profits. This, all else fixed, will cause a reduction in the present value of future expected profits and will tend to decrease investment. The reduction in the interest rate, however, will tend to increase investment because it will increase the discounted present value of future expected profits. The effects, therefore, on investment are ambiguous. AACSB: Written and oral communication Status: 8e question 28) What is Tobin's q? How tight is the relation between Tobin's q and investment? Answer: Tobin constructed a variable corresponding to the value of a unit of capital in place relative to its purchase price. This variable is called Tobin's q. The data shows that it appears that there is a strong relation between investment this year and Tobin's q last year. Put another way, movements in investment this year are more closely associated with movements in the stock market last year. This is because investment decisions and stock market prices depend very much on the same factors-expected future profits and expected future interest rates. AACSB: Written and oral communication Status: 8e question

29) Suppose there is an increase in profitability. This suggests that ________. A) firms have increased their expectations of future profits B) the real interest rate has increased C) the rate of depreciation has increased D) all of these Answer: A AACSB: Application of knowledge Status: 8e question 30) Suppose there is a reduction in cash flow. This suggests that ________. A) firms have decreased their expectations of future profits B) the real interest rate has increased C) the rate of depreciation has increased D) current profits have decreased E) all of these Answer: D AACSB: Application of knowledge Status: 8e question 31) An increase in the rate of depreciation will cause the discounted present value of expected profits to ________. A) decrease B) increase C) remain unchanged if the real interest rate increases by the same amount D) none of these Answer: A AACSB: Application of knowledge Status: 8e question 32) For this question, assume that firms experience a reduction in sales. We would expect that this decrease in sales will cause ________. A) an increase in profit per unit of capital B) a decrease in profit per unit of capital C) no change in profit per unit of capital D) ambiguous effects on profit per unit of capital E) none of these Answer: B AACSB: Application of knowledge Status: 8e question

33) A reduction in the rate of depreciation will cause the discounted present value of expected profits to ________. A) decrease B) increase C) remain unchanged if the real interest rate increases by the same amount D) none of these Answer: B AACSB: Application of knowledge Status: 8e question 34) Suppose a firm has 100 machines and 100 shares outstanding. The price per share is $2, and the purchase price of a machine is $1. So Tobin's q is equal to ________. A) 2 B) 1 C) 0.5 D) 1.5 Answer: A AACSB: Analytical thinking Status: 8e question 15.3

The Volatility of Consumption and Investment

1) Which of the following statements about consumption and investment is correct? A) Consumption is more volatile than investment. B) Investment and consumption exhibit approximately the same degree of volatility. C) A permanent change in income will have a relatively larger effect on consumption than on investment. D) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) Investment accounts for ________ of US GDP. A) 15% B) 20% C) 50% D) 70% Answer: A AACSB: Application of knowledge Status: 8e question

3) Investment depends on ________. A) current profit B) present value of expected future profits C) user cost of capital D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 4) Explain why consumption is less volatile than investment. Answer: At most, we would observe a one-for-one relationship between output and consumption. This is not the case with investment. When Y increases and is viewed as permanent by firms, they may increase investment to maintain a given capital-sales ratio. If this ratio is, say, 2, an increase in sales and output of 100 would require that I increase by 200. So, I will change more than C. AACSB: Written and oral communication Status: 8e question 5) Are changes in consumption and investment typically occur in the same direction and at roughly the same magnitude? Explain. Answer: Consumption and investment usually move together but investment is much more volatile than consumption. Because the level of investment is much smaller than the level of consumption, changes in investment from one year to the next are of the same overall magnitude as changes in consumption. AACSB: Written and oral communication Status: 8e question 6) Recessions are typically associated with increases in both investment and consumption. Answer: FALSE AACSB: Application of knowledge Status: New question 9e 7) Investment is much more volatile than consumption. Answer: TRUE AACSB: Application of knowledge Status: New question 9e

Macroeconomics, 9e (Blanchard) Chapter 16: Expectations, Output, and Policy 16.1

Expectations and Decisions: Taking Stock

1) Changes in future expected interest rates can affect current consumption. Suppose individuals expect future interest rates to decrease. Consumption will change as a result of this lower expected future interest rate because of its effects on which of the following? A) human wealth B) the value of stocks C) the value of bonds D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) Which of the following will not cause aggregate private spending to increase? A) an increase in expected future real interest rates B) an increase in government spending C) a reduction in future taxes D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 3) Which of the following will cause aggregate private spending to decrease? A) a reduction in government spending B) an increase in expected future interest rates C) an increase in expected future taxes D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 4) The IS curve shifts to the left where there is ________. A) a reduction in current taxes B) an increase in expected future taxes C) an increase in expected future output D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 1 Copyright © 2025 Pearson Education, Inc.

5) Suppose individuals now believe that there will be a future tax cut. This reduction in expected future taxes will cause which of the following to occur in the current period? A) the LM curve to shift down B) the LM curve to shift up C) the IS curve to shift rightward D) the IS curve to shift leftward E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 6) Suppose individuals now believe that there will be an increase in the future expected interest rate. This increase in the expected future interest rate will cause which of the following to occur in the current period? A) an upward shift of the LM curve B) a leftward shift of the IS curve C) the IS curve to become flatter D) the LM curve to become steeper E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 7) Suppose there is a fiscal expansion in the current period. This fiscal expansion will tend to cause a smaller increase in current output when ________. A) an increase in current output causes an increase in expected future output B) an increase in the current interest rate causes expectations of expansionary monetary policy in the future C) an increase in the current interest rate causes an increase in expected future interest rates D) none of these E) all of these Answer: C AACSB: Application of knowledge Status: 8e question 8) Which of the following will not cause aggregate private spending to decrease? A) a reduction in expected future real interest rates B) a reduction in government spending C) an increase in future taxes D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

9) Which of the following will cause aggregate private spending to increase? A) an increase in government spending B) a reduction in expected future interest rates C) a reduction in expected future taxes D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 10) The IS curve shifts to the right where there is ________. A) an increase in current taxes B) a reduction in expected future taxes C) a reduction in expected future output D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 11) Suppose individuals now believe that there will be a future tax increase. This increase in expected future taxes will cause which of the following to occur in the current period? A) the LM curve to shift down B) the LM curve to shift up C) the IS curve to shift rightward D) the IS curve to shift leftward E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 12) Suppose there is a reduction in expected future output. This will cause which of the following to occur? A) the IS curve to shift left in the current period B) the IS curve to shift right in the current period C) the LM curve to shift up in the current period D) the LM curve to shift down in the current period Answer: A AACSB: Application of knowledge Status: 8e question

13) Suppose there is a reduction in the expected future interest rate. This will cause which of the following to occur? A) the IS curve to shift left in the current period B) the IS curve to shift right in the current period C) the LM curve to shift up in the current period D) the LM curve to shift down in the current period Answer: B AACSB: Application of knowledge Status: 8e question 14) Explain why the new IS curve that takes into account expectations is likely steeper than the original IS curve that ignored expectations. Answer: There are several factors that determine the size of the slope of the IS curve: the multiplier and the interest rate sensitivity of investment. The multiplier is now smaller because changes in current Y do not have as large an effect on current C. So, the mpc is smaller, the multiplier smaller, and the IS curve steeper. Also, a drop in the interest rate that is now temporary will not cause I to increase as much so the IS curve will be steeper. In the original ISLM model, changes in Y and the interest rate were implicitly assumed permanent. AACSB: Written and oral communication Status: 8e question 15) Explain the determinants of aggregate private spending. Answer: Aggregate private spending, A, equals C plus I. So, A is a function of current income, future expected income, current taxes, future expected taxes, current interest rates, and future expected interest rates. AACSB: Written and oral communication Status: 8e question 16) Explain what effect an increase in future expected output will have on the IS curve and LM curve in the current period. Answer: An increase in Ye will cause human wealth to be higher. Individuals will increase their current consumption and the IS curve will shift right. An increase in Ye will also cause firms to increase their expectations of future expected profits. When this occurs, the discounted present value of future profits is higher causing I to increase. As I increases, the IS curve shifts right. This will have no effect on the LM curve. AACSB: Written and oral communication Status: 8e question 17) Explain what effect a reduction in the future expected interest rate will have on the IS curve and LM curve in the current period. Answer: A reduction in the future expected interest rate will cause an increase in the present value of future disposable income and, therefore, human wealth. This causes current C to increase and the IS curve to shift right. The reduction in the future expected rate will also cause an increase in the present value of future profits. This will cause an increase in investment and another rightward shift in the IS curve. The LM curve will not be affected. AACSB: Written and oral communication Status: 8e question 4 Copyright © 2025 Pearson Education, Inc.

18) Compare the following three ways to model expectations: animal spirits, adaptive expectations, and rational expectations. Answer: Animal spirits assumed that expectations were simply random. Adaptive expectations assumed that individuals formed expectations by looking at past changes in a variable. Rational expectations assumed that individuals form expectations by using all currently available information and an understanding of the model and policy. AACSB: Written and oral communication Status: 8e question 19) Explain what effect a reduction in future expected output will have on the IS curve and LM curve in the current period. Answer: A reduction in Ye will cause human wealth to be higher. Individuals will reduce their current consumption and the IS curve will shift left. A reduction in Ye will also cause firms to decrease their expectations of future expected profits. When this occurs, the discounted present value of future profits is lower causing I to decrease. As I decreases, the IS curve shifts left. This will have no effect on the LM curve. AACSB: Written and oral communication Status: 8e question 20) Explain what effect an increase in the future expected interest rate will have on the IS curve and LM curve in the current period. Answer: An increase in the future expected interest rate will cause a reduction in the present value of future disposable income and, therefore, human wealth. This causes current C to decrease and the IS curve to shift left. The increase in the future expected rate will also cause a reduction in the present value of future profits. This will cause a reduction in investment and another leftward shift in the IS curve. The LM curve will not be affected. AACSB: Written and oral communication Status: 8e question 16.2

Monetary Policy, Expectations, and Output

1) Which of the following will cause the LM curve to shift up? A) an increase in the expected future interest rate B) an increase in current income C) an increase in expected future taxes D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

2) A change in which of the following will have a direct effect on the amount of money individuals wish to hold in the current period? A) the current nominal interest rate B) the current real interest rate C) the expected future nominal interest rate D) the expected future real interest rate E) all of these Answer: A AACSB: Application of knowledge Status: 8e question 3) A reduction in which of the following variables will cause an increase in the amount of money individuals wish to hold in the current period? A) current income B) the current nominal interest rate C) the current real interest rate D) expected future income E) all of these Answer: B AACSB: Application of knowledge Status: 8e question 4) Suppose individuals expect that interest rates will increase in the future. Also assume that the Fed wants to prevent any change in current output. Given this goal of the Fed, the Fed should implement a policy in the current period that ________. A) shifts the IS curve rightward B) shifts the IS curve leftward C) shifts the IS curve leftward and the LM curve upward D) shifts the LM curve upward E) shifts the LM curve downward Answer: E AACSB: Application of knowledge Status: 8e question 5) A change in which of the following variables will cause a shift of the IS curve in the current period? A) the current interest rate B) current output C) current taxes D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

6) The IS curve becomes steeper when ________. A) government spending is relatively small B) the income tax rate in the current period is relatively small C) current changes in the real interest rate cause large changes in current real output D) changes in the current real interest rate cause small changes in current demand E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 7) Assume that the current demand for goods DOES depend on expectations in the IS-LM model. A monetary expansion in the current period will cause a rightward shift in the IS curve if ________. A) current and expected future real interest rates are positively related B) current and expected future real interest rates are negatively related C) current and expected future real interest rates are unrelated D) the central bank is expected to reverse any current movements in monetary policy in the future E) monetary policy cannot affect, directly or indirectly, the position of the IS curve in the current period Answer: A AACSB: Application of knowledge Status: 8e question 8) Rational expectations assumes that individuals ________. A) can accurately predict the future B) make predictions based on the past behavior of the economy C) form their predictions of macroeconomic variables randomly D) have perfect foresight E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 9) Adaptive expectations assumes that individuals ________. A) can accurately predict the future B) base predictions on random events (i.e., animal spirits) C) form their predictions of macroeconomic variables randomly D) use all available information in predicting the future E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

10) "Animal spirits" refers to ________. A) the stubborn refusal of many economic decision-makers to use rational expectations B) movements in investment that cannot be explained by changes in current variables C) the often-observed Fed refusal to cooperate with the government in setting its monetary policy D) the impact of tax-evasion on the budget deficit E) an exotic alcoholic drink favored by Wall Street traders Answer: B AACSB: Application of knowledge Status: 8e question 11) Which of the following would be a violation of the rational expectations assumption? A) "Over the past twenty years, people have consistently under-predicted the inflation rate for the following year." B) "Over the past twenty years, people have never once accurately predicted the inflation rate for the following year." C) "The Fed's announcement that it might ease interest rates caused an immediate drop in shortterm rates, even before the Fed took any action." D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 12) Suppose the Fed increases the money supply in the current period with no other policy change implemented or anticipated. This policy action will cause which of the following shifts in the IS and/or LM curves in the current period? A) IS left; LM up B) IS right; LM up C) no shift in IS; LM down D) IS left; LM down E) IS right; LM down Answer: C AACSB: Application of knowledge Status: 8e question

13) Assume individuals consider only the short-run effects of changes in future macro variables when forming expectations of future output and future interest rates. A permanent increase in the money supply, with no other policy change implemented or anticipated, will most likely cause ________. A) an increase in the current interest rate B) an increase in future output and an increase in the future interest rate C) an unknown effect on the current interest rate D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 14) Suppose the central bank reduces the money supply. This monetary contraction will always cause a greater reduction in output when it is accompanied by ________. A) an increase in expected future taxes B) an increase in expected future interest rates C) a reduction in expected future output D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 15) Which of the following will cause the LM curve to shift down? A) a reduction in the expected future interest rate B) a reduction in current income C) a reduction in expected future taxes D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 16) An increase in which of the following variables will cause a reduction in the amount of money individuals wish to hold in the current period? A) current income B) the current nominal interest rate C) the current real interest rate D) expected future income E) all of these Answer: B AACSB: Application of knowledge Status: 8e question

17) Suppose individuals expect that interest rates will decrease in the future. Also assume that the Fed wants to prevent any change in current output. Given this goal of the Fed, the Fed should implement a policy in the current period that ________. A) shifts the IS curve rightward B) shifts the IS curve leftward C) shifts the IS curve leftward and the LM curve upward D) shifts the LM curve upward E) shifts the LM curve downward Answer: D AACSB: Application of knowledge Status: 8e question 18) Suppose the Fed reduces the money supply in the current period with no other policy change implemented or anticipated. This policy action will cause which of the following shifts in the IS and/or LM curves in the current period? A) IS left; LM up B) IS right; LM up C) no shift in IS; LM up D) IS left; LM down E) IS right; LM down Answer: C AACSB: Application of knowledge Status: 8e question 19) Suppose the central bank implements a monetary expansion in the current period and is expected to continue this monetary expansion in the future. Use the IS-LM model to illustrate graphically and explain the effects of this policy on current output and the current interest rate. Answer: In the current period, the LM curve will shift down causing r to fall and Y to rise. The expectation that this will continue will cause individuals to expect lower future rates and higher future output. The lower future rates will increase current C and current I. The higher future Y will do the same. So, we will also see a rightward shift in the current IS curve. This will tend to increase the current r and current Y as well. AACSB: Written and oral communication Status: 8e question

20) Suppose the central bank announces that it will pursue a monetary expansion in the current period and a monetary expansion in the future. Explain how the credibility of the central bank might influence the effectiveness of this monetary policy action and announcement of a future monetary policy action. Answer: If individuals do not believe the Fed, we will observe the downward shift in the LM curve causing current rates to fall and current output to rise (with no shift in the IS curve). If individuals believe that the Fed will follow through with this in the future, the LM curve will shift down causing r to fall and Y to rise. The expectation that this will continue will cause individuals to expect lower future rates and higher future output. The lower future rates will increase current C and current I. The higher future Y will do the same. So, we will also see a rightward shift in the current IS curve. This will tend to increase the current r and current Y as well. In short, we would observe a shift in the IS curve causing current Y to increase even more. So, the credibility of the Fed plays a critical role in influencing the effectiveness of monetary policy. AACSB: Written and oral communication Status: 8e question 21) Suppose the central bank implements a monetary contraction in the current period and is expected to continue this monetary contraction in the future. Use the IS-LM model to illustrate graphically and explain the effects of this policy on current output and the current interest rate. Answer: In the current period, the LM curve will shift up causing r to rise and Y to fall. The expectation that this will continue will cause individuals to expect higher future rates and lower future output. The higher future rates will decrease current C and current I. The lower future Y will do the same. So, we will also see a leftward shift in the current IS curve. This will tend to decrease the current r and current Y as well. AACSB: Written and oral communication Status: 8e question 16.3

Deficit Reduction, Expectations, and Output

1) Suppose policy makers pass a budget that reduces the budget deficit. A deficit reduction package such as this has a greater chance of increasing current output when ________. A) the policy is front-loaded B) financial markets believe that taxes will not increase in the future C) financial markets believe the Fed will lower interest rates in the future D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question

2) Suppose there is an increase in expected future output. This will cause which of the following to occur? A) the IS curve to shift left in the current period B) the IS curve to shift right in the current period C) the LM curve to shift up in the current period D) the LM curve to shift down in the current period Answer: B AACSB: Application of knowledge Status: 8e question 3) Suppose there is a simultaneous reduction in expected future output and reduction in the future expected interest rate. This will cause which of the following to occur? A) the IS curve to shift left in the current period B) the IS curve to shift right in the current period C) the LM curve to shift up in the current period D) the LM curve to shift down in the current period E) an ambiguous effect on the position of the IS curve in the current period Answer: E AACSB: Application of knowledge Status: 8e question 4) Suppose there is an increase in the expected future interest rate. This will cause which of the following to occur? A) the IS curve to shift left in the current period B) the IS curve to shift right in the current period C) the LM curve to shift up in the current period D) the LM curve to shift down in the current period Answer: A AACSB: Application of knowledge Status: 8e question 5) Suppose there is a simultaneous reduction in the expected future interest rate and increase in future expected output. This will cause which of the following to occur? A) the IS curve to shift left in the current period B) the IS curve to shift right in the current period C) the LM curve to shift up in the current period D) the LM curve to shift down in the current period E) an ambiguous effect on the position of the IS curve in the current period Answer: B AACSB: Application of knowledge Status: 8e question

6) Suppose there is an increase in expected future taxes. This will cause which of the following to occur? A) the IS curve to shift left in the current period B) the IS curve to shift right in the current period C) the LM curve to shift up in the current period D) the LM curve to shift down in the current period Answer: A AACSB: Application of knowledge Status: 8e question 7) Suppose there is a reduction in expected future taxes. This will cause which of the following to occur? A) the IS curve to shift left in the current period B) the IS curve to shift right in the current period C) the LM curve to shift up in the current period D) the LM curve to shift down in the current period Answer: B AACSB: Application of knowledge Status: 8e question 8) Which of the following individuals was responsible for introducing rational expectations into macroeconomic models? A) Keynes B) Tobin C) Phillips D) Solow E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 9) When answering this question, assume individuals consider only the short-run effects of changes in future variables when forming expectations of future output and future interest rates. Suppose policy makers announce a reduction in future government spending. Which of the following will occur as a result of this expected reduction in government spending? A) a reduction in the expected future interest rate and no change in expected future output B) a reduction in the expected future interest rate and an increase in expected future output C) a reduction in the expected future interest rate and an ambiguous effect on expected future output D) none of these Answer: D AACSB: Reflective thinking Status: 8e question

10) When answering this question, assume individuals consider only the medium-run effects of changes in future variables when forming expectations of future output and future interest rates Suppose policy makers announce a reduction in future government spending. Which of the following will occur as a result of this expected reduction in government spending? A) a reduction in the expected future interest rate and no change in expected future output B) a reduction in the expected future interest rate and an increase in expected future output C) a reduction in the expected future interest rate and a reduction in expected future output D) a reduction in the expected future interest rate and an ambiguous effect on expected future output Answer: A AACSB: Reflective thinking Status: 8e question 11) Assume individuals consider only the long run effects of changes in future macro variables when forming expectations of future output and future interest rates. Suppose individuals expect future government spending to decrease. Given this information, individuals will expect ________. A) a reduction in the expected future interest rate and no change in expected future output B) a reduction in the expected future interest rate and an increase in expected future output C) a reduction in the expected future interest rate and a reduction in expected future output D) a reduction in the expected future interest rate and an ambiguous effect on expected future output Answer: B AACSB: Reflective thinking Status: 8e question 12) Assume individuals consider only the short run effects of changes in future macro variables when forming expectations of future output and future interest rates. Suppose individuals expect future taxes to decrease. Given this information, individuals will expect ________. A) an increase in the expected future interest rate and no change in expected future output B) an increase in the expected future interest rate and an increase in expected future output C) an increase in the expected future interest rate and a reduction in expected future output D) an increase in the expected future interest rate and an ambiguous effect on expected future output Answer: B AACSB: Reflective thinking Status: 8e question

13) Assume individuals consider only the medium run effects of changes in future macro variables when forming expectations of future output and future interest rates. Suppose individuals expect future taxes to decrease. Given this information, individuals will expect ________. A) an increase in the expected future interest rate and no change in expected future output B) an increase in the expected future interest rate and an increase in expected future output C) an increase in the expected future interest rate and a reduction in expected future output D) an increase in the expected future interest rate and an ambiguous effect on expected future output Answer: A AACSB: Reflective thinking Status: 8e question 14) Assume individuals consider only the long run effects of changes in future macro variables when forming expectations of future output and future interest rates. Suppose individuals expect future government spending to increase. Given this information, individuals will expect ________. A) an increase in the expected future interest rate and no change in expected future output B) an increase in the expected future interest rate and an increase in expected future output C) an increase in the expected future interest rate and a reduction in expected future output D) an increase in the expected future interest rate and an ambiguous effect on expected future output Answer: C AACSB: Reflective thinking Status: 8e question 15) Assume individuals consider only the short run effects of changes in future macro variables when forming expectations of future output and future interest rates. Suppose current taxes are cut and that individuals expect future taxes to decrease. Given this information, we know with certainty that ________. A) current output and the current interest rate will both increase B) current output will increase C) the current interest rate will increase D) the current output effects are ambiguous Answer: D AACSB: Reflective thinking Status: 8e question

16) Assume individuals consider only the medium run effects of changes in future macro variables when forming expectations of future output and future interest rates. Suppose current taxes are cut AND that individuals expect future taxes to decrease. Given this information, we know with certainty that ________. A) current output and the current interest rate will both increase B) current output will increase C) the current interest rate will increase D) the expected future interest rate will increase Answer: D AACSB: Reflective thinking Status: 8e question 17) Assume individuals consider only the long run effects of changes in future macro variables when forming expectations of future output and future interest rates. Suppose current government spending increases and that individuals expect future government spending to increase. Given this information, we know with certainty that ________. A) current output and the current interest rate will both increase B) current output will not change C) future expected output will decrease D) future expected output will not change Answer: C AACSB: Reflective thinking Status: 8e question 18) Suppose current government spending increases and that individuals expect future government spending to increase. Given this information, in which of the following cases will output in the current period be more likely to increase? A) Individuals consider only the short run effects of changes in future macro variables when forming expectations of future output and future interest rates. B) Individuals consider only the medium run effects of changes in future macro variables when forming expectations of future output and future interest rates. C) Individuals consider only the long run effects of changes in future macro variables when forming expectations of future output and future interest rates. D) Individuals consider both medium and long term effects Answer: A AACSB: Reflective thinking Status: 8e question

19) Suppose current government spending increases and that individuals expect future government spending to increase. Given this information, in which of the following cases will output in the current period be more likely to decrease? A) Individuals consider only the short run effects of changes in future macro variables when forming expectations of future output and future interest rates. B) Individuals consider only the medium run effects of changes in future macro variables when forming expectations of future output and future interest rates. C) Individuals consider only the long run effects of changes in future macro variables when forming expectations of future output and future interest rates. D) Individuals consider both medium and long term effects. Answer: C AACSB: Reflective thinking Status: 8e question 20) Suppose current government spending decreases and that individuals expect future government spending to decrease. Given this information, in which of the following cases will output in the current period be more likely to decrease? A) Individuals consider only the short run effects of changes in future macro variables when forming expectations of future output and future interest rates. B) Individuals consider only the medium run effects of changes in future macro variables when forming expectations of future output and future interest rates. C) Individuals consider only the long run effects of changes in future macro variables when forming expectations of future output and future interest rates. D) Individuals consider both medium and long term effects. Answer: A AACSB: Reflective thinking Status: 8e question 21) Suppose current government spending decreases and that individuals expect future government spending to decrease. Given this information, in which of the following cases will output in the current period be more likely to increase? A) Individuals consider only the short run effects of changes in future macro variables when forming expectations of future output and future interest rates. B) Individuals consider only the medium run effects of changes in future macro variables when forming expectations of future output and future interest rates. C) Individuals consider only the long run effects of changes in future macro variables when forming expectations of future output and future interest rates. D) Individuals consider both medium and long term effects. Answer: C AACSB: Reflective thinking Status: 8e question

22) Assume individuals consider only the short run effects of changes in future macro variables when forming expectations of future output and future interest rates. Suppose individuals expect the central bank to pursue a monetary expansion in the future. Given this information, we know with certainty that ________. A) current output and the current interest rate will both increase B) current output will decrease C) the current interest rate will decrease D) the current output effects are ambiguous Answer: A AACSB: Reflective thinking Status: 8e question 23) Assume individuals consider only the medium run effects of changes in future macro variables when forming expectations of future output and future interest rates. Suppose individuals expect the central bank to pursue a monetary expansion in the future. Given this information, we know with certainty that ________. A) current output and the current interest rate will both increase B) current output will decrease C) the current interest rate will decrease D) the current output effects are ambiguous E) current output will not change Answer: E AACSB: Reflective thinking Status: 8e question 24) Suppose fiscal policy makers pass a budget that increases taxes in the current period and are expected to raise taxes in the future. Use the IS-LM model to illustrate graphically and explain the effects of this policy on current output and the current interest rate. Answer: The increase in current T will cause disposable income to fall and current C to fall. This will cause the IS curve to shift left. The increase in future expected taxes will, all else fixed, decrease human wealth and current consumption. This will also cause the IS curve to shift left. As future T is raised, future Y will fall. This will depress both current C and I and, again, IS shifts to the left. The drop in future interest rates will have the opposite effect on C and I causing the IS curve to shift right. In theory, the effects on current output are ambiguous. The lower expected future interest rates have a positive effect on current demand. All other factors have the opposite effect. AACSB: Written and oral communication Status: 8e question 25) Explain whether a policy that results in a larger budget deficit in the current period can lead to a reduction in current output. Answer: In short, yes. If the effects of the higher future interest rates dominate the other effects, current demand could fall causing current Y to fall. AACSB: Written and oral communication Status: 8e question

26) Explain whether a fiscal policy that causes an increase in current and future government spending can cause a reduction in current output. Answer: Current output could fall. The increase in G will cause the IS curve to shift to the right. The increase in future G will cause an increase in future output which will also shift the IS curve to the right. The increase in future rates, however, will cause current demand to fall and shift the current IS curve to the left. If these effects dominate (or if the Fed is expected to contract in the future), Y could fall in the current period. AACSB: Written and oral communication Status: 8e question 27) Suppose fiscal policy makers pass a budget that cuts taxes in the current period and are expected to cut taxes in the future. Use the IS-LM model to illustrate graphically and explain the effects of this policy on current output and the current interest rate. Answer: The cut in current T will cause disposable income to rise and current C to rise. This will cause the IS curve to shift right. The reduction in future expected taxes will, all else fixed, increase human wealth and current consumption. This will also cause the IS curve to shift right. As future T is cut, future Y will rise. This will increase both current C and I and, again, IS shifts to the right. The increase in future interest rates will have the opposite effect on C and I causing the IS curve to shift left. In theory, the effects on current output are ambiguous. The higher expected future interest rates have a negative effect on current demand. All other factors have the opposite effect. AACSB: Written and oral communication Status: 8e question 28) What is fiscal austerity? Answer: Following the Global Financial Crisis of 2008-2009 some economists and most of the policymakers in the euro area believed that fiscal consolidation had to start immediately and had to be strong. They argued that this was essential to convince investors that the fiscal situation was under control. They argued that, if coupled with structural reforms to increase future output, the effect through anticipation of higher output later would dominate the direct adverse effects of consolidation. A strong reduction in government spending became known as fiscal austerity. AACSB: Written and oral communication Status: New question 9e 29) A budget deficit reduction can lead to an increase in output. Answer: TRUE AACSB: Application of knowledge Status: New question 9e

Macroeconomics, 9e (Blanchard) Chapter 17: Openness in Goods and Financial Markets 17.1

Openness in Goods Markets

1) A tariff is ________. A) a foreign bond B) an order for foreign goods that have not yet been delivered C) a barter arrangement between importers and exporters D) a tax on imported goods E) a restriction on the quantity of imported goods allowed into the country Answer: D AACSB: Application of knowledge Status: 8e question 2) In the U.S., over the past forty years, ________. A) exports as a percentage of GDP have increased, while imports has a percentage of GDP have decreased B) exports as a percentage of GDP have decreased, while imports has a percentage of GDP have increased C) both exports and imports as a percentage of GDP have decreased D) both exports and imports as a percentage of GDP have increased E) both exports and imports as a percentage of GDP have remained constant Answer: D AACSB: Application of knowledge Status: 8e question 3) In 2022, which of the following countries had the highest ratio of exports to GDP? A) Germany B) Netherlands C) Japan D) United States E) Austria Answer: B AACSB: Application of knowledge Status: Modified 8e 4) The ratio of a country's exports to its GDP must ________. A) be greater than one B) be less than one C) equal the ratio of imports to GDP D) be larger than the ratio of imports to GDP E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 1 Copyright © 2025 Pearson Education, Inc.

5) Which of the following best defines the real exchange rate? A) the price of foreign bonds in terms of domestic bonds B) the price of foreign currency in terms of domestic currency C) the price of domestic goods in terms of foreign goods D) the price of domestic currency in terms of foreign currency E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 6) Which of the following, all else fixed, will cause the real exchange rate to increase? A) a nominal depreciation B) a reduction in the foreign price level C) a reduction in the domestic price level D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 7) From the perspective of the United States, an increase in the nominal exchange rate will cause which of the following? A) the dollar becomes less expensive to foreigners B) foreign goods are more expensive to Americans C) foreign currency is more expensive to Americans D) American goods are more expensive to foreigners E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 8) When the dollar appreciates relative to the pound, the pound price of the dollar ________. A) increases B) decreases C) does not change D) increases or decreases, depending on the amount of the depreciation E) changes in the next period Answer: A AACSB: Application of knowledge Status: 8e question

9) Suppose there is a real depreciation of the dollar. Which of the following may have occurred? A) Foreign currency has become more expensive in dollars. B) Foreign goods have become more expensive to Americans. C) The foreign price level has increased relative to the U.S. price level. D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 10) Suppose that over the past decade, U.S. inflation is less than that in Mexico. Further assume that during this same period, the dollar depreciates relative to the Mexican peso. Given this information, ________. A) the real exchange rate remains unchanged B) the real exchange rate must decrease C) the real exchange rate must increase D) the real exchange rate can increase or remain the same, but not decrease E) the real exchange rate can decrease or remain the same, but not increase Answer: B AACSB: Application of knowledge Status: 8e question 11) America's largest trading partner is ________. A) Canada B) Japan C) Mexico D) European Union E) China Answer: D AACSB: Application of knowledge Status: 8e question 12) If the exchange rate between the dollar and the pound (the pound price of the dollar) is currently 1.50, and is expected to be 1.35 in one year, then the expected rate of ________. A) depreciation of the dollar is 10% B) depreciation of the dollar is 15% C) appreciation of the dollar is 10% D) appreciation of the dollar is 15% E) none of these Answer: A AACSB: Analytical thinking Status: 8e question

13) Assume that the uncovered interest parity condition holds. Also assume that the U.S. interest rate is less than the U.K. interest rate. Given this information, we know that investors expect ________. A) the pound to depreciate B) the pound to appreciate C) the dollar-pound exchange rate to remain fixed D) the U.S. interest rate to fall E) none of these Answer: A AACSB: Reflective thinking Status: 8e question 14) Assume that the interest rate in a foreign country is 7% and that the foreign currency is expected to depreciate by 3% during the year. For each dollar that a U.S. resident invests in foreign bonds, he/she can expect to get back an approximate total of ________. A) $.93 B) $.96 C) $1.04 D) $1.07 E) $1.10 Answer: C AACSB: Analytical thinking Status: 8e question 15) Suppose two countries make a credible commitment to fix their bilateral exchange rate. In such a situation, we know that ________. A) the uncovered interest parity condition no longer holds B) the real exchange rate must be constant as well C) each country can freely allow its interest rate to diverge from that of the other country D) the interest rate in the two countries must be equal E) neither country will run a trade deficit Answer: D AACSB: Application of knowledge Status: 8e question 16) In 2022, exports as a percentage of GDP for the United States are approximately ________. A) between 1% and 5% B) between 10% and 20% C) between 20% and 40% D) between 40% and 75% E) between 75% and 90% Answer: B AACSB: Application of knowledge Status: Modified 8e

17) As of 2022, the ratio of exports to GDP for Netherlands was approximately equal to ________. A) 20% B) 40% C) 60% D) 93% Answer: D AACSB: Application of knowledge Status: Modified 8e 18) If the price level in Japan is 1.0, the price level in the U.S. is 2.0, and it costs 100 Yen to buy one dollar, then the real exchange rate between the U.S. and Japan is ________. A) 2 B) 10 C) 50 D) 100 E) 200 Answer: E AACSB: Analytical thinking Status: 8e question 19) Year-to-year movements in real exchange rates between industrialized countries like the U.S. and Canada are caused mostly by ________. A) changes in relative rates of inflation B) changes in relative growth rates of output C) changes in quotas or tariffs D) changes in capital controls E) changes in nominal exchange rates Answer: E AACSB: Application of knowledge Status: 8e question 20) Suppose the U.S. one-year interest rate is 3% per year, while a foreign country has a oneyear interest rate of 5% per year. Ignoring risk and transaction costs, a U.S. investor should invest in foreign bonds as long as the expected yearly rate of depreciation of the foreign currency is ________. A) less than 5% B) greater than 5% C) greater than 2% D) less than 2% E) less than 1% Answer: D AACSB: Analytical thinking Status: 8e question

21) Which of the following has occurred for the United States since 1960? A) The ratio of exports to GDP (X/Y) and the ratio of imports to GDP (IM/Y) have both increased. B) X/Y has increased while IM/Y has decreased. C) X/Y has decreased and IM/Y has increased. D) X/Y has decreased and IM/Y has decreased. Answer: A AACSB: Application of knowledge Status: 8e question 22) Which of the following has occurred for the United States since 1960? A) The ratio of exports to GDP (X/Y) and the ratio of imports to GDP (IM/Y) have both decreased. B) X/Y has increased while IM/Y has decreased. C) X/Y has decreased and IM/Y has increased. D) X/Y and IM/Y have stayed relatively constant. E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 23) The ratio of exports to GDP for the United States in 2022 is approximately equal to ________. A) 6% B) 12% C) 21% D) 31% Answer: B AACSB: Application of knowledge Status: Modified 8e 24) Estimates are that tradable goods in the U.S. account for approximately what share of GDP in the U.S.? A) 10% B) 25% C) 45% D) 60% Answer: D AACSB: Application of knowledge Status: Modified 8e

25) In 2022, which of the following countries had the lowest ratio of exports to GDP? A) Japan B) Switzerland C) Austria D) Netherlands E) United States Answer: E AACSB: Application of knowledge Status: Modified 8e 26) In 2022, which of the following countries had the highest ratio of exports to GDP? A) United States B) Germany C) Japan D) Netherlands Answer: D AACSB: Application of knowledge Status: Modified 8e 27) The differences in the ratios of exports to GDP across countries are believed to be caused primarily by ________. A) trade barriers B) each country's size C) monetary policy D) fiscal policy E) inflation in the domestic country Answer: B AACSB: Application of knowledge Status: 8e question 28) The differences in the ratios of exports to GDP across countries are believed to be caused primarily by ________. A) trade barriers B) each country's size C) geography D) all of these E) a country's size and geography Answer: E AACSB: Application of knowledge Status: 8e question

29) The nominal exchange rate (E) as defined in the text represents ________. A) the number of units of foreign currency you can obtain with one unit of domestic currency B) the number of units of domestic goods you can obtain with one unit of foreign goods C) the price of domestic currency in terms of foreign currency D) none of these E) the number of units of foreign currency you can obtain with one unit of domestic currency and the price of domestic currency in terms of foreign currency Answer: E AACSB: Application of knowledge Status: 8e question 30) When E increases by 5%, we know that ________. A) a real appreciation will occur if P decreases by 5% B) a real depreciation will occur if P also increases by 5% C) a nominal appreciation will occur D) a nominal depreciation will occur Answer: C AACSB: Application of knowledge Status: 8e question 31) When E decreases by 3%, we know that ________. A) a real appreciation will occur if P also falls by 3% B) a real depreciation will occur if P increases by 3% C) nominal appreciation will occur D) nominal depreciation will occur Answer: D AACSB: Application of knowledge Status: 8e question 32) A nominal depreciation of the Mexican peso (against all currencies) indicates that ________. A) the peso price of foreign currency has fallen B) the Mexican real exchange rate will not change if the price level in Mexico falls C) the peso price of, for example, the U.K. pound has increased D) the number of units of foreign currency that one can obtain with one peso has decreased Answer: C AACSB: Application of knowledge Status: 8e question 33) A nominal appreciation of the Japanese yen (against all currencies) indicates that ________. A) the yen price of the U.S. dollar has increased B) the yen price of the U.K. pound has increased C) the number of units of foreign currency that one can obtain with one yen has increased D) all of these Answer: C AACSB: Application of knowledge Status: 8e question 8 Copyright © 2025 Pearson Education, Inc.

34) Which of the following expressions represents the real exchange rate (ε)? A) E/P B) EP*/P C) EP* D) EP/P* E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 35) Which of the following expressions represents the dollar price of foreign currency? A) EP*/P B) EP/P* C) 1/E D) E E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 36) Assume that the nominal exchange rate decreases by 4%. If prices (both domestic and foreign do not change), we know that ________. A) foreign goods are now relatively cheaper B) foreign goods are now relatively more expensive C) domestic goods are now relatively more expensive D) foreign goods are now relatively cheaper and domestic goods are now relatively more expensive Answer: B AACSB: Application of knowledge Status: 8e question 37) Assume that the nominal exchange rate increases by 2%. If prices (both domestic and foreign do not change), we know that ________. A) domestic goods are now relatively cheaper B) domestic goods are now relatively more expensive C) foreign goods are now relatively cheaper D) domestic goods are now relatively more expensive and foreign goods are now relatively cheaper Answer: D AACSB: Application of knowledge Status: 8e question

38) A reduction in the real exchange rate indicates that ________. A) foreign goods are now relatively cheaper B) foreign goods are now relatively more expensive C) domestic goods are now relatively more expensive D) foreign goods are now relatively cheaper and domestic goods are now relatively more expensive Answer: B AACSB: Application of knowledge Status: 8e question 39) An increase in the real exchange rate indicates that ________. A) domestic goods are now relatively cheaper B) domestic goods are now relatively more expensive C) foreign goods are now relatively cheaper D) domestic goods are now relatively more expensive and foreign goods are now relatively cheaper Answer: D AACSB: Application of knowledge Status: 8e question 40) Which of the following will cause a real appreciation? A) a reduction in E B) a decrease in P C) an increase in P* D) none of these Answer: D AACSB: Application of knowledge Status: 8e question 41) Which of the following will cause a real depreciation? A) an increase in E B) a reduction in P* C) a reduction in P D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

42) Which of the following events will cause the smallest change in the real exchange rate (ε)? A) a 6% drop in E and a 6% increase in the foreign price level (P*) B) a 6% increase in the domestic price level (P) and a 6% reduction in P* C) a 6% drop in E and a 6% reduction in P* D) a 3% increase in E E) a 2% increase in E and a 2% increase in P Answer: C AACSB: Application of knowledge Status: 8e question 43) Which of the following events will cause the largest real depreciation for the domestic economy? A) a 6% reduction in E and a 6% increase in the foreign price level (P*) B) a 6% increase in the domestic price level (P) and a 6% reduction in P* C) a 6% reduction in E and a 6% reduction in P* D) a 3% increase in E E) a 2% increase in E and a 2% increase in P Answer: A AACSB: Application of knowledge Status: 8e question 44) Explain the three distinct notions of openness. Answer: There are three notions of openness. First, there is openness in the goods market where agents buy domestic and foreign goods and domestic firms sell goods abroad. Second, there is openness in financial markets where individuals can purchase, for example, domestic or foreign bonds. And third, there is openness in factor markets where firms can locate either domestically or in other countries. Workers can also move between countries. AACSB: Written and oral communication Status: 8e question 45) First, write out the expression/equation for the real exchange rate. Second, explain all factors that determine the real exchange rate. Answer: The real exchange rate is the price of domestic goods in terms of foreign goods. It is represented as EP/P*. An increase in E, a nominal appreciation, raises the pound price of the dollar. This will also raise the relative price of domestic goods. An increase in P*, the foreign price level, reflects an increase in the foreign currency price of foreign goods. This will reduce the relative price of domestic goods. And finally, an increase in P, the domestic price level, reflects an increase in the dollar price of domestic goods. This will increase the relative price of domestic goods in terms of foreign goods. AACSB: Written and oral communication Status: 8e question

46) What are the differences between the real exchange rate and nominal exchange rate? Explain. Answer: The real exchange rate, EP/P*, represents the relative price of domestic goods in terms of foreign goods. The nominal exchange rate, E, is the pound price of domestic currency or, equivalently, the relative price of domestic currency in terms of foreign currency. AACSB: Written and oral communication Status: 8e question 47) Discuss what factors could cause a real depreciation. Answer: Decrease in E; increase in P*; and decrease in P. AACSB: Written and oral communication Status: 8e question 48) Explain the difference between gross domestic product and gross national product. Answer: GDP represents the market value of all final goods and services produced IN a country during a given period. GNP is the market value of all final goods and services produced by domestically owned factors of production in a given period. AACSB: Written and oral communication Status: 8e question 49) The real exchange rate between two countries, such as the United States and the United Kingdom, is known as a ________. A) bilateral exchange rate B) multilateral exchange rate C) real appreciation rate D) real depreciation rate Answer: A AACSB: Application of knowledge Status: New question 9e 17.2

Openness in Financial Markets

1) Another name for "current account transactions" is ________. A) "capital account transactions" B) "investment income" C) "net transfers received" D) "checking account transactions" E) "transactions above the line" Answer: E AACSB: Analytical thinking Status: 8e question

2) Because the U.S. traditionally gives more foreign aid than it receives, the U.S. traditionally has a negative value for ________. A) the capital account balance B) the trade balance C) investment income D) net transfers received E) all of these Answer: D AACSB: Analytical thinking Status: 8e question 3) When the U.S. has a current account surplus, we know that it is also ________. A) running a balanced trade account B) lending to the rest of the world C) borrowing from the rest of the world D) suffering from negative investment income E) none of these Answer: B AACSB: Analytical thinking Status: 8e question 4) The difference between net capital flows and the current account deficit is called the ________. A) capital account surplus B) capital account deficit C) international error D) missing number E) statistical discrepancy Answer: E AACSB: Analytical thinking Status: 8e question 5) In a country like Saudi Arabia, which earns substantial income from holding the stocks and bonds of other countries, we would expect ________. A) GNP to be larger than GDP B) a current account deficit C) a current account surplus larger than GNP D) a current account surplus larger than GDP E) GDP to be larger than GNP Answer: A AACSB: Analytical thinking Status: 8e question

6) Suppose you have one U.S. dollar with which you wish to purchase U.K. (one-year) bonds in period t. Which of the following expressions represents the amount of U.S. dollars you will receive in one year (i.e., period t + 1) from purchasing U.K. bonds in period t? A) i B) 1 + i* C) (1 + i*)Eet+1/Et D) (1 + i*)Et/Eet+1 E) none of the above Answer: D AACSB: Analytical thinking Status: 8e question 7) Suppose you have one U.S. dollar with which you wish to purchase U.K. (one-year) bonds in period t. Which of the following expressions represents the amount of U.K. pounds you will receive in one year (i.e., period t + 1) from purchasing U.K. bonds in period t? A) i B) 1 + i* C) (1 + i*)Eet+1/Et D) (1 + i*)Et/Eet+1 E) none of the above Answer: B AACSB: Analytical thinking Status: 8e question 8) Which of the following expressions represents the amount of foreign currency you can obtain with one U.S. dollar? A) Et B) Eet+1 C) 1/ Eet+1 D) εt E) none of the above Answer: A AACSB: Analytical thinking Status: 8e question 9) For this question, assume the interest parity conditions holds. Also assume that the domestic interest rate is 9% and that the foreign interest rate is 5%. Given this information, we would expect that ________. A) individuals will only hold foreign bonds B) individuals will only hold domestic bonds C) the domestic currency is expected to appreciate by 4% D) the domestic currency is expected to depreciate by 4% Answer: D AACSB: Analytical thinking Status: 8e question 14 Copyright © 2025 Pearson Education, Inc.

10) For this question, assume the interest parity conditions holds. Also assume that the domestic interest rate is 10% and that the foreign interest rate is 7%. Given this information, we would expect that ________. A) individuals will only hold foreign bonds B) individuals will only hold domestic bonds C) the domestic currency is expected to appreciate by 3% D) the domestic currency is expected to depreciate by 3% Answer: D AACSB: Reflective thinking Status: 8e question 11) Assume the interest parity condition holds and that individuals expect the dollar to appreciate by 5% during the coming year. Given this information, we know that ________. A) the interest rate differential between the two countries is less than 5% B) i < i* C) i = i* D) individuals will only hold foreign bonds E) none of the above Answer: B AACSB: Analytical thinking Status: 8e question 12) Which of the following conditions will occur when two countries are engaged in a credible, fixed exchange rate regime? A) E = 1 B) E > 1 C) i = i* D) E < 1 Answer: C AACSB: Analytical thinking Status: 8e question 13) For this question, assume that the domestic interest rate is 8% and that the foreign interest rate is 6%. And finally, assume that the domestic currency is expected to depreciate by 3% during the coming year. Given this information, we know that ________. A) individuals will only hold domestic bonds B) individuals will only hold foreign bonds C) individuals will be indifferent about holding domestic or foreign bonds D) the interest parity condition holds Answer: B AACSB: Analytical thinking Status: 8e question

14) For this question, assume that the domestic interest rate is 6% and that the foreign interest rate 4%. And finally, assume that the domestic currency is expected to appreciate by 3% during the coming year. Given this information, we know that ________. A) individuals will only hold domestic bonds B) individuals will only hold foreign bonds C) individuals will be indifferent about holding domestic or foreign bonds D) the interest parity condition holds Answer: A AACSB: Analytical thinking Status: 8e question 15) For this question, suppose the domestic interest rate is 4% and that the foreign interest rate is 7%. And finally, assume that the domestic currency is expected to depreciate by 3% during the coming year. Given this information, we know that ________. A) individuals will only hold domestic bonds B) individuals will only hold foreign bonds C) individuals will be indifferent about holding domestic or foreign bonds D) the interest parity condition holds Answer: B AACSB: Analytical thinking Status: 8e question 16) Suppose the domestic interest rate is 3% and that the foreign interest rate is 6%. And finally, assume that the domestic currency is expected to appreciate by 4% during the coming year. Given this information, we know that ________. A) individuals will only hold domestic bonds B) individuals will only hold foreign bonds C) individuals will be indifferent about holding domestic or foreign bonds D) the interest parity condition holds Answer: A AACSB: Analytical thinking Status: 8e question 17) Which of the following, all else fixed, will cause the real exchange rate to decrease? A) a nominal appreciation B) an increase in the foreign price level C) an increase in the domestic price level D) all of the above E) none of the above Answer: B AACSB: Application of knowledge Status: 8e question

18) From the perspective of the United States, a reduction in the nominal exchange rate will cause which of the following? A) The dollar becomes more expensive to foreigners. B) Foreign goods are less expensive to Americans. C) Foreign currency is less expensive to Americans. D) American goods are less expensive to foreigners. E) none of the above Answer: D AACSB: Application of knowledge Status: 8e question 19) When the dollar depreciates relative to the pound, the pound price of the dollar ________. A) increases B) decreases C) does not change D) increases or decreases, depending on the amount of the depreciation E) changes in the next period Answer: B AACSB: Application of knowledge Status: 8e question 20) Suppose that over the past decade, U.S. inflation is greater than that in Mexico. Further assume that during this same period, the dollar appreciates relative to the Mexican peso. Given this information, ________. A) the real exchange rate remains unchanged B) the real exchange rate must decrease C) the real exchange rate must increase D) the real exchange rate can increase or remain the same, but not decrease E) the real exchange rate can decrease or remain the same, but not increase Answer: C AACSB: Application of knowledge Status: 8e question 21) Assume that the uncovered interest parity condition holds. Also assume that the U.S. interest rate is greater than the U.K. interest rate. Given this information, we know that investors expect ________. A) the pound to depreciate B) the pound to appreciate C) the dollar-pound exchange rate to remain fixed D) the U.S. interest rate to fall E) none of the above Answer: B AACSB: Application of knowledge Status: 8e question

22) A nominal appreciation of the Mexican peso (against all currencies) indicates that ________. A) the peso price of foreign currency has risen B) the Mexican real exchange rate will not change if the price level in Mexico falls C) the peso price of, for example, the U.K. pound has decreased D) the number of units of foreign currency that one can obtain with one peso has increased Answer: C AACSB: Application of knowledge Status: 8e question 23) Suppose you are considering the purchase of a bond issued in another country. What calculations must you do to calculate the expected return on a foreign bond? Explain. Answer: You must first determine the amount of foreign currency you can obtain with one unit of domestic currency (E). You then must determine how much foreign currency you will obtain in one year after purchasing foreign bonds. And finally, you must then calculate how much domestic currency you will receive in one year when you convert the foreign currency back to domestic currency. AACSB: Written and oral communication Status: 8e question 24) Explain what factors determine the expected return on a foreign bond. Answer: The current exchange rate, the current foreign interest rate, and the future expected exchange rate. AACSB: Reflective thinking Status: 8e question 25) Suppose the interest parity condition holds and that the domestic interest rate is greater than the foreign interest rate. What does this imply about the current versus future expected exchange rate? Explain. Answer: If i > i*, we know that the foreign currency must be expected to appreciate to equate the expected returns on the two bonds. AACSB: Reflective thinking Status: 8e question 26) Suppose the interest parity condition holds. Also assume that the one-year interest rate in the United States is 6% and that the one-year interest rate in Canada is 6%. What does this imply about the current versus future expected exchange rate (for the U.S. and Canadian dollars)? Explain. Answer: This implies that there are no expected exchange gains or losses from holding foreign currency denominated assets for one year. So, the exchange rate that financial market participants expect to occur in one year is equal to the current exchange rate. AACSB: Reflective thinking Status: 8e question

27) Assuming that the interest parity condition holds, what type of information is contained in interest rate differentials between domestic and foreign bonds? Explain. Answer: Given that the domestic rate equals the foreign interest rate minus any expected rate of appreciation of the domestic currency, any difference in interest rates will reflect this expected depreciation/appreciation of the domestic currency. AACSB: Reflective thinking Status: 8e question 28) Explain why a comparison between the interest rates on domestic and foreign bonds might provide misleading information about which bonds yield the highest expected returns. Answer: A simple comparison of interest rates will ignore the expected exchange gains/losses that can occur from holding assets denominated in a foreign currency. Hence, such a comparison will likely provide incorrect information about which bonds have a higher expected return. AACSB: Reflective thinking Status: 8e question 29) Suppose the interest parity condition holds and that the domestic interest rate is less than the foreign interest rate. What does this imply about the current versus future expected exchange rate? Explain. Answer: If i < i*, we know that the foreign currency must be expected to depreciate to equate the expected returns on the two bonds. AACSB: Reflective thinking Status: 8e question 30) Suppose the interest parity condition holds. Also assume that the one-year interest rate in the United States is 5% and that the one-year interest rate in Canada is 6%. What does this imply about the current versus future expected exchange rate (for the U.S. and Canadian dollars)? Explain. Answer: If the interest rate in US is less than the interest rate in Canada, we know that Canadian dollars must be expected to depreciate to equate the expected returns on the two bonds. AACSB: Reflective thinking Status: 8e question 31) Suppose the interest parity condition holds. Also assume that the one-year interest rate in the United States is 6% and that the one-year interest rate in Canada is 5%. What does this imply about the current versus future expected exchange rate (for the U.S. and Canadian dollars)? Explain. Answer: If the interest rate in US is greater than the interest rate in Canada, we know that Canadian dollars must be expected to appreciate to equate the expected returns on the two bonds. AACSB: Reflective thinking Status: 8e question

32) What is uncovered interest parity? Explain. Answer: Uncovered interest parity or interest parity, is an arbitrage condition stating that the expected rates of return in terms of domestic currency on domestic bonds and foreign bonds must be equal. Interest parity implies that the domestic interest rate approximately equals the foreign interest rate minus the expected appreciation rate of the domestic currency. AACSB: Reflective thinking Status: 8e question 33) Suppose the one-year nominal interest rate is 2.0% in the United States and 5.0% in Canada. Should you hold Canadian bonds or U.S. bonds? Explain. Answer: It depends whether you expect the Canadian dollars to depreciate relative to the dollar over the coming year by more or less than the difference between the U.S. interest rate and the Canada interest rate, or 3.0% in this case (5.0% - 2.0%). If you expect the Canadian dollars to depreciate by more than 3.0%, then, despite the fact that the interest rate is higher in Canada than in the United States, investing in Canadian bonds is less attractive than investing in U.S. bonds. By holding Canadian bonds, you will get higher interest payments next year, but the Canadian dollars will be worth less in terms of dollars next year, making investing in Canada bonds less attractive than investing in U.S. bonds. If you expect the Canadian dollars to depreciate by less than 3.0% or even to appreciate, then the reverse holds, and Canadian bonds are more attractive than U.S. bonds. AACSB: Written and oral communication Status: 8e question

Macroeconomics, 9e (Blanchard) Chapter 18: The Goods Market in an Open Economy 18.1

The IS Relation in the Open Economy

1) Which of the following represents the demand for domestic goods? A) C + I + G B) C + I + G + X C) C + I + G - εIM D) C + I + G + X + εIM E) C + I + G + X - IM/ε Answer: E AACSB: Application of knowledge Status: 8e question 2) Which of the following represents the domestic demand for goods? A) C + I + G B) C + I + G + X C) C + I + G - IM/ε D) C + I + G + X - εM/ε E) C + I + G + X + εIM Answer: A AACSB: Application of knowledge Status: 8e question 3) The expression, IM, represents the value of imports in terms of ________. A) foreign currency B) domestic currency C) foreign goods D) domestic goods E) exports Answer: C AACSB: Application of knowledge Status: 8e question 4) The quantity of imports will increase when there is ________. A) a reduction in the real exchange rate B) an increase in domestic output C) an increase in foreign output D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question

5) Exports will decrease when there is ________. A) an increase in the real exchange rate B) an increase in domestic output C) an increase in foreign output D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 6) Explain the difference between: (1) the demand for domestic goods; and (2) the domestic demand for goods. Answer: The demand for domestic goods represents the demand for goods produced IN a country. This measure will take into account those goods produced domestically and sold abroad (exports) and the fact that some goods purchased domestically were produced abroad (imports). The domestic demand for goods represents the demand for goods by domestic individuals, firms, and government: C + I + G. The difference between the two is NX. AACSB: Written and oral communication Status: 8e question 7) Explain the determinants of exports and imports. Answer: Exports are a function of foreign output and the real exchange rate. Imports are a function of domestic output and the exchange rate. AACSB: Application of knowledge Status: 8e question 8) Explain why the demand for domestic goods curve (ZZ) has a different shape than the domestic demand curve (DD). Answer: The marginal propensity to import explains this. As Y increases, C and I will increase causing an increase in DD. Some of this increase in demand is for foreign goods. This must be subtracted from DD to obtain ZZ. So, a given increase in Y will have a larger effect on DD than it will on ZZ. AACSB: Application of knowledge Status: 8e question 18.2

Equilibrium Output and the Trade Balance

1) Which of the following occurs when the goods market is in equilibrium? A) Domestic output (Y) equals the demand for domestic goods. B) Y equals the domestic demand for goods. C) Y equals the domestic demand for domestic goods. D) Net exports equals 0. E) Demand for domestic goods equals the domestic demand for goods. Answer: A AACSB: Application of knowledge Status: 8e question 2 Copyright © 2025 Pearson Education, Inc.

2) Which of the following is true when a country is experiencing a trade surplus (NX > 0)? A) Demand for domestic goods is equal to the domestic demand for goods. B) Demand for domestic goods is greater than the domestic demand for goods. C) Demand for domestic goods is less than the domestic demand for goods. D) A budget surplus exists. Answer: B AACSB: Application of knowledge Status: 8e question 3) Which of the following is true when a county is experiencing a trade deficit (NX < 0)? A) Demand for domestic goods is equal to the domestic demand for goods. B) Demand for domestic goods is greater than the domestic demand for goods. C) Demand for domestic goods is less than the domestic demand for goods. D) A budget deficit exists. Answer: C AACSB: Application of knowledge Status: 8e question 4) Which of the following is true when a country's trade position is balanced (i.e., NX = 0)? A) Demand for domestic goods is equal to the domestic demand for goods. B) Demand for domestic goods is greater than the domestic demand for goods. C) Demand for domestic goods is less than the domestic demand for goods. D) Neither a budget surplus nor deficit exists (i.e., G - T = 0). Answer: A AACSB: Application of knowledge Status: 8e question 5) Assume the Marshall-Lerner condition holds. Which of the following will cause an increase in net exports? A) an increase in government spending B) an increase in investment C) a reduction in foreign output D) a reduction in the real exchange rate E) all of these Answer: D AACSB: Application of knowledge Status: 8e question

6) Using the ZZ/Y and NX graphs, illustrate graphically and explain what effect a reduction in taxes will have on output, exports, imports, and net exports. Clearly label all curves and clearly label the initial and final equilibria. Answer: A reduction in T will cause an increase in C and cause ZZ to shift up as demand rises. Y will increase causing an increase in C and S. As Y rises, imports will rise. Given that exports do not change, net exports will decrease. AACSB: Analytical thinking Status: 8e question 7) Using the ZZ/Y and NX graphs, illustrate graphically and explain what effect a reduction in foreign output (Y*) will have on output, exports, imports, and net exports. Clearly label all curves and clearly label the initial and final equilibria. Answer: A reduction in foreign income, Y*, will cause a decrease in exports (the NX curve shifts up) and an decrease in demand. As demand falls, Y will decrease causing a fall in C and S. As Y decreases, imports will decrease as well. As shown in the text, the decrease in imports will be less than the fall in exports. So, NX will be lower. AACSB: Written and oral communication Status: 8e question 8) Using the ZZ/Y and NX graphs, illustrate graphically and explain what effect an increase in government spending will have on output, exports, imports, and net exports. Clearly label all curves and clearly label the initial and final equilibria. Answer: An increase in government spending will cause ZZ to shift up as demand rises. Y will increase causing an increase in C and S. As Y rises, imports will rise. Given that exports do not change, net exports will decrease. AACSB: Written and oral communication Status: 8e question 18.3

Increases in Demand-Domestic or Foreign

1) In an open economy, an increase in government spending will cause ________. A) a reduction in domestic output B) a reduction in imports C) a reduction in net exports D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

2) In an open economy, which of the following will cause an increase in the size of the multiplier? A) a reduction in the marginal propensity to import B) a reduction in foreign output C) an increase in the marginal propensity to save D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 3) Suppose there is a reduction in foreign output (Y*). This reduction in Y* will cause which of the following in the domestic country? A) a reduction in output B) a reduction in consumption C) a reduction in net exports D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 4) Which of the following will always cause an increase in net exports? A) a reduction in domestic output B) an increase in the real exchange rate C) an increase in government spending D) an increase in investment E) all of these Answer: A AACSB: Application of knowledge Status: 8e question 5) An increase in government spending will have a greater impact on net exports when ________. A) the marginal propensity to save is smaller B) the economy is closed C) the sensitivity of investment to income is smaller D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

6) Which of the following will occur in a small country with a high marginal propensity to import? A) Changes in government spending will cause large changes in output. B) Changes in government spending will cause large changes in the trade balance. C) A depreciation will cause only small changes in the trade balance. D) There is no combination of policies that can eliminate the trade deficit. E) all of these Answer: B AACSB: Application of knowledge Status: 8e question 7) Which of the following would make the spending multiplier smaller? A) a reduction in marginal propensity to save B) a small initial trade deficit C) a reduction in the marginal propensity to import D) a real appreciation E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 8) Suppose that the rest of the world experiences an economic boom causing an increase in foreign output (Y*). This increase in Y* will not cause which of the following to occur? A) the domestic country's output to increase B) the domestic country's consumption to increase C) the domestic country's output to increase and its trade balance to worsen as imports increase D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 9) In an open economy, net exports will be equal to which of the following? A) X - IM/ε B) T - G C) DD D) Z E) S - I Answer: A AACSB: Application of knowledge Status: 8e question

10) Which of the following will occur as a result of a tax increase? A) private saving increases B) investment increases C) the trade balance improves D) the trade balance worsens E) the budget deficit increases Answer: C AACSB: Application of knowledge Status: 8e question 11) An open economy with a low saving rate (private and public) must have ________. A) low investment only B) high investment only C) a trade surplus only D) low investment or a trade deficit E) low investment or a trade surplus Answer: D AACSB: Application of knowledge Status: 8e question 12) Policy coordination is difficult because each country ________. A) prefers to be the one to increase demand B) prefers to be the one to appreciate its currency C) prefers that other countries increase their demand D) prefers to be the one to increase taxes E) prefers that other countries increase taxes Answer: C AACSB: Application of knowledge Status: 8e question 13) Which of the following conditions must be satisfied for the demand for domestic goods to be equal to the domestic demand for goods? A) X = εIM B) X = 0 C) G - T = 0 D) S = I E) X = IM/ε Answer: E AACSB: Application of knowledge Status: 8e question

14) An increase in which of the following variables will cause a reduction in the demand for domestic goods? A) foreign income B) the real exchange rate C) consumer confidence D) domestic income E) all of these Answer: B AACSB: Application of knowledge Status: 8e question 15) A change in which of the following variables will have no direct effect on the level of domestic demand? A) domestic income B) the real exchange rate C) government spending D) the interest rate (r) E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 16) A change in which of the following variables will have no direct effect on domestic demand? A) domestic income B) foreign income C) government spending D) the interest rate (r) E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 17) Assume a country is closed. Given this information, which of the following must occur? A) demand for domestic goods will be less than the domestic demand for goods B) demand for domestic goods will be greater than the domestic demand for goods C) S + T = I + G D) a budget surplus exists E) S = I Answer: C AACSB: Application of knowledge Status: 8e question

18) Assume a country is open. Given this information, which of the following must occur? A) demand for domestic goods will be equal to the domestic demand for goods B) demand for domestic goods will be greater than the domestic demand for goods C) demand for domestic goods will be less than the domestic demand for goods D) S + T = I + G E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 19) An increase in domestic demand will have which of the following effects in an open economy? A) a smaller effect on output than in a closed economy and a positive effect on the trade balance B) a smaller effect on output than in a closed economy and a negative effect on the trade balance C) a larger effect on output than in a closed economy and a positive effect on the trade balance D) a larger effect on output than in a closed economy and a negative effect on the trade balance Answer: A AACSB: Application of knowledge Status: 8e question 20) An increase in the marginal propensity to import will cause ________. A) the ZZ line to become flatter and a given change in government spending (G) to have a larger effect on domestic output B) the ZZ line to become flatter and a given change in government spending (G) to have a smaller effect on domestic output C) the ZZ line to become steeper and a given change in government spending (G) to have a larger effect on domestic output D) the ZZ line to become steeper and a given change in government spending (G) to have a smaller effect on domestic output Answer: B AACSB: Application of knowledge Status: 8e question 21) A reduction in the marginal propensity to import will cause ________. A) the ZZ line to become flatter and a given change in government spending (G) to have a larger effect on domestic output B) the ZZ line to become flatter and a given change in government spending (G) to have a smaller effect on domestic output C) the ZZ line to become steeper and a given change in government spending (G) to have a larger effect on domestic output D) the ZZ line to become steeper and a given change in government spending (G) to have a smaller effect on domestic output Answer: C AACSB: Application of knowledge Status: 8e question

22) An increase in the marginal propensity to import will cause ________. A) the multiplier to increase and a given change in government spending (G) to have a larger effect on domestic output B) the multiplier to increase and a given change in government spending (G) to have a smaller effect on domestic output C) the multiplier to decrease and a given change in government spending (G) to have a larger effect on domestic output D) the multiplier to decrease and a given change in government spending (G) to have a smaller effect on domestic output Answer: D AACSB: Application of knowledge Status: 8e question 23) A reduction in the marginal propensity to import will cause ________. A) the multiplier to increase and a given change in government spending (G) to have a larger effect on domestic output B) the multiplier to increase and a given change in government spending (G) to have a smaller effect on domestic output C) the multiplier to decrease and a given change in government spending (G) to have a larger effect on domestic output D) the multiplier to decrease and a given change in government spending (G) to have a smaller effect on domestic output Answer: A AACSB: Application of knowledge Status: 8e question 24) In a large country, the effect of a given change in government spending ________. A) on output is large and the effect on the trade balance is small B) on output is large and the effect on the trade balance is large C) on output is small and the effect on the trade balance is small D) on output is small and the effect on the trade balance is large Answer: A AACSB: Application of knowledge Status: 8e question 25) In a small country, the effect of a given change in government spending ________. A) on output is large and the effect on the trade balance is small B) on output is large and the effect on the trade balance is large C) on output is small and the effect on the trade balance is small D) on output is small and the effect on the trade balance is large Answer: D AACSB: Application of knowledge Status: 8e question

26) We will generally observe that the more open an economy ________. A) the larger the effect of fiscal policy on output and the larger the effect of fiscal policy on the trade position B) the larger the effect of fiscal policy on output and the smaller the effect of fiscal policy on the trade position C) the smaller the effect of fiscal policy on output and the larger the effect of fiscal policy on the trade position D) the smaller the effect of fiscal policy on output and the smaller the effect of fiscal policy on the trade position Answer: C AACSB: Application of knowledge Status: 8e question 27) We will generally observe that the less open an economy ________. A) the larger the effect of fiscal policy on output and the larger the effect of fiscal policy on the trade position B) the larger the effect of fiscal policy on output and the smaller the effect of fiscal policy on the trade position C) the smaller the effect of fiscal policy on output and the larger the effect of fiscal policy on the trade position D) the smaller the effect of fiscal policy on output and the smaller the effect of fiscal policy on the trade position Answer: B AACSB: Application of knowledge Status: 8e question 28) For an open economy, which of the following expressions represents saving (S)? A) I + T - G + NX B) I + T - G - NX C) I + G - T + NX D) G - T + NX - I E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 29) For an open economy, which of the following expressions represents net exports (NX)? A) S + G - T - I B) S + G - T + I C) S + T - G + I D) G - T + I - S E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

30) Using the ZZ/Y and NX graphs, illustrate graphically and explain what effect an increase in taxes will have on output, exports, imports, and net exports. Clearly label all curves and clearly label the initial and final equilibria. Answer: An increase in T will cause a reduction in C and cause ZZ to shift down as demand falls. Y will fall causing a reduction in C and S. As Y falls, imports will fall. Given that exports do not change, net exports will increase. AACSB: Analytical thinking Status: 8e question 31) Using the ZZ/Y and NX graphs, illustrate graphically and explain what effect an increase in foreign output (Y*) will have on output, exports, imports, and net exports. Clearly label all curves and clearly label the initial and final equilibria. Answer: An increase in foreign income, Y*, will cause an increase in exports (the NX curve shifts up) and an increase in demand. As demand rises, Y will increase causing a rise in C and S. As Y increases, imports will increase as well. As shown in the text, the increase in imports will be less than the rise in exports. So, NX will be higher. AACSB: Analytical thinking Status: 8e question 32) Explain why the multiplier in an open economy is different from the multiplier in a closed economy. Answer: In a closed economy, the effects of any change in Y on demand all falls on domestic goods. In an open economy, some of the increased spending falls on imports. So, the final change in Y will be smaller in an open economy because of the existence of the marginal propensity to import. AACSB: Written and oral communication Status: 8e question 33) Assuming the Marshall-Lerner condition holds and using the ZZ/Y and NX graphs, illustrate graphically and explain what effect a real appreciation will have on output, exports, imports, and net exports. Clearly label all curves and clearly label the initial and final equilibria. Answer: A real appreciation will cause NX to fall. The fall in NX will cause a decrease in demand. As demand falls, Y will decrease causing a fall in C and S. As Y decreases, imports will decrease as well. As shown in the text, the decrease in imports will be less than the fall in exports. So, NX will be lower. AACSB: Written and oral communication Status: 8e question 34) Explain why in practice policy coordination is hard to achieve. Answer: One of reasons is that some countries might have to do more than others and may not want to do so. Second, countries have a strong incentive to promise to coordinate and then not deliver on that promise. Only when things are really bad, does coordination appear to take hold. AACSB: Written and oral communication Status: 8e question

18.4

Depreciation, the Trade Balance, and Output

1) Suppose there is a real appreciation. This real appreciation is more likely to cause a reduction in net exports when ________. A) domestic output is relatively low B) foreign output is relatively high C) the Marshall-Lerner condition does not hold D) imports are not at all sensitive to price changes E) exports and imports are relatively sensitive to price changes Answer: E AACSB: Application of knowledge Status: 8e question 2) The evidence suggests that in rich countries, a depreciation ________. A) immediately improves the trade balance B) eventually improves the trade balance C) first improves, but then worsens the trade balance D) has no effect on the trade balance E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 3) Assume the Marshall-Lerner condition holds. Which of the following will cause a reduction in net exports? A) a reduction in government spending B) a reduction in investment C) an increase in foreign output D) an increase in the real exchange rate E) all of these Answer: D AACSB: Application of knowledge Status: 8e question 4) For this question, assume the Marshal-Lerner condition holds. Which of the following would occur as a result of an increase in the real exchange rate? A) an improvement of the trade balance B) a reduction in the quantity of imports C) an increase in domestic output D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

5) For this question, assume that the Marshall-Lerner condition does not hold. An increase in the real exchange rate will tend to cause which of the following to occur? A) a reduction in NX and a reduction in Y B) a reduction in NX and an increase in Y C) an increase in NX and a reduction in Y D) an increase in NX and an increase in Y Answer: D AACSB: Application of knowledge Status: 8e question 6) For this question, assume that the Marshall-Lerner condition does not hold. A reduction in the real exchange rate will tend to cause which of the following to occur? A) a reduction in NX and a reduction in foreign output (Y*) B) a reduction in NX and an increase in domestic output (Y) C) an increase in NX and a reduction in Y D) an increase in NX and an increase in Y E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 7) For this question, assume that equilibrium output is determined in the ZZ-Y diagram. Further assume that policy makers' goals are (1) to achieve balanced trade (i.e., NX = 0); and (2) to achieve a target level of output, say YT. Now, suppose that the initial level of equilibrium output is equal to YT (i.e., Y = YT) and that a trade deficit exists at this initial level of output. Which of the following policy actions would most likely enable the policy makers to achieve their two goals simultaneously? A) a reduction in government spending B) convince the country's trading partners to pursue policies that will cause an increase in foreign income (Y*) C) a reduction in the real exchange rate D) a reduction in taxes E) a simultaneous increase in government spending and reduction in the real exchange rate F) none of these Answer: F AACSB: Application of knowledge Status: 8e question 8) Suppose policy makers want to increase Y and increase NX. Which of the following policies would most likely achieve this? A) an increase in government spending B) a real depreciation C) a reduction in taxes and an increase in the real exchange rate D) an increase in the real exchange rate Answer: B AACSB: Application of knowledge Status: 8e question 14 Copyright © 2025 Pearson Education, Inc.

9) Explain what the Marshall-Lerner condition represents. Answer: The Marshall-Lerner condition is the condition that must be satisfied for a real depreciation to cause an increase in net exports. The sum of the percentage changes in exports and imports must exceed the percentage change in the real exchange rate. When a real depreciation occurs, three effects occur: the quantity of exports increases, the quantity of imports falls, and the real cost of imports rise. The first two effects must offset the last effect for NX to rise. AACSB: Written and oral communication Status: 8e question 10) Assuming the Marshall-Lerner condition holds and using the ZZ/Y and NX graphs, illustrate graphically and explain what effect a real depreciation will have on output, exports, imports, and net exports. Clearly label all curves and clearly label the initial and final equilibria. Answer: A real depreciation will cause NX to rise. The rise in NX will cause an increase in demand. As demand rises, Y will increase causing a rise in C and S. As Y increases, imports will increase as well. As shown in the text, the increase in imports will be less than the rise in exports. So, NX will be higher. AACSB: Written and oral communication Status: 8e question 18.5

Saving, Investment, and the Current Account Balance

1) Suppose policy makers want to increase Y and keep NX constant. Which of the following policies would most likely achieve this? A) an increase in government spending B) a real depreciation C) an increase in government spending and a reduction in the real exchange rate D) a reduction in the real exchange rate E) encourage the country's trading partners to implement policies that will cause an increase in foreign income (Y*) Answer: C AACSB: Reflective thinking Status: 8e question 2) Suppose policy makers want to increase NX and keep Y constant. Which of the following policies would most likely achieve this? A) a reduction in government spending B) a real depreciation C) a reduction in government spending and a reduction in the real exchange rate D) a reduction in the real exchange rate and a tax cut Answer: C AACSB: Reflective thinking Status: 8e question

3) Suppose the rest of the world experiences an expansion that causes an increase in foreign income (Y*). From the domestic economy's perspective, this increase in foreign income will cause which of the following as the domestic economy adjusts to the rise in Y*? A) an increase in domestic income B) an increase in imports C) an increase in net exports D) all of these E) none of these Answer: D AACSB: Reflective thinking Status: 8e question 4) Suppose the rest of the world experiences a recession that causes a reduction in foreign income (Y*). From the domestic economy's perspective, this reduction in foreign income will cause which of the following as the domestic economy adjusts to the drop in Y*? A) a reduction in income and a reduction in imports B) a reduction in imports and an increase in net exports C) the NX line to shift up D) an ambiguous effect on net exports Answer: A AACSB: Reflective thinking Status: 8e question 5) An increase in the budget deficit can be reflected in ________. A) an increase in private saving B) a reduction in investment C) a reduction in net exports D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 6) A reduction in private saving (S) can be reflected in ________. A) an increase in the budget deficit B) an increase in investment C) a reduction in net exports D) all of these Answer: C AACSB: Application of knowledge Status: 8e question

7) The quantity of imports will decrease when there is ________. A) an increase in the real exchange rate B) a reduction in domestic output C) a reduction in foreign output D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 8) Exports will increase when there is ________. A) a reduction in the real exchange rate B) a reduction in domestic output C) a reduction in foreign output D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 9) In an open economy, a reduction in government spending will cause ________. A) an increase in domestic output B) an increase in imports C) an increase in net exports D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 10) In an open economy, which of the following will cause a reduction in the size of the multiplier? A) an increase in the marginal propensity to import B) an increase on foreign output C) a reduction in the marginal propensity to save D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

11) Which of the following will always cause a reduction in net exports? A) an increase in domestic output B) a reduction in the real exchange rate C) a reduction in government spending D) a reduction in investment E) all of these Answer: A AACSB: Application of knowledge Status: 8e question 12) Which of the following will occur as a result of a tax cut? A) private saving decreases B) investment decreases C) the trade balance improves D) the trade balance worsens E) the budget deficit decreases Answer: D AACSB: Application of knowledge Status: 8e question 13) A reduction in the budget deficit can be reflected in ________. A) a reduction in private saving B) an increase in investment C) an increase in net exports D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 14) An increase in private saving (S) can be reflected in ________. A) a reduction in the budget deficit B) a reduction in investment C) an increase in net exports D) all of these Answer: C AACSB: Application of knowledge Status: 8e question

15) In November 2008, the leaders of the ________ met in an emergency meeting in Washington to coordinate their responses in terms of both macroeconomic and financial policies. A) G20 B) G7 C) OECD countries D) G8 Answer: A AACSB: Application of knowledge Status: 8e question 16) Suppose a country is experiencing a situation where output is above the full employment level of output and a trade deficit. Further assume that the policy makers' goals are to achieve full employment output and balanced trade. Given this information, what type of exchange rate and/or fiscal policy can be used to achieve simultaneously these two goals? Explain. Answer: Y must fall and NX must rise. An appreciation will not work. It would cause Y to fall but will NX will decrease even more. A fiscal contraction would work because it would reduce Y and also reduce imports which will cause NX to rise. AACSB: Written and oral communication Status: 8e question 17) Suppose a country's output is below the policy makers' desired level of output and is experiencing a trade surplus. Assume that the policy makers' goals are to achieve the desired level of output (i.e., full employment output) and balanced trade. Given this information, what type of exchange rate and/or fiscal policy can be used to achieve simultaneously these two goals? Explain. Answer: Y must rise and NX must fall. A depreciation would cause Y to rise but NX would rise even more. In this case, a fiscal expansion would work. Y would rise causing imports to increase and NX to fall. AACSB: Written and oral communication Status: 8e question

Macroeconomics, 9e (Blanchard) Chapter 19: Output, the Interest Rate, and the Exchange Rate 19.1

Equilibrium in the Goods Market

1) Assume that the price levels in two countries are constant. In this situation, we know that ________. A) neither the real nor the nominal exchange rate can change B) the real exchange rate can change, while the nominal exchange rate is constant C) the nominal exchange rate can change, while the real exchange rate is constant D) the real and nominal exchange rate must move together, changing by the same percentage E) the nominal exchange rate will fluctuate more widely than the real exchange rate Answer: D AACSB: Application of knowledge Status: 8e question 2) An increase in the real exchange rate will cause ________. A) an increase in net exports B) an increase in the quantity of imports C) an increase in output D) a decrease in government spending E) all of these Answer: B AACSB: Application of knowledge Status: 8e question 3) As the economy moves up and to the right along the IS curve, which of the following will occur when exchange rates are flexible? A) investment spending increases B) consumption increases C) the domestic currency depreciates D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 4) In an economy operating under flexible exchange rates, explain why the IS curve is downward sloping. Answer: A reduction in i (assume zero inflation) will cause investment to increase for reasons discussed before. This causes an increase in Z and Y. There is a second effect now embedded in the IS curve. As i falls, the demand for the domestic currency drops causing a depreciation. This depreciation causes NX to rise and demand to rise even more. So, there are two components of demand that now change as i changes: I and NX. AACSB: Written and oral communication Status: 8e question 1 Copyright © 2025 Pearson Education, Inc.

19.2

Equilibrium in Financial Markets

1) In order for an individual to be indifferent between holding foreign or domestic bonds, ________. A) the Marshall-Lerner condition must hold B) the foreign and domestic interest rates must be equal C) the expected rate of depreciation of the domestic currency is zero D) the interest parity condition must hold Answer: D AACSB: Application of knowledge Status: 8e question 2) The interest parity condition indicates that the domestic interest rate must be equal to ________. A) the foreign interest rate B) the expected rate of depreciation of the domestic currency C) the expected rate of appreciation of the domestic currency D) the foreign interest rate minus the expected rate of appreciation of the foreign currency E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 3) Assume that the interest parity condition holds. Also assume that the U.S. interest rate is 8% while the U.K. interest rate is 6%. Given this information, financial markets expect the pound to ________. A) depreciate by 14% B) depreciate by 2% C) appreciate by 2% D) appreciate by 6% E) appreciate by 14% Answer: C AACSB: Analytical thinking Status: 8e question 4) Assume that the interest parity holds and that the dollar is expected to depreciate against the pound. Given this information, we know that ________. A) U.S. and U.K. interest rates are equal B) the U.S. interest rate exceeds the U.K. interest rate C) the U.K. interest rate exceeds the U.S. interest rate D) individuals will prefer to hold U.S. bonds because the U.S. interest rate exceeds the U.K. interest rate E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 2 Copyright © 2025 Pearson Education, Inc.

5) In an open economy, we know that individuals must choose between which of the following? A) domestic bonds and foreign currency B) foreign goods and domestic currency C) domestic and foreign bonds D) domestic goods and foreign currency E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 6) A real appreciation will tend to cause ________. A) an increase in exports B) a reduction in imports C) an increase in net exports D) a reduction in demand for domestic goods E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 7) A reduction in the real exchange rate will cause ________. A) a reduction in net exports B) a reduction in the quantity of imports C) a reduction in output D) an increase in government spending E) all of these Answer: B AACSB: Application of knowledge Status: 8e question 8) Assume that the interest parity condition holds. Also assume that the U.S. interest rate is 6% while the U.K. interest rate is 8%. Given this information, financial markets expect the pound to ________. A) depreciate by 14% B) depreciate by 2% C) appreciate by 2% D) appreciate by 6% E) appreciate by 14% Answer: B AACSB: Analytical thinking Status: 8e question

9) Assume that the interest parity holds and that the dollar is expected to appreciate against the pound. Given this information, we know that ________. A) U.S. and U.K. interest rates are equal B) the U.S. interest rate exceeds the U.K. interest rate C) the U.K. interest rate exceeds the U.S. interest rate D) individuals will prefer to hold U.S. bonds because the U.S. interest rate exceeds the U.K. interest rate E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 10) A real depreciation will tend to cause ________. A) a reduction in exports B) an increase in imports C) a reduction in net exports D) an increase in demand for domestic goods E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 11) Explain what the IP curve is and why it is upward sloping. Answer: The IP curve represents the combinations of i and E that maintain the interest parity condition. As i falls, foreign bonds will have a higher expected return. The demand for the dollar will fall causing an immediate depreciation. So, the drop in i causes E to fall. E will fall until all of the drop in i is offset by the expected appreciation of the dollar. AACSB: Written and oral communication Status: 8e question 12) Suppose the domestic and foreign interest rates are both initially equal to 3%. Now suppose the domestic interest rate rises to 5%. Explain what effect this will have on the exchange rate. Also explain what must occur for the interest parity condition to be restored. Answer: Domestic bonds will have a higher return causing the demand for the domestic currency to rise. The dollar will appreciate. It will continue to appreciate as long as the return on domestic bonds exceeds the return on foreign bonds. This immediate appreciation will equal an expected depreciation of the domestic currency that equates the expected returns. So, the dollar will appreciate by 2%. AACSB: Written and oral communication Status: 8e question

13) Suppose the domestic and foreign interest rates are both initially equal to 4%. Now suppose the foreign interest rate rises to 6%. Explain what effect this will have on the exchange rate. Also explain what must occur for the interest parity condition to be restored. Answer: Domestic bonds will have a lower return causing the demand for the domestic currency to fall. The dollar will depreciate. It will continue to depreciate as long as the return on domestic bonds is less than the return on foreign bonds. This immediate depreciation will equal an expected appreciation of the domestic currency that equates the expected returns. So, the dollar will depreciate by 2%. AACSB: Written and oral communication Status: 8e question 19.3

Putting Goods and Financial Markets Together

1) As the economy moves up and to the left along the IS curve, which of the following will occur when exchange rates are flexible? A) investment spending decreases B) consumption decreases C) the domestic currency appreciates D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) In an open economy under flexible exchange rates, a reduction in the interest rate will cause a reduction in which of the following? A) investment B) the exchange rate, E C) net exports D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 3) In an open economy under flexible exchange rates, a reduction in government spending will cause a reduction in which of the following? A) net exports B) the exchange rate, E C) exports D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question

4) In an open economy under flexible exchange rates, a reduction in consumer confidence that causes a reduction in consumption will cause which of the following? A) an appreciation of the domestic currency B) a reduction in the exchange rate, E C) a reduction in net exports D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 5) In an open economy under flexible exchange rates, expansionary monetary policy that results in an increase in the money supply will always cause ________. A) an increase in output B) an increase in exports C) a reduction in the exchange rate, E D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 6) Assume that the interest parity condition holds and that both the expected exchange rate and foreign interest rate are constant. Given this information, a reduction in the domestic interest rate will cause ________. A) a reduction in the exchange rate expected in the future B) a reduction in the current exchange rate C) greater depreciation of the domestic currency expected in the future D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 7) The exchange rate policy of the United States is ________. A) the EMS B) a crawling peg C) a float D) a fixed rate within a band E) none of these Answer: C AACSB: Application of knowledge Status: 8e question

8) In a flexible exchange rate regime, an increase in the foreign interest rate (i*) will cause ________. A) the IP curve to shift to the left/up B) the IP curve to shift to the right/down C) a movement along the IP curve D) neither a shift nor movement along the IP curve Answer: B AACSB: Application of knowledge Status: 8e question 9) In a flexible exchange rate regime, a reduction in the foreign interest rate (i*) will cause ________. A) the IP curve to shift to the left/up B) the IP curve to shift to the right/down C) a movement along the IP curve D) neither a shift nor movement along the IP curve Answer: A AACSB: Application of knowledge Status: 8e question 10) In a flexible exchange rate regime, an increase in the expected future exchange rate will cause ________. A) the IP curve to shift to the left/up B) the IP curve to shift to the right/down C) a movement along the IP curve D) neither a shift nor movement along the IP curve Answer: B AACSB: Application of knowledge Status: 8e question 11) In a flexible exchange rate regime, a reduction in the expected future exchange rate will cause ________. A) the IP curve to shift to the left/up B) the IP curve to shift to the right/down C) a movement along the IP curve D) neither a shift nor movement along the IP curve Answer: A AACSB: Application of knowledge Status: 8e question

12) Assume the interest parity condition holds and that initially i = i*. A reduction in the domestic interest rate will cause ________. A) an increase in the demand for the domestic currency B) a reduction in E C) an expected depreciation of the domestic currency D) all of these Answer: D AACSB: Application of knowledge Status: 8e question 13) Assume the interest parity condition holds and that initially i = i*. A reduction in the foreign interest rate (i*) will cause ________. A) an increase in the demand for the domestic currency B) an increase in E C) an expected depreciation of the domestic currency D) all of these Answer: C AACSB: Application of knowledge Status: 8e question 14) Explain what effect each of the following events will have on the IS curve in a flexible exchange rate regime: (1) an increase in foreign output; (2) a reduction in the foreign interest rate; and (3) an increase in the domestic interest rate. Answer: An increase in Y* causes X to rise, Z to rise, and the IS curve to shift to the right. A reduction in i* will cause an appreciation of the domestic currency, a reduction in NX, and a leftward shift in the IS curve. A change in i will only cause a movement along the IS curve. AACSB: Written and oral communication Status: 8e question 15) Assume the exchange rate is allowed to fluctuate freely. Using the IS-LM-IP model, graphically illustrate and explain what effect a reduction in foreign output (Y*) will have on the domestic economy. In your graphs, clearly label all curves and equilibria. Answer: A reduction in Y* will cause a reduction in X and NX. This causes the IS curve to shift to the left. As demand falls, production will drop. The drop in Y will cause a reduction in money demand. As money demand falls, i will fall causing a depreciation. So, some of the effects of Y* on NX will be offset by the increase in NX caused by the depreciation. We will observe a reduction in NX, a reduction in Y, a reduction in i, and a reduction in E. AACSB: Written and oral communication Status: 8e question

16) Assume the exchange rate is allowed to fluctuate freely. Using the IS-LM-IP model, graphically illustrate and explain what effect an increase in foreign output (Y*) will have on the domestic economy. In your graphs, clearly label all curves and equilibria. Answer: An increase in Y* will cause an increase in X and NX. This causes the IS curve to shift to the right As demand rises, production will increase. The increase in Y will cause an increase in money demand. As money demand rises, i will rise causing an appreciation. So, some of the effects of Y* on NX will be offset by the decrease in NX caused by the appreciation. We will observe an increase in NX, an increase in Y, an increase in i, and an increase in E. AACSB: Written and oral communication Status: 8e question 19.4

The Effects of Policy in an Open Economy

1) For this question, assume that there is a simultaneous tax increase and monetary expansion. In a flexible exchange rate regime, we know with certainty that ________. A) the exchange rate and output would both increase B) the exchange rate would increase and output would decrease C) the exchange rate would decrease D) the exchange rate would decrease and output would increase E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 2) For this question, assume that there is a simultaneous increase in government spending and monetary contraction. In a flexible exchange rate regime, we know with certainty that such a policy mix will cause which of the following? A) an increase in the domestic interest rate B) an increase in the exchange rate C) a reduction in net exports D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 3) Suppose there are two countries that are identical in every way with the following exception. Country A is pursuing a fixed exchange rate regime and country B is pursuing a flexible exchange rate regime. Suppose taxes are increased in both countries rises by the same amount. Given this information, we know that ________. A) the change in output in A will be greater than in B B) the change in output in B will be greater than in A C) the change in output will be the same in both countries D) the relative output effects are ambiguous Answer: A AACSB: Application of knowledge Status: 8e question 9 Copyright © 2025 Pearson Education, Inc.

4) Contractionary monetary policy in a flexible exchange rate regime will cause ________. A) a shift of the IP curve B) a depreciation of the domestic currency C) an increase in E D) no change in E Answer: C AACSB: Application of knowledge Status: 8e question 5) Expansionary monetary policy in a flexible exchange rate regime will cause ________. A) a shift of the IP curve B) an appreciation of the domestic currency C) a reduction in E D) no change in E Answer: C AACSB: Application of knowledge Status: 8e question 6) Assume the exchange rate is allowed to fluctuate freely. Using the IS-LM-IP model, graphically illustrate and explain what effect an increase in government spending will have on the domestic economy. In your graphs, clearly label all curves and equilibria. Answer: An increase in G will cause Z to increase and the IS curve to shift right. As demand increases, Y will rise causing an increase in money demand. The increase in money demand will cause an increase in i. As i rises, the demand for the domestic currency will increase causing an appreciation. This appreciation will cause a drop in NX. Any drop in I and the reduction in NX only partially offset the effects of the increase in G on demand and output. AACSB: Written and oral communication Status: 8e question 7) Assume the exchange rate is allowed to fluctuate freely. Using the IS-LM-IP model, graphically illustrate and explain what effect monetary contraction will have on the domestic economy. In your graphs, clearly label all curves and equilibria. Answer: A reduction in M will cause the LM curve to shift up and the domestic interest rate to rise. As i rises, the return on domestic bonds is greater than foreign bonds. This causes an appreciation and a reduction in NX. So, the demand for goods falls via the drop in I and NX. We will observe a higher domestic interest rate, an increase in E, a drop in I, a reduction in NX, and a reduction in Y. AACSB: Written and oral communication Status: 8e question

19.5

Fixed Exchange Rates

1) Suppose a country with a fixed exchange rate decides to reduce the price of its currency. This change in policy is called ________. A) an appreciation B) a depreciation C) a peg D) a devaluation E) a revaluation Answer: E AACSB: Application of knowledge Status: 8e question 2) Under a "crawling peg" system, a country's exchange rate ________. A) is fixed except for small, surprise changes B) changes at a predetermined rate against the dollar or some other major currency C) can fluctuate within a narrow band D) can change, but the changes are kept secret from the public E) is determined by the central bank of another country Answer: B AACSB: Application of knowledge Status: 8e question 3) In 2005, China increased the price of its currency while continuing to pursue a fixed exchange rate. This change in policy is called ________. A) an appreciation B) a depreciation C) a peg D) a devaluation E) a revaluation Answer: D AACSB: Application of knowledge Status: 8e question 4) For this question, assume that the economy is operating in a fixed exchange rate regime and that perfect capital mobility exists. Given this information, which of the following will occur? A) The domestic and foreign interest rates must be equal. B) The central bank cannot use monetary policy to affect domestic output. C) An expansionary fiscal policy will require that the central bank increase the money supply. D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

5) Suppose a country switches from a fixed to a flexible exchange rate. Which of the following will occur as a result of this change? A) Monetary policy will become a less effective tool for changing output. B) A given change in government spending will now have a greater effect on output. C) Both fiscal and monetary policy will become more effective in changing GDP. D) Both fiscal and monetary policy will become completely ineffective in changing GDP. E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 6) A common argument for fixed exchange rates is that they ________. A) give central banks greater freedom in adjusting their economy's level of output B) forever free the central bank from have to adjust the exchange rate to fundamental changes in the economy C) make trade more costly, and thus encourage domestic citizens to buy domestically produced output D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 7) In practice, under the EMS, a member country ________. A) could never change its interest rate B) could change its interest rate only if other countries changed theirs as well C) must apply to a special European Commission in order to change its interest rate D) had complete freedom in choosing the interest rate it wanted E) had complete freedom in choosing its interest rate only if it is a very small country Answer: B AACSB: Application of knowledge Status: 8e question 8) In the early 1990s, which nation took the lead in driving up European interest rates? A) Spain B) France C) Germany D) England E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

9) In the early 1990s, European unemployment rose largely because of ________. A) the effects of high real interest rates B) undervalued currencies C) overvalued currencies D) high inflation E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 10) Assume that the current exchange rate between U.K. pound and the U.S. dollar is 2 (E = 2.0). If interest parity holds, and the U.S. interest rate is 6% while the U.K. interest rate is 8%, the expected exchange rate in one year is ________. A) 1.98 B) 1.99 C) 2.01 D) 2.02 E) 2.04 Answer: C AACSB: Application of knowledge Status: 8e question 11) Assume policy makers in a fixed exchange rate regime decide to peg the exchange rate at a higher level. This is called ________. A) a devaluation B) a revaluation C) a depreciation D) an appreciation Answer: A AACSB: Application of knowledge Status: 8e question 12) Assume policy makers in a fixed exchange rate regime decide to peg the exchange rate at a lower level. This is called ________. A) a devaluation B) a revaluation C) a depreciation D) an appreciation Answer: B AACSB: Application of knowledge Status: 8e question

13) The European Monetary System represented a ________. A) exchange rate regime with "bands" B) crawling peg C) a flexible exchange rate regime D) none of these Answer: A AACSB: Application of knowledge Status: 8e question 14) Suppose policy makers are pursuing a policy to fix the exchange rate. In such a system with perfect capital mobility, an open market purchase of domestic bonds by the domestic central bank will eventually result in ________. A) a permanent increase in the monetary base B) a permanent reduction in the monetary base C) a change in the composition of the monetary base D) a gradual reduction in the domestic interest rate Answer: C AACSB: Application of knowledge Status: 8e question 15) Suppose policy makers are pursuing a policy to fix the exchange rate. In such a system with perfect capital mobility, an open market sale of domestic bonds by the domestic central bank will eventually result in ________. A) a permanent increase in the monetary base B) a permanent reduction in the monetary base C) a gradual reduction in the domestic interest rate D) a change in the composition of the monetary base Answer: D AACSB: Application of knowledge Status: 8e question 16) Suppose a country is pursuing a fixed exchange rate regime with imperfect capital mobility. The ability of that country to move its domestic interest rate while maintaining its exchange rate will depend on ________. A) the degree of development of its financial markets B) the degree of capital controls C) the amount of foreign exchange it holds D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

17) Under a fixed exchange rate regime, the central bank must act to keep ________. A) P = P* B) the real exchange rate fixed C) i = i* D) E = 1 E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 18) For this question, assume that policy makers are pursuing a fixed exchange rate regime. Now suppose that an increase in stock market wealth causes an increase in consumption. Which of the following will tend to occur in a fixed exchange rate regime? A) an increase in Y B) an increase in the money supply C) no change in the domestic interest rate D) all of these Answer: D AACSB: Application of knowledge Status: 8e question 19) For this question, assume that policy makers are pursuing a fixed exchange rate regime. Now suppose that households decide to decrease consumption because of, for example, a reduction in consumer confidence. Given this information, we would expect which of the following to occur? A) a reduction in the domestic interest rate B) an increase in E C) a reduction in E D) a reduction in investment E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 20) For this question, assume that policy makers are pursuing a fixed exchange rate regime. Now suppose a budget is passed that calls for a reduction in government spending. This reduction in government spending will cause which of the following to occur? A) a reduction in i and an increase in E B) a reduction in investment C) no change in output D) no change in net exports E) an increase in imports Answer: B AACSB: Application of knowledge Status: 8e question

21) Under a fixed exchange rate regime, suppose there is a reduction in housing wealth that causes a reduction in consumption. This wealth-induced reduction in consumption will cause ________. A) a reduction in investment B) an increase in net exports C) a reduction in imports D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 22) Under a fixed exchange rate regime, expansionary fiscal policy will tend to cause which of the following? A) an increase in imports B) an increase in net exports C) a reduction in investment D) all of these Answer: A AACSB: Application of knowledge Status: 8e question 23) For this question, assume that policy makers are pursuing a fixed exchange rate regime. Now suppose that a reduction in stock market wealth causes a decrease in consumption. Which of the following will tend to occur in a fixed exchange rate regime? A) a reduction in Y B) a reduction in the money supply C) no change in the domestic interest rate D) all of these Answer: D AACSB: Application of knowledge Status: 8e question 24) For this question, assume that policy makers are pursuing a fixed exchange rate regime. Now suppose that households decide to increase consumption because of, for example, an increase in consumer confidence. Given this information, we would expect which of the following to occur? A) an increase in the domestic interest rate B) a reduction in E C) an increase in E D) an increase in investment E) none of these Answer: D AACSB: Application of knowledge Status: 8e question

25) Under a fixed exchange rate regime, suppose there is an increase in housing wealth that causes an increase in consumption. This wealth-induced increase in consumption will cause ________. A) an increase in investment B) a reduction in net exports C) an increase in imports D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 26) Under a fixed exchange rate regime, contractionary fiscal policy will tend to cause which of the following? A) a reduction in imports B) a reduction in net exports C) an increase in investment D) all of these Answer: A AACSB: Application of knowledge Status: 8e question 27) For a country pursuing a fixed exchange rate regime, what does the interest parity condition imply about domestic and foreign interest rates? Explain. Answer: As long as the fixed exchange rate regime is credible, the interest rates must be equal. If the exchange rate regime is credible, we know that there will be no expected appreciation or depreciation so i = i*. AACSB: Written and oral communication Status: 8e question 28) Assume the exchange rate is fixed. Using the IS-LM model, graphically illustrate and explain what effect a reduction in consumer confidence will have on the domestic economy. In your graphs, clearly label all curves and equilibria. Answer: A reduction in consumer confidence will cause a drop in C and will cause demand to fall and the IS curve to shift to the left. As Y falls, money demand will fall and the domestic interest rate will tend to fall. If i falls, there will be tremendous pressure on the domestic currency to depreciate as demand falls. The central bank cannot let this occur. To prevent this, it must reduce the money supply so that i does not fall. We will observe a drop in Y, no change in i, a reduction in I (via the drop in I), and an increase in NX caused by the drop in imports. AACSB: Written and oral communication Status: 8e question

29) Assume that policy makers are pursuing a fixed exchange rate regime. Now suppose that the foreign interest rate increases. Discuss what policy makers must do to maintain the pegged exchange rate. Also discuss what effect this will have on domestic output and net exports. Answer: If i* increases, there will be pressure on the domestic currency to depreciate. To prevent this, the domestic central bank must raise its interest rate so that it rises by the same amount as i*. In this case, the LM curve will shift up so that the new equilibrium interest rate is equal to the now higher foreign interest rate. As i rises, E does not change. However, I will fall causing a reduction in demand and output. As Y falls, imports will fall and NX will increase. AACSB: Written and oral communication Status: 8e question 30) To what extent can monetary policy be used to affect output in a fixed exchange rate regime? Explain. Answer: It cannot. To peg the exchange rate, the central bank must keep the domestic interest rate equal to the exogenous foreign interest rate. The domestic central bank cannot independently change its interest rate. AACSB: Written and oral communication Status: 8e question 31) Assume the exchange rate is allowed to fluctuate freely. Using the IS-LM-IP model, graphically illustrate and explain what effect a reduction in government spending will have on the domestic economy. In your graphs, clearly label all curves and equilibria. Answer: A reduction in G will cause Z to decrease and the IS curve to shift left. As demand decreases, Y will fall causing a decrease in money demand. The decrease in money demand will cause an decrease in i. As i falls, the demand for the domestic currency will decrease causing a depreciation. This depreciation will cause a rise in NX. Any increase in I and the increase in NX only partially offset the effects of the reduction on demand and output. AACSB: Written and oral communication Status: 8e question 32) Assume the exchange rate is allowed to fluctuate freely. Using the IS-LM-IP model, graphically illustrate and explain what effect monetary expansion will have on the domestic economy. In your graphs, clearly label all curves and equilibria. Answer: An increase in M will cause the LM curve to shift down and the domestic interest rate to fall. As i falls, the return on domestic bonds is less than foreign bonds. This causes an depreciation and an increase in NX. So, the demand for goods rises via the increase in I and NX. We will observe a lower domestic interest rate, a reduction in E, an increase in I, an increase in NX, and an increase in Y. AACSB: Written and oral communication Status: 8e question

33) Assume the exchange rate is fixed. Using the IS-LM model, graphically illustrate and explain what effect an increase in consumer confidence will have on the domestic economy. In your graphs, clearly label all curves and equilibria. Answer: An increase in consumer confidence will cause an increase in C and will cause demand to rise and the IS curve to shift to the right. As Y rises, money demand will increase and the domestic interest rate will tend to rise. If i rises, there will be tremendous pressure on the domestic currency to appreciate as demand rises. The central bank cannot let this occur. To prevent this, it must increase the money supply so that i does not rise. We will observe an increase in Y, no change in i, an increase in I (via the increase in I), and a reduction in NX caused by the rise in imports. AACSB: Written and oral communication Status: 8e question 34) Assume that policy makers are pursuing a fixed exchange rate regime. Now suppose that the foreign interest rate falls. Discuss what policy makers must do to maintain the pegged exchange rate. Also discuss what effect this will have on domestic output and net exports. Answer: If i* falls, there will be pressure on the domestic currency to appreciate. To prevent this, the domestic central bank must reduce its interest rate so that it falls by the same amount as i*. In this case, the LM curve will shift down so that the new equilibrium interest rate is equal to the now lower foreign interest rate. As i falls, E does not change. However, I will rise causing an increase in demand and output. As Y rises, imports will rise and NX will decrease. AACSB: Written and oral communication Status: 8e question

Macroeconomics, 9e (Blanchard) Chapter 20: Exchange Rate Regimes 20.1

The Medium Run

1) If the exchange rate between two countries is expected to remain fixed at its current rate, then ________. A) output growth rates must be equal in the two countries B) price levels must be equal in the two countries C) inflation rates must be equal in the two countries D) nominal interest rates must be equal in the two countries E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) In a fixed exchange rate regime, a reduction in the price level will cause which of the following? A) a real appreciation and a leftward shift in the aggregate demand curve B) a real appreciation and no shift in the aggregate demand curve C) a real depreciation and a rightward shift in the aggregate demand curve D) a real depreciation and no shift in the aggregate demand curve E) no change in the real exchange rate, and no change in aggregate demand Answer: B AACSB: Application of knowledge Status: 8e question 3) A revaluation causes which of the following to occur in the short run in the AS/AD model? A) a reduction in net exports B) a reduction in the price level C) a reduction in output D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 4) A devaluation causes which of the following to occur in the medium run? A) an increase in net exports B) an increase in the price level C) an increase in output D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 1 Copyright © 2025 Pearson Education, Inc.

5) Suppose a country is perceived to have an overvalued real exchange rate does not devalue. Which of the following would we expect to occur over time? A) a reduction in its price level B) a real depreciation of its currency C) a reduction in its trade surplus D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 6) In a fixed exchange rate regime, which of the following policies could be implemented to reduce a trade deficit and leave aggregate demand constant? A) devalue the currency B) increase government spending C) decrease government spending D) decrease government spending and devalue the currency E) increase government spending and revalue the currency Answer: D AACSB: Application of knowledge Status: 8e question 7) Under the Gold Standard, ________. A) exchange rates could float B) real interest rates were fixed C) real exchange rates were fixed D) nominal interest rates were fixed E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 8) After Britain returned to the Gold Standard in the 1920s, the British pound was ________. A) undervalued, contributing to a long period of inflation B) undervalued, contributing to a long period of recession C) overvalued, contributing to a long period of inflation D) overvalued, contributing to a long period of recession E) value about right, leading to a long period healthy growth with almost no inflation Answer: D AACSB: Application of knowledge Status: 8e question

9) Suppose foreign exchange markets anticipate a devaluation for country A. Further assume that policy makers in country A will continue to fix its nominal exchange rate. In order to peg the currency at its original level, which of the following must occur? A) increase the domestic interest rate B) increase the domestic price level C) convince trading partners to raise their interest rates D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 10) Which of the following is an argument of opponents of devaluations? A) Devaluations cause relatively slow adjustments. B) Participants in foreign exchange markets have a short memory: if the expected devaluation doesn't occur within a short time-period, they will stop expecting it. C) A devaluation causes a nation with fixed exchange rates to lose credibility in the medium run, driving its interest rate higher. D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 11) A country which does not devalue when financial markets expect it to will probably suffer ________. A) a real appreciation of its currency B) higher interest rates C) a default on its national debt D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question

Use the information provided below to answer the following question(s). The exchange rate between the British pound and the U.S. dollar is 2. In England, the price level is 1.0 and the one-year interest rate is 20%. In the United States, the price level is .8 and the oneyear interest rate is 8%. The inflation rate in both countries is zero. 12) Refer to the information above. The real exchange rate (from the United States' perspective) is ________. A) .625 B) .8 C) 1.6 D) 2.0 E) none of these Answer: C AACSB: Analytical thinking Status: 8e question 13) Refer to the information above. The price of U.S. goods measured in pounds is ________. A) .8 B) 1.0 C) 1.6 D) 2 E) none of these Answer: C AACSB: Analytical thinking Status: 8e question 14) For this question, assume that interest parity holds, the future expected exchange rate is constant, the current nominal exchange rate is 1.2, the one-year foreign interest rate is 6% and the one-year domestic interest rate is 3%. Given this information, one can conclude that ________. A) financial market participants expect that the exchange rate (E) will increase by 3% over the coming year B) financial market participants expect that the exchange rate (E) will decrease by 3% over the coming year C) financial market participants expect that the domestic currency to depreciate by 3% over the coming year D) financial market participants expect that the exchange rate (E) will increase by 20% over the coming year Answer: A AACSB: Reflective thinking Status: 8e question

15) In chapter 20, the expected future nominal exchange rate in the long run say, Eet+n, is assumed to be the nominal exchange rate at which ________. A) the current account is in balance B) the future rate of appreciation or depreciation is constant C) domestic and foreign price levels are equal D) one unit of foreign currency exchanges for one unit of domestic currency E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 16) Changes in which of the following variables will cause the current nominal exchange rate to change? A) the future expected long-run nominal exchange rate, Eet+n B) future expected domestic nominal interest rates C) future expected foreign nominal interest rates D) all of these Answer: D AACSB: Application of knowledge Status: 8e question 17) An increase in the foreign one-year interest rate expected to occur in, say, two years will, all else fixed, have which of the following effects in a flexible exchange rate regime? A) The real exchange rate will decrease with no change in the nominal exchange rate. B) The nominal exchange rate will decrease with no change in the real exchange rate. C) Both the real and nominal exchange rate will decrease. D) No change in either the nominal or real exchange rate. E) Both the real and nominal exchange rate will increase. Answer: C AACSB: Application of knowledge Status: 8e question 18) An increase in the domestic one-year interest rate expected to occur in, say, two years will, all else fixed, have which of the following effects in a flexible exchange rate regime? A) The real exchange rate will increase with no change in the nominal exchange rate. B) The nominal exchange rate will increase with no change in the real exchange rate. C) Both the real and nominal exchange rate will increase. D) No change in either the nominal or real exchange rate. Answer: C AACSB: Application of knowledge Status: 8e question

19) In a fixed exchange rate regime, an increase in the price level will cause which of the following? A) a real appreciation and a leftward shift in the aggregate demand curve B) a real appreciation and no shift in the aggregate demand curve C) a real depreciation and a rightward shift in the aggregate demand curve D) a real depreciation and no shift in the aggregate demand curve E) no change in the real exchange rate, and no change in aggregate demand Answer: D AACSB: Application of knowledge Status: 8e question 20) Suppose a reduction in the domestic one-year interest rate expected to occur in two years . All else fixed, will the reduction in interest rate have which of the following effects in a flexible exchange rate regime? A) The real exchange rate will decrease with no change in the nominal exchange rate. B) The nominal exchange rate will decrease with no change in the real exchange rate. C) Both the real and nominal exchange rate will decrease. D) No change in either the nominal or real exchange rate. Answer: C AACSB: Application of knowledge Status: 8e question 21) Suppose country A pegs its nominal exchange rate to country B and that country A has a lower inflation rate than country B. In this situation, country A will experience ________. A) a real depreciation B) a better trade position C) a reduction in the real exchange rate D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 22) Assume that policy makers are pursuing a fixed exchange rate regime. Assume that the economy is initially operating at the natural level (i.e., Y = Yn). Suppose fiscal policy makers increase government spending. This fiscal contraction will cause which of the following? A) The real exchange rate will be permanently higher in the medium run. B) The real exchange rate will be permanently lower in the medium run. C) The effects of this devaluation on the real exchange rate will be ambiguous in the medium run. D) The real exchange rate will be unchanged in the medium run. E) none of these Answer: B AACSB: Application of knowledge Status: 8e question

23) Assume that policy makers are pursuing a fixed exchange rate regime. Assume that the economy is initially operating at the natural level (i.e., Y = Yn). Suppose a reduction in wealth causes households to reduce consumption. This wealth-induced decrease in consumption will cause which of the following to occur? A) The real exchange rate will be permanently higher in the medium run. B) The real exchange rate will be permanently lower in the medium run. C) The effects of this devaluation on the real exchange rate will be ambiguous in the medium run. D) The real exchange rate will be unchanged in the medium run. Answer: B AACSB: Application of knowledge Status: 8e question 24) In a fixed exchange rate regime, which of the following policies could lead to a greater trade deficit and leave aggregate demand constant? A) Devalue the currency. B) Increase government spending. C) Decrease government spending. D) Decrease government spending and devalue the currency. E) Increase government spending and revalue the currency. Answer: E AACSB: Application of knowledge Status: 8e question 25) Suppose foreign exchange markets anticipate a revaluation for country A. Further assume that policy makers in country A will continue to fix its nominal exchange rate. In order to peg the currency at its original level, which of the following must occur? A) Increase the domestic interest rate. B) Increase the domestic price level. C) Convince trading partners to raise their interest rates. D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 26) Explain what factors cause shifts of the aggregate demand curve in the open economy model. Answer: The standard of list of determinants that appeared for the closed economy version of the AD relation still exists here (e.g. G, T, ... ). There are several international variables that must be added: Y*, E, P* and, in a fixed exchange rate regime, i*. The domestic price level also affects AD because of its effect on the real exchange rate. AACSB: Written and oral communication Status: 8e question

27) First, briefly explain why the AD curve is downward sloping in a closed economy. Second, briefly explain why the AD curve is downward sloping in an open economy under fixed exchange rates. And finally, briefly compare the size of the slopes of the two AD curves. Answer: In a closed economy, P affects Y via its effects on M/P, i, and I. In fixed exchange rate regime, changes in P will affect M/P; however, the domestic interest rate cannot change. So, P now affects Y via its effects on the real exchange rate. A drop in P causes a real depreciation, an increase in NX, and an increase in Y. Because the change in P has a second effect in the open economy version, that would tend to make the AD curve steeper in the open economy under fixed exchange rates. However, recall that the multiplier will be smaller in an open economy because of the marginal propensity to import. This would have an offsetting effect. Answer: ambiguous. AACSB: Written and oral communication Status: 8e question 20.2

Exchange Rate Crises under Fixed Exchange Rates

1) Suppose country A pegs its nominal exchange rate to country B and that country A has a higher inflation rate than country B. In this situation, country A will experience ________. A) a real appreciation B) a worsening trade position C) an increase in the real exchange rate D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) Suppose a country that has been pegging its currency is faced with a situation where financial market participants now expect some future devaluation. In such a situation, we would generally expect which of the following to occur? A) a reduction in the domestic interest rate B) an announcement by the central bank that a large devaluation will occur in the near future C) reduction in demand for the country's currency D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

3) An adjustment of central parities in the EMS is called a ________. A) realignment B) nominal appreciation or nominal depreciation C) real appreciation or real depreciation D) re-coupling E) re-paritization Answer: A AACSB: Application of knowledge Status: 8e question 4) During the EMS crisis in 1992, ________. A) all the EMS countries abandoned the system B) Germany abandoned the system C) England and Italy abandoned the system D) France was put in charge of the system E) all the EMS countries stood firm, and refused to change central parities Answer: C AACSB: Application of knowledge Status: 8e question 5) After continuing crises in 1993, the EMS countries ________. A) agreed to entirely abandon the system B) stood firm, refusing to adjust central parities C) narrowed the band of allowable fluctuations around central parities D) removed France from its leading role in the system E) widened the band of allowable fluctuations around central parities Answer: E AACSB: Application of knowledge Status: 8e question 6) A country which does not revalue when financial markets expect it to will probably suffer ________. A) a real depreciation of its currency B) lower interest rates C) a default on its national debt D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question

7) Suppose a country that has been pegging its currency is faced with a situation where financial market participants now expect some future revaluation. In such a situation, we would generally expect which of the following to occur? A) an increase in the domestic interest rate B) an announcement by the central bank that a large revaluation will occur in the near future C) an increase in demand for the country's currency D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 8) Suppose output is above the natural level of output. In a fixed exchange rate regime, explain the two ways the economy can return to the natural level of output. Answer: Revaluation. Policy makers could revalue the currency. This would cause a reduction in NX, and reduction in demand, and a reduction in Y. Graphically, the AD curve would shift to the left. Economy self-corrects. With Y above the natural level, the expected price level (or expected inflation) will rise causing W to rise. As W rises, P will rise. As P rises, a real appreciation occurs and NX falls. We would move along the AD curve. AACSB: Written and oral communication Status: 8e question 9) Suppose the economy is operating below the natural level of output. Discuss the arguments for and against using a devaluation in such a situation. Answer: With a devaluation, Y returns to the natural level much more rapidly. This would cause an increase in NX, an increase in demand, and an increase in Y. Graphically, the AD curve would shift to the right. Economy self-corrects. This is an advantage. However, with a devaluation, individuals might begin to doubt the country's commitment to a fixed exchange rate regime. This could lead to an exchange rate crisis. AACSB: Written and oral communication Status: 8e question 10) Suppose the economy is initially operating above the natural level of output. In a fixed exchange rate regime, explain how the economy will adjust to this situation. Answer: With Y below the natural level, the expected price level (or expected inflation) will fall causing W to fall. As W falls, P will fall. As P falls, a real depreciation occurs and NX increases. We would move along the AD curve. AACSB: Written and oral communication Status: 8e question 11) Assume a country is in a fixed exchange rate regime. Explain what factors might cause individuals to expect that a country will revalue its currency. Answer: The currency might be viewed as undervalued. This could be caused by relatively lower rates of inflation in the country. Also, domestic macro conditions (e.g. an expansion) might call for a revaluation. AACSB: Written and oral communication Status: 8e question 10 Copyright © 2025 Pearson Education, Inc.

12) Assume a country is in a fixed exchange rate regime. Now suppose that individuals expect that policy makers will revalue its currency. Explain the various actions that policy makers can choose in response to this expected revaluation. Answer: Policy makers can attempt to persuade (via official announcements) that they remain committed to pegging the currency at its current rate. Second, they may have to reduce domestic interest rates to prevent any appreciation of the currency. Eventually, they may be forced to revalue because of the expansionary effects of the lower i. AACSB: Written and oral communication Status: 8e question 13) Explain exchange rate crisis. Answer: Exchange rate crisis typically start when participants in financial markets believe a currency may soon be devalued. Defending the parity then requires very high interest rates, with the potentially large adverse macroeconomic effects. These adverse effects may force the country to devalue, even if there were no initial plans for such a devaluation. AACSB: Written and oral communication Status: 8e question 20.3

Exchange Rate Movements under Flexible Exchange Rates

1) When policy makers decide to devalue the currency, such an action generally represents ________. A) a decision to let the currency float B) an increase in the pegged value of the domestic currency C) a reduction in the foreign price level D) a reduction in the domestic price level E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) When policy makers decide to revalue the currency, such an action generally represents ________. A) an increase in the pegged value of the domestic currency B) a decision to let the currency float C) a reduction in the foreign price level D) an increase in the domestic price level E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

3) Suppose the country that pegs its currency has an overvalued real exchange rate and that output is currently above the natural level of output. Which of the following will occur as the economy adjusts to this situation? A) P will decrease over time until Y = Yn. B) A reduction in the pegged value of the domestic currency will cause a leftward shift of the AD curve. C) Net exports will increase as the economy adjusts to this situation. D) Domestic goods will become less competitive as the economy adjusts by itself. E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 4) For this question, assume that exchange rates flexible and that the exchange rate expected to occur in one year is not constant. Suppose that individuals now expect that the domestic central bank will pursue expansionary monetary policy in one year. This expected future monetary expansion will cause which of the following to occur? A) The current nominal exchange rate will decrease. B) The current nominal exchange rate will increase. C) The current nominal exchange rate will not change. D) The effects on the current nominal exchange rate are ambiguous. Answer: A AACSB: Application of knowledge Status: 8e question 5) For this question, assume that exchange rates are flexible and that the exchange rate expected to occur in one year is not constant. Suppose that individuals now expect that the foreign central bank will pursue expansionary monetary policy in one year. This expected future monetary expansion by the foreign central bank will cause which of the following to occur? A) The current nominal exchange rate will decrease. B) The current nominal exchange rate will increase. C) The current nominal exchange rate will not change. D) The effects on the current nominal exchange rate are ambiguous. Answer: B AACSB: Application of knowledge Status: 8e question

6) When we no longer assume that the exchange rate expected to occur in one year is constant, explain what variables affect the current exchange rate in a flexible exchange rate regime. Include in your answer an explanation of how changes in these variables affect the current exchange rate. Answer: The current one-year domestic rate and future expected one-year domestic rates. Also, the current one-year foreign rate and future expected one-year foreign rates. And finally, some long-run nominal expected future exchange rate. Changes in the current one-year domestic and foreign rates have the same effect as described earlier. Changes in the future expected domestic rate will effect the exchange rate that is expected to occur at some point. This will affect the current exchange rate. The same type of analysis applies to the foreign rate. And finally, the long-run expected exchange rate will affect E as well in the same way it did before. AACSB: Written and oral communication Status: 8e question 7) Explain why exchange rates are more volatile than is suggested by the relatively simply interest parity condition presented earlier in the course. Answer: Put simply, there are more variables that can affect the current exchange rate. That is, there are variables in addition to the current domestic and foreign interest rates and one-year expected exchange rate that matter. A change in any of these variables will cause E to change. AACSB: Written and oral communication Status: 8e question 20.4

Choosing between Exchange Rate Regimes

1) Which of the following is an advantage of a common currency in Europe? A) Each country could conduct its own, independent monetary policy. B) Exchange rate uncertainty within the common currency area would be eliminated. C) Each country could conduct its own, independent fiscal policy. D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 2) Which of the following, according to the Maastricht treaty, was a condition for participating in the common currency area? A) a relatively small budget deficit-to-GDP ratio B) at least half the population of the country must speak German, French and English C) a promise that any future devaluations will be announced in advance D) the replacement of the country's prime minister with an appointee of the new "United States of Europe" E) a relatively small amount of foreign aid to countries outside the area Answer: A AACSB: Application of knowledge Status: 8e question

3) Assume that policy makers are pursuing a fixed exchange rate regime and that the economy is initially operating at the natural level. Which of the following will occur as a result of a evaluation? A) The real exchange rate will be permanently higher in the medium run. B) The real exchange rate will be permanently lower in the medium run. C) The effects of this devaluation on the real exchange rate will be ambiguous in the medium run. D) The nominal exchange rate will initially increase in the short run and then decrease in the medium run. E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 4) Assume that policy makers are pursuing a fixed exchange rate regime and that the economy is initially operating at the natural level of output. Which of the following will occur as a result of a revaluation? A) The real exchange rate will be permanently higher in the medium run. B) The real exchange rate will be permanently lower in the medium run. C) The effects of this revaluation on the real exchange rate will be ambiguous in the medium run. D) The real exchange rate will be unchanged in medium run. E) The nominal exchange will initially fall in the short run and then increase in the medium run. Answer: D AACSB: Application of knowledge Status: 8e question 5) Assume that policy makers are pursuing a fixed exchange rate regime. Assume that the economy is initially operating at the natural level (i.e., Y = Yn). Suppose fiscal policy makers increase taxes. This fiscal contraction will cause which of the following? A) The real exchange rate will be permanently higher in the medium run. B) The real exchange rate will be permanently lower in the medium run. C) The effects of this devaluation on the real exchange rate will be ambiguous in the medium run. D) The real exchange rate will be unchanged in the medium run. E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

6) Assume that policy makers are pursuing a fixed exchange rate regime. Assume that the economy is initially operating at the natural level (i.e., Y = Yn). Suppose an increase in wealth causes households to increase consumption. This wealth-induced increase in consumption will cause which of the following to occur? A) The real exchange rate will be permanently higher in the medium run. B) The real exchange rate will be permanently lower in the medium run. C) The effects of this devaluation on the real exchange rate will be ambiguous in the medium run. D) The real exchange rate will be unchanged in the medium run. Answer: B AACSB: Application of knowledge Status: 8e question 7) A number of situations can arise that will cause individuals to believe that policy makers might change the pegged value of a fixed exchange rate. Suppose financial market participants expect a revaluation in the future. The interest parity condition will be maintained if which of the following policy actions are taken in the current period? A) a reduction in the pegged value of the domestic currency B) an increase in i C) a reduction in i D) an increase in government spending Answer: C AACSB: Application of knowledge Status: 8e question 8) For this question, assume that policy makers are pursuing a fixed exchange rate regime and that output is initially less than the natural level of output. The economy will tend to move toward the natural level of output when which of the following occur? A) an increase in the price level B) a devaluation of the currency C) an increase in the domestic interest rate D) a reduction in the foreign price level E) none of these Answer: B AACSB: Reflective thinking Status: 8e question

9) For this question, assume that policy makers are pursuing a fixed exchange rate regime and that output is initially greater than the natural level of output. The economy will tend to move toward the natural level of output when which of the following occur? A) an increase in the price level B) a devaluation of the currency C) a reduction in the domestic interest rate D) an increase in the foreign price level E) none of these Answer: A AACSB: Reflective thinking Status: 8e question 10) European currencies were taken out of circulation and replaced with the Euro in ________. A) 1992 B) 1997 C) 1999 D) 2004 E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 11) The new European Central Bank is located in which country? A) England B) Italy C) France D) Spain E) Germany Answer: E AACSB: Application of knowledge Status: 8e question 12) Policy makers can select from a number of different exchange rate regimes and exchange rate policies. Which of the following policies would most likely represent a hard peg? A) a revaluation B) a devaluation C) a flexible exchange rate regime D) a dollarization Answer: D AACSB: Application of knowledge Status: 8e question

13) Policy makers can select from a number of different exchange rate regimes. One of those options is a "hard peg." Which of the following best represents a hard peg? A) a revaluation B) a currency board C) a flexible exchange rate regime D) the EMS E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 14) Euro coins and bank notes were introduced in January ________. A) 2002 B) 2001 C) 2000 D) 1999 Answer: A AACSB: Application of knowledge Status: 8e question 15) Explain the cases for and against flexible and fixed exchange rate regimes. Answer: Case for fixed: cannot trust the central bank to pursue responsible monetary policy, reduces relative price variability by fixing E. Case for flexible: enables monetary policy to serve as a stabilization tool. AACSB: Written and oral communication Status: 8e question 16) What is an "optimal currency area"? Also, discuss the conditions that must be satisfied for an optimal currency area to exist. Answer: An optimal currency area would be a region where one currency could be used. There are two conditions needed for this to be successful: similar shocks in the countries and high factor mobility. AACSB: Written and oral communication Status: 8e question 17) Explain each of the following and why each might be used: hard pegs, currency boards, and dollarizations. Answer: A hard peg is a fixed exchange rate regime where policy makers, in some way, have made it symbolically or technically harder to change the peg. A dollarization occurs when the domestic currency is replaced by a foreign currency (typically the dollar). Under a currency board, the central bank is prepared to exchange foreign currency for domestic currency at some official rate. Furthermore, the central bank cannot engage in open market operations. AACSB: Written and oral communication Status: 8e question

18) Assume a country is in a fixed exchange rate regime. Explain what factors might cause individuals to expect that a country will devalue its currency. Answer: The currency might be viewed as overvalued. This could be caused by relatively higher rates of inflation in the country. Also, domestic macro conditions might call for a devaluation. AACSB: Written and oral communication Status: 8e question 19) Assume a country is in a fixed exchange rate regime. Now suppose that individuals expect that policy makers will devalue its currency. Explain the various actions that policy makers can choose in response to this expected devaluation. Answer: Policy makers can attempt to persuade (via official announcements) that they remain committed to pegging the currency at its current rate. Second, they may have to raise domestic interest rates to prevent any depreciation of the currency. Eventually, they may be forced to devalue because of the contractionary effects of the higher i. AACSB: Written and oral communication Status: 8e question 20) According to Mundell, countries to constitute an optimal currency area need to satisfy one of the two conditions. Explain these conditions. Answer: Mundell argued these countries need to satisfy one of the two conditions: 1) the countries have to experience similar shocks, then they would have chosen roughly the same monetary policy; 2) Or, if the countries experience different shocks, they must have high factor mobility. AACSB: Written and oral communication Status: 8e question 21) Does Europe constitute an optimal common currency area? Why? Answer: There is less agreement on the question. This is because neither of the two Mundell conditions appears to be satisfied. European countries have experienced very different shocks in the past. Workers move much less within European countries than they do within the United States. Because of language and cultural differences among European countries, mobility between countries is even lower. AACSB: Written and oral communication Status: 8e question

Macroeconomics, 9e (Blanchard) Chapter 21: Should Policymakers be Restrained? 21.1

Uncertainty and Policy

1) In 1994, Republicans introduced their "Contract with America." This plan ________. A) included a PAYGO rule B) would restrict the ability of monetary policy to affect the economy in the short run C) included a line item veto D) would make the Federal Reserve even more independent than it already is E) all of these Answer: C AACSB: Application of knowledge Status: 8e question 2) Econometric models of the U.S. economy generally agree ________. A) on the quantitative impact of monetary policy over a horizon of several years B) that an increase in money growth will increase output in the short run C) that an increase in money growth will decrease output in the short run D) that an increase in money growth will decrease output in the long run E) that "rational expectations" is the best way to generate policy forecasts Answer: B AACSB: Application of knowledge Status: 8e question 3) All of the macroeconometric models currently in use ________. A) originate in the United States B) incorporate rational expectations into their predictions C) originate with government or international agencies D) originate with commercial firms who sell their forecasts to other firms and governments E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 4) For this question, assume that the there exists uncertainty about the impact of monetary policy on the macroeconomy. Given this information, it would be most appropriate for the central bank to increase money growth ________. A) at the midpoint of a recession B) by more than the increase that will yield the desired response C) by less than the increase that will yield the desired response D) by an amount equal to the increase that will yield the desired response E) only after it is certain that the economy has entered a recession Answer: C AACSB: Application of knowledge Status: 8e question 1 Copyright © 2025 Pearson Education, Inc.

5) Given the uncertainty about the effects of macro policy, economists generally propose that ________. A) macro policies should be more active, the lower the level of unemployment or inflation B) changes in money growth should only be used for fine tuning the economy, not for correcting large imbalances (such as high inflation) C) money growth should be set at zero by constitutional amendment D) elected officials should have more input in the determination of monetary policy E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 6) As uncertainty about the effects of policy on output decreases, we would expect that ________. A) policy makers would be more frequently implement fine tuning policies B) policy makers would implement more active policies C) policy makers would implement less active policies D) policy makers would be more frequently implement fine tuning policies and more active policies E) policy makers would be more frequently implement fine tuning policies and less active policies Answer: D AACSB: Application of knowledge Status: 8e question 7) Who is best known for arguing about the fine tuning of monetary policy? A) Friedman B) Keynes C) Modigliani D) Greenspan E) Bernanke Answer: C AACSB: Application of knowledge Status: 8e question 8) Explain whether uncertainty should cause policy makers to do more or do less to stabilize the economy. Answer: As uncertainty increases, policy makers should do less. Alternatively, more active policies would actually lead to more uncertainty. This is based on, as Blanchard notes, multiplicative uncertainty. AACSB: Application of knowledge Status: 8e question

21.2

Expectations and Policy

1) The idea that the economy operates like a complicated, predictable machine is an important aspect of ________. A) game theory B) attrition theory C) the theory of strategic interaction D) time inconsistency theory E) optimal control theory Answer: E AACSB: Application of knowledge Status: 8e question 2) In macroeconomics, game theory focuses on the strategic interactions between which of the following groups of agents? A) individuals; firms B) individuals and firms; policy makers C) policy makers; economic forecasters D) individuals and firms; economic forecasters Answer: B AACSB: Application of knowledge Status: 8e question 3) Which of the following best defines time inconsistency? A) the increasing inaccuracy of econometric models as the time horizon becomes longer B) the tendency for the rise in output to be greater in the early years of a president's term, and smaller in the later years C) the effects of political electoral cycles on the business cycle D) the tendency for policy makers to deviate from a pre-announced optimal policy once agents in the economy have adjusted their behavior and expectations based on the pre-announced policy E) the effect of economic uncertainty on short-run stabilization policy Answer: D AACSB: Application of knowledge Status: 8e question 4) The existence of the time inconsistency problem in macro policy suggests which of the following? A) Use fiscal and monetary policy to fine tune the economy. B) Reduce the independence of the central bank. C) Appoint someone who is more conservative (economically) than the rest of the government to head the central bank. D) Intervene frequently in the foreign exchange market. E) Eliminate rational expectations from econometric models used for forecasting. Answer: C AACSB: Application of knowledge Status: 8e question 3 Copyright © 2025 Pearson Education, Inc.

5) Once people believe the Fed's commitment to keep unemployment at the natural rate, the Fed can reduce unemployment below the natural rate ________. A) in both the short run and the long run B) in both the short run and the long run, but only after changing peoples' expectations C) in the long run, but not the short run D) in the short run, but not in the long run E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 6) To solve the "time inconsistency" problem in macro policy, a nation may well have to ________. A) restrict itself in the present from taking certain policy moves in the future B) lift all restrictions on future policy moves C) present policy moves to the public, for example, in a referendum D) use the courts to settle policy disputes E) make the central bank more responsive to the popular will Answer: A AACSB: Application of knowledge Status: 8e question 7) Research indicates that the more independent the central bank, ________. A) the smaller the budget deficit B) the higher the nominal interest rate C) the lower the rate of inflation D) the larger the time inconsistency problem in making policy E) the greater the likelihood of a "war of attrition" over policy Answer: C AACSB: Application of knowledge Status: 8e question 8) One surprising insight from viewing policy as a "game" is that ________. A) central bankers should project an image of being conservative on economic policy matters, regardless of their personal views B) it is more difficult to control inflation when the central bank is highly independent C) uncertainty over the impact of policy makes little difference in designing an optimal policy D) money growth has little or no impact on inflation in the long run E) decreasing money growth may substantially increase the rate of inflation in the long run Answer: A AACSB: Application of knowledge Status: 8e question

9) Which of the following is the most powerful argument for putting restraints on policy makers (as opposed to self-restraint by policy makers themselves)? A) time inconsistency B) uncertainty about Okun's coefficient C) uncertainty about the natural rate of unemployment D) uncertainty about the timing of policy impacts E) disagreements about the proper structure of an econometric model Answer: A AACSB: Application of knowledge Status: 8e question 10) To deal with the time inconsistency problem associated with monetary policy, some have suggested that ________. A) the head of the central bank be chosen by election B) the central bank implement expansionary monetary policy prior to election years C) elected officials should have a direct influence on the implementation of monetary policy D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 11) Research for a number of OECD countries suggests that inflation will be lower ________. A) the more independent the central bank B) the less independent the central bank C) if the heads of central banks are chosen by election D) when the terms of the heads of central banks coincide with the terms of elected officials Answer: A AACSB: Application of knowledge Status: 8e question 12) Game theory analysis of macro policy suggests that as voters become more short-sighted ________. A) policy makers will be tempted to raise taxes B) policy makers will be forced to balance the budget C) policy makers will adopt policies today to achieve balanced budgets in the future D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

13) Which of the theory is better to think about policy? A) game theory B) optimal control theory C) expectations theory D) none of these Answer: A AACSB: Application of knowledge Status: 8e question 14) The hostage taking example was developed by ________. A) John Nash B) Kydland and Prescott C) John Harsanyi D) Reinhard Selten Answer: B AACSB: Application of knowledge Status: 8e question 15) Which of the following is not an example of the issue of time inconsistency? A) a central bank announced to maintain low inflation and at the same time increased money supply B) a government stated that they will not negotiate with hostage takers. When someone is taken hostage, it negotiates C) a mom says to her kids no cookie before meals and she never gives cookies before her kids eat their meals D) a person on diet eats ice cream for dinner Answer: C AACSB: Application of knowledge Status: 8e question 16) A "conservative" central banker cares ________. A) less about inflation and more about unemployment than the government B) more about economic growth and less about inflation C) more about inflation and less about unemployment than the government D) less about economic growth and more about inflation Answer: C AACSB: Application of knowledge Status: 8e question

17) Wars of attrition arise in which of the following contexts? A) fiscal policy B) deficit reduction C) hyperinflation D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 18) First, what can be done to increase central bank credibility? Second, why is central bank credibility important? Answer: Central bank credibility can be achieved by: (1) imposing rules on the central bank; (2) making the central bank independent (of political pressure); and (3) choosing a conservative central banker. Central bank credibility is important to minimize the chances of occurrence of the time inconsistency problem. Also, whenever a central bank implements a disinflationary policy, the output effects will be smaller the more credible is the central bank. AACSB: Written and oral communication Status: 8e question 19) Discuss the time inconsistency problem and explain how it relates to monetary policy. Answer: The time inconsistency of optimal policy refers to game theory situations where an agent has an incentive to deviate from some stated rule/policy. In terms of monetary policy, central banks will typically announce certain goals (e.g. policies consistent with a certain rate of inflation). Once such a policy is announced, the central bank might have an incentive to deviate from this policy and increase money growth in excess of the rate consistent with its inflation goal. There would be some increase in inflation; however, there would be a significant increase in output. AACSB: Written and oral communication Status: 8e question 20) Suppose a government have a stated policy that it will not negotiate with hostage takers. Now someone is taken hostage, what would be the best policy for the government? Explain. Answer: The best policy of the government is to commit not to negotiate. By giving up the option to negotiate, it is likely to prevent hostage takings in the first place. AACSB: Written and oral communication Status: 8e question

21.3

Politics and Policy

1) In which of the following political systems would a political business cycle be more likely to occur? A) a democracy with elections that occur on a regular basis B) a parliamentary C) communist-type economies D) socialist-type economies E) a democracy with elections that occur on an irregular basis Answer: A AACSB: Analytical thinking Status: 8e question 2) In the United States, presidential elections occur every four years. If a political business cycle exists in the United States, in which year of a presidential term, all else fixed, would we expect output growth to be highest? A) the first year B) the second year C) the third year D) the fourth year Answer: D AACSB: Analytical thinking Status: 8e question 3) In the United States, presidential elections occur every four years. If a political business cycle exists in the United States, in which year of a presidential term, all else fixed, would we expect output growth to be lowest? A) the first or second year B) the second or third year C) the third or fourth year D) the fourth year Answer: A AACSB: Analytical thinking Status: 8e question 4) Which of the following statements is true about the United States over the past fifty years? A) There is no evidence of political business cycles in the United States. B) The debt-to-GDP ratio has been roughly constant. C) Under either party, output growth has been generally higher in the year preceding an election than in other years. D) none of these Answer: C AACSB: Analytical thinking Status: 8e question

5) During which of the following decades was the debt-to-GDP ratio generally highest in the United States? A) 1930s B) 1940s C) 1960s D) 1980s E) 1990s Answer: B AACSB: Analytical thinking Status: 8e question 6) Suppose we compare the average growth rates of output for Republican and Democratic administrations. In which year, on average, is the difference in growth rates for Republican and Democratic administrations greatest? A) first B) second C) third D) fourth E) the growth rates are nearly identical for both parties Answer: B AACSB: Analytical thinking Status: 8e question 7) Analysis of macro policy and theory has resulted in of the following views? A) There should be no constraints imposed on fiscal or monetary policy. B) A constitutional amendment is the most appropriate method to constrain fiscal policy. C) The heads of the central bank should be chosen by popular elections. D) all of these E) none of these Answer: E AACSB: Analytical thinking Status: 8e question 8) Suppose an elected official wishes to introduce a new government program. Under a PAYGO rule, this new program would be adopted only if ________. A) the budget deficit is reduced by the same amount as the costs of the new program B) the budget deficit is reduced by half the amount of the costs of the new program C) the new program does not result in an increase in the current or future budget deficit D) none of these Answer: C AACSB: Analytical thinking Status: 8e question

9) Which of the following was one of the main rules in the 1990 "Budget Enforcement Act"? A) flat tax rate B) spending caps C) indexation of income tax brackets D) consumption tax E) none of these Answer: B AACSB: Analytical thinking Status: 8e question 10) Which of the following was one of the main rules in the 1990 "Budget Enforcement Act"? A) flat tax rate B) PAYGO rule C) indexation of income tax brackets D) consumption tax E) none of these Answer: B AACSB: Analytical thinking Status: 8e question 11) The PAYGO rule was allowed to expire in which year? A) 1990 B) 1991 C) 2002 D) the PAYGO rule still exists Answer: D AACSB: Analytical thinking Status: 8e question 12) Arguments for placing restraints on policy makers fall into which of the following? A) policy makers understand completely how the economy operates B) policy makers have good intentions, but end up doing more harm than good C) policy makers do what is best for them, not necessarily what is best for the country D) all of these E) none of these Answer: C AACSB: Analytical thinking Status: 8e question

13) Fine tuning represents which of the following? A) policy makers' attempts to minimize the deviations of actual output from the natural level of output B) policy makers' attempts to achieve zero inflation C) policy makers' attempts to minimize fluctuations in interest rates D) policy makers' attempts to maintain a given rate of growth in the nominal money supply E) policy makers' attempts to minimize variations in the real exchange rate Answer: A AACSB: Analytical thinking Status: 8e question 14) Who is best known for arguing about the long and variable lags of monetary policy? A) Friedman B) Keynes C) Phillips D) Greenspan E) Bernanke Answer: A AACSB: Analytical thinking Status: 8e question 15) Based on an analysis of macroeconomic outcomes under Republican and Democratic administrations, we would expect which of the following to occur? A) growth rates to be generally higher under Republican administrations B) macroeconomic policy to be relatively contractionary under Democratic administrations C) unemployment rates to be generally higher under Democratic administrations D) inflation rates to be generally lower under Democratic administrations E) none of these Answer: E AACSB: Analytical thinking Status: 8e question 16) Analysis of U.S. growth rates shows that growth rate of output tends to be highest in which year of a presidential administration? A) the first B) the second C) the third D) the fourth Answer: D AACSB: Analytical thinking Status: 8e question

17) Analysis of U.S. budget deficits in the United States between 1990 and 2000 indicates that which of the following is primarily responsible for the reduction in the budget deficit? A) decrease in spending B) increase in tax revenues C) decrease in spending and increase in tax revenues D) lower interest rates E) increases in tax rates Answer: C AACSB: Analytical thinking Status: 8e question 18) Assume that political business cycles do not exist. Given this assumption, we would expect, all else fixed, the output growth to be highest in which period? A) just prior to an election B) just after an election C) in the first year of an administration D) in the second year of an administration E) none of these Answer: E AACSB: Analytical thinking Status: 8e question 19) Which of the following policies toward kidnappings would you recommend to authorities? A) State policy of NO negotiations. If a kidnapping occurs, authorities should negotiate. B) State policy of negotiations. If a kidnapping occurs, authorities should NOT negotiate. C) State policy of negotiations. If a kidnapping occurs, authorities should negotiate. D) none of these Answer: D AACSB: Analytical thinking Status: 8e question 20) Those who are concerned about balanced budget amendments typically argue that balanced budget amendments ________. A) cause interest rates to be higher than they otherwise would be B) would make fluctuations in output around the natural level of output greater C) would increase spending in a recession D) would reduce national saving Answer: B AACSB: Analytical thinking Status: 8e question

21) Democratic administrations generally are relatively more concerned about which of the following? A) reducing government expenditures B) reducing the rate of inflation C) reducing the unemployment rate D) balancing budget deficits E) balancing trade deficits Answer: C AACSB: Analytical thinking Status: 8e question 22) Republican administrations generally are relatively more concerned about which of the following? A) increasing expenditures B) reducing the rate of inflation C) reducing unemployment D) raising taxes E) none of these Answer: B AACSB: Analytical thinking Status: 8e question 23) During democratic presidential administration since 1948, economic growth was highest in ________ year of the administration? A) first B) second C) third D) fourth Answer: B AACSB: Analytical thinking Status: 8e question 24) During republican presidential administration since 1948, economic growth was highest in ________ year of the administration? A) first B) second C) third D) fourth Answer: D AACSB: Analytical thinking Status: 8e question

25) In ________, would-be members of the Euro area signed the Stability and Growth Pact (SPG). A) 1997 B) 1998 C) 1999 D) 2000 Answer: A AACSB: Analytical thinking Status: 8e question 26) The Maastricht treaty set the budget ratio to GDP to be ________ in order for countries to qualify to join the Euro area. A) below 3% B) below 4% C) below 5% D) below 6% Answer: A AACSB: Analytical thinking Status: 8e question 27) The Maastricht treaty set the budget ratio to GDP to be ________ in order for countries to qualify to join the Euro area. A) below 60% B) below 70% C) below 80% D) below 90% Answer: A AACSB: Analytical thinking Status: 8e question 28) Assume a country has presidential elections every three years. If a political business cycle exists in this country, explain any differences in the average annual growth rates of output for each year of a typical administration. Answer: Political business cycles represent the outcomes of politically motivated policies that increase the chances of an incumbent's reelection. Specifically, policies that are implemented to increase the probability of reelection will cause, in theory, output growth to be higher in an election year. Such a cycle where output growth is highest just before an election is called a political business cycle. Because of the inflationary consequences of such a policy, it is more likely that contractionary policies would be implemented in the first year of any administration. So, we would expect output growth to be highest in the election year and lowest, depending on lags, in either the first or second year. AACSB: Written and oral communication Status: 8e question

29) Balanced budget amendments are believed to be destabilizing. Explain why this is so. Answer: When an economy enters a recession, tax revenues automatically fall. A balanced budget amendment would require that either taxes be increased or spending cut — both of which would cause Y to fall even further. AACSB: Written and oral communication Status: 8e question 30) Suppose a government implements rules that result in a more independent central bank. What effect do you think this more independent central bank will eventually have on money growth and inflation in that country? Explain. Answer: Research suggests as central bank independence increases, average inflation rates decrease (which implies that money growth must be lower as well). The possible explanation for this deals with political manipulation of monetary policy. We would expect to see at some point both slower money growth and lower inflation. AACSB: Written and oral communication Status: 8e question 31) Research by Alberto Alesina has documented differences and similarities in the average annual rates of growth in output during each year of Democratic and Republican administrations. Briefly explain what the pattern of these differences and similarities is. Answer: The growth rates are similar in the first year. While there are some differences in years 3 and 4, the differences are small. Where there are sizable differences in growth rates is in year 2. Here, we observe that GDP growth is about two times greater during Democratic administrations. The reason for this is that Democratic administrations presumably prefer more expansionary policies and that the effects of these policies kick in with a lag. AACSB: Written and oral communication Status: 8e question 32) Explain what a PAYGO rule is. Answer: A PAYGO rule requires that any newly proposed government program will have no effect on either the current or future budget deficits. This implies that proponents of a new program must either propose tax increases to pay for the program or cuts in other programs. AACSB: Written and oral communication Status: 8e question 33) Use "wars of attrition" to explain the debate about deficit reduction. Answer: When country is facing large budget deficits, both parties in congress want to reduce the deficit, but they disagree about the way to do it: One party wants to reduce deficits primarily through an increase in taxes; the other wants to reduce deficits primarily through a decrease in spending. Both parties may hold out on the hope that the other side will give in first. Only when debt has increased sufficiently, and it becomes urgent to reduce deficits, will one party give up. These situations are reffed as wars of attrition. The fights between Congress and the Obama administration on how to reduce the large deficits triggered by the crisis are mostly driven by disagreements on whether deficit reduction should be achieved mainly through spending cuts or mainly through tax increases. AACSB: Written and oral communication Status: 8e question 15 Copyright © 2025 Pearson Education, Inc.

34) What were some of the key features in terms of fiscal policy of the Stability and Growth Pact signed in 1997 by would-be members of the Euro? Answer: The Stability and Growth pact: (1) committed countries to balance their budgets in the medium run; (2) countries avoid excessive deficits; and (3) imposed sanctions on countries that ran excessive deficits. AACSB: Written and oral communication Status: 8e question 35) What are the main rules of the Budget Enforcement Act of 1990? Answer: The two main rules are: 1) it imposed constraints on spending; 2) it requires that a new transfer program could only be adopted if it could be shown not to increase deficits in the future. AACSB: Written and oral communication Status: 8e question 36) Explain spending caps set by the Budget Enforcement Act. Answer: The Budget Enforcement Act imposed constrains on spending. These constraints, called spending caps, were set on discretionary spending for the following five years. These caps were set in such a way as to require small but steady decrease in discretionary spending (in real terms). Explicit provisions were made for emergencies. AACSB: Written and oral communication Status: 8e question

Macroeconomics, 9e (Blanchard) Chapter 22: Fiscal Policy: A Summing Up 22.1

What We Have Learned

1) When the economy is in a liquidity trap, which of the following is not correct? A) A reduction in the interest rate can be used to increase output. B) Fiscal policy is more important. C) Interest rate is zero. D) Large increases in spending and cuts in taxes were not enough to avoid the recession. Answer: A AACSB: Application of knowledge Status: 8e question 2) The effects of fiscal policy do not depend on the exchange rate regime. Answer: FALSE AACSB: Application of knowledge Status: New question 9e 3) Fiscal policy affects both output and the trade balance. Answer: TRUE AACSB: Application of knowledge Status: New question 9e 22.2

The Government Budget Constraint: Deficits, Debt, Spending, and Taxes

1) The government budget constraint tells us that the budget deficit is equal to ________. A) interest on the debt B) the primary deficit C) the primary deficit plus interest on the debt D) imports minus exports E) the primary deficit plus the trade deficit plus interest on the debt Answer: C AACSB: Application of knowledge Status: 8e question 2) The primary deficit is ________. A) government spending minus interest on the debt B) government spending minus net tax revenues C) government spending plus interest on the debt minus net tax revenues D) government spending plus net tax revenues minus interest on the debt E) interest on the debt minus net tax revenues Answer: B AACSB: Application of knowledge Status: 8e question

3) A higher deficit in the current year will lead to increased debt in the future only if ________. A) the deficit is greater than the previous year's deficit B) the deficit-to-GDP ratio is greater than the debt-to-GDP ratio C) it causes a drop in private saving D) it causes an increase in private saving E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 4) The "official measure" of the deficit (the one reported by the government) ________. A) tells us the change in government nominal debt B) is equal to nominal interest payments on the debt plus the primary deficit C) overestimates the real budget deficit whenever the inflation rate is positive D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 5) The official measure of the deficit ________. A) always underestimates the correct measure of the deficit when inflation is positive B) differs from the correct measure by the inflation rate times taxes C) depends on the nominal interest rate D) depends on the real interest rate E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 6) The official measure of the deficit becomes more inaccurate as ________. A) the inflation rate rises B) the total debt falls C) taxes rise D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

7) All else equal, a rise in the debt-to-GDP ratio implies ________. A) a greater ratio of interest payments to GDP B) a greater difference between the official and correct measures of the deficit as a fraction of GDP C) a greater surplus is needed to prevent further rises in the debt-to-GDP ratio D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 8) If the government runs a primary deficit in year zero of B0, and decides to repay it in year t (i.e., bring the debt back down to its pre-existing level), then in year t it must run a primary surplus equal to ________. A) zero B) one C) B0 D) B0(1 + r) E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 9) If the government runs a primary deficit in year zero of B0, and, in year 1, decides to stabilize the debt (i.e., prevent the deficit from rising any further), then in year 1 and beyond, it must run a primary surplus equal to ________. A) zero B) B0 C) (1 + r)B0 D) r E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 10) The debt-ratio is the ratio of the debt to ________. A) government spending B) saving C) taxes D) personal disposable income E) GDP Answer: E AACSB: Application of knowledge Status: 8e question

11) The debt ratio will increase by more in any given year when ________. A) the real interest rate is lower B) the growth rate of GDP is higher C) the initial debt ratio is greater D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 12) Since the early 1980s, debt ratios for the OECD countries have ________. A) increased B) remained constant C) decreased slightly D) decreased dramatically, and are now close to zero E) become impossible to define Answer: A AACSB: Application of knowledge Status: 8e question 13) A major reason to be concerned about any U.S. budget deficit is that ________. A) if it were maintained, it would lead to an ever-increasing debt-to-GDP ratio B) it would exacerbate the problem of the low U.S. saving rate C) under current legislation, it would lead to budget surpluses in the future D) if it were to increase, Ricardian equivalence will no longer hold E) since large deficits are associated with wars, the deficit might encourage the U.S. to become more adventuristic in its foreign policy Answer: B AACSB: Application of knowledge Status: 8e question 14) The deficit (as a fraction of GDP) is anticipated to rise over the next several decades due to projections of ________. A) increased defense spending B) increased spending on entitlements C) increased inflation D) decreased corporate tax revenues E) decreased income tax revenues Answer: B AACSB: Application of knowledge Status: 8e question

15) In the short run, an increase in government spending that causes an increase in the budget deficit ________. A) affects the level of output but not its composition B) affects both the level and composition of output C) affects only the price level D) is neutral E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 16) In the medium run, an increase in government spending that causes an increase in the budget deficit ________. A) affects the level of output but not its composition B) affects both the level and composition of output C) will not affect the composition of output but will affect the price level D) is neutral E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 17) In the medium run, a tax cut that causes an increase in the budget deficit will affect which of the following? A) the level of output but not its composition B) both the level and composition of output C) only the composition of output D) only the price level E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 18) In the medium run, a tax increase that causes a reduction in the budget deficit will ________. A) affect only the price level B) not affect the price level but will alter the composition of output C) not affect the level of output, but will affect the composition of output D) affect both the level and composition of output Answer: C AACSB: Application of knowledge Status: 8e question

19) The correct measure of the deficit is also called ________. A) the cyclically-adjusted deficit B) the structural deficit C) the full-employment deficit D) the inflation-adjusted deficit E) all of these Answer: D AACSB: Application of knowledge Status: 8e question 20) The official measure of the deficit is equal to ________. A) iB + G - T B) iB + T - G C) rB - G + T D) (i - π)B + G - T E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 21) The correct measure of the deficit is represented by which of the following expressions? A) iB - G + T. B) iB + T - G. C) rB - G + T. D) (i - π)B + G - T. E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 22) The difference between the official and correct measures of the deficit will be greater, ________. A) the lower is inflation B) the lower is the level of debt, B C) the higher is growth of output D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question

23) The difference between the official and correct measures of the deficit will be greater, ________. A) the lower is government spending B) the lower is the level of debt, B C) the higher is inflation D) none of these Answer: C AACSB: Application of knowledge Status: 8e question 24) The primary deficit is represented by which of the following? A) G - T B) iB - G + T C) iB + G - T D) rB - G + T E) rB + G - T Answer: A AACSB: Application of knowledge Status: 8e question 25) The debt-to-GDP ratio will tend to decline over time when ________. A) r > g B) r < g C) the primary deficit increases D) the initial level of debt increases Answer: B AACSB: Application of knowledge Status: 8e question 26) The debt-to-GDP ratio is higher, ________. A) the lower the real interest rate B) the lower is the ratio of the primary deficit to GDP C) the higher is the growth rate of output D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 27) Which of the following will cause a reduction in the debt-to-GDP ratio? A) an increase in the real interest rate B) an increase in the ratio of the primary deficit to GDP C) an increase in the growth rate of output D) all of these Answer: C AACSB: Application of knowledge Status: 8e question 7 Copyright © 2025 Pearson Education, Inc.

28) The difference between the official and correct measures of the deficit will be smaller, ________. A) the higher is government spending B) the higher is the level of debt, B C) the smaller is inflation D) none of these Answer: C AACSB: Application of knowledge Status: 8e question 29) Which of the following will cause an increase in the debt-to-GDP ratio? A) a reduction in the real interest rate B) a reduction in the ratio of the primary deficit to GDP C) a reduction in the growth rate of output D) all of these Answer: C AACSB: Application of knowledge Status: 8e question 30) The deficit at natural level of output is called ________. A) full-employment deficit B) mid-cycle deficit C) structural deficit D) cyclically adjusted deficit E) all of these Answer: E AACSB: Application of knowledge Status: 8e question 31) Under what conditions will the official measure of the budget deficit be greater than, less than, or equal to the correct measure of the budget deficit. Answer: The official measure of the deficit is: iB + G - T. The correct measure of the deficit is: rB + G - T. The difference between the two measures equals πB; that is, the official measure overstates the correct measure by that amount. The official measure will be greater when inflation is positive. The two measures will be equal when inflation is zero. And finally, the correct measure will be greater when inflation is negative. AACSB: Written and oral communication Status: 8e question

32) Explain what can occur to cause an increase in the debt ratio. Answer: The debt ratio is simply the ratio of the stock of debt to GDP. So, the debt ratio will rise whenever the increase in debt is greater than the increase in GDP. Even if the primary deficit is zero, the debt ratio will increase if the interest payments on the existing debt are such that they more than offset the fact that the economy is growing. So, a comparison of the real interest rate and growth rate of GDP will be important. Also, the debt ratio will rise if the primary deficit exists (or increases). AACSB: Written and oral communication Status: 8e question 33) What are the factors that will determine the size of some future required tax increase to pay off all debt? Answer: The factors will include: the size of the debt at that time, how long it will take to pay off the debt, and the interest rate on the existing debt. AACSB: Written and oral communication Status: 8e question 22.3

Ricardian Equivalence, Cyclical Adjusted Deficits, and War Finance

1) The Ricardian equivalence proposition states that an increase in the deficit causes ________. A) consumption to decrease B) savings to decrease C) investment to decrease D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 2) If the Ricardian equivalence proposition is correct, then an increase in the deficit will lead to ________. A) an increase in private saving B) a decrease in investment spending C) a lower standard of living in the future D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

3) If the Ricardian equivalence proposition is correct, then ________. A) deficits harm future generations B) deficits reduce investment spending C) deficits stimulate the economy in the short run D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 4) The large increases in the deficit during the 1980s in the United States were associated with ________. A) large increases in public saving B) no change in public saving C) large increases in private saving D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 5) Which of the following would increase the cyclically adjusted deficit? A) an increase in income B) a decrease in income C) an increase in the primary deficit D) a decrease in the primary deficit E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 6) If the government thinks the natural unemployment rate is 5%, when it is really 6%, then the government will ________. A) overestimate the actual deficit B) underestimate the actual deficit C) overestimate the cyclically adjusted deficit D) underestimate the cyclically adjusted deficit E) none of these Answer: C AACSB: Application of knowledge Status: 8e question

7) Using taxes to finance a war, rather than deficits, ________. A) leads to a greater future capital stock B) is generally not proposed by economists C) shares less of the burden of the war with future generations D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 8) The United States financed the additional government spending during World War II through ________. A) an increase in the deficit B) an increase in taxes C) an increase in imports D) increases in both the deficit and taxes E) increases in both the deficit and imports Answer: D AACSB: Application of knowledge Status: 8e question 9) To reduce distortions in the economy, it is probably better to finance temporary large government spending with ________. A) deficits B) taxes C) exports D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 10) The Ricardian Equivalence proposition suggests that a tax increase that causes a budget surplus will ________. A) cause an increase in output B) cause no change in output C) cause a reduction in output D) a reduction in consumption Answer: B AACSB: Application of knowledge Status: 8e question

11) A rule of thumb is that a 1% increase in output leads automatically to a reduction in the deficit of what percentage of GDP? A) 0.5% B) 1% C) 1.5% D) 2% Answer: A AACSB: Application of knowledge Status: 8e question 12) The effect of changes in economic activity on the budget deficit is called ________. A) fine tuning B) debt monetization C) the structural deficit D) tax smoothing E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 13) Explain the macroeconomic effects of a tax cut according to the Ricardian Equivalence proposition. Include in your answer the IS-LM graph that shows the effects of this tax cut. Answer: The Ricardian Equivalence proposition describes the effects of, for example, tax cuts. A tax cut will have no effect on the demand for goods according to the Ricardian Equivalence proposition. A tax cut in the current period will cause an increase in the budget deficit. At some point in the future, say one year, taxes will have to increase to pay off this debt. Individuals will realize this. Once they do, they will realize that the current period tax cut is equivalent to a future period tax increase of the same present value. Hence, they realize that their wealth does not increase as a result of this tax cut. So, they do not increase consumption. In fact, they simply save all of the tax cut. In terms of the IS-LM model, the tax cut does not increase consumption or demand. So, the IS curve does not shift and there is no change in output or the interest rate. AACSB: Written and oral communication Status: 8e question

14) Suppose the Ricardian Equivalence proposition holds (i.e., it is correct). What does this imply about the ability of fiscal policy to affect GDP? Explain. Answer: The Ricardian Equivalence proposition describes the effects of, for example, tax cuts. A tax cut will have no effect on the demand for goods according to the Ricardian Equivalence proposition. A tax cut in the current period will cause an increase in the budget deficit. At some point in the future, say one year, taxes will have to increase to pay off this debt. Individuals will realize this. Once they do, they will realize that the current period tax cut is equivalent to a future period tax increase of the same present value. Hence, they realize that their wealth does not increase as a result of this tax cut. So, they do not increase consumption. In fact, they simply save all of the tax cut. In terms of the IS-LM model, the tax cut does not increase consumption or demand. So, the IS curve does not shift and there is no change in output or the interest rate. Simply put, the tax cut will have no effect on household consumption. So, all we would observe is an increase in private saving, no change in consumption, no change in demand, and no change in output. AACSB: Written and oral communication Status: 8e question 15) For this question, assume that Ricardian Equivalence proposition does not hold. Briefly discuss the short-run, medium-run and long-run effects of a fiscal expansion (e.g. tax cut). Answer: Answers could be quite long. In the short run, fiscal policy can affect the level of output, the composition of output, the price level, and financial market variables. In the medium run, changes in fiscal policy will not affect the level of output; however, they will affect the composition of GDP and financial market variables. So, a fiscal expansion would have no effect on output in the medium run. In the long run, fiscal policy will affect output. It will do so by affecting the level of national saving. AACSB: Written and oral communication Status: 8e question 16) Explain what is meant by automatic stabilizers and how they work to minimize fluctuations in economic activity. Answer: Automatic stabilizers refer to the effect that changes in economic activity have on the size of the actual deficit. The fact that T will automatically fall as Y falls, will dampen the effects of any negative shock on the economy. AACSB: Written and oral communication Status: 8e question 17) First, define and explain the cyclically adjusted deficit. Second, explain what effect a recession caused, for example, by a reduction in consumer confidence will have on the size of the cyclically adjusted deficit. Answer: The cyclically adjusted deficit is the deficit that would occur if the economy were operating at the natural level of output. In terms of notation, it would be represented as G - T0 tYN where T0 is autonomous taxes, YN is the natural level of output, and t is the average income tax rate. Deviations in output from YN will not cause changes in the cyclically adjusted deficit. So, a consumption-led recession will have no effect on this particular measure of the budget. AACSB: Written and oral communication Status: 8e question 13 Copyright © 2025 Pearson Education, Inc.

18) Which of the following would decrease the cyclically adjusted deficit? A) an increase in income B) a decrease in income C) an increase in the primary deficit D) a decrease in the primary deficit E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 22.4

The Dangers of High Debt

1) Very high debt burdens can result in ________. A) fine tuning B) automatic stabilizer C) the structural deficit D) tax smoothing E) debt restructuring Answer: E AACSB: Application of knowledge Status: 8e question 2) Based on our understanding of the U.S. budget, we know that ________. A) government accounts treat asset sales as revenues B) government accounts do not treat asset sales as revenues C) the NIPA accounts treat asset sales as revenues D) neither the government accounts nor the NIPA accounts treat asset sales as revenues Answer: A AACSB: Application of knowledge Status: 8e question 3) When a government partially defaults its debt, a "haircut" of 20% means that ________. A) creditors receive 20% of what they owed B) creditors receive 80% of what they owed C) creditors receive 40% of what they owed D) creditors receive 10% of what they owed Answer: B AACSB: Application of knowledge Status: 8e question

4) Government default is also called ________. A) debt restructuring B) debt rescheduling C) private sector involvement D) all of these Answer: D AACSB: Application of knowledge Status: 8e question 5) Hyperinflation refers to inflation in excess of ________ per month. A) 30% B) 10% C) 20% D) 25% Answer: A AACSB: Application of knowledge Status: 8e question 6) In virtually all hyperinflations, rapid money growth begins to occur because of ________. A) a war B) a change of government C) union demands for higher wages D) large and/or growing budget deficits E) the introduction of wage indexation in labor contracts Answer: D AACSB: Application of knowledge Status: 8e question 7) Which of the following represents debt monetization? A) an increase in the budget deficit that is financed by money creation B) an increase in the budget deficit that is financed by foreigner investors' purchases of domestic bonds C) an increase in the budget deficit that coincides with a central bank sale of bonds D) an open market purchase of bonds that results in inflation E) none of these Answer: A AACSB: Application of knowledge Status: 8e question

8) When the budget deficit is financed entirely through money creation, the real budget deficit is equal to which of the following? A) ΔH B) ΔH - ΔP C) (ΔH)/P D) (ΔH)/H E) P[(ΔH)/H] Answer: C AACSB: Application of knowledge Status: 8e question 9) Seignorage is defined as which of the following? A) the part of a budget deficit financed by the issuance of bonds sold to the private sector B) revenue from money creation C) the increase in income tax revenues that occurs during a hyperinflation D) the increase in income tax revenues that occurs as a result nominal income tax brackets not being adjusted to changes in E) the part of a budget deficit financed with foreign lending Answer: B AACSB: Application of knowledge Status: 8e question 10) Seignorage is equal to ________. A) the rate of inflation B) one divided by the rate of inflation C) real money balances D) the percentage growth rate of nominal money E) the percentage growth rate of nominal money times real money balances Answer: E AACSB: Application of knowledge Status: 8e question 11) Given nominal money growth, the amount of seignorage will be greater when ________. A) tax revenues are higher B) real money balances are larger C) the inflation rate is higher D) foreign lending is higher E) none of these Answer: B AACSB: Application of knowledge Status: 8e question

12) During most episodes of hyperinflation, ________. A) the inflation rate is high but constant B) the inflation rate decreases over time C) the inflation rate increases over time D) the inflation rate first increases, and then remains constant E) the inflation rate increases over time, but then rapidly decreases on its own Answer: C AACSB: Application of knowledge Status: 8e question 13) Hyperinflation typically leads to ________. A) a reduction in barter B) a reduction in real money balances C) a preference for domestic over foreign currency D) an increase in real tax revenues collected by the government E) all of these Answer: B AACSB: Application of knowledge Status: 8e question 14) An increase in money growth, holding all other factors constant, will cause ________. A) a reduction in seignorage B) an increase in seignorage C) no change in seignorage D) an ambiguous effect on seignorage Answer: B AACSB: Application of knowledge Status: 8e question 15) A reduction in money growth, holding all other factors constant, will cause ________. A) a reduction in seignorage B) an increase in seignorage C) no change in seignorage D) an ambiguous effect on seignorage Answer: A AACSB: Application of knowledge Status: 8e question

16) Explain fiscal dominance. Answer: Most of the time, fiscal and monetary policies proceed independently. The government finances its deficit through borrowing. The central bank chooses the supply of money so as to achieve its objective (for example, low inflation). But, when the fiscal situation is bad, either because deficits are large or debt is high, and the interest rate faced by the government is high, it becomes increasingly tempting for the government to want to finance itself through money finance. Fiscal policy then determines the behavior of the money supply, a case known as fiscal dominance. AACSB: Application of knowledge Status: 8e question 17) Explain seignorage. Answer: The real revenue from money creation is called seignorage. It is equal to the money creation divided by the price level. AACSB: Reflective thinking Status: 8e question 18) Explain the economic costs of hyperinflation. Answer: The transaction system works less and less well. Price signals become less and less useful. Swings in the inflation rate become larger. AACSB: Reflective thinking Status: 8e question 19) Suppose the central bank decreases the rate of growth of the money supply. What effect will this decrease in money growth have on seignorage in: (1) the short run; and (2) the medium run? Explain. Answer: Seignorage equals the rate of growth of H times real money balances. In the short run, the decrease in money growth will likely cause a reduction in seignorage as long as H/P does not change or does not fall significantly. H/P is a function of real income and the nominal interest rate. In the short run, Y will fall and i will likely rise so H/P will decrease. In the medium run, Y will not change. The decreased money growth will cause a reduction in inflation and a reduction in the nominal interest rate causing H/P to increase. Therefore, the effects of a decrease in money growth on seignorage are ambiguous. AACSB: Written and oral communication Status: 8e question 20) Explain "haircuts" when a government defaults its debt. Answer: Default is often partial and creditors take is what is known as a haircut. A haircut of 40%, for example, means that creditors receive 60% of they were owed. AACSB: Reflective thinking Status: 8e question

21) What are the primary causes of hyperinflations? Explain. Answer: A hyperinflation simply means a very high inflation. For one to occur, money growth must also be very high. Money growth is usually very high when the government is using debt monetization to finance a large and growing budget deficit. AACSB: Reflective thinking Status: 8e question 22) First, explain what seignorage is. Second, write out and explain the expression that represents seignorage. And finally, what policies can a central bank implement to increase seignorage? Answer: Seignorage is the revenue from money creation measured in real terms, seignorage equals ΔH/P. This expression can be rearranged to yield: (ΔH/H)(H/P). The first term is simply the rate of growth of nominal money and the second term is real money balances. To increase seignorage, the central bank can increase the rate of growth of H, assuming H/P does not change. AACSB: Reflective thinking Status: 8e question 23) Suppose the central bank increases the rate of growth of the money supply. What effect will this increase in money growth have on seignorage in: (1) the short run; and (2) the medium run? Explain. Answer: Seignorage equals the rate of growth of H times real money balances. In the short run, the increase in money growth will likely cause an increase in seignorage as long as H/P does not change or does not fall significantly. H/P is a function of real income and the nominal interest rate. In the short run, Y will rise and i will likely fall so H/P will increase. In the medium run, Y will not change. The increased money growth will cause an increase in inflation and an increase in the nominal interest rate causing H/P to fall. Therefore, the effects of an increase in money growth on seignorage are ambiguous. AACSB: Written and oral communication Status: 8e question 22.5

The Challenges Facing US Fiscal Policy Today

1) In 2022, the debt issued by the federal government stood at ________ of GDP. A) 104% B) 122% C) 140% D) 110% Answer: B AACSB: Application of knowledge Status: Modified 8e

2) In 2022, the real interest rate was ________. A) -0.3% B) 7.4% C) -5.1% D) 3.2% Answer: C AACSB: Application of knowledge Status: Modified 8e 3) In 2022, the U.S. federal deficit was equal to ________ of the GDP. A) 5.5% B) 7.1% C) 8.2% D) 15.9% Answer: A AACSB: Application of knowledge Status: New question 9e 4) Discretionary spending includes items such as ________ or the payment of government employees. A) Social Security B) defense spending C) Medicare D) All of these Answer: B AACSB: Application of knowledge Status: New question 9e 5) Nondiscretionary spending includes items such as ________. A) Social Security B) defense spending C) payment of government employees D) All of these Answer: A AACSB: Application of knowledge Status: New question 9e

Macroeconomics, 9e (Blanchard) Chapter 23: Monetary Policy: A Summing Up 23.1

What We Have Learned

1) Monetary policy affects which of the following variables in the long run? A) the level of output B) the rate of unemployment C) the rate of inflation D) the real interest rate E) all of these Answer: C AACSB: Application of knowledge Status: 8e question 2) Which of the following is a function of money? A) medium of exchange B) provides protection from inflation C) it is a flow variable D) all of these E) none of these Answer: A AACSB: Application of knowledge Status: 8e question 3) For the two decades before the Global Financial Crisis, most central banks had converged toward a framework for monetary policy called ________. A) quantitative easing B) monetizing the debt C) inflation targeting D) moderating the money supply Answer: C AACSB: Application of knowledge Status: New question 9e 4) The real interest rate is equal to the nominal interest rate minus expected inflation. Answer: TRUE AACSB: Application of knowledge Status: New question 9e 5) The borrowing rate is equal to the policy rate minus a risk premium, which varies according to the nature of the borrower. Answer: FALSE AACSB: Application of knowledge Status: New question 9e

23.2

From Money Targeting to Inflation Targeting

1) The nominal interest ________. A) will never be negative B) can be negative if inflation is unexpected C) can be negative if the inflation rate is greater than the nominal interest rate D) can be negative if deflation occurs E) can be negative when the real interest rate is negative Answer: A AACSB: Application of knowledge Status: 8e question 2) M1 consists of ________. A) currency only B) currency plus travelers checks only C) currency plus checkable deposits only D) checkable deposits only E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 3) An asset is considered liquid if it ________. A) can be used as a store of value B) has a guaranteed rate of return C) is indexed to the rate of inflation D) acts as a medium of exchange E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 4) When the Fed wants to signal the public about the direction of monetary policy, it will likely use ________. A) a change in the discount rate B) open market operations C) a change in the reserve requirement D) a public announcement about a change in the targeted federal funds rate E) all of these Answer: D AACSB: Application of knowledge Status: 8e question

5) A change in the reserve requirement changes ________. A) the monetary base B) the money multiplier C) the discount rate D) all of these E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 6) Which of the following statements about Fed management of the money supply is correct? A) Over the past thirty years, the Fed has always stayed within its pre-announced target rates for growth in the money supply. B) The most common tool used by the Fed is a change in the required ratio of reserves to deposits. C) The rate at which the Fed lends money to banks is called the "Federal Funds rate." D) The Fed must report each week to Congress on the conduct of monetary policy. E) none of these Answer: E AACSB: Application of knowledge Status: Modified 8e 7) Which of the following would cause a reduction in M1? A) an increase in the required ratio of reserves to deposits B) a reduction in the discount rate C) an open market operation where the Fed sells bonds D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 8) Monetary policy has short-run effects on which of the following? A) the level of output but not its composition B) both the level and composition of output C) only the price level D) only the nominal interest rate, not the real interest rate E) none of these Answer: B AACSB: Application of knowledge Status: 8e question

9) Monetary policy has medium-run effects on which of the following? A) the level of output but not its composition B) both the level and composition of output C) the nominal interest rate D) the real interest rate E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 10) Monetary policy has medium-run effects on which of the following? A) the level of output but not its composition B) both the level and composition of output C) only the price level D) the level of output AND the price level E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 11) In the medium run, an increase in the rate of growth of nominal money will cause ________. A) lower nominal and lower real interest rates B) lower nominal interest rates and no change in the real interest rate C) an increase in inflation and an increase in output growth D) a proportionate increase in inflation Answer: D AACSB: Application of knowledge Status: 8e question 12) In the medium run, an increase in inflation causes ________. A) an increase in the opportunity cost of holding money B) a reduction in the opportunity cost of holding money C) no change in the opportunity cost of holding money D) individuals to switch from holding bonds to money and increase their real money balances Answer: A AACSB: Application of knowledge Status: 8e question 13) The Taylor rule (where a and b are positive parameters) is represented by ________. A) i = i* + a(π* - π) - b(un - u) B) i = i* + a(π - π *) + b(u - un) C) i = i* + a(π* - π) - b(u - un) D) none of these Answer: D AACSB: Analytical thinking Status: 8e question 4 Copyright © 2025 Pearson Education, Inc.

14) Which of the following is not a tool of the Fed? A) the discount rate B) reserve requirements C) open market operations D) the proportion of money held as currency Answer: D AACSB: Application of knowledge Status: 8e question 15) The discount rate represents the interest rate on ________. A) overnight loans between banks B) three-month U.S. securities C) municipal bonds D) one-year discount bonds E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 16) For this question, assume that the Fed sets monetary policy according to the Taylor rule. Suppose current U.S. macroeconomic conditions are represented by the following: π > π?* and u = un. Given this information, we would expect that the Fed will ________. A) implement a monetary contraction B) implement a monetary expansion C) maintain its current stance of monetary policy D) more information is need to answer this question Answer: A AACSB: Application of knowledge Status: 8e question 17) For this question, assume that the Fed sets monetary policy according to the Taylor rule. Suppose current U.S. macroeconomic conditions are represented by the following: π < π?* and u = un. Given this information, we would expect that the Fed will ________. A) implement a monetary contraction B) implement a monetary expansion C) maintain its current stance of monetary policy D) more information is need to answer this question Answer: B AACSB: Application of knowledge Status: 8e question

18) For this question, assume that the Fed sets monetary policy according to the Taylor rule. Suppose current U.S. macroeconomic conditions are represented by the following: π = π?* and u > un. Given this information, we would expect that the Fed will ________. A) implement a monetary contraction B) implement a monetary expansion C) maintain its current stance of monetary policy D) more information is need to answer this question Answer: B AACSB: Application of knowledge Status: 8e question 19) For this question, assume that the Fed sets monetary policy according to the Taylor rule. Suppose current U.S. macroeconomic conditions are represented by the following: π = π?* and u < un. Given this information, we would expect that the Fed will ________. A) implement a monetary contraction B) implement a monetary expansion C) maintain its current stance of monetary policy D) more information is need to answer this question Answer: A AACSB: Application of knowledge Status: 8e question 20) For this question, assume that the Fed sets monetary policy according to the Taylor rule. Suppose current U.S. macroeconomic conditions are represented by the following: π > π?* and u < un. Given this information, we would expect that the Fed will ________. A) implement a monetary contraction B) implement a monetary expansion C) maintain its current stance of monetary policy D) more information is need to answer this question Answer: A AACSB: Application of knowledge Status: 8e question 21) For this question, assume that the Fed sets monetary policy according to the Taylor rule. Suppose current U.S. macroeconomic conditions are represented by the following: π < π?* and u > un. Given this information, we would expect that the Fed will ________. A) implement a monetary contraction B) implement a monetary expansion C) maintain its current stance of monetary policy D) more information is need to answer this question Answer: B AACSB: Application of knowledge Status: 8e question

22) Which of the following would cause an increase in M1? A) a reduction in the required ratio of reserves to deposits B) an increase in the discount rate C) an open market operation where the Fed buys bonds D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 23) Explain the macroeconomic effects of changes in monetary policy in: (1) the short run; and (2) the medium run. Answer: The answers can vary (not to mention be very long!). In the short run, we learned that changes in the money supply can affect financial market variables and economic activity (in addition to the composition of GDP). Monetary policy can also be used to affect the price level/inflation rate in the short run. In the medium run, monetary policy only affects nominal variables and, therefore, is said to be neutral. AACSB: Written and oral communication Status: 8e question 24) First, write out the equation that represents the Taylor rule. Second, discuss how the Taylor rule is used to explain the implementation of monetary policy. Answer: The Taylor rule is represented as the following: i = i* + a(π - π*) - b(u - un). i* is the target interest rate and π* is the desired inflation rate. Two quick cases can be examined. If actual inflation is greater than π*, the central bank should raise the interest rate above the target rate. This will reduce economic activity and reduce the actual inflation rate over time. If the unemployment rate is above the natural rate, the central bank should set the interest rate below the target rate in order to stimulate economic activity. AACSB: Written and oral communication Status: 8e question 25) Briefly discuss the organization of the Federal Reserve. Include in your answer a discussion of the individuals/groups who make decisions about monetary policy. Answer: In terms of the structure of the Fed, answers should mention the 12 district banks (and their presidents), the Board of Governors, the FOMC, and, possibly, the open market desk in New York. In terms of the individuals, answers should include a discussion of the 7 governors (with 14-year terms) and the chair with a renewable 4-year term. The role that district presidents play on the FOMC should also be noted. AACSB: Written and oral communication Status: 8e question

26) List the primary instruments of monetary policy. Answer: The instruments are: the discount rate, open market operations, and reserve requirements. AACSB: Application of knowledge Status: 8e question 27) Discuss the current debate on the optimal inflation target. Answer: At this stage, most central banks in richer countries have an inflation target of about 2%. They are being challenged on two fronts. Some economists want to achieve price stability — that is, 0% inflation. Others want, instead, a higher target rate of inflation, say 4%, to help prevent from falling in the liquidity trap in the future. AACSB: Reflective thinking Status: 8e question 23.3

The Optimal Inflation Rate

1) Which of the following is considered a benefit of inflation? A) the option of a negative real interest rate B) money illusion C) seignorage D) all of these E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 2) Which of the following is an example of the "shoe-leather costs" of inflation? A) a rise in the cost of primary raw materials, like leather for shoes B) an artificial rise in the capital gains tax C) the need to take more trips to the bank D) miscalculations due to money illusion E) All of these Answer: C AACSB: Application of knowledge Status: 8e question 3) The existence of inflation does which of the following? A) reduces tax distortions B) allows governments to benefit from seignorage C) reduces shoe-leather costs D) reduces the costs associated with money illusion Answer: B AACSB: Application of knowledge Status: 8e question

4) The existence of inflation does which of the following? A) reduces tax distortions B) reduces shoe-leather costs C) allows for the possibility of negative real interest rates D) reduces the costs associated with money illusion Answer: C AACSB: Application of knowledge Status: 8e question 5) The existence of inflation does which of the following? A) facilitates the downward adjustment of real wages B) reduces shoe-leather costs C) reduces tax distortions D) reduces the costs associated with money illusion Answer: A AACSB: Application of knowledge Status: 8e question 6) In 2019, the average inflation rate in the OECD countries was ________. A) 1.7% B) 2.1% C) 5.2% D) 3.8% E) 10.5% Answer: B AACSB: Application of knowledge Status: 8e question 7) Explain the costs imposed by an increase in inflation. Answer: The answers to this question should include a discussion of: shoe-leather costs, tax distortions, money illusion, and inflation variability. AACSB: Reflective thinking Status: 8e question 8) Suppose an economy experiences an increase in inflation. Explain the possible macroeconomic benefits of this increase in inflation. Answer: Answers should include discussions of: seignorage, the option of a negative real interest rate, and money illusion. AACSB: Reflective thinking Status: 8e question

9) Explain what role money illusion plays in determining the Fed's ability to affect output in the short run. Answer: Money illusion refers to a situation where individuals make mistakes about the distinction between nominal and real magnitudes. For example, individuals might be reluctant to accept a reduction in the nominal wage (that would cause a reduction in the real wage) while at the same time would "accept" a reduction in the real wage when inflation exists and the nominal wage does not change. Money illusion, therefore, might allow a central bank to inflate an economy and, therefore, cause output to rise temporarily. AACSB: Written and oral communication Status: 8e question 10) Explain what is meant by shoe-leather costs. Answer: In the medium run, an increase in inflation will cause an increase in nominal interest rates. When the nominal interest rate rises, the opportunity cost of holding money increases causing individuals to reduce their money balances. Individuals, therefore, make more trips to the bank. The costs associated with this are called shoe-leather costs. AACSB: Written and oral communication Status: 8e question 11) What are the factors that will determine the optimal inflation rate? Answer: In short, the factors that will determine the optimal inflation rate are the relative magnitudes of the costs and benefits of inflation. Therefore, on the cost side, individuals would consider: shoe-leather costs, tax distortions, money illusion, and inflation variability. On the benefit side, one would consider: seignorage, the option of a negative real interest rate, and money illusion. So, an individual would compare the costs and benefits of inflation and choose some optimal inflation rate. AACSB: Written and oral communication Status: 8e question 12) Suppose the annual inflation rate is 10%, and an asset bought at the beginning of the year for $100,000 is sold for $115,000. If the capital-gains tax rate is 30%, what is the (approximate) effective tax rate on the sale of this asset? A) 10% B) 20% C) 25% D) 30% E) 4% Answer: E AACSB: Application of knowledge Status: 8e question

13) Which of the following would serve to reduce the costs caused by the variability of inflation? A) seignorage B) bracket creep C) a higher capital gains tax D) indexed wages E) none of these Answer: D AACSB: Application of knowledge Status: 8e question 14) Bracket creep would less likely occur in which of the following? A) a progressive income tax system B) a regressive income tax system C) a flat income tax system D) none of these Answer: B AACSB: Application of knowledge Status: 8e question 23.4

Unconventional Monetary Policy

1) Which of the following is not correct about quantitative easing? A) It is one of the conventional monetary policy tools. B) It refers to the Fed's asset purchasing program. C) It helped reduce term premium on long-term government bonds. D) As a result, the balance sheet of the Fed is much larger than it was before the crisis. Answer: A AACSB: Application of knowledge Status: 8e question 2) Which of the flowing is an unconventional monetary policy tool? A) quantitative easing B) open market operation C) changing discount rate D) changing required reserve ratio Answer: A AACSB: Application of knowledge Status: 8e question 3) Quantitative easing has led to ________. A) increase in monetary base B) decrease in monetary base C) increase in risk premia D) decrease in bank reserves at the Fed Answer: A AACSB: Application of knowledge Status: 8e question 11 Copyright © 2025 Pearson Education, Inc.

4) How many rounds of quantitative easing has the Fed engaged in since 2008? A) 1 B) 2 C) 3 D) 4 Answer: D AACSB: Application of knowledge Status: New question 9e 5) Quantitative easing is also called ________. A) credit easing B) monetizing the debt C) seignorage D) conventional monetary policy Answer: A AACSB: Application of knowledge Status: New question 9e 6) The Fed currently uses a ________ where it sets two rates: the rate on reserves, the rate at which banks can in effect lend to the Fed; and the discount rate, the rate at which banks can borrow from the Fed. A) corridor system B) quantitative easing policy C) seignorage system D) none of these Answer: A AACSB: Application of knowledge Status: New question 9e 7) What is the state of U.S. monetary policy in late 2023? Answer: Monetary policy is in flux. The Covid-19 crisis forced the Fed to question the focus on inflation targeting and to explore tools other than the policy rate. As a result of the use of unconventional policies during the zero lower bound period, the balance sheets of the Fed is much larger than it used to be. They hold a much larger quantity of assets than before the crisis, and they have much larger liabilities. They pay interest on a large part of their liabilities, the reserves held by banks at the central bank. The main policy tool has become the interest rate paid to banks on their reserves at the Fed. The main choice facing all central banks at this point is whether to keep their large balance sheets, or to return to a situation closer to the pre-crisis situation, with a small balance sheet and mostly non-interest paying liabilities. While they have in most cases either stabilized or started to decrease their balance sheets, the endpoint has not been decided yet. AACSB: Written and oral communication Status: New question 9e

23.5

Monetary Policy and Financial Stability

1) In the medium run, a reduction in inflation causes ________. A) a reduction in the opportunity cost of holding money B) an increase in the opportunity cost of holding money C) no change in the opportunity cost of holding money D) individuals to switch from holding money to bonds and reduce their real money balances Answer: A AACSB: Application of knowledge Status: 8e question 2) Bracket creep would be more likely occur in which of the following? A) a progressive income tax system B) a regressive income tax system C) a flat income tax system D) none of these Answer: A AACSB: Application of knowledge Status: 8e question 3) LTV ratio appears to be positively related to ________. A) bond price B) stock price C) housing price D) none of these E) all of these Answer: C AACSB: Application of knowledge Status: 8e question 4) An economy is said to be in the liquidity trap when the short-term ________ is down to zero. A) real interest rate on corporate bonds B) nominal interest rate on government bonds C) nominal interest rate on corporate bonds D) real interest rate on government bonds Answer: B AACSB: Application of knowledge Status: 8e question

5) To deal with dangerous behavior in the financial system, macroprudential tools can be used to aim directly at ________. A) borrowers B) lenders C) banks and other financial institutions D) none of these E) all of these Answer: E AACSB: Application of knowledge Status: Modified 8e 6) Reducing the maximum LTV is likely to ________ demand and thus ________ the housing price increase. A) decrease; slow down B) increase; slow down C) decrease; speed up D) increase; speed up Answer: A AACSB: Application of knowledge Status: 8e question 7) From 2000 to 2007, which country had the highest nominal house price increase? A) Spain B) Portugal C) Greece D) Italy Answer: A AACSB: Application of knowledge Status: 8e question 8) From 2000 to 2007, which country had the maximum LTV allowed? A) United Kingdom B) Australia C) Netherlands D) Canada E) United States Answer: C AACSB: Application of knowledge Status: 8e question 9) What are the lessons from the crisis for monetary policy? Answer: Liquidity trap has led a number of countries to explore unconventional monetary policy tools, such as QE. The crisis has shown that stable inflation is not a sufficient condition for macroeconomic stability. This is leading central banks to explore the use of macro prudential tools. AACSB: Written and oral communication Status: 8e question 14 Copyright © 2025 Pearson Education, Inc.

10) What are some of the questions about the macroprudential tools? Answer: 1) In many cases we do not know how well these tools work; 2) there are likely to be complex interaction between the traditional monetary policy tools and these macroprudential tools. 3) Whether macroprudential tools should be under the control of the central bank or under the control of a separate authority. AACSB: Written and oral communication Status: Modified 8e 11) Until the 1990s, how was monetary policy typically conducted in advanced countries? Answer: 1) The central bank chose a target rate for nominal money growth corresponding to the inflation rate it wanted to achieve in the medium run. 2) In the short run, the central bank allowed for deviations of nominal money growth from the target. 3) To communicate to the public both what it wanted to achieve in the medium run and what it intended to do in the short run, the central bank announced a range for the rate of nominal money growth it intended to achieve. AACSB: Written and oral communication Status: 8e question 12) Discuss the change of the design of monetary policy over time. Answer: Traditionally, the design of monetary policy was focused on nominal money growth. But, because of the poor relation between inflation and nominal money growth, this approach was abandoned by most central banks. Central banks now typically focus on an inflation rate target rather than a nominal money growth rate target. And they think about monetary policy in terms of determining the nominal interest rate rather than determining the rate of nominal money growth. The Taylor rule gives a useful way of thinking about the choice of the nominal interest rate. The rule states that the central bank should move its interest rate in response to two main factors: the deviation of the inflation rate from the target rate of inflation, and the deviation of the unemployment rate from the natural rate of unemployment. A central bank that follows this rule will stabilize activity and achieve its target inflation rate in the medium run. AACSB: Written and oral communication Status: 8e question 23.6

Covid-19, Inflation, and Monetary Policy

1) U.S. unemployment peaked at ________ in March 2020 due to the Covid-19 shutdown. A) 8.6% B) 14.7% C) 15.9% D) 17.4% Answer: B AACSB: Application of knowledge Status: New question 9e

2) The high Covid-19-induced unemployment rate led to ________. A) a strong fiscal and monetary policy response B) a reduction in government transfer payments C) civil unrest D) a reduction in unemployment payments Answer: A AACSB: Application of knowledge Status: New question 9e 3) The Fed's response to the Covid-19 pandemic was to ________. A) reduce the money supply B) sell bonds using open market operations C) lower the fed funds rate to zero D) push the fed funds rate into negative territory Answer: C AACSB: Application of knowledge Status: New question 9e 4) The Fed kept the fed funds rate at the zero lower bound until ________. A) mid 2020 B) late 2021 C) early 2023 D) early 2022 Answer: D AACSB: Application of knowledge Status: New question 9e 5) Why did the Fed wait so long to begin raising interest rates after inflation surged following the Covid-19 pandemic? A) The Fed thought the inflation was temporary. B) The Fed always waits until inflation approaches double digits before acting. C) The Fed wanted inflation to exceed the 2% rate to help monetize the debt. D) The Fed was worried about Congress removing its independence. Answer: A AACSB: Reflective thinking Status: New question 9e 6) What were the two main reasons it took the Fed so long to act after inflation surged following the Covid-19 pandemic? Answer: The first reason was the announcement by the Fed that it would not increase the policy rate until two conditions were fulfilled: (1) that labor markets had reached levels consistent with the Committee's assessment of maximum employment, and (2) that inflation had risen to 2 percent or more. While one of the conditions for increasing the rate was satisfied as early as mid2021, the Fed assessed that the second was not, thereby explaining the delay in raising the federal funds rate. AACSB: Written and oral communication Status: New question 9e 16 Copyright © 2025 Pearson Education, Inc.

7) Why did the Fed initially commit to keeping interest rates low following the pandemic? Answer: The intent of the commitment was to send a clear signal to financial markets that they could expect a steady recovery and the Fed would not stand in the way by increasing interest rates too early. By sending such a signal, the Fed believed that this would lead to stronger spending and indeed achieve a faster recovery. AACSB: Written and oral communication Status: New question 9e 8) What factors caused the Fed to make such a big mistake by waiting too long to begin raising interest rates to combat inflation? Answer: The Fed focused on the labor market and concluded that even if the strong fiscal expansion led to low unemployment, the effect of unemployment on wage inflation would be limited, reflecting the relatively flat Phillips curve. What it did not anticipate was the increase in price inflation given wage inflation, reflecting the combination of strong demand and supply constraints, and the general increase in commodity prices. It took time for the Fed to realize the source of inflation and to start increasing the policy rate. AACSB: Written and oral communication Status: New question 9e

Macroeconomics, 9e (Blanchard) Chapter 24: Epilogue: The Story of Macroeconomics 24.1

Keynes and the Great Depression

1) Which of the following statements about Keynes' contribution to macroeconomics is correct? A) Although he published his most important ideas about the economy long before the 1930s, few economists paid attention to Keynes until the Great Depression proved him correct. B) Keynes argued that depressions and recessions were almost always caused by changes in the money supply. C) Keynes argued that balancing the budget could be an effective way to cure a recession or depression. D) all of these E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 2) According to Keynes, ________. A) the Great Depression was caused by ill-considered expansionary fiscal policy B) balancing the budget in the midst of a depression would be a serious mistake C) inflation is always and everywhere a monetary phenomenon D) the Phillips curve is stable E) none of these Answer: B AACSB: Application of knowledge Status: 8e question 3) Liquidity preference refers to ________. A) Keynes' name for the demand for money B) the "random walk" behavior of consumption spending C) monetarists explanations for stagflation D) real business cycle theorists' explanations for stagflation E) the controversy sparked by the Lucas critique Answer: A AACSB: Application of knowledge Status: 8e question 4) "In the long run, we're all dead" was Keynes' way of saying that ________. A) intellectual pursuits, like understanding the economy, are unimportant in the scheme of things B) no one would appreciate his theories during his lifetime C) there is no point in saving for retirement D) it is very important to save for one's retirement E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 1 Copyright © 2025 Pearson Education, Inc.

5) "Effective demand" represents which of the following? A) money demand B) demand for exports C) domestic demand D) the demand for labor E) aggregate demand Answer: E AACSB: Application of knowledge Status: 8e question 6) Liquidity preference refers to the theory of ________. A) money demand B) consumption C) investment D) expectations Answer: A AACSB: Application of knowledge Status: 8e question 24.2

The Neoclassical Synthesis

1) The neoclassical synthesis ________. A) was a name coined by Keynes himself for his new theories B) rejected virtually all of Keynes' insights C) held that econometric models of the economy could not be used to predict the future D) held that economy always operated at or very near the natural rate of unemployment E) was the dominant school of thought among economists in the 1950s and 1960s Answer: E AACSB: Application of knowledge Status: 8e question 2) Which of the following was not part of the neoclassical synthesis? A) the IS curve B) the LM curve C) the Phillips curve D) aggregate demand E) rational expectations Answer: E AACSB: Application of knowledge Status: 8e question

3) Which of the following schools of thought advised against fine-tuning, due to our limited understanding of the economy? A) Monetarist B) Keynesian C) New Keynesianism D) New growth E) Neoclassical Answer: E AACSB: Application of knowledge Status: 8e question 4) The intellectual leader of the monetarists was ________. A) Robert Lucas B) Milton Friedman C) John Maynard Keynes D) Paul Romer E) John Taylor Answer: B AACSB: Application of knowledge Status: 8e question 5) In the 1960s, the monetarist school of thought held that ________. A) monetary and fiscal policy could explain most of the output fluctuations in U.S. history B) there is a long-run tradeoff between inflation and unemployment C) efforts to fine-tune the economy are likely to do more harm than good D) all of these E) none of these Answer: C AACSB: Application of knowledge Status: 8e question 6) If the IS curve is relatively steep, then ________. A) there can be no long-run tradeoff between inflation and unemployment B) monetary policy cannot be very effective in changing GDP C) rational expectations theory is probably correct D) Ricardian equivalence most likely holds E) budget deficits will not affect future capital accumulation Answer: B AACSB: Application of knowledge Status: 8e question

7) During the 1970s and 1980s, macroeconomists were busy integrating the insights of which of the following into their ideas about the economy? A) real business cycle theory B) Keynesian theory C) supply side economics D) classical macroeconomics E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 8) The neoclassical synthesis had emerged by what decade? A) 1930s B) 1940s C) 1950s D) 1960s E) 1990s Answer: C AACSB: Application of knowledge Status: 8e question 9) The IS-LM model was developed by ________. A) Friedman and Phelps B) Hicks and Hansen C) Modigliani and Friedman D) Lucas and Sargent E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 10) The theories of consumption were developed by ________. A) Friedman and Phelps B) Hicks and Hansen C) Modigliani and Friedman D) Lucas and Sargent Answer: C AACSB: Application of knowledge Status: 8e question

11) The theories of investment were developed by ________. A) Friedman and Phelps B) Hicks and Hansen C) Modigliani and Friedman D) Lucas and Sargent E) Tobin and Jorgenson Answer: E AACSB: Application of knowledge Status: 8e question 12) Which of the following argued that the Great Depression was caused by monetary factors? A) Friedman and Schwartz B) Hicks and Hansen C) Modigliani and Friedman D) Lucas and Sargent E) Tobin and Jorgenson Answer: A AACSB: Application of knowledge Status: 8e question 13) Explain several of the key contributions of Keynes. Answer: Obviously, answers to this question could be quite long. Answers should include topics like: the importance of expectations, business cycle theory, the importance of aggregate demand in causing fluctuations, liquidity preference, and the concept of the multiplier. AACSB: Reflective thinking Status: 8e question 14) Explain what is meant by liquidity preference. Answer: Liquidity preference is the phrase Keynes gave to money demand. AACSB: Reflective thinking Status: 8e question 15) Discuss what is meant by the neoclassical synthesis and explain how it emerged. Answer: This is the title given to what was believed to be the emerging consensus in economics. AACSB: Reflective thinking Status: 8e question 16) In the 1960s, there was significant debate between Keynesians and monetarists. Explain several aspects of this debate. Answer: There were three key areas of this debate: (1) the relative importance of monetary and fiscal policy; (2) the perceived stability of the Phillips curve; and (3) the role of policy to stabilize the economy. AACSB: Reflective thinking Status: 8e question

24.3

The Rational Expectations Critique

1) Which of the following events led to the crisis in macroeconomics and to the development of rational expectations theory? A) the Great Depression B) the stock market crash of 1987 C) the stock market speculative bubble of the late 1990s D) stagflation in the 1970s E) large budget deficits in the 1980s Answer: D AACSB: Application of knowledge Status: 8e question 2) Milton Friedman attributed the Great Depression primarily to ________. A) the government's failure to respond to an increase in the budget deficit B) a reduction in the money supply C) economists' and policy-makers' failure to acknowledge their limited knowledge D) the failure of wages to rise E) inaccurate expectations by consumers and firms Answer: B AACSB: Application of knowledge Status: 8e question 3) Which of the following is an implication of rational expectations theory? A) Deviations of output from the natural rate are likely to be serious and long-lived. B) The economy is like a complex machine, that needs to be optimally controlled with the proper policy. C) Macroeconometric models based on past behavior will not be very useful in formulating policy. D) Wages and prices are set almost entirely at random, so it is pointless to try to model their behavior. E) Business cycles almost always result from a shift in aggregate demand. Answer: C AACSB: Application of knowledge Status: 8e question 4) Most economists would agree that, unless it incorporates rational expectations or something like it, a model cannot account for ________. A) the Great Depression B) shifts in aggregate supply C) the relationship between consumption and income D) the stagflation of the 1970s E) the different initial impact of a permanent versus a temporary policy change Answer: E AACSB: Application of knowledge Status: 8e question 6 Copyright © 2025 Pearson Education, Inc.

5) According to rational expectations theory, monetary policy will affect output only if it is ________. A) anticipated B) unanticipated C) a very large change D) a very small change E) a policy that has been tried in the past Answer: A AACSB: Application of knowledge Status: 8e question 6) The staggering of wage and price decisions suggests that ________. A) people do not possess rational expectations B) people do possess rational expectations C) the economy will adjust slowly to shocks even if people possess rational expectations D) the Lucas critique is entirely correct E) real business cycle theory is correct Answer: C AACSB: Application of knowledge Status: 8e question 7) Which of the following argued that a long-run trade-off between inflation and unemployment could not exist? A) Friedman and Phelps B) Hicks and Hansen C) Modigliani and Friedman D) Lucas and Sargent E) Tobin and Jorgenson Answer: A AACSB: Application of knowledge Status: 8e question 8) The steeper is the IS curve, ________. A) the more effective is monetary policy B) the less effective is monetary policy C) the effectiveness of monetary policy does not change D) a given change in the money supply will have a greater effect on output Answer: A AACSB: Application of knowledge Status: 8e question

9) As the IS curve becomes flatter, we know that ________. A) a given change in the money supply will cause a larger change in output B) a given change in the money supply will cause a smaller change in output C) a given change in the money supply will cause the same change in output D) monetary policy becomes less effective Answer: B AACSB: Application of knowledge Status: 8e question 10) Stagflation refers to ________. A) a reduction in inflation B) a simultaneous reduction in inflation and reduction in unemployment C) a liquidity trap D) reduction in the price level and a reduction in the unemployment rate E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 11) Which of the following led a strong attack against mainstream macroeconomists during the 1970s? A) Friedman and Phelps B) Hicks and Hansen C) Modigliani and Friedman D) Lucas, Barro, and Sargent Answer: D AACSB: Application of knowledge Status: 8e question 12) The research by Robert Hall on the theory of consumption suggests that the best forecast of consumption for next year would be ________. A) unpredictable B) random C) this year's consumption D) last year's consumption Answer: C AACSB: Application of knowledge Status: 8e question 13) The more staggered are labor contracts, ________. A) the more rapidly the economy will adjust to changes in aggregate demand B) the less rapidly the economy will adjust to changes in aggregate demand C) the greater the inflationary effects of a given change in money growth in the medium run D) the less inflationary effects of a given change in money growth in the medium run Answer: A AACSB: Application of knowledge Status: 8e question 8 Copyright © 2025 Pearson Education, Inc.

14) The new classical interpretation of the economy suggests that ________. A) output is always above the natural level B) output is always below the natural level C) output is always equal to the natural level D) recessions will not occur Answer: C AACSB: Application of knowledge Status: 8e question 15) The flatter is the IS curve, ________. A) the more effective is monetary policy B) the less effective is monetary policy C) the effectiveness of monetary policy does not change D) a given change in the money supply will have a smaller effect on output Answer: B AACSB: Application of knowledge Status: 8e question 16) As the IS curve becomes steeper, we know that ________. A) a given change in the money supply will cause a larger change in output B) a given change in the money supply will cause a smaller change in output C) a given change in the money supply will cause the same change in output D) monetary policy becomes more effective Answer: A AACSB: Application of knowledge Status: 8e question 17) The less staggered are labor contracts, ________. A) the more rapidly the economy will adjust to changes in aggregate demand B) the less rapidly the economy will adjust to changes in aggregate demand C) the greater the inflationary effects of a given change in money growth in the medium run D) the less inflationary effects of a given change in money growth in the medium run Answer: B AACSB: Application of knowledge Status: 8e question 18) Discuss some of the implications of rational expectations. Answer: Answers should include a discussion of the implications of rational expectations on: (1) our understanding of the behavior of consumption and financial market variables; (2) the determinants of wage and price setting behavior; and (3) the theory, implementation, and effectiveness of policy. AACSB: Written and oral communication Status: 8e question

19) First, what is the Lucas critique? Second, explain how it might relate to the implementation of monetary policy. Answer: The Lucas critique refers to the argument made by Robert Lucas that using existing macro models to make predictions about the effects of proposed policy would not be successful. These models' predictions were based on previous relationships that, as Lucas noted, would no longer hold as new policy is implemented. When monetary policy is implemented, these models might predict, for example, increases in output. However, as we now know, expectations of the effects of these policies would change. AACSB: Written and oral communication Status: 8e question 24.4

Developments in Macroeconomics up to the Global Financial Crisis

1) According to real business cycle theorists, ________. A) fiscal policy explains most changes in output B) price and wage rigidity explain most changes in output C) efficiency wage theory explains wage rigidity D) changes in output primarily represent changes in the natural level of output E) fiscal policy explains most changes in efficiency wage theory Answer: D AACSB: Application of knowledge Status: 8e question 2) One problem with real business cycle theory is that ________. A) it is more successful in explaining expansions than in explaining contractions B) it relies almost entirely on Keynes' original ideas, ignoring much of the progress made since then C) it treats government officials as well-meaning public servants, despite much evidence to the contrary D) it defines "productivity" in a new and not very intuitive way E) its models downplay the importance of technological progress in the economy Answer: A AACSB: Application of knowledge Status: 8e question 3) Those economists who attempt to explain why wages and prices do not freely adjust would most likely be ________. A) real business cycle theorists B) new classical economists C) new Keynesian economists D) new growth theorists E) none of these Answer: C AACSB: Application of knowledge Status: 8e question

4) The existence of menu costs are often used to explain why ________. A) fiscal and monetary policies should be relatively effective B) the price of services, like those provided by restaurants and barbers, rise at a faster rate than the price of goods, like automobiles and clothing C) food prices tend to rise disproportionately rapidly in the consumer price index D) price and wage adjustments will be relatively rapid E) people prefer to look backward, instead of forward, when anticipating the future Answer: A AACSB: Application of knowledge Status: 8e question 5) If consumers are very foresighted, we would expect actual consumption spending to ________. A) increase during recessions B) increase during episodes of stagflation C) have no relation to wealth D) resemble a "random walk" E) be entirely predictable Answer: D AACSB: Application of knowledge Status: 8e question 6) A core belief of modern macroeconomics is that in the short run, ________. A) fiscal policy is more effective in changing output than monetary policy B) monetary policy is more effective in changing output than fiscal policy C) fluctuations in aggregate demand affect unemployment D) fluctuations in aggregate demand have no impact on the price level E) the economy always operates at or near the natural rate of unemployment Answer: C AACSB: Application of knowledge Status: 8e question 7) A core belief of modern macroeconomics is that in the long run, ________. A) a change in money growth will affect the level of output, but not its composition B) a change in money growth will affect the composition of output, but not its level C) output can deviate permanently from its natural level D) a change in fiscal policy will not affect the composition of output E) greater saving will result in greater output Answer: E AACSB: Application of knowledge Status: 8e question

8) One of the most important areas of disagreement among macroeconomists today is over ________. A) the slope of the IS curve B) the slope of the LM curve C) the definition of consumption spending D) the definition of government spending E) none of these Answer: E AACSB: Application of knowledge Status: 8e question 9) Both the new classical and new Keynesian models had in common the belief that ________. A) in the medium run, output returns to its natural level B) output is always at its natural level C) in the short run, output would likely deviate from its natural level D) none of these Answer: A AACSB: Application of knowledge Status: 8e question 10) The main debate during the 1960s was ________. A) between Keynesians and classicals B) between new Keynesians and new classicals C) between Keynesians and monetarists D) between new Keynesians and monetarists Answer: C AACSB: Application of knowledge Status: 8e question 11) The intellectual leader of new classicals is ________. A) Edward Prescott B) John Taylor C) Stanley Fischer D) Ben Bernanke Answer: A AACSB: Application of knowledge Status: 8e question 12) Discuss new classical economics and real business cycle theory. Answer: New classical economics refers to that area of research where it is assumed that there is sufficient wage and price flexibility. It was a fairly logical extension of Lucas' work on rational expectations. Real business cycle theory attempts to explain fluctuations in output as changes in the natural level of output. AACSB: Written and oral communication Status: 8e question

13) Explain what is meant by "new Keynesians" and discuss some of the research conducted in this area. Answer: New Keynesians focus on the implications of market imperfections such as nominal rigidities. This research has also focused on the determination of wages (e.g. efficiency wage theory). Others have focused on "menu costs" to explain why prices might not adjust as rapidly to clear product markets. AACSB: Written and oral communication Status: 8e question 14) Briefly discuss new growth theory. Answer: New growth theory focuses on the determinants of technological progress and on the extent to which increasing returns to scale might exist. AACSB: Written and oral communication Status: 8e question 15) Explain the menu cost explanation of output fluctuations. Answer: Each wage setter or price setter is largely indifferent as to when and how often he changes his own wage or price. Therefore, even small costs of changing prices can lead to infrequent and staggered price adjustment. This staggering leads to slow adjustment of the price level and to large aggregate output fluctuations in response to movements in aggregate demand. In short, decisions that do not matter much at the individual level (how often to change prices or wages) lead to large aggregate effects (slow adjustment of the price level, and shifts in aggregate demand that have a large effect on output). AACSB: Written and oral communication Status: 8e question 24.5

Lessons from the Global Financial Crisis

1) The crisis reflects a major intellectual failure of macroeconomics to understand the macroeconomic importance of ________. A) financial system B) growth C) unemployment D) inflation Answer: A AACSB: Application of knowledge Status: 8e question 2) Work by Doug Diamond and Philip Dybvig in the 1980s had clarified the nature of ________. A) unemployment B) bank runs C) inflation D) growth Answer: B AACSB: Application of knowledge Status: 8e question 13 Copyright © 2025 Pearson Education, Inc.

3) Economist ________ shows the "limits of arbitrage." A) Doug Diamond B) Andrei Shleifer C) Philip Dybvig D) Richard Thaler Answer: B AACSB: Application of knowledge Status: 8e question 4) The Great Depression had led economists to suggest a larger role for ________. A) market mechanism B) government intervention C) price mechanism D) international trade Answer: B AACSB: Application of knowledge Status: 8e question 5) Recent research up to the crisis proceeded mainly on three fronts. Discuss each of them. Answer: New classical: the extent to which fluctuations in output are explained by movements in the natural level of output. New Keynesian: exploring the nature of market imperfections and nominal rigidities and the extent to which they can explain fluctuations in output. New Growth theory: examines the determinants of technological progress and the implications of increasing returns to scale for economic growth. AACSB: Written and oral communication Status: 8e question 6) Discuss the major intellectual failure on macroeconomics from the crisis. Answer: The failure was in not realizing that such a large crisis could happen,that the characteristics of the economy were such that a relatively small shock, in this case the decrease in U.S. housing prices, could lead to a major financial and macroeconomic global crisis. The source of the failure, in turn, was a lack of focus on the role of the financial institutions in the economy. AACSB: Written and oral communication Status: 8e question 7) Discuss research on the role of banks and other financial institutions in the intermediation of funds between lenders and borrowers. Answer: Work by Doug Diamond and Philip Dybvig in the 1980s had clarified the nature of bank runs: liquid assets and liquid liabilities created a risk of runs even for solvent banks. The problem could only be avoided by the provision of liquidity by the central bank if and when needed. Work by Bengt Holmström and Jean Tirole had shown that liquidity issues were endemic to a modern economy. Andrei Shleifer discussed the limits of arbitrage. Behavioral economists had pointed to the way in which individuals differ from the rational individual model typically used in economics, and had drawn implications for financial markets. AACSB: Written and oral communication Status: 8e question 14 Copyright © 2025 Pearson Education, Inc.

8) Discuss the consensus on the adjustment process after the crisis. Answer: The crisis has raised a larger issue, about the adjustment process through which output returns to its natural level. If there is a consensus, it might be that with respect to small shocks and normal fluctuations, the adjustment process works, and policy can accelerate this return; but that, in response to large, exceptional shocks, the normal adjustment process may fail, the room for policy may be limited, and it may take a long time for the economy to repair itself. AACSB: Written and oral communication Status: 8e question 24.6

Current Directions of Research

1) Which of these is NOT listed in this chapter as a current and future research focus? A) Pricing of financial assets during bubbles B) Drawing lessons from the Covid-19 pandemic C) Solving complex models D) Exploring the implications of Keynes's view of the macroeconomy Answer: A AACSB: Application of knowledge Status: New question 9e 2) Which of the following economists spearheaded the construction very large datasets based on both private and public information, which allow for a better and more granular understanding of the economy? A) Emi Nakamura B) Raj Chetty C) Stefanie Stantcheva D) Jean Tirole Answer: B AACSB: Application of knowledge Status: New question 9e 3) Which of these economists is spearheading research that takes a new look at the U.S. Phillips curve? A) Stefanie Stantcheva B) Emi Nakamura C) Raj Chetty D) Jean Tirole Answer: B AACSB: Application of knowledge Status: New question 9e

4) Which of these economists is spearheading research that attempts to understand why some people oppose carbon taxes? A) Jean Tirole B) Emi Nakamura C) Raj Chetty D) Stefanie Stantcheva Answer: D AACSB: Application of knowledge Status: New question 9e

Macroeconomics, 9e (Blanchard) Appendix 1: An Introduction to the National Income and Product Accounts Multiple Choice Questions 1) If GDP exceeds GNP, we know with certainty that ________. A) a budget deficit exists B) a trade surplus exists C) a trade deficit exists D) receipts of factor income from the rest of the world exceed payments of factor income to the rest of the world Answer: D AACSB: Application of knowledge Status: 8e question 2) If GDP is less than GNP, we know with certainty that ________. A) a budget deficit exists B) a trade surplus exists C) a trade deficit exists D) none of these Answer: D AACSB: Application of knowledge Status: 8e question 3) Net national product (NNP) is equal to ________. A) personal income minus taxes B) GNP minus consumption of fixed capital C) GDP plus consumption of fixed capital D) national income plus consumption of fixed capital Answer: B AACSB: Application of knowledge Status: 8e question 4) Which of the following is not a component of consumption? A) nondurable goods B) purchase of a new condominium C) education expenses D) none of these Answer: B AACSB: Application of knowledge Status: 8e question

5) Changes in business inventories will be positive when ________. A) production exceeds sales B) production is less than sales C) a trade surplus exists D) a budget surplus exists Answer: A AACSB: Application of knowledge Status: 8e question 6) Suppose exports are greater than imports. Given this information, we know with certainty that ________. A) a trade surplus exists B) GNP > GDP C) GNP < GDP D) the change in business inventories is positive Answer: A AACSB: Application of knowledge Status: 8e question 7) Which of the following is not included in National Income? A) indirect taxes B) wages and salaries C) net interest D) rental income of persons Answer: A AACSB: Application of knowledge Status: 8e question 8) Which of the following is included in National Income? A) indirect taxes B) consumption of fixed capital C) proprietors' income D) all of these Answer: C AACSB: Application of knowledge Status: 8e question 9) Which of the following is not included in investment? A) the purchase of new equipment by firms B) nondurable goods C) the purchase of a new home D) none of these Answer: B AACSB: Application of knowledge Status: 8e question

10) If GDP is more than GNP, we know with certainty that ________. A) a budget deficit exists B) a trade surplus exists C) a trade deficit exists D) none of these Answer: D AACSB: Application of knowledge Status: 8e question 11) Changes in business inventories will be negative when ________. A) production exceeds sales B) production is less than sales C) a trade surplus exists D) a budget surplus exists Answer: B AACSB: Application of knowledge Status: 8e question 12) Suppose exports are less than imports. Given this information, we know with certainty that ________. A) a trade deficit exists B) GNP > GDP C) GNP < GDP D) the change in business inventories is positive Answer: A AACSB: Application of knowledge Status: 8e question

Macroeconomics, 9e (Blanchard) Appendix 2: A Math Refresher Multiple Choice Questions 1) A linear relation Y=X is represented by ________. A) the 45 degree line B) X axis C) Y axis D) a ray Answer: A AACSB: Analytical thinking Status: 8e question 2) In the linear consumption function C= c0 + c1YD, which of the following is not correct? A) c1 is marginal propensity to consume B) YD is disposable income C) c1 is the intercept D) c1 is the slope Answer: C AACSB: Analytical thinking Status: 8e question 3) Which of the following is not correct? A) GDP grows at a constant rate every year. B) A recession may lead to a few years of negative GDP growth. C) The evolution of GDP would be better represented by using a logarithmic scale. D) The Great Depression was not associated with a permanently lower level of output. Answer: A AACSB: Analytical thinking Status: 8e question 4) In the linear consumption function C= c0 + c1YD, which of the following is correct? A) c1 is marginal propensity to consume B) YD is real GDP C) c1 is the intercept D) c0 is the slope Answer: A AACSB: Analytical thinking Status: 8e question

5) If the evolution of X using logarithmic scale is a straight line, then ________. A) X is growing at a constant rate over time B) X is a linear function of time t C) X is growing at different rates over time D) none of these Answer: A AACSB: Analytical thinking Status: 8e question 6) If the evolution of X using logarithmic scale is not a straight line, then ________. A) X is growing at a constant rate over time B) X is a linear function of time t C) X is growing at different rates over time D) none of these Answer: C AACSB: Analytical thinking Status: 8e question

Macroeconomics, 9e (Blanchard) Appendix 3: An Introduction to Econometrics Multiple Choice Questions 1) "Ordinary least squares" is a technique that can be used to ________. A) identify the best model B) determine which variables in a model are endogenous and which are exogenous C) obtain a bar graph showing successive quarterly increases in output D) obtain a line describing consumption behavior in the real world E) determine the direction of causation between consumption and income Answer: D AACSB: Analytical thinking Status: 8e question 2) When we estimate a regression to determine the relationship between changes in consumption and changes in current income, we find that ________. A) there are no residuals B) the R2 is zero C) the MPC is larger than one D) all of these E) none of these Answer: E AACSB: Analytical thinking Status: 8e question 3) When we use ordinary least squares to determine the relationship between changes in consumption and changes in both current and lagged income, we find that ________. A) only current income influences current consumption B) current income has no impact on current consumption C) consumption is not affected by income in any quarter D) current income, last quarter's income, and income two quarter's ago all have the same impact on current consumption E) current income has a greater impact on consumption than income lagged one quarter Answer: E AACSB: Analytical thinking Status: 8e question 4) When estimating a regression line, a high R2‚ tells us we have ________. A) a good fit B) large residuals C) correctly determined the direction of causation D) all of these E) none of these Answer: A AACSB: Analytical thinking Status: 8e question 1 Copyright © 2025 Pearson Education, Inc.

5) A large "T-statistic" tell us that ________. A) a tiny change in the independent variable will cause a relatively large change in the dependent variable B) we do not have enough data to obtain an accurate regression line C) we can be confident that our estimated coefficient is not zero D) we should have included more "lags" in our model E) we have incorrectly switched the dependent and independent variables in our model Answer: C AACSB: Analytical thinking Status: 8e question 6) Which of the following problems would lead an economist to use instrument variable methods? A) The dependent variable has an impact on the independent variable. B) There are too few quarters of data. C) There are too many independent variables. D) The R2 is too high. E) The residuals are too small. Answer: A AACSB: Analytical thinking Status: 8e question 7) A key step in using instrument variable methods is to ________. A) find one or more exogenous variables that influence your dependent variable B) decrease the number of lags in the regression equation C) conduct interviews to determine how accurate your data really is D) run the regression on two different computers to see if the results differ E) eliminate the dependent variable Answer: A AACSB: Analytical thinking Status: 8e question