Macroeconomics, 11th edition Andrew B Abel Test Bank

Macroeconomics, 11th edition BY Andrew B. Abel

Email: richard@qwconsultancy.com

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 1 Introduction to Macroeconomics 1.1

What Macroeconomics Is About

1) Which of the following is not a topic of macroeconomics?

A) Why nations have different rates of growth.

B) What causes inflation and what can be done about it?

C) What factors contribute to the presence of monopolies in the economy?

D) Why unemployment periodically reaches very high levels.

Answer: C Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 2) The two major reasons for the tremendous growth in output in the U.S. economy over the last 125 years are A) population growth and low inflation.

B) population growth and increased productivity.

C) low unemployment and low inflation.

D) low inflation and low trade deficits.

Answer: B Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 3) The amount of output produced per unit of labor input is called A) the marginal revenue product of labor.

B) average labor productivity.

C) a util.

D) unit labor cost.

Answer: B Diff: 1 Topic: Section: 1.1 Question Status: New 4) The main reason that the United States has such a high standard of living is A) low unemployment.

B) high average labor productivity.

C) low inflation.

D) high government budget deficits.

Answer: B Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition

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5) Which of the following factors are most important for determining the economic growth of a country?

A) The country's level of resources B) The independence of the country's central bank C) The country's rates of saving and investment D) The level of sophistication of a country's financial markets Answer: C Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 6) Average labor productivity is the A) amount of workers per machine.

B) amount of machines per worker.

C) ratio of employed to unemployed workers.

D) amount of output per worker.

Answer: D Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 7) In analyzing macroeconomic data during the past year, you have discovered that average labor productivity fell, but total output increased. What was most likely to have caused this?

A) There is nothing unusual in this outcome because this is what normally occurs.

B) The capital—output ratio probably rose.

C) There was an increase in labor input.

D) Unemployment probably increased.

Answer: C Diff: 2 Topic: Section: 1.1 Question Status: Previous Edition 8) In which of the following periods did average labor productivity in the United States grow the fastest?

A) 1929 to 1935 B) 1949 to 1973 C) 1973 to 1995 D) 1995 to 2007 Answer: B Diff: 1 Topic: Section: 1.1 Question Status: Revised

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9) The most direct effect of an increase in the growth rate of average labor productivity would be an increase in A) the inflation rate.

B) the unemployment rate.

C) the long-run economic growth rate.

D) imported goods.

Answer: C Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 10) Short-run contractions and expansions in economic activity are called A) recessions.

B) expansions.

C) deficits.

D) the business cycle.

Answer: D Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 11) The business cycle describes the A) progression of an industry's structure from monopoly to perfect competition.

B) progression of an industry's structure from perfect competition to monopoly.

C) expansion and contraction of an individual industry within the economy.

D) expansion and contraction of economic activity in the economy as a whole.

Answer: D Diff: 1 Topic: Section: 1.1 Question Status: New 12) When national output rises, the economy is said to be in A) an expansion.

B) a deflation.

C) an inflation.

D) a recession.

Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition

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13) When national output declines, the economy is said to be in A) an expansion.

B) a deflation.

C) an inflation.

D) a recession.

Answer: D Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 14) Which of the following best describes a typical business cycle?

A) Economic expansions are followed by economic contractions.

B) Inflation is followed by unemployment.

C) Trade surpluses are followed by trade deficits.

D) Stagflation is followed by inflationary economic growth.

Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 15) Recessions A) are always followed by long periods of high rates of real economic growth.

B) almost never last more than two consecutive quarters.

C) cause the unemployment rate to increase.

D) do not occur in developed countries, including the United States.

Answer: C Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 16) During recessions, the unemployment rate ________ and output ________.

A) rises; falls B) rises; rises C) falls; rises D) falls; falls Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition

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17) The number of unemployed divided by the labor force equals A) the inflation rate.

B) the labor force participation rate.

C) the unemployment rate.

D) the misery index.

Answer: C Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 18) The unemployment rate is the A) number of unemployed divided by the number of employed.

B) number of employed divided by the number of unemployed.

C) number of unemployed divided by the labor force.

D) labor force divided by the number of unemployed.

Answer: C Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 19) The highest and most prolonged period of unemployment in the United States over the last 125 years occurred during A) World War II. B) the 1890s Depression.

C) the 1990-1991 recession.

D) the Great Depression of the 1930s.

Answer: D Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 20) During the Great Depression, the unemployment rate for the United States peaked at approximately A) 10%.

B) 70%.

C) 45%.

D) 25%.

Answer: D Diff: 2 Topic: Section: 1.1 Question Status: Previous Edition

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21) If a city has 3293 unemployed people and 73,177 in its labor force, then the city's unemployment rate equals A) 45.0%.

B) 4.5%.

C) 4.3%.

D) 0.45%.

Answer: B Diff: 2 Topic: Section: 1.1 Question Status: Previous Edition 22) If a city has 3293 unemployed people and 69,884 employed people, then the city's unemployment rate equals A) 45.0%.

B) 4.5%.

C) 4.3%.

D) 0.45%.

Answer: B Diff: 2 Topic: Section: 1.1 Question Status: Previous Edition 23) A country is said to be experiencing inflation when A) prices of most goods and services are rising over time.

B) prices of most goods and services are falling over time.

C) total output is rising over time.

D) total output is falling over time.

Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 24) From 1800 to 1940, the price level in the United States A) trended neither upward nor downward.

B) fluctuated wildly.

C) declined slowly.

D) increased slowly.

Answer: A Diff: 2 Topic: Section: 1.1 Question Status: Previous Edition

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25) The average price of goods in the United States A) was relatively constant over the 1800-1945 period.

B) was relatively constant over the decade of the 1980s.

C) declined over the decade of the 1970s.

D) is always constant in the long run.

Answer: A Diff: 2 Topic: Section: 1.1 Question Status: New 26) Before World War II, the average level of prices in the United States usually A) fell during wartime and rose during peacetime.

B) fell during wartime and fell during peacetime.

C) rose during wartime and fell during peacetime.

D) rose during wartime and rose during peacetime.

Answer: C Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 27) Historical evidence shows that consumer prices in the United States A) declined between the 1920s and World War II, but increased afterward.

B) increased between the 1920s and World War II, but declined afterward.

C) have shown a continuous inflationary pattern since the 1920s.

D) have displayed no clear-cut trend since the 1970s.

Answer: A Diff: 2 Topic: Section: 1.1 Question Status: New 28) A country is said to be experiencing inflation when A) prices of most goods and services are rising over time.

B) prices of most goods and services are falling over time.

C) total output is rising over time.

D) total output is falling over time.

Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition

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29) A country is said to be experiencing deflation when A) prices of most goods and services are rising over time.

B) prices of most goods and services are falling over time.

C) total output is rising over time.

D) total output is falling over time.

Answer: B Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 30) The inflation rate is the A) percent increase in the average level of prices over a year.

B) percent increase in output over a year.

C) percent increase in the unemployment rate over a year.

D) price level divided by the level of output.

Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 31) The inflation rate is the A) real interest rate minus the nominal interest rate.

B) percentage increase in the average level of prices over a year.

C) number of unemployed divided by the labor force.

D) labor force divided by the number of unemployed.

Answer: B Diff: 1 Topic: Section: 1.1 Question Status: New 32) If the price level was 100 in 2021 and 102 in 2022, the inflation rate was A) 102%.

B) 20%.

C) 2%.

D) 0.2%.

Answer: C Diff: 2 Topic: Section: 1.1 Question Status: Revised

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33) A closed economy is a national economy that A) doesn't interact economically with the rest of the world.

B) has a stock market that is not open to traders from outside the country.

C) has extensive trading and financial relationships with other national economies.

D) has not established diplomatic relations with other national economies.

Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 34) An open economy is a national economy that A) doesn't interact economically with the rest of the world.

B) has a stock market that is open to traders from anywhere in the world.

C) has extensive trading and financial relationships with other national economies.

D) has established diplomatic relations with most other national economies.

Answer: C Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 35) An economy that doesn't interact economically with the rest of the world is called ________ economy.

A) a closed B) an open C) a surplus D) an authoritarian Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 36) U.S. exports are goods and services A) produced abroad and sold to Americans.

B) produced in the United States and sold to Americans.

C) produced abroad and sold to foreigners.

D) produced in the United States and sold to foreigners.

Answer: D Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition

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37) U.S. imports are goods and services A) produced abroad and sold to Americans.

B) produced in the United States and sold to Americans.

C) produced abroad and sold to foreigners.

D) produced in the United States and sold to foreigners.

Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 38) Following World War I and World War II, the United States had a A) small trade surplus.

B) small trade deficit.

C) large trade deficit.

D) large trade surplus.

Answer: D Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 39) In the 1980s, 1990s, and 2000s, the United States has had a A) small trade surplus.

B) small trade deficit.

C) large trade deficit.

D) large trade surplus.

Answer: C Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 40) A country has a trade surplus when A) imports exceed exports.

B) imports equal exports.

C) exports exceed imports.

D) imports equal zero.

Answer: C Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition

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41) A country has a trade deficit when A) imports exceed exports.

B) imports equal exports.

C) exports exceed imports.

D) exports are zero.

Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 42) A country had imports of $50 billion, exports of $60 billion, and GDP of $300 billion. The trade surplus was what percent of GDP? A) 3.3%.

B) 10.0%.

C) 16.7%.

D) 20.0%.

Answer: A Diff: 2 Topic: Section: 1.1 Question Status: New 43) A country had imports of $20 billion, exports of $5 billion, and GDP of $300 billion. The trade deficit was what percent of GDP? A) -3.3%.

B) 3.3%.

C) 5.0%.

D) 50.0%.

Answer: C Diff: 2 Topic: Section: 1.1 Question Status: New 44) Data on exports and imports for the United States over the period from 1890 to 2021 show that A) the United States had large trade deficits throughout this entire period.

B) the United States had large trade surpluses throughout this entire period.

C) the percentage of total output exported by U.S. firms fell dramatically during World War I and World War II. D) a higher percentage of U.S. goods was exported in recent years than in years before 2000.

Answer: D Diff: 2 Topic: Section: 1.1 Question Status: Revised

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45) A central bank is an institution that A) pays for government expenditures.

B) controls a nation's monetary policy.

C) runs a country's stock market.

D) determines a nation's fiscal policy.

Answer: B Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 46) A country's monetary policy is controlled by A) private citizens.

B) the central bank.

C) large banks.

D) the legislature.

Answer: B Diff: 1 Topic: Section: 1.1 Question Status: New 47) In the United States, monetary policy is determined by A) the Federal Reserve.

B) the president.

C) private citizens.

D) the Treasury Department.

Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 48) The peak in U.S. government spending as a percent of GDP occurred during A) World War II. B) the 1960s war on poverty.

C) the Great Depression.

D) the pandemic recession in 2020.

Answer: A Diff: 1 Topic: Section: 1.1 Question Status: Revised

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49) Why were the U.S. government budget deficits of the 1980s and early 1990s so unusual from a historical point of view?

A) It was the first time the U.S. government had ever run deficits.

B) In the past, deficits were usually that large only in wartime.

C) It was the first time that deficits were accompanied by very high rates of inflation.

D) It was the first time that deficits diverted funds from other productive uses, such as investment in modern equipment.

Answer: B Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 50) Critics of the government's fiscal policies argued that government deficits A) prevented capital from flowing into the United States.

B) were linked to the excess of imports over exports that occurred in the 1980s.

C) caused the level of unemployment in the United States to increase during the 1980s.

D) had directly contributed to a decline in the level of demand in the American economy.

Answer: B Diff: 2 Topic: Section: 1.1 Question Status: Previous Edition 51) The government collected receipts of $100 billion and had expenditures of $125 billion. Its GDP was $400 billion. The government's deficit was what percent of GDP? A) 6.25%.

B) 12.5%.

C) 25.0%.

D) 100.0%.

Answer: A Diff: 2 Topic: Section: 1.1 Question Status: New 52) The difference between microeconomics and macroeconomics is that A) microeconomics looks at supply and demand for goods, macroeconomics looks at supply and demand for services.

B) microeconomics looks at prices, macroeconomics looks at inflation.

C) microeconomics looks at individual consumers, macroeconomics looks at national totals.

D) microeconomics looks at national issues, macroeconomics looks at global issues.

Answer: C Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition

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53) Aggregation is the process of A) calculating real GDP based on nominal GDP and the price index.

B) summing individual economic variables to obtain economywide totals.

C) forecasting the components of GDP. D) predicting when recessions will occur.

Answer: B Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 54) The process of adding together individual economic variables to obtain economywide totals is called A) macroeconomics.

B) aggregation.

C) agglomeration.

D) data development.

Answer: B Diff: 1 Topic: Section: 1.1 Question Status: New 55) Starting from a year in which gross domestic product for the economy is $8,000 billion, calculate how much output the national economy would produce in each of the next five years if it continued to grow at its potential real growth rate of 3%.

How much output would the economy produce in each year if it grew by 4% the first year, 2% the second year, 1% the third year, -1% the fourth year, and -3% the fifth year? (Note: A negative growth rate means output is declining.)

By the fifth year, how far is output below its potential level?

Answer: Potential Output (billions) Actual Output (billions) Year 1: $8,000 × 1.03 = $8,240 $8,000 × 1.04 = $8,320 Year 2: $8,240 × 1.03 = $8,487 $8,320 × 1.02 = $8,486 Year 3: $8,487 × 1.03 = $8,742 $8,486 × 1.01 = $8,571 Year 4: $8,742 × 1.03 = $9,004 $8,571 × 0.99 = $8,486 Year 5: $9,004 × 1.03 = $9,274 $8,486 × 0.97 = $8,231 [Note: Don't worry about rounding differences that arise in problems like this, because such differences depend on how many digits you carry over from one calculation to the next.]

Output is below potential output by [(9,274 - 8,231)/9,274] × 100% = 11.2%.

Diff: 2 Topic: Section: 1.1 Question Status: Previous Edition

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56) What are the major factors affecting the long-term growth of the economy's output?

Answer: The major factors are population growth and average labor productivity.

Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 57) Macroeconomic information for the economy of Anchovy is given below.

(a) What was the growth rate of average labor productivity in Anchovy between Year 1 and Year 2? (b) What was the inflation rate in Anchovy between Year 1 and Year 2? (c) What was the unemployment rate in Year 1? In Year 2?

Answer: (a) Average labor productivity: Year 1: 8000/700 = 80/7; Year 2: 9000/800 = 90/8; growth rate = [(90/8)/(80/7)] - 1 = -0.016 = -1.6% (b) Inflation rate: (9/8) - 1 = 0.125 = 12.5% (c) Unemployment rates: Year 1: 70/770 = 0.091 = 9.1%; Year 2: 100/900 = 0.111 = 11.1% Diff: 2 Topic: Section: 1.1 Question Status: Previous Edition 58) Using the CPI measure of the price level, which is 100 in the base year of 2019, calculate the annual inflation rates for (a) 2020, when the index is 103.7. (b) 2021, when the index is 105.5. (c) 2022, when the index is 107.7.

Answer: (a) Inflation in 2020 = (103.7 - 100.0)/100 × 100% = 3.7%. (b) Inflation in 2021 = (105.5 - 103.7)/103.7 × 100% = 1.7%. (c) Inflation in 2022 = (107.7 - 105.5)/105.5 × 100% = 2.1%.

Diff: 2 Topic: Section: 1.1 Question Status: Revised

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59) What is meant by aggregation? Why is aggregation important for macroeconomic analysis?

Answer: Aggregation refers to the process of adding together individual economic variables to obtain economywide totals. Aggregation distinguishes microeconomics from macroeconomics. It allows us to study the economy as a whole, rather than looking at its individual parts.

Diff: 1 Topic: Section: 1.1 Question Status: Previous Edition 1.2

What Macroeconomists Do

1) Many people perceive erroneously that most macroeconomists spend a lot of time engaged in A) forecasting.

B) macroeconomic research.

C) macroeconomic analysis.

D) data development.

Answer: A Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition 2) Of these areas of macroeconomics, which employs the fewest economists?

A) Macroeconomic forecasting B) Macroeconomic analysis C) Macroeconomic research Answer: A Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition 3) The most difficult part of forecasting is A) lack of computing power.

B) not enough theoretical models.

C) insufficient data on the economy.

D) the complexity of the economy.

Answer: D Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition

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4) A macroeconomist who is employed at a university is most likely to be primarily engaged in which of these tasks?

A) Macroeconomic forecasting B) Macroeconomic analysis C) Macroeconomic research D) Macroeconomic data development Answer: C Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition 5) The main function of public-sector macroeconomic analysts is to A) assist in policymaking.

B) find ways to increase corporate profits.

C) engage in theoretical research.

D) forecast the developments in industries.

Answer: A Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition 6) The main goal of macroeconomic research is to A) predict how the macroeconomy will perform in the future.

B) analyze current macroeconomic data.

C) develop new data that can be used to understand better the operation of the economy.

D) make general statements about how the economy works.

Answer: D Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition 7) A set of ideas about the economy that have been organized in a logical framework is called A) empirical analysis.

B) a methodology.

C) economic theory.

D) data development.

Answer: C Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition

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8) A simplified description of some aspect of the economy is called A) empirical analysis.

B) a methodology.

C) an economic model.

D) data development.

Answer: C Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition 9) Assumptions for economic theories and models should be A) rejected if they are not totally realistic.

B) logical rather than empirically testable.

C) simple and reasonable rather than complex.

D) maintained until overwhelming evidence to the contrary occurs.

Answer: C Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition 10) Testing a theory by comparing the theory's implications with data obtained in the real world is called A) empirical analysis.

B) descriptive calibration.

C) historical variance analysis.

D) univariate analysis.

Answer: A Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition 11) If the theory behind an economic model fits the data poorly, you would probably want to A) use the theory to predict what would happen if the economic setting or economic policies change.

B) start from scratch with a new model.

C) enrich the model with additional assumptions.

D) restate the research question.

Answer: B Diff: 2 Topic: Section: 1.2 Question Status: Previous Edition

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12) Why is macroeconomic forecasting so difficult? Does this difficulty mean economics is a worthless field of study?

Answer: Forecasting is difficult because our understanding of how the economy works is imperfect and because it's impossible to take into account all the factors that might affect future economic trends. This just means the field of economics is difficult and complex, not that it's worthless.

Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition 13) What are the four major areas in which macroeconomists work? Give an example of a job in each.

Answer: The four areas are forecasting, analysis, research, and data development. Forecasting: forecasting the stock market on Wall Street; analysis: analyzing the economy for the Federal Reserve; research: investigating the link between the trade deficit and the government budget deficit as a university professor; data development: working at the Bureau of Labor Statistics to develop better ways to measure unemployment.

Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition 14) Match each of the following jobs to its major area: forecasting, analysis, research, or data development. Explain your answers. (a) Economist at university, testing theories about the efficient allocation of resources in the foreign exchange market (b) Economist at Wall Street firm trying to predict the rate of inflation next year using past data (c) Economist at auto firm looking at demand for new automobiles (d) Economist at the International Trade Commission trying to determine whether foreign firms are dumping goods in the United States (e) Economist at the Commerce Department developing new methods for calculating price indexes (f) Economist consulting in Eastern Europe about how to set up free-market financial systems Answer: (a) Research (b) Forecasting (c) Analysis (d) Analysis (e) Data development (f) Analysis Diff: 2 Topic: Section: 1.2 Question Status: Previous Edition

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15) Briefly describe the following tasks of macroeconomists: forecasting; analysis; research; and data development.

Answer: (a) Forecasting. Macroeconomists develop models to predict the future values of macroeconomic variables in one or more markets. These models are usually based on economic theory but are statistical in form and estimated using macroeconomic data. (b) Analysis. Macroeconomists analyze changes in macroeconomic policies as well as other changes in macroeconomic market conditions. This analysis is based on economic theory, uses analytic reasoning techniques, and may rely on forecasting models. (c) Research. The goal of macroeconomic research is to make general statements about how the economy works. Research economists formulate and test theories. (d) Data development. Macroeconomic data development provides the data needed in macroeconomic research, analysis, and forecasting. Most macroeconomic data are collected and published by the government.

Diff: 1 Topic: Section: 1.2 Question Status: Previous Edition 1.3

Why Macroeconomists Disagree

1) Positive analysis of economic policy A) examines the economic consequences of policies but does not address the question of whether those consequences are desirable.

B) examines the economic consequences of policies and addresses the question of whether those consequences are desirable.

C) generates less agreement among economists than normative analysis.

D) is rare in questions of economic policy.

Answer: A Diff: 1 Topic: Section: 1.3 Question Status: Previous Edition 2) Which of the statements below is primarily normative in nature?

A) There is an unequal distribution of income in the United States.

B) The distribution of income is more unequal in the United States than it is in Japan.

C) The inequality of income that exists in the United States is partly caused by an unequal distribution of wealth.

D) The distribution of income in the United States should be more equal than it is.

Answer: D Diff: 2 Topic: Section: 1.3 Question Status: Previous Edition

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3) The principal distinction between positive analysis and normative analysis is that A) positive analysis is useful and normative analysis is not useful.

B) positive analysis is optimistic and normative analysis is neutral.

C) economists always agree on the conclusions of positive analysis but could disagree on the conclusions of normative analysis.

D) positive analysis tells us "what is," but normative analysis tells us "what ought to be."

Answer: D Diff: 1 Topic: Section: 1.3 Question Status: Previous Edition 4) Equilibrium in the economy means A) unemployment is zero.

B) quantities demanded and supplied are equal in all markets.

C) prices are not changing over time.

D) tax revenues equal government spending, so the government has no budget deficit.

Answer: B Diff: 1 Topic: Section: 1.3 Question Status: Previous Edition 5) In equilibrium A) there is no pressure for wages or prices to change.

B) inflation is zero.

C) GDP growth is zero.

D) the unemployment rate is zero.

Answer: A Diff: 1 Topic: Section: 1.3 Question Status: Previous Edition 6) Adam Smith's idea of the "invisible hand" says that given a country's resources and its initial distribution of wealth, the use of markets will A) insulate a nation from the effects of political instability.

B) eliminate problems of hunger and dissatisfaction.

C) eliminate inequalities between the rich and the poor.

D) make people as economically well off as possible.

Answer: D Diff: 1 Topic: Section: 1.3 Question Status: Previous Edition

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7) The two most comprehensive, widely accepted macroeconomic models are A) the classical model and the supply-side model.

B) the supply-side model and the real business cycle model.

C) the classical model and the Keynesian model.

D) the Austrian model and the Keynesian model.

Answer: C Diff: 1 Topic: Section: 1.3 Question Status: Previous Edition 8) Classical economists argue that A) the government should have an active role in the economy.

B) government policies will be ineffective or counterproductive.

C) the government should actively intervene in the economy to eliminate business cycles.

D) wages and prices don't adjust quickly, so the economy is slow to return to equilibrium.

Answer: B Diff: 2 Topic: Section: 1.3 Question Status: Revised 9) The classical approach to macroeconomics assumes that A) wages, but not prices, adjust quickly to balance quantities supplied and demanded in markets.

B) wages and prices adjust quickly to balance quantities supplied and demanded in markets.

C) prices, but not wages, adjust quickly to balance quantities supplied and demanded in markets.

D) neither wages nor prices adjust quickly to balance quantities supplied and demanded in markets.

Answer: B Diff: 1 Topic: Section: 1.3 Question Status: Previous Edition 10) Classical economists who assume the "invisible hand" works reasonably well do not argue that A) wages and prices adjust quickly to bring the economy back to equilibrium.

B) the government should actively intervene in the economy to eliminate business cycles.

C) government policies will be ineffective and counterproductive.

D) the government should have a limited role in the economy.

Answer: B Diff: 1 Topic: Section: 1.3 Question Status: Previous Edition

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11) John Maynard Keynes disagreed with the classical economists because he believed that A) wages and prices adjust slowly.

B) international trade plays a major role in the macroeconomy.

C) government intervention in the economy cannot reduce business cycles.

D) unemployment will be eliminated quickly by the invisible hand of the market.

Answer: A Diff: 1 Topic: Section: 1.3 Question Status: Previous Edition 12) Keynes was motivated to create a macroeconomic theory different from classical theory because A) he believed in government intervention in the economy.

B) he believed in the idea of the invisible hand.

C) monetary policy was more important than the classicals acknowledged.

D) classical theory was inconsistent with the data in the Great Depression.

Answer: D Diff: 1 Topic: Section: 1.3 Question Status: Previous Edition 13) Keynes assumed that wages and prices were slow to adjust in order to explain A) persistently high unemployment.

B) high inflation.

C) the high level of interest rates.

D) why inflation fell in recessions.

Answer: A Diff: 2 Topic: Section: 1.3 Question Status: Previous Edition 14) How did Keynes propose to solve the problem of high unemployment?

A) Increase the growth rate of the money supply.

B) Allow wages to decline, so that firms will want to hire more workers.

C) Put on wage and price controls, so wages won't rise and firms won't have to lay people off to cut costs.

D) Have the government increase its demand for goods and services.

Answer: D Diff: 2 Topic: Section: 1.3 Question Status: Previous Edition

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15) The primary factor that caused most economists to lose their faith in the classical approach to macroeconomic policy was A) the high levels of unemployment that occurred during the Great Depression.

B) the presence of both high unemployment and high inflation during the 1970s.

C) the theoretical proof that classical ideas were invalid.

D) the evidence that classical ideas were useful during economic booms, but not during economic recessions.

Answer: A Diff: 2 Topic: Section: 1.3 Question Status: Previous Edition 16) The primary factor that caused some economists to lose their faith in the Keynesian approach to macroeconomic policy was A) the high levels of unemployment that occurred during the Great Depression.

B) the presence of both high unemployment and high inflation during the 1970s.

C) theoretical proof that Keynes's ideas were invalid.

D) evidence that Keynes's ideas were useful during economic recessions, but not during economic booms.

Answer: B Diff: 2 Topic: Section: 1.3 Question Status: Previous Edition 17) Stagflation is a situation of A) high unemployment and high inflation.

B) high unemployment and low inflation.

C) low unemployment and high inflation.

D) low unemployment and low inflation.

Answer: A Diff: 2 Topic: Section: 1.3 Question Status: Previous Edition

24 .

18) Determine whether each of the following is a positive or normative statement. (a) The Fed should lower interest rates to increase economic growth, because we're in a recession. (b) Higher government budget deficits cause higher interest rates. (c) The trade deficit should decline because of the fall in the value of the dollar. (d) Because of our high inflation rate, we must reduce the rate of money growth. (e) A generous unemployment insurance system is a primary cause of high unemployment in Europe. (f) Increased average labor productivity in a country should lead to faster growth. (g) Government budget deficits are too high in the United States and should be reduced.

Answer: (a) Normative (b) Positive (c) Positive (d) Normative (e) Positive (f) Positive (g) Normative Diff: 2 Topic: Section: 1.3 Question Status: Previous Edition 19) Why is wage and price flexibility crucial to the idea of the "invisible hand"?

Answer: Wage and price flexibility is crucial because in a free-market system, changes in wages and prices are the signals that coordinate the actions of people and businesses in the economy.

Diff: 1 Topic: Section: 1.3 Question Status: Previous Edition 20) Discuss the major differences between classical and Keynesian economists. Be sure to explain how they differ with regard to how quickly equilibrium is restored in the economy as well as what role they see for government action in restoring equilibrium.

Answer: Classical and Keynesian economists differ most with regard to how quickly they see wages and prices adjusting to restore equilibrium in the economy. Classical economists think that when the economy is out of equilibrium, wages and prices adjust quickly to restore equilibrium.

As a result, there shouldn't be long periods of abnormally high unemployment. The quick return to equilibrium means there is no reason for government action. Keynesians, on the other hand, think wages and prices are slow to adjust. As a result, the economy may be out of equilibrium for some time, perhaps with high unemployment. To restore equilibrium quickly may necessitate some government action, such as increasing the government's demand for goods and services.

Diff: 2 Topic: Section: 1.3 Question Status: Previous Edition

25 .

21) Compare and contrast the classical and Keynesian schools of thought for the following economic issues. (a) The flexibility of wages and prices. (b) The importance of macroeconomic policies.

Answer: (a) The flexibility of wages and prices is a principal point of disagreement between classical economists and Keynesians. Classical economists believe that wages and prices are quite flexible; in response to a change in market conditions, wages and prices adjust quickly to their new market-clearing levels. Keynesians believe that wages and prices are rigid or sticky; in response to changes in the economy, wages and prices adjust slowly to their new market-clearing levels. (b) Classicals and Keynesians also disagree about the use of macroeconomic policies. Given wage-price flexibility, classical economists believe that the market economy normally provides for full employment. They believe that government intervention in the form of macroeconomic fiscal and monetary policies is not needed to prevent recessions. Given slow adjustments in wages and prices, Keynesians believe that recessions could plague the economy for several years. They believe that efficient use of macroeconomic policies could return the economy to equilibrium more quickly.

Diff: 2 Topic: Section: 1.3 Question Status: Previous Edition 22) In 1993, the debate heated up in the United States about the North American Free Trade Agreement (NAFTA), which proposed to reduce barriers to trade (such as taxes on or limits to imports) among Canada, the United States, and Mexico. Some people opposed strongly the agreement, arguing that an influx of foreign goods under NAFTA would disrupt the U.S. economy, harm domestic industries, and throw American workers out of work. How might a classical economist respond to these concerns? Would you expect a Keynesian economist to be more or less sympathetic to these concerns than the classical economist? Why? Answer: A classical economist might argue that the economy would work more efficiently with NAFTA because it reduces trade barriers, making the invisible hand work even better. Workers could specialize even more than before so that total output produced by all three countries would be more. Though the industrial mix might change in each country, wages and prices across industries would adjust quickly, and people in industries that closed down in a particular country would quickly find new jobs.

A Keynesian economist might be more sympathetic to concerns about NAFTA because of the belief that adjustment to the changes will not occur quickly. As a result, people in particular industries in a country may become unemployed. Wages won't adjust quickly to restore full employment, so some government action (like retraining programs to give displaced workers new skills) may be desirable.

Diff: 2 Topic: Section: 1.3 Question Status: Previous Edition

26 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 2 The Measurement and Structure of the National Economy 2.1

National Income Accounting

1) The accounting framework used in measuring current economic activity is called A) the U.S. expenditure accounts.

B) the national income accounts.

C) the flow of funds accounts.

D) the balance of payments accounts.

Answer: B Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 2) The three approaches to measuring economic activity are the A) cost, income, and expenditure approaches.

B) product, income, and expenditure approaches.

C) consumer, business, and government approaches.

D) private, public, and international approaches.

Answer: B Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 3) The value of a producer's output minus the value of the inputs it purchases from other producers is called the producer's A) surplus.

B) profit.

C) value added.

D) gross product.

Answer: C Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 4) The value added of a producer is the A) total amount for which all its products sell minus its change in inventories.

B) value of its total sales once externalities are accounted for.

C) value of its output minus the value of the inputs it purchases from other producers.

D) quality-adjusted amount of its total sales less any commissions paid.

Answer: C Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition

1 .

5) The product approach to calculating GDP A) adds together the market values of final goods and services produced by domestic and foreign-owned factors of production within the nation in some time period.

B) includes the market value of goods and services produced by households for their own consumption but excludes the value of the underground economy.

C) is superior to the income approach because, unlike the income approach, it gives us the real value of output.

D) adds together the market values of final goods, intermediate goods, and goods added to inventories.

Answer: A Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 6) NIPA data A) are never revised.

B) are revised once.

C) are revised twice.

D) are revised many times.

Answer: D Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 7) NIPA annual revisions usually occur A) every January.

B) every April.

C) every July.

D) every October.

Answer: C Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 8) NIPA benchmark revisions are those that A) affect data back in time, sometimes as long ago as 1947.

B) use income-tax information.

C) incorporate changes in seasonal factors.

D) are the final revision of the data.

Answer: A Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition

2 .

9) When the NIPA data incorporate changes in data-construction methods or a new base year, the revisions are called A) annual revisions.

B) benchmark revisions.

C) first final revisions.

D) preliminary revisions.

Answer: B Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 10) The Bigdrill company drills for oil, which it sells for $200 million to the Bigoil company to be made into gas. The Bigoil company's gas is sold for a total of $600 million. What is the total contribution to the country's GDP from companies Bigdrill and Bigoil?

A) $200 million B) $400 million C) $600 million D) $800 million Answer: C Diff: 2 Topic: Section: 2.1 Question Status: Previous Edition 11) Sam's Semiconductors produces computer chips, which it sells for $10 million to Carl's Computer Company (CCC). CCC's computers are sold for a total of $16 million. What is the value added of CCC? A) $6 million B) $10 million C) $16 million D) $26 million Answer: A Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 12) The A company collects bushels of wild berries, which it sells for $2 million to the B company to be made into jam. The B company's wild berry jam is sold for a total of $6 million.

What is the total contribution to the country's GDP from companies A and B? A) $2 million B) $4 million C) $6 million D) $8 million Answer: C Diff: 1 Topic: Section: 2.1 Question Status: New 3 .

13) The Compagnie Naturelle sells mounted butterflies, using butterfly bait it buys from another firm for $20,000. It pays its workers $35,000, pays $1000 in taxes, and has profits of $3000.

What is its value added?

A) $3000 B) $19,000 C) $39,000 D) $59,000 Answer: C Diff: 2 Topic: Section: 2.1 Question Status: Previous Edition 14) The equation total production = total income = total expenditure is called A) the goods-market equilibrium condition.

B) the total identity.

C) the fundamental identity of national income accounting.

D) Say's Law. Answer: C Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 15) The fundamental identity of national income accounting is A) total production = total income - total expenditure.

B) total production = total income + total expenditure.

C) total production = total income = total expenditure.

D) total production = total income/total expenditure.

Answer: C Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 16) Unlike final goods and services, intermediate goods and services A) are purchased by businesses.

B) are purchased by the government.

C) are not exported.

D) are completely used up in the current time period.

Answer: D Diff: 1 Topic: Section: 2.1 Question Status: New

4 .

17) To ensure that the fundamental identity of national income accounting holds, changes in inventories are A) treated as part of expenditure.

B) treated as part of saving.

C) ignored.

D) counted as consumption.

Answer: A Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 18) One problem with using market values to measure GDP is that A) you cannot compare completely heterogeneous goods by using their dollar values.

B) some useful goods and services are not sold in markets.

C) prices for some goods change every year.

D) market values of exported goods are usually priced in foreign currencies.

Answer: B Diff: 1 Topic: Section: 2.1 Question Status: Previous Edition 19) Describe the three different approaches to measuring the amount of economic activity that occurs during a period of time and explain why they all give identical measurements.

Answer: The approaches are the product approach, which measures the amount of output produced; the income approach, which measures the incomes received by producers of output; and the expenditure approach, which measures the amount of spending by the ultimate purchasers of output. They give identical measurements because everything that is produced is purchased by someone, so the expenditure and product approaches must be equal, and because anything that is purchased means that someone is earning income in the same amount, so the expenditure and income approaches must be equal.

Diff: 2 Topic: Section: 2.1 Question Status: Previous Edition

5 .

2.2

Gross Domestic Product

1) To what extent are household production and child-rearing accounted for in the government's GDP accounts?

A) Not at all B) Only to the extent that they are provided for pay C) Only to the extent that taxes are paid on them D) All household production and child-rearing are accounted for.

Answer: B Diff: 1 Topic: Section: 2.2 Question Status: Revised 2) The measurement of GDP includes A) nonmarket goods such as household production and child-rearing.

B) the benefits of clean air and water.

C) estimated values of activity in the underground economy.

D) purchases and sales of goods produced in previous periods.

Answer: C Diff: 1 Topic: Section: 2.2 Question Status: Revised 3) Which of the following is included in U.S. GDP? A) The sale of a new car from a manufacturer's inventory B) The purchase of a watch from a Swiss company C) The sale of a used car D) A newly constructed house Answer: D Diff: 1 Topic: Section: 2.2 Question Status: Previous Edition 4) Government statisticians adjust GDP figures to include estimates of A) the value of household production.

B) the underground economy.

C) child-rearing services provided by stay-at-home parents.

D) the costs of pollution to society.

Answer: B Diff: 2 Topic: Section: 2.2 Question Status: Revised

6 .

5) Because government services are not sold in markets, A) they are excluded from measurements of GDP. B) the government tries to estimate their market value and uses this to measure the government's contribution to GDP. C) they are valued at their cost of production.

D) taxes are used to value their contribution.

Answer: C Diff: 1 Topic: Section: 2.2 Question Status: Previous Edition 6) Intermediate goods are A) capital goods, which are used up in the production of other goods but were produced in earlier periods.

B) final goods that remain in inventories.

C) goods that are used up in the production of other goods in the same period that they were produced.

D) either capital goods or inventories.

Answer: C Diff: 1 Topic: Section: 2.2 Question Status: Previous Edition 7) Capital goods are A) a type of intermediate good.

B) final goods, because they are not used up during a given year.

C) produced in the same year as the related final good, whereas intermediate goods are produced in different years.

D) produced in one year, whereas final goods are produced over a period of more than one year.

Answer: B Diff: 1 Topic: Section: 2.2 Question Status: Previous Edition 8) Capital goods are A) not counted in GDP as final goods.

B) not used to produce other goods.

C) used up in the same period that they are produced.

D) goods used to produce other goods.

Answer: D Diff: 1 Topic: Section: 2.2 Question Status: Previous Edition

7 .

9) Marvin's Metal Company produces screws that it sells to Ford, which uses the screws as a component of its cars. In the national income accounts, the screws are classified as A) inventory.

B) final goods.

C) capital goods.

D) intermediate goods.

Answer: D Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition 10) Larry's Lathe-makers Limited produces lathes, which are purchased by furniture manufacturers all over the world. The standard lathe depreciates over a twenty-five-year period.

In the national income accounts, the lathes are classified as A) inventory.

B) raw materials.

C) capital goods.

D) intermediate goods.

Answer: C Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition 11) Fred the farmer purchased five new tractors at $20,000 each. Fred sold his old tractors to other farmers for $50,000. The net increase in GDP of these transactions was A) $50,000.

B) $100,000.

C) $125,000.

D) $150,000.

Answer: B Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition 12) Beautiful Boating purchases five new boats at $200,000 each to rent to vacationers. The firm sells its old boats to the public for $500,000. The net increase in GDP of these transactions was A) $500,000.

B) $1,000,000.

C) $1,250,000.

D) $1,500,000.

Answer: B Diff: 2 Topic: Section: 2.2 Question Status: New

8 .

13) Inventories include each of the following except A) unsold finished goods.

B) goods in process.

C) raw materials held by firms.

D) office equipment.

Answer: D Diff: 1 Topic: Section: 2.2 Question Status: Previous Edition 14) GDP differs from GNP because A) GDP = GNP - net factor payments from abroad.

B) GNP = GDP - net factor payments from abroad.

C) GDP = GNP - capital consumption allowances.

D) GNP = GDP - capital consumption allowances.

Answer: A Diff: 1 Topic: Section: 2.2 Question Status: Previous Edition 15) If an American construction company built a road in Kuwait, this activity would be A) excluded from U.S. GNP. B) fully included in U.S. GDP. C) included in U.S. GNP only for that portion that was attributable to American capital and labor.

D) included in U.S. GDP but not in U.S. GNP. Answer: C Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition 16) Suppose Toyota builds a new automobile plant in Mexico using Japanese management practices, American capital, and Mexican labor. Which of the following statements is true?

A) The portion of output contributed by American capital would be included in American GDP. B) The portion of output contributed by Japanese management would be included in both Japanese GNP and GDP. C) The portion of output contributed by Japanese management would be included in neither Japanese GNP nor GDP. D) The portion of output contributed by Mexican labor would be included in both Mexican GNP and GDP. Answer: D Diff: 2 Topic: Section: 2.2 Question Status: New

9 .

17) Nations such as Egypt and Turkey may have wide differences between GNP and GDP because both the countries A) have a high level of imports and exports relative to GNP. B) have a large portion of their GNP produced by multinational corporations.

C) have a large number of citizens working abroad.

D) purchase large amounts of military wares from other countries.

Answer: C Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition 18) If C = $500, I = $150, G = $100, NX = $40, and GNP = $800, how much is NFP? A) -$10 B) -$5 C) $5 D) $10 Answer: D Diff: 3 Topic: Section: 2.2 Question Status: Previous Edition 19) If C = $250, I = $50, G = $60, NX = -$20, and NFP = $5, how much is GNP? A) $365 B) $335 C) $340 D) $345 Answer: D Diff: 3 Topic: Section: 2.2 Question Status: Previous Edition 20) If C = $400, I = $100, G = $50, NX = $30, and NFP = $5, how much is GDP? A) $580 B) $575 C) $585 D) $550 Answer: A Diff: 3 Topic: Section: 2.2 Question Status: Previous Edition

10 .

21) The income-expenditure identity says that A) Y = C + S + T. B) Y = C + I + G. C) Y = C + I + G + NX. D) Y = C + I + G + NX + CA. Answer: C Diff: 1 Topic: Section: 2.2 Question Status: Previous Edition 22) Which of the following is not a category of consumption spending in the national income accounts?

A) Consumer durables B) Nondurable goods C) Services D) Housing purchases Answer: D Diff: 1 Topic: Section: 2.2 Question Status: Previous Edition 23) Consumer spending is spending by ________ households on final goods and services produced ________.

A) domestic; domestically and abroad B) domestic; domestically C) domestic and foreign; domestically and abroad D) domestic and foreign; domestically Answer: A Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition 24) Business fixed investment includes purchases of A) capital equipment and structures.

B) land and energy.

C) long-term bonds.

D) inventories.

Answer: A Diff: 1 Topic: Section: 2.2 Question Status: Previous Edition

11 .

25) In the expenditure approach to GDP, which of the following would be excluded from measurements of GDP? A) Government payments for goods produced by foreign firms B) Government payments for goods produced by firms owned by state or local governments C) Government payments for welfare D) All government payments are included in GDP. Answer: C Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition 26) Net national product equals A) gross national product minus statistical discrepancy.

B) gross national product minus depreciation.

C) national income minus taxes on production and imports.

D) national income plus depreciation.

Answer: B Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition 27) National income equals A) net national product minus statistical discrepancy.

B) gross national product minus depreciation.

C) GNP minus depreciation and taxes on production and imports.

D) net national product minus taxes on production and imports and employer contributions to Social Security.

Answer: A Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition 28) Monica grows coconuts and catches fish. Last year she harvested 1500 coconuts and 600 fish. She values one fish as having a worth of three coconuts. She gave Rachel 300 coconuts and 100 fish for helping her to harvest coconuts and catch fish, all of which were consumed by Rachel. In terms of fish, Monica's income would equal A) 700 fish.

B) 900 fish.

C) 1100 fish.

D) 2700 fish.

Answer: B Diff: 3 Topic: Section: 2.2 Question Status: Previous Edition

12 .

29) Monica grows coconuts and catches fish. Last year she harvested 1500 coconuts and 600 fish. She values one fish as having a worth of three coconuts. She gave Rachel 300 coconuts and 100 fish for helping her to harvest coconuts and catch fish, all of which were consumed by Rachel. Monica consumed the remaining fish and coconuts. In terms of fish, total consumption by both Monica and Rachel would equal A) 700 fish.

B) 900 fish.

C) 1100 fish.

D) 2700 fish.

Answer: C Diff: 3 Topic: Section: 2.2 Question Status: Previous Edition 30) Monica grows coconuts and catches fish. Last year she harvested 1500 coconuts and 600 fish. She values one fish as having a worth of three coconuts. She gave Rachel 300 coconuts and 100 fish for helping her to harvest coconuts and catch fish, all of which were consumed by Rachel. Monica set aside 200 fish to help with next year's harvest. In terms of fish, consumption would equal A) 700 fish.

B) 900 fish.

C) 1100 fish.

D) 2700 fish.

Answer: B Diff: 3 Topic: Section: 2.2 Question Status: Previous Edition 31) Private disposable income equals A) GNP - taxes + transfers + interest.

B) NNP - taxes + transfers + interest.

C) national income - taxes + transfers + interest.

D) national income - taxes - transfers + interest.

Answer: A Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition

13 .

32) Carl's Computer Center sells computers to business firms. Businesses then use the computers to produce other goods and services. Over the past year, sales representatives were paid $3.5 million, $0.5 million went for rent on the building, $0.5 million went for taxes, $0.5 million was profit for Carl, and $10 million was paid for computers at the wholesale level. What was the firm's total contribution to GDP? Answer: $5 million. Note that the $10 million paid for computers is not part of value added.

Note also that the fact that the firm produces an intermediate good doesn't mean that it doesn't contribute to GDP. Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition 33) Pete the Pizza Man produced $87,000 worth of pizzas in the past year. He paid $39,000 to employees, paid $11,000 for vegetables and other ingredients, and paid $5000 in taxes. He began the year with ingredient inventories valued at $1000, and ended the year with inventories valued at $2000. What was Pete's (and his employees') total contribution to GDP this year?

Answer: $87,000 - $11,000 paid for intermediate goods + $1000 change in inventories = $77,000.

Diff: 2 Topic: Section: 2.2 Question Status: Previous Edition 34) What is the main conceptual difference between GDP and GNP? How different are GDP and GNP for the United States? For countries with many citizens who work abroad?

Answer: GDP represents output produced within a country, while GNP represents output produced by a country's factors of production; the difference is net factor payments from abroad.

For the United States there's little difference, but for countries that have many citizens working abroad, there may be a big difference.

Diff: 1 Topic: Section: 2.2 Question Status: Previous Edition

14 .

35) Citizens of the country of Heehaw produce hay and provide entertainment services (banjo playing). In one year they produced $15 million worth of hay, with $11 million consumed domestically and the other $4 million sold to neighboring countries. They provided $7 million worth of banjo-playing services, $5 million in Heehaw, and $2 million in neighboring countries.

They purchased $6 million worth of soda pop from neighboring countries.

Calculate the magnitudes of GNP, GDP, net factor payments from abroad, net exports, and the current account balance.

Answer: GNP is output by citizens, which equals $15 million + $7 million = $22 million. GDP is output produced in the country, which equals $15 million (hay) + $5 million (domestic banjo playing) = $20 million. Net factor payments from abroad represent the difference between GNP and GDP; this is the $2 million paid for banjo playing in other countries. Net exports are $4 million (hay sold abroad) minus $6 million (soda pop imports) = -$2 million. (Note that banjo playing abroad is not part of GDP, so it is not part of net exports either.) The current account balance is net exports + net factor payments = -$2 million + $2 million = 0.

Diff: 3 Topic: Section: 2.2 Question Status: Previous Edition 36) In the country of Kwaki, people produce canoes, fish for salmon, and grow corn. In one year they produced 5000 canoes using labor and natural materials only, but sold only 4000, as the economy entered a recession. The cost of producing each canoe was $1000, but the ones that sold were priced at $1250. They fished $30 million worth of salmon. They used $3 million of the salmon as fertilizer for corn. They grew and ate $55 million of corn. What was Kwaki's GDP for the year?

Answer: Inventories are valued at the cost of production, so the 1000 canoes in inventory were valued at $1000 each, for a total of $1 million. Four thousand canoes at $1250 each totaled $5 million. Salmon as a final good were worth $27 million (the other $3 million were used up as an intermediate good), and corn worth $55 million was grown. So total GDP (in millions) was $1 + $5 + $27 + $55 = $88 million.

Diff: 3 Topic: Section: 2.2 Question Status: Previous Edition

15 .

37) In one year in the country of Countem, workers earned $4150, proprietor's income was $392, rental income was $20, corporate profits were $683, net interest was $228, taxes on production and imports were $329, business current transfer payments were $12, the current surplus of government enterprises was $3, statistical discrepancy was $28, consumption of fixed capital was $882, factor income received from the rest of the world was $331, and payments of factor income to the rest of the world was $623. Based on these data, compute national income, net national product, gross national product, and gross domestic product.

Answer: The first eight items sum to national income, which equals $5817. Adding the statistical discrepancy to national income gives net national product, which is thus $5845.

Adding consumption of fixed capital to that gives gross national product, which is thus 6727.

Subtract net factor income, which equals factor income received from the rest of the world minus payments of factor income to the rest of the world ($331 - $623 = -$292), from gross national product equals gross domestic product, which is thus $7019.

Diff: 3 Topic: Section: 2.2 Question Status: Previous Edition 2.3

Saving and Wealth

1) The value of a household's assets minus the value of its liabilities is called A) wealth.

B) income.

C) debt.

D) stock.

Answer: A Diff: 1 Topic: Section: 2.3 Question Status: Previous Edition 2) Private saving is defined as A) private disposable income minus consumption.

B) net national product minus consumption.

C) private disposable income minus consumption plus interest.

D) private disposable income minus consumption plus interest plus transfer payments.

Answer: A Diff: 1 Topic: Section: 2.3 Question Status: Previous Edition

16 .

3) In a given year, a country's GDP = $9841, net factor payments from abroad = $889, taxes = $869, transfers received from the government = $296, interest payments on the government's debt = $103, consumption = $8148, and government purchases = $185. The country had private saving equal to A) $285.

B) $3850.

C) $2397.

D) $2112.

Answer: D Diff: 2 Topic: Section: 2.3 Question Status: Previous Edition 4) In a given year, a country's GDP = $9841, net factor payments from abroad = $889, taxes = $869, transfers received from the government = $296, interest payments on the government's debt = $103, consumption = $8148, and government purchases = $185. The country had government saving equal to A) $285.

B) $3850.

C) $2397.

D) $2112.

Answer: A Diff: 2 Topic: Section: 2.3 Question Status: Previous Edition 5) In a given year, a country's GDP = $9841, net factor payments from abroad = $889, taxes = $869, transfers received from the government = $296, interest payments on the government's debt = $103, consumption = $8148, and government purchases = $185. The country had national saving equal to A) $285.

B) $3850.

C) $2397.

D) $2112.

Answer: C Diff: 2 Topic: Section: 2.3 Question Status: Revised

17 .

6) If a local government collects taxes of $500,000, has $350,000 of government consumption expenditures, makes transfer payments of $100,000, and has no interest payments or investment, its budget would A) show a surplus of $150,000.

B) show a surplus of $50,000.

C) be in balance with neither a surplus nor a deficit.

D) show a deficit of $50,000.

Answer: B Diff: 2 Topic: Section: 2.3 Question Status: Previous Edition 7) If a local government collects taxes of $250,000, has $175,000 of government consumption expenditures, makes transfer payments of $75,000, and has no interest payments or investment, its budget would A) show a surplus of $100,000.

B) show a surplus of $75,000.

C) be in balance with neither a surplus nor a deficit.

D) show a deficit of $75,000.

Answer: C Diff: 2 Topic: Section: 2.3 Question Status: Previous Edition 8) The government budget surplus equals A) government purchases plus transfers.

B) government receipts minus government outlays.

C) government purchases minus net receipts.

D) government purchases minus transfers.

Answer: B Diff: 1 Topic: Section: 2.3 Question Status: Previous Edition 9) Which of the following equations describes government saving?

A) T - TR - INT - G B) T - TR - INT + G C) T - TR + INT - G D) T - TR + INT + G Answer: A Diff: 1 Topic: Section: 2.3 Question Status: Previous Edition

18 .

10) Which of the following equations describes the government deficit?

A) G + TR + INT - T B) G + TR - INT - T C) G - TR + INT - T D) G - TR - INT - T Answer: A Diff: 1 Topic: Section: 2.3 Question Status: Previous Edition 11) National saving equals private saving plus government saving, which in turn equals A) C + S + T. B) GDP + C + G. C) GDP + NFP. D) GDP + NFP - C - G. Answer: D Diff: 2 Topic: Section: 2.3 Question Status: Previous Edition 12) The uses-of-saving identity says that an economy's private saving is used for A) investment, interest expenses, and the government budget deficit.

B) investment, the government budget deficit, and the current account.

C) investment, interest expenses, the government budget deficit, and the current account.

D) investment, interest expenses, the government budget deficit, transfer payments, and the current account.

Answer: B Diff: 1 Topic: Section: 2.3 Question Status: Previous Edition 13) The uses-of-saving identity shows that if the government budget deficit rises, then one of the following must happen.

A) Private saving must rise, investment must fall, and/or the current account must fall.

B) Private saving must rise, investment must fall, and/or the current account must rise.

C) Private saving must rise, investment must rise, and/or the current account must fall.

D) Private saving must fall, investment must rise, and/or the current account must rise.

Answer: A Diff: 2 Topic: Section: 2.3 Question Status: Previous Edition

19 .

14) Saving is a ________ variable, and wealth is a ________ variable.

A) stock; flow B) stock; stock C) flow; flow D) flow; stock Answer: D Diff: 1 Topic: Section: 2.3 Question Status: Previous Edition 15) Suppose that private saving is $1590 billion, investment is $1945 billion, and the current account balance is -$489 billion. From the uses-of-saving identity, how much is government saving?

A) -$134 billion B) -$844 billion C) $844 billion D) $134 billion Answer: A Diff: 3 Topic: Section: 2.3 Question Status: Previous Edition 16) Suppose that national saving is $1456 billion, investment is $1945 billion, and private saving is $1590 billion. How much is the current account balance?

A) $489 billion B) $221 billion C) -$221 billion D) -$489 billion Answer: D Diff: 3 Topic: Section: 2.3 Question Status: Previous Edition 17) Private saving is $1071.8 billion, investment is $1287.2 billion, and the current account balance is -$135.4 billion. From the uses-of-saving identity, how much is government saving?

A) -$350.8 billion B) -$80.0 billion C) $80.0 billion D) $350.8 billion Answer: C Diff: 3 Topic: Section: 2.3 Question Status: New

20 .

18) National saving is $717.8 billion, investment is $796.5 billion, and private saving is $986.9 billion. How much is the current account balance?

A) $269.1 billion B) $78.7 billion C) -$78.7 billion D) -$269.1 billion Answer: C Diff: 3 Topic: Section: 2.3 Question Status: New 19) In the mid- to late 1980s, the United States had "twin deficits" because both ________ and ________ were negative.

A) government saving; private saving B) saving; investment C) the current account; investment D) government saving; the current account Answer: D Diff: 2 Topic: Section: 2.3 Question Status: Previous Edition 20) National wealth is the value of A) domestic and foreign physical and financial assets.

B) domestic physical and financial assets.

C) domestic physical assets plus net foreign physical and financial assets.

D) net foreign assets.

Answer: C Diff: 2 Topic: Section: 2.3 Question Status: Previous Edition 21) How are net exports, net factor payments from abroad, and the current account balance related?

Answer: NX + NFP = CA. Diff: 1 Topic: Section: 2.3 Question Status: Previous Edition

21 .

22) How does chain weighting lead to a different measurement of real GDP than the methods used by the BEA prior to 1996? What are the advantages of chain weighting? What are the disadvantages?

Answer: Prior to 1996, the growth rate of real GDP depended on which year was chosen as the base year. Now, however, the current year and preceding year are used as base years, averaging results using each as base year. The advantages of this method are that there is no longer a need to recompute historical data or to change base years. However, a disadvantage is that real GDP is no longer the sum of its components.

Diff: 2 Topic: Section: 2.3 Question Status: Previous Edition 23) In a given year, a country's GDP = $3843, net factor payments from abroad = $191, taxes = $893, transfers received from the government = $422, interest payments on the government's debt = $366, consumption = $3661, and government purchases = $338. Calculate the values of private saving, government saving, and national saving.

Answer: Private saving = Y + NFP - T + TR + INT - C = $3843 + $191 - $893 + $422 + $366 $3661 = $268. Government saving = T -TR - INT - G = $893 - $422 - $366 - $338 = -$233.

National saving = Y + NFP - C - G = $3843 + $191 - $3661 - $338 = $35.

Diff: 2 Topic: Section: 2.3 Question Status: Previous Edition 2.4

Real GDP, Price Indexes, and Inflation

1) The country of Old Jersey produces milk and butter, and it has published the following macroeconomic data, where quantities are in gallons and prices are dollars per gallon.

Between Year 1 and Year 2, nominal GDP grew by A) 60.0%.

B) 65.5%.

C) 83.3%.

D) 190.0%.

Answer: D Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition

22 .

2) The value of real GDP in the current year equals A) the value of current-year output in prices of the base year.

B) the value of current-year output in prices of the current year.

C) the value of base-year output in prices of the base year.

D) the value of base-year output in prices of the current year.

Answer: A Diff: 1 Topic: Section: 2.4 Question Status: Previous Edition 3) The country of Old Jersey produces milk and butter, and it has published the following macroeconomic data, where quantities are in gallons and prices are dollars per gallon.

Between Year 1 and Year 2, the percent change in real GDP (based on Year 1 as a base year) was A) 58%.

B) 60%.

C) 130%.

D) 190%.

Answer: B Diff: 3 Topic: Section: 2.4 Question Status: Previous Edition 4) The country of Old Jersey produces milk and butter, and it has published the following macroeconomic data, where quantities are in gallons and prices are dollars per gallon.

Between Year 1 and Year 2, the GDP deflator (based on Year 1 as a base year) rose A) 60.00%.

B) 81.25%.

C) 83.33%.

D) 123.00%.

Answer: B Diff: 3 Topic: Section: 2.4 Question Status: Previous Edition 23 .

5) Currently, the U.S. national income and product accounts (NIPA) use what type of price index to calculate real GDP? A) Fixed-weight B) Variable-weight C) Chain-weight D) Heavy-weight Answer: C Diff: 1 Topic: Section: 2.4 Question Status: Previous Edition 6) If nominal GDP for 2012 is $6400 billion and real GDP for 2013 is $6720 billion (in 2012 dollars), then the growth rate of real GDP is A) 0%.

B) 0.5%.

C) 5%.

D) 50%.

Answer: C Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 7) If real GDP for 2009 is $6400 billion (in 2012 dollars) and nominal GDP for 2010 is $6720 billion, then the growth rate of real GDP is A) 0%.

B) 0.5%.

C) 5%.

D) unknown based on the given information.

Answer: D Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 8) If real GDP is $18,200 billion (in 2012 dollars) in 2018 Q1 and $18,400 (in 2012 dollars) in 2018 Q2, then the annualized quarterly growth rate of real GDP is A) 1.1%.

B) 4.5%.

C) 1.0%.

D) 0.4% Answer: B Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition

24 .

9) If real GDP is $18,200 billion (in 2012 dollars) in 2018 Q1 and $18,400 (in 2012 dollars) in 2018 Q2, then the non-annualized quarterly growth rate of real GDP is A) 1.1%.

B) 4.5%.

C) 1.0%.

D) 0.4% Answer: A Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 10) If real GDP is $17,700 billion (in 2012 dollars) in 2017 Q2 and $18,400 (in 2012 dollars) in 2018 Q2, then the annual growth rate of real GDP from 2017Q2 to 2018Q2 is A) 1.0%.

B) 4.0%.

C) 16.8%.

D) 0.4% Answer: B Diff: 2 Topic: Section: 2.4 Question Status: Revised 11) If real GDP is $19,728 billion (in 2012 dollars) in 2022 Q1 and $19,682 (in 2012 dollars) in 2022 Q2, then the annualized quarterly growth rate of real GDP is A) -2.3%.

B) -0.9%.

C) -0.2%.

D) 0.2% Answer: B Diff: 2 Topic: Section: 2.4 Question Status: New 12) If real GDP is $19,728 billion (in 2012 dollars) in 2022 Q1 and $19,682 (in 2012 dollars) in 2022 Q2, then the non-annualized quarterly growth rate of real GDP is A) -2.3%.

B) -0.9%.

C) -0.2%.

D) 0.2% Answer: C Diff: 2 Topic: Section: 2.4 Question Status: New

25 .

13) If real GDP is $19,728 billion (in 2012 dollars) in 2022 Q1 and $19,682 (in 2012 dollars) in 2023 Q1, then the annual growth rate of real GDP from 2022Q1 to 2023Q1 is A) -2.3%.

B) -0.9%.

C) -0.2%.

D) 0.2% Answer: C Diff: 2 Topic: Section: 2.4 Question Status: New 14) The abbreviation SAAR means that data are A) serially aggregated at an annual revision.

B) systematically accumulated in an adjusted ratio.

C) seasonally adjusted at an annual rate.

D) sometimes accepted as real.

Answer: C Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 15) In the United States, most macroeconomic data are A) SAAR. B) SA but not AR. C) AR but not SA. D) neither SA nor AR. Answer: A Diff: 1 Topic: Section: 2.4 Question Status: Previous Edition 16) If the price index was 100 in 2000 and 120 in 2010, and nominal GDP was $360 billion in 2000 and $480 billion in 2010, then the value of 2010 GDP in terms of 2000 dollars would be A) $300 billion.

B) $384 billion.

C) $400 billion.

D) $424 billion.

Answer: C Diff: 3 Topic: Section: 2.4 Question Status: Previous Edition

26 .

17) Nominal GDP in 1970 was $1035.6 billion, and in 1980 it was $2784.2 billion. The GDP price index was 30.6 for 1970 and 60.4 for 1980, where 1992 was the base year. Calculate the percent change in real GDP in the decade from 1970 to 1980. Round off to the nearest percentage point.

A) 36% B) 97% C) 136% D) 169% Answer: A Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 18) Nominal personal consumption expenditures in the United States were $1760.4 billion in 1980 and rose to $3839.3 billion in 1990. The price index for personal consumption expenditures was 58.5 for 1980 and 92.9 for 1990, where 1992 was the base year. Calculate the percent change in real personal consumption expenditures (rounded to the nearest percentage point) in the decade.

A) 37% B) 59% C) 118% D) 137% Answer: A Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 19) Nominal gross private domestic investment was $1888.0 billion in 2008 and rose to $2057.4 billion in 2009. The chain-weight price index for gross private domestic investment was 106.6 for 2008 and 110.3 for 2009, where 2005 was the base year. Calculate the percent change in real gross private domestic investment (rounded to the nearest percentage point) from 2008 to 2009.

A) 1% B) 3% C) 4% D) 5% Answer: D Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition

27 .

20) A disadvantage of chain-weighting is that A) past inflation rates change whenever the base year changes.

B) past growth rates of real GDP change whenever the base year changes.

C) it causes output growth to slow.

D) the components of real GDP don't sum to real GDP. Answer: D Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 21) The U.S. inflation rate ________ in the 1960s and 1970s, ________ in the 1980s, and ________ in the 1990s and early 2000s.

A) was steady; rose sharply; fell B) was steady; rose sharply; remained high C) rose; fell sharply; remained low D) rose; fell sharply; rose again Answer: C Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 22) Two years ago, the GDP deflator for Old York was 300, and today it is 330.75. Based on this information the annual average inflation rate for the two years was A) 5%.

B) 5.125%.

C) 10%.

D) 10.25%.

Answer: A Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 23) If the price index last year was 1.0 and today it is 1.4, what is the inflation rate over this period?

A) -4% B) 1.4% C) 4% D) 40% Answer: D Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition

28 .

24) You are given information on the consumer price index (CPI), where the values given are those for December 31 of each year.

In which year was the inflation rate the highest?

A) 2006 B) 2007 C) 2008 D) 2009 Answer: A Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 25) The consumer price index (CPI) was 180 for 2009 when using 1995 as the base year (1995 = 100). Now suppose we switch and use 2009 as the base year (2009 = 100). What is the CPI for 1995 with the new base year?

A) 18.0 B) 55.6 C) 80.0 D) 111.2 Answer: B Diff: 3 Topic: Section: 2.4 Question Status: Previous Edition 26) Nominal government purchases were $2226.2 billion in 2008 and rose to $2372.8 billion in 2009. Real government purchases were $1940.6 for 2008 and $1958.0 for 2009, where 2005 was the base year. Calculate the percent change in the chain-weight price index for government purchases (rounded to the nearest percentage point) from 2008 to 2009.

A) 2% B) 4% C) 6% D) 8% Answer: C Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition

29 .

27) The Boskin Commission concluded that the CPI overstates increases in the cost of living by ________ percentage point(s) per year.

A) less than 1 B) 1 to 2 C) about 3 D) over 4 Answer: B Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 28) The CPI may overstate inflation for all the following reasons except A) problems measuring changes in the quality of goods.

B) substitution by consumers towards cheaper goods.

C) problems measuring the quality of services.

D) changes in Social Security benefits.

Answer: D Diff: 1 Topic: Section: 2.4 Question Status: Previous Edition 29) The Fed prefers to focus on inflation based on which price index?

A) Personal consumption expenditures price index B) Consumer price index C) GDP deflator D) Producer price index Answer: A Diff: 1 Topic: Section: 2.4 Question Status: Previous Edition 30) The Federal Reserve focuses on the inflation rate based on the ________ rather than the CPI; to measure the underlying trend in inflation, it focuses on the ________.

A) GDP deflator; overall GDP deflator B) GDP deflator; core GDP deflator C) PCE price index; core PCE price index D) PCE price index; overall PCE price index Answer: C Diff: 1 Topic: Section: 2.4 Question Status: Previous Edition

30 .

31) What is the difference between nominal and real economic variables? Why do economists tend to concentrate on changes in real magnitudes?

Answer: Nominal variables are in units of money, while real variables are in physical quantities of output. We measure nominal variables using current market prices and real variables using market prices in a given base year. Nominal variables may increase, but you don't know if the increase is due to higher prices and the same quantity, or a higher quantity with unchanged prices; real variables reflect just quantity changes. For the most part, real variables (consumption, investment, and the capital stock) affect each other in the economy, with lesser roles played by nominal variables (money supply, and price level).

Diff: 1 Topic: Section: 2.4 Question Status: Previous Edition 32) The country of Myrule has produced the following quantity of gauges and potatoes, with the price of each listed in dollar terms.

(a) Using Year 1 as the base year, what is the growth rate of real GDP from Year 1 to Year 2? (b) Based on the GDP deflator, what is the inflation rate from Year 1 to Year 2?

Answer: (a) Real GDP for Year 1 = Year 1 quantities at Year 1 prices = (8000 × $4) + (6000 × $8) = $80,000.

Real GDP for Year 2 = Year 2 quantities at Year 1 prices = (10,000 × $4) + (5000 × $8) = $80,000.

Growth rate of real GDP = 0% (b) Nominal GDP for Year 1 = Year 1 quantities at Year 1 prices = (8000 × $4) + (6000 × $8) = $80,000.

Nominal GDP for Year 2 = Year 2 quantities at Year 2 prices = (10,000 × $3) + (5000 × $14) = $100,000.

GDP deflator = nominal GDP/real GDP GDP deflator in Year 1 = $80,000/$80,000 = 1.

GDP deflator in Year 2 = $100,000/$80,000 = 1.25.

Inflation rate = [(1.25/1) - 1] × 100% = 25%.

Diff: 3 Topic: Section: 2.4 Question Status: Previous Edition

31 .

33) By how much does the CPI overstate true increases in the cost of living, according to the Boskin Commission? What are the main reasons for this bias in the CPI? What are the economic implications of the bias?

Answer: The Boskin Commission reported that the CPI overstates inflation by 1 to 2 percentage points per year. The bias arises because of difficulty in measuring quality change (especially for services) and because the CPI doesn't account for the substitution that people make between goods when relative prices change. The bias implies that our measures of real income growth are understated and that Social Security benefits are being adjusted more than they should be to account for inflation.

Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 34) In 1975, Richard Petty won the NASCAR race in Richmond, earning $6265. In 2006, Dale Earnhardt, Jr., won the race, earning $239,166. The CPI index was 52.5 in 1975 and 198.7 in 2006 (base year = 1982-1984). Calculate the real earnings (based on base year 1982-1984) of both Petty and Earnhardt.

Answer: Petty: $6265/(52.5/100) = $11,933. Earnhardt: $239,166/(198.7/100) = $120,365. So Earnhardt's real earnings were over ten times those of Petty (thanks to NASCAR's increased popularity).

Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition 35) Nominal GDP in a country was $8759.9 billion in 2017 and $9254.6 billion in 2018. The GDP deflator was 102.86 for 2017 and 104.37 for 2018. (a) What is the growth rate of nominal GDP between 2017 and 2018? (b) What is the inflation rate from 2017 to 2018? (c) What is the growth rate of real GDP from 2017 to 2018?

Answer: (a) 9254.6/8759.9 × 100% = 5.6%. (b) [(104.37/102.86) - 1] × 100% = 1.5%. (c) Real GDP (2017) = 8759.9/1.0286 = 8516.3.

Real GDP (2018) = 9254.6/1.0437 = 8867.1.

Growth rate = [(8867.1/8516.3) - 1] × 100% = 4.1%.

Note that the growth rate of nominal GDP (5.6%) equals the inflation rate (1.5%) plus the growth rate of real GDP (4.1%).

Diff: 2 Topic: Section: 2.4 Question Status: Previous Edition

32 .

2.5

Interest Rates

1) The nominal interest rate minus the inflation rate is the A) depreciation rate.

B) real interest rate.

C) discount rate.

D) forward rate.

Answer: B Diff: 1 Topic: Section: 2.5 Question Status: Previous Edition 2) The nominal interest rate minus the expected inflation rate is the A) depreciation rate.

B) expected real interest rate.

C) real interest rate.

D) forward rate.

Answer: B Diff: 1 Topic: Section: 2.5 Question Status: New 3) By Marks buys a one-year German government bond (called a bund) for $400. He receives principal and interest totaling $436 one year later. During the year the CPI rose from 150 to 162.

The nominal interest rate on the bond was ________, and the real interest rate was ________.

A) 9%; 1% B) 9%; -1% C) 36%; 24% D) 36%; 12% Answer: A Diff: 2 Topic: Section: 2.5 Question Status: Previous Edition 4) The expected real interest rate (r) is equal to A) nominal interest rate minus inflation rate.

B) nominal interest rate minus expected inflation rate.

C) expected nominal interest rate minus inflation rate.

D) nominal interest rate plus expected inflation rate.

Answer: B Diff: 1 Topic: Section: 2.5 Question Status: Previous Edition

33 .

5) In 2018, inflation exceeded expected inflation. In 2019, expected inflation exceeded inflation.

Therefore the real interest rate was ________ than the expected real interest rate in 2018 and the real interest rate was ________ than the expected real interest rate in 2019.

A) less; less B) less; greater C) greater; less D) greater; greater Answer: B Diff: 2 Topic: Section: 2.5 Question Status: Previous Edition 6) In 2018, expected inflation exceeded inflation. In 2019, inflation exceeded expected inflation.

Therefore the real interest rate was ________ than the expected real interest rate in 2018 and the real interest rate was ________ than the expected real interest rate in 2019.

A) less; less B) less; greater C) greater; less D) greater; greater Answer: C Diff: 2 Topic: Section: 2.5 Question Status: Previous Edition 7) If the expected inflation rate was 2.5%, the expected real interest rate was 4.0%, and the actual inflation rate turned out to be 3.2%, then the real interest rate equals A) 1.7%.

B) 3.2%.

C) 3.3%.

D) 4.7%.

Answer: C Diff: 2 Topic: Section: 2.5 Question Status: Previous Edition 8) If the expected inflation rate was 2.5%, the expected real interest rate was 4.0%, and the real interest rate turned out to be 5.1%, then the actual inflation rate equals A) 1.4%.

B) 1.5%.

C) 2.6%.

D) 6.5%.

Answer: A Diff: 2 Topic: Section: 2.5 Question Status: Previous Edition

34 .

9) If the expected inflation rate was 2.5%, the expected real interest rate was 4.0%, and the real interest rate turned out to be 5.1%, then the nominal interest rate equals A) 1.4%.

B) 1.5%.

C) 2.6%.

D) 6.5%.

Answer: D Diff: 2 Topic: Section: 2.5 Question Status: Previous Edition 10) If the nominal interest rate on a one-year loan was 7%, the expected inflation rate over the year was 3% and the actual inflation rate over the year turned out to be 3.5%, then the expected real interest rate equals A) 6.5%.

B) 4.0%.

C) 3.75%.

D) 3.5%.

Answer: B Diff: 2 Topic: Section: 2.5 Question Status: Previous Edition 11) If the nominal interest rate on a one-year loan was 7%, the actual inflation rate over the year was 3% and the expected inflation rate over the year was 2.5%, then the expected real interest rate equals A) 4.5%.

B) 4.0%.

C) 3.75%.

D) 3.5%.

Answer: A Diff: 2 Topic: Section: 2.5 Question Status: Previous Edition 12) By Marks buys a one-year German government bond (called a bund) for $400. He receives principal and interest totaling $436 one year later. During the year the CPI rose from 150 to 162, but he had thought the CPI would be at 159 by the end of the year. By Marks had expected the real interest rate to be ________, but it actually turned out to be ________.

A) 8%; 1% B) 6%; 3% C) 3%; 1% D) 1%; 3% Answer: C Diff: 3 Topic: Section: 2.5 Question Status: Previous Edition 35 .

13) Historical analysis of real interest rates in the United States shows that A) real interest rates were unusually low in both the 1970s and 1980s.

B) real interest rates were unusually high in both the 1970s and 1980s.

C) real interest rates were unusually low in the 1970s and unusually high in the 1980s.

D) real interest rates were unusually low in the 1980s, spurring the economic growth that occurred during the Reagan administration.

Answer: C Diff: 2 Topic: Section: 2.5 Question Status: Previous Edition 14) Calculate the real interest rate if the nominal interest rate is 8%, the expected inflation rate is 4%, and the inflation rate is 5%.

Answer: Real interest rate = nominal interest rate minus inflation rate = 8% - 5% = 3%.

Diff: 1 Topic: Section: 2.5 Question Status: Previous Edition 15) Calculate the expected real interest rate if the nominal interest rate is 8%, the expected inflation rate is 4%, and the inflation rate is 5%.

Answer: Expected real interest rate = nominal interest rate minus expected inflation rate = 8% 4% = 4%.

Diff: 1 Topic: Section: 2.5 Question Status: Previous Edition 16) The nominal interest rate is 7%, today's price level is 150, and you expect the price level to be 156 one year from now. What is the expected inflation rate? What is the expected real interest rate?

Answer: Expected inflation rate = 156/150 - 1 = 0.04 = 4%; expected real interest rate = 7% 4% = 3%.

Diff: 1 Topic: Section: 2.5 Question Status: Previous Edition

36 .

17) Loretta agrees to lend Ted $500,000 to buy computers for his consulting firm. They agree to a nominal interest rate of 8%. Both expect the inflation rate to be 2%. (a) Calculate the expected real interest rate. (b) If inflation turns out to be 3% over the life of the loan, what is the real interest rate? Who gains from unexpectedly high inflation, Loretta or Ted? (c) If inflation turns out to be 1% over the life of the loan, what is the real interest rate? Who gains from unexpectedly low inflation, Loretta or Ted? Answer: (a) 8% - 2% = 6%. (b) 8% - 3% = 5%. Ted gains from unexpectedly high inflation, because he repays the loan with dollars that aren't worth as much as was expected. (c) 8% - 1% = 7%. Loretta gains from unexpectedly low inflation, because she gets repaid with dollars that are worth more than was expected.

Diff: 2 Topic: Section: 2.5 Question Status: Previous Edition 18) You took out a loan one year ago at a nominal interest rate of 7.5%. The CPI stood at 173.2 at the time and you expected it to rise to 178.6 over the year. Today the CPI is actually 179.5.

Calculate the expected real interest rate on the loan and the real interest rate on the loan.

Answer: The expected inflation rate when you took out the loan equals (178.6 - 173.2)/173.2 = 3.1%, so your expected real interest rate was 7.5% (nominal interest rate) - 3.1% (expected inflation rate) = 4.4%. The actual inflation rate over the period equals (179.5 - 173.2)/173.2 = 3.6%, so your real interest rate was 7.5% (nominal interest rate) - 3.6% (inflation rate) = 3.9%.

Diff: 2 Topic: Section: 2.5 Question Status: Previous Edition

37 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 3 Productivity, Output, and Employment 3.1

How Much Does the Economy Produce? The Production Function

1) A mathematical expression relating the amount of output produced to quantities of capital and labor utilized is the A) real interest rate.

B) productivity relation.

C) production function.

D) marginal product.

Answer: C Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition 2) In the production function Y = AF(K, N), A is ________, K is ________, and N is ________.

A) total factor productivity; the capital stock; the number of workers employed B) total factor productivity; investment; the number of workers employed C) the productivity of labor; the capital stock; the size of the labor force D) the productivity of labor; investment; the size of the labor force Answer: A Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition 3) In the production function Y = AF(K, N), total factor productivity is A) Y/A. B) A. C) K/N. D) Y/N. Answer: B Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition 4) In the production function Y = AF(K, N), A is A) labor productivity.

B) total factor productivity.

C) capital productivity.

D) the marginal productivity of capital.

Answer: B Diff: 1 Topic: Section: 3.1 Question Status: New

1 .

5) Suppose the economy's production function is Y = AK0.3N0.7. If K = 2000, N = 100, and A = 1, then Y = 246. If K and N both rise by 20%, and A is unchanged, by how much does Y increase?

A) 5% B) 10% C) 15% D) 20% Answer: D Diff: 3 Topic: Section: 3.1 Question Status: Previous Edition 6) Suppose the economy's production function is Y = AK0.3N0.7. If K = 2000, N = 100, and A = 1, then Y = 246. If K rises by 10%, and A and N are unchanged, by how much does Y increase?

A) 30% B) 10% C) 6% D) 3% Answer: D Diff: 3 Topic: Section: 3.1 Question Status: Previous Edition 7) Suppose the economy's production function is Y = AK0.3N0.7. If K = 2000, N = 100, and A = 1, then Y = 246. If A rises by 10 percent, and K and N are unchanged, by how much does Y increase?

A) 5% B) 10% C) 15% D) 20% Answer: B Diff: 3 Topic: Section: 3.1 Question Status: Previous Edition 8) Suppose the economy's production function is Y = AK0.3N0.7. If K = 2000, N = 100, and A = 1, then Y = 246. If K and N each increase by 5 percent, and A is unchanged, by how much does Y increase?

A) 5% B) 10% C) 15% D) 20% Answer: A Diff: 3 Topic: Section: 3.1 Question Status: Previous Edition 9) If Y = A × N × (75 + K/N), where K = 1000, N = 20, and A = 10, what happens if K doubles 2 .

and N doubles?

A) Y is unchanged.

B) Y increases by 50%.

C) Y doubles.

D) Y quadruples.

Answer: C Diff: 2 Topic: Section: 3.1 Question Status: Previous Edition 10) Suppose the economy's production function is Y = AK0.3N0.7. When K = 1000, N = 50, and A = 15, what is Y? A) 1842 B) 6106 C) 750,000 D) 123 Answer: A Diff: 2 Topic: Section: 3.1 Question Status: Previous Edition 11) Suppose that Freedonia has GDP equal to 2000 million, the capital stock is 1700 million, and the number of employees equals 70 million. The production function is Y = AK0.25N0.75. Total factor productivity of the economy is approximately equal to A) 0.09.

B) 2.61.

C) 4.19.

D) 12.87.

Answer: D Diff: 3 Topic: Section: 3.1 Question Status: Previous Edition

3 .

12) The table below represents Freedonia's macroeconomic data for Year 1 and Year 2.

Suppose that the production function is given by Y = AK0.25N0.75. Between Year 1 and Year 2, total factor productivity of Freedonia's economy increased by A) -1.5%.

B) 5.0%.

C) 5.5%.

D) 12.7%.

Answer: A Diff: 3 Topic: Section: 3.1 Question Status: Previous Edition 13) The two main characteristics of the production function are A) it slopes downward from left to right, and the slope becomes flatter as the input increases.

B) it slopes upward from left to right, and the slope becomes steeper as the input increases.

C) it slopes upward from left to right, and the slope becomes flatter as the input increases.

D) it slopes downward from left to right, and the slope becomes steeper as the input increases.

Answer: C Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition 14) If the marginal product of capital doesn't change as the amount of capital increases, a figure showing the relationship between output and capital A) is a straight line with constant upward slope.

B) is a straight line with a slope of zero.

C) is a vertical line.

D) slopes upward with a slope that declines as the amount of capital increases.

Answer: A Diff: 2 Topic: Section: 3.1 Question Status: Previous Edition 15) The marginal product of capital is the increase in A) capital needed to produce one more unit of output.

B) output from a one-unit increase in capital.

C) labor needed to accompany a one-unit increase in capital.

D) output from a one-dollar increase in capital.

Answer: B Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition 4 .

16) Suppose the economy's production function is Y = AK0.3N0.7. Suppose K = 200, N = 2000, and A = 1. Calculate the marginal product of capital.

A) 1.0 B) 1.5 C) 2.0 D) 2.5 Answer: B Diff: 3 Topic: Section: 3.1 Question Status: Previous Edition 17) The fact that the production function relating output to capital becomes flatter as we move from left to right means that A) the marginal product of labor is positive.

B) the marginal product of capital is positive.

C) there is diminishing marginal productivity of labor.

D) there is diminishing marginal productivity of capital.

Answer: D Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition 18) In a graph of the production function relating output to capital, it is not true that A) labor supply increases as capital increases.

B) the marginal product of capital can be measured as the slope of the production function.

C) the marginal product of capital falls as the capital stock increases.

D) the shape of the production function reflects diminishing marginal productivity.

Answer: A Diff: 2 Topic: Section: 3.1 Question Status: Previous Edition 19) Because of diminishing marginal productivity, A) the labor supply curve is not vertical.

B) nominal wages are sticky in a downward direction.

C) the labor demand curve is negatively sloped.

D) households save only a small share of their income.

Answer: C Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition

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20) The marginal product of labor A) is measured by the slope of the production function relating capital to employment.

B) is larger when the labor supply is relatively larger.

C) is smaller when the labor supply is relatively smaller.

D) decreases as the number of workers already employed increases.

Answer: D Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition 21) The marginal product of labor A) equals the output produced per unit of labor employed.

B) decreases as more capital is added to the production process.

C) depends on the product price.

D) declines as more labor is added to the production process.

Answer: D Diff: 2 Topic: Section: 3.1 Question Status: Previous Edition 22) The fact that the production function relating output to labor becomes flatter as we move from left to right means that A) the marginal product of labor is positive.

B) the marginal product of capital is positive.

C) there is diminishing marginal productivity of labor.

D) there is diminishing marginal productivity of capital.

Answer: C Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition 23) An adverse supply shock would A) shift the production function up and decrease marginal products at every level of employment.

B) shift the production function down and decrease marginal products at every level of employment.

C) shift the production function down and increase marginal products at every level of employment.

D) shift the production function up and increase marginal products at every level of employment.

Answer: B Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition

6 .

24) In the diagram of the production function, a beneficial supply shock is shown by A) an upward shift in the production function.

B) a movement up along the production function.

C) a downward shift in the production function.

D) an increase in the convexity of the curve.

Answer: A Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition 25) A favorable supply shock would A) shift the production function up and decrease marginal products at every level of employment.

B) shift the production function down and decrease marginal products at every level of employment.

C) shift the production function down and increase marginal products at every level of employment.

D) shift the production function up and increase marginal products at every level of employment.

Answer: D Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition 26) An invention that speeds up the Internet is an example of A) an income effect.

B) an increase in labor.

C) a substitution effect.

D) a supply shock.

Answer: D Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition 27) A supply shock that reduces total factor productivity directly affects which term in the production function Y = AF(K, N)?

A) A B) F C) K D) N Answer: A Diff: 1 Topic: Section: 3.1 Question Status: Previous Edition

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28) Suppose the production function is Y = AK0.3N0.7. Suppose in 2000, K = 1000, N = 100, and Y = 199.5. In 2010, capital, labor, and output have doubled, so K = 2000, N = 200, and Y = 399. (a) By what percentage did productivity grow from 2000 to 2010? (b) If output had risen to 798 instead of 399, and capital and labor doubled, by what percentage would productivity have grown from 2000 to 2010?

Answer: (a) From the production function, you can calculate that A = 1 in both 2000 and 2010, so A is unchanged. (b) Since output doubles (relative to the case in which Y = 399 in 2010) with the same amounts of capital and labor, A doubled.

Diff: 2 Topic: Section: 3.1 Question Status: Previous Edition 29) In the U.S. economy in 1991, real GDP was 4861.4 (in billions of 1987 dollars), the capital stock was 13,806.2 (in billions of 1987 dollars), and employment was 118.4 (in millions of workers). In 1992 the numbers were: real GDP 4986.3, capital stock 14,040.8, employment 119.2. Suppose the production function in both years is Y = AK0.25N0.75. (a) Calculate total factor productivity for 1991 and 1992. (b) How much did total factor productivity grow from 1991 to 1992? (c) Calculate the percent increase in real output between 1991 and 1992. (d) Suppose tax incentives had raised the capital stock in 1992, making it 10% higher, to 15,444.9. If employment didn't change, what would have been the percent increase in real output between 1991 and 1992? (e) Instead of the increase in the capital stock in part d, suppose employment was 10% higher in 1992, making it 131.1. With the capital stock fixed at 14,040.8, what would have been the increase in real output between 1991 and 1992?

Answer: (a) 1991: 12.49; 1992: 12.70 (b) +1.7% (c) +2.6% (d) Y = 5107.5, a 5.1% increase (e) Y = 5356.2, a 10.2% increase Diff: 3 Topic: Section: 3.1 Question Status: Previous Edition

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30) Suppose the economy's production function is Y = AK0.3N0.7. Suppose K = 200, N = 2000, and A = 1.

Calculate the marginal products of labor and capital.

Answer: Using calculus, the marginal product of capital is dY/dK = 0.3A(N/K)0.7 and dY/dN = 0.7A(K/N)0.3.

Plugging in the values for N and K gives: MPK = 0.3 (2000/200)0.7 = 1.5; MPN = 0.7 (200/2000)0.3 = 0.35. If you do not use calculus, you can arrive at the same answer (rounded) by plugging the values of for A, N and K into the production function to find Y = 1002.37. Increase K by 1 and recalculate Y; it is now 1003.88. The difference is the MPK = 1003.88 - 1002.37 = 1.51. Increase N by 1 and recalculate Y; it is 1002.73. The difference is the MPN = 1002.73 1002.37 = 0.36.

Diff: 3 Topic: Section: 3.1 Question Status: Previous Edition 3.2

The Demand for Labor

1) Economists often treat the economy's capital stock as fixed because A) labor is a more important factor of production than capital, so economists ignore capital.

B) it takes a long time for new investment and the scrapping of old capital to affect the overall quantity of capital.

C) there is very little capital in the economy compared with the amount of labor.

D) unless the interest rate changes, the capital stock doesn't change.

Answer: B Diff: 1 Topic: Section: 3.2 Question Status: Previous Edition 2) Changes in the capital stock occur ________, and changes in the amount of labor that firms employ occur ________.

A) quickly; quickly B) slowly; slowly C) slowly; quickly D) quickly; slowly Answer: C Diff: 1 Topic: Section: 3.2 Question Status: Previous Edition

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3) The real wage A) is the nominal wage divided by the price level.

B) automatically increases with the cost of living.

C) is the price level divided by the nominal wage.

D) is the nominal wage multiplied by the price level.

Answer: A Diff: 1 Topic: Section: 3.2 Question Status: Previous Edition 4) An increase in the real wage rate will cause A) the labor demand curve to shift to the right.

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

C) the quantity of labor demanded to rise.

D) a movement along the labor demand curve.

Answer: D Diff: 1 Topic: Section: 3.2 Question Status: Previous Edition 5) A decrease in the real wage would result in a A) movement along the labor demand curve, causing an increase in the number of workers hired by the firm.

B) shift of the labor demand curve, causing an increase in the number of workers hired by the firm.

C) movement along the labor demand curve, causing a decrease in the number of workers hired by the firm.

D) shift of the labor demand curve, causing a decrease in the number of workers hired by the firm.

Answer: A Diff: 1 Topic: Section: 3.2 Question Status: Previous Edition 6) An increase in the real wage would result in a A) movement along the labor demand curve, causing an increase in the number of workers hired by the firm.

B) shift of the labor demand curve, causing an increase in the number of workers hired by the firm.

C) movement along the labor demand curve, causing a decrease in the number of workers hired by the firm.

D) shift of the labor demand curve, causing a decrease in the number of workers hired by the firm.

Answer: C Diff: 1 Topic: Section: 3.2 Question Status: Previous Edition 10 .

7) An increase in the number of workers hired by a firm could result from A) a decrease in the marginal product of labor.

B) a decrease in the marginal revenue product of labor.

C) an increase in the real wage.

D) a decrease in the real wage.

Answer: D Diff: 1 Topic: Section: 3.2 Question Status: Previous Edition 8) A decrease in the number of workers hired by a firm could result from A) an increase in the marginal product of labor.

B) an increase in the marginal revenue product of labor.

C) an increase in the real wage.

D) a decrease in the real wage.

Answer: C Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition 9) What two factors should you equate in deciding how many workers to employ?

A) The marginal product of labor and the marginal product of capital B) The marginal product of labor and the real wage rate C) The marginal product of labor and the real interest rate D) The marginal product of capital and the real wage rate Answer: B Diff: 1 Topic: Section: 3.2 Question Status: Previous Edition 10) One reason that firms hire labor at the point where w = MPN is A) if w < MPN, the cost (w) of hiring additional workers exceeds the benefits (MPN) of hiring them, so they should hire fewer workers.

B) if w > MPN, the cost (w) of hiring additional workers is less than the benefits (MPN) of hiring them, so they should hire more workers.

C) if w < MPN, the cost (w) of hiring additional workers equals the benefits (MPN) of hiring them, so they have the right number of workers.

D) if w > MPN, the cost (w) of hiring additional workers exceeds the benefits (MPN) of hiring them, so they should hire fewer workers.

Answer: D Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition

11 .

11) Firms hire labor at the point where the A) nominal wage rate equals the marginal product of labor.

B) real wage rate equals the marginal revenue product of labor.

C) nominal wage rate equals the marginal revenue product of labor.

D) real wage rate equals the marginal revenue product of capital.

Answer: C Diff: 1 Topic: Section: 3.2 Question Status: Previous Edition 12) The Upstart Company has the following production function.

If the company hires 4 workers, which of the following could be the real wage rate?

A) 2 B) 4 C) 6 D) 8 Answer: B Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition

12 .

13) The Disk-o Company has the following production function.

If the company hires 3 workers, which of the following could be the real wage rate?

A) 2 B) 4 C) 6 D) 8 Answer: C Diff: 2 Topic: Section: 3.2 Question Status: New 14) The Widget Company has the following production function.

If widgets sell for $6 each and the wage rate is $33, how many workers will the company hire?

A) 0 B) 1 C) 2 D) 4 Answer: D Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition

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15) Your boss wants to know if you should lay off any workers. You answer that you should lay off workers if the A) marginal revenue product of labor is greater than the nominal wage rate.

B) marginal product of labor is greater than or equal to the real wage rate.

C) marginal revenue product of labor is equal to the nominal wage rate.

D) marginal product of labor is less than the real wage rate.

Answer: D Diff: 1 Topic: Section: 3.2 Question Status: Previous Edition 16) Zowie! Surfboards has the following production function.

If surfboards sell for $30 and the nominal wage rate is $200, how many workers should the firm employ?

A) 2 B) 3 C) 4 D) 5 Answer: C Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition 17) The marginal product of labor (measured in units of output) for Expando Corp. is given by MPN = A(400 - N) where A measures productivity and N is the number of labor hours used in production. Suppose the price of output is $3 per unit and A = 2.0. What will be the demand for labor if the nominal wage is $18?

A) 57 B) 107 C) 197 D) 397 Answer: D Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition

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18) The marginal product of labor (measured in units of output) for Relient Corp. is given by MPN = A(200 - N) where A measures productivity and N is the number of labor hours used in production. Suppose the price of output is $3 per unit and A = 2.0. What will be the demand for labor if the nominal wage is $30?

A) 170 B) 185 C) 190 D) 195 Answer: D Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition 19) An adverse supply shock, such as a reduced supply of raw materials, would A) increase the marginal product of labor.

B) decrease the marginal product of labor.

C) decrease the marginal product of capital, but have no effect on the marginal product of labor.

D) not affect the marginal product of labor.

Answer: B Diff: 1 Topic: Section: 3.2 Question Status: Previous Edition 20) Which of the following events would lead to an increase in the marginal product of labor for every quantity of labor?

A) An increase in the real wage B) A decrease in the real wage C) A favorable supply shock such as a fall in the price of oil D) An adverse supply shock, such as a reduced supply of raw materials Answer: C Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition 21) A winter ice storm has paralyzed the entire east coast, reducing productivity sharply. This supply shock shifts the marginal product of labor curve A) up and to the right, raising the quantity of labor demanded at any given real wage.

B) down and to the left, reducing the quantity of labor demanded at any given real wage.

C) up and to the right, reducing the quantity of labor demanded at any given real wage.

D) down and to the left, raising the quantity of labor demanded at any given real wage.

Answer: B Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition

15 .

22) A technological breakthrough in using photons for computers will increase the productivity of those working with computers a hundredfold. You would expect this breakthrough to shift the A) marginal product of labor curve up and to the right, raising the quantity of labor demanded at any given real wage.

B) marginal product of labor curve down and to the left, reducing the quantity of labor demanded at any given real wage.

C) labor supply curve up, reducing the quantity of labor demanded at any given real wage.

D) labor supply curve down, raising the quantity of labor demanded at any given real wage.

Answer: A Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition 23) Self-driving trucks greatly reduce the costs of shipping goods. What is the result on the aggregate demand for labor?

A) The aggregate labor demand curve shifts up.

B) The aggregate labor demand curve is unchanged, but there is a movement along the curve.

C) The aggregate labor demand curve shifts down.

D) The aggregate labor demand curve shifts down for low levels of employment and down for high levels of employment.

Answer: A Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition 24) Suppose a firm's hourly marginal product of labor is given by MPN = A (200 - N). (a) If A = 0.2 and the real wage rate is $10 per hour, how much labor will the firm want to hire? (b) Suppose the real wage rate rises to $20 per hour. How much labor will the firm want to hire? (c) With the real wage rate at $10 per hour, how much labor will the firm want to hire if A rises to 0.5?

Answer: (a) The firm will hire labor such that w = MPN, or 10 = 0.2(200 - N), so N = 150. (b) Now 20 = 0.2(200 - N), so N = 100. The firm's labor demand falls when the wage rate rises. (c) Now 10 = 0.5(200 - N), so N = 180. The increase in productivity increases labor demand.

Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition

16 .

25) The marginal product of labor (measured in units of output) of a firm is given by MPN = A(2000 - N) where A measures productivity and N is the number of labor hours used in production. Suppose the price of output is $6 per unit and A = 0.002. (a) What will be the demand for labor if the nominal wage is $18? (b) What will be the demand for labor if the nominal wage rises to $21?

Answer: (a) The real wage = $18/$6 = 3. Setting the real wage equal to the marginal product of labor gives 3 = 0.002(2000 - N), so 0.002N = 1, so N = 500. (b) The real wage = $21/$6 = 3.5. Setting the real wage equal to the marginal product of labor gives 3.5 = 0.002(2000 - N), so 0.002N = 0.5, so N = 250.

Diff: 2 Topic: Section: 3.2 Question Status: Previous Edition 3.3

The Supply of Labor

1) Off-the-job activities, including eating, sleeping, working around the house, and spending time with family and friends are known as A) the gig economy.

B) the underground economy.

C) homework.

D) leisure.

Answer: D Diff: 1 Topic: Section: 3.3 Question Status: Previous Edition 2) The aggregate supply of labor is the A) total amount of time a person works over his or her lifetime.

B) total amount of time a person spends in the labor force over his or her lifetime.

C) unemployment rate.

D) sum of the labor supplied by everyone in the economy.

Answer: D Diff: 1 Topic: Section: 3.3 Question Status: Previous Edition

17 .

3) The tendency of workers to supply more labor in response to a larger reward for working is called the ________ of a higher real wage on the quantity of labor supplied.

A) homogeneous labor supply effect B) negative correlation effect C) income effect D) substitution effect Answer: D Diff: 1 Topic: Section: 3.3 Question Status: Previous Edition 4) The income effect of a higher real wage on the quantity of labor supply is the A) idea that workers feel psychologically wealthier when wages are higher, so they work more.

B) effect that income must rise when wages rise.

C) tendency of workers to supply more labor in response to becoming wealthier.

D) tendency of workers to supply less labor in response to becoming wealthier.

Answer: D Diff: 1 Topic: Section: 3.3 Question Status: Previous Edition 5) If a country's working-age population declines and its wealth increases, then the labor supply curve A) shifts to the left if the effect of the change in wealth is bigger than the effect of the change in the working-age population.

B) shifts to the right if the effect of the change in wealth is bigger than the effect of the change in the working-age population.

C) shifts to the left.

D) shifts to the right.

Answer: C Diff: 2 Topic: Section: 3.3 Question Status: Previous Edition 6) If a country's working-age population increases and its wealth increases, then the labor supply curve A) shifts to the left if the effect of the change in wealth is bigger than the effect of the change in the working-age population.

B) shifts to the right if the effect of the change in wealth is bigger than the effect of the change in the working-age population.

C) shifts to the left.

D) shifts to the right.

Answer: A Diff: 2 Topic: Section: 3.3 Question Status: Previous Edition 18 .

7) If Jeff's wage rate rises, he decides to work fewer hours. From this, we can infer that A) for Jeff, the substitution effect is greater than the income effect.

B) for Jeff, the substitution effect is equal to the income effect.

C) for Jeff, the substitution effect is less than the income effect.

D) Jeff is a nitwit.

Answer: C Diff: 2 Topic: Section: 3.3 Question Status: Previous Edition 8) If Jeff's wage rate rises, he decides to work more hours. From this, we can infer that A) for Jeff, the substitution effect is greater than the income effect.

B) for Jeff, the substitution effect is equal to the income effect.

C) for Jeff, the substitution effect is less than the income effect.

D) Jeff is confused.

Answer: A Diff: 2 Topic: Section: 3.3 Question Status: Previous Edition 9) As a result of the superb economics essay that you wrote during this quarter, you won the Adam Smith prize of $100. The receipt of these funds would be an example of A) the substitution effect being stronger than the income effect.

B) the income effect being stronger than the substitution effect.

C) a pure income effect.

D) a pure substitution effect.

Answer: C Diff: 2 Topic: Section: 3.3 Question Status: Previous Edition 10) A person is more likely to increase labor supply in response to an increase in the real wage, the ________ is the income effect and the ________ is the substitution effect.

A) larger; larger B) larger; smaller C) smaller; larger D) smaller; smaller Answer: C Diff: 2 Topic: Section: 3.3 Question Status: Previous Edition

19 .

11) A permanent increase in the real wage rate has a ________ income effect on labor supply than a temporary increase in the real wage, so labor supply is ________ with a permanent wage increase than for a temporary wage increase.

A) larger; more B) larger; less C) smaller; more D) smaller; less Answer: B Diff: 2 Topic: Section: 3.3 Question Status: Previous Edition 12) Research on labor supply generally shows that A) labor supply rises in response to a permanent increase in the real wage, but falls in response to a temporary increase in the real wage.

B) labor supply rises in response to a temporary increase in the real wage, but falls in response to a permanent increase in the real wage.

C) labor supply rises in response to both a temporary and a permanent increase in the real wage.

D) labor supply falls in response to both a temporary and a permanent increase in the real wage.

Answer: B Diff: 2 Topic: Section: 3.3 Question Status: Previous Edition 13) When workers increase their hours worked, there is said to be a change in the A) extensive margin.

B) intensive margin.

C) hours margin.

D) hours of intensity.

Answer: B Diff: 1 Topic: Section: 3.3 Question Status: Previous Edition 14) A change on the extensive margin occurs when A) people who were employed decide to increase their hours worked.

B) people who were unemployed decide to take jobs.

C) people who were employed decide to decrease their hours worked.

D) people drop out of the labor force after being unemployed.

Answer: B Diff: 1 Topic: Section: 3.3 Question Status: Previous Edition

20 .

15) How would each of the following events affect Cheryl Shirker's supply of labor? (a) Cheryl's firm announces a reorganization plan, in which she will get a big promotion and raise in six months. (b) Cheryl's speculative investment in plutonium futures pays off big, netting her a profit of $300 thousand. (c) Cheryl's father, who had planned to leave her a large bequest, must spend all his wealth on medical bills after a prolonged illness.

Answer: (a) The higher future real wage reduces current labor supply. (b) Higher wealth reduces labor supply. (c) Lower wealth increases labor supply.

Diff: 2 Topic: Section: 3.3 Question Status: Previous Edition 16) Over the past 100 years, what has happened to the average workweek in the U.S. manufacturing industry? Why has this occurred? What are the implications for the size of the income and substitution effects?

Answer: The average workweek in manufacturing has declined from about 56 hours a week a century ago to just over 40 hours a week more recently. The primary reason for the decline in the workweek is the higher real wage. This suggests that the income effect of a permanently higher real wage dominates the substitution effect, as workers choose to have more leisure and to work fewer hours per week.

Diff: 2 Topic: Section: 3.3 Question Status: Previous Edition 17) In each of the following scenarios, state whether the labor supply curve would shift to the left, to the right, not shift at all, or if the shift is ambiguous because there is more than one effect and they would move the curve in opposite directions. (a) The stock market rises sharply. (b) Fewer teenagers work while in school than before. (c) A large fraction of the population flees the country because of a bird flu epidemic. (d) The expected future wage declines and the stock market crashes. (e) The current real wage rate rises.

Answer: (a) Higher wealth shifts the labor supply curve left. (b) Lower participation rate shifts the labor supply curve left. (c) Smaller working-age population shifts the labor supply curve left. (d) The lower future wage shifts the labor supply curve to the right and the stock market crash reduces wealth, also causing the labor supply curve to shift to the right. (e) No effect; just a movement along the curve.

Diff: 2 Topic: Section: 3.3 Question Status: Previous Edition

21 .

3.4

Labor Market Equilibrium

1) Equilibrium in the labor market determines A) productivity and employment.

B) the real wage and employment.

C) inflation and the real wage.

D) inflation and employment.

Answer: B Diff: 1 Topic: Section: 3.4 Question Status: New 2) Suppose the marginal product of labor is MPN = 200 - 0.5N where N is aggregate employment. The aggregate quantity of labor supplied is 300 + 8w, where w is the real wage. What is the equilibrium real wage?

A) 5 B) 10 C) 15 D) 20 Answer: B Diff: 3 Topic: Section: 3.4 Question Status: Previous Edition 3) Suppose the marginal product of labor is MPN = 200 - 0.5N where N is aggregate employment. The aggregate quantity of labor supplied is 300 + 8w, where w is the real wage. What is the equilibrium quantity of employment?

A) 12 B) 190 C) 380 D) 760 Answer: C Diff: 3 Topic: Section: 3.4 Question Status: Previous Edition

22 .

4) Suppose the marginal product of labor is MPN = 200 - 0.5N where N is aggregate employment. The aggregate quantity of labor supplied is 100 + 4w, where w is the real wage. The government imposes a minimum wage of 60. How much unemployment will this create among unskilled labor?

A) 0 B) 60 C) 80 D) 100 Answer: B Diff: 3 Topic: Section: 3.4 Question Status: Previous Edition 5) Suppose the marginal product of labor is MPN = 200 - 0.5N where N is aggregate employment. The aggregate quantity of labor supplied is 100 + 4w, where w is the real wage. The government imposes a minimum wage of 60. What is the quantity of employment?

A) 240 B) 260 C) 280 D) 300 Answer: C Diff: 3 Topic: Section: 3.4 Question Status: Previous Edition 6) Suppose the marginal product of labor is MPN = 200 - 0.5N where N is aggregate employment. The aggregate quantity of labor supplied is 300 + 8w, where w is the real wage. If a supply shock increases the marginal product of labor by 10 (to MPN = 210 - 0.5 N), by how much does the real wage increase?

A) 1 B) 2 C) 3 D) 4 Answer: B Diff: 3 Topic: Section: 3.4 Question Status: Previous Edition

23 .

7) Suppose the marginal product of labor is MPN = 200 - 0.5N where N is aggregate employment. The aggregate quantity of labor supplied is 100 + 4w, where w is the real wage. If an increase in wealth causes the supply of labor to shift to 70 + 4w, by how much does the real wage change?

A) Decreases by 5 B) Decreases by 10 C) Increases by 10 D) Increases by 5 Answer: D Diff: 3 Topic: Section: 3.4 Question Status: New 8) Suppose the marginal product of labor is MPN = 200 - 0.5N where N is aggregate employment. The aggregate quantity of labor supplied is 300 + 8w, where w is the real wage. If a supply shock increases the marginal product of labor by 10 (to MPN = 210 - 0.5 N), by how much does employment increase?

A) 0 B) 4 C) 8 D) 16 Answer: D Diff: 3 Topic: Section: 3.4 Question Status: Previous Edition 9) A tremendous flood along the Mississippi River destroys thousands of factories, reducing the nation's capital stock by 5%. What happens to current employment and the real wage rate?

A) Both employment and the real wage rate would increase.

B) Both employment and the real wage rate would decrease.

C) Employment would increase and the real wage would decrease.

D) Employment would decrease and the real wage would increase.

Answer: B Diff: 2 Topic: Section: 3.4 Question Status: Previous Edition

24 .

10) A sharp increase in stock prices makes people much wealthier. If the main effect of this increased wealth is felt on labor supply, what happens to current employment and the real wage rate?

A) Both employment and the real wage rate would increase.

B) Both employment and the real wage rate would decrease.

C) Employment would increase and the real wage would decrease.

D) Employment would decrease and the real wage would increase.

Answer: D Diff: 2 Topic: Section: 3.4 Question Status: Previous Edition 11) An adverse oil-price shock reduces labor demand. What happens to current employment and the real wage rate?

A) Both employment and the real wage rate would increase.

B) Both employment and the real wage rate would decrease.

C) Employment would increase and the real wage would decrease.

D) Employment would decrease and the real wage would increase.

Answer: B Diff: 2 Topic: Section: 3.4 Question Status: Previous Edition 12) A beneficial oil-price shock increases labor demand. What happens to current employment and the real wage rate?

A) Both employment and the real wage rate would increase.

B) Both employment and the real wage rate would decrease.

C) Employment would increase and the real wage would decrease.

D) Employment would decrease and the real wage would increase.

Answer: A Diff: 2 Topic: Section: 3.4 Question Status: Previous Edition 13) A bird flu epidemic causes many people to flee the country, but does not affect labor demand significantly because almost all the goods produced within the country are exported. What happens to current employment and the real wage rate?

A) Both employment and the real wage rate would increase.

B) Both employment and the real wage rate would decrease.

C) Employment would increase and the real wage would decrease.

D) Employment would decrease and the real wage would increase.

Answer: D Diff: 2 Topic: Section: 3.4 Question Status: Previous Edition

25 .

14) The government announces a tax increase on workers' wages to take effect in the future.

What happens to current employment and the real wage rate?

A) Both employment and the real wage rate would increase.

B) Both employment and the real wage rate would decrease.

C) Employment would increase and the real wage would decrease.

D) Employment would decrease and the real wage would increase.

Answer: C Diff: 2 Topic: Section: 3.4 Question Status: Previous Edition 15) Suppose the banking industry were to fail, leaving the federal government (through its deposit guarantee programs) to pay for trillions of dollars in losses. They do so by imposing a tax of 50% on all individuals' wealth. What happens to current employment and the real wage rate?

A) Both employment and the real wage rate would increase.

B) Both employment and the real wage rate would decrease.

C) Employment would increase and the real wage would decrease.

D) Employment would decrease and the real wage would increase.

Answer: C Diff: 2 Topic: Section: 3.4 Question Status: New 16) The equilibrium level of employment, achieved after the complete adjustment of wages and prices, is known as the A) zero-unemployment level of employment.

B) natural state.

C) invisible handshake.

D) full-employment level of employment.

Answer: D Diff: 1 Topic: Section: 3.4 Question Status: Previous Edition 17) Full-employment output is the level of output that firms in the economy supply when A) taxes are zero.

B) wages and prices have fully adjusted.

C) the unemployment rate is zero.

D) all capital is fully utilized.

Answer: B Diff: 1 Topic: Section: 3.4 Question Status: Previous Edition

26 .

18) An increase in total factor productivity will A) increase the full-employment level of output.

B) lower the rate of return to capital.

C) shift the production function down.

D) increase the unemployment rate.

Answer: A Diff: 1 Topic: Section: 3.4 Question Status: New 19) Suppose oil prices fall temporarily, as oil becomes more plentiful. What impact is this likely to have on the production function, the marginal products of labor and capital, labor demand, employment, and the real wage?

Answer: More output can now be produced by the same amounts of capital and labor, since oil is more abundant and cheaper. The production function shifts upward, with the marginal products of labor and capital rising. Since the marginal product of labor is higher, so is labor demand. As a result of the shift to the right in the labor demand curve, employment rises, as does the real wage.

Diff: 2 Topic: Section: 3.4 Question Status: Previous Edition 20) Suppose the marginal product of labor in the economy is given by MPN = 200 - 0.5 N, while the supply of labor is 100 + 4w. (a) Find the market-clearing real wage rate. (b) What happens if the government imposes a minimum wage of 40? Is there involuntary unemployment? (c) What happens if the government imposes a minimum wage of 60? Is there involuntary unemployment?

Answer: (a) The market-clearing real wage rate equates the demand and supply of labor. Setting w = MPN = 200 - 0.5 N and solving for N gives N = 400 - 2w, which represents labor demand.

Equating labor demand to labor supply gives 400 - 2w = 100 + 4w, or 300 = 6w, or w = 50. (b) A minimum wage of 40 has no effect, as it is below the market wage, so involuntary unemployment is 0. (c) A minimum wage of 60 is binding, as it is above the market wage. At w = 60, labor demand is 400 - (2 × 60) = 280, while labor supply is 100 + (4 × 60) = 340. So unemployment is 60 workers.

Diff: 2 Topic: Section: 3.4 Question Status: Previous Edition

27 .

21) Suppose the marginal product of labor in the economy is given by MPN = 0.002(16,000 - N), while the supply of labor is 1000 + 1000w. (a) Find the market-clearing real wage rate and level of employment. (b) What happens to the wage rate and employment if wealth rises, reducing the supply of labor to 500 + 1000w? (c) What happens to the wage rate and employment if after wealth has risen as in part (b), there is a productivity shock that increases the marginal product of labor to MPN = 0.0025(16,000 N)?

Answer: (a) The market-clearing real wage rate equates the demand and supply of labor. Setting w = MPN = 0.002(16,000 - N), we get w = 32 - 0.002(1000 + 1000w) = 32 - 2 - 2w. Using algebra gives 3w = 30, so w = 10. Plugging into the labor supply equation gives N = 1000 + (1000 × 10) = 11,000. (b) Setting w = MPN = 0.002(16,000 - N), we get w = 32 - 0.002(500 + 1000w) = 32 - 1 - 2w.

Using algebra gives 3w = 31, so w = 10.333. Plugging into the labor supply equation gives N = 500 + (1000 × 10.333) = 10,833. (c) Setting w = MPN = 0.0025(16,000 - N), we get w = 40 - 0.0025(500 + 1000w) = 40 - 1.25 2.5w. Using algebra gives 3.5w = 38.75, so w = 11.071. Plugging into the labor supply equation gives N = 500 + (1000 × 11.071) = 11,571.

Diff: 2 Topic: Section: 3.4 Question Status: Previous Edition 22) How would each of the following events affect the level of employment and the real wage rate? Explain which curves in the labor market diagram would be affected and show your work. (a) The stock market falls sharply. (b) A war destroys a substantial amount of a country's physical capital. (c) A new law reduces immigration of workers into the country.

Answer: (a) Lower wealth shifts the labor supply curve to the right; the new equilibrium has higher employment and a lower real wage. (b) The loss of capital lowers the marginal product of labor, reducing labor demand; the shift of the labor demand curve to the left lowers the real wage and employment. (c) Reduced labor supply causes a rise in the real wage rate in equilibrium and a decline in equilibrium employment.

Diff: 2 Topic: Section: 3.4 Question Status: Previous Edition

28 .

23) How would each of the following events affect the level of employment and the real wage rate? (a) A tremendous boom occurs in the stock market, increasing people's wealth by $100 billion overnight. (b) A major government loan-guarantee program goes bust, losing $500 billion. To pay off the loss, the government announces that tax rates will rise 30% in the future. (c) A nuclear mishap contaminates all auto plants in the Detroit area, destroying their capital. (d) Medical science cures the common cold, causing fewer work days lost due to illness, thus greatly increasing labor productivity.

Answer: (a) Increased wealth reduces labor supply; the shift of the labor supply curve to the left brings a new equilibrium with lower employment and a higher real wage. (b) The loss of wealth increases labor supply, leading to higher employment and a lower real wage. (c) The loss of capital lowers the marginal product of labor, reducing labor demand; the shift of the labor demand curve to the left lowers the real wage and employment. (d) Increased productivity increases the demand for labor; in equilibrium the real wage and employment increase.

Diff: 2 Topic: Section: 3.4 Question Status: Previous Edition 3.5

Unemployment

1) Someone who is not employed and is not looking for work is classified in the household survey as A) not in the labor force.

B) unemployed.

C) not in the population.

D) on welfare.

Answer: A Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition 2) Someone who is looking for work but not employed is classified in the household survey as A) not in the labor force.

B) unemployed.

C) not in the population.

D) on welfare.

Answer: B Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition

29 .

3) What is the unemployment rate if there are 150 million people employed, 25 million people unemployed, and 25 million not in the labor force?

A) 14.3% B) 13.4% C) 12.5% D) 25.0% Answer: A Diff: 2 Topic: Section: 3.5 Question Status: Previous Edition 4) The labor force participation rate is the percentage of the adult population that is A) employed.

B) willing to work but unable to find jobs.

C) unemployed.

D) working or actively looking for work.

Answer: D Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition 5) The ________ is the number of unemployed divided by the labor force and the ________ is the number of employed divided by the adult population.

A) unemployment rate; employment rate B) unemployment rate; employment ratio C) unemployment ratio; participation rate D) discouraged worker ratio; employment rate Answer: B Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition 6) The ________ is the number of unemployed divided by the labor force and the ________ is the labor force divided by the adult population.

A) unemployment rate; employment rate B) unemployment rate; employment ratio C) unemployment rate; participation rate D) discouraged worker ratio; employment rate Answer: C Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition

30 .

7) What is the participation rate if there are 125 million people in the labor force, 100 million people employed, and 25 million not in the labor force?

A) 83% B) 80% C) 75% D) 67% Answer: A Diff: 2 Topic: Section: 3.5 Question Status: Previous Edition 8) What is the unemployment rate if there are 170 million people employed, 25 million people unemployed, and 35 million not in the labor force?

A) 14.7% B) 13.7% C) 12.8% D) 10.9% Answer: C Diff: 2 Topic: Section: 3.5 Question Status: Previous Edition 9) How many people are unemployed if the employment ratio is 75%, there are 90 million people employed, and there are 20 million people not in the labor force?

A) 20 million B) 10 million C) 5 million D) 0 million Answer: B Diff: 3 Topic: Section: 3.5 Question Status: Previous Edition 10) How many people are employed if the labor force participation rate is 60%, there are 3 million people unemployed, and there are 30 million people not in the labor force?

A) 54 million B) 48 million C) 42 million D) 30 million Answer: C Diff: 3 Topic: Section: 3.5 Question Status: Previous Edition

31 .

11) The city of Hope has a labor force of 1000. Twenty people lose their jobs each month and remain unemployed for exactly one month before finding jobs. On January 1, May 1, and September 1 of each year, 50 people lose their jobs for a period of four months before finding new jobs. What is the unemployment rate in any given month?

A) 2% B) 3% C) 5% D) 7% Answer: D Diff: 2 Topic: Section: 3.5 Question Status: Previous Edition 12) The city of Hope has a labor force of 1000. Twenty people lose their jobs each month and remain unemployed for exactly one month before finding jobs. On January 1, May 1, and September 1 of each year, 50 people lose their jobs for a period of four months before finding new jobs. What is the average duration of an unemployment spell?

A) 2.15 months B) 2.85 months C) 3.14 months D) 3.43 months Answer: A Diff: 3 Topic: Section: 3.5 Question Status: Previous Edition 13) Frictional unemployment arises when A) unskilled or low-skilled workers find it difficult to obtain desirable, long-term jobs.

B) labor must be reallocated from industries that are shrinking to areas that are growing.

C) workers must search for suitable jobs and firms must search for suitable workers.

D) output and employment are below full-employment levels.

Answer: C Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition 14) Cyclical unemployment arises when A) unskilled or low-skilled workers find it difficult to obtain desirable, long-term jobs.

B) labor must be reallocated from industries that are shrinking to areas that are growing.

C) workers must search for suitable jobs and firms must search for suitable workers.

D) output and employment are below full-employment levels.

Answer: D Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition

32 .

15) Cyclical unemployment is caused by A) people entering the labor force to search for jobs.

B) technological progress, which causes some industries to expand employment and others to reduce employment.

C) reducing international trade barriers, which causes some industries to expand employment and others to reduce employment.

D) business cycle fluctuations.

Answer: D Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition 16) The type of unemployment for which the net economic costs are most likely to be small is A) cyclical unemployment.

B) chronic unemployment.

C) frictional unemployment.

D) structural unemployment.

Answer: C Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition 17) Discouraged workers are discouraged because A) their employers continue to underpay them.

B) they are working part-time, but they want full-time work.

C) they don't have jobs and are pessimistic about their chances of finding a suitable job.

D) their employers are too demanding.

Answer: C Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition 18) Marginally attached workers A) are not looking for work but indicate that they want to work and are available for a job and have looked for work sometime in the past 12 months.

B) are working part-time, but they want full-time work.

C) don't have jobs and are pessimistic about their chances of finding a suitable job.

D) have a bad attitude towards work.

Answer: A Diff: 1 Topic: Section: 3.5 Question Status: Revised

33 .

19) As a larger fraction of the working-age population becomes older and retires, A) the labor-force participation rate declines.

B) the labor-force participation rate increases.

C) the unemployment rate decreases.

D) the employment-population ratio increases.

Answer: A Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition 20) An increase in the number of discouraged workers in the Great Recession and its aftermath caused A) the labor-force participation rate to decline.

B) the labor-force participation rate to increase.

C) the unemployment rate to decrease.

D) the employment-population ratio to increase.

Answer: A Diff: 1 Topic: Section: 3.5 Question Status: Previous Edition 21) In the United States, the duration of most unemployment spells is A) two or three years.

B) approximately one year.

C) about two months or less.

D) less than two weeks.

Answer: C Diff: 1 Topic: Section: 3.5 Question Status: New 22) Most of the chronically unemployed workers in the U.S. economy are unemployed because A) they do not want to work; they would rather live on welfare.

B) they are too sick or too disabled to work.

C) they do not have the job skills and personal attributes that employers demand.

D) they are too old or too young to work.

Answer: C Diff: 1 Topic: Section: 3.5 Question Status: New

34 .

23) The kind of unemployment created by technological progress and changes in competition is called A) progressive unemployment.

B) competitive unemployment.

C) structural unemployment.

D) frictional unemployment.

Answer: C Diff: 1 Topic: Section: 3.5 Question Status: New 24) In April 2000, the United States had a labor force of 141,230,000, employment of 135,706,000, and there were 67,986,000 people not in the labor force (all numbers rounded to the nearest 1000). (a) Calculate the unemployment rate. (b) Calculate the participation rate. (c) Calculate the employment ratio.

Answer: (a) Unemployment = labor force - employment = 141,230,000 - 135,706,000 = 5,524,000, so the unemployment rate is 5,524,000/141,230,000 = 3.9%. (b) The participation rate is the fraction of the adult population in the labor force. The adult population is the labor force + the number not in the labor force = 141,230,000 + 67,986,000 = 209,216,000. The participation rate is then 141,230,000/209,216,000 = 67.5%. (c) The employment ratio is the employed fraction of the adult population, which is 135,706,000/209,216,000 = 64.9%.

Diff: 2 Topic: Section: 3.5 Question Status: Previous Edition

35 .

25) The city of Hope has a labor force of 1000. Twenty people lose their jobs each month and remain unemployed for exactly one month before finding jobs. On January 1, May 1, and September 1 of each year 50 people lose their jobs for a period of four months before finding new jobs. (a) What is the unemployment rate in any given month? (b) How many unemployment spells are there in a year? (c) What is the average duration of an unemployment spell? (d) On any given date, how many people are undergoing short spells, and how many are undergoing long spells?

Answer: (a) 70/1000 = 7% (b) Short spells: 20 each month × 12 months = 240. Long spells: 50 each × 3 times a year = 150.

Total spells = 240 + 150 = 390. Note that most are short spells. (c) The total duration of all spells is (240 spells × 1 month) 240 months + (150 spells × 4 months) 600 months = 840 months. Average duration = total duration/total spells = 840/390 = 2.15 months. (d) Short: 20; long: 50. Note that most of the unemployed at a given time are undergoing long spells.

Diff: 2 Topic: Section: 3.5 Question Status: Previous Edition 3.6

Relating Output and Unemployment: Okun's Law

1) Okun's law relates ________ to ________.

A) inflation; unemployment B) inflation; output C) output; unemployment D) output; employment Answer: C Diff: 1 Topic: Section: 3.6 Question Status: Previous Edition 2) The relationship between output and employment is known as A) the Phillips curve.

B) the Beveridge curve.

C) the Diamond paradox.

D) Okun's Law. Answer: D Diff: 1 Topic: Section: 3.6 Question Status: Previous Edition

36 .

3) According to Okun's law, an increase in the unemployment rate will cause ________ in the level of employment and ________ in the level of output.

A) an increase; an increase B) an increase; a decrease C) a decrease; an increase D) a decrease; a decrease Answer: D Diff: 1 Topic: Section: 3.6 Question Status: Previous Edition 4) The growth rate form of Okun's law relates ________ to ________.

A) the inflation rate; the change in the unemployment rate B) the inflation rate; the growth rate of output C) the growth rate of output; the change in the unemployment rate D) the growth rate of output; the growth rate of employment Answer: C Diff: 1 Topic: Section: 3.6 Question Status: New 5) Assume that the full-employment level of output is $5000 billion and the natural unemployment rate is 5%. Suppose the current unemployment rate is 8%. What would be the current level of output according to Okun's law (when the Okun's law coefficient is 2)?

A) $4500 billion B) $4700 billion C) $4900 billion D) $5000 billion Answer: B Diff: 3 Topic: Section: 3.6 Question Status: Previous Edition 6) According to Okun's law, if output grew 7% and full-employment output rose 5%, what would be the change in the unemployment rate?

A) -4 percentage points B) -1 percentage point C) 1 percentage point D) 4 percentage points Answer: B Diff: 2 Topic: Section: 3.6 Question Status: Previous Edition

37 .

7) According to Okun's law, if output grew 1% and full-employment output rose 3%, what would be the change in the unemployment rate?

A) -2 percentage points B) -1 percentage point C) 1 percentage point D) 2 percentage points Answer: C Diff: 2 Topic: Section: 3.6 Question Status: Previous Edition 8) Assuming that the growth rate of full-employment output is 3%, and that the actual unemployment rate fell 2 percentage points in the last year, Okun's Law predicts that output growth rate over the past year was A) -1%.

B) 3%.

C) 5%.

D) 7%.

Answer: D Diff: 2 Topic: Section: 3.6 Question Status: Previous Edition 9) According to Okun's Law, if the natural rate of unemployment is 5% and the actual unemployment rate is 4%, what is the level of full-employment output if output equals $10,125 billion?

A) $10,328 billion B) $10,226 billion C) $10,025 billion D) $9926 billion Answer: D Diff: 3 Topic: Section: 3.6 Question Status: Previous Edition 10) State the growth rate form of Okun's Law and define the variables in the equation.

Answer: The growth rate form of Okun's law is ΔY/Y = 3 - 2Δu, where ΔY/Y is the growth rate of output, 3 is the growth rate of full-employment output, and Δu is the change in the unemployment rate.

Diff: 1 Topic: Section: 3.6 Question Status: Previous Edition

38 .

11) Suppose the natural rate of unemployment is 5%, with full-employment output of $7000 billion. Use Okun's Law to calculate the level of national output if the unemployment rate is 7%.

Answer: The output-level form of Okun's law tells us that the percentage deviation of output from full-employment output equals minus two times the deviation of unemployment from the natural rate of unemployment. So, if the unemployment rate is 2 percentage points above the natural rate of unemployment, then output will be 4 percentage points below the fullemployment level of output. So output will be (1 - 0.04) × $7000 billion = $6720 billion.

Diff: 3 Topic: Section: 3.6 Question Status: Previous Edition 12) Suppose the Okun's law coefficient is 2, the full-employment level of output is $5000 billion, and the natural rate of unemployment is 6%. (a) What is the current level of output if the current unemployment rate is 8%? (b) Suppose the unemployment rate falls to 5%; what is the current level of output? (c) Suppose structural changes in the economy raise the natural rate of unemployment to 7%, and lower the full-employment level of output to $4800 billion. If the current unemployment rate is 8%, what is the current level of output?

Answer: (a) From the Okun's law relationship ( - Y)/ = 2 (u - ), we can solve for Y to get Y = [1 - 2(u - )] = [1 - 2(0.08 - 0.06)]5000 = 0.96 × 5000 = $4800 billion. (b) Y = [1 - 2(0.05 - 0.06)]5000 = 1.02 × 5000 = $5100 billion. (c) Y = [1 - 2(0.08 - 0.07)]4800 = 0.98 × 4800 = $4704 billion.

Diff: 2 Topic: Section: 3.6 Question Status: Previous Edition

39 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 4 Consumption, Saving, and Investment 4.1

Consumption and Saving

1) Desired national saving equals A) Y - Cd - G. B) Cd + Id + G. C) Id + G. D) Y - Id - G. Answer: A Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition 2) The distinction between saving and savings is that saving is ________, while savings is ________.

A) the flow of funds that is not consumed out of income; the stock of funds that represents the accumulated amount of net saving over time B) the flow of funds that is not consumed out of income; the plural of saving C) the flow of funds that someone invests in bank savings accounts; the stock of funds that represents the accumulated amount of net saving over time D) the flow of funds that is not consumed out of income; the stock of funds that is invested in bank savings accounts Answer: A Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition 3) With no inflation and a nominal interest rate (i) of .03, a person can trade off one unit of current consumption for ________ units of future consumption.

A) 0.97 B) 1.03 C) .03 D) -.03 Answer: B Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition

1 .

4) The desire to have a relatively even pattern of consumption over time is known as A) excess sensitivity.

B) the substitution effect.

C) the consumption-smoothing motive.

D) forced saving.

Answer: C Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition 5) An expensive and unexpected car repair causes Cathy to reduce her spending this year by $1000 and next year by $1000, as well. She spreads the cost of the repair over time because of A) her misunderstanding of economics.

B) the substitution effect.

C) the consumption-smoothing motive.

D) Okun's law.

Answer: C Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition 6) The government has a new source of revenue from its ownership of natural resources that is likely to be permanent. As a result, the government surprises everyone by cutting taxes. In response, Jeff increases his spending this year by $1000 and next year by $1000, as well. He spreads his increased spending over time because of A) the real interest rate being positive.

B) the substitution effect.

C) the consumption-smoothing motive.

D) the Phillips curve.

Answer: C Diff: 1 Topic: Section: 4.1 Question Status: Revised 7) When a person gets an increase in current income, what is likely to happen to consumption and saving?

A) Consumption increases and saving increases.

B) Consumption increases and saving decreases.

C) Consumption decreases and saving increases.

D) Consumption decreases and saving decreases.

Answer: A Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition

2 .

8) Last year, Linus earned a salary of $25,000 and he spent $24,000, thus saving $1000. At the end of the year, he received a bonus of $1000 and he spent $500 of it, saving the other $500.

What was his marginal propensity to consume?

A) .96 B) .50 C) .04 D) .02 Answer: B Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 9) Rosencrantz's base pay last year was $50,000 and he spent $48,000, thus saving $2,000. At the end of the year, he received a bonus of $2,000 and he spent $200 of it, saving the other $1,800.

What is his marginal propensity to consume?

A) .96 B) .10 C) .04 D) .02 Answer: B Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 10) The fraction of additional current income that a person consumes in the current period is known as the A) consumption-smoothing motive.

B) consumption deficit.

C) saving rate.

D) marginal propensity to consume.

Answer: D Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition 11) An increase in expected future output while holding today's output constant would A) increase today's desired consumption and increase desired national saving.

B) increase today's desired consumption and decrease desired national saving.

C) decrease today's desired consumption and increase desired national saving.

D) decrease today's desired consumption and decrease desired national saving.

Answer: B Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition

3 .

12) A decrease in the economy's expected future income while holding today's income constant would A) increase today's desired consumption and increase desired national saving.

B) increase today's desired consumption and decrease desired national saving.

C) decrease today's desired consumption and increase desired national saving.

D) decrease today's desired consumption and decrease desired national saving.

Answer: C Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 13) In forecasting consumer spending using surveys of consumer confidence, research suggests that A) the forecasts are improved when using consumer confidence measures.

B) the forecasts are not improved when using consumer confidence measures.

C) the forecasts are improved when using consumer confidence measures for forecasts made during recessions, but not expansions.

D) the forecasts are not improved when using consumer confidence measures for forecasts made during expansions, but not recessions.

Answer: B Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 14) When a person receives an increase in wealth, what is likely to happen to consumption and saving?

A) Consumption increases and saving increases.

B) Consumption increases and saving decreases.

C) Consumption decreases and saving increases.

D) Consumption decreases and saving decreases.

Answer: B Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 15) Aunt Agatha has just left her nephew $5000. The most likely response is for her nephew to A) increase current consumption, but not future consumption.

B) decrease current consumption, but increase future consumption.

C) increase future consumption, but not current consumption.

D) increase both current consumption and future consumption.

Answer: D Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition

4 .

16) The stock market just crashed; the Dow Jones Industrial Average fell by 750 points. You would expect the effect on aggregate consumption to be the largest if which of the following facts was true?

A) The crash had been preceded by a large run-up in the price of stocks.

B) Most stocks were owned by insurance companies.

C) Most stocks were owned by pension funds that invested in the market.

D) Many individuals had invested in the stock market immediately prior to the crash.

Answer: D Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 17) An increase in the personal income tax rate on interest income will A) increase desired saving because the expected real after-tax interest rate rises.

B) decrease desired saving because the expected real after-tax interest rate rises.

C) decrease desired saving because the expected real after-tax interest rate falls.

D) increase desired saving because the expected real after-tax interest rate falls.

Answer: C Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 18) If the substitution effect of the real interest rate on saving is larger than the income effect of the real interest rate on saving, then a rise in the real interest rate leads to a ________ in consumption and a ________ in saving, for someone who's a lender.

A) fall; fall B) fall; rise C) rise; rise D) rise; fall Answer: B Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 19) If the substitution effect of the real interest rate on saving is smaller than the income effect of the real interest rate on saving, then a rise in the real interest rate leads to a ________ in consumption and a ________ in saving, for someone who's a lender.

A) fall; fall B) fall; rise C) rise; rise D) rise; fall Answer: D Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition

5 .

20) A small increase in the real interest rate will most likely A) increase desired saving, but the effect will be relatively small.

B) increase desired saving substantially.

C) decrease desired saving substantially.

D) decrease desired saving, but the effect will be relatively small.

Answer: A Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 21) With a nominal interest rate of 4%, an expected inflation rate of 1%, and interest income taxed at a rate of 25%, what is the expected real after-tax interest rate?

A) 3% B) 2% C) 1% D) 0% Answer: B Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 22) With a nominal interest rate of 4%, an expected inflation rate of 3%, and interest income taxed at a rate of 25%, what is the expected real after-tax interest rate?

A) 3% B) 2% C) 1% D) 0% Answer: D Diff: 2 Topic: Section: 4.1 Question Status: New 23) The nominal interest rate is 10%, the expected inflation rate is 5%, and the combined statefederal tax rate is 35%. The expected real after-tax interest rate is A) 1.50%.

B) 3.25%.

C) 5.00%.

D) 6.50%.

Answer: A Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition

6 .

24) Suppose the nominal interest rate is 0.03, the tax rate on interest income is 0.2, and the expected real after-tax interest rate is 0.004. What is the expected inflation rate?

A) 0.03 B) 0.02 C) 0.01 D) 0.00 Answer: B Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 25) Suppose the nominal interest rate is 0.04, the expected inflation rate is 0.025, and the expected real after-tax interest rate is 0.005. What is the tax rate on interest income?

A) 0.30 B) 0.25 C) 0.20 D) 0.15 Answer: B Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 26) Suppose the expected inflation rate is 0.01, the tax rate on interest income is 0.3, and the expected real after-tax interest rate is 0.0145. What is the nominal interest rate?

A) 0.035 B) 0.030 C) 0.025 D) 0.020 Answer: A Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 27) Three factors that cause interest rates among different financial instruments to vary are A) default risk, expected inflation, and taxability.

B) default risk, current inflation, and taxability.

C) default risk, maturity, and taxability.

D) default risk, expected inflation, and maturity.

Answer: C Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition

7 .

28) The relationship between a bond's maturity and the interest rate it pays is called the A) yield curve.

B) amortization schedule.

C) federal funds rate.

D) desired investment curve.

Answer: A Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition 29) The yield curve generally slopes upward because A) longer maturity bonds typically pay higher interest rates than shorter maturity bonds.

B) longer maturity bonds typically pay lower interest rates than shorter maturity bonds.

C) shorter maturity bonds have more default risk.

D) longer maturity bonds are not taxable.

Answer: A Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition 30) If an investor has a tax rate on interest income of 25% and the inflation rate is 4%, which bond has the lowest expected real after-tax interest rate?

A) A Treasury bond paying 9% B) A corporate bond paying 8% C) A Treasury bond paying 7% D) A municipal bond paying 6% Answer: C Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 31) If an investor has a tax rate on interest income of 30% and the inflation rate is 4%, which bond has the highest expected real after-tax interest rate?

A) A Treasury bond paying 8% B) A corporate bond paying 7% C) A Treasury bond paying 7% D) A municipal bond paying 6% Answer: D Diff: 3 Topic: Section: 4.1 Question Status: Previous Edition

8 .

32) The yield curve shows A) the yields on stocks of different maturities.

B) the interest rates on bonds of different maturities.

C) the yields on stocks with differing default risk.

D) the yields on bonds with differing default risk.

Answer: B Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition 33) Desired national saving would increase unambiguously if there were A) an increase in both current output and expected future output.

B) an increase in both expected future output and government purchases.

C) an increase in both expected future output and the expected real interest rate.

D) a fall in both government purchases and expected future output.

Answer: D Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 34) Desired national saving would decrease unambiguously if there were A) a decrease in current output and a decrease in taxes.

B) an increase in expected future output and a decrease in government purchases.

C) an increase in both expected future output and the expected real interest rate.

D) a fall in both government purchases and expected future output.

Answer: A Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 35) The Ricardian equivalence proposition suggests that a government deficit caused by a tax cut A) causes inflation.

B) causes a current account deficit.

C) raises interest rates.

D) doesn't affect consumption.

Answer: D Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition

9 .

36) According to the Ricardian equivalence proposition, a temporary government budget deficit created by cutting taxes A) will cause desired consumption to increase.

B) will cause future taxes to increase but will have no real economic effects.

C) will have the same real economic effects as a budget deficit created by raising government spending.

D) would have the same real effects whether or not consumers expect future taxes to change.

Answer: B Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 37) If the government cuts taxes today, issuing debt today and repaying the debt plus interest next year, a rational taxpayer will A) spend the full amount of the tax cut today and reduce consumption next year.

B) increase consumption today, before taxes go up next year.

C) increase saving today, leaving consumption unchanged.

D) leave a smaller gross bequest to her or his heirs.

Answer: C Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition 38) Which of the factors listed below might cause the Ricardian equivalence proposition to be violated?

A) There may be international capital inflows and outflows.

B) Consumers may not understand that an increase in government borrowing today is likely to lead to higher future taxes.

C) There may be constraints on the level of government spending.

D) There may be constraints on the level of government taxation.

Answer: B Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition 39) Empirical evidence shows that in response to the 2008 and 2009 tax rebates, consumers spent 50% to 90% of the amounts they received. This suggests that A) people do not understand economics.

B) Ricardian equivalence does not hold.

C) budget constraints are not binding.

D) Okun's law holds.

Answer: B Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition

10 .

40) What is the marginal propensity to consume, and why is it always less than one?

Answer: The marginal propensity to consume (MPC) is the amount by which desired consumption rises when current income rises by one unit. The marginal propensity to consume is less than one because a part of any increase in current income is saved.

Diff: 1 Topic: Section: 4.1 Question Status: Previous Edition 41) How would the expected real after-tax rate of return be affected by each of the following events?

(1) the tax rate on interest income increases (2) expected inflation declines Answer: The expected real after-tax rate of return is ra-t = (1 - t) i - expected inflation rate.

(1) Clearly ra-t would decline if the tax rate on interest income increases.

(2) From the formula, ra-t would increase if expected inflation declines.

Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition 42) Sally will earn $30,000 this year and $40,000 next year. The real interest rate is 20% between this year and next year; she can borrow or lend at this rate. She has no wealth at the start of this year and plans to finish next year having consumed everything she possibly can. She would like to consume the same amount this year as next year. The inflation rate is 0%. (a) How much should Sally save this year? How much will Sally consume in each of the two years? (c) How would your answers change if the real interest rate was 40%?

Answer: In general, S = Y(1) - C(1). So in year 2, she has consumption equal to (1 + r)[Y(1) - C(1)] + Y(2) = C(2). Since C(1) = C(2), then (1 + r)[Y(1) - C(2)] + Y(2) = C(2).

This can be solved for C(2) to get C(2) = [(1 + r)Y(1) + Y(2)]/(2 + r). (a) With r = 0.2, then C(2) = [(1.2 × $30,000) + $40,000]/2.2 = $34,545 = C(1). Then S = $30,000 - $34,545 = -$4545. So Sally will borrow. (b) With r = 0.4, then C(2) = [(1.4 × $30,000) + $40,000]/2.4 = $34,167 = C(1). Then S = $30,000 - $34,167 = -$4167. So Sally will borrow, but less than before.

Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition

11 .

43) Jane wants to save $1000 of current income. With an IRA, no taxes are paid on income or interest until the money is withdrawn in five years. Without an IRA, taxes must be paid whenever income or interest is received. Jane's federal/state tax bracket is 35%, and the nominal interest rate is 8%. (a) How much money will Jane have if she puts her money in an IRA and withdraws the money in five years? (b) How much money will Jane have if she does not put her money in an IRA, but rather in a regular (taxable) savings account, for five years? (c) How much does Jane gain in five years by using an IRA rather than a regular savings account?

Answer: (a) $955.06 = [$1000 × (1.08)5] × 0.65 (b) $837.51 = $650 × [1 + (0.08 × 0.65)]5 (c) $117.55 = $955.06 - $837.51 Diff: 3 Topic: Section: 4.1 Question Status: Previous Edition 44) Suppose the one-year T-bill rate was 5% on 1/1/2007, 4% on 1/1/2008, and 6% on 1/1/2009.

The GDP deflator (2004 = 100) was 110 on 1/1/2007, 112 on 1/1/2008, 114 on 1/1/2009, and 120 on 1/1/2010. The tax rate on interest income is 30%. (a) Calculate the nominal after-tax rate of return for 2007, 2008, and 2009. (b) If you began with $1000 on 1/1/2007 and invested in T-bills each year (paying taxes at the end of each year), how much would you have in nominal terms on 1/1/2010? How much would you have in real terms (2004 dollars)? (c) How much was your nominal after-tax interest earned in part (b) over the three years? How much did you earn in real (2004) after-tax dollars?

Answer: (a) 2007: 3.5% = 0.05 × .7; 2008: 2.8% = 0.04 × 0.7; 2009: 4.2% = .06 × 0.7 (b) Nominal: $1108.67 = $1000 × 1.035 × 1.028 × 1.042; Real: $923.89 = $1108.67/(120/100) (c) Nominal: $108.67 = $1108.67 - $1000; Real: $14.80 = $923.89 - $1000/(110/100) = $923.89 - $909.09 Diff: 3 Topic: Section: 4.1 Question Status: Previous Edition

12 .

45) Suppose the nominal interest rate is 6%, the tax rate on interest income is 30%, and expected inflation is 3%. (a) Calculate the expected real after-tax interest rate. (b) Calculate the expected real after-tax interest rate if the nominal interest rate falls to 4%. (c) Calculate the expected real after-tax interest rate if the tax rate increases to 50% (with the nominal interest rate at its original value of 6%). (d) Calculate the expected real after-tax interest rate if expected inflation increases to 5% (with the nominal interest rate at its original value of 6% and the tax rate at its original value of 30%).

Answer: The expected real after-tax interest rate is ra-t = (1 - t)i - expected inflation rate. (a) Given the initial values, ra-t = (1 - .30).06 - .03 = 0.012 = 1.2%. (b) When i = 4%, ra-t = (1 - .30).04 - .03 = -0.002 = -0.2%. (c) When t = 50%, ra-t = (1 - .50).06 - .03 = 0.0 = 0.0%. (d) When expected inflation rate = 5%, ra-t = (1 - .30).06 - .05 = -0.008 = -0.8%.

Diff: 3 Topic: Section: 4.1 Question Status: Previous Edition 46) The nominal interest rate on taxable bonds is 8%, while on municipal bonds (which aren't taxable) it is 5%. The expected inflation rate is 3% and the tax rate on interest income is 40%.

Calculate the expected real after-tax interest rate on both bonds. Which would be the better investment? Now suppose the actual inflation rate turned out to be 6%. Which bond was the better investment? Would your answer change if inflation had turned out to be 0%?

Answer: ra-t (taxable bond) = (1 - 0.40)8% - 3% = 1.8%; ra-t (municipal bond) = 5% - 3% = 2%; municipal bond is the best buy; note that the same expected inflation rate is subtracted from both, so it doesn't matter what the actual inflation rate turns out to be the municipal bond is always the best.

Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition

13 .

47) Suppose you divide your life into two periods: working age and retirement age. When you work, you earn labor income Y; when retired, you earn no labor income, but must live off your savings and the interest it earns. You save the amount S while working, earning interest at rate r, so you have (1 + r)S to live on when retired. Because you don't need to consume as much when retired, you want to set consumption when working twice as high as consumption when retired. (a) Suppose you earn $1 million over your working life, and the real interest rate for retirement saving is 50%. How much will you save and how much will you consume in each part of your life? (b) Suppose your current income went up to $2 million when working. Now what will you save and how much will you consume each period? (c) Suppose a social security system will pay you 25% of your working income when you are retired. Now (with Y = $1 million, as in part (a) how much will you save and how much will you consume each period? (d) Suppose the interest rate rises (starting from the situation in part (a). Will you save more or less?

Answer: (a) cW = Y - S, cR = (1 + r)S; cW = 2cR. So Y - S = 2(1 + r)S, or (3 + 2r)S = Y. With r = 0.5, 3 + 2r = 4. Setting 4S = $1 million, we get S = $250,000, so cR = $375,000, and cW = $750,000. (b) Now 4S = $2 million, so S = $500,000, cR = $750,000, and cW = $1,500,000. Higher current income yields higher saving and consumption in both the present and the future. (c) Now cR = (1 + r)S + pY, where p = .25. So Y - S = 2(1 + r)S + 2pY, or (3 + 2r)S = (1 - 2p)Y. With r = 0.5 and p = .25, we get 4S = 0.5 Y, and with Y = $1 million, this gives S = $125,000, cW = $875,000, and cR = $437,500. The social security system reduces saving and increases consumption in both periods. (d) The basic equation is (3 + 2r)S = Y, so as r rises, S declines, with Y held fixed.

Diff: 3 Topic: Section: 4.1 Question Status: Previous Edition 48) In 1991 the federal government changed the withholding amounts for personal taxes. The change meant that people wouldn't have as much withheld from their paychecks. But there was no change in the tax code itself, so the amount of tax due in April 1992 was not changed. How would consumption and saving respond to this withholding change? (Note: you may assume a real interest rate of 0%.)

Answer: This is just a Ricardian equivalence example. People would not change their consumption, but would increase saving by the amount of the withholding change, so that they would have the same consumption pattern over time.

Diff: 2 Topic: Section: 4.1 Question Status: Previous Edition

14 .

4.2

Investment

1) The user cost of capital is given by the following formula, where pK is the real price of capital goods, d is the depreciation rate, and r is the expected real interest rate.

A) uc = (r + d)/pK B) uc = pK/(r + d) C) uc = d pK/r D) uc = (r + d)pK Answer: D Diff: 1 Topic: Section: 4.2 Question Status: Previous Edition 2) An increase in the price of capital goods will A) increase the expected future marginal product of capital.

B) reduce the expected future marginal product of capital.

C) increase the interest cost and the depreciation cost of capital.

D) increase the interest cost but not affect the depreciation cost of capital.

Answer: C Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 3) Which of the following machines has the lowest user cost? Machine A costs $15,000 and depreciates at a 25% rate, machine B costs $10,000 and depreciates at a rate of 20%, machine C costs $20,000 and depreciates at a rate of 10%, and machine D costs $17,000 and depreciates at a rate of 11%. The expected real interest rate is 5%.

A) Machine A B) Machine B C) Machine C D) Machine D Answer: B Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition

15 .

4) Which of the following machines has the lowest user cost? Machine A costs $15,000 and depreciates at a rate of 25%, machine B costs $10,000 and depreciates at a rate of 20%, machine C costs $20,000 and depreciates at a rate of 10%, and machine D costs $17,000 and depreciates at a rate of 11%. The expected real interest rate is 0%.

A) Machine A B) Machine B C) Machine C D) Machine D Answer: D Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 5) Calculate the user cost of capital of a machine that costs $5000 and depreciates at a rate of 25%, when the expected real interest rate is 5%.

A) $150 B) $500 C) $1500 D) $5000 Answer: C Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 6) Calculate the user cost of capital of a machine that costs $5000 and depreciates at a rate of 25%, when the nominal interest rate is 10% and the expected inflation rate is 5%.

A) $150 B) $500 C) $1500 D) $5000 Answer: C Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 7) Calculate the user cost of capital of a machine that costs $100,000 and depreciates at a rate of 25%, when the nominal interest rate is 4% and the expected inflation rate is 1%.

A) $3000 B) $25,000 C) $28,000 D) $29,000 Answer: C Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition

16 .

8) Calculate the user cost of capital of a machine that costs $5000 and depreciates at a 25% rate, when the nominal interest rate is 5% and the expected inflation rate is 10%.

A) $5000 B) $1500 C) $1000 D) $100 Answer: C Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 9) Calculate the user cost of capital of a machine that costs $10,000 and depreciates at a 10% rate, when the nominal interest rate is 6% and the expected inflation rate is 3%.

A) $300 B) $600 C) $1000 D) $1300 Answer: D Diff: 2 Topic: Section: 4.2 Question Status: New 10) You have just purchased a new DVD player to show videos to your customers. The DVD player cost $500, and you depreciate the machine at a rate of 25% each year. You can borrow money from the bank at 10%, or receive 6% for depositing money at the bank. The expected inflation rate in the coming year is 5%. You used the company's own funds to purchase the DVD player. The firm's user cost of capital for the first year is A) $130.

B) $150.

C) $155.

D) $175.

Answer: A Diff: 3 Topic: Section: 4.2 Question Status: Previous Edition

17 .

11) You are trying to figure out how much capacity to add to your factory. You will increase capacity as long as A) the expected marginal product of capital is positive.

B) the expected marginal product of capital is greater than or equal to the marginal product of capital.

C) the expected marginal product of capital is greater than or equal to the expected marginal product of labor.

D) the expected marginal product of capital is greater than or equal to the user cost of capital.

Answer: D Diff: 1 Topic: Section: 4.2 Question Status: Previous Edition 12) When a company must consider taxes (at rate tau) in determining investment, its desired capital stock is chosen such that A) MPKf = uc(1 - tau).

B) MPKf = uc/(1 - tau).

C) MPKf = tau × uc.

D) tau × MPKf = uc.

Answer: B Diff: 1 Topic: Section: 4.2 Question Status: Revised 13) The desired level of the capital stock will increase if the A) user cost of capital increases.

B) expected future marginal product of capital increases.

C) effective tax rate increases.

D) price of capital increases.

Answer: B Diff: 1 Topic: Section: 4.2 Question Status: Previous Edition 14) If a firm's expected marginal product of capital exceeds its tax-adjusted user cost of capital, the firm will A) increase its investment spending on capital goods.

B) reduce its investment spending on capital goods.

C) not change its investment spending on capital goods.

D) increase the tax-adjusted user cost of capital.

Answer: A Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition

18 .

15) An increase in the expected real interest rate will A) increase the desired capital stock.

B) decrease the desired capital stock.

C) have no effect on the desired capital stock.

D) have the same effect on the desired capital stock as a decrease in corporate taxes.

Answer: B Diff: 1 Topic: Section: 4.2 Question Status: Previous Edition 16) A decrease in the expected real interest rate will A) increase the desired capital stock.

B) decrease the desired capital stock.

C) have no effect on the desired capital stock.

D) have the same effect on the desired capital stock as an increase in corporate taxes.

Answer: A Diff: 1 Topic: Section: 4.2 Question Status: New 17) If the rate of depreciation increases, then user cost ________ and the desired capital stock ________.

A) falls; falls B) falls; rises C) rises; rises D) rises; falls Answer: D Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 18) The relationship between stock prices and firms' investments in physical capital is captured by what theory?

A) User-cost-of-capital theory B) q theory C) Yield-curve theory D) Keynesian theory Answer: B Diff: 1 Topic: Section: 4.2 Question Status: Previous Edition

19 .

19) Tobin's q is equal to A) the ratio of capital's market value to its replacement cost.

B) the ratio of capital's replacement cost to its market value.

C) the expected after-tax real interest rate.

D) the stock market value of a firm.

Answer: A Diff: 1 Topic: Section: 4.2 Question Status: Previous Edition 20) If the stock market value of a firm is $10 million and the firm owns $15 million of capital, then Tobin's q equals A) 2/3.

B) 1.

C) 3/2.

D) 4.

Answer: A Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 21) If the stock market value of a firm is $12 million and the firm owns $8 million of capital, then Tobin's q equals A) 2/3.

B) 1.

C) 3/2.

D) 4.

Answer: C Diff: 2 Topic: Section: 4.2 Question Status: New 22) If the firm owns $8 million of capital and the firm's stock market value is $12 million, then Tobin's q equals A) 2/3.

B) 1.

C) 3/2.

D) 4.

Answer: C Diff: 2 Topic: Section: 4.2 Question Status: New

20 .

23) A firm should invest more if Tobin's q A) equals zero.

B) is less than one.

C) equals one.

D) is more than one.

Answer: D Diff: 1 Topic: Section: 4.2 Question Status: Previous Edition 24) A firm should invest more if Tobin's q A) is negative.

B) is positive.

C) equals one.

D) is more than one.

Answer: D Diff: 1 Topic: Section: 4.2 Question Status: New 25) If a firm's Tobin's q is less than one it should A) not invest more.

B) invest more.

C) invest more only if q equals zero.

D) invest more only if q is negative.

Answer: A Diff: 1 Topic: Section: 4.2 Question Status: New 26) A technological improvement will A) increase the desired capital stock.

B) decrease the desired capital stock.

C) have no effect on the desired capital stock.

D) have the same effect on the desired capital stock as an increase in corporate taxes.

Answer: A Diff: 1 Topic: Section: 4.2 Question Status: Previous Edition

21 .

27) Suppose your company is in equilibrium, with its capital stock at its desired level. A permanent decline in the expected real interest rate now has what effect on your desired capital stock?

A) Raises it, because the future marginal productivity of capital is higher B) Lowers it, because the future marginal productivity of capital is lower C) Raises it, because the user cost of capital is now lower D) Lowers it, because the user cost of capital is now higher Answer: C Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 28) Suppose your company is in equilibrium, with its capital stock at its desired level. A permanent increase in the depreciation rate now has what effect on your desired capital stock?

A) Raises it, because the future marginal productivity of capital is higher B) Lowers it, because the future marginal productivity of capital is lower C) Raises it, because the user cost of capital is now lower D) Lowers it, because the user cost of capital is now higher Answer: D Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 29) Calculate the tax-adjusted user cost of capital of a machine that costs $10,000 and depreciates at a rate of 10%, when the real interest rate is 3% and the tax rate on revenue is 5%.

A) $1238 B) $1300 C) $1368 D) $1800 Answer: C Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 30) Calculate the tax-adjusted user cost of capital of a machine that costs $5000 and depreciates at a rate of 25%, when the real interest rate is 5% and the tax rate on revenue is 25%.

A) $200 B) $275 C) $2000 D) $2750 Answer: C Diff: 2 Topic: Section: 4.2 Question Status: New

22 .

31) Cummins, Hubbard, and Hassett studied the effects of taxes on investment by A) seeing if investment spending is correlated with taxes on investment.

B) examining what happened to investment when major tax reforms took place.

C) raising tax rates on certain businesses and testing their reaction.

D) raising tax rates on equipment and reducing tax rates on structures.

Answer: B Diff: 1 Topic: Section: 4.2 Question Status: Previous Edition 32) Cummins, Hubbard, and Hassett found that investment responded to a tax change that affected the user cost of capital, with an elasticity of A) 0.

B) -0.25.

C) -0.66.

D) -1.

Answer: C Diff: 1 Topic: Section: 4.2 Question Status: Previous Edition 33) What is the difference between gross investment and net investment?

A) Net investment = gross investment minus taxes B) Net investment = gross investment minus net factor payments C) Net investment = gross investment minus inventory accumulation D) Net investment = gross investment minus depreciation Answer: D Diff: 1 Topic: Section: 4.2 Question Status: Previous Edition 34) At the start of the year, your firm's capital stock equaled $100 million, and at the end of the year it equaled $105 million. The average depreciation rate on your capital stock is 20%. Gross investment during the year equaled A) $1 million.

B) $5 million.

C) $7 million.

D) $25 million.

Answer: D Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition

23 .

35) At the start of the year, your firm's capital stock equaled $10 million, and at the end of the year it equaled $15 million. The average depreciation rate on your capital stock is 20%. Net investment during the year equaled A) $3 million.

B) $4 million.

C) $5 million.

D) $7 million.

Answer: C Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 36) At the start of the year, your firm's capital stock equaled $10 million, and at the end of the year it equaled $15 million. The average depreciation rate on your capital stock is 20%. Gross investment during the year equaled A) $3 million.

B) $4 million.

C) $5 million.

D) $7 million.

Answer: D Diff: 2 Topic: Section: 4.2 Question Status: New 37) Your firm has capital stock of $10 million and a depreciation rate of 15%. Gross investment is $3 million. How much is net investment?

A) $1.5 million B) $2.0 million C) $2.5 million D) $3.5 million Answer: A Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 38) You have just purchased a home that cost $250,000. The nominal mortgage interest rate is 8% per annum, mortgage interest payments are tax deductible, and you are in a 30% tax bracket.

The expected inflation rate is 4%. Maintenance and other expenses are 8% of the initial value of the house. What is the real user cost of your house?

A) $20,000 B) $24,000 C) $27,000 D) $30,000 Answer: B Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 24 .

39) How would the desired capital stock be affected by a decline in the user cost of capital?

Answer: A firm sets its capital stock such that the future marginal product of capital equals the user cost, where the future marginal product of capital declines as the amount of capital increases. A decline in the user cost requires that the future marginal product of capital also decline to maintain the equality. So the desired capital stock increases.

Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 40) A firm has current and future marginal productivity of capital given by MPK = 10,000 - 2K + N, and marginal productivity of labor given by MPN = 50 - 2N + K. The price of capital is $5000, the real interest rate is 10%, and capital depreciates at a 15% rate. The real wage rate is $15. (a) Calculate the user cost of capital. (b) Find the firm's optimal amount of employment and the size of the capital stock.

Answer: (a) uc = (r + d)pK = 0.25 × $5000 = $1250. (b) Setting w = MPN gives 15 = 50 - 2N + K, or 2N = 35 + K. Setting uc = MPK gives 1250 = 10,000 - 2K + N, or N = -8750 + 2K, or 2N = -17,500 + 4K. Setting -17,500 + 4K = 35 + K gives 3K = 17,535, which yields K = 5845. Then N = 2940.

Diff: 3 Topic: Section: 4.2 Question Status: Previous Edition

25 .

41) A firm's output (Y) depends on how much capital (K) it has, according to the equation: Y = 20K - K2. The real interest rate is 6% per year, the depreciation rate of capital is 14% per year and the price of a unit of capital is $80, and each unit of output sells for $1. (a) For capital levels of 0 to 6, how much is output? (b) For capital levels from 1 to 6, calculate the marginal product of capital. (c) How many units of capital does the firm desire? (d) If the real interest rate was 1% per year, how many units of capital would the firm desire?

Answer: (a) & (b) Capital Output MPK 0 0 --1 19 19 2 36 17 3 51 15 4 64 13 5 75 11 6 84 9 (c) uc = (r + d)pK = (0.06 + 0.14) × 80 = 16, so the firm would like 2 units of capital; a 3rd unit of capital has an MPK of only 15, which is less than the user cost. (d) uc = (r + d)pK = (0.01 + 0.14) × 80 = 12, so the firm would like 4 units of capital; a 5th unit of capital has an MPK of only 11, which is less than the user cost.

Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 42) What is the q theory of investment? Who developed it? What is q, and what do different values of q imply? How is q related to the stock market value of a firm and its capital stock?

Answer: The q theory of investment captures the relationship between stock prices and firms' investment in physical capital. The theory was developed by James Tobin. Tobin's q equals capital's market value divided by its cost. When Tobin's q exceeds one, more investment should take place. When q is less than one, there should be no investment. Tobin's q is related to the stock market value of the firm via the formula q = V/(pKK), where V is the stock market value of the firm, pK is the price of capital, and K is the quantity of capital.

Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition

26 .

43) Draw a diagram showing the determination of a firm's optimal capital stock, showing the relationship between the user cost of capital and the future marginal product of capital. Suppose the real interest rate declines. Show what happens to the firm's optimal capital stock. What happens to the firm's desired investment?

Answer: This is the standard diagram with the user cost of capital as a horizontal line and the future marginal product of capital as a downward sloping line. The decline in the real interest rate reduces the user cost of capital, thus increasing the optimal capital stock. With a higher optimal capital stock, desired investment increases.

Diff: 2 Topic: Section: 4.2 Question Status: Previous Edition 4.3

Goods Market Equilibrium

1) When desired national saving equals desired national investment (in a closed economy), what market is in equilibrium?

A) The goods market B) The money market C) The foreign exchange market D) The stock market Answer: A Diff: 1 Topic: Section: 4.3 Question Status: Previous Edition 2) In the goods market equilibrium condition for a closed economy, the total demand for goods equals A) Cd + Id. B) Cd + Id + G. C) Cd + Id - G. D) Cd + G - Id. Answer: B Diff: 1 Topic: Section: 4.3 Question Status: Previous Edition 3) One way of writing the goods-market equilibrium condition for a closed economy is A) Y = C + G + S. B) Y = Cd + Gd + S. C) Sd = Id. D) Y - Cd - G - Sd = Id. Answer: C Diff: 1 Topic: Section: 4.3 Question Status: Previous Edition 27 .

4) An economy has full-employment output of 5000. Government purchases are 1000. Desired consumption and desired investment are given by Cd = 3000 - 2000r + 0.10Y Id = 1000 - 4000r where Y is output and r is the real interest rate. The real interest rate that clears the goods market is equal to A) 1.25%.

B) 2.50%.

C) 8.33%.

D) 25.00%.

Answer: C Diff: 3 Topic: Section: 4.3 Question Status: Previous Edition 5) An economy has government purchases of 1000. Desired national saving and desired investment are given by Sd = 200 + 5000r + 0.10Y - 0.20G Id = 1000 - 4000r When the full-employment level of output equals 5000, then the real interest rate that clears the goods market will be A) 1.11%.

B) 5.56%.

C) 16.67%.

D) 21.11%.

Answer: B Diff: 3 Topic: Section: 4.3 Question Status: Previous Edition 6) An economy has government purchases of 2000. Desired national saving and desired investment are given by Sd = 200 + 5000r + 0.10Y - 0.20G Id = 1000 - 4000r When the full-employment level of output equals 5000, then the real interest rate when the goods market is in equilibrium will be A) 7.78%.

B) 10.00%.

C) 14.44%.

D) 23.33%.

Answer: A Diff: 3 Topic: Section: 4.3 Question Status: Previous Edition

28 .

7) An economy has government purchases of 2000. Desired national saving and desired investment are given by Sd = 200 + 5000r + 0.10Y - 0.20G Id = 1000 - 4000r When the full-employment level of output equals 5000, then the level of investment when the goods market is in equilibrium will be A) 66.8.

B) 422.4.

C) 600.0.

D) 688.9.

Answer: D Diff: 3 Topic: Section: 4.3 Question Status: Previous Edition 8) Any change in the economy that raises desired national saving for a given value of the real interest rate will shift the desired national saving curve to A) the right and increase the real interest rate.

B) the right and decrease the real interest rate.

C) the left and increase the real interest rate.

D) the left and decrease the real interest rate.

Answer: B Diff: 1 Topic: Section: 4.3 Question Status: Previous Edition 9) An increase in the expected real interest rate tends to A) raise desired saving only.

B) raise desired investment only.

C) raise both desired saving and desired investment.

D) raise desired saving, but lower desired investment.

Answer: D Diff: 1 Topic: Section: 4.3 Question Status: Previous Edition 10) In the saving-investment diagram, an increase in current output would A) shift the saving curve to the left.

B) shift the investment demand curve to the left.

C) not shift the curves.

D) shift the saving curve to the right.

Answer: D Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition

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11) The saving-investment diagram shows that a higher real interest rate due to a leftward shift of the saving curve A) raises the profitability of investment for firms.

B) causes the amount of firms' investment to increase.

C) increases the total amount of saving because of the increase in the real interest rate.

D) causes the total amounts of saving and investment to fall.

Answer: D Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition 12) A temporary decrease in government purchases would cause A) a rightward shift in the saving curve and a leftward shift in the investment curve.

B) a rightward shift in the saving curve and a rightward shift in the investment curve.

C) a rightward shift in the saving curve, but no shift in the investment curve.

D) no shift in the saving curve, but a leftward shift in the investment curve.

Answer: C Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition 13) A temporary increase in government purchases would cause A) a leftward shift in the saving curve and a leftward shift in the investment curve.

B) a leftward shift in the saving curve and a rightward shift in the investment curve.

C) a leftward shift in the saving curve, but no shift in the investment curve.

D) no shift in the saving curve, but a rightward shift in the investment curve.

Answer: C Diff: 2 Topic: Section: 4.3 Question Status: New 14) Any change in the economy that reduces desired national saving for a given value of the real interest rate will shift the desired national saving curve to A) the right and increase the real interest rate.

B) the right and decrease the real interest rate.

C) the left and increase the real interest rate.

D) the left and decrease the real interest rate.

Answer: C Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition

30 .

15) A temporary supply shock, such as a one month decrease in oil prices, would A) increase the marginal product of capital and increase desired investment, increasing the real interest rate in equilibrium.

B) decrease the marginal product of capital and decrease desired investment, decreasing the real interest rate in equilibrium.

C) have little or no effect on desired investment, thus not changing the real interest rate by much in equilibrium.

D) increase both the marginal product of capital and the marginal product of labor in the longterm future, thus raising the real interest rate in equilibrium.

Answer: C Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition 16) If consumers foresee future taxes completely, a reduction in taxes this year that is accompanied by an offsetting increase in future taxes would cause A) a rightward shift in the saving curve and a rightward shift in the investment curve.

B) a shift in neither the saving nor the investment curve.

C) a leftward shift in the saving curve, but no shift in the investment curve.

D) no shift in the saving curve, but a rightward shift in the investment curve.

Answer: B Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition 17) An invention that raises the future marginal product of capital (in a closed economy) would cause an increase in desired investment, which would cause the investment curve to shift to the ________ and would cause the real interest rate to ________.

A) right; increase B) right; decrease C) left; increase D) left; decrease Answer: A Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition 18) A temporary supply shock, such as a drought, would A) increase the marginal product of capital and increase desired investment.

B) decrease the marginal product of capital and decrease desired investment.

C) have little or no effect on desired investment.

D) decrease both the marginal product of capital and the marginal product of labor in the longterm future.

Answer: C Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition 31 .

19) If the government reduces the effective tax rate on capital (in a closed economy), then the real interest rate ________ and saving ________.

A) falls; declines B) falls; increases C) rises; increases D) rises; declines Answer: C Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition 20) If the stock market booms and people feel wealthier (in a closed economy), then the real interest rate ________ and investment ________.

A) falls; declines B) falls; increases C) rises; increases D) rises; declines Answer: D Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition 21) Onerous regulations on businesses that take effect next year (in a closed economy)reduce businesses' expected future marginal product of capital. As a result, the real interest rate ________ and saving ________.

A) falls; declines B) falls; increases C) rises; increases D) rises; declines Answer: A Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition 22) If consumers believe that next year a recession will occur (in a closed economy), then the real interest rate ________ and investment ________.

A) falls; declines B) falls; increases C) rises; increases D) rises; declines Answer: B Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition

32 .

23) Identify two variables that shift the desired investment curve. Is desired investment negatively related or positively related to each of these variables?

Answer: Variables that shift the desired investment curve are the real interest rate, the expected future marginal product of capital, and the effective tax rate. Desired investment is positively related to the future marginal product of capital, but negatively related to the real interest rate and the effective tax rate.

Diff: 1 Topic: Section: 4.3 Question Status: Previous Edition 24) What are the economic consequences of reductions in defense spending by the government?

What happens to national saving, the interest rate, and investment?

Answer: The reduction in defense spending increases national saving, so that the desired saving curve shifts to the right. As a result, the real interest rate declines, and investment increases.

Diff: 1 Topic: Section: 4.3 Question Status: Previous Edition 25) Use a saving-investment diagram to explain what happens to saving, investment, and the real interest rate in each of the following scenarios in a closed economy. (a) Current output rises due to a temporary productivity increase. (b) The tax code changes so that business firms face higher tax rates on their revenue (offset by other lump-sum tax changes so there's no overall change in tax revenue). (c) The government increases spending temporarily for a one-year project to turn mercury into gold. (d) The average educational level rises, inducing an increase in the future marginal productivity of capital.

Answer: (a) The rise in output raises desired saving, shifting the Sd curve to the right; in equilibrium, this reduces the real interest rate, increasing investment as well. (b) The rise in taxes reduces desired investment, shifting the Id curve to the left; in equilibrium, this reduces the real interest rate, reducing saving as well as investment. (c) The rise in government purchases reduces desired saving, shifting the Sd curve to the left; in equilibrium, this raises the real interest rate, reducing investment as well as saving. (d) The rise in future marginal productivity of capital raises desired investment, shifting the Id curve to the right; in equilibrium, this raises the real interest rate, increasing saving as well as investment.

Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition

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26) Use a saving-investment diagram to explain what happens to saving, investment, and the real interest rate in each of the following scenarios in a closed economy. (a) In an agricultural economy, great weather this year promises a bumper crop next year, leading citizens to expect higher income next year. (b) Government regulations going into effect next year will reduce the marginal product of capital. (c) The government increases lump-sum taxes on citizens.

Answer: (a) The rise in future income reduces desired saving, shifting the Sd curve to the left; in equilibrium, this raises the real interest rate, reducing investment and saving in equilibrium. (b) The lower future marginal product of capital reduces desired investment, shifting the Id curve to the left; in equilibrium, this reduces the real interest rate, reducing saving as well as investment. (c) If Ricardian Equivalence holds, this has no effect on desired national saving and thus no effect in equilibrium on the real interest rate, saving, or investment. If Ricardian Equivalence does not hold, then people may reduce consumption spending somewhat, leading to increased desired national saving, shifting the Sd curve to the right; in equilibrium, this reduces the real interest rate, increasing investment as well as saving.

Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition 27) An economy has full-employment output of 5000. Government purchases are 1000. Desired consumption and desired investment are given by Cd = 3000 - 2000r + 0.10Y Id = 1000 - 4000r where Y is output and r is the expected real interest rate. (a) Find the real interest rate that clears the goods market. Assume that output equals fullemployment output. (b) Calculate the amount of saving, investment, and consumption in equilibrium. (c) If a shock to wealth causes desired consumption to decline by 200 (so that the new equation for desired consumption is Cd = 2800 - 2000r + 0.10Y), find the equilibrium real interest rate, saving, investment, and consumption.

Answer: (a) Sd = Y - Cd - G = 5000 - [3000 - 2000r + 0.10Y] - 1000 = 500 + 2000r.

Setting Sd = Id gives 500 + 2000r = 1000 - 4000r, which can be solved to get r = 0.0833. (b) Plugging this value of r into the equations for consumption and investment gives C = 3333, I = 667, and S = 667. (c) Follow the same steps as above with the new equation for desired consumption to get: r = 0.05, C = 3200, I = 800, S = 800.

Diff: 2 Topic: Section: 4.3 Question Status: Previous Edition

34 .

4.4

A Formal Model of Consumption and Saving (Appendix 4.A)

1) David consumes 200 in the current period and 330 in the future period. The real interest rate is 10% per period. David's present value of lifetime consumption is A) 500.

B) 530.

C) 550.

D) 563.

Answer: A Diff: 2 Topic: App.: 4.A Question Status: Previous Edition 2) David consumes 140 in the current period and 220 in the future period. David's present value of lifetime consumption is 340. The real interest rate is A) 0%.

B) 5%.

C) 10%.

D) 20%.

Answer: C Diff: 2 Topic: App.: 4.A Question Status: Previous Edition 3) David consumes 140 in the current period and 210 in the future period. The real interest rate is 5% per period. David's present value of lifetime consumption is A) 210.

B) 340.

C) 350.

D) 400.

Answer: B Diff: 2 Topic: App.: 4.A Question Status: Previous Edition 4) Rachel earns nothing during her learning period, 1100 during her working period, and nothing during her retirement period. She has initial assets of 300. The real interest rate is zero. Rachel is not allowed to borrow by the banks. Whenever possible, Rachel wants to smooth consumption between periods. How much will she save during her working period?

A) 400 B) 550 C) 700 D) 950 Answer: B Diff: 2 Topic: App.: 4.A Question Status: Previous Edition 35 .

5) A curve that connects all the consumption combinations that yield the same level of utility is known as A) an isoquant.

B) a yield curve.

C) a budget line.

D) an indifference curve.

Answer: D Diff: 1 Topic: App.: 4.A Question Status: Previous Edition 6) If Claudette gets a permanent increase in her income of $1000 per year, she saves an extra $200 this year and consumes an extra $800 this year. If the increase in income had been temporary instead of permanent, she would have saved ________ of the extra income.

A) more than $200 B) less than $200 C) exactly $200 D) none Answer: A Diff: 2 Topic: App.: 4.A Question Status: Previous Edition 7) Suppose the government provides a tax cut today that is matched by a tax increase in the future that's equal in present value to the tax cut. This causes a consumer's saving to A) decrease.

B) increase.

C) remain unchanged.

D) increase if the person was a lender and decrease if the person was a borrower.

Answer: B Diff: 2 Topic: App.: 4.A Question Status: Previous Edition 8) The substitution effect of a decrease in real interest rates is to cause a consumer to A) increase future consumption and decrease current consumption.

B) decrease future consumption and increase current consumption.

C) increase current consumption and increase saving.

D) decrease current consumption and increase saving.

Answer: B Diff: 2 Topic: App.: 4.A Question Status: Previous Edition

36 .

9) For a borrower, an increase in the real interest rate will lead to A) higher current consumption and less borrowing.

B) higher current consumption and less saving.

C) lower current consumption and less borrowing.

D) lower current consumption and less saving.

Answer: C Diff: 2 Topic: App.: 4.A Question Status: Previous Edition 10) How would each of the following affect Cheryl Shirker's current consumption and saving?

Cheryl is a forward-looking consumer with no borrowing constraints. (a) Cheryl's firm announces a reorganization plan, increasing Cheryl's future income dramatically. (b) Cheryl's father, who had planned to leave her a large bequest, must spend all his wealth on medical bills after a prolonged illness. (c) The real interest rate rises from its original level. Cheryl originally planned to have no assets for the future; that is, she planned to spend all her original assets and all her income when she was young, and planned to consume an amount equal to her future income when she was old.

Answer: (a) The rise in future income raises her current consumption and reduces her saving. (b) The reduction in her wealth reduces her current consumption and raises her saving. (c) The rise in the real interest rate causes Cheryl to reduce current consumption and increase saving to allow her to consume more in the future. There's just a substitution effect and no income effect, since Cheryl was at the no-borrowing, no-lending point initially.

Diff: 2 Topic: App.: 4.A Question Status: Previous Edition

37 .

11) Suppose you divide your life into two periods: working age and retirement age. When you work, you earn labor income Y; when retired, you earn no labor income, but must live off your savings and the interest it earns. You have no initial assets. You save the amount S while working, earning interest at rate r, so you have (1 + r)S to live on when retired. Because you don't need to consume as much when retired, you want to set consumption when working twice as high as consumption when retired. (a) Suppose you earn $1 million over your working life, and the real interest rate for retirement saving is 50%. How much will you save, and how much will you consume in each part of your life? (b) Suppose your current income went up to $2 million when working. Now what will you save and how much will you consume each period? (c) Suppose a social security system will pay you 25% of your working income when you are retired. Now (with Y = $1 million as in part (a) how much will you save and how much will you consume each period? (d) Suppose the interest rate rises. Will you save more or less?

Answer: (a) cW = Y - S, cR = (1 + r)S; cW = 2 . So Y - S = 2(1 + r)S, or (3 + 2r)S = Y. With r = 0.5, 3 + 2r = 4. Setting 4S = $1 million, we get S = $250,000, so cR = $375,000, and cW = $750,000. (b) Now 4S = $2 million, so S = $500,000, cW = $750,000, and cW = $1,500,000. Higher current income yields higher saving and consumption in both the present and the future. (c) Now cR = (1 + r)S + pY, where p = .25. So Y - S = 2(1 + r)S + 2pY, or (3 + 2r)S = (1 - 2p)Y. With r = 0.5 and p = .25, we get 4S = 0.5 Y, and with Y = $1 million, this gives S = $125,000, cW = $875,000, and cR = $437,500. The social security system reduces saving and increases consumption in both periods. (d) The basic equation is (3 + 2r)S = Y, so as r rises, S declines, with Y held fixed.

Diff: 3 Topic: App.: 4.A Question Status: Revised

38 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 5 Saving and Investment in the Open Economy 5.1

Balance of Payments Accounting

1) Which of the following transactions would not be included in the current account of the home country?

A) A consumer good is imported into the home country.

B) A home country resident makes a deposit in a foreign bank.

C) A foreign student pays tuition to a university in the home country.

D) A home country resident receives income on his or her foreign assets.

Answer: B Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 2) Net exports of goods are known as A) the balance of payments.

B) the trade balance.

C) the current account.

D) the financial account.

Answer: B Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 3) If a country's exports of goods exceed its imports of goods, it has a A) trade surplus.

B) trade deficit.

C) current account surplus.

D) current account deficit.

Answer: A Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 4) If France has a trade deficit, then A) imports into France exceed exports from France.

B) exports from France exceed imports into France.

C) imports into the United States from France exceed exports from the United States into France.

D) imports into France from the United States exceed exports from France into the United States.

Answer: A Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition

1 .

5) If Germany has a trade surplus, then A) imports into Germany exceed exports from Germany.

B) exports from Germany exceed imports into Germany.

C) imports into the United States from Germany exceed exports from the United States into Germany.

D) imports into Germany from the United States exceed exports from Germany into the United States.

Answer: B Diff: 1 Topic: Section: 5.1 Question Status: New 6) If all international factor payment flows are investment income, then net investment income from abroad equals A) net exports.

B) the current account balance.

C) the trade balance.

D) net income from abroad.

Answer: D Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 7) If the United States donates footballs to Japan, how is the transaction recorded on the U.S. balance of payments accounts?

A) Decline in trade balance; increase in financial account balance B) Decline in financial account balance; increase in trade balance C) Decline in net unilateral transfers; increase in trade balance D) Decline in trade balance; increase in net unilateral transfers Answer: C Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 8) If the United States sells computers to Russia, and uses the proceeds to buy shares of stock in Russian companies, the U.S. trade balance ________ and the U.S. financial account balance ________.

A) rises; rises B) rises; falls C) falls; falls D) falls; rises Answer: B Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition

2 .

9) The current account balance consists of A) the trade balance plus the services balance.

B) net exports of goods and services, minus net unilateral transfers.

C) net exports of goods and services, plus net income from abroad, plus net unilateral transfers.

D) net exports of goods and services, plus net income from abroad, plus net unilateral transfers, minus the financial account balance.

Answer: C Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 10) The sum of net exports of goods and services, net income from abroad, and net unilateral transfers equals A) the financial account balance.

B) the balance of payments.

C) the current account balance.

D) the balance on goods, services, and income.

Answer: C Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 11) The difference between the current account balance and net exports is A) the capital account.

B) net unilateral transfers plus net factor payments from abroad.

C) adjustments in net foreign assets.

D) income receipts from foreign assets.

Answer: B Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 12) If a U.S. firm buys tulips from a Dutch firm and the Dutch firm uses the dollars it gets to buy U.S. stocks, the U.S. trade balance ________ and the U.S. financial account ________.

A) rises; rises B) rises; falls C) falls; falls D) falls; rises Answer: D Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition

3 .

13) If a U.S. company imports 10 Toyotas from Japan at $15,000 each, and the Japanese company buys airline tickets on a U.S. airline with the money, how does this affect the U.S. balance of payments accounts?

A) Decline in trade balance; increase in financial account balance B) Decline in financial account balance; increase in trade balance C) No change in trade balance or financial account balance D) Decline in trade balance; decrease in financial account balance Answer: C Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 14) Suppose a wealthy Canadian donates $10 million to charities in Mexico. Mexican net exports ________ and the current account balance ________.

A) fall; rises B) rise; rises C) are unchanged; is unchanged D) fall; is unchanged Answer: D Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 15) If a French company exports $2 million of machinery to Italy and French tourists spend $2 million at Italian beaches, the French trade balance ________, and the French financial account balance ________.

A) rises; rises B) rises; is unchanged C) is unchanged; is unchanged D) is unchanged; rises Answer: B Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 16) If a French company sells 1000 gallons of Perrier to a U.S. company at 5 euros per gallon, and uses the money to buy stock in a Spanish cork company, how does this affect the French balance of payments accounts?

A) Decrease in financial account balance; increase in trade balance B) Decrease in trade balance; increase in financial account balance C) Decrease in net investment income from abroad; increase in financial account balance D) Decrease in trade balance; increase in net income from abroad Answer: A Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 4 .

17) If a U.S. firm buys stereos from a Japanese firm and the Japanese firm uses the dollars it gets to buy U.S. Treasury bonds, what items are recorded in the U.S. balance of payments accounts?

A) Decrease in trade balance; decrease in financial account balance B) Decrease in trade balance; increase in financial account balance C) Increase in trade balance; decrease in financial account balance D) Increase in trade balance; increase in financial account balance Answer: B Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 18) If a Japanese company sells 200 VCRs to a French company and uses the money to buy U.S. government bonds, the Japanese trade balance ________, and the Japanese financial account balance ________.

A) rises; rises B) rises; falls C) falls; falls D) falls; rises Answer: B Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 19) Which of the following would be part of the nation's current account?

A) An old house purchased by an American in Italy B) The purchase of a U.S. Treasury bond by a foreigner C) The interest an American earns on a British bond D) A factory built by the Japanese in the United States Answer: C Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 20) A country has a current account surplus if A) the value of its exports exceeds the value of its imports, assuming net income from foreign assets and net unilateral transfers have a value of zero.

B) the value of its net exports of services exceeds the value of its net exports of goods.

C) it receives more income from foreign assets than it pays to foreigners for foreign-owned domestic assets.

D) its capital inflows exceed its capital outflows.

Answer: A Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition

5 .

21) Which of the following would be part of the nation's financial account?

A) A night club show seen by an American in Mexico City B) A dividend from a British equity owned by an American C) A payment to the Philippine government for the use of military bases in their country D) One hundred shares of British Petroleum stock purchased by an American Answer: D Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 22) If a French company exports $2 million of machinery to Italy and French tourists spend $2 million at Italian beaches, the Italian current account balance ________, and the Italian financial account balance ________.

A) rises; rises B) rises; is unchanged C) is unchanged; is unchanged D) is unchanged; rises Answer: C Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 23) The balance of payments equals A) the sum of the current account and the financial account.

B) the current account minus net unilateral transfers.

C) net investment income from abroad.

D) the net increase (domestic less foreign) in a country's official reserve assets.

Answer: D Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 24) A negative value for the U.S. official reserve assets line in the balance of payments accounts means that A) U.S. residents have sold more gold to foreigners than they bought.

B) U.S. residents bought more gold from foreigners than they sold.

C) the U.S. central bank has increased its holdings of foreign reserve assets.

D) the U.S. central bank has decreased its holdings of foreign reserve assets.

Answer: D Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition

6 .

25) A positive value for the U.S. official reserve assets line in the balance of payments accounts means that A) U.S. residents have sold more gold to foreigners than they bought.

B) U.S. residents bought more gold from foreigners than they sold.

C) the U.S. central bank has increased its holdings of foreign reserve assets.

D) the U.S. central bank has decreased its holdings of foreign reserve assets.

Answer: C Diff: 2 Topic: Section: 5.1 Question Status: New 26) The balance of payments A) is always negative when there is a current account deficit.

B) equals the financial account balance minus the current account balance.

C) equals the financial account balance plus the current account balance.

D) equals the net increase (domestic less foreign) in a country's official reserve assets.

Answer: D Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 27) The net increase in a country's official reserve assets is known as the A) balance of payments.

B) current account balance.

C) financial account balance.

D) financial deficit.

Answer: A Diff: 1 Topic: Section: 5.1 Question Status: New 28) If the Federal Reserve buys $3 billion worth of Japanese yen and sells $5 billion of euros, how does this affect the balance of payments?

A) Falls by $2 billion B) Rises by $2 billion C) Rises by $3 billion D) Falls by $5 billion Answer: A Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition

7 .

29) If the Federal Reserve buys $3 billion worth of Japanese yen and $6 billion of euros, and sells $5 billion of British pounds, how does this affect the balance of payments?

A) Falls by $4 billion B) Rises by $4 billion C) Rises by $9 billion D) Falls by $5 billion Answer: B Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 30) Suppose the current account shows debits of $5.3 billion and credits of $4.7 billion. The current account balance is ________, and the financial account balance is ________.

A) +$0.6 billion; -$0.6 billion B) +$0.6 billion; +$0.6 billion C) -$0.6 billion; -$0.6 billion D) -$0.6 billion; +$0.6 billion Answer: D Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 31) A financial account surplus necessarily implies A) a balance of payments surplus.

B) a current account surplus.

C) a current account deficit.

D) an increase in the nation's official reserve assets.

Answer: C Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 32) If the United States had a financial account deficit of $50 billion, we could say the United States had A) net imports of $50 billion.

B) net foreign borrowing of $50 billion.

C) acquired net foreign assets of $50 billion.

D) a current account deficit of $50 billion.

Answer: C Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition

8 .

33) A country's financial account balance decreases if A) its current account balance increases.

B) its income payment inflows on foreign assets decrease.

C) its domestic residents working abroad reduce the income they send home to their families.

D) foreigners increase their purchases of its existing assets.

Answer: A Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 34) Except for errors arising from measurement, what is the relationship between a country's current account balance (CA) and its financial account balance (FA)?

A) CA + FA = 0.

B) CA - FA = 0.

C) CA/FA = 1.

D) CA = 1/FA. Answer: A Diff: 1 Topic: Section: 5.1 Question Status: New 35) If a country has a current account surplus, it also has A) a financial account surplus.

B) an increase in its official reserve assets.

C) a balance of payments deficit.

D) an increase in its holding of net foreign assets.

Answer: D Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 36) You just read that forecasters predict the United States will run a current account deficit in 2025. From this you would infer that the United States will also A) run a financial account deficit in 2025.

B) decrease its official reserve assets in 2025.

C) run a balance of payments surplus in 2025.

D) decrease its net foreign assets in 2025.

Answer: D Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition

9 .

37) If there are no net factor payments from abroad and no unilateral transfers, net exports of $10 billion is the same as A) a current account deficit of $10 billion.

B) a financial account surplus of $10 billion.

C) net acquisition of foreign assets of $10 billion.

D) net foreign borrowing of $10 billion.

Answer: C Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 38) An economic benefit of capital outflows is that they A) create future income payment inflows.

B) increase domestic investment.

C) reduce domestic saving.

D) reduce domestic unemployment.

Answer: A Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 39) When a foreign business firm buys or builds capital goods, this is known as A) foreign direct investment.

B) net private domestic investment.

C) net foreign domestic investment.

D) depreciation.

Answer: A Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 40) The United States became a net debtor because A) it ran consistently large current account deficits.

B) it ran consistently large current account surpluses.

C) it lent a lot to people in foreign countries.

D) it provided much foreign aid to other countries.

Answer: A Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition

10 .

41) Since the late 1980s, the United States A) has been a net international debtor.

B) has run consistently large current account surpluses.

C) has lent a lot to people in foreign countries.

D) has run consistently large financial account deficits.

Answer: A Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition 42) A friend claims that the United States is a net international debtor. The best way of testing this claim is to see whether A) U.S. foreign liabilities exceeded U.S. foreign income.

B) U.S. receipts from foreign assets exceeded U.S. payments to foreign owners of U.S. assets.

C) U.S. official reserve assets were positive or negative.

D) the United States ran a balance of payments surplus or deficit last year.

Answer: B Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 43) Suppose output is $35 billion, government purchases are $10 billion, desired consumption is $15 billion, and desired investment is $6 billion. Net foreign lending would be equal to A) -$4 billion.

B) -$2 billion.

C) $2 billion.

D) $4 billion.

Answer: D Diff: 3 Topic: Section: 5.1 Question Status: Previous Edition 44) Assuming no change in the effective tax rate on capital, a decrease in the government budget deficit will reduce the current account deficit if and only if the decrease in the budget deficit A) reduces desired national saving.

B) increases desired national saving.

C) reduces desired national investment.

D) increases desired national investment.

Answer: B Diff: 1 Topic: Section: 5.1 Question Status: Previous Edition

11 .

45) Assume that an increase in Costa Rica's government budget deficit reduced desired national saving by 10 million colon. Assuming Costa Rica is a small open economy, you would expect the government's action to A) increase the current account balance by exactly 10 million colon.

B) increase the current account balance by less than 10 million colon.

C) reduce the current account balance by exactly 10 million colon.

D) reduce the current account balance by more than 10 million colon.

Answer: C Diff: 2 Topic: Section: 5.1 Question Status: Revised 46) An increase in a small open economy's government budget deficit that reduces national saving and the current account balance causes an A) increase in desired saving.

B) increase in the world real interest rate.

C) increase in exports.

D) increase in absorption.

Answer: D Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 47) In a large open economy like the United States, an increased government budget deficit which reduces national saving A) reduces investment and improves the current account balance.

B) reduces investment and reduces the current account balance.

C) has no effect on investment, but reduces the current account balance.

D) has no effect on either investment or the current account balance.

Answer: B Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition

12 .

48) Suppose a country has the following balance of payments data.

(a) Calculate the current account balance. (b) Calculate the financial account balance. (c) Calculate the trade balance. (d) Calculate net factor payments.

Answer: (a) -60 (b) 60 (c) -20 (d) -40 Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition

13 .

49) Suppose a country has the following balance of payments data.

(a) Calculate the current account balance. (b) Calculate the financial account balance. (c) Calculate the trade balance. (d) Calculate net factor payments.

Answer: (a) -70 (b) 70 (c) -40 (d) -30 Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition

14 .

50) For each of the following transactions, explain what happens to the merchandise trade balance, current account balance, and financial account balance in both the United States and Mexico. The exchange rate is 2 Mexican pesos per U.S. dollar. (a) A Mexican firm spends 4 million pesos to buy radiology equipment from a U.S. firm. (b) A U.S. firm buys 20,000 sombreros at 20 pesos each. (c) Mexican computer firms send 200 programmers to universities in the United States, paying tuition and expenses of $3000 each. (d) A Mexican entrepreneur gives 50,000 pesos to the United Way of San Antonio, Texas. (e) Mexican investors buy $10 million worth of 30-year U.S. Treasury bonds.

Answer: (a) U.S. merchandise trade balance and current account rise $2 million, financial account declines by $2 million; Mexican merchandise trade balance and current account decline by 4 million pesos, financial account rises by 4 million pesos. (b) U.S. merchandise trade balance and current account decline by $200,000, financial account rises by $200,000; Mexican merchandise trade balance and current account rise by 400,000 pesos, financial account declines by 400,000 pesos. (c) U.S. merchandise trade balance is unchanged, current account balance rises by $600,000, financial account declines by $600,000; Mexican merchandise trade balance is unchanged, current account balance falls by 1.2 million pesos, financial account rises by 1.2 million pesos. (d) U.S. merchandise trade balance is unchanged, current account balance rises by $25,000, financial account declines by $25,000; Mexican merchandise trade balance is unchanged, current account balance declines by 50,000 pesos, financial account rises by 50,000 pesos. (e) No change in any accounts in either country.

Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 51) Suppose an economy has output of 2100, government spending of 40, consumption of 1600, and absorption of 1940. Calculate the equilibrium values of investment and net exports.

Answer: Since absorption = C + I + G, then 1940 = 1600 + I + 40, so I = 1940 - 1640 = 300.

Net exports = Y - absorption = 2100 - 1940 = 160.

Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition 52) How did the United States become a net debtor in the 1980s? Is our foreign debt a significant problem? Explain.

Answer: In the 1980s, the United States ran large current account deficits, which had to be financed by net foreign borrowing. But the foreign debt doesn't represent a significant problem because it remains small relative to our GDP and because it is mostly in the form of portfolio investment rather than direct investment. But it is worrisome that the increased foreign debt hasn't been accompanied by a rise in our capital stock.

Diff: 2 Topic: Section: 5.1 Question Status: Previous Edition

15 .

5.2

Goods Market Equilibrium in an Open Economy

1) In goods market equilibrium in an open economy, A) the desired amount of exports must equal the desired amount of imports.

B) the desired amount of exports must equal the desired amount of imports less the amount lent abroad.

C) the desired amount of national saving must equal the desired amount of domestic investment.

D) the desired amount of national saving must equal the desired amount of domestic investment plus the amount lent abroad.

Answer: D Diff: 2 Topic: Section: 5.2 Question Status: Previous Edition 2) The goods market equilibrium condition in an open economy shows that A) NX = Sd - Id. B) Sd = NX - Id. C) Sd = Id - NX. D) Sd = Id. Answer: A Diff: 1 Topic: Section: 5.2 Question Status: Previous Edition 3) In goods market equilibrium in an open economy, A) the desired amount of exports must equal the desired amount of imports.

B) the desired amount of exports must equal the desired amount of imports less the amount lent abroad.

C) the desired amount of national saving must equal the desired amount of domestic investment.

D) the desired amount of national saving must equal the desired amount of domestic investment plus the current account balance.

Answer: D Diff: 2 Topic: Section: 5.2 Question Status: Previous Edition 4) Total spending by domestic residents, businesses, and governments is called A) investment.

B) net domestic purchases.

C) absorption.

D) GDP. Answer: C Diff: 1 Topic: Section: 5.2 Question Status: Previous Edition

16 .

5) Absorption refers to A) the total amount of imports purchased by a country.

B) the net amount of imports purchased by a country.

C) total spending by domestic residents, businesses, and governments.

D) GDP less desired consumption, desired investment, and government purchases.

Answer: C Diff: 1 Topic: Section: 5.2 Question Status: Previous Edition 6) Suppose output is $1000 billion, government purchases are $200 billion, desired consumption is $700 billion, and desired investment is $150 billion. Net foreign lending would be equal to A) -$150 billion.

B) -$50 billion.

C) $50 billion.

D) $150 billion.

Answer: B Diff: 2 Topic: Section: 5.2 Question Status: Previous Edition 7) Suppose output is $35 billion, government purchases are $10 billion, desired consumption is $15 billion, and net exports are $4 billion. Then desired investment equals A) $2 billion.

B) $4 billion.

C) $6 billion.

D) $8 billion.

Answer: C Diff: 2 Topic: Section: 5.2 Question Status: Previous Edition 8) Suppose output is $35 billion, government purchases are $10 billion, desired consumption is $15 billion, and desired investment is $6 billion. Desired savings is equal to A) $2 billion.

B) $10 billion.

C) $14 billion.

D) $16 billion.

Answer: B Diff: 2 Topic: Section: 5.2 Question Status: Previous Edition

17 .

9) Suppose output is $35 billion, government purchases are $10 billion, desired consumption is $15 billion, and desired investment is $6 billion. Absorption is equal to A) $25 billion.

B) $31 billion.

C) $35 billion.

D) $39 billion.

Answer: B Diff: 2 Topic: Section: 5.2 Question Status: Previous Edition 10) Suppose output is $440 billion, government purchases are $40 billion, desired consumption is $320 billion, and net exports are $35 billion. Then desired investment equals A) $20 billion.

B) $30 billion.

C) $35 billion.

D) $45 billion.

Answer: D Diff: 2 Topic: Section: 5.2 Question Status: Previous Edition 11) Suppose output is $440 billion, government purchases are $40 billion, desired consumption is $320 billion, and net exports are $35 billion. Absorption is equal to A) $405 billion.

B) $420 billion.

C) $435 billion.

D) $440 billion.

Answer: A Diff: 2 Topic: Section: 5.2 Question Status: Previous Edition 12) Suppose output is $35 billion, government purchases are $10 billion, consumption is $15 billion, and net exports are $4 billion. Assume net factor payments equal 0. (a) Calculate the equilibrium amount of investment. Show your work. (b) Calculate the equilibrium amount of absorption. Show your work. (c) Calculate the equilibrium amount of the financial account balance. Show your work.

Answer: (a) I = Y - (C + G + NX) = 35 - (15 + 10 + 4) = 6. (b) Absorption = C + I + G = 15 + 6 + 10 = 31. (c) FA = -NX = -4.

Diff: 2 Topic: Section: 5.2 Question Status: Previous Edition

18 .

5.3

Saving and Investment in a Small Open Economy

1) An economy is considered a small open economy if it A) is too small to affect the world real interest rate.

B) has GDP less than 1% of world GDP. C) doesn't trade internationally.

D) has a zero trade balance.

Answer: A Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 2) In a saving-investment diagram for a small open economy, A) the saving curve is vertical at some fixed level of output.

B) the saving curve is horizontal at some fixed interest rate.

C) the real interest rate is fixed at the world real interest rate.

D) equilibrium requires that Sd = Id. Answer: C Diff: 1 Topic: Section: 5.3 Question Status: Previous Edition 3) A small open economy has a current account balance of zero. A rise in the world real interest rate causes A) a current account surplus.

B) a financial account surplus.

C) net borrowing from abroad.

D) absorption to exceed income.

Answer: A Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 4) A small open economy has a current account balance of zero. A rise in its investment demand causes A) a current account surplus.

B) a financial account deficit.

C) income to exceed absorption.

D) net borrowing from abroad.

Answer: D Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition

19 .

5) A small open economy increases its investment demand. This causes the world real interest rate to ________ and the country's current account balance to ________.

A) rise; fall B) remain unchanged; rise C) rise; rise D) remain unchanged; fall Answer: D Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 6) A small open economy reduces its desired saving. This causes the world real interest rate to ________ and the country's current account balance to ________.

A) fall; fall B) remain unchanged; rise C) fall; rise D) remain unchanged; fall Answer: D Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 7) A small open economy increases its desired saving. This causes the world real interest rate to ________ and the country's current account balance to ________.

A) fall; fall B) remain unchanged; rise C) fall; rise D) remain unchanged; fall Answer: B Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 8) When a temporary beneficial supply shock hits a small open economy, it causes the current account to ________ and investment to ________.

A) fall; fall B) rise; remain unchanged C) fall; remain unchanged D) rise; fall Answer: B Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition

20 .

9) When future labor income falls in a small open economy, it causes the current account to ________ and investment to ________.

A) fall; rise B) rise; remain unchanged C) fall; remain unchanged D) rise; rise Answer: B Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 10) If there is an increase in the future marginal product of capital in a small open economy, it causes the current account to ________ and saving to ________.

A) fall; rise B) rise; remain unchanged C) fall; remain unchanged D) rise; rise Answer: C Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 11) If there is a decrease in taxes on business firms in a small open economy, it causes the current account to ________ and the equilibrium amount of saving to ________.

A) fall; fall B) rise; remain unchanged C) fall; remain unchanged D) rise; fall Answer: C Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 12) If there is an increase in taxes on business firms in a small open economy, it causes the current account to ________ and the equilibrium quantity of saving to ________.

A) fall; fall B) rise; remain unchanged C) fall; remain unchanged D) rise; fall Answer: B Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition

21 .

13) If a freeze destroys much of the crop of an agricultural nation, then A) the desired investment curve would shift to the left.

B) the desired investment curve would shift to the right.

C) net foreign lending would increase.

D) net foreign lending would decrease.

Answer: D Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 14) The best weather in a decade has given Australia a bumper wheat crop. Australia is a small open economy. Based on this information alone, you would expect that A) desired investment would decrease.

B) desired investment would increase.

C) the current account would increase.

D) the current account would decrease.

Answer: C Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 15) You have just read in the newspaper that a hurricane has destroyed Guatemala's coffee crop for this year. Guatemala is a small open economy. Based on this information alone, you would expect that A) desired investment would decrease in Guatemala.

B) desired investment would increase in Guatemala.

C) net foreign lending by Guatemala would increase.

D) net foreign lending by Guatemala would decrease.

Answer: D Diff: 2 Topic: Section: 5.3 Question Status: New 16) Consider a small open economy with desired national saving of Sd = 200 + 10,000rw and desired investment of Id = 1000 - 5000rw. If rw = 0.05, then net exports equal A) 100.

B) 50.

C) -50.

D) -100.

Answer: C Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition

22 .

17) Consider a small open economy with desired national saving of Sd = 200 + 10,000rw and desired investment of Id = 1000 - 5000rw. If rw = 0.05, and output = 5000, then absorption equals A) 5100.

B) 5050.

C) 4950.

D) 4900.

Answer: B Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 18) In a small open economy, Sd = 200 + 500rw and Id = 300 - 200rw. If rw = 0.1, then net exports = A) -50.

B) -30.

C) 30.

D) 50.

Answer: B Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 19) In a small open economy, Sd = 200 + 500rw and Id = 300 - 200rw. If rw = 0.2, then net exports = A) -60.

B) -40.

C) 40.

D) 60.

Answer: C Diff: 2 Topic: Section: 5.3 Question Status: New 20) In a small open economy, Sd = 200 + 500rw and Id = 300 - 200rw. If rw = 0.2 and output = 1000, then absorption = A) 40.

B) 60.

C) 940.

D) 960.

Answer: D Diff: 2 Topic: Section: 5.3 Question Status: New

23 .

21) In a small open economy, Sd = 200 + 500rw and Id = 300 - 200rw. If rw = 0.2 and absorption = 1000, then output = A) 940.

B) 960.

C) 1000.

D) 1040.

Answer: D Diff: 2 Topic: Section: 5.3 Question Status: New 22) What determines the interest rate in a small open economy?

Answer: The world real interest rate is determined by the aggregate supply of saving and demand for investment in the international capital market. Changes in domestic saving or investment in a small open economy do not affect the interest rate.

Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 23) In a small open economy, Sd = $5 billion + ($100 billion) rw, Id = $10 billion - ($50 billion) rw, Y = $50 billion, G = $3 billion, rw = .06. (a) Calculate the current account balance. (b) Calculate net exports. (c) Calculate desired consumption. (d) Calculate absorption.

Answer: (a) $4 billion (b) $4 billion (c) $36 billion (d) $46 billion Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition

24 .

24) Consider a small open economy with desired national saving of Sd = 20 + 200rw and desired investment of Id = 30 - 200rw.

Calculate national saving, investment, and the current account balance in equilibrium when the real world interest rate is (a) rw = 0.025. (b) rw = 0.05. (c) rw = 0.0. (d) Now suppose something causes desired national saving to increase by 10, so that it is now Sd = 30 + 200rw. Repeat parts (a), (b), and (c). (e) Suppose, with desired national saving at its original level of Sd = 20 + 200rw, something causes desired investment to rise by 10, to Id = 40 - 200rw. Repeat parts (a), (b), and (c).

Answer: (a) S = 25, I = 25, CA = 0. (b) S = 30, I = 20, CA = 10. (c) S = 20, I = 30, CA = -10. (d) rw = 0.025: S = 35, I = 25, CA = 10. rw = 0.050: S = 40, I = 20, CA = 20. rw = 0.000: S = 30, I = 30, CA = 0. (e) rw = 0.025: S = 25, I = 35, CA = -10. rw = 0.050: S = 30, I = 30, CA = 0. rw = 0.000: S = 20, I = 40, CA = -20.

Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 25) Consider a small open economy with desired national saving of Sd = 1000 + 1000rw and desired investment of Id = 1000 - 500rw.

Calculate national saving, investment, and the current account balance in equilibrium when the real world interest rate is (a) rw = 0.025. (b) rw = 0.05. (c) rw = 0.0.

Answer: (a) S = 1025, I = 987.5, CA =37.5. (b) S = 1050, I = 975, CA = 75. (c) S = 1000, I = 1000, CA = 0.

Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition

25 .

26) In a small open economy, describe what happens when an increase in wealth causes national saving to decline. Explain the impact on the real interest rate, saving, investment, net exports, and absorption in equilibrium.

Answer: With the saving curve shifting to the left in a small open economy, in equilibrium, saving declines, but investment and the real interest rate are unchanged. Since NX = S - I, NX declines. Since absorption equals output minus net exports, and net exports decline, then absorption increases.

Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 27) Consider a small open economy in equilibrium with a zero current account balance. What happens to national saving, investment, and the current account balance in equilibrium if (a) future income rises? (b) business taxes rise? (c) government expenditures decline temporarily? (d) the future marginal product of capital rises?

Answer: (a) Saving curve shifts left, so S falls, I is unchanged, CA falls. (b) Investment curve shifts left, so S is unchanged, I falls, CA rises. (c) Saving curve shifts right, so S rises, I is unchanged, CA rises. (d) Investment curve shifts right, so S is unchanged, I rises, CA falls.

Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition

26 .

28) Consider a small open economy in equilibrium. What happens to the real interest rate, national saving, investment, and the current account balance in equilibrium in each of the following situations (each taken separately). Explain which curve shifts and why, and show a diagram explaining your results. (You may assume that none of the shocks is large enough to significantly affect labor supply or labor demand significantly.) (a) wealth declines (b) business taxes decline (c) income rises temporarily Answer: (a) The decline in wealth causes desired consumption to decline today and in the future; with no decline in current income, desired saving increases, so the desired saving curve shifts right. The world real interest rate is unchanged, so investment is unchanged, saving increases, and the current account balance increases. (b) A decline in business taxes leads to a decline in the user cost of capital, increasing the desired capital stock and thus desired investment. As a result, the desired investment curve shifts right. In equilibrium, the world real interest rate is unchanged, so saving is unchanged, investment increases and the current account balance declines. (c) A temporary increase in income causes desired saving to increase, as people will only spend part of the increase in income currently. In equilibrium, the shift to the right in the desired saving curve does not affect the world real interest rate or investment, but saving rises as does the current account balance.

Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition

27 .

29) Consider a small open economy that is in equilibrium with a current account surplus. (a) Draw a diagram showing this situation. (b) Now suppose that future income increases. Show what happens in your diagram. What happens to the world real interest rate and the equilibrium quantities of saving, investment, and the current account balance? (c) Repeat parts (a) and (b) for the case of a large open economy, showing a situation in which the home country initially has a current account surplus. Draw a diagram and describe how the rise in future income in the home country affects all four variables (the world real interest rate and the equilibrium quantities of saving, investment, and the current account balance) in both countries.

Answer: (b) The increase in future income shifts the desired saving curve to the left, so the new equilibrium quantity of saving declines, the equilibrium quantity of investment does not change, the current account balance declines, and the world real interest rate does not change. (c) In a large open economy, the increase in future income in the home country shifts the desired saving curve to the left, which causes the world real interest rate to rise to restore equilibrium. In the home country, the equilibrium quantity of saving declines and the equilibrium quantity of investment declines. In the foreign country, the equilibrium quantity of saving rises, the equilibrium quantity of investment declines, so the current account balance increases (or the current account deficit declines). Since the current account balance increases in the foreign country, it decreases in the domestic country.

Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition 30) Consider a small open economy in equilibrium with a current account deficit. (a) Draw a diagram showing this situation. (b) What happens to national saving, investment, and the current account balance in equilibrium if government expenditures rise temporarily? Show this result in your diagram.

Answer: The diagram must have an initial equilibrium with the quantity of investment exceeding the quantity of national saving, so that the current account balance is negative. The temporary rise in government expenditures causes the desired national saving curve to shift to the left. In equilibrium, national saving declines, investment is unchanged (because the world real interest rate is unchanged), and the current account balance declines.

Diff: 2 Topic: Section: 5.3 Question Status: Previous Edition

28 .

5.4

Saving and Investment in Large Open Economies

1) A large open economy A) dominates world trade in one or more products.

B) is physically larger than all small open economies.

C) has a larger population than all small open economies.

D) lends or borrows enough in the international capital market to influence the world real interest rate.

Answer: D Diff: 1 Topic: Section: 5.4 Question Status: Previous Edition 2) When there are two large open economies, the world real interest rate will be such that A) desired international lending by one country equals desired international borrowing by the other country.

B) desired international lending will be the same in both countries.

C) desired international borrowing will be the same in both countries.

D) desired international lending and borrowing will be zero in both countries.

Answer: A Diff: 1 Topic: Section: 5.4 Question Status: Previous Edition 3) When there are two large open economies, if desired international lending by the domestic country exceeds desired international borrowing by the foreign country, then A) domestic saving must rise.

B) domestic saving must fall.

C) the world real interest rate must fall.

D) the world real interest rate must rise.

Answer: C Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 4) When there are two large open economies, if desired international borrowing by the domestic country exceeds desired international lending by the foreign country, then A) domestic investment must fall.

B) domestic investment must rise.

C) the world real interest rate must fall.

D) the world real interest rate must rise.

Answer: D Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition

29 .

5) A large open economy reduces its investment demand. This causes the world real interest rate to ________ and the country's current account balance to ________.

A) rise; fall B) rise; rise C) fall; rise D) fall; fall Answer: C Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 6) A large open economy increases its desired saving. This causes the world real interest rate to ________ and the country's current account balance to ________.

A) fall; fall B) remain unchanged; rise C) fall; rise D) remain unchanged; fall Answer: C Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 7) In a two-economy model of the United States and another large economy made up of the rest of the world, if desired saving by the rest of the world declined, A) U.S. investment would increase.

B) U.S. saving would decrease.

C) the world real interest rate would increase.

D) the world real interest rate would decrease.

Answer: C Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 8) When a temporary adverse supply shock hits a large open economy, it causes the current account to ________ and investment to ________.

A) fall; fall B) rise; remain unchanged C) fall; remain unchanged D) rise; fall Answer: A Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition

30 .

9) When future labor income falls in a large open economy, it causes the current account to ________ and investment to ________.

A) fall; rise B) rise; remain unchanged C) fall; fall D) rise; rise Answer: D Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 10) When future labor income rises in a large open economy, it causes the current account to ________ and investment to ________.

A) fall; rise B) rise; remain unchanged C) fall; fall D) rise; rise Answer: C Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 11) If there's an increase in the future marginal product of capital in a large open economy, it causes the current account to ________ and saving to ________.

A) fall; rise B) rise; remain unchanged C) fall; remain unchanged D) rise; rise Answer: A Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 12) If business taxes rise in a large open economy, it causes the current account to ________ and saving to ________.

A) fall; fall B) rise; remain unchanged C) fall; remain unchanged D) rise; fall Answer: D Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition

31 .

13) A large country imposes capital controls that prohibit foreign borrowing and lending by domestic residents. The country is currently running a financial account surplus. The imposition of the capital controls will cause A) net exports to decrease.

B) real domestic interest rates to rise.

C) real world interest rates to rise.

D) desired national saving to fall.

Answer: B Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 14) A country's real interest rate would increase if A) the government imposed capital controls in a large open economy and the financial account had been in surplus.

B) the government imposed capital controls in a large open economy and the financial account had been in deficit.

C) there was a temporary positive supply shock in a small open economy.

D) there was a temporary negative supply shock in a small open economy.

Answer: A Diff: 2 Topic: Section: 5.4 Question Status: New 15) A large country imposes capital controls that prohibit foreign borrowing and lending by domestic residents. The country is currently running a financial account deficit. The imposition of the capital controls will cause A) net exports to increase.

B) real domestic interest rates to rise.

C) real world interest rates to fall.

D) desired national saving to fall.

Answer: D Diff: 3 Topic: Section: 5.4 Question Status: Previous Edition 16) Real domestic interest rates would increase in a large open economy if A) there were a temporary negative domestic supply shock.

B) the government imposed capital controls and the capital and financial account had been in deficit.

C) foreigners were more willing to save.

D) there were a temporary negative supply shock abroad in a small open economy.

Answer: A Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 32 .

17) A large open economy's real interest rate will decrease if A) the expected future marginal product of domestic capital rises.

B) the expected future marginal product of foreign capital rises.

C) there is a temporary positive domestic supply shock.

D) there is a temporary negative domestic supply shock.

Answer: C Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 18) Suppose the development of the European Union leads to greater investment in Europe.

You'd expect A) a recession in Europe.

B) a decline in the world real interest rate.

C) a rise in the current account in Europe.

D) an increase in the world real interest rate.

Answer: D Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 19) A large open economy has desired national saving of Sd = 1200 + 1000rw, and desired national investment of Id = 1000 - 500rw. The foreign economy has desired national saving of = 1300 + 1000rw, and desired national investment of equilibrium world real interest rate equals A) 0.05.

B) 0.10.

C) 0.15.

D) 0.20.

Answer: B Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition

33 .

= 1800 - 500rw. The

20) A large open economy has desired national saving of Sd = 1200 + 1000rw, and desired national investment of Id = 1000 - 500rw. The foreign economy has desired national saving of = 1300 + 1000rw, and desired national investment of

= 1800 - 500rw. In

equilibrium, the foreign country has net exports equal to A) 500.

B) 350.

C) -350.

D) -500.

Answer: C Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 21) In a large open economy, the home country's saving and investment equations are: Sd = 200 + 700rw and Id = 300 - 200rw. The foreign country's saving and investment equations are: Sd = 50 + 300rw and Id = 75 - 50rw. In equilibrium, the world real interest rate = A) 0.10.

B) 0.20.

C) 0.25.

D) 0.40.

Answer: A Diff: 3 Topic: Section: 5.4 Question Status: Previous Edition 22) In a large open economy, the home country's saving and investment equations are: Sd = 200 + 700rw and Id = 300 - 200rw. The foreign country's saving and investment equations are: Sd = 50 + 300rw and Id = 75 - 50rw. In equilibrium, the home country's net exports = A) -10.

B) -5.

C) 5.

D) 10.

Answer: A Diff: 3 Topic: Section: 5.4 Question Status: New

34 .

23) Since the 1950s, U.S. exports have generally ________ as a share of GDP, while U.S. imports have generally ________ as a share of GDP. A) risen; risen B) risen; fallen C) fallen; fallen D) fallen; risen Answer: A Diff: 1 Topic: Section: 5.4 Question Status: Previous Edition 24) Tariffs cause the benefits from ________ to be lost.

A) comparative advantage B) absolute advantage C) foreign direct investment D) imperialism Answer: A Diff: 1 Topic: Section: 5.4 Question Status: Previous Edition

35 .

25) A large open economy has desired national saving of Sd = 20 + 200rw, and desired national investment of Id = 30 - 200rw. The foreign economy has desired national saving of + 100rw, and desired national investment of

= 40

= 75 - 400rw.

(a) Calculate the equilibrium values of rw, CA, CAFor, S, I, SFor, and IFor. (b) Suppose Sd rises by 45, so that now Sd = 65 + 200rw. Calculate the equilibrium values of rw, CA, CAFor, S, I, SFor, and IFor. (c) Suppose, with Sd back to Sd = 20 + 200rw, as in part (a), that Id rises by 45, to Id = 75 200rw. Calculate the equilibrium values of rw, CA, CAFor, S, I, SFor, and IFor. Answer: (a) In equilibrium, Sd +

= Id +

so that 60 + 300rw = 105 - 600rw, or 900rw = 45,

so rw = 0.05. Using this in the formulas, we get S = 30, I = 20, CA = 10, SFor = 45, IFor = 55, and CAFor = -10. (b) Now 900rw = 0, so rw = 0.0. Using this in the formulas, we get S = 65, I = 30, CA = 35, SFor = 40, IFor = 75, and CAFor = -35. (c) Now 900rw = 90, so rw = 0.10. Using this in the formulas, we get S = 40, I = 55, CA = -15, SFor = 50, IFor = 35, and CAFor = 15.

Notice that the current account may swing from positive to negative, depending on the value of the real interest rate.

Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 26) A large open economy has desired national saving of Sd = 1200 + 1000rw, and desired national investment of Id = 1000 - 500rw. The foreign economy has desired national saving of = 1000 + 1000rw, and desired national investment of

= 1800 - 500rw. Calculate the

equilibrium values of rw, CA, CAFor, S, I, SFor, and IFor. Answer: In equilibrium, Sd +

= Id +

so that 2200 + 2000rw = 2800 - 1000rw, or

3000rw = 600, so rw = 0.2. Using this in the formulas, we get S = 1400, I = 900, CA = 500, SFor = 1200, IFor = 1700, and CAFor = -500.

Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition

36 .

27) In a large open economy, the home country's saving and investment equations are: Sd = 200 + 1400 rw and Id = 300 - 400 rw.

The foreign country's saving and investment equations are: Sd = 50 + 600rw and Id = 75 - 100 rw.

Calculate the equilibrium world real interest rate, saving and investment in each country, and the current account balance in each country.

Answer: Worldwide savings equals 200 + 1400 rw + 50 + 600 rw = 250 + 2000 rw. Worldwide investment equals 300 - 400 rw + 75 - 100 rw = 375 - 500rw. Setting worldwide saving equal to worldwide investment gives: 250 + 2000 rw = 375 - 500 rw, so 2500 rw = 125, so rw = 125/2500 = 0.05. Plugging into the original equations gives Sd = 200 + 1400 rw = 200 + (1400 × 0.05) = 270, Id = 300 - 400rw = 300 - (400 × 0.05) = 280, CA = S - I = 270 - 280 = -10. In the foreign country, Sd = 50 + 600rw = 50 + (600 × 0.05) = 80, Id = 75 - 100 rw = 75 - (100 × 0.05) = 70, CA = S - I = 80 - 70 = 10.

Diff: 3 Topic: Section: 5.4 Question Status: Previous Edition 28) Consider a large open economy that has a zero current account balance. What are the effects on the world real interest rate, national saving, investment, and the current account balance in equilibrium if (a) future income rises? (b) business taxes decline? (c) government purchases decline? (d) the future marginal product of capital declines?

Answer: (a) rw rises, S falls, I falls, CA falls. (b) rw rises, S rises, I rises, CA falls. (c) rw falls, S rises, I rises, CA rises. (d) rw falls, S falls, I falls, CA rises.

Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition

37 .

29) Consider a large open economy. What are the effects, in equilibrium, on the world real interest rate, domestic national saving, domestic investment, the domestic current account balance, foreign national saving, foreign investment, and the foreign current account balance in each of the following scenarios? Show a diagram to illustrate your results. (a) current income rises in the foreign country (b) the future marginal product of capital rises in the domestic country (c) wealth rises in the foreign country Answer: (a) The foreign savings curve shifts right, causing rw to fall. Domestic economy: S falls, I rises, CA falls. Foreign economy: SFor rises, IFor rises, CAFor rises (because CA falls). (b) The domestic investment curve shifts right, causing rw to rise. Domestic economy: S rises, I rises, CA falls (because CAFor rises). Foreign economy: SFor rises, IFor falls, CAFor rises. (c) The foreign savings curve shifts left, causing rw to rise. Domestic economy: S rises, I falls, CA rises. Foreign economy: SFor falls, IFor falls, CAFor falls (because CA rises).

Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 30) Consider a large open economy that has a positive current account balance. (a) Suppose the domestic government increases the tax rate on firm revenues. Draw a diagram to explain the effects on the world real interest rate, saving in each country, investment in each country, and the current account balance in each country in equilibrium. Explain your work. (b) In addition to the tax increase in part (a), suppose now that the foreign government increases lump-sum taxes on individuals. Draw a new diagram to incorporate the overall effects of both tax changes and explain the effects (from the initial equilibrium with neither tax change) on the world real interest rate, saving in each country, investment in each country, and the current account balance in both countries. Explain your work.

Answer: (a) The increased tax rate on firm revenues increases the tax-adjusted user cost of capital, thus reducing desired investment in the domestic country. To restore equilibrium, the world real interest rate must decline. In equilibrium, both saving and investment in the domestic country are lower; while in the foreign country, saving is lower but investment is higher. The lower saving and higher investment in the foreign country mean that the current account balance is lower in the foreign country. Because the sum of the two countries' current account balances must be zero, the lower foreign current account balance means that the domestic country's current account balance must be higher. (b) If Ricardian Equivalence holds, then all the answers are the same as in part (a). If Ricardian Equivalence does not hold, then the foreign tax increase would increase desired foreign saving and reduce the world real interest rate even more than in part (a). Compared with the initial equilibrium, both domestic saving and investment are lower and foreign investment is higher.

The effect on foreign saving is ambiguous, as the effect of the tax change in part (a) reduces it but the tax change in part (b) increases it. As a result, the current account balance in the foreign country is ambiguous, as is the current account balance in the domestic country.

Diff: 2 Topic: Section: 5.4 Question Status: Previous Edition 38 .

5.5

Fiscal Policy and the Current Account

1) Assuming no change in the effective tax rate on capital, a decrease in the government budget deficit will reduce the current account deficit if and only if the decrease in the budget deficit A) reduces desired national saving.

B) increases desired national saving.

C) reduces desired national investment.

D) increases desired national investment.

Answer: B Diff: 1 Topic: Section: 5.5 Question Status: Previous Edition 2) Assuming no change in the effective tax rate on capital, an increase in the government budget deficit will reduce the current account deficit if and only if the increase in the budget deficit A) reduces desired national saving.

B) increases desired national saving.

C) reduces desired national investment.

D) increases desired national investment.

Answer: A Diff: 1 Topic: Section: 5.5 Question Status: Previous Edition 3) An increase in lump-sum taxes, reducing the government budget deficit, causes the current account balance in an open economy to ________ if Ricardian equivalence holds and to ________ if Ricardian equivalence does not hold.

A) not change; increase B) not change; decrease C) decrease; increase D) decrease; not change Answer: A Diff: 1 Topic: Section: 5.5 Question Status: Previous Edition 4) In the 1980s and most of the 1990s, the U.S. government budget balance was ________ and the U.S. current account balance was ________.

A) negative; negative B) negative; positive C) positive; negative D) positive; positive Answer: A Diff: 1 Topic: Section: 5.5 Question Status: Previous Edition 39 .

5) Assume that an increase in Costa Rica's government budget deficit reduced desired national saving by 10 million colon. Assuming Costa Rica is a small open economy, you would expect the government's action to A) increase the current account balance by exactly 10 million colon.

B) increase the current account balance by less than 10 million colon.

C) reduce the current account balance by exactly 10 million colon.

D) reduce the current account balance by more than 10 million colon.

Answer: C Diff: 2 Topic: Section: 5.5 Question Status: Previous Edition 6) An increase in a small open economy's government budget deficit that reduces national saving and the current account balance causes an A) increase in desired saving.

B) increase in the world real interest rate.

C) increase in exports.

D) increase in absorption.

Answer: D Diff: 2 Topic: Section: 5.5 Question Status: Previous Edition 7) Consider a small open economy with desired national saving of Sd = 200 + 10,000rw and desired investment of Id = 1000 - 5000rw. If rw = 0.05, then a rise in government spending of 50 with no change in private saving causes net exports to become A) 100.

B) 50.

C) -50.

D) -100.

Answer: D Diff: 2 Topic: Section: 5.5 Question Status: Previous Edition 8) In a large open economy like the United States, an increased government budget deficit which reduces national saving A) reduces investment and improves the current account balance.

B) reduces investment and reduces the current account balance.

C) has no effect on investment, but reduces the current account balance.

D) has no effect on either investment or the current account balance.

Answer: B Diff: 2 Topic: Section: 5.5 Question Status: Previous Edition 40 .

9) Suppose the government of a small open economy reduces its spending, so that national saving increases. The result is A) an increase in the real interest rate.

B) an increase in net exports.

C) a decrease in the real interest rate.

D) an increase in investment.

Answer: B Diff: 2 Topic: Section: 5.5 Question Status: Previous Edition 10) Suppose the government of a large open economy reduces its spending, so that national saving increases. The result is A) a decrease in the foreign country's net exports.

B) an increase in the real interest rate.

C) an increase in the foreign country's net exports.

D) a decrease in investment.

Answer: A Diff: 2 Topic: Section: 5.5 Question Status: Previous Edition 11) A large open economy has desired national saving of Sd = 1200 + 1000rw, and desired national investment of Id = 1000 - 500rw. The foreign economy has desired national saving of = 1300 + 1000rw, and desired national investment of

= 1800 - 500rw. Suppose the

foreign country's government increases its spending by 300 and private saving does not change.

Then in equilibrium, the foreign country has net exports equal to A) 500.

B) 350.

C) -350.

D) -500.

Answer: D Diff: 3 Topic: Section: 5.5 Question Status: Previous Edition

41 .

12) What were the principal causes of the U.S. government budget deficits of the 1980s? How did these budget deficits lead to the twin deficits? According to the Ricardian equivalence proposition, should twin deficits arise as a result of tax cuts?

Answer: The principal causes of the U.S. federal government budget deficits of the 1980s were a reduction in government revenue (in part because of the Economic Recovery Tax Act of 1981) and increased military spending. The twin deficits arose because the increased government budget deficit reduced national saving, leading to a current account deficit. According to the Ricardian equivalence proposition, a government budget deficit created by a tax cut will have no real economic effects because it will not affect saving. According to this theory the government budget deficit and the trade deficit are independent events.

Diff: 2 Topic: Section: 5.5 Question Status: Previous Edition 13) Due to a change in the regulatory structure of a small open economy, the desired capital stock becomes higher for both private investment and government investment. Increased government investment spending is financed by borrowing, not by higher taxes. If both desired investment and government spending rise at the same time, will there be "twin deficits"?

Answer: Desired saving shifts left, desired investment shifts right, so the current account balance declines; there are twin deficits.

Diff: 2 Topic: Section: 5.5 Question Status: Previous Edition 14) The government of a small open economy announces a tax cut of $100 this year, combined with a tax increase of $110 next year, when the interest rate is 10%. What are the effects of this change on the world real interest rate, national saving, investment, and the current account balance in equilibrium when (a) Ricardian equivalence holds? (b) Ricardian equivalence does not hold?

Answer: (a) No effect on any of the variables. (b) Real world interest rate unchanged, national saving declines (private saving rises, but not as much as government saving declines), investment is unchanged, and the current account balance declines.

Diff: 2 Topic: Section: 5.5 Question Status: Previous Edition

42 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 6 Long-Run Economic Growth 6.1

The Sources of Economic Growth

1) Between 1870 and 2018, among the United States, Germany, Japan, and Australia, ________ grew at the fastest rate and ________ grew at the slowest rate.

A) United States; Germany B) Germany; United States C) Australia; Japan D) Japan; Australia Answer: D Diff: 2 Topic: Section: 6.1 Question Status: Revised 2) The elasticity of output with respect to capital A) is the increase in output resulting from an increase in the capital stock.

B) is the percentage increase in output resulting from a 1 % increase in the capital stock.

C) is always greater than one.

D) is the inverse of the elasticity of output with respect to labor.

Answer: B Diff: 1 Topic: Section: 6.1 Question Status: Previous Edition 3) Suppose the current level of output is 5000. A 10% increase in productivity would increase the current level of output to A) 5050.

B) 5100.

C) 5500.

D) 6000.

Answer: C Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 4) Suppose the current level of output is 5000 and the elasticity of output with respect to capital is 0.4. A 10% increase in capital would increase the current level of output to A) 5020.

B) 5050.

C) 5200.

D) 5500.

Answer: C Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 1 .

5) Suppose the current level of output is 5000 and the elasticity of output with respect to labor is 0.7. A 10% increase in labor would increase the current level of output to A) 5035.

B) 5070.

C) 5350.

D) 5700.

Answer: C Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 6) Suppose the current level of output is 5000. If the elasticities of output with respect to capital and labor are 0.3 and 0.7, respectively, a 10% increase in capital combined with a 5% increase in labor and a 5% increase in productivity would increase the current level of output to A) 5015.

B) 5325.

C) 5575.

D) 6000.

Answer: C Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 7) Over the past year, productivity grew 2%, capital grew 1%, and labor grew 1%. If the elasticities of output with respect to capital and labor are 0.2 and 0.8, respectively, how much did output grow?

A) 1% B) 2% C) 3% D) 4% Answer: C Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 8) Over the past year, productivity grew 1%, capital grew 2%, and labor grew 2%. If the elasticities of output with respect to capital and labor are 0.3 and 0.7, respectively, how much did output grow?

A) 1% B) 2% C) 3% D) 4% Answer: C Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 2 .

9) Over the past year, productivity grew 1%, capital grew 0%, and labor grew 5%. If the elasticities of output with respect to capital and labor are 0.4 and 0.6, respectively, how much did output grow?

A) 1% B) 2% C) 3% D) 4% Answer: D Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 10) Over the past year, productivity grew 1.8%, capital grew 2%, and labor grew 1%. If the elasticities of output with respect to capital and labor are 0.2 and 0.8, respectively, how much did output grow?

A) 1% B) 2% C) 3% D) 4% Answer: C Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 11) Over the past year, output grew 4%, capital grew 2%, and labor grew 1%. If the elasticities of output with respect to capital and labor are 0.3 and 0.7, respectively, how much did productivity grow?

A) 2.0% B) 2.7% C) 3.0% D) 3.3% Answer: B Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition

3 .

12) From 2000 to 2010 North Samaria's economy grew at an annual rate of 3.5%, but from 2010 to 2020 it grew by only 1% per year. In 2000 per capita income was $8000. How much higher would per capita income have been in 2020 if growth from 2010 to 2020 had been 3.5% rather than 1%?

A) $2241 B) $2448 C) $2508 D) $3285 Answer: B Diff: 2 Topic: Section: 6.1 Question Status: New 13) The growth accounting equation is A) Y = AaKK aNN B) Y = AF(K, N) C) ΔY/Y = ΔA/A + aKΔK/K + aNΔN/N D) ΔY/Y = ΔA/A - aKΔK/K - aNΔN/N Answer: C Diff: 1 Topic: Section: 6.1 Question Status: Previous Edition 14) In the growth accounting equation, productivity growth is equal to A) the difference between output growth and labor growth.

B) the difference between output per worker growth and labor per worker growth.

C) the difference between labor growth and capital growth.

D) output growth minus the sum of labor growth and capital growth, weighted by the elasticities of output with respect to labor and capital.

Answer: D Diff: 1 Topic: Section: 6.1 Question Status: New 15) The equation, ΔY/Y = ΔA/A + aKΔK/K + aNΔN/N, is known as A) the production function.

B) the Solow model.

C) the productivity formula.

D) the growth accounting equation.

Answer: D Diff: 1 Topic: Section: 6.1 Question Status: Previous Edition

4 .

16) If capital and labor each grow 5% in a year, the elasticities of output with respect to capital and labor sum to one, and productivity grows 2% in the year, by how much does output grow during the year?

A) 2% B) 3% C) 5% D) 7% Answer: D Diff: 3 Topic: Section: 6.1 Question Status: Previous Edition 17) Total factor productivity growth is that part of economic growth due to A) capital growth plus labor growth.

B) capital growth less labor growth.

C) capital growth times labor growth.

D) neither capital growth nor labor growth.

Answer: D Diff: 1 Topic: Section: 6.1 Question Status: Previous Edition 18) Over the past year, output grew 4%, capital grew 2%, and labor grew 1%. If the elasticities of output with respect to capital and labor are 0.3 and 0.7, respectively, how much did productivity grow?

A) 2.0% B) 2.7% C) 3.0% D) 3.3% Answer: B Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 19) Over the past year, output grew 4%, capital grew 2%, and labor grew 1%. If the elasticities of output with respect to capital and labor are 0.5 and 0.5, respectively, how much did productivity grow?

A) 1.0% B) 1.5% C) 2.0% D) 2.5% Answer: D Diff: 2 Topic: Section: 6.1 Question Status: New

5 .

20) Over the past year, output grew 5%, capital grew 5%, and labor grew 1%. If the elasticities of output with respect to capital and labor are 0.3 and 0.7, respectively, how much did productivity grow?

A) 0.5% B) 1.0% C) 2.2% D) 2.8% Answer: D Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 21) Over the past year, output grew 6%, capital grew 2%, and labor grew 4%. If the elasticities of output with respect to capital and labor are 0.3 and 0.7, respectively, how much did productivity grow?

A) 2.0% B) 2.6% C) 3.0% D) 3.3% Answer: B Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 22) Over the past year, output grew 5%, capital grew 5%, and labor grew 1%. If the elasticities of output with respect to capital and labor are 0.5 and 0.5, respectively, how much did productivity grow?

A) 0.5% B) 1.0% C) 1.5% D) 2.0% Answer: D Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 23) Labor productivity increased so much in the second half of the 1990s because of A) improved information and communications technologies.

B) higher levels of educational attainment by workers.

C) cheaper foreign imports used in production.

D) increased foreign competition.

Answer: A Diff: 1 Topic: Section: 6.1 Question Status: Previous Edition

6 .

24) The computerization of police departments throughout the country has greatly reduced the crime rate. What macroeconomic variable is likely to be directly affected by this change?

A) Productivity B) Inflation C) The real interest rate D) The trade deficit Answer: A Diff: 1 Topic: Section: 6.1 Question Status: Previous Edition 25) Edward Denison found that labor's contribution to output growth in the United States since 1929 was attributable to all the factors below except A) rising population.

B) an increase in the percentage of the population in the labor force.

C) an increase in the number of hours worked per person.

D) higher educational levels.

Answer: C Diff: 1 Topic: Section: 6.1 Question Status: Previous Edition 26) Edward Denison's analysis of the American economy found that A) total factor productivity was the largest source of economic growth since 1948.

B) the contribution of labor growth has been more variable than the contribution of capital growth.

C) productivity growth has been positive over every period of more than five years since World War II. D) the contribution of labor growth has been greater than the contribution of capital growth.

Answer: D Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 27) A new pollution law requires businesses to pay for inspections of their plants by independent pollution-monitoring firms. What effect is this likely to have?

A) Increase productivity B) Increase the capital stock C) Reduce productivity D) Increase the demand for labor in those firms Answer: C Diff: 1 Topic: Section: 6.1 Question Status: Previous Edition

7 .

28) Improved technology is likely to A) displace workers, causing high unemployment.

B) increase the marginal product of labor.

C) reduce productivity.

D) reduce wages.

Answer: B Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 29) From 1995 to 2008, the growth rate of capital per unit of labor was high, which caused A) labor productivity growth to be much smaller than total factor productivity growth.

B) labor productivity growth to be much higher than total factor productivity growth.

C) wages to grow faster than before.

D) high inflation rates.

Answer: B Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 30) Suppose the current level of output is 10,000 and the elasticity of output with respect to labor is 0.8. A 10% increase in labor would increase the current level of output to A) 10,008.

B) 10,080.

C) 10,800.

D) 18,000.

Answer: B Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition 31) Use the growth accounting equation to calculate productivity growth, given output growth of 3.5%, capital stock growth of 5%, labor employment growth of 2%, the output elasticity of capital of 0.3, and the output elasticity of labor of 0.7.

Answer: The growth accounting equation is ΔY/Y = ΔA/A + aK ΔK/K + aN ΔN/N. Therefore productivity growth is ΔA/A = ΔY/Y - aK ΔK/K - aN ΔN/N. For the given values, productivity growth = 3.5% - (0.3)(5%) - (0.7)(2%) = 0.6%.

Diff: 2 Topic: Section: 6.1 Question Status: Previous Edition

8 .

32) From one year to the next, a country's output rose from 4000 to 4500, its capital stock rose from 10,000 to 12,000, and its labor force declined from 2000 to 1750. Suppose aK = 0.3 and aN= 0.7. (a) How much did capital contribute to economic growth over the year? (b) How much did labor contribute to economic growth over the year? (c) How much did productivity contribute to economic growth over the year?

Answer: (a) aK ΔK/K = 0.3(2000 / 10,000) = 6%. (b) aN ΔN/N = 0.7 (-250 / 2000) = -8.75%. (c) ΔY/Y = 500/4000 = 12.5%. ΔA/A = ΔY/Y - aKΔK/K - aN ΔN/N = 12.5% - 6% - (-8.75%) = 15.25%.

Diff: 3 Topic: Section: 6.1 Question Status: Previous Edition 33) Over the past year, an economy's labor supply increased from 100 to 102, its capital stock increased from 1000 to 1030, and its output increased from 500 to 525. All measurements are in real terms. Calculate the contributions to economic growth of growth in capital, labor, and productivity if aK = 0.2 and aN = 0.8.

Answer: One Year Ago Today Percent Change Y 500 525 5% K 1000 1030 3% N 100 102 2% ΔA/A = ΔY/Y - aK ΔK/K - aN ΔN/N = 5% - (0.2 × 3%) - (0.8 × 2%) = 5% - 0.6% - 1.6% = 2.8% Capital growth contributed 0.6% (aK ΔK / K), labor growth contributed 1.6% (aN ΔN / N), productivity growth was 2.8%.

Diff: 3 Topic: Section: 6.1 Question Status: Previous Edition

9 .

6.2

Long-Run Growth: The Solow Model

1) The per-worker production function in the Solow model assumes A) constant returns to scale and increasing marginal productivity of capital.

B) constant returns to scale and diminishing marginal productivity of capital.

C) increasing returns to scale and diminishing marginal productivity of capital.

D) decreasing returns to scale and diminishing marginal productivity of capital.

Answer: B Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 2) The bowed shape of the per-worker production function is caused by A) wealth effects that reduce labor supply.

B) diminishing marginal productivity of capital.

C) increasing marginal productivity of labor.

D) increasing marginal productivity of capital.

Answer: B Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 3) In the Solow model, if productivity doesn't change, A) the economy must eventually reach a steady state.

B) the capital-labor ratio must decline.

C) the capital-labor ratio must rise.

D) there can be no saving.

Answer: A Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 4) In a steady state, A) both consumption per worker and the capital-labor ratio are constant.

B) consumption per worker is constant, but the capital-labor ratio can change.

C) capital and labor, by definition, are inversely related to one another.

D) consumption per worker can change, but the capital-labor ratio is constant.

Answer: A Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition

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5) Which of the following best describes a steady state?

A) Political stability is maintained by the state.

B) The standard of living is increasing at a stable rate.

C) Each firm in the economy receives a steady stream of income.

D) Output per worker, consumption per worker, and capital per worker are constant.

Answer: D Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 6) Steady-state investment per worker is positively related to the capital-labor ratio because the higher the capital-labor ratio, A) the lower the capital depreciation rate.

B) the greater the amount of resources available for capital investment.

C) the more investment per worker is required to replace depreciating capital.

D) the less the economy needs to equip new workers with the same high level of capital.

Answer: C Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 7) In the absence of productivity growth, in a steady-state economy, A) output per worker and consumption per worker remain constant over time.

B) output per worker remains constant over time, but consumption per worker grows over time.

C) output per worker grows over time, but consumption per worker remains constant over time.

D) output per worker and consumption per worker both grow over time.

Answer: A Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 8) According to the Solow model, an increase in the capital-labor ratio will A) always reduce steady-state consumption per worker.

B) always increase steady-state consumption per worker.

C) reduce steady-state consumption per worker if the capital-labor ratio is below the Golden rule capital stock.

D) increase steady-state consumption per worker if the capital-labor ratio is below the Golden rule capital stock.

Answer: D Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition

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9) According to the Solow model, a decrease in the capital-labor ratio will A) always reduce steady-state consumption per worker.

B) always increase steady-state consumption per worker.

C) reduce steady-state consumption per worker if the capital-labor ratio is below the Golden rule capital stock.

D) increase steady-state consumption per worker if the capital-labor ratio is below the Golden rule capital stock.

Answer: C Diff: 2 Topic: Section: 6.2 Question Status: New 10) Steady-state consumption per worker is A) larger in the short run than in the long run.

B) less than steady-state investment per worker.

C) less than steady-state saving per worker.

D) steady-state production per worker minus steady-state investment per worker.

Answer: D Diff: 2 Topic: Section: 6.2 Question Status: Revised 11) The level of the capital-labor ratio that maximizes consumption per worker in the steady state is known as the A) Solow residual capital-labor ratio.

B) Golden Rule capital-labor ratio.

C) q theory capital-labor ratio.

D) dynamically efficient capital-labor ratio.

Answer: B Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 12) The Golden Rule capital-labor ratio is the level of the capital-labor ratio that, in the steady state, A) maximizes output per worker.

B) maximizes investment per worker.

C) maximizes consumption per worker.

D) maximizes capital per worker.

Answer: C Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition

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13) If the steady-state capital-labor ratio is equal to the Golden Rule capital-labor ratio, then in the steady state, A) output per worker equals investment per worker.

B) output per worker equals depreciation per worker.

C) investment per worker is as large as possible.

D) consumption per worker is as large as possible.

Answer: D Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 14) If the capital-labor ratio is above the Golden Rule capital-labor ratio, then in the steady state, A) capital per worker is above its maximum.

B) output per worker is less than it would be at the Golden Rule capital-labor ratio.

C) investment per worker exceeds output per worker.

D) consumption per worker is not at its maximum.

Answer: D Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 15) The idea that saving equals investment in the Solow model means that a steady state can be reached only when A) s = k.

B) s = n + d.

C) sf(k) = (s + d)k.

D) sf(k) = (n + d)k.

Answer: D Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 16) In the Solow model, if f(k) = 2k0.5, s = 0.3, n = 0.05, and d = 0.15, what is the value of k at equilibrium?

A) 1 B) 3 C) 6 D) 9 Answer: D Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition

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17) In the Solow model, if f(k) = 2k0.5, s = 0.25, n = 0.05, and d = 0.2, what is the value of k at equilibrium?

A) 1 B) 2 C) 3 D) 4 Answer: D Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 18) In the Solow model, if f(k) = 2k0.5, s = 0.25, n = 0.05, and d = 0.2, what is the value of f(k) at equilibrium?

A) 2 B) 4 C) 6 D) 8 Answer: B Diff: 2 Topic: Section: 6.2 Question Status: New 19) In the Solow model, if f(k) = 2k0.5, s = 0.1, n = 0.1, and d = 0.05, what is the value of f(k) at equilibrium?

A) 2/3 B) 4/3 C) 2 D) 8/3 Answer: D Diff: 3 Topic: Section: 6.2 Question Status: Previous Edition 20) In the Solow model, if f(k) = 8k0.5, s = 0.2, n = 0.3, and d = 0.1, what is the value of k at equilibrium?

A) 1 B) 4 C) 9 D) 16 Answer: B Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition

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21) In the Solow model, if f(k) = 2k0.5, s = 0.25, n = 0.1, and d = 0.4, what is the value of k at equilibrium?

A) 1 B) 2 C) 3 D) 4 Answer: A Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 22) In the Solow model, if f(k) = 6k0.5, s = 0.1, n = 0.1, and d = 0.2, what is the value of c at equilibrium?

A) 10 B) 10.4 C) 10.8 D) 11.2 Answer: C Diff: 3 Topic: Section: 6.2 Question Status: Previous Edition 23) In the Solow model, if k = 8, y = 20, and s = 0.2, what is c?

A) 24 B) 20 C) 16 D) 12 Answer: C Diff: 3 Topic: Section: 6.2 Question Status: Previous Edition 24) In the Solow model, if k = 8, y = 25, and s = 0.2, what is c?

A) 24 B) 20 C) 18 D) 12 Answer: B Diff: 3 Topic: Section: 6.2 Question Status: New

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25) In the Solow model, if k = 8, y = 24, and s = 0.25, what is c?

A) 24 B) 20 C) 18 D) 12 Answer: C Diff: 3 Topic: Section: 6.2 Question Status: Previous Edition 26) The Solow model demonstrates that A) in the absence of productivity growth, economic growth will turn negative in the long run.

B) in the absence of productivity growth, economic growth will reach a steady state of zero percapita growth in the long run.

C) productivity growth must exceed the rate of growth in the population to avoid a steady state in the long run.

D) productivity growth will inevitably decline due to diminishing marginal productivity.

Answer: B Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 27) A striking conclusion of the Solow model is that in the absence of productivity growth, in the long run A) the economy reaches a steady state.

B) consumption per worker equals the capital stock per worker.

C) consumption per worker equals output per worker.

D) consumption per worker equals investment per worker.

Answer: A Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 28) An earthquake destroys a good portion of the capital stock. How would you expect this to affect the capital-labor ratio in the long run? There would be A) a rightward movement along the saving-per-worker curve and an increase in the capital-labor ratio.

B) no change in the long-run capital-labor ratio.

C) a downward shift in the saving-per-worker curve and a decrease in the capital-labor ratio.

D) a leftward movement along the saving-per-worker curve and a decrease in the capital-labor ratio.

Answer: B Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition

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29) In the Solow model, if saving per worker initially exceeds investment per worker, A) the economy will experience inflation.

B) the capital-labor ratio will increase.

C) investment per worker will decline.

D) saving per worker will decline.

Answer: B Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 30) Which of the following changes would lead, according to the Solow model, to a higher level of long-run output per worker?

A) A lower level of capital per worker B) An increase in the saving rate C) A rise in the rate of population growth D) A decrease in productivity Answer: B Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 31) An increase in the saving rate in a steady-state economy would cause A) a rightward movement along the saving-per-worker curve and an increase in the capital-labor ratio.

B) an upward shift in the saving-per-worker curve and an increase in the capital-labor ratio.

C) a downward shift in the saving-per-worker curve and a decrease in the capital-labor ratio.

D) a leftward movement along the saving-per-worker curve and a decrease in the capital-labor ratio.

Answer: B Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 32) In the long run, an increase in the saving rate in a steady-state economy will cause A) an increase in the capital-labor ratio and an increase in consumption per worker.

B) an increase in the capital-labor ratio and a decrease in consumption per worker.

C) a decrease in the capital-labor ratio and a decrease in consumption per worker.

D) a decrease in the capital-labor ratio and an increase in consumption per worker.

Answer: A Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition

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33) All else being equal, a permanent decrease in the saving rate in a steady-state economy would cause A) an increase in the capital-labor ratio and an increase in consumption per worker.

B) an increase in the capital-labor ratio and a decrease in consumption per worker.

C) a decrease in the capital-labor ratio and a decrease in consumption per worker.

D) a decrease in the capital-labor ratio and an increase in consumption per worker.

Answer: C Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 34) An increase in the growth rate of population in a steady-state economy would cause A) a parallel shift upward in the investment line.

B) a pivot up and to the left in the investment line.

C) a pivot down and to the right in the investment line.

D) a parallel shift downward in the investment line.

Answer: B Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 35) In the Solow model, the steady-state capital-labor ratio will decline if A) the saving rate per worker increases.

B) the consumption rate per worker declines.

C) population growth increases.

D) productivity increases.

Answer: C Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 36) An increase in population growth will lead to a ________ in the steady-state capital-labor ratio and a ________ in output per worker.

A) fall; fall B) fall; rise C) rise; rise D) rise; fall Answer: A Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition

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37) A decrease in population growth will lead to a ________ in the steady-state capital-labor ratio and a ________ in output per worker.

A) fall; fall B) fall; rise C) rise; rise D) rise; fall Answer: C Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 38) A productivity improvement will cause A) a rightward movement along the saving-per-worker curve and an increase in the capital-labor ratio.

B) an upward shift in the saving-per-worker curve and an increase in the capital-labor ratio.

C) a downward shift in the saving-per-worker curve and a decrease in the capital-labor ratio.

D) a leftward movement along the saving-per-worker curve and a decrease in the capital-labor ratio.

Answer: B Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 39) In the steady-state diagram of the Solow model, an increase in saving per worker is shown by A) shifting the saving-per-worker curve down, resulting in a lower steady-state capital-labor ratio.

B) shifting the saving-per-worker curve up, resulting in a higher steady-state-capital-labor ratio.

C) shifting the saving-per-worker curve up, resulting in a lower steady-state capital-labor ratio.

D) shifting the saving-per-worker curve down, resulting in a higher steady-state capital-labor ratio.

Answer: B Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 40) An increase in pollution has caused a permanent increase in the rate of capital depreciation.

This would cause A) an increase in the capital-labor ratio.

B) output per worker to fall.

C) a decline in consumption per worker.

D) the capital-labor ratio to be unaffected.

Answer: B Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition

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41) In the long run, a reduction in productivity will cause A) an increase in the capital-labor ratio and an increase in consumption per worker.

B) an increase in the capital-labor ratio and a decrease in consumption per worker.

C) a decrease in the capital-labor ratio and a decrease in consumption per worker.

D) a decrease in the capital-labor ratio and an increase in consumption per worker.

Answer: C Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 42) In the very long run, the level of consumption per worker can grow continually if A) the saving rate continually falls.

B) the population growth rate continually rises.

C) productivity continually improves.

D) the depreciation rate continually rises.

Answer: C Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 43) According to the Solow model A) there are constant returns to capital in the long run.

B) there are increasing returns to labor in the long run.

C) an increase in saving per worker will produce continuing increases in a country's standard of living in the long run.

D) the steady state capital-labor ratio will be such that steady state saving per worker equals steady state investment per worker.

Answer: D Diff: 1 Topic: Section: 6.2 Question Status: New 44) According to the Solow model, if new technology increases the useful life of computers, causing a permanent decrease in the rate of capital depreciation. This would cause A) capital per worker to increase.

B) output per worker to fall.

C) consumption per worker to decrease.

D) the total capital stock to be unaffected.

Answer: A Diff: 1 Topic: Section: 6.2 Question Status: New

20 .

45) According to the Solow model, in the long run, a productivity improvement will cause A) an increase in the capital-labor ratio and an increase in consumption per worker.

B) an increase in the capital-labor ratio and a decrease in consumption per worker.

C) a decrease in the capital-labor ratio and an increase in consumption per worker.

D) a decrease in the capital-labor ratio and a decrease in consumption per worker.

Answer: A Diff: 1 Topic: Section: 6.2 Question Status: New 46) An exogenous variable is one that A) is part of the production function.

B) is determined within a model.

C) is taken as given.

D) is a function of endogenous variables.

Answer: C Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 47) An endogenous variable is one that A) is part of the production function.

B) is determined within a model.

C) is taken as given.

D) is a function of endogenous variables.

Answer: B Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 48) It is not legitimate to ask a question like, A) "How is an endogenous variable affected by a change in an exogenous variable?"

B) "How is an exogenous variable affected by a change in an endogenous variable?"

C) "What is the slope of the graph of the production function?"

D) "What is the marginal product of labor?"

Answer: B Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition

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49) Briefly explain the shape of the per-worker production curve in the Solow model. If investment per worker initially exceeds saving per worker, how is the steady-state capital-labor ratio achieved?

Answer: The per-worker production curve is positively sloped because adding capital to each unit of labor increases output per worker. The curve is concave (i.e., increasing at a decreasing rate) because of diminishing marginal productivity of capital; output increases at a slower rate than capital when capital is added to production.

The steady-state capital-labor ratio is the capital-labor ratio at which saving per worker [sf(k)] equals investment per worker [(n + d)k]. If investment per worker initially exceeds saving per worker, then the initial capital-labor ratio exceeds the steady-state capital-labor ratio. The capital-labor ratio will decline because saving is insufficient to provide enough capital to maintain the initial capital-labor ratio. The capital-labor ratio will continue to decline until it reaches the steady-state capital-labor ratio.

Diff: 1 Topic: Section: 6.2 Question Status: Previous Edition 50) A country has the per-worker production function yt = 5

,

where yt is output per worker and kt is the capital-labor ratio. The depreciation rate is 0.2 and the population growth rate is 0.05. The saving function is St = 0.2Yt, where St is total national saving and Yt is total output. (a) What is the steady-state value of the capital-labor ratio? (b) What is the steady-state value of output per worker? (c) What is the steady-state value of consumption per worker?

Answer: (a) sf(k) = (n + d)k, so 0.2 × 5k0.5 = 0.25k; or k0.5 = 4, so k = 16. (b) y = 5k0.5 = 20. (c) c = (1 - s)y = 0.8y = 16.

Diff: 3 Topic: Section: 6.2 Question Status: Previous Edition

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51) A country has the per-worker production function yt = 6

,

where yt is output per worker and kt is the capital—labor ratio. The depreciation rate is 0.1 and the population growth rate is 0.1. The saving function is St = 0.1Yt, where St is total national saving and Yt is total output. (a) What is the steady-state value of capital—labor ratio? (b) What is the steady-state value of output per worker? (c) What is the steady-state value of consumption per worker?

Answer: (a) sf(k) = (n + d)k, so 0.1 × 6k2/3 = 0.2k; or k1/3 = 3, so k = 27. (b) y = 6k2/3 = 54. (c) c = (1 - s)y = 0.9y = 48.6.

Diff: 3 Topic: Section: 6.2 Question Status: Previous Edition 52) A country has the per-worker production function yt = 6

,

where yt is output per worker and kt is the capital-labor ratio. The depreciation rate is 0.1 and the population growth rate is 0.1. The saving function is St = 0.1Yt, where St is total national saving and Yt is total output. (a) What is the steady-state value of capital—labor ratio? (b) What is the steady-state value of output per worker? (c) What is the steady-state value of consumption per worker?

Answer: (a) sf(k) = (n + d)k, so 0.1 × 6 = 0.2 k0.5; or k0.5 = 3, so k = 9. (b) y = 6 × k0.5 = 6 × 3 = 18. (c) c = (1 - s)y = 0.9y = 0.9 × 18 = 16.2.

Diff: 3 Topic: Section: 6.2 Question Status: Previous Edition

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53) What happens in the steady state to the capital-labor ratio, output per worker, and consumption per worker when each of the following events occur? You should assume that the steady-state capital-labor ratio is below the Golden Rule level. (a) Productivity falls. (b) Population growth falls. (c) The saving rate falls. (d) The depreciation rate falls.

Answer: (a) k, y, and c all fall. (b) k, y, and c all rise. (c) k, y, and c all fall. (d) k, y, and c all rise.

Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 54) Country A has a capital-labor ratio that is initially twice as big as that of country B, but neither is yet in a steady state. Both countries have the same production function, f(k) = 6k1/2.

Country A has a 10% saving rate, 10% population growth rate, and 5% depreciation rate, while country B has a 20% saving rate, 10% population growth rate, and 20% depreciation rate. (a) Calculate the steady-state capital-labor ratio for each country. Does the initial capital-labor ratio affect your results? (b) Calculate output per worker and consumption per worker for each country. Which country has the highest output per worker? The highest consumption per worker?

Answer: (a) Using the formula sf(k) = (n + d)k, country A: 0.1 × 6k1/2 = 0.15k, or k1/2 = 4, so k = 16; country B: 0.2 × 6k1/2 = 0.3k, or k1/2 = 4, so k = 16 also. The initial capital—labor ratios have no effect on the steady-state capital—labor ratios. (b) y = 6k1/2 = 24 for both countries. c = (1 - s)y, so country A has c = 0.9y = 21.6, while country B has c = 0.8y = 19.2. The two countries have the same capital-labor ratio and output per worker, but different consumption per worker.

Diff: 3 Topic: Section: 6.2 Question Status: Previous Edition

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55) How would each of the following changes affect the steady-state values of the capital-labor ratio, output per worker, and consumption per worker? (a) A change in the composition of the capital stock raises the depreciation rate. (b) A change in social mores lowers the population growth rate. (c) Government tax policies change to encourage a higher saving rate. (d) A supply shock reduces productivity sharply.

Answer: (a) The rise in d reduces the capital-labor ratio, as well as output per worker and consumption per worker. (b) The decline in n raises the capital-labor ratio, as well as output per worker and consumption per worker. (c) The rise in s raises the capital-labor ratio, as well as output per worker and consumption per worker. (d) The decline in productivity shifts the production function down, reducing the capital—labor ratio, as well as output per worker and consumption per worker.

Diff: 2 Topic: Section: 6.2 Question Status: Previous Edition 6.3

Endogenous Growth Theory

1) Endogenous growth theory attempts to A) replace the Solow model with a model in which money growth plays a key role.

B) explain how societies can more easily reach the "Golden Rule."

C) show how population growth reduces capital and output.

D) explain why productivity changes.

Answer: D Diff: 1 Topic: Section: 6.3 Question Status: Previous Edition 2) Which of these models attempts to explain why productivity changes?

A) The Solow model B) The Taylor rule C) The Phillips curve D) Endogenous growth theory Answer: D Diff: 1 Topic: Section: 6.3 Question Status: New

25 .

3) In the textbook model of endogenous growth, the production function is modeled as A) Y = AK. B) Y = C + I + G + NX. C) Y = X. D) Y = S - I. Answer: A Diff: 1 Topic: Section: 6.3 Question Status: Previous Edition 4) In the textbook model of endogenous growth, in equilibrium, output grows at the rate of A) sA - d.

B) n + d.

C) K. D) A. Answer: A Diff: 1 Topic: Section: 6.3 Question Status: Previous Edition 5) In the textbook model of endogenous growth, long-run output growth would decline if there were either a ________ in the saving rate or a ________ in the depreciation rate.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: C Diff: 2 Topic: Section: 6.3 Question Status: Previous Edition 6) In the textbook model of endogenous growth, long-run output growth would increase if there were either a ________ in the saving rate or a ________ in the depreciation rate.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: B Diff: 2 Topic: Section: 6.3 Question Status: Previous Edition

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7) Which of the following is not an example of human capital formation?

A) Increases in the educational achievements of the population B) Increases in job skills of the labor force C) Improvements in the nutrition and health of the labor force D) Increases in the birth rate of the population Answer: D Diff: 1 Topic: Section: 6.3 Question Status: Previous Edition 8) Describe the main ideas of endogenous growth theory. What does it have to say about the role of government in economic growth?

Answer: Endogenous growth theory explains the main sources of productivity growth: human capital (the knowledge, skills, and training of individuals) and technological innovation (caused by research and development programs and learning by doing). Government may play a positive role, because policies that increase the capital-labor ratio may lead to a virtuous circle of growth, raising living standards. Also, the government may foster education and research and development.

Diff: 1 Topic: Section: 6.3 Question Status: Previous Edition 9) (a) In the model of endogenous growth, if s = 0.1, A = 2, and d = 0.15, calculate the economy's growth rate. Show your work. (b) If the depreciation rate declines to d = 0.10, calculate the economy's growth rate. Show your work. (c) Is the impact on the growth rate arising from a change in the depreciation rate in the endogenous growth model the same as in the Solow model?

Answer: (a) Growth rate = sA - d = (0.1 × 2) - 0.15 = 0.05 = 5%. (b) Growth rate = (0.1 × 2) - 0.10 = 0.10 = 10%. (c) In the endogenous growth model, a lower rate of depreciation increases the growth rate, but in the Solow model, a lower rate of depreciation leads to a higher capital-labor ratio but no change in the growth rate.

Diff: 2 Topic: Section: 6.3 Question Status: Previous Edition

27 .

6.4

Government Policies to Raise Long-Run Living Standards

1) A government policy that would reduce the saving rate is A) eliminating the social security system.

B) giving tax breaks to increase the real return that savers receive.

C) increasing the government budget surplus by cutting government spending.

D) switching the tax system to tax consumption instead of income.

Answer: C Diff: 1 Topic: Section: 6.4 Question Status: Previous Edition 2) Which of the following would be a useful way to increase the saving rate?

A) Tax breaks to increase the real return that savers receive B) Increasing taxes if Ricardian equivalence holds C) Increasing government spending D) Increasing taxes on capital goods Answer: A Diff: 1 Topic: Section: 6.4 Question Status: Previous Edition 3) Government policies to raise the rate of productivity growth include all of the following except A) improving infrastructure.

B) encouraging research and development.

C) reducing the government budget surplus.

D) improving human capital development.

Answer: C Diff: 1 Topic: Section: 6.4 Question Status: Previous Edition 4) Government policies to raise the rate of productivity growth include all of the following except A) improving infrastructure.

B) improving forecasts of unemployment.

C) helping build human capital by worker training programs.

D) encouraging research and development.

Answer: B Diff: 1 Topic: Section: 6.4 Question Status: Previous Edition

28 .

5) A government policy that would raise the rate of productivity growth is A) shifting infrastructure expenditures to the private sector.

B) taxing expenditures on research and development.

C) reducing the government budget surplus.

D) improving human capital development.

Answer: D Diff: 1 Topic: Section: 6.4 Question Status: Previous Edition 6) A Lorenz curve plots A) unemployment and inflation.

B) job openings and the unemployment rate.

C) the distribution of labor supply.

D) the distribution of income.

Answer: D Diff: 1 Topic: Section: 6.4 Question Status: Previous Edition 7) Lorenz curves for the United States in 1967 and 2020 show A) a trade-off between unemployment and inflation in 1967 but no such trade-off in 2020.

B) a changed relationship between job openings and the unemployment rate from 1967 to 2020.

C) a changed relationship between unemployment and inflation from 1967 to 2020.

D) increased income inequality from 1967 to 2020.

Answer: D Diff: 1 Topic: Section: 6.4 Question Status: Revised 8) A Gini coefficient provides A) a numerical measure of unemployment as a function of inflation.

B) a numerical measure of job openings and their relationship with the unemployment rate.

C) a numerical measure of the distribution of labor supply.

D) a numerical measure of the distribution of income.

Answer: D Diff: 1 Topic: Section: 6.4 Question Status: Previous Edition

29 .

9) The Gini coefficient for the United States from 1967 to 2020 shows A) a decline over time in the trade-off between unemployment and inflation from 1967 to 2020.

B) a closer relationship over time between job openings and the unemployment rate from 1967 to 2020.

C) a weaker relationship over time between unemployment and inflation from 1967 to 2020.

D) increased income inequality over time from 1967 to 2020.

Answer: D Diff: 1 Topic: Section: 6.4 Question Status: Revised 10) What types of government policies can increase long-run living standards?

Answer: If, for some reason, the national saving rate were too low, the government could increase national saving by reducing its budget deficit. Government policies could also raise the level of productivity and/or the rate of productivity growth by improving infrastructure, building human capital, and encouraging research and development.

Diff: 1 Topic: Section: 6.4 Question Status: Previous Edition

30 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 7 The Asset Market, Money, and Prices 7.1

What Is Money?

1) A system in which people trade goods they don't want to consume for goods they do want to consume is called A) an indirect exchange economy.

B) a commodity money system.

C) a barter system.

D) a fiat money system.

Answer: C Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 2) A disadvantage of the barter system is that A) no trade occurs.

B) people must produce all their own food, clothing, and shelter.

C) the opportunity to specialize is greatly reduced.

D) gold is the only unit of account.

Answer: C Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 3) The use of money is more efficient than barter because the introduction of money A) reduces the need for economic specialization.

B) reduces the need to exchange goods.

C) reduces the need for other stores of value.

D) reduces transaction costs.

Answer: D Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 4) In economics, money refers to A) income.

B) wealth.

C) assets used and accepted as payment.

D) currency.

Answer: C Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition

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5) The following are all functions of money except A) medium of exchange.

B) store of value.

C) unit of account.

D) source of anxiety.

Answer: D Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 6) Money's primary role in the economy comes from the benefits of lowering transactions costs and allowing specialization. This function of money is called A) store of value.

B) medium of exchange.

C) standard of deferred payment.

D) unit of account.

Answer: B Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 7) For something to satisfy the medium-of-exchange function of money, it must be A) backed by gold.

B) readily exchangeable for other goods.

C) issued by a central bank.

D) an inherently valuable commodity.

Answer: B Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 8) Which of the following best illustrates the medium of exchange function of money?

A) The price of a new car is $25,000.

B) A penny saved is a penny earned.

C) A person owes $10,000 on his or her credit card.

D) You pay $3 to purchase a bag of apples.

Answer: D Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition

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9) In some countries, prices in stores are listed in terms of U.S. dollars, rather than in units of the local currency. That's most likely because A) the country's political system is unstable.

B) interest rates are higher using U.S. dollars than using the local currency.

C) there is no other store of value.

D) the country has experienced high rates of inflation.

Answer: D Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 10) In some countries the U.S. dollar is used as a unit of account rather than the local currency.

The primary reason for this is that A) the nation has been running a trade surplus.

B) the nation has been running a trade deficit.

C) the U.S. inflation rate is higher than the local inflation rate.

D) U.S. dollars reduce the need to change prices frequently.

Answer: D Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 11) The number of units of one good that trade for one unit of alternative goods can be determined most easily when A) there is one unit of account.

B) the goods all weigh about the same.

C) the goods are all new.

D) the goods are actively traded through barter.

Answer: A Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 12) A good that is used as a medium of exchange as well as being a consumption good is called A) a barter money.

B) a commodity money.

C) a legal tender.

D) a debased money.

Answer: B Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition

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13) Why do people keep currency in their pockets when bank deposits pay interest?

A) Because banks might steal your money.

B) Because currency is more liquid.

C) Because bank deposits lose value due to inflation.

D) Because bank deposits lose value due to changes in interest rates.

Answer: B Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 14) One of moneys primary roles in the economy comes from the use of money to transfer purchasing power to the future. This role of money is called A) store of value.

B) unit of account.

C) medium of exchange.

D) standard of deferred payment.

Answer: A Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 15) Which of the following measures is the best measure of money as a medium of exchange?

A) M1 B) M2 C) M3 D) None of the above Answer: A Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 16) Suppose your bank raises its minimum-balance requirement for free checking on checking accounts by $500. You take $500 out of your passbook savings account and put it in your checking account. What is the overall effect on M1 and M2?

A) M1 rises by $500; M2 falls by $500.

B) M1 is unchanged; M2 is unchanged.

C) M1 rises by $500; M2 is unchanged.

D) M1 is unchanged; M2 falls by $500.

Answer: B Diff: 3 Topic: Section: 7.1 Question Status: Revised

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17) Suppose you decide to move $2000 from your checking account and move it to your savings account. What is the overall effect on M1 and M2?

A) M1 declines by $2000, M2 rises by $2000.

B) M1 declines by $2000, M2 is unchanged.

C) M1 is unchanged, M2 is unchanged.

D) M1 is unchanged, M2 falls by $2000.

Answer: C Diff: 3 Topic: Section: 7.1 Question Status: Revised 18) M1 includes A) MMMFs. B) savings accounts.

C) time deposits.

D) Bitcoin.

Answer: B Diff: 1 Topic: Section: 7.1 Question Status: New 19) M1 does not include A) Bitcoin.

B) savings accounts.

C) currency.

D) transaction accounts.

Answer: A Diff: 1 Topic: Section: 7.1 Question Status: New 20) M1 does not include A) MMMFs. B) savings accounts.

C) currency.

D) transaction accounts.

Answer: A Diff: 1 Topic: Section: 7.1 Question Status: Revised

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21) Which of the following is not part of M1?

A) Transaction accounts B) Checking accounts C) Time deposits D) Savings accounts Answer: C Diff: 1 Topic: Section: 7.1 Question Status: Revised 22) Which of the following statements about M1 and M2 is true?

A) Transactions accounts are not part of M1.

B) M2 is more liquid than M1.

C) M1 is larger than M2.

D) Savings deposits are part of M2.

Answer: D Diff: 1 Topic: Section: 7.1 Question Status: Revised 23) Which of the following statements about M1 and M2 is not true?

A) Transaction accounts are part of M1.

B) M2 is more liquid than M1.

C) M2 is larger than M1.

D) Transaction accounts are part of M2.

Answer: B Diff: 2 Topic: Section: 7.1 Question Status: Previous Edition 24) M2 includes A) large-denomination time deposits.

B) institutional MMMFs. C) commercial paper.

D) M1.

Answer: D Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition

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25) M2 does not include A) Treasury bonds.

B) passbook savings accounts.

C) small-denomination time deposits.

D) M1.

Answer: A Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 26) Which of the following is not included in M2?

A) Money market mutual funds held by individuals B) Money market deposit accounts C) Money market mutual funds held by institutions D) Small-denomination time deposits Answer: C Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 27) The stock of U.S. currency per U.S. resident (calculated as the total U.S. currency divided by the U.S. population) in 2021 was about A) $100.

B) $500.

C) $700.

D) $7000.

Answer: D Diff: 1 Topic: Section: 7.1 Question Status: New 28) Over half of U.S. currency is A) held abroad.

B) used in the underground economy.

C) held by banks as reserves.

D) held by businesses, especially retailers, for making transactions.

Answer: A Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition

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29) People in other countries want to hold U.S. dollars as a A) medium of exchange.

B) store of value.

C) unit of account.

D) standard of deferred payment.

Answer: B Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 30) We shouldn't be concerned about U.S. currency held abroad because A) the currency will never return to the United States.

B) foreigners use it to buy U.S. bonds.

C) it represents an interest-free loan to the United States.

D) foreigners can't spend it in their own countries.

Answer: C Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 31) What's the most common way for a central bank to reduce the money supply?

A) Collect higher taxes B) Sell bonds to the public C) Buy bonds from the government D) Buy bonds from the public Answer: B Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 32) What's the most common way for a central bank to increase the money supply?

A) Collect higher taxes B) Sell bonds to the public C) Buy bonds from the government D) Buy bonds from the public Answer: D Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition

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33) What's the most common way for a central bank to change the money supply?

A) Changing tax collections B) Buying bonds from or selling bonds to people in foreign countries C) Buying bonds from or selling bonds to the government D) Using open-market operations Answer: D Diff: 1 Topic: Section: 7.1 Question Status: Revised 34) Suppose you read in the paper that the Federal Reserve plans to expand the money supply.

The Fed is most likely to do this by A) printing more currency and distributing it.

B) purchasing government bonds from the public.

C) selling government bonds to the public.

D) buying newly issued government bonds directly from the government itself.

Answer: B Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 35) A developing country does not have enough taxes to cover its expenditures and is unable to borrow. This government would be most likely to cover its deficit by A) purchasing government bonds from the public.

B) selling government bonds to the public.

C) selling newly issued government bonds directly to the central bank.

D) buying newly issued government bonds directly from the central bank.

Answer: C Diff: 2 Topic: Section: 7.1 Question Status: Previous Edition 36) What are the major components of M1? What are the major components of M2? Describe each component.

Answer: The principal components of M1 are currency and liquid deposits. Currency includes coins and Federal Reserve notes (i.e., paper money). Liquid deposits include transaction accounts and savings deposits. The principal components of M2 are M1, small time deposits, and money market mutual funds (MMMFs). Small time deposits are certificates of deposit (CDs) of less than $100,000 denomination. MMMFs invest their shareholders' funds in short-term securities, pay market-based interest rates, and allow holders to write a limited number of checks.

Diff: 2 Topic: Section: 7.1 Question Status: Revised

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37) What function is money playing in each of these situations: a. You walk into a store in Germany and see that all the prices are in euros. b. You buy a candy bar for $1.25. c. Your Aunt Jane keeps $100 bills tucked into many books in her house.

Answer: a. unit of account; b. medium of exchange; c. store of value.

Diff: 2 Topic: Section: 7.1 Question Status: Previous Edition 38) What happens to M1 and M2 due to each of the following changes? (a) You take $500 out of your checking account and put it into a passbook savings account. (b) You take $1000 out of your checking account and buy three-month Treasury bills. (c) You take $1500 out of your money market mutual fund and deposit into your checking account. (d) You cash in $2000 in savings bonds and invest the money in a certificate of deposit.

Answer: (a) M1 and M2 are unchanged. (b) M1 and M2 both decline by $1000. (c) M1 rises $1500, M2 is unchanged. (d) M1 is unchanged, M2 rises $2000.

Diff: 2 Topic: Section: 7.1 Question Status: Revised 39) Why is per-capita U.S. currency demand so large? Who is holding large amounts of U.S. currency and why are they doing so? Should U.S. policymakers be concerned about this? Why? Answer: Currency demand is large mostly because foreigners hold many dollars. They do so because of inflation or political instability in their countries. Policymakers shouldn't be very concerned, since foreigners' dollar holdings represent an interest-free loan to the United States.

However, a cause for concern may be that fluctuations in our money supply may reflect conditions abroad that are unrelated to the U.S. economy.

Diff: 1 Topic: Section: 7.1 Question Status: Previous Edition 7.2

Portfolio Allocation and the Demand for Assets

1) You are putting together a portfolio of assets. The four most important characteristics of the assets you will choose are expected return, time to maturity, A) risk, and liquidity.

B) risk, and collateral C) risk, and reward.

D) liquidity, and standard issue size.

Answer: A Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 10 .

2) People's best guesses about returns on assets are called A) expected returns.

B) liquidity.

C) risk.

D) the term structure of returns.

Answer: A Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 3) The set of assets that a holder of wealth chooses to own is called A) an asset assortment.

B) a wealth strategy.

C) a portfolio.

D) an investment envelope.

Answer: C Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 4) Which of the following portfolio allocation decisions represents the best individual response to an increase in the interest rate on nonmonetary assets?

A) Sell some stocks and use the money to buy bonds.

B) Sell some bonds and use the money to buy stocks.

C) Buy some nonmonetary assets with cash.

D) Sell some nonmonetary assets to get cash.

Answer: C Diff: 2 Topic: Section: 7.2 Question Status: Previous Edition 5) The uncertainty about the return an asset will earn is A) liquidity.

B) risk.

C) time to maturity.

D) stochastic dominance.

Answer: B Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition

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6) The risk premium is A) the amount by which the expected return on a risky asset exceeds the return on an otherwise comparable safe asset.

B) a measure of the riskiness of the overall economy in a domestic country compared with a foreign country.

C) the amount an investor must pay to insure his or her stock portfolio to protect against a fall in value.

D) the amount an investment bank charges to guarantee an annuity that pays a fixed rate of return in the future.

Answer: A Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 7) The amount by which the expected return on a risky asset exceeds the return on an otherwise comparable safe asset is known as the A) CDS spread.

B) risk premium.

C) VIX. D) term spread.

Answer: B Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 8) The existence of a ________ means that the interest rate on a two-year bond will exceed the average interest rate on two successive one-year bonds.

A) risky asset.

B) securitization premium.

C) term structure.

D) risk premium.

Answer: D Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 9) The ease and quickness with which an asset can be exchanged for goods, services, or other assets is its A) risk.

B) time to maturity.

C) velocity.

D) liquidity.

Answer: D Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 12 .

10) Time to maturity refers to the amount of time until A) an asset repays the principal to an investor.

B) an asset pays interest for the first time.

C) a bond can be sold on the secondary market.

D) the yield curve shows an upward slope.

Answer: A Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 11) Compared with money, bonds have A) less risk and less liquidity.

B) less risk and more liquidity.

C) more risk and less liquidity.

D) more risk and more liquidity.

Answer: C Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 12) AAA Company stock has a higher expected rate of return than ZZZ Company stock. All else being equal, you would expect that relative to ZZZ, AAA company stock provides A) less risk and less liquidity.

B) less risk and more liquidity.

C) more risk and less liquidity.

D) more risk and more liquidity.

Answer: C Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 13) The least liquid asset on this list is A) money.

B) bonds.

C) houses.

D) stocks.

Answer: C Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition

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14) In the early 2000s, lenders began issuing mortgage loans to people who would normally not be qualified to take out loans because they did not meet lending standards. Those borrowers are known as A) alternative borrowers.

B) weak borrowers.

C) subprime borrowers.

D) credit risks.

Answer: C Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 15) The financial crisis occurred in 2008 in large part because of losses on securities consisting of bundles of mortgage loans known as A) home loan loss reserves.

B) credit default swaps.

C) mortgage-backed securities.

D) naked put options.

Answer: C Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 16) A one-year bond has an interest rate of 5% today. Investors expect that in one year, a oneyear bond will have an interest rate equal to 7%. According to the expectations theory of the term structure of interest rates, in equilibrium, a two-year bond today will have an interest rate equal to A) 3.0%.

B) 5.0%.

C) 5.5%.

D) 6.0%.

Answer: D Diff: 2 Topic: Section: 7.2 Question Status: Previous Edition

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17) A one-year bond has an interest rate of 5% today. Investors expect that in one year, a oneyear bond will have an interest rate equal to 7%. Investors expect that in two years, a one-year bond will have an interest rate equal to 9%. According to the expectations theory of the term structure of interest rates, in equilibrium, a three-year bond today will have an interest rate equal to A) 4.0%.

B) 5.0%.

C) 6.0%.

D) 7.0%.

Answer: D Diff: 2 Topic: Section: 7.2 Question Status: Previous Edition 18) The idea that investors today compare the returns on bonds with differing times to maturity to see which is expected to give them the highest return is the underlying principle behind the ________ of the term structure of interest rates.

A) expectations theory B) investors' viewpoint analysis C) segmented-markets theory D) yield comparison theory Answer: A Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 19) The interest rate on long-term bonds is somewhat higher than suggested by the expectations theory because A) the expectations theory doesn't account for taxes.

B) a risk premium exists.

C) an inflation premium must be added to long-term bonds.

D) the Fed can only control short-term interest rates.

Answer: B Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 20) By spreading her investments out over many different assets, an investor achieves A) a higher expected return.

B) increased risk.

C) diversification.

D) greater liquidity.

Answer: C Diff: 1 Topic: Section: 7.2 Question Status: Previous Edition 15 .

21) Suppose that you could buy a one-year bond today, which has an interest rate of 3%. If you wait a year and buy a one-year bond then, the interest rate will be 4%. Two years from now, a one-year bond is expected to offer an interest rate of 5%. According to the expectations theory of the term structure of interest rates, what is the interest rate on a two-year bond today? What is the interest rate on a three-year bond today?

Answer: Two-year bond: (3% + 4%)/2 = 3.5%; Three-year bond: (3% + 4% + 5%)/3 = 4%.

Diff: 2 Topic: Section: 7.2 Question Status: Previous Edition 22) Suppose that: 1) The interest on a one-year bond today is 3%; 2) The interest on a one-year bond starting one year from now is expected to be 4% per year; 3) The interest on a one-year bond starting two years from now is expected to be 5% per year; 4) The risk premium on a two-year bond is 0.5%; and 5) The risk premium on a three-year bond is 1.0%.

Use that information to answer the following questions. a) According to the expectations theory, what is the interest rate today on a two-year bond?

Show your work. b) According to the expectations theory, what is the interest rate today on a three-year bond?

Show your work. c) Plot the yield curve.

Answer: a) (3% + 4%)/2 + 0.5% = 4.0% b) (3% + 4% + 5%)/3 + 1.0% = 5.0% c) plot 3 points with 1, 2, and 3 years to maturity vs. yields of 3%, 4%, and 5%.

Diff: 2 Topic: Section: 7.2 Question Status: Previous Edition 7.3

The Demand for Money

1) A 10% decrease in real income usually leads to ________ in money demand.

A) an increase B) no change C) a decrease of less than 10% D) a decrease of 10% Answer: C Diff: 1 Topic: Section: 7.3 Question Status: Previous Edition

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2) A 5% increase in real income usually leads to ________ in money demand.

A) a decrease B) no change C) an increase of less than 5% D) a decrease of 5% Answer: C Diff: 1 Topic: Section: 7.3 Question Status: Previous Edition 3) Which of the following is most likely to lead to a decrease of 10% in the nominal demand for money?

A) An increase in real income of 5% B) A decrease in real income of 5% C) A decline of 10% in the price level D) An increase of 10% in the price level Answer: C Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 4) Which of the following is most likely to lead to an increase of 1% in the nominal demand for money?

A) An increase in real income of 0.5% B) A decrease in real income of 0.5% C) A decline of 1% in the price level D) An increase of 1% in the price level Answer: D Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 5) The opportunity cost of holding currency decreases when A) income decreases.

B) the interest rate on bonds decreases.

C) the interest rate on money decreases.

D) wealth decreases.

Answer: B Diff: 1 Topic: Section: 7.3 Question Status: Previous Edition

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6) An increase in the real interest rate would cause an increase in the real demand for money A) no matter what the change in expected inflation.

B) if expected inflation fell by less than the rise in the real interest rate.

C) if expected inflation fell by the same amount as the rise in the real interest rate.

D) if expected inflation fell by more than the rise in the real interest rate.

Answer: D Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 7) During the past year, there was an increase in the price level and an increase in interest rates on financial assets, but a fall in personal incomes. The overall demand for money fell. Which of the following factors was most likely to have contributed to this fall in the demand for money?

A) Changes in the price level and in interest rates B) Changes in interest rates and personal incomes C) Changes in the price level and personal incomes D) Changes in personal incomes only Answer: B Diff: 2 Topic: Section: 7.3 Question Status: New 8) An increase in expected inflation is likely to cause A) a decline in the demand for real balances.

B) an increase in the demand for real balances.

C) no change in the demand for real balances.

D) no change in the demand for real balances only if the income elasticity of real money demand is zero.

Answer: A Diff: 1 Topic: Section: 7.3 Question Status: Previous Edition 9) Mr. Pierpont has wealth of $200,000. He wants to keep at least $80,000 in bonds at all times, and will shift $10,000 into bonds from his checking account for each percentage point that the interest rate on bonds exceeds the interest rate on his checking account. If the interest rate on checking accounts is 4% and the interest rate on bonds is 9%, how much does Mr. Pierpont keep in his checking account?

A) $50,000 B) $70,000 C) $130,000 D) $150,000 Answer: B Diff: 1 Topic: Section: 7.3 Question Status: Previous Edition 18 .

10) Mr. Pierpont has wealth of $200,000. He wants to keep at least $80,000 in bonds at all times, and will shift $10,000 into bonds from his checking account for each percentage point that the interest rate on bonds exceeds the interest rate on his checking account. Currently, he keeps $100,000 in bonds, which pay him 7%. What is the current interest rate on checking accounts?

A) 5% B) 7% C) 9% D) 10% Answer: A Diff: 1 Topic: Section: 7.3 Question Status: Previous Edition 11) Money demand is given by Md/P = 1000 + .2Y - 1000i.

Given that P = 200, Y = 2000, and i = .10, real money demand is equal to A) 1300.

B) 1500.

C) 260,000.

D) 300,000.

Answer: A Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 12) Money demand is given by Md/P = 1000 + .2Y - 1000i.

Given that P = 200, Y = 2000, and i = .10, nominal money demand is equal to A) 1300.

B) 1500.

C) 260,000.

D) 300,000.

Answer: C Diff: 2 Topic: Section: 7.3 Question Status: New 13) Over time, the wealth of society increases and payments technologies get more efficient.

What is the effect on money demand of these two changes?

A) Money demand rises proportionately to the rise in wealth.

B) Money demand rises, but less than proportionately to the rise in wealth.

C) The overall effect is ambiguous.

D) Money demand declines.

Answer: C Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 19 .

14) If there is a financial panic and increased uncertainty about the returns in the stock market and bond market, what is the likely effect on money demand?

A) Money demand declines first, then rises when inflation increases.

B) Money demand rises.

C) The overall effect is ambiguous.

D) Money demand declines.

Answer: B Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 15) Suppose a new law imposes a tax on all trades of bonds and stock. What is the likely effect on money demand?

A) Money demand declines first, then rises when inflation increases.

B) Money demand rises.

C) The overall effect is ambiguous.

D) Money demand declines.

Answer: B Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 16) If real income rises 4%, prices rise 1%, and nominal money demand rises 4%, what is the income elasticity of real money demand?

A) 3/4 B) 4/5 C) 5/6 D) 1 Answer: A Diff: 3 Topic: Section: 7.3 Question Status: Previous Edition 17) If real income rises 5%, prices rise 3%, and nominal money demand rises 7%, what is the income elasticity of real money demand?

A) 3/4 B) 4/5 C) 5/6 D) 6/7 Answer: B Diff: 3 Topic: Section: 7.3 Question Status: Previous Edition

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18) If the interest elasticity of money demand is -0.1, by what percent does money demand change if the nominal interest rate rises from 2% to 3%?

A) -0.1% B) 5% C) 0% D) -5% Answer: D Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 19) If the interest elasticity of money demand is -0.25, by what percent does money demand change if the nominal interest rate rises from 4% to 5%?

A) 6.25% B) 0.25% C) -0.25% D) -6.25% Answer: D Diff: 2 Topic: Section: 7.3 Question Status: New 20) If the income elasticity of money demand is 3/4 and the interest elasticity of money demand is -1/4, by what percent does money demand rise if income rises 10% and the nominal interest rate rises from 4% to 5%?

A) 7.50% B) 6.25% C) 5.00% D) 1.25% Answer: D Diff: 3 Topic: Section: 7.3 Question Status: Previous Edition 21) Velocity is defined as A) nominal money stock/nominal GDP. B) nominal GDP/nominal money stock.

C) real money stock/real GDP. D) mc2.

Answer: B Diff: 1 Topic: Section: 7.3 Question Status: Previous Edition

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22) If real GDP is $4 billion, the price level is 1.25, and the nominal money stock is $500 million, then velocity is A) 0.1.

B) 1.

C) 10.

D) 100.

Answer: C Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 23) Money demand is given by Md/P = 1000 + .2Y - 1000i.

Given that P = 200, Y = 2000, and i = .10, velocity is equal to A) 0.65.

B) 0.75.

C) 1.33.

D) 1.54.

Answer: D Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 24) Suppose velocity is 3, real output is 9000, and the price level is 1.5. What is the level of real money demand in this economy?

A) 2000 B) 3000 C) 6000 D) 30,000 Answer: B Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 25) Suppose real money demand is 1000, real output is 6000, and the price level is 200. What is the level of velocity in this economy?

A) 2 B) 3 C) 6 D) 12 Answer: C Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition

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26) If nominal GDP is $7 trillion, the price level is 200, and the nominal money stock is $1 trillion, then velocity is A) 1/7.

B) 2.

C) 3.5.

D) 7.

Answer: D Diff: 2 Topic: Section: 7.3 Question Status: New 27) Suppose real money demand is 400, real output is 16,000, and the price level is 150. What is the level of velocity in this economy?

A) 40 B) 400 C) 4,000 D) 6,000 Answer: A Diff: 2 Topic: Section: 7.3 Question Status: New 28) Suppose velocity is constant at 4, real output is 10, and the price level is 2. From this initial situation, the government increases the nominal money supply to 6. If velocity and output remain unchanged, by how much will the price level increase?

A) 2.4% B) 20% C) 24% D) 50% Answer: B Diff: 3 Topic: Section: 7.3 Question Status: Previous Edition 29) A claim to resources that is recorded in a computer system is called a(n) A) autoimmune claim.

B) cryptocurrency.

C) digital image.

D) stakeholder claim.

Answer: B Diff: 1 Topic: Section: 7.3 Question Status: Previous Edition

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30) According to the quantity theory of money, velocity A) increases with nominal income.

B) is constant.

C) is positively related to the real interest rate.

D) is proportional to the price level.

Answer: B Diff: 1 Topic: Section: 7.3 Question Status: Previous Edition 31) Instability in M1 money demand in the mid-1970s and since the early 1980s is most closely related to changes in A) Federal Reserve chairs.

B) the risks of nonmonetary assets.

C) real output.

D) deregulation, financial innovations, and payment technologies.

Answer: D Diff: 1 Topic: Section: 7.3 Question Status: New 32) What happens to real money demand (rise, fall, no change) due to a change in each of the following factors? (a) A tax on stock market transactions is introduced. (b) Computerized bond trading reduces transactions costs. (c) People's average level of wealth rises. (d) The threat of a recession increases the riskiness of stocks and bonds. (e) The interest rate paid on checking account balances declines. (f) The price level falls in a one-time jump.

Answer: (a) Rises (b) Falls (c) Rises (d) Rises (e) Falls (f) Is unchanged Diff: 1 Topic: Section: 7.3 Question Status: Previous Edition

24 .

33) Give five examples of factors that could reduce the demand for money.

Answer: Lower price level, lower real income, higher real interest rate, higher expected inflation, lower nominal interest rate on money, lower wealth, lower risk on alternative assets, higher risk on money, increased liquidity of alternative assets, or increased efficiency of payments technologies.

Diff: 2 Topic: Section: 7.3 Question Status: Previous Edition 34) Suppose the money demand function is Md/P = 1000 + 0.2Y - 1000 (r + πe). (a) Calculate velocity if Y = 2000, r = .06, and πe = .04. (b) If the money supply (Ms) is 2600, what is the price level? (c) Now suppose the real interest rate rises to 0.11, but Y and Ms are unchanged. What happens to velocity and the price level? So if the nominal interest rate were to rise from 0.10 to 0.15 over the course of a year, with Y remaining at 2000, what would the inflation rate be?

Answer: (a) V = PY/M = Y/(M/P). From the money demand function, M/P = 1300. So V = 2000/1300 = 1.54. (b) P = Ms/(Md/P) = 2600/1300 = 2. (c) Now Md/P = 1250. So V = 2000/1250 = 1.6. P = Ms/(Md/P) = 2600/1250 = 2.08. The inflation rate would be 4%.

Diff: 3 Topic: Section: 7.3 Question Status: Previous Edition 7.4

Asset Market Equilibrium

1) Under a situation of asset market equilibrium, A) the quantity of money supplied equals the quantity of money demanded.

B) the quantity of money supplied equals the quantity of nonmonetary assets demanded.

C) the quantity of nonmonetary assets supplied equals the quantity of monetary assets demanded.

D) the quantity of money supplied equals the quantity of nonmonetary assets supplied.

Answer: A Diff: 1 Topic: Section: 7.4 Question Status: Previous Edition

25 .

2) When the real quantity of money supplied equals the real quantity of money demanded, there is said to be A) goods market equilibrium.

B) asset market equilibrium.

C) monetary neutrality.

D) money illusion.

Answer: B Diff: 1 Topic: Section: 7.4 Question Status: Previous Edition 3) When the quantity of money supplied equals the quantity of money demanded, then A) the goods market is in equilibrium.

B) the asset market is in equilibrium.

C) the money market is in equilibrium.

D) the money market is not in equilibrium.

Answer: B Diff: 1 Topic: Section: 7.4 Question Status: Previous Edition 4) Which of these variables is not a variable in the equation for the asset market equilibrium condition?

A) Nominal money supply B) Price level C) Real income D) Investment Answer: D Diff: 1 Topic: Section: 7.4 Question Status: Previous Edition 5) Which of these variables is not a variable in the equation for the asset market equilibrium condition?

A) Saving B) Expected rate of inflation C) Real interest rate D) Real income Answer: A Diff: 1 Topic: Section: 7.4 Question Status: Previous Edition

26 .

6) If the quantity of money demanded exceeds the quantity of money supplied, then A) the quantity of nonmonetary assets demanded exceeds the quantity supplied.

B) the quantity of nonmonetary assets supplied exceeds the quantity demanded.

C) the quantity of nonmonetary assets demanded will still equal the quantity supplied, all else being equal.

D) you can make no conclusions about the relative supply and demand of nonmonetary assets.

Answer: B Diff: 2 Topic: Section: 7.4 Question Status: Previous Edition 7) If the asset market is to remain in equilibrium, then if the money supply increases, output is unchanged, the price level is unchanged, and the expected inflation rate is unchanged, then A) the real interest rate must rise.

B) the real interest rate must decline.

C) the nominal interest rate must rise.

D) the inflation rate must rise.

Answer: B Diff: 2 Topic: Section: 7.4 Question Status: Previous Edition 8) Suppose the real money demand function is Md/P = 2400 + 0.2Y - 10,000 (r + πe).

Assume M = 4000, P = 2.0, πe = .03, and Y = 5000. The real interest rate that clears the asset market is A) 3%.

B) 6%.

C) 11%.

D) 14%.

Answer: C Diff: 3 Topic: Section: 7.4 Question Status: Previous Edition

27 .

9) Suppose the real money demand function is Md/P = 2400 + 0.2Y - 10,000 (r + πe).

Assume M = 5000, πe = .03, and Y = 5000. If the price level were to decrease from 2.5 to 2.0, then the real interest rate would decrease by how many percentage points (assuming Md, πe, and Y are unchanged)?

A) 4 B) 5 C) 9 D) 14 Answer: B Diff: 3 Topic: Section: 7.4 Question Status: Previous Edition 10) Suppose the real money demand function is Md/P = 2400 + 0.2Y - 10,000 (r + πe).

Assume M = 5000, P = 2.0, and πe = .03. If Y were to increase from 4000 to 5000, then the real interest rate would increase by how many percentage points?

A) 2 B) 4 C) 5 D) 7 Answer: A Diff: 3 Topic: Section: 7.4 Question Status: Previous Edition 11) Suppose real money demand is L = 0.8 Y - 100,000 (r + πe).

If the nominal money supply is 12,000, real output is 15,000, the real interest rate is .02, and the expected inflation rate is .01, then the price level is A) 3/4.

B) 1.

C) 4/3.

D) 3.

Answer: C Diff: 3 Topic: Section: 7.4 Question Status: Previous Edition

28 .

12) Suppose the real interest rate is 4% and the expected inflation rate is 3%. If the money supply increases by 10% and output, the real interest rate, and the expected inflation rate are unchanged, then the price level increases by A) 3%.

B) 4%.

C) 7%.

D) 10%.

Answer: D Diff: 3 Topic: Section: 7.4 Question Status: Previous Edition 13) Define asset market equilibrium and state the asset market equilibrium condition.

Answer: Asset market equilibrium exists when the quantity of assets supplied equals the quantity of assets demanded in a national economy in some time period. The asset market equilibrium equation is M/P = L(Y, r + πe).

Diff: 1 Topic: Section: 7.4 Question Status: Previous Edition 14) Suppose the money demand function is given by Md/P = 640 + 0.1Y - 5000 (r + πe).

Suppose the central bank changes the nominal money supply depending on income and inflation: Ms = 1000 + 0.1Y - 4000π. (a) If expected inflation equals actual inflation = 0.03, Y = 1000, and r = 0.02, calculate the price level. (b) If inflation rises to 0.04 while the other variables remain as in part a, calculate the price level. (c) If expected inflation rises to 0.04 while the other variables remain as in part a, calculate the price level. (d) If the real interest rate rises to 0.03 while the other variables remain as in part a, calculate the price level.

Answer: Plug in the value of Y and use text Eq. (7.10) to get P = [1100 - 4000π]/[740 - 5000(r + πe)]. When r = 0.02, this becomes P = [1100 - 4000π]/[640 - 5000π]. (a) P = 980/490 = 2. (b) P = 940/490 = 1.92. (c) P = 980/440 = 2.23. (d) P = 980/440 = 2.23.

Diff: 2 Topic: Section: 7.4 Question Status: Previous Edition

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15) Assume that prices and wages adjust rapidly so that the markets for labor, goods, and assets are always in equilibrium. What are the effects of each of the following on output, the expected real interest rate, and the current price level? (a) a temporary increase in taxes (b) a reduction in the effective tax rate on capital (c) an increase in expected inflation Answer: (a) Under Ricardian equivalence, no effect on output, real interest rate, or price level. Without Ricardian equivalence, higher national saving means a lower expected real interest rate. Output is unchanged because of no change in labor supply or demand. The lower expected real interest rate increases real money demand, thus reducing the price level. (b) The lower tax rate on capital increases desired investment, thus raising the expected real interest rate. No effect on the labor market, so output is not changed. The higher expected real interest rate reduces real money demand, thus increasing the price level. (c) The increase in the expected inflation rate has no effect on the labor market or goods market, so output and the expected real interest rate do not change. The higher expected inflation rate reduces real money demand, thus increasing the price level.

Diff: 2 Topic: Section: 7.4 Question Status: Previous Edition 7.5

Money Growth and Inflation

1) If the nominal money supply doubles while real money demand is unchanged, what happens to the price level?

A) The price level increases by a factor of four.

B) The price level doubles.

C) The price level is unchanged.

D) The price level falls by one-half.

Answer: B Diff: 1 Topic: Section: 7.5 Question Status: Previous Edition 2) If real money demand doubles while the nominal money supply is unchanged, what happens to the price level?

A) The price level increases by a factor of four.

B) The price level doubles.

C) The price level is unchanged.

D) The price level falls by one-half.

Answer: D Diff: 1 Topic: Section: 7.5 Question Status: Previous Edition

30 .

3) If the asset market is in equilibrium, the growth rate of the nominal money supply minus the growth rate of real money demand equals A) the real interest rate.

B) the inflation rate.

C) the price level.

D) the growth rate of real output.

Answer: B Diff: 2 Topic: Section: 7.5 Question Status: Previous Edition 4) If nominal money supply grows 3% and real money demand grows 8%, the inflation rate is A) -5%.

B) 8/3%.

C) 5%.

D) 11%.

Answer: A Diff: 2 Topic: Section: 7.5 Question Status: Previous Edition 5) If real money demand increases 5% and real money supply increases 10%, by about how much does the price level change?

A) Falls by 5% B) Unchanged C) Rises by 2% D) Rises by 5% Answer: D Diff: 1 Topic: Section: 7.5 Question Status: Previous Edition 6) If the income elasticity of money demand is 3/4 and income increases 8%, by about how much does the price level change?

A) Falls by 6% B) Unchanged C) Rises by 6% D) Rises by 8% Answer: A Diff: 1 Topic: Section: 7.5 Question Status: Previous Edition

31 .

7) If the nominal money supply grows 5%, real income falls 2%, and the income elasticity of money demand is 0.8, then the inflation rate is A) 3.0%.

B) 3.4%.

C) 6.6%.

D) 7.0%.

Answer: C Diff: 2 Topic: Section: 7.5 Question Status: Previous Edition 8) If the nominal money supply grows 6%, real income rises 2%, and the inflation rate is 5%, then the income elasticity of money demand is A) 0.5.

B) 0.75.

C) 1.0.

D) 1.5.

Answer: A Diff: 2 Topic: Section: 7.5 Question Status: Previous Edition 9) If the nominal money supply grows 10%, the inflation rate is 6%, and the income elasticity of money demand is 1.0, then real income growth equals A) 1%.

B) 2%.

C) 3%.

D) 4%.

Answer: D Diff: 2 Topic: Section: 7.5 Question Status: Previous Edition 10) Suppose velocity is constant at 3, real output is 6000, and the price level is 20. From this initial situation, the central bank increases the nominal money supply to 50,000. If velocity and output remain unchanged, by how much will the price level increase?

A) 10%.

B) 20%.

C) 25%.

D) 50%.

Answer: C Diff: 2 Topic: Section: 7.5 Question Status: New

32 .

11) If the asset market is in equilibrium, the money supply increases 5%, the income elasticity of money demand equals 2/3, and real income grows 3%, and all other factors affecting real money demand are unchanged, then the inflation rate equals A) 3%.

B) 5%.

C) 7%.

D) 8%.

Answer: A Diff: 2 Topic: Section: 7.5 Question Status: New 12) Large differences in inflation rates among countries are almost always the result of large differences in A) productivity.

B) real income growth.

C) the growth rates of real money demand.

D) the growth rates of nominal money supplies.

Answer: D Diff: 1 Topic: Section: 7.5 Question Status: Previous Edition 13) When a government prints money to finance its expenditures, it is likely to cause A) unemployment.

B) inflation.

C) deflation.

D) reductions in the use of barter.

Answer: B Diff: 1 Topic: Section: 7.5 Question Status: Previous Edition 14) The most likely explanation for the high inflation rates that countries like Russia and Ukraine have suffered is that A) large inflows of foreign funds increase the money supply, causing inflation.

B) without inflation, these countries would be unable to achieve high rates of growth.

C) borrowing from the central bank is the most expedient method of funding the government's expenditures.

D) the flood of financial innovations has increased liquidity in these nations' economies.

Answer: C Diff: 2 Topic: Section: 7.5 Question Status: Revised

33 .

15) Bonds sold by the U.S. government that offer a certain real interest rate are known as A) zero-coupon bonds.

B) Treasury Inflation-Protected Securities.

C) denominalized securities.

D) savings bonds.

Answer: B Diff: 2 Topic: Section: 7.5 Question Status: Previous Edition 16) The excess of the nominal interest rate over the TIPS interest rate is known as the A) interest-rate differential.

B) break-even inflation rate.

C) yield spread.

D) term structure.

Answer: B Diff: 1 Topic: Section: 7.5 Question Status: Previous Edition 17) The break-even inflation rate is the A) excess of the nominal interest rate over the TIPS interest rate.

B) inflation rate that makes the nominal interest rate equal the real interest rate.

C) negative of the real interest rate.

D) inflation rate that is optimal according to the Friedman rule.

Answer: A Diff: 1 Topic: Section: 7.5 Question Status: Previous Edition 18) How does the break-even inflation rate differ from the expected inflation rate as measured in surveys?

A) They are very close to each other.

B) The break-even inflation rate varies less than the expected inflation rate from surveys.

C) The break-even inflation rate varies more than the expected inflation rate from surveys.

D) The break-even inflation rate is always several percentage points higher than the expected inflation rate from surveys.

Answer: C Diff: 2 Topic: Section: 7.5 Question Status: Previous Edition

34 .

19) Calculate the change in the price level for each of the following events, taken one at a time, with other variables unchanged. (a) Money supply increases 10%. (b) Money demand increases 5%. (c) Money supply decreases 5% while money demand increases 5%. (d) Money supply increases 15% while money demand increases 5%.

Answer: (a) 10% (b) -5% (c) -10% (d) 10% Diff: 1 Topic: Section: 7.5 Question Status: Previous Edition 20) Why did some of the formerly Communist countries of Eastern Europe have inflation rates over 100%, while others didn't? Which factor was more important in explaining the differing inflation rates, real money demand or nominal money supply? Why did the countries with high inflation rates allow inflation to get so high?

Answer: Some countries had high inflation while others didn't because of differences in rates of money growth. Real money demand didn't vary enough to explain the differences in inflation rates; instead, nominal money supply growth was strongly correlated with inflation. The countries allowed inflation to get so high because they were trying to finance government expenditures by printing money.

Diff: 1 Topic: Section: 7.5 Question Status: Previous Edition

35 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 8 Business Cycles 8.1

What Is a Business Cycle?

1) One of the first organizations to investigate the business cycle was A) the Federal Reserve System.

B) the National Bureau of Economic Research.

C) the Council of Economic Advisors.

D) the Brookings Institution.

Answer: B Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 2) The entire sequence of a decline in aggregate economic activity followed by recovery, measured from peak to peak or trough to trough is a A) long-run trend.

B) potential output path.

C) business cycle.

D) recurrent comovement.

Answer: C Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 3) A detailed history of business cycles is known as a A) historical decomposition.

B) trend analysis.

C) Hodrick-Prescott filter.

D) business cycle chronology.

Answer: D Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 4) A business cycle chronology is A) the peak of a business cycle.

B) the trough of a business cycle.

C) the mid-point of a business cycle.

D) a detailed history of business cycles.

Answer: D Diff: 1 Topic: Section: 8.1 Question Status: New

1 .

5) The dates of turning points are determined by a committee from the A) FBI. B) BLS. C) BEA. D) NBER. Answer: D Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 6) The National Bureau of Economic Research produces A) data on GDP. B) data on the unemployment rate.

C) inflation statistics.

D) the U.S. business cycle chronology.

Answer: D Diff: 1 Topic: Section: 8.1 Question Status: New 7) Business cycles all display the following characteristics except A) a period of expansion followed by one of contraction.

B) comovement of many economic variables.

C) rising prices during an expansion and falling prices during the contraction.

D) they last a period of one to twelve years.

Answer: C Diff: 2 Topic: Section: 8.1 Question Status: Previous Edition 8) The trough of a business cycle occurs when ________ hits its lowest point.

A) inflation B) the money supply C) aggregate economic activity D) the unemployment rate Answer: C Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition

2 .

9) The low point in the business cycle is referred to as the A) expansion.

B) boom.

C) trough.

D) peak.

Answer: C Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 10) When aggregate economic activity is increasing, the economy is said to be in A) an expansion.

B) a contraction.

C) a peak.

D) a turning point.

Answer: A Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 11) The high point in the business cycle is referred to as the A) turning point.

B) peak.

C) boom.

D) trough.

Answer: B Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 12) When aggregate economic activity is declining, the economy is said to be in A) a contraction.

B) an expansion.

C) a trough.

D) a turning point.

Answer: A Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition

3 .

13) Peaks and troughs of the business cycle are known collectively as A) volatility.

B) turning points.

C) equilibrium points.

D) real business cycle events.

Answer: B Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 14) Turning points in business cycles occur when A) a new business cycle is initiated at the trough.

B) the economy hits the peak or trough in the business cycle.

C) the business cycle begins to follow a new pattern that differs from previous business cycles.

D) a new business cycle is initiated at the peak.

Answer: B Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 15) Who officially determines whether the economy is in a recession or expansion?

A) The president of the United States B) The U.S. Congress C) The Federal Reserve Board of Governors D) The National Bureau of Economic Research Answer: D Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 16) Which group within the National Bureau of Economic Research officially determines whether the economy is in a recession or expansion?

A) The G-4 B) The Business Cycle Dating Committee C) The Business Cycle Governors D) The Turning Point Group Answer: B Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition

4 .

17) Research on the effects of recessions on the real level of GDP shows that A) recessions cause only temporary reductions in real GDP, which are offset by growth during the expansion phase.

B) recessions cause large, permanent reductions in the real level of GDP. C) recessions cause both temporary and permanent declines in real GDP, but most of the decline is temporary.

D) recessions cause both temporary and permanent declines in real GDP, but most of the decline is permanent.

Answer: C Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 18) The tendency of many different economic variables to have regular and predictable patterns over the business cycle is called A) persistence.

B) comovement.

C) periodicity.

D) recurrence.

Answer: B Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 19) Comovement is A) the tendency for declines in economic activity to be followed by further declines, and for growth in economic activity to be followed by more growth.

B) the idea that the standard pattern of contraction-trough-expansion-peak occurs again and again in industrial economies.

C) the tendency of many economic variables to move together in a predictable way over the business cycle.

D) the idea that peaks and troughs of the business cycle occur at regular intervals.

Answer: C Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 20) The tendency of many economic variables to move together in a predictable way over the business cycle is called A) recurrence.

B) persistence.

C) comovement.

D) inflation.

Answer: C Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 5 .

21) The fact that business cycles are recurrent but not periodic means that A) business cycles occur at predictable intervals, but do not last a predetermined length of time.

B) the business cycle's standard contraction-trough-expansion-peak pattern has been observed to occur over and over again, but not at predictable intervals.

C) business cycles occur at predictable intervals, but do not all follow a standard contractiontrough-expansion-peak pattern.

D) business cycles last a predetermined length of time, but do not all follow a standard contraction-trough-expansion-peak pattern.

Answer: B Diff: 2 Topic: Section: 8.1 Question Status: Previous Edition 22) The tendency for declines in economic activity to be followed by further declines, and for growth in economic activity to be followed by more growth is called A) persistence.

B) comovement.

C) periodicity.

D) recurrence.

Answer: A Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 23) Persistence is A) the tendency for declines in economic activity to be followed by further declines, and for growth in economic activity to be followed by more growth.

B) the idea that the standard pattern of contraction-trough-expansion-peak occurs again and again in industrial economies.

C) the tendency of many economic variables to move together in a predictable way over the business cycle.

D) the idea that peaks and troughs of the business cycle occur at regular intervals.

Answer: A Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition

6 .

24) The idea that the business cycle is recurrent means that A) declines in economic activity tend to be followed by further declines, and growth in economic activity tends to be followed by more growth.

B) the standard pattern of contraction-trough-expansion-peak occurs again and again in industrial economies.

C) many economic variables to move together in a predictable way over the business cycle.

D) peaks and troughs of the business cycle occur at regular intervals.

Answer: B Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 25) Define the following characteristics of business cycles: recurrence and persistence.

Answer: Business cycles exhibit recurrence and persistence: (1) Recurrence means that each complete cycle is followed by another complete cycle.

(2) Persistence means that, once begun, each contraction tends to continue. Likewise, once begun, each expansion tends to continue. For example, the 1981-1982 contraction lasted for 16 months, and the 1982-1990 expansion lasted for 93 months. These are persistent events.

Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 26) Describe the major features of the business cycle. Be sure to discuss what variables are affected by the cycle, a description of the key features that are apparent in the data, how variables are related to one another, how regular the cycle is, and how predictable the cycle is.

Answer: The business cycle is defined as a fluctuation of aggregate economic activity. There are recurrent but not periodic movements of aggregate activity, with many variables moving in the same direction at the same time (comovement). Increases in aggregate economic activity are expansions, while reductions in aggregate economic activity are contractions, or recessions. Both expansions and contractions exhibit persistence, so once an expansion or contraction begins, it tends to last some time.

Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition 27) When a recession occurs, do economists expect it to be a temporary phenomenon? Or is there some degree of permanence? What is the empirical evidence?

Answer: Recent research suggests that recessions may contain permanent components. Some economists argue that only the 1973-1975 recession led to a permanent change in the U.S. economy, because it changed the economy's use of oil permanently. Other studies suggest that perhaps 30% of changes in real output are permanent and 70% are temporary for the postwar United States.

Diff: 1 Topic: Section: 8.1 Question Status: Previous Edition

7 .

8.2

The American Business Cycle: The Historical Record

1) The longest contraction in American history occurred A) during the 1870s.

B) in the years right before World War I began.

C) during the 1930s.

D) during the 1970s.

Answer: A Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 2) The deepest contraction in American history prior to 2020 occurred A) during the 1870s.

B) in the years right before World War I began.

C) during the 1930s.

D) during the 1970s.

Answer: C Diff: 1 Topic: Section: 8.2 Question Status: Revised 3) In the Great Depression, the financial sector collapsed, as A) banks engaged in ruinous competition.

B) the stock market boomed, so people withdrew most of their funds from banks and invested heavily in stocks.

C) the bond market boomed, so people withdrew most of their funds from banks and invested heavily in bonds.

D) many banks closed.

Answer: D Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 4) The deep recession of 1973-1975 was mainly caused by A) flawed technology that caused a drop in TFP. B) an unexplained drop in business optimism.

C) slower money growth.

D) higher oil prices.

Answer: D Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition

8 .

5) The long boom occurred in the A) 1920s and 1930s.

B) 1940s and 1950s.

C) 1960s and 1970s.

D) 1980s and 1990s.

Answer: D Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 6) The long boom began in A) 1947.

B) 1975.

C) 1982.

D) 1991.

Answer: C Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 7) The long boom ended in A) 1999.

B) 2001.

C) 2008.

D) 2012.

Answer: B Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 8) The Great Depression consisted of how many business cycles?

A) 1 B) 2 C) 3 D) 4 Answer: B Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition

9 .

9) By 1937, when a new recession began in the midst of the Great Depression, A) GDP had almost recovered to its 1929 level, but unemployment was still above the 1929 level.

B) unemployment had almost fallen back to its 1929 level, but GDP had yet to recover to its 1929 level.

C) neither GDP nor unemployment had returned to near their 1929 levels.

D) both GDP and unemployment had returned to near their 1929 levels.

Answer: A Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 10) The worst recessions between World War II and 2006 occurred A) during 1945-1946 and 1973-1975.

B) during 1957-1958 and 1973-1975.

C) during 1973-1975 and 1981-1982.

D) during 1945-1946 and 1981-1982.

Answer: C Diff: 1 Topic: Section: 8.2 Question Status: Revised 11) The 1973-1975 recession was caused by A) the Fed's easy monetary policy.

B) the Fed's tight monetary policy.

C) business pessimism about investment caused by high tax rates on capital.

D) the quadrupling of oil prices by OPEC. Answer: D Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 12) The longest economic expansion in the United States occurred during the A) 1940s.

B) 1960s.

C) 2000s.

D) 2010s.

Answer: D Diff: 1 Topic: Section: 8.2 Question Status: Revised

10 .

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

A) December 2007; June 2009 B) December 2007; December 2011 C) October 2008; June 2009 D) October 2008; December 2011 Answer: A Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 14) The recession that began in December 2007 and ended in June 2009 is known as A) the Great Recession.

B) the Great Depression.

C) a jobless recovery.

D) the Great Resignation.

Answer: A Diff: 1 Topic: Section: 8.2 Question Status: New 15) Christina Romer's criticism of the belief that business cycles had moderated since World War II depended on the fact that A) estimates of the timing of business cycles since World War II had been inaccurate.

B) misuse of historical data had caused economists to understate the size of cyclical fluctuations in the post-World War II era.

C) economists had ignored the roles of the government and international trade in mitigating economic fluctuations prior to World War II. D) economists had left out important components of GDP, such as wholesale and retail distribution, transportation, and services, in their pre-World War II estimates.

Answer: D Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 16) Christina Romer argued that A) measured properly, GNP before 1929 varied substantially less over time than the official statistics showed.

B) measured properly, GNP after 1929 varied substantially more over time than the official statistics showed.

C) measured properly, economic expansions after 1929 were shorter than the official statistics showed.

D) measured properly, economic expansions before 1929 were shorter than the official statistics showed.

Answer: A Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 11 .

17) Christina Romer's estimates of the business cycles prior to World War II showed that the business cycle A) had greater fluctuations before World War II than previous estimates had shown.

B) had smaller fluctuations before World War II than previously estimated.

C) had smaller fluctuations before World War II than after World War II. D) had larger fluctuations after World War II than had been previously measured.

Answer: B Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 18) The NBER's Business Cycle Dating Committee picks recession dates by looking at many variables, the four most important of which are industrial production, manufacturing and trade sales, nonfarm employment, and real personal income. These variables are known as A) leading indicators.

B) coincident indicators.

C) lagging indicators.

D) recession indicators.

Answer: B Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 19) The recession of 2001 began in ________ and ended in ________.

A) March; November B) February; December C) April; October D) February; October Answer: A Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 20) The COVID recession of 2020 began in ________ and ended in ________.

A) February; April B) February; December C) March; April D) March; December Answer: A Diff: 1 Topic: Section: 8.2 Question Status: New

12 .

21) The shortest recession in U.S. history occurred in A) 1918.

B) 1980.

C) 2001.

D) 2020.

Answer: D Diff: 1 Topic: Section: 8.2 Question Status: New 22) According to research by Stock and Watson, the recent decline in volatility in many macroeconomic variables was a A) sudden drop that occurred around 1984.

B) gradual decline throughout the 1980s.

C) sudden drop that occurred around 1990.

D) gradual decline throughout the 1990s.

Answer: A Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 23) Stock and Watson found that monetary policy was responsible for about ________% of the reduction in output volatility that occurred in the mid-1980s.

A) 0 to 10 B) 10 to 20 C) 20 to 30 D) 30 to 40 Answer: C Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 24) Stock and Watson found that ________ was responsible for about 20-30 % of the reduction in output volatility that occurred in the mid-1980s.

A) reduced shocks to productivity B) reduced shocks to food and commodity prices C) better monetary policy D) better inventory control Answer: C Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition

13 .

25) The widespread decline in the volatility of many macroeconomic variables after 1984 led economists to term this period the A) Great Moderation.

B) Low Volatility Era. C) Steady State.

D) Long Boom.

Answer: A Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 26) Prior to World War II, the probability that an economic expansion of a given age would end in the next month A) increased as the age of the expansion increased.

B) decreased as the age of the expansion increased.

C) remained fairly steady as the age of the expansion increased.

D) was not associated with the age of the expansion.

Answer: A Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 27) After World War II, the probability that an economic expansion of a given age would end in the next month A) increased as the age of the expansion decreased.

B) decreased as the age of the expansion increased.

C) remained fairly steady as the age of the expansion increased.

D) was not associated with the age of the expansion.

Answer: C Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 28) How has the severity and duration of business cycles changed over time in the United States?

Answer: Though it is a controversial subject, it appears that business cycles have become less severe over time. Recessions have certainly been shorter since World War II than they were before 1929. There is some disagreement about how severe they were before 1929, with Christina Romer arguing that measurement problems in the old data misled economists about how severe those recessions were. But others find that the old data is just about right and conclude that the business cycle is much less severe today.

Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition

14 .

29) If you were a member of the NBER business-cycle dating committee, would you declare that the U.S. economy is now in a recession? Why? Describe the major variables that you would look at to determine whether the economy is in a recession or not, and what features of the data you would look for.

Answer: Many answers are possible. You should discuss GDP and other major macroeconomic variables. You should note that you are looking for co-movement and persistence.

Diff: 1 Topic: Section: 8.2 Question Status: Previous Edition 30) Use the NBER data in Table 8.1 in the textbook on U.S. business cycle turning points to calculate: a) the shortest business cycle from peak to peak; b) the shortest business cycle from trough to trough; c) the longest business cycle from peak to peak; and d) the longest business cycle from trough to trough.

Answer: (a) The shortest business cycle from peak to peak is 17 months, which extended from August 1918 to December 1919. This includes 7 months of contraction followed by 10 months of expansion. (b) The shortest business cycle from trough to trough is 28 months, which extended from July 1980 to October 1982. This includes 12 months of expansion followed by 16 months of contraction. (c) The longest business cycle from peak to peak is 146 months, which extended from December 2007 to February 2020. This includes 18 months of contraction followed by 128 months of expansion. (d) The longest business cycle from trough to trough is 130 months, which extended from June 2009 to April 2020. This includes 128 months of expansion followed by 2 months of contraction.

Diff: 1 Topic: Section: 8.2 Question Status: Revised

15 .

8.3

Business Cycle Facts

1) An economic variable that moves in the same direction as aggregate economic activity (up in expansions, down in contractions) is called A) procyclical.

B) countercyclical.

C) acyclical.

D) a leading variable.

Answer: A Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 2) A procyclical variable is one that A) moves in the same direction as aggregate economic activity (up in expansions, down in contractions).

B) moves in the opposite direction as aggregate economic activity (down in expansions, up in contractions).

C) moves inconsistently compared with aggregate economic activity.

D) is not a leading indicator.

Answer: A Diff: 1 Topic: Section: 8.3 Question Status: New 3) A countercyclical variable is one that A) moves in the same direction as aggregate economic activity (up in expansions, down in contractions).

B) moves in the opposite direction as aggregate economic activity (down in expansions, up in contractions).

C) moves inconsistently compared with aggregate economic activity.

D) is not a leading indicator.

Answer: B Diff: 1 Topic: Section: 8.3 Question Status: New 4) An economic variable that moves in the opposite direction as aggregate economic activity (down in expansions, up in contractions) is called A) procyclical.

B) countercyclical.

C) acyclical.

D) a leading variable.

Answer: B Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 16 .

5) An economic variable that doesn't move in a consistent pattern with aggregate economic activity is called A) procyclical.

B) countercyclical.

C) acyclical.

D) a leading variable.

Answer: C Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 6) A variable that tends to move in advance of aggregate economic activity is called A) a leading variable.

B) a coincident variable.

C) a lagging variable.

D) an acyclical variable.

Answer: A Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 7) A variable that tends to move at the same time as aggregate economic activity is called A) a leading variable.

B) a coincident variable.

C) a lagging variable.

D) an acyclical variable.

Answer: B Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 8) A variable that tends to move later than aggregate economic activity is called A) a leading variable.

B) a coincident variable.

C) a lagging variable.

D) an acyclical variable.

Answer: C Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition

17 .

9) Lagging variables are aggregate economic variables that A) reach a peak after leading variables but before coincident variables reach a peak.

B) reach a peak after coincident variables reach a peak.

C) reach a peak two or more years after aggregate economic activity reaches a peak.

D) are insensitive to business cycles.

Answer: B Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 10) The CFNAI is a A) leading index based on variables released with different frequencies.

B) coincident index based on variables released with different frequencies.

C) leading index based on 85 monthly variables.

D) coincident index based on 85 monthly variables.

Answer: D Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 11) The ADS Business Conditions Index is a A) leading index based on variables released with different frequencies.

B) coincident index based on variables released with different frequencies.

C) leading index based on 85 monthly variables.

D) coincident index based on 85 monthly variables.

Answer: B Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 12) Diebold and Rudebusch showed that the composite index of leading indicators did not improve forecasts of industrial production because A) the index is not produced in a timely manner.

B) the government manipulates the index so it never predicts a recession.

C) the index is not designed for forecasting.

D) data on the components of the index are revised.

Answer: D Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition

18 .

13) Which of the following macroeconomic variables is procyclical and coincident with the business cycle?

A) Residential investment B) Nominal interest rates C) Industrial production D) Unemployment Answer: C Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 14) Which of the following macroeconomic variables is procyclical and leads the business cycle?

A) Business fixed investment B) Residential investment C) Nominal interest rates D) Unemployment Answer: B Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 15) Which of the following macroeconomic variables is procyclical and leads the business cycle?

A) Industrial production B) Money supply C) Real interest rates D) Unemployment Answer: B Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 16) Which of the following macroeconomic variables is acyclical?

A) Real interest rates B) Unemployment C) Money supply D) Consumption Answer: A Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition

19 .

17) Real interest rates are A) procyclical, just like nominal interest rates.

B) acyclical, while nominal interest rates are procyclical.

C) acyclical, just like nominal interest rates.

D) countercyclical, while nominal interest rates are procyclical.

Answer: B Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 18) Which of the following macroeconomic variables is procyclical and lags the business cycle?

A) Business fixed investment B) Employment C) Stock prices D) Nominal interest rates Answer: D Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 19) Which of the following macroeconomic variables would you include in an index of leading economic indicators?

A) Employment B) Inflation C) Real interest rates D) Residential investment Answer: D Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 20) Which of the following is not a leading variable?

A) Inflation B) Stock prices C) Average labor productivity D) Residential investment Answer: A Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition

20 .

21) Which of the following macroeconomic variables would you exclude from an index of leading economic indicators?

A) Money supply B) Industrial production C) Inventory investment D) Residential investment Answer: B Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 22) Which of the following macroeconomic variables could not be used as a leading economic indicator?

A) Residential investment B) Employment C) The money supply D) Stock prices Answer: B Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 23) Industries that are extremely sensitive to the business cycle are the A) durable goods and service sectors.

B) nondurable goods and service sectors.

C) capital goods and nondurable goods sectors.

D) capital goods and durable goods sectors.

Answer: D Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 24) You want to invest in a firm whose profits show large fluctuations throughout the business cycle. Which of the following would you invest in?

A) A corporation that depends heavily on business fixed investment B) A corporation that depends heavily on consumer services C) A corporation that depends heavily on consumer nondurables D) A corporation that depends heavily on government purchases Answer: A Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition

21 .

25) You want to invest in a firm whose profits show small fluctuations throughout the business cycle. Which of the following would you invest in?

A) A corporation that depends heavily on business fixed investment B) A corporation that depends heavily on residential investment C) A corporation that depends heavily on consumer nondurables D) A corporation that depends heavily on consumer durables Answer: C Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 26) Which of the following macroeconomic variables is countercyclical?

A) Real interest rates B) Unemployment C) Money growth D) Consumption Answer: B Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 27) Which of the following macroeconomic variables is not procyclical?

A) Unemployment rate B) Business fixed investment C) Average labor productivity D) Stock prices Answer: A Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 28) When the values of coincident variables are declining, aggregate economic activity A) will begin to decline within six months.

B) might start to decline in the next year.

C) has been declining for at least six months.

D) is declining.

Answer: D Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition

22 .

29) Which of the following is true?

A) Employment and unemployment are both coincident with the business cycle.

B) Employment and unemployment are both procyclical.

C) Employment is procyclical and unemployment is coincident with the business cycle.

D) Employment is procyclical and unemployment is countercyclical.

Answer: D Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 30) The job finding rate is defined as A) the probability that someone who has been unemployed for over a year will find a job in the next month.

B) the probability that someone who is not in the labor force will enter the labor force in the next month.

C) the probability that someone who is employed will change jobs in the next month.

D) the probability that someone who is unemployed will find a job in the next month.

Answer: D Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 31) The job finding rate A) equals 1 minus the job loss rate.

B) remains constant over the business cycle.

C) rises in recessions.

D) rises in expansions.

Answer: D Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 32) The probability that an employed worker will lose his or her job in the next month is known as A) the unemployment rate.

B) the job finding rate.

C) the underemployment rate.

D) the job loss rate.

Answer: D Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition

23 .

33) The job loss rate A) equals 1 minus the job finding rate.

B) remains constant over the business cycle.

C) rises in recessions.

D) rises in expansions.

Answer: C Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 34) Which of the following statements is true?

A) Both nominal and real interest rates are procyclical and leading.

B) Both nominal and real interest rates are procyclical and lagging.

C) Nominal interest rates are procyclical and real interest rates are countercyclical.

D) Nominal interest rates are procyclical and real interest rates are acyclical.

Answer: D Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 35) Using the seasonal business cycle as your guide, during which quarter would you be most likely to expect an increase in your corporation's sales?

A) The first quarter of the year (January-March) B) The second quarter of the year (April-June) C) The third quarter of the year (July-September) D) The fourth quarter of the year (October-December) Answer: D Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition 36) Which of the following macroeconomic variables is the most seasonally procyclical?

A) Expenditure on services B) The unemployment rate C) Expenditure on durable goods D) The real wage Answer: C Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition

24 .

37) Which of the following macroeconomic variables does not vary much over the seasons?

A) The nominal money stock B) The unemployment rate C) The real wage D) Average labor productivity Answer: C Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 38) Identify the comovement (i.e., direction and timing) of the following variables over a business cycle: (a) industrial production; (b) unemployment; (c) nominal interest rates; (d) nominal money supply growth; and (e) investment.

Answer: (a) Industrial production is a procyclical and coincident variable. (b) Unemployment is a countercyclical variable whose timing is unclassified by the Conference Board. (c) Nominal interest rates are procyclical and lagging. (d) Nominal money supply growth is a procyclical and leading variable. (e) Investment includes inventory investment and residential investment, which are procyclical and leading variables; it also includes business fixed investment, which is a procyclical and coincident variable.

Diff: 2 Topic: Section: 8.3 Question Status: Previous Edition 39) What are some of the problems with using the leading indicators to forecast recessions? If you were a policymaker, would you rely on them?

Answer: Although the leading indicators seem to be useful for forecasting the future state of the economy, there are a number of problems in using them. First, the data is usually revised, sometimes substantially, so a signal from the leading indicators may be reversed later. Second, they sometimes give incorrect signals. Third, they don't provide much information on the severity or exact timing of the coming recession. Finally, structural changes in the economy mean the set of indicators must be revised periodically. Policymakers should use the leading indicators as additional information, but should not rely on them alone.

Diff: 1 Topic: Section: 8.3 Question Status: Previous Edition

25 .

8.4

Business Cycle Analysis: A Preview

1) Using the seasonal business cycle as your guide, during which quarter would you be most likely to expect a drop in your corporation's sales, if your company produces consumer goods?

A) The first quarter of the year (January-March) B) The second quarter of the year (April-June) C) The third quarter of the year (July-September) D) The fourth quarter of the year (October-December) Answer: A Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 2) What are the two main components of business cycle theories?

A) A description of shocks and a model of how the economy responds to them B) A model of how people decide to spend and a description of the government's role in the economy C) A model of how equilibrium is reached and a description of the government's role in the economy D) A description of shocks and a description of the government's role in the economy Answer: A Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 3) Economists use the term shocks to mean A) unexpected government actions that affect the economy.

B) typically unpredictable forces that have major impacts on the economy.

C) sudden rises in oil prices.

D) the business cycle.

Answer: B Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 4) Wars, new inventions, harvest failures, and changes in government policy are examples of A) the business cycle.

B) economic models.

C) shocks.

D) opportunity costs.

Answer: C Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition

26 .

5) Hurricanes, terrorist attacks, and droughts are examples of A) the components of GDP. B) propagation mechanisms.

C) shocks.

D) demand innovations.

Answer: C Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 6) The three main components of the aggregate demand-aggregate supply model include A) AD, SRAS, LM. B) SRAS, LRAS, IS. C) AD, IS, LM. D) AD, SRAS, LRAS. Answer: D Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 7) The AD, SRAS, and LRAS curves each show a relationship between which two economic variables?

A) The aggregate price level and output B) The aggregate price level and the interest rate C) Output and unemployment D) Output and the interest rate Answer: A Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 8) When plotted with the aggregate price level on the vertical axis and output on the horizontal axis, which of the following curves slopes downward?

A) SRAS B) AD C) LRAS D) None of the above Answer: B Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition

27 .

9) When plotted with the aggregate price level on the vertical axis and output on the horizontal axis, which of the following curves is vertical?

A) SRAS B) AD C) LRAS D) None of the above Answer: C Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 10) When plotted with the aggregate price level on the vertical axis and output on the horizontal axis, the long-run aggregate supply curve A) slopes upward.

B) slopes downward.

C) is vertical.

D) is horizontal.

Answer: C Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 11) When plotted with the aggregate price level on the vertical axis and output on the horizontal axis, the short-run aggregate supply curve (in the absence of misperceptions) A) slopes upward.

B) slopes downward.

C) is vertical.

D) is horizontal.

Answer: D Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 12) When plotted with the aggregate price level on the vertical axis and output on the horizontal axis, the aggregate demand curve A) slopes upward.

B) slopes downward.

C) is vertical.

D) is horizontal.

Answer: B Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition

28 .

13) An increase in consumer spending caused by an increase in consumer confidence would cause A) the aggregate demand curve to shift up and to the right.

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

C) a movement down and to the right along the aggregate demand curve.

D) a movement up and to the left along the aggregate demand curve.

Answer: A Diff: 2 Topic: Section: 8.4 Question Status: Previous Edition 14) A decrease in government spending on the park system would cause A) the aggregate demand curve to shift to the right.

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

C) a movement down and to the right along the aggregate demand curve.

D) a movement up and to the left along the aggregate demand curve.

Answer: B Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 15) A decline in the stock market, which makes consumers poorer, would cause A) the aggregate demand curve to shift to the right.

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

C) a movement down and to the right along the aggregate demand curve.

D) a movement up and to the left along the aggregate demand curve.

Answer: B Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 16) In the short run, an increase in export sales would cause output to ________ and the price level to ________.

A) rise; rise B) rise; stay constant C) fall; stay constant D) fall; rise Answer: B Diff: 2 Topic: Section: 8.4 Question Status: Previous Edition

29 .

17) After a shift in the aggregate demand curve, which variable adjusts to restore general equilibrium?

A) Price level B) Real interest rate C) Consumption spending D) Investment spending Answer: A Diff: 2 Topic: Section: 8.4 Question Status: Previous Edition 18) In the long run, an increase in consumer spending would cause output to ________ and the price level to ________.

A) rise; rise B) rise; stay constant C) stay constant; stay constant D) stay constant; rise Answer: D Diff: 2 Topic: Section: 8.4 Question Status: Previous Edition 19) In the long run, an increase in government purchases of military equipment would cause output to ________ and the aggregate price level to ________.

A) stay constant; fall B) fall; fall C) fall; stay constant D) stay constant; rise Answer: D Diff: 2 Topic: Section: 8.4 Question Status: Previous Edition 20) According to classical macroeconomists, prices adjust ________ to shocks, so the government should ________.

A) slowly; do little B) rapidly; do little C) rapidly; fight recessions D) slowly; fight recessions Answer: B Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition

30 .

21) According to Keynesian macroeconomists, prices adjust ________ to shocks, so the government should ________.

A) slowly; do little B) rapidly; do little C) rapidly; fight recessions D) slowly; fight recessions Answer: D Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 22) In the long run, an increase in productivity would cause output to ________ and the aggregate price level to ________.

A) fall; rise B) fall; fall C) rise; fall D) rise; rise Answer: C Diff: 2 Topic: Section: 8.4 Question Status: Previous Edition 23) In the long run, a reduction in labor supply would cause output to ________ and the aggregate price level to ________.

A) fall; rise B) fall; fall C) rise; fall D) rise; rise Answer: A Diff: 2 Topic: Section: 8.4 Question Status: Previous Edition 24) In the short run (before the price level adjusts to restore general equilibrium), a decrease in inventory investment by business firms would cause output to ________ and the price level to ________.

A) rise; rise B) rise; stay constant C) fall; stay constant D) fall; rise Answer: C Diff: 2 Topic: Section: 8.4 Question Status: New

31 .

25) In the long run, an increase in consumer spending would cause output to ________ and the aggregate price level to ________.

A) stay constant; rise B) stay constant; stay constant C) rise; stay constant D) rise; rise Answer: A Diff: 2 Topic: Section: 8.4 Question Status: New 26) In the long run, a decrease in inventory investment by firms would cause output to ________ and the aggregate price level to ________.

A) stay constant; fall B) stay constant; stay constant C) rise; fall D) fall; fall Answer: A Diff: 2 Topic: Section: 8.4 Question Status: New 27) The key difference between classical and Keynesian macroeconomists is their differing beliefs about A) the slope of the aggregate demand curve.

B) the speed at which prices adjust.

C) the natural rate of unemployment.

D) the full-employment level of output.

Answer: B Diff: 1 Topic: Section: 8.4 Question Status: Previous Edition 28) Suppose labor supply declined. Would this affect the aggregate demand curve or the aggregate supply curve? What would be the effect on output and the price level?

Answer: The decline in the labor supply shifts the long-run aggregate supply curve to the left, causing the price level to increase and output to decline.

Diff: 2 Topic: Section: 8.4 Question Status: Previous Edition

32 .

29) Suppose the economy is initially in long-run equilibrium. For each of the shocks listed below, explain the short-run effects on output and the price level. (a) A stock market crash reduces consumers' wealth. (b) Businesses decide to hold larger inventories. (c) The government cuts defense spending. (d) Foreign countries buy more U.S. goods.

Answer: (a) Output declines and the price level is unchanged. (b) Output rises and the price level is unchanged. (c) Output declines and the price level is unchanged. (d) Output rises and the price level is unchanged.

Diff: 2 Topic: Section: 8.4 Question Status: Previous Edition 30) Suppose the economy is initially in long-run equilibrium. For each of the shocks listed below, explain the long-run effects on output and the price level. (a) Labor supply decreases. (b) The government shuts down the Bureau of Economic Analysis. (c) Productivity increases.

Answer: (a) Output declines and the price level rises. (b) Output is unchanged and the price level falls. (c) Output rises and the price level falls.

Diff: 2 Topic: Section: 8.4 Question Status: Previous Edition 31) For each outcome below, tell what type of shift must have taken place in either the aggregate demand curve or the long-run aggregate supply curve. (a) In the short run, the price level is unchanged and output rises. (b) In the long run, the price level declines and output is unchanged. (c) In the long run, the price level rises and output declines.

Answer: (a) The aggregate demand curve shifts to the right. (b) The aggregate demand curve shifts to the left. (c) The long-run aggregate supply curve shifts to the left.

Diff: 2 Topic: Section: 8.4 Question Status: Previous Edition

33 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 9 The IS-LM/AD-AS Model 9.1

The FE Line

1) The FE line shows the relationship between the real interest rate and output for which the ________ market is in equilibrium.

A) goods B) asset C) labor D) money Answer: C Diff: 1 Topic: Section: 9.1 Question Status: Revised 2) A graph of the relationship between the real interest rate and output for which the labor market is in equilibrium is known as the A) IS curve B) LM curve C) FE line D) AD curve Answer: C Diff: 1 Topic: Section: 9.1 Question Status: New 3) The FE line A) is horizontal.

B) is vertical.

C) slopes downward.

D) slopes upward.

Answer: B Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition 4) Which of the following curves in the IS-LM model is vertical?

A) The IS curve B) The LM curve C) The FE line D) The AD curve Answer: C Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition 1 .

5) The FE line is vertical because the level of output at full employment doesn't depend on the A) real wage rate.

B) level of employment.

C) marginal product of labor.

D) real interest rate.

Answer: D Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition 6) Which of the following would shift the FE line to the right?

A) An adverse supply shock B) An increase in labor supply C) A decrease in the capital stock D) An increase in the future marginal productivity of capital Answer: B Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition 7) Which of the following would shift the FE line to the right?

A) An adverse supply shock B) A decrease in labor supply C) An increase in the capital stock D) An increase in the future marginal productivity of capital Answer: C Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition 8) Which of the following would shift the FE line to the left?

A) A beneficial supply shock B) An increase in labor supply C) A decrease in the capital stock D) A decrease in the future marginal productivity of capital Answer: C Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition

2 .

9) Which of the following would shift the FE line to the left?

A) A beneficial supply shock B) A decrease in labor supply C) An increase in consumer spending D) An increase in the money supply Answer: B Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition 10) An increase in the money supply would cause the FE line to A) shift to the right.

B) shift to the left.

C) remain unchanged.

D) remain unchanged if Ricardian equivalence holds; otherwise, shift to the right.

Answer: C Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition 11) An increase in investment spending would cause the FE line to A) shift to the right.

B) shift to the left.

C) remain unchanged.

D) remain unchanged if Ricardian equivalence holds; otherwise, shift to the right.

Answer: C Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition 12) An adverse supply shock would cause the FE line to A) shift to the right.

B) shift to the left.

C) remain unchanged.

D) remain unchanged if the shock is temporary; shift to the right if the shock is permanent.

Answer: B Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition

3 .

13) A beneficial supply shock would cause the FE line to A) shift to the right.

B) shift to the left.

C) remain unchanged.

D) remain unchanged if the shock is temporary; shift to the right if the shock is permanent.

Answer: A Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition 14) Identify changes in three variables that would cause the FE line to shift to the right.

Answer: An increase in productivity, an increase in the supply of capital, or an increase in the supply of labor would increase the full-employment level of output, as illustrated by a rightward shift in the FE line.

Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition 15) Describe what happens to the FE line if government purchases increase.

Answer: In the classical model of the labor market, the rise in government purchases reduces people's perceived wealth, so they increase their labor supply. The increase in labor supply results in a new labor market equilibrium with increased employment and a lower real wage. The higher level of employment shifts the FE line to the right.

Diff: 1 Topic: Section: 9.1 Question Status: Previous Edition 9.2

The IS Curve

1) The IS curve shows the combinations of output and the real interest rate for which A) the goods market is in equilibrium.

B) the labor market is in equilibrium.

C) the financial asset market is in equilibrium.

D) an increase in output will cause the market-clearing interest rate to be bid up.

Answer: A Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition

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2) A graph of the relationship between the real interest rate and output for which the goods market is in equilibrium is known as the A) IS curve B) LM curve C) FE line D) AD curve Answer: A Diff: 1 Topic: Section: 9.2 Question Status: New 3) The IS curve A) is horizontal.

B) is vertical.

C) slopes downward.

D) slopes upward.

Answer: C Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition 4) Which of the following curves in the IS-LM model is downward-sloping?

A) The IS curve B) The LM curve C) The FE line D) The AS curve Answer: A Diff: 1 Topic: Section: 9.2 Question Status: New 5) Any change that reduces desired saving relative to desired investment (for a given level of output) causes the real interest rate to ________ and shifts the IS curve ________.

A) increase; down and to the left B) increase; up and to the right C) decrease; down and to the left D) decrease; up and to the right Answer: B Diff: 2 Topic: Section: 9.2 Question Status: Previous Edition

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6) At a given output level, a temporary reduction in government purchases will A) increase desired saving, causing the IS curve to shift down and to the left.

B) increase desired saving, causing the IS curve to shift up and to the right.

C) decrease desired saving, causing the IS curve to shift down and to the left.

D) decrease desired saving, causing the IS curve to shift up and to the right.

Answer: A Diff: 2 Topic: Section: 9.2 Question Status: Previous Edition 7) A decline in expected future output would cause the IS curve to A) shift up and to the right.

B) shift down and to the left.

C) remain unchanged.

D) shift up and to the right only if people face borrowing constraints.

Answer: B Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition 8) A decrease in the effective tax rate on capital would cause the IS curve to A) shift up and to the right.

B) shift down and to the left.

C) remain unchanged.

D) remain unchanged if taxes are fully deductible from income; otherwise, shift up and to the right.

Answer: A Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition 9) An increase in the effective tax rate on capital would cause the IS curve to A) shift up and to the right.

B) shift down and to the left.

C) remain unchanged.

D) remain unchanged if taxes are fully deductible from income; otherwise, shift up and to the right.

Answer: B Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition

6 .

10) An increase in labor supply would cause the IS curve to A) shift up and to the right.

B) shift down and to the left.

C) remain unchanged.

D) shift up and to the right only if people face borrowing constraints.

Answer: C Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition 11) An increase in the money supply would cause the IS curve to A) shift up and to the right.

B) shift down and to the left.

C) remain unchanged.

D) shift up and to the right only if people face borrowing constraints.

Answer: C Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition 12) A temporary decline in productivity would cause the IS curve to A) shift up and to the right.

B) shift down and to the left.

C) remain unchanged.

D) shift up and to the right only if people face borrowing constraints.

Answer: C Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition 13) A decrease in wealth would cause the IS curve to A) shift up and to the right.

B) shift down and to the left.

C) remain unchanged.

D) shift up and to the right only if people face borrowing constraints.

Answer: B Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition

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14) An increase in wealth would cause the IS curve to A) shift up and to the right.

B) shift down and to the left.

C) remain unchanged.

D) shift up and to the right only if people face borrowing constraints.

Answer: A Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition 15) An increase in the expected future marginal product of capital would cause the IS curve to A) shift up and to the right.

B) shift down and to the left.

C) remain unchanged.

D) remain unchanged if firms face borrowing constraints; otherwise, shift down and to the left.

Answer: A Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition 16) The IS curve will shift down and to the left when A) desired saving declines.

B) government purchases increase.

C) consumption increases.

D) the expected future marginal product of capital declines.

Answer: D Diff: 1 Topic: Section: 9.2 Question Status: Previous Edition 17) The IS curve would unambiguously shift up and to the right if there were A) an increase in both government purchases and corporate taxes.

B) an increase in both government purchases and the expected future marginal product of capital.

C) an increase in the expected future marginal product of capital and a decrease in expected future output.

D) a decrease in both corporate taxes and the expected future marginal product of capital.

Answer: B Diff: 2 Topic: Section: 9.2 Question Status: Previous Edition

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18) Draw a saving-investment diagram to show how each of the following changes shifts the IS curve. (a) Future income rises. (b) The future marginal productivity of capital increases. (c) Government purchases decrease temporarily. (d) The effective corporate tax rate increases.

Answer: (a) IS shifts up and to the right. (b) IS shifts up and to the right. (c) IS shifts down and to the left. (d) IS shifts down and to the left.

Diff: 2 Topic: Section: 9.2 Question Status: Previous Edition 9.3

The LM Curve

1) A rise in the price of a bond causes the yield of the bond to A) rise.

B) fall.

C) remain unchanged.

D) rise if it's a short-term bond, fall if it's a long-term bond.

Answer: B Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition 2) A decline in the price of a bond causes the yield of the bond to A) rise.

B) fall.

C) remain unchanged.

D) rise if it's a short-term bond, fall if it's a long-term bond.

Answer: A Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition 3) A rise in the price of a bond causes the yield of the bond to A) rise.

B) fall.

C) remain unchanged.

D) rise if it's a short-term bond, fall if it's a long-term bond.

Answer: B Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition 9 .

4) A graph of the relationship between the real interest rate and output for which the asset market is in equilibrium is known as the A) IS curve B) LM curve C) FE line D) AD curve Answer: B Diff: 1 Topic: Section: 9.3 Question Status: New 5) The LM curve shows the relationship between the real interest rate and output for which the ________ market is in equilibrium.

A) goods B) asset C) labor D) money Answer: B Diff: 1 Topic: Section: 9.3 Question Status: New 6) The LM curve A) is horizontal.

B) is vertical.

C) slopes downward.

D) slopes upward.

Answer: D Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition 7) Which of the following curves in the IS-LM model is upward-sloping?

A) The IS curve B) The LM curve C) The FE line D) The AD curve Answer: B Diff: 1 Topic: Section: 9.3 Question Status: New

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8) Looking only at the asset market, an increase in output would cause A) the LM curve to shift down and to the right.

B) the LM curve to shift up and to the left.

C) an increase in the real interest rate along the LM curve.

D) a decrease in the real interest rate along the LM curve.

Answer: C Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition 9) The LM curve illustrates that when income increases, the A) price level must increase to clear the asset market.

B) real interest rate on nonmonetary assets must increase to clear the asset market.

C) price level must increase to clear the goods market.

D) real interest rate on nonmonetary assets must increase to clear the goods market.

Answer: B Diff: 2 Topic: Section: 9.3 Question Status: Previous Edition 10) A change that increases the real money supply relative to real money demand causes A) the LM curve to shift down and to the right.

B) the LM curve to shift up and to the left.

C) the IS curve to shift down and to the left.

D) the IS curve to shift up and to the right.

Answer: A Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition 11) A change that increases real money demand relative to the real money supply causes A) the LM curve to shift down and to the right.

B) the LM curve to shift up and to the left.

C) the IS curve to shift down and to the left.

D) the IS curve to shift up and to the right.

Answer: B Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition

11 .

12) Banks decide to raise the interest rate they pay on checking accounts from 1% to 2%. This action would A) increase money demand, shifting the LM curve up and to the left.

B) increase money demand, shifting the LM curve down and to the right.

C) decrease money demand, shifting the LM curve up and to the left.

D) decrease money demand, shifting the LM curve down and to the right.

Answer: A Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition 13) You have just read that the Federal Reserve has increased the money supply to avoid a recession. For a given price level, you would expect the LM curve to A) shift up and to the left as the real money supply falls.

B) shift up and to the left as the real money supply rises.

C) shift down and to the right as the real money supply falls.

D) shift down and to the right as the real money supply rises.

Answer: D Diff: 2 Topic: Section: 9.3 Question Status: Previous Edition 14) The Fed has announced that it plans to lower the rate of monetary growth from 10% per year to 2% per year. You would expect this announcement to directly A) increase money demand, shifting the LM curve up and to the left.

B) increase money demand, shifting the LM curve down and to the right.

C) decrease money demand, shifting the LM curve up and to the left.

D) decrease money demand, shifting the LM curve down and to the right.

Answer: A Diff: 2 Topic: Section: 9.3 Question Status: Previous Edition 15) People have reduced their expectations of inflation from 5% to 3%, directly causing A) an increase in money demand, shifting the LM curve up and to the left.

B) an increase in money demand, shifting the LM curve down and to the right.

C) a decrease in money demand, shifting the LM curve up and to the left.

D) a decrease in money demand, shifting the LM curve down and to the right.

Answer: A Diff: 2 Topic: Section: 9.3 Question Status: Previous Edition

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16) The likely effect of introducing an increased number of automatic teller machines is to A) increase money demand, shifting the LM curve up and to the left.

B) increase money demand, shifting the LM curve down and to the right.

C) decrease money demand, shifting the LM curve up and to the left.

D) decrease money demand, shifting the LM curve down and to the right.

Answer: D Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition 17) A financial innovation, such as the introduction of money market mutual funds, which increases the liquidity of alternatives to money, would A) increase money demand, shifting the LM curve up and to the left.

B) increase money demand, shifting the LM curve down and to the right.

C) decrease money demand, shifting the LM curve up and to the left.

D) decrease money demand, shifting the LM curve down and to the right.

Answer: D Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition 18) Looking at the macroeconomic statistics for Friedmanland, you discover that at the beginning of the year, the national money supply was equal to $400 million and by the end of the year it was equal to $420 million. You also found out that the inflation rate in Friedmanland was 7%. In this case, you would expect the LM curve to A) shift up and to the left as the real money supply falls.

B) shift up and to the left as the real money supply rises.

C) shift down and to the right as the real money supply falls.

D) shift down and to the right as the real money supply rises.

Answer: A Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition 19) If the money supply is increased, which curve shifts in the IS-LM model? What direction does it shift? What is the intuition behind this shift?

Answer: An increase in the money supply shifts the LM curve down and to the right. Because the nominal money supply has risen, real money supply is higher. To get an increase in real money demand to restore equilibrium in the asset market, either income must rise or the real interest rate must fall, which can be seen as a shift of the LM curve down and to the right.

Diff: 1 Topic: Section: 9.3 Question Status: Previous Edition

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20) Calculate the real money supply growth rate when the nominal money supply increases by 10% and the price level increases by each of the following percentages: a) 2%; b) 8%; c) 10%; d) 15%.

Answer: Real money supply growth rate = nominal money supply growth rate minus the price level growth rate. (The price level growth rate is the inflation rate.) (a) Real money supply growth rate = 10% - 2% = 8%. (b) Real money supply growth rate = 10% - 8% = 2%. (c) Real money supply growth rate = 10% - 10% = 0%. (d) Real money supply growth rate = 10% - 15% = -5%.

Diff: 2 Topic: Section: 9.3 Question Status: Previous Edition 9.4

General Equilibrium

1) An increase in wealth that doesn't affect labor supply would cause the IS curve to ________ and the FE line to ________.

A) shift down and to the left; be unchanged B) shift down and to the left; shift left C) shift up and to the right; be unchanged D) shift up and to the right; shift left Answer: C Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition 2) An increase in the effective tax rate on capital would cause the IS curve to ________ and the LM curve to ________.

A) shift down and to the left; be unchanged B) shift down and to the left; shift up and to the left C) shift up and to the right; be unchanged D) shift up and to the right; shift up and to the left Answer: A Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition 3) A decrease in the money supply would cause the IS curve to ________ and the LM curve to ________.

A) shift down and to the left; be unchanged B) shift down and to the left; shift up and to the left C) be unchanged; shift up and to the left D) be unchanged; shift down and to the right Answer: C Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition 14 .

4) When all markets in the economy are simultaneously in equilibrium, we say A) markets are complete.

B) markets are perfect.

C) there is disequilibrium.

D) there is general equilibrium.

Answer: D Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition 5) To reach general equilibrium, the price level adjusts to shift the ________ until it intersects with the ________.

A) IS curve; FE line and LM curve B) FE line; LM and IS curves C) LM curve; FE line and IS curve D) ND curve; FE line and NS curve Answer: C Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition 6) What adjusts to restore general equilibrium after a shock to the economy?

A) The LM curve B) The IS curve C) The FE line D) The labor supply curve Answer: A Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition 7) The IS-LM model predicts that a temporary beneficial supply shock A) increases output, national saving, and investment, but not the real interest rate.

B) increases output, national saving, and the real interest rate, but not investment.

C) increases the real interest rate, investment, and output, but not national saving.

D) increases output, national saving, investment, and the real interest rate.

Answer: A Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition

15 .

8) A temporary supply shock, such as a bumper crop, would A) shift the FE line to the right and leave the IS curve unchanged.

B) shift the FE line to the left and shift the IS curve up and to the right.

C) shift the FE line to the left and leave the IS curve unchanged.

D) have no effect on the FE line.

Answer: A Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition 9) A temporary supply shock, such as an increase in oil prices, would A) shift the IS curve down and to the left and leave the FE line unchanged.

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

C) shift the IS curve up and to the right, but leave the FE line unchanged.

D) have no effect on the IS curve.

Answer: D Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition 10) You have just read that Australia has suffered a drought, destroying its wheat crop for this year. The effect of this adverse supply shock on Australia would probably be A) an increase in prices and an increase in real interest rates.

B) an increase in prices, an increase in nominal interest rates, but a decrease in real interest rates.

C) a decrease in prices and a decrease in real interest rates.

D) a decrease in prices, a decrease in nominal interest rates, but an increase in real interest rates.

Answer: A Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition 11) A temporary adverse supply shock directly causes A) a shift down and to the left of the IS curve.

B) a shift to the left of the FE line.

C) a shift down and to the right of the LM curve.

D) a shift up and to the right of the IS curve.

Answer: B Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition

16 .

12) After a temporary beneficial supply shock hits the economy, general equilibrium is restored by A) a shift down and to the left of the IS curve.

B) a shift to the left of the FE line.

C) a shift up and to the left of the LM curve.

D) a shift down and to the right of the LM curve.

Answer: D Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition 13) An adverse supply shock that is permanent shifts which curve in addition to the curves shifted by one that is temporary?

A) The LM curve B) The IS curve C) The FE line D) The labor demand curve Answer: B Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition 14) Which market adjusts the quickest in response to shocks to the economy?

A) The asset market B) The labor market C) The goods market D) The asset, labor, and goods markets adjust at about the same speed to eliminate a disequilibrium in the macroeconomy.

Answer: A Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition 15) A temporary decrease in government purchases causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: D Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition

17 .

16) An increase in expected inflation causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: C Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition 17) An increase in money supply causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: C Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition 18) Suppose the intersection of the IS and LM curves is to the left of the FE line. A decrease in the price level would most likely eliminate a disequilibrium among the asset, labor, and goods markets by A) shifting the LM curve down and to the right.

B) shifting the IS curve up and to the right.

C) shifting the IS curve down and to the left.

D) shifting the FE curve to the left.

Answer: A Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition 19) Suppose the intersection of the IS and LM curves is to the left of the FE line. What would most likely eliminate a disequilibrium among the asset, labor, and goods markets?

A) A rise in the price level, shifting the LM curve up and to the left B) A fall in the price level, shifting the LM curve down and to the right C) A rise in the price level, shifting the IS curve up and to the right D) A fall in the price level, shifting the IS curve down and to the left Answer: B Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition

18 .

20) Suppose the intersection of the IS and LM curves is to the right of the FE line. What would most likely eliminate a disequilibrium among the asset, labor, and goods markets?

A) A rise in the price level, shifting the LM curve up and to the left B) A fall in the price level, shifting the LM curve down and to the right C) A rise in the price level, shifting the IS curve up and to the right D) A fall in the price level, shifting the IS curve down and to the left Answer: A Diff: 1 Topic: Section: 9.4 Question Status: Previous Edition 21) A temporary decrease in government purchases causes the real interest rate to ________ and the price level to ________ in general equilibrium.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: D Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition 22) An increase in taxes (when Ricardian equivalence doesn't hold) causes the real interest rate to ________ and the price level to ________ in general equilibrium.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: D Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition 23) Desired consumption is Cd = 2000 + 0.9Y - 100,000r - G, and desired investment is Id = 1000 - 45,000r. Real money demand is Md/P = Y - 6000i. Other variables are πe = 0.03, G = 500, = 1000, and M = 2100.

The equilibrium value of the real interest rate is A) 0.01 B) 0.02 C) 0.03 D) 0.04 Answer: B Diff: 2 Topic: Section: 9.4 Question Status: New

19 .

24) Desired consumption is Cd = 2000 + 0.9Y - 100,000r - G, and desired investment is Id = 1000 - 45,000r. Real money demand is Md/P = Y - 6000i. Other variables are πe = 0.03, G = 500, = 1000, and M = 2100.

The equilibrium value of consumption is A) 100 B) 200 C) 300 D) 400 Answer: D Diff: 2 Topic: Section: 9.4 Question Status: New 25) Desired consumption is Cd = 2000 + 0.9Y - 100,000r - G, and desired investment is Id = 1000 - 45,000r. Real money demand is Md/P = Y - 6000i. Other variables are πe = 0.03, G = 500, = 1000, and M = 2100.

The equilibrium value of investment is A) 0 B) 100 C) 200 D) 300 Answer: B Diff: 2 Topic: Section: 9.4 Question Status: New 26) Desired consumption is Cd = 2000 + 0.9Y - 100,000r - G, and desired investment is Id = 1000 - 45,000r. Real money demand is Md/P = Y - 6000i. Other variables are πe = 0.03, G = 500, = 1000, and M = 2100.

The equilibrium value of the nominal interest rate is A) 0.00 B) 0.05 C) 0.10 D) 0.15 Answer: B Diff: 2 Topic: Section: 9.4 Question Status: New

20 .

27) Desired consumption is Cd = 2000 + 0.9Y - 100,000r - G, and desired investment is Id = 1000 - 45,000r. Real money demand is Md/P = Y - 6000i. Other variables are πe = 0.03, G = 500, = 1000, and M = 2100.

The equilibrium value of the price level is A) 1 B) 2 C) 3 D) 4 Answer: C Diff: 2 Topic: Section: 9.4 Question Status: New 28) For each of the following changes, which equilibrium curve (IS, LM, or FE) is shifted? Draw the change in the underlying demand or supply curves (for example, money demand and supply for the LM curve) and show how the equilibrium curve changes. (a) Expected inflation increases. (b) The future marginal productivity of capital increases. (c) Labor supply decreases. (d) Future income declines. (e) There's a temporary beneficial supply shock. (f) The nominal interest rate on money rises.

Answer: (a) LM shifts down and to the right. (b) IS shifts up and to the right. (c) FE shifts left. (d) IS shifts down and to the left. (e) FE shifts right. (f) LM shifts up and to the left.

Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition 29) Oil prices have risen temporarily, due to political uncertainty in the Middle East. An advisor to the Fed suggests, "Higher oil prices reduce aggregate demand. To offset this we must increase the money supply. Then the price level won't need to adjust to restore equilibrium, and we'll prevent a recession." Analyze this statement using the IS-LM model.

Answer: This is a change in the FE line, not aggregate demand, so the policy is incorrect.

Instead, to keep the price level fixed, money supply should decrease, so output falls and the real interest rate rises.

Diff: 3 Topic: Section: 9.4 Question Status: Previous Edition

21 .

30) For each of the following changes, what happens to the real interest rate and output in the very short run, before the price level has adjusted to restore general equilibrium? (a) Wealth rises. (b) Money supply rises. (c) The future marginal productivity of capital increases. (d) Expected inflation declines. (e) Future income declines.

Answer: (a) The IS curve shifts up and to the right, so r rises and Y rises. (b) The LM curve shifts down and to the right, so r falls and Y rises. (c) The IS curve shifts up and to the right, so r rises and Y rises. (d) The LM curve shifts up and to the left, so r rises and Y falls. (e) The IS curve shifts down and to the left, so r falls and Y falls.

Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition 31) Desired consumption is Cd = 2000 + 0.9Y - 100,000r - G, and desired investment is Id = 1000 - 45,000r. Real money demand is Md/P = Y - 6000i. Other variables are πe = 0.03, G = 500, = 1000, and M = 2100. (a) Find the equilibrium values of the real interest rate, consumption, investment, and the price level. (b) Suppose government purchases decline to 400. What happens to the variables listed in part (a)? (c) Suppose government purchases rise to 600. What happens to the variables listed in part (a)? (d) What feature in this example leads to the result that you don't need to know the amount of taxes collected by the government to find the equilibrium?

Answer: (a) r = 0.02, C = 400, I = 100, P = 3. (b) C = 500, other variables are unchanged. (c) C = 300, other variables are unchanged. (d) Desired consumption depends on the level of government purchases, not taxes. This is an example of a classical view in which people realize that government purchases must be paid for by taxes today or in the future, so it's the level of government purchases that affects consumption decisions, not the level of taxes.

Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition

22 .

32) Desired consumption is Cd = 100 + 0.8Y - 500r - 0.5G, and desired investment is Id = 100 500r. Real money demand is Md/P = Y - 2000i. Other variables are πe = 0.05, G = 200, = 1000, and M = 2100. (a) Find the equilibrium values of the real interest rate, consumption, investment, and the price level. (b) Suppose the money supply increases to 2800. Find the equilibrium values of the real interest rate, consumption, investment, and the price level. (Assume that the expected inflation rate is unchanged.)

Answer: (a) Use the equation Y = Cd + Id + G = 300 + 0.8Y - 1000r, so 0.2 Y = 300 - 1000r, so Y = 1500 5000r. This is the IS curve. Because full-employment output equals 1000, then 1000 = 1500 5000r, so r = 500/5000 = 0.10. Plug this into the consumption and investment functions to get C = 750 and I = 50.

To find the price level, use the equation M/P = L and plug the values in to get 2100/P = 1000 2000(0.1 + 0.05) = 700, so P = 3. (b) The increase in the money supply to 2800 does not change anything except the price level.

The new equation is 2800/P = 700, so P = 4.

Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition 33) Analyze the following statement, and show what would happen in the long run if such advice were followed by the Fed: "The increase in the stock market has increased people's wealth. As a result, their consumption has increased, increasing aggregate demand and output. So the Fed needs to increase the money supply, since with higher income, people's demand for real money balances will be higher."

Answer: Assuming resources are fully utilized, there will be no increase in output. Higher wealth will reduce saving, shifting the IS curve up and to the right. Increasing the money supply shifts the LM curve down and to the right. But general equilibrium will require the LM curve to shift up and to the left. So the price level must rise, and it rises even more because of the monetary policy suggested by the statement. The correct monetary policy for preventing inflation is to reduce, not increase, the money supply.

Diff: 3 Topic: Section: 9.4 Question Status: Previous Edition

23 .

34) Use the IS-LM model to determine the effects of each of the following on the general equilibrium values of the real wage, employment, output, the real interest rate, consumption, investment, and the price level. (a) Tougher immigration laws reduce the working-age population. (b) There's increased volatility in the prices of stocks and bonds. (c) The government tries to achieve tax equity by an increase in the corporate tax rate. (d) Increased computerization reduces stock market brokerage costs.

Answer: (a) The decline in labor supply increases the real wage and reduces employment and output, shifting the FE line to the left. The LM curve shifts up and to the left as the price level rises to restore equilibrium. As a result, the real interest rate rises, reducing consumption and investment. (b) Real money demand rises, which shifts the LM curve up and to the left. To restore equilibrium, the price level must decline, shifting the LM curve down and to the right. There's no effect on any other variable. (c) The higher tax rate reduces investment, shifting the IS curve down and to the left. To restore equilibrium, the LM curve shifts down and to the right as the price level falls. As a result, the real interest rate declines, so consumption increases. There's no change in the real wage, employment, or output. (d) Increased liquidity on nonmoney assets reduces money demand, shifting the LM curve down and to the right. The price level rises, to restore equilibrium by shifting the LM curve back up and to the left. There's no effect on the other variables.

Diff: 2 Topic: Section: 9.4 Question Status: Previous Edition 35) Suppose the Federal Reserve's short-run response to any change in the economy is to change the money supply to maintain the existing real interest rate. What would happen to money supply if there were a reduction in government purchases? Given the Fed's policy, what would happen in the very short run (before general equilibrium is restored) to output and the real interest rate?

What must happen to the LM curve and the price level to restore general equilibrium?

Answer: The decrease in G shifts the IS curve down and to the left. The Fed's policy decreases the money supply and shifts the LM curve up and to the left, so the real interest rate doesn't change. But output declines in the very short run. To restore general equilibrium, the price level must decline to shift the LM curve down and to the right. If the Fed wanted to keep the price level from changing so much, its correct policy would have been to increase the money supply, not decrease it.

Diff: 3 Topic: Section: 9.4 Question Status: Previous Edition

24 .

36) Suppose you were a forecaster of the real wage rate, employment, output, the real interest rate, consumption, investment, and the price level. A shock hits the economy, which you think is a temporary adverse supply shock. (a) What are your forecasts for each of the variables listed above (rise, fall, and no change)? (b) What if the shock was really due to people's reduced expectations about their future income.

Which variables did you forecast correctly, and which did you forecast incorrectly?

Answer: (a) The real wage rate, employment, output, consumption, and investment decline, while the real interest rate and the price level rise. (b) The IS curve shifts down and to the left, instead of the FE line shifting left, so you are wrong about every variable except consumption. The real wage, employment, and output won't change, the real interest rate and the price level will decline, and investment will rise.

Diff: 3 Topic: Section: 9.4 Question Status: Previous Edition 9.5

Price Adjustment and the Attainment of General Equilibrium

1) A decrease in money supply causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: B Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition 2) An increase in money supply causes the real interest rate to ________ and the price level to ________ in general equilibrium.

A) rise; rise B) remain unchanged; fall C) remain unchanged; rise D) fall; fall Answer: C Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition

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3) A decrease in money supply causes the real interest rate to ________ and the price level to ________ in general equilibrium.

A) rise; rise B) remain unchanged; fall C) remain unchanged; rise D) fall; fall Answer: B Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition 4) After a temporary adverse supply shock hits the economy, general equilibrium is restored by A) a shift down and to the left of the IS curve.

B) a shift to the left of the FE line.

C) a shift up and to the left of the LM curve.

D) a shift down and to the right of the IS curve.

Answer: C Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition 5) The IS-LM model predicts that, in general equilibrium, a temporary adverse supply shock A) reduces output, national saving, and investment, but not the real interest rate.

B) reduces output, national saving, and the real interest rate, but not investment.

C) reduces the real interest rate, investment, and output, but not national saving.

D) reduces output, national saving, investment, and the real interest rate.

Answer: A Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition 6) Suppose the intersection of the IS and LM curves is to the right of the FE line. An increase in the price level would most likely eliminate a disequilibrium among the asset, labor, and goods markets by A) shifting the LM curve up and to the left.

B) shifting the IS curve up and to the right.

C) shifting the IS curve down and to the left.

D) shifting the FE curve to the left.

Answer: A Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition

26 .

7) A decrease in the money supply, in the short run (before the price level has adjusted to restore general equilibrium), causes output to ________ and the real interest rate to ________.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: C Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition 8) When the money supply declines by 10%, in the short run (before the price level adjusts to restore general equilibrium), output ________ and the price level ________.

A) is unchanged; is unchanged B) falls; falls C) is unchanged; falls D) falls; is unchanged Answer: D Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition 9) A decrease in taxes (when Ricardian equivalence does not hold) causes the real interest rate to ________ and the price level to ________ in general equilibrium.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: A Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition 10) An increase in the effective tax rate on capital causes the real interest rate to ________ and the price level to ________ in general equilibrium.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: D Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition

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11) An increase in the money supply, in general equilibrium, causes output to ________ and the real interest rate to ________.

A) rise; fall B) rise; not change C) not change; not change D) not change; fall Answer: C Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition 12) In classical IS-LM analysis, the effects of a decline in desired investment include A) a decline in output.

B) an increase in the price level.

C) a decline in the real interest rate.

D) an increase in unemployment.

Answer: C Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition 13) Classical economists think general equilibrium is attained relatively quickly because A) the real interest rate adjusts quickly.

B) the level of output adjusts quickly.

C) the real wage rate adjusts quickly.

D) the price level adjusts quickly.

Answer: D Diff: 1 Topic: Section: 9.5 Question Status: Previous Edition 14) Keynesian economists think general equilibrium is not attained quickly because A) the real interest rate adjusts slowly.

B) the level of output adjusts slowly.

C) the real wage rate adjusts slowly.

D) the price level adjusts slowly.

Answer: D Diff: 1 Topic: Section: 9.5 Question Status: Previous Edition

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15) Classical economists believe that a market economy will normally A) suffer from extended periods of sustained unemployment.

B) achieve full-employment output.

C) degenerate into pure monopolies in most industries.

D) eliminate the problem of economic scarcity.

Answer: B Diff: 1 Topic: Section: 9.5 Question Status: Previous Edition 16) Keynesian economists believe that in the short run, A) money neutrality exists and prices adjust rapidly.

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

C) money neutrality exists and prices do not adjust rapidly.

D) money neutrality does not exist and prices do not adjust rapidly.

Answer: D Diff: 1 Topic: Section: 9.5 Question Status: Previous Edition 17) Classical economists believe that in the short run, A) money neutrality exists and prices adjust rapidly.

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

C) money neutrality exists and prices do not adjust rapidly.

D) money neutrality does not exist and prices do not adjust rapidly.

Answer: A Diff: 1 Topic: Section: 9.5 Question Status: Previous Edition 18) Under monetary neutrality, an increase in the money supply causes output to ________ and the price level to ________.

A) rise; rise B) rise; not change C) not change; not change D) not change; rise Answer: D Diff: 1 Topic: Section: 9.5 Question Status: Previous Edition

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19) Under an assumption of monetary neutrality, a change in the nominal money supply has A) no effect on the price level.

B) a less than proportionate effect on the price level.

C) a proportionate effect on the price level.

D) a more than proportionate effect on the price level.

Answer: C Diff: 1 Topic: Section: 9.5 Question Status: Previous Edition 20) The theory of monetary neutrality suggests that A) a change in the nominal money supply has no effect on real variables.

B) changes in the real money supply will not affect the real interest rate.

C) money is not an asset.

D) a decline in nominal money supply growth could create a recession.

Answer: A Diff: 2 Topic: Section: 9.5 Question Status: Previous Edition 21) Describe the differences between classical and Keynesian economists in terms of their views about monetary neutrality.

Answer: Keynesians believe that monetary neutrality holds in the long run but not in the short run. Classical economists are more accepting of the view that money is neutral even in the relatively short run.

Diff: 1 Topic: Section: 9.5 Question Status: Previous Edition 22) For each of the following changes, what happens to the real interest rate and output in the very short run, before the price level has adjusted to restore general equilibrium? (a) Wealth declines. (b) Money supply declines. (c) The future marginal productivity of capital declines. (d) Expected inflation rises. (e) Future income rises.

Answer: (a) The IS curve shifts down and to the left, so r falls and Y falls. (b) The LM curve shifts up and to the left, so r rises and Y falls. (c) The IS curve shifts down and to the left, so r falls and Y falls. (d) The LM curve shifts down and to the right, so r falls and Y rises. (e) The IS curve shifts up and to the right, so r rises and Y rises.

Diff: 3 Topic: Section: 9.5 Question Status: Previous Edition

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9.6

Aggregate Demand and Aggregate Supply

1) The aggregate demand curve shows A) the demand for goods depending on the relative price of goods compared to financial assets.

B) the amount of output that can be obtained given the current production function in the economy.

C) the relation between the aggregate quantity of goods demanded and the price level.

D) the relation between the real interest rate and output when the goods market clears.

Answer: C Diff: 1 Topic: Section: 9.6 Question Status: Previous Edition 2) The aggregate demand curve shows the combinations of output and the price level that put the economy on A) the FE line and the IS curve.

B) the FE line, the IS curve, and the LM curve.

C) the IS curve.

D) the IS curve and the LM curve.

Answer: D Diff: 1 Topic: Section: 9.6 Question Status: Previous Edition 3) The aggregate demand curve A) is vertical.

B) slopes upward.

C) is horizontal.

D) slopes downward.

Answer: D Diff: 1 Topic: Section: 9.6 Question Status: Previous Edition 4) Which of the following changes shifts the AD curve down and to the left?

A) A temporary increase in government purchases B) A rise in the nominal money supply C) A decrease in corporate taxes D) A decrease in consumer confidence Answer: D Diff: 2 Topic: Section: 9.6 Question Status: Previous Edition

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5) Which of the following changes shifts the AD curve down and to the left?

A) A decline in the nominal money supply B) A decrease in income taxes C) A decrease in the risk on nonmonetary assets D) An increase in the future marginal productivity of capital Answer: A Diff: 2 Topic: Section: 9.6 Question Status: Previous Edition 6) Which of the following changes shifts the AD curve up and to the right?

A) A rise in the nominal money supply B) An increase in income taxes C) An increase in the risk on nonmonetary assets D) A decrease in the future marginal productivity of capital Answer: A Diff: 2 Topic: Section: 9.6 Question Status: Previous Edition 7) Which of the following changes shifts the AD curve up and to the right?

A) A temporary decrease in government purchases B) A decline in the nominal money supply C) An increase in corporate taxes D) An increase in consumer confidence Answer: D Diff: 2 Topic: Section: 9.6 Question Status: Previous Edition 8) The aggregate supply curve shows the relation between A) the real interest rate and the aggregate amount of output that firms supply.

B) the price level and the aggregate amount of output that firms supply.

C) the supply of goods by firms and the price of goods relative to the price of nonmonetary assets.

D) the inflation rate and the unemployment rate.

Answer: B Diff: 1 Topic: Section: 9.6 Question Status: Previous Edition

32 .

9) The short-run aggregate supply curve (in the absence of misperceptions) A) is vertical.

B) slopes upward.

C) is horizontal.

D) slopes downward.

Answer: C Diff: 1 Topic: Section: 9.6 Question Status: Previous Edition 10) The long-run aggregate supply curve A) is vertical.

B) slopes upward.

C) is horizontal.

D) slopes downward.

Answer: A Diff: 1 Topic: Section: 9.6 Question Status: Previous Edition 11) Which of the following changes shifts the SRAS curve up?

A) An increase in the labor force B) An increase in firms' costs C) A decrease in government purchases D) An increase in the money supply Answer: B Diff: 1 Topic: Section: 9.6 Question Status: Previous Edition 12) Which of the following changes shifts the SRAS curve up?

A) A decrease in the labor force B) A decrease in the money supply C) An increase in government purchases D) An increase in firms' costs Answer: D Diff: 1 Topic: Section: 9.6 Question Status: Previous Edition

33 .

13) Which of the following changes shifts the long-run aggregate supply curve to the right?

A) A demographic change that increases the labor supply B) A decrease in the demand for labor C) An increase in consumer confidence D) A decrease in taxes (assuming Ricardian equivalence doesn't hold) Answer: A Diff: 2 Topic: Section: 9.6 Question Status: Previous Edition 14) Which of the following changes shifts the SRAS curve down?

A) An increase in the labor force B) An increase in the money supply C) A decrease in government purchases D) A decrease in firms' costs Answer: D Diff: 1 Topic: Section: 9.6 Question Status: Previous Edition 15) When the money supply rises by 10%, in the short run, output ________ and the price level ________.

A) rises; is unchanged B) declines; falls C) is unchanged; falls D) declines; is unchanged Answer: A Diff: 2 Topic: Section: 9.6 Question Status: Previous Edition 16) When the money supply declines by 10%, in the long run, output ________ and the price level ________.

A) is unchanged; is unchanged B) declines; falls C) is unchanged; falls D) declines; is unchanged Answer: C Diff: 2 Topic: Section: 9.6 Question Status: Previous Edition

34 .

17) Keynesians contend that in a recession caused by a decline in aggregate demand, a policy of increasing the nominal money supply would A) raise the level of aggregate demand, which would help return the economy to fullemployment output.

B) lower the level of aggregate demand, which would help return the economy to fullemployment output.

C) shift the LM curve to left, which would help return the economy to full-employment output.

D) not affect the position of the LM curve, because the real money supply would not change.

Answer: A Diff: 2 Topic: Section: 9.6 Question Status: Previous Edition 18) Describe the effects, in both the short run and the long run, of an increase in the money supply. Explain what happens to real output and the price level.

Answer: In the short run, an increase in the money supply increases output and has no effect on the price level. In the long run, an increase in the money supply has no effect on output and increases the price level.

Diff: 1 Topic: Section: 9.6 Question Status: Previous Edition 19) For each outcome below, tell what type of shift must have taken place in either the aggregate demand curve or the long-run aggregate supply curve. (a) In the short run, the price level is unchanged and output rises. (b) In the long run, the price level declines and output is unchanged. (c) In the long run, the price level rises and output declines.

Answer: (a) The aggregate demand curve shifts to the right. (b) The aggregate demand curve shifts to the left. (c) The long-run aggregate supply curve shifts to the left.

Diff: 2 Topic: Section: 9.6 Question Status: Previous Edition

35 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 10 Classical Business Cycle Analysis 10.1

Business Cycles in the Classical Model

1) The theory that real shocks to the economy are the primary cause of business cycles is A) monetarism.

B) Keynesian theory.

C) real business cycle theory.

D) Hamiltonian theory.

Answer: C Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 2) Which of the following is not a primary cause of business cycle fluctuations, according to real business cycle theory?

A) A change in the production function B) A change in the size of the labor force C) A change in the money supply D) A change in the real quantity of government purchases Answer: C Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 3) The distinction between real and nominal shocks is that A) real shocks directly affect only the IS curve, but not the FE line or LM curve.

B) real shocks directly affect only the FE line, but not the LM curve.

C) real shocks directly affect only the IS curve or the FE line, but not the LM curve.

D) real shocks have a large direct effect on the IS curve and the FE line, but only a small direct effect on the LM curve.

Answer: C Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition

1 .

4) Real business cycle theorists think that most business cycle fluctuations are caused by shocks to A) the production function.

B) the size of the labor force.

C) the real quantity of government purchases.

D) the spending and saving decisions of consumers.

Answer: A Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 5) According to real business cycle theory, which of the following events is least likely to cause a recession?

A) A decline in the money supply B) A decline in the capital stock C) A decline in productivity D) A decline in labor supply Answer: A Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 6) Which of the following is an example of a productivity shock?

A) The introduction of new management techniques B) A change in taxes on corporate profits C) A change in the level of government transfer programs D) An increase in the money supply Answer: A Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 7) Which of the following would not be an example of a productivity shock?

A) The introduction of new management techniques B) A change in government regulations affecting production C) A change in the level of government transfer programs D) A spell of unusually good or unusually bad weather Answer: C Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition

2 .

8) A temporary adverse productivity shock would A) shift the labor supply curve upward.

B) decrease the level of employment.

C) decrease future income.

D) decrease the expected future marginal product of capital.

Answer: B Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition 9) A temporary beneficial productivity shock would A) shift the labor supply curve down and to the right.

B) increase the level of employment.

C) increase future income.

D) increase the expected future marginal product of capital.

Answer: B Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition 10) In the classical IS-LM/AD-AS model, a beneficial productivity shock would ________ output, ________ the real interest rate, and ________ the price level.

A) increase; decrease; increase B) increase; decrease; decrease C) increase; increase; decrease D) decrease; decrease; increase Answer: B Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition 11) An adverse supply shock would directly ________ labor productivity by changing the amount of output that can be produced with any given amount of capital and labor. It would also indirectly ________ average labor productivity through changes in the level of employment.

A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: C Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition

3 .

12) How do RBC economists face the business cycle fact that inflation is procyclical?

A) They argue that even though inflation doesn't fit their theory, everything else does, and inflation is not important.

B) They note that inflation would not be procyclical if monetary policy were conducted properly.

C) They argue that inflation is procyclical only because monetary policy shocks are the main cause of business cycles.

D) They use alternative statistical methods that suggest that inflation is countercyclical.

Answer: D Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 13) When RBC economists work out a detailed numerical example of a more general theory, they are performing A) econometrics.

B) number theory.

C) calibration.

D) topology.

Answer: C Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition 14) What do RBC economists mean by the term calibration?

A) Modifying the structure of an economic theory to strengthen its logic B) Changing a theory as the economy changes C) Working out a detailed numerical example of a more general theory D) Writing out the implications of a theory for all the main economic variables Answer: C Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 15) When RBC economists compare the volatility in their models to the data, what are they looking at?

A) The degree to which variables lead output over the business cycle B) The strength of procyclicality of different variables C) The amount of random variation in economic variables D) The degree to which different economic variables move together Answer: C Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition

4 .

16) When RBC economists compare the correlations in their models to the data, what are they looking at?

A) The degree to which variables lead output over the business cycle B) The strength of procyclicality of different variables C) The amount of random variation in economic variables D) The degree to which different economic variables move together Answer: D Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition 17) Prescott's calibrated RBC model showed that the actual and simulated ________ of five key macroeconomic variables were very close.

A) magnitudes B) slopes C) volatilities D) betas Answer: C Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition 18) Prescott's calibrated RBC model was able to match the data in terms of the ________ between many key macroeconomic variables and GNP; that is, in terms of how closely they moved with GNP over the business cycle.

A) correlation B) interdependence C) gamma coefficient D) sigma ratio Answer: A Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition 19) Research on productivity shocks has shown that A) productivity shocks have only nominal effects.

B) there have been no identifiable productivity shocks in the U.S. economy since World War II. C) small productivity shocks can explain large business cycle fluctuations.

D) large productivity shocks produce only small deviations in aggregate output.

Answer: C Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition

5 .

20) The most common measure of productivity shocks is known as A) the Solow residual.

B) the Lucas supply curve.

C) the Prescott productivity parameter.

D) the Kydland factor.

Answer: A Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 21) The most common measure of productivity shocks used by real business cycle theorists is A) the Solow residual.

B) average labor productivity.

C) the change in the capital stock.

D) unit labor costs.

Answer: A Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 22) The Solow residual is A) the waste from the production process.

B) the most common measure of productivity shocks.

C) a measure of the efficiency of the production process.

D) a measure of the proportion of involuntarily unemployed workers.

Answer: B Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 23) Given data on capital (K), labor (N), and output (Y), and estimates of capital's share of output (a), the Solow residual is measured as A) Y KaN1-a B) (Y Ka) / N1-a C) Y / (KaN1-a) D) 1/(Y KaN1-a) Answer: C Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition

6 .

24) The formula Y / (KaN1-a) provides a calculation of A) x-efficiency.

B) dynamic efficiency.

C) economywide monopoly power.

D) the Solow residual.

Answer: D Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 25) Measures of the Solow residual show it to be A) strongly procyclical.

B) mildly procyclical.

C) mildly countercyclical.

D) strongly countercyclical.

Answer: A Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 26) One important reason why the Solow residual may be strongly procyclical even if the actual technology used in production doesn't change is that A) employment is procyclical.

B) resource utilization is procyclical.

C) demand shocks are the dominant force determining the business cycle.

D) the coefficients (a and 1 - a) on capital and labor in the production function are procyclical.

Answer: B Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 27) If the utilization rates of capital and labor are procyclical, then A) output will rise in recessions and decline in expansions.

B) measured productivity will be constant.

C) the Solow residual will be procyclical.

D) prices will be countercyclical.

Answer: C Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition

7 .

28) If the utilization rates of capital (uK) and labor (uN) are procyclical, then the Solow residual, as conventionally measured, is A) Y[(uKK)a(uNN)1-a].

B) Y / [(uKK)a(uNN)1-a].

C) A(uK)a(uN)1-a.

D) 1/{Y[(uKK)a(uNN)1-a]}.

Answer: C Diff: 1 Topic: Section: 10.1 Question Status: Revised 29) Labor hoarding occurs when A) firms keep good workers so other firms can't hire them.

B) the unemployment rate exceeds the natural rate of unemployment.

C) involuntary unemployment exceeds voluntary unemployment.

D) because of hiring and firing costs, firms retain workers in a recession that they would otherwise lay off.

Answer: D Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 30) When, because of hiring and firing costs, firms retain workers in a recession that they would otherwise lay off, there is said to be A) labor hoarding.

B) a decline in capacity utilization.

C) voluntary unemployment.

D) involuntary unemployment.

Answer: A Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 31) Burnside, Eichenbaum, and Rebelo found that A) the measured Solow residual varied sharply over the seasons.

B) electricity used per unit of capital rises sharply in economic upturns.

C) professional forecasters have rational expectations of inflation.

D) shocks to fiscal policy are the main source of business cycle fluctuations.

Answer: B Diff: 1 Topic: Section: 10.1 Question Status: Revised

8 .

32) Critics of the RBC approach argue that it's hard to find productivity shocks large enough to cause business cycles. What is the RBC counterargument to this criticism?

A) Business cycles are always and everywhere a monetary phenomenon.

B) Wars and military buildups could be considered productivity shocks.

C) Business cycles could be caused by the accumulation of small productivity shocks.

D) Business cycles are often caused by unobservable productivity shocks, which aren't apparent at the time they occur.

Answer: C Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition 33) Models that are similar to RBC models but allow for shocks other than productivity shocks are known as A) DSGE models.

B) Keynesian models.

C) Solow models.

D) Friedman models.

Answer: A Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 34) DSGE models are A) similar to RBC models but allow for shocks other than productivity shocks.

B) similar to RBC models, but government spending shocks play a major role.

C) similar to Keynesian models except in the long run.

D) similar to Keynesian models except in the short run.

Answer: A Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 35) Classical economists who allow for shocks other than productivity shocks to affect the economy use ________ models rather than RBC models.

A) Keynesian B) monetarist C) nonlinear D) DSGE Answer: D Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition

9 .

36) According to the real business cycle theory, what is the principal cause of business cycle fluctuations?

Answer: According to the real business cycle theory, real shocks, especially productivity shocks, are the principal cause of business cycle fluctuations in aggregate economic activity.

Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 37) Define real shocks, define nominal shocks, and give an example of each.

Answer: Real shocks are changes that disturb labor market equilibrium or goods market equilibrium. Nominal shocks are changes that disturb the asset market. A change in aggregate saving is an example of a real shock. A change in the money supply is an example of a nominal shock.

Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 38) How do RBC theorists answer the objection that there have been few examples of large and easily measurable real shocks to the U.S. economy in recent decades?

Answer: Computer simulations of RBC statistical models have shown that frequent, small, randomly generated productivity shocks can produce large business cycle fluctuations. Therefore large business cycle fluctuations occur even in the absence of large productivity shocks.

Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition 39) Use the classical (RBC) IS-LM-FE model to show the effects on the economy of a temporary beneficial supply shock; for example, a decrease in the price of oil. You should show the impact on the real wage, employment, output, the real interest rate, consumption, investment, and the price level.

Answer: The marginal productivity of labor is increased, shifting the labor demand curve to the right. As a result, the real wage rises and employment increases. Both the higher productivity and increased employment increase output. The FE line shifts right, with the IS curve unchanged, so the LM curve must shift down (the price level declines) to restore equilibrium. As a result, the real interest rate declines, increasing consumption and investment.

Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition

10 .

40) Use the classical (RBC) IS-LM-FE model to show the effects on the economy of a temporary adverse supply shock; for example, an increase in the price of oil. You should show the impact on the real wage, employment, output, the real interest rate, consumption, investment, and the price level.

Answer: The lower TFP reduces the marginal product of labor, thus shifting the labor—demand curve to the left, reducing the real wage and employment. The adverse supply shock thus shifts the FE line to the left because both TFP and employment decline. To restore equilibrium, the price level rises, shifting the LM curve left. The result is lower output and a higher real interest rate. The higher real interest rate reduces investment. The lower income and higher real interest rate reduce consumption.

Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition 41) Describe, in general terms, how an economist calibrates a macroeconomic model. What statistics can be usefully examined to see how well the model corresponds to the data?

Answer: A model is calibrated by working out a detailed numerical example. First, write down a model of the economy with specific functions. Second, express the functions in numerical terms. Third, find out how the numerically specified model behaves when it is hit by random shocks. Fourth, compare the results of this simulation to the behavior of the actual economy to determine how well the model fits reality. Useful statistics in this comparison are the volatilities of key variables and their correlations with output.

Diff: 2 Topic: Section: 10.1 Question Status: Previous Edition 42) How is the Solow residual measured? What problems arise in its measurement when resource utilization varies over the business cycle? What implications do these measurement issues have for evidence supporting the RBC model?

Answer: The Solow residual is measured as Y / (Ka N1-a). But when resource utilization varies over the business cycle, this isn't the correct measure of productivity. As a result, productivity appears to be procyclical, but in fact productivity might be constant. Thus the fact that the measured Solow residual is strongly procyclical, which has been taken as evidence in support of RBC models, may not be proof that productivity shocks drive the business cycle.

Diff: 1 Topic: Section: 10.1 Question Status: Previous Edition

11 .

10.2

Fiscal Policy Shocks in the Classical Model

1) The main avenue by which a temporary change in government purchases in the classical model affects the labor supply is by A) changing the population.

B) affecting the value of the stock market.

C) increasing business confidence.

D) affecting workers' wealth.

Answer: D Diff: 2 Topic: Section: 10.2 Question Status: Previous Edition 2) A temporary increase in government purchases in the classical model would A) shift the production function to the right.

B) shift the marginal product of labor curve to the left.

C) shift the labor demand curve to the right.

D) shift the labor supply curve to the right.

Answer: D Diff: 1 Topic: Section: 10.2 Question Status: Previous Edition 3) People increase their labor supply in response to a temporary increase in government purchases because A) current or future taxes will increase, making them financially worse off.

B) they need to work more to keep up with their neighbors.

C) interest rates will rise, causing a substitution effect.

D) higher spending today will lead to higher spending in the future, as well.

Answer: A Diff: 1 Topic: Section: 10.2 Question Status: Previous Edition 4) In the classical model, a temporary increase in government purchases causes A) a decrease in output and the real interest rate.

B) a decrease in output and an increase in the real interest rate.

C) an increase in output and a decrease in the real interest rate.

D) an increase in output and the real interest rate.

Answer: D Diff: 2 Topic: Section: 10.2 Question Status: Previous Edition

12 .

5) In the classical model, a temporary increase in government purchases causes the new equilibrium to have A) more employment and a lower real wage than before.

B) more employment and a higher real wage than before.

C) less employment and a lower real wage than before.

D) less employment and a higher real wage than before.

Answer: A Diff: 2 Topic: Section: 10.2 Question Status: Previous Edition 6) A temporary decrease in government purchases in the classical model would A) shift the production function to the left.

B) shift the marginal product of labor curve to the right.

C) shift the labor demand curve to the left.

D) shift the labor supply curve to the left.

Answer: D Diff: 2 Topic: Section: 10.2 Question Status: Previous Edition 7) In the classical model, a temporary decrease in government spending would cause a decrease in A) output, the real interest rate, real wages, and the price level.

B) employment, the real interest rate, real wages, and the price level.

C) output, employment, the real interest rate, and the price level.

D) output, employment, real wages, and the price level.

Answer: C Diff: 3 Topic: Section: 10.2 Question Status: Previous Edition 8) People ________ their labor supply in response to a temporary decrease in government purchases because ________.

A) increase; current or future taxes will decrease, making them financially better off B) decrease; current or future taxes will decrease, making them financially better off C) decrease; current or future taxes will increase, making them financially worse off D) increase; current or future taxes will increase, making them financially worse off Answer: A Diff: 2 Topic: Section: 10.2 Question Status: Previous Edition

13 .

9) Classical economists would cite all of the following as reasons why the government cannot smooth out the business cycle except that A) only productivity shocks can cause real fluctuations in the business cycle.

B) the government has imperfect knowledge of the economy.

C) political constraints on policy actions prevent the government from carrying out effective policies.

D) time lags between the onset of a recession and the implementation of effective countermeasures make anti-recessionary macroeconomic policies impractical.

Answer: A Diff: 2 Topic: Section: 10.2 Question Status: Previous Edition 10) According to classical economists, the government should increase government purchases when A) the benefits of the spending exceed the costs.

B) the economy is in a recession.

C) the economy is likely to go into a recession in the next six months to a year.

D) inflation is lower than its targeted level.

Answer: A Diff: 2 Topic: Section: 10.2 Question Status: Previous Edition 11) Classical economists think that the government ________ use fiscal policy to dampen the business cycle because prices and wages adjust ________.

A) should not; rapidly B) should not; slowly C) should; slowly D) should; rapidly Answer: A Diff: 1 Topic: Section: 10.2 Question Status: Previous Edition 12) Fiscal policy may not be effective because of A) lags.

B) a liquidity trap.

C) the zero lower bound.

D) the LM curve's dominant role in determining the short-run equilibrium.

Answer: A Diff: 1 Topic: Section: 10.2 Question Status: Previous Edition

14 .

13) Fiscal policy may not be effective because it takes time for policymakers to realize that a policy change is needed, known as the ________ lag.

A) recognition B) implementation C) impact D) legislative Answer: A Diff: 1 Topic: Section: 10.2 Question Status: Previous Edition 14) Fiscal policy may not be effective because it takes time for policymakers to enact a policy change, known as the ________ lag.

A) recognition B) implementation C) impact D) legislative Answer: D Diff: 1 Topic: Section: 10.2 Question Status: Previous Edition 15) Fiscal policy may not be effective because it takes time for policymakers to implement a policy change, known as the ________ lag.

A) recognition B) implementation C) impact D) legislative Answer: B Diff: 1 Topic: Section: 10.2 Question Status: Previous Edition 16) Fiscal policy may not be effective because it takes time for a policy change to affect the economy, known as the ________ lag.

A) recognition B) implementation C) impact D) legislative Answer: C Diff: 1 Topic: Section: 10.2 Question Status: Previous Edition

15 .

17) During a recession, would classical economists propose that changes in government spending or taxes be used to improve economic conditions? Briefly explain.

Answer: No. Classical economists do not endorse changes in government spending or taxes designed to offset business cycle fluctuations; the classical model shows that such policy attempts are not likely to improve macroeconomic conditions. From a classical viewpoint, government spending and tax decisions should be long-run decisions based on cost-benefit analysis.

Diff: 1 Topic: Section: 10.2 Question Status: Previous Edition 18) Suppose the economy's production function is Y = A(300N - N2). The marginal product of labor is MPN = A(300 - 2N). Suppose that A = 10. The supply of labor is NS = 0.05w + 0.005G. (a) If G is 26,000, what are the real wage, employment, and output? (b) If G rises to 26,400, what are the real wage, employment, and output? (c) If G falls to 25,600, what are the real wage, employment, and output? (d) In cases (b) and (c), what is the government purchases multiplier; that is, what is the change in output divided by the change in government purchases?

Answer: (a) Setting labor supply equal to labor demand gives N = 0.05 × 10 × (300 - 2N) + 0.005G, which can be simplified to get N = 75 + 0.0025G. With G = 26,000, N = 140.

Then w = 10 × [300 - (2 × 140)] = 200 and Y = 10 × [(300 × 140) - 1402] = 224,000. (b) Following the same procedure gives N = 141, w = 180, and Y = 224,190. (c) N = 139, w = 220, and Y = 223,790. (d) In part (b), the multiplier is 190/400 = 0.475. In part (c), the multiplier is 210/400 = 0.525.

Diff: 2 Topic: Section: 10.2 Question Status: Previous Edition 19) Use the classical IS-LM model to show the effects of a temporary decrease in government purchases on the equilibrium levels of output, the real interest rate, employment, the real wage, and the price level.

Answer: The decrease in government purchases reduces workers' current or future taxes, causing them to reduce their labor supply. The leftward shift of the labor supply curve reduces equilibrium employment and increases the real wage. The reduction in employment shifts the FE line to the left. In addition, the reduction in government purchases shifts the IS curve down and to the left. Assuming that the IS curve shifts more to the left than the FE line, the price level will have to decline to shift the LM curve down and to the right to restore general equilibrium.

Overall, the level of output declines, the real interest rate declines, employment declines, the real wage rises, and the price level declines.

Diff: 2 Topic: Section: 10.2 Question Status: Previous Edition

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10.3

Unemployment in the Classical Model

1) According to classical economists, unemployment exists because A) it takes time and effort for someone to find a job.

B) government activity causes unemployment.

C) the minimum wage generates unemployment.

D) workers are all identical.

Answer: A Diff: 1 Topic: Section: 10.3 Question Status: Previous Edition 2) According to classical economists, the increase in unemployment in recessions is caused by A) slack aggregate demand.

B) the failure of wages to adjust to restore equilibrium in the labor market.

C) the power of labor unions, which prevent firms from cutting wages.

D) a mismatch of workers and jobs.

Answer: D Diff: 2 Topic: Section: 10.3 Question Status: Previous Edition 3) According to classical economists, the increase in the unemployment rate in recessions occurs because A) aggregate demand is insufficient.

B) the time needed to find a job rises in recessions.

C) labor unions prevent firms from cutting wages.

D) firms will replace workers by machines.

Answer: B Diff: 2 Topic: Section: 10.3 Question Status: Previous Edition 4) According to classical economists, unemployment rises in recessions due to an increase in ________ unemployment, not ________ unemployment.

A) cyclical; frictional and structural B) frictional and cyclical; structural C) structural; frictional and cyclical D) frictional and structural; cyclical Answer: D Diff: 2 Topic: Section: 10.3 Question Status: Previous Edition

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5) According to classical economists, in recessions, not only does the unemployment rate increase, so does the A) interest rate.

B) level of fiscal stimulus.

C) natural rate of unemployment.

D) level of potential output.

Answer: C Diff: 2 Topic: Section: 10.3 Question Status: Previous Edition 6) According to classical economists, in recessions, the government should A) stimulate the economy to increase demand.

B) actively use fiscal policy to combat the recession.

C) increase the minimum wage so that poor people will be able to afford necessities.

D) eliminate barriers to labor market adjustment, such as burdensome regulations on businesses.

Answer: D Diff: 2 Topic: Section: 10.3 Question Status: Previous Edition 7) Davis and Haltiwanger showed that ________ churning of jobs occurs and that this churning reflects closing of old plants and opening of new ones ________.

A) little; in different industries B) little; within the same industry C) much; within the same industry D) much; in different industries Answer: C Diff: 1 Topic: Section: 10.3 Question Status: Previous Edition 8) In recession years, ________ jobs are lost than created, and vacancies and job openings ________.

A) more; increase B) more; decline C) fewer; decline D) fewer; increase Answer: B Diff: 1 Topic: Section: 10.3 Question Status: Previous Edition

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9) From 1977 to 2014, the rate of job creation has generally A) trended up.

B) trended down.

C) trended up from 1977 to 2000, then trended down after that.

D) trended down from 1977 to 2000, then trended up after that.

Answer: B Diff: 2 Topic: Section: 10.3 Question Status: Previous Edition 10) The rate of job destruction rises during A) expansions.

B) recessions.

C) the Long Boom.

D) the Great Moderation.

Answer: B Diff: 1 Topic: Section: 10.3 Question Status: Previous Edition 11) In recessions, workers will find that their skills do not match the requirements of industries with growing labor demand; these workers may become chronically unemployed, which represents a rise in ________ unemployment.

A) cyclical B) structural C) temporary D) unaided Answer: B Diff: 1 Topic: Section: 10.3 Question Status: Previous Edition 12) Because employment actually continued to fall at the beginning of the recoveries that began in 1991, 2001, and 2009, these recoveries have come to be known as A) pseudo recoveries.

B) non-recoveries.

C) double-dip recoveries.

D) jobless recoveries.

Answer: D Diff: 1 Topic: Section: 10.3 Question Status: Previous Edition

19 .

13) A jobless recovery occurs when A) no jobs are created in an economy after a recession ends.

B) employment continues to fall at the beginning of a recovery.

C) only low-quality jobs are created in a recovery.

D) most of the new jobs created in a recovery are overseas.

Answer: B Diff: 1 Topic: Section: 10.3 Question Status: Previous Edition 10.4

Money in the Classical Model

1) Classical economists believe that A) money is neutral.

B) an increase in the real money supply affects output.

C) inflation is determined by wage growth.

D) monetary policy should be used to combat recessions.

Answer: A Diff: 1 Topic: Section: 10.4 Question Status: Previous Edition 2) Assuming that money is neutral, an increase in the nominal money supply would cause A) an excess supply for goods.

B) an increase in the real money supply.

C) a fall in the price level.

D) a rise in nominal wages.

Answer: D Diff: 1 Topic: Section: 10.4 Question Status: Previous Edition 3) Assuming that money is neutral, a reduction in the nominal money supply would cause A) an excess demand for goods.

B) a decrease in the real money supply.

C) a fall in the price level.

D) a rise in nominal wages.

Answer: C Diff: 1 Topic: Section: 10.4 Question Status: New

20 .

4) Assuming money neutrality in the classical model, a 10% increase in the nominal money supply would cause A) a 10% increase in the real money supply.

B) a 10% decrease in the real money supply.

C) no change in the real money supply.

D) a less-than-10% change in the price level due to a shift in the aggregate supply curve.

Answer: C Diff: 1 Topic: Section: 10.4 Question Status: Previous Edition 5) Assuming money neutrality in the classical model, a 10% decrease in the nominal money supply would cause A) a 10% increase in the real money supply.

B) a 10% decrease in the real money supply.

C) no change in the real money supply.

D) a less-than-10% change in the price level due to a shift in the aggregate supply curve.

Answer: C Diff: 1 Topic: Section: 10.4 Question Status: New 6) The idea that expected future increases in output cause increases in the current money supply and that expected future decreases in output cause decreases in the current money supply, rather than the other way around, is known as A) Granger causality.

B) money neutrality.

C) nominal adjustment.

D) reverse causation.

Answer: D Diff: 2 Topic: Section: 10.4 Question Status: Previous Edition 7) Reverse causation is the idea that A) current increases in output cause future increases in the money supply.

B) current increases in the money supply cause future increases in output.

C) expected future increases in the money supply cause increases in current output.

D) expected future increases in output cause increases in the current money supply.

Answer: D Diff: 2 Topic: Section: 10.4 Question Status: Previous Edition

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8) The basic classical model can account for the procyclical behavior of money if there A) are real business cycles caused by productivity shocks.

B) is reverse causation from future output to money.

C) are rational expectations among the public.

D) are propagation mechanisms in the economy.

Answer: B Diff: 1 Topic: Section: 10.4 Question Status: Previous Edition 9) A decline in the money supply usually precedes a decline in business cycle activity; according to RBC theorists, this shows that the Federal Reserve A) intentionally causes most recessions.

B) should not be allowed to control the money supply.

C) does not know what it is doing.

D) reduces the money supply when money demand falls prior to a recession.

Answer: D Diff: 1 Topic: Section: 10.4 Question Status: New 10) Friedman and Schwartz argue that money is not neutral because A) theoretical models of the economy don't show monetary neutrality.

B) money is a leading, procyclical variable.

C) they found several historical incidents in which changes in the money supply were not responses to macroeconomic conditions, and output moved in the same direction as money.

D) they found no evidence that productivity changes or changes in government spending contributed to business cycles; only monetary changes preceded every recession.

Answer: C Diff: 1 Topic: Section: 10.4 Question Status: Previous Edition 11) Romer and Romer found evidence that money is not neutral because A) in several episodes, such as 1979-1982, changes in monetary policy led to recessions.

B) they found that inflation was highly correlated with the rate of growth of the money supply.

C) if money were neutral, no one would care what the Fed does.

D) they found no evidence that productivity changes or changes in government spending contributed to business cycles; only monetary changes preceded every recession.

Answer: A Diff: 2 Topic: Section: 10.4 Question Status: Previous Edition

22 .

12) Research by Friedman and Schwartz on the monetary history of the United States from 18671960, and the recent updating of this research by Romer and Romer suggests that A) reverse causality can explain why money is a leading, procyclical variable.

B) the Federal Reserve can accurately forecast turning points in the business cycle caused by small, random changes in productivity.

C) money is often nonneutral in the short run.

D) money is often nonneutral in the long run.

Answer: C Diff: 2 Topic: Section: 10.4 Question Status: New 13) You and a friend are arguing over the issue of the nonneutrality of money. You believe that money is not neutral, and to prove your point you would cite all of the following except A) large gold discoveries that increased the money supply preceded an economic boom.

B) a change in monetary institutions preceded a boom or recession.

C) a change in the leadership of the Fed and its policy was followed by noticeable changes in the money supply and a recession or inflation.

D) the fact that every recession was preceded by a drop in the money supply.

Answer: D Diff: 2 Topic: Section: 10.4 Question Status: Previous Edition 14) Why do many economists believe that money affects output? What is the empirical evidence in support of that belief?

Answer: Except for the classical (RBC) model of the economy, other models provide theoretical reasons for the effect of money on output. These include the misperceptions theory, which finds that unanticipated changes in money growth influence output, and the Keynesian theory, which shows that the failure of prices to adjust to return the economy to equilibrium leads money to affect output. Friedman and Schwartz looked at historical episodes in which independent changes in the money supply led to changes in output. This is supported by the work of Romer and Romer, who reviewed and updated the Friedman and Schwartz analysis, and the Volcker episode in the early 1980s.

Diff: 1 Topic: Section: 10.4 Question Status: Previous Edition

23 .

15) A classical economy is described by the following equations: Cd = 500 + 0.5(Y - T) - 100r.

Id = 350 - 100r.

L = 0.5Y - 200i. = 1850. πe = 0.05.

Government spending and taxes are equal where T = G = 200. The nominal money supply M = 3560. (a) What are the equilibrium values of the real interest rate, the price level, consumption, and investment? (b) Suppose an economic shock increases desired investment by 10, so it is now Id = 360 - 100r.

How does this affect the equilibrium values of the real interest rate, the price level, consumption, and investment? (c) Returning to the initial situation in part (a), suppose an economic shock increases desired consumption by 10, so it is now Cd = 510 + 0.5 (Y - T) - 100r. How does this affect the equilibrium values of the real interest rate, the price level, consumption, and investment?

Answer: (a) Sd = Y - Cd - G = 0.5Y - 400 + 100r - 200. Set Sd = Id: 0.5Y - 600 + 100r = 350 - 100r, so 200r = 950 - 0.5Y (IS). With Y = 1850, r = 0.125. Then C = 1312.5 and I = 337.5. From the money demand equation, 3560/P = (0.5 × 1850) - (200 × .175) = 925 - 35 = 890, so P = 4. (b) Set Sd = Id: 0.5Y - 600 + 100r = 360 - 100r, so 200r = 960 - 0.5Y (IS). With Y = 1850, r = .175. Then C = 1307.5 and I = 342.5. From the money demand equation, 3560/P = (0.5 × 1850) - (200 × .225) = 925 - 45 = 890, so P = 4.045. (c) Set Sd = Id: 0.5Y - 610 + 100r = 350 - 100r, so 200r = 960 - 0.5Y (IS). With Y = 1850, r = .175. Then C = 1317.5, I = 332.5, and P = 4.045.

Diff: 2 Topic: Section: 10.4 Question Status: Previous Edition

24 .

16) Suppose the money demand of individuals and firms depends on what they perceive to be the probabilities that the economy will expand or contract over the following six months. Suppose their money demand is given by the equation L = 0.5Y - 100i + 20z, where z is the probability that the economy is expanding six months in the future. If z = 1, the economy will certainly be in recovery, if z = 0, the economy will certainly be in recession, and for z between 0 and 1 there is some uncertainty about the future state of the economy. Use a classical (RBC) model of the economy. If the Fed moves the money supply to target the price level, how does the money supply relate to the expected future state of the economy? Is this an example of reverse causation?

Answer: For a given level of real output and the nominal interest rate, to target the price level means that the nominal money supply moves directly with z (so that ΔM = 20Δz). This a version of reverse causation because the probability of higher future output affects the money supply today.

Diff: 2 Topic: Section: 10.4 Question Status: Previous Edition 10.5

The Misperceptions Theory and the Nonneutrality of Money

1) The misperceptions theory was originally proposed by ________ and rigorously formulated by ________.

A) Milton Friedman; Robert Lucas B) John Maynard Keynes; Robert Solow C) Edward Prescott; Robert King D) James Tobin; Greg Mankiw Answer: A Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 2) If producers have imperfect information about the general price level and sometimes misinterpret changes in the general price level as changes in relative prices, then A) the short-run aggregate supply curve is vertical.

B) the short-run aggregate supply curve slopes upward.

C) the aggregate demand curve is vertical.

D) the aggregate demand curve is horizontal.

Answer: B Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition

25 .

3) Misperceptions theory best explains why A) the AD curve is negatively sloped.

B) the LRAS curve is horizontal.

C) the SRAS curve is positively sloped.

D) the LM curve is positively sloped.

Answer: C Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 4) The short-run aggregate supply curve can slope upward because A) prices are fixed in the short run.

B) wages adjust immediately to changing economic circumstances.

C) producers have misperceptions about the aggregate price level.

D) prices adjust instantaneously.

Answer: C Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 5) According to the misperceptions theory, when the aggregate price level is higher than expected, A) the aggregate quantity of output supplied rises above the full-employment level.

B) the aggregate quantity of output supplied falls below the full-employment level.

C) the aggregate quantity of output demanded falls below the full-employment level.

D) the aggregate quantity of output demanded rises above the full-employment level.

Answer: A Diff: 2 Topic: Section: 10.5 Question Status: Previous Edition 6) According to the misperceptions theory, when the aggregate price level is lower than expected, A) the aggregate quantity of output supplied rises above the full-employment level.

B) the aggregate quantity of output supplied falls below the full-employment level.

C) the aggregate quantity of output demanded falls below the full-employment level.

D) the aggregate quantity of output demanded rises above the full-employment level.

Answer: B Diff: 2 Topic: Section: 10.5 Question Status: New

26 .

7) According to the misperceptions theory, when the price level falls below the expected price level, A) the economy's SRAS curve shifts up.

B) the economy moves along its AD curve.

C) the economy moves along its LRAS curve.

D) the economy moves along its SRAS curve.

Answer: D Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 8) If you expect a general price increase of 5% this year and the price of the hamburgers you sell increases by 10%, you would conclude that the relative price of your good has A) declined, and you would increase your output.

B) declined, and you would decrease your output.

C) increased, and you would increase your output.

D) increased, and you would decrease your output.

Answer: C Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 9) You are likely to think that the relative price of your good has risen and you should increase your output if you expected A) the inflation rate to be 10% and the price of your good rose 7%.

B) the inflation rate to be 10% and the price of your good rose 10%.

C) the inflation rate to be 10% and the price of your good rose 13%.

D) the inflation rate to be 0% and the price of your good fell 10%.

Answer: C Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 10) You are likely to think that the relative price of your good has declined and you should decrease your output if you expected A) the inflation rate to be 10% and the price of your good rose 7%.

B) the inflation rate to be 10% and the price of your good rose 10%.

C) the inflation rate to be 10% and the price of your good rose 13%.

D) the inflation rate to be 0% and the price of your good fell 10%.

Answer: A Diff: 1 Topic: Section: 10.5 Question Status: New

27 .

11) Short-run aggregate supply is greater than long-run aggregate supply in the misperceptions theory if A) the actual price level is greater than the expected price level.

B) the actual price level equals the expected price level.

C) the actual price level is less than the expected price level.

D) output is less than its full-employment level.

Answer: A Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 12) In the misperceptions theory, a 5% decline in the money supply that is unanticipated will A) cause both output and employment to decline in the short run.

B) cause output to increase in the long run.

C) cause employment to decline in the long run.

D) not change employment in the short run or the long run.

Answer: A Diff: 2 Topic: Section: 10.5 Question Status: New 13) Which of the following equations is most likely to represent short-run aggregate supply according to the misperceptions theory?

A) Y = 6000 B) Y = 6000 + 50(P - Pe) C) P = 2 D) PY = 12,000 Answer: B Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 14) According to the misperceptions theory, when P < Pe, output is ________ its fullemployment level and the short-run aggregate supply curve must shift ________ to restore full employment.

A) below; upward B) below; downward C) above; upward D) above; downward Answer: B Diff: 2 Topic: Section: 10.5 Question Status: Previous Edition

28 .

15) According to the misperceptions theory, when P > Pe, output is ________ its fullemployment level and the short-run aggregate supply curve must shift ________ to restore full employment.

A) below; upward B) below; downward C) above; upward D) above; downward Answer: C Diff: 2 Topic: Section: 10.5 Question Status: New 16) According to the misperceptions theory, the amount by which producers increase their output when the general price level rises depends on A) the slope of the aggregate demand curve.

B) the slope of the long-run aggregate supply curve.

C) the size of the Solow residual.

D) how much they think their relative prices have increased.

Answer: D Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 17) If producers believe that the increase in their relative prices is small relative to the increase in the general price level, then the slope of the short-run aggregate supply curve will be A) zero.

B) small.

C) large.

D) negative.

Answer: C Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 18) If producers believe that the increase in their relative prices is large relative to the increase in the general price level, then the slope of the short-run aggregate supply curve will be A) infinite.

B) small.

C) large.

D) negative.

Answer: B Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition

29 .

19) According to the misperceptions theory, an unanticipated decrease in the money supply shifts the AD curve ________, causing output to ________ in the short run.

A) up and to the right; rise B) up and to the right; fall C) down and to the left; rise D) down and to the left; fall Answer: D Diff: 2 Topic: Section: 10.5 Question Status: Previous Edition 20) According to the misperceptions theory, after an unanticipated increase in the money supply has occurred, the SRAS curve must shift ________ to restore general equilibrium; as it does so, the price level ________.

A) downward; rises B) downward; falls C) upward; rises D) upward; falls Answer: C Diff: 2 Topic: Section: 10.5 Question Status: Previous Edition 21) According to the misperceptions theory, after an unanticipated decrease in the money supply has occurred, the SRAS curve must shift ________ to restore general equilibrium; as it does so, the price level ________.

A) downward; rises B) downward; falls C) upward; rises D) upward; falls Answer: B Diff: 2 Topic: Section: 10.5 Question Status: New 22) According to the misperceptions theory, an anticipated decline in the money supply leads to a shift of the AD curve ________ and a shift of the SRAS curve ________.

A) down and to the left; downward B) down and to the left; upward C) up and to the right; downward D) up and to the right; upward Answer: A Diff: 2 Topic: Section: 10.5 Question Status: Previous Edition

30 .

23) According to the misperceptions theory, an anticipated 10% decrease in the money supply leads to a short-run reduction in the price level of A) 0%.

B) 5%.

C) some amount between 0% and 10%.

D) 10%.

Answer: D Diff: 2 Topic: Section: 10.5 Question Status: Previous Edition 24) Which of the following statements is true about the misperceptions theory?

A) Both anticipated and unanticipated changes in the nominal money supply have real effects on the economy.

B) Neither anticipated nor unanticipated changes in the nominal money supply has real effects on the economy.

C) Unanticipated changes in the nominal money supply have real effects, but anticipated changes are neutral.

D) Anticipated changes in the nominal money supply have real effects, but unanticipated changes are neutral.

Answer: C Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 25) If the money supply grows 7% during the year, and people expected the money supply to grow by 5%, what happens to the short-run aggregate supply curve, according to the misperceptions theory?

A) It shifts down.

B) It shifts up.

C) It doesn't shift.

D) It shifts down unless Ricardian equivalence holds, in which case it doesn't shift.

Answer: A Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 26) According to the misperceptions theory, if the Fed wanted to use monetary policy to influence the real economy, it would have to A) increase the money supply whenever the economy was in a recession.

B) decrease the money supply whenever the economy was in an inflationary boom.

C) surprise the public with unexpected changes in monetary policy.

D) abide by the monetary targets it announced.

Answer: C Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 31 .

27) The reason why some economists believe that attempts by the Fed to surprise the public in a systematic way cannot be successful is that A) information about the Fed's plans will inevitably be leaked to the public.

B) the Fed announces its goals before Congress and publishes its policy actions in the Federal Reserve Bulletin six weeks after they take place.

C) the public would eventually figure out what the Fed's policies were, negating the Fed's surprise.

D) competition in the money markets would neutralize the Fed's intervention.

Answer: C Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 28) The primary reason why the Fed cannot systematically surprise the public with its monetary policy is A) the nonneutrality of money.

B) the presence of productivity shocks that generate real business cycles independent of the monetary side of the economy.

C) the presence of rational expectations among the public.

D) the presence of propagation mechanisms within the economy.

Answer: C Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 29) The theory of rational expectations suggests that A) people never make forecast errors.

B) people make intelligent use of available information.

C) people make systematic forecast errors.

D) people are slow to incorporate new information into their forecasts.

Answer: B Diff: 2 Topic: Section: 10.5 Question Status: Previous Edition 30) The misperceptions theory and the rational expectations hypothesis together suggest that systematic attempts by the Federal Reserve to increase aggregate output will A) cause the price level to exceed the expected price level in the short run.

B) not have any real economic effects.

C) not increase the price level.

D) cause the AD curve to shift up and to the right along a fixed SRAS curve.

Answer: B Diff: 2 Topic: Section: 10.5 Question Status: Previous Edition 32 .

31) The Fed had announced to Congress that it would allow M2 to grow 8% this year, and M2 did grow 8% this year. You would NOT expect A) money to be neutral in the short run.

B) money to be neutral in the long run.

C) output to remain unchanged.

D) a movement along the short-run aggregate supply curve.

Answer: D Diff: 2 Topic: Section: 10.5 Question Status: New 32) According to the misperceptions theory, short-lived shocks may have long-term effects on the economy because of A) multiplier effects.

B) propagation mechanisms.

C) accelerator effects.

D) automatic stabilizers.

Answer: B Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 33) The primary reason that short-lived shocks can have long-run effects is A) the nonneutrality of money.

B) misperceptions by the public over the actual price level and the expected price level.

C) the presence of rational expectations among the public.

D) the presence of propagation mechanisms.

Answer: D Diff: 1 Topic: Section: 10.5 Question Status: Previous Edition 34) In the extended classical model, some type of propagation mechanism is needed to explain A) the persistence of a recession caused by a nominal shock.

B) imperfect information.

C) why money is neutral.

D) the difference between correlation and causation.

Answer: A Diff: 1 Topic: Section: 10.5 Question Status: New

33 .

35) Suppose the economy is characterized by the following equations.

IS curve: r = 20.20 - 0.002Y LM curve: M/P = Y - 250(r + πe) SRAS curve: Y = + 100(P - Pe) The nominal money supply is M = 19,800, expected inflation is πe = 0.20, and full-employment output is = 10,000. (a) If the economy begins in general equilibrium, what are the equilibrium values of the price level, output, and the real interest rate? (b) If the expected price level is the price level you found in part (a), what happens to the price level, output, and the real interest rate in the short run if there's an unanticipated decrease in the nominal money supply to 14,737.5? {Hint: guess some price levels that differ from the one you found in part (a) by increments of 0.25.} (c) If the expected price level is the price level you found in part (a), what happens to the price level, output, and the real interest rate in the short run if there's an unanticipated increase in the nominal money supply to 24,937.5?

Answer: (a) From the IS curve with Y = 10,000: r = 20.20 - (0.002 × 10,000) = 0.20.

Combining the IS curve with the LM curve gives the AD curve, with values for output set at fullemployment output (Y = 10,000), and with the price level equal to the expected price level: M/P = Y - 250(r + πe) 19,800/P = 10,000 - 250(0.2 + 0.2) = 9900, so P = 2. (b) Now P may differ from Pe in the short run, so things are a bit more complicated. Combining the IS curve with the LM curve gives the AD curve, with the values for output and the price level to be determined in combination with the SRAS curve: AD: M/P = Y - 250(r + πe) = Y - 250[(20.20 - 0.002Y) + 0.2] = 1.5Y - 5100.

SRAS: Y = 10,000 + 100(P - 2) Plug SRAS into AD to get: M/P = 1.5Y - 5100 = 1.5[10,000 + 100(P - 2)] - 5100 = 9600 + 150P This is a quadratic equation in P for a given M, as you can see by multiplying through by P and rearranging: 150P2 + 9600P - M = 0 Note that in part (a), with M = 19,800, the solution to the equation is P = 2.

With M = 14,737.5, we need to solve the equation 150P2 + 9600P - 14,737.5 = 0. You can use the quadratic formula, or guess the solution by checking increments of P of .25, to find P = 1.5.

Output is Y = 10,000 + 100(P - 2) = 9950. The real interest rate is r = 20.20 - 0.002Y = 0.30.

34 .

(c) With M = 24,937.5, we need to solve the equation 150P2 + 9600P - 24,937.5 = 0, which has the solution P = 2.5. Output is Y = 10,000 + 100(P - 2) = 10,050.

The real interest rate is r = 20.20 - 0.002Y = 0.10.

Diff: 2 Topic: Section: 10.5 Question Status: Previous Edition 36) Analyze the short-run and long-run effects of an unanticipated decrease in the money supply in the misperceptions model. Tell what happens to output, the price level, and the expected price level in both the short run and long run.

Answer: The reduction in money supply shifts the AD curve left, reducing output and the price level, while the expected price level is unchanged, since the decrease in money supply was unanticipated. In the long run, the SRAS curve shifts down as people reduce their expected price level. The economy returns to full-employment output, but at a lower price level.

Diff: 2 Topic: Section: 10.5 Question Status: Previous Edition 37) Why doesn't stabilization policy work, according to economists using the misperceptions theory?

Answer: Stabilization policy requires taking systematic action to combat recessions (using stimulative policy) or to fight inflation (using restrictive policy). But policy works only if it is unanticipated, according to the misperceptions theory. So the use of stimulative policy in a recession would be anticipated and have no effect. Only unanticipated policy would work, but such a policy would have to be random, and could not be used to smooth the business cycle.

Diff: 2 Topic: Section: 10.5 Question Status: Previous Edition

35 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 11 Keynesianism: The Macroeconomics of Wage and Price Rigidity 11.1

Real-Wage Rigidity

1) The existence of labor unions could contribute to real-wage rigidity, except that in the United States A) labor unions are outlawed.

B) most workers aren't in unions.

C) unions are interested in benefits, not wages.

D) unions try to increase employment rather than negotiating over wages.

Answer: B Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 2) Keynesians are skeptical of the classical theory that recessions are periods of increased mismatch between workers and jobs because A) help-wanted advertising falls during recessions.

B) help-wanted advertising rises during recessions.

C) workers spend a lot of time searching for work in recessions.

D) people are indifferent between being employed or not.

Answer: A Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 3) The gift exchange motive suggests that A) workers value benefits like health insurance more than job security.

B) workers prefer a nice work environment, even if they must accept lower wages.

C) workers who feel well treated will work harder and more efficiently.

D) workers will shirk if they are paid a low wage.

Answer: C Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 4) A model in which workers won't be concerned about the possibility of being fired if they don't work hard, because their wage is so low, is called A) a cost-benefit model.

B) a job-stress model.

C) a gift-exchange model.

D) a shirking model.

Answer: D Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 1 .

5) The effort curve is A) horizontal, because work effort is independent of the real wage.

B) negatively sloped, because of diminishing marginal returns to labor.

C) positively sloped, because of the law of increasing cost.

D) S-shaped, because a small increase in the real wage will increase work effort more at an intermediate wage than at a low wage or at a high wage.

Answer: D Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 6) According to the efficiency wage model, firms will pay the real wage that A) maximizes workers' marginal productivity.

B) maximizes the marginal productivity of capital and the marginal productivity of labor together.

C) maximizes effort per dollar of real wage.

D) minimizes hiring and training costs to the firm.

Answer: C Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 7) Assuming no change in the effort curve of employees, the efficiency wage model implies that A) the real wage is rigid and equals the efficiency wage.

B) the real wage exceeds the marginal productivity of labor.

C) an increase in the marginal productivity of capital will increase the real wage.

D) the real wage is procyclical.

Answer: A Diff: 2 Topic: Section: 11.1 Question Status: Previous Edition 8) Real-wage rigidity in the Keynesian efficiency wage diagram of the labor market is depicted by A) a vertical labor supply curve at the efficient level of employment.

B) a vertical labor demand curve at the efficient level of employment.

C) a horizontal line at the efficiency wage.

D) a steep, positively sloped labor supply curve depicting various efficiency wages at various employment levels.

Answer: C Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition

2 .

9) A firm faces the following relationship between the real wage it pays and the effort exerted by its workers.

The marginal product of labor for this firm is given by MPN = E (100 - N)/9. The firm will choose to pay a wage such that the effort level is A) 20.

B) 24.

C) 27.

D) 29.

Answer: C Diff: 2 Topic: Section: 11.1 Question Status: Previous Edition 10) A firm faces the following relationship between the real wage it pays and the effort exerted by its workers.

The marginal product of labor for this firm is given by MPN = E (50 - N)/3. The firm will choose to pay a wage such that the effort level is A) 14.

B) 20.

C) 27.

D) 32.

Answer: C Diff: 2 Topic: Section: 11.1 Question Status: Previous Edition

3 .

11) A firm faces the following relationship between the real wage it pays and the effort exerted by its workers.

The marginal product of labor for this firm is given by MPN = E (100 - N)/9. How many workers will the firm employ?

A) 96 B) 92 C) 88 D) 80 Answer: A Diff: 3 Topic: Section: 11.1 Question Status: Previous Edition 12) A firm faces the following relationship between the real wage it pays and the effort exerted by its workers.

The marginal product of labor for this firm is given by MPN = E (50 - N)/3. How many workers will the firm employ?

A) 48 B) 46 C) 44 D) 40 Answer: A Diff: 3 Topic: Section: 11.1 Question Status: Previous Edition

4 .

13) In the efficiency wage model with the efficiency wage above the market-clearing wage, the level of employment depends on A) the intersection of labor supply and labor demand.

B) the marginal productivity of capital and the marginal productivity of labor.

C) labor demand alone.

D) labor supply alone.

Answer: C Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 14) In the efficiency wage model with the efficiency wage above the market-clearing wage, when employment is at its full-employment level, A) labor supply equals labor demand.

B) there is an excess supply of labor.

C) there is an excess demand for labor.

D) there could be either an excess demand for, or an excess supply of, labor.

Answer: B Diff: 2 Topic: Section: 11.1 Question Status: Previous Edition 15) In the efficiency wage model, an increase in productivity will cause A) no change in the real wage.

B) an increase in the real wage.

C) a decrease in the real wage.

D) an increase in both the real wage and the level of employment.

Answer: A Diff: 2 Topic: Section: 11.1 Question Status: Previous Edition 16) In the efficiency wage model, a decrease in productivity would A) decrease output but increase the real wage.

B) increase the real wage but have no effect on output.

C) decrease output but have no effect on the real wage.

D) have no effect on either output or the real wage.

Answer: C Diff: 2 Topic: Section: 11.1 Question Status: Previous Edition

5 .

17) In the efficiency wage model, if the real wage is higher than the market-clearing wage so that there is an excess supply of labor, A) firms will hire new workers at lower wages.

B) firms will replace high-paid workers with low-paid, formerly unemployed workers.

C) employers will not hire workers who are willing to work for a lower wage.

D) firms will demand a higher level of effort from existing employees.

Answer: C Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 18) According to the efficiency wage model, during a recession, firms will not reduce real wages because A) unions would go on strike, reducing profitability.

B) this would reduce worker effort and productivity.

C) the equilibrium real wage has increased.

D) legally, they can't.

Answer: B Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 19) The efficiency wage model can be modified to allow real wages to vary over the business cycle by assuming that A) workers' effort may depend on the unemployment rate and the real wage.

B) during a recession, labor supply will decrease, reducing the efficiency wage.

C) during a recession, productivity will fall, causing a reduction in the efficiency wage.

D) during a boom, labor demand will increase, causing the efficiency wage to rise.

Answer: A Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 20) In the Keynesian model, the real wage is mildly procyclical because A) demand for labor fluctuates with the demand for final goods.

B) firms take advantage of recessions to pay slightly lower wages, since there's excess labor supply.

C) workers' effort may depend on the unemployment rate and the real wage.

D) the supply of labor fluctuates with the business cycle.

Answer: C Diff: 2 Topic: Section: 11.1 Question Status: Previous Edition

6 .

21) In the efficiency wage model, an increase in productivity would A) increase output but decrease the real wage.

B) decrease the real wage but have no effect on output.

C) increase output but have no effect on the real wage.

D) have no effect on either output or the real wage.

Answer: C Diff: 2 Topic: Section: 11.1 Question Status: Previous Edition 22) In the Keynesian model, with efficiency wages, A) the full-employment line is determined where the quantity of labor demanded equals the quantity of labor supplied.

B) the full-employment level is determined at the intersection of the labor demand curve and the efficiency wage line.

C) an increase in labor supply increases employment.

D) a decrease in labor supply shifts the FE line to the left.

Answer: B Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 23) In the Keynesian model, the full-employment level of output is the amount of output produced when A) the quantity of labor demanded equals the quantity of labor supplied.

B) the market wage exceeds the efficiency wage.

C) labor is paid an efficiency wage, and the real wage equals the marginal product of labor.

D) the real wage exceeds the nominal wage.

Answer: C Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 24) Why might firms pay an efficiency wage rather than a market-clearing wage?

Answer: An efficiency wage is better than a market-clearing wage in that it maximizes effort per dollar of wage income paid to labor. This means that labor productivity per dollar spent on labor is maximized, which means that labor cost per unit of output is minimized. The giftexchange motive and the shirking model provide two explanations for why an efficiency wage that is above the market-clearing wage may increase productivity per wage dollar. The giftexchange motive suggests that workers who believe their employer is treating them fairly will want to do a good job. The shirking model views the wage as the reward that workers risk losing if they are so unproductive that they get fired; a higher wage increases productivity by increasing the expected cost of shirking (i.e., having low productivity).

Diff: 1 Topic: Section: 11.1 Question Status: Previous Edition 7 .

25) The effort of a firm's workers depends on their real wage according to the following schedule.

The marginal product of labor is MPN = E(400 - 4N)/30. (a) What is the efficiency wage? (b) How many workers will the firm hire? (c) Suppose an adverse productivity shock reduces the marginal product of labor to MPN = E(360 - 4N)/30. How would your answers to parts (a) and (b) change?

Answer: The following table shows the real wage (w), the effort level (E), and the effort per unit of real wages (E / w).

(a) The firm will pay a wage of 20, since that wage provides the maximum effort per unit of the real wage (E / w = 1.25). (b) The firm will employ 94 workers, since that is the number of workers for which w = MPN; 20 = 25(400 - 4N)/30, so 4N = 376, so N = 94. (c) No effect on efficiency wage; employment falls to N = 84.

Diff: 2 Topic: Section: 11.1 Question Status: Previous Edition

8 .

26) Describe how each of the following changes would affect the equilibrium in the labor market in terms of the level of the real wage and quantity of employment in equilibrium: (a) Increased immigration leads to higher labor supply at each real wage (b) The effort curve makes a parallel shift upward (c) Labor productivity increases (that is, the marginal product of labor increases at each level of employment).

Answer: (a) The increase in labor supply does not affect the effort curve, so does not affect the efficiency wage. Thus, there is no effect on the equilibrium real wage or employment. (b) The upward shift of the effort curve increases in efficiency wage; but with the marginal product of labor unchanged, the real wage increases and level of employment declines. (c) The higher marginal product of labor shifts the labor demand curve to the right, increasing the equilibrium level of employment. The real wage does not change because there is no change in the effort curve.

Diff: 2 Topic: Section: 11.1 Question Status: Previous Edition 11.2

Price Stickiness

1) A firm is a price taker if it A) always sells its output at the industry-determined price.

B) takes consumer demand into consideration in setting its price.

C) takes its production costs into consideration in setting its price.

D) uses a pricing strategy to gain market share.

Answer: A Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 2) In an economy where firms in most industries are purely competitive firms, individual firms in each industry would produce ________ products and have a ________ share of industry output.

A) differentiated; large B) differentiated; small C) standardized; large D) standardized; small Answer: D Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition

9 .

3) A model in which individual producers act as price setters, because there are only a few sellers and the product they sell is not standardized, is called A) imperfect competition.

B) perfect competition.

C) monopoly.

D) monopsony.

Answer: A Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 4) In the Keynesian model, firms are best characterized as A) perfectly competitive.

B) irrational.

C) price takers.

D) monopolistically competitive.

Answer: D Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 5) In an economy where firms in most industries are monopolistically competitive firms, individual firms in each industry would produce ________ products and have a ________ share of industry output.

A) differentiated; large B) differentiated; small C) standardized; large D) standardized; small Answer: A Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 6) When the demand for an imperfect competitor's product is greater than it planned, the firm will A) increase the price of the product until supply equals demand.

B) meet the demand at its set price.

C) reduce the price until supply equals demand.

D) allow a shortage of the product to develop, without changing the product's price.

Answer: B Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition

10 .

7) If the menu cost theory is true, then firms that change prices less frequently than other firms are likely to be in A) more competitive industries.

B) service, rather than manufacturing, industries.

C) growing, rather than declining, industries.

D) less competitive industries.

Answer: D Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 8) The theory that firms will be slow to change their products' prices in response to changes in demand because there are costs to changing prices is called A) transactions cost theory.

B) cost-benefit theory.

C) menu cost theory.

D) gift exchange theory.

Answer: C Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 9) In the Keynesian model, a firm's high menu costs cause A) real-wage rigidity.

B) full employment.

C) price stickiness.

D) efficiency wages.

Answer: C Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 10) According to the menu cost theory, firms will be slow in changing their prices because A) if prices changed frequently, individuals would reduce their demand for that good because of uncertainty.

B) frequent price changes would be a sign of monopolistic behavior.

C) the cost of changing the price might exceed the additional revenue the price change would generate.

D) demand for their product would fall because consumers would purchase goods from firms that had not raised their prices.

Answer: C Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition

11 .

11) The cost to a firm of producing one more unit of output A) usually exceeds the firm's price.

B) is significantly less than the firm's price for purely competitive firms operating in long-run equilibrium.

C) usually equals the firm's price for monopolistically competitive firms.

D) is the firm's marginal cost.

Answer: D Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 12) In setting the price of its product, a monopolistic competitor sets the price equal to its marginal cost plus an amount called the A) markup.

B) profit.

C) rent.

D) menu cost.

Answer: A Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 13) Firms that charge a price for their output in excess of marginal cost in the short run A) are not maximizing profits.

B) cannot find buyers for their output.

C) are charging a markup.

D) will suffer huge losses.

Answer: C Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 14) According to Nakamura and Steinsson's research, prices are ________ sticky than Bils and Klenow found because the latter failed to account for ________.

A) more; sales B) more; taxes C) less; taxes D) less; sales Answer: A Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition

12 .

15) If firms are price setters, a small decline in the demand for their outputs will cause them to A) reduce price and reduce the level of output produced.

B) reduce output in the short run, but reduce price in the long run.

C) reduce price in the short run, but reduce output only in the long run.

D) increase price in the short run to offset the effect on profits of a decline in output.

Answer: B Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 16) Because of price stickiness in the Keynesian model, a decline in investment demand will not cause the A) LM curve to shift down and to the right in the short run.

B) LM curve to shift in the long run.

C) IS curve to shift down and to the left in the short run.

D) IS curve to shift in the long run.

Answer: A Diff: 2 Topic: Section: 11.2 Question Status: Previous Edition 17) The idea behind the effective labor demand curve is that A) firms are willing to meet demand for their output at a specific price.

B) the marginal product of labor is not equal to the real wage.

C) demand is not as effective as supply.

D) demand is more effective than supply.

Answer: A Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 18) As the economy moves down an effective labor demand curve, A) output declines and employment declines.

B) output declines and employment rises.

C) output rises and employment rises.

D) output rises and employment declines.

Answer: A Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition

13 .

19) When the economy is not on the FE line and the price level is fixed, the ________ gives the level of employment.

A) effective labor demand curve B) production function C) IS curve D) LM curve Answer: A Diff: 1 Topic: Section: 11.2 Question Status: Previous Edition 20) Describe the empirical research on the stickiness of prices. Given some doubt on how sticky prices are, why is it nevertheless useful for the Keynesian model to assume that prices are sticky, especially when analyzing monetary policy?

Answer: Blinder and his students found a high degree of price stickiness, though Kashyap's results suggested that the stickiness may not arise because of menu costs. A more comprehensive study by Bils and Klenow found much less price stickiness than earlier; though Nakamura and Steinsson showed that some of the Bils-Klenow result came from failure to account for sales.

Boivin-Giannoni-Mihov found that prices are not sticky in response to supply or demand shocks in an industry, but they are sticky in the face of shocks to monetary policy. So, the price stickiness assumption is useful when analyzing monetary policy and other aggregate shocks.

Diff: 2 Topic: Section: 11.2 Question Status: Revised 21) In the Keynesian model in the short run, what is likely to happen to employment after each of the following shocks? (a) An increase in taxes (b) An increase in consumer spending generated by a reduced desire for saving (c) An increase in the money supply Answer: (a) The increase in taxes shifts the IS curve to the left, reducing output in the short run and thus employment, based on the effective labor demand curve. (b) The increase in consumer spending shifts the IS curve to the right, increasing output in the short run and thus employment, based on the effective labor demand curve. (c) The increase in the money supply shifts the LM curve to the right, increasing output in the short run and thus employment, based on the effective labor demand curve.

Diff: 2 Topic: Section: 11.2 Question Status: Previous Edition

14 .

11.3

Monetary and Fiscal Policy in the Keynesian Model

1) In the Keynesian model in the short run, the amount of employment is determined by the effective labor demand curve and the level of A) prices.

B) output.

C) the real interest rate.

D) the supply of labor.

Answer: B Diff: 1 Topic: Section: 11.3 Question Status: Previous Edition 2) In the Keynesian model, short-run equilibrium occurs A) where the IS and LM curves intersect.

B) where the IS curve, LM curve, and FE lines intersect.

C) where the IS curve intersects the FE line.

D) where the LM curve intersects the FE line.

Answer: A Diff: 1 Topic: Section: 11.3 Question Status: Previous Edition 3) In the Keynesian model, when the economy is not in long-run equilibrium, then the short-run equilibrium point is not on which curve?

A) SRAS B) FE C) IS D) LM Answer: B Diff: 1 Topic: Section: 11.3 Question Status: Previous Edition 4) In the Keynesian model in the short run, a decrease in the money supply will cause A) a decrease in output and an increase in the real interest rate.

B) an increase in the real interest rate but no change in output.

C) a decrease in the real interest rate and a decrease in output.

D) no change in either the real interest rate or output.

Answer: A Diff: 1 Topic: Section: 11.3 Question Status: Previous Edition

15 .

5) In the Keynesian model in the short run, an increase in the money supply will cause A) an increase in output and a decrease in the real interest rate.

B) a decrease in the real interest rate but no change in output.

C) an increase in the real interest rate and an increase in output.

D) no change in either the real interest rate or output.

Answer: A Diff: 1 Topic: Section: 11.3 Question Status: Previous Edition 6) The distinguishing feature that determines whether an analysis is classical or Keynesian is A) the speed of price adjustment.

B) the slope of the aggregate demand curve.

C) the degree of monopoly power in the economy.

D) the assumption about the transmission mechanism of monetary policy.

Answer: A Diff: 1 Topic: Section: 11.3 Question Status: Previous Edition 7) In the Keynesian model, money is A) neutral in both the short run and the long run.

B) neutral in neither the short run nor the long run.

C) neutral in the short run, but not in the long run.

D) neutral in the long run, but not in the short run.

Answer: D Diff: 1 Topic: Section: 11.3 Question Status: Previous Edition 8) In the Keynesian model in the long run, a decrease in the money supply will cause A) a decrease in output and an increase in the real interest rate.

B) an increase in the real interest rate but no change in output.

C) a decrease in the real interest rate and a decrease in output.

D) no change in either the real interest rate or output.

Answer: D Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition

16 .

9) In the Keynesian model in the long run, an increase in the money supply will cause A) an increase in output and a decrease in the real interest rate.

B) a decrease in the real interest rate but no change in output.

C) an increase in the real interest rate and an increase in output.

D) no change in either the real interest rate or output.

Answer: D Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 10) In the Keynesian model, which curve is vertical?

A) LRAS B) SRAS C) AD D) NS Answer: A Diff: 1 Topic: Section: 11.3 Question Status: Previous Edition 11) In the Keynesian model, which curve is horizontal?

A) LRAS B) SRAS C) AD D) NS Answer: B Diff: 1 Topic: Section: 11.3 Question Status: New 12) In the Keynesian model, which curve is downward-sloping?

A) LRAS B) SRAS C) AD D) NS Answer: C Diff: 1 Topic: Section: 11.3 Question Status: New

17 .

13) In the Keynesian model, which curve is downward-sloping?

A) LRAS B) SRAS C) IS D) LM Answer: C Diff: 1 Topic: Section: 11.3 Question Status: New 14) In the Keynesian model in the long run, a decrease in the money supply will cause ________ in the real interest rate and ________ in the price level.

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: D Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 15) In the Keynesian model in the long run, an increase in the money supply will cause ________ in the real interest rate and ________ in the price level.

A) an increase; an increase B) a decrease; a decrease C) no change; an increase D) no change; a decrease Answer: C Diff: 2 Topic: Section: 11.3 Question Status: New 16) According to Keynesians, the primary reason money is not neutral is A) rational expectations.

B) price stickiness.

C) reverse causation.

D) misperceptions over the aggregate price level.

Answer: B Diff: 1 Topic: Section: 11.3 Question Status: Previous Edition

18 .

17) In the Keynesian model in the long run, an increase in the money supply will raise A) the price level but not the level of output.

B) the level of output but not the price level.

C) both the level of output and the price level.

D) neither the level of output nor the price level.

Answer: A Diff: 1 Topic: Section: 11.3 Question Status: Previous Edition 18) In the Keynesian model, if equilibrium output is less than the full-employment level of output in the short run, A) the price level will rise in the long run.

B) the price level will decline in the long run.

C) the LM curve will shift up and to the left in the long run.

D) the FE line will shift to the left in the long run.

Answer: B Diff: 1 Topic: Section: 11.3 Question Status: New 19) In the Keynesian model, if equilibrium output is more than the full-employment level of output in the short run, A) the price level will rise in the long run.

B) the price level will decline in the long run.

C) the LM curve will shift down and to the right in the long run.

D) the FE line will shift to the left in the long run.

Answer: A Diff: 1 Topic: Section: 11.3 Question Status: New 20) In the Keynesian model, if equilibrium output is more than the full-employment level of output in the short run, A) the LM curve will shift up and to the left to restore general equilibrium.

B) the FE line will shift to the right to restore general equilibrium.

C) the LM curve will shift down and to the right to restore general equilibrium.

D) the FE line will shift to the left to restore general equilibrium.

Answer: A Diff: 1 Topic: Section: 11.3 Question Status: New

19 .

21) In the Keynesian model, if equilibrium output is less than the full-employment level of output in the short run, A) the LM curve will shift up and to the left to restore general equilibrium.

B) the FE line will shift to the right to restore general equilibrium.

C) the LM curve will shift down and to the right to restore general equilibrium.

D) the FE line will shift to the left to restore general equilibrium.

Answer: C Diff: 1 Topic: Section: 11.3 Question Status: New 22) Using the Keynesian model, the effect of an increase in the effective tax rate on capital would be to cause ________ in the real interest rate and ________ in output in the short run.

A) a decrease; a decrease B) a decrease; no change C) an increase; an increase D) no change; a decrease Answer: A Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 23) Using the Keynesian model, the effect of a decrease in the effective tax rate on capital would be to cause ________ in the real interest rate and ________ in output in the short run.

A) a decrease; a decrease B) a decrease; no change C) an increase; an increase D) no change; a decrease Answer: C Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 24) Using the Keynesian model, the effect of a decrease in the effective tax rate on capital would be to cause ________ in the real interest rate and ________ in output in the long run.

A) an increase; no change B) a decrease; no change C) an increase; an increase D) no change; a decrease Answer: A Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition

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25) Using the Keynesian model, the effect of a government-imposed ceiling on interest rates paid on personal checking accounts that is lower than the current market interest rate would be to cause ________ in the real interest rate and ________ in output in the short run.

A) a decrease; a decrease B) a decrease; no change C) a decrease; an increase D) an increase; a decrease Answer: C Diff: 3 Topic: Section: 11.3 Question Status: Previous Edition 26) In the Keynesian model, an increase in government purchases affects output by A) increasing labor supply, because workers feel effectively poorer.

B) increasing saving to pay for future taxes, lowering the real interest rate and shifting the IS curve to the left.

C) increasing the real interest rate due to crowding out, reducing aggregate demand.

D) increasing aggregate demand as national saving declines.

Answer: D Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 27) In the Keynesian model in the short run, a decrease in government purchases causes output to ________ and the real interest rate to ________.

A) fall; rise B) fall; fall C) rise; rise D) rise; fall Answer: B Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 28) In the Keynesian model in the long run, an increase in taxes causes the price level to ________ and the real interest rate to ________.

A) fall; rise B) fall; fall C) rise; rise D) rise; fall Answer: B Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition

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29) In the Keynesian model in the long run, a decrease in taxes causes the price level to ________ and the real interest rate to ________.

A) fall; rise B) fall; fall C) rise; rise D) rise; fall Answer: C Diff: 2 Topic: Section: 11.3 Question Status: New 30) Suppose the government decided to tighten monetary policy and decrease government expenditures. In the short run in the Keynesian model, the effect of these policies would be to ________ the real interest rate and ________ the level of output.

A) lower; decrease B) lower; have an ambiguous effect on C) have an ambiguous effect on; decrease D) raise; decrease Answer: C Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 31) Suppose the government decided to ease monetary policy, then increase taxes. In the short run in the Keynesian model, the effect of these policies would be to ________ the real interest rate and ________ the level of output.

A) lower; increase B) lower; decrease C) lower; have an ambiguous effect on D) have an ambiguous effect on; increase Answer: C Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 32) The 1980s were characterized by ________ monetary policy and ________ fiscal policy.

A) tight; easy B) tight; tight C) easy; easy D) easy; tight Answer: A Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition

22 .

33) Easy monetary policy and tight fiscal policy lead to A) high real interest rates.

B) low real interest rates.

C) roughly unchanged real interest rates.

D) roughly unchanged real interest rates only when Ricardian equivalence holds; otherwise, low real interest rates.

Answer: B Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 34) A monopolistically competitive firm prices its product using the markup pricing formula P = 1.25MC, where MC is the marginal cost of producing an additional unit. Suppose the demand for the firm's product is given by Q = 2000 - 0.1P, so the revenue from selling Q units of the product is PQ = 2000P - 0.1P2. (a) If the marginal cost of producing each unit of the product is $10,000, calculate the price of the product, the quantity produced, and the firm's revenues, costs, and profits. (b) Now suppose the marginal cost rises to $11,000. The firm can keep the price of the product unchanged, or it can change the product's price at a total cost of $700,000. Calculate the price, quantity, revenues, costs, and profits as in part (a) both for changing the price and leaving the price unchanged. Should the firm change the price of its product?

Answer: (a) P = $12,500, Q = 750, revenues = $9.375 million, costs = $7.5 million, profit = $1.875 million. (b) If price is unchanged, quantity and revenues remain the same, while costs rise to $8.25 million and profits fall to $1.125 million. If the firm raises its price, P = $13,750, Q = 625, revenues = $8.59375 million, costs = $6.875 million + $0.7 million = $7.575 million, and profit = $1.01875 million. So the firm should leave the price unchanged.

Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition

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35) (a) Draw a figure, using the Keynesian IS-LM framework, of an economy in recession. (b) Now suppose the IS curve shifts up and to the right far enough that if the real interest rate is unchanged, output will increase beyond full employment. If the Fed's goal is to move output to its full-employment level, what must happen to the real interest rate? What is the effect on the price level? (c) Suppose, before the Fed can act, that the government announces a restrictive fiscal policy, shifting the IS curve down and to the left relative to its position in part (b) What is the Fed likely to do (relative to what it would do if fiscal policy wasn't restrictive) if its goal is to target fullemployment output? What happens to the real interest rate relative to what it is in part (b)?

Answer: (a) The figure should be drawn such that the IS and LM curves intersect to the left of the FE line. (b) The Fed would shift the LM curve to restore general equilibrium. The real interest rate would rise but the price level wouldn't change. (c) Tighter fiscal policy means the Fed shifts the LM curve down and to the right relative to what it would do in part (b). As a result, the real interest rate doesn't rise as much.

Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 36) (a) Draw a figure, using the Keynesian IS-LM framework, of an economy in recession. (b) If the Fed's goal is to move output to its full-employment level, what should it do with monetary policy? What will happen to the real interest rate? What is the effect on the price level?

Show the result in your diagram. (c) Suppose the Fed decides to keep the money supply unchanged. How could the government use fiscal policy to move the economy to full employment? Show the result in your diagram. (d) How does the real interest rate differ between parts (b) and (c)?

Answer: (a) The figure should be drawn such that the IS and LM curves intersect to the left of the FE line. (b) The Fed would increase the money supply. This will shift the LM curve down and to the right to restore general equilibrium. The real interest rate would fall but the price level wouldn't change. (c) The use of easier fiscal policy means the IS curve would shift up and to the right. This would restore full-employment output. (d) The real interest rate would be higher in part (c) than in part (b).

Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition

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37) According to the Keynesian IS-LM model, what is the effect of each of the following on output, the real interest rate, employment, and the price level? Distinguish between the short run and the long run. (a) Expected inflation rises. (b) Wealth increases. (c) Labor supply decreases due to a change in demographics. (d) The future marginal product of capital decreases.

Answer: (a) Short run: Y and N increase; r falls; P is unchanged. Long run: P rises; Y, r, and N are unchanged. (b) Short run: Y, r, and N increase; P is unchanged. Long run: r and P rise; Y and N are unchanged. (c) Nothing happens to any of the variables. (d) Short run: Y, r, and N fall; P is unchanged. Long run: r and P fall; Y and N are unchanged.

Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 38) According to the Keynesian IS-LM model, what is the effect of each of the following on output, the real interest rate, employment, and the price level? Distinguish between the short run and the long run. (a) Expected inflation decreases. (b) Labor supply increases due to a change in demographics. (c) The future marginal product of capital increases.

Answer: (a) Short run: Y and N decrease; r rises; P is unchanged. Long run: P falls; Y, r, and N are unchanged. (b) Nothing happens to any of the variables. (c) Short run: Y, r, and N rise; P is unchanged. Long run: r and P rise; Y and N are unchanged.

Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition

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39) A Keynesian economy is described by the following equations.

Cd = 250 + 0.5(Y - T) - 250r Id = 250 - 250r G = 300 T = 300 L = 0.5Y - 500r + πe M = 3000 = 1250 πe = 0 (a) Calculate the values of the real interest rate, the price level, consumption, and investment for the economy in general equilibrium. (b) Now suppose government purchases increase to 350 with no change in taxes. What will be the real interest rate, the price level, output, consumption, and investment in the short run? (c) What will be the real interest rate, the price level, output, consumption, and investment in the long run?

Answer: (a) r = 0.05, P = 5, C = 712.5, I = 237.5 (b) r = 0.10, P = 5, Y = 1300, C = 725, I = 225 (c) r = 0.15, P = 5.4545, Y = 1250, C = 687.5, I = 212.5 Diff: 3 Topic: Section: 11.3 Question Status: Previous Edition

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40) The following equations describe a Keynesian model of the economy.

Cd = 500 + 0.5(Y - T) - 100r Id = 350 - 100r L = 0.5Y - 200i πe = 0.05, G = T = 200, = 1850 M = 3560 (a) Find the full-employment equilibrium values of the real interest rate, consumption, investment, and the price level. (b) Suppose government purchases decline to 175, with no change in taxes. What happens to the real interest rate, output, consumption, and investment in the short run (in which the price level is fixed)? What happens in the long run to the real interest rate, consumption, investment, and the price level? (c) Suppose instead that government purchases rise to 225, with no change in taxes, starting from the equilibrium in part (a). What happens to the real interest rate, output, consumption, and investment in the short run (in which the price level is fixed)? What happens in the long run to the real interest rate, consumption, investment, and the price level?

Answer: (a) Sd = Y - Cd - G = 0.5Y - 400 + 100r - G. Set Sd = Id: 0.5Y - 400 + 100r - G = 350 - 100r, so 200r = (750 + G) - 0.5Y (IS).

With G = 200 and Y = 1850, r = 0.125. Then C = 1312.5 and I = 337.5.

3560/P = (0.5 × 1850) - (200 × .175) = 925 - 35 = 890, so P = 4. (b) With P = 4, the LM curve is 3560/4 = 0.5Y - 200r - (200 × 0.05), or 0.5Y = 900 + 200r.

Combining this with the IS curve gives Y = 1650 + G. For G = 175, Y = 1825, so r = 0.0625, C = 1306.25, I = 343.75 in the short run.

In the long run, Y = 1850, so r = 0, C = 1325, I = 350, P = 3.891. (c) For G = 225, Y = 1875, so r = 0.1875, C = 1318.75, I = 331.25 in the short run.

In the long run, Y = 1850, so r = 0.25, C = 1300, I = 325, P = 4.116.

Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition

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41) Suppose the economy's production function is Y = A(300N - N2). The marginal product of labor is MPN = A(300 - 2N). Suppose that A = 10. The supply of labor is NS = 0.05w + 0.005G. (a) If G is 26,000, what are the real wage, employment, and output? (b) If G rises to 26,400, what are the real wage, employment, and output? (c) If G falls to 25,600, what are the real wage, employment, and output? (d) In cases (b) and (c), what is the government purchases multiplier; that is, what is the change in output divided by the change in government purchases?

Answer: (a) Setting labor supply equal to labor demand gives N = 0.05 × 10 × (300 - 2N) + 0.005G, which can be simplified to get N = 75 + 0.0025G. With G = 26,000, N = 140.

Then w = 10 × [300 - (2 × 140)] = 200 and Y = 10 × [(300 × 140) - 1402] = 224,000. (b) Following the same procedure gives N = 141, w = 180, and Y = 224,190. (c) N = 139, w = 220, and Y = 223,790. (d) In part (b), the multiplier is 190/400 = 0.475. In part (c), the multiplier is 210/400 = 0.525.

Diff: 2 Topic: Section: 11.3 Question Status: Previous Edition 11.4

The Keynesian Theory of Business Cycles and Macroeconomic Stabilization

1) According to Keynesians, the primary source of business cycle fluctuations is A) aggregate demand shocks.

B) productivity shocks.

C) oil price shocks.

D) consumer confidence shocks.

Answer: A Diff: 1 Topic: Section: 11.4 Question Status: Previous Edition 2) Keynesians believe that the most important shocks for affecting the business cycle are A) productivity shocks.

B) aggregate supply shocks.

C) aggregate demand shocks.

D) government spending shocks.

Answer: C Diff: 1 Topic: Section: 11.4 Question Status: Previous Edition

28 .

3) Examples of aggregate demand shocks include all of the following except changes in A) fiscal policy.

B) the price of oil.

C) consumer confidence about the future that affects desired saving.

D) the demand for money.

Answer: C Diff: 1 Topic: Section: 11.4 Question Status: New 4) The Keynesian theory is consistent with the business cycle fact that inflation is A) procyclical and leading.

B) procyclical and lagging.

C) countercyclical and leading.

D) countercyclical and lagging.

Answer: B Diff: 1 Topic: Section: 11.4 Question Status: Previous Edition 5) The idea that firms retain some workers in a recession, whom they would otherwise lay off, to avoid the costs of hiring and training, is called A) the gift exchange motive.

B) worker pooling.

C) labor hoarding.

D) union busting.

Answer: C Diff: 1 Topic: Section: 11.4 Question Status: Previous Edition 6) Keynesians explain the procyclical behavior of average labor productivity by introducing the concept of A) menu costs.

B) sticky prices.

C) labor hoarding.

D) sticky wages.

Answer: C Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition

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7) The use of macroeconomic policies to smooth or moderate the business cycle is known as A) aggregate demand management.

B) aggregate supply management.

C) automatic stabilization.

D) discretionary policy.

Answer: A Diff: 1 Topic: Section: 11.4 Question Status: Previous Edition 8) In the Keynesian model, the difference between using monetary and fiscal policy to eliminate a recession is that A) monetary policy will eliminate a recession quicker than fiscal policy will.

B) fiscal policy will eliminate a recession quicker than monetary policy will.

C) an expansionary monetary policy will leave the economy with a lower real interest rate than an expansionary fiscal policy.

D) an expansionary fiscal policy will leave the economy with a lower real interest rate than an expansionary monetary policy.

Answer: C Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 9) In the Keynesian model, the difference between no intervention by the government during a recession and intervention using expansionary monetary or fiscal policy is that no intervention will return the economy to its equilibrium level of output A) faster than intervention will and at a lower price level.

B) slower than intervention will and at a higher price level.

C) slower than intervention will and at a lower price level.

D) faster than intervention will and at a higher price level.

Answer: C Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 10) Keynesians believe that the difference between using an increase in the money supply compared with an increase in government spending to increase aggregate demand in the event of a recession is that if government spending is increased, ________ will be ________ than if the money supply is increased.

A) real interest rate; higher B) real interest rate; lower C) the price level; lower D) the price level; higher Answer: A Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 30 .

11) Tight monetary policy and easy fiscal policy lead to A) high real interest rates.

B) low real interest rates.

C) roughly unchanged real interest rates.

D) roughly unchanged real interest rates only when Ricardian equivalence holds; otherwise, low real interest rates.

Answer: A Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 12) During a severe and persistent recession, Keynesians would most likely propose A) tax increases.

B) a tight money policy.

C) annually balanced federal budgets.

D) macroeconomic stabilization.

Answer: D Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 13) Keynesians believe that in the event of a recession, the government should consider A) increasing taxes.

B) decreasing government spending.

C) increasing the money supply.

D) increasing the minimum wage.

Answer: C Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 14) In practice, one of the principal problems with aggregate demand management is that A) changes in aggregate demand do not affect output.

B) changes in aggregate demand cannot reduce unemployment.

C) changes in aggregate demand are highly inflationary.

D) stabilization policies could increase aggregate demand too much and at the wrong times.

Answer: D Diff: 1 Topic: Section: 11.4 Question Status: Previous Edition

31 .

15) A problem with the use of aggregate demand management to stabilize the business cycle is that A) monetary policy isn't available to use when interest rates are already rising because of higher inflation.

B) fiscal policy takes a long time to have any impact on the economy.

C) monetary policy is difficult to use, because the decision-making process is long and complicated.

D) the precise amount that output will change in response to monetary or fiscal policy isn't known.

Answer: D Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 16) In the long run in the Keynesian model, a beneficial supply shock would leave the economy with a higher level of output, but also a ________ real interest rate and a ________ price level.

A) higher; lower B) lower; higher C) lower; lower D) higher; higher Answer: C Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 17) In the short run in the Keynesian model, a sharp increase in oil prices would leave the economy with a ________ level of output and a ________ real interest rate.

A) higher; lower B) lower; higher C) lower; lower D) higher; higher Answer: B Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 18) In the short run in the Keynesian model, a sharp decline in oil prices would leave the economy with a ________ level of output and a ________ real interest rate.

A) higher; lower B) lower; higher C) lower; lower D) higher; higher Answer: A Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 32 .

19) Recent research by Keynesians and classicals has led to A) a reconciliation of the types of models they use.

B) the recognition by classical economists that prices adjust very slowly.

C) convincing evidence that TFP shocks are the dominant force affecting the business cycle.

D) the refutation of the efficiency wage model.

Answer: A Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 20) Keynesians think the price level adjusts ________ to restore general equilibrium and they usually use ________ models.

A) slowly; aggregate B) slowly; microfoundations C) quickly; aggregate D) quickly; microfoundations Answer: A Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 21) Classical macroeconomists think that supply shocks are ________ than demand shocks and that government intervention in the economy is ________.

A) more important; usually unwarranted B) more important; often vital C) less important; usually unwarranted D) less important; often vital Answer: A Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 22) Classical macroeconomists think that the best models are ________ and that inflation expectations ________.

A) dynamic; matter B) dynamic; do not matter C) static; do not matter D) static; matter Answer: A Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition

33 .

23) Do the real effects of aggregate demand shocks differ in the short run and long run in the Keynesian sticky-price model from the effects of these shocks in the classical model of perfectly flexible prices? Briefly explain.

Answer: In the Keynesian model, aggregate demand shocks affect real output, employment, and unemployment in the short run. There is no short-run adjustment period in the classical model, since economic shocks cause prices to adjust immediately to their long-run, general equilibrium values. Keynesian and classical economists agree that aggregate demand shocks have no real output or employment effects in the long run.

Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 24) Do Keynesians and classicals agree on the effectiveness and desirability of macroeconomic stabilization? Briefly explain.

Answer: No, Keynesians and classical economists disagree on the effectiveness and desirability of macroeconomic stabilization. In the classical model, business cycles fluctuations are the optimal response of the economy to various shocks that hit the economy; thus they should not be offset by macroeconomic policy. In the Keynesian model, large and persistent business cycle fluctuations are usually caused by aggregate demand shocks in the presence of price stickiness.

Macroeconomic stabilization policies can effectively reduce business cycle fluctuations, so these policies are desirable in that they can help the economy to maintain output at the fullemployment level.

Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 25) You are the liaison between the Federal Reserve Board and the U.S. Treasury Department.

Your goal is to coordinate policy efforts to achieve full-employment output in the economy while keeping a fixed real interest rate. You must recommend tightening or easing both monetary and fiscal policies to do this. What would your recommendation be in each of the following situations? (a) People decide to increase saving. (b) Expected inflation declines. (c) The future marginal productivity of capital declines. (d) There's an adverse oil price shock in which the LM curve moves farther to the left than does the FE line.

Answer: (a) Loosen fiscal policy, no change in monetary policy (b) Ease monetary policy, no change in fiscal policy (c) Ease fiscal policy, no change in monetary policy (d) Tighten fiscal policy, ease monetary policy Diff: 3 Topic: Section: 11.4 Question Status: Previous Edition

34 .

26) You are the chairperson of the Board of Governors of the Federal Reserve. You believe in a Keynesian model of the economy, and your goal is to keep the economy at the full-employment level of output. How would you respond (tightening or easing policy) in each of the following cases? (a) Government purchases increase (b) Corporate tax rates increase (c) Expected inflation increases (d) There's a beneficial oil price shock (and the LM curve shifts more to the right than the FE line) Answer: (a) Tighten (b) Ease (c) Tighten (d) Tighten Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition 27) Describe the situation of the Japanese economy in the 1990s. What should the Japanese government have done differently, according to critics, to improve the economy?

Answer: The nominal interest rate was essentially zero in Japan. Japan was in a liquidity trap, in which monetary policy alone became ineffective. Japan should have used more expansionary fiscal policy, along with expansionary monetary policy, to escape the trap.

Diff: 1 Topic: Section: 11.4 Question Status: Previous Edition 28) In the Keynesian model, what are the effects (on output, the real interest rate, and the price level) of an adverse productivity (i.e., aggregate supply) shock?

Answer: When there's an adverse productivity shock, the long-run aggregate supply curve shifts to the left, while the aggregate demand curve doesn't shift, and the short-run aggregate supply curve shifts up as well. As a result, output decreases and the price level rises (assuming the shortrun aggregate supply curve shifts sufficiently far up). The productivity shock shifts the FE line to the left, while the rise in the price level shifts the LM curve up and to the left. At the new intersection of the IS and LM curves, the real interest rate is higher. Assuming the LM curve shifts sufficiently far, in the long run, the price level must fall to restore general equilibrium.

This reduces the real interest rate somewhat, but it remains higher than it was initially. The fall in the price level shifts the short-run aggregate supply curve down, so output rises somewhat, but remains less than it was initially. The price level also remains higher than it was initially.

Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition

35 .

29) Describe the effects of an oil price shock in a Keynesian model; why are such supply shocks difficult to handle using macroeconomic stabilization policies?

Answer: The FE line shifts left, the LM curve even more so, so the economy enters a recession.

The price level rises immediately, the real interest rate rises, and output declines.

Macroeconomic stabilization policy can't restore output to its previous level, for the attempt to do so will cause inflation. Even restoring the economy to its (lower) full-employment level of output is difficult without risking even higher inflation.

Diff: 1 Topic: Section: 11.4 Question Status: Previous Edition 30) For each of the following changes, what happens to the real interest rate and output in the long run, after the price level has adjusted to restore general equilibrium? How would the results differ, if at all, between the classical and Keynesian model? Draw a diagram for each part to illustrate your result. (a) Wealth rises. (b) Money supply rises. (c) The future marginal productivity of capital increases. (d) Expected inflation declines. (e) Future income declines.

Answer: (a) The IS curve shifts up and to the right, so r rises and Y rises. (b) The LM curve shifts down and to the right, so r falls and Y rises. (c) The IS curve shifts up and to the right, so r rises and Y rises. (d) The LM curve shifts up and to the left, so r rises and Y falls. (e) The IS curve shifts down and to the left, so r falls and Y falls.

Diff: 2 Topic: Section: 11.4 Question Status: Previous Edition

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Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 12 Unemployment and Inflation 12.1

Unemployment and Inflation: Is There a Trade-Off?

1) The origin of the idea of a trade-off between inflation and unemployment was a 1958 article by A) A.W. Phillips.

B) Edmund Phelps.

C) Milton Friedman.

D) Robert Gordon.

Answer: A Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 2) Phillips's research looked at British data on A) unemployment and inflation.

B) unemployment and nominal wage growth.

C) inflation and nominal wage growth.

D) unemployment and output.

Answer: B Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 3) The negative relationship between unemployment and inflation is known as the A) aggregate supply curve.

B) aggregate demand curve.

C) Phillips curve.

D) efficiency wage line.

Answer: C Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 4) The Phillips curve is a negative empirical relationship between A) bond prices and interest rates.

B) unemployment and output.

C) inflation and the real interest rate.

D) unemployment and inflation.

Answer: D Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition

1 .

5) The Phillips curve appeared to fit the data well for the United States in the A) 1960s.

B) 1970s.

C) 1980s.

D) 1990s.

Answer: A Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 6) The Phillips curve suggests that monetary policymakers could use monetary policy to A) reduce the unemployment rate at the expense of higher inflation.

B) reduce the unemployment rate while reducing inflation.

C) reduce the unemployment rate without affecting the inflation rate.

D) reduce inflation without affecting the unemployment rate.

Answer: A Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 7) Cyclical unemployment is caused by A) people entering the labor force to search for jobs.

B) technological progress, which causes some industries to expand employment and others to reduce employment.

C) reducing international trade barriers, which causes some industries to expand employment and others to reduce employment.

D) recessions.

Answer: D Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 8) Friedman and Phelps suggested that there should not be a stable relationship between inflation and unemployment, but there should be a stable relationship between A) anticipated inflation and frictional unemployment.

B) anticipated inflation and cyclical unemployment.

C) unanticipated inflation and frictional unemployment.

D) unanticipated inflation and cyclical unemployment.

Answer: D Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition

2 .

9) Milton Friedman and Edmund Phelps questioned A) the use of expectations in the Phillips curve.

B) the stability of the relationship between inflation and unemployment.

C) the existence of a natural rate of unemployment.

D) the existence of a full-employment level of output.

Answer: B Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 10) In the extended classical model, an anticipated decrease in the money supply would cause output to ________ and the price level to ________ in the short run.

A) increase; decrease B) increase; remain unchanged C) remain unchanged; increase D) remain unchanged; decrease Answer: D Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 11) In the extended classical model, an unanticipated increase in the money supply would cause output to ________ and the price level to ________ in the short run.

A) increase; increase B) decrease; remain unchanged C) remain unchanged; increase D) decrease; decrease Answer: A Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 12) In the extended classical model, an unexpected decrease in aggregate demand would cause unanticipated inflation to be ________ and cyclical unemployment to be ________.

A) positive; negative B) positive; positive C) negative; negative D) negative; positive Answer: D Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition

3 .

13) Based on the theory of the expectations-augmented Phillips curve, if the expected inflation rate is 2%, the short-run Phillips curve will A) have a kink at an inflation rate of 2%.

B) be the same as the long-run Phillips curve.

C) intersect the long-run Phillips curve at the natural unemployment rate, when the inflation rate is 2%.

D) be horizontal at an expected inflation rate of 2%.

Answer: C Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 14) In the expectations-augmented Phillips curve, π = πe - 3(u - ). If π = 0.03 when πe = 0.06 and u = 0.06, then = A) 0.02.

B) 0.03.

C) 0.04.

D) 0.05.

Answer: D Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition 15) In the expectations-augmented Phillips curve, π = πe - 3(u - ). If π = 0.06 when πe = 0.06 and u = 0.04, then = A) 0.02.

B) 0.03.

C) 0.04.

D) 0.05.

Answer: C Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition 16) In the expectations-augmented Phillips curve, π = πe - 3(u - ). If π = -0.03 when πe = 0.06 and u = 0.06, then = A) 0.02.

B) 0.03.

C) 0.04.

D) 0.05.

Answer: B Diff: 2 Topic: Section: 12.1 Question Status: Revised 4 .

17) In the expectations-augmented Phillips curve, π = πe - 3(u - 0.06). When π = 0.06 and πe = 0.03, the unemployment rate is A) 0.04.

B) 0.05.

C) 0.06.

D) 0.07.

Answer: B Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition 18) In the expectations-augmented Phillips curve, π = πe - 3(u - 0.05). When π = 0.06 and πe = 0.03, the unemployment rate is A) 0.04.

B) 0.05.

C) 0.06.

D) 0.07.

Answer: A Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition 19) In the expectations-augmented Phillips curve, π = πe - 3(u - 0.05). When π = 0.03 and πe = 0.06, the unemployment rate is A) 0.04.

B) 0.05.

C) 0.06.

D) 0.07.

Answer: C Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition 20) In the expectations-augmented Phillips curve, π = πe - 3(u - 0.05). The natural unemployment rate is A) 0.02.

B) 0.03.

C) 0.05.

D) 0.18.

Answer: C Diff: 1 Topic: Section: 12.1 Question Status: Revised

5 .

21) Based on the expectations-augmented Phillips curve, if the natural rate of unemployment is 0.06, and if the actual inflation rate exceeds the expected inflation rate, then the unemployment rate is A) less than 0.06.

B) 0.06.

C) more than 0.06.

D) 0.06 plus 0.5 times the difference between actual and expected inflation.

Answer: A Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition 22) The short-run Phillips curve is the relation between inflation and unemployment that holds for a given natural rate of unemployment and a A) given rate of inflation.

B) given expected rate of inflation.

C) given level of unemployment.

D) given expected level of unemployment.

Answer: B Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 23) Suppose most people had anticipated that inflation would be 3% in the coming year because the Fed would increase the money supply by 3%. Instead, the Fed increases the money supply by 5%. In the short run, this would cause actual output to be ________ full-employment output and prices to increase by ________ 3%.

A) above; more than B) above; less than C) below; more than D) below; less than Answer: A Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition

6 .

24) Suppose most people had anticipated that inflation would be 10% in the coming year because the Fed would increase the money supply by 10%. Instead, the Fed increases the money supply by 5%. In the short run, this would cause actual output to be ________ full-employment output and prices to increase by ________ 5%.

A) above; more than B) above; less than C) below; more than D) below; less than Answer: C Diff: 1 Topic: Section: 12.1 Question Status: New 25) An increase in the expected rate of inflation would A) shift the short-run Phillips curve upward.

B) shift the short-run Phillips curve downward.

C) shift the long-run Phillips curve to the right.

D) shift the long-run Phillips curve to the left.

Answer: A Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 26) If the expected inflation rate is unchanged, a fall in the natural rate of unemployment would A) shift the short-run Phillips curve to the right.

B) not shift the short-run Phillips curve.

C) shift the short-run Phillips curve to the left.

D) shift the short-run Phillips curve to the left and shift the long-run Phillips curve to the right.

Answer: C Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 27) If the expected inflation rate is unchanged, a rise in the natural rate of unemployment would A) shift both the short-run and long-run Phillips curves to the right.

B) not shift either the short-run or long-run Phillips curves.

C) shift both the short-run and long-run Phillips curves to the left.

D) shift the short-run Phillips curve to the left and shift the long-run Phillips curve to the right.

Answer: A Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition

7 .

28) If the expected rate of inflation rose at the same time the natural rate of unemployment rose, the short-run Phillips curve A) would shift down.

B) would shift up.

C) would not move.

D) might shift up or down or not move, depending on which effect was larger.

Answer: B Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 29) A beneficial supply shock would cause A) a movement up the short-run Phillips curve.

B) a movement down the short-run Phillips curve.

C) the short-run Phillips curve to shift upward and to the right.

D) the short-run Phillips curve to shift downward and to the left.

Answer: D Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 30) An adverse supply shock would cause A) a movement up the short-run Phillips curve.

B) a movement down the short-run Phillips curve.

C) the short-run Phillips curve to shift upward and to the right.

D) the short-run Phillips curve to shift downward and to the left.

Answer: C Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 31) The short-run Phillips curve would shift upward and to the right if there were A) a decrease in the expected inflation rate.

B) a decrease in the natural rate of unemployment.

C) an adverse supply shock.

D) a beneficial supply shock.

Answer: C Diff: 1 Topic: Section: 12.1 Question Status: New

8 .

32) Classicals argue that an adverse supply shock would A) raise neither the natural rate of unemployment nor the actual rate of unemployment.

B) raise the actual rate of unemployment, but not the natural rate of unemployment.

C) raise the natural rate of unemployment, but not the actual rate of unemployment.

D) raise both the natural rate of unemployment and the actual rate of unemployment.

Answer: D Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition 33) Historically, Brazil has suffered higher and more variable rates of inflation than Venezuela.

You would expect the short-run aggregate supply curve of Brazil to be ________ than that of Venezuela, and the short-run Phillips curve of Brazil to be ________ than that of Venezuela.

A) flatter; flatter B) flatter; steeper C) steeper; flatter D) steeper; steeper Answer: D Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition 34) The Friedman-Phelps analysis shows that a negative relationship between inflation and unemployment holds A) even when expected inflation changes.

B) even when the natural rate of unemployment changes.

C) even if both the expected inflation rate and the natural rate of unemployment change.

D) as long as the expected inflation rate and the natural rate of unemployment are approximately constant.

Answer: D Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 35) The short-run Phillips curve shifted during the 1970s primarily because of A) the two large oil price shocks.

B) the changing demographics of the population.

C) tight monetary policy.

D) easy fiscal policy.

Answer: A Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition

9 .

36) Examining data on cyclical unemployment plotted against unanticipated inflation shows A) a positive relationship.

B) a negative relationship.

C) no significant relationship.

D) a relationship only during the 1960s.

Answer: B Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 37) The Friedman-Phelps analysis suggests that there is a long-term relationship between A) inflation and unemployment.

B) cyclical inflation and structural unemployment.

C) unanticipated inflation and cyclical unemployment.

D) anticipated inflation and structural unemployment.

Answer: C Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition 38) An analysis of the American economy since 1960 shows that there is a stable relationship between inflation and unemployment A) only in the short run.

B) only in the long run.

C) in neither the short run nor the long run.

D) in both the short run and the long run.

Answer: A Diff: 1 Topic: Section: 12.1 Question Status: Previous Edition

10 .

39) State and briefly explain whether or not the empirical evidence generally supports the belief that there is a fixed trade-off between unemployment and inflation, such that monetary policymakers can achieve the combination they prefer.

Answer: The Phillips curve suggests that there is a stable set of unemployment rate and inflation rate combinations, and that monetary policymakers could achieve the combination they prefer. The macroeconomic data for the 1950s and 1960s for many countries seemed consistent with this view, but further research using data for the 1970s and 1980s failed to show that a stable trade-off exists. The empirical evidence suggests that a stable trade-off exists only during the time period in which expected inflation and the natural unemployment rate remain unchanged. The extended classical model suggests that a nonsystematic expansionary monetary policy attempt to move up a fixed expectations-augmented Phillips curve to a lower unemployment rate and higher inflation rate will achieve its objective only for the short-run period in which the increase in inflation is not anticipated. Systematic monetary policies will be anticipated, so they cannot achieve their objective of temporarily reducing unemployment below the natural unemployment rate.

Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition 40) Suppose Okun's law holds and a one percentage point increase in the unemployment rate reduces real output by 2% of full-employment output. The expectations-augmented Phillips curve is given by π = πe - 2.5 (u - 0.04).

Suppose π = 0.08 and πe = 0.03. (a) What is the natural rate of unemployment? (b) What is the actual rate of unemployment? (c) How much is actual GDP compared with full-employment GDP? Answer: (a) 0.04 (b) 0.02 (c) 4% higher Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition

11 .

41) You are given the following information about the economy.

The natural rate of unemployment is 0.04, Okun's Law is that ( - Y)/ = 2(u - ), and the Phillips curve relationship is π = πe - 2 (u - 0.04). (a) What was the full-employment level of output in each year? (b) Calculate the growth rate of full-employment output each year. (c) If expected inflation was 0.04 for all four years, what was the inflation rate each year?

Answer:

Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition 42) Consider the following misperceptions model of the economy.

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

Answer: (a) 40 (b) Y = 760, u = .0433, P = 50 (c) P = 53 1/3 Diff: 3 Topic: Section: 12.1 Question Status: Revised

12 .

43) The relationship between inflation and unemployment is given by π = πe - 3(u - 0.06). (a) Graph the long-run Phillips curve and three short-run Phillips curves. (b) What is the value of the natural rate of unemployment? (c) If actual inflation is 0.02 and expected inflation is 0.05, what is the unemployment rate? (d) If actual inflation is 0.08 and expected inflation is 0.05, what is the unemployment rate?

Answer: (a) Long run: vertical line at u = = 0.06.

Short run: downward sloping line (curve) crossing the long-run curve at π = πe. (b) 0.06 (c) 0.07 (d) 0.05 Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition 44) The relationship between inflation and unemployment is given by π = πe - 2(u - ). (a) Draw a diagram showing a long-run Phillips curve and two short-run Phillips curves that contain the following points: A: π = .03, πe = .03 B: π = .06, πe = .06 C: π = .03, πe = .06 D: π = .06, πe = .03 Label points A, B, C, and D in your diagram.

The unemployment rate at point A equals .05. (b) What are the values of the natural rate of unemployment and the unemployment rates at points B, C, and D? Answer: (a) Long run: vertical line at u = = 0.05.

Short run: downward sloping line (curve) crossing the long-run curve at π = πe. Points A and D are on the same short-run Phillips curve; points B and C are both on a higher short-run Phillips curve. (b) = 0.05.; B: u = .05; C: u = .065; D: u = .035 Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition

13 .

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

The unemployment rate at point A equals .05. (b) What are the values of the natural rate of unemployment and the unemployment rates at points B, C, and D? Answer: (a) Long run: vertical line at u = = 0.05.

Short run: downward sloping line (curve) crossing the long-run curve at π = πe. Points A and D are on the same short-run Phillips curve; points B and C are both on a higher short-run Phillips curve. (b) = 0.05.; B: u = .05; C: u = .06; D: u = .04 Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition

14 .

46) The expectations-augmented Phillips curve is π = πe - 3(u - 0.05). (a) Graph the long-run Phillips curve and the short-run Phillips curve for an expected inflation rate of 0.03. If the Fed chooses to keep the actual inflation rate at 0.03, what will be the unemployment rate? Label the equilibrium point "A". What is the numerical value of the natural rate of unemployment? (b) An aggregate demand shock (resulting from increased exports of goods) raises the inflation rate to 0.06 (the natural rate of unemployment and the expected inflation rate are not affected).

Show what happens on your graph. Label the equilibrium point "B". What is the numerical value of the unemployment rate? (c) In response to the aggregate demand shock, suppose the Fed allows the inflation rate of 0.06 to persist. Show what happens on your graph, labeling the equilibrium point "C". In the long run, what is the numerical value of the unemployment rate? (d) From the situation in part (c), suppose a supply shock (an oil price increase) raises the natural rate of unemployment by .01 from its original value. If the expected inflation rate does not change, show what happens in your graph, labeling the equilibrium point "D".

Answer: (a) Point A is on the SRPC with expected inflation = .03 and on the LRPC with the natural rate of unemployment = .05, with inflation = .03. (b) Point B is on the same SRPC as A, but has inflation = .06, so unemployment = .04. (c) Point C is on the LRPC with the natural rate = .05 and on the SRPC with inflation = expected inflation = .06, so the unemployment rate = .05. (d) Point D is on the LRPC with the natural rate = .06 and on a new SRPC with expected inflation = .06, and inflation = .06 as well.

Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition

15 .

47) The expectations-augmented Phillips curve is π = πe - 2(u - 0.06). (a) Graph the long-run Phillips curve and the short-run Phillips curve for an expected inflation rate of 0.04. If the Fed chooses to keep the actual inflation rate at 0.04, what will be the unemployment rate? Label the equilibrium point "A". What is the numerical value of the natural rate of unemployment? (b) An aggregate demand shock (resulting from increased exports of goods) raises the inflation rate to 0.06 (the natural rate of unemployment and the expected inflation rate are not affected).

Show what happens on your graph. Label the equilibrium point "B". What is the numerical value of the unemployment rate? (c) In response to the aggregate demand shock, suppose the Fed allows the inflation rate of 0.06 to persist. Show what happens on your graph, labeling the equilibrium point "C". In the long run, what is the numerical value of the unemployment rate? (d) From the situation in part (c), suppose a supply shock raises the natural rate of unemployment by .01 from its original value. If both the inflation rate and the expected inflation rate do not change, show what happens in your graph, labeling the equilibrium point "D". What is the numerical value of the unemployment rate?

Answer: (a) Long run: vertical line at u = 0.06. Short run: downward sloping line (curve) crossing the long-run curve at π = 0.04. The natural rate of unemployment is 0.06. (b) Move up along same short-run Phillips curve; now unemployment rate = 0.05. (c) Now, expected inflation rises to 0.06, with a shift to a higher short-run Phillips curve. The unemployment rate rises to 0.06 as well. (d) The long-run Phillips curve now shifts to the right at an unemployment rate of 0.07. With inflation and expected inflation remaining the same, the short-run Phillips curve shifts to the right.

Diff: 2 Topic: Section: 12.1 Question Status: Previous Edition

16 .

12.2

Macroeconomic Policy and the Phillips Curve

1) Can macroeconomic policy be used systematically to create unanticipated inflation?

A) No, according to Keynesian economists.

B) Yes, according to classical economists.

C) No, according to classical economists.

D) Yes, according to Keynesian economists, if Ricardian equivalence holds.

Answer: C Diff: 2 Topic: Section: 12.2 Question Status: Previous Edition 2) Can macroeconomic policy be used systematically to create unanticipated inflation?

A) Yes, according to Keynesian economists.

B) Yes, according to classical economists.

C) No, according to Keynesian economists.

D) Yes, according to classical economists, if Ricardian equivalence holds.

Answer: A Diff: 2 Topic: Section: 12.2 Question Status: Previous Edition 3) Classical macroeconomists argue that the short-run Phillips curve ________ represent a usable trade-off for policymakers because ________.

A) does; people have rational expectations B) does; people do not have rational expectations C) does not; people do not have rational expectations D) does not; people have rational expectations Answer: D Diff: 2 Topic: Section: 12.2 Question Status: Previous Edition 4) Classical macroeconomists argue that a beneficial supply shock would A) lower neither the natural rate of unemployment nor the actual rate of unemployment.

B) lower the actual rate of unemployment but not the natural rate of unemployment.

C) lower the natural rate of unemployment but not the actual rate of unemployment.

D) lower both the natural rate of unemployment and the actual rate of unemployment.

Answer: D Diff: 2 Topic: Section: 12.2 Question Status: New

17 .

5) Keynesian macroeconomists argue that the short-run Phillips curve ________ represent a usable trade-off for policymakers because ________.

A) does; prices are sticky B) does; prices are not sticky C) does not; prices are not sticky D) does not; prices are sticky Answer: A Diff: 2 Topic: Section: 12.2 Question Status: Previous Edition 6) Both classicals and Keynesians agree that policymakers A) can exploit the Phillips curve in the short run.

B) cannot exploit the Phillips curve in the short run.

C) can keep the unemployment rate permanently below the natural rate by permanently running a high rate of inflation.

D) cannot keep the unemployment rate permanently below the natural rate by permanently running a high rate of inflation.

Answer: D Diff: 1 Topic: Section: 12.2 Question Status: Previous Edition 7) The Lucas critique is an objection to the assumption that A) inflation is always and everywhere a monetary phenomenon.

B) there is a negative relationship between inflation and unemployment.

C) historical relationships between macroeconomic variables will continue to hold after new policies are in place.

D) people form expectations rationally.

Answer: C Diff: 1 Topic: Section: 12.2 Question Status: Previous Edition 8) The argument that when policy changes, people's behavior changes so that historical relationships between macroeconomic variables will no longer hold is known as A) the Phillips curve.

B) the policy irrelevance hypothesis.

C) hysteresis.

D) the Lucas critique.

Answer: D Diff: 1 Topic: Section: 12.2 Question Status: Previous Edition

18 .

9) The idea that new policies change the economic rules and affect economic behavior, so that no one can safely assume that historical relationships between variables will hold when policies change, is known as A) Okun's Law. B) Say's Law. C) the equation of exchange.

D) the Lucas critique.

Answer: D Diff: 1 Topic: Section: 12.2 Question Status: Previous Edition 10) The long-run Phillips curve is A) vertical.

B) horizontal.

C) upward sloping.

D) downward sloping.

Answer: A Diff: 1 Topic: Section: 12.2 Question Status: Previous Edition 11) The fact that the long-run Phillips curve is vertical implies that A) monetary policy can't affect unemployment.

B) money is neutral in the long run.

C) there is a natural rate of inflation.

D) money can't affect inflation in the long run.

Answer: B Diff: 1 Topic: Section: 12.2 Question Status: Previous Edition 12) Starting on a Phillips curve with expected inflation equal to 5% and unemployment at its natural rate, show what happens to unemployment if the Fed tries to reduce inflation, but has no credibility. As time passes and people realize that the inflation rate is now lower, what happens to the short-run Phillips curve?

Answer: The unemployment rate rises as the economy moves along the Phillips curve and as inflation declines. As time passes, inflation expectations begin to decline, shifting the Phillips curve down and to the left until the unemployment rate returns to its natural rate and inflation and expected inflation are equal at a lower level.

Diff: 2 Topic: Section: 12.2 Question Status: Previous Edition

19 .

13) Why did the government use expansionary monetary policies in the late 1970s, and what was the principal negative macroeconomic effect of these policies?

Answer: In the late 1970s the U.S. government used expansionary monetary policies in an attempt to reduce the unemployment rate and to increase the growth rate of output. Relying on the Keynesian model to explain the slowdown in economic growth, policymakers concluded that aggregate demand had declined and that expansionary monetary stabilization policies could pull aggregate demand back to the full-employment level of output. However, aggregate demand had not declined. The recession was created by a decline in aggregate supply caused by an increase in the price of oil. Expansionary monetary policies caused aggregate demand to increase along the new aggregate supply curve, which caused inflation to increase further.

Diff: 2 Topic: Section: 12.2 Question Status: Previous Edition 14) What is the Lucas critique, and why was it so important to macroeconomists in the 1970s?

Answer: The Lucas critique suggests that historical relationships between economic variables will be changed significantly when there are significant changes in the economy such as new policies. In the 1970s this was important as it explained the movement of the Phillips curve.

Diff: 1 Topic: Section: 12.2 Question Status: Previous Edition 12.3

The Problem of Unemployment

1) When the economy goes into a recession, there's an increase in A) frictional unemployment.

B) structural unemployment.

C) cyclical unemployment.

D) voluntary unemployment.

Answer: C Diff: 1 Topic: Section: 12.3 Question Status: Previous Edition 2) Which of the following forms of unemployment probably imposes the greatest personal costs?

A) Frictional unemployment B) Structural unemployment C) Cyclical unemployment D) Voluntary unemployment Answer: B Diff: 2 Topic: Section: 12.3 Question Status: Previous Edition

20 .

3) Krueger, Mitman, and Perri found that, following severe recessions, A) unemployment became higher for people with higher levels of education.

B) the cost of losing one's job varies inversely with one's wealth.

C) the rate of discouraged workers declined.

D) the economy rebounded more quickly and more strongly.

Answer: B Diff: 2 Topic: Section: 12.3 Question Status: Previous Edition 4) The longer a worker is unemployed, the probability of finding a job A) rises.

B) declines.

C) is unaffected.

D) becomes close to zero.

Answer: B Diff: 1 Topic: Section: 12.3 Question Status: Previous Edition 5) According to Okun's law, if full-employment output is $5000 billion, then each percentage point of unemployment sustained for one year reduces output by A) $50 billion.

B) $100 billion.

C) $150 billion.

D) $200 billion.

Answer: B Diff: 2 Topic: Section: 12.3 Question Status: Previous Edition 6) Some economists argue that Okun's Law overstates the cost of cyclical unemployment because A) the cost of retraining workers must be offset against the loss in output that occurs when workers are unemployed.

B) if efficiency wages prevail, and workers are paid their real wage, already employed workers will reduce their effort, reducing output.

C) it ignores the fact that leisure increases during a recession.

D) it ignores the loss of government revenue and additional government expenditures that occur when unemployment rises.

Answer: C Diff: 2 Topic: Section: 12.3 Question Status: Previous Edition

21 .

7) The natural rate of unemployment in the United States generally ________ from 1960 to 1980 and ________ from 1980 to 2000.

A) fell; rose B) fell; fell C) rose; fell D) rose; rose Answer: C Diff: 2 Topic: Section: 12.3 Question Status: Previous Edition 8) The natural rate of unemployment generally A) fell from 1960 to 1980.

B) was stable from 1960 to 1980.

C) rose from 1960 to 1980.

D) rose from 1980 to 2000.

Answer: C Diff: 2 Topic: Section: 12.3 Question Status: New 9) One reason for the fall in the natural rate of unemployment from 1980 to 2000 is A) changes in the demographic composition of the workforce.

B) the decline in inflation.

C) increased competition from foreign workers.

D) the depreciation of the dollar relative to foreign currencies.

Answer: A Diff: 1 Topic: Section: 12.3 Question Status: Previous Edition 10) One reason for the rise in the natural rate of unemployment from 1960 to 1980 is A) changes in the demographic composition of the workforce.

B) the decline in inflation.

C) increased competition from foreign workers.

D) the depreciation of the dollar relative to foreign currencies.

Answer: A Diff: 1 Topic: Section: 12.3 Question Status: Previous Edition

22 .

11) The bulk of the decline in the natural rate of unemployment from 1980 to 2000 is because of A) a decline in the inflation rate.

B) a decline in the share of young workers in the labor force.

C) increased competition from foreign workers.

D) the depreciation of the dollar relative to foreign currencies.

Answer: B Diff: 1 Topic: Section: 12.3 Question Status: Previous Edition 12) In years when teenagers become a greater percentage of the labor force, A) the natural rate of unemployment falls.

B) the natural rate of unemployment rises.

C) the inflation rate rises.

D) the inflation rate falls.

Answer: B Diff: 2 Topic: Section: 12.3 Question Status: Previous Edition 13) A difficulty faced by policymakers who wish to use the unemployment rate as a guide to whether the economy is weak or strong is that A) the natural rate of unemployment is hard to measure.

B) the natural rate of unemployment almost never changes.

C) policymakers must use data on output to tell whether the unemployment rate is too high or too low.

D) the impact of policy on the economy is subject to long and variable lags.

Answer: A Diff: 1 Topic: Section: 12.3 Question Status: Previous Edition 14) Because the natural rate of unemployment is not known precisely, policymakers who use it as a guide for policy must be A) less aggressive with policy changes than they would be if they knew the value of the natural rate.

B) more aggressive with policy changes than they would be if they knew the value of the natural rate.

C) ready to change policy more quickly.

D) aware of other data.

Answer: A Diff: 1 Topic: Section: 12.3 Question Status: Previous Edition

23 .

15) What is the relation between the unemployment rate and the proportion of unemployed workers who have been unemployed for 15 weeks or longer?

A) Both rise in recessions.

B) Both rise in expansions.

C) The unemployment rises in recessions but the proportion of unemployed workers who have been unemployed for 15 weeks or longer declines in recessions.

D) The unemployment falls in recessions but the proportion of unemployed workers who have been unemployed for 15 weeks or longer rises in recessions.

Answer: A Diff: 1 Topic: Section: 12.3 Question Status: Previous Edition 16) Describe the principal costs of unemployment. Are there any benefits to unemployment?

Answer: The costs of unemployment are the loss of output because of idle resources and the personal or psychological cost faced by unemployed workers and their families. There are benefits from unemployment: (1) unemployed workers engage in useful activities, such as searching for a better job match or acquiring new skills; and (2) increased leisure time. But the benefits are likely to be small compared to the costs.

Diff: 1 Topic: Section: 12.3 Question Status: Previous Edition 17) If you were president of the United States, what would you do to reduce the natural rate of unemployment? Propose at least three different methods.

Answer: Provide support for job training and worker relocation; increase labor-market flexibility by reducing the minimum wage; reform the unemployment insurance system; run a high-pressure economy (if there is hysteresis).

Diff: 1 Topic: Section: 12.3 Question Status: Previous Edition

24 .

12.4

The Problem of Inflation

1) One cost of a perfectly anticipated inflation is that it A) transfers wealth from lenders to borrowers.

B) transfers wealth from borrowers to lenders.

C) increases menu costs.

D) damages the role of prices as signals in the economy.

Answer: C Diff: 1 Topic: Section: 12.4 Question Status: Previous Edition 2) The costs in time and effort incurred by people and firms who are trying to minimize their holdings of cash because of inflation are called A) menu costs.

B) shoe leather costs.

C) transactions costs.

D) imperfect competition costs.

Answer: B Diff: 1 Topic: Section: 12.4 Question Status: Previous Edition 3) The costs of quickly trading money for nonmonetary assets to reduce one's holdings of money are the A) menu costs of anticipated inflation.

B) shoe leather costs of anticipated inflation.

C) menu costs of unanticipated inflation.

D) relative price distortion costs of unanticipated inflation.

Answer: B Diff: 1 Topic: Section: 12.4 Question Status: New 4) Shoe leather costs are A) the costs in time and effort incurred by people and firms who are trying to minimize their holdings of cash because of inflation.

B) the costs of changing prices, such as printing and mailing catalogues.

C) the costs of the redistribution of wealth between lenders and borrowers.

D) the costs associated with the confusion of prices as signals.

Answer: A Diff: 1 Topic: Section: 12.4 Question Status: Previous Edition

25 .

5) When actual inflation is greater than expected inflation, A) the natural rate of unemployment rises, according to Phillips-curve analysis.

B) cyclical unemployment rises, according to Phillips-curve analysis.

C) there are transfers from borrowers to lenders.

D) there are transfers from lenders to borrowers.

Answer: D Diff: 1 Topic: Section: 12.4 Question Status: Previous Edition 6) When actual inflation is less than expected inflation, A) the natural rate of unemployment falls, according to Phillips-curve analysis.

B) cyclical unemployment falls, according to Phillips-curve analysis.

C) there are transfers from borrowers to lenders.

D) there are transfers from lenders to borrowers.

Answer: C Diff: 1 Topic: Section: 12.4 Question Status: Previous Edition 7) One cost of an unanticipated inflation is that it A) transfers wealth from lenders to borrowers.

B) transfers wealth from borrowers to lenders.

C) decreases menu costs.

D) increases the purchasing power of money.

Answer: A Diff: 1 Topic: Section: 12.4 Question Status: Previous Edition 8) One cost of a perfectly anticipated inflation is that it A) transfers wealth from lenders to borrowers.

B) transfers wealth from borrowers to lenders.

C) erodes the value of currency.

D) damages the role of prices as signals in the economy.

Answer: C Diff: 1 Topic: Section: 12.4 Question Status: New

26 .

9) A COLA is A) a center of labor activity.

B) a cost of living adjustment.

C) a contract on long-term assets.

D) a crisis of labor analysis.

Answer: B Diff: 1 Topic: Section: 12.4 Question Status: Previous Edition 10) Hyperinflation occurs when A) the inflation rate rises.

B) the inflation rate declines.

C) the inflation rate is extremely high.

D) the inflation rate is extremely low.

Answer: C Diff: 1 Topic: Section: 12.4 Question Status: Previous Edition 11) When there is hyperinflation, all of the following occur except A) people spend a lot of time and energy getting rid of currency as fast as possible.

B) the government finds it difficult to collect taxes.

C) markets become inefficient because prices are no longer reliable signals.

D) people make fixed-rate loans to protect themselves against inflation.

Answer: D Diff: 1 Topic: Section: 12.4 Question Status: New 12) Most economists would agree that the best way to reduce hyperinflation is to A) reduce the nominal money supply growth rate.

B) increase transfer payments.

C) institute wage-price controls.

D) reduce taxes Answer: A Diff: 1 Topic: Section: 12.4 Question Status: New

27 .

13) With fixed interest rates, unanticipated deflation hurts ________ because ________.

A) lenders; they get paid back in less valuable dollars B) lenders; they get paid back in more valuable dollars C) borrowers; they repay the loan in more valuable dollars D) borrowers; they repay the loan in less valuable dollars Answer: C Diff: 2 Topic: Section: 12.4 Question Status: Previous Edition 14) Unanticipated deflation can create unemployment if A) nominal wages are sticky, causing real wages to rise over time.

B) nominal wages are flexible, causing people's real incomes to decline.

C) banks refuse to make loans at low nominal interest rates.

D) nominal interest rates remain positive.

Answer: A Diff: 2 Topic: Section: 12.4 Question Status: Previous Edition 15) An economically efficient way to reduce the costs of unanticipated inflation is to A) impose wage and price controls.

B) make raising prices illegal.

C) always have tight monetary policy.

D) uses indexed contracts.

Answer: D Diff: 2 Topic: Section: 12.4 Question Status: New 16) If nominal interest rates have a lower bound of zero and deflation occurs at 3% (i.e., the inflation rate equals -3%, then the lowest real interest rate possible is A) -3%.

B) 0%.

C) 3%.

D) 6%.

Answer: C Diff: 2 Topic: Section: 12.4 Question Status: Previous Edition

28 .

17) Many central banks around the world target an inflation rate of about ________, because of upward bias in measured inflation and to reduce the risk of deflation.

A) -2%.

B) 0%.

C) 2%.

D) 5%.

Answer: C Diff: 2 Topic: Section: 12.4 Question Status: Previous Edition 18) Describe the major costs of inflation, being sure to distinguish between anticipated and unanticipated inflation.

Answer: Costs of anticipated inflation include an erosion of the value of currency, which leads to shoe-leather costs, and the costs of changing prices. Costs of unanticipated inflation arise because unanticipated inflation transfers wealth between people and because it disturbs the role of prices as signals in the economy.

Diff: 1 Topic: Section: 12.4 Question Status: Previous Edition 19) Suppose expected inflation in the economy is 5%. Banks set nominal interest rates so they'll earn a 2% expected real return. Employers set nominal wages based on a 2% expected real wage increase. Suppose the nominal interest rate and nominal wages are determined this way, but actual inflation turns out to differ from the expected inflation rate. Calculate the actual real interest rate and the percent increase in the real wage for each of the following actual inflation rates: a) 2%; b) 5%; c) 10%.

Answer: The real interest rate (r) = the nominal interest rate minus the inflation rate. In percentage terms, the percentage increase in the real wage (w) = the percentage increase in the nominal wage minus the inflation rate. It is given that the expected inflation rate = 5%, so the nominal interest rate on bank savings deposits = 7%, and the percentage increase in the nominal wage = 7%. When inflation is (a) When inflation is 2%, then r = 7% - 2% = 5%, and the percentage increase in w equals 7% 2% = 5%. (b) When inflation is 5%, then r = 7% - 5% = 2%, and the percentage increase in w equals 7% 5% = 2%. (c) When inflation is 10%, then r = 7% - 10% = -3%, and the percentage increase in w equals 7% - 10% = -3%.

Diff: 2 Topic: Section: 12.4 Question Status: Previous Edition

29 .

12.5

Fighting Inflation: The Role of Inflation Expectations

1) The reduction of the inflation rate is called A) deflation.

B) disinflation.

C) unflation.

D) reflation.

Answer: B Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 2) The costs of disinflation would be low if A) expected inflation falls as inflation falls.

B) wage and price controls were used.

C) the Phillips curve were nearly horizontal.

D) the Phillips curve adjusted slowly to changes in inflation.

Answer: A Diff: 2 Topic: Section: 12.5 Question Status: Previous Edition 3) A rapid and decisive reduction in the rate of growth of the money supply for the purpose of disinflation is called A) a salt water policy.

B) a cold shower policy.

C) gradualism.

D) a cold turkey policy.

Answer: D Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 4) Keynesians prefer a disinflation policy of A) cold turkey.

B) stabilization.

C) gradualism.

D) aggregate demand management.

Answer: C Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition

30 .

5) In analyzing the disinflationary period of the early 1980s in the United States, Keynesians concluded that A) political business cycle theory best explains this monetary policy attempt to reduce unemployment just prior to the 1980 presidential election.

B) the rational expectations hypothesis correctly predicts that systematic monetary policies are anticipated and are neutral.

C) the basic classical model is correct in showing that changes in the money supply have only price effects.

D) the cold turkey approach to reducing inflation can create a costly recession with a sharp increase in cyclical unemployment.

Answer: D Diff: 1 Topic: Section: 12.5 Question Status: New 6) Which of the following disinflationary monetary policies would classical economists prefer?

A) A cold turkey approach that is announced and credible B) A cold turkey approach that is announced, but not credible C) A gradual approach that is announced and credible D) A gradual approach that is unannounced Answer: A Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 7) The sacrifice ratio is A) the amount of output lost when the inflation rate is reduced by one percentage point.

B) the percentage reduction in inflation when output falls one percentage point below potential.

C) the percentage change in employment when output declines by one percentage point.

D) the number of percentage points that the unemployment rate rises when output declines by one percentage point.

Answer: A Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 8) The amount of output lost when the inflation rate is reduced by one percentage point is called A) Okun's law.

B) the sacrifice ratio.

C) the Solow residual.

D) Planck's constant.

Answer: B Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition

31 .

9) Ball found that the disinflation of the early 1980s in the United States had a sacrifice ratio of about A) 0.

B) 1.

C) 2.

D) 3.

Answer: C Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 10) Ball's research showed that the sacrifice ratio A) was the same for all countries.

B) was nearly zero for most countries.

C) was about 10 for all countries except the United States, where it was about 2.

D) varied considerably across countries.

Answer: D Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 11) Ball found that an important factor affecting the sacrifice ratio is A) the flexibility of the labor market.

B) the shape of the yield curve.

C) the real interest rate.

D) the tightness of fiscal policy.

Answer: A Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 12) Countries in which wages adjust slowly to changes in the supply of and demand for labor are likely to have ________ sacrifice ratio.

A) an infinite B) a high C) a low D) a zero Answer: B Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition

32 .

13) Countries in which wages adjust rapidly to changes in the supply and demand for labor are likely to have ________ sacrifice ratio.

A) an infinite B) a high C) a low D) a negative Answer: C Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 14) Countries in which the government does not regulate the labor market are likely to have ________ sacrifice ratio.

A) an infinite B) a high C) a low D) a negative Answer: C Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 15) Countries in which the government heavily regulates the labor market are likely to have ________ sacrifice ratio.

A) an infinite B) a high C) a low D) a negative Answer: B Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 16) Ball's research on disinflation across different countries found that A) costs of disinflation were smaller for rapid disinflation than for gradual disinflation.

B) costs of disinflation were larger for rapid disinflation than for gradual disinflation.

C) costs of disinflation were about the same for both rapid and gradual disinflation.

D) costs of disinflation were smaller when the central bank had a strong inflation-fighting reputation.

Answer: A Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition

33 .

17) If a rapid disinflation has a lower sacrifice ratio than a slow disinflation, then reducing inflation is best accomplished by A) gradualism.

B) increasing money growth.

C) reducing interest rates.

D) a cold-turkey approach.

Answer: D Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 18) The main determinant of how quickly expected inflation adjusts to changes in monetary policy is A) the slope of the Phillips curve.

B) the slope of the short-run aggregate supply curve.

C) the credibility of the central bank.

D) the degree of indexation in the economy.

Answer: C Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 19) The most important factor determining how quickly expected inflation adjusts when the government attempts to reduce inflation is A) the slope of the Phillips curve.

B) the credibility of the government's disinflationary policy.

C) the degree of gradualism in the government's disinflationary policy.

D) the slope of the IS curve.

Answer: B Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition 20) Inflation expectations in the United States generally A) fell from 1971 to 1976, rose from 1977 to 1985, then fell from 1985 to 1995, and have been stable since then.

B) fell from 1971 to 1985, then rose from 1985 to 2000, and have been stable since then.

C) rose from 1971 to 1987, then fell from 1987 to 2006.

D) rose from 1971 to 1982, then fell from 1982 to 2000, and have been stable since then.

Answer: D Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition

34 .

21) From 1980 to 2000, the expected inflation rate in the United States declined by about A) 1 percentage point.

B) 3 percentage points.

C) 5 percentage points.

D) 7 percentage points.

Answer: D Diff: 2 Topic: Section: 12.5 Question Status: Previous Edition 22) What are the pros and cons of using cold turkey disinflation compared to a policy of gradualism?

Answer: Cold turkey disinflation reduces inflation quickly and could be successful if expected inflation fell at the same time; that requires that policy be credible, however. But Keynesians suggest that menu costs and nominal wage contracts will prevent prices and wages from adjusting quickly, so a cold turkey strategy will cause a recession. Further, if a cold turkey strategy is begun, but people think the costs will be so large that the strategy will be abandoned, then expected inflation will not decline. For this reason, Keynesians prefer a gradualist approach to allow wages and prices more time to adjust to policy changes. Such a policy is more likely to be sustainable politically.

Diff: 2 Topic: Section: 12.5 Question Status: Previous Edition 23) How is the sacrifice ratio measured? How big is the sacrifice ratio in the United States? In other countries? What problems are there in measuring the sacrifice ratio?

Answer: The sacrifice ratio is measured as the percentage by which output falls below potential for every percentage point decline in inflation. In the United States, the sacrifice ratio is about 2, while other countries have sacrifice ratios ranging from 3/4 to 3. The sacrifice ratio is difficult to measure because it's hard to calculate what output would have been in the absence of disinflation and because supply shocks may distort the calculation.

Diff: 1 Topic: Section: 12.5 Question Status: Previous Edition

35 .

24) Consider an economy in long-run equilibrium with an inflation rate (π) of 0.08 per year and a natural unemployment rate of 0.05. Suppose Okun's law holds and a one percentage point increase in the unemployment rate reduces real output by 2% of full-employment output. The expectations-augmented Phillips curve is given by π = πe - 2.5 (u - 0.05).

Consider a two-year disinflation. In the first year, π = 0.06 and πe = 0.08. In the second year, π = 0.04 and πe = 0.05. (a) In the first year, what is the value of the unemployment rate? (b) In the first year, by what percentage does output fall short of full-employment output? (c) In the second year, what is the value of the unemployment rate? (d) In the second year, by what percentage does output fall short of full-employment output? (e) What is the sacrifice ratio for this disinflation?

Answer: (a) .06 = .08 - 2.5(u - .05), so u = .058. (b) .058 - .05 = .008 = 0.8%; 0.8 × 2% = 1.6%. (c) .04 = .05 - 2.5(u - .05), so u = .054. (d) .054 - .05 = .004 = 0.4%; 0.4 × 2% = 0.8%. (e) sacrifice ratio = output shortfall/change in inflation rate = (1.6% + 0.8%)/(8% - 4%) = 2.4/4 = 0.6.

Diff: 2 Topic: Section: 12.5 Question Status: Previous Edition

36 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 13 Exchange Rates, Business Cycles, and Macroeconomic Policy in the Open Economy 13.1

Exchange Rates

1) The price of one currency in terms of another is called A) the exchange rate.

B) purchasing power parity.

C) the terms of trade.

D) a currency band.

Answer: A Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 2) An exchange-rate system in which the nominal exchange rate is set by the government is known as A) a flexible exchange-rate system.

B) a floating exchange-rate system.

C) a fixed exchange-rate system.

D) an exchange-rate union.

Answer: C Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 3) The international monetary system in which the exchange rate is determined by the market forces of supply and demand is called A) a flexible exchange-rate system.

B) a managed float.

C) a fixed exchange-rate system.

D) an adjustable-peg system.

Answer: A Diff: 1 Topic: Section: 13.1 Question Status: New 4) The Bretton Woods system relied on A) a flexible exchange-rate system.

B) a floating exchange-rate system.

C) a fixed exchange-rate system.

D) an exchange-rate union.

Answer: C Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 1 .

5) In the post-World War II period, prior to the collapse of the Bretton Woods system in the early 1970s, the exchange rate of the dollar was A) determined in a flexible exchange-rate system.

B) determined by the market forces of supply and demand.

C) fixed at $35 per ounce of gold.

D) determined by a managed float.

Answer: C Diff: 1 Topic: Section: 13.1 Question Status: New 6) The real exchange rate is A) the price of one currency in terms of another.

B) the price of domestic goods relative to foreign goods.

C) the quantity of gold that can be purchased by one unit of currency.

D) the difference in interest rates between two countries.

Answer: B Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 7) The real exchange rate is A) the number of foreign goods that can be obtained in exchange for one unit of the domestic good.

B) the nominal exchange rate minus the rate of inflation.

C) the amount of foreign currency that can be obtained in exchange for one unit of the domestic currency.

D) the amount of domestic currency that can be obtained in exchange for one unit of the foreign currency.

Answer: A Diff: 1 Topic: Section: 13.1 Question Status: New 8) When the domestic currency strengthens under a fixed exchange-rate system, this is called A) a depreciation.

B) an appreciation.

C) a devaluation.

D) a revaluation.

Answer: D Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition

2 .

9) Three-wheel cars made in North Edsel are sold for 5000 pounds. Four-wheel cars made in South Edsel are sold for 10,000 marks. The real exchange rate between North and South Edsel is four three-wheel cars for three four-wheel cars. The nominal exchange rate between the two countries is A) 0.50 marks/pound.

B) 0.66 marks/pound.

C) 1.50 marks/pound.

D) 2.00 marks/pound.

Answer: C Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 10) Three-wheel cars made in North Edsel are sold for 5000 pounds. Four-wheel cars made in South Edsel are sold for 10,000 marks. The nominal exchange rate between the two countries is three marks per pound. The real exchange rate between the two countries is A) 0.50 three-wheel cars per four-wheel car.

B) 0.66 three-wheel cars per four-wheel car.

C) 1.50 three-wheel cars per four-wheel car.

D) 2.00 three-wheel cars per four-wheel car.

Answer: B Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 11) When the domestic currency buys fewer units of foreign currency, the A) nominal exchange rate rises.

B) nominal exchange rate falls.

C) real exchange rate rises.

D) real exchange rate falls.

Answer: B Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition

3 .

12) When the nominal exchange rate falls, A) the domestic currency buys more units of foreign currency and the domestic currency has depreciated.

B) the domestic currency buys fewer units of foreign currency and the domestic currency has depreciated.

C) the domestic currency buys more units of foreign currency and the domestic currency has appreciated.

D) the domestic currency buys fewer units of foreign currency and the domestic currency has appreciated.

Answer: B Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 13) From 1980 to 2000, the yen-dollar exchange rate fell from 240 yen/dollar to 102 yen/dollar, while the dollar-pound exchange rate fell from 2.22 dollars/pound to 1.62 dollars/pound. As a result A) the dollar appreciated relative to the yen, but depreciated relative to the pound.

B) the dollar depreciated relative to the yen, but appreciated relative to the pound.

C) the dollar appreciated relative to both the yen and the pound.

D) the dollar depreciated relative to both the yen and the pound.

Answer: B Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 14) From November 1984 to April 1987, the yen/dollar exchange rate fell from 240 yen/dollar to 145 yen/dollar, while the dollar/pound exchange rate rose from 1.25 dollars/pound to 1.59 dollars/pound. As a result A) the dollar appreciated relative to the yen, but depreciated relative to the pound.

B) the dollar depreciated relative to the yen, but appreciated relative to the pound.

C) the dollar appreciated relative to both the yen and the pound.

D) the dollar depreciated relative to both the yen and the pound.

Answer: D Diff: 2 Topic: Section: 13.1 Question Status: New 15) When the nominal exchange rate in terms of dollars per yen rises, A) the dollar buys more yen and the dollar has depreciated.

B) the dollar buys fewer yen and the dollar has depreciated.

C) the dollar buys more yen and the dollar has appreciated.

D) the dollar buys fewer yen and the dollar has appreciated.

Answer: B Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 4 .

16) A rise in the real exchange rate is called A) a real depreciation.

B) a real appreciation.

C) a real bargain.

D) a real devaluation.

Answer: B Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 17) A fall in the real exchange rate in a flexible exchange-rate system is called A) a real depreciation.

B) a real appreciation.

C) a real revaluation.

D) a real devaluation.

Answer: A Diff: 1 Topic: Section: 13.1 Question Status: New 18) For a given real exchange rate, a nominal appreciation of the domestic currency will result from A) a decline in the terms of trade.

B) an increase in the price of the foreign good.

C) an increase in the price of the domestic good.

D) an increase in the domestic rate of inflation.

Answer: B Diff: 3 Topic: Section: 13.1 Question Status: Previous Edition 19) For a given nominal exchange rate, an increase in the price of foreign goods relative to the price of domestic goods causes A) domestic residents to buy more foreign goods.

B) domestic residents to buy fewer domestic goods.

C) the real exchange rate to decline.

D) an increase in the number of units of the foreign goods needed to buy a unit of the domestic goods.

Answer: C Diff: 3 Topic: Section: 13.1 Question Status: New

5 .

20) If the real exchange rate rises 2%, domestic inflation is 3%, and foreign inflation is 1%, what is the percent change in the nominal exchange rate?

A) 6% B) 4% C) 2% D) 0% Answer: D Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 21) If the real exchange rate rises 4%, domestic inflation is 2%, and foreign inflation is 0%, what is the percent change in the nominal exchange rate?

A) 6% B) 4% C) 2% D) 0% Answer: C Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 22) If the nominal exchange rate rises 5%, domestic inflation is 2%, and foreign inflation is 3%, what is the percent change in the real exchange rate?

A) 8% B) 6% C) 4% D) 2% Answer: C Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 23) If the nominal exchange rate rises 7%, domestic inflation is 3%, and foreign inflation is 4%, what is the percent change in the real exchange rate?

A) 8% B) 6% C) 4% D) 2% Answer: B Diff: 2 Topic: Section: 13.1 Question Status: New

6 .

24) If all countries produce the same good (or the same set of goods) and goods are freely traded among countries, so that the real exchange rate equals one, then the relationship between domestic and foreign prices and the nominal exchange rate is A) P = PFor / enom.

B) P = enom / PFor. C) enom = P × PFor. D) P = PFor. Answer: A Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 25) The idea that similar foreign and domestic goods, or baskets of goods, should have the same price when priced in terms of the same currency is called A) equity.

B) purchasing power parity.

C) efficiency.

D) the tragedy of the commons.

Answer: B Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 26) A look at Big Mac prices around the world shows that purchasing power parity A) holds.

B) does not hold.

C) holds for developed countries.

D) holds for less developed countries.

Answer: B Diff: 1 Topic: Section: 13.1 Question Status: New 27) A look at Big Mac prices around the world, after adjusting for differences in real GDP per capita in each country, shows A) nearly all countries with a PPP-adjusted Big Mac price above the U.S. price.

B) about half of countries with a PPP-adjusted Big Mac price above the U.S. price and half below.

C) nearly all countries with a PPP-adjusted Big Mac price below the U.S. price.

D) all developed countries with a PPP-adjusted Big Mac price above the U.S. price and all less developed countries below.

Answer: B Diff: 1 Topic: Section: 13.1 Question Status: New 28) Purchasing power parity means that 7 .

A) enom = PFor / P. B) P = PFor. C) P = enom / PFor. D) enom = mc2.

Answer: A Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 29) Empirical evidence shows that in the short run, purchasing power parity ________, and in the long run, purchasing power parity ________.

A) holds; does not hold B) holds; holds C) does not hold; holds D) does not hold; does not hold Answer: C Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 30) Purchasing power parity does not hold in the short to medium run because A) exports don't equal imports.

B) exchange rates fluctuate too much.

C) most business cycles are caused by shocks to aggregate demand.

D) countries produce different goods.

Answer: D Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 31) Purchasing power parity does not hold in the short to medium run because A) exports don't equal imports.

B) exchange rates fluctuate too much.

C) some goods aren't internationally traded.

D) most business cycles are caused by shocks to aggregate demand.

Answer: C Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition

8 .

32) Suppose purchasing power parity holds. If the price level in the United States is 100 dollars per good and the price level in Japan is 250 yen per good, then the nominal exchange rate is ________ yen per dollar.

A) 0.25 B) 0.4 C) 2.5 D) 4.0 Answer: C Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 33) Suppose purchasing power parity holds. If in 1997 the price level in the United States is 100, the price level in Japan is 10,000, and the nominal exchange rate is 100 yen per dollar, while in 1998 the price level in Japan rises to 10,500 and the nominal exchange rate rises to 105, then the price level in the United States in 1998 must be A) 95.

B) 100.

C) 105.

D) 110.25.

Answer: B Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 34) Relative purchasing power parity occurs when A) purchasing power parity holds between every two countries.

B) purchasing power parity only holds in recessions.

C) the nominal exchange rate is constant.

D) the real exchange rate is constant.

Answer: D Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 35) When the rate of appreciation of the nominal exchange rate equals the foreign inflation rate minus the domestic inflation rate, we say there is A) relative purchasing power parity.

B) purchasing power parity.

C) a Phillips curve.

D) an aggregate supply shock.

Answer: A Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition

9 .

36) When the dollar rises relative to other currencies, A) foreign goods are more expensive in terms of dollars.

B) foreign currency is more expensive in terms of dollars.

C) U.S. goods become more expensive to foreigners.

D) foreign currency is more expensive in the United States, but foreign goods are cheaper.

Answer: C Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 37) When the British pound rises in value relative to other currencies, then A) goods imported into Britain rise in price.

B) British exports rise in price.

C) neither British exports nor imports rise in price.

D) both British exports and imports rise in price.

Answer: B Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 38) Suppose the euro-yen exchange rate falls while the dollar-yen exchange rate rises. What happens to the price of goods imported into Japan?

A) European goods become more expensive while U.S. goods become cheaper.

B) European goods become cheaper while U.S. goods become more expensive.

C) Both European and U.S. goods become more expensive.

D) Both European and U.S. goods become cheaper.

Answer: A Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 39) Suppose the Swiss franc rises against the British pound but falls against the Japanese yen.

What happens to the prices of goods imported into Switzerland?

A) Both British and Japanese goods fall in price.

B) Both British and Japanese goods rise in price.

C) British goods rise in price while Japanese goods fall in price.

D) British goods fall in price while Japanese goods rise in price.

Answer: D Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition

10 .

40) A depreciation of the dollar causes A) a decrease in U.S. exports.

B) an increase in U.S. imports.

C) an increase in the prices of U.S. imports.

D) an increase in the prices of U.S. exports.

Answer: C Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 41) An appreciation of the dollar causes A) an increase in U.S. exports.

B) a decrease in U.S. imports.

C) an increase in the prices of U.S. imports.

D) an increase in the prices of U.S. exports.

Answer: D Diff: 1 Topic: Section: 13.1 Question Status: New 42) When the euro falls in value relative to other currencies, then A) goods imported into Europe rise in price.

B) European exports rise in price.

C) neither European exports nor imports rise in price.

D) both European exports and imports rise in price.

Answer: A Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 43) Suppose the dollar-euro exchange rate falls. Then A) French firms will import more from the United States into France.

B) U.S. firms will export less to France.

C) the dollar is less valuable relative to the euro.

D) the euro is more valuable relative to the dollar.

Answer: B Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition

11 .

44) There's been a real depreciation of the dollar over the past month. In the long run, you would expect the quantity of A) American imports to fall and the quantity of American exports to fall.

B) American imports to rise and the quantity of American exports to rise.

C) American imports to fall and the quantity of American exports to rise.

D) American imports to rise and the quantity of American exports to fall.

Answer: C Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 45) The J curve implies that a real depreciation will cause A) the nominal exchange rate to appreciate in the short run and depreciate in the long run.

B) the nominal exchange rate to depreciate in the short run and appreciate in the long run.

C) net exports to fall in the short run and rise in the long run.

D) net exports to rise in the short run and fall in the long run.

Answer: C Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 46) The J curve illustrates that a decline in the real exchange rate of the dollar will cause net exports to A) increase immediately, because prices are perfectly flexible.

B) increase after some adjustment period, because it takes some time for people to adjust their buying decisions to a change in the terms of trade.

C) decrease immediately, because prices are perfectly flexible.

D) decrease after some adjustment period, because it takes some time for people to adjust their buying decisions to a change in the real exchange rate.

Answer: B Diff: 1 Topic: Section: 13.1 Question Status: New 47) The rapid depreciation in the dollar from 1985 to 1987 caused net exports during this period A) to rise as the J curve would have predicted, but with a short lag (less than one year).

B) to rise as the J curve would have predicted, but with a long lag (more than one year).

C) to fall as the J curve would have predicted, but with a short lag (less than one year).

D) to fall as the J curve would have predicted, but with a long lag (more than one year).

Answer: B Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition

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48) According to the J curve, the rapid depreciation in the dollar from 1985 to 1987 caused net exports to A) rise in the short run and fall in the long run.

B) rise in the short run and rise further in the long run.

C) fall in the short run and rise in the long run.

D) fall in the short run and fall further in the long run.

Answer: C Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 49) According to the "beachhead effect," in order to undo the effects of a strong-dollar period, the real value of the dollar A) must fall to at least half of its value before appreciation of the dollar began.

B) must fall to the value it had before appreciation of the dollar began.

C) must fall to a much lower level than it had before appreciation of the dollar began.

D) must actually appreciate before it depreciates to undo the effects of a strong-dollar period.

Answer: C Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 50) The nominal exchange rate is 15 crowns per florin, the domestic price level is 6 florins/bottle, and the foreign price level is 2 crowns/bushel. (a) What is the real exchange rate? (b) What is the real exchange rate in the foreign country? (c) If the domestic price level rises to 8 florins/bottle, what must the nominal exchange rate become if the real exchange rate remains unchanged?

Answer: (a) 45 bushels/bottle (b) 1/45 bottle/bushel (c) 11.25 crowns per florin Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition

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51) Suppose the real exchange rate is 10, the domestic price level is 8, and the foreign price level is 4. (a) What is the nominal exchange rate? (b) Suppose the real exchange rate rises by 10%, the inflation rate in the domestic country is 6%, and the inflation rate in the foreign country is 4%. By what percentage does the nominal exchange rate change? (c) Suppose the nominal exchange rate rises by 5%, the real exchange rate rises by 8%, and domestic inflation is 3%. What is the foreign inflation rate?

Answer: (a) 5 (b) 8% (c) 0% Diff: 2 Topic: Section: 13.1 Question Status: Previous Edition 52) What is purchasing power parity? Why might it not hold?

Answer: Purchasing power parity is the idea that similar foreign and domestic goods, or baskets of goods, should have the same price when priced in terms of the same currency. Purchasing power parity may not hold because countries produce different baskets of goods and services, because some goods and services aren't traded internationally, and because transportation and legal barriers may prevent prices of traded goods from being equalized.

Diff: 1 Topic: Section: 13.1 Question Status: Previous Edition 13.2

How Exchange Rates Are Determined: A Supply-and-Demand Analysis

1) Under a flexible exchange-rate system, an increase in the demand for Japanese yen would cause the U.S. dollar-Japanese yen exchange rate to A) fall.

B) rise.

C) remain unchanged, because supply also increases.

D) remain unchanged, because the exchange rate is set by the central bank.

Answer: B Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition

14 .

2) In a flexible exchange-rate system, the value of a currency is determined by A) the government.

B) the intersection of the IS and LM curves.

C) the demand and supply for the currency in the foreign exchange market.

D) Swiss gnomes.

Answer: C Diff: 1 Topic: Section: 13.2 Question Status: Previous Edition 3) An increase in domestic output would cause a ________ in net exports and a ________ in the exchange rate.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: D Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition 4) A decline in domestic output would cause a ________ in net exports and a ________ in the exchange rate.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: A Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition 5) A rise in the domestic real interest rate would cause a ________ in net exports and a ________ in the exchange rate.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: C Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition

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6) A decline in the domestic real interest rate would cause a ________ in net exports and a ________ in the exchange rate.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: B Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition 7) An improvement in the quality of U.S. goods would lead to a ________ in the demand for dollars and a ________ in the exchange rate.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: A Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition 8) Which of the following changes would cause American net exports to increase?

A) An increase in the real value of the dollar B) An increase in American income C) An increase in foreign income D) A shift in demand by American consumers away from domestically produced goods Answer: C Diff: 1 Topic: Section: 13.2 Question Status: Previous Edition 9) Which of the following changes would cause American net exports to decrease?

A) A decrease in the real value of the dollar B) A decrease in American income C) An increase in foreign income D) A shift in demand by American consumers away from domestically produced goods Answer: D Diff: 1 Topic: Section: 13.2 Question Status: Previous Edition

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10) A decline in the exchange rate could have been caused by which of these factors?

A) A decline in domestic output (income) B) An increase in the domestic real interest rate C) A decline in the world demand for domestic goods D) An increase in foreign output (income) Answer: C Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition 11) The U.S. real interest rate rises relative to the British real interest rate. British net exports ________ and the British exchange rate ________.

A) increase; rises B) increase; falls C) decrease; rises D) decrease; falls Answer: B Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition 12) The Japanese real interest rate declines relative to the German real interest rate. German net exports ________ and the German exchange rate ________.

A) increase; rises B) increase; falls C) decrease; rises D) decrease; falls Answer: C Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition 13) Identify changes in two variables that would shift the supply curve of dollars to the right.

Identify changes in two variables that would shift the demand curve for dollars to the right.

Answer: An increase in U.S. output or an increase in the foreign real interest rate will cause the supply curve for dollars to shift to the right. A rightward shift in the supply curve causes the exchange rate to depreciate in a flexible exchange-rate system.

An increase in foreign output or an increase in the U.S. real interest rate will cause the demand curve for dollars to shift to the right. A rightward shift in the demand curve causes the exchange rate to appreciate in a flexible exchange-rate system.

Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition

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14) What happens in the short run in the Keynesian model to the exchange rate and net exports in each of the following cases? (a) The foreign real interest rate falls. (b) Foreign output rises. (c) Foreign demand for domestic goods rises. (d) Domestic output rises. (e) The domestic real interest rate falls.

Answer: (a) Exchange rate rises, net exports fall. (b) Exchange rate rises, net exports rise. (c) Exchange rate rises, net exports rise. (d) Exchange rate falls, net exports fall. (e) Exchange rate falls, net exports rise.

Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition 15) Describe the effects of a rise in the domestic real interest rate on the exchange rate and on both domestic and foreign net exports.

Answer: The rise in the domestic real interest rate leads to a rise in the demand for domestic assets, raising the exchange rate. The rise in the exchange rate reduces domestic net exports and raises foreign net exports.

Diff: 2 Topic: Section: 13.2 Question Status: Previous Edition 13.3

The IS-LM Model for an Open Economy

1) Goods market equilibrium in the open economy occurs when A) desired saving equals desired investment.

B) output equals desired consumption plus desired investment plus government spending.

C) desired consumption equals desired investment.

D) desired saving minus desired investment equals net exports.

Answer: D Diff: 1 Topic: Section: 13.3 Question Status: Previous Edition

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2) In an open economy, a decrease in net exports because of reduced demand for domestic products by foreigners should cause the domestic real interest rate to ________ and should cause desired saving minus desired investment to ________.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: D Diff: 3 Topic: Section: 13.3 Question Status: Previous Edition 3) In an open economy, an increase in net exports because of increased demand for domestic products by foreigners should cause the domestic real interest rate to ________ and should cause desired saving minus desired investment to ________.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: A Diff: 3 Topic: Section: 13.3 Question Status: Previous Edition 4) A decrease in foreign output would cause the domestic country's net exports to ________ and cause the domestic country's IS curve to ________.

A) rise; shift up B) rise; shift down C) fall; shift up D) fall; shift down Answer: D Diff: 2 Topic: Section: 13.3 Question Status: Previous Edition 5) An increase in foreign output would cause the domestic country's net exports to ________ and cause the domestic country's IS curve to ________.

A) rise; shift up B) rise; shift down C) fall; shift up D) fall; shift down Answer: A Diff: 2 Topic: Section: 13.3 Question Status: Previous Edition

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6) A decrease in the foreign real interest rate would cause the domestic country's net exports to ________ and cause the domestic country's IS curve to ________.

A) rise; shift up B) rise; shift down C) fall; shift up D) fall; shift down Answer: D Diff: 2 Topic: Section: 13.3 Question Status: Previous Edition 7) An increase in the foreign real interest rate would cause the domestic country's net exports to ________ and cause the domestic country's IS curve to ________.

A) rise; shift up B) rise; shift down C) fall; shift up D) fall; shift down Answer: A Diff: 2 Topic: Section: 13.3 Question Status: Previous Edition 8) A shift in demand toward the home country's goods would ________ the domestic real interest rate and ________ net desired saving (desired saving less desired investment) in the economy.

A) lower; increase B) lower; decrease C) raise; increase D) raise; decrease Answer: C Diff: 2 Topic: Section: 13.3 Question Status: Previous Edition 9) A shift in demand toward the foreign country's goods would ________ the domestic real interest rate and ________ net desired saving (desired saving less desired investment) in the economy.

A) lower; increase B) lower; decrease C) raise; increase D) raise; decrease Answer: B Diff: 2 Topic: Section: 13.3 Question Status: Previous Edition

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10) In an open economy, a shift down and to the left of the IS curve could have been caused by A) a decline in the foreign real interest rate.

B) an increase in the demand for domestic goods relative to foreign goods.

C) an increase in foreign output.

D) a decline in domestic output.

Answer: A Diff: 2 Topic: Section: 13.3 Question Status: Previous Edition 11) In an open economy, an increase in foreign output would cause the IS curve to shift ________ and a decrease in the foreign real interest rate would cause the IS curve to shift ________.

A) down; down B) down; up C) up; down D) up; up Answer: C Diff: 2 Topic: Section: 13.3 Question Status: Previous Edition 12) In an open economy, an increase in savings because of concerns about the future should cause the domestic real interest rate to ________ and should cause net exports to ________.

A) rise; rise B) rise; fall C) fall; rise D) fall; fall Answer: C Diff: 2 Topic: Section: 13.3 Question Status: Previous Edition 13) In a Keynesian model, what are the short-run effects on output, the real interest rate, and the real exchange rate, for both the domestic economy and a foreign economy, of a decline in investment?

Answer: The IS curve shifts down and to the left, causing Y to decline and r to decline. The decline in Y causes imports to decline and NX to increase. The effect on the exchange rate is ambiguous, because the increase in NX causes the exchange rate to rise, while the decline in r causes it to fall. The increase in NX causes NXrFor to decline, which causes the foreign IS curve to shift down and to the left, causing YFor and rFor to decline.

Diff: 2 Topic: Section: 13.3 Question Status: Previous Edition

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13.4

Macroeconomic Policy in an Open Economy with Flexible Exchange Rates

1) In the Keynesian model of an open economy, a temporary decrease in government purchases would ________ the domestic real interest rate and ________ net desired saving (desired saving less desired investment) in the economy.

A) lower; increase B) lower; decrease C) raise; increase D) raise; decrease Answer: A Diff: 2 Topic: Section: 13.4 Question Status: Previous Edition 2) A temporary increase in government purchases would ________ the domestic real interest rate and ________ net desired saving (desired saving less desired investment) in the economy.

A) lower; increase B) lower; decrease C) raise; increase D) raise; decrease Answer: D Diff: 2 Topic: Section: 13.4 Question Status: Previous Edition 3) A temporary decrease in government purchases would ________ the domestic real interest rate and ________ net desired saving (desired saving less desired investment) in the economy.

A) lower; increase B) lower; decrease C) raise; increase D) raise; decrease Answer: A Diff: 2 Topic: Section: 13.4 Question Status: Previous Edition 4) In a Keynesian model, a temporary increase in government purchases would cause output to ________ and the domestic real interest rate to ________, in the short run.

A) remain unchanged; increase B) remain unchanged; decrease C) increase; increase D) increase; decrease Answer: C Diff: 1 Topic: Section: 13.4 Question Status: Previous Edition 22 .

5) A classical IS-LM model of the world economy can be used to show that in a flexible exchange-rate system, a temporary increase in government purchases will cause A) output and the real interest rate to rise, which reduces net exports but has an ambiguous effect on the real exchange rate.

B) output and the real interest rate to rise, which increases net exports but has an ambiguous effect on the real exchange rate.

C) output to rise and the real interest rate to fall, which reduces net exports and causes the exchange rate to depreciate.

D) the real interest rate to fall, which causes the exchange rate to rise, which reduces net exports.

Answer: A Diff: 3 Topic: Section: 13.4 Question Status: Previous Edition 6) In the short run in the Keynesian model, an increase in the domestic money supply would cause domestic output to ________ and the domestic real interest rate to ________.

A) rise; rise B) fall; rise C) rise; fall D) fall; fall Answer: C Diff: 2 Topic: Section: 13.4 Question Status: Previous Edition 7) An increase in the U.S. money supply would cause the value of the dollar to ________ and U.S. net exports to ________ in the short run using a Keynesian model.

A) fall; fall B) fall; rise C) rise; rise D) rise; fall Answer: A Diff: 2 Topic: Section: 13.4 Question Status: Previous Edition 8) The Federal Reserve has just purchased bonds in the market, carrying out open market operations. In the short run in the Keynesian model, this would cause the foreign real interest rate to ________ and foreign output to ________.

A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: A Diff: 2 Topic: Section: 13.4 Question Status: Previous Edition 23 .

9) According to the classical model, an increase in the American nominal money supply would cause the nominal exchange rate to ________ and the real exchange rate to ________.

A) depreciate; appreciate B) appreciate; depreciate C) depreciate; remain unchanged D) appreciate; remain unchanged Answer: C Diff: 1 Topic: Section: 13.4 Question Status: Previous Edition 10) Suppose Japan is currently running a current account surplus. The most effective way of eliminating this current account surplus would be to temporarily ________ government purchases and ________ the domestic money supply.

A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: A Diff: 3 Topic: Section: 13.4 Question Status: Previous Edition 11) You have just noticed that the dollar appreciated and you suspect that U.S. policymakers were behind this change. Which would you choose as the most likely cause of this appreciation in the real exchange rate?

A) An increase in the money supply B) A decrease in the money supply C) A temporary increase in government purchases D) A temporary decrease in taxes Answer: B Diff: 3 Topic: Section: 13.4 Question Status: Previous Edition 12) You have just noticed that the dollar depreciated and you suspect that U.S. policymakers were behind this change. Which would you choose as the most likely cause of this depreciation in the real exchange rate?

A) An increase in the money supply B) A decrease in the money supply C) A temporary increase in government purchases D) A temporary decrease in taxes Answer: A Diff: 3 Topic: Section: 13.4 Question Status: New 24 .

13) Assume the United States is currently running a current account deficit. The most effective way of eliminating this current account deficit would be to temporarily ________ government purchases and ________ the domestic money supply.

A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease Answer: D Diff: 3 Topic: Section: 13.4 Question Status: Previous Edition 14) To encourage more investment, Mexico has lowered its tax rates to reduce the user cost of capital. Argentina is unable to pay back its foreign debts, causing its expected future marginal product of capital to fall. Mexico's real exchange rate will ________ and its net exports will ________.

A) depreciate; fall B) appreciate; rise C) depreciate; rise D) appreciate; fall Answer: D Diff: 3 Topic: Section: 13.4 Question Status: Previous Edition 15) Suppose the US imposes tariffs on China, which retaliates with tariffs of its own. The ensuing trade war causes both countries to begin producing goods at higher costs than before because of the loss of comparative advantage. The result is a direct effect on the production function, which causes the ________ to shift ________.

A) IS curve; right B) IS curve; left C) LM curve; left D) FE line; left Answer: D Diff: 3 Topic: Section: 13.4 Question Status: Previous Edition

25 .

16) Suppose the US imposes tariffs on China, which retaliates with tariffs of its own. The ensuing trade war causes both countries to begin producing goods at higher costs than before because of the loss of comparative advantage. Assuming the IS curve does not shift, in general equilibrium, the outcome is a ________ level of output and a ________ real interest rate.

A) higher; higher B) higher; lower C) lower; lower D) lower; higher Answer: D Diff: 3 Topic: Section: 13.4 Question Status: Previous Edition 17) Describe the effects of contractionary fiscal policy by the domestic government on output, the real interest rate, and net exports in both the domestic and foreign country, using a Keynesian model.

Answer: Domestic country: output falls, real interest rate falls, and net exports rise Foreign country: output falls, real interest rate falls, and net exports fall.

Diff: 2 Topic: Section: 13.4 Question Status: Previous Edition 18) Describe the effects of contractionary monetary policy by the domestic central bank on output, the real interest rate, and net exports in both the domestic and foreign country, using a Keynesian model in the short run. What happens in the long run? Show a diagram to illustrate the short- and long-run effects in both countries.

Answer: Domestic country: output falls, real interest rate rises, and net exports rise Foreign country: output falls, real interest rate falls, and net exports fall.

There are no real effects in the long run.

Diff: 2 Topic: Section: 13.4 Question Status: Previous Edition

26 .

19) For this question, use the Keynesian IS-LM model with flexible exchange rates.

Eastland's main trading partner is Westland. Suppose Westland undertakes an expansionary monetary policy. (a) What is the effect of Westland's expansionary monetary policy on Eastland's real exchange rate in the short run, assuming no change in Eastland's policies? (b) What is the effect of Westland's expansionary monetary policy on Eastland's real exchange rate in the long run, assuming no change in Eastland's policies? (c) What is the effect of Westland's expansionary monetary policy on Eastland's nominal exchange rate in the short run and in the long run?

Answer: (a) Since LM(West) shifts right, West's output rises, so East's net exports rise, so East's real exchange rate rises. (b) In the long run, the real exchange rate will not change. (c) In the long run, the West's price level rises, so East's nominal exchange rate must be higher to keep the real exchange rate unchanged.

Diff: 2 Topic: Section: 13.4 Question Status: Previous Edition 13.5

Fixed Exchange Rates

1) Under a system of fixed exchange rates, what happens if a country's currency is overvalued?

A) The central bank loses official reserve assets.

B) The central bank gains official reserve assets.

C) The currency appreciates.

D) The exchange rate rises.

Answer: A Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 2) Under a system of fixed exchange rates, what happens if a country's currency is undervalued?

A) The central bank loses official reserve assets.

B) The central bank gains official reserve assets.

C) The currency depreciates.

D) The exchange rate falls.

Answer: B Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition

27 .

3) If a country has an overvaluation problem, the best solution is to A) increase the official rate.

B) buy less of its currency in the foreign exchange market.

C) sell more of its currency in the foreign exchange market.

D) decrease the money supply.

Answer: D Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 4) If a country has an undervaluation problem, the best solution is to A) lower the official rate.

B) buy less of its currency in the foreign exchange market.

C) sell more of its currency in the foreign exchange market.

D) increase the money supply.

Answer: D Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 5) If the fundamental value of the exchange rate is ________ than the official (fixed) exchange rate, the country has an ________ problem, and it will gain reserves.

A) less; overvaluation B) greater; overvaluation C) less; undervaluation D) greater; undervaluation Answer: D Diff: 2 Topic: Section: 13.5 Question Status: Previous Edition 6) If the fundamental value of the exchange rate is less than the official (fixed) exchange rate, the country has an ________ problem, and it will ________ reserves.

A) overvaluation; lose B) overvaluation; gain C) undervaluation; lose D) undervaluation; gain Answer: A Diff: 2 Topic: Section: 13.5 Question Status: Previous Edition

28 .

7) If a country that fixes its exchange rate has an undervalued exchange rate, then it will ________ reserves, unless it ________ its money supply to the appropriate level.

A) gain; increases B) lose; increases C) lose; decreases D) gain; decreases Answer: A Diff: 2 Topic: Section: 13.5 Question Status: Previous Edition 8) If a country that fixes its exchange rate increases its money supply, then its currency will become ________ and it will ________ reserves.

A) overvalued; gain B) overvalued; lose C) undervalued; lose D) undervalued; gain Answer: B Diff: 2 Topic: Section: 13.5 Question Status: Previous Edition 9) In a fixed-exchange-rate system, if the government takes no action, an increase in the world demand for domestic goods will A) increase net exports and create an undervalued domestic currency.

B) reduce net exports and create an overvalued domestic currency.

C) reduce net exports and create an undervalued domestic currency.

D) increase net exports and create an overvalued domestic currency.

Answer: A Diff: 2 Topic: Section: 13.5 Question Status: Previous Edition 10) International businesses like a fixed exchange-rate system because A) they like large swings in currency values when devaluation or revaluation occur.

B) they profit by speculating on devaluation or revaluation.

C) they can plan better if they know what the exchange rate will be.

D) fixed exchange rates are economically efficient.

Answer: C Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition

29 .

11) When a group of countries agree to share a common currency, they are said to have formed a A) currency union.

B) welfare state.

C) monetary alliance.

D) monetary cartel.

Answer: A Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 12) An important advantage of a fixed-exchange-rate system is that it A) prevents an exchange rate from becoming overvalued.

B) prevents an exchange rate from becoming undervalued.

C) protects the domestic economy from being hit by foreign shocks.

D) promotes the growth of international trade and international financial transactions, by reducing the risk to market participants that exchange rates will change unexpectedly and substantially.

Answer: D Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 13) The currency created by the European Monetary Union, for which notes and coins became available in 2002, is the A) ECU. B) euro.

C) EMU. D) pound.

Answer: B Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 14) Currency unions are rare because A) they're to no one's advantage.

B) countries are reluctant to give up having their own currencies.

C) having flexible exchange rates has the same benefits and none of the costs.

D) speculative attacks are likely to occur.

Answer: B Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition

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15) Compared to a system of fixed exchange rates, currency unions are beneficial because they A) allow exchange rates to float.

B) allow every country to have an independent monetary policy.

C) reduce the costs of trading goods and assets.

D) restrict what countries can do with fiscal policy.

Answer: C Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 16) Compared with a system of fixed exchange rates, currency unions are beneficial because they A) restrict what countries can do with fiscal policy.

B) allow exchange rates to float.

C) allow every country to have an independent monetary policy.

D) eliminate the possibility of speculative attacks.

Answer: D Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 17) Compared with a system of fixed exchange rates, currency unions have the disadvantage of A) requiring all its members to share a common monetary policy.

B) allowing exchange rates to float.

C) requiring every country to share a common fiscal policy.

D) decreasing the sacrifice ratio.

Answer: A Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 18) An optimum currency area is a geographic region A) with inflation near zero.

B) that allows exchange rates to float.

C) that has fixed exchange rates.

D) for which the benefits of having a common currency exceed the costs.

Answer: D Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition

31 .

19) A geographic region in which the benefits of having a common currency exceed the costs is A) an optimum currency area.

B) an exchange-rate mechanism.

C) a currency board area.

D) a common currency area.

Answer: A Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 20) Criteria for an optimum currency area include all the following except A) fiscal transfers.

B) similar business cycle patterns.

C) extensive trade with each other.

D) a common language.

Answer: D Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 21) Europe may not be an optimum currency area because A) people speak different languages.

B) workers are not very mobile.

C) the countries do not trade very much with each other.

D) financial markets are weak.

Answer: B Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 22) Europe may not be an optimum currency area because A) people speak different languages.

B) fiscal transfers are weak.

C) the countries do not trade very much with each other.

D) financial markets are weak.

Answer: B Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition

32 .

23) Monetary policy in the European Monetary Union is determined by A) the Bundesbank.

B) the European Union Senate.

C) the European Central Bank.

D) None of the above.

Answer: C Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 24) The Maastricht treaty was the first step toward A) having free trade between Russia and China.

B) European monetary union.

C) gaining credibility for monetary policy.

D) reducing the costs of disinflation.

Answer: B Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition 25) A classical economy is described by the equations AD: Y = 1000 + 100M/P AS: = 1500 The real exchange rate is 3 bushels/bottle, the domestic nominal money supply is 30 florins, and the foreign price level is 8 crowns/bushel. (a) What is the nominal exchange rate? (b) If the government wants to maintain an official nominal exchange rate of 6 crowns/florin, what must the nominal money supply be?

Answer: (a) 4 crowns/florin (b) 20 florins Diff: 2 Topic: Section: 13.5 Question Status: Previous Edition

33 .

26) (a) What happens to the fundamental value of a country's exchange rate when it raises its money supply in a fixed exchange-rate system? Does this make the currency overvalued or undervalued if originally the official rate equaled the fundamental value? (b) What happens to the fundamental value of a country's exchange rate when the foreign country raises its money supply? Does this make the currency overvalued or undervalued if originally the official rate equaled the fundamental value? (c) So, if a country wants to maintain its official rate equal to its fundamental value, what must it do when the foreign country raises its money supply? What happens to inflation?

Answer: (a) Fundamental value falls below the official rate, so the currency is overvalued. (b) Fundamental value increases above the official rate, so the currency is undervalued. (c) The country must raise its money supply. This leads to inflation worldwide.

Diff: 3 Topic: Section: 13.5 Question Status: Previous Edition 27) Describe how the euro was created. What are the benefits of the monetary union? What are the costs?

Answer: The European countries unified their currencies to reduce the costs of trading goods and assets. This is beneficial as it reduces transactions costs and because the European economy would rival that of the United States in scope and wealth. The potential costs are that there may be political conflict if countries disagree about monetary policy, or if inflation isn't as stable or low as some countries desire.

Diff: 1 Topic: Section: 13.5 Question Status: Previous Edition

34 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 14 Monetary Policy and the Federal Reserve System 14.1

Principles of Money Supply Determination

1) Monetary policy in the United States is principally controlled by A) the President of the United States.

B) the U.S. Senate.

C) the Federal Reserve.

D) the U.S. Treasury Department.

Answer: C Diff: 1 Topic: Section: 14.1 Question Status: Previous Edition 2) Privately owned banks and thrift institutions that accept deposits and make loans are known as A) fiduciary institutions.

B) systemic risks.

C) financial holding companies.

D) depository institutions.

Answer: D Diff: 1 Topic: Section: 14.1 Question Status: Previous Edition 3) Which of the following are depository institutions?

A) The Federal Reserve Banks of New York and Chicago B) The U.S. Treasury and the IRS C) Banks and thrifts D) Investment banks and finance companies Answer: C Diff: 1 Topic: Section: 14.1 Question Status: Previous Edition 4) The monetary base is defined as A) bank reserves plus currency held by the nonbank public.

B) bank reserves minus vault cash.

C) all deposits at the Fed. D) deposits at the Fed plus vault cash.

Answer: A Diff: 1 Topic: Section: 14.1 Question Status: Previous Edition

1 .

5) The monetary base is equal to A) banks' reserves plus their holdings of Treasury securities.

B) banks' reserves plus fed funds.

C) banks' reserves plus currency held by the nonbank public.

D) M2 minus M1.

Answer: C Diff: 1 Topic: Section: 14.1 Question Status: Previous Edition 6) High-powered money consists of A) bank reserves plus currency held by the nonbank public.

B) bank reserves minus vault cash.

C) all deposits at the Fed. D) deposits at the Fed plus vault cash.

Answer: A Diff: 1 Topic: Section: 14.1 Question Status: Previous Edition 7) Bank reserves are equal to $3 million, the monetary base is $15 million, and bank deposits are $35 million. Currency held by the nonbank public is A) $3 million.

B) $12 million.

C) $15 million.

D) $20 million.

Answer: B Diff: 2 Topic: Section: 14.1 Question Status: Revised 8) Vault cash equals $1 million, deposits held by banks at the Fed equal $2 million, and customer deposits at banks are $30 million. Bank reserves are equal to A) $2 million.

B) $3 million.

C) $5 million.

D) $10 million.

Answer: B Diff: 2 Topic: Section: 14.1 Question Status: Revised

2 .

9) Fractional reserve banking is the system that A) allows banks not to insure their deposits.

B) allows banks not to join the Federal Reserve System.

C) limits banks' activities from crossing state lines.

D) allows banks to keep smaller reserves than their deposits.

Answer: D Diff: 1 Topic: Section: 14.1 Question Status: Previous Edition 10) Banks hold some deposits on reserve at the Fed because A) the Fed requires every bank to hold at least $100 million on deposit at all times.

B) the Fed will insure those deposits, but will not insure regular bank deposits.

C) these are membership dues for being a member bank.

D) they need to meet the demand for withdrawals by their customers.

Answer: D Diff: 1 Topic: Section: 14.1 Question Status: Revised 11) Banks hold some deposits on reserve at the Fed because A) the Fed requires every bank to hold at least $100 million on deposit at all times.

B) the Fed will insure those deposits, but will not insure regular bank deposits.

C) these are membership dues for being a member bank.

D) they need to pay the checks drawn on customers' accounts.

Answer: D Diff: 1 Topic: Section: 14.1 Question Status: New 12) Which of the following is the Federal Reserve most likely to use to change the nation's money supply?

A) Open-market operations B) Reserve requirements C) Discount lending D) Credit controls Answer: A Diff: 1 Topic: Section: 14.1 Question Status: Previous Edition

3 .

13) The Fed can reduce the money supply by reducing A) the currency-deposit ratio.

B) the monetary base.

C) reserve requirements.

D) the discount rate.

Answer: B Diff: 1 Topic: Section: 14.1 Question Status: Previous Edition 14) The Fed can reduce the monetary base with A) open-market purchases.

B) open-market sales.

C) lower reserve requirements.

D) a lower discount rate.

Answer: B Diff: 1 Topic: Section: 14.1 Question Status: New 15) The Fed can increase the money supply by increasing A) the currency-deposit ratio.

B) the monetary base.

C) reserve requirements.

D) the discount rate.

Answer: B Diff: 1 Topic: Section: 14.1 Question Status: New 16) The Fed can increase the monetary base with A) open-market purchases.

B) open-market sales.

C) higher reserve requirements.

D) an increase in the discount rate.

Answer: A Diff: 1 Topic: Section: 14.1 Question Status: New

4 .

17) A bank run is A) a large-scale, panicky withdrawal of deposits from a bank.

B) the transfer of funds from one bank to another.

C) a situation when a bank borrows from the Fed's discount window.

D) a situation in which a bank borrows at the Federal funds rate.

Answer: A Diff: 1 Topic: Section: 14.1 Question Status: Previous Edition 18) A large-scale, panicky withdrawal of deposits from a bank is A) a bank run.

B) a deposit downturn.

C) a recession.

D) an auto-rollover.

Answer: A Diff: 1 Topic: Section: 14.1 Question Status: New 19) The FDIC gets the funds needed to provide deposit insurance from A) an insurance premium on banks it insures.

B) an allocation of the federal government's budget.

C) state government budgets.

D) its sales of cryptocurrency.

Answer: A Diff: 1 Topic: Section: 14.1 Question Status: New 14.2

Monetary Control in the United States

1) How many Federal Reserve Banks are there?

A) 7 B) 12 C) 15 D) 5500 (approximately) Answer: B Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition

5 .

2) The Federal Reserve is A) a Kentucky bourbon.

B) a wild game preserve.

C) an express mail service.

D) the central bank of the United States.

Answer: D Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 3) The leadership of the Federal Reserve System is provided by A) the Board of Governors.

B) the Federal Advisory Committee.

C) the Federal Open Market Committee.

D) the directors of the twelve Federal Reserve banks.

Answer: A Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 4) The current chair of the Board of Governors of the Federal Reserve System is A) Janet Yellen.

B) Alan Greenspan.

C) Ben Bernanke.

D) Jerome Powell.

Answer: D Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 5) Who determines the open-market operations of the Federal Reserve System?

A) Board of Governors B) FDIC C) FHLBB D) FOMC Answer: D Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition

6 .

6) The Federal Open Market Committee consists of all the following people except A) the Board of Governors of the Federal Reserve System.

B) five presidents of Federal Reserve Banks, on a rotating basis.

C) the chairman of the President's Council of Economic Advisors.

D) the President of the Federal Reserve Bank of New York.

Answer: C Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 7) The largest liability of the Fed from those on this list is A) U.S. Treasury securities.

B) mortgage-backed securities.

C) loans to depository institutions.

D) currency outstanding.

Answer: D Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 8) The largest asset of the Fed from those on this list is A) U.S. Treasury securities.

B) mortgage-backed securities.

C) loans to depository institutions.

D) currency outstanding.

Answer: A Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 9) Which of the Fed's instruments is most frequently used?

A) Changing reserve requirements B) Open-market operations C) Changing the discount rate D) Changing margin requirements for the stock market Answer: B Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition

7 .

10) Which of the following is not a policy instrument of the Fed? A) Changing reserve requirements B) Open-market operations C) Changing the discount rate D) Changing the federal government budget deficit Answer: D Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 11) Since the 1930s, the Fed's most important tool for controlling the money supply has been A) setting the discount rate.

B) setting reserve requirements.

C) moral suasion.

D) open-market operations.

Answer: D Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 12) The primary purpose of the discount window is to A) influence the nation's money supply.

B) fulfill the bank's lender of last resort role.

C) control banks' excess reserves.

D) influence the amount of loans that banks provide to the public.

Answer: B Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 13) When U.S. banks borrow from one another, they must pay the A) discount rate.

B) prime rate.

C) Fed funds rate.

D) Interbank Offer Rate.

Answer: C Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition

8 .

14) The Federal funds market is a market for trading funds between A) a bank and a multinational corporation.

B) a bank and the government.

C) a bank and another bank.

D) a bank and the Federal Reserve Bank.

Answer: C Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 15) If a bank borrows from a Federal Reserve Bank, the interest rate is called A) the prime rate.

B) the discount rate.

C) the Fed funds rate.

D) the reserve availability rate.

Answer: B Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 16) The new monetary policy tool that the Fed began using in 2008 is A) changing the interest rate paid on reserves.

B) imposing a surcharge on credit cards.

C) putting a tax on all financial transactions.

D) borrowing from China.

Answer: A Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 17) Zero lower bound refers to the fact that A) the government budget deficit must be zero in the long run.

B) the lowest possible level of the current account deficit is zero in the long run.

C) the inflation rate can never decline below zero.

D) nominal interest rates cannot fall below zero.

Answer: D Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition

9 .

18) A liquidity trap occurs when A) any additions to the monetary base are held as cash by people or reserves at banks.

B) the Fed increases the money supply, causing the expected inflation rate to rise more than the real interest rate declines, so that the nominal interest rate increases.

C) there are runs on banks that are solvent but illiquid.

D) the demand for loans increases in a country on the gold standard, so that the monetary supply is not able to increase and interest rates rise dramatically.

Answer: A Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 19) When the Fed signals how long it expects interest rates to remain at a low level, it is said to be engaging in A) credit easing.

B) forward guidance.

C) quantitative easing.

D) a maturity extension program.

Answer: B Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 20) The Fed's first forward guidance in 2009 was framed in terms of keeping interest rates low A) for an extended period.

B) at least until a particular date in the future.

C) based on outcomes for the unemployment rate and inflation rate.

D) until the next Presidential election.

Answer: A Diff: 2 Topic: Section: 14.2 Question Status: Previous Edition 21) The Fed's forward guidance in 2011 and early 2012 was framed in terms of keeping interest rates low A) for an extended period.

B) at least until a particular date in the future.

C) based on outcomes for the unemployment rate and inflation rate.

D) until the next Presidential election.

Answer: B Diff: 2 Topic: Section: 14.2 Question Status: Previous Edition

10 .

22) The Fed's forward guidance in late 2012 through mid-2015 was framed in terms of keeping interest rates low A) for an extended period.

B) at least until a particular date in the future.

C) based on outcomes for the unemployment rate and inflation rate.

D) until the next Presidential election.

Answer: C Diff: 2 Topic: Section: 14.2 Question Status: Previous Edition 23) When the Fed alters the types of assets it owns, it is engaging in A) international balance management.

B) forward guidance.

C) quantitative easing.

D) changing the discount rate.

Answer: C Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 24) When the Fed sells short-term bonds and buys long-term bonds, it is engaging in A) changing the discount rate.

B) forward guidance.

C) backward guidance.

D) a maturity extension program.

Answer: D Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 25) When the Fed increases the quantity of assets it owns, it is said to be engaging in A) credit easing.

B) forward guidance.

C) quantitative easing.

D) a maturity extension program.

Answer: C Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition

11 .

26) From 2007 to 2012, the amount of assets owned by the Fed approximately A) doubled.

B) tripled.

C) quadrupled.

D) quintupled.

Answer: B Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 27) From 2007 to 2015, the amount of assets owned by the Fed approximately A) doubled.

B) tripled.

C) quadrupled.

D) quintupled.

Answer: D Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 28) From 2008 to 2014, the Fed engaged in ________ round(s) of quantitative easing.

A) 1 B) 2 C) 3 D) 4 Answer: C Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 29) In late 2007 and early 2008, concerns about financial institutions led the Fed to A) create special lending facilities.

B) raise the target for the fed funds rate.

C) increase reserve requirements.

D) pay interest on bank reserves.

Answer: A Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition

12 .

30) In the financial crisis in 2008, the Federal government created the ________, to purchase financial assets that were thought to be temporarily undervalued, preventing further financial panic.

A) Federal Home Loan Board B) Troubled Asset Relief Program C) Federal Deposit Insurance Corporation D) Bank Insurance Fund Answer: B Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 31) Following the financial crisis in 2008, the Federal government passed the ________, to prevent future financial crises by making major changes to the US financial system.

A) Glass-Steagall Act. B) Dodd-Frank Act. C) FDIC Improvement Act. D) Troubled Asset Relief Program.

Answer: B Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 32) The Dodd-Frank Act attempts to prevent future financial crises by making major changes to the U.S. financial system, including A) increasing banks' reserve requirements.

B) increasing capital requirements for banks.

C) paying banks interest on their reserve holdings.

D) reducing the interest rates banks can charge their customers for loans.

Answer: B Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 33) The Dodd-Frank Act attempts to prevent future financial crises by making major changes to the U.S. financial system, including A) increasing banks' reserve requirements.

B) requiring the Federal Reserve to stress test banks' capital.

C) paying banks interest on their reserve holdings.

D) reducing the interest rates banks can charge their customers for loans.

Answer: B Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition

13 .

34) To reduce systemic risk, the Dodd-Frank Act created a new regulatory body called the A) Troubled Asset Relief Corporation.

B) Financial Stability Oversight Council.

C) Supervisor of Last Resort.

D) Treasury Accord Compliance Committee.

Answer: B Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 35) In the pandemic of 2020, the Fed used some new tools, including A) direct lending to financial institutions.

B) direct lending to business firms.

C) acting as a lender of last resort.

D) paying interest on reserve balances.

Answer: B Diff: 1 Topic: Section: 14.2 Question Status: New 36) In the pandemic of 2020, the Fed made loans to medium-sized businesses through the A) Payroll Protection Program.

B) Main Street Business Lending Program.

C) Term Asset-Backed Paper Facility.

D) Overnight Reverse Repurchase Facility.

Answer: B Diff: 1 Topic: Section: 14.2 Question Status: New 37) In the pandemic of 2020, the Fed supported small businesses through its support for the A) Paycheck Protection Program.

B) Main Street Business Lending Program.

C) Term Asset-Backed Paper Facility.

D) Overnight Reverse Repurchase Facility.

Answer: A Diff: 1 Topic: Section: 14.2 Question Status: New

14 .

38) In the pandemic of 2020, the Fed modified its overall inflation goal by A) flexible average inflation targeting.

B) following the Taylor rule.

C) raising its inflation target from 2% to 3%.

D) abandoning its inflation target to focus more on unemployment.

Answer: A Diff: 1 Topic: Section: 14.2 Question Status: New 39) Describe the difference between a primary credit discount rate and the secondary credit discount rate, including who can borrow at which rate and how such lending is managed by the Fed. Answer: Banks in good condition can take out a primary credit discount loan, without additional supervision from the Fed. Banks that are not in good condition may be allowed to take out a secondary credit discount loan, which carries a higher interest rate and closer supervision by the Fed. Diff: 1 Topic: Section: 14.2 Question Status: Previous Edition 40) Describe, in general terms, the strategy of monetary policy, explaining how monetary-policy tools are used to achieve the goals of monetary policy. What intermediate stages are important in going from tools to goals? What are the links between the different stages? How does the Federal Reserve use this strategy today?

Answer: The Fed uses its tools to influence intermediate targets that in turn affect the goal variables. The link between tools and intermediate targets is an economic relationship such as the relationship between changes in the monetary base and changes in the money supply. The link between intermediate targets and the goal variables is an economic model. Today the Fed targets the Fed funds rate fairly directly, but watches many indicators to figure out the correct funds rate.

Diff: 2 Topic: Section: 14.2 Question Status: Revised

15 .

41) Suppose the Fed has just learned that some foreign economies are headed for recession, which will reduce U.S. exports. This is an economic shock that shifts the IS curve down. What would you do in response to the shock if you want to keep the economy at full-employment equilibrium under each of the following cases? (a) You use the classical (RBC) model. (b) You use the Keynesian (efficiency wage) model. (c) You use the extended classical model with misperceptions.

In each case, show the IS-LM-FE diagram associated with your answer.

Answer: (a) Do nothing, let P adjust. (b) Increase the money supply, shifting LM to the right. (c) Do nothing if the IS shift was anticipated; could increase money supply if the IS shift was unanticipated and the money supply change would be unanticipated; or you could inform people about the IS shock, so they would build it into their expectations.

Diff: 2 Topic: Section: 14.2 Question Status: Previous Edition 14.3

Setting Monetary Policy Targets

1) The Fed's tools are also known as A) goals.

B) intermediate targets.

C) instruments.

D) derivatives.

Answer: C Diff: 1 Topic: Section: 14.3 Question Status: Previous Edition 2) Open-market operations, changes in reserve requirements, changes in the discount rate, and changes in the interest rate on reserves are known as A) goals.

B) intermediate targets.

C) instruments.

D) derivatives.

Answer: C Diff: 1 Topic: Section: 14.3 Question Status: Previous Edition

16 .

3) Which of the following is an instrument of monetary policy?

A) The interest rate on three-month Treasury bills B) The mortgage interest rate C) The discount rate D) The budget deficit Answer: C Diff: 1 Topic: Section: 14.3 Question Status: Previous Edition 4) Macroeconomic variables that the Fed cannot control directly but can influence fairly predictably, and which are related to the Fed's goals, are known as A) instruments.

B) tools.

C) intermediate targets.

D) initial targets.

Answer: C Diff: 1 Topic: Section: 14.3 Question Status: Previous Edition 5) Intermediate targets are A) identical to instruments.

B) macroeconomic variables that the Fed can influence that are related to the Fed's goals.

C) also known as the Fed's tools.

D) macroeconomic variables that never get revised.

Answer: B Diff: 1 Topic: Section: 14.3 Question Status: Previous Edition 6) Which of the following might the Fed rely on as an intermediate target?

A) The monetary base B) The discount rate C) M2 D) The exchange rate of the dollar Answer: C Diff: 1 Topic: Section: 14.3 Question Status: Previous Edition

17 .

7) Which of the following variables is likely to serve as an intermediate target for monetary policy?

A) Money supply B) Inflation rate C) Open-market operations D) Unemployment rate Answer: A Diff: 1 Topic: Section: 14.3 Question Status: Previous Edition 8) In the Keynesian model, suppose the Fed sets a target for the money supply. If the IS curve shifts to the left, and the Fed wants to keep output unchanged, what should the Fed do?

A) Reduce taxes.

B) Reduce the money supply.

C) Increase taxes.

D) Increase the money supply.

Answer: D Diff: 2 Topic: Section: 14.3 Question Status: Previous Edition 9) In the Keynesian model, suppose the Fed sets a target for the real interest rate. If the IS curve shifts to the left, and the Fed wants to keep output unchanged, A) taxes will increase.

B) the money supply will decline.

C) the real interest rate will decrease.

D) taxes will decrease.

Answer: C Diff: 2 Topic: Section: 14.3 Question Status: Previous Edition 10) In the Keynesian model, suppose the Fed wants to keep output unchanged. If the IS curve shifts to the left, and the Fed acts to keep output unchanged, then A) taxes will increase.

B) the money supply will decline.

C) the real interest rate will decrease.

D) taxes will decrease.

Answer: C Diff: 2 Topic: Section: 14.3 Question Status: Previous Edition

18 .

11) In the Keynesian model, suppose the Fed sets a target for the real interest rate. If the IS curve shifts down and to the left, and the Fed wants to keep output unchanged in the short run and the price level unchanged in the long run, it will A) shift the LR curve up.

B) not shift the LR curve.

C) shift the LR curve down.

D) shift the IS curve up and to the right.

Answer: C Diff: 2 Topic: Section: 14.3 Question Status: Previous Edition 12) In the Keynesian model, suppose the Fed sets a target for the real interest rate. If the IS curve shifts up and to the right, and the Fed wants to keep output unchanged in the short run and the price level unchanged in the long run, it will A) shift the LR curve up.

B) not shift the LR curve.

C) shift the LR curve down.

D) shift the IS curve up and to the right.

Answer: A Diff: 2 Topic: Section: 14.3 Question Status: Previous Edition 13) In an abundant-reserves regime, the fed funds rate is bounded above by A) the primary credit discount rate.

B) the interest rate on reserve balances.

C) the prime rate.

D) the 10-year Treasury bond interest rate.

Answer: A Diff: 2 Topic: Section: 14.3 Question Status: New 14) In an abundant-reserves regime, the fed funds rate is bounded below by A) the primary credit discount rate.

B) the interest rate on reserve balances.

C) the prime rate.

D) the 10-year Treasury bond interest rate.

Answer: B Diff: 2 Topic: Section: 14.3 Question Status: New

19 .

15) In an abundant-reserves regime, the fed funds rate is determined by A) the primary credit discount rate.

B) the intersection of the supply and demand for reserves.

C) the prime rate.

D) the 10-year Treasury bond interest rate.

Answer: B Diff: 2 Topic: Section: 14.3 Question Status: New 16) In an abundant-reserves regime, if the Fed wants to reduce the fed funds rate, it can do so by A) using open-market purchases.

B) using open-market sales.

C) reducing the primary credit discount rate.

D) reducing the interest rate on reserve balances.

Answer: D Diff: 2 Topic: Section: 14.3 Question Status: New 17) In an abundant-reserves regime, if the Fed wants to increase the fed funds rate, it can do so by A) using open-market purchases.

B) using open-market sales.

C) increasing the primary credit discount rate.

D) increasing the interest rate on reserve balances.

Answer: D Diff: 2 Topic: Section: 14.3 Question Status: New 18) In the Keynesian model, suppose the Fed sets a target for the real interest rate. If the IS curve shifts down and to the left, and the Fed wants to keep output unchanged in the short run and the price level unchanged in the long run, what should the Fed do? Use the LR curve to formulate your answer.

Answer: Reduce the real interest rate by shifting the LR curve down.

Diff: 2 Topic: Section: 14.3 Question Status: Previous Edition

20 .

19) Describe how the real interest rate changes in a Keynesian model if a shock shifts the IS curve down and to the right and the Fed changes its policy to keep output unchanged.

Answer: If the Fed is going to keep output unchanged, then it will tighten monetary policy, reducing the money supply to offset the shift of the IS curve. The tighter monetary policy will mean that the real interest rate is higher. The LM curve shifts up and to the left, or the LR curve shifts up.

Diff: 2 Topic: Section: 14.3 Question Status: Previous Edition 20) In the Keynesian model, suppose the Fed sets a target for the real interest rate. If the IS curve shifts up and to the right, and the Fed wants to keep output unchanged in the short run and the price level unchanged in the long run, what should the Fed do? Use the LR curve to formulate your answer.

Answer: Increase the real interest rate by shifting the LR curve up.

Diff: 2 Topic: Section: 14.3 Question Status: Previous Edition 21) Suppose the Fed cares only about keeping the economy close to full-employment output. The Fed can target the real money supply (thus keeping the LM curve fixed) or it can target the real interest rate, changing the money supply and shifting the LM curve however is necessary to prevent a change in the real interest rate. (a) Which is the best policy if the main shocks to the economy are shocks to the IS curve?

Explain why. Illustrate with a diagram. (b) Which is the best policy if the main shocks to the economy are shocks to real money demand? Explain why. Illustrate with a diagram.

Answer: (a) Target the real money supply, since targeting r would lead to larger fluctuations in output. (b) Target the real interest rate to offset shocks to money demand and stabilize output.

Diff: 3 Topic: Section: 14.3 Question Status: Previous Edition

21 .

22) Use the LR curve to show what happens to output, the real interest rate, and the price level in the short run and in the long run if the government provides a tax credit to people who buy a new home, which leads to an increase in new housing investment.

Answer: The tax credit causes desired investment to rise, shifting the IS curve up and to the right. The short-run equilibrium occurs at a higher level of output and an unchanged real interest rate. In the long run, the equilibrium must occur at the intersection of the FE line and the IS curve, so the existing real interest rate is not tenable; the price level will increase, causing the LM curve to shift up and to the left, leading the LR curve to shift up. Compared with the initial situation, output is unchanged, the price level is higher, and the real interest rate is higher.

Diff: 3 Topic: Section: 14.3 Question Status: Previous Edition 14.4

Making Monetary Policy in Practice

1) In response to an unanticipated tightening of monetary policy, the Fed funds rate ________ at first, then ________ after 6 to 12 months.

A) rises; returns most of the way to its original value B) falls; returns most of the way to its original value C) remains roughly unchanged; rises significantly D) remains roughly unchanged; falls significantly Answer: A Diff: 2 Topic: Section: 14.4 Question Status: Previous Edition 2) In response to an unanticipated easing of monetary policy, the Fed funds rate ________ at first, then ________ after 6 to 12 months.

A) rises; returns most of the way to its original value B) falls; returns most of the way to its original value C) remains roughly unchanged; rises significantly D) remains roughly unchanged; falls significantly Answer: B Diff: 2 Topic: Section: 14.4 Question Status: Previous Edition 3) In response to an unanticipated easing of monetary policy, output ________ at first, then ________ after about four months.

A) rises; returns most of the way to its original value B) falls; returns most of the way to its original value C) remains roughly unchanged; rises significantly D) remains roughly unchanged; falls significantly Answer: C Diff: 2 Topic: Section: 14.4 Question Status: Previous Edition 22 .

4) In response to an unanticipated tightening of monetary policy, output ________ at first, then ________ after about four months.

A) rises; returns most of the way to its original value B) falls; returns most of the way to its original value C) remains roughly unchanged; rises significantly D) remains roughly unchanged; falls significantly Answer: D Diff: 2 Topic: Section: 14.4 Question Status: Previous Edition 5) In response to an unanticipated tightening of monetary policy, the price level ________ at first, then ________ after a year.

A) rises; returns most of the way to its original value B) falls; returns most of the way to its original value C) remains roughly unchanged; begins to rise D) remains roughly unchanged; begins to fall Answer: D Diff: 2 Topic: Section: 14.4 Question Status: Previous Edition 6) In response to an unanticipated easing of monetary policy, the price level ________ at first, then ________ after a year.

A) rises; returns most of the way to its original value B) falls; returns most of the way to its original value C) remains roughly unchanged; begins to rise D) remains roughly unchanged; begins to fall Answer: C Diff: 2 Topic: Section: 14.4 Question Status: Previous Edition 7) Policymakers may be uncertain about the state of the economy because A) initial releases of data may be less accurate than later data releases.

B) they don't know the predominant source of shocks to the economy.

C) they don't know how shocks affect people's expectations.

D) they are not aware of modern macroeconomic modeling techniques.

Answer: A Diff: 1 Topic: Section: 14.4 Question Status: Previous Edition

23 .

8) Policymakers may be uncertain about the structure of the economy because A) initial releases of data may be less accurate than later data releases.

B) they don't know the predominant source of shocks to the economy.

C) they don't know how shocks affect people's expectations.

D) they are not aware of modern macroeconomic modeling techniques.

Answer: B Diff: 1 Topic: Section: 14.4 Question Status: Previous Edition 9) If the public is not sure about the central bank's motives, then A) initial releases of data may be less accurate than later data releases.

B) the predominant source of shocks to the economy must be shocks to the LM curve.

C) central bankers should try to stabilize the inflation rate.

D) modern macroeconomic modeling techniques will fail.

Answer: C Diff: 1 Topic: Section: 14.4 Question Status: Previous Edition 10) Describe, in general terms, the lags in the effects of monetary policy on interest rates, output, and prices. Be sure to note how long it takes each variable to respond to policy changes.

Answer: Interest rates respond quickly to changes in monetary policy, reacting within the first month. But the effect is transitory, and after 6 to 12 months, the interest rate has returned most of the way to its original value. Output and prices barely respond to a change in monetary policy at first. Output begins to change after about 4 months, with the full effect being felt about 16 to 20 months after the initial policy change. The price level doesn't change much until about a year after the change in policy.

Diff: 1 Topic: Section: 14.4 Question Status: Previous Edition 14.5

The Conduct of Monetary Policy: Rules Versus Discretion

1) Which of the following statements would Milton Friedman disagree with?

A) Monetary policy has few short-run effects on the real economy.

B) In the long run, changes in the money supply primarily affect the price level.

C) In practice, there is little scope for using monetary policy actively to smooth out business cycles.

D) The Federal Reserve cannot be relied on to effectively smooth out business cycles.

Answer: A Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition

24 .

2) Which of the following statements would Milton Friedman agree with concerning the conduct of monetary policy?

A) Information lags are short, enabling the central bank to respond quickly to changes in the economy.

B) There is little uncertainty over the effect of a change in the money supply on the economy.

C) There are long and variable lags between monetary policy actions and their economic results.

D) Wage and price adjustments are relatively slow, so changing the money supply will have a minimal impact on the real economy.

Answer: C Diff: 2 Topic: Section: 14.5 Question Status: Previous Edition 3) Milton Friedman would eliminate the destabilizing effect of the Federal Reserve's monetary policy by A) eliminating the Federal Reserve.

B) removing the Federal Reserve's political independence.

C) requiring that the Federal Reserve choose a monetary aggregate and increase it at a fixed percentage rate each year.

D) eliminating the Federal Reserve's right to carry out open-market operations.

Answer: C Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 4) Monetarists suggest doing which of the following?

A) Maintain a steady growth rate of the money supply.

B) Use fiscal policy to combat unemployment in the short run.

C) Use monetary policy to combat unemployment in the long run.

D) Use fiscal policy to combat inflation in the long run.

Answer: A Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 5) Most Keynesians suggest that the Fed A) use discretion in setting monetary policy.

B) use fiscal policy to combat unemployment in the short run.

C) follow a rule, such as keeping the money growth rate at 3%, regardless of the state of the economy.

D) use fiscal policy to combat inflation in the long run.

Answer: A Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition

25 .

6) The basic Keynesian argument for discretionary monetary policy is that A) monetary policy is the principal cause of business cycles.

B) monetary policy is much more effective than fiscal policy.

C) aggregate demand is unstable and monetary policy can help to stabilize it.

D) reducing unemployment is much more important than reducing inflation.

Answer: C Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 7) The Taylor rule relates A) the nominal Fed funds rate to inflation over the past year and the deviation of output from full-employment output.

B) the growth rate of the monetary base to the growth rate of nominal GDP and the change in velocity over the past year.

C) the nominal Fed funds rate to the growth rate of nominal GDP and the change in velocity over the past year.

D) the growth rate of the monetary base to inflation over the past year and the deviation of output from full-employment output.

Answer: A Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 8) According to the Taylor rule, if inflation in the last year was 6% and output was 2% below its full-employment level, the nominal Fed funds rate should be A) 3%.

B) 5%.

C) 7%.

D) 9%.

Answer: D Diff: 2 Topic: Section: 14.5 Question Status: Previous Edition 9) According to the Taylor rule, if the inflation rate in the last year was 2% and output was equal to its full-employment level, the nominal Fed funds rate should be A) 3%.

B) 4%.

C) 5%.

D) 6%.

Answer: B Diff: 2 Topic: Section: 14.5 Question Status: Revised

26 .

10) According to the Taylor rule, if output is above its full-employment level and inflation is less than 2% A) the Fed should raise the Fed funds rate above 4%.

B) the Fed should reduce the Fed funds rate below 4%.

C) the Fed should make the Fed funds rate exactly 4%.

D) what the Fed should do is ambiguous.

Answer: D Diff: 2 Topic: Section: 14.5 Question Status: Previous Edition 11) According to estimates of the Taylor rule, monetary policy was too easy A) from 1960 to 1965.

B) from 1965 to 1979.

C) in the 1980s.

D) in the 1990s.

Answer: B Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 12) According to estimates of the Taylor rule, monetary policy was too tight A) from 1960 to 1965.

B) from 1965 to 1979.

C) in the 1980s.

D) in the 1990s.

Answer: C Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 13) Based on the Taylor rule, from 1965 to 1979, monetary policy was A) too tight.

B) too easy.

C) just about right.

D) too tight from 1965 to about 1970 and too easy from about 1970 to 1979.

Answer: B Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition

27 .

14) Based on the Taylor rule, in the 1980s, monetary policy was A) too tight.

B) too easy.

C) just about right.

D) too tight in the first half of the decade and too easy in the second half.

Answer: A Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 15) The degree to which the public believes the central bank's announcements about future policy is its A) reputation.

B) transparency.

C) openness.

D) credibility.

Answer: D Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 16) The problem with the strategy of achieving credibility through reputation is that A) reputations are rarely credible.

B) reputations lack any commitment.

C) serious costs may be incurred during the period in which reputation is established.

D) rules always have a lower cost than reputations in maintaining credibility.

Answer: C Diff: 2 Topic: Section: 14.5 Question Status: Previous Edition 17) If the Fed announces that it will reduce the growth rate of the money supply to 3% next year but people do not believe it, the Fed is said to A) engage in commitment.

B) be an inflation nutter.

C) engage in destabilizing policy.

D) lack credibility.

Answer: D Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition

28 .

18) The primary criticism by Keynesians of the credibility argument for rules is that A) reputations are a less costly method of gaining credibility.

B) reputations are a less costly method of maintaining credibility.

C) the cost of losing flexibility over policy choices may exceed the cost of gaining credibility.

D) rules that reduce presidential and congressional influence over monetary policy could ultimately be harmful to the economy.

Answer: C Diff: 2 Topic: Section: 14.5 Question Status: Previous Edition 19) Monetarists argued that the Fed wasn't serious about adhering to a money-growth target because A) it was unable to reduce inflation at all.

B) it tried to target three different monetary aggregates simultaneously.

C) the sacrifice ratio remained too high.

D) it gave too much weight to movements in exchange rates.

Answer: B Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 20) Many countries dropped their use of money-growth targets in the 1980s because A) they were in severe recessions.

B) political opponents claimed money-growth targeting helped the rich at the expense of the poor.

C) money demand became unstable.

D) it was too difficult to coordinate monetary policy with fiscal policy.

Answer: C Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 21) When the central bank announces the inflation rate that it will achieve over the next one to four years, it is following a strategy known as A) money targeting.

B) inflation targeting.

C) a currency board.

D) real business cycle targeting.

Answer: B Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition

29 .

22) The chief disadvantage of inflation targeting is that A) it is difficult to measure the inflation rate precisely.

B) it is not easy for the public to observe the inflation rate.

C) people do not understand what inflation is.

D) it is difficult for the central bank to judge what policy actions are needed to hit the target.

Answer: D Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 23) The Fed first announced an inflation target of 2% in A) 1979.

B) 2005.

C) 2012.

D) 2015.

Answer: C Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 24) Other than following a rule, a country could do each of the following things to help its central bank achieve credibility except A) appoint a tough central banker.

B) change the incentives of the central bankers.

C) increase central bank independence.

D) put the central bank under the government's control.

Answer: D Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 25) What types of rules for monetary policy may be sensible for policymakers to consider? What is the advantage of using rules over discretion? What problems might there be with rules?

Answer: One possible rule is a constant money growth rule, as proposed by Milton Friedman and the monetarists. It has the advantage of being based on economic theory and using observable data. Following such a rule might be preferable to discretion, because people would understand the Fed's rule and form expectations accordingly, which would in turn reduce the costs of disinflation. The problem with such a rule could come if there were structural changes in the economy, such as a change in money demand. In such a case, the rule's lack of flexibility could cause the Fed to follow inappropriate policies.

Diff: 2 Topic: Section: 14.5 Question Status: Previous Edition

30 .

26) Describe the strategy of inflation targeting. Why have many countries begun to use this strategy instead of targeting money growth? What are the advantages and disadvantages of inflation targeting?

Answer: Under inflation targeting, the central bank announces the inflation rate that it will try to achieve over the next 1 to 4 years. Countries have moved to inflation targeting because money-growth targeting had problems in the 1980s as money demand became unstable. Inflation targeting has the advantage of sidestepping the problem of instability in money demand, of being easier to explain to the public, and of increasing the central bank's accountability to the public.

But the major disadvantage of inflation targeting is that the long lags through which inflation responds to monetary policy make it difficult for the central bank to judge what policy actions are needed.

Diff: 1 Topic: Section: 14.5 Question Status: Previous Edition 27) Describe the Taylor rule. If the Fed were following the rule, what would the nominal Fed funds rate be if inflation over the past year were 4% and output were 1% below its fullemployment level?

Answer: The Taylor rule is a rule for monetary policy that allows the Fed to respond to the state of the economy. The rule sets the nominal Fed funds rate as the sum of the inflation rate over the past year plus 2% plus one-half times the percentage deviation of output from its fullemployment level plus one-half times the amount by which inflation over the past year exceeds 2%. If inflation were 4% and output were 1% below its full-employment level, the nominal Fed funds rate would be 0.04 + 0.02 + (0.5 × -0.01) + [0.5 × (0.04 - 0.02)] = 0.065 = 6.5%.

Diff: 2 Topic: Section: 14.5 Question Status: Previous Edition

31 .

Macroeconomics, 11e (Abel/Bernanke/Croushore) Chapter 15 Government Spending and Its Financing 15.1

The Government Budget: Some Facts and Figures

1) Subtracting government investment from government purchases gives us the amount of government A) outlays.

B) primary expenditures.

C) secondary spending.

D) consumption expenditures.

Answer: D Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 2) The three main categories of government outlays are A) net interest payments, government investment, and government consumption expenditures.

B) net government subsidies, the government deficit, and government purchases.

C) government purchases, transfer payments, and net interest payments.

D) government consumption expenditures, government investment, and transfer payments.

Answer: C Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 3) Government purchases, transfer payments, and net interest payments are the three main categories of A) the government deficit.

B) government outlays.

C) government investment.

D) the government primary deficit.

Answer: B Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 4) Government consumption expenditures equal A) government outlays minus transfer payments.

B) government outlays minus net interest payments.

C) government purchases minus government investment.

D) the government primary deficit plus net interest payments.

Answer: A Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 1 .

5) From the late 1960s to the late 1990s, the share of GDP devoted to government purchases A) drifted gradually upward.

B) drifted gradually downward.

C) remained fairly steady.

D) increased, but only after the onset of a war or a military buildup.

Answer: B Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 6) From the 1950s to the 2010s, transfer payments' share of GDP A) steadily increased.

B) steadily decreased.

C) remained fairly steady.

D) increased during Democratic administrations and decreased during Republican administrations.

Answer: A Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 7) Interest payments by the government as a share of GDP A) have steadily increased from the 1940s to the 2010s.

B) remained fairly steady from the 1940s to the 2010s.

C) increased in the 2000s and 2010s, but were fairly steady before that.

D) increased sharply in the 1940s and 1980s.

Answer: D Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 8) Compared with other countries in the OECD, U.S. government spending relative to GDP is A) among the highest.

B) about average.

C) slightly below average.

D) among the lowest.

Answer: D Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition

2 .

9) Compared with other countries in the OECD, French government spending relative to GDP is A) among the highest.

B) about average.

C) slightly below average.

D) among the lowest.

Answer: A Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 10) The largest source of tax receipts for the government is A) personal taxes.

B) contributions for social insurance.

C) taxes on production and imports.

D) corporate taxes.

Answer: A Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 11) The type of tax receipts that has shown the largest growth since the end of World War II has been A) personal taxes.

B) contributions for social insurance.

C) taxes on production and imports.

D) corporate taxes.

Answer: B Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 12) The type of tax receipts that has shown the slowest growth since World War II has been A) personal taxes.

B) contributions for social insurance.

C) taxes on production and imports.

D) corporate taxes.

Answer: D Diff: 2 Topic: Section: 15.1 Question Status: Previous Edition

3 .

13) Net interest payments by the government are usually A) small and sometimes negative for both the federal, and state and local governments.

B) small and sometimes negative for the federal government, but large and positive for state and local governments.

C) small and sometimes negative for state and local governments, but large and positive for the federal government.

D) large and positive for both the federal, and state and local governments.

Answer: C Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 14) State and local governments rely on ________ as their primary source of tax receipts.

A) personal taxes B) contributions for social insurance C) indirect business taxes D) corporate taxes Answer: C Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 15) What portion of government consumptions expenditures on nondefense goods and services is carried out by state and local governments?

A) Under 30% B) About 50% C) About 67% D) Over 80% Answer: D Diff: 1 Topic: Section: 15.1 Question Status: New 16) The primary deficit is equal to A) outlays - tax revenues.

B) government purchases + transfers + net interest - tax revenues.

C) outlays + net interest - tax revenues.

D) government purchases + transfers - tax revenues.

Answer: D Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition

4 .

17) The primary deficit is equal to A) the amount by which government purchases, transfers, and net interest exceed tax revenues.

B) the amount by which government purchases and transfers exceed tax revenues.

C) the deficit plus net interest payments.

D) total tax revenues minus net interest minus government expenditures.

Answer: B Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 18) The deficit is A) the amount by which government purchases, transfers, and net interest exceed tax revenues.

B) the amount by which government purchases and transfers exceed tax revenues.

C) the primary deficit minus net interest payments.

D) total tax revenues minus net interest minus government expenditures.

Answer: A Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 19) The amount by which government purchases and transfers exceed tax revenues is known as the A) primary surplus.

B) primary deficit.

C) primary current deficit.

D) government debt.

Answer: B Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition 20) The current deficit is A) the deficit minus government investment.

B) the deficit plus net interest payments.

C) the deficit minus current expenditures.

D) the deficit minus depreciation.

Answer: A Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition

5 .

21) The current deficit is A) the deficit plus net interest payments.

B) current expenditures minus tax revenues.

C) outlays minus tax revenues.

D) the deficit minus depreciation.

Answer: B Diff: 2 Topic: Section: 15.1 Question Status: Previous Edition 22) The primary current deficit is A) current expenditures - tax revenues.

B) current expenditures + transfers + net interest - tax revenues.

C) current expenditures - net interest - tax revenues.

D) current expenditures + transfers - tax revenues.

Answer: C Diff: 2 Topic: Section: 15.1 Question Status: Previous Edition 23) The primary current deficit is A) the deficit minus tax revenues.

B) the deficit minus net interest.

C) the current deficit minus tax revenues.

D) the current deficit minus net interest.

Answer: D Diff: 2 Topic: Section: 15.1 Question Status: Previous Edition 24) The current deficit minus net interest is called the A) primary deficit.

B) net current deficit.

C) current surplus.

D) primary current deficit.

Answer: D Diff: 1 Topic: Section: 15.1 Question Status: Previous Edition

6 .

25) The U.S. government ran large primary surpluses during A) World War II. B) most of the 1970s.

C) most of the 1980s.

D) the late 1990s.

Answer: D Diff: 1 Topic: Section: 15.1 Question Status: New 26) During the Great Recession from 2007 to 2009, the current deficit ________ and the primary deficit ________.

A) rose; rose.

B) rose; fell.

C) fell; rose.

D) fell; fell.

Answer: A Diff: 1 Topic: Section: 15.1 Question Status: New 27) Because of the tax cut of 2017, the current deficit ________ and the primary deficit ________.

A) rose; rose.

B) rose; fell.

C) fell; rose.

D) fell; fell.

Answer: A Diff: 1 Topic: Section: 15.1 Question Status: New 28) Because of the pandemic in 2020, the current deficit ________ and the primary deficit ________.

A) rose; rose.

B) rose; fell.

C) fell; rose.

D) fell; fell.

Answer: A Diff: 1 Topic: Section: 15.1 Question Status: New

7 .

29) You are given the following budget data for a country that has both a central government and local governments.

(a) How much is the deficit for the central government, the local government, and the total of the central and local governments? (b) How much is the primary deficit for the central government, the local government, and the total of the central and local governments?

Answer: (a) 175, 10, 185 (b) 50, 50, 100 Diff: 2 Topic: Section: 15.1 Question Status: Previous Edition 30) At the beginning of year one, there is no government debt outstanding. The government runs a $100 billion deficit in year one. Interest at a nominal rate of 10% must be paid starting in year two. Assume nominal GDP in year one is $2000 billion and the nominal growth rate of GDP is 4%. Assume the government balances its primary budget in the future and the interest rate and growth rate do not change. (a) What will be the government deficit in years two, three, four, and five? (b) What will be the value of government bonds outstanding at the end of the fifth year? (c) What will be the debt-GDP ratio at the end of year five?

Answer: (a) $10, $11, $12.1, $13.31 (all in billions) (b) $146.41 billion (c) 0.0626 Diff: 2 Topic: Section: 15.1 Question Status: Previous Edition

8 .

31) The following data describe government spending and revenue.

(a) How much is the budget deficit? (b) How much is the primary budget deficit? (c) How much is the full-employment budget deficit? (d) How much is the current deficit? (e) How much is the current primary deficit?

Answer: (a) 300 (b) 100 (c) 450 (d) 100 (e) -100 Diff: 2 Topic: Section: 15.1 Question Status: Previous Edition 15.2

Government Spending, Taxes, and the Macroeconomy

1) Classical economists think that lump-sum tax changes A) should be used to smooth business cycles.

B) have a powerful effect on the economy.

C) affect aggregate demand after a lag.

D) have no effect because of Ricardian equivalence.

Answer: D Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition

9 .

2) The political process by which fiscal policy is made A) is relatively rapid, contributing to the effectiveness of fiscal policy.

B) requires only that the president approve changes to the budget, a decision that takes several months.

C) is efficient in reaching a decision within a year.

D) is slow and results in a long time lag for fiscal policy.

Answer: D Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 3) According to Keynesian economists, the primary problem with using fiscal policy as a stabilization tool is that A) fiscal policy does not have the effect on output in practice that it should have in theory.

B) fiscal policy will be effective only if it is funded through lump-sum tax changes.

C) fiscal policy will be effective only if it is funded through permanent changes in taxes.

D) fiscal policy is inflexible because a large portion of government spending is planned years in advance and cannot easily be changed.

Answer: D Diff: 1 Topic: Section: 15.2 Question Status: New 4) Provisions in the budget that cause government spending to rise or taxes to fall without legislation when GDP falls are known as A) primary deficit enhancers.

B) expansionary fiscal stimulus.

C) non-political fiscal policy.

D) automatic stabilizers.

Answer: D Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 5) Which of the following would not act as an automatic stabilizer?

A) Unemployment insurance B) Government purchases C) Personal income taxes D) Corporate income taxes Answer: B Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition

10 .

6) Because of automatic stabilizers, in recessions the government budget deficit ________, while in expansions the deficit ________.

A) falls; rises B) falls; falls C) rises; falls D) rises; rises Answer: C Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 7) An example of an automatic stabilizer is A) consumer spending.

B) inflation.

C) unemployment insurance.

D) discretionary fiscal policy.

Answer: C Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 8) The amount the government budget deficit would be if the economy were at full employment is known as the A) primary deficit.

B) full-employment deficit.

C) natural deficit.

D) current deficit.

Answer: B Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 9) The full-employment deficit is A) the number of jobs needed to restore full employment.

B) what the government budget deficit would be if the economy were at full employment.

C) the increase in government spending that would be needed to return the economy to full employment.

D) the extra amount paid to government workers under the National Recovery Act. Answer: B Diff: 1 Topic: Section: 15.2 Question Status: New

11 .

10) Since 1960, the only period of several years when the full-employment government budget deficit was negative (that is, there was a full-employment surplus) was A) from 2000 to 2005.

B) the late 1990s and early 2000s.

C) the mid-1980s.

D) the early 1970s.

Answer: B Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 11) Government capital consists of A) money owned by the government.

B) securities owned by the government.

C) the buildings owned by the government in Washington, D.C. D) long-lived physical assets owned by the government.

Answer: D Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 12) All of the following are government capital except A) roads.

B) schools.

C) Treasury securities.

D) mass-transit systems.

Answer: C Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 13) The total amount of taxes paid divided by before-tax income is the A) median taxpayer rate.

B) rate of hysteresis.

C) average tax rate.

D) marginal tax rate.

Answer: C Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition

12 .

14) The marginal tax rate is A) the fraction of an additional dollar of income that must be paid in taxes.

B) the total amount of taxes paid divided by after-tax income.

C) the total amount of taxes paid divided by before-tax income.

D) the average amount of government spending that is financed by taxes.

Answer: A Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 15) The average tax rate is A) the fraction of an additional dollar of income that must be paid in taxes.

B) the total amount of taxes paid divided by after-tax income.

C) the total amount of taxes paid divided by before-tax income.

D) the average amount of government spending that is financed by taxes.

Answer: C Diff: 1 Topic: Section: 15.2 Question Status: New 16) An increase in the marginal tax rate, with the average tax rate held constant, will A) increase the amount of labor supplied at any real wage.

B) not affect the amount of labor supplied at any real wage.

C) decrease the amount of labor supplied at any real wage.

D) increase the amount of labor supplied at any real wage if the average tax rate is above the marginal tax rate, but decrease the amount of labor supplied at any real wage if the average tax rate is below the marginal tax rate.

Answer: C Diff: 2 Topic: Section: 15.2 Question Status: Previous Edition 17) A decrease in the marginal tax rate, with the average tax rate held constant, will A) increase the amount of labor supplied at any real wage.

B) not affect the amount of labor supplied at any real wage.

C) decrease the amount of labor supplied at any real wage.

D) increase the amount of labor supplied at any real wage if the average tax rate is above the marginal tax rate, but decrease the amount of labor supplied at any real wage if the average tax rate is below the marginal tax rate.

Answer: A Diff: 2 Topic: Section: 15.2 Question Status: Previous Edition

13 .

18) A decrease in the average tax rate, with the marginal tax rate held constant, will A) increase the amount of labor supplied at any real wage.

B) not affect the amount of labor supplied at any real wage.

C) decrease the amount of labor supplied at any real wage.

D) increase the amount of labor supplied at any real wage if the average tax rate is above the marginal tax rate, but decrease the amount of labor supplied at any real wage if the average tax rate is below the marginal tax rate.

Answer: C Diff: 2 Topic: Section: 15.2 Question Status: Previous Edition 19) An increase in the average tax rate, with the marginal tax rate held constant, will A) increase the amount of labor supplied at any real wage.

B) not affect the amount of labor supplied at any real wage.

C) decrease the amount of labor supplied at any real wage.

D) increase the amount of labor supplied at any real wage if the average tax rate is above the marginal tax rate, but decrease the amount of labor supplied at any real wage if the average tax rate is below the marginal tax rate.

Answer: A Diff: 2 Topic: Section: 15.2 Question Status: Previous Edition 20) The Tax Act of 2017 A) reduced marginal tax rates for most taxpayers temporarily.

B) reduced marginal tax rates for most taxpayers permanently.

C) reduced marginal tax rates for only wealthy taxpayers temporarily.

D) reduced marginal tax rates for only wealthy taxpayers permanently.

Answer: A Diff: 2 Topic: Section: 15.2 Question Status: Previous Edition

14 .

21) Suppose that all workers place a value on their leisure of 40 goods per day. The production function relating output per day Y to the number of people working per day N is Y = 200N - N2 and the marginal product of labor is MPN = 200 - 2N. A 20% tax is levied on wages. Output per day would be A) 5625.

B) 7250.

C) 9375.

D) 11,250.

Answer: C Diff: 3 Topic: Section: 15.2 Question Status: Revised 22) Suppose that all workers place a value on their leisure of 40 goods per day. The production function relating output per day Y to the number of people working per day N is Y = 200N - N2 and the marginal product of labor is MPN = 200 - 2N. A 20% tax is levied on wages. In terms of lost output, what is the cost of the distortion introduced by this tax?

A) 25 B) 75 C) 150 D) 225 Answer: D Diff: 3 Topic: Section: 15.2 Question Status: Previous Edition 23) Taxes distort economic behavior because they A) change the composition of income and spending.

B) cause deviations in economic behavior from the efficient, free-market outcome.

C) change the balance between private and public expenditures.

D) change the composition of consumption, investment, government spending, and net exports.

Answer: B Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition

15 .

24) Assuming that market prices are efficient, imposing taxes on various economic activities creates A) distortions.

B) a budget surplus.

C) an efficient tax system.

D) tax-rate smoothing.

Answer: A Diff: 1 Topic: Section: 15.2 Question Status: New 25) Assume that the lost output due to tax distortions is proportional to the square of the tax rate.

If the average cost of the distortion created by taxes is currently $1000, and the tax rate is increased from 40% to 50%, the average cost of the distortion created by taxes will increase to A) $383.33.

B) $450.00.

C) $640.

D) $1562.50.

Answer: D Diff: 2 Topic: Section: 15.2 Question Status: Previous Edition 26) The average cost of the distortion created by taxes A) increases proportionately with the tax rate.

B) is lower when the tax rate is constant than when it fluctuates.

C) is higher when the tax rate is constant than when it fluctuates.

D) equals the square root of the tax rate.

Answer: B Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 27) If a government is highly committed to tax rate smoothing, it will A) require annually balanced fiscal budgets.

B) reduce tax rates during a recession.

C) tax every activity and every source of income at the same tax rate.

D) not change tax rates frequently to finance fluctuations in government spending.

Answer: D Diff: 1 Topic: Section: 15.2 Question Status: New

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28) An example of tax smoothing is provided by evidence of A) temporary changes in defense expenditures by the government.

B) reductions in tax rates prior to presidential elections.

C) Keynesian tax cuts designed to help the economy recover from a recession.

D) reliance on debt financing rather than taxation during World War II. Answer: D Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 29) The idea that all aspects of economic behavior, such as labor supply, saving, and investment, respond to economic incentives, especially tax rates, is known as A) New Keynesian economics.

B) new classical economics.

C) tax-structured classical economics.

D) supply-side economics.

Answer: D Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 30) The graph plotting the tax rate on the horizontal axis and tax revenues on the vertical axis, which was used by supply-side economists to suggest that tax rates were too high, in known as the A) Beveridge curve.

B) Phillips curve.

C) Taylor rule.

D) Laffer curve.

Answer: D Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition 31) U.S. data suggest that the U.S. economy is located where on the Laffer curve?

A) On the right side, after the peak in tax revenue B) On the left side, before the peak in tax revenue C) At the peak in tax revenue D) The economy was on the right side before the 1980s and on the left side after 1980.

Answer: B Diff: 1 Topic: Section: 15.2 Question Status: Previous Edition

17 .

32) Suppose that all workers place a value on their leisure of 75 goods per day. The production function relating output per day Y to the number of people working per day N is Y = 500N - 0.4 N2, and the marginal product of labor is MPN = 500 - 0.8 N. A 25% tax is levied on wages. (a) How much is output per day? (b) In terms of lost output, what is the cost of the distortion introduced by this tax?

Answer: (a) 150,000 (b) 2734 Diff: 3 Topic: Section: 15.2 Question Status: Previous Edition 33) Suppose that the federal income tax on individuals is set up as follows: Income above Income below Taxes 0 $8000 0.10 × income $8000 $35,000 $800 + [0.15 × (income - $8000)] $35,000 & up $4850 + [0.25 × (income - $35,000)] Calculate the average tax rate and marginal tax rate for workers with the following levels of income: (a) $6500 (b) $27,000 (c) $72,000 (d) $250,000 Answer: (a) ATR = MTR = .10. (b) T = 800 + [(27,000 - 8000) × .15] = 3650. ATR = 3650/27,000 = .135. MTR = .15. (c) T = 4850 + [(72,000 - 35,000) × .25] = 14,100. ATR = 14,100/72,000 = .196. MTR = .25. (d) T = 4850 + [(250,000 - 35,000) × .25] = 58,600. ATR = 58,600/250,000 = .2344. MTR = .25.

Diff: 3 Topic: Section: 15.2 Question Status: Revised

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15.3

Government Deficits and Debt

1) The total value of government bonds outstanding at any particular time is called the A) government debt.

B) government deficit.

C) seignorage revenue.

D) yield curve.

Answer: A Diff: 1 Topic: Section: 15.3 Question Status: Previous Edition 2) From 1945 to 1995, the debt-GDP ratio in the United States A) steadily fell.

B) steadily increased.

C) fell from 1945 until around 1970 and rose thereafter.

D) fell from 1945 until around 1980 and rose thereafter.

Answer: D Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 3) From 1995 to 2001, the debt-GDP ratio in the United States A) steadily fell.

B) steadily increased.

C) was about constant.

D) fell from 1995 to 1998, then rose sharply.

Answer: A Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 4) From 2001 to 2015, the debt-GDP ratio in the United States A) steadily fell.

B) steadily increased.

C) was about constant.

D) fell from 1995 to 1998, then rose sharply.

Answer: B Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition

19 .

5) Increases in the debt-GDP ratio are primarily caused by A) a high growth rate of GDP. B) a high government deficit relative to GDP. C) increases in government borrowing through bonds.

D) increases in interest rates.

Answer: B Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 6) If the deficit is 0.02 times GDP, the existing debt-GDP ratio is 0.5, and the growth rate of nominal GDP is 0.04, then the change in the debt-GDP ratio is A) +0.05 B) +0.025.

C) 0.

D) -0.025.

Answer: C Diff: 2 Topic: Section: 15.3 Question Status: Revised 7) If the deficit is 0.1 times GDP, the existing debt-GDP ratio is 0.5, and the growth rate of nominal GDP is 0.04, then the change in the debt-GDP ratio is A) +0.08 B) +0.075.

C) 0.

D) -0.075.

Answer: A Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 8) If the deficit is 0.08 times GDP, the existing debt-GDP ratio is 0.8, and the growth rate of nominal GDP is 0.05, then the change in the debt-GDP ratio is A) +0.08.

B) +0.04.

C) 0.

D) -0.08.

Answer: B Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition

20 .

9) If the deficit is 0.03 times GDP, the existing debt-GDP ratio is 0.3, and the growth rate of nominal GDP is 0.03, then the change in the debt-GDP ratio is A) 0.000.

B) 0.003.

C) 0.009.

D) 0.021.

Answer: D Diff: 2 Topic: Section: 15.3 Question Status: New 10) A Social Security system in which payroll taxes that workers and their employers pay in go directly to retirees and other beneficiaries is known as A) a pay-as-you-go system.

B) an individual-account system.

C) a primary-deficit system.

D) a social-lockbox system.

Answer: A Diff: 1 Topic: Section: 15.3 Question Status: Previous Edition 11) According to current projections, in about 2035, the Social Security trust fund will A) own all the government bonds that have been issued.

B) own about half of all the stock issued on the New York Stock Exchange.

C) run out of assets.

D) start to run deficits.

Answer: C Diff: 1 Topic: Section: 15.3 Question Status: Revised 12) Which of the following policies would not prevent the Social Security trust fund from running out of assets?

A) Reduce promised benefits B) Reduce taxes C) Increase taxes D) Earn a higher rate of return Answer: B Diff: 1 Topic: Section: 15.3 Question Status: Previous Edition

21 .

13) Social Security benefits could be reduced in each of the following ways except A) cutting the promised monthly benefit.

B) increasing the retirement age.

C) investing the trust fund in the stock market.

D) reducing the degree to which benefits are adjusted for inflation.

Answer: C Diff: 1 Topic: Section: 15.3 Question Status: Previous Edition 14) To earn a higher return on the assets in the Social Security trust fund, a suggestion has been made to allow the trust fund to A) buy government bonds.

B) sell limited partnerships.

C) sell insurance.

D) invest in the stock market.

Answer: D Diff: 1 Topic: Section: 15.3 Question Status: Previous Edition 15) Recent proposals to allow the Social Security trust fund to invest in the stock market (instead of buying government bonds) are based on the premise that A) the returns to stocks are higher than the returns to bonds.

B) the returns to stocks aren't as risky as the returns to bonds.

C) the transactions costs for investing in stocks are lower than the transactions costs for investing in bonds.

D) stocks are more liquid than bonds.

Answer: A Diff: 1 Topic: Section: 15.3 Question Status: Previous Edition 16) A decreased government deficit created by a lump-sum tax increase will increase national saving if A) the value of government bonds outstanding grows slower than the public's wealth.

B) it causes consumption to fall.

C) the government runs a primary surplus as a result.

D) the real interest rate is less than the growth rate of real GNP. Answer: B Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition

22 .

17) According to the Ricardian equivalence proposition, current deficits A) will not affect consumption or national saving.

B) will affect consumption but not national saving.

C) will affect national saving but not consumption.

D) will affect both consumption and national saving.

Answer: A Diff: 1 Topic: Section: 15.3 Question Status: Previous Edition 18) According to the Ricardian equivalence proposition, a government budget deficit created by a temporary tax cut A) does not affect desired national saving.

B) does not affect expected future taxes.

C) reduces desired investment spending.

D) increases the real interest rate.

Answer: A Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 19) An expansionary fiscal policy will not cause an increase in the price level if the government A) reduces the corporate income tax rate.

B) increases purchases in the classical model.

C) lowers taxes and Ricardian equivalence does not hold.

D) lowers taxes and Ricardian equivalence holds.

Answer: A Diff: 2 Topic: Section: 15.3 Question Status: New 20) Deficits are a burden on future generations if they A) cause higher rates of inflation to occur.

B) are not used for government capital formation.

C) cause national saving to fall.

D) are always a primary government deficit.

Answer: C Diff: 1 Topic: Section: 15.3 Question Status: Previous Edition

23 .

21) Suppose a temporary tax cut today is combined with a rise in tax rates on the next generation of taxpayers. This long delay in increasing future taxes would not in itself cause the Ricardian equivalence proposition to fail to accurately predict the effects of the tax cut, unless the A) parents failed to leave bequests.

B) parents saved the tax cut.

C) parents invested the tax cut.

D) parents were far-sighted in their expectations of future tax increases.

Answer: A Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 22) A decrease in taxes on the current generation would have no effect on consumption or national saving if A) individuals face borrowing constraints.

B) individuals increase their consumption by less than the tax cut.

C) consumers bequeath all of the tax cut to the next generation.

D) consumers are not forward looking concerning their future tax burden.

Answer: C Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 23) Which of the following would not be an argument that government debt imposes a burden on future generations?

A) Lump-sum taxes in the future may be raised to pay higher real interest costs.

B) Higher taxes in the future could increase the average cost of distortions to the economy created by taxes.

C) Higher taxes in the future to repay government debt will transfer resources from the poor to the rich.

D) Higher government deficits resulting from increased purchases may reduce savings, causing investment to fall.

Answer: A Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 24) The stimulus package of 2009 had the effect of A) causing higher rates of inflation to occur.

B) giving new foreign aid to help less developed countries.

C) significantly raising the debt to GDP ratio.

D) reducing the primary government deficit.

Answer: C Diff: 1 Topic: Section: 15.3 Question Status: Previous Edition 24 .

25) Ramey found that a deficit-financed temporary increase in government purchases has a multiplier in the range of A) 0.0 to 0.2.

B) 0.2 to 0.8.

C) 0.8 to 1.5.

D) 1.5 to 2.2.

Answer: C Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 26) Auerbach and Gorodnichenko found that the government spending multiplier is ________ in expansions and ________ in recessions.

A) 1.0 to 1.5; 0.0 to 0.5 B) 1.0 to 1.5; 2.0 to 2.5 C) 0.0 to 0.5; 1.0 to 1.5 D) 0.0 to -0.5; 0.5 to 1.0 Answer: C Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 27) Why is the Social Security system in crisis at a time when it's running large surpluses?

What's the source of the problem? What solutions have been proposed?

Answer: The Social Security system is in a crisis even though it's running large surpluses because its surpluses will turn to large deficits within the next 20 years. The source of the problem is that the baby-boom generation will begin to retire, greatly increasing the Social Security benefits that will be paid out. Potential solutions include reducing benefits, increasing taxes, or getting a higher return for the Social Security trust fund by investing in the stock market.

Diff: 1 Topic: Section: 15.3 Question Status: Previous Edition 28) Who bears the burden of the government debt? Explain why. Under what circumstances is there no burden to be borne?

Answer: If taxes must be raised in the future to pay off the debt, the distortions from higher tax rates are a burden on future generations. Also, if bondholders are on average wealthier than taxpayers, there will be a redistribution of wealth as the debt is repaid. Finally, if the debt reduces national saving, then investment will be lower, which reduces the capital stock, which means a lower standard of living for future generations. But if taxes are lump-sum and Ricardian equivalence holds, there is no burden, since then private saving rises to prevent the debt from having any effects on national saving.

Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 25 .

29) What are the main reasons (give at least three) that Ricardian equivalence might not hold?

Answer: People may face borrowing constraints, they may be shortsighted, they may fail to leave bequests, or their economic behavior may be affected because taxes aren't lump-sum.

Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 30) Suppose that real GDP is 10,000 and remains constant, nominal GDP is initially 30,000, inflation is 3%, and the debt-GDP ratio is 0.7. Find the largest nominal deficit that the government can run without raising the debt-GDP ratio.

Answer: change in debt/GDP = deficit/GDP - (debt/GDP × growth rate) 0 = deficit/30,000 - (0.7 × .03) .021 = deficit/30,000 deficit = .021 × 30,000 = 630.

Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 31) Find the largest nominal deficit that the government can run without raising the debt-GDP ratio, under each of the following sets of assumptions: (a) Suppose that real GDP is 20,000 and remains constant, nominal GDP is initially 30,000, inflation is 4%, and the debt-GDP ratio is 1.2. (b) Suppose that nominal GDP growth is 5% and outstanding nominal debt is 1500.

Answer: Use the equation: change in debt/GDP = deficit/GDP - (debt/GDP × g), where g is the growth rate of GDP. (a) 0 = deficit/30,000 - (1.2 × 0.04), so 0.048 = deficit/30,000, so deficit = 1440. (b) 0 = deficit/GDP - (1500/GDP) × 0.05); so deficit = 75.

Diff: 2 Topic: Section: 15.3 Question Status: Previous Edition 15.4

Deficits and Inflation

1) Seignorage is the revenue a government raises by A) taxation.

B) printing money.

C) borrowing money.

D) charging fees for services.

Answer: B Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition

26 .

2) The revenue that a government raises by printing money is called A) seignorage.

B) monetary revenue.

C) currency credit.

D) currency inflation.

Answer: A Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition 3) State governments in the United States can raise revenue by all the following means except A) increasing income taxes.

B) increasing taxes on corporate profits.

C) increasing sales taxes.

D) increasing the money supply.

Answer: D Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition 4) The relationship between the government deficit and the change in the monetary base is A) deficit equals change in government debt held by the public minus change in monetary base.

B) deficit equals change in government debt held by the public plus change in monetary base.

C) deficit equals change in government debt outstanding plus change in monetary base.

D) deficit equals change in government debt outstanding minus change in monetary base.

Answer: B Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition 5) In which case would you be most likely to expect inflation to occur?

A) The government runs a sustained government deficit by lowering taxes.

B) The government runs a sustained government deficit by increasing purchases.

C) The government runs a sustained primary deficit by increasing purchases.

D) The government funds its sustained deficit by increasing the money supply.

Answer: D Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition

27 .

6) In an all-currency economy in which real output and the real interest rate are fixed and the rates of money growth and inflation are constant, the inflation rate equals A) the real interest rate.

B) the nominal interest rate.

C) the growth rate of the nominal money supply.

D) the level of real seignorage revenue.

Answer: C Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition 7) The real seignorage collected by the government in an all-currency economy is the product of A) the rate of inflation and the real supply of government bonds.

B) the rate of inflation and the real money supply.

C) the debt—GDP ratio and the real money supply.

D) the debt—GDP ratio and the rate of inflation.

Answer: B Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition 8) The inflation tax is primarily a tax on A) government bonds.

B) Social Security recipients.

C) money.

D) real income.

Answer: C Diff: 2 Topic: Section: 15.4 Question Status: Previous Edition 9) Assume that in an all-currency economy the real interest rate is 4%, the expected rate of inflation is 8%, and the nominal interest rate is 12%. The monetary base equals $50 billion. The real seignorage revenue collected by the government would equal A) $4 billion.

B) $6 billion.

C) $8 billion.

D) $12 billion.

Answer: A Diff: 2 Topic: Section: 15.4 Question Status: Previous Edition

28 .

10) Real money demand in the economy is given by L = 0.5Y - 2500i, where Y is real income and i is the nominal interest rate. In equilibrium, real money demand L equals real money supply M/P. Suppose that Y equals 1000 and the real interest rate is 0.02. At what rate of inflation is seignorage maximized?

A) 0.05 B) 0.075 C) 0.09 D) 0.10 Answer: C Diff: 3 Topic: Section: 15.4 Question Status: Previous Edition 11) Real money demand in the economy is given by L = 0.5Y - 2500i, where Y is real income and i is the nominal interest rate. In equilibrium, real money demand L equals real money supply M/P. Suppose that Y equals 1000 and the real interest rate is 0.02.

What is the maximum amount of seignorage revenue?

A) 11.11 B) 20.25 C) 22.25 D) 24.75 Answer: B Diff: 3 Topic: Section: 15.4 Question Status: Previous Edition

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12) Consider an economy that has the following monetary data.

The monetary base and the money supply are expected to grow at a constant rate of 20% per year. Inflation and expected inflation are 20% per year. Suppose that bank reserves and currency pay no interest, all currency is held by the public, and bank deposits pay no interest. What is the cost to the public of the inflation tax?

A) $60 B) $140 C) $190 D) $200 Answer: D Diff: 2 Topic: Section: 15.4 Question Status: Previous Edition 13) Consider an economy that has the following monetary data.

The monetary base and the money supply are expected to grow at a constant rate of 20% per year. Inflation and expected inflation are 20% per year. Suppose that bank reserves and currency pay no interest, all currency is held by the public, and bank deposits pay no interest. What is the nominal value of seignorage over the year?

A) $10 B) $60 C) $70 D) $200 Answer: C Diff: 2 Topic: Section: 15.4 Question Status: Previous Edition

30 .

14) Whether real seignorage revenue increases when the rate of money growth increases depends on whether A) the rise in real money holdings outweighs the decline in inflation.

B) the rise in inflation outweighs the decline in real money holdings.

C) the rise in inflation ratio outweighs the decline in the real supply of currency.

D) the rise in the real supply of currency outweighs the decline in inflation.

Answer: B Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition 15) When did the United States suffer hyperinflation?

A) Revolutionary War B) War of 1812 C) World War II D) Korean War Answer: A Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition 16) When the United States engaged in quantitative easing from 2008 to 2014, ________ rose sharply.

A) bank reserves B) inflation C) the unemployment rate D) the money supply Answer: A Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition 17) When the United States engaged in quantitative easing from 2008 to 2014, why didn't the money supply rise sharply?

A) Foreigners wanted all the new dollars created by the Federal Reserve.

B) Banks held the increased monetary base as excess reserves.

C) The Fed offset the increased monetary base by raising reserve requirements.

D) The Fed offset the increased monetary base by buying foreign currency.

Answer: B Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition

31 .

18) When the economy strengthens, following the period of quantitative easing, the Federal Reserve plans to keep a lid on money growth by A) increasing reserve requirements.

B) selling dollars in foreign-exchange markets.

C) increasing the interest rate paid on reserves.

D) buying dollars in foreign-exchange markets.

Answer: C Diff: 1 Topic: Section: 15.4 Question Status: Previous Edition 19) How is real seignorage revenue related to inflation? How does the quantity of real seignorage revenue change as inflation rises from zero to a positive level, to still higher levels?

Answer: Real seignorage revenue is the inflation rate times the level of real money balances. As inflation rises, real money balances decline. Initially, as inflation rises from zero, real seignorage revenue rises, because inflation rises more than real money balances fall. Real seignorage revenue continues to rise with higher inflation rates until it hits a point at which it begins to decline, because real money balances begin to fall more than inflation rises.

Diff: 2 Topic: Section: 15.4 Question Status: Previous Edition 20) Real money demand in the economy is given by L = 0.3Y - 600i, where Y is real income and i is the nominal interest rate. In equilibrium, real money demand L equals real money supply M/P. Suppose that Y equals 2000 and the real interest rate is 5%. (a) At what rate of inflation is seignorage maximized? (b) What is the maximum amount of seignorage revenue?

Answer: (a) 47.5% (b) 135.375 Diff: 3 Topic: Section: 15.4 Question Status: Previous Edition

32 .

21) Consider an economy that has the following monetary data.

The monetary base and the money supply are expected to grow at a constant rate of 20% per year. Inflation and expected inflation are 20% per year. Suppose that bank reserves and currency pay no interest, all currency is held by the public, and bank deposits pay no interest. (a) What is the cost to the public of the inflation tax? (b) What is the nominal value of seignorage over the year? (c) What is the profit to the banks from the inflation?

Answer: (a) $200 (b) $70 (c) $130 Diff: 2 Topic: Section: 15.4 Question Status: Previous Edition

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