CHAPTER 6

AGGREGATE SUPPLY AND THE PHILLIPS CURVE

Difficulty: Medium
1. The theory of aggregate supply is one of the most controversial in macroeconomics because
A) modern models, while similar in their starting points, reach widely different results in
explaining the AS-curve
B) economists cannot agree whether the Keynesian or the classical AS-curve is a better
reflection of reality
C) economists cannot agree whether wages are completely flexible or rigid in the long run
D) economists cannot agree whether wages are completely flexible or rigid in the very short run
E) economists do not completely agree on the reasons for the slow adjustment of wages and
prices after demand-side disturbances
Ans: E

Difficulty: Medium
2. Friedman and Phelps argued that the Phillips curve is not stable over time because
A) any kind of stabilization policy immediately affects nominal wages
B) any shift in aggregate demand will immediately also shift the Phillips curve
C) workers' expectations about price changes are only wrong temporarily
D) firms change wage rates for workers as soon as product prices change, so profits will not
suffer
E) firms always immediately change their product prices in response to a change in money
supply
Ans: C

Difficulty: Easy
3. For many government decision makers, the original Phillips curve implied
A) a trade-off between lowering unemployment at the cost of higher inflation or lowering
inflation at the cost of higher unemployment
B) that active stabilization policy will always work if applied correctly
C) that severe recessions were a thing of the past, as unemployment could easily adjust to its
natural rate
D) that the natural rate of unemployment can be lowered by expansionary monetary policy
E) all of the above
Ans: A

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Difficulty: Easy
4. If we look at the annual U.S. unemployment rates over the last five decades, we see
A) peaks in 1982, 1992, 2002, and 2008, with each peak higher than the last
B) fairly small variations around the natural rate of 5.2%
C) fairly large variations but with the rate quickly returning to about 4% after each peak
D) that the unemployment rate exceeded 10% at least once
E) that the unemployment rate never exceeded 9%
Ans: D

Difficulty: Easy
5. The original Phillips curve shows an inverse relationship between
A) the level of output and prices
B) the level of output and unemployment
C) the level of prices and employment
D) the rate of change in money wages and the rate of unemployment
E) the level of prices and wage rate changes
Ans: D

Difficulty: Easy
6. According to the Phillips curve relationship, if unemployment is at the natural rate, then
A) the rate of inflation is zero
B) nominal wages will always be equal to real wages
C) the labor supply will be totally price elastic
D) prices will always immediately adjust to changes in money supply
E) none of the above
Ans: E

Difficulty: Medium
7. The newer view of the Phillips curve implies that
A) the natural rate of unemployment can be reduced by expansionary monetary policy
B) in the long run unemployment does not move towards a natural rate if there is frictional
unemployment
C) an increase in monetary growth affects unemployment and inflation in the short run, but only
affects inflation in the long run
D) there is a clear inverse relationship between unemployment and output
E) stagflation can best be addressed by implementing expansionary fiscal policies
Ans: C

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Difficulty: Medium
8. The inflation-expectations-augmented Phillips curve implies that
A) unemployment is at its natural rate when expected inflation is equal to actual inflation
B) stagflation occurs when expected inflation is below actual inflation
C) stagflation occurs when the short-run Phillips curve shifts left
D) the inflation rate is equal to the real output growth rate plus the monetary growth rate
E) the expected inflation rate is always equal to the monetary growth rate
Ans: A

Difficulty: Medium
9. Stagflation, that is, high unemployment combined with high inflation
A) cannot persist, since the economy eventually will return to full employment
B) can only occur if expansionary monetary policy is combined with restrictive fiscal policy
C) is inconsistent with the inflation-expectations-augmented Phillips curve
D) cannot occur as long as the expected inflation rate is above the actual inflation rate
E) none of the above
Ans: A

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

Difficulty: Medium
11. The coordination approach to the Phillips curve focuses on the fact that
A) administrations have problems coordinating fiscal policy with the monetary policy of the
central bank
B) long-term labor contracts tend to expire at different times, so firms cannot coordinate their
hiring
C) unemployed workers are not organized enough to influence wage negotiations
D) firms are unsure about their competitors' behavior and are therefore reluctant to change
wages and prices following a change in aggregate demand
E) workers have only imperfect information about their real wages
Ans: D

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Difficulty: Easy
12. The inverse relationship between inflation and unemployment is called
A) Okun's law
B) the Lucas curve
C) the Phillips curve
D) the replacement ratio
E) the sacrifice ratio
Ans: C

Difficulty: Medium
13. A difference between the inflation-expectations-augmented Phillips curve and the Phillips
curve that is based on rational expectations is that
A) in the latter people never make incorrect forecasts
B) in the latter monetary policy changes cannot affect the rate of inflation
C) in the former a change in monetary policy causes an immediate shift in the Phillips curve
D) in the former expected inflation is always equal to actual inflation
E) none of the above
Ans: E

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

Difficulty: Medium
15. The unemployment gap
A) always grows twice as fast as the output gap
B) always is negative
C) always increases as the rate of inflation increases
D) always stays at its natural level
E) none of the above
Ans: E

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Difficulty: Medium
16. Wages are considered to be sticky rather than flexible since
A) firms encounter menu costs when changing wages but not when changing prices
B) labor contracts contain cost-of-living adjustments
C) firms tend to look at labor as an expendable resource
D) firms are unsure about their competitors' behavior and only reluctantly change prices and
wages following a change in aggregate demand
E) all of the above
Ans: D

Difficulty: Medium
17. Which of the following is NOT true for the expectations-augmented Phillips curve?
A) the short-run curve shifts with changes in inflationary expectations
B) the position of the curve depends on the expected rate of inflation
C) if actual inflation is equal to expected inflation, we are at full-employment
D) if unemployment is below its natural rate, the curve will shift to the right
E) if wages and prices don't respond to changes in unemployment, the curve is vertical
Ans: E

Difficulty: Medium
18. The fact that nominal wages are fixed by a contract at the beginning of a period while prices
of goods may change within that period, implies that
A) unanticipated changes in the money supply do not affect the level of output
B) there is no trade-off between unemployment and inflation
C) firms want to supply more output when prices increase since the real wage rate is lower
D) anticipated monetary policy changes will not affect the level of inflation
E) money supply changes affect prices but not unemployment in the short run
Ans: C

Difficulty: Medium
19. The efficiency wage theory of aggregate supply implies that
A) the AS-curve is vertical
B) paying employees higher wages won't induce them to work harder
C) even unanticipated changes in monetary or fiscal policy have no effect on the level of output
D) since the cost of changing wages and prices is low, wages can easily be adjusted in
proportion to price changes to maintain full employment
E) none of the above
Ans: E

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Difficulty: Medium
20. Which of the following is NOT used in deriving the AS-curve in Chapter 6?
A) the link between output and employment
B) the price-cost relation
C) the Phillips curve
D) the quantity theory of money
E) all of the above are used
Ans: D

Difficulty: Medium
21. The upward-sloping AS-curve will shift eventually to the left if
A) labor productivity increases
B) actual output is lower than the full-employment level
C) actual output is higher than the full-employment level
D) the markup over labor cost falls
E) the level of potential output increases
Ans: C

Difficulty: Medium
22. In an AD-AS model with an upward-sloping AS-curve, the most likely effects of fiscal
expansion would be
A) an increase in prices and interest rates, but a decrease in real money balances
B) an increase in output, prices, and real money balances
C) an increase in consumption and a decrease in investment with no change in output
D) a decrease in unemployment but an increase in interest rates and real money balances
E) a decrease in consumption, but an increase in net exports and investment
Ans: A

Difficulty: Medium
23. Restrictive monetary policy will eventually affect the upward-sloping AS-curve since
A) higher interest rates will increase the cost of production
B) higher interest rates will reduce the capital stock which will, in turn, reduce potential GDP
C) the resulting unemployment will cause downward pressure on nominal wages, so the cost
of production will decrease
D) real wages will decline while nominal wags remain constant
E) firms will start laying off workers in anticipation of a decline in aggregate demand
Ans: C

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Difficulty: Medium
24. In the medium run the aggregate supply curve is upward sloping since
A) workers immediately realize that nominal wage increases are really the result of price
increases
B) firms encounter costs in resetting prices and are reluctant to change wages following a
change in aggregate demand
C) wages and prices always immediately change in proportion to the money stock
D) there is always natural friction in the labor market that prevents unemployment from
reaching zero
E) none of the above
Ans: B

Difficulty: Medium
25. Assume output is at its full-employment level and the Fed restricts money supply. What is the
most likely outcome?
A) an immediate decrease in prices, with no impact on output
B) no change in nominal wages in the short run, but a decline in output and prices in the
medium run
C) no change in real wages, but a decline in output and prices in the medium run
D) a decrease in nominal wages and prices in proportion to money supply, but no change in
output and real interest rates in the long run
E) both B) and D)
Ans: E

Difficulty: Medium
26. Assume the economy is at full employment. Which is the most likely effect of a decrease in
government spending?
A) output, prices, and interest rates will all increase in the medium run
B) output, prices, and interest rates will all decrease in the long run
C) prices and interest rates will decrease in the medium and long run while output will be
negatively affected in the medium run but not in the long run
D) output and prices will remain the same in the long run, but interest rates will increase both in
the medium and long run
E) output, prices and interest rates will all decline in the medium run but only output will be
negatively affected in the long run
Ans: C

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Difficulty: Medium
27. Assume the Fed implements restrictive monetary policy. Which of the following is the most
likely result in an AD-AS framework with an upward sloping AS-curve?
A) the interest rate will increase but output, prices, and real money balances will fall
B) the interest rate, output, and prices will all decline
C) prices and output will fall, but real money balances will increase
D) real money balances will remain unchanged, since money supply and prices will decrease
proportionally
E) real money balances and prices will fall proportionally
Ans: A

Difficulty: Easy
28. In the medium run, a price increase combined with a decrease in the unemployment rate is
most likely the result of
A) an adverse supply shock
B) an adverse supply shock followed by restrictive monetary policy
C) a favorable supply shock
D) a decrease in money supply
E) expansionary fiscal or monetary policy
Ans: E

Difficulty: Medium
29. The most likely long-run result of a tax cut would be
A) lower unemployment but higher prices and interest rates
B) lower interest rates but no change in unemployment
C) higher levels of consumption, investment, and employment
D) more consumption and less investment, with output remaining unchanged
E) higher prices and interest rates, resulting in a less consumption and investment
Ans: D

Difficulty: Medium
30. In the long run, monetary expansion should have the following result:
A) nominal wages change in proportion to nominal money supply
B) real interest rates remain constant
C) real wages remain constant
D) nominal wages and prices change in proportion to nominal money supply
E) all of the above
Ans: E

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Difficulty: Easy
31. In an AD-AS model with an upward sloping AS-curve, what would happen if oil prices
increased and the Fed responded by restricting money supply?
A) real output would increase and the price level would remain the same
B) real output would remain the same but the price level would decrease
C) real output would decrease and the price level would increase sharply
D) real output would decrease and the price level would decrease sharply
E) real output would decrease but we can't tell what would happen to the price level
Ans: E

Difficulty: Medium
32. What sort of event could lead to a simultaneous decrease in the rates of inflation and
unemployment?
A) a decrease in money supply
B) an increase in money supply
C) an adverse supply shock
D) a decrease in material prices
E) restrictive monetary policy following an adverse supply shock
Ans: D

Difficulty: Medium
33. In the static AD-AS model, what is the most likely long-run outcome of an oil price increase,
if no policy change is implemented?
A) real wages will decline while the levels of output and prices will remain unchanged
B) the level of prices will increase while the level of output will remain unchanged
C) the natural unemployment rate and the price level will both increase
D) nominal wages and prices will increase, but real wages will remain unchanged
E) real money balances and real wages will decline while nominal wages will remain unchanged
Ans: A

Difficulty: Easy
34. In the AD-AS model with an upward-sloping AS-curve, a decrease in oil prices will
A) increase prices and output
B) decrease prices and increase output
C) increase prices and decrease output
D) decrease prices and output
E) decrease prices but have no effect on output
Ans: B

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Difficulty: Easy
35. Which of the following is the most likely medium-run outcome of an adverse supply shock?
A) an increase in consumer prices and a higher level of real GDP
B) a decrease in real GDP
C) an increase in real wage rates
D) an increase in frictional unemployment
E) an increase in nominal GDP with real GDP remaining the same
Ans: B

Difficulty: Medium
36. Suppose an increase in oil prices is accompanied by a decline in the level of potential output.
Which of the following is the most likely long-run effect?
A) real GDP will decrease but prices will increase
B) real GDP and prices will both decline
C) real GDP will remain the same but prices will increase
D) real GDP will remain the same but nominal GDP will decrease
E) the unemployment rate and prices will both decrease
Ans: A

Difficulty: Medium
37. If policy makers want to get the price level quickly back to its original level following an
adverse supply shock, they need to
A) implement restrictive monetary policy
B) decrease taxes
C) increase government transfer payments
D) combine a tax increase with an increase in government spending of equal magnitude
E) levy a tariff on imported oil
Ans: A

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

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Difficulty: Medium
39. Assume the economy is at full employment. If the Fed accommodates an increase in oil
prices by expansionary monetary policy, the most likely long-run effect will be that
A) unemployment and prices will both increase
B) unemployment will decrease and prices will remain the same
C) unemployment will increase but prices will remain the same
D) unemployment and prices will both remain unchanged
E) unemployment will remain about the same but prices will increase
Ans: E

Difficulty: Easy
40. The real (inflation adjusted) price of crude oil
A) more than doubled between 1978 and 1981
B) was lower in 1998 than in 1980
C) was higher in 2008 than in 1980
D) increased more than fourfold between 1998 and 2008
E) all of the above
Ans: E

Difficulty: Medium
41. In the long run, what event(s) can lead to an increase in inflation without changing the
unemployment rate above its natural level?
A) a tax decrease combined with a government spending decrease
B) an increase in government spending combined with restrictive monetary policy
C) an adverse supply shock
D) an adverse supply shock accommodated by expansionary monetary policy
E) a favorable supply shock
Ans: D

Difficulty: Easy
42. The sacrifice ratio is defined as
A) the percentage of output lost for every 1 percent increase in the unemployment rate
B) the percentage increase in the unemployment rate for every 1 percent reduction in GDP
C) the percentage of output lost for each 1 percent reduction in the rate of inflation
D) the inflation rate plus the unemployment rate
E) the inflation rate divided by the unemployment rate
Ans: C

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Difficulty: Medium
43. Which of the following event(s) most likely will leave prices relatively unchanged while
increasing output?
A) an increase in money supply combined with an income tax increase
B) expansionary monetary policy in response to an adverse supply shock
C) expansionary fiscal policy employed after a favorable supply shock
D) restrictive monetary policy in response to an oil price decrease
E) none of these
Ans: C

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

Difficulty: Easy
45. Okun's law states that one extra percentage point in unemployment causes
A) a 2 percent fall in GDP
B) a 0.5 percent fall in GDP
C) a 2 percent fall in the rate of inflation
D) a 0.5 percent fall in the rate of inflation
E) a 2 percent increase in the sacrifice ratio
Ans: A

Difficulty: Easy
46. The misery index is constructed by
A) adding the inflation rate and the unemployment rate
B) multiplying the inflation rate with the unemployment rate
C) dividing the inflation rate by the unemployment rate
D) adding the sacrifice ratio and the replacement rate
E) combining the sacrifice ratio with Okun's law
Ans: A

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Difficulty: Easy
47. The misery index for the United States
A) increased steadily from 1950 to 1990, but has since declined
B) is closely but inversely related to the successes of the incumbent party
C) is closely and positively related to the successes of the incumbent party
D) is only loosely and inversely related to the successes of the incumbent party
E) none of the above
Ans: D

Difficulty: Easy
48. A change in the misery index
A) may indicate a change in the chances of an incumbent to get re-elected
B) may arise from a change in the inflation rate even if unemployment remains constant
C) is likely to occur if the economy experiences a positive supply shock
D) all of the above
E) none of the above
Ans: D

Difficulty: Easy
49. Political business cycles consist of fluctuations caused by
A) misguided foreign policies designed to increase political pressure over our trade partners
B) economic policies designed to help win elections
C) the Fed trying to support every policy proposed by the president
D) our trade partners trying to react to changes in U.S. policies
E) the inability of politicians to agree on the right policy mix
Ans: B

Difficulty: Medium
50. Predictions based on the theory of political business cycles suggest that
A) presidents who succeed in reducing inflation sharply before an election have the best chance
to be re-elected even if unemployment increases
B) achieving a low rate of unemployment before an election is less important than achieving a
low rate of inflation
C) presidents who want to be re-elected should aim for low inflation early in their terms and
then try to achieve strong economic growth before the next election
D) the practice of manipulating the economy before an election seldom pays off since voter
behavior is not significantly affected by economic issues
E) none of the above
Ans: C

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