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Macroeconomics Test Bank Chapter 8 9
Macroeconomics Test Bank Chapter 8 9
Chapter 8
Business Cycles
8.1
1) One of the first organizations to investigate the business cycle was
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
B) trend analysis.
C) Hodrick—Prescott filter.
D) business cycle chronology.
Answer: D
4) The dates of turning points are determined by a committee from the
A) FBI. B) BLS. C) BEA. D) NBER.
Answer: D
6) The trough of a business cycle occurs when ________ hits its lowest point.
A) inflation B) the money supply C) aggregate economic activity D) the unemployment rate
Answer: C
11) Peaks and troughs of the business cycle are known collectively as
A) volatility. B) turning points. C) equilibrium points. D) real business cycle events.
Answer: B
14) Which group within the National Bureau of Economic Research officially determines whether the
economy is in a recession or expansion?
A) The G-4
B) The Business Cycle Dating Committee
15) Research on the effects of recessions on the real level of GDP shows that
A) recessions cause only temporary reductions in real GDP, which are offset by growth during the
expansion phase.
16) The tendency of many different economic variables to have regular and predictable patterns over
the business cycle is called
A) persistence. B) comovement. C) periodicity. D) recurrence.
Answer: B
17) Comovement is
A) the tendency for declines in economic activity to be followed by further declines, and for growth in
economic activity to be followed by more growth.
B) the idea that the standard pattern of contraction—trough—expansion—peak occurs again and again
in industrial economies.
C) the tendency of many economic variables to move together in a predictable way over the business
cycle.
D) the idea that peaks and troughs of the business cycle occur at regular intervals.
Answer: C
18) The tendency of many economic variables to move together in a predictable way over the business
cycle is called
A) recurrence. B) persistence. C) comovement. D) inflation.
Answer: C
19) The fact that business cycles are recurrent but not periodic means that
A) business cycles occur at predictable intervals, but do not last a predetermined length of time.
B) the business cycle's standard contraction—trough—expansion—peak pattern has been observed to
occur over and over again, but not at predictable intervals.
C) business cycles occur at predictable intervals, but do not all follow a standard contraction—trough—
expansion—peak pattern.
D) business cycles last a predetermined length of time, but do not all follow a standard contraction—
trough—expansion—peak pattern.
Answer: B
20) The tendency for declines in economic activity to be followed by further declines, and for growth in
economic activity to be followed by more growth is called
A) persistence. B) comovement. C) periodicity. D) recurrence.
Answer: A
21) Persistence is
A) the tendency for declines in economic activity to be followed by further declines, and for growth in
economic activity to be followed by more growth.
B) the idea that the standard pattern of contraction—trough—expansion—peak occurs again and again
in industrial economies.
C) the tendency of many economic variables to move together in a predictable way over the business
cycle.
D) the idea that peaks and troughs of the business cycle occur at regular intervals.
Answer: A
22) The idea that the business cycle is recurrent means that
A) declines in economic activity tend to be followed by further declines, and growth in economic
activity tends to be followed by more growth.
B) the standard pattern of contraction—trough—expansion—peak occurs again and again in industrial
economies.
C) many economic variables to move together in a predictable way over the business cycle.
23) Define the following characteristics of business cycles: recurrence and persistence.
Answer: Business cycles exhibit recurrence and persistence:
(1) Recurrence means that each complete cycle is followed by another complete cycle.
(2) Persistence means that, once begun, each contraction tends to continue. Likewise, once begun,
each expansion tends to continue.
For example, the 1981-1982 contraction lasted for 16 months, and the 1982-1990 expansion lasted for
93 months. These are persistent events.
24) Describe the major features of the business cycle. Be sure to discuss what variables are affected by
the cycle, a description of the key features that are apparent in the data, how variables are related to
one another, how regular the cycle is, and how predictable the cycle is.
Answer: The business cycle is defined as a fluctuation of aggregate economic activity. There are
recurrent but not periodic movements of aggregate activity, with many variables moving in the same
direction at the same time (comovement). Increases in aggregate economic activity are expansions,
while reductions in aggregate economic activity are contractions, or recessions. Both expansions and
contractions exhibit persistence, so once an expansion or contraction begins, it tends to last some
time.
25) When a recession occurs, do economists expect it to be a temporary phenomenon? Or is there
some degree of permanence? What is the empirical evidence?
Answer: Recent research suggests that recessions may contain permanent components. Some
economists argue that only the 1973-1975 recession led to a permanent change in the U.S. economy,
because it changed the economy's use of oil permanently. Other studies suggest that perhaps 30% of
changes in real output are permanent and 70% are temporary for the postwar United States.
8.2
1) The longest contraction in American history occurred
A) during the 1870s.
Answer: D
5) The long boom ended in
A) 1999. B) 2001. C) 2008. D) 2012.
Answer: B
7) By 1937, when a new recession began in the midst of the Great Depression,
A) GDP had almost recovered to its 1929 level, but unemployment was still above the 1929 level.
B) unemployment had almost fallen back to its 1929 level, but GDP had yet to recover to its 1929 level.
C) neither GDP nor unemployment had returned to near their 1929 levels.
D) both GDP and unemployment had returned to near their 1929 levels.
Answer: A
10) The longest economic expansion in the United States occurred during the
12) Christina Romer's criticism of the belief that business cycles had moderated since World War II
depended on the fact that
A) estimates of the timing of business cycles since World War II had been inaccurate.
B) misuse of historical data had caused economists to understate the size of cyclical fluctuations in the
post-World War II era.
C) economists had ignored the roles of the government and international trade in mitigating economic
fluctuations prior to World War II.
D) economists had left out important components of GDP, such as wholesale and retail distribution,
transportation, and services, in their pre-World War II estimates.
Answer: D
18) Stock and Watson found that monetary policy was responsible for about ________% of the
reduction in output volatility that occurred in the mid-1980s.
A) 0 to 10 B) 10 to 20 C) 20 to 30 D) 30 to 40
Answer: C
19) Stock and Watson found that ________ was responsible for about 20—30 % of the reduction in
output volatility that occurred in the mid-1980s.
A) reduced shocks to productivity B) reduced shocks to food and commodity prices
20) The widespread decline in the volatility of many macroeconomic variables after 1984 led
economists to term this period the
A) Great Moderation.
B) Low Volatility Era.
C) Steady State.
D) Long Boom.
Answer: A
21) How has the severity and duration of business cycles changed over time in the United States?
Answer: Though it is a controversial subject, it appears that business cycles have become less severe
over time. Recessions have certainly been shorter since World War II than they were before 1929.
There is some disagreement about how severe they were before 1929, with Christina Romer arguing
that measurement problems in the old data misled economists about how severe those recessions
were. But others find that the old data is just about right and conclude that the business cycle is much
less severe today.
22) If you were a member of the NBER business-cycle dating committee, would you declare that the
U.S. economy is now in a recession? Why? Describe the major variables that you would look at to
determine whether the economy is in a recession or not, and what features of the data you would look
for.
Answer: Many answers are possible. You should discuss GDP and other major macroeconomic
variables. You should note that you are looking for co-movement and persistence. Diff: 1 Topic:
Section: 8.2 Question Status: Previous Edition
23) Use the NBER data in Table 8.1 in the textbook on U.S. business cycle turning points to calculate:
a) the shortest business cycle from peak to peak;
8.3
1) An economic variable that moves in the same direction as aggregate economic activity (up in
expansions, down in contractions) is called
A) procyclical. B) countercyclical. C) acyclical. D) a leading variable.
Answer: A
2) An economic variable that moves in the opposite direction as aggregate economic activity (down in
expansions, up in contractions) is called
A) procyclical.
B) countercyclical.
C) acyclical.
D) a leading variable.
Answer: B
3) An economic variable that doesn't move in a consistent pattern with aggregate economic activity is
called
A) procyclical. B) countercyclical. C) acyclical. D) a leading variable.
Answer: C
Answer: A
5) A variable that tends to move at the same time as aggregate economic activity is called
A) a leading variable. B) a coincident variable. C) a lagging variable. D) an acyclical variable.
Answer: B
6) A variable that tends to move later than aggregate economic activity is called
A) a leading variable. B) a coincident variable. C) a lagging variable. D) an acyclical variable.
Answer: C
Answer: B
8) The CFNAI is a
A) leading index based on variables released with different frequencies.
B) coincident index based on variables released with different frequencies.
10) Diebold and Rudebusch showed that the composite index of leading indicators did not improve
forecasts of industrial production because
A) the index is not produced in a timely manner.
B) the government manipulates the index so it never predicts a recession.
C) the index is not designed for forecasting.
D) data on the components of the index are revised.
Answer: D
11) Which of the following macroeconomic variables is procyclical and coincident with the business
cycle?
A) Residential investment
B) Nominal interest rates
C) Industrial production
D) Unemployment
Answer: C
12) Which of the following macroeconomic variables is procyclical and leads the business cycle?
A) Business fixed investment B) Residential investment C) Nominal interest rates D) Unemployment
Answer: B
15) Which of the following macroeconomic variables is procyclical and lags the business cycle?
A) Business fixed investment B) Employment C) Stock prices D) Nominal interest rates
Answer: D
16) Which of the following macroeconomic variables would you include in an index of leading
economic indicators?
A) Employment B) Inflation C) Real interest rates D) Residential investment
Answer: D
18) Which of the following macroeconomic variables would you exclude from an index of leading
economic indicators?
19) Which of the following macroeconomic variables could not be used as a leading economic
indicator?
A) Residential investment B) Employment C) The money supply D) Stock prices
Answer: B
20) Industries that are extremely sensitive to the business cycle are the
A) durable goods and service sectors. B) nondurable goods and service sectors.
C) capital goods and nondurable goods sectors. D) capital goods and durable goods sectors.
Answer: D
21) You want to invest in a firm whose profits show large fluctuations throughout the business cycle.
Which of the following would you invest in?
22) You want to invest in a firm whose profits show small fluctuations throughout the business cycle.
Which of the following would you invest in?
Answer: D
27) The probability that an employed worker will lose his or her job in the next month is known as
A) the unemployment rate.
B) the job finding rate.
C) the underemployment rate.
D) the job loss rate.
Answer: D
C) Nominal interest rates are procyclical and real interest rates are countercyclical.
D) Nominal interest rates are procyclical and real interest rates are acyclical.
Answer: D
30) Using the seasonal business cycle as your guide, during which quarter would you be most likely to
expect an increase in your corporation's sales?
A) The first quarter of the year (January-March) B) The second quarter of the year (April-June)
C) The third quarter of the year (July-September) D) The fourth quarter of the year (October-
December)
Answer: D
31) Which of the following macroeconomic variables is the most seasonally procyclical?
A) Expenditure on services B) The unemployment rate C) Expenditure on durable goods D) The real
wage
Answer: C
32) Which of the following macroeconomic variables does not vary much over the seasons?
A) The nominal money stock B) The unemployment rate C) The real wage D) Average labor productivity
Answer: C
33) Identify the comovement (i.e., direction and timing) of the following variables over a business
cycle:
(a) industrial production; (b) unemployment; (c) nominal interest rates; (d) nominal money supply
growth; and (e) investment
Answer:
Answer: A
3) Wars, new inventions, harvest failures, and changes in government policy are examples of
4) The three main components of the aggregate demand—aggregate supply model include
A) AD, SRAS, LM. B) SRAS, LRAS, IS. C) AD, IS, LM. D) AD, SRAS, LRAS.
Answer: D
5) The AD, SRAS, and LRAS curves each show a relationship between which two economic variables?
A) The aggregate price level and output B) The aggregate price level and the interest rate
C) Output and unemployment D) Output and the interest rate
Answer: A
6) When plotted with the aggregate price level on the vertical axis and output on the horizontal axis,
which of the following curves slopes downward?
7) 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
8) 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
9) When plotted with the aggregate price level on the vertical axis and output on the horizontal axis,
the aggregate demand curve
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
12) A decline in the stock market, which makes consumers poorer, would cause
A) the aggregate demand curve to shift to the right.
B) the aggregate demand curve to shift to the left.
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
13) In the short run, an increase in export sales would cause output to ________ and the price level to
________.
A) rise; rise B) rise; stay constant C) fall; stay constant D) fall; rise
Answer: B
14) After a shift in the aggregate demand curve, which variable adjusts to restore general equilibrium?
A) price level B) real interest rate C) consumption spending D) investment spending
Answer: A
15) In the long run, an increase in consumer spending would cause output to ________ and the price
level to ________.
A) rise; rise B) rise; stay constant C) stay constant; stay constant D) stay constant; rise
Answer: D
16) In the long run, an increase in government purchases of military equipment would cause output to
________ and the aggregate price level to ________.
A) stay constant; fall B) fall; fall C) fall; stay constant D) stay constant; rise
Answer: D
17) According to classical macroeconomists, prices adjust ________ to shocks, so the government
should ________.
A) slowly; do little B) rapidly; do little C) rapidly; fight recessions D) slowly; fight recessions
Answer: B
18) According to Keynesian macroeconomists, prices adjust ________ to shocks, so the government
should ________.
A) slowly; do little B) rapidly; do little C) rapidly; fight recessions D) slowly; fight recessions
Answer: D
19) In the long run, an increase in productivity would cause output to ________ and the aggregate
price level to ________.
A) fall; rise B) fall; fall C) rise; fall D) rise; rise
Answer: C
20) In the long run, a reduction in labor supply would cause output to ________ and the aggregate
price level to ________.
21) The key difference between classical and Keynesian macroeconomists is their differing beliefs
about
A) the slope of the aggregate demand curve.
22) Suppose labor supply declined. Would this affect the aggregate demand curve or the aggregate
supply curve? What would be the effect on output and the price level?
Answer: The decline in the labor supply shifts the long-run aggregate supply curve to the left, causing
the price level to increase and output to decline.
23) Suppose the economy is initially in long-run equilibrium. For each of the shocks listed below,
explain the short-run effects on output and the price level.
(a) A stock market crash reduces consumers' wealth.
(b) Businesses decide to hold larger inventories.
(c) The government cuts defense spending.
24) Suppose the economy is initially in long-run equilibrium. For each of the shocks listed below,
explain the long-run effects on output and the price level. (a) Labor supply decreases.
(b) The government shuts down the Bureau of Economic Analysis.
(c) Productivity increases.
Answer:
25) For each outcome below, tell what type of shift must have taken place in either the aggregate
demand curve or the long-run aggregate supply curve. (a) In the short run, the price level is
unchanged and output rises.
(b) In the long run, the price level declines and output is unchanged.
(c) In the long run, the price level rises and output declines.
Answer:
(a) The aggregate demand curve shifts to the right.
(b) The aggregate demand curve shifts to the left.
(c) The long-run aggregate supply curve shifts to the left.
Chapter 9 The IS-LM/AD-AS Model
1) The FE line shows the level of output at which the ________ market is in equilibrium.
A) Goods
B) Asset
C) Labor
D) Money
Answer: C
2) The FE line
A) is horizontal.
B) is vertical.
C) slopes downward.
D) slopes upward.
Answer: B
4) The FE line is vertical because the level of output at full employment doesn't depend on the A) real
wage rate.
B) level of employment.
C) marginal product of labor.
D) real interest rate.
Answer: D
13) Identify changes in three variables that would cause the FE line to shift to the right.
Answer: An increase in productivity, an increase in the supply of capital, or an increase in the supply
of labor would increase the full-employment level of output, as illustrated by a rightward shift in the
FE line.
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.
2) The IS curve A) is
horizontal.
B) is vertical.
C) slopes downward.
D) slopes upward.
Answer: C
3) Any change that reduces desired saving relative to desired investment (for a given level of output)
causes the real interest rate to ________ and shifts the IS curve ________.
A) increase; down and to the left
B) increase; up and to the right
C) decrease; down and to the left
D) decrease; up and to the right
Answer: B
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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
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5) 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
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6) 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
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7) 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
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12) 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
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13) 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
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14) The IS curve will shift down and to the left when A) desired
saving declines.
B) government purchases increase.
C) consumption increases.
D) the expected future marginal product of capital declines.
Answer: D
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15) The IS curve would unambiguously shift up and to the right if there were A) an
increase in both government purchases and corporate taxes.
B) an increase in both government purchases and the expected future marginal product of capital. C)
an increase in the expected future marginal product of capital and a decrease in expected future
output.
D) a decrease in both corporate taxes and the expected future marginal product of capital. Answer: B
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16) Draw a saving—investment diagram to show how each of the following changes shifts the IS curve.
(a) Future income rises.
(b) The future marginal productivity of capital increases.
(c) Government purchases decrease temporarily.
(d) The effective corporate tax rate increases.
Answer:
(a) IS shifts up and to the right.
(b) IS shifts up and to the right.
(c) IS shifts down and to the left.
(d) IS shifts down and to the left.
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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
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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
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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
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4) The LM curve A) is
horizontal.
B) is vertical.
C) slopes downward.
D) slopes upward.
Answer: D
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5) Looking only at the asset market, an increase in output would cause A) the
LM curve to shift down and to the right.
B) the LM curve to shift up and to the left.
C) an increase in the real interest rate along the LM curve.
D) a decrease in the real interest rate along the LM curve.
Answer: C
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7) 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.
8) 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
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9) Banks decide to raise the interest rate they pay on checking accounts from 1% to 2%. This action
would
A) increase money demand, shifting the LM curve up and to the left.
B) increase money demand, shifting the LM curve down and to the right.
C) decrease money demand, shifting the LM curve up and to the left.
D) decrease money demand, shifting the LM curve down and to the right.
Answer: A
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10) You have just read that the Federal Reserve has increased the money supply to avoid a
recession. For a given price level, you would expect the LM curve to A) shift
up and to the left as the real money supply falls.
B) shift up and to the left as the real money supply rises.
C) shift down and to the right as the real money supply falls.
D) shift down and to the right as the real money supply rises.
Answer: D
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11) The Fed has announced that it plans to lower the rate of monetary growth from 10% per year to
2% per year. You would expect this announcement to directly
A) increase money demand, shifting the LM curve up and to the left.
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
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12) The probably effect of introducing an increased number of automatic teller machines is to A)
increase money demand, shifting the LM curve up and to the left.
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
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13) Looking at the macroeconomic statistics for Friedmanland, you discover that at the beginning of
the year, the national money supply was equal to $400 million and by the end of the year it was equal
to $420 million. You also found out that the inflation rate in Friedmanland was
7%. In this case, you would expect the LM curve to
A) shift up and to the left as the real money supply falls.
B) shift up and to the left as the real money supply rises.
C) shift down and to the right as the real money supply falls.
D) shift down and to the right as the real money supply rises.
Answer: A
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14) If the money supply is increased, which curve shifts in the IS—LM model? What direction does
it shift? What is the intuition behind this shift?
Answer: An increase in the money supply shifts the LM curve down and to the right. Because the
nominal money supply has risen, real money supply is higher. To get an increase in real money
demand to restore equilibrium in the asset market, either income must rise or the real interest rate
must fall, which can be seen as a shift of the LM curve down and to the right. .
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15) Calculate the real money supply growth rate when the nominal money supply increases by 10%
and the price level increases by each of the following percentages: a) 2%; b) 8%; c) 10%; d) 15%.
Answer: Real money supply growth rate = nominal money supply growth rate minus the price
level growth rate. (The price level growth rate is the inflation rate.) (a) Real
money supply growth rate = 10% - 2% = 8%.
(b) Real money supply growth rate = 10% - 8% = 2%.
(c) Real money supply growth rate = 10% - 10% = 0%.
(d) Real money supply growth rate = 10% - 15% = -5%.
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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
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2) An increase in the effective tax rate on capital would cause the IS curve to ________ and the
LM curve to ________.
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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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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
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
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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
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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
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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
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23) For each of the following changes, which equilibrium curve (IS, LM, or FE) is shifted? Draw the
change in the underlying demand or supply curves (for example, money demand and supply for the LM
curve) and show how the equilibrium curve changes.
(a) Expected inflation increases.
(b) The future marginal productivity of capital increases.
(c) Labor supply decreases.
(d) Future income declines.
(e) There's a temporary beneficial supply shock.
(f) The nominal interest rate on money rises.
Answer:
(a) LM shifts down and to the right.
(b) IS shifts up and to the right.
(c) FE shifts left.
(d) IS shifts down and to the left.
(e) FE shifts right.
(f) LM shifts up and to the left.
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24) Oil prices have risen temporarily, due to political uncertainty in the Middle East. An advisor to
the Fed suggests, "Higher oil prices reduce aggregate demand. To offset this we must increase the
money supply. Then the price level won't need to adjust to restore equilibrium, and we'll prevent a
recession." Analyze this statement using the IS—LM model.
Answer: This is a change in the FE line, not aggregate demand, so the policy is incorrect. Instead, to
keep the price level fixed, money supply should decrease, so output falls and the real interest rate
rises.
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25) For each of the following changes, what happens to the real interest rate and output in the
very short run, before the price level has adjusted to restore general equilibrium? (a) Wealth rises.
(b) Money supply rises.
(c) The future marginal productivity of capital increases.
(d) Expected inflation declines.
(e) Future income declines.
Answer:
(a) The IS curve shifts up and to the right, so r rises and Y rises.
(b) The LM curve shifts down and to the right, so r falls and Y rises.
(c) The IS curve shifts up and to the right, so r rises and Y rises.
(d) The LM curve shifts up and to the left, so r rises and Y falls.
(e) The IS curve shifts down and to the left, so r falls and Y falls.
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26) Desired consumption is Cd = 2000 + 0.9Y - 100,000r - G, and desired investment is Id = 1000 -
45,000r. Real money demand is Md/P = Y - 6000i. Other variables are πe = 0.03, G = 500, = 1000, and
M = 2100.
(a) Find the equilibrium values of the real interest rate, consumption, investment, and the price
level.
(b) Suppose government purchases decline to 400. What happens to the variables listed in part
(a)?
(c) Suppose government purchases rise to 600. What happens to the variables listed in part (a)?
(d) What feature in this example leads to the result that you don't need to know the amount of taxes
collected by the government to find the equilibrium?
Answer:
(a) r = 0.02, C = 400, I = 100, P = 3.
(b) C = 500, other variables are unchanged.
(c) C = 300, other variables are unchanged.
(d) Desired consumption depends on the level of government purchases, not taxes. This is an example
of a classical view in which people realize that government purchases must be paid for by taxes
today or in the future, so it's the level of government purchases that affects consumption decisions,
not the level of taxes.
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27) Desired consumption is Cd = 100 + 0.8Y - 500r - 0.5G, and desired investment is Id = 100 -
500r. Real money demand is Md/P = Y - 2000i. Other variables are πe = 0.05, G = 200, =
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.
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28) Analyze the following statement, and show what would happen in the long run if such advice
were followed by the Fed: "The increase in the stock market has increased people's wealth. As a result,
their consumption has increased, increasing aggregate demand and output. So the Fed needs to
increase the money supply, since with higher income, people's demand for real money balances will be
higher."
Answer: Assuming resources are fully utilized, there will be no increase in output. Higher wealth will
reduce saving, shifting the IS curve up and to the right. Increasing the money supply shifts the LM curve
down and to the right. But general equilibrium will require the LM curve to shift up and to the left. So
the price level must rise, and it rises even more because of the monetary policy suggested by the
statement. The correct monetary policy for preventing inflation is to reduce, not increase, the money
supply.
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29) Use the IS—LM model to determine the effects of each of the following on the general
equilibrium values of the real wage, employment, output, the real interest rate, consumption,
investment, and the price level.
(a) Tougher immigration laws reduce the working-age population.
(b) There's increased volatility in the prices of stocks and bonds.
(c) The government tries to achieve tax equity by an increase in the corporate tax rate. (d) Increased
computerization reduces stock market brokerage costs.
Answer:
(a) The decline in labor supply increases the real wage and reduces employment and output,
shifting the FE line to the left. The LM curve shifts up and to the left as the price level rises to restore
equilibrium. As a result, the real interest rate rises, reducing consumption and investment.
(b) Real money demand rises, which shifts the LM curve up and to the left. To restore equilibrium,
the price level must decline, shifting the LM curve down and to the right. There's no effect on any
other variable.
(c) The higher tax rate reduces investment, shifting the IS curve down and to the left. To restore
equilibrium, the LM curve shifts down and to the right as the price level falls. As a result, the real
interest rate declines, so consumption increases. There's no change in the real wage, employment, or
output.
(d) Increased liquidity on nonmoney assets reduces money demand, shifting the LM curve down
and to the right. The price level rises, to restore equilibrium by shifting the LM curve back up and to
the left. There's no effect on the other variables.
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30) Suppose the Federal Reserve's short-run response to any change in the economy is to change
the money supply to maintain the existing real interest rate. What would happen to money supply if
there were a reduction in government purchases? Given the Fed's policy, what would happen in the
very short run (before general equilibrium is restored) to output and the real interest rate?
What must happen to the LM curve and the price level to restore general equilibrium? Answer: The
decrease in G shifts the IS curve down and to the left. The Fed's policy decreases the money supply
and shifts the LM curve up and to the left, so the real interest rate doesn't change. But output
declines in the very short run. To restore general equilibrium, the price level must decline to shift the
LM curve down and to the right. If the Fed wanted to keep the price level from changing so much, its
correct policy would have been to increase the money supply, not decrease it.
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31) Suppose you were a forecaster of the real wage rate, employment, output, the real interest
rate, consumption, investment, and the price level. A shock hits the economy, which you think is a
temporary adverse supply shock.
(a) What are your forecasts for each of the variables listed above (rise, fall, and no change)?
(b) What if the shock was really due to people's reduced expectations about their future income.
Which variables did you forecast correctly, and which did you forecast incorrectly?
Answer:
(a) The real wage rate, employment, output, consumption, and investment decline, while the real
interest rate and the price level rise.
(b) The IS curve shifts down and to the left, instead of the FE line shifting left, so you are wrong
about every variable except consumption. The real wage, employment, and output won't change, the
real interest rate and the price level will decline, and investment will rise.
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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
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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
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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
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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
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5) Suppose the intersection of the IS and LM curves is to the right of the FE line. An increase in the
price level would most likely eliminate a disequilibrium among the asset, labor, and goods markets by
A) shifting the LM curve up and to the left.
B) shifting the IS curve up and to the right.
C) shifting the IS curve down and to the left.
D) shifting the FE curve to the left.
Answer: A
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7) Classical economists think general equilibrium is attained relatively quickly because A) the
real interest rate adjusts quickly.
B) the level of output adjusts quickly.
C) the real wage rate adjusts quickly.
D) the price level adjusts quickly.
Answer: D
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8) Keynesian economists think general equilibrium is not attained quickly because A) the
real interest rate adjusts slowly.
B) the level of output adjusts slowly.
C) the real wage rate adjusts slowly.
D) the price level adjusts slowly.
Answer: D
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12) Under monetary neutrality, an increase in the money supply causes output to ________ and the
price level to ________.
A) rise; rise
B) rise; not change
C) not change; not change
D) not change; rise
Answer: D
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13) Under an assumption of monetary neutrality, a change in the nominal money supply has A) no
effect on the price level.
B) a less than proportionate effect on the price level.
C) a proportionate effect on the price level.
D) a more than proportionate effect on the price level.
Answer: C
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14) Describe the .erences between classical and Keynesian economists in terms of their views about
monetary neutrality.
Answer: Keynesians believe that monetary neutrality holds in the long run but not in the short run.
Classical economists are more accepting of the view that money is neutral even in the relatively short
run.
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15) For each of the following changes, what happens to the real interest rate and output in the very
short run, before the price level has adjusted to restore general equilibrium?
(a) Wealth declines.
(b) Money supply declines.
(c) The future marginal productivity of capital declines.
(d) Expected inflation rises.
(e) Future income rises.
Answer:
(a) The IS curve shifts down and to the left, so r falls and Y falls. (b) The LM
curve shifts up and to the left, so r rises and Y falls.
(c) The IS curve shifts down and to the left, so r falls and Y falls.
(d) The LM curve shifts down and to the right, so r falls and Y rises. (e) The IS curve shifts
up and to the right, so r rises and Y rises. .
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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
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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
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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
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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
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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
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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
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B) slopes upward.
C) is horizontal.
D) slopes downward.
Answer: C
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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
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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
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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
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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
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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
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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
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17) Describe the effects, in both the short run and the long run, of an increase in the money supply.
Explain what happens to real output and the price level.
Answer: In the short run, an increase in the money supply increases output and has no effect on the
price level. In the long run, an increase in the money supply has no effect on output and increases the
price level.
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18) For each outcome below, tell what type of shift must have taken place in either the aggregate
demand curve or the long-run aggregate supply curve.
(a) In the short run, the price level is unchanged and output rises.
(b) In the long run, the price level declines and output is unchanged. (c) 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.
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