Theory Multiple Choice

Intermediate Macroeconomics, Fall 2014
Practice Questions (1)

1. It is a national income accounting rule that all expenditure on purchases of products is
necessarily equal to:
A) profits of firms.
B) wages of employees.
C) income of the producers of the products.
D) income of employees.
2. To reduce the money supply, the Federal Reserve:

A) buys government bonds.
B) sells government bonds.
C) creates demand deposits.
D) destroys demand deposits.
3. GDP is the market value of all ______ goods and services produced within an economy
in a given period of time.
A) Used
B) intermediate
C) Consumer
D) Final
4. When a pizza maker lists the price of a pizza as $10, this is an example of using money
as a:
A) store of value.
B) unit of account.
C) medium of exchange.
D) flow of value.
5. Assume that a tire company sells four tires to an automobile company for $400, another
company sells a compact disc player for $500, and the automobile company puts all of
these items in or on a car that it sells for $20,000. In this case, the amount from these
transactions that should be counted in GDP is:
A) $20,000.
B) $20,000 less the automobile company's profit on the car.
C) $20,900.
D) $20,900 less the profits of all three companies on the items that they sold.
6. The government raises lump-sum taxes on income by $100 billion, and the neoclassical
economy adjusts so that output does not change. If the marginal propensity to consume
is 0.6, private saving:
A) rises by $40 billion.
B) rises by $60 billion.
C) falls by $60 billion.
D) falls by $40 billion.
7. If nominal GDP in 2009 equals $14 trillion and real GDP in 2009 equals $11 trillion,
what is the value of the GDP deflator?
A) 0.79
B) 1.03
C) 1.27
D) 1.30
8. If a neutral technological advance improves the production function, the neoclassical

theory of distribution predicts:
A) the real wage will rise and the real rental price of capital will fall.
B) both the real wage and the real rental price of capital will fall.
C) both the real wage and the real rental price of capital will rise.
D) the real wage will fall and the real rental price of capital will rise.
9. In the national income accounts, goods bought for future use are classified as which
type of expenditure?
A) Services
B) Investment
C) government purchases
D) net exports
10. If the nominal exchange rate falls 10 percent, the domestic price level rises 4 percent,
and the foreign price level rises 6 percent, the real exchange rate will fall:
A) 0 percent.
B) 8 percent.
C) 10 percent.
D) 12 percent.
11. An increase in the price of imported goods will show up in:
A) the CPI but not in the GDP deflator.
B) the GDP deflator but not in the CPI.
C) both the CPI and the GDP deflator.
D) neither the CPI nor the GDP deflator.
12. In a small open economy, if the government adopts a policy that lowers imports, then
that policy:
A) raises the real exchange rate and increases net exports.
B) raises the real exchange rate and does not change net exports.
C) raises the real exchange rate and decreases net exports.
D) lowers the real exchange rate.
13. Unlike the real world, the classical model with fixed output assumes that:
A) all factors of production are fully utilized.
B) all capital is fully utilized but some labor is unemployed.
C) all labor is fully employed but some capital lies idle.
D) some capital lies idle and some labor is unemployed.
14. In a small open economy, if the world interest rate increases then the supply of domestic
currency on the foreign exchange market will _____ and the real exchange rate will
_____, holding all else constant.
A) decrease; decrease
B) decrease; increase
C) increase; decrease
D) increase; increase
15. The production function feature called “constant returns to scale” means that if we:
A) multiply capital by z1 and labor by z2, we multiply output by z3.
B) increase capital and labor by 10 percent each, we increase output by 10 percent.
C) increase capital and labor by 5 percent each, we increase output by 10 percent.
D) increase capital by 10 percent and increase labor by 5 percent, we increase output
by 7.5 percent.
16. In the small open economy in equilibrium:
A) saving is fixed and investment is determined by the investment function and the
world interest rate.
B) investment is fixed and saving is determined by the saving function and the world
interest rate.
C) saving is fixed and investment is determined by the trade balance.
D) investment is fixed and saving is determined by the trade balance.
17. If output is described by the production function Y = AK0.2L0.8, then the production
function has:
A) constant returns to scale.
B) diminishing returns to scale.
C) increasing returns to scale.
D) a degree of returns to scale that cannot be determined from the information given.
18. If consumption depends positively on the level of real balances, and real balances
depend negatively on the nominal interest rate in a neoclassical model, then:
A) the classical dichotomy still holds.
B) a rise in money growth leads to a fall in consumption and a rise in investment.
C) a rise in money growth leads to a rise in consumption and a fall in investment.
D) a rise in money growth leads to a rise in both consumption and investment.
19. If the consumption function is given by C = 150 + 0.85Y and Y increases by 1 unit, then
C increases by:
A) 0.15 unit.
B) 0.5 unit.
C) 0.85 unit.
D) 1 unit.
20. Compared to periods of lower rates of inflation, during a hyperinflation all of the
following occur except:
A) shoeleather costs increase.
B) menu costs become larger.
C) relative prices do a better job of reflecting true scarcity.
D) tax distortions increase.
21. Assume that the consumption function is given by C = 150 + 0.85(Y – T), the tax
function is given by T = t0 + t1Y, and Y is 5,000. If t1 decreases from 0.3 to 0.2, then
consumption increases by:
A) 85.
B) 425.
C) 500.
D) 525.
22. If inflation is 6 percent and a worker receives a 4 percent wage increase, then the
worker's real wage:
A) increased 4 percent.
B) increased 2 percent.
C) decreased 2 percent.
D) decreased 6 percent.
23. Assume that a firm is considering building a factory that will cost $5 million. It believes
that it can get a profit from this factory of $600,000 per year for many years. The
interest rate at which the firm can borrow money is 15 percent. After evaluating whether
it should build the factory, the firm decides that it should:
A) not build because the rate of return on the factory is only 6 percent.
B) not build because the rate of return on the factory is only 12 percent.
C) build because the rate of return on the factory is 30 percent.
D) build because the rate of return on the factory is 35 percent.
24. Devoting resources to avoiding the costs of expected inflation leads to:
A) eliminating the costs of expected inflation.
B) fewer relative price changes.
C) economic inefficiency.
D) a decrease in the transaction velocity of money.
25. A country's exports may be written as equal to:

A) GDP minus consumption minus investment minus government spending.
B) GDP minus consumption of domestic goods and services minus investment of
domestic goods and services minus government purchases of domestic goods and
services.
C) imports.
D) GDP minus imports.
26. According to the Fisher effect, the nominal interest rate moves one-for-one with
changes in the:
A) inflation rate.
B) expected inflation rate.
C) ex ante real interest rate.
D) ex post real interest rate.
27. Net capital outflow is equal to the amount that:

A) foreign investors lend here.
B) domestic investors lend abroad.
C) foreign investors lend here minus the amount domestic investors lend abroad.
D) domestic investors lend abroad minus the amount that foreign investors lend here.
28. If the real interest rate and real national income are constant, according to the quantity
theory and the Fisher effect, a 1 percent increase in money growth will lead to rises in:
A) inflation of 1 percent and the nominal interest rate of less than 1 percent.
B) inflation of 1 percent and the nominal interest rate of 1 percent.
C) inflation of 1 percent and the nominal interest rate of more than 1 percent.
D) both inflation and the nominal interest rate of less than 1 percent.
29. In a small open economy, if exports equal $20 billion, imports equal $30 billion, and
domestic national saving equals $25 billion, then net capital outflow equals:
A) –$25 billion.
B) –$10 billion.
C) $10 billion.
D) $25 billion.
30. If the money supply increases 12 percent, velocity decreases 4 percent, and the price
level increases 5 percent, then the change in real GDP must be ______ percent.
A) 3
B) 4
C) 9
D) 11
31. The world interest rate:
A) is equal to the domestic interest rate.
B) makes domestic saving equal to domestic investment.
C) is the interest rate charged on loans by the World Bank.
D) is the interest rate prevailing in world financial markets.
32. If the quantity of real money balances is kY, where k is a constant, then velocity is:
A) k.
B) 1/k.
C) kP.
D) P/k.
33. A small open economy with perfect capital mobility is characterized by all of the
following except that:
A) its domestic interest rate always exceeds the world interest rate.
B) it engages in international trade.
C) its net capital outflows always equal the trade balance.
D) its government does not impede international borrowing or lending.
34. If an earthquake destroys some of the capital stock, the neoclassical theory of
distribution predicts:
35. In an open economy:

A) a trade deficit is always good.
B) a trade deficit is always bad.
C) a trade deficit may be good or bad.
D) a trade surplus is always bad.
36. Assume that some large foreign countries decide to subsidize investment by instituting
an investment tax credit. Then a small country's real exchange rate:
A) will fall and its net exports will rise.
B) will rise and its net exports will fall.
C) and net exports will both fall.
D) and exports will both rise.
37. Two reasons why capital may not flow to poor countries are that the poorer countries
may:
A) have economies unlike those described by a Cobb-Douglas production function and
not be subject to diminishing returns to capital.
B) have already accumulated high levels of capital relative to labor and may already
have access to advanced technologies.
C) legally prevent the inflow of foreign capital and provide strong legal protection of
private property.
D) have inferior production capabilities and not enforce property rights.
38. In a small open economy, if the introduction of automatic-teller machines reduces the
demand for money, then net exports:
A) fall and the real exchange rate falls.
B) fall but the real exchange rate remains unchanged.
C) remain unchanged but the real exchange rate falls.
D) and the real exchange rate remain unchanged.
39. If the real exchange rate is high, foreign goods:

A) and domestic goods are both relatively expensive.
B) and domestic goods are both relatively cheap.
C) are relatively expensive and domestic goods are relatively cheap.
D) are relatively cheap and domestic goods are relatively expensive.
40. For a closed economy, when net capital outflow is measured along the horizontal axis
and the real interest rate is measured along the vertical axis, net capital outflow is drawn
as a:
A) vertical line at 0.
B) horizontal line at the world real interest rate.
C) line that slopes up and to the right.
D) line that slopes down and to the right.
Name: __________________________ Date: _____________
1. In the Mundell-Fleming model, the domestic interest rate is determined by the:

A) intersection of the LM and IS curves.
B) domestic rate of inflation.
C) world rate of inflation.
D) world interest rate.
2. Assuming there is perfect capital mobility, compared to a large open economy, a small
open economy is one in which the:
A) exchange rate is fixed.
B) exchange rate is floating.
C) domestic interest rate equals the world interest rate.
D) domestic interest rate is not equal to the world interest rate.
3. In a small open economy with a floating exchange rate, an effective policy to decrease
equilibrium output is to:
A) decrease government spending.
B) decrease taxes.
C) increase the money supply.
D) decrease the money supply.
4. In a small open economy with a floating exchange rate, the supply of real money
balances is fixed and a rise in government spending:
A) raises the interest rate, so that income must rise to maintain equilibrium in the
money market.
B) raises the interest rate so that net exports must fall to maintain equilibrium in the
goods market.
C) cannot change the interest rate so that net exports must fall to maintain equilibrium
in the goods market.
D) cannot change the interest rate so income must rise to maintain equilibrium in the
money market.
5. In a small open economy with a floating exchange rate, if the government decreases the
money supply, then in the new short-run equilibrium:
A) income falls and the exchange rate rises.
B) the exchange rate falls and income rises.
C) income remains unchanged but the exchange rate rises.
D) the exchange rate remains unchanged but income falls.
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6. In a small open economy with a floating exchange rate, if the government imposes an
import quota, then in the new short-run equilibrium the IS* curve shifts to the right,
raising the exchange rate:
A) but not raising net exports or income.
B) and net exports but not income.
C) and income but not net exports.
D) net exports and income.
7. To maintain a fixed-exchange-rate system, if the exchange rate moves below the

fixed-exchange-rate level, then the central bank must:
A) buy foreign currency.
B) sell foreign currency from reserves.
C) raise taxes.
D) decrease government spending.
8. If there is a fixed-exchange-rate system, then in the short run described by the

Mundell-Fleming model:
A) the nominal exchange rate is fixed, but the real exchange rate is free to vary.
B) the real exchange rate is fixed, but the nominal exchange rate is free to vary.
C) both the nominal and real exchange rates are fixed.
D) the nominal exchange rate is fixed, but whether the real exchange rate is fixed
depends on whether the central bank follows a rule of constant growth of the
money supply.
9. In a small open economy with a fixed exchange rate, if the country devalues its
currency, then in the new short-run equilibrium the exchange rate ______, and the LM*
curve shifts to the ______.
A) decreases; left
B) increases; left
C) decreases; right
D) increases; right
10. A devaluation of a currency under a fixed-exchange-rate system occurs when the level
at which the currency is fixed is:
A) increased.
B) decreased.
C) allowed to float.
D) kept fixed within a band.
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11. According to the Mundell-Fleming model, under fixed exchange rates expansionary
fiscal policy causes income to ______, and under flexible exchange rates expansionary
fiscal policy causes income to ______.
A) increase; increase
B) increase; remain unchanged
C) remain unchanged; remain unchanged
D) remain unchanged; increase
12. The risk premium included in the interest rate of small open economies incorporates:
A) country risk and expectations of future exchange-rate changes.
B) the law of one price.
C) inefficient activity by arbitrageurs.
D) capital mobility.
13. According to the Mundell-Fleming model with floating exchange rates, political
uncertainty in Mexico in 1994 caused the risk premium on Mexican interest rates to
______ and the Mexican exchange rate to ______.
B) increase; decrease
C) decrease; increase
D) decrease; decrease
14. A speculative attack on a currency occurs when:

A) a central bank switches from a floating to a fixed exchange rate.
B) investors' perceptions change, making a fixed exchange rate untenable.
C) a country accepts dollarization.
D) a central bank adopts a currency board to back the domestic currency with a
foreign currency.
15. If a country chooses to have free capital flows and to maintain a fixed exchange rate,
then it must:
A) live with exchange-rate volatility.
B) restrict its citizens from participating in world financial markets.
C) give up the use of monetary policy for purposes of domestic stabilization.
D) give up the use of fiscal policy for purposes of domestic stabilization.
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16. According to the sticky-price model:
A) all firms announce their prices in advance.
B) all firms set their prices in accord with observed prices and output.
C) some firms set their prices according to the aggregate supply equation.
D) some firms announce their prices in advance, and some firms set their prices in
accord with observed prices and output.
17. In the sticky-price model, the relationship between output and the price level depends
on:
A) the proportion of firms with flexible prices.
B) the target real wage rate.
C) the target nominal wage rate.
D) the implicit agreements between workers and firms.
18. According to the imperfect-information model, when the price level rises and the
producer expects the price level to rise, the producer:
A) increases production.
B) does not change production.
C) decreases production.
D) hires more workers.
19. After examining international data, the economist Robert Lucas found that aggregate
demand has the biggest effect on output in countries where aggregate demand:
A) and prices are most stable.
B) and prices are most variable.
C) is most stable but prices are most variable.
D) is most variable but prices are most stable.
20. Starting from the natural level of output, an unexpected monetary contraction will cause
output and the price level to ______ in the short run, and in the long run the expected
price level will ______, causing the level of output to return to the natural level.
B) increase; decrease
C) decrease; decrease
D) decrease; increase
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21. Along an aggregate supply curve, if the level of output is less than the natural level of
output, then the price level is:
A) greater than the expected price level.
B) less than the expected price level.
C) equal to the natural price level.
D) stuck at the existing price level.
22. According to the Phillips curve, other things being equal, inflation depends positively on
all of the following except:
A) expected inflation.
B) the unemployment rate.
C) the natural unemployment rate.
D) a supply shock, if one occurs.
23. All of the following are ways that the modern Phillips curve differs from the relationship
observed by A. W. Phillips in 1958 except that the modern Phillips curve:
A) substitutes the output gap for unemployment.
B) includes supply shocks.
C) includes expected inflation.
D) substitutes price inflation for wage inflation.
24. The assumption of adaptive expectations for inflation means that people will form their
expectations of inflation by:
A) taking all information into account using the best economic model available.
B) asking the opinions of experts.
C) basing their opinions on recently observed inflation.
D) flipping a coin.
25. Inflation inertia refers to the idea that inflation:

A) is always present in economies.
B) keeps on going unless something acts to stop it.
C) cannot be reduced unless unemployment is increased.
D) can be generated by either demand-pull or cost-push forces.
26. Cost-push inflation is the result of:

A) high aggregate demand.
B) low aggregate demand.
C) favorable supply shocks.
D) adverse supply shocks.
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27. The Phillips curve analysis described in Chapter 13 implies that there is a negative
tradeoff between inflation and unemployment in:
A) both the short run and long run.
B) in the short run only.
C) in the long run only.
D) in neither the short run nor the long run.
28. The most prominent feature of the U.S. economy in the 1970s was:
A) cost-push deflation.
B) cost-push inflation.
C) demand deflation.
D) demand inflation.
29. The sacrifice ratio measures the:

A) number of percentage points of the money supply that must be reduced to reduce
inflation by 1 percentage point.
B) extra taxes that must be paid to balance the budget.
C) number of months of real gross domestic product (GDP) that must be foregone to
reduce the inflation rate by 1 percentage point.
D) percentage of a year's real gross domestic product (GDP) that must be foregone to
reduce inflation by 1 percentage point.
30. Assume that the sacrifice ratio for an economy is 4. If the central bank wishes to reduce
inflation from 10 percent to 5 percent, this will cost the economy ______ percent of one
year's GDP.
A) 4
B) 5
C) 20
D) 40
31. The rational-expectations point of view, in the most extreme case, holds that if
policymakers are credibly committed to reducing inflation, and rational people
understand that commitment and quickly lower their inflation expectations, then the
sacrifice ratio will be approximately:
A) 5.
B) 2.8.
C) 1.
D) 0.
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32. The estimate of the sacrifice ratio from the Volcker disinflation is approximately:
A) 5–6.
B) 2.5–3.
C) 1–1.5.
D) 0–0.5.
33. A recession may alter an economy's natural rate of unemployment in all of the
following ways except by:
A) changing an unemployed individual's attitude toward work.
B) reducing an unemployed worker's job skills.
C) permanently reducing the money supply.
D) altering the wage-setting process.
34. According to the natural-rate hypothesis, the levels of output and unemployment depend
on:
A) aggregate demand in the short run, but not in the long run.
B) aggregate demand in the long run, but not in the short run.
C) the natural rate of unemployment in the short run, but the natural rate of inflation in
the long run.
D) the natural rate of inflation in the short run, but the natural rate of unemployment in
the long run.
35. The government can lower inflation with a low sacrifice ratio if the:
A) money supply is reduced slowly.
B) public has adaptive expectations.
C) short-run aggregate supply schedule is relatively flat.
D) public believes that policymakers are committed to reducing inflation.
36. Assume that an economy has the usual type of Phillips curve except that the natural rate
of unemployment in an economy is given by an average of the unemployment rates in
the last two years. Then, there is:
A) a long-run tradeoff between inflation and unemployment.
B) no long-run tradeoff between inflation and unemployment.
C) no short-run tradeoff between inflation and unemployment.
D) a sacrifice ratio that is large but not infinite.
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37. In the dynamic model, the demand for goods and services decreases as the natural level
of output ______ or the real rate of interest ______.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases
38. A higher real interest rate reduces the demand for goods and services by:
A) shifting the dynamic aggregate supply curve.
B) decreasing the natural level of output.
C) increasing inflation expectations.
D) reducing investment and consumption spending.
39. According to the Fisher equation, the real interest rate equals the nominal interest rate
minus the:
A) natural rate of interest.
B) expected rate of inflation.
C) ex post rate of inflation.
D) ex ante rate of interest.
40. According to the Phillips curve, the inflation rate depends on all of the following except:
A) previously expected inflation.
B) an exogenous supply shock.
C) the real interest rate.
D) the deviation of output from its natural level.
41. In the dynamic model, the supply shock variable, t, is a variable appearing in which of
the following equations of the model?
A) Fisher equation
B) Phillips curve
C) monetary-policy rule
D) adaptive expectations
42. Expectations of inflation based on recently observed inflation is called the assumption
of ______ expectations.
A) natural
B) rational
C) dynamic
D) adaptive
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43. According to the monetary policy rule, the central bank sets the nominal interest rate so
the real interest rate ______ when inflation is above its target and the real interest rate
______ when output is below its natural level.
A) rises; falls
B) rises; rises
C) falls; falls
D) falls; rises
44. In order to achieve the target for the nominal interest rate established by the monetary
policy rule, the central banks adjusts:
A) the inflation rate.
B) the natural rate of interest.
C) the money supply.
D) the inflation target.
45. According to the Taylor rule, when real GDP is above its natural level, the nominal
federal funds rate should be ______, and when inflation is below 2 percent, the nominal
Federal funds rate should be ______.
A) raised; raised
B) raised; lowered
C) lowered; raised
D) lowered; lowered
46. That output, Yt, and the real interest rate, rt, do not depend on the central bank's inflation
target in long-run equilibrium in the dynamic model of aggregate demand and aggregate
supply demonstrates:
A) monetary neutrality.
B) an impulse response function.
C) adaptive expectations.
D) Taylor's principle.
47. The dynamic aggregate supply curve is derived from which of the five equations of the
model of aggregate demand and aggregate supply?
A) the Fisher equation and adaptive expectations
B) the Phillips curve and adaptive expectations
C) the monetary policy rule and the Fisher equation
D) the Phillips curve and the monetary policy rule
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48. The dynamic aggregate demand curve illustrates the ______ relationship between the
quantity of output demanded in the short run and ______.
A) positive; inflation
B) positive; the price level
C) negative; inflation
D) negative; the price level
49. The dynamic aggregate demand curve is drawn for a given:

A) money supply.
B) real interest rate.
C) monetary policy rule.
D) inflation rate.
50. Graphs that illustrate the time paths of endogenous variables when a shock hits the
economy are called:
A) monetary policy paths.
B) dynamic shock figures.
C) impulse response functions.
D) endogenous growth models.
51. In the dynamic model of aggregate demand and aggregate supply, increases in the
natural level of output lead to ______ in output and ______ in inflation.
B) increases; no change
C) no change; increases
D) no change; no change
52. According to the Taylor Principle, for inflation to be stable, the central bank must
respond to an increase in inflation with ______ increase in the nominal interest rate.
A) no
B) an equal
C) a greater
D) a smaller
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53. Economists who view the economy as inherently unstable generally argue that:
A) stabilization policy is too dangerous to be used.
B) the economy should be stimulated when it is depressed and slowed when it is
overheated.
C) the economy should be slowed when it is depressed and stimulated when it is
overheated.
D) monetary and fiscal policies should follow rigid rules of constant growth.
54. The time between a policy action and its influence on the economy is called the:
A) automatic stabilizer.
B) time-inconsistency of policy.
C) inside lag.
D) outside lag.
55. The lag between the time that the money supply is increased and the time that
investment expenditures increase is an example of a:
A) fiscal inside lag.
B) fiscal outside lag.
C) monetary inside lag.
D) monetary outside lag.
56. Advocates of passive policy argue that, because monetary and fiscal policy lags are:
A) short and fixed, these policies should not be used to offset shocks.
B) long and variable, these policies should not be used to offset shocks.
C) short and fixed, these policies should be used to offset shocks.
D) long and variable, these policies should be used to offset shocks.
57. If people's expectations of inflation are formed rationally rather than based on adaptive
expectations and if policymakers make a credible policy move to reduce inflation, then
the costs of reducing inflation will be ______ traditional estimates of the sacrifice ratio.
A) much higher than
B) much lower than
C) exactly equal to
D) approximately 2 percent greater than
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58. If past economic fluctuations resulted from inept economic policies, then the historical
evidence would support using:
A) active macroeconomic policy only.
B) passive macroeconomic policy only.
C) either active or passive macroeconomic policy.
D) neither active nor passive macroeconomic policy.
59. If policymakers announce in advance how policy will respond to various situations and
commit themselves to following through on this announcement, this is:
A) policy by rule.
B) policy by discretion.
C) time inconsistent policy.
D) monetary policy.
60. If citizens vote on the basis of both low inflation and low unemployment at the time of
the election, then presidents might, in order to ensure their reelection:
A) spur inflation soon after their elections, and then cause a recession.
B) stimulate the economy throughout their terms.
C) cause a recession soon after their elections, and then stimulate the economy.
D) run a tight monetary and fiscal policy throughout their terms.
61. Assume that there is a short-run tradeoff between inflation and unemployment, that the
central bank desires both low inflation and low unemployment, and that the central bank
follows a fixed rule in conducting monetary policy. Initially, households and firms
expect high inflation. Following a credible announcement by the central bank of a
low-inflation policy, households and firms will ______ the central bank's announcement
and ______ their expectations of inflation.
A) believe; lower
B) not believe; not change
C) believe; not change
D) not believe; lower
62. In practice, inflation targeting is better considered operating with constrained discretion
rather than according to a policy rule because central banks with inflation targets
typically:
A) are not allowed to adjust the target in the event of shocks.
B) set the inflation target as a range rather than as a particular number.
C) are not held accountable for achieving their target.
D) must achieve their target regardless of economic conditions.
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63. Government debt equals the:
A) difference between current government purchases and taxes.
B) difference between saving and investment.
C) sum of past budget deficits and surpluses.
D) M1 money supply.
64. Historically, the primary cause of increases in government debt is:

A) printing too much money.
B) cutting taxes.
C) increasing interest rates.
D) financing wars.
65. Holding other factors constant, the ratio of government debt to GDP can decrease as a
result of any of the following changes except:
A) decreases in government spending.
B) increases in GDP.
C) decreases in tax revenues.
D) decreases in transfer payments.
66. In a time of inflation when the real (i.e., deflated) value of the government debt is
constant, then the conventionally:
A) reported government budget will show a deficit equal to the inflation rate times the
outstanding debt.
B) reported government budget will show a deficit equal to less than the inflation rate
times the outstanding debt.
C) reported government budget will be balanced.
D) measured government budget will show a surplus equal to the inflation rate times
the outstanding debt.
67. If capital budgeting procedures were employed, then a budget deficit would be
measured as:
A) the sum of government debt.
B) the change in government debt.
C) the change in government debt minus the change in government capital assets.
D) the change in government capital assets.
Page 13
68. Under capital budgeting, all of the following transactions would affect the federal
budget deficit except the federal government's:
A) sending a check to a welfare recipient.
B) sending a check to the state of Massachusetts.
C) selling a highway to the state of New York and using the proceeds to retire federal
debt.
D) selling an office building.
69. An estimate of what government spending and tax revenue would be if the economy
were operating at its natural level of output and employment is called the ______
budget.
A) cyclically adjusted
B) inflation adjusted
C) capital asset
D) generational accounting
70. Measuring the size of government debt is complicated by all of the following factors
except:
A) inflation.
B) uncounted liabilities.
C) capital assets of the government.
D) failure of the Office of Management and Budget to disclose figures on capital
expenditures and credit programs.
71. According to the traditional viewpoint, a tax cut without a cut in government spending:
A) stimulates consumer spending and reduces national saving.
B) stimulates consumer spending and reduces private saving.
C) has no effect on consumer spending but reduces national saving.
D) has no effect on consumer spending but reduces private saving.
72. According to the theory of Ricardian equivalence, tax cuts that have no plans to reduce
government spending ______ public saving and ______ private saving.
A) reduce; reduce
B) reduce; increase
C) increase; increase
D) increase; reduce
Page 14
73. When President George Bush lowered tax withholding in 1992 without lowering the
amount of taxes owed, surveys showed that:
A) almost everyone spent the higher take-home pay.
B) almost everyone saved the higher take-home pay.
C) a majority of respondents said they would spend the higher take-home pay, but a
significant minority said they would save it.
D) a majority of respondents said they would save the higher take-home pay, but a
significant minority said they would spend it.
74. One way to shift the tax burden from the current generation to future generations is to
finance a war by:
A) raising taxes.
B) printing money.
C) running a budget surplus.
D) running a budget deficit.
75. To force politicians to judge whether government spending is worth the costs, some
economists have argued for:
A) a balanced-budget rule for fiscal policy.
B) a constant money-growth rule for monetary policy.
C) avoiding the assumption of any contingent liabilities.
D) the application of Ricardian equivalence.
76. The average propensity to consume is the:

A) ratio of consumption to income.
B) amount consumed out of an additional dollar of income.
C) amount available for consumption after precautionary saving.
D) ratio of consumption to wealth.
77. The Keynesian consumption function exhibits all of the following properties except
that:
A) the marginal propensity to consume is between zero and one.
B) the average propensity to consume decreases as income increases.
C) only unexpected policy changes influence consumption.
D) current income is the primary determinant of consumption.
Page 15
78. Simon Kuznets found that, over long periods of time in the United States, as income
rose, the average propensity to consume:
A) rose.
B) fell.
C) remained constant.
D) rose and then fell.
79. Which of the following conjectures that underlie the Keynesian consumption function is
not consistent with aggregate U.S. data in the period after World War II?
A) The marginal propensity to consume is between zero and one.
B) The average propensity to consume decreases as income increases.
C) There is a high correlation between income and consumption.
D) Current income is a determinant of consumption.
80. The consumer's budget constraint reflects the fact that because interest is earned on
savings:
A) future income is worth less than current income.
B) future income is worth more than current income.
C) future consumption costs more than current consumption.
D) future consumption is worth more than future income.
81. In the Fisher two-period model, the consumer achieves his or her optimum combination
of current and future consumption by selecting:
A) any combination on his or her highest indifference curve.
B) the combination on his or her highest indifference curve that is tangent to his or her
budget constraint.
C) any combination on his or her budget constraint.
D) the combination on his or her budget constraint where period-one consumption
equals period-one income and period-two consumption equals period-two income.
82. In Irving Fisher's two-period model, if consumption in both periods is a normal good,
then an increase in income in period two:
A) increases consumption in period one only.
B) increases consumption in period two only.
C) increases consumption in both periods.
D) does not increase consumption in either period.
Page 16
83. In Irving Fisher's two-period model, if the consumer is initially borrowing in period one
and the real interest rate rises, first-period consumption will:
A) certainly rise.
B) certainly fall.
C) remain constant.
D) either rise or fall.
84. If a consumer is in a position in which a borrowing constraint limits his or her current
consumption and a one-time tax is levied on his or her current income, then the tax will:
A) lower the consumer's future consumption.
B) not affect the consumer's future consumption.
C) increase the consumer's future consumption.
D) have no effect on either current or future consumption.
85. According to Modigliani's life-cycle hypothesis, if a consumer wants equal consumption

in every year and the interest rate is zero, then the marginal propensity to consume out
of wealth ______ as years ______ decrease.
A) increases; of life remaining
B) decreases; of life remaining
C) increases; until retirement
D) decreases; until retirement
86. According to the life-cycle model, the average propensity to consume does not fall as
income increases in the long run because:
A) wealth and income grow together.
B) as income increases wealth decreases.
C) saving is constant over the life cycle.
D) wealth is constant over the life cycle.
87. Transitory income is:

A) income that persists.
B) average income.
C) random deviations from average income.
D) current income.
88. Precautionary saving is saving for:

A) retirement, when income falls.
B) unpredictable expenses.
C) bequests to benefit children.
D) repayment of debt previously incurred.
Page 17
89. Milton Friedman argued that, on average, consumption is:
A) proportional to income.
B) a fraction of permanent income that rises as permanent income rises.
C) a fraction of permanent income that falls as permanent income falls.
D) proportional to permanent income.
90. Suppose that the government is considering two tax cuts, one temporary and one
permanent. Each cut will give each taxpayer the same amount in the first year. The
permanent-income hypothesis predicts that:
A) each tax cut will lead to the same amount of consumption in the first year.
B) the temporary tax cut will lead to more extra consumption in the first year.
C) the permanent tax cut will lead to more extra consumption in the first year.
D) the temporary tax cut will lead to no extra consumption at all in the first year.
Page 18
Chapter 13
1. According to the sticky-price model:

A) all firms announce their prices in advance.
B) all firms set their prices in accord with observed prices and output.
C) some firms set their prices according to the aggregate supply equation.
D) some firms announce their prices in advance, and some firms set their prices in
accord with observed prices and output.
2. All of the following are requirements for reducing inflation without causing a recession
except:
A) workers and firms must form expectations rationally.
B) the plan must be announced before expectations are formed.
C) the plan must be believed by workers and firms.
D) the government's budget must be balanced.
3. Both models of aggregate supply discussed in Chapter 13 imply that if the price level is
lower than expected, then output ______ natural rate of output.
A) exceeds the
B) falls below the
C) equals the
D) moves to a different
4. In the short run, if the price level is greater than the expected price level, then in the
long run, the aggregate:
A) demand curve will shift leftward.
B) demand curve will shift rightward.
C) supply curve will shift upward.
D) supply curve will shift downward.
5. In the 1960s, in the United States:

A) both the inflation rate and the unemployment rate rose at the same time.
B) the unemployment rate rose but the inflation rate fell.
C) the inflation rate rose but the unemployment rate fell.
D) both the inflation rate and the unemployment rate fell.
Page 1
6. The assumption of adaptive expectations for inflation means that people will form their
expectations of inflation by:
A) taking all information into account using the best economic model available.
B) asking the opinions of experts.
C) basing their opinions on recently observed inflation.
D) flipping a coin.
7. The Phillips curve depends on all of the following forces except:

A) the current exchange rate.
B) expected inflation.
C) the deviation of unemployment from its natural rate.
D) supply shocks.
8. A recession may alter an economy's natural rate of unemployment in all of the

following ways except by:
A) changing an unemployed individual's attitude toward work.
B) reducing an unemployed worker's job skills.
C) permanently reducing the money supply.
D) altering the wage-setting process.
9. The NAIRU is the:

A) North American institutional rate of unemployment.
B) natural aggregate investment return on utilization.
C) nonaccelerating inflation rate of unemployment.
D) normal American inelastic rate of unemployment.
10. To illustrate inflation inertia in an aggregate demand–aggregate supply model, the short-
run aggregate supply curve shifts upward because of increases in ______, and the
aggregate demand curve shifts upward because of increases in ______.
A) the expected price level; the money supply
B) the money supply; the expected price level
C) output; the price level
D) the price level; output
11. After examining international data, the economist Robert Lucas found that aggregate
demand has the biggest effect on output in countries where aggregate demand:
A) and prices are most stable.
B) and prices are most variable.
C) is most stable but prices are most variable.
D) is most variable but prices are most stable.
Page 2
12. The Phillips curve shows a ______ relationship between inflation and unemployment,
and the short-run aggregate supply curve shows a ______ relationship between the price
level and output.
A) positive; positive
B) positive; negative
C) negative; negative
D) negative; positive
13. Inflation inertia is represented in the aggregate supply and aggregate demand model by
continuing upward shifts in the:
A) aggregate demand curve.
B) short-run aggregate supply curve.
C) long-run aggregate supply curve.
D) aggregate demand and short-run aggregate supply curves.
14. Inflation inertia refers to the idea that inflation:

A) is always present in economies.
B) keeps on going unless something acts to stop it.
C) cannot be reduced unless unemployment is increased.
D) can be generated by either demand-pull or cost-push forces.
Use the following to answer question 15:
Exhibit: Short-run Phillips Curve
Page 3
15. (Exhibit: Short-run Phillips Curve) As the short-run Phillips curve shifts from A to B to
C to D, policymakers face:
A) the same tradeoff between inflation and unemployment.
B) a lower rate of inflation for any level of unemployment.
C) a higher rate of inflation for any level of unemployment.
D) higher than expected inflation rates and lower unemployment rates.
16. In the sticky-price model, if no firms have flexible prices, the short-run aggregate
supply schedule will:
A) be vertical.
B) be steeper than it would be if some firms had flexible prices.
C) slope upward to the right.
D) be horizontal.
17. The idea that the natural rate of unemployment is increased following extended periods
of unemployment is called:
A) Okun's law.
B) the cold-turkey approach.
C) the natural-rate hypothesis.
D) hysteresis.
18. The estimate of the sacrifice ratio from the Volcker disinflation is approximately:
A) 5–6.
B) 2.5–3.
C) 1–1.5.
D) 0–0.5.
19. According to the sticky-price model, other things being equal, the greater the
proportion, s, of firms that follow the sticky-price rule, the ______ the ______ in output
in response to an unexpected price increase.
A) greater; increase
B) smaller; increase
C) greater; decrease
D) smaller; decrease
Page 4
20. According to the imperfect-information model, when the price level is greater than the
expected price level, output will ______ the natural level of output.
A) be greater than
B) be less than
C) equal
D) shift the
21. Some firms do not instantly adjust the prices they charge in response to changes in
demand for all of the following reasons except:
A) it is costly to alter prices.
B) they do not want to annoy their frequent customers.
C) prices do not adjust when there is perfect competition.
D) some prices are set by long-term contracts between firms and customers.
22. An economy is initially in equilibrium at the natural level. The central bank increases
the money supply. Graphically illustrate and explain short-run monetary nonneutrality
and long-run monetary neutrality using the AD–AS model.
Use the following to answer questions 23-24:
Exhibit: AD–AS Shifts
Page 5
23. (Exhibit: AD–AS Shifts) Starting from long-run equilibrium at A with output equal to Y
and the price level equal to P1, if there is an unexpected monetary contraction that shifts
aggregate demand from AD1 to AD3, then the long-run neutrality of money is
represented by the movement from:
A) A to B.
B) A to G.
C) A to C.
D) A to D.
24. (Exhibit: AD–AS Shifts) Starting from long-run equilibrium at A with output equal to Y
and the price level equal to P1, a cost-push inflation would be represented by a shift
from:
A) AD1 to AD2.
B) AD1 to AD3.
C) AS1 to AS2.
D) AS1 to AS3.
25. All of the following are exogenous variables in the big, comprehensive model except
the:
A) world interest rate.
B) labor force.
C) world real interest rate.
D) price level.
Page 6
Answer Key
1. D
2. D
3. B
4. C
5. C
6. C
7. A
8. C
9. C
10. A
11. A
12. D
13. D
14. B
15. B
16. D
17. D
18. B
19. A
20. A
21. C
22.
Monetary nonneutrality occurs when changes in money affect real variables.

Graphically, this is shown in the short run as the economy moves from A to B. The
increase in money increases output, a real variable. This occurs because firms and
workers are expecting price level P1, but the price level rises to P2. Eventually, workers'
expectations of the price level increase, shifting the AS curve up.
Monetary neutrality occurs when changes in money affect only nominal variables, not
real variables. Graphically, this is depicted in the long run as the economy eventually
moves from A to C. The increase in money affects only prices.
23. A
Page 7
24. C
25. D

Page 8
Chapter 14
1. The dynamic aggregate demand curve is downward sloping because as inflation falls the
central bank reduces the nominal interest rate by more than the fall in the inflation rate,
which ______ the real interest rate and ______ the quantity of goods and services
demanded.
A) decreases; decreases
B) decreases; increases
C) increases; increases
D) increases; decreases
2. Which of the following would be represented by a positive value of the random supply
shock, t?
A) an irrational wave of optimism among investors
B) an increase in government spending
C) widespread drought leading to large increases in food prices
D) an increase in the central bank's inflation target
3. Of the five endogenous variables in the dynamic model of aggregate demand and
aggregate supply, which are the nominal variables that will change in long-run
equilibrium if the central bank changes its inflation target?
A) Yt , rt, and it
B) Yt, it, and Ett + 1
C) t, it, and Ett + 1
D) rt, t, and it
4. Beginning at long-run equilibrium in the dynamic model of aggregate demand and

aggregate supply, if the central bank permanently reduces its inflation target, then in the
initial period of the change, output ______ and inflation ______.
5. The dynamic aggregate demand curve is drawn for a given:

A) money supply.
B) real interest rate.
C) monetary policy rule.
D) inflation rate.
Page 9
6. According to the Fisher equation, the real interest rate equals the nominal interest rate
minus the:
A) natural rate of interest.
B) expected rate of inflation.
C) ex post rate of inflation.
D) ex ante rate of interest.
7. An increase in the central bank's target rate of inflation is represented by a:

A) movement up the DAD curve.
B) movement down the DAD curve.
C) rightward shift in the DAD curve
D) leftward shift in the DAD curve.
8. That output, Yt, and the real interest rate, rt, do not depend on the central bank's inflation
target in long-run equilibrium in the dynamic model of aggregate demand and aggregate
supply demonstrates:
A) monetary neutrality.
B) an impulse response function.
C) adaptive expectations.
D) Taylor's principle.
9. The interest rate at which banks make loans to other banks is called the:
A) federal funds rate.
B) prime rate.
C) Federal Reserve discount rate.
D) Treasury bill rate.
10. The dynamic aggregate demand curve will shift if any of the following changes except
the:
A) current inflation rate.
B) inflation target.
C) natural level of output.
D) demand shock.
11. Which of the following would be represented by a negative value of the random supply
shock, t?
A) an irrational wave of pessimism among investors
B) a decrease in government spending
C) oil price decreases resulting from a breakdown in the cartel
D) a decrease in the central bank's inflation target
Page 10
12. The dynamic aggregate supply curve is derived from which of the five equations of the
model of aggregate demand and aggregate supply?
A) the Fisher equation and adaptive expectations
B) the Phillips curve and adaptive expectations
C) the monetary policy rule and the Fisher equation
D) the Phillips curve and the monetary policy rule
13. The dynamic aggregate demand curve illustrates the ______ relationship between the
quantity of output demanded in the short run and ______.
A) positive; inflation
B) positive; the price level
C) negative; inflation
D) negative; the price level
14. Starting from long-run equilibrium in the dynamic model of aggregate demand and
aggregate supply, a five-period positive demand shock causes output to ______ the
natural level of output until returning to the natural level in the long run.
A) remain continuously above
B) move above and then below
C) remain continuously below
D) move below and then above
15. A higher real interest rate reduces the demand for goods and services by:
A) shifting the dynamic aggregate supply curve.
B) decreasing the natural level of output.
C) increasing inflation expectations.
D) reducing investment and consumption spending.
aggregate supply, in the first period of a four-period positive demand shock, output
______ and inflation ______.
Page 11
aggregate supply, in the first period of a four-period positive demand shock, the DAS
curve ______ and the DAD curve ______.
A) shifts upward; shifts rightward
B) does not shift; shifts rightward
C) does not shift; does not shift
D) shifts downward; shifts leftward
18. At long-run equilibrium in the dynamic model of aggregate demand and aggregate
supply, the nominal interest rate, it, equals all of the following except:
A) rt + *t.
B) rt + t.
C)  + Et t + 1.
D)  + rt.
19. In the dynamic model of aggregate demand and aggregate supply, one period in time is
connected to the next period through:
A) the monetary policy rule.
B) demand shocks.
C) inflation expectations.
D) the natural level of output.
Page 12
Answer Key
1. B
2. C
3. C
4. C
5. C
6. B
7. C
8. A
9. A
10. A
11. C
12. B
13. C
14. B
15. D
16. A
17. B
18. D
19. C

Page 13
Chapter 15
1. Economic science has provided convincing evidence in favor of the:

A) rule favoring a constant rate of growth of the money supply.
B) rule favoring use of the money supply to hit a nominal GDP target.
C) rule requiring a constantly balanced budget for the federal government.
D) fact that there is no simple and compelling case for any particular view of
macroeconomic policy.
2. The political business cycle refers to the:

A) pattern of holding primaries, conventions, and general elections every four years.
B) cycle of electing U.S. representatives every two years, the U.S. president every
four years, and U.S. senators every six years.
C) manipulation of the economy to win elections.
D) pattern of recession and expansion that follows every election.
3. Inflation targeting is a monetary policy rule that requires the central bank to adjust
_____ in order to attain the desired inflation rate.
A) a price index
B) the velocity of money
C) nominal GDP
D) the money supply
4. The lags involved in implementing monetary and fiscal policy are:

A) short and predictable.
B) long and predictable.
C) short and variable.
D) long and variable.
5. Arguments in favor of passive economic policy include all of the following except:
A) monetary and fiscal policies work with long and variable lags, which can produce
destabilizing results.
B) economic forecasts have too large a margin of error to be useful in formulating
stabilization policy.
C) recessions do not reduce economic well-being, so using monetary and fiscal policy
for stabilization is unnecessary.
D) the Great Depression could have been avoided if the Federal Reserve had pursued a
policy of steady money growth.
Page 14
6. Increasing government spending when the economy is in a recession is an example of:
A) active monetary policy.
B) active fiscal policy.
C) passive monetary policy.
D) passive fiscal policy.
7. According to the Lucas critique, when economists evaluate alternative policies they
must take into consideration:
A) how the policies will affect expectations and behavior.
B) whether the policy will offset the impact of automatic stabilizers.
C) the stage of the political business cycle in which the policy is to be implemented.
D) the length of the inside lags associated with the policies.
8. Unlike a monetarist policy rule, an inflation target has the advantage of:
A) eliminating the need to announce the policy target.
B) providing a real target rather than a nominal one.
C) allowing the central bank unlimited discretion.
D) insulating the economy from changes in money velocity.
9. Arguments in favor of active economic policy include all of the following except:
A) failing to use monetary and fiscal policy leads to inefficient fluctuations in output
and employment.
B) the Great Depression could have been avoided if the Federal Reserve had pursued a
policy of steady money growth.
C) fluctuations in real GDP have been less severe following World War II than prior
to World War I.
D) failure of policymakers to respond to large contractionary shocks to private
spending caused the Great Depression.
10. The lag between the time that the money supply is increased and the time that
investment expenditures increase is an example of a:
A) fiscal inside lag.
B) fiscal outside lag.
C) monetary inside lag.
D) monetary outside lag.
Page 15
11. The outside lag is the time:
A) before automatic stabilizers respond to economic activity.
B) when automatic stabilizers are not effective.
C) between a shock to the economy and the policy action responding to the shock.
D) between a policy action and its influence on the economy.
12. If past economic fluctuations resulted from inept economic policies, then the historical
evidence would support using:
A) active macroeconomic policy only.
B) passive macroeconomic policy only.
C) either active or passive macroeconomic policy.
D) neither active nor passive macroeconomic policy.
13. The Lucas critique argues that because the way people form expectations is based
______ on government policies, economists ______ predict the effect of a change in
policy without taking changing expectations into account.
A) partly; cannot
B) only partly; can
C) in no way; can
D) in no way; cannot
14. The Phillips curve describing an economy takes the form u = un – ( – E). The
central bank directly sets the inflation rate to minimize the following loss function, L(u,
) = u – 2. The symbol u denotes the unemployment rate, un is the natural rate of
unemployment,  is the inflation rate, E is the expected inflation rate, and  and  are
behavioral response parameters of the economy. Private agents form their expectations
rationally before the central bank sets the inflation rate. In an economy in which the
central bank dislikes inflation much more than unemployment:
A)  will be very large.
B)  will be very small.
C)  will be very large.
D)  will be very small.
15. If the velocity of money varies a great deal, steady growth of the money supply is a(n):
A) ineffective way to stabilize aggregate demand.
B) example of discretionary monetary policy.
C) automatic stabilizer.
D) active policy rule.
Page 16
16. The time between a shock to the economy and the policy action responding to that
shock is called the:
A) automatic stabilizer.
B) time-inconsistency of policy.
C) inside lag.
D) outside lag.
17. A central bank operating with discretion can achieve the same outcome as the central
bank committed to a fixed rule of zero inflation if:
A) there are no inside lags.
B) there are no outside lags.
C) the central bank dislikes unemployment much more than inflation.
D) the central bank dislikes inflation much more than unemployment.
18. The long and variable lag before a policy influences the economy makes the job of
economic forecasters:
A) impossible.
B) easier.
C) less important.
D) more important.
19. Economic forecasters did:

A) well in forecasting the Great Depression but did poorly in forecasting the recession
of 1982.
B) poorly in forecasting both the Great Depression and the recession of 1982.
C) well in forecasting both the Great Depression and the recession of 1982.
D) poorly in forecasting the Great Depression but did well in forecasting the recession
of 1982.
Page 17
Answer Key
1. D
2. C
3. D
4. D
5. C
6. B
7. A
8. D
9. B
10. D
11. D
12. B
13. A
14. C
15. A
16. C
17. D
18. D
19. B

Page 18
Chapter 16
1. Hyperinflations typically occur when governments:

A) attempt to keep the unemployment rate below the natural rate.
B) finance spending with the inflation tax.
C) set inflation targets too high.
D) use discretionary monetary policy to stabilize output.
2. The amount by which government spending exceeds government revenues is called the
______, and the accumulation of past government borrowing is called the ______.
A) deficit; debt
B) debt; deficit
C) devaluation; deflation
D) deflation; devaluation
3. A deficit adjusted for inflation should include only government spending to pay _____
interest payments.
A) real
B) nominal
C) foreign
D) domestic
4. The possibility of capital flight is likely to be greater at higher levels of government

debt because there is a greater:
A) temptation to default on the debt.
B) likelihood that the government will begin issuing indexed bonds.
C) probability that a balanced budget will be adopted by the government.
D) potential for tax-smoothing policies to be eliminated.
5. Monetary policy is linked to fiscal policy when government spending is financed by:
A) taxes.
B) borrowing from banks.
C) borrowing from foreigners.
D) printing money.
Page 19
6. Proponents of Ricardian equivalence argue that, if taxes are cut without cutting
government spending and taxes are not expected to increase in the future until after an
individual expects to be dead, then the individual will:
A) spend all of the increase in income.
B) spend some of the increase in income and save the rest.
C) use the increase in income to buy government bonds to help finance the deficit.
D) save all of the increase in income and leave it as a bequest to his or her children.
7. Suppose a household considers only current income in making consumption decisions.

This is an example of:
A) Ricardian equivalence.
B) the permanent-income hypothesis.
C) myopia.
D) the life-cycle model.
8. According to the theory of Ricardian equivalence, tax cuts that have no plans to reduce
government spending ______ public saving and ______ private saving.
A) reduce; reduce
B) reduce; increase
C) increase; increase
D) increase; reduce
9. A strict balanced-budget rule would:

A) permit the use of fiscal policy for stabilization.
B) allow the use of tax smoothing to reduce tax distortions.
C) redistribute tax burdens across generations.
D) restrain political incompetence and opportunism.
10. Each of the following changes would allow the measured budget deficit to provide a
truer picture of fiscal policy except:
A) correcting for the effects of inflation.
B) offsetting changes in government liabilities with changes in government assets.
C) excluding some liabilities altogether.
D) correcting for the effects of the business cycle.
11. Inflation-indexed government bonds have all of the following benefits except:
A) eliminating inflation.
B) reducing the government's incentive to produce surprise inflation.
C) encouraging financial innovation.
D) eliminating inflation risk.
Page 20
12. An estimate of what government spending and tax revenue would be if the economy
were operating at its natural level of output and employment is called the ______
budget.
A) cyclically adjusted
B) inflation adjusted
C) capital asset
D) generational accounting
13. One item that is considered part of the federal debt is:
A) Treasury bills.
B) future Social Security benefits.
C) student loans, which may go into default.
D) potential liabilities of savings and loan associations.
14. If the debt of the U.S. federal government in 2008 was divided equally among the
people in the United States, then the debt per person would equal approximately:
A) $1,900.
B) $19,000.
C) $91,000.
D) $190,000.
15. Given a reduction in income tax withheld, but no change in income tax owed,
households that act according to Ricardian equivalence would ______ the extra take-
home pay, while those facing binding borrowing constraints would ______ the extra
take-home pay.
A) spend; spend
B) spend; save
C) save; save
D) save; spend
16. To force politicians to judge whether government spending is worth the costs, some
economists have argued for:
A) a balanced-budget rule for fiscal policy.
B) a constant money-growth rule for monetary policy.
C) avoiding the assumption of any contingent liabilities.
D) the application of Ricardian equivalence.
Page 21
17. The international impacts of a debt-financed tax cut, according to the traditional view,
are a(n) ______ in net exports and a domestic currency ______.
A) increase; appreciation
B) increase; depreciation
C) decrease; depreciation
D) decrease; appreciation
18. Measuring the size of government debt is complicated by all of the following factors
except:
A) inflation.
B) uncounted liabilities.
C) capital assets of the government.
D) failure of the Office of Management and Budget to disclose figures on capital
expenditures and credit programs.
19. Historically, the primary cause of increases in government debt is:

A) printing too much money.
B) cutting taxes.
C) increasing interest rates.
D) financing wars.
20. Using fiscal policy, including automatic stabilizers, to stabilize output over a business
cycle is not consistent with:
A) rational expectations.
B) inflation targeting.
C) the natural-rate hypothesis.
D) a strict balanced-budget rule.
21. If capital budgeting procedures were employed, then a budget deficit would be
measured as:
A) the sum of government debt.
B) the change in government debt.
C) the change in government debt minus the change in government capital assets.
D) the change in government capital assets.
22. Government debt equals the:

A) difference between current government purchases and taxes.
B) difference between saving and investment.
C) sum of past budget deficits and surpluses.
D) M1 money supply.
Page 22
23. The debt of the U.S. government is underreported in the view of many economists
because all of the following liabilities are excluded except:
A) future pensions of government employees.
B) debt owed to foreigners.
C) future Social Security benefits.
D) government guarantees of student loans.
24. According to the traditional view (as in the Mundell-Fleming model), if taxes are cut
without cutting government spending, then the short-run effects are a(n) ______ of the
dollar and a(n) ______ in net exports.
A) appreciation; increase
B) appreciation; decrease
C) depreciation; increase
D) depreciation; decrease
25. Indexed bonds produce all of the following benefits except:

A) less inflation risk.
B) more financial innovation.
C) better government incentives.
D) lower rates of inflation.
26. The large increase in U.S. government debt between 1980 and 1995 was unusual
because it occurred:
A) during peacetime.
B) during an extended recessionary period.
C) without increased government spending.
D) without tax cuts.
27. The experience of the 1980s:

A) clearly contradicted the Ricardian equivalence view because national saving was
very low.
B) clearly supported the Ricardian equivalence view, for people saved little only
because they were optimistic, as confirmed by the stock market.
C) will provide a clear answer on the validity of Ricardian equivalence as soon as
economists are able to analyze it with their computers.
D) may be used to argue both in favor of and against the Ricardian equivalence view
of the tax cuts.
Page 23
28. Assume that the nominal interest rate is 11 percent, the inflation rate is 8 percent, and
government debt at the beginning of the year equals $4 trillion. By how much is the
government budget deficit overstated as a result of inflation?
A) $0.12 trillion
B) $0.32 trillion
C) $0.44 trillion
D) $0.80 trillion
29. Under capital budgeting, all of the following transactions would affect the federal
budget deficit except the federal government's:
A) sending a check to a welfare recipient.
B) sending a check to the state of Massachusetts.
C) selling a highway to the state of New York and using the proceeds to retire federal
debt.
D) selling an office building.
Page 24
Answer Key
1. B
2. A
3. A
4. A
5. D
6. D
7. C
8. B
9. D
10. C
11. A
12. A
13. A
14. B
15. D
16. A
17. D
18. D
19. D
20. D
21. C
22. C
23. B
24. B
25. D
26. A
27. D
28. B
29. C

Page 25
Chapter 17
1. Examination of data from households shows that households with high current income
______ than do households with low current income.
A) consume less
B) save less
C) save a smaller fraction of current income
D) save a larger fraction of current income
2. Kuznets' data showed a short-run consumption function with a ______ APC and a long-
run consumption function with a ______ APC.
A) constant; constant
B) constant; falling
C) falling; constant
D) falling; falling
3. The determination of consumption as a function of current disposable income is most

strongly associated with:
A) John Maynard Keynes.
B) Irving Fisher.
C) Franco Modigliani.
D) Milton Friedman.
4. During World War II, economists using John Maynard Keynes's theory predicted that
the rate of saving after the war would be very:
A) high, and that is what happened.
B) low, and that is what happened.
C) low, but that did not happen.
D) high, but that did not happen.
5. Empirical studies of Franco Modigliani's life-cycle hypothesis show that:

A) most elderly individuals try to exhaust all their savings by the time they die.
B) the elderly do not seem to run down their wealth in old age, as a simple version of
the theory would predict.
C) elderly individuals generally do not want to leave bequests for their children.
D) precautionary saving is not an important saving motive for the elderly.
Page 26
6. Economists based their prediction that secular stagnation would occur as economies
prospered on the conjecture that:
A) the marginal propensity to consume is greater than zero.
B) the marginal propensity to consume is less than one.
C) the average propensity to consume falls as income rises.
D) income is the primary determinant of consumption.
7. In Irving Fisher's two-period model, if the consumer is initially saving in period one and
the real interest rate rises, then:
A) both the income and substitution effects will make the consumer want to consume
less in period one.
B) both the income and substitution effects will make the consumer want to consume
more in period one.
C) the substitution effect will make the consumer want to consume less in period one,
but the income effect will make him or her want to consume more.
D) the income effect will make the consumer want to consume less in period one, but
the substitution effect will make him or her want to consume more.
8. In Irving Fisher's two-period model, if the consumer is initially borrowing in period one
and the real interest rate rises, first-period consumption will:
A) certainly rise.
B) certainly fall.
C) remain constant.
D) either rise or fall.
9. In Irving Fisher's two-period consumption model, if Y1 = 15,000, Y2 = 20,000, the

interest rate r is 0.50 (50 percent), and there is a constraint on borrowing that is binding,
then C1 equals:
A) 15,000.
B) 20,000.
C) 28,333.
D) 35,000.
10. The pull of instant gratification may lead consumers to save ______ they would like to
save.
A) more than
B) less than
C) approximately the amount
D) precisely the amount
Page 27
11. In Irving Fisher's two-period model, if the consumer is initially a saver and the interest
rate increases, and first-period consumption decreases, then we can conclude that the
income effect:
A) was greater than the substitution effect.
B) was less than the substitution effect.
C) exactly offset the substitution effect.
D) and the substitution effect both decreased consumption.
12. Recent research by Laibson and other economists recognizes the importance of
incorporating ______ effects into the study of consumer behavior.
A) technological
B) meteorological
C) environmental
D) psychological
13. A consumption function based on the Fisher two-period model is consistent with the
Keynesian consumption function for consumers who:
A) would like to borrow, but cannot.
B) are initially borrowers when future income increases.
C) are initially savers when future income increases.
D) are initially borrowers when the interest rate increases.
14. In Irving Fisher's two-period consumption model, if Y1 = 20,000, Y2 = 15,000, and the
interest rate r is 0.50 (50 percent), then the maximum possible consumption in period
one is:
A) 20,000.
B) 25,000.
C) 30,000.
D) 35,000.
15. Milton Friedman argued that, over long periods of time, the average propensity to
consume is constant because, over these long periods of time:
A) the variation in income is dominated by the transitory component.
B) the variation in income is dominated by the permanent component.
C) it is the behavior of the average consumer that dominates.
D) income averages out to a constant.
Page 28
16. According to Modigliani's life-cycle hypothesis, the consumption function shifts upward
as ______ increases.
A) income
B) wealth
C) the marginal propensity to consume out of income
D) the number of years until retirement
17. Empirical evidence finds that the average propensity to consume is falling:
A) for only the short-run consumption function.
B) for only the long-run consumption function.
C) for both the short-run and the long-run consumption functions.
D) for neither the short-run nor the long-run consumption functions.
18. The consumer's budget constraint reflects the fact that because interest is earned on
savings:
A) future income is worth less than current income.
B) future income is worth more than current income.
C) future consumption costs more than current consumption.
D) future consumption is worth more than future income.
19. In Irving Fisher's two-period model, if consumption in both periods is a normal good,
then an increase in income in period two:
A) increases consumption in period one only.
B) increases consumption in period two only.
C) increases consumption in both periods.
D) does not increase consumption in either period.
20. Economic data suggest that when income is expected to fall by $1, consumption falls
by:
A) $1.
B) $0.50.
C) the marginal propensity to consume.
D) the ratio of years until retirement to the years remaining of life.
21. Every indifference curve shows combinations of first-period and second-period

consumption that:
A) are tangent to the intertemporal budget constraint.
B) have equal income and substitution effects.
C) are available to the consumer.
D) make the consumer equally happy.
Page 29
22. Milton Friedman argued that, although household studies showed that high-income
households generally have lower average propensities to consume, this phenomenon is
due to the fact that these households have, on average:
A) positive transitory income.
B) negative transitory income.
C) higher permanent income.
D) lower permanent income.
23. According to Modigliani's life-cycle hypothesis, if a consumer wants equal consumption

in every year, and the interest rate is zero, there are 40 years until retirement, and 60
years of life remaining, then the marginal propensity to consume out of income equals:
A) 0.016.
B) 0.40.
C) 0.60.
D) 0.67.
24. Simon Kuznets found that, over long periods of time in the United States, as income
rose, the average propensity to consume:
A) rose.
B) fell.
C) remained constant.
D) rose and then fell.
25. According to the permanent-income hypothesis, if consumers receive a one-time income

bonus, then they will:
A) save most of it in the current year.
B) spend most of it in the current year.
C) spend one-half of it and save one-half of it in the current year.
D) not alter their consumption or saving in the current year.
26. If consumers obey the permanent-income hypothesis and have rational expectations,
then policy changes affect consumption when the policy changes:
A) are proposed.
B) go into effect.
C) change expectations.
D) do not surprise consumers.

Page 30
Answer Key
1. D
2. C
3. A
4. D
5. B
6. C
7. C
8. B
9. A
10. B
11. B
12. D
13. A
14. C
15. B
16. B
17. A
18. A
19. C
20. B
21. D
22. A
23. D
24. C
25. A
26. C
Page 31

Page 32
Name: __________________________ Date: _____________
1. The natural rate of unemployment is:

A) the average rate of unemployment around which the economy fluctuates.
B) about 10 percent of the labor force.
C) a rate that never changes.
D) the transition of individuals between employment and unemployment.
2. If the number of employed workers equals 200 million and the number of unemployed
workers equals 20 million, the unemployment rate equals ______ percent (rounded to
the nearest percent).
A) 0
B) 9
C) 10
D) 20
3. In a steady state:
A) no hiring or firings are occurring.
B) the number of people finding jobs equals the number of people losing jobs.
C) the number of people finding jobs exceeds the number of people losing jobs.
D) the number of people losing jobs exceeds the number of people finding jobs.
4. If s is the rate of job separation, f is the rate of job finding, and both rates are constant,
then the unemployment rate is approximately:
A) f/(f + s).
B) (f + s)/f.
C) s/(s + f).
D) (s + f)/s.
5. If the fraction of employed workers who lose their jobs each month (the rate of job
separation) is 0.01 and the fraction of the unemployed who find a job each month is 0.09
(the rate of job findings), then the natural rate of unemployment is:
A) 1 percent.
B) 9 percent.
C) 10 percent.
D) about 11 percent.
Page 1
6. In the IS-LM model, which two variables are influenced by the interest rate?
A) supply of nominal money balances and demand for real balances
B) demand for real balances and government purchases
C) supply of nominal money balances and investment spending
D) demand for real money balances and investment spending
7. The IS-LM model takes ______ as exogenous.

A) the price level and national income
B) the price level
C) national income
D) the interest rate
8. The variable that links the market for goods and services and the market for real money
balances in the IS-LM model is the:
A) consumption function.
B) interest rate.
C) price level.
D) nominal money supply.
9. Planned expenditure is a function of:

A) planned investment.
B) planned government spending and taxes.
C) planned investment, government spending, and taxes.
D) national income and planned investment, government spending, and taxes.
10. The equilibrium condition in the Keynesian-cross analysis in a closed economy is:
A) income equals consumption plus investment plus government spending.
B) planned expenditure equals consumption plus planned investment plus government
spending.
C) actual expenditure equals planned expenditure.
D) actual saving equals actual investment.
11. When firms experience unplanned inventory accumulation, they typically:

A) build new plants.
B) lay off workers and reduce production.
C) hire more workers and increase production.
D) call for more government spending.
Page 2
12. In the Keynesian-cross model, if government purchases increase by 250, then the
equilibrium level of income:
A) increases by 250.
B) increases by more than 250.
C) decreases by 250.
D) increases, but by less than 250.
13. In the Keynesian-cross model, if taxes are reduced by 250, then the equilibrium level of
income:
A) increases by 250.
B) increases by more than 250.
C) decreases by 250.
D) increases, but by less than 250.
14. Along any given IS curve:

A) tax rates are fixed, but government spending varies.
B) government spending is fixed, but tax rates vary.
C) both government spending and tax rates vary.
D) both government spending and tax rates are fixed.
15. An increase in government spending generally shifts the IS curve, drawn with income
along the horizontal axis and the interest rate along the vertical axis:
A) downward and to the left.
B) upward and to the right.
C) upward and to the left.
D) downward and to the right.
16. One argument in favor of tax cuts over spending on infrastructure to increase production
is that:
A) tax cuts increase the MPC by a larger amount than spending on infrastructure.
B) tax cuts increase planned spending, but spending on infrastructure offsets private
spending.
C) the tax multiplier is larger than the government spending multiplier.
D) it takes longer to implement spending on infrastructure than to implement tax cuts.
17. When the LM curve is drawn, the quantity that is held fixed is:
A) the nominal money supply.
B) the real money supply.
C) government spending.
D) the tax rate.
Page 3
18. The theory of liquidity preference implies that:
A) as the interest rate rises, the demand for real balances will fall.
B) as the interest rate rises, the demand for real balances will rise.
C) the interest rate will have no effect on the demand for real balances.
D) as the interest rate rises, income will rise.
19. A decrease in the real money supply, other things being equal, will shift the LM curve:
A) downward and to the left.
B) upward and to the left.
C) downward and to the right.
D) upward and to the right.
20. A decrease in the price level, holding nominal money supply constant, will shift the LM
curve:
A) upward and to the right.
B) downward and to the right.
C) downward and to the left.
D) upward and to the left.
21. One reason for unemployment is that:

A) it takes time to match workers and jobs.
B) all jobs are identical.
C) the labor market is always in equilibrium.
D) a laid-off worker can immediately find a new job at the market wage.
22. All of the following are reasons for frictional unemployment except:
A) workers have different preferences and abilities.
B) unemployed workers accept the first job offer that they receive.
C) the flow of information is imperfect.
D) geographic mobility takes time.
23. Sectoral shifts:

A) lead to wage rigidity.
B) explain the payment of efficiency wages.
C) depend on the level of the minimum wage.
D) make frictional employment inevitable.
Page 4
24. Frictional unemployment is inevitable because:
A) different sectors do not shift.
B) the economy needs to be lubricated.
C) workers never quit their jobs to change careers.
D) the demand for different goods always fluctuates.
25. When there is structural unemployment, the real wage is:

A) rigid at a level below the market-clearing level.
B) rigid at the market-clearing level.
C) rigid at a level above the market-clearing level.
D) flexible.
26. Wage rigidity:

A) forces labor demand to equal labor supply.
B) is caused by sectoral shifts.
C) prevents labor demand and labor supply from reaching the equilibrium level.
D) increases the rate of job finding.
27. Workers unemployed as a result of wage rigidity are:

A) actively searching for a job to match their skills.
B) not eligible to receive unemployment insurance benefits.
C) waiting for a job to become available.
D) relocating to another part of the country as a result of sectoral shifts.
28. All of the following are causes of structural unemployment except:

A) minimum-wage laws.
B) the monopoly power of unions.
C) unemployment insurance.
D) efficiency wages.
29. All of the following statements about minimum-wage workers in the United States are
correct except:
A) Minimum-wage workers are more likely to be male.
B) Minimum-wage workers are more likely to work part time.
C) Minimum-wage workers are more likely to be less educated.
D) Minimum-wage workers are more likely to be young.
Page 5
30. Paying efficiency wages helps firms reduce the problem of adverse selection by:
A) generating additional profits that can be used to pay for more proficient hiring
managers.
B) keeping labor unions from organizing workers in the firm.
C) encouraging unsupervised workers to maintain a high level of productivity.
D) providing an incentive for the best-qualified workers to remain with the firm.
31. All of the following are possible explanations for the trends in the U.S. unemployment
rate in the last half of the twentieth century and early twenty-first century except:
A) the changing composition of the U.S. work force.
B) sectoral shifts.
C) a generally increasing real value of the minimum wage.
D) the links between unemployment and productivity.
32. Discouraged workers are individuals who:

A) have jobs that do not match their skills (e.g., a PhD driving a taxi cab).
B) have been unemployed for more than 26 weeks.
C) call themselves unemployed but are not seriously looking for a job.
D) want a job but have given up looking for one.
33. Much of the difference in unemployment rates across Europe is attributable to

differences in:
A) short-term unemployment.
B) long-term unemployment.
C) frictional unemployment.
D) the natural rate of unemployment.
34. The Solow growth model describes:

A) how output is determined at a point in time.
B) how output is determined with fixed amounts of capital and labor.
C) how saving, population growth, and technological change affect output over time.
D) the static allocation, production, and distribution of the economy's output.
35. The consumption function in the Solow model assumes that society saves a:
A) constant proportion of income.
B) smaller proportion of income as it becomes richer.
C) larger proportion of income as it becomes richer.
D) larger proportion of income when the interest rate is higher.
Page 6
36. In the Solow growth model of Chapter 7, the saving rate determines the allocation of
output between:
A) saving and investment.
B) output and capital.
C) consumption and output.
D) investment and consumption.
37. In the Solow growth model of Chapter 7, investment equals:

A) output.
B) consumption.
C) the marginal product of capital.
D) saving.
38. In the steady state, the capital stock does not change because investment equals:
A) output per worker.
B) the marginal product of capital.
C) depreciation.
D) consumption.
39. In the Solow growth model of Chapter 7, the economy ends up with a steady-state level
of capital:
A) only if it starts from a level of capital below the steady-state level.
B) only if it starts from a level of capital above the steady-state level.
C) only if it starts from a steady-state level of capital.
D) regardless of the starting level of capital.
40. An economy in the steady state will have:

A) investment exceeding depreciation.
B) no depreciation.
C) saving equal to consumption.
D) no change in the capital stock.
41. In the Solow growth model of an economy with no population growth and no
technological progress, the higher the steady capital-per-worker ratio, the higher the
steady-state:
A) growth rate of total output.
B) level of total output.
C) growth rate of output per worker.
D) level of output per worker.
Page 7
42. If the per-worker production function is given by y = k1/2, the saving ratio is 0.3, and the
depreciation rate is 0.1, then the steady-state ratio of capital to labor is:
A) 1.
B) 2.
C) 4.
D) 9.
43. If a war destroys a large portion of a country's capital stock but the saving rate is
unchanged, the Solow model predicts output will grow and that the new steady state will
approach:
A) a higher output level than before.
B) the same output level as before.
C) a lower output level than before.
D) the Golden Rule output level.
44. If the national saving rate increases, the:

A) economy will grow at a faster rate forever.
B) capital-labor ratio will increase forever.
C) economy will grow at a faster rate until a new, higher, steady-state capital-labor
ratio is reached.
D) capital-labor ratio will eventually decline.
45. The Solow model shows that a key determinant of the steady-state ratio of capital to
labor is the:
A) level of output.
B) labor force.
C) saving rate.
D) capital elasticity in the production function.
46. The Golden Rule level of capital accumulation is the steady state with the highest level
of:
A) output per worker.
B) capital per worker.
C) savings per worker.
D) consumption per worker.
Page 8
47. The Golden Rule level of the steady-state capital stock:
A) will be reached automatically if the saving rate remains constant over a long period
of time.
B) will be reached automatically if each person saves enough to provide for his or her
retirement.
C) implies a choice of a particular saving rate.
D) should be avoided by an enlightened government.
48. If an economy with no population growth or technological change has a steady-state

MPK of 0.125, a depreciation rate of 0.1, and a saving rate of 0.225, then the
steady-state capital stock:
A) is greater than the Golden Rule level.
B) is less than the Golden Rule level.
C) equals the Golden Rule level.
D) could be either above or below the Golden Rule level.
49. To determine whether an economy is operating at its Golden Rule level of capital stock,
a policymaker must determine the steady-state saving rate that produces the:
A) largest MPK.
B) smallest depreciation rate.
C) largest consumption per worker.
D) largest output per worker.
50. When an economy begins below the Golden Rule, reaching the Golden Rule:
A) produces lower consumption at all times in the future.
B) produces higher consumption at all times in the future.
C) requires initially reducing consumption to increase consumption in the future.
D) requires initially increasing consumption to decrease consumption in the future.
51. Monetary neutrality is a characteristic of the aggregate demand–aggregate supply model

in:
A) both the short run and the long run.
B) in neither the short run nor the long run.
C) in the short run, but not in the long run.
D) in the long run, but not in the short run.
Page 9
52. In the Solow growth model of an economy with population growth but no technological
change, if population grows at rate n, total output grows at rate ______ and output per
worker grows at rate ______.
A) n ; n
B) n ; 0
C) 0 ; 0
D) 0 ; n
53. In the Solow growth model, if two countries are otherwise identical (with the same
production function, same saving rate, same depreciation rate, and same rate of
population growth) except that Country Large has a population of one billion workers
and Country Small has a population of ten million workers, then the steady-state level of
output per worker will be ______ and the steady-state growth rate of output per worker
will be ______.
A) the same in both countries; the same in both countries
B) higher in Country Large; higher in Country Large
C) higher in Country Small; higher in Country Small
D) higher in Country Large; higher in Country Small
54. The Solow growth model of an economy with population growth but no technological
progress can explain:
A) persistent growth in output per worker.
B) persistent growth in total output.
C) persistent growth in consumption per worker.
D) persistent growth in the saving rate.
55. Assume that a war reduces a country's labor force but does not directly affect its capital
stock. Then the immediate impact will be that:
A) total output will fall, but output per worker will rise.
B) total output will rise, but output per worker will fall.
C) both total output and output per worker will fall.
D) both total output and output per worker will rise.
56. If a larger share of national output is devoted to investment, then living standards will:
A) always decline in the short run but rise in the long run.
B) always rise in both the short and long runs.
C) decline in the short run and may not rise in the long run.
D) rise in the short run but may not rise in the long run.
Page 10
57. The efficiency of labor is a term that does not reflect the:
A) high output that comes from labor cooperating with a large amount of capital.
B) health of the labor force.
C) education of the labor force.
D) skills of the labor force acquired through on-the-job training.
58. The number of effective workers takes into account the number of workers and the:
A) amount of capital available to each worker.
B) rate of growth of the number of workers.
C) efficiency of each worker.
D) saving rate of each worker.
59. Assuming that technological progress increases the efficiency of labor at a constant rate
is called:
A) endogenous technological progress.
B) the efficiency-wage model of economic growth.
C) labor-augmenting technological progress.
D) the Golden Rule model of economic growth.
60. Business cycles are:

A) regular and predictable.
B) irregular but predictable.
C) regular but unpredictable.
D) irregular and unpredictable.
61. Over the business cycle, investment spending ______ consumption spending.
A) is inversely correlated with
B) is more volatile than
C) has about the same volatility as
D) is less volatile than
62. Leading economic indicators are:

A) the most popular economic statistics.
B) data that are used to construct the consumer price index and the unemployment
rate.
C) variables that tend to fluctuate in advance of the overall economy.
D) standardized statistics compiled by the National Bureau of Economic Research.
Page 11
63. Most economists believe that prices are:
A) flexible in the short run but many are sticky in the long run.
B) flexible in the long run but many are sticky in the short run.
C) sticky in both the short and long runs.
D) flexible in both the short and long runs.
64. Most economists believe that the classical dichotomy:

A) holds approximately in both the short run and the long run.
B) holds approximately in the long run but not at all in the short run.
C) holds approximately in the short run but not at all in the long run.
D) does not hold even approximately in either the long run or the short run.
65. The results of Alan Blinder's survey of firms suggest all of the following are true except
that:
A) there is only one theory of price stickiness.
B) coordinating wage and price setting could improve welfare.
C) reasons for price stickiness vary by industry.
D) activist monetary policy can be used to cure recessions.
66. Along an aggregate demand curve, which of the following are held constant?
A) real output and prices
B) nominal output and velocity
C) the money supply and real output
D) the money supply and velocity
67. When the Federal Reserve increases the money supply, at a given price level the amount
of output demanded is ______ and the aggregate demand curve shifts ______.
A) greater; inward
B) greater; outward
C) lower; inward
D) lower; outward
68. The vertical long-run aggregate supply curve satisfies the classical dichotomy because
the natural rate of output does not depend on:
A) the labor supply.
B) the supply of capital.
C) the money supply.
D) technology.
Page 12
69. If the short-run aggregate supply curve is horizontal, then changes in aggregate demand
affect:
A) level of output but not prices.
B) prices but not level of output.
C) both prices and level of output.
D) neither prices nor level of output.
70. The short run refers to a period:

A) of several days.
B) during which prices are sticky and unemployment may occur.
C) during which capital and labor are fully employed.
D) during which there are no fluctuations.
71. If the short-run aggregate supply curve is horizontal and the Fed increases the money
supply, then:
A) output and employment will increase in the short run.
B) output and employment will decrease in the short run.
C) prices will increase in the short run.
D) prices will decrease in the short run.
72. In the Solow growth model with population growth and technological change, the
steady-state growth rate of income per person depends on:
A) the rate of population growth.
B) the saving rate.
C) the rate of technological progress.
D) the rate of population growth plus the rate of technological progress.
73. With population growth at rate n and labor-augmenting technological progress at rate g,
the Golden Rule steady state requires that the marginal product of capital (MPK):
A) net of depreciation be equal to n + g.
B) net of depreciation be equal to the depreciation rate plus n + g.
C) plus n be equal to the depreciation rate plus g.
D) plus g be equal to the depreciation rate plus n.
Page 13
74. In a Solow model with technological change, if population grows at a 2 percent rate and
the efficiency of labor grows at a 3 percent rate, then in the steady state, output per
actual worker grows at a ______ percent rate.
A) 0
B) 2
C) 3
D) 5
75. In the Solow model with technological progress, the steady-state growth rate of output
per (actual) worker is:
A) 0.
B) g.
C) n.
D) n + g.
76. The balanced-growth property of the Solow growth model with population growth and
technological progress predicts which of the following sets of variables will grow at the
same rate in the steady state?
A) output per effective worker, capital per effective worker, real wage
B) output per worker, capital per worker, real wage
C) real rental price of capital, real wage, output per worker
D) capital-output ratio, output per worker, capital per worker
77. If two economies are identical (including having the same saving rates, population
growth rates, and efficiency of labor), but one economy has a smaller capital stock, then
the steady-state level of income per worker in the economy with the smaller capital
stock:
A) will be at a lower level than the steady state of the high capital economy.
B) will be at a higher level than the steady state of the high capital economy.
C) will be at the same level as the steady state of the high capital economy.
D) will be proportional to the ratio of the capital stocks in the two economies.
78. Hypotheses to explain the positive correlation between factor accumulation and
production efficiency include each of the following except:
A) the quality of a nation's institutions influences both factor accumulation and
production efficiency.
B) capital accumulation causes greater production efficiency.
C) efficient economies make capital accumulation unnecessary.
D) an efficient economy encourages capital (including human capital) accumulation.
Page 14
79. Other things being equal, all of the following government policies are likely to increase
national saving except:
A) decreasing taxes on savings accounts.
B) running a budget deficit.
C) running a budget surplus.
D) retiring part of the national debt.
80. A possible externality associated with the process of accumulating new capital is that:
A) a reduction in labor productivity may occur.
B) new production processes may be devised.
C) old capital may be made more productive.
D) the government may need to adopt an industrial policy.
81. Increases in the rate of growth of income per person in the United States in the
mid-1990s was most likely the result of:
A) increases in human capital.
B) increases in physical capital.
C) advances in information technology.
D) an increase in the saving rate.
82. The endogenous growth model's assumption of constant returns to capital is more
plausible if capital is defined to include:
A) plant and equipment.
B) knowledge.
C) depreciation.
D) technology.
83. In the two-sector endogenous growth model, the saving rate (s) affects the steady-state:
A) level of income.
B) growth rate of income.
C) level of income and growth rate of income.
D) growth rate of the stock of knowledge.
84. In the two-sector endogenous growth model, income growth persists because:
A) the production function shifts exogenously.
B) the saving rate exceeds the rate of depreciation.
C) the creation of knowledge in universities never slows down.
D) the fraction of the labor force in universities is large.
Page 15
85. Schumpeter's thesis of “creative destruction” is an explanation of economic progress
resulting from:
A) using up scarce natural resources to create new products.
B) breaking down barriers to trade and development.
C) new product producers driving incumbent producers out of business.
D) creating new methods to destroy the environment.
86. Total factor productivity may be measured by:

A) subtracting the rate of growth of capital input and the rate of growth of labor input
from the rate of growth of output.
B) subtracting the rate of growth of capital input, multiplied by capital's share of
output, plus the rate of growth of labor input, multiplied by labor's share of output,
from the rate of growth of output.
C) adding the rate of growth of capital input to the rate of growth of labor input.
D) adding the rate of growth of capital input, multiplied by capital's share of output, to
the rate of growth of labor input, multiplied by labor's share of output.
87. The Solow residual equals the percentage change in output:

A) plus the percentage change in inputs.
B) minus the percentage change in prices.
C) minus the percentage change in inputs.
D) plus the percentage change in costs.
88. In a steady state with population growth and technological progress:

A) the capital share of income increases.
B) the labor share of income increases.
C) in some cases the capital share of income increases and sometimes the labor share
increases.
D) the capital and labor shares of income are constant.
89. The rate of growth of labor productivity (Y/L) may be expressed as the rate of growth of
total factor productivity:
A) plus the capital share multiplied by the rate of growth of the capital-labor ratio.
B) minus the capital share multiplied by the rate of growth of the capital-labor ratio.
C) plus the rate of growth of capital productivity.
D) minus the rate of growth of capital productivity.
Page 16
90. In year 1, capital stock was 6, labor input was 3, and output was 12. In year 2, capital
was 7, labor was 4, and output was 14. If shares of labor and capital were each 1/2,
between the two years, total factor productivity:
A) increased by 1/12.
B) increased by 1/18.
C) decreased by 1/12.
D) decreased by 1/18.
Page 17
Intermediate Macroeconomics, Fall 2014
Assignment 1 & 2
1. GDP is all of the following except the total:

A) expenditure of everyone in the economy.
B) income of everyone in the economy.
C) expenditure on the economy's output of goods and services.
D) output of the economy.
2. If increased immigration raises the labor force, the neoclassical theory of distribution
predicts:
3. Which of the following is a flow variable?

A) Wealth
B) the number unemployed
C) government debt
D) Income
4. Assume that some large foreign countries begin to subsidize investment by instituting an
investment tax credit. Then, if world saving does not depend on the interest rate, world
investment:
A) will rise and small country investment will fall.
B) will rise and small country investment will remain unchanged.
C) will remain unchanged and small country investment will fall.
D) and small country investment will both remain unchanged.
5. Which of the following would most likely be called a hyperinflation?

A) Price increases averaged 300 percent per year.
B) The inflation rate was 10 percent per year.
C) Real GDP grew at a rate of 12 percent over a year.
D) A stock market index rose by 1,000 points over a year.
6. When a firm sells a product out of inventory, GDP:
A) increases.
B) decreases.
C) is not changed.
D) increases or decreases, depending on the year the product was produced.
7. Net capital outflow in a large country:

A) rises as the real domestic interest rate rises.
B) declines as the domestic interest rate rises.
C) depends on the foreign interest rate.
D) depends only on domestic saving.
8. Assume a rancher sells a quarter-pound of meat to McDonald's for $1 and that

McDonald's sells you a hamburger made from that meat for $2. In this case, the value
included in GDP should be:
A) $0.50.
B) $1.
C) $2.
D) $3.
9. The law of one price is enforced by:

A) governments.
B) producers.
C) consumers.
D) arbitrageurs.
10. If nominal wages cannot be cut, then the only way to cut real wages is by:
A) inflation.
B) unions.
C) legislation.
D) productivity increases.
11. If nominal GDP grew by 5 percent and real GDP grew by 3 percent, then the GDP
deflator grew by approximately ______ percent.
A) 2
B) 3
C) 5
D) 8
12. If the real exchange rate depreciates from 1 Japanese good per U.S. good to 0.5
Japanese good per U.S. good, then U.S. exports ______ and U.S. imports ______.
B) decrease; decrease
C) increase; decrease
D) decrease; increase
13. In the national income accounts, consumption expenditures include all of the following
except household purchases of:
A) durable goods.
B) nondurable goods.
C) new residential housing.
D) services.
14. The real exchange rate:

A) measures how many Japanese yen one really gets for a U.S. dollar.
B) is equal to the nominal exchange rate multiplied by the domestic price level
divided by the foreign price level.
C) is equal to the nominal exchange rate multiplied by the foreign price level divided
by the domestic price level.
D) is the price of a domestic car divided by the price of a foreign car.
15. The costs of reprinting catalogs and price lists because of inflation are called:
A) menu costs.
B) shoeleather costs.
C) variable yardstick costs.
D) fixed costs.
16. The two most important factors of production are:

A) goods and services.
B) labor and energy.
C) capital and labor.
D) saving and investment.
17. Starting from a small open economy with balanced trade, if large foreign countries
increase their domestic government purchases, this policy will tend to increase:
A) investment in the small open economy.
B) saving in the small open economy.
C) exports by the small open economy.
D) imports by the small open economy.
18. The marginal product of labor is:
A) output divided by labor input.
B) additional output produced when one additional unit of labor is added.
C) additional output produced when one additional unit of labor and one additional
unit of capital are added.
D) value of additional output when one dollar's worth of additional labor is added.
19. An increase in the trade deficit of a small open economy could be the result of:
A) an increase in taxes.
B) an increase in government spending.
C) a decrease in the world interest rate.
D) the expiration of an investment tax-credit provision.
20. The real return on holding money is:

A) the real interest rate.
B) minus the real interest rate.
C) the inflation rate.
D) minus the inflation rate.
21. The real wage is the return to labor measured in:

A) dollars.
B) units of output.
C) units of labor.
D) units of capital.
22. To increase the money supply, the Federal Reserve:

A) buys government bonds.
B) sells government bonds.
C) buys corporate stocks.
D) sells corporate stocks.
23. In a Cobb-Douglas production function the marginal product of labor will increase if:
A) the quantity of labor increases.
B) the quantity of capital increases.
C) capital's share of output increases.
D) average labor productivity decreases.
24. All of the following are considered major functions of money except as a:
A) medium of exchange.
B) way to display wealth.
C) unit of account.
D) store of value.
25. The ex ante real interest rate is equal to the nominal interest rate:
A) minus the inflation rate.
B) plus the inflation rate.
C) minus the expected inflation rate.
D) plus the expected inflation rate.
26. Other things equal, an increase in the interest rate leads to:
A) a decrease in the quantity of investment goods demanded.
B) no change in the quantity of investment goods demanded.
C) an increase in the quantity of investment goods demanded.
D) sometimes an increase and sometimes a decrease in the quantity of investment
goods demanded.
27. In a neoclassical economy, assume that the government lowers both government
spending and taxes by the same amount. By doing so:
A) investment falls and the interest rate rises.
B) investment rises and the interest rate falls.
C) investment and the interest rate both fall.
D) investment and the interest rate both rise.
28. In the classical model with fixed income, if the demand for goods and services is less
than the supply, the interest rate will:
A) increase.
B) decrease.
C) remain unchanged.
D) either increase or decrease, depending on whether consumption is greater or less
than investment.
29. An example of decreasing returns to scale is when capital and labor inputs:
A) both increase 10 percent and output increases 5 percent.
B) both increase 10 percent and output increases 10 percent.
C) both increase 5 percent and output increases 10 percent.
D) do not change and output increases 5 percent.
30. “Inflation tax” means that:
A) as the price level rises, taxpayers are pushed into higher tax brackets.
B) as the price level rises, the real value of money held by the public decreases.
C) as taxes increase, the rate of inflation also increases.
D) in a hyperinflation, the chief source of tax revenue is often the printing of money.
31. In the classical model with fixed income, if the demand for goods and services is greater
than the supply, the interest rate will:
A) increase.
B) decrease.
C) remain unchanged.
D) either increase or decrease, depending on whether consumption is greater or less
than investment.
32. According to purchasing power-parity, if the dollar price of oil is higher in New York
than in London, arbitrageurs will _____ oil in New York and _____ oil in London to
drive _____ the price of oil in New York.
A) buy; sell; up
B) buy; sell; down
C) sell; buy; up
D) sell; buy; down
33. Public saving is:

A) income minus consumption minus government spending.
B) disposable income minus consumption.
C) disposable income minus government spending.
D) government revenue minus government spending.
34. If the real exchange rate between the United States and Japan remains unchanged, and
the inflation rate in the United States is 6 percent and the inflation rate in Japan is 3
percent, the:
A) dollar will appreciate by 3 percent against the yen.
B) yen will appreciate by 3 percent against the dollar.
C) yen will appreciate by 6 percent against the dollar.
D) yen will appreciate by 9 percent against the dollar.
35. According to the quantity theory of money, ultimate control over the rate of inflation in
the United States is exercised by:
A) the Organization of Petroleum Exporting Countries (OPEC).
B) the U.S. Treasury.
C) the Federal Reserve.
D) private citizens.
36. If net capital outflow is positive, then:

A) exports must be positive.
B) exports must be negative.
C) the trade balance must be positive.
D) the trade balance must be negative.
37. In a small open economy, if the government encourages investment, say through an
investment tax credit, investment:
A) increases and is financed through an increase in national saving.
B) increases and is financed through an increase in exports.
C) increases and is financed through an inflow of foreign capital.
D) does not increase; the interest rate rises instead.
38. A trade deficit can be financed in all of the following methods except by:
A) borrowing from foreigners.
B) selling domestic assets to foreigners.
C) selling foreign assets owned by domestic residents to foreigners.
D) borrowing from domestic lenders.
39. If a graph is drawn with net exports on the horizontal axis and the real exchange rate on
the vertical axis, then the real exchange rate is determined by the intersection of the
______ net-exports schedule and the ______ line representing saving minus investment.
A) downward-sloping; vertical
B) upward-sloping; vertical
C) downward-sloping; upward-sloping
D) upward-sloping; downward-sloping
40. Open-market operations are:

A) Commerce Department efforts to open foreign markets to international trade.
B) Federal Reserve purchases and sales of government bonds.
C) Securities and Exchange Commission rules requiring open disclosure of market
trades.
D) Treasury Department purchases and sales of the U.S. gold stock.

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Intermediate Macroeconomics, Fall 2014

Practice Questions (1)

2. To reduce the money supply, the Federal Reserve:

8. If a neutral technological advance improves the production function, the neoclassical

25. A country's exports may be written as equal to:

27. Net capital outflow is equal to the amount that:

35. In an open economy:

39. If the real exchange rate is high, foreign goods:

1. In the Mundell-Fleming model, the domestic interest rate is determined by the:

7. To maintain a fixed-exchange-rate system, if the exchange rate moves below the

8. If there is a fixed-exchange-rate system, then in the short run described by the

14. A speculative attack on a currency occurs when:

25. Inflation inertia refers to the idea that inflation:

26. Cost-push inflation is the result of:

29. The sacrifice ratio measures the:

49. The dynamic aggregate demand curve is drawn for a given:

64. Historically, the primary cause of increases in government debt is:

76. The average propensity to consume is the:

85. According to Modigliani's life-cycle hypothesis, if a consumer wants equal consumption

87. Transitory income is:

88. Precautionary saving is saving for:

1. According to the sticky-price model:

5. In the 1960s, in the United States:

7. The Phillips curve depends on all of the following forces except:

8. A recession may alter an economy's natural rate of unemployment in all of the

9. The NAIRU is the:

14. Inflation inertia refers to the idea that inflation:

Use the following to answer question 15:

Exhibit: Short-run Phillips Curve

Use the following to answer questions 23-24:

Exhibit: AD–AS Shifts

Monetary nonneutrality occurs when changes in money affect real variables.

4. Beginning at long-run equilibrium in the dynamic model of aggregate demand and

5. The dynamic aggregate demand curve is drawn for a given:

7. An increase in the central bank's target rate of inflation is represented by a:

1. Economic science has provided convincing evidence in favor of the:

2. The political business cycle refers to the:

4. The lags involved in implementing monetary and fiscal policy are:

19. Economic forecasters did:

1. Hyperinflations typically occur when governments:

4. The possibility of capital flight is likely to be greater at higher levels of government

7. Suppose a household considers only current income in making consumption decisions.

9. A strict balanced-budget rule would:

19. Historically, the primary cause of increases in government debt is:

22. Government debt equals the:

25. Indexed bonds produce all of the following benefits except:

27. The experience of the 1980s:

3. The determination of consumption as a function of current disposable income is most

5. Empirical studies of Franco Modigliani's life-cycle hypothesis show that:

9. In Irving Fisher's two-period consumption model, if Y1 = 15,000, Y2 = 20,000, the

21. Every indifference curve shows combinations of first-period and second-period

23. According to Modigliani's life-cycle hypothesis, if a consumer wants equal consumption

25. According to the permanent-income hypothesis, if consumers receive a one-time income

1. The natural rate of unemployment is:

7. The IS-LM model takes ______ as exogenous.

9. Planned expenditure is a function of:

11. When firms experience unplanned inventory accumulation, they typically:

14. Along any given IS curve:

21. One reason for unemployment is that:

23. Sectoral shifts:

25. When there is structural unemployment, the real wage is:

26. Wage rigidity:

27. Workers unemployed as a result of wage rigidity are: