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Chapter 06 Aggregate Supply and Aggregate Demand

MULTICHOICE

1. At the time of the Great Depression, the believed that the economic disruptions being
experienced were temporary and that market forces would eventually reestablish prosperity.

(A) Marxists

(B) classical economists

(C) Keynesian economists

(D) supply-side economists

Answer : (B)

2. predicted that capitalism would fail under the weight of growing unemployment. His
economic ideas formed the basis for the system adopted by the Soviet Union.

(A) Karl Marx

(B) John Maynard Keynes

(C) Vladimir Lenin

(D) Jean Baptiste Say

Answer : (A)

3. proposed the aggregate supply/aggregate demand framework to explain what was

happening in the economy during the Great Depression.
(A) Karl Marx

(B) Vladimir Lenin

(C) John Maynard Keynes

(D) Jean Baptiste Say

Answer : (C)

4. The relationship between the economy-wide price level and the level of real GDP illustrated by the
aggregate demand curve is

(A) neutral.

(B) positive.
(C) direct. (D)

indirect.

Answer : (D)

5. The Pigou effect is one of the reasons that the aggregate demand curve slopes downward.
According to this argument, it suggests when the price level

(A) goes down, interest rates will fall resulting in an increase in the total level of spending.

(B) goes down, peoples' savings are able to purchase more stuff so the total level of spending
increases.

(C) goes down, peoples' savings are able to purchase less stuff so the total level of spending
decreases.

(D) in the US goes down, US goods and services become relatively cheaper compared to things
produced overseas, so the total level of spending on US goods and services increases.

Answer : (B)

6. The three reasons that the economy-wide price level and the level of real GDP move in opposite
directions are

(A) the Pigou effect, the foreign trade effect, and the real savings effect.

(B) the foreign trade effect, Keynes's interest rate effect, and the price effect.

(C) the Pigou effect, Keynes's interest rate effect, and the foreign trade effect.

(D) the foreign trade effect, the government intervention effect, and the real savings effect.

Answer : (C)

7. Keynes's interest rate effect suggests that when the price level rises it causes an increase in the
demand for money, which the interest rate and the level of business spending.

(A) increases; reduces

(B) increases; increases

(C) decreases; reduces

(D) decreases; increases

Answer : (A)

8. Aggregate demand is equal to

(A) C + I + G + (X + M).

(B) C + G + (X - M).

(C) C + I + G + (X - M).

(D) S + I + G + (X - M).

Answer : (C)

9.

Consider Figure 6-1. Which of the following will cause a shift in the aggregate demand curve from
AD1 to AD2?

(A) An increase in personal savings

(B) An increase in personal income taxes

(C) A reduction in personal income taxes

(D) Increased consumer pessimism about the future

Answer : (C)
10.

Consider Figure 6-1. Which of the following will cause a shift in aggregate demand from AD2 to AD1?

(A) An increase in business optimism

(B) An increase in business investment spending

(C) A decrease in interest rates

(D) An increase in interest rates

Answer : (D)

11.

Consider Figure 6-1. Which of the following would cause a shift in the aggregate demand curve from
AD1 to AD2?

(A) An increase in federal government spending on Social Security

(B) An increase in federal government spending on drones

(C) A decrease in federal government spending on highway infrastructure

(D) A decrease in state government spending

Answer : (B)

12. A decrease in aggregate demand would be caused by a(n) in .

(A) increase; exports

(B) increase; imports

(C) decrease; imports

(D) increase; net exports

Answer : (B)

13. It is found that when the disposable income of Elvania increases by $100 billion, household
consumption spending increases by $70 billion. In Elvania, the marginal propensity to consume is

(A) 0.3.

(B) 0.5.

(C) 0.7.

(D) 1.0.

Answer : (C)

14. In the country of Trivia, it is widely believed that the marginal propensity to consume is 0.75.
This means that a onetime increase in spending of $50 billion will result in a(n) in GDP
equal to .

(A) decrease; $66.67 billion

(B) increase; $50 billion

(C) increase; $66.67 billion

(D) increase; $200 billion

Answer : (D)

15. Originally, Keynes conceived of the aggregate supply curve as consisting of two distinct
segments. In this conception, below the full-employment level of output the aggregate supply curve
is , and once the economy reaches the full-employment level of output it becomes
 .

(A) upward sloping; vertical

(B) horizontal; vertical

(C) upward sloping; horizontal

(D) downward sloping; vertical

Answer : (B)

16. With a two-part aggregate supply curve, an increase in aggregate demand when the economy is
at less than full employment will lead to in real GDP and in the price level.

(A) an increase; an increase

(B) an increase; a decrease

(C) an increase; no increase

(D) no change; an increase

Answer : (C)

17. In the late 1940s, economic theorists expanded on the Keynesian aggregate supply model by
broadening it into a three-part aggregate supply curve with

(A) a flat initial segment, followed by a modestly upward-sloping middle segment until full-
employment GDP is reached, and finally a more steeply upward-sloping segment beyond full-
employment GDP.

(B) a flat initial segment, followed by an upward-sloping middle segment until full-employment GDP
is reached, and finally a vertical segment at full-employment GDP.

(C) a flat initial segment until full-employment is reached, followed by a vertical segment at full-
employment GDP, and finally followed by another flat segment once the full-employment price level
is reached.

(D) an upward-sloping initial segment, followed by an upward-sloping segment until full-employment

GDP is reached, and finally followed by another flat segment beyond full-employment GDP.

Answer : (B)

18. The aggregate demand, three-part aggregate supply model has performed relatively well in all
but which of the following situations?

(A) Explaining the Great Depression

(B) Managing the economy during World War II

(C) Understanding the post-World War II economic boom

(D) Understanding the stagflation of the late 1960s and early 1970s

Answer : (D)

19. Stagflation is an economic condition where an economy is experiencing

(A) a high and rising price level and little economic growth with high unemployment.

(B) a low and falling price level and little economic growth with high unemployment.

(C) a high and rising price level with high economic growth and low unemployment.

(D) a low and falling price level and high economic growth with high unemployment.

Answer : (A)

20. The Keynesian aggregate demand/aggregate supply model assumed that people's expectations
were

(A) rational.

(B) ex ante.

(C) adaptive.

(D) ex post.

Answer : (C)

21. When people use all available information to develop expectations about the future and use their
expectations about the future to make current decisions, this is called expectations.

(A) rational

(B) adaptive

(C) realistic

(D) deterministic

Answer : (A)

22. The rational expectations approach postulates two aggregate supply curves:

(A) an upward-sloping short-run aggregate supply curve and a horizontal long-run supply curve at
the maximum price level.

(B) an upward-sloping short-run aggregate supply curve and a vertical long-run supply curve at zero
unemployment rate level of GDP.

(C) an upward-sloping short-run aggregate supply curve and a vertical long-run supply curve at the
full-employment level of GDP.

(D) a vertical short-run aggregate supply curve at the full-employment level of GDP and an
upward0sloping long-run supply curve.

Answer : (C)

23.

Consider Figure 6-2. If the price level turns out to be lower than expected, it would result in a
movement from

(A) A to B.

(B) B to A.

(C) C to A.

(D) D to B.

Answer : (A)
24.

Consider Figure 6-2. A decrease in the cost of productive inputs would lead to a movement from

(A) A to B.

(B) D to C.

(C) A to C.

(D) D to B.

Answer : (C)

25.

Consider Figure 6-2. An increase in uncertainty would lead to a movement from

(A) A to B.
(B) D to C.

(C) A to C.

(D) D to B.

Answer : (D)

26.

Consider Figure 6-3. The situation in Noprovia is represented by SRAS1 and AD1. The long-run
equilibrium real GDP and price level for the economy is represented by point

(A) E.

(B) B.

(C) A.

(D) D.

Answer : (B)
27.

Consider Figure 6-3. The situation in Trombli is characterized by SRAS1 and AD1 when there is an
increase in the money supply shifting the short-run aggregate supply curve to SRAS2. This will
create in the economy.

(A) a depression

(B) recessionary pressure

(C) stagflationary pressure

(D) inflationary pressure

Answer : (D)

28.
Consider the figure representing the current economic situation in Tilantia. The economy of Tilantia
is currently in short-run equilibrium and is thereby experiencing a(n)

(A) inflationary gap.

(B) recessionary gap.

(C) resource gap.

(D) overheated economy.

Answer : (B)

TRUEFALSE

29. The interest rate increases, so Enery reduces his consumption expenditures. This is an example
of the Pigou effect.

(A) True (B)

False

Answer : (B)

30. An output gap exists in an economy when there is a difference between the actual level of real
GDP and the economy's potential real GDP.

(A) True

(B) False

Answer : (A)

31. Rational expectations refers to the idea that people are adaptive in nature, and once something
happens they will adapt to it.

(A) True (B)

False

Answer : (B)

32. When resource markets are efficient, recessionary gaps close by themselves without any
government intervention.

(A) True

(B) False
Answer : (A)

SHORTANSWER

33. Why does the aggregate demand curve slope downward?Answer : There are three reasons why
the aggregate demand curve slopes downward:

34. What is the logic behind the spending multiplier? Provide an example.Answer : The logic behind
the spending multiplier is relatively simple. For example, suppose the government buys $100 million
worth of Jeeps from Chrysler. What does Chrysler do with the money? It will use part of the $100
million to pay the wages and salaries of its employees. It will use another part of the $100 million to
pay its vendors for parts and stock. Another part will go to bondholders for the use of their financial
capital, and yet another part will go to the government in taxes. All of these entities—Chrysler
employees, Chrysler vendors, Chrysler stockholders and bondholders, and the government—now
have additional ability to spend because their incomes increased. And so, the original $100 million
worth of expenditure gets multiplied into further and further expenditure.

35. Explain how an economy might close a recessionary gap without any government intervention.
Answer : A recessionary gap exists when the actual level of real GDP falls below the economy's
potential level of real GDP. If resource markets are efficient, then resource prices will fall, leading
to a shift to the right in the short-run aggregate supply curve. When the SRAS curve shifts to the
right, it will stimulate real output and close the recessionary gap.