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Macroeconomics Australian 4th Edition Blanchard Test Bank Full Chapter PDF
Macroeconomics Australian 4th Edition Blanchard Test Bank Full Chapter PDF
Name___________________________________
MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.
1) Suppose the central bank implements expansionary monetary policy. Which of the following will 1)
occur in the short run?
A) An increase in output.
B) A decrease in unemployment.
C) An increase in the price level.
D) A decrease in the interest rate.
E) All of the above.
Answer: E
Explanation: A)
B)
C)
D)
E)
2) In the aggregate supply relation, the current price level depends in the medium run upon: 2)
A) fiscal policy.
B) business confidence.
C) consumer confidence.
D) monetary policy.
E) the expected price level.
Answer: E
Explanation: A)
B)
C)
D)
E)
3) Suppose the economy is operating at a point where output is less than the natural level of output. 3)
Which of the following statements is correct given this information?
A) The employment rate is greater than the natural employment rate.
B) The price level will be higher next period than this period.
C) The price level is less than the expected price level.
D) Workers will revise upwards price expectations.
E) The unemployment rate is less than the natural unemployment rate.
Answer: C
Explanation: A)
B)
C)
D)
E)
1
4) At the current level of output, suppose the actual price level is greater than the price level that 4)
individuals expect. We know that:
A) any subsequent decrease in the aggregate price level will cause an increase in the real money
supply and a rightward shift in the aggregate demand curve.
B) output is currently less than the natural level of output.
C) the interest rate will tend to rise as the economy adjusts to this situation.
D) the AS curve will tend to shift down over time.
E) the nominal wage will tend to decrease as individuals revise their expectations of the price
level.
Answer: C
Explanation: A)
B)
C)
D)
E)
6) The aggregate demand curve has its particular shape because of which of the following 6)
explanations?
A) A decrease in the aggregate price level will cause an increase in the real wage, a decrease in
employment, and a decrease in output.
B) A decrease in the aggregate price level will cause a decrease in the interest rate and an
increase in output.
C) As the aggregate price level increases, goods and services become relatively more expensive
and individuals respond by decreasing the quantity demanded of goods and services.
D) An increase in the money supply will cause an increase in the interest rate, a decrease in
investment, and a decrease in output.
E) An increase in the aggregate price level prompts the government to decrease government
spending in the hope of bringing down prices.
Answer: B
Explanation: A)
B)
C)
D)
E)
2
7) Results obtained from the Taylor model suggest that the output effects of a change in the money 7)
supply are greatest after approximately how long?
A) Three quarters.
B) Two years.
C) Five years.
D) One quarter.
E) One month.
Answer: A
Explanation: A)
B)
C)
D)
E)
8) Suppose the minimum wage decreases. Given this event, we would expect which of the following 8)
to occur?
A) A decrease in the interest rate in the medium run.
B) No change in the real wage in the medium run.
C) A decrease in the aggregate price level and an increase in output in the short run.
D) A decrease in the natural rate of unemployment.
E) All of the above.
Answer: E
Explanation: A)
B)
C)
D)
E)
3
11) Assume that the economy is initially operating at the natural level of output. An increase in the 11)
price of oil will cause which of the following in the medium run?
A) An increase in output and a decrease in the interest rate.
B) A decrease in unemployment, an increase in the nominal wage and an increase in the
aggregate price level.
C) An increase in the interest rate.
D) An increase in the aggregate price level and no change in output.
E) A decrease in output and an increase in the aggregate price level.
Answer: C
Explanation: A)
B)
C)
D)
E)
12) Assume the economy is initially operating at the natural level of output. Now suppose a budget is 12)
passed that calls for a tax cut. This fiscal expansion will, in the short run, cause an increase in:
A) the output level.
B) the price level.
C) the interest rate.
D) the nominal wage.
E) All of the above.
Answer: E
Explanation: A)
B)
C)
D)
E)
13) Assume that the economy is initially operating at the natural level of output. An increase in the 13)
minimum wage will cause:
A) an increase in the nominal wage in the medium run.
B) no change in the real wage in the medium run.
C) an increase in the real wage in the medium run.
D) a decrease in the real wage in the medium run.
E) a decrease in the nominal wage in the medium run.
Answer: B
Explanation: A)
B)
C)
D)
E)
4
14) Which of the following will cause the aggregate demand curve to shift to the right? 14)
A) A decrease in taxes.
B) A decrease in the money supply.
C) A decrease in consumer confidence.
D) A decrease in the price level.
E) An increase in the price level.
Answer: A
Explanation: A)
B)
C)
D)
E)
15) Suppose that the current price level is equal to the expected price level. Given this information, we 15)
know with certainty that:
A) the unemployment rate is equal to the natural rate of unemployment.
B) only the goods market is in equilibrium.
C) the goods market and financial markets are in equilibrium.
D) the unemployment rate is zero.
E) both the price level and the expected price level are equal to one.
Answer: A
Explanation: A)
B)
C)
D)
E)
16) Assume that the economy is initially operating at the natural level of output. When the central bank 16)
controls the interest rate, an increase in the price target will cause:
A) a decrease in the interest rate in the medium run.
B) an increase in investment in the medium run.
C) an increase in consumption in the medium run.
D) no change in the nominal wage in the medium run.
E) no change in the real wage in the medium run.
Answer: E
Explanation: A)
B)
C)
D)
E)
5
17) For this question, assume that the economy is initially operating at the natural level of output. A 17)
fiscal contraction must cause:
A) an increase in investment in the short run.
B) a decrease in investment in the short run.
C) no change in investment in the medium run.
D) no change in investment in the short run.
E) an increase in investment in the medium run.
Answer: E
Explanation: A)
B)
C)
D)
E)
18) Assume the economy is initially operating at the natural level of output. Suppose that individuals 18)
decide to increase their saving. We know that this increased desire to save will be "neutral" in:
A) both the short run and the medium run.
B) the short run, but not the medium run.
C) the medium run and the long run.
D) neither the medium run nor the short run.
E) the medium run, but not the long run.
Answer: D
Explanation: A)
B)
C)
D)
E)
19) Results obtained from the Taylor model suggest that it takes roughly how long for the effects of 19)
money to become neutral?
A) Ten years.
B) Three months.
C) One year.
D) One month.
E) Four years.
Answer: E
Explanation: A)
B)
C)
D)
E)
6
20) Assume that the economy is initially operating at the natural level of output. A decrease in 20)
consumer confidence will cause:
A) an increase in investment in the short run.
B) a decrease in investment in the short run.
C) an increase in the interest rate in the medium run.
D) an increase in investment in the medium run.
E) a decrease in the real wage in the medium run.
Answer: D
Explanation: A)
B)
C)
D)
E)
21) The aggregate demand curve has its particular shape because of which of the following 21)
explanations?
A) A decrease in the aggregate price level will cause an increase in the interest rate and an
increase in output.
B) An increase in the aggregate price level prompts the government to decrease government
spending in the hope of bringing down prices.
C) An increase in the money supply will cause a decrease in the interest rate, an increase in
investment, and an increase in output.
D) As the aggregate price level increases, goods and services become relatively more expensive
and individuals respond by decreasing the quantity demanded of goods and services.
E) A decrease in the aggregate price level will cause an increase in the real wage, a decrease in
employment, and a decrease in output.
Answer: C
Explanation: A)
B)
C)
D)
E)
22) Assume the economy is initially operating at the natural level of output. Now suppose a budget is 22)
passed that calls for a decrease in government spending. This fiscal contraction will, in the medium
run, have no effect on which of the following?
A) Output and the interest rate.
B) The price level and the interest rate.
C) Output and consumption.
D) Unemployment and investment.
E) The interest rate and unemployment.
Answer: C
Explanation: A)
B)
C)
D)
E)
7
23) In the aggregate demand relation, an increase in the price level causes output to decrease because 23)
of its effect on:
A) government spending.
B) firms' markup over labour costs.
C) the interest rate.
D) the expected price level.
E) the nominal wage.
Answer: C
Explanation: A)
B)
C)
D)
E)
24) Assume the economy is initially operating at the natural level of output. Now suppose a budget is 24)
passed that calls for a tax cut. This fiscal expansion will, in the medium run, have no effect on
which of the following?
A) Output and the interest rate.
B) The interest rate and unemployment.
C) The price level and the interest rate.
D) Unemployment and the price level.
E) Output and investment.
Answer: D
Explanation: A)
B)
C)
D)
E)
25) Assume that the economy is initially operating at the natural level of output. When the central bank 25)
raises the price target, the subsequent one-time 20% increase in the nominal money supply will
cause:
A) a 20% increase in the interest rate in the medium run.
B) a 20% increase in output in the medium run.
C) a 20% increase in the real wage in the medium run.
D) a 20% increase in the price level in the medium run.
E) a 20% increase in the real money supply in the medium run.
Answer: D
Explanation: A)
B)
C)
D)
E)
8
26) Which of the following represents the medium-run effects of an increase in the price of oil? 26)
A) No change in the level of output.
B) No change in employment.
C) No change in the price level.
D) No change in the interest rate.
E) A decrease in the interest rate.
Answer: C
Explanation: A)
B)
C)
D)
E)
27) At the current level of output, suppose the actual price level is less than the price level that 27)
individuals expect. We know that:
A) any subsequent increase in the aggregate price level will cause a decrease in the real money
supply and a leftward shift in the aggregate demand curve.
B) the AS curve will tend to shift down over time.
C) output is currently greater than the natural level of output.
D) the nominal wage will tend to increase as individuals revise their expectations of the price
level.
E) the interest rate will tend to rise as the economy adjusts to this situation.
Answer: B
Explanation: A)
B)
C)
D)
E)
28) When the central bank controls the interest rate, a rise in the price target will, in the short run, 28)
cause:
A) the wage setting curve to shift upward.
B) the wage setting curve to shift downward.
C) an increase in the nominal wage.
D) the AD curve to shift leftward.
E) the price setting curve to shift down.
Answer: C
Explanation: A)
B)
C)
D)
E)
9
29) Assume the economy is initially operating at the natural level of output. Now suppose that 29)
individuals decide to increase their desire to save. We know with certainty which of the following
will occur in the short run as a result of the increased desire to save?
A) Higher investment.
B) An increase in the nominal wage.
C) No change in the economy at all.
D) A decrease in the nominal wage.
E) Lower investment.
Answer: D
Explanation: A)
B)
C)
D)
E)
30) Assume the economy is initially operating at the natural level of output. Which of the following 30)
events will not change the composition of output in the medium run?
A) A decrease in taxes.
B) An increase in government spending.
C) An increase in consumer confidence.
D) An increase in the price target set by the central bank.
E) A decrease in firm confidence.
Answer: D
Explanation: A)
B)
C)
D)
E)
31) Which of the following represents the short-run effects of an increase in the price of oil? 31)
A) An increase in the interest rate.
B) A decrease in output.
C) An increase in the price level.
D) An increase in unemployment.
E) All of the above.
Answer: E
Explanation: A)
B)
C)
D)
E)
10
32) The aggregate supply curve has its particular shape because of which of the following 32)
explanations?
A) An increase in the nominal wage causes a decrease in the amount of output that firms are
willing to produce.
B) An increase in the aggregate price level will cause an increase in the interest rate and a
decrease in output.
C) An increase in output causes an increase in employment, a decrease in unemployment, an
increase in the nominal wage and an increase in the price level.
D) A decrease in output causes a decrease in employment, a decrease in unemployment, an
increase in the nominal wage and an increase in the price level.
E) A decrease in the aggregate price level causes a decrease in nominal money demand and a
decrease in the interest rate.
Answer: C
Explanation: A)
B)
C)
D)
E)
33) Which of the following events will not cause a decrease in the aggregate price level? 33)
A) A decrease in markup.
B) A decrease in output.
C) A decrease in unemployment benefits.
D) A decrease in unemployment.
E) A decrease in expected prices.
Answer: D
Explanation: A)
B)
C)
D)
E)
34) Which of the following represents the medium-run effect of an increase in the price target? 34)
A) An increase in the price level.
B) An increase in the real money supply.
C) An increase in the real wage.
D) An increase in output.
E) An increase in the interest rate.
Answer: A
Explanation: A)
B)
C)
D)
E)
11
35) Assume that the economy is initially operating at the natural level of output. A simultaneous 35)
increase in taxes and a decrease in the price target by the central bank will cause which of the
following?
A) A reduction in investment in the medium run.
B) An increase in the aggregate price level, no change in output, and no change in the interest
rate in the medium run.
C) An increase in output and an increase in the aggregate price level in the short run.
D) A reduction in the interest rate in the medium run.
E) A decrease in output and a decrease in the nominal wage in the short run.
Answer: E
Explanation: A)
B)
C)
D)
E)
36) A decrease in the price of oil will tend to cause which of the following? 36)
A) An increase in the aggregate price level as output increases.
B) No change in the interest rate in the medium run.
C) No change in the real wage in the medium run.
D) An increase in investment in the medium run.
E) An increase in the natural rate of unemployment.
Answer: D
Explanation: A)
B)
C)
D)
E)
37) Assume the economy is initially operating at the natural level of output. Which of the following 37)
events will initially cause a shift of the aggregate supply curve?
A) An increase in the price target.
B) A decrease in the money supply.
C) An increase in the minimum wage.
D) An increase in government spending.
E) An increase in taxes.
Answer: C
Explanation: A)
B)
C)
D)
E)
12
38) Based on your understanding of the AS-AD model, which of the following is an incorrect 38)
statement about the short-run adjustment process for the macroeconomy?
A) A decrease in output decreases employment.
B) Output in excess of the natural level leads to higher prices.
C) An increase in demand increases output.
D) An increase in unemployment leads to higher prices.
E) A decrease in output below the natural level leads to lower nominal wages.
Answer: D
Explanation: A)
B)
C)
D)
E)
39) Assume that the economy is initially operating at the natural level of output. An increase in 39)
government spending will cause:
A) an increase in the real wage in the medium run.
B) no change in the real wage in the medium run.
C) a decrease in the real wage in the medium run.
D) an increase in the nominal wage in the medium run.
E) a decrease in the nominal wage in the medium run.
Answer: B
Explanation: A)
B)
C)
D)
E)
40) Using the AS-AD model, which of the following would cause an increase in the natural level of 40)
output in the medium run?
A) An increase in the money supply.
B) An increase in government spending.
C) A decrease in the oil price.
D) An increase in the price target.
E) A decrease in consumer confidence.
Answer: C
Explanation: A)
B)
C)
D)
E)
13
41) An increase in the aggregate price level will cause: 41)
A) a decrease in the interest rate and a rightward shift in the IS curve.
B) a decrease in the interest rate and a downward shift in the LM curve.
C) an increase in the interest rate and a leftward shift in the IS curve.
D) an increase in investment and an increase in output.
E) an increase in the interest rate and an upward shift in the LM curve.
Answer: E
Explanation: A)
B)
C)
D)
E)
42) Assume that the economy is initially operating at the natural level of output. An increase in taxes 42)
will cause which of the following?
A) A decrease in employment and no change in the nominal wage in the short run.
B) A decrease in output and no change in the aggregate price level in the short run.
C) An increase in the aggregate price level, no change in output and no change in the interest
rate in the medium run.
D) An increase in the interest rate and investment in the medium run.
E) An increase in investment in the medium run.
Answer: E
Explanation: A)
B)
C)
D)
E)
43) The neutrality of money is consistent with which of the following statements? 43)
A) Changes in the money supply will not affect wages in the medium run.
B) Changes in the money supply will not affect employment in the short run.
C) Changes in the money supply will not affect employment in the medium run.
D) Changes in the money supply will not affect the price level in the short run.
E) Changes in the money supply will not affect the price level in the medium run.
Answer: C
Explanation: A)
B)
C)
D)
E)
44) Results obtained from the Taylor model suggest that the effects of changes in the nominal money 44)
supply are neutral after:
A) 2 years. B) 4 years. C) 10 years. D) 6 years. E) 8 years.
Answer: B
Explanation: A)
B)
C)
D)
E)
14
45) Which of the following events will cause the largest rightward shift (as measured horizontally) of 45)
the AD curve?
A) A 15% decrease in the aggregate price level.
B) A 15% decrease in the nominal wage.
C) A tax increase.
D) A 15% increase in the nominal money supply.
E) A decrease in government spending.
Answer: D
Explanation: A)
B)
C)
D)
E)
46) Which of the following would increase the short-run output effects of a monetary expansion? 46)
A) A decrease in the marginal propensity to save.
B) The slope of the IS curve is very flat.
C) An increase in the marginal propensity to consume.
D) An increase in the interest rate sensitivity of investment.
E) All of the above.
Answer: E
Explanation: A)
B)
C)
D)
E)
47) As product markets become less competitive and the markup rises, we would expect which of the 47)
following to occur?
A) A decrease in the interest rate in the medium run.
B) An increase in the aggregate price level as output increases.
C) A decrease in the real wage in the medium run.
D) No change in the real wage in the medium run.
E) No change in output in the medium run.
Answer: C
Explanation: A)
B)
C)
D)
E)
15
48) Assume that the economy is initially operating at the natural level of output. An increase in firm 48)
confidence will cause:
A) no change in the real wage in the medium run.
B) an increase in the nominal wage in the medium run.
C) a decrease in the real wage in the medium run.
D) an increase in the real wage in the medium run.
E) a decrease in the nominal wage in the medium run.
Answer: A
Explanation: A)
B)
C)
D)
E)
49) At the current level of output, suppose the actual price level is less than the price level that 49)
individuals expect. We know that:
A) the AS curve will tend to shift up over time.
B) output is currently less than the natural level of output.
C) the interest rate will tend to rise as the economy adjusts to this situation.
D) the nominal wage will tend to increase as individuals revise their expectations of the price
level.
E) any subsequent decrease in the aggregate price level will cause an increase in the real money
supply and a rightward shift in the aggregate demand curve.
Answer: B
Explanation: A)
B)
C)
D)
E)
50) Which of the following events will cause an increase in the aggregate price level? 50)
A) An increase in unemployment benefits.
B) An increase in the unemployment rate.
C) A decrease in expected prices.
D) A decrease in markup.
E) A decrease in output.
Answer: A
Explanation: A)
B)
C)
D)
E)
16
51) Assume the economy is initially operating at the natural level of output. Now suppose a budget is 51)
passed that calls for a decrease in government spending. This fiscal contraction will, in the short
run, cause a decrease in:
A) the output level.
B) the price level.
C) the nominal wage.
D) the interest rate.
E) All of the above.
Answer: E
Explanation: A)
B)
C)
D)
E)
52) The aggregate supply curve will shift downward when which of the following occurs? 52)
A) A decrease in firm's markup over labour costs.
B) A decrease in the expected price level.
C) A decrease in the level of employment protection.
D) A decrease in unemployment benefits.
E) All of the above.
Answer: E
Explanation: A)
B)
C)
D)
E)
53) An increase in the price of oil will tend to cause which of the following in the short run? 53)
A) An increase in the interest rate.
B) An increase in the natural rate of unemployment.
C) A decrease in output.
D) An increase in the price level.
E) All of the above.
Answer: E
Explanation: A)
B)
C)
D)
E)
17
54) Which of the following events would cause a shift in the aggregate supply curve in the short run? 54)
A) An increase in the money supply.
B) A decrease in government spending.
C) A decrease in consumer confidence.
D) An increase in taxes.
E) An increase in the markup.
Answer: E
Explanation: A)
B)
C)
D)
E)
55) From the mid-1990s to the end of 2008, the real oil price: 55)
A) steadily increased.
B) steadily decreased.
C) decreased dramatically, then increased dramatically.
D) remained more or less the same.
E) increased dramatically, then decreased dramatically.
Answer: A
Explanation: A)
B)
C)
D)
E)
ESSAY. Write your answer in the space provided or on a separate sheet of paper.
18
57) Based on your understanding of the AS-AD model and the IS-LM model, graphically illustrate and explain
what effect a tax increase will have on the economy. In your graphs, clearly illustrate the short-run and
medium-run equilibria.
Answer: A tax increase causes a decrease in consumption and a leftward shift in both the IS and AD curves. As
demand and production decrease, firms reduce employment. This causes a rise in unemployment and a
decrease in the nominal wage. As the nominal wage decreases, firms' costs fall and they lower prices.
Expectations of prices in turn become lower and this continually shifts the AS curve downwards. As
prices fall, the central bank lowers the interest rate according to the interest rate rule. Since the central
bank has not changed its price target, the central bank realises in the medium run that they must lower
the natural rate of interest to avoid prices falling further away from the (unchanged) price target. This
will bring back the AD to its original position so that the economy returns to the equilibrium point with
the same natural level of output and price target. In the medium run, the composition of the output is
different as investment is higher to offset the initial contractionary effect of the tax increase, and the
natural interest rate is permanently lower. In the IS-LM model, following the initial leftward shift in the
IS curve as a result of the tax increase, LM curve continues to shift down as the central bank cuts the
interest rate. This process continues when the price level returns to the price target and output returns to
the natural level of output.
58) Suppose the economy is operating at a point where output is greater than the natural level of output. Given this
information, is the actual price level equal to the expected price level at the current level of output?
Answer: When output is operating at the natural level, Y = Y n, we know that the actual and expected price level
are equal, P = Pe. When output exceeds the natural level of output, Y > Y n, we know that the price level
must have risen above the expected price level, P > Pe. This is because when Y > Yn, current
unemployment is below the natural rate of unemployment, u < un. This puts upward pressure on the
nominal wage and therefore prices would rise above its current expected level.
59) Based on your understanding of the AS-AD model and the IS-LM model, graphically illustrate and explain
what effect an increase in the minimum wage will have on the economy. In your graph, clearly illustrate the
short-run and medium-run equilibria. Also include in your answer an explanation of the effects of this change
in minimum wage on the labour market and the equilibrium real wage.
Answer: The increase in the minimum wage is represented by a rightward shift in the WS curve. This also causes
the natural rate of unemployment to increase and the natural levels of employment and output to
decrease. In the AS-AD graph, the AS curve shifts up and prices rise in the short run. As actual prices
rise, the central bank raises the interest rate as indicated by the interest rate rule which leads to decreases
in investment. Demand decreases and firms decrease production. In the medium run, given that current
output is higher than its natural level, prices are above its expected level, workers revise upwards
expectations and the AS curve shifts further up. The adjustment process continues until the central bank
realises, in the medium run, the need to raise the natural interest rate to lower actual prices back to the
price target. The AD curve therefore shifts left quickly to arrive at a new medium-run equilibrium point
with the same price target and a lower natural level of output. In the medium run, the real wage stays the
same, the natural rate of unemployment is higher, the interest rate is higher, and output lower. In the
IS-LM model, the LM curve continues to shift upward as the central bank raises the interest rate. This
process continues until the price level equals the price target and output reaches the new level of natural
output.
19
60) When output exceeds the natural level of output, explain what adjustments will occur in the labour market and
discuss what effect they will have on output and the price level.
Answer: When output exceeds the natural level of output, Y > Y n, we know that the price level must have risen
above the expected price level, P > Pe. This is because when Y > Yn, current unemployment is below the
natural rate of unemployment, u < un. This puts upward pressure on the nominal wage and therefore
prices would rise above its current expected level. At some point, wage setters realise that the actual price
level has increased and would adjust their price expectations upward. When this occurs, the nominal
wage becomes higher and firms face higher costs. When this occurs, the aggregate price level will rise. As
prices rise, the central bank raises the interest rate as indicated by the interest rate rule, which leads to
falls in real money supply. As the interest rate increases, investment, demand, and output decrease.
61) Explain what the aggregate demand curve represents and why it is downward sloping. Give explanations about
the aggregate demand curve under each of the two possible assumptions about the central bank's conduct of
monetary policy: (1) that the central bank controls the nominal money supply; (2) that the central bank controls
the interest rate and has a price target.
Answer: The aggregate demand (AD) curve captures the effects of the price level on output. Alternatively, the AD
curve represents the combinations of prices (P) and output (Y) that maintain equilibrium in the goods
and financial markets. In (1), as P falls, the real money supply increases causing a decrease in the interest
rate. The fall in the interest rate causes an increase in investment, an increase in demand, and an increase
in production. So, the fall in P causes an increase in Y and the AD curve is downward sloping. In (2), as P
falls, the interest rate rule states that the central bank should lower the interest rate. The central bank
proceeds to conduct open market purchases of bonds to expand the money supply in order to lower the
interest rate. The fall in the interest rate causes an increase in investment, an increase in demand, and an
increase in production. So, the fall in P causes an increase in Y and the AD curve is downward sloping.
62) Explain what effect an increase in the price target has on the aggregate demand curve.
Answer: An increase in the price target, as dictated by the interest rate rule, calls for the interest rate to fall. The
central bank conducts open market purchases of bonds to increase the money supply, which causes the
LM curve to shift down and the interest rate to fall. As the interest rate falls, investment and demand will
increase. Firms will respond to the increase in demand by expanding production. Therefore, the increase
in the price target will lead to a rightward shift in the AD curve.
63) Analysis of the macroeconomic effects of changes in the money supply indicates that money is "neutral" in the
medium run. Suppose there is an increase in government spending. Will this fiscal policy action also be neutral
in the medium run? Explain.
Answer: Changes in government spending or taxes are not neutral in the medium run. Despite the fact that output
returns to its original level, two other real variables are affected by fiscal policy in the medium run: the
(real) interest rate and investment. Specifically in the case of an increase in government spending, the
interest rate will be higher leading to lower investment in the medium run. So, changes in government
spending, while causing some real variables to return to their original levels, also lead to changes in some
other real variables.
64) Explain what the aggregate supply curve represents and why it is upward sloping.
Answer: The AS curve illustrates the effects of output on the price level and is derived from the behaviour of
wages and prices as determined by wage-setting and price-setting behaviour. An increase in output
requires firms to increase employment. An increase in employment causes a decrease in the
unemployment rate. As the unemployment rate decreases, workers have more bargaining power so the
nominal wage will rise. The increase in the nominal wage will cause an increase in firms' costs. As firms'
costs rise, they will increase the prices as determined by price-setting behaviour. So, an increase in
output leads to an increase in prices.
20
65) Based on your understanding of the AS-AD model and IS-LM model, graphically illustrate and explain what
effect a decrease in the price of oil will have on the economy. In your graphs, clearly illustrate the short-run and
medium-run equilibria. Also include in your answer an explanation of the effects of this change in the price of
oil on the labour market and the equilibrium real wage.
Answer: The effect of a fall in the price of oil is captured by a decrease in the markup. A lower markup causes the
PS curve to shift up as firms cut prices and cause the real wage to rise. This also causes the natural rate of
unemployment to fall and the natural levels of employment and output to increase. In the AS-AD graph,
we observe lower prices and a downward shift in the AS curve. As prices fall, the central bank lowers the
interest rate as instructed by the interest rate rule which leads to an increase in investment. Demand
increases and firms increase production. The standard adjustment process occurs until the central bank
realises, in the medium run, the need to lower the natural interest rate to return the actual price level to
the price target. The AD curve therefore shifts up quickly to arrive at a new medium-run equilibrium
point which gives the same price target and a higher natural level of output. In the medium run, the real
wage is higher, the unemployment rate is lower, the interest rate is lower, and output higher. In the
IS-LM model, the LM curve continues to shift down as the central bank lowers the interest rate. This
process comes to an end when the price level returns to the price target and output reaches the new
natural level of output.
66) Discuss the possible explanations as to why the oil price effect on inflation and output has been muted in the
2000s compared to the 1970s.
Answer: (i) the potency of the adverse aggregate supply shock was weaker in the 2000s.
(ii) the bargaining power of workers has been weakened partly due to globalisation and foreign
competition. This meant that workers have been more willing to accept a reduction in wages than their
counterpart in the 1970s, thus limiting the oil price effect on inflation and output.
(iii) the better anchoring of inflation expectations through monetary policy has limited the oil price effect
as the general public have higher confidence in the ability of the central banks in containing potential
inflation rises.
67) Explain how an increase in each of the following variables affects the aggregate price level: (i) the expected price
level; (ii) employment; (iii) the markup; and (iv) unemployment benefits.
Answer: (i) An increase in the expected price level will cause wage setters to seek a higher nominal wage (W). As
W increases, firms' costs rise and they will set their prices higher (as a markup over the higher W). So, P
will rise as the expected price level increases.
(ii) Higher output and therefore employment lower unemployment, which gives workers more
bargaining power to seek higher nominal wages. Firms in turn pay the higher nominal wage in
equilibrium and set their prices higher accordingly.
(iii) An increase in the markup means that firms are setting prices even higher over given costs which
leads to an increase in the price level.
(iv) An increase in unemployment benefits will cause the wage-setting curve to shift up and cause wage
setters to seek a higher nominal wage. As W rises, firms raise the price they charge their customers since
their costs become higher.
21
68) Based on your understanding of the AS-AD model and the IS-LM model, graphically illustrate and explain
what effect a decrease in the price target will have on the economy. In your graphs, clearly illustrate the
short-run and medium-run equilibria.
Answer: As the central bank reduces the price target, PT, the interest rate rule indicates that the central bank
should raise the interest rate. The central bank conducts open market sales of bonds which lead to the LM
curve shifting up and the AD curve shifting to the left. As demand falls, firms hire less workers, as a
result, employment decreases and unemployment increases. The nominal wage falls causing the price
level to decrease. Price expectations adjust downward over time causing the nominal wage to fall and the
AS curve shifts downward. As prices decrease, the central bank lowers the interest rate, which has the
effect of shifting the LM curve downward. The economy moves along the AD curve until the economy
returns to the natural level of output and the new price target. All real variables will return to their initial
levels, e.g., output and the (real) interest rate. Only nominal variables will be affected by this monetary
contraction, e.g., lower prices in the medium run as dictated by the lower price target. There is monetary
neutrality in the medium run.
22
Answer Key
Testname: C7
1) E
2) E
3) C
4) C
5) E
6) B
7) A
8) E
9) D
10) D
11) C
12) E
13) B
14) A
15) A
16) E
17) E
18) D
19) E
20) D
21) C
22) C
23) C
24) D
25) D
26) C
27) B
28) C
29) D
30) D
31) E
32) C
33) D
34) A
35) E
36) D
37) C
38) D
39) B
40) C
41) E
42) E
43) C
44) B
45) D
46) E
47) C
48) A
49) B
50) A
23
Answer Key
Testname: C7
51) E
52) E
53) E
54) E
55) A
56) The neutrality of money refers to the medium-run effects of changes in the nominal money supply. Specifically,
changes in the nominal money supply have no medium-run effects on any real variables. In the medium run, only
nominal variables, e.g., the nominal wage and the price level, change as a result of changes in the nominal money
supply (note here that the interest rate is essentially the same as the real interest rate given zero inflation). Because changes in
the nominal money supply have no effects on real variables in the medium run, money is said to be neutral.
57) A tax increase causes a decrease in consumption and a leftward shift in both the IS and AD curves. As demand and
production decrease, firms reduce employment. This causes a rise in unemployment and a decrease in the nominal
wage. As the nominal wage decreases, firms' costs fall and they lower prices. Expectations of prices in turn become
lower and this continually shifts the AS curve downwards. As prices fall, the central bank lowers the interest rate
according to the interest rate rule. Since the central bank has not changed its price target, the central bank realises in the
medium run that they must lower the natural rate of interest to avoid prices falling further away from the (unchanged)
price target. This will bring back the AD to its original position so that the economy returns to the equilibrium point
with the same natural level of output and price target. In the medium run, the composition of the output is different as
investment is higher to offset the initial contractionary effect of the tax increase, and the natural interest rate is
permanently lower. In the IS-LM model, following the initial leftward shift in the IS curve as a result of the tax
increase, LM curve continues to shift down as the central bank cuts the interest rate. This process continues when the
price level returns to the price target and output returns to the natural level of output.
58) When output is operating at the natural level, Y = Y n, we know that the actual and expected price level are equal, P =
Pe. When output exceeds the natural level of output, Y > Yn, we know that the price level must have risen above the
expected price level, P > Pe. This is because when Y > Yn, current unemployment is below the natural rate of
unemployment, u < un. This puts upward pressure on the nominal wage and therefore prices would rise above its
current expected level.
59) The increase in the minimum wage is represented by a rightward shift in the WS curve. This also causes the natural
rate of unemployment to increase and the natural levels of employment and output to decrease. In the AS-AD graph,
the AS curve shifts up and prices rise in the short run. As actual prices rise, the central bank raises the interest rate as
indicated by the interest rate rule which leads to decreases in investment. Demand decreases and firms decrease
production. In the medium run, given that current output is higher than its natural level, prices are above its expected
level, workers revise upwards expectations and the AS curve shifts further up. The adjustment process continues until
the central bank realises, in the medium run, the need to raise the natural interest rate to lower actual prices back to the
price target. The AD curve therefore shifts left quickly to arrive at a new medium-run equilibrium point with the same
price target and a lower natural level of output. In the medium run, the real wage stays the same, the natural rate of
unemployment is higher, the interest rate is higher, and output lower. In the IS-LM model, the LM curve continues to
shift upward as the central bank raises the interest rate. This process continues until the price level equals the price
target and output reaches the new level of natural output.
60) When output exceeds the natural level of output, Y > Y n, we know that the price level must have risen above the
expected price level, P > Pe. This is because when Y > Yn, current unemployment is below the natural rate of
unemployment, u < un. This puts upward pressure on the nominal wage and therefore prices would rise above its
current expected level. At some point, wage setters realise that the actual price level has increased and would adjust
their price expectations upward. When this occurs, the nominal wage becomes higher and firms face higher costs.
When this occurs, the aggregate price level will rise. As prices rise, the central bank raises the interest rate as indicated
by the interest rate rule, which leads to falls in real money supply. As the interest rate increases, investment, demand,
and output decrease.
24
Answer Key
Testname: C7
61) The aggregate demand (AD) curve captures the effects of the price level on output. Alternatively, the AD curve
represents the combinations of prices (P) and output (Y) that maintain equilibrium in the goods and financial markets.
In (1), as P falls, the real money supply increases causing a decrease in the interest rate. The fall in the interest rate
causes an increase in investment, an increase in demand, and an increase in production. So, the fall in P causes an
increase in Y and the AD curve is downward sloping. In (2), as P falls, the interest rate rule states that the central bank
should lower the interest rate. The central bank proceeds to conduct open market purchases of bonds to expand the
money supply in order to lower the interest rate. The fall in the interest rate causes an increase in investment, an
increase in demand, and an increase in production. So, the fall in P causes an increase in Y and the AD curve is
downward sloping.
62) An increase in the price target, as dictated by the interest rate rule, calls for the interest rate to fall. The central bank
conducts open market purchases of bonds to increase the money supply, which causes the LM curve to shift down and
the interest rate to fall. As the interest rate falls, investment and demand will increase. Firms will respond to the
increase in demand by expanding production. Therefore, the increase in the price target will lead to a rightward shift
in the AD curve.
63) Changes in government spending or taxes are not neutral in the medium run. Despite the fact that output returns to its
original level, two other real variables are affected by fiscal policy in the medium run: the (real) interest rate and
investment. Specifically in the case of an increase in government spending, the interest rate will be higher leading to
lower investment in the medium run. So, changes in government spending, while causing some real variables to return
to their original levels, also lead to changes in some other real variables.
64) The AS curve illustrates the effects of output on the price level and is derived from the behaviour of wages and prices
as determined by wage-setting and price-setting behaviour. An increase in output requires firms to increase
employment. An increase in employment causes a decrease in the unemployment rate. As the unemployment rate
decreases, workers have more bargaining power so the nominal wage will rise. The increase in the nominal wage will
cause an increase in firms' costs. As firms' costs rise, they will increase the prices as determined by price-setting
behaviour. So, an increase in output leads to an increase in prices.
65) The effect of a fall in the price of oil is captured by a decrease in the markup. A lower markup causes the PS curve to
shift up as firms cut prices and cause the real wage to rise. This also causes the natural rate of unemployment to fall
and the natural levels of employment and output to increase. In the AS-AD graph, we observe lower prices and a
downward shift in the AS curve. As prices fall, the central bank lowers the interest rate as instructed by the interest rate
rule which leads to an increase in investment. Demand increases and firms increase production. The standard
adjustment process occurs until the central bank realises, in the medium run, the need to lower the natural interest rate
to return the actual price level to the price target. The AD curve therefore shifts up quickly to arrive at a new
medium-run equilibrium point which gives the same price target and a higher natural level of output. In the medium
run, the real wage is higher, the unemployment rate is lower, the interest rate is lower, and output higher. In the IS-LM
model, the LM curve continues to shift down as the central bank lowers the interest rate. This process comes to an end
when the price level returns to the price target and output reaches the new natural level of output.
66) (i) the potency of the adverse aggregate supply shock was weaker in the 2000s.
(ii) the bargaining power of workers has been weakened partly due to globalisation and foreign competition. This
meant that workers have been more willing to accept a reduction in wages than their counterpart in the 1970s, thus
limiting the oil price effect on inflation and output.
(iii) the better anchoring of inflation expectations through monetary policy has limited the oil price effect as the general
public have higher confidence in the ability of the central banks in containing potential inflation rises.
25
Answer Key
Testname: C7
67) (i) An increase in the expected price level will cause wage setters to seek a higher nominal wage (W). As W increases,
firms' costs rise and they will set their prices higher (as a markup over the higher W). So, P will rise as the expected
price level increases.
(ii) Higher output and therefore employment lower unemployment, which gives workers more bargaining power to
seek higher nominal wages. Firms in turn pay the higher nominal wage in equilibrium and set their prices higher
accordingly.
(iii) An increase in the markup means that firms are setting prices even higher over given costs which leads to an
increase in the price level.
(iv) An increase in unemployment benefits will cause the wage-setting curve to shift up and cause wage setters to seek
a higher nominal wage. As W rises, firms raise the price they charge their customers since their costs become higher.
68) As the central bank reduces the price target, PT, the interest rate rule indicates that the central bank should raise the
interest rate. The central bank conducts open market sales of bonds which lead to the LM curve shifting up and the AD
curve shifting to the left. As demand falls, firms hire less workers, as a result, employment decreases and
unemployment increases. The nominal wage falls causing the price level to decrease. Price expectations adjust
downward over time causing the nominal wage to fall and the AS curve shifts downward. As prices decrease, the
central bank lowers the interest rate, which has the effect of shifting the LM curve downward. The economy moves
along the AD curve until the economy returns to the natural level of output and the new price target. All real variables
will return to their initial levels, e.g., output and the (real) interest rate. Only nominal variables will be affected by this
monetary contraction, e.g., lower prices in the medium run as dictated by the lower price target. There is monetary
neutrality in the medium run.
26
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ole veljeni, vaan Smerdjakov (sillä täällä levittivät kaikki sitä satua,
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takaperin minä näin, että hän oli tämän johdosta sairas. Viime
päivinä hän minun luonani istuessaan houraili. Minä huomasin
hänen järkensä menevän sekaisin. Hän houraili kävellessään, hänet
nähtiin tässä tilassa kaduilla. Tänne saapunut tohtori tutki minun
pyynnöstäni häntä toissa päivänä ja sanoi hänen olevan
saamaisillaan kuumeen, — kaikki hänen takiaan, kaikki pedon takia!
Eilen hän sitten sai tietää Smerdjakovin kuolleen, — se vaikutti
häneen niin voimakkaasti, että hän menetti järkensä… ja kaikki tuo
tapahtui pedon takia, kaikki vain siksi, että hän tahtoi pelastaa
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7.
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