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Chapter 7: Aggregate Demand and Aggregate Supply
Multiple Choice
1. When the Great Depression reached its trough in 1933, real GDP had fallen by ________
since the depression began in 1929.
A) 5%
B) 10%
C) 30%
D) 50%
Ans: C
Difficulty: Easy
2. Which of the following is false about potential output?

A) It is the level of output an economy can achieve when labor is employed at its natural level.
B) It is the long run output level that guarantees price stability.
C) It is also called the natural level of real GDP.
D) If a country is producing its potential output, then it is producing at a point on its production
possibilities frontier.
Ans: B
Difficulty: Medium
3. When an economy fails to produce at its potential,

I. there may be actions that the government or the central bank can take to push the economy
toward its potential.
II. the unemployment rate is below its natural rate.
III. the average price level is likely to rise.
A) I, II, and III
B) I and II only
C) I and III only
D) I only
Ans: D
Difficulty: Medium
©2013 Flat World Knowledge, Inc. 2

4. Potential output is
A) the level of real GDP that exists when the economy is experiencing only cyclical and
structural unemployment.
B) the level of real GDP that exists when the quantity of labor supplied is equal to the quantity
of labor demanded.
C) the level of real GDP that exists when the actual rate of unemployment is zero.
D) the level of real GDP that exists when the economy is experiencing only frictional and
cyclical unemployment.
Ans: B
Difficulty: Medium
5. The economy’s potential output corresponds to the level of

A) natural employment.
B) frictional unemployment.
C) structural unemployment.
D) cyclical unemployment.
Ans: A
Difficulty: Medium
6. What are the four sources of aggregate demand?

A) Consumption, private investment, taxes, and expenditures
B) Consumption, private investment, wage increases, and government expenditures
C) Consumption, private investment, expenditures, and net exports
D) Consumption, private investment, government purchases, and net exports
Ans: D
Difficulty: Medium
7. Aggregate demand is defined as

A) the demand for goods and services generated by all sectors in the economy, holding price
level constant.
B) the relationship between the total quantity of goods and services demanded and the price
level, all other determinants of spending unchanged.
C) the relationship between the total quantity of goods and services demanded and the supply of
factors of production, all other determinants of production unchanged.
D) the relationship between the total quantity of goods and services demanded and the income
level, all other determinants of spending unchanged.
Ans: B
Difficulty: Easy

8. A graph that depicts the relationship between the total quantity of goods and services
demanded and the price level is the
A) aggregate demand curve.
B) average price level.
C) circular flow model.
D) GDP curve.
Ans: A
Difficulty: Easy
9. Aggregate demand is the total value of real GDP that

A) all sectors of the economy are willing to purchase at various average price levels, all other
things unchanged.
B) all sectors of the economy are willing to sell at various average price levels, all other things
unchanged.
C) consumers are willing to purchase at various average price levels, all other things unchanged.
D) consumers are willing to purchase at various national income levels, all other things
unchanged.
Ans: A
Difficulty: Medium
10. A change in the price level, all other things unchanged, causes
A) a movement along the aggregate demand curve.
B) a shift of the aggregate demand curve.
C) both a movement along the aggregate demand curve and a shift in the curve.
D) no change in the value of assets held in the form of money.
Ans: A
Difficulty: Medium
11. According to the wealth effect, if the average price level rises, the value of consumers’
A) real wealth, nominal wealth, and consumption spending fall.
B) nominal wealth and consumption spending fall.
C) real wealth and consumption spending fall.
D) nominal wealth and saving fall.
Ans: C
Difficulty: Medium

12. The aggregate demand curve slopes downward
I. for the same reasons that an ordinary demand curve does.
II. in part because when the price level falls, the real wealth of the public falls, and this
induces people to change their consumption.
III. because as the price level falls, the net export component of aggregate demand increases.
A) I, II, and III
B) II and III
C) II only
D) III only
Ans: C
Difficulty: Medium
13. What is the interest rate effect that explains why the aggregate demand curve slopes
downward?
A) It refers to the effect of changes in the price level on quantity of investment demanded
which in turn affects interest rates.
B) It refers to the effect of interest rates on borrowing which in turn affects consumption
spending.
C) It refers to the effect of changes in the price level on interest rates which in turn affects
the quantity of investment demanded.
D) It refers to the shifts in aggregate demand when interest rates change.
Ans: C
Difficulty: Medium
14. The interest rate effect suggests that the negative slope of the aggregate demand curve results
because changes in the price level affect
A) domestic purchases of foreign goods.
B) the demand for money by households and firms.
C) the real purchasing power of household wealth.
D) the level of income.
Ans: B
Difficulty: Difficult
15. According to the international trade effect, holding everything else unchanged,
A) an increase in net exports shifts the aggregate demand curve to the right.
B) an increase in the domestic price level reduces net exports leading to a movement along the
aggregate demand curve.
C) an increase in the exchange rate shifts the aggregate demand curve to the right.
D) an increase in the price level of foreign goods reduces imports leading to a movement along
the domestic economy’s aggregate demand curve.
Ans: B
Difficulty: Medium
16. All else constant, a lower price level

A) increases imports and decreases exports, resulting in a downward movement along the
economy’s aggregate demand curve.
B) decreases imports and increases exports, resulting in an upward movement along the
C) increases imports and decreases exports, resulting in an upward movement along the
D) decreases imports and increases exports, resulting in a downward movement along the
Ans: D
Difficulty: Medium
17. A movement along the aggregate demand curve is called a

A) change in aggregate demand.
B) change in the aggregate quantity of good and services demanded.
C) determinant of aggregate demand.
D) revealed expenditure on aggregate demand.
Ans: B
Difficulty: Medium
18. A change in the aggregate quantities of goods and services demanded at each price level is
called a
A) change in aggregate demand.
B) change in the aggregate quantity of goods and services demanded.
C) determinant of aggregate demand.
D) revealed expenditure on aggregate demand.
Ans: A
Difficulty: Medium
19. Which of the following will not cause a change in aggregate demand?
A) An increase in consumer wealth
B) An increase in the amount of investment demanded by firms at each price level
C) An increase in an economy’s price level
D) An increase in the price level of a foreign economy
Ans: C
Difficulty: Medium
20. What is the difference between a change in aggregate demand and a change in aggregate
quantity of real GDP demanded?
A) A change in aggregate demand is represented by a movement along the aggregate demand
curve in response to a price change while a change in aggregate quantity of real GDP
demanded is represented by a shift of the aggregate supply curve in response to a change in a
component of aggregate demand.
B) A change in aggregate demand is represented by a shift of the aggregate demand curve in
response to a change in the actual price level while a change in aggregate quantity of real
GDP demanded is represented by a movement along the aggregate demand curve in response
to a change in the expected price level.
C) A change in aggregate demand is represented by a shift of the aggregate demand curve in
response to a change in a component of aggregate demand while a change in aggregate
quantity of real GDP demanded is represented by a movement along the aggregate demand
curve in response to a change in the price level.
D) There is no difference between the two terms.
Ans: C
Difficulty: Medium
Figure 7-1
21. Refer to Figure 7-1. A movement from point A to point B

A) is a change in aggregate demand resulting from a lower price level.
B) is a change in aggregate quantity demanded resulting from a lower price level.
C) could be due to an increase in investment demand.
D) occurs because aggregate output supplied has increased.
Ans: B
Difficulty: Medium
22. Refer to Figure 7-1. What could have caused a movement from point A to point D?
A) Technological advancement
B) An increase in the inflation rate
C) An increase in household wealth
D) A recession in foreign countries
Ans: C
Difficulty: Medium

23. Refer to Figure 7-1. A movement from point B to point E on could be due to
A) an increase in consumer confidence.
B) an increase in the market interest rate.
C) an increase in personal income taxes.
D) a decrease in transfer payments.
Ans: A
Difficulty: Medium
24. Refer to Figure 7-1. What could have caused a movement from point D to point A?
A) An increase in the economy’s general price level
B) A decrease in investment demand due to lower expected sales
C) A decrease in capital gains taxes
D) An increase in money supply that lowers interest rate
Ans: B
Difficulty: Medium
25. Refer to Figure 7-1. What could have caused the aggregate demand curve to shift to the
right from AD1 to AD2?
A) An increase in exports
B) An increase in imports
C) A decrease in defense spending
D) An increase in the domestic price level
Ans: A
Difficulty: Medium
26. All other things unchanged, an increase in personal income tax rates will
A) shift the aggregate demand curve to the right.
B) shift the aggregate demand curve to the left.
C) make the aggregate demand curve flatter.
D) make the aggregate demand curve steeper.
Ans: B
Difficulty: Medium
27. All other things unchanged, an increase in government spending will

C) make the aggregate demand curve flatter.
D) make the aggregate demand curve steeper.
Ans: A
Difficulty: Medium
28. All other things unchanged, an increase in exports relative to imports will
A) cause a movement upward along a given aggregate demand curve.
B) cause a movement downward along a given aggregate demand curve.
C) shift the aggregate demand curve to the right.
D) shift the aggregate demand curve to the left.
Ans: C
Difficulty: Medium
29. Suppose an economy’s exports increase and its imports decrease. All other things
unchanged, this results in
A) a decrease in net exports which will shift the aggregate demand curve to the right.
B) an increase in net exports which will shift the aggregate demand curve to the right.
C) a decrease in net exports which will shift the aggregate supply curve to the left.
D) an increase in net exports which will shift the aggregate supply curve to the right.
Ans: B
Difficulty: Medium
30. Changes in aggregate demand can be caused by changes in

I. wages.
II. raw materials costs.
III. government spending.
IV. government regulations that increase the cost of doing business.
A) I, II, III, and IV
B) I and III only
C) I, III, and IV
D) III only
Ans: D
Difficulty: Medium
31. Suppose households become more future-oriented and decide to save more at each income
level. All other things unchanged, this will
C) not affect aggregate but rather aggregate supply because firms will now produce less.
D) shift both the aggregate demand curve and the aggregate supply curve to the left.
Ans: B
Difficulty: Medium
32. All other things unchanged, a higher exchange rate

A) reduces net exports and aggregate demand.
B) reduces net exports and increases aggregate demand.
C) increases net exports and aggregate demand.
D) increases net exports and reduces aggregate demand.
Ans: A
Difficulty: Medium
33. What happens in the domestic economy when there is an increase in foreign prices, all other
things unchanged?
A) Net exports and aggregate demand fall.
B) Net exports fall and aggregate demand increases.
C) Net exports and aggregate demand increase.
D) Net exports rise and aggregate demand falls.
Ans: C
Difficulty: Medium
34. All other things unchanged, a lower exchange rate

A) increases exports, imports, and aggregate demand.
B) decreases exports, imports, and aggregate demand.
C) increases exports, decreases imports, increases net exports and aggregate demand.
D) decreases exports, increases imports, decreases net exports and aggregate demand.
Ans: C
Difficulty: Medium
35. What happens in the domestic economy when there is a decrease in foreign prices, all other
things unchanged?
A) Net exports and aggregate demand fall.
B) Net exports fall and aggregate demand increases.
C) Net exports and aggregate demand increase.
D) Net exports rise and aggregate demand falls.
Ans: A
Difficulty: Medium
36. Suppose the U.S. government decides to increase its imports from Turkey. All other things
unchanged,
A) U.S. aggregate demand increases and Turkey’s aggregate demand decreases.
B) U.S. aggregate demand decreases and Turkey’s aggregate demand increases.
C) U.S. aggregate demand and Turkey’s aggregate demand increase.
D) U.S. aggregate demand is not affected but Turkey’s aggregate demand increases.
Ans: B
37. How will a recession in the economies of our foreign trading partners affect U.S. aggregate
demand?
A) It will have no effect on our aggregate demand.
B) U.S. aggregate demand will increase.
C) U.S. aggregate demand will decrease.
D) It depends on whether the U.S. offers financial aid to these countries.
Ans: C
Difficulty: Medium

38. Suppose the U.S. experiences a recession while foreign countries that trade with the U.S.
prosper. How will this affect the U.S.?
A) U.S. imports and its aggregate demand will decrease.
B) U.S. net exports and its aggregate demand will decrease.
C) U.S. exports and its aggregate demand will decrease.
D) U.S. exports and its aggregate demand will increase.
Ans: D
Difficulty: Medium
39. The multiplier is given by

A) the ratio of the initial change in a component of aggregate demand to the change in the
quantity of real GDP demanded at each price level.
B) the ratio of the change in the quantity of real GDP demanded at each price level to the initial
change in a component of aggregate demand that produced it.
C) the amount by which the quantity of real GDP demanded at each price level changes in
response to an initial change in a component of aggregate demand.
D) the percentage change between the initial change in a component of aggregate demand and
the final change in the quantity of real GDP demanded at each price level.
Ans: B
Difficulty: Medium

40. Which of the following best explains the multiplier effect as a result of a $100 million
increase in government spending on highways?
A) To fund the government spending, more money must be printed. The resulting increase in
money supply lowers interest rates which in turn stimulates consumption and investment
spending.
B) The initial change in spending will cause an increase in real GDP and it also becomes income
to someone else. As a result, the government’s tax revenue increases which in turn allows the
government to further increase its spending.
C) The government spending creates a demand for domestically produced goods and services
which in turn increases income and higher incomes will lead to increased consumption.
D) The initial change in government spending creates a supply of jobs and stimulates
production of domestically produced goods and services. The resulting increases in wages
and investment demand leads to increased real GDP.
Ans: C
Difficulty: Medium
41. Which of the following best explains why cities want business conventions, political
conventions, and major sports events to be held in their town?
A) Because these activities will boost tourism and attract people who will create a demand for
the city’s goods and services.
B) Because this initial change in spending generated by these activities begins the multiplier
process so that the final increase in the city’s real GDP demanded is much larger than the
initial spending on these activities alone would cause.
C) Because federal and state spending in these cities will increase, thus initiating the multiplier
process.
D) Because these activities create jobs and boost spending, which in turn increases the city’s tax
revenues from income and sales.
Ans: B
Difficulty: Medium
42. Suppose that government spending on defense rises by $50 billion. What happens to the
aggregate demand curve if the multiplier is greater than 1?
A) It shifts right by $50 billion at each price level.
B) It shifts right by more than $50 billion at each price level.
C) It shifts right by less than $50 billion at each price level.
D) The aggregate demand does not shift; the aggregate supply curve shifts right by $50 billion at
each price level.
Ans: B
Difficulty: Medium

43. Suppose investment rises by $50 billion at each price level. If the value of the multiplier is
1.5, what is the amount of change in real GDP demanded at each price level?
A) $50 billion
B) $75 billion
C) $125 billion
D) $150 billion
Ans: B
Difficulty: Medium
44. Suppose net exports decreases by $100 million due to a slump in foreign economies. If the
the value of the multiplier is 2, what happens to the domestic aggregate demand curve?
A) Since less will be produced, the aggregate demand does not shift. The aggregate supply curve
shifts to the left by $100 million at each price level.
B) It shifts to the left by $50 million at each price level.
C) It shifts to the left by $100 million at each price level.
D) It shifts to the left by $200 million at each price level.
Ans: D
Difficulty: Medium
45. Suppose that an increase in government purchases of $100 million caused the aggregate
demand curve to shift to the right by $350 million at each price level. What is the value of the
multiplier?
A) 2.5
B) 3.5
C) 0.285
D) $250 million
Ans: B
Difficulty: Medium
46. The short run in macroeconomic analysis is a period

A) in which wages and some other prices do not respond to changes in economic conditions.
B) in which full wage and price flexibility and market adjustment have been achieved.
C) of less than 12 months.
D) in which all macroeconomic variables are fixed.
Ans: A
Difficulty: Medium

47. The long run in macroeconomic analysis is a period
A) in which wages and some other prices are sticky.
B) in which full wage and price flexibility and market adjustment have been achieved.
C) greater than 12 months.
D) in which the capital stock is held constant.
Ans: B
Difficulty: Medium
48. What do economists mean by the term “sticky wage”?

A) It refers to the reluctance by employers to decrease nominal wages during an inflationary
period.
B) It refers to a wage that is slow to adjust to its equilibrium level, creating sustained periods of
shortage or surplus in the labor market.
C) It refers to a breakdown in wage negotiations between employers and employee unions.
D) It refers to a union negotiated wage.
Ans: B
Difficulty: Easy
49. Wage and price stickiness

A) gives rise to a vertical long-run aggregate supply curve.
B) gives rise to a vertical short-run aggregate supply curve.
C) creates a surplus or a shortage of real GDP.
D) prevents the economy from producing its potential level of real GDP.
Ans: D
Difficulty: Medium
50. The long-run aggregate supply curve is vertical at

A) potential output.
B) the actual level of real output.
C) the actual level of nominal output.
D) 100% employment of the labor force.
Ans: A
Difficulty: Medium
51. The long-run aggregate supply curve

A) relates the level of nominal output produced by firms to the implicit price deflator.
B) relates the level of output produced by firms to the price level in the long run.
C) is vertical because there is one price level and an infinite number of outputs.
D) is determined by the real output demanded by economic agents in an economy.
Ans: B
Difficulty: Medium

52. In a graph that shows the aggregate supply and aggregate demand curves, what are the
variables on the axes of the graph?
A) The price level measured by the implicit price deflator is on the horizontal axis and real GDP
is on the vertical axis.
B) The price level measured by the consumer price index is on the vertical axis and real GDP is
on the horizontal axis.
C) The price level measured by the implicit price deflator is on the vertical axis and real GDP is
on the horizontal axis.
D) The price level measured by the implicit price deflator is on the vertical axis and employment
is on the horizontal axis.
Ans: C
Difficulty: Medium
53. Which of the following statements is true of the economy in the long run? In the long run,
I. real GDP eventually moves to potential output because all wages and prices are assumed
to be flexible.
II. the economy can achieve its natural level of employment and potential output at any
price level.
III. there is no cyclical unemployment.
A) I only
B) I and II only
C) I and III only
D) I, II, and III
Ans: D
Difficulty: Medium
54. In the long run, an increase in aggregate demand, all other things unchanged, will cause the
price level to
A) increase and potential output to increase.
B) decrease and potential output to decrease.
C) increase and potential output to remain stable.
D) decrease and potential output to remain stable.
Ans: C
Difficulty: Medium
55. In the long run, a decrease in aggregate demand, all other things unchanged, will cause the
price level to
A) increase and potential output to increase.
B) decrease and potential output to decrease.
C) increase and potential output to remain stable.
D) decrease and potential output to remain stable.
Ans: D
Difficulty: Medium
56. An increase in aggregate demand, all other things unchanged, in the long run will generate
A) an increase in potential output and no change in the price level.
B) a decrease in potential output and no change in the price level.
C) no change in potential output and an increase in the price level.
D) no change in potential output and a decrease in the price level.
Ans: C
Difficulty: Medium
57. A decrease in aggregate demand, all other things unchanged, in the long run will generate
A) an increase in potential output and no change in the price level.
B) a decrease in potential output and no change in the price level.
C) no change in potential output and an increase in the price level.
D) no change in potential output and a decrease in the price level.
Ans: D
Difficulty: Medium
58. In the long run, the price level is determined by

A) aggregate demand.
B) aggregate supply.
C) the government.
D) consumers and firms.
Ans: A
Difficulty: Medium
59. In the long run, the output level is determined by

A) aggregate demand.
B) long-run aggregate supply.
C) the government.
D) household income.
Ans: B
Difficulty: Medium
Figure 7-2

60. Refer to Figure 7-2. The potential output in this economy is
A) $6,000 billion at a price level of 1.08.
B) $7,000 billion at a price level of 1.12.
C) $7, 100 billion at a price level of 1.16.
D) $7,056 billion at a price level of 1.08.
Ans: B
Difficulty: Medium
61. Refer to Figure 7-2. If the real GDP is $7,000 billion and the implicit price deflator is 1.16,
what is the value of nominal GDP?
A) $6,034 billion
B) $8,120 billion
C) $9,120 billion
D) cannot be determined from the information given
Ans: B
Difficulty: Medium
A) $6,250 billion
B) $7,840 billion
C) $9,000 billion
Ans: B
Difficulty: Medium
A) $6,481 billion
B) $7,000 billion
C) $7,560 billion
Ans: C
Difficulty: Medium
64. Refer to Figure 7-2. Changes in aggregate demand from AD1 to either AD2 or AD3
A) will change nominal GDP but will not change real GDP in the long run.
B) will change real GDP but will not change nominal GDP in the long run.
C) will change the potential level of real GDP.
D) will change the price level and real GDP.
Ans: A
Difficulty: Medium
65. Refer to Figure 7-2. Based on the figure, we can conclude that
A) in the short run, the economy will always achieve full-employment equilibrium.
B) in the long run, given flexible wages and prices, the economy will achieve equilibrium at
its potential output level.
C) flexible wages and prices are irrelevant since the LRAS curve is vertical.
D) in the long run, the aggregate demand curve determines the potential output level.
Ans: B
Difficulty: Medium
66. The intersection of the economy’s aggregate demand and long-run aggregate supply curves
I. determines its equilibrium real GDP in both the long run and the short run.
II. determines its equilibrium price level in both the long run and the short run.
III. occurs at the economy’s potential output.
A) I, II, and III
B) I and III only
C) II and III only
D) III only
Ans: D
Difficulty: Medium
67. The rise and fall of real GDP over the course of the business cycle suggests that
A) the economy is always at full employment.
B) the economy may not always be in long-run equilibrium.
C) the economy is always at its potential output level.
D) wage and price stickiness ensures that the economy moves from a peak to a trough.
Ans: B
Difficulty: Medium
68. An economic analysis of the short run is useful to explain

A) how deviations of real GDP from potential output can and do occur.
B) how deviations of nominal GDP from potential output can and do occur.
C) why the long-run aggregate supply curve is vertical.
D) how an economy’s maximum output is determined.
Ans: A
Difficulty: Medium
69. All of the following statements are true about the short-run aggregate supply curve except
A) it is a graphical representation of the relationship between production and the price level.
B) it is a result of the stickiness or inflexibility of some prices and wages.
C) it is upward-sloping.
D) it is drawn holding price level constant.
Ans: D
Difficulty: Medium
70. All of the following are held constant along a short-run aggregate supply curve except
A) factor prices.
B) output prices.
C) nominal wages.
D) capital stock.
Ans: B
Difficulty: Medium
71. The short-run aggregate supply shows the amount of real GDP that will be
A) made available at various price levels.
B) purchased at various price levels.
C) purchased at various national income levels.
D) made available at various national income levels.
Ans: A
Difficulty: Easy
72. A movement along the short-run aggregate supply curve in response to a change in the price
level is called a
A) determinant of aggregate supply.
B) revealed cost on aggregate supply.
C) change in aggregate supply.
D) change in the aggregate quantity of goods and services supplied.
Ans: D
Difficulty: Easy

73. A change in the aggregate quantity of goods and services supplied at every price level is
called a
A) change in short-run aggregate supply.
B) change in long-run aggregate supply.
C) change in short-run aggregate quantity of output supplied.
D) determinant of short-run aggregate supply.
Ans: A
Difficulty: Easy
74. What is the difference between a change in aggregate supply and a change in aggregate
output supplied?
A) A change in aggregate supply is represented by a movement along the aggregate supply
curve in response to a price change, while a change in aggregate output supplied is
represented by a shift of the aggregate supply curve in response to a change in a determinant
of aggregate supply other than the price level.
B) A change in aggregate supply is represented by a shift of the aggregate supply curve in
response to a change in the actual price level, while a change in aggregate output supplied is
represented by a movement along the aggregate supply curve in response to a change in the
expected price level.
C) A change in aggregate supply is represented by a shift of the aggregate supply curve in
response to a change in a determinant of aggregate supply other than the price level, while
a change in aggregate output supplied is represented by a movement along the
aggregate supply curve in response to a change in the price level.
D) There is no difference between the two terms.
Ans: C
Difficulty: Medium
75. Which of the following will increase the short-run aggregate supply?
A) An increase in wages
B) A decrease in the price of capital
C) An increase in government spending on education
D) An increase in consumption spending
Ans: B
Difficulty: Medium
76. Which of the following will decrease the short-run aggregate supply?
A) An increase in wages
B) An increase in the labor force
C) A decrease in net exports
D) A decrease in the personal income tax rates
Ans: A
Difficulty: Medium
77. Which of the following will increase the aggregate quantity of output supplied?
A) An increase in input prices
B) An increase in the average price level
C) A technological advancement
D) An increase in net exports
Ans: B
Difficulty: Medium
78. Which of the following will decrease the aggregate quantity of output supplied?
A) A decrease in wages
B) A decrease in the labor force
C) A decrease in net exports
D) A decrease in the price level
Ans: D
Difficulty: Medium
79. Suppose the price of an important natural resource such as oil falls. What will be the effect
on the short-run aggregate supply curve?
A) There will be movement to the left, along the aggregate supply curve.
B) The aggregate supply curve will shift to the left.
C) There will be movement to the right, along the aggregate supply curve.
D) The aggregate supply curve will shift to the right.
Ans: D
Difficulty: Medium
80. Suppose that product prices start rising but nominal wages do not. In that case,
A) real wages will fall and firms will want to produce more because doing so will be profitable.
B) real wages will rise and firms will want to produce more because doing so will be profitable.
C) there will be a surplus of goods and services produced.
D) there will be a shortage of goods and services produced.
Ans: A
Difficulty: Medium
81. In the short run, the equilibrium price level and the equilibrium level of total output are
determined by the intersection of
A) the aggregate demand, the short-run aggregate supply and the long-run aggregate supply
curves.
B) the short-run aggregate supply and the long-run aggregate supply curves.
C) the aggregate demand and the short-run aggregate supply curves.
D) the aggregate demand and the long-run aggregate supply curves.
Ans: C
Difficulty: Medium
82. The short-run aggregate supply curve slopes upward because of

A) wage and price stickiness.
B) wage and price flexibility.
C) increasing technology.
D) a reduction in resource availability at higher price levels.
Ans: A
Difficulty: Medium
83. Which of the following is a source of wage stickiness?

I. fixed wage contracts
II. minimum wage laws
III. workers and firms want to avoid complexity of negotiating contracts frequently
A) I only
B) I and II only
C) I and III only
D) I, II, and III
Ans: D
Difficulty: Medium
84. All the following explain price stickiness except

A) firms choose not to adjust prices until they can assess if changes in sales are temporary or
permanent.
B) the more firms produce, the lower the average cost of production. Therefore, firms are
willing to not raise prices as long as they can sell more.
C) firms may be concerned that consumers may be angered by price increases.
D) firms may be concerned that their rivals may not match their price increases.
Ans: B
Difficulty: Medium
85. Which of the following is an explanation for price stickiness?

I. There are adjustment costs associated with changing prices such as the cost of printing
new price lists.
II. Worker unions may forbid firms from raising prices for fear that workers may be laid off
if demand for output falls.
III. Firms may have explicit long-term contracts to sell their products to other firms at
specified prices.
A) I only
B) I and II only
C) I and III only
D) I, II, and III
Ans: C
86. The sticky price explanation of the short-run aggregate supply curve says that when the
average price level rises,
A) some firms will immediately pass the higher prices to consumers.
B) because of adjustment costs associated with changing prices, some firms will not raise their
prices immediately which may temporarily boost their sales.
C) firms will raise their output prices by more than the increase in the average price level to
make up for the shortfall in sales.
D) consumers are unwilling to pay higher prices resulting in a decrease in aggregate demand.
Ans: B
Difficulty: Medium

Figure 7-3
87. Refer to Figure 7-3. Suppose that the economy is in long-run equilibrium at point A. Now
suppose net exports increase. What happens in the short run?
A) There will be an increase in aggregate output demanded and the economy moves from point
A to point G.
B) Real GDP increases to Y2 and the price level rises to P2.
C) Real GDP decreases to Y3 and the price level falls to P3.
D) Since the economy is already at its potential output, only the price level will rise to P2.
Ans: B
Difficulty: Medium
suppose net exports increase. In the short run,
A) unemployment is above its natural level.
B) those who were cyclically unemployed will now find jobs at the going nominal wage rate.
C) those who were structurally or frictionally unemployed will now find jobs at the going
nominal wage rate.
D) the nominal wage rate rises.
Ans: C
suppose net exports increase. As a result of this,
A) real GDP is temporarily above potential output.
B) the economy’s potential output increases to Y2.
C) the economy moves to a new long-run equilibrium at point B.
D) there is some cyclical unemployment.
Ans: A
Difficulty: Medium
suppose net exports increase. What happens in the long-run, all other things unchanged?
A) The economy will return to its initial equilibrium at point A.
B) Equilibrium will be re-established at point B with a higher potential output.
C) Equilibrium will be re-established at point E at a higher price level.
D) The aggregate demand curve will shift back to AD1.
Ans: C
Difficulty: Medium
suppose the stock market crashes, significantly reducing household wealth. What happens in
the short-run?
A) Real GDP remains at Y1 but the price level falls to P3.
B) The quantity of real GDP demanded falls resulting in a movement from point A to point F.
C) Real GDP decreases to Y3 and the price level falls to P3.
D) The economy moves to a short-run equilibrium at point D.
Ans: C
Difficulty: Medium
suppose the stock market crashes, significantly reducing household wealth. In the short-run,
A) the nominal wage rate falls.
B) unemployment is above its natural level.
C) there will be pressure on prices to rise.
D) the short-run aggregate supply curve shifts to the left as firms cut production.
Ans: B
Difficulty: Medium
suppose the stock market crashes, significantly reducing household wealth. As a result,
A) the economy’s potential output decreases to Y3.
B) unemployment is below its natural rate.
C) the economy moves to a new long-run equilibrium at point C.
D) there is some cyclical unemployment.
Ans: D
Difficulty: Medium
suppose the stock market crashes, significantly reducing household wealth. What happens in
the long-run, all other things unchanged?
A) The aggregate demand curve will shift back to AD1.
B) The economy will be stuck at an output level below its potential level.
C) The economy returns to full-employment equilibrium at point A.
D) The economy returns to full-employment equilibrium at point D.
Ans: D
Difficulty: Medium
95. Using the aggregate demand–aggregate supply model, predict what happens in the short run
when the consumer confidence index falls as consumers become pessimistic about their
economic prospects.
A) The aggregate supply curve shifts right; the aggregate demand curve is not affected; price
level decreases; real GDP increases.
B) The aggregate supply curve shifts left; the aggregate demand curve is not affected; price
level increases; real GDP decreases.
C) The aggregate demand curve shifts right; the aggregate supply curve is not affected; price
level and real GDP increase.
D) The aggregate demand curve shifts left; the aggregate supply curve is not affected; price
level and real GDP decrease.
Ans: D
Difficulty: Medium
when there is a general decrease in raw materials cost.
Ans: A
Difficulty: Medium

when the federal government enacts a cut in the personal income tax rates.
Ans: C
Difficulty: Medium
when the federal government lowers the capital gains tax to stimulate investment.
A) The aggregate demand curve shifts left; the aggregate supply curve is not affected; price
B) The aggregate demand curve shifts right; the aggregate supply curve is not affected; price
C) The aggregate supply curve shifts left; the aggregate demand curve is not affected; price
D) The aggregate supply curve shifts right; the aggregate demand curve is not affected; price
Ans: B
Difficulty: Medium
if an increase in health insurance premiums paid by firms raises the cost of employing each
worker.
B) The aggregate demand curve shifts right; the aggregate supply curve is not affected; price
C) The aggregate demand curve shifts left; the aggregate supply curve is not affected; price
D) The aggregate supply curve shifts left; the aggregate demand curve is not affected; price
Ans: D
Difficulty: Medium

100. Suppose the economy is initially in long-run equilibrium. Which of the following events
leads to an increase in the price level and a decrease in real GDP in the short run?
A) A decrease in health insurance premiums paid by firms raises the cost of employing labor
B) An increase in government transfer payments
C) An increase in the cost of a key input such as oil
D) A sharp fall in stock market prices
Ans: C
Difficulty: Medium
leads to an increase in the price level and real GDP in the short run?
Ans: B
Difficulty: Medium
leads to a decrease in the price level and real GDP in the short run?
Ans: D
Difficulty: Medium
leads to a decrease in the price level and an increase in real GDP in the short run?
Ans: A
Difficulty: Medium

104. All of the following contributed to the U.S. recession of 2001 except
A) a decrease in business investment both for computers and software and in structures.
B) an appreciation in the value of the U.S. dollar relative to the currencies of its trading partners.
C) an increase in new residential construction.
D) a fall in stock market prices.
Ans: C
Difficulty: Medium
105. The strong dollar in 2001

A) made U.S. exports more attractive relative to foreign goods, thereby increasing U.S. exports.
B) made U.S. exports more expensive relative to foreign goods, thereby reducing U.S. exports.
C) made U.S. imports more expensive, thereby reducing aggregate demand.
D) made U.S. imports more attractive, thereby increasing aggregate demand.
Ans: B
Difficulty: Medium
106. During the recession of 2001, despite the decrease in aggregate demand, the price level was
essentially stable. Which of the following is a reason for this?
A) Firms responded to the decline in output demanded by making quantity adjustments and not
price adjustments.
B) The short-run aggregate supply curve must have also shifted to the left.
C) The short-run aggregate supply curve must have also shifted to the right.
D) The short-run aggregate supply curve must be horizontal due to severe wage and price
stickiness.
Ans: B
Difficulty: Medium
107. During the recession of 2001, the leftward shifts in aggregate demand and aggregate supply
that occurred at that time necessarily reduced
A) real GDP only.
B) the price level only.
C) real GDP and the price level.
D) potential output.
Ans: A
Difficulty: Medium

Figure 7-4
108. Refer to Figure 7-4. What are the prevailing price level and the output level in the
economy?
A) Price level = P1; real GDP = Yp
B) Price level = P1; real GDP = Y1
C) Price level = P2; real GDP = Y2
D) Price level = P3; real GDP = Yp
Ans: C
Difficulty: Medium
109. Refer to Figure 7-4. Which of the following statements is true?

A) The economy depicted in the figure experiences a recessionary gap = Yp−Y1.
B) The economy depicted in the figure experiences a recessionary gap = Yp−Y2.
C) The economy depicted in the figure experiences a recessionary gap = Y2−Y1.
D) The economy depicted in the figure is in long-run equilibrium but not in short-run
equilibrium.
Ans: B
Difficulty: Medium
110. Refer to Figure 7-4. For the economy represented in the figure,
A) the real wage rate is higher than full-employment real wage.
B) the real wage rate is lower than full-employment real wage.
C) the nominal wage rate is higher than full-employment nominal wage.
D) the nominal wage rate is higher than full-employment nominal wage.
Ans: A
111. Which of the following occurs if an economy experiences a recessionary gap?
I. Actual real GDP is less than potential output.
II. Actual real GDP is greater than potential output.
III. Unemployment is less than the natural rate.
IV. Unemployment is greater than the natural rate.
A) I and III
B) I and IV
C) II and III
D) II and IV
Ans: B
Difficulty: Medium
Figure 7-5
112. Refer to Figure 7-5. What are the prevailing price level and the output level in the
economy?
A) Price level = P1; real GDP = Yp
B) Price level = P1; real GDP = Y1
C) Price level = P2; real GDP = Y2
D) Price level = P3; real GDP = Yp
Ans: C
Difficulty: Medium
113. Refer to Figure 7-5. Which of the following statements is true?

A) The economy depicted in the figure experiences an inflationary gap = Y2 −Yp.
B) The economy depicted in the figure experiences an inflationary gap = Y1 −Yp.
C) The economy depicted in the figure experiences an inflationary gap = Y1−Y2.
D) The economy depicted in the figure is in long-run equilibrium but not in short-run
equilibrium.
Ans: A
Difficulty: Medium
114. Refer to Figure 7-5. For the economy represented in the figure,
A) the real wage rate is higher than full-employment real wage.
B) the real wage rate is lower than full-employment real wage.
C) the nominal wage rate is higher than full-employment nominal wage.
D) the nominal wage rate is higher than full-employment nominal wage.
Ans: B
115. Which of the following occurs if an economy experiences an inflationary gap?

I. Actual real GDP is less than potential output.
II. Actual real GDP is greater than potential output.
III. Unemployment is less than the natural rate.
IV. Unemployment is greater than the natural rate.
A) I and III
B) I and IV
C) II and III
D) II and IV
Ans: C
Difficulty: Medium
116. In the short-run, an output gap occurs because

A) there is insufficient demand for goods and services.
B) there is insufficient supply of goods and services.
C) wages and prices are fully flexible.
D) wages and some prices have not adjusted sufficiently to maintain output at its potential level.
Ans: D
Difficulty: Medium

Figure 7-6
117. Refer to Figure 7-6. Suppose the economy is initially at point A. All of the following
statements are true except
A) the economy is in equilibrium at its potential output.
B) the labor market is in equilibrium.
C) there is no cyclical unemployment.
D) there is no structural or frictional unemployment.
Ans: D
Difficulty: Medium
118. Refer to Figure 7-6. Suppose the economy is initially at point A. Now suppose that there is
an increase in government purchases. In the short-run,
A) the price level rises to Pb and real GDP increases to Yb.
B) the price level rises to Pd.
C) the aggregate supply curve shifts up to SRAS2.
D) the economy’s potential output increases to Yb.
Ans: A
Difficulty: Medium
119. Refer to Figure 7-6. Suppose the economy is initially at point A. Now suppose an increase
in government purchases shifts the aggregate demand curve to AD2. What happens in the new
short run?
A) Firms increase output because product prices rise while real wage falls.
B) Firms increase output because product prices and real wage rise.
C) Firms will have to pay higher nominal wages and employ more workers to supply the
increased output.
D) The price level increases to Pb, real wages, nominal wages, and employment increase.
Ans: A
Difficulty: Medium
in government purchases shifts the aggregate demand curve to AD2. As a result,
A) the economy is not in equilibrium because it operates with an output gap.
B) the economy is in short-run equilibrium and it operates with an inflationary gap.
C) the economy is in short-run equilibrium and it operates with a recessionary gap.
D) the economy is not in equilibrium because the unemployment rate is not equal to the natural
rate of unemployment.
Ans: B
Difficulty: Medium
in government purchases shifts the aggregate demand curve to AD2. Which of the following
statements best explains how the economy responds to restore long-run macroeconomic
equilibrium?
A) The increase in the price level to Pb reduces real GDP demanded, shifting the aggregate
demand curve back to AD1, returning the economy to its potential output at A.
B) Firms produce more in anticipation of future higher prices, thus shifting the SRAS curve
upward until the gap is eliminated at D.
C) Firms and workers will negotiate higher nominal wages to restore lost purchasing power.
This shifts the SRAS curve to the left until the gap is eliminated at D.
D) The increase in the price level to Pb decreases consumption which in turn leads firms to cut
production shifting the SRAS curve to the left until the gap is eliminated at D.
Ans: C
Difficulty: Medium
122. Refer to Figure 7-6. Suppose the economy is initially at A. Now suppose an increase
in government purchases shifts the aggregate demand curve to AD2. Which of the following
is false about the economy after it adjusts to its new long-run equilibrium?
A) Nominal wages increase.
B) The price level rises to Pd.
C) Firms employ more workers than in the short-run equilibrium.
D) There is some frictional and structural unemployment.
Ans: C
Difficulty: Medium
123. Refer to Figure 7-6. Suppose the economy is initially in short-run equilibrium at B. A shift
from AD1 to AD2 could have been caused by all of the following except
A) an increase in consumer optimism.
B) economic prosperity in foreign economies.
C) a personal income tax cut.
D) an increase in the price level from Pa to Pb.
Ans: D
Difficulty: Medium
124. Refer to Figure 7-6. Suppose the economy is initially in short-run equilibrium at B. If
policy-makers decide to intervene to close the gap, which of the following can it do?
A) Decrease personal income taxes.
B) Increase government welfare spending.
C) Decrease the level of government purchases of goods and services.
D) Institute investment tax credits to encourage business investment.
Ans: C
Difficulty: Medium
125. Refer to Figure 7-6. Suppose the economy is initially in short-run equilibrium at B. Policy
makers could either pursue a stabilization policy or allow the economy to adjust on its own.
What is the difference between the two policy choices, if any?
A) A stabilization policy would return real GDP to its potential at a price level of Pa while a
nonintervention policy would return real GDP to its potential at a price level of Pd.
B) A stabilization policy would return real GDP to its potential at a price level of Pd while a
nonintervention policy would return real GDP to its potential at a price level of Pa.
C) Both policies would return real GDP to its potential at a price level of Pa.
D) Both policies would return real GDP to its potential at a price level of Pd.
Ans: A

Figure 7-7
126. Refer to Figure 7-7. At output level YK,

A) the economy is not in equilibrium because it operates with an output gap.
B) the economy is in short-run equilibrium and it operates with an inflationary gap.
C) the economy is in short-run equilibrium and it operates with a recessionary gap.
D) the economy is not in equilibrium because the unemployment rate is below the natural rate of
unemployment.
Ans: C
Difficulty: Medium
127. Refer to Figure 7-7. At output level YK,

A) potential output is less than actual output.
B) there is a surplus of real GDP.
C) the unemployment rate exceeds the natural rate of unemployment.
D) over time aggregate demand will rise to restore long-run equilibrium.
Ans: C
Difficulty: Medium
128. Refer to Figure 7-7. A shift from SRAS1 to SRAS2 could have been caused by all of the
following except
A) an increase in the consumer confidence index.
B) an increase in payroll tax.
C) a rise in health care costs which raises the cost of employing labor.
D) terrorist attacks that destroys an economy’s infrastructure.
Ans: A
Difficulty: Medium
129. Refer to Figure 7-7. Suppose the economy is initially at K. Which of the following
statements best explains how the economy responds to restore long-run macroeconomic
equilibrium?
A) Over time, the aggregate demand curve will shift to the right until long-run equilibrium is
restored at J and the gap is closed.
B) Rising unemployment puts pressure on nominal wages to fall. The SRAS curve shifts right to
SRAS1 closing the gap at H.
C) In response to rising prices, firms will increase production moving along SRAS2 until long-
run equilibrium is restored at J and the gap is closed.
D) Rising unemployment puts pressure on nominal wages to fall. Firms employ more workers
moving along SRAS2 until long-run equilibrium is restored at J and the gap is closed.
Ans: B
Difficulty: Medium
130. Refer to Figure 7-7. Suppose the economy is initially in short-run equilibrium at point K.
If the policy-makers adopt a nonintervention policy, over time,
I. real wages will fall as long as unemployment remains above the natural rate.
II. lower nominal wages will result in a gradual shift from SRAS2 to SRAS1.
III. long-run equilibrium will be established at YP and Ph.
A) I, II, and III
B) I and II only
C) II and III only
D) III only
Ans: A
Difficulty: Medium
131. Refer to Figure 7-7. Suppose the economy is initially in short-run equilibrium at K. Which
of the following stabilization policies could be used to close the gap?
A) Decrease government welfare spending
B) Decrease personal income taxes
C) Decrease government spending on defense
D) Increase payroll taxes
Ans: B
Difficulty: Medium
132. Refer to Figure 7-7. Suppose the economy is initially in short-run equilibrium at K. Policy
makers could either pursue a stabilization policy or allow the economy to adjust on its own.
What is the difference between the two policy choices, if any?
A) Both policies would return real GDP to its potential at a price level of Pj.
B) Both policies would return real GDP to its potential at a price level of Ph.
C) A stabilization policy would return real GDP to its potential at a price level of Pj while a
nonintervention policy would return real GDP to its potential at a price level of Ph.
D) A stabilization policy would return real GDP to its potential at a price level of Ph while a
nonintervention policy would return real GDP to its potential at a price level of Pj.
Ans: C
Difficulty: Medium
133. To eliminate a recessionary gap, policy-makers may pursue

A) an expansionary policy that increases aggregate demand.
B) a contractionary policy that increases aggregate demand.
C) a non-intervention policy that leaves aggregate supply unaffected and increases aggregate
demand.
D) an intervention policy that decreases aggregate supply and increases aggregate demand.
Ans: A
Difficulty: Medium
134. To eliminate an inflationary gap, policy-makers may pursue

A) an expansionary policy that reduces the price level.
B) a contractionary policy that decreases aggregate demand.
C) a non-intervention policy that leaves aggregate demand unaffected and increases aggregate
supply.
D) an intervention policy that increases aggregate supply and decreases aggregate demand.
Ans: B
Difficulty: Medium
135. Inflationary and recessionary gaps are closed by the economy’s self-correcting adjustments
mechanism that shift
A) the SRAS curve.
B) the AD curve.
C) the LRAS curve.
D) both the SRAS and the LRAS curves.
Ans: A
Difficulty: Medium
136. An economy adjusts on its own to close an inflationary gap because there is
A) pressure on nominal wages to fall and this shifts the SRAS curve rightward.
B) pressure on nominal wages to rise and this shifts the SRAS curve rightward.
C) pressure on nominal wages to fall and this shifts the SRAS curve leftward.
D) pressure on nominal wages to rise and this shifts the SRAS curve leftward.
Ans: D
Difficulty: Medium
137. An economy adjusts on its own to close a recessionary gap because there is
A) pressure on nominal wages to fall and this shifts the SRAS curve rightward.
B) pressure on nominal wages to rise and this shifts the SRAS curve rightward.
C) pressure on nominal wages to fall and this shifts the SRAS curve leftward.
D) pressure on nominal wages to rise and this shifts the SRAS curve leftward.
Ans: A
Difficulty: Medium

138. As a recessionary gap is eliminated through an economy’s self-correcting adjustments
process,
A) the equilibrium price level increases and the equilibrium real output decreases.
B) the equilibrium price level decreases and the equilibrium real output increases.
C) the equilibrium price level and the equilibrium real output increase.
D) the equilibrium price level and the equilibrium real output decrease.
Ans: B
Difficulty: Medium
139. As an inflationary gap is eliminated through an economy’s self-correcting adjustments

process,
A) the equilibrium price level increases and the equilibrium real output decreases.
B) the equilibrium price level decreases and the equilibrium real output increases.
C) the equilibrium price level and the equilibrium real output increase.
D) the equilibrium price level and the equilibrium real output decrease.
Ans: A
Difficulty: Medium
140. The use of government purchases, transfer payments, and taxes to influence the level of
economic activity is called
A) monetary policy.
B) fiscal policy.
C) congressional policy.
D) Federal Government policy.
Ans: B
Difficulty: Medium
141. The use central bank policies to influence the level of economic activity is called
A) banking and finance policy.
B) financial market policy.
C) monetary policy.
D) congressional policy.
Ans: C
Difficulty: Medium
Table 7-1
Price Aggregate Aggregate
Level Quantity Demanded Quantity Supplied
($ trillion) ($ trillion)
1.0 7.8 4.8
1.2 7.6 5.2
1.4 7.4 5.6
1.6 7.2 6.0
1.8 7 6.4
2.0 6.8 6.8
2.2 6.6 7.0
2.4 6.4 7.2
2.6 6.2 7.4
2.8 6 7.6
3.0 5.8 7.8
Table 7-1 shows the aggregate demand and short-run aggregate supply curves for an
economy. The potential level of output is $7.6 trillion.
142. Refer to Table 7-1. What is the initial real GDP and price level?
A) Real GDP = 7.6 trillion; price level = 1.2
B) Real GDP = 7.6 trillion; price level = 2.8
C) Real GDP = 6.8 trillion; price level = 2.0
D) Real GDP = 7.8 trillion; price level = 1.0
Ans: C
Difficulty: Medium
143. Refer to Table 7-1. What kind of gap, if any, exists and what is the size of the gap?
A) No gap exists because the economy is in equilibrium.
B) There is a recessionary gap of $0.8 trillion.
C) There is a recessionary gap of $0.2 trillion.
D) There is an inflationary gap of $1 trillion.
Ans: B
Difficulty: Medium
144. Refer to Table 7-1. If policymakers adopt a nonintervention policy, the economy gap
A) would return to potential output at a price level of 2.8.
B) would return to potential output at a price level of 1.2.
C) would return to potential output at a price level of 2.0.
D) would return to long-run equilibrium at an output level of $6 trillion.
Ans: A
Difficulty: Medium
145. Refer to Table 7-1. If policymakers choose to close the gap by using stabilization policy,
they should use
A) contractionary fiscal or monetary policies.
B) expansionary fiscal or monetary policies.
C) a combination of contractionary fiscal and expansionary monetary policies.
D) a combination of expansionary fiscal and contractionary monetary policies.
Ans: B
Difficulty: Medium

True/False
146. The aggregate demand curve shifts when the quantity of real GDP demanded at every price
level changes.
Ans: True
Difficulty: Medium
147. The aggregate demand curve shifts due to changes in consumption expenditures,
investment expenditures, government purchases, or net exports.
Ans: True
Difficulty: Medium
148. In the short run, all prices are flexible.

Ans: False
Difficulty: Medium
149. The short-run aggregate supply curve is vertical at the level of real output that corresponds
to the natural rate of employment.
Ans: False
Difficulty: Medium
150. The long-run aggregate supply curve is vertical at the level of real output that corresponds
to the natural rate of employment.
Ans: True
Difficulty: Medium
151. Inflationary and recessionary gaps are always eliminated automatically through changes in
aggregate demand.
Ans: False
Difficulty: Medium
152. In the long run, real output can be less than, equal to, or greater than the economy’s
potential output.
Ans: False
Difficulty: Medium
153. If an economy is operating at its potential output level, a change in aggregate demand or
short-run aggregate supply will induce an inflationary or a recessionary gap.
Ans: True
Difficulty: Medium

154. An increase in the prices of natural resources will lead to a decrease in short-run aggregate
supply.
Ans: True
Difficulty: Medium
155. Public policy to eliminate inflationary or recessionary gaps is called stabilization policy.
Ans: True
Difficulty: Easy
156. Public policy to eliminate a recessionary gap could involve an increase in taxes.
Ans: False
Difficulty: Medium
157. Taking no action and allowing an economy to adjust by itself is called a nonintervention
policy.
Ans: True
Difficulty: Easy
158. The short run in macroeconomics is a period in which wages and some other prices are
sticky.
Ans: True
Difficulty: Medium
159. The long run in macroeconomics is a period in which wages and prices are flexible and
there is full market adjustment.
Ans: True
Difficulty: Medium
160. The potential level of real GDP is the level of output a society can achieve when labor is
employed at its natural level.
Ans: True
Difficulty: Medium
161. Long-run aggregate supply corresponds to the level of potential output.

Ans: True
Difficulty: Medium
162. A change in the price level produces an immediate shift of the short-run aggregate supply
curve.
Ans: False
Difficulty: Medium

Short Answer
163. What is the difference between the short run and the long run in macroeconomics? Why is
this distinction critical in the analysis of aggregate demand and supply?
164. Explain and discuss the difference between a movement along an aggregate demand curve
and a shift of the aggregate demand curve. Illustrate your answer with a graph.
165. Discuss why the short-run aggregate supply curve is upward sloping unlike the long-run
aggregate supply curve which is vertical.
166. What is the meaning of “sticky” wages? Provide and explain three reasons why wages may
be sticky.

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moaning turmoil and the clanging of the fireengines wont seem to
fade away inside her. She stands irresolutely on a corner while cars,
faces, flicker clatteringly past her. A young man in a new straw hat is
looking at her out of the corners of his eyes, trying to pick her up.
She stares him blankly in the face. He has on a red, green, and blue
striped necktie. She walks past him fast, crosses to the other side of
the avenue, and turns uptown. Seven thirty. She’s got to meet some
one somewhere, she cant think where. There’s a horrible tired
blankness inside her. O dear what shall I do? she whimpers to
herself. At the next corner she hails a taxi. “Go to the Algonquin
please.”
She remembers it all now, at eight o’clock she’s going to have
dinner with Judge Shammeyer and his wife. Ought to have gone
home to dress. George’ll be mad when he sees me come breezing in
like this. Likes to show me off all dressed up like a Christmas tree,
like an Effenbee walking talking doll, damn him.
She sits back in the corner of the taxi with her eyes closed. Relax,
she must let herself relax more. Ridiculous to go round always keyed
up so that everything is like chalk shrieking on a blackboard.
Suppose I’d been horribly burned, like that girl, disfigured for life.
Probably she can get a lot of money out of old Soubrine, the
beginning of a career. Suppose I’d gone with that young man with
the ugly necktie who tried to pick me up.... Kidding over a banana
split in a soda fountain, riding uptown and then down again on the
bus, with his knee pressing my knee and his arm round my waist, a
little heavy petting in a doorway.... There are lives to be lived if only
you didn’t care. Care for what, for what; the opinion of mankind,
money, success, hotel lobbies, health, umbrellas, Uneeda biscuits...?
It’s like a busted mechanical toy the way my mind goes brrr all the
time. I hope they havent ordered dinner. I’ll make them go
somewhere else if they havent. She opens her vanity case and
begins to powder her nose.
When the taxi stops and the tall doorman opens the door, she
steps out with dancing pointed girlish steps, pays, and turns, her
cheeks a little flushed, her eyes sparkling with the glinting seablue
night of deep streets, into the revolving doors.
As she goes through the shining soundless revolving doors, that
spin before her gloved hand touches the glass, there shoots through
her a sudden pang of something forgotten. Gloves, purse, vanity
case, handkerchief, I have them all. Didn’t have an umbrella. What
did I forget in the taxicab? But already she is advancing smiling
towards two gray men in black with white shirtfronts getting to their
feet, smiling, holding out their hands.
Bob Hildebrand in dressing gown and pyjamas walked up and

down in front of the long windows smoking a pipe. Through the
sliding doors into the front came a sound of glasses tinkling and
shuffling feet and laughing and Running Wild grating hazily out of a
blunt needle on the phonograph.
“Why dont you park here for the night?” Hildebrand was saying in
his deep serious voice. “Those people’ll fade out gradually.... We can
put you up on the couch.”
“No thanks,” said Jimmy. “They’ll start talking psychoanalysis in a
minute and they’ll be here till dawn.”
“But you’d much better take a morning train.”
“I’m not going to take any kind of a train.”
“Say Herf did you read about the man in Philadelphia who was
killed because he wore his straw hat on the fourteenth of May?”
“By God if I was starting a new religion he’d be made a saint.”
“Didnt you read about it? It was funny as a crutch.... This man had
the temerity to defend his straw hat. Somebody had busted it and he
started to fight, and in the middle of it one of these streetcorner
heroes came up behind him and brained him with a piece of lead
pipe. They picked him up with a cracked skull and he died in the
hospital.”
“Bob what was his name?”
“I didnt notice.”
“Talk about the Unknown Soldier.... That’s a real hero for you; the
golden legend of the man who would wear a straw hat out of
season.”
A head was stuck between the double doors. A flushfaced man
with his hair over his eyes looked in. “Cant I bring you fellers a shot
of gin.... Whose funeral is being celebrated anyway?”
“I’m going to bed, no gin for me,” said Hildebrand grouchily.
“It’s the funeral of Saint Aloysius of Philadelphia, virgin and
martyr, the man who would wear a straw hat out of season,” said
Herf. “I might sniff a little gin. I’ve got to run in a minute.... So long
Bob.”
“So long you mysterious traveler.... Let us have your address, do
you hear?”
The long front room was full of ginbottles, gingerale bottles,
ashtrays crowded with half smoked cigarettes, couples dancing,
people sprawled on sofas. Endlessly the phonograph played Lady ...
lady be good. A glass of gin was pushed into Herf’s hand. A girl
came up to him.
“We’ve been talking about you.... Did you know you were a man
of mystery?”
“Jimmy,” came a shrill drunken voice, “you’re suspected of being
the bobhaired bandit.”
“Why dont you take up a career of crime, Jimmy?” said the girl
putting her arm round his waist. “I’ll come to your trial, honest I will.”
“How do you know I’m not?”
“You see,” said Frances Hildebrand, who was bringing a bowl of
cracked ice in from the kitchenette, “there is something mysterious
going on.”
Herf took the hand of the girl beside him and made her dance with
him. She kept stumbling over his feet. He danced her round until he
was opposite to the halldoor; he opened the door and foxtrotted her
out into the hall. Mechanically she put up her mouth to be kissed. He
kissed her quickly and reached for his hat. “Good night,” he said.
The girl started to cry.
Out in the street he took a deep breath. He felt happy, much more
happy than Greenwich Village kisses. He was reaching for his watch
when he remembered he had pawned it.
The golden legend of the man who would wear a straw hat out of
season. Jimmy Herf is walking west along Twentythird Street,
laughing to himself. Give me liberty, said Patrick Henry, putting on
his straw hat on the first of May, or give me death. And he got it.
There are no trollycars, occasionally a milkwagon clatters by, the
heartbroken brick houses of Chelsea are dark.... A taxi passes
trailing a confused noise of singing. At the corner of Ninth Avenue he
notices two eyes like holes in a trianglewhite of paper, a woman in a
raincoat beckons to him from a doorway. Further on two English
sailors are arguing in drunken cockney. The air becomes milky with
fog as he nears the river. He can hear the great soft distant lowing of
steamboats.
He sits a long time waiting for a ferry in the seedy ruddy-lighted
waiting room. He sits smoking happily. He cant seem to remember
anything, there is no future but the foggy river and the ferry looming
big with its lights in a row like a darky’s smile. He stands with his hat
off at the rail and feels the riverwind in his hair. Perhaps he’s gone
crazy, perhaps this is amnesia, some disease with a long Greek
name, perhaps they’ll find him picking dewberries in the Hoboken
Tube. He laughs aloud so that the old man who came to open the
gates gave him a sudden sidelong look. Cookoo, bats in the belfry,
that’s what he’s saying to himself. Maybe he’s right. By gum if I were
a painter, maybe they’ll let me paint in the nuthouse, I’d do Saint
Aloysius of Philadelphia with a straw hat on his head instead of a
halo and in his hand the lead pipe, instrument of his martyrdom, and
a little me praying at his feet. The only passenger on the ferry, he
roams round as if he owned it. My temporary yacht. By Jove these
are the doldrums of the night all right, he mutters. He keeps trying to
explain his gayety to himself. It’s not that I’m drunk. I may be crazy,
but I dont think so....
Before the ferry leaves a horse and wagon comes aboard, a
brokendown springwagon loaded with flowers, driven by a little
brown man with high cheekbones. Jimmy Herf walks round it; behind
the drooping horse with haunches like a hatrack the little warped
wagon is unexpectedly merry, stacked with pots of scarlet and pink
geraniums, carnations, alyssum, forced roses, blue lobelia. A rich
smell of maytime earth comes from it, of wet flowerpots and
greenhouses. The driver sits hunched with his hat over his eyes.
Jimmy has an impulse to ask him where he is going with all those
flowers, but he stifles it and walks to the front of the ferry.
Out of the empty dark fog of the river, the ferryslip yawns all of a
sudden, a black mouth with a throat of light. Herf hurries through
cavernous gloom and out to a fog-blurred street. Then he is walking
up an incline. There are tracks below him and the slow clatter of a
freight, the hiss of an engine. At the top of a hill he stops to look
back. He can see nothing but fog spaced with a file of blurred
arclights. Then he walks on, taking pleasure in breathing, in the beat
of his blood, in the tread of his feet on the pavement, between rows
of otherworldly frame houses. Gradually the fog thins, a morning
pearliness is seeping in from somewhere.
Sunrise finds him walking along a cement road between dumping
grounds full of smoking rubbishpiles. The sun shines redly through
the mist on rusty donkeyengines, skeleton trucks, wishbones of
Fords, shapeless masses of corroding metal. Jimmy walks fast to get
out of the smell. He is hungry; his shoes are beginning to raise
blisters on his big toes. At a cross-road where the warning light still
winks and winks, is a gasoline station, opposite it the Lightning Bug
lunchwagon. Carefully he spends his last quarter on breakfast. That
leaves him three cents for good luck, or bad for that matter. A huge
furniture truck, shiny and yellow, has drawn up outside.
“Say will you give me a lift?” he asks the redhaired man at the
wheel.
“How fur ye goin?”
“I dunno.... Pretty far.”
THE END
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© 2013 by Flat World Knowledge, Inc. All rights reserved. Your

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2. Which of the following is false about potential output?

3. When an economy fails to produce at its potential,

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5. The economy’s potential output corresponds to the level of

6. What are the four sources of aggregate demand?

7. Aggregate demand is defined as

©2013 Flat World Knowledge, Inc. 3

9. Aggregate demand is the total value of real GDP that

©2013 Flat World Knowledge, Inc. 4

16. All else constant, a lower price level

17. A movement along the aggregate demand curve is called a

21. Refer to Figure 7-1. A movement from point A to point B

©2013 Flat World Knowledge, Inc. 7

27. All other things unchanged, an increase in government spending will

30. Changes in aggregate demand can be caused by changes in

32. All other things unchanged, a higher exchange rate

34. All other things unchanged, a lower exchange rate

©2013 Flat World Knowledge, Inc. 10

39. The multiplier is given by

©2013 Flat World Knowledge, Inc. 11

©2013 Flat World Knowledge, Inc. 12

46. The short run in macroeconomic analysis is a period

©2013 Flat World Knowledge, Inc. 13

48. What do economists mean by the term “sticky wage”?

49. Wage and price stickiness

50. The long-run aggregate supply curve is vertical at

51. The long-run aggregate supply curve

©2013 Flat World Knowledge, Inc. 14

58. In the long run, the price level is determined by

59. In the long run, the output level is determined by

©2013 Flat World Knowledge, Inc. 16

68. An economic analysis of the short run is useful to explain

©2013 Flat World Knowledge, Inc. 19

82. The short-run aggregate supply curve slopes upward because of

83. Which of the following is a source of wage stickiness?

84. All the following explain price stickiness except

85. Which of the following is an explanation for price stickiness?

©2013 Flat World Knowledge, Inc. 23

©2013 Flat World Knowledge, Inc. 26

©2013 Flat World Knowledge, Inc. 27

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105. The strong dollar in 2001

©2013 Flat World Knowledge, Inc. 29

109. Refer to Figure 7-4. Which of the following statements is true?

113. Refer to Figure 7-5. Which of the following statements is true?

115. Which of the following occurs if an economy experiences an inflationary gap?

116. In the short-run, an output gap occurs because

©2013 Flat World Knowledge, Inc. 32

©2013 Flat World Knowledge, Inc. 35

126. Refer to Figure 7-7. At output level YK,

127. Refer to Figure 7-7. At output level YK,

133. To eliminate a recessionary gap, policy-makers may pursue

134. To eliminate an inflationary gap, policy-makers may pursue

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139. As an inflationary gap is eliminated through an economy’s self-correcting adjustments

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148. In the short run, all prices are flexible.

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161. Long-run aggregate supply corresponds to the level of potential output.