EC 309 Study Guide for Test 2
EC 309 Study Guide for Test 2 EC 309
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This 14 page Study Guide was uploaded by Julie Knight on Saturday April 2, 2016. The Study Guide belongs to EC 309 at University of Alabama - Tuscaloosa taught by Hoda A El-Karasky in Spring2015. Since its upload, it has received 139 views. For similar materials see Intermediate Macroeconomics in Economcs at University of Alabama - Tuscaloosa.
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Date Created: 04/02/16
Hoda Karasky EC 309 Intermediate Macroeconomics Test 2 Study Guide Chapter 10: Introduction to Economic Fluctuations Okun’s law- the negative relationship between GDP and unemployment Leading indicators- variables that tend to fluctuate in advance of the overall economy o Published monthly by the Conference Board o Aims to forecast changes in economic activity 6-9 months into the future o Used in planning by businesses and government, despite not being a perfect predictor Time horizons: o Long run- prices are flexible, respond to changes in supply or demand o Short run- many prices are “sticky” at a predetermined level Aggregate demand- the relationship between the quantity of output demanded and the aggregate price level o MV=PY *** an increase in the money supply shifts the AD curve to the right o Aggregate supply- the relationship between the quantity of goods and services supplied and the price level o Y= F (K, L) *** an increase in M shifts AD to the right increases price output remains the same o Hoda Karasky *** an increase in AD causes output to rise o Shocks- exogenous changes in aggregate supply or demand o Shocks temporarily push the economy away from full employment Demand shocks- a shock that shifts the AD curve o Supply shocks- a shock that shifts the AS curve o alters production costs, affects the prices that firms charge Stabilization policy- policy actions aimed at reducing the severity of short-run economic fluctuations o Practice Questions for Chapter 10: 1. When GDP growth declines, investment spending typically _______ and consumption spending typically _______. a. Increases; increases b. Increases; decreases c. Decreases; decreases d. Decreases; increases Hoda Karasky 2. Okun’s law is the ________ relationship between real GDP and the ________. a. Negative; unemployment rate b. Negative; inflation rate c. Positive; unemployment rate d. Positive; inflation rate 3. Long-run growth in real GDP is determined primarily by _________, while short-run movements in real GDP are associated with ________. a. Variations in labor market utilization; technological progress b. Technological progress; variations in labor market utilization c. Money supply growth rates; changes in velocity d. Changes in velocity; money supply growth rates 4. Leading economic indications are: a. The most popular economic statistics b. Data that are used to construct the consumer price index and the unemployment rate c. Variables that tend to fluctuate in advance of the overall economy d. Standardized statistics compiled by the National Bureau of Economic Research 5. Most economists believe that prices are: a. Flexible in the short run but many are sticky in the long run b. Flexible in the long run but many are sticky in the short run c. Sticky in both the short run and long run d. Flexible in both the short run and long run 6. A 5% reduction in the money supply will, according to most economists, reduce price 5%: a. In both the short run and long runs b. In neither the short nor long run c. In the short run but lead to unemployment in the long run d. In the long run but lead to unemployment in the short run 7. Monetary neutrality, the irrelevance of the money supply in determining values of _________ variables, is generally thought to be a property of the economy in the long run. a. Real b. Nominal c. Real and nominal d. Neither real nor nominal 8. When the Federal Reserve reduces the money supply, at a given price level the amount of output demanded is ________ and the aggregate demand curve shifts __________. a. Greater; inward b. Greater; outward c. Lower; inward d. Lower; outward 9. If the short run aggregate supply curve is horizontal and the long run aggregate supply curve is vertical, then a change in the money supply will change ________ in the short run and change _______ in the long run. a. Only prices; only output b. Only output; only prices c. Both prices and output; only prices d. Both prices and output; both prices and output Hoda Karasky 10. An adverse supply shock ______ the short run aggregate supply curve ______ the natural level of output. a. Raises; but cannot affect b. Raises; and may also lower c. Lowers; but cannot affect d. Lowers; and may also lower Chapter 11: Aggregate Demand I: Building the IS-LM Model IS-LM model- the model of aggregate demand IS curve- investment and savings; goods and services market LM curve- liquidity and money; money market Keynesian cross- o o Government purchases multiplier- o Hoda Karasky Tax multiplier- o Theory of liquidity preferences- the interest rate is determined by money supply and money demand Practice Questions for Chapter 11: 1. The IS-LM model takes _________ as exogenous. a. The price level and national income b. The price level c. National income d. The interest rate 2. In the Keynesian cross model, if the MPC equals 0.75, then a $1 billion increase in government spending increases planned expenditures by _______ and increases the equilibrium level of income by ________. a. $1 billion; more than $1 billion b. $0.75 billion; more than $0.75 billion c. $0.75 billion; $0.75 billion d. $1 billion; $1 billion 3. Tax cuts stimulate _________ by improving workers’ incentive and expand __________ by raising households’ disposable income. a. Velocity; demand for loanable funds b. Demand for loanable funds; velocity c. Aggregate demand; aggregate supply d. Aggregate supply; aggregate demand 4. In the Keynesian cross model, a decrease in the interest rate ___________ planned investment spending and ___________ the equilibrium level of income. a. Increases; increases b. Increases; decreases c. Decreases; decreases d. Decreases; increases 5. Changes in fiscal policy shift the: a. LM curve b. Money demand curve c. Money supply curve d. IS curve 6. According to the theory of liquidity preference, if the demand for real money balances exceeds the supply of real money balances, individuals will: a. Sell interest earning assets in order to obtain non interest bearing money Hoda Karasky b. Purchase interest earning assets in order to reduce holdings of non interest bearing money c. Purchase fewer goods and services d. Be content with their portfolios 7. An increase in income raises money ________ and _________ the equilibrium interest rate. a. Demand; raises b. Demand; lowers c. Supply; raises d. Supply; lowers 8. Equilibrium levels of income and interest rates are ________ related in the goods and services market, and equilibrium levels of income and interest rates are _______ related in the market for real money balances. a. Positively; positively b. Positively; negatively c. Negatively; negatively d. Negatively; positively 9. In the Keynesian cross analysis, if the consumption function is given by C= 100+ 0.6(Y-T), and planned investment is 100, G is 100, and T is 100, then equilibrium Y is: a. 350 b. 400 c. 600 d. 750 d 10. Assume that the money demanded function is (M/P) = 2,200 – 200r, where r is the interest rate in percent. The money supply M is 2,000 and the price level P is 2. If the price level is fixed and the Fed wants to fix the interest rate at 7 percent, it should set the money supply at: a. 2,000 b. 1,800 c. 1,600 d. 1,400 Chapter 12: Aggregate Demand II: Applying the IS-LM Model Equilibrium in the IS-LM model: The intersection determines the unique combination of Y and r that satisfies equilibrium in o o Uses of the IS-LM model: fiscal policy: G and/or T monetary policy: M Hoda Karasky o Fiscal: o o Monetary: o Monetary transmission- an increase in the money supply lowers the interest rate, which stimulates investment and thereby expands the demand for goods and services IS shocks- exogenous changes in the demand for goods and services LM shocks- exogenous changes in the demand for money Pigou effect- the increase in consumer spending that results when a fall in the price level raises real money balances and, thereby, consumers’ wealth Debt-deflation theory- a theory according to which an unexpected fall in the price level redistributes real wealth from debtors to creditors and, therefore, reduces total spending in the economy Practice Questions for Chapter 12: 1. In the IS-LM model, a decrease in government purchases leads to a(n) ________ in planned expenditures, a(n) ________ in total income, a(n) _________ in money demand, and a(n) __________ in the equilibrium interest rate. a. Decrease; decrease; decrease; decrease b. Increase; increase; increase; increase c. Decrease; decrease; increase; increase d. Increase; increase; decrease; decrease 2. In the IS-LM model under the usual conditions in a closed economy, an increase in government spending increases the interest rate and crowds out: Hoda Karasky a. Prices b. Investment c. The money supply d. Taxes 3. In the IS-LM model when M/P rises, in short run equilibrium, in the usual case the interest rate ________ and output __________. a. Rises; falls b. Rises; rises c. Falls; rises d. Falls; falls 4. If taxes are raised, but the Fed prevents income from falling by raising the money supply, then: a. Both consumption and investment remain unchanged b. Consumption rises but investment falls c. Investment rises but consumption falls d. Both consumption and investment fall 5. An increase in the demand for money, at any given income level and level of interest rates, will, within the IS-LM framework, ______ output and ________ interest rates. a. Increase; lower b. Increase; raise c. Lower; lower d. Lower; raise 6. The aggregate demand curve generally slopes downward and to the right because, for any given money supply M a high price liven P causes a _________ real money supply M/P, which _________ the interest rate and _________ spending. a. Lower; raises; reduces b. Higher; lowers; increases c. Lower; lowers; increases d. Higher; raises; reduces 7. A decrease in the price level shifts the ________ curve to the right, and the aggregate demand curve _________. a. IS, shifts to the right b. IS, does not shift c. LM, shifts to the right d. LM, does not shift 8. Analysis of the short and long runs indicates that the ________ assumptions are most appropriate in ____________. a. Classical; both the short and long runs b. Keynesian; both the short and long runs c. Classical; the short run, whereas the Keynesian assumptions are most appropriate in the long run d. Keynesian; the short run, whereas the classical assumptions are most appropriate in the long run 9. The Pigou effect suggests that falling prices will increase income because real balances influence _______ and will shift the ____ curve. a. Money demand; LM b. The money supply; LM c. Consumer spending; IS d. Government spending; IS EC 309 Hoda Karasky 10. If consumption is given by C= 200+ 0.75(Y-T) and investment is given by I= 200- 25r, then the formula for the IS curve is: a. Y= 400 – 0.75T -25r +G b. Y= 1,600 – 3T -11r +4G c. Y= 400+ 0.75T- 25r – G d. Y= 1,600 +3T – 100r - 4G Chapter 13: The Open Economy Revisited: The Mundell Fleming Model Mundell Fleming model o IS curve: o Floating exchange rates- e is allowed to fluctuate in response to changing economic conditions Fixed exchange rates- the central bank trades domestic for foreign currency at a predetermined price Fiscal Floating Monetary Floating o Trade Floating Hoda Karasky o Fiscal Fixed Monetary Fixed o Trade Fixed o Country risk- the risk that the country’s borrowers will default on their loan repayments because of political or economic turmoil; lenders require a higher interest rate to compensate them for this risk Expected exchange rate changes- if a country’s exchange rate is expected to fall, then its borrowers must pay a higher interest rate to compensate lenders for the expected currency depreciation Practice Questions for Chapter 13: 1. In the Mundell Fleming model, the domestic interest rate is determined by the: a. Intersection of the LM and IS curves b. Domestic rate of inflation c. World rate of inflation d. World interest rate 2. In a small open economy with a floating exchange rate, the exchange rate will appreciate if: a. The money supply is increased b. The money supply is decreased Hoda Karasky c. Government spending is decreased d. Taxes are increased 3. In a small open economy with a floating exchange rate, the supply of real money balances is fixed and a rise in government spending: a. Raises the interest rate, so that income must rise to maintain equilibrium in the money market b. Raises the interest rate so that net exports must fall to maintain equilibrium in the goods market c. Cannot change the interest rate so that net exports must fall to maintain equilibrium in the goods market d. Cannot change the interest rate so income must rise to maintain equilibrium in the money market 4. To maintain a fixed exchange rate system, if the exchange rate moves below the fixed exchange rate level, then the central bank must: a. Buy foreign currency b. Sell foreign currency from reserves c. Raise taxes d. Decrease government spending 5. In a small open economy with a fixed exchange rate, an effective policy to increase equilibrium output is to: a. Decrease government spending b. Decrease taxes c. Increase the money supply d. Decrease the money supply 6. In the Mundell Fleming model with fixed exchange rates, attempts by the central bank to decrease the money supply: a. Lead to a lower equilibrium level of income b. Lead to a higher equilibrium level of income c. Must be abandoned in order to maintain the fixed exchange rate d. Must be offset by expansionary fiscal policy 7. The risk premium included in the interest rate of small open economies incorporates: a. Country risk and expectations of future exchange rate changes b. The law of one price c. Inefficient activity by arbitrageurs d. Capital mobility 8. The “impossible trinity” refers to the idea that it is impossible for a country to simultaneously have: a. Low inflation, low unemployment, and rapid rate of GDP growth b. Free capital flows, a fixed exchange rate, and an independent monetary policy c. High interest rates, a budget deficit, and a trade deficit d. An expansionary fiscal policy, a contractionary monetary policy, and a flexible exchange rate 9. In the Mundell Fleming model, if the price level falls, then the equilibrium income a. Rises and the real exchange rate appreciates b. Rises and the real exchange rate depreciates c. Falls and the real exchange rate appreciates d. Falls and the real exchange rate depreciates Hoda Karasky 10. A fall in consumer confidence about the future, which induces consumers to spend less and save more, will, according to the Mundell Fleming model with floating exchange rates, lead to: a. A fall in consumption and income b. No change in consumption or income c. No change in income but a rise in net exports d. No change in income or net exports Chapter 14: Aggregate Supply and the Short-run Tradeoff Between Inflation and Unemployment Sticky price model: o long-term contracts between firms and customers o menu costs o firms not wishing to annoy customers with frequent price changes p a(YP Y ) o o Imperfect information model: o All wages and prices are perfectly flexible; all markets are clear. o Each supplier produces one good, consumes many goods. o Each supplier knows the nominal price of the good she produces, but does not know the overall price level Phillip’s curve- states that inflation depends on: EC 309 Hoda Karasky o expected inflation, E. o cyclical unemployment: the deviation of the actual rate of unemployment from the natural rate o supply shocks n E ( u ) u o Adaptive expectations- an approach that assumes people form their expectations of future inflation based on recently observed inflation Cost-push inflation- inflation resulting from supply shocks o Adverse supply shocks typically raise production costs and induce firms to raise prices, “pushing” inflation up. Demand-pull inflation- inflation resulting from demand shocks o Positive shocks to aggregate demand cause unemployment to fall below its natural rate, which “pulls” the inflation rate up Sacrifice ratio- measures the percentage of a year’s real GDP that must be foregone to reduce inflation by 1 percentage point Rational expectations- people base their expectations on all available information, including information about current and prospective future policies Practice Questions for Chapter 14: 1. According to the sticky price model, other things being equal, the greater the proportion, s, of firms that follow the sticky price rule, the ______ the ______ in output in response to an unexpected price increase. a. Greater; increase b. Smaller; increase c. Greater; decrease d. Greater; increase 2. The imperfect information model bases the difference in the short run and long run aggregate supply curve on: a. Sticky wages b. Sticky prices c. Temporary misperceptions about prices Hoda Karasky d. Procyclical real wages 3. Both models of aggregate supply discussed in Chapter 14 imply that if the price level is higher than expected, then output _______ natural rate of output. a. Exceeds the b. Falls below the c. Equals the d. Moves to a different 4. In the short run, if the price level is greater than the expected price level, then in the long run the aggregate: a. Demand curve will shift leftward b. Demand curve will shift rightward c. Supply curve will shift upward d. Supply curve will shift downward 5. The Phillips curve depends on all of the following forces except a. The current exchange rate b. Expected inflation c. The deviation of unemployment from its natural rate d. Supply shocks 6. The classical dichotomy breaks down for a Phillips curve, which shows the relationship between a nominal variable, _______, and a real variable _________. a. Output; prices b. Money; output c. Inflation; unemployment d. Unemployment; inflation 7. Inflation inertia is represented in the aggregate supply- aggregate demand model by continuing upward shifts in the: a. Aggregate demand curve b. Short run aggregate supply curve c. Long run aggregate supply curve d. Aggregate demand and short run aggregate supply curves 8. In the case of demand-pull inflation, other things being equal: a. Both the inflation rate and the unemployment rate rise at the same time b. The unemployment rate rises but the inflation rate falls c. The inflation rate rises but the unemployment rate falls d. Both the inflation rate and the unemployment rate fall 9. The government can lower inflation with a low sacrifice ratio if the: a. Money supply is reduced slowly b. Public has adaptive expectations c. Short run aggregate supply schedule is relatively flat d. Public believes that policymakers are committed to reducing inflation 10. Assume that an economy has the usual type of Phillips curve except that the natural rate of unemployment in an economy is given by an average of the unemployment rates in the last two years. Then, there is: a. A long run tradeoff between inflation and unemployment b. No long run tradeoff between inflation and unemployment c. No short run tradeoff between inflation and unemployment d. A sacrifice ratio that is large but not infinite
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