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Macroeconomics Exam 2 Flash cards

The origin of the idea of a trade-off between inflation and unemployment was a 1958 article by
A.W. Phillips.
Phillips’s research looked at British data on
unemployment and nominal wage growth.
The negative relationship between unemployment and inflation is known as the
Phillips curve.
The Phillips curve appeared to fit the data well for the United States in the
1960s.
Friedman and Phelps suggested that there should not be a stable relationship between inflation and unemployment, but there should be a stable relationship between
unanticipated inflation and cyclical unemployment.
Milton Friedman and Edmund Phelps questioned
the stability of the relationship between inflation and unemployment.
In the extended classical model, an anticipated decrease in the money supply would cause output to ________ and the price level to ________ in the short run.
remain unchanged; decrease
In the extended classical model, an unanticipated increase in the money supply would cause output to ________ and the price level to ________ in the short run.
increase; increase
In the extended classical model, an unexpected decrease in aggregate demand would cause unanticipated inflation to be ________ and cyclical unemployment to be ________.
negative; positive
In the expectations-augmented Phillips curve, ? = ? e – 3(u – ). If ? = 0.03 when ? e = 0.06 and u = 0.06, then =
0.05.
In the expectations-augmented Phillips curve, ? = ? e – 3(u – ). If ? = 0.06 when ? e = 0.06 and u = 0.04, then =
0.04.
In the expectations-augmented Phillips curve, ? = ? e – 3(u – ). If ? = 0.09 when ? e = 0.06 and u = 0.02, then =
0.03.
In the expectations-augmented Phillips curve, ? = ? e – 3(u – 0.06). When ? = 0.06 and ? e = 0.03, the unemployment rate is
0.05.
In the expectations-augmented Phillips curve, ? = ? e – 3(u – 0.05). When ? = 0.06 and ? e = 0.03, the unemployment rate is
0.04.
In the expectations-augmented Phillips curve, ? = ? e – 3(u – 0.05). When ? = 0.03 and ? e = 0.06, the unemployment rate is
0.06.
The Phillips curve is the relation between inflation and unemployment that holds for a given natural rate of unemployment and a
given expected rate of inflation.
Suppose most people had anticipated that inflation would be 3% in the coming year because the Fed would increase the money supply by 3%. Instead, the Fed increases the money supply by 5%. In the short run, this would cause actual output to be ________ full-employment output and prices to increase by ________ 3%.
above; more than
An increase in the expected rate of inflation would
shift the Phillips curve upward.
If the expected inflation rate is unchanged, a fall in the natural rate of unemployment would
shift the Phillips curve to the left.
If the expected rate of inflation rose at the same time the natural rate of unemployment rose, the Phillips curve
would shift up.
A beneficial supply shock would cause
the short-run Phillips curve to shift downward and to the left.
Classicals argue that an adverse supply shock would
raise both the natural rate of unemployment and the actual rate of unemployment.
Historically, Brazil has suffered higher and more variable rates of inflation than Venezuela. You would expect the short-run aggregate supply curve of Brazil to be ________ than that of Venezuela, and the Phillips curve of Brazil to be ________ than that of Venezuela.
steeper; steeper
The Friedman-Phelps analysis shows that a negative relationship between inflation and unemployment holds
as long as the expected inflation rate and the natural rate of unemployment are approximately constant.
The Phillips curve shifted during the 1970s primarily because of
the two large oil price shocks.
Examining data on cyclical unemployment plotted against unanticipated inflation shows
a negative relationship.
The Friedman-Phelps analysis suggests that there is a long-term relationship between
unanticipated inflation and cyclical unemployment.
An analysis of the American economy since 1960 shows that there is a stable relationship between inflation and unemployment
only in the short run.
Both classicals and Keynesians agree that policymakers
cannot keep the unemployment rate permanently below the natural rate
by permanently running a high rate of inflation.
The Lucas critique is an objection to the assumption that
historical relationships between macroeconomic variables will continue to hold after new
policies are in place
The argument that when policy changes, people’s behavior changes so that historical relationships between macroeconomic variables will no longer hold is known as
the Lucas critique.
The long-run Phillips curve is
vertical.
The fact that the long-run Phillips curve is vertical implies that
money is neutral in the long run.
When the economy goes into a recession, there’s an increase in
cyclical unemployment.
According to Okun’s law, if full-employment output is $5000 billion, then each percentage point of unemployment sustained for one year reduces output by
$100 billion.
Some economists argue that Okun’s Law overstates the cost of cyclical unemployment because
it ignores the fact that leisure increases during a recession.
The natural rate of unemployment in the United States generally ________ from 1960 to 1980 and ________ from 1980 to 1995.
rose; fell
One reason for the fall in the natural rate of unemployment since 1980 is
changes in the demographic composition of the work force.
The bulk of the decline in the natural rate of unemployment since 1980 is because of
a decline in the share of young workers in the labor force.
A difficulty faced by policymakers who wish to use the unemployment rate as a guide to whether the economy is weak or strong is that
the natural rate of unemployment is hard to measure.
Because the natural rate of unemployment is not known precisely, policymakers who use it as a guide for policy must be
less aggressive with policy changes than they would be if they knew the value of the natural rate.
One cost of a perfectly anticipated inflation is that it
increases menu costs.
The costs in time and effort incurred by people and firms who are trying to minimize their holdings of cash because of inflation are called
shoe leather costs.
Shoe leather costs are
the costs in time and effort incurred by people and firms who are trying to minimize their holdings of cash because of inflation.
When actual inflation is greater than expected inflation
there are transfers from lenders to borrowers.
One cost of an unanticipated inflation is that it
transfers wealth from lenders to borrowers.
A COLA is
a cost of living adjustment.
Hyperinflation occurs when
the inflation rate is extremely high.
The reduction of the inflation rate is called
disinflation.
The costs of disinflation would be low if
expected inflation falls as inflation falls.
A rapid and decisive reduction in the rate of growth of the money supply for the purpose of disinflation is called
a cold turkey policy.
Keynesians prefer a disinflation policy of
gradualism
The sacrifice ratio is
the amount of output lost when the inflation rate is reduced by one percentage point.
The amount of output lost when the inflation rate is reduced by one percentage point is called
the sacrifice ratio.
Ball found that the disinflation of the early 1980s in the United States had a sacrifice ratio of about
2.
Ball’s research showed that the sacrifice ratio
varied considerably across countries.
Ball found that an important factor affecting the sacrifice ratio is
the flexibility of the labor market.
Countries in which wages adjust slowly to changes in the supply of and demand for labor are likely to have ________ sacrifice ratio.
a high
Countries in which wages adjust rapidly to changes in the supply and demand for labor are likely to have ________ sacrifice ratio.
a low
Countries in which the government does not regulate the labor market are likely to have ________ sacrifice ratio.
a low
Ball’s research on disinflation across different countries found that
costs of disinflation were smaller for rapid disinflation than for gradual disinflation.
If a rapid disinflation has a lower sacrifice ratio than a slow disinflation, then reducing inflation is best accomplished by
a cold-turkey approach.
a cold-turkey approach.
the credibility of the central bank.
Inflation expectations in the United States generally
rose from 1971 to 1982, then fell from 1982 to 2000, and have been stable since then.
Keynesians are skeptical of the classical theory that recessions are periods of increased mismatch between workers and jobs because
help-wanted advertising falls during recessions.
The gift exchange motive suggests that
workers who feel well treated will work harder and more efficiently.
A model in which workers won’t be concerned about the possibility of being fired if they don’t work hard, because their wage is so low, is called
a shirking model.
The effort curve is
s-shaped, because a small increase in the real wage will increase work effort more at an intermediate wage than at a low wage or at a high wage.
According to the efficiency wage model, firms will pay the real wage that
maximizes effort per dollar of real wage.
Assuming no change in the effort curve of employees, the efficiency wage model implies that
the real wage is rigid and equals the efficiency wage.
A firm faces the following relationship between the real wage it pays and the effort exerted by its workers.

Real Wage Effort (E)
10 20
11 24
12 27
13 29

The marginal product of labor for this firm is given by MPN = E (100 – N)/9. The firm will choose to pay a wage such that the effort level is

27.
A firm faces the following relationship between the real wage it pays and the effort exerted by its workers.

Real Wage Effort (E)
10 20
11 24
12 27
13 29

The marginal product of labor for this firm is given by MPN = E (100 – N)/9. How many workers will the firm employ?

96
In the efficiency wage model with the efficiency wage above the market-clearing wage, the level of employment depends on
labor demand alone.
In the efficiency wage model with the efficiency wage above the market-clearing wage, when employment is at its full-employment level
there is an excess supply of labor.
In the efficiency wage model, an increase in productivity will cause
In the efficiency wage model, an increase in productivity will cause
In the efficiency wage model, if the real wage is higher than the market-clearing wage so that there is an excess supply of labor,
employers will not hire workers who are willing to work for a lower wage.
According to the efficiency wage model, during a recession, firms will not reduce real wages because
this would reduce worker effort and productivity.
The efficiency wage model can be modified to allow real wages to vary over the business cycle by assuming that
workers’ effort may depend on the unemployment rate and the real wage.
In the Keynesian model, the real wage is mildly procyclical because
workers’ effort may depend on the unemployment rate and the real wage.
In the efficiency wage model, an increase in productivity would
increase output but have no effect on the real wage.
In the Keynesian model with efficiency wages,
the full-employment level is determined at the intersection of the labor demand curve and the efficiency wage line.
A firm is a price taker if it
always sells its output at the industry-determined price.
A model in which individual producers act as price setters, because there are only a few sellers and the product they sell is not standardized, is called
imperfect competition.
In the Keynesian model, firms are best characterized as
monopolistically competitive.
When the demand for an imperfect competitor’s product is greater than it planned, the firm will
meet the demand at its set price.
If the menu cost theory is true, then firms that change prices less frequently than other firms are likely to be in
less competitive industries.
The theory that firms will be slow to change their products’ prices in response to changes in demand because there are costs to changing prices is called
menu cost theory.
According to the menu cost theory, firms will be slow in changing their prices because
the cost of changing the price might exceed the additional revenue the price change would generate.
The cost to a firm of producing one more unit of output
is the firm’s marginal cost.
In setting the price of its product, a monopolistic competitor sets the price equal to its marginal cost plus an amount called the
markup.
Because of price stickiness in the Keynesian model, a decline in investment demand will not cause the
LM curve to shift down and to the right in the short run.
In the Keynesian model in the short run, the amount of employment is determined by the effective labor demand curve and the level of
output.
In the Keynesian model, short-run equilibrium occurs
where the IS and LM curves intersect.
In the Keynesian model, when the economy is not in long-run equilibrium, then the short-run equilibrium point is not on which curve?
FE
In the Keynesian model in the short run, a decrease in the money supply will cause
a decrease in output and an increase in the real interest rate.
The distinguishing feature that determines whether an analysis is classical or Keynesian is
the speed of price adjustment.
In the Keynesian model, money is
neutral in the long run, but not in the short run.
In the Keynesian model in the long run, a decrease in the money supply will cause
no change in either the real interest rate or output.
In the Keynesian model, which curve is vertical?
LRAS
In the Keynesian model in the long run, a decrease in the money supply will cause ________ in the real interest rate and ________ in the price level.
no change; a decrease
According to Keynesians, the primary reason money is not neutral is
price stickiness.
In the Keynesian model in the long run, an increase in the money supply will raise
the price level but not the level of output.
Using the Keynesian model, the effect of an increase in the effective tax rate on capital would be to cause ________ in the real interest rate and ________ in output in the short run.
a decrease; a decrease
Using the Keynesian model, the effect of a decrease in the effective tax rate on capital would be to cause ________ in the real interest rate and ________ in output in the long run.
an increase; no change
Using the Keynesian model, the effect of a government-imposed ceiling on interest rates paid on personal checking accounts that is lower than the current market interest rate would be to cause ________ in the real interest rate and ________ in output in the short run.
a decrease; an increase
In the Keynesian model, an increase in government purchases affects output by
increasing aggregate demand as national saving declines.
In the Keynesian model in the short run, a decrease in government purchases causes output to ________ and the real interest rate to ________.
fall; fall
In the Keynesian model in the long run, an increase in taxes causes the price level to ________ and the real interest rate to ________.
fall; fall
Suppose the government decided to tighten monetary policy and decrease government expenditures. In the short run in the Keynesian model, the effect of these policies would be to ________ the real interest rate and ________ the level of output.
have an ambiguous effect on; decrease
Suppose the government decided to ease monetary policy and then increase taxes. In the short run in the Keynesian model, the effect of these policies would be to ________ the real interest rate and ________ the level of output.
lower; have an ambiguous effect on
The 1980s were characterized by ________ monetary policy and ________ fiscal policy.
tight; easy
Easy monetary policy and tight fiscal policy lead to
low real interest rates.
According to Keynesians, the primary source of business cycle fluctuations is
aggregate demand shocks.
The Keynesian theory is consistent with the business cycle fact that inflation is
procyclical and lagging.
The idea that, in order to avoid the costs of hiring and training, firms in a recession retain some workers they would otherwise lay off, is called
labor hoarding.
The use of macroeconomic policies to smooth or moderate the business cycle is known as
aggregate demand management.
In the Keynesian model, the difference between using monetary and fiscal policy to eliminate a recession is that
an expansionary monetary policy will leave the economy with a lower real interest rate than an expansionary fiscal policy.
In the Keynesian model, the difference between no intervention by the government during a recession and intervention using expansionary monetary or fiscal policy is that no intervention will return the economy to its equilibrium level of output
slower than intervention will and at a lower price level.
A problem with the use of aggregate demand management to stabilize the business cycle is that
the precise amount that output will change in response to monetary or fiscal policy isn’t known.
In the 1990s, nominal interest rates in Japan were approximately
0%.
A situation in which expansionary monetary policy has no effect on the economy is known as
a liquidity trap.
Bernanke suggested methods for monetary policy to deal with the lower bound, including all of the following EXCEPT
tightening monetary policy more aggressively.
Worries about the zero bound from 2002 to 2005 led the Fed to
keep the Federal funds rate below the inflation rate.
In the long run in the Keynesian model, a beneficial supply shock would leave the economy with a higher level of output, but also a ________ real interest rate and a ________ price level.
lower; lower
In the short run in the Keynesian model, a sharp increase in oil prices would leave the economy with a ________ level of output and a ________ real interest rate.
lower; higher
Recent research by Keynesians and classicals has led to
a reconciliation of the types of models they use.
The theory that real shocks to the economy are the primary cause of business cycles is
real business cycle theory.
Which of the following is not a primary cause of business cycle fluctuations, according to real business cycle theory?
A change in the money supply
The distinction between real and nominal shocks is that
real shocks directly affect only the IS curve or the FE line, but not the LM curve.
Real business cycle theorists think that most business cycle fluctuations are caused by shocks to
the production function.
Which of the following is an example of a productivity shock?
The introduction of new management techniques
A temporary adverse productivity shock would
decrease the level of employment.
In the classical IS-LM/AD-AS model, a beneficial productivity shock would ________ output, ________ the real interest rate, and ________ the price level.
increase; decrease; decrease
An adverse supply shock would directly ________ labor productivity by changing the amount of output that can be produced with any given amount of capital and labor. It would also indirectly ________ average labor productivity through changes in the level of employment.
decrease; increase
When RBC economists work out a detailed numerical example of a more general theory, they are performing
calibration
When RBC economists compare the volatility in their models to the data, what are they looking at?
The amount of random variation in economic variables
When RBC economists compare the correlations in their models to the data, what are they looking at?
The degree to which different economic variables move together
The most common measure of productivity shocks is known as
the Solow residual.
The Solow residual is
the most common measure of productivity shocks.
Given data on capital (K), labor (N), and output (Y), and estimates of capital’s share of output (a), the Solow residual is measured as
Y / (Ka N1-a).
The formula Y / (Ka N1-a) provides a calculation of
the Solow residual.
Measures of the Solow residual show it to be
strongly procyclical.
One important reason why the Solow residual may be strongly procyclical even if the actual technology used in production doesn’t change is that
resource utilization is procyclical.
If the utilization rates of capital (uK) and labor (uN) are procyclical, then the Solow residual, as conventionally measured, is
A u(a/K) u [(1-a)/N]
Labor hoarding occurs when
because of hiring and firing costs, firms retain workers in a recession that they would otherwise lay off.
Braun and Evans found that
the measured Solow residual varied sharply over the seasons.
Critics of the RBC approach argue that it’s hard to find productivity shocks large enough to cause business cycles. What is the RBC counterargument to this criticism?
Business cycles could be caused by the cumulation of small productivity shocks.
Models that are similar to RBC models but allow for shocks other than productivity shocks are known as
DSGE models.
DSGE models are
similar to RBC models but allow for shocks other than productivity shocks.
A temporary increase in government purchases in the classical model would
shift the labor supply curve to the right.
In the classical model, a temporary increase in government purchases causes
an increase in output and the real interest rate.
In the classical model, a temporary decrease in government spending would cause a decrease in
output, employment, the real interest rate, and the price level.
Classical economists would cite all of the following as reasons why the government cannot smooth out the business cycle EXCEPT that
only productivity shocks can cause real fluctuations in the business cycle.
According to classical economists, the government should increase government purchases when
the benefits of the spending exceed the costs.
According to classical economists, the increase in unemployment in recessions is caused by
a mismatch of workers and jobs.
According to classical economists, unemployment rises in recessions due to an increase in ________ unemployment, not ________ unemployment.
frictional and structural; cyclical
Davis and Haltiwanger showed that ________ churning of jobs occurs and that this churning reflects closing of old plants and opening of new ones ________.
much; within the same industry
In recession years, ________ jobs are lost than created, and vacancies and job openings ________.
more; decline
The term household production refers to
output produced at home.
A household-production model more closely matches the U.S. data than a standard RBC model because it has a
higher standard deviation of market output.
Assuming that money is neutral, an increase in the nominal money supply would cause
a rise in nominal wages.
Assuming money neutrality in the classical model, a 10% increase in the nominal money supply would cause
no change in the real money supply.
The idea that expected future increases in output cause increases in the current money supply and that expected future decreases in output cause decreases in the current money supply, rather than the other way around, is known as
reverse causation.
Reverse causation is the idea that
expected future increases in output cause increases in the current money supply.
The basic classical model can account for the procyclical behavior of money if there
is reverse causation from future output to money.
Friedman and Schwarz argue that money is not neutral because
they found several historical incidents in which changes in the money supply were not responses to macroeconomic conditions, and output moved in the same direction as money.
You and a friend are arguing over the issue of the nonneutrality of money. You believe that money is not neutral, and to prove your point you would cite all of the following EXCEPT
the fact that every recession was preceded by a drop in the money supply.
The misperceptions theory was originally proposed by ________ and rigorously formulated by ________.
Milton Friedman; Robert Lucas
If producers have imperfect information about the general price level and sometimes misinterpret changes in the general price level as changes in relative prices, then
the short-run aggregate supply curve slopes upward.
The short-run aggregate supply curve can slope upward because
producers have misperceptions about the aggregate price level.
According to the misperceptions theory, when the aggregate price level is higher than expected,
the aggregate quantity of output supplied rises above the full-employment level.
According to the misperceptions theory, when the price level falls below the expected price level
the economy moves along its SRAS curve.
If you expect a general price increase of 5% this year and the price of the hamburgers you sell increases by 10%, you would conclude that the relative price of your good has
increased, and you would increase your output.
You are likely to think that the relative price of your good has risen and you should increase your output if you expected
the inflation rate to be 10% and the price of your good rose 13%.
Short-run aggregate supply is greater than long-run aggregate supply in the misperceptions theory if
the actual price level is greater than the expected price level.
Which of the following equations is most likely to represent short-run aggregate supply according to the misperceptions theory?
Y = 6000 + 50(P – P^c)
According to the misperceptions theory, when P < Pc, output is ________ its full-employment level and the short-run aggregate supply curve must shift ________ to restore full employment.
below; downward
According to the misperceptions theory, the amount by which producers increase their output when the general price level rises depends on
how much they think their relative prices have increased.
If producers believe that the increase in their relative prices is small relative to the increase in the general price level, then the slope of the short-run aggregate supply curve will be
large
If producers believe that the increase in their relative prices is large relative to the increase in the general price level, then the slope of the short-run aggregate supply curve will be
small
According to the misperceptions theory, an unanticipated decrease in the money supply shifts the AD curve ________, causing output to ________ in the short run.
down and to the left; fall
According to the misperceptions theory, after an unanticipated increase in the money supply has occurred, the SRAS curve must shift ________ to restore general equilibrium; as it does so, the price level ________.
upward; rises
According to the misperceptions theory, an anticipated decline in the money supply leads to a shift of the AD curve ________ and a shift of the SRAS curve ________.
down and to the left; downward
According to the misperceptions theory, an anticipated 10% decrease in the money supply leads to a short-run reduction in the price level of
10%.
Which of the following statements is true about the misperceptions theory?
Unanticipated changes in the nominal money supply have real effects, but anticipated changes are neutral.
If the money supply grows 7% during the year, and people expected the money supply to grow by 5%, what happens to the short-run aggregate supply curve, according to the misperceptions theory?
it shifts down
According to the misperceptions theory, if the Fed wanted to use monetary policy to influence the real economy it would have to
surprise the public with unexpected changes in monetary policy.
The reason why some economists believe that attempts by the Fed to surprise the public in a systematic way cannot be successful is that
the public would eventually figure out what the Fed’s policies were, negating the Fed’s surprise.
The primary reason why the Fed cannot systematically surprise the public with its monetary policy is
the presence of rational expectations among the public.
The theory of rational expectations suggests that
people make intelligent use of available information.
According to the misperceptions theory, short-lived shocks may have long-term effects on the economy because of
propagation mechanisms.
The primary reason that short-lived shocks can have long-run effects is
the presence of propagation mechanisms.
The FE line shows the level of output at which the ________ market is in equilibrium.
Labor
The FE line
is vertical.
The FE line is vertical because the level of output at full employment doesn’t depend on the
real interest rate.
Which of the following would shift the FE line to the right?
An increase in labor supply
Which of the following would shift the FE line to the left?
A decrease in the capital stock
An increase in the money supply would cause the FE line to
remain unchanged.
An increase in investment spending would cause the FE line to
remain unchanged.
An adverse supply shock would cause the FE line to
shift to the left.
Describe what happens to the FE line if government purchases increase.
In the classical model of the labor market, the rise in government purchases reduces people’s perceived wealth, so they increase their labor supply. The increase in labor supply results in a new labor market equilibrium with increased employment and a lower real wage. The higher level of employment shifts the FE line to the right.
The IS curve shows the combinations of output and the real interest rate for which
the goods market is in equilibrium.
The IS curve
slopes downward.
Any change that reduces desired saving relative to desired investment (for a given level of output) causes the real interest rate to ________ and shifts the IS curve ________.
increase; up and to the right
A decline in expected future output would cause the IS curve to
shift down and to the left.
A decrease in the effective tax rate on capital would cause the IS curve to
shift up and to the right.
An increase in labor supply would cause the IS curve to
remain unchanged.
An increase in the money supply would cause the IS curve to
remain unchanged.
A temporary decline in productivity would cause the IS curve to
remain unchanged.
A decrease in wealth would cause the IS curve to
shift down and to the left.
An increase in the expected future marginal product of capital would cause the IS curve to
shift up and to the right.
The IS curve would unambiguously shift up and to the right if there were
an increase in both government purchases and the expected future marginal product of capital.
Draw a saving-investment diagram to show how each of the following changes shifts the IS curve.
(a) Future income rises.
(b) The future marginal productivity of capital increases.
(c) Government purchases decrease temporarily.
(d) The effective corporate tax rate increases.
(a) IS shifts up and to the right.
(b) IS shifts up and to the right.
(c) IS shifts down and to the left.
(d) IS shifts down and to the left.
A rise in the price of a bond causes the yield of the bond to
fall
A decline in the price of a bond causes the yield of the bond to
rise
The LM curve
slopes upward.
Looking only at the asset market, an increase in output would cause
an increase in the real interest rate along the LM curve.
A change that increases the real money supply relative to real money demand causes
the LM curve to shift down and to the right.
A change that increases real money demand relative to the real money supply causes
the LM curve to shift up and to the left.
Banks decide to raise the interest rate they pay on checking accounts from 1% to 2%. This action would
increase money demand, shifting the LM curve up and to the left.
You have just read that the Federal Reserve has increased the money supply to avoid a recession. For a given price level, you would expect the LM curve to
shift down and to the right as the real money supply rises.
The Fed has announced that it plans to lower the rate of monetary growth from 10% per year to 2% per year. You would expect this announcement to directly
increase money demand, shifting the LM curve up and to the left.
The probable effect of introducing an increased number of automatic teller machines is to
decrease money demand, shifting the LM curve down and to the right.
An increase in wealth that doesn’t affect labor supply would cause the IS curve to ________ and the FE line to ________.
shift up and to the right; be unchanged
An increase in the effective tax rate on capital would cause the IS curve to ________ and the LM curve to ________.
shift down and to the left; be unchanged
When all markets in the economy are simultaneously in equilibrium, we say
there is general equilibrium.
To reach general equilibrium, the price level adjusts to shift the ________ until it intersects with the ________.
LM curve; FE line and IS curve
What adjusts to restore general equilibrium after a shock to the economy?
The LM curve
The IS-LM model predicts that a temporary beneficial supply shock
increases output, national saving, and investment, but not the real interest rate.
A temporary supply shock, such as a bumper crop, would
shift the FE line to the right and leave the IS curve unchanged.
A temporary supply shock, such as an increase in oil prices, would
have no effect on the IS curve.
You have just read that Australia has suffered a drought, destroying its wheat crop for this year. The effect of this adverse supply shock on Australia would probably be
an increase in prices and an increase in real interest rates.
A temporary adverse supply shock directly causes
a shift to the left of the FE line.
After a temporary beneficial supply shock hits the economy, general equilibrium is restored by
a shift down and to the right of the LM curve.
An adverse supply shock that is permanent shifts which curve in addition to the curves shifted by one that is temporary?
The IS curve
Which market adjusts the quickest in response to shocks to the economy?
The asset market
A temporary decrease in government purchases causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.
fall; fall
An increase in expected inflation causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.
fall; rise
Suppose the intersection of the IS and LM curves is to the left of the FE line. A decrease in the price level would most likely eliminate a disequilibrium among the asset, labor, and goods markets by
shifting the LM curve down and to the right.
Suppose the intersection of the IS and LM curves is to the left of the FE line. What would most likely eliminate a disequilibrium among the asset, labor, and goods markets?
A fall in the price level, shifting the LM curve down and to the right
Suppose the intersection of the IS and LM curves is to the right of the FE line. What would most likely eliminate a disequilibrium among the asset, labor, and goods markets?
A rise in the price level, shifting the LM curve up and to the left
A temporary decrease in government purchases causes the real interest rate to ________ and the price level to ________ in general equilibrium.
fall; fall
An increase in taxes (when Ricardian equivalence doesn’t hold) causes the real interest rate to ________ and the price level to ________ in general equilibrium.
fall; fall
For each of the following changes, what happens to the real interest rate and output in the very short run, before the price level has adjusted to restore general equilibrium?
(a) Wealth rises.
(b) Money supply rises.
(c) The future marginal productivity of capital increases.
(d) Expected inflation declines.
(e) Future income declines.
a) The IS curve shifts up and to the right, so r rises and Y rises.
(b) The LM curve shifts down and to the right, so r falls and Y rises.
(c) The IS curve shifts up and to the right, so r rises and Y rises.
(d) The LM curve shifts up and to the left, so r rises and Y falls.
(e) The IS curve shifts down and to the left, so r falls and Y falls.
A decrease in money supply causes the real interest rate to ________ and output to ________ in the short run, before prices adjust to restore equilibrium.
rise; fall
An increase in money supply causes the real interest rate to ________ and the price level to ________ in general equilibrium.
remain unchanged; rise
A decrease in money supply causes the real interest rate to ________ and the price level to ________ in general equilibrium.
remain unchanged; fall
Classical economists think general equilibrium is attained relatively quickly because
the price level adjusts quickly.
Keynesian economists think general equilibrium is not attained quickly because
the price level adjusts slowly.
Keynesian economists believe that in the short run,
money neutrality does not exist and prices do not adjust rapidly.
Classical economists believe that in the short run,
money neutrality exists and prices adjust rapidly.
Under monetary neutrality, an increase in the money supply causes output to ________ and the price level to ________.
not change; rise
Under an assumption of monetary neutrality, a change in the nominal money supply has
a proportionate effect on the price level.
Describe the differences between classical and Keynesian economists in terms of their views about monetary neutrality.
Keynesians believe that monetary neutrality holds in the long run but not in the short run. Classical economists are more accepting of the view that money is neutral even in the relatively short run.
The aggregate demand curve shows
the relation between the aggregate quantity of goods demanded and the price level.
The aggregate demand curve shows the combinations of output and the price level that put the economy on
the IS curve and the LM curve.
The aggregate demand curve
slopes downward.
Which of the following changes shifts the AD curve down and to the left?
A decrease in consumer confidence
Which of the following changes shifts the AD curve up and to the right?
A rise in the nominal money supply
The aggregate supply curve shows the relation between
the price level and the aggregate amount of output that firms supply.
The short-run aggregate supply curve (in the absence of misperceptions)
is horizontal.
The long-run aggregate supply curve
is vertical.
Which of the following changes shifts the SRAS curve up?
An increase in firms’ costs
Which of the following changes shifts the long-run aggregate supply curve to the right?
A demographic change that increases the labor supply
Which of the following changes shifts the SRAS curve down?
A decrease in firms’ costs
When the money supply rises by 10%, in the short run, output ________ and the price level ________.
rises; is unchanged
When the money supply declines by 10%, in the long run, output ________ and the price level ________.
is unchanged; falls

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