Intermediate Macro Mankiw Ch.7 12 Questions PDF

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Name TestBanks Chapter 7 Unemployment

Description
Instructions
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Multiple Choice 1 points
Question
The macroeconomic problem that affects individuals most directly and severely is:
Answer inflation.
unemployment.
low savings.
low investment.
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Question
The unemployment rate in the United States since 1952 has:
Answer never been close to zero.
gravitated toward a steady-state rate of zero.
remained constant from year to year.
equaled the natural rate of unemployment in every year.
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Question
The natural rate of unemployment in the United States since 1950 has averaged between ______ and ______ percent.
Answer 0; 1
1; 3
5; 6
10; 15
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Question
The natural rate of unemployment is:
Answer the average rate of unemployment around which the economy fluctuates.
about 10 percent of the labor force.
a rate that never changes.
the transition of individuals between employment and unemployment.
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Question
If the number of employed workers equals 200 million and the number of unemployed workers equals 20 million, the
unemployment rate equals ______ percent (rounded to the nearest percent).
Answer 0
9
10
20
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Question
In a steady state:
Answer no hiring or firings are occurring.
the number of people finding jobs equals the number of people losing jobs.
the number of people finding jobs exceeds the number of people losing jobs.
the number of people losing jobs exceeds the number of people finding jobs.
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Question
In the model of the steady-state unemployment rate with a fixed labor force, the rate of job finding equals the
percentage of the ______ who find a job each month, while the rate of job separation equals the percentage of the
______ who lose their job each month.
Answer labor force; labor force
labor force; unemployed
employed; labor force
unemployed; employed
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Question
A policy that increases the job-finding rate _____ the natural rate of unemployment.
Answer will increase
will decrease
will not change
could either increase or decrease
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Question
A policy that decreases the job separation rate _____ the natural rate of unemployment.
Answer will increase
will decrease
will not change
could either increase or decrease
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Question
If s is the rate of job separation, f is the rate of job finding, and both rates are constant, then the unemployment rate is
approximately:
Answer f/(f + s).
(f + s)/f.
s/(s + f).
(s + f)/s.
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Question
If the fraction of employed workers who lose their jobs each month (the rate of job separations) is 0.01 and the fraction
of the unemployed who find a job each month is 0.09 (the rate of job findings), then the natural rate of unemployment
is:
Answer 1 percent.
9 percent.
10 percent.
about 11 percent.
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Question
If the steady-state rate of unemployment equals 0.10 and the fraction of employed workers who lose their jobs each
month (the rate of job separations) is 0.02, then the fraction of unemployed workers who find jobs each month (the rate
of job findings) must be:
Answer 0.02.
0.08.
0.10.
0.18.
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Question
If the steady-state rate of unemployment equals 0.125 and the fraction of unemployed workers who find jobs each
month (the rate of job findings) is 0.56, then the fraction of employed workers who lose their jobs each month (the rate
of job separations) must be:
Answer 0.08.
0.125.
0.22.
0.435.
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Question
Any policy aimed at lowering the natural rate of unemployment must either ______ the rate of job separation or ______
the rate of job finding.
Answer reduce; reduce
increase; increase
reduce; increase
increase; reduce
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Question
One reason for unemployment is that:
Answer it takes time to match workers and jobs.
all jobs are identical.
the labor market is always in equilibrium.
a laid-off worker can immediately find a new job at the market wage.
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Question
All of the following are reasons for frictional unemployment except:
Answer workers have different preferences and abilities.
unemployed workers accept the first job offer that they receive.
the flow of information is imperfect.
geographic mobility takes time.
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Question
Frictional unemployment is unemployment caused by:
Answer wage rigidity.
minimum-wage legislation.
the time it takes workers to search for a job.
clashes between the motives of insiders and outsiders.
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Question
Unemployment caused by the time it takes workers to search for a job is called ______ unemployment.
Answer frictional
structural
efficiency
insider
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Question
Which of the following is an example of frictional unemployment?
Answer Dave searches for a new job after voluntarily moving to San Diego.
Elaine is willing to work for less than the minimum wage, but employers cannot hire her.
Bill is qualified and would like to be an airline pilot, but airlines do not find it profitable to hire him at the
wage established by the airline pilot's union.
Joan is willing to work at the going wage, but there are no jobs available.
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Question
Sectoral shifts:
Answer lead to wage rigidity.
explain the payment of efficiency wages.
depend on the level of the minimum wage.
make frictional employment inevitable.
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Question
Economists call the changes in the composition of demand among industries and regions:
Answer insider-outsider conflicts.
sectoral shifts.
moral hazard.
adverse selection.
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Question
Frictional unemployment is inevitable because:
Answer different sectors do not shift.
the economy needs to be lubricated.
workers never quit their jobs to change careers.
the demand for different goods always fluctuates.
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Question
In past nonrecessionary periods, a typical worker in the United States who is covered by unemployment insurance
receives ______ percent of his or her former wages for ______ weeks.
Answer 50; 26
50; 52
67; 26
67; 52
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Question
Unemployment insurance increases the amount of frictional unemployment by:
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Answer making workers more frantic in their search for new jobs.
inducing workers to accept the first job offer that they receive.
making employers more reluctant to lay off workers.
softening the economic hardship of unemployment.
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Question
All of the following policies were adopted by the government in an attempt to reduce the natural rate of unemployment
except:
Answer unemployment insurance.
government employment agencies.
public retraining programs.
the Illinois bonus program for unemployment insurance claimants who found jobs quickly.
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Question
The unemployment insurance system may be desirable because unemployment insurance:
Answer raises the natural rate of unemployment.
reduces the rate of job finding.
increases workers' uncertainty about their incomes.
induces workers to reject unattractive job offers.
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Question
Firms currently have incentives to temporarily lay off workers because firms typically are charged for ______ of
workers' unemployment benefits.
Answer all
only a part
none
twice the cost
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Question
Most current unemployment-insurance programs are:
Answer paid for fully by state governments.
paid for fully by the federal government.
100 percent experience rated.
partially experience rated.
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Question
Government policies directed at reducing frictional unemployment include:
Answer abolishing minimum-wage laws.
making unemployment insurance 100 percent experience rated.
increasing the earned income credit.
making government part of the union-firm wage bargaining process.
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Question
Public policy to increase the job finding rate include _____ and public policy to decrease the job separation rate include
_____.
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Answer government employment agencies; higher unemployment insurance benefits

job training programs; 100 percent experience rated unemployment insurance
higher minimum wage laws; payment of unemployment benefits for longer periods
higher efficiency wages; partially experience rated unemployment insurance
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Question
According to studies of individual unemployed workers, these workers are most likely to find a job:
Answer about three months before their unemployment insurance runs out.
within a few weeks of their unemployment insurance running out.
about three months after their unemployment insurance runs out.
at a time not influenced by the remaining number of weeks of unemployment insurance.
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Question
The unemployment resulting when real wages are held above equilibrium is called ______ unemployment, while the
unemployment that occurs as workers search for a job that best suits their skills is called ______ unemployment.
Answer efficiency; inefficiency
efficiency; structural
frictional; efficiency
structural; frictional
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Question
When there is structural unemployment, the real wage is:
Answer rigid at a level below the market-clearing level.
rigid at the market-clearing level.
rigid at a level above the market-clearing level.
flexible.
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Question
Wage rigidity:
Answer forces labor demand to equal labor supply.
is caused by sectoral shifts.
prevents labor demand and labor supply from reaching the equilibrium level.
increases the rate of job finding.
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Question
The unemployment resulting from wage rigidity and job rationing is called ______ unemployment.
Answer frictional
structural
minimum-wage
insider
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Question
When the real wage is above the level that equilibrates supply and demand:
Answer the quantity of labor supplied exceeds the quantity demanded.
the quantity of labor demanded exceeds the quantity supplied.
there is no unemployment.
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the labor market clears.
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Question
Workers unemployed as a result of wage rigidity are:
Answer actively searching for a job to match their skills.
not eligible to receive unemployment insurance benefits.
waiting for a job to become available.
relocating to another part of the country as a result of sectoral shifts.
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Question
Which of the following is the best example of structural unemployment?
Answer Tim is looking for a job with flexible hours but has not been offered one yet.
Vickie lost her job as a graphic artist at a movie studio because she did not have training in computer-
generated animation.
Kirby is seeking a job as an airline pilot, but the high union wages in the industry have limited the number
of jobs available.
Fatima lost her job at a packing plant but has not looked very intensively for a new job because she still
has 2 months of unemployment insurance benefits left.
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Question
All of the following are causes of structural unemployment except:
Answer minimum-wage laws.
the monopoly power of unions.
unemployment insurance.
efficiency wages.
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Question
If wage rigidity holds the real wage above the equilibrium level, an increase in the supply of labor will ______ the
number unemployed.
Answer increase
decrease
not change
possibly increase, decrease, or leave unchanged
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Question
If wage rigidity holds the real wage above the equilibrium level, an increase in the demand for labor will ______ the
number unemployed.
Answer increase
decrease
not change
possibly increase, decrease, or leave unchanged
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Question
The minimum wage:
Answer is usually about 75 percent of the average wage earned in manufacturing.
raises the wages of highly skilled workers.
encourages master workers to take on apprentices.
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has its greatest impact on teenage unemployment.
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Question
Economists who have studied minimum-wage laws in the United States find that a 10 percent increase in the minimum
wage increases teenage unemployment by about:
Answer 10 to 30 percent.
5 percent.
1 to 3 percent.
0 percent.
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Question
Permitting a lower minimum wage for teenagers would likely:
Answer raise teenage unemployment.
raise teenage wages overall.
prevent teenagers from getting job experience.
raise unemployment among unskilled adults.
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Question
The earned income tax credit:
Answer increases the government's tax revenue.
reduces the incomes of poor working families.
does not raise labor costs.
is not an alternative to raising the minimum wage.
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Question
All of the following statements about minimum-wage workers in the United States are correct except:
Answer minimum-wage workers are more likely to be male.
minimum-wage workers are more likely to work part time.
minimum-wage workers are more likely to be less educated.
minimum-wage workers are more likely to be young.
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Question
The percentage of workers who belong to unions in the United States is approximately:
Answer 13 percent.
23 percent.
33 percent.
53 percent.
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Question
Unions contribute to structural unemployment when collective bargaining results in wages:
Answer above the equilibrium level.
below the minimum wage.
below the equilibrium level.
above the level of unemployment compensation.
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Question
In the case of unions, the conflict of interest between different groups of workers results in insiders wanting ______,
while outsiders want ______.
Answer more hirings; high wages
high wages; more hirings
high wages; fewer hirings
fewer hirings; high wages
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Question
When insiders have a much greater impact on the wage-bargaining process than do outsiders, the negotiated wage is
likely to be ______ the equilibrium wage.
Answer much greater than
much less than
almost equal to
about one-half of
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Question
When outsiders have a greater role than do insiders in the wage-bargaining process, the negotiated wage is likely to
be ______ the equilibrium wage.
Answer much greater than
much less than
much closer to
about twice
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Question
Centralized union wage bargaining with government intervention in Sweden gives relatively more influence to ______,
while firm-level union wage bargaining in the United States gives relatively more influence to ______.
Answer efficiency wages; sectoral shifts
sectoral shifts; efficiency wages
insiders; outsiders
outsiders; insiders
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Question
One efficiency-wage theory implies that firms pay high wages because:
Answer this practice increases the problem of moral hazard.
in wealthy countries, it is important to pay workers high wages to improve their health.
the more a firm pays its workers, the greater their incentive to stay with the firm.
paying high wages promotes adverse selection.
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Question
Efficiency-wage theories suggest that a firm may pay workers more than the market-clearing wage for all of the
following reasons except to:
Answer reduce labor turnover.
improve the quality of the firm's labor force.
increase worker effort.
reduce the firm's wage bill.
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Question
According to efficiency-wage theories, firms benefit by paying higher-than-equilibrium wages because worker _____
increases.
Answer productivity
turnover
unionization
shirking
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Question
Paying efficiency wages helps firms reduce the problem of adverse selection by:
Answer generating additional profits that can be used to pay for more proficient hiring managers.
keeping labor unions from organizing workers in the firm.
encouraging unsupervised workers to maintain a high level of productivity.
providing an incentive for the best-qualified workers to remain with the firm.
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Question
Paying efficiency wages helps firms reduce the problem of moral hazard by:
Answer generating additional profits that can be used to improve working conditions.
matching the wages each worker is paid to the number of units of output each worker produces.
encouraging unsupervised workers to maintain a high level of productivity.
providing an incentive for the best-qualified workers to remain with the firm.
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Question
By paying efficiency wages, firms contribute to higher unemployment because they:
Answer increase the wage bill.
make workers more productive.
keep the wage below the equilibrium level.
keep the wage above the equilibrium level.
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Question
When Henry Ford paid his workers $5 per day when the prevailing wage was between $2 and $3 a day:
Answer it greatly increased his company's costs.
workers reduced their work efforts because they felt they “had it made.”
Ford proved the efficiency-wage theory was wrong.
it raised the efficiency of his workers.
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Question
Suppose that over the course of a year 100 people are unemployed for 4 weeks each (the short-term unemployed),
while 10 people are unemployed for 52 weeks each (the long-term unemployed). Approximately what percentage of
the total spells of unemployment were attributable to the long-term unemployed?
Answer 9 percent.
10 percent.
43.5 percent.
56.5 percent.
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Question
Suppose that over the course of a year 100 people are unemployed for 4 weeks each (the short-term unemployed),
while 10 people are unemployed for 52 weeks each (the long-term unemployed). Approximately what percentage of
the total weeks of unemployment were attributable to the long-term unemployed?
Answer 9 percent.
10 percent.
43.5 percent.
56.5 percent.
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Question
Policies to substantially reduce the natural rate of unemployment should be targeted at:
Answer the short-term unemployed.
the long-term unemployed
discouraged workers.
insiders and outsiders.
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Question
Short-term unemployment is most likely to be ______ unemployment, while long-term unemployment is mostly likely to
be _____ unemployment.
Answer structural; frictional
structural; the natural rate of
the natural rate of; frictional
frictional; structural
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Question
Most spells of unemployment are ______ term, and most weeks of unemployment are attributable to ______-term
unemployment.
Answer short; short
short; long
long; long
long; short
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Question
During the period from 1990 to 2006, in the United States, most spells of unemployment lasted:
Answer less than one month, yet most of the weeks of unemployment occurred in spells lasting two or more
months.
more than one month, and most weeks of unemployment occurred in spells of two or more months.
less than one month, and most weeks of unemployment occurred in spells of one month or less.
more than one month, but most weeks of unemployment occurred in spells of one month or less.
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Question
Data on unemployment in the United States show that:
Answer most spells of unemployment are long.
most weeks of unemployment are attributable to the long-term unemployed.
members of the labor force over age 55 have the highest unemployment rates.
the duration of unemployment falls during recessions.
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Question
Which of the following characteristics made the 2008–2009 recession differ most sharply from previous recessions?
Answer a large spike in the duration of unemployment
a large increase in teenage unemployment
higher rates of female unemployment than rates of male unemployment
an increase in the rate of job separation and a decrease in the rate of job finding
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Question
Economist Robert Barro attributes the increase in the duration of unemployment to ______, while economist Paul
Krugman attributes the increased duration to _____.
Answer increased immigration of low-wage workers; tax cuts given to high-wage workers
contractionary monetary policy; expansionary fiscal policy
high marginal tax rates on the wealthy; high marginal tax rates on low-wage workers
expanded unemployment-insurance coverage; insufficient consumer demand
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Question
In 2007 in the United States among labor-force members ages 16 to 19, the highest unemployment rate was for:
Answer black females.
black males.
white females.
white males.
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Question
Compared with an employed white teenage male, an employed middle-aged white male is ______ likely to become
unemployed and, once unemployed, is ______ likely to find a job.
Answer less; more
less; just as
more; less
just as; more
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Question
Differences in unemployment rates across demographic groups are most closely correlated with differences in:
Answer job-finding rates.
job-separation rates.
unionization rates.
efficiency wage rates.
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Question
Entry into and exit from the labor force are important to the determination of the unemployment rate because:
Answer more than one-half of the unemployed have only recently entered the labor force.
most of the unemployed are young workers still looking for their first job.
discouraged workers are counted as part of the labor force.
almost one-half of all spells of unemployment end in the unemployed person's withdrawal from the labor
market.
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Question
Spells of unemployment end when the unemployed person finds a job or:
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Answer withdraws from the labor force.

enters the labor force.
runs out of unemployment insurance compensation.
refuses to answer unemployment survey questions.
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Question
A spell of unemployment begins when a person leaves his or her job or:
Answer withdraws from the labor force.
enters the labor force.
takes a vacation.
has been without a job for at least four weeks.
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Question
Transitions into and out of the labor force:
Answer rarely occur.
do not affect unemployment statistics.
make unemployment statistics difficult to interpret.
reduce the amount of frictional unemployment.
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Question
Discouraged workers are counted as:
Answer part of the labor force.
out of the labor force.
employed.
unemployed.
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Question
Discouraged workers are individuals who:
Answer have jobs that do not match their skills (e.g., a Ph.D. driving a taxi cab).
have been unemployed for more than 26 weeks.
call themselves unemployed but are not seriously looking for a job.
want a job but have given up looking for one.
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Question
Which of the following rankings (from most severe to least severe) best captures the degree of hardship associated
with various types of unemployment?
Answer discouraged worker, short term, long term
involuntarily part time, job leavers, job losers,
job losers, job leavers, marginally attached
job leavers, involuntary part time, discouraged workers
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Question
Many economists attribute part of the recent increase in European unemployment to:
Answer high birthrates.
slow rates of technological change.
generous benefits for unemployed workers.
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increased demand for unskilled workers.
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Question
The recent reduced demand for unskilled workers relative to skilled workers has led to ______ for unskilled workers in
Europe compared to ______ for unskilled workers in the United States.
Answer unemployment; lower wages
lower wages; unemployment
more unionization; efficiency wages
efficiency wages; more unionization
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Question
As the relative demand for unskilled workers falls, wages for unskilled workers ______ and unemployment
compensation becomes a ______ attractive option.
Answer fall; more
fall; less
rise; more
rise; less
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Question
Results from the Euro-Barometer Survey series suggests that people are happier when inflation is ______ and
unemployment is ______.
Answer high; high
high; low
low; high
low; low
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Question
European unemployment rates are positively correlated with each of the following except:
Answer the percentage of the previous wage replaced by unemployment insurance.
the percentage of the labor force that is unionized.
the length of the period during which unemployment benefits can be collected.
the amount of coordination among employers in bargaining with unions.
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Question
Much of the difference in unemployment rates across Europe is attributable to differences in:
Answer short-term unemployment.
long-term unemployment.
frictional unemployment.
the natural rate of unemployment.
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Question
Which of the following statements most closely describes the variation in unemployment rates across countries in
Europe?
Answer Countries with higher rates of unionization tend to have higher unemployment rates, but this is partially
mitigated if wage negotiations are coordinated among employers.
Countries with higher rates of unionization tend to have higher unemployment rates and this tendency is
exacerbated if wage negotiations are coordinated among employers.
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Countries with more generous unemployment insurance benefits tend to have higher unemployment rates,
but this is partially mitigated if the benefits are offered for a longer period of time.
Countries with more generous unemployment insurance tend to have lower unemployment rates, but this
effect is completely offset if benefits are offered for a longer period of time.
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Question
Across countries of Europe, greater spending on unemployment insurance tends to _____ unemployment and more
“active” labor-market policies tend to _____ unemployment.
Answer increase; increase
increase; decrease
decrease; decrease
decrease; increase
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Question
Examples of “active” labor-market policies include all of the following except:
Answer job-search assistance
subsidized employment
unemployment insurance
job-training programs
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Question
The generosity of unemployment insurance benefits is measured by:
Answer the replacement rate and the duration of benefits.
the median wage and the unemployment rate.
the price level and duration of unemployment.
the job-finding rate and the job-separation rate.
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Question
Which of the following statements correctly describes European labor markets?
Answer In recent years, the unemployment rate in every European country has been higher than the
unemployment rate in the United States.
In recent years, the average unemployment rate in Europe has been higher than the unemployment rate in
the United States.
Within Europe the short-term unemployment rate shows greater variability across countries than does the
long-term unemployment rate.
European countries with more generous unemployment insurance tend to have lower unemployment
rates.
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Question
In recent years, Europe has experienced ______ unemployment than the United States, and employed Europeans
work ______ hours than employed Americans.
Answer more; more
more; fewer
less; fewer
less; more
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Question
Which of the following is not a proposed explanation for that fact that Americans on average work 20 percent more
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hours than the typical resident of western Europe?

Answer Europeans have more taste for leisure than Americans.
Americans have a lower unionization rate than Europeans.
Europeans face higher tax rates than Americans.
The underground economy is larger in America than in Europe.
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Question
Earlier retirement in Europe than in the United States contributes to:
Answer higher employment-to-population ratios in Europe than in the United States.
lower employment-to-population ratios in Europe than in the United States.
more hours worked per year by the average employed person in Europe than the average employed
person in the United States.
fewer hours worked per year by the average employed person in Europe than the average employed
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Question
More frequent holidays for workers in Europe than in the United States contribute to:
Answer higher employment-to-population ratios in Europe than in the United States.
lower employment-to-population ratios in Europe than in the United States.
more hours worked per year by the average employed person in Europe than the average employed
fewer hours worked per year by the average employed person in Europe than the average employed
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Question
Which of the following hypotheses is consistent with fewer hours worked per year in Europe than in the United States?
Answer fewer mandated holidays in Europe than in the United States
higher employment-to-population ratios in Europe than in the United States
higher tax rates in Europe than in the United States
a smaller underground economy in Europe than in the United States
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Question
If the underground economy is larger in Europe than in the United States, then the difference in the _____ number of
hours worked between Europe and the United States may be smaller than the difference in the _____ numbers of
hours worked.
Answer measured; actual
actual; measured
annual; monthly
monthly; annual
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Question
According to Blanchard, Europeans are more likely to use increases in real wages resulting from technological
progress to increase ______, and Americans are more likely to use these increases in real wages to increase ______.
Answer hours of work; hours of leisure
consumption of goods and services; hours of leisure
hours of leisure; consumption of goods and services
unemployment insurance benefits; efficiency wages
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Question
If the rate of separation is 0.02 and the rate of job finding is 0.08 but the current unemployment rate is 0.10, then the
current unemployment rate is ______ the equilibrium rate, and in the next period it will move ______ the equilibrium
rate.
Answer above; toward
above; away from
below; toward
below; away from
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Question
Assume that a country experiences a reduction in productivity that lowers the marginal product of labor for any given
level of labor. In this case, the:
Answer labor supply curve shifts to the right.
labor supply curve shifts to the left.
labor demand curve shifts upward and to the right.
labor demand curve shifts downward and to the left.
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Question
Assume that a country experiences a reduction in productivity that shifts the labor demand curve downward and to the
left. If the labor market were always in equilibrium, this would lead to:
Answer a lower real wage and a rise in unemployment.
a lower real wage and no change in unemployment.
a lower real wage and less unemployment.
no change in real wage or in unemployment.
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Question
Assume that a country experiences a reduction in productivity that shifts the labor demand curve downward and to the
left. If the real wage were rigid, this would lead to:
Answer no change in the real wage and a rise in unemployment.
no change in the real wage and no change in unemployment.
no change in the real wage and a fall in unemployment.
a decrease in the real wage.
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Essay 1 points
Question
If the rate of job separation is 0.02 per month and the rate of job finding is 0.10 per month, what is the natural rate of
unemployment?
Answer 16.67 percent
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Essay 1 points
Question
If the economy were at a steady-state unemployment rate with a separation rate of 0.02 per month and a job-finding
rate of 0.10 per month, and the labor force was 100 million, how many individuals would lose their jobs each month?
Answer 1.67 million
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Essay 1 points
Question
Assume that an employer believes that the “efficiency” (e) it can get from a particular worker, as a function of the hourly
2 3
wage (w), is given by function e = –0.125w + 0.15w – 0.005w , at least up to a wage of 30.
a. Create a table of w, e, e/w, and w/e for wages equal to 5, 10, 14, 15, 16, 20, and 25.
b. Which wage gives the highest ratio of efficiency per unit of labor cost?
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c. Once the firm has hit on an optimal w, whatever it is, would cutting wages whenever demand falls off
increase or decrease wages per unit of efficiency?
Answer a. w e e/w w/e

5 2.50 0.500 2.000
10 8.75 0.875 1.143
14 13/93 0.995 1.005
15 15.00 1.000 1.000
16 15.92 0.995 1.005
20 17.50 0.875 1.143
25 12.50 0.500 2.000
b. 15
c. Cutting wages (any wage lower than 15) would increase wages per unit of efficiency.
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Essay 1 points
Question
Assume that a society consists of two types of workers. For type A, 3 million workers lose their jobs each year, and
each one takes a year to find a new one. For type B, 36 million workers lose their jobs each year (3 million per month),
and each takes one month to find a new job. Thus, at any given time, 6 million are unemployed in this economy.
a. How many “spells” of unemployment occur each year in this economy?
b. What percentage of the “spells” are only one month long?
c. If you take all the workers unemployed each year and multiply each by the length of his or her
unemployment “spell,” how many “months” of unemployment would there be in this economy each
year?
d. Of all the “months” of unemployment, how many are accounted for by the workers unemployed a year at
a time?
Answer a. 39 million b. 92.3 percent c. 72 million d. 50 percent

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Question
Changes in economic policies will frequently have an impact on the unemployment rate. Explain whether each of the
policy changes described is likely to: (1) affect frictional or structural unemployment and (2) increase or decrease the
measured unemployment rate.
a. The government reduces the number of weeks of unemployment insurance that unemployed workers
can receive.
b. The government raises the minimum wage.
c. The government increases spending on job-training programs.
Answer a. Frictional unemployment is likely to be reduced as unemployed workers take fewer weeks to search for
new jobs because of reduced benefits. This process is likely to reduce the measured unemployment
rate.
b. Structural unemployment will probably increase for those workers with marginal product valued below
the higher minimum wage. This policy change is likely to increase the measured unemployment rate.
c. Frictional unemployment will be reduced if workers with obsolete skills receive training that prepares
them for available jobs. This policy change is intended to reduce the measured rate of unemployment.
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Question
The model of the steady-state rate of unemployment assumes that the size of the labor force is fixed. If the size of the
labor force is allowed to vary:
a. explain how the job-loss and job-finding processes will differ from the situation when the labor force is
fixed.
b. explain how interpretations of changes in the unemployment rate will become less clear?
Answer a. With a varying labor force, job finders will include both the unemployed who find jobs and the new
entrants into the labor market. Similarly, job losers will include the unemployed, as well as those who
leave the labor force.
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b. A decrease in the unemployment rate could result from some combination of (1) fewer unemployed
people because the previously unemployed found jobs, (2) fewer unemployed people because
previously unemployed people left the labor force, or (3) an increase in the size of the labor force while
the number of unemployed people remains unchanged.
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Question
The average unemployment rate in western Europe is higher than in the United States.
a. Explain one difference between the European and U.S. economies that is consistent with more
structural unemployment in Europe.
b. Explain one difference between the European and U.S. economies that is consistent with more frictional
unemployment in Europe.
Answer a. The degree of unionization is greater in Europe, so there is more unemployment due to wage rigidity.
b. Unemployment benefits in Europe are more generous, so there is more frictional unemployment than in
the United States.
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Question
Assume that the real wage in an economy is held above equilibrium.
a. Graphically illustrate how an increase in technology that raises the demand for labor will change the
number of unemployed workers. Be sure to label the axes and the quantities of labor hired before and
after the technological progress.
b. Explain in words what happens to the number of unemployed as a result of this change.
Answer a.
b. The number of unemployed falls from (L – L ) to (L – L ).

1 2
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Question
Assume that the real wage in an economy is held above equilibrium.
a. Graphically illustrate how an increase in the supply of labor will change the number of unemployed
workers. Be sure to label the axes and the quantities of labor hired before and after the technological
progress.
b. Explain in words what happens to the number of unemployed as a result of this change.
Answer a.
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b. The number of unemployed increases from (L* – L ) to (L** – L ).

1 1
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Question
Reducing the natural rate of unemployment requires reducing the rate of job separation and increasing the rate of job
finding. Explain at least one policy that will impact each of these aspects of the natural rate of unemployment.
Answer Policies that could improve job finding include government employment agencies, job training programs, and
reducing the amount and duration of unemployment benefits. A policy to reduce the rate of job separation
could be to make unemployment insurance 100% experience rated. This increases the cost of temporarily
laying off employees and could reduce the job separation rate.
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Essay 1 points
Question
Consider two countries: Flexiland and Stuckland. The labor force in each country consists of 100,000 workers. In
Flexiland a different 500 workers are unemployed each month. In Stuckland the same 500 workers are unemployed for
the entire year. Compare and contrast the unemployment situation in the two countries by explaining:
a. the unemployment rate,
b. the number of spells of unemployment,
c. the average duration of each unemployment spell, and
d. whether the unemployment is more likely to be frictional or structural.
Answer a. The unemployment rate in both countries is 5 percent.

b. There are 12 times as many spells of unemployment in Flexiland than in Stuckland.
c. The average duration of each unemployment spell is 12 times longer in Stuckland.
d. Unemployment is more likely to be frictional in Flexiland and structural in Stuckland.
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Question
Explain what type of wage rigidity is most likely to affect the unemployment rates of the following types of workers:
a. workers with low marginal labor productivity,
b. workers in the construction trades, such as plumbers and electricians,
c. workers engaged in creative work that is not easily monitored.
Answer a. minimum wage

b. union wage
c. efficiency wage
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Question
Explain how paying efficiency wages can help employers overcome both moral hazard and adverse selection problems
in employment.
Answer Efficiency wages are wages above the market-clearing level. Higher-than-equilibrium wages give the best
workers more incentive to stay with the firm, thereby reducing the adverse selection problem of an employer
not being able to clearly distinguish good workers from poor workers. Higher-than-equilibrium wages give
workers greater incentive to avoid shirking, a moral hazard problem when workers are not easily monitored,
20 of 21 12/8/2012 11:37
by increasing the penalty (lost wages) of being caught not working.

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Question
Explain how technological changes that have reduced the demand for low-skilled workers can change the natural rate
of unemployment.
Answer The reduction in the demand for low-skilled workers will reduce the equilibrium real wage. The greater
disparity between a rigid wage (the result of a minimum wage, union wage, or efficiency wage) and the
equilibrium wage, the greater the excess supply of labor and the higher the unemployment rate.
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Pool Canvas
Add, modify, and remove questions. Select a question type from the Add Question drop-down list and click Go to add questions. Use Creation Settings to
establish which default options, such as feedback and images, are available for question creation.
Name TestBanks Chapter 8 Economic Growth I: Capital Accumulation and Population Growth
Description
Instructions
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Question
The Solow growth model describes:
Answer how output is determined at a point in time.
how output is determined with fixed amounts of capital and labor.
how saving, population growth, and technological change affect output over time.
the static allocation, production, and distribution of the economy's output.
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Question
Unlike the long-run classical model in Chapter 3, the Solow growth model:
Answer assumes that the factors of production and technology are the sources of the economy's output.
describes changes in the economy over time.
is static.
assumes that the supply of goods determines how much output is produced.
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Question
In the Solow growth model, the assumption of constant returns to scale means that:
Answer all economies have the same amount of capital per worker.
the steady-state level of output is constant regardless of the number of workers.
the saving rate equals the constant rate of depreciation.
the number of workers in an economy does not affect the relationship between output per worker and capital
per worker.
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Question
The production function y = f(k) means:
Answer labor is not a factor of production.
output per worker is a function of labor productivity.
output per worker is a function of capital per worker.
the production function exhibits increasing returns to scale.
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Question
When f(k) is drawn on a graph with increases in k noted along the horizontal axis, the:
Answer graph is a straight line.
slope of the line eventually gets flatter and flatter.
slope of the line eventually becomes negative.
slope of the line eventually becomes steeper and steeper.
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1 of 24 12/8/2012 11:37
Question
When f(k) is drawn on a graph with increases in k noted along the horizontal axis, the slope of the line denotes:
Answer output per worker.
output per unit of capital.
the marginal product of labor.
the marginal product of capital.
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Question
Two economies are identical except that the level of capital per worker is higher in Highland than in Lowland. The
production functions in both economies exhibit diminishing marginal product of capital. An extra unit of capital per worker
increases output per worker:
Answer more in Highland.
more in Lowland.
by the same amount in Highland and Lowland.
in Highland, but not in Lowland.
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Question
The consumption function in the Solow model assumes that society saves a:
Answer constant proportion of income.
smaller proportion of income as it becomes richer.
larger proportion of income as it becomes richer.
larger proportion of income when the interest rate is higher.
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Question
In the Solow growth model of Chapter 8, the demand for goods equals investment:
Answer minus depreciation.
plus saving.
plus consumption.
plus depreciation.
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Question
In the Solow growth model of Chapter 8, where s is the saving rate, y is output per worker, and i is investment per worker,
consumption per worker (c) equals:
Answer sy
(1 – s)y
(1 + s)y
(1 – s)y – i
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Question
In the Solow growth model of Chapter 8, investment equals:
Answer output.
consumption.
saving.
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Question
In the Solow growth model of Chapter 8, for any given capital stock, the ______ determines how much output the economy
produces and the ______ determines the allocation of output between consumption and investment.
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Answer saving rate; production function

depreciation rate; population growth rate
production function; saving rate
population growth rate; saving rate
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Question
In the Solow growth model the saving rate determines the allocation of output between:
Answer saving and investment.
output and capital.
consumption and output.
investment and consumption.
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Question
______ cause(s) the capital stock to rise, while ______ cause(s) the capital stock to fall.
Answer Inflation; deflation
Interest rates; the discount rate
Investment; depreciation
International trade; depressions
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Question
Investment per worker (i) as a function of the saving ratio (s) and output per worker (f(k)) may be expressed as:
Answer s + f(k).
s – f(k).
sf(k).
s/f(k).
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Question
Exhibit: Output, Consumption, and Investment
In this graph, when the capital–labor ratio is OA, AB represents:

Answer investment per worker, and AC represents consumption per worker.
consumption per worker, and AC represents investment per worker.
investment per worker, and BC represents consumption per worker.
consumption per worker, and BC represents investment per worker.
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Question
If the capital stock equals 200 units in year 1 and the depreciation rate is 5 percent per year, then in year 2, assuming no
new or replacement investment, the capital stock would equal _____ units.
3 of 24 12/8/2012 11:37
Answer 210
200
195
190
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Question
In the Solow model, it is assumed that a(n) ______ fraction of capital wears out as the capital–labor ratio increases.
Answer smaller
larger
constant
increasing
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Question
The change in capital stock per worker ( k) may be expressed as a function of s = the saving ratio, f(k) = output per
worker, k = capital per worker, and = the depreciation rate, by the equation:
Answer k = sf(k)/ k.
k = sf(k) × k.
k = sf(k) + k.
k = sf(k) – k.
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Question
The steady-state level of capital occurs when the change in the capital stock ( k) equals:
Answer 0.
the saving rate.
the depreciation rate.
the population growth rate.
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Question
In the steady state with no population growth or technological change, the capital stock does not change because
investment equals:
depreciation.
consumption.
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Question
In the Solow growth model of Chapter 8, the economy ends up with a steady-state level of capital:
Answer only if it starts from a level of capital below the steady-state level.
only if it starts from a level of capital above the steady-state level.
only if it starts from a steady-state level of capital.
regardless of the starting level of capital.
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Question
In the Solow growth model, the steady-state occurs when:
Answer capital per worker is constant.
the saving rate equals the depreciation rate.
output per worker equals consumption per worker.
4 of 24 12/8/2012 11:37
consumption per worker is maximized.
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Question
Exhibit: Capital–Labor Ratio and the Steady State
In this graph, capital–labor ratio k is not the steady-state capital–labor ratio because:
2
Answer the saving rate is too high.
the investment ratio is too high.
gross investment is greater than depreciation.
depreciation is greater than gross investment.
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Question
Exhibit: Steady-State Capital–Labor Ratio
In this graph, the capital–labor ratio that represents the steady-state capital–ratio is:
Answer k0.
k1.
k2.
k3.
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Question
Exhibit: The Capital–Labor Ratio
In this graph, starting from capital–labor ratio k , the capital–labor ratio will:
1
5 of 24 12/8/2012 11:37
Answer decrease.
remain constant.
increase.
first decrease and then remain constant.
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Question
In the Solow growth model, if investment exceeds depreciation, the capital stock will ______ and output will ______ until
the steady state is attained.
increase; decrease
decrease; decrease
decrease; increase
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Question
In the Solow growth model, if investment is less than depreciation, the capital stock will ______ and output will ______ until
the steady state is attained.
increase; decrease
decrease; decrease
decrease; increase
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Question
An economy in the steady state with no population growth or technological change will have:
Answer investment exceeding depreciation.
no depreciation.
saving equal to consumption.
no change in the capital stock.
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Question
In the Solow growth model with no population growth and no technological progress, the higher the steady capital-
per-worker ratio, the higher the steady-state:
Answer growth rate of total output.
level of consumption per worker.
growth rate of output per worker.
level of output per worker.
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Question
The formula for the steady-state ratio of capital to labor (k*), with no population growth or technological change, is s:
Answer divided by the depreciation rate.
multiplied by the depreciation rate.
divided by the product of f(k*) and the depreciation rate.
multiplied by f(k*) divided by the depreciation rate.
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Question
1/2
If the per-worker production function is given by y = k , the saving rate (s) is 0.2, and the depreciation rate is 0.1, then the
steady-state ratio of capital to labor is:
Answer 1.
2.
4.
6 of 24 12/8/2012 11:37
9.
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Question
1/2
If the per-worker production function is given by y = k , the saving ratio is 0.3, and the depreciation rate is 0.1, then the
steady-state ratio of capital to labor is:
Answer 1.
2.
4.
9.
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Question
1/2
steady-state ratio of output per worker (y) is:
Answer 1.
2.
3.
4.
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Question
1/2
steady-state ratio of output per worker (y) is:
Answer 1.
2.
3.
4.
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Question
If a war destroys a large portion of a country's capital stock but the saving rate is unchanged, the Solow model predicts that
output will grow and that the new steady state will approach:
Answer a higher level of output per person than before.
the same level of output per person as before.
a lower level of output per person than before.
the Golden Rule level of output per person.
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Question
Among the four countries—the United States, the United Kingdom, Germany, and Japan—the one that experienced the
most rapid growth rate of output per person between 1948 and 1972 was:
Answer the United States.
the United Kingdom.
Germany.
Japan.
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Question
If the national saving rate increases, the:
Answer economy will grow at a faster rate forever.
capital–labor ratio will increase forever.
economy will grow at a faster rate until a new, higher, steady-state capital–labor ratio is reached.
capital–labor ratio will eventually decline.
7 of 24 12/8/2012 11:37
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Question
Starting from a steady-state situation, if the saving rate increases, the rate of growth of capital per worker will:
Answer increase and continue to increase unabated.
increase until the new steady state is reached.
decrease until the new steady state is reached.
decrease and continue to decrease unabated.
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Question
The Solow model shows that a key determinant of the steady-state ratio of capital to labor is the:
Answer level of output.
labor force.
saving rate.
capital elasticity in the production function.
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Question
A higher saving rate leads to a:
Answer higher rate of economic growth in both the short run and the long run.
higher rate of economic growth only in the long run.
higher rate of economic growth in the short run but a decline in the long run.
larger capital stock and a higher level of output in the long run.
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Question
Assume two economies are identical in every way except that one has a higher saving rate. According to the Solow growth
model, in the steady state the country with the higher saving rate will have ______ level of output per person and ______
rate of growth of output per worker as/than the country with the lower saving rate.
Answer the same; the same
the same; a higher
a higher; the same
a higher; a higher
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Question
In the Solow growth model, with a given production function, depreciation rate, no technological change, and no population
growth, a higher saving rate produces a:
Answer higher MPK in the new steady state.
higher steady-state growth rate of output per worker.
higher steady-state growth rate of total output.
higher steady-state level of output per worker.
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Question
Examination of recent data for many countries shows that countries with high saving rates generally have high levels of
output per person because:
Answer high saving rates mean permanently higher growth rates of output.
high saving rates lead to high levels of capital per worker.
countries with high levels of output per worker can afford to save a lot.
countries with large amounts of natural resources have both high output levels and high saving rates.
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8 of 24 12/8/2012 11:37
Question
The Golden Rule level of capital accumulation is the steady state with the highest level of:
capital per worker.
savings per worker.
consumption per worker.
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Question
The formula for steady-state consumption per worker (c*) as a function of output per worker and investment per worker is:
Answer c* = f(k*) – k*.
c* = f(k*) + k*.
c* = f(k*) ÷ k*.
c* = k* – f(k)*.
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Question
In the Solow growth model, increases in capital ______ output and ______ the amount of output used to replace
depreciating capital.
increase; decrease
decrease; increase
decrease; decrease
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Question
Exhibit: Steady-State Consumption I
The Golden Rule level of the capital–labor ratio is:

Answer
above but below
above
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Question
Exhibit: Steady-State Consumption II
9 of 24 12/8/2012 11:37
Reference: Ref 8-1
(Exhibit: Steady-State Consumption II) The Golden Rule level of steady-state consumption per worker is:
Answer AC.
AB.
BC.
DE.
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Question
Exhibit: Steady-State Consumption II
Reference: Ref 8-1
(Exhibit: Steady-State Consumption II) The Golden Rule level of steady-state investment per worker is:
Answer AC.
AB.
BC.
DE.
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Question
In an economy with no population growth and no technological change, steady-state consumption is at its greatest possible
level when the marginal product of:
Answer labor equals the marginal product of capital.
labor equals the depreciation rate.
capital equals the depreciation rate.
capital equals zero.
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Question
The Golden Rule level of the steady-state capital stock:
Answer will be reached automatically if the saving rate remains constant over a long period of time.
will be reached automatically if each person saves enough to provide for his or her retirement.
implies a choice of a particular saving rate.
10 of 24 12/8/2012 11:37
should be avoided by an enlightened government.
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Question
If an economy is in a steady state with no population growth or technological change and the marginal product of capital is
less than the depreciation rate:
Answer the economy is following the Golden Rule.
steady-state consumption per worker would be higher in a steady state with a lower saving rate.
steady-state consumption per worker would be higher in a steady state with a higher saving rate.
the depreciation rate should be decreased to achieve the Golden Rule level of consumption per worker.
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Question
If an economy with no population growth or technological change has a steady-state MPK of 0.125, a depreciation rate of
0.1, and a saving rate of 0.225, then the steady-state capital stock:
Answer is greater than the Golden Rule level.
is less than the Golden Rule level.
equals the Golden Rule level.
could be either above or below the Golden Rule level.
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Question
If an economy with no population growth or technological change has a steady-state MPK of 0.1, a depreciation rate of 0.1,
and a saving rate of 0.2, then the steady-state capital stock:
Answer is greater than the Golden Rule level.
is less than the Golden Rule level.
equals the Golden Rule level.
could be either above or below the Golden Rule level.
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Question
1/2
With a per-worker production function y = k , the steady-state capital stock per worker (k*) as a function of the saving rate
(s) is given by:
Answer
k* = (s/ )2.
k* = ( /s)2.
k* = s/ .
k* = /s.
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Question
To determine whether an economy is operating at its Golden Rule level of capital stock, a policymaker must determine the
steady-state saving rate that produces the:
Answer largest MPK.
smallest depreciation rate.
largest consumption per worker.
largest output per worker.
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Question
If an economy is in a steady state with no population growth or technological change and the capital stock is above the
Golden Rule level and the saving rate falls:
Answer output, consumption, investment, and depreciation will all decrease.
output and investment will decrease, and consumption and depreciation will increase.
11 of 24 12/8/2012 11:37
output and investment will decrease, and consumption and depreciation will increase and then decrease but
finally approach levels above their initial state.
output, investment, and depreciation will decrease, and consumption will increase and then decrease but
finally approach a level above its initial state.
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Question
Suppose an economy is initially in a steady state with capital per worker exceeding the Golden Rule level. If the saving rate
falls to a rate consistent with the Golden Rule, then in the transition to the new steady state, consumption per worker will:
Answer always exceed the initial level.
first fall below then rise above the initial level.
first rise above then fall below the initial level.
always be lower than the initial level.
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Question
A reduction in the saving rate starting from a steady state with more capital than the Golden Rule causes investment to
______ in the transition to the new steady state.
Answer increase
decrease
first increase, then decrease
first decrease, then increase
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Question
When an economy begins above the Golden Rule, reaching the Golden Rule:
Answer produces lower consumption at all times in the future.
produces higher consumption at all times in the future.
requires initially reducing consumption to increase consumption in the future.
requires initially increasing consumption to decrease consumption in the future.
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Question
If an economy is in a steady state with a saving rate below the Golden Rule level, efforts to increase the saving rate result
in:
Answer both higher per-capita output and higher per-capita depreciation, but the increase in per-capita output would be
greater.
both higher per-capita output and higher per-capita depreciation, but the increase in per-capita depreciation
would be greater.
higher per-capita output and lower per-capita depreciation.
lower per-capita output and higher per-capita depreciation.
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Question
If an economy is in a steady state with no population growth or technological change and the capital stock is below the
Golden Rule:
Answer a policymaker should definitely take all possible steps to increase the saving rate.
if the saving rate is increased, output and consumption per capita will both rise, both in the short and long runs.
if the saving rate is increased, output per capita will at first decline and then rise above its initial level, and
consumption per capita will rise both in the short and long runs.
if the saving rate is increased, output per capita will rise and consumption per capita will first decline and then
rise above its initial level.
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Question
Suppose an economy is initially in a steady state with capital per worker below the Golden Rule level. If the saving rate
increases to a rate consistent with the Golden Rule, then in the transition to the new steady state consumption per worker
12 of 24 12/8/2012 11:37
will:
Answer always exceed the initial level.
first fall below then rise above the initial level.
first rise above then fall below the initial level.
always be lower than the initial level.
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Question
When an economy begins below the Golden Rule, reaching the Golden Rule:
Answer produces lower consumption at all times in the future.
produces higher consumption at all times in the future.
requires initially reducing consumption to increase consumption in the future.
requires initially increasing consumption to decrease consumption in the future.
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Question
An increase in the saving rate starting from a steady state with less capital than the Golden Rule causes investment to
______ in the transition to the new steady state.
Answer increase
decrease
first increase, then decrease
first decrease, then increase
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Question
In an economy with population growth at rate n, the change in capital stock per worker is given by the equation:
Answer k = sf(k) + k.
k = sf(k) – k.
k = sf(k) + ( + n)k.
k = sf(k) – ( + n)k.
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Question
The formula for the steady-state ratio of capital to labor (k*) with population growth at rate n but no technological change,
where s is the saving rate, is s:
Answer divided by the sum of the depreciation rate plus n.
multiplied by the sum of the depreciation rate plus n.
divided by the product of f(k*) and the sum of the depreciation rate plus n.
multiplied by f(k*) divided by the sum of the depreciation rate plus n.
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Question
In the Solow growth model of an economy with population growth but no technological change, the break-even level of
investment must do all of the following except:
Answer offset the depreciation of existing capital.
provide capital for new workers.
equal the marginal productivity of capital (MPK).
keep the level of capital per worker constant.
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Question
In the Solow growth model of an economy with population growth but no technological change, if population grows at rate
n, then capital grows at rate ______ and output grows at rate ______.
13 of 24 12/8/2012 11:37
Answer n; n
n; 0
0; 0
0; n
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Question
In the Solow growth model of an economy with population growth but no technological change, if population grows at rate
n, total output grows at rate ______ and output per worker grows at rate ______.
Answer n; n
n; 0
0; 0
0; n
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Question
Assume two economies are identical in every way except that one has a higher population growth rate. According to the
Solow growth model, in the steady state the country with the higher population growth rate will have a ______ level of
output per person and ______ rate of growth of output per worker as/than the country with the lower population growth
rate.
Answer higher; the same
higher; a higher
lower; the same
lower; a lower
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Question
In the Solow growth model, an economy in the steady state with a population growth rate of n but no technological growth
will exhibit a growth rate of output per worker at rate:
Answer 0.
n.
.
(n + ).
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Question
In the Solow growth model, an economy in the steady state with a population growth rate of n but no technological growth
will exhibit a growth rate of total output at rate:
Answer 0.
n.
.
(n + ).
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Question
In the Solow growth model, if two countries are otherwise identical (with the same production function, same saving rate,
same depreciation rate, and same rate of population growth) except that Country Large has a population of 1 billion
workers and Country Small has a population of 10 million workers, then the steady-state level of output per worker will be
_____ and the steady-state growth rate of output per worker will be _____.
Answer the same in both countries; the same in both countries
higher in Country Large; higher in Country Large
higher in Country Small; higher in Country Small
higher in Country Large; higher in Country Small
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14 of 24 12/8/2012 11:37
Question
In the Solow growth model with population growth, but no technological progress, the steady-state amount of investment
can be thought of as a break-even amount of investment because the quantity of investment just equals the amount of:
Answer output needed to achieve the maximum level of consumption per worker.
capital needed to replace depreciated capital and to equip new workers.
saving needed to achieve the maximum level of output per worker.
output needed to make the capital per worker ratio equal to the marginal product of capital.
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Question
In the Solow growth model, the steady state level of output per worker would be higher if the _____ increased or the _____
decreased.
Answer saving rate; depreciation rate
population growth rate; depreciation rate
depreciation rate; population growth rate
population growth rate; saving rate
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Question
In the Solow growth model with population growth, but no technological change, a higher level of steady-state output per
worker can be obtained by all of the following except:
Answer increasing the saving rate.
decreasing the depreciation rate.
increasing the population growth rate.
increasing the capital per worker ratio.
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Question
In the Solow growth model with population growth, but no technological change, which of the following will generate a
higher steady-state growth rate of total output?
Answer a higher saving rate
a lower depreciation rate
a higher population growth rate
a higher capital per worker ratio
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Question
The Solow growth model with population growth but no technological progress can explain:
Answer persistent growth in output per worker.
persistent growth in total output.
persistent growth in consumption per worker.
persistent growth in the saving rate.
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Question
In the Solow growth model, with a given production function, depreciation rate, saving rate, and no technological change,
higher rates of population growth produce:
Answer higher steady-state ratios of capital per worker.
higher steady-state growth rates of output per worker.
higher steady-state growth rates of total output.
higher steady-state levels of output per worker.
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Question
In the Solow growth model, with a given production function, depreciation rate, saving rate, and no technological change,
lower rates of population growth produce:
15 of 24 12/8/2012 11:37
Answer lower steady-state ratios of capital per worker.

lower steady-state growth rates of output per worker.
lower steady-state growth rates of total output.
lower steady-state levels of output per worker.
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Question
The Solow model with population growth but no technological change cannot explain persistent growth in standards of
living because:
Answer total output does not grow.
depreciation grows faster than output.
output, capital, and population all grow at the same rate in the steady state.
capital and population grow, but output does not keep up.
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Question
With population growth at rate n but no technological change, the Golden Rule steady state may be achieved by equating
the marginal product of capital (MPK):
Answer net of depreciation to n.
to n.
net of depreciation to the depreciation rate plus n.
to the depreciation rate.
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Question
In the Solow growth model with population growth, but no technological progress, in the Golden Rule steady state, the
marginal product of capital minus the rate of depreciation will equal:
Answer 0.
the population growth rate.
the saving rate.
output per worker.
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Question
In the Solow growth model with population growth, but no technological progress, if in the steady state the marginal product
of capital equals 0.10, the depreciation rate equals 0.05, and the rate of population growth equals 0.03, then the capital per
worker ratio ____ the Golden Rule level.
Answer is above
is below
is equal to
will move to
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Question
In the Solow growth model with population growth but no technological progress, increases in capital have a positive
impact on steady-state consumption per worker by _____, but have a negative impact on steady-state consumption per
worker by _____.
Answer increasing the capital to worker ratio; reducing saving in the steady state.
reducing investment required in the steady state; increasing saving in the steady state.
increasing output; increasing output required to replace depreciating capital.
decreasing the saving rate; increasing the depreciation rate.
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Question
An increase in the rate of population growth with no change in the saving rate:
16 of 24 12/8/2012 11:37
Answer increases the steady-state level of capital per worker.

decreases the steady-state level of capital per worker.
does not affect the steady-state level of capital per worker.
decreases the rate of output growth in the short run.
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Question
Analysis of population growth around the world concludes that countries with high population growth tend to:
Answer have high income per worker.
have a lower level of income per worker than other parts of the world.
have the same standard of living as other parts of the world.
tend to be the high-income-producing nations of the world.
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Question
According to Kremer, large populations:
Answer require the capital stock to be spread thinly, thereby reducing living standards.
place great strains on an economy's productive resources, resulting in perpetual poverty.
are a prerequisite for technological advances and higher living standards.
are not a factor in determining living standards.
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Question
According to Malthus, large populations:
Answer require the capital stock to be spread thinly, thereby reducing living standards.
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Question
According to the Solow growth model, high population growth rates:
Answer force the capital stock to be spread thinly, thereby reducing living standards.
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Question
The Malthusian model that predicts mankind will remain in poverty forever:
Answer underestimated the possibility for technological progress.
failed to predict that scarcity would be eliminated in the modern world.
assumed that prosperity would lead to declining human fertility.
recognized that the ability of natural resources to sustain humans is far greater than the power of population to
consume resources.
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Question
According to the Kremerian model, large populations improve living standards because:
Answer crowded conditions put more pressure on people to work hard.
there are more people who can make discoveries and contribute to innovation.
more people have the opportunity for leisure and recreation.
most people prefer to live with many other people.
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17 of 24 12/8/2012 11:37
Question
0.3 0.7
If Y = K L , then the per-worker production function is:
Answer Y = F(K/L).
Y/L = (K/L)0.3.
Y/L = (K/L)0.5.
Y/L = (K/L)0.7.
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Question
1/2
If y = k , there is no population growth or technological progress, 5 percent of capital depreciates each year, and a country
saves 20 percent of output each year, then the steady-state level of capital per worker is:
Answer 2.
4.
8.
16.
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Question
1/2
If y = k , the country saves 10 percent of its output each year, and the steady-state level of capital per worker is 4, then
the steady-state levels of output per worker and consumption per worker are:
Answer 2 and 1.6, respectively.
2 and 1.8, respectively.
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Question
1/2
Assume that two countries both have the per-worker production function y = k , neither has population growth or
technological progress, depreciation is 5 percent of capital in both countries, and country A saves 10 percent of output
whereas country B saves 20 percent. If A starts out with a capital–labor ratio of 4 and B starts out with a capital–labor ratio
of 2, in the long run:
Answer both A and B will have capital–labor ratios of 4.
both A and B will have capital–labor ratios of 16.
A's capital–labor ratio will be 4 whereas B's will be 16.
A's capital–labor ratio will be 16 whereas B's will be 4.
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Question
Assume that a war reduces a country's labor force but does not directly affect its capital stock. Then the immediate impact
will be that:
Answer total output will fall, but output per worker will rise.
total output will rise, but output per worker will fall.
both total output and output per worker will fall.
both total output and output per worker will rise.
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Question
Assume that a war reduces a country's labor force but does not directly affect its capital stock. If the economy was in a
steady state before the war and the saving rate does not change after the war, then, over time, capital per worker will
______ and output per worker will ______ as it returns to the steady state.
Answer decline; increase
increase; increase
decline; decrease
increase; decrease
18 of 24 12/8/2012 11:37
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Question
If a larger share of national output is devoted to investment, then living standards will:
Answer always decline in the short run but rise in the long run.
always rise in both the short and long runs.
decline in the short run and may not rise in the long run.
rise in the short run but may not rise in the long run.
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Question
If a larger share of national output is devoted to investment, starting from an initial steady-state capital stock below the
Golden Rule level, then productivity growth will:
Answer increase in the short run but not in the long run.
increase in the long run but not in the short run.
increase in both the short run and the long run.
not increase in either the short run or the long run.
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Question
If the U.S. production function is Cobb–Douglas with capital share 0.3, output growth is 3 percent per year, depreciation is 4
percent per year, and the Golden Rule steady-state capital–output ratio is 4.29, to reach the Golden Rule steady state, the
saving rate must be:
Answer 17.5 percent.
25 percent.
30 percent.
42.9 percent.
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Question
If all wage income is consumed, all capital income is saved, and all factors of production earn their marginal products, then:
Answer the economy will reach a steady-state level of capital stock below the Golden Rule level.
the economy will reach a steady-state level of capital stock above the Golden Rule level.
wherever the economy starts out, it will not grow.
wherever the economy starts out, it will reach a steady-state level of capital stock equal to the Golden Rule
level.
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Question
If an economy moves from a steady state with positive population growth to a zero population growth rate, then in the new
steady state, total output growth will be ______ and growth of output per person will be ______.
Answer lower; lower
lower; the same as it was before
higher; higher than it was before
higher; lower
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Question
If the production function exhibits decreasing returns to scale in the steady state, an increase in the rate of population
would lead to:
Answer growth in total output and growth in output per worker.
growth in total output but no growth in output per worker.
growth in total output but a decrease in output per worker.
no growth in total output or in output per worker.
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19 of 24 12/8/2012 11:37
Question
If the production function exhibits increasing returns to scale in the steady state, an increase in the rate of growth of
population would lead to:
Answer growth in total output and growth in output per worker.
growth in total output but no growth in output per worker.
growth in total output but a decrease in output per worker.
no growth in total output or in output per worker.
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Essay 1 points
Question
1/2 1/2
Assume that a country's production function is Y = K L .
a. What is the per-worker production function y = f(k)?
b. Assume that the country possesses 40,000 units of capital and 10,000 units of labor. What is Y? What is
labor productivity computed from the per-worker production function? Is this value the same as labor
productivity computed from the original production function?
c. Assume that 10 percent of capital depreciates each year. What gross saving rate is necessary to make
the given capital–labor ratio the steady-state capital–labor ratio? (Hint: In a steady state with no
population growth or technological change, the saving rate multiplied by per-worker output must equal
the depreciation rate multiplied by the capital–labor ratio.)
d. If the saving rate equals the steady-state level, what is consumption per worker?
Answer a. y = k1/2.
b. Y = 20,000; Y/L = 2; y = 2; yes
c. s = 0.2.
d. Consumption per worker will be 1.6.
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Question
1/2
Assume that a country's per-worker production is y = k , where y is output per worker and k is capital per worker. Assume
also that 10 percent of capital depreciates per year (= 0.10).
a. If the saving rate (s) is 0.4, what are capital per worker, production per worker, and consumption per
1/2 1/2
worker in the steady state? (Hint: Use sy = k and y = k to get an equation in s, , k, and k , and
then solve for k.)
b. Solve for steady-state capital per worker, production per worker, and consumption per worker with s =
0.6.
c. Solve for steady-state capital per worker, production per worker, and consumption per worker with s =
0.8.
d. Is it possible to save too much? Why?
Answer a. k = 16; y = 4; consumption per worker is 2.4.

b. k = 36; y = 6; consumption per worker is 2.4.
c. k = 64; y = 8; consumption per worker is 1.6.
d. Yes. If the capital stock gets so big that the extra output produced by more capital is less than the extra
saving needed to maintain it, extra capital reduces consumption per worker. The saving rate exceeds
the Golden Rule rate.
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Question
Suppose that two countries are exactly alike in every respect except that the citizens of country A have a higher saving rate
than the citizens of country B.
a. Which country will have the higher level of output per worker in the steady state? Illustrate graphically.
b. Which country will have the faster rate of growth of output per worker in the steady state?
Answer a. Country A will have the higher level of output per worker.
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b. In the steady state the growth rate of output per worker will be zero in both country A and country B.
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Question
Suppose that two countries are exactly alike in every respect except that population grows at a faster rate in country A than
in country B.
a. Which country will have the higher level of output per worker in the steady state? Illustrate graphically.
b. Which country will have the faster rate of growth of output per worker in the steady state?
Answer a. Country B will have the higher level of output per worker.
b. In the steady state the growth rate of output per worker will be zero in both country A and country B.
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Question
It rains so much in the country of Tropicana that capital equipment rusts out (depreciates) at a much faster rate than it does
in the country of Sahara. If the countries are otherwise identical, in which country will the Golden Rule level of capital per
worker be higher? Illustrate graphically.
Answer The Golden Rule level of capital per worker will be higher in Sahara.
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Question
The economy of Alpha can be described by the Solow growth model. The following are some characteristics of the Alpha
economy:
saving rate (s) 0.20
21 of 24 12/8/2012 11:37
depreciation rate ( ) 0.12

steady-state capital per worker (k) 4
population growth rate (n) 0.02
steady-state output per worker 20,000
a. What is the steady-state growth rate of output per worker in Alpha?
b. What is the steady-state growth rate of total output in Alpha?
c. What is the level of steady-state consumption per worker in Alpha?
d. What is the steady-state level of investment per worker in Alpha?
Answer a. In the steady state, capital per worker is constant, so output per worker is constant. Thus, the growth
rate of steady-state output per worker is 0.
b. In the steady state, population grows at 2 percent rate (0.02). Capital must grow at a rate of 2 percent in
order to maintain a constant capital per worker ratio in the steady state; therefore, given the constant
returns to scale production function, total output must increase at a 2 percent rate.
c. If the saving rate is 20 percent, then the consumption rate is 80 percent (1 – 0.2). Steady-state
consumption per worker is 16,000, which is 80 percent of steady-state output per worker.
d. In the steady state, investment per worker equals saving per worker, which is 20 percent of steady-state
output per worker. Thus, steady-state investment per worker is 4,000.
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Question
The initial steady-state level of capital per worker in Macroland is 5. The Golden Rule level of capital per worker in
Macroland is 8.
a. What must change in Macroland to achieve the Golden Rule steady state?
b. Why might the Golden Rule steady state be preferred to the initial steady state?
c. Why might some current workers in Macroland prefer the initial steady state to the Golden Rule steady
state?
Answer a. The saving rate in Macroland must be increased to achieve the higher capital per worker ratio of the
Golden Rule steady state.
b. Consumption per worker is higher in the Golden Rule steady state than in the initial steady state.
c. In the transition from the initial steady state to the Golden Rule steady state, the level of consumption
per worker must initially decrease to accumulate the additional capital required for the Golden Rule
steady state. Thus, workers who do not want to sacrifice current consumption for future consumption
may prefer the initial steady state.
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Question
The economies of two countries, North and South, have the same production functions, depreciation rates, and saving
rates. The economies of each country can be described by the Solow growth model. Population growth is faster in South
than in North.
a. In which country is the level of steady-state output per worker larger? Explain.
b. In which country is the steady-state growth rate of output per worker larger?
c. In which country is the growth rate of steady-state total output greater?
Answer a. North will have a higher level of steady-state output per worker because the population growth is faster
in South. The same saving in both countries means that investment in both countries will be the same.
However, capital will be spread more thinly per worker in the South, where the population is growing
more rapidly. Given the same production functions, output per worker will be higher in the North
because it has a higher capital per worker ratio than the South.
b. In the steady state in both countries, capital per worker is constant, so output per worker is constant.
The growth rate of output per worker is zero in both North and South.
c. In the steady state, total output grows at the rate of population growth. Since South has a higher rate of
population growth, the growth rate of total output will be higher in South than in North.
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Question
The economies of two countries, Thrifty and Profligate, have the same production functions and depreciation rates. There
is no population growth or technological progress in either country. The economies of each country can be described by the
Solow growth model. The saving rate in Thrifty is 0.3. The saving rate in Profligate is 0.05.
a. In which country is the level of steady-state output per worker larger? Explain.
b. In which country is the steady-state growth rate of output per worker larger?
22 of 24 12/8/2012 11:37
c. In which country is the growth rate of steady-state total output greater?
Answer a. Thrifty will have the higher level of steady-state output per worker. With a higher saving rate in Thrifty,
there will be more saving, more investment, and, consequently, a higher steady-state capital per worker
ratio. For the same production function, the higher capital per worker ratio will produce a higher level of
steady-state output per worker.
b. In the steady state in both countries, capital per worker is constant, so output per worker is constant.
The growth rate of output per worker is zero in both Thrifty and Profligate.
c. Since there is no population growth or technological change in the steady state, total output will be
constant in both countries. The growth rate of total output will be zero in both Thrifty and Profligate.
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Question
Many policymakers are concerned that Americans do not save enough. Using the Solow growth model, with no
technological change and no population growth, explain why:
a. for a given production function and depreciation rate, the saving rate determines the level of output per
worker.
b. a higher saving rate will not necessarily generate more consumption per worker.
c. a higher saving rate will not produce a faster steady-state growth rate of output per worker.
Answer a. The saving rate is the proportion of output that is saved and the proportion of output allocated to
investment. A larger amount of investment can maintain a larger ratio of capital per worker and,
therefore, a higher level of output per worker can be produced than with a smaller saving rate.
b. If a high rate of saving generates a level of capital per worker greater than the Golden Rule level of
capital per worker, then consumption per worker will be smaller than at the Golden Rule level, with a
lower saving rate.
c. In the steady state, the capital per worker ratio is constant, so output per worker is constant. The
steady-state growth rate of output per worker is zero regardless of the saving rate.
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Question
One of the key distinctions made in the analysis of the Solow growth model is between changes in levels and changes in
growth rates. How does an increase in the rate of population growth change the steady-state levels and growth rates of
output and output per worker in the Solow model with no technological change?
Answer The increase in the population growth rate will increase the steady-state level of output and the steady-state
growth rate of output (which will grow at a rate equal to the new higher growth rate of population). The increase in
the population growth rate will decrease the steady-state level of output per worker and will not change the
steady-state growth rate of output per worker which in the long run is zero.
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Question
Explain the two uses of saving in the steady state in the Solow model with population growth, but no technological
progress.
Answer Saving supplies: (1) the investment to replace the depreciating capital, and (2) investment to equip the new
workers with the same amount of capital as existing workers in the economy so that the steady-state capital–
worker ratio does not change.
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Question
Compare and contrast the impact of a faster rate of population growth on the standard of living (output per worker) in the
models by Solow, Malthus, and Kremer.
Answer In the Solow growth model a faster rate of population growth reduces output per worker because capital must be
spread more thinly over the supply of workers. In Malthus's model faster population growth exhausts the supply of
food and leads to a lower standard of living. In Kremer's model faster rates of population growth increase the pool
from which new ideas and innovations can be drawn and thereby improves the standard of living.
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Question
Consider two countries that are otherwise identical (have the same saving rates and depreciation rates), but the population
of Country Large is 100 million, while the population of Country Small is 10 million. Use the Solow model with no
technological change to compare the steady-state levels of output per worker if:
23 of 24 12/8/2012 11:37
a. the population growth rates are the same in the two countries.
b. the population growth rate is higher in Country Large.
Answer a. The steady-state levels of output per worker will be the same in both countries because the assumption
of constant returns to scale means that the absolute size of the economy, measured by number of
workers, does not affect output.
b. The steady-state level of output per worker will be lower in Country Large, because with the same
saving rate but a faster growing population, Country Large will not be able to maintain as high a capital-
per-worker ratio as Country Small.
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Question
Larger quantities of steady-state capital have both a positive and negative effect on consumption per worker in the Solow
model (assume no population growth or technological progress). Explain.
Answer Larger quantities of steady-state capital increase the capital-per-worker ratio and increase the quantity of output,
and, therefore, a greater quantity of output is available for consumption per worker. Large quantities of
steady-state capital generate more depreciation, which must be replaced from output in order to maintain the
steady state, thus reducing the amount of output available for consumption per worker.
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24 of 24 12/8/2012 11:37
Pool Canvas
Name TestBanks Chapter 9 Economic Growth II: Technology, Empirics, and Policy
Description
Instructions
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Question
The efficiency of labor is a term that does not reflect the:
Answer high output that comes from labor cooperating with a large amount of capital.
health of the labor force.
education of the labor force.
skills of the labor force acquired through on-the-job training.
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Question
The efficiency of labor:
Answer is the marginal product of labor.
is the rate of growth of the labor force.
includes the knowledge, health, and skills of labor.
equals output per worker.
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Question
The number of effective workers takes into account the number of workers and the:
Answer amount of capital available to each worker.
rate of growth of the number of workers.
efficiency of each worker.
saving rate of each worker.
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Question
The rate of labor-augmenting technological progress (g) is the growth rate of:
Answer labor.
the efficiency of labor.
capital.
output.
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Question
Assuming that technological progress increases the efficiency of labor at a constant rate is called:
Answer endogenous technological progress.
the efficiency-wage model of economic growth.
labor-augmenting technological progress.
the Golden Rule model of economic growth.
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1 of 19 12/8/2012 11:38
Question
If the labor force is growing at a 3 percent rate and the efficiency of a unit of labor is growing at a 2 percent rate, then
the number of effective workers is growing at a rate of:
Answer 2 percent.
3 percent.
5 percent.
6 percent.
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Question
In a steady-state economy with a saving rate s, population growth n, and labor-augmenting technological progress g,
the formula for the steady-state ratio of capital per effective worker (k*), in terms of output per effective worker (f(k*)), is
(denoting the depreciation rate by ):
Answer sf(k)/( + n + g).
s/((f(k))( + n + g)).
f(k)/((s)( + n + g)).
(s – f(k))/( + n + g).
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Question
In the Solow growth model with population growth and technological change, the break-even level of investment must
cover:
Answer depreciating capital.
depreciating capital and capital for new workers.
depreciating capital and capital for new effective workers.
depreciating capital, capital for new workers, and capital for new effective workers.
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Question
In the Solow growth model, the steady-state growth rate of output per effective worker is ______, and the steady-state
growth rate of output per actual worker is ______.
Answer the sum of the rate of technological progress plus the rate of population growth; zero
zero; the rate of technological progress
zero; zero
the rate of technological progress; the rate of population growth
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Question
In the Solow growth model with population growth and technological change, the steady-state growth rate of income
per person depends on:
Answer the rate of population growth.
the saving rate.
the rate of technological progress.
the rate of population growth plus the rate of technological progress.
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Question
In a steady-state economy with population growth n and labor-augmenting technological progress g, persistent
increases in standards of living are possible because the:
Answer capital stock grows faster than does the labor force.
capital stock grows faster than does the number of effective workers.
rate of depreciation constantly decreases.
saving rate constantly increases.
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2 of 19 12/8/2012 11:38
Question
According to the Solow model, persistently rising living standards can only be explained by:
Answer population growth.
capital accumulation.
saving rates.
technological progress.
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Question
In the Solow model with technological change, the Golden Rule level of capital is the steady state that maximizes:
output per effective worker.
consumption per worker.
consumption per effective worker.
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Question
With population growth at rate n and labor-augmenting technological progress at rate g, the Golden Rule steady state
requires that the marginal product of capital (MPK):
Answer net of depreciation be equal to n + g.
net of depreciation be equal to the depreciation rate plus n + g.
plus n be equal to the depreciation rate plus g.
plus g be equal to the depreciation rate plus n.
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Question
In the Solow model with technological progress, the steady-state growth rate of capital per effective worker is:
Answer 0.
g.
n.
n + g.
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Question
In a Solow model with technological change, if population grows at a 2 percent rate and the efficiency of labor grows at
a 3 percent rate, then in the steady state, output per effective worker grows at a ______ percent rate.
Answer 0
2
3
5
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Question
a 3 percent rate, then in the steady state, output per actual worker grows at a ______ percent rate.
Answer 0
2
3
5
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3 of 19 12/8/2012 11:38
Question
a 3 percent rate, then in the steady state, total output grows at a ______ percent rate.
Answer 0
2
3
5
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Question
In the Solow model with technological progress, the steady-state growth rate of output per effective worker is:
Answer 0.
g.
n.
n + g.
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Question
In the Solow model with technological progress, the steady-state growth rate of output per (actual) worker is:
Answer 0.
g.
n.
n + g.
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Question
In the Solow model with technological progress, the steady-state growth rate of total output is:
Answer 0.
g.
n.
n + g.
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Question
Over the past 50 years in the United States:
Answer output per worker hour, capital stock per worker hour, the real wage, and the real rental price of capital
have all increased about 2 percent per year.
output per worker hour, the real wage, and the real rental price of capital have all increased about 2
percent per year, whereas capital stock per worker hour has increased faster.
output per worker hour and the real wage have both increased about 2 percent per year, whereas capital
stock per worker hour has increased faster and the real rental price of capital has remained about the
same.
output per worker hour, the real wage, and capital stock per worker hour have all increased about 2
percent per year, whereas the real rental price of capital has remained about the same.
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Question
In the Solow model with technological progress, by increasing the efficiency of labor at rate g:
Answer the real wage and the real rental price of capital both grow at rate g.
the real wage grows at rate g but the real rental price of capital is constant.
the real wage is constant but the real rental price of capital grows at rate g.
both the real wage and the real rental price of capital are constant.
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4 of 19 12/8/2012 11:38
Question
The balanced growth property of the Solow growth model with population growth and technological progress predicts
which of the following sets of variables will grow at the same rate in the steady state?
Answer output per effective worker, capital per effective worker, real wage
output per worker, capital per worker, real wage
real rental price of capital, real wage, output per worker
capital-output ratio, output per worker, capital per worker
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Question
The Solow model predicts that two economies will converge if the economies start with the same:
Answer capital stocks.
populations.
steady states.
production functions.
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Question
Conditional convergence occurs when economies converge to:
Answer the same steady state as other economies.
the Golden Rule steady state.
the balanced-growth steady state.
their own, individual steady states.
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Question
International data suggest that economies of countries with different steady states will converge to:
Answer the same steady state.
their own steady state.
the Golden Rule steady state.
steady states below the Golden Rule level.
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Question
If two economies are identical (including having the same saving rates, population growth rates, and efficiency of
labor), but one economy has a smaller capital stock, then the steady-state level of income per worker in the economy
with the smaller capital stock:
Answer will be at a lower level than in the steady state of the high capital economy.
will be at a higher level than in the steady state of the high capital economy.
will be at the same level as in the steady state of the high capital economy.
will be proportional to the ratio of the capital stocks in the two economies.
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Question
If two economies are identical (with the same population growth rates and rates of technological progress), but one
economy has a lower saving rate, then the steady-state level of income per worker in the economy with the lower
saving rate:
Answer will be at a lower level than in the steady state of the high-saving economy.
will be at a higher level than in the steady state of the high-saving economy.
will be at the same level as in the steady state of the high-saving economy.
will grow at a slower rate than in the high-saving economy.
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5 of 19 12/8/2012 11:38
Question
Empirical investigations into whether differences in income per person are the result of differences in the quantities of
the factors of production available or differences in the efficiency with which the factors are employed typically find:
Answer a negative correlation between the quantity of factors and the efficiency of use.
a positive correlation between the quantity of factors and the efficiency of use.
no correlation between the quantity of factors and the efficiency of use.
large gaps between the quantity of factors accumulated and the efficiency of use.
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Question
Hypotheses to explain the positive correlation between factor accumulation and production efficiency include each of
the following except:
Answer the quality of a nation's institutions influences both factor accumulation and production efficiency.
capital accumulation causes greater production efficiency.
efficient economies make capital accumulation unnecessary.
an efficient economy encourages capital (including human capital) accumulation.
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Question
International differences in income per person in accounting terms must be attributed to differences in either ______
and/or ______.
Answer factor accumulation; production efficiency
constant returns to scale; the marginal product of capital
unemployment rates; depreciation rates
consumption; interest rates
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Question
Differences in factor accumulation and/or differences in production efficiency must account for all international
differences in:
Answer human capital and physical capital.
saving rates and population growth rate.
income per person.
labor efficiency.
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Question
The preponderance of empirical evidence supports the hypothesis that economies that are open to trade _____ than
comparable closed economies.
Answer grow more rapidly
have lower steady-state levels of income per worker due to foreign competition
have faster rates of population growth and technological progress
converge more slowly to a steady-state equilibrium
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Question
Empirical evidence supports the theory that free trade:
Answer increases economic growth.
decreases economic growth.
increases imports, but decreases exports because of greater global competition.
increases both imports and exports, but does not contribute to overall economic growth.
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6 of 19 12/8/2012 11:38
Question
If the marginal product of capital net depreciation equals 8 percent, the rate of growth of population equals 2 percent,
and the rate of labor-augmenting technical progress equals 2 percent, to reach the Golden Rule level of the capital
stock, the ____ rate in this economy must be _____.
Answer saving; increased.
population growth; decreased
depreciation; decreased
total output growth; decreased
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Question
If the marginal product of capital net of depreciation equals 10 percent and the rate of population growth equals 2
percent, then this economy will be at the Golden Rule steady state if the rate of technological progress equals _____
percent.
Answer 0
2
8
10
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Question
Which of the following changes would bring the U.S. capital stock, currently below the Golden Rule level, closer to the
steady-state, consumption-maximizing level?
Answer increasing the population growth rate
increasing the rate of capital depreciation
increasing the rate of technological progress
increasing the saving rate
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Question
The analysis in Chapter 9 of the current capital stock in the United States versus the Golden Rule level of capital stock
shows that the capital stock in the United States is:
Answer well above the Golden Rule level.
about equal to the Golden Rule level.
well below the Golden Rule level.
slightly above the Golden Rule level.
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Question
Other things being equal, all of the following government policies are likely to increase national saving except:
Answer decreasing taxes on savings accounts.
running a budget deficit.
running a budget surplus.
retiring part of the national debt.
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Question
Economic research shows that ______ in explaining international differences in living standards.
Answer physical capital is more important than human capital
human capital is at least as important as physical capital
human capital is much more important than physical capital
infrastructure is the most important factor
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7 of 19 12/8/2012 11:38
Question
A possible externality associated with the process of accumulating new capital is that:
Answer a reduction in labor productivity may occur.
new production processes may be devised.
old capital may be made more productive.
the government may need to adopt an industrial policy.
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Question
English-style legal systems give ______ protections to shareholders and creditors than French Napoleonic Codes,
typically resulting in ______ capital markets and faster rates of economic growth.
Answer greater; more developed
greater; more corrupt
less; more developed
less; less corrupt
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Question
The type of legal system and the level of corruption in a country have been found to be:
Answer unrelated to the rate of economic growth in a country.
significant determinants of the rate of economic growth in a country.
important topics for political discussion, but not economic explanations of growth.
important variables explaining the Golden Rule level of capital.
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Question
One explanation for greater economic development in moderate versus tropical climates is that institutions established
by colonial settlers in moderate climates ______, while institutions established by colonists in tropical climates ______.
Answer were based on English common law; were based on the Napoleonic Code
were based on the Napoleonic Code; were based on English common law
protected property rights; were extractive and authoritarian
were extractive and authoritarian; protected property rights
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Question
Public policies in the United States designed to stimulate technological progress do not include:
Answer tax breaks to encourage homeownership.
the temporary monopoly granted by the patent system.
tax breaks for research and development.
subsidies given by the National Science Foundation.
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Question
The recent worldwide slowdown in economic growth began in the early:
Answer 1960s.
1970s.
1980s.
1990s.
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Question
If productivity growth in the United States had remained at its level before the recent productivity slowdown, real
income today would be more than ______ percent higher.
8 of 19 12/8/2012 11:38
Answer 10
20
30
40
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Question
The productivity slowdown that began in the 1970s has been attributed, at least partly, to each of the following except:
Answer running out of new ideas about how to produce.
a deterioration in the quality of education.
a decline in the number of workers in the labor force.
a lower average level of experience among workers.
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Question
Increases in the rate of growth of income per person in the United States in the mid-1990s is mostly likely the result of:
Answer increases in human capital.
increases in physical capital.
advances in information technology.
an increase in the saving rate.
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Question
Endogenous growth theory rejects the assumption of exogenous:
Answer production functions.
rates of depreciation.
population growth rates.
technological change.
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Question
In the Solow growth model, technological change is ______, whereas in endogenous growth theories, technological
change is ______.
Answer assumed; explained
explained; assumed
persistent; constant
constant; persistent
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Question
In the Solow growth model, capital exhibits ______ returns. In the basic endogenous growth model, capital exhibits
______ returns.
Answer constant; diminishing
constant; constant
diminishing; constant
diminishing; diminishing
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Question
In the basic endogenous growth model, income can grow forever—even without exogenous technological progress
—because:
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Answer the saving rate equals the rate of depreciation.

the saving rate exceeds the rate of depreciation.
capital does not exhibit diminishing returns.
capital exhibits diminishing returns.
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Question
The endogenous growth model's assumption of constant returns to capital is more plausible if capital is defined to
include:
Answer plant and equipment.
knowledge.
depreciation.
technology.
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Question
If Y is output, K is capital, u is the fraction of the labor force in universities, L is labor, and E is the stock of knowledge,
and the production Y = F(K,(1 – u) EL) exhibits constant returns to scale, then output (Y) will double if:
Answer K is doubled.
K and u are doubled.
K and E are doubled.
L is doubled.
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Question
In the two-sector endogenous growth model, the saving rate (s) affects the steady-state:
Answer level of income.
growth rate of income.
level of income and growth rate of income.
growth rate of the stock of knowledge.
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Question
In the two-sector endogenous growth model, the fraction of labor in universities (u) affects the steady-state:
Answer level of income.
growth rate of income.
level of income and growth rate of income.
level of income, growth rate of income, and growth rate of the stock of knowledge.
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Question
In the two-sector endogenous growth model, income growth persists because:
Answer the production function shifts exogenously.
the saving rate exceeds the rate of depreciation.
the creation of knowledge in universities never slows down.
the fraction of the labor force in universities is large.
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Question
In the two-sector endogenous growth model, the steady-state stock of physical capital is determined by _____, and the
growth in the stock of knowledge is determined by _____.
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Answer the fraction of labor in universities; the saving rate

the efficiency of labor; the saving rate
the production function; the efficiency of labor
the saving rate; the fraction of labor in universities
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Question
Empirical studies indicate that the rate of social return from positive “standing on others' shoulders” externalities of
research ______ the negative “stepping on toes” externalities of research.
Answer greatly exceed
approximately equal
are substantially less than
are only slightly less than
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Question
Empirical results justify substantial government subsidies to research based on the finding that the:
Answer the private return to research is greater than the social return to research.
the private return to research is approximately equal to the social return to research.
the private return to research is less than the social return to research.
the private return to research is positive, but the social return to research is negative.
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Question
Schumpeter's thesis of “creative destruction” is an explanation of economic progress resulting from:
Answer using up scarce natural resources to create new products.
breaking down barriers to trade and development.
new product producers driving incumbent producers out of business.
creating new methods to destroy the environment.
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Question
When capital increases by K units, output increases by:
Answer L units.
MPL × L units.
K units.
MPK × K units.
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Question
When capital increases by K units and labor increases by L units, output ( Y) increases by:
Answer K+ L units.
MPL + MPK units.
(MPK × K) + (MPL × L) units.
(MPL × K) + (MPK × K) units.
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Question
If capital grows at 3 percent per year and labor grows at 1 percent per year, and capital's share is 1/3 while labor's
share is 2/3, if there is no technological progress and the neoclassical assumptions hold, the growth rate of output will
be:
11 of 19 12/8/2012 11:38
Answer 1-1/3 percent per year.

1-2/3 percent per year.
3 percent per year.
2-1/3 percent per year.
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Question
Total factor productivity may be measured by:
Answer subtracting the rate of growth of capital input and the rate of growth of labor input from the rate of growth of
output.
subtracting the rate of growth of capital input, multiplied by capital's share of output, plus the rate of growth
of labor input, multiplied by labor's share of output, from the rate of growth of output.
adding the rate of growth of capital input to the rate of growth of labor input.
adding the rate of growth of capital input, multiplied by capital's share of output, to the rate of growth of
labor input, multiplied by labor's share of output.
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Question
Changes that can increase measured total factor productivity include:
Answer increased expenditures on education.
regulations requiring reductions in pollution.
regulations requiring increases in worker safety.
increases in the capital–labor ratio.
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Question
The Solow residual measures the portion of output growth that cannot be explained by growth in:
Answer capital and labor.
technology.
the money supply.
the saving rate.
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Question
Prescott interpreted fluctuations in the Solow residual as evidence that:
Answer technology shocks are an important source of short-run economic fluctuations.
the Solow growth model does not converge to a steady-state equilibrium.
endogenous growth models are better explanations of growth than the Solow model.
the marginal product of labor fluctuates more than the marginal product of capital.
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Question
An alternative to Prescott's explanation of the cyclical behavior of the Solow residual is that it is the result of:
Answer labor hoarding in recession and cyclical mismeasurement of output.
bad weather, strict environmental regulations, and oil shocks.
declines in capital utilization and labor force participation.
technology shocks.
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Question
Labor hoarding refers to:
12 of 19 12/8/2012 11:38
Answer keeping workers in low-wage jobs in order to reduce labor costs.

using less capital in production so that more workers will have jobs.
continuing to employ workers during a recession to ensure they will be available in the recovery.
contractually preventing workers from obtaining jobs with competing firms.
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Question
The Solow residual equals the percentage change in output:
Answer plus the percentage changes in factor inputs weighted by each factor's share of output.
minus the percentage changes in prices of factor inputs.
minus the percentage changes in factor inputs weighted by each factor's share of output.
plus the percentage changes in each factor's share of output.
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Question
The Solow residual will fall even if technology has not changed if there is:
Answer population growth.
endogenous growth.
labor hoarding.
balanced growth.
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Question
A recent study suggests that the spectacular growth rates experienced by Hong Kong, Singapore, South Korea, and
Taiwan are largely due to:
Answer rapid growth in total factor productivity.
increases in factor inputs.
high rates of saving.
low rates of capital depreciation.
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Question
1/2
If the production function is y = k , the steady-state value of y is:
Answer
y = ((s + g)/( + n))1/2.
y = (s + g)/( + n).
y = (2/( + n + g))1/2.
y = s/( + n + g).
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Question
If the U.S. production function is Cobb–Douglas with capital share 0.3, output growth is 3 percent per year,
depreciation is 4 percent per year, and the capital–output ratio is 2.5, the saving rate that is consistent with
steady-state growth is:
Answer 12.5 percent.
14 percent.
17.5 percent.
20 percent.
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Question
In a steady state with population growth and technological progress:
13 of 19 12/8/2012 11:38
Answer the capital share of income increases.

the labor share of income increases.
the capital share of income, in some cases, increases, and sometimes the labor share increases.
the capital and labor shares of income are constant.
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Question
In a steady state with population growth and technological progress:
Answer the real rental price of capital is constant and the real wage grows at the rate of technological progress.
the real rental price of capital grows at the rate of technological progress and the real wage is constant.
both the real rental price of capital and the real wage grow at the rate of technological progress.
both the real rental price of capital and the real wage are constant.
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Question
In comparing two countries with different levels of education but the same saving rate, same rate of population growth,
and same rate of technological progress, one would expect the more highly educated country to have:
Answer a higher growth rate of total income and a higher real wage.
a higher growth rate of total income and the same real wage.
the same growth rate of total income and a higher real wage.
the same growth rate of total income and the same real wage.
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Question
If the per-worker production function is y = Ak, where A is a positive constant, then the marginal product of capital:
Answer increases as k increases.
is constant as k increases.
decreases as k increases.
cannot be measured in this case.
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Question
If the per-worker production function is y = Ak, where A is a positive constant, in the steady state, a:
Answer lower saving rate does not affect the growth rate.
higher saving rate does not affect the growth rate.
lower saving rate leads to a higher growth rate.
higher saving rate leads to a higher growth rate.
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Question
2/3 1/3
If the production function is Y = AK L in the land of Solovia, and the labor force increases by 5 percent while capital
is constant, labor productivity will:
Answer increase by 3.33 percent.
increase by 1.67 percent.
decrease by 1.67 percent.
decrease by 3.33 percent.
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Question
In year 1, capital stock was 6, labor input was 3, and output was 12. In year 2, capital was 7, labor was 4, and output
was 14. If shares of labor and capital were each 1/2, between the two years, total factor productivity:
14 of 19 12/8/2012 11:38
Answer increased by 1/12.

increased by 1/18.
decreased by 1/12.
decreased by 1/18.
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Question
The rate of growth of labor productivity (Y/L) may be expressed as the rate of growth of total factor productivity:
Answer plus the capital share multiplied by the rate of growth of the capital–labor ratio.
minus the capital share multiplied by the rate of growth of the capital–labor ratio.
plus the rate of growth of capital productivity.
minus the rate of growth of capital productivity.
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Question
Assume that an economy described by the Solow model is in a steady state with output and capital growing at 3
percent, and labor growing at 1 percent. The capital share is 0.3. The growth-accounting equation indicates that the
contributions to growth of capital, labor, and total factor productivity are:
Answer 0 percent, 1 percent, and 2 percent, respectively.
0.3 percent, 0.7 percent, and 2 percent, respectively.
0.9 percent, 0.7 percent, and 1.4 percent, respectively.
1.8 percent, 0.3 percent, and 0.9 percent, respectively.
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Essay 1 points
Question
0.3 0.7
Assume that a country's production function is Y = AK L . The ratio of capital to output is 3, the growth rate of output
is 3 percent, and the depreciation rate is 4 percent. Capital is paid its marginal product.
a. What is the marginal product of capital in this situation? (Hint: The marginal product of capital may be
computed using calculus by differentiating the production function and using the capital–output ratio or
by using the fact that capital's share equals MPK multiplied by K divided by Y.)
b. If the economy is in a steady state, what must be the saving rate? (Hint: The saving rate multiplied by Y
must provide for gross growth of ( + n + g)K, where is the depreciation rate.)
c. If the economy decides to achieve the Golden Rule level of capital and actually reaches it, what will be
the marginal product of capital?
d. What must the saving rate be to achieve the Golden Rule level of capital?
Answer a. MPK = 0.10 b. s = 0.21 c. MPK = 0.07 d. s = 0.30

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Question
Use the data in the exhibit to complete a and b.
Exhibit: Factors of Production Data
Period Y K L Share of Labor in Output
1 100 200 100 0.5
1 106 205 102 0.5
3 111 210 104 0.5
4 110.5 215 104 0.5
5 110 220 104 0.5
a. Compute and report the value of growth in total factor productivity ((A – A )/A ) in each period from
t t–1 t–1
periods 2 through 5. If the value of A is 1.000 in period 1, also report the value of A in each period.
b. Does the value of A rise in each period? If it declines, do you think this decline is because technological
progress works backward? If so, explain your answer. If not, provide another explanation.
Answer a. Growth in A is equal to plus 3.75 percent, plus 2.52, minus 1.64 percent, and minus 1.62 percent in
periods 2 through 5. The values of A in the five periods are 1.0000, 1.0375, 1.0636, 1.046, and 1.0293,
respectively.
b. A does not rise in each period. Many explanations are possible, but one explanation is that the economy
goes into a recession (output drops in periods 4 and 5) and management “hoards” labor instead of
laying workers off.
15 of 19 12/8/2012 11:38
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Question
Suppose a government is able to permanently reduce its budget deficit. Use the Solow growth model of Chapter 9 to
graphically illustrate the impact of a permanent government deficit reduction on the steady-state capital–labor ratio and
the steady-state level of output per worker.
Be sure to label the: a. axes; b. curves; c. initial steady-state levels; d. terminal steady-state levels; and e. the direction
curves shift.
Answer
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Question
Suppose Congress passes significant tax cuts on household income but does not reduce spending, so that the
government budget deficit is larger. Use the Solow growth model of Chapter 9 to graphically illustrate the impact of the
tax cut on the steady-state capital–labor ratio and the steady-state level of output per worker.
curves shift.
Answer
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Question
Suppose a government is able to impose controls that limit the number of children people can have. Use the Solow
growth model of Chapter 9 to graphically illustrate the impact of the slower rate of population growth on the
steady-state capital–labor ratio and the steady-state level of output per worker.
curves shift.
Answer
16 of 19 12/8/2012 11:38
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Question
Suppose that technological change is not labor-augmenting, but affects only capital. Use the Solow growth model of
Chapter 9 to graphically illustrate the impact of the slower rate of technological change that increases the rate at which
capital wears out (the rate of depreciation increases) on the steady-state capital–labor ratio and the steady-state level
of output per worker.
curves shift.
Answer
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Question
Two countries, Highland and Lowland, are described by the Solow growth model. Both countries are identical, except
that the rate of labor-augmenting technological progress is higher in Highland than in Lowland.
a. In which country is the steady-state growth rate of output per effective worker higher?
b. In which country is the steady-state growth rate of total output higher?
c. Does the Solow growth model predict that the two economies will converge to the same steady state?
Answer a. The steady-state growth rate of output per effective worker is zero in both countries.
b. The steady-state growth rate of total output will be higher in Highland because of the higher rate of
technological progress.
c. No, the Solow growth model predicts that the economies will converge to different steady states
because they have different rates of technological progress.
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Question
Based on the Solow growth model with population growth and labor-augmenting technological progress, explain how
each of the following policies would affect the steady-state level and steady-state growth rate of total output per person:
a. a reduction in the government's budget deficit
b. grants to support research and development
c. tax incentives to increase private saving
d. greater protection of private property rights
Answer a. The reduction in the budget deficit increases the saving rate, which will increase the steady-state level
of output per person, but not alter the steady-state growth rate of output per person.
b. Grants to support research and development may improve the rate of technological progress, which will
increase the steady-state level and growth rate of output per person.
c. Greater private saving increases the saving rate, which will increase the steady-state level of output per
person, but not alter the steady-state growth rate of output per person.
d. Greater protection of property rights may be an institutional improvement that improves the rate of
technological progress, which will increase the steady-state level and growth rate of output per person.
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Question
Explain how the Solow growth model differs from models of endogenous growth with respect to:
a. the sources of technological progress.
b. returns to capital.
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Answer a. The Solow growth model assumes technological growth exists, while endogenous growth models try to
explain where technological progress comes from.
b. The Solow growth model assumes diminishing returns to capital, while endogenous growth models
assume constant returns to capital.
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Question
Income per person exceeds $25,000 in many countries, but it is below $1,000 per person in many other countries.
Based on the Solow growth model, suggest at least four possible explanations for this gap in living standards.
Answer Possible explanations include: richer countries have higher saving rates, lower population growth rates, lower
capital-depreciation rates, higher rates of technological progress, or institutions that better facilitate economic
growth.
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Question
The economy of Macroland can be described by the Solow growth model. In Macroland the labor force grows at 3
percent per year, labor-augmenting technology increases at 2 percent per year, the saving rate is 15 percent per year,
and the rate of capital depreciation is 10 percent per year. Choosing from among the following variables—output per
effective worker, output per worker, total output, labor force, capital per worker, and capital per effective worker—which
variables will be growing at a:
a. 2 percent rate?
b. 3 percent rate?
c. 5 percent rate?
d. 0 percent rate?
Answer a. output per worker, capital per worker

b. labor force
c. total output
d. output per effective worker, capital per effective worker
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Question
The Solow model with population growth and labor-augmenting technological progress predicts balanced growth in the
steady state. Growth rates of which variables are predicted to be balanced (i.e., will be equal) in the steady state?
Answer Output per worker, capital per worker, and the real wage will all grow at rate g, the growth rate of technological
progress in the steady state. Output per effective worker, capital per effective worker, the capital–output ratio,
and the real rental return on capital will all be constant in the steady state.
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Question
What is the difference between convergence and conditional convergence with respect to predictions of the Solow
growth model? Explain.
Answer Convergence applies to economies with the same saving rate, population growth rate, depreciation rate, rate
of technological progress, and production function. These economies will converge to the same steady state
according to the Solow growth model, with the same level of output per worker, capital per worker, and growth
rates (even if the levels were initially different). Conditional convergence applies to economies with different
saving rates, population growth rates, depreciation rates, rates of technological progress, and/or production
functions. These economies will move to different steady state equilibria with different levels of output per
worker, capital per worker, and growth rates determined by the key variables.
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Question
Explain why additional capital generates both positive and negative impacts on steady-state consumption per worker in
the Solow growth model with population growth and technological change.
Answer Increasing the capital per effective worker ratio increases output available for consumption—a positive impact
on consumption per worker. Increasing the capital-per-effective-worker ratio requires that more of the
additional output be devoted to investment in order to replace a larger depreciating capital stock and to equip
a growing workforce of effective workers with the higher ratio of capital per effective worker—a negative
impact on consumption per worker.
18 of 19 12/8/2012 11:38
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Question
Suggest three explanations for the productivity slowdown experienced since 1972.
Answer Possible explanations include: mismeasurement of quality improvements, increases in oil prices, declines in
worker quality, and depletion of ideas.
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Question
a. What is the Solow residual?
b. Compare Prescott's interpretation of the fluctuations of the Solow residual over the business cycle with
more standard explanations of these fluctuations.
Answer a. The Solow residual is the percentage change in total output minus the percentage change in inputs. It is
a measure of total factor productivity.
b. Prescott interprets the cyclical change in the Solow residual, decreasing in recessions and increasing in
expansions, as evidence that business cycles are the result of technological shocks. Critics of this
interpretation suggest that the Solow residual would decline during a recession without any change in
technology if there is labor hoarding during recessions, and if a different type of output, which is more
difficult to measure, is produced during recessions.
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19 of 19 12/8/2012 11:38
Pool Canvas file:///C:/Users/MOHA/Desktop/mac8e/New folder (10)/CourseComp...
Pool Canvas
Name TestBanks Chapter 10 Introduction to Economic Fluctuations

Description
Instructions
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Question
Business cycles are:
Answer regular and predictable.
irregular but predictable.
regular but unpredictable.
irregular and unpredictable.
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Question
Short-run fluctuations in output and employment are called:
Answer sectoral shifts.
the classical dichotomy.
business cycles.
productivity slowdowns.
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Question
Recessions typically, but not always, include at least ______ consecutive quarters of declining real GDP.
Answer two
four
six
eight
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Question
Over the business cycle, investment spending ______ consumption spending.
Answer is inversely correlated with
is more volatile than
has about the same volatility as
is less volatile than
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Question
When GDP growth declines, investment spending typically ______ and consumption spending typically ______.
Answer increases; increases
increases; decreases
decreases; decreases
decreases; increases
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1 of 24 12/8/2012 11:39
Question
Okun's law is the ______ relationship between real GDP and the ______.
Answer negative; unemployment rate
negative; inflation rate
positive; unemployment rate
positive; inflation rate
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Question
The statistical relationship between changes in real GDP and changes in the unemployment rate is called:
Answer the Phillips curve.
the Solow residual.
the Fisher effect.
Okun's law.
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Question
The version of Okun's law studied in Chapter 10 assumes that with no change in unemployment, real GDP normally
grows by 3 percent over a year. If the unemployment rate rose by 2 percentage points over a year, Okun's law predicts
that real GDP would:
Answer decrease by 1 percent.
decrease by 2 percent.
increase by 1 percent.
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Question
The version of Okun's law studied in Chapter 10 assumes that with no change in unemployment, real GDP normally
grows by 3 percent over a year. If the unemployment rate fell by 1 percentage point over a year, Okun's law predicts
that real GDP would:
Answer decrease by 1 percent.
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Question
Long-run growth in real GDP is determined primarily by ______, while short-run movements in real GDP are
associated with ______.
Answer variations in labor-market utilization; technological progress
technological progress; variations in labor-market utilization
money supply growth rates; changes in velocity
changes in velocity; money supply growth rates
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Question
Leading economic indicators are:
Answer the most popular economic statistics.
data that are used to construct the consumer price index and the unemployment rate.
variables that tend to fluctuate in advance of the overall economy.
standardized statistics compiled by the National Bureau of Economic Research.
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2 of 24 12/8/2012 11:39
Question
A decline in the Index of Supplier Deliveries is typically an indicator of a future _____ in economic production, and a
narrowing of the interest rate spread between the 10-year Treasury note and 3-month Treasury bill is typically an
indicator of a future _____ in economic production.
Answer increase; slowdown
increase; increase
slowdown; increase
slowdown; slowdown
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Question
The index of leading indicators compiled by the Conference Board includes 10 data series that are used to forecast
economic activity about ______ in advance.
Answer one month
six to nine months
one to two years
five to ten years
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Question
Measures of average workweeks and of supplier deliveries (vendor performance) are included in the index of leading
indicators, because shorter workweeks tend to indicate ______ future economic activity and slower deliveries tend to
indicate ______ future economic activity.
Answer stronger; stronger
stronger; weaker
weaker; stronger
weaker; weaker
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Question
Most economists believe that prices are:
Answer flexible in the short run but many are sticky in the long run.
flexible in the long run but many are sticky in the short run.
sticky in both the short and long runs.
flexible in both the short and long runs.
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Question
Most economists believe that the classical dichotomy:
Answer holds approximately in both the short run and the long run.
holds approximately in the long run but not at all in the short run.
holds approximately in the short run but not at all in the long run.
does not hold even approximately in either the long run or the short run.
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Question
A 5 percent reduction in the money supply will, according to most economists, reduce prices 5 percent:
Answer in both the short and long runs.
in neither the short nor long run.
in the short run but lead to unemployment in the long run.
in the long run but lead to unemployment in the short run.
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3 of 24 12/8/2012 11:39
Question
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.
Answer real
nominal
real and nominal
neither real nor nominal
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Question
Alan Blinder's survey of firms found that the typical firm adjusts its prices:
Answer more than once a week.
about once a month.
once or twice a year.
less than once a year.
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Question
Alan Blinder's survey of firms found that the theory of price stickiness accepted by the most firms was:
Answer menu costs.
coordination failure.
nominal contracts.
procyclical elasticity.
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Question
All of the following are suggested by the results of Alan Blinder's survey of firms except:
Answer there is only one theory of price stickiness.
coordinating wage and price setting could improve welfare.
reasons for price stickiness vary by industry.
activist monetary policy can be used to cure recessions.
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Question
A difference between the economic long run and the short run is that:
Answer the classical dichotomy holds in the short run but not in the long run.
monetary and fiscal policy affect output only in the long run.
demand can affect output and employment in the short run, whereas supply is the ruling force in the long
run.
prices and wages are sticky in the long run only.
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Question
The aggregate demand curve is the ______ relationship between the quantity of output demanded and the ______.
Answer positive; money supply
negative; money supply
positive; price level
negative; price level
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Question
The relationship between the quantity of output demanded and the aggregate price level is called:
4 of 24 12/8/2012 11:39
Answer aggregate demand.

aggregate supply.
aggregate output.
aggregate consumption.
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Question
If an aggregate demand curve is drawn with real GDP (Y) along the horizontal axis and the price level (P) along the
vertical axis, using the quantity theory of money as a theory of aggregate demand, this curve slopes ______ to the
right and gets ______ as it moves farther to the right.
Answer downward; steeper
downward; flatter
upward; steeper
upward; flatter
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Question
The assumption of constant velocity in the quantity equation is the equivalent of the assumption of a constant:
Answer short-run aggregate supply curve.
long-run aggregate supply curve.
price level in the short run.
demand for real balances per unit of output.
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Question
Along an aggregate demand curve, which of the following are held constant?
Answer real output and prices
nominal output and velocity
the money supply and real output
the money supply and velocity
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Question
According to the quantity theory of money, if output is higher, ______ real balances are required, and for fixed M this
means ______ P.
Answer higher; lower
lower; higher
higher; higher
lower; lower
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Question
According to the quantity equation, if the velocity of money and the supply of money are fixed, and the price level
increases, then the quantity of goods and services purchased:
Answer increases.
decreases.
does not change.
may either increase or decrease.
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Question
For a fixed money supply, the aggregate demand curve slopes downward because at a lower price level real money
balances are ______, generating a ______ quantity of output demanded.
5 of 24 12/8/2012 11:39
Answer higher; greater

higher; smaller
lower; greater
lower; smaller
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Question
The aggregate demand curve tells us possible:
Answer combinations of M and Y for a given value of P.
combinations of M and P for a given value of Y.
combinations of P and Y for a given value of M.
results if the Federal Reserve reduces the money supply.
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Question
When an aggregate demand curve is drawn with real GDP (Y) along the horizontal axis and the price level (P) along
the vertical axis, if the money supply is decreased, then the aggregate demand curve will shift:
Answer downward and to the left.
downward and to the right.
upward and to the left.
upward and to the right.
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Question
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 ______.
Answer greater; inward
greater; outward
lower; inward
lower; outward
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Question
When the Federal Reserve increases the money supply, at a given price level the amount of output demanded is
______ and the aggregate demand curve shifts ______.
Answer greater; inward
greater; outward
lower; inward
lower; outward
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Question
Looking at the aggregate demand curve alone, one can tell ______ that will prevail in the economy.
Answer the quantity of output and the price level
the quantity of output
the price level
neither the quantity of output nor the price level
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Question
The relationship between the quantity of goods and services supplied and the price level is called:
6 of 24 12/8/2012 11:39
Answer aggregate demand.

aggregate supply.
aggregate investment.
aggregate production.
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Question
Aggregate supply is the relationship between the quantity of goods and services supplied and the:
Answer money supply.
unemployment rate.
interest rate.
price level.
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Question
A short-run aggregate supply curve shows fixed ______, and a long-run aggregate supply curve shows fixed ______.
Answer output; output
prices; prices
prices; output
output; prices
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Question
In the long run, the level of output is determined by the:
Answer interaction of supply and demand.
money supply and the levels of government spending and taxation.
amounts of capital and labor and the available technology.
preferences of the public.
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Question
When a long-term aggregate supply curve is drawn with real GDP (Y) along the horizontal axis and the price level (P)
along the vertical axis, this curve:
Answer slopes upward and to the right.
slopes downward and to the right.
is horizontal.
is vertical.
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Question
The vertical long-run aggregate supply curve satisfies the classical dichotomy because the natural rate of output does
not depend on:
Answer the labor supply.
the supply of capital.
the money supply.
technology.
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Question
If the long-run aggregate supply curve is vertical, then changes in aggregate demand affect:
Answer neither prices nor level of output.
both prices and level of output.
level of output but not prices.
7 of 24 12/8/2012 11:39
prices but not level of output.
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Question
The natural level of output is:
Answer affected by aggregate demand.
the level of output at which the unemployment rate is zero.
the level of output at which the unemployment rate is at its natural level.
permanent and unchangeable.
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Question
The long-run aggregate supply curve is vertical at the level of output:
Answer determined by aggregate demand.
at which unemployment is at its natural rate.
at which the inflation rate is zero.
at a predetermined price level.
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Question
If all prices are stuck at a predetermined level, then when a short-run aggregate supply curve is drawn with real GDP
(Y) along the horizontal axis and the price level (P) along the vertical axis, this curve:
Answer is horizontal.
is vertical.
slopes upward and to the right.
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Question
The price level decreases and output increases in the transition from the short run to the long run when the short-run
equilibrium is _____ the natural rate of output in the short run.
Answer above
below
equal to
either above or below
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Question
If the short-run aggregate supply curve is horizontal, then changes in aggregate demand affect:
Answer level of output but not prices.
prices but not level of output.
both prices and level of output.
neither prices nor level of output.
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Question
In the aggregate demand–aggregate supply model, short-run equilibrium occurs at the combination of output and
prices where:
Answer aggregate demand equals long-run aggregate supply.
aggregate demand equals short-run aggregate supply.
aggregate demand equals short-run and long-run aggregate supply.
short-run aggregate supply equals long-run aggregate supply.
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8 of 24 12/8/2012 11:39
Question
If the short-run aggregate supply curve is horizontal, then the:
Answer classical dichotomy is satisfied.
money supply cannot affect prices in the short run.
money supply cannot affect output in the short run.
money supply is irrelevant in the short run.
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Question
The short-run aggregate supply curve is horizontal at:
Answer a level of output determined by aggregate demand.
the natural level of output.
the level of output at which the economy's resources are fully employed.
a fixed price level.
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Question
The short run refers to a period:
Answer of several days.
during which prices are sticky and unemployment may occur.
during which capital and labor are fully employed.
during which there are no fluctuations.
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Question
The long run refers to a period:
Answer of decades.
during which capital and labor are sometimes not fully employed.
during which prices are flexible.
during which output deviates from the full-employment level.
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Question
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.
Answer only prices; only output
only output; only prices
both prices and output; only prices
both prices and output; both prices and output
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Question
In the aggregate demand–aggregate supply model, long-run equilibrium occurs at the combination of output and prices
where:
Answer aggregate demand is greater than long-run aggregate supply.
aggregate demand equals short-run aggregate supply.
aggregate demand equals short-run and long-run aggregate supply.
short-run aggregate supply equals long-run aggregate supply.
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9 of 24 12/8/2012 11:39
Question
If a short-run equilibrium occurs at a level of output above the natural rate, then in the transition to the long run prices
will ______ and output will ______.
decrease; decrease
increase; decrease
decrease; increase
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Question
If a short-run equilibrium occurs at a level of output below the natural rate, then in the transition to the long run prices
will ______ and output will ______.
decrease; decrease
increase; decrease
decrease; increase
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Question
If the short-run aggregate supply curve is horizontal and the Fed increases the money supply, then:
Answer output and employment will increase in the short run.
output and employment will decrease in the short run.
prices will increase in the short run.
prices will decrease in the short run.
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Question
Assume that the economy starts from long-run equilibrium. If the Federal Reserve increases the money supply, then
______ increase(s) in the short run and ______ increase(s) in the long run.
Answer prices; output
output; prices
output; output
prices; prices
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Question
Assume that the economy begins in long-run equilibrium. Then the Fed reduces the money supply. In the short run
______, whereas in the long run prices ______ and output returns to its original level.
Answer output decreases and prices are unchanged; rise
output decreases and prices are unchanged; fall
output and prices both decrease; rise
output and prices both decrease; fall
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Question
Monetary neutrality is a characteristic of the aggregate demand–aggregate supply model in:
Answer both the short run and the long run.
in neither the short run nor the long run.
in the short run, but not in the long run.
in the long run, but not in the short run.
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10 of 24 12/8/2012 11:39
Question
The economic response to the overnight reduction in the French money supply by 20 percent in 1724,
Answer confirmed the neutrality of money because no real variables were affected by this nominal change.
confirmed the quantity theory by leading to an immediate 20 percent reduction in the price level.
confirmed that money is not neutral in the short run because both output and prices dropped.
contradicted Okun's law because decreases in output were not associated with increases in
unemployment.
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Question
When the French money supply was reduced by 45 percent over a period of seven months in 1724, the only values in
the economy that adjusted fully and instantaneously were:
Answer prices in grain markets.
real wages.
foreign exchange rates.
interest rates.
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Question
Stabilization policy refers to policy actions aimed at:
Answer reducing the severity of short-run economic fluctuations.
equalizing incomes of households in the economy.
maintaining constant shares of output going to labor and capital.
preventing increases in the poverty rate.
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Question
Which of the following is an example of a demand shock?
Answer a large oil-price increase
the introduction and greater availability of credit cards
a drought that destroys agricultural crops
unions obtain a substantial wage increase
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Question
Starting from long-run equilibrium, if the velocity of money increases (due to, for example, the invention of automatic
teller machines) and no action is taken by the government:
Answer prices will rise in both the short run and the long run.
output will rise in both the short run and the long run.
prices will rise in the short run and output will rise in the long run.
output will rise in the short run and prices will rise in the long run.
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Question
If the short-run aggregate supply curve is horizontal, and, if each member of the general public chooses to hold a
larger fraction of his or her income as cash balances, then:
Answer output and employment will increase in the short run.
output and employment will decrease in the short run.
prices will increase in the short run.
prices will decrease in the short run.
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11 of 24 12/8/2012 11:39
Question
A reduction in the demand for money is the equivalent of a(n) _______ in velocity and will shift the aggregate demand
curve to the _____.
Answer increase; right
increase; left
decrease; right
decrease; left
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Question
Starting from long-run equilibrium, if the velocity of money increases (due to, for example, the invention of automatic
teller machines), the Fed might be able to stabilize output by:
Answer decreasing the money supply.
increasing the money supply.
decreasing the price level.
increasing the price level.
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Question
Exhibit: Shift in Aggregate Demand
Reference: Ref 10-1
(Exhibit: Shift in Aggregate Demand) In this graph, initially the economy is at point E, with price P and output Y.
0
Aggregate demand is given by curve AD , and SRAS and LRAS represent, respectively, short-run and long-run
0
aggregate supply. Now assume that the aggregate demand curve shifts so that it is represented by AD . The economy
1
moves first to point ______ and then, in the long run, to point ______.
Answer A; D
D; A
C; B
B; C
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Question
12 of 24 12/8/2012 11:39
Reference: Ref 10-1
(Exhibit: Shift in Aggregate Demand) In this graph, initially the economy is at point E, with the price P and output Y.
0
Aggregate demand is given by curve AD , and SRAS and LRAS represent, respectively, short-run and long-run
0
aggregate supply. Now assume that the aggregate demand curve shifts so that it is represented by AD . The economy
2
moves first to point ______ and then, in the long run, to point ______.
Answer A; D
D; A
A; B
B; A
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Question
Reference: Ref 10-1
(Exhibit: Shift in Aggregate Demand) Assume that the economy is initially at point A with aggregate demand given by
AD . A shift in the aggregate demand curve to AD could be the result of either a(n) ______ in the money supply or
2 0
a(n) ______ in velocity.
increase; decrease
decrease; increase
decrease; decrease
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Question
Starting from long-run equilibrium, an increase in aggregate demand increases ______ in the short run, but only
increases ______ in the long run.
Answer output; prices
prices; output
short-run aggregate supply; long-run aggregate supply
the money supply; the natural rate of output
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Question
A supply shock does not occur when:
Answer a drought destroys crops.
unions push wages up.
the Fed increases the money supply.
an oil cartel increases world oil prices.
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13 of 24 12/8/2012 11:39
Question
A favorable supply shock occurs when:
Answer environmental protection laws raise costs of production.
the Fed increases the money supply.
unions push wages up.
an oil cartel breaks up and oil prices fall.
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Question
An adverse supply shock ______ the short-run aggregate supply curve ______ the natural level of output.
Answer raises; but cannot affect
raises; and may also lower
lowers; but cannot affect
lowers; and may also lower
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Question
If the short-run aggregate supply curve is horizontal, an increase in union aggressiveness that pushes wages and
prices up will result in ______ prices and ______ output in the short run.
Answer higher; lower
lower; higher
higher; higher
lower; lower
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Question
Exhibit: Supply Shock
Reference: Ref 10-2
(Exhibit: Supply Shock) In this graph, assume that the economy starts at point A and there is a favorable supply shock
that does not last forever. In this situation, point ______ represents short-run equilibrium and point ______ represents
long-run equilibrium.
Answer B; C
B; A
E; D
E; A
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Question
14 of 24 12/8/2012 11:39
Reference: Ref 10-2
(Exhibit: Supply Shock) Assume that the economy is at point B. With no further shocks or policy moves, the economy
in the long run will be at point:
Answer A.
B.
C.
D.
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Question
Reference: Ref 10-2
(Exhibit: Supply Shock) Assume that the economy is at point E. With no further shocks or policy moves, the economy
in the long run will be at point:
Answer A.
B.
C.
D.
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Question
15 of 24 12/8/2012 11:39
Reference: Ref 10-2
(Exhibit: Supply Shock) Assume that the economy starts at point A and there is a drought that severely reduces
agricultural output in the economy for just one year. In this situation, point ______ represents the short-run equilibrium
immediately following the drought and point ______ represents the eventual long-run equilibrium.
Answer B; C
B; A
E; D
D; A
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Question
In the short run, a favorable supply shock causes:
Answer both prices and output to rise.
prices to rise and output to fall.
prices to fall and output to rise.
both prices and output to fall.
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Question
In the short run an adverse supply shock causes:
Answer both prices and output to rise.
prices to rise and output to fall.
prices to fall and output to rise.
both prices and output to fall.
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Question
Stagflation occurs when prices ______ and output ______.
Answer fall; falls
fall; increases
rise; falls
rise; increases
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Question
The dilemma facing the Federal Reserve in the event that an unfavorable supply shock moves the economy away from
the natural rate of output is that monetary policy can either return output to the natural rate, but with a ______ price
level, or allow the price level to return to its original level, but with a ______ level of output in the short run.
Answer higher; higher
higher; lower
lower; lower
lower; higher
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Question
If the Fed accommodates an adverse supply shock, output falls ______ and prices rise ______.
Answer less; more
less; less
more; less
more; more
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16 of 24 12/8/2012 11:39
Question
Starting from long-run equilibrium, without policy intervention, the long-run impact of an adverse supply shock is that
prices will:
Answer be permanently higher and output will be restored to the natural rate.
return to the old level and output will be restored to the natural rate.
be permanently higher and output will be permanently lower.
return to the old level, but output will be permanently lower.
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Question
Starting from long-run equilibrium, if a drought pushes up food prices throughout the economy, the Fed could move the
economy more rapidly back to full employment output by:
Answer increasing the money supply, but at the cost of permanently higher prices.
decreasing the money supply, but at the cost of permanently lower prices.
increasing the money supply, which would restore the original price level.
decreasing the money supply, which would restore the original price level.
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Question
On two occasions in the 1970s:
Answer world oil prices rose rapidly, inflation was high, and the unemployment rate was high.
world oil prices rose rapidly, inflation was moderate, and the unemployment rate was high.
world oil prices rose rapidly, inflation was high, and the unemployment rate was moderate.
world oil prices rose rapidly, but the Fed used monetary policy to curb inflation.
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Question
In the mid-1980s, oil prices ______, inflation was ______, and the unemployment rate ______.
Answer rose rapidly; high; rose
rose slowly; moderate; high
fell; low; declined
fell; low; rose
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Question
If a change in government regulations allows banks to start paying interest on checking accounts, this will:
Answer increase the demand for money.
decrease the demand for money.
have no effect on the demand for money.
increase the demand for currency but decrease the demand for checking accounts.
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Question
If the demand for money increases, this will:
Answer increase velocity.
decrease velocity.
have no effect on velocity.
cause the Fed to increase the money supply.
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17 of 24 12/8/2012 11:39
Question
If the demand for money increases, but the Fed keeps the money supply the same, then in the short run output will:
Answer fall and in the long run prices will remain unchanged.
remain unchanged and in the long run prices will fall.
remain unchanged and in the long run prices will remain unchanged.
fall and in the long run prices will fall.
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Question
If the Fed reduces the money supply by 5 percent and the quantity theory of money is true, then:
Answer every point on the aggregate demand curve moves 5 percent to the left.
every point on the aggregate demand curve moves up 5 percent.
the aggregate demand curve moves down and to the left, but it is impossible to determine exactly by how
much.
the aggregate demand curve moves up and to the right, but it is impossible to determine exactly by how
much.
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Question
If the Fed reduces the money supply by 5 percent and the quantity theory of money is true, then output will fall 5
percent in the short run and:
Answer prices will remain unchanged in the long run.
output will fall 5 percent in the long run.
prices will fall 5 percent in the long run.
output will remain unchanged in the long run.
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Question
Making use of Okun's law, it may be computed that if the Fed reduces the money supply 5 percent and the quantity
theory of money is true, then the unemployment rate will rise about:
Answer 5 percent in both the short run and the long run.
2.5 percent in both the short run and the long run.
5 percent in the short run but will return to its natural rate in the long run.
2.5 percent in the short run but will return to its natural rate in the long run.
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Question
If the Fed reduces the money supply by 5 percent, then the real interest rate will:
Answer rise in both the short run and the long run.
rise in the short run but return to its original equilibrium level in the long run.
rise in the short run but will fall below its original equilibrium level in the long run.
be unaffected in both the short run and the long run.
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Question
If Central Bank A cares only about keeping the price level stable and Central Bank B cares only about keeping output
at its natural level, then in response to an exogenous decrease in the velocity of money:
Answer both Central Bank A and Central Bank B should increase the quantity of money.
Central Bank A should increase the quantity of money whereas Central Bank B should keep it stable.
Central Bank A should keep the quantity of money stable whereas Central Bank B should increase it.
both Central Bank A and Central Bank B should keep the quantity of money stable.
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18 of 24 12/8/2012 11:39
Question
If Central Bank A cares only about keeping the price level stable and Central Bank B cares only about keeping output
at its natural level, then in response to an exogenous increase in the price of oil:
Answer both Central Bank A and Central Bank B should increase the quantity of money.
Central Bank A should increase the quantity of money whereas Central Bank B should keep it stable.
Central Bank A should keep the quantity of money stable whereas Central Bank B should increase it.
both Central Bank A and Central Bank B should keep the quantity of money stable.
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Essay 1 points
Question
Assume that the long-run aggregate supply curve is vertical at Y = 3,000 while the short-run aggregate supply curve is
horizontal at P = 1.0. The aggregate demand curve is Y = 2(M/P) and M = 1,500.
a. If the economy is initially in long-run equilibrium, what are the values of P and Y?
b. If M increases to 2,000, what are the new short-run values of P and Y?
c. Once the economy adjusts to long-run equilibrium at M = 2,000, what are P and Y?
Answer a. P = 1.0; Y = 3,000

b. P = 1.0; Y = 4,000
c. P = 1.333; Y = 3,000
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Essay 1 points
Question
b. What is the velocity of money in this case?
c. Suppose because banks start paying interest on checking accounts, the aggregate demand function
shifts to Y = (1.5)(M/P). What are the short-run values of P and Y?
d. What is the velocity of money in this case?
e. With the new aggregate demand function, once the economy adjusts to long-run equilibrium, what are P
and Y?
f. What is the velocity now?
Answer a. P = 1.0; Y = 3,000

b. velocity = 2
c. P = 1.0; Y = 2,250
d. velocity = 1.5
e. P = 0.75; Y = 3,000
f. velocity = 1.5
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Essay 1 points
Question
b. Now suppose a supply shock moves the short-run aggregate supply curve to P = 1.5. What are the new
short-run P and Y?
c. If the aggregate demand curve and long-run aggregate supply curve are unchanged, what are the
long-run equilibrium P and Y after the supply shock?
d. Suppose that after the supply shock the Fed wanted to hold output at its long-run level. What level of M
would be required? If this level of M were maintained, what would be long-run equilibrium P and Y?
Answer a. P = 1.0; Y = 3,000

b. P = 1.5; Y = 2,000
c. P = 1.0; Y = 3,000
d. M = 1,500; P = 1.5; Y = 3,000
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19 of 24 12/8/2012 11:39
Essay 1 points
Question
The principal method used by the Federal Reserve to change the money supply is through open-market operations.
Use the aggregate demand–aggregate supply model to illustrate graphically the impact in the short run and the long
run of a Federal Reserve decision to increase open-market purchases. Be sure to label: i. the axes; ii. the curves; iii.
the initial equilibrium values; iv. the direction the curves shift; v. the short-run equilibrium values; and vi. the long-run
equilibrium values. State in words what happens to prices and output in the short run and the long run.
Answer
In the short run, output increases, while the price level remains unchanged. In the long run, prices increase
and output returns to the full-employment level.
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Essay 1 points
Question
The advent of interest-earning checking accounts in the early 1980s led many households to keep a larger proportion
of their wealth in checking accounts. Use the aggregate demand–aggregate supply model to illustrate graphically the
impact in the short run and the long run of this change in money demand. Be sure to label: i. the axes; ii. the curves; iii.
Answer
In the short run, output decreases, while the price level remains unchanged. In the long run, prices decrease
and output returns to the full-employment level.
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Essay 1 points
Question
Suppose that droughts in the Southeast and floods in the Midwest substantially reduce food production in the United
States. Use the aggregate demand–aggregate supply model to illustrate graphically the impact in the short run and the
long run of this adverse supply shock. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the
direction the curves shift; v. the short-run equilibrium values; and vi. the long-run equilibrium values. State in words
what happens to prices and output in the short run and the long run.
Answer
20 of 24 12/8/2012 11:39
In the short run, output decreases, while the price level increases. In the long run, prices decrease and
output returns to the full-employment level.
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Essay 1 points
Question
Suppose that laws are passed banning labor unions and that resulting lower labor costs are passed along to
consumers in the form of lower prices. Use the aggregate demand–aggregate supply model to illustrate graphically the
impact in the short run and the long run of this favorable supply shock. Be sure to label: i. the axes; ii. the curves; iii.
Answer
In the short run output increases, while the price level decreases. In the long run, prices increase and output
returns to the full-employment level.
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Essay 1 points
Question
Suppose you are an economist working for the Federal Reserve when droughts in the Southeast and floods in the
Midwest substantially reduce food production in the United States. Use the aggregate demand–aggregate supply
model to illustrate graphically your policy recommendation to accommodate this adverse supply shock, assuming that
your top priority is maintaining full employment in the economy. Be sure to label: i. the axes; ii. the curves; iii. the initial
equilibrium values; iv. the direction the curves shift; and v. the terminal equilibrium values. State in words what happens
to prices and output as a combined result of the supply shock and the recommended Federal Reserve
accommodation.
Answer
The accommodation policy means that the price level is permanently higher, but output is at the
full-employment level.
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21 of 24 12/8/2012 11:39
Essay 1 points
Question
Throughout much of the 1990s, the United States experienced declining energy prices. Assume that the U.S. economy
was in long-run equilibrium before these declines began.
a. Use the aggregate demand–aggregate supply model to illustrate graphically the short-run and long-run
impact of this decline on output and prices.
b. If the Federal Reserve attempted to offset this deviation from the natural rate in the short run, should the
money supply be increased or decreased?
Answer a.
Output increases and prices decrease in the short run to point B. Output and prices return to their original
levels at point A in the long run.
b. The Federal Reserve must reduce the money supply in the short run, in order to return the economy to
the natural rate, moving the economy to point C with a permanently lower price level.
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Essay 1 points
Question
The long-run and short-run aggregate supply curves reflect fundamental differences between long-run and short-run
macroeconomic analysis.
a. Graphically illustrate the long-run and short-run aggregate supply curves. Be sure to label the axes.
b. What determines the level of output in the long run versus the short run?
c. How do prices behave differently in the long run and the short run?
Answer a.
b. In the long run, output is determined by the factors of production and technology, but in the short run,
output is determined by demand.
c. In the long run, prices are flexible, but in the short run, prices are sticky.
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Essay 1 points
Question
The economy of Macroland is initially in long-run equilibrium. A severe drought causes an adverse supply shock.
a. What happens to prices and output in the short run?
b. What would happen to prices and output in the long run if there is no policy accommodation?
c. If the Central Bank of Macroland wants to prevent the short-run changes in price and output, what policy
action could it take? How would the results of this policy action differ from the prices and output that
would result in the long run with no policy action?
Answer a. In the short run, prices increase and output decreases.

b. With no policy accommodation, both output and prices would return to their initial long-run equilibrium
levels.
c. The central bank could increase the money supply to return output to full employment, but this would
result in a long-run equilibrium at a higher price level than the initial long-run equilibrium.
22 of 24 12/8/2012 11:39
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Essay 1 points
Question
A central bank reduces the money supply in an economy initially in long-run equilibrium.
a. What will happen to output and prices in the short run?
b. What will happen to unemployment in the short run?
c. What will happen to output and prices in the long run?
Answer a. In the short run, output would decrease with little change in prices.
b. In the short run, unemployment will increase.
c. In the long run, output will return to the full-employment level at a lower price level.
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Essay 1 points
Question
An oil cartel effectively increases the price of oil by 100 percent, leading to an adverse supply shock in both Country A
and Country B. Both countries were in long-run equilibrium at the same level of output and prices at the time of the
shock. The central bank of Country A takes no stabilizing policy actions. After the short-run impacts of the adverse
supply shock become apparent, the central bank of Country B increases the money supply to return the economy to
full employment.
a. Describe the short-run impact of the adverse supply shock on prices and output in each country.
b. Compare the long-run impact of the adverse supply shock on prices and output in each country.
Answer a. In both Country A and Country B, output will decline and the price level will rise.
b. In the long run, output in both Country A and Country B will return to the full-employment level, but the
price level will be higher in Country B than in Country A because of the policy accommodation.
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Essay 1 points
Question
An economy is initially in long-run equilibrium. The introduction of an electronic payments system dramatically reduces
the demand for money in the economy.
a. What is the short-run impact on prices and output of the new system?
b. What can the central bank do, if anything, to counteract the short-run changes in output and prices?
c. If the central bank does not take any policy actions, what will be the long-run impact of the electronic
payments system on prices and output?
Answer a. In the short run, output will increase as the reduction in money demand (increase in velocity) shifts the
aggregate demand curve out to the right. There will be an increase in output and little change in prices
in the short run.
b. The central bank could counteract the decline in money demand by reducing the money supply, shifting
the aggregate demand curve back to the left.
c. In the long run with no central bank stabilizing action, output will return to the full-employment level with
a higher price level.
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Essay 1 points
Question
Explain the meaning of monetary neutrality and illustrate graphically that there is monetary neutrality in the long run in
the aggregate demand–aggregate supply model. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium
values; iv. the direction the curves shift; v. the short-run equilibrium values; and vi. the long-run equilibrium values.
Explain in words what your graph illustrates.
Answer
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Monetary neutrality is the property that changes in money do not change real variables. Graphically starting
from long-run equilibrium at A, an increase in the money supply shifts the AD curve rightward. There is a short
run equilibrium at B with higher real output, but in the long run, prices increase, shifting the SRAS upward until
the new long-run equilibrium is reached at C, where there is a higher price level, but no change in real GDP.
This illustrates that in the long-run the change in the money supply does not change the real variable (real
GDP).
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Essay 1 points
Question
You are given information about the following leading indicators. For each indicator explain whether the information
suggests that a recession or expansion should be expected in the future.
a. Average initial weekly claims for unemployment insurance rise.
b. New building permits issued increases.
c. The interest rate spread between the 10-year Treasury note and the 3-month Treasury bill narrows.
d. The Index of Supplier Deliveries falls.
Answer a. Recession. More workers eligible for unemployment insurance benefits indicate that firms are laying off
workers and cutting back on production.
b. Expansion. Planned investment is increasing.
c. Recession. Future interest rates are not expected to rise, which typically occurs in a recession.
d. Recession. Few firms are experiencing slow deliveries, indicating that output and production is slow.
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Essay 1 points
Question
Monetary policy can be either a stabilizing influence on the economy or a source of instability. Give an explanation for
both possibilities.
Answer If monetary policy is used to offset changes in aggregate demand that move an economy away from the
natural rate, then monetary policy actions are stabilizing. If monetary policy actions move an economy away
from the natural rate, either by increasing or decreasing the money supply when the economy is in long-run
equilibrium, then monetary policy is destabilizing.
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24 of 24 12/8/2012 11:39
Pool Canvas file:///C:/Users/MOHA/Desktop/mac8e/New folder (11)/CourseCompa...
Pool Canvas
Name TestBanks Chapter 11 Aggregate Demand I: Building the IS-LM Model

Description
Instructions
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Question
John Maynard Keynes wrote that responsibility for low income and high unemployment in economic downturns should
be placed on:
Answer low levels of capital.
an untrained labor force.
inadequate technology.
low aggregate demand.
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Question
According to classical theory, national income depends on ______, while Keynes proposed that ______ determined the
level of national income.
Answer aggregate demand; aggregate supply
aggregate supply; aggregate demand
monetary policy; fiscal policy
fiscal policy; monetary policy
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Question
The IS–LM model takes ______ as exogenous.
Answer the price level and national income
the price level
national income
the interest rate
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Question
A variable that links the market for goods and services and the market for real money balances in the IS–LM model is
the:
Answer consumption function.
interest rate.
price level.
nominal money supply.
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Question
In the IS–LM model, which two variables are influenced by the interest rate?
Answer supply of nominal money balances and demand for real balances
demand for real money balances and government purchases
supply of nominal money balances and investment spending
demand for real money balances and investment spending
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1 of 24 12/8/2012 11:40
Question
Two interpretations of the IS–LM model are that the model explains:
Answer the determination of income in the short run when prices are fixed, or what shifts the aggregate demand
curve.
the short-run quantity theory of income, or the short-run Fisher effect.
the determination of investment and saving, or what shifts the liquidity preference schedule.
changes in government spending and taxes, or the determination of the supply of real money balances.
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Question
The IS curve plots the relationship between the interest rate and ______ that arises in the market for ______.
Answer national income; goods and services
the price level; goods and services
national income; money
the price level; money
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Question
For the purposes of the Keynesian cross, planned expenditure consists of:
Answer planned investment.
planned government spending.
planned investment and government spending.
planned investment, government spending, and consumption expenditures.
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Question
In the Keynesian-cross model, actual expenditures equal:
Answer GDP.
the money supply.
the supply of real balances.
unplanned inventory investment.
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Question
In the Keynesian-cross model, actual expenditures differ from planned expenditures by the amount of:
Answer liquidity preference.
the government-purchases multiplier.
unplanned inventory investment.
real money balances.
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Question
Planned expenditure is a function of:
Answer planned investment.
planned government spending and taxes.
planned investment, government spending, and taxes.
national income and planned investment, government spending, and taxes.
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2 of 24 12/8/2012 11:40
Question
When planned expenditure is drawn on a graph as a function of income, the slope of the line is:
Answer zero.
between zero and one.
one.
greater than one.
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Question
When drawn on a graph with Y along the horizontal axis and PE along the vertical axis, the line showing planned
expenditure rises to the:
Answer right with a slope less than one.
right with a slope greater than one.
left with a slope less than one.
left with a slope greater than one.
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Question
The equilibrium condition in the Keynesian-cross analysis in a closed economy is:
Answer income equals consumption plus investment plus government spending.
planned expenditure equals consumption plus planned investment plus government spending.
actual expenditure equals planned expenditure.
actual saving equals actual investment.
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Question
With planned expenditure and the equilibrium condition Y = PE drawn on a graph with income along the horizontal
axis, if income exceeds expenditure, then income is to the ______ of equilibrium income and there is unplanned
inventory ______.
Answer right; decumulation
right; accumulation
left; decumulation
left; accumulation
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Question
According to the analysis underlying the Keynesian cross, when planned expenditure exceeds income:
Answer income falls.
planned expenditure falls.
unplanned inventory investment is negative.
prices rise.
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Question
When firms experience unplanned inventory accumulation, they typically:
Answer build new plants.
lay off workers and reduce production.
hire more workers and increase production.
call for more government spending.
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Question
The Keynesian cross shows:
3 of 24 12/8/2012 11:40
Answer determination of equilibrium income and the interest rate in the short run.
determination of equilibrium income and the interest rate in the long run.
equality of planned expenditure and income in the short run.
equality of planned expenditure and income in the long run.
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Question
Exhibit: Keynesian Cross
Reference: Ref 11-1
(Exhibit: Keynesian Cross) In this graph, the equilibrium levels of income and expenditure are:
Answer Y1 and PE1.
Y2 and PE2.
Y3 and PE3.
Y3 and PE4.
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Question
Reference: Ref 11-1
(Exhibit: Keynesian Cross) In this graph, if firms are producing at level Y , then inventories will ______, inducing firms
1
to ______ production.
Answer rise; increase
rise; decrease
fall; increase
fall; decrease
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4 of 24 12/8/2012 11:40
Question
Reference: Ref 11-1
(Exhibit: Keynesian Cross) In this graph, if firms are producing at level Y , then inventories will ______, inducing firms
3
to ______ production.
Answer rise; increase
rise; decrease
fall; increase
fall; decrease
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Question
The government-purchases multiplier indicates how much ______ change(s) in response to a $1 change in
government purchases.
Answer the budget deficit
consumption
income
real balances
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Question
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 ______.
Answer $1 billion; more than $1 billion
$0.75 billion; more than $0.75 billion
$0.75 billion; $0.75 billion
$1 billion; $1 billion
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Question
According to the Keynesian-cross analysis, when there is a shift upward in the government-purchases schedule by an
amount G and the planned expenditure schedule by an equal amount, then equilibrium income rises by:
Answer one unit.
G.
G divided by the quantity one minus the marginal propensity to consume.
G multiplied by the quantity one plus the marginal propensity to consume.
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5 of 24 12/8/2012 11:40
Question
In the Keynesian-cross model, if government purchases increase by 100, then planned expenditures ______ for any
given level of income.
Answer increase by 100
increase by more than 100
decrease by 100
increase, but by less than 100
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Question
In the Keynesian-cross model, if government purchases increase by 250, then the equilibrium level of income:
Answer increases by 250.
increases by more than 250.
decreases by 250.
increases, but by less than 250.
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Question
In the Keynesian-cross model, fiscal policy has a multiplied effect on income because fiscal policy:
Answer increases the amount of money in the economy.
changes income, which changes consumption, which further changes income.
is government spending and, therefore, more powerful than private spending.
changes the interest rate.
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Question
According to the Keynesian-cross analysis, if MPC stands for marginal propensity to consume, then a rise in taxes of
T will:
Answer decrease equilibrium income by T.
decrease equilibrium income by T/(1 – MPC).
decrease equilibrium income by ( T)(MPC)/(1 – MPC).
not affect equilibrium income at all.
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Question
In the Keynesian-cross model, if taxes are reduced by 100, then planned expenditures ______ for any given level of
income.
Answer increase by 100
increase by more than 100
decrease by 100
increase, but by less than 100
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Question
In the Keynesian-cross model, if taxes are reduced by 250, then the equilibrium level of income:
Answer increases by 250.
increases by more than 250.
decreases by 250.
increases, but by less than 250.
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6 of 24 12/8/2012 11:40
Question
The tax multiplier indicates how much ______ change(s) in response to a $1 change in taxes.
Answer the budget deficit
consumption
income
real balances
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Question
In the Keynesian-cross model with a given MPC, the government-expenditure multiplier ______ the tax multiplier.
Answer is larger than
equals
is smaller than
is the inverse of the
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Question
In the Keynesian-cross model, if the MPC equals 0.75, then a $1 billion decrease in taxes increases planned
expenditures by ______ and increases the equilibrium level of income by ______.
Answer $1 billion; more than $1 billion
$0.75 billion; more than $0.75 billion
$0.75 billion; $0.75 billion
$1 billion; $1 billion
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Question
After the Kennedy tax cut in 1964, real GDP:
Answer fell and unemployment rose.
rose and unemployment fell.
and unemployment both rose.
and unemployment both fell.
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Question
Both Keynesians and supply-siders believe a tax cut will lead to growth:
Answer and both agree it works through incentive effects.
but Keynesians believe it works through incentive effects whereas supply-siders believe it works through
aggregate demand.
but Keynesians believe it works through aggregate demand whereas supply-siders believe it works
through incentive effects.
and both agree it works through aggregate demand.
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Question
Tax cuts stimulate ______ by improving workers' incentive and expand ______ by raising households' disposable
income.
Answer velocity; demand for loanable funds
demand for loanable funds; velocity
aggregate demand; aggregate supply
aggregate supply; aggregate demand
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7 of 24 12/8/2012 11:40
Question
In the Keynesian-cross model, the equilibrium level of income is determined by:
Answer the factors of production.
the money supply.
planned spending.
liquidity preference.
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Question
In the Keynesian-cross model, what adjusts to move the economy to equilibrium following a change in exogenous
planned spending?
Answer planned spending
the interest rate
production
the price level
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Question
The Keynesian-cross analysis assumes planned investment:
Answer is fixed and so does the IS analysis.
depends on the interest rate and so does the IS analysis.
is fixed, whereas the IS analysis assumes it depends on the interest rate.
depends on expenditure and so does the IS analysis.
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Question
The simple investment function shows that investment ______ as ______ increases.
Answer decreases; the interest rate
increases; the interest rate
decreases; government spending
increases; government spending
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Question
An increase in the interest rate:
Answer reduces planned investment, because the interest rate is the cost of borrowing to finance investment
projects.
increases planned investment, because people who make money from interest have more money to
invest.
has no effect on investment.
may be caused by a drop in investment demand.
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Question
An explanation for the slope of the IS curve is that as the interest rate increases, the quantity of investment ______,
and this shifts the expenditure function ______, thereby decreasing income.
Answer increases; downward
increases; upward
decreases; upward
decreases; downward
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8 of 24 12/8/2012 11:40
Question
In the Keynesian-cross model, a decrease in the interest rate ______ planned investment spending and ______ the
equilibrium level of income.
Answer increases; increases
increases; decreases
decreases; decreases
decreases; increases
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Question
When drawn on a graph with income along the horizontal axis and the interest rate along the vertical axis, the IS curve
generally:
Answer is vertical.
is horizontal.
slopes upward and to the right.
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Question
Along any given IS curve:
Answer tax rates are fixed, but government spending varies.
government spending is fixed, but tax rates vary.
both government spending and tax rates vary.
both government spending and tax rates are fixed.
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Question
The IS curve shifts when any of the following economic variables change except:
Answer the interest rate.
government spending.
tax rates.
the marginal propensity to consume.
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Question
An increase in government spending generally shifts the IS curve, drawn with income along the horizontal axis and the
interest rate along the vertical axis:
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Question
An increase in taxes shifts the IS curve, drawn with income along the horizontal axis and the interest rate along the
vertical axis:
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9 of 24 12/8/2012 11:40
Question
Based on the Keynesian model, one reason to support government spending increases over tax cuts as measures to
increase output is that:
Answer government spending increases the MPC more than tax cuts.
the government-spending multiplier is larger than the tax multiplier.
government-spending increases do not lead to unplanned changes in inventories, but tax cuts do.
increases in government spending increase planned spending, but tax cuts reduce planned spending.
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Question
Gary Becker's criticism of government spending on infrastructure as part of President Obama's stimulus plan was that:
Answer spending on infrastructure would not increase production in the economy.
there is a conflict between where spending on infrastructure would benefit employment and where
infrastructure is most needed.
government spending on infrastructure is less effective in increasing production than an equal amount of
private spending on infrastructure.
government spending on infrastructure only increases demand, but tax cuts increase demand and supply.
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Question
One argument in favor of tax cuts over spending-based fiscal stimulus is that:
Answer tax cuts increase the MPC by a larger amount than government spending.
tax cuts temporarily increase planned spending, but government spending permanently increases private
spending.
in theory the tax multiplier is larger than the government spending multiplier.
historically tax cuts have been more successful than spending-based fiscal stimulus.
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Question
Changes in fiscal policy shift the:
Answer LM curve.
money demand curve.
money supply curve.
IS curve.
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Question
Along an IS curve all of the following are always true except:
Answer planned expenditures equal actual expenditures.
planned expenditures equal income.
the demand for real balances equals the supply of real balances.
there are no unplanned changes in inventories.
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Question
An IS curve shows combinations of:
Answer taxes and government spending.
nominal money balances and price levels.
interest rates and income that bring equilibrium in the market for real balances.
interest rates and income that bring equilibrium in the market for goods and services.
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10 of 24 12/8/2012 11:40
Question
The IS curve shows combinations of ______ that are consistent with equilibrium in the market for goods and services.
Answer inflation and unemployment
the price level and real output
the interest rate and the level of income
the interest rate and real money balances
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Question
The IS curve generally determines:
Answer income.
the interest rate.
both income and the interest rate.
neither income nor the interest rate.
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Question
When the LM curve is drawn, the quantity that is held fixed is:
Answer the nominal money supply.
the real money supply.
the tax rate.
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Question
According to the theory of liquidity preference, the supply of real money balances:
Answer decreases as the interest rate increases.
increases as the interest rate increases.
increases as income increases.
is fixed.
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Question
According to the theory of liquidity preference, the supply of nominal money balances:
Answer is chosen by the central bank.
depends on the interest rate.
varies with the price level.
changes as the level of income changes.
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Question
The theory of liquidity preference implies that:
Answer as the interest rate rises, the demand for real balances will fall.
as the interest rate rises, the demand for real balances will rise.
the interest rate will have no effect on the demand for real balances.
as the interest rate rises, income will rise.
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Question
If the interest rate is above the equilibrium value, the:
Answer demand for real balances exceeds the supply.
supply of real balances exceeds the demand.
11 of 24 12/8/2012 11:40
market for real balances clears.

demand for real balances increases.
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Question
According to the theory of liquidity preference, if the supply of real money balances exceeds the demand for real
money balances, individuals will:
Answer sell interest-earning assets in order to obtain non-interest-bearing money.
purchase interest-earning assets in order to reduce holdings of non-interest-bearing money.
purchase more goods and services.
be content with their portfolios.
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Question
According to the theory of liquidity preference, if the demand for real money balances exceeds the supply of real
money balances, individuals will:
Answer sell interest-earning assets in order to obtain non-interest-bearing money.
purchase interest-earning assets in order to reduce holdings of non-interest-bearing money.
purchase fewer goods and services.
be content with their portfolios.
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Question
Exhibit: Market for Real Money Balances
Reference: Ref 11-2
(Exhibit: Market for Real Money Balances) Based on the graph, the equilibrium levels of interest rates and real money
balances are:
Answer r1 and M1/P1
r2 and M2/P2
r3 and M2/P2
r3 and M3/P3
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Question
12 of 24 12/8/2012 11:40
Reference: Ref 11-2
(Exhibit: Market for Real Money Balances) Based on the graph, if the interest rate is r , then people will ______ bonds
1
and the interest rate will ______.
Answer sell; rise
sell; fall
buy; rise
buy; fall
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Question
Reference: Ref 11-2
(Exhibit: Market for Real Money Balances) Based on the graph, if the interest rate is r , then people will ______ bonds
3
and the interest rate will ______.
Answer sell; rise
sell; fall
buy; rise
buy; fall
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Question
The theory of liquidity preference implies that, other things being equal, an increase in the real money supply will:
Answer lower the interest rate.
raise the interest rate.
have no effect on the interest rate.
first lower and then raise the interest rate.
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13 of 24 12/8/2012 11:40
Question
When Paul Volcker tightened the money supply:
Answer the inflation rate immediately fell.
nominal interest rates fell in the short run.
nominal interest rates fell in the long run.
real balances rose in the short run.
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Question
According to the theory of liquidity preference, tightening the money supply will ______ nominal interest rates in the
short run, and, according to the Fisher effect, tightening the money supply will ______ nominal interest rates in the long
run.
increase; decrease
decrease; decrease
decrease; increase
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Question
Reducing the money supply ______ nominal interest rates in the short run, and ______ nominal interest rates in the
long run.
Answer produces no change in; raises
raises; produces no change in
raises; lowers
lowers; raises
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Question
In the liquidity preference model, what adjusts to move the money market to equilibrium following a change in the
money supply?
Answer planned spending
the interest rate
production
the price level
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Question
The theory of liquidity preference implies that the quantity of real money balances demanded is:
Answer negatively related to both the interest rate and income.
positively related to both the interest rate and income.
positively related to the interest rate and negatively related to income.
negatively related to the interest rate and positively related to income.
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Question
With the real money supply held constant, the theory of liquidity preference implies that a higher income level will be
consistent with:
Answer no change in the interest rate.
a lower interest rate.
a higher interest rate.
first a lower and then a higher interest rate.
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14 of 24 12/8/2012 11:40
Question
According to the theory of liquidity preference, holding the supply of real money balances constant, an increase in
income will ______ the demand for real money balances and will ______ the interest rate.
increase; decrease
decrease; decrease
decrease; increase
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Question
The LM curve, in the usual case:
Answer is vertical.
is horizontal.
slopes down to the right.
slopes up to the right.
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Question
An explanation for the slope of the LM curve is that as:
Answer the interest rate increases, income becomes higher.
the interest rate increases, income becomes lower.
income rises, money demand rises, and a higher interest rate is required.
income rises, money demand rises, and a lower interest rate is required.
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Question
An LM curve shows combinations of:
Answer taxes and government spending.
nominal money balances and price levels.
interest rates and income, which bring equilibrium in the market for real money balances.
interest rates and income, which bring equilibrium in the market for goods and services.
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A decrease in the real money supply, other things being equal, will shift the LM curve:
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A decrease in the nominal money supply, other things being equal, will shift the LM curve:
Answer upward and to the right.
downward and to the left.
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A decrease in the price level, holding nominal money supply constant, will shift the LM curve:
15 of 24 12/8/2012 11:40
Answer upward and to the right.

downward and to the left.
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Question
An increase in income raises money ______ and ______ the equilibrium interest rate.
Answer demand; raises
demand; lowers
supply; raises
supply; lowers
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Question
At a given interest rate, an increase in the nominal money supply ______ the level of income that is consistent with
equilibrium in the market for real balances.
Answer raises
lowers
does not change
may either raise or lower
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Changes in monetary policy shift the:
Answer LM curve.
planned spending curve.
money demand curve.
IS curve.
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The LM curve shows combinations of ______ that are consistent with equilibrium in the market for real money
balances.
Answer inflation and unemployment
the price level and real output
the interest rate and the level of income
the interest rate and real money balances
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For any given interest rate and price level, an increase in the money supply:
Answer lowers income.
raises income.
has no effect on income.
lowers velocity.
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The LM curve generally determines:
Answer income.
the interest rate.
16 of 24 12/8/2012 11:40
neither income nor the interest rate.
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The IS and LM curves together generally determine:
Answer income only.
the interest rate only.
income, the interest rate, and the price level.
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The interest rate determines ______ in the goods market and money ______ in the money market.
Answer government spending; demand
government spending; supply
investment spending; demand
investment spending; supply
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The intersection of the IS and LM curve determines the values of:
Answer r, Y, and P, given G, T, and M.
r, Y, and M, given G, T, and P.
r and Y, given G, T, M, and P.
p and Y, given G, T, and M.
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Question
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.
Answer positively; positively
positively; negatively
negatively; negatively
negatively; positively
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The IS–LM model is generally used:
Answer only in the short run.
only in the long run.
both in the short run and the long run.
in determining the price level.
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Question
The IS curve provides combinations of interest rates and income that satisfy equilibrium in the market for ______, and
the LM curve provides combinations of interest rates and income that satisfy equilibrium in the market for ______.
Answer saving and investment; planned spending
real-money balances; loanable funds
goods and services; real money balances
real-money balances; goods and services
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17 of 24 12/8/2012 11:40
Question
According to the Keynesian-cross analysis, if the marginal propensity to consume is 0.6, and government expenditures
and autonomous taxes are both increased by 100, equilibrium income will rise by:
Answer 0.
100.
150.
250.
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Question
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:
Answer 350.
400.
600.
750.
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Question
Using the Keynesian-cross analysis, assume that the consumption function is given by C = 100 + 0.6(Y – T). If planned
investment is 100 and T is 100, then the level of G needed to make equilibrium Y equal 1,000 is:
Answer 200.
240.
250.
260.
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Question
In the Keynesian-cross analysis, assume that the analysis of taxes is changed so that taxes, T, are made a function of
income, as in T = T + tY, where T and t are parameters of the tax code and t is positive but less than 1. As compared to
a case where t is zero, the multiplier for government purchases in this case will:
Answer not change.
be smaller.
be bigger.
be equal to 1.
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Consider the impact of an increase in thriftiness in the Keynesian-cross analysis. Assume that the marginal propensity
to consume is unchanged, but the intercept of the consumption function is made smaller so that at every income level
saving is greater. This will:
Answer lower equilibrium income by the decrease in the intercept multiplied by the multiplier.
lower equilibrium income by the decrease in the intercept.
raise equilibrium income by the decrease in the intercept.
raise equilibrium income by the decrease in the intercept multiplied by the multiplier.
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Consider the impact of an increase in thriftiness in the Keynesian-cross analysis. Assume that the marginal propensity
to consume is unchanged, but the intercept of the consumption function is made smaller so that at every income level
saving is greater. This will:
Answer increase saving by the decrease in the intercept.
lead to no change in saving.
decrease saving by the decrease in the intercept.
18 of 24 12/8/2012 11:40
lead to an increase in investment.
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Question
d
Assume that the money demand 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. The equilibrium interest rate is ______ percent.
Answer 2
4
6
8
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d
supply M is 2,000 and the price level P is 2. If the price level is fixed and the supply of money is raised to 2,800, then
the equilibrium interest rate will:
Answer drop by 4 percent.
drop by 2 percent.
drop by 1 percent.
remain unchanged.
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d
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:
Answer 2,000.
1,800.
1,600.
1,400.
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Essay 1 points
Question
Consider a closed economy to which the Keynesian-cross analysis applies. Consumption is given by the equation C =
200 + 2/3(Y – T). Planned investment is 300, as are government spending and taxes.
a. If Y is 1,500, what is planned spending? What is inventory accumulation or decumulation? Should
equilibrium Y be higher or lower than 1,500?
b. What is equilibrium Y? (Hint: Substitute the values of equations for planned consumption, investment,
and government spending into the equation Y = C + I + G and then solve for Y.)
c. What are equilibrium consumption, private saving, public saving, and national saving?
d. How much does equilibrium income decrease when G is reduced to 200? What is the multiplier for
government spending?
Answer a. Planned spending is 1,600. Inventory decumulation is 100. Equilibrium Y should be higher than 1,500.
b. Equilibrium Y is 1,800.
c. Consumption is 1,200, private saving is 300, public saving is 0, and national saving is 300.
d. Equilibrium Y decreases by 300. The multiplier is 3.
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Question
Assume that the consumption function is given by C = 200 + 0.5(Y – T) and the investment function is I = 1,000 – 200r,
where r is measured in percent, G equals 300, and T equals 200.
a. What is the numerical formula for the IS curve? (Hint: Substitute for C, I, and G in the equation Y = C + I
+ G and then write an equation for Y as a function of r or r as a function of Y.) Express the equation two
ways.
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b. What is the slope of the IS curve? (Hint: The slope of the IS curve is the coefficient of Y when the IS
curve is written expressing r as a function of Y.)
c. If r is one percent, what is I? What is Y? If r is 3 percent, what is I? What is Y? If r is 5 percent, what is I?
What is Y?
d. If G increases, does the IS curve shift upward and to the right or downward and to the left?
Answer a. Y = 2,800 – 400r or r = 7 – 0.0025Y.

b. The slope of the IS curve is –0.0025.
c. If r is 1 percent, I is 800 and Y is 2,400. If r is 3 percent, I is 400 and Y is 1,600. If r is 5 percent, I is 0
and Y is 800.
d. IS shifts upward and to the right.
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Question
Assume that the equilibrium in the money market may be described as M/P = 0.5Y – 100r, and M/P equals 800.
a. Write the LM curve two ways, expressing Y as a function of r and r as a function of Y. (Hint: Write the
LM curve only relating Y and r; substitute out M/P.)
b. What is the slope of the LM curve?
c. If r is 1 percent, what is Y along the LM curve? If r is 3 percent, what is Y along the LM curve? If r is 5
percent, what is Y along the LM curve?
d. If M/P increases, does the LM curve shift upward and to the left or downward and to the right?
e. If M increases and P is constant, does the LM curve shift upward and to the left or downward and to the
right?
f. If P increases and M is constant, does the LM curve shift upward and to the left or downward and to the
right?
Answer a. Y = 1,600 + 200r, or r = –8 + 0.005Y.

b. The slope of the LM curve is 0.005.
c. If r is 1 percent, Y is 1,800. If r is 3 percent, Y is 2,200. If r is 5 percent, Y is 2,600.
d. The LM curve shifts downward and to the right.
e. The LM curve shifts downward and to the right.
f. The LM curve shifts upward and to the left.
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Question
a. Suppose Congress decides to reduce the budget deficit by cutting government spending. Use the
Keynesian-cross model to illustrate graphically the impact of a reduction in government purchases on
the equilibrium level of income. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium
values; iv. the direction the curve shifts; and v. the terminal equilibrium values.
b. Explain in words what happens to equilibrium income as a result of the cut in government spending and
the time horizon appropriate for this analysis.
Answer a.
b. The equilibrium level of income falls. This analysis is appropriate in the short run when prices and the
interest rate are constant.
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20 of 24 12/8/2012 11:40
Essay 1 points
Question
a. Suppose Congress passes legislation that significantly reduces taxes. Use the Keynesian-cross model
to illustrate graphically the impact of a reduction in taxes on the equilibrium level of income. Be sure to
label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curve shifts; and v.
the terminal equilibrium values.
b. Explain in words what happens to equilibrium income as a result of the tax cut and the time horizon
appropriate for this analysis.
Answer a.
b. The equilibrium level of income increases. This analysis is appropriate in the short run when prices and
the interest rate are constant.
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Question
a. Use the Keynesian-cross model to illustrate graphically the impact of an increase in the interest rate on
the equilibrium level of income. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium
values; iv. the direction the curve shifts; and v. the terminal equilibrium values.
b. Explain in words what happens to equilibrium income as a result of the increase in the interest rate.
Answer a.
b. The equilibrium level of income falls.
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Question
a. Graphically illustrate the impact of an open-market purchase by the Federal Reserve on the equilibrium
interest rate using the theory of liquidity preference and the market for real money balances. Be sure to
label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curve shifts; and v.
the terminal equilibrium values.
b. Explain in words what happens to the equilibrium interest rate as a result of the open-market purchase.
21 of 24 12/8/2012 11:40
Answer a.
b. The equilibrium interest rate falls.
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a. As an economy moves into a recession, income falls. Illustrate graphically the impact of a decrease in
income on the equilibrium interest rate using the theory of liquidity preference and the market for real
money balances. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the
direction the curve shifts; and v. the terminal equilibrium values.
b. Explain in words what happens to the equilibrium interest rate as a result of the fall in income.
Answer a.
b. The equilibrium interest rate falls.
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Question
In explaining the 2003 bill to cut taxes, President Bush is quoted as saying, “When people have more money, they can
spend it on goods and services.”
a. In the IS–LM model, will a tax cut change the money supply in the economy? Does a change in the
money supply shift the IS or the LM curve?
b. In the IS–LM model, does a tax cut shift the IS or the LM curve?
c. Based on your answers in a and b, how can you reconcile the president's statement with economics?
Can you suggest how his statement could be modified to be consistent with the IS–LM model?
Answer a. Tax cuts do not change the money supply, which is controlled by the central bank (Federal Reserve).
Changes in the money supply shift the LM curve.
b. Tax cuts shift the IS curve.
c. The president used the word money as it is popularly understood, but his use was not according to its
macroeconomic meaning. Rephrasing the statement to say “when people have more disposable income
as a result of the tax cut, they can spend more on goods and services” would make the statement
consistent with the economic model.
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Question
Explain what force moves the market back to equilibrium if the market is initially in disequilibrium in:
a. the market for goods and services;
b. the market for real money balances.
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Answer a. In the market for goods and services if planned spending exceeds actual spending, for example, then
inventories will become depleted, firms will increase production, hire more workers, and increase
income and output until equilibrium is achieved.
b. In the market for real money balances if the supply of real money balances exceeds the demand, for
example, households will buy bonds, driving bond prices up and interest rates down. Interest rates will
continue to decline until households are eventually willing to hold the amount of real money balances
supplied.
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Question
Two identical countries, Country A and Country B, can each be described by a Keynesian-cross model. The MPC is
0.9 in each country. Country A decides to increase spending by $2 billion, while Country B decides to cut taxes by $2
billion. In which country will the new equilibrium level of income be greater?
Answer Income in Country A will increase more. The government-spending multiplier in Country A equals 10, so
income in Country A will increase by $20 billion. The tax multiplier in Country B equals 9, so income in
Country B will only increase by $18 billion.
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Question
a. The interest rate affects which variable in: (1) the market for goods and services and (2) the market for
real money balances?
b. The level of income affects which variable in: (1) the market for goods and services and (2) the market
for real money balances?
Answer a. The interest rate affects (1) investment in the market for goods and services, and (2) the demand for
money in the market for real money balances.
b. The level of income affects (1) consumption in the market for goods and services, and (2) the demand
for money in the market for real money balances.
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Question
Compare the predicted impact of an increase in the money supply in the liquidity preference model versus the impact
predicted by the quantity theory and the Fisher effect. Can you reconcile this difference?
Answer The liquidity preference model predicts that an increase in the money supply will decrease interest rates. The
quantity theory predicts that an increase in the money supply will increase inflation, which, via the Fisher
effect, will increase the nominal interest rate. The liquidity preference model emphasizes the short-run effect
when prices are fixed, while the quantity theory and Fisher effect are long-run effects when prices are flexible.
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Question
The IS–LM model simultaneously determines equilibrium in two markets.
a. Which two markets?
b. What two variables adjust to bring equilibrium in the markets?
Answer a. The IS–LM model simultaneously determines equilibrium in the goods market and the money market.
b. The interest rate (r) and real output (Y) are the two variables that adjust to bring equilibrium in both
markets.
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Question
Explain why a decrease in planned investment, which is a change in the goods market, will upset the equilibrium in the
money market.
Answer A decrease in planned investment spending decreases planned spending, which will reduce the equilibrium
level of income in the goods market. A decrease in income decreases the demand for real money balances in
the money market, which will decrease the equilibrium level of the interest rate in the money market.
Graphically, this is represented by a shift in the IS curve to the left and a movement down the LM curve.
23 of 24 12/8/2012 11:40
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Question
Explain why an increase in the money supply, which is a change in the money market, will upset the equilibrium in the
goods market.
Answer An increase in the money supply will decrease the equilibrium interest rate in the money market. A lower
interest rate will increase investment spending in the goods market, which will increase the equilibrium level of
income in the goods market. Graphically, this is represented by a shift in the LM curve to the right and a
movement down the IS curve.
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Question
During a recession, consumers may want to save more to provide themselves with a reserve to cushion possible job
losses. Use the Keynesian model to describe the impact of an exogenous decrease in consumption (a decrease in C)
on the equilibrium level of income in the economy. Will aggregate national saving increase?
Answer A decrease in exogenous consumption reduces planned spending, which reduces the equilibrium level of
income by a greater amount via the consumption spending multiplier, i.e., a decrease in consumption
spending leads to a decrease in income, which leads to another decrease in consumption spending, and so
on. At the new lower equilibrium level of income, both income and consumption spending will have decreased
by the same amount, so that national saving (Y – C – G) will be unchanged.
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Question
a. Graphically illustrate how an increase in income affects the equilibrium levels of saving, investment, and
the interest rate in the loanable funds model. Be sure to label: i. the axes; ii. the curves; iii. the initial
equilibrium values; iv. the direction the curve shifts; and v. the terminal equilibrium values.
b. Explain in words what happens to the equilibrium levels of saving, investment, and the interest rates as
a result of the increase in income.
Answer a.
b. The equilibrium levels of saving and investment increase. The interest rate falls.
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24 of 24 12/8/2012 11:40
Pool Canvas
Name TestBanks Chapter 12 Aggregate Demand II: Applying the IS-LM Model
Description
Instructions
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Question
The interaction of the IS curve and the LM curve together determine:
Answer the price level and the inflation rate.
the interest rate and the price level.
investment and the money supply.
the interest rate and the level of output.
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Exhibit: IS–LM Fiscal Policy
Reference: Ref 12-1
(Exhibit: IS–LM Fiscal Policy) Based on the graph, starting from equilibrium at interest rate r and income Y , a
1 1
decrease in government spending would generate the new equilibrium combination of interest rate and income:
Answer r2, Y2
r3, Y2
r2, Y3
r3, Y3
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1 of 31 12/8/2012 11:40
Reference: Ref 12-1
(Exhibit: IS–LM Fiscal Policy) Based on the graph, starting from equilibrium at interest rate r and income Y , an
1 1
increase in government spending would generate the new equilibrium combination of interest rate and income:
Answer r2, Y2
r3, Y2
r2, Y3
r3, Y3
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Question
Reference: Ref 12-1
(Exhibit: IS–LM Fiscal Policy) Based on the graph, starting from equilibrium at interest rate r and income Y , a tax cut
1 1
would generate the new equilibrium combination of interest rate and income:
Answer r2, Y2
r3, Y2
r2, Y3
r3, Y3
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Question
In the IS–LM model when government spending rises, in short-run equilibrium, in the usual case the interest rate
______ and output ______.
Answer rises; falls
rises; rises
falls; rises
falls; falls
2 of 31 12/8/2012 11:40
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Question
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.
Answer decrease; decrease; decrease; decrease
increase; increase; increase; increase
decrease; decrease; increase; increase
increase; increase; decrease; decrease
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Question
In the IS–LM model, the impact of an increase in government purchases in the goods market has ramifications in the
money market, because the increase in income causes a(n) ______ in money ______.
Answer increase; supply
increase; demand
decrease; supply
decrease; demand
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Question
In the IS–LM model when taxation increases, in short-run equilibrium, the interest rate ______ and output ______.
Answer rises; falls
rises; rises
falls; rises
falls; falls
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Question
If the LM curve is vertical and government spending rises by G, in the IS–LM analysis, then equilibrium income rises
by:
Answer G/(1 – MPC).
more than zero but less than G/(1 – MPC).
G.
zero.
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Question
If MPC = 0.75 (and there are no income taxes) when G increases by 100, then the IS curve for any given interest rate
shifts to the right by:
Answer 100.
200.
300.
400.
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Question
If MPC = 0.75 (and there are no income taxes but only lump-sum taxes) when T decreases by 100, then the IS curve
for any given interest rate shifts to the right by:
Answer 100.
200.
300.
400.
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3 of 31 12/8/2012 11:40
Question
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:
Answer prices.
investment.
the money supply.
taxes.
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Question
The increase in income in response to a fiscal expansion in the IS–LM is:
Answer always less than in the Keynesian-cross model.
less than in the Keynesian-cross model unless the LM curve is vertical.
less than in the Keynesian-cross model unless the LM curve is horizontal.
less than in the Keynesian-cross model unless the IS curve is vertical.
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Question
Using the IS–LM analysis, if the LM curve is not horizontal, the multiplier for an increase in government spending is
______ for an increase in government purchases using the Keynesian-cross analysis.
Answer larger than the multiplier
the same as the multiplier
smaller than the multiplier
sometimes larger and sometimes smaller than the multiplier
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Question
The reason that the income response to a fiscal expansion is generally less in the IS–LM model than it is in the
Keynesian-cross model is that the Keynesian-cross model assumes that:
Answer investment is not affected by the interest rate whereas in the IS–LM model fiscal expansion raises the
interest rate and crowds out investment.
investment is not affected by the interest rate whereas in the IS–LM model fiscal expansion lowers the
interest rate and crowds out investment.
investment is autonomous whereas in the IS–LM model fiscal expansion encourages higher investment,
which raises the interest rate.
the price level is fixed whereas in the IS–LM model it is allowed to vary.
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Question
In the IS–LM model, changes in taxes initially affect planned expenditures through:
Answer consumption.
investment.
the interest rate.
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Question
In the IS–LM analysis, the increase in income resulting from a tax cut is usually ______ the increase in income
resulting from an equal rise in government spending.
Answer less than
greater than
equal to
sometimes less and sometimes greater than
4 of 31 12/8/2012 11:40
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Question
Exhibit: IS–LM Monetary Policy
Reference: Ref 12-2
(Exhibit: IS–LM Monetary Policy) Based on the graph, starting from equilibrium at interest rate r and income Y , a
1 1
decrease in the money supply would generate the new equilibrium combination of interest rate and income:
Answer r2, Y2
r3, Y2
r2, Y3
r3, Y3
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Question
Exhibit: IS–LM Monetary Policy
Reference: Ref 12-2
(Exhibit: IS–LM Monetary Policy) Based on the graph, starting from equilibrium at interest rate r and income Y , an
1 1
increase in the money supply would generate the new equilibrium combination of interest rate and income:
Answer r2, Y2
r3, Y2
r2, Y3
r3, Y3
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Question
If the money supply increases, then in the IS–LM analysis the ______ curve shifts to the ______.
5 of 31 12/8/2012 11:40
Answer LM; left

LM; right
IS; left
IS; right
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Question
In the IS–LM model when M/P rises, in short-run equilibrium, in the usual case the interest rate ______ and output
______.
Answer rises; falls
rises; rises
falls; rises
falls; falls
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Question
In the IS–LM model when M rises but P remains constant, in short-run equilibrium, in the usual case the interest rate
______ and output ______.
Answer rises; falls
rises; rises
falls; rises
falls; falls
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Question
In the IS–LM model when M remains constant but P rises, in short-run equilibrium, in the usual case the interest rate
______ and output ______.
Answer rises; falls
rises; rises
falls; rises
falls; falls
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Question
If the demand for real money balances does not depend on the interest rate, then the LM curve:
Answer slopes up to the right.
slopes down to the right.
is horizontal.
is vertical.
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Question
In the IS–LM model when the Federal Reserve decreases the money supply, people ______ bonds and the interest
rate ______, leading to a(n) ______ in investment and income.
Answer buy; rises; increase
sell; falls; decrease
sell; rises; decrease
buy; rises; decrease
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Question
The monetary transmission mechanism works through the effects of changes in the money supply on:
6 of 31 12/8/2012 11:40
Answer the budget deficit.

investment.
government expenditures.
taxation.
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Question
The monetary transmission mechanism in the IS–LM model is a process whereby an increase in the money supply
increases the demand for goods and services:
Answer directly.
by lowering the interest rate so that investment spending increases.
by raising the interest rate so that investment spending increases.
by increasing government spending on goods and services.
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Question
If Congress passed a tax increase at the request of the president to reduce the budget deficit, but the Fed held the
money supply constant, then the two policies together would generally lead to ______ income and a ______ interest
rate.
Answer lower; lower
lower; higher
no change in; lower
no change in; higher
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Question
According to the IS–LM model, if Congress raises taxes but the Fed wants to hold the interest rate constant, then the
Fed must ______ the money supply.
Answer increase
decrease
first increase and then decrease
first decrease and then increase
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Question
According to the IS–LM model, if Congress raises taxes but the Fed wants to hold income constant, then the Fed must
______ the money supply.
Answer increase
decrease
first increase and then decrease
first decrease and then increase
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Question
If taxes are raised, but the Fed prevents income from falling by raising the money supply, then:
Answer both consumption and investment remain unchanged.
consumption rises but investment falls.
investment rises but consumption falls.
both consumption and investment fall.
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Question
Exhibit: Policy Interaction
7 of 31 12/8/2012 11:40
Reference: Ref 12-3
(Exhibit: Policy Interaction) Based on the graph, starting from equilibrium at interest rate r , income Y , IS , and LM , if
3 2 1 1
there is an increase in government spending that shifts the IS curve to IS , then in order to keep the interest rate
2
constant, the Federal Reserve should _____ the money supply shifting to _____.
Answer increase; LM
2
decrease; LM
2
increase; LM
3
decrease; LM
3
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Question
Reference: Ref 12-3
3 2 1 1
there is an increase in government spending that shifts the IS curve to IS , then in order to keep output constant, the
2
Federal Reserve should _____ the money supply shifting to _____.
Answer increase; LM
2
decrease; LM
2
increase; LM
3
decrease; LM
3
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Question
8 of 31 12/8/2012 11:40
Reference: Ref 12-3
3 2 1 1
there is an increase in government spending that shifts the IS curve to IS and the Federal Reserve does not change
2
the money supply, the new equilibrium combination of interest and income will be _____.
Answer r1, Y2
r2, Y3
r3, Y3
r3, Y4
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Question
According to the macroeconometric model developed by Data Resources Incorporated, the response of GDP four
quarters after an increase in government spending, with the nominal interest rate held constant, will be ______ the
response of GDP to a similar change with the money supply held constant.
Answer less than half as great as
approximately equal to
more than two times as great as
more than three times as great as
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Question
According to the macroeconometric model developed by Data Resources Incorporated, if taxes are increased by $100
billion, but the money supply is held constant, then GDP will fall by about:
Answer zero.
$25 billion.
$75 billion.
$100 billion.
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Question
An increase in investment demand for any given level of income and interest rates—due, for example, to more
optimistic “animal spirits”—will, within the IS–LM framework, ______ output and ______ interest rates.
Answer increase; lower
increase; raise
lower; lower
lower; raise
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Question
An increase in consumer saving for any given level of income will shift the:
9 of 31 12/8/2012 11:40
Answer LM curve upward and to the left.

LM curve downward and to the right.
IS curve downward and to the left.
IS curve upward and to the right.
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Question
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.
Answer increase; lower
increase; raise
lower; lower.
lower; raise
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Question
In the IS–LM model, a decrease in the interest rate would be the result of a(n):
Answer increase in the money supply.
increase in government purchases.
decrease in taxes.
increase in money demand.
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Question
In the IS–LM model, a decrease in output would be the result of a(n):
Answer decrease in taxes.
increase in the money supply.
increase in money demand.
increase in government purchases.
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Question
The U.S. recession of 2001 can be explained in part by a declining stock market and terrorist attacks. Both of these
shocks can be represented in the IS–LM model by shifting the ______ curve to the ______.
Answer LM; right
LM; left
IS; right
IS; left
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Question
One policy response to the U.S. economic slowdown of 2001 was tax cuts. This policy response can be represented in
the IS–LM model by shifting the ______ curve to the ______.
Answer LM; right
LM; left
IS; right
IS; left
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Question
One policy response to the U.S. economic slowdown of 2001 was to increase money growth. This policy response can
be represented in the IS–LM model by shifting the ______ curve to the ______.
10 of 31 12/8/2012 11:40
Answer LM; right

LM; left
IS; right
IS; left
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Question
When bond traders for the Federal Reserve seek to increase interest rates, they ______ bonds, which shifts the
______ curve to the left.
Answer buy; IS
buy; LM
sell; IS
sell; LM
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Question
When bond traders for the Federal Reserve seek to decrease interest rates, they ______ bonds, which shifts the
______ curve to the right.
Answer buy; IS
buy; LM
sell; IS
sell; LM
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Question
The aggregate demand curve generally slopes downward and to the right because, for any given money supply M a
higher price level P causes a ______ real money supply M/P, which ______ the interest rate and ______ spending.
Answer lower; raises; reduces
higher; lowers; increases
lower; lowers; increases
higher; raises; reduces
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Question
An economic change that does not shift the aggregate demand curve is a change in:
Answer the money supply.
the investment function.
the price level.
taxes.
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Question
A change in income in the IS–LM model for a fixed price
Answer represents a shift in the aggregate demand curve.
represents a movement along the aggregate demand curve.
has the same effect on the aggregate demand curve as a change in income in the IS–LM model resulting
from a change in the price level.
does not represent a change in the aggregate demand curve.
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Question
An increase in the money supply shifts the ______ curve to the right, and the aggregate demand curve ______.
11 of 31 12/8/2012 11:40
Answer IS; shifts to the right

IS; does not shift
LM: shifts to the right
LM; does not shift
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Question
A tax cut shifts the ______ to the right, and the aggregate demand curve ______.
IS; does not shift
LM; does not shift
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Question
A decrease in the price level shifts the ______ curve to the right, and the aggregate demand curve ______.
IS; does not shift
LM; does not shift
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Question
A change in income in the IS–LM model resulting from a change in the price level is represented by a ______
aggregate demand curve, while a change in income in the IS–LM model for a given price level is represented by a
______ aggregate demand curve.
Answer movement along the; shift in the
shift in the; movement along the
vertical; horizontal
horizontal; vertical
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Question
Exhibit: IS–LM to Aggregate Demand
Reference: Ref 12-4
(Exhibit: IS–LM to Aggregate Demand) Based on the graph, if LM shifts to LM because the price level decreases
1 2
from P to P then, holding other factors constant:
1 2
Answer the aggregate demand curve will shift to the right.
the aggregate demand curve will shift to the left.
this represents a movement up the aggregate demand curve.
this represents a movement down the aggregate demand curve.
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12 of 31 12/8/2012 11:40
Question
Reference: Ref 12-4
(Exhibit: IS–LM to Aggregate Demand) Based on the graph, if LM shifts to LM because the money supply decreases
3 2
from M to M then, holding other factors constant:
3 2
Answer the aggregate demand curve will shift to the right.
the aggregate demand curve will shift to the left.
this represents a movement up the aggregate demand curve.
this represents a movement down the aggregate demand curve.
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Question
Reference: Ref 12-4
(Exhibit: IS–LM to Aggregate Demand) Based on the graph, which is the correct ordering of the price levels and money
supplies?
Answer P1 > P2 and M1 > M2
P1 > P2 and M1 < M2
P1 < P2 and M1 > M2
P1 < P2 and M1 < M2
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Question
A movement along an aggregate demand curve corresponds to a change in income in the IS–LM model ______, while
a shift in an aggregate demand curve corresponds to a change in income in the IS–LM model ______.
Answer resulting from a change in monetary policy; resulting from a change in fiscal policy
resulting from a change in fiscal policy; resulting from a change in monetary policy
at a given price level; resulting from a change in the price level
resulting from a change in the price level; at a given price level
13 of 31 12/8/2012 11:40
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Question
Starting from a short-run equilibrium greater than the natural rate of output, as the economy returns to a long-run
equilibrium:
Answer both output and the price level will increase.
output will decrease, but the price level will increase.
output will increase, but the price level will decrease.
both output and the price level will decrease.
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Question
If the short-run IS–LM equilibrium occurs at a level of income below the natural level of output, then in the long run the
price level will ______, shifting the ______ curve to the right and returning output to the natural level.
Answer increase; IS
decrease; IS
increase; LM
decrease; LM
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Question
If the short-run IS–LM equilibrium occurs at a level of income above the natural level of output, in the long run the
______ will ______ in order to return output to the natural level.
Answer price level; increase
interest rate; decrease
money supply; increase
consumption function; decrease
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Question
Exhibit: Short Run to Long Run
Reference: Ref 12-5
(Exhibit: Short Run to Long Run) Based on the graph, if the economy starts from a short-term equilibrium at A, then the
long-run equilibrium will be at ____ with a _____ price level.
Answer B; higher
B; lower
C; higher
C; lower
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Question
Exhibit: Short Run to Long Run
Reference: Ref 12-5
(Exhibit: Short Run to Long Run) Based on the graph, if the economy starts from a short-term equilibrium at D, then the
long-run equilibrium will be at ____ with a _____ price level.
Answer B; higher
B; lower
C; higher
C; lower
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Question
The macroeconomic model may be completed by adding either the Keynesian assumption that ______ or the classical
assumption that ______.
Answer output is fixed; prices are fixed
prices are fixed; output is fixed
the interest rate is fixed; the money supply is fixed
prices are flexible; output varies
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Question
Analysis of the short and long runs indicates that the ______ assumptions are most appropriate in ______.
Answer classical; both the short and long runs.
Keynesian; both the short and long runs.
classical; the short run, whereas the Keynesian assumptions are most appropriate in the long run.
Keynesian; the short run, whereas the classical assumptions are most appropriate in the long run.
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Question
The spending hypothesis suggests that the Great Depression was caused by a:
Answer leftward shift in the IS curve.
rightward shift in the IS curve.
leftward shift in the LM curve.
rightward shift in the LM curve.
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Question
All of the following events are consistent with the spending hypothesis as contributing to the Great Depression except:
Answer the decline in investment spending on housing because of a decline in immigration in the 1930s.
the decline in consumption spending caused by the stock market crash of 1929.
fiscal policy to reduce the budget deficit by raising taxes in 1932.
the 25-percent reduction in the money supply between 1929 and 1933.
15 of 31 12/8/2012 11:40
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Question
The money hypothesis suggests that the Great Depression was caused by a:
Answer leftward shift in the IS curve.
rightward shift in the IS curve.
leftward shift in the LM curve.
rightward shift in the LM curve.
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Question
The Great Depression in the United States:
Answer probably was caused by a rightward shift in the LM curve because the price level fell more rapidly than the
fall in the money supply from 1929 to 1933.
cannot be attributed to a fall in the money supply because the money supply did not fall.
probably cannot be considered to have started because of a leftward shift in the LM curve because real
balances did not fall between 1929 and 1931.
probably was caused by a leftward shift in the LM curve because interest rates remained high between
1929 and 1933.
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Question
The Pigou effect:
Answer suggests that as prices fall and real money balances rise, consumers should feel less wealthy and spend
less.
suggests that as prices fall and real money balances rise, consumers should feel wealthier and spend
more.
suggests that as prices fall and real money balances rise, consumers should feel less wealthy but spend
more.
is generally accepted as adequate proof that the economy must be able to correct itself.
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Question
The Pigou effect suggests that falling prices will increase income because real balances influence ______ and will shift
the ______ curve.
Answer money demand; LM
the money supply; LM
consumer spending; IS
government spending; IS
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Question
If real money balances enter the IS–LM model both through the theory of liquidity preference and the Pigou effect, then
a fall in the price level will shift:
Answer only the LM curve.
only the IS curve.
both the LM and the IS curves.
neither the LM nor the IS curve.
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Question
If real money balances enter the IS–LM model both through the theory of liquidity preference and the Pigou effect, then
a fall in the price level will result in higher income and:
16 of 31 12/8/2012 11:40
Answer higher interest rates.

lower interest rates.
no change in interest rates.
either higher, lower, or unchanging interest rates.
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Question
The debt-deflation theory of the Great Depression suggests that an ______ deflation redistributes wealth in such a way
as to ______ spending on goods and services.
Answer unexpected; reduce
unexpected; increase
expected; reduce
expected; increase
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Question
The debt-deflation hypothesis explains the fall in income as a consequence of unexpected deflation transferring wealth
______, and that creditors have ______ propensity to consume than debtors.
Answer from debtors to creditors; a smaller
from debtors to creditors; a larger
from creditors to debtors; a smaller
from creditors to debtors; a larger
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Question
An unexpected deflation can change demand by redistributing wealth from:
Answer creditors to debtors, thus raising consumption.
creditors to debtors, thus lowering consumption.
debtors to creditors, thus lowering consumption.
debtors to creditors, thus raising consumption.
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Question
Possible explanations put forth for the Great Depression do not include:
Answer a shift in the IS curve.
a shift in the LM curve.
the debt-deflation theory.
the Pigou effect.
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Question
Investment depends on the ______ interest rate, and money demand depends on the ______ interest rate.
Answer real; real
nominal; nominal
real; nominal
nominal; real
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Question
In the IS–LM model, starting with no expected inflation, if expected inflation becomes negative, then the:
Answer IS curve shifts leftward.
IS curve shifts rightward.
LM curve shifts leftward.
17 of 31 12/8/2012 11:40
LM curve shifts rightward.
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Question
One explanation for the impact of expected price changes on the level of output is that an increase in expected
deflation ______ the nominal interest rate and ______ the real interest rate, so that investment spending declines.
Answer lowers; raises
raises; lowers
raises; raises
lowers; lowers
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Question
In the IS–LM model, a decrease in expected inflation (or an increase in expected deflation), leads to a(n):
Answer increase in both output and the nominal interest rate.
decrease in both output and the nominal interest rate.
increase in output and a decrease in the nominal interest rate.
decrease in output and an increase in the nominal interest rate.
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Question
Other things equal, an expected deflation can change demand by:
Answer lowering the demand for money, thus shifting the LM curve.
increasing the demand for money, thus shifting the LM curve.
raising the real interest rate for any given nominal interest rate, thus reducing desired investment.
lowering the real interest rate for any given nominal interest rate, thus increasing desired investment.
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Question
During the financial crisis of 2008–2009, many financial institutions stopped making loans even to creditworthy
customers, which could be represented in the IS–LM model as a(n):
Answer expansionary shift in the IS curve.
contractionary shift in the IS curve.
expansionary shift in the LM curve.
contractionary shift in the LM curve.
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Question
All of the following may have contributed to the financial crisis and economic downturn of 2008–2009 except:
Answer high inflation.
low interest rates.
stock market volatility.
falling house prices.
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Question
Most economists believe:
Answer the Great Depression is very likely to be repeated.
it is likely that the money supply might again fall by one-fourth, but that fiscal policy would be expansionary
enough in this case to avoid a Great Depression.
it is unlikely that the money supply might fall again by one-fourth, but it is likely that fiscal policy might be
so contractionary as to cause a Great Depression.
18 of 31 12/8/2012 11:40
in view of what economists now know about monetary and fiscal policy, and in view of institutional
changes, a repeat of the Great Depression is unlikely.
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Question
A liquidity trap occurs when:
Answer banks have too much currency and close their doors to new customers.
the central bank mistakenly prints too much money, generating hyperinflation.
interest rates fall so low that monetary policy is no longer effective.
dams and locks are built to prevent flooding.
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Question
If a liquidity trap does exist, then ______ policy will not be effective in increasing income when interest rates reach very
______ levels.
Answer monetary; high
monetary; low
fiscal; high
fiscal; low
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Question
If expected inflation equals 3 percent and monetary policymakers push the nominal interest rate to 1 percent, the real
interest rate equals ______ percent.
Answer 4
1
0
–2
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Question
When drawn with the interest rate on the vertical axis and income on the horizontal axis, the IS curve will be steeper
the:
Answer larger the level of government spending.
smaller the level of government spending.
greater the sensitivity of investment spending to the interest rate.
smaller the sensitivity of investment spending to the interest rate.
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Question
The slope of the IS curve depends on:
Answer the interest sensitivity of investment and the amount of government spending.
the interest sensitivity of investment and the marginal propensity to consume.
the interest sensitivity of investment and the tax rates.
tax rates and government spending.
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Question
A given increase in taxes shifts the IS curve more to the left the:
Answer larger the marginal propensity to consume.
smaller the marginal propensity to consume.
larger the government spending.
smaller the government spending.
19 of 31 12/8/2012 11:40
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Question
The LM curve is steeper the ______ the interest sensitivity of money demand and the ______ the effect of income on
money demand.
Answer greater; greater
greater; smaller
smaller; smaller
smaller; greater
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Question
If the demand function for money is M/P = 0.5Y – 100r, then the slope of the LM curve is:
Answer 0.001.
0.005.
0.01.
0.05.
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Question
If the demand function for money is M/P = 0.5Y – 100r and if M/P increases by 100, then the LM curve for any given
interest rate shifts to the:
Answer left by 100.
left by 200.
right by 100.
right by 200.
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Question
Other things equal, a given change in government spending has a larger effect on demand the:
Answer flatter the LM curve.
steeper the LM curve.
smaller the interest sensitivity of money demand.
larger the income sensitivity of money demand.
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Question
Other things equal, a given change in government spending has a larger effect on demand the:
Answer flatter the IS curve.
steeper the IS curve.
larger the interest sensitivity of expenditure demand.
smaller the interest sensitivity of money demand.
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Question
Other things equal, a given change in money supply has a larger effect on demand the:
Answer flatter the IS curve.
smaller the interest sensitivity of expenditure demand.
larger the income sensitivity of money demand.
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20 of 31 12/8/2012 11:40
Question
Other things equal, a given change in money supply has a larger effect on demand the:
Answer larger the income sensitivity of money demand.
smaller the income sensitivity of money demand.
flatter the LM curve.
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Question
If money demand does not depend on the interest rate, then the LM curve is ______ and ______ policy has no effect
on output.
Answer horizontal; fiscal
vertical; fiscal
horizontal; monetary
vertical; monetary
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Question
If neither investment nor consumption depends on the interest rate, then the IS curve is ______ and ______ policy has
no effect on output.
Answer vertical; monetary
vertical; fiscal
horizontal; fiscal
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Question
If money demand is infinite below some certain r (e.g., r*) and zero above r*, then the LM curve is ______ and ______
policy has no effect on output.
Answer vertical; fiscal
horizontal; fiscal
vertical; monetary
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Question
If investment demand is infinite below some certain r (e.g., r**) and zero above r**, then the IS curve is ______ and
______ policy has no effect on output.
Answer vertical; monetary
vertical; fiscal
horizontal; fiscal
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Question
If the investment demand function is I = c – dr and the quantity of real money demanded is eY – fr, then fiscal policy is
relatively potent in influencing aggregate demand when d is ______ and f is ______.
Answer large; small
small; small
small; large
large; large
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21 of 31 12/8/2012 11:40
Question
If the investment demand function is I = c – dr and the quantity of real money demanded is eY – fr, then monetary
policy is relatively potent in influencing aggregate demand when d is ______ and f is ______.
Answer large; small.
small; also small.
small; large.
large; also large.
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Question
Those economists who believe that fiscal policy is more potent than monetary policy argue that the:
Answer responsiveness of investment to the interest rate is small.
responsiveness of investment to the interest rate is large.
IS curve is nearly horizontal.
LM curve is nearly vertical.
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Question
Those economists who believe that monetary policy is more potent than fiscal policy argue that the:
Answer responsiveness of money demand to the interest rate is large.
responsiveness of money demand to the interest rate is small.
IS curve is nearly vertical.
LM curve is nearly horizontal.
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Question
According to the IS–LM model, when the government increases taxes and government purchases by equal amounts:
Answer income, the interest rate, consumption, and investment are unchanged.
income and the interest rate rise, whereas consumption and investment fall.
income and the interest rate fall, whereas consumption and interest rise.
income, the interest rate, consumption, and investment all rise.
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Question
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:
Answer Y = 400 – 0.75T – 25r + G.
Y = 1,600 – 3T – 100r + 4G.
Y = 400 + 0.75T – 25r – G.
Y = 1,600 + 3T – 100r – 4G.
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Question
If the IS curve is given by Y = 1,700 – 100r and the LM curve is given by Y = 500 + 100r, then equilibrium income and
interest rate are given by:
Answer Y = 1,100, r = 6 percent.
Y = 1,200, r = 5 percent.
Y = 1,000, r = 5 percent.
Y = 1,100, r = 5 percent.
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Question
d
If the IS curve is given by Y = 1,700 – 100r, the money demand function is given by (M/P) = Y – 100r, the money
22 of 31 12/8/2012 11:40
supply is 1,000, and the price level is 2, then if the money supply is raised to 1,200, equilibrium income rises by:
Answer 200 and the interest rate falls by 2 percent.
100 and the interest rate falls by 1 percent.
50 and the interest rate falls by 0.5 percent.
200 and the interest rate remains unchanged.
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Question
If investment does not depend on the interest rate, then the ______ curve is ______.
Answer IS; vertical
IS; horizontal
LM; vertical
LM; horizontal
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Question
If money demand does not depend on income, then the ______ curve is ______.
Answer IS; vertical
IS; horizontal
LM; vertical
LM; horizontal
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Question
If money demand is extremely sensitive to the interest rate, then the ______ curve is ______.
Answer IS; vertical
IS; horizontal
LM; vertical
LM; horizontal
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Question
If the government wants to raise investment but keep output constant, it should:
Answer adopt a loose monetary policy but keep fiscal policy unchanged.
adopt a loose monetary policy and a loose fiscal policy.
adopt a loose monetary policy and a tight fiscal policy.
keep monetary policy unchanged but adopt a tight fiscal policy.
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Question
A tax cut combined with tight money, as was the case in the United States in the early 1980s, should lead to a:
Answer rise in the real interest rate and a fall in investment.
fall in the real interest rate and a rise in investment.
rise in both the real interest rate and investment.
fall in both the real interest rate and investment.
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Question
An increase in the money supply:
Answer increases income and lowers the interest rate in both the short and long runs.
increases income in both the short and long runs, but leaves the interest rate unchanged in the long run.
lowers the interest rate in both the short and long runs, but leaves income unchanged in the long run.
23 of 31 12/8/2012 11:40
lowers the interest rate and increases income in the short run, but leaves both unchanged in the long run.
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Question
An increase in government spending raises income:
Answer and the interest rate in the short run, but leaves both unchanged in the long run.
in the short run, but leaves it unchanged in the long run, while lowering investment.
in the short run, but leaves it unchanged in the long run, while lowering consumption.
and the interest rate in both the short and long runs.
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Question
An increase in taxes lowers income:
Answer and the interest rate in the short run, but leaves both unchanged in the long run.
in the short run, but leaves it unchanged in the long run, while increasing consumption and lowering
investment.
in the short run, but leaves it unchanged in the long run, while lowering consumption and increasing
investment.
and the interest rate in both the short and long runs.
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Essay 1 points
Question
Assume the following model of the economy, with the price level fixed at 1.0:
C = 0.8(Y – T) T = 1,000
I = 800 – 20r G = 1,000
Y=C+I+G Ms/P = Md/P = 0.4Y – 40r
Ms = 1,200
a. Write a numerical formula for the IS curve, showing Y as a function of r alone. (Hint: Substitute out C, I,
G, and T.)
b. Write a numerical formula for the LM curve, showing Y as a function of r alone. (Hint: Substitute out
M/P.)
c. What are the short-run equilibrium values of Y, r, Y – T, C, I, private saving, public saving, and national
saving? Check by ensuring that C + I + G = Y and national saving equals I.
d. Assume that G increases by 200. By how much will Y increase in short-run equilibrium? What is the
government-purchases multiplier (the change in Y divided by the change in G)?
s
e. Assume that G is back at its original level of 1,000, but M (the money supply) increases by 200. By how
much will Y increase in short-run equilibrium? What is the multiplier for money supply (the change in Y
s
divided by the change in M )?
Answer a. Y = 5,000 – 100r.

b. Y = 3,000 + 100r.
c. In the short-run equilibrium, Y = 4,000; r = 10; Y – T = 3,000; C = 2,400; I = 600; private saving is 600;
public saving is 0; and national saving is 600.
d. Y increases by 500. The government spending multiplier is 2.5.
e. Y increases by 250. The multiplier for money supply is 1.25.
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Essay 1 points
Question
Assume that an economy is characterized by the following equations:
C = 100 + (2/3)(Y – T)
T = 600
G = 500
I = 800 – (50/3)r
Ms/P = Md/P = 0.5Y – 50r
a. Write the numerical IS curve for the economy, expressing Y as a numerical function of G, T, and r.
b. Write the numerical LM curve for this economy, expressing r as a function of Y and M/P.
24 of 31 12/8/2012 11:40
c. Solve for the equilibrium values of Y and r, assuming P = 1.0 and M = 1,200. How do they change when
P = 2.0? Check by computing C, I, and G.
d. Write the numerical aggregate demand curve for this economy, expressing Y as a function of G, T, and
M/P.
Answer a. Y = 2,700 + 3G – 2T – 50r.

b. r = 0.01Y – 0.02(M/P).
c. For P = 1.0, Y = 2,800 and r = 4; C = 1,566.67 and I = 733.33 For P = 2.0, Y = 2,400 and r = 12; C =
1,300 and I = 600.
d. Y = 1,800 + 2G – (4/3)T + (2/3)M/P.
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Essay 1 points
Question
Assume that an economy is described by the IS curve Y = 3,600 + 3G – 2T – 150r and the LM curve Y = 2 M/P + 100r
[or r = 0.01Y – 0.02(M/P)]. The investment function for this economy is 1,000 – 50r. The consumption function is C =
200 + (2/3)(Y – T). Long-run equilibrium output for this economy is 4,000. The price level is 1.0.
a. Assume that government spending is fixed at 1,200. The government wants to achieve a level of
investment equal to 900 and also achieve Y = 4,000. What level of r is needed for I = 900? What levels
of T and M must be set to achieve the two goals? What will be the levels of private saving, public
saving, and national saving? (Hint: Check C + I + G = Y.)
b. Now assume that the government wants to cut taxes to 1,000. With G set at 1,200, what will the interest
rate be at Y = 4,000? What must be the value of M? What will I be? What will be the levels of private,
public, and national saving? (Hint: Check C + I + G = Y.)
c. Which set of policies may be referred to as tight fiscal, loose money? Which set of policies may be
referred to as loose fiscal, tight money? Which “policy mix” most encourages investment?
Answer a. r = 2; T = 1,450; M = 1,900. Private saving = 650; public saving = 250; national saving = 900.
b. r = 8; M = 1,600; I = 600; private saving = 800; public saving = –200; national saving = 600.
c. The policy under part a is tight fiscal, loose money. The policy under part b is loose fiscal, tight money.
The policy under part a most encourages investment.
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Essay 1 points
Question
Suppose Congress wishes to reduce the budget deficit by reducing government spending. Use the IS–LM model to
illustrate graphically the impact of the reduction in government spending on output and interest rates. Be sure to label:
i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; and v. the terminal
equilibrium values.
Answer
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Essay 1 points
Question
Suppose Congress passes legislation that reduces taxes. Use the IS–LM model to illustrate graphically the impact of
the tax reduction on output and interest rates. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium
values; iv. the direction the curves shift; and v. the terminal equilibrium values.
Answer
25 of 31 12/8/2012 11:40
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Essay 1 points
Question
How can the Fed keep the economy from falling into a recession if the budget deficit is reduced? Use the IS–LM model
to illustrate graphically the impact of both the fiscal policy reducing the deficit and the monetary policy, which prevents
output from falling. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the
curves shift; and v. the terminal equilibrium values.
Answer
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Essay 1 points
Question
Use the IS–LM model to illustrate graphically the impact on output and interest rates of a one-time increase in the price
level due to a large increase in oil prices. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv.
the direction the curves shift; and v. the terminal equilibrium values.
Answer
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Question
Suppose that people finally realize that they must save a larger proportion of their income in order to retire and that
they simultaneously begin to use new technology that allows them to reduce their holdings of real cash balances as a
proportion of their income. Use the IS–LM model to illustrate graphically the impact of these two changes in household
behavior on output and interest rates. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the
direction the curves shift; and v. the terminal equilibrium values.
Answer
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The interest rate decreases, but the impact on output is ambiguous, depending on whether the IS or LM
curve shifts more.
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Question
Use the IS–LM model to illustrate graphically the impact of the Pigou effect on the equilibrium level of income and
interest rate during the Great Depression, when prices were falling.
Answer
Income increases because the falling prices increase money balances, thus making consumers feel wealthier.
The increase in wealth causes consumers to consume more, thereby shifting the IS curve to the right. Income
also increases because the decrease in prices increases real money balances, which shifts the LM curve to
the right. The impact on interest rates is indeterminate.
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Essay 1 points
Question
Assume that initially everyone expects the price level to stay the same. Now the Federal Reserve announces that it will
increase the rate of money growth in one year. People now expect inflation. Use the IS–LM model to illustrate
graphically the impact of expected inflation on the level of output and on the real and nominal interest rates.
Answer
The increase in expected inflation increases output and the nominal interest rate, and lowers the real
interest rate.
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Essay 1 points
Question
Assume that the economy is initially in short-run equilibrium at a level of output above the natural rate. Use the IS–LM
model to illustrate graphically how the levels of income and interest rates change as the economy returns to the natural
rate of output in the long run.
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Answer
Prices increase, reducing real money balances, resulting in lower output and a higher interest rate.
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Question
Two identical countries, Alpha and Beta, can be described by the IS–LM model in the short run. The governments of
both countries cut taxes by the same amount. The Central Bank of Alpha follows a policy of holding a constant money
supply. The Central Bank of Beta follows a policy of holding a constant interest rate. Compare the impact of the tax cut
on income and interest rates in the two countries.
Answer The interest rate will increase in Alpha, but remain constant in Beta. The increase in output will be larger in
Beta because the Central Bank of Beta will increase the money supply to keep the interest rate constant in the
face of the tax cut. Thus, there will be no crowding out of investment in Beta, but there will be crowding out in
Alpha because of the higher interest rate.
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Question
Policymakers are contemplating undertaking either an increase in government spending or an increase in the money
supply. Either policy is forecast to have the same impact on income in the short run. Use the IS–LM model to compare
the impact on consumption and investment of the two policy alternatives.
Answer The increase in government spending will increase interest rates, but the increase in the money supply will
lower interest rates. The amount of consumption will be the same under either policy. There will be less
investment if the policy of increasing government spending is chosen because some investment will be
crowded out to accommodate the higher level of government spending. There will be more investment if the
monetary supply expansion is chosen, because interest rates will be lower.
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Essay 1 points
Question
A decrease in government spending reduces output more in the Keynesian-cross model than in the IS–LM model.
Explain why this is true.
Answer In the Keynesian-cross model, both the price level and interest rate are held constant. A decrease in
government spending reduces output by 1/(1 – MPC) times the change in government spending. In the IS–LM
model, the reduction in output caused by the decrease in government spending is partially offset by an
increase in investment (crowding in). In the IS–LM model, the decrease in government spending reduces
income as in the Keynesian-cross model, but the reduction in income also reduces the demand for money,
which in turn reduces the interest rate for a given money supply. The lower interest rate stimulates the
off-setting investment spending.
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Question
Compare the impact of a tax cut on consumption, investment, output, and interest rates in the classical model of
Chapter 3 versus the IS–LM model.
Answer Output increases in the IS–LM model, but it is fixed at the natural level in the classical model because it is
determined by the factors of production and technology. In both models, consumption increases because the
tax cut increases disposable income. The interest rate increases in both models. In the classical model, the
tax cut reduces saving, which increases the interest rate and reduces the equilibrium quantity of investment.
In a closed classical economy, since income is fixed, the increase in consumption exactly offsets the decrease
in investment. In the IS–LM model, the increase in income increases money demand, which results in a higher
interest rate to bring money demand into equilibrium with the constant money supply. The higher interest rate
partially crowds out investment in the IS–LM model (for the usual interest sensitivities of investment and
money demand).
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Essay 1 points
Question
a. An economy is initially at the natural level of output. There is an increase in government spending. Use
the IS–LM model to illustrate both the short-run and long-run impact of this policy change. Be sure to
label: i. the axes; ii. the curves; iii. the initial equilibrium, iv. the short-run equilibrium, and v. the terminal
equilibrium.
b. Explain in words the short-run and long-run impact of the change in government spending on output and
interest rates.
Answer a.
b. The economy is initially at output Y and interest rate r . As a result of the increase in government
n 1
spending in the short run, output increases to Y and the interest rate increases to r as the IS curve
1 2
shifts from IS to IS . In the long run, the price level increases, shifting the LM curve from LM to LM .
1 2 1 2
Output returns to Y and the interest rate eventually increases to r in the long run.
n 3
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Question
An increase in money supply shifts the LM curve to the right, but an increase in money demand shifts the LM curve to
the left. Explain why there is a difference.
Answer When the money supply increases (for a fixed money demand and price level), the demand for money is less
than the money at the existing interest rate, so households use the extra money to buy bonds, which drives up
the price of bonds and reduces the interest rate. The same level of income is associated with a lower interest
rate, which shifts the LM curve downward to the right. When money demand increases (for a fixed money
supply and price level), money demand exceeds the unchanged money supply, so people start to sell bonds,
which drives down the price of bonds and increases the interest rate. The same level of income is now
associated with a higher interest rate, which shifts the LM curve upward to the left.
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Essay 1 points
Question
Assume the economy is initially in a short-run equilibrium at a level of output below the natural rate.
a. Use the IS–LM model to graphically illustrate: (1) how the economy will adjust in the long-run if the no
policy action is taken; and (2) the long-run equilibrium if fiscal policy is used to return the economy to the
natural rate of output.
b. Explain how investment, the interest rate, and the price level differ in the new long-run equilibrium in the
two cases.
Answer
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a. The economy starts in equilibrium at A. (1) With no policy change the price level will eventually fall,
shifting LM to LM . The new long-run equilibrium will be at B. (2) If fiscal policy is used to restore the
1 2
natural rate, IS will shift to IS and the new equilibrium will be a C.
1 2
b. If no policy is used to restore full employment, the interest rate and the price level fall. Since the
long-run interest rate will be lower, investment will be larger. If fiscal policy is used, the IS curve will shift
to the right. The price level will not change, but the long-run interest rate will increase. This will reduce
the amount of private investment at the new equilibrium, C.
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Essay 1 points
Question
If inflation is bad, why isn't deflation good? Use the IS–LM model to explain how deflation could result in a contraction
in output.
Answer An unexpected deflation will reduce output by transferring wealth from debtors to creditors. If creditors have a
lower propensity to spend than debtors, then the reduction in spending by debtors will be more than the
increase in spending by creditors. This reduction in consumption will shift the IS curve to the left, resulting in a
lower equilibrium level of output. If there is an expected deflation, this increases the real interest at every level
of nominal interest rate and reduces investment spending. The decrease in investment spending shifts the IS
curve to the left and results in a lower equilibrium level of income.
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Essay 1 points
Question
The LM curve can shift to the right if there is an increase in the supply of money or a fall in the price level. In which
case is this movement along the aggregate demand curve, and in which case is this a shift of the aggregate demand
curve? Explain.
Answer The aggregate demand curve shows the relationship between income and the price level, holding other
factors constant, including the money supply. An increase in the money supply which shifts the LM curve to
the right also shifts the aggregate demand curve to the right because the money supply is not constant since it
is along any given aggregate demand curve. A reduction in the price level that shifts the LM curve to the right
is a movement down the demand curve, because the money supply is held constant along the aggregate
demand curve, and the aggregate demand curve shows how income changes as the price level changes.
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Essay 1 points
Question
Use the IS–LM model to predict the short-run impact on the interest rate and output if the Fed pushes interest rates
down at the same time that both consumption and investment fall due to a financial crisis. Illustrate your answer
graphically. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium; and iv. the direction the curves shift.
Explain your answer in words.
Answer
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Starting from A with interest rate r and income Y , the reduction in interest rates by the Fed moves the LM
1 1
curve to the right. The fall in consumption and investment spending moves the IS curve to the left. At the new
equilibrium the interest rate will be lower, but the impact on output will depend on the relative magnitudes of
the shifts. If the IS curve shifts relatively more than the LM curve, output will be lower. If the LM curve shifts
relatively more than the IS curve, output will increase.
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