Quiz 571

Related: Economics, Microeconomics

64 Questions

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Quiz 571

Subjective Short Answer

1. As the aggregate demand curve shifts to the right, what happens to the price level and output?
What do these changes imply happens to the inflation rate and the unemployment rate?

2. According to the Phillips curve, which fiscal policies can be used to reduce unemployment in
the short run?

3. If asset prices fall and inflation expectations remain unchanged, what happens to inflation and
unemployment? Defend your answer.

4. Suppose that businesses become less optimistic about the future. Assuming no change in
inflation expectations, how would the effects of this shock be shown on the Phillips curve
diagram and what would happen to inflation and unemployment?

5. Government expenditures increase. What happens to the price level and output? Explain how
the change in the price level and output effect the inflation rate and the unemployment rate.

6. If consumer confidence rises and inflation expectations remain unchanged, what happens to
inflation and unemployment? Defend your answer.

7. U.S. net exports fall due to recessions in foreign countries.

A. According to the aggregate demand and supply model, what happens to the price level and
output in the short run?
B. According to the short-run Phillips curve what happens to inflation and unemployment in the
short run?
C. If the Fed wanted to reverse the effects of this shock on output, what should it do?
8. According to the long-run Phillips curve, if the Fed increases the growth rate of the money
supply, what happens to the inflation rate and the unemployment rate in the long run?

9. What is meant by the natural rate of unemployment?

10. List one specific policy that would shift the long-run Phillips curve to the right.

11. Suppose, as in the 1970’s in the U.S., that demographic groups which typically have higher
unemployment rates become a larger percentage of the labor force. Would this have any effect
on the long-run Phillips curve?

12. For a given short-run Phillips curve, if expected inflation is 10% but actual inflation is 8%, is
the unemployment rate above or below its natural rate?

13. If expected inflation rises but actual inflation remains the same, what happens to the
unemployment rate? Defend your answer.

14. If expected inflation decreases does the short-run Phillips curve shift? If so, what direction
does it shift? Does the long-run Phillips curve shift? If so, what direction does it shift?

15. If the Fed raised the money supply growth by more than expected then the unemployment
rate would _____ in the short run. Explain the process by which the economy moves to the long
run if the Fed maintains the higher money supply growth rate.

16. What does the natural-rate hypothesis claim?

17. An increase in the natural rate of unemployment shifts the short-run Phillips curve to the
_____. If the central bank sees the increase in the unemployment rate, but thinks the natural rate
has remained the same and so wants to reduce unemployment, it would ________ the money
supply growth rate. If it maintains this money supply growth rate, eventually the short run
Phillips curve will shift _____ and unemployment will be _____.

18. The Fed increases the money supply growth rate. Assuming inflation expectations remain
constant, use a Phillips curve diagram to show the short-run effects of the Fed’s policy.

19. What does an unexpected decrease in the growth rate of the money supply do to inflation and
unemployment in the short-run? What does it do to inflation and unemployment in the long run?

20. For a given short-run Phillips curve, if expected inflation is 8% but actual inflation is 10%, is
the unemployment rate above or below its natural rate?

21. If expected inflation falls but actual inflation remains the same, what happens to the
unemployment rate? Defend your answer.

22. Use the sticky-wage theory of aggregate demand to explain the short-run Phillips curve.
23. Write the equation representing the short-run Phillips curve.

24. List three things that shift the short-run Phillips curve to the right.

25. Friedman and Phelps argued that it was dangerous to think of the short-run Phillips curve as a
menu of options for policymakers to choose from. Explain the logic of their argument.

26. How is a decrease in the natural rate of unemployment shown in the Phillips curve diagram?
Does this decrease change the inflation rate?

27. A central bank raises the money supply growth rate and keeps it at that higher rate. Explain
the process by which the economy moves to long-run equilibrium.

28. A central bank raises the money supply growth rate and keeps it higher. As the economy
moves from the short-run equilibrium created by the increase in the money supply growth back
to long-run equilibrium what happens to the unemployment rate?

29. What evidence does the Volcker disinflation provide concerning the importance of inflation
expectations to the costs of disinflation?

30. How are the effects of a favorable supply shock shown in the Phillips curve diagram? If the
Fed wants to return unemployment to its natural rate after the shock, what should it do?

31. If there is a large and sudden but temporary increase in the price of oil, which way does the
short-run Phillips curve shift? If the central bank does not respond what happens to inflation and
the unemployment rate in the long run?

32. If there is a favorable supply shock which direction does the short-run Phillips curve shift?
What initially happens to unemployment and inflation as a result of this shock?

33. What is meant by accommodation?

34. If the Fed responded to an adverse supply shock by increasing the growth rate of the money
supply and maintained the higher growth rate, what would eventually happen to the short-run
Phillips curve? Why?

35. If there were a favorable supply shock and the central bank wanted to offset the change in the
unemployment rate, what would it do?

36. How does a central bank’s accommodation of an adverse supply shock change the long-run
results of the shock?

37. What would a central bank need to do to reverse the effects of a favorable supply shock on
inflation? What would its reaction do to the unemployment rate in the short run?
38. Suppose that a central bank reduces the money supply growth rate to disinflate. What does
disinflation mean? If people do not alter their inflation expectations, what happens to output and
unemployment?

39. Suppose the price level is 110.00 at the end of 2020, 121.00 at the end of 2021, and 128.26 at
the end of 2022. Can we accurately describe the period 2021-2022 as a period of disinflation?

40. Suppose the price level is 115.00 at the end of 2020, 112.02 at the end of 2021, and 109.08 at
the end of 2022. Can we accurately describe the period 2021-2022 as a period of disinflation?

41. If because they expect the central bank to disinflate, people reduce their inflation
expectations, then is the sacrifice ratio larger or smaller the otherwise? Defend your answer by
referring to the Phillips curve.

42. A central bank disinflates. Output falls by 3% for one year, 2% the second year, and 1% the
third year. If inflation fell by 2 percentage points, what was the sacrifice ratio?

43. A central bank pledges to reduce the inflation rate from 20% to 5%. People reduce their
inflation expectations to 10%, but the central bank only reduces inflation to 15%. What happens
to the unemployment rate?

44. According to the Phillips curve diagram, if a central bank disinflates what ultimately happens
to the unemployment rate?

45. How are the effects of the financial crisis shown using the Phillips curve diagram?

46. A central bank disinflates. Output is 4% less for one year, 3% less the next year, and 2% less
the third year. If inflation fell by 2 percentage points, what was the sacrifice ratio?

47. Assuming that rational expectations theory does not hold, if a central banks attempts to
reduce the inflation rate what happens to the unemployment rate in the short-run?

48. A central bank pledges to reduce the inflation rate from 10% to 3%. People reduce their
inflation expectations to 5%, but the central bank reduces inflation to 3%. What happens to the
unemployment rate?

49. If there is a decline in business confidence and the Fed desires to return unemployment
towards its natural rate, what should it do? If business confidence eventually returns to normal
but the Fed does not reverse its policy, what eventually happens to the inflation rate?

50. Does a more steeply sloped Phillips curve make the sacrifice ratio smaller or larger than
otherwise?

51. Assume the natural rate of unemployment is 6%. Draw the short-run and long-run Phillips
curves and show the position of the economy if expected inflation is 3% and the actual inflation
rate is 2%.
52. Assume the natural rate of unemployment is 6%. Draw the short-run and long-run Phillips
curves and show the position of the economy if expected inflation is 3% and the actual inflation
rate is 4%.

53. In the long run what primarily determines the natural rate of unemployment? In the long run
what primarily determines the inflation rate? How does this relate to the classical dichotomy?

54. Are the effects of an increase in aggregate demand in the aggregate demand and aggregate
supply model consistent with the Phillips curve? Explain.

55. The Phillips curve and the short-run aggregate supply curve are closely related, yet one
slopes downward and the other slopes upward. Discuss.

56. Explain the connection between the vertical long-run aggregate supply curve and the vertical
long-run Phillips curve.

57. Suppose that the Fed unexpectedly pursues contractionary monetary policy. What will
happen to unemployment in the short run? What will happen to unemployment in the long run?
Justify your answer using the Phillips curves.

58. What did Friedman and Phelps predict would happen if policymakers tried to move the
economy upward along the Phillips curve? Did the behavior of the economy in the late 1960s
and the 1970s prove them wrong?

59. Some countries have inflation around or in excess of 8 percent. Suppose that the sacrifice
ratio is 2.5. What is the cost of reducing inflation from 8 percent to 2 percent? In your answer,
define the sacrifice ratio and explain how you found the cost of inflation reduction.

60. Why does a downward-sloping Phillips curve imply a positive sacrifice ratio?

61. Suppose that the economy is at an inflation rate such that unemployment is above the natural
rate. How does the economy return to the natural rate of unemployment if this lower inflation
rate persists? Use sticky-wage theory to explain your answer.

62. Some economists argue suddenly reducing money supply growth is a costly way to reduce
inflation and that it may not work. For example, if a government cuts money growth but makes
no real fiscal reforms, people will expect the government will eventually need to expand the
money supply to pay for its expenditures. Thus, the promise to fight inflation will not be
credible. Explain why credibility is important to a reduction in the inflation rate.

63. Some countries have had relatively high inflation and relatively high unemployment for long
periods of time. Is this consistent with the Phillips curve? Defend your answer.

64. Suppose that the Prime Minister and Parliament of Veridian are disappointed with the high
inflation rates under the current system where the Veridian Ministry of Finance is in charge of
the money supply. They make reforms to lower inflation from its current rate of 8%. Suppose
further that the public is confident that with the reforms in place that inflation will fall to 2%.
Also suppose that those in control of the money supply actually conduct monetary policy so that
the actual inflation rate is 4%. Using long-run and short-run Phillips curves and assuming the
natural rate of unemployment is 6%, show the initial long run equilibrium of Veridian and label
it “A”. Assuming that the government had actually set inflation at 2% and that the public
believed this, label the long-run equilibrium “B”. Now, suppose that inflation expectations fell to
2% and that the government unexpectedly created inflation of 4%. Show the short-run
equilibrium and label it “C”. If the money supply continues to grow at a rate consistent with 4%
inflation, show where the economy ends up and label that point “D”.