Macroeconomics Principles and Practice Asia Pacific 1st Edition Littleboy Test Bank

Macroeconomics Principles and
Practice Asia Pacific 1st Edition

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Chapter 7
1. What is the difference between a temporary growth slowdown and a recession?
ANS:
During a temporary growth slowdown, the real GDP growth rate declines but does not turn negative.
During a recession, the real GDP growth rate becomes negative.
PTS: 1 DIF: basic NAT: Changes in spending cause fluctuations in

production
2. Graphically show the difference between what is meant by a growth slowdown as opposed to a
recession.
ANS:
The figure below is an example of a growth slowdown. Notice that at point a, the rate of growth slows
down without turning negative. Sooner or later, there is a slump – if the growth rate of spending is less
than the growth rate of potential GDP.
The figure below is an example of a recession. Notice that at point a, the rate of growth becomes
negative.
PTS: 1 DIF: challenging NAT: Changes in spending cause fluctuations in

production
3. The textbook defines economic fluctuations as

a. the rise and fall of real GDP.
b. periods when there is excessive GDP volatility.
c. periods when the economy is in either a recession or a boom.
d. departures of the economy from its long-term growth trend.
e. the rise and fall of unemployment.
ANS: D PTS: 1 DIF: basic
NAT: Introduction
4. Between December 2007 and June 2009

a. the United States economy was in recession and millions of jobs were lost.
b. the United States economy moved upward and millions of jobs were created.
c. the United States economy grew, but not many jobs were created.
d. the United States economy moved downward, but still many jobs were created.
e. the United States economy remained stationary.
ANS: A PTS: 1 DIF: basic
NAT: Introduction
5. Over the15 or 20 years before the global financial crisis, economic fluctuations
a. became more severe than in the past.
b. occurred more often than in the past.
c. had not changed in severity when compared to past economic fluctuations.
d. became less severe than in the past.
e. occurred just as often as in the past.
NAT: Introduction
6. True or False. Economic fluctuations have been common for at least 200 years, but they have
diminished in frequency and severity in the United States and many other countries, particularly in the
last 25 years.
ANS: T PTS: 1 DIF: moderate

NAT: Introduction
7. T or F. Economic fluctuations have been common only since the beginning of the 20th century, when
governments began to expand their interventions in markets.
ANS: F PTS: 1 DIF: basic

NAT: Introduction
8. Changes in total domestic spending occur when

a. foreign countries are experiencing recession.
b. the government changes the tax laws.
c. the government reduces military spending.
d. consumers become more optimistic about the future and increase their spending.
e. All of these.
ANS: E PTS: 1 DIF: moderate
NAT: Introduction
9. The economist who, in the 1930s, stressed that the Great Depression was a result of insufficient
spending was
a. Milton Friedman.
b. Robert Malthus.
c. Alfred Marshall.
d. Joseph Schumpeter.
e. John Maynard Keynes.
NAT: Introduction
10. T or F. An improvement in consumer confidence will affect the growth rate of the economy.
ANS: T PTS: 1 DIF: basic

NAT: Introduction
11. T or F. A recession in other countries has no effect on forecasted growth in this country.

NAT: Introduction
12. Which of the following is true?

a. Potential GDP is determined by the available supply of labour, capital, and technology
only in the long run.
b. Real GDP is determined by aggregate expenditure only in the short run.
c. Potential GDP is equal to aggregate expenditure in the long run.
d. Real GDP is determined by aggregate expenditure only in the long run.
e. Potential and real GDP are always equal.
ANS: C PTS: 1 DIF: moderate
NAT: Introduction
Exhibit 7.1
13. According to Exhibit 7.1, line abd shows the path of potential GDP. Suppose that the Year 2 spending
balance has the economy at point b where real GDP equals potential GDP. Which of the following
would cause the economy to be at point c in Year 3?
a. There is an increase in wealth.
b. Firms decrease their optimism about the state of the economy.
c. The marginal propensity to consume decreases.
d. The quantity of imports increases.
e. The government increases taxes.
ANS: A PTS: 1 DIF: moderate
NAT: Changes in spending cause fluctuations in production
14. According to Exhibit 7.1, line abd shows the path of potential GDP. In Year 2, suppose the
expenditure line intersects the 45-degree line at the level of spending corresponding to point b. If, in
Year 3, the economy is at point c, then
a. the expenditure line has shifted up the 45-degree line more than it would have if real GDP
equalled potential GDP in Year 3.
b. the expenditure line has shifted down the 45-degree line.
c. the expenditure line has shifted up the 45-degree line and equals a level of income greater
than real GDP.
d. the expenditure line has shifted up the 45-degree line to a point where real GDP equals
potential GDP in Year 3.
e. potential GDP has risen, and we’ve moved to a new point of spending balance.
15. According to Exhibit 7.1, line abd shows the path of potential GDP. In Year 2, suppose the
expenditure line intersects the 45-degree line at the level of spending corresponding to point b. If, in
Year 3, the economy is at point e, then
a. the expenditure line has shifted up the 45-degree line to a point where real GDP equals
potential GDP in Year 3.
b. the expenditure line has shifted up the 45-degree line, but the level of income is less than
the amount corresponding to real GDP.
c. the expenditure line has shifted down the 45-degree line.
d. the expenditure line has shifted up the 45-degree line more than it would have if real GDP
equalled potential GDP in Year 3.
e. potential GDP has declined, and we’ve moved to a new point of spending balance.
16. T or F. If the economy is growing along the same path as potential GDP, the expenditure line will not
shift over time.
ANS: F PTS: 1 DIF: moderate

17. At the end of a recession, typically

a. real GDP is greater than potential GDP.
b. potential GDP is greater than real GDP.
c. potential GDP is less than real GDP.
d. real GDP is falling.
e. potential GDP equals real GDP.
ANS: B PTS: 1 DIF: moderate
Exhibit 7.2
18. According to Exhibit 7.2, which of the following is true?
a. All recessions are of the same duration.
b. In normal times, real GDP is above potential GDP.
c. Aggregate demand fell between year B and year D.
d. Potential GDP fell between year B and year D.
e. Unemployment rose between year D and year F.
ANS: C PTS: 1 DIF: basic
19. According to Exhibit 7.2, which of the following best explains the change in real GDP from year B to
year D?
a. The supply of labour fell.
b. Foreigners decided to purchase more of our goods.
c. The government cut taxes.
d. Consumers became more optimistic.
e. Firms became more pessimistic.
20. In a boom year,

a. potential GDP equals real GDP.
b. prices fall.
c. total spending exceeds potential GDP.
d. prices rise.
e. potential GDP is greater than real GDP.
21. To compare economic fluctuations in different countries, one should look at

a. the per cent difference between real and nominal GDP.
b. the difference between potential and real GDP measured in dollars.
c. the difference between real and nominal GDP measured in dollars.
d. the difference between aggregate demand and real GDP measured in dollars.
e. the per cent difference between potential and real GDP.
22. T or F. The economy’s long-term growth trend for GDP is known as real GDP and is determined by
the available supply of capital, labour, and technology.

23. T or F. Potential GDP represents what firms would want to produce in ‘normal times’, when the
economy is in neither a recession nor a boom.

24. In mature economies, manufacturing capacity utilisation in normal times typically equals
a. 60 per cent.
b. 90 per cent.
c. 70 per cent.
d. 100 per cent.
e. 80 per cent.
ANS: E PTS: 1 DIF: basic
25. When the unemployment rate is equal to the natural unemployment rate, capacity utilisation in mature
economies is usually close to
a. 80 per cent.
b. 90 per cent.
c. 70 per cent.
d. 60 per cent.
e. 100 per cent.
26. If capacity utilisation in a mature industrialised economy is 95 per cent,

a. the unemployment rate will probably be below the natural rate of unemployment.
b. the unemployment rate will approximately equal the natural unemployment rate.
c. real GDP approximately equals potential GDP.
d. workers will be laid off.
e. real GDP is below potential GDP.
27. When the unemployment rate drops below the natural unemployment rate,
a. the economy is in a recession.
b. real GDP is rising above potential GDP.
c. real GDP is falling below potential GDP.
d. the capacity utilisation rate is declining.
e. All of these.
28. Which of the following does not occur when real GDP rises above potential GDP?
a. The unemployment rate falls below the natural unemployment rate.
b. The capacity utilisation rate increases.
c. Firms increase their prices.
d. Capacity utilisation exceeds 100 per cent.
e. Demand increases.
29. T or F. When firms are at full capacity, real GDP equals potential GDP.

30. T or F. In normal times, when the economy is in neither a recession nor a boom, manufacturing
capacity utilisation is at 100 per cent.

31. T or F. The actual unemployment rate will fall below the natural unemployment rate when real GDP
rises above potential GDP.

32. T or F. To forecast real GDP, economic forecasters divide aggregate demand into its four key
components: private sector, public sector, investment sector, and foreign sector.

33. Changes in total domestic spending mean that producers need to consider whether to change output or
change price or both. If price adjustment is small because of ____, the response of production is ____
a. menu costs ; small.
b. implicit contracts ; large.
c. limited information ; zero.
d. All of these.
e. nominal flexibilities ; zero
NAT: Limited information and implicit contracts
34. Suppose the economy is booming and many firms begin to experience an increase in the demand for
their goods and services.
a. Suppose the firms do not know whether the change is temporary or permanent. How will
they adjust price and output?
b. Suppose the firms determine that the change is permanent. How will they adjust price
and output?
c. Explain the relationship between imperfect information and economic fluctuations based
on your answers to (a) and (b) above.
ANS:
a. They will increase output first and decide on price later. Many firms have some excess
capacity, so they can easily adjust output first. The price adjustment will come later after
they evaluate whether the change is temporary or permanent. In addition, the idea of
implicit contracts suggests that firms are reluctant to change price frequently.
b. They will increase price. As price increases, some of the increase in demand will be
offset.
c. With imperfect information, firms adjust output first, based on demand, and price later.
Fluctuations are larger than if firms had perfect information, in which case firms would
change price for permanent changes but not for temporary changes.
PTS: 1 DIF: moderate NAT: Understanding and applying economic models
35. Supporters of real business cycle theories argue that economic fluctuations are a response to changes
in
a. money velocity.
b. the money supply.
c. production possibilities.
d. real GDP.
e. aggregate demand.
NAT: Could economic fluctuations also be due to changes in potential GDP?
36. A macroeconomic theory that stresses the fact that shifts in potential GDP are a primary cause of
fluctuations in real GDP is known as
a. potential GDP theory.
b. real business cycle theory.
c. economic cycle theory.
d. perennial growth theory.
e. None of these.
37. Which of the following would a real business cycle theorist emphasise as a primary cause of economic
fluctuations?
a. Changes in the weather that severely impact the agricultural sector
b. Changes in investment spending
c. Changes in technology
d. Changes in taxes
e. Changes in government spending
38. Changes in the factors that underlie potential GDP growth

a. are the major sources of economic fluctuations.
b. evolve too quickly to be able to explain economic fluctuation.
c. are as important as changes in aggregate demand in explaining economic fluctuations.
d. evolve too slowly to be able to explain economic fluctuations.
e. were, until the 1920s, a valid explanation of economic fluctuations.
ANS: D PTS: 1 DIF: moderate
39. T or F. Economic fluctuations are largely a result of changes in aggregate demand.

40. T or F. Real business cycle theories focus on changes in potential GDP as the source of economic
fluctuations.

41. T or F. In real business cycle theories, changes in tastes are most frequently assumed to be the reason
for changes in potential GDP.

42. T or F. Potential GDP growth is relatively smoother than aggregate demand growth.

43. Explain the connection between fluctuations in the unemployment rate around the natural rate of
unemployment and fluctuations in real GDP around potential GDP.
ANS:
Real GDP rises above potential GDP when aggregate demand rises. This increase in demand causes
firms to increase their capacity utilisation. As production expands, more workers are employed, thus
causing the unemployment rate to fall below the natural rate.
Real GDP falls below potential GDP when aggregate demand falls. The reduction in demand causes
firms to reduce their capacity. As production decreases, the amount of workers employed declines. The
decline in employment causes the unemployment rate to rise above the natural rate.
PTS: 1 DIF: moderate NAT: Measuring the economy
44. Is it possible for economic fluctuations to occur for reasons not associated with changes in aggregate
demand? Explain.
ANS:
Yes. Some economists believe that fluctuations can occur as a result of changes in potential GDP. In
particular, they argue that fluctuations are a response to technological shocks.
PTS: 1 DIF: moderate

45. Why are most economists sceptical about the real business cycle theory of economic fluctuations?
ANS:
They are sceptical because the factors that determine potential GDP grow smoothly and gradually over
time. Aggregate demand, however, exhibits more variability in its growth.
PTS: 1 DIF: moderate NAT: Could economic fluctuations also be due to

changes in potential GDP?
46. Which of the following relationships do forecasters use to make their one-year-ahead predictions for
real GDP?
a. Real GDP is the sum of consumption, investment, government expenditure, and net
exports.
b. Real GDP is determined by the amount of capital, labour, and technology available in the
economy.
c. Real GDP is mostly determined by the growth in the money supply.
d. Real GDP in any year should equal MV/P.
e. Real GDP equals nominal GDP during the base year.
47. T or F. Consumption is usually the largest component of total spending.

NAT: Consumption spending during fluctuations in GDP
48. The consumption function originated with

a. Edmund Phelps.
b. John Maynard Keynes.
c. Robert Lucas.
d. Milton Friedman.
e. Joseph Schumpeter.
ANS: B PTS: 1 DIF: basic
49. The consumption function shows the relationship between consumption and
a. the interest rate.
b. the money supply.
c. the price level.
d. potential GDP.
e. income.
50. According to the consumption function, as income increases, consumption

a. increases by the same amount.
b. decreases by a smaller amount.
c. decreases by a greater amount.
d. increases by a greater amount.
e. increases by a smaller amount.
51. The consumption function describes

a. the negative relationship between consumption and government spending.
b. the positive relationship between consumption and income.
c. the negative relationship between consumption and the interest rate.
d. the negative relationship between consumption and income.
e. the positive relationship between consumption and the interest rate.
52. The relationship describing how consumption depends on income is known by economists as
a. the income function.
b. the budget constraint function.
c. the purchasing power function.
d. the affordability function.
e. None of these
53. The slope of the consumption function is equal to

a. the nominal interest rate.
b. the real interest rate.
c. the marginal propensity to consume.
d. the relative price of consumption.
e. the marginal propensity to save.
Exhibit 7.3
54. Given the data in Exhibit 7.3, what is the marginal propensity to consume?
a. 0.80
b. 0.90
c. 0.75
d. 1.25
e. 0.60
55. Given the data in Exhibit 7.3, what is the level of consumption if income increases to 400?
a. 480
b. 450
c. 515
d. 465
e. 470
56. If the consumption function is C = 200 + 0.8Y, which of the following is true?
a. This economy’s consumption is 300 when income is 100.
b. When income increases by 100, consumption increases by 90.
c. This economy’s consumption is 200 when income is 0.
d. The marginal propensity to consume in this economy is .2.
e. When income increases by 100, consumption increases by 20.
57. If the consumption function is C = 1,000 + 0.87Y, then what is the marginal propensity to consume?
a. 1,000
b. 0.87
c. 0.13
d. 870
e. None of these
58. Which of the following consumption functions has a marginal propensity to consume equal to 0.95?
a. C = 95 + 0.87Y
b. C = 0.95 + 0.87Y
c. C = 1,000 + 0.05Y
d. C = 1,000 + 95Y
e. None of these
ANS: E PTS: 1 DIF: challenging
NAT: Understanding and applying economic models
59. The marginal propensity to consume is best defined as

a. the change in consumption expenditure caused by an increase in the interest rate.
b. the change in consumption expenditure caused by a one-unit increase in income.
c. the change in real GDP caused by a change in consumption expenditure.
d. the change in consumption expenditure caused by a change in some other spending
category.
e. total consumption divided by total income.
60. When Tom’s income is $20,000, he spends $18,000 and when his income increases to $30,000, he
spends $23,000. His MPC is
a. 0.3.
b. 0.5.
c. 0.65.
d. 0.77.
e. 0.90.
61. If two successive levels of disposable personal income are $160 and $190 billion, respectively, and if
the change in consumption spending is $20 billion between these two levels of disposable personal
income, then the MPC will equal
a. 0.50.
b. 0.67.
c. 0.80.
d. 0.20.
e. 1.50.
ANS: B PTS: 1 DIF: challenging
62. If the marginal propensity to consume declines, then

a. for any given change in income, there will be a smaller change in saving.
b. nothing will happen to the consumption function.
c. for any given change in income, there will be a larger change in consumption.
d. for any given change in consumption, there will be a smaller change in income.
e. for any given change in income, there will be a smaller change in consumption.
63. Which of the following statements is false?

a. Aggregate income is equal to real GDP.
b. The consumption function is a linear relationship between consumption and income.
c. The consumption function shows the relationship between consumption and disposable
income.
d. The consumption function shows the relationship between consumption and real GDP.
e. The consumption function is represented as a non-linear relationship between
consumption and income.
64. The consumption function for the whole economy

a. looks different when real GDP is used instead of disposable income.
b. looks similar for either real GDP or disposable income.
c. is non-linear when real GDP is used.
d. is non-linear when aggregate income is used.
e. is non-linear when disposable income is used instead of real GDP.
65. Which of the following statements is true?

a. A change in sales tax has no effect on disposable income.
b. Interest and dividend payments are not included in disposable income.
c. A decrease in transfer payments reduces disposable income.
d. Household consumption is not sensitive to changes in disposable income.
e. All of these.
66. Disposable income is the income that households

a. save for entertainment purposes and vacations.
b. receive in wages, dividends, and interest payments minus taxes they pay to the
government and minus mortgage payments.
c. have available for saving, once the necessary living expenses have been subtracted from
the wages, dividends, and interest payments they receive.
d. receive in wages, dividends, and interest payments plus transfers they may receive from
the government minus any income-taxes they pay to the government.
e. None of these.
67. T or F. The consumption function is a straight-line relationship between consumption and income.

68. T or F. The marginal propensity to consume is best defined as the change in consumption expenditure
caused by a one-unit increase in income.

69. T or F. When examining consumption behaviour at the household level, it does not make a difference
whether real household income or disposable income is used.

70. The consumption function shifts upwards if

a. wealth rises.
b. income rises.
c. interest rates rise.
d. All of these.
e. banks collapse.
71. The consumption function shifts downwards if

a. share prices rise.
b. income falls.
c. interest rates fall.
d. All of these.
e. eligibility for government transfer payments is restricted.
72. During economic fluctuations

a. changes in the interest rate are the major factor affecting consumption.
b. income has little effect on consumption.
c. wealth is the major factor affecting consumption.
d. changes in income have a large effect on consumption.
e. there is little movement in total consumption.
73. T or F. Interest rates do not affect consumption.

74. T or F. Income has a strong effect on consumption during a recession.

75. Define the marginal propensity to consume. Graphically, how is the marginal propensity to consume
shown?
ANS:
The MPC measures the change in consumption with respect to a change in aggregate income.
Graphically, it is the slope of the consumption function that shows the relationship between income
and consumption.
PTS: 1 DIF: moderate

76. Does it make a difference whether disposable income is used instead of real GDP when working with
the relationship between aggregate consumption and aggregate income? Explain.
ANS:
At the aggregate level, it does not make a difference whether disposable income or real GDP is used.
This is because taxes and transfer payments are nearly proportional to income. Hence, disposable
income and real GDP are both linearly related to consumption.
PTS: 1 DIF: challenging

77. Answer the questions below:

a. Suppose your boss gives you a $100 raise. Identify the three categories or uses among
which you will divide the $100. Hint: Do you get to keep the entire $100?
b. Suppose the consumption function is C = 100 + 75YD, where YD is disposable income.
Prove that the marginal propensity to save is 0.25.
ANS:
a. Consumption, saving, and taxes.
b. Note that YD = C + S. Substitute in for C to get YD = 100 + .75D + S or S = −100 +
.25YD.

Exhibit 7.4
78. Refer to the data in Exhibit 7.4.
a. What is the marginal propensity to consume?
b. If real GDP were $340 billion, what would consumption equal?
ANS:
a. The table shows that, for every $25 billion increase in real GDP, consumption increases
by $15 billion. The .
b. At $315 billion, consumption is $290 billion. If real GDP were $25 billion more, or $340
billion, consumption would be $15 billion more, or $305 billion.

Exhibit 7.5
79. Plot the consumption function based on the data in Exhibit 7.5. What is the marginal propensity to
consume? If the marginal propensity to consume changes to 0.85, show what happens to the
consumption function.
ANS:
The relationship between consumption and income is shown in figure I below. The MPC is 0.7. If the
MPC changes to 0.85, the relationship between income and consumption is shown in figure II. Notice
how the consumption function has pivoted up.
PTS: 1 DIF: moderate NAT: Consumption spending during fluctuations in GDP

a. A change in income has no effect on consumption, but a change in consumption will cause
income to change.
b. A change in income will affect consumption, but a change in consumption will not affect
income.
c. A change in income has no effect on consumption, and a change in consumption has no
effect on income.
d. A change in income causes consumption to change, and a change in consumption will
cause income to change.
e. None of these.
81. If US firms decide to decrease their purchases of US-produced goods,

a. the decrease in investment will have no effect on US income or consumption.
b. the decrease in investment will cause US income to increase, which will cause US
consumption to increase.
c. the decrease in investment will cause US income to decrease, which will cause US
consumption to decrease.
d. US real GDP will increase by the same amount that investment spending decreased.
e. US real GDP will decrease by the same amount that investment spending decreased.
82. If foreigners decide to increase their purchases of US-made goods by $15 million, US real GDP will
a. remain unchanged.
b. increase by more than $15 million.
c. increase by less than $15 million.
d. increase by $15 million.
e. decrease by more than $15 million.
83. T or F. A decline in government spending causes consumption to decline.

84. T or F. Income depends on consumption, but consumption does not depend on income.

85. The components that make up aggregate expenditures are

a. consumption and government purchases.
b. investment, government purchases, and net exports.
c. consumption, investment, government purchases, and net exports.
d. income and consumption.
e. consumption and investment.
NAT: Finding real GDP
86. The expenditure line

a. is steeper than the 45-degree line.
b. slopes upward because consumption depends positively on income.
c. slopes upward because the MPC is less than 1.
d. slopes upward because consumption and investment depend positively on income.
e. shows the relationship between consumption spending and income.
87. If adding net exports to C + I + G causes the expenditure line to shift up in a parallel way,
a. imports and exports are not sensitive to changes in income.
b. both exports and imports are sensitive to changes in income.
c. exports are sensitive to changes in income.
d. imports are sensitive to changes in income.
e. imports and exports have an uncertain effect on income.
88. The slope of the expenditure line is

a. greater than the slope of the 45-degree line.
b. equal to 1.
c. equal to the MPC.
d. the same as the slope of the 45-degree line.
e. equal to one-MPC.
89. The slope of the expenditure line is

a. greater than the slope of the 45-degree line.
b. equal to 1.
c. always equal to the MPC.
d. equal to the MPC, when I, G, exports and imports are all autonomous.
e. equal to one-MPC.
90. An increase in the marginal propensity to consume results in

a. the expenditure line shifting up in a parallel direction.
b. no change in the expenditure line.
c. the expenditure line becoming steeper.
d. the expenditure line shifting down in a parallel direction.
e. the expenditure line becoming flatter.
91. If government expenditures decrease, the expenditure line will

a. shift up in a parallel direction.
b. stay constant.
c. shift down in a parallel direction.
d. pivot down to the right.
e. pivot up to the left.
92. Which of the following would not shift the expenditure line?
a. An increase in government spending to finance a war
b. An increase in investment
c. A decrease in net exports brought about by an appreciation of the dollar
d. All of these would shift the expenditures curve.
ANS: D PTS: 1 DIF: challenging
93. An increase in investment results in

a. a downward shift of the expenditure line.
b. a steeper expenditure line.
c. a flatter expenditure line.
d. an upward shift of the expenditure line.
e. both the intercept and the slope of the expenditure line increasing.
94. Which of the following will cause an upward shift of the expenditure line?
a. A decrease in wealth
b. A decrease in government purchases
c. A decrease in taxes
d. An increase in imports
e. An increase in saving
95. T or F. Each of the four spending components is assumed to depend on income.

96. T or F. The sum of the four spending components depends on income.

97. T or F. The slope of the expenditure line is greater than 1.
ANS: F PTS: 1 DIF: challenging

98. T or F. Changes in autonomous T, I, G, and X affect only the intercept of the expenditure line.

99. T or F. The expenditure line will shift if government spending increases, but not if it decreases.

100. T or F. Only changes in consumption spending will shift the expenditure line.

101. T or F. Changes in spending behaviour shift the expenditure line and help explain economic
fluctuations.

102. Along the 45-degree line,

a. spending equals income.
b. real GDP equals potential GDP.
c. spending is greater than income.
d. real GDP equals nominal GDP.
e. spending is equal to the marginal propensity to consume times income.
103. T or F. Along the 45-degree line spending and income are equal.


a. A change in government purchases affects income. However, the change in income does
not affect consumption.
b. A change in government purchases does not affect income or consumption.
c. A change in government purchases affects GDP, which is the same as income. The change
in income affects consumption.
d. A change in government purchases affects GDP but not income.

e. A change in government purchases has no effect on GDP, but it does affect consumption.
105. Which of the following best explains why the expenditure line intersects the 45-degree line?
a. The slopes of both lines are the same.
b. The slope of the expenditure line is greater than the slope of the 45-degree line.
c. The slope of the 45-degree line is greater than the slope of the expenditure line.
d. The slope of the expenditure line is greater than 1.
e. The slope of the expenditure line is negative.
ANS: C PTS: 1 DIF: challenging
106. The 45-degree line identifies

a. all possible equilibrium points.
b. All of these.
c. all points of possible spending balance.
d. points where all output is bought.
e. points where real GDP equals spending.
ANS: B PTS: 1 DIF: challenging
107. Which of the following statements best describes what is meant by a spending balance?
a. People’s consumption is described by the consumption function.
b. Consumption and spending are the same, and people’s consumption is described by the
c. Income and output are the same.
d. Consumption and income are the same, and people’s consumption is described by the
e. There is no unplanned spending.
108. Spending balance exists if

a. the economy is at potential GDP.
b. income and spending are the same, and we are on the expenditure line.
c. income, production and spending are the same, as defined in the national accounts.
d. income and spending are the same, we are on the expenditure line, and we are at potential
GDP.
e. All of these.
Exhibit 7.6
109. If output was at the level corresponding to point E in Exhibit 7.6, then
a. income would increase.
b. aggregate output would decrease.
c. it would be in equilibrium.
d. the marginal propensity to consume would decrease.
e. spending would decrease.
110. If spending was equal to the amount corresponding to point B in Exhibit 7.6,
a. aggregate output would increase.
b. aggregate output would decrease.
c. spending is too high, and the expenditure line will shift down.
d. the economy would be in equilibrium.
e. the marginal propensity to consume would increase.
111. Suppose the expenditure line is given by the equation E = 800 + .75Y, and output is equal to 3,000.
Which of the following is true?
a. There is an incentive for firms to increase output.
b. Spending is less than income.
c. Spending is equal to income.
d. The economy is in equilibrium.
e. There is too much output.
ANS: A PTS: 1 DIF: challenging
112. If the marginal propensity to consume increases,

a. firms will increase production.
b. spending will remain above output until interest rates increase and equilibrium is restored.
c. the expenditure line will shift upward in a parallel fashion.
d. investment will have to fall to restore equilibrium.
e. too much output is being produced, and firms will cut production until equilibrium is
restored.
113. According to the table below, when the economy is at the point of spending balance, consumption
equals
a. 25.
b. 4.
c. 20.
d. 16.
e. 12.
114. Suppose C = 2 + .65Y. For there to be a spending balance,

a. Y = 2 + .65Y + I + G + X.
b. Y = 2 + .65Y + I + G + X − C.
c. Y = 2 + .65Y.
d. C = I + G + X.
e. C = 2 + .65Y + I + G + X.
115. T or F. If real GDP is less than spending, output will rise.

116. T or F. If spending as given by the expenditure line is greater than output, then spending is too high,
and the expenditure line will shift down until equilibrium is achieved.

117. T or F. When spending balance is achieved, the economy has reached a long-run equilibrium.

118. T or F. If spending is greater than output, a firm’s inventories will increase, and output will decrease.

119. T or F. Equilibrium output in the short run, as given by spending balance, can be above or below
potential GDP.

120. If there is an increase in government purchases, real GDP will

a. increase by more than the amount of the purchases.
b. increase by less than the amount of the purchases.
c. not change.
d. increase by the amount of the purchases.
e. decrease by less than the amount of the purchases.
NAT: Finding real GDP TOP: Forecasting GDP
121. T or F. According to the spending balance model, an initial change (shift) in spending causes a change
in income, which causes further changes in spending and income.


a. Explain the meaning of the 45-degree line.
b. Explain what the expenditure line (AE) measures and how it is derived.
c. Explain how the 45-degree line and the expenditure line can be combined to find the
point of spending balance.
ANS:
a. The 45-degree line identifies all points where spending is equal to output. These
represent the possible equilibrium points because, when planned spending is equal to
output, there is no incentive to increase or decrease production.
b. The expenditure line measures desired (planned) spending by the four groups for any
level of income. It is derived by adding up the four spending categories. It excludes
unplanned investment.
c. Spending balance is where the 45-degree line and the expenditure line intersect. At this
point, output is equal to desired spending, and there is no incentive for the firm to change
production. Aggregate unplanned inventories equal zero. At any other level of output,
spending will either be above or below output, and firms will either increase or decrease
production.
PTS: 1 DIF: moderate NAT: Finding real GDP
123. When does the slope of the expenditure line equal the MPC?
ANS:
The expenditure line is parallel to the consumption function when the consumption function is the only
component of aggregate expenditures that is sensitive to income. For simplicity, the other expenditures
are sometimes assumed to be constants. Hence, the slope of the expenditure line will have the same
slope as the consumption function, which is the MPC.

a. Suppose a firm finds that its inventory is unexpectedly rising. What does this imply
about the level of spending as compared to the level of output?
b. Is the firm likely to continue producing at the same level?
c. Explain why inventory changes for the whole economy are monitored as a sign of future
economic activity.
ANS:
a. If inventories are rising unexpectedly, spending by customers is less than output.
b. Sooner or later the firm will reduce output so that inventory will not keep growing.
c. If unplanned inventory changes are positive and significantly large for some period of
time, this indicates that firms will reduce output. This will also cause income and
spending to fall.
125. When spending is equal to output and the economy has reached spending balance, inventory
investment must equal zero. Please answer true or false, and explain.
ANS:
False. If spending is equal to output as given by spending balance, then there are no unintended
changes to inventory. Firms can still have planned increases or decreases in inventory.
PTS: 1 DIF: challenging NAT: Finding real GDP

a. Plot the line showing where income and spending are equal. What does the slope of this
line equal?
b. Using the information in the table below, plot the line showing the relationship between
expenditure and income. What is the slope of this line?
c. Using the graphical approach and the information in the above table, show what happens
to the spending balance if government expenditures increase by 9.
d. Using the graphical approach and the information in the above table, show what happens
to the spending balance if the MPC increases to 0.9.
ANS:
a. As shown in the figure below, this line is the 45-degree line. The slope of the line is 1.
b. The figure below is a graph of the expenditure line. The slope of the line is equal to the
MPC, which is 0.7.
c. The increase in government expenditures causes the expenditure line to shift up from E1
to E2. The new spending balance is at 60 as opposed to 30.
d. The expenditure line pivots up from E1 to E2. The spending balance occurs at 60 instead
of 30.
PTS: 1 DIF: basic NAT: Finding real GDP
127. Suppose you are given the following information about the economy:
C = 200 + 0.75Y
I = 50
G = 250
X = 100
a. Find the aggregate expenditure function (the total amount of spending by the four
groups), and plot it on a graph with spending on the vertical axis and output on the
horizontal axis.
b. Suppose current output is 2,800. On your graph, identify this output level and the level of
spending associated with it.
c. Is Y = 2,800 the short-run equilibrium level of output? Please explain and demonstrate
graphically.
ANS:
a. E = C + I + G + X = 200 + 0.75Y + 50 + 250 + 100 = 600 + 0.75Y.
b. At Y = 2,800, E = 600 + 0.75(2,800) = 2,700.
c. The short-run level of equilibrium output is not 2,800. When Y = 2,800, spending is only
2,700. Firms will reduce output and spending will fall. Equilibrium output is 2,400.

a. A recession occurs when the expenditure line shifts down the 45-degree line.
b. A recession occurs whenever potential GDP is less than real GDP at the point of spending
balance.
c. A recession occurs whenever income and expenditures are not equal.
d. A recession occurs when the expenditure line crosses the 45-degree line at a level of
income less than potential GDP.
e. The expenditure line cannot be used to identify recessions or expansions.
129. Assume initially that Australia’s real GDP is equal to potential GDP. Explain carefully whether each
of the following would cause real GDP to rise above or fall below potential GDP.
a. Many of the people who grew up in the 1930s, because they grew up in the Great
Depression, have much higher rates of saving than the current generations. Suppose
many of these wealthy Depression-era people begin to die and leave their accumulated
wealth to their heirs.
b. The European economies experience a surge in growth as a result of the weak euro,
which has stimulated exports and hence production in the European countries.
ANS:
a. As people die and leave their wealth to their heirs, consumption spending will increase
and/or saving will fall. People will have more wealth to spend. The expenditure line will
shift upward, and Australia’s real GDP will rise above potential GDP.
b. As growth in the European economies surges, they will have more income to spend on
imported goods and services. Our exports will increase, and the expenditure line will
shift up. Australia’s real GDP will rise above potential GDP.
130. Describe what happens to Australia’s aggregate expenditure line in each of the following cases:
a. The government cuts capital gains taxes.
b. The European Union imposes a ban on Australian-produced dairy products.
c. A new law requires builders of new homes to pay a $5,000 tax.
d. Baby boomers begin to worry about retirement and increase their average propensity to
save.
ANS:
a. The decrease in taxes causes the expenditure line to shift up.
b. This ban causes net exports to decline. The expenditure line shifts down.
c. The excise tax causes a decline in residential investment. The expenditure line shifts
down.
d. The increase in the APS causes a parallel drop in MPC. The expenditure line shifts
down.
131. Sketch the 45-degree line and the expenditure line on a diagram. What determines the slope of each
line? Explain why the point of intersection is the only possible equilibrium point. Use this diagram to
show what happens to the level of income if government purchases decline.
ANS:
The slope of the expenditure line is the MPC. This shows the change in E (or C) for a given change in
income. The slope of the 45-degree line is 1. The point where the aggregate expenditure line intersects
the 45-degree line is referred to as the point of spending balance. The initial point of spending balance
is where the aggregate expenditure line E0 intersects the 45-degree line. Only at this point is desired
spending, as given by E, equal to output.
As shown in the diagram below, a decline in government purchases causes the aggregate expenditure
line to shift down in a parallel way to E1 from E0.
132. Suppose business executives become very pessimistic and reduce their investment spending. Sketch a
diagram that illustrates how this change in opinion affects real GDP.
ANS:
A pessimistic attitude by businesses causes investment spending to decline. The effect on aggregate
expenditure and income is illustrated in the diagram below.
133. Suppose most European economies are in a recession. How would you expect this to affect the
European demand for Australian goods? What happens to net exports? Sketch a diagram that
illustrates how this change in net exports affects Australia’s real GDP.
ANS:
The recession in Europe results in a decline in our net exports.
134. Suppose you read in the paper that government purchases will decrease by $50 billion. Next to the
article are three forecasting companies’ predictions of the effect the reduction in government purchases
will have on real GDP. The predictions are:
Firm A: There will be no other changes in spending, and real GDP will fall by $50 billion.
Firm B: There will be no other changes in spending, and real GDP will fall by $75 billion.
Firm C: Investment will increase by $50 billion, and real GDP will remain the same.
Which forecast do you believe?
ANS:
You should not believe Firm A. This firm has ignored the effect on consumption of a fall in income
associated with the fall in government spending. You may believe Firm B or Firm C. You would need
to find out why one firm believes investment will increase and why the other firm does not. If there
were no other changes in spending, real GDP would fall by more than $50 billion. If investment rose
by $50 billion, this would exactly offset the fall in government purchases, and real GDP would not
change.
135. T or F. Most short-term forecasts are based on expected changes in aggregate demand.

NAT: Forecasting real GDP
136. One-year-ahead forecasts for real GDP

a. reflect forecasters’ beliefs about the determinants of potential GDP over the next year.
b. are usually equal to the current year’s GDP.
c. are usually equal to a weighted average of real GDP over the past five years.
d. reflect what forecasters believe will happen to the different spending components of real
GDP.
e. have no real use and are seldom done.
NAT: Forecasting real GDP
137. Inflation does not change in the short run because

a. real and potential GDP are not equal.
b. potential GDP does not change.
c. of sticky wage and price adjustment.
d. real GDP does not change.
e. there is no spending balance.
NAT: Why changes in demand affect production more than prices in the short run
138. All else being equal, if households choose to consume a lower share of GDP, then
a. people must be saving less.
b. people will consume less in the future.
c. there must have been an increase in GDP.
d. people will consume more in the future.
e. there must have been a decrease in GDP.
NAT: The consumption function
139. A higher real interest rate today makes current consumption

a. more expensive relative to future consumption because the return on saving is lowered.
b. more expensive relative to future consumption because the return on saving is increased.
c. less expensive relative to future consumption because the return on saving is increased.
d. less expensive relative to future consumption because the return on saving is lowered.
e. rise by the same percentage.
NAT: What about interest rates and other effects on consumption?
140. Suppose that the generation of people who lived through the Great Depression prefer to save a higher
fraction of their income than the baby-boom generation does. The baby boomers have tended to
consume more freely and go more into debt.
a. As those who lived through the Great Depression die, they are leaving their accumulated
wealth to their baby-boom children. Explain what effect this will have on the
b. As the baby boomers continue to spend freely on consumption, how might their spending
affect consumption expenditure of future generations?
ANS:
a. Wealth is redistributed from people who are thriftier to those who are less thrifty. When
less thrifty people experience increases in wealth, they tend to increase their
consumption as a percentage of their income by a larger amount than their parents, and
the aggregate consumption function will shift upwards.
b. If they spend so much that their debt continues to grow, future generations may be forced
to reduce consumption in the future, which would shift the consumption line down. Also,
if baby boomers consume rather than invest, less capital passes to future generations and
less consumption will be possible than if the saving and investment of the baby boomers
had been higher. The production possibilities curve shifts rightwards slower if the
consumption share at Y* is higher.
PTS: 1 DIF: challenging NAT: What about interest rates and other effects on
consumption?
141. Suppose businesses believe that, within a year, a new generation of computers will be developed that
will be more powerful than the current ones but cheaper to run. Assuming everything else held
constant, how will investment and AE be affected?
ANS:
Expenditures on computers will decline in this period since many firms will wait until next year to
acquire the better yet cheaper computer system.
PTS: 1 DIF: challenging NAT: The aggregate expenditure line
142. The following table shows the relationship between income and consumption in an economy.
Assume that investment (I) is $5 billion, government expenditure (G) is $4 billion, and net exports (X)
are $1 billion.
a. What is the numerical value of the marginal propensity to consume?
b. Construct a table that is analogous to the one presented in the text for this economy.
What is the level of income at the point of spending balance?
c. Suppose the above problem is modified to include taxes. Suppose first that, at any level
of income, consumers must pay taxes equal to $3 billion. Find the new level of spending
balance by modifying the table. Hint: If consumers have to pay taxes, this is income that
they cannot use for consumption.
d. Graphically illustrate what happens to spending balance when the government increases
taxes by $3 million.
ANS:
a. The value of the marginal propensity to consume is 0.7.
b. At the point of spending balance, real GDP is 60.
c. To modify the table, you will need to subtract 3 from each level of consumption and each
level of AE. Spending balance is now at a level of 50.
d. See graph below. The expenditure line will shift down. The new spending balance is 40.
PTS: 1 DIF: moderate NAT: Determining real GDP through spending balance
143. To simplify the analysis, the textbook assumes that

a. consumption is the only component of expenditures that responds to income.
b. consumption is the only component of expenditures that responds to government
purchases and government purchases are the only influence on consumption.
c. net exports are zero.
d. there is no investment spending.
e. expenditures change only because of changes in consumption.
NAT: Determining real GDP through spending balance
144. If government purchases decrease, in the AE model

a. consumption will increase as income increases.
b. consumption, investment, and net exports will increase as income increases.
c. consumption and investment will increase as income increases.
d. consumption will fall and net exports will increase as income falls.
e. consumption will increase, and real GDP will remain at potential GDP.
NAT: How real GDP changes in the short run
Toolkit
145. Suppose you are given the following information about the economy:
C = 400 + 0.75Y
I = 250
G = 250
X = −100
Find real GDP at the point of spending balance.
ANS:
E = C + I + G + X = 400 + .75Y + 250 + 250 + (−100) = 800 + 0.75Y.
Setting E = Y results in Y = 3,200.
PTS: 1 DIF: moderate NAT: Toolkit

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Macroeconomics Principles and Practice Asia Pacific 1st Edition Littleboy Test Bank

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Macroeconomics Principles and

Practice Asia Pacific 1st Edition

PTS: 1 DIF: basic NAT: Changes in spending cause fluctuations in

PTS: 1 DIF: challenging NAT: Changes in spending cause fluctuations in

3. The textbook defines economic fluctuations as

4. Between December 2007 and June 2009

ANS: T PTS: 1 DIF: moderate

ANS: F PTS: 1 DIF: basic

8. Changes in total domestic spending occur when

ANS: T PTS: 1 DIF: basic

ANS: F PTS: 1 DIF: basic

12. Which of the following is true?

ANS: F PTS: 1 DIF: moderate

17. At the end of a recession, typically

20. In a boom year,

21. To compare economic fluctuations in different countries, one should look at

ANS: F PTS: 1 DIF: moderate

ANS: T PTS: 1 DIF: moderate

26. If capacity utilisation in a mature industrialised economy is 95 per cent,

ANS: F PTS: 1 DIF: moderate

ANS: F PTS: 1 DIF: basic

ANS: T PTS: 1 DIF: basic

ANS: F PTS: 1 DIF: basic

PTS: 1 DIF: moderate NAT: Understanding and applying economic models

38. Changes in the factors that underlie potential GDP growth

39. T or F. Economic fluctuations are largely a result of changes in aggregate demand.

ANS: T PTS: 1 DIF: basic

ANS: F PTS: 1 DIF: basic

ANS: T PTS: 1 DIF: moderate

PTS: 1 DIF: moderate NAT: Measuring the economy

PTS: 1 DIF: moderate

PTS: 1 DIF: moderate NAT: Could economic fluctuations also be due to

47. T or F. Consumption is usually the largest component of total spending.

ANS: T PTS: 1 DIF: basic

48. The consumption function originated with

50. According to the consumption function, as income increases, consumption

51. The consumption function describes

53. The slope of the consumption function is equal to

59. The marginal propensity to consume is best defined as

62. If the marginal propensity to consume declines, then

63. Which of the following statements is false?

64. The consumption function for the whole economy

65. Which of the following statements is true?

66. Disposable income is the income that households

ANS: T PTS: 1 DIF: basic

ANS: T PTS: 1 DIF: basic

ANS: F PTS: 1 DIF: moderate

70. The consumption function shifts upwards if

71. The consumption function shifts downwards if

72. During economic fluctuations

73. T or F. Interest rates do not affect consumption.

74. T or F. Income has a strong effect on consumption during a recession.

ANS: T PTS: 1 DIF: moderate

PTS: 1 DIF: moderate

PTS: 1 DIF: challenging

77. Answer the questions below:

PTS: 1 DIF: challenging

PTS: 1 DIF: challenging

80. Which of the following statements is true?

81. If US firms decide to decrease their purchases of US-produced goods,

83. T or F. A decline in government spending causes consumption to decline.

ANS: T PTS: 1 DIF: moderate

ANS: F PTS: 1 DIF: moderate

85. The components that make up aggregate expenditures are