Name: ___________________________ Class: _________________ Date: __________

midterm3

1. The long-run model determines ________, whereas the short-run model

determines ________ inflation.

a. potential output and long-run inflation; current output and current

b. potential output and unemployment; current output and long-run
c. current output and long-run inflation; unemployment and current
d. potential output and unemployment; unemployment and current
e. current output and unemployment; potential output and current

2. If we define Yt as current output, as potential output, and as short-run

fluctuations, which of the following equations is correct?

a.
b.
c.
d.

e.

3. According to the Phillips curve, short-term changes in inflation are due to changes
in

a. interest rates.
b. unemployment.
c. short-term output fluctuations.
d. long-term inflation.
e. long-term output.

Refer to Figure 9.1 when answering the following questions.

Figure 9.1: Output versus Time
4. Consider Figure 9.1. The dashed line is potential output and the solid line is
current output; therefore,

a. areas a and b are booms.

b. area b represents an economic boom, and area a is a recessionary gap.
c. the economy is in neither a recession nor a boom in areas a and b.
d. area a represents an economic boom, and area b is a recessionary gap.
e. areas a and b are expansions.

5. Considering Figure 9.1,

a. area a is where current output is less than potential output, and area b is
where current output is greater than potential output.
b. area a is where current output is greater than potential output, and area b is
where current output is less than potential output.
c. point c is where economic fluctuations are zero, and at point b, the
economy is in a boom.
d. at point c, current output equals the short-term fluctuations.
e. area a is where current output is greater than potential output, and at point
c, the economy is in a boom.

6. According to the Phillips curve presented in the text, a positive macroeconomic

shock

a. increases the rate of inflation.

 b. decreases the rate of inflation.
c. has no effect on the rate of inflation.
d. has a negative effect on the unemployment rate.
e. has a positive effect on the unemployment rate.

7. According to the Phillips curve presented in the text, a negative macroeconomic

shock

a. increases the rate of inflation.

b. decreases the rate of inflation.
c. has no effect on the rate of inflation.
d. has a negative effect on the unemployment rate.
e. has a positive effect on the unemployment rate.

8. If the macroeconomy is

a. in an expansionary gap.
b. at its potential level of output.
c. in a recessionary gap.
d. None of these answers is correct.
e. Not enough information is given.

9. If the macroeconomy is

a. in a recession.
b. in an expansionary gap.
c. at its potential level of output.
d. Not enough information is given.
e. None of these answers is correct.

10.If the macroeconomy is

a. at its potential level of output.

b. in a recessionary gap.
c. in an expansionary gap.
d. Not enough information is given.
 e. None of these answers is correct.

Refer to Figure 9.4 when answering the following questions.

Figure 9.4: Phillips Curve

11.Consider the Phillips curve at in Figure 9.4. Which of the following is true?

a. The economy is booming.

b. The economy is deflationary.
c. The economy is at potential output.
d. The economy is in recession.
e. Unemployment is above the natural level.

12.Consider the Phillips curve at in Figure 9.4. The economy is

a. booming.
b. inflationary.
c. in recessionary gap.
d. at potential output.
e. Not enough information is given to determine.

13.Consider the Phillips curve at in Figure 9.4. The economy is

a. booming.
 b. inflationary.
c. at its potential output.
d. in recession.
e. Not enough information is given to determine.

14.Okun’s law shows the ________ relationship between ________.

a. negative; the unemployment gap and economic fluctuations

b. positive; the unemployment gap and economic fluctuations
c. negative; the unemployment gap and inflation
d. positive; the unemployment gap and inflation
e. negative; inflation and economic fluctuations

15.Every six to eight weeks, or so, the Federal Reserve meets to set the ________
rate.

a. discount
b. mortgage
c. federal funds
d. 10-year bond
e. tax

16.The IS curve describes short-run movements in an economy via which of the

following?

a. ↑ Interest rate ⇒ ↑ Investment ⇒ ↓ Output

b. ↑ Interest rate ⇒ ↓ Investment ⇒ ↓ Output
c. ↑ Tax rate ⇒ ↓ Consumption ⇒ ↓ Output
d. ↑ Interest rate ⇒ ↑ Investment ⇒ ↑ Output
e. ↑ Tax rate ⇒ ↑ Government expenditure ⇒ ↑ Output

17.The IS curve describes the ________ relationship between ________.

a. negative; tax rate and investment

b. positive; interest rate and output
c. positive; tax rate and government expenditure
 d. negative; interest rate and output
e. negative; interest rate and money supply

18.According to the IS curve, when interest rates rise, ________ and ________.

a. governments borrow less; firms produce less

b. firms and households borrow more; firms produce less
c. firms and households borrow less; firms produce less
d. firms and households borrow more; firms produce more
e. firms and households borrow more; governments produce more

19.The foundation of the IS curve is the equation ________, which is the ________.

a. Yt=Ct+It+Gt+EXt-IMt; national income identity

b. Yt = Ct + It + Gt + IMt; national income identity
c. Yt = Ct + It + Gt; national income identity
d. Yt = Ct + It + Gt + EXt + IMt; current account
e. Yt = Ct + It + Gt + IMt + EXt; current account

20.In the IS curve, consumption, government expenditure, exports, and imports are a
function of

a. expectations.
b. current output.
c. potential output.
d. the interest rate.
e. output fluctuations.

21.In the IS curve, consumption is represented as a constant fraction of ________,

and therefore is ________ than current output.

a. potential output; more volatile

b. potential output; smoother
c. short-run fluctuations; smoother
d. short-run fluctuations; more volatile
 e. the interest rate differential; smoother

22.Which of the following describes the consumption function in the IS curve that is
used in the textbook?

a.
b.
c.
d.
e.

23.In the simple IS curve analysis, which of the following includes both the real
interest rate and the potential output?

a. exports
b. consumption
c. government expenditures
d. investment
e. imports

24.If the real interest rate is less than the marginal product of capital, firms are better
off

a. producing at a loss.
b. saving their earnings in an economywide financial market.
c. accumulating more inventory.
d. borrowing in financial markets and buying more capital.
e. using more imported intermediate goods.

25.In the long run, the

a. federal funds rate equals the 10-year bond rate.

b. marginal product of capital is greater than the real interest rate.
c. marginal product of capital equals the nominal interest rate.
d. marginal product of capital equals the real interest rate.
e. marginal product of capital is less than the real interest rate.
26.Using the IS curve in the long run, ________, so that the
economy is ________.

a. equals one and in recession

b. is greater than one and at its long-run equilibrium
c. equals zero and at its long-run equilibrium
d. equals one and expanding
e. equals one and Rt = 1; in recession

27.In the IS curve the term is called

a. the tax rate.

b. the elasticity of output with respect to the interest rate.
c. a consumption expenditure shock.
d. the deviation of the real interest rate to the marginal product of capital.
e. an aggregate demand shock.

28.In the IS curve, represents

a. potential output.
b. total real output.
c. short-run fluctuations.
d. the real interest rate.
e. None of these answers is correct.

Refer to Figure 11.5 when answering the following questions.

Figure 11.5: IS Curve
29.Consider Figure 11.5. If the economy initially is at its long-run equilibrium and the
real interest rate increases, the economy will move from point ________ to point
________.

a. b; a
b. d; a
c. d; b
d. a; d
e. d; c

30.Consider Figure 11.5. If the economy initially is at its long-run equilibrium and the
real interest rate decreases, the economy will move from point ________ to point
________.

a. b; a
b. d; a
c. d; c
d. c; d
e. d; b

31.Suppose we assume and the real interest rate rises to

. In this scenario of the IS curve, the economy will, in the short run,

a. remain at its long-run equilibrium.

b. move from 1 percent below its potential to its long-run equilibrium.
 c. move from its long-run equilibrium to 1 percent above its potential.
d. move from its long-run equilibrium to 1 percent below its potential.
e. have increased output.

32.Suppose we assume that and the real interest rate falls to

. In this scenario of the IS curve, the economy will, in the short run,

a. remain at its long-run equilibrium.

b. have reduced output.
c. move from 1 percent below its potential to its long-run equilibrium.
d. move from its long-run equilibrium to 1 percent above its potential.
e. move from its long-run equilibrium to 1 percent below its potential.

33.Suppose we assume that initially If rises 2 percent and

the real interest rate falls 2 percent, short-run output will

a. fall 2 percent.
b. rise 1 percent.
c. rise 3 percent.
d. fall 1 percent.
e. not change.

34.Suppose we assume that initially If rises 2 percent and

the real interest rate rises 2 percent, short-run output will

a. rise 2 percent.
b. rise 1 percent.
c. fall 2 percent.
d. rise 4 percent.
e. not change.

Refer to Figure 11.6 when answering the following questions.

Figure 11.6: IS Curve
35.Consider the IS curve in Figure 11.6. If there is a positive aggregate demand
shock and interest rates remain constant, the economy will move from point e to
point

a. a.
b. c.
c. d.
d. b.
e. f.

36.An increase in consumer expenditures during the holiday season, a decrease in

purchases of U.S. goods by foreigners, a tax increase, and a decline in new
home starts are examples of

a. a monetary policy.
b. an aggregate supply shock.
c. an aggregate demand shock.
d. expectations.
e. Ricardian equivalence.

37.Which of the following is NOT an example of an IS shock?

i. a change in interest rates

ii. a change in tax policy

 iii. a natural disaster

iv. a change in the price of oil

a. i
b. ii
c. iii
d. iv
e. i and iii

38.The permanent-income hypothesis suggests that people will base their

consumption on their

a. permanent incomes only.

b. temporary incomes more than their permanent incomes.
c. permanent incomes more than their temporary incomes.
d. temporary incomes only.
e. future incomes.

39.When the multiplier is included in the IS curve, a

a. demand shock has a larger impact on short-run fluctuations than with the
standard IS curve.
b. change in the real interest rate has a smaller impact on short-run
fluctuations than with the standard IS curve.
c. demand shock has a smaller impact on short-run fluctuations than with the
standard IS curve.
d. change in taxes has no impact on short-run output.
e. change in the marginal product of capital has a smaller effect on short-run
fluctuations in output than with the standard IS curve.

40.What is the main policy tool available to the Federal Reserve?

a. the reserve rate

b. the discount rate
c. the federal funds rate
d. printing money
e. the mortgage rate
41.The structure of the short-run model is best described as which of the following?

a. Nominal interest rate → Real interest rate → Short-run output → Change in

inflation
b. Nominal interest rate → Real interest rate → Change in inflation
c. Nominal interest rate → Short-run output → Change in inflation
d. Real interest rate → Short-run output → Change in inflation → Nominal
interest rate
e. Short-run output → Change in inflation → Real interest rate → Nominal
interest rate

42.The MP curve stands for ________ and describes how ________.

a. monopoly pricing; firms set prices

b. monetary policy; the Federal Reserve sets the inflation rate
c. monetary policy; the federal government sets short-run output fluctuations
d. money prices; the Federal Reserve sets the inflation rate
e. monetary policy; the Federal Reserve sets the nominal interest rate

43.The federal funds rate is

a. equal to the rate of inflation.

b. the interest rate at which banks borrow from the Federal Reserve.
c. the interest rate at which banks borrow from and loan to each other
overnight.
d. an interest rate that is some fixed amount above the prime lending rate.
e. the return to stock markets over the long term.

44.According to the Fisher equation, the nominal interest rate is equal to the

a. rate of inflation.
b. real interest rate minus the rate of inflation.
c. real interest rate plus the rate of inflation.
d. rate of unemployment.
e. real interest rate plus short-run economic fluctuations.
45.The link between real and nominal interest rates is summarized in

a. the MP curve.
b. the Phillips curve.
c. Okun’s law.
d. the Fisher equation.
e. Jones’s equality.

46.When economists say “sticky inflation,” they mean that

a. inflation does not immediately react to changes in monetary policy.

b. inflation adjusts quickly.
c. inflation does not react directly to changes in fiscal policy.
d. taxes do not react to changes in prices.
e. inflation never responds to monetary policy.

47.A key assumption of the short-run model is

a. zero inflation.
b. perfect price flexibility.
c. that unemployment always equals its natural rate.
d. that the economy never deviates from its long-run equilibrium.
e. sticky inflation.

48.An implication of sticky inflation is that, through monetary policy changes, the
Federal

Reserve (the Fed)

a. has no impact on inflation.

b. can alter the real interest rate in the long run.
c. can alter the real interest rate in the short run.
d. has no impact on the real interest rate.
e. has no impact on the unemployment rate.

49.If prices are sticky and there are no aggregate demand shocks, and if the Fed
raises the interest rate, ________ and ________.
 a. unemployment will fall; potential output will fall
b. the real interest rate will fall; short-run output will fall
c. the unemployment rate will rise; short-run output will rise
d. the real interest rate will rise; short-run output will fall
e. the real interest rate will fall; current output will fall

50.The term structure of interest rates shows the relationship between

a. corporate bonds and the federal funds rate.

b. high- and low-quality corporate bonds.
c. U.S. Treasury bills with different maturities.
d. U.S. Treasury rates and municipal bond yields.
e. mortgage rates and the London Inter-Bank Offered Rate (LIBOR).

51.Normally, yields on short-term Treasury bonds are ________ yields on long-term

Treasury bonds.

a. equal to the federal funds rate minus

b. equal to inflation plus
c. the same as
d. higher than
e. lower than

Refer to Figure 12.4 when answering the following questions.

Figure 12.4: Phillips Curve
52.Consider the Phillips curve in Figure 12.4. At point a, the economy is ________;
at point c, the economy is ________.

a. in recession; booming
b. in recession; in recession
c. in recession; in its long-run equilibrium
d. booming; in recession
e. in its long-run equilibrium; in recession

53.Consider the Phillips curve in Figure 12.4. At point b, the economy is ________,
and at point a, the economy is ________.

a. in recession; booming
b. in recession; in its long-run equilibrium
c. in recession; in recession
d. booming; in recession
e. in its long-run equilibrium; in recession

54.According to the Phillips curve, if the

a. inflation rate is falling, the economy is booming.

b. inflation rate is rising, the economy is in recession.
c. inflation rate is rising, the economy is booming.
d. unemployment rate is falling, the economy is booming.
e. None of these answers is correct.

55.With adaptive expectations, the Phillips curve can be written as

a.
b.
c.
d.
e. πt = πt-1.
56.Based on the reasoning of the original version of the Phillips curve, the
conventional wisdom of the 1960s was that

a. money is not neutral.

b. there is a strong positive relationship between unemployment and inflation.
c. there is no relationship between economic growth and the savings rate.
d. there is a permanent trade-off between inflation and economic
performance.
e. the real interest rate is always equal to 2 percent.

57.In the Phillips curve, is

a. a demand shock.
b. an inflation shock.
c. a measure of the sensitivity of inflation to demand conditions.
d. a permanent price trend.
e. fiscal policy shock.

58.The most immediate and visible form of inflation shock is

a. the real wage.

b. the price of corn.
c. the price of oil.
d. growth in the stock market.
e. bond prices.

59.An increase in the interest rate ordered by the Federal Reserve will affect only
real interest rates because

a. inflation is sticky in the short run.

b. of the quantity theory of money.
c. prices are flexible in the short and long runs.
d. contracts apply only in the very short run.
e. we are in the long run.

60.Which of the following scenarios best describes the short-run model?

 a.
b.
c.
d.
e. None of these answers is correct.

61.Once a ________ is chosen, the main tool the Federal Reserve will use to
change the money supply is ________.

a. federal funds rate; open-market operations

b. federal funds rate; changing the discount rate
c. tax rate; changing the exchange rate
d. number of dollars in circulation; changing the reserve rate
e. discount rate; borrowing money from the federal government

62.When we “mechanically” raise the federal funds rate by 2 percent for every 1
percent increase in the inflation rate, this is an example of

a. a fiscal policy rule.

b. a monetary policy rule.
c. discretionary monetary policy.
d. discretionary fiscal policy.
e. None of these answers is correct.

63.The simple monetary policy rule that is discussed at length in the text is

a.
b.
c.
d.
e.

64.In the simple monetary policy rule measures:

a. the marginal product of capital.

b. the deviation of the inflation rate from the target rate.
 c. how sensitive monetary policy is to changes in inflation.
d. the target rate of inflation.
e. the debt-to-GDP ratio.

65.The simple monetary policy rule implies that if

a. the Federal Reserve should lower the interest rate.

b. the Federal Reserve should lower the interest rate.
c. the Federal Reserve should raise the interest rate.
d. the interest rate is zero.
e. All of these answers are correct.

66.Combining the IS and monetary policy rule curves results in

a. Okun’s law.
b. the Phillips curve.
c. the aggregate demand curve.
d. the MP curve.
e. current output.

67.The aggregate demand (AD) curve is given by

a.
b.
c.
d.
e.

68.Which of the following best describes movement along the AD curve?

a. A change in the inflation rate causes the central bank to change interest
rates, thereby causing a corresponding proportional change in investment.
b. a sudden increase in the tax rate
c. change in monetary policy
d. A change in the inflation rate causes the federal government to reduce
discretionary spending.
 e. A change in unemployment causes the federal government to reduce
discretionary spending.

69.A change in which of the following parameters will shift the AD curve
?

a. πt
b.
c.
d.
e. None of these answers is correct.

70.A change in which of the following parameters would cause a movement along
the AD curve ?

a.
b. πt
c.
d.
e. None of these answers is correct.

71.The aggregate supply (AS) curve is derived from

a. Okun’s law.
b. the Phillips curve.
c. the Fisher equation.
d. the monetary policy rule.
e. the interaction of the IS and MP curves.

72.Which of the following is the aggregate supply curve?

a.
b.
c.
d.
 e. Kt-1 = sYt - dKt

73.On the aggregate supply curve, an increase in inflation causes ________,

whereas a price shock causes ________.

a. upward movement along the curve; the curve to shift

b. downward movement along the curve; the curve to shift
c. the curve to shift; movement along the curve
d. downward movement along the curve; upward movement along the curve
e. Not enough information is given.

74.Which of the following will shift the aggregate supply curve?

a. a change in ū
b. an increase in the price of oil
c. the current inflation rate
d. raising the federal funds rate
e. All of these answers are correct.

75.Which of the following best describes why the aggregate demand curve slopes
downward?

a. If the central bank observes a high rate of inflation, the monetary policy rule
will dictate an increase in the real interest rate. The high interest rate
reduces output by reducing investment demand in the economy.
b. If the central bank observes a low rate of inflation, the monetary policy rule
will dictates an increase in the real interest rate. The high interest rate
reduces output by reducing investment demand in the economy.
c. If the central bank observes a high rate of inflation, the monetary policy rule
will dictates a decrease in the real interest rate. The low interest rate
increases output by reducing investment demand in the economy.
d. If the central bank observes a low rate of inflation, the monetary policy rule
will dictates a decrease in the real interest rate. The low interest rate
reduces output by reducing investment demand in the economy.
e. None of these answers is correct.

76.Which of the following best describes why the aggregate supply curve slopes
upward?

a. When actual output exceeds potential, firms struggle to keep production in

line with the high demand. They therefore raise their prices by more than
the usual amount in an attempt to cover increased production costs.
b. When actual output exceeds potential, firms have an easy time keeping
production in line with the high demand. They therefore lower their prices
by more than the usual amount in an attempt to cover increased production
costs.
c. When actual output exceeds potential, firms struggle to keep production in
line with the high demand. They therefore lower their prices with decreased
production costs.
d. When actual output falls below potential, firms easily keep production in line
with the high demand. They therefore raise their prices by more than the
usual amount in an attempt to cover increased production costs.
e. None of these answers is correct.
Answer Key

midterm3

1. Answer: A

2. Answer: B

3. Answer: C

4. Answer: D

5. Answer: B

6. Answer: A

7. Answer: B

8. Answer: C

9. Answer: B

10.Answer: A

11.Answer: A

12.Answer: C

13.Answer: C

14.Answer: A

15.Answer: C

16.Answer: B

17.Answer: D

18.Answer: C

19.Answer: A

20.Answer: C
21.Answer: B

22.Answer: D

23.Answer: D

24.Answer: D

25.Answer: D

26.Answer: C

27.Answer: E

28.Answer: C

29.Answer: C

30.Answer: C

31.Answer: D

32.Answer: D

33.Answer: C

34.Answer: E

35.Answer: B

36.Answer: C

37.Answer: E

38.Answer: C

39.Answer: A

40.Answer: C

41.Answer: A

42.Answer: E
43.Answer: C

44.Answer: C

45.Answer: D

46.Answer: A

47.Answer: E

48.Answer: C

49.Answer: D

50.Answer: C

51.Answer: E

52.Answer: C

53.Answer: D

54.Answer: C

55.Answer: A

56.Answer: D

57.Answer: B

58.Answer: C

59.Answer: A

60.Answer: A

61.Answer: A

62.Answer: B

63.Answer: C

64.Answer: C
65.Answer: A

66.Answer: C

67.Answer: D

68.Answer: A

69.Answer: B

70.Answer: B

71.Answer: B

72.Answer: D

73.Answer: A

74.Answer: B

75.Answer: A

76.Answer: A