Deck 10: Aggregate Demand I: Building the Is-Lm Model

Question 1

When GDP growth declines, investment spending typically and consumption spending typically .

A).increases; increases.
B)increases; decreases. .decreases; decreases.
D)decreases; increases.

Answer 1

A

Question 2

Business cycles are:

A)regular and predictable.
B)irregular but predictable.
C)regular but unpredictable.
D)irregular and unpredictable.

Answer 2

D

Question 3

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.

A)stronger; stronger.
B)stronger; weaker.
C)weaker; stronger.
D)weaker; weaker.

Answer 3

C

Question 4

The assumption of constant velocity in the quantity equation is the equivalent of the assumption of a constant:

A)short-run aggregate supply curve.
B)long-run aggregate supply curve.
C)price level in the short run.
D)demand for real balances per unit of output.

Question 5

Short-run fluctuations in output and employment are called:

A)sectoral shifts.
B)the classical dichotomy.
C)business cycles.
D)productivity slowdowns.

Question 6

According to the quantity theory of money, if output is higher, real balances are required, and for fixed M this means P.

A)higher; lower.
B)lower; higher.
C)higher; higher.
D)lower; lower.

Question 7

If the long-run aggregate supply curve is vertical, then changes in aggregate demand affect:

A)neither prices nor level of output.
B)both prices and level of output.
C)level of output but not prices.
D)prices but not level of output.

Question 8

Alan Blinder's survey of firms found that the theory of price stickiness accepted by the most firms was:

A)menu costs.
B)coordination failure.
C)nominal contracts.
D)procyclical elasticity.

Question 9

The index of leading indicators compiled by the Conference Board includes 10 data series that are used to forecast economic activity about in advance.

A)one month.
B)six to nine months.
C)one to two years.

Question 10

Over the business cycle, investment spending consumption spending.

A)is inversely correlated with.
B)is more volatile than.
C)has about the same volatility as.
D)is less volatile than.

Question 11

A difference between the economic long run and the short run is that:

A)the classical dichotomy holds in the short run but not in the long run.
B)monetary and fiscal policy affect output only in the long run.
C)demand can affect output and employment in the short run, whereas supply is the ruling force in the long run.
D)prices and wages are sticky in the long run only.

Question 12

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.

A)higher; greater.
B)higher; smaller.
C)lower; greater.
D)lower; smaller.

Question 13

Alan Blinder's survey of firms found that the typical firm adjusts its prices:

A)more than once a week.
B)about once a month.
C)once or twice a year.
D)less than once a year.

Question 14

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.

A)real.
B)Nomina.
C)real and nominal.

Question 15

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:

A)slopes upward and to the right.
B)slopes downward and to the right.
C)is horizontal.
D)is vertical.

Question 16

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:

A)decrease by 1 percent.
B)decrease by 2 percent.
C)decrease by 3 percent.
D)increase by 1 percent.

Question 17

Looking at the aggregate demand curve alone, one can tell that will prevail in the economy.

A)the quantity of output and the price level.
B)the quantity of output.
C)the price level.
D)neither the quantity of output nor the price level.

Question 18

In the long run, the level of output is determined by the:

A)interaction of supply and demand.
B)money supply and the levels of government spending and taxation.
C)amounts of capital and labor and the available technology.
D)preferences of the public.

Question 19

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.

A)downward; steeper.
B)downward; flatter.
C)upward; steeper.
D)upward; flatter.

Question 20

The relationship between the quantity of output demanded and the aggregate price level is called:

A)aggregate demand.
B)aggregate supply.
C)aggregate output.
D)aggregate consumption.

Question 21

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?

Question 22

The long run refers to a period:

A)of decades.
B)during which capital and labor are sometimes not fully employed.
C)during which prices are flexible.
D)during which output deviates from the full-employment level.

Question 23

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. 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?

Question 24

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:

A)is horizontal.
B)is vertical.
C)slopes upward and to the right.
D)slopes downward and to the right.

Question 25

The short run refers to a period:

A)of several days.
B)during which prices are sticky and unemployment may occur.
C)during which capital and labor are fully employed.
D)during which there are no fluctuations.

Question 26

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?

Question 27

The long-run aggregate supply curve is vertical at the level of output:

A)determined by aggregate demand.
B)at which unemployment is at its natural rate.
C)at which the inflation rate is zero.
D)at a predetermined price level.

Question 28

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.

Question 29

The natural level of output is:

A)affected by aggregate demand.
B)the level of output at which the unemployment rate is zero.
C)the level of output at which the unemployment rate is at its natural level.
D)permanent and unchangeable.

Question 30

Monetary neutrality is a characteristic of the aggregate demand-aggregate supply model in:

A)both the short run and the long run.
B)in neither the short run nor the long run.
C)in the short run, but not in the long run.
D)in the long run, but not in the short run.

Question 31

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.

Question 32

If the short-run aggregate supply curve is horizontal, then the:

A)classical dichotomy is satisfied.
B)money supply cannot affect prices in the short run.
C)money supply cannot affect output in the short run.
D)money supply is irrelevant in the short run.

Question 33

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. 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.

Question 34

In the aggregate demand-aggregate supply model, long-run equilibrium occurs at the combination of output and prices where:

A)aggregate demand is greater than long-run aggregate supply.
B)aggregate demand equals short-run aggregate supply.
C)aggregate demand equals short-run and long-run aggregate supply.
D)short-run aggregate supply equals long-run aggregate supply.

Question 35

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:

A)prices in grain markets.
B)real wages.
C)foreign exchange rates.
D)interest rates.

Question 36

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?

Question 37

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?

Question 38

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.

Question 39

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 = 3(M/P) and M = 1,000.
a. If the economy is initially in long-run equilibrium, what are the values of P and Y?
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?

Question 40

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. 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.

Question 41

Monetary policy can be either a stabilizing influence on the economy or a source of instability. Give an explanation for both possibilities.

Question 42

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?

Question 43

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.

Question 44

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.