Question 1

As a result of an increase in expected inflation, the:

Accepted Answer

An increase in expected inflation typically leads to higher costs for businesses, as they anticipate paying more for inputs and labor. This expectation reduces the quantity of goods and services supplied at any given price level in the short run, effectively shifting the Short-Run Aggregate Supply (SRAS) curve up and to the left. This reflects a decrease in supply due to higher anticipated costs.

Question 2

If a baker observes an increase in demand for bread, should the baker increase output or raise prices?

Accepted Answer

The correct response depends on the underlying cause of the demand increase. If the demand rises due to a stronger preference for bread, increasing output might be the best response. However, if the demand increase is driven by inflation, raising prices could be more appropriate to maintain profitability.

Question 3

In the AD-AS model, an unexpected increase in the growth rate of the money supply:

Accepted Answer

In the short run, an unexpected increase in the growth rate of the money supply will increase aggregate demand, shifting the AD curve to the right. This will result in an increase in both the inflation and real growth rates. However, in the long run, the AS curve will shift upwards due to increased inflation expectations and wage pressures, resulting in a return to the original output level but with higher inflation. Therefore, in the long run, the increase in inflation will outweigh any positive effect on real growth, leading to a decrease in both the inflation and real growth rates.

Question 4

Use the following to answer questions: Figure: Three AD Curves 
-(Figure: Three AD Curves) Beginning at Point A in the accompanying diagram, a negative money shock could result in a short-run growth rate of:

Accepted Answer

A negative money shock typically shifts the aggregate demand curve to the left, leading to a lower short-run growth rate. Starting at Point A, the new equilibrium after the shock would likely be at a lower growth rate, such as 1.2%.

Question 5

Which of the following scenarios could result in a recession?

Accepted Answer

A decrease in aggregate demand combined with sticky wages can result in a recession. When wages are sticky, they do not adjust quickly to changes in demand or supply conditions, which can lead to an imbalance in the labor market. As a result, firms may have to lay off workers, leading to higher unemployment, further reducing aggregate demand and potentially resulting in a recession. Flexible wages enable the labor market to adjust more quickly to changes in demand, reducing the likelihood of a recession. An increase in aggregate demand, regardless of whether wages are flexible or sticky, is unlikely to result in a recession.

Question 6

In the AD-AS model with a long-run potential growth rate of 2%, a 6 percentage point increase in the money supply growth rate will cause the economy's growth rate to be _____ in the long run.

Accepted Answer

In the long run, changes in the money supply growth rate only affect the price level, not real output. Therefore, the economy's growth rate in the long run will remain at its potential growth rate of 2%.

Question 7

From an initial equilibrium in the AD-AS model, an unexpected increase in money supply growth will cause inflation:

Accepted Answer

An unexpected increase in money supply growth typically leads to lower interest rates, which boosts investment and consumption. This increase in aggregate demand can lead to higher output (real growth) and higher prices (inflation) in the short run, as prices and wages are sticky and do not adjust immediately.

Question 8

Which of the following occurs in the long run?

Accepted Answer

In the long run, unexpected inflation is absent because prices adjust fully to changes in the money supply. Prices are no longer sticky in the long run, and the intersection of the SRAS curve with the AD curve occurs at the economy's potential output level, which is determined by the natural rate of unemployment and the Solow growth rate. Workers do not confuse real wages with nominal wages in the long run.

Question 9

The short-run aggregate supply curve is upward-sloping because:

Accepted Answer

In the short run, wages and prices are sticky, meaning they do not adjust immediately to changes in demand or supply. This means that an increase in demand will lead to an increase in output, but not an increase in wages and prices. Therefore, firms are willing to increase production in the short run as they can sell the output at a higher price than their costs, resulting in an upward-sloping short-run aggregate supply curve.

Question 10

In the AD-AS model, money is not neutral in the short run if:

Accepted Answer

In the short run, if wages and prices are sticky (meaning they do not adjust quickly or easily to changes in demand or supply), then an increase in the money supply can lead to a temporary increase in output and employment. This is because firms may temporarily lower prices relative to wages, leading to an increase in the quantity of goods and services demanded. As a result, an increase in the money supply can have real effects on output and employment in the short run, making money not neutral. However, in the long run, prices and wages are more likely to adjust to changes in the money supply, leading to a return to the natural rate of output regardless of changes in the money supply.

Question 11

The costs of changing prices are called:

Accepted Answer

The costs of changing prices are known as menu costs. This includes the time and resources required to update price lists, modify advertising materials, and communicate new prices to customers, among other expenses. The term "menu costs" originated from the restaurant industry, where menus would need to be reprinted each time prices changed. However, the concept applies to many other types of businesses that regularly adjust their prices.

Question 12

The lowering of the growth rate of the money supply is represented graphically by a:

Accepted Answer

A decrease in the growth rate of the money supply would lead to a decrease in aggregate demand, as there would be less money circulating in the economy for consumers and businesses to spend. This is represented graphically by a shift to the left of the Aggregate Demand (AD) curve.

Question 13

If prices are completely flexible, then an increase in spending growth will lead to an immediate:

Accepted Answer

In a scenario where prices are completely flexible, an increase in spending growth will lead to an immediate increase in inflation, as the higher demand can be met with immediate price adjustments without affecting the real output growth, which is determined by factors like technology and resource availability in the short term.

Question 14

Which of the following is an explanation for why prices may be sticky in the short run?

Accepted Answer

Menu costs make it costly for firms to change their prices frequently, leading to sticky prices in the short run.

Question 15

If the actual rate of inflation turns out to be higher than the expected rate of inflation, what happens to the growth rate of output before expectations are updated?

Accepted Answer

When the actual rate of inflation is higher than expected, it can temporarily boost economic activity as real interest rates are lower than anticipated, encouraging borrowing and investment. This can lead to a growth rate higher than the Solow growth rate until expectations adjust.

Question 16

In the AD-AS model, an unexpected decrease in the growth rate of the money supply causes:

Accepted Answer

An unexpected decrease in the growth rate of the money supply would cause a decrease in spending, leading to a leftward shift of the AD curve. As firms adjust to lower levels of demand, they will reduce production and increase prices, leading to an upward shift of the SRAS curve. Therefore, the correct answer is a leftward shift of the AD curve and then a downward shift of the SRAS curve, which is represented by choice D.

Question 17

Which of the following explains why the inflation rate is slow to adjust over time?

Accepted Answer

The high menu costs of changing prices, such as the cost of printing new menus or changing price tags, make it expensive and time-consuming for firms to adjust their prices frequently. This leads to a slower adjustment of the inflation rate over time.

Question 18

If prices are completely flexible, then a positive aggregate demand shock will lead to:

Accepted Answer

The answer of If prices are completely flexible, then a...

Question 19

Prices are especially sticky in the:

Accepted Answer

Prices are generally more resistant to decreasing than increasing. This is because businesses are often reluctant to reduce their prices due to concerns about profits, signaling effects, and potentially harming their brand reputation. As a result, prices tend to be stickier in the downward direction.

Question 20

Use the following to answer questions: Figure: Three AD Curves 
-(Figure: Three AD Curves) In the accompanying diagram, the economy's long-run growth rate following a positive money shock would be:

Accepted Answer

The answer of Use the following to answer questions: Figure:...

Quiz 13: Business Fluctuations: Aggregate Demand and Supply