Question 1

According to the Phillips curve, inflation depends on expected inflation because:
A)the real interest rate depends on the expected rate of inflation.
B)the central bank sets its target inflation rate based on the expected rate of inflation.
C)the natural level of output depends on the expected rate of inflation.
D)when some firms set prices in advance, expected inflation influences future prices.

Accepted Answer

The Phillips curve states that there is an inverse relationship between unemployment and inflation. However, in the short run, inflation can be influenced by expected inflation because when some firms set prices in advance, expected inflation can influence future prices. This means that if firms expect prices to rise, they may set higher prices, leading to an increase in inflation. Therefore, expected inflation can directly influence actual inflation, according to the Phillips curve.

Question 2

In the dynamic model, the demand for goods and services will as the natural level of output increases and
As the real interest rate increases.
A)increase; increase
B)increase; decrease
C)decrease; decrease
D)decrease; increase

Accepted Answer

According to the dynamic model, as the natural level of output increases, the demand for goods and services will increase. However, as the real interest rate increases, the demand for goods and services will decrease. Therefore, the best choice is B, which states that the demand for goods and services will increase as the natural level of output increases, but decrease as the real interest rate increases.

Question 3

To follow a monetary policy rule, the central bank raises the nominal interest rate by:
A)raising the inflation target.
B)decreasing the money supply.
C)increasing the GDP gap.
D)decreasing inflation expectations.

Accepted Answer

According to the Taylor Rule, an often cited monetary policy rule, the central bank should raise the nominal interest rate when there is inflationary pressure in the economy. This can be achieved by decreasing the money supply, which would increase the cost of borrowing and slow down economic activity, ultimately leading to lower inflation. A) is incorrect because raising the inflation target would lead to looser monetary policy and a lower interest rate. C) is incorrect because increasing the GDP gap (the difference between actual and potential GDP) would indicate a need for expansionary, not contractionary, monetary policy. D) is incorrect because decreasing inflation expectations would not directly impact the nominal interest rate.

Question 4

Which of the following would be represented by a negative value of the random supply shock, υt
$\text { ? }$
A)an irrational wave of pessimism among investors
B)a decrease in government spending
C)oil price decreases resulting from a breakdown in the cartel
D)a decrease in the central bank's inflation target

Accepted Answer

A negative value of the random supply shock, υt, typically represents a positive supply shock, such as a decrease in oil prices due to a breakdown in the cartel, which would increase supply and reduce costs.

Question 5

The dynamic model of aggregate demand and aggregate supply assumes that people form expectations of inflation based on:
A)forecasts optimally using all available information.
B)recently observed inflation.
C)the central bank's inflation target.
D)the difference between the nominal and real interest rate.

Accepted Answer

The answer of The dynamic model of aggregate demand and...

Question 6

The natural rate of interest is the real interest rate:
A)at which the demand for goods and services equals the natural level of output.
B)that most people anticipate based on their expectations of inflation.
C)at which the natural rate of unemployment equals the natural rate of output.
D)equal to the nominal interest rate minus the natural rate of inflation.

Accepted Answer

The natural rate of interest is the real interest rate at which the economy's output is at its natural level, meaning the demand for goods and services equals the natural level of output.

Question 7

A higher real interest rate reduces the demand for goods and services by:
A)shifting the dynamic aggregate supply curve.
B)decreasing the natural level of output.
C)increasing inflation expectations.
D)reducing investment and consumption spending.

Accepted Answer

A higher real interest rate increases the cost of borrowing, making it less attractive for businesses and individuals to invest or consume. This reduction in investment and consumption spending leads to decreased demand for goods and services.

Question 8

According to the monetary policy rule, when inflation is at its target level and output is at the natural level, then the real interest rate equals the:
A)nominal rate of interest.
B)target rate of inflation.
C)natural rate of interest.
D)current rate of inflation.

Accepted Answer

According to the monetary policy rule, when inflation is at its target level and output is at the natural level, then the real interest rate equals the natural rate of interest. This is the rate at which the economy can grow at its potential without generating inflationary pressures.

Question 9

According to the monetary policy rule, the central bank sets the nominal interest rate so the real interest rate
When inflation is above its target and the real interest rate when output is below its natural level.
A)rises; falls
B)rises; rises
C)falls; falls
D)falls; rises

Accepted Answer

When inflation is above its target, the central bank needs to increase the nominal interest rate to reduce aggregate demand and bring inflation back to target. This leads to a rise in the real interest rate, which is the nominal interest rate adjusted for inflation. When output is below its natural level, the central bank wants to stimulate aggregate demand and boost the economy by lowering the real interest rate. This can be achieved by decreasing the nominal interest rate, which leads to a fall in the real interest rate. Therefore, the correct answer is A - rises; falls.

Question 10

The real interest rate at which, in the absence of any shock, the demand for goods and services equals the natural level of output is called the rate of interest.
A)ex ante
B)ex post
C)natural
D)nominal

Accepted Answer

The question describes the natural rate of interest, which is the real interest rate that balances demand and potential output in the long run. Therefore, the correct answer is C, natural rate. The other terms, ex ante and ex post, refer to expectations of future outcomes, and nominal refers to the interest rate before accounting for inflation.

Question 11

Expectations of inflation based on recently observed inflation is called the assumption of expectations.
A)natural
B)rational
C)dynamic
D)adaptive

Accepted Answer

The assumption of expectations based on recently observed inflation is known as adaptive expectations. This means that people's expectations for future inflation are based on their recent experiences with inflation. As such, they may be slow to adjust their expectations when inflation changes over time, since they are anchored to their past experiences. This is in contrast to rational expectations, which assume that people have access to all available information and use it to form their expectations for future inflation.

Question 12

In the dynamic model, the supply shock variable, υ , is a variable appearing in which of the following equations of the
T
Model?
A)Fisher equation
B)Phillips curve
C)monetary-policy rule
D)adaptive expectations

Accepted Answer

The supply shock variable, υ, is typically included in the Phillips curve equation in the dynamic model. This is because a supply shock affects the level of prices and output in the short run, a relationship that is captured by the Phillips curve. The Fisher equation and monetary policy rule are typically related to the determination of interest rates and are not directly affected by supply shocks. Adaptive expectations can be incorporated throughout the model, but do not specifically relate to the supply shock variable.

Question 13

According to the Phillips curve, firms prices when output is below the natural level of output, or equivalently, when the unemployment rate is the natural rate of unemployment.
A)raise; above
B)raise; below
C)lower; above
D)lower; below

Accepted Answer

The Phillips curve shows an inverse relationship between unemployment and inflation. This means that when unemployment is above its natural rate, firms will have less pricing power and will lower their prices to remain competitive. Therefore, choice C is correct: firms lower prices when output is below the natural level of output, or equivalently, when the unemployment rate is above the natural rate of unemployment.

Question 14

According to the monetary policy rule, the central bank sets the nominal interest rate so the real interest rate increases when inflation its target, or output its natural level.
A)rises above; rises above
B)rises above; falls below
C)falls below; falls below
D)falls below; rises above

Accepted Answer

The monetary policy rule suggests that the central bank raises the nominal interest rate to increase the real interest rate when inflation rises above its target or when output rises above its natural level, to stabilize the economy.

Question 15

The monetary policy rule specified in the dynamic model of aggregate demand and aggregate supply indicates that the central bank adjusts interest rates in response to fluctuations in:
A)inflation expectations.
B)money supply and money demand.
C)inflation and output.
D)nominal and real exchange rates.

Accepted Answer

The monetary policy rule in the dynamic model of aggregate demand and aggregate supply suggests that the central bank adjusts interest rates based on the changes in inflation and output. This is because the main goal of monetary policy is to stabilize prices while promoting economic growth.To achieve this objective, the central bank uses interest rate adjustments to influence spending, investment, and borrowing in the economy. Therefore, the correct answer is C.

Question 16

Long-run growth the demand for goods and services.
A)increases
B)decreases
C)does not change
D)may either increase or decrease

Accepted Answer

Long-run growth generally increases the demand for goods and services as the population grows, incomes rise, and technological advancements are made.

Question 17

Which of the following would be represented by a positive value of the random supply shock, υ ?
T
A)an irrational wave of optimism among investors
B)an increase in government spending
C)widespread drought leading to large increases in food prices
D)an increase in the central bank's inflation target

Accepted Answer

A positive value of the random supply shock, υ, typically represents an adverse supply shock, such as a widespread drought leading to large increases in food prices.

Question 18

According to the Phillips curve, firms raise prices when output is the natural level of output, or equivalently, when the unemployment rate is the natural rate of unemployment.
A)above; above
B)above; below
C)below; below
D)below; above

Accepted Answer

The Phillips curve shows an inverse relationship between inflation and unemployment. Specifically, it suggests that as unemployment falls below its natural rate, inflation will rise, and vice versa. Therefore, when unemployment is below its natural rate (i.e. the economy is at or above its potential level of output), firms will raise their prices. Conversely, when unemployment is above its natural rate (i.e. the economy is below its potential level of output), firms will lower their prices to compete for a smaller pool of demand, leading to lower inflation. Choice B correctly identifies that firms raise prices when output is at the natural level of output (or above), and when unemployment is at the natural rate of unemployment (or below).

Question 19

In the dynamic model, the demand for goods and services decreases as the natural level of output or the real rate of interest .
A)increases; increases
B)increases; decreases
C)decreases; decreases
D)decreases; increases

Accepted Answer

According to the dynamic model, an increase in the natural level of output or real rate of interest leads to a decrease in demand for goods and services, as higher output and interest rates result in lower investment and consumption spending by households and businesses. Therefore, the correct option is D, which shows that the demand for goods and services decreases as the natural level of output or the real rate of interest increases.

Question 20

In order to achieve the target for the nominal interest rate established by the monetary policy rule, the central banks adjusts:
A)the inflation rate.
B)the natural rate of interest.
C)the money supply.
D)the inflation target.

Accepted Answer

The central bank adjusts the money supply in order to achieve the target for the nominal interest rate established by the monetary policy rule. By increasing or decreasing the money supply, the central bank can affect the market interest rates and move them towards the desired level. The inflation rate and target, as well as the natural rate of interest, may affect the central bank's decision to adjust the money supply, but they are not directly adjusted themselves.

Quiz 14: The Basic Tools of Finance

According to the Phillips curve, inflation depends on expected inflation because:

In the dynamic model, the demand for goods and services will as the natural level of output increases and As the real interest rate increases.

To follow a monetary policy rule, the central bank raises the nominal interest rate by:

Which of the following would be represented by a negative value of the random supply shock, υt ? \text { ? } ?

The dynamic model of aggregate demand and aggregate supply assumes that people form expectations of inflation based on:

The natural rate of interest is the real interest rate:

A higher real interest rate reduces the demand for goods and services by:

According to the monetary policy rule, when inflation is at its target level and output is at the natural level, then the real interest rate equals the:

According to the monetary policy rule, the central bank sets the nominal interest rate so the real interest rate When inflation is above its target and the real interest rate when output is below its natural level.

The real interest rate at which, in the absence of any shock, the demand for goods and services equals the natural level of output is called the rate of interest.

Expectations of inflation based on recently observed inflation is called the assumption of expectations.

In the dynamic model, the supply shock variable, υ , is a variable appearing in which of the following equations of the T Model?

According to the Phillips curve, firms prices when output is below the natural level of output, or equivalently, when the unemployment rate is the natural rate of unemployment.

According to the monetary policy rule, the central bank sets the nominal interest rate so the real interest rate increases when inflation its target, or output its natural level.

The monetary policy rule specified in the dynamic model of aggregate demand and aggregate supply indicates that the central bank adjusts interest rates in response to fluctuations in:

Long-run growth the demand for goods and services.

Which of the following would be represented by a positive value of the random supply shock, υ ? T

According to the Phillips curve, firms raise prices when output is the natural level of output, or equivalently, when the unemployment rate is the natural rate of unemployment.

In the dynamic model, the demand for goods and services decreases as the natural level of output or the real rate of interest .

In order to achieve the target for the nominal interest rate established by the monetary policy rule, the central banks adjusts:

Which of the following would be represented by a negative value of the random supply shock, υt $\text { ? }$