Deck 16: Expectations Theory and the Economy

Question 1

The Samuelson-Solow version of the Phillips curve showed the relationship between unemployment rates and

A)Real GDP growth rates.
B)price inflation rates.
C)wage inflation rates.
D)imports.

Answer 1

B

Question 2

Milton Friedman argued that the economy is not in long-run equilibrium if the expected inflation rate __________ the actual inflation rate.

A)is less than
B)is greater than
C)equals
D)a and b

Answer 2

D

Question 3

According to new classical theory,if the public correctly anticipates a government policy to increase aggregate demand,then the

A)short-run Phillips curve will be upward sloping,but the long-run Phillips curve will be downward-sloping.
B)long-run Phillips curve will be upward sloping,but the short-run Phillips curve will be downward-sloping.
C)short-run Phillips curve will be upward sloping,but the long-run Phillips curve will be vertical.
D)long run Phillips curve will be upward sloping,but the short-run Phillips curve will be vertical.
E)short- and long-run Phillips curves will be vertical.

Answer 3

E

Question 4

Milton Friedman argued that there

A)are two Phillips curves,a short-run one and a long-run one.
B)are three Phillips curves,a short-run one,a long-run one,and one in stagflation.
C)is one Phillips curve,and it is vertical.
D)is one Phillips curve,and it is nearly flat or horizontal.

Question 5

In their 1960 article,Paul Samuelson and Robert Solow found

A)a direct relationship between inflation and investment expenditures.
B)an inverse relationship between inflation and investment expenditures.
C)a direct relationship between inflation and unemployment.
D)an inverse relationship between inflation and unemployment.

Question 6

According to new classical economists,if a decrease in aggregate demand is correctly anticipated,the short-run aggregate supply curve will shift __________ at the same time the AD curve shifts _________ so that there will be no change in Real GDP.

A)rightward;rightward
B)leftward;rightward
C)leftward;rightward
D)rightward;leftward
E)none of the above

Question 7

New classical economists believe that there is

A)a short-run tradeoff between inflation and unemployment when policy is unanticipated.
B)a short-run tradeoff between inflation and unemployment when policy is correctly anticipated.
C)no short-run tradeoff between inflation and unemployment when policy is correctly anticipated.
D)a and b
E)a and c

Question 8

Exhibit 16-1
Refer to Exhibit 16-1.Milton Friedman would most likely have called the vertical line on which points A and C are located the

A)long-run aggregate supply curve.
B)Friedman curve.
C)long-run Phillips curve.
D)short-run aggregate supply curve.
E)short-run Phillips curve.

Question 9

The short-run Phillips curve holds that

A)high inflation and high unemployment can occur together.
B)low inflation and low unemployment can occur together.
C)high inflation and low unemployment can occur together.
D)b and c

Question 10

If the public has rational expectations,

A)the only effective policy would be one that is implemented by surprise.
B)if the public incorrectly anticipates a given policy,there could be adverse results.
C)if policymakers do not do what they say they are going to do,then there could be adverse results.
D)a,b,and c
E)none of the above

Question 11

According to rational expectations theory,

A)every day is a new day and yesterday's occurrences have no bearing on today's decisions.
B)when making decisions a person will consider only information based on past experience.
C)even though a person considers information related to future events as potentially important for decision making,he realizes that such information is unreliable and worthless.
D)past experience is a good guide for decision making,but so is information related to possible future outcomes.

Question 12

Exhibit 16-1
Refer to Exhibit 16-1.Suppose the economy is currently at point B on the short-run Phillips curve,SRPC₁.What could get the economy to move to point C on SRPC₂?

A)The realization on the part of workers that their currently held expected inflation rate is too high;they revise it upward,thus shifting the short-run aggregate supply curve rightward.
B)The realization on the part of workers that their currently held expected inflation rate is too high;they revise it downward,thus shifting the short-run aggregate supply curve rightward.
C)The realization on the part of workers that their currently held expected inflation rate is too low;they revise it upward,thus shifting the short-run aggregate supply curve leftward.
D)The realization on the part of workers that their currently held expected inflation rate is too low;they revise it downward,thus shifting the short-run aggregate supply curve rightward.

Question 13

Exhibit 16-1
Refer to Exhibit 16-1.Suppose the economy is currently at point A on the short-run Phillips curve,SRPC₁.What could get the economy to move to point B?

A)an increase in aggregate demand combined with an unchanged expected inflation rate
B)an increase in aggregate demand combined with a rise in the expected inflation rate
C)a rise in the expected inflation rate
D)a decrease in aggregate demand combined with an unchanged expected inflation rate
E)none of the above

Question 14

The Phillips curve that Samuelson and Solow fitted to their data was

A)upward sloping.
B)downward sloping.
C)vertical.
D)horizontal.

Question 15

Stagflation is the simultaneous occurrence of

A)low inflation and high unemployment.
B)high inflation and low unemployment.
C)low inflation and low unemployment.
D)high inflation and high unemployment.

Question 16

According to the new classical theory,if the public correctly anticipates a government policy to increase aggregate demand,then

A)there will be a short-run tradeoff between inflation and unemployment,but there will not be a long-run tradeoff.
B)there will be a long-run tradeoff between inflation and unemployment,but there will not be a short-run tradeoff.
C)there will be both a long-run and a short-run tradeoff between inflation and unemployment.
D)there will be neither a long-run nor a short-run tradeoff between inflation and unemployment.
E)there may be a short-run tradeoff between inflation and unemployment,but one cannot say for certain whether there will be a long-run tradeoff.

Question 17

Stagflation implies that

A)a tradeoff between inflation and unemployment may not always exist.
B)policymakers can choose to have less unemployment if they are willing to accept a higher rate of inflation.
C)the short-run Phillips curve is stable.
D)the short-run Phillips curve is vertical.

Question 18

When everyone correctly anticipates that the Fed will buy government securities,then they know that prices will increase.Which of the following adjustments is not likely to occur?

A)Workers will negotiate higher wages.
B)Suppliers of resources will demand higher prices for their resources.
C)Producers will prevent the price level from increasing and hurting their sales.
D)Producers will raise prices.

Question 19

Milton Friedman argued that there is a

A)permanent downward-sloping Phillips curve.
B)temporary downward-sloping Phillips curve.
C)temporary upward-sloping Phillips curve.
D)permanent upward-sloping Phillips curve.

Question 20

The simultaneous occurrence of high inflation and high unemployment is called

A)reverberation.
B)disinflation.
C)stagflation.
D)"fooling."

Question 21

Starting from long-run equilibrium,if the public anticipates that policymakers will increase aggregate demand by less than policymakers do increase aggregate demand,and if the short-run aggregate supply curve fully adjusts to the (incorrectly)anticipated increase in aggregate demand,then Real GDP will __________ and the price level will __________.

A)rise;rise
B)decline;fall
C)stay constant;rise
D)decline;rise

Question 22

Exhibit 16-2
Refer to Exhibit 16-2.Suppose the economy starts at point A.Fed monetary policy shifts the AD curve to AD₂.A rise in Real GDP is likely if the economy operates under __________ assumptions,such as wage and price __________.

A)new classical;flexibility
B)new classical;inflexibilities
C)new Keynesian;flexibility
D)new Keynesian;inflexibilities

Question 23

If expectations are formed rationally,wages and prices are completely flexible in both the short run and the long run,and policy is correctly anticipated,increases in aggregate demand will stimulate the economy to higher levels of Real GDP in

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

Question 24

Exhibit 16-2
Refer to Exhibit 16-2.Suppose the economy starts out at point A and the public correctly anticipates that the AD curve will shift from AD₁ to AD₂.If wages are temporarily fixed,SRAS₁ will __________ and the economy will end up at point __________.

A)shift;D
B)shift;B
C)not shift;D
D)not shift;E

Question 25

The difference between new classical theory and new Keynesian theory is that

A)in new classical theory wages are assumed to be flexible,and in new Keynesian theory wages are assumed to be somewhat inflexible.
B)in new classical theory wages are assumed to be somewhat inflexible,and in new Keynesian theory wages are assumed to be flexible.
C)adaptive expectations is the dominant expectations theory in new classical theory,and rational expectations is the dominant expectations theory in new Keynesian theory.
D)in new Keynesian theory the short-run aggregate supply curve is vertical,and in new classical theory the short-run aggregate supply curve is upward sloping.

Question 26

The original Phillips curve depicted the relationship between

A)price inflation and unemployment.
B)price inflation and employment.
C)wage inflation and unemployment.
D)wage inflation and employment.

Question 27

Implied in new Keynesian theory is that when policy is correctly anticipated,there is a tradeoff between inflation and unemployment in

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

Question 28

According to new Keynesian theory,if policy is correctly anticipated,increases in aggregate demand will stimulate the economy to higher levels of Real GDP and lower levels of unemployment in

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

Question 29

The Friedman natural rate theory implies that there is a tradeoff between inflation and unemployment in

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

Question 30

If expectations are formed rationally,wages and prices are not completely flexible in the short run,and policy is correctly anticipated,increases in aggregate demand will stimulate the economy to higher levels of Real GDP and lower levels of unemployment in

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

Question 31

If expectations are formed rationally,wages and prices are completely flexible in the short run and policy is correctly anticipated,increases in aggregate demand will

A)cause lower short-run price level increases than a Keynesian would expect.
B)cause higher short-run price level increases than a Keynesian would expect.
C)not impact the general price level.
D)produce both increases and decreases in the price level at different times.

Question 32

Suppose that in a new classical model the public anticipates that policymakers will increase aggregate demand.However,aggregate demand increases by less than what the public anticipated.The result in the short run is that Real GDP ____________ and the price level ____________.

A)decreases;decreases
B)increases;increases
C)increases;decreases
D)decreases;increases

Question 33

Stagflation

A)is highly unlikely if the Phillips curve is downward sloping.
B)implies that a tradeoff between inflation and unemployment may not always exist.
C)is the simultaneous occurrence of high rates of inflation and unemployment.
D)b and c
E)a,b,and c

Question 34

New classical economists believe that if policy is correctly anticipated and if rational expectations hold,when the Fed increases the money supply the result will be a(n)______________ in the price level and ____________________________.

A)decrease;no change in Real GDP
B)decrease;decrease in Real GDP
C)increase;no change in Real GDP
D)increase;increase in Real GDP

Question 35

Exhibit 16-2
Refer to Exhibit 16-2.Suppose the economy starts at point B.Fed monetary policy shifts the AD curve to AD₁.A recession is likely if the economy operates under __________ assumptions,which include wage and price __________.

A)new classical;flexibility
B)new classical;inflexibilities
C)new Keynesian;flexibility
D)new Keynesian;inflexibilities

Question 36

Samuelson and Solow,in their 1960 study of the Phillips curve as it applies to the U.S.experience,argued that there was a tradeoff between inflation and unemployment.Later experience showed their analysis to be

A)entirely correct in every situation.
B)generally correct,but it could not explain stagflation.
C)wholly wrong in every situation.
D)in general agreement with rational expectations theory.
E)capable of explaining stagflation,but not other economic scenarios.

Question 37

According to a new Keynesian theorist,a correctly anticipated increase in aggregate demand will

A)cause the price level to increase by a greater amount in the short run than what a new classical rational expectations theorist would predict.
B)cause the price level to increase by a smaller amount in the short run than what a new classical rational expectations theorist would predict.
C)cause the price level to increase by the same amount in the short run that a new classical rational expectations theorist would predict.
D)leave the price level unchanged in the short run,but Real GDP will increase more than what a new classical theorist would predict.
E)leave the price level unchanged in the short run,but Real GDP will increase less than what a new classical theorist would predict.

Question 38

The difference between the new classical theory and the new Keynesian theory is the assumption of

A)rational expectations.
B)adaptive expectations.
C)complete flexibility of wages and prices in the short run.
D)a and c
E)b and c

Question 39

The Friedman natural rate theory states that

A)in both the short run and the long run the economy stays at its natural rate of unemployment.
B)the economy will not return to its natural rate of unemployment in either the short run or the long run.
C)the economy stays at its natural rate of unemployment in the short run,but not in the long run.
D)in the long run the economy returns to its natural rate of unemployment.

Question 40

New Keynesian theorists argue that

A)price and wage adjustments in response to policy changes often overcompensate and cause further price disruptions.
B)prices and wages may not be free to adjust in response to policy changes.
C)unions and big business have considerable power and often choose not to change wages and prices so as to deliberately offset policy changes enacted by the government.
D)the Fed and the Congress rarely do what they say they will do,so one should never listen to what they say.
E)new classical rational expectations theories about how expectations are formed are completely wrong.

Question 41

According to the real business cycle theory,business cycle contractions are generally caused by

A)the self-interest of politicians.
B)decreases in business investment.
C)decreases in the growth rate of the money supply.
D)decreases in the economy's capacity to produce.
E)all of the above

Question 42

Which theory of the business cycle emphasizes initiating changes in aggregate supply?

A)the Friedman "fooling" theory
B)the real business cycle theory
C)the Keynesian theory
D)the new classical theory

Question 43

An unexpected decrease in aggregate demand will cause

A)a movement up the short-run Phillips curve.
B)a movement down the short-run Phillips curve.
C)an upward shift in the short-run Phillips curve.
D)a downward shift in the short-run Phillips curve.

Question 44

Events of the 1970s and early 1980s showed that

A)the Phillips curve presents policymakers with a stable menu of choices.
B)cycles of unemployment and inflation rates appear to have gravitated around a 6 percent unemployment rate.
C)lower inflation rates are consistently accompanied by higher unemployment rates.
D)a tradeoff between inflation and unemployment may not always exist.
E)a and c

Question 45

Which of the following changes would not be considered a likely source of changes in Real GDP according to real business cycle theory?

A)a natural disaster
B)a technological change
C)a change in the price of an important input
D)a change in the money supply
E)none of the above

Question 46

For the period 1961 to 1969,the Phillips curve for the United States displayed the same shape that
A)horizontal.

A)W.Phillips found for the United Kingdom for the period 1861 to 1913---it was
B)vertical.
C)downward sloping.
D)upward sloping.

Question 47

The original (1958)Phillips curve stated that

A)unemployment and money wage rates move in the same direction.
B)unemployment and money wage rates move in opposite directions.
C)there is an inverse relationship between price inflation and unemployment.
D)there is a direct relationship between price inflation and unemployment.
E)a and c

Question 48

The Samuelson-Solow version of the Phillips curve states that

A)there is an inverse relationship between the wage inflation rate and unemployment.
B)there is a direct relationship between the wage inflation rate and unemployment.
C)there is an inverse relationship between price inflation and unemployment.
D)there is a direct relationship between price inflation and unemployment.
E)a and b

Question 49

The real business cycle theory holds that the business cycle

A)originates as a result of factors affecting aggregate supply.
B)originates as a result of factors affecting aggregate demand.
C)is the result of correctly anticipated policies.
D)is the result of incorrectly anticipated policies.

Question 50

According to the original Phillips curve,the cost of reducing the unemployment rate in the short run is a

A)fall in Real GDP.
B)fall in nominal GDP.
C)lower rate of price inflation.
D)higher rate of wage inflation.

Question 51

As incorrectly low inflation expectations catch up with the higher actual inflation rate,the SRAS curve shifts __________ and the short-run Phillips curve shifts __________.

A)leftward;downward
B)rightward;upward
C)leftward;upward
D)rightward;downward

Question 52

The original (1958)Phillips curve

A)showed that stagflation is inevitable.
B)showed the tradeoff between the use of monetary and fiscal policy.
C)has never been used as an important economic policy tool.
D)suggested a tradeoff between wage inflation and the unemployment rate.
E)none of the above

Question 53

The main difference between new classical and new Keynesian theory is with respect to the assumption of

A)how expectations are formed.
B)how flexible wages and prices are.
C)the slope of the SRAS curve.
D)the slope of the AD curve.

Question 54

One of the ideas that found a permanent place in macroeconomics after Milton Friedman's presidential address to the American Economic Association in 1967 was that

A)there is not only a temporary tradeoff between inflation and unemployment,but a permanent tradeoff as well.
B)the tradeoff between unemployment and inflation exists only in the long run,but not in the short run.
C)people's expectations about economic events affect economic outcomes.
D)a and b

Question 55

An increase in the actual inflation rate is represented by a

A)movement up and along a given Phillips curve.
B)movement down and along a given Phillips curve.
C)leftward shift in the Phillips curve.
D)rightward shift in the Phillips curve.

Question 56

In the real business cycle theory,business cycle contractions begin as a result of changes in

A)aggregate GDP.
B)aggregate spending.
C)aggregate demand.
D)aggregate consumption.
E)long-run aggregate supply.

Question 57

Under new Keynesian theory,a correctly anticipated decrease in aggregate demand will lead to __________ in Real GDP and __________ in the price level.

A)a decrease;a decrease
B)no change;an increase
C)no change;no change
D)an increase;an increase
E)an increase;no change

Question 58

In the 1970s and early 1980s,the U.S.economy experienced

A)stagflation.
B)low inflation and low unemployment.
C)high inflation and low unemployment.
D)high inflation and high unemployment.
E)a and d

Question 59

In real business cycle theory,business cycle expansions begin as a result of changes in

A)GDP.
B)long-run aggregate supply.
C)aggregate demand.
D)consumption.
E)investment demand.

Question 60

Real business cycle theory would emphasize the ability of a beneficial supply shock to shift the __________ curve rightward and __________ Real GDP.

A)AD;lower
B)AD;raise
C)LRAS;lower
D)LRAS;raise

Question 61

New classical economists build their theories upon

A)adaptive expectations.
B)inflexible wages and prices.
C)rational expectations.
D)the assumption that it takes a long time for markets to achieve equilibrium values.

Question 62

The economy is in long-run equilibrium when government unexpectedly increases aggregate demand.The expected inflation rate is slow to adjust to the higher (actual)inflation rate.If follows that in the short run,according to the Friedman natural rate theory,__________ rises and the __________ falls.

A)the unemployment rate,price level
B)Real GDP rises,unemployment rate
C)nominal interest rate,real interest rate
D)the unemployment rate,Real GDP level
E)none of the above

Question 63

Exhibit 16-4
Refer to Exhibit 16-4.If LRAS₁ shifts to LRAS₂,and this causes AD₁ to shift to AD₂,economists would call this a

A)rational expectations cycle.
B)policy ineffectiveness proposition.
C)short run Phillips curve.
D)real business cycle.

Question 64

Exhibit 16-4
Two key assumptions of new Keynesian theory include:

A)(1)people hold rational expectations,and (2)wages and prices are not completely flexible in the short run.
B)(1)people hold adaptive expectations,and (2)wages and prices are inflexible.
C)(1)people hold rational expectations,and (2)wages and prices are flexible.
D)(1)people hold neither adaptive nor rational expectations and (2)prices are inflexible.
E)none of the above

Question 65

The economy is in long-run equilibrium when there is a correctly anticipated increase in aggregate demand.In new Keynesian theory,the price level will rise __________ in the short run than it is predicted to rise in new classical theory.

A)by more
B)by less
C)by the same amount
D)faster
E)slower

Question 66

Exhibit 16-4
Refer to Exhibit 16-4.The economy is initially at point A,in long run equilibrium.A real business cycle would be represented by the following sequence of curve shifts:

A)SRAS₁ to SRAS₂,then LRAS₁ to LRAS₂.
B)AD₁ to AD₂,then LRAS₁ to LRAS₂.
C)LRAS₁ to LRAS₂,then AD₁ to AD₂.
D)LRAS₁ to LRAS₂,then SRAS₁ to SRAS₂.
E)none of the above

Question 67

The economy is in long-run equilibrium when there is an incorrectly anticipated increase in aggregate demand brought about by expansionary monetary policy.Specifically,aggregate demand increases by less than people anticipate (bias upward).According to new classical theory,the price level will __________ and Real GDP will __________ in the short run.In the long run,the price level will be __________ than it was before aggregate demand increased.

A)rise;rise;lower
B)rise;fall;higher
C)rise;fall;higher
D)fall;rise;lower
E)rise;rise;higher

Question 68

The economy is in long-run equilibrium when there is an incorrectly anticipated increase in aggregate demand brought about by expansionary monetary policy.Specifically,aggregate demand increases by more than people anticipate (bias downward).According to new classical theory,the price level will __________ and Real GDP will __________ in the short run.In the long run,the price level will be __________ than it was before aggregate demand increased.

A)rise;fall;higher
B)rise;rise;higher
C)fall;rise;lower
D)fall;rise;higher
E)rise;rise;lower

Question 69

The Friedman natural rate theory is built upon

A)rational expectations.
B)adaptive expectations.
C)flexible wages and prices.
D)the assumption of one Phillips curve.
E)b and c

Question 70

The Samuelson and Solow Phillips curve suggested a(n)__________ relationship between the rate of change in __________ and the unemployment rate.

A)direct;real wage rates
B)inverse;money wage rates
C)inverse;prices
D)direct;prices
E)none of the above

Question 71

The expected inflation rate is equal to the actual inflation rate.According to the (Friedman)natural rate theory,the economy is

A)in a recessionary gap.
B)in an inflationary gap.
C)at a point on the short-run Phillips curve,but not on the long-run Phillips curve.
D)biased toward producing a higher percentage of services than goods.
E)producing Natural Real GDP.

Question 72

Stagflation consists of

A)high inflation and low unemployment.
B)low inflation and high unemployment.
C)high inflation and high unemployment.
D)high unemployment and an economy in a deep recession.
E)none of the above

Question 73

The original Phillips curve suggests a(n)__________ relationship between the rate of change in __________ and the __________.

A)direct;prices;unemployment rate
B)inverse;money wage rates;unemployment rate
C)inverse;prices;unemployment
D)direct;money wage rates;money supply
E)inverse;money wage rates;money supply

Question 74

Milton Friedman argued that as long as

A)the unemployment rate is higher than the inflation rate,the economy is not in long-run equilibrium.
B)Real GDP grows,the inflation rate will fall.
C)the expected inflation rate is not equal to the actual inflation rate,the economy is not in long-run equilibrium.
D)nominal wages rise,so do real wages.
E)none of the above

Question 75

According to real business cycle theorists,if the long-run aggregate supply (LRAS)curve shifts to the left,Real GDP __________,the price level __________,the demand for labor __________,money wages __________,real wages __________,and workers choose to work __________.

A)falls;falls;rises;fall;fall;less
B)falls;rises;rises;fall;rise;more
C)falls;rises;falls;fall;fall;less
D)rises;rises;falls;fall;rise;more
E)rises;falls;rises;fall;fall;more

Question 76

According to Milton Friedman,the reason there are two Phillips curves is because

A)the expected inflation rate is always higher than the actual inflation rate.
B)wages are inflexible.
C)prices are inflexible.
D)the expected inflation rate does not instantaneously adjust to changes in the actual inflation rate.
E)the expected inflation rate is equal to 1 minus the actual inflation rate.

Question 77

According to new classical economists,when monetary and fiscal policies are __________ anticipated,people form their expectations __________,and wages and prices are __________,the policy ineffectiveness proposition (PIP)results.

A)correctly;adaptively;inflexible
B)correctly;rationally;flexible
C)incorrectly;adaptively;inflexible
D)incorrectly;rationally;flexible
E)correctly;rationally;inflexible

Question 78

The economy was in long-run equilibrium when aggregate demand increased.At this point in time,the expected inflation has started to adjust to the new higher actual inflation rate.According to the (Friedman)natural rate theory,this means the unemployment rate in the economy must currently be

A)decreasing.
B)increasing.
C)higher than it was in long-run equilibrium.
D)equal to what it was in long-run equilibrium.
E)There is not enough information to answer the question.

Question 79

If there is a stable downward-sloping Phillips curve,it follows that an economy can choose the combination of

A)high unemployment and low inflation.
B)low unemployment and high inflation.
C)moderate unemployment and moderate inflation.
D)low inflation and low unemployment.
E)a,b,and c

Question 80

The economy is in long-run equilibrium when there is a correctly anticipated increase in aggregate demand.According to new classical theory,the price level will __________ and Real GDP will __________.

A)fall;rise
B)rise;fall
C)fall;remain unchanged
D)rise;remain unchanged
E)remain unchanged;remain unchanged