Question 1

Real business cycle theory emphasizes that an adverse supply shock will shift the LRAS curve leftward and cause a decline in Real GDP.

Accepted Answer

Real business cycle theory posits that fluctuations in economic activity are primarily driven by changes in technology and productivity, which are considered supply-side factors. An adverse supply shock, such as a sudden increase in oil prices or a natural disaster that disrupts production, would reduce the supply of goods and services and shift the LRAS curve leftward. This would result in higher prices and lower real GDP, as the economy operates at a lower level of output and employment due to the reduced availability of productive resources.

Question 2

The Friedman natural rate theory is based on rational expectations and is also called the new classical theory.

Accepted Answer

The Friedman natural rate theory is based on the concept that there is a natural rate of unemployment in the economy, but it does not rely on rational expectations. The theory of rational expectations is a separate concept that was later integrated into macroeconomic models by the New Classical economists.

Question 3

A person's real wage will fall if the nominal wage falls,the price level rises,or both.

Accepted Answer

Real wage is the purchasing power of a person's wage. If the nominal wage falls (the wage amount in current dollars), and the price level rises (the cost of goods and services), then the purchasing power of the person's wage decreases, leading to a fall in their real wage.

Question 4

New classical economists believe that monetary and fiscal policies are never effective.

Accepted Answer

New classical economists believe that monetary and fiscal policies can be effective in the short run but argue that in the long run, these policies are neutralized by adjustments in expectations and behavior, making them ineffective in changing real output or employment.

Question 5

The policy ineffectiveness proposition (PIP)argument states that under certain circumstances,neither expansionary demand-side fiscal policy nor expansionary monetary policy is effective at achieving macroeconomic goals.

Accepted Answer

The policy ineffectiveness proposition argues that under conditions of rational expectations, policy actions will not have a significant impact on economic outcomes because individuals will adjust their behavior in anticipation of the policy actions. Thus, neither fiscal policy nor monetary policy can effectively achieve macroeconomic goals.

Question 6

If stagflation is present the short-run Phillips curve is vertical.

Accepted Answer

Stagflation is characterized by high inflation and high unemployment, which suggests that the short-run Phillips curve is not vertical. A vertical Phillips curve implies that there is no trade-off between inflation and unemployment, which contradicts the conditions of stagflation.

Question 7

The original Phillips curve depicted an inverse relationship between wage inflation and unemployment.

Accepted Answer

The original Phillips curve showed that as unemployment decreases, wage inflation increases, and vice versa.

Question 8

One of the arguments supporting new classical theory is the policy ineffectiveness proposition (PIP).

Accepted Answer

The policy ineffectiveness proposition is a central argument of the new classical theory, stating that changes in macroeconomic policy will not have a significant impact on the long-run level of output or employment.

Question 9

According to new classical theory,if policy is correctly anticipated,expectations are formed rationally,and wages and prices are fully flexible,then an increase in aggregate demand will change Real GDP,but not the price level.

Accepted Answer

According to new classical theory, if policy is correctly anticipated, expectations are formed rationally, and wages and prices are fully flexible, then an increase in aggregate demand will not change Real GDP, but only the price level.

Question 10

The real business cycle theory focuses on the impact that changes in long-run aggregate supply will have on the business cycle.

Accepted Answer

The real business cycle theory emphasizes the role of technological shocks and changes in the labor market as the primary drivers of business cycles, and how they affect long-run aggregate supply.

Question 11

The terms rational expectations and adaptive expectations are two different names for the same concept.

Accepted Answer

Rational expectations and adaptive expectations are not the same concept. Rational expectations assume that individuals use all available information to form their expectations, while adaptive expectations assume that individuals form their expectations based on past experiences or trends.

Question 12

Rational expectations theory is also known as the Friedman fooling theory.

Accepted Answer

Rational expectations theory was developed by economists other than Friedman, and the term "Friedman fooling theory" was not widely used.

Question 13

An unanticipated decrease in aggregate demand will cause an upward shift in the short-run Phillips curve.

Accepted Answer

According to the Phillips curve, there is a negative relationship between unemployment and inflation. An unanticipated decrease in aggregate demand will lead to lower output and higher unemployment in the short run, which will shift the Phillips curve downward (i.e., lower inflation for any given level of unemployment).

Question 14

Although the possibility exists for an economy to experience stagflation,it has never actually happened in the United States.

Accepted Answer

Stagflation has actually occurred in the United States during the 1970s, marked by a combination of high inflation and high unemployment.

Question 15

As long as some people anticipate policy,the economic consequences may be the same as if all persons do so.

Accepted Answer

The anticipation of policy by some individuals can have a significant impact on economic behavior and outcomes, even if not everyone anticipates it. For example, if investors anticipate a change in interest rates, they may adjust their investment decisions accordingly, affecting asset prices and overall economic activity. Therefore, the economic consequences of policy anticipation may be similar to those of widespread anticipation, even if not everyone is aware of it.

Question 16

Rational expectations are based on the past alone,while adaptive expectations are based on the past,the present,and the future.

Accepted Answer

Rational expectations are based on all available information, including past, present, and future, while adaptive expectations are based primarily on past information.

Question 17

New Keynesian theory differs from new classical theory in that New Keynesian theory assumes that wages and prices are not completely flexible in the short-run,while fully flexible wages and prices are an assumption of new classical theory.

Accepted Answer

New Keynesian theory assumes that wages and prices are not completely flexible in the short-run, while new classical theory assumes fully flexible wages and prices.

Question 18

The Friedman natural rate theory holds that there is an inverse relationship between inflation and unemployment in the long run,but not in the short run.

Accepted Answer

The Friedman natural rate theory actually posits that there is no trade-off between inflation and unemployment in the long run, meaning that attempts to reduce unemployment below its natural rate by increasing inflation only lead to higher inflation in the long run without affecting unemployment.

Question 19

New classical economists believe that it is possible under certain circumstances for an increase in the money supply to lead to a decrease in Real GDP in the short run.

Accepted Answer

New classical economists argue that in the short run, an increase in the money supply might lead to an increase in prices and wages, which in turn could increase the cost of production and decrease the overall supply of goods and services. This can lead to a decrease in Real GDP in the short run. However, they believe that in the long run, prices and wages will adjust to the increase in the money supply, and Real GDP will return to its natural level.

Question 20

According to Milton Friedman,there are two Phillips curves,a short-run one and a long-run one.

Accepted Answer

Milton Friedman proposed that there are two Phillips curves- a short-run Phillips curve and a long-run Phillips curve. The short-run Phillips curve represents the inverse relationship between inflation and unemployment in the short run, while the long-run Phillips curve shows that in the long run there is no trade-off between inflation and unemployment.

Quiz 16: Expectations Theory and the Economy