Question 1

Consider the AD/AS model. In the long run, after factor prices have fully adjusted to any output gaps, real GDP

Accepted Answer

The answer of Consider the AD/AS model. In the long...

Question 2

If an economy is experiencing neither a recessionary gap nor an inflationary gap, the real output of the economy will be reflected by

Accepted Answer

When an economy is experiencing neither a recessionary gap nor an inflationary gap, it is producing at its potential output level, which is represented by the intersection of the aggregate demand (AD) and aggregate supply (AS) curves. Therefore, the answer is E, the intersection of the AD and AS curves at potential output.

Question 3

As a global recession began in late 2008, the governments of all major economies searched for policy responses to dampen the effects of the recession. In general, governments were aiming to

Accepted Answer

Governments aimed to shift the AD curve to the right through large increases in government spending to stimulate demand and boost economic activity during the recession. This policy response is known as expansionary fiscal policy. A decrease in tax rates might also boost demand but would be less effective during a recession when people may choose to save rather than spend. Increasing potential GDP through long-term structural reforms and investments also remains important, but government spending was the most effective short-term response to the recession. Shifting the AS curve cannot be achieved through government spending alone and would require structural reforms, supply-side policies, or changes in market conditions. Increasing wage rates would shift the AS curve to the left, reducing output and increasing inflation, which would be counterproductive during a recession.

Question 4

Which of the following statements about fiscal policy is the best description of "fine tuning"?

Accepted Answer

Fine tuning refers to the continuous adjustment of fiscal policy (spending and taxing) by the government to ensure that the economy is operating at its potential level of output. This may involve both increasing or decreasing spending or taxes, depending on the economic situation, in order to steer the economy towards full employment and stable prices. Option C correctly describes this concept. Options A and D refer to specific instances of policy action rather than the continuous adjustment of policy, while option B refers to a one-time action in response to a recessionary gap. Option E refers specifically to automatic stabilizers, which are a feature of fiscal policy that can aid in stabilizing the economy, but is not a description of fine tuning.

Question 5

The "asymmetry" in the behaviour of aggregate supply refers to the

Accepted Answer

The asymmetry in the behaviour of aggregate supply refers to the fact that the economy adjusts to positive output gaps (when actual output is above potential output) more slowly than it adjusts to negative output gaps (when actual output is below potential output). This is because prices and wages are sticky and adjust more slowly in response to positive shocks such as increased demand. In comparison, in response to negative shocks such as a recession, prices and wages can adjust more readily downward.

Question 6

The Phillips curve provides a theoretical link between

Accepted Answer

The Phillips curve provides a theoretical link between the goods market and the labour market by describing the inverse relationship between unemployment and inflation. The curve suggests that as unemployment decreases, inflation increases and vice versa. This is because when the labour market is tight and there are few workers available, employers are forced to increase wages to attract workers, which leads to higher costs for businesses and ultimately higher prices for goods and services. On the other hand, in times of high unemployment, workers are more willing to accept lower wages and there is less pressure on businesses to increase prices.

Question 7

The growth rate of potential output might be decreased by an expansionary fiscal policy if

Accepted Answer

An expansionary fiscal policy, which involves increased government spending and/or tax cuts, can lead to crowding out of private investment. This occurs when the increased demand for funds from the government leads to higher interest rates, making it expensive for private businesses to borrow money for investment. If private investment is crowded out, it can lead to a decrease in productivity and potential output growth.

Question 8

An expansionary fiscal policy that takes the form of an increase in government purchases carries the possibility that private investment _ and, as a result, the future growth rate of .

Accepted Answer

An expansionary fiscal policy in the form of an increase in government purchases may raise interest rates, which can discourage private investment by making it more expensive to borrow money. This is known as crowding out. As a result, potential output may be reduced because private investment is a key driver of economic growth.

Question 9

Which of the following characteristics define the long run in macroeconomics?

Accepted Answer

In the long run, factor prices adjust to eliminate output gaps, and technology and factor supplies can change, reflecting economic growth and development.

Question 10

An inflationary output gap occurs when

Accepted Answer

An inflationary output gap occurs when actual GDP exceeds potential GDP, which means that the economy is producing more than its long-run potential and is operating above its capacity. This can lead to increased inflationary pressures in the economy. Option A is incorrect as it describes a situation of a recessionary output gap where actual GDP is lower than potential GDP. Option B is irrelevant to an inflationary output gap. Option C is also incorrect as it describes a recessionary output gap. Option E describes a situation where there is inflation but does not necessarily relate to an output gap.

Question 11

Which of the following describes the distinction between the Phillips curve and the AS curve?

Accepted Answer

The AS (Aggregate Supply) curve typically has the price level on the vertical axis, while the Phillips curve has the rate of wage changes or inflation on the vertical axis.

Question 12

What is sometimes called the "long- run aggregate supply curve" shows the relationship between the price level and aggregate supply over a time period long enough to permit

Accepted Answer

The answer of What is sometimes called the "long- run...

Question 13

Suppose the government had made a decision to change fiscal policy, but it then took nine months to implement a tax reduction. This is an example of

Accepted Answer

The delay in implementing the tax reduction is an example of an execution lag, which occurs when the government decides to change fiscal policy but takes time to implement the policy. Automatic fiscal stabilizers refer to changes in government spending and taxation that occur automatically without explicit action from policy-makers. A decision lag is the time it takes for policy-makers to recognize a problem and decide on a course of action, while fine tuning and gross tuning refer to the degree and direction of changes in fiscal policy.

Question 14

Income taxes in Canada can be considered to be automatic stabilizers because tax

Accepted Answer

Income taxes in Canada can be considered to be automatic stabilizers because they increase when income increases, which helps to reduce the increase in aggregate demand. This happens because as income increases, people have more disposable income, and therefore may spend more, which can drive up demand and potentially lead to inflation. However, higher income also means higher taxes, which reduces the amount of disposable income available to spend. As a result, higher taxes can help to moderate increases in aggregate demand and stabilize the economy.

Question 15

Consider the AD/AS macro model. A permanent demand shock that causes equilibrium output to rise above potential output will

Accepted Answer

In the long run, the economy will adjust and shift the short-run aggregate supply curve leftward, returning output to potential and negating the demand shock. This adjustment process may involve higher wages, increased investment, and technological advances that boost productivity. As a result, the price level may end up higher, lower, or the same as before the demand shock, depending on the specifics of the adjustment process. However, the economy will not get stuck in an inflationary spiral or deflationary spiral, as the AD/AS model emphasizes the self-correcting nature of market forces.

Question 16

The economy's output gap is defined as the

Accepted Answer

The economy's output gap is defined as the difference between actual GDP and potential GDP. This represents the amount of unused economic resources in the economy, and can be used as a measure of economic underutilization or overutilization.

Question 17

Which of the following statements about output gaps is true?

Accepted Answer

When actual GDP is above potential GDP, the economy is operating above its capacity, leading to increased demand for labor and upward pressure on wages.

Question 18

A common assumption among macroeconomists is that when real GDP is less than potential output, factor prices adjust and the

Accepted Answer

When real GDP is less than potential output, factor prices, such as wages, tend to decrease slowly, leading to a gradual rightward shift of the Aggregate Supply (AS) curve as the economy adjusts back to potential output.

Question 19

Consider the basic AD/AS model, and suppose there is a negative output gap. If an expansionary fiscal policy is pursued and the AS curve shifts leftward unexpectedly, the fiscal policy may be , and real GDP may _ _ potential GDP.

Accepted Answer

If the AS curve shifts leftward unexpectedly, it indicates a decrease in aggregate supply, which can counteract the effects of expansionary fiscal policy. This means the fiscal policy might be too weak to close the negative output gap, and real GDP may remain below potential GDP.

Question 20

A recessionary output gap implies that

Accepted Answer

A recessionary output gap means that the actual output is less than the potential output, indicating underutilization of resources and lower demand for factor services.

Quiz 24: From the Short Run to the Long Run: the Adjustment of Factor Prices