Question 1

Following any AD or AS shock, economists typically assume that the adjustment process continues until
A)the output gap is at a stable level.
B)factor prices have returned to their levels previous to the shock.
C)Y* adjusts to its long- run equilibrium level.
D)the AD and AS curves intersect each other at the correct price level.
E)real GDP returns to Y*.

Accepted Answer

Economists assume that after a shock, the economy will adjust until real GDP returns to its potential level, Y*, which represents the long-run equilibrium.

Question 2

Consider the basic AD/AS macro model in long- run equilibrium. A negative AS shock will the price level and output in the short run. In the long run, the price level will
And output .
A)increase; increase; increase further; will be restored to potential output
B)decrease; decrease; decrease further; will decrease further
C)increase; decrease; decrease; will be restored to potential output
D)increase; decrease; increase further; will be restored to potential output
E)decrease; decrease; decrease further; will be restored to potential output

Accepted Answer

A negative AS shock increases the price level and decreases output in the short run. In the long run, the price level decreases as the economy adjusts, and output is restored to potential output.

Question 3

The "long- run aggregate supply curve", vertical at Y^*, shows that A)prices will always rise in the long run. B)potential output is compatible with one particular price level. C)potential output will fall as prices rise. D)potential output will rise as prices rise. E)potential output is compatible with any price level.

Accepted Answer

The long-run aggregate supply curve is vertical because it represents the economy's potential output, which is determined by factors like technology and resources, and is not affected by the price level.

Question 4

The experience of many economies suggests that
A)upward pressures on wages are largely ineffective in booms.
B)downward pressure on wages during slumps is not as intense as upward pressure on wages during booms.
C)slumps and booms are not common; the economy is usually in equilibrium at potential output.
D)unit labour costs fall quickly during booms.
E)downward pressure on wages during slumps results in sharply increased labour costs.

Accepted Answer

Many economies have experienced that during slumps, there is not as intense pressure on wages to fall as there is during booms to increase. This may be due to factors such as minimum wage laws or the difficulty of convincing employees to accept lower wages even during tough economic times.

Question 5

Consider a simple macro model with demand- determined output. Which of the following parameters will produce the largest fluctuations in real GDP from autonomous expenditure shocks?
A)MPC = 0.7, t = 0.1, m = 0.4
B)MPC = 0.8, t = 0.2, m = 0.3
C)MPC = 0.8, t = 0.1, m = 0.2
D)MPC = 0.7, t = 0.3, m = 0.2
E)MPC = 0.9, t = 0.2, m = 0.4

Accepted Answer

The largest fluctuations in real GDP occur when the marginal propensity to consume (MPC) is high and the tax rate (t) and marginal propensity to import (m) are low. Option C has a high MPC of 0.8 and the lowest combined t and m values, leading to a larger multiplier effect.

Question 6

Suppose Canada's economy is in a long- run equilibrium with real GDP equal to potential output. Now suppose there is a decrease in the Canadian price of all imported raw materials. In the short run, . In the long run, .
A)real GDP and the price level both rise; real GDP returns to its original level with a higher price level
B)real GDP rises and the price level falls; real GDP and the price level return to their original levels
C)real GDP and the price level both fall; real GDP is below its original level with a lower price level
D)real GDP falls and the price level rises; real GDP is below its original level with a higher price level
E)real GDP and the price level both rise; real GDP is above its original level with a higher price level

Accepted Answer

The decrease in the price of imported raw materials will reduce production costs for Canadian firms, leading to an increase in short-run aggregate supply (SRAS) and a corresponding increase in real GDP. However, since the decrease in imported raw materials prices is a temporary shock and not a permanent change in the economy's productive capacity, the long-run aggregate supply (LRAS) curve will remain at its original position, returning the economy to its potential output level in the long run. Therefore, in the long run, both real GDP and price level will return to their original levels.

Question 7

Suppose Canada's economy is in a long- run equilibrium with real GDP equal to potential output. Now suppose there is an increase in the Canadian- dollar price of all imported raw materials. In the short run, . In the long run, .
A)real GDP and the price level both fall; real GDP is below its original level with a lower price level
B)real GDP and the price level both rise; real GDP is above its original level with a higher price level
C)real GDP falls and the price level rises; real GDP and the price level return to their original levels
D)real GDP and the price level both rise; real GDP returns to its original level with a higher price level
E)real GDP rises and the price level falls; real GDP returns to its original level with a lower price level

Accepted Answer

In the short run, the increase in imported raw material prices leads to an increase in production costs, which leads to a decrease in aggregate supply (AS). This means that both real GDP and the price level fall. However, in the long run, firms will adjust their production processes, technology, and inputs to become more efficient and mitigate the effects of the cost increase. This means that AS shifts back to its original position, and real GDP returns to its potential level. The price level will be higher than before the shock, but it will also have adjusted and returned to its original level. Therefore, real GDP falls and the price level rises, but both return to their original levels in the long run.

Question 8

Suppose that the government announces temporary tax cuts to stimulate consumers' consumption expenditures but the impact of this tax change on consumption is observed to be very small. This outcome might be explained by the fact that
A)this economy is suffering from the paradox of thrift.
B)the government has little credibility.
C)this economy is already at its long- run equilibrium.
D)the consumers anticipate that the tax change is only temporary and thus is unlikely to affect their "lifetime" income.
E)the impact of the policy is dampened by the automatic fiscal stabilizers.

Accepted Answer

Consumers may not increase their consumption expenditures if they believe that the tax cut is temporary, and therefore will not impact their overall lifetime income. If consumers do not anticipate a permanent increase in their income, they may instead opt to save the additional funds from the tax cut, rather than spend it.

Question 9

Consider a simple macro model with demand- determined output. Which of the following parameters will produce the strongest automatic stabilizer?
A)MPC = 0.7, t = 0.1, m = 0.4
B)MPC = 0.9, t = 0.2, m = 0.4
C)MPC = 0.7, t = 0.3, m = 0.2
D)MPC = 0.8, t = 0.1, m = 0.2
E)MPC = 0.8, t = 0.2, m = 0.3

Accepted Answer

The answer of Consider a simple macro model with demand-...

Question 10

Suppose the economy begins in a long- run equilibrium with Y = Y*. A permanent increase in aggregate demand will have its short- run effect on real GDP reversed in the long run with a shift of _ .
A)leftward; the aggregate demand curve
B)rightward; the aggregate demand curve
C)leftward; the aggregate supply curve
D)rightward; the aggregate supply curve
E)rightward; Y*

Accepted Answer

In the short run, a permanent increase in aggregate demand will cause real GDP to increase above its long-run equilibrium level, leading to inflationary pressures. However, in the long run, prices will adjust to this increase in demand, leading to an increase in production costs (due to higher input costs) and a decrease in profits. As a result, firms will reduce production and real GDP will return to its long-run equilibrium level, but at a higher price level. This adjustment process is represented by a leftward shift of the aggregate supply curve.

Question 11

The paradox of thrift does not exist in the long run because
A)aggregate supply has an impact on real GDP only in the short run.
B)changes in aggregate demand have no impact on real GDP in the long run.
C)potential output is determined by changes in the price level.
D)not everyone increases saving in the long run.
E)everyone increases consumption in the long run.

Accepted Answer

In the long run, the economy is at full employment, and changes in aggregate demand only affect the price level, not real GDP, due to the economy's self-correcting mechanism.

Question 12

Consider the AD/AS model after factor prices have fully adjusted to output gaps. An increase in the level of potential output, with aggregate demand constant, will
A)decrease real GDP and the price level.
B)decrease real GDP and raise the price level.
C)increase real GDP and lower the price level.
D)affect only the price level.
E)affect only the level of real GDP.

Accepted Answer

When the level of potential output increases, it means that the economy can produce more goods and services without putting upward pressure on factors prices. This, in turn, shifts the long-run aggregate supply (LRAS) curve to the right. With aggregate demand being constant, the intersection of AD and the new LRAS curve will occur at a higher level of real GDP and a lower price level. Therefore, an increase in the level of potential output will result in an increase in real GDP and a lower price level.

Question 13

If the short- run macroeconomic equilibrium occurs with real GDP greater than potential output, the economy is
A)threatened with a demand shock.
B)experiencing an inflationary output gap.
C)experiencing a recessionary output gap.
D)at its full- employment level of output.
E)operating at full capacity.

Accepted Answer

When the short-run macroeconomic equilibrium occurs with real GDP greater than potential output, it indicates that the economy is operating beyond its capacity and experiencing an inflationary output gap. This means that there is more demand for goods and services than what the economy can produce, leading to upward pressure on prices.

Question 14

Suppose Canada's economy is in a long- run equilibrium with real GDP equal to potential output. Now suppose there is an unexpected and sharp reduction in desired business investment expenditure. In the short run, _ . In the long run, _ .
A)real GDP and the price level both rise; real GDP is above its original level with a higher price level
B)real GDP falls and the price level rises; real GDP is below its original level with a higher price level
C)real GDP rises and the price level falls; real GDP returns to its original level with a lower price level
D)real GDP and the price level both fall; real GDP is at its original level with a lower price level
E)real GDP and the price level both rise; real GDP returns to its original level with a higher price level

Accepted Answer

In the short run, a reduction in investment decreases aggregate demand, leading to lower real GDP and a lower price level. In the long run, the economy self-corrects, and real GDP returns to its potential level, but with a lower price level.

Question 15

A recessionary output gap is characterized by
A)rising prices.
B)real GDP falling below potential output.
C)constant prices.
D)real GDP exceeding potential output.
E)real output that varies one- for- one with aggregate demand.

Accepted Answer

A recessionary output gap occurs when actual real GDP is lower than potential output, indicating a downturn in the economy. This is associated with high unemployment and low production levels, so rising prices (A) would not be expected. Constant prices (C) may occur, but do not characterize a recessionary output gap. Real GDP exceeding potential output (D) indicates an inflationary output gap, which is the opposite of a recessionary output gap. Real output that varies one-for-one with aggregate demand (E) is known as the Keynesian short-run aggregate supply curve, which is not directly related to the concept of an output gap.

Question 16

In any decision about stimulating the economy with a fiscal expansion (increasing government purchases), the government must weigh the short- run benefits of against the long- run costs of .
A)increased economic activity; lower economic growth
B)increased potential output; a higher price level
C)a higher price level; unemployment
D)increased real GDP; higher economic growth
E)a higher price level; lower real GDP

Accepted Answer

In the short run, fiscal expansion can boost economic activity, but in the long run, it may lead to lower economic growth due to increased debt or inflationary pressures.

Question 17

An inflationary output gap would generate which of the following conditions in the economy?
A)There is an unusually small demand for labour.
B)Workers have a relatively large amount of bargaining power with employers.
C)Firms are making low profits.
D)There is much idle capacity.
E)There is downward pressure on wages.

Accepted Answer

An inflationary output gap occurs when actual output exceeds potential output, leading to high demand for labor and increased bargaining power for workers, as firms compete to hire and retain employees.

Question 18

An adjustment "asymmetry" in the aggregate supply curve is shown by
A)the difference in speed of decreases in output levels..
B)its concave shape.
C)its convex shape.
D)the difference in speed of increases in factor prices versus wage rates..
E)the difference in speed of a rightward shift versus a leftward shift (when wages adjust to output gaps).

Accepted Answer

An adjustment asymmetry in the aggregate supply curve refers to the difference in the speed of adjustments, such as how quickly the curve shifts rightward compared to leftward, often due to wage adjustments in response to output gaps.

Question 19

Fiscal policy refers to the
A)business sector's influence on investment and GDP.
B)households' attempts to change saving to encourage growth.
C)government's use of trade- related policy tools to influence the net export function, thereby influencing GDP.
D)government's use of spending and taxing policies to influence equilibrium real GDP.
E)government's attempts to maintain a vertical AS curve so as to stabilize output.

Accepted Answer

Fiscal policy refers to the government's use of spending and taxing policies to influence equilibrium real GDP. It is a tool used to stabilize the economy during times of recession or inflation. The government can increase spending and/or lower taxes to stimulate economic growth or decrease spending and/or increase taxes to control inflation.

Question 20

In the basic AD/AS model, which of the following is a defining characteristic of the adjustment process that takes the economy from the short run to the long run?
A)factor prices are assumed to respond to output gaps
B)firms cannot operate near their normal capacity
C)technology used in production is endogenous
D)the level of potential output fluctuates with the price level
E)factor supplies are assumed to be varying

Accepted Answer

Factor prices are assumed to adjust in response to output gaps in the long run. This allows the economy to reach its potential output level and operate at full capacity, which is a defining characteristic of the long run in the AD/AS model.

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

Following any AD or AS shock, economists typically assume that the adjustment process continues until

Consider the basic AD/AS macro model in long- run equilibrium. A negative AS shock will the price level and output in the short run. In the long run, the price level will And output .

The "long- run aggregate supply curve", vertical at Y^*, shows that

The experience of many economies suggests that

Consider a simple macro model with demand- determined output. Which of the following parameters will produce the largest fluctuations in real GDP from autonomous expenditure shocks?

Suppose Canada's economy is in a long- run equilibrium with real GDP equal to potential output. Now suppose there is a decrease in the Canadian price of all imported raw materials. In the short run, . In the long run, .

Suppose Canada's economy is in a long- run equilibrium with real GDP equal to potential output. Now suppose there is an increase in the Canadian- dollar price of all imported raw materials. In the short run, . In the long run, .

Suppose that the government announces temporary tax cuts to stimulate consumers' consumption expenditures but the impact of this tax change on consumption is observed to be very small. This outcome might be explained by the fact that

Consider a simple macro model with demand- determined output. Which of the following parameters will produce the strongest automatic stabilizer?

Suppose the economy begins in a long- run equilibrium with Y = Y*. A permanent increase in aggregate demand will have its short- run effect on real GDP reversed in the long run with a shift of _ .

The paradox of thrift does not exist in the long run because

Consider the AD/AS model after factor prices have fully adjusted to output gaps. An increase in the level of potential output, with aggregate demand constant, will

If the short- run macroeconomic equilibrium occurs with real GDP greater than potential output, the economy is

Suppose Canada's economy is in a long- run equilibrium with real GDP equal to potential output. Now suppose there is an unexpected and sharp reduction in desired business investment expenditure. In the short run, _ . In the long run, _ .

A recessionary output gap is characterized by

In any decision about stimulating the economy with a fiscal expansion (increasing government purchases) , the government must weigh the short- run benefits of against the long- run costs of .

An inflationary output gap would generate which of the following conditions in the economy?

An adjustment "asymmetry" in the aggregate supply curve is shown by

Fiscal policy refers to the

In the basic AD/AS model, which of the following is a defining characteristic of the adjustment process that takes the economy from the short run to the long run?