Question 1

Suppose Canada's economy is in a long- run equilibrium with real GDP equal to potential output. Now suppose there is an increase in world demand for Canada's goods. In the short run, . In the long run, .

Accepted Answer

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Question 2

Consider the basic AD/AS macro model in long- run equilibrium. An expansionary AD shock has price- level effect in the short run and price- level effect in the long run.

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Question 3

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

Accepted Answer

A positive AS shock decreases the price level and increases output in the short run. In the long run, the price level returns to its initial level, and output is restored to potential output.

Question 4

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

Accepted Answer

When real GDP exceeds potential output, there is upward pressure on factor prices, such as wages and raw material prices. This leads to increased costs for firms, causing the AS curve to shift to the left. The speed at which the shift occurs depends on the extent of the excess demand in the economy. A gradual excess demand may lead to a slower shift, while a sudden excess demand may cause a more rapid shift to occur. Therefore, the AS curve shifts to the left fairly rapidly. Choice A is incorrect because a rightward shift in the AS curve implies an increase in potential output, which is not the case. Choice B is incorrect because a leftward shift in the AD curve would only exacerbate the situation by further increasing the excess demand in the economy. Choice C is also incorrect because a slow shift in the AS curve would not be consistent with the upward pressure on factor prices. Finally, choice E is incorrect because the AS curve must shift to reflect the changed economic conditions.

Question 5

Which of the following statements about fiscal policy is the best example of "gross tuning"?

Accepted Answer

Gross tuning refers to the use of fiscal policies in a broad, overall manner to stabilize the economy rather than making small adjustments. Cutting taxes to remove a large and persistent recessionary gap is a broad, overall measure and hence an example of gross tuning. The other options involve more precise adjustments and are therefore not examples of gross tuning.

Question 6

The "paradox of thrift" refers to the understandable tendency of people who are worried about their economic situation to their saving, but in aggregate this behaviour causes a recession.

Accepted Answer

The "paradox of thrift" suggests that while individuals may save more during economic uncertainty, this collective increase in saving can lead to decreased aggregate demand, potentially worsening a recession.

Question 7

Consider the basic AD/AS diagram. The vertical line at Y* shows the relationship between the price level and the amount of output have adjusted to output gaps.

Accepted Answer

The vertical line at Y* in the AD/AS diagram represents the long-run aggregate supply (LRAS), which shows the level of output supplied by firms after all factor prices have adjusted.

Question 8

One advantage of using expansionary fiscal policy rather than relying on automatic adjustment to recover from a recessionary gap is that

Accepted Answer

Expansionary fiscal policy involves government increasing spending and reducing taxes to stimulate aggregate demand and close a recessionary gap. This can lead to a more rapid recovery as the increased spending and tax cuts can quickly boost consumer and business confidence and lead to greater economic activity. Automatic adjustment, on the other hand, relies on market forces to adjust prices and wages to eventually close the gap, which can be a slower and more uncertain process.

Question 9

In the basic AD/AS macro model, the "paradox of thrift" is only a short- run phenomenon because

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The answer of In the basic AD/AS macro model, the...

Question 10

Suppose the economy is experiencing an inflationary gap in the short run. The advantage of using a contractionary fiscal policy rather than allowing the economy's natural adjustment process to operate is that

Accepted Answer

Contractionary fiscal policy helps reduce the upward pressure on the price level by decreasing aggregate demand, thus addressing the inflationary gap more quickly than waiting for the economy to self-adjust.

Question 11

Suppose the economy is experiencing a significant recessionary gap, but it has taken the government six months to determine that it will change fiscal policy. This is an example of

Accepted Answer

The fact that it took the government six months to determine a change in fiscal policy implies that there was a delay between identifying the recessionary gap and taking action to address it, which is referred to as a decision lag. The other options do not accurately describe the scenario described in the question.

Question 12

In macroeconomic analysis, the assumption that potential output (Y*)is changing is a characteristic of

Accepted Answer

The assumption that potential output (Y*) is changing is a characteristic of the long run in macroeconomic analysis. This is because potential output refers to the maximum level of output that an economy can produce given its resources and technology. In the long run, these factors can change and thus affect potential output. In contrast, the short run is a period of time where potential output is assumed to be fixed and only aggregate demand can affect the economy's output.

Question 13

In the long run, aggregate demand is _ for determining real GDP, and the paradox of thrift .

Accepted Answer

In the long run, real GDP is determined by aggregate supply, not aggregate demand, as the economy is at full employment. The paradox of thrift, which suggests that increased saving can lead to a decrease in aggregate demand and thus lower total savings, does not apply in the long run because the economy adjusts to changes in savings.

Question 14

In the basic AD/AS macro model, permanent increases in real GDP are possible only if

Accepted Answer

Based on the basic AD/AS macro model, permanent increases in real GDP are only possible if potential output increases. This means that there is an increase in the economy's ability to produce goods and services in the long run, which shifts the long-run aggregate supply (LRAS) curve to the right. This can happen due to factors such as improvements in technology, increases in the quantity and quality of inputs, and better institutional arrangements. Therefore, options A, C, D, and E are incorrect because they do not address the fundamental issue of potential output. Additionally, automatic stabilizers can help stabilize the economy in the short run, but do not contribute to permanent increases in real GDP. Similarly, fiscal policy and aggregate demand shocks can have positive effects on GDP, but only in the short run.

Question 15

there are long and uncertain lags in implementing fiscal policy.

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Question 16

Which of the following is a defining characteristic of the AD/AS macro model in the short run?

Accepted Answer

In the AD/AS macro model in the short run, factor prices are assumed to be constant, while in the long run they are allowed to adjust to changes in demand and supply. This is a defining characteristic of the short run in the model. The other options are not necessarily defining characteristics of the short run in the model.

Question 17

Net tax revenues that rise with national income act as an automatic stabilizer by the marginal propensity to spend and thereby causing the simple multiplier to .

Accepted Answer

Net tax revenues that rise with national income decrease the marginal propensity to spend because more income is taxed away, leading to a decrease in the simple multiplier.

Question 18

The wage- adjustment process is asymmetrical because

Accepted Answer

The wage-adjustment process is asymmetrical because wages tend to rise quickly in a boom when there is a shortage of labor, but they fall slowly during a slump when there is an oversupply of labor. This asymmetry is due to factors such as worker resistance to wage cuts, collective bargaining agreements, and minimum wage laws that prevent wages from falling below a certain level. In contrast, employers may delay wage increases during a boom to maintain profitability, but they can lay off workers quickly during a slump to reduce costs. Therefore, the adjustment process for wages is asymmetric.

Question 19

In the basic AD/AS macro model, which of the following events would cause stagflation?

Accepted Answer

A large increase in the price of raw materials would shift the short-run aggregate supply curve to the left, causing both higher prices and lower output. This combination of rising prices and stagnant output is known as stagflation. None of the other choices would directly cause stagflation.

Question 20

Suppose that the economy is initially in a long- run macroeconomic equilibrium. A shock then hits the economy and we observe that the unemployment rate decreases and the price level increases. We can conclude that has increased and there is now a(n)_ gap.

Accepted Answer

When the unemployment rate decreases and the price level increases, it is an indication of an inflationary gap. An inflationary gap occurs when the aggregate demand in the economy is exceeding the aggregate supply, leading to increases in both prices and output. As a result, choice C, which attributes the cause of the shock to aggregate demand, is the correct answer.

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