Question 1

The ex ante real interest rate that prevails at time t equals: A)i_t - E_tπ_t. B)i_t - E_tπ_{t + 1.} C)i_t - π_t. D)i_t - π_{t + 1.}

Accepted Answer

B

Question 2

Which of the following would be represented by a positive value of the random supply shock, υ_t? A)an irrational wave of optimism among investors B)an increase in government spending C)widespread drought leading to large increases in food prices D)an increase in the central bank's inflation target

Accepted Answer

A positive value of the random supply shock, υ_t, typically represents an adverse supply shock, such as a widespread drought leading to large increases in food prices.

Question 3

According to the Phillips curve, firms raise prices when output is _____ the natural level of output or, equivalently, when the unemployment rate is _____ the natural rate of unemployment.
A)above; above
B)above; below
C)below; below
D)below; above

Accepted Answer

According to the Phillips curve, firms raise prices when output is above the natural level of output or, equivalently, when the unemployment rate is below the natural rate of unemployment. Therefore, option B, which states that firms raise prices when output is above the natural level of output and unemployment rate is below the natural rate of unemployment, is the correct choice.

Question 4

Which of the following would be represented by a negative value of the random demand shock, ε_t? A)an irrational wave of optimism among investors B)a decrease in government spending C)an aggressive increase in oil prices by a cartel D)a decrease in the central bank's inflation target

Accepted Answer

A negative value of the random demand shock, ε_t, typically represents a decrease in demand. A decrease in government spending would reduce overall demand in the economy, thus being represented by a negative demand shock.

Question 5

Which of the following would be represented by a positive value of the demand shock, ε_t? A)an irrational wave of optimism among investors B)a decrease in government spending C)an aggressive increase in oil prices by a cartel D)an increase in the central bank's inflation target

Accepted Answer

A positive value of the demand shock, ε_t, indicates an increase in demand. An irrational wave of optimism among investors would lead to increased investment and consumption, thus increasing demand.

Question 6

In the dynamic model, the supply shock variable, υ_t, is a variable appearing in which of the following equations of the model? A)Fisher equation B)Phillips curve C)monetary-policy rule D)adaptive expectations

Accepted Answer

The supply shock variable, υ_t, typically appears in the Phillips curve equation, which relates inflation to expected inflation, output gap, and supply shocks.

Question 7

According to the monetary policy rule, when inflation is at its target level and output is at the natural level, then the real interest rate equals the:
A)nominal rate of interest.
B)target rate of inflation.
C)natural rate of interest.
D)current rate of inflation.

Accepted Answer

According to the monetary policy rule, when inflation is at its target level and output is at the natural level, the real interest rate should equal the natural rate of interest. This is because the natural rate of interest represents the level at which the economy is in equilibrium, and therefore it is the rate that is consistent with stable inflation and full employment. The nominal interest rate may be higher or lower than the natural rate depending on the level of inflation expectations or any other factors, but in order to achieve the desired outcomes of monetary policy, the real interest rate should be equal to the natural rate.

Question 8

Expectations of inflation based on recently observed inflation is called the assumption of _____ expectations.
A)natural
B)rational
C)dynamic
D)adaptive

Accepted Answer

The assumption of adaptive expectations is based on the idea that individuals form their expectations of inflation based on past experiences and current observations of inflation. Therefore, this assumption implies that individuals do not have perfect knowledge or access to all relevant information and adjust their expectations slowly over time as new information becomes available.

Question 9

In the dynamic model, the demand for goods and services will _____ as the natural rate of output increases and _____ as the real interest rate increases.
A)increase; increase
B)increase; decrease
C)decrease; decrease
D)decrease; increase

Accepted Answer

In the dynamic model, as the natural rate of output increases, it implies an increase in economic productivity and potential, leading to higher demand for goods and services. Conversely, as the real interest rate increases, borrowing costs become higher, which typically reduces consumption and investment, thereby decreasing the demand for goods and services.

Question 10

For any level of inflation, long-run growth _____ the demand for goods and services.
A)increases
B)decreases
C)does not change
D)may either increase or decrease

Accepted Answer

Long-run growth increases the demand for goods and services because as the economy grows, people's incomes increase, which allows them to buy more goods and services.

Question 11

The dynamic model of aggregate demand and aggregate supply assumes that people form expectations of inflation based on:
A)forecasts optimally using all available information.
B)recently observed inflation.
C)the central bank's inflation target.
D)the difference between the nominal and real interest rate.

Accepted Answer

The answer of The dynamic model of aggregate demand and...

Question 12

In the dynamic model, changes in fiscal policy are captured in changes in the:
A)natural rate of interest.
B)expected rate of inflation.
C)demand shock.
D)natural level of output.

Accepted Answer

In the dynamic model, fiscal policy changes are typically reflected as demand shocks, affecting aggregate demand and economic output.

Question 13

According to the Phillips curve, inflation depends on expected inflation because:
A)the real interest rate depends on the expected rate of inflation.
B)the central bank sets its target inflation rate based on the expected rate of inflation.
C)the natural level of output depends on the expected rate of inflation.
D)when some firms set prices in advance, expected inflation influences future prices.

Accepted Answer

According to the Phillips curve, inflation depends on expected inflation because when some firms set prices in advance, expected inflation influences future prices. As a result, if firms expect higher inflation in the future, they will set higher prices for their products to cover their increased costs, leading to actual inflation.

Question 14

According to the monetary policy rule, the central bank sets the nominal interest rate so that the real interest rate increases when inflation _____ its target or output _____ its natural level.
A)rises above; rises above
B)rises above; falls below
C)falls below; falls below
D)falls below; rises above

Accepted Answer

According to the monetary policy rule, when inflation rises above its target, the central bank will increase the nominal interest rate to make the real interest rate higher. This is intended to slow down economic growth and reduce inflation. Similarly, if output or real GDP rises above its natural level, the central bank will increase the interest rate to cool down the economy and bring output back to its potential level. Therefore, the correct choice is A, where the real interest rate increases when inflation rises above its target or output rises above its natural level.

Question 15

A higher real interest rate reduces the demand for goods and services by:
A)shifting the dynamic aggregate supply curve.
B)decreasing the natural level of output.
C)increasing inflation expectations.
D)reducing investment and consumption spending.

Accepted Answer

A higher real interest rate makes borrowing more expensive, which reduces investment and consumption spending. This decrease in spending leads to a reduction in demand for goods and services.

Question 16

The nominal interest rate, i_t, is the nominal rate of return between periods: A)t - 1 and t. B)t and t + 1. C)t - 1 and t + 1. D)t and t + 2.

Accepted Answer

The nominal interest rate, i_t, is the rate of return from period t to t + 1, reflecting the cost of borrowing or the return on investment over one period.

Question 17

The ex post real interest rate at time t equals: A)i_t - E_tπ_t. B)i_t - E_tπ_{t + 1.} C)i_t - π_t. D)i_t - π_{t + 1.}

Accepted Answer

The answer of The ex post real interest rate at...

Question 18

According to the Phillips curve, the inflation rate depends on all of the following except:
A)previously expected inflation.
B)an exogenous supply shock.
C)the real interest rate.
D)the deviation of output from its natural rate.

Accepted Answer

The Phillips curve describes the relationship between inflation and unemployment (or the deviation of output from its natural rate), not the real interest rate. It suggests that inflation is influenced by previously expected inflation, exogenous supply shocks, and the gap between actual and potential output, but not directly by the real interest rate.

Question 19

According to the Fisher equation, the real interest rate equals the nominal interest rate minus the:
A)natural rate of interest.
B)expected rate of inflation.
C)expected rate of interest.
D)ex ante rate of interest.

Accepted Answer

The Fisher equation states that the real interest rate equals the nominal interest rate minus the expected rate of inflation. Therefore, the best choice is B, as it represents the expected rate of inflation subtracted from the nominal interest rate.

Question 20

The real interest rate at which, in the absence of any shock, the demand for goods and services equals the natural rate of output is called the _____ rate of interest.
A)ex ante
B)ex post
C)natural
D)nominal

Accepted Answer

The question defines the real interest rate that corresponds to equilibrium between demand and natural output, which is known as the natural rate of interest. Choice A, ex ante, refers to expected interest rates, which may or may not be realized. Choice B, ex post, refers to realized interest rates after the fact. Choice D, nominal, refers to the stated interest rate without adjusting for inflation. None of these terms capture the specific concept described in the question.

Quiz 15: A Dynamic Model of Economic Fluctuations

The ex ante real interest rate that prevails at time t equals:

Which of the following would be represented by a positive value of the random supply shock, υ_t?

According to the Phillips curve, firms raise prices when output is _ the natural level of output or, equivalently, when the unemployment rate is _ the natural rate of unemployment.

Which of the following would be represented by a negative value of the random demand shock, ε_t?

Which of the following would be represented by a positive value of the demand shock, ε_t?

In the dynamic model, the supply shock variable, υ_t, is a variable appearing in which of the following equations of the model?

According to the monetary policy rule, when inflation is at its target level and output is at the natural level, then the real interest rate equals the:

Expectations of inflation based on recently observed inflation is called the assumption of _____ expectations.

In the dynamic model, the demand for goods and services will _ as the natural rate of output increases and _ as the real interest rate increases.

For any level of inflation, long-run growth _____ the demand for goods and services.

The dynamic model of aggregate demand and aggregate supply assumes that people form expectations of inflation based on:

In the dynamic model, changes in fiscal policy are captured in changes in the:

According to the Phillips curve, inflation depends on expected inflation because:

According to the monetary policy rule, the central bank sets the nominal interest rate so that the real interest rate increases when inflation _ its target or output _ its natural level.

A higher real interest rate reduces the demand for goods and services by:

The nominal interest rate, i_t, is the nominal rate of return between periods:

The ex post real interest rate at time t equals:

According to the Phillips curve, the inflation rate depends on all of the following except:

According to the Fisher equation, the real interest rate equals the nominal interest rate minus the:

The real interest rate at which, in the absence of any shock, the demand for goods and services equals the natural rate of output is called the _____ rate of interest.