Question 1

One central idea in supply-side economics concerning budget deﬁcits is illustrated by the

Accepted Answer

The Laffer Curve, a central idea in supply-side economics, illustrates the relationship between tax rates and government revenue. According to supply-side theory, lowering tax rates can stimulate economic growth and actually increase government revenue in the long run, as individuals and businesses are incentivized to work and invest more. This theory suggests that cutting taxes can help reduce budget deficits. Therefore, the correct answer choice is C) Laffer Curve.

Question 2

Assume contracts between workers and employers that call for an increase in the wage rate of 5 percent are based on an expected inﬂation rate of 3 percent. Should inﬂation actually be 6 percent,
Then

Accepted Answer

If the expected inflation rate is 3% and the actual inflation rate turns out to be 6%, then there is an unexpected increase in inflation of 3%. This means that the real wage increase is not as large as expected, because prices are rising more quickly than anticipated.

To calculate the real wage increase, we can subtract the inflation rate from the nominal wage increase:

Real wage increase = Nominal wage increase - Inflation rate

Real wage increase = 5% - 6%

Real wage increase = -1%

This means that real wages actually fall by 1%. While nominal wages still increase by 5%, the rise in prices wipes out some of the purchasing power gained by the higher wage rate.

Question 3

The automatic adjustment mechanism that makes the economy move toward the long-run Phillips Curve is

Accepted Answer

In the long-run, inﬂation expectations and wage adjustments drive the economy towards the long-run Phillips Curve by influencing worker bargaining power and the level of output. As workers anticipate higher inflation, they demand higher wages, causing firms to increase prices leading to a higher price level. As a result, there is an upward shift in the short-run Phillips Curve. However, over time, workers and firms adjust their inflation expectations, and wages adjust accordingly leading to a downward shift of the short-run Phillips Curve. Ultimately, the economy settles at the natural rate of unemployment at which the short-run Phillips Curve intersects the long-run Phillips Curve.

Question 4

Supply-side economists contend that the system of taxation in the United States

Accepted Answer

Supply-side economists argue that high taxes reduce the incentive to work, save, and invest, which can slow economic growth.

Question 5

In the short run, if the actual rate of inﬂation falls lower than the expected rate, then

Accepted Answer

When actual inflation is lower than expected, real wages are higher than anticipated, leading to higher labor costs for firms. This results in lower profits and potentially higher unemployment as firms adjust to the unexpected cost increase.

Question 6

A Congressional representative who calls for a decrease in tax rates in order to increase saving, work effort, and economic growth would most likely be advocating

Accepted Answer

A decrease in tax rates with the intention of increasing saving, work effort, and economic growth is a characteristic of supply-side fiscal policy. This approach holds that cutting taxes will increase incentives to work and invest, leading to increased economic activity and eventually higher tax revenues.

Question 7

In an aggregate demand-aggregate supply framework, ﬁscal policy that emphasizes cutting taxes as a means of improving incentives to work, save, and invest would be characterized primarily as a

Accepted Answer

Fiscal policy that focuses on cutting taxes to improve incentives to work, save, and invest directly affects the productive capacity of the economy by encouraging more labor and investment. This leads to an increase in the potential output, which is represented by a rightward shift of the long-run aggregate supply curve.

Question 8

The analysis of the short-run and long-run Phillips Curve suggests that an increase in aggregate demand

Accepted Answer

The short-run Phillips Curve suggests that there is a negative relationship between unemployment and inflation in the short run, meaning an increase in aggregate demand would lead to an increase in output and employment and a decrease in unemployment in the short run. However, in the long-run, the Phillips Curve becomes vertical, suggesting that in the long run, changes in aggregate demand only lead to changes in the price level, not output or employment. Therefore, an increase in aggregate demand influences real output and employment in the short run but not in the long run.

Question 9

Which action will tend to decrease aggregate supply, according to supply-side economists?

Accepted Answer

Supply-side economists believe that an increase in marginal tax rates on individuals and businesses will decrease the incentive to work, save, and invest. As a result, businesses may reduce production and investment, which decreases aggregate supply. Therefore, an increase in marginal tax rates tends to decrease aggregate supply according to supply-side economists.

Question 10

Accepted Answer

Moving to point $c _ { 2 }$ allows for the possibility to move on to $B _ { 3 }$ in the long run while also avoiding the possibility of being stuck at point $B _ { 2 }$ indefinitely.

Question 11

The short-run Phillips Curve intersects the long-run Phillips Curve at the

Accepted Answer

The long-run Phillips Curve represents the vertical line at the natural rate of unemployment, which is determined by structural factors like labor market institutions, demographics, and technology. In the short run, there may be fluctuations in inflation and unemployment due to demand-side factors like monetary policy, fiscal policy, or shocks to aggregate demand or supply. The short-run Phillips Curve slopes downward, indicating that lower unemployment is associated with higher inflation, and vice versa. However, this relationship is only temporary, as workers and firms adjust their expectations and behavior in response to changes in prices and wages. Eventually, the economy will return to its natural rate of unemployment, and inflation will converge to the rate consistent with stable prices in the long run. Therefore, the short-run Phillips Curve intersects the long-run Phillips Curve at the natural rate of unemployment, which is the only sustainable level of employment in the economy. The other options are not relevant to the Phillips Curve theory.

Question 12

According to the Laffer Curve, a cut in the tax rate from above the maximum-revenue rate to a rate lower than the maximum-revenue rate will

Accepted Answer

The Laffer Curve illustrates that cutting tax rates from a point above the maximum-revenue rate can actually increase tax revenues by incentivizing more economic activity, leading to a broader tax base.

Question 13

Disinﬂation can be explained by the Phillips Curve analysis as resulting from a situation where the actual rate of inﬂation is initially less than the expected rate, causing the unemployment rate to

Accepted Answer

Disinflation, according to the Phillips Curve, leads to a temporary rise in unemployment as the actual inflation rate is lower than expected. Over time, nominal wages decrease to adjust to this lower inflation rate, aligning actual and expected inflation rates and stabilizing the economy.

Question 14

Based on the Phillips Curve, when the actual rate of inﬂation is greater than the expected rate, the unemployment rate will

Accepted Answer

The Phillips Curve suggests that when actual inflation is higher than expected, employers can hire more workers at what seems to be the same real wage, due to the lag in wage adjustments to inflation. This increases employment and decreases unemployment temporarily, until nominal wages increase to match the new level of inflation, restoring the balance between expected and actual inflation rates.

Question 15

If the expected rate of inﬂation rises, then the short-run Phillips Curve will

Accepted Answer

A rise in the expected rate of inflation indicates that individuals and firms will adjust their behavior by demanding higher wages and prices, which leads to an increase in actual inflation. This shift in behavior leads to the short-run Phillips Curve shifting to the right.

Question 16

Which is a basic proposition of supply-side economics?

Accepted Answer

The basic proposition of supply-side economics is that tax-hikes on business reduce productivity and output, and reduce aggregate supply. This theory suggests that reducing tax rates on businesses and high-income individuals will increase savings, investment, and entrepreneurial activity, leading to economic growth.

Question 17

The short-run Phillips Curve assumes an unchanging

Accepted Answer

The short-run Phillips Curve assumes an unchanging expected rate of inflation, allowing for the analysis of the trade-off between inflation and unemployment in the short term.

Question 18

The long-run Phillips Curve is vertical at

Accepted Answer

The long-run Phillips Curve is vertical at the natural rate of unemployment, meaning there is no tradeoff between inflation and unemployment in the long run. However, it is not vertical at a specific price level, natural rate of inflation, or potential GDP.

Question 19

Supply-side policies can be described in terms of the aggregate demand and aggregate supply model as an attempt to shift

Accepted Answer

Supply-side policies aim to increase the production capacity and efficiency of the economy, leading to an increase in the aggregate supply. This is represented by a shift of the aggregate supply curve to the right, resulting in lower prices and higher output. There is no direct effect on the aggregate demand curve.

Question 20

When the rate of inﬂation is decreasing, this economic condition is called

Accepted Answer

When the rate of inflation is decreasing, the condition is called disinflation. It means that there is still an increase in prices but at a slower rate than before. Depreciation is related to the decrease in the value of a currency in the foreign exchange market. Stagflation is a condition of slow economic growth, high unemployment, and inflation. Deflation is the condition when there is a general decrease in prices.

Quiz 18: Extending the Analysis of Aggregate Supply