Question 1

One factor that explains the short-run tradeoff between inflation and unemployment is labor contracts that fix wages for an extended period of time.

Accepted Answer

Labor contracts that fix wages for a certain period of time can create a situation where wages cannot adjust quickly to changes in the economy. In an inflationary period, wages are fixed at a higher level than the market would set, leading to higher unemployment as employers respond by reducing the amount of labor they demand. Conversely, in a deflationary period, wages are fixed at a lower level than the market would set, leading to higher employment as the cost of labor becomes cheaper. This creates a short-run tradeoff between inflation and unemployment.

Question 2

Suppose that unemployed workers expect inflation to be 10 percent, but inflation actually turns out to be 12 percent. If the workers do not revise their reservation wages and wage offers are in line with the actual inflation rate, then a movement up the short-run Phillips curve should take place.

Accepted Answer

If workers do not revise their reservation wages and wage offers adjust to the actual inflation rate, then the natural rate of unemployment would be higher than the short-term level. This creates a positive short-run Phillips curve, which shows that there's a trade-off between inflation and unemployment. As inflation is higher than expected, workers would demand higher wages, and firms would tend to reduce employment, which leads to higher unemployment. This would result in an upward movement along the short-run Phillips curve.

Question 3

According to the government budget constraint, government spending is equal to the fiscal deficit plus the change in the money supply.

Accepted Answer

According to the government budget constraint, government spending is equal to the sum of the fiscal deficit and the change in government debt or borrowing, not the change in the money supply.

Question 4

Because the growth in the money supply is unrelated to government spending, fiscal policy and monetary policy can be conducted independently.

Accepted Answer

The growth in the money supply is directly affected by monetary policy, which is controlled by the central bank. Fiscal policy, on the other hand, relates to government spending and taxation. The two policies can influence each other, and coordination may be necessary to achieve macroeconomic goals.

Question 5

The belief that people use all available past and current information to make economic decisions is the basis of the adaptive expectations theory.

Accepted Answer

Adaptive expectations theory suggests that people form their expectations about the future based on past experiences and gradually adjust those expectations as they receive new information, rather than using all available past and current information.

Question 6

If the inflation rate has been 6 percent over the past four years and the Federal Reserve announces an increase in the growth of the money supply, then adaptive expectations theory would predict an inflation rate of 6 percent.

Accepted Answer

According to adaptive expectations theory, individuals base their expectations of future inflation on past inflation rates. In this scenario, if the inflation rate has been 6 percent for the past four years, individuals will expect future inflation rates to continue at 6 percent, even if the Federal Reserve announces an increase in the growth of the money supply.

Question 7

If workers realize that an increase in nominal wage rates also constitutes a rise in real wages, then we would expect an increase in employment and an upward movement along the short-run Phillips curve.

Accepted Answer

If workers understand that an increase in nominal wage rates is accompanied by an increase in purchasing power, which increases their real wages, then they are less likely to demand higher wages in the future. This reduces the upward pressure on inflation and leads to lower unemployment, which causes an upward movement along the short-run Phillips curve.

Question 8

A recessionary real shock is associated with an outward shift of the short-run Phillips curve and a leftward shift of the short-run aggregate supply curve.

Accepted Answer

A recessionary real shock, which can be caused by factors such as a decrease in consumer confidence or a decrease in productivity, leads to a decrease in aggregate demand and a leftward shift in the short-run aggregate supply curve. This results in an increase in inflation and unemployment, causing an outward shift of the short-run Phillips curve. Therefore, the statement is true.

Question 9

The oil price shocks of the 1970s demonstrated that business-cycle fluctuations are not solely a function of discretionary government policy.

Accepted Answer

The oil price shocks of the 1970s were external shocks that affected the economy, demonstrating that business-cycle fluctuations can also be caused by factors beyond government policy.

Question 10

When economic conditions change, all firms can adjust wages to those conditions.

Accepted Answer

Although firms can adjust wages to some extent, they may face constraints such as labor regulations, contractual agreements, and resistance from employees. Additionally, some industries or regions may have wage rigidity due to factors such as high unionization rates or prevailing wage norms. Therefore, not all firms can easily and quickly adjust wages to changes in economic conditions.

Question 11

The long-run Phillips curve assumes that every unemployed worker who is looking for a job has a constant reservation wage.

Accepted Answer

The long-run Phillips curve is vertical, indicating that there is no trade-off between inflation and unemployment in the long run. It does not make assumptions about the reservation wages of unemployed workers; instead, it is based on the natural rate of unemployment, where inflation expectations are fully adjusted.

Question 12

A reduction in inflation constitutes disinflation.

Accepted Answer

Disinflation refers to a decrease in the rate of inflation. It is not the same as deflation, which refers to the actual decrease in prices.

Question 13

Political business-cycle theory asserts that political manipulation of the business cycle is an ineffective way to increase economic growth.

Accepted Answer

Political business-cycle theory argues that attempts by politicians to manipulate the economy for electoral gain are ineffective and can even be harmful.

Question 14

Research indicates that worker morale is a major reason wages are not reduced during recessions.

Accepted Answer

Studies have shown that reducing wages during a recession can have a negative impact on worker morale and productivity. Additionally, workers may feel that their efforts are not valued and it could lead to higher turnover rates. Therefore, employers may choose not to reduce wages in order to maintain positive morale and retain valuable employees.

Question 15

If aggregate demand rises unexpectedly, inventories fall, inflation is higher than expected, and unemployment rises.

Accepted Answer

When aggregate demand rises unexpectedly, inventories tend to fall because consumers are buying more goods than anticipated. However, this situation typically leads to higher inflation due to increased demand, but unemployment is likely to decrease, not rise, as companies hire more workers to meet the higher demand.

Question 16

In rational expectations theory, an expected increase in the money supply is represented by an upward movement along the vertical Phillips curve.

Accepted Answer

In rational expectations theory, an expected increase in the money supply is represented by an upward movement along the vertical Phillips curve because agents anticipate the inflationary effects of the increased money supply and adjust their expectations accordingly.

Question 17

Oil price shocks, technological improvements, and expansionary fiscal policy are all examples of real business-cycle shocks.

Accepted Answer

Real business-cycle shocks are shocks that affect the economy's productive capacity. Oil price shocks, technological improvements, and expansionary fiscal policy are all examples of aggregate demand shocks, which affect the economy's demand for goods and services.

Question 18

If nominal wages are contractually fixed and cannot change in the short run, then an unexpected decline in the inflation rate reduces business revenues and lowers the unemployment rate.

Accepted Answer

An unexpected decline in the inflation rate, when nominal wages are fixed, increases the real wage (since the purchasing power of the wages increases). This can lead to businesses reducing their workforce to cut costs, potentially increasing the unemployment rate, not lowering it.

Question 19

Unexpected inventory changes, fixed wage contracts, and unexpected changes in the nominal wage rate are associated with a movement along the short-run Phillips curve.

Accepted Answer

Unexpected inventory changes, fixed wage contracts, and unexpected changes in the nominal wage rate can all affect the level of output and employment in the short run, influencing the relationship between inflation and unemployment captured by the Phillips curve. Changes that impact the cost of production (such as changes in input prices, taxes, subsidies, or productivity) or aggregate demand (such as changes in exports, government purchases, or investment) can shift the short-run Phillips curve, while changes in expectations or inflationary pressure can affect the long-run Phillips curve.

Question 20

Adaptive expectations and rational expectations differ only in the fact that adaptive expectations suggest agents are irrational.

Accepted Answer

Adaptive expectations do not necessarily suggest that agents are irrational. Rather, they suggest that agents update their expectations based on past experiences and observations, while rational expectations suggest that agents use all available information to form their expectations. Both approaches are valid and can coexist in economic models.

Quiz 16: Macroeconomic Policy, Business Cycles, and Growth