Question 1

At a constant rate of exchange between currencies, higher inflation makes domestic goods sold abroad ____expensive and, hence, ____ short-run equilibrium output.
A) more; increases
B) less; increases
C) less; decreases
D) more; decreases

Accepted Answer

A rise in domestic inflation causes the prices of domestic goods in foreign markets to rise more quickly. As domestic goods become relatively more expensive to foreign purchasers, export sales decline. Net exports are part of aggregate expenditure, and so we find that increased inflation reduces spending and the short-run equilibrium output.

Question 2

As inflation increases, households become _____ uncertain leading to _____ spending.
A) more; more
B) more; less
C) less; more
D) less; less

Accepted Answer

When inflation is high, people become less certain about what things will cost in the future, and uncertainty makes planning more difficult. In an uncertain economic environment, both households and firms may become more cautious, reducing their spending as a result.

Question 3

The aggregate demand curve shows the relationship between inflation and:
A) the nominal interest rate.
B) the exchange rate.
C) the real interest rate.
D) short-run equilibrium output.

Accepted Answer

The aggregate demand (AD) curve shows the relationship between short-run equilibrium output and the inflation rate, holding all other factors constant.

Question 4

High levels of inflation ___ the real value of money and, hence, ____ short-run equilibrium output.
A) reduce; increase
B) increase; decrease
C) reduce; decrease
D) increase; increase

Accepted Answer

One reason for the downward slope of the AD curve is the effect of inflation on the real value of money held by households and businesses. At high levels of inflation, the purchasing power of money held by the public declines, reducing the public's real wealth. This may cause households to restrain consumption spending, thereby reducing short-run equilibrium output.

Question 5

If the Fed's monetary policy reaction function does not change, then when inflation increases the Fed responds by _____ the real interest rate, which _____ consumption and investment spending, which _____ output.
A) increasing; increases; increases
B) increasing; increases; decreases
C) increasing; decreases; decreases
D) decreasing; decreases; decreases

Accepted Answer

When the inflation rate increases, the Fed responds by raising the real interest rate per its reaction function. This increase in the real interest rate reduces consumption and investment, thereby reducing the short-run equilibrium output.

Question 6

All else equal, a decrease in the rate of inflation ____ aggregate spending and ____ short-run equilibrium output.
A) increases; increases
B) decreases; increases
C) increases; decreases
D) decreases; decreases

Accepted Answer

The AD curve slopes downward showing the inverse relationship between aggregate spending and the inflation rate - lower inflation rates cause consumption, investment and net exports to increase and the short-run equilibrium output to increase.

Question 7

Higher rates of inflation reduce spending because:
A) the Fed reacts to the higher inflation by lowering interest rates.
B) the reduction in wealth, resulting from the reduced real value of money, restricts spending.
C) resources are redistributed from low-spending households to high-spending households.
D) the real value of money increases.

Accepted Answer

At high levels of inflation, the purchasing power of money held by the public declines, reducing the public's real wealth. This may cause households to restrict consumption spending. This is one of the reasons for the downward slope of the AD curve.

Question 8

For a fixed target real interest rate and target inflation rate, when inflation increases, the Fed ____ interest rates, hence _____ short-run equilibrium output.
A) increases; increasing
B) decreases; increasing
C) increases; decreasing
D) decreases; decreasing

Accepted Answer

When the inflation rate increases, the Fed responds by raising the real interest rate per its reaction function. This increase in the real interest rate reduces consumption and investment, thereby decreasing the short-run equilibrium output.

Question 9

Because increases in inflation reduce aggregate spending and short-run equilibrium output:
A) the short-run aggregate supply line is downward sloping.
B) the aggregate demand curve is horizontal.
C) the aggregate demand curve is downward sloping.
D) the aggregate demand curve is upward sloping.

Accepted Answer

The AD curve slopes downward, showing the inverse relationship between aggregate spending and the inflation rate - higher inflation rates cause consumption, investment and net exports to fall.

Question 10

The aggregate demand curve is downward sloping for all of the following reasons EXCEPT for the:
A) response of the Fed to inflation through its policy reaction function.
B) effect of inflation on the value of money.
C) impact of inflation on the consumer price index (CPI).
D) distributional impact of inflation on spending.

Accepted Answer

When the inflation rate increases, the Fed responds by raising the real interest rate per its reaction function, which reduces consumption and investment. Additional reasons for the downward slope of the AD curve include the effect of inflation on the real value of money held by households and businesses and distributional effects.

Question 11

Increases in inflation redistribute resources from _____-spending to ____-spending households and hence, _____ short-run equilibrium output.
A) high; low; increase
B) low; high; increase
C) high; low; decrease
D) low; high; decrease

Accepted Answer

According to the distributional effects, a burst of inflation redistributes resources from relatively high-spending and low saving (less affluent) households toward relatively low-spending and high-saving (more affluent) households. As a consequence, overall spending and the short-run equilibrium output may decline.

Question 12

Lower rates of inflation increase planned spending because:
A) the Fed reacts to the lower inflation by lowering interest rates.
B) the reduction in wealth, resulting from the reduced real value of money, restrains spending.
C) resources are redistributed from high-spending households to low-spending households.
D) the prices of domestic goods sold abroad increase (with a constant exchange rate).

Accepted Answer

When the inflation rate decreases, the Fed responds by lowering the real interest rate per its reaction function, which increases consumption and investment spending. This is one of reasons for the downward slope of the AD curve.

Question 13

If the Fed's monetary policy reaction function does not change, then when inflation decreases the Fed responds by _____ the real interest rate, which _____ consumption and investment spending, which _____ output.
A) decreasing; increases; increases
B) increasing; increases; decreases
C) increasing; decreases; decreases
D) decreasing; decreases; decreases

Accepted Answer

When the inflation rate decreases, the Fed responds by lowering the real interest rate per its reaction function. This decrease in the real interest rate increases consumption and investment, thereby increasing the short-run equilibrium output.

Question 14

Because decreases in inflation increase aggregate spending and short-run equilibrium output:
A) the short-run aggregate supply line is downward sloping.
B) the aggregate demand curve is horizontal.
C) the aggregate demand curve is downward sloping.
D) the aggregate demand curve is upward sloping.

Accepted Answer

The AD curve slopes downward, showing the inverse relationship between aggregate spending and the inflation rate - lower inflation rates cause consumption, investment and net exports to increase.

Question 15

Changes in aggregate spending not caused by changes in output or the inflation rate, also known as exogenous changes in spending, will shift the:
A) short-run aggregate supply curve.
B) long-run aggregate supply curve.
C) potential output line.
D) aggregate demand curve.

Accepted Answer

Shifts in the aggregate demand curve are caused by changes in spending caused by factors other than output or inflation rates, which is referred to as exogenous changes in spending.

Question 16

All else equal, an increase in the rate of inflation ____ aggregate spending and ____ short-run equilibrium output.
A) increases; increases
B) decreases; increases
C) increases; decreases
D) decreases; decreases

Accepted Answer

The AD curve slopes downward showing the inverse relationship between aggregate spending and the inflation rate - higher inflation rates cause consumption, investment and net exports to decrease and the short-run equilibrium output to decrease.

Question 17

The aggregate demand curve shows the relationship between short-run equilibrium output and the:
A) nominal interest rate.
B) real interest rate.
C) unemployment rate.
D) inflation rate.

Accepted Answer

The aggregate demand (AD) curve shows the relationship between short-run equilibrium output and the inflation rate, holding all other factors constant.

Question 18

As inflation decreases, households become _____ uncertain leading to _____ spending.
A) more; more
B) more; less
C) less; more
D) less; less

Accepted Answer

When inflation is low, people become less uncertain (more certain) about what things will cost in the future, and making planning ahead easier. Both households and firms may become less cautious, increasing their spending as a result.

Question 19

The aggregate demand curve shifts when there are changes in:
A) inflation inertia and aggregate supply shocks.
B) exogenous spending and the Fed's reaction function.
C) exogenous spending and inflation inertia.
D) potential output and exogenous spending.

Accepted Answer

Shifts in the aggregate demand curve are caused by changes in spending caused by factors other than output or inflation rates, which is referred to as exogenous changes in spending; and changes in the Fed's monetary policy, as reflected in a shift in the Fed's policy reaction function.

Question 20

For a fixed target real interest rate and target inflation rate, when inflation decreases, the Fed ____ interest rates, hence _____ short-run equilibrium output.
A) increases; increasing
B) decreases; increasing
C) increases; decreasing
D) decreases; decreasing

Accepted Answer

When the inflation rate decreases, the Fed responds by lowering the real interest rate per its reaction function. This decrease in the real interest rate increases consumption and investment, thereby increasing the short-run equilibrium output.

Quiz 12: Inflation and Aggregate Supply

At a constant rate of exchange between currencies, higher inflation makes domestic goods sold abroad expensive and, hence, short-run equilibrium output.

As inflation increases, households become _ uncertain leading to _ spending.

The aggregate demand curve shows the relationship between inflation and:

High levels of inflation _ the real value of money and, hence, __ short-run equilibrium output.

If the Fed's monetary policy reaction function does not change, then when inflation increases the Fed responds by ___ the real interest rate, which _ consumption and investment spending, which ___ output.

All else equal, a decrease in the rate of inflation aggregate spending and short-run equilibrium output.

Higher rates of inflation reduce spending because:

For a fixed target real interest rate and target inflation rate, when inflation increases, the Fed interest rates, hence _ short-run equilibrium output.

Because increases in inflation reduce aggregate spending and short-run equilibrium output:

The aggregate demand curve is downward sloping for all of the following reasons EXCEPT for the:

Increases in inflation redistribute resources from _-spending to -spending households and hence, _ short-run equilibrium output.

Lower rates of inflation increase planned spending because:

If the Fed's monetary policy reaction function does not change, then when inflation decreases the Fed responds by ___ the real interest rate, which _ consumption and investment spending, which ___ output.

Because decreases in inflation increase aggregate spending and short-run equilibrium output:

Changes in aggregate spending not caused by changes in output or the inflation rate, also known as exogenous changes in spending, will shift the:

All else equal, an increase in the rate of inflation aggregate spending and short-run equilibrium output.

The aggregate demand curve shows the relationship between short-run equilibrium output and the:

As inflation decreases, households become _ uncertain leading to _ spending.

The aggregate demand curve shifts when there are changes in:

For a fixed target real interest rate and target inflation rate, when inflation decreases, the Fed interest rates, hence _ short-run equilibrium output.