Question 1

New classical economists believe that it is possible under certain circumstances for an increase in the money supply to lead to a decrease in Real GDP in the short run.

Accepted Answer

New classical economists argue that in situations where prices are sticky in the short run, an increase in the money supply could lead to an increase in price levels but not necessarily an increase in Real GDP. This is known as the "liquidity trap" where individuals and firms hoard money rather than spend it, and therefore, monetary policy may not be an effective tool for stimulating the economy.

Question 2

As long as some people anticipate policy,the economic consequences may be the same as if all persons do so.

Accepted Answer

Anticipating policy can affect the behavior of individuals and businesses, leading to changes in the economy regardless of whether every single person anticipates it. Thus, the economic consequences may be the same whether everyone anticipates policy or not.

Question 3

The real business cycle theory focuses on the impact that changes in long-run aggregate supply will have on the business cycle.

Accepted Answer

The real business cycle theory, also known as the new classical theory, argues that changes in long-run aggregate supply (productive capacity of the economy) are the primary cause of economic fluctuations or the business cycle. This theory emphasizes the role of productivity shocks, technology innovation, and changes in labor supply, which affect the economy's potential output and influence the short-run fluctuations in output, employment, and prices. Therefore, it differs from other theories that focus on aggregate demand-driven or monetary factors as the primary drivers of the business cycle.

Question 4

One of the arguments supporting new classical theory is the policy ineffectiveness proposition (PIP).

Accepted Answer

The policy ineffectiveness proposition (PIP) argues that monetary policy is not effective in the long run and that any attempts to stimulate the economy through monetary policy will ultimately only lead to inflation. This is a key argument supporting new classical theory.

Question 5

New classical economists believe that monetary and fiscal policies are never effective.

Accepted Answer

New classical economists believe that monetary and fiscal policies can be effective in the short run but argue that in the long run, these policies are neutralized by adjustments in expectations and behavior, making them ineffective in changing real output or employment.

Question 6

The policy ineffectiveness proposition (PIP)argument states that under certain circumstances,neither expansionary demand-side fiscal policy nor expansionary monetary policy is effective at achieving macroeconomic goals.

Accepted Answer

The policy ineffectiveness proposition argues that when the economy is at full employment or there are long and variable time lags associated with the implementation of policy measures, expansionary demand-side fiscal policy or expansionary monetary policy may not be effective at achieving macroeconomic goals.

Question 7

Although the possibility exists for an economy to experience stagflation,it has never actually happened in the United States.

Accepted Answer

Stagflation did occur in the United States during the 1970s when inflation soared while economic growth remained stagnant.

Question 8

The Friedman natural rate theory is based on rational expectations and is also called the new classical theory.

Accepted Answer

The Friedman natural rate theory is based on the concept that there is a natural rate of unemployment in the economy, but it does not rely on rational expectations. The theory of rational expectations is a separate concept that was later integrated into macroeconomic models by the New Classical economists.

Question 9

Real business cycle theory emphasizes that an adverse supply shock will shift the LRAS curve leftward and cause a decline in Real GDP.

Accepted Answer

In real business cycle theory, supply shocks (such as an increase in the price of oil) can cause a leftward shift in the LRAS curve, leading to a decrease in potential output and a decline in real GDP. This is because the economy's long-term productive capacity is reduced by the shock, leading to a lower level of output that can be sustained over time.

Question 10

The original Phillips curve depicted an inverse relationship between wage inflation and unemployment.

Accepted Answer

The original Phillips curve, proposed by economist A.W. Phillips, showed an inverse relationship between unemployment and wage inflation. As unemployment decreased, wages would increase and vice versa, resulting in a downward sloping curve.

Question 11

According to new classical theory,if policy is correctly anticipated,expectations are formed rationally,and wages and prices are fully flexible,then an increase in aggregate demand will change Real GDP,but not the price level.

Accepted Answer

According to new classical theory, if policy is correctly anticipated and expectations are formed rationally, an increase in aggregate demand will not change Real GDP but will only lead to higher prices. In other words, new classical theory assumes that prices are not perfectly flexible in the short run, and therefore an increase in aggregate demand will lead to an increase in the price level rather than an increase in Real GDP.

Question 12

According to Milton Friedman,there are two Phillips curves,a short-run one and a long-run one.

Accepted Answer

Milton Friedman argued that there are two Phillips curves: a short-run one that shows an inverse relationship between unemployment and inflation, and a long-run one that is vertical at the natural rate of unemployment, indicating that there is no trade-off between inflation and unemployment in the long run.

Question 13

An unanticipated decrease in aggregate demand will cause an upward shift in the short-run Phillips curve.

Accepted Answer

An unanticipated decrease in aggregate demand will cause a downward shift in the short-run Phillips curve, not an upward shift. This is because the decrease in aggregate demand leads to a decrease in prices, causing inflation to fall in the short run. As a result, the Phillips curve shifts down, reflecting the lower level of inflation associated with any given level of unemployment.

Question 14

If stagflation is present the short-run Phillips curve is vertical.

Accepted Answer

Stagflation is characterized by high inflation and high unemployment, which suggests that the short-run Phillips curve is not vertical. A vertical Phillips curve implies that there is no trade-off between inflation and unemployment, which contradicts the conditions of stagflation.

Question 15

New Keynesian theory differs from new classical theory in that New Keynesian theory assumes that wages and prices are not completely flexible in the short-run,while fully flexible wages and prices are an assumption of new classical theory.

Accepted Answer

New Keynesian theory assumes that there are sticky prices and wages in the short-run, while new classical theory assumes that prices and wages are fully flexible.

Question 16

Rational expectations are based on the past alone,while adaptive expectations are based on the past,the present,and the future.

Accepted Answer

Rational expectations are based on all available information, including both past and current information as well as future expectations. Adaptive expectations, on the other hand, rely only on past observations to predict future outcomes, without taking into account current or future information.

Question 17

The terms rational expectations and adaptive expectations are two different names for the same concept.

Accepted Answer

Rational expectations and adaptive expectations are not the same concept. Rational expectations assume that individuals form their expectations based on all available information and economic models, while adaptive expectations assume that individuals base their expectations on past experiences or outcomes.

Question 18

A person's real wage will fall if the nominal wage falls,the price level rises,or both.

Accepted Answer

A person's real wage is calculated by dividing their nominal wage by the price level. Therefore, if the nominal wage falls or the price level rises, the real wage will also fall.

Question 19

Rational expectations theory is also known as the Friedman fooling theory.

Accepted Answer

Rational expectations theory is a widely accepted economic theory that states that individuals make decisions based on their rational expectations of the future, rather than solely on past events. It was first proposed by John F. Muth in the 1960s and further developed by economists like Robert Lucas and Thomas Sargent. However, it is not known as the "Friedman fooling theory" – this is a term that does not exist in economics literature. Milton Friedman did influence the development of rational expectations theory, but he did not create or name it.

Question 20

The Friedman natural rate theory holds that there is an inverse relationship between inflation and unemployment in the long run,but not in the short run.

Accepted Answer

The Friedman natural rate theory actually posits that there is no trade-off between inflation and unemployment in the long run, meaning that attempts to reduce unemployment below its natural rate by increasing inflation only lead to higher inflation in the long run without affecting unemployment.

Quiz 16: Expectations Theory and the Economy