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16 CHAPTER Extending the Analysis of Aggregate Supply Topic 1. 2. 3. 4. 5. Short-run and long-run aggregate supply Extended AD-AS model Phillips Curve Long-run Phillips Curve Taxation and aggregate supply Last Word True-False Question numbers 1-26 27-44 45-63 64-90 91-99 100-102 103-116 ___________________________________________________________________________________________________ ___________________________________________________________________________________________________ Multiple Choice Questions Short-run and long-run aggregate supply 1. In terms of aggregate supply, a period in which nominal wages and other input prices are constant is called the: A) long run. B) short run. C) immediate market period. D) very long run. 2. In terms of aggregate supply, a period in which nominal wages and other input prices are variable is called the: A) long run. B) short run. C) immediate market period. D) very long run. 3. In the extended analysis of aggregate supply, the short-run aggregate supply curve is: A) vertical and the long-run aggregate supply curve is horizontal. B) horizontal and the long-run aggregate supply curve is vertical. C) upward sloping and the long-run aggregate supply curve is vertical. D) horizontal and the long-run aggregate supply curve is upward sloping. 4. In the extended analysis of aggregate supply, the long-run aggregate supply curve is: A) vertical and the short-run aggregate supply curve is horizontal. B) horizontal and the short-run aggregate supply curve is vertical. Page 1 C) horizontal and the short-run aggregate supply curve is upward sloping. D) vertical and the short-run aggregate supply curve is upward sloping. 5. In terms of aggregate supply, the short run is a period in which: A) the price level is constant. B) employment is constant. C) real output is constant. D) nominal wages and other input prices are constant. 6. In terms of aggregate supply, the difference between the long run and the short run is that in the long run: A) the price level is variable. B) employment is variable. C) real output is variable. D) nominal wages and other input prices are variable. 7. The long-run aggregate supply curve is vertical: A) because the rate of inflation is steady in the long run. B) because resource prices eventually catch up with product prices. C) because product prices always increase at a faster rate than resource prices. D) only when the money supply increases at the same rate as real GDP. 8. The short-run aggregate supply curve is upsloping because: A) of the interest rate effect. B) higher price levels create incentives to expand output when resource prices remain constant. C) of the net export effect. D) higher price levels create an expectation among producers of still higher price levels. 9. Other things equal, an increase in the price level will: A) shift the aggregate supply curve to the right. B) shift the aggregate demand curve to the right. C) cause a movement up along a short-run aggregate supply curve. D) cause a movement down an aggregate demand curve. 10. Other things equal, a decrease in the price level will: A) shift the aggregate supply curve to the left. B) shift the aggregate demand curve to the left. C) cause a movement up a short-run aggregate supply curve. D) cause a movement down an aggregate supply curve. Use the following to answer questions 11-14: Suppose the natural level of real output (Q) for a hypothetical economy is $500, the price level (P) initially is 100, and that prices and wages are flexible both upward and downward. Use the following short-run aggregate supply schedules to answer the next question(s). Page 2 (a) AS(P100) P Q 125 $560 100 500 75 440 (b) AS(P125) P Q 125 $500 100 440 75 380 (c) AS(P75) P Q 125 $620 100 560 75 500 11. Refer to the information above. If the price level unexpectedly increases from 100 to 125, the level of real output in the short run will: A) rise from $500 to $560. B) fall from $500 to $440. C) fall from $560 to $500. D) rise from $440 to $500. 12. Refer to the information above. In the long run, an increase in the price level from 100 to 125 will: A) increase real output from $500 to $560. B) decrease real output from $500 to $440. C) change the aggregate supply schedule from (a) to (c) and result in an equilibrium level of real output of $560. D) change the aggregate supply schedule from (a) to (b) and result in an equilibrium level of real output of $500. 13. Refer to the information above. If the price level unexpectedly declines from 100 to 75, the level of real output in the short run will: A) rise from $500 to $560. B) fall from $500 to $440. C) fall from $560 to $500. D) rise from $440 to $500. 14. Refer to the information above. In the long run, a fall in the price level from 100 to 75 will: A) decrease real output from $500 to $440. B) increase real output from $500 to $620. C) change the aggregate supply schedule from (a) to (c) and produce an equilibrium level of real output of $500. D) change the aggregate supply schedule from (a) to (b) and produce an equilibrium level of real output of $500. 15. The: A) short-run aggregate supply curve is downward sloping. B) short-run aggregate supply curve is vertical. C) long-run aggregate supply curve is vertical. D) long-run aggregate supply curve is upsloping. Use the following to answer questions 16-21: Page 3 16. Refer to the above diagram. Assume that nominal wages initially are set on the basis of the price level P2 and that the economy initially is operating at its full-employment level of output Qf. In the short run, an increase in the price level from P2 to P3 will: A) change aggregate supply from AS2 to AS3. B) increase real output from Q1 to Q2. C) change aggregate supply from AS2 to AS1. D) increase real output from Qf to Q2. 17. Refer to the above diagram. Assume that nominal wages initially are set on the basis of the price level P2 and that the economy initially is operating at its full-employment level of output Qf. In the long run, an increase in the price level from P2 to P3 will: A) increase real output from Qf to Q2. B) change aggregate supply from AS2 to AS1. C) decrease real output from Q2 to Q1. D) move the economy from b to d. 18. Refer to the above diagram. Assume that nominal wages initially are set on the basis of the price level P2 and that the economy initially is operating at its full-employment level of output Qf. In terms of this diagram, the long-run aggregate supply curve: A) is AS2. B) is a vertical line extending from Qf upward through e, b, and d . C) may be either AS1, AS2, or AS3 depending on whether the price level is P1, P2, or P3. D) is a horizontal line extending from P2 rightward through f , b, and g. 19. Refer to the above diagram. Assume that nominal wages initially are set on the basis of the price level P2 and that the economy initially is operating at its full-employment level of output Qf. In the short run, demand-pull inflation could best be shown as: A) a move from b to c on AS2. B) a move from b to c to d. C) a change of aggregate supply from AS2 to AS3. D) a move from b to d. Page 4 20. Refer to the above diagram. Assume that nominal wages initially are set on the basis of the price level P2 and that the economy initially is operating at its full-employment level of output Qf. In the long run, demand-pull inflation could best be shown as: A) a move from b to c on AS2. B) a move from b to f to d. C) a change of aggregate supply from AS2 to AS1. D) a move from b to d. 21. Refer to the above diagram. Assume that nominal wages initially are set on the basis of the price level P2 and that the economy initially is operating at its full-employment level of output Qf. In the short run, costpush inflation could best be shown as: A) a leftward shift of aggregate supply from AS2 to AS3. B) a move from b to c on AS2. C) a move from b to c to d. D) a move from b to f to d. 22. Other things equal, the short-run aggregate supply curve shifts positions when: A) the price level changes. B) the rate of inflation changes. C) nominal wages and other input prices change. D) aggregate demand changes. Use the following to answer questions 23-26: 23. Refer to the above diagram relating to short-run and long-run aggregate supply. The A) short-run aggregate supply curve is A. B) short-run aggregate supply curve is B. C) long-run aggregate supply curve is B. D) long-run aggregate supply curve is D. 24. Refer to the above diagram. If the price level rises above P1 because of an increase in aggregate demand, Page 5 the: A) economy will move up along curve B and output will temporarily increase. B) long-run aggregate supply curve C will shift upward. C) short-run aggregate supply curve B will automatically shift to the right. D) economy's output first will decline, then increase, and finally return to Q1. 25. Refer to the above diagram. The long-run aggregate supply curve is: A) A. B) B. C) C. D) D. 26. Refer to the above diagram. The short-run aggregate supply is: A) A. B) B. C) D. D) not represented in the diagram. Extended AD-AS model 27. The "extended AD-AS model": A) distinguishes between short-run and long-run aggregate demand. B) explains inflation but not recession. C) includes G and Xn whereas the simple AD-AD model does not. D) distinguishes between short-run and long-run aggregate supply. 28. In the extended aggregate demand-aggregate supply model: A) long-run equilibrium occurs wherever the aggregate demand curve intersects the short-run aggregate supply curve. B) the long-run aggregate supply curve is horizontal. C) the price level is the same regardless of the location of the aggregate demand curve. D) long-run equilibrium occurs at the intersection of the aggregate demand curve, the short-run aggregate supply curve, and the long run aggregate supply. 29. In the extended aggregate demand-aggregate supply model: A) long-run equilibrium occurs wherever the aggregate demand curve intersects the short-run aggregate supply curve. B) the long-run aggregate supply curve is horizontal. C) the level of real output is the same in the long run regardless of the location of the aggregate demand curve. D) the short-run aggregate supply curve is downsloping. Use the following to answer questions 30-35: Page 6 30. Refer to the above diagram. The initial aggregate demand curve is AD1 and the initial aggregate supply curve is AS1. Demand-pull inflation in the short run is best shown as: A) a shift of the aggregate demand curve from AD1 to AD2. B) a move from d to b to a. C) a move directly from d to a. D) a shift of the aggregate supply curve from AS1 to AS2. 31. Refer to the above diagram. The initial aggregate demand curve is AD1 and the initial aggregate supply curve is AS1. In the long run, demand-pull inflation is best shown as: A) a shift of aggregate demand from AD1 to AD2 followed by a shift of aggregate supply from AS1 to AS2. B) a move from d to b to a. C) a shift of aggregate supply from AS1 to AS2 followed by a shift of aggregate demand from AD1 to AD2. D) a move from a to d. 32. Refer to the above diagram. The initial aggregate demand curve is AD1 and the initial aggregate supply curve is AS1. In the long run, the aggregate supply curve is vertical in the diagram because: A) nominal wages and other input prices are assumed to be fixed. B) real output level Qf is the potential level of output. C) price level increases produce perfectly offsetting changes in nominal wages and other input prices. D) higher than expected rates of actual inflation reduce real output only temporarily. 33. Refer to the above diagram. The initial aggregate demand curve is AD1 and the initial aggregate supply curve is AS1. Cost-push inflation in the short run is best represented as a: A) leftward shift of the aggregate supply curve from AS1 to AS2. B) rightward shift of the aggregate demand curve from AD1 to AD2. C) move from d to b to a. D) move from d directly to a. Page 7 34. Refer to the above diagram. The initial aggregate demand curve is AD1 and the initial aggregate supply curve is AS1. Assuming no change in aggregate demand, the long-run response to a recession caused by cost-push inflation is best depicted as a: A) move from a to d along the long-run aggregate supply curve. B) rightward shift of the aggregate supply curve from AS2 to AS1. C) move from a to c to d. D) leftward shift of the aggregate supply curve from AS1 to AS2. 35. Refer to the above diagram. The initial aggregate demand curve is AD1 and the initial aggregate supply curve is AS1. If government offsets the decline in real output resulting from short-run cost-push inflation by increasing aggregate demand from AD1 to AD2: A) real output will rise above Qf. B) the price level will rise from P1 to P2. C) it is possible that aggregate supply will shift rightward from AS2 because nominal wage demands will rise. D) the price level will rise from P2 to P 3. 36. If government uses fiscal policy to restrain cost-push inflation, we can expect: A) the unemployment rate to rise. B) the unemployment rate to fall. C) the aggregate demand curve to shift rightward. D) tax-rate declines and increases in government spending. 37. One policy dilemma posed by cost-push inflation is that: A) an increase in aggregate demand will increase inflation and the unemployment rate simultaneously. B) tax rates can be reduced without lowering tax revenues. C) the reduction of aggregate demand to restrain inflation will cause a further reduction in the real GDP. D) the adjustment of aggregate demand can neither increase real GDP nor reduce inflation. 38. If government uses its stabilization policies to maintain full employment under conditions of cost-push inflation: A) a deflationary spiral is likely to occur. B) an inflationary spiral is likely to occur. C) stagflation is likely to occur. D) the Phillips Curve is likely to shift inward. Use the following to answer questions 39-44: Page 8 39. Refer to the above diagram and assume that prices and wages are flexible both upward and downward in the economy. In the extended AD-AS model: A) demand-pull inflation would involve a rightward shift of curve A, followed by a leftward shift of curve C. B) cost-push inflation would involve a rightward shift of curve A, followed by a leftward shift of curve C. C) recession would involve a leftward shift of curve A followed by a leftward shift of curve C. D) recession would involve a rightward shift of curve D, followed by leftward shifts of curves A and C. 40. Refer to the above diagram and assume that prices and wages are flexible both upward and downward in the economy. In the extended AD-AS model: A) demand-pull inflation would involve a rightward shift of curve A, followed by a rightward shift of curve C. B) cost-push inflation would involve first a leftward shift of curve C, then a rightward shift of curve C. C) recession would involve a leftward shift of curve A followed by a leftward shift of curve C. D) recession would involve a rightward shift of curve D, followed by leftward shifts of curves A and C. 41. Refer to the above diagram and assume that prices and wages are flexible both upward and downward in the economy. In the extended AD-AS model: A) demand-pull inflation would involve a rightward shift of curve A, followed by a rightward shift of curve C. B) cost-push inflation would involve a rightward shift of curve A, followed by a leftward shift of curve C. C) recession would involve a leftward shift of curve A followed by a rightward shift of curve C. D) recession would involve a rightward shift of curve D, followed by leftward shifts of curves A and C. 42. Refer to the above diagram and assume that prices and wages are flexibility both upward and downward in the economy. In the extended AD-AS model: A) demand-pull inflation would involve a rightward shft of curve A, followed by a rightward shift of curve C. B) cost-pust inflation would involve a rightward shift of curve A, followed by a leftward shift of curve C. C) recession would involve a leftward shift of curve A followed by a leftward shift of curves C and D. D) recession could be caused by either a leftward shift of curve A or a leftward shift of curve C. 43. Refer to the above diagram and assume that prices and wages are flexible both upward and downward in the economy. In the extended AD-AS model: Page 9 A) B) C) D) demand-pull inflation would involve a shift of curve D to the right. cost-push inflation would involve a shift of curve B downward. recession would involve a leftward shift of curve A. frictional unemployment would be zero in the long run. 44. Refer to the above diagram. Assume both upward and downward price and wage flexibility in the economy. In the extended AD-AS model: A) demand-pull inflation would involve a rightward shift of curve A, followed by a rightward shift of curve C. B) cost-push inflation would involve a leftward shift of curve C, followed by an upward shift of curve B. C) recession would involve a leftward shift of curve A. D) a rightward shift of curve D would be equivalent to an outward shift of the nation's production possibilities curve. Phillips Curve 45. The traditional Phillips Curve suggests a tradeoff between: A) price level stability and income equality. B) the level of unemployment and price level stability. C) unemployment and income equality. D) economic growth and full employment. 46. The basic problem portrayed by the traditional Phillips Curve is: A) that a level of aggregate demand sufficiently high to result in full employment may also cause inflation. B) that changes in the composition of total labor demand tend to be deflationary. C) that unemployment rises at the same time the general price level is rising. D) the possibility that automation will increase the level of noncyclical unemployment. 47. The traditional Phillips Curve suggests that, if government uses an expansionary fiscal policy to stimulate output and employment: A) unemployment may actually increase because of the crowding-out effect. B) tax revenues may increase even though tax rates have been reduced. C) inflation may result. D) the natural rate of unemployment may fall. Use the following to answer questions 48-53: Page 10 48. Refer to the above diagram for a specific economy. The curve on this graph is known as a: A) Laffer Curve. B) Phillips Curve. C) labor demand curve. D) production possibilities curve. 49. Refer to the above diagram for a specific economy. Which of the following best describes the relationship shown by this curve? A) The demand for labor is large when the rate of inflation is small. B) When the rate of unemployment is high, the rate of inflation is high. C) The rate of inflation and the rate of unemployment are inversely related. D) The rate of inflation and the rate of unemployment are directly related. 50. Refer to the above diagram for a specific economy. A reduction in structural unemployment or bottleneck problems in labor markets will: A) shift this curve to the right. B) shift this curve to the left. C) move this economy southeast along the curve. D) move this economy northwest along the curve. 51. Refer to the above diagram for a specific economy. An increase in aggregate demand will: A) shift this curve to the right. B) shift this curve to the left. C) move this economy southeast along the curve. D) move economy this northwest along the curve. 52. Refer to the above diagram for a specific economy. Which of the following best describes a decision by policymakers that moves this economy from point b to point a? A) Policymakers have instituted an easy money policy and/or a budgetary deficit, thereby accepting more unemployment to reduce the rate of inflation. B) Policymakers have instituted a tight money policy and/or a budgetary surplus, thereby accepting a higher rate of inflation to reduce unemployment. C) Policymakers have instituted an easy money and/or a budgetary deficit, thereby accepting a higher rate of inflation to reduce unemployment. D) Policymakers have instituted a tight money policy and/or a budgetary surplus, thereby accepting more unemployment to reduce the rate of inflation. 53. Refer to the above diagram for a specific economy. The shape of this curve suggests that: A) the price level rises at a diminishing rate as the level of aggregate demand increases. B) full employment and price stability are compatible goals only when aggregate demand is falling. C) each successive unit of decline in the unemployment rate is accompanied by a smaller increase in the rate of inflation. D) each successive unit of decline in the unemployment rate is accompanied by a larger increase in the rate of inflation. 54. Stagflation refers to: A) an increase in inflation accompanied by decreases in real output and employment. Page 11 B) a decline in the price level accompanied by increases in real output and employment. C) a simultaneous increase in real output and the price level. D) a simultaneous reduction in real output and the price level. 55. Inflation accompanied by falling real output and employment is known as: A) Laffer's law. B) Okun's law. C) stagflation. D) the Phillips Curve. 56. Which of the following allegedly contributed to the mid-1970s' stagflation? A) appreciation of the dollar B) a sharp drop in the prices of farm products C) a dramatic increase in oil prices D) rising productivity in manufacturing. 57. Statistical data for the 1970s and 1980s suggest that: A) the Phillips Curve was stable. B) the Phillips Curve was unstable. C) low levels of unemployment were consistently associated with high rates of inflation. D) the inflation rate was highly stable. 58. A rightward shift of the traditional Phillips Curve would suggest that: A) the productivity of labor increased. B) the rate of inflation is now higher at each rate of unemployment. C) cost-push inflation decreased. D) the rate of inflation is now lower at each rate of unemployment. 59. A major adverse aggregate supply shock: A) automatically shifts the aggregate demand curve rightward. B) causes the Phillips Curve to shift rightward and upward. C) can be caused by rising productivity. D) can be caused by falling wages. 60. Rightward and upward shifts of the Phillips Curve in the 1970s and early 1980s were caused by: A) adverse shocks to aggregate supply. B) adverse shocks to aggregate demand. C) an increase in the misery index. D) the Vietnam War. 61. An adverse aggregate supply shock could result from: A) a sharp rise in productivity. B) a rapid rise in oil prices. C) a decline in wages. D) an appreciation of the dollar. Page 12 62. An adverse aggregate supply shock: A) automatically shifts the aggregate demand curve rightward. B) causes the Phillips Curve to shift leftward and downward. C) can be caused by a boost in the rate of growth of productivity. D) can cause stagflation. 63. The last few years of the 1990s in the United States were characterized by: A) low inflation and high unemployment. B) stagflation. C) low inflation and low unemplyment. D) a high misery index. Long-run Phillips Curve 64. Which of the following is a true statement? A) Under normal conditions there is a short-run tradeoff between inflation and unemployment. B) There is a long-run tradeoff between inflation and unemployment. C) The short-run Phillips Curve is vertical. D) The long-run Phillips Curve is horizontal. 65. Which of the following is a true statement? A) There is a long-run tradeoff between inflation and unemployment. B) The short-run Phillips Curve is vertical. C) The long-run Phillips Curve is horizontal. D) Adverse aggregate supply shocks can simultaneously worsen unemployment and inflation. 66. Which of the following is a true statement? A) There is a long-run tradeoff between inflation and unemployment. B) There is no tradeoff between inflation and unemployment in the long run. C) The short-run Phillips Curve is horizontal. D) The long-run Phillips Curve is horizontal. 67. Which of the following is a true statement? A) The short-run Phillips Curve is horizontal. B) The long-run Phillips Curve is horizontal. C) There is a long-run tradeoff between inflation and unemployment. D) The short-run Phillips Curve is downward sloping. 68. Which of the following is a true statement? A) There is a long-run tradeoff between inflation and unemployment. B) There is no tradeoff between inflation and unemployment in the short-run. C) The short-run Phillips Curve is horizontal. D) The long-run Phillips Curve is vertical. 69. In the last half of the 1990s, the usual short-run tradeoff between inflation and unemployment did not arise because: Page 13 A) B) C) D) the Fed held interest rates constant. the Federal government balanced its budget. the U.S. personal savings rate rose. productivity (and thus aggregate supply ) grew faster than previously. 70. Suppose that the CPI for a particular economy rose from 110 to 120 in year 1, 120 to 130 in year 2, and 130 to 140 in year 3. We could conclude that this economy is experiencing: A) accelerating inflation. B) deflation. C) disinflation. D) a constant rate of inflation. 71. Disinflation occurs when: A) the price level is falling. B) investment plans exceed saving. C) a speculative investment "bubble" is bursting. D) the inflation rate is declining. 72. As distinct from reductions in the price level, reductions in the rate of inflation are referred to as: A) dollar depreciation. B) stagflation. C) deflation. D) disinflation. 73. When the actual rate of inflation is less than the expected rate: A) the unemployment rate will temporarily rise. B) firms will increase their output to recoup their falling profits. C) the unemployment rate will temporarily fall. D) firms will experience rising profits and thus increase their employment. 74. When the actual rate of inflation exceeds the expected rate: A) the unemployment rate will temporarily rise. B) firms will experience rising profits and thus increase their employment. C) the actual rate of inflation will fall. D) nominal wages will decline. Use the following to answer questions 75-80: Page 14 Annual rate of inflation (%) 9 c3 b4 b3 6 c2 c1 3 b2 b1 7 3 5 6 2 4 Unemployment rate (%) 75. The above diagram is the basis for explaining: A) the traditional Phillips Curve. B) the long-run Phillips Curve. C) how central planning can make full employment and price level stability compatible goals. D) new policies for eliminating unemployment. 76. The natural rate of unemployment for this economy is: A) 3 percent. B) 5 percent. C) 6 percent. D) 4 percent. 77. Refer to the above diagram. Assume the economy is initially at point b1. With a time lag between price and nominal wage adjustments, an increase in aggregate demand will temporarily move the economy from: A) b2 to b1. B) c1 to b2. C) b1 to c1. D) b1 to b2. 78. Refer to the above diagram and assume the economy is initially at point b1. Which of the following movements is consistent with the traditional Phillips Curve? A) the movement from b1 to b2 B) the movement from b1 to c1 C) the movement from c1 to b2 D) the movement from b2 to b1 79. Refer to the above diagram and assume the economy is initially at point b1. Point c1 represents: A) a stable position because reality and expectations are consistent. B) a stable position because full employment and a constant annual inflation rate are represented. C) an unstable situation because government will undertake contractionary policies D) an unstable situation because nominal wage rates will increase. 80. Refer to the above diagram and assume the economy is initially at point b1. The long-run relationship Page 15 between the unemployment rate and the rate of inflation is represented by: A) the line connecting b1 and c1. B) the line through b1, b2, b3 , and b4. C) the line connecting c1 and b2. D) any line parallel to the horizontal axis. 81. Government can push the unemployment rate below the natural rate only by: A) instituting supply-side economic policies. B) producing a higher rate of inflation than people expect. C) balancing the federal budget. D) achieving zero inflation. 82. In the long run: A) attempts to "fine tune" the economy cause the rate of unemployment to accelerate. B) there is no long-run inflation-unemployment tradeoff. C) there is an inflation-unemployment tradeoff and the terms of that tradeoff have worsened in recent years. D) there is an inflation-unemployment tradeoff, but the terms of that tradeoff have improved in recent years. Use the following to answer questions 83-86: PCLR Inflation rate (%) 6 d a 4 c PC1 b PC2 0 4 5 7 Unemployment rate (%) 83. Refer to the above diagram. Assume that the natural rate of unemployment is 5 percent and that the economy is initially operating at point a where the expected and actual rates of inflation are each 6 percent. If the actual rate of inflation unexpectedly falls from 6 percent to 4 percent, then the unemployment rate will: A) temporarily fall from 5 percent to 4 percent. B) permanently fall from 5 percent to 4 percent. C) temporarily rise from 5 percent to 7 percent. D) permanently rise from 5 percent to 7 percent. Page 16 84. Refer to the above diagram. Assume that the natural rate of unemployment is 5 percent and that the economy is initially operating at point a where the expected and actual rates of inflation are each 6 percent. In the long run, the decline in the actual rate of inflation from 6 percent to 4 percent will: A) reduce the unemployment rate. B) reduce corporate profits in real terms. C) have no effect on the unemployment rate. D) reduce real domestic output. 85. Refer to the above diagram. Assume that the natural rate of unemployment is 5 percent and that the economy is initially operating at point c where the expected and actual rates of inflation are each 4 percent. If the actual rate of inflation unexpectedly rises from 4 percent to 6 percent, the economy will: A) move from a to b and eventually to c. B) move directly from c to b. C) remain at a. D) move from c to d and eventually to a. 86. In the above diagram: A) any rate of inflation is consistent with the natural rate of unemployment in the long run. B) inflation can occur but disinflation cannot occur. C) unemployment rates exceeding the natural rate are permanent. D) unemployment rates less than the natural rate are permanent. Use the following to answer questions 87-90: 87. Refer to the above diagram. Point b on short-run Phillips Curve PC1 represents a rate of: A) inflation below the natural rate. B) inflation above the natural rate. C) unemployment above the natural rate. D) unemployment below the natural rate. 88. Refer to the above diagram. Point b would be explained by: A) an actual rate of inflation that exceeds the expected rate. B) an actual rate of inflation that is less than the expected rate. C) cost-push inflation. D) an increase in long-run aggregate supply. Page 17 89. Refer to the above diagram. Point b would not be permanent because the: A) economy would move from b to a on PC1. B) short-run Phillips Curve would shift from PC1 to PC2 and unemployment would increase to the natural rate at c. C) economy would immediately move from b to c to d. D) economy would move from b directly to d. 90. Refer to the above diagram. The move of the economy from c to e on short-run Phillips Curve PC2 would be explained by an: A) increase in aggregate demand in the economy. B) increase in aggregate supply in the economy. C) actual rate of inflation that is less than the expected rate. D) actual rate of inflation that exceeds the expected rate. Taxation and aggregate supply 91. Which of the following is a tenet of supply-side economics? A) High marginal tax rates severely discourage work, saving, and investment. B) Increases in social security taxes and other business taxes shift the aggregate supply curve to the right. C) The Federal Reserve should adhere to a monetary rule that limits increases in the money supply to a 10 percent annual rate. D) Transfer payments increase incentives to work. 92. The Laffer Curve is a central concept in: A) monetarism. B) Keynesianism. C) welfare economics. D) supply-side economics. Use the following to answer questions 93-94: 93. The above curve is known as the: A) Taylor rule. B) Okun Curve. C) Laffer Curve. Page 18 D) Phillips Curve. 94. Refer to the above diagram. Supply-side economists believe that tax rates are: A) such that an increase in tax rates will increase tax revenues. B) at some level below b. C) at some level above b. D) at d. 95. Supply-side economist Arthur Laffer has argued that: A) there is no empirically proven relationship between tax rates and incentives. B) large reductions in personal and corporate income taxes will increase aggregate supply much more than aggregate demand. C) the only way to eliminate inflation is to increase taxes to induce a recession severe enough to eliminate inflationary expectations. D) large cuts in income taxes will increase aggregate demand more than aggregate supply. 96. A basic criticism of supply-side economics is that: A) empirical research clearly shows that incentives to work and invest vary directly with marginal tax rates. B) lower taxes will increase aggregate supply much more than they will increase aggregate demand. C) lower taxes will increase aggregate demand much more than they will increase aggregate supply. D) higher taxes will reduce incentives to work, invest, and innovate. 97. Critics of supply-side economics: A) argue that a tax cut will increase aggregate supply by more than it increases aggregate demand. B) contend that the relationship between tax rates and economic incentives is small and of uncertain direction. C) believe that a decline in tax rates will increase tax revenues. D) point out that tax cuts enable households to "buy more leisure" by working less. Use the following to answer questions 98-99: Average Tax Rate 20% 40 60 80 Tax Revenue (billions of dollars) $250 300 250 200 98. If graphed, the relationship shown above would depict this economy's: A) Laffer Curve. B) Lorenz Curve. C) Tax Freedom Curve. D) Phillips Curve. 99. In 1993 the Federal government boosted income tax rates. In the seven years that followed: Page 19 A) B) C) D) tax revenues fell slightly. productivity growth slowed. the unemployment rate increased. tax revenues expanded rapidly. Last Word Questions 100. (Last Word) Which of the following is a reason why changes in the price of imported oil have less of an effect on the U. S. economy than in the 1970s and early 1980s? A) The United States is now more reliant on domestic oil and less reliant on imported oil. B) The amount of energy consumed in producing each dollar of GDP has greatly declined. C) The United States has vastly expanded its hydroelectric capacity (dams and reservoirs). D) The United States has greatly expanded its passenger train services. 101. (Last Word) In recent years: A) significant changes in the price of oil have had much less effect on the U. S. economy than did similar changes in oil prices in previous decades. B) large increases in the price of oil have reduced U. S. aggregate supply and caused cost-push inflation. C) large decreases in the price of oil have increased U. S. aggregate supply and caused deflation. D) the United States has become a net exporter of oil. 102. (Last Word) Relative to previous decades, the U.S. economy is less affected by changes in the price of oil partly because: A) the composition of GDP has changed from larger, heavier items such as earth movers and steel products toward smaller, lighter items such as software and microchips. B) The United States is now more reliant on domestic oil and less reliant on imported oil. C) The United States has vastly expanded its hydroelectric capacity (dams and reservoirs). D) The ratio of passenger cars to passenger trucks has increased. True/False Questions 103. The short-run aggregate supply curve is vertical and the long-run aggregate supply curve is horizontal. 104. The short-run aggregate supply curve shifts to the left when nominal wages rise in response to price level increases. 105. The extended AD-AS model distinguishes between short-run and long-run aggregate supply 106. In the extended AD-AS model, the long-run aggregate supply curve is vertical. Use the following to answer questions 107-110: Answer the next question(s) on the basis of the following economic data for a hypothetical economy: Page 20 Year 1997 1998 1999 2000 Average hourly Index of Price Rate of wage industrial Unemployment level increase in rates production rate index productivity $6.40 197 5.5% 130 3.0% 6.72 199 5.8 133 2.9 7.24 196 7.2 139 3.1 8.02 192 8.3 147 2.8 107. The above data indicate that the economy has entered a period of demand-pull inflation. 108. Refer to the above data. It would be appropriate stabilization policy to raise interest rates, raise taxes, and reduce government expenditures. 109. Refer to the above data. There is evidence that cost-push inflationary pressure is present in this economy. 110. Refer to the above data. This economy has encountered stagflation. 111. Demand-pull inflation and cost-push inflation are identical concepts because both involve rising nominal wages and rising prices. 112. The Phillips Curve suggests an inverse relationship between increases in the price level and the level of employment. 113. A shift in the Phillips Curve to the left will improve the inflation-unemployment choices available to society. 114. A rightward and upward shift of the Phillips Curve is consistent with the occurrence of stagflation. 115. The Laffer Curve shows the tradeoff between the price level and tax rates. 116. The Laffer Curve underlies the contention that lower tax rates need not reduce tax revenues. Page 21 Answer Key -- ch 16 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. B A C D D D B B C D A D B C C D D B A D A C B A A B D D C A A C A B D A C B A B C D C D B A C B C B D C D A Page 22 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. 86. 87. 88. 89. 90. 91. 92. 93. 94. 95. 96. 97. 98. 99. 100. 101. 102. 103. 104. 105. 106. 107. 108. 109. 110. C C B B B A B D C A D B D D D C D D A B B B C B D B B B C C D A D A B C A D C C B C B A D B A A False True True True False False True True Page 23 111. 112. 113. 114. 115. 116. False False True True False True Page 24

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