10 CHAPTER WORKING WITH OUR BASIC AGGREGATE DEMAND AND AGGREGATE SUPPLY MODEL
1. Which of the following would be most likely to cause an increase in current aggregate demand in the United States? a. increased fear that the U.S. economy was going into a recession b. an increase in the real interest rate c. sharp increase in the value of stocks owned by Americans d. a recession in Canada, Mexico, and Western Europe Which of the following will most likely accompany an unanticipated increase in aggregate demand? a. an increase in real output b. an increase in unemployment c. a decrease in real GDP d. a decrease in the demand for resources In the aggregate demand/aggregate supply model, when the output of an economy is less than its long-run potential, the economy will experience a. declining real wages and interest rates that will stimulate employment and real output. b. rising interest rates that will stimulate aggregate demand and restore full employment. c. a budget surplus that will stimulate demand and, thereby, help restore full employment. d. rising real wages and real interest rates that will restore equilibrium at a higher price level. Which of the following will most likely result from an unanticipated decrease in aggregate supply due to unfavorable weather conditions in agricultural areas? a. a decrease in inflation b. a decrease in unemployment c. an increase in the general level of prices d. an increase in the natural rate of unemployment Which of the following will most likely increase aggregate supply in the long run? a. unfavorable weather conditions in agricultural areas b. an increase in the expected inflation rate c. higher real interest rates d. an increase in the rate of capital formation Within the AD/AS model, an unanticipated increase in short-run aggregate supply will cause real output to a. increase and the general level of prices to fall. b. decrease and the general level of prices to rise. c. increase and the general level of prices to rise. d. decrease and the general level of prices to fall.
2.
3.
4.
5.
6.
7.
An increase in the long-run aggregate supply curve indicates that a. the natural rate of unemployment has increased. b. unemployment has increased. c. the general level of prices has increased. d. potential real GDP has increased. If the general level of prices is lower than business decision makers anticipated when they entered into long-term contracts for raw materials and other resources, which of the following is most likely to occur? a. an economic boom b. highly attractive profit margins c. output less than the economys long-run potential d. a sharp increase in imports When output is less than the economys long-run capacity, which of the following is most likely to occur? a. an abnormally low rate of unemployment b. reductions in real interest rates and real resource prices c. a sharp increase in imports d. a government budget surplus During the year 2000, there was a sharp reduction in stock prices and a sharp increase in the world price of crude oil. Within the framework of the AD/AS model, how would these two changes influence the U.S. economy? a. The lower stock prices would increase SRAS, and the higher crude oil prices would reduce AD; as a result, there would be downward pressure on the general level of prices. b. The lower stock prices would reduce SRAS, and the higher crude oil prices would increase AD; as a result, there would be upward pressure on the general level of prices. c. The lower stock prices would increase AD, and the higher crude oil prices would increase SRAS; as a result, output would tend to increase. d. The lower stock prices would reduce AD, and the higher crude oil prices would reduce SRAS; as a result, output would tend to decline.
8.
9.
10.
ANSWER KEY 1 THROUGH 10
1. (c), 2. (a), 3. (a), 4. (c), 5. (d), 6. (a), 7. (d), 8. (c), 9. (b), 10. (d)
CHAPTER 11 KEYNES AND THE EVOLUTION OF MACROECONOMICS
1. Which of the following views would a Keynesian economist be most likely to stress? a. Supply creates its own demand. b. Businesses will not produce goods and services if they do not think people will buy them. c. You cannot spend your way out of a recession. d. When the unemployment rate is high, wage rates will fall. e. A dollar saved is a dollar earned; a high rate of saving is the key to prosperity. When Keynesian equilibrium is present, a. the planned aggregate expenditures on goods and services will equal the current rate of output. b. business inventories will be increasing. c. full employment must be present. d. the actual rate of unemployment must equal the natural rate of unemployment. The Great Depression provided support for the declaration of John Maynard Keynes that a. government action was necessary to ensure interest rates remained at the equilibrium level. b. prolonged periods of unemployment were possible. c. falling resource prices would bring the economy out of a recession. d. lower interest rates would quickly restore the full-employment equilibrium of an economy. The multiplier principle indicates that if business decision makers become more optimistic about the future and, as a result, increase their investment expenditures by $5 billion, real GDP will a. increase by less than $5 billion if the economy was initially operating well below capacity. b. increase by more than $5 billion if the economy was initially operating well below capacity. c. increase by more than $5 billion if the economy was initially operating at fullemployment capacity. d. decline if the marginal propensity to consume is less than 1. When the planned spending of consumers, businesses, government, and foreigners (net exports) is less than the current level of output, the Keynesian model suggests that a. the economys output will fall short of its potential. b. prices will rise. c. equilibrium real GDP will increase. d. inventories will decline.
2.
3.
4.
5.
6.
Which of the following is the primary source of changes in output within the framework of the Keynesian model? a. changes in the price level b. changes in aggregate expenditures c. changes in interest rates d. changes in wage rates According to Says law, a general overproduction of goods and services cannot happen because a. there will always be foreign countries willing to buy the excess output. b. the production of goods generates enough income to buy the total output. c. government will redistribute the excess output to the poor. d. excess output leads to rising prices, which then provides the income necessary to buy the surplus goods. Within the Keynesian model, if the output of an economy is less than the full-employment level, a. a reduction in government expenditures will direct the economy back to fullemployment equilibrium. b. a reduction in wage rates and resource prices will quickly restore full-employment equilibrium. c. a reduction in the real interest rate will soon restore full-employment equilibrium. d. output will tend to remain below full-employment capacity unless aggregate expenditures increase. Which of the following is an important insight of Keynesian analysis? a. Changes in output, as well as changes in prices, play a role in the macroeconomic adjustment process. b. When widespread unemployment is present, increases in aggregate demand will exert a larger impact on real output than when the economy is operating at or near full employment. c. Policies that effectively stabilize aggregate demandthat minimize abrupt changes in demandwill substantially reduce economic instability. d. All of the above are correct. e. None of the above are correct. What is the major source of economic instability according to the Keynesian view of the business cycle? a. errors made by policymakers b. wide fluctuations in private investment c. wide fluctuations in private consumption d. wide fluctuations in imports relative to exports
7.
8.
9.
10.
ANSWER KEY 1 THROUGH 10
1. (b), 2. (a), 3. (b), 4. (b), 5. (a), 6. (b), 7. (b), 8. (d), 9. (d), 10. (b)
CHAPTER 12 FISCAL POLICY
1. When government expenditures exceed revenue from all sources, a. a budget deficit is present. b. the supply of money will c. increase. the governments outstanding debt will decline. d. all of the above are true. According to the Keynesian view, which of the following would most likely decrease aggregate demand? a. a decrease in tax rates b. a decrease in government expenditures c. an increase in transfer payments d. an increase in the budget deficit Automatic stabilizers are government programs that tend to a. increase the ups and downs in aggregate demand without legislative action. b. bring expenditures and revenues automatically into balance without legislative action. c. shift the budget toward a deficit when the economy slows but shift it toward a surplus during an expansion. d. increase tax collections automatically during a recession. Keynesian analysis implies that a planned expansion in the size of the budget deficit is a. always necessary to ensure full employment. b. proper during slack economic conditions but highly inappropriate if the economy is already operating at capacity. c. of little consequence unless there is a corresponding change in the money supply. d. an effective method of dealing with inflation. Which of the following is true? a. Inability to forecast the future and political delays reduce the effectiveness of fiscal policy as a stabilization tool. b. Legislative action is necessary if automatic stabilizers are going to smooth the ups and downs of the business cycle. c. The crowding-out effect indicates that the expectation of higher future tax rates will undermine the potency of expansionary fiscal policy. d. The new classical theory indicates that higher real interest rates will undermine the potency of expansionary fiscal policy. The crowding-out effect suggests that a. expansionary fiscal policy causes inflation. b. restrictive fiscal policy is an effective weapon against inflation. c. a reduction in private spending that results from higher interest rates caused by a budget deficit will largely offset the expansionary effects of the deficit. d. a tax reduction financed by borrowing will increase the disposable income of households and, thereby, lead to a strong expansion in aggregate demand, output, and employment.
2.
3.
4.
5.
6.
7.
The supply-side effects of a reduction in taxes are the result of a. increases in the disposable income of households accompanying reductions in tax rates. b. the stimulus effects of increases in government expenditures. c. increased attractiveness of productive activity relative to leisure and tax avoidance. d. reductions in interest rates that generally accompany expansionary fiscal policy. The new classical model implies that substitution of debt for tax financing a. increases aggregate demand and exerts an expansionary effect on real output. b. is highly effective against inflation. c. reduces savings because it increases both the current and future tax liability of households. d. leaves wealth, and therefore aggregate demand, unchanged because the debt will require higher future tax rates. If a fiscal policy change is going to exert a stabilizing impact on the economy, it must a. add demand stimulus during a slowdown but restraint during an economic boom. b. exert an expansionary impact during all phases of the business cycle. c. restrain aggregate demand during all phases of the business cycle. d. keep the governments budget in balance. Since 1986, the top marginal personal income tax rate has been 40 percent or less compared to 70 percent or more prior to 1981. During the last 15 years, the share of personal income taxes collected from high income taxpayers a. has declined sharply. b. has been virtually unchanged. c. has increased. d. rose prior to the capital gains tax cut of 1997, but has fallen sharply since that time.
8.
9.
10.
ANSWER KEY 1 THROUGH 10
1. (a), 2. (b), 3. (c), 4. (b), 5. (a), 6. (c), 7. (c), 8. (d), 9. (a), 10. (c)
SPECIAL TOPIC 1 GOVERNMENT SPENDING AND TAXATION
QUESTIONS 1 THROUGH 5 ARE A SUGGESTED SPECIAL TOPIC QUIZ.
1. Between 1960 and 2003, the share of federal spending allocated to national defense a. declined sharply, while the share allocated to health care increased substantially. b. rose sharply, while the share allocated to health care declined substantially. c. was relatively constant, while the share allocated to health care declined modestly. d. declined modestly, while the share allocated to health care was relatively constant.
2.
How much does it cost to tax a dollar of revenue away from the private sector and transfer it to the government to finance a government program? a. one dollar b. less than one dollar because the administration of and compliance with the tax laws creates jobs for people c. more than a dollar because collection of the taxes requires resources that would otherwise be available for private sector production d. more than a dollar because of the excess burden resulting from the elimination of productive exchanges by the taxes e. Both c and d are correct. Real (adjusted for inflation) federal spending per person in the United States a. has increased by approximately 10 percent per decade during the last 225 years. b. increased more rapidly during the nineteenth century than during the twentieth century. c. in 2002 was approximately 60 times the level of 1916. d. increased rapidly during the first half of the twentieth century but has changed very little since 1950. Compared to the situation prior to 1980, the top marginal personal income tax rate imposed on the rich is now substantially a. lower and so is the share of the revenue collected from them. b. higher and so is the share of the revenue collected from them. c. lower, but the share of the revenue collected from them is now higher. d. higher, but the share of the revenue collected from them is now lower. Government expenditures as a share of the U.S. economy are a. the largest in the world. b. the smallest in the world. c. smaller than most Western European countries but larger than a number of highgrowth Asian economies. d. larger than Canada, France, and the United Kingdom but slightly smaller than Germany and Italy.
3.
4.
5.
ANSWER KEY 1 THROUGH 5
1. (a), 2. (e), 3. (c), 4. (c), 5. (c)
SPECIAL TOPIC 5 THE FEDERAL BUDGET AND THE NATIONAL DEBT
1. Which of the following is true? a. A budget deficit will reduce the national debt. b. A budget deficit will increase the national debt. c. A balanced budget will increase the national debt. d. A budget surplus will increase the national debt.
2.
In 2003, more than half of the national debt was held by a. foreign investors. b. Federal Reserve banks. c. large corporations. d. government trust funds and the Federal Reserve system. It is important to distinguish between the privately held portion of the national debt and the portion held by government agencies and the Federal Reserve system because a. the government will not have to repay the privately held debt. b. only the privately held debt creates a net interest liability for the federal government. c. the privately held debt does not create a net interest liability for the federal government. d. taxes will have to be raised in order to pay the interest on the debt held by the Federal Reserve system. (I) The traditional, or crowding-out, view holds that budget deficits cause high interest rates, reducing private investment and the formation of the capital stock. (II) The new classical view holds that people view government borrowing as higher future taxes and thus save more in response to budget deficits. In this view, interest rates should remain unchanged by the size of the deficit. a. I is true; II is false. b. I is false; II is true. c. Both I and II are true. d. Both I and II are false. How does inclusion of the current revenues and expenditures of the Social Security trust fund into the budget calculation affect the reported budget deficit of the federal government? a. It increases the reported deficit. b. It reduces the reported deficit. c. It exerts no effect on the reported deficit. d. It increases the deficit during an economic boom but reduces it during a recession.
3.
4.
5.
ANSWER KEY 1 THROUGH 5
*1. (b), 2. (d), 3. (b), 4. (c), 5. (b)