Guide
To Study Accompany Macroeconomics: Theory and Policy
By B. Modjtahedit
Prepared by
T. J. McCarthy and B. Modjtahedi
University of California, Davis
Chapter 15
Key Points
In the long run, the economy produces the potential level of output, so
there is only natural unemployment (the labor market is in a state of full
employment)
In the real world, the rate of inflation () is equal to the difference
between the rate of growth of the money supply (m) and the rate of
growth of real GDP (g) in the long run (assuming that the Cambridge k is
constant in the long run), i.e., = m g
In the classical model, the rate of inflation was found to be equal to the
rate of growth of the money supply; this is because the real GDP growth
rate was assumed to be zero.
For simplicity, the model used here maintains the classical assumption
that real GDP is constant in the long run (Y = YP), so we again have =
m in the long run
So in the long run: u = un and = m
Key Points
In the short run, we can observe either a positive or a negative
relationship between the rate of inflation and the unemployment rate
Demand shocks cause the rate of inflation and the unemployment rate
to move in opposite directions (this negative relationship is called the
Phillips curve)
Positive demand shocks cause the rate of inflation to increase and
the unemployment rate to decrease, as firms increase their prices at
a higher rate than before and hire more workers
Negative demand shocks cause the rate of inflation to decrease and
the unemployment rate to increase, as firms increase their prices at a
lower rate than before and lay off workers
Supply shocks cause the rate of inflation and the unemployment rate to
move in the same direction (this is viewed as a shift in the Phillips curve)
A supply shock that increases production costs causes the rate of
inflation and the unemployment rate to increase, as firms increase
their prices at a higher rate than before and lay off workers
A supply shock that decreases production costs causes the rate of
inflation and the unemployment rate to decrease, as firms increase
their prices at a lower rate than before and hire more workers
Key Points
The negative slope of the Phillips curve seems to imply that policymakers have to make a choice between reducing the inflation rate and
reducing the unemployment rate; they are not able to do both.
However, the Phillips curve only describes the short run relationship
between the inflation rate and the unemployment rate; in the long run,
the inflation rate is equal to the money supply growth rate, and the
unemployment rate is equal to the natural rate of unemployment, so
there is no inflation-unemployment trade-off in the long run, only in the
short run.
Because the unemployment rate is equal to the natural rate of
unemployment in the long run regardless of the level of inflation, the
vertical line at u = un is sometimes called the long run Phillips curve
Key Points
The location of the short run Phillips curve depends on peoples
expectations about the future rate of inflation (if people expect higher
inflation, the short run Phillips curve shifts up)
In the long run, the expected rate of inflation (e) is equal to the actual
rate of inflation, as peoples forecasting errors are eventually reduced to
zero (so the short run Phillips curve stops shifting); since the real wage is
constant in the long run, this implies that the rate of growth of nominal
wages is also equal to the inflation rate
Combining all of the above properties implies that at the intersection of
the short run Phillips curve and the long run Phillips curve (reached in
the long run), we must have m = = e = nominal wage growth rate.
Key Points
Sacrifice ratio: measures the percentage increase in the unemployment
rate that will result (in the short run) from a one percent reduction in
the inflation rate
Under the rational expectations hypothesis, the sacrifice ratio can be
zero if the Fed is credible and announces the intended reduction in
the inflation rate in advance; as people will correctly adjust their
expectations in response to this announcement, the short run
Phillips curve will immediately move to the desired position.
Inflation and Unemployment: Long Run
un
In the long run, inflation rate
will equal the rate of growth of
money supply (m) regardless of
the unemployment rate, here
assumed 5%.
In the long run, the economy will be
at the intersection point of the two
lines.
m
5%
In the long run, unemployment rate
will equal natural unemployment
rate regardless of the inflation rate,
here assumed 5%.
5%
u
Inflation and Unemployment: Short Run
Connecting all these inflationunemployment points gives us
the Phillips Curve (PC), which is a
negative relationship between u
and .
un
In the short run, , all else being
the same, an increase in
aggregate demand will cause an
increase in inflation rate and a
reduction in unemployment rate.
m
5%
In the short run, all else being
the same, a reduction in
aggregate demand will cause a
reduction in inflation rate and an
increase in unemployment rate.
PC
5%
u
Inflation and Unemployment: Short Run
un
In the short run, , all else being the same,
an increase in resource prices such as oil
price or the wage rate will increase both
the inflation and unemployment rates. It
will shift the PC up (higher ) and to the
right (higher u). This is called stagflation.
m
5%
In the short run, , all else
being the same, a decrease in
resource prices will reduce
both the inflation and
unemployment rates. The PC
will shift down (lower ) and
to the left (lower u).
PC
5%
u
Location of the PC is Determined by Inflation Rate Expected in the Past (e)
Intersection of PC and un Happens at e
un
If this 4% inflation persists, people will revise
their inflation expectation upwards to e = 4%
and PC will shift up to pass through = 4%.
4%
If in the past people had expected inflation rate to
be 3%, PC would intersect un at e = 3% today
3%
But today the inflation rate could
actually turn out to be = 4%, in which
case people have made a forecasting
error of e = 4% 3% = 1%.
PC
5%
u
A Permanent Increase in m
In the long run settles at 8% and people revise their expectations
The Fed permanentlye = 8%. This to 8% per year.to shift up and cross un at 8%.
upwards to increases m causes the PC
un
Suppose the money supply has been increasing
at the rate of m = 3% per year. So, over the
years, the inflation rate had settled at = m =
3%, and people have been expecting an
inflation rate of e = 3% per year.
8%
3%
m
In the short run this
expansionary monetary
policy causes u to decrease
and to increase.
PC
5%
u
A Permanent Decrease in m
un
Suppose the money supply has been increasing
at the rate of m = 8% per year. So, over the
years, the inflation rate had settled at = m =
8%, and people have been expecting an
inflation rate of e = 8% per year.
m
8%
In the long run settles at 3%
and people revise their
expectations downward to e
= 3%. This causes the PC to
shift down and cross un at 3%.
PC
3%
In the short run this contractionary
monetary policy causes u to
increase and to decrease.
The Fed permanently reduces
m to 3% per year.
5%
u
A Recession
un
A reduction in aggregate demand causes
higher unemployment and lower inflation. This
results in a movement along PC down (lower
) and to the right (higher u).
m
5%
Over time, unemployment is
reduced due to self
correcting mechanism and
the inflation rate equals m.
PC
5%
u
A One-Time Increase in M
un
If the Fed increases the
supply of money, AD will
increase. This will cause u
to decrease and to
increase. This will be a
movement along the PC.
m
5%
In the long run u will
increase to natural and
will equal m.
PC
5%
u
A Supply Shock
un
An increase in the price
of oil will cause
stagflation: a higher
and a higher u.
m
5%
In the long run u will
decrease to natural and
will equal m.
PC
5%
u
Key Terms
What word or phrase corresponds to the definition or description presented?
Click for the answer
Causes the rate of inflation and the unemployment rate to move in opposite directions.
Variable that explains the difference between the inflation rate and the rate of growth of
the money supply observed in the real world.
Demand Shocks
GDP Growth Rate
Term used to refer to the negative relationship between the rate of inflation and the
unemployment rate.
Phillips Curve
Causes the rate of inflation and the unemployment rate to move in the same direction.
Supply Shocks
Measures the percentage increase in the unemployment rate that will result (in the short
run) from a one percent reduction in the inflation rate.
Sacrifice Ratio
Multiple Choice Questions - 1
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U.S. data shows that in
most of the past
recessions:
The general price level had gone down, but the
inflation rate had remained steady.
Both the general price level and the inflation
rate had increased.
Both the general price level and the inflation
rate had decreased.
The general price level had gone up, but the
inflation rate had gone down.
None of the above.
Multiple Choice Questions - 2
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U.S. data shows that
except for the episodes
of stagflation:
Generally, during a recession the inflation and
cyclical unemployment rates move in the same
direction.
Generally, during a recession inflation rate
increases but cyclical unemployment rate
decreases.
Generally, during a recession inflation rate
increases but cyclical unemployment rate
remains steady.
Generally, during a recession inflation rate
decreases but cyclical unemployment rate
increases.
None of the above.
Multiple Choice Questions - 3
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Which of the following
statements is true about
the relationship
between price level and
inflation rate over
several years?
They can both be constant.
Inflation rate could be constant while the price
level is increasing.
Inflation rate could be constant while the price
level is decreasing.
All of the above.
None of the above.
If = 0 then P will be constant. So they are
both constant.
If = 5%, then inflation rate will be
constant but P will increase at 5%.
If = -2%, then the inflation rate will be
constant and P will be decreasing.
Multiple Choice Questions - 4
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Which of the following
statements is true about
the relationship
between price level and
inflation rate over
several years?
The price level can go up while the inflation rate
is going down.
The price level can go up while the inflation rate
is negative.
The price level can stay the same while the
inflation rate is negative.
The price level can go down while the inflation
rate is positive.
None of the above.
So the price level goes up at a lower rate.
Multiple Choice Questions - 5
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Which of the following
statements is true?
In the long run total unemployment is zero.
In the long run cyclical unemployment is zero.
In the long run frictional unemployment is zero.
In the long run structural unemployment is zero.
None of the above.
u = un + uc
In the long run uc = 0 and u = un
Multiple Choice Questions - 6
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Which of the following
statements is true?
In the long run total unemployment equals
cyclical unemployment.
In the long run cyclical unemployment equals
natural unemployment.
In the long run total unemployment equals
natural unemployment.
In the long run natural unemployment equals
structural unemployment.
None of the above.
u = un + uc
In the long run uc = 0 and u = un
Multiple Choice Questions - 7
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Which of the following
statements is true about
the relationship
between the inflation
and unemployment
rates in the long run?
Total unemployment rate is zero regardless of
the rate of inflation.
Total cyclical unemployment rate is zero at high
rates of inflation.
Cyclical unemployment and inflation rates are
negatively related.
Cyclical rate of unemployment is zero regardless
of the rate of inflation.
None of the above.
u = un + uc
In the long run uc = 0 and u = un
Multiple Choice Questions - 8
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Which of the following
statements is true about
the relationship
between the inflation
and unemployment
rates in the long run?
There is no relationship between
unemployment and inflation rates.
Unemployment and inflation rates are
negatively related.
Unemployment and inflation rates are positively
related.
Natural unemployment and inflation rates are
negatively related.
None of the above.
u = un + uc
In the long run uc = 0 and u = un
Multiple Choice Questions - 9
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Which of the following
conclusions can we
draw from studying the
U.S. data concerning the
relationship between
the inflation and
unemployment rates in
the long run?
An expansionary demand management policy
can reduce the unemployment rate at the cost
of increasing the inflation rate.
An expansionary demand management policy
can reduce both the unemployment and the
inflation rate.
An expansionary demand management policy
can reduce the unemployment rate without
affecting the inflation rate.
A contractionary demand management policy
can reduce the inflation rate without affecting
the unemployment rate.
None of the above.
Multiple Choice Questions - 10
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Which of the following
conclusions can we
draw from studying the
U.S. data concerning the
relationship between
the inflation and money
supply growth rates in
the long run?
Generally they both move in the same direction.
They move in opposite directions.
There is no relationship between the two.
It is impossible to draw any conclusion about
the relationship between the two.
None of the above.
Multiple Choice Questions - 11
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We have the following data for a country for
two consecutive years:
Rate of growth of money supply = +7%
Rate of change in Cambridge k = +1%
Rate of growth of real GDP = 2%
What is the rate of inflation () between
these two years?
= 8%.
= 6%
= 5%
= 4%
None of the above.
M=kPY
So rates of change are additive:
7% = 1% + + 2%
= 4%
Multiple Choice Questions - 12
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We have the following data for a country for
two consecutive years:
= 2%.
= 3%
= 8%
= 15%
None of the above.
Rate of growth of money supply = +5%
Rate of growth of real GDP = 3%
Assume the classical demand for money
function. What is the rate of inflation () M = k P Y
between these two years?
So rates of change are additive:
5% = 0% + + 3%
= 2%
Multiple Choice Questions - 13
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The U.S. data shows that
in the long run:
The rate of inflation equals the rate of growth of
money supply minus the rate of growth of real
GDP.
The rate of inflation equals the rate of growth of
money supply plus the rate of growth of real
GDP.
The rate of inflation equals the rate of growth of
money supply plus the rate of growth of
Cambridge k.
The rate of inflation equals the rate of growth of
money supply minus the rate of growth of
Cambridge k.
None of the above.
The rate of change of velocity
seems to be zero. So
=mg
Multiple Choice Questions - 14
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A problem with the
standard AD/AS model of
the economy is that, in the
real world:
The AD function almost never shifts.
The real GDP grows at a lower or a higher rate;
but it almost never falls.
The price level increases at a lower or a higher
rate; but it seldom falls.
All of the above.
None of the above.
The rate of change of velocity
seems to be zero. So
=mg
Multiple Choice Questions - 15
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The U.S. data and
economic theory suggest
that, in the long run:
Policymakers cannot do anything to reduce the
rate of inflation.
Policymakers can reduce the inflation rate by
reducing the government spending.
Policymakers can reduce the rate of
unemployment using an expansionary money
policy.
Policymakers cannot reduce the unemployment
rate using demand management policies.
None of the above.
Multiple Choice Questions - 16
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The U.S. data and
economic theory suggest
that, in the long run:
Policymakers can reduce the rate of inflation at
the cost of increasing the rate of
unemployment.
Policymakers can reduce the rate of inflation
without increasing the rate of unemployment.
Policymakers can reduce the rate of
unemployment at the cost of increasing the rate
of inflation.
Policymakers can reduce the rate of
unemployment without increasing the rate of
inflation.
None of the above.
Multiple Choice Questions - 17
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Which of the following
statements is true about
the short-run relationship
between the
unemployment and
inflation rates?
In the case of a demand shock, they will both
move in the same direction.
In the case of a demand shock, they will move in
opposite directions.
In the case of a demand shock, unemployment
rate will change but the inflation rate will
remain the same.
In the case of a demand shock, inflation rate will
change but the unemployment rate will remain
the same.
None of the above.
Multiple Choice Questions - 18
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What does Phillips Curve
show?
It shows a positive relationship between the
rate of growth of money supply and the rate of
inflation.
It shows a positive relationship between the
rate unemployment and the rate of inflation.
It shows a negative relationship between the
rate unemployment and the rate of inflation.
It shows a positive relationship between the
rate unemployment and the rate of change of
Cambridge k.
None of the above.
Multiple Choice Questions - 19
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Which of the following is
true about the short-run
relationship between the
unemployment and
inflation rates?
In the case of a supply shock, they will both
move in the same direction.
In the case of a supply shock, they will move
opposite directions.
In the case of a supply shock, unemployment
rate will change but the inflation rate will
remain the same.
In the case of a supply shock, inflation rate will
change but the unemployment rate will remain
the same.
None of the above.
Multiple Choice Questions - 20
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4%
A
Inflation Rate
3%
Consider the graph above
that shows the
unemployment and
inflation rates for an
economy. Currently the
economy is in a state of
long-run equilibrium with a
natural unemployment rate
of 3% and money supply
growth rate of 2%. Which
point would the economy
move in the short run if the
Fed increases the money
supply?
B
X
2%
C
1%
D
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
Negative relationship in the case
Point A
of a demand shock (Here, an
Point B
increase in AD).
Point C
Point D
None of the above.
6%
Multiple Choice Questions - 21
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4%
A
Inflation Rate
3%
X
2%
C
1%
Consider the graph above that
shows the unemployment and
inflation rates for an economy.
Currently the economy is in a
state of long-run equilibrium
with a natural unemployment
rate of 3% and money supply
growth rate of 2%. Which
point would the economy
move in the short run if
consumers suddenly lose their
confidence in the economy?
B
D
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
Negative relationship in the case
Point A
of a demand shock (Here, a
Point B
decrease in AD).
Point C
Point D
None of the above.
6%
Multiple Choice Questions - 22
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4%
A
Inflation Rate
3%
X
2%
C
1%
Consider the graph above that
shows the unemployment and
inflation rates for an economy.
Currently the economy is in a
state of long-run equilibrium
with a natural unemployment
rate of 3% and money supply
growth rate of 2%. Which
point would the economy
move in the short run if OPEC
unexpectedly increased the
price of oil?
B
D
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
Positive relationship in the case
Point A
of a supply shock (Here, a
Point B
stagflation).
Point C
Point D
None of the above.
6%
Multiple Choice Questions - 23
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4%
A
Inflation Rate
3%
X
2%
C
1%
Consider the graph above that
shows the unemployment and
inflation rates for an economy.
Currently the economy is in a
state of long-run equilibrium
with a natural unemployment
rate of 3% and money supply
growth rate of 2%. Which
point would the economy
move in the short run if as a
result of some new discoveries
the prices of raw materials
unexpectedly fell?
B
D
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
Positive relationship in the case
Point A
of a supply.
Point B
Point C
Point D
None of the above.
6%
Multiple Choice Questions - 24
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Consider the classical
demand for money
function and assume
that the money market
clears. Suppose that the
inflation rate is 8% and
the rate of growth of
real GDP is 2%? What is
the rate of change of
Cambridge k?
0%
4%
6%
10%
None of the above.
In the classical model k is constant
Multiple Choice Questions - 25
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Consider the classical
demand for money
function and assume
that the money market
clears. Suppose that the
inflation rate is 8% and
the rate of growth of
real GDP is 2%? What is
the rate of change of
money supply?
0%
4%
6%
10%
None of the above.
M=k xPxY
Growth rates are additive and k is constant. So
10% = 8% + 2%
Multiple Choice Questions - 26
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What is the implication
of the shape of the
short-run Phillips Curve
for economic policy?
It implies that in the short run you can either
reduce inflation rate or unemployment rate, but
not both.
It implies that an expansionary monetary policy
can increase both the inflation rate and
unemployment rate.
It implies that in the short run you can reduce
the inflation rate but not the unemployment
rate.
It implies that in the short run you can reduce
the unemployment rate but not the inflation
rate.
None of the above.
Multiple Choice Questions - 27
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As far as reducing
unemployment and
inflation rates is
concerned,
policymakers are
confronted with a menu
of choices because:
In the short run there is a negative relationship
between the unemployment and inflation rates.
In the short run there is a positive relationship
between the unemployment and inflation rates.
In the short run the Phillips curve is vertical.
In the short run the Phillips curve is horizontal.
None of the above.
Multiple Choice Questions - 28
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Who said, Inflation
always and everywhere
is a monetary
phenomenon?
John Maynard Keynes
Irving Fisher
Robert Lucas
Milton Friedman
None of the above.
Multiple Choice Questions - 29
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Which year did the U.S.
Phillips Curve began to
shift?
1960
1970
1980
1990
None of the above.
Multiple Choice Questions - 30
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6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state of long run
equilibrium. Which
sequence of points best
describes what would
happen if the government
increased spending?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
X to A to B
X to C to B
This is a one-time increase in AD.
X to A to X
X to C to X
None of the above.
6%
Multiple Choice Questions - 31
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6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state of long run
equilibrium. Which
sequence of points best
describes what would
happen if the government
decreased taxes?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
X to A to B
X to C to B
This is a one-time increase in AD.
X to A to X
X to C to X
None of the above.
6%
Multiple Choice Questions - 32
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6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state of long run
equilibrium. Which
sequence of points best
describes what would
happen if consumers lost
confidence in the economy?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
X to D to E
X to F to E
This is a one-time decrease in AD.
X to D to X
X to F to X
None of the above.
6%
Multiple Choice Questions - 33
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6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state of long run
equilibrium. Which
sequence of points best
describes what would
happen if business firms
became more pessimistic
about future profits?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
X to D to E
X to F to E
This is a one-time decrease in AD.
X to D to X
X to F to X
None of the above.
6%
Multiple Choice Questions - 34
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6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state long of run
equilibrium. Which
sequence of points best
describes what would
happen if business firms
became more optimistic
about future profits?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
X to A to B
X to C to B
This is a one-time increase in AD.
X to A to X
X to C to X
None of the above.
6%
Multiple Choice Questions - 35
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6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state of long run
equilibrium. Which
sequence of points best
describes what would
happen if the Fed increased
the rate of growth of money
supply to 5%?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
X to A to B
X to C to B
Only an increase in m can cause
X to A to X
an increase in in the long run.
X to C to X
None of the above.
6%
Multiple Choice Questions - 36
Choose the answer that best completes the statement or answers the question
Click for the answer
6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state of long run
equilibrium. Which
sequence of points best
describes what would
happen if the Fed decreased
the rate of growth of money
supply to 1%?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
X to D to E
X to F to E
Only an decrease in m can cause
X to D to X
a decrease in in the long run.
X to F to X
None of the above.
6%
Multiple Choice Questions - 37
Choose the answer that best completes the statement or answers the question
Click for the answer
6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state of long run
equilibrium. Which
sequence of points best
describes what would
happen if OPEC increased
the price of oil?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
X to A to B
X to C to B
This is a one-time supply shock.
X to A to X
X to C to X
None of the above.
6%
Multiple Choice Questions - 38
Choose the answer that best completes the statement or answers the question
Click for the answer
6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state of long run
equilibrium. Which
sequence of points best
describes what would
happen if a new discovery
reduced the prices of raw
materials?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
X to D to E
X to F to E
This is a one-time supply shock.
X to D to X
X to F to X
None of the above.
6%
Multiple Choice Questions - 39
Choose the answer that best completes the statement or answers the question
Click for the answer
6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state of long run
equilibrium. Which
sequence of points best
describes what happened
under Volcker Disinflation?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
Unemployment Rate
X to D to E
X to F to E
This is was a permanent
X to D to X
reduction in m.
X to F to X
None of the above.
5%
6%
Multiple Choice Questions - 40
Choose the answer that best completes the statement or answers the question
Click for the answer
6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state of long run
equilibrium. Which
sequence of points best
describes what would
happen under the rational
expectations hypothesis if
the Fed reduced the rate of
growth of money supply to
1%?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
X to D to E
X to F to E
Since people will correctly
X to E
anticipate the reduction in ,
X to E to X
there will be no misperceptions
None of the above.nd will decrease immediately.
a
6%
Multiple Choice Questions - 41
Choose the answer that best completes the statement or answers the question
Click for the answer
6%
B
The graph above shows
some data for a hypothetical
economy. The natural rate
of unemployment and the
rate of growth of money
supply are both equal to 3%.
The economy is currently in
a state of long run
equilibrium. Which
sequence of points best
describes what would
happen if the Fed increased
the rate of growth of money
supply to 5%, under the
rational expectations
hypothesis?
Inflation Rate
5%
A
4%
C
X
3%
D
F
2%
E
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
X to A to B
X to C to B
Since people will correctly
X to B
anticipate the reduction in ,
X to B to X
there will be no misperceptions
None of the above.nd will decrease immediately.
a
6%
Multiple Choice Questions - 42
Choose the answer that best completes the statement or answers the question
Click for the answer
5%
The graph above shows the
short-run Phillips Curve for a
hypothetical economy. The
natural rate of
unemployment is 2% and
the rate of growth of money
supply is 4%. The economy
is currently in a state of long
run equilibrium. What
would be the sacrifice ratio
in the short run if the Fed
reduced the inflation rate to
2%?
Inflation Rate
4%
3%
2%
1%
0%
0%
1%
2%
3%
4%
5%
Unemployment Rate
1
% %
=
=
2
% %
0.5
0.25
None of the above.
6%
7%
Multiple Choice Questions - 43
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%. If
the actual rate of inflation
equals the expected, then
the unemployment rate
equals:
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
6%
Unemployment Rate
2%
Because, P.C. intersects the natural-rate
3%
line (also called long-run Phillips Curve)
where = e.
4%
5%
None of the above.
7%
Multiple Choice Questions - 44
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
Inflation Rate
8%
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%. If
the actual rate of inflation
equaled the expected, then
the economy could be at
which of the following
points?
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
6%
Unemployment Rate
Point K Because, P.C. intersects the natural-rate
Point L line (also called long-run Phillips Curve)
Point M where = e.
Point N
None of the above.
7%
Multiple Choice Questions - 45
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
Inflation Rate
8%
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%. If
the actual rate of inflation
equaled the expected, then
the economy could NOT be
at which of the following
points?
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
6%
Unemployment Rate
Point C Because, P.C. intersects the natural-rate
Point H line (also called long-run Phillips Curve)
Point M where = e.
Point N
None of the above.
7%
Multiple Choice Questions - 46
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%.
People had expected the
inflation rate to be 4%, but
it actually turns out to be
6%. This information leads
us to believe that the
economy is at which of the
following points?
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
6%
Unemployment Rate
Point M
P.C. intersects the natural-rate line
Point K
where = e = 4%. This is point M.
Point H
This information determines which
Phillips Curve you are on. Now that
Point E
the actual
None of the above. inflation rate is 6%, then
you must be at point K.
7%
Multiple Choice Questions - 47
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%.
People had expected the
inflation rate to be 6%, but
it actually turns out to be
4%. This information leads
us to believe that the
economy is at which of the
following points?
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
6%
Unemployment Rate
Point K
P.C. intersects the natural-rate line
Point H
where = e = 6%. This is point H.
Point M
This information determines which
Phillips Curve you are on. Now that
Point J
the actual
None of the above. inflation rate is 4%, then
you must be at point J.
7%
Multiple Choice Questions - 48
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
Currently we are at point C. If is
reduced to 6%, then u will increase
to 6%. Then:
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%.
Suppose that currently the
actual inflation rate equals
the expected rate of 8%.
What will be the sacrifice
ratio in the short run if the
Fed reduces the inflation
rate to 6%?
B
9%
F
8%
Inflation Rate
% %
=
=
% %
A
10%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
Sacrifice ratio = 0
Sacrifice ratio = 0.5
Sacrifice ratio = 1
Sacrifice ratio = 2
None of the above.
6%
7%
Multiple Choice Questions - 49
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
Currently we are at point C. If is
reduced to 6%, then u will increase
to 7%. Then:
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%.
Suppose that currently the
actual inflation rate equals
the expected rate of 8%.
What will be the sacrifice
ratio in the short run if the
Fed reduces the inflation
rate to 7%?
B
9%
F
8%
Inflation Rate
% %
=
=
% %
A
10%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
Sacrifice ratio = 0
Sacrifice ratio = 0.5
Sacrifice ratio = 1
Sacrifice ratio = 2
None of the above.
6%
7%
Multiple Choice Questions - 50
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%.
Suppose that currently the
actual inflation rate equals
the expected rate of 8%.
What will be the sacrifice
ratio in the long run if the
Fed reduces the inflation
rate to 4%?
B
9%
F
8%
Inflation Rate
Currently we are at point C. In the
long run we will move to point M
and u will remain at the natural
rate of 4%.
A
10%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
Sacrifice ratio = 0
Sacrifice ratio = 0.5
Sacrifice ratio = 1
Sacrifice ratio = 2
None of the above.
6%
7%
Multiple Choice Questions - 51
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
B
9%
F
8%
Inflation Rate
We will be on the long-run vertical
Phillips Curve and will have only
natural unemployment of 4%.
Cyclical rate will be zero.
A
10%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%.
Suppose that people had
expected the inflation rate
to be 6% and it turns out to
be 6%. Then:
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
The natural rate of unemployment = 0%
The total rate of unemployment = 0%
The cyclical rate of unemployment = 0%
The cyclical rate of unemployment = 4%
None of the above.
6%
7%
Multiple Choice Questions - 52
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
B
9%
F
8%
Inflation Rate
We will be on the long-run vertical
Phillips Curve and will have only
natural unemployment of 4%.
Cyclical rate will be zero.
A
10%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%.
Suppose that people had
expected the inflation rate
to be 6% and it turns out to
be 6%. Then:
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
The natural rate of unemployment = 4%
The total rate of unemployment = 4%
The cyclical rate of unemployment = 0%
All of the above
None of the above.
6%
7%
Multiple Choice Questions - 53
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
We will be at point G.
9%
F
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%.
Suppose that people had
expected the inflation rate
to be 6% but it turns out to
be 7%. Then:
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
Unemployment rate = 2%
Unemployment rate = 3%
Unemployment rate = 4%
Unemployment rate = 5%
None of the above.
6%
7%
Multiple Choice Questions - 54
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
We will be at point J.
9%
F
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%.
Suppose that people had
expected the inflation rate
to be 6% but it turns out to
be 4%. Then:
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
Unemployment rate = 2%
Unemployment rate = 3%
Unemployment rate = 4%
Unemployment rate = 5%
None of the above.
6%
7%
Multiple Choice Questions - 55
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
We will be at point J.
uc = u un = 6% - 4%
9%
F
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%.
Suppose that people had
expected the inflation rate
to be 6% but it turns out to
be 4%. Then:
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
Cyclical unemployment rate = 2%
Cyclical unemployment rate = 3%
Cyclical unemployment rate = 4%
Cyclical unemployment rate = 5%
None of the above.
6%
7%
Multiple Choice Questions - 56
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%.
Which of the following
sequences of points best
describes the process of
Volcker Disinflation?
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
CHM
CKLM
CGH
CEIM
None of the above.
6%
7%
Multiple Choice Questions - 57
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%. The
rate of growth of money
supply is 4%. The economy
is in long-run equilibrium.
Which of the following
events could cause the
economy to move to point K
in the short run?
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
An increase in money supply.
An increase in taxes.
A decrease in transfer payments.
A decrease in government spending.
None of the above.
6%
7%
Multiple Choice Questions - 58
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%. The
rate of growth of money
supply is 4%. The economy
is in long-run equilibrium.
What is the most probable
path that the economy
would follow in the long run
in the Keynesian model if
the Fed permanently
increased the money
growth rate 8%?
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
MEDC
MFBC
MHC
MKGC
None of the above.
6%
7%
Multiple Choice Questions - 59
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%. The
rate of growth of money
supply is 4%. The economy
is in long-run equilibrium.
What is the most probable
path that the economy
would follow in the long run
in the rational expectations
model if the Fed
permanently increased the
money growth rate to 8%?
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
MGC
MDC
MC
MFC
None of the above.
6%
7%
Multiple Choice Questions - 60
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%. The
rate of growth of money
supply is 8%. The economy
is in long-run equilibrium.
What event would cause the
economy to move to point
E, then I, and ultimately M?
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
6%
A once-and-for-all reduction in government
spending.
A once-and-for-all increase in taxes.
A once-and-for-all reduction in oil prices.
A permanent reduction in the money
supply growth rate.
None of the above.
7%
Multiple Choice Questions - 61
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%. The
rate of growth of money
supply is 4%. The economy
is in long-run equilibrium.
What event would cause the
economy to move to point L
and ultimately H?
Inflation Rate
8%
C
G
D
7%
K
6%
H
L
5%
E
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
A once-and-for-all increase in government
spending.
A once-and-for-all increase in transfer
payments.
A once-and-for-all increase in oil prices.
A permanent increase in the money supply
growth rate.
None of the above.
6%
7%
Multiple Choice Questions - 62
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%. The
rate of growth of money
supply is 6%. The economy
is in long-run equilibrium.
What event would cause the
economy to move to point D
and then to H?
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
An increase in expected future profits.
An increase in uncertainty about future
profits.
An oil shock
A decrease in real wealth.
None of the above.
6%
7%
Multiple Choice Questions - 63
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%. The
rate of growth of money
supply is 6%. The economy
is in long-run equilibrium.
What event would cause the
economy to move to point I
and then to H?
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
An expansionary fiscal policy.
A recession.
An economic expansion.
An oil shock.
None of the above.
6%
7%
Multiple Choice Questions - 64
Choose the answer that best completes the statement or answers the question
Click for the answer
11%
A
10%
B
9%
F
The graph above shows
three short-run Phillips
Curves for a hypothetical
economy. The natural rate
of unemployment is 4%. The
rate of growth of money
supply is 6%. The economy
is in long-run equilibrium.
What event would cause the
economy to move to point I
and then to H?
Inflation Rate
8%
C
G
D
7%
K
6%
H
E
L
5%
I
M
4%
J
N
3%
O
2%
1%
0%
1%
2%
3%
4%
5%
Unemployment Rate
An expansionary fiscal policy.
A recession.
An economic expansion.
An oil shock.
None of the above.
6%
7%
Multiple Choice Questions - 65
Choose the answer that best completes the statement or answers the question
Click for the answer
9
un
8
A
7
B
6
C
D
E
5
4
G
m
H
I
3
The figure above shows the
money supply growth rate,
natural rate of unemployment,
and short run Phillips curve for
an economy. The economy is
initially in a state of long run
equilibrium at point E.
Suppose that aggregate
demand decreases, and as a
result a recession occurs. As a
result, the economy will move
to point ______ in the short
run, then move to point
______ in the long run.
F
PC
2
1
0
0
1
2
3
4
5
6
7
In the face of a negative demand shock such
as this, the inflation rate will decrease (firms
B; D
increase their prices at a lower rate) and the
C; A
unemployment rate will increase (firms lay off
workers). In the short run the economy moves
G; I
to point H. Since the natural rate of
H; E
unemployment and the money supply growth
None of the above changed, the economy will
rate have not
return to point E in the long run.
u8
Multiple Choice Questions - 66
Choose the answer that best completes the statement or answers the question
Click for the answer
9
un
8
A
7
B
6
C
D
E
5
4
G
m
H
I
3
The figure above shows the
money supply growth rate,
natural rate of unemployment,
and short run Phillips curve for
an economy. The economy is
initially in a state of long run
equilibrium at point E.
Suppose that the government
implements an expansionary
fiscal policy in an attempt to
reduce unemployment. As a
result, the economy will move
to point ______ in the short
run, then move to point
______ in the long run.
F
PC
2
1
0
0
1
2
3
4
5
6
7
In the short run, a positive demand shock will
B; D
cause the inflation rate to increase and the
C; A
unemployment rate to decrease (the economy
G; I
moves to point B). Since the natural rate of
H; E
unemployment and the money supply growth
None of rate above changed, the economy will
the have not
return to point E in the long run.
u8
Multiple Choice Questions - 67
Choose the answer that best completes the statement or answers the question
Click for the answer
9
un
8
A
7
B
6
C
D
E
5
4
G
m
H
I
3
The figure above shows the
money supply growth rate,
natural rate of unemployment,
and short run Phillips curve for
an economy. The economy is
initially in a state of long run
equilibrium at point E.
Suppose that the government
increases the amount of
unemployment benefits paid
to recently laid-off workers,
and as a result the natural rate
of unemployment increases.
The new long run equilibrium
of the economy will be at point
F
PC
2
1
0
0
1
2
3
4
5
6
7
In a long run equilibrium, the inflation rate
C
must be equal to the money supply growth
E
rate, and the rate of unemployment must be
F
equal to the natural rate of unemployment.
Since the natural rate of unemployment has
H
increased (and the money supply growth rate
None of the above
has not), the economy must be at a point on
the original money supply growth rate curve
that is to the right of the original long run
Phillips curve.
u8
Multiple Choice Questions - 68
Choose the answer that best completes the statement or answers the question
9
un
8
A
7
B
6
C
D
E
5
4
G
F
m
H
I
3
PC
2
The figure above shows the
money supply growth rate,
natural rate of unemployment,
and short run Phillips curve for
an economy. The economy is
initially in a state of long run
equilibrium at point E.
Suppose that stagflation
occurs in the economy, and the
government responds with a
contractionary fiscal policy. In
the short run, the economy
will move to point
1
0
0
1
2
3
4
5
6
7
A
Stagflation entails a move to point C in the
short run (higher inflation and higher
C
unemployment); a contractionary policy
E
avoids this increase in inflation at the expense
F
of higher unemployment, moving the
None of the above point F in the short run before it
economy to
returns to a state of long run equilibrium at
point E.
u8
Multiple Choice Questions - 69
Choose the answer that best completes the statement or answers the question
Click for the answer
9
un
8
A
7
B
6
C
D
E
5
4
G
m
H
I
3
The figure above shows the
money supply growth rate,
natural rate of unemployment,
and short run Phillips curve for
an economy. The economy is
initially in a state of long run
equilibrium at point E.
Suppose that the Fed
unexpectedly reduces the
money supply growth rate. As
a result, the economy will
move to point ______ in the
short run, then move to point
______ in the long run.
F
PC
2
1
0
0
1
2
3
4
5
6
7
G; E
Since the money supply growth rate is lower
G; I
than anticipated, the economy moves to point
H; E
H in the short run (interest rates increase, so
H; I
aggregate demand decreases, resulting in a
recession).
None of the above Since the natural rate of
unemployment has not changed, and the
money supply growth rate has decreased, the
new long run equilibrium will be at a point
directly below the original equilibrium (same
unemployment rate, lower inflation rate).
u8
Multiple Choice Questions - 70
Choose the answer that best completes the statement or answers the question
Click for the answer
9
Because the Feds action is
fully anticipated, the
economy will immediately
move to the new long run
equilibrium at point A
(higher inflation rate, same
unemployment rate),
skipping the usual short run
The figure above shows the
move to point B. While
money supply growth rate,
hatural a decrease in the
aving rate of unemployment,
n
money supply growth rate for
and short run Phillips curve be
fully anticipated (as
an economy. The economy is
diiscussed in the text)long run
nitially in a state of avoids
the short run cost of
equilibrium at point E.
iSuppose that the Fed makes a
ncreased unemployment,
fully-anticipated increase to
rational expectations in this
the money supply growth rate.
case led to the loss of the
sAs a result, the economy will
hort run benefit of
move to point ______ in the
decreased unemployment
short run, then move to point
that would otherwise
______ in the long run.
accompany the increase in
inflation.
un
8
A
7
B
6
C
D
E
5
4
G
F
m
H
I
3
PC
2
1
0
0
1
2
B; A
B; E
C; A
C; E
None of the above
3
4
5
6
7
8