Chapter 9

Question 1

What are the assumptions of the short-run macroeconomic model?

Answer 1

Factor prices are assumed to be exogenous; they may change, but any change is not explained within the model
Technology and factor supplies are assumed to be constant (and therefore Y* is constant)

Question 2

What are the assumptions of the theory of the adjustment process?

Answer 2

Factor prices are assumed to adjust in response to output gaps
Technology and factor supplies are assumed to be constant (and therefor Y* is constant)

Question 3

What are the assumptions of the macroeconomic model in the long-run?

Answer 3

Factor prices are assumed to have fully adjusted to any output gap
Technology and factor supplies are assumed to be changing (and this means any type of change like increasing and decreasing)

Question 4

When does a recession occur?

Answer 4

When we produce below potential

Question 5

When does inflation occur?

Answer 5

When we produce more than potential

Question 6

When firms are producing above their normal capacity output (when output is above potential), what happens?

Answer 6

There is excess demand for all factor inputs (including labour)
Workers will find that they have considerable bargaining power, and they will put upward pressure on wages

Question 7

The boom that is associated with an inflationary gap generates which conditions that lends to what?

Answer 7

High profits for firms and excess demand for labour - that tends to cause wages to rise (and other factor prices)

Question 8

When firms are producing below their normal capacity output (output is below potential), what happens?

Answer 8

There is an excess supply of all factor inputs including labour
Firms will have below-normal sales and not only will resist upward pressures on wages but also may seek reductions in wages

Question 9

The slump that is associated with a recessionary gap generates which conditions?

Answer 9

Low profits for firms and an excess supply of labour - that tends to cause wages to fall (and other factor prices)

Question 10

How quickly can wages rise or fall during booms and recessions?

Answer 10

Wages rise rapidly during booms
Wages fall slowly during recessions

Question 11

When do wages tend to fall according to A.Q. Philips?

Answer 11

They tend to fall in periods of high unemployment and rise in periods of low unemployment

Question 12

Following an AD or AS shock, what happens to the short-run equilibrium level of output?

Answer 12

It may be different from potential output. Any output gap is assumed to cause wages and other factor prices to adjust, eventually bringing the equilibrium level of output back to potential

Question 13

What acts like an anchor for the economy?

Answer 13

The level of potential output

Question 14

Where do positive AD shocks make the AD curve shift?

Answer 14

To the right

Question 15

Where does the AS curve shift during positive AD shocks?

Answer 15

It shifts to the left

Question 16

Where does the AD curve shift during negative AD shocks?

Answer 16

It shifts to the left

Question 17

Where does the AS curve shift during negative AD shocks?

Answer 17

To the right

Question 18

What does a positive AD shock lead to?

Answer 18

Inflation

Question 19

What does a negative AD shock lead to?

Answer 19

Recession

Question 20

What does the economy’s adjustment process do to the effects of the negative AS shock?

Answer 20

It reverses the AS shift and eventually returns the economy to its starting point

Question 21

In which direction does the AS curve shift during a negative AS shock?

Answer 21

To the left

Question 22

How long does the adjustment of factor prices last following any AD or AS shocks?

Answer 22

Until real GDP returns to Y*

Question 23

When is the economy in long-run equilibrium?

Answer 23

When the adjustment process is complete and there is no longer an output gap
The economy is in long-run equilibrium when the intersection of the AD and AS curves occurs at Y*

Question 24

What do positive output gaps do to wages and costs?

Answer 24

It drives them upward

Question 25

What do negative output gaps do to wages and costs?

Answer 25

It tends to drive wages and costs downwards

Question 26

What kind of tools will the government use to try to push real GDP back towards potential output?

Answer 26

fiscal tools

Question 27

What are alternatives to using fiscal stabilization policy?

Answer 27

Wait for the recovery of private-sector demand (a shift in the AD curve
Wait for the economy’s adjustment process (a shift in the AS curve)

Question 28

The effect of any given shift in AD will be divided between a change in [Y/P] and a change in [Y/P]

Answer 28

Y
P

Question 29

The steeper the AS curve, the [greater/smaller] the price effect and the [greater/smaller] the output effect

Answer 29

greater
smaller

Question 30

What do AS shocks make P and Y do?

Answer 30

It makes them change in opposite directions

Question 31

A negative supply shock shifts the AS curve [left/right] and the rise in the price level shifts the AE curve [up/down]

Answer 31

left
down

Question 32

What is the paradox of thrift? When is it true?

Answer 32

It is the idea that an increase in saving reduces the level of real GDP. It is true only in the short run

Question 33

What is the path of real GDP determined by in the long run?

Answer 33

It is determined by the path of potential output

Question 34

What long-run effect does the increase in saving cause?

Answer 34

It causes increasing investment and therefore increasing potential output

Question 35

What increases along with real GDP and falls?

Answer 35

Government tax revenues rise
Government transfers fall

Question 36

What does the tax-and-transfer system do to the value of the multiplier?

Answer 36

Its reduces the values of the multiplier and acts as an automatic stabilizer for the economy

Question 37

What does the rise in tax revenues do to the overall increase in real GDP?

Answer 37

It dampens it

Question 38

What is the equation for the marginal propensity to spend on national income?

Answer 38

z = MPC(1-t) - m

Question 39

What is the equation for the simple multiplier?

Answer 39

Simple multiplier = 1/(1-z)

Question 40

The [lower/higher] the net tax rate (t) the larger the simple multiplier and thus the less stable is real GDP in response to shocks to autonomous spending

Answer 40

lower

Question 41

What are the limitations of discretionary fiscal policy?

Answer 41

decision and execution lags
temporary versus permanent tax changes
fine tuning versus gross tuning

Question 42

What is decision lag?

Answer 42

It is the delay between the initial recognition of a recessionary or inflationary gap and the enactment of legislation to change fiscal policy
May be several months long

Question 43

What is execution lag?

Answer 43

It is the additional time between the enactment of legislation and the implementation of the policy action

Question 44

What is fine tuning?

Answer 44

It is the attempt to maintain output at potential level Y* through frequent changes in fiscal or monetary policy

Question 45

What is gross tuning?

Answer 45

It is the use of macroeconomic policy to stabilize the economy such that large deviations from potential output do not persist for extended periods of time

Question 46

If an increase in government purchases leads to an
increase in potential output (or its growth rate), the
negative effects from the crowding out of private
investment will be [increased/reduced].

Answer 46

reduced

Question 47

What do reductions in tax rates generate in the short-run and long-run?

Answer 47

It generates short-run demand stimulus and may also generate a longer-run increase in the level and growth rate of potential output.