ECO-2013 Lecture 9: Chapter 10

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10 Mar 2016

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Chapter 10: dynamic change, economic fluctuations, and the ad-as model. People react and behave differently to events that are foreseen (anticipated) and events that are surprising (unanticipated) If asian economics suffer a serious economic slump, u. s. net exports will fall, ad will shift right, unemployment will rise. Lower real interest rate will most likely increase aggregate demand: six changing factors that shift ad, real wealth, real interest rate, expectation, expected rate of in ation. If an improvement in the quality of education in the u. s. increases the productivity of labor, this will increase both the long-run and short-run aggregate supply. In contrast, an increase in resource prices will decrease short-run aggregate supply: short run v. s. Long run: for long run, think about capacity (what are we able to produce? remember shifting the ppc, for the short run, think about pro ts. Factors that shift sras: changes in resource prices, changes in the expected rate of in ation, supply shocks.

Related Questions

MBA502, Economics for Business

Apply and Discover 7.2

You are responsible for economic policymaking in your country. Your desire is to eliminate inflation, keeping prices absolutely stable at P = 100, no matter what happens to output. Currently, the economy is in equilibrium at Q = 3200 (where Q = potential GDP) and P = 100. You can use monetary and fiscal policies to affect aggregate demand but you cannot affect aggregate supply in the short run. How would you respond to the following scenarios?

Explain and illustrate how each of these events would affect aggregate demand, aggregate supply, and prices, then explain how you would respond with economic policies.

1. A surprise increase in investment spending

In the short run, when investment spending increases, it results in an increase in Aggregate Demand (AD), which in turn pushes up both GPD and the price index.

To counterbalance this development, government might pursue contractionary fiscal policy by increasing taxes (to reduce consumption) or decreasing its own investment and spending so that the AD curve shifts back to its original position. Alternatively, the government can pursue contractionary monetary policy by reducing money supply and increasing interest rate to discourage economic activity.

2. Catastrophic floods that cause a sharp food price increase

In this case, sharp food shortages and consequent price increases cause a shock-type adjustment of the aggregate supply curve (it shift up and to the left). The result is a lower GDP and a higher price level.

The government cannot do anything to adjust AS in the short run. However, if the goal is to maintain the price level constant, the government can decide to do something to decrease the aggregate demand to force prices to come down, though it will be accompanies by another contraction in GDP and so it would not be a smart thing to do.

To cause AD to decrease, the government, similar to example above, can pursue fiscal policy (increase taxes, decrease spending) or monetary policy (reduce supply of money to the economy and thus increase interest rates).

3. A productivity decline that reduces potential output

In this case, AS shifts to the left, as was the case in example 2. As a result, price levels go up, as the same amount of money is chasing the reduced amount of goods and services, and GDP declines.

Government remedies here would be centered about causing AD to decrease through contractionary fiscal (higher taxes, lower spending) or monetary (reduce money supply and increase interest rates) policy. Again, this decision reduces inflation but at expense of GDP, as real output shrinks further.

4. A deep depression in East Asia that causes a sharp decrease in net exports to the United States

A decrease in exports of goods to from the United States to Asia will mean that the aggregate demand (which includes net exports

Show transcribed image text

1.Ceteris paribus, if the U.S. federal government reduces its budget deficit which of the following will be observed?

Answer

	a.	The aggregate demand curve will shift to the right.
	b.	The economy will always approach potential GDP.
	c.	The marginal propensity to consume will increase.
	d.	The average price level will increase.
	e.	The aggregate demand curve will shift to the left.

2. If the government wants to close a GDP gap, it can:

Answer

	a.	lower government spending on social security.
	b.	adopt contractionary fiscal policies to control inflation.
	c.	increase its budget deficit.
	d.	repay its borrowings.
	e.	raise both direct and indirect tax rates.

3. Suppose the short-run equilibrium level of income exceeds the full employment level of income and there is high inflation. Hence, the government decides to implement a fiscal policy that will act to reduce national output and price level. This can be accomplished by:

Answer

	a.	lowering average tax rates such that aggregate supply is increased.
	b.	increasing government spending such that aggregate expenditures are increased.
	c.	increasing transfer payments such that aggregate expenditures decline.
	d.	raising taxes and government spending by the same amount such that aggregate supply is decreased and aggregate demand is increased.
	e.	decreasing government spending such that aggregate demand is reduced.

4. A drop in investment spending caused by increased government budget deficits is referred to as:

Answer

	a.	the multiplier effect.
	b.	crowding out.
	c.	an expansionary gap.
	d.	the paradox of thrift.
	e.	the Ricardian equivalence.

5. Discretionary fiscal policy is best defined as:

Answer

	a.	the deliberate manipulation of the money supply to expand the economy.
	b.	the deliberate change in tax laws and government spending to change equilibrium income.
	c.	the policy action taken by the Congress to reduce the federal budget deficit.
	d.	the arbitrary fluctuation in tax laws and budget requirements.
	e.	the automatic change in certain fiscal instruments when real GDP changes.

6. Which of the following can be considered as an automatic stabilizer in the economy?

Answer

	a.	Money supply
	b.	Disposable income
	c.	Real exchange rate
	d.	Real interest rate
	e.	Unemployment insurance

7. Which of the following is true about automatic stabilizers?

Answer

	a.	When income rises, automatic stabilizers increase/boost spending.
	b.	Automatic stabilizers are a part of discretionary fiscal policy.
	c.	An automatic stabilizer is any program that responds to fluctuations in the business cycle in a way that moderates the effects of those fluctuations.
	d.	Any kind of trade policy adopted by the government will be considered as an automatic stabilizer.
	e.	The interest rate is an example of an automatic stabilizer.

8. Increased budget deficits

Answer

	a.	can cause interest rates to increase and hence decrease net exports
	b.	have no effect on net exports
	c.	can cause interest rates to decrease and hence increase net exports
	d.	never impose additional interest costs on the government

9. The Ricadian Equivalence implies that when financing additional government expenditures

Answer

	a.	there is no difference between increasing current taxes or borrowing now and increasing taxes in the future because consumption will decrease either way.
	b.	there is no difference between increasing current taxes or borrowing now and increasing taxes in the future because consumption will increase either way.
	c.	increasing borrowing is the best option
	d.	increasing current taxes is the best option

10. Assuming no effects on aggregate supply, if the government increases government spending and decreases taxes in an attempt to prevent a possible recession, aggregate demand will shift to the ____, the price level will either remain constant or ____, and the level of real GDP will ____.

Answer

	a.	right; decrease; increase
	b.	right; decrease; decrease
	c.	left; decrease; decrease
	d.	left; increase; increase
	e.	right; increase; increase

11. For a hypothetical economy, the MPS is 0.08 and the MPI is 0.17. If government spending increases by $35 and taxes increase by $35, what will be the net effect on equilibrium income?

Answer

	a.	A decrease of $35
	b.	An increase of $105
	c.	An increase of $35
	d.	A decrease of $105
	e.	A decrease of $15

12.12. The term fiscal policy refers to

Answer

	a.	the adjustment of the GDP for inflation.
	b.	the purchase and sale of U.S. government securities to regulate the money supply.
	c.	the use of government spending and taxation to influence the level of economic growth and inflation.
	d.	the use of fines to penalize unfair business practices.
	e.	a policy action by Congress to overrule unpopular budget cuts by the president.

13. If aggregate demand intersects aggregate supply in the vertical range of the aggregate supply curve, then, other things equal, an increase in government spending will

Answer

	a.	raise the price level and leave real GDP unchanged.
	b.	raise real GDP by the amount indicated by the government spending multiplier and leave the price level unchanged.
	c.	raise both real GDP and the price level by a multiple of the initial spending increase.
	d.	have no effect on real GDP or on the price level, because all private investment will be crowded out.
	e.	lower real GDP by an amount equal to the spending increase and reduce inflation.

14. Which of the following is not a means to finance government spending?

Answer

	a.	Government subsidies
	b.	Government debt
	c.	Capital gains taxes
	d.	Personal income taxes
	e.	Money creation

15. An automatic stabilizer is

Answer

	a.	a change in government spending aimed at achieving a policy goal.
	b.	an element of fiscal policy that automatically changes in value as real GDP changes.
	c.	an element of monetary policy that automatically changes in value as real GDP changes.
	d.	a decrease in tax rates as the economy moves into a recession.
	e.	a deliberate change in taxation aimed at increasing real GDP.

16. Budget deficits tend to grow during recessions because

Answer

	a.	real GDP growth is zero, which causes neither tax receipts nor government expenditures to grow.
	b.	real GDP growth is positive, which reduces both tax receipts and transfer payments.
	c.	real GDP growth is negative, which reduces transfer payments in relation to tax receipts.
	d.	real GDP growth is negative, which reduces tax receipts in relation to government expenditures.
	e.	real GDP growth is positive, which increases tax receipts in relation to government expenditures.

Question 32

Tim, a citizen of the United States living in Virginia, buys a computer that was made in South Korea by a Japanese firm. This transaction would affect the GDP of the United States in which way?

		Net exports would decrease and GDP would decrease.
		Net exports would decrease and GDP would be unaffected.
		Net exports would increase and GDP would increase.
		Net exports would increase and consumption would increase.

1 points

Question 33

An increase in U.S. government spending tends to

		increase U.S. interest rates and increase the U.S. capital account surplus.
		increase U.S. interest rates and decrease the U.S. capital account surplus.
		decrease U.S. interest rates and increase the U.S. capital account surplus.
		decrease U.S. interest rates and decrease the U.S. capital account surplus.

1 points

Question 34

A _______ is a system in which the government intervenes extensively in the foreign exchange market to keep the exchange rate within certain bounds.

dirty float

floating exchange rate

fixed exchange rate

dollarization

1 points

Question 35

Suppose the exchange rate between the euro and the dollar is E0.5 to $1. If a Big Mac costs $3 in the United States and E1.5 in Germany, then the real exchange rate is

1:1.

2:1.

1:2.

It cannot be determined from this information.

1 points

Question 36

Which of the following prevent the purchasing power parity theorem from holding perfectly?

transportation costs

goods that cannot be shipped

tariffs and quotas

Each of these answers is correct.

1 points

Question 37

Fiscal policy is more effective in affecting economic activity if

		many resources are unemployed.
		there is a real shock instead of an aggregate demand shock.
		the economy returns to the long-run condition almost immediately.
		there is a long implementation lag.

1 points

Question 38

In a typical year, changes in government spending compared to overall spending are relatively

small.

large.

unpredictable.

well-timed.

1 points

Question 39

Which statement is TRUE about the difference between monetary and fiscal policy?

		Fiscal policy can quickly adjust to changes in aggregate demand.
		Fiscal policy can have a more direct impact.
		Monetary policy is subject to many long lags.
		Monetary policy can affect the economy regardless of the actions banks take.

1 points

Question 40

Fiscal policies that help an economy in a recession without additional actions by policy makers are called

consumption smoothers.

Ricardian equalizers.

automatic stabilizers.

Each of these answers is correct.

1 points

Question 41

The U.S. individual income tax system can best be described as a

regressive tax system.

flat tax system.

zero tax system.

progressive tax system.

1 points

Question 42

What demographic change in the United States will cause government spending to increase in the next 50 years?

The population over 65 will grow.

The population will be younger.

Women will have fewer children.

Immigration will increase.

1 points

Question 43

What kind of rising costs will mostly cause U.S. government spending to skyrocket in the future?

defense

environmental protection

education

health care

1 points

Question 47

The Fed could have popped the bubble of the housing boom in the 2000s by

lending directly to homeowners.

regulating the stock markets more.

reducing the growth rate of the money supply.

doing nothing.

1 points

Question 48

Which of the following would be an example of running monetary policy by rules?

A 5 percent increase in money supply automatically leads to a 2 percent increase in real GDP.

An increase in money supply automatically leads to an increase in inflation.

The Fed will increase money growth to different levels, depending on the severity of the recession.

A 1 percent drop in real GDP will automatically elicit a 2 percent increase in money supply.

Question 50

Moral hazard occurs when

		the failure of one financial institution can bring down other institutions as well.
		financial institutions take on too much risk because they are insured.
		financial institutions become insolvent because they issued too many loans.
		there are more short-term liabilities than short-term assets.

Which of the following is NOT a transmission mechanism?

reductions in the money supply

intertemporal substitution

uncertainty

sticky wages and prices

Question 56

For a given increase in government spending growth, intertemporal substitution is more widespread when

		the impact of AD growth on both inflation and real GDP growth is stronger.
		the impact of AD growth on both inflation and real GDP growth is weaker.
		the impact of AD growth on inflation is stronger and the impact of the AD growth on real GDP growth is weaker.
		the impact of AD growth on inflation is weaker and the impact of AD growth on real GDP growth is stronger.

Stalin:

		instituted democratic reforms, leading to widespread prosperity.
		took government control of the farms in Ukraine, leading to the starvation of millions of people.
		increased the provision of public goods, which had a positive effect on lowering the unemployment rate.
		tried unsuccessfully to expand voting rights in 1924 Russia.

1 points

Question 60

1 points

Question 59

If voters care about two issues such as taxes and war, then politicians:

		will form a stable policy on these issues.
		can pose a policy that will never lose against another policy.
		must assume that there is no median voter.
		may never converge on a stable outcome.

1 points

Question 58

Policy A adversely affects 50 million people at a cost of $1 per person. But Policy A also benefits 1,000 people at $30,000 per person. Which of the following statements is true?

		Policy A will not become law because it hurts more people than it helps.
		Policy A concentrates all the costs among a small group of people and all the benefits among a large group of people.
		Policy A is likely to be supported by politicians even though it makes society worse off.
		Since Policy A negatively affects many people, and so rational ignorance will not be a problem.

1 points

Question 57

Data for the United States show that the incumbent party tends to win the election if:
I. personal disposable income is growing.
II. the inflation rate is low.
III. the political party has not been in power for too many continuous terms.

		I only
		I and II only
		I and III only
		I, II, and III

1 points

Question 53

1 points

Question 52

What is the purpose of the Fed's structure?

		to give the President of the United States as many tools as possible to regulate the economy
		to make sure all states are given equal access to monetary policy decisions
		to keep the private sector out of the monetary policy making arena
		to keep the power of the Fed dispersed

1 points

Question 51

An increase in money growth will cause inflation to increase in

		the short run only.
		the long run only.
		both the short run and the long run.
		neither the short run nor the long run.

ECO-2013 Lecture 9: Chapter 10

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Related Questions

		dirty float
		floating exchange rate
		fixed exchange rate
		dollarization

		transportation costs
		goods that cannot be shipped
		tariffs and quotas
		Each of these answers is correct.

		consumption smoothers.
		Ricardian equalizers.
		automatic stabilizers.
		Each of these answers is correct.

		regressive tax system.
		flat tax system.
		zero tax system.
		progressive tax system.

		The population over 65 will grow.
		The population will be younger.
		Women will have fewer children.
		Immigration will increase.

		lending directly to homeowners.
		regulating the stock markets more.
		reducing the growth rate of the money supply.
		doing nothing.

		1:1.
		2:1.
		1:2.
		It cannot be determined from this information.

		small.
		large.
		unpredictable.
		well-timed.

		defense
		environmental protection
		education
		health care