Introduction to Economic Reasoning, 8e (Rohlf)
Chapter 11: Aggregate Demand and Supply: The Model of the Self-Correcting Economy
1) The aggregate demand curve is
A) horizontal because when there is substantial unemployment, the price level tends to remain
stable.
B) downward sloping because a reduction in the price level leads to a lower interest rate which
causes consumption and investment spending to increase.
C) downward sloping because an increase in the price level causes the interest rate to fall which
in turn lowers consumption and investment spending.
D) upward sloping because as output is expanded shortages of resources are encountered which
cause prices to rise.
E) downward sloping because when the price of a product falls, it tends to be substituted in the
place of other products.
2) The downward slope of the aggregate demand curve is due to
A) the interest rate effect, real balance effect, and substitution effect.
B) the international trade effect, real balance effect, and interest rate effect.
C) the real balance effect, income effect, and substitution effect.
D) the income effect and interest rate effect.
E) the income and substitution effects.
3) According to the real balance effect, a decrease in the overall price level will
A) decrease the quantity of real output demanded because households will feel poorer.
B) decrease the quantity of real output demanded because the value of savings accounts and
other financial assets will decline.
C) increase the quantity of real output demanded because cheaper products will be substituted in
the place of more expensive items.
D) increase the quantity of real output demanded because the purchasing power of financial
assets will increase.
E) increase the quantity of real output demanded because interest rates will tend to decline, and
this will stimulate spending.
4) The real balance effect
A) is one reason why the aggregate demand curve is downward sloping.
B) can cause the aggregate demand curve to shift to a new position.
C) has to do with the impact of price level changes on the prevailing interest rate.
D) helps to explain why the aggregate supply curve is upward sloping.
E) can cause the aggregate supply curve to shift to a new position.
5) According to the interest rate effect,
A) an increase in the price level tends to increase the demand for money, raise interest rates, and
lower spending.
B) a reduction in the price level tends to increase the demand for money, raise interest rates, and
lower spending.
C) an increase in the price level tends to decrease the demand for money, lower interest rates,
and increase spending.
D) a reduction in the price level tends to decrease the demand for money, lower interest rates,
and increase spending.
E) a reduction in the price level tends to increase the demand for money, raise interest rates, and
increase spending.
6) According to the interest rate effect, an increase in the price level should
A) raise interest rates and increase spending on GDP; the aggregate demand curve should shift to
the right.
B) lower interest rates and decrease spending on GDP; the aggregate demand curve should shift
to the left.
C) raise interest rates and decrease spending on GDP; the aggregate demand curve should shift to
the right.
D) lower interest rates and increase spending on GDP; the aggregate demand curve should be
downward sloping.
E) raise interest rates and decrease spending on GDP; the aggregate demand curve should be
downward sloping.
7) Which of the following would tend to increase aggregate demand?
A) a reduction in the overall wealth of the society
B) pessimistic expectations about the future
C) a reduction in the money supply
D) a reduction in tax rates
E) a reduction in government spending
8) A reduction in aggregate demand could be caused by
A) a reduction in income taxes.
B) increased business optimism.
C) a substantial decline in the stock market.
D) increased spending by government for social programs.
E) an expansionary monetary policy.
9) An increase in aggregate demand could be caused by all of the following EXCEPT
A) increased government spending on highways.
B) Federal Reserve policy to expand the money supply.
C) a reduction in the overall price level.
D) widespread optimism about the future.
E) a reduction in interest rates.
10) When government spending increases, the aggregate demand curve
A) shifts to the left because private spending is being crowded out.
B) shifts to the right because more output is being demanded at every price level.
C) shifts to the right because a reduction in the price level causes the interest rate to be reduced
and thereby stimulates spending.
D) shifts to the left because the higher level of government spending raises the interest rate and
lowers total spending.
E) does not shift.
11) A reduction in the money supply would tend to
A) shift the aggregate demand curve to the right.
B) shift the aggregate supply curve to the right.
C) shift the aggregate demand curve to the left.
D) shift the aggregate supply curve to the left.
E) shift both the aggregate demand and aggregate supply curves to the left.
12) The short-run aggregate supply curve slopes
A) downward because lower price levels tend to stimulate spending for goods and services.
B) upward because higher price levels mean higher incomes and greater spending for goods and
services.
C) downward because prices tend to fall as the overall economy expands its output of goods and
services.
D) upward because businesses can generally purchase labor and other inputs at fixed costs for
some period of time.
E) upward because an increase in the price level will increase the real value of financial assets
and thereby stimulate spending.
13) The short-run aggregate supply curve will be upward sloping if
A) wages and input prices are highly flexible in the short run.
B) producers cannot expand or contract output in the short run.
C) some input prices tend to be fixed in the short run.
D) product prices are unable to change in the short run.
E) output never deviates from potential GDP.
14) When the overall price level in the economy FALLS,
A) businesses may supply more or less output depending on the size of the reduction in the price
level.
B) businesses will supply more output since some input costs are fixed in the short run.
C) the economy’s potential GDP will increase.
D) businesses will supply less output since wage rates and some other input costs are fixed by
long-term contracts.
E) businesses will tend to supply more output since more output can be sold at the lower price
level.
15) When the overall price level in the economy rises,
A) businesses may supply more or less output depending on the size of the increase in the price
level.
B) businesses will supply more output since some input costs are fixed in the short run making it
profitable to expand output.
C) the economy’s potential GDP will increase.
D) businesses will supply less output since wage rates and some other input costs are fixed by
long-term contracts.
E) businesses will tend to supply more output since more output can be sold at the higher price
level.
16) Which of the following will not increase short-run aggregate supply?
A) a reduction in the average wage rate
B) a widespread increase in labor productivity
C) a reduction in the price of imported oil
D) an increase in the money supply
E) a major technological advance
17) Which of the following would cause the short-run aggregate supply curve to shift upward (to
the left)?
A) a decrease in the level of government spending
B) a general increase in raw materials prices
C) an increase in the economy’s productive capacity
D) a reduction in the money supply
E) a reduction in the minimum wage
18) A supply shock such as an increase in the price of imported oil would tend to
A) reduce equilibrium GDP and the price level.
B) increase both equilibrium GDP and the price level.
C) reduce both unemployment and inflation.
D) generate unemployment but lower the price level.
E) increase unemployment while also raising the price level.
19) An increase in aggregate supply could be caused by
A) an increase in the money supply and would tend to lower both equilibrium GDP and the price
level.
B) a reduction in the minimum wage and would tend to raise both equilibrium GDP and the price
level.
C) an increase in labor productivity and would tend to increase real GDP while lowering the
price level.
D) an increase in input prices and would tend to increase real GDP while lowering the price
level.
E) an abundant agricultural harvest and would tend to increase real GDP while raising the price
level.
20) Which of the following is not a source of cost-push inflation?
A) an increase in the minimum wage
B) higher crop prices caused by a drought
C) an increase in the level of government spending for social programs
D) union mandated wage increases in excess of productivity gains
E) an increase in the price of raw materials imported from abroad
21) Demand-pull inflation is caused by
A) increases in the cost of raw materials.
B) increases in the level of total spending in the economy.
C) reductions in aggregate supply.
D) demands for wage increases in excess of productivity gains.
E) reductions in the demand for consumer goods.
22) A supply shock which reduces aggregate supply
A) may increase the level of equilibrium output as it raises the price level.
B) may lower the price level and the level of equilibrium output.
C) may reduce the equilibrium output as it raises the price level.
D) is represented by shifting the aggregate supply curve downward.
E) is represented by shifting the aggregate demand curve to the right.
23) Given a stationary short-run aggregate supply curve, a reduction in aggregate demand will
tend to
A) decrease the level of equilibrium GDP and the overall price level.
B) increase the level of equilibrium GDP and the overall price level.
C) increase the level of equilibrium GDP but decrease the overall price level.
D) decrease the level of equilibrium GDP but increase the overall price level.
E) decrease potential GDP and the overall price level.
24) A decrease in aggregate demand, coupled with an increase in aggregate supply, would tend
to
A) increase both real GDP and the price level.
B) decrease both real GDP and the price level.
C) decrease the level of real GDP, but the impact on the price level is indeterminate.
D) increase the level of real GDP, but the impact on the price level is indeterminate.
E) decrease the price level, but the impact on real GDP is indeterminate.
25) Suppose the economy suffers an adverse supply shock. If the Federal Reserve responds by
increasing the money supply, the short-run result will be
A) lower unemployment and less inflation.
B) a lower equilibrium GDP coupled with higher prices.
C) lower unemployment but higher prices.
D) lower prices but higher unemployment.
E) greater unemployment and higher inflation.
26) Shocks to the economy such as OPEC oil price increases and higher grain prices due to poor
growing conditions would be represented graphically by
A) shifting the aggregate demand curve to the right.
B) shifting the aggregate supply curve to the right.
C) shifting the aggregate demand curve to the left.
D) shifting the aggregate supply curve to the left.
E) shifting the total expenditure function to the right.
27) Adverse supply shocks present policymakers with a dilemma because
A) if aggregate demand is stimulated to reduce unemployment, the inflation rate also falls.
B) if aggregate demand is reduced to combat inflation, unemployment also falls.
C) any change in aggregate demand will aggravate both unemployment and inflation.
D) any expansion in aggregate supply will reduce inflation but intensify unemployment.
E) any expansion in aggregate demand will reduce unemployment but raise the price level.
28) Attempts to combat cost-push inflation through restrictive monetary or fiscal policies will
tend to
A) increase the price level.
B) reduce both the price level and the level of employment.
C) reduce the price level and increase the level of equilibrium GDP.
D) increase the level of employment but lower the price level.
E) increase both the price level and the level of equilibrium GDP.
29) Stagflation poses a dilemma for policymakers because
A) if aggregate demand is reduced to combat inflation, equilibrium GDP will tend to rise.
B) if aggregate demand is increased to combat unemployment, the price level will tend to fall.
C) if aggregate demand is stimulated to expand the economy, the price level will tend to rise.
D) any reduction in aggregate demand will tend to lower both the price level and the
unemployment rate.
E) any expansion in aggregate demand will tend to raise both the price level and the
unemployment rate.
30) Supply-side policies are intended to
A) increase both aggregate demand and aggregate supply.
B) shift the aggregate supply curve to the left.
C) decrease both aggregate demand and aggregate supply.
D) shift the aggregate supply curve to the right.
E) make the aggregate supply curve vertical.
31) Successful supply-side policies will
A) reduce unemployment but increase inflation.
B) reduce both unemployment and the price level.
C) increase unemployment but reduce inflation.
D) reduce both real GDP and the price level.
E) increase both real GDP and the price level.
32) Suppose that an increase in aggregate demand propels the economy to an equilibrium output
in excess of potential GDP. According to the self-correcting model,
A) the aggregate demand curve will eventually shift back to the left (downward) and return the
economy to potential GDP.
B) the short-run aggregate supply curve will eventually shift to the right (downward) and return
the economy to potential GDP.
C) the short-run aggregate supply curve will eventually shift to the left (upward) and return the
economy to potential GDP.
D) the higher price level will increase labor productivity, which will shift the short-run aggregate
supply curve to the right and increase potential GDP.
E) potential GDP will immediately expand to match the increase in aggregate demand.
33) Suppose the economy is in equilibrium at an output less than potential GDP. According to
the self-correcting model,
A) aggregate demand will immediately expand and return the economy to potential GDP.
B) wages and input prices will eventually fall, which will shift the short-run aggregate supply
curve to the right and restore potential GDP.
C) policymakers will eventually increase aggregate demand, which will restore potential GDP.
D) wages and input prices will eventually fall, which will shift the short-run aggregate supply
curve to the left and restore potential GDP.
E) wages and input prices will eventually rise which will push the aggregate demand curve to the
right and return the economy to potential GDP.
34) The self-correcting model of the economy relies on
A) monetary and fiscal policies to return the economy to potential GDP.
B) deliberate supply-side policies to return the economy to potential GDP.
C) constant economic growth to return the economy to potential GDP.
D) input price adjustments to return the economy to potential GDP.
E) increases in labor productivity to return the economy to potential GDP.
35) Assume that potential GDP is $1,000 billion. Suppose that the economy is presently in
equilibrium at a price level of 120 and an output of $1,500 billion. According to the self-
correcting model, the economy will
A) ultimately return to an output of $1,000 billion but at a price level less than 120.
B) will remain at an output of $1500 billion, but the price level will fall to something less than
120.
C) ultimately return to an output of $1,000 billion but at a price level greater than 120.
D) will remain at an output of $1500 billion, but the price level will rise above 120.
E) ultimately return to an output of $1,000 billion at a price level of 120.
36) Assume that the economy is initially in equilibrium at a price level of 100 and a potential
GDP of $1,000 billion. If aggregate demand falls,
A) the price level will initially decline but will return to 100 when the self-correcting mechanism
restores potential GDP.
B) the price level will initially rise but will return to 100 when the self-correcting mechanism
restores potential GDP.
C) the price level will initially decline but will fall even further when the self-correcting
mechanism restores potential GDP.
D) the price level will initially increase but will rise even further when the self-correcting
mechanism restores potential GDP.
E) the price level will initially decline but will rise above 100 when the self-correcting
mechanism restores potential GDP.
Answer the following question(s) on the basis of the following diagram.
37) Based on the figure above, the economy represented in the diagram is presently
A) experiencing unemployment, which will be corrected in the long run when the economy
moves to point B.
B) operating beyond potential GDP, which will be corrected in the long run when the economy
moves to point B.
C) producing less than potential GDP, which will be corrected in the long run when the economy
moves to point C.
D) experiencing unemployment, which will be corrected in the long run when the economy
moves to point D.
E) operating at potential GDP.
38) Based on the figure above, the economy represented above
A) will return to long-run equilibrium when the self-correcting mechanism increases aggregate
demand, propelling the economy to point D.
B) will return to long-run equilibrium when contracts expire and input prices are negotiated
downward.
C) will return to long-run equilibrium when the AS curve intersects point B.
D) will return to long-run equilibrium when the self-correcting mechanism increases aggregate
demand, propelling the economy to point B.
E) is in long-run equilibrium.
Use the following diagram in answering the following question(s).
39) Based on the figure above, the economy represented is
A) operating below potential. The self-correcting mechanism will ultimately return it to point C.
B) operating above potential. The self-correcting mechanism will ultimately return it to point C.
C) operating below potential. The self-correcting mechanism will ultimately return it to point B.
D) operating above potential. The self-correcting mechanism will ultimately return it to point D.
E) operating above potential. The self-correcting mechanism will ultimately return it to point B.
40) Based on the figure above, the self-correcting mechanism will return the economy to
potential GDP
A) when aggregate demand decreases so that AD intersects AS at point B.
B) when AD increases and AS decreases, intersecting at point C.
C) when contracts are renegotiated and higher wage rates and other resource prices shift the AS
curve through point D.
D) when lower wage rates and other resource prices shift the AD down through point B.
E) when contracts are renegotiated and lower wage rates and other input prices shift the AS
curve through point D.
1) “The inflation seemed to be the result of optimistic consumers, who were willing to borrow
against the escalating value of their homes and use the proceeds to buy furniture, automobiles,
and a host of other products.” This quote describes
A) demand-pull inflation.
B) cost-push inflation.
C) structural inflation.
D) expenditure inflation.
2) If a reduction in the price level causes more real output to be demanded,
A) the aggregate demand curve will shift to the right.
B) the aggregate demand curve is downward sloping.
C) the short-run aggregate supply curve will shift to the right.
D) the short-run aggregate supply curve is downward sloping.
3) Which of the following will shift the aggregate demand curve to the left?
A) an increase in government spending
B) a reduction in labor productivity
C) an increase in personal income taxes
D) an increase in society’s aggregate wealth
4) Which of the following will increase both the price level and real GDP?
A) a nationwide drought that drives up the prices of agricultural products
B) a reduction in government spending for goods and services
C) a reduction in the money supply
D) greater optimism among business executives
5) In 1974 disease killed many anchovies and raised anchovy prices. Anchovies are used in cattle
feed as a source of protein. The likely impact of this event would be to
A) raise both the price level and real GDP.
B) lower both the price level and real GDP.
C) raise the price level but lower real GDP.
D) lower the price level but raise real GDP.
6) According to the real balance effect,
A) a reduction in the price level stimulates spending by lowering interest rates.
B) an increase in the money supply will shift the aggregate demand curve to the right.
C) an increase in the price level reduces spending by lowering the real value of society’s financial
assets.
D) an increase in society’s aggregate wealth will shift the aggregate demand curve to the right.
7) If the U.S. labor force became better educated and therefore more productive, the
A) the aggregate demand curve would shift right, raising both real GDP and the price level.
B) the aggregate supply curve would shift left, lowering real GDP and raising the price level.
C) the aggregate demand curve would shift left, lowering both real GDP and the price level.
D) the aggregate supply curve would shift right, raising real GDP and lowering the price level.
8) A decrease in foreign income levels would, ceteris paribus, tend to shift the aggregate
________ curve for U.S. products to the ________.
A) demand; right
B) demand; left
C) supply; right
D) supply; left
9) The international trade effect provides a rationale for
A) shifts in the aggregate demand curve.
B) shifts in the aggregate supply curve.
C) the slope of the aggregate demand curve.
D) the slope of the aggregate supply curve.
10) In the short run, an increase in the money supply will
A) reduce both real GDP and the price level.
B) reduce real GDP and increase the price level.
C) increase both real GDP and the price level.
D) increase real GDP and reduce the price level.