11) Suppose that the value of the average family home increased dramatically. This change
would tend to shift the
A) aggregate demand curve to the left, lowering real GDP and the price level.
B) aggregate supply curve to the right, raising real GDP and lowering the price level.
C) aggregate demand curve to the right, raising real GDP and the price level.
D) aggregate supply curve to the left, lowering real GDP and raising the price level.
12) Suppose that Congress increased government spending at the same time that the price of
imported oil (which is used to manufacture gasoline and heating oil) increased. In the short run,
this would clearly
A) increase both the price level and real GDP.
B) reduce both the price level and real GDP.
C) increase the price level, but the impact on real GDP is uncertain.
D) increase real GDP, but the impact on the price level is uncertain.
13) The short-run aggregate supply curve slopes upward
A) as a result of the real balance effect and the interest rate effect.
B) if all wages and input prices are flexible in the short run.
C) because increases in the overall price level result in enhanced labor productivity and higher
real output.
D) because input price rigidities make it profitable for firms to expand output when product
prices rise.
14) Suppose that the economy is operating below potential GDP. According to the self-
correcting model, the economy will ultimately return to potential because
A) the Fed will expand the money supply.
B) wages and resource prices will fall as contracts expire and are renegotiated.
C) workers will eventually demand higher wages, and resource suppliers will demand higher
input prices.
D) aggregate demand will automatically increase enough to push the economy back to potential
GDP.
15) When the overall price level rises,
A) businesses tend to reduce output because production becomes less profitable.
B) wage rates and other input prices tend to increase immediately, forcing businesses to cut back
on production.
C) businesses have incentive to expand output because many costs are fixed by long-term
contracts.
D) businesses may either increase or decrease output, depending on the magnitude of the hike in
the price level.
16) According to the self-correcting model, if the economy is producing a level of output in
excess of potential GDP,
A) potential GDP will automatically expand to match the actual level of production.
B) workers and input suppliers will eventually negotiate higher wages and prices, which will
return the economy to potential GDP.
C) wages and input prices will ultimately fall, which will return the economy to potential GDP.
D) None of the above; the economy cannot operate beyond potential GDP.
17) According to the self-correcting model,
A) unemployment can exist indefinitely.
B) the economy can never operate beyond potential GDP.
C) unemployment is eventually eliminated by falling wages and prices.
D) the economy always operates at potential GDP.
18) Which of the following would not shift the long-run AS curve to the right?
A) an increase in the stock of capital
B) a technological advance
C) a reduction in the average wage rate
D) an increase in worker training
1) Aggregate demand may be best defined as
A) the amount of a product that a consumer is willing and able to purchase at various prices in a
given period of time.
B) the amount of a product that all consumers together are willing and able to purchase at
various prices in a given period of time.
C) the total quantity of output demanded by all sectors in the economy together at various price
levels in a given period of time.
D) the total quantity of output demanded by all households in the economy together at various
price levels in a given period of time.
2) Which of the following is not a reason for the downward slope of the aggregate demand
curve?
A) the real balance effect
B) the government policy effect
C) the interest rate effect
D) the international trade effect
3) The interest rate effect occurs when
A) the Federal Reserve increases the money supply, which lowers interest rates and causes
consumers to demand more goods and services.
B) a reduction in the price level lowers the demand for money, and the resulting lower interest
rate causes businesses and others to purchase more goods and services.
C) an increase in the price level reduces the real value of the public’s financial assets and causes
them to buy fewer goods and services.
D) All of the above
4) Which of the following accurately describes the real balance effect?
A) If society’s aggregate wealth increases for instance, because of a stock market
boom households will demand more goods and services. This will shift the aggregate demand
curve to the right.
B) If the price level increases, this increase in the price level will increase the demand for money
and raise the interest rate. The higher interest rate will lead to increased spending on goods and
services; more real GDP will be demanded at the lower price level.
C) If the price level falls, the real value of society’s financial wealth will increase. A portion of
this increased wealth will be spent on goods and services; more real GDP will be demanded at
the lower price level.
D) If you fail to record all your checks, your checkbook will not accurately reflect your real
balance.
5) An increase in aggregate demand could be due to
A) a decrease in the price level.
B) a reduction in society’s aggregate wealth.
C) an increase in personal income taxes.
D) None of the above
6) The real balance effect
A) is one of the reasons that the aggregate supply curve is upward sloping.
B) causes the aggregate demand curve to shift to the right.
C) helps to explain why the aggregate demand curve is downward sloping.
D) causes the aggregate supply curve to shift to the right.
7) Which of the following would not reduce aggregate demand?
A) a drop in the stock market
B) an increase in consumer pessimism
C) a reduction in U.S. interest rates
D) a recession in Europe
8) Economists generally assume that resource or input prices are
A) rigid or inflexible in both the short run and the long run.
B) rigid or inflexible in the short run, but flexible in the long run.
C) rigid or inflexible in the long run, but flexible in the short run.
D) flexible in both the short run and the long run.
9) When aggregate demand increases,
A) the aggregate demand curve shifts to the right.
B) the economy moves down along a stationary aggregate demand curve.
C) the aggregate demand curve shifts to the left.
D) the economy moves up along a stationary aggregate demand curve.
10) The aggregate supply curve is normally drawn as
A) upward sloping.
B) upward sloping in the long run, but vertical in the short run.
C) upward sloping in the short run, but vertical in the long run.
D) vertical.
11) The shape of the short-run aggregate supply curve stems from the assumption that when
A) product prices increase, input prices quickly rise as well.
B) product prices rise, input prices remain fixed for some time.
C) product prices fall, input prices drop as well.
D) input prices rise, product prices remain fixed in the short run.
12) The type of inflation caused by increased spending for goods and services is termed
A) demand-pull inflation.
B) cost-push inflation.
C) structural inflation.
D) expenditure inflation.
13) All of the following would shift the short-run aggregate supply curve to the right EXCEPT
A) an increase in the supply of labor.
B) an increase in wage rates.
C) an increase in the productivity of labor.
D) a reduction in raw material prices.
14) In the short run, a tax cut would
A) increase both real GDP and the price level.
B) reduce both real GDP and the price level.
C) increase real GDP, but lower the price level.
D) reduce real GDP, but raise the price level.
15) Demand-pull inflation could be caused by all of the following EXCEPT
A) an increase in government spending.
B) an increase in the money supply.
C) an increase in society’s aggregate wealth.
D) an increase in the minimum wage.
16) Which of the following could generate stagflation?
A) Congress cuts taxes.
B) Asian economies become stronger and buy more American products.
C) OPEC engineers an increase in crude oil prices
D) The Federal Reserve reduces U.S. interest rates.
17) If unemployment exists in the short run, this unemployment tends to be eliminated in the
long run by the economy’s self-correcting mechanism. The key to this self-correcting mechanism
is the fact that
A) aggregate demand tends to increase automatically in the long run.
B) unemployment leads to higher wages which cause aggregate demand to increase and restore
full employment.
C) wages and input prices will tend to fall when contracts expire in the long run.
D) unemployment ultimately leads to government action to stimulate aggregate demand.
Use the following diagram in answering the following question(s).
18) Based on the figure above, suppose consumer pessimism reduces aggregate demand from
AD1 to AD2. If the economy is allowed to correct itself, full employment will be restored in the
long run when
A) the aggregate demand curve shifts back to its original position.
B) falling wages and input prices shift the aggregate supply curve to the right.
C) potential GDP is reduced to $3 trillion.
D) wage and input contracts expire and are renegotiated upward.
19) Based on the figure above, when the self-correcting mechanism has completed its task, the
economy will be in equilibrium at an output of
A) $5 trillion and a price level of 100.
B) $4 trillion and a price level of 100.
C) $5 trillion and a price level of 90.
D) $5 trillion and a price level of less than 90.
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Use the following diagram in answering the following question(s).
20) Based on the figure above, suppose an increase in aggregate wealth shifts aggregate demand
from AD1 toAD2, and moves the economy beyond potential. If the economy is left to correct
itself, full employment will be restored in the long run when
A) wages and input prices fall, and shift the aggregate supply curve downward.
B) aggregate demand decreases back to its original level.
C) contracts expire and workers and input suppliers demand higher wages and input prices,
respectively.
D) potential GDP expands to $6 trillion.
21) Based on the figure above, when the self-correcting mechanism has completed its task, the
economy will be in equilibrium at an output of
A) $6 trillion and a price level of 100.
B) $5 trillion and a price level of 100.
C) $6 trillion and a price level of 110.
D) $5 trillion and a price level of more than 110.
22) Which of the following is a true statement about the model of a self-correcting economy?
A) If the economy starts in long run equilibrium at $5 trillion, an increase in aggregate demand
will ultimately result in an equilibrium output of $5 trillion and a higher price level.
B) If the economy starts in a long-run equilibrium at $5 trillion, a reduction in aggregate demand
will ultimately result in an equilibrium output of $5 trillion and a lower price level.
C) Because increases or decreases in aggregate demand change only prices in the long run, the
long-run aggregate supply curve is a vertical straight line.
D) All of the above
23) Which of the following will not shift the long-run aggregate supply curve to a new position?
A) an increase in labor productivity
B) an increase in wage rates
C) a reduction in the stock of capital equipment
D) an improvement in manufacturing technology
24) An increase in the productivity of the labor force would be likely to shift
A) the aggregate supply curve to the right.
B) the aggregate demand curve to the right.
C) the aggregate supply curve to the left.
D) the aggregate demand curve to the left.
1) The aggregate demand curve is downward sloping because of the income and substitution
effects.
2) The three reasons for the downward slope of the AD curve are the real balance effect, the
interest rate effect, and the international trade effect.
3) According to the real balance effect, a reduction in the overall price level will tend to increase
the real incomes of households and cause them to demand more goods and services.
4) The real balance effect explains why the aggregate demand curve tends to shift to the right
when the price level falls.
5) The short-run aggregate supply curve will be upward sloping if some input costs are fixed in
the short run.
6) If a reduction in the price level causes more real output to be demanded, the aggregate demand
curve will shift to the right.
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7) The real balance effect describes the increase in the amount of real output that is demanded
when a reduction in the overall price level increases the real value of the public’s financial assets.
8) According to the interest rate effect, a reduction in the price level will increase the demand for
money and raise interest rates.
9) An increase in the overall price level should increase the demand for money, raise interest
rates, and lower the amount of real GDP demanded.
10) If a reduction in the overall price level makes U.S. products more attractive relative to
foreign products, more real output will be demanded because of the international trade effect.
11) A reduction in the overall price level in the United States will tend to make U.S. products
more attractive relative to foreign products and shift the AD curve to the right.
12) If households and/or businesses become more optimistic about the future, the AD curve will
tend to shift to the right.
13) An increase in the overall wealth of the society will tend to reduce aggregate demand
because households have satisfied more of their wants.
14) Higher interest rates will tend to shift the AD curve to the right.
15) Increases in the money supply have the same impact as increases in taxes; they both shift the
AD curve to the right.
16) The upward slope of the short-run aggregate supply curve results from the assumption that
all wages and prices are highly flexible.
17) If wages and other input prices immediately adjust upward whenever product prices rise, the
Page 23
short-run aggregate supply curve would be a vertical straight line.
18) When product prices rise, firms find it profitable to expand output because some input prices
are rigid in the short run.
19) If wage rates increase, the aggregate supply curve will shift downward.
20) Increased labor productivity will tend to shift the AS curve to the right.
21) If households and businesses become pessimistic about the future, both the price level and
the level of real GDP will tend to fall.
22) Higher tax rates would tend to raise the overall price level but lower the level of equilibrium
GDP.
23) An increase in the incomes of Japanese consumers would tend to raise the level of U.S.
exports and cause U.S. GDP to rise.
24) Lower income levels in Canada, Mexico, and other trading partners of the United States will
tend to reduce equilibrium GDP in the United States, ceteris paribus.
25) An increase in personal income taxes will shift the short-run AS curve to the right.
26) Higher levels of government spending lead to “cost- push” inflation.
27) Stagflation is caused by reductions in aggregate supply.
28) If the minimum wage is increased, the short-run aggregate supply curve will shift to the left,
reducing equilibrium GDP and raising the overall price level.
29) Bad agricultural harvests can lead to stagflation.
30) Anything that raises labor productivity will tend to shift the short-run AS curve to the left
and raise the overall price level in the economy.
31) If a reduction in aggregate supply leads to stagflation, increasing government spending will
aggravate the inflation problem.
32) Whenever stagflation exists, attempts to reduce the inflation will aggravate unemployment,
and attempts to reduce the unemployment will aggravate inflation.
33) Suppose the economy is in equilibrium at less than full employment. According to the self-
correcting model, in the long run the AD curve will shift to the right and restore full
employment.
34) If unemployment exists, the self-correcting model predicts that it will ultimately be
eliminated by an increase in aggregate supply.
35) According to the self-correcting model, the existence of unemployment ultimately leads to
wage reductions which shift the short-run aggregate supply curve and restore full employment.
36) The economy can never operate beyond potential GDP.
37) The economy cannot sustain an output beyond potential GDP.
38) If the economy is in equilibrium beyond potential GDP, the self-correcting model predicts
that aggregate demand will eventually fall.
Question Status: Previous Edition
39) If the economy is in equilibrium beyond potential, wage rates and input prices will tend to
rise in the long run.
40) Whenever the economy is in equilibrium beyond potential, wage rates and input prices will
ultimately rise, pushing the short-run AS curve to the left.
41) In the self-correcting model of the economy, the mechanism that returns the economy to
potential GDP is adjustments in both aggregate supply and aggregate demand.
42) The self-correcting model relies on adjustments in aggregate supply, not in aggregate
demand.
43) Suppose the economy is in equilibrium at potential GDP. The self-correcting model predicts
that efforts to raise output beyond potential are ultimately offset by rightward shifts of the short-
run aggregate supply curve.
44) Whenever the economy is in equilibrium below potential, unemployment ultimately leads to
falling wages which cause the AD curve to shift to the right and restore full employment and
potential GDP.
45) According to the self-correcting model, the economy can deviate from potential GDP in the
short run but not in the long run.
1) Explain in detail why more real output tends to be demanded at lower price levels than at
higher price levels.
2) Increases in the overall level of wealth will tend to shift the aggregate demand curve to the
right. Reductions in the price level cause the real balance effect which is also related to the level
of wealth but is graphed as movement along a stationary AD curve. Explain how these
phenomena differ and why they are graphed differently.
Question Status: Previous Edition
3) Suppose the economy is in equilibrium at less than potential GDP. Discuss the long-run
adjustments predicted by the self-correcting model and supplement your answer with the
appropriate graph or graphs.
4) The AS curve is drawn as upward sloping in the short run, but vertical in the long run.
Explain.
5) Describe the impact of each of the following events on the U.S. economy’s equilibrium GDP
and price level.
(a) Congress reduces personal income tax rates.
(b) OPEC raises crude oil prices.
(c) Consumers become more optimistic about the future.
(d) New technologies raise labor productivity.
(e) Europe enters a recession.
6) Suppose the economy is in short-run equilibrium above potential GDP. Describe the forces
that will ultimately return the economy to potential GDP.