Chapter 11
Classical and Keynesian Macro Analyses
11.1 The Classical Model
1) Whom among the following was a classical economist?
A) Adam Smith B) A. C. Pigou
C) David Ricardo D) all of the above
2) All of the following were classical economists EXCEPT
A) Adam Smith B) A. C. Pigou
C) David Ricardo D)
J
ohn Maynard Keynes.
3) Which of the following is NOT an assumption of the classical model?
A) Wages and prices are fixed.
B) People are motivated by the own self interest.
C) Pure competition exists.
D) Buyers react to changes in relative prices.
4) The idea that supply creates its own demand is known as
A) the law of supply. B) the law of demand.
C) Keynes law. D) Say s law.
5) In the classical model, an increase in aggregate demand will cause
A) an increase in actual output, or Gross Domestic Product (GDP).
B) a decrease in actual output, or Gross Domestic Product (GDP).
C) an increase in price level.
D) a decrease in price level.
6) Classical economists assumed that
A) prices were sticky.
B) individuals suffered from money illusion.
C) wages were inflexible.
D) none of the above.
7) The first systematic attempt to explain the determinants of the price level and national levels of
income, employment, consumption and real Gross Domestic Product (GDP) was made by
________ economists.
A) Keynesian B) supply side C) monetarist D) classical
8) Classical economists wrote from the 1770s to the ________.
A) 1850s B) 1890s C) 1930s D) 1960s
9) Supply creates its own demand is known as
A) Smith s law. B) Say s law.
C) the circular flow. D) the Ricardian dilemma.
10) Say s law says that
A) consumption is greater than supply.
B) desired expenditures always equal actual expenditures.
C) people produce the goods they consume.
D) people consume the goods they produce.
11) Say s law argues that
I. overproduction is typical in a market economy.
II. supply creates its own demand.
A) I only B) II only C) Both I and II D) Neither I nor II
12) Say s law states that
A) supply creates its own demand.
B) supply and demand are never equal.
C) demand may be greater than supply.
D) supply will usually be greater than demand.
13) The classical model uses the assumption that
A) all wages and prices are flexible.
B) monopoly is widespread in the economy.
C) interest rates are not flexible.
D) economic markets are fragile and have no tendency to move towards an equilibrium.
14) According to the classical model, the income generated by production is
A) enough to meet the needs of everyone in society.
B) enough to purchase all the goods and services produced.
C) fully spent on savings.
D) always insufficient to purchase all the goods and services produced.
15) The implication of Say s law is that
A) Gross Domestic Product is the same whether we use the expenditure approach or the
income approach.
B) a barter economy is the most efficient economy.
C) increased consumption today leads to increased production tomorrow.
D) overproduction in a market economy is not possible.
16) All the following are assumptions of the classical model EXCEPT
A) pure competition exists.
B)
b
uyers and sellers react to nominal money prices rather than to relative prices.
C) people are motivated by self interest.
D) wages and prices are flexible.
17) Say s law explains
A) how long term real Gross Domestic Product (GDP) stability is achieved in the classical
model.
B) how long run real Gross Domestic Product (GDP) stability is achieved in the Keynesian
model.
C) how the economy can go into recession.
D) why economies experience business cycles.
18) If a consumer buys less gasoline because gas prices increased by 10 percent, even though all
other prices have also increased by 10 percent, then
A) the consumer is paying too close attention to changes in relative prices.
B) wages and prices are too flexible.
C) the consumer has been fooled by money illusion.
D) inflation is not a problem in the economy.
19) Which of the following is an example of money illusion?
A) An individual is willing to work more hours when the nominal wage rises by 5 percent
and the overall price level rises by 4 percent.
B) An individual is willing to work more hours when the nominal wage rises by 5% and the
overall price level rises by 7 percent.
C) An individual will neither increase nor decrease the number of hours she is willing to
work when the nominal wage rises by 5 percent and the overall price level rises by 5
percent.
D) none of the above.
20) According to the circular flow of income and output, saving causes
A) total output to fall.
B) consumption expenditures and total output to fall.
C) consumption expenditures to fall short of total output.
D) investment spending to fall.
21) One key assumption of the classical model is
A) government spending plays a major role.
B) money illusion cannot fool workers.
C) wages are sticky.
D) prices are sticky.
22) Classical economists tend to
A) see unemployment as a persistent economic problem.
B)
b
elieve in Keynesian economics.
C) reject the equality of savings and investment.
D) support Say s law.
23) In the classical model, an increase in the unemployment rate
A) will persist when the reduction in output is caused by a reduction in aggregate demand.
B) will result in an increase in the price level if the reduction in output is caused by a change
in aggregate demand.
C) will likely be temporary.
D) is a signal of demand pull inflation.
24) According to classical economists,
A) Say s law is not valid.
B) unemployment will not be a serious problem in a market economy.
C) wage levels are always sticky.
D) demand stimulus is needed to produce full employment.
25) In the classical model, aggregate demand and aggregate supply will
A) not exist.
B) intersect at less than full employment.
C) intersect at the point of full employment.
D) not intersect.
26) An individual who is suffering from money illusion is more concerned with
A) relative prices than with nominal prices. B) relative prices than with real prices.
C) nominal prices than with relative prices. D) real prices than with nominal prices.
27) An individual who suffers from money illusion will
A) feel that a doubling of prices and income improves his economic position.
B) concentrate on relative prices.
C) never be fooled by the impact of price changes on the purchasing power of income.
D) try to use counterfeit money.
28) Suppose Paris thinks a 5 percent increase in her hourly wage as an incentive to work more
hours while the price level also increases by 5 percent. Paris is said to be suffering from
A) money illusion. B) rationality.
C) irrationality. D) the effects of competition.
29) The classical model assumes that
A) imperfect competition predominates in most markets.
B) people have money illusion.
C) wages and prices are flexible.
D) wages are flexible but prices are not.
30) All of the following are assumptions of the classical model EXCEPT
A) inflexible wages. B) absence of money illusion.
C) pure competition. D) self interest of economic actors.
31) One tenet of classical economics is that
A) the role of the government should be limited, since the market will always be
self correcting.
B) the government should intervene whenever necessary to avoid any unemployment.
C) wages and prices are sticky downward.
D) the government should set a minimum wage slightly above the natural market
equilibrium rate.
32) Which of the following statements is correct?
I. If other factors are held constant, the level of employment in the economy determines real
Gross Domestic Product (GDP).
II. According to classical economists, only voluntary unemployment exists in the long run.
A) I only B) II only C) Both I and II D) Neither I nor II
33) Which of the following statements about the classical model of the economy is FALSE?
A) Savings and investment will always be equal.
B) Wages and prices are flexible.
C) The economy will always move toward, or be at, full employment.
D) Individuals pursue the public interest, not their own self interest.
34) If you feel you are better off because you receive a 20 percent raise even when the price level
also increases by 20 percent, then you are a victim of the
A) real income effect. B) money income effect.
C) money illusion. D) real purchasing power effect.
35) Which of the following is NOT an assumption of the classical model?
A) Wages and prices are flexible. B) People are motivated by self interest.
C) Money illusion exists. D) Pure competition exists.
36) A classical model of the economy predicts
A) full employment in the long run.
B) a 15 to 20 percent unemployment level whenever the economy is in equilibrium.
C) the same unemployment rates as the Keynesian model.
D) cyclical changes in the unemployment rate.
37) A key assumption in the classical model is
A) sticky wages.
B) pure competition exists.
C) sticky prices.
D) the government plays a major role in economic problems.
38) According to the classical model, more saving leads to more investment because
A) the people who save are the same people who invest.
B) the interest rate adjusts to keep investment equal to saving.
C) saving and investment are two sides of the same activity.
D) the interest rate is set by the federal government.
39) At higher rates of interest,
A) households save less and businesses invest more.
B) households save less and businesses invest less.
C) households save more and businesses invest less.
D) households save more and businesses invest more.
40) The equilibrating force in the credit market in the classical model is
A) the interest rate. B) the price level.
C) full employment. D) fiscal policy.
41) Classical economists argued that
A) there would always be an excess of saving over investment.
B) workers had money illusion.
C) excess savings would create unemployment.
D) a flexible interest rate would make saving equal to investment.
42) According to classical economists, a decrease in the rate of interest will
A) increase unemployment. B) increase consumer saving.
C) increase business investment. D) increase business failures.
43) Individuals will increase their saving as
A) the interest rate falls. B)
b
usiness investment falls.
C) the rate of unemployment increases. D) the interest rate increases.
44) In the classical model, desired saving
A) exceeds investment. B) is inversely related to real income.
C) is equal to desired investment. D) is less than desired investment.
45) The classical economists argued that planned saving and planned investment will always be
equal because of changes in
A) the level of real disposable income. B) the interest rate.
C) the price level. D) wages.
46) According to classical theory, desired saving always equals investment due to changes in
A) prices. B) wages.
C) the interest rate. D) taxes.
47) In economics, investment is defined as
A) the spending by businesses on capital goods and inventories.
B) the spending by households on human capital and durable goods.
C) disposable income minus consumption.
D) disposable income plus consumption.
48) With respect to unemployment, the classical model states that
A) unemployment of any kind cannot exist.
B) only voluntary unemployment exists.
C) unemployment fluctuates with the interest rate.
D) involuntary unemployment will always exceed voluntary unemployment.
49) According to classical theory, full employment in the labor market occurs
A) whenever aggregate demand is less than aggregate supply.
B) at a wage rate at which quantity demanded equals quantity supplied.
C) only when the economy has just experienced a demand shock.
D) only when actual expenditures are greater than desired expenditures.
50) In the classical model, what occurs if a wage of $20/hour results in unemployed workers?
A) The workers will go on strike to demand that more jobs be created.
B) Producers will quickly create more jobs and hire the unemployed workers, so
unemployment is short lived.
C) The wage rate will drop, more workers will be hired, and the unemployment rate falls.
D) The government will step in and order firms to hire more workers.
51) According to classical theory, total employment and real Gross Domestic Product (GDP) are
A) unrelated. B) positively related.
C) inversely related. D) negatively related.
52) In the classical model, the aggregate supply curve is
A) upward sloping. B) downward sloping.
C) horizontal. D) vertical.
53) In the classical model, real Gross Domestic Product (GDP) per year is
A) due to supply conditions plus the extent of government intervention in the economy.
B) determined by supply and demand conditions together.
C) supply determined.
D) demand determined.
54) Suppose an economy originally in long run equilibrium experiences a decrease in aggregate
demand. According to the classical model,
A) real Gross Domestic Product (GDP) will not change but the price level will fall.
B) real Gross Domestic Product (GDP) will fall, and then the price level will fall also.
C) the price level will not change but real Gross Domestic Product (GDP) will fall.
D) real Gross Domestic Product (GDP) will fall, wages will fall, but the prices of goods and
services will stay the same.
55) In the classical model, a shift to the right in aggregate demand would result in
A) a permanent increase in unemployment.
B) a permanent increase in real incomes.
C) an increase in the price level.
D) a permanent shift past full employment.
56) According to the classical theory, an inward shift in aggregate demand would reduce
A) real Gross Domestic Product (GDP) and the price level.
B) the price level but have no effect on real Gross Domestic Product (GDP).
C) real income but have no impact on the price Gross Domestic Product (GDP).
D) the price level but increase real Gross Domestic Product (GDP).
57) According to classical theory, a shift in aggregate demand will affect
A) the price level only.
B) real Gross Domestic Product (GDP) only.
C) the level of employment only.
D)
b
oth real Gross Domestic Product (GDP) and the level of employment.
58) According to the classical model, an increase in aggregate demand would
A) lead the economy to recession.
B) lead the economy to a deflationary cycle.
C) cause an adjustment to a higher price level.
D) raise real Gross Domestic Product (GDP) but leave the price level unchanged.
59) In the classical model, the aggregate supply curve is
A) upward sloping in the short run but vertical in the long run.
B) always vertical.
C) the same as the aggregate supply curve in the Keynesian model.
D) flat at low levels of output and then eventually slopes upward as output increases.
60) According to the classical theory, the aggregate supply curve is
A) downward sloping. B) horizontal.
C) upward sloping. D) vertical.
61) According to classical theory, any changes in aggregate demand will
A) lead to changes in the price level.
B) lead to changes in real Gross Domestic Product (GDP), but not in the price level.
C) lead to changes in both real Gross Domestic Product (GDP) and the price level.
D) have no affect on prices or real Gross Domestic Product (GDP).
62) According to Say s law,
A) desired expenditures are always less than actual expenditures.
B) desired expenditures are always more than actual expenditures.
C) desired expenditures are always equal to actual expenditures.
D) desired expenditures cannot be compared with actual expenditures.
63) Say s law implies that
A) the willingness to purchase other goods is unrelated to the production of goods and
services.
B) producing goods and services generates the means and the willingness to purchase other
goods and services.
C) prices and wages are sticky downwards.
D) wages and prices are inflexible.
64) In a classical model,
A) equilibrium real GDP is supply determined.
B) equilibrium real GDP is demand determined.
C) equilibrium real GDP is determined by both aggregate supply and aggregate demand.
D) equilibrium real GDP is neither determined by aggregate supply nor by aggregate
demand.
65) The condition of fully flexible wages and prices was assumed by
A) the classical economists. B) the Keynesian economists.
C) modern economists. D) no economists.
66) The approach to understanding the determination of real GDP and the price level that
emphasizes flexible wages and prices and competitive markets is
A) the classical model. B) the Keynesian model.
C) Adam Smith s Law. D) the aggregate demand model.
67) The classical economists assumed that
A) monopoly was widespread in the economy.
B) government intervention in the economic system was necessary and helpful.
C) wages and prices were inflexible, especially downward.
D) wages and prices were flexible.
68) According to the classical economists, an economy producing $15 trillion in goods and services
A) may be producing too much since the needs of people may not be this great.
B) simultaneously generates the income necessary to purchase $15 trillion in goods and
services.
C) is supplying $15 trillion in goods and services, but could be demanding more or less than
$15 trillion in goods and services for a very long period of time.
D) could experience a permanent glut if no one has estimated the demand for goods and
services in the economy.
69) According to the classical economists, actual real GDP
A) always equals actual aggregate income.
B) sometimes equals actual aggregate income.
C) never equals actual aggregate income.
D) is not related to aggregate income.
70) Supply creates its own demand is known as
A) Keynes Rule. B) the circular flow.
C) Smith s law. D) Say s law.
71) The concept that producing goods and services generates the means and the willingness to
purchase other goods and services is
A) the Keynesian approach. B) money illusion.
C) Say s Law. D) cost push inflation.
72) Say s law states that
A) desired expenditures will equal actual expenditures.
B) people produce only the goods they want.
C) demand is always less than supply.
D) overproduction is never possible because of limited resources.
73) Which of the following statements is NOT true about Say s law?
A) Desired expenditures will equal actual expenditures.
B) Surpluses will be eliminated by falling prices and shortages will be eliminated by
increasing prices.
C) People produce more goods than they want for their own use only if they seek to trade
them for other goods.
D) Markets would be regularly hit by severe shortages and surpluses.
74) Say s law implies that
A) surpluses never occur.
B) surpluses or shortages are possible, but only for a short time.
C) there will always be unemployment.
D) shortages never occur.
75) Which of the following is NOT true according to Say s law?
A) Supply creates its own demand.
B) No overproduction is possible in a market economy in the long run.
C) Desired expenditures will always be higher than actual expenditures.
D) Producing goods and services generates the means and the willingness to purchase other
goods and services.
76) An assumption of the classical model is that
A) money illusion is widespread.
B) people make decisions based on nominal prices rather than real prices.
C) prices are flexible while wages are inflexible.
D) people are motivated by self interest.
77) Which of the following is NOT an assumption of the classical model?
A) Wages and prices are flexible. B) Investment will lead to money illusion.
C) People are motivated by self interest. D) Pure competition exists.
78) Which of the following is NOT an assumption of the classical model?
A) Buyers and sellers react to changes in relative prices.
B) Households want to maximize economic well being.
C) No single buyer or seller of a commodity can affect its price.
D) Wages and prices will move freely in the upward direction but not the downward
direction.
79) Given the assumptions of the classical model,
A) the economy will often experience recessions and expansions.
B) expansion will be the normal condition, but recessions will often be severe and require
government intervention.
C) the macroeconomy is erratic, and problems will often be increased over time.
D) the market is a self correcting mechanism.
80) A consumer who buys more coffee when the price of coffee falls 5 percent, while all other prices
fell 5 percent too, is
A) suffering from money illusion.
B) worrying too much about a coming recession.
C)
b
ehaving in accordance with classical economic theory.
D) paying too much attention to changes in relative prices.
81)
J
oe s increase in wages has been identical to the increase in the price level. Joe thinks that he is
better off and has increased his expenditures. Joe s behavior is consistent with
A) Say s Law. B) the classical model.
C) a vertical aggregate supply curve. D) money illusion.
82) Money illusion is
A) a basic condition that all classical economists assume people have.
B) when people think they are better off when their income increases even though prices
have increased by the same amount.
C) when people are motivated by self interest.
D) could not exist if the economy did not have competitive markets.
83) Saving represents
A) a source of funds for business investment.
B) a normal part of the circular flow of income and output.
C) an injection to the circular flow of income and output.
D) a counter example to Say s Law that the classical economists never considered.
84) Leakages in the circular flow model are
A) caused by people not acting rational.
B) possible when unemployment exists.
C) reflected in the vertical long run aggregate supply curve.
D) caused by people saving instead of spending.
85) In an economy with no government and no international trade, consumption expenditures will
be less than the total value of goods and services when
A) investment is zero.
B) saving is zero.
C) people save some of their income.
D) people barter rather than use money in making exchanges.