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Chapter 17
Stabilization in an Integrated World Economy
17.1 Active versus Passive Policymaking
1) Active policy making refers to
A) actions taken by policy makers in response to or in anticipation of some change in the
overall economy.
B) policy making that is carried out in response to a rule.
C) relying on policies that act as automatic stabilizers.
D) nondiscretionary policy making.
2) Active policy making would include all of the following EXCEPT
A) interest rate changes by the Fed.
B) tax increases.
C) unemployment insurance benefits.
D) increased government spending by the Congress.
3) Which of the following would be an example of passive policy making?
A) Establishing a system of automatic tax stabilizers
B) Marginal rate tax cuts intended to increase real Gross Domestic Product (GDP)
C) Government spending decreases intended to decrease real Gross Domestic Product (GDP)
D) None of the above
4) Monetary and fiscal policy making that is carried out in response to a pre set rule and does not
respond to changes in economic activity is known as
A) active policy making. B) discretionary policy making.
C) nondiscretionary policy making. D) Keynesian policy making.
5) With discretionary policy making, fiscal and monetary policies are usually
A) undertaken in response to or anticipation of some change in the overall economy.
B) set according to pre established standards that do not take into account any changes in the
economy.
C) immune to any political overtones.
D) immune to any lag times that might counter their effectiveness.
6) If a policy maker is convinced that time lags frequently negate the impact of short run
stabilization efforts, it is likely she would favor ________ policy making.
A) nondiscretionary B) discretionary
C) active D) aggressive
7) When policy makers take actions in response to or in anticipation of some change in the overall
economy, there is
A) active policy making. B) passive policy making.
C) rationalization policy making. D) rational expectations policy making.
8) Proponents of passive policy making believe that
A) the existence of time lags makes active policy ineffective or even procyclical.
B) time lags do not exist so the economy will adjust too rapidly with active policy.
C) government should not follow any particular policy.
D) fiscal policy is always better than monetary policy in stabilizing the economy.
9) Which of the following scenarios can be classified as passive policy making?
A) The Federal Reserve cuts the federal funds rate in order to increase economic activity.
B) The federal government increases spending in order to create jobs.
C) The Federal Reserve adjusts the money supply as appropriate to attain a target rate of
inflation.
D) Congress increases expenditures in an effort to stimulate economic activity.
10) Actions on the part of monetary and fiscal policy makers that are undertaken in response to
some change in the overall economy are known as
A) nondiscretionary policy making. B) passive policy making.
C) creative policy making. D) active policy making.
11) When policy makers base their actions on a rule there is
A) active policy making. B) passive policy making.
C) rationalization policy making. D) rational expectations policy making.
12) An example of nondiscretionary policy making is
A) a rule under which the Fed targets the inflation rate.
B) expansionary fiscal policy.
C) changes in the interest rate initiated by the Fed.
D) a Congressional tax rate cut aimed at boosting real GDP.
13) If a policy is carried out by a rule, then we have an example of
A) active policy making. B) discretionary policy making.
C) nondiscretionary policy making. D) natural policy making.
14) Suppose a constitutional amendment is passed that mandates a balanced federal budget every
year and the President and Congress consistently carry this mandate out. This would be an
example of
A) active policy making. B) decisive policy making.
C) nondiscretionary policy making. D) cooperative policy making.
15) The Federal Reserve is anticipating a contractionary period in the economy. The Fed decides to
engage in open market operations to stimulate the economy. This action is
A) active policy making. B) passive policy making.
C) the monetary rule. D) Phillips policy making.
16) Which of the following statements has been proposed as a benefit of passive policy making?
A) Passive policy making allows for making immediate changes in response to an anticipated
change in economic performance.
B) Passive policy making utilizes the rational expectations hypothesis.
C) When using passive policy making there is no tradeoff between price stability and
unemployment.
D) Passive policy making does not wait for the time lag between recognition of a problem and
policy action before engaging in economic policies to stabilize the economy.
17) Which one of the following is an example of passive policy making?
A) introducing expansionary monetary policy to combat a recession
B) introducing expansionary monetary policy to combat inflation
C) introducing expansionary fiscal policy to combat a recession
D) following a predetermined monetary policy rule
18) What best defines active policy making?
A) taking action to offset a change in economic performance
B) taking action to increase long term economic growth
C) taking action to make markets more competitive so as to improve efficiency
D) taking action to make markets less competitive so as to improve equity
19) policy making that is carried out in response to a rule is
A) active policy making. B) passive policy making.
C) restrictive policy making. D) determined policy making.
20) The idea of policy making taking place in response to a predetermined set of rules is referred to
as
A) active policy making. B) discretionary policy making.
C) passive policy making. D) Keynesianism.
21) The idea of policy making being undertaken as a response to a change in the economy is
referred to as
A) active policy making. B) non discretionary policy making.
C) passive policy making. D) Keynesianism.
22) If the rate of growth in the money supply is predetermined on the basis of a monetary rule, this
is known as
A) direct policy making. B) active policy making.
C) passive policy making. D) fiscal policy making.
23) If the Fed engages in open market sales in direct response to an increase in the rate of inflation,
this is known as
A) direct policy making. B) active policy making.
C) passive policy making. D) fiscal policy making.
24) Explain the difference between active and passive policy making.
17.2 The Natural Rate of Unemployment
1) Structural unemployment is likely to be affected by
A) recessions and expansions.
B) the reservation wage curves of people.
C) minimum wage laws and other rigidities in the economy.
D) the amount of the money supply.
2) Which of the following is the rate of unemployment that occurs after all adjustments in the labor
market have occurred?
A) the frictional rate of unemployment. B) the natural rate of unemployment.
C) the NAIRU rate of unemployment. D) the structural rate of unemployment.
3) What types of unemployment will still exist when the economy is at the natural rate of
unemployment?
A) frictional and cyclical unemployment only
B) frictional and structural unemployment only
C) structural and cyclical unemployment only
D) frictional, structural, and cyclical unemployment
4) The Phillips curve shows the relationship between
A) the price level and real Gross Domestic Product (GDP).
B) the tax rate and tax revenues.
C) the unemployment rate and inflation rate.
D) the interest rate and exchange rate.
5) Structural unemployment may result from all of the following factors EXCEPT
A) union wage contracts.
B) government imposed licensing arrangements that restrict entry into certain professions.
C) improved elementary and secondary education.
D) welfare and unemployment benefits.
6) Your friend recently graduated from college and is actively looking for employment. The
economy has completely recovered from the last recession and your friend is taking her time,
looking for the perfect job. In the meantime, the unemployment she is experiencing is
categorized as
A) cyclical. B) structural. C) seasonal. D) frictional.
7) The natural rate of unemployment is
A) zero.
B) the unemployment rate when there is no structural unemployment.
C) the unemployment rate when there is no structural or cyclical unemployment.
D) the unemployment rate that exists in long run equilibrium, after adjustments to all
changes have occurred.
8) The natural rate of unemployment is defined as the rate of unemployment that
A) prevails in long run macroeconomic equilibrium, when all workers and employers have
fully adjusted to any changes in the economy.
B) prevails in the short run macroeconomic equilibrium, before workers and employers have
had a chance to adjust to an economic shock.
C) exists due to welfare and unemployment benefits that reduce potential workers incentives
to find work.
D) exists only during periods of recession or depression in the economy.
9) The natural rate of unemployment includes
A) frictional and cyclical unemployment.
B) only cyclical unemployment.
C) only unemployment due to layoffs and corporate downsizing.
D) frictional unemployment and structural unemployment.
10) According to the text, the probability of an unemployed person finding a job doubles when
A) his unemployment benefits expire.
B) his unemployment benefits are extended.
C) the economy enters a recessionary phase.
D) he is threatened with arrest.
11) According to the text, minimum wage laws cause increases in
A) employment possibilities. B) structural unemployment.
C) poverty. D) productivity.
12) Frictional and structural unemployment both exist when
A) the economy is in an expansionary phase.
B) the economy is in long run equilibrium.
C) the economy is at the peak of the business cycle.
D) the economy is in short run equilibrium.
13) An increase in unemployment insurance and other transfer payments may
A) increase the natural rate of unemployment.
B) increase the number of discouraged workers.
C) reduce the rate of inflation at every level of unemployment.
D) lead to less unanticipated inflation.
14) From 1950 until the late 1980s, the natural rate of unemployment in the United States
A) fell sharply as government retraining programs helped put the unemployed back to work.
B) cycled up and down in tandem with the actual rate of unemployment.
C) rose sharply, always exceeding the actual rate of unemployment.
D) trended upward.
15) From the late 1980s to 2000, the natural rate of unemployment
A) climbed sharply.
B) held constant.
C) fluctuated up and down, following the path of the actual rate of unemployment.
D) gradually declined.
16) During a recession, the overall unemployment rate
A) falls rapidly.
B) exceeds the natural rate of unemployment.
C) falls below the natural rate of unemployment.
D) equals the inflation rate.
17) Cyclical unemployment is
A) the difference between the unemployment rate when the economy is in a recession and the
unemployment rate when the economy is at the peak of an expansion.
B) the difference between the actual unemployment rate and the natural rate of
unemployment.
C) the unemployment due to union activities and government imposed restrictions to entry
into specific occupations.
D) the unemployment due to the unemployment benefits and welfare programs of the
government.
18) If cyclical unemployment is negative, then
A) the actual unemployment rate is below the natural rate of unemployment.
B) the natural rate of unemployment is getting smaller.
C) there have been some errors in classifying the type of unemployment experienced by some
people.
D) structural unemployment must be increasing.
19) Which of the following unemployment rates can be negative?
A) the cyclical unemployment rate
B) the natural unemployment rate
C) the seasonal unemployment rate
D) the official unemployment rate reported by the Bureau of Labor Statistics
20) Which type of unemployment is associated with the slump in aggregate demand that
accompanies a recession?
A) Expansionary unemployment B) Cyclical unemployment
C) Frictional unemployment D) Structural unemployment
21) An unexpected increase in aggregate demand typically causes
A) frictional unemployment to increase but structural unemployment to decrease.
B) the price level to increase but has no effect on the unemployment rate.
C) the price level to increase and the unemployment rate to fall.
D) the price level to increase and the unemployment rate to increase.
22) In the above figure, start with the economy in equilibrium at point A. Then an unanticipated
reduction in aggregate demand triggers a shift from AD1to AD2. In the short run, this would
cause
A) the price level to fall from P1to P2
,
real Gross Domestic Product (GDP) to fall from Y1to
Y2, and the rate of unemployment to increase.
B) the price level to move from P1to P2
,
but real Gross Domestic Product (GDP) would stay
at Y1.
C) the price level to fall by some amount less than P1but greater than P2
,
and the rate of
unemployment would decrease.
D) no change in either the price level or real Gross Domestic Product (GDP), but a decrease in
unemployment.
23) Suppose the economy is initially operating at point A in the above figure. Which of the
following statements is true?
A) An unexpected reduction in aggregate demand will cause the economy to move from
point A to point B in the long run.
B) An unexpected reduction in aggregate demand will cause the economy to move from
point A to point B in the short run.
C) An unexpected reduction in aggregate demand will cause the economy to move from
point A to point C in the short run.
D) none of the above
24) One result of an unanticipated reduction in aggregate demand would be that
A) fewer firms would be hiring. B) more firms would be hiring.
C) there would be no change in hiring. D) the price level would rise.
25) On average, the greater the unexpected decline in aggregate demand,
A) the weaker is the resulting deflation. B) the greater is the resulting deflation.
C) the greater is the resulting inflation. D) the greater is the rise in the price level.
26) In the above figure, if A is the initial equilibrium point and there is an unanticipated rise in
aggregate demand from AD1to AD2, then
A) the new short run equilibrium will be at point B.
B) the new long run equilibrium will be at point B.
C) the new short run equilibrium will be at point D.
D) real Gross Domestic Product (GDP) per year will fall below Y1.
27) In the above figure, if initial equilibrium is at point A and if there is an unanticipated increase in
aggregate demand from AD1to AD2, then
A) in the short run real output will remain at Y1.
B) in the short run real output will increase above Y1
,
but in the long run it will return to Y1.
C) in the long run real output will increase above Y1.
D) real output will increase above Y1in both the short run and in the long run.
28) In the above figure, if initial equilibrium is at point A and there is a fully anticipated increase in
aggregate demand from AD1to AD2due to an anticipated increase in the money supply, then
A) the economy will move directly from point A to point C without passing through point B.
B) the economy will move directly from point A to point B, and will remain at point B in the
long run.
C) the price level will shift to P2in the short run.
D) the price level will shift to P2in the long run.
29) The rate of unemployment below which the rate of inflation tends to rise and above which the
rate of inflation tends to fall is known as the
A) Phillips rate of unemployment.
B) contrary rate of unemployment.
C) non accelerating inflation rate of unemployment (NAIRU).
D) menu cost rate of unemployment.
30) The Phillips Curve will shift when
A) the expected inflation rate changes.
B) the price level falls.
C) the overall employment rate remains unchanged.
D) none of the above.
31) Based on the work of economist A.W. Phillips, economists concluded that
A) there is no trade off between inflation and unemployment.
B) high inflation rates are associated with low unemployment rates.
C) unemployment can be effectively combated by raising wages.
D) higher rates of inflation are associated with higher rates of unemployment.
32) The Phillips curve shows
A) a positive relationship in the long run between the rate of inflation and the rate of
unemployment.
B) a negative relationship between the inflation rate and the unemployment rate, at least in
the short run.
C) a positive relationship between contractionary monetary policy and higher price levels.
D) a positive relationship between price stability and constant, small increment changes in
the fiscal policy on the part of the Fed.
33) What happens to the Phillips curve when the expected rate of inflation rises?
A) The curve shifts to the right B) The curve shifts to the left
C) The curve becomes horizontal D) The Phillips curve is unaffected
34) The short run Phillips curve suggests what policy making implications?
A) Active policy making does not yield any predictable results.
B) Passive policy making is more effective than active policy making.
C) Using discretionary policies, it may be possible to achieve just the right unemployment
and inflation mix.
D) Maintaining both the inflation and unemployment rates at low levels is possible if policy
makers will rely solely on nondiscretionary policy making.
35) Critics of the Phillips curve argue that in the long run,
A) there is a trade off between unemployment and inflation.
B) for any given unemployment level there is a corresponding inflation rate to which the
economy will automatically revert.
C) employees are not able to anticipate future rates of inflation, and therefore unemployment
can always be reduced by inflating the economy.
D) there is no trade off between inflation and unemployment because workers expectations
adjust to any systematic attempts to reduce unemployment below the natural rate.
36) The Phillips curve shows
A) the relationship between the rate of interest and planned investment.
B) the relationship between the money supply and the price level.
C) that an increase in government spending will decrease real national income.
D) that an increase in inflation may be associated with a decrease in the rate of
unemployment.
37) The Phillips curve trade off relationship implies that
A) the government can fine tune the economy and generate both the natural rate of
unemployment and zero inflation.
B) the government can fine tune the economy and pick the most preferred combination of
unemployment and inflation.
C) low unemployment can be obtained only by generating rapidly increasing inflation.
D) there is no relationship between inflation and unemployment, at least in the long run.
38) Suppose that the inflation rate has been 3 percent per year for several years, and the
unemployment rate has been stable at 5 percent. Unanticipated changes in government policy
cause the inflation rate to increase to 6 percent. In the short run, we would expect the
unemployment rate to
A) remain constant.
B) increase to 10 percent.
C) increase, but the exact amount cannot be known for sure.
D) decrease.
39) In the short run, unanticipated inflation typically leads to
A) higher rates of unemployment.
B) decreases in aggregate demand.
C) lower rates of unemployment.
D) workers thinking the real wage has been reduced.
40) When the actual unemployment rate is greater than the NAIRU, the inflation rate
A) tends to increase. B) tends to decrease.
C) remains unchanged. D) falls to zero.
41) Assume that the government decides to use fiscal or monetary policy to stimulate the economy
and that this action comes as a surprise to most individuals and businesses. In the short run, the
result will be
A) a decrease in the average duration of unemployment and a decrease in the unemployment
rate.
B) an increase in the average duration of unemployment and an increase in the
unemployment rate.
C) a decrease in aggregated demand and a rise in the price level.
D) an increase in aggregate demand and a fall in the price level.
42) An important source of structural unemployment is
A) seasonal variations in aggregate demand.
B) unemployment insurance benefits.
C) people looking for the right job decide to change jobs.
D) recessions.
43) Which of the following is NOT a possible cause of structural unemployment?
A) individuals take the time to search for the best job opportunities
B) a mismatch of worker training and skills with requirements of employers
C) government imposed minimum wage laws
D) union activity that sets wages above the equilibrium level
44) The natural rate of unemployment is
A) the unemployment rate when cyclical unemployment is the only type of unemployment.
B) the unemployment rate when there is no frictional unemployment.
C) the rate of unemployment associated with long run equilibrium.
D) zero.
45) A trade off between unemployment and inflation is reflected in the
A) natural rate of unemployment.
B) Phillips Curve.
C) economic stability.
D) nonaccelerating inflation rate of unemployment (NAIRU).
46) The natural rate of unemployment consists of
A) no workers looking for employment. B) only seasonal unemployment.
C) only structural unemployment. D) structural and frictional unemployment.
47) When the economy is in long run equilibrium, there will be
A) no unemployment. B) frictional and structural unemployment.
C) cyclical unemployment only. D) cyclical and seasonal unemployment.
48) Empirical evidence suggests that, when unemployment benefits run out, the probability that an
unemployed person will find a job
A) remains constant. B) goes down by 20 percent.
C) about doubles. D) about triples.
49) Deviations of the actual unemployment rate from the natural rate of unemployment are called
A) frictional unemployment. B) cyclical unemployment.
C) seasonal unemployment. D) underemployment.
50) When the economy is operating at a level of real GDP that is greater than its potential level, we
know that
A) the actual unemployment rate is greater than the natural rate of unemployment.
B) the structural rate of unemployment is negative.
C) the frictional unemployment is zero.
D) the cyclical rate of unemployment is negative.
51) During a recession, the
A) natural rate of unemployment has fallen.
B) cyclical rate of unemployment is positive.
C) cyclical rate of unemployment is zero.
D) cyclical rate of unemployment is negative.
52) Deviations of the actual unemployment rate away from the natural rate are
A) cyclical unemployment. B) frictional unemployment.
C) structural unemployment. D) the monetary rule.
53) Suppose the natural rate of unemployment is 5 percent. If the actual unemployment rate is 7
percent, then the cyclical unemployment rate
A) is 2 percent.
B) is 2 percent.
C) is 12 percent.
D) cannot be determined given the information.
54) Suppose the natural rate of unemployment is 5 percent. If the actual unemployment rate is 4
percent, then the cyclical unemployment rate is
A) 9 percent.
B) 1 percent.
C) 1 percent.
D) 0 percent as cyclical unemployment cannot be less than zero.
