File: Chapter 26 The Keynesian Short-Run Policy Model: Demand-Side Policies
1. In principle, we would expect the aggregate demand curve to be vertical because the price
level is a reference point, the actual value of which should not matter.
2. In the AS/AD model, as the price level falls, the holders of money become richer and buy
more. This is one reason why the aggregate demand curve is downward sloping.
3. The repercussions that the money wealth and international effects have on aggregate
production and aggregate expenditure cause the aggregate demand curve to become steeper than
it would be without such repercussions.
4. The short-run aggregate supply curve is upward sloping in part because increases in aggregate
demand cause some firms to increase their price markups.
5. If productivity and wages both rise by 3 percent, then the aggregate supply curve shifts up.
6. Starting from a long-run equilibrium, an increase in government expenditures increases
output in the short run but not in the long run.
7. If the economy is not in a long-run equilibrium and other things are equal, then prices will
eventually adjust to bring the economy to a long-run equilibrium.
8. Most economists agree that it is possible for fiscal policy to fine tune the economy.
9. As a response to the 2008 recession, the U.S. government employed expansionary policy to
push the economy out to its level of potential output.
10. After the 2008 expansionary policy, unemployment remained higher than desired and output
was much lower than desired.
11. Some economists believe that the good times of the early 2000s were not sustainable because
they were creating a dangerous financial bubble and trade deficit.
12. According to Keynes, the economy could become stuck at a low income level if:
A. declines in aggregate demand and aggregate supply reinforce one another.
B. declines in aggregate demand are not accompanied by declines in aggregate supply.
C. declines in aggregate supply are not accompanied by declines in aggregate demand.
D. aggregate demand and aggregate supply are independent of one another.
13. Equilibrium income is that level of income:
A. which the economy always produces.
B. toward which the economy gravitates in the short-run.
C. which an economy is capable of producing without generating accelerating inflation.
D. which an economy is capable of producing without generating unemployment.
14. Potential income is that level of income that:
A. the economy always produces.
B. toward which the economy gravitates in the short-run.
C. an economy is capable of producing without generating higher inflation.
D. an economy is capable of producing without generating unemployment.
15. Keynes believed equilibrium income was:
A. not fixed at the economy’s potential income.
B. fixed at the economy’s potential income.
C. always below the economy’s potential income.
D. always above the economy’s potential income.
16. Keynes believed that:
A. the government could not aid market forces to push the economy to its potential income.
B. market forces pushing the economy into cumulative spirals were weak.
C. market forces pushing the economy to potential income were weak.
D. market forces pushing the economy to potential income were strong.
17. Keynes believed the economy was:
A. fluctuating around potential income.
B. always at potential income.
C. always moving away from potential income.
D. always moving toward potential income.
18. According to Keynes, market economies:
A. never experience significant declines in aggregate demand.
B. quickly recover after they experience a significant decline in aggregate demand.
C. may recover slowly after they experience a significant decline in aggregate demand.
D. are constantly experiencing a significant declines in aggregate demand.
19. According to Keynes, why might deflation create problems for an economy?
A. Consumers might expect prices to fall further and cut back consumption now
B. In expectation of increased spending, too many entrepreneurs would begin businesses and
most would fail.
C. Producers might increase production to take advantage of falling input prices.
D. People would drop out of unions because unions would become ineffective at keeping wages
of members high.
20. According to the Keynesian model,
A. wages are flexible because workers wouldn’t otherwise be able to keep their jobs.
B. the price level is somewhat fixed due to social forces, which keeps an economy from
remaining at an equilibrium level of unemployment.
C. prices are subject to significant fluctuations as demand and supply change.
D. the government puts price controls on the economy, keeping the price level fixed.
21. From 2007 to 2012, the U.S. personal savings rate rose. If the additional savings were not
translated into investment, Keynes would predict that aggregate income would:
A. decline and remain there.
B. rise indefinitely.
C. accelerate.
D. rise and remain there.
22. The paradox of thrift occurs when:
A. an increase in saving raises output.
B. an increase in saving reduces output.
C. saving is unrelated to output.
D. a decrease in saving reduces output.
23. Keynes believed that an increase in savings would:
A. raise aggregate demand by reducing investment.
B. raise aggregate demand by increasing consumption
C. reduce aggregate demand by reducing investment.
D. reduce aggregate demand by reducing consumption.
24. The paradox of thrift will not arise if:
A. increases in saving are translated into identical increases in investment.
B. increases in saving are translated into identical decreases in consumption.
C. decreases in saving are translated into identical increases in investment.
D. decreases in saving are translated into identical decreases in consumption.
25. Keynes argued that, for the period that he was writing about:
A. the long run is a more important policy concern than the short run.
B. the short run is a more important policy concern than the long run.
C. both the short run and the long run are equally important.
D. the distinction between the short run and the long run is irrelevant.
26. By the 1950s, the views of the Classical economists among American economists:
A. had been largely eclipsed by Keynesian views.
B. had largely replaced Keynesian views.
C. were about as widely held as Keynesian views.
D. were just starting to be developed in response to the Great Depression.
27. The shapes of the curves in the AS/AD model are based upon the:
A. principle of substitution.
B. principle of opportunity cost.
C. relationship between a single good and its price.
D. relationship between the price level and total output.
28. The AS/AD model looks similar to the microeconomic supply and demand model
A. but is not based on it.
B. is based on the microeconomic supply and demand model because the AS/AD is a macro
representation of the micro model.
C. is based on the microeconomic supply and demand model because both are based on the
principle of substitution.
D. is based on the microeconomic supply and demand model because both are based on
opportunity costs.
29. The reason why the AS/AD model does not depend upon the concepts of substitution and
opportunity cost is that:
A. in groups, people do not make the same choices as when they are alone.
B. the AS/AD model considers total output. There are no goods to substitute.
C. the AS/AD model considers the effects of other countries’ decisions.
D. other things remain constant in the AS/AD model.
30. Refer to the following graphs.
Which of the graphs correctly labels the axes of the AS/AD model?
A. A
B. B
C. C
D. D
31. Why would one expect the AD curve to be vertical?
A. If the price level rises, relative prices haven’t changed so people would not change their
choices.
B. If the price level rises, changes in choices by suppliers are offset by changes in demanders.
C. People do not make choices based on relative prices, but instead based on absolute prices.
D. Substitution is not one of the reasons why the AD curve has its slope.
32. The theoretical proposition that the price level is just a numeraire and should not affect
aggregate expenditures suggests the AD curve is:
A. downward sloping.
B. horizontal.
C. vertical.
D. upward sloping.
33. As prices fall, the value of people’s existing assets rises and people increase expenditures.
This occurs as a result of the:
A. international effect.
B. multiplier effect.
C. interest rate effect.
D. money wealth effect.
34. A fall in the price level will:
A. increase the value of money in people’s pockets.
B. decrease the value of money in people’s pockets.
C. not affect the value of money in people’s pockets.
D. reduce real wealth.
35. A fall in the price level:
A. reduces the value of money in peoples’ pockets, so people buy less goods.
B. reduces the value of money in peoples’ pockets, so people buy more goods.
C. increases the value of money in peoples’ pockets, so people buy less goods.
D. increases the value of money in peoples’ pockets, so people buy more goods.
36. An increase in the price level:
A. increases the purchasing power of money, leading to lower interest rates, which increases
investment.
B. increases the purchasing power of money, leading to higher interest rates, which decreases
investment.
C. decreases the purchasing power of money, leading to lower interest rates, which increases
investment.
D. decreases the purchasing power of money, leading to higher interest rates, which decreases
investment.
37. If the price level falls but people don’t feel richer because of that fall, then the AD curve
would likely:
A. shift in.
B. shift out.
C. be flatter than it otherwise would be.
D. be steeper than it otherwise would be.
38. If the price level rises, the interest rate effect will cause investment:
A. and the quantity of aggregate demand to increase.
B. and the quantity of aggregate demand to decrease.
C. to increase and the quantity of aggregate demand to decrease.
D. to decrease and the quantity of aggregate demand to increase.
39. The interest rate effect helps to explain why:
A. an increase in the price level reduces the quantity of aggregate demand.
B. an increase in the price level raises investment.
C. a decrease in the price level reduces the quantity of aggregate demand.
D. a decrease in the price level reduces investment.
40. An increase in real money balances resulting from a lower price level will:
A. reduce both interest rates and investment.
B. reduce interest rates and increase investment.
C. increase interest rates and reduce investment.
D. increase both interest rates and investment.
41. A fall in the U.S. price level will cause foreigners to:
A. substitute U.S. goods for their own domestically-produced goods.
B. substitute their own domestically-produced goods for U.S. goods.
C. buy more of their own domestically-produced goods.
D. buy fewer U.S. goods.
42. A rise in the U.S. price level will cause:
A. both exports and imports to increase.
B. both exports and imports to decrease.
C. exports to increase and imports to decrease.
D. exports to decrease and imports to increase.
43. In the 1990s, the price level in Japan fell relative to the price level in the United States. If the
exchange rate did not change, one would expect that:
A. U.S. exports to Japan would rise and U.S. imports from Japan would decline.
B. U.S. exports to Japan would decline and U.S. imports from Japan would rise.
C. both U.S. exports to Japan and U.S. imports from Japan would rise.
D. both U.S. exports to Japan and U.S. imports from Japan would fall.
44. Which of the following is not a reason why the AD curve slopes downward?
A. International effect
B. Interest rate effect
C. Substitution effect
D. Money wealth effect
45. In the AS/AD model, the repercussion that a change in aggregate quantity demanded has on
production and subsequently on income and expenditures is called the:
A. accelerator effect.
B. expenditure effect.
C. multiplier effect.
D. money wealth effect.
46. The multiplier effect makes the aggregate demand curve:
A. steeper.
B. flatter.
C. horizontal.
D. vertical.
47. The multiplier effect exists because:
A. production and expenditures are interdependent.
B. when one person increases expenditures, everyone decreases expenditures.
C. production and expenditures are independent.
D. production lowers expenditures.
48. If the multiplier effect did not exist, the aggregate demand curve would:
A. be steeper.
B. be flatter.
C. be horizontal.
D. not exist.
49. An increase in the price level might cause:
A. a decrease in the quantity of aggregate demand because of the substitution effect.
B. an increase in the quantity of aggregate demand because of the money wealth effect.
C. a decrease in the quantity of aggregate demand because of the interest rate effect.
D. an increase in the quantity of aggregate demand because of the multiplier effect.
50. If the money wealth, interest rate, and international effects reduce the quantity of aggregate
demand by 3 percent when the price rises by 6 percent and the multiplier is 2, then the slope of
the aggregate demand curve is:
A. -1/2.
B. -1.
C. -2.
D. -3.
51. If the money wealth, interest rate, and international effects increase the quantity of aggregate
demand by 2 percent when the price falls by 2 percent and the multiplier is 4, then the slope of
the aggregate demand curve is:
A. -1/4.
B. -1/2.
C. -1.
D. -4.
52. If the money wealth, interest rate, and international effects reduce the quantity of aggregate
demand by 5 percent when the price rises by 10 percent and the multiplier is 3, then the slope of
the aggregate demand curve is:
A. -1/2.
B. -2/3.
C. -2.
D. -3.
53. Refer to the graph shown. Given the increase in the price level in the graph, it is likely that
the multiplier effect:
A. reduces the quantity of aggregate demand by Yo – Ye.
B. reduces the quantity of aggregate demand by less than Y0 – Ye.
C. raises the quantity of aggregate demand by Y0 – Ye.
D. raises the quantity of aggregate demand by less than Y0 – Ye.
54. Refer to the graph shown. Given the price increase in the graph, we can infer that the
international effect by itself:
A. raises the quantity of aggregate demand by Y0 – Ye.
B. raises the quantity of aggregate demand by less than Y0 – Ye.
C. reduces the quantity of aggregate demand by Y0 – Ye.
D. reduces the quantity of aggregate demand by less than Y0 – Ye.
55. Most economists agree that the aggregate demand curve is:
A. vertical.
B. relatively steep.
C. relatively flat.
D. horizontal.
56. A fall in a foreign country’s income will most likely cause:
A. a reduction in U.S. exports, so the U.S. aggregate demand curve shifts left.
B. a reduction in U.S. exports, so the U.S. aggregate demand curve shifts right.
C. an increase in U.S. exports, so the U.S. aggregate demand curve shifts left.
D. an increase in U.S. exports, so the U.S. aggregate demand curve shifts right.
57. If businesses expect future demand to increase, this will cause a:
A. movement down the aggregate demand curve.
B. movement up the aggregate demand curve.
C. rightward shift of the aggregate demand curve.
D. leftward shift of the aggregate demand curve.