1. Multiple Choice

1. Multiple choice:

1. Which of the following is a series of events that accurately describes effective contractionary monetary policy?
2. Decrease in interest rate, decrease in MS, increase in I.
3. Decrease in MS, increase in interest rate, decrease in I.
4. Increase in MS, decrease in I, decrease in interest rate.
5. Increase in MS, increase in interest rate, increase in I.

1. Monetary policy is most likely to result in inflation when the aggregate supply curve is
2. vertical and the Fed lowers the discount rate.
3. vertical and the Fed raises the reserve requirement.
4. horizontal and the Fed sells securities.
5. horizontal and the Fed lowers the reserve ratio.

1. If a bank does not have enough reserves to cover its required reserves, it can
2. buy securities on the open market.
3. lend to other banks in the federal funds market.
4. borrow reserves from the “discount window.”
5. make more loans to the public.

1. Which of the following will not shift the aggregate supply curve(long run or short run)?
2. New technology.
3. A decrease in oil prices.
4. An increase in the price level.
5. An increase in wages.

1. Which one of the following statements is accurate?
2. Inflation means that, on average, the prices of the goods and services produced by an economy are falling.
3. Inflation can be measured in terms of only one price index.
4. Inflation means that, on average, the prices of the goods and services produced by an economy are climbing.
5. Deflation means that, on average, the prices of the goods and services produced by an economy are climbing.
6. Stagflation is when prices have stagnated, not going up or down.

1. Doubts about the nature and the existence of a negatively sloped Phillips Curve arose in the 1970s when the economy experienced
2. simultaneously high rates of inflation and unemployment.
3. simultaneously low rates of inflation and unemployment.
4. a high rate of unemployment, along with a low rate of inflation.
5. a high rate of inflation, along with a low rate of unemployment.
6. no inflation at all for several years.

1. All the following are policies that might be used to curb an inflationary trend, with the exception of:
2. an increase in personal tax rates.
3. an increase in the size of the federal deficit.
4. an increase in the reserve requirements of commercial banks.
5. a reduction in government spending.
6. all of the above, with no exception tend to curb inflation.

1. 
   You have the following data on the economy: Ypotential = 1,000 and Y* = 1,200.

a)See graph.

b)There will be upward pressure on the price level which will result in inflation and then, eventually, wage rates will increase creating and leftward shift back in the short run aggregate supply curve. We achieve Ypotential again but with a higher price level.

c)Fiscal policies to try; increase taxes, decrease government expenditures, decrease transfer payments, etc. Monetary policies to try; increase the discount rate, increase the required reserve ratio, open market sales, etc. All the above policies will shift the aggregate demand curve to the left so that we achieve the full/potential employment again. What “cost” do you pay to get Ypotential? Well that can be answered several ways depending on if you wait for the economy to self-adjust or try to stimulate it to self adjust. But either way you are looking at lower Y and lower employment levels (higher unemployment) and possibly a higher price level. Again the answer to this question is contingent on what the policy makers do.

1. There is no tradeoff between unemployment and inflation. Agree/Disagree/comment.

Be careful...depends on what you mean by what you say and what you are assuming. Do you mean in the short-run, while you exploit the short-run Phillips Curve? Or in the long run as expectations adjust. In the short-run it appears there is a tradeoff until inflationary expectations alter the position of the SR Phillips Curve. In the long run there is no real tradeoff if the long-run Phillips curve is vertical at the NAIRU.

1. Explain the relationship between each of the following.

a)Cost-push inflation AND increases in labor productivity.

If the wage increase is greater than the rise in labor productivity, then there would be cost-push inflation.

b)A “supply shock” caused by a sudden rise in the price of oil purchased from OPEC nations AND rising unemployment in America.

If OPEC raises the price of oil, Americans have to spend more on oil from the OPEC nations, and consequently have less to spend at home. This implies a drop in aggregate demand (C+I+G), and therefore a rise in unemployment.

c)The Phillips Curve AND the natural rate of unemployment.

The Phillips curve is a graph that shows the tradeoff between inflation and the unemployment rate. The natural rate of unemployment is the sum of frictional and structural unemployment. The long run Phillips curve is vertical at the natural rate of unemployment. Any attempt to reduce unemployment below the natural rate by stimulating aggregate demand (C+I+G+EX-IM) will therefore lead mainly to rising prices or an increase in the inflation rate, with very little, if any, reduction in unemployment. In the short run, while people’s expectations about inflation are incorrect, you tend to see a negative relationship between U and inflation, and you can see short run reductions in the unemployment rate below U* with rising price levels. But once expectations adjust the short run Phillips curve will shift up/right and you will end up back at U* with a stable but higher level of inflation.

1. Briefly discuss the classical view of the labor market. Specifically, to what extent can unemployment occur based on the classical view? Explain.

In the classical view, wages are completely flexible in both the up and down direction, so they always adjust to get rid of any labor surplus or shortage. If there is excess demand for labor there is an increase in the wage rate, which will increase the quantity of labor supplied and decrease the quantity of labor demanded until there is equilibrium in the labor market. If there is an excess supply of labor there is a decrease in the wage rate, which will increase the quantity of labor demanded and decrease the quantity of labor supplied until there is equilibrium in the labor market. So in the classical view there should not be cyclical unemployment.

1. How will an increase in the money supply affect the short run Phillips Curve?

MS up  AD shifts up/right  movement up along to the northeast on the AS (Short run)  Y up and Price Level up  we’re moving along the existing short run Phillips Curve northwest/up. If we end up moving to the left of NAIRU or U*, we will see an increase in expected inflation and the short run Phillips curve will shift up/right until actual inflation equals expected inflation at NAIRU or U*.

1. Explain what NAIRU represents. Explain what happens if the actual unemployment rate does not equal NAIRU. And finally, discuss what factors might cause NAIRU to change.

NAIRU, the non-accelerating inflation rate of unemployment, is the unemployment rate that occurs when there is no pressure for the inflation rate to increase. If the actual unemployment rate is below NAIRU, the inflation rate will increase. And if the actual unemployment rate is above NAIRU, the inflation rate will decrease. Cost shocks, labor market dynamics, and, for example, increased foreign competition are the types of things that can cause changes in NAIRU.