I. Match Concepts to Definitions

1. 0Fiscal Policy

2. Balanced trade

3. Aggregate Expenditure Model.

4. Aggregate Demand-Supply Model

5. Liquidity Preference

6. Liquidity Trap

7. MPC

8. Natural rate hypothesis

9. Long run Phillips Curve

10. Rational Expectations

A. Positive level of net exports

B. Net exports are equal to zero.

C. Economy fluctuates around potential output, cannot be persistently below potential

D. Relationship between real Consumption plus Investment plus Government plus Net Exports and price level.

E. The purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners.

F. When interest rates are close to zero.

G. Government spending and taxation policy.

H. Interest rate adjusts to bring money supply and money demand into equilibrium.

I. Relationship between total desired or planned expenditures on goods and services in the economy and real income assuming no change in the price level.

J. Only unanticipated changes in monetary policy had real effects. As soon as people understood that Fed targeted a lower rate of inflation, prices and wages would adjust, without the need for sustained high unemployment.

K. Fraction of extra income that households consume rather than save

L. Any attempt to keep the unemployment rate below the natural rate will cause inflation to spiral upward.

II. Answer True or False

1. If MPC = 0.5 and there is no crowding out, an increase in G by $50 would increase income by $100.

2. In the 1980s the increased unemployment to reduce inflation. This eventually would cause a decrease in the price level lowering money demand, raising the interest rate which increases investment which increases the aggregate quantity of goods & services demanded.

3. If the Fed increases the money supply it causes the interest rate to fall, which stimulates investment and shifts the aggregate demand curve rightward.

4. An increase in G will increases AD by the multiplier, but the resulting higher Y will increased money demand and r lowering AD. This is called crowding out.

5. A bigger MPC means changes in Y cause bigger changes in C, which in turn cause bigger changes in Y.

6. The multiplier is the additional shifts in AD that result when an increase in G increases income and thereby increases consumer spending

7. The Fed can raise r by reducing the money supply. An increase in r increases the quantity of goods and services demanded

III. Multiple Choice

1. The aggregate-demand curve shows the

a. Quantity of labor and other inputs that firms want to buy at each price level.

b. quantity of labor and other inputs that firms want to buy at each inflation rate.

c. quantity of domestically produced goods and services that households want to buy at each price level.

d. quantity of domestically produced goods and services that households, firms, the government, and customers abroad want to buy at each price level.

2. Which of the following adjust to bring aggregate supply and demand into balance?

a. the price level and real output

b. the real rate of interest and the money supply

c. government expenditures and taxes

d. the saving rate and net exports

4. Which of the following would help explain why the aggregate demand curve slopes downward?

a. An unexpectedly low price level raises the real wage, which causes firms to hire fewer workers and produce a smaller quantity of goods and services.

b. A lower price level causes domestic interest rates to rise and the real exchange rate to appreciate, which stimulates spending on net exports.

c. A higher price level increases real wealth, which stimulates spending on consumption.

d. A lower price level reduces the interest rate, which encourages greater spending on investment goods.

5. As the price level rises

a. people will want to buy more bonds, so the interest rate rises.

b. people will want to buy fewer bonds, so the interest rate falls.

c. people will want to buy more bonds, so the interest rate falls.

d. people will want to buy fewer bonds, so the interest rate rises.

6. Which of the following decreases in response to the interest-rate effect from an increase in the price level?

a. both investment and consumption

b. consumption but not investment

c. investment but not consumption

d. neither investment nor consumption

7. When the dollar depreciates, U.S.

a. net exports rise, which increases the aggregate quantity of goods and services demanded.

b. net exports rise, which decreases the aggregate quantity of goods and services demanded.

c. net exports fall, which increases the aggregate quantity of goods and services demanded.

d. net exports fall, which decreases the aggregate quantity of goods and services demanded.

8. When the Fed buys bonds

a. the supply of money increases and so aggregate demand shifts right.

b. the supply of money decreases and so aggregate demand shifts left.

c. the supply of money decreases and so aggregate demand shifts right.

d. the supply of money increases and so aggregate demand shifts left.

9. Suppose the economy is in long-run equilibrium and the government decreases its expenditures. Which of the following helps explain the logic of why the economy moves back to long-run equilibrium?

a. as people revise their price-level expectations upward, firms and workers strike bargains for higher nominal wages.

b. as people revise their price-level expectations upward, firms and workers strike bargains for lower nominal wages.

c. as people revise their price-level expectations downward, firms and workers strike bargains for higher nominal wages.

d. as people revise their price-level expectations downward, firms and workers strike bargains for lower nominal wages.

10. When production costs rise,

a. the short-run aggregate supply curve shifts to the right.

b. the short-run aggregate supply curve shifts to the left.

c. the aggregate demand curve shifts to the right.

d. the aggregate demand curve shifts to the left.

11. Suppose the economy starts at Z. If changes occur that move the economy to a new short run equilibrium of P1 and Y1 , then it must be the case that

a. short run aggregate supply has decreased.

b. short run aggregate supply has increased.

c. aggregate demand has increased.

d. aggregate demand has decreased.

12. Assume the AD-SRAS-LRAS diagram for the U.S. economy starts in a long-run equilibrium, what happens if the US exchange rate falls?

a. AD shifts to the right

b. SRAS shifts to the right

c. The quantity of AD increases

d. The quantity of AD decreases

IV. Short Answers

1. Describe the process in the money market (demand and supply of/for money) by which the interest rate reaches its equilibrium value if it starts above equilibrium.

2. Explain why long run aggregate supply curve is vertical.

3. Explain why the aggregate demand curve slopes down.

4. Use the sticky wage theory of aggregate supply to explain what will happen to output and the price level in the long run. What role does expected price level play in the adjustment?

5. Describe how an increase in the money supply affects aggregate demand.

6. Why in the short run does the interest rate adjust to balance the supply and demand for money.