14.02 Principles of Macroeconomics

Problem Set 9

Posted: Wednesday, November 29, 2000

Due: Monday, December 11, 2000

Please Note: This problem set consists of 35 multiple choice questions. When you writeup your solutions, please indicate the correct answer (there is only one for each question) clearly and circle the letter on your solutions. A brief explanation is all that is needed to justify your choice.

Chapter 7

1. At the current level of output, suppose the actual price level is less than the price level that individuals expect (i.e., Pt<Pet). Based on out understanding of the AS-AD model presented by Blanchard (1997), we know that:

a. Output is currently above the natural level of output

b. The interest rate will tend to fall as the economy adjusts to this situation

c. The nominal wage will increase as individuals revise their expectations of the price level

d. any subsequent reduction in the aggregate price level will cause an increase in the real money supply and a rightward shift in the aggregate demand curve

e. none of the above

2. Which of the following events will cause the largest rightward shift (as measured horizontally) of the AD curve?

a. A tax increase

b. A 10% reduction in the aggregate price level

c. A 5% increase in the nominal money supply

d. A 15% reduction in the nominal wage

3. For this question, assume that the economy is initially operating at the natural level of output and that the expected price in period t is based on the following: Pet=Pt-1. Based on out understanding of the AS-AD model, we know with certainty that a reduction in taxes will cause which of the following?

a. An increase in output and no change in the aggregate price level in the short run

b. an increase in employment and no change in the nominal wage in the short tun

c. A reduction in investment in the medium run

d. An increase in the aggregate price level, no change in output and no change in the interest rate in the medium run

4. For this question, assume that the economy is initially operating at the natural level of output and that the expected price in period t is based on the following: Pet=Pt-1. Based on our understanding of the AS-AD model we know with certainty that an increase in the nominal money supply will cause:

a. An increase in the real wage in the medium run

b. an increase in investment in the medium run

c. A reduction in the interest rate in the medium run

d. An increase in the nominal wage in the medium run

5. For this question, assume that the economy is initially operating at the natural level of output and that the expected price in period t is based on the following: Pet=Pt-1. Based on our understanding of the AS-AD model we know with certainty that an increase in consumer confidence will cause:

a. An increase in investment in the short run

b. A reduction in the real wage in the medium run

c. An increase in the interest rate in the medium run

d. Ambiguous effects on investment in the medium run.

Chapter 8

6. When inflation has been persistent, as in the U.S. during the 1970s and 1980s, very low unemployment rates will be associated with

a. Very low natural rates of unemployment.

b. Very high natural rates of unemployment.

c. high but stable rates of inflation.

d. Low but stable rates of inflation.

e. Greater increases in the inflation rate.

7. If government officials overestimate the natural rate of unemployment, they may follow policies that cause the U.S. to have

a. More unemployment than necessary.

b. An unemployment rate that is "too low".

c. a higher inflation rate than necessary.

d. a steadily increasing inflation rate.

e. a dramatically fluctuating unemployment rate.

8. Deflation refers to a situation where:

a. Inflation and unemployment are both increasing

b. Inflation and unemployment are both decreasing

c. inflation in negative

d. The rate of inflation is falling

9. Assume that expected inflation is based on the following: (pi)et=(theta)(pi)t-1. An increase in theta will cause:

a. An increase in the natural rate of unemployment

b. A reduction in the natural rate of unemployment

c. No change in the natural rate of unemployment

d. Inflation in period t to be more responsive to changes in unemployment if period t

10. Which of the following does NOT explain the relatively low price inflation compared to the higher wage inflation in the U.S. during the 1990s?

a. The appreciation of the dollar

b. A reduction in benefits paid to workers

c. An increase in the natural rate of unemployment

d. a reduction in the price of oil

Chapter 9

11. In the medium run, a reduction in nominal money growth from 7% to 3% will cause the unemployment rate to

a. Decrease by 4%

b. decrease by 2%

c. Increase by 4%

d. increase by 2%

e. remain unchanged.

12. Which of the following would allow the authorities to maintain the unemployment rate 1% below the natural rate?

a. nominal money growth of 1%.

b. nominal money growth that is 1% greater than the normal growth rate of output.

c. nominal money growth that is 1% greater than the inflation rate.

d. nominal money growth that is 1% greater than the the sum of the inflation rate and the normal output growth rate.

e. None of the above.

13. Which of the following will increase the inflation rate in the medium run?

a. A permanent increase in the price of oil.

b. A large budget deficit.

c. A permanent increase in nominal money growth.

d. All of the above.

e. None of the above.

Chapter 10

14. In the U.S., output per capita in 1994 was about twice that in

a. 1890

b. 1920

c. 1950

d. 1975

e. 1985

15. A country with a permanently higher saving rate will have

a. A permanently faster growth rate.

b. A permanently higher level of output per capita.

c. A permanently higher level of capital per worker.

d. Both a. and b.

e. Both b. and c.

16. To indefinitely maintaqin a heigh growth rate of output per capita, a country needs

a. Technological progress.

b. Capital accumulation.

c. Continual increases in capital per worker.

d. A higher saving rate.

e. Increases in population.

17. For which of the following groups of countries has convergence NOT occured?

a. The five richest countries

b. African countries

c. the 'four tigers' in Asia

d. OECD countries

Chapter 14

18. The real interest rate tells us

a. How much consumption we must give up next year in order to consume more goods today.

b. How many dollars we must give up next year in order to consume more goods today.

c. How many dollars we must give up next year in order to have more dollars today.

d. How many dollars we must give up today in order to have more dollars next year.

e. How many dollars we must give up today in order to consume more goods today.

19. Whenever the inflation rate is positive,

a. The real interest rate must be less than the nominal interest rate.

b. The real interest rate must be negative.

c. The real interest rate must be positive.

d. The nominal interest rate must be negative.

e. None of the above.

20. Data on real and nominal interest rates of one-year U.S. T-Bills show that, over the past twenty years,

a. The nominal rate has always been less than the real rate.

b. Whenever the nominal rate rises, the real rate falls, and vice versa.

c. the nominal rate has varied, but the real rate has not.

d. the real rate has varied, but the nominal rate has not.

e. The real rate has always been less than the nominal rate.

21. A rise in the nominal interest rate will always cause

a. the real interest rate to decrease.

b. The expected inflation rate to decrease.

c. the demand for money to decrease.

d. all of the above.

e. None of the above.

22. Which of the following is true of the LM curve when the nominal interest rate is on the vertical axis?

a. A change in expected inflation will shift the LM curve.

b. A change in expected inflation will have no effect on the position of the LM curve.

c. an increase in the expected inflation rate will make the LM curve steeper.

d. an increase in the expected inflation rate will make the LM curve flatter.

e. A change in the expected inflation rate causes neither a shift, nor a movement along, nor a change in the slope of the LM curve.

23. When the IS curve is drawn with the nominal interest rate on the vertical axis, an increase in the expected inflation rate will cause

a. The IS curve to shift rightward.

b. The IS curve to shift leftward.

c. The IS curve to become steeper.

d. The IS curve to become flatter.

e. No change in the IS curve.

24. Let: (1) Pt be the price of one unit of a market basket of goods (i.e., a composite commodity) in year t; (2) Pet+1 be the expected price of one unit of a market basket of goods in year t+1; (3) (pi)et be the expected rate of inflation between period t and t+1; and (4) it be the one-year nominal interest rate. Suppose an individual borrows the equivalent of one unit of a composite commodity today. Given this information, which of the following expressions represents (i.e., is equal to) the amount of the composit commodity one must repay in one year?

a. (1+it)(Pet+1)/(Pt)

b. (1+(pi)et)/1+it)

c. {((1+(pi)et)/1+it)}-1

d. {(1+it)(Pt)/(Pet+1)}-1

e. none of the above

25. In the short run, higher money growth causes:

a. Lower real interest rates and lower nominal interest rates

b. Lower real interest rates and higher nominal interest rates

c. Higher real interest rates and higher nominal interest rates

d. Higher real interest rates and lower nominal interest rates

26 In the medium run, higher money growth causes:

a. Lower real interest rates and lower nominal interest rates

b. Lower real interest rates and higher nominal interest rates

c. Higher real interest rates and higher nominal interest rates

d. Higher real interest rates and lower nominal interest rates

e. none of the above

27. Suppose the economy is initially operating at the natural level of output. Now, suppose the central bank reduces the rate of nominal money growth by 3%. Given this information, we would expect that:

a. The real interest rate will fall by less than 3% in the medium run.

b. The real interest rate will fall by exactly 3% in the medium run.

c. The real interest rate will increase by exactly 3% in the medium run.

d. None of the above.

28. Suppose the economy is initially operating at the natural level of output. Now, suppose the central bank reduces the rate of nominal money growth by 3%. Given this information, we would expect that:

a. The nominal interest rate will fall by less than 3% in the medium run

b. The nominal interest rate will fall by exactly 3% in the medium run

c. The nominal interest rate will increase by exactly 3% in the medium run

d. The nominal interest rate will not change in the medium run

e. none of the above

29. In the medium run, which of the following expressions will represent the nominal interest rate?

a. rn-(pi)e

b. rn+gm

c. rn-gm

d. gY+gm

Chapter 21

30. Under fixed exchange rates, a rise in the price level will cause

a. A real depreciation and a decrease in aggregate demand.

b. A real depreciation and an increase in aggregate demand.

c. A real appreciation and a decrease in aggregate demand.

d. A real appreciation and an increase in aggregate demand.

e. No change in the real exchange rate and no change in aggregate demand.

31. In the short run, a devaluation leads to

a. An increase in net exports.

b. an increase in the price level.

c. an increase in output.

d. all of the above.

e. none of the above.

32. In the medium run, a devaluation leads to

a. An increase in net exports.

b. an increase in the price level.

c. an increase in output.

d. all of the above.

e. none of the above.

33. If a country with an overvalued real exchange rate does not devalue, then over time we can expect

a. A fall in its price level.

b. A real depreciation of its currency.

c. a reduction in its trade deficit.

d. all of the above.

e. none of the above

34. If country A pegs its nominal exchange rate to country B, and country A has a higher inflation rate than country B, then country A will experience

a. A real appreciation.

c. An increase in domestic demand.

d. All of the above.

e. none of the above.

35. For this question, assume that policy makers are pursuing a fixed exchange rate regime. Assume that the economy is initially operating at the natural level (I.e., Y=Yn). Suppose policy makers decide to increase government spending. Given this information, we know that:

a. The real exchange rate will be permanently higher in the medium run

b. The real exchange rate will be permanently lower in the medium run

c. The effects of this devaluation on the real exchange rate will be ambiguous in the medium run

d. The real exchange rate will be unchanged in the medium run