Test Bank for Principles of Macroeconomics Canadian

8th Edition Sayre Morris 1259030695 9781259030697

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MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) What is potential GDP?

A) The total amount of production by an economy, adjusted for inflation.
B) The total amount of production when all of an economy's resources are being fully utilized.
C) The total amount of production an economy produces at equilibrium.
D) A prediction of what an economy will likely produce in the future.
Answer: B

2) All of the following, except one, refer to the total amount of production when all of an economy's
resources are being fully utilized. Which is the exception?
A) Economic capacity. B) Full-employment GDP.
C) Potential GDP. D) Equilibrium GDP.
Answer: D

3) What is the slope of the LAS curve?

A) Vertical.
B) It is the same slope as the SAS curve.
C) Upward-sloping.
D) Downward-sloping.
E) Horizontal.
Answer: A

4) What does the LAS curve reflect?

A) Various levels of employment. B) Less than capacity output.
C) The effect of a change in the price level. D) A constant real wage level.
Answer: D

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5) Which of the following movements best illustrates an increase in potential GDP?
A) From B to C. B) From A to C.
C) From PP1 to PP2. D) From A to B.
Answer: C

6) Which of the following statements is true about Canada's annual rate of economic growth from 1997
to 2012?
A) It averaged 2.6 percent.
B) It was positive in every year.
C) There were more negative than positive years.
D) It was 5% or above in most years.
Answer: A

7) All of the following, except one, are sources of economic growth. Which is the exception?
A) The amount of human capital available.
B) The amount of capital stock available.
C) High interest rates.
D) The amount and quality of natural resources available.
E) It reflects the amount of resources devoted to research and development.
Answer: C

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 8) All of the following, except, one are correct statements about labour productivity. Which is the
exception?
A) It depends on human capital.
B) It depends on physical capital.
C) It is an integral part of what is considered labour quality.
D) It reflects the amount of resources devoted to research and development.
E) It is the basis for measuring economic growth.
Answer: E

9) What is the business cycle?

A) The rise and fall in the rate of inflation.
B) The expansionary and contractionary phases in the growth rate of real GDP.
C) The expansionary and contractionary phases in the rate of unemployment.
D) The continuous rise in GDP that Canada has experienced throughout the Twentieth Century.
Answer: B

10) What does it mean to say that the economy is in a contractionary phase of the business cycle?
A) That real GDP is increasing
B) That inflation is declining.
C) That the rate of growth of real GDP is positive.
D) That the rate of growth of real GDP is falling.
E) That real GDP is declining.
Answer: D

11) All of the following, except one, are possible causes of the business cycle. Which is the exception?
A) A change in the foreign demand for Canadian products.
B) A significant technological breakthrough.
C) An increase in the economic growth rate.
D) A change in interest rates.
E) A change in government spending.
Answer: C

12) What is aggregate supply?

A) The aggregate quantity produced by all sellers at equilibrium.
B) The aggregate quantity produced by all sellers at the current price level.
C) The aggregate quantity produced by all sellers at full employment.
D) The aggregate quantity produced by all sellers at various different prices.
Answer: D

13) "The aggregate quantity of goods and services produced by all sellers at various prices". Of what is
this a definition?
A) Aggregate demand. B) Potential GDP.
C) Aggregate expenditure. D) Aggregate supply.
Answer: D

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14) What is true of a movement up the aggregate supply curve?
A) The nominal wage remains constant but the real wage declines.
B) Both the nominal and real wages decline.
C) The real wage remains constant but the nominal wage increases.
D) The real wage remains constant but the nominal wage declines.
Answer: A

15) Why is the AS curve upward-sloping?

A) A higher price means higher total profits and therefore firms will produce more.
B) Higher prices mean higher real wages and therefore firms must produce more to in order to
maintain profit levels.
C) Because, since nominal wages increase when production rises, then so too must the price level.
D) Higher prices increase the demand and therefore the quantity supplied must also increase.
Answer: A

16) Since the AS curve is upward sloping, as production increases, all of the following are true except:
A) the firm will be forced to use less suitable resources.
B) productivity is likely to fall.
C) the price of resources increases
D) the cost of production to rise.
Answer: C

17) What is the slope of the AS curve?

A) The same slope as the LAS curve.
B) Downward-sloping.
C) Upward-sloping.
D) Vertical.
E) Horizontal.
Answer: C

18) At low levels of real GDP, what is the result of a decrease in aggregate demand?
A) The price level will fall a little and real GDP will rise a lot.
B) The price level will fall a lot and real GDP will fall a little.
C) Both the price level and real GDP will fall about the same amount.
D) The price level will fall a little and real GDP will rise a little.
E) The price level will fall a little and real GDP will fall a lot.
Answer: E

19) If the economy is close to full employment, what will be the result of an increase in aggregate
demand?
A) Both the price level and real GDP will increase a lot.
B) Both the price level and real GDP will increase only a little.
C) The price level will increase a lot, and real GDP will increase only a little.
D) The price level will increase only a little, and real GDP will increase a lot.
Answer: C

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20) Which of the following is true regarding the aggregate demand curve?
A) It is downward-sloping because a lower price means higher real wealth and therefore people
will purchase more.
B) It is downward-sloping because production costs decline as real output increases.
C) It is upward-sloping because at higher output levels total spending is higher.
D) It is upward-sloping because production costs rise as real output increases.
E) It is downward-sloping because at lower prices total incomes are higher.
Answer: A

21) Which of the following is true regarding the aggregate demand curve?
A) It is upward-sloping because as output increases, aggregate expenditures increase.
B) It is horizontal when there is considerable unemployment in the economy.
C) It is downward-sloping because of the interest-rate, real balances, and foreign-trade effects.
D) It is downward-sloping because production costs decrease as real output increases.
E) It is vertical at the full-employment level of GDP.
Answer: C

22) What does the interest-rate effect mean?

A) That an increase in real GDP will increase the price level.
B) That an increase in the price level will decrease interest rates, and decrease consumption and
investment spending.
C) That an increase in the price level will decrease the demand for money and spending.
D) That an increase in the money supply will increase the rate of interest and cause investment to
fall.
E) That a decrease in prices will reduce the rate of interest which will cause investment to
increase.
Answer: E

23) Why are the interest-rate, foreign-trade and real balances effects important?
A) They help explain the shape of the aggregate supply curve.
B) They help explain the shape of the aggregate demand curve.
C) They help explain shifts in the aggregate demand curve.
D) They help explain why demand-management policies are ineffective in fighting stagflation.
E) They help explain shifts in the aggregate supply curve.
Answer: B

24) What does the foreign-trade effect suggest will happen if there is a decrease in the Canadian price
level relative to other countries?
A) It will increase the volume of Canadian exports but decrease the volume of imports.
B) It will increase the volume of both Canadian exports and imports.
C) It will decrease the volume of Canadian exports but increase the volume of imports.
D) It will decrease the volume of both Canadian exports and imports.
Answer: A

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25) What does the interest-rate effect explain?
A) The shape of the aggregate supply curve.
B) The change in the aggregate supply shifts.
C) The shape of the aggregate demand curve.
D) The change in the aggregate demand curve.
E) The change in economic growth.
Answer: C

26) What does the foreign-trade effect explain?

A) The change in the aggregate supply curve.
B) The shape of the aggregate demand curve.
C) The change in economic growth.
D) The change in the aggregate demand curve.
E) The shape of the aggregate supply curve.
Answer: B

27) All of the following, except one, is another way of thinking of full-employment GDP. Which is the
exception?
A) It is the level of GDP when cyclical unemployment is zero.
B) It is the level of GDP when frictional and structural unemployment is zero.
C) It is the same as potential GDP.
D) It is the level of GDP at the natural rate of unemployment.
E) It is often referred to as long-run aggregate supply.
Answer: B

28) What does macroeconomic equilibrium imply?

A) It is possible only at various price levels.
B) It is where the aggregate demand curve intersects the LAS curve.
C) The point where real GDP is at capacity.
D) The point where the quantity of real GDP demanded equals the quantity of real GDP supplied.
E) Full employment GDP.
Answer: D

29) Refer to the information above to answer this question. What is the equilibrium level of prices?
A) 180. B) 220. C) 200. D) 190. E) 210.
Answer: C

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30) Refer to the information above to answer this question. Which of the following would be true if the
price level was 190?
A) There would be a surplus of goods and services of 200.
B) Prices would fall.
C) Equilibrium exists.
D) There would be a shortage of goods and services of 200.
E) Aggregate supply will rise.
Answer: D

31) What does macroeconomic equilibrium imply?

A) AS = LAS B) AD = AS = LAS C) AD = LAS D) AD = AS
Answer: D

32) If at a certain price level the AS exceeds the AD then what are the implications?
A) There is a shortage of goods and services, and eventually prices will decrease.
B) There is a surplus of goods and services, and eventually prices will decrease.
C) There is a surplus of goods and services, and eventually prices will increase.
D) There is a shortage of goods and services, and eventually prices will increase.
Answer: B

33) Refer to the above graph to answer this question. What are the implications if the price level is
currently P1?
A) There is a surplus of goods and services and there is a recessionary gap. B)
There is a surplus of goods and services and there is an inflationary gap. C)
There is a shortage of goods and services and there is an inflationary gap. D)
There is a shortage of goods and services and there is a recessionary gap.
Answer: A

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 34) Refer tothe above graph to answer this question. What will happen in the long run if the price level
is currently P1?
A) The price level will decrease but the nominal wage will increase.
B) The price level will increase but the nominal wage will decrease.
C) Both the price level and the nominal wage will increase.
D) Both the price level and the nominal wage will decrease.
Answer: D

Assume that the present price level is P1.

35) Refer tothe above graph to answer this question. Which graph illustrates full-employment
equilibrium?
A) C B) A C) B D) D
Answer: A

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36) Refer to the above graph to answer this question. Which graph illustrates a recessionary gap?
A) A B) B C) C D) D
Answer: A

37) Refer to the above graph to answer this question. Which graph illustrates an inflationary gap?
A) A B) B C) C D) D
Answer: B

38) Refer to the above graph to answer this question. Which graph illustrates a surplus of goods and
services?
A) A B) B C) C D) D
Answer: D

39) When does macroeconomic equilibrium occur?

A) When the aggregate supply equals the long-run Aggregate Supply.
B) When exports equal imports.
C) When the aggregate demand equals the long-run Aggregate Supply.
D) When the aggregate quantity demanded is equal to the aggregate quantity supplied.
Answer: D

40) What is a recessionary gap?

A) The difference between actual and potential real GDP when the economy is below its potential.
B) The difference between nominal and real GDP.
C) The difference between the quantity of goods and services demanded and supplied.
D) The difference between actual and potential real GDP when the economy is above full
employment.
Answer: A

41) What is an inflationary gap?

A) The difference between actual and potential real GDP when the economy is below its potential.
B) The difference between nominal and real GDP.
C) The difference between actual and potential real GDP when the economy is above full
employment.
D) The difference between the quantity of goods and services demanded and supplied.
Answer: C

42) What could cause the aggregate demand curve to shift to the right?
A) An increase in interest rates. B) A fall in the price level.
C) A fall in people's real balances. D) An increase in income levels abroad.
Answer: D

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43) Which of the following will shift the aggregate demand curve left?
A) An increase in government spending.
B) An increase in wealth holdings.
C) A rise in the exchange rate.
D) An increase in the incomes of our major trading partners.
E) A decrease in labour productivity.
Answer: C

44) Which of the following will cause the aggregate demand curve to shift to the right?
A) A decrease in the incomes of our major trading partners.
B) A decrease in the money supply.
C) A decrease in the interest rate.
D) An increase in the exchange rate.
E) The discovery of new oil fields.
Answer: C

45) Which of the following will lead to an increase in aggregate demand?

A) A decrease in the price of capital goods.
B) A decrease in stock prices.
C) A decrease in the price level.
D) An increase in the price level.
E) An increase in interest rates.
Answer: A

46) All of the following, except one, will cause an increase in aggregate demand. Which is the
exception?
A) An increase in investment. B) An increase in imports.
C) An increase in consumption. D) An increase in government spending.
Answer: B

47) All of the following, except one, will cause an increase in aggregate demand. Which is the
exception?
A) An decrease in interest rates. B) A decrease in the price of capital goods.
C) An decrease in stock prices. D) A decrease in the exchange rate.
Answer: C

48) All of the following, except one, will cause a decrease in aggregate demand. Which is the
exception?
A) An increase in the money supply.
B) An increase in the exchange rate of the Canadian dollar.
C) An increase in taxes.
D) An increase in the price of capital goods.
Answer: A

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49) Refer to the above graph to answer this question. What could cause the movement from point A to
point B?
A) A decrease in labour costs.
B) A decrease in the interest rate.
C) An increase in productivity.
D) A decrease in government spending.
E) A decrease in labour productivity.
Answer: E

50) Refer to the above graph to answer this question. What could cause the movement from point B to
point A?
A) A decrease in labour productivity. B) The discovery of new oil fields.
C) An increase in wage rates. D) A decrease in government spending.
Answer: B

51) What will cause the AS curve to shift?

A) A rise in money wages.
B) A change in the capital stock.
C) A rise in money wages, a change in the capital stock and the introduction of technological
change.
D) The introduction of technological change.
Answer: C

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52) Which of the following is true of a rightward shift in the LAS curve?
A) The AS will not shift.
B) The AS will shift right.
C) It will raise the level of prices.
D) It could not be caused by an improvement in technology.
E) It would result if the aggregate demand curve shifted to the right.
Answer: B

53) Assuming that the price level remains unchanged, what will an increase in money wages do?
A) It will affect the LAS curve.
B) It will mean higher profits and production levels.
C) It will mean lower profits and production levels.
D) It will not affect price or output levels.
E) It will mean lower profits and no change in production levels.
Answer: C

54) What will be the effect of a leftward shift in the AS curve?

A) It will shift the LAS curve left.
B) It will not affect output levels.
C) It will cause a rise in the price level.
D) It might be caused by a decrease in resource prices.
Answer: C

55) Which of the following will cause an increase in aggregate supply?

A) An increase in factor prices.
B) An increase in exchange rates.
C) An increase in the labour force participation rate.
D) An increase in government spending.
Answer: C

56) Which of the following will cause a decrease in aggregate supply?

A) An increase in factor prices.
B) A decrease in tax rates.
C) An increase in human capital.
D) An increase in the labour force participation rate.
Answer: A

57) All of the following, except one, will cause an increase in both aggregate supply and long-run
aggregate supply. Which is the exception?
A) An increase in human capital. B) Technological improvement.
C) An increase in the capital stock. D) A decrease in factor prices.
Answer: D

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58) Which of the following will cause an increase in both aggregate supply and long-run aggregate
supply?
A) A decrease in the labour participation rate. B) An increase in factor prices.
C) A decrease in factor prices. D) An increase in productivity.
Answer: D

59) Refer to the graph above to answer this question. What could cause the change in aggregate supply
from AS 1 to AS2 ?
A) An increase in resource prices.
B) The real balances, interest-rate, and foreign-trade effects.
C) An increase in business taxes.
D) An improvement in technology.
E) A decrease in the price level.
Answer: D

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The following are an aggregate demand and supply schedules for a hypothetical economy. All figures in $ billion

60) Refer to the information above to answer this question. What is the equilibrium level of output?
A) 900. B) 1,050. C) 1,100. D) 800. E) 1,000.
Answer: E

61) Refer to the information above to answer this question. What are the implications if the price level
is 120?
A) There is a surplus of real output of 300. B) There is a surplus of real output of 150.
C) There is a shortage of real output of 300. D) The price level is above equilibrium.
Answer: C

62) Refer to
the information above to answer this question. If the aggregate quantity demanded falls by
150, what will be the equilibrium price level and real output respectively?
A) $130 and 950.
B) $120 and 900.
C) $140 and 950.
D) $160 and 1,050.
E) $150 and 1,050.
Answer: A

63) Refer to the information above to answer this question. At what level of real output will full
employment occur?
A) 1,100.
B) 950.
C) 1,000.
D) 900.
E) It cannot be determined.
Answer: E

14
64) What could cause the level of real GDP to rise but the price level to fall?
A) A leftward shift in the aggregate demand curve.
B) A leftward shift in the aggregate supply curve.
C) A rightward shift in the aggregate demand curve.
D) A rightward shift in the aggregate supply curve.
Answer: D

65) What happens if the aggregate demand curve shifts to the right?
A) Aggregate supply will also rise. B) Both A and B will occur.
C) The price level will rise. D) Real GDP will increase.
Answer: B

66) What is the multiplier?

A) It is the effect on autonomous spending of a change in income.
B) It is the effect on the level of investment of a change in income.
C) It is the effect on aggregate demand of a change in income.
D) It is the effect on income of a change in autonomous spending.
Answer: D

67) Under what circumstances will the multiplier effect have a big impact on real GDP?
A) When the economy is booming. B) When the AS is horizontal.
C) When the AD curve is vertical. D) When the AS curve is vertical.
Answer: B

68) If the economy is at full employment and the LAS curve shifts to the right because of, say, an
increase in labour force participation rate, then which of the following will result?
A) The AS curve may or may not shift depending on what happens to the wage rate.
B) The AS curve will shift to the left and full employment will be maintained.
C) The AS curve will also shift to the right but a recessionary gap will result.
D) The AS curve will not be affected.
E) The AS curve will also shift to the right and full employment will be maintained.
Answer: C

69) If the economy is at full employment and both the AS curve and the LAS curve shift right, why
might the economy experience a recessionary gap?
A) Because there is no reason to assume that the aggregate demand curve will shift.
B) Because a new equilibrium price level may be established that is above the price level needed
to maintain full employment
C) Because prices are inflexible downwards.
D) Because a new equilibrium price level may be established that is below the price level needed
to maintain full employment
E) Because the LAS curve will always shift more than the AS curve.
Answer: B

15
The following are aggregate demand and supply schedules for a hypothetical economy. All figures are in $ billio

The potential GDP is 3,000.

70) Refer to the information above to answer this question. What will equilibrium price level and GDP
be?
A) 170 and 3,600 B) 150 and 3,000 C) 150 and 2,600 D) 170 and 3,000
Answer: D

71) Refer to
the information above to answer this question. Assume that technological change increases
aggregate supply by 340. What will the equilibrium price and quantity be?
A) 160 and 3,100.
B) 170 and 3,440.
C) 140 and 2,820.
D) 140 and 2,760.
E) 160 and 3,440.
Answer: A

72) Refer to the information above to answer this question. Assume that technological change increases
aggregate supply by 340. What would be the result?
A) A new full employment level of real GDP of 3,340 and lower prices.
B) An inflationary gap of 340.
C) A new full-employment level of real GDP of 3,340 with no change in prices.
D) A recessionary gap of 240.
E) A new equilibrium of real GDP of some indeterminate level depending on how much prices
fell.
Answer: D

73) Refer to
the information above to answer this question. Assume that reduced investment spending
lowers aggregate demand by 600. What would the new equilibrium price level and real GDP be?
A) 170 and 2,400. B) 130 and 3,000. C) 130 and 2,400. D) 150 and 2,600.
Answer: D

16
 74) What would result if the AS curve shifts to the left?
A) Equilibrium GDP will rise and prices will also rise.
B) Equilibrium GDP will fall and prices will also fall.
C) Equilibrium GDP will rise and prices will fall.
D) Equilibrium GDP will fall and prices will rise.
Answer: D

75) What is the result of a decrease in the AS curve?

A) It will raise the price level and decrease real GDP.
B) It will raise the price level and raise real GDP.
C) It will decrease the price level and decrease real GDP.
D) It will decrease the price level and may or may not change real GDP depending on the shape of
the SAS curve.
E) It will decrease the price level and raise real GDP.
Answer: A

76) What is the result of a decrease in the LAS curve?

A) It will raise the price level and decrease real GDP.
B) It will lower the price level and decrease real GDP.
C) It will lower the price level and raise real GDP.
D) It will leave the price level unchanged and decrease real GDP.
E) It will raise the price level and raise real GDP.
Answer: A

Answer the question(s) on the basis of the following table:

77) Refer to the above information to answer this question. What will happen if resource prices
increase?
A) 2 and C B) 2 and B C) 1 and A D) 3 and B
Answer: A

78) Refer to the above information to answer this question. What will happen if the labour participation
rate increases?
A) 2 and B B) 3 and A C) 2 and C D) 1 and A
Answer: D

17
 79) Refer to the above information to answer this question. What will happen if there is a decrease in
productivity?
A) 1 and A B) 2 and C C) 2 and B D) 3 and A
Answer: C

The following is a list of economic events:

1. A big cut in the price of imported oil.

2. An increase in the money supply.
3. An increase in labour productivity.
4. A decline in the GDP of the USA
5. A big rise in nominal wages.

80) Refer to the information above to answer this question. Which of the listed economic events will
cause an increase in aggregate demand?
A) 2 only. B) 1, 2 and 5. C) 1 only. D) 1 and 2.
Answer: A

81) Refer to the information above to answer this question. Which of the listed economic events will
cause an increase in both the aggregate supply and in the LAS curve?
A) 2 only B) 5 only C) 1 only D) 3 only
Answer: D

82) How does the economy eventually adjust to a recessionary gap?

A) The nominal wage and price levels will both increase.
B) The nominal wage level will decrease but the price level will increase.
C) The nominal wage and price level will both decrease.
D) The nominal wage level will increase but the price level will decrease.
Answer: C

83) How does the economy eventually adjust to an inflationary gap?

A) The nominal wage and price level will both decrease.
B) The nominal wage and price levels will both increase.
C) The nominal wage level will decrease but the price level will increase.
D) The nominal wage level will increase but the price level will decrease.
Answer: B

18
84) Refer to the graph above to answer this question. Which of the following statements is not true if the
economy is at point A?
A) Unemployment is above its natural rate.
B) An increase in aggregate supply will move the economy towards full employment.
C) A recessionary gap exists.
D) Money wages will eventually be forced down.
E) Firms will find it difficult to hire labour and people will find it easy to find jobs.
Answer: E

85) Refer to the graph above to answer this question. If the economy was initially at point A, what
would a movement to point B suggest?
A) The movement could be the result of an increase in prices.
B) The movement could be the result of an increase in aggregate demand.
C) The movement could be the result of increased government spending.
D) The movement could be the result of an increase in nominal wages.
E) The movement could be the result of a decrease in the costs of production.
Answer: E

86) How did the neoclassical school view equilibrium?

A) Where AS = LAS.
B) As occurring at capacity output.
C) As being a natural result of flexible prices and wages.
D) In a way that implied full employment.
E) As occurring at capacity output, where AS = LAS, in a way that implied full employment and
as being a natural result of flexible prices and wages.
Answer: E

19
87) According to Keynesians, which of the following statements is correct?
A) The AD curve is vertical but the AS is upward sloping.
B) The AS is vertical but the AD is upward sloping.
C) The AS is horizontal but the AD is downward sloping.
D) The AD curve is horizontal but the AS is upward sloping.
Answer: C

88) According to neoclassical economists, which of the following statements is correct?

A) The AD curve is horizontal but the AS is vertical.
B) The AS is vertical.
C) The AS is horizontal.
D) The AD curve is vertical but the AS is horizontal.
Answer: B

89) According to neoclassical economists, what is true of the aggregate supply curve?
A) It is vertical because prices tend to be inflexible.
B) It is upward-sloping since higher outputs will only be produced at higher price levels.
C) It is vertical at the capacity level of output in the economy.
D) It is horizontal because supply creates its own demand.
E) It is horizontal because prices tend to be fixed.
Answer: C

90) Which of the following is true?

A) Keynes believed that recessionary gaps will not correct themselves because prices and wages
are not flexible.
B) Keynes believed that recessionary gaps will correct themselves because prices and wages are
flexible.
C) A recessionary gap can be cured in the short run if prices and wages remain stable.
D) A recessionary gap can be cured in the long run if prices and wages remain stable.
E) Recessionary gaps can be avoided if the economy grows fast enough.
Answer: A

91) Which of the following is true regarding Neoclassicists?

A) They believed that recessionary and inflationary gaps were inevitable.
B) They believed that wages and prices were inflexible downwards.
C) They made no distinction between the short run and the long run in reference to aggregate
supply.
D) They concentrated their analysis on the AS curve.
Answer: C

20
92) Which of the following is true regarding changes in aggregate demand?
A) It may or may not change the price level according to neoclassicists.
B) It may or may not change the price level according to Keynesians.
C) It would never change the price level according to Keynesians.
D) It would never change real GDP according to Keynesians.
E) It would never change the price level according to neoclassicists.
Answer: C

93) What is the focus of the Keynesian-neoclassical controversy?

A) The position of the AD curve. B) The shape of the LAS curve.
C) The shape of the AS curve. D) The shape of the AD curve.
Answer: C

21
94) Refer to
the graph above to answer this question. What does Figure B illustrate?
A) Full-employment equilibrium.
B) The situation that existed during World War II.
C) The situation that existed in the 1930s.
D) A situation where individual firms cannot be making profits.
E) An inflationary gap situation.
Answer: C

95) Refer to
the graph above to answer this question. What does Figure C illustrate?
A) An inflationary gap situation.
B) A recessionary gap situation.
C) The situation that existed in the 1930s.
D) A situation where individual firms cannot be making profits.
E) Full-employment equilibrium.
Answer: A

22
 96) Refer to the graph above to answer this question. What does Figure A illustrate?
A) A situation of unstable prices.
B) The situation that Keynes felt existed in the 1930s.
C) Full-employment equilibrium.
D) A situation where individual firms cannot be making profits.
E) An inflationary gap situation.
Answer: C

97) Why is the AD curve downward-sloping?

A) Because lower prices cause interest rates to increase which increases spending.
B) Because higher prices cause an increase in real balances which increases spending.
C) Because production costs decline as real GDP increases.
D) Because lower prices cause an increase in real balances which increase spending.
Answer: D

98) Why is the AS curve upward-sloping?

A) Because firms will experience higher profits at higher prices and will therefore produce more.
B) Because the LAS curve is also upward sloping.
C) Because firms will produce more if prices are higher, despite no increase in profits.
D) Because aggregate demand rises with higher prices.
Answer: A

99) Which of the following will cause the aggregate demand curve to shift to the right?
A) A decrease in government spending. B) A decrease in the money supply.
C) A decrease in the interest rate. D) An increase in the exchange rate.
Answer: C

100) When does macroeconomic equilibrium occur?

A) When aggregate supply equals long-run aggregate supply.
B) When full employment occurs.
C) When the aggregate demand curve intersects the LAS curve.
D) When the aggregate demand curve intersects the aggregate supply curve.
Answer: D

101) What could cause the level of real GDP to rise but the price level to fall?
A) A leftward shift in the aggregate supply curve. B)
A rightward shift in the aggregate supply curve. C)
A leftward shift in the aggregate demand curve. D)
A rightward shift in the aggregate demand curve.
Answer: B

102) What can cause an increase in the LAS?

A) A decrease in taxes. B) Technological improvement.
C) A leftward shift in the AS curve. D) An increase in nominal wage rates.
Answer: B

23
103) What does the real-balances effect mean?
A) A lower price level will lead to an increase in the rate of interest, thereby causing a decrease in
consumption.
B) A higher price will decrease the real value of financial assets, thereby causing a decrease in
consumption.
C) A higher price will decrease the real value of financial assets, thereby causing an increase in
consumption.
D) A higher price level will lead to an increase in the rate of interest, thereby causing a decrease in
consumption.
E) A higher price will increase the real value of financial assets, thereby causing an increase in
consumption.
Answer: B

104) Refer to the figure above to answer this question. What could cause the change from point a to point
b?
A) A decrease in taxes.
B) The discovery of new oil fields.
C) A decrease in labour productivity.
D) An increase in government spending.
E) A decrease in the prevailing nominal wage.
Answer: C

24
105) On average, Canada's real GDP has grown by % per year between the years of 1997-2012.
A) 2.6 B) 3.25 C) 5.75 D) 4.5
Answer: A

106) What is the business cycle?

A) The expansionary and contractionary phases in the growth rate of real GDP.
B) The periodic cycles of profits and losses that all firms experience.
C) The fact that real GDP falls as often as it rises.
D) The natural evolution of new firms growing quickly at first, then slowing and fading into
obsolescence.
Answer: A

107) What is meant by the term human capital?

A) The average age of those engaged in formal education.
B) The amount of physical capital that each worker has to work with.
C) The accumulated skills and knowledge of human beings.
D) The sum of all assets owned by people.
Answer: C

108) All of the following, except one, will contribute to economic growth. Which is the exception?
A) Increased levels of human capital.
B) Technological change.
C) Increases in the capital stock.
D) Increased quantities of natural resources.
E) Higher prices.
Answer: E

109) What are the four components of aggregate demand?

A) Consumption, investment, government spending and net exports.
B) Consumption, investment, productivity and human capital.
C) LAS, AD, AS and the GDP deflator.
D) Consumption, investment, productivity and net exports.
Answer: A

110) What effect will an increase in the Canadian price level have on trade?
A) It will decrease the volume of both Canadian exports and imports.
B) It will increase the volume of Canadian exports but decrease the volume of imports.
C) It will decrease the volume of Canadian exports but increase the volume of imports.
D) It will increase the volume of both Canadian exports and imports.
Answer: C

25
111) What is the domestic effect of an increase in the incomes of a country's major international trading
partners?
A) The aggregate demand curve will shift to the left.
B) The aggregate demand curve will shift to the right.
C) The aggregate supply curve will shift to the right.
D) The aggregate supply curve will shift to the left.
Answer: B

112) Refer to the figure above to answer this question. All of the following, except one, would cause a
movement from a to b. Which is the exception?
A) An increase in wealth holdings.
B) An increase in foreign incomes.
C) An increase in government spending.
D) A decrease in the interest rate.
E) An increase in the price level.
Answer: E

113) Refer to the figure above to answer this question. Which of the following would cause a movement
from point a to point c?
A) An increase in government spending.
B) An increase in the interest rate.
C) An increase in wealth holdings.
D) An increase in foreign incomes.
E) A decrease in the price level.
Answer: B

26
Table 5.2 shows the aggregate demand and supply schedules for the economy of Adana.

114) Refer to Table 5.2 to answer this question. What are the implications if the price level is 100?
A) The price level is above equilibrium. B) There is a surplus of real output of $250.
C) There is a shortage of real output of $250. D) There is a surplus of real output of $150.
Answer: C

115) Refer to Table 5.2 to answer this question. If the aggregate quantity demanded falls by $100 at every
price level, what will be the new equilibrium price level and real output, respectively?
A) 110 and $650. B) 105 and $650. C) 100 and $550. D) 115 and $500.
Answer: B

116) Refer to Table 5.2 to answer this question. At what level of real output will full-employment occur
in this economy?
A) $700.
B) $650.
C) $600.
D) Cannot be determined from the information.
Answer: D

117) What is the slope of the aggregate supply curve, according to neoclassical economists?
A) Vertical, because prices tend to be inflexible.
B) Horizontal, because prices are flexible.
C) Horizontal, because wages are flexible.
D) Vertical at the capacity level of output in the economy.
Answer: D

27
118) Refer to the figure above to answer this question. If the economy was initially at point a, then what
would a movement to point b suggest?
A) The movement could be the result of an increase in aggregate demand.
B) It is a movement from one full-employment level of real GDP to another.
C) The movement could be the result of a decrease in wages.
D) The movement could be the result of expansionary monetary policy.
E) The movement could be the result of a decrease in prices.
Answer: C

119) What is the shape of the AS curve according to Keynesians?

A) Vertical, because prices tend to be inflexible.
B) Vertical, at the level of LAS.
C) Downward-sloping, because wages are inflexible.
D) Horizontal, because wages are inflexible.
Answer: D

120) Which of the following will provide a macroeconomy with prospects for sustained growth in the
future?
A) Increases in actual GDP.
B) Efficient use of all resources.
C) Unemployment at its natural rate.
D) Increases in aggregate demand.
E) Increases in long-run aggregate supply.
Answer: E

28
121) Which of the following is true of the concept of economic capacity?
A) It is impossible for an economy to produce at a higher level of output.
B) It is the amount firms prefer to produce at any price level.
C) It is equal to actual GDP.
D) It is very expensive for an economy to produce at a higher level of output.
E) It will always increase over time.
Answer: D

122) Which of the following will most likely lead to long-term economic growth?
A) A decrease in the interest rate.
B) A decrease in the price level.
C) An increase in consumer spending.
D) An increase in the quality of labour resources.
E) A decrease in the quantity of labour resources.
Answer: D

123) Which of the following statements about the AS curve is true?

A) It is usually a straight line.
B) The AS curve will shift when the price level increases.
C) The curve becomes steeper as it approaches potential GDP.
D) It is a function of aggregate demand.
E) Real wages are constant along an AS curve.
Answer: C

124) Which of the following is the result of the price level increasing while resource costs remain
constant?
A) A movement up the aggregate supply curve.
B) A shift to the left of the aggregate supply curve.
C) A shift to the right of the long-run aggregate supply curve.
D) A shift to the right of the aggregate supply curve.
E) A movement down the aggregate supply curve.
Answer: A

125) Explain how the substitution effect will affect aggregate demand when the price level decreases.
A) The substitution effect will cause aggregate demand to increase.
B) There's no substitution effect if incomes are also rising.
C) The substitution effect will cause aggregate demand to decrease.
D) There is no substitution effect as there's no substitute for all goods.
E) There is a substitution effect that is smaller than the income effect, so it's uncertain what will
happen to aggregate demand.
Answer: D

29
126) Which of the following is an example of the real-balances effect?
A) Consumption decreases when the price level increases, because future prices are expected to
fall.
B) Workers are better able to negotiate a wage increase when the price level increases.
C) Nominal interest rates will increase when the price level increases.
D) Consumption decreases because products are more expensive when the price level increases.
E) The real value of savings will decrease when the price level increases.
Answer: E

127) Which component of aggregate demand is most likely to change as a result of the interest-rate
effect?
A) Imports.
B) Investment.
C) Exports.
D) Government spending.
E) Consumption.
Answer: B

128) All of the following, except one, will shift the aggregate the demand to the right. Which is the
exception?
A) Increase in business expectations.
B) Increase in wealth.
C) Increase in income levels abroad.
D) Decrease government regulations.
E) Increase in the rate of interest.
Answer: E

129) Which of the following is true of a recessionary gap?

A) Firms will decrease output because the price level is low.
B) Firms have no incentive to produce more because it's very expensive to employ more labour.
C) It is correctly described as "too much money chasing too few goods."
D) Firms will increase output because real GDP is below potential GDP.
E) Firms have no incentive to produce more because they can't sell additional output.
Answer: E

130) Which of the following is true of an inflationary gap?

A) It is often described as "too much money chasing too many goods."
B) The level of aggregate demand is equal to potential GDP.
C) The level of aggregate demand is greater than the level of aggregate supply.
D) People are trying to buy more than the economy can produce on a sustainable basis.
E) It is often described as "too little money chasing too many goods."
Answer: D

30
131) Which of the following will likely happen if an economy is experiencing an inflationary gap?
A) Consumption will decrease because goods and services are too expensive.
B) Unemployment will be equal to the natural rate because of high aggregate demand.
C) Firms will bid up wage rates in an effort to attract and secure scarce labour.
D) Unemployment will be above the natural rate because real GDP is less than potential GDP.
E) Firms will bid down wage rates in order to create unemployment.
Answer: C

132) Which of the following is not a determinant of aggregate demand?

A) Foreign exchange rates. B) The money supply.
C) Interest rates. D) Labour productivity.
Answer: D

133) How will the age of the existing capital stock affect aggregate demand?
A) An older capital stock will increase the level of investment and decrease aggregate demand.
B) The age of the capital stock will not affect the level of investment or aggregate demand.
C) An older capital stock will increase the level of investment and increase aggregate demand.
D) An older capital stock will decrease the level of investment and decrease aggregate demand.
E) An older capital stock will decrease the level of investment and increase aggregate demand.
Answer: C

134) Which of the following is least likely to affect the level of government spending in an economy?
A) Political philosophy of the government.
B) People's expectations.
C) The amount of time left in a government's mandate.
D) Age of consumer durables.
E) Social and cultural standards.
Answer: D

135) Which of the following will cause a decrease in aggregate supply but no change in long-run
aggregate supply?
A) An increase in factor prices. B) A decrease in the labour participation rate.
C) An increase in the capital stock. D) A decrease in labour productivity.
Answer: A

136) According to Keynesian economists, why are prices and wages often inflexible?
A) Because of government regulation of the market.
B) Because the AS curve is vertical.
C) Because of high unemployment.
D) Because the AD curve is horizontal.
E) Because of the existence of large corporations and unions.
Answer: E

31
137) What is the relationship between LAS and the price level?
A) Negative. B) Independent.
C) Positive. D) Positive or negative.
Answer: B

138) A high interest rate will lead to:

A) high investment spending. B) no changes in investment spending.
C) no investment spending. D) low investment spending.
Answer: D

139) What is real wage?

A) It is equal to nominal wage plus the price level.
B) It is equal to the nominal wage divided by the price level.
C) It is equal to the nominal wage multiplied by the price level.
D) It is equal to the nominal wage minus the price level.
Answer: B

140) All of the following, except one, will change net exports. Which is the exception?
A) Foreign income.
B) Interest rates.
C) Price of competitive (foreign) goods.
D) Value of exchange rate.
E) Tastes of foreigners.
Answer: B

141) Assume an economy is currently in equilibrium with real GDP at $500 billion. If potential real GDP
(LAS) is $400 billion, which of the following is true?
A) There is a recessionary gap of $100 billion.
B) There is an inflationary gap of $100 billion.
C) There is an inflationary gap of 100 percent.
D) There is a recessionary gap of 100 percent.
Answer: B

142) Assume an economy is currently in equilibrium with real GDP at $716 billion. If potential real GDP
(LAS) is $627 billion, which of the following is true?
A) There is a recessionary gap of 89 percent. B) There is an inflationary gap of 89 percent.
C) There is an inflationary gap of $89 billion. D) There is a recessionary gap of $89 billion.
Answer: C

32
 143) Assume an economy is currently in equilibrium with real GDP at $1,627 billion. If potential real
GDP (LAS) is $1,800 billion, which of the following is true?
A) There is a recessionary gap of 173 percent.
B) There is an inflationary gap of $173 billion.
C) There is a recessionary gap of $173 billion.
D) There is an inflationary gap of 173 percent.
Answer: C

144) Assume an economy is currently in equilibrium with real GDP at $500 billion. If potential real GDP
(LAS) is $600 billion, which of the following is true?
A) There is a recessionary gap of 100 percent.
B) There is an inflationary gap of $100 billion.
C) There is a recessionary gap of $100 billion.
D) There is an inflationary gap of 100 percent.
Answer: C

145) An increase in exports will have what effect on aggregate demand?

A) It will increase.
B) It will have no effect on aggregate demand.
C) It will decrease.
D) It may increase or decrease depending on the marginal propensity to import.
Answer: A

TRUE/FALSE. Write 'T' if the statement is true and 'F' if the statement is false.

146) Aggregate demand is the total quantity of final goods and services that consumers, businesses,
government and those living outside the country would buy at various different price levels.
Answer: True False

147) The foreign-trade effect is the effect that a change in exports and imports has on the price level.
Answer: True False

148) The aggregate supply curve is upward-sloping.

Answer: True False

149) Macroeconomic equilibrium occurs where the aggregate demand is equal to long-run aggregate
supply.
Answer: True False

150) A change in resource prices will shift both the aggregate supply and the LAS curves.
Answer: True False

151) An increase in the long-run aggregate supply has no effect on macroeconomic equilibrium.
Answer: True False

33
 152) An increase in aggregate demand will cause an increase in both real GDP and the price level.
Answer: True False

153) An increase in wage rates will cause an increase in both real GDP and the price level.
Answer: True False

154) According to Keynes, the aggregate supply curve is vertical.

Answer: True False

155) According to neoclassicists, an increase in aggregate demand will have no effect upon real GDP but
will cause the price level to increase.
Answer: True False

SHORT ANSWER. Write the word or phrase that best completes each statement or answers the question.

156) What does the term potential GDP mean?

Answer: Potential GDP refers to the total amount that the economy is capable of producing when all of
its resources are being fully utilized. (It is also referred to as capacity GDP or full-employment
GDP).

157) What are the three reasons for the downward slope of the aggregate demand curve?
Answer: The aggregate demand curve is downward-sloping because of: real-balances effect which
refers to the fact that a lower price level increases the value of real balances which will cause
an increase in consumption; interest-rate effect which means that a lower price level will
reduce interest rates and thereby causing an increase in investment; foreign-trade effect which
means that a lower price level will make domestic products more competitive on world
markets thus increasing exports and decreasing imports.

158) What does the term aggregate supply mean?

Answer: Aggregate supply is the total quantity of goods and services produced by all sellers at various
price levels. It can be depicted in the form of a supply schedule or graph.

159) What factors can cause an increase in aggregate supply?

Answer: Aggregate supply will increase if there is:

• an improvement in human capital;

• an increase in the amount of capital;
• a technological improvement;
• an increase in natural resources;
• a decrease in factor prices.

34
160) Explain the three types of macroeconomic equilibrium.
Answer: Full employment equilibrium occurs when the economy is at both equilibrium and at full empl
output.
Below full employment equilibrium (a recessionary gap) occurs when the economy is at equilib
output but that output is below full employment output.
Above full employment equilibrium (an inflationary gap) occurs when the economy is at equili
output but that output is above full employment output.

161) Demonstrate graphically and explain a recessionary gap. Describe two solutions for closing the gap.
diagram of the gap:

The explanation of the gap diagram:

The diagram above shows a recessionary gap of (YFE-Y1 ). The economy is in equilibrium at point A
with price level P1 and real output level Y1 . A recessionary gap exists when equilibrium output is
below potential output as it is in the diagram.

35
Answer:

Diagram A: Allowing the economy to solve the problem on its own means waiting for the
excess supply of factors of production to result in a fall in costs and wages. When cost and
wages fall, the AS curve will shift right from AS to AS1 and will intersect AD at point B.
Point B represents a new equilibrium with a lower price level of P2 (P2 < P1) and an
increased real output level of Y FE (YFE > Y1). Since at point B our equilibrium output level i
potential output level, we no longer have a recessionary gap.

Diagram B

Diagram B: If the government gets actively involved and increases spending, this results in an i
36
 in AD from AD to AD1 . The result is a new equilibrium at point B. At point B the price level i
now a higher P2 and real output has increased from Y1 to YFE, and the recessionary gap has
been closed.

162) Demonstrate graphically and explain the case of an inflationary gap. Describe the forces in the
economy that will result in the gap closing itself.
Answer: The diagram:

The explanation:
Initially we are in equilibrium with a price level of P 1 and real output level of Y1 . An inflation
gap of (Y1 - YFE) exists because our current equilibrium level (Y1 ) is greater than the
potential output level (YFE). When this occurs the economy is straining its resources. To be
able to produce beyond the potential output level, workers must work overtime and firms get
extra workers by bidding them away from other companies. The result is higher wages and
increased costs for firms. The increase in wages and costs results in the AS curve shifting up
from AS to AS1 .

37
163) Indicate whether each of the following factors will affect aggregate demand (AD) or aggregate
supply (AS) and whether the effect would be an increase or a decrease. Then indicate what will
happen to the price level and the level of real GDP and what type of equilibrium will result
assuming that the economy is initially in a long-run equilibrium.

a) A decrease in the nominal wage rate.

b) A decrease in exports.
c) A decrease in the exchange rate.
d) The discovery of vast new oil field in Northern B.C.
e) An increase in government spending.

Answer:

164) Suppose that the economy of Umbria is initially at full-employment equilibrium. Explain, in terms of
AD or AS, how the following results could occur:

a) Real GDP increases; the price level decreases; the economy is experiencing an inflationary gap.
b) Real GDP increases; the price level increases; the economy is experiencing an inflationary gap.
c) Real GDP increases; the price level decreases; the economy is experiencing a recessionary gap.
d) Real GDP decreases; the price level increases; the economy is experiencing a recessionary gap.
e) Real GDP decreases; the price level increases; the economy is experiencing an inflationary gap.
Answer: a) Increase in AS
b) Increase in AD
c) Increase in AS and in potential GDP
d) Decrease in AS
e) Decrease in AS and in potential GDP.

38
165) Assume that the potential GDP in the economy of Peruggia is $750 and that the aggregate demand an
aggregate supply are as shown below:

a) What is the value of equilibrium GDP and the price level? What type of macroeconomic equilibriu
exists?
b) Suppose that a serious firestorm hits parts of the country reducing its aggregate supply by $130. W
be the new values of equilibrium GDP and the price level?
c) What type of gap now exists and what is its size.
Answer: a) Price level: 110; GDP: $750; full-employment equilibrium.
b) Price level: 112; GDP: $710
c) (Above full-employment equilibrium) inflationary gap of $90. (Potential GDP has fallen to $

166) Assume that the nominal wage rate increases from $16.50 to $18.40 and, at the same time, the price
index increases from 110 to 115. By how much has the real wage rate changed?
Answer: Real wage has increase by $1, or 6.7%, from $15 ($16.5/110 x 100) to $16 ($18.40/115 x
100).

39
167) The following figure depicts the economy of Atlas, which is presently in equilibrium.

a) What is the size of its recessionary gap?

b) What is the size of its gap as a percentage of its actual GDP?
c) If the natural rate of unemployment is 5 percent, using Okun's Law, calculate the amount of unemp
in Atlas.
Answer: a) $100
b) 25%
c) 15% (Cyclical unemployment = 25% x (1/2.5) = 10% + natural rate of 5%)

40
168) Suppose that the economy of Wetland shown in the following figure is in full-employment equilibriu
present nominal wage is $800 per week

a) What is the real wage (in base year prices)?

b) Suppose that aggregate demand increases by $100. At the new equilibrium, what will be the new v
the real wage rate?
c) As a result of the change in b), suppose the nominal wage increases, causing aggregate supply to d
by $100. At the new equilibrium, what will be the new real wage rate?
d) At the new equilibrium in c), what is the value of the nominal wage rate?
Answer: a) $1,000 per week. ($800/80 x 100)
b) $800 per week. ($800/100 x 100)
c) $1,000 per week. (Real wage rate is constant at full-employment GDP. Therefore, same as in
d) $1,200 per week ($1,000 x 120/100).

169) Why is the aggregate supply curve upward sloping?

Answer: All else held constant, an increase in the price level will increase profits and this will cause the
firm to increase production.

170) "A change in aggregate supply implies a change in potential GDP and a change in potential GDP
implies a change in aggregate supply." Evaluate this statement.
Answer: The first part of the statement is incorrect. The factors that change potential GDP are the same
factors that change aggregate supply, but the factors that change aggregate supply does not
necessarily change potential GDP. A change in factor prices will change aggregate supply but
not potential GDP. However, the second part of the statement is incorrect.

41
171) Assume that an economy is at full employment.

a) Using an AD/AS diagram, illustrate the economy at full employment.

b) Now suppose there is an increase in exports. Explain and illustrate in the same diagram (as part a),
effect of this increase.
c) Explain how the economy will revert back to full employment by itself.
Answer: a)

b) An increase in exports will shift the aggregate demand curve to the right. This will lead to an
in the price level and real GDP and the economy will have an inflationary gap.

c) Since there is an inflationary gap the economy is over-employed. Factor prices will rise whic
decrease aggregate supply.

42
172) Assume that an economy is at full employment.

a) Using an AD/AS diagram, graphically illustrate the economy at full employment.

b) Now suppose there is a decrease in imports. Explain and illustrate in the same diagram (as part a),
effect of this decrease.
c) Explain how the economy will revert back to full employment by itself.
Answer: a)

b) A decrease in imports will shift the aggregate demand curve to the right. This will lead to an
in the price level and real GDP and the economy will have an inflationary gap.

c) Since there is an inflationary gap the economy is over-employed. Faced with high demand, f
producing above their normal capacity and find it difficult to hire labour. Nominal wages (facto
will rise which would decrease aggregate supply.

43
173) Assume that an economy is at full employment.

a) Using an AD/AS diagram, graphically illustrate the economy at full employment.

b) Now suppose there is an increase in imports. Illustrate in the same diagram (as part a), the effect o
increase in imports.
Answer: a)

b) Increases in imports will shift the aggregate demand curve to the left. This will lead to a dec
the price level and real GDP and the economy will have a recessionary gap.

44
174) What are the components of aggregate demand?
Answer: The components of aggregate demand are:

• consumption;
• investment;
• government spending on goods and services;
• net exports.

175) Assume that the economy is at full employment. Now suppose there is an increase in consumption. A
equilibrium,

a) will there be an output gap? What type?

b) what is the effect on the price level?
c) what is the effect on the level of real GDP
Answer: An increase in consumption expenditure will increase aggregate demand and an increase in agg
demand will lead to an

a) inflationary gap.
b) increase in the price level.
c) increase in real GDP.

176) Assume that the economy is at full employment. Now suppose a decrease in investment spending. At
equilibrium,

a) will there be an output gap? What type?

b) what is the effect on the price level?
c) what is the effect on the level of real GDP?
Answer: An decrease in investment will decrease aggregate demand and this will lead to a

a) recessionary gap
b) decrease in the price level
c) decrease in real GDP

45
177) Assume that the economy is at full employment. Now suppose there is an increase in the size of the l
force. At the new equilibrium,

a) Will there be an output gap? What type?

b) What is the effect on the price level?
c) What is the effect on the level of real GDP?
Answer: An increase in the size of the labour force will increase Long-run Aggregate Supply and aggreg
supply and this will lead to a(n)

a) Recessionary gap.
b) Decrease in the price level.
c) Increase in real GDP.

178) Assume that the economy is at full employment. For each of the following events determine whether
will be an output gap. If yes, what type?

a) Increase in aggregate demand.

b) Increase in aggregate supply.
c) Increase in long-run aggregate supply.
d) Decrease in long-run aggregate supply.
Answer: a) Yes, inflationary gap.
b) Yes, inflationary gap.
c) Yes, recessionary gap.
d) Yes, inflationary gap.

179) Explain why a decrease in nominal wages does not necessarily imply a decrease in real wages.
Answer: Real wage is equal to nominal wage divided by the price level. If the percentage decrease in
the price level is greater than the percentage decrease in nominal wages, then the real wage
will increase. And if the percentage decrease in the price level is equal to the percentage
decrease in nominal wages, the real wage will not change.

180) What are the three determinants of consumption?

Answer: The three determinants of consumption are
• wealth;
• age of consumer durables;
• consumer expectations.

181) Assume there is an inflationary gap in the economy. If investment spending increases, what will
happen to the inflationary gap?
Answer: An increase in investment will increase aggregate demand and the size of the inflationary gap
will increase.

46
182) The following table shows the aggregate demand and aggregate supply schedules for the economy of
Andrews

a) What are the equilibrium values of price and real GDP?

b) If the price level were 100, would there be a surplus or a shortage? How much? Explain how the e
will revert back to equilibrium.
Answer: a) The equilibrium price level is 110 and the value of real GDP is $140.
b) If the price level is 100, there is a shortage of $30. Since the aggregate quantity demanded is
than the aggregate quantity supplied, the price level will increase.

183) Explain the modern view of the aggregate supply curve.

Answer: The modern view of the aggregate supply curve is that at low levels of real GDP the aggregate
supply is relatively flat, the Keynesian range. As real GDP rises, the aggregate supply
becomes steeper. In the middle of the aggregate supply curve is the intermediate range. As real
GDP approaches full employment the aggregate supply curve becomes almost vertical, the
neoclassical range.

47
184) The following table shows the aggregate demand and aggregate supply schedules for the economy of
Island

a) What are the equilibrium values of price and real GDP?

b) Suppose potential GDP is $1,600. What is the output gap for Queen's Island?
c) Assume that aggregate demand shift so such that economy of Queen's Island is at full employment
and by how much does the aggregate demand change? What are the new equilibrium values of price
GDP?
d) Assume that aggregate supply shifts so that economy of Queen's Island is at full employment. How
how much does the aggregate supply change? What are the new equilibrium values of price and real
Answer: a) Equilibrium price level is 110 and the value of real GDP is $1,400.
b) There is a recessionary gap of $200 for Queen's Island because potential GDP is greater than
GDP.
c) Aggregate demand increases by $600 at every price level. The new equilibrium price level is
the value of real GDP is $1,600.
d) Aggregate supply increases by $300 at every price level. The new equilibrium price level is
100 and the value of real GDP is $1,600.

185) What are the five determinants of investment spending?

Answer: The determinants of investment spending are:
• interest rates;
• purchase price, installation and maintenance cost of capital goods;
• age of capital goods and amount of space capacity;
• business expectations;
• government regulations.

186) List the four factors that can cause a decrease in exports?
Answer: The following will cause a decrease in exports:
• increase in the exchange rates;
• decrease in income levels abroad;
• decrease in the price of competitive (foreign) goods;
• decrease in the preference for exports (by foreigners).

48
187) Distinguish between physical capital and human capital.
Answer: Physical capital is all human-made resources that can be used to produce goods and services.
Human capital is the accumulated skills and knowledge of human beings; it is the quality of
the labour resources.

188) Distinguish the difference between a Keynesian AS curve and Neoclassical AS curve
Answer: Keynesian economists believed that prices and wages are not flexible because the market is
not competitive and inefficient; therefore any changes in aggregate demand will have little
impact on the price level. The aggregate supply curve, according to Keynesians, is horizontal
at the prevailing price level. Neoclassical economists believed that prices and wages are
flexible because the market is competitive and efficient; therefore any changes in aggregate
demand will have no effect on real GDP and only affect the price level. The aggregate supply
curve, according to neoclassical school, is vertical at the full-employment level of real GDP.

49
Answer Key
Testname: UNTITLED4

1) B
2) D
3) A
4) D
5) C
6) A
7) C
8) E
9) B
10) D
11) C
12) D
13) D
14) A
15) A
16) C
17) C
18) E
19) C
20) A
21) C
22) E
23) B
24) A
25) C
26) B
27) B
28) D
29) C
30) D
31) D
32) B
33) A
34) D
35) A
36) A
37) B
38) D
39) D
40) A
41) C
42) D
43) C
44) C
45) A
46) B
47) C
48) A
49) E
50) B
50
Answer Key
Testname: UNTITLED4

51) C
52) B
53) C
54) C
55) C
56) A
57) D
58) D
59) D
60) E
61) C
62) A
63) E
64) D
65) B
66) D
67) B
68) C
69) B
70) D
71) A
72) D
73) D
74) D
75) A
76) A
77) A
78) D
79) C
80) A
81) D
82) C
83) B
84) E
85) E
86) E
87) C
88) B
89) C
90) A
91) C
92) C
93) C
94) C
95) A
96) C
97) D
98) A
99) C
100) D
51
Answer Key
Testname: UNTITLED4

101) B
102) B
103) B
104) C
105) A
106) A
107) C
108) E
109) A
110) C
111) B
112) E
113) B
114) C
115) B
116) D
117) D
118) C
119) D
120) E
121) D
122) D
123) C
124) A
125) D
126) E
127) B
128) E
129) E
130) D
131) C
132) D
133) C
134) D
135) A
136) E
137) B
138) D
139) B
140) B
141) B
142) C
143) C
144) C
145) A
146) TRUE
147) FALSE
148) TRUE
149) FALSE
150) FALSE
52
Answer Key
Testname: UNTITLED4

151) FALSE
152) TRUE
153) FALSE
154) FALSE
155) TRUE
156) Potential GDP refers to the total amount that the economy is capable of producing when all of its
resources are being fully utilized. (It is also referred to as capacity GDP or full-employment GDP).
157) The aggregate demand curve is downward-sloping because of: real-balances effect which refers to the fact
that a lower price level increases the value of real balances which will cause an increase in consumption;
interest-rate effect which means that a lower price level will reduce interest rates and thereby causing an
increase in investment; foreign-trade effect which means that a lower price level will make domestic
products more competitive on world markets thus increasing exports and decreasing imports.
158) Aggregate supply is the total quantity of goods and services produced by all sellers at various price levels.
It can be depicted in the form of a supply schedule or graph.
159) Aggregate supply will increase if there is:

• an improvement in human capital;

• an increase in the amount of capital;
• a technological improvement;
• an increase in natural resources;
• a decrease in factor prices.
160) Full employment equilibrium occurs when the economy is at both equilibrium and at full employment outp
Below full employment equilibrium (a recessionary gap) occurs when the economy is at equilibrium output
output is below full employment output.
Above full employment equilibrium (an inflationary gap) occurs when the economy is at equilibrium outpu
that output is above full employment output.

53
Answer Key
Testname: UNTITLED4

161)

Diagram A: Allowing the economy to solve the problem on its own means waiting for the excess supply of
factors of production to result in a fall in costs and wages. When cost and wages fall, the AS curve will
shift right from AS to AS1 and will intersect AD at point B. Point B represents a new equilibrium with a
lower price level of P2 (P2 < P1) and an increased real output level of Y FE (YFE > Y1). Since at point B
our equilibrium output level is the potential output level, we no longer have a recessionary gap.

Diagram B

54
Answer Key
Testname: UNTITLED4

Diagram B: If the government gets actively involved and increases spending, this results in an increase in A
AD to AD1 . The result is a new equilibrium at point B. At point B the price level is now a higher P 2 and
real output has increased from Y1 to YFE, and the recessionary gap has been closed.
162) The diagram:

The explanation:
Initially we are in equilibrium with a price level of P 1 and real output level of Y1 . An inflationary gap of (Y
YFE) exists because our current equilibrium level (Y1 ) is greater than the potential output level (Y FE).
When this occurs the economy is straining its resources. To be able to produce beyond the potential output
level, workers must work overtime and firms get extra workers by bidding them away from other
companies. The result is higher wages and increased costs for firms. The increase in wages and costs
results in the AS curve shifting up from AS to AS 1.

163)
164) a) Increase in AS
b) Increase in AD
c) Increase in AS and in potential GDP
d) Decrease in AS
e) Decrease in AS and in potential GDP.
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Answer Key
Testname: UNTITLED4

165) a) Price level: 110; GDP: $750; full-employment equilibrium.

b) Price level: 112; GDP: $710
c) (Above full-employment equilibrium) inflationary gap of $90. (Potential GDP has fallen to $620.
166) Real wage has increase by $1, or 6.7%, from $15 ($16.5/110 x 100) to $16 ($18.40/115 x 100).
167) a) $100
b) 25%
c) 15% (Cyclical unemployment = 25% x (1/2.5) = 10% + natural rate of 5%)
168) a) $1,000 per week. ($800/80 x 100)
b) $800 per week. ($800/100 x 100)
c) $1,000 per week. (Real wage rate is constant at full-employment GDP. Therefore, same as in a).)
d) $1,200 per week ($1,000 x 120/100).
169) All else held constant, an increase in the price level will increase profits and this will cause the firm to
increase production.
170) The first part of the statement is incorrect. The factors that change potential GDP are the same factors that
change aggregate supply, but the factors that change aggregate supply does not necessarily change
potential GDP. A change in factor prices will change aggregate supply but not potential GDP. However,
the second part of the statement is incorrect.
171) a)

b) An increase in exports will shift the aggregate demand curve to the right. This will lead to an increase in
level and real GDP and the economy will have an inflationary gap.

56
Answer Key
Testname: UNTITLED4

c) Since there is an inflationary gap the economy is over-employed. Factor prices will rise which would dec
aggregate supply.
172) a)

b) A decrease in imports will shift the aggregate demand curve to the right. This will lead to an increase in
level and real GDP and the economy will have an inflationary gap.

57
Answer Key
Testname: UNTITLED4

c) Since there is an inflationary gap the economy is over-employed. Faced with high demand, firms are pro
above their normal capacity and find it difficult to hire labour. Nominal wages (factor prices) will rise whic
decrease aggregate supply.

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Answer Key
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173) a)

b) Increases in imports will shift the aggregate demand curve to the left. This will lead to a decrease in the
and real GDP and the economy will have a recessionary gap.

174) The components of aggregate demand are:

• consumption;
• investment;
• government spending on goods and services;
• net exports.

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Answer Key
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175) An increase in consumption expenditure will increase aggregate demand and an increase in aggregate dema
lead to an

a) inflationary gap.
b) increase in the price level.
c) increase in real GDP.
176) An decrease in investment will decrease aggregate demand and this will lead to a

a) recessionary gap
b) decrease in the price level
c) decrease in real GDP
177) An increase in the size of the labour force will increase Long-run Aggregate Supply and aggregate supply a
will lead to a(n)

a) Recessionary gap.
b) Decrease in the price level.
c) Increase in real GDP.
178) a) Yes, inflationary gap.
b) Yes, inflationary gap.
c) Yes, recessionary gap.
d) Yes, inflationary gap.
179) Real wage is equal to nominal wage divided by the price level. If the percentage decrease in the price level
is greater than the percentage decrease in nominal wages, then the real wage will increase. And if the
percentage decrease in the price level is equal to the percentage decrease in nominal wages, the real wage
will not change.
180) The three determinants of consumption are
• wealth;
• age of consumer durables;
• consumer expectations.
181) An increase in investment will increase aggregate demand and the size of the inflationary gap will
increase.
182) a) The equilibrium price level is 110 and the value of real GDP is $140.
b) If the price level is 100, there is a shortage of $30. Since the aggregate quantity demanded is greater than
aggregate quantity supplied, the price level will increase.
183) The modern view of the aggregate supply curve is that at low levels of real GDP the aggregate supply is
relatively flat, the Keynesian range. As real GDP rises, the aggregate supply becomes steeper. In the
middle of the aggregate supply curve is the intermediate range. As real GDP approaches full employment
the aggregate supply curve becomes almost vertical, the neoclassical range.

60
Answer Key
Testname: UNTITLED4

184) a) Equilibrium price level is 110 and the value of real GDP is $1,400.
b) There is a recessionary gap of $200 for Queen's Island because potential GDP is greater than actual GDP
c) Aggregate demand increases by $600 at every price level. The new equilibrium price level is 130 and the
real GDP is $1,600.
d) Aggregate supply increases by $300 at every price level. The new equilibrium price level is 100 and the
value of real GDP is $1,600.
185) The determinants of investment spending are:
• interest rates;
• purchase price, installation and maintenance cost of capital goods;
• age of capital goods and amount of space capacity;
• business expectations;
• government regulations.
186) The following will cause a decrease in exports:
• increase in the exchange rates;
• decrease in income levels abroad;
• decrease in the price of competitive (foreign) goods;
• decrease in the preference for exports (by foreigners).
187) Physical capital is all human-made resources that can be used to produce goods and services. Human
capital is the accumulated skills and knowledge of human beings; it is the quality of the labour resources.
188) Keynesian economists believed that prices and wages are not flexible because the market is not competitive
and inefficient; therefore any changes in aggregate demand will have little impact on the price level. The
aggregate supply curve, according to Keynesians, is horizontal at the prevailing price level. Neoclassical
economists believed that prices and wages are flexible because the market is competitive and efficient;
therefore any changes in aggregate demand will have no effect on real GDP and only affect the price level.
The aggregate supply curve, according to neoclassical school, is vertical at the
full-employment level of real GDP.

61