CHAPTER 5

AGGREGATE SUPPLY AND DEMAND

Difficulty: Easy
1. If factor markets were perfectly competitive, then full employment would be the normal
condition and
A) inflation would always be zero
B) output would rise steadily with price increases
C) there would never be any reason for prices to change
D) the AS-curve would be horizontal
E) the AS-curve would be vertical
Ans: E

Difficulty: Difficult
2. In the medium run, if government purchases are increased and nominal money supply is
decreased, we can expect that
A) aggregate demand and prices will increase but interest rates will not change
B) aggregate demand, prices, and the interest rate will all decrease
C) aggregate demand and interest rates will decrease but prices will increase
D) the AD-curve will shift to the right and the AS-curve will shift to the left
E) the interest rate will increase while aggregate demand and prices may increase, decrease, or
remain the same
Ans: E

Difficulty: Medium
3. The AS-curve is horizontal or very flat if
A) additional resources (especially labor) can be hired to produce additional output with little or
no increase in existing prices
B) wages fall rapidly with an increase in unemployment, reducing spending and income to
restore equilibrium
C) firms lower wages less than prices to avoid a loss in profit during a recession
D) the nominal wage adjustment occurs fairly rapidly
E) nominal wages and prices always change proportionally, leaving the real wage rate
unchanged
Ans: A

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Difficulty: Easy
4. Assume you mistakenly buried a $100 bill in a time capsule in 1970 and dug it up again in
2012. What would be its real purchasing power ?
A) $122
B) $100
C) $88
D) $42
E) $17
Ans: E

Difficulty: Medium
5. Which of the following was NOT true during the Great Depression?
A) investment as a share of GDP was below 3 percent
B) unemployment averaged about 18.8 percent
C) prices dropped by one-fourth
D) output fell by nearly 30 percent
E) both B) and C)
Ans: A

Difficulty: Easy
6. The level of GDP that corresponds to full employment in the labor market is called
A) potential GDP
B) real GDP
C) nominal GDP
D) natural GDP
E) GDP per capita
Ans: A

Difficulty: Easy
7. Most economists prior to Keynes thought that
A) unemployment could be eliminated by active fiscal policies
B) the economy always adjusted rapidly to full employment
C) the economy always adjusted to a natural rate of inflation
D) monetary policy could be employed to eliminate the business cycle
E) government intervention was needed to avoid persistent unemployment
Ans: B

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Difficulty: Medium
8. The Keynesian AS-curve differs from the classical AS-curve, since Keynes
A) thought that labor markets worked smoothly to always establish full employment
B) thought that nominal wages were flexible even when there was unemployment
C) thought that nominal wages were rigid even when there was unemployment
D) described the AS-curve as completely vertical
E) assumed that firms tried to exploit the work force by paying them substandard wages
Ans: C

Difficulty: Medium
9. The Keynesian AS-curve implies that
A) the economy is always at the full-employment level of output
B) the price level is unaffected by current levels of GDP
C) wages are perfectly flexible
D) real money balances decrease as the AD-curve shifts to the right
E) an increase in nominal money supply will not affect the level of real GDP
Ans: B

Difficulty: Medium
10. In the Keynesian aggregate supply curve case,
A) firms will always supply the amount of goods demanded at the existing price level
B) consumers will demand whatever is supplied by firms at each price
C) the economy is always at full employment
D) unemployment is always at its natural rate
E) none of the above
Ans: A

Difficulty: Medium
11. In which of the following cases will the AS-curve be horizontal?
A) if nominal wages and prices always change proportionally, leaving real wages unchanged
B) if nominal wages do not change even if there is high unemployment
C) if nominal wages are completely flexible
D) if the economy is always in a full-employment equilibrium
E) if fiscal policy has no impact on the output level
Ans: B

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Difficulty: Easy
12. Given the Keynesian AS-curve, expansionary monetary policy will
A) increase the level of output but leave the price level unchanged
B) increase the price level but leave the level of output unchanged
C) increase both the level of output and the price level
D) leave the level of output and the price level unchanged
E) increase the level of output but decrease the price level
Ans: A

Difficulty: Easy
13. In the Keynesian aggregate supply curve case, a fiscal expansion will
A) have no impact on equilibrium income or prices
B) increase prices but have no impact on equilibrium income
C) increase prices more than income
D) increase income more than prices
E) increase equilibrium income but have no impact on prices
Ans: E

Difficulty: Medium
14. Which of the following is FALSE?
A) the AS-curve is horizontal in the Keynesian case
B) the AS-curve is vertical in the classical case
C) the AS-curve is upward sloping in the medium run
D) the AS-curve is more price elastic in the long run than in the short run
E) none of the above
Ans: D

Difficulty: Easy
15. The AD-AS diagram used in this chapter
A) is unrelated to the demand and supply diagram used in microeconomics
B) uses the average price level of all goods and services we buy as “price”
C) uses an AS-curve that is relatively more price elastic in the medium run than in the long run
D) uses an AS-curve that is vertical in the long run and horizontal in the very short run
E) all of the above
Ans: E

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Difficulty: Easy
16. Which of the following is NOT reflected in a shift of the AD-curve?
A) a change in real money balances due to a change in the price level
B) a change in real money balances due to a change in nominal money supply
C) a change in government transfer payments
D) a change in the confidence of consumers and businesses
E) all of the above will shift the AD-curve
Ans: A

Difficulty: Easy
17. The slope of the AS-curve becomes steeper
A) as nominal wages become more flexible
B) as nominal wages become more rigid
C) as the actual level of output moves further away from potential output
D) as the economy approaches full employment
E) both A) and D)
Ans: E

Difficulty: Medium
18. A decrease in real money supply caused by an increase in the price level is graphically
represented by
A) a shift of the AD-curve to the right
B) a shift of the AD-curve to the left
C) movement along the AD-curve to the right
D) movement along the AD-curve to the left
E) a shift of the AS-curve to the right
Ans: D

Difficulty: Easy
19. The natural rate of unemployment is
A) always zero
B) the unemployment rate that exists when inflation is zero
C) the unemployment rate that exists when output is assumed to be at its full-employment level
D) the unemployment rate that exists above frictional unemployment
E) none of the above
Ans: C

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Difficulty: Easy
20. Frictional unemployment is defined as
A) all unemployment above the natural rate
B) unemployment that is cyclical in nature
C) the natural unemployment rate minus cyclical unemployment
D) unemployment resulting from people shifting between jobs and looking for new jobs
E) any unemployment that is above 6%
Ans: D

Difficulty: Easy
21. If output is at its full-employment level, then
A) the actual unemployment rate is zero
B) the natural rate of unemployment is zero
C) there are no frictions in the labor market since wages have reached their market-clearing
level
D) there is still some positive level of unemployment due to frictions in the labor market
E) nobody who is currently employed is looking for a new job
Ans: D

Difficulty: Medium
22. A shift of the AD-curve to the left can be caused by
A) a decrease in taxes
B) an increase in business and consumer confidence
C) an increase in nominal money supply
D) a decrease in government transfer payments
E) a decrease in money demand
Ans: D

Difficulty: Medium
23. The AD-curve has a negative slope since
A) firms will produce less if they have to lower their prices
B) lower prices mean higher real wages so firms can no longer afford to produce as many goods
and services
C) a decrease in the price level increases real money balances, leading to lower interest rates and
increased spending
D) lower prices drive up the demand for goods since buyers fear future market shortages
E) lower prices increase consumer confidence, which encourages spending
Ans: C

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Difficulty: Medium
24. A shift of the AD-curve to the right could be caused by
A) a decrease in taxes
B) a decrease in government transfer payments
C) an increase in money demand
D) a decrease in defense spending
E) both A) and C)
Ans: A

Difficulty: Easy
25. An increase in aggregate demand can be caused by
A) an increase in government expenditures
B) an increase in nominal money supply
C) a decrease in taxes
D) an increase in business and consumer confidence
E) all of the above
Ans: E

Difficulty: Medium
26. To maintain a fixed level of aggregate demand, a central bank would have to respond to a tax
increase by
A) increasing reserve requirements for banks
B) restricting money supply
C) buying bonds in the open market
D) selling bonds in the open market
E) both A) and B)
Ans: C

Difficulty: Medium
27. In a normal AD-AS diagram with an upward-sloping AS-curve, if the government wanted to
maintain a fixed level of output, it would need to respond to a decrease in money supply by
A) decreasing government expenditures
B) increasing government spending
C) urging the Fed to sell bonds in the open market
D) increasing income taxes
E) decreasing taxes and government spending by the same amount
Ans: B

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Difficulty: Medium
28. In an AD-AS diagram with an upward-sloping AS-curve, if a tax decrease is combined with
money expansion,
A) output will remain relatively unaffected but interest rates will decrease
B) output will remain relatively unaffected but interest rates will definitely increase
C) aggregate demand, the price level, and output will all decrease
D) aggregate demand, the price level, and output will all increase
E) the price level will increase but we can't say what will happen to output or interest rates
Ans: D

Difficulty: Difficult
29. If government purchases and taxes are both increased by the same lump sum, we can expect
the following in the medium run:
A) output, prices, and interest rates will all remain unchanged
B) output, prices, and interest rates will all decrease
C) output, prices, and interest rates will all increase
D) output and prices will remain the same but interest rates will increase
E) output and prices will increase but interest rates will remain the same
Ans: C

Difficulty: Medium
30. In an AD-AS diagram with an upward-sloping AS-curve, an increase in money supply will
A) increase output and the price level but not affect the interest rate
B) increase output, the price level, and the interest rate
C) increase output and the price level but lower the interest rate
D) decrease the interest rate, increase the price level, but leave output unchanged
E) increase the price level but leave output and the interest rate unchanged
Ans: C

Difficulty: Medium
31. When nominal money supply is held constant and the price level increases, then
A) real money balances increase and real interest rates decrease
B) real money balances decrease and real interest rates increase
C) real money balances decrease and real interest rates remain the same
D) the AS-curve must have shifted to the right
E) both B) and D)
Ans: B

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Difficulty: Medium
32. In the medium run, if government purchases are decreased and nominal money supply is
increased, then we can expect that
A) aggregate demand will decrease and aggregate supply will increase, leaving the level of
output the same
B) output, prices, and interest rates will all increase
C) output and prices will decrease, while interest rates will increase
D) interest rates will decrease, while output and prices may increase, decrease, or remain the
same
E) none of the above
Ans: D

Difficulty: Easy
33. A decrease in nominal money supply will be reflected in
A) a shift of the AD-curve to the right
B) a shift of the AD-curve to the left
C) movement along the AD-curve from right to left
D) movement along the AD-curve from left to right
E) a shift of the AS-curve to the left
Ans: B

Difficulty: Medium
34. Expansionary fiscal policy is very effective in significantly increasing the level of output
A) if the AS-curve is totally price inelastic
B) in the classical case
C) if the economy is close to full employment
D) if the economy is in a recession
E) both A) and D)
Ans: D

Difficulty: Easy
35. Expansionary monetary policy will increase nominal GDP
A) in the Keynesian case
B) in the classical case
C) in the medium run
D) all of the above
E) only A) and C)
Ans: D

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Difficulty: Difficult
36. In the classical supply curve case, monetary expansion will
A) increase P, lower i, and leave Y unchanged
B) increase Y, lower i, and leave P unchanged
C) leave Y and i unchanged but increase P
D) leave Y, i, and P unchanged
E) increase Y, i, and P
Ans: C

Difficulty: Medium
37. In which of the following cases is expansionary fiscal policy LEAST effective in increasing
output?
A) if wages adjust rapidly to maintain equilibrium in the labor market
B) if wages do not change much even when there is high unemployment
C) if it is combined with expansionary monetary policy
D) if we have a Keynesian AS-curve
E) if the Fed is trying hard to keep interest rates from rising
Ans: A

Difficulty: Medium
38. An increase in government purchases will NOT increase the level of output if
A) the AS-curve is totally price elastic
B) the price level is fixed
C) wages and prices are completely rigid
D) wages and prices are completely flexible
E) real money balances are not affected
Ans: D

Difficulty: Medium
39. Fiscal policy will affect prices and interest rates but not the level of output if
A) the AD-curve is vertical
B) the AS-curve is vertical
C) the AD-curve is horizontal
D) the AS-curve is horizontal
E) both A) or D)
Ans: B

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Difficulty: Medium
40. Assume investment is very interest sensitive and wages always adjust immediately to
maintain an equilibrium in the labor market. Which of the following would be most effective
in significantly increasing the level of output?
A) expansionary fiscal policy
B) expansionary monetary policy
C) increased government spending accompanied by monetary expansion
D) an increase in government transfer payments
E) none of the above policies would succeed in significantly increasing the level of output
Ans: E

Difficulty: Medium
41. In the AD-AS model, fiscal or monetary policy cannot affect the level of output in
A) the medium run and the long run
B) the medium run and the short run
C) the short run only
D) the medium run only
E) the long run only
Ans: E

Difficulty: Medium
42. The income velocity of money can be calculated using the following formula
A) V = M/(PY)
B) V = (MY)/P
C) V = (PY)/M
D) V = MY
E) none of the above
Ans: C

Difficulty: Easy
43. A large decrease in the income tax rate will most likely cause
A) a fairly large increase in aggregate demand
B) a fairly small increase in aggregate supply
C) an increase in the price level
D) all of the above
E) none of the above
Ans: D

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Difficulty: Medium
44. If nominal GDP is $12,600 billion and nominal money supply is $6,300 billion, then the
income velocity of money is
A) V = $2 billion
B) V = 0.5
C) V = 2
D) V can only be determined if the price level is known
E) none of the above
Ans: C

Difficulty: Medium
45. If restrictive monetary policy leads to a lower price level but leaves real output, employment,
and real interest rates unchanged, then
A) real money balances must be unchanged
B) it must have been accompanied by expansionary fiscal policy
C) it must have been accompanied by restrictive fiscal policy
D) money is said to be neutral
E) both A) and D)
Ans: E

Difficulty: Easy
46. Supply-side economics involves policy measures designed to
A) encourage technological progress
B) remove unnecessary government regulations
C) give investment tax credits to stimulate specific capital investments
D) all of the above
E) none of the above
Ans: D

Difficulty: Medium
47. Cutting income tax rates will most likely cause
A) a large shift in the AD-curve but a small shift in the AS-curve
B) a small shift in the AD-curve but a large shift in the AS-curve
C) a large increase in output resulting in a large increase in tax revenues
D) a budget deficit so large that income growth is no longer possible
E) both B) and C)
Ans: A

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Difficulty: Easy
48. When we say that potential GDP is exogenous with respect to the price level, we refer to
A) the fact that changes in real money balances cause output to rise
B) the fact that the long-run AS-curve shifts to the right over time
C) the short-run AS-curve
D) the medium-run AS-curve
E) the Keynesian AS-curve
Ans: B

Difficulty: Medium
49. In the long run, as potential GDP grows at a steady pace and nominal money supply is
continuously increased over time
A) the level of output is essentially determined by shifts in the AS-curve
B) the level of output is essentially determined by shifts in the AD-curve
C) the price level will not change since the AS-curve is horizontal
D) real money balances continuously decrease as the AD-curve remains constant
E) the price level is determined solely by the shift in the AS-curve
Ans: A

Difficulty: Medium
50. As nominal money supply is steadily increased and the long-run AS-curve shifts to the right
over time, we realize that
A) the price level decreases since the AS-curve shifts right while the AD-curve remains constant
B) the price level stays the same, while output continuously increases
C) the price level increases or decreases depending on the respective shifts in the AD-curve and
the AS-curve, but the level of output is essentially determined by the shifts in the AS-curve
D) we will experience a substantial increase in inflation with very little increase in output
E) none of the above
Ans: C

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