Question

1. According to the Taylor rule, if there is an expansionary gap of 2 percent of potential output and inflation is 3 percent, what real interest rate will the Fed set?

A) 1.5 percent B) 2 percent C) 3.5 percent D) 2.5 percent

2. The money demand curve will shift to the right if:

A) the price level decreases. B) the price level increases. C) the nominal interest rate increases. D) the nominal interest rate decreases

3. The aggregate demand curve shifts to the right when the Fed:

A) decreases its target inflation rate, reflected by an upward shift in the Fed's policy reaction function. B) increases its target inflation rate, reflected by a downward shift in the Fed's policy reaction function. C) decreases real interest rates in response to inflation, but does not change its target inflation rate or the Fed's policy reaction function. D) increases real interest rates in response to inflation, but does not change its target inflation rate or the Fed's policy reaction function.

4. Two drawbacks in using fiscal policy as a stabilization tool are that fiscal policy can affect ________ as well as aggregate demand and that fiscal policy is ________.

A) potential output; offset by automatic stabilizers B) consumption; offset by automatic stabilizers C) potential output; not flexible enough D) consumption; too flexible

5. According to the AD-AS diagram, policy makers face a short-term trade-off between ________ when implementing anti-inflation policies.

A) long-term equilibrium and short-term equilibrium B) inflation and unemployment C) inflation and expansion D) recession and stagflation

6. For a fixed inflation rate target, a decrease in the inflation rate corresponds to a ________ the aggregate demand curve and a decrease in exogenous spending corresponds to a ________ the aggregate demand curve.

A) shift left of; movement up B) shift left of; shift right of C) movement up; shift right of D) movement down; shift left of

7. In a certain economy, the components of planned spending are given by: C = 500 + 0.8(Y – T) – 300r I P = 200 – 400r

G = 200 NX = 10 T = 150

Given the information about the economy above, which expression gives autonomous

expenditures?

A) [790 − 700r ] B) 0.8Y C) [910 − 700r ] D) [760 − 700r ]

8.  In the short-run, if the Federal Reserve decreases interest rates, then consumption and investment

________, planned aggregate expenditure ________, and short-run equilibrium output ________.

A) increase; increases; decreases B) increase; increases; increases

C) increase; decreases; decreases D) decrease; decreases; decreases

Answer 1

Answer;

1. D) 2.5 percent.

Explanation: Targeted interest rate = 0.5 (potential output) + 0.5 (inflationary gap)

= 0.5 (2%) + 0.5 (3%) = 2.5%

2. D. the nominal interest rate decreases.

Explanation: Since interest rate is not measured on any of the axes, decrease in the interest rate increases the purchasing power of the people thus increasing the demand, due to which demand curve shifts rightward.

3. c) decreases the real interest rate in response to the inflation.

Explanation: As interest rate decreases, people can more easily borrow money so they have more money in hand now, due to which their aggregate demand increases.

4. A) potential output and offset by automatic stabilizers

Fiscal policy can affect both potential output and aggregate demand and because of the automatic stabilizers, the effects of policy is offset.

5. B) inflation and unemployment

Explanation: inflation and unemployment are inversely related to each other. As inflation increases unempoyment decreases and vice-versa.

6. D) movement down, shift left of

Explanation: As prices are measured on y-axis, decrease in inflation rate leads to decrease in prices, leading to movement down the demand curve whereas decrease in exogeneous spending leads to leftward shift of the demand curve.