AP Macro Unit 5

If an economy is in long-run equilibrium, which of the following combinations of policy actions will result in inflation?

• Increasing the money supply and increasing government spending

• Increasing the discount rate and decreasing income taxes

• Increasing the required reserve ratio and increasing the discount rate

• Selling government bonds on the open market and decreasing government spending

• Buying government bonds on the open market and decreasing government spending

Answer explanation

Increasing the money supply is an expansionary monetary policy that will increase aggregate demand, real output, and the price level. Increasing government spending is an expansionary fiscal policy that will increase aggregate demand, real output, and the price level. Both policies are expansionary and will result in inflation.

Given the situation illustrated in the graph and holding all other influences constant, which of the following policies will restore the macroeconomic equilibrium to full employment?

• A contractionary fiscal policy and an expansionary monetary policy

• A contractionary fiscal policy and a contractionary monetary policy

• An expansionary fiscal policy and a contractionary monetary policy

• An expansionary fiscal policy and an expansionary monetary policy

• An expansionary fiscal policy without monetary policy

Answer explanation

The economy is experiencing an inflationary gap as the current short-run equilibrium is beyond full-employment output. A contractionary fiscal policy will decrease aggregate demand and real output. A contractionary monetary policy will decrease aggregate demand and output. The two policies are contractionary and will move the economy back towards full employment.

Country X’s economy is in recession. Which of the following combinations of fiscal and monetary policy actions would move the economy toward full employment in the short run?

• A decrease in government spending and an increase in the discount rate

• A decrease in income taxes and targeting a higher interest rate on overnight interbank loans

• A decrease in income taxes and a sale of government bonds on the open market by the country’s central bank

• An increase in government spending and a decrease in the required reserve ratio

• An increase in income taxes and a purchase of government bonds on the open market by the country’s central bank

Answer explanation

An increase in government spending is an expansionary fiscal policy that will increase aggregate demand and real output. A decrease in the required reserve ratio is an expansionary monetary policy that will increase aggregate demand and real output. Both policies are expansionary and will move the economy out of recession and toward full employment.

Which of the following will cause a movement from point X to point Y along the short-run Phillips curve (SRPC)

that is shown in the graph above?

• An increase the expected inflation rate

• An increase in the required reserve ratio

• An increase in government spending

• An increase in input costs

• An increase in income taxes

Answer explanation

This response is an expansionary fiscal policy that will increase aggregate demand and cause an upward movement along the short-run Phillips curve from point X to point Y.

Assume members of the Organization of the Petroleum Exporting Countries (OPEC) agree to a coordinated increase in oil production. If the economy is at equilibrium at point B, what effect will this have on the Phillips curve model in the long run?

• The SRPC will shift to the left.

• The SRPC will shift to the right.

• The LRPC will shift to the right.

• There will be a movement from point B to point C.

• There will be a movement from point B to point A.

Answer explanation

Point B illustrates long-run equilibrium. An increase in oil production increases short-run aggregate supply, increases real output, and decreases the price level. A positive supply shock corresponds to a leftward shift of the SRPC.

Which of the following could cause a movement along a country’s short-run Phillips curve toward higher unemployment and lower inflation?

• A significant reduction in energy prices

• A recession in the economies of the nation’s major trading partners

• A decrease in savings by the country’s consumers

• A movement of the economy from the recovery phase to the expansionary phase of the business cycle

• An improvement in technology

According to the short-run Phillips curve, a contractionary fiscal policy will result in

• a decrease in both unemployment and prices

• a decrease in inflation and an increase in unemployment

• a decrease in both wage rates and unemployment

• an increase in both wage rates and unemployment

• an increase in unemployment due to crowding out

Which of the following is true of the long-run Phillips curve?

• It shows there is a trade-off between unemployment and inflation.

• It is positively sloped when the inflation rate exceeds the unemployment rate.

• It is vertical at the natural rate of unemployment.

• It shifts to the right if aggregate demand increases.

• It is created by an adverse supply shock.

Which of the following is implied by a long-run Phillips curve?

• Wages are sticky.

• There is no trade-off between unemployment and inflation.

• The long-run aggregate supply curve is upward-sloping.

• Expected inflation exceeds actual inflation.

• The unemployment rate falls with higher inflation.

Which of the following will occur if the federal government runs a budget deficit?

• The expenditure multiplier will increase.

• The size of the national debt will increase.

• The economy's output will decrease.

• State governments will run a budget surplus to offset the federal deficit.

• Interest rates will tend to decline.