1) C. An increse in oil price endsup in increase in markup. An increase in oil rate will cause an decrease in natural level of output and thus higher level of natural unemployment rate, which is the unemployment rate in the medium run.As natural level of output decreases,output also decreases.this will increse the price.and leads to increase in real policy rate.

2)d Okun's law can also pertain to how a rise in unemployment affects gross domestic product (GDP), where a percentage increase in unemployment causes a 2% fall in GDP.

3)b  In the medium run, the price level has fallen below the expected price level, P e , and so the expected price level falls too. This pushes the price level down further, which in turn pushes up the real money supply (M/P) and so shifts the LM Curve further down, to LM2. The level of output increases back to the natural level of output, Yn, and the interest rate falls further to i2. The fall in the price level shifts the AS Curve downwards, giving the medium run equilibrium at A2, with output at the natural level (Yn) and the price level falling to P2. Overall, output is back to its natural level and the price level is lower. But the interest rate is also lower in the medium run and this is how fiscal policy can affect the level of investment in the economy. Investment is higher than before the fiscal contraction due to the fall in the interest rate. This is clear from looking at the IS relation: Yn = C(Yn - T) + I(Yn, i) + G The level output is the same as before (Yn), as is consumption (C) and tax (T). The fall in government spending (G) is therefore offset by the increase in investment (I).

4)c  

A deflationary spiral is a downward price reaction to an economic crisis leading to lower production, lower wages, decreased demand, and still lower prices. Deflation occurs when general price levels decline, as opposed to inflation which is when general price levels rise.

When deflation occurs, central banks and monetary authorities can enact expansionary monetary policies to spur demand and economic growth. If monetary policy efforts fail, however, due to greater-than-anticipated weakness in the economy or because target interest rates are already zero or close to zero, a deflationary spiral may occur even with an expansionary monetary policy in place. Such a spiral amounts to a vicious cycle, where a chain of events reinforces an initial problem.

Monetary Policy Tools

Lowering bank reserve limits

In a fractional reserve banking system, as in the U.S. and the rest of the developed world, banks use deposits to create new loans. By regulation, they are only allowed to do so to the extent of the reserve limit. That limit is currently 10% in the U.S., meaning that for every $100 deposited with a bank, it can loan out $90 and keep $10 as reserves. Of that new $90, $81 can be turned into new loans and $9 kept as reserves, and so on, until the original deposit creates $1000 worth of new credit money: $100 / 0.10 multiplier. If the reserve limit is relaxed to 5%, twice as much credit would be generated, incentivizing new loans for investment and consumption.

Open market operations (OMO)

Central banks buy treasury securities in the open market and, in return, issue newly created money to the seller. This increases the money supply and encourages people to spend those dollars. The quantity theory of money states that like any other good, the price of money is determined by its supply and demand. If the supply of money is increased, it should become less expensive: each dollar would buy less stuff and so prices would go up instead of down.

Lowering the target interest rate

Central banks can lower the target interest rate on the short-term funds that are lent to and among the financial sector. If this rate is high, it will cost the financial sector more to borrow the funds needed to meet day-to-day operations and obligations. Short-term interest rates also influence longer-term rates, so if the target rate is raised, long-term money, such as mortgage loans, also becomes more expensive. Lowering rates makes it cheaper to borrow money and encourages new investment using borrowed money. It also encourages individuals to buy a home by reducing monthly costs.

Quantitative easing

When nominal interest rates are lowered all the way to zero, central banks must resort to unconventional monetary tools. Quantitative easing (QE) is when private securities are purchased on the open market, beyond just treasuries. Not only does this pump more money into the financial system, but it also bids up the price of financial assets, keeping them from declining further. (See also: Why Didn't Quantitative Easing Lead to Hyperinflation.)

Negative interest rates

Another unconventional tool is to set a negative nominal interest rate. A negative interest rate policy (NIRP) effectively means that depositors must pay, rather than receive interest on deposits. If it becomes costly to hold on to money, it should encourage spending of that money on consumption, or investment in assets or projects that earn a positive return.

5)e Potential output is the maximum amount of goods and services an economy can turn out when it is most efficient—that is, at full capacity. Often, potential output is referred to as the production capacity of the economy.­The output gap is an economic measure of the difference between the actual output of an economy and its potential output

Just as GDP can rise or fall, the output gap can go in two directions: positive and negative. Neither is ideal. A positive output gap occurs when actual output is more than full-capacity output. This happens when demand is very high and, to meet that demand, factories and workers operate far above their most efficient capacity. A negative output gap occurs when actual output is less than what an economy could produce at full capacity. A negative gap means that there is spare capacity, or slack, in the economy due to weak demand.­

An output gap suggests that an economy is running at an inefficient rate—either overworking or underworking its resources.­

Policymakers often use potential output to gauge inflation and typically define it as the level of output consistent with no pressure for prices to rise or fall. In this context, the output gap is a summary indicator of the relative demand and supply components of economic activity. As such, the output gap measures the degree of inflation pressure in the economy and is an important link between the real side of the economy—which produces goods and services—and inflation. All else equal, if the output gap is positive over time, so that actual output is greater than potential output, prices will begin to rise in response to demand pressure in key markets. Similarly, if actual output falls below potential output over time, prices will begin to fall to reflect weak demand.­