Gajah Putih University - ECONOMICS 

Great Recession Problems

Multiple Choice

1)The IS curve describes the relationship between  and      .

 a negative; tax rate; investment

1. 2. positive; interest rate; output
   3. positive; tax rate; government expenditure d negative; interest rate; output

e negative; interest rate; money supply

2. In the IS curve, consumption, government expenditure, exports, and imports are a function of: a expectations.

2. current output.
3. potential output.
4. the interest rate.
5. output fluctuations.

3. In the IS curve, consumption is represented as a constant fraction of      , and, therefore, is

                   than current output.

a potential output; more volatile b potential output; smoother

3. short-run fluctuations; smoother
4. 
   short-run fluctuations; more volatile e none of the above

4. In the equation for investment, if b is close to infinity,

a investment is extremely sensitive to real interest rate changes.

b investment is somewhat sensitive to changes in the marginal product of capital. c investment is not very sensitive to real interest rate changes.

d investment is sensitive to tax rate changes. e none of the above

5. In the short run, if the Federal Reserve reduces interest rates, a firms do not change their capital stock.

2. firms buy less capital and the marginal product of capital falls.
3. firms allow their capital to fully depreciate. d firms accumulate more inventory.

e firms buy more capital and the marginal product of capital falls.

6. In the IS curve Y˜  = a − b(R_t − r) , the term a is called: a the tax rate.

2. the elasticity of output with respect to the interest rate.
3. a consumption expenditure shock.
4. the deviation of the real interest rate to the marginal product of capital. e an aggregate demand shock.

7. If investment is interest rate insensitive, the economy would be characterized by   . a a horizontal IS curve

2. &nsp; a vertical IS curve
3. a downward sloping IS curve d an upward sloping IS curve

e Not enough information is given.

8. In the equation (Y − T − C) + (T − G) + (IM − EX) = I, the term (Y − T − C) is and (T − G) is                                .

1. aggregate saving; tax revenues
2. &nsp; private saving; government saving
3. foreign saving; private saving
4. the government debt; investment
5. the trade balance; the financial account

9. Suppose a_c = 0.60, a_i = 0.20, a_g = 0.20, a_ex = 0.10, and a_im = 0.20. For any given R_t, a equals

                   and the economy                 . a 0.00; is in its long-run equilibrium

2. 0.90; has experienced a positive aggregate demand shock
3. 0.30; has experienced a positive aggregate demand shock
4. −0.10; has experience a negative aggregate emand shock
5. 1.00; is in its long-run equilibrium

10. You hear that the Federal Reserve is raising interest rates. From this new information, you conclude that

a short-run output will fall along the IS curve, possibly pushing the economy toward recession.

2. short-run output will rise along the IS curve, possibly pushing the economy toward expansion.
3. short-run output will fall as the IS curve shifts left, possibly pushing the economy toward recession. d the federal government will lower taxes.

e there will be no change in short-run output.

11. Suppose we assume a = 0, b = 1, R_t = r = 5%, and the real interest rate rises to R_t = 6%. The economy would

1. remain at its long-run equilibrium.
2. move from 1 percent below its potential to its long-run equilibrium. c move from its long-run equilibrium to 1 percent above its potential.

4. move from its long-run equilibrium to 1 percent below its potential.

5. none of the above

12. If there is an aggregate demand shock, a the IS curve shifts to the right.

2. the IS curve shifts to the left.
3. there is rightward movement along the IS curve. d there is leftward movement along the IS curve. e Not enough information is given.

13. An increase in consumer expenditures during the holiday season, a decrease in purchases of U.S. goods by foreigners, a tax increase, and a decline in new home starts are examples of a(n):

1. monetary policy.
2. aggregate supply shock.
3. aggregate demand shok.
4. expectations.
5. None of the above.

14. Recently, Americans have been increasing their debt. This is an example of: a a negative aggregate demand shock.

2. &nsp; a positive aggregate demand shock.
3. a rightward movement along the IS curve. d a positive aggregate supply shock.

e Not enough information is given.

15. If all the economies of the European Union experience a recession, the United States experiences

                   and the IS curve                  . a no change; stays constant

2. a positive aggregate demand shock; shifts right
3. a negative aggregate demand shok; shifts left
4. no change; shifts right
5. Not enough information is given.

16. The fundamental lesson of the Life Cycle and Permanent Income hypotheses is that: a individuals smooth their consumption patterns over their lifetime.

2. individuals vary their consumption patterns over their lifetime.
3. individuals’ consumption patterns vary as their income changes.
4. individuals’ consumption changes with changes in their temporary income. e taxes are ineffectual.

17. When the multiplier is included in the IS curve,

a a demand shock has a larger impact on short-run fluctuations than with the standard IS curve. b a change in the real interest rate has a larger impact on short-run fluctuations than with the

standard IS curve.

c a demand shock has a smaller impact on short-run fluctuations than with the standard IS curve. d a change in taxes has no impact on short-run output.

e a and b are correct.

18. U.S. government spending on goods and services:

1. can act as a temporary shock that causes short-run fluctuations.
2. can act as a policy instrument designed to mitigate short-run fluctuations. c represents about 20 percent of the U.S. GDP.

4. All of the above are correct.
5. None of the above is correct.

Short Answer

1. When does long-run equilibrium occur along the IS curve?

2. Suppose consumption is:  ^Ct  = a_c − b_c(R_t − r).  With this formulation what happens to the slope of

3. Explain what happens to the macroeconomy in the short run in each of the following circumstances: a There is deep recession in Europe;

2. Housing values rise above their trend;

3. Mortgage lenders raise interest rates;

4. The government decides to close 20 percent of its military bases around the country;

5. The long-run interest rate rises.

4. What is the main conclusion of both the Permanent Income hypothesis and Life Cycle model of consumption? Carefully explain.