Queens College, CUNY - ECON 201

CHAPTER 9: An Introduction to the Short Run

MULTIPLE CHOICE

1)John Maynard Keynes is famous for saying, “In the long run         .”

1. 1. there is no tomorrow
   2. we are all dead
   3. the only thing we have to fear is fear itself
   4. the study of economics will be redundant
   5. we will tear down this wall

2. One implication of the Keynes quote, “In the long run we are all dead,” is:
   1. the economy is always in its long-run equilibrium
   2. we know with certainty what the long run is
   3. the long run is made up of a sequence of short runs
   4. there is no difference between the long and short runs
   5. there is no short run

3. The long-run model determines           and               , while the short-run model determines

                and               .

1. 1. potential output; long-run inflation; current output; current inflation
   2. potential output; unemployment; current output; long-run inflation
   3. current output; long-run inflation; unemployment; current inflation
   4. potential output; unemployment; unemployment; current inflation
   5. current output; unemployment; potential output; current inflation

4. The long-run model determines           and               .
   1. current output; unemployment              d. potential output; potential inflation
   2. potential output; unemployment            e.   potential output; long-run inflation
   3. current output; long-run inflation

5. The short-run model determines           and               .
   1. current output; current inflation            d. unemployment; potential output
   2. current output; long-run inflation          e.   potential output; unemployment
   3. unemployment; current inflation

6. Which of the following is NOT an example of a short-term macroeconomic “shock”?
   1. political unrest                                        d. increased military spending
   2. a change in the tax code                        e.   None of these answers are correct.

1. 3. a drought

7. Which of the following is NOT an example of a short-term macroeconomic “shock”?
   1. a drought                                                d. a change in the tax code
   2. planned investment expenditures          e.   political unrest
   3. increased military spending

8. Which of the following is NOT an example of a short-term macroeconomic “shock”?
   1. planned investment expenditures          d. a change in the tax code
   2. a hurricane                                             e.   new technology
   3. increased military spending

9. Which of the following is NOT an example of a short-term macroeconomic “shock”?
   1. increased oil prices                                 d. a change in the tax code
   2. a drought                                                e.   None of these answers are correct.
   3. increased military spending

10. Which of the following is NOT an example of a short-term macroeconomic “shock”?
    1. a drought                                                d. a change in the tax code
    2. high unemployment                                e.   political unrest
    3. increased military spending

11. Which of the following is NOT an example of a short-term macroeconomic “shock”?
    1. a change in the tax code                        d. planned investment expenditures
    2. pork-barrel spending                              e.   political unrest
    3. increased military spending

12. New technology, oil price changes, pork-barrel spending, interest rate changes, changes in planned investment, and disasters are examples of:
    1. long-term economic shocks                    d. monetary policy
    2. short-term economic shocks                  e.   fiscal policy
    3. political unrest

13. Potential output is defined as:
    1. the amount of total output if all inputs were utilized at their long-run, sustainable levels

1. 2. what an economy produces when it is at capacity
   3. the current level of output
   4. the amount of output where inflation is zero
   5. the level of output when unemployment is 10 percent

14. Current output is defined as:
    1. the amount of output when inflation is about 2 percent
    2. what an economy produces when it is at capacity
    3. the amount of total output at the current level of input utilization
    4. the amount of total output if all inputs are utilized at their long-run sustainable levels
    5. the amount of output where unemployment is zero

15. Output fluctuations are defined as:
    1. the amount of output where inflation is about 2 percent
    2. what an economy produces when it is at capacity
    3. the percentage difference between current output and potential output
    4. the amount of total output if all inputs were utilized at their long-run sustainable levels
    5. the amount of output where unemployment is zero

16. Taxes, oil price changes, government spending, interest rate changes, new technologies, and disasters are examples of:
    1. long-term economic shocks                    d. monetary policy
    2. short-term economic shocks                  e.   fiscal policy
    3. political unrest

17. What is the best definition of the short term in the short-term model?
    1. about two years
    2. the amount of time the economy spends at its potential output
    3. the length of time for short-term deviations to return to their long-run values
    4. the length of a recession
    5. There is no such thing as the short term.

18. Defining    as current output,  as potential output, and as short-run fluctuations, which of the following equations is correct?

a.

b.

c.

d.

e.

19. Defining    as current output,  as potential output, and as short-run fluctuations, which of the following equations is correct?

a.

b.

c.

d.

e.

20. Defining    as current output,  as potential output, and as short-run fluctuations, which of the following equations does the text use to measure the fluctuations component of output?

a.

b.

c.

d.

e.

21. Defining    as current output,  as potential output, and as short-run fluctuations, how can the equation                          be best defined?
    1. the percentage deviation of current output from potential output
    2. the difference between current output and potential output
    3. the percentage deviation of potential output from current output
    4. the deviation of current output from potential output
    5. the difference between potential output and current output

22. If current output is            billion and potential output             billion, then the economy is in a

                and    is about               .

1. 1. recession; ?4.7 percent                          d. recession; ?5 percent
   2. boom; 4.7 percent                                  e.   boom; 5 percent
   3. boom; ?4.7 percent

23. According to the Phillips curve, short-term changes in inflation are due to changes in:
    1. interest rates                                          d. long-term inflation
    2. unemployment                                        e.   long-term output
    3. short-term output fluctuations

24. Suppose an economy exhibits a large unexpected increase in productivity growth that lasts for a decade; however, monetary policymakers are slow to recognize that the change is to potential, not current, output, and they interpret the increase in output as a boom that leads current to exceed potential output. In this scenario, policymakers believe that     pressures are building and incorrectly respond by                                              interest rates, sending the economy into a(n)                    gap.
    1. inflationary; raising; recessionary          d. recessionary; reducing; recessionary
    2. inflationary; reducing; recessionary       e.   Not enough information is given.
    3. recessionary; raising; expansionary

25. Suppose an economy exhibits a large unexpected decrease in productivity growth that lasts for a decade; however, monetary policymakers are slow to recognize that the change is to potential, not current, output, and they interpret the decrease in output as a recession that leads current to fall below potential output. In this scenario, policymakers believe that                  pressures are building and incorrectly respond by                                              interest rates, sending the economy into a(n)                    gap.
    1. inflationary; raising; inflationary            d. recessionary; reducing; inflationary
    2. inflationary; reducing; inflationary        e.   Not enough information is given.
    3. inflationary; raising; recessionary

26. If current output is            billion and potential output               billion, then the economy is in a

                and    is about               .

1. 1. boom;       percent                                  d. boom; 6.7 percent
   2. recession;       percent                             e.   None of these answers are correct.
   3. recession;       percent

27. According to the text, which of the following can be used to characterize potential output?

1. Assume a perfectly smooth trend is passing through the quarter-to-quarter movements in the real GDP.

2. Take averages of the surrounding actual GDP numbers.
3. Gather current data from statistical agencies, such as the Bureau of Economic Analysis.

28. According to the text, which of the following can be used to approximate potential output?

1. Assume a perfectly smooth trend is passing through the quarter-to-quarter movements in the real GDP.
2. Survey leading economists.
3. Gather current data from statistical agencies, such as the Bureau of Economic Analysis.

29. According to the text, which of the following can be used to estimate potential output?

1. Get the data from the Census Bureau.
2. Survey leading economists.
3. Gather current data from statistical agencies, such as the Bureau of Economic Analysis.

30. Which is responsible for dating business cycles?
    1. Business Cycle Committee of the National Bureau of Economic Research
    2. Business Cycle Committee of the Department of Treasury
    3. Department of Treasury
    4. Commerce Department
    5. Board of Governors of the Federal Reserve System

31. Which is responsible for dating business cycles?
    1. Congressional Budget Office
    2. Business Cycle Committee of the National Bureau of Economic Research
    3. President’s Council of Economic Advisors
    4. New York City Federal Reserve Bank president
    5. Board of Governors of the Federal Reserve System

Refer to the following figure when answering the next two questions.

32. Consider Figure 9.1. The dashed line is potential output and the solid line is current output; therefore:
    1. areas a and b are booms
    2. area b represents an economic boom, and area a is a recession
    3. the economy is in neither a recession nor a boom in areas a and b
    4. area a represents an economic boom, and area b is a recession
    5. areas a and b are expansions

33. Considering Figure 9.1:
    1. area a is where current output is less than potential output, and area b is where current output is greater than potential output
    2. area a is where current output is greater than potential output, and area b is where current output is less than potential output
    3. point c is where economic fluctuations are zero, and at point b, the economy is in a boom
    4. at point c, current output equals the short-term fluctuations
    5. area a is where current output is greater than potential output, and at point c, the economy is in a boom

Refer to the following figure when answering the next five questions.

Figure 9.2: U.S. Output Fluctuations 1960?2012

(Source: BEA and CBO, data from Federal Reserve Economic Data, St. Louis Federal Reserve)

34. Consider Figure 9.2. The line represents short-run fluctuations,      . Since 1960, the largest boom was in about     and the deepest recession was in about        .

a.   1983; 1965

b.   1974; 1976

c.   2000; 1983

d.   1966; 1983

e.   The economy always produces at its potential.

35. Consider Figure 9.2. In 1989, the U.S. economy experienced an economic      , and current output was about              potential output.
    1. boom; 1 percent above
    2. recession; 1 percent above
    3. boom; 2 percent above
    4. This cannot be determined from the information given.
    5. None of these answers are correct.

36. Consider Figure 9.2. In approximately which of the following years was current output equal to potential output?

a.   1966, 1974, 1979, 2000, and 2004         d.   1961, 1975, 1979, 2000, and 2008

b.   1961, 1975, 1983, 2002, and 2009         e.   1966, 1974, 1983, 2002, and 2010

c.                                1964, 1980, 1991, 2001, and 2008

37. Consider Figure 9.2, which represents           . In approximately what years did the U.S. economy experience its longest economic expansion?

a.   1964–1970

b. 1978?1980

c.   1996–2001

d.   1972–1974

e.   This cannot be determined from the information given.

38. Consider Figure 9.2, which represents           . In approximately what years did the U.S. economy experience its longest economic downturn, using the text’s definition?

39. When the U.S. economy bottomed out during the Great Depression, the unemployment rate hit about

                percent in              .

40. The Great Depression stimulated           to write              , which is considered to be the birth of modern macroeconomics.
    1. John Hicks; Value and Capital
    2. Karl Marx; Das Kapital
    3. David Ricardo; Principles of Political Economy and Taxation
    4. Milton Friedman and Anna J. Schwartz; A Monetary History of the United States, 1867– 1960
    5. John Maynard Keyes; The General Theory of Employment, Interest, and Money

41. Generally speaking, the rate of inflation          during a recession.
    1. stays the same                                        d. falls, then rises
    2. falls                                                         e.   None of these answers are correct.
    3. rises

42. The short-run model is built on which of the following?

1. The economy is constantly being hit by “shocks.”
2. Economic policy has no impact on output.
3. There is trade-off between output and inflation.
   1. i only                                                       d. ii only

43. The Phillips curve in the text shows the           relationship between             and               .
    1. positive; the change in inflation; short-term economic fluctuations
    2. negative; the change in inflation; short-term economic fluctuations
    3. positive; inflation; unemployment
    4. negative; inflation; unemployment
    5. negative; the change in inflation; unemployment

44. The Phillips curve in the text shows the           relationship between             and               .
    1. positive; inflation; unemployment
    2. positive; inflation; short-term economic fluctuations
    3. positive; the change in inflation; short-term economic fluctuations
    4. negative; inflation; unemployment
    5. negative; the change in inflation; unemployment

45. According to the Phillips curve presented in the text, a positive macroeconomic shock:
    1. increases the rate of inflation
    2. decreases the rate of inflation
    3. has no effect on the rate of inflation
    4. has a negative effect on the unemployment rate
    5. has a positive effect on the unemployment rate

46. According to the Phillips curve presented in the text, a negative macroeconomic shock:
    1. increases the rate of inflation
    2. decreases the rate of inflation
    3. has no effect on the rate of inflation
    4. has a negative effect on the unemployment rate
    5. has a positive effect on the unemployment rate

47. If          , the macroeconomy is:
    1. in an expansionary gap                           d. None of these answers are correct
    2. at its potential level of output                e.   Not enough information is given.
    3. in a recessionary gap

48. If          , the macroeconomy is:

1. 1. in a recession                                          d. Not enough information is given.
   2. in an expansion                                       e.   None of these answers are correct.
   3. at its potential level of output

49. If          , the macroeconomy is:
    1. at its potential level of output                d. Not enough information is given.
    2. in a recessionary gap                              e.   None of these answers are correct.
    3. in an expansionary gap

50. If            , the macroeconomy is:
    1. in an expansion                                       d. Not enough information is given.
    2. in a recession                                          e.   None of these answers are correct.
    3. at its potential level of output

51. If           , the macroeconomy is:
    1. in a recession                                          d. Not enough information is given.
    2. in an expansion                                       e.   None of these answers are correct.
    3. at its potential level of output

52. If           , the macroeconomy is:
    1. in a recession                                          d. Not enough information is given.
    2. in an expansion                                       e.   None of these answers are correct.
    3. at its potential level of output

Refer to the following figure when answering the next three questions.

Figure 9.3: Phillips Curve

53. Consider the Phillips curve at   in Figure 9.3.Which of the following is true?
    1. The economy is booming.
    2. The economy is deflationary.
    3. The economy is at potential output.
    4. The economy is in recession.
    5. Unemployment is above the natural level.

54. Consider the Phillips curve at   in Figure 9.3. The economy is:
    1. booming
    2. inflationary
    3. in recession
    4. at potential output
    5. Not enough information is given to determine.

55. Consider the Phillips curve at       in Figure 9.3. The economy is:
    1. booming
    2. inflationary
    3. at its potential output
    4. in recession
    5. Not enough information is given to determine.

56. In 1979, the inflation rate reached about 14 percent. The Federal Reserve    interest rates, sending the economy into a(n)        . When doing so, the Federal Reserve knew this would be the case because of the                    .
    1. raised; expansion; Phillips curve            d. lowered; recession; Phillips curve
    2. raised; recession; Phillips curve             e.   lowered; expansion; Phillips curve
    3. raised; recession; Okun relationship

57. In 1979, the inflation rate reached about 14 percent, due in part to   . The Board of Governors of the Federal Reserve under                decided to               interest rates, sending the economy into a

               .

1. 1. a fall in oil prices; Volcker; raise; recession
   2. an increase in consumer spending; Volcker; lower; recession
   3. an increase in oil prices; Volcker; raise; recession
   4. an increase in oil prices; Volcker; lower; boom
   5. a fall in oil prices; Greenspan; raise; recession

58. According to the text, the slope of the Phillips curve in the United States is about    . Thus, if the gap is 6 percent, the change in inflation would be              percent.

a.   1/4; 1.5                                                    d. 1/2; 3

b.   1/3; 2                                                      e.   1/2; 12

c.                                1/4; 24

59. According to the text, the slope of the Phillips curve in the United States is about    . Thus, if the change in inflation is 1 percent, the gap would be              percent.

60. Okun’s law shows the              relationship between             and               .
    1. negative; the unemployment gap; economic fluctuations
    2. positive; the unemployment gap; economic fluctuations
    3. negative; the unemployment gap; inflation
    4. positive; the unemployment gap; inflation
    5. negative; inflation; economic fluctuations

61. Defining u as the unemployment rate and    as the natural rate of unemployment, we can write Okun’s law as the following equation:

a.                                                                                d.

b.                                                                       e.

c.                                

62. Defining u as the unemployment rate and    as the natural rate of unemployment, Okun’s law is given by the following equation:

a.

b.

c.

d.

e.

63. In the text, Okun’s law is given as: a.

b.

c.

d.

e.

64. According to Okun’s law, if the Federal Reserve wants to reduce unemployment, it should  

interest rates, which would            output.

1. 1. reduce; reduce                                        d. reduce; not change
   2. increase; increase                                   e.   not change; increase
   3. reduce; increase

65. According to Okun’s law, if the Federal Reserve wants to increase unemployment, it should  

interest rates, which would            output.

1. 1. increase; increase                                   d. reduce; not change
   2. increase; reduce                                     e.   not change; increase
   3. reduce; reduce

66. Taken together, the Phillips curve and Okun’s law imply there is a short-term     relationship between               and inflation.
    1. positive; interest rates                            d. negative; unemployment
    2. positive; unemployment                         e.   Not enough information is given.
    3. negative; interest rates

67. Taken together, the Phillips curve and Okun’s law imply there is a       relationship between

                and unemployment.

1. 1. positive; inflation                                    d. positive; interest rates
   2. negative; inflation                                   e.   Not enough information is given.
   3. negative; interest rates

Refer to the following figure when answering the next four questions.

(Source: Bureau of Labor Statistics)

68. Consider Figure 9.4, which shows the annual inflation rate. According to the Phillips curve, the period from about 1998 to 2000 was a period of:
    1. stagnation                                               d. None of these answers are correct.
    2. recession                                                 e.   Not enough information is given.
    3. expansion

69. Consider Figure 9.4, which shows the annual inflation rate. According to the Phillips curve, the period from about 2001 to 2002 was a period of:
    1. expansion                                                d. None of these answers are correct.
    2. recession                                                 e.   Not enough information is given.
    3. stagnation

70. Consider Figure 9.4, which shows the annual inflation rate. According to the Phillips curve, the period from about 2003 to 2005 was a period of:
    1. recession                                                 d. None of these answers are correct.
    2. expansion                                                e.   Not enough information is given.
    3. stagnation

71. Consider Figure 9.4, which shows the annual inflation rate. According to the Phillips curve, the period from about 2009 to 2010 was a period of:
    1. recession                                                 d. macroeconomic equilibrium
    2. expansion                                                e.   Not enough information is given.
    3. stagnation

72. Consider two economies. Economy 1 has a steep Phillips curve and Economy 2 has a gently sloped Phillips curve. If each economy experiences an identical economic expansion,       would increase less in             .
    1. the change in inflation; Economy 2
    2. the change in unemployment; Economy 1
    3. the change in unemployment; Economy 2
    4. the change in interest rates; Economy 1
    5. Not enough information is given.

73. If an economy has a horizontal Phillips curve and experiences an expansion, inflation:
    1. falls                                                         d. does not change
    2. rises sharply                                            e.   falls sharply
    3. rises, but not very much

74. Suppose an economy’s natural rate of unemployment is 5 percent. If the unemployment rate is 3 percent, according to Okun’s law,            is:
    1. 2 percent                                                 d. ?2 percent
    2. ?4 percent                                               e.   Not enough information is given.
    3. 4 percent

75. Suppose an economy’s natural rate of unemployment is 5 percent. If the unemployment rate is 7 percent, according to Okun’s law,            is:
    1. 4 percent                                                 d. ?2 percent
    2. ?4 percent                                               e.   Not enough information is given.
    3. 2 percent

76. You are a staff economist with the Federal Reserve. The chairman says to you, “The rate of change in inflation is too high, and I don’t think the Phillips curve is very steep. What should we do to reduce these inflationary increases?” What do you respond?
    1. “Because the Phillips curve is relatively flat, we need to increase interest rates a lot, as the change in inflation is not very responsive to changes in output.”
    2. “Because the Phillips curve is relatively flat, we need to decrease interest rates a lot, as the change in inflation is not very responsive to changes in output.”

1. 3. “Because the Phillips curve is relatively flat, we need to increase interest rates only a little, as the change in inflation is very responsive to changes in output.”
   4. “Because the Phillips curve is relatively flat, we need to increase interest rates only a little, as the change in inflation is not very responsive to changes in output.”
   5. “Because the Phillips curve is relatively flat, we can do nothing to interest rates, as the change in inflation does not respond to changes in output.”

77. You are a staff economist with the Federal Reserve. The chairman says to you, “The rate of change in inflation is too high and I think the Phillips curve is horizontal. What should we do to reduce these inflationary increases?” How do you respond?
    1. “Because the Phillips curve is flat, we can do nothing to change the rate of inflation, as it does not respond to changes in output.”
    2. “Because the Phillips curve is flat, we need to increase interest rates a lot, as the change in inflation is not very responsive to changes in output.”
    3. “Because the Phillips curve is flat, we need to decrease interest rates a lot, as the change in inflation is not very responsive to changes in output.”
    4. “Because the Phillips curve is flat, we need to increase interest rates a lot, as the change in inflation is infinitely responsive to changes in output.”
    5. “You are not giving me enough information.”

TRUE/FALSE

1. The relationship between actual output in an economy, the long-run component, and the short-run component is given as: Long-run trend = Current output + Short-run fluctuations.

2. The relationship between actual output in an economy, the long-run component, and the short-run component is given as: Current output = Long-run trend + Short-run fluctuations.

3. Defining    as current output,  as potential output, and as short-run fluctuations, the relationship between the three can be written as           .

4. Defining    as current output,  as potential output, and as short-run fluctuations, the text uses the following equation to measure the fluctuations component of output:

.

5. Defining    as current output,  as potential output, and as short-run fluctuations, the equation is defined as the percentage deviation of current output from potential output.

6. The Board of Governors of the Federal Reserve is responsible for dating business cycles.

7. In Figure 9.5, area b represents an economic boom, and area a is a recession.

8. Post-World War II, the deepest recessionary gap occurred during the Volcker-Reagan recession in the early 1980s.

9. Generally speaking, the rate of inflation rises during a recession.

10. The Phillips curve shows the negative relationship between output fluctuations and the change in inflation.

11. According to the text, the slope of the Phillips curve in the United States is about ?1/3.

12. According to the Phillips curve presented in the text, a positive macroeconomic shock decreases the rate of inflation.

13. If          , the macroeconomy is in a recession.

14. Suppose an economy’s natural rate of unemployment is 5 percent. If the unemployment rate is 7 percent, according to Okun’s law,    is 4 percent.

15. Defining u as the unemployment rate and    as the natural rate of unemployment, Okun’s law is given by              .

16. If          , the macroeconomy is producing at its potential level of output.

17. Suppose an economy exhibits a large unexpected decrease in productivity growth that lasts for a decade; however, monetary policymakers are slow to recognize that the change is to potential, not current, output and they interpret the decrease in output as a recession that leads current output to fall below potential output. In this scenario, policymakers believe that recessionary pressures are building and incorrectly respond by increasing interest rates, sending the economy into a recessionary gap.

18. An increase in planned investment expenditures is a short-term economic “shock.”

19. A country with a steep Phillips curve experiences a smaller increase in the rate of inflation than a country with a relatively flat Phillips curve, assuming the size of the positive demand shock in each country is the same.

20. A decline in long-term productivity implies that an economy requires more resources to produce goods; therefore, as costs of production rise, we should see an acceleration in inflation.

21. If output is above potential, so that   is positive, the change in the inflation rate will be negative, so inflation will fall over time.

22. When current output rises above potential output, we hire fewer workers, which reduces the costs of production. The change in inflation will be negative.

SHORT ANSWER

Source: BEA (actual output); CBO (potential output)

1. This table displays the United States’ potential and actual output for six select months between 1960 and 2012. In which year/month does the economy have the largest expansionary gap? Largest recessionary gap?

2. How is a recession “officially’’ determined?

3. What does the Phillips curve represent?