1. the Real Wealth Effect Predicts That Higher Prices

Problem Set 4 Econ 201 (03,04) Spring 2002 (Dr. Tin-Chun Lin)

1. The real wealth effect predicts that higher prices:

(A) Make people worse off by reducing the value of their wealth, leading them to save more and spend less. (B) Make people worse off by reducing the value of their wealth, leading them to save less and spend more. (C) Make people better off by increasing the value of their wealth, leading them to save less and spend more. (D) Increase borrowing, leading to higher interest rates and less investment. (E) Make domestic goods relatively more expensive, increasing the demand for domestic goods and decreasing the demand for foreign goods. (Answer: (A))

2. The negative slope of the aggregate demand curve is caused by:

(A) The real wealth effect, the interest rate effect, and the price level effect. (B) The real wealth effect, the money supply effect, and the net exports effect. (C) The interest rate effect, the net exports effect, and the real GDP effect. (D) The real wealth effect, the interest rate effect, and the net exports effect. (E) The real wealth effect, the substitution effect, and the income effect. (Answer: (D))

3. The idea that higher prices reduce the purchasing power of financial assets and lead to less consumption and more saving is known as the:

(A) Interest rate effect. (B) Real wealth effect. (C) Foreign purchases effect. (D) Income effect. (E) Aggregate demand effect. (Answer: (B))

4. When the supply of credit is fixed, an increase in the price level stimulates the demand for credit, which in turn reduces consumption and investment spending. This argument is called the:

(A) Real balance effect. (B) Real wealth effect. (C) Interest rate effect. (D) Net exports effect. (E) Substitution effect. (Answer: ( C )) 5. Which of the following would cause a rightward shift in the aggregate supply curve?

(A) Larger-than-expected wage increases. (B) Increased investment spending. (C) Greater government regulation (D) The government cuts taxes. (E) Lower oil prices. (Answer: (E))

6. The classical economic theory viewed the long-run aggregate supply curve as being:

(A) Horizontal at the full-employment level of real GDP. (B) Positively sloped at the full-employment level of real GDP. (C) Vertical at the full-employment level of real GDP. (D) Downward sloping at the full-employment level of real GDP. (E) Backward bending at the full-employment level of real GDP. (Answer: ( C ))

7. In the horizontal segment of the aggregate supply curve, when GDP:

(A) Increases, the price level does not change. (B) Increases, the price level rises. (C) Decreases, the price level falls. (D) Increases, the price level falls. (E) Increases, the price level first rises and then falls. (Answer: (A))

8. Suppose workers become pessimistic about their future employment, which causes them to save more and spend less. If the economy is on the intermediate range of the aggregate supply curve, then:

(A) Real GDP will fall and the price level will rise. (B) Both real GDP and the price level will fall. (C) Real GDP will rise and the price level fall. (D) Both real GDP and the price level will rise. (E) Both real GDP and the price level do not change. (Answer: (B))

9. (True or False) An increase in total spending in the economy will shift the aggregate demand curve to the left. (Answer: False)

10. (True or False) The classical economists believed there was no role for government to play in stabilizing the business cycle. (Answer: True)