A Rise in the Price of Oil Imports Has Resulted in a Decrease of Short-Run Aggregate Supply

Economics 2 Unit 2 Test Class Day/Time: Name:

Part A. Answer the following questions in the space provided. Each question is worth 4 points except question 1 which is worth 8 points.

1. Use an aggregate demand and aggregate supply diagram to show what will happen to output, prices, unemployment and wages in the U.S. economy if there is an increase in aggregate demand. On your diagram, mark the starting output as QN, the output at the end of the short run as Q2, and the output at the end of the long run as Q3. Mark the starting price as P1, the price at the end of the short run as P2, and the price at the end of the long run as P3. Next to the diagram, write in what direction prices, output, unemployment and wages are moving for both time periods (for the long run, answer the direction they are moving as we go from the short run to the long run). Assume we start from a position of natural real GDP (QN).

2. Using a table similar to the one used in class, show the effect of a $900 increase in government spending in the Keynesian system. Show the effect on government, consumption, and GDP for each of three rounds and what the total effect will be on each after all potential rounds are completed. Assume the marginal propensity to consume (MPC) is 2/3 or 0.67 Also assume there is no crowding out. Illustrate the effect of the first 2 rounds and the total effect after all the rounds are completed on an AD/AS diagram with a flat SRAS curve. Be sure to write the amount of the change for each line shift on your diagram and the amount of the total change. 3. Use the aggregate demand and short-run aggregate supply curves to show the effect of a perfectly predicted increase in aggregate demand on output and prices. Label the beginning quantity Q1 and the quantity we move to Q2. If you think we will move to more than one new quantity over time, label the successive quantities Q2, Q3 and so on. Do the same for the price level, using P1, P2 and so on.

4. Use the aggregate demand and short-run aggregate supply curves to show the effect of an unexpected increase in aggregate demand on output and prices. Label the beginning quantity Q1 and the quantity we move to Q2. If you think we will move to more than one new quantity over time, label the successive quantities Q2, Q3 and so on. Do the same for the price level, using P1, P2 and so on.

5. A. Veronica has an income of $8 which she uses only to buy $1 pizzas. So does Wayne. Veronica also has $10 cash in the cookie jar of which she plans to use 40% to buy pizzas. Wayne has nothing in the cookie jar (except cookies). How many pizzas will each person buy?

Veronica _____ Wayne ______

B. Now imagine that the situation is the same, but before any pizzas are bought, both the incomes and the price of pizza doubles. Now how many pizzas will both people buy?

Veronica ______Wayne______

C. Who cuts back purchases the most when prices rise (circle the correct answer):

Someone with a lot of money Someone with only a little money

6. Draw a Milton Freidman adaptive expectations Philips Curve for part a and draw a rational expectationists Philips Curve for part b. Each part is worth 2 points. Don’t forget to label both axis for each curve and, if necessary, label your lines as short-run and long-run. You do not have to have numbers on your diagram, but will be graded on the shape of your line.

7. a. Here is Fred’s basket of purchases in 2015: Pizzas – 25, Beer – 40, Gas – 60. The prices of these three things in 2015 are: Pizzas – $10, Beer – $2, and Gas – $5 In 2016, the prices change to Pizzas – $12, Beer – $3, and Gas – $4. How much does Fred spend on his purchases in each year?

2015 ______

2016 ______b. Now create an index of prices for the two years with 2015 being the base year.

2015 ______

2016 ______

c. What was the inflation rate from 2015 to 2016?

Part B. Mark the letter of the best answer on your scantron. Each question is worth 1 point.

1. Wage rates fall when: a. the current actual unemployment rate is greater than the natural unemployment rate. b. the current actual unemployment rate is less than the natural unemployment rate. c. the current actual unemployment rate equals the natural unemployment rate. d. the relationship between actual unemployment and the natural rate of unemployment has no effect on wages.

2. Which of the following could be a line that is downward sloping? a. Long-run aggregate supply. b. Aggregate demand. c. Short-run aggregate supply.

3. When an economy is in a recession, then the shorter the time that wages stay the same or are “sticky”: a. the shorter the recession will last. b. the longer the recession will last. c. how long wages stay fixed will have no effect on how long a recession lasts.

4. Which of the following revert back to their natural levels at the end of the long-run? a. Unemployment. b. Output c. Prices d. Both a and b.

5. The inflationary gap part of the AD/AS diagram is: a. to the left of QN. b. to the right of QN. c. directly at QN. d. all of the above. 6. According to the concept of the multiplier, if a government shutdown dropped people’s income by 1 million dollars, then the actual drop in aggregate demand will be: a. greater than 1 million dollars. b. less than 1 million dollars. c. equal to 1 million dollars.

7. When the macroeconomy is working well, which of the following will be high? a. output. b. prices. c. unemployment. d. all of the above.

8. If we are in the recessionary gap, then in the long-run: a. prices will rise and output fall. b. output will rise and prices will fall. c. both prices and output will rise. d. both prices and output will fall.

9. Which of the following a reason that people buy more U.S. made goods when U.S. prices fall? a. The rising buying effect. b. The interest rate effect. c. The barter effect. d. All of the above.

10. What goes down when an economy goes into the inflationary gap in the short-run? a. output. b. unemployment. c. wages. d. none of the above.

11. According to the international trade effect, when U.S. prices rise, : a. U.S. imports will rise. b. U.S. exports will rise. c. purchases of U.S. goods will increase. d. Both b and c.

12. In the short-run, when prices rise: a. cost of production goes up as much as the sales price of the item. b. cost of production goes up, but less than the sales price of the item. c. cost of production does not go up, while the sales price of the item does. d. there is not enough information to tell.

13. Which of the following is true for the aggregate supply/aggregate demand model we used in much of this unit? a. Wage increases increased AD since workers bought more. b. Wage increase decreased AD since bosses bought less. c. Wage increases did not change AD since workers spending more and the bosses spending less cancelled each other out. 14. What is true in our modal about the point on the AD/AS graph where AD intersects SRAS? a. The economy is always at that point. b. The economy is never at that point. c. The economy is occasionally at that point. d. Trick question – the two lines never intersect.

15. A person with a marketable labor skill (computer programing or accountancy) who is laid off because the business were he works went bankrupt is in what category of unemployment? a. Frictional. b. Structural. c. Cyclical. d. Seasonal.

16. In the long-run, when prices rise: a. cost of production goes up as much as the sales price of the item. b. cost of production goes up, but less than the sales price of the item. c. cost of production does not go up, while the sales price of the item does. d. cost of production goes up, while the sales price stays the same.

17. In the long-run, when prices rise, what happens to real profits? a. They stay the same. b. They rise, so businesses make more products. c. They fall, so businesses make less products. d. Sometimes they go up, sometimes they go down.

18. Why has the federal government run deficits 43 of the last 45 years? a. Voters like to vote for politicians who promise more government help and lower taxes. b. Because for 43 of the last 45 years, we have been in danger of falling into the recessionary gap and so the proper Keynesian response is to run deficits. c. Politicians are always telling lies to get elected. d. Trick question – we have actually had government surpluses for more than half of the last 45 years.

19. Expected higher inflation will cause interest rates to: a. fall. b. rise. c. stay the same.

20. What is the real rate of interest? a. the inflation rate minus the nominal interest rate. b. the nominal interest rate plus the inflation rate. c. the nominal interest rate minus the inflation rate. d. the nominal interest rate times the inflation rate.

21. Keynesians would propose contractionary fiscal policy: a. if the economy is in a recessionary gap. b. if the economy is in an inflationary gap. c. as a stabilizing measure if the economy is in long-run equlibrium. 22. Which of the following combinations constitutes contractionary fiscal policy? a. Increasing government spending and cutting taxes. b. Cutting government spending and cutting taxes. c. Increasing government spending and increasing taxes. d. Cutting government spending and increasing taxes.

23. If the MPC is 0.8, then a $100 increase in government spending financed by borrowing (with causes GDP to rise by how much? a. $0 b. $80 c. $100 d. $500 e. $800

24. Which behavior fits best with the rational expectations model? a. People expect inflation next year to be what it was last year. b. People read newspaper articles featuring economists’ predictions about inflation next year based on current Federal Reserve policy. c. Workers and bosses sign wage contracts with immediate raises tied to the government’s announced CPI inflation statistics each month. d. Both b and c.

25. If the SRAS curve is a line straight up (vertical), then increasing AD causes: a. prices to rise, but not output. b. output to rise, but not prices. c. both output and prices to rise. d. neither output nor prices to rise.

26. When is the SRAS curve likely to be vertical (straight up)? a. When the economy has no unused resources for production b. When the economy has very many unused resources for production. c. When the economy has the natural level of unused resources for production. d. Never.

27. The government surveyed 2,000 people, and found that 1,200 had jobs, 100 had no job and wanted one, and 700 had no job and did not want one. What is the unemployment rate? a. 5.0%. b. 7.7% c. 8.3% d. 14.2% e. 40.0% 28. According to Milton Friedman, when people expect lower inflation,: a. The Phillips curve moves outward (up and to the right). b. The Phillips curve moves inward (down and to the left). c. The Phillips curve stays where it is and we move along the Phillips curve to a position of higher inflation and lower unemployment. d. Nothing on the Phillips curve changes. The curve does not move, nor does our position on the curve.

29. After congress passed the Keynesian stimulus package early in his first term as President, actual unemployment during his first term was: a. lower than what he predicted it would be if his stimulus package was passed. b. higher than what he predicted it would be if his stimulus package was passed. c. just about equal to what he predicted it would be if his stimulus package was passed. d. trick question – no stimulus package was passed early in his first term.

30. Which of the of following is not a reason the government may not be able to use Keynesian Fiscal policy to get the economy out of a recession? a. There could be lags gathering the necessary data, then further lags for Congress to pass the program and then to move down the rounds of the Keynesian table. b. Political fighting between the parties may keep Congress doing what Keynesians think is correct. c. The Keynesian multiplier may be larger than what the President and congress expect it to be. . d. All of the above. e. both a and b.

31. Why might a business prefer to lay-off workers to cutting wages? a. Workers may reduce work effort if their wages are cut. b. If the workers keep working as hard as ever in either case, there will be less of a drop in output with a drop in number of workers. c. Firms know that by refusing to cut wages, they are helping the recession to end faster. d. Both b and c.

32. Suppose the price of government and investment goods rise at a faster rate than the price of consumer goods. Which will rise more, the GDP deflator or the consumer price index? a. GDP deflator. b. CPI c. Both will rise the same. d. Any of the above could happen.