Labor Market, AD-AS Model Solutions

MOCK EXAM: LABOR MARKET, AD-AS MODEL, LONG-RUN ECONOMIC GROWTH, GOODS MARKET IN AN OPEN ECONOMY. 1. Suppose for this exercise that the AS is completely horizontal. A rightward shift in the aggregate demand curve will cause employment to_________ and the price level to________. (A) Increase/Increase (B) Increase/Decrease (C) Increase/No change (D) Decrease/No change 2. Which of the following is a fiscal policy that would increase aggregate demand in the short-run? (A) A decrease in personal income taxes (B) A decrease in government spending (C) An increase in corporate income taxes (Corporate income taxes affects firms’ cost of production and therefore is a SUPPLY side variable) (D) A purchase of government bonds by the Federal Reserve (MONETARY) 3. The aggregate supply curve will shift to the right in the short-run when… (A) energy prices increase. (B) labor productivity decrease. (C) prices of inputs decrease. (D) investment spending decreases. AS shifts to the right if the cost of production decreases. 4. Which of the following best describes aggregate supply? (A) The amount buyers plan to spend on output. It refers to the demand. (B) A relation showing the trade-off between inflation and unemployment . (C) A relation indicating the level of real output that will be purchased at each possible price level. This the definition of AD. (D) A relation indicating the level of real output that will be produced at each possible price level. It is the opposite “The price at which each level of production will be produced”. AS Y increases and firms uses more workers (N increases), unemployment decreases and wages increase (cost), therefore the price (P) increases. 5. If the government increases both taxes and government spending by $25 billion, the price level and real GDP will most likely change in which of the following ways in the short-run? Price Level will________ and Real GDP will_________. (A) Increase/Increase (B) Increase/Decrease (C) Increase/No Change (D) Decrease/Decrease Tax increase by 25B: negative demand shock, AD shifts left. G increase by 25B: positive demand shock, AD shifts right. The increase in G dominates, so in net terms AD shifts right. 6. If the primary goal is to reduce inflation, which of the following fiscal policy actions would be appropriate during a period of a rapidly increasing consumer price index? I. Reduce government spending. II. Reduce taxes. III. Increase taxes. (A) I only (B) II only (C) III only (D) I and III only This is a situation in which Y>Yn, so production is too high, what generates inflation. The demand should shift left (negative shock). Both an increase of taxes (T) or an decrease of government spending (G) shifts the AD to the left. 7. If there is a shift to the left in the aggregate supply curve and no changes in monetary and fiscal policies are implemented, the economy in the medium-run will… (A) remain at the new price and output level. (B) continue to have rising prices and decreasing real GDP. (C) return to the original output and price level. (D) experience a leftward shift in the aggregate demand curve. After a negative demand shock the new medium-term equilibrium is at point B: 8. Suppose the economy is closed. Then at every point along the aggregate demand curve, (a) Y = C + I + G (b) Y = C (c) G = T (d) none of the answers Equilibrium conditions: 1. Goods Market: Y=Z; Z=C+I+G -> Y=C+I+G. 2. Money market: Md=Ms. 9. The aggregate demand curve will shift leftwards if (a) the output level decreased (b) the price level increased (c) net taxes decreased (d) the money supply decreased 10. The economy would move upwards along the same AD curve if (a) the money supply increased (b) the price level increases (c) taxes increased (d) both money supply increased and/or taxes increased Movement along AD: as P increases, Ms/P decreases, i increases, I decreases and Z and Y decrease. 11. Using the model of AD and AS, what happens to real GDP (Y), the price level (P), and unemployment (u) in the short-run with more consumption spending (C)? A. Real GDP increases, Price level decreases, Unemployment decreases. B. Real GDP decreases, Price level increases, Unemployment increases. C. Real GDP increases, Price level increases, Unemployment decreases. D. Real GDPdecreases, Price level decreases, Unemployment decreases. 12. Stagflation most likely results from A. Increasing AD with constant AS. B. decreasing AS with constant AD. C. decreasing AD with constant AS. D. a decrease in both AD and AS. 13. Suppose equilibrium real GDP is below its potential level and the government lowers taxes. Which is the likely result of this policy? A. Unemployment falls with inflation B. Unemployment rises with deflation C. Unemployment falls with deflation E. No change occurs in unemployment or inflation 14. The maximum quantity that an economy can produce, given its existing levels of labor, physical capital, technology, and institutions, is called: A. real GDP. B. potential GDP. C. aggregate supply. D. aggregate demand. This is the definition of potential GDP. 15. Potential GDP in the U.S. will be unaffected by ____________________. A. technology. B. productivity. C. cyclical unemployment. D. government institutions. The remaining are structural variables affecting firms’ cost of production. 16. Suppose that consumers are pessimistic about their future incomes so they reduce consumption today. How does this increase pessimism affect the economy in the medium-run? A. No change in unemployment, decrease of Y, decrease of P. B. Increase of unemployment, no change in Y, decrease of P. C. No change in unemployment, no change in Y, increase of P. D. No change in unemployment, no change in Y, decrease of P. Medium term effect is the change from A to C: 17. Why is labor productivity growth considered to be one of the most important factors in the AD/AS model? A. it shifts the AD curve in the medium-term B. it shifts the AD curve in the short-term C. it shifts the AS curve in the short-term D. it increases potential output. Because it is the way of increasing potential output and to sustain economic growth in the medium and long-run. 18. The potential output will shift to the right if the economy A. experiences deflation. B. net exports decrease. C. has a decrease in population. D. experiences technological improvement. Related with the previous question, a technological improvement leads to higher productivity which expands potential output. 19. Hurricane Katrina destroyed oil and natural gas reserves, making the price of these inputs to increase. 3 years later, once the refining capacity was restored, these prices came back down. The restoration of refining capacity should A. shift the aggregate supply curve to the right in the short-run. B. move the economy down along the same aggregate supply curve in the short-run. C. shift the aggregate supply curve to the left in the short-run. D. move the economy up along the same aggregate supply curve in the short-run. Katrina was a negative supply side shock (AS shifts left). The retoration of the refining capacity is a positive supply shock (it shifts the AS to the right): 20. Interest rates in the economy have fallen. How will this affect aggregate demand and equilibrium in the medium-run? A. P will fall, Y will rise and aggregate demand (Z) will increase. B. P will increase, Y will rise and aggregate demand (Z) will increase. C. P will fall, Y and Z will not change. D. P will increase, Y and Z will not change. As interest rates decrease AD shifts right (positive demand shock). The short-term effect is the change from A to B. In the medium term AS shifts left (inflationary spiral) and the economy moves to point C. The medium-term effect is the shift from A to C, P increases but Y and Z do not change: 21. Which of the following is considered a negative supply side shock? A. an increase in unemployment B. an improvement in technology C. an increase in the cost of production D. increasing immigration in the economy causes the labor supply to rise. Anything increasing the cost of production is a supply-side shock. 22. Which of the following is an effect of an increase in government spending in the medium run a. Decrease in private investment. b. Decrease in interest rates. c. Increase in private consumption. d. Decrease in savings. Crowding-out Effect: an increase in G will generate inflation and higher interest rates in the medium run and Investment will decrease. 23. Which of the following policy options would simultaneously increase interest rates and decrease output in the short-run? A) The Central Bank sells bonds through open market operations. B) The government increases its spending. C) The Central Bank expands the money supply. D) The government increases the tax rate. A contractionary Open Market Operation (the Central Bank sells bonds) reduces the money supply, increasing interest rates and reducing output. 24. Suppose that taxes increase and money supply increases in such a way that output does not change. These policy changes will produce in the short-run… A) An increase in investment and a decrease in consumption. B) An increase in investment and a decrease in government spending. C) An increase in investment and an increase in private saving. D) A decrease in investment and an increase in public saving. Tax increase: negative demand shock, as T increases C will decrease. Increase Ms: positive demand shock, as interest rates decrease, I increases. 25. Suppose that money supply increases. In the medium-run we could expect… A) An increase in investment and a decrease in private consumption. B) An increase in investment and no change in private consumption. C) An increase in investment and an increase in private consumption. D) No change in investment and no change in private consumption In the medium run there is no change in output, so consumption does not change. Investment depends on output (Y) and the interest rate (i). An expansion of the money supply does not affect interest rates in the medium-run (Neutrality of Money) so investment does not change in the medium run. 26. A simultaneous increase in the money supply and a drop in consumer confidence will in the short-run lead to A) A decrease in output with an ambiguous effect on the interest rate. B) An increase in output and a decrease in the interest rate. C) An ambiguous effect on output and an increase in the interest rate. D) An ambiguous effect on output and a decrease in the interest rate Increase Ms, positive Demand shock, this will decrease the interest rates. Decrease C, negative demand shock. It is not possible to know if output increases or decreases as these are two opposing shocks, positive and negative. 27. Which of the following variables is most directly determined in the labor market? A) nominal wages B) interest rates C) both of them D) none of them 28. In the wage-setting relation, the nominal wage tends to decrease when A) the price level increases. B) the unemployment rate decreases. C) unemployment benefits decrease. D) the minimum wage increases. As workers protection increase workers bargaining power increases and W increases. 29. In the wage setting relation W = PeF(u,z), the variable z does not include which of the following variables? A) the minimum wage B) unemployment benefits C) the extent to which firms mark up prices over their marginal cost D) all of them 30. In an open economy, exports will decrease when there is A) an increase in the real exchange rate. B) an increase in domestic output. C) an increase in foreign output. D) a decrease in domestic output. The real exchange rate is ε =EP/P*, so if it increases then domestic goods are becoming more expensive, what penalizes exports. 31. In an open economy, which of the following represents the domestic demand for goods? A) C + I + G B) C + I + G + X C) C + I + G - IM/ε D) C + I + G + X - IM/ε It’s D=C+I+G. 32. In an open economy, which of the following will always cause an increase in net exports? A) a reduction in domestic output B) an increase in government spending C) an increase in investment D) all of them NX=X-IM; imports depends positively on both the real exchange rate and domestic output. As domestic output decreases, imports decreases as well, making net exports (NX) to increase. 33. In an open economy, which of the following will occur as a result of a tax increase in the short-run? A) private saving increases B) investment increases C) the trade balance improves D) the trade balance worsens As T increases, C decreases and also Z and Y. The decrease in Y will reduce IM and therefore will increase NX. 34. Which of the following will cause a reduction in output per worker in the long run? A) capital accumulation or technological progress B) capital accumulation C) an increase in the number of workers D) expansionary monetary policy 35. Which of the following must occur to sustain economic growth in the long run? A) technological progress B) capital accumulation C) a lower saving rate D) all of them Important: capital accumulation is subject to decreasing returns, so in order to sustain growth in the long run technological progress is required. 36. Suppose there are two countries that are identical with the following exception. The saving rate in country A is greater than the saving rate in country B. Given this information, we know that in the long run A) the capital-labor ratio (K/N) will be greater in B than in A. B) the capital-labor ratio (K/N) will be greater in A than in B. C) the capital-labor ratio (K/N) will be the same in the two countries. D) economic growth will be higher in A than in B. Capital accumulation (K/N) depends in investment which depends on savings. The higher the saving rate the higher investment and therefore capital accumulation. 37. Which of the following will cause a reduction in output per worker (Y/N)? A) a reduction in the capital stock (K) B) a reduction in the saving rate C) a reduction in K/N D) all of them 38. An open economy is defined by C=100+0.8(Y-T) I=400 X=0.3Y* IM=0.3Y T=1000, G=1000, Y*=1000 The equilibrium level of production is: A) 2000 B) 2200 C) 2400 D) None is correct We use Y=C+I+G+X-IM and replace Y=100+0.8(Y-1000)+ 400+1000+0.3*1000-0.3Y Y-0.8Y+0.3Y = 100-800+400+1000+300 0.5Y=1000 Y=2*1000=2000 39. An open economy is defined by C=100+0.8(Y-T) I=400 X=0.3Y* IM=0.3Y T=1000, G=1000, Y*=1000 The multiplier of this economy is: A) 5 B) 2 C) 1.2 D) None is correct The multiplier in an open economy is MULT=(1/(1-c1-b1+im1)), in this case c1=0.8, b1=0, im1=0.3, therefore MULT=(1/(1-0.5-0+0.3))=2 40. An open economy is defined by C=100+0.8(Y-T) I=400 X=0.3Y* IM=0.3Y T=1000, G=1000, Y*=1000 Net exports (NX) this economy is: A) -100 B) 300 C) -300 D) None is correct Since Y=2000, we calculate NX=X-IM=0.3*1000-0.3*2000=-0.3*1000=-300. 1. In the long run, what matters for improving a country´s living standards is to be able to keep the economy stable around its natural (potential) level of output. TRUE/FALSE Briefly explain your answer In the long run what matters is to expand potential output by productivity and technological improvements. In the short run it is important to control economic cycles, that is, to keep Y around Yn. 2. One of the big challenges faced by industrial countries today is the massive influx of refugees from regions suffering armed conflicts. From a pure economic point of view, and using the model you have learned in this course, you can say that the impact of this influx is negative both in the short and in the long run. TRUE/FALSE Briefly explain your answer In the long run it is important to expand Yn, which is defined as Yn=(1-un)*A*L The influx of refuges increases the labor force (L) and therefore potential output. 3. A country with a large public deficit and a large public debt is reducing long term economic growth. TRUE/FALSE Briefly explain your answer As debt increases national savings decrease. In the long run a necessary condition for a country to grow is to invest (I) in new physical assets (K/N). We know that investment (I) depends in savings, so as savings decrease investment will decrease and therefore the potential to grow in the future. 4. The trade war engaged by the US with China, consisting on imposing tariffs in a wide range of goods coming from China into the US, can be seen as a Shock to US Aggregate Supply, to the extent that some imports are used in the production of goods in the US. In this sense, according to our basic model for AD/AS, we expect the impact of the trade war in the US to be a fall in economic activity (in real GDP) and a rise in the price level. TRUE/FALSE Briefly explain your answer (T) AS input prices increase the cost of production of US firms will tend to increase, this will shift the AS to the left, making prices to increase and production to decrease both in the short and in the medium term. 5. The unemployment rate in the Netherlands in 3.3% while the unemployment rate in Spain is 13.9%. Despite being so different, both can be considered natural rates of unemployment for their respective countries, to the extent that inflation rates are quite stable but positive. TRUE/FALSE Briefly explain your answer (T) The natural rate of unemployment is the unemployment rate that does not generate inflation nor deflation. In the example inflation is positive, so those cannot be natural rates of unemployment. 6. The multiplier in Germany is 1.5, while the multiplier in the US is 3.2, this implies that economic cycles will have more amplitude and will be longer in Germany than in the US. TRUE/FALSE Briefly explain your answer (T) It would be the opposite case, the larger the multiplier the longer and the more amplitude economic cycles will have. Note that the multiplier determines the change in output after a change in the demand, the longer the multiplier the larger the effect on output. 7. An increase of the Budget deficit usually generates trade deficit. TRUE/FALSE Briefly explain your answer (T) An increase in the budget deficit (T-G<0) is a positive shock to production, either by increasing G or by decreasing T. As G increases and or T decreases domestic output increases, what makes imports to increase, generating budget deficit X-IM<0. 8. Small economies with larger imports and exports usually have lower multipliers. TRUE/FALSE Briefly explain your answer (T) The multiplier is MULT=(1/(1-c1-b1+im1)), the proportion of imports to GDP is im1, so the more imports the larger im1 and, therefore, the lower the multiplier.