Sample Questionnaire
1. Assume that two countries both have the per-worker production function y = k1/2, neither has
population growth or technological progress, depreciation is 5 percent of capital in both
countries, and country A saves 10 percent of output whereas country B saves 20 percent. If A
starts out with a capital-labour ratio of 4 and B starts out with a capital-labour ratio of 2, in the
long run:
A) both A and B will have capital-labour ratios of 4.
B) both A and B will have capital-labour ratios of 16.
C) A's capital-labour ratio will be 4 whereas B's will be 16.
D) A's capital-labour ratio will be 16 whereas B's will be 4.
2. If y = k1/2, there is no population growth or technological progress, 5 percent of capital
depreciates each year, and a country saves 20 percent of output each year, then the steadystate level of capital per worker is:
A) 2.
B) 4.
C) 8.
D) 16.
3. In the Solow growth model of Chapter 7, where s is the saving rate, y is output per worker, and
i is investment per worker, consumption per worker (c) equals:
A) sy.
B) (1 – s)y.
C) (1 + s)y.
D) (1 – s)y – i.
4. The formula for the steady-state ratio of capital to labour (k*), with no population growth or
technological change, is s:
A) divided by the depreciation rate.
B) multiplied by the depreciation rate.
C) divided by the product of f(k*) and the depreciation rate.
D) multiplied by f(k*) divided by the depreciation rate.
5. Assume that a war reduces a country's labour force but does not directly affect its capital
stock. If the economy was in a steady state before the war and the saving rate does not change
after the war, then, over time, capital per worker will ______ and output per worker will grow
______ than it did before the war.
A) decline; faster
B) increase; faster
C) decline; more slowly
D) increase; more slowly
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6. The production function y = f(k) means:
A) labour is not a factor of production.
B) output per worker is a function of labour productivity.
C) output per worker is a function of capital per worker.
D) the production function exhibits increasing returns to scale.
7. In an economy with population growth at rate n, the change in capital stock per worker is given
by the equation:
A) k = sf(k) + k.
B) k = sf(k) – k.
C) k = sf(k) + (+ n)k.
D) k = sf(k) – ( + n)k.
8. (Exhibit: Steady-State Capital-Labour Ratio) In this graph, the capital-labour ratio that
represents the steady-state capital-labour ratio is:
A)
B)
C)
D)
k0.
k1.
k2.
k3.
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9. (Exhibit: Output, Consumption, and Investment) In this graph, when the capital-labour ratio is
OA, AB represents:
A)
B)
C)
D)
investment per worker, and AC represents consumption per worker.
consumption per worker, and AC represents investment per worker.
investment per worker, and BC represents consumption per worker.
consumption per worker, and BC represents investment per worker.
10. When f(k) is drawn on a graph with increases in k noted along the horizontal axis, the:
A) graph is a straight line.
B) slope of the line eventually gets flatter and flatter.
C) slope of the line eventually becomes negative.
D) slope of the line eventually becomes steeper and steeper.
11. If productivity growth in Canada had remained at its level before the recent productivity
slowdown, real income today would be more than ______ percent higher.
A) 15
B) 25
C) 35
D) 45
12. The benefits of the computer revolution had a lagged impact on productivity growth because:
A) it took time for firms to figure out the best use of computer technology.
B) the government restricted which new computer technologies could be implemented.
C) it was difficult to overcome the inertia generated by the large initial size of the computer
industry.
D) military computer applications took precedence over commercial applications.
13. If the production function is Y = AK2/3L1/3 in the land of Solovia, and the labour force increases
by 5 percent while capital is constant, labour productivity will:
A) increase by 3.33 percent.
B) increase by 1.67 percent.
C) decrease by 1.67 percent.
D) decrease by 3.33 percent.
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14. In a steady-state economy with population growth n and labour-augmenting technological
progress g, persistent increases in standard of living are possible because the:
A) capital stock grows faster than does the labour force.
B) capital stock grows faster than does the number of effective workers.
C) capital stock grows faster than does depreciation.
D) saving rate constantly increases.
15. In the Solow growth model, technological change is ______, whereas in endogenous growth
theories, technological change is ______.
A) assumed; explained
B) explained; assumed
C) persistent; constant
D) constant; persistent
16. In a steady state with population growth and technological progress:
A) the real rental price of capital is constant, and the real wage grows at the rate of
technological progress.
B) the real rental price of capital grows at the rate of technological progress, and the real
wage is constant.
C) both the real rental price of capital and the real wage grow at the rate of technological
progress.
D) both the real rental price of capital and the real wage are constant.
17. In the Solow model with technological progress, the steady-state growth rate of output per
effective worker is:
A) 0.
B) g.
C) n.
D) n + g.
18. The number of effective workers takes into account the number of workers and the:
A) amount of capital available to each worker.
B) rate of growth of the number of workers.
C) efficiency of each worker.
D) saving rate of each worker.
19. Other things being equal, all of the following government policies are likely to increase national
saving except:
A) decreasing taxes on savings accounts.
B) running a budget deficit.
C) running a budget surplus.
D) retiring part of the national debt.
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20. If the short-run aggregate supply curve is horizontal, an increase in union aggressiveness that
pushes wages and prices up will result in ______ prices and ______ output in the short run.
A) higher; lower
B) lower; higher
C) higher; higher
D) lower; lower
21. Short-run fluctuations in output and employment are called:
A) sectoral shifts.
B) the classical dichotomy.
C) business cycles.
D) productivity slowdowns.
Use the following to answer question 22:
(Exhibit: Supply Shock)
22. (Exhibit: Supply Shock) In this graph, assume that the economy starts at point A and there is a
favourable supply shock that does not last forever. In this situation, point ______ represents
short-run equilibrium and point ______ represents long-run equilibrium.
A) B; C
B) B; A
C) E; D
D) E; A
23. Long-run growth in real GDP is determined primarily by ______, while short-run movements in
real GDP are associated with ______.
A) variations in labour-market utilization; technological progress
B) technological progress; variations in labour-market utilization
C) money supply growth rates; changes in velocity
D) changes in velocity; money supply growth rates
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24. If the long-run aggregate supply curve is vertical, then changes in aggregate demand affect:
A) neither prices nor level of output.
B) both prices and level of output.
C) level of output but not prices.
D) prices but not level of output.
25. When a long-term aggregate supply curve is drawn with real GDP (Y) along the horizontal axis
and the price level (P) along the vertical axis, this curve:
A) slopes upward and to the right.
B) slopes downward and to the right.
C) is horizontal.
D) is vertical.
26. When the Bank of Canada reduces the money supply, at a given price level the amount of
output demanded is ______ and the aggregate demand curve shifts ______.
A) greater; inward
B) greater; outward
C) lower; inward
D) lower; outward
27. Throughout much of the 1990s, North America experienced declining energy prices. Assume
that the Canadian economy was in long-run equilibrium before these declines began.
a.
b.
Use the aggregate demand–aggregate supply model to illustrate graphically the
short-run and long-run impact of this decline on output and prices.
If the Bank of Canada attempted to offset this deviation from the natural rate
in the short run, should the money supply be increased or decreased?
28. An economy is initially in long-run equilibrium. The introduction of an electronic payments
system dramatically reduces the demand for money in the economy.
a.
b.
c.
What is the short-run impact on prices and output of the new system?
What can the central bank do, if anything, to counteract the short-run changes in
output and prices?
If the central bank does not take any policy actions, what will be the long-run impact
of the electronic payments system on prices and output?
29. The theory of liquidity preference implies that the quantity of real money balances demanded
is:
A) negatively related to both the interest rate and income.
B) positively related to both the interest rate and income.
C) positively related to the interest rate and negatively related to income.
D) negatively related to the interest rate and positively related to income.
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30. According to the Keynesian-cross analysis, if the marginal propensity to consume is 0.6, and
government expenditures and autonomous taxes are both increased by 100, equilibrium
income will rise by:
A) 0.
B) 100.
C) 150.
D) 250.
31. a.
b.
Graphically illustrate how an increase in income affects the equilibrium levels
of saving, investment, and the interest rate in the loanable funds model.
Be sure to label:
i. the axes
ii. the curves
iii. the initial equilibrium values
iv. the direction the curve shifts to
v. the terminal equilibrium values.
Explain in words what happens to the equilibrium levels of saving, investment,
and the interest rates as a result of the increase in income.
32. Tax cuts stimulate ______ by improving worker's incentive and expand ______ by raising
households' disposable income.
A) velocity; demand for loanable funds
B) demand for loanable funds; velocity
C) aggregate demand; aggregate supply
D) aggregate supply; aggregate demand
33. The simple investment function shows that investment ______ as ______ increases.
A) decreases; the interest rate
B) increases; the interest rate
C) decreases; government spending
D) increases; government spending
34. The IS curve shows combinations of ______ that are consistent with equilibrium in the market
for goods and services:
A) inflation and unemployment
B) the price level and real output
C) the interest rate and the level of income
D) the interest rate and real money balances
35. In the Keynesian-cross analysis, if the consumption function is given by C = 100 + 0.6(Y – T), and
planned investment is 100, G is 100, and T is 100, then equilibrium Y is:
A) 350.
B) 400.
C) 600.
D) 750.
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36. The IS curve provides combinations of interest rates and income that satisfy equilibrium in the
market for ______, and the LM curve provides combinations of interest rates and income that
satisfy equilibrium in the market for ______.
A) saving and investment; planned spending
B) real-money balances; loanable funds
C) goods and services; real-money balances
D) real-money balances; goods and services
37. In the Keynesian-cross model, if the MPC equals .75, then a $1 billion decrease in taxes
increases planned expenditures by ______ and increases the equilibrium level of income by
______.
A) $1 billion; more than $1 billion
B) $.75 billion; more than $.75 billion
C) $.75 billion; $.75 billion
D) $1 billion; $1 billion
38. An increase in government spending raises income:
A) and the interest rate in the short run, but leaves both unchanged in the long run.
B) in the short run, but leaves it unchanged in the long run, while lowering investment.
C) in the short run, but leaves it unchanged in the long run, while lowering consumption.
D) and the interest rate in both the short and long runs.
39. A tax cut shifts the ______ to the right, and the aggregate demand curve ______.
A) IS; shifts to the right
B) IS; does not shift
C) LM: shifts to the right
D) LM; does not shift
40. If MPC = 0.75 (and there are no income taxes but only lump-sum taxes), when T decreases by
100, then the IS curve for any given interest rate shifts to the right by:
A) 100.
B) 200.
C) 300.
D) 400.
41. If MPC = 0.75 (and there are no income taxes) when G increases by 100, then the IS curve for
any given interest rate shifts to the right by:
A) 100.
B) 200.
C) 300.
D) 400.
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42. Two identical countries, Alpha and Beta, can be described by the IS-LM model in the short run.
The governments of both countries cut taxes by the same amount. The Central Bank of Alpha
follows a policy of holding a constant money supply. The Central Bank of Beta follows a policy
of holding a constant interest rate. Compare the impact of the tax cut on income and interest
rates in the two countries.
43. In the IS-LM model when M remains constant but P rises, in short-run equilibrium, in the usual
case, the interest rate ______ and output ______.
A) rises; falls
B) rises; rises
C) falls; rises
D) falls; falls
44. Other things equal, a given change in money supply has a larger effect on demand, the:
A) larger the income sensitivity of money demand.
B) smaller the income sensitivity of money demand.
C) flatter the LM curve.
D) steeper the IS curve.
45. If the IS curve is given by Y = 1,700 – 100r and the LM curve is given by Y = 500 + 100r, then
equilibrium income and interest rate are given by:
A) Y = 1,100, r = 6 percent.
B) Y = 1,200, r = 5 percent.
C) Y = 1,000, r = 5 percent.
D) Y = 1,100, r = 5 percent.
46. A change in income in the IS-LM model for a fixed price
A) represents a shift in the aggregate demand curve.
B) represents a movement along the aggregate demand curve.
C) has the same effect on the aggregate demand curve as a change in income in the IS-LM
model resulting from a change in the price level.
D) does not represent a change in the aggregate demand curve.
47. Compare the impact of a tax cut on consumption, investment, output, and interest rates in the
classical model of Chapter 3 versus the IS-LM model.
48. Two identical countries, Country A and Country B, can each be described by a Keynesian-cross
model. The MPC is .9 in each country. Country A decides to increase spending by $2 billion,
while Country B decides to cut taxes by $2 billion. In which country will the new equilibrium
level of income be greater?
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49. Suppose you are an economist working for the Bank of Canada when droughts in the Prairies
and floods in Ontario substantially reduce food production in Canada. Use the aggregate
demand–aggregate supply model to illustrate graphically your policy recommendation to
accommodate this adverse supply shock, assuming that your top priority is maintaining full
employment in the economy.
Be sure to label:
i. the axes
ii. the curves
iii. the initial equilibrium values
iv. the direction the curves shift
v. the terminal equilibrium values.
State in words what happens to prices and output as a combined result of the supply shock
and the recommended Bank of Canada accommodation.
50. Assume that a country's per-worker production is y = k1/2, where y is output per worker and k is
capital per worker. Assume also that 10 percent of capital depreciates per year (= 0.10).
a.
b.
c.
d.
If the saving rate (s) is 0.4, what are capital per worker, production per worker, and
consumption per worker in the steady state? (Hint: Use sy = k and y = k1/2 to get
an equation in s, , k, and k1/2, and then solve for k.)
Solve for steady-state capital per worker, production per worker, and consumption
per worker with s = 0.6.
Solve for steady-state capital per worker, production per worker, and consumption
per worker with s = 0.8.
Is it possible to save too much? Why?
51. The economies of two countries, North and South, have the same production functions,
depreciation rates, and saving rates. The economies of each country can be described by the
Solow growth model. Population growth is faster in South than in North.
a.
b.
c.
In which country is the level of steady-state output per worker larger? Explain.
In which country is the steady-state growth rate of output per worker larger?
In which country is the growth rate of steady-state total output greater?
52. Explain how the Solow growth model differs from models of endogenous growth with respect
to:
a.
b.
the sources of technological progress.
returns to capital.
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53. A central bank reduces the money supply in an economy initially in long-run equilibrium.
a.
b.
c.
What will happen to output and prices in the short run?
What will happen to unemployment in the short run?
What will happen to output and prices in the long run?
54. As an economy moves into a recession, income falls.
a.
Illustrate graphically the impact of a decrease in income on the equilibrium
interest rate using the theory of liquidity preference and the market for real
money balances.
b.
Be sure to label:
i. the axes
ii. the curves
iii. the initial equilibrium values
iv. the direction the curve shifts
v. the terminal equilibrium values.
Explain in words what happens to equilibrium interest rate as a result of the
open-market purchase.
55. According to the IS-LM model, if the government raises taxes but the Bank of Canada wants to
hold the interest rate constant, then the Bank of Canada must ______ the money supply.
A) increase
B) decrease
C) first increase and then decrease
D) first decrease and then increase
Answer Key
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
C
D
B
D
C
C
D
C
C
B
C
A
D
A
A
A
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17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
A
C
B
A
C
D
B
D
D
C
a.
b.
28. a.
b.
c.
Output increases and prices decrease in the short run to point B. Output and
prices return to their original levels at point A in the long run.
The Bank of Canada must reduce the money supply in the short run, in order to
return the economy to the natural rate, moving the economy to point C with a
permanently lower price level.
In the short run, output will increase as the reduction in money demand (increase in
velocity) shifts the aggregate demand curve out to the right. There will be little change
in prices in the short run.
The central bank could counteract the decline in money demand by reducing the
money supply, shifting the aggregate demand curve back to the left.
In the long run, with no central bank stabilizing action, output will return to the fullemployment level with a higher price level.
29. D
30. B
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31. a.
32.
33.
34.
35.
36.
37.
38.
39.
40.
41.
42.
43.
44.
45.
46.
47.
48.
b.
The equilibrium levels of saving and investment increase. The interest rate falls.
D
A
C
C
C
B
B
A
C
D
The interest rate will increase in Alpha, but remain constant in Beta. The increase in output will
be larger in Beta because the Central Bank of Beta will increase the money supply to keep the
interest rate constant in the face of the tax cut. Thus, there will be no crowding out of
investment in Beta, but there will be crowding out in Alpha because of the higher interest rate.
A
B
A
A
Output increases in the IS-LM model, but is fixed at the natural level in the classical model
because it is determined by the factors of production and technology. In both models,
consumption increases because the tax cut increases disposable income. The interest rate
increases in both models. In the classical model, the tax cut reduces saving, which increases
the interest rate and reduces the equilibrium quantity of investment. In a closed classical
economy, since income is fixed, the increase in consumption exactly offsets the decrease in
investment. In the IS-LM model, the increase in income increases money demand, which
results in a higher interest rate to bring money demand into equilibrium with the constant
money supply. The higher interest rate partially crowds out investment in the IS-LM model (for
the usual interest sensitivities of investment and money demand).
Income in Country A will increase more. The government-spending multiplier in Country A
equals 10, so income in Country A will increase by $20 billion. The tax multiplier in Country B
equals 9, so income in Country B will only increase by $18 billion.
49.
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50.
51.
52.
53.
The accommodating policy means that the price level is permanently higher, but output is at
the full-employment level.
a. k = 16; y = 4; Consumption per worker is 2.4.
b. k = 36; y = 6; Consumption per worker is 2.4.
c. k = 64; y = 8; Consumption per worker is 1.6.
d. Yes. If the capital stock gets so big that the extra output produced by more capital
is less than the extra saving needed to maintain it, extra capital reduces
consumption per worker. The saving rate exceeds the Golden Rule rate.
a. North will have a higher level of steady-state output per worker because the
population growth is faster in South. The same saving in both countries means
that investment in both countries will be the same. However, capital will be
spread more thinly per worker in the South, where the population is growing
more rapidly. Given the same production functions, output per worker will be
higher in the North because it has a higher capital per worker ratio than the
South.
b. In the steady state in both countries, capital per worker is constant, so output
per worker is constant. The growth rate of output per worker is zero in both
North and South.
c. In the steady state, total output grows at the rate of population growth. Since
South has a higher rate of population growth, the growth rate of total output
will be higher in South than in North.
a.
The Solow growth model assumes technological growth exists, while endogenous
growth models try to explain where technological progress comes from.
b.
The Solow model assumes diminishing returns to capital, while endogenous growth
models assume constant returns to capital.
a.
In the short run, output would decrease with little change in prices.
b.
In the short run, unemployment will increase.
c.
In the long run, output will return to the full-employment level at a lower price level.
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54. a.
b.
55. B
The equilibrium interest rate falls.
Page 15