PRACTICE QUESTIONS ON CHAPTER 14 ECO62 SPRING 2011 UDAYAN ROY
Name: __________________________ Date: _____________
1. In the DAD-DAS model, the demand for goods and services will ______ as the natural
level of output ( ) increases and ______ as the real interest rate (r) increases.
A) increase; increase
B) increase; decrease
C) decrease; decrease
D) decrease; increase
2. In the DAD-DAS model, changes in fiscal policy appear as changes in the:
A) natural rate of interest (r).
B) expected rate of inflation (Eπ).
C) random demand shock (ε).
D) natural level of output ( ).
3. A higher real interest rate reduces the demand for goods and services by:
A) shifting the dynamic aggregate supply curve.
B) decreasing the natural level of output.
C) increasing inflation expectations.
D) reducing investment and consumption spending.
4. Which of the following would be represented by a positive value of the random demand
shock, εt?
A) a sudden wave of optimism among investors
B) a decrease in government spending
C) an aggressive increase in oil prices by a cartel
D) an increase in the central bank's inflation target
5. Which of the following would be represented by a negative value of the random demand
shock, εt?
A) a sudden wave of optimism among investors
B) a decrease in government spending
C) an aggressive increase in oil prices by a cartel
D) a decrease in the central bank's inflation target
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6. The natural rate of interest (ρ) is the real interest rate (r):
A) at which the demand for goods and services (Y) equals the natural level of output
( ).
B) that most people anticipate based on their expectations of inflation.
C) at which the natural rate of unemployment equals the natural rate of output.
D) equal to the nominal interest rate minus the natural rate of inflation.
7. According to the Fisher equation, the real interest rate equals the nominal interest rate
minus the:
A) natural rate of interest.
B) expected rate of inflation.
C) ex post rate of inflation.
D) ex ante rate of interest.
8. According to the Fisher equation the real interest, rt, equals the nominal interest rate, it,
minus the expected inflation rate, which is written as:
A) Ett.
B) Ett+1.
C) Et + 1t.
D) Et + 1t +1.
9. The ex post real interest rate that prevails at time t equals:
A) it – Ett.
B) it – Ett + 1.
C) it – t.
D) it – t + 1.
10. The current inflation rate, t, represents the change in the price level between periods:
A) t – 1 and t. That is, t = (Pt – Pt-1)/ Pt-1.
B) t and t + 1. That is, t = (Pt+1 – Pt)/ Pt.
C) t – 1 and t + 1. That is, t = (Pt+1 – Pt-1)/ Pt-1.
D) t and t + 2. That is, t = (Pt+2 – Pt)/ Pt.
11. The nominal interest rate, it, is the rate of return between periods:
A) t – 1 and t.
B) t and t + 1.
C) t – 1 and t + 1.
D) t and t + 2.
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12. According to the Phillips curve, inflation depends on expected inflation because:
A) the real interest rate depends on the expected rate of inflation.
B) the central bank sets its target inflation rate based on the expected rate of inflation.
C) the natural level of output depends on the expected rate of inflation.
D) when some firms set prices in advance, expected inflation influences future prices.
13. According to the Phillips curve, firms raise prices when output is ______ the natural
level of output, or equivalently, when the unemployment rate is ______ the natural rate
of unemployment.
A) above; above
B) above; below
C) below; below
D) below; above
14. According to the Phillips curve, firms ______ prices when output is below the natural
level of output, or equivalently, when the unemployment rate is ______ the natural rate
of unemployment.
A) raise; above
B) raise; below
C) lower; above
D) lower; below
15. In the DAD-DAS model, the inflation shock variable, t, is a variable appearing in
which of the following equations of the model?
A) Fisher equation
B) Phillips curve
C) monetary-policy rule
D) adaptive expectations
16. Which of the following would be represented by a negative value of the random
inflation shock, t?
A) a sudden wave of pessimism among investors
B) a decrease in government spending
C) oil price decreases resulting from a breakdown in the cartel
D) a decrease in the central bank's inflation target
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17. Which of the following would be represented by a positive value of the random inflation
shock, t?
A) a sudden wave of optimism among investors
B) an increase in government spending
C) widespread drought leading to large increases in food prices
D) an increase in the central bank's inflation target
18. Expectations of inflation based on recently observed inflation is called the assumption
of ______ expectations.
A) natural
B) rational
C) dynamic
D) adaptive
19. In the specification of adaptive expectation used in the DAD-DAS model of aggregate
demand and aggregate supply, people at time t – 1 forecast the inflation rate in time
period t will be:
A) t – 2.
B) t – 1.
C) t.
D) t + 1.
20. According to the monetary policy rule in the DAD-DAS model, when inflation (π) is at
its target level (π*) and output (Y) is at the natural level ( ), then the real interest rate (r)
equals the:
A) nominal rate of interest (i).
B) target rate of inflation (π*).
C) natural rate of interest (ρ).
D) current rate of inflation (π).
21. According to the monetary policy rule, the central bank sets the nominal interest rate so
the real interest rate increases when inflation ______ its target, or output ______ its
natural level.
A) rises above; rises above
B) rises above; falls below
C) falls below; falls below
D) falls below; rises above
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22. To follow a monetary policy rule, the central bank raises the nominal interest rate by:
A) raising the inflation target.
B) decreasing the money supply.
C) increasing the GDP gap.
D) decreasing inflation expectations.
23. In order to achieve the target for the nominal interest rate established by the monetary
policy rule, the central banks adjusts:
A) the inflation rate.
B) the natural rate of interest.
C) the money supply.
D) the inflation target.
24. The monetary policy rule specified in the DAD-DAS model of aggregate demand and
aggregate supply indicates that the central bank adjusts interest rates in response to
fluctuations in:
A) inflation expectations.
B) money supply and money demand.
C) inflation and output.
D) nominal and real exchange rates.
25. John Taylor's rule for setting the federal funds rate proposes increasing the nominal
federal funds rate as inflation ______ and the GDP gap ______.
A) increases; increases
B) increases; decreases
C) decreases; increases
D) decreases; decreases
26. The Taylor rule can be written as FF rate =  + 2.0 + 0.5( – 2.0) + 0.5(GDP gap),
where FF rate is the nominal federal funds rate,  is the inflation rate, and the GDP gap
is the percentage deviation of real GDP from its natural level. If inflation is 4 percent
and the GDP gap is 2 percent, then according to the Taylor rule, the Fed should set the
nominal federal funds rate at ______ percent.
A) 4
B) 8
C) 10
D) 12
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27. The Taylor rule can be written as FF rate =  + 2.0 + 0.5( – 2.0) + 0.5(GDP gap),
where FF rate is the nominal federal funds rate,  is the inflation rate, and the GDP gap
is the percentage deviation of real GDP from its natural level. If inflation is 2 percent
and the GDP gap is –2 percent, then according to the Taylor rule, the Fed should set the
nominal federal funds rate at ______ percent.
A) 2
B) 3
C) 4
D) 5
28. All of the following are endogenous variables in the DAD-DAS model of aggregate
demand and aggregate supply except:
A) Yt, output.
B) *t, central bank's inflation target.
C) rt, real interest rate.
D) Ett + 1, expected inflation.
29. Which of the following is an exogenous variable in the DAD-DAS model of aggregate
demand and aggregate supply?
A) Ett + 1, expected inflation
B) rt, real interest rate
C) t, inflation
D) t, inflation shock
30. Long-run equilibrium occurs in the DAD-DAS model of aggregate demand and
aggregate supply when:
A) dynamic aggregate demand equals dynamic aggregate supply.
B) there are no shocks (ε = ν = 0) and inflation is stable (t = t-1).
C) the demand shock equals the supply shock (ε = ν).
D) the nominal interest rate equals the real interest rate (i = r).
31. Of the five endogenous variables in the DAD-DAS model of aggregate demand and
aggregate supply, which are the real variables that do not depend on the monetary policy
in long-run equilibrium?
A) Yt and t
B) it and rt
C) Ett + 1 and t
D) Yt and rt
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32. Of the five endogenous variables in the DAD-DAS model of aggregate demand and
aggregate supply, which are the nominal variables that will change in long-run
equilibrium if the central bank changes its inflation target (*)?
A) Yt , rt, and it
B) Yt, it, and Ett + 1
C) t, it, and Ett + 1
D) rt, t, and it
33. The dynamic aggregate supply (DAS) curve shows the short-run relation between:
A) the natural level of output and inflation.
B) the natural level of output and expected rate of inflation.
C) output and inflation.
D) output and the natural rate of interest.
34. The dynamic aggregate supply curve is derived from which of the five equations of the
model of aggregate demand and aggregate supply?
A) the Fisher equation and adaptive expectations
B) the Phillips curve and adaptive expectations
C) the monetary policy rule and the Fisher equation
D) the Phillips curve and the monetary policy rule
35. The dynamic aggregate supply curve illustrates a short-run ______ tradeoff between
output and ______.
A) positive; inflation
B) positive; the price level
C) negative; inflation
D) negative; the price level
36. The upward slope of the dynamic aggregate supply curve indicates that, holding other
factors constant, high levels of economic activity are associated with:
A) the natural level of output.
B) the inflation target.
C) positive supply shocks.
D) high inflation.
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37. The dynamic aggregate supply curve will shift if any of the following changes except
the:
A) current inflation rate.
B) past inflation rate.
C) natural level of output.
D) supply shock.
38. The dynamic aggregate demand (DAD) curve is derived from each of the following
equations of the model of aggregate demand and aggregate supply except:
A) the Fisher equation.
B) the Phillips curve.
C) adaptive expectations.
D) the monetary policy rule.
39. The dynamic aggregate demand curve will shift if any of the following changes except
the:
A) current inflation rate.
B) inflation target.
C) natural level of output.
D) demand shock.
40. The dynamic aggregate demand curve is downward sloping because as inflation falls the
central bank reduces the nominal interest rate by more than the fall in the inflation rate,
which ______ the real interest rate and ______ the quantity of goods and services
demanded.
A) decreases; decreases
B) decreases; increases
C) increases; increases
D) increases; decreases
41. According to the monetary policy rule (assuming  > 0) when inflation increases, the
central bank increases the nominal interest rate by ______ the increase in the rate of
inflation, which ______ the real interest rate.
A) more than; increases
B) less than; decreases
C) an amount equal to; does not change
D) less than; increases
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42. The dynamic aggregate demand curve will shift to the right if there is a:
A) tax cut.
B) cut in government spending.
C) decrease in the money supply.
D) cut in oil prices when the cartel falls apart.
43. An increase in the central bank's target rate of inflation is represented by a:
A) movement up the DAD curve.
B) movement down the DAD curve.
C) rightward shift in the DAD curve
D) leftward shift in the DAD curve.
44. The short-run equilibrium in the DAD-DAS model of aggregate demand and aggregate
supply at time t is determined by the intersection of the:
A) DADt and DASt – 1.
B) DADt and DASt.
C) Yt and DASt.
D) DADt – 1 and Yt.
45. The short-run equilibrium in the DAD-DAS model of aggregate demand and aggregate
supply determines the:
A) inflation rate and inflation target.
B) real interest rate and natural level of output.
C) level of output and inflation rate.
D) natural level of output and level of output.
46. In the DAD-DAS model of aggregate demand and aggregate supply, one period in time
is connected to the next period through:
A) the monetary policy rule.
B) demand shocks.
C) inflation expectations.
D) the natural level of output.
47. In the DAD-DAS model of aggregate demand and aggregate supply, changes in the
natural level of output ( ) change:
A) the DAD curve, but not the DAS curve.
B) the DAS curve, but not the DAD curve.
C) both the DAD curve and the DAS curve.
D) neither the DAD nor the DAS curve.
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48. In the DAD-DAS model of aggregate demand and aggregate supply, increases in the
natural level of output ( ) lead to ______ in output and ______ in inflation.
A) increases; increases
B) increases; no change
C) no change; increases
D) no change; no change
49. Beginning at long-run equilibrium in the DAD-DAS model of aggregate demand and
aggregate supply, in the period in which a positive inflation shock (ν > 0) occurs the
DAS curve ______ and the DAD curve ______.
A) shifts upward; shifts rightward
B) shifts upward; does not shift
C) does not shift; does not shift
D) shifts downward; shifts leftward
50. Beginning at long-run equilibrium in the DAD-DAS model of aggregate demand and
aggregate supply, in the period in which a positive inflation shock (ν > 0) occurs, output
______ and inflation ______.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases
51. Starting from long-run equilibrium in the DAD-DAS model of aggregate demand and
aggregate supply, a one-period positive inflation shock causes output to:
A) remain above the natural level for only one period.
B) remain above the natural level for more than one period.
C) remain below the natural level for only one period.
D) remain below the natural level for more than one period.
52. Beginning at long-run equilibrium in the DAD-DAS model of aggregate demand and
aggregate supply, in the first period of a four-period positive demand shock (ε > 0), the
DAS curve ______ and the DAD curve ______.
A) shifts upward; shifts rightward
B) does not shift; shifts rightward
C) does not shift; does not shift
D) shifts downward; shifts leftward
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53. Beginning at long-run equilibrium in the DAD-DAS model of aggregate demand and
aggregate supply, in the first period of a four-period positive demand shock (ε > 0),
output ______ and inflation ______.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases
54. Beginning at long-run equilibrium in the DAD-DAS model of aggregate demand and
aggregate supply, in the periods after a multi-period positive demand shock occurs, the
DAS shifts upward because:
A) the central bank increases the target rate of inflation in response to higher rates of
inflation.
B) the deviation of output from the natural level of output increases as a result of
higher rates of inflation.
C) higher rates of inflation generate positive supply shocks.
D) expectations of inflation increase as a result of higher inflation in previous periods.
55. Starting from long-run equilibrium in the DAD-DAS model of aggregate demand and
aggregate supply, a five-period positive demand shock causes output to ______ the
natural level of output until returning to the natural level in the long run.
A) remain continuously above
B) move above and then below
C) remain continuously below
D) move below and then above
56. Starting from long-run equilibrium in the DAD-DAS model of aggregate demand and
aggregate supply, a temporary five-period tax increase causes output to ______ the
natural level of output until returning to the natural level in the long run.
A) remain continuously above
B) move above and then below
C) remain continuously below
D) move below and then above
57. Beginning at long-run equilibrium in the DAD-DAS model of aggregate demand and
aggregate supply, if the central bank permanently reduces its inflation target (π*↓), then
in the initial period the DAS curve ______ and the DAD curve ______.
A) shifts upward; shifts rightward
B) does not shift; shifts leftward
C) does not shift; does not shift
D) shifts downward; shifts leftward
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58. Beginning at long-run equilibrium in the DAD-DAS model of aggregate demand and
aggregate supply, if the central bank permanently reduces its inflation target (π*↓), then
in the initial period of the change, output ______ and inflation ______.
A) increases; increases
B) increases; decreases
C) decreases; decreases
D) decreases; increases
59. Beginning at long-run equilibrium in the DAD-DAS model of aggregate demand and
aggregate supply, in the periods after a permanent reduction in the central bank's
inflation target (π*↓), the DAS shifts downward because:
A) the natural level of output increases in response to the lower rates of inflation.
B) the deviation of output from the natural level of output increases as a result of
lower rates of inflation.
C) lower rates of inflation generate negative supply shocks.
D) expectations of inflation decrease as a result of lower inflation in previous periods.
Use the following to answer question 60:
Equation: Monetary Policy Rule
it = t +  + (t – *t) + (Yt –
t)
60. (Equation: Monetary Policy Rule) Given the monetary policy rule of the DAD-DAS
model of aggregate demand and aggregate supply, if the inflation rate increases by 1
percentage point, by how much does the nominal interest increase?
A) 1
B) 1 + 
C) 1 + 
D) 1 +  (1 – *t)
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Answer Key Ch. 14
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
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24.
25.
26.
27.
28.
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30.
31.
32.
33.
34.
35.
36.
37.
38.
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40.
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44.
B
C
D
A
B
A
B
B
D
A
B
D
B
C
B
C
C
D
B
C
A
B
C
C
A
B
B
B
D
B
D
C
C
B
A
D
A
B
A
B
A
A
C
B
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45.
46.
47.
48.
49.
50.
51.
52.
53.
54.
55.
56.
57.
58.
59.
60.
C
C
C
B
B
D
D
B
A
D
B
D
B
C
D
C
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