MACROECONOMICS
REVIEW FOR TEST No. 3
Chapters 7, 8, & 9
CHAPTER 7
Inflation
Deflation
CPI
Disinflation
Why is inflation feared?
Real Income
The differences between Income & Wealth
Real Interest Rate
Demand-Pull Inflation
Cost-Push Inflation
Hyperinflation
CHAPTER 8
Classical Economists
Say’s Law
Keynes & Wage Rates
New Keynesians & Wage Rates
Keynes on Prices
Consumption Function
Dissaving
Autonomous Consumption
Price Level
Expectations & the Investment Expenditure
Marginal Propensity to Save (MPS) & Marginal Propensity to Consume (MPC)
Interest Rates & the Investment Expenditure
CHAPTER 9
Autonomous Spending & the Spending Multiplier
Inflationary Gap & Recessionary Gap
1
Practice Questions for Macro Economics Test # 3
Directions: It’s not enough to just take this practice test. Go back to your notes and to all the
self-tests. Make sure to cover the How, Why and What of all required concepts. And for extra
credit, don’t forget to log on to http://samarreine.com/EconLatestTopics.html and read the top
articles (pertinent to recent class discussions), listed under the heading “Today’s Topics.”
1. Which of the following will exacerbate inflation during an Inflationary Gap?
a. Increasing taxes
b. Decreasing taxes
c. Increasing consumption
d. Decreasing consumption
e. B & C
2. Union contracts can be problematic because in the long run they may reduce real income
for the employees if inflation in any one year exceeds the stipulated wages and raises in
the union contract, and obviously restrict sellers ability to adjust wages in the short term.
3. Say’s Law is applicable in:
a. Money economy
b. Barter economy
4. What do people do with their liquid assets during periods of hyperinflation?
They get rid of them since they are losing value very fast. They are better off with
assets that appreciate or with storing their money in a different, more stable
currency.
5. Which sector possesses autonomous consumption?
Household sector as it is the only one possessing disposable income.
6. What is autonomous consumption?
Consumption that must be incurred regardless of the level of disposable income,
as in the necessary bills that must be paid, even if disposable income changes.
7. Interpret the following: At a disposable income of $100, Shirley spends $70, but at a
disposable income of $200, Shirley spends $160.
At $100 MPC = 70%, but at $200 it’s now 80% which is consistent behavior as
disposable income rises.
8. What happens to spending, consumption and investments when interest rates drop?
They increase.
9. Which of the following does the CPI not include?
a. Food
b. Energy
c. Plane engines
d. Highways
2
10. Deflation is most common during troughs, but not necessarily during recessions, though
they do occur during specific months or regions throughout a recession. On balance,
recessions usher disinflation.
11. If the Multiplier is 10, and Autonomous Consumption is $2 million, and Autonomous
Spending is $4 million, then how is the RGDP affected?
AS * M = increase in RGDP. So $4 million * 10 = $40 million increase in RGDP
12. What is the lender’s real interest rate on a loan that has a nominal interest rate of 17% and
an inflation rate of 3.5%? Is this good?
17% - 3.5% = 13.5% in real interest. Yes, it’s good because it’s interest rate
earned.
13. Demand-pull inflation happens for this reason: income rises, raising buyers’ ability and
willingness to pay the higher prices, which makes them bid the prices up. And most likely
during these phases: expansions and peaks.
14. MPC and the RGDP are inversely related. False.
15. According to Classical economists, what keeps the economy in equilibrium and,
therefore, all prices as well?
Competition.
16. What do Classical economists say about wages?
a. Wages are flexible
b. Wages are inflexible
Because sellers are able to adjust wages as the prices for their products change. No
impediments preclude them from being able to do so.
17. What do Keynesians say about wages?
a. Wages are flexible
b. Wages are inflexible
Because unions lock wages into 2-3 year contracts that robs employers from their ability
to adjust wages.
18. If price level decreases, then consumption and investments increase.
19. Cost-push inflation is less desirable than demand-pull. True.
20. Why is cost-push inflation less desirable than demand-pull inflation?
Because the remedies that would normally be effective for demand-pull inflation, like raising
interest rates or taxes, actually worsen it. It’s a more entrenched, long term, and involved
problem especially if caused by more expensive imported commodities due to external inflation.
3
21. Businesses profit from cost-push inflation. False.
22. What happens to investments if businesses anticipate prices to decrease in the future?
They rise now.
23. The RGDP changes the most important resource for buyers and sellers—money.
For the buyer real national disposable income changes.
For the seller real national profits and total production change.
24. If the Natural GDP exceeds the RGDP, we have a recessionary gap.
25. If the RGDP is more than the natural RGDP, then the odds are that the actual
Unemployment Rate is smaller than the natural UR. True.
26. How can you beat inflation?
1. If one’s income rises at a faster rate than the inflation rate.
2. If interest rates earned are higher than the inflation rate or if interest rates paid are
lower than the inflation rate.
3. If one owns real estate.
4. If one owns inflation-indexed securities. Also known as Treasury inflation-protected
securities = TIPS.
http://www.treasurydirect.gov/instit/marketables/tips/tips.htm
27. What transpires during a recessionary gap? Specify the direction of your indicators.
Look at the list we made in class and read your textbook.
28. When is inflation a problem?
Only if it reduces real income. Your notes are full of quantitative examples.
29. Give a qualitative example on the multiplier.
Example like the ice cream one in your booklet.
What are the 'reverberations' that multiply the initial change into a bigger result?
Everyone's income depends on someone else's spending. If you spend $50 dining out at a
restaurant, you have provided $50 of income that will be divided among the restaurant’s owner,
chef, cooks, waiters and suppliers. These people will spend some of the income on goods and
services, thus creating income for still other people. At the macro-level, the same kind of
reverberation between income and spending is responsible for multiplying a change aggregate
demand.
4
Consider the previous example where the Congress increases government spending by $100B
with a M of 3. That increase in spending infuses households with more income. In turn, the extra
income fuels more consumer spending. The additional consumer spending pumps still more
income into households, stimulating even more consumer spending. As the reverberation of
spending and income continues, GDP eventually grows by $300B.
30. What is your real income if your nominal income = $90,000 and CPI = 184.7? b) What
happens to disposable income if next year your income increase by $3000 and CPI
increases to 186.2?
Year 1: 90,000 / 1.847 = 48,727.67 in real income
Year 2: 93,000 / 1.862 = 49,946.30
$49,946.30 - $48,727.67 = $1,218.63 in additional disposable income, which is
approximately 2.5% increase in real income.
5