4: Stabilization Policy

This question is a mix of the shock/response/new eq approach from Module 3 and the stabilization policy discussion of Module 4.  In other words, it's an example of a longer MT2 question...

Through much of the 1990s, firms had spent significant amounts of money investing in servers and other tech to establish internet-based storefronts for their businesses.  In 1999 and 2000, firms became somewhat disillusioned with the profit potential from these internet investments.  In particular, firms dramatically decreased their purchases of internet related capital in 1999 and 2000.

Suppose the economy was originally at potential output, and then this decrease in capital spending occurred.  Which of the following best captures this shock in the AS/AD model?

•  Short Run Aggregate Supply shifts up

• Aggregate Demand shifts out

• Long Run Aggregate Supply shifts out

• Aggregate Demand shifts in

Aggregate Demand shifts in

This question is a mix of the shock/response/new eq approach from Module 3 and the stabilization policy discussion of Module 4.  In other words, it's an example of a longer MT2 question...

Through much of the 1990s, firms had spent significant amounts of money investing in servers and other tech to establish internet-based storefronts for their businesses.  In 1999 and 2000, firms became somewhat disillusioned with the profit potential from these internet investments.  In particular, firms dramatically decreased their purchases of internet related capital in 1999 and 2000.

Suppose the economy was originally at potential output, and then this decrease in capital spending occurred.  How will GDP and the price level change in the short run?

• Real GDP stays the same, but the price level decreases.

• Real GDP will be above Y*, but the price level will remain the same.

• Real GDP will be below Y*, but the price level will remain the same.

• Real GDP and the price level decrease.

Real GDP will be below Y*, but the price level will remain the same.

This question is a mix of the shock/response/new eq approach from Module 3 and the stabilization policy discussion of Module 4.  In other words, it's an example of a longer MT2 question...

Through much of the 1990s, firms had spent significant amounts of money investing in servers and other tech to establish internet-based storefronts for their businesses.  In 1999 and 2000, firms became somewhat disillusioned with the profit potential from these internet investments.  In particular, firms dramatically decreased their purchases of internet related capital in 1999 and 2000.h

Suppose the economy was originally at potential output, and then this decrease in capital spending occurred.  How will the transition to a new long run equilibrium begin?

• Since short run GDP is above Y*, eventually firms will respond to weak demand with lower prices.

• Since short run GDP is below Y*, eventually firms will respond to weak demand with lower prices.

• Since short run GDP is above Y*, eventually firms will respond to strong demand with higher prices.

• Since short run GDP is below Y*, eventually firms will respond to strong demand with higher prices.

Since short run GDP is below Y*, eventually firms will respond to weak demand with lower prices.

This question is a mix of the shock/response/new eq approach from Module 3 and the stabilization policy discussion of Module 4.  In other words, it's an example of a longer MT2 question...

Through much of the 1990s, firms had spent significant amounts of money investing in servers and other tech to establish internet-based storefronts for their businesses.  In 1999 and 2000, firms became somewhat disillusioned with the profit potential from these internet investments.  In particular, firms dramatically decreased their purchases of internet related capital in 1999 and 2000.

Suppose the economy was originally at potential output, and then this decrease in capital spending occurred.  Which of the following best describes how GDP will respond as the economy transitions to a new long-run equilibrium?

• Falling prices lead to higher money demand and higher interest rates. These higher borrowing costs make previously profitable projects unprofitable, reducing Investment spending.

• Falling prices lead to lower money demand and lower interest rates. These lower borrowing costs make previously unprofitable projects profitable, increasing Investment spending.

• Rising prices lead to lower money demand and lower interest rates. These lower borrowing costs make previously profitable projects unprofitable, increasing Investment spending.

• Rising prices lead to higher money demand and higher interest rates. These higher borrowing costs make previously profitable projects unprofitable, reducing Investment spending.

Falling prices lead to lower money demand and lower interest rates. These lower borrowing costs make previously unprofitable projects profitable, increasing Investment spending.

This question is a mix of the shock/response/new eq approach from Module 3 and the stabilization policy discussion of Module 4.  In other words, it's an example of a longer MT2 question...

Through much of the 1990s, firms had spent significant amounts of money investing in servers and other tech to establish internet-based storefronts for their businesses.  In 1999 and 2000, firms became somewhat disillusioned with the profit potential from these internet investments.  In particular, firms dramatically decreased their purchases of internet related capital in 1999 and 2000.

Suppose the economy was originally at potential output, and then this decrease in capital spending occurred.  Which of the following best describes the new long-run equilibrium?

• GDP will return to potential output, while the price level will be lower than before the shock.

• GDP will return to potential output, while the price level will be higher than before the shock.

• GDP and the price level will return to their pre-shock levels.

• Both GDP and the price level will stabilize at a higher level than before the shock.

GDP will return to potential output, while the price level will be lower than before the shock.

This question is a mix of the shock/response/new eq approach from Module 3 and the stabilization policy discussion of Module 4.  In other words, it's an example of a longer MT2 question...

Through much of the 1990s, firms had spent significant amounts of money investing in servers and other tech to establish internet-based storefronts for their businesses.  In 1999 and 2000, firms became somewhat disillusioned with the profit potential from these internet investments.  In particular, firms dramatically decreased their purchases of internet related capital in 1999 and 2000.

Suppose the economy was originally at potential output, and then this decrease in capital spending occurred.  Congress is considering using fiscal policy to offset the effects of this shock on the economy.  Which of the following best describes the policies they would consider?

• Reduce government purchases and/or higher taxes.

• Increase interest rates.

• Increase government purchases and/or lower taxes.

• Lower interest rates.

Increase government purchases and/or lower taxes.

This question is a mix of the shock/response/new eq approach from Module 3 and the stabilization policy discussion of Module 4. In other words, it's an example of a longer MT2 question...

Through much of the 1990s, firms had spent significant amounts of money investing in servers and other tech to establish internet-based storefronts for their businesses. In 1999 and 2000, firms became somewhat disillusioned with the profit potential from these internet investments. In particular, firms dramatically decreased their purchases of internet related capital in 1999 and 2000.

Suppose Congress implemented the fiscal policy from the previous question. How would this change the results of this shock, relative to the case of not doing the fiscal policy?

• Short-run GDP would be lower -- a smaller boom. The transition to a new long-run equilibrium would be shorter, and the final price level would increase more than it would without the policy.

• Short-run GDP would be higher -- a less severe recession. The transition to a new long-run equilibrium would be shorter, and the final price level would decrease more than it would without the policy.

• Short-run GDP would be higher -- a less severe recession. The transition to a new long-run equilibrium would be shorter, and the final price level would decrease less than it would without the policy.

• Short-run GDP would be lower -- a smaller boom. The transition to a new long-run equilibrium would be shorter, and the final price level would increase less than it would without the policy.

Short-run GDP would be higher -- a less severe recession. The transition to a new long-run equilibrium would be shorter, and the final price level would decrease less than it would without the policy.

Consumption smoothing is best described as

• Consumers spend most but not all of their income according to the marginal propensity to consume.

• Savers change the amount they save based on forecasting their future earnings.

• We assume that people prefer their consumption to be stable and predictable, even when their income is not.

• People choose occupations where income is less variable in order to avoid big swings in their consumption.

We assume that people prefer their consumption to be stable and predictable, even when their income is not.

Reasons why tax cuts may increase GDP less than the same money spent on increases in government purchases include all of the following except

• Wealthier families may have a lower marginal propensity to consume.

• Consumers will save some of the increase in income, so the multiplier process begins with a smaller change in spending.

• If the tax cuts are viewed as temporary, consumers may save a large portion of the tax cut.

• Tax cuts can increase productivity in the economy.

Tax cuts can increase productivity in the economy.

The mandate/mission of the Federal Reserve includes conducting monetary policy to pursue

• a 2% target for inflation.

• stable interest rates.

• Maximum employment and stable prices.

• minimum variability in GDP.

Maximum employment and stable prices.

If the US economy is currently experiencing strong real GDP growth (5%), low unemployment (4%), and rising inflation (4% and increasing), which AS/AD shock is the most likely cause of these symptoms?

• Aggregate Demand shifts in

• Short Run Aggregate Supply shifts up

• Aggregate Demand shifts out

• Long Run Aggregate Supply shifts out

Aggregate Demand shifts out

The US economy is currently experiencing strong real GDP growth (5%), low unemployment (4%), and rising inflation (4% and increasing).  Based on their mandate, how would you expect the Federal Reserve to respond to this situation?

• They will be worried about unemployment based on their maximum employment goal. They will lower interest rates to help shrink the negative output gap.

• Both goals are in jeopardy, making the best course unclear. The Fed might lower interest rates a little to help with unemployment. But only a little bit, so that they don't take away too much of the downward pressure on prices.

• They will be worried about rising inflation based on their price stability goal. They will increase interest rates to shrink the positive output gap.

• They will be worried about rising inflation based on their price stability goal. They will decrease interest rates to shrink the negative output gap.

They will be worried about rising inflation based on their price stability goal. They will increase interest rates to shrink the positive output gap.

If the US economy is currently experiencing weak real GDP growth (1.5%), high unemployment (7%), and rising inflation (4% and increasing), which AS/AD shock is the most likely cause of these symptoms?

• Long Run Aggregate Supply shifts out

• Aggregate Demand shifts out

• Short Run Aggregate Supply shifts up

• Aggregate Demand shifts in

Short Run Aggregate Supply shifts up

If the US economy is currently experiencing weak real GDP growth (1.5%), high unemployment (7%), and rising inflation (4% and increasing).  Based on their mandate, how would you expect the Federal Reserve to respond to this situation?

• Both goals are in jeopardy, making the best course unclear. The Fed might lower interest rates a little to help with unemployment. But only a little bit, so that they don't take away too much of the downward pressure on prices.

• They will be worried about unemployment based on their maximum employment goal. They will lower interest rates to help shrink the negative output gap.

• They will be worried about rising inflation based on their price stability goal. They will decrease interest rates to shrink the negative output gap.

• They will be worried about rising inflation based on their price stability goal. They will increase interest rates to shrink the positive output gap.

Both goals are in jeopardy, making the best course unclear. The Fed might lower interest rates a little to help with unemployment. But only a little bit, so that they don't take away too much of the downward pressure on prices.

Reasons that some observers are skeptical that the Federal Reserve can stimulate the economy with lower interest rates include....

•  Lower risk-free interest rates might be offset by lenders charging higher risk premia during a recession -- actual borrowing costs might not go down.

• The long lead time on lowering interest rates might only stimulate spending after the recession is over.

• All of these are reasons why the Fed might not be able to stimulate the economy with lower interest rates.

• If a recession leaves firms pessimistic about expanding their businesses, lower borrowing costs might not be enough to get them to buy more capital.

All of these are reasons why the Fed might not be able to stimulate the economy with lower interest rates.