ECO 252 AD & AS Model

The most important determinant of consumption is

the current disposable income

(not interest rate,

price level,

nor household wealth)

Which of the following causes saving to increase

an increase in the interest rate

(not increase in consumption,

increase in price level,

increase in unemployment)

Which one of the following is not a determinant of consumption spending

The growth rate in the United States relative to the growth rates in other countries

( not household wealth,

current disposable income,

nor interest rate)

A rise in stock prices and housing prices

increases household wealth which in turn increases consumption and leads to an upwards shift of the consumption function

( not increases household wealth which in turn increases consumption and leads to an upward movement along the consumption function,

does not affect consumption because they do not have any direct impact on disposable income,

reduces consumption due to increase in prices and causes the consumption function to shift downward )

The existence of unemployment insurance makes it _______ that consumption will fluctuate over the business cycle.

less likely

because with unemployment​ insurance, current disposable income fluctuates less over the business cycle

( not with unemployment​ insurance, household wealth fluctuates less over the business cycle,

with unemployment​ insurance, business investment fluctuates less over the business cycle,

with unemployment​ insurance, interest rates are unlikely to change with the business cycle)

An increase in the price level

decrease consumption

An increase in household wealth

increase consumption

An increase in expected future income

increase consumption

An increase in current disposable income

income consumption

An increase in the interest rate

decrease consumption

What are the four main determinant of investment?

expectation of future profitability

interest rates

taxes

cash flow

How would an increase in interest rates affect investment

Real investment spending declines

The behavior of consumption and investment over time can be describes as follows

Consumption follows a smooth, upward trend, but investment is subject to significant fluctuations

Which of the following statements about investment spending is correct?

The optimism of pessimism of firms is an important determinant of investment spending.

When the economy moves into a​ recession, many firms will postpone buying investment goods even if the demand for their own product is strong.

A higher real interest rate results in less investment spending.

Which of the following statements is​ correct?

An increase in the corporate income tax decreases the​ after-tax profitability of investment spending.

During periods of​ recession, the ability of firms to finance spending on new factories or machinery and equipment increases.

( not correct: Changes in tax laws have no effect on investment spending.)

Which of the following will increase planned investment spending on the part of​ firms?

Increased optimism about future demand for its product

A lower real interest rate

(will not increase: Increases in the corporate income tax)

Which of the following is NOT included in the calculation of total government​ purchases?

Unemployment insurance benefits paid for by the federal government

(things that are included:

The salaries of high school teachers paid for by state government,

A new interstate highway purchased by the federal government,

A local government installs a new stop sign)

Which of the following is not a main determinant of net​ exports?

Expectations of future profitability in the United States.

( Is a determinant:
The price level in the United States relative to price levels in other countries,

The growth rate of GDP in the United States relative to the growth rates of GDP in other countries,

The exchange rate between the dollar and other currencies.)

How would an increase in the growth rate of GDP in Canada and Mexico affect U.S. net​ exports?

An increase in the growth rate of GDP in Canada and Mexico will

increase U.S. net exports by increasing exports to these countries

Which of the the following is NOT a determinant of net exports?

The Interest rate

( Is a determinant:

the growth rate if US GDP relative to growth rates of other countries,

The growth rate of the U.S. price level relative to price levels of other countries,

The exchange rate between the dollar and other currencies)

Consider the following four statements.

i. The iPhone is made in​ China, using​ Chinese-made parts.

ii. The iPhone is made in the United​ States, using​ U.S.-made parts.

iii. The iPhone is made in the United​ States, using​ Chinese-made parts.

iv. The iPhone is made​ China, using parts that are all made outside of China.

Which of the statements above is​ correct?

What relevance does your answer have to how the Bureau of Economic Analysis calculates data on U.S.​ imports?

Statement iv is correct. The iPhone is assembled in China using parts shipped to China from many countries.

Relevance: Producers increasingly rely on global supply​ chains, so there are flaws in accounting for imports and exports.

An increase in the US price level relative to other countries’ price levels

decrease net exports

An increase in the growth rate of US GDP relative to other countries

decrease net exports

An increase in the exchange rate between the dollar and other currencies

decrease net exports

If inflation in the United States is lower than inflation in other​ countries, then U.S. exports​ ________ and U.S. imports​ ________, which​ _________ net exports.

increase; decrease; increases

When incomes rise faster in the United States than in other​ countries,

US net export will fall

Which of the following statements is correct if real GDP in the United States had declined by more during the 2020 recession than did real GDP in​ Canada, China, and other trading partners of the United​ States?

Imports to the United States would have fallen more than the U.S.​ exports, leading to an increase in net exports.

A depreciation in the domestic currency will

increase exports and decrease​ imports, thereby increasing net exports.

Foreign households and foreign firms demand U.S. dollars in exchange for foreign currency for all of the​ following, except

when U.S. firms and households want foreign currencies so that they can buy goods and services produced in those foreign countries.

( false:

when foreign firms and households want to invest in the United States either through foreign direct investment or through foreign portfolio investment.,

when currency traders want dollars because they expect that the value of the dollar in the future to be greater than its current value ,

when foreign firms and households want dollars so that they can buy goods and services produced in the United States.)

U.S.households and U.S. firms supply U.S. dollars in exchange for foreign currency

if the interest rate and other conditions in the foreign countries are lucrative for U.S. firms and households to invest dollars.

When the euro was introduced in January​ 1999, the exchange rate was​ $1.19 per euro. In December 2024​, the exchange rate was $1.05 per euro.

For U.S. firms exporting goods and services to​ Europe, this change in the value of the euro was

bad news because one euro would buy fewer ​dollars, making U.S. goods more expensive for European buyers.

On May 01​, 2025 ​(shown as 2025 minus 05 minus 01 in​ FRED), the pound was trading at ​$ 1.3358 per pound. On May 01​, 2024 ​(shown as 2024 minus 05 minus 01 in​ FRED), the pound was trading at ​$ 1.2636 per pound. This is

an appreciation of the pound and a depreciation of the dollar.

Given the change in the exchange rate between November and December​, did U.S. imports from Japan change in a way that economic theory would​ predict?

It went from ​$12,077.98286 million to 12,452.25728 million for US Imports from Japan

Yes. Since the dollar appreciated against the​ yen, economic theory would predict that U.S. imports from Japan would increase.

Given the change in the exchange rate between December and January​, did U.S. exports to Japan change in a way that economic theory would​ predict?

US Exports to Japan went from 6462.36402 million to 6014.23938 million

Yes. Since the dollar appreciated against the​ yen, economic theory would predict that U.S. exports to Japan would decrease.

The U.S. aggregate demand curve slopes downward due to all of the following reasons

wealth​ effect, where a change in the price level affects consumption.,

interest-rate effect, where a change in the price level affects investment,

international-trade effect, where a change in the price level affects net exports.

(Not b/c of government-spending effect, where a change in the price level affects government purchases.)

Compared to the U.S. aggregate demand​ curve, the reason that the demand curve for an individual​ product, such as​ bananas, slopes downward is

different, because consumers can substitute between individual products.

An economics student makes the following​ statement:

​"It's easy to understand why the aggregate demand curve is downward​ sloping: When the price level​ increases, consumers substitute into less expensive​ products, thereby decreasing total spending in the​ economy."

This statement is false because the aggregate demand curve is

downward sloping because as prices​ rise, consumer real wealth​ declines, interest rates​ rise, and exports become more expensive.

The aggregate demand curve shows the relationship between

the price level and output demanded

The aggregate demand curve is downward sloping because

an increase in the price level reduces real money​ holdings, which reduces the amount of expenditures.

Consider the​ downward-sloping aggregate demand​ (AD) curve to the right. Which of the following results in a movement from point A to point B​ (a movement up along the AD​ curve) or from point A to point C​ (a movement down along the AD​ curve)? ​(Mark all that​ apply.)

Interest rate effect and wealth effect

(Not Inflation effect , nor multiplier effect)

Milovia is a small open economy. The general price level in the economy has been increasing at a rate of about 7.5 percent each year. Jane​ Wilson, an industry​ analyst, is of the opinion that such high inflation is adversely affecting aggregate demand in the economy and therefore its ability to grow. Her​ colleague, Harry​ Gomes, however, disagrees. According to​ Harry, some amount of inflation is unavoidable in a growing economy. Higher prices for products help to increase the level of corporate profits and induce firms to increase aggregate output.

​Jane's argument is based on which of the following​ assumptions?

The purchasing power of nominal assets declines with an increase in the price level.

The wealth effect refers to the fact that

when the price level​ falls, the real value of household wealth​ rises, and so will consumption.

The interest rate effect refers to the fact that a higher price level results in

higher interest rates and lower investment.

The​ international-trade effect refers to the fact that an increase in the price level will result in

a decrease in exports and an increase in imports.

Which of the following would cause a decrease in aggregate​ demand?

a decrease in government spending

(Not a depreciation in the U.S. dollar relative to foreign currencies,

a decrease in interest rates through monetary policy,

a decrease in taxes)

The graph to the right shows the aggregate demand curve for an economy AD₁

The effect of a monetary policy change that causes a decrease in interest rates AD₂

_{_________} would cause a similar shift in the aggregate demand curve.

A decrease in taxes

An increase in the price level will cause a

movement up along the aggregate demand curve

An increase in government purchases will cause a

rightward shift of the aggregate demand curve.

An increase in state income taxes will cause a

leftward shift of the aggregate demand curve.

An increase in interest rates will cause a

leftward shift of the aggregate demand curve.

A faster income growth in other countries will cause a

rightward shift of the U.S. aggregate demand curve.

A movement from point A to point B on AD Subscript 1 could be the result of a

change in the price level

(NOT natural disaster, change in the cost of production, nor change in government policies)

A movement from point A to point C could be the result of a

change in the expectation of households

(Not change in the cost production, natural disaster, nor change in the price level)

Firms become more optimistic and increase their spending on machinery and equipment. Because this is a change in

investment, it will cause a shift to the right in the aggregate demand curve.

The federal government increases taxes in an attempt to reduce a budget deficit. Because this is a change in

consumption, it will cause a shift to the left in the aggregate demand curve.

The U.S. economy experiences 4 percent inflation. Because this is a change in

the price level, it will cause a movement along the aggregate demand curve

In the diagram to the​ right, moving from point A to point B is called a

movement along the AD curve.

Moving from point A to point C is referred to as a

shift in the AD curve.

Which of the following would cause a shift in the aggregate demand curve from point A to point C

Lower interest rates, decrease in the US exchange rate relative to other currencies, lower taxes, increased consumer optimism

(Not Inflation, nor decrease in the price level)

Which of the following factors does not cause the aggregate demand curve to​ shift?

a change in price level

(Does cause a shift:

a change in foreign variables, a change in government monetary or fiscal policies, a change in the expectations of households and firms)

How can government policies shift the aggregate demand curve to the​ right?

by increasing government purchases

(Not by increasing business taxes, nor by increasing personal income taxes)

The country of Cubania was adversely affected by the global recession of 2008. David​ Oster, a sociology professor at the University of​ Cubania, is of the opinion that tax rates on wealthy individuals should be lowered. Since the wealthy have a higher level of​ income, a tax cut would significantly increase consumption and aggregate demand.

Which of the following would weaken​ David's argument that tax cuts for the wealthy would increase consumption and aggregate​ demand?

Economic research shows that wealthy individuals have a high marginal propensity to save.

The multiplier represents the

total amount of additional increases in consumption spending induced by an initial change in aggregate expenditure.

According to the multiplier​ effect, an initial increase in government purchases increases real GDP by

more than the initial increase in government purchases.

The formula for the multiplier is

1/ (1 - MPC)

The value of the multiplier is larger when

the value of the MPC is larger.

If there is an increase in the marginal propensity to consume​ (MPC), then

the value of the expenditure multiplier will increase.

Indicate which of the following is correct about the multiplier effect.

A decrease in autonomous spending decreases real GDP by a multiple of the change.

The multiplier ignores the effect on real GDP of​ imports, inflation, and interest rates.

The larger the​ MPC, the more additional consumption that occurs.

An MPC equal to 0 implies a multiplier of​ 1, meaning that a​ $1 increase in autonomous expenditures would increase real GDP by only​ $1.

Why does an MPC of 0 result in no multiplier​ effect? Explain your answer using the logic of the multiplier process.

When the MPC is​ 0, any additional income does not induce any additional consumption spending. 

​Conversely, an MPC equal to 1 implies an infinite​ multiplier, meaning that a​ $1 increase in autonomous expenditures would increase real GDP by an infinite amount.

Why does an MPC of 1 result in an infinite​ multiplier? Explain your answer using the logic of the multiplier process.

An MPC of 1 means that any additional income induces a matching increase in consumption​ spending, which leads to a matching increase in​ income, and so on.

Why does a​ $1 increase in government purchases lead to more than a​ $1 increase in income and​ spending?

Through the government purchases​ multiplier, the​ $1 increase in government spending will lead to

an increase in aggregate demand and national​ income, which will lead to an increase in induced spending.

Another infrastructure project in northern California funded in part by ARRA funds involved expanding the Caldecott Tunnel between the cities of Oakland and Orinda.

A spokesperson for the California state agency in charge of the project mentioned that the Caldecott tunnel project would have a​ "ripple effect" on employment. The ripple effect meant that

the job creation would spread to other industries and eventually to the whole economy due to the consumption of the construction workers.

An opinion column in the New York Times quotes an​ economist's analysis of the effect of government infrastructure spending on new bridges and highways in the United​ States: "The investment multiplier would give a further kick to the U.S.​ economy."

The​ "investment multiplier" referred to by the economist is the

larger change in equilibrium real GDP resulting from a change in investment.

By saying that the investment multiplier would​ "give a further kick to the U.S.​ economy," the economist means

the multiplied effect of the increased infrastructure spending will increase real GDP and employment.

In a closed​ economy, the MPC is 0.50. Government spending changes by 400 The change in equilibrium GDP is

800 b/c 1/(1- 0.5) = 2 × 400

What is the effect on real GDP of a $150 billion change in planned investment if the MPC is 0.65?

429 billion b/c 1/ (1-0.65) * 150

Suppose booming economies in the BRIC nations​ (Brazil, Russia,​ India, and​ China) causes net exports​ (NX) to rise by ​$150 billion in the United States.

If the MPC is 0.5​, the change in equilibrium GDP will be ​$

300 billion b/c 1/(1-0.5)*150

Suppose the marginal propensity to consume increases from 0.68 to

0.95. The value of the expenditure multiplier will increase from

3.13 to 20.00 b/c 1/(1-0.68) = 3.125 and 1/(1-0.95) = 20

When the value of the multiplier​ increases, all else​ equal, a change in expenditure will raise aggregate expenditure by a larger amount.

Would a larger multiplier lead to more severe recessions or less severe​ recessions?

A larger multiplier means that small changes in spending lead to large changes in​ GDP, and thus recessions would be more severe.

The table below provides expenditure and unemployment data for the years 1929 and

1933 — transition points of the Great Depression.  

Year	Consumption	Investment	Exports	Real GDP	Unemployment Rate
1929	​$781 billion	​$124 billion	​$40 billion	​$1,056 billion	​2.9%
1933	​$638 billion	​$27 billion	​$22 billion	​$778 billion	​20.9%

If the multiplier had a value of 4 in​ 1929, then how large must the change in autonomous expenditure

A_o have been to cause the decline in real GDP between 1929 and 1933 shown in the​ table?

ΔA_o = $ -69.5 billion b/c 778 - 1056 = -278 and -278/4 = -69.5​

An article published in an economics journal found the​ following: "For the poorest​ households, the marginal propensity to consume was close to​ 70%. For the richest​ households, the MPC was only​ 35%."

​Source: Atif Mian and Amir​ Sufi, "Who Spends Extra​ Cash?," House of Debt​,

April​ 13, 2014.

Assume that the macroeconomy can be divided into three sections.

Section A consists of the poorest households.

Section B consists of the richest households.

Section C consists of all other households.

The value of the multiplier for Section A is

3.33 b/c 1/(1-0.7)

The value of the multiplier for Section B is

1.54 b/c 1/(1-0.35)

Assume there was an increase in planned investment of​ $4 billion.

If the MPC for the economy was 70 percent​ (or 0.70), the change in equilibrium real GDP would be ​$

 

If the MPC for the economy was 35 percent​ (or 0.35), the change in equilibrium real GDP would be ​$

13.3 b/c 1/(1-0.7) * 4

6.2 b/c 1/(1-0.35) * 4

A study by the management consulting company McKinsey​ & Company recommended that the U.S. increase spending on​ infrastructure, such as bridges and​ highways, by between​ $150 and​ $180 billion per year. The study estimated that the result would be an increase in GDP of between​ $270 billion and​ $320 billion per year.

​Source: David​ Harrison, "Nation's Crumbling Roads Put a Dent in​ Drivers' Wallets," Wall Street Journal​, July​ 31, 2015.

If the McKinsey​ study's estimate of the effect of infrastructure spending on GDP is​ correct, the implied value of the multiplier is between

1.78 and 1.80 b/c 270/150 = 1.8 and 320/180 = 1.78

What component of aggregate expenditure would a decline in consumer confidence be likely to​ affect?

Consumption, as consumers cut spending over concerns about the future.

What component of aggregate expenditure would a decline in business confidence likely​ effect?

​Investment, as decreasing business optimism would decrease investment expenditures.

Holding constant other factors affecting the U.S.​ economy, can you be certain whether these changes will cause real GDP to increase or to​ decrease?

Autonomous expenditure and real GDP will unambiguously decrease.

The position of the​ long-run aggregate supply​ (LRAS) curve is determined by

the number of​ workers, the amount of​ capital, and the available technology.

The​ long-run aggregate supply curve is vertical because in the long​ run,

changes in the price level do not affect potential​ GDP, as potential GDP depends on the size of the labor​ force, capital​ stock, and technology.

The price level increases.

Because this is a change in the price level

the LRAS curve will not change

The labor force increases.

Because this is a change in the productive capacity of the economy

the LRAS will shift to the right

There is an increase in the quantity of capital goods.

Because this is a change in the productive capacity of the economy

the LRAS will shift to the right.

Technological change occurs.

Because this is a change in the productive capacity of the economy

the LRAS will shift to the right

An article in the Economist magazine noted​ that:

​"the economy's potential to supply goods and services​ [is] determined by such things as labour force and capital​ stock, as well as inflation​ expectations."

Source:"Money's Muddled​ Message" Economist​, May​ 19, 2009.

This list of the determinants of potential GDP is

incorrect since changes in the expected price level affect short run aggregate supply but not the long run aggregate supply.

How does an increase in the price level affect the quantity of real GDP supplied in the long​ run?

Changes in the price level do not affect the level of GDP in the long run.

Which of the following factors will cause the​ long-run aggregate supply curve to shift to the​ right?

an increase in the number of workers in the economy

the accumulation of more machinery and equipment

technological change

In the long​ run, changes in the price level

do not affect the level of real GDP.

Consider the figure to the right. Why does the​ short-run aggregate supply curve​ (SRAS) slope​ upward?

Prices of final goods rise more quickly than the prices of inputs.

Contracts keep wages​ "sticky".

Firms and workers fail to predict changes in the price level.

The​ short-run aggregate supply curve slopes upward because of all of the following reasons

in the short​ run, as prices of final goods and services​ increase, input prices react more slowly.

in the short​ run, as prices of final goods and services​ increase, some firms are very slow to adjust their​ prices, thus their sales increase.

in the short​ run, prices of final goods and services adjust slowly due to the existence of menu costs.

(Not in the short​ run, an unexpected change in the price of an important resource can change the cost to firms.)

Why does the​ short-run aggregate supply curve slope​ upward?

Profits rise when the prices of the goods and services firms sell rise more rapidly than the prices they pay for inputs.

Why does the failure of workers and firms to accurately predict the price level result in an​ upward-sloping aggregate supply​ curve?

because menu costs make some prices​ "sticky"

because contracts between workers and firms make some wages and prices​ "sticky"

because firms are often slow to adjust wages