Macroeconomics Study Questions

Chapter 2:

1. Which of the following is a flow variable?

A. The value of the house in which you live

B. The balance in your savings account

C. Your monthly consumption of hamburgers

D. The number of hamburgers in your refrigerator at the beginning of the month

The correct answer is C. As explained in Section 2-1, a flow is a

quantity measured per unit time and a stock is a quantity measured
at a given point in time.

2. Which of the following is not a stock variable?

A. Government debt

B. The labor force

C. The amount of money held by the public

D. Inventory investment

The correct answer is D. Inventory investment is a quantity

measured per unit time, so it is a flow variable. See Section 2-1.

3. GDP is

A. a stock.

B. a flow.

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 C. both a stock and a flow.

D. neither a stock nor a flow.

The answer is B. GDP is a quantity measured per unit time, so it is a

flow. See Section 2-1.
4. GDP measures

A. expenditure on all final goods and services.

B. total income of everyone in the economy.

C. total value-added by all firms in the economy.

D. all of the above.

The correct answer is D. See Section 2-1 for a discussion of what

GDP measures.

5. Suppose that a farmer grows wheat and sells it to a baker for $1, the baker makes bread
and sells it to a store for $2, and the store sells it to the customer for $3. This transaction
increases GDP by

A. $1.

B. $2.

C. $3.

D. $6.

The correct answer is C. As explained in Section 2-1, GDP includes

only the value of the final goods and services. Therefore, this
transaction increases GDP by $3.

6. Which of the following is not included in GDP?

A. The salary paid to a federal judge

B. The value of housing services enjoyed by homeowners

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 C. The value of automobile services enjoyed by car owners

D. The value-added of a shipping company that transports goods from the factory to
retail stores

The correct answer is C. In principle, GDP should include the

imputed rent on automobiles, but in practice it does not. See
Section 2-1.

7. In which case is total expenditure in an economy not equal to total income?

A. if total saving is larger than total investment

B. if net exports are not zero

C. if inventory investment is negative

D. none of the above--they are always equal

The correct answer is D. As explained in Section 2-1, total

expenditure in an economy always equals total income.

8. All other things equal, GDP will rise if

A. imports rise.

B. exports fall.

C. durable goods consumption rises.

D. military spending falls.

The answer is C. A rise in imports, a fall in exports, or a fall in

military spending will decrease GDP. A rise in durable goods
consumption will increase GDP. See Section 2-1.

9. Which of the following statements describes the difference between nominal and real
GDP?

A. Real GDP includes only goods; nominal GDP includes goods and services.

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 B. Real GDP is measured using constant base-year prices; nominal GDP is measured
using current prices.

C. Real GDP is equal to nominal GDP less the depreciation of the capital stock.

D. Real GDP is equal to nominal GDP multiplied by the CPI.

The answer is B. For a discussion of the differences between real

and nominal GDP, see Section 2-1.

10. If production remains the same and all prices double, then real GDP

A. and nominal GDP are both constant.

B. is constant and nominal GDP is reduced by half.

C. is constant and nominal GDP doubles.

D. doubles and nominal GDP is constant.

The answer is C. Real GDP is measured in constant prices, so it is

unaffected by a price increase. Nominal GDP is measured in current
prices. If prices double, so will nominal GDP. See Section 2-1.

11. Real GDP equals

A. nominal GDP minus net exports.

B. nominal GDP divided by the GDP deflator.

C. nominal GDP multiplied by the GDP deflator.

D. GDP minus depreciation.

The correct answer is B. As explained in Section 2-1, real GDP

equals nominal GDP divided by the GDP deflator.

12. If production remains the same and all prices double relative to the base year, then the
GDP deflator is

A. 1/4.

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 B. 1/2.

C. 1.

D. 2.

The answer is D. As explained in Section 2-1, the GDP deflator

equals nominal GDP divided by real GDP. If prices double, nominal
GDP will double and real GDP will be unchanged. Therefore, the GDP
deflator will equal 2.

13. Consider the following table:

APPLES/ ORANGES Year Production/Price Production/Price

1995 20/ $0.50 10/$1.00

2000 10/ $1.00 10/$0.50

If 1995 is the base year, what is the GDP deflator for 2000?

A. 0

B. between 0 and 1

C. 1

D. greater than 1

The correct answer is C. The GDP deflator is nominal GDP divided by

real GDP. Nominal and real GDP are both $15 in 2000, so the GDP
deflator equals 1. See Section 2-1.

14. To obtain the net domestic product (NDP), start with GDP and subtract

A. depreciation.

B. depreciation and indirect business taxes.

C. depreciation, indirect business taxes, and corporate profits.

D. depreciation, indirect business taxes, corporate profits, and social insurance

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contributions.

The correct answer is A. For an explanation of net domestic product,

see Section 2-1.

15. To obtain national income, start with GDP and subtract

A. depreciation.

B. depreciation and indirect business taxes.

C. depreciation, indirect business taxes, and corporate profits.

D. depreciation, indirect business taxes, corporate profits, and social insurance

contributions.

The answer is B. National income equals GDP minus depreciation

and indirect business taxes. See Section 2-1.

16. Approximately what percentage of national income consists of compensation of

employees?

A. 10 percent

B. 25 percent

C. 70 percent

D. 95 percent

The correct answer is C. The components of national income are

discussed in section 2-1.

17. The consumer price index (CPI)

A. measures the price of a fixed basket of goods and services.

B. measures the price of a basket of goods and services that constantly changes as the
composition of consumer spending changes.

C. measures the amount of money that it takes to produce a fixed level of utility.

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 D. is one of the many statistics in the National Income Accounts.

The correct answer is A. The CPI measures the price of a fixed

basket of goods. See Section 2-2.

18. Suppose that the typical consumer buys one apple and one orange every month. In the
base year 1986, the price for each was $1. In 1996, the price of apples rises to $2, and the
price of oranges remains at $1. Assuming that the CPI for 1986 is equal to 1, the CPI for
1996 would be equal to

A. 1/2.

B. 1.

C. 3/2.

D. 2.

The correct answer is C. The CPI measures the change in the price
of the typical consumer's basket of goods. Since the price of the
basket was $2 in 1986, and it is $3 in 1996, the CPI for 1996 is
equal to 3/2. See Section 2-2.

19. Consider the following table:

Consumption Goods Nonconsumption Goods
Year Production Price Production Price
1995 20/$0.50 10/$1.00
2000 10/$1.00 10/$0.50
If 1995 is the base year, the CPI in 2000 is

A. 0.

B. 1/2.

C. 1.

D. 2.

The correct answer is D. The CPI is a measure of the price of a fixed

basket of consumption goods. Since the price of consumption goods

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doubled between 1995 and 2000, the 2000 CPI will equal 2. See
Section 2-2.

20. Which of the following statements about the CPI and the GDP deflator is true?

A. The CPI measures the price level; the GDP deflator measures the production of an
economy.

B. The CPI refers to a base year; the GDP deflator always refers to the current year.

C. The weights given to prices are not the same.

D. The GDP deflator takes the price of imported goods into account; the CPI does not.

The correct answer is C. For a discussion of the CPI and the GDP
deflator, see Section 2-2.

21. All other things equal, if the price of foreign-made cars rises, then the GDP deflator

A. and the CPI will rise by equal amounts.

B. will rise and the CPI will remain the same.

C. will remain the same and the CPI will rise.

D. and the CPI will rise by different amounts.

The correct answer is C. Goods and services produced abroad do

not enter the GDP deflator, but are included in the CPI if the foreign
goods are in the consumers’ basket. See Section 2-2.

22. General Motors increases the price of a model car produced exclusively for export to
Europe. Which U.S. price index is affected?

A. The CPI

B. The GDP deflator

C. Both the CPI and the GDP deflator

D. Neither the CPI nor the GDP deflator

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The correct answer is B. The GDP deflator is affected because the
cars are produced domestically. The CPI does not change because
the cars are not consumed domestically. See Section 2-2.

23. Which of the following events will cause the unemployment rate to increase?

A. An increase in population, with no change in the size of the labor force

B. A proportionally equal increase in the labor force and the number of unemployed
workers

C. An increase in the labor force with no change in the number of employed workers

D. An increase in the number of employed workers with no change in the number of

unemployed workers

The correct answer is C. The unemployment rate is defined as the

number of unemployed workers divided by the labor force. If the
labor force increases and employment does not change, the
unemployment rate will increase. See Section 2-3.

24. An example of a person who is counted as unemployed is a

A. retired worker below the mandatory retirement age.

B. part-time worker who would like to work full-time.

C. senator who resigns her job to run for president.

D. student going to school full-time.

The correct answer is C. For a discussion of who is considered

unemployed, see Section 2-3.

25. Suppose that a factory worker turns 62 years old and retires from her job. Which
statistic is not affected?

A. Number of unemployed

B. Unemployment rate

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 C. Labor force

D. Labor-force participation rate

The correct answer is A. The factory worker willingly leaves her job
so she is not considered to be unemployed. See Section 2-3.

26. Suppose that the size of the labor force is 100 million and that the unemployment rate
is 5 percent. Which of the following actions would reduce the unemployment rate the most?

A. 1 million unemployed people get jobs.

B. 2 million unemployed people leave the labor force.

C. 3 million people join the labor force and they all get jobs.

D. 10 million people join the labor force and half of them get jobs.

The correct answer is B. The unemployment rate is equal to the

number of unemployed workers divided by the size of the labor
force. If you calculate it for each of the above situations, you will
see that it is most reduced when 2 million unemployed people leave
the labor force. See Section 2-3.

27. Okun's law expresses a relationship between a change in

A. the price level and a change in real GDP.

B. the price level and a change in the unemployment rate.

C. investment and change in the unemployment rate.

D. real GDP and a change in the unemployment rate.

The correct answer is D. Okun's law states a relationship between

changes in real GDP and changes in the unemployment rate. See
Section 2-3.

28. Suppose that a Canadian citizen crosses the border each day to work in the United
States. Her income from this job would be counted in

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 A. U.S. GNP and Canadian GNP.

B. U.S. GNP and Canadian GDP.

C. U.S. GDP and Canadian GNP.

D. U.S. GDP and Canadian GDP.

The correct answer is C. Her income is counted as U.S. GDP and

Canadian GNP. See Section 2-1 for the definitions of gross domestic
product (GDP) and gross national product (GNP).

29. Suppose that an Italian working in the United States renounces his Italian citizenship
and is granted U.S. citizenship. Which of the following will happen?

A. Italian GDP will fall; U.S. GNP will rise.

B. Italian GNP will fall; U.S. GNP will rise.

C. Italian GDP will fall; U.S. GDP will rise.

D. Italian GNP will fall; U.S. GDP will rise.

The answer is B. The worker's income was counted as Italian GNP

and U.S. GDP. After the worker becomes a U.S. citizen, his income
is counted as U.S. GNP and GDP. Therefore, Italian GNP falls and
U.S. GNP rises. See Section 2-1.

Chapter 3:

1. The returns to scale in the production function Y = K0.5 L0.5 are

A. decreasing.

B. constant.

C. increasing.

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 D. subject to wide fluctuations.

The correct answer is B. If the amounts of capital and labor were

both doubled, then output would double. This implies that the above
production function has constant returns to scale. See Section 3-1
and mathematical footnote 4.

2. If a production function has two inputs and exhibits constant returns to scale, then
doubling both inputs will cause the output to

A. reduce by half.

B. stay the same.

C. double.

D. quadruple.

The correct answer is C. If a production function has constant

returns to scale, then an equal percentage increase in all factors of
production causes the same percentage increase in output. See
Section 3-1.

3. If the supplies of capital and labor are fixed and technology is unchanging, then real
output is

A. fixed.

B. determined by demand.

C. uncertain.

D. subject to wide fluctuations.

The answer is A. In this case, real output will be fixed. As discussed

in Section 3-1, it can only change if capital, labor, or technology
change.

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4. If a production function has the property of diminishing marginal product, then doubling

A. all of the inputs will less than double the output.

B. all of the inputs will double the output.

C. all of the inputs will more than double the output.

D. one of the inputs will reduce its marginal product.

The correct answer is D. The correct answer is D. If a production

function has the property of diminishing marginal product, then
increasing the amount of one input reduces its marginal product.
See Section 3-2.

5. Consider the following production table:

Labor Capital Output
(i) 1,000 1,000 10,000
(ii) 2,002 2,000 20,010
Assuming that the production function displays constant returns to scale, what is the
marginal product of labor when labor and capital are both equal to 1,000?

A. 1

B. 5

C. 10

D. 20

The correct answer is B. Since the above production function has

constant returns to scale, row (ii) may be divided by 2 to yield the
following information: 1,001 units of labor and 1,000 unit of capital
produce 10,005 units of output. Hence, the marginal product of
labor when capital and labor are both equal to 1,000 is 5. See
Section 3-2.

6. Consider the following production table:

Labor Capital Output
1 2 3
2 2 6
3 2 8

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By how much does the marginal product of labor decrease as labor input increases from 1 to 2
and from 2 to 3?

A. 0

B. 1

C. 2

D. 3

The correct answer is B. When labor input increases from 1 to 2 the

change in output is 3. Thus means the marginal product of labor is
equal to 3. Likewise, the marginal product when labor input
increases from 2 to 3 is equal to 2. Thus, the change in the marginal
product of labor is 1. See Section 3-2.

7. Euler's theorem implies that if a production function exhibits constant returns to scale

A. economic profit is zero.

B. accounting profit is zero.

C. the marginal product of labor equals the real wage.

D. the marginal product of capital equals the real interest rate.

The answer is A. Euler's theorem states that if each factor is paid its
marginal product, then the sum of these factor payments equals
output. This implies that economic profit is zero. See Section 3-2 for
a more detailed explanation of Euler's theorem.

8. If a firm with a constant returns to scale production function pays all factors their marginal
products, then

A. economic and accounting profits are both zero.

B. economic profit is zero and accounting profit is positive.

C. economic profit is positive and accounting profit is zero.

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 D. economic and accounting profit are both positive.

The correct answer is B. Euler's theorem guarantees that economic

profits are zero. Accounting profits equal economic profits plus the
return to capital. Since the return to capital is positive, accounting
profits must be positive. See Section 3-2.

9. Which of the following is not a decision made by a competitive firm?

A. The number of employees to hire

B. How much to invest in machines

C. What price to ask for its product

D. How much to produce

The correct answer is C. A competitive firm is assumed to take the

price as given. See Section 3-2.

10. A competitive firm hires labor until the marginal product of labor equals the

A. real wage.

B. rental price of capital.

C. price of output.

D. capital/labor ratio.

The answer is A. In order to maximize profit, a firm will hire labor as

long as the extra revenue from an additional unit (the marginal
product) is greater than or equal to the cost (the wage). Thus, the
firm hires labor until the marginal product of labor equals the wage.
See Section 3-2.

11. A competitive firm rents capital until the marginal product of capital equals the

A. real wage.

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 B. rental price of capital.

C. price of output.

D. capital/labor ratio.

The correct answer is B. In order to maximize profit, a firm will rent

capital as long as the extra revenue from an additional unit (the
marginal product) is greater than or equal to the cost (the rental
price).Thus, the firm hires capital until the marginal product of
capital equals the rental price. See Section 3-2.

12. Economic profit is the same as accounting profit minus

A. the return to labor.

B. the return to capital.

C. depreciation.

D. corporate taxes.

The correct answer is B. As explained in Section 3-2, accounting

profits include both economic profits and the return to capital.

13. Suppose that a major natural disaster destroys a large part of a country's capital stock but
miraculously does not cause anybody bodily harm. What will happen to the real wage rate?

A. It will not change.

B. It will rise.

C. It will fall.

D. It could rise or fall.

The correct answer is C. As explained in Section 3-2, the real wage

paid to each worker equals the marginal product of labor. If a large
part of the capital stock is destroyed, then there will be less capital
per worker, which means the marginal product of labor will be lower.
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This will result in a lower real wage.
14. Which of the following is not a characteristic of the Cobb-Douglas production function?

A. Capital and labor receive equal fractions of income.

B. Economic profit is zero.

C. Factor payments are a constant fraction of income.

D. Constant returns to scale.

The answer is A. For an explanation of the properties of the Cobb-

Douglas production function, see Appendix to Chapter 3.
15. In the Cobb-Douglas production function, Y = K a L 1-a , the fraction of income spent in
payments to labor is

A. a.

B. 1 - a.

C. dependent on the amount of labor employed.

D. dependent on the amount of capital employed.

The correct answer is B. Since the real wage equals the marginal
product of labor (MPL), payments to labor (L) equal MPL * L. As
shown in Section 3-2, the MPL of the above production function
equals (1 - a)Y/L. Therefore payments to labor equal (1 - a)Y and (1
- a) is the fraction of income spent in payments to labor.

16. In a closed economy, the supply of goods and services must be equal to

A. consumption.

B. consumption + investment.

C. consumption + investment + government purchases.

D. consumption + investment + government purchases - taxes.

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The correct answer is C. As explained in Section 3-3, in a closed
economy, the supply of goods and services is allocated among three
uses--consumption, investment, and government purchases.
17. Suppose that a consumer has a marginal propensity to consume of 0.7. If this consumer earns
an extra $2, her consumption spending would be expected to increase by

A. $0.60.

B. $0.70.

C. $1.40.

D. $1.70.

The correct answer is C. Since her marginal propensity to consume

is 0.7, this individual will consume 70 cents of every dollar she
earns. Therefore, if her income rises by $2, her consumption
spending will rise by $1.40. See Section 3-3.

18. Suppose that a consumer has a marginal propensity to consume of 0.8. If this consumer
receives and extra $2 of disposable income, her saving would be expected to increase by

A. $0.40.

B. $0.80.

C. $1.20.

D. $1.60.

The answer is A. Since her marginal propensity to consume is 0.8,

this individual will consume 80 cents of every dollar she earns.
Therefore, if her disposable income increases by $2, she will
consume and extra $1.60, and save an extra 40 cents. See Section
3-3.

19. Which of the following operations is not considered investment?

A. A family builds a house in which it plans to live.

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 B. A car dealer stores some of this year's models for next year.

C. An individual purchases several pieces of antique furniture.

D. A firm buys a computer for word processing.

The correct answer is C. As discussed in Section 3-3, the reallocation

of existing assets among different individuals is not investment for
economy.

20. Suppose that Jones builds a new house, then she sells it to Smith, and then Smith sells it to
Williams. The total net investment from these transactions is

A. zero.

B. 1 house.

C. 2 houses.

D. 3 houses.

The correct answer is B. As explained in Section 3-3, building a new

house counts as investment; selling an existing house does not.

21. If the real interest rate rises, the quantity of investment demanded

A. will fall.

B. will not change.

C. will rise.

D. could rise or fall.

The answer is A. To be profitable, the return on an investment must

exceed its cost. The real interest rate represents the cost of
investment. Thus, if the real interest rate rises, fewer investment
projects are profitable, so the quantity of investment demanded will
fall. See Section 3-3.

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22. The real interest rate is equal to the nominal interest rate minus

A. accounting profit.

B. economic profit.

C. taxes.

D. inflation.

The correct answer is D. As explained in Section 3-3, the real

interest rate is equal to the nominal interest rate minus inflation.

23. Choose the pair of words that best completes this sentence: Investment depends on the
________ interest rate because higher inflation will ________ the value of the dollars with which
the firm will repay the loan.

A. real, increase

B. nominal, increase

C. real, decrease

D. nominal, decrease

The correct answer is C. As explained in Section 3-3, the nominal

interest rate is the rate that investors pay to borrow money, but it is
the real interest rate that firms care about when they make their
investment decisions because higher inflation decreases the value of
the dollars with which the firm will repay the loan.

24. In a closed economy that is in equilibrium, investment is equal to

A. private saving.

B. public saving.

C. private saving plus public saving.

D. disposable income minus consumption.

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The correct answer is C. In equilibrium, the supply of loanable funds
must equal the demand. In a closed economy, the demand for
loanable funds is investment and the supply is the sum of private
and public saving. Thus, investment must equal private saving plus
public saving. See Section 3-4.

25. The government is running a budget deficit if

A. government spending is greater than tax revenue.

B. tax revenue is greater than government spending.

C. tax revenue is greater than consumption spending.

D. tax revenue is greater than investment spending.

The answer is A. If the government spends more than the revenue it

receives from taxes, then it runs a budget deficit. See Section 3-3.
26. Private saving is equal to

A. income - consumption.

B. income - consumption - taxes.

C. income - consumption - government spending.

D. income - consumption - government spending - taxes.

The correct answer is B. Private saving equals income minus

consumption and taxes. See section 3-4.

27. The supply of loanable funds, or "national saving," is equal to

A. income - consumption.

B. income - consumption - taxes.

C. income - consumption - government spending.

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 D. income - consumption - government spending - taxes.

The correct answer is C. National saving is equal to the sum of

private and public saving. Since private saving is equal to income
minus consumption and taxes and public savings is equal to taxes
minus government spending, national saving equals income minus
consumption and government spending. See Section 3-4.

28. In a closed economy, with total output and taxes fixed, if government spending rises

A. consumption falls.

B. national saving rises.

C. the real interest rate falls.

D. investment falls.

The correct answer is D. If government spending rises, then public

saving falls. This means that national saving--the supply of loanable
funds--falls. Thus the real interest rate must rise so that the demand
for loanable funds--investment--falls. See Section 3-4.

29. In a closed economy with total income fixed, a reduction in taxes will cause consumption

A. to rise and investment to fall.

B. and investment both to rise.

C. to fall and investment to rise.

D. and investment both to fall.

The correct answer is A. Lower taxes imply higher disposable

income. This means that consumption will rise. This also means that
national saving (income minus consumption and government
spending) will fall. Since investment must equal national saving in a
closed economy, investment must also fall. See Section 3-4.

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30. Suppose that there is a positive shock to investment demand: that is, at every interest rate, the
desired amount of investment rises. In a closed economy with the national saving fixed, the real
interest rate will

A. fall.

B. remain constant.

C. rise.

D. first fall and then rise.

The correct answer is C. An increase in investment demand

represents an increase in the demand for loanable funds. Since the
supply of loanable funds (national saving) is fixed, the real interest
rate must rise so that the quantity of investment demanded will fall
and the market for loanable funds will remain in equilibrium. See
Section 3-4.

31. According to the simple macroeconomic model presented in Chapter 3, which of the
following will not be caused by an increase in government spending?

A. Increase in interest rate

B. Decrease in consumption

C. Decrease in investment

D. Increase in government debt

The correct answer is B. Consumption depends only on disposable

income (income minus taxes). See Section 3-4.

32. In a closed economy with output fixed, an increase in government spending matched by an
equal increase in taxes will

A. increase consumption.

B. increase the interest rate.

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 C. increase investment.

D. leave all other variables unchanged.

The correct answer is B. National saving (the supply of loanable

funds) decreases since the reduction in consumption caused by the
tax increase is not large enough to offset the increase in government
spending. This means that the interest rate must rise so that
investment (the demand for loanable funds) will also fall. See
Section 3-4.

33. In a closed economy with fixed output, an increase in government spending without any
change in taxes will lead to a(n)

A. increase in the real interest rate and a decrease in private saving.

B. decrease in the real interest rate and an increase in private saving.

C. decrease in the real interest rate and no change in private saving.

D. increase in the real interest rate and no change in private saving.

The correct answer is D. Since output and taxes do not change,

private saving does not change. National saving falls due to the
increase in government spending. Since saving must equal
investment, the fall in national saving causes the interest rate to rise
so that the quantity of investment demanded also falls. See Section
3-4. Since output and taxes do not change, private saving does not
change. National saving falls due to the increase in government
spending. Since saving must equal investment, the fall in national
saving causes the interest rate to rise so that the quantity of
investment demanded also falls. See Section 3-4.

34. In the simple macroeconomic model of Chapter 3, a decrease in taxes will shift the

A. investment demand curve to the left.

B. investment demand curve to the right.

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 C. savings curve to the left.

D. savings curve to the right.

The correct answer is C. A decrease in taxes causes consumption to

rise. This means that national saving falls. See Section 3-4.

35. A leftward shift of the savings curve cannot be caused by a(n)

A. positive shock to consumption.

B. increase in the government budget deficit.

C. reduction in taxes.

D. increase in the real interest rate.

The correct answer is D. A leftward shift in the savings curve will

cause an increase in the interest rate but cannot be caused by such
an increase. See Section 3-4.

36. In the full model of the economy presented in chapter 3, the variable that adjusts to equilibrate
the supply and demand for goods and services is

A. government spending.

B. consumption.

C. taxes.

D. the real interest rate.

The correct answer is D. See Section 3-4 for an explanation of the

model.
Chapter 4:

1. Which of the following is not a function of money?

A. It is a means of production.

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 B. It is a unit of account.

C. It is a store of value.

D. It is a medium of exchange.

The answer is A. See Section 4-1 for a description of the different

functions of money.

2. One purpose of money is to transfer purchasing power from the present into the future.
This function of money is called

A. store of value.

B. index of inflation.

C. medium of exchange.

D. unit of account.

The correct answer is A. See Section 4-1 for a description of the

different functions of money.

3. One purpose of money is to provide the terms in which prices are quoted and debts are
recorded. This function of money is called

A. store of value.

B. index of inflation.

C. medium of exchange.

D. unit of account.

The correct answer is D. See Section 4-1 for a description of the

different functions of money.

4. One purpose of money is to be the item we use to buy and sell things. This function of
money is called

A. store of value.

26 | P a g e
 B. index of inflation.

C. medium of exchange.

D. unit of account.

The correct answer is C. See Section 4-1 for a description of the

different functions of money.

5. Of all of the following that could be used as money, which would be most likely to be
characterized as fiat money?

A. Chocolate bars

B. Silver jewelry

C. Gum wrappers

D. Salt

The correct answer is C. Fiat money has no intrinsic usefulness. Of

the above items, gum wrappers have the least intrinsic worth. See
Section 4-1.

6. Which of the following is a type of open-market operation?

A. The government sells Treasury bills to the public.

B. The government prints money and uses it to buy army

C. The Fed sells Treasury bills to the public.

D. The Fed buys foreign currency in the exchange market.

The correct answer is C. Open-market operations are a way the Fed

controls the money supply. To increase the money supply, the Fed
buys government bonds from the public. To decrease the money
supply, the Fed sells government bonds to the public. See Section
4-1.

27 | P a g e
7. M2 does not include

A. currency.

B. long-term government bonds.

C. traveler's checks.

D. demand deposits.

The correct answer is B. See Section 4-1 for an explanation of the

different measures of the money supply.

8. In the quantity equation, V represents the

A. total number of transaction during some period of time.

B. price of a typical transaction.

C. the rate at which each unit of money circulates in the economy.

D. quantity of money.

The correct answer is C. V represents velocity which is the rate at

which money circulates in the economy. See Section 4-2.

9. According to the quantity equation, if M increases by 3 percent and V increases by 2

percent, then

A. real income increases by approximately 5 percent.

B. the price level increases by approximately 5 percent.

C. the nominal interest rate increases by approximately 5 percent.

D. nominal income increases by approximately 5 percent.

The correct answer is D. The quantity equation implies % Change in

M + % Change in V = % Change in P + % Change in Y. The right
hand side of the equation is % Change in nominal income. A 3
percent increase in M and a 2 percent increase in V causes a 5
percent increase in nominal income. See Section 4-2.

28 | P a g e
10. According to the quantity equation, which of the following might happen if the money
supply increases?

A. Velocity is constant, prices are constant, and total output increases.

B. Velocity increases, prices are constant, and total output is constant.

C. Velocity is constant, prices fall, and total output is constant.

D. Velocity rises, prices fall, and total output is constant.

The correct answer is A. The quantity equation states that the

money supply multiplied by velocity equals the price level multiplied
by total output. If the money supply increases, one possible
outcome is that velocity and prices are constant and output
increase.

11. Consider an economy where the money supply is growing at 7 percent per year and
velocity is constant. Which of the following statements about real GDP growth and the
inflation rate could be true?

A. Real GDP is growing at 2 percent and inflation is 5 percent.

B. Real GDP is growing at 7 percent and inflation is 7 percent.

C. Real GDP is growing at 2 percent and inflation is 9 percent.

D. Real GDP is growing at 9 percent and inflation is 2 percent.

The correct answer is A. The percent change form of the quantity

equation implies that if the money supply is growing at 7 percent
and velocity is constant, the sum of the growth rate of real GDP and
the inflation rate will equal 7 percent. See Section 4-2.

12. Consider an economy where the only goods traded are coconuts and pineapples. Last
year, 100 coconuts were sold at $1 apiece, and 200 pineapples were sold at $2.50 apiece. If
the money supply was $100, what was velocity?

A. 30

B. 15

29 | P a g e
 C. 6

D. 5

The correct answer is C. Velocity is computed as the dollar value of

transactions divided by the money supply. The dollar value of
transactions was $600; the money supply was $100; so velocity
was 6.

13. Which component of the quantity equation is assumed constant by the quantity theory
of money?

A. The money supply

B. The velocity of money

C. The level of income

D. The price level

The answer is B. See Section 4-2 for an explanation of the quantity

theory of money.

14. The quantity theory of money states that if the money supply doubles and output is
constant, prices will

A. fall by half.

B. remain the same.

C. double.

D. fall only if velocity rises.

The answer is C. According to the quantity theory, if the money

supply doubles and output is constant, prices will double. See
Section 4-2.

30 | P a g e
15. The difference between the nominal interest rate and the real interest rate is

A. inflation.

B. taxes.

C. seignorage.

D. hyperinflation.

The correct answer is A. The real interest rate (r) and the nominal
interest rate (i) are related by the equation i = r + inflation. The
difference between the two interest rates is inflation. See Section 4-
4.

16. The Fisher equation states that a 1 percent rise in the rate of inflation causes a 1
percent rise in the

A. real interest rate.

B. nominal interest rate.

C. money supply.

D. number of transactions.

The correct answer is B. The Fisher equation states that the nominal
interest rate is the sum of the real interest rate and inflation. Since
the real interest rate is determined by savings and investment, a 1
percent rise in the inflation rate will cause a 1 percent rise in the
nominal interest rate. See Section 4-4.

17. The ex ante real interest rate differs from the ex post real interest rate only when

A. the money supply grows at a constant rate.

B. the money supply remains the same.

C. the money supply falls at a constant rate.

D. actual inflation differs from expected inflation.

31 | P a g e
The correct answer is D. The ex ante real interest rate is equal to
the nominal interest rate minus expected inflation and the ex post
real interest rate equals the nominal interest rate minus actual
inflation. They are equal if actual inflation equals expected inflation.
See Section 4-4.

18. Which of the following statements is false?

A. If inflation is higher than the real interest rate, then the nominal interest rate must
be negative.

B. If inflation is higher than the nominal interest rate, then the real interest rate must
be negative.

C. If the nominal interest rate is higher than the real interest rate, then inflation must
be positive.

D. If the nominal interest rate is higher than inflation, then the real interest rate must
be positive.

The correct answer is A. The nominal interest rate is just the sum of
inflation and the real interest rate. See Section 4-4.

19. Consider the following table

Year Inflation Rate Nominal Interest Rate
1 5% 10%
2 10% 5%
By how much has the real interest rate changed between year 1 and year 2?

A. It has increased 5 percent.

B. It has decreased 5 percent.

C. It has increased 10 percent.

D. It has decreased 10 percent.

The correct answer is D. Since the real interest rate is equal to the
nominal interest rate minus the inflation rate, it was equal to 5
percent in year 1 and -5 percent in year 2. Between year 1 and year
2, it decreased by 10 percent. See Section 4-4.

32 | P a g e
20. The expected rate of inflation does not influence the

A. demand for real money balances.

B. ex post real interest rate.

C. nominal interest rate.

D. current price level.

The correct answer is B. The expected rate of inflation influences

the demand for real money balances, the nominal interest rate, and
the current price level, but it does not influence the ex post real
interest rate. See Section 4-5.

21. Government revenue raised through the printing of money is called

A. hyperinflation.

B. seignorage.

C. income taxes.

D. sales taxes.

The answer is B. See Section 4-3 for a discussion of seignorage.

22. Suppose that the price level has risen but the government has not collected any
seignorage. Which of the following might have happened?

A. V rose, M and Y were constant

B. Y rose, M and V were constant

C. M rose, Y and V were constant

D. M rose, Y fell, V was constant

The correct answer is A. If M grows then the government will collect

seignorage-- this rules out choices (C) and (D). If Y rose while M
and V were constant, P would have to fall, thus ruling out choice
(B). See Section 4-3.

33 | P a g e
23. When the government raises revenue by printing money, it imposes an "inflation tax"
because the

A. real value of money holdings falls.

B. interest rate falls.

C. difference between nominal and real interest rates becomes smaller.

D. nominal value of money holdings falls.

The answer is A. When the government raises revenue by printing

money, it increases the money supply. The increase in the money
supply leads to inflation which reduces the real value of people's
money holdings. See Section 4-3.

24. The cost of holding money is determined by the

A. inflation rate.

B. real interest rate.

C. growth rate of the money supply.

D. nominal interest rate.

The correct answer is D. The cost of holding money is the difference

between the real return on other assets and the real return on
money. The real return on alternative assets is the real interest rate
and the real return on money is the negative of the expected rate of
inflation. See Section 4-5.

25. An increase in the expected rate of inflation will

A. lower the demand for real balances because the real interest rate will rise.

B. lower demand for real balances because the nominal interest rate will rise.

C. increase the demand for real balances because the real interest rate will fall.

34 | P a g e
 D. increase the demand for real balances because the nominal interest rate will rise.

The correct answer is B. The demand for real balances is a negative

function of the nominal interest rate. If expected inflation increases,
the nominal interest rate will increase and the demand for real
balances will fall. See Section 4-5.

26. The expected future money supply does not have an effect on

A. expected future inflation.

B. the current price level.

C. the current nominal money supply.

D. the future price level.

The answer is C. The current nominal money supply is controlled by

the central bank; it is not influenced by the expected future money
supply. See Section 4-5.

27. Choose the pair of words that best completes this sentence: The nominal interest rate is
the sum of the ex ante real interest rate and the _________ inflation rate, and real money
balances are a function of the ___________ interest rate.

A. expected; nominal

B. actual; nominal

C. actual; real

D. expected; real

The correct answer is A. The nominal interest rate is the sum of the
ex ante real interest rate and the expected inflation rate. Real
money balances depend on the opportunity cost of holding money
which is the nominal interest rate. See Section 4-5.

28. If an individual is to hold lower money balances on average, she must make more
frequent trips to the bank to withdraw money. This inconvenience of reducing money
holding is called

35 | P a g e
 A. a menu cost.

B. a shoeleather cost.

C. an inflation tax.

D. seignorage.

The answer is B. See Section 4-6 for a discussion of shoeleather

costs.

29. One effect of an unexpected rise in inflation is that wealth is redistributed from

A. borrowers to lenders.

B. lenders to borrowers.

C. young people to old people.

D. government to firms.

The answer is B. An unexpected rise in inflation reduces the ex post

real return paid by the borrower to the lender. Therefore, it
redistributes wealth from lenders to borrowers. See Section 4-6.

30. Which of the following is not a social cost of inflation?

A. The money that people hold loses value due to the inflation tax.

B. People hold smaller real balances and so have to make more frequent trips to the
bank.

C. Firms have to spend money to change prices more frequently.

D. Inflation leads to greater variability in the relative prices charged by firms.

The correct answer is A. The wealth lost by individuals due to the

inflation tax is collected by the government in the form of
seignorage and is thus not a social loss. See Section 4-6.

36 | P a g e
31. One possible benefit from inflation is:

A. inflation causes restaurants to update their menus more often.

B. inflation reduces distortions to relative prices.

C. if nominal wages are fixed, inflation decreases real wages.

D. if nominal wages are fixed, inflation increases real wages.

The correct answer is C. It is sometimes the case that a fall in real

wages is required to clear labor markets. Workers are reluctant to
accept cuts to their nominal wage. Inflation allows real wages to fall
while the nominal wage stays constant or even rises. See section 4-
6.

32. Hyperinflation usually starts when

A. people start spending too much money.

B. firms demand higher and higher prices for their goods.

C. governments are forced to print money to finance their spending.

D. fiscal deficits are small.

The correct answer is C. Governments that cannot raise money by

taxing or borrowing must print money to finance their spending.
This increase in the money supply will cause inflation. Inflation, in
turn, leads to a fall in real tax revenue and the need to print even
more money. See Section 4-7.

33. According to the classical dichotomy, which of these magnitudes is affected by monetary
policy?

A. The price level

B. The real wage

C. The real interest rate

37 | P a g e
 D. The rate of growth of real GDP

The answer is A. According to the classical dichotomy, changes in

the money supply influence only nominal variables such as the price
level. See Section 4-8.

Chapter 5:

1 of 26
2 Consider the following table
Consumption of foreign goods and services 100
Consumption of domestic goods and services 900
Investment of foreign goods and services 20
Investment of domestic goods and services 180
Government purchases of foreign goods and services 0
Government purchases of domestic goods and services 500
Exports 100
Based on the data, what are total imports?

A. 0

B. 120

C. 1,000

D. 1,580

The correct answer is B. Imports are the sum of consumption of

foreign goods and services, investment of foreign goods and
services and government purchases of foreign goods and services.
The above table indicates that imports are equal to 120. See
Section 5-1.

2 of 26

38 | P a g e
3 Consider the following table
Consumption of foreign goods and services 100
Consumption of domestic goods and services 900
Investment of foreign goods and services 20
Investment of domestic goods and services 180
Government purchases of foreign goods and services 0
Government purchases of domestic goods and services 500
Exports 100
Based on the data, what are net exports?

A. -20

B. 0

C. 120

D. 1,580

The correct answer is A. Imports, which are calculated as the sum

of consumption, investment, and government purchases of foreign
goods and services, equal 120. Net exports, which are calculated as
exports minus imports, equal -20. See Section 5-1.

3 of 26
4 If net exports are positive, which of the following is false?

A. Domestic output exceeds domestic spending.

B. Domestic saving exceeds domestic investment.

C. Net capital outflow is positive.

D. There is a balance of trade deficit.

The correct answer is D. If net exports are positive, there is a trade

surplus. See Section 5-1.
39 | P a g e
4 of 26
5 If net capital outflow is positive, then

A. S - I is negative.

B. private savings exceeds private investment.

C. NX is positive.

D. public saving exceeds public investment.

The correct answer is C. Net capital outflow must always equal the
balance of trade. If net capital outflow is positive, there must be a
trade surplus. This means that net exports are positive. See
Section 5-1.

5 of 26
6 In a small open economy, the interest rate is determined by the

A. equilibrium of saving and investment.

B. interest rate in the rest of the world.

C. excess of government spending over government revenue.

D. value of net capital outflow.

The correct answer is B. As explained in Section 5-2, the economy

of a small open country has a negligible effect on the world
economy. The interest rate it faces is given by the world interest
rate, since its financial markets are too small to influence it.

40 | P a g e
6 of 26
7 In a small open economy, which interest rate equals the world
interest rate?

A. The real interest rate

B. The nominal interest rate

C. Both the real and the nominal interest rates

D. It depends on whether the exchange rate is fixed or

floating.

The correct answer is A. Investors are considered with how much

purchasing power they will get from an investment, not with how
many units of currency they will receive. So, they care about the
real interest rate.

7 of 26
8 If a Canadian investor buys one million dollars worth of stock in
an American company, how does this transaction appear in the
national income accounts of the United States?

A. The balance of trade rises as we export $1 million of stock.

B. The balance of trade falls as we import Canadian

investment.

C. Net capital outflow rises by $1 million.

D. Net capital outflow falls by $1 million.

The correct answer is D. Trade in financial assets is counted in net

41 | P a g e
foreign investment. Since a foreigner is buying American assets,
this appears as a decrease in U.S. net capital outflow.

8 of 26
9 Consider the following data on the Transalpinian economy
Y = 1,000
C = 700
G = 150
I = 250 - 10r*
The world interest rate is 5 percent. What are net exports of
Transalpinia?

A. 50

B. -50

C. 150

D. -150

The answer is B. Investment is 200, and so total domestic spending

is 1,050. Since domestic output is 1,000, net exports must be -50.
See Section 5-2.

9 of 26
10 Consider the following data on the Transalpinian economy
Y = 1,000
C = 650
G = 200
I = 250 - 20r*
The world interest rate is 7.5 percent. How does the world
interest rate have to change to make net exports zero?

42 | P a g e
 A. It has to rise by 5 percent.

B. It has to rise by 2.5 percent.

C. It has to remain constant.

D. It has to fall by 2.5 percent.

The correct answer is D. If the world real interest rate falls to 5

percent, then investment will be 150, and C + I + G will be equal to
Y, so that NX will be zero. See Section 5-2.

10 of 26
11 In the small open economy model of Chapter 5, if a country
begins in a position of balanced trade, what happens when the
government increases taxes?

A. Net capital outflow becomes negative.

B. The interest rate rises.

C. Net exports decrease.

D. The balance of trade goes into surplus.

The correct answer is D. An increase in taxes reduces disposable

income and consumption and increases national saving. This
increases S - I, raises net exports and the trade balance. Since the
trade balance was initially 0, it now must be in surplus. See Section
5-2.

11 of 26
12 Which of the following characterizes the U.S. economy since
2001?

43 | P a g e
 A. Government budget deficit and negative net capital outflow

B. Government budget deficit and positive net capital outflow

C. Government budget surplus and negative net capital

outflow

D. Government budget surplus and positive net capital outflow

The correct answer is A. Since 2001, the United States faced a

government budget deficit and negative Net capital outflow. See
Section 5-2.

12 of 26
13 Which of the following did not contribute to an increase in
government saving in the 1990's?

A. Tax increases under presidents Bush and Clinton.

B. Congressional restraint in increasing government

spending.

C. A shrinking trade deficit.

D. Rapid productivity growth

The correct answer is C. According to our models, a shrinking trade

deficit is a consequence of an increase in government saving, not a
cause. As explained in the case study in Section 5-2, however, the
trade deficit failed to fall in the 1990's despite the increase in
government saving.

13 of 26

44 | P a g e
14 In the small open economy model of Chapter 5, starting from
balanced trade, an increase in the world interest rate from a fiscal
expansion abroad leads to which of the following?

A. Negative net capital outflow and a trade surplus.

B. Positive net capital outflow and a trade surplus.

C. Positive net capital outflow and a trade deficit.

D. Negative net capital outflow and a trade deficit.

The correct answer is B. An increase in the world interest rate

reduces investment, so S - I increases. This means that net foreign
investment becomes positive. Since the balance of trade must
equal net capital outflow, it must go into surplus. See Section 5-2.

14 of 26
15 The price of one currency in terms of another currency, such
as 150 yen for $1, is an example of

A. a nominal exchange rate.

B. a real exchange rate.

C. purchasing-power parity.

D. a constant world interest rate.

The correct answer is A. See Section 5-3 for an explanation of the

nominal exchange rate.

15 of 26

45 | P a g e
16 If the nominal exchange rate is $1 equals 150 Japanese yen,
and a Big Mac costs $2 in the U.S. and 300 yen in Japan, then
the real exchange rate of U.S. Big Macs for Japanese Big Macs is

A. 1.

B. 2.

C. 150.

D. 300.

The correct answer is A. A U.S. Big Mac would cost $2 x (150

yen/dollar) or 300 Japanese yen. This means that you could
exchange 1 U.S. Big Mac for 1 Japanese Big Mac. The real
exchange rate must be 1. See Section 5-3.

16 of 26
17 If a country's real exchange rate falls (depreciates), then

A. net exports rise.

B. net exports fall.

C. exports and imports rise by the same amount.

D. exports and imports fall by the same amount.

The correct answer is A. If the real exchange rate falls, exports are
relatively less expensive to foreigners and imports are relatively
more expensive to the domestic population. This means that
exports will rise and imports will fall. Therefore, net exports will
rise. See Section 5-3.

17 of 26

46 | P a g e
18 Choose the pair of words that best complete this sentence: If
government purchases increase, national saving will ________
and the equilibrium real exchange rate will _______.

A. fall; fall

B. fall; rise

C. rise; rise

D. rise; fall

The answer is B. An increase in government purchases causes a

reduction in national saving which causes a reduction in the supply
of dollars and an increase in the equilibrium real exchange rate.
See Section 5-3.

18 of 26
19 In the model of Chapter 5, if the government prevented the
import of foreign cars, then, in the resulting equilibrium, net
exports would

A. rise because fewer cars would be imported.

B. remain constant because saving and investment would not

change.

C. fall because the real exchange rate would rise.

D. rise because the real exchange rate would fall.

The answer is B. This policy raises the demand for net exports and
causes the real exchange to rise. Net exports remain constant,
because saving and investment do not change. See Section 5-3.

47 | P a g e
19 of 26
20 If the United States has an inflation rate of 10 percent, Great
Britain has an inflation rate of 12 percent, and the United States
dollar has a nominal appreciation against the British pound of 3
percent, then the real appreciation of the United States dollar
against the British pound is

A. 1 percent.

B. 13 percent.

C. 15 percent.

D. 25 percent.

The correct answer is A. As explained in Section 5-3, the percent

change in the real exchange rate equals the percent change in the
nominal exchange rate minus the difference in inflation rates. Since
the nominal exchange rate appreciates by 3 percent and the
difference in inflation rates is 2 percent, the real exchange rate
appreciates by 1 percent.

20 of 26
21 The law of one price applied to the international marketplace
is called

A. arbitrage.

B. nominal exchange rates.

C. real exchange rates.

D. purchasing-power parity.

The correct answer is D. See Section 5-3 for an explanation of

purchasing power parity.
48 | P a g e
21 of 26
22 Suppose that a bicycle costs $300 in the United States and
150 pounds in Great Britain. What would the nominal exchange
rate have to be for purchasing-power parity to hold?

A. 0.5

B. 1

C. 2

D. 2.5

The correct answer is A. For purchasing-power parity to hold, one

should be able to exchange one United States bicycle for one British
bicycle. In pounds, a United States bicycle costs 300 x the nominal
exchange rate. If the nominal exchange rate is 0.5, the United
States bicycle costs 150 pounds--the same as a British bicycle. See
Section 5-3.

22 of 26
23 Assume that the nominal exchange rate for the euro is .75
euros per dollar. Suppose that a Volkswagen Golf costs 10,000
euros in Germany, while it costs $12,000 in the United States.
What is the real exchange rate?

A. 0.75

B. 0.9

C. 1.2

D. 1.1

49 | P a g e
The answer is B. See Section 5-3 for an explanation of how to
calculate the real exchange rate.

23 of 26
24 Suppose that a country experiences inflation while the nominal
exchange rate and the price level in its trading partner remain
unchanged. What will happen to the country's real exchange rate
and to net exports?

A. The real exchange rate will fall; net exports will rise.

B. The real exchange rate will fall; net exports will fall.

C. The real exchange rate will rise; net exports will fall.

D. The real exchange rate will rise; net exports will rise.

The correct answer is C. The change in the real exchange rate

equals the change in the nominal exchange rate minus the
difference between inflation abroad and domestic inflation. In this
case, the difference is negative, so the real exchange rate rises and
net exports fall. See Section 5-3.

24 of 26
25 Which of the following causes a decrease in the real exchange
rate?

A. An exogenous increase in foreign demand for domestic

goods

B. An exogenous decrease in investment

C. An increase in government purchases

50 | P a g e
 D. A decrease in taxes

The correct answer is B. A decrease in investment raises S - I, and

so raises NX. To achieve this higher level of NX, the real exchange
rate has fall. See Section 5-3.

25 of 26
26 If the Japanese government wants to reduce its trade surplus
with the United States, which measure would achieve this?

A. Remove the import quotas for U.S. cars.

B. Impose export quotas on Japanese cars.

C. Enact legislation that would make Japanese companies less

competitive.

D. None of the above.

The correct answer is D. As explained in Section 5-3, trade

restrictions have no effect on the balance of trade.

26 of 26
27 Consider the following table
Domestic inflation: 5%
Foreign inflation: 6%
Change in nominal exchange rate: 3%
Based on the data, what is the change in the real exchange rate?

A. 2 percent

B. 3 percent

51 | P a g e
 C. 5 percent

D. 8 percent

The correct answer is A. The change in the real exchange rate

equals the change in the nominal exchange rate minus the
difference between inflation abroad and domestic inflation. In this
case, the change in the real exchange rate is 2 percent. See Section
5-3.
Chapter 6:

1. If the rate of unemployment is neither rising nor falling, then the number of people
finding jobs must equal the number of people

A. unemployed.

B. losing or leaving jobs.

C. looking for jobs.

D. leaving the labor force.

The correct answer is B. The number of people leaving jobs must

equal the number of people finding jobs for the rate of
unemployment to be constant. See Section 6-1.

2. If the rate of job finding rises, the natural rate of unemployment will

A. remain constant.

B. increase.

C. decrease.

D. rise or decline, depending on the rate of job separation.

The answer is C. As explained in Section 6-1, the higher the rate of

job finding, the lower the natural rate of unemployment.

52 | P a g e
3. Suppose that 2 percent of the employed lose their jobs each month (s = 0.02) and 38
percent of the unemployed find a job each month (f = 0.38). Then, the steady-state rate of
unemployment is

A. 2 percent.

B. 5 percent.

C. 16 percent.

D. 36 percent.

The answer is B. As explained in Section 6-1, the steady-state rate

of unemployment is given by U = s/(s + f).

4. The unemployment rate is 10 percent. The rate of job separation is 5 percent. How high
does the rate of job finding have to be to keep the unemployment rate constant?

A. 10 percent

B. 45 percent

C. 50 percent

D. 90 percent

The answer is B. Since 90 percent of the labor force is working and

the separation rate is 5 percent, 4.5 percent of the labor force loses
its job each period. For unemployment to be constant, the same
fraction of the labor force must find jobs each period. See Section
6-1.

5. Unemployment insurance

A. frictional unemployment.

B. seasonal unemployment.

C. teenage unemployment.

D. cyclical unemployment.

53 | P a g e
The correct answer is A. Since unemployment insurance programs
reduce the economic hardships associated with unemployment, they
increase the amount of frictional unemployment. See Section 6-2.

6. The unemployment caused by the time that it takes to match workers and jobs is called

A. frictional unemployment.

B. the discouraged-worker effect.

C. structural unemployment.

D. wage rigidity.

The answer is A. For a discussion of frictional unemployment, see

Section 6-2.

7. Frictional unemployment occurs because

A. the minimum wage is too high.

B. unions exert pressure in the labor market.

C. rigidities exist in the wage-setting process.

D. it takes time to match firms and workers.

The correct answer is D. For a discussion of frictional

unemployment, see Section 6-2.

8. Which of the following policies would reduce the amount of frictional unemployment?

A. A reduction in corporate taxes

B. An increase in unemployment insurance

C. An increase in the minimum wage

D. Public retraining programs

The correct answer is D. Public retraining programs ease the

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transition of workers from declining to growing industries, thereby
reducing frictional unemployment. See Section 6-2.

9. If the government increases the amount of unemployment insurance that unemployed

workers can collect, the amount of frictional unemployment would be expected to

A. fall.

B. remain constant.

C. rise.

D. first rise and then fall.

The correct answer is C. If the amount of unemployment insurance

rises, the economic hardships of unemployed workers are reduced,
so there is less incentive to search for a new job. This causes
frictional unemployment to rise. See Section 6-2.

10. When the real wage is above the level that equilibrates supply and demand, then the
quantity of labor supplied

A. depends on the nominal wage.

B. is smaller than the quantity of labor demanded.

C. is equal to the quantity of labor demanded.

D. is greater than the quantity of labor demanded.

The correct answer is D. If the real wage is above its equilibrium

value, labor supply will be greater than labor demand. See Section
6-3.

11. The unemployment resulting from wage rigidity and job rationing is called

A. the natural rate of unemployment.

B. the discouraged-worker effect.

C. structural unemployment.

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 D. insiders versus outsiders.

The correct answer is C. For a discussion of structural

unemployment, see Section 6-3.

12. A teenager is not able to find a job because the legal minimum wage is higher than the
wage that firms are willing to offer.This situation is an example of

A. frictional unemployment.

B. structural unemployment.

C. cyclical unemployment.

D. efficient unemployment.

The correct answer is B. For a discussion of structural

unemployment, see Section 6-3.

13. Minimum-wage laws are an example of

A. collective bargaining.

B. wage rigidity.

C. the discouraged-worker effect.

D. insiders versus outsiders.

The correct answer is B. Minimum wage laws prevent the nominal

wage from falling below a certain level. Thus, they cause wage
rigidity. See Section 6-3.

14. Structural unemployment results when

A. the minimum wage is set to increase in the near future.

B. there is generous unemployment insurance.

C. workers are temporarily laid off due to weather conditions.

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 D. the real wage is above its market-clearing level.

The correct answer is D. For a discussion of structural

unemployment, see Section 6-3.

15. Which of the following is not a cause for real wage rigidity?

A. Minimum-wage laws

B. Unemployment insurance

C. Union power

D. Efficiency wages

The correct answer is B. For a discussion of the causes of real wage

rigidity, see Section 6-3.

16. The unemployment caused by unions and by the threat of unionization is an instance of

A. structural unemployment.

B. the discouraged-worker effect.

C. efficiency wages.

D. conflict between insiders and outsiders.

The correct answer is D. Unemployment occurs because workers

already employed by a firm (insiders) fight to keep their wages
high. High wages prevent the firm from hiring new workers
(outsiders). See Section 6-3.

17. Unions may cause unemployment if

A. outsiders push wages down.

B. insiders force real wages higher than the market-clearing level.

C. outsiders are subject to minimum-wage legislation.

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 D. insiders are fired and outsiders are hired.

The answer is B. Unions may force wages above their market-

clearing level, causing labor supply to be higher than labor demand.
The resulting form of unemployment is called "structural
unemployment." See Section 6-3.

18. Efficiency wage theories claim that firms may pay high real wages in order to

A. avoid the threat of unionization.

B. make workers more productive.

C. discourage unskilled workers from applying.

D. reduce the level of frictional unemployment.

The answer is B. For an explanation of efficiency wage theories, see

Section 6-3.

19. Efficiency wages do not lead to

A. structural unemployment.

B. wages above their equilibrium level.

C. lower firm profits.

D. increased worker productivity.

The correct answer is C. Firms pay efficiency wages in order to

increase worker productivity. This results in higher firm profits. See
Section 6-3.

20. Which of the following statements about unemployment is true?

A. Most spells of unemployment are long.

B. Most unemployment is accounted for by the long-term unemployed.

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 C. The long-term unemployed make up only a small fraction of the unemployed.

D. Most people who become unemployed remain unemployed for a long time.

The correct answer is B. Most spells of unemployment are short, but

a large fraction of the people unemployed at any given time are in
long spells of unemployment. See Section 6-4.

21. Compared to long-term unemployment, short-term unemployment is more likely to be

A. frictional unemployment.

B. structural unemployment.

C. a result of minimum-wage laws.

D. a result of union activity.

The correct answer is A. Short-term unemployment is more likely to

be frictional unemployment. See Section 6-4.

22. Suppose that 130 people are unemployed for part of a given year; 120 are unemployed
for 1 month, 10 are unemployed throughout the year; what percentage of total months of
unemployment is attributable to the long-term unemployed?

A. 7.7 percent

B. 10 percent

C. 13 percent

D. 50 percent

The answer is D. There are 240 total months of unemployment, of

which half are short-term and half are long-term. See Section 6-4.

23. Measured unemployment may be lower than actual unemployment because

A. measured unemployment does not include the frictionally unemployed.

B. some individuals may want a job but have become discouraged and stopped looking

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for one.

C. some individuals claim to be unemployed when they are not looking very seriously
for a job.

D. measured unemployment does not include teenage unemployment.

The answer is B. If there are individuals who want jobs, but are
discouraged and no longer looking for them, actual unemployment
will be higher than measured unemployment. See Section 6-4.

24. Discouraged workers who want jobs, but have stopped looking for jobs are

A. frictionally unemployed.

B. unemployed due to structural unemployment.

C. no longer in the labor force.

D. helped by minimum-wage legislation.

The correct answer is C. Individuals who are not working or actively

searching for a job are not considered to be part of the labor force.
See Section 6-4.

25. Many economists believe that the rise in European unemployment is caused by

A. generous government benefits.

B. the decreased influence of union insiders.

C. an increase in the number of younger workers who have higher rates of

unemployment.

D. economic inequality.

The answer is A. Many European countries allow their unemployed

to collect benefits indefinitely. This makes taking a job a less
attractive alternative. See Section 6-5.

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