Economics (McConnell), AP Edition, 20th Edition Chapter (27)

Chapter 27: Business Cycles, Unemployment, and Inflation Multiple-Choice Questions 1. A recession is generally characterized by I. a decrease in real GDP II. a decrease in employment III. an increase in price level (A) I only (B) III only (C) I and II only (D) II and III only (E) I, II, and III (C) As GDP falls, fewer workers are needed to make the diminishing number of products. While prices tend to be sticky downward, at the minimum they would remain the same and would not rise. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Macroeconomic Issues: Business Cycle, Unemployment, Inflation, Growth Book Section: Phases of the Business Cycle 2. Which of the following events could lead to a recessionary phase of the business cycle? (A) An increase in worker productivity (B) Firms investing in new technology (C) An increase in consumer confidence (D) A supply shock that reduces the costs of production for firms (E) A reduction in the money supply (E) A reduction in the money supply makes it more difficult and expensive for firms and consumers to obtain credit, so aggregate demand would fall. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Macroeconomic Issues: Business Cycle, Unemployment, Inflation, Growth Book Section: Causation: A First Glance 3. Which sectors of the economy are most strongly impacted by business cycles? (A) Capital goods and consumer durable goods (B) Services and consumer non-durable goods (C) Public goods and exports (D) Imports and financial instruments (E) Tax revenues and energy (A) Capital goods are affected because firms can wait to invest until they expect a profitable return on their investment. Consumer durable goods are strongly affected because they tend to consume a large proportion of the consumer's budget, and consumers can make do with existing goods until the economy improves. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Macroeconomic Issues: Business Cycle, Unemployment, Inflation, Growth Book Section: Cyclical Impact: Durables and Nondurables 4. Unemployment measures the percentage of people in the labor force who (A) are not working (B) are not looking for jobs (C) are not working and are actively looking for jobs (D) have given up looking for jobs (E) are not working or are only working part-time (C) Unemployment only measures those who are available for work, want jobs, and are actively looking but cannot find employment. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Definition and Measurement Book Section: Measurement of Unemployment 5. The official unemployment rate is not completely accurate because it leaves out people who I. have given up looking for work II. are unemployed but have not filed for unemployment benefits III. are working part-time but want full-time jobs IV. do not have phones (A) I only (B) I and IV only (C) II and III only (D) II, III, and IV only (E) I, III, and IV only (E) Whether an unemployed person has filed for unemployment benefits is irrelevant to the calculation of the official unemployment rate. What is relevant is that the unemployed worker is actively looking for work. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Definition and Measurement Book Section: Measurement of Unemployment 6. A college graduate searching for her first job is experiencing (A) frictional unemployment (B) structural unemployment (C) seasonal unemployment (D) cyclical unemployment (E) underemployment (A) Frictional unemployment is the temporary unemployment that comes with entering the labor force or searching for a new job after losing another. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Types of Unemployment Book Section: Types of Unemployment 7. Full employment rate of unemployment (NRU) is achieved when the economy experiences no (A) frictional unemployment (B) structural unemployment (C) seasonal unemployment (D) cyclical unemployment (E) unemployment (D) Frictional, structural, and seasonal unemployment are unavoidable. When a downturn in the business cycle causes workers to lose jobs (cyclical unemployment), the rate of unemployment increases and is higher than the natural rate (NRU). Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Natural Rate of Unemployment Book Section: Definition of Full Employment 8. If the consumer price index (CPI) for this year is 240 and the CPI for last year was 200, what is the rate of inflation for this year? (A) –40% (B) 1.2% (C) 20% (D) 40% (E) 83% (C) Inflation Rate = (This Year's CPI – Last Year's CPI) / Last Year's CPI = (240 – 200) / 200 = 40 / 200 = 0.20 x 100 = 20% Difficulty: Hard Style: Application AP Economics Curricular Requirement Macroeconomics: Price Indices Book Section: Measurement of Inflation 9. If a worker’s nominal income increases by 5% and the inflation rate increases by 3%, how did the worker’s real income change? (A) It fell by 8%. (B) It fell by 2%. (C) It rose by 2%. (D) It rose by 5%. (E) It rose by 8%. (C) The worker’s paycheck rose by 5%, but because prices increased by 3%, the real income—what can be bought with the paycheck—only rose 2% (%? in real wage = % ? in nominal wage minus the inflation rate). Difficulty: Medium Style: Application AP Economics Curricular Requirement Macroeconomics: Nominal and Real Values Book Section: Redistribution Effects of Inflation 10. Which of the following factors would cause demand-pull inflation? (A) Increase in the cost of raw materials for firms (B) Increase in the money supply (C) Significant decrease in the supply of oil (D) Serious crop failure (E) Reduction in imports allowed into the country (B) If too much money chases too few goods, the excess demand pulls prices up. The other four options cause cost-push inflation by reducing supply. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Demand-Pull versus Cost-Push Inflation Book Section: Types of Inflation 11. Which of the following groups of people is least likely to be hurt by unanticipated inflation? (A) Retirees living on a fixed pension (B) People who have borrowed money to buy cars (C) Savers earning income from interest on savings accounts (D) Workers earning the minimum wage (E) Creditors who provide loans to customers (B) Borrowers can actually gain from inflation, because the dollars they use to pay back the loan are not worth as much as the dollars they borrowed. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Costs of Inflation Book Section: Redistribution Effects of Inflation 12. If a bank charges customers a nominal interest rate of 12% for car loans and expects a 7% inflation rate over the life of the loan, what is the real interest rate? (A) –5% (B) 5% (C) 5.8% (D) 19% (E) 12% (B) Real Interest Rate = Nominal Interest Rate – Expected Inflation Rate (12% – 7% = 5%). Difficulty: Easy Style: Application AP Economics Curricular Requirement Macroeconomics: Real versus Nominal Interest Rates Book Section: Anticipated Inflation 13. When a nation’s economy is operating at its natural rate of unemployment (NRU) and is experiencing only frictional and structural unemployment, the economy is said to be (A) inside of its production possibilities curve because unemployment exists (B) in a recession with cyclical unemployment because unemployment exists (C) operating at full employment GDP (D) operating below its potential GDP because unemployment exists (E) facing a recessionary gap because actual GDP is less than potential GDP (C) When only structural and frictional unemployment exist, the economy is said to be at full employment GDP. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Natural Rate of Unemployment Book Section: Definition of Full Employment 14. If the CPI in the year 2010 is 200 and the CPI in year 2011 is 220, then the rate of inflation for the year 2011 was (A) .10% (B) 10% (C) .20% (D) 20% (E) 55% (B) The rate of inflation is equal to the percentage growth of the CPI from one year to the next. The 2011 inflation rate = ([2011 CPI – 2010 CPI] ÷ 2010 CPI) x 100. 2011 Rate of Inflation = [(220-200)/200] x 100 = 10%. Difficulty: Hard Style: Application AP Economics Curricular Requirement Macroeconomics: Inflation Measurement and Adjustment Book Section: Measurement of Inflation 15. Assuming that the base year for calculating the consumer price index (CPI) is set to the year 2000, the CPI for year 2011 would be (A) [(CPI for 2011) – (CPI for 2010)] x 100 (B) [(CPI for 2011) ÷ (CPI for 2010)] x 100 (C) [(price of market basket for 2011) – (price of market basket for 2010)] x 100 (D) [(price of market basket for 2011) – (price of market basket for 2010)] ÷ [(price of market basket for base year 2000)] x 100 (E) [(price of market basket for 2011) ÷ (estimated price of market basket for base year 2000)] x 100 (E) The CPI for a year equals the price of that year’s market basket divided by the price of the base year’s market basket; that is then multiplied by 100. Difficulty: Hard Style: Application AP Economics Curricular Requirement Macroeconomics: Price Indices Book Section: Measurement of Inflation 16. “Too much money chasing too few goods” describes (A) cost-push inflation (B) bottle-neck inflation (C) wage inflation (D) demand-pull inflation (E) supply-side inflation (D) “Too much money chasing too few goods” results in an excess of demand limited by insufficient output. When demand-pull inflation occurs, the excess demand causes prices increase. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Demand-Pull versus Cost-Push Inflation Book Section: Types of Inflation 17. The core inflation rate differs from the CPI in that the core inflation rate (A) includes volatile items such as food and energy that are at the heart of an economy, whereas the CPI excludes volatile items (B) includes only the prices of critical resources that are at the heart of an industrial economy, whereas the CPI includes the prices of a broad basket of goods (C) excludes volatile items such as food and energy which can rise and fall suddenly, whereas the CPI includes volatile items in calculating the broad basket of goods (D) excludes food prices which can rise and fall suddenly, whereas the CPI does not (E) excludes energy prices which can rise and fall suddenly, whereas the CPI does not (C) In evaluating inflationary trends, economists focus on the core inflation rate, which only includes price changes among the stable components of the CPI. It excludes those goods that tend towards rapid, temporary changes in price such as energy and food. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Inflation Measurement and Adjustment Book Section: Core Inflation 18. If a contract worker received an increase in nominal annual salary of 3% and the price level rose in that year by 2%, then that contract worker received a real annual salary (A) increase of 3% (B) increase of 5% (C) increase of less than 3% but greater than 2% (D) decrease of 1% (E) increase of 1% (E) The percentage change in real income (wage) equals the percentage change in nominal income (wage) minus the percentage change in price level. Difficulty: Medium Style: Application AP Economics Curricular Requirement Macroeconomics: Nominal and Real Values Book Section: Redistribution Effects of Inflation 19. Assume that Ashley holds a $1000 savings account that pays 6% annually. At the end of the first year, Ashley receives $60 in interest, but the inflation rate over the year is 13%. The nominal and real value of the savings account is (A) $1060 nominal and $1000 real (B) $ 1000 nominal and $1060 real (C) $1060 nominal and $938 real (D) $938 nominal and $1060 real (E) $1000 nominal and $938 real (C) The nominal value of the savings account at the end of the year is $1000 + $60 = $1060. The real value of the account is adjusted for changes in the price level [($1060 ÷ 1.13) = $938]. The net result is that the nominal balance of $1060 is reduced to a real balance of $938. Difficulty: Hard Style: Application AP Economics Curricular Requirement Macroeconomics: Nominal and Real Values Book Section: Who is Hurt by Inflation? 20. When the economy is operating at potential output, then the unemployment rate is (A) zero and the economy is operating at the natural rate of unemployment (NRU) (B) positive, it includes the frictional rate of unemployment, and the economy is operating at the natural rate of unemployment (NRU) (C) positive, it includes the frictional rate of unemployment, and the economy is operating above the natural rate of unemployment (NRU) (D) positive, it includes both frictional and structural unemployment, and the economy is operating above the natural rate of unemployment (NRU) (E) positive, it includes both frictional and structural unemployment, and the economy is operating at the natural rate of unemployment (NRU) (E) When the economy is at potential output, the economy is said to be at its full-employment rate of unemployment. At potential output, the unemployment rate is positive, it includes both frictional and structural unemployment, and the economy is operating at the natural rate of unemployment (NRU). Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Unemployment Book Section: Definition of Full Employment 21. Because of short-run price stickiness, the economy generally responds to negative demand shocks by increasing (A) output (B) wages (C) unemployment (D) prices (E) real GDP (C) Real GDP, employment, and output fall when aggregate demand decreases. While both wages and prices are downwardly sticky and may not decrease, they certainly will not increase when aggregate demand falls. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Business Cycle and Economic Fluctuations Book Section: Causation: A First Glance 22. Business cycles occur as a result of supply and demand shocks that are caused by I. irregular innovation II. changes in productivity III. political events IV. changes in the money supply (A) I and II only (B) II and III only (C) III and IV only (D) I, II, and IV only (E) I, II, III, and IV (E) New products and production methods, unexpected changes in labor productivity, wars and other political shocks, and changes in the money supply can all cause positive or negative shocks to the economy. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Business Cycle and Economic Fluctuations Book Section: Causation: A First Glance 23. The GDP gap is the difference between (A) actual GDP and potential GDP (B) nominal GDP and real GDP (C) inflation and unemployment (D) the actual unemployment rate and the natural rate of unemployment (E) actual GDP and nominal GDP (A) When the actual GDP is lower than potential GDP, output is less than potential, and the unemployment rate is higher than the natural rate of unemployment. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Actual versus Full-Employment Output Book Section: Economic Cost of Unemployment 24. Inflation is defined as an increase in (A) real GDP beyond potential GDP (B) the general level of prices (C) the value of the dollar (D) the purchasing power of money (E) nominal GDP (B) An increase in prices among a wide variety of products (though not necessarily all products) defines inflation. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Inflation Measurement and Adjustment Book Section: Meaning of Inflation 25. The significant decrease in the supply of oil during the 1973-1974 oil crisis caused (A) a positive supply shock (B) demand-pull inflation (C) a positive GDP gap (D) cost-push inflation (E) a decrease in per-unit production costs (D) When the cost of a resource increases, producers increase the prices they charge consumers for final products. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Business Cycle and Economic Fluctuations Book Section: Types of Inflation Free-Response Question A nation’s inflation rate increases by its expected average 2% per year. (a) Explain the effect of this inflation on the real income of a worker whose nominal income rises 2% per year. (b) Now assume that this year, the inflation rate unexpectedly jumped to 10%. Explain the effect of this increase in inflation on each of the following. (i) A worker whose nominal income rose 2% this year (ii) A retiree living on a fixed pension (iii) A senior citizen living on Social Security which is indexed with a COLA (iv) A homeowner paying a 30-year home mortgage with a fixed interest rate Free-Response Explanation 10 points (2 + 8) (a) 2 points: 1 point is earned for stating that the worker's real income would not change. 1 point is earned for explaining that the wage increase equals the inflation rate, so the worker can buy the same amount of goods with the new paycheck. (b) 8 points: 1 point is earned for stating that the worker's real income would fall 8%. 1 point is earned for explaining that the change in real wage equals the change in nominal wage minus the change in the inflation rate (2% – 10% = –8%). 1 point is earned for stating that the retiree's real income would fall. 1 point is earned for explaining that prices increased but the retiree's income did not. 1 point is earned for stating that the senior citizen's real income did not change. 1 point is earned for explaining that the COLA (cost of living adjustment) is designed to change the nominal income at the same rate as inflation, to keep real income the same. 1 point is earned for stating that the homeowner gains from inflation. 1 point is earned for explaining that the money repaid is not worth as much as the money that was borrowed. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Inflation Measurement and Adjustment Book Section: Redistribution Effects of Inflation