AP Macro Aggregate Models 3 — Questions and Answers
Question 1: If the MPC is 0.75, what is the value of the simple spending multiplier?
- 1.33
- 2.5
- 4 (Correct answer)
- 0.25
Correct answer: 4
The multiplier = 1/(1-MPC) = 1/(1-0.75) = 1/0.25 = 4.
Question 2: In the AD-AS model, which of the following best explains why the AD curve slopes downward?
- Firms produce less when prices rise because wages fall
- Higher price levels reduce real wealth, raise interest rates, and make exports less competitive (Correct answer)
- Lower prices shift the SRAS curve rightward, increasing output
- Higher prices increase consumer confidence, reducing saving
Correct answer: Higher price levels reduce real wealth, raise interest rates, and make exports less competitive
The downward slope of AD reflects the wealth effect, interest rate effect, and net export effect — all of which reduce spending when the price level rises.
Question 3: The 'crowding out' effect of expansionary fiscal policy refers to:
- Government spending replacing private consumption directly
- Higher interest rates caused by government borrowing reducing private investment (Correct answer)
- Tax cuts reducing government revenue and increasing the deficit
- Imports rising when domestic income increases from stimulus spending
Correct answer: Higher interest rates caused by government borrowing reducing private investment
When government borrows to finance spending it competes for loanable funds, driving up interest rates and reducing private sector investment.
Question 4: According to the Classical model, if wages and prices are perfectly flexible, a recessionary gap will:
- Persist indefinitely without government intervention
- Automatically self-correct as falling wages shift SRAS rightward (Correct answer)
- Require expansionary monetary policy to resolve
- Worsen over time due to declining consumer confidence
Correct answer: Automatically self-correct as falling wages shift SRAS rightward
Classical economists believe that wage and price flexibility will automatically restore full employment as lower wages reduce costs and shift SRAS right.
Question 5: Which of the following correctly describes the difference between the short-run and long-run aggregate supply curves?
- SRAS is horizontal; LRAS is upward sloping
- SRAS is upward sloping because input prices are sticky; LRAS is vertical at potential GDP (Correct answer)
- Both SRAS and LRAS are vertical but at different output levels
- SRAS is vertical; LRAS is downward sloping due to competition
Correct answer: SRAS is upward sloping because input prices are sticky; LRAS is vertical at potential GDP
SRAS slopes upward because wages and input prices are sticky in the short run, while LRAS is vertical because all prices adjust fully in the long run.
Question 6: An economy experiences a simultaneous decrease in AD and SRAS. What is the certain outcome?
- Real GDP falls and the price level is indeterminate (Correct answer)
- The price level rises and real GDP is indeterminate
- Real GDP rises and the price level falls
- Both real GDP and the price level fall with certainty
Correct answer: Real GDP falls and the price level is indeterminate
Both shifts reduce real GDP, so output certainly falls; but AD falling lowers prices while SRAS falling raises them, leaving the net price level effect ambiguous.
Question 7: In the Keynesian model, autonomous consumption refers to:
- Spending that rises proportionally with income
- Spending that occurs even when disposable income is zero (Correct answer)
- Government transfer payments that automatically increase in recessions
- Investment that does not depend on the interest rate
Correct answer: Spending that occurs even when disposable income is zero
Autonomous consumption is the baseline level of consumption that exists regardless of income, often financed by dissaving or borrowing.
AP Macro Aggregate Models 3
If the MPC is 0.75, what is the value of the simple spending multiplier?