MEcon Master of Economics Master of Economics: Introduction to Macroeconomics 3 — Questions and Answers
Question 1: According to Ricardian equivalence, a tax cut financed by government borrowing will:
- Stimulate consumption because households feel wealthier
- Have no net effect on consumption because households save the tax cut to pay future taxes (Correct answer)
- Reduce consumption by raising interest rates
- Permanently raise GDP through the multiplier effect
Correct answer: Have no net effect on consumption because households save the tax cut to pay future taxes
Rational forward-looking households anticipate higher future taxes and save the entire tax cut, leaving consumption unchanged.
Question 2: The Taylor Rule provides a benchmark for setting the federal funds rate based on:
- The money supply growth rate and the unemployment gap only
- Deviations of inflation from its target and output from potential (Correct answer)
- The exchange rate and the current account balance
- The debt-to-GDP ratio and the fiscal deficit
Correct answer: Deviations of inflation from its target and output from potential
The Taylor Rule specifies the policy rate as a function of the inflation gap and the output (GDP) gap.
Question 3: In a model with rational expectations, anticipated monetary policy expansions tend to:
- Raise real output permanently
- Have no effect on real output but raise the price level (Correct answer)
- Reduce inflation below target
- Lower nominal wages by reducing money demand
Correct answer: Have no effect on real output but raise the price level
Under rational expectations, agents adjust prices and wages immediately, so anticipated money growth only raises the price level without boosting real activity.
Question 4: The 'sacrifice ratio' in macroeconomics measures:
- The reduction in real output required to lower inflation by one percentage point (Correct answer)
- The cost of fiscal consolidation expressed as a share of government revenue
- The trade-off between unemployment and wage growth in union bargaining
- The long-run cost of capital in terms of foregone consumption
Correct answer: The reduction in real output required to lower inflation by one percentage point
The sacrifice ratio is the cumulative output loss (as % of GDP) needed to permanently reduce inflation by one percentage point.
Question 5: Which economic concept explains why a country can specialize in and export a good even if another country can produce it more efficiently in absolute terms?
- Absolute advantage
- Comparative advantage (Correct answer)
- The Heckscher-Ohlin theorem
- The Leontief paradox
Correct answer: Comparative advantage
Comparative advantage shows that trade is beneficial as long as opportunity costs differ, regardless of absolute productivities.
Question 6: In the aggregate demand–aggregate supply (AD-AS) framework, stagflation is best represented as:
- A rightward shift of the AD curve combined with a leftward SRAS shift
- A leftward shift of both the AD and SRAS curves simultaneously
- A leftward shift of the SRAS curve with unchanged AD (Correct answer)
- A rightward shift of the LRAS curve with falling prices
Correct answer: A leftward shift of the SRAS curve with unchanged AD
A negative supply shock shifts SRAS left, raising the price level while reducing output — the definition of stagflation.
Question 7: The natural rate of unemployment is best described as:
- The unemployment rate that exists when cyclical unemployment is zero (Correct answer)
- The minimum unemployment consistent with zero inflation
- The average unemployment rate over the past business cycle
- The unemployment rate targeted by Congressional mandate
Correct answer: The unemployment rate that exists when cyclical unemployment is zero
The natural rate equals frictional plus structural unemployment, occurring when the economy is at full employment and cyclical unemployment is absent.
MEcon Master of Economics Master of Economics: Introduction to Macroeconomics 3
According to Ricardian equivalence, a tax cut financed by government borrowing will: