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Exam 16: Expectations Theory and the Economy

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Question 71

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One of the arguments supporting new classical theory is the policy ineffectiveness proposition (PIP).

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Question 72

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An unanticipated decrease in aggregate demand will cause an upward shift in the short-run Phillips curve.

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Exhibit 16-2 -Refer to Exhibit 16-2. Suppose the economy starts out at point A. Next, the public anticipates that the Fed will use expansionary monetary policy to shift the AD curve from AD₁ to AD₂. What happens, instead, is that the Fed does not raise aggregate demand as much as the public expects (bias upward) . Instead the Fed pushes the AD curve from AD₁ to AD₃. As a result, according to new classical theory in the short run the economy moves to point

Events of the 1970s and early 1980s showed that

According to new classical economists, if a decrease in aggregate demand is correctly anticipated, the short-run aggregate supply curve will shift __________ at the same time the AD curve shifts _________ so that there will be no change in Real GDP.

Exhibit 16-2 -Refer to Exhibit 16-2. Suppose the economy starts at point A. The AD curve shifts from AD₁ to AD₂ and the public perfectly anticipates this. Under new Keynesian macroeconomic assumptions, the most likely short-run equilibrium point will be

According to the original Phillips curve, the cost of reducing the unemployment rate in the short run is a

The economy is in long-run equilibrium when there is an incorrectly anticipated increase in aggregate demand brought about by expansionary monetary policy. Specifically, aggregate demand increases by more than people anticipate (bias downward) . According to new classical theory, the price level will __________ and Real GDP will __________ in the short run. In the long run, the price level will be __________ than it was before aggregate demand increased.

Wages and prices are assumed to be completely inflexible in the new classical theory.

If expectations are formed rationally, wages and prices are completely flexible in both the short run and the long run, and policy is correctly anticipated, increases in aggregate demand will stimulate the economy to higher levels of Real GDP in

Two key assumptions of new Keynesian theory include:

The economy was in long-run equilibrium when aggregate demand increased. At this point in time, the expected inflation has started to adjust to the new higher actual inflation rate. According to the (Friedman) natural rate theory, this means the unemployment rate in the economy must currently be

As the price level rises, real wage ____________and people choose to work ___________.

In real business cycle theory, business cycle expansions begin as a result of changes in

Samuelson and Solow, in their 1960 study of the Phillips curve as it applies to the U.S. experience, argued that there was a tradeoff between inflation and unemployment. Later experience showed their analysis to be

Stagflation consists of

The Samuelson-Solow version of the Phillips curve showed the relationship between unemployment rates and

Suppose that in a new classical model the public anticipates that policymakers will increase aggregate demand. However, aggregate demand increases by less than what the public anticipated. The result in the short run is that Real GDP ____________ and the price level ____________.

Exhibit 16-3 -Refer to Exhibit 16-3. The economy is at point A. As the result of an unexpected increase in aggregate demand, in the short run, the Friedman natural rate theory would predict

Exhibit 16-8 -Refer to Exhibit 16-8. Assume that the starting point is point 1. Suppose that the Fed implements expansionary monetary policy that raises aggregate demand. Which of the following best goes with the diagram shown?