Macroeconomics Questions and Answers

Answer: C

The optimum capital stock is reached when the user cost of capital equals the marginal product of capital. Firms keep adding capital until the extra output of one more unit just matches the cost of using it, which is the interest and depreciation cost per unit.

The interest rate and the depreciation rate are only components of the user cost, not the whole of it. Tobin's Q is a ratio of market value to replacement cost, which guides investment, but it is not the quantity the user cost is equated to.

Answer: C

When the economy is already at potential GDP, an increase in the money supply raises aggregate demand but cannot raise output, so the extra demand pulls up prices. That is demand-side (demand-pull) inflation.

Stagflation needs falling output together with rising prices, which does not follow from a monetary expansion. Structural inflation arises from rigidities in the supply structure, and supply-side inflation from rising costs, neither of which is the effect of more money chasing the same goods.

Answer: B

For the orthodox (early) Keynesians, statements 1, 3 and 4 hold. They believed that the interest elasticity of money demand is very high (the liquidity trap region), that changes in the money supply therefore have no important predictable effect on activity, and that the demand for money is unstable.

Statement 2, that the interest elasticity is low, is the monetarist view and not the Keynesian one. The codes containing 2 are therefore not correct.

Answer: A

The first statement is false. The IS curve is flatter when the Keynesian multiplier is larger and when investment is more responsive to the interest rate, not when the multiplier is lower and investment is less responsive.

The second statement states it correctly, that the IS curve is steeper with a lower multiplier and a lower interest responsiveness. The statements about the LM curve are also correct standard results, so the one that reverses the IS relationship is the false statement.

Answer: A

Statements 1 and 2 are true. Government spending acts directly on aggregate spending, so it works faster than a rise in the money supply, which has to work through interest rates first. When aggregate supply is vertical, an increase in demand only raises prices and leaves real output unchanged.

Statement 3 is wrong because crowding out is not always one for one, and statement 4 reverses the speed comparison. So only the code with 1 and 2 is right.

Answer: C

Full employment does not mean zero unemployment: it is the level at which there is no involuntary unemployment, but frictional and structural unemployment, which come from the movement of workers between jobs and from changes in the structure of the economy, still exist. So full employment is consistent with frictional and structural unemployment, 3 and 4, option (C). Involuntary unemployment (1) is excluded by definition, and disguised unemployment (2) is a sign of underemployment in a poor economy and not of full employment.

Answer: B

In C = α0 + by the marginal propensity to consume b is a constant, so it does not depend on the level of income. The statement that MPC is dependent on income is therefore false, which is option (B). APC = α0/y + b falls as income rises, as the first term shrinks, and it is always above b when α0 is positive, so APC \(\gt\) MPC is true. So (A), (C) and (D) are true and (B) is the false one.

Answer: A

Both the assertion and the reason are correct and the reason explains it. In a liquidity trap the interest rate is so low that everyone expects it to rise, and so everyone expects bond prices to fall; people therefore hold money and the demand for money is perfectly interest elastic. The reason, that investors expect the rate to rise towards the natural rate, is the cause of this elasticity. So (A) is the answer, and the options that call either statement wrong are mistaken. The demand curve for money in a liquidity trap is horizontal, so any quantity of money can be absorbed without a fall in the rate of interest.

Answer: A

The rate of net investment spending per period depends on the steepness of the downward slope of the marginal efficiency of investment schedule. It shows how much investment is undertaken at each rate of interest, so a steeper schedule means that a fall in the rate of interest raises investment less. The marginal efficiency of capital schedule is related but is a stock concept, and the LM and IS schedules relate to money and goods markets. So (A) is the answer. This slope is important for policy, since it decides how much investment responds to monetary policy.

Answer: A

The official key gives N. Kaldor as the economist whose model uses the stock adjustment principle to explain business cycles, with the capital stock adjusting slowly in response to the level of income and so producing the turning points. Hicks and Samuelson are associated with the multiplier-accelerator models and Keynes with the multiplier and the marginal efficiency of capital. The answer is (A). The key follows the version of the model in which the stock of capital is the variable that adjusts slowly.