FILL-IN QUESTIONS
1. Macroeconomics studies the business cycle or (short-run, long-run) _______________ fluctuations
in output and employment and _______________ economic growth that leads to higher standards
of living over time.
2. To tell if an economy is growing from one year to the next year, economists compare (nominal,
real)____________ GDP from one year to the next because it shows if there is a change in output
rather than prices.
3. An increase in the overall level of prices is called (sticky prices, inflation) _______________. The
condition where a person is willing to work but cannot get a job is (recession, unemployment)
_______________.
4. The basic difference between modern economic growth and economic growth in ancient or
preindustrial times is that with modern economic growth output per person (increases, stays about
the same) _______________ whereas with growth in ancient or preindustrial times, output per
person.
5. Richer nations have experienced modern economic growth for (shorter, longer) _______________
time periods than have poorer nations and as a consequence their standards of living are
significantly (lower, higher)_____________.
6. When current consumption is less than current output, it creates (investment, saving)
_______________, and when economic resources are devoted to increasing future output, such
activity is considered to be ____________.
7. The purchase of newly created capital goods for the purpose of expanding or growing a business
would be considered by economists to be an example of (financial, economic) _______________
investment whereas the purchase of an asset such as a share of stock in a corporation in the
expectation that its price would appreciate would be an example of _______________
investment.
8. The amount of economic investment is ultimately limited by the amount of (saving, inventory)
_______________, and for there to be more investment then _______________ must increase.
Such an increase, however, means that there will be a(n) (increase, decrease) _______________ in
current consumption.
9. The principal source of savings is (businesses, households) ______________ and the main
economic investors are ______________. The transfer of savings to investors is done primarily
through (government, banks) ___________ and other financial institutions.
10. Expectations are important in macroeconomics because people will save and invest more if they
hold (positive, negative) _______________ expectations about the future, but they will save and
invest less if they hold _______________ expectations about the future.
11. Uncertainty about the future means that expectations may not be met, which creates a(n)
(investment, shock) _______________, and there can be a demand _______________ or a supply
_______________.
12. A situation where demand turns out to be higher than expected would be a (positive, negative)
_______________ demand shock, but a situation in which demand turns out to be lower than
expected would be a _______________ demand shock.
13. Many economists think that most short-run fluctuations are the result of (supply, demand)
_______________ shocks, although it is also possible for there to be _______________ shocks; but
the textbook will focus primarily on _______________ shocks.
14. In the short run, real world prices are often (flexible, inflexible) _______________, but in the long
run, prices are more _______________. When prices are inflexible, they are referred to as being
(“sticky,” “stuck”) ____________.
15. In the short run, the only way for the economy to adjust to demand shocks when prices are
inflexible or sticky is through changes in (prices, output) _______________ and employment, but in
the long run, the adjustments are made through changes in _______________.
16. A store of output that has been produced but not sold is a(n) (financial investment, inventory)
______________, and they help businesses adjust to short-run changes in demand.
17. If demand for a product increases, then business firms can respond by (increasing, decreasing)
_______________ their inventories of the product, and if the demand for the product decreases,
then business firms can respond by _______________ their inventories of the product.
18. If prices are fixed and there is a negative demand shock, it will cause sales to (increase, decrease)
______________ and inventories to _______________, and if they become too high, then firms
will have to ______________ output and ______________ employment.
19. One reason that prices are sticky is that consumers prefer (stable, fluctuating) _______________
prices, and businesses do not want to annoy consumers. Another reason is that cutting prices may
result in a price (shock, war) _______________ with competing firms that will be
counterproductive for business.
20. In short-run macroeconomic models, prices tend to be (inflexible, flexible) _______________ and
output and employment change with changes in demand, but in macroeconomic models with a
longer time horizon, prices tend to be _______________ and output and employment remain
relatively constant.
TRUE–FALSE QUESTIONS
1. Macroeconomics studies long-run economic growth and short-run economic fluctuations. T F
2. Real GDP totals the dollar value of all goods and services within the borders of a given country
using their current prices during the year they were produced. T F
3. Unemployment is a waste of resources because the economy gives up the goods and services that
unemployed workers could have produced if they had been working. T F
4. If a household’s income does not rise as fast as the prices of goods and services that it consumes,
its standard of living will rise. T F
5. An example of a macroeconomic policy question would be “Can governments promote long-run
economic growth?” T F
6. Modern economic growth means that output rises at about the same rate as the population. T F
7. The vast differences in living standards between rich and poor nations today are largely the result
of only some nations having experienced modern economic growth. T F
8. To raise living standards over time, an economy must devote at least some fraction of its current
output to increasing future output. T F
9. An example of economic investment, as economists use the term, would be the purchase of a
corporate stock or bond. T F
10. The only way that an economy can pay for more investment to achieve higher consumption in the
future is to increase saving in the present. T F
11. Banks and other financial institutions collect the savings of households after paying interest,
dividends, or capital gains and then lend those funds to businesses. T F
12. Expectations about the future are important because if people expect a good future, households
will increase their savings and businesses will reduce their investments. T F
13. Economies are exposed to both demand shock and supply shocks. T F
14. A positive demand shock refers to a situation where demand turns out to be lower than expected.
T F
15. Economists believe that most short-run fluctuations in the economy are the result of demand
shocks. T F
16. In the short run, the prices of most goods and services change very quickly. T F
17. Fluctuations in the business cycle arise because the actual demand for goods and services is either
higher or lower than what people expected. T F
18. If prices are flexible for an economy, an increase in demand will result in a significant change in
output and employment. T F
19. An inventory is a store of output that has been produced and sold. T F
20. Given fixed prices, a negative demand shock for businesses will reduce sales, increase inventories,
and eventually reduce output and employment. T F
21. The prices for most goods and services that people consume are sticky in the short run. T F
22. One reason that prices are sticky is that business firms try to please consumers by giving them
predictable and stable prices for planning. T F
23. Another reason prices are sticky is that business firms want to engage in a price war with rival firms
to gain market share. T F
24. Only in the short run are prices totally inflexible. T F
25. A macroeconomic model that allows for flexible prices would be more useful for understanding
how the economy behaves over time. T F
PROBLEMS
1. Assume that in Year 1 an economy produces 100 units of output that sell for $50 a unit, on average.
In Year 2, the economy produces the same 100 units of output, but sells them for $55 a unit, on
average.
a. What is nominal GDP in Year 1? ________. What is nominal GDP in Year 2? ________. Nominal
GDP increased from Year 1 to Year 2 because (prices, out-put) ________ increased.
b. Use Year 1 prices to calculate real GDP in Year 1 and Year 2. What is real GDP in Year 1?
________. What is real GDP in Year 2? ________. Real GDP did not increase from Year 1 to Year
2 because (prices, output) ________ did not change.
2. The following is a demand and supply model for a business firm producing a product. Assume that
100 units of output is the optimal and most profitable level of production for the firm. Assume that
the price for the product is flexible.
a. At the medium level of demand ( D M ), the equilibrium price will be $________ and the
equilibrium quantity will be ________ units.
b. If there is a demand shock that unexpectedly lifts demand higher ( D H ), the equilibrium price
will be $________ and the equilibrium quantity will be ________ units.
c. If there is a demand shock that unexpectedly lowers demand ( D L ), the equilibrium price will
be $________ and the equilibrium quantity will be ________ units.
d. Generalizing for the individual firm, if there are demand shocks, they get accommodated by a
change in (price, output) ________, but not a change in ________.
e. And applying this logic to the economy as a whole, if prices are flexible in the economy and
there are demand shocks, the economy would adjust through a change in (price, output)
________, but not a change in ________.
3. The following is a different demand and supply model for the same business firm producing a
product as in problem 2. Assume that 100 units of output is the optimal and most profitable level of
production for the firm. Now assume that the price for the product is inflexible.
a. At the medium level of demand ( D M ), the equilibrium price will be $________ and the
equilibrium quantity will be ________ units.
b. If there is a demand shock that unexpectedly lifts demand higher ( D H ), the equilibrium price
will be $________ and the equilibrium quantity will be ________ units.
c. If there is a demand shock that unexpectedly lowers demand ( D L ), the equilibrium price will
be $________ and the equilibrium quantity will be ________ units.
d. Generalizing for the individual firm, if there are demand shocks, they get accommodated by a
change in (price, output) ________, but not a change in ________.
e. And applying this logic to the economy as a whole, if prices are inflexible in the economy and
there are demand shocks, the economy would adjust through a change in (price, output)
________, but not a change in ________.
SHORT ANSWER AND ESSAY QUESTIONS
1. Explain how business cycles can be thought of as short-term fluctuations or variability in the rate of
economic growth.
2. Describe the basic difference between real GDP and nominal GDP. Which concept is more useful
for measuring change in the economy over time? Why?
3. What is the opportunity cost of unemployment for the economy?
4. How does inflation affect people’s standard of living and saving?
5. What types of policy questions can macroeconomic models help answer? Give two examples.
6. Compare and contrast the characteristics of economic growth in ancient or preindustrial times with
modern economic growth today.
7. What accounts for differences in living standards between rich and poor countries today?
8. Describe differences in purchasing power parity of rich nations and poor nations.
9. Explain the relationship between saving, investment, and present and future consumption.
10. Provide a definition and an example of economic investment and of financial investment.
11. Discuss the role that banks and other financial institutions play in collecting savings and allocating
investment in an economy.
12. Explain the ways in which uncertainty and expectations influence economic behavior in
macroeconomics.
13. How are shocks related to expectations? Give an example of a positive and a negative demand
shock.
14. Discuss the relationship between demand shocks and business cycle fluctuations.
15. How does an economy adjust to a demand shock when prices are flexible?
16. How does an economy adjust to a demand shock when prices are sticky?
17. Explain what happens to inventories when prices are sticky and there is a demand shock.
18. Describe and give examples of the stickiness of prices based on the average number of months
between price changes for selected goods and services.
19. Describe two reasons why businesses hesitate to change prices.
20. How can price stickiness be used to categorize macroeconomic models?