Tackle the Test: Free-Response Questions

1. Question

   
   

   1. According to monetarism, business cycles are associated with fluctuations in what?

      
      
   
   

   2. Does monetarism advocate discretionary fiscal policy? Discretionary monetary policy?

      
      
   
   

   3. What monetary policy does monetarism suggest?

      
      
   
   

   4. What is the velocity equation? Indicate what each letter in the equation stands for.

      
      
   
   

   5. Use the velocity equation to explain the major conclusion of monetarism.

      
      
   
   

   Rubric for FRQ 1 (10 points)

   1 point: The money supply

   1 point: No

   1 point: No

   1 point: A monetary policy rule

   1 point: M × V = P × Y

   1 point: M is the money supply.

   1 point: V is the velocity of money.

   1 point: P is the aggregate price level.

   1 point: Y is real GDP.

   1 point: Since V is stable, a steady growth of M will lead to a steady growth in GDP.

2. Question

   For each of the following economic theories, identify its fundamental conclusion.

   
   

   
   

   1. the classical model of the price level

      
      
   
   

   2. Keynesian economics

      
      
   
   

   3. monetarism

      
      
   
   

   4. the natural rate hypothesis

      
      
   
   

   5. rational expectations

      
      
   
   

   6. real business cycle theory (6 points)

      
      
   
   

   Rubric for FRQ 2 (6 points)

   1 point: The aggregate supply curve is vertical, so changes in the money supply affect only the aggregate price level.

   1 point: Changes in aggregate demand will affect aggregate output.

   1 point: Business cycles are associated with fluctuations in the money supply.

   1 point: To avoid inflation, the unemployment rate must be set so that actual inflation equals expected inflation.

   1 point: Individuals and firms make optimal decisions using all available information.

   1 point: Fluctuations in total factor productivity growth cause business cycles.