AA Economics Theories 2 — Questions and Answers
Question 1: According to Keynesian economics, what is the primary cause of recessions?
- Excessive money supply growth
- Insufficient aggregate demand (Correct answer)
- Overproduction by firms
- High interest rates set by central banks
Correct answer: Insufficient aggregate demand
Keynes argued that recessions result from a shortfall in total spending (aggregate demand) in the economy.
Question 2: The Laffer Curve illustrates the relationship between tax rates and:
- Government spending efficiency
- Tax revenue collected (Correct answer)
- Income inequality
- Inflation levels
Correct answer: Tax revenue collected
The Laffer Curve shows that both very low and very high tax rates generate less revenue, with a peak somewhere in between.
Question 3: Which theory argues that wages are 'sticky downward,' making unemployment worse during downturns?
- Classical economics
- Keynesian economics (Correct answer)
- Monetarism
- Supply-side economics
Correct answer: Keynesian economics
Keynesian theory holds that nominal wages resist falling, so firms cut jobs instead of wages during recessions.
Question 4: In public choice theory, the term 'rent-seeking' refers to:
- Landlords raising rents above market value
- Firms lobbying government for favorable regulations (Correct answer)
- Central banks earning interest on reserves
- Consumers seeking the cheapest housing
Correct answer: Firms lobbying government for favorable regulations
Rent-seeking describes using political influence to gain economic advantages rather than creating new wealth.
Question 5: The permanent income hypothesis, developed by Milton Friedman, predicts that consumers base spending on:
- Their current paycheck only
- Expected long-run average income (Correct answer)
- Government transfer payments
- The interest rate on savings accounts
Correct answer: Expected long-run average income
Friedman argued people smooth consumption over time based on expected lifetime income, not just today's income.
Question 6: Which economic school of thought holds that only unexpected changes in the money supply affect real output?
- Keynesian economics
- New Classical economics (Correct answer)
- Post-Keynesian economics
- Institutional economics
Correct answer: New Classical economics
New Classical economists, building on rational expectations, argue that anticipated policy changes are neutralized by private agents.
Question 7: The Coase Theorem suggests that externalities can be resolved efficiently without government intervention when:
- Markets are perfectly competitive
- Property rights are well-defined and transaction costs are low (Correct answer)
- Firms internalize all social costs voluntarily
- The externality affects only two parties
Correct answer: Property rights are well-defined and transaction costs are low
Ronald Coase showed that if parties can bargain freely, they will reach the efficient outcome regardless of who holds the property right.
AA Economics Theories 2
According to Keynesian economics, what is the primary cause of recessions?