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.
