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Remember, the next test will be over AD/AS [about half] and AE and Fiscal Policy. Make sure you know these 28 questions on AE and Fiscal Policy.

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Presentation on theme: "Remember, the next test will be over AD/AS [about half] and AE and Fiscal Policy. Make sure you know these 28 questions on AE and Fiscal Policy."— Presentation transcript:

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2 Remember, the next test will be over AD/AS [about half] and AE and Fiscal Policy. Make sure you know these 28 questions on AE and Fiscal Policy.

3 Expansionary fiscal policy 1. Expansionary fiscal policy will be most effective is [increase GDP] when the AS curve is (vertical/horizontal) & (incr/decr) “C” and (incr/decr) unemployment. paradox of thrift 2. The paradox of thrift indicates that an increase in saving (matched/unmatched) by an increase in investment will lower equilibrium GDP.

4 contractionary fiscal policydecr G, incr T 3. A contractionary fiscal policy [decr G, incr T] would cause a[an] (incr/decr) in output[GDP] and a[an] (incr/decr) in interest rates. expansionary fiscal policyincr G, decr T 4. An expansionary fiscal policy [incr G, decr T] would cause a[an] (incr/decr) in output[GDP] and a[an] (incr/decr) in interest rates. AE[AD]doesn’t buy up FE output(GDP) 5. In the AE model, if AE[AD]doesn’t buy up FE output(GDP), then the equilibrium output is (less than/more then) full employment output. [G ; LFM ; In. Rates ] [#3 & #4, start from a balanced budget] “Recessionary Gap” “Inflationary Gap” G $2 Trillion T $2 Trillion [T ; LFM ; In. Rates ]

5 decrease AD the greatest amount 6. To decrease AD the greatest amount, the government should: (decrease “G” only/increase “T” only/both decr G & incr T) 7. To increase AD the greatest amount, the “G” should: (increase “G” only/ decrease “T” only/both incr G and decr T) current output at $ With a MPC of.5 and current output at $500 billion, but F.E. output is $700 billion, correct fiscal policy would be to (increase G/Decrease T) by $100 billion. unplanned increase in 9. If businesses are experiencing an unplanned increase in inventoriesFE output and inventories, AE is (less than/greater than) FE output and spending in the economy spending in the economy will (increase/decrease). unplanned decrease in 10. If businesses are experiencing an unplanned decrease in inventoriesdisinvestment inventories [disinvestment]AE is (less than/greater than) FE output & spending in the economy FE output & spending in the economy will (increase/decrease).

6 “C” equals income at $500 billionMPC is If “C” equals income at $500 billion, & MPC is.9, then an increase in Ig of $10 billion will change equilibrium GDP to ($400/$490/$510/$600) billion. conservative economist 12. A conservative economist would want tax (incr/decr) during recessioninflationary times a recession & (incr/decr) in “G” during inflationary times. liberal economist 13. A liberal economist would want tax (incr/decr) during an inflationrecessionary periods inflation & (incr/decr) in “G” during recessionary periods. 14. An inflationary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP. recessionary gap 15. A recessionary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP. increase GDP [but reduce military spending] 16. To increase GDP [but reduce military spending], we would combine two (domestic/overseas) bases into one (domestic/overseas) base. tax cut to expand the economy 17. A tax cut to expand the economy would (incr/decr) Y & (incr/decr) in. rates. tax increase to contract the economy 18. A tax increase to contract the economy would (incr/decr) Y & (incr/decr) IR

7 increase equilibrium GDP by $400, To increase equilibrium GDP by $400,000, with a MPC of.5, a Keynesian economist would ( decrease “T” /increase “G” ) by $ 200,000. quilibrium GDP is $500 billion 20. E quilibrium GDP is $500 billion and MPS is.4. Now “G” collects taxes of $22 billion and spends the entire amount. As a result, equilibrium GDP will change to: ($445/$478/$522/$555). MPC of.5$12 billion 21. With a MPC of.5, a $12 billion increase increase “C” in “G” will increase “C” by ($12/$24/$36) bil. MPC of With a MPC of.5 and the economy in a recessionary spending gap of $12 billion recessionary spending gap of $12 billion, we may conclude that the equilibrium is short of FE GDP ($12/$24/$36) billion short of FE GDP.

8 increase in Ig of $25 billion 23. An increase in Ig of $25 billion resulted in an increase in equilibrium income (GDP) of $50B, so the MPS was? contractionary fiscal policy 24. A contractionary fiscal policy results in a(n) (incr/decr) in output, and a(n) (incr/decr) in interest rates. Increasing T or decreasing G 25. Increasing T or decreasing G will (increase/decrease) consumption, and (increase/decrease) unemployment..5 Gap$50 billionGinflationaryGDP reducing government spending 26. With a MPC of.5, and the economy with an inflationary GDP Gap of $50 billion, G could eliminate this inflationary GDP by reducing government spending by? [Incr T or Decr G] $25 billion

9 increase in Ig 27. An increase in Ig in an economy (increase)/decrease) GDP & (increase/decrease) C. equal increase in G and T of $25 bil 28. If there is an equal increase in G and T of $25 billion in the horizontal range of AS, then output will (increase/decrease/stay the same). PL RGDP AD 1 AD 2

10 250 1,200 GDP [bil] 1.From the above graph, moving from equilibrium “E” to “F”, what can we conclude about the following: A. How much is G? B. The increase in Y? C. The M E [Chg in Y/Chg in Expenditures = M E ]? [Public Sector] [No Public Sector]

11 ADASREP 2. Know what these do to the AD [ C+Ig+G+Xn ] or AS [ REP ] curves. A. Trade partners incomes increase? ___ decrease?___ B. Availability of land, labor, & capital increase?__ decrease?__ C. Productivity increases? ___ D. Resource[input] cost increases? ___ decreases? ___ E. Government spending increases? ___ decreases? ___ F. Stock Market drastically increases? ___ decreases? ___ E. A strong dollar’s impact on net exports. ___ F. A strong dollar’s impact on resource cost. ___

12 3. Know the above on a graph like this: K recessionaryinflationary output gap A. At “ K ”, we have a [recessionary/inflationary] output gap ? J recessionaryinflationary output gap B. At “ J ”, we have a [recessionary/inflationary] output gap ? r ecessionary SPENDING gap C. The r ecessionary SPENDING gap is [KH/E I/JG ] inflationary SPENDING gap D. The inflationary SPENDING gap is [KH/ED/E I ] fiscal policy C+Ig1 C. Correct fiscal policy if we are at “C+Ig1” if “0B” is FE Y would be to [increase/decrease] G and [increase/decrease] T.

13 4. Which of the following would be the A. Classical AS curve B. Keynesian AS curve C. Supply-side AS curve increase in AD 5. If there is an increase in AD in each one of these, what happens to PL, Output & Employment? AS (a.) (b.) (c.) PL -; Y/Empl. – PL – ; Y/Empl. - PL – ; Y/Empl. – PL RGDP Y* (a.) (b.) (c.) AD 1 AD 2 AD 1 AD 2 AD1 AD2 PL

14 6. Paradox of Thrift applies in the Keynesian range or Classical range? “sticky” 7. Ratchet effect – are prices and wages “sticky” up or down? 8. Crowding out - An increase in government spending causes the interest rate to (increase/decrease) &, Ig to (increase/decrease)? recessionary spending gap of 9. If MPS is.50 and we have a recessionary spending gap of $10 FE GDP $10 billion, how short are we of FE GDP? 10. What is a political business cycle? 11. What triggers the wealth effect, interest rate effect, and the foreign purchase effect? 12. Know how to figure productivity and per unit production cost. 13. Know the difference between a A. “Change in AQD or AQS” B. “Change in AD or AS”

15 14. If income increases from $500 B to $600 B, and Ig of $25 B caused the $100 B increase in Y, then the M E and MPS were? 15. The MPS is.50, and “C” = “Y” at $600 billion. Now Ig is increased by $50 billion, therefore the new equilibrium Y is? $700 $600 Consumption $600 B AE[C+Ig] RGDP [billions] $50 B 16. Now G increases G&T by 50 bil., then the new equilibrium Y would be?

16 “OT” consumption 1. At income level “OT”, the volume of consumption is _____. “OT” saving 2. At income level “OT”, the volume of saving is _____ “APC”“1” 3. The “APC” is equal to “1” at income level ___. Ig1“equilibrium GDP” 4. If Ig is Ig1, then “equilibrium GDP” is _____. Ig2“equilibrium GDP” 5. If Ig is Ig2, then “equilibrium GDP” is _____. Ig1Ig2equilibrium GDP increases 6. If Ig increases from Ig1 to Ig2, equilibrium GDP increases by _____. Ig1Ig2“MPC” 7. If Ig increases from Ig1 to Ig2, the “MPC” is equal to __________. OVOU“MPS” 8. As we move from income level OV to OU, the “MPS” is ________. “dissaving” 9. The economy is “dissaving” at income level _____. Consumption will be equal to income at income level 10. Consumption will be equal to income at income level ___. W V U T B 0 AE (C+Ig) AE (C+Ig2) AE (C+Ig1) Consumption F E D C Real GDP 45 G A B 11. Going from “OV” to “OU”, what is the M E? AP

17 1. An increase in Ig of $75B results in an increase in equilibrium income ( GDP ) of $300billion, so the MPS is? expansionary fiscal policy 2. An expansionary fiscal policy results in a(n) (incr/decr) in output, & a(n) (incr/decr) in interest rates. 3. Increasing T or decreasing G will (increase/decrease) consumption, and (increase/decrease) unemployment. inflationary GDP Gap of $80B$80 billion inflationary GDP Gap 4. With a MPC of.75, & the economy with an inflationary GDP Gap of $80B, G could eliminate this $80 billion inflationary GDP Gap by reducing government spending by? current output at $650 bil. but FE output is $700 billion 5. With a MPC of.60 & current output at $650 bil. but FE output is $700 billion, correct fiscal policy would be to (increase G/decrease T) by $20 billion.. $2 Tr. G T

18 increase in Ig in an economy 6. An increase in Ig in an economy will (incr)/decr) GDP & (incr/decr ) C. inflationary economy 7. In an inflationary economy, (actual Y/potential Y) exceeds (actual Y/potential Y). complex economy C+Ig+G+Xn leakagesinjections 8. In the complex economy (C+Ig+G+Xn), the leakages are? & the injections are?, 9. If there is an equal increase in G&T of $10 billion, then output will (increase/decrease). [S, T, & M] [G, I g, X]

19 ,000 1,600 2,200 bil ,000 1,600 2,200 bil. 0 N Q K L M $2,200 $1,600 $1,000 $700 $400 J P I H G E F A B C D AE 3 [C + I g+ G + X n ] AE 3 [C + I g+ G + X n ] AE 2 [C+Ig+G] AE 1 [C+Ig] Consumption Real GDP Inflat.Gap R ecess. Gap APC is “one” 1. The APC is “one” at letter: (J/H/G/A). Consumption will be equal to income(GDP) 2. Consumption will be equal to income(GDP) at (200/400/1000). AE 2 AE 3 3. A shift from AE 2 to AE 3 would be caused by a[an] (appreciation/depreciation) of the dollar. J H, the simple multiplier 4. If there is a shift from J to H, the simple multiplier is: (2/3/4/5) 5. With an MPC of.75, an increase in G of $200 billion, would increase “C” “C” [not income] by: a. $800 billion b. $600 billion c. $150 billion FE GDP is OL & we are at AE 1 6. If the FE GDP is OL & we are at AE 1, the (recess./inflat.) gap is (AB/BC). $ AE[C+Ig+G+Xn] $500 $

20 ,000 1,600 2,200 bil ,000 1,600 2,200 bil. 0 N Q K L M $2,200 $1,600 $1,000 $700 J P I H G E F A B C D AE 3 [C + I g+ G + X n ] AE 3 [C + I g+ G + X n ] AE 2 [C+Ig+G] AE 1 [C+Ig] Consumption Real GDP AE[C+Ig+G+Xn] Inflat.Gap R ecess. Gap FE GDP is OL [$1,600] AE 3 7. If the FE GDP is OL [$1,600] and we are at AE 3, the recessionaryinflationary (recessionary/inflationary) gap is: (BC or AB). equilibrium level of GDP at AE 3 $1,000$1,600$2, The equilibrium level of GDP at AE 3 is ($1,000/$1,600/$2,200). FE is OL [$1,600] & we are at AE1, correct fiscal policy 9. If FE is OL [$1,600] & we are at AE1, correct fiscal policy increasedecrease G increasedecrease T would be to ( increase / decrease ) “G” &/or ( increase / decrease ) “T”. FE is OL [$1,600] & we are at AE If FE is OL [$1,600] & we are at AE 3, correct fiscal policy (increase/decrease) G (increase/decrease) T would be to (increase/decrease) “G” &/or (increase/decrease) “T”. OKsaving 11. At income level OK, the volume of saving is: ($300/$700/$1,000). dissaving 12. The economy is dissaving GDP level: ($200/$400/$600) $200 $400 $500 $

21 Inflat.Gap AE1 [$1,000], G decreases both G & T by $400 billion 16. At AE1 [$1,000], the G decreases both G & T by $400 billion to balance the budget. With a simple multiplier of 5, the GDP (increases/decreases) to ($600/$1,000/ $1,600/$1,800). AE1 ($1,000), G spends $500 billionincreases taxes 17. At AE1 ($1,000), the G spends $500 billion & increases taxes by $500 billion balance the budgetsimple multiplier by $500 billion to balance the budget. With a simple multiplier of 5increasesdecreases of 5 the GDP (increases/decreases) to ($500/$1,000/$1,500/$1,800). “J” to “H” 13. A shift from “J” to “H” MPC would result in a MPC of: (HK/OK or IP/QK or HI/OK) “J” to “H” 14. A shift from “J” to “H” MPS would result in a MPS of: (HK/OK or IP/QK or HI/QK) 15. A t AE1, consumption totals ($200/$300/$700) ,000 1,600 2,200 bil ,000 1,600 2,200 bil. 0 N Q K L M $2,200 $1,600 $1,000 $700 $400 J P I H G E F A B C D AE 3 [C + I g+ G + X n ] AE 2 [C+Ig+G] AE 1 [C+Ig] C AE[C+Ig+G+Xn] R ecess. Gap +300 $200 $500 $

22 dissaving 1.T he economy is dissaving at a. 200 b. 400 c. 1,000 saving will be 2. Aggregate saving will be zero zero where GDP is a. $ 200 b. $ 400 c. $ 600 AE 1, savings totals 3. At AE 1, savings totals a. $300 b. $700 c. $1,000 FE GDP is OL 4. If the FE GDP is OL & we at AE 3 inflationary are at AE 3 the inflationary spending gap spending gap is a. BC b. AB c. CD 5. With an MPC of.60, an increase in G of $100 billion would increase “C” “C” [not income] to: a. $150 B b. $250 B c. $600 B J to HMPC 6. Moving from J to H, the MPC is: a. FE/KL b. IP/OK c. IP/QK AE 2 to AE 3 caused by 7. A movement from AE 2 to AE 3 would be caused by a(an) _______ of the dollar? A. appreciation b. depreciation FE GDP is OL AE 1 8. If the FE GDP is OL and we are at AE 1 the recessionary spending gap is: a. AB b. BC c. CD Consumption is equal to GDP 9. Consumption is equal to GDP at: a. 200 b. $400 c. $600 AE 1 ($1,000 GDP) G increases G&T by $100 billion 10. At AE 1 ($1,000 GDP), G increases G&T by $100 billion. W ith a “M” of 2, GDP increases to: a. $1,000 b. $1,100 c. $1,200 Hard Quiz G $ $400 $

23 1.a 2. b 3. a 4. b 5. a 6. c 7. b 8. b 9. b 10. b Answers to previous quiz Answers to previous quiz

24 (64%) Crowding out (64%) 1. Crowding out is best described as which of the following? a. The decrease in full-employment output caused by an increase in taxes b. The decrease in private investment spending & consumption caused by an increase in government spending c. The decrease in government spending caused by a decrease in taxes d. The increase in the amount of capital outflow caused by the increase in government spending e. The increase in the amount of capital inflow caused by the increase in government spending (51%) increase in government spending (51%) 2. An increase in government spending with no change in taxes leads to a a. lower income level b. lower price level c. smaller money supply d. higher interest rate e. higher bond price (39%) business conditions will deteriorate (39%) 3. If investors feel that business conditions will deteriorate in the future, the demand for loans and real interest ratein theloanable fundsmarket demand for loans and real interest rate in the loanable funds market will change in which of the following ways in the short run? Demand for LoansReal Interest Rate a. IncreaseIncrease b. Increase Decrease c. Decrease Increase d. DecreaseDecrease e. DecreaseNot change Fiscal Policy

25 AE & Fiscal Policy Questions on 2000 AP Exam value of the spending multiplier 4. (81%) The value of the spending multiplier (M E ) decreases when a. tax rates are reduced d. government spending increases b. exports decline e. the marginal propensity to save increases c. imports decline Keynesian recommend 5. (75%) Which of the following policies would a Keynesian recommend during high unemployment and low inflation a period of high unemployment and low inflation? a. decreasing the MS to reduce AD b. decreasing taxes to stimulate AD c. decreasing government spending to stimulate AS d. balancing the budget to stimulate AS equilibrium income will 6. (47%) Which of the following best explains why equilibrium income will increase by more than $100 in response to a $100 increase inG increase by more than $100 in response to a $100 increase in G? a. Incomes will rise, resulting in a tax decrease. b. Incomes will rise, resulting in higher consumption. c. The increased spending raises the aggregate price level. d. The increased spending increases the money supply, lowering interest rates. e. The higher budget deficit reduces investment. Unexpected increases in inventories 7. (56%) Unexpected increases in inventories usually precede a. increases in inflationb. increases in importsc. stagflation d. decreases in productione. decreases in unemployment

26 economy on the right is 8. (63%) The economy on the right is experiencing currently experiencing a. inflation b. recession c. expansion d. stagflation e. rapid growth monetary policy 9. (77%) Correct monetary policy to reach FE GDP increase reach FE GDP is to increase a. the MS b. the RR c. discount rate d. taxes e. exports minimum increase in government 10. (36%) The minimum increase in government spending reach full employment spending to reach full employment is a. $2,000 b. $1,000 c. $500 d. $200 e. $100 simple Keynesian AE model[not AD/AS] 11. (58%) In the simple Keynesian AE model [not AD/AS] of an economy, changes in Ig or G lead to a change in which changes in Ig or G will lead to a change in which of the following? a. the price level b. the level of output and employment c. interest rates d. the AS curve closed-privateAPC is.75true 12. (83%) In a closed-private in which the APC is.75, which of following is true? a. If income is $100, then saving is $75.d. If income is $200, then “C” is $75 b. If income is $100, then “C” is $50e. If income is $500, then saving is $100 c. If income is $200, then saving is $50Full.Employ. C C+IgAE $500 $400 0 $800 $1,000 $2,000 E A

27 Fiscal Policy Questions from 2000 Exam Fiscal Policy Questions from 2000 Exam inflationary gap can be eliminated EXCEPT 13. (73%) An inflationary gap can be eliminated by all of the following EXCEPT a. an increase in personal income taxesd. a decrease in G b. an increase in the MSe. a decrease in Xn c. an increase in the interest rate advantage of automatic stabilizers 14. (56%) A major advantage of automatic stabilizers in fiscal policy is that they a. reduce the public debt b. increase the possibility of a balanced budget c. stabilize the unemployment rate d. go into effect without passage of new legislation e. automatically reduce the inflation rate Which answer does not slow the economy?

28 contractionary fiscal policyAD 15. (70%) In the short run, a contractionary fiscal policy will cause AD, outputprice level output, and the price level to change in which of the following ways? ADOutputPrice level a. decreasedecreasedecrease b. decreaseincreaseincrease c. increase decreasedecrease d. increaseincreaseincrease Crowding out 16. (52%) Crowding out due to government borrowing occurs when a. lower interest rates increase private sector investment b. lower interest rates decrease private sector investment c. higher interest rates decrease private sector investment d. a smaller money supply increases private sector investment expansionary monetary policies 17. (42%) Compared to expansionary monetary policies adopted to expansionary fiscal policies counteract a recession, expansionary fiscal policies tend to result in a. less public spendingc. a high rate of economic growth b. higher interest ratesd. lower prices

29 1995 AP Exam increase inincrease the value of the M E 18. (71%) An increase in which will increase the value of the M E ? a. The supply of moneyd. The marginal propensity to consume b. Equilibrium outpute. The required reserve ratio c. Personal income tax rates AS curve may be horizontal over some range 19. (61%) An AS curve may be horizontal over some range because within that range a. a higher PL leads to higher interest rates, which reduces the MS & “C” b. changes in the aggregate PL do not induce substitution c. output cannot be increased unless prices and interest rates increase d. rigid prices prevent employment from fluctuating e. resources are underemployed & an increase in AD will be satisfied without any pressure on the PL cause simultaneous increases in inflation & unemployment 20. (45%) What could cause simultaneous increases in inflation & unemployment a. a decrease in government spendingd. An increase in inflationary expectations b. A decrease in the money supplye. An increase in productivity c. A decrease in the velocity of money greatest increase in AD 21. (85%) Which of the following will result in the greatest increase in AD? a. A $100 increase in taxes b. A $100 decrease in taxes c. A $100 increase in government expenditures d. A $100 increase in government expenditures, coupled with a $100 increase in taxes e. A $100 increase in government expenditures, couples with a $100 decrease in taxes decrease in government spending 22. (65%) Which of the following will result from a decrease in government spending? a. An increase in outputd. A decrease in AS b. An increase in the price levele. A decrease in AD c. An increase in employment

30 C+Ig C+Ig+GAE$325 $200 0 $1,000 $1,500 0 $1,000 $1,500 GDP E F equilibrium at E 23. (61%) The graph indicates equilibrium at E closed economy for a closed economy without G. If the addition of G results in equilibrium at F addition of G results in equilibrium at F, which of the following is true? a. G is $300 and the multiplier is 5. b. G is $125 and the multiplier is 4. c. G is $100 and consumption increased by $500. d. G and Ig increase by $500. e. Consumption and GDP increase by $500 each. Keynesian theorydecreasing taxes and increasing G 24. (84%) According to Keynesian theory, decreasing taxes and increasing G will change consumptionunemployment most likely change consumption and unemployment in which of the following ways? ConsumptionUnemployment a. DecreaseNo change b. DecreaseNo change c. IncreaseDecrease d. IncreaseIncrease e. No change Decrease economy at full employment 25. (79%) In an economy at full employment, a presidential candidate proposes cutting increase T and reducing G the government debt in half in 4 years by increase T and reducing G. According to Keynesian theoryincrease Keynesian theory, implementation of these policies is most likely to increase a. unemploymentd. aggregate supply b. consumer pricese. the rate of economic growth c. aggregate demand

31 severe recession 26. (79%) If the economy is in a severe recession, which of the following is the fiscal policymost effective instimulating production and employment fiscal policy most effective in stimulating production and employment? a. Government spending increases. b. Government spending decreases. c. Personal income taxes are increased. d. The Fed sells bonds on the open market. e. The Fed buys bonds on the open market. decrease 27. (27%) Faced with a large federal budget deficit, the government decides to decrease expenditures tax revenuesby the same amountaffect expenditures and tax revenues by the same amount. This action will affect outputinterest rates output and interest rates in which of the following ways? OutputInterest Rates a. IncreaseIncrease b. IncreaseDecrease c. No changeDecrease d. DecreaseIncrease e. DecreaseDecrease crowding outpartially effects of a tax cut 28. (28%) If crowding out only partially offsets the effects of a tax cut, which of the changesinterest ratesGDP following changes in interest rates and GDP are most likely to occur. I nterest R ates GDP a. Increase Increase b. Increase Remain unchanged c. Increase Decrease d. Remain unchanged Increase e. Decrease Decrease

32 Keynesian saving schedule aggregate income increasessavings will 29. (62%) According to the Keynesian saving schedule, when aggregate income increases by a given amount, savings will a. remain the same b. decrease by the amount of the change in income c. increase by the amount of the change in income d. increase by less than the amount of the change in income e. increase by more than the amount of the change in income

33 Check your answers!!

34 Remember, the next test will be over AD/AS [about half] and AE and Fiscal Policy. Make sure you know these 28 questions on AE and Fiscal Policy.

35 Expansionary fiscal policy 1. Expansionary fiscal policy will be most effective is [increase GDP] when the AS curve is (vertical/horizontal) & (incr/decr) “C” and (incr/decr) unemployment. paradox of thrift 2. The paradox of thrift indicates that an increase in saving (matched/unmatched) by an increase in investment will lower equilibrium GDP.

36 contractionary fiscal policydecr G, incr T 3. A contractionary fiscal policy [decr G, incr T] would cause a[an] (incr/decr) in output[GDP] and a[an] (incr/decr) in interest rates. expansionary fiscal policyincr G, decr T 4. An expansionary fiscal policy [incr G, decr T] would cause a[an] (incr/decr) in output[GDP] and a[an] (incr/decr) in interest rates. AE[AD]doesn’t buy up FE output(GDP) 5. In the AE model, if AE[AD]doesn’t buy up FE output(GDP), then the equilibrium output is (less than/more then) full employment output. [G ; LFM ; In. Rates ] [#3 & #4, start from a balanced budget] “Recessionary Gap” “Inflationary Gap” G $2 Trillion T $2 Trillion [T ; LFM ; In. Rates ]

37 decrease AD the greatest amount 6. To decrease AD the greatest amount, the government should: (decrease “G” only/increase “T” only/both decr G & incr T) 7. To increase AD the greatest amount, the “G” should: (increase “G” only/ decrease “T” only/both incr G and decr T) current output at $ With a MPC of.5 and current output at $500 billion, but F.E. output is $700 billion, correct fiscal policy would be to (increase G/Decrease T) by $100 billion. unplanned increase in 9. If businesses are experiencing an unplanned increase in inventoriesFE output and inventories, AE is (less than/greater than) FE output and spending in the economy spending in the economy will (increase/decrease). unplanned decrease in 10. If businesses are experiencing an unplanned decrease in inventoriesdisinvestment inventories [disinvestment]AE is (less than/greater than) FE output & spending in the economy FE output & spending in the economy will (increase/decrease).

38 “C” equals income at $500 billionMPC is If “C” equals income at $500 billion, & MPC is.9, then an increase in Ig of $10 billion will change equilibrium GDP to ($400/$490/$510/$600) billion. conservative economist 12. A conservative economist would want tax (incr/decr) during recessioninflationary times a recession & (incr/decr) in “G” during inflationary times. liberal economist 13. A liberal economist would want tax (incr/decr) during an inflationrecessionary periods inflation & (incr/decr) in “G” during recessionary periods. 14. An inflationary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP. recessionary gap 15. A recessionary gap indicates AE[actual GDP] (exceeds/falls short of) FE GDP. increase GDP [but reduce military spending] 16. To increase GDP [but reduce military spending], we would combine two (domestic/overseas) bases into one (domestic/overseas) base. tax cut to expand the economy 17. A tax cut to expand the economy would (incr/decr) Y & (incr/decr) in. rates. tax increase to contract the economy 18. A tax increase to contract the economy would (incr/decr) Y & (incr/decr) IR

39 increase equilibrium GDP by $400, To increase equilibrium GDP by $400,000, with a MPC of.5, a Keynesian economist would ( decrease “T” /increase “G” ) by $ 200,000. quilibrium GDP is $500 billion 20. E quilibrium GDP is $500 billion and MPS is.4. Now “G” collects taxes of $22 billion and spends the entire amount. As a result, equilibrium GDP will change to: ($445/$478/$522/$555). MPC of.5$12 billion 21. With a MPC of.5, a $12 billion increase increase “C” in “G” will increase “C” by ($12/$24/$36) bil. MPC of With a MPC of.5 and the economy in a recessionary spending gap of $12 billion recessionary spending gap of $12 billion, we may conclude that the equilibrium is short of FE GDP ($12/$24/$36) billion short of FE GDP.

40 increase in Ig of $25 billion 23. An increase in Ig of $25 billion resulted in an increase in equilibrium income (GDP) of $50B, so the MPS was? contractionary fiscal policy 24. A contractionary fiscal policy results in a(n) (incr/decr) in output, and a(n) (incr/decr) in interest rates. Increasing T or decreasing G 25. Increasing T or decreasing G will (increase/decrease) consumption, and (increase/decrease) unemployment..5 Gap$50 billionGinflationaryGDP reducing government spending 26. With a MPC of.5, and the economy with an inflationary GDP Gap of $50 billion, G could eliminate this inflationary GDP by reducing government spending by? [Incr T or Decr G].5 $25 billion

41 increase in Ig 27. An increase in Ig in an economy (increase)/decrease) GDP & (increase/decrease) C. equal increase in G and T of $25 bil 28. If there is an equal increase in G and T of $25 billion in the horizontal range of AS, then output will (increase/decrease/stay the same). PL RGDP AD 1 AD 2 [would increase by $25 billion]

42 250 1,200 GDP [bil] 1.From the above graph, moving from equilibrium “E” to “F”, what can we conclude about the following: A. How much is G? B. The increase in Y? C. The M E [Chg in Y/Chg in Expenditures = M E ]? $50 B $200 B $200 B/$50 B = 4 [Public Sector] [No Public Sector]

43 ADASREP 2. Know what these do to the AD [ C+Ig+G+Xn ] or AS [ REP ] curves. A. Trade partners incomes increase? ___ decrease?___ B. Availability of land, labor, & capital increase?__ decrease?__ C. Productivity increases? ___ D. Resource[input] cost increases? ___ decreases? ___ E. Government spending increases? ___ decreases? ___ F. Stock Market drastically increases? ___ decreases? ___ E. A strong dollar’s impact on net exports. ___ F. A strong dollar’s impact on resource cost. ___ AB C D C A B AB C D B C

44 3. Know the above on a graph like this: K recessionaryinflationary output gap A. At “ K ”, we have a [recessionary/inflationary] output gap ? J recessionaryinflationary output gap B. At “ J ”, we have a [recessionary/inflationary] output gap ? r ecessionary SPENDING gap C. The r ecessionary SPENDING gap is [KH/E I/JG ] inflationary SPENDING gap D. The inflationary SPENDING gap is [KH/ED/E I ] fiscal policy C+Ig1 C. Correct fiscal policy if we are at “C+Ig1” if “0B” is FE Y would be to [increase/decrease] G and [increase/decrease] T.

45 4. Which of the following would be the A. Classical AS curve B. Keynesian AS curve C. Supply-side AS curve increase in AD 5. If there is an increase in AD in each one of these, what happens to PL, Output & Employment? AS (a.) (b.) (c.) (c.) (a.) (b.) PL - no change; Y/Empl. - increase PL – increase; Y/Empl. - increase PL – increase; Y/Empl. – no change PL RGDP Y* (a.) (b.) (c.) AD 1 AD 2 AD 1 AD 2 AD1 AD2 PL

46 6. Paradox of Thrift applies in the Keynesian range or Classical range? “sticky” 7. Ratchet effect – are prices and wages “sticky” up or down? 8. Crowding out - An increase in government spending causes the interest rate to (increase/decrease) &, Ig to (increase/decrease)? recessionary spending gap of 9. If MPS is.50 and we have a recessionary spending gap of $10 FE GDP $10 billion, how short are we of FE GDP? 10. What is a political business cycle? 11. What triggers the wealth effect, interest rate effect, and the foreign purchase effect? 12. Know how to figure productivity and per unit production cost. 13. Know the difference between a A. “Change in AQD or AQS” B. “Change in AD or AS” Keynesian range $20 billion Rev up economy before an election Change in PL Caused by chg in PL Caused by chg in C I GXn or REP How many outputs from inputs; Total input cost divided by outputs

47 14. If income increases from $500 B to $600 B, and Ig of $25 B caused the $100 B increase in Y, then the M E and MPS were? 15. The MPS is.50, and “C” = “Y” at $600 billion. Now Ig is increased by $50 billion, therefore the new equilibrium Y is? 4 and.25 $700 $600 Consumption $600 B AE[C+Ig] RGDP [billions] $50 B 16. Now G increases G&T by 50 bil., then the new equilibrium Y would be? $750 billion

48 “OT” consumption 1. At income level “OT”, the volume of consumption is _____. “OT” saving 2. At income level “OT”, the volume of saving is _____. “APC”“1” 3. The “APC” is equal to “1” at income level ___. Ig1“equilibrium GDP” 4. If Ig is Ig1, then “equilibrium GDP” is _____. Ig2“equilibrium GDP” 5. If Ig is Ig2, then “equilibrium GDP” is _____. Ig1Ig2equilibrium GDP increases 6. If Ig increases from Ig1 to Ig2, equilibrium GDP increases by _____. Ig1Ig2“MPC” 7. If Ig increases from Ig1 to Ig2, the “MPC” is equal to __________. OVOU“MPS” 8. As we move from income level OV to OU, the “MPS” is ________. “dissaving” 9. The economy is “dissaving” at income level _____. Consumption will be equal to income at income level 10. Consumption will be equal to income at income level _____. TC CF OV OU OT UT BC/UT AE / VU OW OV W V U T B 0 AE (C+Ig) AE (C+Ig2) AE (C+Ig1) Consumption F E D C Real GDP 45 G A B 11. Going from “OV” to “OU”, what is the M E? AP 4

49 1. An increase in Ig of $75B results in an increase in equilibrium income ( GDP ) of $300billion, so the MPS is? expansionary fiscal policy 2. An expansionary fiscal policy results in a(n) (incr/decr) in output, & a(n) (incr/decr) in interest rates. 3. Increasing T or decreasing G will (increase/decrease) consumption, and (increase/decrease) unemployment. inflationary GDP Gap of $80B$80 billion inflationary GDP Gap 4. With a MPC of.75, & the economy with an inflationary GDP Gap of $80B, G could eliminate this $80 billion inflationary GDP Gap by reducing government spending by? current output at $650 bil. but FE output is $700 billion 5. With a MPC of.60 & current output at $650 bil. but FE output is $700 billion, correct fiscal policy would be to (increase G/decrease T) by $20 billion..25 $20 bil. [Decr T or Incr G] $2 Tr. G T

50 increase in Ig in an economy 6. An increase in Ig in an economy will (incr)/decr) GDP & (incr/decr ) C. inflationary economy 7. In an inflationary economy, (actual Y/potential Y) exceeds (actual Y/potential Y). complex economy C+Ig+G+Xn leakagesinjections 8. In the complex economy (C+Ig+G+Xn), the leakages are? & the injections are?, 9. If there is an equal increase in G&T of $10 billion, then output will (increase/decrease). [S, T, & M] [G, I g, X]

51 ,000 1,600 2,200 bil ,000 1,600 2,200 bil. 0 N Q K L M $2,200 $1,600 $1,000 $700 $400 J P I H G E F A B C D AE 3 [C + I g+ G + X n ] AE 3 [C + I g+ G + X n ] AE 2 [C+Ig+G] AE 1 [C+Ig] Consumption Real GDP Inflat.Gap R ecess. Gap APC is “one” 1. The APC is “one” at letter: (J/H/G/A). Consumption will be equal to income(GDP) 2. Consumption will be equal to income(GDP) at (200/400/1000). AE 2 AE 3 3. A shift from AE 2 to AE 3 would be caused by a[an] (appreciation/depreciation) of the dollar. J H, the simple multiplier 4. If there is a shift from J to H, the simple multiplier is: (2/3/4/5) 5. With an MPC of.75, an increase in G of $200 billion, would increase “C” “C” [not income] by: a. $800 billion b. $600 billion c. $150 billion FE GDP is OL & we are at AE 1 6. If the FE GDP is OL & we are at AE 1, the (recess./inflat.) gap is (AB/BC). $ AE[C+Ig+G+Xn] $500 $

52 ,000 1,600 2,200 bil ,000 1,600 2,200 bil. 0 N Q K L M $2,200 $1,600 $1,000 $700 J P I H G E F A B C D AE 3 [C + I g+ G + X n ] AE 3 [C + I g+ G + X n ] AE 2 [C+Ig+G] AE 1 [C+Ig] Consumption Real GDP AE[C+Ig+G+Xn] Inflat.Gap R ecess. Gap FE GDP is OL [$1,600] AE 3 7. If the FE GDP is OL [$1,600] and we are at AE 3, the recessionaryinflationary (recessionary/inflationary) gap is: (BC or AB). equilibrium level of GDP at AE 3 $1,000$1,600$2, The equilibrium level of GDP at AE 3 is ($1,000/$1,600/$2,200). FE is OL [$1,600] & we are at AE1, correct fiscal policy 9. If FE is OL [$1,600] & we are at AE1, correct fiscal policy increasedecrease G increasedecrease T would be to ( increase / decrease ) “G” &/or ( increase / decrease ) “T”. FE is OL [$1,600] & we are at AE If FE is OL [$1,600] & we are at AE 3, correct fiscal policy (increase/decrease) G (increase/decrease) T would be to (increase/decrease) “G” &/or (increase/decrease) “T”. OKsaving 11. At income level OK, the volume of saving is: ($300/$700/$1,000). dissaving 12. The economy is dissaving GDP level: ($200/$400/$600) $200 $400 $500 $

53 Inflat.Gap AE1 [$1,000], G decreases both G & T by $400 billion 16. At AE1 [$1,000], the G decreases both G & T by $400 billion to balance the budget. With a simple multiplier of 5, the GDP (increases/decreases) to ($600/$1,000/ $1,600/$1,800). AE1 ($1,000), G spends $500 billionincreases taxes 17. At AE1 ($1,000), the G spends $500 billion & increases taxes by $500 billion balance the budgetsimple multiplier by $500 billion to balance the budget. With a simple multiplier of 5increasesdecreases of 5 the GDP (increases/decreases) to ($500/$1,000/$1,500/$1,800). “J” to “H” 13. A shift from “J” to “H” MPC would result in a MPC of: (HK/OK or IP/QK or HI/OK) “J” to “H” 14. A shift from “J” to “H” MPS would result in a MPS of: (HK/OK or IP/QK or HI/QK) 15. A t AE1, consumption totals ($200/$300/$700) ,000 1,600 2,200 bil ,000 1,600 2,200 bil. 0 N Q K L M $2,200 $1,600 $1,000 $700 $400 J P I H G E F A B C D AE 3 [C + I g+ G + X n ] AE 2 [C+Ig+G] AE 1 [C+Ig] C AE[C+Ig+G+Xn] R ecess. Gap +300 $200 $500 $

54 dissaving 1.T he economy is dissaving at a. 200 b. 400 c. 1,000 saving will be 2. Aggregate saving will be zero zero where GDP is a. $ 200 b. $ 400 c. $ 600 AE 1, savings totals 3. At AE 1, savings totals a. $300 b. $700 c. $1,000 FE GDP is OL 4. If the FE GDP is OL & we at AE 3 inflationary are at AE 3 the inflationary spending gap spending gap is a. BC b. AB c. CD 5. With an MPC of.60, an increase in G of $100 billion would increase “C” “C” [not income] to: a. $150 B b. $250 B c. $600 B J to HMPC 6. Moving from J to H, the MPC is: a. FE/KL b. IP/OK c. IP/QK AE 2 to AE 3 caused by 7. A movement from AE 2 to AE 3 would be caused by a(an) _______ of the dollar? A. appreciation b. depreciation FE GDP is OL AE 1 8. If the FE GDP is OL and we are at AE 1 the recessionary spending gap is: a. AB b. BC c. CD Consumption is equal to GDP 9. Consumption is equal to GDP at: a. 200 b. $400 c. $600 AE 1 ($1,000 GDP) G increases G&T by $100 billion 10. At AE 1 ($1,000 GDP), G increases G&T by $100 billion. W ith a “M” of 2, GDP increases to: a. $1,000 b. $1,100 c. $1,200 Hard Quiz G $ $400 $ a 2. b 3. a 4. b 5. a 6. c 7. b 8. b 9. b 10. b

55

56 (64%) Crowding out (64%) 1. Crowding out is best described as which of the following? a. The decrease in full-employment output caused by an increase in taxes b. The decrease in private investment spending & consumption caused by an increase in government spending c. The decrease in government spending caused by a decrease in taxes d. The increase in the amount of capital outflow caused by the increase in government spending e. The increase in the amount of capital inflow caused by the increase in government spending (51%) increase in government spending (51%) 2. An increase in government spending with no change in taxes leads to a a. lower income level b. lower price level c. smaller money supply d. higher interest rate e. higher bond price (39%) business conditions will deteriorate (39%) 3. If investors feel that business conditions will deteriorate in the future, the demand for loans and real interest ratein theloanable fundsmarket demand for loans and real interest rate in the loanable funds market will change in which of the following ways in the short run? Demand for LoansReal Interest Rate a. IncreaseIncrease b. Increase Decrease c. Decrease Increase d. DecreaseDecrease e. DecreaseNot change Incr in G causes incr in I.R. in LFM, decr “Ig” & “C”. Starting from a bal. bud., G would now run a deficit and have to borrow in the LFM, pushing up the I.R. The “negative profit expectations”cause firms to decr Ig & not borrow as much, decr the I.R. Fiscal Policy

57 AE & Fiscal Policy Questions on 2000 AP Exam value of the spending multiplier 4. (81%) The value of the spending multiplier (M E ) decreases when a. tax rates are reduced d. government spending increases b. exports decline e. the marginal propensity to save increases c. imports decline Keynesian recommend 5. (75%) Which of the following policies would a Keynesian recommend during high unemployment and low inflation a period of high unemployment and low inflation? a. decreasing the MS to reduce AD b. decreasing taxes to stimulate AD c. decreasing government spending to stimulate AS d. balancing the budget to stimulate AS equilibrium income will 6. (47%) Which of the following best explains why equilibrium income will increase by more than $100 in response to a $100 increase inG increase by more than $100 in response to a $100 increase in G? a. Incomes will rise, resulting in a tax decrease. b. Incomes will rise, resulting in higher consumption. c. The increased spending raises the aggregate price level. d. The increased spending increases the money supply, lowering interest rates. e. The higher budget deficit reduces investment. Unexpected increases in inventories 7. (56%) Unexpected increases in inventories usually precede a. increases in inflationb. increases in importsc. stagflation d. decreases in productione. decreases in unemployment If MPS incr from.10 to.20, the M E would decrease from 10 to 5. more C The Multiplier ensures more C with each round.

58 economy on the right is 8. (63%) The economy on the right is experiencing currently experiencing a. inflation b. recession c. expansion d. stagflation e. rapid growth monetary policy 9. (77%) Correct monetary policy to reach FE GDP increase reach FE GDP is to increase a. the MS b. the RR c. discount rate d. taxes e. exports minimum increase in government 10. (36%) The minimum increase in government spending reach full employment spending to reach full employment is a. $2,000 b. $1,000 c. $500 d. $200 e. $100 simple Keynesian AE model[not AD/AS] 11. (58%) In the simple Keynesian AE model [not AD/AS] of an economy, changes in Ig or G lead to a change in which changes in Ig or G will lead to a change in which of the following? a. the price level b. the level of output and employment c. interest rates d. the AS curve closed-privateAPC is.75true 12. (83%) In a closed-private in which the APC is.75, which of following is true? a. If income is $100, then saving is $75.d. If income is $200, then “C” is $75 b. If income is $100, then “C” is $50e. If income is $500, then saving is $100 c. If income is $200, then saving is $50Full.Employ. C C+IgAE $500 $400 0 $800 $1,000 $2,000 E A Determine what the “M” is going from A to E; then M X ? = $1,000

59 Fiscal Policy Questions from 2000 Exam Fiscal Policy Questions from 2000 Exam inflationary gap can be eliminated EXCEPT 13. (73%) An inflationary gap can be eliminated by all of the following EXCEPT a. an increase in personal income taxesd. a decrease in G b. an increase in the MSe. a decrease in Xn c. an increase in the interest rate advantage of automatic stabilizers 14. (56%) A major advantage of automatic stabilizers in fiscal policy is that they a. reduce the public debt b. increase the possibility of a balanced budget c. stabilize the unemployment rate d. go into effect without passage of new legislation e. automatically reduce the inflation rate Which answer does not slow the economy?

60 contractionary fiscal policyAD 15. (70%) In the short run, a contractionary fiscal policy will cause AD, outputprice level output, and the price level to change in which of the following ways? ADOutputPrice level a. decreasedecreasedecrease b. decreaseincreaseincrease c. increase decreasedecrease d. increaseincreaseincrease Crowding out 16. (52%) Crowding out due to government borrowing occurs when a. lower interest rates increase private sector investment b. lower interest rates decrease private sector investment c. higher interest rates decrease private sector investment d. a smaller money supply increases private sector investment expansionary monetary policies 17. (42%) Compared to expansionary monetary policies adopted to expansionary fiscal policies counteract a recession, expansionary fiscal policies tend to result in a. less public spendingc. a high rate of economic growth b. higher interest ratesd. lower prices

61 1995 AP Exam increase inincrease the value of the M E 18. (71%) An increase in which will increase the value of the M E ? a. The supply of moneyd. The marginal propensity to consume b. Equilibrium outpute. The required reserve ratio c. Personal income tax rates AS curve may be horizontal over some range 19. (61%) An AS curve may be horizontal over some range because within that range a. a higher PL leads to higher interest rates, which reduces the MS & “C” b. changes in the aggregate PL do not induce substitution c. output cannot be increased unless prices and interest rates increase d. rigid prices prevent employment from fluctuating e. resources are underemployed & an increase in AD will be satisfied without any pressure on the PL cause simultaneous increases in inflation & unemployment 20. (45%) What could cause simultaneous increases in inflation & unemployment a. a decrease in government spendingd. An increase in inflationary expectations b. A decrease in the money supplye. An increase in productivity c. A decrease in the velocity of money greatest increase in AD 21. (85%) Which of the following will result in the greatest increase in AD? a. A $100 increase in taxes b. A $100 decrease in taxes c. A $100 increase in government expenditures d. A $100 increase in government expenditures, coupled with a $100 increase in taxes e. A $100 increase in government expenditures, couples with a $100 decrease in taxes decrease in government spending 22. (65%) Which of the following will result from a decrease in government spending? a. An increase in outputd. A decrease in AS b. An increase in the price levele. A decrease in AD c. An increase in employment

62 C+Ig C+Ig+GAE$325 $200 0 $1,000 $1,500 0 $1,000 $1,500 GDP E F equilibrium at E 23. (61%) The graph indicates equilibrium at E closed economy for a closed economy without G. If the addition of G results in equilibrium at F addition of G results in equilibrium at F, which of the following is true? a. G is $300 and the multiplier is 5. b. G is $125 and the multiplier is 4. c. G is $100 and consumption increased by $500. d. G and Ig increase by $500. e. Consumption and GDP increase by $500 each. Keynesian theorydecreasing taxes and increasing G 24. (84%) According to Keynesian theory, decreasing taxes and increasing G will change consumptionunemployment most likely change consumption and unemployment in which of the following ways? ConsumptionUnemployment a. DecreaseNo change b. DecreaseNo change c. IncreaseDecrease d. IncreaseIncrease e. No change Decrease economy at full employment 25. (79%) In an economy at full employment, a presidential candidate proposes cutting increase T and reducing G the government debt in half in 4 years by increase T and reducing G. According to Keynesian theoryincrease Keynesian theory, implementation of these policies is most likely to increase a. unemploymentd. aggregate supply b. consumer pricese. the rate of economic growth c. aggregate demand

63 severe recession 26. (79%) If the economy is in a severe recession, which of the following is the fiscal policymost effective instimulating production and employment fiscal policy most effective in stimulating production and employment? a. Government spending increases. b. Government spending decreases. c. Personal income taxes are increased. d. The Fed sells bonds on the open market. e. The Fed buys bonds on the open market. decrease 27. (27%) Faced with a large federal budget deficit, the government decides to decrease expenditures tax revenuesby the same amountaffect expenditures and tax revenues by the same amount. This action will affect outputinterest rates output and interest rates in which of the following ways? OutputInterest Rates a. IncreaseIncrease b. IncreaseDecrease c. No changeDecrease d. DecreaseIncrease e. DecreaseDecrease crowding outpartially effects of a tax cut 28. (28%) If crowding out only partially offsets the effects of a tax cut, which of the changesinterest ratesGDP following changes in interest rates and GDP are most likely to occur. I nterest R ates GDP a. Increase Increase b. Increase Remain unchanged c. Increase Decrease d. Remain unchanged Increase e. Decrease Decrease An equal decrease in G & T [Let’s say by $10 billion] would decrease GDP by $10 billion decrease GDP by $10 billion. The decrease in GDP would decrease in interest rates decrease PL which would cause a decrease in interest rates. PartiallyGDP increases Partially means GDP increases. Starting from a balanced budget, the tax cut would put the G in deficit and the G borrowing would increase demand for money push up interest rates in the LFM and push up interest rates.

64 Keynesian saving schedule aggregate income increasessavings will 29. (62%) According to the Keynesian saving schedule, when aggregate income increases by a given amount, savings will a. remain the same b. decrease by the amount of the change in income c. increase by the amount of the change in income d. increase by less than the amount of the change in income e. increase by more than the amount of the change in income


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