Chapter 25 Aggregate Demand and Aggregate Supply by run16684

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									Chapter 25: Aggregate Demand and Aggregate Supply

True or False
1. Aggregate demand (AD) _ Consumption (C) _ Investment (I) _ Government purchases (G) _
Net exports (X _ M). T
2. Because consumption is such a stable part of GDP, analyzing its determinants is not important
for an understanding of the forces leading to changes in aggregate demand. F
3. Good business conditions tend to increase the level of investment by firms. T
4. A $1 million increase in exports has a smaller direct effect on aggregate demand than a $1
million increase in government purchases. F
5. Either an increase in exports or a decrease in imports would increase net exports. T
6. Ceteris paribus, negative net exports would decrease aggregate demand. T
7. The aggregate demand (AD) curve indicates the quantities of nominal GDP demanded at
different price levels. F
8. The AD curve is downward sloping for the same reasons that the demand curve for a particular
product is downward sloping. F
9. An increase in the price level causes the quantity of RGDP demanded to fall. T
10. The real wealth effect reflects the fact that the real (adjusted for inflation) value of any asset of
fixed dollar value, such as cash, falls as the price level increases. T
11. A lower price level, other things being equal, will lead to increased real wealth and an
increase in the quantity of RGDP demanded. T
12. At a higher price level, interest rates will fall, other things being equal. F
13. If the price level fell, interest rates would fall, which would trigger greater investment and
consumer durable spending. T
14. A lower price level, other things being equal, would decrease the interest rate and increase
both the level of investment and the quantity of RGDP demanded. T
15. If domestic prices of goods and services fall relative to foreign prices, more domestic products
will be bought, increasing RGDP demanded. T
16. An increased price level will tend to increase the demand for domestic goods and increase
RGDP demanded. F
17. The real wealth effect, the interest rate effect, and the open economy effect all shift the AD
curve. F
18. A change in the price level will not change aggregate demand. T
19. A decrease in C, I, G, or X _ M for reasons other than changes in the price level will shift AD
leftward. T
20. An increase in consumer confidence, an increase in wealth, or a tax cut may each increase
consumption and shift AD to the right. T
21. An increase in consumer debt, other things being equal, would tend to shift AD to the left. T
22. If either business confidence increases or real interest rates rise, business investment will
increase and AD will shift to the right. F
23. A reduction in government purchases shifts AD to the left. T
24. An economic boom in the economies of major trading partners may lead to an increase in
U.S. exports to them, causing net exports to rise and AD to increase. T
25. The aggregate supply curve represents how much RGDP suppliers will be willing to produce
at different price levels. T
26. Nominal wages are assumed to adjust quickly in the short run. F
27. The long-run relationship refers to a period long enough for the prices of outputs and all
inputs to fully adjust to changes in the economy. T
28. In the short run, the aggregate supply curve is vertical. F
29. In the short run, the slow adjustments of input prices are due to the longer-term input
contracts that do not adjust quickly to price-level changes. T
30. When price level rises in the short run, it will increase producers’ profit margins and make it in
the producers’ selfinterest to expand their production. T
31. If the price level falls, input prices, producers’ profits, and real output will fall in the short run. F
32. When the price level falls, producers can be fooled into supplying more as a result of a short-
run misperception of relative prices. F
33. Along the short-run aggregate supply curve, we assume that wages and other input prices
have time to adjust. F
34. Along the long-run aggregate supply curve, we are looking at the relationship between RGDP
produced and the price level, once input prices have been able to respond to changes in output
prices. T
35. Along the LRAS curve, a 10 percent increase in the price of goods and services is matched
by a 10 percent increase in the price of inputs. T
36. Along the LRAS curve, the economy is assumed to be at full employment.T
37. In the long run, the economy will produce at the maximum sustainable level allowed by its
capital, labor, and technological inputs, regardless of the price level. T
38. Long-run equilibrium occurs wherever SRAS and AD intersect. F
39. The economy can be in short-run equilibrium without being in long-run equilibrium. T
40. Ceteris paribus, lower production costs will motivate producers to produce more at any given
price level, shifting AS rightward. T
41. Any permanent change in the quantity of any factor of production available—capital,
entrepreneurship, land, or labor—can cause a shift in the long-run aggregate supply curve but not
the short-run aggregate supply curve. F
42. Less and lower-quality capital will shift both the short-run aggregate supply curve and the
long-run aggregate supply curve to the left. T
43. Added investments in human capital will shift the short-run aggregate supply curve right but
leave the long-run aggregate supply curve unchanged. F
44. If entrepreneurs can find ways to lower the costs of production, then the short-run and long-
run aggregate supply curves both shift to the right. T
45. Successful oil exploration would leave LRAS unchanged because it would not change the
total amount of oil in the earth. F
46. An expanded labor force increases the economy’s potential output, increasing LRAS. T
47. Increases in government regulations that make it more costly for producers shift SRAS left but
leave LRAS unchanged. F
48. The price of factors, or inputs, that go into producing outputs will affect only SRAS if they
don’t reflect permanent changes in the supplies of some factors of production. T
49. If wages increase without a corresponding increase in labor productivity, SRAS will shift to the
left; but LRAS will not shift, because with the same supply of labor as before, potential output
does not change. T
50. Changes in input prices only affect SRAS if they reflect permanent changes in the supplies of
those inputs. F
51. Adverse supply shocks can increase the costs of production, shifting SRAS to the left; but
once the temporary effects of these disasters have been felt, no appreciable change in the
economy’s productive capacity occurs, so LRAS doesn’t shift as a result. T
52. In long-run equilibrium, the economy operates at full employment, regardless of the level of
the aggregate demand curve. T
53. Short-run equilibrium can change only when the short-run aggregate supply curve shifts. F
54. A change in aggregate demand will change RGDP in the short-run equilibrium, but not in the
long run. T
55. When short-run equilibrium occurs beyond the economy’s level of potential output, it results in
an expansionary gap. T
56. Demand-pull inflation causes a recessionary gap. F
57. Demand-pull inflation causes the prices of the goods producers sell to rise faster than the
costs of the inputs they use in production. T
58. As long as AD is increasing more rapidly than LRAS, the economy will tend toward both
inflation and economic growth. T
59. The economy can never operate beyond its potential output. F
60. Short-run real output beyond potential output (and employment beyond full employment)
cannot be sustained in the long run. T
61. In response to an inflationary gap in the short run, real wages and other real input prices will
tend to rise. T
62. When an increase in AD causes an inflationary gap in the short run, the only long-run
difference from the initial equilibrium is the new, higher price level. T
63. A leftward shift in the aggregate supply curve can cause cost-push inflation. T
64. The primary culprits responsible for the leftward shift in SRAS in the 1970s were oil price
decreases. F
65. Starting with the economy initially at full-employment equilibrium, a sudden increase in oil
prices would result in a recessionary gap. T
66. Holding AD constant, falling oil prices would lead to lower prices, lower output, and lower
rates of unemployment. F
67. A fall in AD would reduce real output and the price level and increase unemployment in the
short run—a recessionary gap. T
68. In a recession, unemployed workers and other input suppliers will bid down wages and prices,
and the resulting reduction in production costs shifts the short-run aggregate supply curve to the
right. T
69. Downward wage stickiness may lead to prolonged periods of recession in response to
decreases in aggregate demand by making the economy’s adjustment mechanism slower. T
70. If the economy is currently in a recessionary gap, with output less than potential output, the
price level is higher than workers anticipated. F
71. When aggregate demand increases, workers’ and input suppliers’ purchasing power falls in
the short run; but input suppliers’ purchasing power is restored at a higher price level in the long
run. T
72. The AD/AS model is a precise tool for analyzing the economy. F

Multiple Choice
1. The largest component of aggregate demand is
a. government purchases.
b. net exports.
c. consumption.
d. investment.

2. A reduction in personal income taxes, other things being equal, will
a. leave consumers with less disposable income.
b. decrease aggregate demand.
c. leave consumers with more disposable income.
d. increase aggregate demand.
e. do both c and d.

3. Aggregate demand is the sum of ____________.
a. C _ I _ G
b. C _ I _ G _ X
c. C _ I _ G _ (X _ M)
d. C _ I _ G _ (X _ M)

4. Empirical evidence suggests that consumption ____________ with any ____________.
a. decreases, increase in income
b. decreases, tax cut
c. increases, decrease in consumer confidence
d. increases, increase in income
e. Both a and b are true.

5. Investment (I) includes
a. the amount spent on new factories and machinery.
b. the amount spent on stocks and bonds.
c. the amount spent on consumer goods that last more than one year.
d. the amount spent on purchases of art.
e. all of the above.
6. If private consumption in the United States were 67 percent of GDP, investment were 16
percent, government purchases were 13 percent, exports were 12 percent, and imports were 8
percent, net exports would be equal to ____________ percent of GDP.
a. 4
b. _4
c. 20
d. _20
e. none of the above

7. If our exports of final goods and services increase more than our imports, other things being
equal, aggregate demand will
a. increase.
b. be negative.
c. decrease by the change in net exports.
d. stay the same.
e. do none of the above.

8. The aggregate demand curve
a. is negatively sloped.
b. demonstrates an inverse relationship between the price level and real gross domestic product
demanded.
c. shows how real gross domestic product demanded changes with the changes in the price
level.
d. All of the above are correct.

9. As the price level increases, other things being equal,
a. aggregate demand decreases.
b. the quantity of real gross domestic product demanded increases.
c. the quantity of real gross domestic product demanded decreases.
d. aggregate demand increases.
e. both a and c occur.

10. According to the real wealth effect, if you are living in a period of falling price levels on a fixed
income (that is not indexed), the cost of the goods and services you buy ____________ and your
real income ____________.
a. decreases; decreases
b. increases; increases
c. decreases; remains the same
d. decreases; increases

11. As the price level decreases, real wealth ____________, purchasing power ____________,
and the quantity of RGDP
demanded ____________.
a. increases; decreases; increases
b. increases; increases; increases
c. decreases; decreases; decreases
d. decreases; decreases; increases
e. increases; decreases; decreases

12. As the price level increases, interest rates ____________, investments ____________, and
the quantity of RGDP demanded ____________.
a. decrease; increase; decreases
b. increase; increase; decreases
c. decrease; decrease; increases
d. decrease; increase; increases
e. increase; decrease; decreases

13. What is the open economy effect?
a. If prices of the goods and services in the domestic market rise relative to those in global
markets as a result of a higher domestic price level, consumers and businesses will buy less from
foreign producers and more from domestic producers.
b. People are allowed to trade with anyone, anywhere, anytime.
c. It is the ability of firms to enter or leave the marketplace—easy entry and exit with low entry
barriers.
d. If prices of the goods and services in the domestic market rise relative to those in global
markets as a result of a higher domestic price level, consumers and businesses will buy
more from foreign producers and less from domestic producers, other things being equal.

14. Which of the following helps explain the downward slope of the aggregate demand curve?
a. the real wealth effect
b. the interest effect
c. the open economy effect
d. all of the above
e. none of the above

15. Which of the following will result as part of the interest rate effect when the price level rises?
a. Money demand will increase.
b. Interest rates will increase.
c. The dollar amount of investment will decrease.
d. A lower quantity of real GDP will be demanded.
e. All of the above will result.

16. Which of the following will not decrease when the price level falls?
a. money demand
b. the real interest rate
c. the real level of investment
d. a and b
e. b and c

17. A decrease in the U.S. price level will
a. increase U.S. exports.
b. increase U.S. imports.
c. increase RGDP demanded in the United States.
d. do both a and c.
e. do both b and c.

18. An economic bust or severe downturn in the Japanese economy will likely result in a(n)
a. decrease in U.S. exports and U.S. aggregate demand.
b. increase in U.S. exports and U.S. aggregate demand.
c. decrease in U.S. imports and U.S. aggregate demand.
d. increase in U.S. imports and U.S. aggregate demand.

19. Which of the following will cause consumption and, as a result, aggregate demand to
decrease?
a. a tax increase
b. a fall in consumer confidence
c. reduced stock market wealth
d. rising levels of consumer debt
e. all of the above
20. A massive increase in interstate highway construction will affect aggregate demand through
which sector? Will this change increase or decrease aggregate demand?
a. investment, increase
b. government purchases, increase
c. government purchases, decrease
d. consumption, decrease

21. An increase in government purchases, combined with a decrease in investment, would have
what effect on aggregate demand?
a. AD would increase.
b. AD would decrease.
c. AD would stay the same.
d. AD could either increase or decrease, depending on which change was of greater
magnitude.

22. An increase in consumption, combined with an increase in exports, would have what effect on
aggregate demand?
a. AD would increase.
b. AD would decrease.
c. AD would stay the same.
d. AD could either increase or decrease, depending on which change was of greater magnitude.

23. What would happen to aggregate demand if the federal government increased military
purchases and state and local governments decreased their road-building budgets at the same
time?
a. AD would increase because only federal government purchases affect AD.
b. AD would decrease because only state and local government purchases affect AD.
c. AD would increase if the change in federal purchases were greater than the change in
state and local purchases.
d. AD would decrease if the change in federal purchases were greater than the change in state
and local purchases.

24. If exports and imports both decrease, but exports decrease more than imports,
a. AD would decrease.
b. AD would increase.
c. AD would be unaffected.
d. AD could either increase or decrease.

25. If exports increased and imports decreased,
a. AD would decrease.
b. AD would increase.
c. AD would be unaffected.
d. AD could either increase or decrease.

26. The short-run aggregate supply curve slopes
a. downward because firms can sell more, and hence, will produce more when prices are lower.
b. downward because firms find it costs less to purchase labor and other inputs when prices are
lower, and hence they produce more.
c. upward because when the price level rises, output prices rise relative to input prices
(costs), raising profit margins and increasing production and sales.
d. upward because firms find that it costs more to purchase labor and other inputs when prices
are higher, and hence they must produce and sell more in order to make a profit.

27. If the price level rises, what will happen to the quantity of RGDP produced along the long-run
aggregate supply curve?
a. It will increase.
b. It will usually increase, but not always.
c. Nothing will happen to it.
d. It will decrease.
e. It will usually decrease, but not always.

28. If the price level rises, what happens to the level of real GDP supplied?
a. It will increase in both the short run and long run.
b. It will increase in the short run but not in the long run.
c. It will decrease in both the short run and long run.
d. It will decrease in the short run but not in the long run.
e. It will usually decrease, but not always.

29. What is the typical response of firms to an increase in the price of what they sell, for given
input prices?
a. an increase in output
b. an increase in hiring factors of production
c. an increase in the profit level of firms
d. an increase in employment in the industry
e. all of the above

30. The short run is
a. a time period in which the prices of output cannot change but in which the prices of inputs have
time to adjust.
b. a time period in which output prices can change in response to supply and demand but
in which all input prices have not yet been able to completely adjust.
c. a time period in which neither the prices of output nor the prices of inputs are able to change.
d. any time period of less than a year.

31. The profit effect is explained in the text as follows:
a. When the price level decreases, output prices rise relative to input prices (costs), raising
producers’ short-run profit margins.
b. At equilibrium prices, when costs rise, profit margins are able to float with them and be passed
along.
c. The profit effect is only a long-run phenomenon.
d. When the price level rises, output prices rise relative to input prices (costs), raising
producers’ short-run profit margins.

32. The text’s explanation of the misperception effect for an upward-sloping short-run aggregate
supply curve is based on
a. falling profit margins as the price level rises.
b. rising costs of production as the price level rises.
c. fixed-wage labor contracts.
d. the fact that producers may be fooled into thinking that the relative price of the item
they are producing is rising and as a result increase production.

33. In the short run, a decrease in the price level
a. increases output prices relative to input prices.
b. increases the profit margins of many producers.
c. decreases RGDP supplied.
d. decreases unemployment rates.
e. does none of the above.

34. Which of the following would shift the long-run aggregate supply curve if it changed?
a. the level of capital in the economy
b. the amount of land in the economy
c. the amount of labor in the economy
d. the technology in the economy
e. any of the above

35. The short-run aggregate supply curve will shift to the left, other things being equal, if
a. energy prices fall.
b. technology and productivity increase in the nation.
c. a short-term increase in input prices occurs.
d. the capital stock of the nation increases.

36. An increase in input prices causes
a. the short-run aggregate supply curve to shift outward, which means the quantity supplied at
any price level declines.
b. the short-run aggregate supply curve to shift inward, which means the quantity supplied
at any price level declines.
c. the short-run aggregate supply curve to shift inward, which means the quantity supplied at any
price level increases.
d. the short-run aggregate supply curve to shift outward, which means the quantity supplied at
any price level increases.

37. How will an increase in money wages affect the short-run aggregate supply curve?
a. It will shift left (a decrease in short-run aggregate supply).
b. It will shift left (an increase in short-run aggregate supply).
c. It will shift right (a decrease in short-run aggregate supply).
d. It will shift right (an increase in short-run aggregate supply).

38. An unusual series of rainstorms washes out the grain crop in the upper plains states, severely
curtailing the supply of corn and wheat, as well as soybeans. What effect would this situation
have on aggregate supply?
a. It would shift the SRAS left, but not the LRAS.
b. It would shift both the SRAS and the LRAS left.
c. It would shift the SRAS right, but not the LRAS.
d. It would shift both the SRAS and the LRAS right.

39. Any permanent increase in the quantity of any of the factors of production—capital, land,
labor, or technology—available, will cause
a. the SRAS to shift to the left and LRAS to remain constant.
b. the SRAS to shift to the right and LRAS to remain constant.
c. both SRAS and LRAS to shift to the right.
d. both SRAS and LRAS to shift to the left.

40. Which of the following could be expected to shift the short-run aggregate supply curve
upward?
a. a rise in the price of oil
b. a natural disaster
c. wage increases without increases in labor productivity
d. all of the above

41. A temporary positive supply shock will shift ___________; a permanent positive supply shock
will shift ___________.
a. SRAS and LRAS right; SRAS and LRAS right
b. SRAS but not LRAS right; SRAS and LRAS right
c. SRAS and LRAS right; SRAS but not LRAS right
d. SRAS but not LRAS right; SRAS but not LRAS right

42. A year of unusually good weather for agriculture would
a. increase SRAS but not LRAS.
b. increase SRAS and LRAS.
c. decrease SRAS but not LRAS.
d. decrease SRAS and LRAS.

43. When the price of oil experiences a temporary sharp increase, which curve(s) will shift left?
a. SRAS
b. LRAS
c. neither SRAS nor LRAS
d. both SRAS and LRAS

44. Inflation that occurs as a result of a decrease in aggregate supply is called
a. cost-push.
b. demand-pull.
c. inflationary push.
d. none of the above.

45. Assuming a constant level of aggregate demand, the short-run effects of an adverse supply
shock include
a. an increase in the price level and a decrease in real output.
b. an increase in the price level and an increase in real output.
c. a decrease in the price level and an increase in real output.
d. a decrease in the price level and a decrease in real output.

46. Cost-push inflation occurs when
a. the aggregate demand curve shifts right at a faster rate than short-run aggregate supply.
b. the short-run aggregate supply curve shifts left, while aggregate demand is fixed.
c. the aggregate demand curve shifts left and aggregate supply is fixed.
d. the short-run aggregate supply curve shifts right.

47. A recession could result from
a. a decrease in aggregate demand.
b. an increase in long-run aggregate supply.
c. an increase in aggregate demand.
d. an increase in short-run aggregate supply.
e. none of the above.

48. When SRAS and AD intersect at the natural level of real output, it is
a. a short-run equilibrium and a long-run equilibrium.
b. a short-run equilibrium but not necessarily a long-run equilibrium.
c. just a short-run equilibrium.
d. not necessarily either a short-run equilibrium or a long-run equilibrium.

49. Where SRAS and AD currently intersect at a real output level greater than the natural level of
real output,
a. it is a short-run equilibrium, and real output will tend to fall from its current level as it
adjusts to long-run equilibrium.
b. it is a short-run equilibrium, and real output will tend to rise from its current level as it adjusts to
long-run equilibrium.
c. it is a short-run disequilibrium, and real output will tend to fall from its current level as it adjusts
to long-run equilibrium.
d. it is a short-run disequilibrium, and real output will tend to rise from its current level as it adjusts
to long-run equilibrium.

50. Starting from long-run equilibrium, an increase in aggregate demand will cause
a. an inflationary gap in the short run.
b. a recessionary gap in the short run.
c. an inflationary gap in the short run and long run.
d. a recessionary gap in the short run and long run.
e. neither an inflationary nor a recessionary gap in the short run or the long run.

51. When a recessionary gap occurs,
a. real output exceeds the natural level of output, and unemployment exceeds its natural rate.
b. real output exceeds the natural level of output, and unemployment is less than its natural rate.
c. real output is less than the natural level of output, and unemployment exceeds its
natural rate.
d. real output is less than the natural level of output, and unemployment is less than its natural
rate.

52. Which of the following could begin an episode of demand-pull inflation?
a. an increase in consumer optimism
b. a faster rate of economic growth for a major trading partner country
c. expectations of higher rates of return in investment
d. any of the above
e. none of the above

53. If real output is currently less than the natural level of real output, a decrease in aggregate
demand will
a. make the current inflationary gap larger.
b. make the current inflationary gap smaller.
c. make the current recessionary gap larger.
d. make the current recessionary gap smaller.

54. In the short run, demand-pull inflation
a. increases both unemployment and the price level.
b. increases unemployment but not the price level.
c. increases the price level but not unemployment.
d. decreases unemployment and increases the price level.

55. In a stagflation situation,
a. unemployment increases and the price level increases.
b. unemployment increases and the price level decreases.
c. unemployment decreases and the price level increases.
d. unemployment decreases and the price level decreases.

56. A sharp fall in oil prices will cause a(n) _____________; a sudden increase in the wages
demanded by workers will cause a(n) _____________.
a. recessionary gap; inflationary gap
b. recessionary gap; recessionary gap
c. inflationary gap; inflationary gap
d. inflationary gap; recessionary gap

57. Starting from long-run equilibrium, an increase in aggregate demand
a. causes an inflationary gap.
b. results in a lower price level.
c. increases unemployment.
d. does all of the above.
e. does b and c, but not a.

58. During the self-correction process after a fall in aggregate demand,
a. the price level increases and real output increases.
b. the price level increases and real output decreases.
c. the price level decreases and real output increases.
d. the price level decreases and real output decreases.

59. Which of the following can contribute to slowing the adjustment to a recessionary gap?
a. efficiency wages
b. the minimum wage
c. menu costs
d. all of the above
e. b and c, but not a

60. An unexpected increase in aggregate demand will
a. increase real wages in the short run but not the long run.
b. increase real wages in the short run and long run.
c. decrease real wages in the short run but not the long run.
d. decrease real wages in the short run and long run.

Problems
1. Describe what the effect on aggregate demand would be, other things being equal, if
a. exports increase. increase
b. both imports and exports decrease. indeterminate
c. consumption decreases. decrease
d. investment increases. increase
e. investment decreases and government purchases increase. indeterminate
f. the price level increases. No change (change in quantity of RGDP demanded)
g. the price level decreases. No change (change in quantity of RGDP demanded)

2. Fill in the blanks in the following explanations:
a. The real wealth effect is described by the following: An increase in the price level leads to a(n)
__decrease__ in real wealth, which leads to a(n) __decrease__ in purchasing power, which
leads to a(n) __decrease__ in RGDP demanded.
b. The interest rate effect is described by the following: A decrease in the price level leads to a(n)
__decrease__ in the interest rate, which leads to a(n) __increase__ in investments, which leads
to a(n) __increase__ in RGDP demanded.
c. The open economy effect is described by the following: An increase in the price level leads to
a(n) __decrease__ in the demand for domestic goods, which leads to a(n) __decrease__ in
RGDP demanded.

3. How will each of the following changes alter aggregate supply?
                                                             Short-Run                 Long-Run
Change                                                    Aggregate Supply         Aggregate Supply
An increase in aggregate demand                           no change                no change
A decrease in aggregate demand                            no change                no change
An increase in the stock of capital                       increase (shift right)   increase (shift right)
A reduction in the size of the labor force                decrease (shift left)    decrease (shift left)
An increase in input prices (that does not reflect
  permanent changes in their supplies)                    decrease (shift left)    no change
A decrease in input prices (that does reflect permanent
  changes in their supplies)                              increase (shift right)   increase (shift right)
An increase in usable natural resources                   increase (shift right)   increase (shift right)
A temporary adverse supply shock                          decrease (shift left)    no change
Increases in the cost of government regulations           decrease (shift left)    decrease (shift left)



4. Use the accompanying diagram (from page 715) to answer questions a and b.
a. On the exhibit provided, illustrate the short-run effects of an increase in aggregate demand.
What happens to the price level, real output, employment, and unemployment?




The price level increases, real output increases, employment increases, and
unemployment decreases.

b. On the exhibit provided, illustrate the long-run effects of an increase in aggregate demand.
What happens to the price level, real output, employment, and unemployment?




The price level ends up higher, real output ends up back where it began at potential
output, employments ends up back at where it began at full employment, and
unemployment ends up back where it began at natural rate of unemployment.

5. Use the accompanying diagram (from page 716) to answer questions a and b.
a. On the exhibit provided, illustrate the short-run effects of a decrease in aggregate demand.
What happens to the price level, real output, employment, and unemployment?




The price level falls, real output falls, employment falls, and unemployment rises.

b. On the exhibit provided, illustrate the long-run effects of a decrease in aggregate demand.
What happens to the price level, real output, employment, and unemployment?




The price level ends up lower, real output ends up back where it began at potential output,
employment ends up back where it began at full employment, and unemployment ends up
back where it began at the natural rate of unemployment.

6. Use the accompanying diagram (from page 716) to answer questions a and b.
a. Illustrate a recessionary gap on the diagram provided.




b. Using the results in a, illustrate and explain the eventual long-run equilibrium in this case.




In the long run, the price level will end up lower than before, but real output and
unemployment will return to their initial long-run equilibrium levels.

7. Use the accompanying diagram (from page 716) to answer questions a and b.




a. Illustrate an inflationary gap on the diagram provided.
b. Using the results in a, illustrate and explain the eventual long-run equilibrium in this case.




In the long run, the price level will end up higher than before, but real output and
unemployment will return to their initial long-run equilibrium levels.

8. If retailers such as Wal-Mart and Target find that inventories are rapidly being depleted, would
it have been caused by a rightward or leftward change in the aggregate demand curve? What are
the likely consequences for output and investment? A rapid depletion of inventories is
consistent with a rightward shift of the aggregate demand curve. As a result of an increase
in aggregate demand, both output and investment are likely to increase.

9. Evaluate the following statement: “A higher price level decreases the purchasing power of the
dollar and reduces RGDP.” The statement is correct. A higher price level reduces the
quantity of goods and services that can be purchased with a U.S. dollar. Exports will
decrease, since a higher U.S. price level makes it relatively more expensive for foreign
consumers to purchase U.S. goods. At the same time, imports will increase, since, faced
with higher prices at home, more U.S. residents will buy imported goods. Net exports,
and therefore real GDP demanded, decrease.

10. How does a higher price level in the U.S. economy affect purchases of imported goods?
Explain. A higher price level in the U.S. makes it more expensive for domestic consumers
to purchase goods produced at home. As a result, domestic consumers turn toward
foreign-produced substitutes, increasing imports.

11. Explain how a recession in Latin America may affect aggregate demand in the U.S. economy.
A recession in Latin America will reduce the incomes of Latin Americans. As a result, Latin
Americans will buy fewer U.S. goods and services, decreasing U.S. exports and aggregate
demand.

12. You operate a business in which you manufacture furniture. You are able to increase your
furniture prices by 5 percent this quarter. You assume that the demand for your furniture has
increased and begin increasing furniture production. Only later do you realize that prices in the
macroeconomy are rising generally at a rate of 5 percent per quarter. This is an example of what
effect? What does it imply about the slope of the short-run aggregate supply curve? This is an
example of the misperception effect. The misperception effect implies an upward sloping
supply curve.

13. Distinguish cost-push from demand-pull inflation. Provide an example of an event or shock to
the economy that would cause each. Cost-push inflation occurs when the short-run
aggregate supply curve shifts to the left, pushing up prices. Demand-pull inflation occurs
when the aggregate demand curve shifts to the right, pulling up prices. Examples will
vary. Cost-push inflation may be caused by an increase in input prices, such as the price
of crude oil or wages. Demand-pull inflation may be caused by an increase in consumer
confidence or a decrease in taxes.

14. Is it ever possible for an economy to operate above the full-employment level in the short
term? Explain. Yes, an economy may operate above full employment in the short-run by
using its resources more intensively. Firms encourage workers to work overtime, extend
the hours of part-time workers, hire recently retired employees, or reduce frictional
unemployment through more extensive searches for employees. However, this level of
output and employment cannot be sustained in the long run.

								
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