Download Macro – Unit 3 – Short Answer Essay Practice Questions

Macro – Unit 3 – Short Answer Essay Practice Questions
3. Some economists claim that investment spending is more
important than consumption spending in causing changes in
the business cycle. However, investment spending is only
one-fourth of consumption spending. Explain why
investment spending can be so important if it is so much
less than consumption spending.
Decisions regarding investment spending are a marginal
cost-marginal benefit analysis. The benefit is the
expected rate of return from the planned investment in
capital and the cost is the rate of interest to borrow or lose
from using saved funds. Investment spending is the
unstable component of aggregate demand. Investment
does not closely follow GDP, yet investment in capital
goods provides the seeds of productivity gains, the
implementation of technological advances and future
increases in output. New investment increases the longrun aggregate supply curve and allows for more capacity.
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4. In 1981, factories used 79 percent of their capacity. In
1982, factories used 71 percent of their capacity. In which
year do you think the economy was on a steeper portion of
its short-run aggregate supply curve? Explain.
The economy would be on the steeper part of the
aggregate-supply curve in 1981 at a 79 percent capacity
utilization rate. The economy would be approaching the
potential level of output. In 1982, with a 71 percent
capacity utilization rate, the economy would be further
away from potential GDP. In addition, the price level was
probably rising faster in 1981 than in 1982 because as the
economy nears full-employment (potential GDP),
pressure on prices increases.
A typical short-run aggregate supply curve
Price level
AS
AD4
O
Y1
Y2
AD3
AD2
AD1
Y3
Y4
YP
National output
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6. A town’s largest industry invests $50 million to expand
its plant capacity. Without using a formula, explain how
this expenditure will affect the town’s economy through the
multiplier effect.
Suppose that the plant expansion takes the form of adding
a new building. Local construction firms will supply the
labor for the construction and hence their incomes
increase as do the number of laborers hired to build the
new plant. In turn these people spend part of their new
income in town to buy food and other consumer products.
The incomes of stores increase and store owners in turn
spend a proportion of their income and the process
continues multiplying the initial $50 million expenditure.
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7. Throughout most of the decade of the 1990’s, gains were
made in productivity. What effect do these yearly gains
have on the short-run aggregate supply curve? Is there any
change in long-run aggregate supply?
Gains in productivity shift the short-run aggregate supply
curve to the right. In turn, the long-run aggregate supply
curve also shifts to the right.
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