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Solutions to Problems
Chapter 23
1a. An increase in the money supply will reduce interest rates and, all other things being equal, the lower interest rates will
encourage firms and households to borrow more, lend less and increase spending on durable goods. The increased spending on
durable goods is an increase in aggregate demand.
1b. The significance of a slowdown in the rate of technological change is it slows down increases in the productivity of labour and
capital with smaller consequent increases in longrun and short-run aggregate supply (smaller movement to the right the LAS
and SAS curves). This is a movement along the AD curve. Students could argue that there would be a slower growth in
aggregate demand as well (a smaller rightward movement of the AD curve), because firms and households will not have as many
new technology goods to spend their money on.
1c. The increase in award wages rate increases business costs and at any given price level reduces profitability. In the short run there
will be a reduction in aggregate supply and an increase in unemployment. The SAS curve moves to the left.
1d. An increase in immigration could be expected to increase both long run and short run aggregate supply and aggregate demand.
The increased size of the population increases total demand for goods and services (the AD curve shifts to the right) and the
larger potential workforce increases potential real GDP (a rightward shift of the LAS/SAS curves). The larger supply of labour
could lower wage rates as well, and this has the potential further increase short run aggregate supply.
3a. Refer to figure 1.
A severe recession in the Japanese economy will reduce equilibrium real GDP and cause a fall in the price level.
In recession the Japanese economy will demand less Australian exports and cause a fall in Australian aggregate demand; the AD
curve moves from AD0 to AD1. Equilibrium real GDP will decrease and the price level will fall as the economy moves
equilibrium a to equilibrium c.
Expectations of higher profits will increase equilibrium real GDP and increase the price level.
When businesses expect huge profits in the near future, they will increase investment now and Aggregate demand will increase.
The aggregate demand curve will shift rightward from AD0 to AD2, real GDP will increase and the price level will fall.
An across-the-board pay increase will decrease equilibrium real GDP and increase the price level.
The higher wages increase business costs and reduce short-run aggregate supply, the short-run aggregate supply curve shifts
leftward from SAS0 to SAS1. Real GDP decreases and the price level rises as equilibrium moves from a to d.
3b. Real GDP will decrease and the price level will rise.
The fall in external demand due to the Japanese recession is offset by the increase in domestic demand from the higher levels of
investment. So together there will be little impact on real GDP and prices from changes in aggregate demand. The increase in
wages will lead to a rise in the price level and a fall in real GDP. So together, the price level will rise and there will be a fall in
short run equilibrium real GDP. The economy will move from a to d in figure 1.
3c. Equilibrium d in figure 1 is below potential real GDP and so unemployment will be above the natural rate. To increase aggregate
demand, the government might increase its expenditures or cut taxes and the Reserve Bank might increase the quantity of money
and decrease interest rates. These policies will increase real GDP and return the economy to full employment.
Problem 2
Price level
Problem 1
LAS
SAS0
• a
•
c
•
d
LAS1
Price level
SAS1
LAS0
SAS1
c
•b
•
•
a
•
SAS0
SAS2
b
AD1
•d
AD0
AD2
AD0
AD1
Real GDP
Real GDP
Figure 1
Figure 2
5a. The aggregate demand curve and the short-run aggregate supply curve have been plotted in figure 4.
5b. Equilibrium real GDP is $400 billion, and the price level is 100.
Short-run macroeconomic equilibrium occurs at the intersection of the aggregate demand curve and the short-run aggregate
supply curve.
5c
The long-run aggregate supply curve is a vertical line at real GDP of $500 billion.
5d. Since short run equilibrium real GDP is less than long run real GDP, unemployment is above its natural rate.
Miniland – Problem 6&8
LAS
Price level
Price level
Mainland – Problem 5&7
160
SAS
140
LAS
SAS
180
160
140
120
b
a
•
100
•
120
a
b
•
•
100
80
AD1
AD0
60
AD0
80
AD1
60
40
0
0
250
300
350
400
450
500
550
600
Real GDP($ billions)
7.
100 150 200 250 300 350 400 450 500 550 600
Real GDP($ billions)
Real GDP increases to $450 billion, and the price level rises to 110.
Aggregate demand increases by $100 billion at each value of the price level, and the aggregate demand curve shifts rightward by
$100 billion from AD0 to AD1. The new aggregate demand curve intersects the short-run aggregate supply curve at a real GDP of
$450 billion and a price level of 110 (see figure 3).
9b. The equilibrium point is point d.
The short-run aggregate supply curve is the red curve SAS1. The aggregate demand curve is now the red curve AD1 These curves
intersect at point d.
9c. Aggregate demand increases if (1) expected future incomes, inflation, or profits increase; (2) the government increases its
expenditures or reduces taxes; (3) the central bank increases the quantity of money and decrease interest rates; or (4) the
exchange rate decreases or there is an increase in foreign capital inflow.
9d. Short-run aggregate supply decreases if resource prices increase.