Download Principles to be Learned

Assignment 2: Aggregate Supply and Aggregate Demand
Reading: Economics for Today, 3rd edition, Irvin B. Tucker, Chapter 20
Due Date:
February 8, 2004 by 6:00 PM
General Instructions:
The homework assignment is designed to help you understand the material. Some of the
questions are easy, others are more difficult. You are expected to complete the
assignment in your group without help from other class members or any of the faculty.
Once you have answered all the questions, please send them as an attachment to me at the
following e-mail address: [email protected]. Your grade will be
determined by the accuracy and completeness of your answers as well as the quality of
your presentation.
Principles to be Learned
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Aggregate demand is the quantity of real gross domestic product, GDP, demanded
at each price level.
“Price” in the model is the overall price level in the economy, not the price of a
particular good or service.
The aggregate demand curve is downward sloping, so a fall in the overall price
level will be accompanied by an increase in the amount of goods and services
demanded.
A change in the price level is reflected by a movement along the aggregate
demand curve.
Factors that can shift aggregate demand are: consumption and investment
spending, government expenditures and taxes, and a change in the money supply.
The short-run aggregate supply curve depicts the relationship between an
economy’s supply of goods and services and its overall price level in the shortrun. Short-run aggregate supply curves typically are upward sloping.
The long-run aggregate supply curve depicts the relationship between an
economy’s supply of goods and services and its overall price level in the long-run.
The long-run aggregate supply curve is vertical. In the long-run, all resources are
fully employed so increases in prices cannot elicit more output.
A change in the price level is reflected by a movement along the aggregate supply
curve.
Factors that can shift the aggregate supply curve include: changes in input costs,
political events that impose supply constraints, natural disasters, and changes in
the weather.
Short-run equilibrium occurs where the AD and SRAS curves intersect. At this
point, the quantity of goods and services demanded equals the quantity supplied.
Technical Details to be Mastered
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Distinguish between a movement along the aggregate demand curve or aggregate
supply curve and a shift of either curve.
Learn how to shift the aggregate demand and aggregate supply curves.
Understand how to determine equilibrium in the aggregate demand and aggregate
supply model and move from one equilibrium point to another.
Calculate the spending multiplier.
Strategies for Learning
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Be sure to practice shifting the aggregate demand curve and the aggregate supply
curve.
Pay special attention to the difference between shifts in aggregate supply and
aggregate demand and movements along the curves.
Be sure to learn which variables shift the aggregate demand curve and which shift
the aggregate supply curve.
Assignment:
1.
What are the components of aggregate demand?
2.
Explain why the aggregate demand curve slopes down.
3.
Draw a typical downward sloping aggregate demand curve and do the following:
a.
Demonstrate an increase in aggregate demand and a decrease in aggregate
demand. List the causes of a change in aggregate demand.
b.
Differentiate between a shift in the aggregate demand curve and a
movement along the curve. Give examples to illustrate your answer
4.
Discuss the conditions that must exist for aggregate supply curves to be
horizontal, upward sloping or vertical.
5.
Draw a typical short-run aggregate supply curve and do the following:
a.
Demonstrate an increase in aggregate supply and a decrease in aggregate
supply. List the causes of a change in aggregate supply.
b.
Differentiate between a shift in the aggregate supply curve and a
movement along the curve. Give examples to illustrate your answer.
6.
Define the concept of equilibrium. Draw a typical aggregate demand and
aggregate supply model and do the following:
a.
Determine the equilibrium price level and level of output.
b.
Explain what happens if the economy is not at equilibrium; i.e., if output is
greater than equilibrium output or less than equilibrium output?
c.
What would have to happen so that the economy could return to
equilibrium?
7.
For each of the theories for the slope of the short-run aggregate supply curve,
explain the following:
a.
b.
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How does the economy recover from a recession and return to its long-run
equilibrium without any policy intervention on the part of the
government?
What determines the speed of that recovery?
Suppose that firms become very optimistic about future business conditions and
invest heavily in new capital equipment.
a.
Use the aggregate demand/aggregate supply model to show the short-run
effect of this optimism on the economy. Assume the economy was at full
employment of resources when the new investment spending occurred.
Label the new levels of price and output. Explain in words how and why
the aggregate quantity of output supplied changes in the short-run.
b.
Now, use the model from part (a) to find the new long-run equilibrium of
the economy. (For now, assume there is no change in the long-run
aggregate supply curve.) Explain in words why the aggregate quantity of
output demanded changes between the short run and the long run
equilibrium positions.
c.
How might the investment boom affect the long run aggregate supply
curve in the long-run? Explain.
Application:
1.
Draw a typical aggregate demand and aggregate supply for the U.S. economy.
Each of the events described in Table 1 occurred in the U.S. economy in the past.
Indicate whether the event caused an increase, decrease, or no change in the
following:
a.
Aggregate demand (shift in AD)
b.
Aggregate supply (shift in AS)
c.
Aggregate demand (movement along AD)
d.
Aggregate supply (movement along AS)
e.
Equilibrium price level
f.
Equilibrium level of income
Table 1
An increase in the productivity of factor inputs.
An increase in corporate investment.
An increase in U.S. exports of 50%, coupled with an increase in imports of 75% over the
same period.
A 40% increase in the Dow Jones Industrial Average.
An increase in federal spending.
An increase in government taxes on households at all levels.
A decrease in the availability of oil and other important natural resources.
An increase in corporate bullishness about the future.
A decrease in the corporate income tax
An increase in consumer confidence about the future.
A boom in residential construction.
An increase in the number of immigrants working in the country.
Example: An increase in corporate investment.
Aggregate demand (shift in AD)
Investment is a component of aggregate demand. An increase in investment shifts AD to
the right.
Aggregate supply (shift in AS)
There is no shift in aggregate supply. The capital stock of the United States is
approximately 2.5 times larger than GDP. Investment in any one year has a negligible
affect on aggregate supply. However, if the investment continues over time, the
aggregate supply curve shifts to the right.
Aggregate demand (movement along AD)
There is no movement along the AD curve. The change in investment is an example of
an exogenous change that shifts the curve. To move along the curve, the price level
would have to be the initiating event.
Aggregate supply (movement along AS)
To reach the new equilibrium, we move up along the AS curve. Aggregate demand has
increased. To meet the new, higher level of demand, aggregate supply must also
increase. Aggregate supply increases as the price level rises.
Equilibrium price level
The new equilibrium price level is higher.
Equilibrium level of income
The new equilibrium level of income is higher.