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Principles of Economics II – Macroeconomics
Homework: Ch 32~34
Book Questions (6th Edition only!)
Questions for Ch32: 1, 5, 6
Questions for Ch33: 1, 2, 6
Questions for Ch34: 1, 3, 11
Ch 32: 1, 5, 6
1. a. If Congress passes an investment tax credit, it subsidizes domestic investment. The desire to
increase domestic investment leads firms to borrow more, increasing the demand for loanable funds,
as shown in Figure 5. This raises the real interest rate, thus reducing net capital outflow. The
decline in net capital outflow reduces the supply of dollars in the market for foreign exchange,
raising the real exchange rate. The trade balance also moves toward deficit, because net capital
outflow, hence net exports, is lower. The higher real interest rate also increases the quantity of
national saving. In summary, saving increases, domestic investment increases, net capital outflow
declines, the real interest rate increases, the real exchange rate increases, and the trade balance
moves toward deficit.
b. A rise in the real exchange rate reduces exports.
Figure 5
5. An export subsidy increases net exports at any given real exchange rate. This causes the demand for dollars to shift to
the right in the market for foreign exchange, as shown in Figure 8. The effect is a higher real exchange rate, but no
change in net exports. So the senator is wrong; an export subsidy will not reduce the trade deficit.
Figure 8
6. a. When the French develop a strong taste for California wines, the demand for dollars in the
foreign-currency market increases at any given real exchange rate, as shown in Figure 7.
b. The result of the increased demand for dollars is a rise in the real exchange rate.
c. The quantity of net exports is unchanged.
Figure 7
Questions for Ch33: 1, 2, 6
1. a. When the United States experiences a wave of immigration, the labor force increases, so longrun aggregate supply shifts to the right.
b. When Congress raises the minimum wage to $10 per hour, the natural rate of unemployment
rises, so the long-run aggregate-supply curve shifts to the left.
c. When Intel invents a new and more powerful computer chip, productivity increases, so long-run
aggregate supply increases because more output can be produced with the same inputs.
d. When a severe hurricane damages factories along the East Coast, the capital stock is smaller, so
long-run aggregate supply declines.
2. a. The current state of the economy is shown in Figure 6. The aggregate-demand curve and
short-run aggregate-supply curve intersect at the same point on the long-run aggregate-supply
curve.
b. A stock market crash leads to a leftward shift of aggregate demand. The equilibrium level of
output and the price level will fall. Because the quantity of output is less than the natural rate of
output, the unemployment rate will rise above the natural rate of unemployment.
c. If nominal wages are unchanged as the price level falls, firms will be forced to cut back on
employment and production. Over time as expectations adjust, the short-run aggregate-supply
curve will shift to the right, moving the economy back to the natural rate of output.
6. a. The statement that "the aggregate-demand curve slopes downward because it is the horizontal
sum of the demand curves for individual goods" is false. The aggregate-demand curve slopes
downward because a fall in the price level raises the overall quantity of goods and services
demanded through the wealth effect, the interest-rate effect, and the exchange-rate effect.
b. The statement that "the long-run aggregate-supply curve is vertical because economic forces do
not affect long-run aggregate supply" is false. Economic forces of various kinds (such as population
and productivity) do affect long-run aggregate supply. The long-run aggregate-supply curve is
vertical because the price level does not affect long-run aggregate supply.
c. The statement that "if firms adjusted their prices every day, then the short-run aggregatesupply curve would be horizontal" is false. If firms adjusted prices quickly and if sticky prices were
the only possible cause for the upward slope of the short-run aggregate-supply curve, then the
short-run aggregate-supply curve would be vertical, not horizontal. The short-run aggregate
supply curve would be horizontal only if prices were completely fixed.
d. The statement that "whenever the economy enters a recession, its long-run aggregate-supply
curve shifts to the left" is false. An economy could enter a recession if either the aggregatedemand curve or the short-run aggregate-supply curve shifts to the left.
Questions for Ch34: 1, 3, 11
1. a. When the Fed’s bond traders buy bonds in open-market operations, the money-supply curve
shifts to the right from MS 1 to MS 2, as shown in Figure 1. The result is a decline in the interest
rate.
Figure 1
Figure 2
b. When an increase in credit card availability reduces the cash people hold, the money-demand
curve shifts to the left from MD 1 to MD 2, as shown in Figure 2. The result is a decline in the
interest rate.
c. When the Federal Reserve reduces reserve requirements, the money supply increases, so the
money-supply curve shifts to the right from MS 1 to MS 2, as shown in Figure 1. The result is a
decline in the interest rate.
d. When households decide to hold more money to use for holiday shopping, the money-demand
curve shifts to the right from MD 1 to MD 2, as shown in Figure 3. The result is a rise in the interest
rate.
Figure 3
e. When a wave of optimism boosts business investment and expands aggregate demand, money
demand increases from MD 1 to MD 2 in Figure 3. The increase in money demand increases the
interest rate.
3. a. The increase in the money supply will cause the equilibrium interest rate to decline, as shown
in Figure 4. Households will increase spending and will invest in more new housing. Firms too will
increase investment spending. This will cause the aggregate demand curve to shift to the right as
shown in Figure 5.
Figure 5
b. As shown in Figure 5, the increase in aggregate demand will cause an increase in both output and
the price level in the short run.
c. When the economy makes the transition from its short-run equilibrium to its long-run equilibrium,
short-run aggregate supply will decline, causing the price level to rise even further.
d. The increase in the price level will cause an increase in the demand for money, raising the
equilibrium interest rate.
e. Yes. While output initially rises because of the increase in aggregate demand, it will fall once
short-run aggregate supply declines. Thus, there is no long-run effect of the
increase in the money supply on real output.
11. a. Tax revenue declines when the economy goes into a recession because taxes are closely
related to economic activity. In a recession, people's incomes and wages fall, as do firms' profits, so
taxes on these things decline.
b. Government spending rises when the economy goes into a recession because more people get
unemployment-insurance benefits, welfare benefits, and other forms of income support.
c. If the government were to operate under a strict balanced-budget rule, it would have to raise tax
rates or cut government spending in a recession. Both would reduce aggregate demand, making the
recession more severe.