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Business Learning Center – Econ 102 (Eudey) – Chapter 9 (Keynesian AD/AS Model)
Tutor: Kanit Kuevibulvanich
This week, you will learn:
- Keynesian Economics: Assumptions, consequences, comparison to Classical economics
- Aggregate Demand: Definition, derivation, slopes, MPC/MPS, multiplier, shifts, movement
- Short-run and Long-run Aggregate Supply: Definition, derivation, shifts, movement
- Equilibrium: Short-run vs long-run equilibrium, unemployment rate, output, price level
Keynesian Economics
1. What is the disagreement between Classical and Keynesian Economists about prices?
The Foundation of Aggregate Demand and Aggregate Supply
1. Explain why the aggregate demand (AD) is downward-sloping.
i. Wealth effect
ii. Interest rate effect
iii. International trade effect
2. What are the factors that causes the shift of AD?
3. Explain why the short-run aggregate supply (SRAS) curve is upward-sloping when wages
are sticky. What are the determinants of SRAS?
4. What are the factors that causes the shift of SRAS?
5. Explain why the long-run aggregate supply (LRAS) curve is vertical. What is the determinant
of LRAS?
6. What are the factors that causes the shift of LRAS?
7. Keynesian economists think that SRAS is [ vertical / upward-sloping ], whereas Classical
economists think it is [ vertical / upward-sloping ].
8. Keynesian economists think that LRAS is [ vertical / upward-sloping ], whereas Classical
economists think it is [ vertical / upward-sloping ].
Multiplier
1. Write down the formula for the multiplier.
2. If your consumption increases by $750 when your income increases by $1,000, then your
marginal propensity to consume is __________ and marginal propensity to save is __________.
3. Explain the effect of the following variables on consumption
i. Income
ii. Household wealth
iii. Price level
iv. Interest rate
4. Suppose you need to consume the minimum of $10,000 each year to survive, but for every
$100 increase in your disposable income, your consumption increases by $80. Write down the
consumption function.
5. If savings are $5,000 when GDP is $15,000, and $7,000 when GDP is $20,000, then the MPC is
____________ and MPS is _____________.
6. For each of the following MPCs, fill in the blanks.
MPC Multiplier MPS A $1 increase in autonomous To change GDP by $1, the
part of C, I or G will increase autonomous part of C, I or G
GDP by
must change by
0.95
10
0.2
$4
0.6
$0.5
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Business Learning Center – Econ 102 (Eudey) – Chapter 9 (Keynesian AD/AS Model)
Tutor: Kanit Kuevibulvanich
7. Suppose the government expenditure decreases by $300 billion and the MPC is 0.8, what is
the expected shift in AD curve?
8. Suppose the government needs to increase the aggregate demand by $400 billion and the MPS
is 0.25, then the government must increase her expenditure by ________________.
Application of Aggregate Demand and Aggregate Supply in Sticky Wages
1. Illustrate the long-run equilibrium in the AD/AS model.
2. Analyze how the AD, SRAS or LRAS shifts in the following scenarios:
i. An increase in government spending
ii. A decrease in consumer and business confidence
iii. An increase in demand for our goods by foreigners
iv. A decrease in oil price used in production
v. An increase in wage
vi. Improvement in productivity
vii. Destruction of capital stock
3. If prices go up, Keynesian economists would [ agree / disagree ] that GDP will increase in the
long run. Explain.
4. Suppose the economy is initially in the equilibrium operating above the potential GDP. Is this
economy in the long-run equilibrium? If not, graphically and verbally explain what would
happen towards the long run.
5. Suppose the economy is initially in the equilibrium operating below the potential GDP,
graphically and verbally explain what would happen towards the long run.
6. Suppose the economy is initially in the long-run equilibrium and assume that the wage is
sticky. In each of the following cases:
- Graphically analyze the effect towards short-run and long-run equilibrium GDP, price
level and unemployment.
- Clearly mark the short-run and long-run equilibrium points on the graph.
i. Negative concerns by investors towards the economic prosperity
ii. Large increase in government spending
iii. Oil shock (also known as cost-push inflation and results in stagflation, explain)
iv. New discovery of shale oil drops the oil price to record low
v. The increase in capital stock and/or technological progress
7. Compare and contrast your findings on the effects of an increase in government spending
when the wage is flexible and sticky. Clearly explain the short-run and long-run effects in
each case of wage rigidity.
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