Download answer key

Unit 3/Macroeconomics
ACTIVITY 21 ANSWER KEY (Keynesian)
Full Employment in a Capitalist Economy
1. Do business-cycle fluctuations occur as a result of external or internal factors?
Explain. Both external and internal. Level of output depends on level of AE,
which is affected by internal and external factors.
2. Are periods of economic instability temporary, or can they be of long duration?
They vary and can be of long duration. Unemployment can be sustained for
an indefinite period of time.
3. Identify and explain the main determinant of the level of output and employment
in the economy.
The level of AD or AE. If income increases, consumers will buy more, and
producers will produce more. If income declines, however, consumers will
fail to purchase the output produced, and producers will cut back.
4. If people save their income instead of spending it, what will be the effect on the
level of output and employment? Will interest rates automatically equate the leakage of saving with an injection of investment spending by business firms? Explain
why or why not.
Some output will not be purchased, and producers will cut back. Interest
rates will not automatically adjust. Because savers and investors are different people.
5. Are wages and prices downwardly flexible in the event of decreases in aggregate
demand? Explain why or why not.
Wages and prices are not downwardly flexible. Because of collective bargaining agreements between unions and management, which have some
monopoly power.
6. Does a capitalist economy contain inherent self-adjusting mechanisms that assist it
in achieving and sustaining full-employment levels of output?
No because interest rates, wages, and prices are inflexible.
7. What should be the proper role of government in the capitalist economy? Explain why.
Because the capitalist economy cannot adjust itself automatically, government must have demand-management policies to maintain a full-employment level of output.
8. Describe the shape of the aggregate supply curve. Illustrate how the shape of the AS
curve explains, in the event of changing aggregate demand, the conclusion drawn
in question 6.
Horizontal. The AS curve is horizontal
which means changes in AD affect
output but do not affect the price level.
-AS
AD2
Real national output (GDP)
409
Unit 3/Macroeconomics
ACTIVITY 22 ANSWER KEY (Classical)
Full Employment in a Capitalist Economy
1. Do business cycle fluctuations occur as a result of external or internal factors?
Explain.
External. Caused by temporary abnormalities such as wars and natural disasters.
The capitalist economy will automatically readjust after one of these events.
2. Are periods of economic instability temporary, or can they be of long duration?
They are temporary. In the long run, the economy will self-adjust.
3. Identify and explain the main determinant of the level of output and employment
in the economy.
"Supply creates its own demand." If AD declines, the economy must only
produce output to maintain employment; the act of producing output generates the exact amount of income necessary to purchase the output.
4. If people save their income instead of spending it, what will be the effect on the
level of output and employment? Will interest rates automatically equate the leakage of saving with an injection of investment spending by business firms? Explain
why or why not.
Output will not decline. Yes. The mechanism of interest rates maintains an
equilibrium between savings and investment. If consumers save more, interest rates will fall and businesses will invest more. If saving declines, interest
rates will rise and business investment will decline.
5. Are wages and prices downwardly flexible in the event of decreases in aggregate
demand? Explain why or why not.
Yes. If AD falls, wages fall. If wages fall, price falls. Lower prices will be an
incentive for consumers to buy more which will increase AD.
6. Does a capitalist economy contain inherent self-adjusting mechanisms that assist it
in achieving and sustaining full-employment levels of output?
Yes because interest rates, wages, and prices are flexible.
7. What should be the proper role of government in the capitalist economy? Explain why.
There is no need for government intervention in the economy because of
the economy's self-regulating mechanisms. Government involvement in the
economy may, in fact, interfere with the self-regulating mechanisms and
thereby cause instability.
8. Describe the shape of the aggregate supply curve. Illustrate how the shape of the AS
curve explains, in the event of changing aggregate demand, the conclusion drawn
in question 6.
Vertical.
The AS curve is vertical which means
changes in AD affect the price level and
not output. The economy automatically
adjusts to full employment.
Real national output (GDP)
410
4
Unit 3/Macroeconomics
ACTIVITY 23 ANSWER KEY
Classical and Keynesian Views of the Economy
Part A. The Classical View
1. According to the classical theory, equilibrium is always at full employment. Flexible wages, prices, and interest rates always bring the economy
back to full employment.
2. The price level will increase, but real national output will not change.
According to the classical theory, increases in AD increase the price level
only.
3. The price level will decrease, but output will stay the same. LRAS will
determine the full-employment level of real national output while AD will
establish the price level.
4. At full employment, output cannot increase regardless of changes in AD
because the full amount of resources is already provided. However, LRAS
can increase with sound growth policies.
Part B. The Keynesian View
1. Because resources are unemployed, increases in AD will result in a higher
real national output without an increase in the price level.
2. The simple Keynesian model assumes the price level is fixed. This is not
realistic because at least some inflation occurred every year with the
exception of the Great Depression years.
3. Output will increase, but the price level will be unchanged. Output will
increase as more resources are employed. Because unemployed resources
are used, there will not be any upward pressure on prices.
4. Output will decrease, and the price level will be unchanged. With insufficient AD, resources become unemployed. Because prices and wages are
downwardly rigid or inflexible, there will be no automatic adjustment
back to full employment.
5. It is more likely to be horizontal during periods of unemployment because
increases in AD will cause unemployed resources to be used instead of
putting upward pressure on prices.
6. There are unemployed resources (land, labor, capital).
Part C.
Answers will vary.
411