Download CHAPTER SIX Answers to Self Test Questions - McGraw

CHAPTER SIX
Answers to Self Test Questions
1.
A drop in the price level increases the value of real balances, implying an increase in wealth which will
cause an increase in consumption (real balance effect). In addition, a drop in the price level will lower
interest rates thereby cutting the cost of borrowing for firms, which will cause an increase in investment
(interest rate effect). Finally, a drop in Canadian prices will make our products more attractive abroad
and make foreign products relatively more expensive in Canada, so that net exports will increase (foreign
trade effect).
2.
A) Equilibrium price level is 100 and equilibrium GDP is $1100.
B) At a 4price level of 95, there would be a shortage of $125 since aggregate quantity demanded
exceeds the aggregate quantity supplied by this much. At a price level of 115, there would be a
surplus of $270 since the aggregate quantity supplied exceeds the aggregate quantity demand by
this amount.
3.
F) and G) will cause an increase in aggregate demand and cause it to shift right. A), D), and E) will cause
a decrease in aggregate demand and cause it to shift left. B), C), and H) do not change aggregate demand
but instead lead only to a movement up or down on the aggregate demand curve.
4.
A) and B); See Figure AK 15
Figure AK 15
5.
D), E), and G) will all cause both the long- and short-run supplies to increase and the curves to shift right.
A) will cause an increase in the short-run supply only (right shift); B), C), and F) will cause a decrease in
the short-run supply only (left shift).
6.
A)
B)
7.
When both the short- and long-run aggregate supplies increase, in order to sell increased quantities with
the aggregate demand unchanged, the price level is forced down, which will discourage some suppliers
from producing at capacity outrput.
8.
A)
Equilibrium price level is 105; equilibrium GDP is $1800.
Equilibrium price level is 95; equilibrium GDP is $1700.
Equilibrium price level is 110; equilibrium GDP is $1500; this is full employment equilibrium.
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B) Equilibrium price level is 100; equilibrium GDP is $1600. There is now a recessionary gap since
the improvement in productivity will increase both the short- and long-run aggregate supplies, so
that full-employment GDP (the position of the new long-run aggregate supply) is now at $1800.
Therefore, there is a recessionary gap of $200.
9.
A) Both nominal GDP and real GDP will increase according to the Keynesians since the economy was
at less that full employment to start with.
B) Nominal GDP will increase but real GDP will not according to the Neoclassicists since they assume
that the economy must have been at full employment equilibrium to start with.
Answers to Study Guide Questions
Are You Sure?
1.
2.
3.
4.
5.
6.
True.
False: it is the effect which a change in the price level has upon exports and imports.
True.
False: where aggregate demand equals the short-run aggregate supply.
False: it will not shift the long-run aggregate supply.
False: it will because any change in the long-run aggregate supply will also affect the short-run aggregate
supply and, therefore, equilibrium.
7. True.
8. False: it will cause a decrease in real GDP.
9. False: to Keynes, it is horizontal.
10. True.
Choose the Best
11.
12.
13.
14.
15.
16.
17.
b
b
b
b
b
c
c
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
d
c
a
b
b
d
a
d
e
b
b
b
c
Problems
31. a)
b)
c)
d)
e)
Price level = 40; real GDP = $350; recessionary gap of $50.
Surplus of $125.
Shortage of $125.
Increase of $75; price level increases by 5 to 45.
Increase of $250; price level decreases by 20 to 20.
32. a)
Aggregate demand will decrease which will decrease the price level and real GDP.
b) Both short-run and long-run aggregate supply will increase. The price level will fall and the level
of real GDP will rise.
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c)
This is not the cause of a shift in any curve but is the effect of either of aggregate demand
increasing (which would increase the price level) or aggregate supply increasing (which would
decrease the price level).
d) Aggregate demand will increase which will increase both the price level and real GDP.
e)
The short-run aggregate supply (only) will increase. The price level will fall and real GDP will
increase.
f)
This is the same answer as d) above.
g) This is the same answer as a) above.
33. a)
b)
c)
d)
e)
f)
The AD curve shifts to the right.
The SAS curve shifts to the right.
Both the SAS and LAS curves shift to the left.
The SAS curve shifts to the left.
The AD curve shifts to the left.
The SAS curve shifts to the right.
34. a)
b)
c)
d)
$728
$700 ($910/130 x 100)
$728 (At full-employment real GDP, real wage is constant i.e. same as in a)).
$1019.20 ($728 x 140/100).
Translations
At a price level of P1, there is a surplus of goods and services. In the short run, this will cause a decrease
in the price level until the surplus is eliminated (i.e., at the intersection of the AD and SAS curves).
However, a recessionary gap will still exist since the economy is below full-employment GDP (which is
indicated by the position of the LAS). In the long run, the wage levels will drop causing the short-run
aggregate supply to increase. This will cause a further drop in the price level and an increase in real GDP,
thus eventually eliminating the recessionary gap.
Key Problem
a)
The plotting is fairly straightforward, though you will appreciate that the SAS is not a straight
line and therefore needs a little care in its drawing. The LAS curve is located at the fullemployment level of real income. Since Chunderland is in equilibrium and at full employment,
the LAS is located at the equilibrium of the AD1 and SAS1. This is shown in Figure AK 16.
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40
80
120
160
200
240
280
Real GDP
Figure AK 16
b) The equilibrium values can be read off the graph or by glancing at Table 6.2 and l locating the
price at which the quantity demanded is equal to the quantity supplied. This occurs at a price of
80 and a quantity of real GDP of $180.
c)
The increase in demand is shown in Table AK 12 which reproduces a part of the original Text
Table 6.2.
Table AK 12
Price
$75
80
85
90
95
Aggregate Quantity
Supplied (SAS1)
$160
180
200
220
230
Aggregate Quantity Aggregate Quantity
Demanded (AD1)
Demanded (AD2)
$200
$280
180
260
160
240
140
220
120
200
The new demand curve, AD2, is shown in Figure AK 16. The table and the graph both confirm that
the new equilibrium is at a price of 90 and real GDP of $220. Therefore the change in the price level
is 10 (from 80 to 90), and the change in real GDP is $40. from $180 to $220, Since the new
equilibrium is to the right of full-employment GDP (the LAS curve), there is an inflationary gap.
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d) The decrease in demand is shown in Table AK 13 which reproduces a part of the original Text
Table 6.2.
Table AK 13
Price
$70
72
75
80
85
Aggregate Quantity
Supplied (SAS1)
$100
132
160
180
200
Aggregate Quantity
Demanded (AD1)
$220
212
200
180
160
Aggregate Quantity
Demanded (AD3)
$140
132
120
100
80
The new demand curve, AD3, is shown in Figure AK 16. The table and the graph both show that the
new equilibrium is at a price of 72 and real GDP of $132. Therefore, the change in the price index is
8 (from 80 to 72), and the change in real GDP is $48 (from $180 to $132). Since the new
equilibrium is to the left of full-employment GDP (the LAS curve), there is now a recessionary gap.
e)
Comparing the effect of the increase in AD in c) and the decrease in AD in d), you can ‘ see that
the increase had a bigger impact on the price level than did the decrease. This is because the
economy was already at full employment and therefore it would be more difficult to induce more
output without it greatly affecting the price level. For the same reason, the increase in AD had a
smaller impact on real GDP than did the drop in AD.
f)
The drop in money wages will cause the short-run aggregate supply to increase and the SAS
curve to shift right. The new SAS2 is shown in Table AK 14 which reproduces a part of the
original Text Table 6.2.
Price
$70
72
75
80
85
Table AK 14
Aggregate Quantity Aggregate Quantity
Supplied (S AS2)
Supplied (SAS1)
$100
$140
132
172
160
200
180
220
200
240
Aggregate Quantity
Demanded (AD1)
$220
212
200
180
160
The new supply curve, SAS2, is shown in Figure AK 16. The table and the graph both confirm that
the new equilibrium now is at a price of 75 and real GDP of $200. Since the new equilibrium s now to
the right of full-employment GDP (the LAS curve), there is now an inflationary gap.
g) There is a difference. A change in wage rates changes only the SAS and has no effect on the
LAS. However, a change in technology will affect both the SAS and the LAS. The LAS curve
therefore will shift to the right by 40 to a real GDP level of $220. The new equilibrium level of
GDP at $200 would then be below the full-employment level of real GDP. This would result in a
recessionary gap.
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More of the Same
a)
See Figure AK 17
Figure AK 17
b) P = 100; real GDP = $400; recessionary gap of $50.
c) See Figure AK 17; change of + 35 (new P level = 135); change of + $75 (new level of GDP =
$475); inflationary gap of $25.
d) See Figure AK 17; change of − 40 (new P level = 60); change of − $150 (new level = $250);
recssionary gap of $200.
e)
In c), the economy is close to full-employment and the effect of a change in aggregate demand
on real GDP is small while the effect on the price level is large (the SAS is steep). In d), the
effect on real GDP is much bigger and the effect on the price level smaller since the SAS is less
steep.
f)
See Figure AK 17; price = 120; real GDP = $300. recessionary gap of $150.
g) The price and real GDP would have been the same as in f). However, the LAS also shifts to the
left by $150. The new full-employment real GDP would be $300, and the economy would
therefore be at full-employment.
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