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CHAPTER 5
INTRODUCTION TO MACROECONOMICS
In this chapter, you will find:
Chapter Outline with PowerPoint Script
Chapter Summary
Teaching Points (as on Prep Card)
Answers to the End-of-Book Questions and Problems for Chapter 5
Supplemental Cases, Exercises, and Problems
INTRODUCTION
To introduce students to macroeconomics in a natural and familiar way, the economy is compared to the
human body and parallels are drawn. The history of the U.S. economy is traced, using aggregate supply
and demand, and both demand-side economics and supply-side economics are discussed. The chapter also
conveys the difficulty of testing macroeconomic theories and includes a brief discussion of the twin
deficits.
LEARNING OUTCOMES
1
Discuss macroeconomics and the national economy
Macroeconomics concerns the overall performance of the national economy. A standard measure of
performance is the growth of real gross domestic product, or real GDP, the value of final goods and services
produced in the nation during the year.
2
Discuss economic fluctuations and growth
The economy fluctuates between two phases: periods of expansion and periods of contraction. No two business
cycles are the same. Before 1945, expansions averaged 29 months and contractions 21 months. Since 1945,
expansions have averaged 57 months and contractions 11 months. Despite the Great Depression and later
recessions, the economy’s output has grown more than thirteenfold since 1929 and jobs have grown faster than
the population.
3
Explain aggregate demand and aggregate supply
The aggregate demand curve slopes downward, reflecting a negative, or inverse, relationship between the price
level and real GDP demanded. The aggregate supply curve slopes upward, reflecting a positive, or direct,
relationship between the price level and real GDP supplied. The intersection of the two curves determines the
economy’s real GDP and price level.
4
Describe the history of the U.S. economy
The Great Depression and earlier depressions prompted John Maynard Keynes to argue that the economy is
unstable, largely because business investment is erratic. Keynes did not believe that contractions were selfcorrecting. His demand-side policies of increased government spending and decreased taxes dominated
macroeconomic thinking between World War II and the late 1960s.
During the 1970s, higher oil prices and global crop failures reduced aggregate supply. The result was stagflation,
the troublesome combination of declining real GDP and rising inflation. Supply-side tax cuts in the early 1980s were aimed
at increasing aggregate supply, thereby increasing output while dampening inflation. Unfortunately, federal spending
increased faster than federal tax revenue, resulting in a budget deficits that grew into the early 1990s. Tax increases, a
slower growth in government spending, and an expanding economy all helped erase budget deficits by 1998, creating a
federal budget surplus. The economy then experienced an eight-month recession which ended in late 2001, but
unemployment continued to rise into 2003. Tax cuts and a sluggish recovery boosted the federal deficit. Jobs began
growing once again in late 2003, and by 2007, the economy added more than 8 million jobs. This growth cut the federal
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
Introduction to Macroeconomics
68
deficit to about $160 billion. After spikes in the price of oil and other commodities and the collapse of the housing market,
the U.S. economy lost 2.5 million jobs in 2008. The federal budget deficit swelled to $450 billion in 2008. With lower tax
revenues and increased stimulus spending, the deficit was sharply higher in 2012.
CHAPTER OUTLINE WITH POWERPOINT SCRIPT
USE POWERPOINT SLIDES 2-8 FOR THE FOLLOWING SECTION
The National Economy:
 Economy: the structure of economic life, or economic activity, in a community, a region, a country, a
group of countries, or the world.
 GDP (gross domestic product): The market value of all final goods and services produced in the U.S.
during a given period, usually a year.
What’s Special about the National Economy? Each country has its own “rules of the game” (laws,
regulations, customs, manners, and conventions).
The Human Body and the Economy: The economy, like the body: (1) consists of many parts, each
performing particular functions yet linked, (2) is continually renewing itself, and (3) involves circular flow
through the system.
Flow and Stock Variables
 Flow: A variable that measures an amount per unit of time.
 Stock: Amount measured at particular point in time.
Testing New Theories: There is no laboratory in which macroeconomic theories can be tested. Therefore,
economists examine historical and international evidence for clues about how the economy works.
Knowledge and Performance: We must know how a healthy economy works before we can consider
whether anything can be done about it.
USE POWERPOINT SLIDES 9-14 FOR THE FOLLOWING SECTION
Economic Fluctuations and Growth
Economic fluctuations (business cycles): The rise and fall of economic activity relative to the long-term
growth trend of the economy.
U.S. Economic Fluctuations: Two phases: periods of expansion and contraction
 Depression: A severe contraction or reduction in the nation’s total production lasting more than a
year and accompanied by high unemployment.
 Recession: A mild contraction, a decline in total output lasting at least two consecutive quarters.
 Periods of expansion: Begin when economic activity starts to increase and continues until the
economy reaches a peak.
USE POWERPOINT SLIDES 15-16 FOR THE FOLLOWING SECTION
CaseStudy: The Global Economy
USE POWERPOINT SLIDE 17 FOR THE FOLLOWING SECTION
Leading Economic Indicators: Foreshadow a turning point in economic activity
USE POWERPOINT SLIDES 18-19 FOR THE FOLLOWING SECTION
Aggregate Demand and Aggregate Supply
Aggregate Output and the Price Level
 Aggregate output: Total amount of final goods and services produced in the economy during a given
period, real GDP.
 Price level: The average price of aggregate output (CPI or GDP price index.)
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
Introduction to Macroeconomics
69
USE POWERPOINT SLIDES 20-25 FOR THE FOLLOWING SECTION
Aggregate Demand Curve: Shows the relationship between the economy’s price level and real GDP
demanded
Aggregate Supply Curve: Shows how much producers in an economy are willing and able to supply at
each price level.
 Factors held constant along an aggregate supply curve:
1) Resource prices
2) State of technology
3) “Rules of the Game” that provide production incentives
Equilibrium: Determined by the intersection of the aggregate supply and the aggregate demand curves.
USE POWERPOINT SLIDES 26-30 FOR THE FOLLOWING SECTION
A Short History of the U.S. Economy
The Great Depression and Before: Due to the 1929 stock market crash, aggregate demand declined so
severely that one of the deepest contractions of the economy was created. Prior to that time,
macroeconomic policy was based on the “laissez-faire” philosophy of Adam Smith.
USE POWERPOINT SLIDES 31-36 FOR THE FOLLOWING SECTION
The Age of Keynes: After the Great Depression to the Early 1970s
 Demand-side economics: Focused on how changes in aggregate demand could promote full
employment.
USE POWERPOINT SLIDES 37-39 FOR THE FOLLOWING SECTION
Stagflation: 1973 to 1980
 Stagflation: A contraction in the economy’s aggregate output, along with inflation, or a rise in the
economy’s price level.
USE POWERPOINT SLIDES 40-44 FOR THE FOLLOWING SECTION
Relatively Normal Times: 1980 to 2007
 Supply-side economics: Theorizes that lowering federal tax rates would increase after-tax wages,
which would provide an incentive to increase the supply of labor and other resources.
 Output and employment grew nicely during the 1990s. The expanding economy increased federal
revenues enough to create a federal budget surplus by the end of the decade. After achieving the
longest expansion on record, the U.S. economy slipped into recession aggravated by the terrorist
attacks of September 2001. The subsequent expansion lasted until 2007.
USE POWERPOINT SLIDES 45-51 FOR THE FOLLOWING SECTIONS
The Recession of 2008-2009 and Beyond
 The economy went in recession in early 2008 because of falling home prices and rising foreclosure
rates. The collapse of a Wall Street bank in September 2008 panicked financial markets around the
world, cutting investment and consumption. Job losses were the worst since the Great Depression.
 Massive federal programs aimed at stabilizing the economy resulted in gigantic federal deficits.
Economic growth returned in the second half of 2009.
USE POWERPOINT SLIDES 52-54 FOR THE FOLLOWING SECTION
CaseStudy: Eight Decades of Real GDP and Price Levels
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
Introduction to Macroeconomics
70
CHAPTER SUMMARY
Macroeconomics focuses on the national economy. A standard measure of performance is the growth of
real gross domestic product, or real GDP, the value of all final goods and services produced in the nation
during the year.
The economy has two phases: periods of expansion and periods of contraction. No two business cycles are
the same. Before 1945, expansions averaged 29 months, and contractions 21 months. Since 1945,
expansions have averaged 57 months and contractions 11 months. Despite the Great Depression and later
recessions, the economy’s output has grown more than thirteenfold since 1929 and jobs have grown faster
than the population.
The aggregate demand curve slopes downward, reflecting a negative, or inverse, relationship between the
price level and real GDP demanded. The aggregate supply curve slopes upward, reflecting a positive, or
direct, relationship between the price level and real GDP supplied. The intersection of the two curves
determines the economy’s real GDP and price level.
The Great Depression and earlier depressions prompted John Maynard Keynes to argue that the economy
is unstable, largely because business investment is erratic. Keynes did not believe that contractions were
self-correcting. He argued that whenever aggregate demand sagged, the federal government should spend
more or tax less to stimulate aggregate demand. His demand-side policies dominated macroeconomic
thinking between World War II and the later 1960s.
During the 1970s, higher oil prices and global crop failures reduced aggregate supply. The result was
stagflation, the troublesome combination of declining real GDP and rising inflation. Demand-side policies
appeared less effective in an economy suffering from a reduction in aggregate supply because stimulating
aggregate demand would worsen inflation.
Supply-side tax cuts in the early 1980s were aimed at increasing aggregate supply, thereby increasing
output while dampening inflation. Some hoped that the added tax revenue from a stronger economy would
offset the loss in tax revenue from cuts in tax rates. But federal spending increased faster than federal tax
revenue, resulting in budget deficits that grew into the 1990s. Tax increases, a slower growth in
government spending, and an expanding economy all helped erase budget deficits by 1998, creating a
federal budget surplus. But after the longest expansion on record, the economy experienced an eightmonth recession. The recession ended in late 2001, but unemployment continued to rise into 2003. Tax
cuts and a sluggish recovery boosted the federal deficit. Jobs began growing once again in late 2003, and
by 2007 the economy added more than 8 million jobs. This growth cut the federal deficit to about $160
billion. After spikes in the price of oil and other commodities and the collapse of the housing market, the
U.S. economy lost 2.5 million jobs in 2008. The federal budget deficit swelled to $450 billion in 2008.
With lower tax revenues and increased stimulus spending, the deficit was sharply higher in 2012.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
Introduction to Macroeconomics
71
TEACHING POINTS
1. It may be useful to point out to students here that the reasons for the negative and positive slopes of
the demand and supply curves of individual goods do not apply in dealing with the AS and AD
curves. For example, holding “other prices” and “money income” constant is not appropriate in
construction of the AD curve, and aggregate suppliers may be neither willing nor able to offer more
output when the aggregate price level increases.
2. A short time series (projected roughly on the screen) will show that the U.S. economy did not really
have a serious fall in income until 1931. The low point was reached in 1933 during a period of terrific
monetary contraction. Many people mistakenly believe that the economy rose continually after that
point in time (owing to FDR’s New Deal). However, the economy turned down again in 1938,
although the drop was not as deep as the one that occurred in 1933. After 1938 the economy rose
steadily as a result of the military spending that began at that time.
3. Some students may think that study of the Great Depression is akin to the study of dinosaurs.
However, many have noted parallels between recent times and the Great Depression, especially as
they relate to the dramatic rises and falls in the stock market and the global recession of 2008-2009.
4. The purpose of introducing AS-AD in this chapter is to provide the student with a sense of the two
sides to macroeconomics: supply and demand. It capsulizes national income determination and the
determination of the price level in a heuristic way. Nevertheless, it can be troublesome explaining why
a lower price level increases the quantity of aggregate output demanded (certainly not because of a
decrease in the demand for substitute goods). A drop in the price level, holding all else constant,
makes money balances more valuable, thus giving rise to greater demand for output.
5. You may wish to ask the students how the AS and AD curves would shift in each of the following
situations: (1) government spending increases, (2) consumer confidence improves, (3) personal tax
rates are cut, and (4) the aggregate price level changes (which does not shift either curve).
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
Introduction to Macroeconomics
72
ANSWERS TO END-OF-BOOK QUESTIONS AND PROBLEMS
1.1 (The National Economy) Why do economists pay more attention to national economies (for example,
the U.S. or Canadian economies) than to state or provincial economies (such as California or
Ontario)?
Each national economy has its own “rules of the game,” that is, its own laws, regulations, customs,
and conventions for conducting economic activity. U.S. gross domestic product provides a measure
of the performance of the national economy and of how it interacts with the rest of the world.
2.1 (Economic Fluctuations) Describe the various components of fluctuations in economy activity over
time. Because economic activity fluctuates, how is long-term growth possible?
The economy moves through periods of expansion and periods of contraction. Contractions include
recessions in which total output and employment decline over a six-month period and more serious
depressions in which sharp reductions occur in output and employment that last more than a year.
The end of a contraction is marked by the trough, or lowest point. After the trough, the economy
enters an expansion period in which total output increases until the economy reaches its peak.
The economy grows over time. This is possible because the growth during expansions more than
offsets the decline during recessions. Economic fluctuations reflect movements around the long-term
growth trend.
3.1 (Aggregate Demand and Supply) Review the information on demand and supply curves in Chapter
4. How do the aggregate demand and aggregate supply curves presented in this chapter differ from
the market curves of Chapter 4?
The demand and supply curves in Chapter 4 describe the relationship between the price of an
individual product or product category, such as textbooks or food, and the quantities of that
individual item demanded and supplied. Aggregate demand and aggregate supply describe the
relationship between the average price level of all goods and services and the total quantities of
goods and services demanded and supplied throughout the entire economy.
3.2 (Aggregate Demand and Supply) Determine whether each of the following would cause a shift of the
aggregate demand curve, a shift of the aggregate supply curve, neither, or both. Which curve shifts,
and in which direction? What happens to aggregate output and the price level in each case?
a. The price level changes.
b. Consumer confidence declines.
c. The supply of resources increases.
d. The wage rate increases.
a. Neither curve would shift. A change in the price level would cause a movement along the curves.
b. Aggregate Demand shifts left because less consumer confidence reduces the aggregate output
demanded at each price level. Therefore, both aggregate output and the price level fall.
c. Aggregate Supply shifts right. There is an increase in the aggregate output supplied at each price
level. Therefore, aggregate output increases and the price level falls.
d. Aggregate Supply shifts left as the costs of production have risen. Therefore, aggregate output
falls and the price level rises..
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Chapter 5
Introduction to Macroeconomics
73
4.1 (Supply-Side Economics) One supply-side measure introduced by the Reagan administration was a
cut in income tax rates. Use an aggregate demand/aggregate supply diagram to show what effect was
intended. What might happen if such a tax cut also shifted the aggregate demand curve?
Lower tax rates were intended to increase after-tax earnings and thus increase incentives for
resource owners to provide labor and capital. The resulting rightward shift in Aggregate Supply
would increase aggregate output and lower the price level. The increase in after-tax earnings would
also increase Aggregate Demand, which would increase aggregate output and raise the price level.
The overall impact on the price level would depend on the relative sizes of the shifts in the aggregate
supply and the aggregate demand.
SUPPLEMENTAL CASES, EXERCISES, AND PROBLEMS
Case Studies
These cases are available to students online at www.cengagebrain.com.
The Global Economy
Years ago what happened in other economies was not that important to Americans. But now many
resources flow freely across borders. Technology has also spread around the globe. Though business
cycles are not perfectly synchronized across countries, a link is usually apparent. Consider the experience
of two leading economies—the United States and the United Kingdom, economies separated by the
Atlantic Ocean. Exhibit 3 shows for each economy the year-to-year percentage change in real GDP since
1978. Again, real means that the effects of inflation have been erased, so remaining changes reflect real
changes in the total amount of goods and services produced each year.
If you spend a little time following the annual changes in each economy, you can see the similarities.
For example, both economies went into recession in the early 1980s, grew well for the rest of the decade,
entered another recession in 1991, recovered for the rest of the decade, then slowed down in 2001. Both
economies picked up steam in 2004, but the global financial crisis of 2008 caused sharply lower output by
2009.
One problem with the linkage across economies is that a slump in other major economies could worsen
a recession in the United States and vice versa. For example, the financial crisis of 2008 affected
economies around the world, increasing unemployment and cutting production. Trouble in seemingly
minor economies, such as Greece, can spill over and drag other economies down with them. On the other
hand, economic strength overseas can give the U.S. economy a lift. As the Wall Street Journal reported,
“Many U.S. companies are finding strength in overseas profits, helping to offset a weak housing market
and a credit crunch at home.”
Source: Timothy Aeppel, “Overseas Profits Help U.S. Firms Through Tumult,” Wall Street Journal, 9
August 2007; Bob Davis, “Geithner Plans to Press Germany on European Rescue,” Wall Street Journal,
22 May 2010; “The Greek Crisis: The End of the Party,” The Economist, 8 May 2010; Economic Report
of the President, February 2010; and the Bureau of Economic Analysis at http://bea.gov/index.htm.
Figures for 2010 and 2011 are projections found in OECD Economic Outlook, 87 (May 2010), Table 1.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
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Chapter 5
Introduction to Macroeconomics
74
Eight Decades of Real GDP and Price Levels
Points in Exhibit 8 trace the U.S. real GDP and price level for each year since 1929. Aggregate demand
and aggregate supply curves are shown for 2010, but all points in the series reflect such intersections.
Years of growing GDP are indicated as blue points and years of declining GDP as red ones. Despite the
Great Depression of the 1930s and the 11 recessions since World War II, the long-term growth in output is
unmistakable. Real GDP, measured along the horizontal axis in 2005 constant dollars, grew from about
$1.0 trillion in 1929 to about $13.2 trillion in 2010—a thirteenfold increase and an average annual growth
rate of 3.4 percent. The price index also rose, but not quite as fast, rising from 10.6 in 1929 to 110.7 in
2010—more than a tenfold increase and an average inflation rate of 3.0 percent per year. Note that what
matters here is the growth in real GDP, because that nets out the effects of inflation (inflation is mostly
troublesome noise in the economy). Since 1983, annual output declined only twice—in 1991 and in 2009.
Because the U.S. population is growing, the economy must create more jobs just to employ the
additional people entering the workforce. For example, the U.S. population grew from 122 million in 1929
to 309 million in 2010, a rise of 153 percent. Fortunately, employment grew even faster, from 47 million
in 1929 to 154 million in 2010, for a growth of 228 percent. So, since 1929, employment grew more than
enough to keep up with a rising population. Despite the recessions, the United States has been an
impressive job machine over the long run.
Not only did the number employed triple since 1929, the average education of workers increased as
well. Other resources, especially capital, also rose sharply. What’s more, the level of technology improved
steadily, thanks to breakthroughs such as the personal computer and the Internet. The availability of more
and higher-quality human capital and physical capital increased the productivity of each worker,
contributing to the thirteenfold jump in real GDP since 1929.
Real GDP is important, but the best measure of the average standard of living is an economy’s real
GDP per capita, which tells us how much an economy produces on average per resident. Because real
GDP grew much faster than the population, real GDP per capita jumped sixfold between 1929 and 2010.
The United States is the largest economy in the world and a leader among major economies in output per
capita.
Sources: “GDP and the Economy,” Survey of Current Business 90 (April 2010); 1–5; Economic Report of
the President, February 2010; Economic Report of the President, January 1980; and OECD Economic
Outlook 87 (May 2010). For the latest real GDP and price level data, go to http://bea.gov/. For the latest
population data, go to http://www.census.gov. For the latest employment data, go to http:// www.bls.gov.
Experiential Exercises
1. The National Bureau of Economic Research maintains a Web page devoted to business cycle
expansions and contractions at http://www.nber.org/cycles.html. Have students take a look at this page
to see if they can determine how the business cycle has been changing in recent decades. Has the
overall length of cycles been changing? Have recessions been getting longer or shorter?
2. Ask students to review the Summary of Commentary on Current Economic Conditions by Federal
Reserve District (Beige Book), available through the Federal Reserve System at http://
www.federalreserve.gov/FOMC/BeigeBook/2012/default.htm (or replace with the current year). Have
them:
a. Summarize the national economic conditions for the most recent period covered in the report.
Overall, is the economy healthy? If not, what problems is it experiencing?
b. Go to the summary applicable to their district. Summarize the economic conditions for the
last reporting period. Is the economy in their district healthy? If not, what problems is it
experiencing?
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
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Chapter 5
Introduction to Macroeconomics
75
3. This chapter introduced the tools of aggregate demand and supply. Test your students’ understanding
by having them find an article in today’s Wall Street Journal describing an event that may affect the
U.S. price level and real GDP. They can look under “Economy” or “International” in the First Section
of the newspaper. Students should then draw an initial set of AD and AS curves and determine which
curve will be affected and in which direction it will shift. Ask them to predict what will happen to the
price level and real GDP.
4. (Global Economic Watch) Go to the Global Economic Crisis Resource Center. Select Global Issues
in Context. In the Basic Search box at the top of the page, enter the phrase "growth imperative." On
the Results page, go to the News Section. Click on the link for the July 31, 2010, article "The Growth
Imperative." What did the author David Brooks suggest as remedies for the poor condition of the U.S.
business cycle?
At the end of the article, David Brooks suggested simplifying the tax code, targeting welfare spending,
and building strong infrastructure. This article is an illustration of using good economic ideas from
people who might otherwise be on different political sides.
5. (Global Economic Watch) Go to the Global Economic Crisis Resource Center. Select Global Issues
in Context. In the Basic Search box at the top of the page, enter the phrase "leading indicators." Find
an article no more than two years old about U.S. leading indicators. Find a similar article no more than
two years old about leading indicators in a foreign country. Compare and contrast what the leading
indicators in the two countries are forecasting.
Student answers will vary. The best answers will realize that the leading indicators point to
probabilities, not certainties.
Additional Questions and Problems
(From student Web site at www.cengagebrain.com)
1.
(The Human Body and the U.S. Economy) Based on your own experiences, extend the list of
analogies between the human body and the economy as outlined in this chapter. Then determine
which variables in your list are stocks and which are flows.
Answers will vary. Students could describe parallels between the food that the body needs for energy
and growth with the savings that an economy must generate to fuel investment and economic growth.
Food and savings are examples of flow variables, measured over a period of time. When a body is
weighed, a human has an objective idea of his or her size at a certain point in time. When the
government measures the inventory of the economy, the economy has a measure of its size at a
particular point in time. Weight and inventory are examples of stock variables.
2.
(Stocks and Flows) Differentiate between stock and flow variables. Give an example of each.
Stock variables are measures at a given point in time such as height, weight, checking account
balance. Flow variables measure something over an interval such as annual income, monthly
budget.
3.
(Economic Fluctuations) Why doesn’t the National Bureau of Economic Research identify the
turning points in economic activity until months after they occur?
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Chapter 5
Introduction to Macroeconomics
76
The economy does not move smoothly through recessions and expansions. Throughout each year, the
economy goes through seasonal fluctuations, for example, the tourist industry in Colorado expands
during the winter months. In addition, the economy experiences random disturbances, such as the
impact due to hurricanes or earthquakes. The NBER must wait to determine whether a change in the
direction of the economy is sustained in order to distinguish the impact of seasonal fluctuations and
random disturbances and the movement into a recession or expansion.
4.
(Leading Economic Indicators) Define leading economic indicators and give some examples. You
may wish to take a look at The Conference Board’s index of leading economic indicators at
http://www.conference-board.org/data/.
Leading economic indicators are economic statistics that change prior to a change in the overall
economy. That is, they turn downward before a recession and upward before an expansion, thus
pointing to the future direction of the overall economy. Examples include orders for machinery and
equipment, the stock market index, consumer confidence, and household spending on durable goods.
5.
(Aggregate Demand and Aggregate Supply) Why does a decrease of the aggregate demand curve
result in less employment, given an aggregate supply curve?
When aggregate demand decreases along a fixed aggregate supply curve, both the price level and
the output level drop. As aggregate output declines, fewer workers are needed and unemployment
rises.
6.
(Aggregate Demand and Aggregate Supply) Is it possible for the price level to fall while production
and employment both rise? If it is possible, how could this happen? If it is not possible, explain why
not.
Yes, this could occur if aggregate supply and aggregate demand increased. Both curves would shift
to the right, but the aggregate supply curve would shift more than the aggregate demand curve. This
would force down the price level while increasing production. Increased production and a lower
price level would also occur if aggregate supply increased along a fixed demand curve.
7.
(Aggregate Demand Curve) Describe the relationship illustrated by the aggregate demand curve.
Why does this relationship exist?
Aggregate demand describes an inverse relationship between the average price level of all goods
and services and the total quantities of goods and services demanded throughout the entire economy.
The quantity of aggregate output demanded depends in part on household wealth. An increase in the
price level decreases the purchasing power of bank accounts and currency. Thus, households are
poorer when the price level increases, so they decrease the quantity of aggregate output demanded.
8.
(Demand-Side Economics) What is the relationship between demand-side economics and the federal
budget deficit?
Demand-side economics focuses on the ability of the government to affect aggregate demand and
thus promote full employment. During periods of unemployment, demand-side economics
recommends that the federal government expand aggregate demand by increasing government
spending and/or cutting taxes. This is likely to result in budget deficits, when government
expenditures exceed government tax revenues.
© 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted
in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
Chapter 5
9.
Introduction to Macroeconomics
77
(Stagflation) What were some of the causes of the stagflations of 1973 and 1979? In what ways were
these episodes of stagflation different from the Great Depression of the 1930s?
In 1973, crop failures around the world caused grain prices to rise substantially. At the same time,
OPEC raised oil prices sharply. These two events combined to reduce aggregate supply, causing the
price level to rise while output and employment fell. In 1979, oil prices again rose sharply, and
aggregate supply dropped.
In contrast, the Great Depression occurred with a significant drop in aggregate demand. Therefore,
while output and employment fell, prices dropped—unlike the price increases that come with
stagflation. In addition, the Great Depression lasted much longer and caused a much greater drop in
output and employment.
10.
(Recession of 2007-2009) How did the recession of 2007-2009 affect the economy?
Employment fell by 8.4 million jobs. The federal budget deficit tripled from $408 billion to $1.4
trillion. GDP fell by about two percent.
ANSWERS TO ONLINE CASE STUDIES
1.
(CaseStudy: The Global Economy) How are economic fluctuations linked among national
economies? Could a recession in the United States trigger a recession abroad?
Economies are linked globally, especially those in a given region (Europe, North America or Asia
for example). If the major U.S. trading partners experience an economic slump, they purchase fewer
U.S. goods and services, contributing to a recession in the United States. Then, if U.S. residents
purchase fewer imports, this deepens the recessions in foreign economies. The opposite linkage
occurs during economic expansions.
2.
(CaseStudy: Eight Decades of Real GDP and Price Levels) The price level grew faster than real
GDP between 1947 and 2010. Does this mean that the rising price level masked an actual decline in
output? Why or why not?
No, there was an actual increase in aggregate output between 1947 and 2010. Real GDP figures are
adjusted already for any increases in the price level. The fact that the price level increased so much
faster means that nominal GDP grew at a much faster rate than real GDP.
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