Download Answers to Text Questions and Problems in

Answers to Text Questions and Problems in Chapter 10
Answers to Review Questions
1.
Stagflation is the combination of a recessionary gap and a rising price level. This situation is hard to
depict on a Keynesian cross diagram, because the basic Keynesian model assumes that prices are
constant.
2. This is the fallacy of composition. If the long-run aggregate supply curve is vertical, then a rise in
the overall price level has no effect on potential output.
3. A horizontal short-run aggregate supply curve would occur if firms provide the output demanded by
customers at the prices that the firms have posted.
4. False. The law of demand explains why a rise in the price of an individual good leads to a fall in the
quantity demanded. This is because other prices are held constant, so consumers substitute away from the
more-expensive good. However, the aggregate demand curve includes all goods, so there is no possible
good to substitute toward if the overall price level rises. Instead, the aggregate demand curve shows an
inverse relationship between the price level and output due to the real-balances effect, the interest rate
effect, and the foreign trade effect.
5. Although the AD-AS model shows a self-correcting economy, a recessionary gap will take time to be
eliminated. Therefore, expansionary macroeconomic policy can be used to eliminate the recessionary gap
more quickly.
6. Stagflation is caused by an adverse price shock that shifts up the SRAS curve, leading to a lower
level of output and a higher price level.
7. To some extent, the rationale for an upward-sloping SRAS curve and the rationale for an upwardsloping industry supply curve are the same: both are based on an assumption that input prices are held
constant. In microeconomics, if the market price rises while all else is held constant, a profit-maximizing
firm will find that its profit will rise if it produces more; this produces an upward-sloping supply curve. In
macroeconomics, the assumption behind the upward-sloping SRAS curve is that input prices, such as
wages, lag behind the price level; a rise in the price level therefore gives firms a profit incentive to expand
output in the short run.
8.
The short-run Phillips curve shows that, for given inflationary expectations, there is an inverse
relationship between actual unemployment and the inflation rate.
9. The expectations-augmented Phillips curve model shows that there is an inverse relationship
between unemployment and inflation only in the short run; once inflation adjusts, this relationship no
longer exists. Therefore, there is no tradeoff between unemployment and inflation.
Answers to Problems
1.
The real value of your cash would fall to $1000/1.10 = $909.09.
2. In the short run, prices are fixed in the AD-AS model, so an increase in autonomous aggregate
expenditure causes a rise in income that is the same as in the basic Keynesian model. This is depicted as
the movement from A to B in the diagram below.
Price level
LRAS
B
SRAS
A
AD'
AD
Output
Y*
In the long run, if the economy starts with a recessionary gap, then the increase in autonomous aggregate
expenditure can bring GDP just to potential output, as in the movement from A to B below.
Price level
LRAS
B
SRAS
A
AD'
AD
Output
Y*
However, if the economy starts at potential output, then the short-run rise in output (from A to B) leads to
a rise in prices over time; as the short-run aggregate supply curve shifts up, output falls back to potential
output (from B to C). Therefore, the multiplier is zero.
Price level
LRAS
C
SRAS'
B
SRAS
A
AD'
AD
Y*
Output
3a.
b.
c.
d.
e.
A rise in exports would cause the aggregate demand to shift right.
The aggregate demand curve would shift left, as investment would fall.
The short-run aggregate supply curve would shift up, as prices faced by consumers would rise.
The fall in oil prices would make the short-run aggregate supply curve shift down.
The aggregate demand curve would shift left, as exports would fall and imports would rise.
4. In the short run, the economy moves from A to B as the aggregate demand curve shifts right. Over
time, the short-run aggregate supply curve shifts up, output falls back to potential output, and the
economy moves from B to C.
Price level
LRAS
C
SRAS'
B
SRAS
A
AD'
AD
Y*
Output
5. If the actual rate of unemployment is higher than the natural rate, and policymakers implement
expansionary macroeconomic policy to move the actual rate to the natural rate, then the inflation rate will
increase over time and the economy will move up the (constant) short-run Phillips curve, from A to B.
However, if instead policymakers allow the economy to self-correct, then eventually inflationary
expectations will fall, shifting the short-run Phillips curve to the left (from A to C) and bringing the
unemployment rate down to the natural rate.
Β
LRPC
B
A
C
U*
SRPC
SRPC'
Unemployment rate
6. If the initial price level is 100, a two-percentage point drop in the price level would result in a new
price level of 98. However, a two-percentage point drop in the inflation rate would result not in a lower
price level, but in a slower rate of increase in the price level.
Sample Homework Assignment
1.
a.
b.
c.
2.
a.
b.
c.
Use the aggregate demand–aggregate supply model to explain the short-run and long-run effects on
an economy of each of the following changes.
An increase in imports.
Expansionary monetary policy.
An increase in oil prices.
Suppose that AD is given by Price Level = 500 – 0.4Y, SRAS is given by Price Level = 120, and
potential output is equal to 1000.
What is short-run equilibrium output?
If the economy is allowed to adjust on its own, what will be the price level and the level of output in
the long run?
Instead, if policymakers decide to use monetary policy to bring the economy back to potential
output, what will be the new AD curve?
Multiple Choice Quiz
1.
a.
b.
c.
d.
e.
What does the aggregate demand–aggregate supply model add to the basic Keynesian model?
Fiscal policy.
Monetary policy.
Changes in output.
Changes in prices.
Changes in interest rates.
2.
a.
b.
c.
d.
e.
The long-run aggregate supply curve
is vertical.
is horizontal.
is upward-sloping.
is downward-sloping.
has a slope equal to zero.
3.
a.
b.
c.
d.
e.
An improvement in technology will cause
the short-run aggregate supply curve to shift up.
the aggregate demand curve to shift right.
the long-run aggregate supply curve to shift right.
the aggregate demand curve to shift left.
the long-run aggregate supply curve to shift left.
4.
a.
b.
c.
d.
e.
The short-run aggregate supply curve will shift up if
government spending rises.
government spending falls.
interest rates fall.
input costs fall.
input costs rise.
5.
a.
b.
c.
d.
e.
Which of the following is not a reason for the downward slope of the aggregate demand curve?
A fall in the price level causes the real value of money to rise.
Higher prices mean that consumers spend more on foreign goods.
Increased prices mean that consumers cannot afford to buy as many goods.
A rise in prices will lower the real value of wealth in the economy.
Lower prices make domestic goods more attractive on world markets.
6.
a.
b.
c.
d.
e.
Expansionary fiscal policy will cause
the aggregate demand curve to shift right.
the aggregate demand curve to shift left.
the short-run aggregate supply curve to shift right.
the short-run aggregate supply curve to shift left.
the long-run aggregate supply curve to shift right.
7.
If an economy is initially producing at less than potential output, how does it move to the long-run
equilibrium?
The aggregate demand curve shifts right.
The short-run aggregate supply curve shifts up.
The long-run aggregate supply curve shifts left.
The short-run aggregate supply curve shifts down.
The long-run aggregate supply curve shifts left.
a.
b.
c.
d.
e.
8.
a.
b.
c.
d.
e.
Suppose that the LRAS is vertical at 10,000 and the AD curve is represented by P = 400 – 0.02Y.
What is the price level in the long run?
400.
300.
200.
100.
0.
9.
a.
b.
c.
d.
e.
Stagflation is the combination of
a recessionary gap and a falling price level.
a recessionary gap and a rising price level.
an expansionary gap and a falling price level.
an expansionary gap and a rising price level.
no recessionary or expansionary gap, but a rising price level.
10. The long-run Phillips curve is
a. downward-sloping.
b. upward-sloping.
c.
d.
e.
horizontal at the natural rate of unemployment.
vertical at the natural rate of unemployment.
vertical at the current actual rate of unemployment.
Problems/Short Answer
1.
a.
b.
c.
2.
a.
b.
c.
Use the aggregate demand–aggregate supply model to explain the short-run and long-run effects on
an economy of each of the following changes.
A rise in exports brought about by a weaker currency.
Contractionary fiscal policy.
A fall in unionization that leads to lower wages throughout the economy.
Suppose that AD is given by Price Level = 440 – 0.3Y and SRAS is given by Price Level = 110.
What is short-run equilibrium output?
Suppose that input costs rise and SRAS is now given by Price Level = 125. Now what is short-run
equilibrium output?
Now suppose that policymakers want to use monetary policy to bring the economy back to the
output in (a). What will the new AD curve have to be?
Answer Key to Extra Questions in Instructor’s Manual
Sample Homework Assignment
1a. An increase in imports, holding all else constant, shifts the aggregate demand curve to the left.
Output therefore falls in the short run, but the price level is constant. The recessionary gap causes prices
to fall over time, shifting down the short-run aggregate supply curve. Output increases until it reaches the
initial level, but at a permanently lower price level.
b. Expansionary monetary policy shifts the aggregate demand curve to the right, raising output and
opening up an expansionary gap. Over time, the price level increases, so the short-run aggregate supply
curve shifts up and output returns to potential output, but at a permanently higher price level.
c. An increase in oil prices shifts up the short-run aggregate supply curve and causes a recessionary
gap. Over time, prices fall and the short-run aggregate supply curve shifts down. There is no long-run
impact on output or the price level.
2a. 500 – 0.4Y = 120, so Y = 950.
b. In the long run, output must be equal to potential output, or 1000. The price level must then be 500 –
0.4(1000) = 100.
c. The new AD curve must be Price Level = 520 – 0.4Y.
Multiple Choice
1.
2.
3.
4.
d
a
c
e
5.
6.
7.
8.
9.
10.
c
a
d
c
b
d
Problems/Short Answer
1a. A rise in exports shifts the aggregate demand curve to the right. At the given price level, output has
increased. Over time, firms will respond to the expansionary gap by raising prices; this shifts up the shortrun aggregate supply curve and brings output back to the initial level.
b. Contractionary fiscal policy shifts aggregate demand left, causing output to fall in the short run. The
recessionary gap will cause the price level to fall over time, shifting down the short-run aggregate supply
curve until the economy returns to potential output.
c. Lower wages represent lower input costs, allowing the short-run aggregate supply curve to shift
down. The resulting expansionary gap will eventually cause firms to raise prices, bringing the economy
back to the initial equilibrium point.
2a. 110 = 440 – 0.3Y, so Y = 1100.
b. 125 = 440 – 0.3Y, so Y = 1050.
c. The new AD curve must be Price Level = 455 – 0.3Y.