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Answer Key, Principles of Macroeconomics, 8e – Chapter 5
CHAPTER FIVE
Answers Test Your Understanding Questions
1. GDP gap is $45 billion (cyclical unemployment of 3% x 2.5 x $600 billion)
Potential GDP is $645 billion (actual GDP of $600 + GDP gap of $45)
2 a) If the price increases by 10 percent to 88, then real GDP will increase from $1000 to
$1300 which is a growth rate of 30% ($300/$1000).
b) If the price increases by 10 percent to 110, then real GDP will increase from $1450
to $1500 which is a growth rate of 3.4% ($50/$1450).
3) Consumption, investment and net exports would all rise because of the real-balances
effect, the interest-rate effect, and the foreign-trade effect respectively.
4. a) Price level: 100;
GDP: $1100.
b) Shortage of $125.
(At a price level of 95, aggregate quantity demanded exceeds the aggregate quantity
supplied by this much).
Surplus of $270.
(At a price level of 115, aggregate quantity supplied exceeds the aggregate quantity
demand by this much.)
5. a) inflationary gap of $100;b) recessionary gap of $100; c) recessionary gap of $200;
6. a) AD;
7. a) AS;
d) AS
b) AD;
c) AD;
d) AD;
e) AD
b) AS and potential GDP; c)
e) AS and potential GDP
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AS and potential GDP;
Answer Key, Principles of Macroeconomics, 8e – Chapter 5
8. See following figure:
9. a)
b)
Price level: 105; GDP: $1800.
Price level: 95;
GDP: $1700.
10. a) Price level: 110; GDP: $1500.
This is full-employment equilibrium.
b) Price level: 100; GDP: $1600; recessionary gap of $200.
This is because the improvement in productivity will increase both the aggregate
supply and potential GDP. The new potential GDP is $1800 and the new
equilibrium GDP is $200 below this.
11. 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.
12. a) The new intersection is now at: GDP = $800; P = 95.
b) The new intersection is now at: GDP = $1100; P = 110.
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Answer Key, Principles of Macroeconomics, 8e – Chapter 5
Answers to Connect Study Problems
1.
$504 billion. (the GDP gap is equal to cyclical unemployment of 2% x 2.5 x actual
GDP of $480 = $24 billion. Potential GDP(LAS) is equal to actual GDP of $480 +
GDP gap of $24 = $504)
2. a) Real GDP: $1000; price level: 100;
as potential GDP (LAS)).
There is no gap. (Actual GDP is the same
b) See the following table:
TABLE 5.2 (Completed)
Aggregate
Quantity
Demanded
($)
$1080
1060
1040
1020
1000
980
960
940
920
900
Aggregate
Quantity
Demanded 2
Price Index
Aggregate
Quantity
Supplied ($)
$1145
1125
1105
1085
1065
1045
1025
1005
985
965
96
97
98
99
100
101
102
103
104
105
$880
940
965
985
1000
1015
1025
1033
1040
1045
c) Real GDP: $1025; price level: 102; (This is where the aggregate quantity
demanded 2 equals the aggregate supply.)
d) There is an inflationary gap of $25 (Actual GDP of 1025 is $25 greater than
potential GDP (LAS) of 1000).
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The real wage has increased by $1 from $15 (18/120 x 100) to $16 (20.8/130 x 100).
4. a) Inflationary gap of $100. (Actual GDP ($600) exceeds Potential GDP (LAS
of $500) by $100.
b) Recessionary gap of $100. (Potential GDP (LAS of $700) exceeds actual GDP
($600) by $100.
c) Recessionary gap of $300. (Potential GDP (LAS of $900) exceeds actual GDP
($600) by $100.
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Answer Key, Principles of Macroeconomics, 8e – Chapter 5
5. a) 30%. Real GDP increases from 500 to 650 so the growth rate is +150/500 x 100 =
30%.
b) 7.7%. Real GDP increases from 650 to 700 so the growth rate is +50/650 x 100
= 7.7%.
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a) $20; (This is the difference between potential GDP (LAS) of $420 and equilibrium
GDP of $400.)
b) 5 percent (20/400 x 100);
c) Since the GDP gap is 2 ½ times the amount of cyclical unemployment, the latter
must equal 2% (5/2.5). Therefore the unemployment rate must be 8 percent (natural
rate of 6% plus cyclical unemployment of 2%).
7.
a) See the following figure:
Figure 5.26 (Completed)
b) Price 90;
Real GDP $750. (Where AD and AS intersect.)
c) Recessionary gap of $50. (Potential GDP (LAS) of $800 exceeds equilibrium
GDP of $750 by this amount.
d) See Figure 5.26 (Completed)
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Answer Key, Principles of Macroeconomics, 8e – Chapter 5
e) Price 110;
Real GDP $850. (Where the AD2 and AS intersect.)
f) Inflationary gap of $50. (Equilibrium GDP of $850 exceeds LAS of $800 by
this amount.
8.
real GDP (output)
employment (inputs)
productivity
last year
$160 (168/105 x 100)
20
$8 ($160/20)
this year
$200 (220/110 x 100)
23.5
$8.5 ($200/23.5)
Therefore productivity increased by 6.25% (+0.5/8 x 100)
9.
a) neoclassical supply:
Keynesian supply:
Aggregate Quantity Supplied 1
Aggregate Quantity Supplied 2
b) price: 80; real GDP: $800.
c) price: 100; real GDP: $600.
d) price: 95; real GDP: $800.(real GDP would not be affected by a change in
AD but the price level would increase).
e) price: 100; real GDP: $750. (the price level would not be affected by a change
in AD but real GDP would increase.)
10.
a) $21.82 ($24/110 x 100); i.e. real wage = nominal wage/price index x 100
b) See the following figure:
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Answer Key, Principles of Macroeconomics, 8e – Chapter 5
Figure 5.27 (Completed)
c) $20.00 ($24/120 x 100);
d) See Figure 5.27 (completed)
e) $21.82 (at full-employment the real wage is the same as it was originally in a).
f) $28.37 (nominal wage = real wage (21.82) x price index (130) ÷100
Answer to Comprehensive Problem
a) The plotting is fairly straightforward, though you will appreciate that the AS is not
a straight line and therefore needs a little care in drawing it. The LAS (potential
GDP) curve is a vertical straight line at $200. Since Everton is in equilibrium and at
full employment, the LAS is located at the intersection of the AD1 and AS1 curves.
See the following figure:
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Answer Key, Principles of Macroeconomics, 8e – Chapter 5
Figure 5.28 (Completed)
b) Price: 80;
real GDP: $200
The equilibrium values can be read off the graph or by glancing at Table 5.3 and
locating the price at which the quantity demanded is equal to the quantity supplied.
c) See the following table:
TABLE 5.6 (Completed)
Price Index
Aggregate
Quantity
Supplied 1 (AS1)
Aggregate
Quantity
Demanded 1
(AD1)
Aggregate
Quantity
Demanded 2 (AD2)
Aggregate
Quantity Supplied
2 (AS2)
65*
$0
$260
200
$100
70*
100
240
180
180
75
160
220
160
220
80
200
200
140
245
85
230
180
120
260
90
250
160
100
270
95
260
140
80
274
100
270
120
60
275
(*The price level is inflexible downward at $70 for AS1 and at $65 for AS2)
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Answer Key, Principles of Macroeconomics, 8e – Chapter 5
d) See Figure 5.28 (completed).
The new AD2 curve is 3 squares to the left of AD1.
e) Price: 75;
real GDP: $160
f) Recessionary gap of $40.
(The difference between the new equilibrium GDP and the LAS (potential GDP).)
g) increased exports
higher taxes
higher interest rates
lower government spending
X
X
X
h) See Figure 5.28 (Completed) above.
i) Price: 75;
real GDP: $220
j) Inflationary gap of $20.
(The difference between the new equilibrium GDP and the LAS (potential GDP).)
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