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Answer Key, Principles of Macroeconomics, 8e – Chapter 13
CHAPTER THIRTEEN
Answers to Test Your Understanding Questions
1. The Neoclassical aggregate supply curve is vertical at the full-employment level of
GDP because they argue that only real factors have an effect on capacity GDP.
Changes in aggregate demand and prices have no effect on the full-employment level
of GDP.
2. A decrease in the demand for loanable funds (for investment) or an increase in the
supply of loanable funds (from savers) will cause a decrease in interest rates.
3. a) wage rate: $7; workers employed: 12 million
b) employed: 10.8; unemployed: 2.7
c) Since employment dropped from 12 million to 10.8 million, 1.2 million have lost
their jobs. The rest of the unemployed, 1.5 million, are the result of more people
looking for jobs (quantity supplied increased from 12 to 13.5 million).
4. Keynes suggested that interest rates have little or no effect upon the level of savings.
First, he argued that income is by far the major determinant of savings, and second
because, if income remains the same, an increase in savings means a drop in
consumption and such a drop is painful for most people because it involves a change
in habits and in lifestyles.
5. According to Keynesian theory, an increase in aggregate demand will cause an
increase in real GDP (except at full employment). Since the price level remains
constant, it will also cause an increase in nominal GDP.
6.
Real GDP will rise as will the price level. The unemployment rate will fall.
7.
Fiscal policy will be more effective because the expansionary monetary will prevent
interest rates from rising and this will mean that there is no crowding out of
investment spending as a result of higher aggregate demand.
8. The major cause was the financial crisis was the bursting of the housing market
bubble in the USA. The dramatic fall in house prices led to millions of mortgage
holders to default leading to the collapse of a number of major banks. The problem
was made worse by the lack of regulations on banks and investment houses which led
these institutions to market new types of securities like derivatives which were highly
risky and of dubious value.
9. The reason that Canada’s Action Plan emphasized fiscal rather than monetary policy
is because interest rates were already extremely low in Canada and it was felt that
there would be little to be gained by decreasing them further.
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Answer Key, Principles of Macroeconomics, 8e – Chapter 13
10. a) Neoclassicists argued that although stimulus packages may have helped back in
the 1930s that’s because deficits and debt were much smaller then than they are
today. They are so large today that increasing them further would cause more harm
than good.
b) The value of the multiplier is much smaller than Keynesians would suggest and
therefore the impact of stimulus spending is likely to be small.
c) While stimulus packages may help a little in the short run, they do a great deal of
harm in the long run because the high deficits and debt that result tend to cause
business and consumers to lose faith in government and the economy.
Answers to Connect Study Problems
1.
a)
b)
c)
d)
e)
2.
a)
b)
c)
d)
3.
rate of interest: 8%;
rate of interest: 7% (At 7% savings equals 100);
rate of interest: 10% (At 10% investment equals 100);
change in savings: + $60 (shift S curve 3 squares right) ;
new level of savings/investment: $140;
change in investment:  $60 (shift I curve 3 squares left);
new level of savings/investment: $80
GDP: $800;
Price: 108 (Where the AD and AS intersect.)
Increase of $400. (The AD must shift 4 squares (400) to the right so that it
intersects the AS at Potential GDP (LAS).
GDP: $1000;
Price: 112 (Where the new AD and AS intersect.)
Keynesian.
a) See the following figure:
Figure 13.8 (Completed)
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Answer Key, Principles of Macroeconomics, 8e – Chapter 13
b) 0.75 millions.
(This is the difference ‒ 3 squares = 0.75 ‒ between the
quantity demanded and the quantity supplied at $12.)
c) Wage rate: $10
D2 intersect.)
quantity of labour: 9.5 millions
4. a) GDP: $1800 billions;
(This is where S and
price index: 122 (Where AD and AS intersect.)
b) Increase by $400 billions. (The AS needs to shift right so that it intersects the
AS at potential GDP (LAS). This means a shift of 4 squares, or $400.)
c) GDP: $2000 billions;
intersect.)
price index: 120 (Where the new AD and AS
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Answer Key, Principles of Macroeconomics, 8e – Chapter 13
5. a) Interest rate: 5%; loanable funds: $400 (The interest rate at which
investment (column 2) and saving (column 4 are equal.)
b) See the table below:
Table 13.2 (Completed)
(1)
(2)
(3)
(4)
(5)
Rate of
interest (%)
Investment
Spending
(billions)
Investment
Spending 2
(billions)
Saving
(billions)
Saving 2
(billions)
1
800
950
200
350
2
700
850
250
400
3
600
750
300
450
4
500
650
350
500
5
400
550
400
550
6
300
450
450
600
7
200
350
500
650
8
100
250
550
700
c) increase of $50 billions of loanable funds and an increase of 1% point in the
rate of interest.
(The new equilibrium ‒where investment 2 (column 3) and
saving (column 4) ‒ is at 6% and $450.
d) See Table 13.2 (Completed)
e) increase of $100 billions of loanable funds and a decrease of 1% point in
the rate of interest.
(The new equilibrium ‒where investment (column
2) and saving 2 (column 5) ‒ is at 4% and $500.
6. a) No, (there is a surplus and) prices will fall to 100 (This is because the fullemployment equilibrium is at a price of 100 and GDP of $350 which implies a
surplus at a price of 110.)
b) No change in real GDP, and prices rise to 105. (Think of the AS being a vertical
line at 35; an increase of AD by 50 shifts the AD curve right one square).
c) real GDP: 250 (This is the amount of GDP at the price of $110, which means it is
below the full-employment level of $350.)
d) GDP rises to 300, and prices stay at 110. (Think of AS as a horizontal line at a
price of 110; an increase of AD one curve to the right).
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Answer Key, Principles of Macroeconomics, 8e – Chapter 13
Answer to Comprehensive Problem
a) See the following figure:
Figure 13.11 (Completed)
b) The AD curve shifts to the right by 12 squares in Figure 13.11 (Completed) .
(Since aggregate demand changes by $20 billion for every 1% change in taxes, a
6% decrease in taxes will cause a $120 billion increase in aggregate demand.)
c) Real GDP has increased by $40, and the price level has increased by 16 points.
Reading the graph in Figure 13.11 (Completed) shows that the new equilibrium
is at a real GDP level of $640 and a price level of 116.
d) The AS and the Potential GDP (LAS) curves shift to the right by 3 squares as
shown in Figure 13.11 (Completed). Since aggregate supply changes by $5
billion for every 1% change in taxes, a 6% decrease in taxes will cause a $30
billion increase in both the aggregate supply and Potential GDP (LAS) curves.
e) Real GDP has increased by $20, and the price level has decreased by 4 points.
Ignoring the new AD2 curve, Figure 13.11 (Completed) shows that the increase
in the aggregate supply curve to AS2 which would bring about a new equilibrium
at a real GDP level of $620 and a price level of 96.
f) The total increase is the sum of the aggregate demand increase of $40 and the
aggregate supply increase of $20. The two together would therefore increase real
GDP by $60. The increase in aggregate demand pushes up the price level by 16
points whereas the increase in the aggregate supply pushes the price level down
by 4 points. Overall, therefore, the price level has increased by 12 points.
g) Inflationary gap of $20.
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Answer Key, Principles of Macroeconomics, 8e – Chapter 13
The Potential GDP (LAS) initially was at the $610 level of real GDP.
(Equilibrium was at $600, and the introduction to the question said there was a
$10 recessionary gap.) The decrease in taxation shifted both the AS and the
Potential GDP (LAS) curves since it increased the productivity of Copland. The
new Potential GDP (LAS) curve therefore increases by $30 and is located at the
$640 level of GDP. Since equilibrium (the intersection of AD2 and AS2) is at
$660, there is an inflationary gap.
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