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Macroeconomics, HW 1 Craig Schroeder January 11, 2005 Page 105, Chapter 5 Problem 15: (Aggregate Demand and Supply) Determine whether each of the following would cause a shift in the aggregate demand curve, the aggregate supply curve, neigher, 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. The price level is assumed to be determined by the free market. Fluctuations in price will cause changes in neither aggregate supply nor aggregate demand. As such, the price level will converge to its appropriate value. Aggregate output will fluctuate until the price level becomes stable. Over time, heither the price level nor output are affected. (b) Consumer confidence declines. Decreased consumer confidence will shift the aggregate demand curve to the left, resulting in a reduction in demand. Consumer confidence does not affect the aggregate supply curve. Decreasing aggregate demand without changing aggregate supply results in decreased aggregate output and a lower price level. (c) The supply of resources increases. An increase in the availability of resources does not affect the quantity or goods that people demand. As such, the aggregate demand curve is unaffected. Resource increases will lower the costs of suppliers. The result is a shift of the aggregate supply curve to the right. Shifting the aggregate supply curve to the right without changing the aggregate demand curve results in an increase in aggregate output and a drop in the price level. (d) The wage rate increases. Wage increases will cause the aggregate demand curve to shift to the right. More wages result in additional spendable cash, which can then be used to purchase more goods that would otherwise not be demanded. Wage increases do not directly affect the aggregate supply curve. Increasing aggregate demand without changing aggregate supply results in increased aggregate output and a higher price level. Problem 16: (Supply-side Economics) One supply-side measure advocated by the Reagan administration was a cut in income tax rates. Use an aggregate demand-supply diagram to show what affect was intended. What might happen if such a tax cut also generated a change in aggregate demand? An aggregate demand-supply diagram is illustrated in Figure 1(a). The negatively-sloped aggregate demand curve is unaffected, The intended result is a right shift in the supply curve and the resulting rise in aggregate output and reduction in price level. If the tax cut also creates a change in aggregate demand, then a right shift of aggregate demand will result. This may produce an affect like that shown in Figure 1(b). Aggregate output will increase even further, but price levels will not drop as much and may actually increase. 1 AD P r i c e P r i c e AS AD AS Quantity Quantity (a) Supply Only. (b) Supply and Demand. Figure 1: Result of Right Shifting Aggregate Supply or Demand. Country Profile Comparison 1 2 3 4 5 6 7 8 Country Year Covered Population Per Capita Income Economic Growth Rate Unemployment Rate Inflation Rate Total Merchandise Exports and Imports and Balance Currency Used Russia 2004 143,782,338 $8,900 7.3% 8.5% 13.7% $134.4 billion $74.8 billion $35.91 billion Russian ruble (RUR) United States 2004 293,027,571 $37,800 3.1% 6% 2.3% $714.5 billion $1.26 trillion $-541.8 billion US dollar (USD) Notes Per Capita Income was realized as GDP - per capita. Economic Growth Rate was realized as GDP - real growth rate. Reference Cited 1. CIA - The World Factbook - Russia. http://www.cia.gov/cia/publications/factbook/geos/rs.html 2. CIA - The World Factbook - United States. http://www.cia.gov/cia/publications/factbook/geos/us.html 2