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Appendix 20A
The Self-Correcting
Aggregate Demand
and Supply Model
©2004 South-Western
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1. An assumption of the short-run aggregate supply curve is
that it is a period of time which:
a. knowledge is complete.
b. wages are fixed.
c. wages are constant for under one year.
d. prices firms charge for products are fixed.
B. The short-run aggregate supply curve (SRAS) is
based on two assumptions: (1) incomplete knowledge
and (2) fixed-wage contracts.
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2. The long-run aggregate supply curve is based on the assumption
that
a. both the price level and nominal incomes are fixed.
b. prices are flexible after one year.
c. both the price level and nominal incomes change by the
same percentage.
d. potential GDP is undermined.
C. The long-run aggregate supply curve (LRAS) is a
vertical curve at full-employment real GDP along which
profits remain unchanged because the price level and
nominal income change proportionally.
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3. Graphically, long-run macro equilibrium occurs at the
a. Midpoint of the aggregate demand curve.
b. Intersection of the aggregate demand and long-run
aggregate supply curves regardless of the short-run
aggregate supply curve.
c. mid-point of the long-run aggregate supply curve.
d. Intersection of the aggregate demand, short-run
aggregate supply, and long-run aggregate supply
curves.
D. The intersection of these curves establishes the
equilibrium price level and full-employment real GDP.
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4. An increase in nominal incomes of workers results in the
a. aggregate demand curve shifting to the left.
b. long-run aggregate supply curve shifting to the right.
c. short-run aggregate supply curve shifting to the left.
d. short-run aggregate supply curve shifting to the
right.
C. If workers increase their nominal incomes to restore
their purchasing power, the higher cost of labor means
firms must increase the price level at each possible level
of real GDP to maintain profits.
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5. An increase in aggregate demand in the long-run will
result in ____ in full employment real GDP and ____ in
the price level.
a. no change; an increase.
b. an increase; no change.
c. a decrease; no change.
d. no change; a decrease.
A. Since the long-run aggregate supply curve (LRAS) is
vertical at full-employment real GDP, an increase in the
aggregate demand curve (AD) causes an upward
movement along LRAS to establish a higher price level.
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Exhibit A-7
Aggregate Demand
and Supply Model
6. In Exhibit A-7, the intersection of AD1 with SRAS indicates:
a. short-run equilibrium.
b. long-run equilibrium.
c. that the economy is not operating at full employment.
d. that prices and wages are inflexible.
B. Long-run equilibrium occurs where the aggregate
demand curve (AD1) intersects both the short-run
aggregate supply curve (SRAS) and the long-run
aggregate supply curve (LRAS).
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7. In Exhibit A-7, the intersection of AD2 with SRAS indicates:
a. short-run equilibrium.
b. long-run equilibrium.
c. that the economy is operating at full employment.
d. that prices and wages are inflexible.
A. Since the intersection of aggregate demand curve
(AD2) and the aggregate supply curve (SRAS) does not
occur along the long-run supply curve (LRAS), it is a
short-run equilibrium situation.
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8. In Exhibit A-7, the self-correcting AD/AS model argument
is that, if D2 equals SRAS, competition:
a. from unemployed workers causes an increase in
nominal wages and a rightward shift in SRAS.
b. from unemployed workers causes a rightward shift in
LRAS.
c. among firms for workers increases nominal wages and
this causes a leftward shift in SRAS.
d. among consumers causes an increase in the CPI and a
rightward shift in SRAS.
A. In short-run equilibrium below full-employment real
GDP, unemployed workers will force a lower wage rate
causing the short-run aggregate supply curve (SRAS) to
shift rightward.
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9. In Exhibit A-7, the self-correcting AD/AS model theory is
that in the long run the economy will
a. will remain where SRAS intersects AD1.
b. shift to the intersection of AD2 and SRAS.
c. shift to the intersection of AD2 and LRAS.
d. shift to the intersection of AD2 and a new leftwardshifted SRAS.
C. In the long-run, the rightward shift of the short-run
aggregate supply curve (SRAS) will establish long-run
equilibrium where the aggregate demand curve (AD2)
intersects the long-run aggregate supply curve (LRAS).
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10. In A-7, the self-correcting AD/AS model predicts that
the long-run result of the decrease from AD1 to AD2 will
be a (an)
a. higher price level and higher unemployment rate.
b. lower price level and higher unemployment rate.
c. unchanged price level and full employment.
d. lower price level and full employment.
D. At any real GDP below the point where the long-run
aggregate supply curve (LRAS) intersects the
horizontal real GDP axis, the unemployment rate is
higher than the full-employment rate. Also, observe that
along the vertical axis that the price level (CPI) falls in
this case from moving to long-run equilibrium.
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11. Which of the following is the most likely to cause a leftward
shift in the long-run aggregate supply curve?
a. An increase in labor.
b. An increase in capital.
c. An advance in technology.
d. Destruction of resources.
D. A leftward shift in the long-run aggregate supply
curve is caused by decreases in resources (land, labor,
or capital) that reduces the productive capacity of the
economy.
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END
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