Download Chapter 13 Aggregate Demand and Aggregate Supply

Chapter 13 Aggregate Demand and Aggregate Supply
Review Questions
2.
False. Fiscal policy (which involves changing the level of government purchases and/or
taxes) will shift the AD curve; however, changes in these variables in order to achieve
other government goals, or changes in autonomous consumption spending, investment
spending, net exports, or the money supply will also shift the AD curve.
4.
The short-run aggregate supply curve captures the idea that changes in real GDP cause
changes in the price level. It slopes upward because a rise in GDP increases unit costs,
thereby increasing the price level, and a fall in GDP decreases unit costs, consequently
depressing the price level.
6.
The economy’s self-correcting mechanism is the long-run adjustment process whereby
the economy returns to full employment after a demand shock. When a demand shock
pushes the economy away from full-employment, changes in the wage rate and the price
level return the economy to full-employment. For instance, consider a negative demand
shock that decreases GDP. Assuming that initially the economy operated at fullemployment GDP, a decrease in GDP will cause wages to fall due to high
unemployment. As wages fall, unit costs decrease and the price level decreases causing
GDP to rise. When the economy returns to full-employment output, this process stops.
8.
Since the long-run aggregate supply curve is vertical, fiscal policy has no effect on GDP
in the long run. It can only affect the price level. This is consistent with the classical view
of fiscal policy. The vertical long-run AS curve also supports the classical view of
crowding out. Beginning at full-employment output, a rise in government purchases will
have no effect on GDP. Therefore, private sector spending must fall by as much as
government purchases increase. That is, complete crowding out occurs, just as the
classical model predicts.
10.
Real GDP growth did not keep up with productivity in 2002 for two reasons. First, real
GDP growth was unusually low because business investment had fallen (perhaps due to
continuing global uncertainty after September 11, 2001, and because, due to high levels
of investment during the 1990s, firms had caught up with the amount of capital they
desired). Second, productivity growth did not slow down because firms were able to
adjust their workforce more easily to fluctuations in production due to a greater reliance
on part-time and temporary workers.
Problems and Exercises
2.
Initially, the economy is at points E, J, and S. When the money supply curve shifts from
MS1 to MS2 the interest rate rises. The higher interest rate causes aggregate expenditure
to decrease, leading to a decrease in GDP. At any price level, equilibrium GDP has
decreased, and thus the AD curve shifts to the left. If the price level remains unchanged,
the economy will come to rest at points F, K, and T. The interest rate is higher, real
aggregate expenditure is lower, and the AD curve has shifted to the left.
4.
Assume that the economy is initially in equilibrium at point E. A decline in investment
spending will shift the AD curve leftward, leading to a lower price level and smaller GDP
at the new equilibrium point F. If the price level were held constant, then GDP would fall
even more, to point G.
6.
The increase in autonomous consumption shifts the AD curve rightward from AD1 to
AD2, increasing both the price level and real GDP in the short run (from point A to point
B). In the absence of government intervention, eventually the AS curve would shift
leftward from AS1 to AS2, moving the economy to point C. In the long run, an increase in
autonomous consumption would lead to a higher price level and no net change in real
GDP.
8.
a.
If the Fed did nothing, eventually the AS curve would have shifted back to its
original position as unusually high unemployment would drive the wage rate down,
and the economy would have returned to point E.
b.
The Fed’s actions were designed to boost investment spending, which would shift the
AD curve rightward to ADpost 1991. If successful, the economy would reach a new
equilibrium at point F.
c. If the Fed did nothing then the price level would have fallen as the AS curve shifted
downward. As it was, the price level rose due to the Fed action.
10.
a.
An increase in competition will shift the AS curve downward, from AS1 to AS2.
b.
After the initial increase in competition shifts the AS curve downward from AS 1 to
AS2, the Fed will cut interest rates in order to shift the AD curve rightward, from AD1
to AD2. The economy will reach a new equilibrium at point F, where the price level is
once again P1. Real GDP increases from Y1 to Y2.
12. a.
A temporary decrease in nonlabor input prices will temporarily move the economy
from point (A) to point (B), as the AS curve temporarily shifts from AS1 to AS2.
b. If the decrease lasts for an extended period the self-correcting mechanism will bring
the economy back to full employment as wages rise, and shift the AS curve back up
to AS1.
c. The Fed would reduce the money supply to move the economy away from point (B).
This would shift the AD curve from AD1 to AD2, and the economy would end up at
point (C), rather than at point (A).
Challenge Questions
2.
The Fed countered the downward AS curve shift by increasing the money supply, which
led to an increase in AD. Although the downward AS curve shift put downward pressure
on the price level, this was offset by the upward pressure on the price level from the
increase in AD.
Economic Application Exercises
2.
The diagram shows this relationship.