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CHAPTER 16
Extending the Analysis of Aggregate Supply
A. Short-Answer, Essays, and Problems
1. What is the basic difference between the short run and long run as these terms relate to
macroeconomics? Why does this difference occur?
New 2. Complete the table below.
Price Index
Nominal Wage
Per hour
100
97
94
91
88
85
$10
10
10
10
10
10
Real Wage
$_____
_____
_____
_____
_____
_____
New 3. Complete the table below.
Price Index
100
103
106
109
112
115
Nominal Wage
Per hour
$10
10
10
10
10
10
Real Wage
$_____
_____
_____
_____
_____
_____
New 4. Assume that one year the nominal wage for a worker is $12 per hour and there is no
inflation. The next year the nominal wage stays the same but the rate of inflation is 10
percent. What is the new real wage after taking inflation into account? What nominal
wage would workers ask for to keep their real wage equal to what it was the first year?
New 5. Assume that one year the nominal wage for a worker is $15 per hour and there is no
inflation. The next year the nominal wage stays the same but the rate of inflation is 8
percent. What is the new real wage after taking inflation into account? What nominal
wage would workers ask for to keep their real wage equal to what it was the first year?
6. Describe the characteristics of the short-run aggregate supply curve. Explain what
happens to: (1) nominal wages; (2) real wages; (3) employment; (4) output; (5)
revenues; and, (6) profits as the price level increases from the full-employment level of
output. Then explain what happens to these variables as the price level decreases from
the full-employment-level of output.
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7. Suppose the potential level of real domestic output (Q) for a hypothetical economy is
$250 and the price level (P) initially is 100. Use the following short-run aggregate
supply schedules below to answer the questions.
AS (P
P
110
100
90
= 100)
Q
280
250
220
AS (P
P
110
100
90
= 110)
Q
250
220
190
AS (P
P
110
100
90
= 90)
Q
310
280
250
(a) What will be the short-run level of real GDP if the price level rises unexpectedly
from 100 to 110 because of an increase in aggregate demand? Falls unexpectedly from
100 to 90 because of a decrease in aggregate demand? Explain each situation.
(b) What will be the long-run level of real GDP when the price level rises from 100 to
110? Falls from 100 to 90? Explain each situation.
(c) Show the circumstances described in (a) and (b) on the graph below and derive the
long-run aggregate supply curve.
8. Suppose the potential level of real domestic output (Q) for a hypothetical economy is
$160 and the price level (P) initially is 200. Use the following short-run aggregate
supply schedules to answer the questions.
AS (P
P
210
200
190
= 200)
Q
190
160
130
AS (P
P
210
200
190
= 210)
Q
160
130
100
AS (P = 190)
P
Q
210
220
200
190
190
160
(a) What will be the short-run level of real GDP if the price level rises unexpectedly
from 200 to 210 because of an increase in aggregate demand? Falls unexpectedly from
200 to 190 because of a decrease in aggregate demand? Explain each situation.
(b) What will be the long-run level of real GDP when the price level rises from 200 to
210? Falls from 200 to 190? Explain each situation.
9. Describe the characteristics of the long-run aggregate supply curve. Explain how
changes in the price level affect the short-run aggregate supply curve and the long-run
aggregate supply curve.
10. What is the long-run equilibrium in the extended aggregate demand and aggregate
supply model?
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Extending the Analysis of Aggregate Supply
11. Describe the process that occurs with demand-pull inflation in the extended aggregate
demand and aggregate supply model.
12. Describe cost-push inflation in the extended aggregate demand and aggregate supply
model. Explain the policy dilemma for government policy if they take no action or use
monetary and fiscal policy to counter the cost-push inflation.
13. Differentiate between “demand-pull” and “cost-push” inflation in the basic aggregate
demand and aggregate supply model.
14. Explain what happens in the extended aggregate demand and aggregate supply model
when there is a recession.
New 15. What are three significant generalizations supported by results from the extended ADAS model?
16. What is the Phillips Curve? What concept does it illustrate?
17. Explain the Phillips Curve concept and construct an example of the curve on the below
graph.
18. If the Phillips Curve exists in reality, what dilemma does this create for fiscal and
monetary policies? Explain.
19. What is stagflation and what was one of its causes in the 1970s and early 1980s?
20. Assume the following information is relevant for an advanced economy over a threeyear period. Describe in detail the macroeconomic situation faced by this society. Is
cost-push inflation evident? What corrective policies would you recommend and why?
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Chapter 16
Year
Price
index
Increase in
labor
productivity
Increase in
industrial
production
Unemp.
rate
1
2
3
167
174
181
4%
3
2.5
4%
2
1.5
4.5%
5.2
5.8
Average
hourly
wage
$6.00
6.50
7.10
21. What contributed to stagflation's demise between 1982 and 1989? How did these events
affect aggregate supply and the Phillips Curve?
22. Compare and contrast the short-run Phillips Curve and the long-run Phillips Curve.
New 23. Answer the questions based on the following diagram.
(a) Assume the economy is initially at point B 1 and there is an increase in aggregate
demand which results in a 4% increase in prices. Describe the short-run and long-run
outcomes that would result in this economy.
(b) Assume the economy is initially at point B 2, and there is an increase in aggregate
demand. What will happen in the economy? Explain, using the graph.
(c) Based on this diagram, what would the prediction be for the natural (fullemployment) rate of unemployment?
New 24. Why is the difference between the actual and expected rates of inflation important for
explaining inflation?
New 25. What is disinflation? Give examples of it.
New 26. Why is the difference between the actual and expected rates of inflation important for
explaining disinflation?
27. Explain the basic arguments for supply-side economics.
28. What is the Laffer Curve? Explain the relationship that is shown in the curve.
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Extending the Analysis of Aggregate Supply
29. Use the following diagram to answer the next three questions.
(a) What is this diagram called and what does it say about the relationship between tax
rates and tax revenues?
(b) If tax rates are at level c, should the government raise or lower tax rates to increase
revenues? Explain.
(c) What does tax level b represent? Could policy makers find the actual rate that b
represents? Discuss this point.
30. Draw a Laffer Curve and explain the relationship it purports to portray. Why might this
curve be important for macroeconomic policy?
31. What are the major criticisms of the Laffer curve and supply-side economics?
New 32. (Last Word) Has the effect of oil prices increases on the economy been diminished?
Cite evidence to support the case for a diminished effect.
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