Chapter 14

Question 1

AGGREGATE DEMAND

Answer 1

AGGREGATE DEMAND is a curve that shows the amounts of real output/ GDP that buyers
desire to purchase at each possible price level.

Question 2

What is the relationship between price level and the amount of real GDP demanded?
Why?

Answer 2

Negative or inverse
Due to the real balances effect, interest effect and foreign purchases effect

Question 3

What happens to real GDP as price levels increase?

Answer 3

Real GDP declines

Question 4

Draw a graph/s showing how to derive the AD curve from the AE model

Answer 4

See Figure 14.1 in the textbook. p302

Question 5

What does the shift in the AD curve illustrate in relation to aggregate expenditures?

Answer 5

It is a multiple of the initial change in aggregate expenditures.

Question 6

What are the depterminants of aggregate demand?

Answer 6

Consumer spending
* Consumer wealth
* consumer expectations
* household debt
* personal taxes

Investment spending
* Real interest rates
* expected returns
-ecxpectations about future business conditions
-technology
-degree of excess capacity
-business taxes

Government Spending

Net export spending
* national income abroad
* exchange reates

Question 7

How will the following impact AD?

1. Increase in wealth or income
2. consumers expect inflation in the near future
3. Increases household debt
4. tax reductions
5. Real interest rates increases
6. Expected returns are high
7. Government spending increases
8. Consumers buy less
9. exports are higher thatn imports
10. increases in national income
11. rand depreciation

Answer 7

1. Increases
2. consumers will buy more, AD will increase
3. AD increases
4. AD increases
5. AD decreases
6. AD increases
7. AD increases
8. AD decreases
9. AD increases
10. AD increases
11. AD increases

Question 8

What 2 components do changes in the aggregate demand involve?

Answer 8

• A change in one of the detiminants of aggregate demand that directly changes the amounf of real GDP demanded
• A multiplier effect that produces a greated ultimate hcange in aggregate demand than the initating change in spending.

Question 9

illustrate graphically in increase and decrease in AD

Answer 9

See figure 14.4 in textbook. p 305

Question 10

Why does the AD curve have a downward slope?

Answer 10

Real balance effect
Interest rate effect
Foreign purchase effect

Question 11

Real balances effect

Answer 11

The tendency for increases in the price level to lower the real value (or purchasing power) of financial assets with fixed money value and, as a result, to reduce total spending and real output, and conversely for decreases in the price level.

Question 12

Interest rate effect

Answer 12

The tendency for increases in the price level to increase the demand for money, raise interest rates and, as a result, reduce total spending and real output in the economy (and the reverse for price-level decreases).

Question 13

foreign purchase effect

Answer 13

The inverse relationship between the net exports of an economy and its price level relative to foreign price levels.
When average price levels rise, foreigners buy less which means exports decrease.

Question 14

AGGREGATE SUPPLY

Answer 14

is a curve showing the level of real domestic output that firms will produce at each price level.

Question 15

In aggregate supply the relationship between price level and amount of GDP supplied is

Answer 15

Positive or direct

Question 16

Define long and short run in macroeconomics. How do they vary?

Answer 16

• Long run: A period in which nominal wages and other resource prices match changes in the price level.
• Short run: a period in which nominal wages and other resource prices do not respond to price level changes.
• Vary by degree of wage adjustments, not by set length of time.

Question 17

Discuss Aggregate supply in the long run.
2 points

Answer 17

• In long run AS is vertical at economy’s full employement output
• When wages respond completely to changes in the price level, those price level changes to not alter the amount of real GDP produced and offered.

Question 18

Graphically illustrate the short and long run Aggregate supply curve

Answer 18

See figure 14.5 and 14.6

Question 19

Answer the following based on the short run AS curve

1. Why is it up sloping?
2. Why is it relatively flat below the full employment output?
3. Why is it relatively steep beyond the full employment output?

Answer 19

1. There is a direct or positive reltionship between the price level and the amount of real output that firms will offer for sale. When prices are higher firms will produce more.
2. unemploued resources and unused capacity allow firms to resond to price level rieses with large increases in real output.
3. resource shortages and capacity limitations make it difficult ot expand output as the price level rises.

Question 20

Formula for per-unit production cost

Answer 20

Total input cost / units of output

Question 21

What happens to per unit production costs as the economy expands and why.

Answer 21

generally rises because of reduced efficiency

Question 22

Formula for productivity

Answer 22

total output/total input

Question 23

DETERMINANTS OF AGGREGATE SUPPLY

Answer 23

change in Input prices
* domestic resource prices
* Prices of importes resources
* market power

change in Productivity
* Productivity (total output/total input)
* Per unit production cost (total input costs / units of output)

change in Legal institutional environment
* changes in business taxes
* changes in business subsidies
* changes in government regulations

Question 24

Graphically illustrate an increase and decrease in AS

Answer 24

See figure 14. 7

Question 25

# How will the following impact Aggregate supply 1. decrease in wages 2. Increase in prices of machinery 3. Increases in productivity levels 4. Higher taxes 5. More subsidies 6. Higher government regulations

Answer 25

1. Reduces per unit production costs, AS increases 2. Increases per unit production cost, AS decreases 3. reduces per unit prodiction cost, AS increases 4. increases per unit production cost, AS decreases 5. decreases per unit production cost, AS increases 6. Costly to comply, higher costs, AS decreases

Question 26

Where will equilibrium price level and real output be found on AS and AD curve?

Answer 26

Where AD intersect AS.

Question 27

Shortly describe what happends when AD increases

Answer 27

**Demand pull inflation** * Price level increases * Price level is beyond full employment level of output * Causes inflation * Demand-pull inflation occcures * Real output increases * decreases in unemployment * Actual GDP exceeds potential GDP, a positive gap * Rise of price level decreases multiplier effect * Any increase in real output will be smaller the greater hte increases in price level.

Question 28

The bigger the increase in price level, the "....................." will the increase in real output be. a. smaller b. bigger

Answer 28

a. smaller

Question 29

Shortly describe what happens when AD decreases

Answer 29

**Recession and cycical unemployment** * If flexible, Price level decreases, causing deflation * If not flexible, price level stays same but GDP still decreases. * Disinflation: rate of inflation fell, price level did not decline * Reduces real GDP * Negative GDP gat * Need less workers, causing recession and cyclical unemployment

Question 30

Explain what disinflation is

Answer 30

Rate of inflation fell, there is a GDP gap, but price levels do not fall.

Question 31

What are the reasons for disinflation

Answer 31

* Fear of price wars * Menu costs: firms think recession will be short-lived, reluctant to cut prices. * Morale, effort and productivity: Lower wages will only work if productivity stays the same. * Minimum wage

Question 32

Shortly describe what happens when AS decreases

Answer 32

**Cost push inflation** * Price levels increase * decreases GDP * increases inflation * increases in unemployment

Question 33

How is the price level and amount of real output determinded

Answer 33

Intersesction of AD and As

Question 34

What do decreases in AD cause and why?

Answer 34

Causes: recessions and cyclical unemployment Why: pricel and wages tend to be inflexible in a downward direction

Question 35

What does decreases in AS cause?

Answer 35

Cost push inflation

Question 36

What does IS stand for

Answer 36

Investment and savings

Question 37

What does LM stand for

Answer 37

Liquidity and Money

Question 38

The IS curve can be derived from the ______

Answer 38

Keynesian cross diagram

Question 39

Illustrate how the IS curve can be derives from the AE curve

Answer 39

See graph 14.14

Question 40

The LM curve can be derived from changes in the ________

Answer 40

Money market equilibrium

Question 41

IS describes the _____ market

Answer 41

goods and services

Question 42

LM describes the _____ market

Answer 42

money

Question 43

Illustrate graphically how to derive the LM curve using chages in the money market equilibrium

Answer 43

See graph 14. 15

Question 44

Where is equilibrium in the IS/LM model?

Answer 44

Where the IS (goods market) intersects with LM (money market)

Question 45

Define fiscal policy

Answer 45

Changes in government spending and tax collections designed to achieve a full-employment and non-inflationary domestic output; also called discretionary fiscal policy.

Question 46

Define expansionary fiscal policy

Answer 46

expansionary fiscal policy An increase in government purchases of goods and services, a decrease in net taxes, or some combination of the two for the purpose of increasing aggregate demand and expanding real output.

Question 47

When the government reduces tax, what will happen to the IS curve?

Answer 47

shift right

Question 48

When the government increases spending, what will happen to the IS curve?

Answer 48

Shift right

Question 49

The implementation of a relaxed monetary policy will shift the Lm curve to the _____

Answer 49

right

Question 50

The implementation of a tighter monetary policy will shift the LM curve to the ______

Answer 50

left

Question 51

Illustrate graphically: the increase of IS Increase of LM

Answer 51

See figure 14. 6 in textbook

Question 52

Explain briefly what increases in IS causes

Answer 52

Increase in interest rates Increases in GDP

Question 53

Explain briefly what decreases in the LM curve causes

Answer 53

Decreases in the interest rates and increase in GDP