Econ 203_Chap.9

Question 1

What happens to wages and other factor prices in the short run?

Answer 1

They are fixed (do not change).

Question 2

How is real GDP determined in the short run?

Answer 2

By the interaction of Aggregate Demand (AD) and Aggregate Supply (AS).

Question 3

What causes GDP to deviate from potential output (Y)?

Answer 3

Economic shocks (such as demand increases, recessions, or supply disruptions).

Question 4

What happens to wages when output is too high (Y > Y)?

Answer 4

Wages rise because workers have more bargaining power.

Question 5

What happens to wages when output is too low (Y < Y)?

Answer 5

Wages fall, but slowly (wage stickiness).

Question 6

Why do wages rise faster than they fall (wage stickiness)?

Answer 6

Workers resist wage cuts, and contracts often prevent immediate reductions.

Question 7

Why does GDP always tend to return to potential output (Y)?

Answer 7

Changes in wages and costs shift AS, bringing GDP back to Y*.

Question 8

How do wages and prices behave in the long run?

Answer 8

They fully adjust to economic conditions.

Question 9

What factors cause potential GDP (Y) to increase over time?

Answer 9

Growth in technology, labor force, and capital.

Question 10

Why is the economy never fully in the long run?

Answer 10

Constant AD and AS shocks prevent full adjustment.

Question 11

How do businesses react when real GDP is above potential output (Y > Y)?

Answer 11

They increase wages to attract more workers, raising costs.

Question 12

How do businesses react when real GDP is below potential output (Y < Y)?

Answer 12

They avoid raising wages and may try to reduce them.

Question 13

Why do costs rise when wages increase?

Answer 13

Higher wages increase production costs, shifting AS left.

Question 14

Why do wages fall slowly during recessions?

Answer 14

Contracts, worker resistance, and labor laws prevent fast wage cuts.

Question 15

What does the Phillips Curve show?

Answer 15

The relationship between unemployment and wage inflation.

Question 16

What happens to wages when unemployment is low?

Answer 16

Wages rise quickly.

Question 17

What happens to wages when unemployment is high?

Answer 17

Wages fall, but slowly.

Question 18

What role does potential output (Y) play in the economy?

Answer 18

It acts as the economy’s long-term equilibrium level.

Question 19

Why does real GDP return to Y after a shock?

Answer 19

Wage and price adjustments shift AS, stabilizing GDP at Y*.

Question 20

What happens to GDP in the short run after a positive AD shock?

Answer 20

GDP rises above Y*, wages and prices increase.

Question 21

How does the economy adjust to a positive AD shock in the long run?

Answer 21

Rising wages increase costs, shifting AS left, bringing GDP back to Y*.

Question 22

What happens to GDP in the short run after a negative AD shock?

Answer 22

GDP falls below Y*, unemployment rises.

Question 23

How does the economy adjust to a negative AD shock in the long run?

Answer 23

Lower wages reduce costs, shifting AS right, bringing GDP back to Y*.

Question 24

What happens to GDP and prices after a negative AS shock?

Answer 24

GDP falls, prices rise (stagflation).

Question 25

What is stagflation, and how does it occur?

Answer 25

Stagflation is when prices rise and GDP falls, often caused by a negative AS shock.

Question 26

How does the economy adjust to a negative AS shock over time?

Answer 26

Lower wages and costs shift AS right, restoring GDP to Y*.

Question 27

What happens to real GDP in the long run after an AD or AS shock?

Answer 27

It returns to potential output (Y*).

Question 28

Why do AD shocks only affect prices in the long run?

Answer 28

Because GDP always returns to Y*, but prices remain higher or lower.

Question 29

How can the government respond to a recessionary gap (Y < Y)?

Answer 29

Increase government spending, lower taxes (shifting AD right).

Question 30

How can the government respond to an inflationary gap (Y > Y)?

Answer 30

Reduce government spending, raise taxes (shifting AD left).

Question 31

What are automatic stabilizers?

Answer 31

Policies that adjust automatically (e.g., unemployment benefits, progressive taxes).

Question 32

How do taxes and benefits help stabilize the economy?

Answer 32

During recessions, taxes fall and benefits rise, boosting spending. During booms, taxes rise and benefits fall, slowing the economy.

Question 33

What are the main delays in using fiscal policy?

Answer 33

Decision lag (recognizing a problem), execution lag (implementing a solution).

Question 34

Why don’t temporary tax cuts always change spending behavior?

Answer 34

People may save the extra money instead of spending it.

Question 35

How can too much government spending 'crowd out' private investment?

Answer 35

It can increase interest rates, making borrowing more expensive for businesses.

Question 36

Why does the economy naturally adjust to economic shocks?

Answer 36

Changes in wages and costs shift AS, bringing GDP back to Y*.

Question 37

Why do wages rise quickly in booms but fall slowly in recessions?

Answer 37

Workers have more bargaining power in booms but resist wage cuts in recessions.

Question 38

What are the pros and cons of government intervention in the economy?

Answer 38

Pros: Can speed up recovery, reduce unemployment, stabilize prices. Cons: Can cause delays, increase debt, and lead to inflation if overused.