Chapter 15 Study ECO Exam

1. factors that shift some component of the aggregate demand and supply model. 2. Of the factors identified above that shift the​ short-run aggregate supply​ curve, the only factor that possibly also shifts the​ long-run aggregate supply curve is

1. * Households and businesses come to expect an acceleration in inflation. * A negative price shock occurs in the form of higher oil prices. * Output remains persistently high relative to potential output (Y>YP). -------------------------------- 2. price shocks but only if this factor is permanent.

1. The inflation rate tends to​ increase, as expected inflation _________

1. Increases

2. The inflation rate tends to​ increase, as the unemployment gap ___________

2. Decreases

3. The inflation rate tends to​ increase as the actual unemployment rate ____________

3. Decreases

Classify the following situation as a supply or demand​ shock: Steel Workers go on strike for 4 weeks.

A Negative (temporary) supply shock

Which of the following factors would not cause an increase in aggregate​ demand?

A decrease in the price level.

Classify the following situation as a supply or demand​ shock: Household and firms become more optimistic about the economy.

A positive demand shock.

During the first half of​ 2010, Fed officials discussed the possibility of increasing interest rates as a way of fighting potential increases in expected inflation. If the public came to expect higher inflation rates in the​ future, what would be the effect on the​ short-run aggregate supply curve.

AS1----AS2 , Shifts Upward

If huge budget deficits cause the public to think that there will be higher inflation in the future but have no effect on business or consumer​ optimism, what will happen to the position of the aggregate demand​ curve?

Aggregate demand will not change.

Which of the following is an example of a​ "good" supply​ shock?

Changes in the healthcare industry in the late 1990's

"If prices and wages are perfectly​ flexible, then γ ​= 0 and changes in aggregate demand have a smaller effect on​ output." Is this statement​ true, false ?

False. As prices and wages become more​ flexible, γ becomes​ larger, and thus for a given aggregate demand​ shock, the effects on output are smaller.

Which of the following describes a reason why the​ long-run Phillips curve relationship differs from the​ short-run relationship?

In the long​ run, expected inflation is taken into account when making work and hiring decisions.

What​ trade-offs does this relationship seem to offer​ policymakers?

Policymakers can increase inflation to decrease unemployment.

If huge budget deficits cause the public to think that there will be higher inflation in the​ future, what will happen to the position of the​ short-run aggregate supply​ curve?

Short-run aggregate supply will shift leftward.

Internet sites that allow people to post their resumes reduce the cost of a job search. How do you think the Internet has affected the natural rate of​ unemployment?

The Internet has decreased the natural rate of unemployment

As the labor force becomes more productive over​ time, how does that affect the​ long-run aggregate supply​ curve?

The LRAS curve shifts to the right because the existing labor​ force, along with a given amount of capital and other​ resources, can produce more output.

What determines the unemployment rate when output is at​ potential?

The length of time between jobs when a worker is transition from one job to another.

"The depreciation of the dollar from December 2008 to December 2009 had a positive effect on aggregate demand in the​ U.S." Is this statement​ true, false, or​ uncertain? Explain your answer.

True, since a cheaper dollar increases net​ exports, a component of aggregate demand.

Why are central banks so concerned about inflation​ expectations?

When inflation expectations​ rise, the​ short-run aggregate supply curve shifts​ up, leading to higher actual inflation in the short run.

The financial crisis that began in August 2007 in the United​ States:

caused a collapse of​ China's exports and the Chinese government used a fiscal stimulus package to restore economic activity.

The​ short-run aggregate supply curve slopes upward because an increase in output relative to potential​ output:

creates tight labor and product markets that cause inflation to rise.

Even after the aggregate supply curve shifted rightward after July​ 2008, the severity of the negative demand shock hitting after the Lehman Brothers bankruptcy caused the U.K. economy to move ____________ potential output.

farther from

Chinese exports collapsed in late 2008 most likely because Western Europe and the U.S. are two very big markets for Chinese​ exports, and both of these economies had substantial income declines following the negative shock of the Lehman Brothers bankruptcy.

incomes fell in its key export markets.

Suppose that the White House decides to sharply increase military spending without decreasing government spending in other areas. This measure​ would, all else​ constant, cause aggregate demand to

increase AD Shifts to the Right

The Federal Reserve pursued inherently recessionary policies in the early 1980s​ to:

lower the inflation​ rate, which had spun out of control.

Adaptive expectations are based​ on:

past values

In the absence of the negative demand shock​ (precipitated by the Lehman Brothers bankruptcy and the reversal of the oil price​ increase, the U.K. economy would likely have evolved back toward full employment via its :

self-correcting mechanism

The aggregate demand curve slopes downward because a rise in inflation​ leads:

the monetary policy authorities to raise real interest rates.

The stimulus package used by China after the financial crisis that began in August 2007 in the United States​ was:

three times larger than the U.S. fiscal stimulus package relative to GDP.

Had the Chinese government elected to rely solely on the​ economy's self-correcting​ mechanism, how, aside from​ timing, would the​ long-run outcome have differed from that which the policy stimulus produced​ (which was the restoration of equilibrium at point 1 in Figure 18 panel (a)

(View External Graph Paper) Only inflation would be lower.

Once the U.K. economy sank to the​ short-run equilibrium at point 3 in Figure 17 panel (a) the restoration of equilibrium at full employment could come from the combined effects of aggressive expansionary macro policies and the​ economy's self-correcting mechanism. In terms of the ​AD-AS​ analysis, this restoration works itself out as

(View External Graph Paper) both AD and AS shifting rightward.

In the United​ Kingdom, the unemployment rate increased from​ 5.4% in 2006 to​ 7.8% in December​ 2009, while the inflation rate rose from​ 2.3% to​ 3.9% and then fell to​ 2.1% over this same time period. This can be explained by the following changes in aggregate demand and aggregate​ supply:

* Aggregate supply initially decreased.​ Subsequently, (-) * Aggregate supply​ increased, (+) * while aggregate demand decreased. (-)

aggregate demand curve shifts left when

* Consumer pessimism spreads as the media reports disappointing news about the economy * Foreign economies crash, producing a substantial drop in net exports. * The government allows previously enacted tax cuts to​ expire, resulting in much higher taxes for households.

Proposals have come before Congress that advocate the implementation of a national sales tax. Which of the following is true if such a tax is​ implemented? Which of the following best explains why aggregate supply would decrease in the short run due to the implementation of a national sales​ tax?

* It would cause a decrease in aggregate supply in the short run and no change in the long run. * The cost of goods sold would​ increase, making production more expensive.

Why did China fare much better than the United States and the United Kingdom during the​ 2007-2009 financial​ crisis?

* The Chinese economy is less closely tied to the functioning of financial markets than the economies of the United States and the United Kingdom. *China pursued an autonomous easing of monetary policy.

What factors led to a decrease in both the unemployment rate and the inflation rate in the​ 1990s?

* The computer revolution, which caused rapid increases in productivity * Improved demographic factors, such as an increase in the average age of the workforce.

According to the​ expectations-augmented Phillips​ curve, which of the following factors determines the rate of​ inflation?

* The degree of tightness in the labor market. * The difference between the unemployment rate and the natural rate of unemployment. *Expected inflation

does not affect the position of the aggregate demand curve

* The government adopts ​ill-advised regulations that diminish the​ economy's overall efficiency. * The prospect of worsening inflation induces the Federal Reserve to tighten monetary policy * Actual output falls below falls below potential​ output, eliminating"tightness" in resource markets.

aggregate demand curve shifts right when

* war breaks​ out, forcing the government to substantially enhance defense expenditures. * Optimism within the business community induces a surge in planned business expenditures. *The Federal Reserve autonomously loosens monetary policy.

When the unemployment rate is above the natural rate of​ unemployment, there is __________ in the labor market and output is ________ potential. This causes the​ short-run aggregate supply curve to ___________. Hence inflation _____________ and output ___________over​ time, until the economy reaches a ___________equilibrium.

*Slack *Below *Shift downward *Decreases *Increases *Long-Run

(Graph 22.6) Suppose the economy is starting from a situation of​ long-run equilibrium. In this​ case, we know that its equilibrium output (Y*) is _____________ suppose the economy experiences a PERMANENT | POSITIVE | supply shock. ***** POSITIVE PERMANENT = LRAS moves to the RIGHT past SRAS (view graph 22.6) Positive Supply Shock

1. Equal to it's potential output (Yp) (view graph 22.6) Negative Supply Shock 2. Higher Output , Lower inflation 3. Negative Output GAP (The GAP has decreased) 4. Down and to the Right (Starting from original location (1) the line will move from 1 to 2 , therefore , Down and to the Right. Negative output gap means the gap not existing) 5. * the output gap falls to zero. * the AS curve intersects AD1 and LRAS2 * a new​ long-run equilibrium is attained.

(Graph 22.6) Suppose the economy is starting from a situation of​ long-run equilibrium. In this​ case, we know that its equilibrium output (Y*) is _____________ suppose the economy experiences a PERMANENT | Negative | supply shock. ***** NEGATIVE PERMANENT = LRAS moves to the Left past SRAS Starting from its​ long-run equilibrium at point 1 in the figure to the​ right, suppose the economy experiences a permanent negative supply shock. (view graph 22.6) Negative Supply Shock 2. Compared to its original​ state, the economy in the​ short-run equilibrium at point 2 has output that is_________and inflation that is_______ 3. At the new​ short-run equilibrium, the output gap (Y*-Yp) is 4. The positive output gap means that the aggregate supply curve ​(AS2​) will shift 5. The shifts in the​ short-run aggregate supply curve continue​ until:

1. Equal to it's potential output (Yp) (view graph 22.6) Negative Supply Shock 2. Lower Output , Higher inflation 3. Positive Output GAP (The GAP has increased) 4. up and to the left (Positive output gap means the gap is getting larger to the left) 5. * the output gap falls to zero. * the AS curve intersects AD1 and LRAS2 * a new​ long-run equilibrium is attained.

4. The inflation rate tends to​ increase as the natural rate of unemployment __________

4. Increases

(Graph 22.6) Suppose the economy is starting from a situation of​ long-run equilibrium. In this​ case, we know that its equilibrium output (Y*) is _____________ suppose the economy experiences a Temporary| Positive | supply shock. (view graph 22.6) Positive Supply shock Starting from its​ long-run equilibrium at point 1 in the figure to the​ right, suppose the economy experiences a permanent Positive supply shock. Temporary| Positive = Tightness Temporary| Negative = Slack (Both correspond to firms raising their prices) Any Temporary Short runs return back to 1, 2--->1 , Shift up and left, Shift down and right. Both Temporary Output Gaps Narrow and are Unchanged.

Equal to it's potential output (Yp) Short-run equilibrium at point 2 has output that is (HIGHER) and inflation that is (LOWER) In this short-run equilibrium at point 2, labor markets would likely see increasing tightness (BECAUSE) : Increasing (TIGHTNESS) occurs since the unemployment rate is less than the natural rate, owning to the fact that the output gap (Y*-Yp) is positive. Due to the tightness, strong wages and cost that force firms to raise their (PRICES) at a more rapid rate. Graphically, this chain reaction from wages to costs to prices produces shifts in the​ short-run aggregate supply curve ​(AS2​) that are (UP AND TO THE LEFT) These shifts in the​ short-run aggregate supply curve result in output gaps that are (NARROWING) and the economy is evolving toward an eventual new​ long-run equilibrium at which inflation and output​ are, compared to their original​ values (UNCHANGED)

* What happens to inflation and output in the short run and the long run when government spending​ increases?

If government spending​ increases, the [aggregate demand] curve shifts [rightward] *In the SHORT RUN, [inflation increases] and [output increases] This leads to tightness in the labor​ market, which [raises inflation] expectations and shifts the [short-run aggregate supply curve up] When this​ occurs, the economy moves to a new [long-run] ​equilibrium, [output falls back to potential]​, and [inflation increases]

Suppose the inflation rate remains relatively​ constant, and output decreases and the unemployment rate increases. This is possible​ if: View Graph 22.4 (Normal inflation but Output decrease/ Unemployment Decrease)

In order for the unemployment rate to rise and inflation to remain​ constant, both the aggregate supply and demand curves would have to shift to the left. If they shift horizontally to the left by the same​ amount, the result is inflation remaining the​ same, but output falling and unemployment rising in the short​ run

Steel Workers go on strike for 4 weeks. Determine the effects on inflation and output in the short run and the long run using ​AD/AS graph analysis.

In the short​ run, output [decreases] and inflation [increases]. In the long​ run, output [rises] to potential and inflation [decreases to its original level] Graph D View Graph Render 22.6 Workers go on strike.

Household and firms become more optimistic about the economy. Determine the effects on inflation and output in the short run and the long run using ​AD/AS graph analysis.

In the short​ run, output [increases] and inflation [increases]. In the long​ run, output [falls] to potential and inflation [rises] Graph B View Graph Render 22.6 Households.

Given the relative size of the Chinese fiscal stimulus and its acknowledged success in restoring strong growth to the Chinese​ economy, one might cautiously​ conclude, with the U.S. economy still languishing well into​ 2010, that the comparable U.S. effort was ____________

Inadequate

Which of the following justifies the assumption of adaptive expectations in Phillips curve​ analysis?

Inflation expectations are sticky

What basic relationship does the​ short-run Phillips curve​ describe?

It describes the negative relationship between unemployment and inflation.

What basic relationship does the​ long-run Phillips curve​ describe?

It indicates unemployment will move toward its natural rate regardless of the inflation rate.

In what ways is the Volcker disinflation considered a​ success? What are the negative aspects of​ it?

The Volcker disinflation was successful in bringing inflation down with contractionary​ policies; however, these policies resulted in two recessions and a significant increase in unemployment.

Suppose that the public believes that a newly announced​ anti-inflation program will work and so lowers its expectations of future inflation. What will happen to aggregate output and the inflation rate in the short​ run?

The inflation rate will fall and aggregate output will rise

When aggregate output is below the natural​ rate, what will happen to the inflation rate over time if the aggregate demand curve remains​ unchanged?

The inflation rate will fall because the slackness of the labor market will eventually cause wages to fall.