Chapter 7: Aggregate Demand/Suppy

In the short run, the equilibrium price level and the equilibrium level of total output are determined by the intersection of

the aggregate demand and the short-run aggregate supply curves.

Which of the following will increase the short-run aggregate supply?

A decrease in the price of capital

Which of the following will decrease the short-run aggregate supply?

An increase in wages

Graph A: Suppose the economy is initially in short-run equilibrium at point K. If the policy-makers adopt a nonintervention policy, over time,

I. real wages will fall as long as unemployment remains above the natural rate. II. lower nominal wages will result in a gradual shift from SRAS2 to SRAS1. III. long-run equilibrium will be established at YP and Ph. ANSWER: I,II, and III

"Fracking" is a new technology that allows for more extraction of natural gas and oil than was previously possible. How is this technological discovery likely to affect the economy, assuming this not a temporary change (it has long-term effects.

Increase both SRAS and LRAS, leading to a long-term increase in output and decrease in prices.

Stagflation is a situation where

The price level increase while real GDP decrease.

Suppose the price (or cost) of an important natural resource such as oil falls. What will be the effect on the short-run aggregate supply curve?

The aggregate supply curve will shift to the right.

Graph B Suppose the economy is initially at A. Now suppose an increase in government purchases shifts the aggregate demand curve to AD2. Which of the following is false about the economy after it self-adjusts to its new long-run equilibrium?

a. Nominal wages increase. b. The price level rises to Pd. c. Firms employ more workers than in the short-run equilibrium. d. There is some frictional and structural unemployment. ANSWER: C

Graph A: Suppose the economy is initially at K. Which of the following statements best explains how the economy responds to restore long-run macroeconomic equilibrium?

a. Over time, the aggregate demand curve will shift to the right until long-run equilibrium is restored at J and the gap is closed. b. Rising unemployment puts pressure on nominal wages to fall. The SRAS curve shifts right to SRAS1 closing the gap at H. c. In response to rising prices, firms will increase production moving along SRAS2 until long- run equilibrium is restored at J and the gap is closed. d. Rising unemployment puts pressure on nominal wages to fall. Firms employ more workers moving along SRAS2 until long-run equilibrium is restored at J and the gap is closed. ANSWER: B

Graph B Suppose the economy is initially at point A. Now suppose an increase in government purchases shifts the aggregate demand curve to AD2. Which of the following statements best explains how the economy responds (using self-correction) to restore long-run macroeconomic equilibrium?

a. The increase in the price level to Pb reduces real GDP demanded, shifting the aggregate demand curve back to AD1, returning the economy to its potential output at A. b. Firms produce more in anticipation of future higher prices, thus shifting the SRAS curve upward until the gap is eliminated at D. c. Firms and workers will negotiate higher nominal wages to restore lost purchasing power. This shifts the SRAS curve to the left until the gap is eliminated at D. d. The increase in the price level to Pb decreases consumption which in turn leads firms to cut production shifting the SRAS curve to the left until the gap is eliminated at D. ANSWER: C

Graph B: Suppose the economy is initially in short-run equilibrium at B. A shift from AD1 to AD2 could have been caused by all of the following except

a. an increase in consumer optimism. b. economic prosperity in foreign economies. c. a personal income tax cut. d. an increase in the price level from Pa to Pb. ANSWER: D

Graph A A shift from SRAS1 to SRAS2 could have been caused by all of the following except

a. an increase in the consumer confidence index. b. an increase in payroll tax. c. a rise in health care costs which raises the cost of employing labor. d. terrorist attacks that destroys an economy's infrastructure. ANSWER: A

Graph A: At output level Yk

a. potential output is less than actual output. b. there is a surplus of real GDP. c. the unemployment rate exceeds the natural (normal) rate of unemployment. d. over time aggregate demand will rise to restore long-run equilibrium. ANSWER: C

Graph B: Suppose the economy is initially at point A. All of the following statements are true except

a. the economy is in equilibrium at its potential output. b. the economy is in its long-run equilibrium. c. there is no cyclical unemployment. d. there is no structural or frictional unemployment. ANSWER: D

Graph A: At output level Yk

a. the economy is in its long-term equilibrium because it operates without an output gap. b. the economy is in short-run equilibrium and it operates with an inflationary gap. c. the economy is in short-run equilibrium and it operates with a recessionary gap. d. the economy is not in its long-term equilibrium because the unemployment rate is below the natural rate of unemployment. ANSWER: C

Graph B: Suppose the economy is initially at point A. Now suppose an increase in government purchases shifts the aggregate demand curve to AD2. As a result,

a. the economy is not in equilibrium because it operates with an output gap. b. the economy is in short-run equilibrium and it operates with an inflationary gap. c. the economy is in short-run equilibrium and it operates with a recessionary gap. d. the economy is not in equilibrium because the unemployment rate is not equal to the natural rate of unemployment. ANSWER: B

Graph B: Suppose the economy is initially at point A. Now suppose that there is an increase in government purchases. In the short-run,

a. the price level rises to Pb and real GDP increases to Yb. b. the price level rises to Pd. c. the aggregate supply curve shifts up to SRAS2. d. the economy's potential output increases to Yb. ANSWER: A

An economy adjusts on it's own to close a recessionary gap because there is

pressure on nominal wages to fall and this shifts the SRAS curve rightward.

Inflationary and recessionary gaps that do NOT create a permanent change are closed by the economy's self-correcting adjustments mechanism that shift

the SRAS curve.

In the short-run, an output gap occurs because

wages and some prices have not adjusted sufficiently to maintain output at its potential level.