Macro Econ quiz #5

What is the definition/formula for AD

AD = C + I + G + NX

Which of the following policies/events would result in the economy moving to a short-run equilibrium where the price level is greater than expected and output is greater than potential? a. The stock market performs better than expected b. The government increases spending on social welfare programs c. Germany experiences an economic boom

ALL of the above! *In order for the short-run equilibrium to have a price level higher than expected and output greater than potential, aggregate demand must have increased. So we need to find which of the above policies would cause aggregate demand to increase. It will be helpful to keep in mind that aggregate demand is defined by the GDP expenditure equation. Namely, AD=C+I+G+NX. Therefore, policies/events that cause any of the components to increase will also cause AD to increase. The stock market performing better than expected will cause consumer wealth and optimism to increase which leads to increased consumption spending. The government increasing spending directly enters the aggregate demand curve from G. When a foreign country experiences an economic boom, their incomes are increasing. This means they are able to purchase more goods and services from the United States (exports). When exports rise, net exports rises as well. Therefore, all of the answers are correct.

The economy is in a short-run equilibrium where price is lower than the expected price level and output is lower than potential GDP. What is true?

Aggregate demand decreased and the economy is in a recession. *Given the price level and output in the short-run equilibrium relative to their long-run levels, it is always possible to determine which curved shifted to bring the economy to its current point. In this case, since both the price level and output are lower than the long-run levels, aggregate demand must have decreased. Recessions and expansions are based entirely on what is happening to output. Since output is less than potential, the economy is experiencing a recession.

What is not a reason aggregate demand is downward sloping

As the price level decreases, government spending increases *There are three reasons that aggregate demand is downward sloping: • Wealth Effect o When Price level decreases, consumption increases • Interest rate Effect o When Price level decreases, investment increases • Exchange rate Effect o When Price level decreases, net exports increases This automatic change in spending stemming from a change in the price level does not exist for government spending because the government can increase or decrease spending regardless of what is occurring with the price level.

As the price of a bond increases, the interest rate

Decreases *There is an inverse relationship between bond prices and the interest rate. Therefore, as bond prices increase, the interest rate decreases.

The economy is in short-run equilibrium where the price level is lower than expected and output is higher than potential. The economy is experiencing...

Expansion *Since the price level is falling, it cannot be inflation or stagflation (stagflation is inflation plus lower output). Expansions occur whenever output is greater than potential while recessions occur whenever output is less than potential. This means that this economy is experiencing an expansion.

What would cause and increase in Aggregate Demand?

Fed increases money supply *Aggregate demand is determined by AD = C+I+G+NX. Therefore, we need to find which of the above will increase one of the components of aggregate demand. If the government increases income taxes, consumer wealth falls and consumption falls. If France experiences a recession, the income of French citizens is falling so they will buy fewer U.S. exports (NX falls). When new, better solar panel technology is invented, the short-run aggregate supply curve shifts to the right (increases). By process of elimination it must be that AD increases whenever the Fed increases the money supply. This is because when the Fed increases the money supply, the interest rate falls which stimulates investment spending (causing AD to rise)

Whenever the Fed increases the money supply, the demand for bonds _____, and interest rates _____.

Increase, decrease *When the Fed increases the money supply, the quantity of money supplied exceeds the quantity of money demanded at the prevailing interest rate. People will attempt to exchange some of this excess money in exchange for bonds. As a result, the demand for bonds increases. As the demand for bonds increases, the price of bonds rises which means the interest rate that the bonds yield decreases. Bond prices and bond interest rates always move in the opposite direction.

When the money supply increases

Interest rates decrease and aggregate demand increases * When the money supply increases, the equilibrium interest rate decreases (according to the money supply-money demand model). When interest rates decrease, investment spending rises. According to the AD-AS model, when investment rises, aggregate demand increases. In general, interest rates and aggregate demand move in opposite directions.

All else equal, which would occur as a result of an increase in the price level in the economy?

Money Demand Increases *Remember that the money supply is set by the Fed which means it will not react to changes in the price level. However, when the price level increases, it takes more dollar bills to purchase the same goods and services. Therefore, consumers will want to hold more wealth as cash in order to purchase goods and services. This implies that money demand will increase.

The relationship between the interest rate and the quantity of money demanded is ______. Therefore, when the interest rate rises, the quantity of money demanded ______.

Negative, Decreases *The money demand curve is downward sloping with respect to the interest rate which means that there is a negative relationship between the interest rate and the quantity of money demanded. This means that when the interest rate rises, the quantity of money demanded decreases.

All else equal, as the interest rate rises, the opportunity cost of holding wealth as cash ____ and _____.

Rises; quantity of money demanded increases *The interest rate is the opportunity cost of holding wealth as cash (because instead of holding it as cash you could have held it in an interest-bearing asset). This means that when the interest rate increases, the opportunity cost of holding wealth as cash also increases because you are forgoing more interest income.

What is the definition of Short-run Aggregate Supply?

SRAS = A x F(K,L,H,N)

Suppose the expected price level decreases, what occurred in the economy?

Short-Run Aggregate Supply Increased *The expected price level is determined by the intersection of the shortrun aggregate supply curve and the long-run aggregate supply curve. If the expected price level decreases, the short-run aggregate supply curve must have shifted to the right (increased). Using the AD-AS model and graphing the two types of aggregate supply is very helpful for determining the correct answer here.

Suppose the economy starts in long-run equilibrium. A short-run fluctuation moves the economy to a point where the price level is higher than expected and output is less than potential. Which of the following must have occurred?

Short-run aggregate supply decreased *This combination of a price level higher than expected and output less than potential could only be caused by a shift to the left in short-run aggregate supply. Therefore, short-run aggregate supply decreased.

Suppose the economy is in long-run equilibrium. Do to actions by the central bank, people and businesses begin to expect a lower price level. What do you expect to happen in the economy?

Short-run aggregate supply increases *In order for the expected price level to decrease, the short-run aggregate supply curve must increase (shift to the right). This is because the expected price level is determined by the intersection of SRAS and LRAS.

What is a reason the short-run aggregate supply curve is upward sloping?

Sticky Prices *The short-run aggregate supply curve is upward sloping - which implies that as the price level increases, the amount of output increases. This occurs partially due to stick prices. Sticky prices means that certain prices in the economy (like wages) remain at the expected price level. Therefore, when the price level increases, labor becomes relatively cheap and firms are willing to hire extra labor to increase output.

Suppose the price level increases, what impact do you expect?

The interest rate increases *When the price level increases, money demand will increase. According to our Money Supply - Money Demand model, this will cause the equilibrium interest rate to increase in order balance the quantity of money demand and the quantity of money supplied

What would be the result of the price level being lower than expected and output being less than expected

The stock market performs poorly *If the price level is lower than expected and output is less than potential, aggregate demand must have decreased. This would occur if the stock market performed poorly because it would reduce consumer wealth and create pessimism. Natural disasters, like the hurricane, would cause a decrease in SRAS. New technologies would cause an increase in SRAS (and LRAS too). And an increase in the average value of houses would cause consumer wealth to increase which would lead to an increase in aggregate demand.

As output rises...

Unemployment falls *This is one of the facts of the macroeconomy. Output and unemployment move in opposite directions.

Which of the following payoffs would you prefer if the interest rate is 6%? a. $3,400 today b. $4,340 in four years c. $5,115 in seven years d. $6,116 in ten years

b. $4,340 in four years *: This question requires you to use the present value formula: PV = FV/ (1+r)^N

Which of the following explains why the long-run aggregate supply curve is vertical? a. Sticky prices b. Liquidity preference c. The wealth effect d. Money neutrality

d. Money neutrality *The long-run aggregate supply curve being vertical implies that there is no relationship between the price level and the level of output. This occurs because of money neutrality which states that changes in the money supply do not affect real variables in the long-run.