MACRO EXAM ch 31-35

The Federal Reserve reduces banks' reserve requirements. supply of money: demand for money: interest rate:

money supply shifts right demand for money no change interest rate decreases

Which of the following is an example of an automatic stabilizer? When the economy goes into a recession,

more people become eligible for unemployment insurance benefits. Automatic stabilizers are changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action. For example, when the economy goes into a recession and workers are laid off, more people apply for unemployment insurance benefits, welfare benefits, and other forms of income support. This automatic increase in government spending stimulates aggregate demand at exactly the time when aggregate demand is insufficient to maintain full employment. See Section: Automatic Stabilizers.

According to the sticky-price theory, the economy is in a recession because

not all prices adjust quickly

With the economy in a recession because of inadequate aggregate demand, the government increases its purchases by $1,200. Suppose the central bank adjusts the money supply to hold the interest rate constant, investment spending is fixed, and the marginal propensity to consume is

$3,600 Because each dollar spent by the government can raise the aggregate demand for goods and services by more than a dollar, government purchases are said to have a multiplier effect on aggregate demand. The size of the multiplier is a function of the marginal propensity to consume (MPC), and is calculated using the following formula: Multiplier = 1/1 mpc

Suppose the economy is in a long-run equilibrium, as shown in the following graph. Now suppose that a stock market crash causes aggregate demand to fall.

As a result of this change, the unemployment rate rises Initially, the aggregate-demand curve ( AD1 ) and short-run aggregate-supply curve ( AS1 ) intersect at the same point on the long-run aggregate-supply curve. A stock market crash leads to a leftward shift of aggregate demand (to AD2 ). The equilibrium level of output and the price level will fall. Because the quantity of output is less than the natural rate of output, the unemployment rate will rise above the natural rate of unemployment. See Section: Fact 3: As Output Falls, Unemployment Rises.

An increase in credit-card availability reduces the cash people hold. supply of money: demand for money: interest rate:

money supply no change demand for money no change interest rate decrease

The idea that economic downturns result from an inadequate aggregate demand for goods and services is derived from the work of which economist?

John Maynard Keynes Economist John Maynard Keynes believed that recessions and depressions can occur because of inadequate aggregate demand for goods and services. Because of this, he advocated policies to increase aggregate demand during times of recession. This is in contrast to the classical approach of allowing the economy to correct itself in the long run. See Section: The Origins of the Model of Aggregate Demand and Aggregate Supply.

Suppose an economy is in long-run equilibrium. The central bank raises the money supply by 5 percent. What causes the economy to move from its short-run equilibrium to its long-run equilibrium?

Nominal wages, prices, and perceptions adjust upward to this new price level.

Stagflation is caused by

a leftward shift in the aggregate-supply curve. Stagflation is a period of time where output is falling and prices are rising. When firms experience an increase in the costs of production, selling goods becomes less profitable, and firms supply less output at any given price level. This causes the aggregate-supply curve to shift to the left, resulting in lower output and a higher price level. See Section: The Effects of a Shift in Aggregate Supply.

The Fed's bond traders buy bonds in open-market operations. supply of money: demand for money: interest rate:

money supply shifts right demand for money no change interest rate decrease

According to the misperceptions theory, the economy is in a recession when the price level is_______ what was expected.

below According to the sticky-wage theory, the economy is in a recession because the price level has declined so that real wages are too high, thus labor demand is too low. Over time, as nominal wages are adjusted so that real wages decline, the economy returns to full employment. According to the sticky-price theory, the economy is in a recession because not all prices adjust quickly. Over time, firms are able to adjust their prices more fully, and the economy returns to the long-run aggregate-supply curve. According to the misperceptions theory, the economy is in a recession when the price level is below what was expected. Over time, as people observe the lower price level, their expectations adjust, and the economy returns to the long-run aggregate-supply curve. See Section: Why the Aggregate-Supply Curve Slopes Upward in the Short Run.

The Federal Reserve's target rate for the federal funds rate

commits the Fed to set a particular money supply so that it hits the announced target. When the Federal Reserve sets a target for the federal funds rate, it commits itself to adjusting the money supply to make the equilibrium in the money market hit that target. For any given money supply, fluctuations in money demand would lead to fluctuations in interest rates, aggregate demand, and output. By contrast, when the Fed announces a target for the federal funds rate, it essentially accommodates the day-to-day shifts in money demand by adjusting the money supply accordingly. See Section: The Role of Interest-Rate Targets in Fed Policy.

If the government wants to contract aggregate demand, it can ________ government purchases or ________ taxes.

decrease, increase To contract aggregate demand, the government can either decrease its own purchases (directly reducing the quantity of output demanded), or increase taxes (indirectly reducing the quantity demanded by reducing disposable income). See Sections: Changes in Government Purchases; and Changes in Taxes.

When the economy goes into a recession, real GDP ________, and unemployment ________.

falls, rises A recession is a period of economic contraction rather than growth. During such periods, the economy produces fewer goods and services; thus, real GDP falls and unemployment rises. See Section: Fact 3: As Output Falls, Unemployment Rises.

true or false The aggregate-demand curve slopes downward because it is the horizontal sum of the demand curves for individual goods. The long-run aggregate-supply curve is vertical because the price level does not affect long-run aggregate supply. If firms adjusted their prices every day, then the short-run aggregate-supply curve would be horizontal. Whenever the economy enters a recession, its long-run aggregate-supply curve shifts to the left.

false true false false The statement "The aggregate-demand curve slopes downward because it is the horizontal sum of the demand curves for individual goods" is false. The aggregate-demand curve slopes downward because a fall in the price level raises the overall quantity of goods and services demanded through the wealth effect, the interest-rate effect, and the exchange-rate effect. See Section: Why the Aggregate-Demand Curve Slopes Downward. The statement "The long-run aggregate-supply curve is vertical because the price level does not affect long-run aggregate supply" is true. Economic forces of various kinds (such as population and productivity) do affect long-run aggregate supply, but the price level does not. See Section: Why the Aggregate-Supply Curve Is Vertical in the Long Run. The statement "If firms adjusted their prices every day, then the short-run aggregate-supply curve would be horizontal" is false. If firms adjusted prices quickly and if sticky prices were the only possible cause for the upward slope of the short-run aggregate-supply curve, then the short-run aggregate-supply curve would be vertical, not horizontal. The short-run aggregate-supply curve would be horizontal only if prices were completely fixed. See Section: Why the Aggregate-Supply Curve Slopes Upward in the Short Run. The statement "Whenever the economy enters a recession, its long-run aggregate-supply curve shifts to the left" is false. An economy could enter a recession if either the aggregate-demand curve or the short-run aggregate-supply curve were to shift to the left. See Section: Why the Long-Run Aggregate-Supply Curve Might Shift.

According to the sticky-wage theory, the economy is in a recession because the price level has declined so that real wages are too_____ thus, labor demand is too_____

high, low

An increase in the aggregate demand for goods and services has a larger impact on output ________ and a larger impact on the price level ________.

in the short run, in the long run An increase in aggregate demand affects output in the short run. In the long run, however, an increase in aggregate demand has no impact on output and affects only the price level, as wages and prices adjust to bring output back to the natural rate of output. See Section: The Effects of a Shift in Aggregate Demand.

increase, decrease, or have no effect on long-run aggregate supply?: The United States experiences a wave of immigration. Congress raises the minimum wage to $10 per hour. Intel invents a new and more powerful computer chip. A severe hurricane damages factories along the East Coast.

increase decrease increase decrease When the United States experiences a wave of immigration, the labor force increases, so long-run aggregate supply increases (curve shifts to the right). When Congress raises the minimum wage to $10 per hour, the natural rate of unemployment rises, so long-run aggregate-supply decreases (curve shifts to the left). When Intel invents a new and more powerful computer chip, productivity increases, so long-run aggregate supply increases because more output can be produced with the same inputs. When a severe hurricane damages factories along the East Coast, the capital stock is smaller, so long-run aggregate supply decreases. See Section: Why the Long-Run Aggregate-Supply Curve Might Shift.

If the central bank wants to expand aggregate demand, it can ________ the money supply, which would ________ the interest rate.

increase, decrease An increase in the money supply shifts the money-supply curve to the right. Because the money-demand curve has not changed, the interest rate falls to balance money supply and money demand. That is, the interest rate must fall to induce people to hold the additional money the Fed has created, restoring equilibrium in the money market. See Section: Changes in the Money Supply.

Suppose the government increases its purchases by $1,200 while holding the money supply constant. The change in aggregate demand resulting from an increase in government purchases if the government allows interest rates to adjust (as compared to the change if it were to hold them constant) will be

smaller but still positive. As an increase in government spending increases aggregate demand, the demand for money increases as well. If the money supply is held constant, this leads to higher interest rates. Higher interest rates dampen private investment spending, one of the components of aggregate demand. This is known as the crowding-out effect, the result of which is a smaller, but still positive, increase in aggregate demand after an increase in government purchases. See Section: The Crowding-Out Effect.

Households decide to hold more money to use for holiday shopping. supply of money: demand for money: interest rate:

supply of money no change demand for money shifts right interest rate increases

A wave of optimism boosts business investment and expands aggregate demand. supply of money: demand for money: interest rate:

supply of money no change, demand for money shifts right interest rates increase

A sudden crash in the stock market shifts

the aggregate demand curve. A stock market crash, or any event that causes consumers to cut back in spending and firms to cut back in their investments, reduces aggregate demand at any given price level (that is, causes a shift in the aggregate-demand curve). See Section: Why the Aggregate-Demand Curve Might Shift.

A change in the expected price level shifts

the short-run aggregate-supply curve. A change in the expected price level shifts the short-run aggregate-supply curve. If people expect lower prices in the future, they will accept lower wages (that is, supply more labor for any given price level) and set lower prices (or produce more output at any given price level). This would be reflected in a rightward shift of the short-run aggregate-supply curve. See Section: Why the Short-Run Aggregate-Supply Curve Might Shift.