Chapter 15: Aggregate Demand, Aggregate Supply, and inflation
In the short-run, an anti-inflationary shift in mAonetary policy has which of the following effects?
-Lower output -Higher unemployment
Which of the following explain the downward-sloping AD curve?
-The real value of money -The price of domestic goods sold abroad. -Distributional effects -Uncertainty
Which of the following groups are more adversely affected by rapid inflation?
-Workers receiving minimum wage -Retirees on fixed incomes -People at lower income levels
If the government wants to decrease aggregate demand, then it can:
-decrease government spending -increase the real interest rate
To increase aggregate demand, the government can:
-increase government spending -cut taxes
If the government wants to increase aggregate demand, then it can:
-increase government spending -decrease the real interest rate
In modern economies, inflation tends to adjust slowly due to:
-long-term wage contracts -inflation expectations -long-term price contracts
In the short run, a negative inflation shock such as a sharp rise in oil prices will
-open up a recessionary gap. -shift the AS curve upward.
To decrease aggregate demand, the government can:
-raise taxes -increase the real interest rate
In the short run, a positive inflation shock such as a sharp fall in oil prices will
-shift the AS curve to the right. -lead to an expansionary gap.
When actual output exceeds potential output:
-the inflation rate tends to increase. -an expansionary gap exists
Aggregate supply shocks occur when:
-there are sharp changes in potential output -there are sharp changes in inflation
Match the type of output gap on the left to the behavior of inflation on the right. 1. No output gap (Y=Y*) 2. Expansionary gap (Y>Y*) 3. Recessionary gap (Y*)
1. Inflation remains unchanged 2. Inflation rises (π↑) 3. Inflation falls (π↓)
What is the short-run effect of a positive aggregate supply shock?
A recessionary gap
A key feature of the _____ model is the fact that output gaps will not last indefinitely but will be closed by rising or falling inflation.
AD-AS
Consider the diagram to the right. In the long run, we would expect the:
AS curve to shift to the left.
Consider the graph on the right. In the long run, we would expect the:
AS curve to shift to the right.
How do long-term contracts "build in" wage and price increases?
Contracts signed during periods of high inflation will likely require large wage increases over the duration of the contract.
Higher rates of inflation tend to do which of the following?
Create uncertainty Reduce spending
On the AD-AS diagram, the intersection of the AD and the SRAS curve illustrates which of the following?
Short-run equilibrium
On the AD-AS digram, potential output is marked by which of the following?
The LRAS line
In the presence of a recessionary gap, how does the economy adjust?
The SRAS and inflation both fall until the the economy reaches long-run equilibrium.
On the AD-AS diagram, the current rate of inflation is shown by
The SRAS line
One consequence of disinflation is:
a large recessionary gap
In the short run, a decrease in aggregate demand will cause
a recessionary gap.
The curve that shows the amount of output that consumers, firms, government and customers abroad want to purchase at each inflation rate (holding all else constant) is the _____.
aggregate demand curve
When actual output exceeds potential output:
an expansionary gap exists
When potential output exceeds actual output:
an recessionary gap exists
Lower output, higher unemployment, and little reduction in inflation are all effects of:
anti-inflationary monetary policy
Movements along the AD curve
are due to changes in the inflation rate.
When interest rates rise:
both consumption and investment will fall
As long as the Fed sets the real interest rate in accordance with a fixed policy reaction function,
changes in the real interest will not shift the AD curve.
When a recessionary gap leads inflation to fall, the Fed responds by _____ real interest rates.
decreasing
A reduction in government spending will likely shift the aggregate _____.
demand curve to the left
An increase in government spending is likely to shift the aggregate _____.
demand curve to the right
A substantial reduction in the inflation rate is called _____.
disinflation
People who are less well off are hurt more by high inflation than wealthier people. This describes:
distributional effects
Higher inflation reduces spending. As a result, the AD curve is _____-sloping.
downward
Households and firms tend to reduce their spending levels in the presence of:
economic uncertainty
A(n) ____ gap exists when actual output exceeds potential output.
expansionary
In part, inflation is determined by:
expectations of inflation
If exports decrease, then we would expect net exports to _________ and spending to ________.
fall; fall
When there is a recessionary gap, the rate of inflation will tend to _____, and when there is an expansionary gap, the rate of inflation will tend to _____.
fall; rise
People expect inflation to be ____ if it has been high for an extended period of time
high
In the long run in AD-AS model, an expansionary gap will lead expected future inflation to _____ causing the AS curve to shift _____ so that the output gap is eliminated.
increase; to the left
In the AD-AS model, the AD curve is downward sloping because when inflation increases, the Fed _______ real interest rates, leading output to _____.
increases; fall
When inflation increases due to an expansionary gap, the Fed typically responds by ______ the real interest rate.
increasing
Along the aggregate demand (AD) curve:
inflation and output are negatively related
The negative slope of the AD curve implies that as:
inflation falls, output rises
The aggregate demand curve shows the amount of output that consumers, firms, government and customers abroad want to purchase at each _____, holding all other factors constant.
inflation rate.
The aggregate demand (AD) curve implies that if:
inflation rises, then output will fall
A negative aggregate supply shock causes the LRAS curve to shift to the _____.
left
An exogenous decrease in spending will decrease short-run equilibrium output at all inflation levels. As a result, the AD curve shifts to the _____.
left
The aggregate demand curve will shift to the ______ when there is a reduction in government purchases.
left
In the short run, a negative demand shock will cause the AD curve to shift to the _____ leading to a _______ gap.
left; recessionary
An decrease in aggregate demand is represented by a
leftward shift in the AD curve.
When the AD curve, the SRAS line, and the LRAS line all intersect at the same place, it is called _____-run equilibrium
long
People expect inflation to be _____ if it has been low for an extended period of time
low
If the Fed is concerned that the current level of output is too far below actual output, then it may _____ the real interest rate so that the aggregate demand (AD) curve shifts to the _____.
lower; right
If the Fed wants to increase its target rate of inflation, it can _____ the real interest rate so that aggregate demand will _____.
lower; rise
In the AD-AS model, when inflation falls, the Fed responds by _____ real interest rates, leading output to _____.
lowering; rise
A _____ policy rule describes how a central bank, like the Fed, takes action in response to changes in the state of the economy.
monetary
Actual output minus potential output is called the ____ gap.
output
In the AD-AS model:
output gaps will not last indefinitely, but will be closed by rising or falling inflation.
During an economic expansion, if the Fed believes that actual output is too high relative to potential output, the Fed might _____ the real interest rate so that the aggregate demand (AD) curve shifts to the _____.
raise; left
If the Fed wants to lower its target rate of inflation, it should _____ the real interest rate so that the aggregate demand (AD) curve shifts to the _____.
raise; left
A(n) _____ gap exists when actual output is less than potential output.
recessionary
In the AD-AS model, _____ gaps will not persist in the long run because the AS curve will shift down due to the fall in expected future inflation, thereby eliminating the output gap.
recessionary
A positive aggregate supply shock causes the LRAS curve to shift to the ____.
right
An exogenous increase in spending will increase short-run equilibrium output at all inflation levels. As a result, the AD curve shifts to the ______.
right
An increase in government purchases will shift the aggregate demand curve to the ______.
right
In the short run, a positive demand shock will cause the AD curve to shift to the _____ leading actual output to _______ potential output.
right; rise above
An increase in aggregate demand is represented by a
rightward shift in the AD curve.
All else equal, consumption and investment will fall when the real interest rate _____.
rises
Graphically, the SRAS line _____ (one word) in the presence of an expansionary gap.
rises
A change in aggregate demand is represented by a
shift of the AD curve.
When there are sharp changes in potential output and inflation, it is called an aggregate supply _____.
shock
Relative to other economic variables such as stock prices or commodity prices, inflation tends to be relatively _____ over time.
stable
In the absence of external shocks, inflation
tends to be relatively stable over time.
A rule that describes how _____ takes action in response to changes in the state of the economy is known as a monetary policy rule.
the central bank
When the difference between actual output and potential output is zero:
the inflation rate is constant
The difference between actual output and potential output is called, in general,
the output gap
At high levels of inflation,
the purchasing power of money decreases.
Long-term contracts, such as union wage contracts, contribute to:
the slow adjustment of inflation
In the long run, recessionary gaps are not expected to persist in the AD-AS model because the AS curve will shift _____ as expected future inflation _____.
to the right; falls
On the AD-AS diagram short-run equilibrium occurs:
where AD intersects SRAS
On the AD-AS diagram, long-run equilibrium occurs:
where AD, SRAS, and LRAS all intersect
Inflation expectations and long-term wage and price contracts help explain
why inflation adjusts relatively slowly in modern economies.
If the output gap is ______, then the rate of inflation tends to remain constant
zero