ECO chapter 14
Given the marginal propensity to save (MPS) is .25, what is the spending multiplier?
4 (Great! An MPC of .75 implies that change in AE eventually leads to a $4 change in real GDP.) (This is the marginal propensity to consume. Use this to calculate the spending multiplier. The spending multiplier = 1 divided by 1-MPC.)
Match each statement with the portion of the aggregate demand-aggregate supply model that would be affected by it.
A game manufacturer produces 5,000 puzzles and sells 5,200 over the course of the year. Correct label:negative unplanned investment Anticipating an increase in the demand for refrigerators, an appliance manufacturer builds a new factory. Correct label:planned investment An auto manufacturer produces 2,000 cars this month and sells 1,700 of them to consumers and 100 of them to businesses. Correct label:positive unplanned investment
Assume a hypothetical economy starts in long-run equilibrium at point 1, then experiences a crisis due to a contagious virus crippling the economy, leading to a decrease in both aggregate demand and long-run aggregate supply. Which of the following statements reflect an aggregate demand-aggregate supply model analysis of the impact of the virus on the economy during this period?
Correct Answer(s) At point B the economy is in long-run equilibrium. The supply shock had a permanent impact on the economy. Incorrect Answer(s) There was an increase in productivity. At the new output level in 2020 there was massive inflation.
Compared to other recessions post-World War II, what did the Great Recession have?
Higher levels of unemployment and a slower real GDP recovery. (Unemployment levels were much higher during the Great Recession, and it took real GDP many more years to reach prerecession levels than during typical recessions.)
Match each statement with the correct portion of the aggregate demand-aggregate supply model that would be affected by it.
A temporary lockdown due to the COVID-19 pandemic causes firms in certain industries to shut down for weeks. Correct label:short-run aggregate supply Financial market instability temporarily decreases output. Correct label:short-run aggregate supply New oversight of financial markets makes it permanently more difficult for firms to get funds for investment. Correct label:long-run aggregate supply The initial lockdown led to a permanent closure of some firms as they went out of business. Correct label:long-run aggregate supply There are declines in expected income due to lower consumer confidence. Correct label:aggregate demand There are declines in expected income due to lower consumer confidence. Correct label:aggregate demand
Drag each label to the appropriate curve to build the aggregate expenditure model below.
use book & picture (Net exports is the last part of the aggregate expenditures model.)
In a classical economy, citizens begin to expect lower prices five years in the future. As a result, prices and nominal wages fall in the present and remain low, while GDP and real wages fall for a few months but then return to normal.
AD2- shifted to right (Because of citizens' expectations of lower prices in the future, they will consume less in the present. This causes a decrease in aggregate demand. In the long run, a decrease in aggregate demand lowers prices and wages but leaves output unchanged. Classical economists believe the long run is achieved quickly.)
Put the following dates and events in chronological order beginning with the earliest.
the era in which the classical view dominated economic thought The beginning of the great depression J.M. Keynes's General Theory of Employment, interest, and money published end of the great depression F.A. Hayek's road to Serfdom published Beginning of the great recession (Classical economics seemed to describe the pre-Depression world well.)
Fill in the blanks to complete the passage.
Classical economists believed that the economy self-corrects. They trusted that market adjustments would take place quickly and saw no need for macroeconomic governmental policy to correct for underperformance or overperformance of the economy.
Which of the following statements regarding the Great Recession are correct?
Correct Answer(s) After output began to decline, it took four years for U.S. GDP to return to pre-recession levels. Incorrect Answer(s) The peak unemployment rate in the United States during this period was 25%. The recession was four years long. The peak unemployment rate in the United States during this period was 7%. (An unemployment rate of 25% was reached during the Great Depression, but during the Great Recession the peak rate was 10%.)(In the United States, the unemployment rate reached 10% during the Great Recession. A peak unemployment rate of 7% is a better fit for the typical post-WWII recession.)
Which of the following statements regarding the Great Depression are true?
Correct Answer(s) Like the Great Recession, the Great Depression involved significant stress in financial markets. In the first few years of the Great Depression, stock prices fell by 90%. Incorrect Answer(s) After output began to decline, it took four years for U.S. GDP to return to pre-Depression levels. The Dodd-Frank Act was the primary legislative response to the Great Depression. The unemployment rate peaked at about 10%. (The Dodd-Frank Act was a response to the financial market conditions that contributed to the Great Recession.)
Which of the following are true according to the Keynesian economic view?
Correct Answer(s) Nominal prices matter to the long-run economy. Incorrect Answer(s) Prices are perfectly flexible. Even a severe decrease in citizens' expectations of future income will not affect long-run economic output. A decrease in the government-spending component of aggregate demand will not affect real GDP for very long. (By contrast, classical economists believe that long-run output is not dependent on prices.)
Fill in the following passage concerning the Great Depression.
The Great Depression is generally regarded as beginning with the stock market crash of October 29, 1929. Including that day, stock prices fell by almost 90% over the next few years. The Great Depression ended in 1938. (The Great Depression actually consisted of two recessions, one lasting from 1929 to 1933 and the other lasting from 1937 to 1938.)
Along with the aggregate demand-aggregate supply model, there is another model that economists use to analyze people's overall spending patterns.
The aggregate expenditures model is essentially another way of viewing a country's aggregate demand. In this model, the economy is viewed from a Keynesian economist's perspective, and it assumes that in the short run, prices are sticky.
Fill in the blanks to complete the passage about real GDP before and after the Great Recession.
The figure above depicts U.S. real GDP (the red line) and the long-run trend in GDP that prevailed before the Great Recession (the dotted blue line). After the Great Recession, there does not appear to be any tendency for real GDP to return to the long-run trend line. This situation is most consistent with a permanent decrease in aggregate supply. (According to classical economists, a decrease in aggregate demand cannot impact long-run output; it could only impact prices.)(It is still possible that the economy will eventually recover the lost GDP. But to date it has not.)
Refer to the figure below. Which economist would believe that the macroeconomy will not quickly reach point B after a shift in aggregate demand from AD1 to AD2?
Keynesian economics (Keynesian economics predicts that macroeconomic adjustments happen slowly because prices are downward sticky. This is why Keynesians emphasize the short run.)
Assume that a country is currently producing at a level of output equal to $600 billion. The government decides to increase expenditures by $25 billion, and the nation's MPC is 0.8. Based on the spending multiplier, what is the nation's new level of total output (in billions of dollars)?
725 (If the MPC is 0.8, then the spending multiplier is 5. Government spending will increase total GDP by $125 billion (multiplier × the change in government spending).
Marnie earns $25,000 a year while working at a local bookstore. Because the bookstore did very well this past year, Marnie received a $500 raise. She consumes part of this additional income and saves part of it. If Marnie's MPC = 0.75, how much money from her raise will she save?
125 (If her MPC = 0.75, then her MPS = 0.25. She will save (0.25)*$500.)
The graph below plots the log of U.S. real GDP growth over the course of more than a century. Click on the region of the graph that depicts the Great Depression.
1930-1940 (The decline in production during the Great Depression was larger than any other contraction in modern U.S. history.)
Based on the graph, which time interval which shows a surge in real GDP?
1940-1950 (During this period, there was a surge of growth in real GDP after the Great Depression in a relatively short period of time.)
The graph below depicts the FHFA House Purchase Price Index for U.S. houses, a useful statistic for analyzing housing price changes over time. Click on the segment of the graph that corresponds to the start of the Great Recession.
2008 (This price index began falling in 2007 and continued to fall throughout the Great Recession.)
The graph below plots the unemployment rate over time from the start of the Great Recession. Click on the unemployment rate range that contains the maximum unemployment rate reached during the Great Depression of the 1930s. Click or tap the appropriate place in the image.
25
In April 2020, when most non-essential stores were closed and travel was limited, the average person's savings rate increased. Assuming a marginal propensity to consume (MPC) of 0.7, calculate the spending multiplier.
3.33 (This means for every $1 increase in spending, GDP will increase by $3.33: ms=11 - 0.7=10.3=3.33)
What are the effects of a war fought on home soil on long-run aggregate supply?
Effect(s) inflation lower real GDP Not an Effect unchanged Inflation higher real GDP higher employment
During a pandemic, an economy goes into a recession due to a decrease in aggregate demand. Assume the government creates a program to help stabilize the economy by increasing expenditures by $700 billion. How much spending would occur during the third round of spending if the marginal propensity to consume (MPC) was 0.6 in the economy?
252 (MPC×(Round 2 Spending Increase)=0.6×(420)=252)
The graph below plots the unemployment rate over time from the start of the Great Recession. Click on the unemployment rate range that contains the maximum unemployment rate reached during the Great Depression of the 1930s.
25 (The Great Depression was also much more severe than the Great Recession in terms of duration and total decline in GDP.)
In 2009 dollars, U.S. GDP was $1057 billion at the start of the Great Depression but fell to $778 billion by 1933. What percentage decline does this represent?
26% (The percent decline in output during the Great Recession was significantly smaller.)
Fill in the blanks to complete the passage about the effects of a decrease in aggregate demand.
An aggregate demand factor such as decrease in investment causes the aggregate demand curve to shift leftward. The effect on the economy is increased unemployment rate.
Match each statement with the portion of the aggregate demand-aggregate supply model that would be affected by it.
Anticipating an increase in the demand for refrigerators, an appliance manufacturer builds a new factory. Correct label:planned investment An auto manufacturer produces 2,000 cars this month and sells 1,700 of them to consumers and 100 of them to businesses. Correct label:positive unplanned investment A game manufacturer produces 5,000 puzzles and sells 5,200 over the course of the year. Correct label:negative unplanned investment
Fill in the blank to complete the statement about the Great Recession.
Dodd-Frank Act (The Dodd-Frank Act established several new oversight bodies and new regulations for financial institutions.)
Assume that Y0 is the full employment level of the economy. Match each scenario to the corresponding level of output.
Due to a new free-trade agreement, US exports increase. Y1 Unemployment equals the natural unemployment rate. Y0 People's wealth falls due to decreasing stock market values. Y2 (When aggregate expenditures decrease, real GDP decreases. When aggregate expenditures increase, real GDP increases.)
Refer to the figure below and fill in the blanks to complete the following passage. (Great recession)
Economists use the Consumer Sentiment Index, which is graphed above, as a measure of consumers' confidence in their financial future. One cause of the Great Recession was a fall in aggregate demand, and one cause of this decline in aggregate demand was a decline in expected income. Looking at the graph, one can see that the index began falling in 2007 and fell significantly during the recession. In 2012, the index remained below pre-recession levels.
The new financial regulations imposed under the Dodd-Frank Act in 2010 represented a permanent decline in short-run aggregate supply but not in long-run aggregate supply.
False (The new regulations imposed by the Dodd-Frank Act have permanently made it harder for firms to receive funding for investment.)
The aggregate supply and aggregate demand model is a useful tool for analyzing recessions. The graph below is a model of the Great Recession. Correctly label the long-run aggregate supply (LRAS) and aggregate demand (AD) curves below to complete this model.
Figure 14.9 (While the Great Depression is best characterized by a large decline in aggregate demand, the Great Recession is best characterized by a decline in aggregate demand and long-run aggregate supply.)
Fill in the blanks to complete the sentence about how an increase in aggregate demand occurs.
If a consumer confidence increases, meaning that consumers are more optimistic about future economic conditions, they increase their consumption, which increases aggregate demand.
Match each statement with the correct portion of the aggregate demand-aggregate supply model that would be affected by it.
Financial market instability temporarily decreases output. Correct label:short-run aggregate supply There are declines in expected income due to lower consumer confidence. Correct label:aggregate demand New oversight of financial markets makes it permanently more difficult for firms to get funds for investment Correct label:long-run aggregate supply A temporary lockdown due to the COVID-19 pandemic causes firms in certain industries to shut down for weeks Correct label:short-run aggregate supply The initial lockdown led to a permanent closure of some firms as they went out of business. Correct label:long-run aggregate supply There are declines in wealth due to decreases in real estate values. Correct label:aggregate demand
What are the similarities and the differences between the Great Recession and the Great Depression?
Similarities Stock market values declined. The economic downturn was longer and more severe than in an average recession. Problems existed in financial markets. Differences The overall price level fell significantly. Declining aggregate demand was the primary cause. There was a decrease in the money supply.
The events below describe the leadup to the COVID-19 recession. Place these events in order, so that each event causes the event that follows.
State issues lockdown, forcing firms to find a new ways to produce good ad services Short run aggregate supply curve shifts to the left long run aggregate supply shifts to the left aggregate demand decreace
While classical economists believe prices to be fully flexible, Keynesian economists believe prices to be sticky.
TRUE (Classical economists believe the market could adjust to correct itself in any state of the economy, whereas Keynesian economists believed macroeconomic policy is necessary to provide correction for the economy because prices are sticky in the short run.)
In 1928 and 1929, the federal government's tightening of the money supply was one of the policies that contributed to the Great Depression.
TRUE (The tightening was prompted by a concern about too-high stock prices, but it led to an across-the-board drop in demand for goods and services.)
Complete the following passage regarding the Great Depression.
The Great Depression challenged the prevailing classical economic belief that the macroeconomy quickly returns to long-run equilibrium following a demand shock, since it wasn't until seven years after the Depression began that real GDP returned to pre-Depression levels.
The items below describe the events leading up to and including the Great Recession. Put these events in order of causation, so that each event causes the event that follows.
U.S Home prices began to fall The vales of mortgage-backed securities fall The loadable funds market stops functioning properly Aggregate supply decreases The great recession begins
Drag each label to its proper place on the graph representing a short-run aggregate supply-induced recession.
Use book Figure 14.2 (Negative shifts in aggregate supply curve can move the economy into a recessionary period. This causes increases in unemployment and inflation.)
Drag each label to its proper place on the graph representing a demand-induced recession.
Use book Figure 14.1 (Negative shifts in aggregate demand can move the economy into a recessionary period. This causes high unemployment and decreased GDP. However, in the long run the effects dissipate.)
Drag each label to its proper place on the graph representing the type of induced recession
Y1-> U>U* : Y*-> U=U* low consumer confidence because future economic outlook is dismal ;declining business firm confidence Y1->U>U* : Y* -> U=U* (SARS 1& SARS ) rising oil prices (oil is an input for many goods) Y** -> U=U** : Y* -> U=U* (LRAS 1 & LARS 0) natural disaster collapsed government (Natural disaster causes a shift in both LRAS and SRAS.)
Match each term with the phrase that best describes it.
a cause of sticky prices Correct label:long-term contracts a source of long-run economic growth Correct label:savings shape of long-run aggregate supply curve Correct label:vertical Keynesian motivation for government intervention Correct label:sticky prices direction in which Keynesians believe prices are sticky Correct label:downward time frame emphasized by classical economists Correct label:long run
Which of the graphs below best represents the classical economist's view of the macroeconomy during a typical recession?
one y; price level 100->90; shifts left and down(ish) (Classical economists believe that the economy is self-correcting and will quickly move back to full employment.)