Ch. 11: Classical and Keynesian Macro Analyses

n the figure to the​ right, if planned saving was less than planned​ investment, what would be true of the interest rate in relation to its equilibrium​ value? How would the interest rate​ adjust? Using the line drawing​ tool, draw a horizontal line at an interest rate​ (IR) at which planned saving is less than planned investment. Label your line LRM Since it is _______ its equilibrium value, the interest rate would adjust ________.

below, upward

With stable aggregate​ demand, an abrupt shift inward in SRAS may lead to what is called _________ inflation.

cost-push

In modern Keynesian​ theory, the ​short-run aggregate supply​ curve, SRAS​, shows the relationship between the price level and real GDP without full adjustment or full information. It is upward sloping because it allows for ________ price adjustment in the short run.

partial

The horizontal​ short-run aggregate supply curve has been called the Keynesian​ short-run aggregate supply curve because Keynes believed that many​ prices, especially​ wages, would not be ________ even when aggregate demand decreased.

reduced

According to modern Keynesian​ analysis, the​ short-run aggregate supply curve is A. horizontal. B. downward sloping. C. vertical. D. upward sloping.

D. upward sloping.

When saving is introduced into the​ model, equilibrium occurs in the credit market through changes in the interest rate such that desired ________ equals desired ________ at the equilibrium rate of interest.

saving; investment

Suppose that the economy is depicted in the graph to the right. a. The current equilibrium price level and output level respectively​ are: ________ and $______ trillion. b. Using the line drawing tool​, show a change in aggregate demand that leads to an inflationary gap. Use the line drawing tool and label this new line ​'AD1​'.

80; 10 trillion

What is Say's Law?

A dictum of economist J.B. Say that supply creates its own demand. Producing goods and services generates the means and the willingness to purchase other goods and services.

If the prices were​ sticky, according to​ Keynes, this would then imply that the A. ​short-run aggregate demand horizontal. B. long-run aggregate supply is vertical. C. long-run aggregate demand vertical. D. short-run aggregate supply is horizontal.

D. short-run aggregate supply is horizontal. Note: Aggregate demand is concerned with​ consumption, investment, government spending and net exports. It does not reflect the costs of production. If prices are sticky downward then they cannot decrease as output changes. This implies a horizontal​ short-run aggregate supply curve.

A temporary change in input prices will shift only the _________ curve.

SRAS

What is an aggregate demand shock?

Any event that causes the aggregate demand curve to shift inward or outward.

With stable aggregate​ supply, an abrupt outward shift in AD may lead to what is called _________ inflation.

demand-pull

Real GDP can be expanded in the short run because firms can use existing workers and capital equipment more ________. ​Also, in the short​ run, when input prices are​ fixed, a higher price level means ________ profits, which induce firms to hire more workers.

intensively; higher

A ________ dollar will reduce the cost of imported​ inputs, thereby causing SRAS to shift outward to the right. At the same​ time, a _________ dollar will lead to lower net​ exports, causing the aggregate demand curve to shift inward. The equilibrium price level definitely​ falls, but the net effect on equilibrium real GDP depends on which shift is larger.

stronger; stronger

Between early 2005 and late​ 2007, total planned expenditures by U.S. households substantially increased in response to an increase in the quantity of money in circulation. From a​ short-run Keynesian​ perspective, the predicted effects of this event on the equilibrium U.S. price level and equilibrium U.S. real GDP were A. an increase in the price level along with an increase in equilibrium real GDP. B. a decrease in the price level along with an increase in equilibrium real GDP. C. an increase in the price level along with a decrease in equilibrium real GDP. D. a decrease in the price level along with a decrease in equilibrium real GDP.

A. an increase in the price level along with an increase in equilibrium real GDP.

Given that the economy is currently in a long run equilibrium where SRAS​ = LRAS​ = AD there is increased security about jobs and future income the economy would then experience A. an inflationary gap. B. a recessionary gap. C. stagflation. D. a depressionary gap.

A. an inflationary gap. Note: Anytime the​ macro-equilibrium lies to the right of full employment real GDP an inflationary gap exists.

a. One of the main conclusions of​ Say's Law was that A. if people supply goods in order to then demand​ goods, there can be no overproduction in a market economy and full employment will be the normal state of affairs. B. if people demand goods in order to then supply​ goods, there can be no overproduction in a market economy and full employment will be the normal state of affairs. C. if people supply goods in order to then demand​ goods, there can be overproduction in a market economy and less than full employment will be the normal state of affairs. D. if people demand goods in order to then supply​ goods, there can be overproduction in a market economy and less than full employment will be the normal state of affairs.

A. if people supply goods in order to then demand​ goods, there can be no overproduction in a market economy and full employment will be the normal state of affairs.

Consider the assumptions of the Classical Model. ​1.) Using the line drawing tool​, draw the​ long-run aggregate supply curve such that real GDP is ​$8 trillion. ​2.) Using the line drawing tool​, draw the aggregate demand curve. Properly label your line. Suppose that aggregate demand were to decrease due to a stronger dollar. Which of the following would be the​ result? A. Inflation only. B. Deflation only. C. An increase in real GDP and deflation. D. An increase in real GDP and inflation.

B. Deflation only. Note: The Classical Model has a vertical aggregate supply curve. Therefore any change in the aggregate demand​ (AD) curve will only result in a change in the price level. Next Question

The current state of the US domestic economy is depicted in the graph. a. Suppose that the US dollar depreciates. Consider the two effects of a weaker dollar. ​1.) Using the line drawing tool​, draw a new aggregate demand curve. Properly label your line. ​2.) Using the​ 3-point curved line drawing tool​, draw a new SRAS curve. Properly label your curve. b. Suppose the​ short-run supply curve shifts by more than the aggregate demand curve. In this​ case, the result would be that A. both the price level and real GDP increase. B. the price level increases and real GDP decreases. C. both the price level and real GDP decrease. D. the price level decreases and the real GDP increases.

B. the price level increases and real GDP decreases.

An appreciation of the US​ $ should result in A. a lower price level and a higher level of real GDP. B. a higher price level and a higher level of real GDP. C. a lower price level but the impact on the level of real GDP depends on the magnitude of the shifts in the aggregate demand and​ short-run aggregate supply curves. D. a higher price level and a lower level of real GDP.

C. a lower price level but the impact on the level of real GDP depends on the magnitude of the shifts in the aggregate demand and​ short-run aggregate supply curves. Note: The aggregate demand curve decreasing and the​ short-run aggregate supply curve increasing both cause the price level to​ fall, but move the output in opposite directions. The final result with respect to real GDP depends on which curve has the greatest movement. If it happens to be the aggregate demand curve then output​ decreases; if it is the​ short-run aggregate supply then output increases.

Cost-push inflation is caused by persistent A. increases in aggregate demand. B. decreases in aggregate demand. C. decreases in​ short-run aggregate supply. D. increases in​ short-run aggregate supply.

C. decreases in​ short-run aggregate supply.

Suppose that there is a​ temporary, but significant increase in oil prices in an economy with an​ upward-sloping SRAS curve. As a policy response to this​ short-lived but sudden increase in oil​ prices, a central bank A. can stabilize both the price level and the real GDP simultaneously. B. can stabilize neither the price level nor the real GDP. C. has no responsibility to stabilize the real GDP. D. cannot stabilize both the price level and the real GDP simultaneously.

D. cannot stabilize both the price level and the real GDP simultaneously. Note: As a policy response to a​ short-lived but sudden increase in oil​ prices, a central bank cannot stabilize both the price level and the real GDP simultaneously. The central bank can try to stabilize the real GDP by using expansionary monetary​ policy, thereby shifting the AD curve to the right and as a result the real GDP will go up but the price level will go up even​ further, thus worsening the inflation situation. On the other​ hand, the central bank can try to stabilize the price level with a contractionary monetary​ policy, that will shift the AD curve to the​ left, reducing the price level but also reducing the real GDP even​ further, thus worsening the recession.

Suppose that there is a temporary​, but​ significant, increase in oil prices in the economy depicted in the figure to the right. a. Using the 3​-point curved line drawing tool​, show the impact the elevated oil prices have on the macroeconomy. Properly label this line. b. If the central bank wishes to prevent the equilibrium real GDP from changing in response to the oil price​ increase, it should A. decrease the quantity of money in circulation in order to shift the​ short-run aggregate supply curve rightward. B. decrease the quantity of money in circulation in order to shift aggregate demand leftward. C. decrease the quantity of money in circulation so that oil prices will fall. D. increase the quantity of money in circulation in order to shift aggregate demand rightward.

D. increase the quantity of money in circulation in order to shift aggregate demand rightward. Note: By increasing the quantity of money in circulation the central bank will ideally push the AD curve rightward so that the real GDP remains at its original level. The economy moves from point A to point B.

Since the modern Keynesian Model allows for some price​ response, the aggregate supply curve A. is downward sloping. B. is horizontal. C. is vertical. D. is upward sloping.

D. is upward sloping.

Changes in factors of production that influence economic growth will A. shift SRAS but not LRAS. B. not shift SRAS or LRAS. C. shift LRAS but not SRAS. D. shift SRAS and LRAS.

D. shift SRAS and LRAS.

A​ short-lived change in production input prices will A. shift SRAS and LRAS. B. shift LRAS but not SRAS. C. not shift SRAS or LRAS. D. shift SRAS but not LRAS.

D. shift SRAS but not LRAS.

The modern Keynesian Model assumes that A. that prices are sticky upward. B. that the economy only responds via output. C. that prices fully respond to changes in aggregate demand so the economy is always at full employment. D. that prices respond to changes in aggregate demand but not fully.

D. that prices respond to changes in aggregate demand but not fully.

Consider a country whose economic structure matches the assumptions of the classical model. Suppose that businesses in this nation suddenly anticipate lower future profitability from investments they undertake today. From the following list choose the letter that gives the resulting outcome for each of the variables given​ below: I-Increase D−Decrease N−No Effect ​The current equilibrium interest rate. ________ Current equilibrium real GDP.________ Current equilibrium employment.________ Current equilibrium saving.________

I, N, N, I, i Note: In the Classical​ Model, the equilibrium level of real GDP per year is completely supply determined. The​ supply, in​ turn, is fixed by the​ country's resource endowments and the state of its technology and productivity.

What is an inflationary gap?

The gap that exists whenever equilibrium real GDP per year is greater than full-employment real GDP, as shown by the position of the long-run aggregate supply curve.

in the figure to the​ right, will all people who desire to work be employed if the current wage rate is ​$26 hour? How many people will be employed and unemployed at this wage​ rate? If the current wage rate is $26 per hour, there will be an _________ in the labor market and _________ people who desire to work will be able to. There will be ________ million people employed and _________ million people unemployed at this wage rate.

equilibrium, all 160 million, 0 million Note: If the current wage rate is ​$26 per​ hour, there will be an equilibrium in the labor market and all people who desire to work will be able to.

Any change in factors influencing ________-run output, such as _________, capital, or ________, will shift both the SRAS curve and the LRAS curve.

long; labor; technology

The classical model assumes that​ (1) ________ exists, (2) ________ and ________ are completely flexible, (3) individuals are motivated by _______, and (4) they cannot be fooled by _________.

pure competition; wages; prices; self-interest; money illusion

Consider the figure to the right. If the Federal Reserve increases the quantity of money in circulation sufficiently to generate a rightward shift in the aggregate demand curve by​ $0.5 trillion, will actual equilibrium real GDP rise by this amount in the classical​ model? Explain. ​1.) Using the line drawing​ tool, draw a new AD curve that shows the effects of increasing the quantity of money in circulation by​ $0.5 trillion. Label your line ​'AD2​.' ​2.) Using the point drawing tool​, indicate the​ economy's new​ long-run equilibrium price and level of real GDP. Label this point ​'E2​.' In the classical model, actual equilibrium real GDP ________ rise by this amount because prices _________ and the economy moves _________ from E1 to E2. In other​ words, with A. ​Say's law and inflexible interest​ rates, prices and wages would always lead to less than full employment at a level of real GDP of under​ $18 trillion. B. Say's law and flexible interest​ rates, prices and wages would always lead to full employment at a level of real GDP of​ $18 trillion. C. Say's law and inflexible interest​ rates, prices and wages would always lead to greater than full employment at a level of real GDP of over​ $18 trillion. D. inflexible interest​ rates, prices and wages would always lead to full employment at a level of real GDP of​ $18 trillion.

will not; rise; quickly B. Say's law and flexible interest​ rates, prices and wages would always lead to full employment at a level of real GDP of​ $18 trillion.

The Keynesian Model was supported empirically by data from the decade of the A. 1930s. B. 1920s. C. 1970s. D. 1940s.

A. 1930s. Note: The 1930s are depicted as the era of the Great Depression. This is when Keynes developed his model in hopes of providing macroeconomic tools for governments to correct the economy.

Which of the following would create​ demand-pull inflation? A. An increase in household income. B. A decrease in wages paid to workers. C. An increase in the real rate of interest. D. Increased international trade barriers.

A. An increase in household income.

Suppose that the value of the US dollar​ ($) yesterday was​ $1 = 4 pesos. Today the exchange rate changed such that​ $1 = 5 pesos. Given that the US​ $ has​ appreciated, the aggregate demand in the United States should A. shift to the left. B. shift to the right. C. not be affected.

A. shift to the left. Note: Aggregate demand shifts leftward. The dollar is more expensive for foreigners to buy and US exports decrease. At the same time the dollar buys more foreign goods and services then before so US imports increase. Both these cause the aggregate demand to decrease.

Suppose that the value of the US dollar​ ($) yesterday was​ $1 = 4 yen. Today the exchange rate changed such that​ $1 = 22 yen. Given that the US dollar has​ depreciated, the aggregate demand in the United States should A. shift to the right. B. shift to the left. C. not be affected.

A. shift to the right.

Given that the US​ $ has​ appreciated, the​ short-run aggregate supply in the United States should A. shift to the right. B. shift to the left. C. not be affected.

A. shift to the right. Note: The aggregate supply shifts to the right because foreign inputs and resources are relatively less expensive than they used to be. So US firms purchase more foreign imports lowering domestic production costs and increasing the​ short-run aggregate supply.

Inflation in an economy implies that A. the average price level has increased over a stated period of time. B. that real GDP is overstated due to the higher price level. C. stores have increased their prices for no other reason than to earn more profit. D. the price of every good has increased.

A. the average price level has increased over a stated period of time.

The current state of the US domestic economy is depicted in the graph. a. Suppose that foreign currencies depreciate relative to the dollar. Consider the two effects of this change in the value of the dollar by​ drawing: ​1.) Using the line drawing tool​, draw a new aggregate demand curve. Properly label your line. ​2.) Using the​ 3-point curved line drawing tool​, draw a new SRAS curve. Properly label your curve. b. Suppose that the curves you drew in the graph shifted by the same proportion. In this case the result would be that A. the price level decreses and real GDP remains at the original level. B. the price level decreases and the real GDP decreases. C. both the price level and real GDP increase. D. both the price level and real GDP decrease.

A. the price level decreses and real GDP remains at the original level.

What did Keynes mean when he said that prices are​ sticky? A. ​Prices, especially the price of​ labor, are inflexible downward. B. Prices are inflexible upward due to the aversion people have to higher prices. C. Prices are sticky because of​ cost-push inflation. D. Prices need to be sticky or we would have​ cost-push inflation.

A. ​Prices, especially the price of​ labor, are inflexible downward.

The lower the rate of​ interest, the​ ________ profitable it is to invest and the​ ________ the level of desired investment. A. ​more; higher B. less; higher C. ​more; lower D. less; lower

A. ​more; higher

Which of the following would create​ cost-push inflation? A. Increased training costs that produce a more than proportionate increase in worker productivity. B. An increase in wages paid to workers. C. Improved technology reducing transportation and shipping times. D. An increase in household income.

B. An increase in wages paid to workers.

A stonger dollar contributes to inflation. A. True B. False

B. False

Cost-push inflation arises due to A. a higher price level. B. a decrease in the​ short-run aggregate supply curve. C. an increase in the aggregate demand. D. an increase in the​ short-run aggregate supply curve.

B. a decrease in the​ short-run aggregate supply curve. Note: A decrease in the​ short-run aggregate supply curve shifts the curve to the left. It slides up along the aggregate demand curve and a new​ short-run equilibrium is established at a higher price level.

Suppose that there is a temporary​, but​ significant, increase in oil prices in the economy depicted in the figure to the right . a. Using the 3​-point curved line drawing tool​, show the impact the elevated oil prices have on the macroeconomy. Properly label this line. b. If the central bank wishes to prevent the equilibrium price level from changing in response to the oil price​ increase, it should A. decrease the quantity of money in circulation in order to shift the​ short-run aggregate supply curve rightward. B. decrease the quantity of money in circulation in order to shift aggregate demand leftward. C. decrease the quantity of money in circulation so that oil prices will fall. D. increase the quantity of money in circulation in order to shift aggregate demand rightward.

B. decrease the quantity of money in circulation in order to shift aggregate demand leftward.

Given that the US dollar has depreciated the​ short-run aggregate supply in the United States should A. not be affected. B. shift to the left. C. shift to the right.

B. shift to the left.

The current state of the US domestic economy is depicted in the graph. a. Suppose that the US dollar appreciates. Consider the two effects of a stronger dollar. ​1.) Using the line drawing tool​, draw a new aggregate demand curve. Properly label your line. ​2.) Using the​ 3-point curved line drawing tool​, draw a new SRAS curve. Properly label your curve. b. Suppose that the curves you drew in the graph shifted by the same proportion. In this case the result would be that A. both the price level and real GDP increase. B. the price level decreases and real GDP remains at the original level. C. the price level decreases and the real GDP decreases. D. both the price level and real GDP decrease.

B. the price level decreases and real GDP remains at the original level.

Which of the following will occur when aggregate supply remains stable but aggregate demand falls in the short​ run? A. The unemployment rate falls. B. The price level rises. C. A recessionary gap is created. D. An inflationary gap is created.

C. A recessionary gap is created.

Which of the following statements best characterizes​ demand-pull and​ cost-push inflation? A. Both cause prices and output to increase. B. Both cause prices to rise and output to fall. C. Both are short run types of inflation. D. Demand-pull is a short run type of inflation while​ cost-push is a long run type of inflation.

C. Both are short run types of inflation. Note: They are both short run since​ cost-push is caused by a shift of the​ short-run aggregate supply curve. Any increase in the aggregate demand curve generates a movement along the​ short-run supply curve to establish the new​ equilibrium, at a higher price level.​ Therefore, since the​ short-run aggregate supply curve is still​ relevant, demand-pull is a​ short-run type of inflation as well.

b. Which of the following best exemplifies​ Say's Law? A. The more you consume the less additional satisifaction you obtain from the next unit of the good. B. A decrease in the price of a good leads to a larger amount of the good being purchased. C. The production of a​ $4000 plasma TV set creates demand for other goods and services valued at​ $4000. D. Increases in labor eventually lead to smaller and smaller increases in output.

C. The production of a​ $4000 plasma TV set creates demand for other goods and services valued at​ $4000.

Suppose that the value of the US​ $ yesterday was​ $1 = 4 euros. Today the exchange rate changed such that​ $1 = 5 euros. One can say the A. US​ $ depreciated. B. The euro appreciated. C. US​ $ appreciated. D. The euro decelerated.

C. US​ $ appreciated. Note: The dollar has appreciated. If a dollar buys more of a foreign currency then it previously did it has appreciated.

Suppose that the value of the US dollar​ ($) yesterday was​ $1 = 4 euros. Today the exchange rate changed such that​ $1 = 22 euros. One can say that the A. The euro depreciated. B. US​ $ appreciated. C. US​ $ depreciated. D. The euro accelerated.

C. US​ $ depreciated.

Suppose that an economy is currently in a long run equilibrium where SRAS​ = LRAS​ = AD. Given that there is decreased security about jobs and future income, the new short run position of the economy finds itself in is termed A. a depressionary gap. B. an inflationary gap. C. a recessionary gap. D. stagflation.

C. a recessionary gap. Note: Since the aggregate demand has decreased the equilibrium in the economy is now left of the​ long-run supply curve. The economy is operating below the full employment level of real GDP. The price level has fallen as​ well, since the​ short-run aggregate supply curve is upward sloping.

Suppose that an economy is currently in a long run equilibrium where SRAS​ = LRAS​ = AD. If there is decreased security about jobs and future income​, which of the following is the best description of the outcome in the​ economy? A. ​Long-run aggregate supply increases. B. Short-run aggregate supply decreases. C. Aggregate demand increases. D. Aggregate demand decreases.

D. Aggregate demand decreases.

Which of the following will occur when aggregate supply remains stable but aggregate demand increases in the short​ run? A. A recessionary gap is created. B. The unemployment rate rises. C. The price level falls. D. An inflationary gap is created.

D. An inflationary gap is created.

A depreciation of the U.S. dollar should result in A. a lower price level and a higher level of real GDP. B. a higher price level and a lower level of real GDP. C. a higher price level and a higher level of real GDP. D. a higher price level but the impact on the level of real GDP depends on the magnitude of the shifts in the aggregate demand and​ short-run aggregate supply curves.

D. a higher price level but the impact on the level of real GDP depends on the magnitude of the shifts in the aggregate demand and​ short-run aggregate supply curves.

​Demand-pull inflation arises due to A. a decrease in the aggregate demand. B. a decrease in the​ short-run aggregate supply. C. a higher price level. D. an increase in household income.

D. an increase in household income.

Consider the open economy displayed in the figure to the right. Firms in this nation do import raw materials and other productive inputs from​ abroad, and foreign residents purchase many of the​ nation's goods and services. a. Using the three point curved line drawing tool, determine the most likely​ short-run effect on this​ nation's economy if there is a significant raw materials price inflation in other nations around the world. Label this line​ 'Shock'. b. According to your​ diagram, the ​short-run effect upon the economy is A. a higher price level and an economic expansion. B. deflation and a lower real GDP. C. a lower price level and an economic recession. D. inflation and a lower real GDP.

D. inflation and a lower real GDP.

As the dollar becomes stronger in international foreign exchange​ markets, the​ short-run aggregate supply curve will shift to the​ ________ and the aggregate demand curve will shift to the​ ________. A. ​left; right B. left; left C. right; right D. right; left

D. right; left

Persistent inflation arises due to A. the​ short-run aggregate supply curve increasing by a larger proportion than the​ long-run aggregate supply curve. B. the​ short-run aggregate supply curve decreasing. C. the aggregate demand curve increasing by a larger proportion than the​ short-run aggregate supply curve. D. the aggregate demand curve increasing by a larger proportion than the​ long-run aggregate supply curve.

D. the aggregate demand curve increasing by a larger proportion than the​ long-run aggregate supply curve.

Consider a country whose economic structure matches the assumptions of the classical model. After reading a recent​ best-seller documenting a growing population of high−income elderly people who were over−prepared for​ retirement, most residents of this country decide to decrease their saving at any given interest rate. From the list given below choose the letter that gives the resulting outcome for each of the following​ variables: I−Increase D-Decrease N−No Effect The current equilibrium interest rate ________ Current equilibrium real GDP. _________ Current equilibrium employment. ________ Current equilibrium investment. ________ Future equilibrium real GDP. ________

I, N, N, D, D

What is demand-pull inflation?

Inflation caused by increases in aggregate demand not matched by increases in aggregate supply.

What is the Keynesian short-run aggregate supply curve?

The horizontal portion of the aggregate supply curve in which there is excessive unemployment and unused capacity in the economy.

What is the short-run aggregate supply curve (SRAS)?

The relationship between total planned economywide production and the price level in the short run, all other things held constant. If prices adjust incompletely in the short run, the curve is positively sloped.

When aggregate demand decreases while aggregate supply is​ stable, _________ gap can​ occur, defined as the difference between how much the economy could be producing if it were operating on its LRAS and the equilibrium level of real GDP. An increase in aggregate demand leads to ________ gap.

a recessionary; an inflationary

In the labor​ market, full employment occurs at ________ at which quantity demanded equals quantity supplied. That particular level of employment is associated with the​ full-employment level of real GDP per year.

a wage rate

Consider the aggregate demand and supply curves in the figure to the right. The economy is initially at an equilibrium at E0. Using the line drawing​ tool, draw and label the appropriate curve that shows the effect of the following​ event: Increase in government spending. This will result in _________ gap.

an inflationary Note: An inflationary gap exists whenever equilibrium real GDP per year is greater than​ full-employment real​ GDP, as shown by the position of the​ long-run aggregate supply curve. A recessionary gap exists whenever equilibrium real GDP per year is less than​ full-employment real GDP as shown by the position of the​ long-run aggregate supply curve.

If we assume that the economy is operating on a horizontal​ short-run aggregate supply​ curve, the equilibrium level of real GDP per year is completely ________ determined.

demand

Consider the figure to the right. Suppose that businesses in this nation initially had been exporting significant amounts of domestically produced goods and services abroad. Assume that other nations of the world have experienced a sudden decline in economic conditions. What happens to the​ nation's aggregate demand​ curve? In the short​ run, will the nation experience an inflationary gap or a recessionary​ gap? Explain. ​1.) Using the line drawing​ tool, draw a new AD curve that shows the effects of a sudden decline in economic conditions in other nations. Label your line ​'AD2​.' ​2.) Using the point drawing tool​, indicate the​ economy's new​ short-run equilibrium price and level of real GDP. Label this point ​'E2​.' In the short​ run, the equilibrium price level will _________ and the nation will experience ________ gap because the short-run equilibrium level of real GDP per year is ________ real GDP at full employment.

fall; a recessionary; less than

The macroeconomy is depicted by the graph to the right. a. Suppose that AD has changed due to reduced taxes. Using the line drawing tool​, draw this new line and label it ​'D1​'. b. The new​ short-run equilibrium price level has _______ and real GDP has ________. c.​ Thus, in the short run it is ________ to produce beyond the full employment of real GDP. d. The cost of producing beyond the full employment level of real GDP is ________.

increased; increased; possible; a higher price level

Suppose that an economy begins in equilibrium at E1 as depicted in the graph to the right. Assume that the economy follows the Classical Model assumptions. a. Using the line drawing tool​, draw a new aggregate demand​ (AD) curve reflecting an increase in the amount of money in circulation. Properly label this line. b. During the rapid adjustment period​ (that results from the change in the AD​ curve), the economy will immediately tend toward a price level that _________ and a level of real GDP that ________ before quickly returning to full employment. c. Now that the macroeconomy is in a​ disequilibrium, what happens in the labor​ market? A. The government imposes a minimum wage to support the economy. B. Wages decrease to reduce production. C. Unemployment decreases, which increases wages. D. Workers unionize to negotiate higher wages so the economy continues to overproduce. d. As the wage increases​, the A. quantity demanded of labor decreases​, while the law of supply increases the number of workers seeking jobs. B. demand for labor increases, reinforcing the expansion.the expansion. C. supply of labor decreases. D. demand for labor decreases and production decreases back to the full employment level.

remains constant; increases C. Unemployment decreases, which increases wages. A. quantity demanded of labor decreases​, while the law of supply increases the number of workers seeking jobs. Note: The price level remains constant as expenditures have increased​, creating the gap between expenditures and production.

Consider the figure to the right. If this​ country's government decides to enact short-term import restrictions, what happens to the​ short-run equilibrium price​ level, and​ why? Is this an example of​ demand-pull or​ cost-push inflation? Explain. ​1.) Using the line drawing​ tool, draw either a new aggregate demand​ (AD) curve or a new​ short-run aggregate supply​ (AS) curve that shows the effects of temporary government import restrictions. Properly label your line. ​2.) Using the point drawing tool​, indicate the​ economy's new​ short-run equilibrium price and level of real GDP. Label this point ​'E2​.' The ________ in the general level of prices in the short run because of the upward shift in __________ caused by the temporary government import restrictions is an example of _________ inflation.

rise, aggregate supply, cost-push

________-run equilibrium occurs at the intersection of the aggregate demand​ curve, ​AD, and the​ short-run aggregate supply​ curve, SRAS. ________-run equilibrium occurs at the intersection of AD and the​ long-run aggregate supply​ curve, LRAS.

short; long

Say's law states that _________ creates its own ________ and therefore desired expenditures will equal actual expenditures.

supply; demand

An economy is currently in a long run equilibrium where SRAS​ = LRAS​ = AD. Suppose that there is increased security about jobs and future income, which of the following is the best explanation of the​ outcome? A. Aggregate demand increases. B. Aggregate​ demand, short-run and​ long-run aggregate supply all increase. C. ​Short-run aggregate supply increases. D. Long-run aggregate supply increases.

A. Aggregate demand increases. Note: Increased job expenditures leads to greater expenditures.

Which of the following is a possible explanation for sticky​ prices? A. Labor contracts cause wages to be fixed over the contract period. B. Lack of union power to lower prices on products allows firms to maintain higher priced goods. C. It is illegal for firms to lower prices without the consent of the courts. D. All firms act as a cartel and maintain a constant​ non-competitive price.

A. Labor contracts cause wages to be fixed over the contract period. Note: Labor contracts are the main factor that creates the potential for sticky prices. Firms are locked into these costs for several years at a time. This reduces the​ firm's flexibility in trying to adjust to changing economic conditions and could prevent their prices from falling.

Which of the following will increase both the​ short-run and​ long-run aggregate supply​ curves? A. Younger workers in the labor force receive better and more training than their predecessors. B. The wage rate decreases throughout the economy temporarily. C. The supply of key raw materials such as petroleum and bauxite are reduced. D. There are fewer firms involved in perfectly competitive and monopolistically competitive market structures as the economy features more oligopolies than before.

A. Younger workers in the labor force receive better and more training than their predecessors. Note: Additional training for younger workers should increase their productivity levels at the present moment and throughout their lifetime.​ Hence, additional training of younger workers has effects in the present period and in the long run.

According to​ Keynes, when there is excess capacity in an​ economy, the equilibrium level of real GDP per year is determined by A. aggregate demand. B. long-run aggregate supply. C. the price level. D. short-run aggregate supply.

A. aggregate demand.

The​ long-run aggregate supply curve will not shift if there is a change in A. the price level. B. technology. C. amount of capital. D. amount of labor.

A. the price level

All of the following will shift the​ short-run aggregate supply and the​ long-run aggregate supply except for A. increased training and education of the labor force. B. a temporary change in input prices. C. a depletion of raw materials. D. decreased competition.

B. a temporary change in input prices.

What is an aggregate supply shock?

Any event that causes the aggregate supply curve to shift inward or outward.

Suppose that the economy is depicted in the graph to the right. a. The equilibrium price level and real GDP in this economy are respectively A. ​$80 trillion;​ $10 trillion. B. 80; $10 trillion. C. $80; $10 trillion. D. 80​ trillion; 10. b. Using the line drawing tool​, show a change in aggregate demand that leads to a recessionary gap. Label this new line 'AD1​'.

B. 80; $10 trillion.

a. Complete the following diagram. ​1.) Using the line drawing tool​, draw a​ long-run aggregate supply curve for any value of GDP greater than​ $2 trillion. Label it​ 'LRAS'. ​2.) Using the​ 3-point curved line drawing tool​, draw a ​ short-run aggregate supply curve. Label it​ 'SRAS'. b. Which of the following factors will shift the​ short-run aggregate supply curve but not the​ long-run AS? A. Improvements in technology. B. An economy wide decrease in wages. C. An increase in capital. D. A permanent decrease in oil production. c. If petroleum prices decrease temporarily the _________ curve would shift to the ________.

B. An economy wide decrease in wages. short-run aggregate supply; right Note: Temporary changes impact the​ short-run, not the​ long-run aggregate supply curve. In this​ case, a temporary decrease in the price of petroleum shifts the​ short-run aggregate supply curve to the right.

Which of the following is true concerning shifts of the​ long-run aggregate supply​ curve? A. A decrease in the​ long-run aggregate supply curve cannot happen in the modern Keynesian Model. B. An increase in the​ long-run aggregate supply curve is depicted as a rightward shift and an increase in real GDP. C. An increase in the​ long-run aggregate supply curve causes its slope to become steeper as real GDP increases. D. An increase in the​ long-run aggregate supply curve causes greater unemployment.

B. An increase in the​ long-run aggregate supply curve is depicted as a rightward shift and an increase in real GDP.

The economy is depicted in the graph to the right. a.​ Suppose, there are fewer regulatory impediments to business. Which of the following best describes the result of this​ event? A. Both the short and​ long-run aggregate supply curves shift inward. B. Both the​ short-run and​ long-run aggregate supply curves shift outward. C. The​ short-run aggregate supply curve shifts out while the​ long-run aggregate supply curve shifts in. D. The​ short-run aggregate supply curve shifts inward while the​ long-run aggregate supply curve shifts outward. b. Complete the diagram. ​1.) Using the line drawing tool​, draw the new​ long-run aggregate supply curve representing this shock. Label it as LRAS1. ​2.) Using the​ 3-point curved line drawing tool​, draw the new SRAS representing this shock. Label it ​'SRAS1​'.

B. Both the​ short-run and​ long-run aggregate supply curves shift outward.

The classical economists believed that the leakage of saving would be matched by the injection of business investment. A. False B. True

B. True

The level of employment in an economy determines its real GDP. A. False B. True

B. True

Suppose that the rental rate of machinery decreased temporarily. The result of this would be best described by A. a decrease in the​ short-run aggregate supply curve only. B. an increase in the​ short-run aggregate supply curve only. C. an increase in both the​ short-run aggregate supply and long run aggregate supply curves. D. a decrease in both the​ short-run aggregate supply and​ long-run aggregate supply curves.

B. an increase in the​ short-run aggregate supply curve only. Note: A temporary change in the price of an input only affects the​ short-run aggregate supply curve.

The resulting spending gap between early 2005 and late 2007 when total planned expenditures by U.S. households substantially increased in response to an increase in the quantity of money in circulation can best be described as A. a recessionary gap. B. an inflationary gap. C. a full employment gap. D. a deflationary gap.

B. an inflationary gap

The​ short-run Keynesian aggregate supply curve is A. vertical. B. horizontal. C. downward sloping. D. upward sloping.

B. horizontal.

​Say's law asserts that A. demand creates its own supply. B. supply creates its own demand. C. permanent shortages are normal occurrences in a market economy. D. permanent surpluses are normal occurrences in a market economy.

B. supply creates its own demand.

According to modern Keynesian​ analysis, the​ short-run aggregate supply curve is A. downward sloping. B. upward sloping. C. vertical. D. horizontal.

B. upward sloping.; A. Lower wages for labor.

The Modern Keynesian​ short-run aggregate supply curve is best described by which of the following​ statements? A. It is very flat at low levels of real​ GDP; increases slightly as real GDP​ grows; and becomes horizontal at full employment. B. It is very steep at low levels of real​ GDP; decreases slightly as real GDP​ grows; and becomes very flat as real GDP surpasses full employment. C. It is very flat at low levels of real​ GDP; increases slightly as real GDP​ grows; and becomes very steep as real GDP surpasses full employment. D. It is very steep at low levels of real​ GDP; decreases slightly as real GDP​ grows; and becomes horizontal at full employment.

C. It is very flat at low levels of real​ GDP; increases slightly as real GDP​ grows; and becomes very steep as real GDP surpasses full employment. Note: At low levels of real GDP there is still excess labor so the economy can still expand without much worry of inflation. As the economy approaches full employment the inflationary pressure rises. If the economy surpasses full​ employment, the price level rises very rapidly.

Which of the following is not one of the four major assumptions of the classical​ model? A. People are motivated by​ self-interest. B. Wages and prices are flexible. C. People suffer from money illusion. D. Pure competition exists.

C. People suffer from money illusion.

If an excess quantity of labor is supplied at a particular wage​ level, the wage level A. could be​ above, below, or at equilibrium. B. must be below equilibrium. C. must be above equilibrium. D. must be at equilibrium.

C. must be above equilibrium.

a. The Keynesian model argues that prices are sticky. One reason supporting this argument is that A. all unemployment is voluntary. B. government price ceilings. C. nominal wages are inflexible downwards. D. nominal wages are flexible but real wages are not. b. Since the nominal wage is deemed​ inflexible, a decrease in aggregate demand causes firms to A. increase wages to increase income so AD increases. B. simply have all workers produce at a slower rate without any unemployment. C. reduce their workforce. D. lower the real wage. c.​ Thus, according to the Keynesian model full employment is ________.

C. nominal wages are inflexible downwards.; C. reduce their workforce.; possible but not guaranteed Note: Labor contracts prevent nominal wages from falling Note: Since contracts make it impossible to lower the​ wage, firms would then resort to eliminating jobs as production fell.

An important difference between the Classical Model and the Keynesian Model is that A. the Classical Model did not incorporate government taxes and spending and the Keynesian Model did. B. the equilibrium level of real GDP is​ demand-determined in the Classical Model and is​ supply-determined in the Keynesian Model. C. prices adjust to bring about equilibrium in the Classical Model and output adjusts to bring about an equilibrium in the Keynesian Model. D. the Classical Model did not account for foreign trade and the Keynesian Model did account for foreign trade.

C. prices adjust to bring about equilibrium in the Classical Model and output adjusts to bring about an equilibrium in the Keynesian Model. Note: ​Yes, price is the mechanism that keeps the economy at full employment according to the Classicalists. According to​ Keynes, in abnormal​ times, the price level is constant so output must adjust.

According to the classical​ economists, A. increasing government spending is the most reliable method of restoring full employment. B. the amount households plan to save is determined primarily by their wage. C. the interest rate will ensure that the amount households plan to save will equal the amount businesses desire to invest. D. unemployment is caused by too little spending.

C. the interest rate will ensure that the amount households plan to save will equal the amount businesses desire to invest. Note: Equilibrium between the saving plans of consumers and the investment plans of businesses comes​ about, in the classical​ model, through the working of the credit market.

c.​ Say's Law fits best in the ________ since this philosophy placed great importance on _________ to determine the __________.

Classical Theory; aggregate supply; level of output

Suppose that an economy begins at the​ short-run equilibrium shown as point A in the figure to the right. Identify which of the other points on the diagram−points B​, ​C, D, or E−could represent a new short​-run equilibrium after the described events given below take place and move the economy away from point A. Few worker in this nation's economy are union members, and unions have sheepishly consented to large wage givebacks. At the same time, economic conditions suddenly improve abroad, raising real GDP and disposable income in other nations of the world. ________ A run of good weather has led to unprecedented crop harvests throughout the country. At the same time, the nation's central bank has significantly pushed down the rate of growth of the nation's money supply. ________ A strengthening of the value of this nation's currency in terms of other countries' currencies affects both the SRAS curve and the AD curve. ________

D, C, C,

The extent to which real GDP responds to changes in the price level along the​ short-run aggregate supply curve is largely determined by A. the speed with which input prices adjust and people become more fully informed. B. the ability of firms to use existing workers and capital more intensively. C. the ability of firms to hire additional​ inputs, particularly workers. D. All of the above. E. B and C only.

D. All of the above.

Which of the following will occur when aggregate supply remains stable but aggregate demand increases in the short​ run? A. The price level falls. B. The unemployment rate rises. C. A recessionary gap is created. D. An inflationary gap is created.

D. An inflationary gap is created.

In the Modern Keynesian Model the short run aggregate supply curve slopes upward. How could one explain the shape of the upward sloping​ short-run aggregate supply curve by only focusing on the capital​ input? A. New machinery can be added. B. The firm takes workers off the assembly line to increase worker training time. C. Increase maintenance of machines to assure proper working order. D. Existing machinery can be used longer hours.

D. Existing machinery can be used longer hours. Note: By increasing the number of hours machines can produce more by using the available capital more intensively. Firms can do this in the short run.

How could one explain the shape of the upward sloping​ short-run aggregate supply curve by only focusing on​ profits? A. Firms earn more profit as the price level decreases since consumers can afford more of their product then. B. Firms are able to earn profit as long as the price level and wage rates increase by the same rates. C. Higher prices mean that workers need to work longer to maintain their current purchasing​ power, so thus production increases. D. Firms are able to earn higher profits as long as the price level increases and the nominal wage rate remains constant.

D. Firms are able to earn higher profits as long as the price level increases and the nominal wage rate remains constant. Note: If firms are able to increase their prices and costs remain​ constant, their profit margins rise. The price level in the macroeconomy will rise too.

Between early 2008 and the beginning of​ 2009, a gradual stock market crash and plummeting home prices generated a substantial reduction in U.S. household wealth that induced most U.S. residents to reduce their planned real spending at any given price level. From a​ short-run Keynesian​ perspective, the predicted effects of this event on the equilibrium U.S. price level and equilibrium U.S. real GDP were​ what? A. an increase in the price level along with an increase in equilibrium real GDP B. an increase in the price level along with a decrease in equilibrium real GDP C. a decrease in the price level along with an increase in equilibrium real GDP D. a decrease in the price level along with a decrease in equilibrium real GDP

D. a decrease in the price level along with a decrease in equilibrium real GDP

According to the classical​ model, if the economy starts at full employment an increase in aggregate demand will cause all of the following to occur except A. an increase in input prices. B. a decrease in unemployment. C. a rise in real GDP above its​ long-run level. D. a decrease in wage rates.

D. a decrease in wage rates.

The spending gap caused by the reduction in household wealth and spending between early 2008 and the beginning of 2009 can best be described as A. an inflationary gap. B. a deflationary gap. C. an equlibrium gap. D. a recessionary gap.

D. a recessionary gap.

The model of​ long-run equilibrium A. and the Classical Model are based on totally different assumptions. B. assumes that markets always clear but the Classical Model assumes that markets sometimes may not clear. C. is the same as the Keynesian Model. D. is the same as the Classical Model.

D. is the same as the Classical Model.

Suppose that the Keynesian​ short-run aggregate supply curve is applicable for a​ nation's economy. Now suppose that an increase occurs in energy prices. a. Using the line drawing tool​, show how this change affects the economy in the short run. Properly label your line. Carefully follow the instructions​ above, and only draw the required objects. b. Which of the following might also yield the outcome shown by your​ diagram? A. A decrease in productivity. B. An increase in union bargaining power. C. A decrease in regulations. D. All of the above. E. A and B only. c. In considering the forces which may increase an​ economy's real GDP in the long​ run, which of the following will NOT play a​ role? A. Lower wages for labor. B. An expanded workforce. C. Greater capital accumulation. D. Increased education and training. E. Discoveries of new raw materials.

E. A and B only.

An important difference between the Classical Model and the Keynesian Model is that the a. Keynesians believe that the aggregate supply curve is ________. b. The Classical model assumes prices ________ so that the aggregate supply curve is ________ and the economy is always at ________. c. The Keynesian model indicates that the economy will find an equilibrium however the economy will not always ________.

horizontal in the short run; are flexible; vertical; full employment; reach full employment

Consider the figure to the right. Suppose that the real interest rate suddenly declines for reasons that have nothing to do with the value of the price level. What happens to the​ nation's aggregate demand​ curve? In the short​ run, will the nation experience an inflationary gap or a recessionary​ gap? Explain. ​1.) Using the line drawing​ tool, draw a new AD curve that shows the effects of a sudden fall in the real interest rate. Label your line ​'AD2​.' ​2.) Using the point drawing tool​, indicate the​ economy's new​ short-run equilibrium price and level of real GDP. Label this point ​'E2​.' In the short​ run, the equilibrium price level will _________ and the nation will experience _________ gap because desired investment ________ and the short-run equilibrium level of real GDP per year is ________ real GDP at full employment.

rise; an inflationary; rises; greater than

Any unanticipated shifts in aggregate demand or supply are called aggregate demand or aggregate supply __________.

shocks

The Keynesian Model of the macroeconomy argues that prices are sticky due to labor contracts and unions. a. The existence of sticky prices causes the ________ to be horizontal. b. Suppose that the aggregate demand changes due to an decrease in the amount of money in circulation. Using the line drawing tool​, draw the new aggregate demand curve. Label it AD1.

short-run aggregate supply; Note: It is the​ short-run aggregate supply curve that is horizontal. Sticky prices prevent firms from making adjustments to labor in the short run.

In the classical​ model, because LRAS is _________, the equilibrium level of real GDP is supply determined. Any changes in aggregate demand simply change the __________.

vertical; price level

The aggregate supply curve implied by the classical model is __________, so that a reduction in aggregate demand will mean a lower overall level of ___________.

vertical; prices Note: The classical model assumes​ (1) pure​ competition, (2) flexible wages and​ prices, (3)​ self-interest, and​ (4) no money illusion. The​ short-run aggregate supply curve is vertical at​ full-employment real GDP. Variations in aggregate demand along aggregate supply generate changes in the equilibrium price level. Next Question