Chapter 11

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.

In the modern Keynesian short run, when the price level rises partially, real GDP can be expanded beyond the level consistent with its long-run growth path, for a variety of reasons:

1. In the short run, most labor contracts implicitly or explicitly call for flexibility in hours of work at the given wage rate. Therefore, firms can use existing workers more intensively: They can get workers to work harder, to work more hours per day, and to work more days per week. 2. Existing capital equipment can be used more intensively. Machines can be worked more hours per day. Some can be made to operate faster. Maintenance can be delayed. 3. If wage rates are held constant, a higher price level leads to increased profits from additional production, which induces firms to hire more workers. All these adjustments cause real GDP to rise as the price level increases.

The classical model makes four major assumptions:

1. Pure competition exists. 2. Wages and prices are flexible. 3. People are motivated by self-interest. 4. People cannot be fooled by money illusion.

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.

In the short​ run, if aggregate demand shifts to the left while the position of the​ short-run aggregate supply curve does NOT​ change, then A. a recessionary gap occurs. B. an inflationary gap occurs. C. the level of economic activity rises. D. there is no change in real GDP and the price level.

A. a recessionary gap occurs.

The​ short-run aggregate supply curve in modern Keynesian analysis A. is an upward sloping curve. B. is a negatively sloped curve. C. is a vertical line the same as in the classical model. D. is a horizontal line the same as in the Keynesian model.

A. is an upward sloping curve.

A decrease in aggregate demand will cause A. prices to fall according to classical​ economists, and unemployment to increase according to Keynes. B. aggregate supply to fall according to​ Keynes, and unemployment to increase according to classical economists. C. aggregate supply to fall according to classical​ economists, and prices to fall according to Keynes. D. prices to fall and unemployment to increase according to both classical economists and Keynes.

A. prices to fall according to classical​ economists, and unemployment to increase according to Keynes.

Suppose that the value of the US dollar​ ($) yesterday was​ $1 = 4 euros. Today the exchange rate changed such that​ $1 = 33 euros. Given that the US dollar has​ depreciated, the aggregate demand in the United States should A. shift to the right. B. not be affected. C. shift to the left. Given that the US dollar has depreciated the​ short-run aggregate supply in the United States should A. shift to the left. B. shift to the right. C. not be affected.

A. shift to the right. A. shift to the left.

The classical economists argued that planned saving and planned investment will always be equal because of changes in A. the interest rate. B. the price level. C. the level of real disposable income. D. wages.

A. the interest rate.

An inflationary gap occurs when A. the​ short-run equilibrium level of real GDP is greater than​ long-run aggregate supply. B. aggregate demand​ falls, but other things remain constant. C. the​ short-run equilibrium level of real GDP is less than​ long-run aggregate supply. D. ​short-run aggregate supply​ falls, but other things remain constant.

A. the​ short-run equilibrium level of real GDP is greater than​ long-run aggregate supply.

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

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

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

A. ​short-run aggregate supply is horizontal.

Credit spread

An unusual widening of the credit spread indicates weakened credit-market sentiment that can signal a sudden looming decline in total real expenditures, whereas an atypical credit-spread narrowing can indicate a pending spending rise.

There is a core class of events that causes a shift in both the short-run aggregate supply curve and the long-run aggregate supply curve.

Any change in factors of production—labor, capital, or technology—that influence economic growth will shift SRAS and LRAS.

Aggregate demand shock

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

Aggregate supply shock

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

Which of the following is NOT an assumption of the classical​ model? A. Pure competition exists. B. Wages and prices are fixed. C. Buyers react to changes in relative prices. D. People are motivated by the own​ self-interest.

B. Wages and prices are fixed. Wages are prices are flexible in the classical model.

If the U.S. dollar becomes weaker in international​ markets, the net effects will include A. an increase in​ short-run aggregate supply and a decrease in aggregate demand. B. a decrease in​ short-run aggregate supply and an increase in aggregate demand. C. an increase in both short run aggregate supply​ (SRAS) and aggregate demand. D. a decrease in both short run aggregate supply​ (SRAS) and aggregate demand.

B. a decrease in​ short-run aggregate supply and an increase in aggregate demand.

If equilibrium level of real Gross Domestic Product​ (GDP) is less than the​ full-employment real Gross Domestic Product​ (GDP) consistent with the position of the​ economy's long-run aggregate supply​ (LRAS) curve, then the difference between​ full-employment real Gross Domestic Product​ (GDP) and current equilibrium real Gross Domestic Product​ (GDP) is A. an aggregate demand shock. B. a recessionary gap. C. an aggregate supply shock. D. an inflationary gap.

B. a recessionary gap.

According to the classical​ model, the income generated by production is A. enough to meet the needs of everyone in society. B. enough to purchase all the goods and services produced. C. fully spent on savings. D. always insufficient to purchase all the goods and services produced.

B. enough to purchase all the goods and services produced.

One of the main conclusions of​ Say's Law was that A. 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. B. 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. C. 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. D. 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.

B. 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.

The classical model makes four major assumptions: 3. People are motivated by self-interest.

Businesses want to maximize their profits, and households want to maximize their economic well-being.

The classical model makes four major assumptions: 4. People cannot be fooled by money illusion.

Buyers and sellers react to changes in relative prices. That is to say, they do not suffer from money illusion. For example, workers will not be fooled into thinking that doubling their wages makes them better off if the price level has also doubled during the same time period.

Which of the following can cause​ inflation? A. Decreases in aggregate demand B. Increases in​ short-run aggregate supply C. Decreases in​ short-run aggregate supply D. Increases in​ long-run aggregate supply

C. Decreases in​ short-run aggregate supply

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

Suppose that the value of the US dollar​ ($) yesterday was​ $1 = 4 yenyen. Today the exchange rate changed such that​ $1 = 11 yenyen. One can say that the A. The yen depreciated. B. US​ $ appreciated. C. US​ $ depreciated. D. The yen accelerated. 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 higher level of real GDP. C. a higher price level and a lower 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.

C. US​ $ depreciated. 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.

One possible result of a fall in aggregate demand coupled with a stable​ short-run aggregate supply is A. a rise in the stock market. B. an economic expansion. C. a recession. D. an increase in employment levels.

C. a recession.

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 a decrease in equilibrium real GDP. B. a decrease in the price level along with a decrease in equilibrium real GDP. C. an increase in the price level along with an increase in equilibrium real GDP. D. a decrease in the price level along with an increase in equilibrium real GDP. 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 deflationary gap. B. a recessionary gap. C. an inflationary gap. D. a full employment gap.

C. an increase in the price level along with an increase in equilibrium real GDP. C. an inflationary gap.

In the classical​ model, a rightward shift in the aggregate demand curve​ will, in the long​ run, A. decrease real GDP and will not change the price level. B. increase real GDP and the price level. C. not change real GDP and will increase the price level. D. increase real GDP and will not change the price level.

C. not change real GDP and will increase the price level.

The​ short-run aggregate supply curve is a relationship between A. inflation and time. B. unemployment and real GDP. C. real GDP and price level. D. capital goods and consumer goods.

C. real GDP and price level.

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

C. the price level.

In the ___​ 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.

Classical

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

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

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

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 depletion of raw materials. C. decreased competition. D. a temporary change in input prices.

D. a temporary change in input prices.

Suppose the Federal Reserve increases the money supply. Which of the following will tend to occur as a result of this policy in a Keynesian​ model? A. a movement along the​ short-run aggregate supply curve B. ​demand-pull inflation C. an inflationary gap D. all of the above

D. all of the above

Which of the following would increase aggregate​ supply? A. a discovery of new raw materials B. a reduction in input prices C. increased training and education D. all of the above

D. all of the above

The discovery of new iron ore fields will cause A. the​ short-run aggregate supply curve to shift to the​ right, but not the​ long-run aggregate supply curve. B. the​ long-run aggregate supply curve to shift to the right and the​ short-run aggregate supply curve to shift to the left. C. the​ long-run aggregate supply curve to shift to the​ right, but not the​ short-run aggregate supply. D. both the​ long-run and the​ short-run aggregate supply curves to shift to the right.

D. both the​ long-run and the​ short-run aggregate supply curves to shift to the right.

These determinants will cause a shift in the short-run or the long-run aggregate supply curve or both, depending on whether they are temporary or permanent. Changes That Cause an Decrease in Aggregate Supply

Depletion of raw materials Decreased competition An increase in international trade barriers More regulatory impediments to business A decrease in labor supplied Decreased training and education An increase in marginal income tax rates An increase in input prices

These determinants will cause a shift in the short-run or the long-run aggregate supply curve or both, depending on whether they are temporary or permanent. Changes That Cause an Increase in Aggregate Supply

Discoveries of new raw materials Increased com petition A reduction in international trade barriers Fewer regulatory impediments to business An increase in the supply of labor Increased training and education A decrease in marginal income tax rates A reduction in input prices

Cost-push Inflation

Inflation caused by decreases in short-run aggregate supply.

Demand-pull inflation

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

What does Say's law really mean?

It states that the very process of producing specific goods (supply) is proof that other goods are desired (demand).

The classical model makes four major assumptions: 1. Pure competition exists.

No single buyer or seller of a commodity or an input can affect its price.

Money illusion

Reacting to changes in money prices rather than relative prices. If a worker whose wages double when the price level also doubles thinks he or she is better off, that worker is suffering from money illusion.

Say's law:

Supply creates its own demand. Hence, it follows that desired expenditures will equal actual expenditures.

The classical model makes four major assumptions: 2. Wages and prices are flexible.

The assumption of pure competition leads to the notion that prices, wages, and interest rates are free to move to whatever level supply and demand dictate (as the economy adjusts). Although no individual buyer can set a price, the community of buyers or sellers can cause prices to rise or to fall to an equilibrium level.

To measure credit-market sentiment, these economists typically utilize the "credit spread."

The credit spread is the differential between an interest rate that households must pay to obtain credit and an open-market interest rate such as a U.S. Treasury bond rate.

Inflationary gap

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

Recessionary gap

The gap that 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.

credit-market sentiment

The overall emotional state of household borrowers of credit and financial managers who extend credit

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.

Anything other than the price level that affects the production of final goods and services will shift ___ ___ ___.

aggregate supply curves

Say's Law fits best in the Classical Theory since this philosophy placed great importance on ___ ___ to determine the ___ ___.

aggregate supply; level of output

In the ___ model, any change in aggregate demand will quickly cause a change in the price level.

classical

Some economists recently have proposed that ___ ___ ___ is a key determinant of the quantity of credit utilized by consumers to purchase durable goods.

credit-market sentiment

The level of ___ ___ per year clearly does not depend on the level of aggregate demand. Hence, we say that in the classical model, the equilibrium level of real GDP per year is completely supply determined. Changes in aggregate demand affect only the ___ ___.

real GDP; price level, not real GDP

We have learned, then, that a ___ dollar simultaneously leads to an increase in SRAS and a decrease in AD

stronger

Hence, we say that in the classical model, the equilibrium level of real GDP per year is completely ___ ___. Changes in aggregate demand affect only the price level, not real GDP.

supply determined

The classical economists concluded, after taking account of the four major assumptions...

that the role of government in the economy should be minimal. They assumed that pure competition prevails, all prices and wages are flexible, and people are self-interested and do not experience money illusion. If so, they argued, then any problems in the macroeconomy will be temporary. The market will correct itself.

According to Keynes, ___ and ___ ___ are real-world factors that explain the inflexibility of nominal wage rates.

unions and long-term contracts