CHP. 11 Classical and Keynesian Macro Analysis

U.S. minimum wage increase generated an _________across the Puerto Rican economy that adversely affected its equilibrium real GDP.

"aggregate supply shock"

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 price level, not real GDP.

Equilibrium real GDP rises after the dollar strengthened. From this we can conclude that

the decrease in aggregate demand was less than the increase in aggregate supply.

Suppose that the US dollar depreciates. Consider the two effects of a weaker dollar.

the price level increases and real GDP decreases.

The extent to which real GDP responds to changes in the price level along the​ short-run aggregate supply curve is largely determined by

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. All of the above.

Say's Law

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

An inflationary gap occurs when

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

Classical model

traces its origins to the 1770s, was the first systematic attempt to explain the determinants of the price level and the national levels of real GDP, employment, consumption, saving, and investment.

Incomplete adjustment

was first developed by a twentieth-century economist named John Maynard Keynes (pronounced like canes).

Holding the level of prices fixed implies that a given decrease in aggregate demand

will have a larger effect on real GDP than would be the case if prices were more flexible.

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?

​demand-pull inflation, an inflationary gap, a movement along the​ short-run aggregate supply curve

The modern Keynesian Model assumes that

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

Inflation in an economy implies that ​Cost-push inflation arises due to Which of the following would create​ cost-push inflation?

the average price level has increased over a stated period of time. a decrease in the​ short-run aggregate supply curve. An increase in wages paid to workers.

In the figure at​ right, if the relevant aggregate demand curve is AD 2​, what type of gap exists and how large is​ it? (shifted downward)

recessionary gap of​ $500 billion

Since the nominal wage is deemed​ inflexible, a decrease in aggregate demand causes firms to

reduce their workforce.

According to classical​ theory, desired saving always equals investment due to changes in

the interest rate.

In modern Keynesian​ analysis, an increase in aggregate demand will result in

. an increase in both the price level and output.

Classical Model 4 main 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.

Which of the following factors will shift the​ short-run aggregate supply curve but not the​ long-run AS?

An economy wide decrease in wages.

Which of the following is true concerning shifts of the​ long-run aggregate supply​ curve?

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

Why U.S. Nominal Wages Have Been Slow to Adjust

As a result, average wages earned by male workers declined even as women's average wages have risen, which explains why average wages across both male and female workers have hardly increased.

According to classical​ economists,

B. unemployment will not be a serious problem in a market economy.

Refer to the figure at right. Which point or points​ represent(s) a​ short-run equilibrium?

C only the intersection of the SRAS and the AD

Say's Law fits best in the _______ since this philosophy placed great importance on ______ to determine the __________ .

Classical Theory aggregate supply level of output

If the central bank wishes to prevent the equilibrium price level from changing in response to the oil price​ increase, it should

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

a. The Keynesian model argues that prices are sticky. One reason supporting this argument is that

D. nominal wages are inflexible downwards.

Changes That Cause an Increase in Aggregate Supply

Discoveries of new raw materials, Increased competition, A reduction in international trade barriers, Fewer regulatory impediments to business

Refer to the figure at right. Suppose the economy had been at point A and now is at B. What could have caused the movement to​ B? shifted up to the right on SRAS curve

Government spending increased causing aggregate demand to increase.

If the aggregate demand curve shifts beyond AD 5, which of the following would we NOT​ expect? (See figure at

Increases in real net domestic product

When income is saved, it is not reflected in product demand.

It is a type of leakage from the circular flow of income and output because saving withdraws funds from the income stream. Therefore, total planned consumption spending can fall short of total current real GDP. In such a situation, it appears that supply does not necessarily create its own demand.

The graph shows aggregate​ demand, long-run aggregate​ supply, and the​ short-run aggregate supply​ curve, using modern Keynesian analysis. Suppose that there is an increase in real interest rates.

LRAS and SRAS stays the same. AD decreases so SR equilibrium price and output is decreased

Which of the following is a possible explanation for sticky​ prices?

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.

Minimum wages increasing above market clearing wages lead to

Labor surpluses

The Relationship between Employment and Real GDP

Rather, the level of employment in an economy determines its real GDP (output), other things held constant.

#1 hw Suppose that businesses in this nation suddenly anticipate higherhigher future profitability from investments they undertake today. Current equilibrium real GDP=N Current equilibrium employment.=N Future equilibrium real GDP.=I

Recall that​ Say's law coupled with flexible​ wages, prices, and interest rates keeps the LRAS curve vertical at the quantity of output that would be produced in an economy with full information and full adjustment of wages and prices.

Suppose that the US dollar depreciates. Consider the two effects of a weaker dollar. Suppose that the curves you drew in the graph shifted by the same proportion. In this case the result would be that

SRAS goes to the left and AD shift to the right the price level increases and real GDP remains at the original level.

The graph shows​ long- and​ short-run aggregate supply​ curves, using modern Keynesian analysis. Suppose that there is a temporary increase in food costs there is a temporary increase in food costs due to Midwest flooding due to Midwest flooding.

SRAS moved up to the left (Decreased)

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 macro

SRAS shifts up to the left

Suppose that the Keynesian​ short-run aggregate supply curve is applicable for a​ nation's economy. Now suppose that a decrease occurs in nominal wages. Which of the following might also yield the outcome shown by your​ diagram? 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?

SRAS went down. (An increase in productivity, and a decrease in raw materials prices) A and B only. Lower wages for labor.

Why is persistent unemployment a possibility in the Keynesian model but NOT in the classical​ model?

The Keynesian model assumes that nominal wages are inflexible downward.

Suppose the U.S. dollar gains strength against the euro​ (and against other major​ currencies). This strengthening of the dollar will cause which of the following to​ occur?

The aggregate demand curve will shift to the left and the​ short-run aggregate supply will shift to the right.

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

Which of the following best exemplifies​ Say's Law?

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

HW #10

The​ long-run aggregate supply curve indicates the full employment level of real GDP.

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.

The​ supply, in​ turn, is fixed by the​ country's resource endowments and the state of its technology and productivity.

Suppose that the value of the US​ $ yesterday was​ $1 = 4 yenyen. Today the exchange rate changed such that​ $1 = 66 yenyen. One can say the

US​ $ appreciated.

#19 hw

When the​ short-run aggregate supply curve decreases and the aggregate demand curve increases they both cause the price level to increase. ​However, the increase in aggregate demand causes the real GDP to rise while the decrease in the short minus run aggregate supply short−run aggregate supply causes it to fall. If they shift by an equal proportion the rise in real GDP from the demand side is the same as the fall from the supply side and the end result is no change in real GDP.

Which of the following will increase both the​ short-run and​ long-run aggregate supply​ curves?

Younger workers in the labor force receive better and more training than their predecessors.

Which of the following will NOT shift the Keynesian shortminus−run aggregate supply​ curve?

a change in the price level

All of the following will shift the​ short-run aggregate supply​ (SRAS) curve EXCEPT

a change in the price level.

In the Classical​ Model, an increasean increase in aggregate demand will result in

an increasean increase in the price level and no change in output.

An appreciation of the US​ $ should result in

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.

One possible result of a fall in aggregate demand coupled with a stable​ short-run aggregate supply is

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

an increase 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

an inflationary gap.

According to the classical​ model, the income generated by production is

enough to purchase all the goods and services produced.

The Keynesian Approach

established by John Maynard Keynes; suggested that government should lower taxes, spend money, and run up deficits.

Involuntary unemployment

exists when there is an excess quantity of labor supplied.

Suppose that AD has changed due to reduced real interest rates

he new​ short-run equilibrium price level has increased and real GDP has increased Thus, in the short run it is possible to produce beyond the full employment level of real GDP. The cost of producing beyond the full employment level of real GDP is a higher price level.

One of the main conclusions of​ Say's Law was that

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.

Keynesian model

in the 1930s, Europe and the United States entered a period of economic decline that seemingly could not be explained by the classical model. Keynes contended that in such a world, which has large amounts of excess capacity and unemployment, an increase in aggregate demand will not raise the price level, and a decrease in aggregate demand will not cause firms to lower prices.

. If the central bank wishes to prevent the equilibrium real GDP from changing in response to the oil price​ increase, it should

increase the quantity of money in circulation in order to shift aggregate demand rightward.

Which of the following would increase aggregate​ supply?

increased training and education, a reduction in input prices, a discovery of new raw materials

A permanent reduction in international trade barriers would

increase​ long-run aggregate supply.

​Cost-push inflation is

inflation caused by decreases in aggregate supply that are not matched by decreases in aggregate demand.

.​ Thus, according to the Keynesian model full employment

is possible but not guaranteed .

Since the modern Keynesian Model allows for some price​ response, the aggregate supply curve

is upward sloping.

money illusion

occurs when people interpret nominal changes in wages or prices as real changes. People cannot be fooled by this. 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.

An assumption of the classical model is that

people are motivated by​ self-interest.

An upward sloping​ short-run aggregate supply curve suggests that

prices and wages adjust in part to​ short-run demand changes.

A decrease in aggregate demand will cause

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