Chapter 15: Aggregate Demand, Aggregate Supply, and inflation

In the short-run, an anti-inflationary shift in mAonetary policy has which of the following effects?

-Lower output -Higher unemployment

Which of the following explain the downward-sloping AD curve?

-The real value of money -The price of domestic goods sold abroad. -Distributional effects -Uncertainty

Which of the following groups are more adversely affected by rapid inflation?

-Workers receiving minimum wage -Retirees on fixed incomes -People at lower income levels

If the government wants to decrease aggregate demand, then it can:

-decrease government spending -increase the real interest rate

To increase aggregate demand, the government can:

-increase government spending -cut taxes

If the government wants to increase aggregate demand, then it can:

-increase government spending -decrease the real interest rate

In modern economies, inflation tends to adjust slowly due to:

-long-term wage contracts -inflation expectations -long-term price contracts

In the short run, a negative inflation shock such as a sharp rise in oil prices will

-open up a recessionary gap. -shift the AS curve upward.

To decrease aggregate demand, the government can:

-raise taxes -increase the real interest rate

In the short run, a positive inflation shock such as a sharp fall in oil prices will

-shift the AS curve to the right. -lead to an expansionary gap.

When actual output exceeds potential output:

-the inflation rate tends to increase. -an expansionary gap exists

Aggregate supply shocks occur when:

-there are sharp changes in potential output -there are sharp changes in inflation

Match the type of output gap on the left to the behavior of inflation on the right. 1. No output gap (Y=Y*) 2. Expansionary gap (Y>Y*) 3. Recessionary gap (Y*)

1. Inflation remains unchanged 2. Inflation rises (π↑) 3. Inflation falls (π↓)

What is the short-run effect of a positive aggregate supply shock?

A recessionary gap

A key feature of the _____ model is the fact that output gaps will not last indefinitely but will be closed by rising or falling inflation.

AD-AS

Consider the diagram to the right. In the long run, we would expect the:

AS curve to shift to the left.

Consider the graph on the right. In the long run, we would expect the:

AS curve to shift to the right.

How do long-term contracts "build in" wage and price increases?

Contracts signed during periods of high inflation will likely require large wage increases over the duration of the contract.

Higher rates of inflation tend to do which of the following?

Create uncertainty Reduce spending

On the AD-AS diagram, the intersection of the AD and the SRAS curve illustrates which of the following?

Short-run equilibrium

On the AD-AS digram, potential output is marked by which of the following?

The LRAS line

In the presence of a recessionary gap, how does the economy adjust?

The SRAS and inflation both fall until the the economy reaches long-run equilibrium.

On the AD-AS diagram, the current rate of inflation is shown by

The SRAS line

One consequence of disinflation is:

a large recessionary gap

In the short run, a decrease in aggregate demand will cause

a recessionary gap.

The curve that shows the amount of output that consumers, firms, government and customers abroad want to purchase at each inflation rate (holding all else constant) is the _____.

aggregate demand curve

When actual output exceeds potential output:

an expansionary gap exists

When potential output exceeds actual output:

an recessionary gap exists

Lower output, higher unemployment, and little reduction in inflation are all effects of:

anti-inflationary monetary policy

Movements along the AD curve

are due to changes in the inflation rate.

When interest rates rise:

both consumption and investment will fall

As long as the Fed sets the real interest rate in accordance with a fixed policy reaction function,

changes in the real interest will not shift the AD curve.

When a recessionary gap leads inflation to fall, the Fed responds by _____ real interest rates.

decreasing

A reduction in government spending will likely shift the aggregate _____.

demand curve to the left

An increase in government spending is likely to shift the aggregate _____.

demand curve to the right

A substantial reduction in the inflation rate is called _____.

disinflation

People who are less well off are hurt more by high inflation than wealthier people. This describes:

distributional effects

Higher inflation reduces spending. As a result, the AD curve is _____-sloping.

downward

Households and firms tend to reduce their spending levels in the presence of:

economic uncertainty

A(n) ____ gap exists when actual output exceeds potential output.

expansionary

In part, inflation is determined by:

expectations of inflation

If exports decrease, then we would expect net exports to _________ and spending to ________.

fall; fall

When there is a recessionary gap, the rate of inflation will tend to _____, and when there is an expansionary gap, the rate of inflation will tend to _____.

fall; rise

People expect inflation to be ____ if it has been high for an extended period of time

high

In the long run in AD-AS model, an expansionary gap will lead expected future inflation to _____ causing the AS curve to shift _____ so that the output gap is eliminated.

increase; to the left

In the AD-AS model, the AD curve is downward sloping because when inflation increases, the Fed _______ real interest rates, leading output to _____.

increases; fall

When inflation increases due to an expansionary gap, the Fed typically responds by ______ the real interest rate.

increasing

Along the aggregate demand (AD) curve:

inflation and output are negatively related

The negative slope of the AD curve implies that as:

inflation falls, output rises

The aggregate demand curve shows the amount of output that consumers, firms, government and customers abroad want to purchase at each _____, holding all other factors constant.

inflation rate.

The aggregate demand (AD) curve implies that if:

inflation rises, then output will fall

A negative aggregate supply shock causes the LRAS curve to shift to the _____.

left

An exogenous decrease in spending will decrease short-run equilibrium output at all inflation levels. As a result, the AD curve shifts to the _____.

left

The aggregate demand curve will shift to the ______ when there is a reduction in government purchases.

left

In the short run, a negative demand shock will cause the AD curve to shift to the _____ leading to a _______ gap.

left; recessionary

An decrease in aggregate demand is represented by a

leftward shift in the AD curve.

When the AD curve, the SRAS line, and the LRAS line all intersect at the same place, it is called _____-run equilibrium

long

People expect inflation to be _____ if it has been low for an extended period of time

low

If the Fed is concerned that the current level of output is too far below actual output, then it may _____ the real interest rate so that the aggregate demand (AD) curve shifts to the _____.

lower; right

If the Fed wants to increase its target rate of inflation, it can _____ the real interest rate so that aggregate demand will _____.

lower; rise

In the AD-AS model, when inflation falls, the Fed responds by _____ real interest rates, leading output to _____.

lowering; rise

A _____ policy rule describes how a central bank, like the Fed, takes action in response to changes in the state of the economy.

monetary

Actual output minus potential output is called the ____ gap.

output

In the AD-AS model:

output gaps will not last indefinitely, but will be closed by rising or falling inflation.

During an economic expansion, if the Fed believes that actual output is too high relative to potential output, the Fed might _____ the real interest rate so that the aggregate demand (AD) curve shifts to the _____.

raise; left

If the Fed wants to lower its target rate of inflation, it should _____ the real interest rate so that the aggregate demand (AD) curve shifts to the _____.

raise; left

A(n) _____ gap exists when actual output is less than potential output.

recessionary

In the AD-AS model, _____ gaps will not persist in the long run because the AS curve will shift down due to the fall in expected future inflation, thereby eliminating the output gap.

recessionary

A positive aggregate supply shock causes the LRAS curve to shift to the ____.

right

An exogenous increase in spending will increase short-run equilibrium output at all inflation levels. As a result, the AD curve shifts to the ______.

right

An increase in government purchases will shift the aggregate demand curve to the ______.

right

In the short run, a positive demand shock will cause the AD curve to shift to the _____ leading actual output to _______ potential output.

right; rise above

An increase in aggregate demand is represented by a

rightward shift in the AD curve.

All else equal, consumption and investment will fall when the real interest rate _____.

rises

Graphically, the SRAS line _____ (one word) in the presence of an expansionary gap.

rises

A change in aggregate demand is represented by a

shift of the AD curve.

When there are sharp changes in potential output and inflation, it is called an aggregate supply _____.

shock

Relative to other economic variables such as stock prices or commodity prices, inflation tends to be relatively _____ over time.

stable

In the absence of external shocks, inflation

tends to be relatively stable over time.

A rule that describes how _____ takes action in response to changes in the state of the economy is known as a monetary policy rule.

the central bank

When the difference between actual output and potential output is zero:

the inflation rate is constant

The difference between actual output and potential output is called, in general,

the output gap

At high levels of inflation,

the purchasing power of money decreases.

Long-term contracts, such as union wage contracts, contribute to:

the slow adjustment of inflation

In the long run, recessionary gaps are not expected to persist in the AD-AS model because the AS curve will shift _____ as expected future inflation _____.

to the right; falls

On the AD-AS diagram short-run equilibrium occurs:

where AD intersects SRAS

On the AD-AS diagram, long-run equilibrium occurs:

where AD, SRAS, and LRAS all intersect

Inflation expectations and long-term wage and price contracts help explain

why inflation adjusts relatively slowly in modern economies.

If the output gap is ______, then the rate of inflation tends to remain constant

zero