Chapter 9

When foreigners' preferences for U.S. goods fall: Will price levels increase/ decrease/ ambiguous

Decrease A decrease in exports will cause a decrease in total spending, causing a new equilibrium with less output and lower prices.

When foreigners' preferences for U.S. goods fall: Will real GDP increase/ decrease/ ambiguous

Decrease A decrease in exports will cause a decrease in total spending, causing a new equilibrium with less output and lower prices.

When labor force participation increases: Will price levels increase or decrease

Decrease The increase in the labor force will mean that the economy can produce more at each level of output. Thus, an increase in aggregate supply (a shift to the right of the aggregate supply curve) will mean downward pressure on prices and a rising level of real GDP.

What is aggregate demand?

Demand for all goods and services produced in an economy. (The total amount of spending, measured in constant dollars, at each price level)

An economy is initially in equilibrium. Suppose that the government decides to increase spending . 1. The aggregate demand curve shifts to the right 2. Businesses respond by increasing output 3. Marginal costs begin to rise as production increase 4. Businesses start to increase price 5. Spending on consumption, investment, and net exports decrease as the price level rises 6. A new equilibrium is reached at a higher price and higher level of real GDP

Expliantion: The first item is the initial change to the model: Aggregate demand increases. Each subsequent item should be a direct result of the previous item. At the old price level, desired spending exceeds production so inventories begin to fall. Businesses respond by increasing output but this causes marginal cost to rise so businesses begin to increase prices. As prices rise, spending on consumption, investment, and net exports decreases until a new equilibrium is reached at a higher price level and a higher level of output.

When consumers become optimistic and plan to spend more: Will price levels increase/ decrease/ ambiguous

Increase Given that total spending is now greater than total production, businesses will begin to expand and prices will begin to rise. Eventually, a new equilibrium will be reached at a higher level of real GDP and a higher price level

When government increases spending: Will price levels increase/ decrease/ ambiguous

Increase Given that total spending is now greater than total production, businesses will begin to expand and prices will begin to rise. Eventually, a new equilibrium will be reached at a higher level of real GDP and a higher price level.

When government increases spending: Will real GDP increase/ decrease/ ambiguous

Increase Given that total spending is now greater than total production, businesses will begin to expand and prices will begin to rise. Eventually, a new equilibrium will be reached at a higher level of real GDP and a higher price level.

When labor force participation increases: Will real GDP increase or decrease

Increase The increase in the labor force will mean that the economy can produce more at each level of output. Thus, an increase in aggregate supply (a shift to the right of the aggregate supply curve) will mean downward pressure on prices and a rising level of real GDP.

When consumers become optimistic and plan to spend more: Will real GDP increase/ decrease/ ambiguous

Increases Given that total spending is now greater than total production, businesses will begin to expand and prices will begin to rise. Eventually, a new equilibrium will be reached at a higher level of real GDP and a higher price level.

Categorize each of the following scenarios as likely to cause immediate shifts in AD, AS, or both. 1. Sudden drop in the stock market, reducing household wealth 2. A flood damages factory equipment 3. A wave of consumers and businesses optimism

1. AD as consumers will reduce spending at all price levels. 2. AS as it is now more costly to produce things at any level of output. 3. AD consumers and businesses will increase spending at all price levels.

When consumers become optimistic and plan to spend more: Will aggregate supply change (yes or no)

No

When foreigners' preferences for U.S. goods fall: Will aggregate supply change (yes or no)

No

When government increases spending: Will aggregate supply change (yes or no)

No

When labor force participation increases: Will aggregate demand change (yes or no)

No

When consumers become optimistic and plan to spend more: Will aggregate demand change (yes or no)

Yes An increase in planned consumption spending will cause part of total spending to increase. Thus, aggregate demand will increase. The aggregate demand curve will shift to the right.

When foreigners' preferences for U.S. goods fall: Will aggregate demand change (yes or no)

Yes A decrease in exports will cause a decrease in total spending, causing a new equilibrium with less output and lower prices.

When government increases spending: Will aggregate demand change (yes or no)

Yes An increase in government spending will cause part of total spending to increase. Thus, aggregate demand will increase. The aggregate demand curve will shift to the right.

When labor force participation increases: Will aggregate supply change (yes or no)

Yes The increase in the labor force will mean that the economy can produce more at each level of output. Thus, an increase in aggregate supply (a shift to the right of the aggregate supply curve) will mean downward pressure on prices and a rising level of real GDP.

Assuming we are producing near full capacity, an increase in demand (a shift to the right in AD) will result in which of the following? Select all that apply. a. An increase in real GDP b. An increase in the price level c. A shift in the AS curve d. Movement along the AS curve

a. An increase in real GDP b. An increase in the price level d. Movement along the AS curve Since we are near full capacity, output can still grow somewhat so real GDP rises. As the AD curve shifts to the right, the price level rises since we are on the upward-sloping part of the AS curve. A shift in the AD curve causes a movement along the AS curve.

Which of the following changes would cause a shift in the aggregate demand curve? Select all that apply. a. Increase in investment at each price b. Decrease in productivity at each price c. Increase in consumption at each price

a. Increase in investment at each price c. Increase in consumption at each price A shift in the aggregate demand curve is caused by changes in factors influencing the amount of spending in the economy. Thus, both investment spending and consumption spending will shift the aggregate demand curve. A change in productivity will affect the amount that businesses can produce at each price level. Thus, a decrease in productivity will reduce aggregate supply and shift the aggregate supply curve to the left.

Use the AS AD model to predict how a fall in interest rates is likely to change investment, real GDP, prices, and employment in the short run. a. Increase investment, real GDP, prices, and employment b. Decrease investment, real GDP, prices and employment c. Increase investment and real GDP, but decrease prices and employment d. Decrease investment and real GDP, but increase prices and employment

a. Increase investment, real GDP, prices, and employment A decrease in interest rates decreases the opportunity cost associated with investing, so investment increases. This increase in aggregate demand results in a higher level of real GDP, higher employment, and likely higher prices. The question asks about the short run effects. Thus, it is likely that investment will not have sufficient time to affect aggregate supply.

An increase in the tax on wages will cause which of the following? Select all that apply. a. a decrease in aggregate demand b. an increase in aggregate demand c. a decrease in aggregate supply d. an increase in aggregate supply

a. a decrease in aggregate demand c. a decrease in aggregate supply An increase in the tax on wages will reduce household disposable income and will likely reduce consumption spending. Therefore, aggregate demand would shift left. An increase in the cost of employing labor will increase the cost of producing goods and services. The supply curve shifts to the left if the prices of inputs increase. An increase in the tax on wages also decreases aggregate supply.

A decrease in aggregate supply results in a __________. a. higher GDP deflator and lower real GDP b. higher GDP deflator and higher real GDP c. lower GDP deflator and higher real GDP d. lower GDP deflator and lower real GDP

a. higher GDP deflator and lower real GDP A shift of the AS to the left leads to a lower real GDP. This situation causes spending to exceed production which causes inventories to fall. Firms respond by producing more (partial offset of the lower real GDP), but can only do so at a higher marginal cost of production, leading to increases in prices (the GDP deflator).

Which of the following would cause AD to decrease, that is, shift to the left? a. increase in income taxes b. decrease in income taxes c. optimism about future income d. lower GDP deflator

a. increase in income taxes An increase in income taxes leads to less disposable income for consumers. Therefore, consumers are able to purchase less at any given price level, which causes the AD curve to shift to the left. (b and c are shifts to the right, d is a movement along the curve)

Which of the following changes will eventually cause a shift in the aggregate supply curve? Select all that apply. a. increase in investment b. decrease in productivity c. increase in consumption

a. increase in investment b. decrease in productivity The aggregate supply curve shifts in response to changes that affect the amount of labor, capital, technology, and input prices. A decrease in productivity reduces the amount of goods and services that can be produced at any given price level. An increase in investment spending increases the amount of capital. An increase in consumption will increase spending and cause movement along the aggregate supply curve, but it will not change the capacity to produce.

The long-run effect of an increase in investment spending will be a shift of the aggregate demand curve to the ______________ and ______________ shift of the aggregate supply curve. a. right; rightward b. right; leftward c. left; leftward d. left; rightward e. right; no

a. right; rightward A change in investment spending directly affects aggregate demand through firms buying new equipment. Thus, the aggregate demand will increase and the AD curve will shift to the right. Eventually aggregate supply will also increase as the amount of capital in the economy increases. The aggregate supply curve shifts to the right.

Suppose an increasing number of consumers become worried about job security. This may affect consumption spending and be most likely to subsequently cause which of the following? a. a decrease in employment and perhaps an increase in inflation b. A decrease in employment and perhaps a decrease in inflation c. An increase in employment and perhaps an increase in inflation d. An increase in employment and perhaps a decrease in inflation

b. A decrease in employment and perhaps a decrease in inflation Reduced consumer confidence is likely to decrease consumer spending. A decrease in spending causes a decrease in aggregate demand by shifting the aggregate demand curve to the left and the equilibrium down and to the left. This puts downward pressures on prices and decreases output and employment.

How would we model the effect of a new costly regulation on businesses? a. A shift left of the AD curve b. A shift left of the AS curve c. A shift right of the AD curve d. A shift right of the AS curve

b. A shift left of the AS curve If the new regulation is costly, then the cost of production increases at any level of output or alternatively firms are willing to produce less at any given price level (due to lower profits). This causes the AS curve to shift to the left.

A booming stock market may affect consumption spending and be most likely to cause which of the following? a. A decrease in employment and perhaps an increase in inflation b. An increase in employment and perhaps an increase in inflation c. A decrease in employment and perhaps a decrease in inflation d. An increase in employment and perhaps a decrease in inflation

b. An increase in employment and perhaps an increase in inflation An increase in consumption spending may result from a booming stock market as wealth increases. The increase in aggregate demand will increase output, employment, and put upward pressure on prices.

Which of the following represents movement along the aggregate demand curve? Select all that apply. a. Optimistic consumers decide to spend more. b. As the average price level falls¸ consumers have more financial wealth and decide to increase spending. c. Falling prices decreases the demand for money¸ decreasing interest rates¸ and investment spending rises. d. Businesses increase investment spending. e. Government increases spending. f. People from around the world want to buy more Tesla's as the price level in the U.S. falls.

b. As the average price level falls¸ consumers have more financial wealth and decide to increase spending. c. Falling prices decreases the demand for money¸ decreasing interest rates¸ and investment spending rises. f. People from around the world want to buy more Tesla's as the price level in the U.S. falls. Movement along the curve involves changes in prices while holding all else constant. In A, consumers spend more because they're optimistic, not because the price level fell. This would be a shift in AD. The same basic idea holds for D, and E. B, C, and F are changing prices initially causing an increase or decrease in overall spending.

An increase in Aggregate Demand results in a ____________. (the GDP deflator is a price index) a. higher GDP deflator and lower real GDP b. higher GDP deflator and higher real GDP c. lower GDP deflator and higher real GDP d. lower GDP deflator and lower real GDP

b. higher GDP deflator and higher real GDP As the AD curve shifts to the right, spending exceeds production, inventories fall and firms produce more (higher real GDP), but they can only do so at a higher marginal cost of production, leading to increases in prices (the GDP deflator).

In 2007, the price of houses fell dramatically across the country. As a result, the wealth of most households fell substantially. How would we model the effect of this change in terms of AS/AD? a. Movement along the AD curve to the right b. A shift in the AS curve to the right c. A shift in the AD curve to the left d. A shift in the AD curve to the right

c. A shift in the AD curve to the left While there is a decrease in wealth here, it is caused by a decrease in assets other than money. The wealth effect that moves us along the Aggregate Demand curve talks about money holdings, that is wealth derived from cash and deposits. If the wealth is reduced by changes in the values of other assets, such as real estate or stock holdings, then the AD curve shifts.

How would we model an increase in the amount of capital available in an economy? a. Movement along the AS curve b. Movement along the AD curve to the left c. A shift to the right of the AS curve d. A shift to the left of the AS curve

c. A shift to the right of the AS curve If there is more capital in the economy, firms can produce more at any given price level. This leads to a shift of the AS curve to the right. Looking at the AS-AD model overall, the shift in the AS curve leads to a movement along the AD curve to the right. ​

People tend to like higher incomes and lower prices. What kind of change in our model results in higher incomes and lower prices? a. An increase in AD b. A decrease in AD c. An increase in AS d. A decrease in AS

c. An increase in AS As AS shifts to the right, production exceeds spending, which leads firms to lower prices over time. The shift in the AS to the right typically leads to higher output, which means higher income (since GDP represent both the production and income in the economy).

When US prices rise, exports ______ and imports ______. a. fall; fall b. rise; rise c. fall; rise d. rise, fall

c. fall; rise

As spending increases, there will be upward pressure on the price of inputs. As the marginal cost of production rises, businesses start to increase prices as they attempt to produce more. This scenario best describes _____________. a. movement along the aggregate demand curve b. a shift in aggregate supply c. movement along the aggregate supply curve

c. movement along the aggregate supply curve The key here is that we are talking about input prices and production so we are describing something about aggregate supply. Since the increase in input prices is driven by businesses attempting to produce more in response to increases in spending, we know this is movement along the AS curve.

People really dislike falling income and rising prices. What kind of change in our model will make people really unhappy? a. An increase in AD b. A decrease in AD c. An increase in AS d. A decrease in AS

d. A decrease in AS A shift of the AS to the left leads lowers real GDP, which lowers income. This situation causes spending to exceed production which causes inventories to fall. Firms respond by producing more (partial offset of the lower real GDP), but can only do so at a higher marginal cost of production, leading to increases in prices (the GDP deflator).

A decrease in government spending of $100 billion will cause aggregate quantity demanded at each price level to ______________. a. increase by 100 billion b. decrease by 100 billion c. increase by more than 100 billion d. decrease by more than 100 billion e. no change

d. decrease by more than 100 billion A change in consumption, investment, government spending, or net exports will have a multiplied effect of total spending, which will cause the aggregate demand curve to change by more than the initial change in spending. The multiplied effect occurs because the change in spending affects incomes. The change in income then further affects consumption spending. Total spending will decrease if the initial change is a decrease and increase if the initial change is an increase.

If businesses have excess capacity and will produce more without an increase in prices, the slope of the aggregate supply curve is _________. a. vertical b. steep c. impossible to determine d. flat

d. flat If additional spending results in increased output and no change in price, we move to the right without moving up on a graph with price on the vertical axis and real GDP on the horizontal axis.

In the following sentence, indicate the direction of the change and whether the demand or the supply curve changes. If people in the U.S. develop an increasing taste for Latin American products, the effect is a (rightward/leftward) movement of the U.S. aggregate (demand/supply) curve. a. rightward; demand b. rightward; supply c. leftward; supply d. leftward; demand

d. leftward; demand Increasing tastes for Latin American goods will increase imports. Net exports will fall. Total spending on U.S. goods and services will fall. The aggregate demand curve will shift to the left. There would be a movement along the aggregate supply curve.

A decrease in Aggregate Demand results in a _____________. a. higher GDP deflator and lower real GDP b. higher GDP deflator and higher real GDP c. lower GDP deflator and higher real GDP d. lower GDP deflator and lower real GDP

d. lower GDP deflator and lower real GDP As the AD curve shifts to the left, production exceeds spending, inventories rise, firms produce less (lower real GDP) which lowers the marginal cost of production, leading to decreases in prices (the GDP deflator)

Greece experienced a large drop in total spending. How would we model this change in our model of aggregate supply and aggregate demand? a. with a shift to the right of aggregate supply b. with a shift to the left of the aggregate supply c. with a shift to the right of the aggregate demand d. with a shift to the left of the aggregate demand e. none of the curves have shifted

d. with a shift to the left of the aggregate demand A drop in total spending is a shift to the left of aggregate demand.

The immediate or short-run effect of an increase in government spending on goods and services will be a ______________ movement of the aggregate demand curve and ______________ movement of the aggregate supply curve. a. rightward; rightward b. rightward; leftward c. leftward; leftward d. leftward; rightward e. rightward; no

e. rightward; no Spending (with the exception of investment) in the economy only affects aggregate demand. There is no effect on aggregate supply. An increase in any component of total spending will increase total spending. That is the same as a shift to the right of the aggregate demand curve.