Chapter 11

The Federal Reserve's policy to ________ means that the Fed decreases the interest rate when output is low. A. "be dust in the wind" B. "stand upwind" C. "inherit the wind" D. "lean against the wind"

"lean against the wind"

Refer to figure 11.1 this economy reaches capacity at A) $500 billion. B) $1,000 billion. C) $1,500 billion. D) an output level that is indeterminate from this information because aggregate demand is not given.

$1,500 billion.

What are two additional reasons why the AD curve may slope down?

1. In addition to the planned investment, consumption spending also falls as the interest rate rises 2. The real wealth effect is the change in consumption brought about by a change in real wealth and results from a change in the price level

What is cost shock, or supply shock?

A change in costs that shifts the short-run aggregate supply (As) curve

r↓➝I↑➝AE↑➝Y↑

A fall in interest rates implies an increase in investment, which leads to an increase in planned aggregate expenditure resulting in an increase in aggregate output

What is the aggregate supply (AS) Curve?

A graph that shows the relationship between the aggregate quantity of output supplied by all firms in an economy and the overall price level

r↑→I↓→AE↓→Y↓

A rise in interest rates implies a decrease in investment, which leads to a decrease in planned aggregate expenditure resulting in an increase in aggregate output

What implies that the economy is operating at 100 percent capacity?

A vertical short-run AS curve. This is not sustainable in the long run since plants need some downtime for preventive maintenance

A real wealth effect on consumption also contributes to downward-sloping of what?

AD curve

When there are higher interest rates what does this cause aggregate output to do?

Aggregate output falls when there are higher interest rates

The quantity of output supplied at different price levels is represented by the A. Aggregate expenditures curve B. production function C. aggregate demand curve D. aggregate supply curve

Aggregate supply curve

A rightward shift in the aggregate demand curve can be caused by A) a decrease in taxes. B) an increase in government spending. C) an increase in net exports. D) All of the above

All of the above

Which of the following will, unambiguously, increase the price level? A. an increase in government spending and a decrease in costs B. a decrease in government spending and a decrease in costs C. an increase in government spending and an increase in costs D. a decrease in government spending and an increase in costs

An increase in government spending and an increase in costs

What happens to the demand for money, interest rate and aggregate expenditure when the price level is increase

An increase in the price level causes the demand for money to rise, increasing rate and decreasing aggregate expenditure

Where is the equilibrium on the IS curve?

Any point on the IS curve is an equilibrium in the goods market for the given interest rate

What variables are at equilibrium?

At equilibrium, values of other endogenous variables (r, C,I) are determined

What happens to the planned aggregate expenditure (AE) when their is an increase in interest rate?

At every level of income falls

What levels of the aggregate output is the curve fairly flat?

At low levels

when would the short run AS curve be flatter?

At low levels of output

The Ad curve is not a market demand curve, and it is not the sum of ll market demand curves in the economy why?

Because many prices rise together when the overall price level rises, we cannot use the ceteris paribus assumption to draw the AD curve

Why does the AD curve slope down?

Because the Fed raises the interest rate(r) when P increases and because I depends negatively on r

AD falls when P increases why?

Because the higher P leads the Fed to raise r, which decreases I and thus Y

Why does the vertical portion of the short-run AS curve exist?

Because there are physical limits to the amount that an economy can produce in any given time period

That change in ____ brought about by a change in real wealth that results from a change in the ____ is the real wealth effect. A) The money supply; money demand B) taxes; interest rate C) aggregate output; level of investment D) consumption; price level

Consumption; price level

Refer to figure 11.6 suppose the equilibrium output is initially $600 billion. An oil embargo would probably. A) decrease the equilibrium output and increase the price level. B) increase both the equilibrium output and the price level. C) increase the equilibrium output and decrease the price level. D) decrease both the equilibrium output and the price level.

Decrease the equilibrium output and increase the price level

Where can you find the equilibrium point on the AD curve?

Each point on the Ad curve is an equilibrium point

At every point along the aggregate demand curve, the level of aggregate output demanded is A) Less than planned aggregate expenditure. B) equal to planned aggregate expenditure. C) unrelated to the concept of planned aggregate expenditure. D) greater than planned aggregate expenditure.

Equal to planned aggregate expenditure

What is the Fed rule?

Equation that shows how the Fed's interest rate decision depends on the state of the economy

Refer to figure 11.1 At aggregate output levels below $500 billion, this economy is most likely experiencing A) excess capacity. B) rapid increases in the growth rate of the money supply. C) a boom. D) excess demand.

Excess capacity

What is Y0 sometimes called?

GDP

what determines the slope of the aggregate supply curve is A) how much more the economy can produce without any change in the price level. B) how fast the output level changes after a technological advance. C) how fast the price of factors of production respond to changes in the price level. D) None of the above

How fast the price of factors of production respond to changes in the price level

What is the relationship between output and the interest rate in the goods market (IS)?

In the goods market, there is a negative relationship between output and interest rate because planned investment depends negatively on the interest rate.

Refer to Figure 11.6. Suppose the equilibrium price level is 110. An increase in the supply of oil would probably A. increase both the equilibrium output and the price level. B. decrease the equilibrium output and increase the price level. C. decrease both the equilibrium output and the price level. D. increase the equilibrium output and decrease the price level.

Increase the equilibrium output and decrease the price level

What happens to demand, output and price level if there are low levels of capacity utilization?

Increases in demand result in increases in output with little impact on the price level.

Refer to Figure 11.7. Which of the following statements characterizes an output level of $800 billion? A. It is attainable in the short run but it is associated with increases in the price level. B. It is sustainable over the long run without inflation. C. It can be achieved only if investment is independent of the interest rate. D. It is achievable only in the long run.

It is attainable in the short run but it is associated with increases in the price level

What happens when there is an increase in G?

It shifts IS and AD to the right. An increase in Z shifts the Fed rule curve and the Ad curve to the left.

What happens to equilibrium output (income) (Y) when AE decreases?

Lowers equilibrium output (income) (Y) by a multiple of the initial decrease in I

What is the effect of the planned aggregate expenditure and the equilibrium output when we increase the interest rate from 3% to 6%

Lowers planned aggregate expenditure and reduces equilibrium output

What happens to planned investment and output when P increases, and the Fed raises the interest rate?

Negative effect

What relationship does the AD curve reflect ?

Negative relationship between P and Y

What are the two main inputs into the Fed;s interest rate decision?

Output (Y) and inflation(P)

What happens to output in the AS long-run curve if wages fully adjust?

Output will be back to Y0

since planned investment (I) is an inverse function of the interest rate

Planned aggregate expenditure (AE) must also be an inverse function of the interest rate

Why does output fall as the interest rate increases along the IS curve?

Planned investment depends negatively on the interest rate

In the short run does the aggregate supply curve (the price/output response curve) have a positive or negative slope?

Positive

In the short run, the aggregate supply curve (the price/output response curve) have a positive or negative slope?

Positive

An increase in government spending (G) with the interest rate fixed increases output (Y) would shift the IS curve which way?

Shift the IS curve to the right

Wages respond in the longer run by

Shifting the AS curve from AS0 to AS1

Since the As curve is flatter at low levels what happens to the price levels?

Small price increases may be associated with relatively large output responses

What is the aggregate supply curve better thought of as?

The "price/output response" curve

How is the Ad curve derived?

The AD curve is derived from the model of goods market and from the behavior of the Fed

What happens to the AS curve if there are any "sticky prices"?

The AS curve may slope upward

What is the IS curve?

The IS curve is the relationship between aggregate output and the interest rate in the goods market

Where are the intersection of the As and Ad curves determined?

The aggregate output and the aggregate price level are determined by the intersection of the AS and AD curves

It is very important to distinguish between the short run and the long run when we are discussing A) the aggregate supply. B) the aggregate demand. C) the aggregate expenditures. D) changes in the price level

The aggregate supply

The aggregate supply (AS) Curve: Define the aggregate supply curve and discuss shifts in the short-run AS curve

The aggregate supply curve is a graph that describes the total output of all sellers in an economy. Also the Aggregate supply curve sometimes is referred to as the "price/output price curve".

What is the real wealth effect?

The change in consumption brought about by a change in real wealth that results from a change in the price level

What happens to the AS curve when the economy approaches capacity?

The curve becomes nearly vertical

what happens to the short run aggregate supply curve when the capacity approaches?

The curve becomes nearly vertical

What happens to the equilibrium when the AD long-run curve shifts from AD0 to AD1

The equilibrium price level initially rises from P0 to p1 and output rises from Y0 to Y1

What will happen mto the GDP if the economy is in a short-run equilibrium below potential GDP?

The level of GDP may eventually rise.

What is potential output, or potential GDP?

The level of aggregate output that can be sustained in the long run without inflation

in the fed rule what happens to the output when the fed raises the interest rate?

The output increases, other things being equal

What happens when the interest rate rises to the planned investment?

The planned investment falls shifting the AE curve down. This causes equilibrium income to fall

The aggregate demand curve slopes downward because at a higher price level A) the purchasing power of consumers' assets increases and consumption increases. B) the purchasing power of consumers' assets declines and consumption increases. C) producers can get more for what they produce, and they increase production. D) the purchasing power of consumers' assets declines and consumption decreases

The purchasing power of consumers' assets declines and consumption decreases

What is aggregate supply?

The total supply of all goods and services in an economy

Where is the economy's maximum (capacity) output located on the short-run As curve?

The vertical part

Why would the short run aggregate supply curve have an upward slope?

The wages are a large fraction of total costs, and wage changes lag behind price changes.The short-run aggregate supply curve slopes upward. When an economy is in a deep recession, the short-run aggregate supply may be fairly flat. The deeper the economy sinks into recession, the flatter the short-run AS curve (usually). AS becomes steeper at higher levels of output. As the economy approaches full employment, increases in aggregate demand cause smaller increases in output and larger increases in price level

What would happen to the short-run aggregate supply curve slope if all prices including input prices changed at the same rate?

There would not be any output response making it a vertical

Technological process and increases in the size of the labor force both shift the AS curve.

This can be the result of increases in the supply labor, the stock of capital, labor quality (human capital), or technological improvements.

The higher the bonds the lower the interest rate or the yield

This is because the bonds and interest rate have an inverse relationship

The interest rate rises and equilibrium output falls.

Thus as P rises equilibrium Y falls. This is the basis for the downward-sloping AD curve.

An increase in G shifts the IS curve where?

To the right. For the interest rate is assumed to remain constant

Why does the aggregate supply (AS) curve have an upward slope?

Wages are a large fraction of total costs, and wage changes lag behind price changes. This gives us an upward-sloping short-run AS curve

What happens when the economy approached 100 percent capacity?

Wages begin to rise faster, causing the short-run AS curve to shift upward and moving the equilibrium back toward potential GDP

The aggregate demand curve slopes downward because of ______ A) wealth effect, interest rate effect, foreign exchange rate effect. B) public sector effect, marginal tax rate effect, foreign exchange rate effect. C) marginal tax rate effect, wealth effect, depreciation rate effect. D) foreign exchange rate effect, public sector borrowing rate effect, economic growth rate effect

Wealth effect, interest rate effect, foreign exchange rate effect

The aggregate demand (AD) Curve: Derive the aggregate demand curve

When we derive the supply curve for a firm we assumed per unit production costs were constant in the short run. Firms set prices instead of simply responding to them. In other words, we are assuming imperfect competiton for most firms in the economy. And since firms in imperfect competition have no supply curves, we cannot simply add the firms' individual supply curves to get a market supply curve- there is nothing to add

what happens when a change in the price level raises the real value of money and makes consumers wealthier?

Which in turn encourages them to spend more

what is the affect on government spending (G), AE and Y in equilibrium with the interest rate fixed?

With the interest rate foxed, an increase in government spending (G) increases AE and thus Y in equilibrium

Can the economy be in a short-run equilibrium below potential GDP?

Yes(Equilibrium simply means planned spending equals actual output. That may or may not happen at potential GDP.)

At the intersection of two curves, what can you find?

You can find the equilibrium values of output and the interest rate for given values of government spending (G), the price level (P) and the factors in Z

What is the Price/output response curve?

a curve that traces out the price decisions and output decisions of all firms in the economy under different levels of aggregate demand

The aggregate demand curve shows that, ceteris paribus, A. at higher price levels, total quantity of output supplied is lower. B. at higher price levels, total quantity of output demanded is higher. C. at lower price levels, total quantity of output demanded is higher. D. at lower price levels, total quantity of output supplied is lower.

at lower price levels, total quantity of output demanded is higher

To decrease output the government could adopt policies that A. Increase aggregate supply and decrease aggregate demand. B. decrease aggregate supply and increase aggregate demand. C. increase aggregate supply and aggregate demand. D. decrease aggregate supply and aggregate demand.

decrease aggregate supply and aggregate demand

What happens to planned investment (I) when a high interest rate(r)

discourages planned investment (I)

Refer to Figure 11.6. Suppose the equilibrium output is initially $600 billion. A decrease in wages and an increase in government spending will, for sure, increase A. the price level. B. equilibrium output. C. both the equilibrium output and the price level. D. equilibrium output and decrease the price level.

equilibrium output

Refer to Figure 11.7. Potential output A. Is $400 million. B. is $700 million. C. is $800 million. D. cannot be determined from this information because aggregate demand is not given.

is $700 million

What is potential GDP?

is the level of aggregate output that can be sustained in the long run without inflation

The level of aggregate output demanded falls when the price level rises, because the resulting increase in the interest rate will lead to A) Lower investment spending and higher consumption spending B) higher investment spending and lower consumption spending. C) lower investment spending and lower consumption spending. D) higher investment spending and higher consumption spending

lower investment spending and lower consumption spending

The aggregate demand curve shows a ____ relationship between ____ and aggregate output ____. A) negative; the price level; demanded B) positive; the interest rate; demanded C) positive; the price level; demanded D) negative; the price level; supplied

negative; the price level; demanded

What is the Fed rule equation?

r=aY + BP+ yZ

Which of the following sequence of events follows an open market purchase by FED? A) r↓⇒ I↑⇒ AE↑⇒ Y↑ B) r↑⇒ I↑⇒ AE↓⇒ Y↑ C) r↑⇒ I↓⇒ AE↓⇒ Y↓ D) r↓⇒ I↓⇒ AE↓⇒ Y↓

r↓⇒ I↑⇒ AE↑⇒ Y↑

If the economy is operating on the relatively flat segment of the aggregate supply curve, an increase in aggregate demand causes a _____ change in the price level and a ____ change in output. A) big; big B) small; big C) small; small D) big; small

small; big

Other things equal, an increase in government spending shifts A. the AD curve to the right. B. the AD curve to the left. C. the AS curve to the right. D. the AS curve to the left.

the AD curve to the left

Where does the Potential GDP lie?

the Potential GDP lies to the left of the level of output at which the short-run AS curve become vertical.

Refer to figure 11.6 suppose the equilibrium price level is 110. An increase in wages and an increase in government spending will, for sure A) Increase the price level. B) both the equilibrium output and the price level. C) equilibrium output and decrease the price level. D) equilibrium output.

the price level

Economists who believe the AS curve is vertical in the long run believe that output

will tend to rise when wages fall with high employment