Macroecon Exercise 8

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Macroeconomics Chapter 32 Exercise 8 1. Which of the following will shift the aggregate supply curve to the right? A new networking technology increases productivity all over the economy, Business taxes fall. 2. Answer the following: a. According to the “real-balances effect,” if prices. decline, the purchasing power of assets will rise, so spending at each income level should rise. b. According to the “wealth effect,” a change in consumer wealth causes a shift in consumer spending and a shift of the aggregate demand curve. c. Which of the following statements is true concerning the real-balances effect and the wealth effect? The real-balances effect explains the shape of the aggregate demand curve, whereas the wealth effect causes shifts of the aggregate demand curve. 3. An upsloping aggregate supply curve weakens the realized multiplier effect because any increase in demand will have both a price and an output effect. 4. Suppose that the table presented below shows an economy’s relationship between real output and the inputs needed to produce that output: a. What is the level of productivity in this economy? Productivity = output input = 400 75 = ¿ 5.33 b. What is the per-unit cost of production if the price of each input unit is $5? I nputs perunit of output = total inputs total outputs = 75 400 = 0.1875 P er Unit cost of Production = inputs per unitof output × priceof output = 0.1875 × 5 = 0.9375 c. Assume that the input price increases from $5 to $6 with no accompanying change in productivity. What is the new per-unit cost of production? P er Unit cost of Production = inputs per unitof output × priceof output = 0.1875 × 6 = 1.125 In what direction would the $1 increase in input price push the economy’s aggregate supply curve? To the left What effect would this shift of aggregate supply have on the price level and the level of real output? The price level would increase, and real output would decrease. d. Suppose that the increase in input price does not occur but, instead, that productivity increases by 25 percent. What would be the new per-unit cost of production? 5.33 × 0.25 = 1.33255.33 + 1.3325 = 6.6658 input = output prductivity = 1 6.67 = 0.1499 P er Unit cost of Production = inputs per unitof output × priceof output = 0.1499 × 5 = 0.7495 What effect would this change in per-unit production cost have on the economy’s aggregate supply curve? It would cause the aggregate supply curve to shift right What effect would this shift of aggregate supply have on the price level and the level of real output? The price level would decrease, and real output would increase. 5. Answer the following: a. The U.S. experience of strong economic growth, full employment, and price stability in the late 1990s and early 2000s can be explained by a rightward shift of aggregate demand and a rightward shift of aggregate supply. b. A strong negative wealth effect from, say, a precipitous drop in house prices could cause a recession even though productivity is surging if aggregate demand shifts left while aggregate supply shifts right. 6. The diagram below represents the aggregate demand and aggregate supply of the United States in equilibrium. Suppose a severe, widespread drought in the Midwest causes a poor grain crop. a. Using the AD–AS model below, graphically show the impact of the drought on aggregate demand or aggregate supply. Assume no other changes in the economy. b. The phenomenon depicted in the diagram is known as cost-push inflation Input Quantity Real GDP 75 400 56.25 300 37.5 200

c. The phenomenon causes real domestic output to decrease and the price level to increase. 7. If the price of oil suddenly increases by a large amount, AS will shift left, but the price level will not rise thanks to price inflexibility. FALSE 8. “Unemployment can be caused by a decrease of aggregate demand or a decrease of aggregate supply.” True, but the magnitude of the effect on unemployment depends on the economic situation. 9. At the current price level, producers supply $375 billion of final goods and services while consumers purchase $355 billion of final goods and services. The price level is: above equilibrium. 10. What effects would each of the following have on aggregate demand or aggregate supply, other things equal? a. A widespread fear by consumers of an impending economic depression. Aggregate demand will decrease b. A new national tax on producers based on the value added between the costs of the inputs and the revenue received from their output. Aggregate supply will decrease c. A reduction in interest rates. Aggregate demand will increase d. A major increase in spending for health care by the federal government. Aggregate demand will increase e. The general expectation of coming rapid inflation. Aggregate demand will increase f. The complete disintegration of OPEC, causing oil prices to fall by one-half. Aggregate supply will increase g. A 10 percent across-the-board reduction in personal income tax rates. Aggregate demand will increase h. A sizable increase in labor productivity (with no change in nominal wages). Aggregate supply will increase i. A 12 percent increase in nominal wages (with no change in productivity). Aggregate supply will decrease j. An increase in exports that exceeds an increase in imports (not due to tariffs). Aggregate demand will increase 11. Suppose that the aggregate demand and aggregate supply schedules for a hypothetical economy are as shown in the following table. Amount of Real GDP demanded, Billions Price Level (Price Index) Amount of Real GDP Supplied, Billions $100 300 $450 $200 250 $400 $300 200 $300 $400 150 $200 $500 100 $100 a. Use the data above to graph the aggregate demand and aggregate supply curves. What are the equilibrium price level and the equilibrium level of real output in this hypothetical economy? Equilibrium Price Level = 200 Equilibrium Level of Real Output = $300 billion Is the equilibrium real output also necessarily the full-employment real output? No. b. If the price level in this economy is 150, will quantity demanded equal, exceed, or fall short of quantity supplied? Exceed By what amount? $200 billion If the price level is 250, will quantity demanded equal, exceed, or fall short of quantity supplied? Fall Short By what amount? $200 billion c. Suppose that buyers desire to purchase $200 billion of extra real output at each price level. What are the new equilibrium price level and level of real output? (only add to GDP demanded)

Equilibrium Price level = 250 Equilibrium Level of Real Output = $400 billion 12. Assume that ( a ) the price level is flexible upward but not downward and ( b ) the economy is currently operating at its full- employment output. Other things equal, how will each of the following affect the equilibrium price level and equilibrium level of real output in the short run? a. An increase in aggregate demand. The price level rises rapidly and there is little change in real output. b. A decrease in aggregate supply, with no change in aggregate demand. Price level rises and real output decreases. c. Equal increases in aggregate demand and aggregate supply. The price level does not change, but real output increases. d. A decrease in aggregate demand. The price level does not change, but real output declines. e. An increase in aggregate demand that exceeds an increase in aggregate supply. The price level increases somewhat, with a relatively large change in output. 13. Which of the following will shift the aggregate demand curve to the left? Interest rates rise, The government raises corporate profit taxes. 14. Answer the following questions on the basis of the following three sets of data for the country of North Vaudeville: (A) (B) (C) Price Level Real GDP Price Level Real GDP Price Level Real GDP 110 235 110 285 100 210 100 235 100 260 100 235 95 235 95 235 100 260 90 235 90 210 100 285 a. Which set of data illustrates aggregate supply in the immediate short run in North Vaudeville? The data in C The Short Run? The Data in B The Long Run? The data in A b. Assuming no change in hours of work, if real output per hour of work decreases by 5 percent, what will be the new levels of real GDP in the right column of B? At a price level of 110: 285 ( 1 - 0.05) = 270.75 At a price level of 100: 260 (1 – 0.05) = 247.0 At a price level of 95: 235 (1 – 0.05) = 223.25 At a price level of 90: 210 (1 – 0.05) = 199.5 Does the new data reflect an increase in aggregate supply, or does it indicate a decrease in aggregate supply? Decrease in aggregate supply. 15. Suppose that consumer spending initially rises by $5 billion for every 1 percent rise in household wealth and that investment spending initially rises by $20 billion for every 1 percentage point fall in the real interest rate. Also assume that the economy’s multiplier is 3. a. If household wealth falls by 4 percent because of declining house values, and the real interest rate falls by 3 percentage points, in what direction and by how much will the aggregate demand curve initially shift at each price level? 16. The diagram below depicts an economy that is initially in equilibrium. Suppose that the central bank causes real interest rates in the economy to increase. Using the diagram provided, graphically show the effects of this action on the short-run equilibrium. a. Short-run equilibrium quantity will decrease b. Short-run equilibrium price level will decrease 17. Use AD-AS analysis to explain the impacts of the following events on real GDP. a. In early 2001 investment spending sharply declined in the United States. This caused a

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leftward shift in aggregate demand, and lower investment would have caused a leftward shift in aggregate supply. b. In the two months following the September 11, 2001, attacks on the United States, consumption also declined. This caused a leftward shift in aggregate demand, and lower investment would have caused a leftward shift in aggregate supply. 18. Decreases in AD normally lead to decreases in both output and the price level. FALSE 19. Answer the following: a. The long-run aggregate supply curve is vertical because the economy’s potential output is determined by the availability and productivity of real resources, not by the price level. b. The shape of the short-run aggregate supply curve is upsloping, because wages adjust more slowly than the price level. c. The short-run aggregate supply curve is relatively flat to the left of the full-employment output because there are large amounts of unused capacity and idle human resources. 20. Match the following descriptions with the correct aggregate supply curve. a. Immediate short run The price level is fixed. A horizontal line. b. Short run Output prices are flexible, but input prices are fixed. An upsloping curve. c. Long run A vertical line. Output is fixed. 21. Answer the following: a. A reduction in short-run aggregate demand in the actual economy reduces real output, rather than the price level, because Prices are inflexible downward. b. A full-strength multiplier applies to a decrease in aggregate demand when aggregate supply is horizontal. 22. Answer the following questions: a. The downsloping aggregate demand curve can be explained by the interest-rate effect, the real-balances effect, and the foreign purchases effect. b. The explanation for a downsloping aggregate demand curve differs from the explanation for the downsloping demand curve for a single product because a downsloping, single-product demand curve assumes constant money income such that a lower price causes a substitution of the now relatively cheaper product for those whose prices have not changed. c. The multiplier causes an initial change in spending to generate an even larger change in the aggregate demand curve.