Aggregate Demand and Aggregate Supply

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For my awesome girlfriend, Caroline!!!

During recessions...

Workers are laid off / Factories are idle / Firms may find they unable to sell all they produce

Which of the following effects helps to explain the downward slope of the aggregate demand curve?

The exchange-rate effect / The wealth effect / The interest-rate effect

Other things the same, if the price level rises, people...

Decrease foreign bond purchases, so the supply of dollars in the market for foreign currency exchange decreases

The aggregate quantity of goods and service demanded changes as the price level falls because...

Real wealth rises, interest rates fall, and the dollar depreciates

In the context of aggregate demand and aggregate supply, the wealth effect refers to the idea that, when the price level decreases, the real wealth of households

Increases and as a result consumption spending increases. This effect contributes to the
downward slope of the aggregate-demand curve.

The initial impact of an increase in an investment tax credit is to shift

aggregate demand right

When the money supply decreases

interest rates rise and so aggregate demand shifts left.

The sticky-wage theory of the short-run aggregate supply curve says that the quantity of output firms supply will increase if

the price level is higher than expected making production more profitable.

The sticky-price theory of the short-run aggregate supply curve says that when the price level is higher than expected, some firms will have

higher than desired prices which leads to an increase in the aggregate quantity of goods
and services supplied.

The sticky-price theory of the short-run aggregate supply curve says that when the price level is higher than expected, some firms will have

increases by more than expected so that firms believe the relative price of their output
has increased.

When the actual change in the price level differs from its expected change, which of the following can explain why firms might change their production?

both menu costs and mistaking a price level change for a change in relative prices

An increase in the expected price level shifts short-run aggregate supply to the

left, and an increase in the actual price level does not shift short-run aggregate supply.

An economic contraction caused by a shift in aggregate demand remedies itself over time as the expected price level

falls, shifting aggregate supply right.

An increase in the money supply would move the economy from C to

B in the short run and A in the long run. SEE GRAPH

If the economy is at A and there is a fall in aggregate demand, in the
short run the economy

moves to D. SEE GRAPH

If the economy starts at A and there is a fall in aggregate demand, the
economy moves

to C in the long run. SEE GRAPH

What, if anything, did policymakers do in response to the recession of 2001?

tax cuts and expansionary monetary policy

Shifts in the aggregate-demand curve can cause fluctuations in

the level of output and in the level of prices.

Liquidity preference theory is most relevant to the

short run and supposes that the interest rate adjusts to bring money supply and money
demand into balance.

According to liquidity preference theory, the slope of the money demand curve is explained as follows:

People will want to hold more money as the cost of holding it falls.

What is measured along the horizontal axis of the left-hand graph?

the quantity of money SEE GRAPH

What does Y represent on the horizontal axis of the right-hand graph?

real output SEE GRAPH

Which of the following quantities is held constant as we move from one point to another on either graph?

the expected rate of inflation SEE GRAPH

A decrease in Y from Y1 to Y2 is explained as follows:

An increase in P from P1 to P2 causes the money-demand curve to shift from MD1 to
MD2; this shift of MD causes r to increase from r1 to r2; and this increase in r causes Y
to decrease from Y1 to Y2. SEE GRAPH

As we move from one point to another along the money-demand
curve MD1,

the price level is held fixed at P1. SEE GRAPH

If the money-supply curve MS on the left-hand graph were to shift to the right, this would

represent an action taken by the Federal Reserve. SEE GRAPH

Assume the money market is always in equilibrium. Under the assumptions of the model,

the real interest rate is higher at Y2 than it is at Y1. / the quantity of money is the same at Y1 as it is at Y2. / the price level is higher at r2 than it is at r1.

Which of the following statements is correct?

Liquidity preference theory assumes the interest rate adjusts to bring the money market into equilibrium; classical theory assumes the price level adjusts to bring the money market into equilibrium.

Which of the following statements is correct for the long run?

Output is determined by the amount of capital, labor, and technology; the interest rate
adjusts to balance the supply and demand for loanable funds; the price level adjusts to
balance the supply and demand for money.

slope of the aggregate-demand curve?

As the price level increases, the interest rate rises, so spending falls.

If the stock market booms, then

aggregate demand increases, which the Fed could offset by decreasing the money
supply.

The multiplier for changes in government spending is calculated as

1/(1 - MPC).

Assuming a multiplier effect, but no crowding-out or investment-accelerator effects, a $100 billion increase in government expenditures shifts aggregate

demand rightward by more than $100 billion.

The price of imported oil rises. If the government wanted to stabilize output, which of the following could it do?

increase government expenditures or increase the money supply

Which of the following policy alternatives would be an appropriate response to a sharp increase in investment spending, assuming policymakers want to stabilize output?

increase taxes

Critics of stabilization policy argue that

there is a lag between the time policy is passed and the time policy has an impact on the
economy. / the impact of policy may last longer than the problem it was designed to offset. / policy can be a source of, instead of a cure for, economic fluctuations.

In the long run inflation

is primarily determined by the rate of money supply growth while unemployment is
primarily determined by labor market factors.

The short-run relationship between inflation and unemployment is often called

the Phillips curve

According to the Phillips curve, policymakers would reduce inflation but raise unemployment if they

decreased the money supply.

If policymakers decrease aggregate demand, then in the short run the price level

falls and unemployment rises.

If the central bank decreases the money supply, then in the short run prices

fall and unemployment rises

Starting from C and 3, in the short run an unexpected increase in money supply growth moves the economy to

D and 4 SEE GRAPH

Starting from C and 3, in the short run, an unexpected decrease in money supply growth moves the economy to

B and 2 SEE GRAPH

Starting from C and 3, in the long run, an increase in money supply growth moves the economy to

F and 5 SEE GRAPH

Starting from C and 3, in the long run, a decrease in money supply growth moves the economy to

A and 1 SEE GRAPH

The economy would move from 3 to 5

in the long run if money supply growth increases. SEE GRAPH

The economy would move from C to B

in the short run if money supply growth decreased unexpectedly. SEE GRAPH

Which of the following results in higher inflation and higher unemployment in the short run?

an adverse supply shock such as an increase in the price of oil

Disinflation is defined as a

reduction in the rate of inflation

Proponents of rational expectations argued that the sacrifice ratio

could be low because people might adjust their expectations quickly if they found anti-
inflation policy credible.

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