Aggregate demand and aggregate supply answers to even-numbered online review questions

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Chapter 26

Chapter 26



2. False. Fiscal policy (which involves changing the level of government purchases or taxes) will shift the AD curve; however, changes in these variables in order to achieve other government goals, or changes in autonomous consumption spending, investment spending, net exports, or the money supply will also shift the AD curve.

4. The short-run aggregate supply curve depicts the idea that changes in real GDP cause changes in the price level. It slopes upward because a rise in GDP increases unit costs, thereby increasing the price level, and a fall in GDP decreases unit costs, consequently depressing the price level.
6. The economy’s self-correcting mechanism is the long-run adjustment process whereby the economy returns to full employment after a demand shock. When a demand shock pushes the economy away from full-employment, changes in the wage rate and the price level return the economy to full-employment. For instance, consider a negative demand shock that decreases GDP. Assuming that initially the economy operated at full-employment GDP, a decrease in GDP will cause wages to fall due to high unemployment. As wages fall, unit costs decrease and the price level decreases causing GDP to rise. When the economy returns to full-employment output, this process stops.

8. Since the long-run aggregate supply curve is vertical, fiscal policy has no effect on GDP in the long run. It can only affect the price level. This is consistent with the classical view of fiscal policy. The vertical long-run AS curve also supports the classical view of crowding out. Beginning at full-employment output, a rise in government purchases will have no effect on GDP. Therefore, private sector spending must fall by as much as government purchases increase. That is, complete crowding out occurs, just as the classical model predicts.

10. Real GDP growth did not keep up with productivity in 2002 for two reasons. First, real GDP growth was unusually low because business investment had fallen (perhaps due to continuing global uncertainty after September 11, 2001, and because, due to high levels of investment during the 1990s, firms had caught up with the amount of capital they desired). Second, productivity growth did not slow down because firms were able to adjust their workforce more easily to fluctuations in production due to a greater reliance on part-time and temporary workers.

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