The short-run keynesian policy model: demand-side policies problem set

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Chapter 09 - The Short-Run Keynesian Policy Model: Demand-Side Policies

NAME: _______________________________________ DATE: ____ / ____ / ____
Give the best answer to each of the following questions.
1. Match each of the following reasons for the aggregate demand’s slope with their correct explanation:

a. money wealth effect ___

1. As domestic prices fall, exports increase and imports decrease.

b. interest rate effect ___

2. As prices fall, people can buy more with the accumulated money that they hold.

c. international effect ___

3. As prices fall, people do not need to hold as much cash, so they deposit cash in banks, making more available to lend.

d. multiplier effect ___

4. Initial increases in expenditures are magnified as the effects of the initial increases circulate through the economy.

2. Given the following, state whether the SAS curve will shift up, down, or not at all:

a. Productivity rises by 2% while wages rise by 3%.
b. Productivity falls by 2% while wages remain constant.
c. Productivity rises by 4% while wages rise by 2%.
3. An economy is currently at point A in the graph below.

a. Is the economy in a recessionary gap or an inflationary gap?

b. How would this economy return to equilibrium if fiscal or monetary policy alone were used? On the graph, label the new equilibrium point that would result from this policy as point B. (Do not draw any new curves.)

c. How would this economy return to equilibrium if no policy action were taken? On the graph, label the new equilibrium point that would result from this policy as point C. (Do not draw any new curves.)

4. State whether the following events would shift the AD curve to the right, to the left, or not at all:

a. Foreign income decreases.
b. The exchange rate value of the dollar falls.
c. Consumers expect lower income in the future.
d. The distribution of income shifts toward wealthier families that purchase more imported goods.
e. Home heating oil prices rise, so people switch to natural gas.
f. The U.S. price level rises as expected.

5. State, in your own words, the paradox of thrift.

6. Describe the short-run and long-run effects on real output and the price level for each the following events. Assume the economy begins at short-run and long-run equilibrium.
a. Import prices suddenly rise.

b. Government institutes a significant reduction in taxes on production.

c. People hold off on spending because they expect prices to fall.

d. Government increases spending.

7. What are two problems with using fiscal policy to address problems in the economy?

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