BEC 6 - Macroeconomics 2 - Aggregate Supply & Demand/Equilibrium

Question 1

Give at least three examples of investment spending.

Answer 1

1. Residential construction;
2. Nonresidential construction;
3. Business durable equipment;
4. Business inventory.

Question 2

What is the effect of interest rate on investment spending?

Answer 2

1. Higher interest rates _ lower levels of investment;

2. Lower interest rates _ higher levels of investment.

Question 3

Define “aggregate demand”.

Answer 3

Total spending of individuals, businesses, governmental entities, and net foreign spending on goods and services at different prices at the macroeconomic (economy) level.

Question 4

Define the “consumption function”.

Answer 4

The relationship between consumption spending and disposable income.

Question 5

Define “marginal propensity to consume” and “marginal propensity to save”.

Answer 5

1. MPC = Change in consumption as a result of a change in disposable income (or percent of an additional dollar of disposable income that will be spent).
2. MPS = Change in savings as a result of a change in disposable income (or percent of an additional dollar of disposable income that will be saved).
3. MPC + MPS = 1 (i.e., the change in disposable income).

Question 6

Define “average propensity to consume” and “average propensity to save”.

Answer 6

1. APC = Percent of disposable income spent on consumption goods;
2. APS = Percent of disposable income saved;
3. APC + APS = 1 (i.e., Disposable Income).

Question 7

What are the factors that determine the level of imports?

Answer 7

1. Relative levels of income and wealth;
2. Relative values of currencies;
3. Relative price levels;
4. Import and export restrictions and tariffs;
5. Relative inflationary rates.

Question 8

Define “discretionary fiscal policy”.

Answer 8

Intentional changes by the government in its tax receipts and/or spending to increase or decrease aggregate demand. (e.g., to close a recessionary gap - increase demand;-to close an inflationary gap - reduce demand.)

Question 9

List the significant factors that cause a negatively-sloped demand curve.

Answer 9

1. Interest rate factor;
2. Wealth-level factor;
3. Foreign purchasing power factor.

Question 10

T/F: An increase in government spending (by itself) increases aggregate demand in the economy.

Answer 10

True

Question 11

T/F: The shape of the aggregate supply curve is less certain than the shape of the aggregate demand curve.

Answer 11

True

Question 12

What is the slope of a Classical aggregate supply curve?

Answer 12

It is completely vertical; supply remains unchanged at various price levels.

Question 13

What factors will cause a change in the level of a supply curve?

Answer 13

1. Resource availability;
2. Resource cost;
3. Technological advances.
4. But NOT the Price of the item supplied, which causes a movement along a given Supply Curve.

Question 14

Define “aggregate supply”.

Answer 14

Total output of goods and services at different price levels at the macroeconomic (economy) level.

Question 15

What is the slope of a Conventional aggregate supply curve?

Answer 15

It is a continuously positive slope, with steeper slope beginning at the level of full employment; supply increases with price, but requires proportionately higher prices at full employment.

Question 16

What is the slope of the Keynesian aggregate supply curve?

Answer 16

Kinked.
It is horizontal up to the level of output at full employment, then slopes upward to the right; supply increases with no change in price until the economy is at full employment.

Question 17

An individual receives an income of $3,000 per month, and spends $2,500. An increase in income of $500 per month occurs, and the individual spends $2,800. The individual's marginal propensity to save is 
 A.   0.2 
 B.   0.4 
 C.   0.6 
 D.   0.8

Answer 17

B. The marginal propensity to save is the change in savings divided by the change in income [($700 − $500)/($3,500 − $3,000) = 0.4].

Question 18

What is the effect on aggregate equilibrium of a decrease in aggregate demand (only) when a Conventional supply curve is assumed?

Answer 18

Since the Conventional supply curve has a continuous positive slope, as Aggregate Demand decreases, both supply (quantity) and price will decrease.

Question 19

What is the effect on aggregate equilibrium of an increase in aggregate demand (only) when a Keynesian supply curve is assumed?

Answer 19

Since the Keynesian supply curve is horizontal up to the point of full employment, as Aggregate Demand increases, there will be an increase in supply (quantity) with no change in price until the level of full employment is reached, at which point both quantity and price increase.

Question 20

What is the effect on aggregate equilibrium of an increase in aggregate demand (only) when a Classical supply curve is assumed?

Answer 20

Since the Classical supply curve is completely vertical, an increase in Aggregate Demand (alone) will increase price with no change in the quantity supplied.

Question 21

What determines aggregate equilibrium for an economy?

Answer 21

The level of output and price at which aggregate demand and aggregate supply are equal.

Question 22

Describe the elements of business cycles:

1. peak
2. trough
3. Economic Expansion or Expansionary Period
4. Economic Contraction or Recessionary Period

Answer 22

1. Peak: Point that marks the end of rising aggregate output and the beginning of a decline in output;
2. Trough: Point that marks the end of a decline in aggregate output and the beginning of an increase in output;
3. Economic Expansion or Expansionary Period: Periods during which aggregate output is increasing;
4. Economic Contraction or Recessionary Period: Periods during which aggregate output is decreasing.

Question 23

Give examples of lagging indicators (of the business cycle).

Answer 23

1. Changes in labor cost;
2. Ratio of inventory to sales;
3. Duration of unemployment;
4. Commercial loans outstanding;
5. Ratio of consumer installment credit to personal income.

Question 24

Give examples of leading indicators (of the business cycle).

Answer 24

1. Consumer expectations;
2. Initial claims for unemployment;
3. Weekly manufacturing hours;
4. Stock prices;
5. Building permits;
6. New orders for consumer goods;
7. Real money supply.

Question 25

Define “leading indicators of business cycles”.

Answer 25

Measures of economic activity that occurs before a change in the business cycle.

Question 26

Define “lagging indicators of business cycles”.

Answer 26

Measures of economic activity associated with changes that occur after changes in the business cycle.

Question 27

Define “business cycles”.

Answer 27

Cumulative fluctuations in aggregate real GDP which last at least two years.

Question 28

Describe the “multiplier effect”.

Answer 28

A change in a single factor that causes a change in aggregate demand will have a multiplied effect on aggregate demand. It is caused by and can be calculated using the marginal propensity to consume. Receipients of additional income will spend some portion of that new income - their marginal propensity to consume a portion - which will provide income to others, a portion of which they will spend, and so on.

Question 29

How is the multiplier effect calculated so that it can be measured?

Answer 29

Multiplier Effect = Initial Change in Spending x (1/(1-MPC))

Because MPC is the reciprocal of MPS, the element of (1-MPC) in the above equation is the same as (MPS). Thus, the equation can be simplified as:
Multiplier Effect = Initial Change in Spending x (1/MPS)