CH9 - From the Short Run to the Long Run

Question 1

It the short-run macro model, it is assumed that factor prices are ______ and the level of potential output is ______

∆ in GDP are cause by fluctuations in what?

Answer 1

constant
constant

the AD and AS

Question 2

What are the 2 assumptions regarding the short run model?

Answer 2

1. Factor prices are assumed to be exogenous (they may ∆ but it is not explained why)
2. Technology and factor supplies are assumed to be constant (therefore, potential output (Y*) is constant)

Question 3

What are the 2 assumptions regarding the adjustment process?

Answer 3

1. Factor prices are assumed to adjust in response to output gaps (they are flexible)
2. Technology and factor supplies are assumed to be constant (therefore, (Y*) is constant) (simplifying assumption)

Question 4

What are the 2 assumptions regarding the long-run model?

Answer 4

1. Factor prices are assumed to have fully adjusted to any output gap
   (Real GDP returns to the level of potential output)
2. Technology and factor supplies are assumed to be changing (and typically growing)

Question 5

A recessionary gap leads to excess _______? It causes wages and unit costs to _______. Firms _____ _______ prices to supply any level of​ output, and so the AS curve shifts ________.

Answer 5

Supply of labor
Fall
Accept lower
rightward (down)

Question 6

What is the downward wage stickiness

Answer 6

“Booms” cause wages to rise rapidly while recessions usually cause wages to fall slowly

Question 7

What is the assumption when real GDP is greater than potential output?

Answer 7

There’s a pressure on factor prices to rise because of a higher level of demand for factor inputs

Question 8

What is the assumption when real GDP is smaller than potential output?

Answer 8

There’s a pressure on factor prices to fall because of a lower level of demand for factor inputs

Question 9

When output is greater than potential, factor prices will ______ until equilibrium GDP is reached
What happens to the AS or AD curve

Answer 9

rise

AS curve shifts up

Question 10

When output is lower than potential, factor prices will ______ until equilibrium GDP is reached
What happens to the AS or AD curve

Answer 10

fall

AS shifts down

Question 11

What is the Philipps curve?

Answer 11

The negative relationship between unemployment and the rate of change in wages

Question 12

What did A.W. Philipps observe?

Answer 12

Wages tended to fall in periods of high unemployment and rise in periods of low unemployment

Question 13

Why does potential output act as an anchor for the economy?

Answer 13

Any output gap is assumed to cause wages and other factor prices to adjust, eventually bringing the equilibrium level of output back to potential.

Question 14

When there is an inflationary gap, the level of actual unemployment ___________ the natural level of unemployment

Answer 14

fall below

Question 15

When moving to a long-run equilibrium, after an inflationary gap, what happens to equilibrium price level and to equilibrium level of output?

Answer 15

Equilibrium price level will increase

Equilibrium level of output will decrease

Question 16

What type of aggregate shock happens when there is a change in prices?

Answer 16

A supply shock

Question 17

What is the only way permanent changes in real GDP are possible in the long run?

Answer 17

By a change in potential output

Question 18

In the long run, what determines total output?

Answer 18

The potential output

Question 19

What does aggregate demand determines in the long run?

Answer 19

The price level

Question 20

Between 2006 and​ 2012, the Canadian government reduced both personal and corporate income taxes. Is this a​ demand-side or a​ supply-side policy?

Answer 20

​Both, since in this situation the tax cut increases desired consumption and investment​ expenditures, and it also increases the return to working​ (as opposed to​ leisure).

Question 21

The larger the simple multiplier, the ______ the AD curve?

Answer 21

Flatter

Question 22

The _____ the AD curve, the less stable real GDP in the presence of AS shocks.

Answer 22

flatter

Question 23

What is the effect of the economy’s automatic stabilizers on the multiplier?

Answer 23

They reduce its size

Question 24

When the AD curve shifts to the right (increase in AD), what happens to wages and unit costs?

Answer 24

They will rise, shifting the AS curve to the left (upward)

Question 25

In going from the initial to the new​ long-run equilibrium, the composition of real GDP __________?

Answer 25

may change because there could be some crowding out of private investment

Question 26

What would be the effect of a reduction in the net tax rate for potential GDP?

Answer 26

An increase in Y* because firms increase their investments, which will lead to increase the economy’s capital stock

Question 27

The simple multiplier measures the size of the change in real GDP caused by an AD shock when _______

Answer 27

the price level is held constant

Question 28

Since __________, the AD shock causes ___________ to​ increase, which causes the actual change in real GDP to be ________ than the change predicted by the simple multiplier.

Answer 28

the AS curve is positively sloped

the price level

less

Question 29

A steeper slope of the AS curve would result in _______ ​short-run change in real GDP in response to an AD​ shock

Why?

Answer 29

a smaller

Because a steeper slope results in MORE of the effect of the shock being reflected in the PRICE LEVEL, which
REDUCES the value of the multiplier.

Question 30

Considering an economy with an inflationary gap.

What is the advantage of using a contractionary fiscal policy rather than allowing the​ economy’s natural adjustment mechanism to operate

Answer 30

It will reduce the inflationary pressure on prices that would otherwise occur

Question 31

Consider the basic​ AD/AS model, and suppose there is a negative output gap. If an expensionary fiscal policy is pursued and the AS curve shifts leftwards ​unexpectedly, the fiscal policy may be​ ________, and real GDP may​ ________ potential GDP.

Answer 31

too weak

stay below