Chapter 11

Question 1

State “Say’s Law.”

Answer 1

Supply creates its own demand. Hence, it follows that desired expenditures will equal actual expenditures.

Question 2

True or False

One implication of Say’s law is that there is no general overproduction possible in a market economy.

Answer 2

True

Question 3

State the assumptions of the classical model.

Answer 3

1. Pure Competition exists.
2. Wage and prices are flexible.
3. People are motivated by self-interest.
4. People cannot be fooled by money illusion

Question 4

With respect to the classical model, what does the assumption “Pure Competition exists” refer to?

Answer 4

No single buyer or seller of a commodity or an input can affect its price.

Question 5

With respect to the classical model, what does the assumption “Wage and prices are flexible” refer to?

Answer 5

Wages and prices are free to move whenever supply and demand dictate (the economy shifts).

Question 6

With respect to the classical model, what does the assumption “money illusion” refer to?

Answer 6

The money illusion is when someone reacts to changes in prices instead of relative prices. (Purchasing power is the key)

Example: A worker whose wages double when the price of all commodities double and thinks they’re better off is under the money illusion.

Question 7

What does a classical economist think the role of government should be in the economy?

Answer 7

As minimal as possible.

Question 8

In classical economic theory, when income is _____ by households, it is not reflected in product _____.

Answer 8

Saved

Demand

Question 9

Saving ______ funds from the circular income stream.

Answer 9

Withdrawals

Question 10

Total planned consumption spending can fall short of total current real GDP because people can ____ their money.

Answer 10

Save

Question 11

In a situation where people save their money, rather than put it back in the circular money flow, supply does ______ create its own demand.

Answer 11

Not necessarily.

Question 12

Classical economists assumed that businesses would _____ as much money as households would _____.

Answer 12

Invest

save

Question 13

In the credit market, the price of credit is the _______.

Answer 13

Interest rate.

Question 14

True or False
With respect to the classical model, at equilibrium, the price of credit–the interest rate – ensures that the amount of credit demanded to fund businesses’ investment equal the amount of credit supplied by savers.

Answer 14

True

Question 15

In the classical model, why is there no reason to be concerned about “leakage” due to savings?

Answer 15

Because in the classical model, the planned investment just equals planned savings so there is no discrepancy between the total money present in the economy.

Question 16

What is the slope of the investment curve? Explain why.

Answer 16

Negative.

The higher the rate of interest, the less profitable it is to invest and the lower is the level of desired investment.

Question 17

What is the slope of the savings curve? Explain why.

Answer 17

Positive.

Because people will opt to save more if the interest rates are higher.

Question 18

True or False

The level of employment in an economy determines its real GDP output (all other things held constant).

Answer 18

True

Question 19

In the classical model, unemployment greater than the natural unemployment rate is _______.

Answer 19

Impossible.

Question 20

In the classical model, the equilibrium level of real GDP per year is completely _________.

Answer 20

Supply determined.

Question 21

In the classical model, changes in aggregate demand affect only the ______, not _______.

Answer 21

Price level

Real GDP

Question 22

Who developed the Keynesian model?

Answer 22

John Maynard Keynes

Question 23

What is the main argument of the Keynesian model with respect to the price of labor?

Answer 23

Price, especially, the price of labor (wages), we inflexible downward to the existence of unions and long-term contracts between businesses and workers.

Question 24

Keynes argued that ____ will not fall when aggregate demand ____ and that there is excess capacity so prices will ____ when demand _____.

Answer 24

prices
falls
not rise
increases

Question 25

Under the Keynesian model, the equilibrium level of real GDP per year is completely __________.

Answer 25

Demand determined.

Question 26

What is the Keynesian short-run aggregate supply curve?

Answer 26

The horizontal portion of the aggregate supply curve in which there is excessive unemployment and unused capacity in the economy.

Question 27

What is the underlying assumption of the simplified Keynesian model?

Answer 27

The relevant range of the short-run aggregate supply schedule (SRAS) is horizontal.

Question 28

What is the short-run aggregate supply curve?

Answer 28

SRAS shows the relationship between total planned economywide production and the price level in the short run.

Question 29

When is the short-run aggregate supply curve positively sloped?

Answer 29

If prices adjust incompletely in the short run.

Question 30

In the Keynesian model, after the SRAS crosses the LRAS the slope _________.

Answer 30

Gets steeper.

Question 31

For both the LRAS and the SRAS, what will (in general) cause the curves to shift?

Answer 31

Any positive or negative change in the factors of production. Depending on what factor of production the effect could be short or long term.

Question 32

List the factors that cause an increase in aggregate supply.

Answer 32

Basically any positive determinant other than a price level change.

1. Discoveries of new raw materials.
2. Increased Competition
3. A reduction in international trade barriers
4. Fewer regulatory impediments to business
5. Increase in the supply of labor
6. Increased training/education
7. A decrease in marginal income tax rates
8. A reduction in input prices

Question 33

List factors that cause a decrease in aggregate supply.

Answer 33

Basically any non-price level determinant that is negative.

1. Depletion of raw materials.
2. Decreased competition
3. Increase in international trade barriers
4. More regulations for businesses
5. A decrease in labor availability
6. Decrease in training/education
7. Increase in income taxes
8. Increase in input prices

Question 34

What is an aggregate demand/supply shock?

Answer 34

Any event that causes the aggregate demand/supply curve to shift inward or outward.

Question 35

What happens in the short run when aggregate supply remains stable but aggregate demand falls?

Answer 35

The short-run outcome will be a rise in the unemployment rate.

Question 36

What is a recessionary gap?

Answer 36

The gap that exists whenever equilibrium real GDP per year is less than full-employment real GDP as shown by the position of the LRAS curve.

Question 37

What is an inflationary gap?

Answer 37

The gap that exists whenever equilibrium real GDP per year is greater than the full-employment real GDP, as shown by the position of the long-run aggregate supply curve.

Question 38

In a growing economy, the reason for persistent inflation is that __________.

Answer 38

Aggregate demand outruns LARS.

Question 39

True or False

Short-run variations in inflation can arise as a result of both demand and supply factors.

Answer 39

True

Question 40

What is “demand-pull” inflation?

Answer 40

Inflation caused by increases in aggregate demand not matched by increases in aggregate supply.

Question 41

A strengthening of the dollar would cause the SRAS curve to shift _____.

Answer 41

Right

Question 42

If the dollar is strengthened, what happens to:

1. Equilibrium real GDP
2. Price Level
3. Employment levels

Answer 42

Equilibrium GDP rises
Price level drops
Employment would increase

Question 43

What effect does a strong dollar have on the aggregate demand curve?

Answer 43

Shifts it left.

Question 44

For a stronger dollar, the equilibrium price level will _____.

Answer 44

Fall

Question 45

True or False

Deflation is associated with a weak dollar.

Answer 45

False, it’s associated with a stronger dollar.