Chapter 20: Aggregate Demand and Aggregate Supply

Question 1

The Wealth Effect

Answer 1

A lower price level increases real wealth, which stimulates spending on consumption

Question 2

The Interest-Rate Effect

Answer 2

A lower price level reduces the interest rate, which stimulates spending on investment

Question 3

The Exchange-Rate Effect

Answer 3

A lower price level causes the real exchange rate to depreciate, which stimulates spending on net exports

Question 4

Effect of Consumer Tax Changes

Answer 4

An increased tax rate decreases consumer spending, AD shifts left
A decreased tax rate increases consumer spending, AD shifts right

Question 5

Effect of Changes in Stock Market

Answer 5

An increased stock value increases consumer spending, AD shifts right
A decreased stock value decreases consumer spending, AD shifts left

Question 6

Effect of Business Perception of the Future

Answer 6

Optimistic outlook means more investment, AD shifts right

Pessimistic outlook means less investment, AD shifts left

Question 7

Effect of Interest Rates

Answer 7

Increased interest rates increases cost of borrowing, AD shifts left
Decreased interest rates decreases cost of borrowing, AD shifts right

Question 8

Effect of Government Purchases

Answer 8

Changes in government purchases directly affect AD

Question 9

Effect of Foreign Country

Answer 9

Economic growth increases foreign country’s importation, AD shifts right
Economic recession decreases foreign country’s importation, AD shifts left

Question 10

Effect of Currency Exchange Rate

Answer 10

Depreciation decreases foreign cost of importing, AD shifts right
Appreciation increases foreign cost of importing, AD shifts left

Question 11

Business cycle

Answer 11

Fluctuations in the economy

Not regular and almost impossible to predict

Question 12

Recession

Answer 12

A period of declining real incomes and rising unemployment

Question 13

Depression

Answer 13

Severe recession

Question 14

How are macroeconomics change in the short-run?

Answer 14

Real and nominal values fluctuate together during the short run
However, they fluctuate at different amounts

Question 15

How are real output and unemployment related?

Answer 15

Output and utilization of the labor force are strongly correlated
Decreased output means less people are employed
Unemployment increases as output decreases

Question 16

How is the short run economy modeled?

Answer 16

Through aggregate supply and aggregate demand

Question 17

Aggregate demand curve

Answer 17

Shows the quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level

Question 18

Aggregate supply

Answer 18

Shows the quantity of goods and services that firms choose to produce and sell at each price level

Question 19

Reason long run and short run aggregate supply are different

Answer 19

In the long run, an economy’s production of goods and services depends on largely immutable factors
Resources can, in the long run, be changed so that no matter the price level, all parts of the economy are engaged in the production of goods and services

Question 20

natural level of output

Answer 20

the production of goods and services that an economy achieves in the long run when unemployment is at its normal rate
AKA: potential output or full-employment output

Question 21

Factors Affecting Aggregate Supply

Answer 21

Changes in Labor
Changes in Capital
Changes in Natural Resources
Changes in Technological Knowledge

Question 22

Most important factors affecting the long run economy

Answer 22

Technology: enhances ability to produce

Monetary policy

Question 23

Reason for sloped short run Aggregate Supply Curve

Answer 23

The actual price level deviates from people’s expected price level

Question 24

Sticky Wage Theory

Answer 24

States short-run AS slopes upward because nominal wages are slow to adjust to changing economic conditions
Encourages less output when actual price level is less than expected (Each unit of good produced nominally worth less than expected)
Encourages more output when actual price level is more than expected (Each unit of good produced nominally worth more than expected)

Question 25

Sticky-Price Theory

Answer 25

Prices of some goods and services adjust sluggishly in response to changing economic conditions
Caused, in part, by menu costs (the cost to adjust prices)
Lower than expected price level causes too high of a price and lower sales
Higher than expected price level causes too low of a price and higher sales

Question 26

Misperceptions Theory

Answer 26

Changes in the overall price level can temporarily mislead suppliers about what is happening in the individual markets in which they sell their output

Question 27

Formula for Quantity of Output Supplied

Answer 27

Natural Level of Output + a (Actual price level - Expected price level)

a is a number that determines how much output responds to unexpected changes in the price level

Question 28

stagflation

Answer 28

A period of falling output and rising prices

Question 29

wage price spiral

Answer 29

Higher prices leading to higher wages causing higher prices and so on

Question 30

accommodative policy

Answer 30

accepts a permanently higher level of prices to maintain a higher level of output and employment

Question 31

cartel

Answer 31

a group of sellers that attempts to thwart competition and reduce production to raise prices