chapter 23

Question 1

What does an increase in P cause in terms of private sector wealth and effect on net exports?

Answer 1

An increase in P thus reduces private-sector wealth:
• reduction in desired consumption
• downward shift in AE curve (reduces desired aggregate expenditure)

There is also an effect on net exports:
• the NX function shifts downward
• further downward shift in AE curve

Conversely for a fall in P

Question 2

what does a fall in P do with regards to the real value of money holdings?

Answer 2

it raises the real value of money holdings

• Much of private
  sectors total wealth is held in the form of assets with a fixed nominal value.

Question 3

aggregate demand curve relates equilibrium real GDP to what?

Answer 3

the price level

For any given P, the AD curve shows the level of real GDP for which desired aggregate expenditure equals actual GDP.

Changes in the price level cause movements along the AD curve.

Question 4

Why is the aggregate demand (AD) negatively sloped? (two reasons)

Answer 4

1. A fall in the price level leads to a rise in private sector wealth, which increases desired consumption and thus leads to an increase in equilibrium GDP.
2. A fall in the price level (for a given exchange rate) leads to a rise in net exports and thus leads to an increase in equilibrium GDP.

Question 5

Any shock that increases
equilibrium GDP at a
given price level shifts the AD curve to the ________

Answer 5

right

• The horizontal shift of
  the AD curve is the simple multiplier times the change in autonomous spending

Question 6

What does the AD curve say nothing about

Answer 6

It says nothing about whether producers would want to produce
that income, only that if it is produced, purchasers will be willing to
buy it.

Question 7

describe the AS curve

Answer 7

The AS curve relates the price level to the quantity of output that
firms would like to produce and sell.

The AS curve is drawn for a given:
• level of technology
• set of factor prices

As unit costs rise with output, firms will produce more output only if prices increase:
–> AS curve is upward sloping

Question 8

Describe the upward slope of the AS curve

Answer 8

The slope of the AS curve is increasing as output rises:
• when output is low, firms typically have excess capacity –> costs do not rise quickly
• when output is nearer Y*, costs rise as output rises –> firms need higher
prices

Question 9

What causes the AS curve to shift up?

Answer 9

anything that increases firms’ costs:

• factor prices
• technology

Question 10

Where is demand behaviour consistent with supply behaviour?

Answer 10

• at the intersection of the two curves

- macroeconomic equilibrium

Question 11

expansionary or contractionary shocks refer to what with regards to the AD and AS curves

Answer 11

-shifts the direction of the AD or AS curve

Question 12

“expansionary” or “contractionary” refers to

the effect on __________

Answer 12

equilibrium output

Question 13

demand shocks cause what?

Answer 13

P and Y to change in

the same direction.

Question 14

What are some possible causes of demand shocks

Answer 14

Possible	causes:
• ΔG	>	0
• ΔI	>	0
• ΔX	>	0
• ΔC	>	0

Question 15

Describe the mechanics of an AD shift

Answer 15

The shock causes the AE curve to shift upward, but the rise in the price level causes it to shift down.

With an upward sloping AS curve, the multiplier is smaller than the simple
multiplier.

Question 16

Describe the mechanics of an AD shift in steps

Answer 16

1. The equilibrium is at point E0 in both parts.
2. These equilibrium is at price P0
3. Without changing the level of prices. We still have P0
4. There is Δ A.
5. AE shifts up.
6. We change to a new equilibrium: E’ 1
7. This will shift AD to the right
8. Remember we are still with P0
9. Look at the second graph: E1 is not an equilibrium point.
   The forces in the market will
   move the economy out of this
   point and will bring it to a new
   equilibrium
10. This new equilibrium is
    associated to a new level of
    prices: P1
11. The increase in prices will
    reduce AE. Why? Channels?
12. And we shift AE
    1 to AE1

Question 17

The effect of any given shift of the AD curve will depend on what?

Answer 17

depend on the slope of the AS curve.

The steeper the AS curve,
the greater the price effect and the smaller the output effect.

Question 18

Aggregate supply shocks cause what?

Answer 18

cause P and Y to change in opposite directions

Question 19

what are the possible causes of AS shocks?

Answer 19

• Δ price of inputs
• Δ wages
• Δ technology

Question 20

Many economic events (especially changes in the world prices
of ________) cause both aggregate demand and aggregate
supply shocks.

The overall effect on the economy depends on the ________

Answer 20

raw materials

depends on th relative importance of the two separate effects.