Chapter 9

Question 1

What Assumptions are Made in the Short Run in Macroeconomics?

Answer 1

The short run assumes that factor prices are exogenous and technology and factor supplies are constant.

Example sentence: In the short run, the economy may experience fluctuations in output and employment.

Question 2

What Happens During the Adjustment Process in Macroeconomics?

Answer 2

During the adjustment process, factor prices respond to output gaps, while technology and factor supplies are assumed to be constant.

Additional information: The adjustment process helps bring the economy back to equilibrium.

Question 3

What Assumptions are Made in the Long Run in Macroeconomics?

Answer 3

In the long run, factor prices are assumed to have fully adjusted to output gaps, and technology and factor supplies are assumed to change.

Example sentence: Long-run growth is influenced by changes in technology and factor supplies.

Question 4

What is Potential Output (Y*)?

Answer 4

Potential output is the level of real GDP at which all factors of production are fully employed.

Additional information: Potential output represents the maximum sustainable output level.

Question 5

What is the Output Gap?

Answer 5

The output gap is the difference between potential output and the actual level of real GDP, the latter determined by the intersection of the AD and AS curves.

Example sentence: The output gap indicates the degree of economic slack.

Question 6

What is an Inflationary Gap?

Answer 6

An inflationary gap occurs when actual GDP (Y) is greater than potential output (Y*), leading to excess demand in factor markets, rising wages and other factor prices, and a shifting up of the AS curve.

Additional information: Inflationary gaps can lead to overheating in the economy.

Question 7

What is a Recessionary Gap?

Answer 7

A recessionary gap occurs when actual GDP (Y) is less than potential output (Y*), leading to excess supply in factor markets, falling wages and other factor prices, and a gradual shifting down of the AS curve.

Example sentence: Recessionary gaps can result in high unemployment rates.

Question 8

How Does Potential Output Act in the Economy?

Answer 8

Potential output acts as an “anchor” for the economy, with wages and factor prices adjusting to bring output back to potential.

Additional information: Potential output plays a crucial role in guiding economic policy.

Question 9

What Happens with a Positive Demand Shock?

Answer 9

A positive demand shock creates an inflationary gap, causing wages and factor prices to rise, firms’ unit costs to rise, and the AS curve to shift upward, bringing output back toward potential output (Y*).

Example sentence: Positive demand shocks can lead to economic expansions.

Question 10

What Happens with a Negative Demand Shock?

Answer 10

A negative demand shock creates a recessionary gap, leading to a slow adjustment process due to sticky downward factor prices, causing the recessionary gap to persist for some time.

Additional information: Negative demand shocks can result in economic downturns.

Question 11

What are Aggregate Supply Shocks?

Answer 11

Aggregate supply shocks, such as changes in input prices, shift the AS curve, changing real GDP and the price level. The adjustment process eventually returns the economy to its initial output and prices.

Example sentence: Aggregate supply shocks can disrupt the economy’s equilibrium.

Question 12

What is Macroeconomic Equilibrium in the Long Run?

Answer 12

In the long run, macroeconomic equilibrium occurs when real GDP equals potential output (Y), with the price level determined by the intersection of the AD curve and the vertical Y curve.

Additional information: Long-run equilibrium is a key concept in macroeconomics.

Question 13

How Do Shocks Affect GDP in the Short and Long Run?

Answer 13

Shocks to the AD or AS curves change real GDP in the short run. For a shock to have long-run effects, it must alter potential output (Y*).

Example sentence: Shocks can have both short-term and long-term impacts on the economy.

Question 14

How Can Fiscal Policy Stabilize Output?

Answer 14

Fiscal policy can stabilize output by shifting the AD curve. To remove a recessionary gap, the government can increase spending or cut taxes. To remove an inflationary gap, the opposite policies are used.

Additional information: Fiscal policy plays a critical role in managing economic fluctuations.

Question 15

What is the Paradox of Thrift?

Answer 15

In the short run, increases in desired saving reduce real GDP, known as the paradox of thrift. In the long run, increased saving leads to increased investment and economic growth.

Example sentence: The paradox of thrift highlights the importance of consumption in economic stability.

Question 16

What are Automatic Stabilizers?

Answer 16

Government tax-and-transfer programs that reduce the size of the multiplier, acting as automatic stabilizers by dampening fluctuations in economic activity.

Additional information: Automatic stabilizers help cushion the economy during downturns.

Question 17

What Are Decision Lags and Execution Lags in Fiscal Policy?

Answer 17

Decision lags are the time it takes to decide on a policy change, and execution lags are the time it takes to implement the policy, both of which limit the speed of discretionary fiscal policy effects.

Example sentence: Decision and execution lags can delay the effectiveness of fiscal policy.

Question 18

How Does Fiscal Expansion Affect the Economy?

Answer 18

In the short run, a fiscal expansion through increased government purchases (G) or reduced taxes increases real GDP. In the long run, the effect on potential output depends on the nature of the government purchases or the impact of tax reductions on investment and work effort.

Additional information: Fiscal expansion can have varying effects on economic growth depending on its implementation.

Question 19

What is the Output Gap and Factor Prices Relationship?

Answer 19

The output gap affects factor prices, with inflationary gaps leading to rising factor prices and recessionary gaps leading to falling factor prices.

Example sentence: Factor prices play a crucial role in adjusting to output gaps.

Question 20

What are Inflationary and Recessionary Gaps?

Answer 20

Inflationary gaps occur when actual GDP exceeds potential output, causing upward pressure on prices. Recessionary gaps occur when actual GDP is below potential output, causing downward pressure on prices.

Additional information: Inflationary and recessionary gaps are key indicators of economic performance.

Question 21

What is the Output Gap and Factor Prices Relationship?

Answer 21

The output gap affects factor prices, with inflationary gaps leading to rising factor prices and recessionary gaps leading to falling factor prices.

Example: Inflationary gaps result in higher wages for workers.

Question 22

What are Inflationary and Recessionary Gaps?

Answer 22

Inflationary gaps occur when actual GDP exceeds potential output, causing upward pressure on prices. Recessionary gaps occur when actual GDP is below potential output, causing downward pressure on prices.

Additional Information: Recessionary gaps can lead to deflation.

Question 23

What is the Asymmetry of Wage Adjustment?

Answer 23

Wages tend to be flexible upward during inflationary gaps but sticky downward during recessionary gaps, leading to slower adjustments in the economy.

Example: During a recessionary gap, workers may resist wage cuts.

Question 24

What is the Phillips Curve?

Answer 24

The Phillips curve shows the inverse relationship between inflation and unemployment, reflecting the trade-off between these two variables in the short run.

Example: A decrease in unemployment may lead to an increase in inflation.

Question 25

How Does Potential Output Act as an Anchor for the Economy?

Answer 25

Potential output anchors the economy by guiding the adjustment of factor prices and wages, helping to return the economy to its long-term equilibrium.

Additional Information: Potential output is also known as full employment output.

Question 26

What Are the Short-Run and Long-Run Effects of AD and AS Shocks?

Answer 26

In the short run, AD and AS shocks change real GDP and the price level. In the long run, the economy adjusts back to potential output, with long-term effects depending on changes in potential output.

Example: An increase in aggregate demand can lead to higher inflation in the short run.

Question 27

What is Fiscal Stabilization Policy?

Answer 27

Fiscal stabilization policy uses government spending and taxation to influence aggregate demand, stabilizing the economy by addressing inflationary and recessionary gaps.

Additional Information: Fiscal policy can be expansionary or contractionary.

Question 28

What is the Paradox of Thrift?

Answer 28

The paradox of thrift is the idea that increased saving reduces aggregate demand and real GDP in the short run, but leads to higher investment and economic growth in the long run.

Example: During a recession, increased saving can worsen the economic downturn.

Question 29

What Are Decision Lags and Execution Lags?

Answer 29

Decision lags are delays in recognizing the need for a policy change, while execution lags are delays in implementing the policy once decided.

Example: Decision lags can be caused by conflicting economic indicators.

Question 30

What Are Automatic Stabilizers?

Answer 30

Automatic stabilizers are government programs that automatically reduce fluctuations in economic activity without additional legislative action, such as unemployment benefits and progressive taxes.

Additional Information: Automatic stabilizers can help dampen the effects of economic cycles.

Question 31

What is Fine Tuning and Gross Tuning in Fiscal Policy?

Answer 31

Fine tuning refers to small, precise adjustments in fiscal policy to stabilize the economy, while gross tuning involves larger, more general adjustments.

Example: Fine tuning may involve adjusting specific tax rates.