12 >> CHECK YOUR UNDERSTANDING Aggregate Demand and Aggregate Supply >> Krugman/Wells CHECK YOUR UNDERSTANDING

Check Your Understanding 12-1 Question 1

a movement up along the aggregate demand curve. 1a) A rise in the interest rate caused by a change in monetary policy causes: a movement up along the aggregate demand curve. a movement down along the aggregate demand curve. a leftward shift of the aggregate demand curve. a rightward shift of the aggregate demand curve. A higher interest rate decreases investment and consumption at every price level, so the aggregate demand curve shifts to the left.

a movement up along the aggregate demand curve. 1b) A fall in the real value of money in the economy due to a higher price level causes: a movement up along the aggregate demand curve. a movement down along the aggregate demand curve. a leftward shift of the aggregate demand curve. a rightward shift of the aggregate demand curve. As the price level rises, the real value of money holdings falls. This is the interest rate effect of a change in the aggregate price level: as the value of money falls people want to hold more money, so they borrow more and lend less. This increases interest rates and reduces consumer and investment spending. So this is a movement along the aggregate demand curve.

1c) Expectations of a poor job market next year causes: a movement up along the aggregate demand curve. a movement down along the aggregate demand curve. a leftward shift of the aggregate demand curve. a rightward shift of the aggregate demand curve. The aggregate demand curve shifts to the left because expectations of a poor job market and lower incomes will reduce spending today.

1d) A fall in tax rates causes: a movement up along the aggregate demand curve. a movement down along the aggregate demand curve. a leftward shift of the aggregate demand curve. a rightward shift of the aggregate demand curve. Lower tax rates increases disposable income so that people can spend more at any price level, which shifts the aggregate demand curve to the right.

a movement up along the aggregate demand curve. 1e) A rise in the real value of assets in the economy due to a lower price level causes: a movement up along the aggregate demand curve. a movement down along the aggregate demand curve. a leftward shift of the aggregate demand curve. a rightward shift of the aggregate demand curve. As the price level falls, the real value of assets rises. This is the wealth effect of a change in the price level: as the value of assets rises, people will increase their consumption plans. This leads to higher consumption spending and a movement down the aggregate demand curve.

a movement (increase) along the aggregate demand curve. 1f) A rise in the real value of assets in the economy due to a surge in real estate values causes: a movement (increase) along the aggregate demand curve. a movement (decrease) along the aggregate demand curve. a leftward shift of the aggregate demand curve. a rightward shift of the aggregate demand curve. The aggregate demand curve shifts because an increase in the value of assets due to an increase in real estate values raises consumer spending at any price level.

Check Your Understanding 12-2 Questions 1 and 2

movement along the SRAS curve. 1a) A rise in CPI leads producers to increase output. This represents a: shift in the SRAS curve. movement along the SRAS curve. This represents a movement along the SRAS curve because the CPI – like the GDP deflator – is a measure of the aggregate price level of final goods and services in the economy.

movement along the SRAS curve. 1b) A fall in the price of oil leads producers to increase output. This represents a: shift in the SRAS curve. movement along the SRAS curve. This represents a shift of the SRAS because oil is a commodity. The SRAS curve will shift to the right because production costs are lower now, leading to a higher quantity of output supplied at any given price level.

movement along the SRAS curve. 1c) A rise in legally mandated retirement benefits paid to workers leads producers to reduce output. This represents a: shift in the SRAS curve. movement along the SRAS curve. This represents a shift of the SRAS curve because it involves a change in nominal wages. An increase in benefits to workers is equivalent to an increase in nominal wages. As a result the SRAS curve will shift leftward because production costs are now higher, leading to a lower quantity of aggregate output supplied at any given aggregate price level.

movement along the SRAS curve. 2) Assume that an economy is initially at potential output and then the quantity of aggregate output supplied increases. At the same time the aggregate price level increased. This represents a: shift in the SRAS curve. movement along the SRAS curve. If the price level and the quantity of output supplied both increase, this is caused by a movement along the SRAS.

Check Your Understanding 12-3 Questions 1 and 2

1a) The government sharply increases the minimum wage, raising the wages of many workers. This causes a(n) ______ in output as measured by real GDP and a(n) ______ in the price level. increase; increase decrease; decrease increase; decrease decrease; increase An increase in the minimum wage raises the nominal wage and shifts the short-run aggregate supply curve to the left. As a result of this negative supply shock, output decreases and the price level increases.

1b) Telecommunications companies launch a major program of investment spending. This causes a(n) ______ in output as measured by real GDP and a(n) ______ in the price level. increase; increase decrease; decrease increase; decrease decrease; increase Increased investment increases aggregate demand, which causes an increase in output and the price level.

1c) Congress raises taxes and cuts spending 1c) Congress raises taxes and cuts spending. This causes a(n) ______ in output as measured by real GDP and a(n) ______ in the price level. increase; increase decrease; decrease increase; decrease decrease; increase Higher taxes and less government spending decreases aggregate demand, which causes a decrease in both output and the price level.

1d) Severe weather destroys crops around the world 1d) Severe weather destroys crops around the world. This causes a(n) ______ in output as measured by real GDP and a(n) ______ in the price level. increase; increase decrease; decrease increase; decrease decrease; increase This is a negative supply shock which decreases short-run aggregate supply. The decrease in SRAS decreases output and increases the price level.

2) A rise in productivity increases potential output, but demand for the additional output will be insufficient in the long run. True False As long-run growth increases potential output, the long-run aggregate supply curve shifts to the right. If, in the short run, there is now a recessionary gap, nominal wages will fall, shifting the SRAS to the right. As prices fall, we move down the aggregate demand curve until actual output is equal to potential output

Check Your Understanding 12-4 Questions 1 and 2

1) “Expansionary monetary or fiscal policy does nothing but temporarily over stimulate the economy—you have a brief high, but then you have the pain of inflation.” Which statement below best describes how the AS-AD model represents this statement? The policy causes the AD curve to shift to the right, causing aggregate price and output to rise. After a period of time nominal wages rise, shifting the AS curve to the left until output falls back to potential output. The policy causes a movement along the AD curve which increases prices. After time the prices fall back to their initial levels. The policy causes the AS curve to shift to the right causing prices and output to rise. After a period of time nominal wages rise and output falls back to potential output but prices remain elevated. If expansionary monetary or fiscal policy is implemented when the economy is in long-run macroeconomic equilibrium, then aggregate demand increases to create an inflationary gap, with higher output and prices. Eventually nominal wages will increase and shift the SRAS to the left, returning output to potential output.

2) In 2008 after the collapse of the housing bubble and the sharp rise in the price of commodities, especially oil, the appropriate policy for the Fed was to lower interest rates. True False Uncertain Lowering interest rates would increase aggregate demand, increasing output, but increasing the price level. Leaving interest rates unchanged feared that increasing aggregate demand through lower interest rates during a negative supply shock would cause inflation.