Chapter 20: Aggregate Demand and Supply

Chapter 20 Aggregate Demand and Supply Key Concepts Summary Practice Quiz Internet Exercises1In this chapter, you will learn to solve these economic puzzles:Why does the aggregate supply curve have three different segments?Would the greenhouse effect cause inflation, unemployment, or both?Was John Maynard Keynes’s prescription for the Great Depression right?2What is the Aggregate Demand Curve?The curve shows the level of real GDP purchased by households, businesses, government, and foreigners at different price levels during a time period, ceteris paribus3What does the Horizontal Axis measure? The value of final goods and services included in real GDP measured in base year dollars4What does the Vertical Axis measure?It is an index of the overall price level, such as the GDP deflator or the CPI5Why does the Aggregate Demand Curve slope downward to the right?Real balance wealth effectInterest rate effectNet exports effect6What is theReal Balance Effect?Consumers spend more on goods and services because lower prices make their dollars more valuable7What is theInterest Rate Effect?Assuming fixed credit, an increase in the price level translates through higher interest rates into a lower real GDP8What is theNet Exports Effect?A higher domestic price level makes U.S. goods more expensive compared to foreign goods, exports decrease, imports increase, decreasing real GDP9$200$150$100$502468BA1210ADPrice LevelReal GDPThe Aggregate Demand Curve10What can cause a shift in the Aggregate Demand Curve?Consumption, investments, government spending and net exports can change11200150100502468BAReal GDP1210AD2AD1Price Level (CPI)A Shift in the Aggregate Demand Curve12What is theAggregate Supply Curve?The curve that shows the level of real GDP produced at different price levels during a time period, ceteris paribus13Why did Keynes assume fixed product prices and wages?During a deep recession or depression, there are many idle resources in the economy14Why do idle Resources mean Fixed Prices?Producers are willing to sell additional output at current prices because there is plenty of resources to go around for everyone who wants them15Why do idle Resources mean Fixed Wages?The supply of unemployed workers willing to work for the prevailing wage rate diminishes the power of workers to increase their wages16What kind of Supply Curve would explain Fixed Prices and Wages?A horizontal supply curve17200150100502468E2E1Real GDPPrice Level (CPI)1210ASAD2AD1The Keynesian Horizontal Aggregate Supply Curve18Government spending (G) increasesAggregate demand increases and the economy moves from E1 to E2Price level remains constant, while real GDP and employment rise19According to Keynes, what will a shift in Aggregate Demand do?It will restore a depressed economy to full employment20200150100502468E2E1Real GDPPrice Level (CPI)Full employment1210ASAD2AD1The Keynesian Horizontal Aggregate Supply Curve21What is the Classical view of the Aggregate Supply Curve?It is a vertical line at the full employment output22According to the Classical Economists, where does the economy normally operate? The economy normally operates at its full employment level23How do the Classical Economists view Prices and Costs?The price level of products and production costs change by the same percentage in order to maintain full employment24200150100502468AD2E2E1AD110121416Real GDPFull employmentEThe Classical Aggregate Supply CurveASSurplusPrice Level (CPI)1725YKReal GDPKeynesian RangeThree Ranges of the Aggregate Supply CurveASPrice LevelIntermediate RangeClassical RangeYFFull Employment2624681012AS050100150200Full EmploymentPrice LevelAD1AD2AD3AD4AD6AD5Real GDPIncreasing Demand27What factors can cause a shift in theAggregate Supply Curve?A change in ~resource pricestechnologytaxessubsidiesregulations2820015010050246810121416Full employmentA Rightward Shift in the Aggregate Supply CurveAS1Price Level17ADE1E2AS2Real GDP29Change in one or more nonprice-level determinants: resource prices, technological change, taxes, subsidies, and regulationsIncrease in the aggregate supply curve30What are the two types of Inflation?Cost pushDemand pull31What isCost Push Inflation?A rise in the general price level resulting from an increase in the cost of production3220015010050246810121416Full employmentCost Push InflationAS2Price Level17ADE1E2AS1Real GDP33What isDemand Pull Inflation?A rise in the general price level resulting from an excess of total spending3420015010050246810121416Full employmentDemand Pull InflationPrice Level17AD1E1E2ASReal GDPAD235What determines the Business Cycle?Shifts in the aggregate demand and aggregate supply curves36Key Concepts37Key ConceptsWhat is the Aggregate Demand Curve?Why does the Aggregate Demand Curve slope downward to the right?What can cause a shift in the Aggregate Demand Curve?What is the Aggregate Supply Curve?Why did Keynes assume fixed product prices and wages?What kind of Supply Curve would explain Fixed Prices and Wages?38Key Concepts cont.According to Keynes, what will a shift in Aggregate Demand do?What is the Classical view of the Aggregate Supply Curve?According to the Classical Economists, where does the economy normally operate?What factors can cause a shift in the Aggregate Supply Curve?What are the two types of Inflation?39Summary40 The aggregate demand curve shows the level of real GDP purchased in the economy at different price levels during a period of time.41 Reasons why the aggregate demand curve is downward-sloping include the following three effects:42 (1) The real balances or wealth effect is the impact on real GDP caused by the inverse relationship between the purchasing power of fixed value financial assets and inflation, which causes a shift in the consumption schedule.43 (2) The interest-rate effect assumes a fixed money supply, and, therefore, inflation increases the demand for money. As the demand for money increases, the interest rate rises, causing consumption and investment spending to fall.44 (3) The net exports effect is the impact on real GDP caused by the inverse relationship between net exports and inflation. An increase in the U.S. price level tends to reduce U.S. exports and increase imports, and vice versa. 45200150100502468BAReal GDP1210AD2AD1Price Level (CPI)A Shift in the Aggregate Demand Curve46 The aggregate supply curve shows the level of real GDP that the economy will produce at different possible price levels. The shape of the aggregate supply curve depends on the flexibility of prices and wages as real GDP expands and contracts. The aggregate supply curve has three ranges:47 (1) The Keynesian range of the curve is horizontal because neither the price level nor production costs will increase when there is substantial unemployment in the economy. 48 (2) In the intermediate range, both prices and costs rise as real GDP rises toward full employment. Prices and production costs rise because of bottlenecks, the stronger bargaining power of labor, and the utilization of less productive workers and capital49 (3) The classical range is the vertical segment of the aggregate supply curve. It coincides with the full-employment output. Because output is at its maximum, increases in aggregate demand will only cause a rise in the price level. 50YKReal GDPKeynesian RangeThree Ranges of the Aggregate Supply CurveASPrice LevelIntermediate RangeClassical RangeYFFull Employment51 Aggregate demand and aggregate supply analysis determines the equilibrium price level and the equilibrium real GDP by the intersection of the aggregate demand and the aggregate supply curves. In macroeconomic equilibrium, businesses neither overestimate nor underestimate the real GDP demanded at the prevailing price level. 52 Stagflation exists when an economy experiences inflation and unemployment simultaneously. Holding aggregate demand constant, a decrease in aggregate supply results in the unhealthy condition of a rise in the price level and a fall in real GDP and employment.53 Cost-push inflation is inflation that results from a decrease in the aggregate supply curve while the aggregate demand curve remains fixed. Cost-push inflation is undesirable because it is accompanied by declines in both real GDP and employment. 5420015010050246810121416Full employmentCost Push InflationAS2Price Level17ADE1E2AS1Real GDP55 Demand-pull inflation is inflation that results from an increase in the aggregate demand curve in both the classical and the intermediate ranges of the aggregate supply curve while the aggregate supply curve is fixed. 5620015010050246810121416Full employmentDemand Pull InflationPrice Level17AD1E1E2ASReal GDPAD257 Chapter 20 Quiz©2000 South-Western College Publishing581. The aggregate demand curve is defined as a. the net national product.b. the sum of wages, rent, interest, and profits.c. the real GDP purchased at different possible price levels.d. the total dollar value of household expectations.C. Answers a, b, and c are not real GDP purchases at different possible price levels during a time period.592. When the supply of credit is fixed, an increase in the price level stimulates the demand for credit, which, in turn, reduces consumption and investment spending. This effect is called the a. real balance effect.b. interest-rate effect.c. net exports effect.d. substitution effect.B. At a high price level, the demand for borrowed money increases and results in higher cost of borrowing (interest rates). Higher interest rates result in lower consumption and investment spending.603. The real balance effect occurs because a higher price level reduces the real value of people’s a. financial assets.b. wages.c. unpaid debt.d. physical investments.A. As price increase the dollars people receive in their paychecks and wealth are worth less. As a result, real GDP demand decreases. 614. The net exports effect is the inverse relationship between net exports and the _______of an economy. a. Real GDP.b. GDP deflator.c. Price level.d. Consumption spending.C. A higher domestic price level makes U.S. goods more expensive relative to foreign goods and vice versa.625. Which of the following will shift the aggregate demand curve to the left? a. An increase in exports.b. An increase in investment.c. An increase in government spending.d. A decrease in government spending.D. Answers a, b, c shift the aggregate demand curve to the right. 636. Which of the following will not shift the aggregate demand curve to the left?a. Consumers become more optimistic about the future.b. Government spending decreases.c. Business optimism decreases.d. Consumers become pessimistic about the future.A. Answers b, c and d shift the aggregate demand curve leftward.647. The popular theory prior to the Great Depression that the economy will automatically adjust to achieve full employment is a. supply-side economics.b. Keynesian economics.c. classical economics.d. mercantilism.C. Supply-side economic concerns shifts in aggregate supply. Keynesians do not believe the economy automatically adjusts to full employment. Mercantilism is the idea that gold or silver is the source of a nation’s wealth.658. Classical economists believed that the a. price system was stable.b. goal of full employment was impossible. c. price system automatically adjusts the economy to full employment in the long run.d. government should not attempt to restore full employment.C. This is a key assumption for the vertical shape of the classical aggregate supply curve. 669. Which of the following is not a range on the eclectic or general view of the aggregate supply curve?a. Classical range.b. Keynesian range.c. Intermediate range.d. Monetary range.D. Answers a, b, and c are the three district ranges of the aggregate supply at a level of real GDP below full employment. 67YKReal GDPKeynesian RangeThree Ranges of the Aggregate Supply CurveASPrice LevelIntermediate RangeClassical RangeYFFull Employment6810. Macroeconomic equilibrium occurs when a. aggregate supply exceeds aggregate demand.b. the economy is at full employment.c. aggregate demand equals aggregate supply.d. aggregate demand equals the average price level.C. Note that aggregate demand can equal aggregate supply at a level of real GDP below full employment. 6911. Along the classical or vertical range of the aggregate supply curve, a decrease in the aggregate demand curve will decrease a. both the price level and real GDP.b. only real GDP.c. only the price level.d. neither real GDP or the price level.C. Along the vertical range of the aggregate supply curve, the economy is at full employment and only the price level changes.7012. Other factors held constant, a decrease in resource prices will shift the aggregate a. demand curve leftward.b. demand curve rightward.c. supply curve leftward.d. supply curve rightward.D. Changes in production costs do not affect the aggregate demand curve.7113. Assuming a fixed aggregate demand curve, a leftward shift in the aggregate supply curve causes a (an)a. increase in the price level and a decrease in real GDP.b. increase in the price level and an increase in real GDP.c. decrease in the price level and a decrease in real GDP.d. decrease in the price level and an increase in real GDP.A. 7220015010050246810121416Full employmentCost Push InflationAS2Price Level17ADE1E2AS1Real GDP7314. An increase in the price level caused by a rightward shift of the aggregate demand curve is called a. cost-push inflation.b. supply shock inflation.c. demand shock inflation.d. demand-pull inflation.D.7420015010050246810121416Full employmentDemand Pull InflationPrice Level17AD1E1E2ASReal GDPAD27515. Suppose workers become pessimistic about their future employment, which causes them to save more and spend less. If the economy is on the intermediate range of the aggregate supply curve, thena. both real GDP and the price level will fall.b. real GDP will fall and the price level will rise. c. real GDP will rise and the price level will fall.d. both real GDP and the price level will rise.A. A leftward movement of the aggregate demand curve along a downward sloping aggregate supply curve will result in lower prices and less employment. 76Internet ExercisesClick on the picture of the book, choose updates by chapter for the latest internet exercises77END78