Exercise 3 Answers

ECONTWO: Exercise 3 ____________________________ __________________ Name Section (1) When the actual price level is greater than the expected price level, the aggregate quantity of goods and services supplied will be (higher than, lower than, equal to) higher than the natural rate of output. When the actual price level is less than expected, the aggregate quantity of goods and services supplied will be (higher than, lower than, equal to) lower than the natural rate of output. When the actual price level is equal to the expected price level, the aggregate quantity of goods and services supplied will be (higher than, lower than, equal to) equal to the natural rate of output.

A D

B C

(2) In the figure above, suppose the economy were in long run equilibrium at point A, at the natural rate of output. The stock market crashes and a bank run causes households to withdraw their deposits from the banking system and hold on to their money. Banks increase their excess reserves and reduce lending. As a result, money supply (increases, decreases, remains unchanged) decreases and the (aggregate demand curve, short run aggregate supply curve, long run aggregate supply curve) aggregate demand curve (does not change, shifts to the right, shifts to the left) shifts to the left. In the new short run equilibrium, prices are (higher, lower, unchanged) lower and real GDP is (higher , lower, the same) lower than the natural rate at point (A, B, C, D) D (3) Suppose the economy were at point D and the government decides to do nothing. People expect prices to be (higher, lower) lower therefore the (aggregate 1

demand curve, short run aggregate supply curve, long run aggregate supply curve) short run aggregate supply curve (shifts to the right, shifts to the left) shifts to the right. In the new long run equilibrium, prices are (higher, lower, unchanged) lower and real GDP is (higher , lower, the same) higher at point (A, B, C, D) C. (4 )Suppose the economy were at point D and the Central Bank decides to buy government bonds from the public. This will (increase, decrease) increase money supply so that interest rates will (rise, fall) fall and therefore consumption and investment will (increase, decrease) increase and the (aggregate demand curve, short run aggregate supply curve, long run aggregate supply curve) aggregate demand curve (does not change, shifts to the right, shifts to the left) shifts to the right. In the new long run equilibrium, prices are (higher, lower, unchanged) higher and real GDP is (higher , lower, the same) higher at point (A, B, C, D) A. (5) Suppose the economy were at point D and the national government decides to reduce taxes and or increase spending. This will (increase, decrease) increase aggregate demand so that the (aggregate demand curve, short run aggregate supply curve, long run aggregate supply curve) aggregate demand curve (does not change, shifts to the right, shifts to the left) shifts to the right. In the new long run equilibrium, prices are (higher, lower, unchanged) higher and real GDP is (higher , lower, the same) higher at point (A, B, C, D) A. (6) Suppose the economy were in long run equilibrium at point C, at the natural rate of output, when a new president considered by many to be honest, efficient, and fair is elected. As a result, a wave of optimism boosts business investment and household consumption. The (aggregate demand curve, short run aggregate supply curve, long run aggregate supply curve) aggregate demand curve (shifts to the right, shifts to the left) right. In the new short run equilibrium, prices are (higher, lower, unchanged) higher and real GDP is (higher, lower, the same) higher than the natural rate at point (A, B, C, D) B. (7) Suppose the economy were at point B and the government decides to do nothing. People expect prices to be (higher, lower) higher therefore the (aggregate demand curve, short run aggregate supply curve, long run aggregate supply curve) short run aggregate supply curve (shifts to the right, shifts to the left) shifts to the left. In the new long run equilibrium, prices are (higher, lower, unchanged) higher and real GDP is (higher , lower, the same) lower at point (A, B, C, D) A. (8)Suppose the economy were at point B and the Central Bank becomes concerned with inflation and an asset bubble. It therefore decides to sell bonds. As a result, money supply (increases, decreases, remains unchanged) decreases and the (aggregate demand curve, short run aggregate supply curve, long run aggregate supply curve) aggregate demand curve (does not change, shifts to the right, shifts to the left) shifts to the left. In the new equilibrium, prices are (higher, 2

lower, unchanged) lower and real GDP is (higher , lower, the same) lower at point (A, B, C, D) C (9) Suppose the economy were in long run equilibrium at point C, at the natural rate of output, when the price of oil increases substantially. The (aggregate demand curve, short run aggregate supply curve, long run aggregate supply curve) short run aggregate supply curve (shifts to the right, shifts to the left) left. In the new short run equilibrium, prices are (higher, lower, unchanged) higher and real GDP is (higher, lower, the same) lower than the natural rate at point (A, B, C, D) D. (10) Suppose that instead of doing nothing, the government decides to reduce taxes and or increase spending. Consumption will (increase, decrease) increase and the (aggregate demand curve, short run aggregate supply curve, long run aggregate supply curve) aggregate demand curve (does not change, shifts to the right, shifts to the left) shifts to the right. In the new long run equilibrium, prices are (higher, lower, unchanged) higher and real GDP is (higher, lower, the same) higher at point (A, B, C, D) A. MS

r2 r1

P2 P1

MD 2

AD MD 1

Y2

.

Y1

(11) Suppose the price level rises from P1 to P2. As a result, the (demand, supply) demand for money (increases, decreases) increases and the money (demand, supply) demand curve shifts to the (right, left) right. Interest rates (rise, fall) rise and the quantity demanded for goods and services (increases, decreases) decreases from (Y1, Y2) Y1 to (Y1, Y2) Y2. (12) Suppose the price level falls from P2 to P1. As a result, the (demand, supply) demand for money (increases, decreases) decreases and the money (demand, supply) demand curve shifts to the (right, left) left. Interest rates (rise, fall) fall and the quantity demanded for good and services (increases, decreases) increases from (Y1, Y2) Y2 to (Y1, Y2) Y1

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(13) Suppose the Central Bank buys government securities from the public. Consequently, the (demand, supply) supply of money (increases, decreases) increases and the (demand supply) supply curve of money shifts to the (right, left )right . Interest rates (increase, decrease) decrease and households (increase, decrease) increase consumption while firms (increase decrease) increase investments. The quantity demanded for goods and services (increases, decreases) increases and the aggregate demand curve shifts to the(left, right) right . (14) Suppose the Central Bank sells government securities to the public. As a result the (demand, supply) supply of money (increases, decreases) decreases and the (demand supply) supply curve of money shifts to the (right, left) left. Interest rates (increase, decrease) increase and household consumption (increases, decreases) decreases while firms (increase, decrease) decrease investments. The quantity demanded for goods and services (increases, decreases) decreases and the aggregate demand curve shifts to the (right, left) left. (15) Suppose the MPC = .8 and government spending increases by $20 billion. Assuming there is no crowding-out effect, this will cause aggregate demand to increase by $100 billion. The multiplier is equal to 5. What if there is a crowdingout effect equal to $60 billion. Aggregate demand will increase by $40 billion.

4

P

MS

r2 r1

MD 2

AD

2

AD3

MD 1

AD 1

Y 16) Suppose the government were to increase its purchases of goods and services so that the aggregate demand curve shifts from AD1 to AD2. The resulting increase in income (increases, decreases) increases the (demand, supply) demand for money. As a result, the money (demand, supply) demand curve shifts to the (left, right) right and interest rates (rise, fall) rise. Consumption and investment (decreases, increases) decreases and the aggregate demand curve shifts to the (left, right) left.

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