PROBLEM SET 4
PROBLEMS FOR AGG. DEMAND-AGG. SUPPLY MODEL (HANDOUT AND
CHAPTER 5) AND INTRODUCTION TO MONEY
1.
What factors will shift the short-run aggregate supply curve? What factors shift the
medium-run aggregate supply curve?
2.
For each of the following, determine whether the aggregate demand curve shifts or the
short-run aggregate supply curve shifts. Draw a separate graph to illustrate each situation
(Mark the initial equilibrium so that all three curves cross at the full-employment output). Show
clearly what happens to the inflation rate and real output/income in the short-run.
a. A decrease in consumption spending.
b. An increase in government spending.
c. Wage costs increase less rapidly or fall.
d. The prices of raw materials used in production increase more rapidly.
e. A cut in income taxes that households pay.
f. Energy prices increase less rapidly or fall.
g. The money supply increases.
h. Interest rates increase.
i. Businesses expect that sales and profits will fall in the future (HINT: Consider
the impact on investment spending).
j. Imports decrease.
k. Exports increase.
Given what happens to equilibrium real output/income in the short-run in each part above, what
will happen to equilibrium real output/income in the medium-run?
How is long-run growth defined in the aggregate demand – aggregate supply model?
Which of the following will cause positive long-run growth? Which will cause long-run
growth to be negative?
i. Labor productivity increases.
ii. The capital stock increases.
iii. Labor productivity decreases.
iv. Technological change occurs.
c. Using the aggregate demand – aggregate supply model, how do we illustrate positive
long-run growth graphically? How do we illustrate negative growth graphically?
3. a.
b.
4.
Suppose the economy is in a recession. What is the major cause of a recession? What
kinds of fiscal and monetary policies could alleviate the situation? Explain your answer fully.
5.
Suppose the economy is experiencing higher demand-pull inflation. What is the major
cause of demand-pull inflation? What kinds of fiscal and monetary policies could alleviate the
situation? Explain your answer fully.
2
6.
a.
Suppose the money supply (M) is $1000 and velocity (V) is 4. Calculate the
nominal value of national output (PQ). If the money supply (M) increases to $1200, what
happens to the nominal value of national output (PQ)? If the money supply decreases to
$800, what happens to the nominal value of national output (PQ)?
b.
Suppose the money supply (M) is $1000, velocity (V) is 5, and real output (Q) is
2500. Calculate the price level (P). Suppose V and Q stay the same, but the money
supply increases to $2000. What happens to the price level (P)?
ANSWERS
1.
Changes in the rate of change in prices or costs of the inputs used in production shift
the short-run aggregate supply curve. Changes in the amount of labor available for production
and changes in the productivity of labor change the natural level of output the economy can and
therefore shift the medium-run aggregate supply curve. Labor productivity changes when the
amount of capital or the skill level of the average worker changes or when there is technological
change. Another way to say this is that the medium-run aggregate supply curve shifts when
there is a change in the amount of resources available for production or in the level of
technology.
2.
Arrows show direction relevant curve shifts and directions of changes in INFL and y.
a. INFL
MRAS
b.
INFL
MRAS SRAS
SRAS
INFL2
AD'
INFL1
E1
INFL1
E1
E2
INFL2
AD
AD
AD’
Y2
yn
y
yn y2
y
3
c.
INFL
MRAS
d
INFL
SRAS
MRAS SRAS’
SRAS
SRAS’
INFL1
E1
INFL1
E1
AD
e.
INFL
yn
MRAS
AD
y
f.
INFL
yn
MRAS
SRAS
INFL1
y
SRAS
SRAS’
E1
INFL1
E1
AD’
AD
yn
g.
INFL
AD
y
yn
MRAS
h.
INFL
SRAS
INFL1
E1
y
MRAS
SRAS
INFL1
E1
AD’
AD’
AD
yn
y
yn
AD
y
4
i.
Same as h.
j.
Same as g.
k.
Same as g.
In the medium-run, real output/income always returns to the natural level (yn). If y increased
above yn in the short-run, in the medium-run it will decrease back to yn. If y decreased below yn
in the short-run, in the medium-run it will increase back to yn.
3.
a.
b.
c.
Long-run growth refers to sustained changes in the amount of output that the
economy can produce when it is operating at its natural level of output (i.e.
changes in yn).
Positive long-run growth (increases in yn): i, ii, and iv.
Negative long-run growth (decreases in yn): iii.
Positive Long-Run Growth
Negative Long-Run Growth
PL
PL
MRAS MRAS’
yn1
yn2
MRAS’
y
yn2
MRAS
yn1
y
4. Cause of recession: aggregate demand (total spending) is too low.
Expansionary fiscal policy: increase government spending and decrease taxes; expansionary
monetary policy: increase money supply.
5. Cause of demand-pull inflation: aggregate demand is rising too rapidly.
Contractionary fiscal policy: decrease government spending and increase taxes;
contractionary monetary policy: decrease money supply.
6.
a.
M = 1000: MV = $4000 = PQ
M = 1200: MV = $4800 = PQ
M = 800: MV = $3200 = PQ
b.
M = 1000: P = 2
M = 2000: P = 4