AK Macroeconomics – Chapter 5
CHAPTER FIVE
Answers to Self-Test Questions
1. GDP gap is $45 billion (cyclical unemployment of 3% x 2.5 x $600 billion)
Potential GDP is $645 billion (actual GDP of $600 + GDP gap of $45)
2 a) If the price increases by 10 percent to 88, then real GDP will increase from $1000 to
$1300 which is a growth rate of 30% ($300/$1000).
b) If the price increases by 10 percent to 110, then real GDP will increase from $1450
to $1500 which is a growth rate of 3.4% ($50/$1450).
3) Consumption, investment and net exports would all rise because of the real-balances
effect, the interest-rate effect, and the foreign-trade effect respectively.
4. a) Price level: 100;
GDP: $1100.
b) Shortage of $125.
(At a price level of 95, aggregate quantity demanded exceeds the aggregate quantity
supplied by this much).
Surplus of $270.
(At a price level of 115, aggregate quantity supplied exceeds the aggregate quantity
demand by this much.)
5. a) inflationary gap of $100;b) recessionary gap of $100; c) recessionary gap of $200;
6. a) AD;
7. a) AS;
d) AS
b) AD;
c) AD;
d) AD;
e) AD
b) AS and potential GDP; c)
e) AS and potential GDP
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AS and potential GDP;
AK Macroeconomics – Chapter 5
8. See following figure:
9. a)
b)
Price level: 105; GDP: $1800.
Price level: 95;
GDP: $1700.
10. a) Price level: 110; GDP: $1500.
This is full-employment equilibrium.
b) Price level: 100; GDP: $1600; recessionary gap of $200.
This is because the improvement in productivity will increase both the aggregate
supply and potential GDP. The new potential GDP is $1800 and the new
equilibrium GDP is $200 below this.
11. a) Both nominal GDP and real GDP will increase according to the Keynesians
since the economy was at less that full employment to start with.
b) Nominal GDP will increase but real GDP will not according to the Neoclassicists
since they assume that the economy must have been at full employment equilibrium
to start with.
12. a) The new intersection is now at: GDP = $800; P = 95.
b) The new intersection is now at: GDP = $1100; P = 110.
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AK Macroeconomics – Chapter 5
Answers to Study Guide Questions
1.
2.
3.
4.
5.
6.
True
False: it is the effect which a change in the price level has upon exports and imports.
True
False: where aggregate demand equals the short-run aggregate supply.
False: it will not shift the potential GDP curve.
False: it will, because any change in potential GDP will also affect the aggregate supply
and, therefore, equilibrium.
7. True
8. False: it will cause a decrease in real GDP.
9. False: to Keynes, it is horizontal.
10. True
11. c
12. b
13. b
14. b
15. c
36A.
16. c
17. e
18. b
19. b
20. b
21. d
22. b
23. b
24. a
25. d
26. a
27. a
28. d
29. b
30. b
31. d
32. b
33. b
34. c
35. c
Key Problem
a) The plotting is fairly straightforward, though you will appreciate that the AS is not
a straight line and therefore needs a little care in drawing it. The potential GDP
curve is a vertical straight line at $200. Since Everton is in equilibrium and at full
employment, the potential GDP is located at the intersection of the AD1 and AS1
curves. See the following figure:
Figure 5.26 (completed)
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AK Macroeconomics – Chapter 5
b) Price: 80;
real GDP: $200
The equilibrium values can be read off the graph or by glancing at Table 5.3 and
locating the price at which the quantity demanded is equal to the quantity supplied.
c) See Figure 5.26 (completed) above. The new AD2 curve is 3 squares to the left of
AD1.
Price: 75;
real GDP: $160
d) Recessionary gap of $40.
(The difference between the new equilibrium GDP and potential GDP.)
e) increased exports
higher taxes
X
higher interest rates
X
lower government spending
X
f) See Figure 5.26 (completed) above.
Price: 75;
real GDP: $220
g) Inflationary gap of $20.
(The difference between the new equilibrium GDP and potential GDP.)
37A.
a) Improved levels of human capital (an increase in the quantity or quality
of labour employed);
b) an increase in the capital stock;
c) technological change;
d) additional quantities of natural resources.
38A.
$504 billion. (the GDP gap is equal to cyclical unemployment of 2% x 2.5 x actual
GDP of $480 = $24 billion. Potentail GDP is equal to actual GDP of $480 + GDP
gap of $24 = $504)
39A.
a)
b)
c)
d)
e)
f)
AD;  price level;
AS;  price level;
AD;  price level;
AD;  price level;
AD;  price level;
AS;  price level;
40A.
a)
b)
c)
d)
AD;
AS;
AS;
AD;
41A.
 real GDP;
 real GDP;
 real GDP;
 real GDP;
 real GDP;
 real GDP;
inflationary gap
recessionary gap
recessionary gap
recessionary gap
inflationary gap
recessionary gap
If the AS was horizontal.
42A. a) Real GDP: $1000; price level: 100; There is no gap. (Actual GDP is the
same as potential GDP).
b) Real GDP: $1025; price level: 102; c) There is an inflationary gap of $25
(Actual GDP is $25 greater than potential GDP)..
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AK Macroeconomics – Chapter 5
43A The real wage has increased by $1 from $15 (18/120 x 100) to $16 (20.8/130 x
100).
44A Potential GDP refers to the total amount that the economy is capable of producing
when all of its resources are being fully utilized. (It is also referred to as capacity GDP or
full-employment GDP).
45A. Any of the following factors will increase aggregate demand:
↑ consumption
↑ investment
↑ net exports
government
↑ wealth
↓ interest rate
↓ $ Canadian
↑ age of consumer
goods
↑ consumer
confidence
↑ age of capital goods ↑ foreign incomes
↑ government
spending
↓ taxes
↑ business confidence ↑ foreign prices
↑ money supply
↓ price of capital
goods
46A. See the following graph:
Figure 5.27 (completed)
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AK Macroeconomics – Chapter 5
47A. See the following graph:
Figure 5.27 (completed)
a) b) and c) Choose any three from the following possible reasons:
 consumption:
wealth
age of consumer
goods
 consumer
confidence
 investment:
 interest rate
age of capital
goods
 business
confidence
 price of
capital goods
 net exports
 government spending
 $ Canadian
 taxes
 foreign income  money supply
 foreign prices
48A There must have been an increase in unemployment in Mersin.
49A
a) $20;
b) 5 percent (20/400 x 100);
c) Since the GDP gap is 2 ½ times the amount of cyclical unemployment, the latter
must equal 2% (5/2.5). Therefore the unemployment rate must be 8 percent
(natural rate of 2% plus cyclical unemployment of 2%).
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AK Macroeconomics – Chapter 5
50A.
a) 1;
b) 1;
c) 4;
d) 6;
e) 3;
f) 5
51A. The aggregate demand curve is downward-sloping because of:
real-balances effect which refers to the fact that a lower price level increases the
value of real balances which will cause an increase in consumption;
interest-rate effect which means that a lower price level will reduce interest rates and
thereby causing an increase in investment;
foreign-trade effect which means that a lower price level will make domestic
products more competitive on world markets thus increasing exports and decreasing
imports.
52A. An increase in aggregate demand will lead to an increase in both real GDP and in the
price level. As a result the economy will be above potential, full-employment GDP, i.e. an
inflationary gap will exist.
53A.
real GDP (output)
employment (inputs)
productivity
last year
$160 (168/105 x 100)
20
$8 ($160/20)
this year
$200 (220/110 x 100)
23.5
$8.5 ($200/23.5)
Therefore productivity increased by 6.25% (+0.5/8 x 100)
54A.
An increase in potential GDP would also produce an equal increase in aggregate
supply. However, since aggregate demand has not changed, at the prevailing price
level there will be a surplus of goods and services. As a result, the price level will
be forced down. This will cause firms to reduce their outputs below the new higher
level of potential GDP. The result will be a recession since the economy is
producing below its potential GDP.
55A. a) neoclassical supply: Aggregate Quantity Supplied 1
Keynesian supply:
Aggregate Quantity Supplied 2
b) price: 80; real GDP: $800.
c) price: 100; real GDP: $600.
d) price: 95; real GDP: $800.(real GDP would not be affected by a change in
AD but the price level would increase).
e) price: 100; real GDP: $750. (the price level would not be affected by a change
in AD but real GDP would increase.)
56A. a) ↑ AD
b) ↑ AS c) ↓ AS and potential GDP.
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AK Macroeconomics – Chapter 5
57A. a) $21.82 ($24/110 x 100);
b) $20.00 ($24/120 x 100);
c) $21.82 (at full-employment, potential GDP, real GDP is constant, i.e. back at its
original level in a);
d) $28.37 (nominal wage = real wage (21.82) x price index (130) ÷100
58A. A recessionary gap will leave employers in a more powerful position since there is
high unemployment. Eventually wage rates will be forced down and as a result of the
reduced costs to business, production and GDP will increase until the economy is back at
full employment. Graphically, this implies a right shift in the aggregate supply curve.
An inflationary gap will leave employees in a more powerful position since the number of
jobs available exceeds the number of unemployed people. Eventually wage rates will be
forced up and as a result of the increased costs to business, production and real GDP will
decrease until the economy is back at full-employment. Graphically, this implies a left
shift in the aggregate supply curve.
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