Review Questions

Self-Check Questions

1 . Describe the mechanism by which supply creates its own demand. 2 . Describe the mechanism by which demand creates its own supply. 3 . The short run aggregate supply curve was constructed assuming that as the price of outputs increases, the price of inputs stays the same. How would an increase in the prices of important inputs, like energy, affect aggregate supply? 4 . In the AD/AS model, what prevents the economy from achieving equilibrium at potential output? 5 . Suppose the U.S. Congress passes significant immigration reform that makes it more difficult for foreigners to come to the United States to work. Use the AD/AS model to explain how this would affect the equilibrium level of GDP and the price level. 6 . Suppose concerns about the size of the federal budget deficit lead the U.S. Congress to cut all funding for research and development for ten years. Assuming this has an impact on technology growth, what does the AD/AS model predict would be the likely effect on equilibrium GDP and the price level? 7 . How would a dramatic increase in the value of the stock market shift the AD curve? What effect would the shift have on the equilibrium level of GDP and the price level? 8 . Suppose Mexico, one of our largest trading partners and purchaser of a large quantity of our exports, goes into a recession. Use the AD/AS model to determine the likely impact on our equilibrium GDP and price level. 9 . A policymaker claims that tax cuts led the economy out of a recession. Can we use the AD/AS diagram to show this? 10 . Many financial analysts and economists eagerly await the press releases for the reports on the home price index and consumer confidence index. What would be the effects of a negative report on both of these? What about a positive report? 11 . What impact would a decrease in the size of the labor force have on GDP and the price level according to the AD/AS model? 12 . Suppose, after five years of sluggish growth, the European Union's economy picks up speed. What would be the likely impact on the U.S. trade balance, GDP, and employment? 13 . Suppose the Federal Reserve begins to increase the supply of money at an increasing rate. What impact would that have on GDP, unemployment, and inflation? 14 . If the economy is operating in the neoclassical zone of the SRAS curve and aggregate demand falls, what is likely to happen to real GDP? 15 . If the economy is operating in the Keynesian zone of the SRAS curve and aggregate demand falls, what is likely to happen to real GDP?

Review Questions

16 . What is Say’s law? 17 . What is Keynes’ law? 18 . Do neoclassical economists believe in Keynes’ law or Say’s law? 19 . Does Say’s law apply more accurately in the long run or the short run? What about Keynes’ law? 20 . What is on the horizontal axis of the AD/AS diagram? What is on the vertical axis? 21 . What is the economic reason why the SRAS curve slopes up? 22 . What are the components of the aggregate demand (AD) curve? 23 . What are the economic reasons why the AD curve slopes down? 24 . Briefly explain the reason for the near-horizontal shape of the SRAS curve on its far left. 25 . Briefly explain the reason for the near-vertical shape of the SRAS curve on its far right. 26 . What is potential GDP? 27 . Name some factors that could cause the SRAS curve to shift, and say whether they would shift SRAS to the right or to the left. 28 . Will the shift of SRAS to the right tend to make the equilibrium quantity and price level higher or lower? What about a shift of SRAS to the left? 29 . What is stagflation? 30 . Name some factors that could cause AD to shift, and say whether they would shift AD to the right or to the left. 31 . Would a shift of AD to the right tend to make the equilibrium quantity and price level higher or lower? What about a shift of AD to the left? 32 . How is long-term growth illustrated in an AD/AS model? 33 . How is recession illustrated in an AD/AS model? 34 . How is cyclical unemployment illustrated in an AD/AS model? 35 . How is the natural rate of unemployment illustrated in an AD/AS model? 36 . How is pressure for inflationary price increases shown in an AD/AS model? 37 . What are some of the ways in which exports and imports can affect the AD/AS model? 38 . What is the Keynesian zone of the SRAS curve? How much is the price level likely to change in the Keynesian zone? 39 . What is the neoclassical zone of the SRAS curve? How much is the output level likely to change in the neoclassical zone? 40 . What is the intermediate zone of the SRAS curve? Will a rise in output be accompanied by a rise or a fall in the price level in this zone?

Critical Thinking Questions

41 . Why would an economist choose either the neoclassical perspective or the Keynesian perspective, but not both? 42 . On a microeconomic demand curve, a decrease in price causes an increase in quantity demanded because the product in question is now relatively less expensive than substitute products. Explain why aggregate demand does not increase for the same reason in response to a decrease in the aggregate price level. In other words, what causes total spending to increase if it is not because goods are now cheaper? 43 . Economists expect that as the labor market continues to tighten going into the latter part of 2015 that workers should begin to expect wage increases in 2015 and 2016. Assuming this occurs and it was the only development in the labor market that year, how would this affect the AS curve? What if it was also accompanied by an increase in worker productivity?