aggregate demand questons

Chapter Review: Key Points

1.Most economists, whether classicallyoriented or Keynesians, now agree that, in the long run, Aggregate Supply curves are vertical. However, the new Keynesians contend that wage and price stickiness can make the short run Aggregate Supply curve positively-sloped for lengthy periods, and thus short run targets may be most appropriate for macroeconomic policymaking.

2.Long-term labor contracts (whether implicit or explicit), efficiency wages, and dual labor markets all provide microfoundations to help explain wage stickiness and involuntary unemployment in an Aggregate Demand/Aggregate Supply framework.

3.Declines in the Aggregate Supply curve trigger supply-side inflation and reduces real income and output. Demand-side inflation results from rapid increases in the Aggregate Demand curve, and is usually preceded by higher income and output.

4.If Aggregate Demand grows excessively in a fully employed economy, the first phase of the demand-side cycle entails rising prices, outputs, employment, and incomes. In the second phase, supply-side adjustments to the demand-originated disturbances drive up prices further, but total employment, production, and income fall. Demand-side inflation induces a path of counterclockwise adjustment of real output versus inflation. If the economy starts at less than full employment, only the first phase necessarily occurs when Aggregate Demand is increased.

5.Supply-side inflation generates a clockwise adjustment pattern. In the first phase of a supply-side (cost-push) cycle, prices rise while real output and incomes fall. If the government attempts to correct for the resulting inflationary recession by increasing Aggregate Demand, the second phase occurs--prices continue to rise, but real output and income rise as well.

6.Stagflation, a contraction of the terms stagnation and inflation, is the simultaneous occurrence of high rates of both unemployment and inflation.

7.Mild demand-side inflation accompanied the prosperity of the 1960s. From the mid1970s into the early 1980s, stagflation took over. Whether this stagflation was the supply-adjustment phase of the earlier demand-pull cycle or originated from supply-related shocks cannot be established conclusively. It seems likely, however, that even if the economy had been stable when the supply shocks listed previously emerged, considerable supplyside inflation would have plagued the American economy from 1973 to 1980.

8.Disinflation is a significant reduction in the rate of inflation. Most people adjust their behavior if they expect inflation.

Their expectations cause disinflation to entail losses in real income before it restores the economy to a relatively stable growth path. Thus, the 1981-83 recession was especially severe.

9.In recent decades, accelerating technological advances and the internationalization of economic activity have increased the speed of structural economic change. A massive wave of corporate mergers in the 1980s and 1990s has lead to significant corporate downsizing, with reduced job security for many workers who had intended to be career employees at large firms.

a.The labor market consists of primary and secondary sectors.

b.Can exist in the short run, but not in the long run.

c.Employment rises in the initial stage.

d.Reduces investment when the price level rises.

e.Purchasing power of assets falls when prices rise.

f.Generates a clockwise adjustment path of the price level versus real output.

g.Intended to raise the cost of dismissal and reduce shirking by employees.

h.Attempts to curb inflation without cutting Aggregate Demand.

i.Explains in part why wages adjust slowly.

j.Inflationary recession.

___ 4. Aggregate Supply curves are shifted by changes in monetary or fiscal policies and changes in consumption or investment expenditures.

___10. Money wages can increase at rates equal to growth rates of labor productivity without causing price inflation.

___ 8. Which of the following is NOT a reason why Aggregate Supply curves are positively sloped?

a.Costs adjust less quickly than prices do to changes in demand.

b.Price changes trigger wealth effects.

c.Diminishing returns causes it to become ever more difficult to expand output as the economy approaches its capacity.

d.Higher prices are needed to cover rising production costs as larger amounts of output are demanded.

e.Expanding production causes more intense competition for resources when the economy nears full employment.

___ 9. Which of the following would be the LEAST likely to cause demand-pull inflation?

a.A tax cut.

b.An increase in government spending.

c.A hike in the discount rate.

d.A cut in reserve requirements.

e.The FED buys bonds from banks.

___10. Stagflation occurs when Aggregate:

a.Demand and Aggregate Supply shift right.

b.Demand shifts right.

c.Demand shifts left.

d.Supply shifts right.

e.Supply shifts left.

___11. Cost-push inflation is a likely result if the:

a.money supply grows faster than our productive capacity.

b.Aggregate Demand shifts right.

c.Aggregate Supply curve shifts left.

d.federal government runs a huge deficit.

e.Congress repeals all inefficient regulations.

___12. A supply-side inflationary cycle follows a _____ path.

a.clockwise.

b.counterclockwise.

c.cyclical.

d.countercyclical.

e.sinusoidal.

___13. Compared to market clearing wages, efficiency wages tend to:

a.be higher.

b.increase unemployment.

c.raise the costs of being fired.

d.reduce shirking.

e.All of the above.

___14. The segmentation of the national labor market into primary and secondary sectors is known as the:

a.foreign sector substitution effect.

b.interest rate effect.

c.dual labor market.

d.wealth effect.

e.efficiency wages effect.

___15. One reason wages fail to adjust as fast as prices do is the existence of:

a.efficiency wages.

b.labor contracts.

c.dual labor markets.

d.the wealth effect.

e.supply-side inflation.

___ 1. Workers are said to suffer from money illusion when:

a.they make their work decisions after adjusting prevailing money wage rates for expected inflation.

b.they anticipate real wage rates that are not realized.

c.they work more but realize only decreased real wages because of inflation.

d.their expected rate of inflation equals realized inflation.

___ 2. Incomes policies:

a.include various measures intended to dampen inflationary pressures but not Aggregate Demand.

b.may reduce labor's inflationary expectations.

c.include such measures as wage and price controls.

d.may worsen inflationary pressures if their inefficiencies cause the Aggregate Supply curve to shift inward and to the left.

___ 3. During the initial stage of a demandside inflation:

a.business firms offer higher money wages for more labor to produce more output at higher prices.

b.the demand for labor schedule shifts to the left.

c.the supply schedule of labor will shift leftward, assuming that labor suffers from money illusion.

d.workers suffering from money illusion offer more labor services at a reduced real wage rate.

___ 4. The Aggregate Supply curve:

a.would be nearly vertical if workers quickly secured increases in money wage rates offsetting any increases in the price level.

b.would be nearly vertical if workers' expected rates of inflation were much less than the actual rates of inflation.

c.shifts rightward as workers revise their inflationary expectations upward.

d.shifts leftward as business firms lower the prices they charge for goods.

___ 5. Inflationary recession occurs during the:

a.initial stage of a demand-side inflation.

b.initial stage of a supply-side inflation.

c.latter stage of a demand-side inflation as workers adjust their inflationary expectations to agree with actual inflation.

d.latter stage of a supply-side inflation as government resorts to demand-management policies to restore full-employment.

___ g. The Aggregate Supply curve depicted is composed of both a Keynesian segment and a Classical segment.

___ k. An increase in autonomous saving might shift the Aggregate Demand curve from AD1 to AD2.

___ h. As the economy moves up along the Keynesian segment of its supply curve, the real wage rate remains unchanged.

___ l. The demand curve for labor services corresponding to the Keynesian portion of the supply curve is a horizontal line.

___ a. The original equilibrium would be at full employment with price level Pe (point a).

___ b. Increases in federal spending or growth of the money supply could expand Aggregate Demand from AD0 to AD1.

___ c. Workers’ real wages rise with a move from point a to point d.

___ d. Real wages rise during a move from b to c.

___ e. Realizing that wages have not kept pace with inflation at point d,

workers will compensate by reducing their supplies of labor, so that Aggregate Supply shifts from AS0 to AS1.

___ f. Movements such as those from point a to point d to point c are often referred to as Supply-side inflation.

___ g. Stagflation occurs when the economy moves from a to b.

___ h. A move from a to b cuts real wages.

___ i. The real wage at c and at a are equal.

___ j. Macroeconomic movements from a to b to c are compatible with a Demandside inflation.

___ k. Shifts of Aggregate Demand from AD0 to AD1 could be induced by a drop in the discount rate.

___ l. Unemployment rates are higher at point a than at point b.

___ m. A movement from b to c could follow if policymakers tried to fight a recession originated by supply shocks.

___ n. In the short-run, labor probably suffers from inflationary (money) illusion.

___ o. Labor eventually shrinks its supply curve to offset unexpected inflation.

___ p. A shift from AS1 to AS0 could follow an increase in the capital gains tax.

___ q. Policies to reduce monopolistic practices could shift Aggregate Demand from AD0 to AD1.

___ r. A movement from a to b could reflect external supply shocks that induced an inflationary recession.