pes16pset8sol - Principles of Economics W1105.002 Spring...

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Principles of Economics W1105.002 Spring 2016 Prof. Musatti Student Name: _______________________ UNI __________________________ Section Number_____________________ Problem Set 8 Solutions 1. Briefly explain why the Aggregate Expenditure curve is upward sloping while the Aggregate Demand curve is downward sloping. The Aggregate Expenditure curve illustrates the relationship between real GDP and total spending (C+Ipl+G+NX). Since Consumption depends positively on current disposable income, that is real GDP minus net taxes, the Aggregate Expenditure curve is upward sloping. The Aggregate Demand curve illustrates the relationship between the price level and total spending. Since higher prices lower consumption, investment and net exports through the interest rate effect, the wealth effect and the international trade effect, Aggregate Demand curve is downward sloping. 2 . With the aid of AD/AS diagrams, explain how each of the following events affects real GDP and the GDP deflator in the short-run and in the long run. In each case, assume the economy starts from a long-run macroeconomic equilibrium with real GDP = $16.5 trillion and real GDP deflator = 115. a. A surge in consumer confidence leads to a sharp increase in private consumption expenditure. b. The federal government cuts government purchases and allows tax credits to expire. c. The easing of geopolitical tension and innovations in freight and logistics sharply lower the price of imported raw materials.
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