Mid3ReviewSP08

Mid3ReviewSP08 - 1 ECN 211 Lecture Hall Classes 10:40 and...

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ECN 211 Lecture Hall Classes: 10:40 and 1:40 Review for Midterm 3 Chapters 10, 11, 13, 14, 15 Spring Semester, 2008 Note: Questions marked with * will not be included on Midterm 3 but will be included on Midterm 4. 1. What the biggest short-coming of Keynesian theory that led to its demise and replacement with the AD— AS model? (Answer: In the Keynesian model the economy cannot experience unemployment and inflation at the same time. The fundamental macroeconomic problem of the decade of the 1970s was the simultaneous existing of both high (and rising) unemployment and high (and rising) inflation.) 2. What is the AD schedule and how is it derived? (Answer: The AD schedule shows the total of aggregate expenditures (C + I + G + X – M) at each possible domestic price level, all other things equal.) 3. Explain the “real balances” (or “wealth”) effect of a change in the price level. (Answer: The wealth effect is one of three reasons why the AD schedule is negatively sloped with respect to the price level. A lower price level increases the value of household wealth and increases consumption expenditures at each possible level of GDP and DI. A lower domestic price level will cause a downward movement along the demand schedule.) 4. Explain the “interest rate” effect of a change in the price level. (Answer: The interest rate effect is the second of three reasons why the AD schedule is negatively sloped with respect to the domestic price level. As the domestic price level falls, nominal interest rates decline and investment expenditures increase, all other things equal. This causes the total of aggregate expenditures to rise and the domestic price level falls.) 5. Explain the “foreign trade” effect of a change in the price level. (Answer: The foreign trade effect is the third of three reasons why the AD schedule is negatively sloped with respect to the domestic price level, all other things equal. A lower domestic price level will cause exports to rise and imports to fall. Remember, in the “all other things equal” we include foreign price levels as well. So, when the domestic price level falls U.S. goods become more price-attractive to foreign buyers, and exports rise. At the same time, a lower domestic price level will cause domestic buyers to switch from imports to domestically-produced goods. The result is an increase in aggregate expenditures as the domestic price level falls.) 6. Explain the “profit effect” of a change in the price level. (Answer: If some costs of production are “fixed” in the short-run, a rise in the domestic price level will cause revenues from increased sales to exceed the additional costs of increasing the level of output. The result will be that profit maximizing firms respond to a rise in the domestic price level by increasing production and the overall level of GDP supplied to the economy. This is one of two explanations of why a rise in the domestic price level will cause business firms to expand real production (real GDP) when the domestic price level rises). 7.
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Mid3ReviewSP08 - 1 ECN 211 Lecture Hall Classes 10:40 and...

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