answerkey ch10 3ed

answerkey ch10 3ed - Answers to Text Questions and Problems...

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Answers to Text Questions and Problems in Chapter 10 Answers to Review Questions 1. Stagflation is the combination of a recessionary gap and a rising price level. This situation is hard to depict on a Keynesian cross diagram, because the basic Keynesian model assumes that prices are constant. 2. This is the fallacy of composition. If the long-run aggregate supply curve is vertical, then a rise in the overall price level has no effect on potential output. 3. A horizontal short-run aggregate supply curve would occur if firms provide the output demanded by customers at the prices that the firms have posted. 4. False. The law of demand explains why a rise in the price of an individual good leads to a fall in the quantity demanded. This is because other prices are held constant, so consumers substitute away from the more-expensive good. However, the aggregate demand curve includes all goods, so there is no possible good to substitute toward if the overall price level rises. Instead, the aggregate demand curve shows an inverse relationship between the price level and output due to the real-balances effect, the interest rate effect, and the foreign trade effect. 5. Although the AD - AS model shows a self-correcting economy, a recessionary gap will take time to be eliminated. Therefore, expansionary macroeconomic policy can be used to eliminate the recessionary gap more quickly. 6. Stagflation is caused by an adverse price shock that shifts up the SRAS curve, leading to a lower level of output and a higher price level. 7. To some extent, the rationale for an upward-sloping SRAS curve and the rationale for an upward- sloping industry supply curve are the same: both are based on an assumption that input prices are held constant. In microeconomics, if the market price rises while all else is held constant, a profit-maximizing firm will find that its profit will rise if it produces more; this produces an upward-sloping supply curve. In macroeconomics, the assumption behind the upward-sloping SRAS curve is that input prices, such as wages, lag behind the price level; a rise in the price level therefore gives firms a profit incentive to expand output in the short run. 8. The short-run Phillips curve shows that, for given inflationary expectations, there is an inverse relationship between actual unemployment and the inflation rate. 9. The expectations-augmented Phillips curve model shows that there is an inverse relationship between unemployment and inflation only in the short run; once inflation adjusts, this relationship no longer exists. Therefore, there is no tradeoff between unemployment and inflation.
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