Microsoft Word - Solution-Chapter-10

Microsoft Word - Solution-Chapter-10 - Chapter 27 1 The...

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C h a p t e r 2 7 1. The following events have occurred at times in the history of the United States: A deep recession hits the world economy. The world oil price rises sharply. U.S. businesses expect future profits to fall. a. Explainforeacheventwhetheritchangesshort-runaggregate supply, long-run aggregate supply, aggregate demand, or some combination of them. A deep recession inthe world economy decreases aggregate demand. A sharp rise in oil prices decreases short-run aggregate supply. The expectation of lower future profits decreases investment and decreases aggregate demand. b. Explain the separate effects of each event on U.S. real GDP and the price level, starting from a position of long-run equilibrium. A deep recession inthe world economy decreases aggregatedemand, which decreases real GDP and lowers the price level. A sharp rise in oil prices decreases short-run aggregate supply, which decreases real GDP and raises the price level. The expectation of lower future profits decreases investment and decreases aggregate demand, which decreases real GDP and lowers the price level. c. Explain the combined effects of these events on U.S. real GDP and the price level, starting from a position of long-run equilibrium. The combined effect of a deep recession in the world economy, a sharp rise in oil prices, and the expectation of lower future profits decreases both aggregate demand and short-run aggregate supply,whichdecreasesrealGDPandthepricelevelrises,falls, or remains the same. d. Describe what a classical macroeconomist, a Keynesian, and a monetarist would want todo in response toeachof theabove events. Classical and monetarist economists probably would recommend no policy action for all three of the events. If they suggested any policy at all, the policy would involve cutting taxes. A Keynesian economist likely would suggest several policies for all three events, such as the U.S. government should increase aggregate demand by increasing its expenditure on goods and services or by cutting taxes. The Keynesian economist alsowouldsuggestthatthe Fed should increase the quantity of money and lower interest rates. Real GDP demanded Real GDP supplied in the short run Price level (billions of 2001 pounds) 100 1,150 1,050 110 1,100 1,100 120 1,050 1,150 130 1,000 1,200 140 950 1,250 150 900 1,300 160 850 1,350
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A G G R E G A TE S U P P L Y A N D A G G RE G AT E D E M A N D 1 5 6 2. In the United Kingdom, potential GDP is 1,050 billion pounds and the table shows the aggregate demand and short-run aggregate supply schedules. a. What is the short-run equilibrium real GDP and price level? The short-run equilibrium real GDP and price level are determined by the price level that sets the quantity of real GDP demanded equal to the quantity of real GDP supplied in the short run. From the table, the short-run equilibrium real GDP is £1,100 billion and the price level is 110.
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