Econ_2030_Final_Exam_Answers

Econ_2030_Final_Exam_Answers - Chapter 27 Aggregate Demand...

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Questions and Exercises 1. The central difference between activist and laissez-faire economists is their differing views about whether the economy is self-regulating. Laissez-faire economists (Classicals) believe the pricing mechanism will bring the economy to an equilibrium (potential output and full employment). Keynesians, on the other hand, believe that the government sometimes needs to use fiscal policies (such as changing tax levels and government spending) in order to keep the economy from getting stuck above or below potential output and full employment. 2. Classicals felt that if the wage level fell, the Depression would end. They saw labor unions as preventing the fall in wages, and they believed that government lacked the political will to break up unions. 3. One expects the AD curve to be vertical because when the price level rises, all prices rise together. That is, since wages have risen as much as prices for consumer goods, no relative prices have changed and therefore people’s decisions to consume should not change either. 4. Five factors that shift the AD curve are: changes in foreign income, changes in expectations, changes in exchange rates, changes in the distribution of income, and changes in governmental aggregate demand policy. 5. a. A rise in the price level reduces the value of cash people hold. They withdraw more from their banks to regain that value, which reduces the amount banks have to lend. The interest rate rises, which reduces investment expenditures. b. Assuming fixed exchange rates, a rise in the price level would make goods less internationally competitive. This would lead to a decrease in net exports. c. When there is a rise in the price level the holders of money become poorer so they will buy less. 6. a. The AD curve will be steeper because a change in the price level will be offset by a change in the exchange rate eliminating the international effect on the AD curve. b. The AD curve will become steeper if a fall in the price level doesn't make people feel richer since the fall in the price will not cause them to increase their expenditures. This is an example of the money wealth effect not holding true. c. The AD curve will be steeper if a fall in the price level creates expectations of a further fall in the price level (it may even be backward bending) since the fall in the price level will cause people to reduce their present expenditures in the hope of getting more for their money in the future. d. Assuming that poor people spend a higher percentage of their income than rich people (as suggested by the data), the AD curve will shift to the right. e. The AD curve will shift to the right by a multiple of 20 (the multiplier effect). 1
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Econ_2030_Final_Exam_Answers - Chapter 27 Aggregate Demand...

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