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Unformatted text preview: Chapter 10 Problem Set--Answer
1. Explain why the long-run aggregate supply curve is vertical. Real GDP (output) of the economy in the long run is determined by the productivity of
resources and technology, not the level of prices (ﬁxed). A vertical LRAS also
represents full employment and is like the PPC. 2. Explain why (three reasons) the aggregate demand curve is downward sloping.
a. Real Balance effect: A rise in the price level decreases the real value ofa given
amount of money balances and planned spending will decrease.
b. Interest rate effect: Higher prices lead to more borrowing and thus an increase
in interest rates.
c. Open economy effect: An increase in the price level in the United States makes
U.S. goods relatively more expensive compared with foreign produced goods. Net exports falls 3. Draw a diagram with aggregate demand, and long-run aggregate supply. Be careful to
label all curves and axes correctly. LRAS 140
- AD OLA—F—J—ﬁl_L_L__|___|_‘ Price Level 9 1O 11 12 13 14 15 16 Real GDP pcrYear
($ trillions) 4. Explain which of the following affect the LRAS or AD? a. The state government of Indiana increases spending for IU. Increase AD increase G b. Due to concerns about their future people increase their savings.
Affects both LRAS (savings rises) and AD (C falls) c. The Fed lowers interest rates.
Increases AD through C, I & X d. The federal government increases cigarette prices taxes.
Decreases AD through C (note: may or may not increase G, since taxes are the income for G) c. Retraining efforts make people more productive workers.
Increases LRAS 5. Use the LRAS-AD model to illustrate the long-run effects of such shifts (a-e) above. LRAS
85 AD 0 10 20 30 40 50
RGDP You’ll have to draw the shifts described below. a. The state government of Indiana increases spending for 1U. Increase AD: Prices rise, no change in GDP or employment b. Due to concerns about their ﬁJture people increase their savings.
Affects both LRAS (savings) rises and AD (through C) falls: Prices fall, GDP and
employment rise 0. The Fed lowers interest rates. Increase AD: Prices rise, no change in GDP or employment d. The federal government increases cigarette prices taxes.
Decreases AD Prices fall, no change in GDP or employment e. Retraining efforts make people more productive workers. Increases LRAS: Prices fall, GDP and employment rise ...
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- Fall '11