Principles of Macroeconomics: Economics 201

Fall 2015 (Starts, 08/31/2015, Ends 12/20/2015)

Instructor:
Kaycea Campbell, Ph.D.
e-Mail:
kcampbel@chapman.edu
Class Section:
9111/9112
Office Hours:
2:30 4:00 pm on M/W Location (BK 403, Cubicle 1)

Participation #8 (Key)

Question 1
Why is AD curve downward sloping? List and explain the three effects

The aggregate demand (AD) curve shows that as the price level drops, purchases of real
domestic output increase. The AD curve slopes downward for three reasons. The first is
the interest rate effect. We assume the supply of money to be fixed. When the price level
increases, more money is needed to make purchases and pay for inputs. With the money
supply fixed, the increased demand for it will drive up its price, the rate of interest. These
higher rates will decrease the buying of goods with borrowed money, thus decreasing the
amount of real output demanded.
The second reason is the real balances effect. As the price level rises, the real valuethe
purchasing powerof money and other accumulated financial assets (bonds, for instance)
will decrease. People will therefore become poorer in real terms and decrease the quantity
demanded of real output.
The third reason is the foreign purchases effect. As the United States price level rises
relative to other countries, Americans will buy more abroad in preference to their own output. At the same time foreigners,
finding American goods and services relatively more expensive, will decrease their buying of American exports. Thus, with
increased imports and decreased exports, American net exports decrease and so, therefore, does the quantity demanded of
American real output.
Question 2
Draw the. AS curve. Identify the ranges on the graph

Horizontal range, upsloping/intermediate range (SRAS), vertical range (LRAS). Read in notes. All of these ranges show a
relationship between actual output and full employment.

Multiple Choice Questions

1.

The aggregate demand curve:

A)
is upsloping because a higher price level is necessary to make production profitable as production costs rise.
B)
is downsloping because production costs decline as real output increases.
C)
shows the amount of expenditures required to induce the production of each possible level of real output.
D)
shows the amount of real output which will be purchased at each possible price level.

2.

The aggregate demand curve shows the:

A)
inverse relationship between the price level and real GDP purchased.
B)
direct relationship between the price level and real GDP produced.
C)
inverse relationship between interest rates and real GDP produced.
D)
direct relationship between real-balances and real GDP purchased.

3.

The aggregate demand curve is:

A)
vertical if full employment exists.
B)
horizontal when there is considerable unemployment in the economy.
C)
downsloping because of the interest-rate, wealth or real balances, and foreign trade effects.
D)
downsloping because production costs decrease as real output increases.

4.

The interest-rate effect suggests that:

A)
a decrease in the supply of money will increase interest rates and reduce interest-sensitive consumption and investment spending.
B)
an increase in the price level will increase the demand for money, reduce interest rates, and decrease consumption and investment
spending.
C)
an increase in the price level will increase the demand for money, increase interest rates, and decrease consumption and
investment spending.
D)
an increase in the price level will decrease the demand for money, reduce interest rates, and increase consumption and investment
spending.
The real-balance effect indicates that:
A)
an increase in the price level will increase the demand for money, increase interest rates, and reduce consumption and investment
spending.
B)
a lower price level will decrease the real value of many financial assets and therefore reduce spending.
C)
a higher price level will increase the real value of many financial assets and therefore increase spending.
D)
a higher price level will decrease the real value of many financial assets and therefore reduce spending.

5.

6.

The interest-rate and real-balance effects are important because they help explain:
A)
rightward and leftward shifts of the aggregate demand curve.
B)
why demand-management policy cannot be used effectively to curb stagflation.
C)
the shape of the aggregate demand curve.
D)
the shape of the aggregate supply curve.

7.

Other things being equal, the higher the price level, the lower the level of domestic output purchased. This occurs because of:
A)
the real-balance effect.
B)
consumer spending on capital goods.
C)
the full-employment-unemployment rate.
D)
the sensitivity to demand-pull inflation

8.

The long-run aggregate supply curve is vertical:

A)
because the rate of inflation is steady in the long run.
B)
because resource prices eventually catch up with product prices.
C)
because product prices always increase at a faster rate than resource prices.
D)
only when the money supply increases at the same rate as real GDP.

9.

The short-run aggregate supply curve is upsloping because:

A)
of the interest-rate effect.
B)
higher price levels create incentives to expand output when resource prices remain constant.
C)
of the net export effect.
D)
higher price levels create an expectation among producers of still higher price levels.

10.

Other things equal, a decrease in the price level will:

A)
shift the aggregate supply curve to the left.
B)
shift the aggregate demand curve to the left.
C)
cause a movement up a short-run aggregate supply curve.
D)
cause a movement down an aggregate supply curve.