# Chapter 22. Aggregate Demand and Supply Analysis Aggregate Demand

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1 Chapter 22 Aggregate Demand and Supply Analysis 22.1 Aggregate Demand 1) The aggregate demand curve is the total quantity of an economyʹs A) intermediate goods demanded at all price levels. B) intermediate goods demanded at a particular price level. C) final goods and services demanded at a particular price level. D) final goods and services demanded at different price levels. 2) The total quantity of an economyʹs final goods and services demanded at different price levels is A) the aggregate supply curve. B) the aggregate demand curve. C) the Phillips curve. D) the aggregate expenditure function. 3) According to the quantity theory of money, changes in the money supply are A) unrelated to changes in the price level. B) unrelated to changes in inflation. C) unrelated to shifts in the aggregate demand curve. D) the primary source of changes in aggregate spending. 4) The quantity theory of money concludes that changes in aggregate spending are primarily determined by changes in A) government spending and taxes. B) the velocity of money. C) interest rates. D) the money supply.

2 Chapter 22 Aggregate Demand and Supply Analysis 595 5) The average number of times per year that a dollar is spent on final goods and services is called A) velocity. B) acceleration. C) the equation of exchange. D) nominal output. 6) Suppose nominal GDP is equal to \$200 trillion and the money supply equals \$50 trillion. In this case, the velocity of money is equal to. A) 1 B) 2 C) 4 D) 5 7) Suppose real GDP is equal to \$100 trillion, the money supply is equal to \$50 trillion and the price level is equal to 2. In this case, the velocity of money is equal to. A) 1 B) 2 C) 4 D) 5 8) The quantity theory of money is derived from A) the concept of velocity. B) the Keynesian monetary transmission mechanism. C) the equation of exchange. D) the money supply.

3 596 Mishkin Economics of Money, Banking, and Financial Markets, Eighth Edition 9) As approached through the quantity theory of money, aggregate demand is derived from A) the equation of exchange. B) its three component parts: consumer expenditure, investment spending, and government spending. C) its four component parts: consumer expenditure, investment spending, government spending, and net exports. D) the spending multiplier. 10) The aggregate demand curve slopes downward because a decrease in the price level means in the real money supply and therefore a level of real spending. A) an increase; higher B) an increase; lower C) a decrease; lower D) a decrease; higher 11) According to the quantity theory of money approach to aggregate demand, an increase in the money supply, other things equal, aggregate. C) decreases; supply D) increases; supply 12) According to the quantity theory of money approach to aggregate demand, a decrease in the money supply, other things equal, aggregate. C) decreases; supply D) increases; supply

4 Chapter 22 Aggregate Demand and Supply Analysis ) One way to derive aggregate demand is by looking at its four component parts, which are: A) consumer expenditures, planned investment spending, government spending, and net exports. B) consumer expenditures, actual investment spending, government spending, and net exports. C) consumer expenditures, planned investment spending, government spending, and gross exports. D) consumer expenditures, planned investment spending, government spending, and taxes. 14) By analyzing aggregate demand through its component parts, we can conclude that, everything else held constant, a decline in the price level causes A) a decline in the real money supply, an increase in interest rates, a decline in investment spending, and a decline in aggregate output demand. B) a decline in the real money supply, a decline in interest rates, an increase in investment spending, and an increase in aggregate output demand. C) an increase in the real money supply, a decline in interest rates, an increase in investment spending, and an increase in aggregate output demand. D) an increase in the real money supply, an increase in interest rates, a decline in investment spending, and a decline in aggregate output demand. 15) By looking at aggregate demand via its component parts, we can conclude that the aggregate demand curve is downward sloping because A) a lower price level, holding the nominal quantity of money constant, leads to a larger quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending. B) a lower price level, holding the nominal quantity of money constant, leads to a larger quantity of money in nominal terms, causes the interest rate to rise, and stimulates planned investment spending. C) a higher price level, holding the nominal quantity of money constant, leads to a larger quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending. D) a higher price level, holding the nominal quantity of money constant, leads to a smaller quantity of money in real terms, causes the interest rate to fall, and stimulates planned investment spending.

5 598 Mishkin Economics of Money, Banking, and Financial Markets, Eighth Edition 16) By looking at aggregate demand through its component parts, we can conclude that a price level the real quantity of money, higher spending. A) lower; expands; encouraging B) higher; contracts; encouraging C) lower; contracts; discouraging D) higher; expands; encouraging 17) By analyzing aggregate demand via its component parts, we can conclude that changes in the money supply A) have no effect on aggregate demand. B) affect aggregate demand in the opposite direction of the change in government spending. C) affect aggregate demand in the same direction as the change in government spending. D) affect the quantity of aggregate output demand. 18) An increase in government spending, other things equal, aggregate. C) decreases; supply D) increases; supply 19) A decrease in government spending, other things equal, aggregate. C) decreases; supply D) increases; supply

6 Chapter 22 Aggregate Demand and Supply Analysis ) A decrease in net taxes, other things equal, aggregate. C) decreases; supply D) increases; supply 21) An increase in net taxes, other things equal, aggregate. C) decreases; supply D) increases; supply 22) Everything else held constant, a balanced budget increase in government spending (that is, an increase in government spending that is matched by an identical increase in net taxes) will A) increase aggregate demand, but not by as much if just government spending increases. B) increase aggregate demand by more than if just government spending increases. C) will not affect aggregate demand. D) decrease aggregate demand. 23) An increase in net exports, other things equal, aggregate. C) decreases; supply D) increases; supply

7 600 Mishkin Economics of Money, Banking, and Financial Markets, Eighth Edition 24) A decrease in net exports, other things equal, aggregate. C) decreases; supply D) increases; supply 25) Everything else held constant, an increase in planned investment expenditure aggregate. C) decreases; supply D) increases; supply 26) Everything else held constant, a decrease in planned investment expenditure aggregate. C) decreases; supply D) increases; supply 27) Everything else held constant, aggregate demand increases when A) taxes are cut. B) government spending is reduced. C) animal spirits decrease. D) the money supply is reduced.

8 Chapter 22 Aggregate Demand and Supply Analysis ) Everything else held constant, aggregate demand increases when A) net exports decrease. B) taxes increase. C) planned investment spending increases. D) the money supply decreases. 29) Everything else held constant, which of the following does not cause aggregate demand to increase? A) An increase in net exports. B) An increase in government spending. C) An increase in taxes. D) An increase in consumer optimism. 30) Explain through the component parts of aggregate demand why the aggregate demand curve slopes down with respect to the price level. Be sure to discuss two channels through which changes in prices affect demand. fall in the price level increases the real value of a fixed nominal money supply. This increase in the real money supply lowers interest rates. Lower rates increase investment, thereby increasing aggregate demand. Lower interest rates also cause depreciation of the domestic currency, increasing net exports and aggregate demand Aggregate Supply 1) The aggregate supply curve is the total quantity of A) raw materials offered for sale at different prices. B) final goods and services offered for sale at the current price level. C) final goods and services offered for sale at different price levels. D) intermediate and final goods and service offered for sale at different price levels.

9 602 Mishkin Economics of Money, Banking, and Financial Markets, Eighth Edition 2) The aggregate supply curve shows the relationship between A) the level of inputs and aggregate output. B) the price level and the level of inputs. C) the wage rate and the level of employment. D) the price level and the level of aggregate output supplied. Ques Status: Previous Edition 3) The long-run rate of unemployment to which an economy always gravitates is the A) normal rate of unemployment. B) natural rate of unemployment. C) neutral rate of unemployment. D) inflationary rate of unemployment. 4) The long-run aggregate supply curve is A) a vertical line through the non-inflationary rate of output. B) a vertical line through the current level of output. C) a vertical line through the natural rate level of output. D) a horizontal line through the current level of output. Ques Status: Previous Edition 5) The long-run aggregate supply curve is a vertical line passing through A) the natural rate of output. B) the natural-rate price level. C) the actual rate of unemployment. D) the expected rate of inflation.

10 Chapter 22 Aggregate Demand and Supply Analysis 603 6) The short-run aggregate supply curve is upward sloping because in the short run, costs of many factors that go into producing goods and services are, meaning that the price for a unit of output will relative to input prices and the profit per unit will rise. A) fixed; rise B) fixed; fall C) flexible; rise D) flexible; fall 7) The positively sloped short-run aggregate supply curve reflects the assumption that factor prices are A) more flexible than output prices. B) less flexible than output prices. C) fixed in the long run. D) perfectly flexible in both the short run and the long run. 8) Everything else held constant, an increase in the cost of production aggregate. C) increases; supply D) decreases; supply 9) Everything else held constant, a decrease in the cost of production aggregate. C) increases; supply D) decreases; supply

11 604 Mishkin Economics of Money, Banking, and Financial Markets, Eighth Edition 10) Everything else held constant, when output is the natural rate level, wages will begin to, increasing short-run aggregate supply. A) above; fall B) above; rise C) below; fall D) below; rise 11) Everything else held constant, when output is the natural rate level, wages will begin to, decreasing short-run aggregate supply. A) above; fall B) above; rise C) below; fall D) below; rise 12) Everything else held constant, when actual output exceeds the natural rate of output aggregate supply. A) short-run; decreases B) short-run; increases C) long-run; increases D) long-run; decreases 13) If workers demand and receive higher real wages (a successful wage push), the cost of production and the short-run aggregate supply curve shifts. A) rises; leftward B) rises; rightward C) falls; leftward D) falls; rightward

12 Chapter 22 Aggregate Demand and Supply Analysis ) Everything else held constant, if workers expect an increase in the price level, aggregate supply. A) long-run; increases B) long-run; decreases C) short-run; decreases D) short-run; increases 15) Everything else held constant, a change in workersʹ expectations about the aggregate price level will cause to change. A) aggregate demand B) short-run aggregate supply C) the production function D) long-run aggregate supply 16) A decrease in the availability of raw materials that increases the price level is called a shock A) negative demand B) positive demand C) negative supply D) positive supply 17) A negative supply shock causes to. A) aggregate demand; increase B) aggregate demand; decrease C) short-run aggregate supply; decrease D) short-run aggregate supply; increase

13 606 Mishkin Economics of Money, Banking, and Financial Markets, Eighth Edition 18) A positive supply shock causes to. A) aggregate demand; increase B) aggregate demand; decrease C) short-run aggregate supply; decrease D) short-run aggregate supply; increase 19) Which of the following increases aggregate supply in the short-run, everything else held constant? A) An increase in the price of crude oil. B) A successful wage push by workers. C) Expectations of a higher aggregate price level. D) A technological improvement that increases worker productivity Equilibrium in Aggregate Supply and Demand Analysis 1) The fact that an economy always returns to the natural rate level of output is known as A) the excess demand hypothesis. B) the price-adjustment mechanism. C) the self-correcting mechanism. D) the natural rate of unemployment. 2) Assuming the economy is starting at the natural rate of output and everything else held constant, the effect of in aggregate is a rise in both the price level and output in the short-run, but in the long-run the only effect is a rise in the price level. A) a decrease; supply B) a decrease; demand C) an increase; supply D) an increase; demand

14 Chapter 22 Aggregate Demand and Supply Analysis 607 3) The aggregate demand-aggregate supply framework indicates that the long-run effect of a in the money supply is an increase in, everything else held constant. A) fall; aggregate output B) fall; the price level C) rise; aggregate output D) rise; the price level 4) Suppose the economy is producing at the natural rate of output. Everything else held constant, the development of a new, more productive technology will cause in the unemployment rate and in the aggregate price level in the short run. C) a decrease; an increase D) no change; no change 5) Suppose the economy is producing at the natural rate of output. Assuming a fixed natural rate of output and everything else held constant, the development of a new, more productive technology will cause in the unemployment rate and the aggregate price level in the long run. C) a decrease; an increase D) no change; no change 6) Suppose the economy is producing at the natural rate of output. An increase in consumer and business confidence will cause in real GDP and in the aggregate price level in the short run, everything else held constant.

15 608 Mishkin Economics of Money, Banking, and Financial Markets, Eighth Edition 7) Suppose the economy is producing at the natural rate of output. An increase in consumer and business confidence will cause in real GDP and in the aggregate price level in the long run, everything else held constant. 8) Suppose the economy is producing at the natural rate of output. A decrease in consumer and business confidence will cause in real GDP and in the aggregate price level in the short run, everything else held constant. 9) Suppose the economy is producing at the natural rate of output. A decrease in consumer and business confidence will cause in real GDP and in the aggregate price level in the long run, everything else held constant. 10) Suppose the economy is producing at the natural rate of output. An open market purchase of bonds by the Fed will cause in real GDP and in the aggregate price level in the short run, everything else held constant.

16 Chapter 22 Aggregate Demand and Supply Analysis ) Suppose the economy is producing at the natural rate of output. An open market purchase of bonds by the Fed will cause in real GDP and in the aggregate price level in the long run, everything else held constant. 12) Suppose the economy is producing at the natural rate of output. An open market sale of bonds by the Fed will cause in real GDP and in the aggregate price level in the short run, everything else held constant. 13) Suppose the economy is producing at the natural rate of output. An open market sale of bonds by the Fed will cause in real GDP and in the aggregate price level in the long run, everything else held constant. 14) Suppose the U.S. economy is producing at the natural rate of output. A depreciation of the U.S. dollar will cause in real GDP and in the aggregate price level in the short run, everything else held constant. (Assume the depreciation causes no effects in the supply side of the economy.)

17 610 Mishkin Economics of Money, Banking, and Financial Markets, Eighth Edition 15) Suppose the U.S. economy is producing at the natural rate of output. A depreciation of the U.S. dollar will cause in real GDP and in the aggregate price level in the long run, everything else held constant. (Assume the depreciation causes no effects in the supply side of the economy.) 16) Suppose the U.S. economy is producing at the natural rate of output. An appreciation of the U.S. dollar will cause in real GDP and in the aggregate price level in the short run, everything else held constant. (Assume the appreciation causes no effects in the supply side of the economy.) 17) Suppose the U.S. economy is producing at the natural rate of output. An appreciation of the U.S. dollar will cause in real GDP and in the aggregate price level in the long run, everything else held constant. (Assume the appreciation causes no effects in the supply side of the economy.)

18 Chapter 22 Aggregate Demand and Supply Analysis ) Suppose the economy is producing below the natural rate of output and the government is suffering from large budget deficits. To deal with the deficit problem, suppose the government takes a policy action to reduce the size of the deficits. This policy action will cause in the unemployment rate and in the aggregate price level in the short run, everything else held constant. C) a decrease; an increase D) an increase; a decrease 19) Suppose the economy is producing at the natural rate of output and the government passes legislation that severely restricts a companyʹs ability to reduce production costs via outsourcing. Everything else held constant, this policy action will cause in the unemployment rate and in the aggregate price level in the short run. C) a decrease; an increase D) no change; no change 20) Suppose the U.S. economy is operating at potential output. A negative supply shock that is accommodated by an open market purchase by the Federal Reserve will cause in real GDP and in the aggregate price level in the long run, everything else held constant. A) no change; an increase B) no change; a decrease C) an increase; an increase D) a decrease; a decrease 21) A theory of aggregate economic fluctuations called real business cycle theory holds that A) changes in the real money supply are the only demand shocks that affect the natural rate of output. B) aggregate demand shocks do affect the natural rate of output. C) aggregate supply shocks do affect the natural rate of output. D) changes in net exports are the only demand shocks that affect the natural rate of output. Ques Status: Previous Edition

19 612 Mishkin Economics of Money, Banking, and Financial Markets, Eighth Edition 22) This theory views shocks to tastes (workersʹ willingness to work, for example) and technology (productivity) as the major driving forces behind short-run fluctuations in the business cycle because these shocks lead to substantial short-run fluctuations in the natural rate of output. A) The natural rate hypothesis B) Hysteresis C) Real business cycle theory D) The Phillips curve model Ques Status: Previous Edition 23) Because shifts in aggregate demand are not viewed as being particularly important to aggregate output fluctuations, they do not see much need for activist policy to eliminate high unemployment. ʺTheyʺ refers to proponents of A) the natural rate hypothesis. B) monetarism. C) the Phillips curve model. D) real business cycle theory. Ques Status: Previous Edition 24) A group of economists believe that the natural rate of output is affected by aggregate shocks. They contend that the natural rate level of unemployment and output are subject to, a departure from full employment levels as a result of past high unemployment. A) supply; hysterisis B) supply; systerisis C) demand; hysterisis D) demand; systerisis Ques Status: Previous Edition 25) A reduction of aggregate demand may raise the natural rate of unemployment above the full employment level, meaning that the self-correcting mechanism will only be able to return the economy to the natural rate level of output and unemployment not to the full employment levels. Such a view is consistent with A) monetarism. B) hysterisis. C) Keynesianism. D) real business cycle theory. Ques Status: Previous Edition

20 Chapter 22 Aggregate Demand and Supply Analysis ) According to aggregate demand and supply analysis, Americaʹs involvement in the Vietnam War had the effect of A) increasing aggregate output, lowering unemployment, and raising the price level. B) decreasing aggregate output, lowering unemployment, and lowering the price level. C) increasing aggregate output, raising unemployment, and raising the price level. D) decreasing aggregate output, raising unemployment, and lowering the price level. 27) According to aggregate demand and supply analysis, the negative supply shocks of and had the effect of A) increasing aggregate output, lowering unemployment, and raising the price level. B) decreasing aggregate output, raising unemployment, and raising the price level. C) increasing aggregate output, raising unemployment, and raising the price level. D) decreasing aggregate output, raising unemployment, and lowering the price level. 28) According to aggregate demand and supply analysis, the favorable supply shock of had the effect of A) increasing aggregate output, lowering unemployment, and raising inflation. B) decreasing aggregate output, raising unemployment, and raising inflation. C) increasing aggregate output, lowering unemployment, and lowering inflation. D) decreasing aggregate output, raising unemployment, and lowering inflation. 29) According to aggregate demand and supply analysis, the negative demand shock of had the effect of A) increasing aggregate output, lowering unemployment, and raising inflation. B) decreasing aggregate output, raising unemployment, and raising inflation. C) increasing aggregate output, lowering unemployment, and lowering inflation. D) decreasing aggregate output, raising unemployment, and lowering inflation.

21 614 Mishkin Economics of Money, Banking, and Financial Markets, Eighth Edition 30) Using the aggregate demand-aggregate supply model, explain and demonstrate graphically the short-run and log-run effects of an increase in the money supply. Answer: See figure below. An increase in the money supply increases aggregate demand, from AD1 to AD2. The economy moves from point 1 to point 1ʹ. In the short run both the price level and real output increase. In the long run, wages adjust, decreasing short-run aggregate supply, to AS2, raising prices further and reducing real output until the economy returns to the natural level of output. The long-run result is to only increase the price level. The path is from 1 to 1ʹ to 2. 31) Explain and demonstrate graphically the effects of a negative supply shock in both the short-run and long-run. Answer: See figure below. The supply shock decreases short-run aggregate supply from AS1 to AS2, reducing real output and raising the price level, or from points 1 to 2 in the graph. In the long run, the supply curve eventually adjusts back to the original position as wages fall. The economy adjusts from 2 back to 1.

22 Chapter 22 Aggregate Demand and Supply Analysis Web Appendix: Aggregate Supply and the Phillips Curve 1) The Phillips curve indicates that when the labor market is, production costs will and aggregate supply increases. A) easy; rise B) easy; fall C) tight; fall D) tight; rise 2) The Phillips curve indicates that when the labor market is, production costs will and aggregate supply decreases. A) easy; rise B) easy; fall C) tight; fall D) tight; rise 3) The expectations-augmented Phillips curve implies that as expected inflation increases, nominal wages to prevent real wages from. A) fall; rising B) fall; falling C) rise; falling D) rise; rising Ques Status: Previous Edition 4) The Lucas supply function indicates that deviations of unemployment from the natural rate level respond to A) any increase in aggregate demand. B) unanticipated inflation. C) a supply shock. D) expected changes in inflation.

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