Chat with AIExam 8: The Aggregate Demand-Aggregate Supply Model
What are feedback effects, and how does the AS/AD model incorporate them?
(38) 
VerifiedFeedback effects occur when people believe that changes in output or prices will continue, and that these changes themselves signal changes in the health of the economy, and not the other way around.Feedback effects can cause serious problems for the economy by destabilizing it.The AS/AD model does not incorporate feedback effects, but rather assumes that they do not exist.
Why might we expect the AD curve to be vertical?
(31) VerifiedWe might expect the AD curve to be vertical, because the price level is simply a numeraire-a reference point.For example, if the price of all things, including your wages, doubled, relative prices would not have changed and you would not change your choices.
Imagine you are the chief economist on the President's Council of Economic Advisers.The President has asked you to develop a policy that she can announce during her upcoming State of the Union Address.Your staff knows the President has a fondness for the SAS-AD model.Unfortunately, you can't you give her solid policy prescriptions based on that model because you do not know the location of the LAS curve.Explain why that is a serious problem.
(35) VerifiedUnfortunately, on the basis of an AD-SAS diagram you are not able to give any policy advice to the President because your staff has not told you where potential output (LAS) is.If potential output is equal to the AD-SAS equilibrium output, you can tell the President to announce everything is great and we'll have more of the same.If the potential output is greater than the AD-SAS equilibrium, the economy is in a recessionary gap and you would likely suggest to the President that she announce some new spending or tax cut programs to increase AD.If the potential output is less than the AD-SAS equilibrium output, the economy is in an inflationary gap.You can then advise the President to either; wait it out and let the economy correct itself or reduce government spending to decrease AD.Which policy advice to give? You cannot know unless you can come up with an accurate assessment of where potential output is.And that is no easy task.
Short Answer Questions
What are the three ways that falling asset prices can affect aggregate demand?
(42) Explain verbally and demonstrate graphically how in an AS/AD model with dynamic feedback effects, a decline in the price level can lead to a vicious downward spiral.
(38) Consider the following diagram 
Demonstrate graphically and explain verbally the impact of a decrease of 50 in government spending on the AD curve in the diagram when the multiplier is 3.
Demonstrate graphically and explain verbally the impact of a decrease of 50 in government spending on the AD curve in the diagram when the multiplier is 3. (33) Describe two distinct and opposing effects that a fall in interest rates (that are not caused by changes in the price level) could have on the AS/AD model.
(31) Demonstrate graphically and explain verbally the case of an inflationary gap.Describe the forces in the economy that will result in the gap closing itself.
(44) Demonstrate graphically and explain verbally a recessionary gap.Describe two solutions for closing the gap.
(39) Suppose the economy is in an inflationary gap, as illustrated by point A in the diagram below: 
Suppose that everyone knows that inflationary gaps lead to cost pressures that will eventually result in the price level rising.Since people expect the price level to rise soon, suppose they increase their buying now (before prices rise).Demonstrate graphically and explain verbally how this will complicate the economy's adjustment story described in the text.
Suppose that everyone knows that inflationary gaps lead to cost pressures that will eventually result in the price level rising.Since people expect the price level to rise soon, suppose they increase their buying now (before prices rise).Demonstrate graphically and explain verbally how this will complicate the economy's adjustment story described in the text. (23) What is the difference, in terms of the time frame of analysis, between Classicals and Keynesians?
(42) What are the effects of an increase in aggregate demand (AD) in the short run and the long run? What is the effect of an increase in the short run aggregate supply (SAS)? What is the effect of an increase in Long run Aggregate Supply (LAS)?
(44) If the price level had more flexibility, would recessions and depressions be less likely?
(35) Assuming the economy is in long-run equilibrium, using an AS/AD diagram, demonstrate graphically and explain verbally the long-run impact on the price level and real output of an expectation by business executives of a recession in the near future.
(40) If an economist argues that equilibrium output differs from potential output, is that economist most likely a Keynesian or Classical economist?
(37) 
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