Exam 10: Aggregate Demand I: Building the Is-Lm Model

The assumption of constant velocity in the quantity equation is the equivalent of the assumption of a constant:

If an aggregate demand curve is drawn with real GDP (Y) along the horizontal axis and the price level (P) along the vertical axis, using the quantity theory of money as a theory of aggregate demand, this curve slopes to the right and gets as it moves farther to the right.

In the long run, the level of output is determined by the:

Throughout much of the 1990s, the United States experienced declining energy prices. Assume that the U.S. economy was in long-run equilibrium before these declines began. a. Use the aggregate demand-aggregate supply model to illustrate graphically the short-run and long-run impact of this decline on output and prices. b. If the Federal Reserve attempted to offset this deviation from the natural rate in the short run, should the money supply be increased or decreased?

Measures of average workweeks and of supplier deliveries (vendor performance) are included in the index of leading indicators, because shorter workweeks tend to indicate future economic activity and slower deliveries tend to indicate future economic activity.

Over the business cycle, investment spending consumption spending.

Monetary policy can be either a stabilizing influence on the economy or a source of instability. Give an explanation for both possibilities.

When the French money supply was reduced by 45 percent over a period of seven months in 1724, the only values in the economy that adjusted fully and instantaneously were:

Explain the meaning of monetary neutrality and illustrate graphically that there is monetary neutrality in the long run in the aggregate demand-aggregate supply model. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; v. the short-run equilibrium values; and vi. the long-run equilibrium values. Explain in words what your graph illustrates.

Suppose that laws are passed banning labor unions and that resulting lower labor costs are passed along to consumers in the form of lower prices. Use the aggregate demand-aggregate supply model to illustrate graphically the impact in the short run and the long run of this favorable supply shock. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; v. the short-run equilibrium values; and vi. the long-run equilibrium values. State in words what happens to prices and output in the short run and the long run.

If all prices are stuck at a predetermined level, then when a short-run aggregate supply curve is drawn with real GDP (Y) along the horizontal axis and the price level (P) along the vertical axis, this curve:

The long-run aggregate supply curve is vertical at the level of output:

An economy is initially in long-run equilibrium. The introduction of an electronic payments system dramatically reduces the demand for money in the economy. a. What is the short-run impact on prices and output of the new system? b. What can the central bank do, if anything, to counteract the short-run changes in output and prices? c. If the central bank does not take any policy actions, what will be the long-run impact of the electronic payments system on prices and output?

Looking at the aggregate demand curve alone, one can tell that will prevail in the economy.

Assume that the long-run aggregate supply curve is vertical at Y = 3,000 while the short-run aggregate supply curve is horizontal at P = 1.0. The aggregate demand curve is Y = 2(M/P) and M = 1,500. a. If the economy is initially in long-run equilibrium, what are the values of P and Y? b. If M increases to 2,000, what are the new short-run values of P and Y? c. Once the economy adjusts to long-run equilibrium at M = 2,000, what are P and Y?

Business cycles are:

An oil cartel effectively increases the price of oil by 100 percent, leading to an adverse supply shock in both Country A and Country B. Both countries were in long-run equilibrium at the same level of output and prices at the time of the shock. The central bank of Country A takes no stabilizing policy actions. After the short-run impacts of the adverse supply shock become apparent, the central bank of Country B increases the money supply to return the economy to full employment. a. Describe the short-run impact of the adverse supply shock on prices and output in each country. b. Compare the long-run impact of the adverse supply shock on prices and output in each country.

Suppose that droughts in the Southeast and floods in the Midwest substantially reduce food production in the United States. Use the aggregate demand-aggregate supply model to illustrate graphically the impact in the short run and the long run of this adverse supply shock. Be sure to label: i. the axes; ii. the curves; iii. the initial equilibrium values; iv. the direction the curves shift; v. the short-run equilibrium values; and vi. the long-run equilibrium values. State in words what happens to prices and output in the short run and the long run.

The natural level of output is:

For a fixed money supply, the aggregate demand curve slopes downward because at a lower price level real money balances are , generating a quantity of output demanded.