Chapter 20A
The Self-Correcting Demand and Supply Model
1. One reason for the short-run aggregate supply curve (SRAS) is
a. a fixed CPI market basket.
b. perfect knowledge of workers.
c. fixed-wage contracts.
d. the upward-sloping production function.
ANS
a. Incorrect. This is a meaningless response.
b. Incorrect. Incomplete knowledge is a reason for the short-run aggregate supply curve (SRAS).
c. Correct. Fixed-wage contracts hold wages fixed in the short run while firms can change product prices.
d. Incorrect. A production function relates output to resource inputs, which is not the relationship between the price level and real GDP.
2. The full-employment level of real GDP is the level that can be produced with
a. given technology and productive resources.
b. frictional and structural unemployment equal to zero.
c. cyclical unemployment equal to zero.
d. both a and b.
e. both a and c.
ANS
a. Incorrect. This is one of the correct answers.
b. Incorrect. At full employment, frictional and structural unemployment are expected to exist.
c. Incorrect. This is one of the correct answers.
d. Incorrect. Answer a. is correct, but answer b. is incorrect.
e. Correct. Both answer a. and c. are correct.
3. Which of the following would cause a decrease in the short-run aggregate supply curve (SRAS)?
a. an increase in oil prices.
b. an advance in technology.
c. an increase in the CPI.
d. an increase in the long-run aggregate supply curve (LRAS).
ANS
a. Correct. An increase in oil prices increases the CPI at each point along the SRAS and therefore the curve shifts leftward.
b. Incorrect. An advance in technology increases the real GDP produced at each point along the SRAS and therefore the curve shifts rightward.
c. Incorrect. An increase in the CPI causes an upward movement along the SRAS curve.
d. Incorrect. The long-run aggregate supply curve (LRAS) is determined by the level of full-employment real GDP and not the short-run aggregate supply curve (SRAS).
4. If nominal wages and salaries are fixed as firms change product prices, the short-run aggregate supply curve (SRAS) is
a. vertical.
b. horizontal.
c. negatively sloped.
d. positively sloped.
ANS
a. Incorrect. This means that aggregate supply remains unchanged regardless of changes in prices, which is only true at full employment in the long run.
b. Incorrect. This means that aggregate supply is infinite at a given price level, which is unrealistic.
c. Incorrect. This means that as prices fall, and profits fall because wages are fixed, firms increase aggregate supply, which is unrealistic.
d. Correct. The realistic argument is that, as prices rise, and profits rise because wages are fixed, firms increase production of real GDP.
5. Which of the following explains why the short-run aggregate supply curve is upward-sloping is because?
a. The quantity of real output supplied is inversely related to the aggregate supply curve.
b. Nominal incomes are fixed.
c. The capital-output ratio.
d. An increase in price will increase the supply of money.
ANS
a. Incorrect. Real GDP output is directly related to the aggregate supply curve in the short run.
b. Correct. Fixed wages and salaries is a key assumption for the short-run aggregate supply curve.
c. Incorrect. This answer is meaningless.
d. Incorrect. This answer is meaningless.
6. In an economy where nominal incomes adjust equally to changes in the price level, we would expect the long-run aggregate supply curve to be
a. vertical.
b. horizontal.
c. negatively sloped.
d. positively sloped.
ANS
a. Correct. At the full employment real GDP, the long-run aggregate supply curve is vertical.
b. Incorrect. Unrealistically, this would mean real GDP output is infinite at a given price level in the long run.
c. Incorrect. Unrealistically, there would mean that real GDP output rises as the price level falls, and the economy does not operate at full employment in the long run.
d. Incorrect. Unrealistically, this would mean that real GDP output rises as the price level rise, and the economy does not operate at full employment in the long run.
7. In the AD/AS model, a point where the economy’s long-run AS curve, short-run AS curve, and AD curve all intersect at a single point represents a point where
a. real GDP is equal to its full-employment level.
b. the conditions of short-run equilibrium are fulfilled.
c. the conditions of long-run equilibrium are fulfilled.
d. All of the above answers are correct .
e. Answers a and c are correct.
ANS
a. Incorrect. Answers b. and c. are also true.
b. Incorrect. Answers a. and c. are also true.
c. Incorrect. Answers a. and c. are also true.
d. Correct. Answers a., b., and c. are true.
e. Incorrect. Answers b. is true.
8. The intersection between the long-run aggregate supply and aggregate demand curves determines the
a. level of full-employment real GDP.
b. average level of prices (CPI).
c. marginal product.
d. both a and b.
ANS
a. Incorrect. Answer b. is also correct.
b. Incorrect. Answer a. is also correct.
c. Incorrect. This answer is meaningless.
d. Correct. Where AD equals LRAS, this is the price level where real GDP demanded by households equals real GDP output of firms.
9. The adjustment of nominal incomes to changes in the price level (CPI) is fixed because of the
a. volatility of investment spending.
b. existence of long-term contracts.
c. complete information possessed by workers.
d. All of the above answers are correct.
ANS
a. Incorrect. This is a meaningless answer.
b. Correct. Over time workers’ wage contracts expire and workers can
renegotiate their wages to maintain their real incomes.
c. Incorrect. Another reason for the fixed wages is the short-run assumption that workers have incomplete knowledge of price changes.
d. Incorrect. Only answer b is correct.
10. In the self-correcting AD/AS model, the economy’s short-run equilibrium
position is indicated by the intersection of which two curves?
a. short-run aggregate supply and long-run aggregate supply.
b. short-run aggregate supply and aggregate demand.
c. long-run aggregate supply and aggregate demand.
d. long-run aggregate demand and short-run personal consumption
expenditures curve.
ANS
a. Incorrect. The intersection of the short-run aggregate supply curve and the aggregate demand curve determines short-run equilibrium, and not the long-run aggregate supply curve.
b. Correct. Note that the intersection of the short-run aggregate supply and aggregate demand curves does not necessarily correspond to long-run equilibrium.
c. Incorrect. The intersection of the short-run aggregate supply curve and the aggregate demand curve determines short-run equilibrium, and not the long-run aggregate supply curve.
d. Incorrect. This is a meaningless answer.
11. Which of the following causes a leftward shift in the short-run aggregate supply curve?
a. an increase of goods prices while nominal incomes are unchanged.
b. an increase in nominal incomes.
c. an increase of full-employment real GDP.
d. an increase of personal consumption expenditures while the price level is
unchanged.
ANS
a. Incorrect. This situation results in an upward movement along the short-run
aggregate supply curve.
b. Correct. An increase in resource costs (nominal incomes of workers) means
firms must raise product prices at each level of real GDP to maintain profits.
c. Incorrect. This situation shifts the long-run aggregate supply curve rightward.
d. Incorrect. This is a meaningless answer.
Exhibit A.8 Macro AD/AS Models
12. In Parts (a) and (b) of Exhibit A.8, the intersection of AD with SRAS indicates
a. a short-run equilibrium.
b. a long-run equilibrium.
c. that the economy needs policies to reduce unemployment.
d. that the economy is at full employment.
ANS
a. Correct. In the long run, AD = SRAS = LRAS, which is not true if AD only equals SRAS.
b. Incorrect. In the long run, AD = SRAS = LRAS, which is not true if AD only equals SRAS.
c. Incorrect. Part (b) represents an inflationary gap.
d. Incorrect. The economy is operating at full employment only at Yp.
13.In Part (a) of Exhibit A.8, suppose that the initial equilibrium is at real GDP level Y1 and price level P2. At real GDP level Y1 there is
a. an inflationary gap.
b. a recessionary gap.
c. full employment.
d. long-run equilibrium.
ANS
a. Incorrect. An inflationary gap would occur at any real GDP above Yp .
b. Correct. Since Y1 is below Yp which corresponds to the long-run aggregate supply curve (LRAS) and full employment, there is a recessionary gap.
c. Incorrect. Full employment occurs at Yp potential real GDP, which corresponds to the long-run aggregate supply curve (LRAS).
d. Incorrect. Long-run equilibrium occurs at Yp where full employment real GDP
corresponds to long-run aggregate supply curve (LRAS).
14. In Part (b) of Exhibit A.8, the intersection of SRAS with AD indicates
a. an economy experiencing a recessionary gap.
b. an economy experiencing an inflationary gap.
c. that the economy is in long-run equilibrium.
d. that the economy has an unemployment rate currently less than the natural rate of unemployment.
ANS
a. Incorrect. A recessionary gap would occur at any real GDP below Yp, such as Y1.
b. Correct. Since Y1 is above Yp, which corresponds to the long-run aggregate supply curve (LRAS) and full employment, there is an inflationary gap.
c. Incorrect. Full employment occurs at Yp potential real GDP, which corresponds to the long-run aggregate supply curve (LRAS).
d. Incorrect. At Y1 real GDP, the economy has an unemployment rate above the natural rate of unemployment.
15. In Part (b) of Exhibit A.8, the intersection of SRAS with LRAS indicates
a. an economy experiencing a recessionary gap.
b. long-run equilibrium if the aggregate demand curve (AD) shifts leftward to this point.
c. that the economy is in long-run equilibrium.
d. that the economy has an unemployment rate currently greater than the natural
rate of unemployment.
ANS
a. Incorrect. This economy is experiencing an inflationary gap.
b. Correct. Long-run equilibrium occurs where AD = SRAS = LRAS.
c. Incorrect. Since AD does not equal SRAS and LRAS, the economy is not in long-run equilibrium.
d. Incorrect. The economy is in short-run equilibrium with an unemployment rate
below the natural rate.
Exhibit A.9 Aggregate demand and supply model
16. As shown in Exhibit A.9, and assuming the aggregate demand curve shifts from
AD1 to AD2, the full-employment level of real GDP is
a. $10 billion.
b. $4 billion.
c. $100 billion.
d. unable to be determined.
ANS
a. Correct. The economy’s path to a new long-run equilibrium is represented by a
movement from E1 to E2 to E3 corresponding to $10 billion real GDP.
b. Incorrect. The economy’s path to a new long-run equilibrium is represented by
a movement from E1 to E2 to E3 corresponding to $10 billion real GDP.
c. Incorrect. The economy’s path to a new long-run equilibrium is represented by
a movement from E1 to E2 to E3 corresponding to $10 billion real GDP.
d. Incorrect. Answer a is correct.
17. Beginning from a point of short-run equilibrium at point E2 in Exhibit A.9, the economy’s movement to a new position of long-run equilibrium from that point would best be described as
a. a movement downward along the AD2 curve with a shift in the SRAS1 curve to SRAS2.
b. a movement along the SRAS2 curve with a shift in the AD2 curve.
c. a shift in the LRAS curve to an intersection at E3.
d. no shift of any kind.
ANS
a. Correct. At E2, competition among unemployed workers for available jobs drives wages lower and the short-run aggregate supply curve (SRAS1) shifts rightward to long-run equilibrium at E3 where SRAS2 intersects LRAS.
b. Incorrect. There is no movement along the SRAS2 curve or shift in the AD2 curve.
c. Incorrect. There is a shift from SRAS1 to SRAS2, but no shift in the LRAS curve.
d. Incorrect. There is a shift from SRAS1 to SRAS2.
Exhibit A.10Aggregate demand and supply model
18. Based on Exhibit A.10, when the aggregate demand curve shifts to the position AD2 and the economy is operating at point E2, the economy’s position of long-run equilibrium corresponds to point
a. E1.
b. E2.
c. E3.
d. E1 or E3.
ANS
a. Incorrect. E1 is the initial position before aggregate demand shifted from AD1 to AD2.
b. Incorrect. E2 is not a point on the long-run aggregate supply curve (LRAS) and therefore is not long-run macro equilibrium.
c. Correct. At E2, competition among firms for the short supply of workers drives wages higher and the short-run aggregate supply curve (SRAS1) shifts leftward to long-run equilibrium where SRAS2 intersects LRAS at E3.
d. Incorrect. Point E2 is correct, but E1 is not correct because it is the initial position before aggregate demand shifts from AD1 to AD2.
19. Beginning in Exhibit A.10 from long-run equilibrium at point E1, the aggregate demand curve shifts to AD2 . The economy’s path to a new long-run equilibrium is represented by a movement from
a. E3 to E1 to E2.
b. E1 to E3 to E2.
c. E2 to E1 to E2.
d. E1 to E2 to E3.
ANS
a. Incorrect. The economy is initially at E1 and not E3.
b. Incorrect. To move from E1 to E3, both prices and wages must adjust. However, the movement from E1 to E2 assumes fixed wages.
c. Incorrect. The economy is initially at E1 and not E2.
d. Correct. At E2, firms increase prices while wages remain fixed. Over time, wages are not fixed and rise causing the shift from short-run aggregate supply curve (SRAS1) to SRAS2. Long-run equilibrium is therefore established at E3.
20. Economic growth would be represented in Exhibit A.10 by a(an)
a. leftward shift in the long-run aggregate supply curve (LRAS).
b. inward shift of the production possibilities curve.
c. rightward shift in the long-run aggregate supply curve (LRAS).
d. movement along the long-run aggregate supply curve (LRAS).
ANS
a. Incorrect. This means that full-employment output has declined.
b. Incorrect. This means that full-employment output has declined.
c. Correct. This represents an increase in full-employment output.
d. Incorrect. This represents changes in the price level at the full-employment output.
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