Economic Questionnaire
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1. The amount of money that people demand is:
A. positively
2.
related to the interest rate.
B. positively or negatively related to the interest rate depending on the state of the
economy.
C. independent the interest rate.
D. negatively related to the interest rate.
1 points
QUESTION 2
1. The federal funds rate is the interest rate on _____, and it is controlled by the _____.
A. reserves
2.
that banks lend to each other; Federal Open Market Committee
B. reserves that banks lend to each other; president and Congress
C. loans from the Federal Reserve to banks; Federal Open Market Committee
D. loans from the Federal Reserve to banks; president and Congress
1 points
QUESTION 3
1. The money supply curve is:
A. horizontal.
2.
B. vertical.
C. downward sloping.
D. upward rising.
1 points
QUESTION 4
1. An increase in the supply of money with no change in demand will lead to a(n) _____ in the
equilibrium quantity of money and a _____ in the equilibrium interest rate.
A. decrease;
2.
fall
B. decrease; rise
C. increase; fall
D. increase; rise
1 points
QUESTION 5
1. A decrease in the supply of money with no change in demand for money will lead to a(n)
_____ in the equilibrium quantity of money and a _____ in the equilibrium interest rate.
A. increase;
2.
rise
B. increase; fall
C. decrease; rise
D. decrease; fall
1 points
QUESTION 6
1. If the target rate of interest is higher than the equilibrium interest rate, the Federal Reserve
will _____ Treasury bills in the open market, _____ the supply of money, and _____ the interest
rate to the target rate.
A. buy;
2. decrease; raise
B. sell; decrease; raise
C. sell; increase; lower
D. buy; increase; lower
1 points
QUESTION 7
1. Suppose the Federal Reserve has set a target for the federal funds rate. If initially the
equilibrium interest rate happens to be higher than the target interest rate, then the Federal
Reserve should _____ Treasury bills in the open market, _____ the money supply, shift the
supply of money curve to the _____, and _____ the interest rate to the target rate.
A. sell;
2. increase; left; raise
B. sell; decrease; left; raise
C. purchase; decrease; left; lower
D. purchase; increase; right; lower
1 points
QUESTION 8
1. The Federal Open Market Committee has decided that the federal funds rate should be 2%
rather than the current rate of 1.5%. The appropriate open market action is to _____ Treasury
bills to _____ money _____.
A. sell;
2. decrease; demand
B. buy; increase; demand
C. buy; decrease; supply
D. sell; decrease; supply
1 points
QUESTION 9
1. The Federal Open Market Committee has decided that the federal funds rate should be 0.5%
rather than the current rate of 1.25%. The appropriate open market action is to _____
Treasury bills to _____ money _____.
A. buy;
2. decrease; demand
B. buy; increase; supply
C. buy; decrease; supply
D. sell; decrease; demand
1 points
QUESTION 10
1. When the Fed uses quantitative easing, it is:
A. selling
2.
longer-term government debt.
B. buying three-month Treasury bills.
C. selling three-month Treasury bills.
D. buying longer-term government debt.
1 points
QUESTION 11
1. When economists and policymakers refer to the Fed’s dual mandate, they are referring to:
A. price
2. stability and moderate long-term interest rates.
B. price and exchange rate stability.
C. price stability and maximum employment.
D. moderate long-term interest rates and maximum employment.
1 points
QUESTION 12
1. The discount window is
A. the
2. period each month during which banks are allowed to apply for discount loans.
B. the spread between the discount rate and the T-bill rate.
C. another name for the discount rate.
D. the means by which the Fed makes discount loans to banks.
1 points
QUESTION 13
1. Discount loans available to healthy banks which can be used for any purpose are called
A. repo
2. loans.
B. secondary credit.
C. primary credit.
D. seasonal credit.
1 points
QUESTION 14
1. Discount loans intended for banks that are NOT financially healthy are called
A. seasonal
2.
credit.
B. repo loans.
C. primary credit.
D. secondary credit.
1 points
QUESTION 15
1. The benchmark default-free interest rate of the financial system is generally considered to
be
A. the
2. federal funds rate.
B. the 30-year fixed rate mortgage.
C. the interest rate on the 10-year Treasury note.
D. the discount rate.
1 points
QUESTION 16
1. An important problem facing the Fed is that
A. it 2.
has been given responsibility for meeting policy goals, but true control over monetary
policy remains with the president.
B. it lost effective control over the monetary base.
C. it has been given responsibility for meeting policy goals, but true control over monetary
policy remains with Congress.
D. the goals for economic growth and price stability may conflict in the short run.
1 points
QUESTION 17
1. The Fed’s inability to instantaneously observe changes in inflation and economic growth
result in
A. policy
2.
lag.
B. impact lag.
C. jet lag.
D. information lag.
1 points
QUESTION 18
1. The inflation gap can best be described as
A. the
2. difference between inflation and its target.
B. the change in the inflation rate from one year to the next.
C. the percentage difference between GDP and its potential.
D. the difference between the inflation rate and the average inflation rate of that of the
nations with the 3 lowest inflation rates.
1 points
QUESTION 19
1. The output gap can best be described as
A. the
2. percentage difference between real GDP and its potential.
B. the difference between GDP and its forecasted level.
C. he difference between GDP in the current year compared to the previous year.
D. the difference between a nation’s GDP and that of the nation with the highest GDP.
1 points
QUESTION 20
1. According to the Taylor rule, what should the federal funds rate target be if actual inflation is
5%, the target rate of inflation is 2%, the equilibrium real federal funds rate is 2%, fullemployment real GDP is $9 trillion, and current real GDP is $8.55 trillion?
A. 9%
2.
B. 6%
C. 4%
D. 5%
1 points
QUESTION 21
1. According to the Taylor rule, what should the federal funds rate target be if actual inflation is
3.5%, the target rate of inflation is 2%, the equilibrium real federal funds rate is 2%, fullemployment real GDP is $21.89 trillion, and current real GDP is $20.8 trillion?
A. 3.50%
2.
B. 3.76%
C. 2.22%
D. 3.67%
1 points
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QUESTION 1
1. Which of the following would shift the aggregate demand curve to the LEFT?
A. an
2.increase in the aggregate price level
B. monetary policy that raises the interest rate
C. stronger consumer optimism about income
D. an increase in consumer wealth
1 points
QUESTION 2
1. Raising taxes shifts the _____ curve to the _____.
A. aggregate
2.
demand; left
B. short-run aggregate supply; left
C. aggregate demand; right
D. long-run aggregate supply; left
1 points
QUESTION 3
1. Increasing the quantity of money in circulation shifts the _____ curve to the _____.
A. short-run
2.
aggregate supply; right
B. long-run aggregate supply; right
C. aggregate demand; right
D. aggregate demand; left
1 points
QUESTION 4
1. A decrease in the supply of money shifts the aggregate _____ curve to the _____.
A. demand;
2.
left
B. supply; right
C. supply; left
D. demand; right
1 points
QUESTION 5
1. The positive relationship between the aggregate price level and aggregate output supplied
gives the short-run aggregate supply curve a(n) _____ slope.
A. downward
2.
B. upward
C. vertical
D. horizontal
1 points
QUESTION 6
1. In the short run, wages and some prices are considered to be:
A. extremely
2.
flexible.
B. irrelevant.
C. sticky.
D. unpredictable.
1 points
QUESTION 7
1. The point where the long-run aggregate supply curve intercepts the horizontal axis is:
A. the
2. point that reflects the economy’s actual output.
B. the economy’s potential output.
C. impossible to attain.
D. the level of real GDP the economy would produce if all prices were flexible and wages
were fixed.
1 points
QUESTION 8
1. The short-run aggregate supply curve will shift to the:
A. left
2. if nominal wages increase.
B. right if government spending increases.
C. right if commodity prices increase.
D. left if productivity increases.
1 points
QUESTION 9
1. Stagflation may result from:
A. a 2.
decrease in the supply of money.
B. an increase in the supply of money.
C. a decrease in the price of oil.
D. an increase in the price of oil.
1 points
QUESTION 10
Figure: An Increase in Aggregate Demand
1.
Reference: Ref 16-9
(Figure: An Increase in Aggregate Demand) Look at the figure An Increase in Aggregate
Demand. Assume that the economy is initially in long-run equilibrium at Y P and P 1. Now
suppose that there is an increase in the level of government purchases at each price level.
This will:
A. lead to decreased output and a decreased price level.
B. shift the aggregate demand curve from AD1 to AD2.
C. lead to increased output and a decrease in the price level.
D. shift the aggregate demand curve from AD2 to AD1.
1 points
QUESTION 11
1. Suppose the Federal Reserve is conducting an expansionary monetary policy. It will _____
Treasury bills on the open market, so that the money supply will _____, interest rates will
_____, planned investment spending will _____, and the AD curve will shift to the _____.
A. buy;
2. decrease; fall; fall; left
B. sell; decrease; rise; fall; left
C. buy; increase; fall; rise; right
D. sell; increase; rise; rise; left
1 points
QUESTION 12
1. If the Federal Reserve wants to close an inflationary gap, it will _____ the money supply and
_____ the interest rate, thus _____ investment spending and GDP. The AD curve will shift to
the _____.
A. decrease;
2.
lower; lowering; right
B. increase; raise; increasing; right
C. decrease; raise; lowering; left
D. increase; lower; lowering; left
1 points
QUESTION 13
Figure: Monetary Policy and the AD SRAS Model
1.
2.
Reference: Ref 19-7
(Figure: Monetary Policy and the ADSRAS Model) Look at the figure Monetary Policy and
the ADSRAS Model. The economy could move from point g to point f as a result of:
A. an increase in the money supply.
B. purchases of government securities in the open market.
C. a reduction in the discount rate.
D. a decrease in the money supply.
1 points
QUESTION 14
1. Monetary neutrality implies that in the long run:
A. long-run
2.
aggregate supply depends on monetary policy.
B. changing the money supply does not affect the aggregate price level.
C. aggregate demand is independent from monetary policy.
D. monetary policy does not affect the level of economic activity.
1 points
QUESTION 15
1. Economists argue that money is neutral:
A. in2.the long run, but money does not affect the price level.
B. in the short run only.
C. in both the short and the long run.
D. in the long run, but money does affect the price level.
1 points
QUESTION 16
1. Which of the following statements is FALSE? In the long run, monetary policy:
A. affects
2.
only the aggregate price level.
B. does not affect aggregate output.
C. increases potential output.
D. is neutral.
1 points
QUESTION 17
1. Figure: Monetary Policy and the AD SRAS Model
Reference: Ref 19-7
(Figure: Monetary Policy and the ADSRAS Model) Look at the figure Monetary Policy and
the ADSRAS Model. An increase in the money supply is most likely to cause a shift:
A. from AD to AD’.
B. from SRAS’ to SRAS.
C. from AD’ to AD.
D. from SRAS to SRAS’.
1 points
QUESTION 18
1. Figure: Monetary Policy I
Reference: Ref 19-12
(Figure: Monetary Policy I) Look at the figure Monetary Policy I. If the economy is initially in
equilibrium at E 1 and the central bank chooses to sell Treasury bills, _____ shift to the _____
a(n) _____ gap.
A. AD1 will; left, closing; recessionary
B. AD2 will; right, causing; inflationary
C. AD2 may; AD1, causing; recessionary
D. AD1 may; AD2, closing; recessionary
1 points
QUESTION 19
1. Figure: Monetary Policy I
Reference: Ref 19-12
(Figure: Monetary Policy I) Look at the figure Monetary Policy I. If the economy is initially in
equilibrium at E 1 and the central bank chooses to buy Treasury bills, _____ shift to _____ a(n)
_____ gap.
A. AD1 may; AD2, closing; recessionary
B. AD2 may; AD1, causing; recessionary
C. AD1 will; left, increasing; recessionary
D. AD2 will; right, causing; inflationary
1 points
QUESTION 20
1. Figure: Monetary Policy I
Reference: Ref 19-12
(Figure: Monetary Policy I) Look at the figure Monetary Policy I. If the economy is initially in
equilibrium at E 2 and the central bank chooses to buy Treasury bills, _____ shift to _____ a(n)
_____ gap.
A. AD1 will; left, increasing; recessionary
B. AD2 may; AD1, causing; recessionary
C. AD2 will; right, causing; inflationary
D. AD1 may; AD2, closing; recessionary
1 points
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Money, Banking, and the Financial System
Third Edition
Chapter 17
Monetary Theory I: The
Aggregate Demand and
Aggregate Supply Model
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Learning Objectives
After studying this chapter, you should be able to:
17.1 Explain how the aggregate demand curve is derived
17.2 Explain how the aggregate supply curve is derived
17.3 Demonstrate macroeconomic equilibrium using the aggregate
demand and aggregate supply model
17.4 Use the aggregate demand and aggregate supply model to show
the effects of monetary policy on the economy
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Why Did Employment Grow Slowly After the
Great Recession? (1 of 2)
Many economists and policymakers found it disturbing that, in 2016,
the fraction of the population working had not yet recovered to the
levels before the Great Recession that ended in July 2009.
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Why Did Employment Grow Slowly After the
Great Recession? (2 of 2)
Structural factors for the decline in the employment-population ratio,
particularly for men:
An expansion of Society Security disability payments that has
provided some men with an alternative source of income
Higher incarceration rates that have made some men less
attractive to potential employers
The decline in demand for unskilled workers as a result of
automation and the effects of globalization
Monetary policy is intended to increase the total level of spending in
the economy and is not suited to addressing such structural problems.
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Key Issue and Question
Issue: During the recovery from the financial crisis of the 2007?2009,
the employment-population ratio remained low.
Question: What explains the relatively slow growth of employment
during the economic expansion that began in 2009?
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17.1 Learning Objective
Explain how the aggregate demand curve is derived.
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The Aggregate Demand Curve
Aggregate expenditure (AE) on the economys output of goods and
services equals:
???? = ?? + ?? + ?? + ????
1. C = spending by households on goods & services for consumption
2. I = planned spending by firms on capital goods, and by households on
new homes
3. G = local, state, and federal government purchases of goods &
services
4. NX = Net exports, i.e., spending by foreign firms and households on
goods & services produced domestically minus spending by domestic
firms and households on goods & services produced in other countries
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Figure 17.1 The Aggregate Demand Curve
Aggregate demand (AD) curve A curve that shows the relationship
between aggregate expenditure on goods and services and the price
level.
The aggregate demand (AD) curve
shows the relationship between the
price level and the level of aggregate
expenditure.
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The Money Market and the Aggregate Demand
Curve (1 of 2)
The market for money involves the interaction between the demand for
M1 by households and firms and the supply of M1, as controlled by the
Fed.
The analysis of the market for money is also called the liquidity
preference theory (coined by John Maynard Keynes).
Real money balances is the value of money held by households and
firms, adjusted for changes in the price level.
The primary reason for the demand for money is called the
transactions motiveto hold money as a medium of exchange.
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The Money Market and the Aggregate Demand
Curve (2 of 2)
Households and firms face a trade-off: The higher the interest rate on
short-term assets (e.g., Treasury bills), the more households and firms
give up when they hold large money balances.
So, the short-term nominal interest rate is the opportunity cost of
holding money.
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Figure 17.2 The Money Market
Panel (a) shows the demand for real balances and the supply of real balances.
Panel (b) shows that an increase in the price level causes the supply curve for real
balances to shift from (M/P)S to (M/P)S, thereby increasing the equilibrium interest rate from
i1 to i2.
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Shifts of the Aggregate Demand Curve
Key factors that cause the aggregate demand curve to shift:
1. Increases and decreases in the money supply.
2. Changes in the household saving rate.
3. Changes in households expected future incomes.
4. The expected future profitability of capital.
5. Changes in taxes on households and firms.
6. Changes in government purchases.
7. Changes in foreign demand for U.S.-produced goods and services.
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Table 17.1 Variables That Shifts the
Aggregate Demand Curve (1 of 4)
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Table 17.1 Variables That Shifts the
Aggregate Demand Curve (2 of 4)
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Table 17.1 Variables That Shifts the
Aggregate Demand Curve (3 of 4)
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Table 17.1 Variables That Shifts the
Aggregate Demand Curve (4 of 4)
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17.2 Learning Objective
Explain how the aggregate supply curve is derived.
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The Aggregate Supply Curve
Aggregate supply is the total quantity of output, or GDP, that firms are
willing to supply at a given price level.
Short-run aggregate supply (SRAS) curve is a curve that shows the
relationship in the short run between the price level and the quantity of
aggregate output supplied by firms.
Although the short-run aggregate supply curve slopes upward like the
supply curve facing an individual firm, it represents different behavior.
Next, we examine the new classical and new Keynesian views that
attempt to explain why the SRAS curve slopes upward.
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The Short-Run Aggregate Supply (SRAS)
Curve (1 of 3)
The new classical view, also sometimes called the misperception
theory emphasizes the difficulty firms have in distinguishing between
relative price increases from general price increases.
If all prices in the economy rise but relative prices dont change, and
individual producers fail to recognize this situation, then aggregate
output increases.
Conversely, if all producers expect the price level to increase by 10%,
and the price level actually increases by only 5%, producers (having
expected a 10% increase in the price level) will collectively cut
production.
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The Short-Run Aggregate Supply (SRAS)
Curve (2 of 3)
If P is the actual price level and Pe is the expected price level, the
relationship between aggregate output and the price level, according to
the new classical view is
?? = ?? P + ??(?? ? ???? )
If ?? = ???? , then ?? = ?? P . If ?? > ???? , then Y will increase. If ?? < ???? , then Y
will decrease.
John Maynard Keynes provided an alternative explanation for the upward
slope of the SRAS curve:
prices adjust slowly in the short run in response to changes in
aggregate demand, i.e., prices are sticky in the short run.
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The Short-Run Aggregate Supply (SRAS)
Curve (3 of 3)
In the most extreme view of price stickiness, the SRAS curve is
horizontal: firms adjust their production levels to meet changes in
demand without changing their prices.
Contemporary followers of Keyness view (new Keynesian view) have
sought reasons for the failure of prices to adjust in the short run using
real-world market characteristics: rigidity of long-term contracts and
imperfect competition.
New Keynesian economists argue that prices will adjust only gradually
in monopolistically competitive markets (price setter rather than price
takers) when there are costs to changing prices (menu costs).
If potential profits from making a price change are small relative to the
cost of making the price change, the firm wont change its price.
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The Long-Run Aggregate Supply (LRAS)
Curve
Long-run aggregate supply (LRAS) curve is a curve that shows the
relationship in the long run between the price level and the quantity of
aggregate output supplied by firms.
The long-run aggregate supply (LRAS) curve is vertical at YP.
In the new Keynesian view, in the short run many input costs are fixed,
so firms can expand output without experiencing an increase in input
cost that is proportional to the increase in their output prices.
Over time, though, input costs increase in line with the price level, so
all firms adjust their prices in response to a change in demand in the
long run.
As with the new classical view, the LRAS curve is vertical at potential
GDP, or Y = YP.
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Figure 17.3 The Short-Run and Long-Run
Aggregate Supply Curves
The SRAS curve is upward sloping. The LRAS curve is vertical at
potential GDP,YP.
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Shifts in the Short-Run Aggregate Supply
(SRAS) Curve
Supply shock is an unexpected change in production costs or in
technology that causes the short-run aggregate supply curve to shift.
There are three main factors that cause the short-run aggregate supply
curve to shift:
1. Changes in labor costs.
2. Changes in other input costs.
3. Changes in the expected price level.
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Making the Connection:
Fracking Transforms Energy Markets in the United
States (1 of 2)
Falling natural gas prices between 2010 and 2012 were the result of the
growing use of hydraulic fracturing (fracking) technology in the United
States.
Natural gas has long been a source of energy for manufacturing and for
long-haul trucking transportation.
Reductions in energy costs have caused the SRAS curve for the United
States to shift to the right.
Despite the economic benefits of the new fracking technology,
policymakers are concerned about its drawbacks, including water
contamination at production sites.
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Making the Connection:
Fracking Transforms Energy Markets in the United
States (2 of 2)
Source: U.S. Energy Information Administration.
U.S. oil production went into a long-run decline and by the mid-1990s, for
the first time the United States was importing more oil than it produced.
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Shifts in the Long-Run Aggregate Supply
(LRAS) Curve
The LRAS curve shifts over time to reflect growth in the potential level
of output.
Sources of this economic growth include:
increases in capital and labor inputs
increases in productivity growth (output produced per unit of input)
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Table 17.2 Variables That Shift the Short-Run and
Long-Run Aggregate Supply Curves (1 of 2)
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Table 17.2 Variables That Shift the Short-Run and
Long-Run Aggregate Supply Curves (2 of 2)
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17.3 Learning Objective
Demonstrate macroeconomic equilibrium using the aggregate
demand and aggregate supply model.
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Equilibrium in the Aggregate Demand and
Aggregate Supply Model
Short-Run Equilibrium
Figure 17.4 Short-Run Equilibrium
The economys short-run equilibrium is
represented by the intersection of the AD
and SRAS curves at E1.
Higher price levels are associated with an
excess supply of output, and lower price
levels are associated with excess demand
for output.
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Long-Run Equilibrium (1 of 2)
Figure 17.5 Adjustment to Long-Run Equilibrium
From an initial equilibrium at E1, an increase in aggregate demand shifts the AD curve from
AD1 to AD2, increasing output from YP to Y2.
Because Y is greater than YP, prices rise, shifting the SRAS curve from SRAS1 to SRAS2.
The economys new equilibrium is at E3. Output has returned to YP, but the price level has
risen to P2.
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Long-Run Equilibrium (2 of 2)
Because the LRAS curve is vertical, economists generally agree that in
the long run changes in aggregate demand affect the price level but
not the output level.
This adjustment back to potential GDP is an automatic mechanism
because it occurs without any actions by the government.
Monetary neutrality is the proposition that changes in the money supply
have no effect on output in the long run.
An increase (decrease) in the money supply raises (lowers) the price
level in the long run but does not change the equilibrium level of
output.
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Economic Fluctuations in the United States
Shocks to Aggregate Demand, 19641969
During the Vietnam War, the Fed was concerned that the rise in
aggregate demand caused by increases in government purchases
would increase money demand and the interest rate.
To avoid an increase in the interest rate, the Fed pursued an
expansionary monetary policy.
Because fiscal and monetary expansion continued for several years,
ADAS analysis confirms that output growth and inflation should have
risen from 1964 through 1969.
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Supply Shocks, 19731975 and After 1995
The early 1970s was a period of stagflation (rising inflation and falling
output) as a result of two negative supply shocks: a sharp reduction in
the supply of oil and poor crop harvests around the world.
The negative supply shocks shift the SRAS curve to the left, raising the
price level and reducing output.
A similar pattern occurred as a result of negative supply shocks
caused by rising oil prices in the 19781980 period.
In the late 1990s and 2000s, the U.S. economy experienced favorable
supply shocks, such as the acceleration in productivity growth.
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Credit Crunch and Aggregate Demand During
and After the 20072009 Recession
Following the failure of Lehman Brothers, a credit crunch occurred as
banks and other financial firms cut bank on lending.
Spending for consumer durable goods and business plant and
equipment fell as household and businesses were not able to replace
bank loans with funds from other sources.
In ADAS analysis, the decline in spending reduces AD and puts
downward pressure on prices, shifting the SRAS curve down.
In fact, real GDP fell by 4.2% during the 20072009 recession and
inflation declined from 2.9% in 2007 to 0.3% in 2009.
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Are Investment Incentives Inflationary?
In the late 1990s, many economists and policymakers urged tax
reforms that would stimulate business investment through increasing
investment demand and output of capital goods.
Would they also increase inflation?
In ADAS analysis, the stimulus to investment increases aggregate
demand, shifting the AD curve to the right.
However, investment in new plant and equipment would also increase
the economys capacity, so that the SRAS and LRAS curves shift to
the right, reducing the inflationary pressure from the tax reform.
Recent evidence suggests that the supply response is substantial and
investment incentives are unlikely to be inflationary.
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17.4 Learning Objective
Use the aggregate demand and aggregate supply model to show the
effects of monetary policy on the economy.
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The Effects of Monetary Policy
Business cycle is alternating periods of economic expansion and
economic recession.
Stabilization policy is a monetary policy or fiscal policy intended to
reduce the severity of the business cycle and stabilize the economy.
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An Expansionary Monetary Policy (1 of 2)
Figure 17.6 Effects of Monetary Policy (1 of 2)
At an initial full-employment equilibrium of
E1, an aggregate demand shock shifts the
AD curve from AD1 to AD2, and output falls
from YP to Y2.
At E2, the economy is in a recession.
Over time, the price level adjusts
downward, restoring the economys full
employment equilibrium at E3.
Copyright © 2018, 2014, 2012, Pearson Education, Inc. All Rights Reserved.
An Expansionary Monetary Policy (2 of 2)
Figure 17.6 Effects of Monetary Policy (2 of 2)
At an initial full-employment equilibrium of E1,
an aggregate demand shock shifts the AD
curve from AD1 to AD2.
At E2, the economy is in a recession.
The Feds expansionary monetary policy shifts
the AD curve back from AD2 to AD1.
Relative to the nonintervention case, the
economy recovers more quickly back to full
employment, but with a higher long-run price
level.
Copyright © 2018, 2014, 2012, Pearson Education, Inc. All Rights Reserved.
Solved Problem 17.4
Dealing with Shocks to Aggregate Demand and Aggregate
Supply (1 of 4)
Assume that the economy is initially in equilibrium at full employment.
Then suppose that the economy is hit simultaneously with negative
aggregate demand and aggregate supply shocks.
a. Draw an AD-AS graph to illustrate the initial equilibrium and the shortrun equilibrium after the shocks. Do we know with certainty whether
the price level will be higher or lower in the new equilibrium?
b. Suppose that the Fed decides not to intervene with an expansionary
monetary policy. Show how the economy will adjust back to its longrun equilibrium.
c. Now suppose that the Fed decides to intervene with an expansionary
monetary policy. If the Feds policy is successful, show how the
economy adjusts back to its long-run equilibrium.
Copyright © 2018, 2014, 2012, Pearson Education, Inc. All Rights Reserved.
Solved Problem 17.4
Dealing with Shocks to Aggregate Demand and Aggregate
Supply (2 of 4)
Step 1 Review the chapter material.
Step 2 Answer part (a) by drawing the appropriate graph and
explaining whether we know whether the price level will rise or fall.
Copyright © 2018, 2014, 2012, Pearson Education, Inc. All Rights Reserved.
Solved Problem 17.4
Dealing with Shocks to Aggregate Demand and Aggregate
Supply (3 of 4)
Step 3 Answer part (b) by drawing the appropriate graph.
Copyright © 2018, 2014, 2012, Pearson Education, Inc. All Rights Reserved.
Solved Problem 17.4
Dealing with Shocks to Aggregate Demand and Aggregate
Supply (4 of 4)
Step 4 Answer part (c) by redrawing the appropriate graph.
Copy
