Economics (McConnell), AP Edition, 20th Edition Chapter (26)

Chapter 36: Extending the Analysis of Aggregate Supply Multiple-Choice Questions 1. A decrease in short-run aggregate supply would result if (A) corporate income taxes decreased (B) the number of available workers in the labor supply increased (C) the cost of production increased (D) the money supply decreased (E) government spending increased (C) An increase in the cost of production reduces supply for firms, decreasing output and increasing the price level. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Short-Run and Long-Run Analyses Book Section: Short-Run Aggregate Supply 2. A favorable supply shock, such as a significant increase in crop output, will cause which of the following effects on real output and the price level? Real Output Price Level (A) Increase Increase (B) Increase Decrease (C) Decrease Increase (D) Decrease Decrease (E) No change Decrease (B) A favorable supply shock shifts the aggregate supply curve to the right, lowering the price level and increasing real GDP. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Real Output and Price Level Book Section: Short-Run Aggregate Supply 3. Long-run economic growth occurs when the (A) aggregate demand curve shifts rightward (B) upward-sloping aggregate supply curve shifts rightward (C) upward-sloping aggregate supply curve shifts leftward (D) aggregate demand curve shifts leftward (E) vertical aggregate supply curve shifts rightward (E) The long-run aggregate supply curve represents full-employment output, and an increase, which shifts the curve to the right, illustrates economic growth. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Definition of Economic Growth Book Section: Economic Growth with Ongoing Inflation 4. Demand-pull inflation most likely results from (A) increased interest rates (B) increased consumer incomes (C) reduced money supply (D) increased unemployment rates (E) increased personal income tax rates (B) With additional income, consumers increase aggregate demand for products, pushing the price level higher. Higher interest rates, a lower money supply, an increase in the tax rate, and higher unemployment would instead decrease aggregate demand. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Demand-Pull versus Cost-Push Inflation Book Section: Demand-Pull Inflation in the Extended AD-AS Model 5. Which of the following factors could result in cost-push inflation? I. An increase in energy costs II. An increase in workers’ wages III. A decrease in interest rates (A) I only (B) III only (C) I and II only (D) II and III only (E) I, II, and III (C) An increase in the cost of production shifts aggregate supply to the left and causes cost-push inflation. A decrease in interest rates would lead to increased investment, increasing aggregate demand in the short run and aggregate supply in the long run. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Demand-Pull versus Cost-Push Inflation Book Section: Cost-Push Inflation in the Extended AD-AS Model 6. Long-run economic growth is illustrated by a rightward shift of the I. vertical aggregate supply curve II. upward-sloping aggregate supply curve III. production possibilities curve (A) I only (B) II only (C) I and III only (D) II and III only (E) I, II, and III (C) The vertical aggregate supply curve is the long-run aggregate supply curve, and a rightward shift indicates long-run economic growth. The production possibilities curve also shifts outward to illustrate that even more of all products can be produced. The upward-sloping aggregate supply curve is the short-run curve, indicating short-run changes in aggregate supply but not long-run growth. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Definition of Economic Growth Book Section: Economic Growth with Ongoing Inflation 7. Each of the following factors promotes long-run economic growth EXCEPT (A) increases in the quantity of capital stock (B) increases in worker productivity (C) increases in the labor supply (D) improvements in technology (E) increases in the interest rate (E) When interest rates go up, firms invest less in plant and equipment, which reduces the long-run rate of economic growth. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: Determinants of Economic Growth Book Section: Economic Growth with Ongoing Inflation 8. Which of the following would be the most effective policy combination for resolving a recession in the short run, while still promoting long-run economic growth? Monetary Policy Fiscal Policy (A) Increase the money supply Do nothing (B) Reduce the money supply Reduce government spending (C) Do nothing Increase government spending (D) Reduce the money supply Increase taxes (E) Increase the money supply Reduce taxes (A) Increasing the money supply reduces the interest rate, which promotes investment in plant and equipment. Aggregate demand increases in the short run as firms buy the equipment, resolving the recession. Aggregate supply increases in the long run as firms put the plant and equipment into operation and increase production at a lower cost. While fiscal policy would also address the recession through lower taxes or increased government spending, the government borrowing required to finance the deficit would push interest rates up (the crowding-out effect), reducing long-run economic growth. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Supply-Side Effects Book Section: Recession and the Extended AD-AS Model 9. The short-run Phillips curve illustrates the relationship between (A) aggregate supply and aggregate demand (B) tax rates and government revenue (C) the money supply and interest rates (D) inflation and unemployment (E) interest rates and capital investment (D) The inverse relationship between the inflation rate and the unemployment rate shows that in the short run, if aggregate supply remains stable, when the inflation rate increases, the unemployment rate decreases. Difficulty: Easy Style: Factual AP Economics Curricular Requirement Macroeconomics: The Phillips Curve Book Section: The Phillips Curve 10. The long-run Phillips curve illustrates that the natural rate of unemployment (A) is relatively stable (B) is quite unstable (C) changes frequently with the level of aggregate demand (D) changes frequently with the level of aggregate supply (E) is inversely related to the interest rate (A) The long-run Phillips curve is vertical at the natural rate of unemployment. While the unemployment rate may increase or decrease in the short run due to changes in aggregate supply and aggregate demand or changes in fiscal and monetary policy, in the long run, it returns to the natural rate of unemployment. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Short-Run and Long-Run Phillips Curves Book Section: Long-Run Vertical Phillips Curve 11. Stagflation results from (A) an increase in aggregate demand (B) a decrease in aggregate demand (C) an increase in aggregate supply (D) a decrease in aggregate supply (E) simultaneous decreases in aggregate demand and aggregate supply (D) A leftward shift in aggregate supply increases the price level while also increasing the unemployment rate. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Business Cycle and Economic Fluctuations Book Section: Aggregate Supply Shocks and the Phillips Curve 12. According to the Laffer curve, economic growth is best promoted through the increased incentives to work, save, and invest provided by lower (A) taxes (B) interest rates (C) government spending (D) imports (E) inflation rates (A) According to the Supply-Side school of economic thought, a lower tax rate gives workers an incentive to work more and increase both spending and saving, leading to increased investment and long-run economic growth. Difficulty: Easy Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Supply-Side Effects Book Section: The Laffer Curve 13. In the graph above, in the short run, a movement from point a1 to a2 along the short-run aggregate supply curve is based on the assumption that the I. expected price level for resources remains constant II. expected price level for resources will increase to P2 III. price level will increase IV. real output will increase (A) I only (B) II only (C) I, III, and IV only (D) II, III, and IV only (E) III and IV only (C) The movement from a1 to a2 occurs with the expectation that nominal wages and other factor input prices do not change, with the consequence that the expected price level for resources will remain at P1. However, price levels will increase to P2 resulting in greater real output (Q2) at higher price levels (P2). Difficulty: Hard Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Short-Run and Long-Run Analyses Book Section: Short-Run Aggregate Supply 14. In the graph above, in the long run, the shift from point a2 on SRAS1 to b2 on SRAS2 occurs when I. nominal wages increase II. price levels increase III. profits decrease IV. real output decreases (A) I only (B) II only (C) III only (D) I, III, and IV only (E) I, II, III, and IV (D) As wages and resource prices increase, the short-run aggregate supply curve SRAS1 shifts leftward to SRAS2 and real output falls. With the increase in the cost of production, profit will decrease. Difficulty: Hard Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Short-Run and Long-Run Analyses Book Section: Long-Run Aggregate Supply 15. In the graph above, assume the economy is operating in the long-run equilibrium position identified by point a. If the government were to increase spending, then (A) AD1 would shift to the right, forcing SRAS1 to shift to the left, resulting in a new short-run equilibrium point at point c (B) SRAS1 would shift to the left, forcing AD1 to shift to the right, resulting in a new short-run equilibrium point at point c (C) SRAS1 would shift to the left, leading to higher resource prices, higher price levels in the short-run, and a new short-run equilibrium point at point d (D) AD1 would shift to the right, leading to higher business profits, higher short-run price levels, and a new short-run equilibrium point at point b (E) AD1 would shift to the right, price levels would increase, but there would be no increase in short-run output (D) In the short-run, an increase in government spending would shift AD1 right, resulting in a movement along the existing SRAS1, higher price levels, and higher real output in the short run. Business profits would increase, but resource prices in the short run would not change. Difficulty: Hard Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Short and Long Run Book Section: Demand-Pull Inflation in the Extended AD-AS Model Use the graph below to answer questions 16-17. 16. Assume an oil-importing economy is operating in long-run equilibrium. Unexpectedly, widespread civil unrest severely curtails oil exports in oil-producing countries, resulting in severe world-wide shortages. In the short run, the most likely impact would be that Aggregate Short-run Price Real Gross Demand Aggregate Supply Level Domestic Product (A) Increases Increases Increases Uncertain (B) Decreases Decreases Uncertain Decreases (C) Constant Decreases Increases Decreases (D) Decreases Increases Increases Uncertain (E) Constant Decreases Increases Uncertain (C) In the short run, the oil shortage would shift short-run aggregate supply to the left, the price level would increase due to increased resource prices, and real gross domestic product would decrease. Difficulty: Medium Style: Application AP Economics Curricular Requirement Macroeconomics: Short and Long Run Book Section: Cost-Push Inflation in the Extended AD-AS Model 17. Assume that the economy is operating in long-run equilibrium. To balance the budget, the government raises personal income taxes. In the short run, the increase in personal income taxes would most likely cause each of the following changes. Aggregate Short-Run Price Real Gross Demand Aggregate Supply Level Domestic Product (A) Increase Decrease Increase Uncertain (B) Decrease Constant Decrease Decrease (C) Constant Decrease Decrease Decrease (D) Decrease Decrease Decrease Uncertain (E) Decrease Increase Decrease Decrease (B) In the short run, an increase in personal income taxes will decrease aggregate demand. The price level will decrease and real gross domestic product will decrease, but short-run aggregate supply will remain constant. Difficulty: Medium Style: Application AP Economics Curricular Requirement Macroeconomics: Short and Long Run Book Section: Recession and the Extended AD-AS Model Use the graph below to answer questions 18-19. 18. Assume that the economy is operating in short-run equilibrium at point A. Without government intervention, the following adjustments would most likely happen. Aggregate Short-Run Price Real Gross Demand Aggregate Supply Level Domestic Product (A) Increase Increase Uncertain Increase (B) Decrease Constant Decrease Decrease (C) Increase Constant Increase Increase (D) Constant Increase Decrease Increase (E) Constant Decrease Decrease Increase (D) Without intervention, resources prices including workers’ wages would decrease, short-run aggregate supply would increase, price levels would decrease, and real gross domestic product would increase. Aggregate demand would remain constant. Difficulty: Hard Style: Application AP Economics Curricular Requirement Macroeconomics: Actual versus Full-Employment Output Book Section: Long-Run Equilibrium in the Extended AD-AS Model 19. Assume that the economy is operating in short-run equilibrium at point A. Then the central bank initiates expansionary monetary policy. In the long run, the following adjustments would most likely happen. Aggregate Short-Run Price Real Gross Demand Aggregate Supply Level Domestic Product (A) Increase Increase Uncertain Increase (B) Decrease Constant Decrease Decrease (C) Increase Constant Increase Increase (D) Constant Increase Decrease Increase (E) Constant Decrease Decrease Increase (C) Expansionary monetary policy would cause aggregate demand to increase, price levels to increase, and real gross domestic product to increase. Short-run aggregate supply would remain constant. Difficulty: Hard Style: Application AP Economics Curricular Requirement Macroeconomics: Short and Long Run Book Section: Recession and the Extended AD-AS Model 20. In the graph above, assume the economy is operating in short-run equilibrium at point A. Without government intervention, the following adjustments would most likely happen. Aggregate Short-Run Price Real Gross Demand Aggregate Supply Level Domestic Product (A) Increase Increase Uncertain Increase (B) Decrease Constant Decrease Decrease (C) Increase Constant Increase Decrease (D) Constant Decrease Increase Decrease (E) Constant Decrease Decrease Increase (D) Without intervention, resources prices including workers’ wages would increase, short-run aggregate supply would decrease, price levels would increase, and real gross domestic product would decrease. Aggregate demand would remain constant. Difficulty: Hard Style: Application AP Economics Curricular Requirement Macroeconomics: Actual versus Full-Employment Output Book Section: Long-Run Equilibrium in the Extended AD-AS Model 21. An expansionary fiscal policy would cause a movement (A) to the left along the Phillips curve, reducing the unemployment rate but increasing the inflation rate (B) to the left along the Phillips curve, reducing the inflation rate but increasing the unemployment rate (C) to the right along the Phillips curve, reducing the unemployment rate but increasing the inflation rate (D) to the right along the Phillips curve, reducing the inflation rate but increasing the unemployment rate (E) to the left of the entire Phillips curve, reducing both the inflation rate and the unemployment rate (A) Expansionary fiscal policy would increase aggregate demand, which would raise the price level and increase output, leading to increased employment. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Short-Run and Long-Run Phillips Curves Book Section: The Phillips Curve 22. If the actual inflation rate is higher than the expected inflation rate I. wages temporarily increase II. profits temporarily increase III. unemployment temporarily falls (A) I only (B) I and II only (C) II and III only (D) I and III only (E) I, II, and III (C) Because wages are “sticky” in the short run, when aggregate demand rises, firms can hire additional workers without having to raise wages in the short run. Because the firms can charge higher prices while their costs remain constant, their profits increase. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Role of Expectations Book Section: Short-Run Phillips Curve 23. As illustrated by the long-run Phillips curve, in the long run (A) there is a positive relationship between inflation and unemployment (B) there is an inverse relationship between inflation and unemployment (C) the inflation-unemployment relationship strengthens (D) fiscal and monetary policy interfere in the inflation-unemployment relationship (E) there is no relationship between inflation and unemployment (E) In the long run, the natural rate of unemployment rests at the full-employment output, regardless of the inflation rate. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Short-Run and Long-Run Phillips Curves Book Section: The Long-Run Phillips Curve 24. Given a stable long-run Phillips curve with a 5% natural rate of unemployment, attempts to use monetary policy to reduce the unemployment rate below 5% in the long run will (A) have no effect on the unemployment rate (B) only cause deflation (C) reduce the unemployment rate (D) increase interest rates (E) actually increase the unemployment rate (A) Movements along the Phillips curve as a result of fiscal or monetary policy are only temporary. In the long run, the economy returns to its natural rate of unemployment. Difficulty: Medium Style: Conceptual AP Economics Curricular Requirement Macroeconomics: Short-Run and Long-Run Phillips Curves Book Section: Long-Run Vertical Phillips Curve 25. Criticisms of the Laffer curve include concerns that tax cuts I. have little impact on incentives and are slow to emerge II. give some workers an incentive to work less, because they can afford to “buy more leisure” III. lead to lower government revenues and a higher national debt (A) II only (B) III only (C) I and II only (D) I and III only (E) I, II, and III (E) All three criticisms have been leveled at Supply-Side theory, bolstered by empirical evidence of economic response after Supply-Side tax cuts were implemented in the Reagan and George W. Bush administrations. Difficulty: Medium Style: Factual AP Economics Curricular Requirement Macroeconomics: Supply-Side Effects Book Section: Criticisms of the Laffer Curve Free-Response Questions 1. Assume a nation's economy is operating at less than full-employment output. (a) Using a correctly labeled aggregate demand-aggregate supply graph, show each of the following. (i) Long-run aggregate supply (ii) Current output and price level (b) Identify an appropriate monetary policy to address the recessionary gap. (c) Explain the effect of the monetary policy you identified in (b) on each of the following. (i) The interest rate (ii) Aggregate demand (iii) Long-run aggregate supply 2. Assume a nation's economy is operating at full-employment output in year 1. (a) Using a correctly labeled short-run Phillips curve, label a point on the curve "Year 1." (b) Now assume that the nation has entered into a recession in year 2. On the same graph you used for year 1, indicate the correct position for a point illustrating the impact of a recession and label that point "Year 2." (c) Now assume that in year 3, the cost of energy has significantly increased for the nation. Illustrate the change on your graph and label your new point "Year 3." (d) In year 3, if Congress begins with a balanced budget and addresses the energy costs by lowering taxes, explain the impact of that fiscal policy on each of the following. (i) The unemployment rate (ii) The expected inflation rate (iii) The interest rate (iv) Long-run economic growth Free-Response Explanations 1. 10 points (3 + 1 + 6) (a) 3 points: 1 point is earned for a correctly labeled aggregate demand-aggregate supply graph. 1 point is earned for including a vertical long-run aggregate supply curve. 1 point is earned for showing current equilibrium (output and price level) to the left of the long-run aggregate supply curve. (b) 1 point: 1 point is earned for identifying an appropriate monetary policy. Acceptable answers include: Decrease the reserve requirement Decrease the discount rate Purchase bonds on the open market (c) 6 points: 1 point is earned for stating that the interest rate decreases. 1 point is earned for explaining that the monetary policy increases the money supply, causing the interest rate to fall. 1 point is earned for stating that the aggregate demand increases. 1 point is earned for explaining that as interest rates fall, investment and interest-sensitive consumer borrowing and spending increase, raising aggregate demand. 1 point is earned for stating that the long-run aggregate supply increases. 1 point is earned for explaining that the investment in plant and equipment fosters long-run economic growth. Difficulty: Medium Style: Application AP Economics Curricular Requirement Macroeconomics: Fiscal and Monetary Policy Book Section: Applying the Extended AD-AS Model 2. 12 points (1 + 1 + 2 + 8) (a) 1 point: 1 point is earned for a correctly labeled short-run Phillips curve with a point "Year 1" labeled on the curve. (b) 1 point: 1 point is earned for correctly labeling point "Year 2" on the same short-run Phillips curve, indicating a higher unemployment rate and lower inflation rate than for "Year 1." (c) 2 points: 1 point is earned for drawing a new short-run Phillips curve, shifted out from the origin of the original Phillips curve. 1 point is earned for correctly labeling point "Year 3" on the new Phillips curve. (d) 8 points: 1 point is earned for stating that the unemployment rate will decrease. 1 point is earned for explaining that lower taxes increase disposable income, so aggregate demand will increase, which increases employment. 1 point is earned for stating that the inflation rate will increase. 1 point is earned for explaining that when aggregate demand increases, the price level increases. 1 point is earned for stating that the interest rate will increase. 1 point is earned for explaining that the government must borrow more money to finance the deficit spending, and the increased demand for loanable funds increases the interest rate. 1 point is earned for stating that long-run economic growth will decrease. 1 point is earned for explaining that because the interest rate increased, investment in plant and equipment will decrease, reducing the long-run growth rate. Difficulty: Hard Style: Application AP Economics Curricular Requirement Macroeconomics: The Phillips Curve Book Section: The Inflation-Unemployment Relationship