Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12-1
CHAPTER 12
Aggregate Demand and Aggregate Supply (+ Appendix)
A. Short-Answer, Essays, and Problems
1. Why is there a need for an aggregate demand and aggregate supply model of the economy? Why can’t the
supply and demand model for a single product explain developments in the economy?
2. What is the aggregate demand curve? What is the character of its slope?
3. What is the difference in the explanation of the shape of the aggregate demand curve and a single product
demand curve? After all, both demand curves show an inverse relationship between price and quantity.
4. Why can’t the substitution and income effects be used to explain the downward slope of the aggregate
demand curve?
5. Explain the three reasons given for the downward slope of the aggregate demand curve.
6. The determinants of aggregate demand “determine” the location of the aggregate demand curve. What are
the four basic determinants of aggregate demand.
7. Identify three factors that affect consumer spending. How does a change in consumer spending affect
aggregate demand?
8. Identify two basic factors that affect investment spending. How does a change in investment spending
affect aggregate demand?
9. How does a change in investment spending affect aggregate demand?
10. State two basic factors that affect net export spending. How does a change in net export spending affect
aggregate demand?
11. Identify the ways in which each of the following determinants would have to change if each was causing a
decrease in aggregate demand: consumer wealth, consumer expectations, business taxes, national income
in countries abroad, exchange rates.
12. Describe the likely effect of the following events would on the aggregate demand (AD) curve.
(a) A boost in research and development by computer companies produces more powerful and efficient
computers and equipment.
(b) Income falls in several countries that trade heavily with the U.S.
(c) Prices fall across several industries.
(d) After a budget surplus, Congress moves to cut personal income taxes.
13. What are the three time horizons used to categorize aggregate supply? What is the difference between the
immediate short-run and the short-run aggregate supply?
14. Define aggregate supply. Describe the characteristics of the aggregate supply curve in the immediate short-
run, short-run and long-run perspectives.
15. Explain the rationale for the shape of the short-run aggregate supply curve in the immediate short run.
16. Explain the reasoning behind the shape of the short-run aggregate supply curve in the short run.
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12-2
17. What factors determine the vertical shape of the aggregate supply curve in the long-run? Explain.
18. Identify the three major factors that can cause a shift in aggregate supply.
19. What are two underlying factors affecting input prices? How does a change in input prices affect aggregate
supply?
20. How will a change in productivity increase or decrease aggregate supply?
21. What two factors affect the legal-institutional environment? Discuss the effect of changes in the legal-
institutional environment on aggregate supply.
22. Describe the change in aggregate supply that should result from each of the following changes in
determinants. Assume that nothing else is changing besides the identified change. (Use “Decrease” or
“Increase.”) (a) A rise in the average price of inputs; (b) An increase in worker productivity; (c)
Government antipollution regulations become stricter; (d) A new subsidy program is enacted for new
business investment in productive equipment; (e) Energy prices decline.
23. Prepare a list of events that would shift the aggregate supply curve leftward.
24. Prepare a list of government tax or spending policy options that would tend to shift the aggregate supply
curve rightward.
25. What determines the equilibrium price level and the level of real domestic output in the aggregate demand–
aggregate supply model?
26. What happens to bring the AD–AS system back into equilibrium when prices are below the equilibrium
level? Above the equilibrium level?
27. Suppose that a hypothetical economy has the following relationship between its real domestic output and
the input quantities necessary for producing that level of output.
Input quantity
Real domestic output
400
800
300
600
100
200
(a) What is the level of productivity in this economy?
(b) What is the unit cost of production if the price of each input is $2.00?
(c) If the input price decreases from $2 to $1.50, what is the new per unit cost of production? In what
direction would the aggregate supply curve move? What effect would this shift have on the price level
and the level of real domestic output if the economy is initially operating in the intermediate range?
(d) Suppose that instead of the input price decreasing, the productivity had increased by 25 percent. What
will be the new unit cost of production? In what direction would the aggregate supply curve move?
What effect would this shift have on the equilibrium price and output level if the economy?
28. Suppose the aggregate demand and supply schedules for a hypothetical economy are as shown below.
Amount of real
domestic output
demanded, billions
Price level
(price index)
Amount of real
domestic output
supplied, billions
$ 200
300
$800
400
250
800
600
200
600
800
150
400
1000
100
200
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12-3
(a) Use these sets of data to graph the aggregate demand and supply curves on the below graph.
(b) What will be the equilibrium price and output level in this hypothetical economy? Is it also the full–
employment level of output? Explain.
(c) Why won’t the 150 index be the equilibrium price level? Why won’t the 250 index be the equilibrium
price level?
(d) Suppose demand increases by $400 billion at each price level. What will be the new equilibrium price
and output levels?
(e) What factors might cause a change in aggregate demand?
29. Suppose the aggregate demand and supply schedules for a hypothetical economy are as shown below.
Amount of real
domestic output
demanded, billions
Price level
(price index)
Amount of real
domestic output
supplied, billions
$ 60
350
$240
120
300
240
180
250
180
240
200
120
300
150
60
(a) What will be the equilibrium price and output level in this hypothetical economy? Is it also the full–
employment level of output? Explain.
(b) Why won’t the 200 index be the equilibrium price level? Why won’t the 300 index be the equilibrium
price level?
(c) Suppose demand increases by $120 billion at each price level. What will be the new equilibrium price
and output levels?
(d) List five factors that might cause a change in aggregate demand.
30. Describe each of the following outcomes in terms of shifts in aggregate demand or aggregate supply
curves.
(a) A recession deepens while the rate of inflation increases
(b) The price level rises sharply while real output and employment increase
(c) The price level falls, but the unemployment rate rises
(d) Real output rises, unemployment rate falls, and the price level rises
31. Evaluate the effect of the following on the AD curve, AS curve, equilibrium price level and equilibrium
output.
(a) The U.S. imposes tariffs on foreign goods to promote domestic industry. In retaliation, foreign
countries impose tariffs on U.S. goods.
(b) Congress decides to decrease personal income taxes, and to compensate for the lost revenue they
decrease business subsidies.
(c) A technology boom improves technology across industries, improving their productivity.
(d) U.S. oil companies discover new large oil reserves in the U.S. The international price of oil falls.
32. What is the effect of the multiplier when aggregate demand increases and there is a large increase in the
price level? What happens when there only is a small increase in the price level?
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12-4
33. In the table below are aggregate demand and supply schedules.
Price level
Real domestic output
Demanded
Supplied
(1)
(2)
(3)
(4)
250
1400
1900
2000
225
1500
2000
2000
200
1600
2100
1900
175
1700
2200
1700
150
1800
2300
1400
125
1900
2400
1000
100
2000
2500
500
(a) On the graph below, plot the aggregate demand curve shown in columns (1) and (2) in the above table,
and label this curve AD1.
(b) On the graph below, plot the aggregate supply curve shown in columns (1) and (4) in the above table;
and label this curve AS.
(c) What is the level of equilibrium real domestic output and price level?
(d) Now assume that aggregate demand changes. Use columns (1) and (3) to plot the new aggregate
demand curve; and label this curve AD2.
(e) What is the new level of equilibrium real domestic output and price level?
34. Use this aggregate demand–aggregate supply schedule for a hypothetical economy to answer the following
questions.
Real domestic
output demanded
(in billions)
Price level
Real domestic
output supplied
(in billions)
$3000
350
$9000
4000
300
8000
5000
250
7000
6000
200
6000
7000
150
5000
8000
100
4000
(a) What will be the equilibrium price level and quantity of real domestic output?
(b) If the quantity of real domestic output demanded increased by $2000 at each price level, what will be
the new equilibrium price level and quantity of real domestic output?
(c) Using the original data from the table, if the quantity of real domestic output demanded increased by
$5000 and the quantity of real domestic output supplied increased by $1000 at each price level, what
would the new equilibrium price level and quantity of real domestic output be?
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12-5
35. What are five reasons for the downward price–level inflexibility, especially as it pertains to wages and
prices?
36. Is there downward price inflexibility applicable to today’s economy? What factors might explain it?
37. (Consider This) What is the ratchet effect? How does it apply to price level changes in the economy as
aggregate demand changes?
38. Explain “cost–push” inflation using aggregate demand–aggregate supply analysis.
39. Some economists argue that it is easier to resolve demand-pull inflation than it is cost-push inflation. Use
the aggregate demand and aggregate supply model to explain this assertion.
40. How would the following developments affect aggregate demand or aggregate supply?
(a) A reduction in personal income taxes.
(b) More funding for research and development in new technologies.
(c) An increase in business subsidies.
41. Suppose an economic advisor to the President recommended a personal income tax increase. Indicate the
expected effects on aggregate demand and on aggregate supply.
42. Use an aggregate demand–aggregate supply analysis to explain the impact of the public’s expectations of
severe inflation on real domestic output and the price level.
43. How can an economy achieve full employment without igniting inflation?
44. (Last Word) Have rises in oil prices lost their inflationary punch in the United States? If so, why?
45. (Last Word) Based on the discussion in the text, use the AD–AS framework to depict why the rise in oil
prices has had less effect on prices than in the past.
46. (Last Word) Has the effect of oil prices’ increases on the economy been diminished? Cite evidence to
support the case for a diminished effect.
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12-6
B. Answers to Short-Answer, Essays, and Problems
1. Why is there a need for an aggregate demand and aggregate supply model of the economy? Why can’t the
supply and demand model for a single product explain developments in the economy?
2. What is the aggregate demand curve? What is the character of its slope?
3. What is the difference in the explanation of the shape of the aggregate demand curve and a single product
demand curve? After all, both demand curves show an inverse relationship between price and quantity.
4. Why can’t the substitution and income effects be used to explain the downward slope of the aggregate
demand curve?
5. Explain the three reasons given for the downward slope of the aggregate demand curve.
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
6. The determinants of aggregate demand “determine” the location of the aggregate demand curve. What are
the four basic determinants of aggregate demand.
7. Identify three factors that affect consumer spending. How does a change in consumer spending affect
aggregate demand?
8. Identify two basic factors that affect investment spending. How does a change in investment spending
affect aggregate demand?
9. How does a change in investment spending affect aggregate demand?
10. State two basic factors that affect net export spending. How does a change in net export spending affect
aggregate demand?
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
11. Identify the ways in which each of the following determinants would have to change if each was causing a
decrease in aggregate demand: consumer wealth, consumer expectations, business taxes, national income
in countries abroad, exchange rates.
12. Describe the likely effect of the following events would on the aggregate demand (AD) curve.
(a) A boost in research and development by computer companies produces more powerful and efficient
computers and equipment.
(b) Income falls in several countries that trade heavily with the U.S.
(c) Prices fall across several industries.
(d) After a budget surplus, Congress moves to cut personal income taxes.
13. What are the three time horizons used to categorize aggregate supply? What is the difference between the
immediate short-run and the short-run aggregate supply?
14. Define aggregate supply. Describe the characteristics of the aggregate supply curve in the immediate short-
run, short-run and long-run perspectives.
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12-9
15. Explain the rationale for the shape of the short-run aggregate supply curve in the immediate short run.
16. Explain the reasoning behind the shape of the short-run aggregate supply curve in the short run.
17. What factors determine the vertical shape of the aggregate supply curve in the long-run? Explain.
18. Identify the three major factors that can cause a shift in aggregate supply.
19. What are two underlying factors affecting input prices? How does a change in input prices affect aggregate
supply?
20. How will a change in productivity increase or decrease aggregate supply?
21. What two factors affect the legal-institutional environment? Discuss the effect of changes in the legal-
institutional environment on aggregate supply.
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
22. Describe the change in aggregate supply that should result from each of the following changes in
determinants. Assume that nothing else is changing besides the identified change. (Use “Decrease” or
“Increase.”) (a) A rise in the average price of inputs; (b) An increase in worker productivity; (c)
Government antipollution regulations become stricter; (d) A new subsidy program is enacted for new
business investment in productive equipment; (e) Energy prices decline.
23. Prepare a list of events that would shift the aggregate supply curve leftward.
24. Prepare a list of government tax or spending policy options that would tend to shift the aggregate supply
curve rightward.
25. What determines the equilibrium price level and the level of real domestic output in the aggregate demand–
aggregate supply model?
26. What happens to bring the AD–AS system back into equilibrium when prices are below the equilibrium
level? Above the equilibrium level?
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12–11
27. Suppose that a hypothetical economy has the following relationship between its real domestic output and
the input quantities necessary for producing that level of output.
Input quantity
Real domestic output
400
800
300
600
100
200
(a) What is the level of productivity in this economy?
(b) What is the unit cost of production if the price of each input is $2.00?
(c) If the input price decreases from $2 to $1.50, what is the new per unit cost of production? In what
direction would the aggregate supply curve move? What effect would this shift have on the price level
and the level of real domestic output if the economy is initially operating in the intermediate range?
(d) Suppose that instead of the input price decreasing, the productivity had increased by 25 percent. What
will be the new unit cost of production? In what direction would the aggregate supply curve move?
What effect would this shift have on the equilibrium price and output level if the economy?
28. Suppose the aggregate demand and supply schedules for a hypothetical economy are as shown below.
Amount of real
domestic output
demanded, billions
Price level
(price index)
Amount of real
domestic output
supplied, billions
$ 200
300
$800
400
250
800
600
200
600
800
150
400
1000
100
200
(a) Use these sets of data to graph the aggregate demand and supply curves on the below graph.
(b) What will be the equilibrium price and output level in this hypothetical economy? Is it also the full–
employment level of output? Explain.
(c) Why won’t the 150 index be the equilibrium price level? Why won’t the 250 index be the equilibrium
price level?
(d) Suppose demand increases by $400 billion at each price level. What will be the new equilibrium price
and output levels?
(e) What factors might cause a change in aggregate demand?
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12–12
29. Suppose the aggregate demand and supply schedules for a hypothetical economy are as shown below.
Amount of real
domestic output
demanded, billions
Price level
(price index)
Amount of real
domestic output
supplied, billions
$ 60
350
$240
120
300
240
180
250
180
240
200
120
300
150
60
(a) What will be the equilibrium price and output level in this hypothetical economy? Is it also the full–
employment level of output? Explain.
(b) Why won’t the 200 index be the equilibrium price level? Why won’t the 300 index be the equilibrium
price level?
(c) Suppose demand increases by $120 billion at each price level. What will be the new equilibrium price
and output levels?
(d) List five factors that might cause a change in aggregate demand.
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
30. Describe each of the following outcomes in terms of shifts in aggregate demand or aggregate supply
curves.
(a) A recession deepens while the rate of inflation increases
(b) The price level rises sharply while real output and employment increase
(c) The price level falls, but the unemployment rate rises
(d) Real output rises, unemployment rate falls, and the price level rises
31. Evaluate the effect of the following on the AD curve, AS curve, equilibrium price level and equilibrium
output.
(a) The U.S. imposes tariffs on foreign goods to promote domestic industry. In retaliation, foreign
countries impose tariffs on U.S. goods.
(b) Congress decides to decrease personal income taxes, and to compensate for the lost revenue they
decrease business subsidies.
(c) A technology boom improves technology across industries, improving their productivity.
(d) U.S. oil companies discover new large oil reserves in the U.S. The international price of oil falls.
32. What is the effect of the multiplier when aggregate demand increases and there is a large increase in the
price level? What happens when there only is a small increase in the price level?
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12–14
33. In the table below are aggregate demand and supply schedules.
Price level
Real domestic output
Demanded
Supplied
(1)
(2)
(3)
(4)
250
1400
1900
2000
225
1500
2000
2000
200
1600
2100
1900
175
1700
2200
1700
150
1800
2300
1400
125
1900
2400
1000
100
2000
2500
500
(a) On the graph below, plot the aggregate demand curve shown in columns (1) and (2) in the above table,
and label this curve AD1.
(b) On the graph below, plot the aggregate supply curve shown in columns (1) and (4) in the above table;
and label this curve AS.
(c) What is the level of equilibrium real domestic output and price level?
(d) Now assume that aggregate demand changes. Use columns (1) and (3) to plot the new aggregate
demand curve; and label this curve AD2.
(e) What is the new level of equilibrium real domestic output and price level?
34. Use this aggregate demand–aggregate supply schedule for a hypothetical economy to answer the following
questions.
Real domestic
output demanded
(in billions)
Price level
Real domestic
output supplied
(in billions)
$3000
350
$9000
4000
300
8000
5000
250
7000
6000
200
6000
7000
150
5000
8000
100
4000
(a) What will be the equilibrium price level and quantity of real domestic output?
(b) If the quantity of real domestic output demanded increased by $2000 at each price level, what will be
the new equilibrium price level and quantity of real domestic output?
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
(c) Using the original data from the table, if the quantity of real domestic output demanded increased by
$5000 and the quantity of real domestic output supplied increased by $1000 at each price level, what
would the new equilibrium price level and quantity of real domestic output be?
35. What are five reasons for the downward price–level inflexibility, especially as it pertains to wages and
prices?
36. Is there downward price inflexibility applicable to today’s economy? What factors might explain it?
37. (Consider This) What is the ratchet effect? How does it apply to price level changes in the economy as
aggregate demand changes?
38. Explain “cost–push” inflation using aggregate demand–aggregate supply analysis.
39. Some economists argue that it is easier to resolve demand-pull inflation than it is cost-push inflation. Use
the aggregate demand and aggregate supply model to explain this assertion.
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
40. How would the following developments affect aggregate demand or aggregate supply?
(a) A reduction in personal income taxes.
(b) More funding for research and development in new technologies.
(c) An increase in business subsidies.
41. Suppose an economic advisor to the President recommended a personal income tax increase. Indicate the
expected effects on aggregate demand and on aggregate supply.
42. Use an aggregate demand–aggregate supply analysis to explain the impact of the public’s expectations of
severe inflation on real domestic output and the price level.
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12–17
43. How can an economy achieve full employment without igniting inflation?
44. (Last Word) Have rises in oil prices lost their inflationary punch in the United States? If so, why?
45. (Last Word) Based on the discussion in the text, use the AD–AS framework to depict why the rise in oil
prices has had less effect on prices than in the past.
46. (Last Word) Has the effect of oil prices’ increases on the economy been diminished? Cite evidence to
support the case for a diminished effect.
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12–18
C. Appendix Questions
47. How can the aggregate demand curve be derived from the aggregate expenditures model?
48. Explain the relationship between the aggregate expenditures model in graph (A) below and the aggregate
demand–aggregate supply model in graph (B) below. In other words, explain how points 1, 2, and 3 are
related to points 1’, 2’, and 3’.
49. How does the aggregate expenditures analysis differ from the aggregate demand–aggregate supply
analysis?
50. Why does aggregate demand shift outward by a greater amount than the initial change in spending?
51. Explain the relationship between the aggregate expenditures model in graph (A) below and the aggregate
demand–aggregate supply model in graph (B) below where aggregate demand is shifting while the price
level remains constant.
(A) (B)
Graph A
Graph B
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
D. Answers to Appendix Questions
47. How can the aggregate demand curve be derived from the aggregate expenditures model?
47. Explain the relationship between the aggregate expenditures model in graph (A) below and the aggregate
demand–aggregate supply model in graph (B) below. In other words, explain how points 1, 2, and 3 are
related to points 1’, 2’, and 3’.
49. How does the aggregate expenditures analysis differ from the aggregate demand–aggregate supply
analysis?
Chapter 12 – Aggregate Demand and Aggregate Supply (+ Appendix)
12–20
50. Why does aggregate demand shift outward by a greater amount than the initial change in spending?
51. Explain the relationship between the aggregate expenditures model in graph (A) below and the aggregate
demand–aggregate supply model in graph (B) below where aggregate demand is shifting while the price
level remains constant.