978-0077660772 Chapter 12 Solution Manual Part 1

Chapter 12 – Aggregate Demand and Aggregate Supply

McConnell, Brue, and Flynn 20e

DISCUSSION QUESTIONS

1. Why is the aggregate demand curve downsloping? Specify how your explanation differs from

the explanation for the downsloping demand curve for a single product. What role does the

multiplier play in shifts of the aggregate demand curve? LO1

Answer: The aggregate demand (AD) curve shows that as the price level drops,

purchases of real domestic output increase. The AD curve slopes downward for

The second reason is the real balances effect. As the price level rises, the real

The third reason is the foreign purchases effect. As the United States’ price level

rises relative to other countries, Americans will buy more abroad in preference to

These reasons for the downsloping AD curve have nothing to do with the reasons

for the downsloping single-product demand curve. In the case of the dropping

The multiplier acts on an “initial change in spending” to generate an even greater

shift in the aggregate demand curve. (Figure 12.2)

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Chapter 12 – Aggregate Demand and Aggregate Supply

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Chapter 12 – Aggregate Demand and Aggregate Supply

2. Distinguish between “real-balances effect” and “wealth effect,” as the terms are used in this

chapter. How does each relate to the aggregate demand curve? LO1

Answer: The “real balances effect” refers to the impact of price level on the

purchasing power of asset balances. If prices decline, the purchasing power of

The “wealth effect” assumes the price level is constant, but a change in consumer

consumer spending.

3. What assumptions cause the immediate-short-run aggregate supply curve to be horizontal?

Why is the long-run aggregate supply curve vertical? Explain the shape of the short-run aggregate

supply curve. Why is the short-run aggregate supply curve relatively flat to the left of the full-

employment output and relatively steep to the right? LO3

Answer: The immediate short-run supply curve is horizontal because of

contractual agreements. These ‘contracts’ for both input and output prices imply

that prices do not change along the immediate short-run aggregate supply curve.

The shape of the short-run supply curve is upsloping. Wages and other input

prices adjust more slowly than the price level, leaving room for firms to take

To the left of full-employment output the curve is relatively flat because of the

To the right of full-employment output the curve is relatively steep because most

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Chapter 12 – Aggregate Demand and Aggregate Supply

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Chapter 12 – Aggregate Demand and Aggregate Supply

4. Explain how an upsloping aggregate supply curve weakens the realized multiplier effect from

an initial change in investment spending. LO6

Answer: An upsloping aggregate supply curve weakens the effect of the

multiplier because any increase in aggregate demand will have both a price and an

5. Why does a reduction in aggregate demand in the actual economy reduce real output, rather

than the price level? Why might a full-strength multiplier apply to a decrease in aggregate

demand? LO6

Answer: A reduction in aggregate demand causes a decline in real output rather

than the price level because prices are inflexible downward (“sticky”). If we

6. Explain: “Unemployment can be caused by a decrease of aggregate demand or a decrease of

aggregate supply.” In each case, specify the price-level outcomes. LO6

Answer: The statement is true, although the magnitude of the effect on

unemployment can vary considerably, particularly with decreases in aggregate

demand. A decrease in aggregate supply will unambiguously increase the price

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AD1

AD2

P1

P2

Q2 Q1

AS1 AS2

Chapter 12 – Aggregate Demand and Aggregate Supply

7. Use shifts of the AD and AS curves to explain (a) the U.S. experience of strong economic

growth, full employment, and price stability in the late 1990s and early 2000s and (b) how a

strong negative wealth effect from, say, a precipitous drop in house prices could cause a recession

even though productivity is surging. LO6

Answer:

(a) While AD is increasing and shifting to right, AS is shifting rightward as well,

(b) In this situation AD shifts left from AD1 to AD2 because of the precipitous

8. In early 2001 investment spending sharply declined in the United States. In the 2 months

following the September 11, 2001, attacks on the United States, consumption also declined. Use

AD-AS analysis to show the two impacts on real GDP. LO6

Answer: Both events would be represented by a leftward shift in aggregate

demand, and the initial declines in spending would be multiplied. (See Figure

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Chapter 12 – Aggregate Demand and Aggregate Supply

9. LAST WORD What were the monetary and fiscal policy responses to the Great Recession?

What were some of the reasons suggested for why those policy responses didn’t seem to have as

large an effect as anticipated on unemployment and GDP growth?

Answer: When it was widely recognized in late 2008 that the downturn was

going to be unusually severe, public officials took extraordinarily strong steps to

While many economists credit these actions for preventing a worse downturn, the

effects on unemployment and economic growth were smaller than anticipated.

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