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Chapter 12 - Aggregate Demand and Aggregate Supply
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)
12-1
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Chapter 12 - Aggregate Demand and Aggregate Supply
12-2
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consent of McGraw-Hill Education.
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
12-3
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Chapter 12 - Aggregate Demand and Aggregate Supply
12-4
Copyright © 2015 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
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
12-5
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consent of McGraw-Hill Education.
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
12-6
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consent of McGraw-Hill Education.
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.
12-7
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consent of McGraw-Hill Education.
