Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
CHAPTER 26: THE SHORT-RUN KEYNESIAN POLICY
MODEL: DEMAND-SIDE POLICIES
Questions and Exercises
1. According to Keynesians the economy could deviate from its potential because if
aggregate demand falls for some unexplained reason, firms would respond by
2. When prices are falling, profits decline, making entrepreneurs hesitant to start
businesses, slowing the growth of the economy. Asset values (prices of assets
3. The paradox of thrift is the notion that an increase in saving can lead to a decrease
4. One expects the AD curve to be vertical because when the price level rises, all
prices rise together. That is, since wages have risen as much as prices for
5. a. A rise in the price level reduces the value of cash people hold. They withdraw
1
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
b. Assuming fixed exchange rates, a rise in the price level would make goods less
c. When there is a rise in the price level the holders of money become poorer so they
6. Five factors that shift the AD curve are: (1) changes in foreign income, (2)
changes in expectations, (3) changes in exchange rates, (4) changes in the
7. A falling price level could reduce aggregate demand (shift the demand curve to
8. a. The AD curve will be steeper because a change in the price level will be offset by
b. The AD curve will become steeper if a fall in the price level doesn't make people
c. The AD curve will be steeper if a fall in the price level creates expectations of a
d. Assuming that poor people spend a higher percentage of their income than rich
9. Two factors that shift the SAS curve are changes in productivity and changes in
2
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
10. a. The SAS curve will shift up, with inflation equal to 1 percent since wages rise by
11. The LAS curve is vertical because potential output depends on the capacity for
12. a. An increase in the availability of inputs will shift the LAS curve to the right. The
13. If the economy is in short-run equilibrium below potential output, underutilization
of inputs will cause input prices to fall, causing the short-run aggregate supply
14. a. This implies that productivity is increasing significantly. If computers are a large
15. a It is likely that the rise in oil prices will shift the SAS curve up and the drop in
world income will shift the AD curve in, causing equilibrium income to fall even
3
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
b. We might suggest expansionary fiscal
and monetary policy to shift the AD
curve out (from AD0 to AD2) and
16. a. The slowing of foreign economies
will reduce exports, shifting the AD
b. An economy operating above potential output is shown by point A in graph (b).
To keep the inflation from rising (the SAS curve from shifting up), the government
c. A new technology that increases potential output will shift the LAS curve to the
right (from LAS0 to LAS1), as shown in graph (c), creating excess capacity and
Real output
YP
AD1AD0
SAS
LAS
Real output
Y0
P0
Y1
AD0
AD1
SAS0
SAS1
A
(a) (c)
Real output
YP
AD1AD0
SAS
LAS
(b)
Y0
P1
P0
LAS1
LAS0
A
B
C
4
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
AD0
AD1
SAS1
LAS
C
17. When the price level falls, people may
expect aggregate demand to decline
because falling asset prices reduce
18. To design an appropriate fiscal policy, it is important to know the level of
19. The simple model abstracts from a number of important issues such as the
20. Countercyclical fiscal policy is difficult to implement because it is difficult to
Questions from Alternative Perspectives
1. Austrian
a. It could be consistent with the AS/AD model if one sees the SAS and AD curves
b. Austrians would favor an institutional system that had far less government
5
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
SAS0
2. Institutionalist
a. When oil production declines, the production possibility curve shifts in, the LAS
b. This will shift real income from individuals and nations that are net consumers of
3. Post Keynesian
While Minsky predicted many of the current problems, he did not predict the timing
of those problems, which allows people to argue that his theory is not generally
4. Radical
a. The excess capacity is shown by
the gap between the quantity of
b. What should be done is a
judgment question and
judgments differ. Classicals tend
6
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
c. It suggests that the model (positive economics) embodies in it certain biases
d. While some measure of value judgment is inherent in positive economics, it
Issues to Ponder
1. a. Keynes used models not in a mechanistic way, but in an interpretive way. He was
b. It fits in nicely with the “other things constant” assumption since the policy
c. It definitely was primarily in the art of economics since the above method is the
2. Yes, they would emphasize the inherent value of the program rather than
7
© 2017 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in
any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.
