Notice that real GDP trends upward over time but experiences ups and downs in the short run. These short-run fluctuations in real GDP are often referred to as RECESSIONS OR THE BUSINESS CYCLE OR EXPANSIONS True or False: Small ups and downs in real GDP follow a consistent, predictable pattern. True False Which of the following probably occurred as the U.S. economy experienced increasing real GDP in 1954? Check all that apply. Total real income increased. Corporate profits increased. Consumer spending declined. Car sales declined. 2. Problems and Applications Q4 In 1939, with the U.S. economy not yet fully recovered from the Great Depression, President Roosevelt proclaimed that Thanksgiving would fall a week earlier than usual so that the shopping period before Christmas would be longer. Graph A Graph B LRAS LRAS Aggregate Supply Aggregate Supply Price Level Price Level Aggregate Demand Aggregate Demand Quantity of Output Quantity of Output Which of the graphs represents the state of the economy before this pronouncement? Graph A Graph B a WTrue or False: President Roosevelt was trying to increase aggregate demand. True False 3. Problems and Applications Q5 True or False: Whenever the economy enters a recession, its long-run aggregate supply curve shifts to the left. True False 4. Problems and Applications Q7 The economy begins in long-run equilibrium. Then one day, the president appoints a new Fed chair, who is well known for holding the view that inflation is not a major problem for an economy. Note: You will not be graded on any changes you make to the following graph, but you may use it to help you understand the scenario described. LRAS Aggregate Supply Aggregate Demand Aggregate Supply Price Level LRAS Aggregate Demand Quantity of Output Which of the following statements accurately describes what would happen as a result of this news? Check all that apply. People would expect the price level to fall. a WWhich of the following statements accurately describes what would happen as a result of this news? Check all that apply. People would expect the price level to fall. The nominal wage that workers and firms agree to in their new labor contracts would be higher than it would be otherwise. The profitability of producing goods and services at any given price level would decrease. The short-run aggregate-supply curve would shift to the right. If aggregate demand is held constant, the shift in the aggregate-supply curve will cause the price level to RISE OR FALL and the quantity of output produced to RISE OR FALL 5. Economic fluctuations | The following graph shows a hypothetical economy in long-run equilibrium at an expected price level of 120 and a natural output level of $600 billion. Suppose firms become pessimistic about future business conditions and cut back on investment spending. Using the graph, shift the short-run aggregate supply (AS) curve or the aggregate demand (AD) curve to show the short-run impact of the business pessimism. Aggregate supply - SHIFT LEFT OR SHIFT RIGHT OR NO CHANGE Aggregate demand - SHIFT LEFT OR SHIFT RIGHT OR NO CHANGE 240 a WIn the short run, the decrease in investment spending associated with business pessimism causes the price level to RISE ABOVE OR FALL BELOW the price level people expected and the quantity of output to RISE ABOVE OR FALL BELOW the natural level of output. The business pessimism will cause the unemployment rate to RISE ABOVE OR FALL BELOW the natural rate of unemployment in the short run. Again, the following graph shows a hypothetical economy experiencing long-run equilibrium at the expected price level of 120 and natural output level of $600 billion, prior to the decrease in investment spending associated with business pessimism. Along the transition from the short run to the long run, price-level expectations will ADJUST UPWARD OR ADJUST DOWNWARD OR REMAIN THE SAME and the AGGREGATE DEMAND OR SHORT-RUN AGGREGATE SUPPLY curve will shift to the LEFT OR RIGHT Using the graph, illustrate the long-run impact of the business pessimism by shifting both the aggregate demand (AD) curve and the short-run aggregate supply (AS) curve in the appropriate directions. 240 O AS 200 AD 160 AS PRICE LEVEL 120 80 AD 40 200 400 600 800 1000 1200 OUTPUT (Billions of dollars) Aggregate supply - SHIFT LEFT OR SHIFT RIGHT OR NO CHANGE Aggregate demand - SHIFT LEFT OR SHIFT RIGHT OR NO CHANGE In the long run, due to the business pessimism, the price level INCREASES OR DECREASES OR REM AINS THE SAME, the quantity of output EXCEEDS OR aRETURNS TO OR FALLS SHORT OF the natural level of output, and the unemployment rate EXCEEDS OR RETURNS TO OR FALLS SHORT OF the natural rate. 6. The opportunity cost of holding money Suppose you've just inherited $5,000 from a relative. You're trying to decide whether to put the $5,000 in a non-interest-bearing account so that you can use it whenever you want (that is, hold it as money) or to use it to buy a U.S. Treasury bond. The opportunity cost of holding the inheritance as money depends on the interest rate on the bond. For each of the interest rates in the following table, compute the opportunity cost of holding the $5,000 as money. Interest Rate on Government Bond Opportunity Cost (Percent) (Dollars per year) 9 0.09 or 55,556.00 or 450.00 or 5,000 or 9.00 11 45,455.00 or 11.00 or 550.00 or 5,000 or 0.11 What does the previous analysis suggest about the market for money? The supply of money is independent of the interest rate. The quantity of money demanded increases as the interest rate rises. The quantity of money demanded decreases as the interest rate rises. 7. The theory of liquidity preference and the downward-sloping aggregate demand curve Suppose the money market for some hypothetical economy is given by the following graph, which plots the money demand and money supply curves. Assume the central bank in this economy (the Fed) fixes the quantity of money supplied. Suppose the price level increases from 90 to 105. Shift the appropriate curve on the graph to show the impact of an increase in the overall price level on the market for money. Money demand shifts - RIGHT OR LEFT OR NO CHANGE a W