Look at Those Curves
Draw (and ACE) an AD-AS model illustrating an economy in a recession.
What are the (four) basic determinants (shifters) of aggregate demand (AD)?
Consumer spending, business investment, government spending, and net exports.
What is the marginal propensity to consume and marginal propensity to save of the economy described below?
| Disposable Income | Consumption |
| $100 | $150 |
| $200 | $225 |
| $300 | $300 |
| $400 | $375 |
MPC = 0.75
MPS = 0.25
How will an economy with a negative output gap autocorrect in the long-run? (What has to happen and which curve will shift?)
Workers desperate for work will begin to accept lower wages, input costs will fall, and short-run aggregate supply will shift to the right.
What are two fiscal policy strategies the government can use to close a negative output gap? What kind of policy would this be?
Increase spending or decrease taxes. This would be expansionary fiscal policy.
Draw a production possibilities frontier (PPF) model of an economy with an inflationary gap. Label short-run equilibrium X.
The X should be on the outside of the PPF curve.
Draw an AD-AS model that shows the impact of a decrease in consumer spending.
(AD should shift to the left.)
What are the spending and tax multipliers of the economy described below?
| Disposable Income | Consumption |
| $200 | $240 |
| $300 | $320 |
| $400 | $400 |
| $500 | $480 |
The spending multiplier is 5 and the tax multiplier is (-)4.
Draw an AD-AS model of how an economy with an inflationary gap will self-correct in the long-run (be sure you ACED your graph).
(Y1 should be to the right of the LRAS, SRAS should shift left towards the LRAS.)
Draw an AD-AS model illustrating the impact of contractionary fiscal policy (be sure you ACED your graph).
(AD should shift to the left.)
Both supply and short-run aggregate supply are upward sloping. What is the major factor that causes SRAS to be upward sloping?
Fixed costs, sticky wages, wage/resource contracts
In the short-run, because of contracts, wages/costs are sticky/fixed so firms make more profit and are more incentivized to produce goods and services at higher costs.
Draw an AD-AS model showing the impact that increased government regulation will have (in the short-run).
How much should an economy with an MPC of 0.9 increase or decrease spending to close a negative output gap of $20B?
They should increase spending by $2B.
What type of tax system is the most effective automatic stabilizer?
Progressive
What are two (of the three) ways a government can (not necessarily wisely) finance a deficit?
Raise taxes, borrow from the public, create money.
What is one reason why the aggregate demand curve is downward sloping?
The wealth effect, interest-rate effect, and foreign purchases effect.
Draw an AD-AS model illustrating the impact of a decrease in imports (be sure you ACED your graph).
(AD should shift to the right.)
How much should an economy with an MPC of 0.8 increase or decrease taxes to close an inflationary output gap of $20B?
They should increase taxes by $5B.
Draw an AD-AS model illustrating the impact of demand-pull inflation. (Be sure you ACED your graph.)
(AD will shift to the right.)
What impact will expansionary fiscal policy have on aggregate demand, the budget, and the national debt?
Expansionary policy will cause aggregate demand to increase, the budget to run a deficit, and the national debt will increase.
What is the slope of the long-run aggregate supply curve and why?
The LRAS is vertical because it represents the total amount of goods and services an economy can sustainably produce and ultimately has no relationship with price.
What are the (two) basic determinants (shifters) of long-run aggregate supply (LRAS)?
Increases/decreases in available/accessible resources and increases/decreases in productivity.
What are two ways a government can close a recessionary output gap of $30B with an MPS of 0.4? What kind of fiscal policy would this be?
Increase spending by $12B.
Decrease taxes by $20B.
This is an example of expansionary fiscal policy.
What type of inflation is caused by a rise of input prices? This will cause which curve to shift in which direction?
Cost-push inflation; SRAS will shift to the left
What impact does contractionary fiscal policy have on output, unemployment, and inflation?
Output will decrease/fall, unemployment will increase/rise, and inflation should decrease/fall.