Aggregate Supply and Aggregate Demand

2. 13 Aggregate Supply and Aggregate Demand CHECKPOINTS

3. Checkpoint 13.1 Checkpoint 13.2 Checkpoint 13.3 Problem 1 Problem 1 Clicker version Problem 1 Clicker version Problem 2 Problem 2 Clicker version Problem 2 Problem 3 Clicker version Problem 3 Problem 4

4. Practice Problem 1 Explain the influence of each of events on the quantity of real GDP supplied and aggregate supply in India and use a graph to illustrate. Fuel prices rose. U.S. firms moved their call handling, IT, and data functions to India. Wal-Mart and Starbucks opened in India. Universities in India increased the number of engineering graduates. The money wage rate in India rose. The price level in India increased. CHECKPOINT 13.1

5. Solution As fuel prices rose, the quantity of real GDP supplied at the current price level decreased The AS curve shifted leftward. CHECKPOINT 13.1

6. As businesses moved their call handling, IT and data functions to India, real GDP supplied at the current price level increased. The AS curve shifted rightward. CHECKPOINT 13.1

7. As Wal-Mart and Starbucks opened in India, the quantity of real GDP supplied at the current price level increased. The AS curve shifted rightward. CHECKPOINT 13.1

8. With more engineering graduates, the number of skilled workers increased, and production increased at the current price level. The AS curve shifted rightward. CHECKPOINT 13.1

9. As money wage rates rose, firms’ costs increased and the quantity of real GDP supplied at the current price level decreased. The AS curve shifted leftward. CHECKPOINT 13.1

10. As the price level increased, other things remaining the same, businesses became more profitable. As the price level increased, firms increased the quantity of real GDP supplied along the AS curve. The AS curve did not shift. CHECKPOINT 13.1

11. Study Plan Problem Over the past decade, U.S. firms moved their call handling, IT and data functions to India. In the short run, India’s aggregate supply _________. A. increased B. didn’t change, but U.S. aggregate supply increased C. decreased because more of India’s workers are now employed by U.S. firms D. didn’t change, but a higher price level brought an increase in the quantity of real GDP supplied CHECKPOINT 13.1

12. Over the past decade, fuel prices rose in India. In the short run, India’s aggregate supply _________. A. increased B. didn’t change, the quantity of real GDP supplied decreased C. didn’t change, but the quantity of real GDP supplied increased D. decreased CHECKPOINT 13.1

13. Over the past decade, Wal-Mart and Starbucks opened in India. In the short run, India’s aggregate supply _______. A. increased B. didn’t change, the quantity of real GDP supplied decreased C. didn’t change, but the quantity of real GDP supplied increased D. decreased CHECKPOINT 13.1

14. Over the past decade, universities in India increased the number of engineering graduates. In the short run, India’s aggregate supply _______. didn’t change, the quantity of real GDP supplied decreased increased C. didn’t change, but the quantity of real GDP supplied increased D. decreased CHECKPOINT 13.1

15. Over the past decade, the money wage rate in India rose. In the short run, India’s aggregate supply _______. didn’t change, but the price level rose and the quantity of real GDP supplied increased increased didn’t change, but the price level fell and the quantity of real GDP supplied decreased decreased CHECKPOINT 13.1

16. Over the past decade, the price level in India increased. In the short run, India’s aggregate supply _______. didn’t change, but the quantity of real GDP supplied decreased increased didn’t change, but the quantity of real GDP supplied increased decreased CHECKPOINT 13.1

17. Practice Problem 2 Wages could hit steepest plunge in 18 years A bad economy is starting to drag down wages for millions of workers. The average weekly wage of private-sector workers has fallen 1.4% this year through September. Colorado will become the first state to lower its minimum wage since the federal minimum wage law was passed in 1938, when the state cuts its rate by 4 cents an hour. Source: USA Today, October 16, 2009 Explain how the fall in the average weekly wage and the minimum wage will influence aggregate supply. CHECKPOINT 13.1

18. Solution The cut in the money wage rate decreases the real wage rate and increases aggregate supply. If the cut in the minimum wage decreases the natural unemployment rate, potential GDP increases and aggregate supply increases further. CHECKPOINT 13.1

19. Practice Problem 1 Mexico trades with the United States. Explain the effect of each of the following events on Mexico’s aggregate demand. The government of Mexico cuts income taxes. The United States experiences strong economic growth. Mexico sets new environmental standards that require factories to upgrade their production facilities. CHECKPOINT 13.2

20. Solution A tax cut increases disposable income, which increases Mexico’s aggregate demand. The AD curve shifts rightward. CHECKPOINT 13.2

21. Strong U.S. growth increases the demand for Mexican-produced goods and increases Mexico’s aggregate demand. The AD curve shifts rightward. CHECKPOINT 13.2

22. As factories upgrade their facilities, investment increases. Aggregate demand increases. The AD curve shifts rightward. CHECKPOINT 13.2

23. Study Plan Problem If the government of Mexico cuts income taxes,Mexico’s aggregate demand _________. A. decreases, and the AD curve shifts leftward B. increases, and the AD curve shifts rightward C. is unchanged because it just increases the amount that taxpayers transfer to the government D. is unchanged, but the price level rises and the quantity of real GDP demanded decreases CHECKPOINT 13.2

24. Mexico trades with the United States. If the United States experiences strong economic growth, Mexico’s aggregate demand _________. A. decreases and the AD curve shifts leftward B. is unchanged, but the quantity of real GDP demanded increases C. is unchanged, but U.S. aggregate demand increases D. increases because its exports to the United States increases CHECKPOINT 13.2

25. When Mexico sets new environmental standards that require factories to upgrade their production facilities. Mexico’s aggregate demand _________. increases because investment increases is unchanged, but the quantity of real GDP demanded increases C. is unchanged, but the quantity of real GDP demanded decreases D. decreases CHECKPOINT 13.2

26. Practice Problem 2 Explain the effect of each of the following events on Mexico’s aggregate demand. Europe trades with Mexico and goes into a recession. The price level in Mexico rises. Mexico increases the quantity of money. CHECKPOINT 13.2

27. Solution A recession in Europe decreases European demand for Mexican goods. Mexico’s exports decrease. Aggregate demand decreases and the AD curve shifts leftward. CHECKPOINT 13.2

28. A rise in the price level decreases the quantity of real GDP demanded along the AD curve, but the AD curve does not shift. CHECKPOINT 13.2

29. An increase in the quantity of money increases aggregate demand, and the AD curve shifts rightward. CHECKPOINT 13.2

30. Practice Problem 3 Durable goods orders surge in May, new-homes sales dip The Commerce Department announced that demand for durable goods rose 1.8%, while new-home sales dropped 0.6% in May. U.S. companies suffered a sharp drop in exports as other countries struggle with recession. Source: USA Today, June 24, 2009 Explain how the items in the news clip influence U.S. aggregate demand. CHECKPOINT 13.2

31. Solution The purchase of durable goods and new homes is investment. Investment increased, which increased aggregate demand. The drop in U.S. exports is a decrease in the demand for U.S.-produced goods and services, so the drop in U.S. exports decreased U.S. aggregate demand. CHECKPOINT 13.2

32. Practice Problem 1 The U.S. economy is at full employment when the following events occur: A deep recession hits the world economy. The world oil price rises by a large amount. U.S. businesses expect future profits to fall. Explain the effect of each event separately on aggregate demand and aggregate supply. How will real GDP and price level change in the short run? CHECKPOINT 13.3

33. Solution A deep recession in the world economy decreases U.S. aggregate demand. The AD curve shifts leftward. In the short run, U.S. real GDP decreases and the price level falls. CHECKPOINT 13.3

34. A rise in the world oil price decreases U.S. aggregate supply. The AS curve shifts leftward. In the short run, U.S. real GDP decreases and the price level rises. CHECKPOINT 13.3

35. A fall in expected future profits decreases U.S. aggregate demand. The AD curve shifts leftward. In the short run, U.S. real GDP decreases and the price level falls. CHECKPOINT 13.3

36. Practice Problem 2 The U.S. economy is at full employment when the following events occur: A deep recession hits the world economy. The world oil price rises by a large amount. U.S. businesses expect future profits to fall. Explain the combined effect of these events on real GDP and price level. CHECKPOINT 13.3

37. Solution All three events decrease U.S. real GDP. The deep world recession and the fall in expected future profits decrease the price level. The rise in the world oil price increases the price level. So the combined effect on the price level is ambiguous. CHECKPOINT 13.3

38. Study Plan Problem The U.S. economy is at full employment when a deep recession hits the world economy, the world oil price rises by a large amount, and U.S. businesses expect future profits to fall. The U.S. price level rises and real GDP decreases The U.S. price level falls and real GDP decreases U.S. real GDP decreases, but the price level might rise or fall. D. U.S. real GDP increases, but the price level might rise or fall. CHECKPOINT 13.2

39. Practice Problem 3 The U.S. economy is at full employment when the following events occur: A deep recession hits the world economy. The world oil price rises by a large amount. U.S. businesses expect future profits to fall. Which event, if any, brings stagflation? CHECKPOINT 13.3

40. Solution Stagflation occurs when the price level rises and real GDP decreases at the same time. The rise in the world oil price brings stagflation because it decreases aggregate supply, decreases real GDP, and raises the price level. CHECKPOINT 13.3

41. Study Plan Problem The U.S. economy is at full employment. Stagflation occurs, if ______. a deep recession hits the world economy the world oil price rises by a large amount U.S. businesses expect future profits to fall. D. A, or B, or C occur. CHECKPOINT 13.2

42. Practice Problem 4 Stronger spending helps real GDP shrink at a slower 0.7% The 0.7% decline in U.S. economic activity in the second quarter was better than the 1.2% contraction that was expected. It was also an improvement from the first quarter, when GDP fell at a 6.4% rate. Consumer spending fell 0.9%, business investment fell by 9.6% as inventories plunged, and exports fell in the last two months. Source: Reuters, September 30, 2009 Explain the combined effect of these events in terms of the AS-AD model. CHECKPOINT 13.3

43. Solution The news clip gives no information about aggregate supply. Consumer spending, business investment, and exports influence aggregate demand. The news clip pins all the change in real GDP as arising from a slowing of the decrease in aggregate demand and a movement along the AS curve. CHECKPOINT 13.3