chapter11/10 eco201

What will happen to the position of the SAS curve and/or LAS curve in the following circumstances?

Available factors of production increase.
Answer:  The LAS will shift to the right. The SAS curve will not shift initially.

b. A civil war occurs.
Answer:  The LAS will shift left while the SAS will shift up.

Wages that were fixed become flexible, and aggregate demand increases.
Answer:  The SAS curve will shift up. The LAS curve will not shift.

If an economy is in short-run equilibrium that is below potential, what forces will bring the economy to long-run equilibrium?
Answer:  Underutilization of inputs will cause input prices to fall, causing the short-run aggregate supply curve to shift  down and the price level to fall . This will set the wealth, interest rate, and international effects in motion,  increasing the quantity of aggregate demand and thereby bringing the economy into long-run equilibrium at potential output.”




a. The economy begins at potential output, but foreign economies slow dramatically.
Ans:  Increase spending while decreasing taxes (expansionary fiscal policy).

The economy has been operating above potential output and inflationary pressures rise.
Ans:  Decrease spending while increasing taxes (contractionary fiscal policy).

A new technology is invented that significantly raises potential output.
Ans:  Increase spending while decreasing taxes (expansionary fiscal policy).


Choose those factors that might destabilize the economy when the price level falls.

1. Falling asset prices reduce perceived wealth.  CORRECT
2. Domestic goods are more competitive internationally.  INCORRECT
3. Banks call in loans as asset values fall.  CORRECT
4. The value of the money people hold in cash rises.  INCORRECT
5. Interest rates fall.   INCORRECT
6. People expect aggregate demand to fall.  CORRECT

Why is countercyclical fiscal policy difficult to implement?
ANS:
 	IT is difficult to assess the condition of the economy at any one time.
It takes a long time to enact new government policies.
Politically it is difficult to raise taxes, even when countercyclical policy is contractionary.

Why is knowing the level of potential output important to designing appropriate fiscal policy?
ANS:  Knowing where the economy is relative to potential output tells you whether to implement expansionary or contractionary policy.

In the late 1990s, a growing number of economists argued that world policy makers were focusing too much on fighting inflation. The economists also argued that the technical level of potential output had risen. Show their argument using the AS/AD model.
ANS:  A large increase in potential output would shift the LAS curve to the right and cause downward pressure on the price level. As the price level shifts down, the SAS curve also shifts down and the output level increases.
Why is macro policy more difficult than the simple model suggests?

Without knowing potential income, we cannot know whether expansionary or contractionary policy is called for.

The model does not take into account the difficulties in implementing fiscal policies.

The model does not take into account the uncertain effectiveness of fiscal policies.
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The model does not take into account potential negative feedback effects.
ALL THE ABOVE