chapter10

The central difference between activist and laissez-faire economists is their differing views about whether the economy is self-regulating. Laissez-Faire economists, also known as Classicals believe the pricing mechanism will bring the economy to an equilibrium of potential output and full employment. Keynsians, on the other hand, believe that the government sometimes needs to use fiscal policies, such as changing tax levels and government spending, in order to keep the economy from getting stuck above or below potential output and full employment.

Classicals saw the Depression as a political problem, not an economic problem. Why?
A:  Classicals felt that if the wage level fell, the Depression would end. They saw labor unions as preventing the fall in wages, and they believed that government lacked the political will to break up unions.

Why, in principle, would one expect the AD curve to be vertical?
A:  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 consumer goods, no relative prices have changed and therefore people’s decisions to consume should not change either.

What are five factors that cause the AD curve to shift?
A:  (1) Changes in foreign income, (2) changes in expectations, (3) changes in exchange rates, (4) changes in the distribution of income, and (5) changes in governmental aggregate demand policy.

Explain how a rise in the price level affects aggregate quantity demanded with the Interest rate effect.
A;  A rise in the price level reduces the value of cash people are holding. To keep the real value constant, they withdraw more from their banks. This reduces the amount banks have to lend, which leads to higher interest rates and lower investment expenditures.

Explain how a rise in the price level affects aggregate quantity demanded with the International effect.
A:  Assuming fixed exchange rates, a rise in the price level makes goods less internationally competitive, decreasing exports.

Explain how a rise in the price level affects aggregate quantity demanded with the Money wealth effect
A:  The money people hold in cash is worth less, which decreases spending.

What will likely happen to the slope or position of the AD curve in the following circumstances?
The exchange rate changes from fixed to flexible.

A:  Steeper.

A fall in the price level doesn’t make people feel richer.
A:  Steeper.

A fall in the price level creates expectations of a further-falling price level.
A:  Steeper.

 Income is redistributed from rich people to poor people.
A:  Shift to the right.

Autonomous exports increase by 20.
A:  Shift to the right by a multiple of 20.

Government spending decreases by 10.
A:  Shift to the left by a multiple of 10.

What dynamic feedback effects can offset the interest rate, international, and money wealth effects?
A:
If the price level falls, expectations of falling aggregate demand
If the price level falls, lower asset prices
If the price level falls, expectations of government intervention
If the price level falls, an increase in spending