Macroeconomics 11th Edition Arnold Solutions Manual

Macroeconomics 11th Edition Arnold
Solutions Manual
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CHAPTER 8
Aggregate Demand and Aggregate Supply
Chapter 8 develops the aggregate demand-aggregate supply model of the economy that will be
used to analyze the material in coming chapters. It examines aggregate demand and short-run
aggregate supply (and the AD and SRAS curves) and the factors that affect them. It shows how
changes in these factors lead to changes in the price level, Real GDP, and the unemployment
rate. Finally, it defines the two equilibrium states in an economy—short-run and long-run
equilibrium—and uses the AD, SRAS, and long-run aggregate supply (LRAS) curves to depict
these states.
◼ KEY IDEAS
1. The economy has two sides. One side is the aggregate demand or the buying side. The
other is the aggregate supply or producing side.
2. There is a difference between a change in the quantity demanded of Real GDP and a
change in aggregate demand.
3. Most economists would say that a change in the money supply would shift the AD curve.
4. There is a difference between moving along a given SRAS curve and shifting to a new
SRAS curve.
5. Economic forces will eliminate shortages and surpluses.
6. A change in a factor of AD or a factor of SRAS (or both) will change the point of market
equilibrium in a predictable way.
7. Aggregate supply includes both short-run and long-run aggregates supply.
◼ CHAPTER OUTLINE
I. A WAY TO VIEW THE ECONOMY
The two sides to an economy are the buying side (aggregate demand) and the
producing side (aggregate supply.) Production in the short run is called short-run
aggregate supply (SRAS), while production in the long run is called long-run aggregate
supply (LRAS). Economists often use the AD-AS framework of analysis to discuss the
price level, GDP, Real GDP, unemployment, economic growth, and other major
macroeconomic topics. The AD-AS framework has three parts: AD, SRAS, and LRAS.
II. AGGREGATE DEMAND
Aggregate demand refers to the quantity demanded of (U.S.) Real GDP, at various price
levels, ceteris paribus. There is an inverse relationship between the price level and the
quantity demanded of Real GDP. An AD curve is the graphical representation of AD.
122
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Aggregate Demand and Aggregate Supply 123
A. Why Does the Aggregate Demand Curve Slope Downward?
The real balance effect, the interest rate effect, and the international trade effect
explain the inverse relationship between the price level and the quantity
demanded of Real GDP.
Real Balance Effect (Due to a Change in the Price Level)

The real balance effect states that the inverse relationship is established through
changes in the value of monetary wealth. As the price level changes, the
purchasing power of monetary wealth changes, causing the quantity demanded
of Real GDP to change.
Interest Rate Effect (Due to a Change in the Price Level)

The interest rate effect states that the inverse relationship is established through
changes in household and business spending that is sensitive to interest rate
changes. As the price level changes, it takes a different quantity of money to
purchase a fixed bundle of goods, and this leads to a change in savings (the
supply of credit increases). Subsequently, the price of credit, which is the interest
rate, changes, causing households and businesses to change their borrowing
levels, and changing the quantity of Real GDP to change.
International Trade Effect (Due to a Change in the Price Level)

The international trade effect states that the inverse relationship is established
through foreign sector spending. As the price level in the U.S. changes, U.S.
goods become relatively cheaper or more expensive than foreign goods. As a
result, Americans and foreigners change the amounts of U.S. goods they buy,
changing the quantity of Real GDP to change.
B. An Important Word on the Three Effects
Remember that a change in the price level causes each of these three effects.
This is important since some other things can also cause the interest rate to
change, and not everything that causes the interest rate to change leads to a
movement from one point to another along the AD curve.
C. A Change in the Quantity Demanded of Real GDP Versus a Change in

Aggregate Demand
There is a difference between a change in the quantity demanded of Real GDP

and a change in aggregate demand. A change in the quantity demanded of Real
GDP is brought about by a change in the price level and is shown by moving
from one point on another point on an AD curve, while a change in AD is brought
about by a change in a factor of AD and is shown by shifting the entire AD curve.
D. Changes in Aggregate Demand: Shifts in the AD Curve
If spending on U.S. goods by U.S. residents, firms, governments, or foreigners

increases at a given price level, then AD rises (shifts rightward). If spending on
U.S. goods by U.S. residents, firms, governments, or foreigners decreases at a
given price level, then AD falls (shifts leftward).
124 Chapter 8
E. How Spending Components Affect Aggregate Demand
Total expenditures on U.S. goods and services is the sum of consumption,

investment, government purchases and net exports. If, at a given price level, one
of these components rises, then spending on U.S. goods and services will rise. If,
at a given price level, one of these components falls, then spending on U.S.
goods and services will fall.
F. Why is There More Total Spending?
Total spending can rise for one of two reasons. The first deals with a decline in
prices and leads to a movement along a given AD curve. The second deals with
a change in some factor other than prices and leads to a shift in the AD curve
G. Factors That Can Change C, I, G, and NX (EX – IM) and Therefore Can
Change AD (Shift the AD Curve)
Consumption
Changes in wealth, expectations about future prices and income, the interest
rate, or income taxes will cause consumption to change and therefore shift the
AD curve. If wealth rises, the interest rate falls, income taxes fall, or consumers
expect higher prices or incomes in the future, consumption will rise and the AD
curve will shift rightward. If wealth falls, the interest rate falls, income taxes fall, or
consumers expect lower prices or incomes in the future, consumption will fall and
the AD curve will shift leftward.
Investment
Changes in the interest rate, expectations about future sales, and business taxes
will cause investment to change and therefore shift the AD curve. If the interest
rate falls, business taxes fall, or if businesses become optimistic about future
sales, investment will rise and the AD curve will shift rightward. If the interest rate
rises, business taxes rise, or if businesses become pessimistic about future
sales, investment will rise and the AD curve will shift rightward.
Net Exports
Changes in foreign real national income and the exchange rate will cause net
exports to change and therefore shift the AD curve. If foreign real national
income rises, then U.S. exports will rise, causing U.S. net exports to rise and the
AD curve will shift rightward, and vice versa. If the dollar depreciates, U.S.
exports will rise and U.S. imports will fall, causing U.S. net exports to rise and the
AD curve will shift rightward, and vice versa.
H. Can a Change in the Money Supply Change Aggregate Demand?
Most economists would say that a change in the money supply will shift the AD
curve. One way to explain the effect is to say a change in the money supply
affects interest rates, causing changes in consumption and investment, which
affects aggregate demand.
I. If Consumption Rises, Does Some Other Spending Component Have to

Decline?
Total spending in the economy is the product of the money supply times velocity,
where velocity is the average number of times a dollar is spent to buy final goods
and services in a year. If both the money supply and velocity are constant, a rise
in one spending component (such as consumption) necessitates a decline in one
or more other spending components. If either the money supply or velocity rises,
one spending component can rise without requiring other spending components
to decline.
III. SHORT-RUN AGGREGATE SUPPLY
Aggregate supply refers to the quantity supplied of Real GDP at various price levels,
ceteris paribus. Aggregate supply includes both short-run and long-run aggregate
supply.
A. Short-Run Aggregate Supply Curve: What it is and Why it is Upward-

Sloping
Economists have put forth the following explanations as to why the SRAS curve
is upward-sloping.
Sticky Wages
Firms pay nominal wages, but they often base their decision on how many
workers to hire on real wages (nominal wages divided by the price level). When
the price index falls, real wages rise and firms cut back on labor. With fewer
workers working, less output is produced.
Worker Misperceptions
Workers change the quantity of labor they are willing to supply when their real
wage changes. If workers overestimate the drop in their real wage rate, they may
reduce the quantity of labor they are willing to supply, and firms will end up
producing less.
B. What Puts the “Short Run” in the SRAS Curve?
It is only for a period of time—identified as the short run—that the issues of sticky
wages and prices and producer and worker misperceptions are likely to be
relevant. Wages will not be sticky forever, prices won’t be sticky forever,
producers will figure out that they misperceived relative price changes, and
workers will figure out that they misperceived real wage changes.
C. Changes in Short-Run Aggregate Supply: Shifts in the SRAS Curve
The factors that can shift the SRAS curve include wage rates, prices of nonlabor
inputs, productivity, and supply shocks. If wage rates or prices of nonlabor inputs
fall, or if productivity rises, or if there is a beneficial supply shock, the SRAS
curve will shift rightward. If wage rates or prices of nonlabor inputs rise, or if
126 Chapter 8
productivity falls, or if there is an adverse supply shock, the SRAS curve will shift
leftward.
D. Something More to Come: People’s Expectations
In Chapter 16 we will add another factor that can shift the SRAS curve—the
expected price level.
IV. PUTTING AD AND SRAS TOGETHER: SHORT-RUN EQUILIBRIUM
Aggregate demand and short-run aggregate supply determine the price level, Real GDP,
and the unemployment rate in the short run.
A. How Short-Run Equilibrium in the Economy is Achieved
In instances of both surplus and shortage, economic forces move the economy
towards the point of short-run equilibrium where the quantity demanded of Real
GDP equals the short-run quantity supplied of Real GDP. A change in AD or
SRAS or both will affect the price level and/or Real GDP.
B. Thinking in Terms of Short-Run Equilibrium Changes in the Economy
To a large degree, economists naturally think in terms of flow charts. Economics

is about establishing a connection or link between an effect (such as a fall in Real
GDP) and a correct cause (such as an adverse supply shock that shifts the
SRAS curve to the left). If a factor change shifts AD rightward, the price level and
Real GDP will rise and the unemployment rate will fall. If a factor change shifts
AD leftward, the price level and Real GDP will fall and the unemployment rate will
rise. If a factor change shifts SRAS rightward, the price level will fall, Real GDP
will rise, and the unemployment rate will fall. If a factor change shifts SRAS
leftward, the price level will rise, Real GDP will fall and the unemployment rate
will rise.
C. An Important Exhibit
Exhibit 13 in the text brings together much of the material discussed in this
chapter.
V. Long-Run Aggregate Supply
A. Going from the Short Run to the Long Run
Short-run equilibrium identifies the Real GDP the economy produces when
wages are sticky or when there are worker misperceptions. In time, though,
wages will become unstuck and misperceptions will turn into accurate
perceptions. When this happens, the economy is said to be in the long run.
Most economists argue that in the long run, the economy produces the full-
employment Real GDP or the Natural Real GDP, which is identified by the long-
run aggregate supply (LRAS) curve.
Long-run equilibrium identifies the level of Real GDP the economy produces
when wages and prices have adjusted to their (final) equilibrium levels and there
are no misperceptions. This occurs at the intersection of the AD and LRAS
curves.
B. Short-Run Equilibrium, Long-Run Equilibrium, and Disequilibrium
There are two equilibrium states in an economy—short-run equilibrium and long-

run equilibrium. In short-run equilibrium, quantity supplied and demanded of Real
GDP are either more than or less than Natural Real GDP. When the economy is
in neither short-run equilibrium nor long-run equilibrium, it is said to be in
disequilibrium.
◼ TEACHING ADVICE
1. Many principles instructors rely on multiple-choice exams, especially if they teach large
sections. However, it is critically important for students to actually learn to pick up a
pencil and draw the graphs for aggregate supply and aggregate demand shifts. The AD
and SRAS Quiz (in two versions below) is designed to accomplish the goal of requiring
students to draw while imposing minimal costs on graders (especially if no partial credit
is given). This quiz takes, at most, 30 minutes of class time to administer. For immediate
feedback, have students remain seated after they finish their quiz, and then show the
students the key after collecting their quiz papers.
2. Have your students go to http://www.federalreserve.gov/releases/h15/data.htm to see

how various interest rates have changed over the last two or three years. Use the data
as a springboard for discussing how to show these changes using the AD curve. If the
interest rate changes are due to price level changes, then we would see a movement
along the existing AD curve. If, on the other hand, the interest rate changes occur for
other reasons, then we would see a shift to a new AD curve. You may also want to visit
www.bls.gov/cpi to see how the price level (as measured by the CPI) has changed over
the period in question. If the price level has been fairly constant then you could conclude
that interest rate changes would shift the AD curve.
3. The SRAS curve shows the level of actual production at each price level. The AD curve
shows what consumers, firms, the government, and foreigners plan to buy. Use the
following graph to relate the SRAS curve to the expenditures approach to measuring
Real GDP from Chapter 7.
PC is the equilibrium price level because the amount of output that firms produce is equal
to the amount of output that consumers, firms, the government, and foreigners plan to
buy.
At a price level above equilibrium like PA, firms produce Real GDP equal to Q2, while
consumers, firms, the government, and foreigners only plan to buy Q1. (Q2 – Q1)
represents unplanned spending by firms on inventory (in essence, firms “buy” the output
that they cannot sell to others). At a price level below equilibrium like PB, firms produce
Real GDP equal to Q1, while consumers, firms, the government, and foreigners buy Q2
128 Chapter 8
units of output. (Q2 – Q1) units were produced in some previous year (and represent
unplanned inventory depletion).
◼ ASSIGNMENTS FOR MASTERING KEY IDEAS

Assignment 8.1
Key Idea: The economy has two sides. One side is the aggregate demand side.
1. State the relationship between the price level and the quantity demanded of Real GDP.
2. Draw an AD curve. Label each axis.
3. List the reasons why the AD curve is sloped downward.
Assignment 8.2
Key Idea: There is a difference between a change in the quantity demanded of Real GDP and a
1. Explain the differences between a change in the quantity demanded of Real GDP and a
2. Graphically evaluate the difference between an increase in the quantity demanded of
Real GDP and an increase in aggregate demand.
3. Graphically evaluate the difference between a decrease in the quantity demanded of
Real GDP and a decrease in aggregate demand.
4. List the changes that would shift the AD curve rightward.
5. List the changes that would shift the AD curve leftward.
Assignment 8.3
Key Idea: Most economists would say that a change in the money supply would shift the AD
curve.
1. Give an explanation of how a change in the money supply will lead to a change in
aggregate demand.
Assignment 8.4
Key Idea: The economy has two sides. One side is the aggregate supply side.
1. State the short run relationship between the price level and the quantity supplied of Real
GDP.
2. Draw an SRAS curve. Label each axis.
3. List the reasons why the SRAS curve is upward-sloping.
Assignment 8.5
Key Idea: There is a difference between moving along a given SRAS curve and shifting to a
new SRAS curve.
1. Name the one change that leads to a movement along a given SRAS curve.
2. List the changes that would will the SRAS curve rightward.
3. List the changes that would will the SRAS curve leftward.
Assignment 8.6
Key Idea: Economic forces will eliminate shortages and surpluses.
1. State what will happen to the price level when there is a surplus.
2. State what will happen to the price level when there is a shortage.
Assignment 8.7
Key Idea: A change in a factor of AD or a factor of SRAS (or both) will change the point of
equilibrium in a predictable way.
1. Tell what will happen to the price level, Real GDP, and the unemployment rate in the
following cases:
a. AD rises and SRAS is constant.
b. AD falls and SRAS is constant.
c. AD is constant and SRAS rises.
d. AD is constant and SRAS falls.
e. AD rises by more than SRAS rises.
f. AD rises by the same amount that SRAS rises.
g. AD rises by less than SRAS rises.
h. AD rises by more than SRAS falls.
i. AD rises by the same amount that SRAS falls.
j. AD rises by less than SRAS falls.
k. AD falls by more than SRAS rises.
l. AD falls by the same amount that SRAS rises.
m. AD falls by less than SRAS rises.
n. AD falls by more than SRAS falls.
o. AD falls by the same amount that SRAS falls.
p. AD falls by less than SRAS falls.
Assignment 8.8
Key Idea: Aggregate supply includes both short-run and long-run aggregate supply.
1. State the long run relationship between the price level and the quantity supplied of Real
GDP.
2. Draw an LRAS curve. Label each axis.
3. Explain why the LRAS curve is vertical.
4. Define the term “Natural Real GDP.”
◼ ANSWERS TO ASSIGNMENTS FOR MASTERING KEY IDEAS

Assignment 8.1 Answers
130 Chapter 8
1. There is an inverse relationship between the price level and the quantity demanded of
Real GDP.
2.
3. The AD curve is sloped downward due to the real balance effect, the interest rate effect,
and the international trade effect.

1. A change in the quantity demanded of Real GDP can only be caused by a change in the
price level, and is shown by moving along an existing AD curve, while a change in
aggregate demand is caused by a change in a factor of AD, and is shown by drawing a
new AD curve.
2. One would show an increase in the quantity demanded of Real GDP by moving down
along an existing AD curve, while one would show an increase in aggregate demand by
shifting the entire AD curve rightward.
3. One would show a decrease in the quantity demanded of Real GDP by moving up along
an existing AD curve, while one would show a decrease in aggregate demand by shifting
the entire AD curve leftward.
4. The AD curve would shift rightward if consumption, investment, government purchases,
or net exports increase. Consumption will rise if wealth increases, if individuals expect
higher prices or higher incomes in the future, or if interest rates or income taxes fall.
Investment will rise if businesses become optimistic about future sales, or if interest
rates or business taxes fall. Net exports will rise if foreign real national income rises or if
the country’s currency depreciates.
5. The AD curve would shift leftward if consumption, investment, government purchases, or
net exports decrease. Consumption will fall if wealth decreases, if individuals expect
lower prices or lower incomes in the future, or if interest rates or income taxes rise.
Investment will fall if businesses become pessimistic about future sales, or if interest
rates or business taxes rise. Net exports will fall if foreign real national income falls or if
the country’s currency appreciates.

1. A change in the money supply will affect interest rates, which will affect consumption and
investment and therefore, will affect aggregate demand.

1. In the short run, the price level and the quantity supplied of Real GDP are directly
related.
2.
3. The SRAS curve is upward-sloping due to sticky wages and worker misperceptions.

1. A change in the price level is the only thing that leads to a movement along a given
SRAS curve.
2. The SRAS curve will shift rightward if wage rates or the prices of nonlabor inputs fall, if
productivity rises, or if a beneficial supply shock occurs.
3. The SRAS curve will shift leftward if wage rates or the prices of nonlabor inputs rise, if
productivity falls, or if an adverse supply shock occurs.

1. When there is a surplus, the price level will fall until equilibrium is achieved.
2. When there is a shortage, the price level will rise until equilibrium is achieved.

1. a. The price level and Real GDP will rise, and the unemployment rate will fall.
b. The price level and Real GDP will fall, and the unemployment rate will rise.
c. The price level will fall, Real GDP will rise, and the unemployment rate will fall.
d. The price level will rise, Real GDP will fall, and the unemployment rate will rise.
e. The price level and Real GDP will rise, and the unemployment rate will fall.
f. The price level will stay the same, Real GDP will rise, and the unemployment
rate will fall.
g. The price level will fall, Real GDP will rise, and the unemployment rate will fall.
h. The price level and Real GDP will increase, and the unemployment rate will fall.
i. The price level will rise, Real GDP will stay the same, and the unemployment
rate will stay the same.
j. The price level will rise, Real GDP will fall, and the unemployment rate will rise.
k. The price level and Real GDP will fall, and the unemployment rate will rise.
l. The price level will fall, Real GDP will stay the same, and the unemployment rate
will stay the same.
132 Chapter 8
. m. The price level will fall, Real GDP will rise, and the unemployment rate will fall.
n. The price level and Real GDP will fall, and the unemployment rate will rise.
o. The price level will stay the same, Real GDP will fall, and the unemployment rate
will rise.
p. The price level will rise, Real GDP will fall, and the unemployment rate will rise.

1. In the long run, the price level and the quantity supplied of Real GDP are not related.
2.
3. The LRAS curve is vertical because wages and prices will eventually become unstuck
and misperceptions will turn into accurate perceptions.
4. Natural Real GDP (also called full-employment Real GDP) is the level of output the
economy produces in the long run.
◼ ANSWERS TO VIDEO QUESTIONS AND PROBLEMS

1. Explain how the real balance effect works?
A fall in the price level causes purchasing power to rise, which increases a person’s monetary
wealth. As people become wealthier, they buy more goods and services and the quantity
demanded of Real GDP rises. A rise in the price level causes purchasing power to fall, which
decreases a person’s monetary wealth. As people become less wealthy, they buy fewer goods
and services and the quantity demanded of Real GDP falls.
2. Suppose that business taxes and wage rates decline and that any change in
aggregate demand is greater than any change in short-run aggregate supply.
Explain and diagrammatically represent the changes in the price level and Real
GDP in the short run.
When business taxes decrease, investment in the economy increases. Aggregate demand will
increase and the AD curve shifts to the right. When wages decrease, aggregate supply
increases and the AS curve shifts to the right. When the ΔAD is greater than the ΔAS, both the
equilibrium price and Real GDP increase.
3. How will either the AD curve or SRAS curve shift as a result of each of the
following changes:
a. A rise in the interest rate
b. An adverse supply shock
c. A rise in wealth
Price Price Price

SRAS2
SRAS1
AD1 AD2
AD2 AD1
GDP 0 (a) Real GDP 0 (b) Real GDP 0 (c) Real GDP
a. When the interest rate rises, both investment and consumption decrease. The AD curve
shifts to the left.
134 Chapter 8
b. When there is an adverse supply shock, short-run aggregate supply decreases. The
SRAS curve shifts to the left.
c. When there is a rise in wealth, consumption increases. The aggregate demand curve
shifts to the right.
4. Explain and diagrammatically represent the difference between equilibrium in the

short run and in the long run using the AD-SRAS-LRAS model.
At point 1, the SRAS curve intersects the AD curve and the economy is in short-run equilibrium.
The equilibrium quantity of Real GDP (Q1) is lesser than the long-run equilibrium quantity of
Real GDP (QN). At point 2, the LRAS curve intersects the AD curve and the economy is in long-
run equilibrium. The equilibrium quantity of Real GDP (QN) is greater than the short-run
equilibrium quantity of Real GDP (Q1).
5. Explain what happens to U.S. net exports and to U.S. aggregate demand as the
dollar depreciates.
As the dollar depreciates against foreign currencies, foreign goods become more expensive for
the consumers in the U.S. and the U.S. goods become cheaper for foreign customers.
Therefore, imports in the U.S. decrease and exports increase, resulting in an increase in net
exports. The aggregate demand curve would shift to the right, causing both Real GDP and the
price level to increase in the short run.
◼ ANSWERS TO CHAPTER QUESTIONS AND PROBLEMS

1. Is aggregate demand a specific dollar amount? For example, is it correct to say
that aggregate demand is $9 trillion this year?
Aggregate demand is not a specific dollar amount. It is a schedule that shows the Real GDP
people are willing to buy at different price levels. Remember that along an AD curve there are
many points, not just one.
2. Explain each of the following: (a) real balance effect, (b) interest rate effect, and (c)
international trade effect.
The real balance effect states that the inverse relationship between the price level and the
quantity demanded of Real GDP is established through changes in the value of monetary
wealth. As the price level changes, the purchasing power of monetary wealth changes, causing
the quantity demanded of Real GDP to change.
The interest rate effect states that the inverse relationship between the price level and the
quantity demanded of Real GDP is established through changes in household and business
spending that is sensitive to interest rate changes. As the price level changes, it takes a
different quantity of money to purchase a fixed bundle of goods, and this leads to a change in
savings (the supply of credit increases). Subsequently, the price of credit, which is the interest
rate, changes, causing households and businesses to change their borrowing levels, and
changing the quantity of Real GDP to change.
The international trade effect states that the inverse relationship between the price level and the
quantity demanded of Real GDP is established through foreign sector spending. As the price
level in the U.S. changes, U.S. goods become relatively cheaper or more expensive than
foreign goods. As a result, Americans and foreigners change the amounts of U.S. goods they
buy, changing the quantity of Real GDP to change.
3. Graphically portray each of the following: (a) a change in the quantity demanded
of Real GDP and (b) a change in aggregate demand.
A change in the quantity demanded is illustrated in Exhibit 4(a) of the text, and a change in
aggregate demand is illustrated in Exhibit 4(b).
4. There is a difference between a change in the interest rate that is brought about
by a change in the price level and a change in the interest rate that is brought
about by a change in some factor other than the price level. The first will change
the quantity demanded of Real GDP and the second will change in the AD curve.
Do you agree or disagree with this statement? Explain your answer.
Agree. Since the price level is shown on the vertical axis of an AD curve, any effect of a change
in the price level, such as the change in the interest rate that results from a change in
purchasing power from a change in the price level, will be shown by sliding along the AD curve
(which is referred to as a change in quantity demanded of Real GDP). If the interest rate
changes for any other reason, however, the entire AD curve will shift.
5. The amount of Real GDP (real output) that households are willing and able to buy
may change if there is a change in either (a) the price level, or (b) some nonprice
factor, such as wealth, interest rates, and the like. Do you agree or disagree?
Explain your answer.
Agree. Both a change in the price level and changes in nonprice factors could affect Real GDP;
however, a change in the price level would change the quantity demanded of Real GDP (shown
by sliding along an existing AD curve), and a change in a nonprice factor would cause a change
in aggregate demand (shown by shifting to a new AD curve).
136 Chapter 8
6. Explain what happens to aggregate demand in each of the following cases: (a) The
interest rate rises; (b) Wealth falls; (c) The dollar depreciates relative to foreign
currencies; (d) Households expect lower prices in the future; (e) Business taxes
rise.
In examples (a), (b), (d), and (e), the aggregate demand curve would shift to the left, causing
both Real GDP and the price level to decrease in the short run. In (c), the aggregate demand
curve would shift to the right, causing both Real GDP and the price level to increase in the short
run.
7. Explain what is likely to happen to U.S. export and import spending as a result of
the dollar depreciating in value.
A depreciation of the U.S. dollar makes foreign goods more expensive for Americans and
American goods cheaper for foreigners. Therefore, U.S. exports will likely rise (foreigners will
buy more American goods since they are cheaper) and U.S. imports will likely fall (Americans
will buy fewer foreign goods since they are more expensive).
8. Explain how expectations about future prices and incomes will affect
consumption.
If individuals expect higher prices in the future, they increase current consumption expenditures
to buy goods at the lower current prices, and vice versa. If individuals expect higher incomes in
the future, they will loosen their purse strings today and increase current consumption
expenditures, and vice versa.
9. Explain how expectations about future sales will affect investment.
Businesses invest because they expect to sell the goods they produce. If they expect to sell
more goods in the future they will increase investment, and vice versa.
10. How will a change in the money supply affect aggregate demand?
A change in the money supply will change interest rates, which will change consumption and
investment, therefore changing aggregate demand.
11. Under what conditions can consumption rise without some other spending
component declining?
Consumption can rise without some other spending component declining if the money supply
rises and/or velocity rises.
12. Can total spending be a greater dollar amount than the money supply? Explain
your answer.
Total spending can be a greater dollar amount than the money supply as long as velocity is
greater than 1.
13. Will a direct increase in the price of U.S. goods relative to foreign goods lead to a
change in the quantity demanded of Real GDP or to a change in aggregate
demand? Will a change in the exchange rate that subsequently increases the price
of U.S. goods relative to foreign goods lead to a change in the quantity demanded
of Real GDP, or to a change in aggregate demand? Explain your answers.
An increase in the price of U.S. goods relative to foreign goods leads to a decrease in the
quantity demanded of Real GDP, as typified by the foreign trade effect. Graphically, this would
be shown by sliding up along a given AD curve. A change in the exchange rate that
subsequently increases the price of U.S. goods relative to foreign goods would be a change in a
nonprice factor and would therefore lead to a decrease in aggregate demand, shown by shifting
the AD curve leftward.
14. Explain how each of the following can affect short-run aggregate supply: (a) An
increase in wage rates; (b) A beneficial supply shock; (c) An increase in the
productivity of labor; (d) A decrease in the price of a nonlabor resource (such as
oil).
The increase in wages in (a) will shift the short-run aggregate supply curve to the left because
the higher wage rates will cause Real GDP to be produced at a higher price level than existed
before. The three remaining changes in (b), (c), and (d) would each shift the short-run
aggregate supply curve to the right since, in these three cases, the same level of Real GDP
could be produced at a lower price level.
15. What is the difference between a change in the quantity supplied of Real GDP and
a change in short-run aggregate supply?
A change in the quantity supplied of Real GDP is brought about by a change in the price level
and is shown as a movement along the SRAS curve, while a change in short-run aggregate
supply is brought about by a change in wage rates, the prices of nonlabor inputs, productivity, or
supply shocks and is shown as a shift of the SRAS curve.
16. A change in the price level affects which of the following? (a) The quantity
demanded of Real GDP; (b) Aggregate demand; (c) Short-run aggregate supply;
(d) The quantity supplied of Real GDP.
A change in the price level would affect the quantity demanded of Real GDP and the quantity
supplied of Real GDP (both [a] and [d]), but it would not change either aggregate demand or
short-run aggregate supply (either [b] or [c]).
17. In the short run, what is the impact on the price level and Real GDP of each of the
following? (a) An increase in consumption brought about by a decrease in interest
rates; (b) A decrease in exports brought about by an appreciation of the dollar; (c)
A rise in wage rates; (d) A beneficial supply shock; (e) An adverse supply shock;
(f) A decline in productivity.
(a) A decrease in interest rates increases autonomous consumption, which shifts the AD
curve rightward. The price level and Real GDP rise, ceteris paribus.
(b) An autonomous decrease in exports shifts the AD curve leftward. The price level and
Real GDP fall, ceteris paribus.
(c) A rise in wage rates shifts the SRAS curve leftward. The price level rises and Real GDP
falls, ceteris paribus.
(d) A beneficial supply shock shifts the SRAS curve rightward. The price level falls and Real
GDP rises, ceteris paribus.
138 Chapter 8
(e) An adverse supply shock shifts the SRAS curve leftward. The price level rises and Real
GDP falls, ceteris paribus.
(f) A decline in productivity shifts the SRAS curve leftward. The price level rises and Real
GDP falls, ceteris paribus.
18. Identify the details of each of the following explanations for an upward-sloping
SRAS curve: (a) Sticky-wage explanation; (b) Worker-misperception explanation.
(a) Firms pay nominal wages, but they often base their decision on how many workers to
hire on real wages (nominal wages divided by the price level). When the price index
falls, real wages rise and firms cut back on labor. With fewer workers working, less
output is produced.
(b) Workers change the quantity of labor they are willing to supply when their real wage
changes. If workers overestimate the drop in their real wage rate they may reduce the
quantity of labor they are willing to supply, and firms will end up producing less.
19. What is the difference between short-run equilibrium and long-run equilibrium?
Short-run equilibrium occurs at the intersection of SRAS and AD, while long-run equilibrium
occurs at the intersection of LRAS and AD. Because there are reasons why SRAS may be
upward sloped, there is no reason to assume that short-run equilibrium will occur at the full
employment level in the economy. LRAS does not suffer these issues and will be located at the
Natural Real GDP level, or full employment equilibrium.
20. An economist is sitting in the Oval Office of the White House, across the desk
from the president of the United States. The president asks, “How does the
unemployment rate look for the next quarter?” The economist answers, “It’s not
good. I don’t think Real GDP is going to be as high as we initially thought. The
problem seems to be foreign income; it’s just not growing at the rate we thought it
was going to grow.” How can foreign income affect U.S. unemployment?
Foreign income is linked to the unemployment rate in the United States through changes in Real
GDP. If foreign income falls, foreigners may buy fewer exports from the U.S. And if U.S. export
spending declines, so does aggregate demand for U.S.-produced goods and services. A decline
in aggregate demand, in turn, leads to lower Real GDP in the short run. And a lower Real GDP
is likely to come with a higher unemployment rate.
◼ ANSWERS TO PROBLEMS IN THE WORKING WITH NUMBERS AND

GRAPHS SECTION
1. Suppose that at a price index of 154, the quantity demanded of U.S. Real GDP is
$10.0 trillion worth of goods. Do these data represent aggregate demand or a
point on an aggregate demand curve? Explain your answer.
These data represent a point on the aggregate demand curve. Aggregate demand is not a
specific dollar amount. It is a schedule that shows the Real GDP people are willing to buy at
different price levels. Remember that along an AD curve there are many points, not just one.
2. Diagrammatically represent the effect on the price level and Real GDP in the short-
run of each of the following: (a) An increase in wealth, (b) An increase in wage
rates, and (c) An increase in labor productivity.
Panel (a) in the figure shows the effect of an increase in wealth. Increases in wealth lead to
increases in consumption. When consumption increases, aggregate demand rises and the AD
curve shifts to the right.
Panel (b) in the figure shows the effect of an increase in wage rates. When wage rates become
higher, a firm’s profits at a given price level decrease. Consequently, the firm reduces
production and the SRAS shifts leftward.
Panel (c) in the figure shows the effect of an increase in labor productivity. An increase in labor
productivity means businesses will produce more output with the same amount of labor, causing
the SRAS curve to shift rightward.
3. Diagrammatically represent the following and identify the effect on Real GDP and
the price level in the short run: (a) An increase in SRAS that is greater than the
increase in AD; (b) A decrease in AD that is greater than the increase in SRAS;
and (c) An increase in SRAS that is less than the increase in AD.
140 Chapter 8
(a) An increase in SRAS that is greater than the increase in AD will lead to an increase in Real
GDP and a fall in the price level.
(b) A decrease in AD that is greater than the increase in SRAS will lead to a fall in both the Real
GDP and the price level.
(c) An increase in SRAS that is less than the increase in AD will lead to an increase in both the
4. In the following figure, which part is representative of each of the following: (a) A
decrease in wage rates, (b) An increase in the price level, (c) A beneficial supply
shock, and (d) An increase in the price of nonlabor inputs.
(a) Panel (a)

(b) Panel (b)
(c) Panel (a)
(d) Panel (c)
◼ AD AND SRAS QUIZ VERSION 1

Name __________________________
Section _________
Directions: For each question, draw an economy in equilibrium, labeling the initial equilibrium
price level and equilibrium quantity of Real GDP. Then shift the appropriate curve and label the
new equilibrium price and equilibrium quantity. Next, fill in the blanks to describe what
happened. No partial credit will be given. You have 30 minutes to complete this quiz.
1. There is a decrease in wealth.
The price level will _______________ and Real GDP will _______________.
2. There is a decrease in wage rates.
3. Consumers start to expect lower future incomes.
142 Chapter 8
4. There is a decrease in productivity.
5. Consumers start to expect higher future prices.
6. There is a decrease in personal income taxes.
7. There is an adverse supply shock.
8. There is an increase in foreign real national income.
9. What will happen if there is a decrease in interest rates at the same time that there is an
increase in wage rates, and AD shifts by more than SRAS shifts?
10. What will happen if there is a decrease in the value of the U.S. dollar at the same time
that there is a decrease in the prices of nonlabor inputs, and AD and SRAS shift by the
same amounts?
144 Chapter 8
◼ AD AND SRAS QUIZ VERSION 1 ANSWERS
1. There is a decrease in wealth.
The price level will fall and Real GDP will fall .
2. There is a decrease in wage rates.
The price level will fall and Real GDP will rise .
3. Consumers start to expect lower future incomes.
4. There is a decrease in productivity.
The price level will rise and Real GDP will fall .
5. Consumers start to expect higher future prices.
The price level will rise and Real GDP will rise .
6. There is a decrease in personal income taxes.
146 Chapter 8
7. There is an adverse supply shock.
9. What will happen if there is a decrease in interest rates at the same time that there is an
increase in wage rates, and AD shifts by more than SRAS shifts?
10. What will happen if there is a decrease in the value of the U.S. dollar at the same time
that there is a decrease in prices of nonlabor inputs, and AD and SRAS shift by the
same amounts?
The price level will stay the same and Real GDP will rise .
148 Chapter 8
◼ AD AND SRAS QUIZ VERSION 2

Name __________________________
Section _________
Directions: For each question, draw an economy in equilibrium, labeling the initial equilibrium
price level, and equilibrium quantity of Real GDP. Then shift the appropriate curve and label the
new equilibrium price level and equilibrium quantity. Next, fill in the blanks to describe what
happened. No partial credit will be given. You have 30 minutes to complete this quiz.
1. There is an increase in interest rates.
2. There is an increase in productivity.
4. There is an appreciation in the country’s currency.
5. There is a decrease in prices of nonlabor inputs.
6. There is an increase in business taxes.
7. Consumers start to expect higher future incomes.
150 Chapter 8
8. There is a decrease in government purchases.
9. What will happen if businesses become optimistic about future sales at the same time
that there is an increase in wage rates, and AD shifts by less than SRAS shifts?
10. What will happen if business taxes decrease at the same time that there is a
beneficial supply shock, and AD and SRAS shift by the same amounts?
◼ AD AND SRAS QUIZ VERSION 2 ANSWERS

1. There is an increase in interest rates.
2. There is an increase in productivity.
152 Chapter 8
4. There is an appreciation in the country’s currency.
5. There is a decrease in prices of nonlabor inputs.
6. There is an increase in business taxes.
7. Consumers start to expect higher future incomes.
8. There is a decrease in government purchases.
9. What will happen if businesses become optimistic about future sales at the same time
that there is an increase in wage rates, and AD shifts by less than SRAS shifts?
154 Chapter 8
10. What will happen if business taxes decrease at the same time that there is a
beneficial supply shock, and AD and SRAS shift by the same amounts?
The price level will stay the same and Real GDP will rise .

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Macroeconomics 11th Edition Arnold

II. AGGREGATE DEMAND

A. Why Does the Aggregate Demand Curve Slope Downward?

Real Balance Effect (Due to a Change in the Price Level)

Interest Rate Effect (Due to a Change in the Price Level)

International Trade Effect (Due to a Change in the Price Level)

B. An Important Word on the Three Effects

C. A Change in the Quantity Demanded of Real GDP Versus a Change in

There is a difference between a change in the quantity demanded of Real GDP

D. Changes in Aggregate Demand: Shifts in the AD Curve

If spending on U.S. goods by U.S. residents, firms, governments, or foreigners

E. How Spending Components Affect Aggregate Demand

Total expenditures on U.S. goods and services is the sum of consumption,

F. Why is There More Total Spending?

H. Can a Change in the Money Supply Change Aggregate Demand?

I. If Consumption Rises, Does Some Other Spending Component Have to

III. SHORT-RUN AGGREGATE SUPPLY

A. Short-Run Aggregate Supply Curve: What it is and Why it is Upward-

B. What Puts the “Short Run” in the SRAS Curve?

C. Changes in Short-Run Aggregate Supply: Shifts in the SRAS Curve

D. Something More to Come: People’s Expectations

IV. PUTTING AD AND SRAS TOGETHER: SHORT-RUN EQUILIBRIUM

A. How Short-Run Equilibrium in the Economy is Achieved

B. Thinking in Terms of Short-Run Equilibrium Changes in the Economy

To a large degree, economists naturally think in terms of flow charts. Economics

V. Long-Run Aggregate Supply

A. Going from the Short Run to the Long Run

B. Short-Run Equilibrium, Long-Run Equilibrium, and Disequilibrium

There are two equilibrium states in an economy—short-run equilibrium and long-

2. Have your students go to http://www.federalreserve.gov/releases/h15/data.htm to see

◼ ASSIGNMENTS FOR MASTERING KEY IDEAS

◼ ANSWERS TO ASSIGNMENTS FOR MASTERING KEY IDEAS

Assignment 8.2 Answers

Assignment 8.3 Answers

Assignment 8.4 Answers

Assignment 8.5 Answers

Assignment 8.6 Answers

Assignment 8.7 Answers

Assignment 8.8 Answers

◼ ANSWERS TO VIDEO QUESTIONS AND PROBLEMS

Price Price Price

4. Explain and diagrammatically represent the difference between equilibrium in the

◼ ANSWERS TO CHAPTER QUESTIONS AND PROBLEMS

9. Explain how expectations about future sales will affect investment.

◼ ANSWERS TO PROBLEMS IN THE WORKING WITH NUMBERS AND

(a) Panel (a)

◼ AD AND SRAS QUIZ VERSION 1

1. There is a decrease in wealth.

2. There is a decrease in wage rates.

3. Consumers start to expect lower future incomes.

4. There is a decrease in productivity.

5. Consumers start to expect higher future prices.

6. There is a decrease in personal income taxes.

7. There is an adverse supply shock.

8. There is an increase in foreign real national income.

◼ AD AND SRAS QUIZ VERSION 1 ANSWERS

1. There is a decrease in wealth.

2. There is a decrease in wage rates.

3. Consumers start to expect lower future incomes.

4. There is a decrease in productivity.

5. Consumers start to expect higher future prices.

6. There is a decrease in personal income taxes.

7. There is an adverse supply shock.

8. There is an increase in foreign real national income.