If prices fall, then real wealth __________ and the quantity of aggregate demand __________.

Chapter 13

The Aggregate Demand–Aggregate SupplyModel

Concept Map

I. Business Cycle

II. Aggregate Demand

A. Slope of the Aggregate Demand Curve

1. The Wealth Effect

2. The Interest Rate Effect

3. The International Trade Effect

B. Shifts of the Aggregate Demand Curve

III. Aggregate Supply

A. Long-Run Aggregate Supply

B. Short-Run Aggregate Supply

IV. Equilibrium in the Aggregate Demand–Aggregate Supply Model

A. Adjusting to Shifts in Long-Run Aggregate Supply

B. Adjusting to Shifts in Short-Run Aggregate Supply

C. Adjusting to Shifts in Aggregate Demand

MULTIPLE-CHOICE QUESTIONS

1. Which of the following is true about recessions in the United States?

a. They are more common today than in the past.

b. They are rarer today than in the past.

c. They occur predictably about every two years.

d. They occur predictably about every eight years.

e. They are often caused by changes in government policy.

.

2. How many recessions have there been in the United States since 1982?

a. none

b. one

c. two

d. three

e. four

.

3. The term ___________ is a popular way to describe the recession-expansion pattern followed by the economy.

a. business cycle

b. output cycle

c. inflation cycle

d. unemployment cycle

e. long-run cycle

.

4. Business-cycle theory focuses on time horizons of less than:

a. five years.

b. ten years.

c. two years.

d. one year.

e. one month.

.

5. The model used to study business cycles is the:

a. labor model.

b. savings model.

c. growth model.

d. aggregate demand–aggregate supply model.

e. interest rate model.

.

6. Unemployment rises and real gross domestic product (GDP) growth slows during the:

a. expansion phase of a business cycle.

b. recession phase of a business cycle.

c. entire business cycle.

d. recovery phase of a business cycle.

e. short-run phase of a business cycle.

.

7. Aggregate demand is determined by adding up the spending of:

a. domestic consumers who buy goods and services produced in the United States.

b. domestic consumers and firms that buy goods and services produced in the United States.

c. domestic and foreign consumers who buy goods and services produced in the United States.

d. domestic and foreign consumers and firms that buy goods and services produced in the United States.

e. consumers, firms, the government, and foreigners that buy goods and services produced in the United States.

I.

8. The aggregate demand curve is best represented by which of the following equations?

a.

b.

c.

d.

e.

9. The aggregate demand curve illustrates the:

a. positive relationship between the price level and the quantity demanded of real gross domestic product (GDP).

b. positive relationship between the price level and the quantity demanded of nominal GDP.

c. inverse relationship between the price level and the quantity demanded of real GDP.

d. inverse relationship between the price level and the quantity demanded of nominal GDP.

e. positive relationship between the level of spending and the level of real GDP.

10. The price index used to illustrate the aggregate demand curve is the:

a. gross domestic product (GDP) deflator. (price level)

b. consumer price index.

c. producer price index.

d. nominal price index.

e. real price index.

11. Which of the following would cause an upward movement along the aggregate demand curve?

a. There is an increase in expected income.

b. An increase in the price level increases the value of real wealth.

c. An increase in housing prices increases the value of real wealth.

d. The value of the dollar increases.

e. There is an increase in the expected price level.

DIF: Difficult TOP: II.

REF: The Slope of the Aggregate Demand Curve MSC: Applying

12. Which of the following would cause a downward movement along the aggregate demand curve?

a. A rise in the price level makes U.S. goods relatively more expensive than foreign goods.

b. The value of real wealth rises.

c. There is a decline in the expected price level.

d. A fall in the price level increases savings and lowers interest rates.

e. The value of the dollar decreases.

DIF: Difficult TOP: II.

REF: The Slope of the Aggregate Demand Curve MSC: Applying

13. Consider the wealth effect, interest rate effect, and international trade effect. Of these, the __________ effect is the most significant and the __________ effect is the least significant.

a. wealth; international trade

b. wealth; interest rate

c. interest rate; wealth

d. interest rate; international trade

e. international trade; wealth

I.A.

REF: The Slope of the Aggregate Demand Curve

14. The aggregate demand curve slopes downward because:

a. as price rises, consumers substitute cheaper goods for more expensive goods.

b. all demand curves slope downward.

c. a higher price level will increase purchasing power.

d. a higher price level will increase exports.

e. a higher price level reduces wealth.

DIF: Medium TOP: II.A.

REF: The Slope of the Aggregate Demand Curve

15. The wealth effect, interest rate effect, and international trade effect all explain why the:

a. aggregate demand (AD) curve has a negative slope.

b. AD curve has a positive slope.

c. aggregate supply (AS) curve has a positive slope.

d. AS curve has a negative slope.

e. price level and real gross domestic product (GDP) are unrelated.

DIF: Medium TOP: II.A.

REF: The Slope of the Aggregate Demand Curve

16. When the price level rises, __________ declines from the wealth effect, __________ declines from the interest rate effect, and __________ decline(s) from the international trade effect.

a. consumption; investment; net exports

b. consumption; consumption; consumption

c. investment; investment; net exports

d. investment; consumption; net exports

e. investment; investment; investment

DIF: Medium TOP: II.A.

REF: The Slope of the Aggregate Demand Curve MSC: Understanding

17. The value of one’s accumulated assets is best defined as:

a. money.

b. wealth.

c. income.

d. saving.

e. net worth.

DIF: Medium TOP: II.A.1.

REF: The Slope of the Aggregate Demand Curve

18. The wealth effect is best described as resulting from:

a. an increase in the price level reducing the real value of wealth.

b. a decrease in the price level reducing the real value of wealth.

c. an increase in wealth due to capital gains.

d. a decrease in wealth due to capital gains.

e. an increase in disposable income due to a reduction in taxes.

DIF: Medium TOP: II.A.1.

REF: The Slope of the Aggregate Demand Curve

19. An increase in the price level that reduces the real value of wealth is likely to __________ consumption and __________ saving.

a. increase; increase

b. decrease; decrease

c. decrease; increase

d. increase; decrease

e. have no effect on; have no effect on

DIF: Medium TOP: II.A.1.

REF: The Slope of the Aggregate Demand Curve MSC: Understanding

20. A fall in the price level that causes a change in the real value of wealth results in:

a. a downward movement along the aggregate demand curve.

b. an upward movement along the aggregate demand curve.

c. a rightward shift of the demand curve.

d. a leftward shift of the demand curve.

e. no change in the quantity of aggregate demand.

DIF: Medium TOP: II.A.1.

REF: The Slope of the Aggregate Demand Curve MSC: Understanding

21. If prices fall, then real wealth __________ and the quantity of aggregate demand __________.

a. increases; increases

b. increases; decreases

c. decreases; decreases

d. decreases; increases

e. is unaffected; is unaffected

DIF: Medium TOP: II.A.1.

REF: The Slope of the Aggregate Demand Curve MSC: Applying

22. When a change in the price level leads to a change in saving, this is known as the:

a. wealth effect.

b. international trade effect.

c. savings effect.

d. interest rate effect.

e. output effect.

I.A.2.

REF: The Slope of the Aggregate Demand Curve

23. When a change in the price level leads to a change in the interest rate and thus a change in the quantity of aggregate demand, it is called the:

a. interest rate effect.

b. wealth effect.

c. savings effect.

d. output effect.

e. price effect.

I.A.2.

REF: The Slope of the Aggregate Demand Curve

24. The interest rate effect results from people:

a. saving less when the price level rises.

b. consuming more when the price level rises.

c. spending more when the interest rate rises.

d. feeling more wealthy when the price level rises.

e. spending more when the price level falls.

DIF: Medium TOP: II.A.2.

REF: The Slope of the Aggregate Demand Curve

25. When firms invest less because people are saving less, it is called the:

a. wealth effect.

b. international trade effect.

c. interest rate effect.

d. savings effect.

e. investment effect.

DIF: Medium TOP: II.A.2.

REF: The Slope of the Aggregate Demand Curve

26. According to the interest rate effect, an increase in the price level leads to __________ in the interest rate, and therefore to __________ in the quantity of aggregate demand.

a. no change; no change

b. a rise; a fall

c. a rise; a rise

d. a fall; a fall

e. a fall; a rise

DIF: Medium TOP: II.A.2.

REF: The Slope of the Aggregate Demand Curve MSC: Understanding

27. Suppose that an increase in the price level reduces the value of real wealth, which then causes a reduction in consumption but no change in saving. In this case:

a. there is both an interest rate effect and a wealth effect.

b. there is no wealth effect.

c. there is an interest rate effect but no wealth effect.

d. there is a wealth effect but no interest rate effect.

e. there is no wealth effect and no interest rate effect.

DIF: Difficult TOP: II.A.2.

REF: The Slope of the Aggregate Demand Curve MSC: Understanding

28. When saving declines, the quantity of investment will __________, and therefore aggregate demand will __________.

a. increase; increase

b. decrease; decrease

c. decrease; increase

d. increase; decrease

e. remain unchanged; decrease

DIF: Medium TOP: II.A.2.

REF: The Slope of the Aggregate Demand Curve MSC: Applying

29. A rise in the price level that leads to a change in the interest rate, and therefore to a change in the quantity of aggregate demand, will cause:

a. an upward movement along the aggregate demand curve.

b. a downward movement along the aggregate demand curve.

c. a rightward shift of the aggregate demand curve.

d. a leftward shift of the aggregate demand curve.

e. no change in the quantity of aggregate demand.

DIF: Difficult TOP: II.A.2.

REF: The Slope of the Aggregate Demand Curve MSC: Applying

30. When a change in the price level leads to a change in the quantity of net exports demanded, it is called the:

a. international trade effect.

b. export effect.

c. import effect.

d. net export effect.

e. interest rate effect.

I.A.3.

REF: The Slope of the Aggregate Demand Curve

31. When U.S. goods become more expensive relative to foreign goods, exports will __________ and imports will __________.

a. decrease; decrease

b. increase; increase

c. increase; decrease

d. decrease; increase

e. decrease; be unaffected

I.A.3.

REF: The Slope of the Aggregate Demand Curve MSC: Understanding

32. When the price level rises and U.S. goods become relatively more expensive than foreign goods, there will be:

a. a rightward shift of the aggregate demand curve.

b. a leftward shift of the aggregate demand curve.

c. an upward movement along the aggregate demand curve.

d. a downward movement along the aggregate demand curve.

e. a downward movement along the aggregate supply curve.

DIF: Medium TOP: II.A.3.

REF: The Slope of the Aggregate Demand Curve MSC: Applying

33. Shifts in the aggregate demand curve are caused by:

a. the wealth effect.

b. the interest rate effect.

c. money illusion.

d. changes in labor productivity.

e. changes in spending.

I.B.

REF: Shifts in Aggregate Demand

34. Suppose the majority of students who are graduating in May from a large university have found jobs and signed employment contracts by February. Starting in February, these students are likely to __________ spending and __________ saving.

a. increase; increase

b. decrease; decrease

c. decrease; increase

d. increase; decrease

e. not change their rate of; not change their rate of

I.B.

REF: Shifts in Aggregate Demand

MSC: Understanding

35. You read in the paper that there has been a significant increase in the consumer confidence index. Having taken an economics class, you predict that spending in the economy will __________ and aggregate demand will __________.

a. decrease; increase

b. decrease; decrease

c. increase; be unaffected

d. increase; decrease

e. increase; increase

I.B.

REF: Shifts in Aggregate Demand

MSC: Applying

36. When median home prices rise, the value of real wealth __________ and aggregate demand __________.

a. increases; is unaffected

b. increases; increases

c. increases; decreases

d. decreases; decreases

e. is unaffected; is unaffected

I.B.

REF: Shifts in Aggregate Demand

MSC: Applying

37. If people expect higher income in the future, then spending today __________ and aggregate demand __________.

a. increases; is unaffected

b. increases; increases

c. increases; decreases

d. decreases; decreases

e. is unaffected; is unaffected

I.B.

REF: Shifts in Aggregate Demand

MSC: Applying

38. An increase in the value of the dollar will __________ exports and __________ imports.

a. increase; increase

b. decrease; decrease

c. have no effect on; have no effect on

d. decrease; increase

e. increase; decrease

I.B.

REF: Shifts in Aggregate Demand

MSC: Applying

39. When foreign income rises, U.S. aggregate:

a. demand will shift to the right.

b. supply will shift to the right.

c. demand will shift to the left.

d. supply will shift to the left.

e. demand and aggregate supply will be unaffected.

DIF: Medium TOP: II.B.

REF: Shifts in Aggregate Demand

MSC: Applying

40. An increase in the value of the dollar will:

a. have no effect on aggregate demand or supply.

b. decrease aggregate supply.

c. increase aggregate supply.

d. increase aggregate demand.

e. decrease aggregate demand.

DIF: Medium TOP: II.B.

REF: Shifts in Aggregate Demand

MSC: Applying

41. __________ would cause a rightward shift of the aggregate demand curve.

a. A decrease in the expected price level

b. A decrease in foreign income

c. An increase in expected income

d. A decrease in real wealth

e. An increase in the value of the dollar

DIF: Medium TOP: II.B.

REF: Shifts in Aggregate Demand

MSC: Applying

42. __________ would cause a leftward shift of the aggregate demand curve.

a. An increase in real wealth

b. An increase in expected income

c. A decrease in foreign income

d. An increase in the expected price level

e. A decrease in the value of the dollar

DIF: Medium TOP: II.B.

REF: Shifts in Aggregate Demand

MSC: Applying

43. If large emerging economies continue to grow rapidly, we can expect U.S. aggregate:

a. demand to increase.

b. demand to decrease.

c. supply to increase.

d. supply to decrease.

e. demand and supply to be unaffected.

DIF: Medium TOP: II.B.

REF: Shifts in Aggregate Demand

MSC: Applying

44. You read a study that predicts that rising oil prices projected for this summer are certain to fuel inflation. Having taken an economics class, due to this expected change in prices, you predict that spending today will _________ and aggregate demand today will _________.

a. be unaffected; be unaffected

b. increase; increase

c. decrease; decrease

d. decrease; increase

e. increase; decrease

DIF: Difficult TOP: II.B.

REF: Shifts in Aggregate Demand

MSC: Applying

45. Which of the following would shift aggregate demand to the right?

a. College graduates are having a difficult time finding jobs.

b. There is a decline in consumer confidence.

c. Stock market values increase by 20%.

d. A fall in the price level increases the value of real wealth.

e. The value of the dollar increases.

DIF: Difficult TOP: II.B.

REF: Shifts in Aggregate Demand

MSC: Applying

46. Which of the following would shift aggregate demand to the left?

a. A study predicts that the recent drought will increase food prices this winter.

b. There is a rise in the median price of houses.

c. A rise in the price level reduces saving and increases interest rates.

d. The value of the dollar increases.

e. The European Union emerges from recession.

DIF: Difficult TOP: II.B.

REF: Shifts in Aggregate Demand

MSC: Applying

47. Input prices affect the firm’s _________, and output prices affect the firm’s _________.

a. revenue; costs

b. costs; costs

c. costs; revenue

d. revenue; revenue

e. decisions in the short run but not in the long run; decisions in the long run but not in the short run

II.

REF: What Is Aggregate Supply?

48. Aggregate demand is about _________ and aggregate supply is about _________.

a. income; spending

b. spending; production

c. production; spending

d. production; income

e. saving; profit

II.

REF: What Is Aggregate Supply?

49. Aggregate supply describes a relationship between:

a. spending and income.

b. output and prices.

c. costs and revenue.

d. spending and output.

e. spending and prices.

II.

REF: What Is Aggregate Supply?

50. When decision makers have time to fully adjust to changes in the overall price level, we refer to this as:

a. the short run.

b. the long run.

c. short-run equilibrium.

d. a period of time longer than one year.

e. equilibrium.

II.

REF: What Is Aggregate Supply?

51. The long run is best defined as a period of time such that:

a. more than one year has passed.

b. more than five years have passed.

c. some prices have adjusted.

d. all prices have adjusted.

e. all firms are maximizing profit.

II.

REF: What Is Aggregate Supply?

52. When prices in the economy have not fully adjusted, we say that:

a. we are in the short run.

b. we are in the long run.

c. it is a period of time less than one year.

d. it is a period of time less than five years.

e. the market is not in equilibrium.

II.

REF: What Is Aggregate Supply?

53. Which of the following is true about the price level and aggregate supply?

a. The price level influences aggregate supply in both the long run and short run.

b. The price level influences aggregate supply in the long run but not in the short run.

c. The price level influences aggregate supply in the short run but not in the long run.

d. The price level never impacts aggregate supply.

e. There is no clear relationship between the price level and aggregate supply.

II.

REF: What Is Aggregate Supply?

54. Which of the following is true?

a. Long-run aggregate supply is independent of the price level.

b. Short-run aggregate supply is independent of the price level.

c. Long-run aggregate supply is positively related to the price level.

d. Short-run aggregate supply is inversely related to the price level.

e. Long-run aggregate supply is inversely related to the price level.

DIF: Medium TOP: III.

REF: Long-Run Aggregate Supply

55. In the long run, the output of an economy:

a. does not grow.

b. grows at a positive rate.

c. depends on aggregate demand.

d. is equal to full employment output.

e. depends on the price level.

II.A.

REF: Long-Run Aggregate Supply

56. Shifts in the long-run aggregate supply curve are caused by:

a. changes in labor productivity.

b. the wealth effect.

c. supply shocks.

d. changes in spending.

e. the interest rate effect.

II.A.

REF: Long-Run Aggregate Supply

57. The long-run aggregate supply curve is:

a. vertical because full employment output is independent of the price level.

b. upward sloping because the economy grows over time.

c. horizontal because full employment output is independent of the price level.

d. upward sloping because as the price level rises, firms will increase output.

e. downward sloping because rising prices reduce real wealth and spending.

II.A.

REF: Long-Run Aggregate Supply

58. The long-run aggregate supply curve is:

a. vertical at the level of full employment output.

b. horizontal at the going-price level.

c. illustrating a positive relationship between price and output.

d. illustrating a negative relationship between price and output.

e. the same as the short-run aggregate supply curve.

II.A.

REF: Long-Run Aggregate Supply

59. The long-run output of an economy depends on:

a. the level of spending.

b. the level of unemployment.

c. the level of inflation.

d. the level of aggregate demand.

e. resources, technology, and institutions.

II.A.

REF: Long-Run Aggregate Supply

60. In the long run, a technological advance that improves communication can be expected to _________ labor productivity and _________ unemployment.

a. have no effect on; have no effect on

b. increase; decrease

c. increase; increase

d. increase; have no effect on

e. decrease; increase

DIF: Medium TOP: III.A.

REF: Long-Run Aggregate Supply

MSC: Understanding

61. A rightward shift of the long-run aggregate supply curve means there has been:

a. a decrease in the unemployment rate.

b. an increase in the unemployment rate.

c. an increase in the price level.

d. a decrease in the price level.

e. economic growth.

II.A.

REF: Long-Run Aggregate Supply

MSC: Applying

62. When an economy experiences economic growth:

a. the long-run aggregate supply curve is unaffected.

b. the long-run aggregate supply curve shifts to the right.

c. the long-run aggregate supply curve shifts to the left.

d. the aggregate demand curve shifts to the left.

e. the short-run aggregate supply curve shifts to the left.

II.A.

REF: Long-Run Aggregate Supply

MSC: Applying

63. New computer technologies can be expected to:

a. increase long-run aggregate supply.

b. increase the price level.

c. increase the unemployment rate.

d. decrease aggregate demand.

e. decrease aggregate supply.

II.A.

REF: Long-Run Aggregate Supply

MSC: Applying

64. Which of the following would cause an increase in long-run aggregate supply?

a. The price level increases.

b. The price level decreases.

c. Firms and workers expect the price level to fall.

d. Firms and workers expect the price level to rise.

e. The stock of capital increases.

II.A.

REF: Long-Run Aggregate Supply

MSC: Applying

65. If the price level rises by 10%, then all else being equal, the long-run quantity of aggregate supply will:

a. increase by 10%.

b. decrease by 10%.

c. remain unchanged.

d. increase by more than 10%.

e. increase by less than 10%.

DIF: Medium TOP: III.A.

REF: Long-Run Aggregate Supply

MSC: Applying

66. If the price level falls by 5%, then all else being equal, the long-run aggregate supply curve will:

a. remain unchanged.

b. shift to the right to reflect an increase in output of 5%.

c. shift to the right to reflect an increase in output of more than 5%.

d. shift to the left to reflect a decrease in output of 5%.

e. shift to the left to reflect a decrease in output of