Macroeconomics [ch. 20]

The statement is true because when the price level decreases, the purchasing power of money increases. This means that individuals can buy more goods and services with the same amount of money. As a result, consumer spending tends to rise, leading to an increase in aggregate demand. This relationship between the price level and consumer spending is known as the wealth effect, and it is one of the reasons why aggregate demand slopes downward.

The classical dichotomy refers to the separation of real variables (such as output and employment) from nominal variables (such as money supply and prices) in the long run. Monetary neutrality suggests that changes in the money supply do not have long-term effects on real variables. If both of these concepts hold true, then the long-run aggregate-supply curve should be vertical, indicating that changes in the money supply do not affect the economy's potential output.

Investment refers to the purchase of capital goods, such as machinery, equipment, and buildings, by businesses. The level of investment tends to fluctuate significantly over the business cycle. During periods of economic expansion, businesses are more confident about future prospects and tend to increase their investment spending. Conversely, during recessions or periods of economic contraction, businesses become more cautious and reduce their investment spending. Therefore, investment is indeed a particularly volatile component of spending across the business cycle.

An increase in aggregate demand leads to an increase in output because businesses produce more goods and services to meet the higher demand. This increase in production also leads to an increase in the price level because businesses may raise prices to take advantage of the higher demand and maximize their profits. Therefore, the statement that an increase in aggregate demand results in an increase in output and the price level is true.

A rise in the price of oil tends to cause stagflation because oil is a crucial input in many industries, and an increase in its price leads to higher production costs. This, in turn, can lead to a decrease in output, higher unemployment, and rising prices, which are all characteristics of stagflation. Additionally, higher oil prices can also lead to a decrease in consumer spending power, further exacerbating the stagflationary effects. Therefore, it is true that a rise in the price of oil tends to cause stagflation.

When the Federal Reserve increases the money supply, it actually causes the aggregate-demand curve to shift to the right, not to the left. This is because an increase in the money supply leads to lower interest rates, making borrowing cheaper and encouraging increased spending by businesses and consumers. This increase in spending ultimately leads to an increase in aggregate demand, shifting the curve to the right. Therefore, the statement that the aggregate-demand curve shifts to the left when the Federal Reserve increases the money supply is incorrect.

The statement is false because economists refer to fluctuations in output as the "business cycle" not because they are regular and predictable, but because they are irregular and unpredictable. The business cycle refers to the periodic ups and downs in economic activity, including fluctuations in output, employment, and other macroeconomic variables. These fluctuations are often caused by various factors such as changes in consumer spending, investment, government policies, and external shocks, making them difficult to predict or forecast accurately.

An increase in price expectations does not shift the long-run aggregate supply curve to the left. In the long run, the aggregate supply is determined by factors such as technology, capital, and labor. Price expectations may influence short-term fluctuations in aggregate supply, but in the long run, it is not a determinant. Therefore, the statement is false.

If the government cuts back spending to balance its budget in the short-run, it is likely to cause a recession. This is because government spending plays a crucial role in stimulating economic growth. When the government reduces spending, it decreases the overall demand in the economy, leading to a decrease in consumer spending and business investment. This reduction in demand can result in a decline in economic output, job losses, and a slowdown in economic activity, which are characteristics of a recession.

In the short run, a drought that destroys much of the wheat crop would lead to a decrease in the supply of wheat. As a result, the aggregate supply curve would shift to the left, causing a decrease in output. At the same time, the decrease in supply relative to demand would cause prices to rise. Therefore, the correct answer is "Prices rise; output falls."

When there is a rise in price expectations, it leads to an increase in wages. This increase in wages causes an increase in production costs for firms. As a result, firms reduce their level of output and supply less in the short run. This shift to the left of the short-run aggregate supply curve indicates a decrease in the quantity of goods and services supplied at each price level. Therefore, the statement is true.

The statement suggests that policymakers should decrease aggregate demand in order to move the economy out of a recession. However, this is not true. During a recession, the economy experiences a decrease in demand, which leads to a decrease in production and employment. In such a scenario, policymakers typically use expansionary fiscal and monetary policies to increase aggregate demand and stimulate economic growth. Therefore, the correct answer is false.

The misperceptions theory does not explain why the long-run aggregate supply curve is downward sloping. The misperceptions theory suggests that in the short run, firms may mistakenly believe that changes in the overall price level are due to changes in relative prices, leading to changes in output. However, in the long run, firms adjust their expectations and understand that changes in the overall price level are not due to relative price changes, resulting in a vertical long-run aggregate supply curve. Therefore, the statement is false.

An increase in consumer optimism means that consumers are more confident about the future and are more willing to spend. This leads to an increase in consumer spending, which is a component of aggregate demand. As a result, the aggregate demand curve shifts to the right, indicating an increase in overall demand in the economy.

The long-run aggregate-supply curve is vertical because an equal change in all prices and wages leaves output unaffected. This means that in the long run, changes in prices and wages do not affect the overall level of output in the economy. Instead, the long-run aggregate-supply curve represents the economy's potential output level, which is determined by factors such as technology, capital stock, and the available resources. The curve does not shift due to changes in the natural rate of unemployment or government policies like raising the minimum wage.

In a recession, the economy is operating below its long-run natural rate, indicating a shortfall in demand. To move output to its long-run natural rate, policymakers should attempt to shift aggregate demand to the right. This can be done through measures such as increasing government spending, reducing taxes, or implementing monetary policies to stimulate consumer and business spending. By increasing aggregate demand, the economy can recover from the recession and move towards its long-run potential.

The U.S. economy has grown at about 3 percent per year.

The answer states that a variety of spending, income, and output measures can be used to measure economic fluctuations because most macroeconomic quantities tend to fluctuate together. This is true because economic fluctuations affect various aspects of the economy, such as consumer spending, business investment, and overall output. These variables are interconnected and tend to move in the same direction during economic fluctuations. Therefore, by analyzing multiple measures, economists can get a comprehensive understanding of the state of the economy and the extent of economic fluctuations.

The natural rate of output is the amount of real GDP produced when the economy is at the natural rate of unemployment. This means that all available resources, including labor, are being utilized efficiently and there is no cyclical unemployment. At the natural rate of unemployment, the economy is considered to be operating at its full potential and there is no need for any further expansionary or contractionary policies.

Stagflation refers to a situation in the economy where there is a combination of rising prices (inflation) and falling output (recession). This is a unique and challenging scenario because typically, inflation and recession are seen as opposite phenomena. Rising prices can lead to reduced consumer spending and business investment, resulting in a decline in output. Stagflation is detrimental to the economy as it creates a difficult environment for policymakers to address both inflation and unemployment simultaneously.

When the price level falls, firms with fixed nominal wage contracts experience a decrease in profitability. As a result, they reduce production. This scenario aligns with the sticky-wage theory of the short-run aggregate-supply curve. According to this theory, wages are slow to adjust to changes in the price level, leading to changes in production and employment levels. The other options, such as the sticky-price theory, misperceptions theory, and classical dichotomy theory, do not adequately explain the specific situation described in the question.

The aggregate-demand curve slopes downward because of the wealth effect, the interest-rate effect, and the exchange-rate effect. The classical dichotomy/monetary neutrality effects do not contribute to the downward slope of the aggregate-demand curve.

An increase in price expectations would not cause a shift in the long-run aggregate-supply curve. This is because price expectations are related to short-term changes in the economy and do not affect the long-run aggregate-supply curve, which is determined by factors such as available labor, capital, and technology. Price expectations may impact short-term aggregate supply, but in the long run, the aggregate-supply curve is determined by structural factors that are not affected by price expectations.

In a recession, the economy does not automatically adjust to long-run equilibrium on its own as wages and price expectations rise. In fact, during a recession, there is typically a decrease in both wages and prices as businesses struggle to survive and consumers have less disposable income. This decrease in wages and prices can lead to a deflationary spiral, where lower prices lead to lower demand, which in turn leads to further decreases in wages and prices. Therefore, the statement that the economy will adjust to long-run equilibrium on its own as wages and price expectations rise is false.

The correct answer is the misperceptions theory of the short-run aggregate-supply curve. According to this theory, suppliers may mistakenly interpret a fall in the price level as a decrease in the relative price of their product. As a result, they reduce production, leading to a decrease in the short-run aggregate supply. This theory suggests that changes in the price level can affect real economic variables in the short run due to misperceptions by suppliers.

According to the wealth effect, lower prices increase the value of money holdings. When prices decrease, consumers can purchase more goods and services with their money, which increases their overall wealth. As a result, consumer spending increases because people feel wealthier and are more willing to spend.

According to the interest-rate effect, lower prices reduce the value of money holdings. As a result, individuals and businesses will have less money on hand, which will lead to an increase in lending. The increase in lending will cause interest rates to fall, making it cheaper for businesses to borrow money. This will lead to an increase in investment spending as businesses will be more willing to invest in new projects and expand their operations. Therefore, the correct answer is "lower prices reduce money holdings, increase lending, interest rates fall, and investment spending increases."

An increase in government spending does not necessarily lead to an increase in output and prices in the long-run. While government spending can stimulate economic activity in the short-term, it may also lead to negative consequences such as inflation and crowding out private investment. In the long-run, the impact of government spending on output and prices depends on various factors such as the effectiveness of spending, the capacity of the economy to produce goods and services, and the overall fiscal policy framework. Therefore, it is not accurate to say that an increase in government spending always leads to higher output and prices in the long-run.

When there is a reduction in military spending due to the end of the Cold War, it leads to a decrease in aggregate demand. In the short run, this decrease in aggregate demand causes prices to fall as there is less demand for goods and services. Additionally, the decrease in aggregate demand also leads to a decrease in output as businesses produce less to match the lower demand. Therefore, both prices and output fall in the short run.

When there is a reduction in military spending due to the end of the Cold War, it leads to a decrease in aggregate demand. As a result, there is an excess supply of goods and services in the economy. In the long run, this excess supply puts downward pressure on prices. Therefore, prices fall. However, since the reduction in military spending does not directly impact the productive capacity of the economy, the output remains unchanged from its initial value.

According to the model of aggregate supply and aggregate demand, in the long run, an increase in the money supply should cause prices to rise and output to remain unchanged. This is because in the long run, prices are flexible and can adjust to changes in the money supply. As the money supply increases, there is more money available in the economy, which leads to an increase in aggregate demand. This increase in demand puts upward pressure on prices. However, in the long run, increases in the money supply do not affect the potential output of the economy, so output remains unchanged.

A drop in oil prices shifts the short-run aggregate-supply curve to the right because it reduces production costs for businesses. When oil prices decrease, businesses spend less on energy and transportation, which lowers their overall costs of production. As a result, businesses can increase their output levels and offer goods and services at lower prices. This leads to an increase in aggregate supply and a rightward shift of the short-run aggregate-supply curve.

Policy makers "accommodate" an adverse supply shock by responding to it with an increase in aggregate demand. This is done in order to counteract the negative effects of the shock on the economy. By increasing aggregate demand, policy makers aim to stimulate economic activity and mitigate the impact of the supply shock. However, this increase in demand can also lead to higher prices, as the increased demand puts upward pressure on prices in the short run.

If policymakers allow the economy to adjust to the long-run natural rate on its own, people will reduce their price expectations. This means that individuals and businesses will expect lower prices in the future, leading them to lower their own prices in the present. As a result, the short-run aggregate supply curve will shift to the right. This shift indicates that businesses are willing to supply a larger quantity of goods and services at each price level, which helps to stimulate economic growth and recovery from the recession.

In the long run, the economy will adjust to the drought shock by reducing the aggregate supply of wheat. As a result, prices will rise due to the decrease in supply. However, in the long run, the economy will also experience a decrease in aggregate demand as higher prices reduce consumer purchasing power. This decrease in aggregate demand will offset the increase in prices, resulting in no change in output. Therefore, the correct answer is that output and the price level are unchanged from their initial values.