Unit 3 Quiz Changes in AD and AS

Which of the following changes will necessarily cause inflation?

• A decrease in aggregate demand and a decrease in short-run aggregate supply.

• A decrease in aggregate demand and an increase in short-run aggregate supply.

• A decrease in aggregate demand with no change in short-run aggregate supply.

• An increase in aggregate demand and a decrease in short-run aggregate supply.

• An increase in aggregate demand and an increase in short-run aggregate supply.

Answer explanation

An increase in aggregate demand causes the price level to increase, and a decrease in short-run aggregate supply causes the price level to increase. Therefore, the price level will increase, and there will be inflation

An economy is in long-run macroeconomic equilibrium. What will be the short-run effects of an increase in investment spending?

• An increase in real output, an increase in unemployment, and a decrease in the price level

• An increase in real output, an increase in unemployment, and an increase in the price level

• An increase in real output, a decrease in unemployment, and an increase in the price level

• A decrease in real output, a decrease in unemployment, and a decrease in the price level

• A decrease in real output, a decrease in unemployment, and no change in the price level

Answer explanation

An increase in investment spending, a component of aggregate demand, shifts the aggregate demand curve to the right, resulting in a new short-run equilibrium with higher real output, lower unemployment, and a higher price level.

Based on the diagram, which answer describes what will happen in the long-run adjustment process?

• The natural rate of unemployment will increase.

• Potential real GDP will increase

• Aggregate demand will decrease

• Short-run aggregate supply will increase

• Wages and input prices will increase.

Answer explanation

There is an inflationary gap because short-run equilibrium real GDP(Yb) is greater than long-run equilibrium real GDP

(potential real GDP, which is Ya); therefore, the economy is operating above full employment. In the long run, wages and input prices will increase because of shortages of inputs and increasing production beyond potential GDP. This will shift the short-run aggregate supply curve to the left and restore full employment.

An economy is currently in short-run equilibrium, and real output is below the full-employment level of output. Which of the following market adjustments is most likely to occur in the long run?

• The recessionary gap will create upward pressure on prices, shifting the aggregate demand curve to the left.

• The existence of cyclical unemployment will increase consumption spending and increase real output.

• Full-employment output will fall to equal the short-run equilibrium real output.

• Nominal wages will fall, shifting the short-run aggregate supply curve to the right.

• Input prices will increase as firms compete for labor and capital.

Answer explanation

When the short-run equilibrium real output is below the full-employment output, then cyclical unemployment occurs because of underutilization of resources, causing input prices and nominal wages to fall in the long run and shifting the short-run aggregate supply curve to the right to restore full employment.

If there is an adverse (negative) short-run aggregate supply shock due to an increase in the price of natural resources and the government pursues no policy to address the supply shock, then which of the following will occur in the long run?

• Nominal wages will fall with no change in the natural rate of unemployment.

• Inflation will rise and nominal wages will fall.

• Deflation will worsen and nominal wages will rise.

• Aggregate demand will increase to restore full employment.

• The long-run aggregate supply curve will shift right and increase unemployment.

Answer explanation

The supply shock results in a leftward shift of the short-run aggregate supply curve, which will increase unemployment (above the natural rate), leading to a decrease in nominal wages but not necessarily a change in the natural rate of unemployment. In the long run the short-run aggregate supply curve will shift right and restore full employment.

Assume the countries of Ornania and Kumbagi are major trading partners. Ornania is currently in long-run macroeconomic equilibrium. As a result of a recession in its economy, Kumbagi decreases its demand for goods produced in Ornania. Which of the following will occur in Ornania in the short run?

• The aggregate demand curve will shift to the right, causing the actual rate of unemployment to exceed the natural rate of unemployment.

• The aggregate demand curve will shift to the left, resulting in an inflationary gap.

• The aggregate demand curve will shift to the left, resulting in a recessionary gap.

• The short-run aggregate supply curve will shift to the left, resulting in an inflationary gap.

• The short-run aggregate supply curve will shift to the left, resulting in a recessionary gap.

Answer explanation

The aggregate demand curve will shift to the left because of the decrease in Ornania’s exports to Kumbagi. This will result in a recessionary gap.

According to the graph, which statement is true?

• At point Z, the economy has cyclical unemployment.

• At point Z, the economy is in long-run equilibrium but not in short-run equilibrium.

• At point Y, the natural rate of unemployment is zero.

• At point X, the economy is experiencing a recessionary gap.

• At point X, there is no frictional unemployment.

Answer explanation

At point X, the economy is in a short-run equilibrium, where real output is below full employment, resulting in a recessionary gap.

Which statement describes the graph's short run equilibrium?

• The economy is operating at full employment.

• The economy is operating below full employment.

• The economy is operating above full employment.

• There will be downward pressure on the price level.

• There is a recessionary gap.

Answer explanation

Short-run equilibrium realGDP(Yb) is greater than long-run equilibrium real GDP (potential real GDP, which is Ya); therefore, the economy is operating above full employment. AD and SRAS intersect at P1 and Yb, which exceeds potential real GDP.

In the AD-AS model, which of the following is true?

• The economy is in an inflationary gap when the short-run equilibrium real output is below the long-run equilibrium real output.

• The economy is in an inflationary gap when the short-run equilibrium real output is at the long-run equilibrium real output.

• The economy is in a recessionary gap when the short-run equilibrium real output is at the long-run equilibrium real output.

• The economy is in a recessionary gap when the short-run equilibrium real output is below the long-run equilibrium real output.

• The economy is in a recessionary gap when the short-run equilibrium real output is above the long-run equilibrium real output.

Answer explanation

The economy is in a recessionary gap when the short-run equilibrium real output is below the long-run equilibrium real output.

Stagflation is most likely to be caused by

• an increase in aggregate demand

• a decrease in aggregate demand

• an increase in aggregate supply

• a decrease in aggregate supply

• a large increase in the money supply