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Chapter 12: Q7. (page 259)

True or False. Decreases in AD normally lead to decreases in both output and the price level.

Short Answer

Expert verified

The statement is true.

Step by step solution

01

Meaning and shifts in the aggregate demand curve

An aggregate demand curve represents price level at different levels of the real output, which the consumers are willing to pay collectively in the economy. The aggregate demand for an open public economy comprises private consumption, gross investment, government expenditure, and net exports.

The aggregate demand is estimated by what the consumers are paying at the given output level in the economy. A change in any of the components of the aggregate demand causes an overall shift in aggregate demand.

02

Reason for the true statement

As the aggregate demand decreases, the aggregate demand curve shifts from AD to the left (AD’) along the constant supply curve AS. Thus, the economy’s equilibrium shifts from e to e’ along the AS curve.

At the initial equilibrium e, the price level is P, and the real output is Y. As the equilibrium shifts to the left, the price comes down to P’, and the output reduces to Y’.

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Most popular questions from this chapter

Distinguish between "real-balances effect" and "wealth effect," as the terms are used in this chapter. How does each relate to the aggregate demand curve?

What effects would each of the following have on aggregate demand or aggregate supply, other things equal? In each case, use a diagram to show the expected effects on the equilibrium price level and the level of real output, assuming that the price level is flexible both upward and downward.

  1. A widespread fear by consumers of an impending economic depression.

  2. A new national tax on producers based on the value added between the costs of the inputs and the revenue received from their output.

  3. A reduction in interest rates.

  4. A major increase in spending for health care by the federal government.

  5. The general expectation of coming rapid inflation.

  6. The complete disintegration of OPEC, causing oil prices to fall by one-half.

  7. A 10 percent across-the-board reduction in personal income tax rates.

  8. A sizable increase in labor productivity (with no change in nominal wages).

  9. A 12 percent increase in nominal wages (with no change in productivity).

  10. An increase in exports that exceeds an increase in imports (not due to tariffs).

Suppose that consumer spending initially rises by \(5 billion for every 1 percent rise in household wealth and that investment spending initially rises by \)20 billion for every 1 percentage point fall in the real interest rate. Also, assume that the economy’s multiplier is 4. If household wealth falls by 5 percent because of declining house values, and the real interest rate falls by 2 percentage points, in what direction and by how much will the aggregate demand curve initially shift at each price level? In what direction and by how much will it eventually shift?

Answer the following questions on the basis of the following three sets of data for the country of North Vaudeville:

(A)
(B)
(C)
Price Level
Real GDP
Price Level
Real GDP
Price Level
Real GDP
110275100200110225
100250100225100225
9522510025095225
9020010027590225

  1. Which set of data illustrates aggregate supply in the immediate short-run in North Vaudeville? The short-run? The long run?

  2. Assuming no change in hours of work, if real output per hour of work increases by 10 percent, what will be the new levels of real GDP in the right column of A? Do the new data reflect an increase in aggregate supply or do they indicate a decrease in aggregate supply?

Assume that (a) the price level is flexible upward but not downward and (b) the economy is currently operating at its full-employment output. Other things equal, how will each of the following affect the equilibrium price level and equilibrium level of real output in the short run?

  1. An increase in aggregate demand.

  2. A decrease in aggregate supply, with no change in aggregate demand.

  3. Equal increases in aggregate demand and aggregate supply.

  4. A decrease in aggregate demand.

  5. An increase in aggregate demand that exceeds an increase in aggregate supply.
See all solutions

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