Questions and Answers
According to classical macroeconomic theory, changes in the money supply change nominal but not real variables.
True
When output rises, unemployment falls.
True
An increase in the money supply causes output to rise in the long run.
False
Although wages, incomes, and interest rates are most often discussed in nominal terms, what matters most are their real values.
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A change in the money supply changes only nominal variables in the long run.
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Most economists agree that money changes real GDP in both the short and long run.
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The aggregate-demand curve shows the quantity of domestic goods and services that households, firms, the government, and customers abroad want to buy at each price level.
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The aggregate demand and aggregate supply model helps us to understand both short-run economic fluctuations and how the economy moves from the short to the long run.
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The downward slope of the aggregate demand curve is based on logic that as the price level rises, consumption, investment, and net exports all fall.
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Aggregate demand shifts to the left if the money supply increases.
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A decrease in the money supply causes the interest rate to rise so that investment falls.
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An increase in the money supply causes the interest rate to fall, investment spending to rise, and aggregate demand to shift right.
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An increase in the money supply shifts the long-run aggregate supply curve to the right.
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Technological progress shifts the long-run aggregate supply curve to the right.
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Other things being equal, technological progress raises the price level.
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Because the price level does not affect the long-run determinants of real GDP, the long-run aggregate supply is vertical.
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When the price level rises unexpectedly, some businesses may mistake part of the increase for an increase in the price of their product relative to others and so decrease their production.
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All explanations for the upward slope of the short-run aggregate supply curve suppose that the quantity of output supplied increases when the actual price level exceeds the expected price level.
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The only way to rationalize an upward slope for the short-run aggregate supply curve is to argue that wages are sticky in the short run.
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An increase in the actual price level does not shift the short-run aggregate supply curve, but an expected increase in the price level shifts the short-run aggregate supply curve to the left.
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Fluctuations in real GDP are caused only by changes in aggregate demand and not by changes in aggregate supply.
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Increased uncertainty and pessimism about the future of the economy lead firms to desire less investment spending, which shifts the aggregate-demand curve to the left.
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Increased optimism about the future leads to rising prices and falling unemployment in the short run.
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If aggregate demand shifts right, then eventually price level expectations rise. The increase in price level expectations causes the short-run aggregate-supply curve to shift to the left.
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If aggregate demand shifts right, then eventually price level expectations rise. This increase in price level expectations causes the aggregate demand curve to shift to the left back to its original position.
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In the long run, an increase in aggregate demand increases the price level, but not real GDP.
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Policymakers who influence aggregate demand can potentially mitigate the severity of economic fluctuations.
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Stagflation results from continued decreases in aggregate demand.
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The primary purpose of the aggregate demand and aggregate supply model is to demonstrate the classical dichotomy.
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If the central bank increased the money supply in response to a decrease in short-run aggregate supply, unemployment would return towards its natural rate, but prices would rise even more.
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Study Notes
Macroeconomic Theories and Concepts
- Changes in the money supply primarily affect nominal variables, with no impact on real variables in the long run.
- An inverse relationship exists between output and unemployment; as output increases, unemployment decreases.
- Real values of wages, incomes, and interest rates are more significant than their nominal counterparts.
Aggregate Demand
- The aggregate-demand curve illustrates the total demand for domestic goods and services at various price levels.
- The model of aggregate demand and supply is crucial for understanding short-run economic fluctuations and the transition to long-run equilibrium.
- A downward-sloping aggregate demand curve indicates that higher price levels lead to decreases in consumption, investment, and net exports.
Money Supply Effects
- Increases in the money supply lower interest rates, promoting investment and shifting aggregate demand to the right.
- Conversely, a decrease in the money supply raises interest rates, resulting in reduced investment.
Long-Run Dynamics
- Technological advancements shift the long-run aggregate supply curve to the right, indicating growth in productive capacity.
- The long-run aggregate supply is vertical as price levels do not influence the long-term determinants of real GDP.
- Price level rises do not affect the position of the short-run aggregate-supply curve; however, anticipated price increases can shift it left.
Short-Run Aggregate Supply (SRAS)
- The upward slope of the short-run aggregate supply curve is justified by the assumption that actual prices exceeding expected prices lead to increased output.
- Real GDP fluctuations stem from both aggregate demand and aggregate supply shifts, not solely demand changes.
Aggregate Demand Shifts and Economic Outlook
- Increased uncertainty or pessimism about the economy prompts firms to reduce investment, shifting aggregate demand left.
- Optimism about future economic conditions results in rising prices and decreased unemployment in the short run.
- Following a rightward shift in aggregate demand, rising price level expectations can lead to a leftward shift in the short-run aggregate-supply curve.
Long-Run Aggregate Demand Implications
- In the long run, heightened aggregate demand raises the price level without altering real GDP.
- Policymakers can influence aggregate demand, helping to lessen the impact of economic fluctuations.
Economic Phenomena and Misconceptions
- Stagflation is not the result of continuous declines in aggregate demand.
- The aggregate demand and supply model's primary purpose is not the demonstration of the classical dichotomy.
- If a central bank increases the money supply in response to short-run aggregate supply reductions, it may restore unemployment levels but also amplify price increases.
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Description
Test your knowledge about classical macroeconomic theories with this quiz. Evaluate statements regarding money supply, output, and unemployment to see how well you understand these key concepts. Perfect for students or anyone interested in economics!
