BR14: Bridge: Aggregate Demand and Aggregate Supply
Question 1
The country of Doomsville is currently in a recession. The government of Doomsville, in an effort to maintain its tax revenues in a time when incomes are falling, decides to increase the tax rate. Would this policy help or hurt the recession?
A. This policy would have an unknown effect on Doomsville’s economy.
B. This policy would likely have no effect on Doomsville’s economy.
C. This policy would likely help Doomsville recover faster.
D. This policy would likely make Doomsville’s recession worse.
Hint
A tax increase is a contractionary fiscal policy.Answer
D. This policy would likely make Doomsville’s recession worse. A contractionary fiscal policy, such as a tax increase, will reduce spending, thereby decreasing aggregate demand and depressing the economy further.Question 2
Using the vertical long-run aggregate supply curve, an increase in aggregate demand would have which of the following effects in the long run?
A. No change in aggregate output and a rise in the price level.
B. No change in aggregate output and a fall in the price level.
C. An increase in aggregate output and a rise in the price level.
D. A decrease in aggregate output and a fall in the price level.
Hint
Think of the shape of the long-run aggregate supply curve and what that implies about the effects of changes in aggregate demand.Answer
A. No change in aggregate output and a rise in the price level. The vertical long-run aggregate supply curve reflects the idea that output always reverts to potential output in the long run. Thus, an increase in aggregate demand that shifts the aggregate demand curve to the right will have no long-run effect on output but only raise the price level. Only changes in technology or the availability of factors of production can shift the long-run aggregate supply curve.Question 3
Which of the following policies would be most effective to control inflation?
A. An increase in government spending to shift aggregate demand to the right.
B. A decrease in government spending to shift aggregate demand to the left.
C. An increase in taxes to shift aggregate supply to the left.
D. None of the above would reduce inflation.
Hint
It may be helpful to draw a graph of the AD and AS curves. Which of the options would lead to a fall in the price level?Answer
B. A decrease in government spending to shift aggregate demand to the left. A decrease in government spending shifts the AD to the left, and with upward sloping AS curve, equilibrium at a lower price level and thereby reducing inflation.Question 4
If Eastland’s consumer confidence rises, what would happen to macroeconomic equilibrium in the short-run if the short-run aggregate supply curve is upward sloping?
A. AD shifts left, aggregate output decreases, and prices fall.
B. AD shifts right, aggregate output increases, and prices rise.
C. AD shifts right, aggregate output increases, and prices fall.
D. AD shifts left, aggregate output decreases, and prices rise.
Hint
How do consumers behave when they are confident and optimistic about the economy?Answer
B. AD shifts right, aggregate output increases, and prices rise. If consumer confidence rises, consumption will rise and so will investment, shifting AD to the right. At the new short run equilibrium, aggregate output increases and prices rise, if the short run AS curve is upward sloping.Question 5
Which of the following would be most likely to cause the short-run aggregate supply curve to shift left?
A. A rise in government spending.
B. A spike in food prices due to a drought.
C. A reduction in oil prices due to increased drilling.
D. A decrease in investor confidence.