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Macroeconomic Issues

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a. Assume initially that the economy is in a state of long-run equilibrium. The real GDP equals potential GDP and only natural unemployment exists. Now suppose that consumer confidence plummets and the aggregate demand decreases. What will happen to the general price level (P) and the real GDP (Y) in the short run? Why? What will happen to P and Y in the long run? Why? Describe the process of self-correcting mechanism from the beginning to the end.
b. After the aggregate demand decreases in part "a" above, what kind of a demand-management policy would a typical liberal economist propose, an active policy or do nothing? How about a conservative economist? What justifications would they provide for their respective proposed policies?
c. In general, how does an expansionary monetary policy work? (Describe the steps through which an increase in money supply affects the real GDP).
d. In general, how does fiscal policy work? (Describe the steps through which an increase in G or TR, or a decrease in TX, affects the real GDP).
e. What are the advantages and disadvantages of using an expansionary monetary policy in a recession compared to using fiscal policy? (Please note: I am not asking you how monetary policy works. You have already answered it in part c above. The question is specifically about the advantages of monetary policy compared fiscal policy in a recession).
f. What are the advantages and disadvantages of using an expansionary fiscal policy in a recession (That is, compared to using monetary policy)?

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a. If consumer confidence plummets and aggregate demand decreases, the general price level decreases and the real GDP also decreases in the short run. The short run aggregate supply curve is upward sloping and with a decrease in aggregate demand, the new equilibrium point is lower than the earlier point. This means the price level or inflation decrease and real output also decreases. In the short run suppliers find it difficult make supplies. In the long run P will decrease and the Y will return to the earlier output. The long term aggregate supply curve is vertical. It does not change with short term changes in demand. The self corrective process is one that eliminates temporary imbalances in resource markets, especially because of unemployment and over employment of labor. The self correction process closes both the recessionary gaps and inflationary gaps (1). When short run equilibrium real production is less than full employment real production, the resource markets have a surplus and there is a recessionary gap. Self-correction takes place in the short run by increasing aggregate supply, and in the long run by lowering wages. In case of an inflationary gap, where the resource markets have shortages and labor is over employed, self correction leads to a decrease in short run aggregate supply and in the long run there is higher wages.

b. If demand decreased as explained in part (a), a liberalist economist would advocate an economic policy by the government to stimulate demand in times of high unemployment. For example, the government may spend more on public works, or construction of ...

Solution Summary

The answer to this problem explains important macroeconomics issues. The references related to the answer are also included.

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11) Alden has a summer beach cottage that he has owned for many years. The cottage is valued at $100,000. This year, Alden spends $300 on paint and $500 on trees, and then paints the exterior of the cottage and plants the trees himself. If he had hired a professional painter it would cost $1000 to paint the cottage ( not including the cost of paint), and if he had hired a professional landscaper, it would have cost $375 (not including the cost of the trees) to do the planting. How much does Alden's improvements to the cottage add to GDP this year? the increase in GDP would be $ -----------.

12) Real time data analysis exercise The following table contains income and consumption data from Fred for the quarter of 2015. Real time data provided by Federal reserve economic data (FRED) federal reserve bank of saint Louis.
title value
personal income $15,604.9 billion
disposable personal income $13,618.1 billion
personal consumption expenditures 12,429 billion
Since personal consumption expenditures are exceeded by disposable income, the implication is that the fourth quarter of 2015 saw households engaged in ---------------.

13) The graph shows the aggregate demand curve in a representative economy. Suppose that there is a decrease in taxes. using the line drawing tool, show the effect on the aggregate demand curve, and label your new curve .

14) Suppose that the full employment level of nominal GDP rises in one year from $13.8 to 14.2 trillion. The long -run equilibrium price level, however, remains unchanged at 115. By how much ( in real dollars) has the long run aggregate supply curve shifted to the right from one year to the next? $ ---------trillion ( round answer to two decimal places.)

15) suppose that the position of a nation's long run aggregate supply (LRAS) curve has not changed , but its long - run equilibrium price level has decreased.
factors
a) a fall in the value of the domestic currency relative to other world currencies.
b.) a decrease in the quantity of money in circulation
c) an increase in the labor force participation rate
d.) an increase in taxes
e) a fall in real incomes of countries that are key trading partners of this nation
f) increased long -run economic growth
Of the factors given above, which could account for the price level decrease with constant LRAS?
a) factors a, c, and f
b) factors b, d, & e
c)factors b, c, d, &f
d) factors c &f

16) Consider the accompanying diagram when answering the questions that follow. Suppose that the current price level is P2. In this case, the price will fall toward P1 because
a) actual real GDP would be greater than total planned real expenditures
b.) inventories of unsold goods would begin to accumulate
c.) firms would stand ready to offer more services than people wish to purchase
d). all of the above
e.) a and b, but not c

22) an economy's consumption function is depicted in the table below.
disposable income yd ($ billions) consumption c ($billion)
0 100
125 188
250 275
375 363
500 450
625 538
The economy's marginal propensity to save is
a. $12 billion b. 0.30 c. 0.70 d. 0.032

24)Complete the following table which depicts a hypothetical economy in which the marginal propensity to consume is constant at all levels of real GDP and investment spending is autonomous. Equilibrium real GDP is equal to $8,000. There is no government. real GDP consumption saving investment
$2000 $2,500
4000 $ 4,000
6000 $ 5,500
8000 $ 7,000
10,000 $8,500
12,000 $10,000

25) The marginal propensity to consume (MPC) is .60. The multiplier is --------- ( round answer to one decimal place.)

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