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# Aggregate Expenditures, Aggregate Supply and Aggregate Demand Questions

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1. 20 points. Use an aggregate demand (AD) and aggregate supply (AS) model (short run model) to analyze this problem. Do not use a different model. Use AD & AS.
NOTE: this may be fastest with a hand-drawn graph. One option is to draw and scan, while another option is to draw, take a photo and insert the photo to your document. Feel free to use other approaches too.

A. Represent an initial equilibrium price and output level with the economy operating at or near full capacity (Hint: think about the shape of the AS curve and what this means for where AD crosses along the AS curve).
Label the following: each axis, the AD curve, the AS curve, the equilibrium output level and the equilibrium price level.

B. Suppose there is a tax cut, holding constant government purchases and all other factors affecting the AD curve. Illustrate the short run effects on output and the price level and LABEL them.

C. Give a 2 -4 sentence explanation and include why the initial state of the economy matters in your explanation.

2. 15 points. Suppose, ceteris paribus, government purchases decreased by \$4 billion, investment spending increased by \$40 billion.

A. EXPLAIN (no calculation yet). Would total output increase or decrease? What is the multiplier effect and how does it influence the answer to the question.
B. SOLVE. If 70% of a change in income is spent on new goods and services, what is the anticipated change in total output? Use the formula for the multiplier effect to calculate the change in total output.

3. 10 points. Evaluate the following as true or false and explain:
A five percent sales tax on food is an example of a flat tax.

4. 10 points. How does the article "Meltdown Averted, Bernanke Struggled to Stoke Growth- Fed Chairman Fails to Engineer Robust Recovery, Even with Extraordinary Measures"" illustrate the Federal Reserve's dual mandate, monetary policy, and monetary policy tools? Use your notes and book to describe the purpose of the Fed and the article for examples.

https://brainmass.com/economics/aggregate-demand-and-supply/aggregate-expenditures-aggregate-supply-aggregate-demand-questions-584346

## SOLUTION This solution is FREE courtesy of BrainMass!

QUESTION 1

Note that the above AD and AS lines were drawn as straight lines rather than the curved lines that AD and AS lines should be. This is because it is difficult to draw curved lines in PowerPoint. You can replace the straight lines by curves lines anytime - I attached the PowerPoint where I drew the graph.

Whenever taxes on consumer income is reduced, in the short run, it is expected that the aggregate demand shifts to the right - consumers tend to spend most of what they saved on the tax cuts. However, the aggregate supply curve doesn't move because the tax cuts doesn't affect the producers. Nevertheless, since the demand cruve shifted to the right, then it is expected that the equilibrium price will also increase thus increasing the equilirium output. When tax cuts is implemented, the initial state of the economy impacts how large a shift in demand will be. For example, if the economy is where consumers are already consuming their optimal level, tax cuts won't necessarily increase demand.

QUESTION 2
Yes, total output will increase.

The multiplier effect states that a dollar increase or decrease in any of the components of aggregate demand - consumer spending, investment, government spending, imports and exports - will impact outpur which is usually measured by GDP, gross domestic product, by a number higher or lower than 1. For example, if government increased spending by \$100 billion and output increased by \$200 billion, then we can say that the multiplier is 2.0.

The multiplier in this case (the question) will impact how much is the decrease in gvernment spending and increase in investment will increase total output.

Change in total output = (\$40 billion - \$4 billion)*70% = \$25.2 billion

QUESTION 3
FALSE
Flat tax as the name implies is a tax levied on income that is applied equally to everyone regardless of income levels. Sales tax is NOT an example of flat tax since it is a tax levied on expenditures or spending.

QUESTION 4
We know that the Federal Reserve uses different monetary policy and tools to ensure that the economy is lead towards a path with increasing production while at the same time minimizing unemployment. Ben Bernanke, Chairman of the Fed, apparently failed in both respects - the economy grew at a rate that should have been higher if the Fed, through his leadership, used the tools available at its disposal well and the unemployment rate high. Critics and admirers alike bemoan the fact that the complex policies implemented by Bernanke haven't lived to their promises of economic recover, as yet. Though the economy did recover, this recover remain relatively weak compared to the complexity and extraordinariness of the policies implemented to avert a bigger crisis. Even Mr. Bernanke himself admitted that the Fed's efforts specifically its efforts in supervising financial institutions were weak and obviously did nothing to avert the economic crisis jump started by the shenanigans of the financial industry.

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