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4 Question about Aggregate Demand Curve

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1. What is the effect of an increase in the quantity of money? What is the difference between real variables and nominal variables? Are these variables affected by the quantity of money? If so, how?

2. What is the difference between the real exchange rate and the nominal exchange rate? If the nominal exchange rate goes from 120 to 160 pesos per dollar, what has happened to the value of a dollar?

3. Why does the aggregate demand curve slope downward? Give at least three reasons and examples when addressing this question. Identify an event that would shift the AD curve and which direction the AD curve will shift.

4. Assume that the federal government increases spending on public works programs, such as highway construction, by $40 billion. How does this change in spending affect the aggregate demand curve? Explain why the shift may be higher or lower than the original $40 billion.

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1. The effect of an increase in the quantity of money is different in the long and short run. In the long run, it is generally agreed that an increase in the quantity of money, all else being equal causes prices to increase. In the short run, an increase in the quantity of money may cause an increase in spending and thus consumption. This helps us understand the difference between a real and a nominal variable. A nominal variable is not adjusted for inflation. For instance, the nominal price of most household goods has risen markedly over the past 50 years. However, if one tracks these prices against measures of the overall price level, it is possible to adjust those prices for inflation. This is how one arrives at a real variable. Thus, if the sticker price of a tomato rises by 20% while the overall price level in the economy also rises by 20%, then the nominal price of the tomato has increased while the real price has not. Since an increase in the quantity of money, all else equal, tends to raise prices in the long run, the ...

Solution Summary

The effect of an increase in the quantity of money is explained among other things in answer to these 4 questions, using 701 words with reference links.

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Answers and explanations for common multiple-choice Macroeconomics test questions.

Question #1
What is the short term economic outcome if price levels in the US increase and consumers buy less output as a result?
1. Aggregate demand shifts to the right.
2. Aggregate demand shifts to the left.
3. Aggregate demand does not shift, movement along this curve.

2. Question #2
Suppose that the real wealth of households increases significantly. As a result, the short term impact is that
1. Aggregate demand shifts to the right.
2. Aggregate demand shifts to the left
3. Aggregate demand does not shift, instead there is a movement along this curve.

3. Question #3
When expectations for corporate profits are diminished, economists expect that in the short term
1. Aggregate demand shifts to the right.
2. Aggregate demand shifts to the left.
3. Aggregate demand does not shift, instead there is a movement along this curve.

4. Question #4
If a series of tornados damages factories and infrastructure in the industrial regions of the US, a short term consequence is that
1. Aggregate supply shifts to the right.
2. Aggregate supply shifts to the left.
3. Aggregate supply does not shift, instead there is a movement along this curve.

5. Question #5
If companies invest in more efficient machinery and equipment, then
1. Aggregate supply shifts to the right for the short term.
2. Aggregate supply shifts to the left for the short term.
3. Aggregate supply does not shift, instead there is movement along this curve in the short term.

6. Question #6
If the Environmental Protection Agency significantly relaxes (reduces) environmental regulations, then one short term outcome is that
1. Aggregate supply shifts to the right.
2. Aggregate supply shifts to the left
3. Aggregate supply does not shift, instead there is a movement along this curve.

7. Question #7
In an effort to reduce budget deficits, the federal government decides to reduce its spending. The reduction is likely to impact both real GDP and the aggregate price level in the THE SHORT TERM. In fact:
1. Real GDP increases and the price level decreases.
2. Real GDP decreases and the price level decreases.
3. Real GDP increases and the price level increases
4. Real GDP decreases and the price level increases.

8. Question #8
Suppose that potential shareholders anticipate an increase in profitability so that there is a sharp increase in stock prices. In the short term,
1. Real GDP increases and the price level decreases.
2. Real GDP decreases and the price level decreases.
3. Real GDP increases and the price level increases.
4. Real GDP decreases and the price level increases.

9. Question #9
A widespread technological advance occurs so that the industrial sector of the economy becomes more efficient. In the short run:
1. Real GDP increases and the price level decreases.
2. Real GDP decreases and the price level decreases.
3. Real GDP increases and the price level increases.
4. Real GDP decreases and the price level increases.

10. Question #10
Remarkably, the price of an important raw material decreases. The price change leads to a short term
1. Increases in real GDP and the price level decreases.
2. Decreases in real GDP and the price level decreases.
3. Increases in real GDP and the price level increases.
4. Decreases in real GDP and the price level increases.

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