Chapter Nineteen: GDP and the Price Level in the Long-Run

Table of Contents

1. Chapter Nineteen: GDP and the Price Level in the Long-Run

Chapter Nineteen: GDP and the Price Level in the Long-Run

1

Question 1 If the economy starts at potential GDP, has a positively sloped short-run aggregate supply curve, and there is an increase in government spending, the effects will be what? a) In the short run output will rise while prices fall and in the long run prices will return to the original position and GDP will be higher. b) In the short run there will be some increase in GDP and some in prices, but in the long run there will be higher prices but no increase in GDP. c) In the short run there will be some fall in GDP and prices, but both will return to their starting point in the long run. d) In the short run prices will rise while GDP falls, and both will return to their initial position in the long run. e) In the short and long run there will be a rise in the price level but no change in real GDP. Correct.Incorrect. The answer is b) In the short run there will be some increase in GDP and some in prices, but in the long run there will be higher prices but no increase in GDP.Your answer has been saved.

2

Question 2 If the economy starts at potential GDP and there is an exogenous increase in investment spending, the effects will be what? a) In the short run output will rise while prices fall and in the long run prices will return to the original position and GDP will be higher. b) In the short run there will be some fall in GDP and prices, but both will return to their starting point in the long run. c) In the short run prices will rise while GDP falls, and both will return to their initial position in the long run. d) In the short run GDP will fall while the price level rises but in the long run GDP will rise by the change in I times the multiplier. e) In the short run there will be some increase in GDP and some in prices, and in the long run there will be higher prices but no increase in GDP. Correct.Incorrect. The answer is e) In the short run there will be some increase in GDP and some in prices, and in the long run there will be higher prices but no increase in GDP.Your answer has been saved.

3

Question 3 If the economy starts at potential GDP and there is an increase in exports, X, due to a rise in world demand the effects will be (assume a positively sloped short-run aggregate supply curve and a vertical long-run aggregate supply curve) what? a) In the short run output will rise while prices fall and in the long run prices will return to the original position and GDP will be higher. b) In the short run there will be some fall in GDP and prices, but both will return to their starting point in the long run. c) In the short run prices will rise while GDP falls, and both will return to their initial position in the long run. d) In the short run there will be some increase in GDP and some in prices, but in the long run there will be higher prices but no increase in GDP. e) In the short run, the SRAS curve will shift to the right producing higher output and lower prices, and the LRAS curve will also shift right making the output increase permanent. Correct.Incorrect. The answer is d) In the short run there will be some increase in GDP and some in prices, but in the long run there will be higher prices but no increase in GDP.Your answer has been saved.

4

Question 4 Fiscal policy works in which of the following ways? a) Lower taxes or higher G shift the SRAS curve to the right. b) Lower taxes or higher G shift the AD curve to the right. c) Lower taxes or higher G shift the AD curve to the left. d) Lower taxes or higher G shift the LRAS curve to the left. e) Lower taxes of higher G shift LRAS curve to the right. Correct.Incorrect. The answer is b) Lower taxes or higher G shift the AD curve to the right.Your answer has been saved.

5

Question 5 A negative supply shock to the macro economy (such as a rise in oil prices) starting at potential GDP and assuming no change in monetary or fiscal policies, would: a) Shift the SRAS curve to the right causing higher GDP and lower price level in the short run, but no change to GDP and prices in the long run. b) Shift the SRAS curve to the left causing lower GDP and lower prices in the short run but no change to either in the long run. c) Shift the SRAS curve to the left causing lower GDP and higher prices in the short run but no change to either in the long run. d) Shift the SRAS curve to the left causing lower GDP and higher prices in the short run, and lower prices and lower GDP in the long run. e) Shift the AD curve to the right causing higher prices and lower GDP in both the sort and long run. Correct.Incorrect. The answer is c) Shift the SRAS curve to the left causing lower GDP and higher prices in the short run but no change to either in the long run.Your answer has been saved.

6

Question 6 Draw a set of flow charts to illustrate why: (a) inflationary gap conditions in an economy will lead to an upward pressure on wages; (b) recessionary gap conditions in an economy will lead to a downward pressure on wages. Hint: re-read 'Induced changes in input prices' pp 423-25. Drawing flow charts is a useful revision aid. It will encourage you to identify each stage of a process and to describe each stage succinctly.

7

Question 7 Draw diagrams to show how a demand shock (positive or negative) can create an inflationary/deflationary gap situation with the economy ultimately returning to its potential output level, but at a higher price level. Hint: re-read 'The long-run consequences of aggregate demand shocks' pp 425-27. You may wish to construct a set of flow charts to complement the diagrams you have drawn.

8	Question 8 Why doesn't the vertical portion of the long-run aggregate supply curve represent the same thing as the vertical portion of the short-run aggregate supply curve? Hint: re-read 'Shape of the LRAS curve' pp 428-29.

9

Question 9 Why did the Keynesian revolution in economic policymaking necessitate an increase in the production of economic statistics? Hint: re-read 'Government policy and the business cycle' pp 432-36. The answer to this question isn't given specifically in this section of the book, but it should provide a strong lead for you to deduce why.

10	Question 10 What do economists mean by the term 'automatic stabilizers'? Why are these stabilizers important? Hint: re-read 'Automatic stabilizers' pp 433-34.

11	Question 11 Why won't fiscal policy have an instantaneous impact on the level of economic activity taking place within an economy? Hint: re-read 'Limitations of discretionary fiscal policy' pp 435-36.

12	Question 12 In May 1999, Chancellor Gordon Brown introduced two rules: the 'Golden Rule' and the 'Sustainable Investment Rule'. What are their policy implications? Hint: re-read 'UK fiscal rules' p437.