- True or False: All else equal, the higher the prices in the economy, the lower aggregate demand? 2) The aggregate demand curve is downward sloping to two reasons - wealth effect and substitution effect. a) According to the wealth effect, and increase in prices causes an increase or a decrease in savings? b) According to the intertemporal substitution effect, as price rises, interest rates also rise. Why does this cause a decrease in demand? c) According to the international substitution effect, as price rises, why does aggregate demand fall? 3) True or false, an increase in expected inflation causes an increase in demand? 4) True or false, a tax cut creates an increase in demand? 5) True or false, a rise in foreign exchange rates increases demand? 6) Why do we have business cycles where real gdp and potential gdp are not kept in synch? 7) An analyst makes the following statements. “In the short run, an increase in the supply of money creates an increase in supply. This creates an increase of Real GDP in excess of potential GDP. Firms enjoy higher profits while producing higher prices goods with labor at a lower wage. However, in the long run, worker’s will demand higher wages or leave the firm, forcing the firm to increase wages and reduce production. In the end, prices are higher and there’s no long term benefit to potential GDP.” “Stagflation is the combination of inflation and recession. One reason an economy may experience stagflation is a rise in the cost of foreign supplied oil. Firms are forced to reduce production which lowers supply. However, if the economy demands the same amount of the good, prices will rise. In the end you have higher prices and lower potential GDP” That analyst is correct with regards to Statement 1 and 2 Statement 1 but not statement 2 Not statement 2 but statement 1 Neither statement. 8) Match the School of Thought with their guiding principals A) Keynesian B) Monetarist C) Classical economist i) Economy is self-regulating and will operate a full-employment is money supply growth is kept at steady pace. Money wages rates are sticky and will take a long time to adjust to move economy back to full employment. ii) Economy is self-regulating and always at full employment. Changes in technology are the key driver behind demand and supply. Money wages rate is completely flexible (hence always at full employment). iii) Economy, if left alone, will rarely operate at full employment; fiscal and monetary policy are necessary. Expectations are the key driver to aggregate demand. Money wage rates are ‘extremely’ sticky and will never adjust downward if unaided.
Demand… it’s less popular than supply --------------------------------------------------- 1) True or False: All else equal, the higher the prices in the economy, the lower aggregate demand? True. Both the wealth effect (lower real buying power) and substitution effect (saving for future periods rather than spending in high cost period in order to regain real wealth) come into play. 2) The aggregate demand curve is downward sloping to two reasons - wealth effect and substitution effect. a) According to the wealth effect, and increase in prices causes an increase or a decrease in savings? It causes and increase in savings. b) According to the intertemporal substitution effect, as price rises, interest rates also rise. Why does this cause a decrease in demand? Rising interest rates make borrowing to spend more expensive. Suddenly a home, in real terms, costs much more due to higher mortgage rates. It’s better to save. c) According to the international substitution effect, as price rises, why does aggregate demand fall? Foreign goods likely become cheaper, so domestic purchaser will buy these goods rather than domestic goods. On the flip side, foreign buyers will not demand much of the domestic good at the higher price. 3) True or false, an increase in expected inflation causes an increase in demand? True. People are concerned about a decrease in the buying power of their wealth, so they purchase goods in the present period rather than the future. 4) True or false, a tax cut creates an increase in demand? True. Tax cuts put more money in the hand of the consumer. Part of this will be saved, but part will also be used to purchase new goods. The offset is that the government could also increased demand by increasing spending from the tax revenue. However, the CFAi clearly states that tax cuts = demand increases. 5) True or false, a rise in foreign exchange rates increases demand? False. 6) Why do we have business cycles where real gdp and potential gdp are not kept in synch? It is a result of the lag in wage rates resetting to reflect that changes in price. 7) An analyst makes the following statements. “In the short run, an increase in the supply of money creates an increase in supply. This creates an increase of Real GDP in excess of potential GDP. Firms enjoy higher profits while producing higher prices goods with labor at a lower wage. However, in the long run, worker’s will demand higher wages or leave the firm, forcing the firm to increase wages and reduce production. In the end, prices are higher and there’s no long term benefit to potential GDP.” “Stagflation is the combination of inflation and recession. One reason an economy may experience stagflation is a rise in the cost of foreign supplied oil. Firms are forced to reduce production which lowers supply. However, if the economy demands the same amount of the good, prices will rise. In the end you have higher prices and lower potential GDP” That analyst is correct with regards to Statement 1 but not statement 2: Stagflation has no impact on potential GDP. 8) Match the School of Thought with their guiding principals A) Keynesian (iii) B) Monetarist (i) C) Classical economist (ii) i) Economy is self-regulating and will operate a full-employment is money supply growth is kept at steady pace. Money wages rates are sticky and will take a long time to adjust to move economy back to full employment. ii) Economy is self-regulating and always at full employment. Changes in technology are the key driver behind demand and supply. Money wages rate is completely flexible (hence always at full employment). iii) Economy, if left alone, will rarely operate at full employment; fiscal and monetary policy are necessary. Expectations are the key driver to aggregate demand. Money wage rates are ‘extremely’ sticky and will never adjust downward if unaided.
> 7) An analyst makes the following statements. > “In the short run, an increase in the supply of > money creates an increase in supply. This creates > an increase of Real GDP in excess of potential > GDP. Firms enjoy higher profits while producing > higher prices goods with labor at a lower wage. > However, in the long run, worker’s will demand > higher wages or leave the firm, forcing the firm > to increase wages and reduce production. In the > end, prices are higher and there’s no long term > benefit to potential GDP.” > > “Stagflation is the combination of inflation and > recession. One reason an economy may experience > stagflation is a rise in the cost of foreign > supplied oil. Firms are forced to reduce > production which lowers supply. However, if the > economy demands the same amount of the good, > prices will rise. In the end you have higher > prices and lower potential GDP” > > That analyst is correct with regards to > > Statement 1 but not statement 2: Stagflation has > no impact on potential GDP. Do you make up these questions yourself? They are really good. However, I don’t agree with statement 1 of question 8. Increase in money supply would increase aggregate demand (instead of supply) in short run. Price level increase, real GDP > potential GDP. Then, supply responds with shifting leftward.
You’re correct. It should read and increase in money supply leads to an increase in demand. Good catch. And yeah, I’m making them on my own… basically forcing myself to walk through the details of the sections i’ve been getting spanked on.
According to the wealth effect, and increase in prices causes an increase or a decrease in savings? It causes and increase in savings. - SHouldn’t it decrease savings?
mcf - According to the wealth effect, and increase in prices causes an increase or a decrease in savings? It causes and increase in savings. - SHouldn’t it decrease savings?
Nope. When you have increasing prices, you will try to restore your overall wealth by increasing the amount you save. This leads to a decreased in consumption and a decrease in aggregate demand. Econ pg 321. Are you thinking more about the income effect regarding an individuals balance between leisure/labor.
thanks for these mcf - really useful!!