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Aggregate Supply and Aggregate Demand

29CHECKPOINTS

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Problem 2Problem 2

Problem 3Problem 3

Problem 1Problem 1

Problem 2Problem 2

Problem 1Problem 1

Checkpoint 29.1 Checkpoint 29.2 Checkpoint 29.3

Problem 1Problem 1 Clickerversion

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ClickerversionIn the newsIn the news

In the newsIn the news

In the newsIn the news

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Practice Problem 1 Explain the influence of each of events on the quantity of real GDP supplied and aggregate supply in India and use a graph to illustrate.

• Fuel prices rise.

• U.S. firms move their IT and data functions to India.

• Wal-Mart and Starbucks open in India.

• Universities in India increase the number of engineering graduates.

• The money wage rate in India rises.

• The price level in India rises.

CHECKPOINT 29.1

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SolutionAs fuel prices rise, the quantity of real GDP supplied at the current price level decreases.

The AS curve shifts leftward.

CHECKPOINT 29.1

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As businesses move their IT and data functions to India, real GDP supplied at the current price level increases.

The AS curve shifts rightward.

CHECKPOINT 29.1

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As Wal-Mart and Starbucks open in India, the quantity of real GDP supplied at the current price level increases.

The AS curve shifts rightward.

CHECKPOINT 29.1

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With more engineering graduates, the number of skilled workers increases, and production increases at the current price level.

The AS curve shifts rightward.

CHECKPOINT 29.1

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As money wage rates rises, firms’ costs increase and the quantity of real GDP supplied at the current price level decreases.

The AS curve shifts leftward.

CHECKPOINT 29.1

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As the price level increases, other things remaining the same, businesses become more profitable.

As the price level increases, firms increase the quantity of real GDP supplied along the AS curve.

The AS curve does not shift.

CHECKPOINT 29.1

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Study Plan ProblemU.S. firms move their IT and data functions to India. In the short run, India’s aggregate supply _________.

CHECKPOINT 29.1

A. increases

B. doesn’t change, but U.S. aggregate supply increases

C. decreases because more of India’s workers are now employed by U.S. firms

D. doesn’t change, but a higher price level brings an increase in the quantity of real GDP supplied

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Fuel prices rise in India. In the short run, India’s aggregate supply _________.

CHECKPOINT 29.1

A. increases

B. doesn’t change, the quantity of real GDP supplied decreases

C. doesn’t change, but the quantity of real GDP supplied increases

D. decreases

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Wal-Mart and Starbucks open in India. In the short run, India’s aggregate supply _______.

CHECKPOINT 29.1

A. increases

B. doesn’t change, the quantity of real GDP supplied decreases

C. doesn’t change, but the quantity of real GDP supplied increases

D. decreases

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Universities in India increase the number of engineering graduates. In the short run, India’s aggregate supply _______.

CHECKPOINT 29.1

A. doesn’t change, the quantity of real GDP supplied decreases

B. increases

C. doesn’t change, but the quantity of real GDP supplied increases

D. decreases

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The money wage rate in India rises. In the short run, India’s aggregate supply _______.

CHECKPOINT 29.1

A. doesn’t change, but the price level rises and the quantity of real GDP supplied increases

B. increases

C. doesn’t change, but the price level falls and the quantity of real GDP supplied decreases

D. decreases

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The price level in India rises. In the short run, India’s aggregate supply _______.

CHECKPOINT 29.1

A. doesn’t change, but the quantity of real GDP supplied decreases

B. increases

C. doesn’t change, but the quantity of real GDP supplied increases

D. decreases

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In the newsMinimum wage to rise in eight states

Colorado, Montana, Ohio, Washington, and Oregon recently announced their 2012 minimum wages, which contain rises ranging from 28 cents to 37 cents per hour. Thus translates into annual raises of between$582 and $770 for full-time workers.

Source: CNN Money, October 3, 2011

Explain how the rise in the minimum wage will influence aggregate supply.

CHECKPOINT 29.1

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Solution

The rise in the minimum wage at the current price level increases the real wage rate and decreases aggregate supply.

If the rise in the minimum wage rate increases the natural unemployment rate, potential GDP decreases and aggregate supply decreases farther.

CHECKPOINT 29.1

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Practice Problem 1Mexico trades with the United States.

Explain the effect of each of the following events on Mexico’s aggregate demand.

• The government of Mexico cuts income taxes.

•The United States experiences strong economicgrowth.

•Mexico sets new environmental standards that require factories to upgrade their production facilities.

CHECKPOINT 29.2

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SolutionA tax cut increases disposable income, which increases Mexico’s aggregate demand.

The AD curve shifts rightward.

CHECKPOINT 29.2

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Strong U.S. growth increases the demand for Mexican-produced goods and increases Mexico’s aggregate demand.

The AD curve shifts rightward.

CHECKPOINT 29.2

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As factories upgrade their facilities, investment increases.

Aggregate demand increases.

The AD curve shifts rightward.

CHECKPOINT 29.2

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Study Plan ProblemIf the government of Mexico cuts income taxes,Mexico’s aggregate demand _________.

CHECKPOINT 29.2

A. decreases, and the AD curve shifts leftward

B. increases, and the AD curve shifts rightward

C. is unchanged because it just increases the amount that taxpayers transfer to the government

D. is unchanged, but the price level rises and the quantity of real GDP demanded decreases

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Mexico trades with the United States. If the United States experiences strong economic growth, Mexico’s aggregate demand _________.

CHECKPOINT 29.2

A. decreases and the AD curve shifts leftward

B. is unchanged, but the quantity of real GDP demanded increases

C. is unchanged, but U.S. aggregate demand increases

D. increases because its exports to the United States increases

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When Mexico sets new environmental standards that require factories to upgrade their production facilities. Mexico’s aggregate demand _________.

CHECKPOINT 29.2

A. increases because investment increases

B. is unchanged, but the quantity of real GDP demanded increases

C. is unchanged, but the quantity of real GDP demanded decreases

D. decreases

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Practice Problem 2Explain the effect of each of the following events on Mexico’s aggregate demand.

•Europe trades with Mexico and Europe goes into recession.

•The price level in Mexico rises.

•Mexico increases the quantity of money.

CHECKPOINT 29.2

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SolutionA recession in Europe decreases European demand for Mexican goods.

Mexico’s exports decrease.

Aggregate demand decreases and the AD curve shifts leftward.

CHECKPOINT 29.2

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A rise in the price level decreases the quantity of real GDP demanded along the AD curve, but the AD curve does not shift.

CHECKPOINT 29.2

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An increase in the quantity of money increases aggregate demand, and the AD curve shifts rightward.

CHECKPOINT 29.2

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In the news

Durable goods orders fall, new-homes sales pick up

The BEA announced that demand for durable goods fell 5.3%, while new-home sales rose 4.2% in the second quarter of 2011. U.S. exports increased 3.6%.

Source: BEA, September 29, 2011

Explain how the items in the news clip influence U.S. aggregate demand.

CHECKPOINT 29.2

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SolutionThe purchase of durable goods and new homes is investment.

A decrease in durable goods sales decreases aggregate demand, while the increase in new home sales increased aggregate demand.

The rise in U.S. exports is an increase in the demand for U.S.-produced goods and services, so the rise in U.S. exports increased U.S. aggregate demand.

CHECKPOINT 29.2

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Practice Problem 1The U.S. economy is at full employment when the following events occur:

• A deep recession hits the world economy.

• The world oil price rises by a large amount.

• U.S. businesses expect future profits to fall.

Explain the effect of each event separately on aggregate demand and aggregate supply.

How will real GDP and price level change in the short run?

CHECKPOINT 29.3

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SolutionA deep recession in the world economy decreases U.S. aggregate demand.

The AD curve shifts leftward.

In the short run, U.S. real GDP decreases and the price level falls.

CHECKPOINT 29.3

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A rise in the world oil price decreases U.S. aggregate supply.

The AS curve shifts leftward.

In the short run, U.S. real GDP decreases and the price level rises.

CHECKPOINT 29.3

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A fall in expected future profits decreases U.S. aggregate demand.

The AD curve shifts leftward.

In the short run, U.S. real GDP decreases and the price level falls.

CHECKPOINT 29.3

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Practice Problem 2The U.S. economy is at full employment when the following events occur:

• A deep recession hits the world economy.

• The world oil price rises by a large amount.

• U.S. businesses expect future profits to fall.

Explain the combined effect of these events on real GDP and price level.

CHECKPOINT 29.3

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Solution

All three events decrease U.S. real GDP.

The deep world recession and the fall in expected future profits decrease the price level.

The rise in the world oil price increases the price level.

So the combined effect on the price level is ambiguous.

CHECKPOINT 29.3

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Study Plan ProblemThe U.S. economy is at full employment when a deep recession hits the world economy, the world oil price rises by a large amount, and U.S. businesses expect future profits to fall.

CHECKPOINT 29.2

A. The U.S. price level rises and real GDP decreases

B. The U.S. price level falls and real GDP decreases

C. U.S. real GDP decreases, but the price level might rise or fall.

D. U.S. real GDP increases, but the price level might rise or fall.

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Practice Problem 3The U.S. economy is at full employment when the following events occur:

• A deep recession hits the world economy.

• The world oil price rises by a large amount.

• U.S. businesses expect future profits to fall.

Which event, if any, brings stagflation?

CHECKPOINT 29.3

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SolutionStagflation occurs when the price level rises and real GDP decreases at the same time.

The rise in the world oil price brings stagflation because it decreases aggregate supply, decreases real GDP, and raises the price level.

CHECKPOINT 29.3

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Study Plan ProblemThe U.S. economy is at full employment. Stagflation occurs, if ______.

CHECKPOINT 29.2

A. a deep recession hits the world economy

B. the world oil price rises by a large amount

C. U.S. businesses expect future profits to fall.

D. A, or B, or C occur.

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In the news

U.S. incomes fall for the first time in 2 years

Consumer spending rose 0.2 percent, down from 0.7 percent in July. Incomes fell 0.1 percent—the first decline since October 2009. Consumer spending accounts for 70 percent of economic activity.

Source: Associated Press, September 30, 2011

Explain the combined effect of these events in terms of the AS-AD model.

CHECKPOINT 29.3

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Solution

The news clip gives no information about aggregate supply.

Consumption expenditure is 70 percent of aggregate demand, so an increase in consumption expenditure would increase aggregate demand, GDP, and aggregate incomes.

CHECKPOINT 29.3

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But incomes fell, so the other components of aggregate demand (investment, government expenditure, net exports) must have decreased, ….

moving the economy down along the AS curve.

Or aggregate supply must have decreased, moving the economy up along the AD curve.

CHECKPOINT 29.3