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Aggregate Demand, Aggregate Supply and Modern Macroeconomics

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Chapter 25: Aggregate Demand, Aggregate Supply and Modern Macroeconomics
Questions for Thought and Review

1. The central difference between activist and laissez-faire economists is their differing views about whether the economy is self-regulating. Laissez-faire economists (Classicals) believe the pricing mechanism will bring the economy to an equilibrium (potential output and full employment) while activist economists (Keynesians) do not share that belief.

2. Classicals felt that if the wage was lowered, the Depression would end. They saw unions as preventing the fall in wages, and they saw the government lacking the political will to break up unions.

3. Five factors that shift the AD curve are: changes in foreign income, changes in expectations, changes in exchange rates, changes in the distribution of income, and changes in government aggregate demand policy.

4. Say there is a rise in the price level. That would make the holders of money poorer (the wealth effect). It would also reduce the real money supply, increasing the interest rate (the interest rate effect). Assuming fixed exchange rates, it would also make goods less internationally competitive (the international effect). All three account for the quantity of aggregate demand decreasing—decreasing spending as the price level rises. These initial increases are then multiplied by the multiplier effect as the initial spending reverberates through the economy.

5. Two factors that shift the SAS curve are changes in productivity and changes in input prices.

6. If the economy is in short-run equilibrium below potential output, input prices will fall, causing the short-run aggregate supply curve to shift down and the price level to fall. This will set the wealth, interest rate, and international effects in motion, increasing the quantity of aggregate demand and thereby bringing the

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