Principles of MacroEconomics: 101
Problem Set #3: Answer Key
Explain each of the following: (a) the wealth effect, (b) interest rate effect, and (c) international trade effect.
The real balance effect states that the inverse relationship is established through changes in the value of monetary wealth. As the price level changes, the purchasing power of monetary wealth changes, causing the quantity demanded of Real GDP to change.
The interest rate effect states that the inverse relationship is established through changes in household and business spending that is sensitive to interest rate changes. As the price level changes, it takes a different quantity of money to purchase a fixed bundle of goods, and this leads to a change in savings (the supply of credit increases). Subsequently, the price of credit, which is the interest rate, changes, causing households and businesses to change their borrowing levels, and changing the quantity of Real GDP to change.
The international trade effect states that the inverse relationship is established through foreign sector spending. As the price level in the U.S. changes, U.S. goods become relatively cheaper or more expensive than foreign goods. As a result, Americans and foreigners change the amounts of U.S. goods they buy, changing the quantity of Real GDP to change.
Explain what happens to the aggregate demand in each of the following cases: (a) The interest rate rises; (b) Wealth falls; (c) The dollar depreciates relative to foreign currencies; (d) Households expect lower prices in the future; (e) Business taxes rise.
In examples (a), (b), (d), and (e), the aggregate demand curve would shift to the left, causing both Real GDP and the price level to decrease in the short run. In (c), the aggregate demand curve would shift to the right, causing both Real GDP and the price level to increase in the short run.
Explain what is likely to happen to U.S. export and import spending as a result of the dollar depreciating in value.
A depreciation of the U.S. dollar makes foreign goods more expensive for Americans and American goods cheaper for foreigners. Therefore, U.S. exports will likely rise (foreigners will buy more American goods since they are cheaper) and U.S. imports will likely fall (Americans will buy fewer foreign goods since they are more expensive).
How will a change in the money supply affect aggregate demand?
A change in the money supply will change interest rates, which will change consumption and investment, therefore changing aggregate demand.
Explain how each of the following can affect short-run aggregate supply: (a) An increase in wage rates; (b) A beneficial supply shock; (c) An increase in the productivity of labor; (d) A decrease in the price of a nonlabor resource (such as oil).
An increase in wages in (a) will shift the short-run aggregate supply curve to the left because the higher wage rates will cause Real GDP to be produced at a higher price level than existed before. The three remaining changes in (b), (c), and (d) would each shift the short-run aggregate supply curve to the right since, in these three cases, the same level of Real GDP could be produced at a lower price level.
A change in the price level affects which of the following? (a) The quantity demanded of Real GDP; (b) Aggregate demand; (c) Short-run aggregate supply; (d) The quantity supplied of Real GDP.
A change in the price level would affect the quantity demanded of Real GDP and the quantity supplied of Real GDP (both [a] and [d]), but it would not change either aggregate demand or short-run aggregate supply (either [b] or [c]).
In the short run, what is the impact on the price level and Real GDP of each of the following: (a) An increase in consumption brought about by a decrease in interest rates; (b) A decrease in exports brought about by an appreciation of the dollar; (c) A rise in wage rates; (d) A...
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