e.This is a movement down along the aggregate demand
curve. As the aggregate price level falls, the real value of
assets rises. This is the wealth effect of a change in the
aggregate price level: as the value of assets rises, people
will increase their consumption plans. This leads to high-
er consumer spending. So it is a movement along the
aggregate demand curve.
f.This is a shift of the aggregate demand curve. A rise in
the real value of assets in the economy due to a surge in
real estate values raises consumer spending at any given
aggregate price level. So the aggregate demand curve
shifts to the right.
Tackle the Test:
Multiple-Choice Questions
- d
- c
- c
- a
- a
Tackle the Test:
Free-Response Question
- The two effects that cause the aggregate demand curve to
have a downward slope are the wealth effect and the
interest rate effect of a change in the aggregate price level.
The wealth effect: When the price level increases, the
purchasing power of money decreases, causing consumers
to scale back on spending. Because consumer spending is
a component of aggregate demand, increases in the aggre-
gate price level lead to decreases in the quantity of aggre-
gate output demanded. The opposite is true for decreases
in the price level. This negative relationship between the
price level and the quantity of aggregate output demanded
results in a downward-sloping aggregate demand curve.
The interest rate effect: Increases in the aggregate price
level cause people to want to hold more money, which
increases the demand for money and drives interest rates
up. Higher interest rates reduce investment spending
because it costs more to borrow money. Thus, a rise in the
price level leads to less investment spending, which is a
component of aggregate demand, and causes the quantity
of aggregate output demanded to decrease (and vice versa).
The result is a downward-sloping aggregate demand curve.
Module 18
Check Your Understanding
- a.This represents a movement along the SRAScurve because
the CPI—like the GDP deflator—is a measure of the
aggregate price level, the overall price level of final goods
and services in the economy.
b.This represents a shift of the SRAScurve because oil is a
commodity. The SRAScurve will shift to the right because
production costs are now lower, leading to a higher quan-
tity of aggregate output supplied at any given aggregate
price level.
c.This represents a shift of the SRAScurve because it
involves a change in nominal wages. An increase in legal-
ly mandated benefits to workers is equivalent to an
increase in nominal wages. As a result, the SRAScurve
will shift leftward because production costs are now high-
er, leading to a lower quantity of aggregate output sup-
plied at any given aggregate price level.
- You would need to know what happened to the aggregate
price level. If the increase in the quantity of aggregate
output supplied was due to a movement along the SRAS
curve, the aggregate price level would have increased at
the same time as the quantity of aggregate output sup-
plied increased. If the increase in the quantity of aggre-
gate output supplied was due to a rightward shift of the
LRAScurve, the aggregate price level might not rise.
Alternatively, you could make the determination by
observing what happened to aggregate output in the long
run. If it fell back to its initial level in the long run, then
the temporary increase in aggregate output was due to a
movement along the SRAScurve. If it stayed at the higher
level in the long run, the increase in aggregate output
was due to a rightward shift of the LRAScurve.
Tackle the Test:
Multiple-Choice Questions - e
- a
- c
- d
- e
Tackle the Test:
Free-Response Questions - a.The vertical axis should be labeled “Aggregate price level”
(or “Price level”), the horizontal axis should be labeled
“Real GDP” and the graph should show an upward slop-
ing curve labeled “SRAS.”
b.SRASshifts to the left.
c.an increase in commodity prices, an increase in nominal
wages, and a decrease in productivity
Module 19
Check Your Understanding
- a.An increase in the minimum wage raises the nominal
wage and, as a result, shifts the short - run aggregate sup-
ply curve to the left. As a result of this negative supply
Real GDP
Aggregate
price
level SRAS 2
SRAS 1
SOLUTIONS TO AP REVIEW QUESTIONS S-11