AP_Krugman_Textbook

218 section 4 National Income and Price Determination

12.Using aggregate demand, short -run aggregate supply, and
long -run aggregate supply curves, explain the process by which
each of the following government policies will move the econ-
omy from one long -run macroeconomic equilibrium to an-
other. Illustrate with diagrams. In each case, what are the
short -run and long -run effects on the aggregate price level and
aggregate output?
a.There is an increase in taxes on households.
b.There is an increase in the quantity of money.
c.There is an increase in government spending.

13.The economy is in short -run macroeconomic equilibrium at
pointE 1 in the accompanying diagram. Based on the diagram,
answer the following questions.

a.Is the economy facing an inflationary or a recessionary gap?

b.What policies can the government implement that might

bring the economy back to long -run macroeconomic equi-

librium? Illustrate with a diagram.

c.If the government did not intervene to close this gap, would

the economy return to long -run macroeconomic equilib-

rium? Explain and illustrate with a diagram.

d.What are the advantages and disadvantages of the govern-

ment implementing policies to close the gap?

14.In the accompanying diagram, the economy is in long -run
macroeconomic equilibrium at point E 1 when an oil shock
shifts the short -run aggregate supply curve to SRAS 2. Based on
the diagram, answer the following questions.

a.How do the aggregate price level and aggregate output

change in the short run as a result of the oil shock? What is

this phenomenon known as?

b.What fiscal policies can the government use to address the

effects of the supply shock? Use a diagram that shows the

effect of policies chosen to address the change in real GDP.

Real GDP

Aggregate

price

level

Y 1

LRAS

SRAS 2

SRAS 1

P 1

AD 1

E 1

Real GDP

Aggregate

price

level

Y 1 YP

LRAS

SRAS 1

AD 1

E 1

P 1

Use another diagram to show the effect of policies chosen

to address the change in the aggregate price level.

c.Why do supply shocks present a dilemma for government

policy makers?

15.The late 1990s in the United States were characterized by sub-

stantial economic growth with low inflation; that is, real GDP

increased with little, if any, increase in the aggregate price level.

Explain this experience using aggregate demand and aggregate

supply curves. Illustrate with a diagram.

16.In each of the following cases, either a recessionary or infla-

tionary gap exists. Assume that the aggregate supply curve is

horizontal, so that the change in real GDP arising from a shift

of the aggregate demand curve equals the size of the shift of

the curve. Calculate both the change in government purchases

of goods and services, and, alternatively, the change in govern-

ment transfers necessary to close the gap.

a.Real GDP equals $100 billion, potential output equals

$160 billion, and the marginal propensity to consume is 0.75.

b.Real GDP equals $250 billion, potential output equals

$200 billion, and the marginal propensity to consume is 0.5.

c.Real GDP equals $180 billion, potential output equals

$100 billion, and the marginal propensity to consume is 0.8.

17.Most macroeconomists believe it is a good thing that

taxes act as automatic stabilizers and lower the size of the

multiplier. However, a smaller multiplier means that the

change in government purchases of goods and services, gov-

ernment transfers, or taxes necessary to close an inflationary

or recessionary gap is larger. How can you explain this ap-

parent inconsistency?

18.The accompanying table shows how consumers’ marginal

propensities to consume in a particular economy are related to

their level of income.

a.Suppose the government engages in increased purchases of

goods and services. For each of the income groups in the ac-

companying table, what is the value of the multiplier—that

is, what is the “bang for the buck” from each dollar the gov-

ernment spends on government purchases of goods and

services in each income group?

b.If the government needed to close a recessionary or infla-

tionary gap, at which group should it primarily aim its fis-

cal policy of changes in government purchases of goods

and services?

19.From 2003 to 2008, Eastlandia experienced large fluctuations

in both aggregate consumer spending and disposable income,

but wealth, the interest rate, and expected future disposable in-

come did not change. The accompanying table shows the level

of aggregate consumer spending and disposable income in

Income range Marginal propensity to consume

$0−$20,000 0.9

$20,001−$40,000 0.8

$40,001−$60,000 0.7

$60,001−$80,000 0.6

Above $80,000 0.5