AP_Krugman_Textbook

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

1. d


2. c


3. c


4. a


5. a

Tackle the Test:

Free-Response Question

2. 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

1. 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.

2. 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


3. e


4. a


5. c


6. d


7. e
   Tackle the Test:
   Free-Response Questions


8. 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

1. 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