ECONTWO: Exercise 3

____________________________
__________________
Name
Section
(1) When the actual price level is greater than the expected price level, the
aggregate quantity of goods and services supplied will be (higher than, lower than,
equal to) ______________ the natural rate of output. When the actual price level is
less than expected, the aggregate quantity of goods and services supplied will be
(higher than, lower than, equal to) ________________ the natural rate of output. When
the actual price level is equal to the expected price level, the aggregate quantity of
goods and services supplied will be (higher than, lower than, equal to)
______________ the natural rate of output.

A
D

B
C

(2) In the figure above, suppose the economy were in long run equilibrium at point
A, at the natural rate of output. The stock market crashes and a bank run causes
households to withdraw their deposits from the banking system and hold on to their
money. Banks increase their excess reserves and reduce lending. As a result, money
supply (increases, decreases, remains unchanged) ___________ and the (aggregate
demand curve, short run aggregate supply curve, long run aggregate supply curve)
_________________ (does not change, shifts to the right, shifts to the left)
_________________. In the new short run equilibrium, prices are (higher, lower,
unchanged) _______________ and real GDP is (higher , lower, the same)
______________than the natural rate at point (A, B, C, D) ____.
(3) Suppose the economy were at point D and the government decides to do
nothing. People expect prices to be (higher, lower) __________therefore the
1

(aggregate demand curve, short run aggregate supply curve, long run aggregate
supply curve) ________________ (shifts to the right, shifts to the left) _______________.
In the new long run equilibrium, prices are (higher, lower, unchanged) _________ and
real GDP is (higher , lower, the same) _____________ at point (A, B, C, D) ______.
(4 )Suppose the economy were at point D and the Central Bank decides to buy
government bonds from the public. This will (increase, decrease)
_____________money supply so that interest rates will (rise, fall) __________ and
therefore consumption and investment will (increase, decrease) __________ and the
(aggregate demand curve, short run aggregate supply curve, long run aggregate
supply curve) ______________ (does not change, shifts to the right, shifts to the left)
________________. In the new long run equilibrium, prices are (higher, lower,
unchanged) ____________ and real GDP is (higher , lower, the same) ___________at
point (A, B, C, D) ____.
(5) Suppose the economy were at point D and the national government decides to
reduce taxes and or increase spending. This will (increase, decrease)
_________________aggregate demand so that the (aggregate demand curve, short run
aggregate supply curve, long run aggregate supply curve) ________________________
(does not change, shifts to the right, shifts to the left) _______________. In the new
long run equilibrium, prices are (higher, lower, unchanged) ___________and real GDP
is (higher , lower, the same) _______________ at point (A, B, C, D) ______.
(6) Suppose the economy were in long run equilibrium at point C, at the natural rate
of output, when a new president considered by many to be honest, efficient, and
fair is elected. As a result, a wave of optimism boosts business investment and
household consumption. The (aggregate demand curve, short run aggregate supply
curve, long run aggregate supply curve) ____________________ (shifts to the right,
shifts to the left) ________. In the new short run equilibrium, prices are (higher,
lower, unchanged) ___________ and real GDP is (higher, lower, the same) ___________
than/as the natural rate at point (A, B, C, D) ______.
(7)Suppose the economy were at point B and the government decides to do
nothing. People expect prices to be (higher, lower) __________ therefore the
(aggregate demand curve, short run aggregate supply curve, long run aggregate
supply curve) _______________________________ (shifts to the right, shifts to the left)
____________________. In the new long run equilibrium, prices are (higher, lower,
unchanged) ____________and real GDP is (higher, lower, the same) ____________at
point (A, B, C, D) _____.
(8)Suppose the economy were at point B and the Central Bank becomes concerned
with inflation and an asset bubble. It therefore decides to sell bonds. As a result,
money supply (increases, decreases, remains unchanged) ______________________
and the (aggregate demand curve, short run aggregate supply curve, long run
2

aggregate supply curve) ______________________________________ (does not change,

shifts to the right, shifts to the left) _________________________. In the new
equilibrium, prices are (higher, lower, unchanged) _____________ and real GDP is
(higher , lower, the same) __________ at point (A, B, C, D) _____.
(9) Suppose the economy were in long run equilibrium at point C, at the natural
rate of output, when the price of oil increases substantially. The (aggregate demand
curve, short run aggregate supply curve, long run aggregate supply curve)
__________________ (shifts to the right, shifts to the left) -____________________. In the
new short run equilibrium, prices are (higher, lower, unchanged) ___________ and
real GDP is (higher, lower, the same) ____________ than the natural rate at point (A,
B, C, D) _____.
(10) Suppose that instead of doing nothing, the government decides to reduce taxes
and or increase spending. Consumption will (increase, decrease) ____________ and
the (aggregate demand curve, short run aggregate supply curve, long run
aggregate supply curve) _______________________ (does not change, shifts to the
right, shifts to the left) ________________. In the new long run equilibrium, prices are
(higher, lower, unchanged) ___________ and real GDP is (higher, lower, the same)
_____________ at point (A, B, C, D) _____.
MS

r2
r1

P2
P1

MD
2

AD
MD
1

Y2

Y1

(11) Suppose the price level rises from P1 to P2. As a result, the (demand, supply)
_________________for money (increases, decreases) ___________________ and the
money (demand, supply) _______________curve shifts to the (right, left) ____________.
Interest rates (rise, fall) _________ and the quantity demanded for goods and
services (increases, decreases) _____________ from (Y1, Y2) ______to (Y1, Y2) _______.
(12) Suppose the price level falls from P2 to P1. As a result, the (demand, supply)
_________________for money (increases, decreases) ________________ and the money
(demand, supply) _______________curve shifts to the (right, left) _____________.

Interest rates (rise, fall) _______ and the quantity demanded for good and services
(increases, decreases) _____________ from (Y1, Y2) ______ to (Y1, Y2) ________.

(13) Suppose the Central Bank buys government securities from the public.
Consequently, the (demand, supply) ________________ of money (increases,
decreases) ___________________and the (demand supply) ________________ curve of
money shifts to the (right, left )____________. Interest rates (increase, decrease)
__________________and households (increase, decrease) ________________consumption
while firms (increase decrease) _____________investments. The quantity demanded
for goods and services (increases, decreases) _________________and the aggregate
demand curve shifts to the(left, right) __________ .
(14) Suppose the Central Bank sells government securities to the public. As a result
the (demand, supply) ____________of money (increases, decreases) _________________
and the (demand supply) ___________ curve of money shifts to the (right, left)
________. Interest rates (increase, decrease) _______________and household
consumption (increases, decreases) ______________while firms (increase, decrease)
_______________investments. The quantity demanded for goods and services
(increases, decreases) ______________and the aggregate demand curve shifts to the
(right, left_________.
(15) Suppose the MPC = .8 and government spending increases by $20 billion.
Assuming there is no crowding-out effect, this will cause aggregate demand to
increase by __________________. The multiplier is equal to _________. What if there is a
crowding-out effect equal to $60 billion. Aggregate demand will increase by
______________.

MS

r2
r1

MD
2

AD

AD3

MD
1

AD 1

Y
16) Suppose the government were to increase its purchases of goods and services
so that the aggregate demand curve shifts from AD1 to AD2. The resulting increase
in income increases the (demand, supply) __________ for money. As a result, the
money (demand, supply) _________ curve shifts to the (left, right) ________ and
interest rates (rise, fall) ______. Consumption and investment (decreases, increases)
___________ and the aggregate demand curve shifts to the (left, right) ___________.