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Chapter 12: Q8. (page 258)

In early 2001 investment spending sharply declined in the United States. In the 2 months following the September 11, 2001 attacks on the United States, consumption also declined. Use AD-AS analysis to show the two impacts on real GDP.

Short Answer

Expert verified

The two impacts on real GDP using AD-AS analysis is shown below:

Step by step solution

01

Explanation

As the investment spending declines sharply in the United States, the AD curve will shift downward, as investment spending is a component of the AD curve. After the attacks on the United States, the consumption fell; thus, the AD curve again fell and shifted leftward. The two impacts will lead to a decrease in real output and a fall in the price level.

Initially, with the fall in investment spending, the AD curve falls from AD1 to AD2; after the fall in consumption, the AD curve falls further from AD2 to AD3. The price level falls from P1 to P3, and quantity falls from Q1 to Q3.

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Most popular questions from this chapter

What effects would each of the following have on aggregate demand or aggregate supply, other things equal? In each case, use a diagram to show the expected effects on the equilibrium price level and the level of real output, assuming that the price level is flexible both upward and downward.

  1. A widespread fear by consumers of an impending economic depression.

  2. A new national tax on producers based on the value added between the costs of the inputs and the revenue received from their output.

  3. A reduction in interest rates.

  4. A major increase in spending for health care by the federal government.

  5. The general expectation of coming rapid inflation.

  6. The complete disintegration of OPEC, causing oil prices to fall by one-half.

  7. A 10 percent across-the-board reduction in personal income tax rates.

  8. A sizable increase in labor productivity (with no change in nominal wages).

  9. A 12 percent increase in nominal wages (with no change in productivity).

  10. An increase in exports that exceeds an increase in imports (not due to tariffs).

Suppose that the aggregate demand and aggregate supply schedules for a hypothetical economy are as shown in the following table.

Amount of Real GDP Demanded, BillionsPrice Level (Price Index)Amount of Real GDP Supplied, Billions
\(100300450
200250400
300200300
400150200
500100100

a. Use the data above to graph the aggregate demand and aggregate supply curves. What are the equilibrium price level and the equilibrium level of real output in this hypothetical economy? Is the equilibrium real output also necessarily the full-employment real output?

b. If the price level in this economy is 150, will quantity demanded equal, exceed, or fall short of the quantity supplied? By what amount? If the price level is 250, will the quantity demanded equal, exceed, or fall short of the quantity supplied? By what amount?

c. Suppose that buyers desire to purchase \)200 billion of extra real output at each price level. Sketch in the new aggregate demand curve as AD1. What are the new equilibrium price level and level of real output?

Use shifts of the AD and AS curves to explain (a) the U.S. experience of strong economic growth, full employment, and price stability in the late 1990s and early 2000s and (b) how a strong negative wealth effect from, say, a precipitous drop in house prices could cause a recession even though productivity is surging.

Explain how an upsloping aggregate supply curve weakens the realized multiplier effect from an initial change in investment spending.

What assumptions cause the immediate-short-run aggregate supply curve to be horizontal? Why is the long-run aggregate supply curve vertical? Explain the shape of the short-run aggregate supply curve. Why is the short-run curve relatively flat to the left of the full-employment output and relatively steep to the right?
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