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Chapter 23: Q 9. (page 617)

If large budget deficits cause the public to think there will be higher inflation in the future, what is likely to happen to the short-run aggregate supply curve when budget deficits rise?

Short Answer

Expert verified

The short-run aggregate supply curve will shift upward when there is budget deficit.

Step by step solution

01

Step 1. Define aggregate supply.

Aggregate supply, often known as total production, is the total amount of products and services in a given economy over a certain time period at a given overall price.

02

Step 2. What is likely to happen to the short-run aggregate supply curve if big budget deficits encourage the public to believe that inflation will rise in the future?

When there is a budget deficit and expected inflation rises, the short-run aggregate supply curve swings upward. Inflation rises at every level of output because firms and households expect the Fed to pursue policies that cause it to do so. They will want to raise wages and prices by this amount because they do not want their real wages to fall, which accounts for inflation and is measured in the quantity of goods and services that money can buy.

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Most popular questions from this chapter

Suppose the inflation rate remains relatively constant while output decreases and the unemployment rate increases. Using an aggregate demand and supply graph, show how this scenario is possible.

The Problems update with real-time data in My Lab Economics and are available for practice or instructor assignment.

1. Go to the St. Louis Federal Reserve FRED database, and find data on real government spending (GCEC1), real GDP (GDPC1), taxes (WO06RC1 Q 027 SBEA), and the personal consumption expenditure price index (PCECTPI), a measure of the price level. Download all of the data into a spreadsheet, and convert the tax data series into real taxes. To do this, for each quarter, divide taxes by the price index and then multiply by 100 .

a. Calculate the level change in real GDP over the four most recent quarters of data available and the four quarters prior to that.

b. Calculate the level change in real government spending and real taxes over the four most recent quarters of data available and the four quarters prior to that.

c. Are your results consistent with what you would expect? How do your answers to part (b) help explain, if at all, your answer to part (a)? Explain using the IS and A D curves.

Explain why the aggregate demand curve slopes downward and the short-run aggregate supply curve slopes upward.

Are there any “good” supply shocks? Explain.

Classify each of the following as a supply shock or a demand shock. Use a graph to show the effects on inflation and output in the short run and in the long run.

a. Financial frictions increase.

b. Households and firms become more optimistic about the economy.

c. Favorable weather produces a record crop of wheat and corn in the Midwest.

d. Auto workers go on strike for four months.
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