Exam 6 Sample Questions 1 Using the graphs for the money market the demand for investment curve and the aggregate expenditure curve derive the aggregate demand AD curve 2 Why is the aggregate demand curve downward sloping 3 Derive the long run aggregate supply curve 1 0 version of macroeconomic model AS with a constant level of labor 4 Using the same model from above why will increases in capital lead to an increase in aggregate output 5 Using the same model from above why will changes in aggregate demand have no effect on aggregate output in this macro economy 6 Derive the short run aggregate supply curve version 1 1 macroeconomic model AS with changes in labor due to wage changes 7 Why will a decline in the aggregate demand in this macro economy cause a recession 8 What is the interest rate effect and why does it cause a change in consumption 9 Why are some firms so slow to adjust wages Why are adjusting wages downward so difficult 10 Why does a decrease in investment cause an initial decrease in aggregate output but eventually lower prices and wages bring us back to the long run aggregate supply curve 1 Exam 6 Sample Question Answers 2 The aggregate demand curve is downward sloping because as prices increase we will see autonomous consumption decrease because the household s relative income has decreased The relative income has decreased because households can purchase fewer goods than they previously could with the same level of income due to increased prices We will also see exports decrease because domestic goods are now more expensive to foreign markets Imports will increase because foreign goods are now relatively cheaper than they were before the price change Increased imports and decreased exports means that net exports NX will decrease Decreases in autonomous consumption and net exports will shift our aggregate expenditure curve down causing equilibrium income to decrease So we can see that as prices increase equilibrium income decreases causing the downward slope in our aggregate demand curve 3 4 A constant supply of labor will give us the vertical labor supply curve in the labor market graph in the bottom right graph Because of this vertical labor supply curve any changes in the labor demand curve that may arise out of changes in price levels will lead only to higher wages and no change in equilibrium labor in this market so we will always be producing at the same level given constant labor and capital If either of those changes we will see the LRAS shift If capital increases we will see the LRAS shift out and if labor supply increases then we will see the LRAS shift out as well If there is an increase in capital we will see out production function the upper right graph stretch vertically away from the x axis so that the same level of labor will be able to produce more than it previously could This in turn means that the aggregate output will be increased shifting out the LRAS curve to the right but it will still be vertical as it was before The opposite will occur if capital is somehow decreased NOTE We will see the LRAS curve shift out to the right as well if labor supply is increased because we will now be producing higher up on our production function increasing aggregate output and shifting out the LRAS The opposite would occur if the labor supply is decreased 5 Because the LRAS curve is a vertical curve shifts in the AD curve will move up and down the LRAS curve increasing and decreasing the price level in the economy We will see no changes in the aggregate output as a result of changes solely in AD curve because of the vertical LRAS curve in this model 6 7 We can see now that because the labor supply curve is no longer vertical but is upward sloping because we assume that as wages increase more people will want to work people will want to work more that changes in the price level will lead to not only increased wages but also increased levels of labor As this level of labor increases be produce at different points on the production function causing the aggregate output AKA equilibrium income to change These changes cause us to have an upward sloping short run aggregate supply curve meaning that as price level increase firms will increase their output If aggregate demand were to decrease for whatever reason it would shift down to the somewhere like the red dot that coincides with the point Y 2 P2 At this point the equilibrium in the aggregate demand and aggregate supply would be lower As a result we would see decreased price levels as a well as a decreased aggregate output Because we have seen aggregate output decrease negative output growth this macro economy is experiencing a recession NOTE If we were to see an increase in the aggregate demand the opposite would occur and there would be an increase in aggregate output which is as we know the period of the business cycle that is referred to as an expansion 8 Interest rates change as a result in the price level increased price level or inflation will lead to increased interest rates As interest rates increase we will see a drop in investment and consumer borrowing for consumption of durable goods which will decrease consumption These drops will lead to decreases in our aggregate expenditure and consumption 9 Firms are slow to adjust wages during periods of recession because the decrease in the demand for labor puts downward pressure on wages so that they either remain stagnant or grow at a rate slower than the laborers were seeing before the recession Also increasing wages causes firm s profits to decrease because increased wages cause increased costs and lowered profits These lowered profits decrease productivity and output hurting the well being of the firm Wages are especially hard to adjust downwards for a number of reasons including the fact the laborers may be a part of a labor union the firms don t want the negative publicity of decreased wages employees may not accept decreased wages and if wages are decreased worker morale and productivity would likely take a hit which could then affect the production and efficiency of the firm 10 For this question it is easiest to watch Dr Becker s video because for me to graph everything out it would get extremely confusing When we see a decrease in investment the AD curve will shift down so when you see the AD curve shift in his video know that it is due to changes in investment for our purposes in answering this question The video can be found here http www