Macroeconomics • Answer Key • Chapter Five

Chapter Five: Aggregate Demand and Supply

Answers Test Your Understanding Questions

1. GDP gap is $45 billion (cyclical unemployment of 3% × 2.5 × $600 billion)

Potential GDP is $645 billion (actual GDP of $600 + GDP gap of $45)

2. a) If the price increases by 10 percent to 88, then real GDP will increase from $1000 to
$1300 which is a growth rate of 30% ($300/$1000).
b) If the price increases by 10 percent to 110, then real GDP will increase from $1450
to $1500 which is a growth rate of 3.4% ($50/$1450).

3. Consumption, investment and net exports would all rise because of the real-balances
effect, the interest-rate effect, and the foreign-trade effect respectively.

4. a) Price level: 100; GDP: $1100.

b) Shortage of $125.
(At a price level of 95, aggregate quantity demanded exceeds the aggregate quantity
supplied by this much).

Surplus of $270.
(At a price level of 115, aggregate quantity supplied exceeds the aggregate quantity
demand by this much.)

5. a) inflationary gap of $100; b) recessionary gap of $100; c) recessionary gap of

$200;

6. a) AD; b) AD; c) AD; d) AD; e) AD

7. a) AS; b) AS and potential GDP; c) AS and potential GDP;

d) AS; e) AS and potential GDP

Sayre/Morris, Principles of Macroeconomics

9th Edition ©McGraw-Hill Education, 2018

Sayre/Morris, Principles of Macroeconomics

9th Edition ©McGraw-Hill Education, 2018
5-1
 Macroeconomics • Answer Key • Chapter Five

8. See following figure:

9. a) Price level: 105; GDP: $1800.

b) Price level: 95; GDP: $1700.

10. a) Price level: 110; GDP: $1500.

This is full-employment equilibrium.

b) Price level: 100; GDP: $1600; recessionary gap of $200.

This is because the improvement in productivity will increase both the aggregate
supply and potential GDP. The new potential GDP is $1800 and the new
equilibrium GDP is $200 below this.

11. a) Both nominal GDP and real GDP will increase according to the Keynesians
since the economy was at less that full employment to start with.

b) Nominal GDP will increase but real GDP will not according to the Neoclassicists
since they assume that the economy must have been at full employment equilibrium
to start with.

12. a) The new intersection is now at: GDP = $800; P = 95.

b) The new intersection is now at: GDP = $1100; P = 110.

It’s News to Me

I. d II. b

Sayre/Morris, Principles of Macroeconomics

9th Edition ©McGraw-Hill Education, 2018
5-2
 Macroeconomics • Answer Key • Chapter Five

Answers to Study Problems

1. $504 billion. The GDP gap is equal to cyclical unemployment of 2% × 2.5 × actual
GDP of $480 = $24 billion. Potential GDP (LAS) is equal to actual GDP of $480 +
GDP gap of $24 = $504

2. a) Real GDP: $1000; price level: 100; There is no gap. (Actual GDP is the same
as potential GDP (LAS)).

b) See the following table:

TABLE 5.7 (Completed)

Aggregate Aggregate Price Index Aggregate

Quantity Quantity Quantity
Demanded 1 Demanded 2 Supplied
$1080 $1145 96 $880
1060 1125 97 940
1040 1105 98 965
1020 1085 99 985
1000 1065 100 1000
980 1045 101 1015
960 1025 102 1025
940 1005 103 1033
920 985 104 1040
900 965 105 1045

c) Real GDP: $1025; price level: 102; (This is where the aggregate quantity
demanded 2 equals the aggregate supply.)

d) There is an inflationary gap of $25 (Actual GDP of 1025 is $25 greater than
potential GDP (LAS) of 1000).

3. The real wage has increased by $1 from $15 (18/120 × 100) to $16 (20.8/130 × 100).

Sayre/Morris, Principles of Macroeconomics

9th Edition ©McGraw-Hill Education, 2018
5-3
 Macroeconomics • Answer Key • Chapter Five

4. a) Inflationary gap of $100. (Actual GDP ($600) exceeds Potential GDP (LAS
of $500) by $100.

b) Recessionary gap of $100. (Potential GDP (LAS of $700) exceeds actual GDP
($600) by $100.

c) Recessionary gap of $300. (Potential GDP (LAS of $900) exceeds actual GDP
($600) by $100.

5. a) 30%. Real GDP increases from 500 to 650 so the growth rate is +150/500 × 100 =
30%.

b) 7.7%. Real GDP increases from 650 to 700 so the growth rate is +50/650 × 100
= 7.7%.

6. a) $20; (This is the difference between potential GDP (LAS) of $420 and equilibrium
GDP of $400.)

b) 5 percent (20/400 × 100);

c) Since the GDP gap is 2 ½ times the amount of cyclical unemployment, the latter
must equal 2% (5/2.5). Therefore the unemployment rate must be 8 percent (natural
rate of 6% plus cyclical unemployment of 2%).

7. a) See the following figure:

Figure 5.27 (Completed)

Sayre/Morris, Principles of Macroeconomics

9th Edition ©McGraw-Hill Education, 2018
5-4
 Macroeconomics • Answer Key • Chapter Five

b) Price 90; Real GDP $750. (Where AD and AS intersect.)

c) Recessionary gap of $50. (Potential GDP (LAS) of $800 exceeds equilibrium

GDP of $750 by this amount.

d) See Figure 5.27 (Completed)

e) Price 110; Real GDP $850. (Where the AD2 and AS intersect.)

f) Inflationary gap of $50. (Equilibrium GDP of $850 exceeds LAS of $800 by

this amount.

8.
last year this year
real GDP (output) $160 (168/105 × 100) $200 (220/110 × 100)
employment (inputs) 20 23.5
productivity $8 ($160/20) $8.5 ($200/23.5)

Therefore productivity increased by 6.25% (+0.5/8 × 100)

9. a) neoclassical supply: Aggregate Quantity Supplied 1

Keynesian supply: Aggregate Quantity Supplied 2

b) price: 80; real GDP: $800.

c) price: 100; real GDP: $600.

d) price: 95; real GDP: $800.(real GDP would not be affected by a change in
AD but the price level would increase).

e) price: 100; real GDP: $750. (the price level would not be affected by a
change in AD but real GDP would increase.)

10. a) $21.82 ($24/110 × 100); i.e. real wage = nominal wage/price index × 100
b) See the following figure:

Sayre/Morris, Principles of Macroeconomics

9th Edition ©McGraw-Hill Education, 2018
5-5
 Macroeconomics • Answer Key • Chapter Five

Figure 5.27 (Completed)

c) $20.00 ($24/120 × 100);

d) See Figure 5.27 (completed)

e) $21.82 (at full-employment the real wage is the same as it was originally in a).

f) $28.37 (nominal wage = real wage (21.82) × price index (130) ÷100)

Sayre/Morris, Principles of Macroeconomics

9th Edition ©McGraw-Hill Education, 2018
5-6