Economics 12th Edition Arnold Solutions Manual

Economics 12th Edition Arnold
Solutions Manual
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CHAPTER 9
Classical Macroeconomics and the Self-Regulating
Economy
This chapter uses the aggregate demand-aggregate supply model developed in Chapter 8 to
describe the three possible states of an economy (: recessionary gap, inflationary gap, and
long-run equilibrium.), and It analyzes the concept of the a self-regulating economy, developed
by the classical economists and advocated by some modern economists.
◼ KEY IDEAS
1. Although classical economists lived and wrote many years ago, their ideas are often
employed by some modern economists.
2. There are three possible states of an economy (: recessionary gap, inflationary gap, and
long-run equilibrium).
3. The concept of a self-regulating economy was developed by the classical economists
and is advocated by some modern economists.
4. Business-cycle and economic-growth macroeconomics compose two categories of
macroeconomics.
◼ CHAPTER OUTLINE
I. THE CLASSICAL VIEW
Although classical economists lived and wrote many years ago, their ideas are often
A. Classical Economists and Say’s Law
Classical economists believed that there could never be a general surplus of

goods and services in the economy because they believed in Say’s law. Say’s
law says states that production creates demand sufficient to purchase all goods
and services produced. If Say’s law is valid, then people will spend enough to
buy all of the goods and services produced.
Even if people will save part of their income, interest rate flexibility will ensure
that the money saved by consumers will be spent on investment goods by firms.
II. CLASSICAL ECONOMISTS AND INTEREST RATE FLEXIBILITY Formatted: Heading 3

B. Classical Economists and Interest Rate Flexibility
According to classical economists, Say’s law holds both in a barter economy and
in a money economy since interest rates will adjust to equate saving and
155
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Rights Reserved. May not be scanned, copied or duplicated,
or posted to a publicly accessible website, in whole or in part.
156 Chapter 9
investment. Therefore, any fall in consumption (and a consequent rise in saving)

will be matched by an equal rise in investment.
A C. Classical Economists on Prices and Wages: Both are Flexible
Classical economists believed that most, if not all, markets are competitive, so
that wage rates and prices in the goods and services market will adjust quickly to
any surpluses or shortages and equilibrium will be quickly reestablished.
III.II. T THREE STATES OF THE ECONOMY
This section provides the background information essential to understanding the views
of economists who believe that the economy is self-regulating.
A. Real GDP and Natural Real GDP: Three Possibilities
The three possible states of an economy are (1) Real GDP is less than Natural
Real GDP; (2) Real GDP is greater than Natural Real GDP; and (3) Real GDP is
equal to Natural Real GDP.
A recessionary gap occurs if Real GDP is less than Natural Real GDP. An
inflationary gap occurs if Real GDP is greater than Natural Real GDP. The
economy is in Llong-Rrun Eequilibrium if Real GDP is equal to Natural Real
GDP.
B. The Labor Market and the Three States of the Economy
If the economy is in a recessionary gap, the unemployment rate is higher than

the natural unemployment rate and a surplus exists in the labor market. If the
economy is in an inflationary gap, the unemployment rate is lower than the
natural unemployment rate and a shortage exists in the labor market. If the
economy is in long-run equilibrium, the unemployment rate is equal to the natural
unemployment rate and the labor market is in equilibrium.
C. Common Misconceptions About the Unemployment Rate and the Natural

Unemployment Rate
The A physical PPF shows the different output combinations that can be
produced given the physical constraints of finite resources and the current state
of technology, while the an institutional PPF shows the different output
combinations that can be produced given the physical constraints of finite
resources, and the current state of technology, and any institutional constraints.
The institutional PPF is associated with the natural unemployment rate. When
the economy is operating beyond its institutional PPF (but below its physical
PPF), the unemployment rate will be lower than the natural rate.
IVIII. THE SELF-REGULATING ECONOMY
Classical Macroeconomics and the Self-Regulating Economy 157
The concept of a self-regulating economy was developed by the classical economists

A. What Happens If a Self-Regulating Economy Is in a Recessionary Gap?
If a recessionary gap exists, then the labor market will be in disequilibrium.: at At

the current wage rate there is a surplus of labor. This surplus will drive down
wage rates. At lower wage rates, firms will find it profitable to hire more workers
and produce more output. The short-run aggregate supply (SRAS) curve shifts to
the right, until the recessionary gap is eliminated.
B. What Happens If the Economy Is in an Inflationary Gap?
If an inflationary gap exists, then the labor market will be in disequilibrium.: at At

the current wage rate there is a shortage of labor. This shortage will drive up
wage rates. At higher wage rates, firms will find it necessary to let go of some
workers and produce less output. The SRAS curve shifts to the left, until the
inflationary gap is eliminated.
C. The Self-Regulating Economy: A Recap
Flexible wage rates (and other resource prices) play a critical role in the self-
regulating economy.
D. Policy Implication of Believing That the Economy is Self-Regulating
For economists who believe in a self-regulating economy, full employment is the

norm. This position on how the economy works has led these some economists
to advocate a macroeconomic policy of laissez-faire, or noninterference.
E. Changes in a Self-Regulating Economy: Short Run and Long Run
If the economy is self-regulating, a change in aggregate demand can change the

price level and Real GDP in the short run, but in the long run the only effect is a
change in the price level.
F. A Recap of Classical Macroeconomics and a Self-Regulating Economy
This section recaps the arguments made above.

According to classical macroeconomists in a self-regulating Formatted: Normal, Indent: Left: 1"
economy, Say’s law
holds and interest rate changes to make savings equal to
investment. Prices and
wages are flexible and since the economy is self-regulation,
laissez-faire is the
policy prescription.
G. Business-Cycle Macroeconomics and Economic-Growth Macroeconomics
Business-cycle and economic-growth macroeconomics compose make up two

categories of macroeconomics. Business-cycle macroeconomics deals with
158 Chapter 9
changes in Real GDP (up and down) around a fixed long run aggregate supply
(LRAS) curve, while economic-growth macroeconomics deals with increases in
Real GDP due to a rightward-shifting LRAS curve. Some upcoming chapters will
deal with business-cycle macroeconomics while others will deal with economic-
growth macroeconomics.
◼ TEACHING ADVICE
1. Remind students of the importance of being in equilibrium at Natural Real GDP.; that at
At this level of output, there is no cyclical unemployment (although frictional and
structural unemployment still exist).
2. Recessionary gaps and inflationary gaps occur when spending doesn’tdoes not match
production. It is helpful to show students three graphs with identical LRAS and SRAS
curves. Add an AD curve to the first graph showing “too little” spending in the economy
and point out that this level of spending results in a recessionary gap. Add an AD curve
to the second graph showing “too much” spending in the economy and point out that this
level of spending results in an inflationary gap. Finally, add an AD curve to the third
graph showing “the perfect amount” of spending, and point out that the economy ends
up in long run equilibrium only when the perfect amount of spending occurs. You could
make this a quiz or a homework assignment.
3. Have students compare the U.S.’s actual Real GDP available here:
http://www.bea.gov/iTable/iTable.cfm?ReqID=9&step=1 (Table 1.1.6 under Section 1 -
Domestic Product And Income) with the U.S.’s natural, or potential, Real GDP (available
at http://research.stlouisfed.org/fred2/data/GDPPOT.txt) to determine whether the U.S. is
currently experiencing a recessionary gap, an inflationary gap, or a long-run equilibrium.
◼ ASSIGNMENTS FOR MASTERING KEY IDEAS

Assignment 9.1
Key Idea: Although classical economists lived and wrote many years ago, their ideas are often
1. State Say’s law.
2. Explain why classical economists believed that there could never be a general surplus of
goods and services in the economy.
3. Explain why classical economists believed that Say’s law holds in a money economy.
4. Explain why classical economists believed that wage rates and prices in the goods and
services market adjust quickly.
Assignment 9.2
Key Idea: There are three possible states of an economy.
1. Describe the relationship between Real GDP and Natural Real GDP in the three states
of an economy.
2. Describe the relationship between the unemployment rate and the natural
unemployment rate in the three states of an economy.
3. Explain when labor market shortages and surpluses occur.
4. Explain how the an economy’s unemployment rate can be less than the its natural
unemployment rate.
Assignment 9.3
Key Idea: The concept of a self-regulating economy was developed by the classical economists
1. Describe how a self-regulating economy moves out of a recessionary gap.
2. Describe how a self-regulating economy moves out of an inflationary gap.
3. Describe the implication of believing the an economy is self-regulating.
Assignment 9.4
Key Idea: Business-cycle and economic-growth macroeconomics compose two categories
of macroeconomics.
1. Which category of macroeconomics deals with changes around a fixed LRAS curve and
which category deals with a rightward-shifting LRAS curve?
◼ ANSWERS TO ASSIGNMENTS FOR MASTERING KEY IDEAS

Assignment 9.1 Answers
1. Say’s law says states supply creates its own demand.
2. Classical economists believed that there could never be a general surplus of goods and
services in the economy because production creates demand sufficient to purchase all
goods and services produced.
3. Classical economists believed that Say’s law holds in a money economy because
interest rate flexibility ensures that any fall in consumption will be matched by an equal
rise in investment.
4. Classical economists believed that wage rates and prices in the goods and services
market adjust quickly because they thought that most, if not all, markets are competitive.

1. In a recessionary gap, an economy’s Real GDP is less than its Natural Real GDP. In an
inflationary gap, an economy’s Real GDP is greater than its Natural Real GDP. In long-
run equilibrium, an economy’s Real GDP is equal to its Natural Real GDP.
2. In a recessionary gap, the an economy’s unemployment rate is higher than the its
natural unemployment rate. In an inflationary gap, the an economy’s unemployment rate
is lower than itsthe natural unemployment rate. In long-run equilibrium, the an
economy’s unemployment rate is equal to the its natural unemployment rate.
3. Labor market shortages occur when the an economy is in an inflationary gap. Labor
market surpluses occur when the an economy is in a recessionary gap.
4. The unemployment rate of an economy can be less than the its natural unemployment
rate if the economy is operating beyond its institutional PPF (which is associated with the
natural rate of unemployment).

1. The surplus of labor that occurs during a recessionary gap drives down the wage rate,
shifting the SRAS curve rightward until the recessionary gap disappears.
2. The shortage of labor that occurs during an inflationary gap drives up the wage rate,
shifting the SRAS curve leftward until the inflationary gap disappears.
160 Chapter 9
3. The implication of believing the an economy is self-regulating is an advocacy of laissez

faire (noninterference) macroeconomic policy.

1. Business-cycle macroeconomics deals with changes around a fixed LRAS curve, while
economic-growth macroeconomics deals with rightward-shifting LRAS curve.
◼ ANSWERS TO VIDEO QUESTIONS AND PROBLEMS
1. Explain and diagrammatically represent how a self-regulating economy removes

itself from a recessionary gap.
Formatted: Left
LRAS
SRAS1
SRAS2
Price Level
AD1
m,
0 Q1 QN Real GDP
The economy is in a recessionary gap at point 1. Since there is a surplus in the labor market,
wages fall and the SRAS curve shifts rightward. The economy is in equilibrium at the natural
level of Real GDP at point 2.
2. Explain and diagrammatically represent how a self-regulating economy removes

itself from an inflationary gap.
The economy is in an inflationary gap at point 1. Since there is a shortage in the labor market,
wages rise. The SRAS curve shifts to the left. The economy is in equilibrium at the natural level
of Real GDP at point 2.
3. Flexible wages play a critical role in removing an economy from a recessionary

gap. Do you agree or disagree? Explain your answer.
LRAS
SRAS1
SRAS2
Price Level
AD1
m,
0 Q1 QN Real GDP
In the above figure, the economy is in a recessionary gap at point 1. If there are flexible wages
in the economy, the labor surplus causes wages to decrease and the SRAS curve shifts to the
right. At point 2, the economy is in long-run equilibrium. If wages in the economy are not flexible,
the SRAS curve will not shift and the economy cannot remove itself from the recessionary gap.
4. If the economy is in an inflationary gap, where is it located with respect to both

the institutional PPF and the physical PPF?
162 Chapter 9
At point D, above the institutional PPF.When an economy is in an inflationary gap, it may Formatted: Indent: First line: 0"
be located at a point like D. Point D is located beyond the institutional PPF of the
economy but below the physical PPF. An economy can never operate beyond its
physical PPF but can operate beyond its institutional PPF because institutional
constraints are not always equally effective.
Formatted: Indent: Left: 0", First line: 0"

5. Formatted: Indent: Left: 0", First line: 0"
5. Explain the classical view of the credit market.
In the classical theory, the interest rate is flexible and adjusts so that saving equals investment.
If saving increases and the saving curve shifts rightward from S1 to S2 (arrow 1), the increase in
saving causes the interest rate to fall from i1 to i2 (arrow 2). A new equilibrium is established at
E2 (arrow 3), where the amount households save equals the amount firms invest.
◼ ANSWERS TO CHAPTER QUESTIONS AND PROBLEMS

1. What is the classical economics position with respect to (a) wages, (b) prices, and
(c) interest rates?
All three are considered by classical economics to be flexible both upward and downward, and
to be are determined by the interaction of supply and demand in their respective markets,
leading to a position of equilibrium.
2. According to classical economists, does Say’s Law hold in a money economy?

Explain your answer.
The classical position is that Say’s law holds in a money economy, since interest rate flexibility
ensures that money saved will reappear in the spending stream as investment.
3. How do you explain why investment falls as the interest rate rises?
The interest rate is the cost of borrowing funds. The higher is the cost of borrowing funds is, the
lower will be the fewer funds that firms will borrow and invest.
4. Explain why saving rises as the interest rate rises.
The higher is the interest rate, the higher is the reward for saving (or the higher is the
opportunity cost of consumingconsumption), and therefore, fewer funds are allocated to
consumption and the more funds are saved.
5. According to classical economists, does an increase in saving shift the AD curve

to the left? Explain your answer.
No, because the increase in savings (and the resulting decrease in consumption) will be exactly
offset by an increase in investment created when the additional savings forces interest rates
down.
6. What does it mean to say that the economy is in a recessionary gap? In an

inflationary gap? In long-run equilibrium?
In a recessionary gap, Real GDP < Natural Real GDP. In an inflationary gap, Real GDP >
Natural Real GDP. When Real GDP = Natural Real GDP, the economy is said to be in long-run
equilibrium.
7. What is the state of the labor market in (a) a recessionary gap, (b) an inflationary
gap, (c) long-run equilibrium?
(a) There is a labor market surplusA surplus exists in the labor market.
(b) There is a labor market shortageA shortage exists in the labor market.
(c) The labor market is in equilibrium.
164 Chapter 9
8. Describe the relationship of the (actual) unemployment rate to the natural

unemployment rate in each of the following economic states: (a) a recessionary
gap, (b) an inflationary gap, and (c) long-run equilibrium.
In a recessionary gap, the actual unemployment rate is greater than the natural unemployment
rate; in an inflationary gap, the actual unemployment rate is less than the natural unemployment
rate; and in long-run equilibrium, the actual unemployment rate equals the natural
unemployment rate.
9. Diagrammatically represent an economy in (a) an inflationary gap, (b) a

recessionary gap, and (c) long-run equilibrium.
These three situations are illustrated in the text in Exhibit 3.
10. Explain how the economy can operate beyond its institutional PPF but not beyond
its physical PPF.
The institutional PPF includes institutionally or /government-imposed restrictions on economic

activity, such as the minimum wage. Because Since the minimum wage reduces economic
efficiency, it could prevent the economy from operating on its physical PPF.; Hhowever, inflation
could reduce the real minimum wage, allowing the economy to move closer to its physical PPF.
Since the physical PPF is determined by the nation’s resource endowment and technology, the
economy could not operate beyond the physical PPF.
11. According to economists who believe in a self-regulating economy, what

happens—step by step—when the economy is in a recessionary gap? What
happens when the economy is in an inflationary gap?
According to economists who believe in a self-regulating economy, if the economy is in a

recessionary gap, it will move back to its long-run equilibrium without any intervention by the
government. In a recessionary gap, excess unemployment exists. This will causes wages to fall,
and the SRAS curve to will shift to the right. The economy, moving moves along the AD curve
until the economyit returns to its long-run equilibrium. In an inflationary gap, unemployment is
below its natural rate, creating wage inflation. This shifts the SRAS curve to the left. The
economy, moving moves along the AD curve until the it economy returns to its long-run
equilibrium.
12. If wage rates are not flexible, can the economy be self-regulating? Explain your
answer.
Flexible wages are an essential assumption of the self-regulating economy. Without flexible
wages, the SRAS curve would not shift in response to an inflationary gap or a recessionary gap.
Without this flexibility, the economy could not move back to its long-run equilibrium, and the
economy would not be self-regulating.
13. Explain the importance of the real balance, interest rate, and international trade
effects to long-run (equilibrium) adjustment in the economy.
The real balance, interest rate, and international trade effects explain the downward slope of the
AD curve. Each reflects how aggregate demand responds to a change in prices. For example,
an increase in prices reduces the purchasing power of consumers’ bank accounts and other
cash-related assets. Consequently, an increase in prices would reduce aggregate demand.
When the SRAS curve shifts, the price level will adjust upward or downward, and to keep the
economy in equilibrium, the real balance, interest rate, and international trade effects allow the
economy to move along the AD curve to the new equilibrium.
14. Suppose that the economy is self-regulating, that the price level is 132, that the
quantity demanded of Real GDP is $4 trillion, that the quantity supplied of Real
GDP in the short run is $3.9 trillion, and that the quantity supplied of Real GDP in
the long run is $4.3 trillion. Is the economy in short-run equilibrium? Will the price
level in long-run equilibrium be greater than, less than, or equal to 132? Explain
your answers.
Formatted: Left
Formatted: Left
Formatted: Font: (Default) Calibri, Font color: Black,
Formatted: Left, Don't adjust space between Latin and
Asian text, Don't adjust space between Asian text and
166 Chapter 9
An economy is in short-run equilibrium when aggregate demand equals short-run aggregate

supply. In this examplethe above figure, aggregate demand ($4,000 billiontrillion) is greater than
short-run aggregate supply ($3.,900 billiontrillion). The economy is not in short-run equilibrium.
At the short run equilibrium (point A), a recessionary gap exists. As labor surpluses at point A
drive wage rates down, the SRAS curve will shift rightward to SRAS’. In long-run equilibrium (at
Point B), the price level would be less than 132.
15. Suppose that the economy is self-regulating, that the price level is 110, that the
quantity demanded of Real GDP is $4 trillion, that the quantity supplied of Real
GDP in the short run is $4.9 trillion, and that the quantity supplied of Real GDP in
the long run is $4.1 trillion. Is the economy in short-run equilibrium? Will the price
level in long-run equilibrium be greater than, less than, or equal to 110? Explain
your answers.
Formatted: Left
As shown in the above figure, in the short run, aggregate demand ($4 trillion) is less than short-
run aggregate supply ($4.9 trillion), so the economy is not in short-run equilibrium. At the short
run equilibrium (point A), an inflationary gap exists. As labor shortages at point A drive wage
rates up, the SRAS curve will shift rightward to SRAS’. In long-run equilibrium, the price level
would be less than 100.
16. Yvonne is telling her friend Wendy that wages are rising but that so is the
unemployment rate. She tells Wendy that she (Yvonne) may be the next person to
be fired at her company and that she may have to move back in with her parents.
What does the economy have to do with Yvonne possibly having to move back in
with her parents?
When wages are rising and the unemployment rate is rising, too, the economy is self-regulating
and removing itself from an inflationary gap. Some people will become unemployed as the
economy stabilizes itself at the natural unemployment rate. If Yvonne is one of these people,
she may have to move back in with her parents for a while.
17. Jim says, “I think it’s a little like when you have a cold or the flu. You don’t need to
see a doctor. In time your body heals itself. That’s sort of the way the economy
works too. We don’t really need government coming to our rescue every time the
economy gets a cold.” According to Jim, how does the economy work?
Jim believes the economy is self-regulating and will heal itself. The economy will move itself out
of either an inflationary gap or a recessionary gap and will settle down (eventually) in long-run
equilibrium at the natural unemployment rate and Natural Real GDP.
18. Beginning in long-run equilibrium, explain what happens to the price level and
Real GDP in the short run and in the long run as a result of (a) a decline in AD, (b)
a rise in AD, (c) a decline in SRAS, (d) a rise in SRAS.
168 Chapter 9
(a) The price level and Real GDP will fall in the short run; the price level will fall further in the
long run while Real GDP will rise to its initial level in the long run.
(b) The price level and Real GDP will rise in the short run; the price level will rise further in the
long run while Real GDP will fall to its initial level in the long run.
(c) The price level will rise and Real GDP will fall in the short run; the price level will be higher in
the long run, but Real GDP will return to its initial level.
(d) The price level will fall and Real GDP will rise in the short run; the price level will be lower in
the long run, but Real GDP will return to its initial level.
◼ ANSWERS TO PROBLEMS IN THE WORKING WITH NUMBERS AND

GRAPHS SECTION
1. In the following figure, which point is representative of: (a) the economy on its
LRAS curve, (b) the economy in a recessionary gap, and (c) the economy in an Formatted: Font: Italic
inflationary gap?
Formatted: Indent: Left: 0", First line: 0"

Formatted: Centered
(a) Point B
(b) Point D
(c) Point C
2. In the following figure, which of partsWhich of the following figures, (a)-(c), is

consistent with or representative of: (a) the economy operating at the natural
unemployment rate, (b) a surplus in the labor market, (c) a recessionary gap, and
(d) a cyclical unemployment rate of zero.
(a) Part (c)

(b) Part (a)
(c) Part (a)
(d) Part (c)
3. Diagrammatically represent the followingRepresent the following situations

diagrammatically: (a) Aan economy in which AD increases as it is the economy is
self-regulating out of a recessionary gap, and (b) anAn economy in which AD
decreases as it is the economy is self-regulating out of an inflationary gap.
4. Economist Jones believes that there is always sufficient (aggregate) demand in

the economy to buy all the goods and services supplied at full employment.
Diagrammatically represent what the economy looks like for Jones.
170 Chapter 9
The economy would always be at Natural Real GDP, where LRAS equals SRAS.
5. Diagrammatically show what happens when the institutional constraints in the

economy become less effective.
In the figure, the institutional PPF shifts outward toward the physical PPF, in this case from
PPF1 to PPF2.
6. Diagrammatically represent an economy in a recessionary gap. Next, identify

where the economy in a recessionary gap lies in terms of both the institutional
and physical PPFs.
LRAS Physical PPF

SRAS
All Other Goods
Institutional PPF
Price Level
AD1
0 Q1 QN Real GDP 0 Real GDP
Recessionary Gap Good X
(a) (b)
In figure (a), the economy is producing a level of Real GDP in the short run that is less than its
Natural Real GDP level. When the Real GDP that the economy is producing is less than its
Natural Real GDP, the economy is said to be in a recessionary gap. In figure (b), point A, below
the institutional PPF, represents an economy in a recessionary gap, where the economy is
producing less than Natural Real GDP, QN.

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Economics 12th Edition Arnold

A. Classical Economists and Say’s Law

Classical economists believed that there could never be a general surplus of

II. CLASSICAL ECONOMISTS AND INTEREST RATE FLEXIBILITY Formatted: Heading 3

investment. Therefore, any fall in consumption (and a consequent rise in saving)

A C. Classical Economists on Prices and Wages: Both are Flexible

III.II. T THREE STATES OF THE ECONOMY

A. Real GDP and Natural Real GDP: Three Possibilities

B. The Labor Market and the Three States of the Economy

If the economy is in a recessionary gap, the unemployment rate is higher than

C. Common Misconceptions About the Unemployment Rate and the Natural

IVIII. THE SELF-REGULATING ECONOMY

The concept of a self-regulating economy was developed by the classical economists

A. What Happens If a Self-Regulating Economy Is in a Recessionary Gap?

If a recessionary gap exists, then the labor market will be in disequilibrium.: at At

B. What Happens If the Economy Is in an Inflationary Gap?

If an inflationary gap exists, then the labor market will be in disequilibrium.: at At

C. The Self-Regulating Economy: A Recap

D. Policy Implication of Believing That the Economy is Self-Regulating

For economists who believe in a self-regulating economy, full employment is the

E. Changes in a Self-Regulating Economy: Short Run and Long Run

If the economy is self-regulating, a change in aggregate demand can change the

F. A Recap of Classical Macroeconomics and a Self-Regulating Economy

This section recaps the arguments made above.

G. Business-Cycle Macroeconomics and Economic-Growth Macroeconomics

Business-cycle and economic-growth macroeconomics compose make up two

◼ ASSIGNMENTS FOR MASTERING KEY IDEAS

◼ ANSWERS TO ASSIGNMENTS FOR MASTERING KEY IDEAS

Assignment 9.2 Answers

Assignment 9.3 Answers

3. The implication of believing the an economy is self-regulating is an advocacy of laissez

Assignment 9.4 Answers

◼ ANSWERS TO VIDEO QUESTIONS AND PROBLEMS

1. Explain and diagrammatically represent how a self-regulating economy removes

2. Explain and diagrammatically represent how a self-regulating economy removes

3. Flexible wages play a critical role in removing an economy from a recessionary

4. If the economy is in an inflationary gap, where is it located with respect to both

Formatted: Indent: Left: 0", First line: 0"

5. Explain the classical view of the credit market.

◼ ANSWERS TO CHAPTER QUESTIONS AND PROBLEMS

2. According to classical economists, does Say’s Law hold in a money economy?

4. Explain why saving rises as the interest rate rises.

5. According to classical economists, does an increase in saving shift the AD curve

6. What does it mean to say that the economy is in a recessionary gap? In an

8. Describe the relationship of the (actual) unemployment rate to the natural

9. Diagrammatically represent an economy in (a) an inflationary gap, (b) a

These three situations are illustrated in the text in Exhibit 3.

The institutional PPF includes institutionally or /government-imposed restrictions on economic

11. According to economists who believe in a self-regulating economy, what

According to economists who believe in a self-regulating economy, if the economy is in a

An economy is in short-run equilibrium when aggregate demand equals short-run aggregate

◼ ANSWERS TO PROBLEMS IN THE WORKING WITH NUMBERS AND

Formatted: Indent: Left: 0", First line: 0"

2. In the following figure, which of partsWhich of the following figures, (a)-(c), is

(a) Part (c)

3. Diagrammatically represent the followingRepresent the following situations

4. Economist Jones believes that there is always sufficient (aggregate) demand in

5. Diagrammatically show what happens when the institutional constraints in the

6. Diagrammatically represent an economy in a recessionary gap. Next, identify

LRAS Physical PPF

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