On the aggregate demand and supply diagram, what do output and price represent?
- Output is real GNP and the price level is the GNP Deflator.
How can the price level go up and yet the “price” of each good remain unchanged?
- An increase in the price level that raises all prices and equal percentage amount will leave the relative price of all goods unchanged.
How does a lower price level increase the aggregate output demanded?
- A lower price level increases the purchasing power of money; bonds, and other nominally fixed assets. This increase in wealth causes people to buy more goods.
When prices are lower, total dollar spending may fall. Does this contradict the fact that lower prices increase aggregate demand?
- Aggregate demand refers to total desired real spending. So it is possible for total dollar spending to fall, but if prices fall even more, real spending (i.e., the real quantity of goods bought) will go up.
Does output always go up when prices go up?
- No. If aggregate supply decreases, output can fall when prices rise.
In the Great Depression, prices and output fell. What shift in aggregate demand and supply would best describe the cause of this event?
- A decrease in aggregate demand.
What changes in wages will cause the short-run aggregate supply curve to shift to the left?
- An increase in wages.
How should the government shift the aggregate demand curve if it wants to raise output? What will happen to the price level?
- The government should increase aggregate demand so that the curve shifts right. Prices will rise.
How should the government shift the aggregate demand curve to reduce inflation? What will happen to output?
- To reduce inflation, the government should decrease aggregate demand so that the curve shifts left. Output will fall.
How will wages and other input costs tend to change when unemployment is above its natural rate?
- Wages and other factor costs will fall.
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