Question

Why is the AD-curve downward sloping?

2.   Why is the AS-curve upward sloping in the intermediate run?   

3.   True or false? Why?

      “Monetary policy does not affect real output in the Keynesian supply curve model.”

4.“In the classical AS-curve case, an increase in government spending will increase interest rates and real money balances.” Comment on this statement.         

5.   Comment on the following statement:

“In the classical aggregate supply curve model, the economy is always at the full-employment level of output and the unemployment rate is always zero.”

6.   “Restrictive fiscal policy does not affect the level of real output or real money balances in the classical AS-curve case.” Comment on this statement.           

7.   “Monetary expansion will not change interest rates in the classical AS-curve model.” Comment on this statement with the help of an AD-AS diagram.                                                                      

8.Assume a technological advance leads to lower production costs. Show the effect this will have on national income, unemployment, inflation, and interest rates with the help of an AD-AS diagram, assuming completely flexible wage rates

9. Explain the effect of restrictive fiscal policy on the level of output, prices, and interest rates for (i) the Keynesian AS-curve case, (ii) the classical AS-curve case, and (iii) the intermediate case.

10. “The real impact of demand management policy is largely determined by the flexibility of wages and prices.” Comment on this statement.

Answer 1

(1)

The AD curve slopes downward, reflecting a negative relationship between price level and quantity of real GDP (output) demanded. There are three reasons for this.

(A) Pigou Wealth Effect

As price level falls (rises), purchasing power rises (falls), which increases (decreases) real wealth of consumers. This increases (decreases) consumption demand, therefore increasing (decreasing) aggregate demand.

(B) Keynes' Interest rate effect

As price level falls (rises), purchasing power rises (falls), so people reduce (increase) their demand for money. A fall (rise) in demand for money will decrease (increase) interest rate, which will boost (dampen) investment and the portion of consumption funded by borrowing, leading to an increase (decrease) in aggregate demand.

(C) Mundell-Fleming Exchange rate/Net exports effect

As domestic price level falls (rises), exportable goods become more (less) cheap in global market, and imported goods become costlier (cheaper), so export demand rises (falls) and import demand falls (rises). This increases (decreases) net exports and increases (decreases) aggregate demand.

NOTE: As per Answering Policy, 1st question is answered.