Question

1)What is a significant difference between the way Keynes saw aggregate demand and the way the Classicals saw aggregate demand?

a)both Classicals and Keynes did not believe that money impacted AD

b)Keynes felt money had a big impact on AD but not fiscal policy

c)Classicals believed that the only factor that could impact AD was money. Keynes believed that changes in government spending and shocks to investment expectations would all have effects on AD

d)Keynes believed that AD was not an important topic of study, Classicals thought is critical to understanding short run fluctuations

2)

Assuming a mpc of 0.80 calculate the impact on the equilibrium level of income for a $100 increase in investment.

		$500
		$100
		$400
		Can not be determined

3)Why might prices be sticky in the short run?

		sticky wages (contracts)
		menu costs
		misperceptions
		all of the above

4)

Which of the following captures the idea that Keynesian policy recommendation to "lean against the wind"?

		Use active fiscal and/or monetary policy to combat short run economic shocks
		laissez-faire
		to push against public pressure for expansionary yet unsustainable growth
		to be stubborn in the face of adversity

Answer 1

1) ANSWER: c) Classicals believed that the only factor that could impact AD was money. Keynes believed that changes in government spending and shocks to investment expectations would all have effects on AD.

The classical model did not had any explicit theory of aggregate demand. The quantity theory of money provided an implicit theory of aggregate demand, using the quantity theory relationship, MV=PY ; with the assumption that V is constant and PY can be determined for a given value of M. The keynesian demand curve on the other hand depends on the variables like government spending, tax, autonomous investment etc.

2) ANSWER: a) 500

First we will calculate the multiplier i.e,

Multiplier = 1 / 1-MPC = 1/ 1-0.8 = 5

Therefore, for a $100 increase in investment the income will increase by ;

5 * 100 = 500

3) ANSWER: d) all of the above

Sticky prices also known as nominal price rigidity is the idea that some prices and wages are not fully flexible and cannot completely respond to changes such as inflation or deflation. Prices are sticky beacuse of sticky wages in the short run, the idea behind “menu costs” is that output prices are sticky too and some misconceptions regarding the expectations.

4) ANSWER: