AD, AS, Unemployment and Inflation

1 Determine whether each of the following would cause a shift of the aggregate
demand (AD) curve, a shift of the aggregate supply (AS) curve, neither, or both.
Which curve will shift, and in which direction? What will happen to aggregate output
and the price level in each case?
a. The price level changes.
i.
Which curve will shift?
Variations in price will cause changes in neither aggregate supply nor aggregate demand. Thus, no curve
shifts when the price level changes

ii.
Which direction does it shift?
The price level will converge to its appropriate value and the curve will shift in either
direction liable on price changes.
iii.
What will happen to aggregate output?
The aggregate output will vary until the price level becomes stable
iv.
What will happen to the price level?
Over time, neither the price level nor output are a ected.
b. Consumer confidence declines.
i.
Which curve will shift?
The aggregate demand curve will change

ii.
Which direction does it shift?
Decreased consumer condence will change the aggregate demand curve to the
left, thus decreasing demand.
iii.
What will happen to aggregate output?
Consumer condence does not necessarily aect the aggregate output but it may
decrease
iv.
What will happen to the price level?
Decrease in aggregate output leads to decrease in price level
c.

The supply of resources increases.

i.
Which curve will shift?
An increase in supply of resources does not affect the demand, hence the
aggregate demand curve is not affected. Only the aggregate supply curve shifts
ii.
Which direction does it shift?
The aggregate supply curve shift to the right
iii.
What happens to aggregate output?
The aggregate output may remain unaffected but could increase
iv.
What happens to the price level?
Shifting the aggregate supply curve to the right without changing the aggregate
demand will decrease the price level

d.

The wage rate increases.

i.

Which will curve shift?

The aggregate demand curve will shift while aggregate supply curve will not be
affected
ii.
Which direction does it shift?
The aggregate demand curve shift to the right. More wages result in additional
spendable cash, which can then be used to buy more goods that would otherwise
not be demanded
iii.
What will happen to aggregate output?
Increasing aggregate demand without changing aggregate supply results will
increase aggregate output
iv.
What will happen to the price level?
Since aggregate supply is not affected, the price level will increase
2 Determine whether the following statements are true or false.
i.
ii.
iii.
iv.

Some people who are officially unemployed are not in the labor force.
False
Some people in the labor force are not working.
True
Everyone who is not unemployed is in the labor force.
False
Some people who are not working are not unemployed.
True

3 Refer to the following data on the U.S. consumer price index and answer the
questions below.
Year
1988
1989
1990
1991
1992

CPI
118.3
124.0
130.7
136.2
140.3

Year
1993
1994
1995
1996
1997

CPI
144.5
148.2
152.4
156.9
160.5

Year
1998
1999
2000
2001
2002

CPI
163.0
166.6
172.2
177.1
179.9

Year
2003
2004
2005
2006

CPI
184.0
188.9
195.3
201.8

a. Compute the inflation rate for each year 1988-1989, 1989-1990, 1990-1991,
1991-1992 etc. using the CPI data for 1988-2006 in the table above. Show
your work.
Inflation rate= Year 2-Year 1/CPI
Year Inflation rate Year Inflation rate Year inflation rate Year inflation rate
1993 2.99
1998 1.56
2003 2.28
1989 4.82
1994 2.56
1999 2.21
2004 2.66

1990 5.40
1991 4.21
1992 3.01

1995 2.83
1996 2.95
1997 2.30

2000 2.85
2001 2.85
2002 1.58

2005 3.39
2006 3.33

b. Which years were years of inflation? What do you expect to happen to real
interest rates during this time period if nominal rates remain unchanged?
1990, 1995, 1996, 1999, 2000, 2003, 2004, 2005
The real rate of interest is the amount that the lender receives before allowing for inflation. This
can be computed by subtracting inflation rate from nominal interest rate. During this time period,
the real interest rate would decrease

c. In which years did deflation occur? What do you expect to happen to real
interest rates during this time period if nominal rates remain unchanged?
There is no year that reflect deflation. In that case, the real interest rate and
nominal interest rate would not be affected
d. In which years did disinflation occur?
1991, 1992, 1993, 1994, 1997, 1998, 2001, 2002, 2006

4 What are the costs associated with unanticipated inflation? Why do these inflation
costs differ from those associated with anticipated inflation?
The costs related to unanticipated inflation comprise uncertainty or confusion by
consumers, tax increases, reduced effectiveness, and unstable economic cycles.
These inflation costs differ from those associated with anticipated inflation because
savings account holders will gain extra money in the bank to accumulate more
interest.

Monetary Policy and Fiscal Policy

1. Determine whether each of the following is counted in the M1 measure of the money
supply:
i.
ii.
iii.
iv.
v.

The coins in your piggy bank.

Yes because this is considered currency
The funds in your checking account at First National Bank.
Yes, the value of the checking account is also comprised
The funds in your savings account at Second National Bank.
No, this is included in M2
The travelers check you have left over from your trip to Germany.
Yes
The available balance on your Citico Gold MasterCard.
No, this is included in M2

2. Refer to the simplified balance sheet for a bank and answer the following questions.
Assets
Reserves

$10,000

Liabilities
Deposits

$70,000

Loans

$66,000

Stockholder's equity

$6,000

a. If the required reserve ratio is 5%, how much in excess reserves does this bank
hold?
Excess reserves = $10,000-(70,000*.10) = $3,000
b. What is the maximum amount this bank can expand on its loans?
The maximum amount this bank can expand its loans by is $ 3,000
c. What will happen to the M1 money supply if it makes the loans under (b) above
and those funds are deposited into another bank by the borrowers?
If deposited in another bank, banks deposits will then increase by the amount
deposited for M1, and decrease that amount from the original bank.
3. Identify each of the following events as:
a) part of an expansionary fiscal policy
b) part of a contractionary fiscal policy
c) part of an expansionary monetary policy
d) part of a contractionary monetary policy
i. The corporate income tax rate is increased.
B
ii. Defense spending is increased.
A
iii. Families are allowed to deduct all daycare expenses from their federal income taxes.
C
iv. The Federal Reserve Bank sells Treasury securities.
C
v. The Federal Reserve Bank buys Treasury securities.
D
4. Assume the Federal government runs a budget deficit in the current fiscal year.
i.

How can the Federal government fund (finance) the budget deficit?
By issuing treasury bonds to borrow funds appropriate to bridge the gap between
taxes and expenditure.

ii.

If the Federal government decides to issue U.S. Treasury securities to fund the
deficit, what will happen to the level of national debt, all other factor held
constant?
In fact, anyone can purchase them and basically the federal government will be
owing the money. The level of national debt will decrease, which in turn slows the
economy growth.

iii.

Assuming the Federal government and firms compete for the same savers
dollars in the loanable funds market, what will likely happen to interest rates?
The interest rates will increase due to increase in demand

iv.

Given your answer under (ii & iii) above, is crowding out more or less likely to
occur if the deficit is funded by Treasury securities? Explain.
Most likely, due to that crowding out happens when there is a decrease in
investment expenditure, the government purchases will increase. This is because
higher interest rates result businesses to reduce their investment expenditure,
hence, the government budget is negatively affected.