Economics

David Begg, Gianluigi Vernasca, Stanley Fische

Chapter 21

Aggregate supply, prices and adjustment to shocks - all with Video Answers

Educators

Chapter Questions

Problem 1

(a) Define the aggregate demand schedule. (b) How does a fiscal expansion affect the schedule under a flexible inflation target? (c) How would the central bank have to change monetary policy to hit its given inflation target in the long run?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 2

Common fallacies Why are these statements wrong? (a) Fiscal expansion can increase output for ever.
(b) Higher inflation always reduces output.

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 3

An economy has the choice of having half its workers make annual wage agreements every January, and the other half make annual wage agreements every July, or instead forcing everyone to make their annual agreement on 1 July. Which system is likely to induce greater wage flexibility during a period of a few months and during a period of several years?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 4

How do the following affect the short-run supply schedule, and hence output and inflation in the short run: (a) a higher tax rate; (b) higher labour productivity?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 5

Which of the following statements is correct? (a) Inflation targeting implies the central bank can ignore what is happening to output. (b) Inflation targeting implies nominal interest rates will typically rise by more than the rise in inflation. (c) Inflation targeting was immediately abandoned once the financial crash of 2009 occurred.

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 6

Suppose opportunities for investing in high-tech applications boost aggregate demand in the short run but aggregate supply in the long run. Using $A S$ and $A D$ schedules, show why output might rise without much inflation.

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 7

OPEC raises the price of oil for a year but then an increase in the supply of oil from Russia bids oil prices back down again. Contrast the evolution of the economy if monetary policy follows: (a) a fixed interest rate or (b) flexible inflation targeting.

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 8

Distinguish between adjustment in the UK (small open economy, flexible exchange rate) and the US (large economy, international trade a much smaller proportion of its GDP).

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 9

Use the Taylor rule $r-r^{*}=(1+a)\left(\pi-\pi^{*}\right)+b\left(Y-Y^{*}\right)$ to answer the following questions: (a) What does the long-run target for the nominal interest rate depend on? (b) In the nominal interest version of the Taylor rule, what happens when there is an increase in inflation? (c) What do the absolute and relative sizes of both the parameters $a$ and $b$ respectively tell us?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 10

In 2007 , the governor of the Bank of England had to write to the Chancellor of the Exchequer to explain why UK inflation had exceeded the target range laid down by the Chancellor. (a) Why were these difficult circumstances? (b) Was the letter proof that the Bank of England was unable to keep inflation in check?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 11

Central banks, by focusing too much on the inflation rate for goods and services neglected important signals from asset prices that risk-taking had become excessive.' Do you agree? What is this likely to imply in future?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 12

Imagine that the UK adopts the euro, and interest rates are set by the European Central Bank. (a) Are euro interest rates likely to be adjusted to help stabilize either UK inflation or UK output? (b) What automatic mechanisms, if any, can still achieve these outcomes? (c) Would UK fiscal policy be able to help more?

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 13

Use Figure $21.8$ to explore how the collapse of bank lending to companies affects short-run supply curves, and show how the adjustment process subsequently occurs.

Haricharan Gupta

Haricharan Gupta

Numerade Educator

Problem 14

Essay question 'Climate change is essentially a permanent adverse supply shock. Production costs will rise; potential output will fall. If the private sector fails to adjust, then either monetary or fiscal policy will have to reduce aggregate demand to the required lower level.' Discuss.

Haricharan Gupta

Haricharan Gupta

Numerade Educator