Problem Set # 8, ID s

Transcription

1 Problem Set # 8, ID s Aggregate Demand and Aggregate Supply in the Real World Name: Overview: In this problem set, you will apply what you know about Aggregate Demand and Aggregate Supply to real world data. In a series of five graphs, you will plot the condition of the U.S. economy at different periods of time. You will analyze the changes that occurred in terms of the Aggregate Demand and Short-Run Aggregate Supply model. I. Instructions for Graphs 1 & 2: (Use Price on Your Vertical Axis) Graph 1: ; The Great Contraction a. On the attached graph 1 or your own spreadsheet printout, neatly plot the Price Level (vertical axis) and Real GDP (horizontal axis) for each year from 1929 to Clearly label each point with its year. The data for this can be found on page 2. b. Draw AD and SRAS curves through your points. Clearly label each curve with its year. There is no single right way to draw the curves as long as you: Make sure that your AD curves always slope down. Make sure that your SRAS curves slope up and that each SRAS curve s slope increases as the level of output increases. Make sure that no AD curve crosses any other AD curve. Make sure that no SRAS curve crosses any other SRAS curve. You can use the same AD curve for more than one point if the points will easily fit on the same AD curve. Likewise, you may use the same SRAS curve for more than one point if the points will easily fit on the same SRAS curve. c. Pay attention the chart on wages; i.e. figure 5 of the Meet the Great Depression handout, when drawing your SRAS curves. Based on the change in wages, which way would SRAS be shifting? This set of graphs (1 & 2) is the only set for which you have wage information, by the way. Graph 2: ; Recovery? a. On the attached graph 2 or your own spreadsheet printout, neatly plot the Price Level (vertical axis) and Real GDP (horizontal axis) for each year from 1933 to The data for this can be found on page 2. b. Draw AD and SRAS curves through your points. Clearly label each curve with its year. Make sure that your AD curves always slope down. Make sure that your SRAS curves slope up and that each SRAS curve s slope increases as the level of output increases. Make sure that no AD curve crosses any other AD curve. Make sure that no SRAS curve crosses any other SRAS curve. You can use the same AD curve for more than one point if the points will easily fit on the same AD curve. Likewise, you may use the same SRAS curve for more than one point if the points will easily fit on the same SRAS curve. 1

2 Year GDP PI (1996 = base) The Data: Real GDP (Billions of 96 $s) Year GDP PI (1996 = base) Real GDP (Billions of 96 $s) $ $ $ $ $ $ $ $ $ $ $ $909.1 II. Instructions: Graphs 3 5. For graphs 3 5, use Inflation (%ΔPrice) on the Vertical Axis. See pages for an explanation why inflation works better than price for these time periods. Graph 3: ; Disco Isn t the Only Thing That Sucks! a. On the attached graph 3 or your own spreadsheet printout, neatly plot the inflation rate and real GDP for each year from 1972 to Label each point with the year. The data for this can be found on page 6. b. Draw AD & SRAS curves through your points. Clearly label each curve with its year. Follow the same instructions as in Graphs 1 (1b) and 2 (2b). Graph 4: ; It s the Economy Stupid a. On the attached graph 4 or your own spreadsheet printout, neatly plot the inflation rate and real GDP for each year from 1990 to Label each point with the year. The data for this can be found on page 5 (below). b. Draw AD & SRAS curves through your points. Clearly label each curve with its year. Follow the same instructions as in Graph 1 b. The Data: Year Inflation Real '96 GDP Real Year Inflation '96 GDP (Billions) (Billions) % $ 3, % $ 6, % $ 4, % $ 6, % $ 4, % $ 6, % $ 4, % $ 7, % $ 4, % $ 7, % $ 7, % $ 7, % $ 8, % $ 8, % $ 8,

3 Graph 5: ; The Economic Wonder Years a. On the attached graph (p 13) or your own spreadsheet printout, neatly plot the inflation rate and real GDP for each year from 1993 to Label each point with the year. The data for this can be found on page 6. b. Draw AD & SRAS curves through your points. Clearly label each curve with its year. Follow the same instructions as in Graphs 1 (1b) and 2 (2b). III. Answer the following questions on the pages below. The Great Contraction: According to your AD-SRAS graphs, what was the main cause of the economic crash from 1929 to 1933? a. a decrease (leftward shift) in SRAS c. a decrease (leftward shift) in AD b. an increase (rightward shift) in SRAS d. an increase (rightward shift) in AD 2. According to your AD-SRAS graphs, and the graph below, was the long-run adjustment process working to fix the economy from 1929 to 1933? Is the SRAS curve shifting the way is should according to (classical or neo-classical) economic theory? a. Not at all. SRAS isn't moving or is moving the "wrong" direction. b. SRAS is shifting the desired direction, but not enough to provide much relief. c. SRAS is shifting the desired direction and is largely curing the recession. 3

4 4. According to your AD-SRAS graphs, and the graph below, which of the following is true of monetary policy during the Great Contraction, especially the early years? a. The Fed did everything modern economists think it should do to get an economy out of a recession. Apparently, items beyond the Fed's control caused the recession to continue. b. The Fed did absolutely nothing. It neither pursued a tight (i.e. expansionary) money, nor an easy (i.e. restrictive) money policy. c. The Fed often did the exact opposite of modern economists think it should do to get an economy out of a recession. The Recovery?: According to your AD-SRAS graphs, what most caused the economy to recover from the Great Depression? a. a decrease (leftward shift) in SRAS c. a decrease (leftward shift) in AD b. an increase (rightward shift) in SRAS d. an increase (rightward shift) in AD That '70's Show: According to your AD-SRAS graphs, what most caused the horrible economic conditions of the mid-1970's (namely, )? a. an increase (rightward shift) in SRAS c. an increase (rightward shift) in AD b. a decrease (leftward shift) in SRAS d. a decrease (leftward shift) in AD 7. Which of the following most caused the horrible economic conditions of the mid-1970's (namely, )? Hint: You might look back over your chapter 17 notes. a. a large decrease in the federal budget deficit b. a large increase in the federal budget deficit c. a large decrease in energy prices d. a large increase in energy prices 4

5 "It's the Economy Stupid": According to your AD-SRAS graphs, what most caused the horrible economic conditions of the early 1990''s? a. an increase (rightward shift) in SRAS c. an increase (rightward shift) in AD b. a decrease (leftward shift) in SRAS d. a decrease (leftward shift) in AD 9. According to your AD-SRAS graphs, was the long-run adjustment process working to fix the economy from 1990 to 1992? Is the SRAS curve shifting the way is should according to (classical or neo-classical) economic theory? a. Not at all. SRAS isn't moving or is moving the "wrong" direction. b. SRAS is shifting the desired direction, but not enough to provide much relief. c. SRAS is shifting the desired direction and is largely curing the recession. The Wonder Years: According to your AD-SRAS graphs, what most caused the wonderful economic conditions of the middle and late 1990's? a. an increase (rightward shift) in SRAS c. an increase (rightward shift) in AD b. a decrease (leftward shift) in SRAS d. a decrease (leftward shift) in AD 11. What caused the wonderful economic conditions of the middle and late 1990's (as indicated on your AD-SRAS curves)? Indicate Yes or No for each event. Yes No Event technological developments coming at a very rapid rate a lack of technological development (compared to the wave of innovations in the late 1980's) causing consumers to spend their money rather than save it stable or falling energy prices rising energy prices IV. Turn in pages 1-11 at the beginning of class on the due date. Staple everything together. Your 5 graphs should be neat and well labeled. Problem sets without the graphs are not accepted. Photocopies of graphs will not be accepted. 5

6 13.0 Name: Graph 1: GDP Price Index ('96 = 100) $500 $550 $600 $650 $700 $750 Real ('96) GDP $800 $850 $900 $950 $1,000 6

7 13.0 Name: Graph 2: GDP Price Index ('96 = 100) $500 $550 $600 $650 $700 $750 Real ('96) GDP $800 $850 $900 $950 $1,000 7

8 Name: Graph 3: % 9.5% 9.0% 8.5% 8.0% 7.5% 7.0% 6.5% 6.0% 5.5% 5.0% 4.5% 4.0% 3.5% 3.0% $3,800 $3,850 $3,900 $3,950 $4,000 $4,050 $4,100 $4,150 $4,200 $4,250 $4,300 $4,350 $4,400 % Δ GDP Price Index ('96 = 100) Real ('96) GDP 8

9 5.0% Name: Graph 4: % 4.0% % Δ GDP Price Index ('96 = 100) 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% $6,550 $6,600 $6,650 $6,700 $6,750 Real ('96) GDP $6,800 $6,850 $6,900 $6,950 9

10 3.5% Name: Graph 5: % 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% $6,800 $7,000 $7,200 $7,400 $7,600 $7,800 $8,000 $8,200 $8,400 $8,600 $8,800 $9,000 $9,200 $9,400 % Δ GDP Price Index ('96 = 100) Real ('96) GDP 10

11 Econ Introduction to Macroeconomics Notes on Inflation Expectations and the Modified AD-SRAS Model: Believe it or not, the Great Depression is relatively easy to analyze within the AD-SRAS model. The reason is that there is less reason to worry about the effect of inflation expectations on the year to year shifts of AD and SRAS. Simply put, prior to 1929, the economy had not seen long periods of continuous inflation. Expected inflation (according to adaptive expectations theory, pp ) can be assumed to have been about 0%. This is no longer true once we move into the time periods examined in graphs 2, 3, and 4. During these time periods, the 70, 80 s, and 90 s, people in the economy came to expect a certain inflation rate. According to adaptive expectations theory, they would base their inflation expectations on inflation rates from years recently past. This would cause both AD and SRAS to shift up, automatically, by the expected inflation rate even if nothing else changed. For example, assume that buyers, sellers, workers, heck everybody, expects 2% inflation. Each year, buyers would be willing to pay 2% more for the same goods and services as before. This will cause AD to shift up automatically. Wages and other costs will also have to increase by 2% a year just to keep workers (and other resource owners) up with expected inflation. i.e. If firms want workers to work the same amount, firms will have to automatically raise their wages 2% a year. Because of their (2% a year) increase in costs, year, sellers would only be willing to produce the same amount if they receive 2% more for it. SRAS will therefore automatically shift up by 2% a year. In figure 1a this economy is graphed according to the conventional AD-SRAS model. Yowsa! A new AD and SRAS curve have to be drawn each year even though there is no major changes in the economy. Since the economy has been experiencing 2% inflation and everyone expects 2% inflation in the near future, both AD and SRAS shift upwards by 2% a year. Hmmm lot of work just to depict an economy that is doing everything the same (including the 2% inflation rate) as it has done in the past. Figure 1: Two ways of depicting the same thing: An economy with no growth of real GDP and no change in the inflation rate. Figure 1a Figure 1b P % inflation as expected SRAS 2 SRAS 1 E 2 AD 2 rising price pressures 3 % inflation rate 2% E 1 & E 2 SRAS 1 & SRAS E 1 AD 1 Q (Real GDP) 1 % falling price pressures 0 % Q (Real GDP) AD 1 & AD 2 11

12 Econ Introduction to Macroeconomics Instead of using a standard AD-SRAS model for charts 2 4, you will use a modified AD-SRAS model. The modified AD-SRAS model has the Inflation Rate on its vertical axis, not the price level. In figure 2b the economy just described (i.e. expecting 2% inflation) is graphed according the modified AD- SRAS model. A lot simpler, huh? Things get even more complex for the price (as opposed to the inflation) graph when the inflation rate changes. Consider our economy which has been expecting 2% inflation. Both AD and SRAS will shift up by 2% a year ceteris paribus. Assume, however, that government spending increases greatly and AD increases faster than 2%, say 5%. In the normal (i.e. Price on the vertical axis) AD-SRAS model, things are a bit hairy. This is shown in figure 2a (next page). The modified AD-SRAS model handles this faster than expected growth of AD in a simpler manner as shown in. Figure 2b (below). Figure 2: Two ways of depicting the same thing: An economy expecting continued 2% inflation but in which AD grows faster than expected. Figure 2a Figure 2b P % expected But AD actually grows faster than expected SRAS 2 E 2 AD 2 SRAS 1 E 1 rising price pressures inflation rate from previous year 2% SRAS 1 & SRAS 2 E 1 E 2 AD 1 AD 2 AD 1 falling price pressures Q (Real GDP) Q (Real GDP) The second reason for using the modified model is that it more directly addresses our concern as economists. We tend to ask; What causes an increase in inflation?, not What causes a 12% inflation rate? or What causes a price level of 162?. Likewise, good economists ask; How can an economy reduce inflation? rather than How can an economy achieve a 10% inflation rate? Okay back to your instructions. 12