1. How is aggregate demand and supply different from market demand and supply?

Market demand and supply tells us the quantities of a good that consumers are willing to
buy and producers are willing to sell for a given price. Aggregate demand and supply tells us
the total goods and services that the economy as a whole would purchase and produce at a
given price level.

2. What would cause the AD and AS to shift?

Aggregate demand consists of consumption, investments, government expenditures and net

exports in the economy. Any changes in these variables would shift your aggregate demand
curve. On the other hand, aggregate supply represents the productive capacity of the
economy. Any changes in total factors would shift your aggregate supply. That can be a
change in labor force participation, availability of capital and natural resources, and
technology. Angara’s policy recommendation on lower income tax would more likely shift
the aggregate demand curve due to a boost in consumption. Lower income taxes would
strengthen the spending power of consumers and consequently, allow them to increase
spending on a variety of goods and services.

3. Why are the measures of economic activity measured in terms of value rather than in quantities?

It is basically because goods and services vary in their units of measurement and unit counts
alone would not weigh the goods and services according to their value. Potable water is
measured in mLs, while airplanes are measured in kilograms. The production process of a
liter of potable water is obviously different from that of an airplane. Counting one at par
with the other does not treat those goods according to their value.

4. TRUE! Recall that y (real GDP per capita) = Y (real GDP)/ N (population)
You can transform this into a log equation: log y = log Y – log N
Take the total derivatives, which will give you the relationship of the variables in “growth”
form:
Growth rate of real GDP per capita = growth rate of real GDP – population growth

5. The long run AS curve is vertical at potential output because the economy can only produce up to
the extent that it fully employs its resources (Basically, when its unemployment is at its natural rate.)
The “very” short run AS curve is horizontal because prices do not immediately adjust to changes in
the economy. Laborers are bound by contracts, so their wages cannot adjust to increases in
production. And, there are menu costs to changing prices (Menu costs here to refer to the
inconvenience faced by restaurants in printing a new menu as a response to change in the prices of
ingredients). One example of menu costs preventing changes in the price level was UP Tuition before
2007. Tuition fee should have increased earlier than it should have, but since there are “menu
costs”, which is largely explaining to college students the fee increase and facing resistance from
student activist, the TOFI was delayed and the subsequent market-implied TOFIs become jampacked
in the one-time 2007 TOFI.

6. FALSE. You can prove this using a numerical exercise.

7. The Federal Reserve Bank pushed interest rates down to near-zero level in order to reduce the
cost of borrowing and encourage investments in a time when investor confidence was very poor.
This would allow the aggregate demand curve to shift, increase output, and consequently, the jobs
available in the economy.
8. TRUE.

9. Business cycles are fluctuations in economic activity from a boom to a contraction. A shift in
aggregate demand will lead to a large increase in output, above potential output. Since this level is
unsustainable given economy’s productive capacity, output would eventually fall (contraction) and
the “overheat” will be dampened by higher level of prices. Potential output is not always the same
as actual output because “shocks” are incorporated in actual output and not in potential output.
Graphically, the SRAS and LRAS are differently sloped.

10.

11. Overall price level would surely fall but production would change marginally or would not even
change at all.

12. Aggregate supply becomes steeper as output moves further to the right of potential output
because when the economy is employing its resources beyond capacity, incremental output will only
be a little due to exhaustion. On the other hand, with a surplus of resources available, firms can
easily adjust to changes in aggregate demand by employing more resources; hence, the flatter
curvature of short run AS to the left of potential output.

13. Roosevelt moved Thanksgiving to the 3rd Thursday of November to provide leeway to increase
Christmas shopping purchases. With earlier Thanksgiving, people would have more time to buy gifts;
leading aggregate demand to shift to the right, and firms to ramp up production as a response to the
aggregate demand shift. Since we are talking about a period of recession (in fact, a depression),
output is below potential output, and changes in AD would hardly change prices, but would increase
output; thus, moving the economy closer to potential output.