ECON 100 Aggregate Supply & Demand Answers

St. Charles Community College
ECON 100    Survey Economics
Answers to Class Discussion Question


What effects might each of the following have upon aggregate demand or aggregate supply?  In each case sketch a diagram to show the expected effects upon the equilibrium price level and level of real national output.  Assume that all other things remain constant.

1.   Foreign countries purchase an unusually large number of U. S. manufactured passenger and military airplanes.

Answer:  This activity would affect the international trade sector of aggregate demand (exports minus imports).  The net exports would increase, so the aggregate demand curve would shift to the right.  The equilibrium price level would increase, and the real net output would also increase.    

 2.    Russia raises its oil exports which causes international oil prices to fall.

Answer:  When we think of oil in this case we want to think of it as a raw material or a manufacturing input.  When there is a fall in the price of a major raw material, the short run aggregate supply curve shifts to the right.  There is no change in aggregate demand since we are talking about a raw material.  The equilibrium price level should decrease, and the real national output will increase.
 

3.    The average U. S. production worker demonstrates a large increase in productivity.

Answer:  Worker productivity is an aggregate supply function.  An increase in worker productivity will cause the short run aggregate supply curve to shift to the right. The equilibrium price level will fall, and the real national output will increase.

                
4.    The percentage of workers that are unionized decreases.

Answer:  We must make an assumption here.  That assumption is that since unionized workers are generally higher paid than non-union workers, a drop in the percentage of the workers that are unionized will mean that wages, on average, will fall.  Labor costs are the main portion of aggregate supply.  Therefore, if wages drop, the short run aggregate supply curve will shift to the right.  It then follows that the equilibrium price level will drop, and real national output will increase.          

 

5.    A federal law is passed which permits the more rapid accounting depreciation on industrial and commercial equipment.

Answer:  An increase in the depreciation rates will encourage manufacturers to expand their production facilities or purchase new equipment, especially more modern equipment.  This will increase investment, so aggregate demand will increase, and the aggregate demand curve will shift to the right.  There will be an increase in the price level, and the real national output will increase. 

 
6.    Consumer confidence surveys show that U. S. households expect a prolonged recession.  At the same time, firms also expect a prolonged recession.

Answer:  When consumers get restless about the economy they tend to reduce their spending.  This decrease in consumption will cause the aggregate demand curve to shift to the left.  

When firms expect the economy to perform poorly they commonly cut back in production so as not to build up inventories of output that they can’t sell.  This causes the short run aggregate supply curve to shift to the left also.  With these two factors working together it is difficult to determine where the price level will end up. Depending on where the economy is on the short run aggregate supply curve, it could end up as shown on the diagram below with no change at all.  However, there will be a decrease in real national output.                      

7.    The Fed aggressively buys bonds in the open market.

Answer:  When the Fed buys bonds, more money in put into circulation.  When more money is put into circulation, consumption and investment both increase.  This will cause the aggregate demand curve to shift to the right.  The equilibrium price level will increase, and the real national output will increase.
                 

8.    The federal government requires all firms with more than three employees to provide complete, company paid, medical insurance to all full time and part time employees.

Answer:  A move such as this would impose a significant labor cost on all suppliers.  Since labor cost is an input cost, this action will affect the aggregate supply side, moving the short run aggregate supply curve to the left.  This means that there will be an increase in the equilibrium price level, and the national output will decrease. 

               
9.    Federal personal income tax rates are reduced by an average of ten percent.

Answer:  Federal personal income taxes affect households, but they do not affect firms.  When consumers get tax cuts, they tend to spend most of if not all of that money. Consumption will increase, the price level will increase, and real national income (output) will increase.  Initially, there will be no change in the short run aggregate supply.                  
   

10.    The federal government reduces spending for higher education.

Answer:  Any time the government reduces spending, aggregate demand decreases.  Therefore, the aggregate demand curve will shift to the left, the equilibrium price level will decrease, and real national output will decrease.                                               
11.    A new comprehensive Medicare prescription drug plan for senior citizens becomes law.

Answer:  Medicare is a federal program, which means that government spending is involved.  This action will cause government spending to increase, aggregate demand will shift to the right, the equilibrium price level will increase, and real national output will increase.  There will be no immediate effect on short run aggregate supply.                  
   

12.    During a period in which the economy is strong, environmental pollution standards are tightened substantially.

Answer:  Environmental standards are a type of regulation on business, and such regulations add a cost to suppliers.  Anything that adds costs to suppliers shifts the short run aggregate supply curve to the left.  The equilibrium price level will increase, and the real national output will fall.


13.    The vegetable growing areas of California, Texas, and Florida face a prolonged drought.

Answer:  Weather affects short run aggregate supply, and bad weather affects the short run aggregate supply adversely.  Therefore, the short run  aggregate supply curve will shift to the left, the equilibrium price level will increase, and the real national output will decrease                  

 

14.    A major recession hits our principal European trading partners.

Answer:  This is another international issue.  In order to have international trade you must have international customers who have the money to purchase your goods.  If  foreign customers are forced to cut back on the purchasing of your products,  exports will decrease.  If exports decrease, aggregate demand will decrease, the equilibrium price level will fall, and real national output will fall also.                      
                    

15.    The U. S. installs a high import tariff.  At the same time, the Fed expands the money supply.

Answer:  The first part of this question is a bit tricky.  When a nation places a tariff on imported goods, those imported good become relatively more expensive than domestically produced goods.  This means that consumers and firms will purchase domestic goods, probably at a price that is higher than it was before the imposition of the tariff..  Therefore, because of the increased demand for the domestic goods at these higher prices, consumption and investment will increase, aggregate demand will increase, the price level will increase, and real national output will increase.  If the Fed increases the money supply at the same time, aggregate demand will increase even more.   Prices will increase even more, and real national output will also increase even more.    
                 


16.    Free trade zones similar to NAFTA are expanded to include additional South American countries.

Answer:  The history from NAFTA has shown us that both exports and imports increase when free trade zones are established.  The immediate effect will be in the net exports part of aggregate demand.  The aggregate demand curve will shift to the right, the equilibrium price level will increase, and the real national output will increase.
                     


17.    The U. S. spends heavily on homeland security.

Answer:  This is a government spending issue.  Aggregate demand will increase, the equilibrium price level will increase, and real national output will also increase.

 
                         
18.    The percentage of the female population in the work force increases dramatically.

Answer:  If the percentage of the female population in the workforce increases, the work force is increasing.  A larger work force will shift the short run aggregate supply curve to the right.  The equilibrium price level will increase, and the real national output will also increase.
                 

                      
19.    The AIDS epidemic in southern Africa becomes so severe that countries there are forced to purchase larger amounts of American wheat.

Answer:  This is another net exports issue, the same as question “a”.  Aggregate demand will increase, the equilibrium price level will increase, and real national output will also increase.
                    

 
20.    More and more American workers elect to work past the usual social security retirement age of 65+.

Answer:  The question is very similar to question “r”.  The labor force is growing.  The short run aggregate supple curve will shift to the right, the equilibrium price level will go down, and real national output will increase.