Part I : For each of the following, fill in the blanks by choosing from the term

Question

Part I: For each of the following, fill in the blanks by choosing from the terms in parentheses. Assume that prices are flexible upwards but not downwards. Answer a-b by writing the letter for each and giving your response on a separate row. (4 points each)

a. If a large decrease in health insurance premiums reduces national labor costs, the aggregate _______ (demand / supply ) curve will shift to the _______ (left / right). As a result, the price level will _______ (increase / decrease / not change) and output will _______ (increase / decrease / not change).

b. If businesses become optimistic that business conditions will improve, the aggregate _______ (demand / supply ) curve will shift to the _______ (left / right). As a result, the price level will _______ (increase / decrease / not change) and output will _______ (increase / decrease / not change).

Part II: Answer one and only one of the following questions, in your own words, by writing the letter and your response on a separate row. (2 points)

c. Give and explain one of the three reasons for the downward slope of the aggregate demand curve.

d. Explain why the short-run aggregate supply curve is relatively flat below the full employment level of output and relatively steep above it.

Explanation / Answer

For each of the following, fill in the blanks by choosing from the terms in parentheses. Assume that prices are flexible upwards but not downwards. Answer a-b by writing the letter for each and giving your response on a separate row. (4 points each)

a. If a large decrease in health insurance premiums reduces national labor costs, the aggregate supply (demand / supply ) curve will shift to the right (left / right). As a result, the price level will decrease (increase / decrease / not change) and output will increase (increase / decrease / not change).

An increase in aggregate supply due to lower labor costs, will encourage firms to produce more. The result will be a decrease in price level and an increase in output.

b. If businesses become optimistic that business conditions will improve, the aggregate demand (demand / supply ) curve will shift to the right (left / right). As a result, the price level will increase (increase / decrease / not change) and output will increase (increase / decrease / not change).

If business is optimistic about the future, AD will shift to the right causing inflationary pressure.

c. Wealth effect, if PL falls then the value of wealth increases and consumption increases.

Interest rate effect: A higher price level, causes the interest rates to increase because of greater demand for money. When interest rates increase, cost of borrowing increases.

International trade effect: When exports become costlier due to increase in price level of home country, net exports will fall.

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