Explain the theory of the classical economists that flexible prices and wages ensure that the economy operates at full employ

Unit 6 Homework Assignment

Homework Assignments: 

Assignment 6 (50 points)

  1. Explain the theory of the classical economists that flexible prices and wages ensure that the economy operates at full employment.
  2. Assume the aggregate demand and aggregate supply curves intersect at a price level of 100. Explain the effect of a shift in the price level to 120 and to 50.
  1. Assume an economy operates in the intermediate range of its aggregate supply curve. State the direction of shift for the aggregate demand or aggregate supply curve for each of the following changes in c What is the effect on the price level? On real GDP? On employment?

A.  The price of crude oil rises significantly.

B.  Spending on national defense doubles.

C.  The costs of imported goods increase.

D.  An improvement in technology raises labor productivity.

4. How does each of the following affect the aggregate demand curve?

A.  Government spending increases.

B.  The amount of taxes collected decreases.

5. Why does a reduction in taxes have a smaller multiplier effect than an increase in government spending of an equal amount?

6. Consider an economy that is operating at the full-employment level of real GDP. Assuming the MPC is 0.90, predict the effect on the economy of a $50 billion increase in government spending balanced by a $50 billion increase in taxes.

7. What is the difference between discretionary fiscal policy and automatic stabilizers? How are federal budget surpluses and deficits affected by the business cycle?

8. Suppose Congress enacts a tax reform law, and the average federal tax rate drops from 30 per- cent to 20 percent. Researchers investigate the impact of the tax cut and find that the income subject to the tax increases from $600 billion to $800 billion. The theoretical explanation is that workers have increased their work effort in response to the incentive of lower taxes. Is this a movement along the downward-sloping or the upward-sloping portion of the Laffer curve?

9. Why does the aggregate demand (AD) curve slope downward? What could cause the AD curve to shift to the right? What impact would a rightward shift of the AD curve have on the economy?

Exhibit 11-1 Disposable income and consumption data

Income (Y)

Change inDisposable Income

Consumption (C)


















10.     In Exhibit 11-1, when disposable income is increased from $2,000 to $3,000 to $4,000,


total consumption increases by $1,000.


the marginal propensity to consume remains constant.


the marginal propensity to consume decreases from 0.7 to 0.6.


the marginal propensity to consume decreases from 0.8 to 0.7.

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