Problem Set 2
Complete all questions listed below. Clearly label your answers 1. What impact would a change that shifts an economy’s production possibilities curve outward have on the long run aggregate supply curve? How have improvements in computer technology affected production possibilities and the long run aggregate supply curve? Explain
Answer: Growth of population and the labor-force participation rate
Improvements in technology
2. Construct the AD, SRAS, and LRAS curves for an economy experiencing: (a) full employment, (b) an economic boom, and (c) a recession. (Graphs can be hand drawn or done by computer; label all curves and axes clearly.)
a=full employment; b=boom; c= recession
3. What is a budget deficit? How are budget deficits financed? Why do Keynesians believe that budget deficits will increase aggregate demand?
Answer: A budget deficit occurs when the government spending exceeds government revenue in a given time period, usually one year. Budget deficits are financed by a country’s bonds. In the U.S., it’s financed by Treasury bills, notes and bonds. This is the government’s way of printing money. Actually, it is creating more credit denominated in that country’s currency. However, it has the same effect — it lowers the value of that country’s currency. As bonds flood the market, the supply outweighs the demand. The Keynesians believe that when aggregated demand exceeds productive capacity of the economy, the federal government can prevent inflationary overheating by reducing demand with a budget surplus generated by a combination of less spending and higher taxes.
4. When output and employment slowed in early 2008, the Bush Administration and the Democratic Congress passed a legislation sending households a check for $600 for each adult (and $300 per child). These checks were financed by borrowing. Would a Keynesian favor this action? Why or why not?
Answer: No, the Keynesian would not agree with this action because their opinion is generating a combination of less spending and higher taxes, not giving away money.
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