Aggregate Supply and Aggregate Demand - Practice Quiz

Stagflation refers to a situation where there is a combination of recession and inflation in the economy. It is characterized by high unemployment rates and stagnant economic growth, along with rising prices. This term was coined during the 1970s when many countries faced simultaneous high inflation and high unemployment rates. Stagflation is considered a challenging economic condition as it presents policymakers with a dilemma on how to address both issues effectively.

Aggregate income refers to the total income earned by all individuals in an economy. Taxes are the amount of money paid to the government by individuals and businesses. Transfer payments are government payments to individuals for various reasons, such as social security or unemployment benefits. When taxes are subtracted from aggregate income and transfer payments are added, the resulting amount is known as disposable income. Disposable income represents the amount of money individuals have available for spending or saving after taxes and transfer payments have been taken into account. Therefore, the correct answer is disposable income.

When the price level rises, the purchasing power of individuals decreases, leading to a decrease in real wealth. As a result, people have less disposable income, causing a decrease in consumption. With lower consumption, businesses experience a decrease in demand for their goods and services, leading to a decrease in aggregate demand. Therefore, the correct answer is that real wealth decreases, consumption decreases, and aggregate demand decreases.

Aggregate supply is the total amount of goods and services that all industries in an economy are willing and able to produce at a given price level. It is influenced by various factors such as the quantity of labor, the state of technology, and the quantity of capital. However, the price level itself does not directly affect the aggregate supply. Instead, it is determined by the interaction of aggregate demand and aggregate supply in the economy. Therefore, the correct answer is price level.

A change in the price level does not cause the aggregate demand curve to shift. The aggregate demand curve represents the relationship between the overall price level and the quantity of goods and services demanded in an economy. Changes in factors such as monetary policy, fiscal policy, and expectations can affect the overall level of demand in the economy, causing the aggregate demand curve to shift. However, changes in the price level do not directly cause the aggregate demand curve to shift as it is already reflected in the curve itself.

In the long run, real GDP equals potential GDP because potential GDP represents the maximum level of output an economy can produce when all resources are fully utilized. In the long run, the economy adjusts to its natural level of output, which is determined by factors such as the quantity and quality of labor, capital, and technology. When real GDP equals potential GDP, it indicates that the economy is operating at its full capacity and there is no cyclical unemployment.

A recessionary gap occurs when the actual level of real GDP falls below the potential level of GDP. This means that potential GDP, which represents the maximum level of output an economy can produce without causing inflation, exceeds the actual level of real GDP. In other words, the economy is producing below its full capacity, indicating a recessionary situation.

In the short-run, the aggregate supply curve assumes that all factors remain constant except for the unemployment rate. This means that factors such as potential GDP, prices of other resources, and the money wage rate are assumed to remain unchanged. The level of unemployment, however, is considered to be a determinant of the short-run aggregate supply. Changes in the unemployment rate can affect the availability of labor and therefore impact the overall level of production in the economy.

When the price level rises but the money wage rate and other resource prices remain the same, the quantity of real GDP supplied increases. This is because as the price level increases, producers are incentivized to increase their output in order to earn higher profits. However, since the money wage rate and other resource prices remain the same, there is no increase in production costs. Therefore, the increase in output leads to an upward movement along the short-run aggregate supply curve, indicating a higher quantity of real GDP supplied.

In the short run, labor is not a fixed factor. This means that the amount of labor used can be adjusted in response to changes in production needs. Unlike capital, which refers to physical assets like machinery and equipment, labor represents the human resources involved in production. In the short run, a company can hire or lay off workers based on demand fluctuations, making labor a variable factor that can be adjusted to meet changing production requirements.