APM 3.7-3.9 Long-Adjustments & Fiscal Tools

Short-Run vs. Long Run
What characterizes the short-run aggregate supply curve?

• • It is vertical.

• • It is horizontal.

• • It is upward sloping.

• • It is downward sloping

Answer explanation

Rationale: The short-run aggregate supply curve is upward sloping due to sticky wages and prices.
Incorrect Answers:

• A) Vertical: This describes the long-run aggregate supply curve, not the short-run.

• B) Horizontal: This could represent a situation of perfect elasticity in a short-run context but is not accurate for aggregate supply.

• D) Downward sloping: This is not representative of aggregate supply, as it typically rises with higher prices in the short run.

SHORT-RUN VS. LONG RUN

What happens to wages in the long run?

• • They remain constant.

• • They are flexible and adjust.

• • They decrease indefinitely.

• • They increase indefinitely.

Answer explanation

• Rationale: In the long run, wages adjust to reflect economic conditions, leading to a vertical LRAS.
  Incorrect Answers:

  • A) Remain constant: Wages do not stay fixed; they adjust based on supply and demand dynamics.

  • C) Decrease indefinitely: While wages may fall in certain conditions, they do not do so indefinitely and will eventually adjust back.

  • D) Increase indefinitely: Wages may rise but are influenced by various factors and not guaranteed to rise indefinitely.

SHORT-RUN VS. LONG RUN

The main difference between short-run and long-run economic analysis is:

• • Timeframe.

• • Changes in resource prices.

• • Government intervention.

• • Demand levels.

Answer explanation

Rationale: The difference is primarily about how quickly resources adjust to economic changes.
Incorrect Answers:

• A) Timeframe: While time may play a role, the critical factor is the adjustment of prices and wages.

• C) Government intervention: This does not define the short-run versus long-run distinction, as both can involve government actions.

• D) Demand levels: Changes in demand can happen in both short and long runs, but they do not define the distinction.

SHORT RUN-RECESSIONARY GAP TO LONG-RUN EQUILIBRIUM
What is indicated by a recessionary gap?

• • Actual output exceeds potential output.

• • Actual output is less than potential output.

• • Full employment is achieved.

• • Unemployment is at the natural rate.

Answer explanation

Rationale: A recessionary gap occurs when actual output is below the full employment level.
Incorrect Answers:

• A) Exceeds potential output: This describes an inflationary gap, not a recessionary gap.

• C) Full employment is achieved: This is incorrect; a recessionary gap indicates that full employment is not being met.

• D) Unemployment is at the natural rate: A recessionary gap is characterized by unemployment being above the natural rate.

SHORT-RUN RECESSIONARY GAP TO LONG-RUN EQUILIBRIUM
How do lower wages affect the short-run aggregate supply curve?

• • They shift the SRAS curve to the left.

• • They shift the SRAS curve to the right.

• • They do not affect the SRAS curve.

• • They lead to an increase in unemployment.

Answer explanation

Rationale: Lower wages reduce production costs, shifting the SRAS curve to the right.
Incorrect Answers:

• A) Shift to the left: This would indicate rising production costs, which is opposite of what lower wages do.

• C) No effect on SRAS curve: Lower wages will impact production costs and therefore shift the SRAS curve.

• D) Increase in unemployment: While lower wages can sometimes increase unemployment, they primarily lead to shifts in supply curves, not necessarily a direct increase in unemployment.

SHORT-RUN RECESSIONARY GAP TO LONG-RUN EQUILIBRIUM
Which type of unemployment is likely to rise during a recessionary gap?

• • Frictional unemployment.

• • Structural unemployment.

• • Cyclical unemployment.

• • Seasonal unemployment

Answer explanation

1. Rationale: Cyclical unemployment increases due to economic downturns, as seen in recessionary gaps.
   Incorrect Answers:

   • A) Frictional unemployment: This is related to transitional job seekers and is not directly tied to economic downturns.

   • B) Structural unemployment: This type is due to changes in the economy and does not necessarily correlate with cyclical downturns.

   • D) Seasonal unemployment: This occurs due to seasonal work patterns and is not directly linked to a recession.

SHORT-RUN INFLATIONARY GAP TO LONG-RUN EQUILIBRIUM

An inflationary gap occurs when:

• • Actual output is less than potential output.

• • Actual output exceeds potential output.

• • Full employment is achieved.

• • Unemployment is at the natural rate.

Answer explanation

Rationale: An inflationary gap happens when actual output surpasses the full employment level.
Incorrect Answers:

• A) Less than potential output: This describes a recessionary gap, not an inflationary one.

• C) Full employment is achieved: While there may be high employment, inflationary gaps indicate that output is above potential.

• D) Unemployment is at the natural rate: This is incorrect; an inflationary gap typically occurs when unemployment is below the natural rate.

SHORT-RUN INFLATIONARY GAP TO LONG-RUN EQUILIBRIUM

What happens to wages during an inflationary gap?

• • Wages decrease.

• • Wages remain constant.

• • Wages increase.

• • Wages fluctuate unpredictably.

Answer explanation

Rationale: In an inflationary gap, high demand leads to increased wages due to labor shortages.
Incorrect Answers:

• A) Decrease: Wages typically rise in response to increased demand for labor during inflationary periods.

• B) Remain constant: This would not reflect the economic dynamics of an inflationary gap.

• D) Fluctuate unpredictably: While wages can fluctuate, they generally trend upward in this context due to demand pressures.

SHORT-RUN INFLATIONARY GAP TO LONG-RUN EQUILIBRIUM
The leftward shift of the SRAS curve is primarily caused by:

• • Decreased consumer confidence.

• • Rising input costs.

• • Lower production levels.

• • Decreased wages.

Answer explanation

Rationale: Rising input costs, including increased wages, push the SRAS curve leftward, reducing aggregate supply.
Incorrect Answers:

• A) Decreased consumer confidence: This can affect aggregate demand but does not directly shift the SRAS curve.

• C) Lower production levels: This is an outcome of a leftward shift but not a cause of it.

• D) Decreased wages: Lower wages would typically shift the SRAS curve to the right, not left.

LONG-RUN TO SHORT-RUN AND BACK
What causes the economy to shift from long-run to short-run equilibrium?

• • Changes in government policies.

• • Shifts in aggregate demand or supply.

• • Changes in the natural rate of unemployment.

• • Fluctuations in inflation rates

Answer explanation

Rationale: Shifts in aggregate demand or supply cause the economy to move from long-run to short-run equilibrium.
Incorrect Answers:

• A) Changes in government policies: While policies can influence aggregate demand, they are not the only cause of shifts.

• C) Changes in the natural rate of unemployment: This impacts the long-run equilibrium but does not cause shifts directly.

• D) Fluctuations in inflation rates: Inflation can be a result of shifts but does not inherently cause shifts in equilibrium.