Variations in economic activity: AD and AS practice questions.

Which of the following would shift the aggregate demand curve to the right?

• An increase in income tax rates
• A rise in consumer confidence
• An increase in the central bank's policy interest rate
• A fall in household wealth

Answer: A rise in consumer confidence

Higher consumer confidence raises consumption at every price level, shifting AD right. Higher taxes, higher interest rates and lower wealth all reduce spending and shift AD left.

A cut in interest rates stimulates aggregate demand mainly through which two components?

• Government spending and exports
• Consumption and government spending
• Consumption and investment
• Investment and exports

Answer: Consumption and investment

Lower interest rates reduce the cost of borrowing for households (durable goods, mortgages) and firms (capital goods), boosting both consumption and investment.

A sharp rise in the world price of imported oil will, in the short run, most likely:

• shift the SRAS curve to the left
• shift the SRAS curve to the right
• cause a movement along the SRAS curve
• shift the LRAS curve to the right

Answer: shift the SRAS curve to the left

Higher energy prices raise firms' costs of production at every level of output, shifting short-run aggregate supply to the left (a negative supply shock).

In the Keynesian AS model, the horizontal section of the curve indicates that:

• the economy is at full employment
• output can rise with the price level unchanged
• any increase in AD is purely inflationary
• wages are perfectly flexible in both directions

Answer: output can rise with the price level unchanged

At low output with much unused labour and capital, firms can expand production without bidding up wages or prices, so the AS curve is horizontal in this range.

In the monetarist/new classical model, an increase in AD in an economy already at full employment will, in the long run, result in:

• higher real output and a higher price level
• higher real output and an unchanged price level
• lower unemployment with stable prices
• a higher price level, real output unchanged

Answer: a higher price level, real output unchanged

With a vertical LRAS at potential output, a rightward AD shift only raises the price level in the long run; wage adjustments return output to the full-employment level.

An economy's equilibrium level of real output lies below its full-employment level of output. This situation is called:

• a deflationary gap
• an inflationary gap
• a positive output gap
• stagflation

Answer: a deflationary gap

When equilibrium output is below potential output, insufficient aggregate demand creates a deflationary (recessionary) gap, associated with cyclical unemployment.