Problems 1

1. In 1939, with the US economy not yet fully recovered from the Great Depression, President Roosevelt proclaimed that Thanksgiving would fall a week earlier than usual so that the shopping period before Christmas would be longer. Explain what President Roosevelt might have been trying to achieve using the model of aggregate demand and aggregate supply.

2. For each of the following events, explain the short run effects on output and the price level, assuming that policymakers take no action using the model of aggregate demand and aggregate supply:

a. The stock market declines sharply, reducing consumers' wealth.

b. The federal government increases spending on national defense.

c. A technological improvement raises productivity.

d. A recession overseas causes foreigners to buy fewer US goods.

Problems 2

3. Consider two policies: a tax cut that will last one year and a tax cut that is expected to be permanent. Which policy will stimulate greater spending by consumers? Which policy will have the greater impact on aggregate demand?

4. An economy is operating with output $400 billion below its natural rate, and fiscal policymakers want to close this recessionary gap. The central bank agrees to adjust the money supply to hold the interest rate constant, so there is no crowding out. The marginal propensity to consume is 0.8, and the price level is completely fixed in the short run. In what direction and by how much would government spending need to change to close the recessionary gap?