ECON1220-GJK: Introductory Macroeconomics

Spring 2024
Chi-Wa Yuen
Answer Key for Mid-Term Test

Part A: Short-Answer Questions (80 points)

(Q1) Movements along the AS curves [15 points]

As the economy moves up/right-ward from point B to point D along the (upward-
sloping) SRAS curve, the price level (P ) would rise along with the quantity of output
supplied (Y s )— i.e., PB < PD and YBs < YDs :

1.1) The quantity of labor services (N ) supplied by the workers at point B is

smaller than that at point D.

P " =) a drop in the real wage, i.e., w# = W =P " or wB > wD ; given the …xed
nominal wage W or WB = WD .
w# =) a down/left-ward movement along the (upward-sloping) labor supply
curve, thus resulting in a fall in the quantity supplied of labor, i.e., NBs > NDs .
Note that this question is about the quantity of labor “supplied”(rather than the
quantity “demanded” or “equilibrium” quantity). So only the quantity on the
N s -curve matters here.
Thus the statement is FALSE.

1.2) The real rate of rental return on capital (rk ) at point B is the same as that
at point D.

Although the drop in real wage would induce workers to supply less labor to the
labor market (i.e., N s# ) (as explained in Q1.1 above), it would, however, result in
a rise in equilibrium labor employment (N )— as N is determined by labor demand
alone (“let the boss decide”)— i.e., w# =) N " or NB = NBd < NDd = ND :
Under the …xed production technology (A or AB = AD ) and capital stock (K or
KB = KD ), it is this increase in labor employment which actually contributes to
the rise in output supplied (Y s ).
Given factor complementability, the rise in labor employment would raise the
marginal productivity of capital M P K " and cause an increase (up/right-ward
shift) in the demand for capital inputs, thus resulting in a rise in (the demand-
determined) real rental— i.e., rk" or rkB < rkD .
But the increase in capital demand would not a¤ect capital employment (i.e.,
KB = KD ), which is supply-determined.
Thus the statement is FALSE.

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1.3) The long-run aggregate supply (LRAS) curve must have shifted to the left
as the economy moves downward along the SRAS curve from point D to
point B.

For any given labor contract (or any given nominal wage), there is only one point
where the SRAS curve intersects the LRAS curve.. But that intersection point
need NOT be point B nor point D.
So the LRAS curve can be anywhere in the Y s -P quadrant as we move down the
SRAS curve from point D to point B:
But SRAS shares the same building blocks with LRAS (viz., N s -curve, N d -curve,
K s -curve, K d -curve, and the production function), it is hard to conceive a shift
in LRAS while we are considering a movement along, rather than a shift in, the
SRAS curve.
The only exception is perhaps a change in labor supply.
Thus the statement is FALSE.

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(Q2) Shift of AS due to technical progress [25 points]

Such technology innovation would shift the entire production function (3D surface)
upward, just like a rise in the productivity parameter from A0 to A1 in the production
function.

As a result, the marginal productivities of labor and capital inputs would increase
simultaneously, so that demand for both inputs would rise together.

Capital employment would remain unchanged as it is supply-determined.

But the rise in labor demand would increase labor employment in both the long and
short runs.

Combined with a new and better technology, the bigger labor inputs would help pro-
duce bigger outputs. In other words, aggregate supply would increase in both the long
and short runs.

Summary of e¤ects of (labor-augmenting and capital-augmenting) technical progress

2.1) supply of capital input

K s -curve unchanged

2.2) demand for capital input

K d -curve% due to M P K " (and to factor complementarity)

2.3) supply of labor input

N s -curve unchanged

2.4) demand for labor input

N d -curve% due to M P N "

2.5) the production function, including the relation (production curve) between labor input
and output

both the 3D-surface and the 2D-curve would shift upward as the productivity
parameter takes on a bigger value A"

2.6) LRAS

Upward shift in demand for capital inputs K d (:) = M P K without any change
in supply would leave capital employment unchanged K :
Upward shift in demand for labor inputs N d (:) = M P N without any change in
supply would increase labor employment (N " from N0 to N1LR ) [cf. intersection
between new N d (:) and old N s (:) curves].

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 LR
At any given P -level, new output Y1s = A1 F N1LR ; K0 would be bigger than
Y0s = A0 F (N0 ; K0 ), given A1 > A0 and N1LR > N0 : In other words, LRAS shifts
to the right.
LRAS shifts rightward

2.7) SRAS

Upward shift in demand for capital inputs K d (:) = M P K without any change
in supply would leave capital employment unchanged.
Upward shift in demand for labor inputs N d (:) = M P N would increase labor
employment at the original w-level (N " from N0 to N1SR )— resulting in over-full
employment or EDN; with N1SR = N1d (w0 ) > N s (w0 ) : Observe that 4N SR >
4N LR :
SR
At any given P -level, new output supplied Y1s = A1 F N1SR ; K0 would be
bigger than Y0s = A0 F (N0 ; K0 ), given A1 > A0 and N1SR > N0 : In other words,
SRAS shifts to the right. Observe that the horizontal displacement of SRAS
is bigger than that of LRAS— i.e., bigger quantity adjustment due to W -rigidity
(restricted price adjustment).
SRAS shifts right/down-ward

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(Q3) Movement along the AD curve [15 points]

As the economy moves down/right-ward from point B to point D along the (downward-
sloping) AD curve, the price level (P ) would fall while the quantity of output demanded
Y d would rise— i.e., PB > PD and YBd < YDd :

3.1) The level of capital investment (I) made by business …rms at point B is the
same as that at point D:

An increase in income Y " implies1

– an increase in saving S " and thus an increase in the supply of loanable
funds— i.e., a down/right-ward shift in the Ls -curve
– a decrease in net exports N X # and thus a decrease in the demand for
loanable funds— i.e., a down/left-ward shift in the Ld -curve
The increase in Ls and decrease in Ld would together imply a fall in the real rate of
interest rcredit # , which would in turn imply a rise in the level of investment— i.e.,
I " or IB < ID .
Thus the statement is FALSE.

3.2) The total quantity of real balance demanded by people at point B is higher
than at point D:

P # =) a rise in the quantity of real balances of money supplied by the cen-

tral bank, i.e., ms" = M s =P # or msB < msD ; given the …xed nominal balances
M s or MBs = MDs .
In equilibrium, the total quantity of real balances demanded by people would
increase by the same amount as ms : In other words, mdB < mdD : Both components
of money demand would be higher — asset/speculative demand due to the fall
in interest rate (RB > RD ) following the increase in (msB < msD ) and transaction
demand due to the rise in income YBd < YDd :
Thus the statement is FALSE.

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The rise in income would also increase the (transactions) demand for money— i.e., up/right-ward shift in
the md -curve. As a result, the nominal rate of interest would rise Rmoney " ; thus creating an interest-rate
gap rcredit < rmoney : This r-gap would be closed via a fall in the price level P # as the economy moves
from point B to point D: Hence, we know that both r and R would be lower at D than at B; so that
IB < ID .

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3.3) Both the SRAS and LRAS curves must have shifted to the left as the econ-
omy moves upward along the AD curve from point D to point B:

Only one point (call it E SR , for equilibrium) on the AD curve, where it intersects
the SRAS curve, would be the short-run equilibrium. That equilibrium point
need NOT be point B nor point D.
Similarly, only one point (call it E LR , for equilibrium) on the AD curve, where it
intersects the LRAS curve, would be the long-run equilibrium. That equilibrium
point need NOT be point B; nor point D; nor point E SR .
Since the AD curve is derived independently of SRAS and LRAS; the 3 curves
don’t necessarily have to intersect at common points such as B and D: Unless
“point B” = EBSR = EBLR and “point D” = ED SR
= EDLR
; a downward movement
along AD from point B to point D need NOT involve any shift in SRAS and/or
LRAS.
Thus the statement is FALSE.

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Part B: Multiple-Choice Questions (20 points)

Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10
A C C B C D D A B C

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