Comprehensive Analysis: Aggregate Models and Macroeconomic Policies

This assignment delves into the intricacies of aggregate models and macroeconomic policies, offering a detailed analysis of key economic principles. The student evaluates the truth or falsity of statements concerning the short-run and long-run aggregate supply curves, the impact of monetary policy on aggregate demand, and the causes of stagflation. Furthermore, the assignment explores the money market, examining the relationship between real money demand and supply, and the roles of fiscal and monetary policies in influencing macroeconomic activities. The analysis includes explanations and supporting rationale for each answer, providing a comprehensive understanding of the concepts discussed. The student also presents a discussion of equilibrium in the money market and the influence of reserve requirements, illustrating the concepts with graphs and economic models.

Running head: AGGREGATE MODELS AND MACROECONOMIC POLICIES
Aggregate Models and Macroeconomic Policies
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1AGGREGATE MODELS AND MACROECONOMIC POLICIES
Table of Contents
Part 1................................................................................................................................................2
Answer 1......................................................................................................................................2
Part 2................................................................................................................................................3
Answer 1......................................................................................................................................3
References........................................................................................................................................6

2AGGREGATE MODELS AND MACROECONOMIC POLICIES
Part 1
Answer 1
a.The given statement is false.
The short run supply curve shows the relation between aggregate output and price level in
the short run. The supply curve in the short run slopes upward because aggregate supplied
quantity increases with increase in prices. In the short run, firms have at least one fixed
production input (normally capital). As the curve shifts rightward, there is an increase in real
GDP and aggregate output at the given price (Goodwin et al., 2015). This indicates a positive
correlation between output and price level. This positive correlation between output and price is
reflected in the upward sloping short run supply curve.
b. The given statement is false.
The long run aggregate supply curve is vertical at the level of potential output. The long
run supply curve though changes slowly but it is not true that long run can never be shifted. The
supply curve in the long run can shift due to a change in quantity of factor of production. For
example, if the number of workers available increase or if there is an increase labor hours, then
the supply curve shifts rightward (Gandolfo, 2016). An improvement in technology can also shift
long run supply curve outward by increasing potential output with the same amount of output.
c. The given statement is true.
Either a decrease in nominal money supply or an increase in price level means a decrease
in real money balance. Decrease in money supply shifts the real money curve to the left. Given
the money demand, a decrease in real money supply increases the interest rate. As interest rate

3AGGREGATE MODELS AND MACROECONOMIC POLICIES
increases, there is a decline in investment, which lowers the aggregate demand in the economy.
The decline in aggregate demand shifts the aggregate demand cure to the left.
d. The given statement is true.
Keynes defines short run aggregate supply curve as a horizontal. In the Keynesian model,
supply curve in the short run remains flat. During recession, the price level remains constant.
This is observed in the Keynesian zone of short run supply curve (Uribe & Schmitt-Grohe,
2017). The short run supply curve as described by Keynes is suitable for recessionary trend of
decline in real GDP keeping prices at the same level.
e. The given statement is false.
Stagflation refers to the economic condition of a slow economic growth resulting in a
relatively high rate of unemployment. In other words, it defines economic stagnation that is
accompanied by a higher price level or inflation. Stagflation therefore occurs when high inflation
is combined with low output and low income resulted from considerable increase in major inputs
(Heijdra, 2017). When the aggregate demand shifts out on the upward sloping portion of short-
run aggregate supply curve, this indicates an expansion of aggregate demand. In response to a
higher demand, both real GDP and price level increases, which does not indicate a situation of
stagflation.
Part 2
Answer 1
1. The given statement is true.

4AGGREGATE MODELS AND MACROECONOMIC POLICIES
When demand of a good exceeds the available supply, there exists a shortage of the good.
In the presence of supply shortage in the market, equilibrium price increases to reduce the
demand. Similar is the situation in the money market when real money demand is larger than real
money supply. As money, demand is greater than supply there is a shortage of money. People
then sells bond to obtain more money (Johnson, 2017). Increase in supply bonds lowers the bond
price. Firms the issue bonds at a higher interest rate in order to recover the loss in price.
Figure 1: Shortage of money in the money market
2. The given statement is false.
Policymakers in an economy have two policy tools to influence macroeconomic
activities- fiscal policy and monetary policy. Fiscal policy is worked through adjustment in
government spending or taxes. Adjustment in the money supply, which influences interest rate, is
part of the monetary policy. Both fiscal and monetary policies are used as a primary tool to
impact macro economy by affecting aggregate demand.
3. The given statement is false.

5AGGREGATE MODELS AND MACROECONOMIC POLICIES
Reserve requirements refer to the certain proportion of reserves that commercial banks
have to keep in the central banks. The reserve ratio influences money supply in the economy by
influencing available reserves in the bank. If reserve requirement decreases, there is a greater
proportion of reserves available in banks. The banks can then lend a larger amount of money
because of an increased reserve (Mitchell, 2019). This in in turn increases supply of money in the
economy. A decrease in reserve requirement thus increases money supply instead of decreasing
money supply as banks have more resources.
4. The given statement is true.
Money demand refers to the amount of money that people willing to hold at a certain point of
time. Interest rate is the opportunity cost of holding money and is inversely related with money
demand. Higher money demand shows people and businesses are more willing to spend on
goods and services, Reverse is the case with lower money demand (Keen, 2015). The real money
demand curve that depicts the relation between money demand and interest rate thus show how
household and businesses change their spending in response to change in the interest rate.
5. The given statement is false.
Real money supply in an economy depends on both nominal money supply and price level. Rea
money supply obtained as nominal money supply divided by price level. Change in either
nominal money supply or price level or both affect the real money supply. An increase in
nominal money supply increases real money supply and shifts the real money supply curve to the
right. An increase in price level reduces value of money in real terms (Fontana & Setterfield,
2016). This decreases the real money supply. Higher price level therefore means a lower real
money balance, which shifts the real money supply curve to the left.

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References
Fontana, G., & Setterfield, M. (Eds.). (2016). Macroeconomic theory and macroeconomic
pedagogy. Springer.
Gandolfo, G. (2016). International Finance and International Macroeconomics: An Overview.
In International Finance and Open-Economy Macroeconomics (pp. 3-9). Springer,
Berlin, Heidelberg.
Goodwin, N., Harris, J. M., Nelson, J. A., Roach, B., & Torras, M. (2015). Macroeconomics in
context. Routledge.
Heijdra, B. J. (2017). Foundations of modern macroeconomics. Oxford university press.
Johnson, H. G. (2017). Macroeconomics and monetary theory. Routledge.
Keen, S. (2015). The macroeconomics of endogenous money: response to Fiebiger, Palley and
Lavoie. Review of Keynesian Economics, 3(4), 602-611.
Mitchell, W. (2019). Macroeconomics. Macmillan International Higher Education.
Uribe, M., & Schmitt-Grohe, S. (2017). Open economy macroeconomics. Princeton University
Press.