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8 May, 2015 - 11:44

Supply side policies can be shown by attributing periods of stagflation (high prices and low level of output) to upward shifts of aggregate supply. The recommended policy would then not be an increased aggregate demand which adds to inflation, but instead a shift in aggregate supply downward by cutting costs of production.

During the 1980's, the American administration has attempted to control the economy by paying more attention to the supply side of the economy. Specifically, costs of production are affected by regulations, restrictions and subsidies enacted by government bodies.

Review Quiz

  1. What (2) words are used to designate the sum total of what the entire population of a country plans to purchase? ............. ...........
  2. True or False: Keynesian theory explains periods of recession, which classical theory ignored.
    1. true,
    2. false,
    3. no valid answer.
  3. True or False: In the Keynesian view, banks are capable to make more investment possible than there is saving.
    1. true,
    2. false,
    3. no valid answer.
  4. True or False: The classical theory is founded on laissez faire.
    1. true,
    2. false,
    3. no valid answer.
  5. What part of aggregate demand will be affected most if interest rates rise?
    1. food and related items,
    2. electricity and fuel,
    3. eating out and other services,
    4. cars and home appliances.
  6. Which of the following is NOT part of the Keynesian argument that investment and saving do not equate?
    1. investors and savers are separate groups,
    2. different motivation of savers and investors,
    3. Say's law,
    4. money balances may be idle.
  7. The focus of the classical range of aggregate supply is on changes in
    1. prices,
    2. inflation,
    3. wealth,
    4. quantities.
  8. Unutilized resources and price rigidity on the down side will result in prices not changing much in which of the three ranges?
    1. classical,
    2. Keynesian,
    3. intermediate,
    4. intermediate and classical.
  9. Which one of the following groups of economists pays more attention to quantity adjustments by firms than price adjustments (over the business cycle)?
    1. classical economists,
    2. supply-side economists,
    3. monetarists,
    4. Keynesian economists.
  10. Which of the following is NOT a proposition of the classical theory?
    1. prices and wages are flexible,
    2. supply creates its own demand,
    3. unemployment does not disappear,
    4. no unvoluntary unemployment exists.
  11. Which of the following correctly summarizes Say's law?
    1. returns are diminishing after a certain output level,
    2. price and quantity are inversely related,
    3. supply creates its own demand,
    4. supply is upsloping.
  12. Aggregate demand is affected by prices because when prices increase
    1. interest rates decrease,
    2. people usually buy more,
    3. the purchasing power of money balances decreases,
    4. money is worth more.
  13. Which of the following is a foremost reason why prices and wages may not be flexible?
    1. prohibition of price fixing,
    2. government supervision over banks,
    3. monopolistic power (for instance, of unions),
    4. foreign trade restrictions (for instance, with tariffs).
  14. The intermediate range of aggregate supply reflects
    1. wealth changes only,
    2. quantity changes only,
    3. price changes only,
    4. simultaneous price and quantity changes.
  15. In the introductory graph where aggregate supply is made of 3 sections, which is the classical section?
    1. vertical,
    2. horizontal,
    3. intermediate,
    4. 45 degree angle.
  16. The classical theory proposes that investment and saving are equal because
    1. prices and quantities change,
    2. unemployment disappears,
    3. interest rates adjust to make them equal,
    4. a ratchet effect takes place.


  2. A
  3. A
  4. A
  5. D
  6. C
  7. A
  8. B
  9. D
  10. C
  11. C
  12. C
  13. C
  14. D
  15. A
  16. C


  1. Outline the basic propositions of the classical theory. What are their views about individual markets?
  2. Outline the essence of Keynesian critique of the classical theory.
  3. Compare the views offered in the classical theory and the Keynesian model on what should be done about the business cycle.
  4. Draw the 3 ranges of aggregate supply in the introductory graph. Explain each.
  5. In the introductory graph, discuss what would happen if the aggregate demand is shifted in the Keynesian range, then if it is shifted in the classical range.
  6. Show in the introductory graph how policies dealing with unemployment would work. Explain.
  7. Show in the introductory graph how policies intended to deal with inflation are supposed to work. Explain.
  8. In the introductory graph, show and explain what would be accomplished by shifting aggregate supply.