Tuesday 2 March

For questions 1 through 4, for the event listed on its own, indicate whether

    1. aggregate demand increases,
    2. aggregate supply increases,
    3. both aggregate demand and aggregate supply increase, or
    4. neither changes.

1. Technology improves, increasing both productivity [output from existing resources] and investment in the new technology.

(c) "output from existing resources" increasing indicates aggregate supply has increased, i.e. moved to the right; but "investment in the new technology" is part of I, part of aggregate demand [C + I + G + (X - M)], so if that increases aggregate demand has increased too.

2. There is a change in the social security system, leading to a reduction in payroll taxes but an equal increase in (compulsory) savings in individual accounts.

(d) taxes went down, increasing disposable income (which would be expected to increase C, part of AD), BUT savings went up by an equal amount, so consumption does not change, aggregate demand does not change. This is the simple answer. A more sophisticated answer if you were writing rather than picking a multiple choice response would be to realize that even if compulsory, savings are savings, so there might be some substitution between the new compulsory savings and savings already being made, so consumption probably would go up a bit -- in other words, when the taxes were reduced, disposable income was increased and so you might expect consumption to go up even if the tax is replaced with equal compulsory savings -- people might reduce their (previous) voluntary savings some. In that case, (a), aggregate demand increasing, would be the correct answer.

3. The federal government reduces income taxes by $500 per person.

(a) Simpler; here disposable income clearly increases, so C increases, so AD increases.

  1. The world price of soybeans (a major US export) increases.

(a) again. This implies that X, exports, part of AD, increases, so AD increases.