Economics 112                                                                                                         Worksheet #3

1.       The demand curve for an individual product slopes downward because consumers switch to substitutes for the product as the price rises.  Why does the aggregate demand curve for all goods and services produced in the economy (real GDP) slope downward?

2.      Briefly explain, as you would to someone who is not familiar with economics, what economists mean when they use the phrase "the natural rate of unemployment".  Likewise, explain what is meant by "potential GDP" and how it is related to the natural rate of unemployment.  Explain some of the factors that determine potential GDP and the natural rate of employment.

3.      For this question you need to think like a classical economist, act like a classical economist, and if at all possible, look like a classical economist.  Using the classical AD-AS model show how a permanent increase in aggregate demand would affect real output and the price level (if everything else that affects AD and AS remains constant).  Using a properly labeled diagram representing the labor market, show how this permanent increase in aggregate demand, in the classical model, affects employment, the average nominal wage, and the average real wage.

4.      Since the 1940's worker productivity and technology have increased in the U.S.  Using the classical AD-AS model show what effect you would expect this to have on real output and the price level (if everything else that affects AD and AS remained constant).  In the classical framework, also show what you would expect to happen in the labor market with respect to employment and average nominal and real wages.

5.      Assume that the economy is currently producing at potential GDP.  Using the appropriately labeled diagrams show and explain how a classical economist and Keynesian economist would differ in their expectations of what would happen to real output and the price level if aggregate demand were to decline due to decreased consumption and investment demand.  Also, show and explain what would happen in the labor market to average nominal and real wages, and employment.