32. Business Fluctuations: Aggregate Demand and Supply Flashcards
Define business fluctuations.
Fluctuations of the growth rate of GDP and its trend in growth rate.
Define a recession.
A decline in real income and employment.
True or false: Economic growth is not smooth.
True.
What do AD and AS stand for?
Aggregate demand and aggregate supply.
What does aggregate mean?
Total (combination of fragments)
What are the two types of economic shocks?
1) Real shocks (aggregate supply shocks)
2) Aggregate demand shocks
What does the aggregate demand curve show?
It shows all combinations of inflation and real growth that are consistent with a specified rate of spending growth.
What does more spending plus the same goods equal?
Higher prices.
What does M stand for in the aggregate demand curve?
Growth rate in money supply.
What does v stand for in the aggregate demand curve?
Growth rate in velocity.
What does P stand for in the aggregate demand curve?
Growth rate in prices; inflation (pie).
What does Yr stand for in the aggregate demand curve?
Growth rate of real GDP (real growth).
What do the arrows on top of letters stand for in the aggregate demand curve?
Growth rate.
What does M + V (with arrows on top) also equal to?
Inflation + real growth.
How does the AD curve shift?
Along the AD curve.
How does an AD curve shift if spending growth increases?
Up and to the right (outward).
True or false: An increase in spending growth can be caused by either an increase in M or v (with arrows on top).
True.
What does economic growth depend on?
Increase in the stocks of labor and capital, and productivity.
What is the Solow growth rate?
An economy’s potential growth rate given that there are flexible prices and existing real factors of production.
What is money like in the long run?
Neutral
What is the long-run aggregate supply (LRAS) curve like? And on which axis is the inflation rate and real growth rate on?
It’s a vertical line at the Solow growth rate.
Inflation on the vertical axis, real growth on the horizontal.
What is the “real business cycle” (RBC) model used for?
Business fluctuations caused by real shocks.
What do AD and LRAS curves determine?
The equilibrium inflation rate and growth rate.
What is a consequence of real shocks (productivity shocks)?
Increase or decreases on an economy’s ability to produce goods and services.
Increases or decreased the potential growth rate.
They increase or decrease the Solow growth rate.
Are changes in the economy by real shocks rapid, moderate or slow?
Rapid
What does an aggregate demand shock entail?
A rapid and unexpected shift in the AD curve (spending).
What are “sticky” wages and prices? What curve does it relate to?
“Sticky” means not very flexible.
It related to the short-run aggregate supply (SRAS).
What are the effects of a positive shock (increase in spending) in the short run and long run?
Short-run: increased output
Long-run: increased prices (inflation)
What is the curve for short-run aggregate supply (SRAS) like?
Upward-sloping.
What is the symbol for expected inflation rate?
E(pie)
Define nominal wage.
Wage number.
When does nominal wage confusion occur?
When workers respond to wage numbers on their checks instead of what the money can actually buy.
Define menu costs.
Costs of changing prices.
Where is the actual inflation rate found?
Where the LRAS curve intersects the AD curve.
Why does an economy take a long time to adjust to a decrease in aggregate demand?
Sticky wages, menu costs and uncertainty makes businesses reluctant to change prices immediately.
What is a short run effect in a fall in aggregate demand?
It is split between a fall in inflation rates and a fall in growth.
What would a fall in aggregate demand induce in the long-run?
A recession
What do changes to V (with arrow on top) result to in the short run and long run?
Short run: decreased inflation
Long run: shifts back to equilibrium
(therefore changes are temporary)
What can tax shocks shift?
Consumption growth and investment spending growth.
What are some positive shocks that increase AD?
- confidence
- faster money growth rate
- increased wealth
- lower taxes
- increased export growth
- decreased import growth
What was the initial shock that caused the Great Depression in 1929? How did it affect people? What did it do to the AD curve?
Wealth shock (fall in stock prices).
People limited spending, so consumption fell. Money supply fell.
The AD curve shifted inwards and to the left.
What shocks followed in 1930 during the Great Depression?
Confidence shock (drop of confidence) regarding banks. People had bank runs.
What was the largest negative shock to aggregate demand in American history in 1931?
Shock for money supply, where money supply fell by about 1/3 .
The Fed’s decision not to increase money supply made the Great Depression longer than it needed to be.
What did a decrease in aggregate demand cause during the Great Depression?
A fall in prices which raised the value of debts. Many debtors went bankrupt.
Debtors spent less money, thereby decreasing aggregate demand more.
What were failures of the American Government during the Great Depression?
- Federal Reserve failed to increase money supply
- tried to combat falling prices by reducing supply
- raised tariffs (taxes) on imported goods (other countries retaliated); the tariffs were a negative productivity shock
What was a natural shock of the Great Depression?
The Dust Bowl (drought caused dust storms).
