Aggregate demand and aggregate supply Flashcards
Recession
period of declining real incomes and rising unemployment. 2 quarters of negative GDP, and it is announced by National Bureau of Economic research.
Three facts about economic fluctuations
- economic fluctuations are irregular and unpredictable
- Most macroeconomic quantities fluctuate together
- as output falls, Unemployment rises
Most common variable to monitor short-run changes in the economy and why?
real GDP because it is the most comprehensive measure of economic activity. Real GDP measures the value of all final goods and services produced within a given period of time.
Do macroeconomic variables fluctuate together at the same amounts? Give examples
They do fluctuate together but by different amounts. Example is investment spending that averages about one seventh of GDP, but declines in investment account for 2/3 of the declines in GDP during recessions
What happens to unemployment as real GDP declines
the rate of unemployment decreases because firms produce a smaller quantity of goods and services and lay of workers
Classical dichotomy
separation of variables into real and nominal variables. According to this theory, changes in the money supply affect nominal variables but not real variables in the long run thus resulting in monetary neutrality
Monetary neutrality
Changes in the money supply don’t affect real variables in the long run
What is the purpose the model of aggregate demand and aggregate supply
to focus on the interaction of real and nominal variables in the short run because monetary neutrality doesn’t apply in the long run
Output is a ____ variable, while price level is a ______________ variable
output is real, whereas price level is variable
Output of goods and services is measured by______________. The level of prices is measured by __________
output is measured by real GDP and level of prices is measured by CPI or GDP deflator
Model of aggregate demand and aggregate supply
model that most economists use to explain short-run fluctuations in economic activity around its long-run trend
aggregate demand curve
curve that shows quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level.
Aggregate supply curve
quantity of goods and services that firms produce and sell at each price level.
Price level and consumption: the wealth effect
When the price level falls the dollars you are holding rise in value, which increases your real wealth and ability to buy goods and services. A decrease in the price level raises the real value of money and makes consumers wealthier, encouraging them to spend more. The increase in consumer spending means a larger quantity of goods and services demanded. An increase in the price level reduces the real value of money and makes consumers poorer, reducing consumer spending
Price level and investment: the interest-rate effect
When price level falls, households try to reduce their holdings of money by lending some of it out. As households try to convert some of their money into interest-bearing assets, they drive interest rates down. Interest rates affect spending on goods and services as lower interest rates encourage borrowing and thus new plants and equipment and spending. This increases the quantity of goods and services.
A lower price level reduces the interest rate, encourages greater spending on the investment goods, and increases the quantity of goods and services demanded.
Price level and net exports: the exchange rate effect
When a fall in the US price level causes US interest rates to fall, thereal value of the dollar declines in foreign exchange markets. This depreciation stimulates US net exports and increases quantity of goods and serces demanded. When US prices level rises and casus US interest rates to rise, the real value of the dollar increases, and this appreciation reduces US net exports and quantity of goods and services demanded
Why might the aggregate demand curve shift?
Changes in consumption, investment, Government purchases, or net exports
What are shifts in the AD curve from consumption?
Event like (tax cut/ stock market boom) that makes consumers spend more at a given price level shifts the AD curve to the right. Conversely, a tax hike/stock market decline shifts AD to the left
What are shifts in the AD curve from investment?
Even that makes firms invest more at a given price level (optimism about the future, a fall in interest rates due to an increase in the money supply) shifts the AD to the right. Pessimism about future/rise in interest rates due to a decrease in the money supply shifts the AD to the left
What are shifts in the AD curve from Government Purchases?
Increase in gov purchases of goods and services (greater spending on defense or highway construction) shifts AD curve to the right. Cutback in defense or highway spending shifts AD to the left
What are shifts in the AD curve from Changes in Net exports?
Event that raises spending on net exports at a given price level (boom overseas, speculation that causes an exchange-rate depreciation) shifts AD curve to the right. Recession overseas, speculation that causes an exchange-rate appreciation shifts AD to left
in the long run, the AS supply curve is _____, and in the short run ,the AS is
vertical in long run, but upward sloping in the short run
Why does the short run aggregate supply curve slope upward?
The sticky-wage theory, sticky-price theory, and misperceptions theory
Sticky wage theory
An explanation for the SRAS curve sloping upward. It says an unexpectedly low price level raises real wage, which causes firms to hire few workers and produce a small quantity of goods and services
Sticky-price theory
An explanation for the SRAS curve sloping upward. It says an unexpectedly low price level leaves some firms with higher than desired prices, which depresses their sales and leads them to cut back production
Misperceptions theory
An explanation for the SRAS curve sloping upward. An unexpectedly low price level leads some suppliers to think their relative prices have fallen, which induces a fall in production
Why might the SRAS curve shift?
Changes in Labor, Capital, Natural resources, Technology, or Expected Price level
Stagflation
A period of falling output and rising prices (inflation).
Natural rate of output
the production of goods and services that an economy achieves in the long run when unemployment is at its normal rate
Shifts in SRAS curve from changes in labor
increase in quanity of labor available (fall in the natural rate of employment) shifts the AS curve to the right. Decrease in quantity of labor available shifts AS curve to left
Shifts in SRAS curve from changes in capital
increase in physical or human capital shifts aggregate supply curve to the right. Decrease in physical or human capital shifts AS curve to left
Shifts in SRAS curve from changes in natural resources
increase in availability of Nat Resources shifts AS curve to the right. Decrease in nat resources shifts AS to left.
Shifts in SRAS curve from changes in technology
Advance in technological knowledge shifts AS to right. Decrease in available tech (perhaps due to gov regulation) shifts curve to left
Shifts in SRAS curve from changes in expected price level
decrease in expected price level shifts SRAS to right. Increase in expected price level shifts SRAS to left
Why is the supply curve vertical in the long run?
because the overall level of prices don’t affect the economy’s ability to produce goods and services
What constitutes productivity?
physical capital, human capital, natural resources, technological knowledge
…the government can raise productivity by encouraging saving and investment, get investment from abroad, education, and health and nutrition, R&D, and growing the population
