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.
