Aggregate Demand and Aggregate Supply Flashcards
Economic Activity fluctuates from year to year:
What happens in most years?
production of goods and services rises
FACT 1: Economic Fluctuations
Economic fluctuations are irregular and unpredictable
FACT 2:Economic Fluctuations
Most macroeconomic quantities fluctuate together
FACT 3: Economic Fluctuations
As output falls, unemployment rises
What part of real GDP fluctuates most over the course of the business cycle?
Investment
Recessions
periods of falling real incomes and rising unemployment
Depressions
severe recessions
very rare
Most economists use what to study fluctuations?
model of aggregate demand and aggregate supply
What is the model of aggregate demand and aggregate supply used to explain?
the short run
What are the two groups that the Classical Dichotomy splits into?
Real: quantities, relative prices
Nominal: Measured in terms of money
The neutrality of money
changes in the money supply affect nominal but not real variables
What do most economists believe
That eh classical theory describes the world in the long run, but not the short run
A shift in the Supply curve to the left
Stagflation: Shows recession: but the prices went up, therefore inflation went up
The worst kind of recession
A shift in the Demand Curve to the left
Shows recession
An economic boom is shown by:
A shift to the right in both or either Supply and or Demand
What does the AD curve show?
the quantity of all g& s demanded in the economy at any given price level
The wealth effect (P and C)
Suppose P rises:
The dollars people hold buy fewer g&s (decrease value of money)
people feel poorer: C falls( spending falls)
The Interest-Rate Effect (P and I)
Suppose P rises:
Buying g&s requires more dollars
to get these dollars people sell bonds or other assets
This drives up interest rates
“I” falls
What happens to NX with an increase in P
increases demand for U.S dollars by foreigners, appreciates the dollar and reduces NX
An increase in P reduces the quantity of G&S demanded because
The wealth effect (C falls) The interest rate effect (I falls) exchange rate effect (NX falls)
Why the AD curve might shift
Any event that changes
C, I, G, or NX
EXCPET a change in P
Changes in C
- Stock Market boom/crash
- Preferences: such as consumption/ saving tradeoff
- Tax hikes/ cuts
Changes in I
- Firms buy new computers, equipment, factories
- Expectations, optimism/pessimism • Interest rates, monetary policy
- Investment Tax Credit or other tax incentives.
Changes in G
- Federal spending, e.g. defense
* State & local spending, e.g. roads, schools
Changes in NX
• Booms/recessions in countries that buy our
exports.
Suppose the demand for exports falls as a result of recession overseas. in the short run, the economy will likely experience
A decrease in the output (GDP)
What does the AS curve show
The total quantity of g&s firms produce and sell at any given level
The long-run aggregate supply curve (LRAS)
The natural rate of output (Yn) is
the amount of output the economy produces when unemployment is at its natural rate
Yn is also called
Potential output
or
full-employment output
Why is LRAS a vertical line… What is Yn determined by?
the economy’s stocks of labor, capital, and natural resources, and on the level of technology
An increase in P
does not affect any of the factors that Yn is determined by, therefore does not affect Yn; classical dichotomy
What causes the LRAS curve to shift?
Changes in L or natural rate of unemployment
Changes in K or H
Changes in Natural Resources
Changes in Technology
Shifts in LRAS: Changes in L or natural rate of unemployment
- Immigration
* Baby-boomers retire • Govt policies reduce natural u-rate
Shifts in LRAS:
Changes in K or H
- Investment in factories, equipment
- More people get college degrees
- Factories destroyed by a hurricane.
Shifts in LRAS: Changes in Natural Resources
• discovery of new mineral deposits
• reduction in supply of imported oil
• changing weather patterns that affect
agricultural production
Shifts in LRAS: Changes in technology
• productivity improvements from technological
progress.
If AS is vertical;
fluctuations in AD do not cause fluctuations in output or employment
If AS slopes up;
then shifts in AD do affect output and employment
Expansionary Monetary Policy
Shifts AD to the right; up
Done by the FED
Contractionary Monetary Policy
Shifts AD to the left; down
The Short Run Aggregate Supply
upward sloping;
over the period of 1-2 years, an increase in P causes an increase in the quantity of g&s supplied
Fiscal Policy
Change in G and or Tax done by the president (government)
What is the shape of Aggregate Supply in the long run?
Vertical
What is the shape of the Aggregate Supply in the short run?
Upward slope
What is the shape of the Aggregate Demand in the short run or long run?
Downward slope
The long-run Equilibrium
PE= P Y= Yn unemployment is at its natural rate PE= Expected Price Yn= Potential level of GDP
Economic Fluctuations
Caused by events that shift the AD and or AS curves
Four Steps to analyzing economic fluctuations
- Determine whether the event shifts AD or AS
- Determine whether curve shifts left or right
- Use AD-AS diagram to see how the shift
changes Y and P in the short run 4. Use AD-AS diagram to see how economy
moves from new SR eq’m to new LR eq’m.
Suppose a stock market crash makes people feel poorer. In the AD-AS model this would shift
Aggregate Demand to the left
The economic boom of the early 1940s resulted mostly from
increased government expenditures
During the 2008-2009 Recession unemployment rose from about 4.4% to about
10.1%
What played a major role in the 2008-2009 recession
the housing market
During the Recession of 2008-2009 how much did the GDP fall?
about 4%
Rising house prices during 2002-2006 is due to:
Low interest rates
easier credit for “sub-prime” borrowers
government policies to increase homeownership
securitization of mortgages
The recession of 2008-2009 could have been the result of
Losses in the financial market which caused AD to shift to the left
The Effects of a Shift in SRAS
Event: Oil Prices Rise
- Increase in costs shifts the SRAS (assuming that LRAS is constant)
- SRAS shifts left
- SR equilibrium at the new point is higher, Y is lower, unemployment is higher
The Effects of a Shift in SRAS
Event: Oil Prices Rise
If policy makers do nothing
Low employment causes wages to fall, SRAS shifts right until LR equilibrium back to point “A”
Which of the following causes the short run aggregate supply curve to shift left?
an increase in the price of oil
How do economists analyze fluctuations?
using the model of aggregate demand and aggregate supply
