Aggregate Demand/Supply Flashcards
3 Facts about economic fluctuations
1) Irregular + Unpredictable
2) Most macro quantities fluctuate together
3) Reducing Output –> Increased unemployment
What is classical theory
1) Says need to look behind veil (look past nominal variables) and look at real variables
2) Applies in long run but not in short run
Aggregate-Demand + Aggregate Supply Curve
1) Like supply + demand curve
2) Vertical axis = price level, horizontal = quantity of output
3) idea is that output/price level adjust to point where two lines intersect
Aggregate Demand Curve
1) Decrease in economy’s overall level of prices –> raises quantity of goods + services demanded
2) As price level falls –> real wealth rises, interest rates fall –> stimulates spending on consumption, investment, NX –> increasing # goods/services demanded
Explain why price level dropping increases spending
1) Wealth effect:
2) Interest Rate effect:
3) Exchange Rate effect:
Wealth Effect from dropping price level
Decreased price level –> increases real value of money –> consumers are wealthier –> spend more
Interest rate effect from dropping price level
Decreased price level –> reduced interest rate –> encourages spending on investment goods –> increased quantity goods/services demanded
Exchange Rate effect from dropping price levels
Decreased price level –> reduced US interest rates –> real value of dollar declines in foreign markets –> stimulates net exports –> increases quantity goods/services demanded
Why does aggregate demand curve shift
1) Changes in consumption (cut in taxes –> shifts right bc ppl spend more)
2) Changes in investment (more investment –> shifts right)
3) Changes in money supply (increased $ supply –> lower interest rate –> demand shifts right)
4) Government purchases
5) Changes in net exports (more net exports –> shift right)
Aggregate Supply Curve LR
1) in LR –> vertical bc price level does not affect long run determinants of real GDP
Changes in long run aggregate supply
1) Changes in labor (increased unemployment –> shift left, increased immigration –> shift right)
2) Changes in capital (increase in capital –> increases productivity + shifts right)
3) Changes in natural resources (finding more natural resources –> shift right)
4) Changes in Tech knowledge (robots + free trade –> shift right)
Natural level of output
1) the production of goods and services that an economy achieves in the long run when unemployment is at its normal rate
2) Changes that affect natural level of output shift LR Aggregate supply
Explain why inflation happens using LR Aggregate supply + demand
1) Tech knowledge shifts LR Supply to right
2) Fed increases money supply –> shifts demand to the right
3) resulting intersections keep going up in price level –> more inflation
Why does short run ag. supply slope upward
1) Sticky-Wage theory: nominal wages slow adjusting to economic conditions –> if price level lower than expected –> firms reduce # of ppl they hire (since its expensive) –> reducing quantity supplied
2) Sticky-Price theory: expensive to change prices in response to economic changes –> firms keep higher prices BUT lose customers –> downscale
3) Misperceptions: price level changes mislead suppliers + output, ex: farmers notice fall in wheat prices before they notice other consumer goods reduce –> grow less wheat
Quantity of output supplied equation
Quantity output = natural level + a (Actual price level - expected)
Shifts to short run aggregate supply
1) Everything for LR
2) Changes in price level
- increase in price level –> shift left
- decrease in price level –> shift right
When economy is in long run equil, intersection of ag demand + short run supply is ___ as intersection of agg demand with long run supply
same
Effects of shift in aggregate demand
1) Shifts in ag. demand –> fluctuations in economy’s output in short run
2) In long run –> shifts in ag demand affect price level BUT NOT output
3) policymakers influence agg. demand –> can mitigate severity of economic fluctuations
Effects of shift in aggregate supply
1) shifts in ag supply –> can cause stagflation (recession + inflation)
2) policymakers can influence aggregate demand to mitigate impact on output BUT only at cost of inflation
