Aggregate Supply and Demand

Question 1

What does the AS-AD model explain in macroeconomics?

Answer 1

The AS-AD model explains how equilibrium real GDP and the price level are determined and how they fluctuate.

Question 2

What factors determine the quantity of real GDP supplied?

Answer 2

The quantity of real GDP supplied depends on the quantities of labor, physical capital, human capital, and the state of technology.

Question 3

Which factor can vary in the short run to change the quantity of real GDP supplied?

Answer 3

At a given time, only the quantity of labor can vary to change the quantity of real GDP supplied.

Question 4

What are the possible states of the labor market in terms of employment?

Answer 4

The labor market can be at full employment, above full employment, or below full employment.

Question 5

What is potential GDP?

Answer 5

Potential GDP is the quantity of real GDP supplied at full employment.

Question 6

How does real GDP fluctuate in relation to potential GDP over the business cycle?

Answer 6

Over the business cycle, employment fluctuates around full employment, as real GDP fluctuates around potential GDP.

Question 7

What defines the Long-run Aggregate Supply (LAS) in macroeconomics?

Answer 7

LAS is the relationship between the quantity of real GDP supplied (Y) and the price level (P) when money wage rates change in step with the price level to maintain full employment.

Question 8

What is the characteristic shape of the LAS curve and why?

Answer 8

The LAS curve is vertical at potential GDP. An increase in the price level leads to an equivalent percentage increase in resource prices, keeping profits and real wages constant, resulting in no change in employment or the quantity of real GDP supplied.

Question 9

What causes the LAS curve to shift rightward?

Answer 9

The LAS curve shifts rightward when potential GDP increases, which can occur due to an increase in the full employment quantity of labor, an increase in the capital stock, or technological advancements.

Question 10

What is the Short-run Aggregate Supply (SAS) in macroeconomics?

Answer 10

SAS is the relationship between the quantity of real GDP supplied and the price level, assuming that the money wage rate, other resource prices, and potential GDP are held constant.

Question 11

What is the characteristic shape of the SAS curve and why?

Answer 11

The SAS curve is upward sloping. An increase in the price level leads to an increase in profits, employment, and thus an increase in the quantity of real GDP supplied.

Question 12

Under what conditions does the SAS curve shift?

Answer 12

The SAS curve shifts along with the LAS curve, but it can also shift independently if there are changes in resource prices, money wage changes due to expected inflation, or shifts in full employment creating changes in the labor market.

Question 13

What is the quantity of real GDP demanded?

Answer 13

The quantity of real GDP demanded is the total amount of final goods and services produced in Canada that economic agents plan to buy.

Question 14

On what factors does the quantity of real GDP demanded depend?

Answer 14

It depends on the price level, expectations, fiscal and monetary policies, and the world economy.

Question 15

What is Aggregate Demand (AD) in macroeconomics?

Answer 15

Aggregate Demand (AD) is the total quantity of real GDP demanded (Y = C + I + G + X - M) at a given price level (P).

Question 16

How does an increase in the price level (P) affect the quantity of real GDP demanded?

Answer 16

An increase in P decreases the quantity of real GDP demanded, represented by a movement up along the AD curve due to wealth and substitution effects.

Question 17

What causes the AD curve to shift?

Answer 17

Changes in factors such as fiscal and monetary policies, expectations, and the world economy can shift the AD curve.

Question 18

How does a cut in taxes or an increase in government expenditure affect AD?

Answer 18

Fiscal policy that cuts taxes (increasing disposable income) or increases government expenditure leads to an increase in AD.

Question 19

What effect does a decrease in interest rates or an increase in the quantity of money have on AD?

Answer 19

Monetary policy that decreases interest rates or increases the quantity of money causes an increase in AD.

Question 20

How do changes in the exchange rate or foreign income affect AD?

Answer 20

A decrease in the exchange rate or an increase in foreign income leads to an increase in AD.

Question 21

How do increased expectations of future disposable income, future inflation, or future profits influence AD?

Answer 21

Increased expectations of future disposable income, future inflation, or future profits all lead to an increase in AD

Question 22

What are the two types of macroeconomic equilibrium?

Answer 22

Long-run equilibrium is the state toward which the economy is heading. Short-run equilibrium is the normal state of the economy, occurring at each point in time along the path to long-run equilibrium.

Question 23

When does long-run macroeconomic equilibrium occur?

Answer 23

Long-run macroeconomic equilibrium occurs when real GDP equals potential GDP, i.e., when AD (Aggregate Demand) equals SAS (Short-run Aggregate Supply) and LAS (Long-run Aggregate Supply).

Question 24

When does short-run macroeconomic equilibrium occur?

Answer 24

Short-run macroeconomic equilibrium occurs when real GDP demanded equals real GDP supplied (where AD equals SAS), with the price level adjusting to achieve equilibrium.

Question 25

What causes economic growth in macroeconomic terms?

Answer 25

Economic growth results from the LAS shifting rightward on average, due to increases in labor, capital, and technology advancements.

Question 26

What causes persistent inflation in the economy?

Answer 26

Persistent inflation occurs when AD grows faster than LAS. According to the quantity theory of money, growth in the money supply is the most likely source of persistent inflation.

Question 27

Why is growth in real GDP (Y) not steady and subject to cycles?

Answer 27

Growth in real GDP is not steady but goes in cycles because AD and SAS do not shift at the same pace, leading to fluctuations in economic activity

Question 28

What is full-employment equilibrium in the context of the business cycle?

Answer 28

Full-employment equilibrium occurs when real GDP equals potential GDP, where AD (Aggregate Demand) and SAS (Short-run Aggregate Supply) intersect at the LAS (Long-run Aggregate Supply).

Question 29

What characterizes a below full-employment equilibrium?

Answer 29

Below full-employment equilibrium occurs when AD intersects SAS to the left of LAS; real GDP is less than potential GDP by the amount of the recessionary gap, which is the output gap between real GDP and potential GDP.

Question 30

What characterizes an above full-employment equilibrium?

Answer 30

Above full-employment equilibrium occurs when AD intersects SAS to the right of LAS; real GDP is greater than potential GDP by the amount of the inflationary gap.

Question 31

Why does the economy fluctuate in the short run?

Answer 31

The economy fluctuates in the short run due to fluctuations in AD and SAS, leading to varying equilibrium states over the business cycle.

Question 32

What happens if AD increases so that real GDP exceeds potential GDP?

Answer 32

If AD increases so that real GDP exceeds potential, upward pressures on the money wage rate cause the SAS to shift leftward, moving the economy toward long-run equilibrium.

Question 33

What results from an increase in resource prices that causes the SAS to shift leftward?

Answer 33

If resource prices increase and cause the SAS to shift leftward while real GDP is below potential, stagflation results, characterized by inflation and falling real GDP.

Question 34

What do classical macroeconomists believe about the economy and business cycles?

Answer 34

Classical macroeconomists believe the economy is self-regulating and always at full employment, implying that any deviations from this state are temporary and will self-correct.

Question 35

How do new classical economists view business cycles?

Answer 35

New classical economists view business cycles as efficient responses of the economy to uneven technological changes, suggesting that fluctuations in business cycles are natural and beneficial adjustments to innovation.

Question 36

What is the Keynesian view on economic equilibrium and policy intervention?

Answer 36

Keynesian macroeconomists believe that the economy is rarely at full employment and requires active monetary and fiscal policies to achieve and maintain employment levels.

Question 37

How do New Keynesian economists expand on Keynesian beliefs?

Answer 37

New Keynesian economists agree with Keynesians on the point that money wages are sticky (slow to adjust), and they extend this to other prices as well, suggesting that prices do not adjust quickly to changes in supply and demand.

Question 38

What is the monetarist perspective on economic regulation and business cycles?

Answer 38

Monetarists believe that the economy is generally self-regulating and normally at full employment, as long as monetary policy is not erratic. They emphasize the importance of stable monetary policy for maintaining economic stability.