AS/AD Test Flashcards
What is the interest rate effect?
As price level rises so will interest rates, and rising interest rates in turn cause a reduction in certain kinds of consumption and business spending. AD assumes a fixed money supply, so a higher price level will increase the demand for money, and the costs of borrowing will increase
What is the wealth effect (real balance effect)?
At higher price levels the real value or purchasing power of accumulated financial assets will diminish. Certain purchases will be delayed.
What is the foreign purchase effect (foreign trade effect)?
If the price levels rise in the US relative to foreign countries, American buyers will purchase more imports at the expense of American goods
What is the ratchet effect?
Product and resource prices tend to be “sticky” or inflexible downward. Prices go up and stay there unless they are forced back down
When is the full strength effect of the multiplier realized?
In the horizontal range of the AS curve
What is a reduced multiplier?
Dissipated by inflation; therefore not reflected in increases real output and employment
What is the equation for the GDP multiplier?
Change in real GDP/ initial change in spending
What’s the difference between classical theory and Keynesian economics?
-Classical •before Great Depression •economy self corrects bc downward flexible wages/prices •laissez faire -Keynesian •caused by Great Depression •economy doesn't self correct •inflexible (downward wage/prices) •gov involvement
GDP=
NI=PI=DI
Dissavings=
Prosperity
Multiplier=
1/MPS
MPS + MPC=
1
Consumption and saving schedules go in opposite directions except for when?
Taxes are changed
In an investment demand curve what is the only thing that doesn’t shift the curve but causes movement on the curve?
Interest rate
What is the only thing price levels change?
Quantity supplied
What is the name of John Maynard Keynes book?
General Theory of Employment, Interest, and Money
When wealth increase what happens to consumption and saving?
Consumption increases, saving decreases
What happens when there is a raise in taxes?
Consumption decreases, saving decreases
What is savings?
The gap below the 45 degree GDP reference line and above the consumption line
What is dissavings?
The gap below the consumption line and above the 45 degree GDP reference line
If something isn’t consumed, it is by definition
Saved
What shifts the consumption and saving schedule?
-Wealth •shifts consumption up, saving down -Price •shifts consumption up,saving down -Expectation of inflation or shortages •shifts consumption schedule up -Consumer debt •lower debt levels shift consumption up,saving down -Taxation •lower taxes shift both schedules up
Only a change in disposable income causes
A change in the amount consumed (movement from one point to another on a given schedule)
What’s the rule in investing?
Invest up to the point at which expected rate of net profit equals the interest rate
A rise in consumer confidence would shift AD to the?
Right
A tax hike would shift AD to the?
Left
An increase in expected future sales would shift AD to the?
Right
Rise in interest rate shifts AD to the?
Left
Increase in military spending shifts AD to the?
Right
A decrease in highway construction shifts AD to the?
Left
Decrease in the value of dollars shifts the AD to the?
Right (because exports increase)
Canada hating US products shifts AD to the?
Left
What is happening in the horizontal range of the AS curve?
(Recession) real GDP is much less the Qf; high unemployment and unused capacity. As movement to right occurs there’s a gain in real GDP, but no price level change. Production costs usually don’t rise since resources aren’t yet scarce
What happens in the vertical range of the AS curve?
Economy on PPC; real GDP can’t grow. Firms will bid resources form other firms and resource prices will rise causing some firms to exit the industry. Product prices will rise but real GDP will remain steady
What happens in the intermediate range of the AS curve?
No simultaneous full-employment full-production in all forms; specific labor/resource shortages; per unit costs rise and firms must get higher prices to retain profit margins
What shifts the AS curve?
-Changes in input prices
•domestic resource availability (factors of production)
•price of imported resources
•market power (OPEC, powerful labor unions)
-Changes in productivity
•effect of training programs
•technological gains
-Change in legal-institutional environments
•business taxes
•business subsidies
•gov regulation
What are causes of downward price level inflexibility?
Wage contract, effort, morale, productivity, training investment, minimum wage, menu costs, fear of price wars
How does the economy self correct with prices, wages, and interest rates?
If there is excess supply of labor (unemployment), workers will reduce their wage demands, causing employers to want to hire more labor and workers to offer less labor for sale, until the surplus is eliminated. Likewise, if there is excess saving, the interest rate will decline, causing people to save less and borrow more, until that surplus is eliminated. In this view, a recovery (from a period of low employment and output) involves a decrease in the price level.
What are the 3 reasons that aggregate demand curve is downward sloping?
- interest rate effect
- wealth effect (real balance effect)
- foreign purchases effect (foreign trade effect)
Why does the investment demand curve have a downward slope?
The higher the interest rate, the less investments are made because the cost of borrowing is high
If interest rates rise, will the investment demand curve shift to a new location?
No, just movement along curve
What’s the relationship between the price level and real GDP according to an AD curve?
Inverse; the lower the price level, the higher the real GDP
What shifts a product demand curve?
- income effect
- substitution effect
- diminishing marginal utility
What shifts the aggregate demand curve?
- IR effect
- wealth effect
- net export effect
If congress cuts taxes what would happen to AD curve?
Shifts right
If autonomous investment spending decreases, what happens to AD curve?
Shifts left
What happens to AD curve if gov spending is increasing the next fiscal year, and the president promises no increase in taxes?
Shifts right
What happens to AD curve if survey shows consumer confidence jumps?
Shifts right
What happens to AD curve if the stock market collapsed and investors lose billions?
Shifts left
What happens to AD curve if productivity rises for fourth straight year?
Nothing (supply side issue)
What happens to AS curve if president cuts defense spending by 20%; no increase in domestic spending?
Shifts left
Under what conditions would an economy have a horizontal SRAS curve?
Recession or depression
When would an economy have a vertical SRAS curve?
Full employment; no more goods can be produced
When would an economy have a positively sloped SRAS curve?
Getting close to full employment; pressure on prices
What would be the effect on real GDP if the economy had a horizontal SRAS curve?
- no effect in PL
- increase in real GDP
What’d be the effect on real GDP and PL if the economy had a positively sloped SRAS curve?
-increase in both real GDP and PL
What’d be the effect on real GDP and PL if the economy had a vertical SRAS curve?
- no effect on GDP
- increase in PL
If unions grow more aggressive, and wage rates increase, SRAS curve shifts?
Left
What would happen to SRAS curve if OPEC successfully increase oil prices?
Shift left
What happens to SRAS curve if labor productivity increase dramatically?
Shifts right
What happens to SRAS curve if giant natural gas discovery decreases energy prices
Shifts right
What happens to SRAS curve if computer technology brings new efficiency to industry?
Shifts right
What happens to SRAS curve if: gov spending increases, cuts in tax rates increase incentives to save, low birth rate will decrease labor force in future?
Nothing (demand side issue)
What happens to SRAS curve if research shows that improved schools have increased the skills of American workers and managers?
Shifts right
