Ch. 12- Aggregate Demand and Aggregate Supply Flashcards
Aggregate Demand
The total demand for all goods and services in the economy
Aggregate Demand Curve (AD curve)
A curve that shows the relationship between the overall price level and the level of demand in the economy. Slopes downward.
Why does the aggregate demand curve slope downwards?
> The Wealth Effect
The Interest Rate Effect
The Exchange Rate Effect
Wealth Effect
When people are less wealthy or prices rise, they reduce their consumption
Interest Rate Effect
When prices increase, interest rates increase. Therefore, firms invest less since it is more expensive for them to borrow
Exchange Rate Effect
When prices of domestic goods increase, imports increase, exports decrease. Therefore, net exports decrease and GDP decreases
What causes the aggregate demand curve to shift?
Non-price changes in consumption, investment, government spending, or net exports.
Asset-price bubble
When people buy assets for no reason other than thinking that the price will increase
What effect does the multiplier effect have on shifts in aggregate demand?
Each dollar of expenditure in the economy leads to more than a dollar of output.
Aggregate Supply
The sum total of the production of all the firms in the economy
Aggregate Supply Curve (AS curve)
Shows the relationship between the overall price level in the economy and total production (output)
What are the differences between the AS curve and the supply curve in microeconomics?
> AS represents production in the economy as a whole rather than just one good or service
> AS represents that there is a difference between how the economy operates in the short-run vs the long-run
Sticky Wages
Not all input prices increase immediately as they adjust slowly in response to changes in the economy.
Why is the SRAS curve upward sloping?
Due to sticky wages, firms have an incentive to increase production when the prices of their output are rising (input costs will remain fixed).
Short-run Aggregate Supply Curve (SRAS curve)
Short-run relationship between prices and output. Changes in the price level and non-price changes affect the economy’s output (and shift the SRAS).
Long-Run Aggregate Supply Curve (LRAS curve)
Long-run relationship between prices and output. Only non-price changes can shift the LRAS curve
Why is the LRAS curve vertical?
A change in price level does not affect output since in the long-run, input prices will adjust. So while revenues may be higher, costs are also higher.
What time period is the long-run defined as?
The long-run is not a set amount of time. It is however long it takes for prices of inputs to fully adjust to changes in economic conditions.
Business Cycles
Fluctuations of GDP either above or below the potential level of GDP in the economy.
Supply Shocks
Significant events that directly affect production and the aggregate-supply curve in the short-run
Short-run equilibrium
Given by the intersection of the aggregate demand and SRAS curves
Long-run equilibrium
Given by the intersection between the aggregate demand, SRAS, and LRAS curves (same point).
Why do business cycles occur?
> Instability of AD - significant expansions and contraction in the components of AD.
Supply shocks
How does the economy return to the long-run equilibrium?
Contracts must be negotiated to adjust wages. This causes the SRAS to gradually shift until equilibrium is restored.
What are the effects of a shift in AD?
> Short-run: There are fluctuations in the economy’s output of goods and services.
> Long-run: Affects the overall price level but do not affect the level of output
> Policymakers who intervene can potentially mitigate the severity of business cycles
What are the effects of a shift in AS?
> Stagflation
Policymakers who intervene can potentially mitigate the adverse impact on output but at the cost of increasing price level.
Stagflation
A period of decreasing output and increasing prices.
Why is it desirable for government to intervene when the economy undergoes supply/demand shocks?
It can take a long time for the economy to fully adjust to aggregate demand/supply shocks on its own.
How can governments respond to supply and demand shocks?
By adjusting spending to shift the AD/AS curve towards long-term equilibrium.
