CH9 - From the Short Run to the Long Run Flashcards
It the short-run macro model, it is assumed that factor prices are ______ and the level of potential output is ______
∆ in GDP are cause by fluctuations in what?
constant
constant
the AD and AS
What are the 2 assumptions regarding the short run model?
- Factor prices are assumed to be exogenous (they may ∆ but it is not explained why)
- Technology and factor supplies are assumed to be constant (therefore, potential output (Y*) is constant)
What are the 2 assumptions regarding the adjustment process?
- Factor prices are assumed to adjust in response to output gaps (they are flexible)
- Technology and factor supplies are assumed to be constant (therefore, (Y*) is constant) (simplifying assumption)
What are the 2 assumptions regarding the long-run model?
- Factor prices are assumed to have fully adjusted to any output gap
(Real GDP returns to the level of potential output) - Technology and factor supplies are assumed to be changing (and typically growing)
A recessionary gap leads to excess _______? It causes wages and unit costs to _______. Firms _____ _______ prices to supply any level of output, and so the AS curve shifts ________.
Supply of labor
Fall
Accept lower
rightward (down)
What is the downward wage stickiness
“Booms” cause wages to rise rapidly while recessions usually cause wages to fall slowly
What is the assumption when real GDP is greater than potential output?
There’s a pressure on factor prices to rise because of a higher level of demand for factor inputs
What is the assumption when real GDP is smaller than potential output?
There’s a pressure on factor prices to fall because of a lower level of demand for factor inputs
When output is greater than potential, factor prices will ______ until equilibrium GDP is reached
What happens to the AS or AD curve
rise
AS curve shifts up
When output is lower than potential, factor prices will ______ until equilibrium GDP is reached
What happens to the AS or AD curve
fall
AS shifts down
What is the Philipps curve?
The negative relationship between unemployment and the rate of change in wages
What did A.W. Philipps observe?
Wages tended to fall in periods of high unemployment and rise in periods of low unemployment
Why does potential output act as an anchor for the economy?
Any output gap is assumed to cause wages and other factor prices to adjust, eventually bringing the equilibrium level of output back to potential.
When there is an inflationary gap, the level of actual unemployment ___________ the natural level of unemployment
fall below
When moving to a long-run equilibrium, after an inflationary gap, what happens to equilibrium price level and to equilibrium level of output?
Equilibrium price level will increase
Equilibrium level of output will decrease
What type of aggregate shock happens when there is a change in prices?
A supply shock
What is the only way permanent changes in real GDP are possible in the long run?
By a change in potential output
In the long run, what determines total output?
The potential output
What does aggregate demand determines in the long run?
The price level
Between 2006 and 2012, the Canadian government reduced both personal and corporate income taxes. Is this a demand-side or a supply-side policy?
Both, since in this situation the tax cut increases desired consumption and investment expenditures, and it also increases the return to working (as opposed to leisure).
The larger the simple multiplier, the ______ the AD curve?
Flatter
The _____ the AD curve, the less stable real GDP in the presence of AS shocks.
flatter
What is the effect of the economy’s automatic stabilizers on the multiplier?
They reduce its size
When the AD curve shifts to the right (increase in AD), what happens to wages and unit costs?
They will rise, shifting the AS curve to the left (upward)
In going from the initial to the new long-run equilibrium, the composition of real GDP __________?
may change because there could be some crowding out of private investment
What would be the effect of a reduction in the net tax rate for potential GDP?
An increase in Y* because firms increase their investments, which will lead to increase the economy’s capital stock
The simple multiplier measures the size of the change in real GDP caused by an AD shock when _______
the price level is held constant
Since __________, the AD shock causes ___________ to increase, which causes the actual change in real GDP to be ________ than the change predicted by the simple multiplier.
the AS curve is positively sloped
the price level
less
A steeper slope of the AS curve would result in _______ short-run change in real GDP in response to an AD shock
Why?
a smaller
Because a steeper slope results in MORE of the effect of the shock being reflected in the PRICE LEVEL, which
REDUCES the value of the multiplier.
Considering an economy with an inflationary gap.
What is the advantage of using a contractionary fiscal policy rather than allowing the economy’s natural adjustment mechanism to operate
It will reduce the inflationary pressure on prices that would otherwise occur
Consider the basic AD/AS model, and suppose there is a negative output gap. If an expensionary fiscal policy is pursued and the AS curve shifts leftwards unexpectedly, the fiscal policy may be ________, and real GDP may ________ potential GDP.
too weak
stay below
