Chapter 10 Flashcards
Long run aggregate supply (definition)
The relationship between the quantity of real GDP supplied and the price level when the money wage rate changes in step with the price level to maintain full employment
why is LAS curve vertical?
because potential GDP is independent of the price level
Short run aggregate supply (definition)
The relationship between the quantity of real GDP supplied and the price level when the money wage rate, the prices of other resources, and potential GDP remain constant
What happens at the price level where the real wage rate is at its full-employment equilibrium level
At this price level, the quantity of real GDP supplied equals potential GDP and the SAS curve intersects the LAS curve
Cause of movement along the short-run aggregate supply curve
A change in the price level changes the quantity of real GDP supplied
Shift of aggregate supply curve
Aggregate supply changes when an influence on production plans other than the price level changes. These other influences include changes in potential GDP and changes in the money wage rate.
Changes in potential GDP and aggregate supply
- When potential GDP changes, aggregate supply changes
- An increase in potential GDP increases both long-run aggregate supply and short-run aggregate supply
Why does potential GDP increase
Potential GDP can increase for any of three reasons:
1.) An increase in the full-employment quantity of labour
2.) An increase in the quantity of capital
3.) An advance in technology
An Increase in the Full-Employment Quantity of Labour (changes in potential GDP)
Over time, real GDP increases because the labour force increases. But (with constant capital and technology) potential GDP increases only if the full-employment quantity of labour increases. Fluctuations in employment over the business cycle bring fluctuations in real GDP. But these changes in real GDP are fluctuations around potential GDP. They are not changes in potential GDP and long-run aggregate supply.
An Increase in the Quantity of Capital (changes in potential GDP)
- For the economy, as the quantity of capital increases, the labour force becomes more productive and potential GDP increases.
- Capital includes human capital
An advance in technology (changes in potential GDP)
Technological change enables firms to produce a larger output from any given amount of factors of production. So even with fixed quantities of labour and capital, improvements in technology increase potential GDP.
Changes in the money wage rate and aggregate supply
When the money wage rate (or the money price of any other factor of production such as oil) changes, short-run aggregate supply changes but long-run aggregate supply does not change.
rise in money wage rate and SAS
A rise in the money wage rate decreases short-run aggregate supply because it increases firms’ costs. With increased costs, the quantity that firms are willing to supply at each price level decreases, which is shown by a leftward shift of the SAS curve.
Why rise in money wage rate does not change LAS
A change in the money wage rate does not change long-run aggregate supply because on the LAS curve, the change in the money wage rate is accompanied by an equal percentage change in the price level. With no change in relative prices, firms have no incentive to change production, so real GDP remains constant at potential GDP. With no change in potential GDP, the long-run aggregate supply curve LAS does not shift.
What makes money wage rate change
2 reasons
1.) departures from full employment - Unemployment above the natural rate puts downward pressure on the money wage rate, and unemployment below the natural rate puts upward pressure on it
2.) expectations about inflation - An expected rise in the inflation rate makes the money wage rate rise faster, and an expected fall in the inflation rate slows the rate at which the money wage rate rises
The quantity of real GDP demanded (Y) formula
Y= C + I + G + X - M
The quantity of real GDP demanded definition
the total amount of final goods and services produced in Canada that consumers, businesses, and governments in Canada and around the world plan to buy.
Aggregate demand (definition)
the relationship between the quantity of real GDP demanded and the price level
why does the aggregate demand curve slope down
The aggregate demand curve slopes downward for two reasons:
1.) Wealth effect
2.) Substitution effects
Wealth effect
- When the price level rises and other things remain the same, real wealth decreases
- Real wealth is the amount of money in the bank, bonds, shares, and other assets that people own, measured not in dollars but in terms of the goods and services that the money, bonds, and shares will buy
- People save and hold money, bonds, and shares for many reasons (r.g education or retirement)
- If the price level rises, real wealth decreases
- People then try to restore their wealth. To do so, they must increase saving and, equivalently, decrease current consumption expenditure
- As the price level rises, the decrease in consumption expenditure decreases the quantity of real GDP demanded
Substitution effects (Intertemporal)
- involves changing the timing of purchases of capital and consumer durable goods
- faced with a higher interest rate, people and businesses delay plans to buy new capital and consumer durable goods and cut back on spending today
- faced with a higher interest rate, people and businesses delay plans to buy new capital and consumer durable goods and cut back on spending today
substitution effects (International prices)
- When the Canadian price level rises and other things remain the same, Canadian-made goods and services become more expensive relative to foreign-made goods and services
- This change in relative prices encourages people to spend less on Canadian-made goods and more on foreign-made goods.
Changes in the Quantity of Real GDP Demanded
- When the price level rises and other things remain the same, the quantity of real GDP demanded decreases - a movement up along the AD curve
- When the price level falls and other things remain the same, the quantity of real GDP demanded increases—a movement down along the AD curve
Main factors that change aggreagate demand
1.) Expectations
2.) Fiscal policy
3.) Monetary policy
4.) The world economy
