Chapter 10 - Intro to Economic Fluctuations

Question 1

Why is the Long Run Aggregate Supply (LRAS) vertical in the AD/AS model derived from the quantity theory of money?

Answer 1

Price (P) does not affect output in the long run

Question 2

Why is the Short Run Aggregate Supply (SRAS) horizontal in the AD/AS model derived from the quantity theory of money?

Answer 2

All prices are stuck at a predetermined level in the short run (sticky prices)
Firms are willing to sell as much at that price level as their consumers are willing to buy

Question 3

Okun’s Law

Answer 3

The negative relationship between GDP and unemployment

Question 4

Index of Leading Economic Indicators (LEI)

Answer 4

Forecasts changes in economic activity six to nine months into the future

Question 5

Is the Index of Leading Economic Indicators a perfect predictor for economic activity?

Answer 5

No. However, it is still used in planning by businesses and governments (better than using no predictor most of the time)

Question 6

Aggregate Demand (AD) Curve

Answer 6

Shows the relationship between the price level (P) and the quantity of output demanded for all goods in the economy (Y).

Question 7

In the AD/AS model, which variables in the quantity equation are exogenous? Which ones are endogenous?

Answer 7

Exogenous: M, V
Endogenous: P, Y

Question 8

Is unemployment equal to 0 at full-employment?

Answer 8

No, there is always a natural rate of unemployment that is present even when unemployment is 0.

Question 9

What happens in the long run if the government does not shift the aggregate demand curve?

Answer 9

Level of output > Natural level of output: Price rises

Level of output < Natural level of output: Price falls

Level of output = Natural level of output: Price stays constant
Price adjusts until AD = LRAS

Question 10

Shocks

Answer 10

Exogenous changes in AD or AS. Shocks temporarily push the economy away from full employment.

Question 11

Supply Shock

Answer 11

Alters production costs, affects the prices that firms change. Can be adverse or favourable.

Question 12

Stabilization Policy

Answer 12

Policy actions aimed at reducing the severity of short-run economic fluctuations. Example: using monetary policy to combat the effects of adverse supply shocks (shift AD right)

Question 13

Stagflation

Answer 13

High inflation, but slow economic growth (fall in output, increase in prices). A consequence of adverse price shocks.