Chapter 11: Aggregate Demand & Supply Flashcards
Say’s Law
“Supply creates its own demand”
Argues that supply is the most important determinant of the size of the macroeconomy, while demand just tags along
Keynes’ Law
“Demand creates its own supply”
Argues that demand is the most important determinant of the size of the macroeconomy, while supply just tags along
What “law” do neoclassical economists tend to think determines the size of the macroeconomy?
Say’s Law
demand determines macroeconomy
Explain the mechanism by which supply creates demand (Say’s Law)
In order to supply goods, suppliers must employ workers, whose incomes increase as a result of their labor. They use this additional income to demand goods of an equivalent value to those they supply.
Explain the mechanism by which demand creates supply (Keynes’ Law)
When consumers demand more goods than are available on the market, prices are driven higher and the additional opportunities for profit induce more suppliers to enter the market, producing an equivalent amount to that which is demanded.
Which supply & demand “law” applies more accurately when examining an economy in the short-run?
Keynes’ Law
Which supply & demand “law” applies more accurately when examining an economy in the long-run?
Say’s Law
Potential GDP
or
Full-Employment GDP
Quantity that an economy can produce by fully employee its existing levels or labor, physical capital, and technology
Aggregate Demand
Amount of total spending on domestic goods and services in an economy
Aggregate Supply
Total quantity of output firms will produce and sell
Aggregate Supply Curve
Total quantity of output (real GDP on x-axis) that firms will produce and sell at each price level (y-axis)
What does Potential GDP look like on an Aggregate Supply Curve?
A vertical line, at the maximum quantity of Real GDP an economy can produce at full employment of workers and physical capital
What does the aggregate supply curve look like on a graph?
Upward slope
Reason: as the price level for output rises (price of inputs stays fixed), firms have an incentive to produce more and to earn higher profits
What does the aggregate demand curve look like on a graph?
Downward slope
Reason: as the price level rises, the amount of total spending on domestic goods and services declines
Aggregate Demand Curve
Total spending (real GDP on x-axis) on domestic goods at each price level (y-axis)
Aggregate Demand
calculation
Aggregate Demand = C + I + G + E - I
How does the Wealth Effect impact aggregate demand?
Consumption spending falls as the price level increases, as stored up savings are diminished by inflation
How does the Interest Effect impact aggregate demand?
Higher interest rates reduces borrowing, thus reducing consumption and investment spending
How do rising prices in the US impact exports and imports?
Reduces exports
Increases imports
What is the most important factor shifting the Aggregate Supply Curve?
Productivity Growth
One measure is output per worker, or GDP per capita.
Other shifts can occur due to shocks to input goods, or labor.
What are two things that could cause the Aggregate Demand Curve to shift?
Changes in the behavior of consumers/firms
Changes in government tax or spending policy
How does consumer and business confidence affect Aggregate Demand?
If confidence is high, consumers tend to consume more and businesses tend to invest more
Keynesian Zone
of an Aggregate Supply Curve
Relatively flat portion of SRAS curve on the far left
Neoclassical Zone
of an Aggregate Supply Curve
Relatively vertical portion of SRAS curve on the far right
