Chapter 12 Flashcards
What is mainstream business cycle theory?
Potential GDP grows at a steady pace while aggregate demand grows at a fluctuating rate, so real GDP fluctuates around potential GDP
What is real business cycle theory?
Real business cycle theory regards random fluctuations in productivity as the main source of economic fluctuations
Where do the fluctuations in productivity come from in RBC?
Mostly from the pace of technological change
What are the 2 effects that follow a change in productivity?
Change in investment demand
Change in the demand for labor
How does a decrease in productivity affect the Real Wage Rate?
Productivity ↓ - Investment ↓ - Demand for Loanable Funds ↓ - Real Interest rate ↓ - Labour Supply ↓ - Employment ↓ - Real Wage Rate ↓
What is Demand-Pull inflation?
inflation that starts because aggregate demand increases
What are factors that cause demand-pull inflation? (6)
Interest Rate ↓
Quantity of Money ↑
Government Expenditure ↑
Taxes ↓
Exports ↑
Expected Profits ↑
What are the effects of demand-pull inflation, and how is there a return to equilibrium?
Aggregate demand → - Price Level ↑ - Real GDP ↑ - Money Wage ↑ - SAS ←
What is a demand-pull inflation spiral?
Repeated demand-pull inflation
What effect creates a sustained demand-pull inflation spiral?
An increase in the quantity of money
What is Cost-Push inflation?
Inflation that starts with an increase in costs
What are the two main sources of an increase in costs?
- Increase in the money wage rate
- An increase in price of raw materials
What are the effects of cost-push inflation, and how is there a return to equilibrium?
SAS ← - RGDP ↓ - Price Level ↑ - Quantity of Money ↑ - RGDP ↑ - Price Level ↑
What happens when expected inflation is equal to actual inflation?
Money wage rate increases in line with expected inflation, so when there is demand-pull inflation, there is an increase in prices with no change in Real GDP
What happens when expected inflation is less than actual inflation?
Demand-pull inflation
What happens when expected inflation is more than actual inflation?
Supply-push inflation
What is a rational expectation?
The best forecast using all available information
Describe employment when the rational expectation is correct.
Full employment
What is deflation?
A persistent fall in the price level that happens when aggregate supply grows faster than aggregate demand
When does deflation occur?
Δ Money < Δ RGPD - Δ Velocity
What are the effects of deflation?
Redistribution of income and wealth
Lower RGDP
Lower Employment
Diverts resources from production
How is deflation ended?
Increase the growth rate of money more than the growth rate in RGDP - Velocity change
What is a Phillips curve?
The relationship between the inflation rate and the unemployment rate
What are the 2 timeframes for the Phillips curve?
Short-run
Long-run
What does the SRPC hold constant?
Expected inflation rate
Natural unemployment
What happens when the inflation rate exceeds the expected inflation rate?
Unemployment rate decreases
What happens when the inflation rate is less than the expected inflation rate?
Unemployment rate increases
What is the LRPC?
The relationship between inflation and unemployment when the actual inflation rate equals the expected inflation rate
Where is the LRPC?
Vertical at the natural unemployment rate
Where do the SRPC and the LRPC intersect?
At the expected inflation rate
What happens when the expected inflation rate shifts downwards?
SRPC ↓
What happens when there is an increase in the natural unemployment rate?
LRPC → - SRPC →
