Chapter 12: Chapter 12 Aggregate Demand and Aggregate Supply Flashcards

1
Q

What is the AD-AS model?

A

The aggregate demand–aggregate supply (AD–AS) model is a macroeconomic model that uses aggregate demand and aggregate supply to determine and explain the price level and real GDP.

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2
Q

Define aggregate demand.

A

Aggregate demand is a curve that shows the total amount of a nation’s output (real GDP) that buyers collectively wish to purchase at each possible price level.

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3
Q

Why does the aggregate demand curve slope downward?

A

Unlike demand for individual products, aggregate demand slopes downward due to the real-balances effect, interest-rate effect, and foreign purchases effect.

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4
Q

What is the real-balances effect?

A

The real-balances effect is the tendency for increases in the price level to reduce the real value of financial assets, which decreases total spending and real output.

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5
Q

What is the interest-rate effect?

A

The interest-rate effect occurs when a higher price level increases the demand for money, raises interest rates, and thus reduces spending and real output.

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6
Q

What is the foreign purchases effect?

A

The foreign purchases effect refers to how a higher domestic price level makes exports more expensive and imports cheaper, reducing net exports and aggregate demand.

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7
Q

How does consumer wealth affect aggregate demand?

A

An increase in consumer wealth shifts the aggregate demand curve right due to a wealth effect, while a decrease in wealth shifts it left.

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8
Q

How do consumer expectations influence aggregate demand?

A

Positive expectations about future income or prices increase current consumption, shifting AD right; negative expectations reduce consumption, shifting AD left.

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9
Q

What effect does household borrowing have on aggregate demand?

A

Increased borrowing shifts aggregate demand right, while reduced borrowing or increased savings for debt repayment shifts it left.

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10
Q

How does a change in real interest rates affect aggregate demand?

A

Higher real interest rates raise borrowing costs, reducing investment and aggregate demand, while lower rates do the opposite.

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11
Q

How do expected returns influence aggregate demand?

A

Higher expected returns encourage investment, shifting AD right; lower expected returns discourage investment, shifting AD left.

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12
Q

What role does government spending play in aggregate demand?

A

Increased government spending shifts AD right, while decreased spending shifts it left.

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13
Q

How do changes in net export spending affect aggregate demand?

A

Higher net exports increase aggregate demand, shifting AD right; lower net exports reduce AD, shifting it left.

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14
Q

How does national income abroad affect aggregate demand?

A

Rising income abroad increases foreign demand for domestic goods, shifting AD right; declining foreign income reduces AD, shifting it left.

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15
Q

What is the effect of dollar depreciation on aggregate demand?

A

Dollar depreciation makes U.S. goods cheaper abroad, increasing exports and net exports, thus shifting aggregate demand right.

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16
Q

What is the multiplier effect in the context of aggregate demand?

A

The multiplier effect magnifies an initial change in spending, causing a larger overall change in aggregate demand.

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17
Q

What is Aggregate Supply (AS)?

A

Aggregate supply is a curve showing the relationship between a nation’s price level and the quantity of real domestic output (real GDP) that firms produce.

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18
Q

What are the three time horizons for Aggregate Supply?

A

1) Immediate Short Run, 2) Short Run, 3) Long Run.

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19
Q

What characterizes the Immediate Short Run in Aggregate Supply?

A

Both input prices and output prices are fixed.

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20
Q

Why is the Immediate Short-Run AS curve horizontal?

A

With fixed prices, firms adjust output to match demand, creating a horizontal AS curve at the current price level.

21
Q

What happens in the Short Run in terms of Aggregate Supply?

A

Output prices are flexible, but input prices are fixed, leading to an upward-sloping AS curve.

22
Q

Why does the Short-Run AS curve slope upward?

A

Higher output prices increase profits with fixed input costs, motivating firms to produce more.

23
Q

What happens to the slope of the AS curve when output exceeds full employment?

A

The AS curve becomes steeper due to resource constraints, making further output expansion costly.

24
Q

Describe the Long Run for Aggregate Supply.

A

Both input prices and output prices are flexible, and the AS curve is vertical at the full-employment output level.

25
Q

Why is the Long-Run AS curve vertical?

A

In the long run, input prices adjust to match output prices, keeping real profits stable and output at the full-employment level regardless of price changes.

26
Q

Why do economists focus on the Short-Run AS curve in analysis?

A

The Short-Run AS curve can handle simultaneous movements in price levels and output, making it useful for understanding business cycles and macroeconomic policy.

27
Q

How does the Immediate-Short-Run AS curve differ from the Long-Run AS curve?

A

The Immediate-Short-Run AS curve is horizontal due to fixed prices, while the Long-Run AS curve is vertical, showing full employment is maintained regardless of price changes.

28
Q

What causes a change in output along the Short-Run AS curve?

A

Changes in the price level increase or decrease real profits, prompting firms to adjust output accordingly.

29
Q

What does a rightward shift in the aggregate supply (AS) curve indicate?

A

An increase in aggregate supply, meaning more output at each price level.

30
Q

What does a leftward shift in the aggregate supply (AS) curve indicate?

A

A decrease in aggregate supply, meaning less output at each price level.

31
Q

What are the main determinants of aggregate supply?

A

Input prices, productivity, and the legal-institutional environment.

32
Q

How do domestic resource prices affect aggregate supply?

A

Lower resource prices (e.g., wages, land) reduce production costs and shift AS to the right; higher prices increase costs and shift AS to the left.

33
Q

How do imported resource prices impact the AS curve?

A

Lower prices for imported resources reduce costs, shifting AS to the right; higher prices increase costs, shifting AS to the left.

34
Q

Define productivity in the context of aggregate supply.

A

Productivity is the output per unit of input, where higher productivity reduces production costs, shifting AS right.

35
Q

What happens to aggregate supply if productivity decreases?

A

Production costs increase, shifting AS to the left.

36
Q

How do business taxes and subsidies affect aggregate supply?

A

Higher taxes increase costs, shifting AS left; subsidies lower costs, shifting AS right.

37
Q

What is the impact of government regulation on aggregate supply?

A

Increased regulation typically raises costs and shifts AS left, while deregulation can reduce costs and shift AS right.

38
Q

What causes a rightward shift in the AS curve?

A

Factors that reduce per-unit production costs, such as lower input prices, higher productivity, subsidies, or deregulation.

39
Q

What causes a leftward shift in the AS curve?

A

Factors that increase per-unit production costs, such as higher input prices, lower productivity, higher taxes, or more regulation.

40
Q

What determines the equilibrium price level and real GDP in the AD-AS model?

A

The intersection of the aggregate demand (AD) and aggregate supply (AS) curves establishes the equilibrium price level and real GDP.

41
Q

What happens at the equilibrium point in the AD-AS model?

A

At equilibrium, the amount of real output demanded equals the amount of real output supplied, stabilizing the price level and real GDP.

42
Q

What is the result if the price level is set below the equilibrium level?

A

A shortage occurs, as the real output demanded exceeds the real output supplied, driving the price level up toward equilibrium.

43
Q

What effect does a surplus have on price levels in the AD-AS model?

A

A surplus, where the real output supplied exceeds demand, will cause the price level to decrease toward equilibrium.

44
Q

Why does the AD curve slope downward?

A

The AD curve slopes downward due to the real-balances effect, interest-rate effect, and foreign purchases effect.

45
Q

Why does the AS curve slope upward?

A

The AS curve slopes upward because per-unit production costs rise as real GDP approaches or exceeds the full-employment level.

46
Q

What market forces drive the economy back to equilibrium in the AD-AS model?

A

Shortages at lower-than-equilibrium price levels increase prices, and surpluses at higher-than-equilibrium levels decrease prices, balancing real GDP demanded and supplied.

47
Q

What does a shortage in the AD-AS model indicate?

A

A shortage means that the quantity of real output demanded is greater than the quantity supplied, pushing prices up toward equilibrium.

48
Q

What does a surplus in the AD-AS model indicate?

A

A surplus means that the quantity of real output supplied is greater than the quantity demanded, pushing prices down toward equilibrium.

49
Q

How do the real-balances, interest-rate, and foreign purchases effects impact AD?

A

These effects increase the amount of real GDP demanded as the price level decreases, contributing to the downward slope of the AD curve.