Chapter 14 Flashcards
What are the three key facts about short-run economic fluctuations?
Economic fluctuations are irregular and unpredictable.
Most macroeconomic quantities fluctuate together.
As output falls, unemployment rises.
What does the model of aggregate demand and supply explain?
It explains short-run economic fluctuations around the long-run trend using the interaction between aggregate demand and aggregate supply.
What is the definition of aggregate demand (AD)?
The total quantity of goods and services demanded in the economy at each price level by households, firms, the government, and foreigners.
What is the definition of aggregate supply (AS)?
The total quantity of goods and services that firms are willing and able to produce and sell at each price level.
Why does the aggregate demand curve slope downward?
Wealth effect: Lower price level increases real wealth, increasing consumption.
Interest-rate effect: Lower prices reduce interest rates, increasing investment.
Exchange-rate effect: Lower prices cause currency depreciation, increasing net exports.
What causes shifts in the aggregate demand curve?
Changes in consumption, investment, government spending, or net exports that are not related to price level.
Why is the long-run aggregate supply (LRAS) curve vertical?
Because, in the long run, output depends on real factors (labour, capital, natural resources, technology) and is unaffected by the price level.
What is the natural rate of output?
The level of output the economy produces when unemployment is at its natural rate (also called potential output or full-employment output).
What shifts the long-run aggregate supply (LRAS) curve?
Changes in labour force (e.g., immigration)
Capital stock
Natural resources
Technological progress.
Why does the short-run aggregate supply (SRAS) curve slope upward?
Because of:
Sticky wages
Sticky prices
Misperceptions.
All of which cause firms to adjust output when price level changes unexpectedly.
What causes the SRAS curve to shift?
Same factors that shift LRAS.
Changes in expected price level (higher expectations shift SRAS left).
What is stagflation?
A situation with rising prices (inflation) and falling output, typically caused by a supply shock.
What happens when aggregate demand increases in the short run?
Output and prices rise; unemployment falls temporarily.
What happens in the long run after an increase in aggregate demand?
Output returns to natural rate, but the price level is permanently higher.
How does a negative supply shock affect the economy?
SRAS shifts left, output falls, and prices rise (stagflation).
How does the economy self-correct from a recession without policy intervention?
Nominal wages and expectations adjust over time, shifting SRAS right and returning output to its natural level.
How do sticky wages affect employment in the short run?
If the price level falls but wages don’t, real wages rise, making employment less profitable and reducing output and hiring.
According to the sticky-price theory, what happens when prices fall unexpectedly?
Firms with higher-than-desired prices lose sales, reduce production, and the economy’s output falls.
According to the misperceptions theory, how does output respond to unexpected price changes?
Producers misinterpret price changes as changes in relative demand for their product and adjust output accordingly.
What does the equation Y = YN + α(P – PE) represent?
Short-run output as a function of the difference between actual and expected price levels, based on the short-run aggregate supply curve.
