Chapter 14 Flashcards
Define recession
a period of declining real incomes and rising unemployment
What are the 3 key facts about economic fluctuations?
- economic fluctuations are irregular and unpredictable
- most macroeconomic quantities fluctuate together
- as output falls, unemployment rises
What is the model of AD and AS?
the model that most economists use to explain short run fluctuations in economic activity around its long run trend
What is the AD curve?
a curve that shows the quantity of goods and services that households, firms, and the government want to buy at each price level
What is the AS curve?
a curve that shows the quantity of goods and services that firms choose to produce and sell at each price level
Y = G + C + I + NX
G is fixed by policy
therefore I, C, and NX depend on economic conditions and therefore price level
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Wha
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Why does the AD curve slope downward
- price level & consumption (the wealth effect)
- price level & investment (the interest rate effect)
- price level & net exports (the real exchange rate effect)
What is the wealth effect?
decrease in the price level makes consumers wealthier, which encourages them to spend more, which demands a larger quantity of goods and services
What is the interest rate effect?
lower price level reduces interest rate, which encourages spending on investment goods, and increases the quantity of goods and services demanded
What is the real exchange rate effect?
a fall in the price level causes the real exchange rate to depreciate, which stimulates net exports, which increases the quantity of goods and services demanded
Why might the AD curve shift?
- change in consumption
- change in investment
- change in government purchases
- change in net exports
Why is the AS curve vertical in the long run?
the price level does not effect the long run determinants of GDP (labour, capital, natural resources, & technology determine Q of goods supplied, and this Q supplied is the same regardless of what the price level is)
Why might the long run AS curve shift?
- changes in labour
- changes in capital
- changes in natural resources
- changes in technological knowledge
Define natural rate of output
the production of goods and services that an economy achieves in the long run when unemployment is at its normal rate
Define natural rate of output
the production of goods and services that an economy achieves in the long run when unemployment is at its normal rate
Why does the AS curve slope up in the short run?
in the short run, the price level does affect the economy’s output; increase in price level tends to raise the quantity of goods and services supplied
When the price level raises above its expected level, output rises above its natural rate
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What are the reasons the AS curve slopes up in the short run?
- sticky wage theory
- sticky price theory
- misperceptions theory
What is the sticky wage theory?
an unexpected fall in the price level temporarily rises real wages, which induces firms to reduce employment and production
what is the sticky price theory?
an unexpected fall in the price level leaves some firms that are temporarily too high (menu costs), which reduces their sales and causes them to cut back on production
What is the misperceptions theory?
an unexpected fall in the price level leads suppliers to mistakenly believe that their relative prices have fallen, which makes them reduce production
Compare the short run AS curve calculation vs the long run AS curve calculation:
SR:
quantity of output supplied = natural rate of output + a( actual price level - expected price level)
a: number that determines how much output responds to unexpected changes in the price level
LR:
quantity of output supplied = natural rate of output (vertical)
Why might the short run AS curve shift?
changes in labour, capital, natural resources, or technological knowledge
What is stagflation?
a period of falling output and rising prices
