Chapter 14

Question 1

Define recession

Answer 1

a period of declining real incomes and rising unemployment

Question 2

What are the 3 key facts about economic fluctuations?

Answer 2

1. economic fluctuations are irregular and unpredictable
2. most macroeconomic quantities fluctuate together
3. as output falls, unemployment rises

Question 3

What is the model of AD and AS?

Answer 3

the model that most economists use to explain short run fluctuations in economic activity around its long run trend

Question 4

What is the AD curve?

Answer 4

a curve that shows the quantity of goods and services that households, firms, and the government want to buy at each price level

Question 5

What is the AS curve?

Answer 5

a curve that shows the quantity of goods and services that firms choose to produce and sell at each price level

Question 6

Y = G + C + I + NX

G is fixed by policy
therefore I, C, and NX depend on economic conditions and therefore price level

Answer 6

.

Question 7

Wha

Answer 7

l

Question 8

Why does the AD curve slope downward

Answer 8

1. price level & consumption (the wealth effect)
2. price level & investment (the interest rate effect)
3. price level & net exports (the real exchange rate effect)

Question 9

What is the wealth effect?

Answer 9

decrease in the price level makes consumers wealthier, which encourages them to spend more, which demands a larger quantity of goods and services

Question 10

What is the interest rate effect?

Answer 10

lower price level reduces interest rate, which encourages spending on investment goods, and increases the quantity of goods and services demanded

Question 11

What is the real exchange rate effect?

Answer 11

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

Question 12

Why might the AD curve shift?

Answer 12

1. change in consumption
2. change in investment
3. change in government purchases
4. change in net exports

Question 13

Why is the AS curve vertical in the long run?

Answer 13

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)

Question 14

Why might the long run AS curve shift?

Answer 14

1. changes in labour
2. changes in capital
3. changes in natural resources
4. changes in technological knowledge

Question 15

Define natural rate of output

Answer 15

the production of goods and services that an economy achieves in the long run when unemployment is at its normal rate

Question 16

Define natural rate of output

Answer 16

the production of goods and services that an economy achieves in the long run when unemployment is at its normal rate

Question 17

Why does the AS curve slope up in the short run?

Answer 17

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

Question 18

When the price level raises above its expected level, output rises above its natural rate

Answer 18

.

Question 19

What are the reasons the AS curve slopes up in the short run?

Answer 19

1. sticky wage theory
2. sticky price theory
3. misperceptions theory

Question 20

What is the sticky wage theory?

Answer 20

an unexpected fall in the price level temporarily rises real wages, which induces firms to reduce employment and production

Question 21

what is the sticky price theory?

Answer 21

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

Question 22

What is the misperceptions theory?

Answer 22

an unexpected fall in the price level leads suppliers to mistakenly believe that their relative prices have fallen, which makes them reduce production

Question 23

Compare the short run AS curve calculation vs the long run AS curve calculation:

Answer 23

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)

Question 24

Why might the short run AS curve shift?

Answer 24

changes in labour, capital, natural resources, or technological knowledge

Question 25

What is stagflation?

Answer 25

a period of falling output and rising prices