Chapter 14 Flashcards
Recessions
periods of falling real incomes and rising unemployment
Depressions
severe recessions (very rare)
Short-run economic fluctuations are often called:
business cycles
3 Facts about Economic Fluctuations
1. Economic fluctuations are irregular and unpredictable
- Most macroeconomic quantities fluctuate together
- As output falls, unemployment rises
What model is used to study fluctuations?
Model of aggregate demand and aggregate supply
Does the model of aggregate demand and aggregate supply explains long run fluctuations or short run fluctuations?
long run
Classical Dichotomy is the separation of variables into what two groups?
real - quantities, relative prices
Nominal - measured in terms of money
define: changes in the money supply affect nominal but not real variables
neutrality of money
T or F: In the short run, changes in nominal variables (like the money supply or P ) can affect real variables (like Y or the u-rate).
true
T or F: Most economists believe classical theory describes the world in the short run,
but not the long run.
false; Most economists believe classical theory describes the world in the long run,
but not the short run.
Economists use the model of ___________ to explain short-run fluctuations in economic activity around its long-run trend.
model of aggregate demand and aggregate supply
The _____________ curve shows the quantity of goods and services that households, firms, and the government want to buy at each price level.
aggregate demand ; sum of demand
The _____________ curve shows the quantity of goods and services that firms choose to produce and sell at each price level.
aggregate-supply; sum of supply
The Model of Aggregate Demand and Aggregate Supply : the equilibrium output = _________
real GDP
The Model of Aggregate Demand and Aggregate Supply: Aggregate supply is in the short run or the long run?
short run
The Model of Aggregate Demand and Aggregate Supply: the Aggregate-Demand (AD) curve shows:
the quantity of all g&s demanded
in the economy at any given price level.
The Wealth Effect (P and C)
if P rises,
then C ____.
falls; The dollars people hold buy fewer g&s,
so real wealth is lower.
The Interest-Rate Effect (P and I )
Suppose P rises,
then I ____.
falls;
Buying g&s requires more dollars; To get these dollars, people sell bonds or other assets; This drives up interest rates.
T or F: I depends negatively on interest rates.
True
The Exchange-Rate Effect (P and NX )
If P rises,
NX ____.
falls;
Foreign investors desire more Canadian bonds.
! Higher demand for $ in foreign exchange market.
Canadian exchange rate appreciates.
Canadian exports more expensive to people abroad, imports cheaper to Canadian residents.
An ________ in P reduces the quantity of g&s demanded.
increase
Changes in what variables would cause a shift in the AD curve?
C , I , G, or NX
NOT P
Would there be a shift in the AD curve? If so which way?
A stock market boom
makes households feel wealthier.
C rises,
the AD curve shifts right.
The following would cause a change in which of the productivity variables?
Stock market boom/crash
Preferences re: consumption/saving tradeoff
Tax hikes/cuts
variable C (consumption)
The following would cause a change in which of the productivity variables?
Federal spending, e.g., defense
Provincial & municipal spending, e.g., roads, schools
variable G (govt spending)
The following would cause a change in which of the productivity variables?
Booms/recessions in countries that buy our
exports.
Appreciation/depreciation resulting from international speculation in foreign exchange market
variable NX (net exports)
The following would cause a change in which of the productivity variables?
Firms buy new computers, equipment, factories
Expectations, optimism/pessimism
Interest rates, monetary policy
Investment Tax Credit or other tax incentives
Variable I (investment)
What happens to the AD curve in the following scenario?
A ten-year-old investment tax credit expires.
I falls, AD curve shifts left.
What happens to the AD curve in the following scenario?
The Canadian exchange rate falls.
NX rises, AD curve shifts right.
What happens to the AD curve in the following scenario?
A fall in prices increases the real value of consumers’ wealth.
Move down along AD curve (wealth-effect).
What happens to the AD curve in the following scenario?
Provincial governments replace their sales taxes with new taxes on interest, dividends, and capital gains
new taxes on interest, dividends, and capital gains.
C rises, AD shifts right.
The Aggregate-supply (AS) curve shows:
the total quantity of g&s firms produce and sell at any given price level.
which Aggregate curve is: upward-sloping in the short run and vertical in the long run?
Aggregate supply curve
Which Aggregate curve is downward sloping and is explained by G being fixed
Aggregate demand curve
Natural Rate of output (Yn)
amount of output
the economy produces when unemployment
is at its natural rate.
potential output or full-employment output is also known as:
natural rate of output (Yn)
Why Long-Run Aggregate supply is vertical?
An increase in P does not affect any of these,
so it does not affect Yn.
Yn is determined by the economy’s stocks of ______ , _______, and _______ ________, and on the level of technology
labour, capital, natural resources (land)
T or F: by changing any variable in the formula : Y = C + I + G + NX will shift the LRAS curve
False; Y = A, F(L, K , H, N)
Immigration increases L, causing Yn to ___.
rise
These scenarios will cause which variable to shift the LRAS curve?
Immigration
Baby-boomers retire
Govt policies reduce natural u-rate
Changing in L or natural rate of unemployment
These scenarios will cause which variable to shift the LRAS curve?
- Investment in factories, equipment
- More people get college degrees
- Factories destroyed by a hurricane
Changes in K or H
These scenarios will cause which variable to shift the LRAS curve?
• Discovery of new mineral deposits
• Reduction in supply of imported oil
• Changing weather patterns that affect
agricultural production
Changes in natural resources
These scenarios will cause which variable to shift the LRAS curve?
Productivity improvements from technological progress
changes in technology
Over the long run, tech. progress shifts LRAS to the _____.
right
and growth in the money supply shifts AD to the _____.
right
Shifts to the right cause ongoing ______ and _______ in output.
inflation ; growth
The SRAS curve is upward or downward sloping?
upward
the time period for “short run” is considered __ - ___ years; Tom porter says : __ - ___ months;
1-2 years; 3 - 24 months
T or F: If AS is vertical, fluctuations in AD cause fluctuations in output or employment.
false; If AS is vertical, fluctuations in AD
do not cause fluctuations in output or employment.
T or F: If AS slopes up, then shifts in AD do affect output and employment.
true
3 theories of SRAS:
- Sticky-Wage Theory
- Sticky-Price Theory
- The misperceptions Theory
T or F: Output deviates from its natural rate when the actual price level deviates from the price level people expected
True
T or F: The three theories of SRAS are all some type of market imperfection.
True
Which SRAS theory corresponds to the information below?
Imperfection:
Nominal wages are adjust sluggishly in the short run.
Due to labour contracts, social norms
The sticky-wage theory
Which SRAS theory corresponds to the information below?
Firms and workers set the nominal wage in the advance based on Pe, the price level they expect to prevail
The sticky-wage theory
Which SRAS theory corresponds to the information below?
If P>Pe, revenue is higher, but labour cost is not. Production is more profitable, so firms increase output and employment. Hence, higher P causes higher Y, so the SRAS curve slopes upward.
Sticky-wage theory
Which SRAS theory corresponds to the information below?
Imperfection:
Firms may confuse changes in P with changes in the relative price of the products they sell.
The misperceptions Theory
Which SRAS theory corresponds to the information below?
If P rises above PE, a firm sees its price rise before realizing all prices are rising.
The firm may believe its relative price is rising, and may increase output and employment.
The misperceptions theory
Which SRAS theory corresponds to the information below?
Imperfection:
Many prices are sticky in the short run.
Due to menu costs, the costs of adjusting prices.
Examples: cost of printing new menus, the time required to change price tags
Sticky-price theory
Which SRAS theory corresponds to the information below?
Suppose the Bank of Canada increases the money supply unexpectedly. In the long run, P will rise.
In the short run, firms without menu costs can raise their prices immediately.
Firms with menu costs wait to raise prices. Meantime, their prices are relatively low,
which increases demand for their products, so they increase output and employment.
Sticky-price theory
What do the 3 SRAS theories have in common?
In all 3 theories, Y deviates from YN when P deviates from PE.
Y = Yn + a(P-Pe)
In the Formula Y = Yn + a(P-Pe):
What is this formula used to explain shifts in which curve?
SRAS curve
In the Formula Y = Yn + a(P-Pe):
Y:
Output
In the Formula Y = Yn + a(P-Pe):
Yn:
Natural rate of output (long-run) (Y-@ equilibrium)
In the Formula Y = Yn + a(P-Pe):
a:
a>0, measures how much Y responds to unexpected changes in P
In the Formula Y = Yn + a(P-Pe):
P:
actual price level
In the Formula Y = Yn + a(P-Pe):
Pe:
expected price level
T or F: The imperfections in these theories are temporary. Over time,
• some sticky wages and prices become flexible
• some misperceptions are not corrected
False; The imperfections in these theories are temporary. Over time,
• sticky wages and prices become flexible • misperceptions are corrected
T or F: In the LR, Pe = P
true; AS curve is vertical
T or F: In the long run, Pe = P and Y = Yn.
True
T or F: EVERYTHING that shifts LRAS , shifts SRAS too.
True
What happens to the SRAS curve?
If Pe rises,
workers and firms set higher wages..
Y ____ ,
SRAS shifts ____
falls; left
Economic Fluctuations are caused by events that shift the ______ and/or ______ curves.
AD; AS
What are the 4 steps to analyzing economic fluctuations?
- Determine whether the event shifts AD or AS
- Determine whether curve shifts left or right
- Use AD-AS diagram to see how the shift changes Y and P in the short run
- Use AD-AS diagram to see how economy moves from new SR equilibrium to new LR equilibrium.
What would happen to the AS AD curves if :
Event: Stock market crash
- Affects C, AD curve
- C falls, so AD shifts left
- SR eq’m at B. P and Y lower, A unemp higher
4. Over time, PE falls,
SRAS shifts right, until LR eq’m at C. Y and unemp back at initial levels.
Example:
1. Draw the AD-SRAS-LRAS diagram for the Canadian economy
starting in a long-run equilibrium.
2. A boom occurs in the U.S..
Use your diagram to determine
the SR and LR effects on Canadian GDP, the price level, and unemployment.
- Affects NX, AD curve
- Shifts AD right
- SR eq’m at point B.
P and Y higher, unemp lower - over time, PE rises, SRAS shifts left, until LR eq’m at C. Y and unemp back at initial levels
What would happen to the AS AD curves if:
Event: Oil prices rise
1.Increase costs, shifts SRAS (assume LRAS constant)
2. SRAS shifts left
3. SR eq’m at point B.
P higher, Y lower, unemp higher
E1 to E2 = stagflation (a period falling output and rising prices)
4. (if policymakers do nothing) low unemployment causes wages to fall, SRAS shifts right, until LR eq’m at A. or E1
OR policymakers could use fiscal or monetary policy to increase AD and accomodate the AS shift . Y back to Yn, but P permanently higher.
Stagflation
a period of falling output and rising prices
T or F: policymakers could use fiscal or monetary policy to increase AD and accommodate the AS shift, but P permanently is higher.
True
T or F: John Maynard Keynes: Argued recessions and depressions can result from inadequate demand; policymakers should shift AD.
True
This chapter has introduced the model of aggregate demand and aggregate supply, which helps explain_______ ______.
economic fluctuations
economic fluctuations are deviations from the ____-___ trends explained by the models we learned in previous chapters.
long run
T or F: policymakers can not affect aggregate demand.
False; policymakers can affect aggregate demand with fiscal and monetary policy.
Short-run fluctuations in GDP and other macroeconomic quantities are regular and predictable.
False; Short-run fluctuations in GDP and other macroeconomic quantities are irregular and unpredictable.
________ are periods of falling real GDP and rising unemployment.
Recessions
Economists analyze _______ using the model of aggregate demand and aggregate supply.
fluctuations
The aggregate demand curve slopes downward because a change in the ______ ______ has a wealth effect on ________, an interest-rate effect on ________, and an exchange-rate effect on ____ ______.
price level; investment; net exports
P,C, I, NX
G IS FIXED
T or F: Anything that changes C, I, G, or NX – including a change in the price level – will shift the aggregate demand curve.
False; Anything that changes C, I, G, or NX – except a change in the price level – will shift the aggregate demand curve.
The long-run aggregate supply curve is vertical because changes in the _____ _____do not affect output in the long run.
price level
In the long run, output is determined by ______, _______, _____ ________, and _______; changes in any of these will shift the long-run aggregate supply curve.
labour, capital, natural resources, technology
T or F: In the short run, output deviates from its natural rate when the price level is different than expected
True
In an upward-sloping short-run aggregate supply curve:
The three theories proposed to explain this upward slope are the ____ ____ theory, the _____ ______ theory, and the ________ theory.
sticky wage, sticky price, misperceptions
The short-run aggregate-supply curve shifts in response to: (2 things)
changes in the expected price level
anything that shifts the long-run aggregate supply curve
T or F: Economic fluctuations are caused by movement along aggregate demand and aggregate supply curves.
False; Economic fluctuations are caused by shifts in aggregate demand and aggregate supply.
When aggregate demand falls, output and the price level _____ in the short run.
Over time, a change in expectations causes wages, prices, and perceptions to adjust, and the short-run aggregate supply curve shifts _______.
In the long run, the economy returns to the natural rates of output and unemployment, but with a _____ price level
fall; rightward; lower
A fall in aggregate supply results in ________ – falling output and rising prices.
Wages, prices, and perceptions adjust over time, and the economy recovers.
stagflation
