Chapter 22: Aggregate Demand and Supply Analysis Flashcards
Four component parts of aggregate demand
1) Consumption expenditure
2) Planned investment spending
3) Government purchases
4) Net exports
Consumption expenditure
the total demand for consumer goods and services
Planned investment spending
the total planned spending by business firms on new machines, factories, and other capital goods, plus planned spending on new homes
Government purchases
spending by all levels of government (federal, state, and local) on goods and services
Net exports
the net foreign spending on domestic goods and services
Long-run aggregate supply curve
- Determined by amount of capital and labor and the available technology
- Vertical at the natural rate of output generated by the natural rate of unemployment
Short-run aggregate supply curve
- Wages and prices are sticky
- Generates an upward sloping SRAS as firms attempt to take advantage of short-run profitability when price level rises
Shifts in the LRAS curve
1) Increase in total capital in the economy = shift right
2) Increase in the total amount of labor supplied in the economy = shift right
3) Increase in the available technology = shift right
4) Decline in the natural rate of unemployment = shift right
Shifts in the SRAS curve
1) Increase in expected inflation = shift left (upward)
2) Increased inflation shock = shift left
3) Persistent output gap = shift left
Equilibrium in Aggregate Demand and Supply Analysis
the point where the quantity of aggregate output demanded equals the quantity of aggregate output supplied
Self-Correcting Mechanism
Regardless of where output is initially, it returns eventually to the natural rate
-Slow:
+Wages are inflexible, particularly downward
+Need for active government policy
Rapid:
+Wages and prices are flexible
+Less need for government intervention
Positive Demand Shock
SEE FIGURE 9
The Volcker Disinflation
SEE FIGURE 10
Negative Demand Shock
SEE FIGURE 11
Temporary Negative Supply Shock
SEE FIGURE 12
Real business cycle theory
the belief that business cycle fluctuations result from permanent supply shocks alone
Permanent Negative Supply Shock
SEE FIGURE 14
Positive Supply Shock
SEE FIGURE 15
Conclusions from aggregate demand and supply analysis
1) A shift in the aggregate demand curve affects output only in the short run and has no effect in the long run
2) A temporary supply shock affects output and inflation only in the short run and has no effect in the long run (holding the aggregate demand curve constant)
3) A permanent supply shock affects output and inflation both in the short and the long run
4) The economy has a self-correcting mechanism that returns it to potential output and the natural rate of unemployment over time
Negative Supply and Demand Shocks and the 2007–2009 Crisis
SEE FIGURE 16
U.K. Financial Crisis, 2007-2009
SEE FIGURE 17
China and the Financial Crisis, 2007-2009
SEE FIGURE 18
The Phillips Curve
- the negative relationship between unemployment and inflation
- When unemployment rate is low, firms may have difficulty hiring qualified workers and even keeping present employees => firms will raise wages to attract needed workers raise their prices at a more rapid rate
The Short- and Long-Run Phillips Curve
SEE FIGURE APPENDIX FIGURE 2
Three Important Conclusions
1) There is no long-run trade-off between unemployment and inflation
2) There is a short-run trade-off between unemployment and inflation
3) There are two types of Phillips curves, long run and short run
Okun’s Law
- negative relationship between the unemployment gap and the output gap
- for each percentage point that output is above potential, the unemployment rate is one-half of a percentage point below the natural rate of unemployment
- for every percentage point that unemployment is above its natural rate, output is two percentage points below potential output
