Chapter 22: Aggregate Demand and Supply Analysis

Question 1

Four component parts of aggregate demand

Answer 1

1) Consumption expenditure
2) Planned investment spending
3) Government purchases
4) Net exports

Question 2

Consumption expenditure

Answer 2

the total demand for consumer goods and services

Question 3

Planned investment spending

Answer 3

the total planned spending by business firms on new machines, factories, and other capital goods, plus planned spending on new homes

Question 4

Government purchases

Answer 4

spending by all levels of government (federal, state, and local) on goods and services

Question 5

Net exports

Answer 5

the net foreign spending on domestic goods and services

Question 6

Long-run aggregate supply curve

Answer 6

• 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

Question 7

Short-run aggregate supply curve

Answer 7

• Wages and prices are sticky

- Generates an upward sloping SRAS as firms attempt to take advantage of short-run profitability when price level rises

Question 8

Shifts in the LRAS curve

Answer 8

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

Question 9

Shifts in the SRAS curve

Answer 9

1) Increase in expected inflation = shift left (upward)
2) Increased inflation shock = shift left
3) Persistent output gap = shift left

Question 10

Equilibrium in Aggregate Demand and Supply Analysis

Answer 10

the point where the quantity of aggregate output demanded equals the quantity of aggregate output supplied

Question 11

Self-Correcting Mechanism

Answer 11

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

Question 12

Positive Demand Shock

Answer 12

SEE FIGURE 9

Question 13

The Volcker Disinflation

Answer 13

SEE FIGURE 10

Question 14

Negative Demand Shock

Answer 14

SEE FIGURE 11

Question 15

Temporary Negative Supply Shock

Answer 15

SEE FIGURE 12

Question 16

Real business cycle theory

Answer 16

the belief that business cycle fluctuations result from permanent supply shocks alone

Question 17

Permanent Negative Supply Shock

Answer 17

SEE FIGURE 14

Question 18

Positive Supply Shock

Answer 18

SEE FIGURE 15

Question 19

Conclusions from aggregate demand and supply analysis

Answer 19

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

Question 20

Negative Supply and Demand Shocks and the 2007–2009 Crisis

Answer 20

SEE FIGURE 16

Question 21

U.K. Financial Crisis, 2007-2009

Answer 21

SEE FIGURE 17

Question 22

China and the Financial Crisis, 2007-2009

Answer 22

SEE FIGURE 18

Question 23

The Phillips Curve

Answer 23

• 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

Question 24

The Short- and Long-Run Phillips Curve

Answer 24

SEE FIGURE APPENDIX FIGURE 2

Question 25

Three Important Conclusions

Answer 25

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

Question 26

Okun’s Law

Answer 26

• 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