chapter 8 Flashcards
The macro PPF shows
the maximum combinations of consumer goods and capital goods that the economy can produce
Points inside the PPF represent
unemployed inputs (AKA workers without jobs, factories not operating, farmland not producing crops, etc.)
Long-Run Aggregate Supply
potential GDP; the quantity of real GDP supplied when all inputs are fully employed
Quantity of real GDP in LRAS Curve
No matter what the price level is at potential GDP, the quantity of real GDP does not change
All quantities of real GDP less than potential GDP in the LRAS curve represent
unemployed inputs, including unemployed workers
Long run period of time
time long enough for all prices and wages to adjust so that Adam Smith’s invisible hand works well
Short run period of time
where some input prices do not change → they have not adjusted to clear all markets and some choices are not coordinated
definition
Short-Run Aggregate Supply
Quantity of real GDP macroeconomic players plan to supply at different price levels
The SRAS curve is ____ sloping because input prices are fixed in the short-run
upward
The intersection of LRAS and SRAS curves means
that short-run supply plans hit the target of potential GDP
Law of Short-Run Aggregate Supply
- as the price level rises, aggregate quantity supplied of real GDP increases
- With fixed input prices, higher output prices create incentives for increased production through higher profits and by covering higher marginal opportunity costs of production
supply plans
to increase inputs
Increase in aggregate supply
increase in economy’s capacity to produce real GDP caused by increases in quantity/quality of inputs
An increase in inputs shifts
both LRAS and SRAS rightward
A decrease in inputs shifts
both LRAS and SRAS leftward
A change in aggregate quantity supplied is caused by
a change in the price level, which is a movement along an unchanged short-run aggregate supply curve
A change in aggregate supply is caused by
changes in the quality or quantity of inputs, which is a shift of both the LRAS and SRAS curves
Changing input prices shift
the SRAS curve but do not shift LRAS
* Rising input prices shift SRAS leftward
* Falling input prices shift SRAS rightward
what do they do
Negative supply shocks
decrease short-run aggregate supply
what do positive supply shocks do?
increase short-run aggregate supply
Aggregate Demand
quantity of real GDP macroeconomic players plan to demand at different price levels
Law of Aggregate Demand
as the price level rises, aggregate quantity demanded of real GDP decreases
the law of aggregate demand is an example of
the fallacy of composition
When average prices of all Canadian products and services rise
imported products and services produced in other countries become cheaper for Canadian consumers
As the prices of Canadian exports rise
the rest of the world buys less of them, switching to cheaper substitutes from other countries
What happens to AQD when Canadians buy more imports and R.O.W buys fewer Canadian exports
aggregate quantity demanded of Canadian products and services decreases
the largest part of aggregate demand
Consumer spending
Most unpredictable part of AD
business investment spending
business investment spending, LRAS and SRAS
New inputs increase LRAS and SRAS, but because the machinery that businesses buy are outputs produced by other businesses, the purchases are also part of aggregate demand
Government and AD
Government transfer payments go to consumers and show up in aggregate demand as part of planned consumer spending from that transfer payment income, so transfer payments are not part of government spending
R.O.W (exports)
Canadian exports are products and services produced here but sold to the rest of the world
Imports and AD
- DO NOT contribute to Canadian planned aggregate demand or real GDP
- Imports are included in the planned spending categories of consumption, investment, and government purchases of products and services
Demand shocks
changes in factors other than the price level that change aggregate demand and shift the aggregate demand curve
Negative demand shocks and AD
decrease aggregate demand and shift AD leftward
Positive demand shocks and AD
increase aggregate demand and shift AD rightward
Factors that Shift Aggregate Demand
- Expectations
- Interest Rates
- Government Policy
- GDP in ROW
- Exchange rates
Expectations: Investment and consumer spending
Future:
* Pessimistic expectations about future economic conditions are a negative demand shock
* Optimistic expectations are a positive demand shock since investment spending increases and so does aggregate demand
Consumer spending:
* When consumers become more pessimistic about their economic future, they may decrease spending and increase savings
* When consumers become more optimistic about their economic future, they increase spending and decrease savings
Interest Rates
- Rising interest rates are a negative demand shock, as borrowing to finance investment projects becomes more expensive and fewer investment projects are profitable
- Falling interest rates are a positive demand shock, as borrowing becomes cheaper and more investment projects become profitable, leading to an increase in aggregate demand
effect onAggregate Demand
Government Policy
- Higher taxes are a negative demand shock as consumers and businesses have less money to spend, decreasing aggregate demand
- Tax cuts and more government spending are positive demand shocks, increasing aggregate demand
GDP in R.O.W
- Decreases in GDP in ROW are a negative demand shock, decreasing the demand for Canadian exports and decreasing Canadian aggregate demand
- Increases in GDP in ROW are a positive demand shock
Exchange rates
- A rise in the exchange rate is a negative demand shock, decreasing exports and increasing imports, decreasing Canadian aggregate demand
- A fall in the exchange rate is a positive demand shock, increasing exports and decreasing imports, increasing Canadian aggregate demand
Macroeconomic Equilibrium
Aggregate demand matching aggregate supply
Short-run aggregate equilibrium
the point where short-run aggregate supply (SRAS) and aggregate demand (AD) intersect
Long-run equilibrium
the point where SRAS, AD and LRAS all intersect
Market for loanable funds
banks coordinate the supply of loanable funds (savings) with the demand for loanable funds (borrowing for investment spending). The interest rate is the price of loanable funds
negative demand shocks cause
a recessionary gap: falling average prices, decreased real GDP and increased unemployment
Positive demand shocks cause
an inflationary gap: rising average prices, increased real GDP, and decreased unemployment
negative supply shocks cause
stagflation: rising average prices, decreased real GDP and increased unemployment
Positive supply shocks cause
falling average prices, increased real GDP and continued full employment
Origin of Shocks and Business Cycles: Yes, markets self-adjust, so hands-off
- Shocks to aggregate supply and aggregate demand that trigger business cycles largely come from outside the economy
- Mistaken government fiscal and monetary policies are viewed as demand shocks that can cause a recession
- Government does not intend to cause economic problems, but it is difficult to time policy decisions and unintentional policy mistakes can cause business cycles → government is part of the problem not part of the solution
- Individuals are rational and make logical decisions
- Price adjustments in markets work to quickly restore long-run macroeconomic equilibrium
- Government should back off
Origin of Shocks and Business Cycles: No, markets fail often, so hands-on
- Shocks to SRAS and aggregate demand are internally generated as unintended byproducts of markets
- Investment plans are based on expectations and decisions are based largely on a gut-level instinct to act
- relying on other investors and the nature of investments all combine to make expectations and investment spending decisions very volatile
- When uncertain about the future, money is put into savings
- only government can fix these things
