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Economics 144 > Chapter 8: Aggregate Demand & Supply > Flashcards

Chapter 8: Aggregate Demand & Supply Flashcards

0
Q

3 Components of the AD/AS framework

A
  • Aggregate demand
  • Long run aggregate supply
  • Short run aggregate supply
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1
Q

The AD-AS framework relates…

A

Various economic variables (wealth, interest rate, exchange rate, wage rate) to:

  • Real GDP
  • Price Levels
  • Unemployment
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2
Q

Components of aggregate demand

A
  • Household
  • Firms
  • Government
  • The foreign sector
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3
Q

3 reasons for an inverse relationship between GDP and Price Level:

A
  • Real money balance effect
  • Interest rate effect
  • International trade effect
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4
Q

Explain the process of the real money balance effect:

A

If price levels fall >
Purchasing power rises >
Monetary wealth rises >
Consumers buy more goods

(And vice versa)

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5
Q

Interest rate effect process

A 
Price level rises >
purchasing power falls >
People borrow money in order to buy a fixed bundle of goods >
Demand for credit rises >
Interest rate rises >
Businesses and Households borrow less >
Buy fewer goods

And vice versa

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6
Q

International trade effect process

A

If the price level in SA rises relative to foreign price levels >
South African goods are relatively more expensive than foreign goods >
Both Americans and foreigners buy less South African goods

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7
Q

Interest rate’s effect on I

A

Reduction in interest rates should bring increased business activity, a rise in inflation rate and depreciation of the national currency.

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8
Q

Central bank benchmark interest rate

A

The overnight rate at which central banks make loans to commercial banks under their jurisdiction
Moving the benchmark interest rates, the central bank is able to make an impact on interest rates of commercial banks, inflation level and the national currency exchange rate.

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9
Q

Aggregate Supply

A

The quantity supplied of all goods and services at various price levels.

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10
Q

Why does the short run aggregate supply curve have a positive slope

A
  • Workers’ misconceptions

- Sticky (inflexible) wages

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11
Q

Which changes cause the SRAS-curve to shift?

A
  • Wage-rate
  • Price of non-labour inputs
  • Labour productivity
  • Supply shocks
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12
Q

What can be determined by AD-SRAS in the short run?

A

Market price levels and real GDP

And higher real GDP > lower unemployment

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13
Q

Why, in the long run, is the positive relation between quantity supplied and price levels no longer applicable

A
  • Wages adjust
  • Prices become flexible
  • Workers’ misperceptions are corrected
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15
Q

Why is the long-run aggregate supply curve a straight line?

A
  • There is no relationship between the price levels and quantity of real GDP supplied in the long run.
  • Real GDP is determined by economic capacity (natural real GDP, natural Unemployment)
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16
Q

Aggregate Demand

A

The quantity demanded of all goods and services (Real GDP) at different price levels, ceteris paribus.

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17
Q

Aggregate Demand Curve

A

A curve that shows the quantity demanded of all goods and services (Real GDP) at different price levels, ceteris paribus.

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18
Q

Why does the aggregate demand curve slope downward.

A
  • Real balance effect
  • Interest rate effect
  • International trade effect.
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19
Q

Real Balance Effect

A

The change in the purchasing power of rand-denominated assets that results in a change in the price level.

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20
Q

Working of the real balance effect

A

A rise in price level causes purchasing power to fall, which decreases a person’s monetary wealth.
Less wealth causes the quantity demanded of Real GDP to fall.

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21
Q

Purchasing power

A

The quantity of goods and services that can be purchased with a unit of money.
Purchasing power and the price level are inversely related.
As price level goes up, purchasing power falls.

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22
Q

Interest Rate Effect

A

The changes in household and business buying as the interest rate changes.

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23
Q

International Trade Effect

A

The change in foreign sector spending as the price level changes.

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24
Q

If - at a given price level - consumption, investment, government purchases or net exports rise, aggregate demand will…

A

Rise

AD-curve will shift right

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25
Q

What can change aggregate demand in the economy (4)

A
  • Consumption
  • Investment
  • Government spending
  • Net exports
26
Q

4 Factors that affect consumption

A
  • Wealth
  • Expectations about future prices and income
  • Interest rate
  • Income Taxes
27
Q

Wealth

A

The value of all assets owned, both monetary and nonmonetary.

28
Q

How does wealth affect consumption?

A

Individuals consume not only on income, but on wealth as well. If one has accumulated savings, they would be more willing to spend/consume more of their income.

29
Q

The effect on consumption

If individuals expect higher prices in the future

A

Consumptions will increase (increase in aggregate demand)

They increase their current consumption to buy goods at the lower current prices.

30
Q

The effect on consumption

If individuals expect future income

A

Consumption and aggregate demand (currently) will increase. Consumers be less prudent.

31
Q

Interest rate’s effect on consumption

A

Buyers often pay by borrowing.

An increase in the interest rate, increases the monthly payment amounts linked to the purchase. Thus consumption and aggregate demand falls.

And vice versa

32
Q

Income Taxes effects on consumption

A

If income taxes rise, disposable income falls and consumption (aggregate demand) falls.

33
Q

3 Factors affecting Investment

A
  • Interest Rate
  • Expectations about future sales
  • Business taxes
34
Q

Interest rate’s effect on investment

A

As the interest rate rises, the cost of an investment project rises, and businessmen invest less. Aggregate demand decreases.

(and vice versa)

35
Q

Effects on investment

Expectations about future sales

A

If businessmen are optimistic about future sales, investment spending grows and aggregate demand increases.

(and vice versa)

36
Q

Businesses taxes’ effect on investment

A

Increase in business taxes lowers expected profitability. Thus businesses invest less. Aggregate demand falls.

(and vice versa)

37
Q

2 factors affecting Net exports

A
  • Foreign Real National Income

- Exchange rate

38
Q

The effect of foreign real national income on net exports

A

If foreign real national income rises, foreigners buy more of our goods and services. Exports rise. Aggregate demand increases

And vice versa

39
Q

Foreign real national income

A

The national income of foreign countries/consumers adjusted for price changes.

40
Q

Exchange rate

A

The price of one currency in terms of another.

41
Q

Appreciation

A

An increase in the value of one currency relative to other currencies.

42
Q

Depreciation

A

A decrease in the value of one currency relative to other currencies.

43
Q

How can a change in the money supply change aggregate demand?

A
  • A change in the money supply affects interest rates
  • A change in interest rates changes consumption and investment
  • A change in consumption and investment affects aggregate demand.
44
Q

Aggregate Supply

A

The quantity supplied of all goods and services (Real GDP) at different price levels, ceteris paribus.

45
Q

Short-Run Aggregate Supply Curve

A

A curve that shows the quantity supplied of all goods and services at different price levels, ceteris paribus.

46
Q

2 Explanations for an upward sloping SRAS curve

A
  • Sticky Wages

- Worker Misperceptions

47
Q

Explain Sticky Wages’ Effect

A

If wages are sticky, a decrease in the price level (which pushes REAL wages up) will result in a decrease in output (firms cut back on labor).

48
Q

Explain Worker Misperceptions’ Effect

A

If workers misperceive real wage changes, then a fall in price level will bring about a decline in output. (As workers may reduce the quantity of labor they are willing to supply).

49
Q

Why does the Short Run AS curve differ from the Long Run AS curve

A

Sticky wages or worker misperceptions change over time. Wages will not be sticky forever (labor contracts will expire), workers will correct their misperceptions.
These issues will only be relevant for a period of time: the short run.

50
Q

Name 4 factors that can shift the SRAS curve

A
  • Wage Rates
  • Prices of nonlabor inputs
  • Productivity
  • Supply Shocks
51
Q

Explain the effects of Wage Rates on SRAS

A

Higher wage rates mean higher costs and - at constant prices - translate into lower profits and a reduction in the number of units that firms will want to produce.

And vice versa.

52
Q

Explain the effects of prices of nonlabor inputs on SRAS

A

An increase in the price of nonlabor input shifts the SRAS curve leftward.

A decrease => rightward

53
Q

Explain the effects of productivity on SRAS

A

An increase in productivity means businesses will produce more output with the same amount of labor - causing the SRAS-curve to shift rightward.

And vice versa.

54
Q

Productivity

A

The output produced per unit of input employed over some period of time.

55
Q

Two varieties of supply shocks

A

Adverse and Beneficial supply shocks

56
Q

Adverse supply shocks

A

Shift the SRAS curve leftward.

57
Q

Beneficial supply shocks

A

Shift the SRAS curve rightward.

58
Q

Short-run Equilibrium

A

The condition in the economy when the quantity demanded of Real GDP equals the (short-run) quantity supplied of Real GDP.

This condition is met where the aggregate demand curve intersects the short-run aggregate supply curve.

59
Q

Natural Real GDP

A

The Real GDP that is produced at the natural unemployment rate. The Real GDP that is produced when the economy is in long-run equilibrium.

60
Q

Long-Run Aggregate Supply Curve

A

A vertical line at the level of Natural Real GDP. It represents the output the economy produces when wages and prices have adjusted to their final equilibrium levels and when workers do not have any relevant misperceptions.

61
Q

Long-run Equilibrium

A

The condition that exists in the economy when wages and prices have adjusted to their final equilibrium levels and when workers do not have any relevant misperceptions.

Where AD and LRAS curves intersect.

Economics 144 (16 decks)

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