Chapter 8B | Aggregate Supply and Aggregate Demand Pt.2

Question 1

Demand Shocks

Answer 1

changes in factors other than the price level that change aggregate demand and shift aggregate demand curve (AD)

Question 2

Causes of Demand Shocks

Answer 2

Expectations
Interest rates
Government policy
GDP in R.O.W
Exchange rates

Question 3

Negative demand shocks

Answer 3

decrease demand, AD shifts leftward

Question 4

Positive demand shocks

Answer 4

increase demand, AD shifts rightward

Question 5

Negative demand shocks decrease aggregate demand, AD shifts leftward

Answer 5

More pessimistic expectations (I)

Higher interest rates (I or C)

Lower government spending or higher taxes (G or C)

Decreased GDP in R.O.W (X)

Higher value of Canadian dollar (X and IM)

Question 6

Positive demand shocks increase aggregate demand, AD shifts rightward

Answer 6

More optimistic expectations (I)

Lower interest rates (I or C)

Higher government spending or lower taxes (G or C)

Increased GDP in R.O.W (X)

Lower value of Canadian dollar (X and IM)

Question 7

AS/AD Model Puts Together…

Answer 7

SAS (Short-Run Aggregate Supply)

Short-Run supply plans by all macro players with fixed input prices

Question 8

AD (Aggregate Demand) and AS

Answer 8

Short-run demand plans by all macro players

Question 9

LAS (Long-Run Aggregate Supply)

Answer 9

Different from SAS and AD. LAS is a performance where all economists want the economy to end up.

Question 10

Equilibriums of Short run

Answer 10

Short-run macro equilibrium at intersection SAS and AD

Question 11

Equilibriums of Long-run

Answer 11

Long-run macro equilibrium at intersection SAS and AD and LAS

Aggregate quantity supplied = Aggregate quantity demanded of real GDP = Potential GDP

Question 12

How To Use AS/AD Models to Think Like an Economist

Answer 12

Remember LAS is different from SAS and AD. LAS is a performance target. SAS and AD are plans

Always start the story in long-run macroeconomic equilibrium, where LAS, SAS,

AD all intersect
Model a macroeconomic event as 1 of the 4 possible shocks == positive/negative aggregate supply/demand shock. Examine results of shock on GDP, unemployment, inflation

Analyze the return to long-run equilibrium after the shock
- Yes and No camps disagree about how markets adjust after shocks – no simple stories

Question 13

Scenario One

Answer 13

SAS and AD plans Match and Economy Hits Target of LAS

Question 14

Scenario Two

Answer 14

SAS and AD plans Match Even with Saving, But Investment Offsets Saving so Economy Hits Growing LAS Target Over Time

Question 15

To explain macroeconomic equilibrium with savings add the banking system

Answer 15

Market for loanable funds - banks coordinate supply of loanable funds (saving) with demand for loanable funds (borrowing for investment spending)
Interest rate is the price of loanable funds
If bank loan out savings to business borrowers who spend on new factories and equipment, that spending replaces consumer saving
Short-run aggregate supply still = aggregate demand

Question 16

Scenario Three

Answer 16

Mismatches between SAS and AD plans

Four mismatches between aggregate demand aggregate supply move economy away from long-run equilibrium targets

Question 17

Scenario Three Negative Demand Shocks

Answer 17

Negative demand shocks cause a recessionary gap – falling average prices, decreased real GDP, increased unemployment

Question 18

Scenario Three Positive Demand Shocks

Answer 18

Positive demand shocks cause an inflationary gap – rising average prices, increased real GDP, decreased unemployment

Question 19

Demand shocks

Answer 19

Y and P move in the same direction
Unemployment and inflation move in opposite directions; like Phillips Curve

Question 20

Negative supply shocks cause stagflation

Answer 20

rising average prices, decreased real GDP, increased unemployment

Question 21

Positive supply shocks cause

Answer 21

falling average prices, increased real GDP, continued full unemployment

Question 22

Supply shocks

Answer 22

Y and P move in opposite directions
Unemployment and inflation move in same direction: inconsistent with original Phillips Curve