Chapter 9.3 Flashcards
Monetarist/new classical economics
Believes in the importance of the price mechanism in coordinating economic activities, the concept of competitive market equilibrium and thinks of the economy as a system that tends automatically towards full employment
Long-run aggregate supply
The relationship between long-run supply and aggregate output
LRAS curve
Shows the long-run aggregate supply, is vertical at potential GDP
When is the economy in long-run equilibrium?
When the AD and SRAS curve intersect at any point on the LRAS curve
What does the fact that the LRAS is vertical indicate?
That in the long run the economy produced potential GDP which is independent of price level
Why is the LRAS curve vertical?
Since in the long run wages change to match output price changes, a firms’ cost of production will remain constant, so with constant real costs firms will have no incentive to change output levels
Deflationary gap
A situation where real GDP is less than potential GDP due to insufficient aggregate demand
Inflationary gap
A situation where real GDP is greater than potential GDP due to excess aggregate demand
Full employment level of output/potential output
When the economy is at its full employment equilibrium level of GDP, reducing where the AD and SRAS curve intersect at the level of potential GDP
What is the effect of changes in aggregate demand in the short run and in the long run?
In short run, aggregate demand can affect real GDP but in the long run it only changes the price level as real GDP will remain constant at the level of potential output
What ensures that the LRAS curve is vertical at the level of potential GDP in the long run?
The monetarist/new classical perspective says that recessionary and inflationary gaps will be eliminated in the long run
