Chp. 20: Aggregate Demand and Aggregate Supply Flashcards
Concept: Monetary Neutrality
Changes in money supply that only affect nominal variables and not the real variables
What do changes in the money supply affect?
prices and other nominal variables
What happens to the assumption of monetary neutrality in the short-run?
it becomes no longer appropriate to the short-run, because real and nominal variables become highly intertwined
In the short-run, what happens when there are changes in the money supply?
It can temporarily push real GDP away from its long-run trend
What are the models of aggregate demand (AD) and aggregate supply (AS) used for?
They are used to explain short-run fluctuations in economic activity
What is the aggregate demand curve representative of?
It is representative of the quantity of goods and services that households, firms, the government and customers abroad want to buy at each price level.
Which direction is the slope of the aggregate-demand curve?
It is downward sloping
What is the aggregate supply curve representative of?
It is representative of the quantity of goods and services that firms choose to produce and sell at each price level.
Which direction is the slope of the aggregate supply curve?
it is upward sloping
When analyzing the economy in the context of aggregate demand and aggregate supply, what is one assumption we make about government spending?
it is fixed by policy
What explains the aggregate demand curves’ downward slope?
wealth effect (C), interest rate effect (I), exchange rate effect (NX)
Analyzing: In which ways does the wealth effect (consumption) affect the aggregate demands’ downward slope?
Decrease in price level leads to an increase in the real value of money, and then consumers are wealthier, which leads to an increase in consumer spending, and an increase in quantity demanded of goods and services
Analyzing: In which ways does the interest rate (price level and investment) affect the aggregate demand’s downward slope?
There is a decrease in price level, which leads to a decrease in the interest, which leads to an increase in spending on investment goods, and an increase in quantity demanded of goods and services
Analyzing: In which ways does the exchange rate (price level and net exports) affect the aggregate demand’s downward slope?
A decrease in the U.S price level, leads to a decrease in the interest rate, which leads to the U.S dollar depreciating, stimulating net exports, which leads to an increase in quantity demanded of goods and services
In AD, a fall in price level would mean,
an increase in the quantity of goods and services demanded
reason:
-consumers are wealthier: this stimulates the demand for consumption goods
-interest rates fall: stimulates the demand for investment goods
-currency depreciates: stimulates the demand for net exports
In AD, a rise in price level would mean,
A decrease in the quantity of goods and services demanded
reason: consumers are poorer: depress consumer spending
higher interest rates fall: depress investment spending
currency appreciates: depress net exports
The AD curve might shift when there are…
changes in consumption, changes in investment, changes in government purchases, and changes in net exports
What would cause a change in consumption?
A change in consumption would happen if there is a change in taxes or consumer wealth
If there is an increase in consumer spending (Consumption), where does the aggregate demand curve shift?
To the right
What would cause a change in investment?
A change in investment would come about by better technology, tax policy, or money supply
If there is an increase in investment, where would the aggregate demand curve shift?
shift right
What would cause a change in government purchases (government spending/ G)
A change in government spending might be cause by the building of new roads
Where does the Aggregate-Demand curve shift to, when there is an increase in government purchases
an increase in government purchases, shifts eh aggregate demand curve to the right
What would cause a change in net exports (NX)
A change in net exports would be caused by a recession in Europe, international speculators – change in exchange rate
What direction would the aggregate demand curve go, if there is an increase in net exports
Aggregate demand curve would shift to the right
In aggregate demand…What is on the Y and X axis?
Y = price level (the amt. they’re selling for)
x= Q of output (i.e, goods and services produced)
What is characteristic of the Long Run aggregate supply curve (LRAS)?
It is is vertical.
Reasoning: price level does not affect the long-run determinants of GDP which are supplies of labor, capital, and natural resources
Is price level a determinant of GDP?
NO.
Labor, capital, and natural resources are
+ available tech
What is characteristic of the short-run aggregate supply curve?
It is upward sloping /
What is the natural level of output?
The natural level of goods and services produced that an economy achieves in the long run when ~ unemployment is at its normal rate.
Another way of thinking about it, is that the natural level of output is the full-employment output – this is the amt. that the economy will produced at full employment
Where does the LRAS curve rest on, in regards to the x-axis?
it rests on the natural level of output, which means you can read it as…
LRAS being constant when there is full employment, or the unemployment rate is at its normal rate
In which instances might the LRAS curve shift?
It might shift when there are any of the following:
- changes in labor
-changes in capital
-changes in natural resources
-changes In technological knowledge
so in other words, LRAS will shift when any of the GDP determinants change
Analyzing: changes in labor their effect on the aggregate supply curve
If labor increase , the supply curve will shift to the right
if the natural rate of unemployment increases , the supply curve will shift to the left
Analyze: changes in capital its effect on the aggregate supply curve
if capital stock increase, the ASC shifts right
if physical and human capital increase - then the curve will shift to the right
Analyze: changes in natural resources and its effects on the aggregate supply curve
A new discover of a natural resources, leads the supply curve to shift to the right
Analyze: changes in technology
The development of new tech, for given labor, capital and natural resources, shifts the curve to the right
Note***
In the long run, technological progress shifts long-run aggregate supply
In which direction does the aggregate supply curve slope in the short-run?
It slopes upward
Does price level affect the short run aggregate supply curve?
Yes.
An increase in overall level of prices in the economy tends to raise the quantity of goods and services supplied
a decrease in the level of prices tends to reduce the quantity of goods and services supplied
How a fall in price level affects the output… (in regards to the aggregate supply curve)
a fall in the price level from 5,000 to 4,000 moves the quantity of goods supplied to a lower point on the short-run aggregate supply slope
Explanations for the short-run Aggregate Supply curve sloping upwards…
-sticky wage theory
-sticky rice theory
-misperceptions theory
Theories for Short-run aggregate supply curve sloping upwards: sticky wage-theory
nominal wages - slow to adjust to changing economic conditions which might be to long-term contracts, slowly changing social Norms, notions of fairness
nominal wages function based on expected prices, which sometimes don’t respond immediately when actual price level is different from what was expected
Conceptual sticky wage theory:
price level < expected
* firms are incentivized to produce less output
price level > expected
* firms are incentivized to produce for output
Theories for Short-run aggregate supply curve sloping upwards: sticky price theory
prices of some goods and services are slow to adjust to changing economic conditions
Theories for Short-run aggregate supply curve sloping upwards: misperceptions theory
changes in the overall price level can temporarily mislead suppliers about changes in individual markets or changes in relative prices. Suppliers respond to changes in level of prices, which change the quantity supplied of goods and services
Equation for Aggregate Supply curve
Q of output supplied = natural level of output + a (actual price level - expected price level)
*** where a is the number that determines how much output response to unexpected changes in the price level
In which instances might the short run AS curve shift?
when there are changes in labor, capital, natural resources, or technological knowledge
expected price level increases. And aggregate-supply curve shifts left
When analyzing the causes of economic fluctuations, we always assume that the economy begins in…
long-run equilibrium
What is long run equilibrium?
on a graph, it is the intersection of AD and LRAS curves, which makes the natural level of output and the actual price level
When the economy reaches this point, the expected price level is equal to the actual price
What is happening at the intersection of the AD and the short-run AS curve?
this is where you can see the expected price level, and the actual price level
What a wave of pessimism does to the aggregate demand curve…
a wave of pessimism will shift AD to the left.
short run effects:
output falls, and the price level falls
Long-run effects:
short-run aggregate supply curve shifts right, the output is at the natural level, and the price level falls
Causes of a shift in aggregate supply…
firms increase in production costs, when aggregate supply curve shifts left
in the short-run, this will result in stagflation where output falls and price level rises
in the long run, If AD is held constant
the short run AS will shift back to the right, and the output will be at the natural level while the price level falls
