ECON Final Flashcards

Question

2 Price Setting Strategies for Monopolies

Answer 1

1. Single-Price Monopoly: firm sells goods & services at same price for all customers 2. Price Discrimination: firm sells different units of good or service for different prices for different customers

Answer 2

1. Q=MR=MC, P=D @Q 2. Profit=P*Q-ATC*Q

Answer 3

Elastic: e>1, MR>0, TR rises Unit elastic: e=1, MR=0, TR constant Inelastic: e<1, MR<0, TR falls

Answer 4

Perfect Competition: profit=0 in long run as firms freely enter & exit market, P=MR=MC Q=MR=MC Single-Price Monopoly: profit>0 in long run as monopoly has no competitors & can temporarily shutdown or exit if it starts incurring economic loss

Answer 5

Pursuit of wealth by capturing economic rent - any surplus (producer, consumer, economic profit, etc.) 1. Buy a monopoly transfer rent to creator: ATC rises = P to breakeven point, no economic profit & massive DWL 2. Create Monopoly: get law on you side, political policies

Answer 6

Price Discrimination: Monopoly's practice of selling different units of a good or service for different prices in the goal of converting all consumer surplus into economic profit by: 1. Identifying & separating different buyer types by discrimination among groups of buyers & units of good 2. Sell a product that cannot be resold Perfect Price Discrimination: D=MR=P 1. Firm sells each unit of output for highest price each customer is willing to pay so no consumer surplus left 2. Greater economic profit than Single Price Monopoly leads to inefficient rent seeking

Answer 7

Price Ceiling: a regulation that makes illegal to charge above a maximum price Ex. In housing market = Rent Ceiling Price Floor: regulation that makes it illegal to trade lower than minimum price Ex. In labor market = Wage Floor

Answer 8

Wage Floor -Ineffective: below equilibrium, market will operate at legal equilibrium -Effective: above equilibrium, market consequences Inefficiency - Unemployment: - Effective min wage is set above equilibrium → QS>QD quantity of labor supplied by workers exceeds the quantity demanded by employers - Quantity of labor decreases - Surplus of labor/workers → unemployment (inefficient outcome) - Less workers are hired than within an unregulated labor market - Marginal social cost of labor to workers (leisure forgone)>Marginal social benefit from labor (value of goods produced) - Full Loss Increases: DWL rises + Potential loss from increased job search increases → decreasing workers’ & firms’ surplus Minimum Wage isn’t Fair: - Increases the unemployment of rate of low-skilled younger workers as they lack job experience & wages have increased - Government needs to create more job opportunities

Answer 9

Rent Ceiling (R): price ceiling in the housing market Ineffective above market equilibrium, market will operate at equilibrium legally Effective below market equilibrium, market consequences Legal price cannot eliminate the shortage other mechanisms operate: - Increase in potential loss from search activity: time spent looking for someone with whom to do business, costly, - Black markets: illegal market that operates alongside a legal market where a price ceiling or other restriction is imposed. Illegal arrangements are made between renters & landlords at rents above the rent ceiling or unregulated market Inefficiency of Rent Ceiling = Shortage - Marginal Social Benefit>Marginal Social Cost = QD>QS=shortage - Deadweight loss arises, producer surplus & consumer surplus shrinks - Increase in potential loss from increased search activity Rent Ceilings are Unfair - Blocks voluntary exchange, generally does not benefit the poor as wealthy offer the highest profit - Rent ceiling decreases quantity of housing & scarce housing is unfairly allocated by Lottery (the lucky) First-come first-served (to those with greatest foresight & get their names on the list first) Discrimination (housing to friends, family members, selected race, sex or political status)

Answer 10

1. Isolate for Q or P 2. Equilibrium Qe Pe, Rent Ceiling/Min Wage efficient or inefficient above or below equilibrium 3. Sub in Rceil or Wmin in Q equations. Depending on which is greater QD or Qs, surplus or shortage, find difference 4. Area of arrow point triangle from Qs to Qe 5. Rectangle between CS & PS 6. Area of top and bottom triangles 7. Blocks voluntary exchange, generally does not benefit the poor as wealthy offer the highest profit Rent ceiling decreases quantity of housing & scarce housing is unfairly allocated by Lottery, First-come first-served, discrimination Minimum Wage isn’t Fair Increases the unemployment of rate of low-skilled younger workers as they lack job experience & wages have increased Government needs to create more job opportunities

Answer 11

1. Price Cap/Rent Ceiling 2. Price Floor/Min Wage 3. Tax 4. Production Quotas + Subsidies

Answer 12

Taxes: fee added onto price Direct: income tax Indirect: GST, goods & services Tax Revenue: tax x QS Tax Incidence: division of tax between sellers & buyers, how much for who as government places tax on sellers who in turn pass tax on buyers -Buyer Tax Paid=Additional price paid by buyers=original price-price after tax - Seller Tax Paid=Tax Imposed-Buyer Tax Paid Buyers Pay Tax: price rises by the full amount of the tax Buyers and Sellers Share: price rises by a lesser amount than the tax Sellers Pay Tax: price doesn’t rise at all

Answer 13

Tax Imposed on Seller: supply line shifts left, decreases in supply, price incr. for same quantity - S+tax=supplies+tax Tax Imposed on Buyer: demand line shifts left, demand decreases, price willing to pay decreases for same quantity - D-tax=price-tax Tax Incidence stays the same no matter imposed on seller or buyer

Answer 14

Tax incidence depends on elasticities of demand & supply, the steeper the line for D (more inelastic demand) or the more flat the line for S (more elastic supply) the more tax paid by buyers Perfectly inelastic demand: buyers pay the entire tax, they have must buy good no matter the price Perfectly elastic demand: sellers pay entire tax, very competitive market so seller must pay all the tax Perfectly inelastic supply: sellers pay entire tax, must sell quantity of resources already made Perfectly elastic supply: buyers pay entire tax, supply of resources malleable no rush to sell everything

Answer 15

Production Quota: upper limit to the quantity of a good that maybe produced (rent ceiling) - Inefficient Set Below Equilibrium: Marginal social benefit=market price increases Marginal social cost has decreased Production is inefficient & producers have an incentive to cheat Subsidy: payment made by government to a produce (opposite of tax) causes overproduction loss for society - Inefficient Overproduction: marginal social benefit = market demand price decreases. Marginal social cost increases, exceeding marginal social benefit

Answer 16

Imports: g+s bought from other countries Exports: g+s sold to other countries National Comparative Advantage: ability of a nation to produce or perform g+s at a lower opportunity cost than any other nation

Answer 17

Imported good lowers in price. 1. QD-QS 2. Area of CS Top Triangle, PS Bottom Triangle 3. CSAT-CSBT vs PSAT-PSBT 4. (TSAT=CSAT+PSAT)-(TSBT=CSBT+PSBT)

Answer 18

Import Tariff: Pw rises, tax on imported good to promote domestic producers and earn government revenue 1. Produced domestically Qs, Consumed domestically QD 2. WP+Tariff 3. QD-Qs 4. Tariff x QAT 5. CSAT+ PSAT + TR 6. Compare CSAT-CSBT & PSAT-CSBT, TSAT-TSBT - Canadian consumers lose (higher P lower Q bought), Canadian producers gain (cost of producing lower than P so more shirts produced), Society loses from arising deadweight loss (production costs increased and decreased imports) 7. TSFree Trade-TSAT 8. Free trade, tariff, domestic

Answer 19

Import Quota: maximum quantity units that can be imported in a given period 1. If PDom Pw($5), supply will come from domestic & ROW for Quota# unit → QS=___+Quota# 2. Qe-1 3. Area of small square 4. Area of 2 small triangles 5. Compare CSAQ-CSBQ & PSAQ-PSBQ, (TSAQ=CS+PS+Importer Profit)-TSBQ(=CS+PS) - Canadian consumers lose (higher P lower Q bought), Canadian producers gain (cost of producing lower than P so more shirts produced), Society loses from arising deadweight loss (production costs increased and decreased imports)

Answer 20

Increases price of an exported good. 1. QS(produced)-QD(consumed) 2. Area of CS top triangle, PS bottom triangle, TS(CS+PS) 3. Compare CSAT-CSBAT vs PSAT-PSBAT - Producers gain (higher P for same Q=more revenue), Consumers lose (more expensive) Overall Societal Gain = TS Free Trade - TS No Trade

Answer 21

Subsidy: payment by government for a domestic producer of an exported good, production cost decreases so domestic supply increases → domestic over production, international underproduction creating DWL Others: health, safety restrictions

Answer 22

**Human Capital** is largely provided by governments through public education - Improvements in labour force generated by education, training, knowledge **Physical capital** is mainly created through private investment spending - Manufactured resources, buildings, machines **Financial Capital**: funds from savings available for investment spending, from domestic or positive net capital inflow, flow of funds into the country from abroad - Financial Asset (physical and financial): bonds, mutual funds, stocks, properties, businesses, confidence & dollar as hard currency makes people invest - Bonds: confidence and dollar as hard currency makes people invest, promises to pay fixed amount whatever happens - Stocks: give investors a share of future profits

Answer 23

Set of markets & institutions that channels the funds of savers into productive investment spending, increases labor productivity as it allows firms to purchase physical capital. Where governments, firms & individuals trade promises to pay in the future

Answer 24

Savings & investment are always equal.

Answer 25

G=Nx=0 S=I Y=C+I=C+S=HH consumption + savings/investment=income S=I=Y-C=Income - HH Consumption

Answer 26

Nx=0 Snational=I Y=C+I+G=Aggregate Consumption(C+G)+ Snational(I) I=S=Y-C-G=income after(-) spending I=Snational=Spublic+Spvt Spublic=T-TR-G Spvt=Y-C-T+TR

Answer 27

Budget Balance=Spublic =Net Tax Revenue-Spending =T-TR-G - Income>Spending=budget surplus=positive - Income=Spending=budget balanced=0 - Income

Answer 28

Nx=NFI Y=C+I+G+Nx I+Nx=Y-C-G=Snational=I+X-M Nx=Snational-Inational NFI=Outflow of Funds - Inflow of Funds =IDforeign-IFdomestic =(SDforeign+SDdomestic)-(SDdomestic+SFdomestic) =SDforeign-SFdomestic =Snational-Inational Inational=Snational-Nx =SDdomestic+SFdomestic Snational=I+Nx=SDdomestic+SDforeign Nx=NFI Savings allocated by accumulating physical capital (investing domestically) or acquiring foreign assets (investing abroad) = Funds that finance domestic investment come from domestic funds (national savings) and foreign funds (capital inflow=negative NFI)

Answer 29

Net Foreign Investment = Outflow of Funds-Inflow of Funds - Outflow of Funds: foreign investment funded by domestic savings - Inflow of Funds: domestic investment funded by foreign savings Trade Balance = Export - Import - Positive O>I=E>I, Capital Outflow=Trade Surplus: more domestic investment in foreign countries, funds leaving country, funds lent to foreigners to use excess trade surplus amount - Negative O

Answer 30

**Higher national cost** the more foreign capital inflow than investment spending financed by national savings Interest on domestic savings is different from interest on a foreigner's interest. Thus, dollar generated by national savings and dollar generated by foreign capital inflow are not equivalent.

Answer 31

**Net Present Value**: present value of current & future revenues - present value of current & future costs. Best project to undertake is the one with the highest net present value **Face Value:** amount lent, price of bond at the time is was issued - **Maturity (m)**: when amount lent/face value will be returned (30-100 years usually) - 1 yr **Coupon Value (C)**: feature of bond depending on the interest offered, bond yield - $5 **Money Returned** = Face Value + Coupons **Yield Rate** = (Money Return-Face Value)/Face Value **Present Value**: future return adjusting to inflation every year **Interest Rate (i)**: inflation's affect on value/purchasing power of everything There is an inverse relationship b/w the price of a bond & the nominal interest rate 1) Make timeline 2) Find present values of coupons of each year, maturity year with principle return, C/(1+i)+C/(1+i)^2+... + C/(1+i)^(m-1)+(C+F)/(1+i)^m 3) Sum up earnings & compare with initial cost. Gives max willing to pay. If it is greater than initial cost it is profitable.

Answer 32

1) $98.19 2) $810

Answer 33

A(1+i)t=B → A=225/(1.1)1 = 204.55

Answer 34

Coupon/Annual Interest Payment=6%*1000=$60 per year Present Value at Today’s Market Equilibrium = 60/(1.05)+60/(1.05)2+60(1.05)3+60/(1.05)4+160/(1.05)5=$1043.30 Today willing to pay no more than $1043.30 or else spend $1043.30 or less on a new bond. When determining the price of a preexisting bond, the interest rate used to calculate that price is the current market equilibrium interest rate, not the interest rate that was current when the bond was originally issued.

Answer 35

When current market equilibrium interest rate is unchanged from when the bond was issued, the present value of the bond is equal to its face value, regardless of how many periods are left until it matures because r = i-tau=nominal interest-inflation rate = 6%-6%=0=no change in purchase power or value

Answer 36

Price of a bond goes up when market equilibrium interest falls. When price falls when market equilibrium interest rate goes up. When the market interest rate on comparable bonds rises, the price of existing bonds falls. When market interest rate on comparable bonds falls, the price of existing bonds rises High-risk bonds will sell at a lower price than a low-risk bond with the same maturity, face value, annual coupon payments. The lower price compensates the owner of the high-risk bond for the risk she faces of not being repaid in full

Answer 37

Bond entitles the owner to interest payments, a share of stock entitles its owner to a share of the company’s profits (dividend) as a stock represents ownership of a portion of the company. No time of maturity, goes on indefinitely Stock Price=Dividend/(1+r)+Dividend/(1+r)2+Dividend(1+r)3+... , r=interest rate, no m If company’s profits/dividends grow at a constant rate every year stock price Stock Price=Dividend/(r-Growth Rate) Highly variable dividends as profits vary year to year so stock prices are based on demand & supply

Answer 38

A hypothetical simplified market used to coordinate investors (Gov or Firms) & savers (HH), what makes S=I=Nominal Interest Rate, as there are so many different instruments to invest & borrow having their own markets with own D & S. Hypothetical to estimate one singular interest rate (i) to calculate returns, works as all interest rates a linked together, usually nominal interest rate unadjusted for inflation. D: projects of firm borrowers, firms with investment spending projects S: savings of savers, savings of the households & the government Price - price of borrowing x Quantity - quantity of loanable funds

Answer 39

Borrowers (Firms+Gov) demand for loanable funds is a downward trend due to **opportunity cost**: As the interest rate (i) goes up, the higher the opportunity cost/attractiveness of investment spending, as putting money in a bank and earn interest on it is the highest-value alternative, as cost becomes greater than investment return calculated by present value, less loaning occurs. If interest rate gets lower, the greater the quantity of loanable funds demanded as cost is less than investment return or as putting money in a bank and earn interest on it as the highest-value alternative. As interest rate increases, less loaning occurs, . - Money loses its value in the future, so use Present Value calculations to make sure that the future return adjusted to inflation is greater than the initial cost today (A=B/(1+i)). Simple Words: Interest rate=cost of borrowing. The higher i=cost of borrowing, the less demand for loans. The lower i=cost of borrowing the more demand for loans. Actual i = Nominal i - Inflation Rate - Bigger Nominal i, bigger actual i, greater value of return to lenders = more costly for borrowers - Smaller Nominal i, less actual i, smaller value of return to lenders = less costly for borrowers

Answer 40

Lenders (HH & Gov) supply of loanable funds is an upward trend due to **opportunity cost**: as interest rate increases it will become more attractive to save as return-->consumption is greater in the future than if spent now, the more people are willing to forgo current consumption and make a loan to a borrower. Actual i = Nominal i - Inflation Rate - Bigger Nominal i, bigger actual i, greater value of return/earnings to lenders= more costly for borrowers - Smaller Nominal i, less actual i, smaller value of return/earnings to lenders = less costly for borrowers

Answer 41

Interest rate at which the quantity of loanable funds supplied equals the quantity of loanable funds demanded. - Right Investments Get Made: Investment spending projects that are financed have higher payoffs than those that do not get financed - Right People do the Saving & Lending: The savers who actually lend funds are willing to lend for lower interest rates than those who do not Interest rate above equilibrium, profitable for lenders, but projects unaccepted by borrowers (Funded+Unaccepted). Below Equilibrium, profitable for projects of borrowers, but unfunded by lenders. (Unfunded+Accepted)

Answer 42

**Changes in perceived business profitability and/or opportunities:** increase or decrease amount of desired spending at any given interest rate. (ex. Fracking, technological advancement) - As demand for loanable funds rises, (i) equilibrium rises as borrowers are willing to borrow more & supply/investment increases/shifts up+right in economy - As demand for loanable funds falls, (i) equilibrium rises falls borrowers are willing to borrow less & supply/investment decreases/shifts down+left in economy **Changes in government policy that affects investment decisions decentivize & incentivize certain sectors:** - Tax Credit (allows certain sectors to pay less tax): promotes investment making it more attractive/less expensive to undertake → As more investment projects are undertaken at any level of interest, … shifts demand curve up+right… - Subsidy for investment (Ex. Clean energy technology has been incentivised by government)

Answer 43

**Changes in private savings behavior** - **Recessions** encourages households to save more, increasing loans, leads to fall → curve shifts right - **Expansion** encourages households consumption, decreasing loans → curve shifts left, fall in i **Changes in budget surplus:** - **Budget Surplus=Saver**: (T-TR)-G>0 → (T-TR)>G, SPub>0, spending less than savings → savings used to finance investment spending, shift right - **Budget Deficit=Borrower**: (T-TR)-G<0 → (T-TR)

Answer 44

Reduction of supply of loanable funds leads to rise in interest rate tells us an increasing persistent government budget deficits are a concern, businesses and households will cutback on investment spending → balancing budget is top priority

Answer 45

**Crowding Out**: negative effect of budget deficits on private investment, which occurs because government borrowing drives up interest rates In a recession crowding out may not occur, government spending can lead to higher incomes→ increased savings→ gov borrowing without increasing interest rate

Answer 46

**Global Loanable Funds Market**: international capital flows are so large that they had the effect of completely equalizing interest rates across countries - Most of the time, capital flows from countries where i is relatively low to countries where i is relatively high, resulting in raising i where it was low and reducing i where they were high - Assumption world if frictionless, ceteris paribus to describe how nominal interest rate changes between countries, however investing abroad is not frictionless as risk is involved (political volatility & currency exchange)

Answer 47

Factors driving flow of funds b/w markets: interest rate differential, risk status, (currency) exchange rate Ex. High world interest rate causes capital outflow, low world interest rate causes capital inflow from Canada to rest of the world

Answer 48

1) Savers/Lenders want higher returns/interest rate → borrowers in UK compete with US in US → capital inflow increases quantity of loanable funds supplied to US → pushes US interest down/downward pressure - Reduces supply quantity of loanable funds supplied to UK → pushing interest rate up in UK → continues until gap between interest rates is eliminated 2) Borrowers/Firms want lower interest rate, thus borrowers in US compete with UK in UK → capital outflow increases demand of loanable funds in UK → pushes UK interest up/upward pressure - Reduces demand quantity of loanable funds supplied to US → pushing interest down in US → continues until gap between interest rates is eliminated 3) US borrowers face competition, demand increases, supply decreases → excess demand - Supply quantity of loanable funds in US exceeds demand in US, excess exported in the form of capital outflow to UK UK lenders face competition so demand decreases, supply increases → excess supply - Quantity of demanded loanable funds in UK exceeds supply quantity in UK, gap filled by imported funds=capital inflow from US Excess demand & supply of both countries cancel out See notes.

Answer 49

**Comparative Advantage**: Capital moves from places where it would be cheap in the absence of international capital flows to places where it would be expensive in the absence of such flows to earn more profit.

Answer 50

r = i - tau real interest=nominal interest-inflation rate **Fisher Effect**: expected real interest rate is unaffected by changes in expected future inflation, only nominal interest rate. 1) Interest rate/equilibrium in loanable funds market corresponds to the fluctuations of the expected inflation. Thus lenders and borrowers base decisions on expected real interest rate as true cost of borrowing and true pay off of lending is real interest rate )ex. Zero-Interest Loan: 0=10%-10%) - The nominal interest rate is the accounting interest rate – the percentage by which the amount of dollars (or other currency) owed by a borrower to a lender grows over time, while the real interest rate is the percentage by which the real purchasing power of the loan grows over time. In other words, the real interest rate is the nominal interest rate adjusted for the effect of inflation on the purchasing power of the outstanding loan. 2) Change in expected inflation shifts equally both demand & supply of loanable funds simultaneously=shifts in demand and supply curves changes the interest rate; leads to a new nominal interest rate in loanable funds market, - **equilibrium quantity doesn’t change**

Answer 51

Nominal interest rate used rather than real interest rate because no one knows future inflation rate when making a deal. Expected inflation rate is held fixed based on recent experience, only nominal is dynamic **Significance**: our expectation of inflation shifts with the economy, unions base wage negotiations on expected tau

Answer 52

Role of the government in current modern economies is huge, 50% spending, changing this causes - Affects to flow of income: funds flow into G (taxes & borrowing) & funds flow out (G purchases of g+s & transfers to HHs) - Affects to aggregate demand Tool To Maintain Economy: **Fiscal Policy**: changes in taxes & G spending to stabilize the economy by shifting aggregate demand curve (AD)

Answer 53

**Goal**: to shift aggregate demand curve to close recessionary or inflationary gap **Drivers:** - DeltaC Disposable Income=total income-taxes+government transfers, T & TR government can alter. Fall/Rise in disposable income leads to a Fall/Rise in consumer spending, shifting aggregate demand - Delta C+I Incentive to Spend on Investment Goods by changing rules that determine how much a business owes, shifting aggregate demand **Types** - Direct Influence is changing G, changing demand in economy Indirect Influence is changing t or - TR, changing disposable income→ spending → demand **1) Expansionary FP when economy is in Recessionary Gap**: * Delta G spending of g+s rise, * Delta C Tax fall, Transfer Revenue rise more pension plans+social assistance * Delta I Tax breaks, incentives, subsidies **2) Contractionary FP when economy is in inflationary gap:** * Delta G Spending of g+s fall * Delta C Tax rise, Transfer Revenue fall, Less pension plans+social assistance * Delta I Tax hikes, disincentives, fines/fees

Answer 54

Although criticism in safe/ordinary economic conditions, appropriate for when the economy is depressed. In fiscal policy, timing is crucial Extent of expansionary fiscal policy effectiveness depends upon circumstances. Naturally economy will balance, could overdo things, causing inflation or recession. **1) Government spending always crowds out private spending (Wrong):** aggregate output/demand/expenditure is fixed, increasing G spending, all other factors will decrease (more taxes), total spending will not increase. Upping G spending would tax the struggling households even more. - Wrong in Principle: In reality, during recessionary gap (unemployed resources, output below potential), puts unemployed resources to work, generates higher spending & higher income (starts a multiplier effect). Only crowds out private spending when economy is operating at full employment **2) Government borrowing always crowds out private investment spending (Valid under some, but not all circumstances,):** government borrowing funds that would have been used for private investment spending, crowding them out - Wrong: if the economy isn’t depressed, incr. government borrowing → demand for loanable funds can raise interest rates & crowd out private investment. If economy is depressed (less than full employment), fiscal expansion raises incomes, increasing savings at any given interest rate, allows government to borrow without driving up interest rates - In deep recession, lots of unutilized resources, government bring back capacity, generates more income, household increase in disposable income **3) Government budget deficits reduce private spending (Raises important issues, isn’t a good argument, Ricardian equivalence):** expansionary fiscal policy leads to larger budget deficit greater debt which will require a raise of taxes to pay off, and in anticipation of this consumers will cut spending today to save money Ricardian Equivalence. Implies policy will have no effect because far-sighted consumers will undo any attempts at expansion or contraction by government - Wrong: doubtful consumers behave with such foresight & budgeting discipline, cutting back will be gradual extended period to save over time to pay future tax bill nor is policy completely ineffective. Government spending will be concentrated in the near future, consumer cuts will be much in comparison, and will bring unused resources into the economy fast enough.

Answer 55

Governments that try too hard to stabilize the economy can end up making the economy less stable due to time lags b/w when policy is decided, when it is implemented → attempts to increase spending take to long to get going, economy has already recovered on its own, turning from recessionary to inflationary gap when expansionary fiscal policy takes effect making things worse - Gov. had to realize recessionary gap exists through collection + analysis of economic data, takes months, hard to pinpoint exactly when economic events occured - Gov. has to develop spending plan taking months, particularly if politicians take time debating and passing legislation - Takes time to spend money, big projects follow small project like construction, causing some to wait

Answer 56

**Taxes**: required payments to government, collected at - National/federal level: income tax on personal income & corporate profits, social insurance taxes - Provincial/territorial level & Local/municipal level: mix of sales, property, income taxes & fees of various kinds

Answer 57

1) Direct Purchases of G+S (G expenditure approach): range from diagnostic equipment for hospitals, salaries for public school teachers, civil servants 2) Transfer Payments (C in expenditure approach as not final g+s): payments to HHs for which no g+s is provided in return - Public Pension Plans: guaranteed income to older, disabled, surviving spouses or dependent children of deceased or retired beneficiary Canadians - Other Social Assistance Payments: help HHs maintain an acceptable level of earnings

Answer 58

Social Insurance: government programs intended to protect families against economic hardships including payments form public pension plans (CPP/QPP, GIS, OAS), general welfare & family allowance payments, smaller programs (veterans' benefits, motor vehicle accident compensation payments, legal aid, daycare subsidies) - Largely paid for with special dedicated taxes on wages

Answer 59

Business cycle is driven by ups in downs by export or investment spending, and multiplier effects

Answer 60

**Informal Definition**: an initial change (rise or fall) is followed by multiple rounds of increases/decreases in aggregate output (income & expenditure), so it is used to measure the total effect of any such initial change in aggregate expenditure in the economy MPC is used **Formal Definition**: ratio of total change in real GDP caused by an autonomous change in aggregate expenditure to the size of that autonomous change - Ex. Spain additional car export causes rising output & income leads to more consumer spending leading to more income gains & so on **Equation**: Multiplier=1/(1-MPC) =1/MPS= (1+MPC+MPC^2+MPC^3+...)=AY/AAE_0, there is an eventual limit to multiplier effect leading to a fixed amount increase in aggregate income determined by MPC & MPS as each stage, rise in disposable income leaks out because it is saved

Answer 61

1) Sub in C=AC+MPC x YD into AEPlanned: AEPlanned=C+IPlanned=AC+MPCYD+IPlanned 2) Since YD=Y & income-expenditure equilibrium Y=Y*=AEPlanned: Y*=AC+MPC x Y*+IPlanned 3) Subtract MPCY* from both sides: Y*-(MPC x Y*)=AC+(MPC x Y*-MPCY*)+IPlanned Y*(1-MPC)=AC+IPlanned 4) Divide both sides by 1-MPC: y*=AC+IPlanned1-MPC 5) Let AC=C so C+IPlanned=AE0: 1/(1-MPC) x AE0 Multiplier=1/(1-MPC)

Answer 62

1) Producers are willing to supply additional output at a fixed price: without driving up overall prices with additional spending from C+I, so Aggregate expenditure=Aggregate output=Aggregate Income (fine in short run, not long run) Nominal=Real GDP 2) Interest rate is fixed → determines borrowing & investment, we take it as given 3) No government spending and no taxes, Y = C + I 4) Closed economy (X = M = O → Nx=0) 5) y0=y=Disposable Income= GDP = y - (T-TR), T=TR=0

Answer 63

MPC - Marginal Propensity to Consume: increase in consumer spending b/w 0-1 when disposable income rises by $1, as only a portion of it is spent * MPC=Delta consumer spending/Delta disposable income * Disposable Income=consumer spending + savings = Y-T+TR MPS - Marginal Propensity to Save: proportion of an additional dollar saved or not spent on consumption purposes - MPS=1-MPC,

Answer 64

Y= (1+MPC+MPC2+MPC3)*Delta AE_0 = 1/(1-MPC)*Delta AE_0

Answer 65

**Autonomous Change in Aggregate Expenditure**: initial rise/fall in aggregate expenditure at a given level of real GDP, autonomous as it is self-governing, the cause not after effect of chain reaction. Triggered by a change up & above the initial real GDP

Answer 66

* High MPC & Low MPS = more spending + less saving = high multiplier = bigger expansion = GDP growth * Low MPC & High MPS = less spending more saving = low multiplier = smaller expansion = GDP fall

Answer 67

Consumer spending accounting for 60% of toal spending of g+s

Answer 68

An equation showing how an individual household’s consumer spending varies by household’s disposable income (the greatest determinant) C=ac+MPCyd - **Upward Positive Trend**: higher disposable income, higher consumption spending - yd= individual household current disposable income - ac = Autonomous Consumer Spending: spending if HH had 0 disposable income, always greater than 0 by borrowing or using savings. Constant term, intercept, y when x=0, or plug in a point in y=mx+b after finding slope - c= individual HH consumer - MPC =c/yd=y/x= Marginal Propensity to Consume: how spending rises if current disposable income rises by $1 slope, rise/run, can be determined with any given 2 points= A(yd1,c1), B(yd2,c2) c=MPC*yd - Y-axis consumption spending, x-axis disposable income - Each dot is a household at different income and consumption spending - Below line, is HH saving, above line is HH spending savings

Answer 69

**Shifts of the Aggregate Consumption Function**: when factors other than disposable income change, aggregate consumption shifts at any level of current disposable income by 2 principle causes: 1) Changes in expected future disposable income (ex. Getting a first job, income → consumption will increase or losing job, income→consumption will decrease) * Puzzle: why does a higher income economy doesn’t necessarily mean more savings? * **Permanent Income Hypothesis** (Milton Friedman): consumer spending depends mainly on income people expect to have over the long term rather than on their current income due to systematic difference b/w current disposable & expected disposable income in individual households that creates upward trend b/w current income & savings rate * Low income often due to unusual bad year (laid off, will find job soon), expecting higher future income → low or negative savings, more spending * High income often due to unusual good year (investments that did well) expecting lower future income → high + more savings, less spending * When economy grows, current & expected incomes rise leading to higher savings→ weaker relationship b/w current income & saving 2)Changes in aggregate wealth: those with more wealth, even if all have identical income, will spend more * **Life Cycle Hypothesis**: consumers plan their spending over a lifetime not just in response to disposable income, want a consistent smooth sustained consumption level (standard of living) * Eventually people’s wealth levels off/retire without income. So to prepare they build up wealth, saving income + investing=build up in assets (wealth=value of assets) to maintain a certain living standard. * Thus, rise in aggregate wealth (Boom in stock or housing market)→ higher consumption spending in economy, vice versa * Bank Scam: offering loans to anybody not able to return loans while housing market is rising, led to crisis * Borrowing: buy house now, house will go up in value, earn money in future

Answer 70

C=3000+0.633^YD

Answer 71

**Aggregate Consumption Function**: C=AC+MPCYD derived by aggregating individual consumption spending decisions, relationship b/w aggregate current disposable income & aggregate consumer spending. Add intercepts + difference of sum of all consumer spending in an interval divided by add up all disposable income earned in same interval * YD= aggregate current disposable income/disposable income (Sum of all HH ac=y-intercepts) * AC aggregate autonomous consumer spending, a constant used to represent a situation where the HH has no income, even when disposable income is 0, C>0 * MPC=CYD, captures the amount by which the expenditure increase in response to a $1 increase in income (Sum difference of all HH consumption divided by sum difference in all disposable income)

Answer 72

**Planned Investment Spending**: the investment spending that businesses plan or intend to undertake during a given period depends on 1) **Interest Rate**: downward relationship, higher interest rate the lower the planned investment spending (IPlanned), vice versa, from comparison b/w rate of return & market interest rate (Construction, housing loans) * Fall in interest rate (cost of borrowing)→ projects/investments are more likely to be carried out as they are less costly, rate of return higher than cost to borrow, more profitable * Rise in interest rate (cost of borrowing) → projects/investments are less likely to be carried out as they are too costly, rate of return lower than cost to borrow, less profitable * Retained Earnings: past profits used to finance investment spending, doesn’t make trade off/opportunity cost any better (ex.Funds invested in machinery vs lending to collect interest) 2) **Expected Future Real GDP + Production Capacity**: firms incr/decr investment to build up stock capital, increase production output, depending on sales growth/demand for their product dictated by expected future real GDP, high levels of IPlanned occur when expected sales grow rapidly and excess production capacity will be used up * Expected Future Real GDP (Accelerator Principle): positive effect on investment spending: higher expected future GDP higher investment spending. If firms will undertake more investment spending when they expect their sales to grow. Firms will engage in lower investment spending only to replace existing capital that wears out or rendered obsolete by new technologies if sales are not expected to grow. * Current Level of Production Capacity: negative effect on investment spending: the higher the current capacity the lower the investment spending. If a firm has more capacity than needed to meet current production needs, they won’t undertake investment spending until sales catch up to excess capacity. If a firm has less capacity than required, they will undertake investment spending.

Answer 73

**Unplanned Investment Spending:** investment spending, positive or negative that occurred but was unplanned **Inventory Investment/Spending (New-Old**): value change of total inventories from unexpected fluctuations in sales held in economy during a given period of time, can hold more or less than intended * **Inventories**: stocks of goods & inputs held to satisfy future sales needs, keep a steady supply (cushion/safety against chain/supply disruption) & to quickly satisfy buyers instead of keeping them waiting to be manufactured (8.5% of GDP). * **Positive**: producing too much, unexpected increase in the value of inventory (incr. Inventory from unexpected sales) → slowing economy as sales lower than forecast ($8000 prepped for expected $8000 sales, however only $7000 sold, Inventory Investment=Planned -Actual =10-5=+5) * **Negative**: producing not enough, unexpected fall in value of inventory (unexpected sales, spoilage) → growing economy as sales greater than forecast (Inventory Investment=Planned -Actual =10-15=-5)

Answer 74

I=Iplanned+Iunplanned

Answer 75

**Income-Expenditure Model**: an increase in GDP deflator (prices) reduces equilibrium GDP, shown numerically, graphically & algebraically * No Government + Closed Economy * Prices aren't fixed GDP=C+I= YD=AEPlanned+IUnplanned, C=AC+MPC*YD, IPlanned fixed=Y-AEplanned

Answer 76

AEPlanned=C+IPlanned: total amount of planned expenditure in the economy, as households don’t take unintended actions. AEPlanned depends on GDP: Higher GDP → higher disposable income → higher consumer spending → higher planned aggregate expenditure → higher GDP… multiplier effect, vice versa.

Answer 77

**Income-Expenditure Equilibrium**: Y=AEPlanned, IUnplanned=0, no unplanned inventory investment, firms don’t have an incentive to change output, any point on the Keynesian Cross (45 degree) is the equilibrium. AEPlanned differs from Y when IUnplanned=0 * Firm’s will adjust output/production to eliminate unanticipated changes in inventory & reach equilibrium * Since GDP=AEPlanned+IUnplanned IUnplanned=Y-AEPlanned * Below equilibrium AEPlanned>Y, underproduction as IUnplanned=-ve, underestimate * Firms incr. production → GDP incr. * Above equilibrium AEPlanned

Answer 78

Y*1Y*2 AEplanned = C + Iplanned **1) Change of Aggregate Consumption Function (C)**: change expected future disposable income and/or in aggregate wealth, leads to Autonomous Change in Planned Aggregate Expenditure (AE0): change in desired level of spending of whole economy at any given level of real GDP Rise in income expenditure equilibrium greater than AE0 due to multiplier effect=Delta Y*/DeltaAEPlanned → Y*=Multiplier*AE_0 **Process In Depth**: (X→E1)AE0 incr. Gap b/w AEPlanned & Y→Production rises → GDP rises (Y1→Y2) → Disposable income rises → C rises → Real GDP rises → YD again loop… Vice versa as well **2) Change in Investment Spending (IPlanned)**: change in interest rate, expected future GDP, production capacity, inventory investment from unexpected fluctuations in sales

Answer 79

**Autonomous Change in Planned Aggregate Expenditure (AE0)**: change in desired level of spending of whole economy at any given level of real GDP =DeltaY*/Delta AEPlanned

Answer 80

1) Export=Income=Spending=AE0 2) Multiplier effect weaker/lower depending on Marginal Propensity to Import (MPI) as C=ImportGDP domestic Algebraic: AEp=C+Ip+(X-M) * Export: x=x0, fixed, depends on foreign GDP, not ours * Import: M=my, 0

Answer 81

Based on the income-expenditure model shows change in AEplanned curve, shows how much aggregate output demanded (real GDP) by HH, firms, gov, rest of world, at any given aggregate price level (GDP Deflator) **Downward sloping relationship**: higher the aggregate price level reduces quantity of aggregate output demanded, lower aggregate price level increases quantity of aggregate output demanded **1) Wealth Effect**: the effect on consumer spending caused by the effect of a change in the aggregate price level on the purchasing power of consumers’ assets * an increase in aggregate price level reduces the purchasing power of many assets, causing a scaling back in aggregate consumption plans, aggregate demand falls (ex.25% rise in GDP deflator = $5,000 in the bank → becomes $4000) * P rise, PP fall, C fall * A decrease in aggregate price level increases the purchasing power of many assets, causing a scaling up in aggregate consumption plans, aggregate demand rises (ex.25% fall in GDP deflator = $5,000 in the bank → becomes $6,666) * Downward shift of the AEplanned **2) Interest Rate Effect**: a rise in the aggregate price level depresses investment and consumer spending through its effect on the purchasing power of money holdings * Money is held to reduce the cost & inconvenience of making transactions. An increase in aggregate price level reduces purchasing power of a given amount of money holdings. This results in less supply and high demand of loanable funds as more borrowing or selling of loans occurs to increase money holdings and less money is saved in bank accounts, driving up interest rates. * Rise in interest rate reduces investment spending as cost of borrowing is higher, and reduces consumer spending as money is saved. * P rise, Hold money fall, buy today rise, savings fall, interest rate rise to attract people to save, cost of borrowing rise, investment fall, consumption fall * Downward shift of the AEplanned Not law of demand as the AD curve considers a simultaneous change in the prices of all final goods & services, the basket of g+s is irrelevant. Law of demand hinges on how specific prices don’t change and the variety of the basket

Answer 82

Aggregate expenditure at any given aggregate price level is derived from the Income-Expenditure model that no longer has fixed planned aggregate spending (C+I=y), prices are not fixed. Shifts in the Income-Expenditure Model caused by changes in the aggregate price level derive the AD curve. * Income-expenditure equilibrium: planned aggregate expenditure crosses the 45 degree line (keynesian cross) * When aggregate price level changes, the income-expenditure model shifts: * Ex. A fall in aggregate price level causes AEplanned curve to shift up * Fall in aggregate price level causes an upward shift of the Income-Expenditure Model and a rise in real GDP → downward trend of AD curve

Answer 83

**1) Changes in expectations of the future:** Optimistic aggregate spending rises, pessimistic aggregate spending decreases due to a decrease in autonomous consumption & investment * Delta C: consumer spending is based on income they expect to have in the future (ex. Expected income → planned consumption rises→aggregate consumption/expenditure/output shifts up). * Delta Iplanned: firm investment spending is based on sales they expect to make in the future **2) Changes in wealth Delta C**: independent of changes in price index, real prices of assets rise/fall → purchasing power rise/fall → aggregate expenditure rise/fall * Ex. Housing bubble, everybody buying homes, banks making loans to people uncredited worthy, banks have no risk will sell, aggregate spending rises. When it burst, price levels of assets fell, aggregate spending fell. **3) Size of the existing stock of physical capital Iplanned:** investment spending depends on how much physical capital they have small/large & the more/less they need * Ex. China, real estate ghost towns as borrowing was too easy, there isn’t much demand, too much stock of physical capital, massive drop in investment in the sector, aggregate spending falls as price levels fall. **4) Fiscal policy**: use of government spending or tax policy to stabilize the economy through contractionary & expansionary aims. Governments are 50% of World GDP, a huge share in the modern economy, what they do has a huge influence on the economy. Given this role, they can shift aggregate demand by changing household and firms decisions, indirectly influence *** Increasing aggregate demand → expansionary fiscal policy**, (1)direct-buy more stuff G, (2)indirect-transfer more disposable income to up consumption spending TR, (3)reducing tax more disposable income to spend T (sales, federal, provincial), combination of 3 * **Decreasing aggregate demand → contractionary fiscal policy -** opposite of the combination of 3 (1)direct-buy less G (2)indirect-transfer less disposable income to lower consumption spending TR (3)increasing tax to reduce disposable income to spend T **5) Monetary Policy:** use of changes in the quantity of money or the interest rate to stabilize the economy, contractionary and expansionary * **Increasing aggregate demand → expansionary monetary policy * Expansionary -** * Increasing quantity of money in circulation→ firms+HH have more money willing to be lent out, drives interest rate down * Decrease interest rate→make money cheaper→will borrow more→ more investment spending → increases AD *** Decreasing aggregate demand → Contractionary monetary policy** - increase interest rate, money expensive, will borrow less, less investments, more savings * Decrease quantity of money in circulation→ firms+HH have less money willing to be lent out, drives interest rate up * Increase interest rate→make money more valuable→will borrow less→ less investment spending → decreases AD

Answer 84

Shows as aggregate price level (GDP deflator) rises aggregate output supplied (real GDP) rises, a fall of aggregate price level causes a fall in aggregate output supplied due to the greater than or less than cost of producing that unit of output. * Short Run Aggregate Supply Curve * Long Run Aggregate Supply Curve

Answer 85

**Short Run AS Curve (SRAS):** no change in technology & input prices don’t change, Sticky prices, takes times for prices to change due to shocks in economy, slower to change. - Potential Aggregate output different from Aggregate Output; Below Potential or Above Potential, shifts until the point where LRAS and SRAS intercept is at the Potential Aggregate Output * Wages are the stickiest/most inflexible/fixed: any worker compensation, health care, retirement benefits, addition to earnings, because nominal wage=sticky wages is often determined by contract signed long before or informal agreements. Firms will only reduce wages if the downturn has been long or severe for fear of generating worker resentment or raise wages until at risk of losing workers to competitors during good economic times to not encourage workers to routinely demand higher wages. **Long Run AS Curve (LRAS)**: technological improvement is a possibility and all, both output & input prices are flexible; long enough for input prices/wages to adjust to changes in price index. Aggregate price level has no effect on the quantity of aggregate output supplied as prices and costs adjust proportionally the same, changes in aggregate price level, composed of prices of final g+s, will be accompanied by equal proportional changes in all input prices, including nominal wages

Answer 86

**Upward Slope driven by nominal sticky wages/prices & profit per unit of output**, as some production costs are fixed in the short run, a change in aggregate price levels leads to a change in producers’ profit per unit of output → change in the profit-maximizing level of aggregate output supplied **Perfectly Competitive Firms**: Price takers, can’t influence price, operate where their MC Marginal Cost curve is at or above the AVC Average Variable Cost Curve, s **If aggregate prices decreases**, profit per unit of output decreases and input prices are fixed → reduces per unit profit → reduces supply in short run To limit decline in per unit profit costs need to be cut → land, capital, technology, wages are fixed in short-run only option is to decrease the level of labor **Law of Diminishing Marginal Productivity:** marginal product of labor declines as the number of workers employed rises, implying layoffs raise marginal productivity of labor lowers production costs & increases profit Costs greater than price → labor level falls, marginal productivity rise, marginal cost fall, per unit profit rise at the new price, output/supply falls to mitigate drop in profit per unit If aggregate prices rise, higher price for final g+s, profit per unit rises as production costs are fixed and price of unit rises → output increases as more profitable **Imperfectly Competitive Firms: Price makers**, they decide price when they they have market power **Rise in demand** → output increases at any given price → with pricing power will choose to increase price + output to increase profit per unit of output **Fall in demand** → limit fall in sales by cutting prices + lowering output

Answer 87

Per Unit Profit of Output drives firm’s decisions, greater more, less less which changes depending on cost of production: increase cost → profit falls →production fall → output fall, vice versa **1) Changes in Commodity Prices while output prices do not change:** are not final goods, hence not included in aggregate price level, are a significant cost of production having large impacts, volatile due to industry-specific shocks to supply * Commodity: standardized input bought & sold in bulk quantities (refined inputs aluminum, iron, oil, nickel, potash, copper) **2) Change in Nominal Wage**: enough time passed for contracts for informal agreements to be renegotiated, * Ex. Healthcare insurance, Minimum wages for addressing sticky wages, increased cost of production, profit decr.--> aggregate output shift left. * Knock-On Effect: surge in oil prices commodity price raised overall consumer prices → nominal wages with cost-of-living-allowances **3) Changes in Productivity:** ex. Barcode scanners, * P: less stuff to produce the same amount = improvement in productivity → less cost per output → increase in aggregate supply **4) Change in Regulation**: ex.Filing more reports, forms * R: fall of productivity from inefficient use of time → higher cost of production → reducing production → shift in aggregate output

Answer 88

**Vertical graph**: firms makes adjustments, need to reduce labor is no longer a problem, no relationship, same output is produced at all price levels, Potential output reached **Horizontal Intercept = economy’s Potential Output**: the level of real GDP the economy would produce if all prices were perfectly flexible, not maximum level of output, output when all factors of production are effectively & fully utilized. In reality, output is always above or below gravitating towards/fluctuating around it. Other names: full employment level, long-run equilibrium level of output, natural rate level of output. Determined by the production capacity using production function: labor force, capital stock, resources, technological improvement, and Long-Run Economic Growth factors

Answer 89

Always in 1 of 2 states, both curves simultaneously if they cross (Aggregate Output=Potential Output) or SRAS shifting over time until they intersect * GDP>Potential Output → low profits low unemployment, need for workers, rise in bargaining power for wage → rise in nominal wages → production cost rise → supply decreases to Potential Output * GDP high profits high unemployment, too many workers, fall in bargaining power for wage → fall in nominal wages → production cost falls → supply increases to Potential Output

Answer 90

**Short-Run Macroeconomic Equilibrium (ESR):** intersection at which AD & SRAS curves intersect, quantity of aggregate output supplied is equal to the quantity demanded by HH, firms, government & rest of the world * P_E Short-Run Equilibrium Aggregate Price Level * Y_E Short-Run Equilibrium Aggregate Output * If aggregate price level is above E, SRAS>AD → aggregate price level will fall to E * If aggregate price level is below E, SRAS

Answer 91

**Demand Shock/Shifts of Aggregate Demand (AD) Curve:** an event causes AD curve to shift, while aggregate supply stays fixed, caused by factors listed above changes in expectations, wealth, effect of the size of existing stock of physical capital, use of fiscal or monetary policy. Aggregate output and price levels move in same direction **Positive Demand Shock**: aggregate demand increases (AD shift right), short-run price levels and output rise, higher equilibrium, upward movement along SRAS curve ex. an expansionary fiscal policy shifts the AD curve to the right (see factors that shift demand above), solved the Great Depression **Negative Demand Shock**: aggregate demand decreases (AD shift left), short-run price levels & output fall, lower equilibrium, downward movement along SRAS curve ex. Recession abroad cause a negative demand shock → fall in export, Contractionary fiscal policy, less spending, less demand, Monetary make spending more costly, buying less, less demand (investment spending is particularly sensitive)

Answer 92

**Supply Shock/Shifts of Aggregate Supply (SRAS) Curve**: an event causes the SRAS curve to shift, changes in costs of production causes profit to change (see factors listed above; change in commodity prices, nominal wage, tech/productivity), aggregate output & aggregate price level move in opposite directions. Harder for government to shift. **Positive Supply Shock (favourable)**: an event causing per unit profit to increase for the given price level that reduces production cost & increases quantity supplied at any given price level (SRAS right shift) → short-run price levels fall & output rises, downward movement along AD curve * Technological improvement, internet 1995-2000 * Declining inflation + full employment, optimism **Negative Supply Shock**: an event causing the per unit profit to decrease that raises production costs & reduces the quantity producers are willing to supply at any given aggregate level (SRAS left shift) → short-run price levels rise & output falls, upward movement along AD curve * Increase in oil prices 1973 & 1979, drives permanent rise in cost, reduces supply * **Stagflation** (stagnation+inflation): inflation/rising aggregate price levels & falling aggregate output leads to rising unemployment, purchasing power squeezed by rising prices, pessimism

Answer 93

**Long- Macroeconomic Equilibrium (ELR)**, when the short-run macroeconomic equilibrium is on the long-run aggregate supply curve. All 3 curves must agree AD, SRAS and LRAS. Long Run the economy is self-correcting, Output is unaffected, Price Levels are affected in Long-Run * P_E Long-Run Equilibrium Aggregate Price Level * Y_P Potential Output = Long-Run Equilibrium Aggregate Output

Answer 94

**Output Gap**: percentage difference b/w actual aggregate output (Short-Run) & potential output (Long-Run) =(Actual Aggregate Output-Potential Aggregate Output)/Potential Aggregate Output x100, always tends to 0, the YP * (-ve) **Recessionary Gap**: YEYP aggregate output is above potential output, nominal wages + sticky prices rise, moving back to YP

Answer 95

**E1 (LR)**: all 3 agree at one point, long-run aggregate supply curve Y1=YP **E2 (SR)**: AD falls (left) → fall in P2 and Y2 as suddenly the economy doesn’t want to buy→produce as much as E1 → below potential output and recessionary gap created (high unemployment, no need for so many workers for little demand or production) In the long run, even if the government does nothing, naturally SRAS will increase, as high unemployment=bargaining power for wage decreases, nominal wages fall=downward pressures on prices, production costs decrease, upward push on SRAS to increase output as profit per unit rises until… **E3 (LR)**: will return to equilibrium of all 3, long-run macroeconomic equilibrium, Y3=YP, lower aggregate price level P3

Answer 96

**E1 (LR)**: all 3 agree at one point, long-run aggregate supply curve Y1=YP **E2 (SR)**: AD increases (right shift), suddenly the economy wants to buy→produce more than E1, P2 & Y2 rises above potential output and inflationary gap created (low unemployment to produce higher level of aggregate output) In the long run, even if the government does nothing, naturally SRAS will decrease, more firm competition, higher bargaining power for wages, upward pressures on wages, production costs increase, downward left push on SRAS decreasing output until.. **E3 (LR)**: will return to equilibrium of all 3, long-run macroeconomic equilibrium, Y3=YP, higher aggregate price level P3>PE

Answer 97

Recessions are mainly caused by demand shocks, negative supply shocks tend to be more severe stagflation=inflation+falling output as macroeconomic policies have a harder time dealing with supply shocks. Biggest from Oil conflicts.