Feb 5 & 10 Flashcards
where does macroeconomic equilibrium occur?
at the intersection of the AD and AS curves
an increase in P does what to private-sector wealth?
reduces it
- reduction in desired consumption
- downward shift in AE curve
effect of increase in P on net exports?
NX function shifts downwards
causes a further downward shift in the AE curve
how does a fall in P affect private sector wealth and NX?
increases private sector wealth
moves NX (X - IM) up
wealth effect: reduction in desired consumption
a fall in P raises the REAL VALUE of MONEY HOLDINGS
much of private sector’s total wealth = held in form of assets with a fixed nominal value
much of private sector’s wealth is held in form of assets with…
a FIXED nominal value
ie. money > what can money buy? depends on the prices
an INCREASE in P REDUCES the real value of money holdings (have to pay more for the same thing)
a FALL in P RAISES the real value of money holdings
looking at our AE function, explain why increase in P shifts the AE function down
AE = (a + I + G + X) + [b (1 - t) - m] Y
Prices affect a and X
a: increased prices mean less consumption so a falls
X: if prices in our economy increase, our goods become less attractive in the international market, so X falls
2 channels through which an increase in prices shifts AE down
- constant a: consumption
^ higher prices = less consumption
- X: exports
^ higher prices = lower exports
wealth effect in a nutshell
a decrease in consumption because of an increase in prices
aggregate demand (AD) curve relates…
relates equilibrium real GDP to the price level
for any given P, the AD curve shows…
the level of real GDP for which desired AE equals actual GDP
what causes movements along the AD curve?
changes in the price level
as the price level rises, what happens to the AE curve and the AD curve?
the AE curve shifts down (because of effects on a and X)
and the economy moves upward and left along the AD curve to meet the new equilibrium
2 reasons why the AD curve is negatively sloped
- fall in price level leads to rise in private sector wealth - this increases desired consumption and thus leads to an increase in equilibrium GDP
- a fall in price level (for given exchange rate) leads to a rise in net exports and thus leads to an increase in equilibrium GDP
any shock that increases equilibrium GDP at a given price level…
shifts the AD curve to the right
what does the horizontal shift of the AD curve equal?
the simple multiplier times the change in autonomous spending
does the AD curve say anything about whether producers want to produce that income?
no
it says nothing about whether producers would want to produce that income
only says that if it’s produced, purchasers will be willing to buy it
the AS curve relates…
the PRICE LEVEL to
the QUANTITY OF OUTPUT that firms would LIKE TO PRODUCE and SELL
AS curve is drawn for a given…
- level of technology
- set of factor prices
as unit costs rise with output, firms will produce more output only…
only if prices increase
AS curve is UPWARD SLOPING
what happens to slope of AS curve as output rises?
slope increases
when output is low, firms typically have EXCESS CAPACITY so costs don’t rise as fast
but when output is nearer Y*, costs RISE as output rises, so firms need higher prices
what causes the AS curve to shift up?
anything that increases firms’ costs
ie. increased factor prices
ie. more expensive technology
why is the AS curve upward sloping?
because as unit costs rise with output, firms will produce more output only if prices increase
where is demand behaviour consistent with supply behaviour?
only at the intersection of the 2 curves
E0 is the macroeconomic equilibrium
Keynesian AS curve
extreme version of the AS curve
it’s horizontal over some range of real GDP
range where real GDP is below potential and firms are operating with excess capacity
firms can respond to changes in demand by altering output while keeping prices constant
a horizontal AS curve indicates that…
any output up to potential output will be supplied at the going price level
with a horizontal AS curve, what determines the amount of output produced?
the position of the AD curve
it’s DEMAND DETERMINED
demand and supply shocks can be either…
expansionary or contractionary
^ refers to effect on equilibrium output
demand shocks cause P and Y to change in what directions?
in the same direction
possible causes of demand shocks
- change in G
- change in I
- change in X
- change in C
the multiplier when the price level varies - increase in P
AE curve shifts down because of rise in price level (first an increase in A shifts the AE up, but the accompanying increase in prices eventually shift it down)
with an upward sloping AS curve, the multiplier is smaller than the simple multiplier
with an upward sloping AS curve what happens to the multiplier?
it’s smaller than the simple multiplier
because of the increase in prices as the curve gets steeper
with an upward sloping AS curve, the multiplier is _________ than the simple multiplier
smaller
effect of any given shift of the AD curve will depend on…
the slope of the AS curve
the steeper the AS curve:
- the GREATER THE PRICE EFFECT
- the SMALLER THE OUTPUT EFFECT
aggregate supply shocks cause P and Y to change in which directions?
opposite
ie. increase in P = decrease in Y
ie. increase in Y = decrease in P
possible causes of aggregate supply shocks
- change in price of inputs
- change in wages
- change in technology
Asian Crisis and the Canadian Economy
- 1997 - economies of Malaysia, Indonesia, Thailand, South Korea and Philippines = suffering major RECESSIONS
- AD: these economies are important users of raw materials and their demand for them declined sharply = LEFTWARD SHIFT of the CAD AD
- AS: CAD firms use raw materials as INPUTS. reduction in price of raw materials implies REDUCTION in COST for FIRMS = RIGHTWARD SHIFT of the CAD AS
NET EFFECT OF THESE 2 SHOCKS = REDUCE CAD AD
^ because the effect on exports was larger than effect on supply
analyzing the 2020 pandemic recession with AD/AS model
- combined negative AS shock and AD shock = sharp reduction in output and employment
- economy’s ability to combine land, labour and capital to produce output was severely reduced - large leftward shift in AS curve, real GDP declined
- both businesses and households reduced their demand - large leftward shift of AD curve, real GDP declined
- by mid-2021, vaccines for COVID were rolling out and economies were recovering
- once individuals were able to safely return to their workplaces, AS shocks reversed but LESS than we EXPECTED
- once stores, restaurants, airlines and hotels were able to safely conduct business, households and firms returned to their normal levels of demand - AD shock quickly reversed
effects of 25% increase in US tariffs on Canadian imports
- AD will fall due to fall in NX
^ exports will decrease due to reduced demand from US
^ imports will also decline due to CAD retaliation, but the reduction will be smaller than the drop in exports
- AS will shift left
^ higher tariffs increase prices of imported goods
^ increased costs of imported inputs raises production costs for CAD firms
^ their cost-push effect shifts the AS curve to the left, leading to higher prices and lower output
