Macro Unit 2 Flashcards
Recession
2 consecutive quarters (6 months) of declining real output (negative real GDP) accompanied by delcining real income and rising unemployment
Depresion
a very severe, long recession
When output falls, unemployment…
Rises
On a graph, price level measures…and output (real GDP) measures…
Price level: value of money (inflation)
Output: quantity of goods produced
Aggregate demand curve
Curve that shows what ALL SECTORS want to buy at each price level. Shows how GDP (C + I + G +NX) varies with price level
Why is the aggregate demand curve downward sloping?
- Real interest rate
- wealth effect
- NX effect
Real Interest rate effect
A lower price level reduces interest rate, encouraging greater spending on investment goods, increases QD of goods and services
Exchange rate effect
An increase in price level makes goods more expensive to foreigners.
Wealth effect
A decrease in price level makes consumers wealthier, therefore encouraging them to spend more. Increased spending=larger Q of goods and services demanded
What will shift the AD curve?
-Any change to C, I, G and NX that is NOT caused by a change in price level
Aggregate supply curve
A curve that shows the amount of goods and services all sectors are willing to supply at each price level
Long run
all costs are variable, fixed costs can be changed
Short run
as long as some of the costs are fixed, the firm is in the short run
Classical theory/Say’s Law
Supply creates demand
When something is produced, it generates income equal to its value
Prices and wages are FLEXIBLE, they will adjust to ensure that everything is purchased, and recessions will always correct themselves
Assumes economy is fully utilizing its resources
Why is the LRAS curve vertical in the long run?
An economy’s production (GDP) and growth is dependent on its avaliability of LLC and its ability to use those resources to create good, NOT on price level
What will shift the LRAS
Anything that alters the natural rate of output (what the economy produces at the natural rate of unemployment)
Changes in labor, capital, natural resources, technology
Keynesian theory
Say’s law is not always true, deemand is key and people will save extra in bad times
Not all resources will be used during a recession
Wages and prices are fixed or sticky in the short run
Why does the SRAS slope upwards?
- sticky wage theory
- sticky price theory
- misperceptions theory
Sticky wage theory
SRAS slopes up because nominal wages are slow to adjust in the short run to the price level. A lower price level make employment and production less profitable, so firms reduce the Q of goods and services they supply
Sticky price theory
Prices of goods and services are slow to adjust in response to changing economic conditions (menu costs)
Misperceptions theory
A lower price level causes misperceptions about relative prices, which induces suppliers to respond to a lower price level by decreasing QS of goods and services
Things that will shift the SRAS
- anything that shifts LRAS
- Expectations about prices: increase in expected price level shifts SRAS left, decrease in expected price level shifts SRAS right
The economy at equilibrium
Full employment (has 5% enemployment) Y=Max GDP, 5% unemployment, and max income
Real GDP can only increase when…
Nominal GDP can only increase with…
Real GDP can only increase when an economy produces more output (goods and services)
Nominal GDP can only increase with an increase in price level
To show a recession using AS/AD model, SRAS and SRAD must intersect
Below full emmployment level of output
How to fix a recession:
- AD shifts left (could be due to a terrorist attack, bubble burst, bank failures)
- Prices and real GDP fall, economy is not producing at max potential output
- Over time, AS shifts right, people expect the price level to be lower
- Economy returns to Eq in the long run. Output remains at full employment in the long run, and the price level has fallen
Productivity
Explains the large variations in living standards around the world. It is the amount of goods and services from each hour of a worker’s time
A growth in productivity leads to…
A growth in living standards
How is productivity determined?
Physical capital, human capital, natural resources, technology
Physical capital
stock of equipment and structures used to produce goods and services.
Workers are more productive with more tools
Capitial is a factor of production used to make goods and services including more capital
Human capital
The knowledge and skill workers acquire through education, training and experience.
Raises a nation’s ability to produce goods and services
Natural resources
Inputs into the production of goods and services that are produced by nature. Either renewable or nonrenewable.
Technological knowledge
Society’s understanding of the best ways to produce goods and services
Importance of saving and investment for productivity
One way to raise future productivity is to invest in more current resources in the production of capital
If society wants to invest more capital, it must consume less and save more of its current income
Diminishing returns
property where the benefit from an extra unit of an input declines as the quantity of the input increases
Workers who already have a large quantity in producing goods and services will only benefit slightly from an additional unit of capital, while workers with less capital will benefit largely with additional capital
Catch up effect
Property saying that countries that start off poor tend to grow more rapidly than countries that start off rich
In the long run, a higher savings rate leads to…
a higher level of productivity and income, but NOT to higher growth
Investment abroad
A country can invest in new capital with foreigners
Foreign direct investment
A capital investment that is owned and operated by a foreign entity.
Foreign portfolio investment
An investment financed with foreign money but operated by domestic residents
When a country invests in a foreign country, whose capital stock, productivity, GDP, and GNP does their ouput contribute to?
Capital stock, productivity and GDP contributes to the foreign country. GNP contributes to their own country’s
How does investment abroad help a country grow?
It increases stock of capital, which leads to higher productivity and wages. It also helps poor countries use modern technology from richer countries
Factors thay help in economic growth?
- Investment abroad
- Education
- Property rights and political stability
- Free trade
- Research and development
Economic growth
A long run/sustained increase in real GDP
Developed countries aime for 2%-3% growth per year
Productivity
The quantity of goods and services produced per worker
Determines a nation’s potential growth
Factors that shift the labor demand curve
Any changes from MPxP
P: anything that changes the price of product (shifts in product market)
MP: anything that changes the MPL (technology, supply of other factors of production)
What can increase a worker’s productivity?
Increases in
- capital goods (stock)
- human captial (skill)
- natural resources
- technological knowledge
An increase in productivity leads to a shift of the LRAS…
Right, showing economic growth
Globalization
Process of removing barriers to open the world into one single community
Stagflation
Falling output and rising prices
No automatic fix
Inflationary gap
The economy is operating BEYOND full employment level of output (unemployment us below natural rate)
Resources are working overtime
Inflation will eventually cause a leftward shift in SRAS
