Topic 7 Flashcards
Consumption growth and investment growth both fluctuate with GDP, which is more volatile?
Investment
What does Okun’s Law describe?
The negative relationship between GDP and unemployment
See
slide on real GDP, C, I and U
2 reasons consumption is less volatile than investment?
1) consumers save tf buffer to shocks to GDP and income
2) also consumers try to ‘smooth out’ income across lifetime
Why is investment growth more volatile than GDP growth?
Accelerator effect:
When an increase in GDP -> proportionately larger increase in Investment
Why does the accelerator effect occur?
When firms believe that demand is growing and will continue to grow, they tend to overcompensate in investment because they don’t want to be caught without stock to provide
Draw Okun’s law diagram
See topic 7 slide 6
See
Notes: recap of classical macro theory
What does AD curve show?
Relationship between price level and quantity of output demanded
What implies the DWS AD curve?
MV=PY
If MV constant, increase in P means decrease in Y and vice versa
How would an increase in money supply affect AD curve?
Shift it right (change in V would also affect the curve)
Mechanism that builds the AD curve?
Increase in price level -> decrease in RMB -> decrease in D for G and S
See
AS stuff bottom of side 1 page 1
What are the SRAS and LRAS curves like and why?
SR: flat; all prices fixed in SR, firms willing to sell as much as consumers wish to buy
LR: vertical; prices fully flexible, output determined by the fixed supply of K and L, not by demand
Draw and explain the SR and LR effects of an increase in the money supply?
Shifts AD right;
SR: P constant, Y increases
LR: P rises, Y returns to natural level
see notes for diagram
Draw and explain the SR and LR effects of a negative demand shock?
See notes
What are supply shocks?
Shocks that alter production costs, also called price shocks
See examples of adverse and favourable supply shocks
notes now
Explain part 1 of the 1970s oil price shocks?
Early 70s, OPEC coordinates a reduction in the supply of oil -> increase in prices (11% in ‘73, 68% in ‘74, 16% in ‘75)
Increase in price -> increase in SRAS -> fall in Y and rise in U
Over time, prices fell back to point A
Draw diagram to show this and see notes
Explain part 1 of the 1970s oil price shocks?
BUT in late 70s prices shot back up due to supply shock, in 1980s there was a favourable shock that then reduced the prices of oil and returned inflation and U back to natural levels
What is stabilization policy?
Policy aimed at reducing the severity of SR fluctuations
Example of stabilization policy?
Using monetary policy to combat the effects of adverse supply shocks
See
diagram at end of notes
