Unit 03: National Income and Price Determination Flashcards
03.01 Classical Economics and Say’s Law
What is the Classical Theory?
Views full employment as the norm of a capitalist economy
- best way achieve price stability, full empoyment, and steady economy = government stay out of economy
- Hands-off approach: Laissez-faire
- Focus long-run: wages, prices, interest rates fully flexable → short run aggregated supply curve more verticle
- prices act rationing system for goods and services
Result:
- Price rise: fewer people willing and able purchase
- Price fall: more people purchase
03.01 Classical Economics and Say’s Law
What contributed the creation of classical economics?
- Adam Smith’s The Wealth of Nations
- at a time economy at time when factories were in use and labor fully employed
- society = Potential GDP
- economy should be self-regulated
03.01 Classical Economics and Say’s Law
What determines growth in the economy from a classical viewpoint?
Amout of resources and improvements in technology
03.01 Classical Economics and Say’s Law
How does the classical theory say money supply influence the economy?
- Increase money supply directly affect total spending in economy
03.01 Classical Economics and Say’s Law
What is Say’s Law?
Who: Jean-Baptiste Say
- supported Smith’s work /own theory
- The Supply would be traded (demand) for other goods and services. Say and other Classical economics believe that producers only produce goods people willing to buy.*
- “Supply creates its own demand” = Say’s Law*
Fully flexible wages, prices, and interest rates result in an economy that quickly stabilizes.
A proposal that “supply creates its own demand” is called Say’s Law.
Because the economy is self-correcting, there is no need for government involvement.
According to Classical economists, the aggregate supply curve is more vertical
Classical economists believe the economy is inherently stable
03.02 Aggregate Supply
Define short-run aggregated supply.
- Total amount of goods and services that firms are willing and able to produce within economy.*
- short-run, long-run, and immediate short-run
03.02 Aggregate Supply
What is the immediate short-run? how does it relate to supply?
- few days to few months
- input and output fixed
Short-run supply curve: horizontal line at fixed price
03.02 Aggregate Supply
What is the short-run? how does it relate to supply?
- input fixed and output varies
- Prices go up → produce more of producct
- resource prices (especially wages) may not adjust
- SRAS: up-sloping shape
- producers need time adjust changing resource costs
- unemployment recources at lower level = SRAS relatively flat
- Rising levels = produce more until full capacity
03.02 Aggregate Supply
What is the long-run? how does it relate to supply?
- input and output is variable
- price lvel not affect supply
- Supply determined:
- level of productivity
- supply of resources (especially capital and labor)
- Market-forces: self-adjusted to changes
Curve: verticle & economy using all productive resources
- label YF (Y → acronym national income)
- Supply refers to potential output
- Intersection of aggregated demand and SRAS = real or actual output
03.02 Aggregate Supply
What are the three ranges of the short run aggreagate supply curve?
-
Keynesian (Horizontal) Range:
- recession or depression
- produce more at nearly same price - many unemployed resources
- Keynesian: never at full employment of resources and price level is stable
- reason unemployment result lack of demand
- government step in and create demand
-
Intermediate Range:
- approaching full-employment resources
- healthy economy
-
Classical (Verticle) Range:
- full employment resources
- increase demand results higher prices and little or no more production
- Classical
- economy self-correcting
03.02 Aggregate Supply
What are the 4 determinants of Short-run Aggregate supply?
- Resouce Prices
- Actions by the government
- Political or environmental phenonema
- Productivity
03.02 Aggregate Supply
Determinant of SRAS: Resource Prices (explain and its effect)
changes in input prices raw materials
- Resource prices fall → SRAS increases
- Resource prices rise → SRAS decrease
03.02 Aggregate Supply
Determinant of SRAS: Action by government (explain and its effect)
Changes in business taxes, business subsidies, and business regulations
- SRAS decreases:
- taxes rise
- subsidies fall
- regulations increase
- SRAS increase:
- taxes fall
- subsidies rise
- regulations decrease
03.02 Aggregate Supply
Determinant of SRAS: Political or environmental phenonema (explain and its effect)
Changes in inflationary expectations, wars, and natural disasters
- SRAS decreases:
- inflationary expectations increase
- war or other natural disaster
- SRAS increases:
- inflationary expectations decrease
03.02 Aggregate Supply
Determinant of SRAS: Productivity (explain and its effect)
Changes in technology, worker education, or other factors that affect productivity
- SRAS increases:
- technology increases
- education increase
- productivity increase
- SRAS decrease:
- technology decreases
- workers education decrease
- productivity decrease
03.02 Aggregate Supply
New laws result in an influx of highly educated immigrants. Aggregate supply will
- increase.
- decrease.
- remain the same.
1. increase
03.02 Aggregate Supply
Young adults of today, as a group, are more highly educated than the previous generation. The determinant causing the shift in this scenario is
- price.
- resource cost.
- productivity.
- government intervention (taxes, subsidies, or regulations).
- political or environmental phenomena
- consumer spending.
3. productivity
03.02 Aggregate Supply
Congress votes to substantially increase the minimum wage. Aggregate supply will
- increase.
- decrease.
- remain the same.
2. decrease
03.02 Aggregate Supply
The government cuts business taxes by 10%. Aggregate supply will
- increase.
- decrease.
- remain the same.
1. increase
03.02 Aggregate Supply
Congress votes to increase farm subsidies by 15%. The determinant causing the shift in this scenario is
- price.
- productivity.
- resource cost
- government intervention (taxes, subsidies, or regulations).
- political or environmental phenomena
- consumer spending.
- investment.
4. government intervention (taxes, subsidies, or regulations).
03.02 Aggregate Supply
A new process for producing glass revolutionizes the industry. Aggregate supply will
- increase.
- decrease.
- remain the same.
increase
03.02 Aggregate Supply
A new process for producing glass revolutionizes the industry. The determinant causing the shift in this scenario is
- price.
- productivity.
- resource cost
- government intervention (taxes, subsidies, or regulations).
- political or environmental phenomena
- consumer spending.
2. productivity
03.02 Aggregate Supply
New sources of silicon are located in Wyoming. The determinant causing the shift in this scenario is
- price.
- productivity.
- resource cost
- government intervention (taxes, subsidies, or regulations).
- political or environmental phenomena
- resource cost
03.02 Aggregate Supply
Short-run aggregate supply
- is down sloping because producers supply less at higher prices.
- is up sloping because producers supply less at higher prices.
- shows how much Americans are willing and able to consume at each price level.
- shows the various amounts that producers are willing and able to produce at each price level.
- is up sloping because consumers demand more at higher prices.
4. shows the various amounts that producers are willing and able to produce at each price level
03.02 Aggregate Supply
Classical economists believe that
- the economy will adjust to at full employment of resources.
- the economy was never at full employment of resources.
- the producer can produce more of the product at the same price.
- the economy is approaching full employment as wages and prices increase.
- there are many unemployed resources.
1. the economy will adjust to at full employment of resources
03.02 Aggregate Supply
If a new microchip technology was infused into all production processes, then
- there is a movement down the AS curve as price level decreased.
- AS shifts right and price level would decrease.
- AS shifts right and price level would increase.
- AS shifts left and price level would decrease.
- AS shifts left and the price level would increase.
2. AS shifts right and price level would decrease
03.02 Aggregate Supply
If the best weather in years increased food production in the Midwest, then
- there is a movement down the AS curve as price level decreased.
- AS shifts right and price level would decrease.
- AS shifts right and price level would increase.
- AS shifts left and price level would decrease.
- AS shifts left and the price level would increase.
2.AS shifts right and price level would decrease
03.02 Aggregate Supply
If Midwestern farmers were awarded record subsidies, then
- there is a movement down the AS curve as price level decreased.
- AS shifts right and price level would decrease.
- AS shifts right and price level would increase.
- AS shifts left and price level would decrease.
- AS shifts left and the price level would increase.
2. AS shifts right and price level would decrease
03.02 Aggregate Supply
If an economic crisis caused the collapse of the automobile industry, then
- there is a movement down the AS curve as output decreased.
- AS shifts right and output would decrease.
- AS shifts right and output would increase.
- AS shifts left and output would decrease.
- AS shifts left and the output would increase.
- AS shifts left and output would decrease
03.02 Aggregate Supply
If subsidies were given to all road construction firms in the U.S as part of a stimulus package, then
- there is a movement down the AS curve as output decreased.
- AS shifts right and output would decrease.
- AS shifts right and output would increase.
- AS shifts left and output would decrease.
- AS shifts left and the output would increase.
3. AS shifts right and output would increase
03.02 Aggregate Supply
OPEC radically cuts back on the production of oil used by U.S. manufacturers. Aggregate supply will
- increase.
- decrease.
- remain the same.
2. decrease
03.02 Aggregate Supply
OPEC radically cuts back on the production of oil used by U.S. manufacturers. The determinant causing the shift in this scenario is
- price.
- productivity.
- resource cost
- government intervention (taxes, subsidies, or regulations).
3. resource cost
03.02 Aggregate Supply
Consumer spending increases suddenly. Aggregate supply will
- increase.
- decrease.
- remain the same.
3.remain the same
03.02 Aggregate Supply
Which of the following statements is true about the Keynesian range of the short-run aggregate supply curve?
- Price level is increasing at all production levels.
- Price level is decreasing at all production levels.
- Price level is nearly constant at all production levels.
- Price level may increase or decrease as production increases or decreases.
- Output is constant at all production levels.
3. Price level is nearly constant at all production levels
03.02 Aggregate Supply
Which of the following statements is true about the Classical range of the short-run aggregate supply curve?
- Price level is decreasing at all production levels.
- Price level is constant at all production levels.
- Output is increasing at all production levels.
- Output may increase or decrease as price level increases or decreases.
- Output is nearly constant at all production levels.
5. Output is nearly constant at all production levels
03.02 Aggregate Supply
When the economy is at full employment of resources,
- the economy is operating in the vertical segment of the SRAS curve.
- the economy is operating in the intermediate segment of the SRAS curve.
- the economy is operating in the horizontal segment of the SRAS curve.
- there is no unemployment in the economy.
- there is no inflation in the economy.
1. the economy is operating in the vertical segment of the SRAS curve
03.02 Aggregate Supply
A healthy economy would operate
- in the Keynesian range of the SRAS.
- in the Intermediate range of the SRAS.
- in the Classical range of the SRAS.
- in the vertical range of the SRAS.
- in the horizontal range of the SRAS.
2. in the Intermediate range of the SRAS
03.02 Aggregate Supply
Keynes believed that
- the economy was always at full employment of resources.
- the economy was never at full employment of resources.
- the economy was self-correcting.
- any increase in demand will only be met with higher prices and little or no more production.
- wages and prices increase to attain full employment of resources.
2. the economy was never at full employment of resources.
03.02 Aggregate Supply
If the tourist industries were awarded subsidies due to the downturn in the economy, then
- there is a movement down the AS curve as output decreased.
- AS shifts right and output would decrease.
- AS shifts right and output would increase.
- AS shifts left and output would decrease.
- AS shifts left and the output would increase.
3. AS shifts right and output would increase
03.03 Aggregate Demand
Define aggregate demand (AD)?
Total quantity of output demanded by individuals (consumers), business (industry), and government at different price levels in a given time.
03.03 Aggregate Demand
How is aggregate demand different from demand?
- Price of one good or service not really reflected in AD unless there is no substitute
03.03 Aggregate Demand
What is the formula for Aggregate Demand?
AD = C + Ig + G + (X – M)
- AD - aggregate demand
- C - consumer spending
- Ig - investment spending
- G - government purchases
- (X - M) - Net Exports [exports - imports]
03.03 Aggregate Demand
How does Aggregate Demand compare to GDP?
AD about spending & GDP is about production
- GDP not include transfer payments; no good or service is produced in transaction
- AD include transfer payments; consumer spending change with change in income
03.03 Aggregate Demand
What is Consumer Spending (in relation to AD)?
All goods purchased (consumed) by households.
- largest portion AD (2/3 percent)
- Too much results in demand pull inflation
03.03 Aggregate Demand
What 4 concepts effect consumer spending?
-
Consumer Wealth:
- greater income = more consumer spending
- less income = less consumer spending
-
Consumer expectation:
- except economy to do well = spend more money
-
Consumer Indebtedness:
- more debt = not spend more new money
-
Taxes and transfer payments:
- lower taxes = more money to spend
- higher taxes = decreases spending ability
- –
- more transfer payments = more income to save and spend
03.03 Aggregate Demand
What is investment spending and what are the 4 determinants?
- All goods and services purchased by businesses make products.*
- Gross private investment; not net investment*
-
Interest Rates:
- lowerst rates → stimuate investment spending
- higher rates → less investment spending
-
Profit expectations on projects:
- business except high profits → more likely borrow money for investment spending
-
Degree of excess capacity: (how much factory space is used)
- high degree excess capacity = lot empty room = no need engage investment spending
- low degree = encourage investment spending
-
Producer confidence:
- except economy improve = increase investment spending
03.03 Aggregate Demand
Define Government Spending (AD)
Purchased by government (not transfer payments)
03.03 Aggregate Demand
Describe the aggergate demand curve
- similar demand curve
- Slope increase - real gross domestic product will be lower and as price levels drop
03.03 Aggregate Demand
What is the difference between price and price level?
- Price: supply and demand curve & indicates how much one product will cost at each point
- Price Level: average price all goods and services in economy
03.03 Aggregate Demand
What are the three reasons the AD is downwards sloping?
-
Wealth Affect:
- Price rise → real value of household income decline and consumer spending drops
- Drop = decrease in real GDP
-
Interest Rate Affect:
- Price rise - real value household income declines
- Continue current lifestyle: borrow money
- Increase demands for loans → increase interest rate
- Interest rates increase →
- less investment spending by businesses
- consumers put off buying high ticket items like homes
- decrease real GDP
- Price drop - interest rates decrease
- consumer and investment spending increase
- increase real GDP
- Price rise - real value household income declines
-
Net Exports (Foreign Trade) Effect:
- price rise: buy cheaper goods & fewer domestic products = decrease net exports
- Demand foreign products increase = interest rates abroad increase
- Domestic” more appealing put money overseas assests rather keeping in domestic financial assets
- decrease real GDP
- Price decrease: reverse
03.03 Aggregate Demand
Congress decreases personal income taxes. Aggregate demand will
- increase.
- decrease.
- remain the same.
1. increase
03.03 Aggregate Demand
Congress decreases personal income taxes. Which determinant of aggregate demand causes the change?
- Price
- Consumer spending
- Investment spending
- Government spending
- Net exports
- Productivity
- Resource cost
- Government intervention (taxes, subsidies, or regulations)
- None of the above
2. Consumer spending
03.03 Aggregate Demand
Consumers rush to purchase new gaming systems and other electronic goods. Aggregate demand will
- increase.
- decrease.
- remain the same
1. increase