week 23

Question 1

what is the aggregate demand curve

Answer 1

the relationship between short-run equilibrium output and rate of inflation
reflects that short-run equilibrium output is determined by and equals total planned spending in the economy

Question 2

why does aggregate demand increase in inflation

Answer 2

reduced planned spending and short run equilibrium output, aggregate demand curve is downward sloping

Question 3

why does the AD curve slope downwards

Answer 3

Keynesian model assumes output adjusts to demand at preset prices in the short run
prices are not fixed indefinitely
Keynesian model does not explain the behaviour of inflation

Question 4

what are distributional effects for AD curve

Answer 4

inflation hurts people with lower incomes more, these people spend more of their income so Y drops when their income does

Question 5

what is uncertainty for AD curve

Answer 5

inflation causes uncertainty about future prices, people may be more cautious when spending

Question 6

what are exports for AD curve

Answer 6

inflation causes prices of exported goods to rise, lowering exports

Question 7

what does the aggregate demand curve look like

Question 8

what causes movement along the AD curve

Answer 8

π and Y are inversely related
changes in π cause a change in Y which causes movement along the AD curve
as π increases, Y decreases

Question 9

what causes shifts in the AD curve

Answer 9

any factor that changes Y at a given π shifts the AD curve
shift caused by exogenous spending and changes in Feds policy reaction function

Question 10

draw the shift in AD graph

Question 11

when does inflation remain roughly constant

Answer 11

if operating at Y* and there are no external shocks to the price level
inflation tends to change slowly from year to year

Question 12

what is inflation inertia

Answer 12

all prices in the economy are continuously adjusted with relation to a price index by force of contracts
occurs for two reasons: inflation expectations and long term wage and price contracts

Question 13

what are the inflation expectations

Answer 13

public negotiate wages and prices for future sales
prices agreed are based on their expectations about inflation
if you think there will be high inflation, agree to higher prices which can lead to actual inflation as prices rise

Question 14

what are long term wage and price contracts

Answer 14

union wage contracts set wages for several years, contracts setting the price of raw materials and parts for manufacturing firms also cover several years
reflect the inflation expectations when signed

Question 15

what three factors increase inflation rate

Answer 15

output gap
inflation shock
shock to potential output

Question 16

what are the three output gaps and how are they affected by inflation

Answer 16

Y = Y* - inflation remains unchanged
Y > Y* - inflation rises
Y < Y* - inflation falls

Question 17

what is long run aggregate supply

Answer 17

a vertical line showing the economy’s potential output Y*

Question 18

what is short run aggregate supply

Answer 18

a horizontal line showing the current rate of inflation, as determined by past expectations and pricing decisions

Question 19

what is the aggregate demand for short run equilibrium

Answer 19

a situation in which inflation equals the value determined by past expectations and pricing decisions and output equals the level of shirt-run equilibrium output that is consistent with that inflation rate
graphically short run equilibrium occurs at the intersection of the AD curve and the SRAS line

Question 20

what is the aggregate demand for kong run equilibrium

Answer 20

a situation in which actual output equals potential output and the inflation rate is stable
graphically, long run equilibrium occurs when the AD curve, the SRAS line and the LRAS line all intersect at a single point

Question 21

what is the aggregate supply, aggregate demand curve

Answer 21

a review of the adjustment process to a recessionary gap
firms that are selling less than they want to will start to lower prices
as inflation falls the Fed lowers r and AD increases
falling inflation reduces uncertainty which also increases AD
as Y increases, cyclical unemployment falls
adjustment continues until long run equilibrium is reached

Question 22

what is a self correcting economy

Answer 22

in the long run the economy tends to be self correcting
the keynesian model does not include a self correcting mechanism
the keynesian model concentrates on the short run with no price adjustment
the self-correcting mechanism concentrates on the long-run with price adjustments

Question 23

what is a slow self correcting mechanism

Answer 23

fiscal and monetary policy can help stabilise the economy

Question 24

what is a fast self correcting mechanism

Answer 24

fiscal and monetary policy are not effective and may destabilise the economy

Question 25

what does the speed of correction depend on

Answer 25

the use of long term contracts
the efficiency and flexibility of labour markets

Question 26

what is an inflation shock

Answer 26

a sudden change in the normal behaviour of inflation, unrelated to the nations output gap

Question 27

what is aggregate supply shock

Answer 27

either an inflation shock or shock to potential output
adverse aggregate supply shocks of both types reduce output and increase inflation