week 23 Flashcards
what is the aggregate demand curve
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
why does aggregate demand increase in inflation
reduced planned spending and short run equilibrium output, aggregate demand curve is downward sloping
why does the AD curve slope downwards
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
what are distributional effects for AD curve
inflation hurts people with lower incomes more, these people spend more of their income so Y drops when their income does
what is uncertainty for AD curve
inflation causes uncertainty about future prices, people may be more cautious when spending
what are exports for AD curve
inflation causes prices of exported goods to rise, lowering exports
what does the aggregate demand curve look like
what causes movement along the AD curve
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
what causes shifts in the AD curve
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
draw the shift in AD graph
when does inflation remain roughly constant
if operating at Y* and there are no external shocks to the price level
inflation tends to change slowly from year to year
what is inflation inertia
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
what are the inflation expectations
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
what are long term wage and price contracts
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
what three factors increase inflation rate
output gap
inflation shock
shock to potential output
what are the three output gaps and how are they affected by inflation
Y = Y* - inflation remains unchanged
Y > Y* - inflation rises
Y < Y* - inflation falls
what is long run aggregate supply
a vertical line showing the economy’s potential output Y*
what is short run aggregate supply
a horizontal line showing the current rate of inflation, as determined by past expectations and pricing decisions
what is the aggregate demand for short run equilibrium
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
what is the aggregate demand for kong run equilibrium
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
what is the aggregate supply, aggregate demand curve
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
what is a self correcting economy
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
what is a slow self correcting mechanism
fiscal and monetary policy can help stabilise the economy
what is a fast self correcting mechanism
fiscal and monetary policy are not effective and may destabilise the economy
what does the speed of correction depend on
the use of long term contracts
the efficiency and flexibility of labour markets
what is an inflation shock
a sudden change in the normal behaviour of inflation, unrelated to the nations output gap
what is aggregate supply shock
either an inflation shock or shock to potential output
adverse aggregate supply shocks of both types reduce output and increase inflation
