Macroeconomics Chapter 33 - Aggregate Demand And Aggregate Supply

Front 1

Over the long run, GDP grows about __% per year on average

Back 1

3%

Front 2

__________ are periods of falling real incomes and rising unemployment

Back 2

Recessions

Front 3

__________ are severe recessions

Back 3

Depressions

Front 4

Short-run economic fluctuations are often called __________

Back 4

Business cycles (this term may be misleading, as "cycle" implies something more regular and predictable.

Front 5

Three Facts about Economic Fluctuations

Back 5

1. Economic fluctuations are irregular and unpredictable.
2. Most macroeconomic quantities fluctuate together.
3. As output falls, unemployment rises.

Front 6

The Classical Dichotomy

Back 6

The separation of variables into two groups:
- Real (quantities, relative prices)
- Nominal (measured in terms of money)

Front 7

The Neutrality of Money

Back 7

Changes in the money supply affect nominal but not real variables.

Front 8

Classical Economics basics

Back 8

- Most economists believe classical theory describes the world in the long run, but not the short run.
- In the short run, changes in nominal variables can affect real variables (like Y or unemployment rate)

Front 9

The __________ curve shows the quantity of all goods and services demanded in the economy at any given price level.

Back 9

The Aggregate-Demand (AD) Curve

Front 10

Why the AD Curve Slopes Downward

Back 10

A fall in the price level increases the quantity of goods and services demanded.

Three reasons for this negative relationship:
- As price level falls, real wealth rises, interest rates fall, and exchange rate depreciates
- This stimulates spending on consumption, investment, and net exports
- Increased spending means a larger quantity of g&s demanded

Front 11

The Wealth Effect (P and C)

Back 11

--> Suppose P rises
(even with no change in income, the dollars people hold buy fewer goods & services - so real wealth is lower, and people feel poorer)

--> C falls

Front 12

The Interest-Rate Effect (P and I)

Back 12

--> Suppose P rises
(buying goods & services requires more dollars. To get these dollars, people sell bonds or other assets. This drives up interest rates)

--> I falls
(I depends negatively on interest rate)

Front 13

The Exchange-Rate Effect (P and NX)

Back 13

--> Suppose P rises
(US interest rates rise, foreign investors desire more US bonds, higher demand for $ in foreign exchange market, US exchange rate appreciates, US exports more expensive to people abroad imports cheaper to US residents.

--> NX falls

Front 14

Slope of the AD Curve:

An increase in P (increases/reduces) the quantity of G&S demanded because:
-The wealth effect (C ____)
-The interest-rate effect (I ____)
-The exchange-rate effect (NX ____)

Back 14

An increase in P REDUCES the quantity of G&S demanded because:
-The wealth effect (C FALLS)
-The interest-rate effect (I FALLS)
-The exchange-rate effect (NX FALLS)

Front 15

Why might the AD Curve shift?

Back 15

Any event that changes C, I, G, or NX -except a change in P- will shift the AD curve.

Front 16

Why the AD Curve Might Shift:

Changes in C (3)

Back 16

- Stock market boom/crash
- Preferences re: consumption/saving tradeoff
- Tax hikes/cuts

Front 17

Why the AD Curve Might Shift:

Changes in I (4)

Back 17

- Firms buy new equipment, factories, etc.
- Expectations, optimism/pessimism
- Interest rates, monetary policy
- Investment Tax Credit or other tax incentives

Front 18

Why the AD Curve Might Shift:

Changes in G (2)

Back 18

- Federal spending
- State & local spending

Front 19

Why the AD Curve Might Shift:

Changes in NX (2)

Back 19

- Booms/recessions in countries that buy our exports
- Appreciation/depreciation resulting from international speculation in foreign exchange market

Front 20

The _______ curve shows the total quantity of goods & services firms produce and sell at any given price level

Back 20

The Aggregate-Supply Curve

Front 21

The AS slope is _________ in the short run and ________ in the long run.

Back 21

The AS slope is UPWARD-SLOPING in the short run and VERTICAL in the long run.

Front 22

Long-Run Aggregate-Supply Curve:

The _________________ is the amount of output the economy produces when unemployment is at its natural rate.

Back 22

The Natural Rate of Output (also called potential output or full-employment output)

Front 23

What determines LRAS and why is it vertical?

Back 23

- It's determined by the economy's stocks of labor, capital, and natural resources, and on the level of technology.
- An increase in P does not affect any of these, so it does not affect Natural Rate of Output

Front 24

Why might the LRAS curve shift?

Back 24

Any event that changes any of the determinants of the Natural Rate of Output will shift LRAS. (L, K/H, natural resources, technology)

Front 25

Why the LRAS Curve Might Shift:

Changes in L or natural rate of unemployment (3)

Back 25

- Immigration
- Baby-boomer retire
- Gov't policies reduce natural unemployment rate

Front 26

Why the LRAS Curve Might Shift:

Changes in K or H (3)

Back 26

- Investment in factories or equipment
- Increase in education
- Factories or equipment destroyed

Front 27

Why the LRAS Curve Might Shift:

Changes in natural resources (3)

Back 27

- Discovery of new mineral deposits
- Reduction in supply of imported resources (long-term)
- Changing weather patterns (long-term)

Front 28

Why the LRAS Curve Might Shift:

Changes in technology (1)

Back 28

- Productivity improvements from technological progress

Front 29

The Short-Run Aggregate Supply (SRAS) has a _________. This is because:

Back 29

UPWARD-SLOPE

In the short run, a fall in the price level reduces the quantity of output supplied. This positive relationship could be attributed by 3 different theories. Over time, wages, prices, and perceptions adjust, so this positive relationship is only temporary

Front 30

Three Theories of upward slope of SRAS

--> In each, some type of market imperfection is present...output deviates from its natural rate when the actual price level deviates from the price level people expected.

Back 30

1. The Sticky-Wage Theory
2. Sticky-Price Theory
3. The Misperceptions Theory

Front 31

Imperfection of The Sticky-Wage Theory

Back 31

Nominal wages are sticky in the short run, they adjust sluggishly

- Firms and workers set the nominal wage in advance based on P-E, the price level they expect to prevail
- if P > P-E, revenue is higher but labor cost is not. Production in more profitable, so firms increase output and employment
- Higher P causes higher Y, So the SRAS curve slopes upward

Front 32

Imperfection of The Sticky-Price Theory

Back 32

Many prices are sticky in the short run, due to menu costs, the cost of adjusting prices.

- Firms set sticky prices in advance based on P-E.
- Higher P is associated with higher Y, so the SRAS curve slope upward.

Front 33

Imperfection of the Misperceptions Theory

Back 33

Firms may confuse changes in P with changes in the relative price of the products they sell.

- If P rises above P-E, a firm sees its price rise before realizing all prices are rising. The firm may believe its relative price is rising, and may increase output and employment
- So, an increase in P can cause an increase in Y, making the SRAS curve upward-sloping

Front 34

Equation for 3 Theories Explaining SRAS

Back 34

Quantity of output supplied = Natural rate of output + a (Actual price level - Expected price level)

a is a number that determines how much output responds to unexpected changes in the price level
(Theories suggest that output deviates from its natural rate when the price level deviates from the price level that people expected.)

Front 35

In the long-run equilibrium,
P-E ___ P
Y ___ Y-N

Back 35

P-E = P (expected price = actual price)
Y = Y-N (output = natural rate of output)
*and unemployment is at its natural rate.

Front 36

Four Steps to Analyzing Economic Fluctuations

Back 36

1. Determine whether the event shifts AD or AS.
2. Determine whether curve shifts left or right.
3. Use AD-AS diagram to see how the shift changes Y and P in the short run.
4. Use AD-AS diagram to see how economy moves from new SR equilibrium to LR equilibrium