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26 Cards in this Set

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Define: aggregate demand curve

The relationship between the price level and quantity of real GDP demanded by households, firms and the government

Define: short-run aggregate supply curve

The short-run relationship between the price level and the quantity supplied by firms.

Define: household wealth and the wealth effect.

Household Wealth: the difference between a household's assets and its debts.

Wealth Effect: the effects of the price level has on consumption via the household wealth. I.e. as price level increases, consumption falls through the lower household wealth affected by inflation.

Define: interest-rate effect

Price levels change the money demanded, which determines interest rates. The higher it is, the higher the cost of borrowing.

Define: international trade-effect

As inflation occurs, the price level of domestic products become more expensive causing net exports to decrease.

What are three reasons for the aggregate demand having a downward slope?

1. Household Effect

2. Interest-rate Effect

3. International trade-effect

What will cause a shift in the aggregate demand? What won't? What are those three variables?

Changes in variables other than price. If prices change, holding all other variables constant, it will only cause a movement along the curve.

1. Changes in government policies

2. Changes in the expectation of firms and households

3. Changes in foreign variables

Define: monetary and fiscal policy. What are they used for?

Monetary Policy: actions by the central bank to manage the money supply and the interest rate

Fiscal Policy: changes in federal taxes and purchases to achieve macroeconomic policy objectives

To shift the aggregate demand curve

What is the effect of expectations of incomes of households and firms have on the aggregate demand?

A shift relative to the 'emotional' expectation of future income

Explain: changes in the price level does not affect the level of real GDP (long-run aggregate supply). Hence, what causes a shift in the long-run aggregate supply?

As the long-run real GDP is the normal capacity to produce, which is not affected by price level changes, real GDP is unaffected.

Shift: changes in labor force, capital stock and technology

Why is the short-run aggregate supply upward sloping? 2 reasons.

Profits increase as the price level of inputs rise more slowly than final products; thereby increasing the willingness of firms to supply more.

This can also be true when firms don't change prices relative to other substitutes. Thus, sales increase.

What are the three most common explanations for the inaccurate predictions of the price level causing the short-run aggregate supply to be upward sloping?

1. Sticky wages: by contract, prices of inputs remain constant, regardless of changes in the price level.

2. Slow to adjust: despite contracts, firms are still slow to adjust wages, creating losses or profits.

3. Menu costs: costs to change "menu costs" will prevent firms from changing costs; thereby fixing their price relative to substitutes. Hence, profits can increase.

What are five important variables affecting the aggregate supply curve to shift?

1. Increases in labor force and capital stock

2. Technological changes

3. Expected price level

4. Adjustments to expectations

5. Supply shocks

If prices are expected to increase by a certain amount, how much will the SRAS shift by? Why it so?

By the same amount because firms will adjust wages to preserve the purchasing power.

Define: supply shock.

Unexpected events (e.g. input price rise) causing the short-run aggregate supply curve to shift.

Explain: adjustments in previous errors in predictions of the price-level will shift the short-run aggregate supply.

As firms adjust to correct previous predictions, they will need a different price to sustain the same purchasing power, thus the same level of real GDP.

In the context of the ADAS model, when can the economy operate at potential GDP?

When the macroeconomic equilibrium occurs at a point along the long-run aggregate supply curve.

Define: automatic mechanism (ADAS).

The process of the adjustment back of the macroeconomic equilibrium to the potential GDP without any actions taken by the government.

Explain: what is a way a recession will revert back to potential GDP?

Due to deflation in a recession, wages will decrease as workers are more accepting of lower pay. This causes firms to supply more because of lower prices of inputs.

In the long-run, what is the end effect of a n increase in the aggregate demand?

A change in price level. A shift to the left will cause deflation and vice versa.

Define: stagflation. What can cause it?

A combination of a recession and inflation. This can be caused by supply shocks causing the short-run aggregate supply to shift to the left.

According to to the ADAS model, what is the cause of most inflation?

When spending (AD) is growing faster than production (AS).

If the exchange rate rises, what does it imply regarding currency strength and the aggregate demand?

The local currency is stronger relative to others. This causes imports to increase as a result of cheaper prices, which shifts AD to the left from lower net exports.

In general, what is the most common cause for a shift in aggregate supply? Why?

The expected inflation rate and adjustments back to it to preserve purchasing power. This is because the aggregate supply is determined by the prices of inputs (i.e. wages).

If there is a supply shock, what will happen that causes demand and supply to revert back to equilibrium?

As unemployment increases, workers will be willing to accept lower nominal wages and firms are willing to accept lower prices. Hence, SRAS shifts to the right.

If actual output is less than potential and the price level is higher than previous equilibrium, what does it imply regarding the SRAS and SRAD?

What if it were lower?

SRAS decreased while SRAD increased.

SRAD decreased while SRAS increased.

Use graph.