Study your flashcards anywhere!

Download the official Cram app for free >

  • Shuffle
    Toggle On
    Toggle Off
  • Alphabetize
    Toggle On
    Toggle Off
  • Front First
    Toggle On
    Toggle Off
  • Both Sides
    Toggle On
    Toggle Off
  • Read
    Toggle On
    Toggle Off
Reading...
Front

How to study your flashcards.

Right/Left arrow keys: Navigate between flashcards.right arrow keyleft arrow key

Up/Down arrow keys: Flip the card between the front and back.down keyup key

H key: Show hint (3rd side).h key

A key: Read text to speech.a key

image

Play button

image

Play button

image

Progress

1/64

Click to flip

64 Cards in this Set

  • Front
  • Back
Classical economic theory states what?
Nominal variables such as the money supply and price level do not influence real variable such as output and unemployment.
When is the classical economic theory accurate?
In the long run, not the short run.
What is used to analyze short run economic fluctuations?
The model of aggregate demand and aggregate supply.
According to the model of aggregate demand and aggregate supply...
the output of goods and services and the overall level of prices adjust to balance aggregate demand and aggregate supply.
What are the three reasons the aggregate demand curve slopes downward?
1. The wealth effect
2. The interest-rate effect
3. The exchange-rate effect
What is the wealth effect?
A lower price level raises the real value of households' money holdings, which stimulates consumer spending.
What is the interest-rate effect?
-A lower price level reduces the quantity of money households demand.
-As households try to convert money into interest-bearing assets, interest rates fall.
-This stimulates investment spending.
What is the exchange-rate effect?
-A lower price level reduces interest rates
-The dollar depreciates in the market for foreign-currency exchange
-Thus stimulating net exports
What events or policies increase aggregate demand?
Ones that raise:
-consumption
-investment
-government purchases
-net exports
-(GDP)
How is the long run aggregate supply curve shaped? Why?
-vertical
-long run quantity of supply does not depend on overall price levels
What affects long run aggregate supply?
the economy's:
-labor
-capital
-natural resources
-technology
What shape is the aggregate demand curve?
downward sloping
What three theories attempt to explain the upward sloping short-run aggregate supply curve?
1. Sticky-wage theory
2. Sticky-price theory
3. Misperceptions theory
What is the sticky-wage theory?
What does it attempt to explain?
1. -An unexpected fall in the price level temporarily raises real wages
-this induces firms to reduce employment and production
2. The upward slope of the short-run aggregate supply curve.
What is the sticky-price theory?
1. -An unexpected fall in the price level leaves some firms with prices that are temporarily too high
-This reduces their sales and causes them to cut back production.
What is the misperceptions theory?
-An unexplained fall in the price level leads suppliers to mistakenly believe their relative prices have fallen
-This induces them to reduce production.
What do all three theories on the upward slope of aggregate supply imply?
Output deviates from its natural rate when the actual price level deviates from the price level that people expected.
What events alter an economy's ability to produce output?
-labor
-capital
-resources
-technology
What two things shift the short-run aggregate supply curve?
1. Events that alter the economy's ability to produce output
2. The expected price level
What are two possible cause of economic fluctuations?
-A shift in aggregate demand.
-A shift in aggregate supply.
What happens when the aggregate demand curve shifts to the left? How does this affect the aggregate supply curve in the short run? Why?
-output and prices fall in the short-run.
-The aggregate supply curve shifts to the right
-a change in the expected price level causes wages, prices, and perceptions to adjust.
What effect has the short-run aggregate supply curve shifting to the left? What is this called?
-Falling output and rising prices.
-Stagflation
Who developed the theory of liquidity preference?
Keynes
What is the theory of liquidity preference?
The interest rate adjusts to balance the supply and demand for money.
How does an increase in the overall price level affect the money demand and interest rates?
it raises money demand and increases the interest rate that brings the money market into equilibrium.
What does the interest rate represent?
The cost of borrowing
What does a rising interest rate cause?
A reduction in investment and the quantity of goods and services demanded
What does the downward sloping aggregate demand curve express?
The negative relationship between the price level and the quantity of output.
What are two ways that policy makers can influence aggregate demand?
Fiscal and Monetary policy
What is the effect of an increase in the money supply on the interest rate, investment spending, and aggregate demand?
-Reduction of the equilibrium interest rate for any given price level.
-Lower interest rate stimulates investment spending.
-Aggregate demand curve shifts to the right.
What is the cause of a lower interest rate?
an increase in investment spending
What is the effect of a decrease in the money supply on interest rates and demand?
-Increase in the equilibrium interest rate for any given price level
-Shifts aggregate demand curve to the left.
What are two ways the government can use fiscal policy?
-Government spending
-Taxes
What is the effect of an increase in government purchases on aggregate demand?
Aggregate demand curve shifts to the right
What is the effect of an increase in taxes on aggregate demand?
Aggregate demand curve shifts to the left
What is the effect of a decrease in government purchases on aggregate demand?
Aggregate demand curve shifts to the left
What is the effect of a decrease in taxes on aggregate demand?
Aggregate demand curve shifts to the right
What amplifies the effects of fiscal policy on aggregate demand?
The multiplier effect
What dampens the effects of fiscal policy on aggregate demand?
The crowding-out effect
What two things cause fiscal policy to not have an exact impact on aggregate demand?
1. The multiplier effect
2. The crowding-out effect
What are the beliefs of advocates of active stabilization policy?
-changes in attitudes of households and firms shift aggregate demand
-if the gov't does not respond the result is undesirable and unnecessary fluctuations in output and employment
WHat are the beliefs of critics of active stabilization policy?
Monetary and fiscal policy work with such long lags that attempts to stabilize the economy often end up in destabilization.
What is the multiplier effect?
The additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending
What is the crowding out effect?
The offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending
What is an automatic stabilizer?
a change in fiscal policy that stimulates aggregate demand when the economy goes into a recession without policy makers having to take deliberate action
What is the most important automatic stabilizer? Why?
-The tax system
-Taxes collected in a recession fall because they are almost all tied to economic activity
What does the Phillips curve describe?
A negative relationship between inflation and unemployment.
What does an expansion of aggregate demand by policy makers cause in regards to the Phillips curve?
Higher inflation and lower unemployment.
When does the trade-off between inflation and unemployment in the Phillips curve hold true?
Only in the short-run
What does the Phillips curve look like in the long run and at what rate? Why?
-It is vertical at the natural rate of unemployment.
-In the long run expected inflation adjusts to actual inflation causing the short-run Phillips curve to shift.
What are three causes of shifts in the short-run Phillips curve?
1. Expected inflation adjusting to actual inflation
2. Shocks in aggregate supply
3. Policies that cause changes in aggregate demand.
What does an adverse supply shock cause in regards to the Phillips curve? Which way does it shift?
-A less favorable trade-off between inflation and unemployment.
-It shifts to the right.
What happens when the fed contracts growth in the money supply in regards to the short-run Phillips curve?
Lower inflation and higher unemployment.
What effect does an increase in aggregate demand have on the Phillips curve?
Higher inflation rate and lower unemployment.
What effect does a decrease in aggregate demand have on the Phillips curve?
Lower inflation and higher unemployment
What are the labels for the X and Y axes of aggregate demand and aggregate supply?
X - Quantity of Output
Y - Price Level
What are the labels for the X and Y axes of the Phillips curve?
X - Unemployment rate
Y - Inflation rate
Why is it called the "natural" rate of unemployment?
It is beyond the influence of monetary policy
What is the natural rate of unemployment?
The rate of unemployment at which the economy gravitates to in the long run
What is the equation for the Phillips curve?
Unemployment rate = Natural rate of unemployment - (actual inflation - expected inflation)
How does a higher expected inflation rate shift the Phillips curve?
It shifts to the right.
What is the sacrifice ratio?
the number of percentage points of annual output lost in the process of reducing inflation by 1 percentage point
What is the theory of rational expectations?
the theory that people optimally use all the information they have, including information about government policies, when forecasting the future.
How do advocates of active monetary and fiscal policy view the economy?
Inherently unstable