ch. 33

In 1939, with the US economy no recovered from the Depression, President Roosevelt said Thanksgiving would fall a week earlier than usual so that the shopping period before Christmas would be longer. Explain what he might have been trying to achieve.

He wanted to increase aggregate demand. This couldve increased output back to its long-run equilibrium level,. graph is the same except AD has shifted right

explain why this is false: the long run aggregate supply curve is vertical because economic forces do not affect long run aggregate supply

economic forces of various kinds do affect long run ag-supply. the LRAS curve is vertical because price level doesn't affect it.

shift in the short-run aggregate supply curve

events that alter the eocnomy's ability to produce output, such as changes in labor, capital, natural resources, or technology. these may also shift the long run curve as well. position of the short run aggregate supply curve depends on the expected price level.

economy is in long run equilibrium but then stock market collapse leads to a leftward shift of ag-demand. the equilibrium level of output and price level will fall. sticky wage theory says

if nominal wages are unchanged as the price level falls, firms will be required to cut back on employment and production. overtime as expectations adjust, short run ag-supply curve will shift to the right, moving the economy back to the natural rate of output.

money has real effects in the short run but is neutral in the long run

in the LR, increase in money supply causes an increase in nominal wage but leaves real wage unchanged.

long run aggregate supply curve is vertical

in the long run, quantity of goods and services supplied depends on the economy's labor, capital, natural resources, and technology but not on the overall level of prices.

US experiences a wave of immigration

increase in labor supply, long run ag-supply shifts to the right

The economy begins in long run equilibrium. President appoints a new chairman of the Federal Reserve. This new chairman is well known for his view that inflation is not a major problem for an economy. Was this new chairman a good appointment?

no, his opinion regarding inflation leads to a worse problem of stagflation (inflation coupled with low output)

Explain whether each of the following events shifts the SRAS,AD,both or neither. florida orange groves suffer a prolonged period of below freezing temperatures

reduced AS in short run and long run. LRAS shifts left as does AS.

cause of economic fluctuations

shift in aggregate demand. when it shifts to the left, output and prices fall in the short run. overtime, as a change in the expected price level causes wages, prices, and perceptions to adjust, the short run aggregate supply curve shifts to the right. this returns the economy to its natural rate of output at a new, lower price level.

second cause of economic fluctuations

shift in aggregate supply. when short run ag-sup shifts left the effect is falling output and rising prices--a combo called stagflation. overtime, as wages, prices adjust, short run ag-sup shift back to the right and returns the price level and output to original levels

model of aggregate demand and aggregate supply

the model most used to explain short run fluctuations in economic activity around its long-run trend

natural rate of output

the production of goods and services that an economy achieves in the long run when unemployment is at its normal rate

Congress raises the minimum wage to $10/hr

there would be a natural rate of unemployment, so LRAS shifts left

explain why this is false: if firms adjusted their prices every day then the short run ag-supply curve would be horizontal

this would make the short run ag supply curve vertical, not horizontal. SRAS would only be horizontal if prices were completely fixed

Suppose the fed expands the money supply but b/c the public expects this fed action, it simultaneously raises its expectation of the price level. what will happen to output and the price level in the short run? compare this result to the outcome if the fed expanded the money supply but the public didn't change its expectation of the price level.

1. the AD would shift right. SRAS shfits left. intersection of the new curve shifts equilibrium where there is no change in the output level but a change takes place in the price level (price increases) 2. there would be no change in AS, equilibrium would shift and Q and P would both increase

aggregate demand curve slopes downward

1. wealth effect: a lower price level raises the real value of households' money holdings (stimulates consumer spending) 2. interest rate effect: lower price level reduces the quantity of money households demand (households try to convert money into interest-bearing assets, interest rates fall, stimulates investment spending) 3. exchange-rate effect: a lower price level reduces interest rates, the dollar depreciates in the market for foreign currency exchange, stimulating net exports.

economy A: workers agree on nominal wages. economy B: half of the workers have nominal awge contracts, the other half ahve indexed employment contracts so their wages rise and fall automatically w/ the price level. according to sticky wage theory of AS, which economy has a more steeply sloped SRAS curve? in which economy would a 5% increase in the money supply have a larger impact on output? in which economy would it have a larger impact on the price level?

1.stickiness of behavior of nominal wages is attributed to long term contacts between workers and firms that fix nominal wages; thus determine the slope of the as curve. 2. economy B will have a steep slope. 3. in the SR 5% increase shift AD curve to right b/c money supply is one of the determinants of aggregate demand. increase in money supply will have larger impact on output than price levels in economy A because nominal wages are sticky. it has a larger impact on price levels in economy B where nominal wages are not sticky and immediately respond to a price change.

if the central bank raises the money supply by 5%; what happens to output and price level as the economy moves from the initial to the new short-run equilibrium

AD will shift right. In the short run, there is an increase in output and the price level and the demand and supply curves intersect.

suppose economy is in long run equilibrium: what is the initial equilibrium. include short run and long run ag-supply

LRAS is vertical. AD1 is farther left than AD 2 and AS1 is farther right than AS 2

economy is in long run equilibrium, draw a diagram to illustrate the state of the economy.

LRAS--vertical AD--slopes down left to right SRAD--slopes up left to right

Diagram of aggregate demand, short run aggregate supply, and long run aggregate supply.

LRAS--vertical AD--slopes down left to right SRAD--slopes up left to right y axis- price level x axis-quantity of output

after this :if the central bank raises the money supply by 5%; what happens to output and price level as the economy moves from the initial to the new short-run equilibrium; what is the new long run equilibrium?

Nominal wages, prices,and perceptions will result in a new price level, this shifts the short run aggregate supply curve towards left.

for each event, explain the short run and long run effects on output and price level, assuming policy makers take no action. federal government increases spending on national defense

SR: AD shifts right. E also shifts right and price and output level are increased LR:expected price level adjusts, short run as-sup shifts left. this shifts E up. this corresponds to a still lower price and level of output reduces to be equal to the original level of output

for each event, explain the short run and long run effects on output and price level, assuming policy makers take no action. technological improvement raise productivity

SR: AS shifts right. economy has reduced price level and increase level of output LR: long run AS shifts right, SRAS shift towards right. output levl increases and price level falls

for each event, explain the short run and long run effects on output and price level, assuming policy makers take no action. stock market declines sharply, reducing consumers' wealth

SR: ad shifts left and economy's equil shifts left. price level and output level are reduced LR: expected price level adjusts, SR AS shifts right. this shifts equilibrium to a still lower price but corresponds to the original level of employment

for each event, explain the short run and long run effects on output and price level, assuming policy makers take no action. a recession overseas causes foreigners to buy fewer U.S. goods

SR: ad will reduce causing a reduce price level and reduced level of output. an external shock and persists for SR only

economy is in long run equilibrium but then stock market collapse leads to a leftward shift of ag-demand. the equilibrium level of output and price level will fall.

SRAS shift right and AD shift left. Here the quantity of output is less than the natural rate of output, the unemployment rate will rise above the natural rate of unemployment. The output may increase the level of quantity

aggregate supply curve

a curve that shows the quantity of goods and services that firms choose to produce and sell at each price level

aggregate demand curve

a curve that shows the quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level

stagflation

a period of falling output and rising prices

depression

a severe recession

short run economic fluctuations

all societies experience short run economic fluctuations around long run trends. They're regular and unpredictable . when recessions occur, real GDP and other measures of income, spending, and production fall, and unemployment rises.

explain why this is false: whenever the economy enters a recession, its long run aggregate supply curve shifts to the left

an economy could enter a recession if either the ag-demand curve or the SRAS curve shifts to the left

increase in aggregate demand

any event/policy that raises consumption, investment, government purchases, or net exports at a given price level increases aggregate demand.

classical economic theory

based on the assumption that nominal variables such as the money supply and price level do not influence real variables such as output and employment. accurate in the long run bt not short run. short run fluctuations analyzed with aggregate demand & supply. according to this model, the output of g+s and overall level of prices adjust to balance aggregate demand & supply.

A severe hurricane damages factories along the East Coast

capital stock is smaller so LRAS declines and shifts left.

Explain whether each of the following events shifts the SRAS,AD,both or neither. increased job opportunities overseas cause many people to leave the country

causes AS to decline in SR and LR. this is because less people will be available to produce output. AD will also fall because fewer people will consume g+s

The economy begins in long run equilibrium. President appoints a new chairman of the Federal Reserve. This new chairman is well known for his view that inflation is not a major problem for an economy. if workers demand more nominal wages how would the profitability of producing g+s at any given price level be affected?

demand for higher nominal wages by workers increases the cost of production for the firms; thus reduces profitability

Explain whether each of the following events shifts the SRAS,AD,both or neither. households decide to save a larger share of their income

increased saving reduces expenditures on consumer goood, AD shifts left

aggregate demand curve shifts left

inverse relationship between quantity demanded and its price. fall in price increases quantity demanded in the economy. shifts in ag-demand occurs due to response of the aggregate demand for changes in factors other than price level 1. less consumption spending: people spend less on consumption at a given price due to a tax hike or stock market decline 2. less investment spending: people spend less on investments at a given price due to pessimism about future rise in interest rate, high taxes on investment returns, 3. decreased gov spending: when gove reduces spending on goods and services due to a defense cutback 4. reduced spending on net exports: event s like an oversea recession or exchange rate appreciation that reduces spending on net exports When ag-demand curve shifts to the left, equilibrium price and quantity falls

Suppose firms become very optimistic about future business conditions and invest heavily in new capital equipment. how might the invstment boom affect the LRAS curve?

it increases b/c an increase in the capital investment in the present increases the capital stock in the future. an increased capital stock leads to increased produtivity and increased level of output.

The economy begins in long run equilibrium. President appoints a new chairman of the Federal Reserve. This new chairman is well known for his view that inflation is not a major problem for an economy. how would this news affect the price level that people would expect to prevail?

people expect price level to rise

recession

period of declining real incomes and rising unemployment

The economy begins in long run equilibrium. President appoints a new chairman of the Federal Reserve. This new chairman is well known for his view that inflation is not a major problem for an economy. if AD is held constant, how does the left shift in AS curve affect the price level and quantity of output produced?

price level increases and output level reduces

Intel invents a new and more powerful computer chip

productivity increases, LRAS shifts right.

two macroeconomic variables that decline when the economy goes into a recession

real GDP, and investment spending. as the economy faces recession, there would be a fall in the value of money resulting in less investment. this results in the decline of real gdp.

The economy begins in long run equilibrium. President appoints a new chairman of the Federal Reserve. This new chairman is well known for his view that inflation is not a major problem for an economy. how would a decrease in profitability affect the SRAS?

reduces level of profitability shifts the AS curve to the left

For each of the 3 theories for the upward slope of the SRAS, explain the following: how the economy recovers from a recession and returns to its long run equil w/o any policy intervention and what determines the speed of that recovery

sticky wage:over time, as nominal wages are adjusted so that real wages decline, the economy returns to full employment. sticky price: over time, firms are able to adjust their prices more fully and the economy returns to the LRAS misperceptions: over time as people observe the lower price level, their expectations adjust, and the economy returns to the LRAS the speed of the recovery in each theory depends on how quickly price expectations, wages, and prices adjust

Suppose firms become very optimistic about future business conditions and invest heavily in new capital equipment explain why AQ of output demanded changes between the SR and the LR

the AQ of output demanded will decrease for a rise in price level. Demand changes between the short run and long run b/c in the SR shifts in aggregate demand causes fluctuations in the economy's output of g+s, but in the LR, the shift in aggregate demand is reflected fully in the price level and do not effect output.

explain why this is false ag-demand curve slope downward because it is the horizontal sum of the demand curves for individual goods

the ag-demand curve slopes downward because a fall in the price level raises the overall quantity of goods and services demanded through the wealth effect, the interest-rate effect, and the exchange rate effect.

short-run aggregate supply curve slopes upward

three theories: 1. sticky-wage theory:unexpected fall in the price level temporarily raises real wages which induces firms to reduce employment and production. 2. sticky price theory: an unexpected fall in the price level leaves some firms with prices that are temporarily too high, which reduces their sales and causes them to cut back production 3. misperceptions theory: unexpected fall in the price level leads suppliers to mistakenly beleive that their relative prices have falle, which induces them to reduce production. all theories imply that output deviates from its natural rate when the actual price level deviates from the price level that people expected

one macroeconomic variable that rises during a recession

unemployment rate. the fall in investment resulting in the fall of production.

Suppose firms become very optimistic about future business conditions and invest heavily in new capital equipment draw an AD/AS diagram to show the SR effect of this optimism. explain why AQ of output supplied changes

when firms invest more in new capital equipment, the ad curve shift the orignal curve right. it results in a higher price and higher level of output. AQ of output supplied will increase b/c of the people's misconception that prices are sticky and it will not adjust.

The economy begins in long run equilibrium. President appoints a new chairman of the Federal Reserve. This new chairman is well known for his view that inflation is not a major problem for an economy. how would an increase in expected price level affect the nominal wage that workers and firms agree to in their new labor contracts?

workers start demanding more nominal wages from the firms to face the heat of inflation