ECON 2 ch 33

In the long run, an increase in money growth

will change: price level and the inflation rate. the economy's long-run potential output will not change

rising price level

If the price level rises, people will need more money to carry out day-to-day transactions. As people demand more money, the cost of borrowing money—the interest rate—will rise (assuming that the quantity of money in the economy is fixed). As a result, business investment slows, leading to a decreased demand for domestic output. This is known as the interest rate effect of a change in the price level. So, at a higher interest rate, business investment decreases and household saving increases, leading to a decreased demand for domestic output.

sticky price theory

If true price level is above a firm's forecast level, the firm's products will be relatively cheap and producers will "oversupply" these products. if true price level is below a firm's forecast level, the firm is relatively expensive and a firm will produce relatively little. Firms may take a small economic profit loss if cheaper than "reprinting menus"

short-run impact of economic prosperity abroad

In the short run, the increase in foreign spending on domestic goods associated with expansion abroad causes the aggregate demand curve to shift to the right, resulting in a higher-than-expected price level and a quantity of output that exceeds the natural level of output. The increase in production causes firms to hire more workers, so the unemployment rate will fall below the natural rate of unemployment.

fluctuations

Most macroeconomic quantities fluctuate together. A decrease in real GDP, coincides with declining total income, declining personal income, and falling corporate profits. As incomes decline during a recession, so, too, does consumer spending on retail goods and services and on durable goods, such as automobiles. As households spend less on products, firms cut back on industrial production and curb investment expenditures on physical capital. The unemployment rate tends to rise during periods of falling real GDP as firms cut back on production and lay off workers. The unemployment rate tends to fall during economic expansions as firms expand production and hire additional workers.

Quantity of Output Supplied =

Natural Level of Output+α×(Price LevelActual−Price LevelExpected) α represents a number that determines how much output responds to unexpected changes in the price level.

stagflation

The combination of stagnation (falling output) and inflation (rising prices) higher oil prices increase costs and makes the sale of goods and services less profitable, so firms reduce the quantity of output they supply at each price level, causing the short-run aggregate supply curve to shift leftward and decreasing output in the short run. Output falls below the natural level of output, and the price level increases.

long-run impact of economic prosperity abroad

The increase in foreign spending on domestic goods associated with expansion abroad shifts the aggregate demand curve rightward in the short run, resulting in a higher-than-expected price level and output. During the transition from the short run to the long run, the public's price-level expectations will begin to adjust to higher levels. As higher price-level expectations work their way into price and wage contracts, it becomes more costly for firms to hire workers and buy inputs. Consequently, they will cut production at any price level. This is reflected in a leftward shift of the short-run aggregate supply curve (AS). In the long run, the increase in foreign spending on domestic goods associated with expansion abroad results in a higher price level but output returns to the natural level of output and unemployment returns to the natural rate of unemployment.

short run aggregate supply curve

The short-run quantity of output supplied by firms will fall below the natural level of output when the actual price level falls below the price level that people expected.

long-run aggregate supply curve

a vertical line at the economy's natural rate of output. the money supply and the price level—nominal variables—have no impact on the quantity of goods and services—a real variable—that the economy produces in the long run. The natural rate of output is the level of output consistent with the economy's natural unemployment rate. increase of the minimum wage will cause the natural rate of unemployment to rise and the supply curve will shift to the left

misperception theory

holds that sellers see their own product's prices as separate from average price of products If their own product's price goes up, they respond to higher Marginal Revenue with increased production, neglecting fact that the price of consumption goods they want to buy is higher If their own product's price is low, believe MR of their product is low, so decrease production

things that shift the long run aggregate supply curve

if the size of the labor force contracts, the economy's productive potential declines. The lras curve shifts to the left. improvement in technology shifts right. improving skill of labor force shifts right

short run

real and nominal variables are intertwined. horizontal axis measures quantity of output (real) vertical axis measures price level (nominal) The demand curve shows the quantity of output that the government, consumers, business firms, and foreign customers wish to buy at each price level. The supply curve shows the quantity of output that firms produce and sell at each price level.

change needed to increase aggregate supply

shift curve to the right input prices - decrease human capital - improve burdensome regulations - decrease

accommodative policy

shift the aggregate demand curve to the right in response to a leftward shift of the short-run aggregate supply curve. By pursuing an accommodative policy, the government accepts a permanently higher price level in order to immediately return the economy to the natural level of output and the natural rate of unemployment. In the long run, the price level rises , and the quantity of output returns to the natural level of output

business cycle

short run fluctuations in the real GDP

short run vs long run

short run- variables haven't fully adjusted long run- when the general price level, contractual wage rates, and expectations adjust fully to the state of the economy During the transition from the short run to the long run, price-level expectations will adjust upward and the short-run aggregate supply curve will shift to the left

impact of rising price level on the domestic interest rate

the real value of the dollar torise in foreign exchange markets. The number of domestic products purchased by foreigners (exports) will therefore fall, and the number of foreign products purchased by domestic consumers and firms (imports) will rise. Net exports will therefore fall, causing the quantity of domestic output demanded to fall. This phenomenon is known as the exchange rate effect.

sticky wage theory

the short-run aggregate supply curve slopes upward because nominal wages are slow to adjust to economic conditions. If the price level turns out to be higher than what firms and workers anticipated when they negotiated wage contracts, output prices will rise even as wages remain fixed at the agreed-upon level. As firms see their output prices rise faster than their input prices, their profits rise, which gives them an incentive to increase production. Conversely, if the price level is unexpectedly low, firms will see their output prices fall below expected levels with no change in their labor costs. They will respond by reducing output.

change needed to decrease aggregate demand

wealth - decrease taxes- increase expected rate of return on investment - decrease income in other countries- decrease