econ 2105 Exam 2 Key Notes

Inflation involves

a decline in the value or "purchasing power" of currency. >This causes all dollar-denominated measures, not only prices but also incomes to increase.

An increase in spending creates ..

a direct effect and generates multiple rounds of additional increases on spending.

GDP deflator might include (......)

a larger set of goods and services compate to CPI.

Inflation does not usually (.....)

affect an individual's ability to buy things.

If price level increases, it does not mean that

all prices are increasing.

CPI can include the (......) While in GDP we might have (....)

imported goods. capital goods.

If actual inflation ends up being lower than expectation, then ex ante real interest rate is

higher than the ex post real interest rate: borrowers lose, lenders win

Higher profits allow firms to produce (more or less)

more

Anytime there are increasing aggregate prices, firms tend to produce (more or less) because...

more; because they have limited increase in cost of production (wages are slow to adjust to changing prices) but huge revenue increases

The aggregate demand (AD) curve is (.....) sloped. since the aggregate price level is (....)

negatively; inversely related to the quantity of aggregate output demanded.

In the construction of CPI, we have to (.......). and should assume that

set a fixed basket of goods and services. Every year a typical urban consumer will consume the same items at the same weights.

GDP deflator and CPI does not give the same inflation rate, because

they are not measuring the same thing.

In order for dollar values from different time periods to be comparable, the (....)

values must be converted to the same year's dollar values. >Otherwise, it is simply like comparing apples to oranges.

An increase in aggregate demand is shown by

the rightward shift of the aggregate demand curve.

*Tip to remember short run* Life is so short that we don't have enough time in the factor markets to keep up with the changing prices.

...

At the fully flexible economy, potential output = actual output

...

LRAS curve is vertical: and there is no relationship between the aggregate price level and potential output.

...

LRAS curve tells us the potentia output

...

The aggregate supply curve behaves differently in the short run than in the long run

...

There is a difference between potential output and actual output

...

Four simplifying Assumptions:

1. Producers are willing to supply additional output at a fixed price. 2. The interest rate is given. 3. There is no government spending or taxes. 4. Exports and imports are zero.

Price index takes the value of (....) at the base yeaer for both the CPI and GDP deflator or for any index

100

What are the major supply shocks (supply shifters) in the short run

>wages, >commodity prices, >temporary changes in the availability of factors of production >changes in taxes on corporation, >changes in regulation >changes in labor productivity

If the cost of production decreases or if there is an increase in the productivity, the overall production increases in the short run.

A shift occurs on the SRAS curver

The aggregate demand curve shifts when: (5 things)

A. There is a change in firm or consumer expectations. B. There is a change in wealth. C. Firms feel a need to change the size of the existing stock of physical capital. D.There is a change in fiscal policy. E. There is a change in monetary policy.

An increase in production cost will lead firms to (increase or decrease) their production if they are price-taker.

Decrease; they can only reduce their level or production, they will downsize the firm.

Aggregate supply (increases or decreases) with increasing factor prices.

Decreases; leftward shift on the SRAS curve.

In the CPI, both in the numerator and denominator we have the (....)

base yeaer quantites of goods and services.

If the actual inflation rate is higher than expected

borrowers gain at the expense of lenders

While in the GDP deflator, we have the (......)

current year production of goods and services.

An increase in CPI means (....). Because, we need to

cost of living is going up. Pay more to get to get the same amount of goods and service.

When the inflation rate drops from 10% to 5% the economy is undergoing

disinflation

In the long run,the factor market will have enough time to adjust their prices to inflation; as a result firms

do not change their level of production when they face higher aggregate price level in the economy.

Potential output is

determined by factors such as availability of labor, capital, land and other natural resources, human capital and the level of technology.

To measure the inflation rate based on CPI, calculating the percentage change in the cost of market basket would give you the (.........) that would be measured from calculating the percentage change in the price index.

exact inflation rate

Actual output

fluctuates in response to aggregate demand

Fiscal policy affects aggregate demand (directly or indirectly) through

government purchases, and indirectly through changes in taxes or government transfers.

Production cost (increases or decreases) with increasing factor prices, such as nominal wages, rents, interest rates, etc.

increases

Due to sticky factor prices (wages, rents, etc.) in the short run,firms can make profit with (increasing or decreasing aggregate price level?)...

increasing aggregate price level so they produce more when the aggregate price level increases.

Monetary policy affects aggregate demand (directly or indirectly?)

indirectly through changes in the quantity of money in circulation

If aggregate price level rises, what happens to the overall production in the short run?

it increases.

If the actual inflation rate is lower than expected

lenders will gain at the expense of borrowers

if actual inflation rate ends up being higher than expectation, then ex ante real interest rate is

lower than the ex post real interest rate: borrowers win, lenders lose.

Potential output is

the economy's capacity to produce, as determined by the size and productivity of the labor force

The wealth effect of a change in the aggregate price level is

the effect on consumer spending caused by the effect of a change in the aggregate price level on the purchasing power of consumers' assets.

The next export (trade or the exchange rate) effect of a change in the aggregate price level is

the effect on exports and imports caused by the change in the relative price of foreign goods in terms of domestic goods.

The interest rate effect of a change in the aggregate price level is

the effect on investment spending and consumer spending caused by the effect of a change in the aggregate price level on the purchasing power of consumers' and firms' money holdings.

SRAS curve is upward sloping then ...

the higher the aggregate price level, the higher the aggregate output.

Also, some goods prices may be falling even if

the overall prices of goods are going up.

An increase in aggregate demand means that

the quantity of aggregate output demanded increases at any given aggregate price level.

The aggregate demand (AD) curve shows

the relationship between the aggregate price level and the quantity of aggregate output demanded by households, businesses, the government, and the rest of the world.