Econ: Ch. 33

What occurred as the U.S. economy experienced increasing real GDP in 1950?

- The unemployment rate declined - Consumer spending increased

to increase aggregate supply...

- decrease input prices -- higher input costs increase the cost of production, causing firms to supply a lower quantity of aggregate output at each price level - improve human capital -- improving the knowledge and skills embodied in the workforce enhances productivity (output per hour of labor) - decrease burdensome regulations -- increases the cost of producing output, so reducing burdensome regulations will lower input costs for firms since they'll have fewer regulation compliance costs

Fed doubles the growth rate of the quantity of money in the economy. In the long run, the increase in money growth will change...

- the price level - the inflation rate -- economy's real GDP depends on labor, capital, natural resources, and technological knowledge -- long-run level of output not influenced by changes in money because real and nominal variables are separate and only nominal prices are impacted, not production (monetary neutrality)

to decrease aggregate demand...

- worsen consumer expectations -- if households expect weak economic growth and stagnant or falling earnings, they will spend less today - decrease government spending - increase interest rates -- higher interest rates raise the cost of borrowing and discourage business investment - appreciate the value of the domestic currency relative to the foreign currency -- citizens of the domestic country will find foreign goods less expensive and foreigners will find domestic products more expensive. -- Causes imports to rise and exports to fall which leads to a decrease in net exports (exports - imports)

interest rate effect

As the price level falls, the cost of borrowing money will fall, causing the quantity of output demanded to rise. - as a result business investment speeds up, leading to increased demand for domestic output and also consumer spending because people will want to save less

exchange rate effect

As the price level falls, the impact on the domestic interest rate will cause the real value of the dollar to fall in foreign exchange markets. - number of domestic products purchased by foreigners (exports) will rise, the number of foreign products purchased by domestic consumers and firms (imports) will fall. - when each dollar buys fewer units of foreign currencies, foreign goods become more expensive than domestic goods; foreigners find domestic goods to be cheap because of dollar depreciation - net exports will rise, causing the quantity of domestic output demanded to rise

sticky-wage theory

Asserts that the output prices adjust more quickly to changes in the price level than wages because of long-term wage contracts - according to this, the economy is in a recession because the price level has declined so that real wages are too high, so labor demand is too low; the economy is in a recession because not all prices adjust quickly - the SRAS slopes upward because nominal wages are slow to adjust to economic conditions - if price level higher than what firms and workers thought when wage contracts negotiated, output prices will rise even as wages remain fixed at the agreed-upon level; as firms see output prices rise faster than input prices, their profits rise which motivates them to increase production - of AS, nominal wages at initial equilibrium = nominal wages at SR equilibrium and < nominal wages at LR equilibrium; real wages at initial equilibrium > nominal wages at SR equilibrium and = nominal wages at LR equilibrium

accommodative policy

Government pursues this by increasing government purchases in response to the SR economic impact of higher price levels - shifts AD to the right in response to SRAS - government accepting a permanently higher price level in order to return the economy to the natural rate of output and the natural rate of unemployment - in LR price level rises and quantity of output return to natural rate of output

John Maynard Keynes

The idea that economic downturns result from an inadequate aggregate demand for goods and services is derived from his work. - believed that recessions and depressions can occur because of inadequate AD so he advocated polices to increase aggregate demand during times of recession

classical dichotomy

The separation of real variables and nominal variables. - an increase in money supply, a nominal variable, will cause the price level, a nominal variable, to increase but will have a long-run effect on the quantity of goods and services the economy can produce, a real variable

aggregate-supply curve

a curve that shows the quantity of goods and services that firms choose to produce and sell at each price level - changes in the expected price level shifts SRAS - LRAS increases when immigration increases - LRAS decreases when minimum wage increases - LRAS increases when new tech - LRAS decreases when natural disaster

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 - slopes downward because a fall in the price level raises the overall quantity of goods and services demanded through the wealth effect, interest-rate effect, and the exchange-rate effect - in SR, increase in foreign spending on domestic goods associated with expansion abroad causes AD to shift right, resulting in a higher price level that exceeds the natural rate of output which makes the unemployment rate fall below the natural rate of unemployment -- transition from SR to LR leads to public's expectations to adjust to higher levels, it becomes more costly for firms to hire workers and buy inputs, leads to cut production at any price level, leads to SRAS to shift left, in LR higher price level but output returns to natural rate of output and unemployment returns to natural unemployment rate - crash in the stock market shifts AD to the left - increase in AD for goods and services has a larger impact on output in the SR and larger impact on the price level in the LR

stagflation

a period of falling output and rising prices - combination of stagnation (falling output) and inflation (rising prices) - SR economic outcome resulting from the increase in production costs - the increase in costs makes the sale of goods and services less profitable so firms reduce the quantity of output they supply at each price level, causing the SRAS to shift left and decrease the output in the SR, output falls below the natural rate of output and the price level increases - caused by a leftward shift in AS

depression

a severe recession

recall real GDP

measures economy's total output and total income simultaneously - decrease in real GDP => declining total income, personal income, and falling corporate profits

quantity of output supplied

natural rate of output + a X (actual price level - expected price level) - where a is a number that determines how much output responds to unexpected changes in the price level -- SR quantity of output supplied by firms will rise above the natural rate of output when the actual price level rises above the price level that people expected

expansion

periods where most businesses do well - economic fluctuations correspond closely to business conditions - unemployment rate tends to fall as firms expand production and hire additional workers

Suppose the government passes a law that significantly increases the minimum wage. The policy will cause the natural rate of unemployment to rise, which will...

shift the long-run aggregate supply curve to the left - LRAS curve depends on the natural rate of unemployment -- sharp increase in the minimum wage will increase structural unemployment, thereby raising the natural rate of unemployment and reducing the economy's productive potential --- LRAS shifts right if the government allows more immigration of working-age adults ---- increases the labor force and the economy's productive potential --- LRAS shifts left if government requires that the country's nuclear power plants be permanently shut down for environmental and safety reasons ---- similar to a reduction in technological knowledge or a reduction in natural resources, ban reduces the economy's productive potential --- LRAS shifts left if a natural disaster destroys a significant amount of the economy's production facilities ---- reduces the economy's stock of physical capital such as factories, plants, office buildings, and heavy machinery

the business cycles

short-run fluctuations in real GDP - real GDP trends upward over time but experiences ups and downs in the short run - not a regular cycle

model of aggregate demand and aggregate supply

the model that most economists use to explain short-run fluctuations in economic activity around its long-run trend - vertical axis measures the overall price level

natural level of output

the production of goods and services that an economy achieves in the long run when unemployment is at its normal rate - the long-run aggregate supply curve is a vertical line at the economy's natural rate of output because the price level has no bearing on the economy's long-run level of real output

recession

a period of declining real incomes and rising unemployment - recessions may occur close together or far apart - output tends to rise and fall at different rates over time - as incomes decline during a recession, so does consumer spending on retail goods and services and on durable goods, such as automobiles. - Households contribute declining investment by purchasing less new homes, leads to firms cutting back on industrial production and curb investment expenditures on physical capital - unemployment rate rises as firms cut back on production and lay off workers - Real GDP falls, and unemployment rises - enter recession if either AD or SRAS shift to the left - according to the misperceptions theory, the economy is in a recession when the price level is below what was expected