MACRO exam 3

leveraging*

Financial leverage refers to the use of debt to acquire additional assets. Financial leverage is also known as trading on equity. Below are two examples to illustrate the use of financial leverage, or simply leverage. https://www.accountingcoach.com/blog/what-is-financial-leverage

Explain the chains of events that cause the aggregate demand curve to be upward sloping according to the sticky-price model.

Following are summaries of the two chains of events that characterize the relationship between the price level and output in the sticky-price model. First, when firms expect a high price level they set their relatively sticky prices high. Other firms follow suit and set their prices high as well. Thus, a high expected price level leads to a high actual price level. When the expected price level is high, producers produce more output. Second, when the level of output is high, the demand for goods and services is also high. When the demand for goods and services is high, the price charged for goods and services is also high. When the price charged for goods and services is high, firms set their relatively sticky prices high. When some firms set their relatively sticky prices high, other firms follow suit. Thus, the overall price level increases.

What happens when the domestic interest rate is lower than foreign interest rates?

Foreign investment shift domestically Domestic investment shifts abroad Domestic investment is unchanged Foreign investment is unchanged answr. Domestic investment shifts abroad

Which of the following sources of purchases is not included in aggregate demand?

Foreigners

What area of aggregate demand would social security fall under?

Government spending

key points of fiscal levers

** In expansionary policy, the extent to which government spending and tax cuts increase aggregate demand depends on spending and tax multipliers. **The tax multiplier is smaller than the spending multiplier. This is because the entire government spending increase goes towards increasing aggregate demand, but only a portion of the increased disposable income (resulting for lower taxes) is consumed. **The multiplier effect of a tax cut can be affected by the size of the tax cut, the marginal propensity to consume, as well as the crowding out effect.

key takeaways on the AS-DS model regarding expansion and contracted policy

**Keynes advocated counter-cyclical fiscal policies -implementing an expansionary fiscal policy during a recession and a contractionary policy during times of rapid economic expansion. **In pursuing either expansionary or contractionary fiscal policy, the government has two levers - government spending and taxation levels. **The effects of fiscal policy can be limited by crowding out.

reaons for shift in AS

**The short-run aggregate supply curve is affected by production costs including taxes, subsides, price of labor (wages), and the price of raw materials. The long-run aggregate supply curve is affected by events that change the potential output of the economy.

2 reasons the money wage rate can change

1. departures from full employment 2. expectations about inflation

multiplier

A ratio used to estimate total economic effect for a variety of economic activities

reason for each curve?

Aggregate DEMAND curve: slopes downward. this means that the price level has dropped, the quantity of output demanded increases

What other curve is required to complete the AS-AD model?

Aggregate supply

When does real GDP = potential GDP?

At full employment

What is an example of an exogenous change in the IS-LM model?

Changes in tastes

What area of aggregate demand would movie tickets fall under?

Consumption

how do we know that aggregate supply is upward sloping in the short run and vertical in the long run?

First, recall from microeconomics that output is a function of capital and labor--the inputs to production. Thus, in the long run, the levels of capital and labor in an economy fix the level of output. The only way to increase output in the long run is to increase the levels of capital and labor. This is called increasing the capital stock--the result of investment--and increasing the labor force--the result of more people working. Therefore, in the long run, the aggregate supply curve is affected only by the levels of capital and labor and not by the price level. Thus, the long run aggregate supply is vertical with respect to the price level.

When the price level is low, what is aggregate demand?

High

complete AS-DS model

In general, any expansionary policy shifts the aggregate demand curve to the right while any contractionary policy shifts the aggregate demand curve to the left. In the long run, though, since long-term aggregate supply is fixed by the factors of production, short-term aggregate supply shifts to the left so that the only effect of a change in aggregate demand is a change in the price level.

What are the short-run and long-run effects of a decrease in aggregate demand?

In the short run, both the price level and output decrease as the new aggregate demand curve meets the short-run aggregate supply curve at a new intersection that is to the lower left of the old intersection. But, as the economy adjusts, the short-run aggregate supply curve shifts until the economy is again in long-run equilibrium at a lower price level with output unchanged.

What are the short-run and long-run effects of an increase in aggregate demand?

In the short run, both the price level and output increase as the new aggregate demand curve meets the short-run aggregate supply curve at a new intersection that is to the upper right of the old intersection. But, as the economy adjusts, the short-run aggregate supply curve shifts until the economy is again in long-run equilibrium at a higher price level with output unchanged.

What are the short-run and long-run effects of a positive supply shock?

In the short run, the price level increases and output decreases, also known as stagflation, as the new short-run aggregate supply curve meets the aggregate demand curve at a new intersection that is to the upper left of the old intersection. But, as the economy adjusts, the aggregate demand curve shifts until the economy is again in long- run equilibrium at a lower price level with output unchanged.

What is the horizontal axis of the IS-LM model?

Income and output

Potential GDP will increase if:

Increase in the full-employment quantity of labor, increase in quantity of capital, an advance in technology

What is the vertical axis of the IS-LM model?

Interest rate

What is the effect of a high price level on interest rates?

Interest rates tend to be high

What are of aggregate demand would new housing fall under?

Investment

When the price level increases, which direction does the LM curve shift?

Inward

Which of the aggregate demand models is based on investment spending?

Keynes model

Which model of aggregate demand is based upon exchange rates?

Mundell-Fleming model

What economic number can be derived from output?

National income

What are of aggregate demand would raw materials shipped to Asia fall under?

Net exports

When the real exchange rate decreases, what happens to net exports?

Net exports rise

What happens when the aggregate demand curve shifts left?

Output decreases at all price levels

What happens when the aggregate demand curve shifts right?

Output increases at all price levels

What is the horizontal axis of the aggregate demand curve?

Output or income

What is the vertical axis of the aggregate demand curve?

Price level

The term NX(e) means that net exports are dependent upon what?

Real exchange rate

The term I(r) means that investment is dependent upon what?

Real interest rate

aggregate demand curve

Recall that the aggregate demand curve relates price level to income and output. The simplest way to derive the downward sloping aggregate demand curve from the IS-LM model is to look at the effects of an increase in the price level on output or income.

Pigou's wealth effect

Recall that the nominal (face) value of money is fixed, but the real value is dependent upon the price level. This is because for a given amount of money, a lower price level provides more purchasing power per unit of currency. When the price level falls, consumers are wealthier, a condition which induces more consumer spending. Thus, a drop in the price level induces consumers to spend more, thereby increasing the aggregate demand.

Explain the chain of events that causes the aggregate demand curve to be upward sloping according to the worker- misperception model.

The chain of events that leads from an increase in the price level to an increase in output in the worker-misperception model: when the price level rises, firms increase nominal wages; when nominal wages increase, workers-- due to misperceptions--believe that real wages also increase; when workers believe that real wages increase, workers provide more labor; when workers provide more labor, output increases.

tax multiplier

The change in aggregate demand caused by a change in taxation levels.

What is the aggregate demand curve most similar to?

The demand curve for a firm

What is the equation for the aggregate supply curve in the short run?

The equation for the aggregate supply curve in the short run is Y = Ynatural + a(P - Pexpected).

Which direction does the LM curve slope?

Upward

when the short-run aggregate supply curve shifts, (rarer)

a short- run equilibrium exists where the short-run aggregate supply curve intersects the aggregate demand curve. then.. Then the aggregate demand curve shifts along the short-run aggregate supply curve until the aggregate demand curve intersects both the short-run and the long-run aggregate supply curves. Once the economy reaches this new long-run equilibrium, the price level is changed but output is not.

stagflation occurs when

during an adverse supply shock. a short run equilibrium stage where the AD curve shifts left due to higher prices and lower output, and the short run AS curve shits up and left. higher prices and lower output.

all in all... what is the AD curve trying to reach

in time of expansionary policy, the AD curve is trying to shift to the potential GDP line where the AS curve meets the AD curve creating equilibrium. so in times on expansion, the AD curve will shift to the right, and in times of contractionary policy, the AD curve will shift to the left. The point where the long-run aggregate supply curve and the aggregate demand curve meet is always the long-run equilibrium

The long-run equilibrium is always dictated by***

is always dictated by the intersection of the vertical long-run aggregate supply curve and the aggregate demand curve.

contractionary fiscal policy

is implemented when there is demand-pull inflation. It can also be used to pay off unwanted debt. In pursuing contractionary fiscal policy the government can decrease its spending, raise taxes, or pursue a combination of the two. Contractionary fiscal policy shifts the AD curve to the left. If tax revenues exceed government spending, this type of policy will lead to a budget surplus.

Define Short-Run Aggregate Supply

relationship between the quantity of real GDP supplied and the price level when the money wage rate, the prices of other resources, and potential GDP remain constant.

There are four basic explanatory models

sticky-wage model, the worker- misperception model, the imperfect-information model, and the sticky-price model

deriving aggregate supply

the aggregate demand curve alone does not tell us the equilibrium price level or the equilibrium level of output. In order to obtain this information, we need to add the aggregate supply curve to the diagram containing the aggregate demand curve. Then, and only then, do the equilibrium values of the economy in the AS-AD model appear.

When the aggregate demand curve shifts

the economy always shifts from the long-run equilibrium to the short-run equilibrium and then back to a new long-run equilibrium

When the short-run aggregate supply curve shifts... **** SUPPLY SHOCK

the economy always shifts from the long-run equilibrium to the short-run equilibrium and then back to a new long-run equilibrium

how to close a recessionary gap

the government can also close recessionary gaps by decreasing income taxes, which increases aggregate demand and real GDP, which in turn increases prices.

how to close and expansionary gap

the government would increase income taxes, which decreases aggregate demand, the real GDP, and then prices.

The short-run equilibrium is always dictated by

the intersection of the short-run aggregate supply curve and the aggregate demand curve.

The short-run equilibrium is always dictated by***

the intersection of the short-run aggregate supply curve and the aggregate demand curve.

long-run equilibrium is always dictated by

the intersection of the vertical long run aggregate supply curve and the aggregate demand curve. WHERE ALL 3 CURVES MEET

what does the AS curve show?

the relationship between the price level and the quantity of goods and services supplied in an economy.

Define quantity of real GDP demanded

the total amount of final goods and services produced in the U.S. that people and businesses plan to buy

aggregate demand

the total demand for goods and services within a particular market. "it is generally assumed that increases in credit stimulate aggregate demand"

aggregate supply

the total supply of goods and services available to a particular market from producers. "the aim of the tax changes is to stimulate the supply side of the economy and therefore boost aggregate supply." Total supply of goods and services that firms plan to sell in a given time period

Define Quantity of Real GDP supplied

total quantity of goods and services valued in constant base year dollars, that firms plan to produce in a given time period

Monetarist theory

view view that the market economy works well, that aggregate fluctuations are the natural consequence of an expanding economy, but that fluctuations in the quantity of money generate the business cycle

short run equilibrium

when the demand curve shifts to the right and meets the second short run AS curve

macroeconomic equilibrium occurs when?

when the quantity of real GDP demanded equals the quantity of real GDP supplied at the point of intersection of the AD curve and the AS curve. 1. A full-employment equilibrium occurs when equilibrium real GDP equals potential GDP.

reasons for aggregate demand's downward slope:

1. Pigou's wealth effect, 2. Keyne's interest-rate effect, and 3. Mundell-Fleming's exchange-rateeffect.

Which of the following types of economic activity are not represented in aggregate demand?

Aid from foreigners Aid to foreigners Government transfers Consumption spending answ. aid from foreigners

Define the Long-Run Aggregate Supply

Amount of GDP supplied at full employment given a fixed level of capital and technology. LRAS isn't affected by the price level

assumptions of the short run growth theories?

An assumption of Monetarist business cycle theory is that wages are temp. sticky in both directions

supply shock

An event that suddenly changes the price of a commodity or service. It may be caused by a sudden increase or decrease in the supply of a particular good.

what does the equation for the aggregate supply curve mean?

Basically, this equation means that output deviates from the natural rate of output when the price level deviates from the expected price level.

Why is the IS curve downward sloping?

Because as the interest rate falls, investment increases, thus increasing output

Why is the LM curve upward sloping?

Because higher income leads to higher money demand which leads to higher interest rates

Which of the following would not be considered consumption under aggregate demand?

Books Movie tickets New houses Food Answr. New houses

The term C(Y - T) means that consumption is dependant upon what?

Disposable income

Which direction does the IS curve slope?

Downward

What is the general slope of the aggregate demand curve?

Downwards

Which of the following would not be considered investment under aggregate demand?

Education Machinery Factories Used housing Answr. used housing

What information can be obtained from the AS-AD model of the economy?

Equilibrium in the domestic market for goods and services

give two examples of adverse supply shock

Examples of adverse supply shocks are increases in oil prices, higher union pressures, and a drought that destroys crops. Basically, anything that drastically and immediately increases the cost of output is considered an adverse supply shock.

Give three examples of events that will shift the aggregate demand curve to the left?

Examples of events that will shift the aggregate demand curve to the left include exogenous decreases in consumption, investment, and net exports, an increase in the savings rate, a decrease in the marginal propensity to consume, an increase in the interest rate, and an increase in the real exchange rate.

Give three examples of events that will shift the aggregate demand curve to the right?

Examples of events that will shift the aggregate demand curve to the right include exogenous increases in consumption, investment, and net exports, a decrease in the savings rate, an increase in the marginal propensity to consume, a decrease in the interest rate, and a decrease in the real exchange rate.

Give two examples of positive supply shocks

Examples of positive supply shocks are decreases in oil prices, lower union pressures, and a great crop season. Basically, anything that drastically and immediately decreases the cost of output is considered a positive supply shock

When consumers feel or become wealthier, what is the effect on consumption spending?

It increases consumption spending

What is the effect of a decrease in the price level on wealth?

It increases wealth

When disposable income falls, what happens to the aggregate demand curve?

It shifts left

When happens to the aggregate demand curve when the savings rate increases?

It shifts left

What happens to the aggregate demand curve when government spending increases?

It shifts right

What happens to the aggregate demand curve when the marginal propensity to consume increases?

It shifts right

SHORT Run Growth theories:

Keynesian & Monetarist.

When the price level is high, what is aggregate demand?

Low

Which of the aggregate demand models is based on consumption spending?

Pigou model

Explain the basics of the IS-LM model.

The IS curve describes equilibrium in the market for goods and services in terms of r and Y. The IS curve is downward sloping because as the interest rate falls, investment increases, thus increasing output. The LM curve describes equilibrium in the market for money. The LM curve is upward sloping because higher income results in higher demand for money, thus resulting in higher interest rates. The intersection of the IS curve with the LM curve shows the equilibrium interest rate and price level.

How does the Keynes model explain the downward sloping aggregate demand curve?

The Keynes model states that a drop in the price level decreases the interest rate, which increases the demand for investment and thereby increases aggregate demand.

How does the Mundell-Fleming model explain the downward sloping aggregate demand curve?

The Mundell-Fleming model states that a drop in the price level decreases the interest rate, which increases the demand for investment and thereby increases aggregate demand.

How does the Pigou model explain the downward sloping aggregate demand curve?

The Pigou model states that a drop in the price level induces consumers to spend more thereby increasing the aggregate demand.

Explain the chain of events that causes the aggregate demand curve to be upward sloping according to the sticky-wage model.

The chain of events that leads from an increase in the price level to an increase in output in the sticky-wage model: when the price level rises, real wages fall; when real wages fall, labor becomes cheaper; when labor becomes cheaper, firms hire more labor; when firms hire more labor, output increases.

According to the aggregate demand curve, what is the effect on output or income of a drop in the price level?

The aggregate demand curve shows that a drop in the price level creates a drop in output or income.

What are two uses for the aggregate demand curve?

The aggregate demand curve tells how the price level and output and income are related. It shows the general effects of changes in many economic variables on the relationship between price level and output and income.

What relationship does the aggregate supply curve show?

The aggregate supply curve shows the relationship between the price level and the quantity of goods and services supplied in an economy.

Explain the chain of events that causes the aggregate demand curve to be upward sloping according to the imperfect- information model.

The chain of events that leads from an increase in the price level to an increase in output in the imperfect-information model: when the overall price level rises, producers mistake it for a relative increase in the price level. When the relative price level rises, the real wage earned by producers rises. When the real wage earned by producers rises, the amount of labor supplied by producers increases. When the amount of labor supplied by producers increases, output increases.

What does each of the terms mean in the equation for the short-term aggregate supply curve and what does the equation mean overall?

The equation for the short run aggregate supply curve, is Y = Ynatural + a(P - Pexpected). In this equation, Y is output, Ynatural is the natural rate of output that exists when all productive factors are used at their normal rates, a is a constant greater than zero, P is the price level, and Pexpected is the expected price level. This equation means that output deviates from the natural rate of output when the price level deviates from the expected price level.

the imperfect-information model

The imperfect-information model of the upward sloping short- run aggregate supply curve is again based on the labor market. In this model, unlike either the sticky-wage model or the worker-misperception model, neither the worker nor the firm has complete information. That is, neither is better informed than the other is about the real wage, the nominal wage, or the price level. In this model, producers are considered to be really only aware of the price of the goods and services that they produce. That is, producers are unable to recognize overall increases in the price level because they are focused on their products only. Instead, producers only recognize changes in the prices of the goods and services that they produce. Given that producers are unable to recognize changes in the overall price level, they are likely to confuse changes in the goods and services they produce (relative changes in the price level) with changes in the overall price level (absolute changes in the price level). Recall that producers are willing to provide more labor when the wage is high. That is, they will work harder when they are getting paid more for their work. Also recall that producers cannot differentiate between relative changes in the price level and absolute changes in the price level. Thus, when a producer sees a change in the price level, she will likely believe that it is a relative change in the price level, even if it is an absolute change in the price level. Because of this, the producer will work more and produce more output when the price level rises. Thus, an increase in the price level causes output to rise. Let's summarize the chain of events that leads from an increase in the price level to an increase in output in the imperfect-information model. When the overall price level rises, producers mistake it for a relative increase in the price level. When the relative price level rises, the real wage earned by producers rises. When the real wage earned by producers rises, the amount of labor supplied by producers increases. When the amount of labor supplied by producers increases, output increases

Give one reason for why the long-term aggregate supply curve is vertical and four models for why the short-term aggregate supply curve is upward sloping.

The long run aggregate supply curve is vertical because output in the long run is fixed by the factors of production, namely capital and labor. Four models for why the short run aggregate supply curve is upward sloping are the sticky-wage model, the worker-misperception model, the imperfect-information model, and the sticky-price model.

What does the real exchange rate represent?

The rate at which the goods from one country can be traded for the goods of another country

Which market does the IS curve reflect?

The market for goods and services

Which market does the LM curve reflect?

The money market

shifts in aggregate demand in the AS-DS model

The point where the short-run aggregate supply curve and the aggregate demand curve meet is always the short-run equilibrium. It is helpful to keep in mind that aggregate demand for an economy is divided into four components: consumption, investment, government spending, and net exports. Changes in any of these components will cause the aggregate demand curve to shift. in expansionary policy... the AD shifts to the right in contractionary policy...the AD shifts to the left

Which of the following is not related to the interest rate?

The price of output The price of consumption The price of loans The price of investment The price of output

What does aggregate demand express?

The quantity of goods and services demanded in an economy

Keyne's interest-rate effect

The second reason for the downward slope of the aggregate demand curve is Keynes's interest-rate effect. Recall that the quantity of money demanded is dependent upon the price level. That is, a high price level means that it takes a relatively large amount of currency to make purchases. Thus, consumers demand large quantities of currency when the price level is high. When the price level is low, consumers demand a relatively small amount of currency because it takes a relatively small amount of currency to make purchases. Thus, consumers keep larger amounts of currency in the bank. As the amount of currency in banks increases, the supply of loans increases. As the supply of loans increases, the cost of loans--that is, the interest rate--decreases. Thus, a low price level induces consumers to save, which in turn drives down the interest rate. A low interest rate increases the demand for investment as the cost of investment falls with the interest rate. Thus, a drop in the price level decreases the interest rate, which increases the demand for investment and thereby increases aggregate demand.

What is the slope of both the short run aggregate supply curve and of the long run aggregate supply curve?

The slope of the short-term aggregate supply curve is (1/a); the long-term aggregate supply curve is vertical and therefore has no slope.

the sticky-price model

The sticky-price model of the upward sloping short-run aggregate supply curve is based on the idea that firms do not adjust their price instantly to changes in the economy. There are numerous reasons for this. First, many prices, like wages, are set in relatively long-term contracts. Imagine if your wage at McDonalds changed every day as the economy changed. Second, firms hold prices stable to keep from annoying regular customers. It would really be a pain if the price of a newspaper changes from 24 cents to 25 cents to 23 cents as the price of paper and ink changed. Third, firms hold prices stable because of menu costs. Menu costs are those costs that are associated with printed catalogues and menus. It would be very expensive to constantly change catalogues and menus in response to economic changes. But how does the fact the prices are sticky in the short run lead to an upward sloping relationship between the price level and output? When firms prepare to set their prices, they take into account the expected price level. When the expected price level is high, firms set their prices high to compensate for the high price of inputs. When the price charged for output is high firms produce more output, as the incentive for production is also high. Thus, an increase in the price level leads rather directly to an increase in output in the sticky-price model. There is another way to conceptualize the relationship between the price level and output in the sticky-price model. When the level of output is high, the demand for goods and services is also high. Thus, when firms set their sticky- prices, they set them high to account for the high demand. When firms set their prices high, the overall price level increases. Thus, a high level of output leads to a high level of demand, which leads to a high price level. Let's summarize the two chains of events that characterize the relationship between the price level and output in the sticky-price model. First, when firms expect a high price level they set their relatively sticky prices high. Other firms follow suit and set their prices high as well. Thus, a high expected price level leads to a high actual price level. When the expected price level is high, producers produce more output. Second, when the level of output is high, the demand for goods and services is also high. When the demand for goods and services is high, the price charged for goods and services is also high. When the price charged for goods and services is high, firms set their relatively sticky prices high. When some firms set their relatively sticky prices high, other firms follow suit. Thus, the overall price level increases.

sticky-wage model

The sticky-wage model of the upward sloping short run aggregate supply curve is based on the labor market. In many industries, short run wages are set by contracts. That is, workers are paid based on relatively permanent pay schedules that are decided upon by management or unions or both. When the economy changes, the wage the workers receive cannot adjust immediately. Given that wages are sticky, the chain of events leading from an increase in the price level to an increase in output is fairly straightforward. When the price level rises, the nominal wage remains fixed because this is solely based on the dollar amount of the wage. The real wage, on the other hand, falls because this is based on the purchasing power of the wage. A higher price level means that a given wage is able to purchase fewer goods and services. Let's summarize the chain of events that leads from an increase in the price level to an increase in output in the sticky-wage model. When the price level rises, real wages fall. When real wages fall, labor becomes cheaper. When labor becomes cheaper, firms hire more labor. When firms hire more labor, output increases.

Mundell-Fleming's exchange-rate effect

The third reason for the downward slope of the aggregate demand curve is Mundell-Fleming's exchange-rate effect. Recall that as the price level falls the interest rate also tends to fall. When the domestic interest rate is low relative to interest rates available in foreign countries, domestic investors tend to invest in foreign countries where return on investments is higher. As domestic currency flows to foreign countries, the real exchange rate decreases because the international supply of dollars increases. A decrease in the real exchange rate has the effect of increasing net exports because domestic goods and services are relatively cheaper. Finally, an increase in net exports increases aggregate demand, as net exports is a component of aggregate demand. Thus, as the price level drops, interest rates fall, domestic investment in foreign countries increases, the real exchange rate depreciates, net exports increases, and aggregate demand increases.

Keynesian theory

The view that the market economy is inherently unstable and needs active government intervention to achieve full employment and sustained economic growth.

What are the four major models of aggregate supply?

There are four major models that explain why the short-run aggregate supply curve slopes upward. The first is the sticky-wage model. The second is the worker-misperception model. The third is the imperfect-information model. The fourth is the sticky-price model.

What is the effect of a shift in the aggregate demand curve to the left?

When the aggregate demand curve shifts to the left, the total quantity of goods and services demanded in an economy decreases as the price level increases.

What is the effect of a shift in the aggregate demand curve to the right?

When the aggregate demand curve shifts to the right, the total quantity of goods and services demanded in an economy increases as the price level decreases.

expansionary vs. contractionary fiscal policy

When the economy is producing less than potential output, expansionary fiscal policy can be used to employ idle resources and boost output.

overview of ASC

While each of these four models of the upward sloping short run aggregate supply curve is useful, it is the combination of all four that provides the most realistic picture of aggregate supply. The conclusion drawn from these models is that, in the short run, the aggregate supply curve is upward sloping. Again, this relationship is represented by Y = Ynatural + a(P - Pexpected), where Y is output, Ynatural is the natural rate of output that exists when all productive factors are used at their normal rates, a is a constant greater than zero, P is the price level, and Pexpected is the expected price level.

What is the general equation for aggregate demand?

Y = C(Y - T) + I(r) + G + NX(e)

equation for ASC in the short run

Y = Ynatural + a(P - Pexpected) In this equation, Y is output, Ynatural is the natural rate of output that exists when all productive factors are used at their normal rates, a is a constant greater than zero, P is the price level, and Pexpected is the expected price level. This equation holds only in the short run because in the long run the aggregate supply curve is a vertical line, as output is dictated by the factors of production alone.

what are the two types of supply shock?

adverse supply shocks ( increase in oil prices, a drough that destroys crops, and aggressice union actions) this causes the price level for a given amount of output to increase which is represented by a shift of the short run aggregate supply curve to the left positive supply shock include things like a decrease in oil prices or an unexpected great crop season. so, In general, positive supply shocks cause the price level for a given amount of output to decrease. This is represented by a shift of the short-run aggregate supply curve to the right.

the worker- misperception model

also based on the labor market. This time, unlike in the sticky-wage model, wages are free to move as the economy changes. The amount of work that an employee is willing to supply is based on the expected real wage. That is, workers know how many dollars they are being paid, the nominal wage, but workers can only guess at how much goods and services they can purchase with this wage, the real wage. In general, the higher the real wage, the more work that workers are willing to supply. Let's summarize the chain of events that leads from an increase in the price level to an increase in output in the worker-misperception model. When the price level rises, firms increase nominal wages. When nominal wages increase, workers--due to misperceptions--believe that real wages also increase. When workers believe that real wages increase, workers provide more labor. When workers provide more labor, output increases.

what are sticky wages?

an economic hypothesis theorizing that the pay of employed workers tends to have a slow response to the changes in the performance of a company or of the broader economy.

IS-LM model of aggregate demand

another useful way to explain the aggregate demand curve. This model is called the IS-LM model after the two curves that are involved in the model. The IS curve describes equilibrium in the market for goods and services where Y = C(Y - T) + I(r) + G and the LM curve describes equilibrium in the money market where M/P = L(r,Y). The IS-LM model exists in a plane with r, the interest rate, on the vertical axis and Y, being both income and output, on the horizontal axis. The IS-LM model has the same horizontal axis as the aggregate demand curve, but a different vertical axis. The IS curve describes equilibrium in the market for goods and services in terms of r and Y. The IS curve is downward sloping because as the interest rate falls, investment increases, thus increasing output. The LM curve describes equilibrium in the market for money. The LM curve is upward sloping because higher income results in higher demand for money, thus resulting in higher interest rates. The intersection of the IS curve with the LM curve shows the equilibrium interest rate and price level.

contractionary policy causes what?

causes output and the price level to decrease in the short run, but on the price level to decrease in the long run

GDP

gross domestic product. best way to measure a country's economy

Shifts in the Aggregate Demand Curve

http://www.sparknotes.com/economics/macro/aggregatedemand/section3.rhtml

Keynesian economics

if the economy is producing less than potential output, government spending can be used to employ idle resources and boost output. Increased government spending will result in increased aggregate demand, which then increases the real GDP, resulting in an rise in prices. This is known as expansionary fiscal policy. Conversely, in times of economic expansion, the government can adopt a contractionary policy, decreasing spending, which decreases aggregate demand and the real GDP, resulting in a decrease in prices. extra spending allows businesses to hire more people and pay them, which in turn allows a further increase in spending, and so on in a virtuous circle.

expansionary fiscal policy

is used to kick-start the economy during a recession. It boosts aggregate demand, which in turn increases output and employment in the economy. In pursuing expansionary policy, the government increases spending, reduces taxes, or does a combination of the two. Since government spending is one of the components of aggregate demand, an increase in government spending will shift the demand curve to the right. A reduction in taxes will leave more disposable income and cause consumption and savings to increase, also shifting the aggregate demand curve to the right. An increase in government spending combined with a reduction in taxes will, unsurprisingly, also shift the AD curve to the right. The extent of the shift in the AD curve due to government spending depends on the size of the spending multiplier, while the shift in the AD curve in response to tax cuts depends on the size of the tax multiplier. If government spending exceeds tax revenues, expansionary policy will lead to a budget deficit.

nature of a ASC graph.

long run aggregate supply is vertical short run aggregate supply is upward sloping

expansionary policy causes what?

output and the price level to increase in the short run, but only the price level to increase in the long run.

an adverse supply shock causes

output to decrease and the price level to increase in the short run, but only the price level to increase in the long run.